I don’t want to just end the [Iraq] war, but I want to end the mind-set that got us into war in the first place.
– Presidential candidate Barack Obama, January 31, 2008

Behind the ostensible government sits enthroned an invisible government owing no allegiance and acknowledging no responsibility to the people.
– Theodore Roosevelt (1882-1945), 26th US president

If we are strong, our character will speak for itself. If we are weak, words will be of no help.
– John F. Kennedy (1917-1963), 35th US President

If the Nuremberg laws were applied, then every post-war American president would have been hanged.
– Noam Chomsky, linguist and political expert

Barack H. Obama was a good presidential candidate but, so far, in crucial areas, he has been a somewhat disappointing president.

In November 2008, Democratic presidential candidate Barack H. Obama, and the first black American to have that chance, got to the U.S. presidency on the coattails of a despised Bush-Cheney administration. Indeed, it was a relief for a majority of Americans to have Senator Obama replace “facts-do-not-matter” George W. Bush as president of the United States. His Republican opponent, Sen. John McCain was little more than a Bush-retread. It was therefore unavoidable that such an election would generate big expectations that things would change for the better. As a matter of fact, candidate Obama’s electoral slogans were “Yes we can” and “change we can believe in”.

Because President Obama is America’s first black President, he is symbolically the culmination of Martin Luther King’s Civil Rights movement. Because of that, many have hesitated to criticize him or his administration. But his record, so far, speaks for itself. In two central areas, defense and the economy, his performance has been, at best, lackluster. In fact, Obama’s performance in these areas has betrayed a lot of highly held expectations.

He seems to have been ill prepared for such a big time job. It is true that the function of president of the United States, as the country becomes more and more a militaristic empire and less and less a democratic republic, is most demanding. Possibly, nobody can be qualified and prepared enough for such a challenge.

In Obama’s case, he was promoted from being a junior senator with a limited staff (one secretary and a few assistants), and no real administrative experience, to running the huge U.S. government with its three trillion dollar budget. And, moreover, he had not had the time or the wisdom to build around him a strong enough “brain-trust” to intellectually control the agenda. Rather the agenda seems to have been imposed upon him. It can be said that he asked for it when, after moving into office, his first move was to keep at their job key Bush appointees to implement the all-too-important defense and economic policies. As it is said in French “Plus ça change, plus c’est pareil” (The more things change, the more they remain the same!)

In Obama’s case, the disappointment is not only a question of poor performance due to a lack of depth, formation or experience. It is a question of promises not kept and of vision betrayed. The disappointment is palpable in polls. His job approval rating hovers around 50 percent (only 45 percent of adults), while only 43 percent of Americans say they would vote to reelect him, and 48 percent say they would vote for someone else. Obama’s performance has reinforced the cynicism and disillusion felt by many voters and their uneasy feeling that most politicians are either corrupt, incompetent, deceitful or hypocrites, or all of the above. In such an environment, it appears to many that voting has become a waste of time. Voter turnout in the U.S., already one of the lowest in the world, may take a turn for the worse if confidence is not restored soon. On that score, the 2010 turnout should be watched closely, especially among young disillusioned voters.

As far as foreign wars are concerned, Obama’s record is less than positive. Although there has been a timid beginning of troop withdrawals in Iraq—notwithstanding the promises—in Afghanistan, things have taken a turn for the worse. Indeed, President Obama has only made things worse in that remote part of the world, by accelerating the killing and by illegally upgrading the killing in Pakistan with the Pentagon’s drones. This is dangerous politics because this open-ended military adventure is all too reminiscent of the Vietnam quagmire that destroyed President Johnson, mired the last days of President Nixon’s term, and tarnished America’s reputation in the world.

Similarly in financial matters. Under Obama, the causes of the 2007-2009 financial crisis have not been clearly identified, let alone corrected or eradicated. Instead, they have been swept under the rug and covered with tax money bailouts and an orgy of newly created money. In fact, just as for defense, President Obama has delegated his economic and financial policies to the troika of Bernanke-Geithner-Summers, just as President Clinton had delegated the same responsibility to the troika of Greenspan-Rubin-Summers, and just as President G. W. Bush had done with the troika of Bernanke-Paulson-Geithner. We cannot help but detecting a pattern here.

