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Introduction
A few days ago, Kay M brought to my attention an OP-ED piece in the Boston Herald by Stephen Roach, chief economist at Morgan Stanley. Roach asked whether economic Armageddon was imminent While I never paid much attention to the forever ultra-conservative Herald, I was surprised to see a similar OP-ED in the New York Times, Nov 26, 2004. Roach, a perma-bear, also outlined his views in the Nov 26 Morgan Stanley digest. Today, the New York Times printed an analysis of Bush's Social Security privatization.

Introduction

A few days ago, Kay M brought to my attention an OP-ED piece in the Boston Herald by Stephen Roach, chief economist at Morgan Stanley. Roach asked whether economic Armageddon was imminent While I never paid much attention to the forever ultra-conservative Herald, I was surprised to see a similar OP-ED in the New York Times, Nov 26, 2004. Roach, a perma-bear, also outlined his views in the Nov 26 Morgan Stanley digest.

Today, the New York Times printed an analysis of Bush's Social Security privatization.

Business Week has also repeatedly brought up the issue of the falling U.S. dollar, and most recently "The China Price" (BW, 12/6/2004).

What have these things to do with anything? Just everything, that's all.

Roach's scenario of doom involves a rapidly falling dollar. He may be correct about it, if the dollar falls rapidly, because the present circumstances are similar to those in 1930. Then, Hoover and the Congress adopted the infamous Smoot-Hawley tariff which is thought to have globalized the American recession. In addition to the tariffs, Hoover sought to balance the budget by decreasing spending, rather than increasing spending while raising taxes or just printing money; thus, the Republican-induced Great Depression began. [I think young Americans have never learned why Americans who suffered in the Depression (most of them) would never vote for Republicans. For a decade or more after the Great Depression, "business," "businessman," Hoover and Republican were dirty words. Try being poor; you'll see what they meant.]

A rapid fall in the currency amounts to the same thing as imposing a tariff, because the effect of both devices is to raise the price of imports while lowering the price of exports. The idea is to take business away from some trading partners (foreigners), and give it to others (your friends at home). For that reason, such policies are usually part of a 'beggar thy neighbor' strategy. In this case, the ones on the beggaring block are the Europeans, whose currency has risen the most with respect to the dollar. So far, the Chinese have escaped because the Renminbi is pegged to the dollar. The Japanese have spent Yen fortunes buying U.S. dollars, so that Japanese exports will remain saleable.

In the 1930s, neither Europe nor Japan was in recession or Depression very long. Only the United States continued to have a Great Depression after 1935. The French suffered the least, as they benefitted from Germany's woe and bourgeois Socialism (decadence) during the 1930s. The Great Depression lasted a long time in the United States because of self-inflicted wounds, such as Smoot-Hawley. In addition, it was the U.S. financial community that had floated the Weimar Republic debt, which was enormous due to the Versailles Treaty. Hitler repudiated the debt, thus voiding interest income to American bond holders and, eventually, their principal as well. All of that income and capital was thus unavailable for domestic re-investment. This deficiency was compounded by the American adversity to Keynesian economics, even in Roosevelt's White House. Full blown Keynesian policies were not implemented until World War II started, elsewhere, in 1939. By the time Japan attacked Pearl Harbor two years later, the U.S. economy was already at full tilt. (In other words, it was not WWII that saved the U.S. from the Depression. Nonetheless, the myth persists that war-spending boosts the economy.)

Again, in our present times, the declining dollar could have the same effect as Smoot-Hawley, but those to be beggared are different. The Bush authorities and Wall St want China to float the Yuan (Renminbi), thus (they hope) increasing its value. That would stop Chinese imports, which as the current BW issue has it, set "the China price." That low price is ruining American corporations, which find themselves unable to compete. To avoid going out of business, U.S. multi-nationals have adopted a strategy of playing the middle man. They build factories in China, or invest in China, or buy Chinese products, and then sell what is produced in America. This, of course, eliminates U.S. jobs, and eventually brings down the U.S. economy (for lack of purchasing power); but, in the meantime, there is at least a sales commission income. (Note: the Japanese and Koreans have an unbreakable lock on mass transport by sea (shipping), even if FedEX and UPS dominate the air.)

