Monday, May 30, 2005

Signs of the Economic Apocalypse 5-30-05

From Signs of the Times 5-30-05:

The euro closed at 1.2542 dollars on Friday, down 0.17% from last week's 1.2563 dollars, with traders reacting in advance to France's rejection of the proposed EU constitution. That put the dollar at .7973 euros compared to .7960 the previous Friday. In U.S. stock markets, the Dow Jones Industrial Average closed at 10,542.55 on Friday, up 0.67% from 10,471.91 a week earlier. The NASDAQ closed at 2075.73 up 1.4% from 2,046.42 the week before. The yield on the ten-year U.S. Treasury bond was 4.07% at Friday's close, down five basis points from 4.12 the previous Friday, continuing a trend of falling long-term interest rates recently in the United States at a time when short-term rates are rising. Gold closed at $422.70 an ounce up 1.2% from 417.60 on the previous Friday. Gold in euros would be 337.03 euros an ounce, up 1.4% from 332.40 a week earlier. Oil closed at 51.85 dollars a barrel, up sharply (9.2%) from last week's $47.50. In euros, a barrel of oil would cost 41.34 euros, up 9.3% from 37.81 at the previous week's close. An ounce of gold would buy 8.15 barrels of oil down 7.9% compared to 8.79 on the previous Friday.

The vote on Sunday the 29th in France to reject the proposed EU constitution, which polls had predicted during the past week, led to some continuing weakness in the euro and to some soul-searching in Europe.

Euro Drops Versus Dollar, Yen; France Rejects EU Constitution

May 30 (Bloomberg) -- The euro fell against the dollar and yen in Asia after France rejected the European Union constitution in a referendum, hindering integration of the region's economies.

The legislation was aimed at streamlining decision-making after the EU's expansion last year to 25 members from 15. The euro has dropped 2.8 percent this month as opinion polls showed ebbing support for the constitution and reports indicated the region's economy is struggling to grow.

"This is pretty bad news," said Luke Waddington, head of currency trading in Tokyo at Royal Bank of Scotland Group Plc. "It's quite straight-forward: sell the euro. It's going to go lower."

Against the dollar, the euro fell to $1.2540 as of 10:27 a.m. in Tokyo, from $1.2584 late on May 27 in New York, according to electronic currency-dealing system EBS. The currency was headed for its worst decline in four months against the dollar. It also fell to 135.33 yen from 135.82.

Waddington, who came in at 4 a.m. to monitor the results, said the euro may fall below $1.25 today.

Fifty-five percent of French voters cast their ballots against the constitution compared with 45 percent in favor, the Interior Ministry said.

The French "no" vote means "we're entering a period of high uncertainty, and investors don't like uncertainty," French Finance Minister Thierry Breton said on France 2 television.

Declines in the euro may be limited because many investors probably sold the currency in the weeks before the vote as opinion polls suggested a rejection of the treaty, said John Horner, a currency strategist at Deutsche Bank AG in Sydney.

"Widely Expected"

"It was widely expected we'd get a result like this," Horner said. "It's pretty closed to priced in. The euro may fall to about $1.2450 and that would pretty much do it."

...The French referendum result kills the EU constitution and may cast doubt on closer ties with members of the bloc that haven't adopted the euro, and set back plans by countries including Turkey and Croatia to join.

"A Problem"

Rejection by France, one of the EU's founding members, gives investors already disappointed by the region's faltering economy one more reason to sell the euro, said Guy Stern, who oversees $17.8 billion in assets as chief investment officer of Credit Suisse Asset Management's German business in Frankfurt. The currency is down 8 percent from a record $1.3666 on Dec. 30.

"We will have a problem with the euro," Stern said. "It could depreciate 5 percent to 10 percent."

The poor growth numbers for the euro-zone countries has even led to some questioning as to whether the euro is a good thing for Europe or not. The OECD (Organization for Economic Cooperation and Development) released its semi-annual report last week, pointing to the slow growth in Europe and to the massive deficits in the United States as contributors to a possible "doomsday." Here's Nick Beams:

A summary of the report presented by OECD chief economist Jean-Philippe Cotis made clear that the continued lack of growth in Europe is causing increased concern. "The smooth scenario where the recovery was expected to spread more evenly across the OECD has not materialised. While some elements of this scenario, such as a relatively successful 'soft landing' in the United States and a rebound of activity in Japan may be in place, what is badly lacking is sustained momentum in the euro zone."

Cotis said that "circumstantial arguments" used to explain the lack of growth in Europe, such as the Iraq war, oil and commodity price shocks as well as currency fluctuations, were "not sufficient to explain the string of aborted recoveries in Europe."

..."These continuing divergences in domestic demand between Europe and some Asian countries on the one hand, and the United States on the other, cannot be treated with benign neglect," he said. Given the unsustainable US current account position, the pressure to correct the imbalances would grow, possibly taking the form of "an abrupt weakening of the dollar with adverse consequences for the OECD area as a whole."

Cotis told the Financial Times (FT): "Were not saying there will be doomsday tomorrow morning ... but because the adjustments (to global imbalances) are relatively slow, we are running the risk an accident will happen. That's where we are. Time is running out. The numbers are getting big, big, big."

What might be causing lack of growth in Europe?

For some years the prevailing mantra has been that Europe must undergo "structural reforms" - the adoption of "free market" measures, cuts in social welfare and a more "flexible" workforce - in order to boost growth. But, according to a member of the European Central Bank (ECB), these measures do not seem to be working.

Erkki Liikanen, governor of the Bank of Finland, told the Financial Times this week that reforms that allowed for increased competition had not overcome poor economic performance. The issue had been discussed in the ECB but "we don't have an answer. Perhaps the reforms first increase uncertainty." Liikanen said he was unsure whether the eurozone economy would pick up this year.

One reason for the sluggish domestic demand can be seen in the figures on real wages for the euro area prepared by the OECD. These show that, on average, real hourly rates across the region are falling at the rate of 1 percent, with the largest declines experienced in Italy and Germany. With falling wages putting a dampener on consumption demand, the OECD has called on the ECB to make a significant cut in interest rates, saying that in the context of low underlying inflation and weak aggregate demand, the case for an easing of monetary policy looked "rather compelling."

Could it be the euro itself that is hampering national economies in Europe? From Business Week:

Squeezed By The Euro

By Jack Ewing in Frankfurt, with Carol Matlack in Paris, Stanley Reed in London, Maureen Kline in Milan, Carlta Vitzthum in Madrid, and bureau reports

Fri May 27, 8:07 AM ET
Were the skeptics right? In early 1998, University of Bonn Professor Manfred J.M. Neumann mobilized 155 fellow economists to protest the coming introduction of the European common currency. The euro was dangerously premature, they argued in open letters published in major newspapers. Big countries such as Germany and France lacked the flexible labor markets they needed to compensate for losing control over monetary policy as a tool to promote growth. Needless to say, the protests had little effect. The euro blasted off on Jan. 1, 1999, as planned.

Six years later, Neumann's warning seems ominously prescient. Far from becoming a powerhouse to compete with the U.S. and Asia, Europe in the past four years has been nearly stagnant, with average annual growth in the euro zone of of 1.2% since 2002. Meanwhile, it's hard to overlook the superior economic performance of European Union members that stayed clear of the common currency. Britain and Sweden have enjoyed healthy expansions and lower unemployment. Britain's jobless rate is 4.7%, compared with 8.9% for the euro zone.

Even common currency champions such as European Central Bank President Jean-Claude Trichet see little chance of a euroland boom anytime soon. Just as Neumann predicted, overregulated labor markets in much of the euro zone prevent pay scales from reacting fast enough to competitive pressure from abroad. And individual countries can no longer compensate for these rigidities by devaluing their currencies to boost exports, usually through the swift downward movement of interest rates. "Unfortunately," says Professor Neumann ruefully, "we were right."

That raises a larger question: Was the euro a mistake? Not even euro-skeptics such as Neumann argue that the currency should be scrapped now that euro coins and notes have become a fact of life from Finland to Greece. "It would be insane to give up the euro. We have to make the most of it," Neumann says.

Impatience On The Rise

Still, the question hangs in the air, especially amid evidence of growing popular discontent over core Europe's dreadful economic performance. A dramatic expression of that discontent came on May 22 when German Chancellor Gerhard Schroder's Social Democratic Party [SPD] was booted from power in North Rhine-Westphalia, an economically battered industrial state that had been ruled by the party for four decades. Schroder, in what amounts to an admission that his tepid economic reforms have failed, has called for national elections in September, a year early. In addition, French and Dutch voters may reject the proposed European constitution in referendums May 29 and June 1. If so, the votes will surely be interpreted as protests against a European system that seems ever more powerful yet ever more unable to deliver jobs and prosperity. The euro is integral to that system.

Stagnation and political upheaval were obviously not part of the plan when the currency was launched six years ago. At the time, euro-optimism was running high. The idea was this: Before they could adopt the currency, countries like France, Germany, Italy, and others would rein in their budget deficits, and afterwards keep public spending in check to support monetary union. The existence of one currency, backed by fiscal discipline across the board, would then turn the half-fiction of a common market into reality. As Europe's various economies melded together into one, internal barriers to competition would tumble and the best-managed countries and companies would pull ahead. Countries that lagged would respond by loosening labor rules and cutting taxes to boost competitiveness. Like the Bundesbank, which had made Germany a beacon of monetary stability, the ECB would squash any hint of inflation with a rate hike. If countries wanted to grow, they would have to deregulate their economies and keep wage hikes in line with productivity.