It must be recorded that the Bernanke-Geithner-Summers team was deeply involved in the financial deregulation that led to the securization banking crisis and to the subprime mortgage crisis. When one considers the trillions of dollars in public money that have been used to camouflage the large N. Y. banks’ bad debts, it is obvious that the Obama administration has adopted the old political technique of pandering to the rich with the blind support of the poor. (N.B.: The top 23 Wall Street banks and financial firms are expected to hand out a record $140 billion in bonus compensation during this year of 2009—$10 billion more than the previous record year of 2007. It has since been announced that the seven largest bailed out banks may see their bonus plans scaled down, and the Obama admistration should get the benefit of the doubt for this small and possibly symbolic step toward public morality.)

Such practically unconditional bailouts of “too-big-to-fail” banks can be seen as some plush state socialism for the rich, coupled with harsh and unregulated market capitalism for the poor, saddled as they are with unlimited home foreclosures and personal bankruptcies.

The epicenter of the unprecedented banking salvage operation has been the Federal Reserve System, sort of a parallel government with the power to impose hidden taxes. Even more than the Treasury’s generous Troubled Asset Relief Program (TARP) of purchasing preferred equity in troubled banks, and other similar Treasury plans, the bulk of the banking bailouts came from the Federal Reserve system. The list of the Fed’s bailout programs is very long and very complicated and remains mostly off screen, because it is mostly camouflaged within a super-easy monetary policy.

The U.S. Fed is a sort of semi-private central bank that often caters to private banking interests at the expense of the public good. Many Americans realize that the Fed is as much a creator of financial crises as it is an instrument to fight them. In fact, the Fed is presently busy preparing the next big financial crisis, i.e., the collapse of the bond market two or three years from now. That could explain why the remote and mysterious semi-private Fed is the least popular of all American federal institutions, and why grass roots efforts to submit it to a public audit are gaining momentum.

In fact, the U.S. Fed is an institution that has gone much further than the U.S. Treasury in socializing the large N.Y. banks’ losses and in privatizing their huge profits in the hands of profiteers, at a time, especially after the Sept. 15 (2008) demise of Lehman Brothers, when many of them were technically insolvent.

Thus, by buying large amounts of toxic and unmarketable assets from the large N.Y. banks and from large insurers, such as the huge American International Group (AIG), at close to zero cost to them, and by creating new deposits in exchange, and by paying interest on such bank deposits, the Fed has in effect transferred all or most of the seigniorage of money creation from the public to the private sector. Everybody holding U.S. dollars has paid a huge hidden tax imposed by the Fed to salvage the large “too-big-to-fail” N.Y. banks. Sooner or later, somebody will have to calculate that hidden tax and make it public. Most likely, this could only be done if the Fed were to be thoroughly audited, which it has so far staunchly refused.

All and all, and where it counts the most, in matters of wars and peace and in economic matters, things have hardly changed under the new Obama administration. It is likely that an even more pugnacious McCain administration would have been worse, considering Sen. McCain’s public declarations and pronouncements. Nevertheless, this is poor consolation to those who had high expectations and who were led to believe that President Obama’s election would really bring fundamental change.

The liberty of a democracy is not safe if the people tolerate the growth of private power to the point where it becomes stronger than the democratic state itself. That in its essence is fascism — ownership of government by an individual, by a group or any controlling private power.

Franklin D. Roosevelt (1882-1945), 32nd and longest-serving US president

This great and powerful force—the accumulated wealth of the United States—has taken over all the functions of Government, Congress, the issue of money, and banking and the army and navy in order to have a band of mercenaries to do their bidding and protect their stolen property.

Senator Richard Pettigrew, Triumphant Plutocracy, 1922

I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around the banks will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered.

Thomas Jefferson, (1743-1826), 3rd US President, 1802

The U.S. national debt clock is clicking and it is fast approaching the $12 trillion mark, all the while the Fed (less a central bank than the banks’ Bank) is printing new money like crazy and lending it to its client banks at close to zero interest rates (i.e. at negative interest rates). What is wrong with this picture? It simply means that most Americans are losing big at this game, but a handful of mega-banks and their affiliates are raking in tremendous amounts of money in easily made profits.

Indeed, the Federal Reserve’s balance sheet has more than doubled since August 2007, going from $870 billion to more than $2 trillion. It is expected to keep growing as banks avail themselves of the cheap funds the Fed made available to them. The Fed, indeed, has the unique ability to create new dollars (paper currency) for the accounts of assets (good or bad) that it buys from banks, the Treasury, or other entities. This increases the monetary base (the sum of currency plus total banking reserves), and banks through their lending can expand this money supply even further.