While U.S. authorities want to beggar China, in reality the main losers so far are the Europeans. That's because the Euro continues to rise, as the EU is unwilling to buy enough American securities to compensate for the increased American debt. Only the Japanese follow some Code of Bushido that impels them (suicidally, I think) to buy dollars, thus reducing pressure on the Yen. But, the European discomfort may be only temporary, as the biggest long-term losers in the event of American default would be the Japanese and, secondarily, the Chinese. To escape that fate, both China and Russia are considering dumping the dollar and moving to Euros or a basket of currencies. That would leave Japan - currently the United States most stalwart economic ally - holding the bag. Unless, that is, the Japanese already see the handwriting on the wall, as evidenced in their increased investments in China and India rather than America. Of course, the largest American corporations are doing exactly the same thing: investing in China and India. (As reported in BW last week, the Indian outsourcing bonanza restarted on Nov 3, and Indian stocks have risen outrageously since Bush's re-election.)

Is this a confusing story with too many threads? I hope not, but let me simplify it a little. First, the end result is another Great Depression in the United States. What the story tells is how all that would (will) happen. The key point is the relationship of easy credit and insufficient purchasing power. Americans want to lead the Good Life, which they take to be a life filled with things. Very few Americans are satisfied by a classical painting or symphony, historical monument, or great novel; they want toys, lots of them, big and small, preferably aggressively noisy. But, scarcely anyone could afford a Ferrari or a Hummer, except for the miracle of credit. Easy credit makes dreams come true, provided those dreams don't require invention or creativity, for only $399 per month. Of course, someone has to provide the credit and someone has to make the toys. When the toys were made in the United States, ordinary people earned an income ("wages" ) that allowed them to keep up with their credit payments. That income derived from wages squeezed corporate profits, so the jobs were moved elsewhere. Corporate profits rose, but net income to American workers decreased. To prevent bankruptcy, home equity loans were made available in massive amounts at lower rates, thus stretching out the payments on credit debt and offering real security to lenders in the event of default. In other times, all of this would have been recognized as a transfer of property to wealthy people and corporations; i.e., dispossession.

In the end, an autocratic elite ends up owning most of everything while the rest of the people are lucky to get by. In case you wanted to know, we are already far down that trail. The top 10% by wealth now own 90% of everything, including most of the houses workers occupy. The people at the top won't be severely affected by another bad depression in America, because they can flee to other places where they can live off their Swiss Bank Accounts. Unless, of course, those other places decide to fleece them,. too.

What does Bush's Social Security privatization have to do with the foregoing? It's going to be one of the main causes of increased debt and decreased income all at once. The decreased income comes about because (a) those who subscribe to privatized accounts will get a cut in benefits of about 1/3 - 1/2, and (b) pensioners will have to depend almost entirely on their investments for most of their benefits. Not all retirees will benefit from the increased market value of private investments, because that value will change from time to time (boom and bust) and because not everyone will be a winner (make good investments). The reduced tax income under Bush's plan would be made up by issuing more debt instruments, which would also have the effect of increasing interest rates.

Thus, we have a potent mixture of reduced income and increasing debt, while prices rise due to the dollar's fall. This is somewhat like the circumstances of Weimar Germany. The historical question is whether similar causes lead to similar results.

From the Herald:

Economic `Armageddon' predicted

By Brett Arends/ On State Street
Tuesday, November 23, 2004

Stephen Roach, the chief economist at investment banking giant Morgan Stanley, has a public reputation for being bearish. But you should hear what he's saying in private.

Roach met select groups of fund managers downtown last week, including a group at Fidelity. His prediction: America has no better than a 10 percent chance of avoiding economic ``armageddon.''

Press were not allowed into the meetings. But the Herald has obtained a copy of Roach's presentation. A stunned source who was at one meeting said, ``it struck me how extreme he was - much more, it seemed to me, than in public.''

