The Dark Side Part II - Fritz the Cat

The Dark Side Part 2
America’s Secrete Weapon: Consumer Power
Consumer Angst: It’s not just about paying your bills anymore

While not traditionally considered to be part of America’s soft power, the effects of American consumption patterns would seem to be a major cause of the various economic crises around the world today. (Spring 2014)  It was long ago observed that when America sneezed, the world caught cold. Likewise, it could be said that when America quits consuming, the world gets depressed.

In part 1 of the Dark Side I argued that America's politicians, being only human, were corrupt to the bone, and that the American founding fathers devised a system that harnessed that corruption for the common good. I defined corruption, implicitly at least, as the belief in progress at any cost, and the devil take the hindmost.  In this part 2 I will try to show the role of American consumption in America"s drive to empire.
Consumer society arguably began when Henry Ford decided to pay his workers enough so that they could buy the cars they produced. Perhaps he wanted a materialistic argument to use against the idealistic argument of worker"s power put forth by the Russian Bolsheviks, or perhaps it was the logical outcome of the division of labor, the assembly line and mass production.  In any event it was the beginning of the blue collar middle class, backbone of the consumer society.

Traditionally the middle class had been the province of doctors, lawyers, high government officiats, etc. But their preferred status markers, fine homes, books, art, musical instruments, etc., had the disadvantage of not being amenable to mass production, and so not capable of adding to the positive feedback loop required for the exponential growth needed to feed American expansion. For that cars and a certain amount of vulgarity were required. The rat race, and keeping up with the Joneses must be open to everyone in a democratic society.

So the assembly line worker used his wages to pay for the products of other assembly lines. The workers got a cut, the owners got a cut, and the government taxed them both. It was a machine, and the government’s job was to keep it well oiled. When the machine required more consumption, the government favored labor, when it required more production, the government favored management, always with an eye to the bottom line, taxable income.

Key to understanding the privileged position the American consumer has within America  Inc is the easy convertibility of a production line making consumer goods into one producing war material. Whether Henry Ford and the others who built the American auto industry had this in mind is arguable. That Adolph Hitler had it in mind when he convinced the Porsche family to produce a car for the masses, the Volkswagen, seems less debatable. Modern society is mass production, mass consumption, and mass taxation, all in the service of modern war.

So the production lines producing consumer goods of the 30s were easily converted into the production lines producing war material of the 40s, and back again to producing consumer goods of the 50s. Another plus is when industry can produce consumer goods and war material off the same production line, as was done with the Hummer, where the same basic frame, body, and engine could be seen in the suburbs of America and the battle fields of Iraq.

At the post WW2 Bretton Woods conference the U.S. re-made the world into our own image, as consumers. The U.S. would loan Europe and lapan the money to rebuild the cities we had bombed. Every year the interest on these loans took a big bite out of their GDP and added it to ours. If memory serves, it was at Bretton Woods that the U.S. devalued the dollar by setting the value of gold at 35 dollars an ounce, down from 40 dollars an ounce, thus creating, at the stroke of a pen, all the money we would lend the world.

In the same way Henry Ford promised his workers something the Bolsheviks could not, Le. the keys to a new car, the rebuilding of Western Europe showed the eastern workers what they were missing out on by not being part of the club. A steady stream of them entered the Soviet sector of Berlin, and left via one of the western sectors, forcing construction of the Berlin Wall, an explicit admission of failure. Did the west purposely leave a divided Berlin in the eastern part of a divided Germany as some sort of Trojan horse?

Empirical evidence shows that revolutions do not occur under conditions of the most abject poverty, for then al¡ one's energy is used acquiring food. It is when ¡¡fe has been getting better and then begins getting worse that people start demonstrating, looking for scapegoats, and rebelling. Easy credit is the surest way to create prosperity in the short run, and in the U.S. the short term credit is in the hands of the Federal Reserve Board, and nowhere else. Both the Roaring 20s and the long economic expansion starting with Reagan and continuing until the crash of 2005 were the result of easy credit, and the easy credit available to the U.S. consumer was largely spent on products made in the third world, spreading a degree of affluence around the world.