And the Fed has been extraordinarily generous to the banks, the largest of them are in fact owners of the twelve regional Fed banks.

In fact, the Fed has broken practically every central banking rule in order to provide cheap funds to the banks. First, it has pushed the fed funds rate to close to zero so banks could have credit at close to zero cost to them. Second, it has expanded the range and quality of assets it stood ready to accept as collateral for its loans to the banks, so much so that it can be said that the U.S. Fed is presently creating new money backed by the shakiest of assets, some being called “toxic waste.” This is reminiscent of the eighteenth century (beginning in 1789) practice of the French revolutionary government of creating new money (the assignats) backed by the seized properties of the Catholic Church.

Let’s summarize quickly the numerous ways the Fed (and to a certain extent, the U.S. Treasury) have found to channel cheap funds to the banks and to brokers. In September 2008, some investment banks, such as Goldman Sachs and J.P. Morgan, officially became commercial banks in order to profit from the Fed’s new generosity.

• The Term Auction Facility (TAF);
• The Primary Dealer Credit Facility (PDCF);
• The Foreign Exchange Swap programs (the currency swap lines);
• The Commercial Paper Funding Facility (CPFF);
• The Term Asset-Backed Securities Loan Facility (TALF);
• The Agency debt, Agency mortgage-backed securities (MBS) and Treasury purchase programs;
• The Treasury’s $700 billion Troubled Asset Relief Program (TARP);
• The payment of interest on the banks’ excess reserves at the Fed.

The last disposition is worthy of attention. Because of the easy and cheap lending to the banks, the latter piled up tremendous amounts of excess reserves at the Fed, reaching more than $700 billion. Normally, banks would quickly lend these non-interest paying excess reserves to the economy. But, in October 2008, the Fed got imaginative and obtained the authority to pay interest on the banks’ reserves, including excess reserves, at a risk-free rate (the IOER rate). Since then, the banks have been earning interest on their excess reserve holdings, and therefore had little inclination to lend those reserves out to creditworthy but nevertheless risky borrowers in the rest of the economy. With this practice, the circle has been closed, and the Fed was able to provide needed funds to the banks, at close to zero cost, and enable them to rid themselves of their bad investments, without risking creating inflation. That’s quite a banking salvage operation that will be studied by economists in detail in the future.

Indeed, it was well understood after the onset of the financial crisis in August 2007, that public capital would be needed to refinance the American banking system. Private capital was too risk adverse to do that. What was less understood was the fact that the Bush administration, and now the Obama administration that continues this policy, intended to provide this capital at close to no cost to the banks and with very scant conditions.

But who really paid and has continued to pay for this imaginative recapitalization of American banks, and who profits the most?

First of all, of course, bank profits, specially those profits by big international banks, have exploded. Bank stocks have followed suit with tremendous gains. That’s why I say the stock market rally since March 5 (2009) has been a liquidity-driven rally, engineered by the Fed.

And it is easy to see why banks raked in so much money: They have been borrowing funds at close to zero cost to themselves and either were paid by the Fed to leave these funds unused or they have used them, with leverage through their hedge fund like activities, to buy interest-paying assets in the U.S. or abroad. In essence, the large “too big to fail” have been allowed to make various trading bets with the cheap public capital provided by the Fed. They gorged themselves with near free public money and used it to enrich themselves, and very little to finance the real economy.

One profitable trade, among others, that large international banks and other operators are found to embrace is a form of arbitrage: They borrow and sell the currency of the country that has the lowest possible short-term funding costs and invest the proceeds in countries whose currency and asset markets yield the most. This has the consequence of depreciating further the currency with low interest rates and of appreciating the other currencies.

During the 1990s, the Japanese economy was in the doldrums. Its short-term interest rates, just as in the U.S. today, were close to zero. International banks and hedge funds would then borrow yens in Japan, sell them for dollars or euros and invest the proceeds in high-yielding financial assets in the U.S. or in Europe. Provided the interest rate environment does not change suddenly, this sort of “carry trade” is an easy way to make money. The result, however, is a more depressed currency than necessary for the low interest rate country and more imported inflation as the price of imported goods (oil, food, commodities…) increases.