Of course, for Business Week, it is the fault of Europeans for not being "flexible" enough, but Europeans are smart enough to know that "flexibility" usually means that the rich get richer and everyone else gets poorer and less secure. And, sure enough, the article calls for those countries in the euro-zone which are lagging in "reform" (neo-liberal, low-wage, low-benefit, low-social spending reform) to get with the program in order to save the euro.

ECB President Trichet was at pains to point out the euro's benefits to an Italian business audience recently. But in a sign of growing nervousness within the bank, he also warned political leaders to step up the pace of reform. "Many countries have not adapted their economic, social, and legal frameworks in order to face the new challenges," Trichet said.

Some governments have pulled off those changes, cutting taxes, rolling back job regulations, and eliminating barriers to competition. That's true of countries in the euro, like Ireland, and outside it, like Britain, Denmark, and Sweden, which focused on deep structural reforms after experiencing wrenching economic crises. Now, Germany may get a reformist government in September led by Christian Democrat Angela Merkel.

In past weeks we have looked at the problem of outsourcing in Europe as well as the neoliberal attack on European social democracy. Clearly, global capital wants to reduce social safety net spending in Europe and to reduce wages there as well. Both of these things (falling wages and the real probability of falling benefits) will tend to reduce consumer spending. The only reason they haven't in the United States is the insane level of consumer debt there. In Europe, in contrast to the United States, long, often-painful, national histories provide the antidote to the temptation to live in a rosy illusion (American exceptionalism, and optimism). Consumer capitalism thrives on illusion, however, so it will entice suckers into the hall of mirrors whenever it can, and we in the United States like our illusions. As the American Al Martin ( put it:

The Norwegians, unlike the British, have wisely subordinated all of their North Sea oil income for the first 30 years into a national trust fund, for the benefit of the Norwegian people.

Why can't we have that? Because we have Bushonomics. Norway is not plagued with Bushes. Norway is a Western European country; i.e., a country where citizens are more adroit, more educated, more aware of economics than Americans, and the fiscal practices practiced in the United States under Bushonian regimes would not be allowed. There is no other nation on earth that it would be allowed. It is only the naivete of the American people on all things economic which allows the fiscally destructive practice of Bushonomics to be maintained. Because the American people don't know the difference.

This then bespeaks of the growing schism between Washington and the rest of the planet.

Martin says that the rest of the world is starting to pull the plug on the United States economy:

T]he US Treasury Department announced on May 16 that foreign investments in U.S. securities fell from $84.1 billion in February 2005 to $45.7 billion in March 2005.

This is a monthly statistic known as "net foreign flow of funds." It did raise some eyebrows since the net foreign inflows into the United States by about half of the number of the previous month. The Street was looking for a number of about $70 billion. Another interesting thing about this number is that foreign accounts were net sellers of U.S. Treasury securities in April for the first time in 18 months.

... This is being accomplished the way that the South Korean central bank is doing it, which announced that they are actually allowing some of their 2-year U.S. Treasury notes to go into redemption without rolling them over.

In other words, the foreign central banks aren't actually selling U.S. Treasury securities outright. They are simply taking short term 2- and 3-year U.S. Treasury notes that they hold and simply not rolling them over. In essence, they are allowing them to go into redemption, as a way to withdraw funds from the United States.

As the South Korean bank, interestingly enough, points out, they were concerned about becoming direct sellers of U.S. Treasury instruments in a market which is increasingly uncertain. The South Korean bank was saying -- Who would be the potential buyers?

...However, if the central banks began selling, remember, this is what Paul O'Neill called 'The Bushonian Nightmare Scenario.' If the central banks begin selling, and they constitute 2/3 of the buyers, there is no market for them.

As former Treasury Secretary Paul O'Neill pointed out, the U.S. Treasury no longer has the ability to step into the markets, acting either on its own behalf or through the Federal Reserve, to purchase U.S. Treasury instruments on an emergency basis in order to stabilize the market. Why? Because the Bush Cheney regime has bled out from the U.S. Treasury and the Federal Reserve all of its operating surplus accounts as well as the Federal Reserve's $20 billion emergency currency stabilization account.

Yet the housing bubble continues in the United States, with "McMansions" going up everywhere you look. According to Business Week, this housing-driven boom is distorting the U.S. economy by sending spending to the lower-tech sectors.

The Cost of All Those McMansions

By Michael Mandel

It's like living in a parallel universe. Surprising most economists, mortgage rates have gone down in recent weeks rather than up. The housing market, instead of cooling, has stayed hot, with record sales of existing homes in April. And prices are up 15% over a year ago. Even Federal Reserve Chairman Alan Greenspan, who has regularly dismissed the possibility of a housing bubble, is worrying that current trends are "unsustainable."

But whether prices level out, crash, or even keep going up, the housing boom is already having pernicious economic effects. The real problem: the incredible amount of resources -- workers, materials, and money -- being sucked into home construction and renovation.

EVER UPWARD. Residential investment has become a black hole, absorbing a staggering 5.8% of gross domestic product. That's the highest level since the late 1940s and early '50s, when an entire generation of returning soldiers was setting up families and expanding into newly built suburbs. This time, Americans are building second homes and enlarging current ones at a record pace.

By comparison, the tech boom of the '90s was at worst a baby bubble. Starting in 1991, business investment in information technology and communications gear began a steady climb, going from 3.1% to a peak of 4.8% in 2000 before collapsing.

Without much fanfare, residential construction basically followed the same path in the 1990s. Starting at 3.4% of GDP in 1991, it rose to 4.6% in 2000. But rather than turn down, as tech did, spending on housing just kept climbing, fueled by low interest rates. Measured by the increase in its share of GDP, the housing boom so far is about 40% larger than the tech boom.

LOW-TECH. Is the housing boom a bubble? As Greenspan has said, it's hard to tell. But what's certain is that housing-driven growth, while creating jobs and lifting wealth, is also distorting the economy, benefiting low-tech commodity sectors rather than the high-tech industries at the heart of America's competitive strength.

New homes are built mainly out of materials, such as wood for the frame and floors, plasterboard for the walls, and fabricated metal parts for plumbing fixtures. High-tech equipment plays a very small role. Even when new homes include cable for broadband -- so-called structured wiring -- the high-tech component accounts for at most 1% or 2% of the entire cost of the home.

Calculations by BusinessWeek show that construction is among the least info-tech-intensive of all industries. In 2003, the latest data available, only 1.6 cents of every construction dollar was used for info-related products and services, such as computer gear, data-processing services, and telecom services. This includes both the tech-related products used in the building process and tech investment by construction companies. Most other industries -- including retailing, manufacturing, education, and health care -- are much heavier users of info tech.

Here again, we see the bourgeois, neo-liberal bias of Business Week in their unexamined assumptions. They seem to look down their noses at real substances ("New homes are built mainly out of materials..." no kidding! ). The problem is not where the money is going it's where it came from (debt). And the lack of investment in high-tech jobs (not companies) in the United States. The fact that the housing industry is not "high tech" is meaningless in this regard, since high-tech consumer spending goes towards electronics, which are not produced in the United States. The computer software industry, once a dominant strength of the United States, is offshoring its jobs as fast as it can to India. Construction trades cannot be offshored, someone has to come to your site and pound nails, connect wires and install the plumbing. And, not surprisingly, formerly rural townspeople in the exurbs (the far reaches of suburbia) have seen great increases in wealth during the housing boom of the last ten years (that, and the fact that most of the recipients of those jobs and that wealth were white male, small business owners provided a lot of votes for Bush in the last two elections). The class bias of the editors of Business Week is clear, the money should go to educated "innovators" not skilled craftspeople. After an economic crash, however, it may be the craftspeople who will have skills that still mean something.

Business Week concludes with this:

What happens when the housing boom finally slows? The share of GDP going into housing construction will fall sharply, hurting construction workers, architects, and homebuilders. Homeowners will no longer be able to draw on rising home equity. And what about Americans who borrowed heavily to buy properties for investment, expecting prices to keep climbing? Much like the companies who built miles of now-unused fiber-optic cable during the 1990s, they will be in deep trouble.

Yet even if there are temporary disruptions, the end of the housing boom may be good news for the overall economy. The U.S. doesn't need to drive growth with ornate new homes and elaborate kitchens with expensive marble counters. Instead, a shift away from housing could free up hundreds of billions of dollars for other, more productive investments.

That "deep trouble" will probably extend a lot farther than they are letting on in that article if the U.S. housing bubble pops. But articles like the one above do make it seem like they are setting the stage to pop the bubble soon. When the lumbering New York Times jumps on the bandwagon, the pop is well overdue. In contrast to Business Week, however, they do manage to understand the consequences:

Hear a Pop? Watch Out

NOW that even Alan Greenspan is talking about "froth" in real estate markets, how concerned should people be - not just about the value of their own homes, but about the entire country?

After all, we just had a big stock market bust and it barely dented the economy. Outside of brokers, speculators, and a few unlucky sellers, would a real estate crash really matter to the country as a whole?

In a word, yes. To understand why, first look at how pervasive the effects of real estate are throughout the economy.

Start with the so-called wealth effect. If people tend to spend more when their net worth increases, they'll spend less when it decreases. Economists use this rule of thumb: a $1 change in household wealth leads to a roughly 5-cent change in consumer spending. By that measure, a 10 percent decline in real estate prices would knock about half a percent off the gross domestic product.

Even more significant for the economy, though, would be a collapse in home equity lending. The industry has been booming as housing prices have soared. But if prices stop rising, new borrowing against home equity will drop, and may disappear.

That is important, because home equity lending amounted to more than $200 billion last year - or nearly 2 percent of the economy, according to, a research group based outside Philadelphia. If all that borrowing - which freed up cash that was spent on new furniture, appliances, vacations, cars and the like - simply vanished, the effect could be large enough all by itself to send the economy into recession.