China was especially favored as a source of consumer goods, being blessed with an entrepreneurial spirit and a mass of hard working, low paid labor. Crucial to the U.S., China’s billion people were led by a small coterie of bureaucrats and their sycophants, ensuring that any creativity rising from below would be suppressed rather than unleashed, a recipe for the middle income trap (to be described below), and unceasing turmoil when millions of aspirations are frustrated, as surely will happen when America Inc. stops consuming the products they are so busy assembling.

Intellectual author of the ideology of easy money is John Maynard Keynes. Keynes, writing in the 1930s, attempting an explanation of the Great Depression, articulated what became known as the "demand" side of economic theory, which argued that it was the consumption side of the consumption production equation that should receive priority in the government’s attention. Keynesian economic theory was, on the surface an attempt to damp down the capitalist business cycle by withdrawing money from the business cycle during its boom phase, and injecting that money back into the system during the bust phase, through welfare, unemployment insurance, government grants'(i.e. pell), etc. This money in the hands of the working an d middle class, so the argument went, would rapidly be spent on consumer goods, which the "supply" side would automatically begin to fill by hiring the workers needed for production, their wages adding to the demand, requiring more workers, etc.

In addition the government stimulated the demand side by adjusting the interest rate downward. This was done by the Federal Reserve Board, made up of 8 of the 14 presidents of the Federal Reserve Banks and a chairman appointed by the U.S.

President  Nominally separate from the government in its day to day activity, the majority of the Fed must be convinced of the wisdom of the chairman’s proposals. The Fed is governed by statutes passed by the Congress stipulating broad goals, currently a stable dollar and low inflation. Guarding against financial "bubbles" is not part of its remit, and is anyway fruitless in a market economy, so the argument goes. The Fed was created by Congress in 1913, and Congress sets its goals and could dissolve it. The Fed’s board members are appointed for 14 year terms.

Growth of the economy is good, but excess growth is bad, as it leads to inflation. Excess growth is when the productive capacity is being used at or very near 100%, and productivity per worker, i.e. production divided by worker's wages, is stagnant or falling. Two interconnected things happen when growth is in excess: consumers bid up prices and workers bid up wages. Together, if not handled properly, they lead to hyper as happened in Weimar Germany after WW1, destroying the middle class and fueling extremism. Inflation last started getting out of hand in the U.S. during the Carter administration, from 1976 to 1980, probably as the result of Presidents Johnson (1962 and Nixon (1968-1974) efforts to fund the unpopular Vietnam conflict without raising taxes.

If decreasing the short term interest to slow the decent into the trough of the business cycle, and taxation and raising the short term rate are Keynesian remedies for excess growth, then there is another unacknowledged (or misrepresented) lever of government control over business, and that is regulation. My argument that consumption patterns are a component of U.S. government soft power depends on the government being able to throttle up consumption (primarily through easy credit) and choke it off (primarily through tight money and government regulations). Obviously, more consumption is an easy sell to anyone who has bought into the American Dream, and not consuming is the very antithesis of that dream and is something that must be pushed off as either accidental or due to the mismanagement off the other party.

Deregulation of business under Reagan (1980-1988) is credited, at least by Reaganites, for the long business boom during his administration, but deregulation started under Jerry Ford and continued under Carter. What Reagan did that his two predecessors did not do was deregulate the labor market, which he did by breaking the labor unions. As economic theory before Reagan had favored the demand side, economic theory under Reagan favored the supply side. The cost of labor is typically 30% of total production costs, and changing from union to non-union labor can cut up to 1/3 of that cost. Reagan got the ball rolling by firing the striking Professional Air Traffic Controllers Organization (PATCO), (striking is something government employees are forbidden to do). Realizing that Reagan had their backs covered, management started its assault on labor, and wages started trickling down, and have yet to recover.

This was the start of the blue collar middle classes' slow steady decline. I remember thinking at the time, "but who is going to buy their stuff"? One answer was the third world, and the Asian Tigers, South Korea, Thailand, and Taiwan, grew its middle class and began consuming, as did Mexico and Chile, and more recently the BRICs, Brazil, Russia, India and China. Of course they could never replace the American consumer because low wages is what attracted manufacturing to the third world in the first place.