The U.S. is presently in that predicament. The U.S. Fed and Treasury have abandoned the U.S. dollar and the large international banks have depressed it further at the same time they fill their coffers. That is why we can say that, besides the profitable carry currency trade that banks and other operators employ to dump the U.S. dollar on foreign exchange markets, this currency will remain under pressure for as long as the spread of short-term interest rates favors other currencies and as long as the spread of expected inflation rates and of expected economic growth remain stable. Paradoxically, longer-term interest rates have only increased marginally. This is because banks and other Fed borrowers, when they do not leave their low interest-paying excess reserves dormant at the Fed, can buy risk-free Treasury bonds. This has the consequence of depressing longer-term interest rates and of boosting stock market prices, even as inflation expectations are on the rise.

What is to be understood is that the weak dollar is the direct consequence of the Fed’s extraordinary cheap money policy. To summarize, the average American household is being hit from all sides with this policy. First, if it is a net creditor (as most retirees are), its savings are earning paltry returns (most likely negative after inflation and taxes). Second, the U.S. dollar keeps falling in value, raising the cost of traveling abroad and of everything that is imported. Third, real incomes fall with rising prices as the purchasing power of stable or declining money incomes contracts. Fourth, the exploding public debt will translate sooner or later into higher taxes, thus reducing private disposable incomes. All in all, the standard of living of most people falls.

Don’t get me wrong. I do not question the need to inject liquidity into the banking system after the onset of the financial crisis in August 2007. What I question is the way this was done and how the public interest was sacrificed in favor of narrow private interests. Indeed it was done in the worst possible social way, with private gains and social costs. They (the Bush and Obama administrations) recapitalized the banks to the benefit of a small class of bankers, while taxing the entire population in a multitude of ways to finance the public subsidy.

There were other ways to attain the same end without taxing the many for the benefit of a few. The U.S. Treasury and the U.S. Fed, both under the Bush administration and the Obama administration discarded these solutions. That’s where the scandal lies. But since it is likely that only a handful of senators and congressmen understand what has happened, I would not be too confident in expecting that there would ever be a public investigation of the scandal, beginning with Congress auditing the Federal Reserve’s subsidized banking loans to large banks and its lack of needed regulatory activities. Kudos, however, to the Manhattan Chief U.S. District Court Judge who has ordered the Fed to make public its lending records.

Similarly, at least, some timid steps are being taken in the U.S. and in Europe to impose some limits or restrictions on the discretionary and exorbitant bankers’ bonuses. This comes a bit late, and we shall see if this is merely some political window-dressing to deflect criticism or if it is a structural step to curb oligopolistic and abusive banking practices.

Our interest in Afghanistan is to prevent it from becoming a haven for terrorists bent on attacking us. That does not require the scale of military operations that the incoming administration is contemplating. It does not require wholesale occupation. It does not require the endless funneling of human treasure and countless billions of taxpayer dollars to the Afghan government.

– Bob Herbert, New York Times, January 6, 2009

I don’t want to just end the [Iraq] war, but I want to end the mind-set that got us into war in the first place.

– Presidential candidate Barack Obama, January 31, 2008

If we are strong, our character will speak for itself. If we are weak, words will be of no help.

– John F. Kennedy (1917-1963) 35th U.S. President

No nation ever profited from a long war.

– Sun Tzu, author of The Art of War

A solid majority of Americans (54 percent) now oppose President Obama’s Afghanistan-Pakistan War. In fact, among Democrats, only twenty-six (26) percent support such a foreign war. In other words, by enlarging this conflict, President Obama is governing as if the opinion of a majority of Americans and of his own political base did not matter. In a democracy, a politician can do that for a while, but not for very long.

This undeclared war, just like LBJ’s Vietnam War (1959–1975) and George W. Bush’s Iraq War, is an adventure with no clear objective and no clear exit strategy, but with tremendous costs in lives and money. Nobody can tell if the U.S. and NATO are killing people in Afghanistan and in Pakistan because this is an operation to stop al-Qaeda terrorists from mounting future Sept. 11-type attacks, or because it is part of a larger plan to counter a Taliban insurgency and prevent this Pashtun Islamist party to regain power. But also, it has been said that it is a war waged to protect a pipeline crossing Afghanistan. Such a pipeline would move oil from the Caspian Basin to the coast of Pakistan through Afghanistan. Nevertheless, since this is not clearly explained, the war remains a blur for most people. The reason why such a war brings fewer open protests than the Vietnam War is essentially because it is waged with mercenaries.