But that's not all. The housing sector has even broader effects on the economy, by some estimates accounting for 25 percent of all activity. A decline in property values would most likely lead to declines in other industries, like construction, brokerage, banking and insurance. And these are important for future growth. Construction, for example, amounts to 4 percent to 5 percent of the economy, according to the Bureau of Economic Analysis.

Then there's banking. Because of the leverage associated with real estate, a fall in values would affect banks and other lenders. It would probably lead to tightened credit standards, less lending and higher interest rates. If lenders begin to suffer steep losses, there is always the danger of financial contagion, in which problems at one institution ripple out to others it does business with.

And there's a new wild card for the economy. In 2004, adjustable-rate mortgages made up a third of new mortgage originations. No one knows what the effect of the widespread use of A.R.M.'s would be in a down market. A climb in interest rates, of course, would put downward pressure on real estate prices, but A.R.M. borrowers would feel the pinch rapidly. If those borrowers started to default, lenders would be hurt.

Adding it all up, it's easy to see how a drop in real estate prices would spell trouble for the economy. To put that in perspective, the International Monetary Fund conducted a detailed study in 2003 that assessed the potential economic impact of a property slump. Reviewing the experience in the United States and 13 other industrialized countries, the I.M.F. found that a real estate bust is far more dangerous to the economy than a stock market bust.

Monday, May 23, 2005

Signs of the Economic Apocalypse 5-23-05

From Signs of the Times 5-23-05:

U.S. Stocks rose fairly sharply last week. The Dow closed at 10,471.91 on Friday, up 3.3% compared to the previous Friday's close of 10,140.12. The NASDAQ closed at 2,046.42, up 3.5% from the 1976.80 close from a week earlier. The yield on the ten-year U.S. Treasury bond fell one basis point to 4.12% on Friday the 20th from it's 4.12% close the previous Friday. The dollar closed at .7960 euros on Friday up 0.3% from .7933 euros a week earlier. That put the euro at 1.2563 dollars compared to 1.2606 the previous Friday. Oil closed at $47.50 a barrel on Friday, down again (2.5%) from $48.67. That represents a drop of 7.3% for the past two weeks. Comparing oil to euros, the price of oil converted to euros was 37.81 per barrel on Friday, down 2.1% from the previous Friday's 38.61. Gold closed at $417.60 an ounce, down 0.7% from the previous week's $420.60. In euros, gold closed at 332.40 euros an ounce, down 0.38% from last Friday's 333.66. At Friday's close an ounce of gold would buy 8.79 barrels of oil compared to 8.64 a week earlier, a decrease in the price of oil in gold terms of 1.8%.

It made for a strange contrast this past week, with the United States economy appearing stronger against the background of some disturbing stories from the United States' wars in southwest Asia and in that country's domestic politics. In fact, the Christian Science Monitor ran a story on Thursday that seems to encapsulate the subtle mix of scary facts, clever distortions and reassuring talk that we in the United States have been receiving from our media on both military and economic matters:

The rising economic cost of the Iraq war

By Peter Grier, Staff writer of The Christian Science Monitor
Thu May 19, 4:00 AM ET

Fighting in Iraq has been prolonged and remains intense enough that it has pushed the total cost of US military operations since Sept. 11, 2001, close to that of the Korean War.

Despite the yawning federal deficit, Congress hasn't blinked at this price. And while annual defense spending is now as high as it ever was during the Reagan buildup, the US economy as a whole is much larger, making it easier, in economic terms, for the nation to shoulder the bill.

Yet the costs for Pentagon operations are likely to pile up in years ahead. By 2010, war expenses might total $600 billion, according to the Congressional Budget Office. Much depends on when - and how many - US military personnel can be withdrawn from the Iraqi theater of operations.

"We can't be any more certain about the trend of the defense budget than we can be about the number of troops that will be deployed overseas," says Steven Kosiak, director of budget studies for the Center for Strategic and Budgetary Assessments.

The demands and unpredictability of war have, in essence, turned the defense budget into a two-part allocation. First is the regular budget request, which contains acquisition and research and development funds as well as personnel and operations costs, and which Congress considers in its normal appropriations process. Second is the supplemental appropriations - the add-on emergency spending requested by the administration later in the year.

Here the normally left-of–center Monitor is parroting the Republican party line, that the reason they don't write the costs of the Iraq and Afghanistan wars into the defense appropriation bill is that they don't know how much it will cost. That is clearly nonsense since at the time the bill is being written, "unnamed sources" tell us how much the next supplemental appropriation will be for. What is really happening, is that the Bush administration is reluctant to put the full amount the wars are costing into the main appropriation bill so as not to reduce support for either the wars or for their tax cuts for the rich.

Congress gave final passage to a 2005 supplemental defense bill just last week. Of the $82 billion contained in the bill, all but $76 billion will pay for Defense Department operations costs. The cost of the US military in Iraq is running about $5 billion a month, estimated the former Pentagon comptroller earlier this year.

Fighting in Iraq "is lasting longer, and is more intense, and the cost to keep troops in the theater of operations is proving to be much greater than anyone anticipated," wrote Rep. John Spratt (news, bio, voting record) (D) of South Carolina, ranking minority member of the House Budget Committee, in a recent Democratic report on war costs.

Speak for yourself, Rep. Spratt! SOME people anticipated just this sort of Vietnam-style quagmire.

Overall, Congress has approved about $192 billion for the Iraq war itself, according to an analysis by the Congressional Research Service. Another $58 billion has been allocated for Afghanistan, and some $20 billion has gone for enhanced air security and other Pentagon preparedness measures in the US.

That totals $270 billion for all military operations since 2001, according to the CRS analysis. The cost of war in Iraq by itself has already far exceeded the $85 billion inflation-adjusted price tag of the 1991 Gulf War, notes Mr. Kosiak. Plus, that war was largely paid for by contributions from US allies.

As for all military operations combined, add in the $50 billion in war spending the Senate Armed Services Committee last week added to the fiscal 2006 defense budget bill, and the total will surpass $320 billion in US funds. "That's close to the Korean war level of $350 billion [in today's dollars]," says Kosiak.

Unsurprisingly, operations and maintenance constitute the single largest extra expense of the Iraq war. Almost half of the just-passed emergency spending bill's defense funds went for ground operations, flying hours, fuel, and travel.

Iraq fighting has been particularly grinding, noted Secretary of Defense Donald Rumsfeld at a Senate budget hearing in February. On average, combat vehicles are experiencing four and a half years of peacetime wear in one year.

"A bradley fighting vehicle that usually runs about 800 miles a year - that's in peacetime training - now sometimes is being driven in the range of 4,000 miles in Iraq," said Secretary Rumsfeld.

About half of the remaining emergency defense funds was devoted to personnel. This means not basic pay but incremental costs: the extra money paid reserve troops when they are called to active duty, for instance, as well as hazard pay and other special compensation.

The rest went largely to weapons procurement, such as replacement of six National Guard UH-60 helicopters lost in Iraqi and Afghan operations.

More spending on the war is sure to come - even if the US begins to draw down troops levels. While it is difficult to estimate precisely, it is sure to be in the hundreds of billions, experts say. The Congressional Research Service pegs the cost of US operations in Iraq and Afghanistan at an additional $458 billion through 2014.

This is hardly cheap, but given the overall size of the US economy, and the levels of defense spending maintained during the cold war, it is well within the bounds of recent experience, according to Center for Strategic and International Studies military expert Anthony Cordesman.

Total defense spending in 2006 will probably be around 4 percent of gross national
product, notes Mr. Cordesman. The average since 1992 for this measure has been 3.6 percent.

"When it does come to economic and federal 'overstretch,' defense is unlikely to be the cause," Cordesman argues in a recent report.

One of the reasons that apologists for the war such as Cordesman can be so reassuring about the United States' economy to handle the war, is the fact that much of the money spent on the war went to fatten the balance sheets of the Halliburtons, Lockheed-Martins and the shadowy "private security companies" (mercenaries) of the world. Note also how much was spent on "incremental personnel costs," much of it in the form of inducements for people to enlist or reenlist, not to mention death benefits for surviving families and medical costs for the large number of injured soldiers. That money certainly is a short-term stimulus for the domestic consumer economy. Such wars, however, only act as a stimulus to the economy of the perpetrator if they are short and successful, and this war will be neither.

Clearly, however, something is keeping the U.S. economy afloat. It appears to be those countries who have increased holdings of U.S. government debt lately, i.e., those most dependent politically on the success of the United States. First on the list of holders of U.S. Treasury debt is Japan who is far ahead of anyone else at nearly $700 billion followed by China at roughly $200 billion. Next comes the Caribbean offshore banking havens for the people who own the world (politicians, financiers, ruling-class wealthy, corporations, organized criminals, etc.). These entities combine for holdings in the $100 billion range. Then comes Tony Blair's United Kingdom, also in the 100s. It drops off a bit after that to the 40 to 70 billion dollar range where we find OPEC countries, Taiwan, Germany, Switzerland, Canada and Mexico. These are the countries that hold U.S. government debt. Why does Japan hold so much? Richard Duncan:

How Japan financed global reflation
May 17, 2005
Richard Duncan is a financial analyst based in Asia and author of "The Dollar Crisis: Causes, Consequences, Cures" (John Wiley & Sons, 2003), now available in a "Revised & Updated" paperback edition with 7 new chapters.