Following Reagan carne Bush the elder, and America's deindustrialization began to hit home, as tax revenue declined the budget deficit grew, and as we increasingly bought from the third world instead of selling there our balance of payments went into deficit, fueling a runaway national debt. Under more normal assumptions it would seem strange for the U.S. government to give tax breaks to companies that moved overseas at this time, as happened, but if, as I am arguing, the intention was to throw the world into depression, then it makes sense.

Recall my new money-old money argument from the first part of the Dark Side. In it I assumed that manufacturing, under the protection of the Democratic Party, had dominated the U.S., and so world, economy from the time of Henry Ford until the late 60s-early 70s, when it was displaced by Big Oil, under Republican Party sponsorship. At this point the Democratic Party had to find a new cash cow, and fastened of a consortium led by Wall Street, with Silicon Valley, the Hollywood-NYC entertainment-information complex backing them up, and al¡ things green serving as a kind of window dressing.

The Democratic Party was not caught flat footed by manufacturing's demise. Indeed, this demise may have been either planned or assumed as a foregone conclusion, because given the assumptions governing modern society (the division of labor, the drive for empire, progress at al¡ costs and the devil take the hindmost), it was bound to happen, as is the purport of this paper. It has been said (probably by a politician) that generals always fight the last was. True or not, The U.S. founding fathers, in their wisdom, placed ultimate control of the military in the hands of politicians.

As part of my argument 1 will assume the validity of the so called "middle income trap". Under that theory a large part of the developing world has followed the consumptionist path laid out at Bretton Woods, and has managed to raise the income level of its citizens, (and so its tax base) to some substantial (30-50%) part of the first world level. The first country to fall into the middle income trap was probably South Korea, followed by the other Asian Tigers. These became role models for other developing countries to follow.

The middle income trap is part of the globalization process examined in Part 1 of the Dark Side. The earliest part of the process is the construction of an infrastructure. The workers must be forced to work for subsistence wages in this part of the trap, and so an authoritarian regime is required. After the infrastructure is constructed attention can be given to the construction of productive facilities (factories, export agriculture, etc.) which produce a profit that can be shared with the workers. At this point some variant of democracy is necessary for the development of a merit based middle class, itself necessary for the full development of the country, because under an authoritarian regime the self-reliance, risk taking, postponement of rewards, and other hallmarks of a merit based middle class are discouraged as a threat to the existing leadership.

The middle income trap is sprung at this point when the U.S., as leader of the IMF and World Bank, who loaned the money to get them this far, refuses to fund the research universities and research and development facilities which would allow these countries to develop their own innovations, where the future (and big money) lies, and instead encourages the "brain drain" of the best and brightest to the U.S. Probably not 1 in 50 returns, lured by the carrot of the U.S. standard of living and opportunity, and the stick of high crime and lack of opportunity in their home country. And fools think the U.S. is in inevitable decline. Hardly! Henry Ford and others developed the production techniques that allowed the U.S. to come out of WW2 the strongest power in the world. We can now afford to slough off these production techniques, the better to concentrate on the production techniques that will win the next war, probably those developed by Steve Jobs, Bill Gates, and others in Silicon Valley. Only a Ross Perot, rich enough to fund his own campaign, but not conversant with current thought, could run a presidential campaign on the platform of bringing manufacturing back to the U.S. That is so 20 th Century. He did split the Republican vote and allow Bill Clinton to beat Bush the elder.

The Silicon Dot Com boom began with Clinton"s election and ended with Bush Jr’s. The Democratic machine focused government largess on Silicon Valley, creating hundreds of millionaires and a few billionaires, who were taxed heavily, but the taxable income of the Dot Com companies was pitiful in comparison to the $85 million a day in fees, taxes, and royalties paid to the Treasury Dept. every day by the petroleum industry.