That may be a reason why such open-ended wars fought with mercenaries can last for so long. For its part, Great Britain, a country used to colonial occupations, says through its incoming military Chief of Staff, General Sir David Richards, that it could stay in Afghanistan for 40 years. Even Germany seems to have regained its taste for military adventures, as its Defense Minister says it could occupy Afghanistan for ten years.

With this frame of mind, the world could be back in the nineteenth century, a century characterized by the anarchy of lawless armed conflicts, with militarized empires involved in prolonged wars, if not perpetual wars, with colonial and imperial military occupations. If the collapse of the Soviet empire in 1991 has simply ended the restraining its presence imposed on other empires from being lawless and imperialistic, then the world may be on a very dangerous course. It will be back to the future. All the democratic ideals of the second part of the twentieth century would be gone.

One has the feeling that such badly designed military adventures as the Afghanistan war, with no clear objectives in sight, are primarily launched and expanded to keep the military establishment busy and the military-industrial complex prosperous.

Mired in financial scandals and plunged into a deep economic recession, many Americans suffer from war exhaustion. There seems to be too many of these endless and costly wars, even though the professional warmongers relish them. For his part, Secretary of Defense Robert Gates declares that the American public is “pretty tired” of the seemingly endless war in Afghanistan, and he believes that the situation has to be turned around in a year.

Indeed. Only a few months ago, a substantial majority of Americans thought they had kicked the Bush-Cheney neocon warmongering crowd out of power. Those who favor American-led wars of aggression had a choice in voting for Republican candidate John McCain. But, to no avail. The Obama-Biden soft-neocon crowd seems to be in the same camp as Bush and McCain. Nothing of substance has changed, or hardly.

At least in terms of foreign policy, the question can be asked if the Obama-Biden administration is anything more than a third term of the Bush-Cheney administration? The Obama-Biden administration did not arrive in power determined to take control of the government apparatus and to change its direction. In fact, the reverse seems to have happened: It was pre-empted and subdued by the entrenched governing nomenklatura. This reflects a lack of preparedness, dedication and vision.

As soon as it was sworn in, the Obama-Biden administration began planning to enlarge the Afghan conflict with more troops and more mercenaries, and, to make its intentions crystal-clear, kept in his post Bush’s Secretary of Defense (Robert Gates) while asking Congress for $109 billion more funds to finance the adventure. Then President Obama fired Gen. David McKiernan, who had been in charge in Afghanistan, and replaced him with Lt. Gen. Stanley McChrystal, a former Green Beret who lead the secretive Joint Special Operations Command, an outfit of commando teams that was involved in widespread murder and carnage in Iraq. And, what is strange, Lt. Gen. Stanley McChrystal proposed to President Obama the adoption of a Soviet Strategy of building bases and troop build-up for Afghanistan. With friends like this, Barack Obama needs no enemies.

As a matter of fact, Obama’s political enemies, beginning with Rupert Murdoch’s Wall Street Journal, but also other right-wing corporate media, are salivating at the thought. I wonder how many editorials the WSJ will write supporting candidate Obama in 2012!

But the die is cast: President Barack Obama now “owns” the Afghanistan-Pakistan (AfPak) war and he will have to live with the consequences. If the British and Soviet examples of foreign occupations in that part of the world are good indications of things to come, Commander-in-Chief Obama is going to be bogged down in this devastated mountainous land for years to come, and this may very well cost him his presidency in 2012. For a while, the Republicans and some neocon Democrats are going to cheer him. But later on, most Americans are going to turn against him.

Let’s place things in perspective here. Just as in Vietnam, the U.S. is intervening in a civil war involving Pashtuns (40% of the Afghan population), Uzbeks, Tajiks, and Hazara Shiites, among over ten minority groups sharing a traditional and often repressive and barbaric Islamic culture, in a country called Afghanistan. And it is waging guerrilla warfare in Afghan villages and towns in order to support a corrupt and illegitimate Islamist government.

The foreign soldiers are trying to “flush out the Taliban from villages” just as they were trying to flush out the Vietcong from villages. Since such wars cause many civilian deaths, sooner or later, the entire population will turn against the foreign military invaders and they are likely to be kicked out. That was the story in Vietnam and there is little doubt that this will be the story in Afghanistan-Pakistan. Sending more troops to this Asiatic region will only make matters worse. The advantage for the military establishment, besides generals getting a few stars on the shoulder, is that a prolonged conflict will keep the money flowing in their coffers and in those of their suppliers.