In 2003 and the first quarter of 2004, Japan carried out a remarkable experiment in monetary policy – remarkable in the impact it had on the global economy and equally remarkable in that it went almost entirely unnoticed in the financial press. Over those 15 months, monetary authorities in Japan created ¥35 trillion. To put that into perspective, ¥35 trillion is approximately 1% of the world's annual economic output. It is roughly the size of Japan's annual tax revenue base or nearly as large as the loan book of UFJ, one of Japan's four largest banks. ¥35 trillion amounts to the equivalent of $2,500 for every person in Japan and, in fact, would amount to $50 per person if distributed equally among the entire population of the planet. In short, it was money creation on a scale never before attempted during peacetime.

Peacetime? 2003? Perhaps this was Japan's contribution to the U.S. invasion of Iraq...

Why did this occur? There is no shortage of yen in Japan. The yield on two year JGBs is 10 basis points. Overnight money is free. Japanese banks have far more deposits than there is demand for loans, which forces them to invest up to a quarter of their deposits in low yielding government bonds.

So, what motivated the Bank of Japan to print so much more money when the country is already flooded with excess liquidity?

The Bank of Japan gave the ¥35 trillion to the Japanese Ministry of Finance in exchange for MOF debt with virtually no yield; and the MOF used the money to buy
approximately $320 billion from the private sector. The MOF then invested those dollars into US dollar- denominated debt instruments such as government bonds and agency debt in order to earn a return.

The MOF bought more dollars through currency intervention then than during the
preceding 10 years combined, and yet the yen rose by 11% over that period. Historically, foreign exchange intervention to control the level of a currency has met with mixed success, at best; and past attempts by the MOF to stop the appreciation of the yen have not always succeeded. They were very considerably less expensive, however. It is also interesting, and perhaps important, to note that the MOF stopped intervening in March 2004 just when the yen was peaking; that the yen depreciated immediately after the intervention stopped; and that when the yen began appreciating again in October 2004, the MOF refrained from further intervention.

So, what happened in 2003 that prompted the Japanese monetary authorities to create so much paper money and hurl it into the foreign exchange markets? Two scenarios will be explored over the following paragraphs.

Duncan doesn't mention it, but clearly the most important historical event of 2003 was the U.S. invasion of Iraq. Could that, with a possible guarantee to Japan of oil supplies, be part of it?

In 2002, the United States faced the threat of deflation for the first time since the Great Depression. Growing trade imbalances and a surge in the global money supply had contributed to the credit excesses of the late 1990s and resulted in the New Paradigm technology bubble. That bubble popped in 2000 and was followed by a serious global economic slowdown in 2001. Policy makers in the United States grew increasingly alarmed that deflation, which had taken hold in Japan, China and Taiwan, would soon spread to America.

Deflation is a central bank's worst nightmare. When prices begin to fall, interest rates follow them down. Once interest rates fall to zero, as is the case in Japan at present, central banks become powerless to provide any further stimulus to the economy through conventional means and monetary policy becomes powerless. The extent of the US Federal Reserve's concern over the threat of deflation is demonstrated in Fed staff research papers and the speeches delivered by Fed governors at that time. For example, in June 2002, the Board of Governors of the Federal Reserve System published a Discussion Paper entitled, "Preventing Deflation: Lessons from Japan's Experience in the 1990s." The abstract of that paper concluded "...we draw the general lesson from Japan's experience that when inflation and interest rates have fallen close to zero, and the risk of deflation is high, stimulus-both monetary and fiscal- should go beyond the levels conventionally implied by baseline forecasts of future inflation and economic activity."

From the perspective of mid-2002, the question confronting those in charge of preventing deflation must have been how far beyond the conventional levels implied by the base case could the economic policy response go? The government budget had already swung back into a large deficit and the Federal Funds rate was at a 41 year low. How much additional stimulus could be provided? A further increase in the budget deficit seemed likely to push up market determined interest rates, causing mortgage rates to rise and property prices to fall, which would have reduced aggregate demand that much more. And, with the Federal Funds rate at 1.75% in mid- 2002, there was limited scope left to lower it further. Moreover, given the already very low level of interest rates, there was reason to doubt that a further rate reduction would make any difference anyway.

In a speech entitled, "Deflation: Making Sure 'It' Doesn't Happen Here", delivered on November 21, 2002, Federal Reserve Governor Ben Bernanke explained to the world exactly how far beyond conventional levels the policy response could go. Governor Bernanke explained that the Fed would not be "out of ammunition" just because the Federal Funds rate fell to 0% because the Fed could create money and buy bonds of longer maturity in order to drive down yields at the long end of the yield curve as well. Moreover, he said, "In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices."

He made similar remarks in Japan in May 2003 in a speech entitled, "Some Thoughts on Monetary Policy in Japan". He said, "My thesis here is that cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own. Consider for example a tax cut for households and businesses that is explicitly coupled with incremental BOJ purchases of government debt-so that the tax cut is in effect financed by money creation." These speeches attracted tremendous attention and for some time financial markets believed the Fed intended to implement the "unorthodox" or "unconventional" monetary policy options Governor Bernanke had outlined.

In the end, the Fed did not resort to unorthodox measures. The Fed did not create money to finance a broad-based tax cut in the United States. The Bank of Japan did, however. Three large tax cuts took the US budget from a surplus of $127 billion in 2001 to a deficit of $413 billion in 2004. In the 15 months ended March 2004, the BOJ created ¥35 trillion which the MOF used to buy $320 billion, an amount large enough to fund 77% of the US budget deficit in the fiscal year ending September 30, 2004. It is not certain how much of the $320 billion the MOF did invest into US Treasury bonds, but judging by their past behavior it is fair to assume that it was the vast majority of that amount.

Was the BOJ/MOF conducting Governor Bernanke's Unorthodox Monetary Policy on behalf of the Fed? There is no question that the BOJ created money on a very large scale as the Fed would have been required to do under Bernanke's scheme. Nor can there be any question that the money created was used to buy an increasing supply of US Treasury bonds being issued to finance the kind of broad-based tax cuts Governor Bernanke had discussed. Moreover, was it merely a coincidence that the really large scale BOJ/MOF intervention began during May 2003, while Governor Bernanke was visiting Japan? Was the BOJ simply serving as a branch of the Fed, as The Federal Reserve Bank of Tokyo, if you will? This is Scenario One.

If this was globally coordinated monetary policy (unorthodox or otherwise) it worked beautifully. The Bush tax cuts and the BOJ money creation that helped finance them at very low interest rates were the two most important elements driving the strong global economic expansion during 2003 and 2004. Combined, they produced a very powerful global reflation. The process seems to have worked in the following way:

US tax cuts and low interest rates fueled consumption in the United States. In
turn, growing US consumption shifted Asia's export-oriented economies into overdrive. China played a very important part in that process. With a trade surplus vis-à-vis the United States of $124 billion, equivalent to 9% of its GDP in 2003 (rising to approximately $160 billion or above 12% of GDP in 2004), China became a regional engine of economic growth in its own right. China used its large trade surpluses with the US to pay for its large trade deficits with most of its Asian neighbors, including Japan. The recycling of China's US Dollar export earnings explains the incredibly rapid "reflation" that began across Asia in 2003 and that was still underway at the end of 2004. Even Japan's moribund economy began to reflate.

Whatever its motivation, Japan was well rewarded for creating money and buying US Treasury bonds with it. Whereas the BOJ had failed to reflate the Japanese economy directly by expanding the domestic money supply, it appears to have succeeded in reflating it indirectly by expanding the global money supply through financing the sharp increase in the MOF's holdings of US Dollar foreign exchange reserves. There is no question as to if this happened. It did. The only question is was it planned (globally coordinated monetary policy) or did it simply occur by coincidence, driven by other considerations?

What other considerations could have prompted the BOJ to create ¥35 trillion over 15 months? A second scenario is that a "run on the dollar" forced the monetary authorities in Japan to intervene on that scale to prevent a balance of payments crisis in the United States. This is Scenario Two.

During the Strong Dollar Trend of the late 1990s, foreign investors, both private and public, invested heavily in the United States. Those investments put upward pressure on the dollar and on US asset prices, including stocks and bonds. The trend became self-reinforcing. The more capital that entered the US, the more the dollar and dollar denominated assets rose in value. The more those assets appreciated, the more foreign investors wanted to own them. Because of the large sums entering the country, the United States had no difficulty in financing its giant current account deficit, even though that deficit nearly tripled between 1997 and 2001.

By 2002, however, with the US current account deficit approaching 5% of US GDP, it became increasingly apparent that the Strong Dollar Trend was unsustainable. The magnitude of the current account deficit made a downward adjustment in the value of the dollar unavoidable. At that point, the Strong Dollar Trend gave way and the Weak Dollar Trend began. Foreign investors who had invested in US dollar denominated assets during the late 1990s naturally wanted to take their money back out of the United States once it became clear that a sharp correction of the dollar was underway. Moreover, many US investors, and hedge funds in particular, also began selling dollar- denominated assets and buying non-US dollar-denominated assets to profit from the dollar's decline.

The change in the direction of capital flows can be seen very clearly in the breakdown of Japan's balance of payments.

… Traditionally, Japan runs a large current account surplus and a slightly less large financial account deficit, with the difference between the two resulting in changes (usually additions) to the country's foreign exchange reserves. Beginning in 2003, however, there was a startling change in the direction of the financial account. Instead of large financial outflows from Japan to the rest of the world, there were very large financial inflows. For instance, in May 2003, Japan's financial account reflected a net inflow of $23 billion into the country. The net inflow in September was $21 billion. These amounts increased considerably during the first quarter of 2004, averaging $37 billion a month.

The capital inflows into Japan at that time were massive, even relative to Japan's traditionally large annual current account surpluses. But, why did Japan, which normally exported capital, suddenly experience net capital inflows on a very large scale in the first place? The most likely explanation is that very large amounts of private sector money began fleeing the dollar and seeking refuge in the relative safety of the yen.