Roach sees a 30 percent chance of a slump soon and a 60 percent chance that ``we'll muddle through for a while and delay the eventual armageddon.'' The chance we'll get through OK: one in 10. Maybe.

In a nutshell, Roach's argument is that America's record trade deficit means the dollar will keep falling. To keep foreigners buying T-bills and prevent a resulting rise in inflation, Federal Reserve Chairman Alan Greenspan will be forced to raise interest rates further and faster than he wants.

The result: U.S. consumers, who are in debt up to their eyeballs, will get pounded. Less a case of ``Armageddon,'' maybe, than of a ``Perfect Storm.'' Roach marshaled alarming facts to support his argument.

To finance its current account deficit with the rest of the world, he said, America has to import $2.6 billion in cash. Every working day. That is an amazing 80 percent of the entire world's net savings. Sustainable? Hardly.

Meanwhile, he notes that household debt is at record levels. Twenty years ago the total debt of U.S. households was equal to half the size of the economy. Today the figure is 85 percent. Nearly half of new mortgage borrowing is at flexible interest rates, leaving borrowers much more vulnerable to rate hikes. Americans are already spending a record share of disposable income paying their interest bills. And interest rates haven't even risen much yet.

You don't have to ask a Wall Street economist to know this, of course. Watch people wielding their credit cards this Christmas. Roach's analysis isn't entirely new. But recent events give it extra force. The dollar is hitting fresh lows against currencies from the yen to the euro. Its parachute failed to open over the weekend, when a meeting of the world's top finance ministers produced no promise of concerted intervention. It has farther to fall, especially against Asian currencies, analysts agree. The Fed chairman was drawn to warn on the dollar, and interest rates, on Friday.

Roach could not be reached for comment yesterday. A source who heard the presentation concluded that a ``spectacular wave of bankruptcies'' is possible. Smart people downtown agree with much of the analysis. It is undeniable that America is living in a ``debt bubble'' of record proportions. But they argue there may be an alternative scenario to Roach's. Greenspan might instead deliberately allow the dollar to slump and inflation to rise, whittling away at the value of today's consumer debts in real terms. Inflation of 7 percent a year halves ``real'' values in a decade. It may be the only way out of the trap.

Higher interest rates, or higher inflation: Either way, the biggest losers will be long-term lenders at fixed interest rates. You wouldn't want to hold 30-year Treasuries, which today yield just 4.83 percent.

From the Times:

Vast Borrowing Seen in Altering Social Security

By RICHARD W. STEVENSON
Published: November 28, 2004

Washington, Nov 27 - White House and Republicans in Congress are all but certain to embrace large-scale government borrowing to help finance President Bush's plan to create personal investment accounts in Social Security, according to administration officials, members of Congress and independent analysts.

The White House says it has made no decisions about how to pay for establishing the accounts, and among Republicans on Capitol Hill there are divergent opinions about how much borrowing would be prudent at a time when the government is running large budget deficits. Many Democrats say that the costs associated with setting up personal accounts just make Social Security's financial problems worse, and that the United States can scarcely afford to add to its rapidly growing national debt.

But proponents of Mr. Bush's effort to make investment accounts the centerpiece of an overhaul of the retirement system said there were no realistic alternatives to some increases in borrowing, a requirement the White House is beginning to acknowledge.

...

Borrowing by the government could be necessary to establish the personal accounts because of the way Social Security pays for benefits. Under the current system, the payroll tax levied on workers goes to benefits for people who are already retired. Personal accounts would be paid for out of the same pool of money; they would allow workers to divert a portion of their payroll taxes into accounts invested in mutual funds or other investments.

The money going into the accounts would therefore no longer be available to pay benefits to current retirees. The shortfall would have to be made up somehow to preserve benefits for people who are already retired during the transition from one system to the other, and by nearly all estimates there is no way to make it up without relying at least in part on government borrowing.

Greed, Gluttony and Gold