But wait. Now Obama is enlarging the Afghan conflict, not only by waging a drone war against tribesmen in Pakistan, but he also wants to turn the Afghanistan war into a war against Afghan drug lords. The logic here, I gather, it to multiply your enemies: the Taliban, al-Qaeda, Pakistan tribesmen, Afghan drug lords, etc. The more you have, the more likely the conflict will endure.

When you forget that the initial objective in Afghanistan, after the 9/11 attacks, was a narrow one, i.e., to prevent that country from becoming again a haven for terrorists, it is easy to widen a conflict ad nauseam. As a matter of fact, this was tried before in Afghanistan. The Soviets tried it for nine years, from December 1979 to February 1989, and despite sending in hundreds of thousand troops, they did not succeed. It was the Soviet Union’s Vietnam War, to paraphrase Zbigniew Brzezinski, President Jimmy Carter’s Security advisor.

Similarly, Obama’s war in Afghanistan-Pakistan would require hundreds of thousands of troops on the ground. Like the Soviet Union, the U.S. is building large military bases in Afghanistan and its commanders think there are never enough troops. Presently, the U.S. has some 60,000 troops in Afghanistan. Next year, it is easy to predict it will have more than 100,000 troops in that remote country, if the current policy is followed.

And under what legal basis? It is stretching quite a bit the terms of the U.N. Security Council’s resolution 1368 of September 12, 2001, to justify an open-ended war in Afghanistan and in Pakistan. That resolution was adopted under Article 51 of the U.N. Charter that affirms the inherent right of individual or collective self-defense. Since the 9/11 terrorists had trained in Afghanistan under Taliban control, such training camps had to be dismantled, either by the Afghan government or by external forces. Since the Taliban government refused to comply, the U.S. was in its right to intervene. Thus the overthrow of the Taliban government and the destruction of al-Qaeda training camps in that country. This was done in the fall of 2001.

On December 20, 2001, the U.N. Security Council (Resolution 1386) authorized the creation of a NATO-led military international force to assist the newly established Afghan Transitional Authority in creating a secure environment in and around the capital Kabul and to support the reconstruction of Afghanistan. That’s the legal reason why there are foreign soldiers in Afghanistan. They operate under the umbrella of the so-called International Security Assistance Force (ISAF), whose mission has been expanded, year after year, to cover most of Afghanistan (see U.N. Security Council Resolution 1510).

Later, the U.N. Security Council also authorized a mission of assistance in Afghanistan. In March 2002, the U.N. Security Council organized an Assistance Mission in Afghanistan’s (UNAMA) with the adoption of Resolution 1401. UNAMA’s primary mandate is “to manage all humanitarian, relief, recovery and reconstruction activities.” That mandate has been renewed in March of each year, the last time on March 23, 2009, extending it until March 23, 2010.

But now we are in 2009, eight years after 2001. Is there really a legal basis for the U.S. to drop bombs over villages in Pakistan and to occupy Afghanistan indefinitely with foreign troops? There is some play with words here. For example, the European countries participating in the NATO-U.S.-led mission in Afghanistan talk about a “police mission” to justify the presence of their soldiers in Afghanistan. In fact, this so-called police mission has turned into a permanent military occupation of Afghanistan and into a guerilla war against local militants and insurgents, in both Afghanistan and Pakistan.

Let’s keep in mind that many of the so-called “militants” or “insurgents” in Afghanistan, the Mujahideen and to a certain extent the Taliban, used to be called “Freedom fighters” by President Ronald Reagan (see the Reagan Doctrine) when they were fighting the Soviet invaders, with the help of the American C.I.A., Saudi Arabia and the Pakistani secret police (ISI). This shows how such “freedom fighters” conveniently change names when they switch camp! They have gone from being called “heroic” to being called “insurgents”. Such is the propaganda of war. —An historical fact remains: The unintended consequence of the Reagan Doctrine is the current Afghanistan-Pakistan war, and it may have played an important role in preparing the ground for the 9/11 catastrophe.

Nevertheless, let us say that this is stretching the U.N. Charter to the limit to say that it now permits the permanent military occupation of a sovereign country by foreign troops. It is true that the U.N. Charter, under Chapter VII (Action with Respect to Threats to the Peace, Breaches of the Peace and Acts of Aggression), can authorize collective action against a country for good reasons. But the intent of such a military intervention is to be short-term and not be turned into a permanent colonial occupation.