When the Strong Dollar Trend broke, had the BOJ/MOF not bought the dollars that the private sector sold in such large quantities, the United States would have faced a balance of payments crisis, in which, in addition to having to fund a half a trillion dollar a year trade deficit, it would have had to find a way to fund a deficit of several hundred billion on its financial account as well.

Any other country facing a large shortfall on its balance of payments would have experienced a reduction in its foreign exchange reserves. The United States, however, maintains only a limited amount of such reserves; only $75 billion as at the end of 2003, far too little to fund the private capital outflows occurring at that time.

Once those reserves had been depleted, market-determined interest rates in the US would have begun to rise, in all probability, popping the US property bubble and throwing the country into recession. Under that scenario, a reduction in consumption in the United States would have undermined global aggregate demand and created a severe world-wide economic slump.

The US current account deficit more or less finances itself since the central banks of the surplus countries buy the dollars entering their countries to prevent their currencies from appreciating and then recycle those dollars back into US dollar-denominated assets in order to earn interest on them.

Large scale private sector capital flight out of dollars presented the recipients of that capital with the same choice. The central bank of each country receiving the capital inflow had the choice of either printing their domestic currency and buying the incoming capital or else allowing their currency to appreciate as the private sector
swapped out of dollars. The European Central Bank chose to allow the euro to appreciate. The Bank of Japan and the People's Bank of China chose to print yen and renminbe and accumulate the incoming dollars to prevent their currencies from rising. If some central bank had not stepped in and financed the private
sector capital flight out of the dollar, then sharply higher US interest rates most likely would have thrown the world into a severe recession.
It is quite likely that this consideration also played a role in influencing the actions of the Japanese monetary authorities during this episode.

…The BOJ/MOF stopped intervening in March 2004. By that time, the Fed had indicated that it planned to begin tightening interest rates. That put a stop to the private sector capital flight out of the dollar. Therefore no more intervention was required. At the same time, by the end of the first quarter of 2004, it was becoming clear that strong economic growth in the US was creating higher than anticipated tax revenues. That meant a smaller than expected budget deficit. In July, the President's Office of Management and Budget revised down its estimate of the budget deficit from $521 billion to $445 billion. The actual deficit turned out to be $413 billion. Thus less funding was required than initially anticipated.

So, what did motivate the monetary authorities in Japan to create the equivalent of 1% of global GDP and lend it to the United States? Was it simply, straightforward self interest to prevent a very sharp surge in the value of the yen? Was it globally coordinated monetary policy designed to pull the world out of the 2001 slump and prevent deflation in the United States? Or, was it necessary to stave off a US balance of payments crisis that would have produced a global economic crisis?

Perhaps it was only straightforward foreign exchange intervention to prevent a crippling rise in the value of the yen. Intentionally or otherwise, however, by creating and lending the equivalent of $320 billion to the United States, the Bank of Japan and the Japanese Ministry of Finance counteracted a private sector run on the dollar and, at the same time, financed the US tax cuts that reflated the global economy, all this while holding US long bond yields down near historically low levels.

In 2004, the global economy grew at the fastest rate in 30 years. Money creation by the Bank of Japan on an unprecedented scale was perhaps the most important factor responsible for that growth. In fact, ¥35 trillion could have made the difference between global reflation and global deflation. How odd that it went unnoticed.

How odd that Duncan doesn't notice that Japan enabled the United States to invade Iraq, just as Japan contributed massive sums to the first Iraq War under Bush I. This is the sort of thing financial writers don't like to look at. If the United States economy had collapsed in late 2002, could the war have been started? With Bush, who knows, but it is worth asking the question.

What does Japan fear? No oil and China. The United States can help them with both. Many people have commented on the poodle-like subservience of Blair, but few have mentioned Koizumi's strong support of the war and complete backing of U.S. foreign policy.

Monday, May 16, 2005

Signs of the Economic Apocalypse 5-16-05

From Signs of the Times 5-16-05:

In the U.S. stock market, the Dow Jones Industrial Average closed at 10,140.12 on Friday, down 2% from the previous Friday’s close of 10,345.40. The NASDAQ closed at 1976.80, up 0.48% from the previous week’s 1967.35. The yield on the ten-year U.S. Treasury bond closed at 4.13% down from the previous week’s 4.26%. The dollar closed at .7933 euros, up 1.8% compared to the previous Friday’s close of .7791. That put a euro at 1.2606 dollars compared to last week’s 1.2824. Oil fell last week, closing at $48.67 a barrel, down 4.7% from $50.96 a week earlier. In euros, the price of oil closed at 38.61 euros a barrel, down 2.9% from the previous Friday’s close of 39.74. Gold closed at $420.60 an ounce on Friday, down 1.5% from $426.80 the previous Friday. Gold in euros would be 333.66 an ounce, down just 0.26% from last Friday’s 332.81. Gold did better against oil last week. At Friday’s close an ounce of gold would buy 8.64 barrels of oil, up 2.5% from the previous week’s 8.43.

The announcement recently by IBM that it was cutting thousands of jobs in western Europe, brought into relief the fact that, while lagging a bit behind the United States in this, the more advanced economies of Europe are seeing the outsourcing and offshoring wave begin to crest. (Note, while we often lump both under the term ‘outsourcing’, it is worth keeping in mind the difference: ‘outsourcing’ refers to firms contracting out various business processes to other companies, while ‘offshoring’ refers to companies moving jobs to low wage countries, whether or not those jobs remain within the firm in question):

Major Job Losses At Computer Giant IBM
Computer giant IBM has announced plans to shed thousands of workers. Up to 13,000 jobs are expected to go - most of them from its struggling European operations. The company signalled the job cuts were part of efforts to reinvent itself after it ditched its personal computer unit.

It said it foresaw reducing its 329,000-strong workforce through "voluntary and involuntary" cuts by 10,000 to 13,000 employees worldwide.

"The majority of the overall workforce reductions are planned for Europe, and the company has initiated discussions of these changes with local consultation bodies," a statement said.

IBM said the success of the revamp depended "on reducing bureaucracy and infrastructure in lower-growth countries and creating teams that can work across country borders."

"This eliminates the need for a traditional pan-European management layer to co-ordinate activity.

"As a result, IBM will create a number of smaller, more flexible local operating units in Europe to increase direct client contact."

This process will put considerable pressure on the social safety net of which Europeans are so justly proud. Here’s Business Week:

May 23, 2005


U.S. multinationals are scaling back their presence in Western Europe in favor of more promising venues.

David N. Farr, chairman and chief executive of St. Louis industrial group Emerson Electric Co., keeps a close eye on Europe. That makes sense. The region accounts for about one-fourth of Emerson's $15.6 billion revenues and 16% of its worldwide assets. But more and more, Farr is discouraged by what he sees. Western European sales have been flat for months, as corporate customers delay purchasing the power networks, air-conditioning systems, and other big-ticket capital goods Emerson sells. Come to think of it, there hasn't been much life in these markets for years. "The European economies have continued to weaken and weaken," Farr laments. Even worse, a strong euro and stringent anti-layoff laws make it tough to trim costs.

Now, Emerson has had enough. It has halted new investment in Western Europe, while pouring money into faster-growing, more lightly regulated economies in the old Soviet bloc. Vacant jobs in Western Europe are not being filled. "As we need more capacity, we're putting it in Eastern and Central Europe," says Edward L. Monser, Emerson's chief operating officer.

It's hardly news that Western Europe is a tough place to do business these days. Growth for the euro zone economy is forecast to be below 1.5% this year, less than half the rate in the U.S. and Asia. Unemployment averages 8.9%, retail sales are sagging, and euro zone manufacturing production shrank in April. High oil prices only add to the gloom. U.S. multinationals from McDonald's to Caterpillar to Wal-Mart complain that their European operations, particularly in Germany, are dragging down companywide sales and profits.


But as Europe heads into a fifth year of economic anemia, some U.S. multinationals are finally concluding that a robust recovery won't arrive soon -- if ever. Like Emerson, they're scaling back longstanding operations and diverting investment to more promising venues. Until now, many U.S. companies have hesitated to reduce European payrolls because of local laws requiring cumbersome, expensive layoff procedures. But more and more are concluding that it's worth the trouble. IBM says that the bulk of the 10,000 to 13,000 worldwide job cuts it announced on May 5 will be in Western Europe, while the company is hiring in Hungary and Slovakia. General Motors Corp. plans to eliminate up to 12,000 Western European jobs by 2006, even as it expands manufacturing in Poland.

The big numbers tell the story most clearly. Foreign direct investment in the European Union's 15 longstanding member countries fell almost 50% in 2004, to $165 billion, with every one of the EU's major economies except Britain posting a decline. By contrast, in the eight Central and Eastern European countries that joined the EU last year, foreign investment rose by one-third, to $36 billion. Foreign direct investment in the U.S. also rose sharply last year.

Of course, the U.S. is losing manufacturing and service jobs to lower-wage countries, too. And European companies are doing plenty of offshoring themselves. A survey by Woodlands (Texas)-based consulting firm TPI found that European companies accounted for 49% of all major outsourcing contracts last year, ahead of U.S. companies, which had 44%.

There are two trends at work here, neither of which bode well for western Europeans. First, the neoliberal corporate project to use transnational bodies like the WTO to undermine national sovereignty in the area of economic and social policy proceeds apace. The project is to punish Europe for showing that you can have an advanced, dynamic economy with many elements of socialism in place. That will not be allowed to continue if the capitalist globalisers have anything to say about it. Second, we can also see the development of economic spheres of influence, with much of the western European offshoring going to eastern Europe, rather than Latin America or India as is the case in the United States (which is not to say that many European jobs will not be lost to India or China).