The revenue made by the primary leg of the Democratic New Money cash cow, the banking industry, was substantial, but much of that profit was made on loans to overseas governments and companies, and was not taxable until repatriated. As there was not much use for that money in the U.S. at that time, that money stood, and still stands, in offshore tax havens, to the tune of $18 trillion.

New money’s third leg, the information-entertainment complex, with its "fiction" segment located in Hollywood, and its "non-fiction" segment located in NYC, is probably never going to be a big tax payer, but the consensus it contrives to establish is absolutely necessary for the maintenance of that version of reality without which the machine stops. If my argument has been at all convincing thus far, there should be no need to explain the "scare quotes" put around fiction and non-fiction. How could there be such a distinction in the manufactured reality we live in? Is the Great Recession we are going through now fiction or non-fiction? I am arguing that we are living through a script written at Bretton Woods in 1946, at the creation of America Inc.

Recall that in part 1 of the Dark Side 1 suggested that this does not go back to Bretton Woods, it goes back to Plato and Aristotle. We pretend to be a caring people, and at some leve¡ that is true, but we care first about ourselves and then hierarchically down through family, friends, countrymen, and the devil take the hindmost, especially if the script says he is the enemy. This is the Abyss we are looking into, the human soul. Nietzsche said if you look into the abyss long enough, it looks back at you. He also said we need more of the abyss, not less. How much of Socrates' poisoned chalice can you stand? Heidegger, following Nietzsche, says we are on the cusp of a leap into a new phase of being, of a mystery inaccessible to the reality we consider every day, much like the fish who didn't realize he was swimming in water until he crawled out onto dry land. Anyone who wants to follow that argument (which is not separate from this argument) should read the Heidegger part of It www.fritzthecat.net.

But now I must, finally, put my keystone in place. I've mentioned it before, the housing crisis. Many books have been written about it, so I'll be brief. The books I've read are "The Big Short" by Michael Lewis, and "Financial¡ Shock" by Mark Zandi. A related book about Wall Street malfeasance is "A License To Steal" by Ben Stein. There are others. The following section of the Savings and Loan crisis and the sub-prime crisis follows pages 247 in Niall Furgeson's "The Ascent of Money".

Government supported housing started with F.D. Roosevelt's New Deal in the early 30s, as FDR sought to re-invent capitalism, giving the working and middle classes more of a stake in the American democratic experiment. In 1932 the Federal Home Loan Bank was set up to encourage and oversee local mortgage lenders known as Savings and Loans. To encourage lenders traumatized by bank failures in the previous decade FDR created the Federal Deposit Insurance Corporation (FDIC), which in the event of a bank failure would take over the bank's assets (its loans, which collected interest) and its liabilities (its deposits, on which it paid interest, and its cash on hand, which paid no interest).

The next step was the Federal Housing Administration, created in 1938 which, by providing loans to non-savings and loans banks, sought to encourage long (20 year) low interest home loans. The Federal national Mortgage Association (Fannie Mae) was authorized by Congress to issue bonds and use the proceedings to buy mortgages from local Savings and Loans under conditions which reduced the average monthly payment, making home ownership possible for many more Americans, and fostering creation of the suburb, a sort of mass marketed, mass produced home buillding system on some level equivalent to an assembly line.

After WW2 home ownership and home mortgage debt soared, home ownership growing from 40% after WW2 to 60% by 1960. A fly appeared in the ointment when banks began charging some customers a higher interest rate, in theory because of their credit rating, in reality because of their race. A red line was drawn around predominantly black areas, and home mortgages in that area cost more. In 1968 a part of Fannie Mae was chartered to deal with veterans and the poor, called the Government National Mortgage Association (Ginnie Mae). Two years later the Federal Loan Home Mortgage Association (Freddie Mac) was set up to give Ginnie Mae some competition. Red lining on the basis of race became a federal offence. In 1977 under the Community Redevelopment Act banks carne under statutory pressure to lend to minority communities.