For readers of these pages it is old news, but there are increasing signs that mainstream commentators are thinking in apocalyptic terms, especially when it comes to the economy. We would like to welcome The New York Times to the doomsday club!

The Perfect Storm That Could Drown the Economy

We seem to be living in apocalyptic times. On NBC's "Revelations," Bill Pullman and Natascha McElhone seek signs of the End of Days. In the Senate, gray-haired eminences speak of the "nuclear option."

The doomsday theme is seeping into the normally circumspect world of economics. In April, Arjun Murti, a veteran analyst at the investment bank Goldman Sachs, warned that oil could "super-spike" to $105 a barrel. And increasingly, economists are prophesying that the American economy as a whole may be sailing into choppy waters.

Just look at the many obvious and worrisome portents. The government each year spends much more than it brings in, and so the nation has a large budget deficit ($412 billion in fiscal 2004, and growing). Americans also import far more goods than they export, and so the nation has record trade and current account deficits.

As consumers, Americans personally spend significantly more than they earn. Worse, some imbalances are eerily reminiscent of conditions that helped touch off recent economic crises: Mexico in 1994, Asia in 1997, Russia in 1998 and Argentina in 2002. Throw in rising interest rates, warnings of a housing bubble and the potential for higher inflation and slower growth (a k a stagflation) - and you can understand why some economic analysts may be plumbing the New Testament for inspiration.

The forces propelling and buffeting the economy are like a series of interrelated and interconnected weather systems. Could they be setting the conditions for a perfect storm - a swift series of disturbances that causes lasting damage? If so, what would it look like?

"There's a pattern that is familiar from so many other countries that have gotten into debt problems," said Jeffrey A. Frankel, an economist at Harvard's Kennedy School of Government. "A simultaneous rise in interest rates, fall in securities prices and depreciation of the currency."

Of course, economists, always armed with bandoliers of caveats, are quick to warn that the economy is relatively healthy. Job growth numbers released on Friday were strong, with 274,00 new jobs created in April.

And they warn against drawing parallels too sharply between the mighty United States and emerging markets. The dollar remains the world's reserve currency, and the United States is a global military and political hegemon. And the nation has been able to borrow huge amounts for years without suffering a crisis.

That said, how might a perfect storm be created? It would likely gather overseas, and wouldn't necessarily take the form of a terrorist strike or oil shock. The United States finances its spendthrift ways by selling dollars and dollar-denominated securities (like Treasury bills) to foreign creditors, mostly to central banks in Asia. To sustain growth, the United States needs foreign creditors to continue to add to their piles every day.

Any signs to the contrary are worrisome. In February, when the Korean government suggested that the Bank of Korea might diversify its foreign exchange holdings, "this seemingly innocuous statement set off a small panic in our stocks and bond markets," said James Grant, editor of Grant's Interest Rate Observer.

If the Bank of China, which has been accumulating dollars at the rate of $200 billion a year, decides to cut back on new purchases, either to diversify or to let its currency appreciate, the United States would quickly have to offer sharply higher interest rates to retain existing investors and entice new ones. Nouriel Roubini, an economics professor at New York University's Stern School of Business, estimates that if China cut its rate of accumulation by half, long-term interest rates in the United States could rise by 200 basis points over a few months and the value of the dollar would fall.

Such a rising tide - the yield on the 10-year bond shooting from 4.25 to 6.25, the average 30-year mortgage rising from 6 percent to 8 percent - would mean instantly higher borrowing costs for the government, businesses and consumers. It would drench Wall Street, soaking the stocks of giant interest-rate-sensitive blue chips like Citigroup and making life difficult for speculative, debt-ridden companies. Some highly leveraged hedge funds or investment banks caught on the wrong side of trades would incur significant losses.

The United States weathered a sharp decline in the stock market just a few years ago, in large part because of the housing market's strength. But a sharp rise in interest rates would literally hit home. For new home buyers, or for people with adjustable rate mortgages, 200 extra basis points of interest on a $400,000 mortgage would represent $8,000 a year in extra payments. If mortgage rates were to rise sharply, housing prices would level off and perhaps do the unthinkable: fall.

Suddenly, the mechanisms that have allowed consumers to keep the economy afloat - the ability to realize profits from selling homes, to refinance mortgages at lower rates and to borrow cheaply against home equity - would be broken. In the absence of sharply rising wages, that $8,000 in extra interest would be $8,000 less to spend at Home Depot, or at the Cheesecake Factory, or at Disney World.

"Personal expenditures in the past 15 months have been largely financed by borrowing," said Wynne Godley, a Cambridge University economist who is affiliated with the Levy Institute at Bard College. "And even a reduction in the pace of debt creation will force people to start spending less, on a big scale."

If the dollar weakens and consumption falls, the trade and current account deficits would start to narrow. But the United States economy would slow and, perhaps, even shrink.

"The result would not be a full-blown financial crisis most likely, but it would still be a major recession," said Barry Eichengreen, a professor of economics and political science at the University of California at Berkeley.

What would create the full-blown crisis? When the slowdown starts to radiate across the globe, said Catherine L. Mann, senior fellow at the Washington-based Institute for International Economics.

For years, the American consumer has been the engine of global growth, by gobbling up the output of oil wells in Saudi Arabia and factories from Mexico to China. "The slowdown in consumer spending is going to have a negative influence on the global economy through reduced international trade," Ms. Mann said.

What's more, a recovery would be comparatively slow in coming. When the global economy came to a screeching, synchronous halt in 2001, the United States led much of the world back to growth because the federal government went on a stimulus binge for several years: Congress significantly increased government spending while cutting taxes, and the Federal Reserve slashed interest rates to historic lows, and held them there.

But in the perfect economic storm, none of these three powerful levers would be readily available. Today's deep budget deficits make both significant tax cuts and spending increases unlikely. And rising interest rates would make it difficult, if not impossible, for the Federal Reserve to reduce the cost of borrowing.

It sure sounds alarming. But as the clouds gather and the wind stiffens, we sail onward, with no apparent adjustment in course, full steam ahead.

We are seeing now a blitzkrieg, a shock and awe attack on those who work for a living. Medicaid is being cut. Corporations are slipping out of their commitments to retired workers. One wonders how much the ballyhooed financial problems of General Motors are smokescreens for their attempt to break their promises on pay and healthcare to their retired workers. A reader wrote in with the following:

Many more worthless promises will be exposed before this cycle of economic chaos ends.

Other companies are waiting in the wings to unload their pension promises to workers as part of the effort to make American business more "competitive". GM and Ford, Delta, and many others will now see this ruling as a green light to declare bankruptcy and rid themselves of the obligations and promises they made to their employees over the years.

And I'll wager that executive pension plans will be unaffected by this ruling.

But something even more insidious is at work here than just a pension plan scam.

This is just another step in the ruination of the American middle class. While the corporation gets to slide out of its pension obligations by declaring bankruptcy, under the new personal bankruptcy law just passed, the individual won't be able to escape their debt obligations as easily as this. The personal bankruptcy revision has made it harder and more complicated to do so.

Step 1: Lure people into taking on greater and greater loads of debt. Place ads for EZ loans everywhere, on computers, in the mail, on TV, in newspapers, everywhere.
Encourage everyone to buy overpriced homes and to refinance those loans as often as possible to keep people spending.

Promote adjustable rate mortgages and interest only home loans so everyone can participate.

Status of this step: in place

Step 2: Change the personal bankruptcy laws to make it harder for individuals to have debt excused.

Status of this step: in place, due to be fully implemented around Sept-Oct 2005.

Step 3: Allow corporate pension liabilities to be erased or modified as part of keeping America competitive.

Pretend that the government will see to it that pensions will never be allowed to fully default.

Get people used to making sacrifices for the good of the economy.

Status of this step: in progress right now.

Systematically, all the exits are being sealed for the middle class American and any hope of financial independence. When the time is right, the trap door will open and down the hatch they'll go, probably expressing shock and awe that something like this could ever happen in the greatest nation in the world.

The next step will be for them to crawl on their hands and knees to the government seeking "help".

I suspect that the Sept-Oct 2005 time frame is ripe for the trap door to be opened. That's when the new personal bankruptcy law will be in place and binding.

The scandal of the pensions is compounded by what these corporations did with the pension profits in the 1990s. Then, when the stock market was soaring, corporations counted the paper gains of their pension funds as revenue. Companies like General Motors probably were not making much money selling cars, but they could count the increases of their pension fund as revenue and, adding to that the profits of their financial arm, GMAC, they could appear to be a healthy company and enjoy stock price increases as a result. Now, with the stock market stalled, they are trying to get out of their commitments to their retired workers.

United Airlines pension default sign of growing pressures

The 6.6 billion dollar pension plan default by United Airlines may have been the largest in US history. But it won't be the last, analysts say.

And it is likely that many Americans who get company-sponsored pensions will end up with significantly smaller retirement incomes than they had been counting on.
Company-funded defined benefit pension plans, which cover 44 million Americans, are underfunded to the tune of 450 billion dollars, according to data from the Pension Benefit Guaranty Corp., the government insurer of private pensions.

The US government insurance program, designed to protect workers from pension plan defaults, is also in trouble.

At the same time, President George W. Bush's proposal to create private accounts within the Social Security system could pose additional risks for retirees.

"It's a ticking time bomb waiting to go off and the longer we wait the larger the blast will be," said Randall Krozner, an economics professor at the University of Chicago's Graduate School of Business who has advised Bush on pension reform.

The crisis with the defined benefit pension system could cost taxpayers as much as the 125-billion-dollar bailout of the savings and loan industry in the 1980s, Krozner said.

United's default could easily force other airlines to take similar actions in order to remain competitive. The nation's top two automakers, Ford and General Motors, may also be at risk of defaulting on their massive pension plans if there are unable to revitalize weak sales and recover from recent credit downgrades to junk status, Krozner added.

The trouble began when the stock market started sliding in March of 2000. Pension funds took a massive hit and companies already struggling with weak economic performance cut back their contributions.

Then the bankruptcies started. By the end of 2004, the Pension Benefit Guarantee Corp. had a 23.3 billion dollar deficit.

While future stock market growth will help many underfunded pension plans recover their losses, reform of the insurance program is needed to help prop up the system, said Cary Burnell, a researcher with the United Steelworkers of America.

"Defined benefit plans are one of the pillars that have built the American middle class and brought seniors out of poverty," said Burnell, who worked on the 3.7-billion-dollar Bethlehem Steel pension plan default.

"Pension plan termination is a terrible thing," he said.

Further complicating matters is the fact that US corporations have been moving away from defined benefit pension plans and have instead offered defined contribution plans, known as 401k plans, which are tax-sheltered savings accounts.

While these easily transferable plans are popular with the nation's highly mobile workforce, they are not insured and shift all of the risk onto individual workers.

The Bush administration is also promoting a system that would shift Social Security contributions to personal accounts.

Even the Catholic Church is doing this. Pension fund abandonment has even reached the Catholic Church! The Boston Archdiocese, under the corporate-style leadership of Archbishop O’Malley, has seen plant closings (closing of parish churches) and now we hear them saying that the Archdiocesan pension fund is “underfunded.” They want to cut back on health benefits for retired priests!

Retirement changes eyed for priests

By Michael Paulson, Globe Staff

May 12, 2005

The cash-strapped Catholic Archdiocese of Boston is considering significant changes in its expectations of senior priests that would encourage clergy to continue to work after they retire and require priests with financial assets to help pay for nursing-home or assisted-living care.

The archdiocese says that it remains committed to taking care of its clergy and that it will guarantee that no retired priests are without shelter, healthcare, or income. But the archdiocese says it must change benefits or risk running out of money in its pension fund.

The adjustments, which were circulated in a draft policy to all priests and are being discussed at meetings with clergy around the archdiocese, are being proposed as many private companies are eliminating or reducing pension benefits.

The archdiocese says it faces a $55 million unfunded liability in its pension fund for priests. Actuaries say that is the amount the archdiocese has promised to retirees, an amount that it does not have in the bank. The archdiocese attributes the problem to poor investment performance and longer average life span and says the shortfall is unrelated to the costs of settling abuse cases or closing parishes.

Given the pattern we have been noticing wherein some bogus good economic news is released on Friday afternoon of a week with a lot of bad news, there was some reason to doubt the reliability of the “strong” U.S. jobs report that came out the previous Friday. Sure enough, sceptics have shown that when you look beneath the surface of the report, the picture does not look so good. Here is Paul Craig Roberts:

America is Losing

More Phony Jobs Hype


Careless journalists and commentators are hyping the 274,000 new April payroll jobs as evidence of the health of the US economy. An examination of the details of the new jobs puts a different view on the matter.

April's job growth is consistent with the depressing pattern of US employment growth in the 21st century: The outsourced US economy can create jobs only in domestic nontradable services.

Of the 274,000 April jobs, 256,000 were in the private or nongovernment sector, and 211,000 of these were in the service sector as follows: 58,000 in leisure and hospitality (primarily restaurants and bars), 47,000 in construction, 29,200 in wholesale and retail trade, 28,000 in health care and social assistance, 17,300 in administrative and support services (primarily temps), 11,700 in transportation and warehousing, 8,800 in real estate. A few scattered jobs in other service categories completes the picture.

Americans regard themselves as “the world's only superpower,” but the pattern of American job growth in the 21st century is that of a third world economy. The US economy has ceased to create jobs in high tech sectors and in export and import-competitive sectors. Offshore outsourcing of manufacturing and of engineering and professional services is dismantling the ladders of upward mobility that made the American Dream possible.

Related to the pattern of exporting high paying jobs while keeping low paying ones, wages fell in the United States at the sharpest rate since 1991, at the end of another Bush’s run at power, according to the Financial Times:

Wages in US show steepest fall in rate since 1991

By Christopher Swann in Washington

May 11 2005

Real wages in the US are falling at their fastest rate in 14 years, according to data surveyed by the Financial Times.

Inflation rose 3.1 per cent in the year to March but salaries climbed just 2.4 per cent, according to the Employment Cost Index. In the final three months of 2004, real wages fell by 0.9 per cent.

The last time salaries fell this steeply was at the start of 1991, when real wages declined by 1.1 per cent.

Stingy pay rises mean many Americans will have to work longer hours to keep up with the cost of living, and they could ultimately undermine consumer spending and economic growth.

Many economists believe that in spite of the unexpectedly large rise in job creation of 274,000 in April, the uneven revival in the labour market since the 2001 recession has made it hard for workers to negotiate real improvements in living standards.

Even after last month's bumper gain in employment, there are 22,000 fewer private sector jobs than when the recession began in March 2001, a 0.02 per cent fall. At the same point in the recovery from the recession of the early 1990s, private sector employment was up 4.7 per cent.

“There is still little evidence that workers are gaining much traction in their negotiations,” said Paul Ashworth, US analyst at Capital Economics, the consultancy. “If this does not pick up, it raises the prospect of a sharper slowdown in consumer spending than we have been expecting.”

The amazing thing is that in the United States there are many analysts who keep saying that offshoring is good for the economy. Common sense, on the one hand, or sophisticated, non-linear analysis on the other will tell you that that can’t be true, but neo-classical economics has neither common sense nor the understanding of non-linear dynamics. Furthermore, neo-classical economics feeds into the dangerous tendency in the United States to believe in American Exceptionalism, the notion that the normal workings of cause and effect do not apply to the United States. The idea that “things are different here” is not much different than the belief that drove the stock bubble of the internet era: “things are different now.”

We may be reaching the end of the line for American Exceptionalism. Empires fall by overreaching. At some point the money spent on the military goes to protect old gains rather than bringing new wealth in. Often, the leaders choose to bet everything in order to avoid collapse, a “double or nothing” strategy of desperation. Watching the money go down the Iraq sinkhole, one can’t help but wonder if the United States is poised for a complete collapse, not just an economic one. According to Willam S. Lind:

When people ask me what to read to find an historical parallel with America's situation today, I usually recommend J.H. Elliott's splendid history of Spain in the first half of the 17th century, The Count-Duke of Olivares: A Statesman in an Age of Decline. One of the features of the Spanish court in that period was its increasing disconnection with reality. At one point, Spain was trying to establish a Baltic fleet while the Dutch navy controlled the Straits of Gibraltar.

A similar reality gap leapt out at me from a story in the May 3 Washington Post, “Wars Strain U.S. Military Capability, Pentagon Reports.” Were that the Pentagon's message, it would be a salutary one. But the real message was the opposite: no matter what happens, no one can defeat the American military. According to the Post,

The Defense Department acknowledged yesterday that the wars in Iraq and Afghanistan have stressed the U.S. military to a point where it is at higher risk of less swiftly and easily defeating potential foes, though officials maintained that U.S. forces could handle any military threat that presents itself . . .

The officials said the United States would win any projected conflict across the globe, but the path to victory could be more complicated.

“There is no doubt of what the outcome is going to be,” a top defense official said. “Risk to accomplish the task isn't even part of the discussion.”

It isn't, but it certainly should be. The idea that the U.S. military cannot be defeated is disconnected from reality.

Let me put it plainly: the U.S. military can be beaten. Any military in history could be beaten, including the Spanish army of Olivares's day, which had not lost a battle in a century until it met the French at Rocroi. Sooner or later, we will march to our Rocroi, and probably sooner the way things are going.

Why do our senior military leaders put out this "we can't be beaten" bilge? Because they are chosen for their willingness to tell the politicians whatever they want to hear. A larger question is, why do the American press and public buy it? The answer, I fear, is "American exceptionalism" ­ the belief that history's laws do not apply to America. Unfortunately, American exceptionalism follows Spanish exceptionalism, French exceptionalism, Austrian exceptionalism, German exceptionalism and Soviet exceptionalism.

Reality tells us that the same rules apply to all. When a country adopts a wildly adventuristic military policy, as we have done since the Cold War ended, it gets beaten. The U.S. military will eventually get beaten, too. If, as seems more and more likely, we expand the war in Iraq by attacking Iran, our Rocroi may be found somewhere between the Euphrates and the Tigris rivers.

If the United States invades one more country, things like the monthly jobs numbers will have little to do with what happens to the world economy.

Monday, May 09, 2005

Signs of the Economic Apocalypse 5-9-05

From Signs of the Times 5-9-05:

A stronger than expected U.S. jobless report for April lifted U.S. stocks last week. The Dow Jones Industrial Average closed Friday at 10,345.40 up 1.5% from the previous week’s close of 10,192.51. The NASDAQ closed at 1967.35 up 2.4% from the previous week’s 1921.65. The yield on the ten-year U.S. Treasury bond closed at 4.26%, up from last week’s 4.20%. The euro closed at 1.2824 dollars, or .7791 euros to a dollar, up 0.3% against dollar from the previous week’s 1.2866 or .7772 euros/dollar. Gold closed at $426.80 an ounce (332.81 euros/ounce) Friday, down 2% from the previous Friday’s close of $435.50 (338.49 euros/ounce), down 1.7% in euros. Oil closed at $50.96 a barrel, up 2.5% from the previous week’s close of $49.72. That would put oil in euros at 39.74 a barrel up 2.8% from the previous Friday’s close of 38.64. At Friday’s close, an ounce of gold would buy 8.43 barrels of oil, down 3.9% from the previous Friday’s close of 8.76.