The Savings and Loans were required to pay no more than 3% on deposits and write 20 year mortgages at 6%. When interest rates rose above 6% in the late 60s and early 70s, the borrower repaid less, in real dollars, than he borrowed. By 1979 interest rate reached 13.3% and Federal Reserve Board Chairman raised interest rates. The government gave S&Ls tax breaks and deregulated them, but they couldn't compete with the higher rates paid by money market funds, and the high interest rates dried up the housing market. Deregulation from the early 80s on allowed the S&Ls to invest in whatever they liked, not just long term home mortgages, fueling a market for commercial property, stocks, junk bonds, and anything else that caught their fancy. At the same time the government raised the amount guaranteed to $100,000. The S&Ls could also sell brokered loans put together by middle men as certificates of deposit with alluringly high interest rates, and since they were government guaranteed, they could invest in highly dubious business propositions with no risk to themselves. The result was a property boom with plenty of buildings but no buyers. The S&L industry became awash in long term loans to insider using money borrowed short term from outsiders. The temptation to corruption overcame the entire industry, with campaign contributions to politicians delaying the day of reckoning. By 1986 it became clear that the government agency insuring the deposits was itself insolvent. By the early 90s nearly 500 S&Ls went bankrupt or were forced to close down and a similar number forced to merge by the Resolution Trust Corporation set up by Congress to clear up the mess. One estimate was that nearly half of the insolvent institutions had seen fraud and potentially criminal conduct by insiders. By 1991 764 people had been charged, 550 convicted, and 326 sentenced to jail. The final cost of cleaning up the S&L mess was $153 billion, of which the taxpayer paid $124 billion.

The next step in this macabre dance was taken by Wall Street. When the desperate S&Ls sought to unload some of their loans ¡in an effort to stay solvent a clever fellow at Solomon Brothers reinvented the home mortgage by bundling thousands of them together in a new security that could be sold as an alternative to government and corporate bonds. Once bundled the interest payments due on the mortgages could be divided into strips with different maturities and credit risks. The first issue of these "collateralized mortgage obligations" occurred in 1983.

This process was known as securitization, and the majority of the mortgages so securitized enjoyed an implicit government guarantee by the government sponsored Freddy, Fannie, and Ginnie, giving the rating agencies a green light to give them an investment grade rating. Between 1983 and 2007 the volume of such securities grew from $200 million to $4 trillion. Private Wall Street bond insurers insured an additional $2 trillion of loans that didn't meet government qualifications.

The boom in the housing market left a lot of homes empty. To fill these homes brokers started offering mortgages to people with poor credit ratings, the so called sub-prime loans. Many of these were interest only loans, and a high percentage of these were adjustable rate mortgages, with an introductory low interest rate that jumped significantly, usually after two years. In some low income zip codes these sub-prime loans could amount to 50% of al¡ mortgages. Many of these sub-primes refinanced existing loans, allowing borrowers to take equity out of their homes in cash. Between 1997 and 2006 U.S. consumers withdrew and estimated $9 trillion in cash out of their homes. By the first quarter of 2006 home equity extraction amounted to nearly 10% of disposable personal income.

In 2003 President Bush signed the American Dream Down payment Act which subsidized first time home ownership among lower income groups. Lenders were pressured by the administration not to press borrowers for full documentation. Fannie Mae and Freddy Mac carne under pressure from the Dept. of Housing and Urban Development (HUD) to support the sub-prime market. Congress had mandated Freddy Mac and Fannie Mae to make housing affordable and in 1992 they began meeting quotas for sub-prime loans, starting at 30% and reaching 56% in 2008.

As a business model sub-prime lending worked beautifully, as long as interest rates stayed low, people kept their jobs, and property prices continued to rise. The originator of these loans pocketed a hefty commission and quickly sold them to Wall Street bankers who bundled them into "residential mortgage backed securities" (RMBSs) and "collateralized debt obligations" (CDOs), and Moodys and Standard and Poors gave them a Triple A investment grade rating. Sub-prime to top of the line through the magic of Wall Street and an implicit government guarantee.

As soon as the teaser rate ran out the sub-primes often began defaulting. As early as

March of 2007 foreclosures or the threat thereof burst the housing bubble and prices began to fall. Soon a majority of the sub-prime loans were worth more than the houses they represented.  By May 2008 1.8 million U.S. mortgages were in default, and an estimated 9 million U.S. homes had fallen into negative equity. Most analysts put the beginning of the sub-prime crisis at June of 2007, when two hedge firms owned by Bear Stearns were asked to put up additional collateral, and one collapsed. When the rating agencies began to downgrade al¡ RMBS CDOs disaster loomed, especially to the heavily leveraged hedge funds. Across America estimated losses amounted to $1 trillion.

Freddie Mack, as a government supported enterprise, was required to report its doings to a congressional committee, and in June of 2008 it was forced to correct some of its reports. It now admitted to $244 billion in sub-prime loans rather than the $6 billion it had previously reported. And Freddie had $541 billion in Alt-A loans rather than the $190 billion reported. There were 28 million sub-prime and Alt-A loans outstanding as of June 30, 2008 valued at $4.8 trillion, some Y2of the mortgages in the U.S., 74% of which are on the government books.

Between Oct. 2007 and Oct. 2011 investors lost $4 trillion. At the same time home owners have seen the value of their homes fall to the tune of $7 trillion. In 2007 the U.S  debt hit a record $2.5 trillion. The bank assets (loans) of the world's major economies are equal to 150% of those country's combined GDP. Total investment banking assets in Dec. 2006 were equivalent to $29 trillion, roughly 63% of the world's GDP.

1 have placed the housing crisis at the center of my theory not because of its absolute magnitude. That dubious honor probably belongs to the derivative market, which grew to over $600 trillion before the 08 crisis. But derivatives are not the main investment vehicle of the majority of the middle class, do not pluck at the heart strings like home ownership, are the province of sophisticated investors, hedge funds and private wealth management firms, the George Soros investors of the world, etc. Derivatives are not government regulated and not government guaranteed, and anyway, that shoe has yet to drop, it has yet to go through its Bear Stearns moment. Finally, I can't place the derivatives market in America Inc.'s drive to empire. It may have a place, but I haven't had my-ha moment yet.
An important adjunct to the home loan crisis in America Inc.'s drive to empire is the student loan and credit card crises. In the 3 rd quarter of 2011 the American public had an outstanding credit card debt of $700 billion. Student loan debt now exceeds $1 trillion. Fewer than 60% of freshmen graduate within 6 years. For 25% of borrowers annual repayment exceeds $4,500. Default rates are 9%, and defaulted borrowers may be sued, tax refunds may be intercepted, and or wages may be garnished. Bankruptcy proceedings are not available to credit card and student loan debts.

The world remains in a badly contained slump. As of Aug. 2012 industrial output was still below its previous peaks in Germany (-2%), U.S. (-3), Canada (-8), France (9), Sweden (-10), Britain (-11), Belgium (-12), Japan (-15), Hungary (-15), Italy (-17), Spain (-22), Greece (-27), al¡ according to St. Louis Reserve Bank Data. The U.S. is $18 trillion in debt and faces $100 trillion in unfunded liabilities. In 2011 nearly 1/3 of government revenue in Italy, Greece, and Japan were spent on pensions. One in four Italians is on a pension. In 2012 76,000 Irish left their country. Data from German statistics show that migration from Greece and Spain to Germany grew by 84% and 49% respectively in the first half of 2011. Between 2000 and 2010 German labor cost remained stable, while Greece's rose nearly 37% and Italy and Spain's by nearly 30%. 30% of Greece"s and Italy"s economy is off the books.

The world’s economy has improved since 2011, but still remains on tender hooks, only one financial shock or political crisis away from another massive stock market sell-off that governments seem to take as carte-blanche to do almost anything. The 2nd week of April 2014 saw a 2% stock market sell-off around the world, reportedly due to Russian threats to Ukraine. Will Putin, an insignificant mid-level KGB bureaucrat not that long ago, allows his ego to be inflated by the western media to the point where he believes he can restore Russian glory on the cheap, as if an idealistic, if ineffectual intellectual like Obama (or Woodrow Wilson or Nevil Chamberlain) was all that stood in his way? Will a Russian invasion of Ukraine be enough to set off a powder keg, or will Putin be fed a little more rope with which to hang himself?.