Let’s take a look at the good news the U.S. analysts were trumpeting, the “strong” jobs numbers:

Payrolls grow more than expected in April
By Glenn Somerville

Sat May 7, 6:45 AM ET
The addition of a surprisingly strong 274,000 U.S. jobs in April plus upward revisions for hiring numbers in two prior months showed the economy rebounding from a first-quarter slowdown.

The April jobs total, reported by the Labor Department on Friday, eclipsed analysts' expectations of 170,000 new jobs. It implied that interest rates are likely to keep rising since lofty energy prices have not sapped the durability of the three-year old economic expansion.

Further underlining the surge, the government said 93,000 more jobs were created in February and March than it previously reported -- 146,000 in March instead of 110,000 and a whopping 300,000 in February instead of 243,000.

"So much for soft spots, unless you think it is possible to create 700,000 jobs in the past three months and not have a solid economy," said economist Joel Naroff of Naroff Economic Advisors in Holland, Pennsylvania.

The unemployment rate, which is calculated from a separate survey, was unchanged at 5.2 percent in April.

The jobs data sent U.S. Treasury debt prices skidding lower on a conviction that a strong economy will keep the Federal Reserve pushing interest rates higher to curb inflation.


U.S. central bank policy-makers on Tuesday raised the bellwether federal funds rate, charged on overnight loans between banks, for an eighth straight time since last June to 3 percent and analysts see it going higher as a bulwark against price pressures.

A Reuters poll of 20 big banks that deal directly with the Fed found they unanimously expect another quarter percentage point rate hike after their next policy session on June 29-30. Almost all foresee a further quarter point hike on Aug. 9.

"The risk is that unless the Fed puts a speed-bump in the way of the economy that we will see a rise in end-user inflation," said Stuart Schweitzer, global investment strategist with J.P. Morgan Asset Management in New York.

Schweitzer said the Fed is "well along but not nearly finished" with its rate-rising campaign and predicted the fed funds rate will move up to 4 percent by the end of the year.

April job gains were broad-based with manufacturing the only major sector to shed positions. Construction employment snapped back after a soft March, adding 47,000 to payrolls for the strongest hiring since March 2004.


Treasury Secretary John Snow, in a blitz of television appearances after the jobs report was issued, said the economy was well poised for steady expansion. "I think we can continue to have good strong, noninflationary growth that creates lots of jobs going forward," Snow said on CNBC television.

So far in 2005, about 210,000 jobs a month have been created, ahead of the roughly 150,000 that economists estimate are needed just to absorb new entrants to the

Economist Gary Thayer of A.G. Edwards and Sons Inc. of St. Louis, Missouri, said the first-quarter softening in the pace of economic growth now appears to have been temporary rather than a portent of a broader slowdown, judging by corporations' willingness to bet on the future by adding to payrolls.

"It suggests that the cooling off we've seen is not a significant problem. High energy prices are hurting confidence, but don't appear to be hurting job creation," he added.

The strong data were a balm for financial markets after recent nervousness that recent data might point to a spreading economic soft spot. Major stock indexes rose after the report but the gains were checked by heightened concern over prospective interest-rate rises. The major indexes closed on Friday virtually unchanged.

"Not only is the April report strong, but it's stronger than what the summary suggests," said economist Richard DeKaser of National City Corp. in Cleveland. "We have huge upward revisions. We see hours worked rising sharply in the month of April, which indicates how the workforce is being utilized."

Average hourly earnings in private industry climbed five cents to a record $16 in the month, while the average workweek increased to 33.9 hours from 33.7 in March.

The zeal with which the Bush-allied officials and analysts seized on these numbers could be an indication of their desperation earlier this week when most of the news was bad.

The dollar has been holding its own against the euro as well, lately, with the European economy looking shaky at the moment. From a survey of the world economy by Nick Beams:

According to a report issued by the European Commission, economic confidence is falling across the region. The commission said the decline in its “economic sentiment” index to the lowest level since October 2003 indicated “a considerable slowing of output growth in the first half of 2005”.

Amelia Torres, the EU spokeswoman for the economy and finance commented that “the situation is not exactly rosy at the moment”. Growth-oriented policy changes in countries like Germany, she said, were “taking time to bear fruit”. This is a reference to new regulations which bring in severe cuts to unemployment benefits and have helped push unemployment rates to over 5 million.

Ken Wattret, an economist with BNP Paribas in London, told the International Herald Tribune that the numbers showed a European economy in trouble. “We thought services would rebound in anticipation of better prospects in industry, and so pessimism really is the order of the day.”

The commission said the biggest decreases in its economic sentiment index, which covers industrial, retail, construction, services and consumer confidence, had been in the UK, followed by France. French unemployment has risen to a five-year high of 10.2 percent with a report showing that business confidence in April was at an 18-month low. The business leaders interviewed for the survey were particularly downbeat about the prospects for exports.

While the German unemployment rate declined slightly last month, revised data issued last week show that the economy is in a technical recession, with two consecutive quarters of negative growth in the second half of 2004. The governments of Germany and Italy have both revised downward their estimates of economic growth from 1.6 percent to 1 percent and from 2.1 percent to 1.2 percent respectively.

German business confidence is down to its lowest level since September 2003, after three months of successive declines. Consumer confidence is also reported to be falling.

Asia is looking shaky as well, as the whole world looks in trepidation at the ability of consumers in the United States to keep buying as while being paid less and while falling deeper in debt. Again from Nick Beams:

Despite the continuing boom in the Chinese economy, the overall situation in Asia is little better. Last week, the Bank of Japan acknowledged that the economy, the world’s second largest, is still stuck in deflation in spite of three years of stop-start growth. While the fall in prices of 0.2 percent in the year to March was less than the 0.8 percent declines experienced in each of the previous two years, the bank does not expect prices to start rising until 2007.

The latest result means that Japan has experienced eight years of deflation since the collapse of the real estate and share market bubble in the early 1990s. With interest rates at zero and plenty of liquidity there is little financial authorities can do to boost the economy. Increased government spending is also ruled out because previous measures, which failed to provide any long-term revival, have left Japan with a public debt equivalent to 160 percent of gross domestic product.

Japan’s domestic economy is virtually stagnant, with real domestic demand only averaging an annual increase of 0.9 percent over the past years. What growth there has been is largely the result of exports, especially to China, which have increased at a rate of 7.4 percent over the same period. But even this source of growth could dry up if China’s growth rate begins to fall as a result of a slowdown in the US.

The dependence of the Chinese economy on the US and other foreign markets is reflected in the share of exports as a percentage of GDP: up from 20 percent in 1999 to 35 percent in 2004. Of these exports, one third goes to the US. The picture is the same throughout Asia.

According to calculations by Morgan Stanley economists, over the past five years exports from non-Japan Asia have increased at an annual rate of 15.3 percent; more than triple the 4.9 percent annual increase in domestic consumption spending over the same period.

These figures underscore the growing reliance of China and the rest of Asia on the expansion of the American market and signify that any sustained slowdown in the US economy, not to speak of a recession, will have far-reaching consequences.

Notice how long Japan has had to spend burning off all the bad debt from the collapse of their real-estate bubble. Will the United States be next to hear the bubble pop? If it does, say goodbye to overvalued stock prices. Will the United States have the luxury Japan has had, selling goods to the United States and still investing abroad while trying to sweat out all the bad loans?

How will the United States ever get out of debt? The government is now doing little more than funneling tax money to corporations via procurement contracts and various privatization schemes. The tax cuts on the wealthy are being made permanent. The people are being impoverished with falling wages, fewer benefits and more resposibility for their own catastrophic losses with the systematic dismantling of social insurance. The people can only default on the debts they have incurred out of their optimistic nature: the belief that they will be earning more in the future. After the default, when Americans lose everything and the dollar crashes, workers in the United States can provide cheap labor for other countries, kept in line by Patriot Act laws.

Without a radical redirection of economic policy, what else can happen at this point? What does the United States as a whole produce? Raw materials, of course, like any continental nation. But supplying raw materials to the world market is a recipe for poverty. The United States grows food in abundance (if in a heavily petroleum-using way). The United States also jointly controls with Canada (with whom it is trying to merge) a large percentage of the world’s surface fresh water in the Great Lakes.

The United States produces culture, but, as Peter Jackson’s new film complex in New Zealand shows, culture can move quickly and historically has moved quickly, following the money. The film industry is the one part of the culture industry which has the largest infrastructure of fixed assets and its center of gravity could shift to Hong Kong, Bombay (Bollywood), or Wellington.

The United States produces knowledge, but has always done so by attracting scholars from all over the world to supplement its native born talent, but that era is ending. Patriot Act laws and visa restrictions make it harder to bring in foreign students and scholars, and the obnoxious foreign policy of the Bush administration is making it so no one who has other choices wants to come here. We may even see a brain drain of native talent leaving for other shores.

But what high-end, high value-added commodities? Where is the heavy adding of value done? One of the only type of advanced manufacturing done completely in the United States is advanced weaponry (don’t want to outsource THAT to China or India!). The U.S. is also turning out lots of people trained to operate these weapon-systems and are spending a lot of money and effort trying to recruit U.S. children to do just that. The bet, then, is on advanced weapons keeping the ruling classes of the United States in place as the hegemonic world power. No wonder the rest of the world sees the United States as the greatest threat to world peace.

The former members of the American middle class will not be helped by that hegemony, though. They will have the choice of serving in the war machine or in the civilian work camps.