In conclusion, let us say that since the Obama administration is clearly enlarging the Afghan conflict and has authorized drone bombings in Pakistan, it would seem that the U.N. Security Council should be called to authorize or condemn such an enlargement of the conflict. It should also indicate that it favors a compromise solution to the conflict.

The empire of the dollar is crashing.

– Hugo Chavez, Venezuelan President

The U.S. dollar is a worthless piece of paper.

– Mahmoud Ahmadinejad, Iranian President

[The U.S. dollar is] losing its status as the world currency.

– Xu Jian, vice director, People’s Bank of China

It is the policy of the United States and it will remain the policy of the United States to remain committed to a strong dollar.

– Timothy Geithner, U.S. Treasury Secretary, (July 15, 2009)

[The dollar will remain the world’s dominant currency for] many years to come.

– He Yafei, China’s vice foreign minister, (July 5, 2009)

Presently, there is a vacuum in international affairs coming from the decline in the moral and economic stature of the United States. It is a vacuum because no other country or organization has the credibility, legitimacy and capability to fill the gap. This is particularly true in monetary and financial affairs. By default, the U. S. dollar is de facto the main supranational key currency used to finance international trade and investment.

Many countries deplore this quasi monopoly of the dollar, the more so since the financial crisis that originated in the U. S. has spread around the world, and it has profoundly damaged the reputation of the United States and severely undermined the confidence that this country inspired in the past. Add to that the illegal war of aggression that the Bush-Cheney launched against Iraq, a country that had not attacked the United States, and the lack of financial confidence in the USA is reinforced by a lack of political confidence.

The table is therefore set for revisiting the international monetary arrangements that were created in the aftermath of World War II. What were they?

In June 1944, during a monetary conference held in Bretton Woods, New Hampshire, an attempt was made to create a new world currency, above and beyond the national currencies of particular countries. Let’s keep in mind that many decades before, the British pound had been used as the main international currency. A first proposal for reform came from British economist John Maynard Keynes, who advanced the idea of creating a supranational currency, the bancor, to which other currencies would have been pegged and in which countries would have held their foreign exchange reserves. An alternative plan was proposed by U.S. Treasury economist Harry D. White, in view of establishing a “Gold Exchange Standard” whose main characteristics was to use the U.S. dollar as the main key currency, the only currency then that was fully convertible and which had an official value in gold, initially at a rate of one dollar for 1/35 ounce of gold, and later, at a rate of 1/38 ounce of gold. As we all know, this was the plan that was adopted. Nevertheless, Keynes’ idea was partially adopted when the International Monetary Fund (IMF) created “Special Drawing Rights” (SDRs) in 1969, to supplement the member countries’ stocks of international reserves.

On August 15 1971, however, the U.S. Government unilaterally ended its obligations to convert U.S. dollars into gold. A few years later, in the aftermath of the first oil crisis, the rates of exchange of currencies of most of the industrial world were allowed to fluctuate with the state of their balances of payments, thus reducing considerably the need to hold foreign exchange reserves, most of which were still denominated in U.S. dollars. This is the system that has prevailed until now, that is to say a flexible exchange rate system with the U.S. dollar as the main key currency.

It seems nowadays that most everybody who holds dollar-denominated assets is calling for a new international monetary system. The largest creditors, the Chinese, have initiated the debate, because they have the most to lose from the collapse of the U.S. dollar. Even the Catholic Pope has thrown in his piece of advice.

What are the chances that there could be agreement on a new supranational key currency? Close to none. Essentially, this is because there is no viable alternative to the U.S. dollar as an international currency.

It is true that the United States, as a sovereign country, has abused and is still abusing its privileged position derived from the fact that its national currency is being used as the world key currency. So much so that there is presently an oversupply of U.S. dollars around the world. Over the years, the USA has built up huge external debts without having to suffer the full economic consequences of its profligacy. Moreover, it has used it seigniorage gains to deploy troops and military equipment around the world, a move that has created much resentment.

Politically, thus, but also financially, the rest of the world finds it increasing difficult to have to rely mainly on the U.S. dollar to finance international trade and international capital movements. It is therefore understandable that many countries would like to free the world from the obligation to use the U.S. dollar.

The most natural complement or substitute to the U.S. dollar as an international key currency would be the euro. After all, this a currency backed by fourteen strong European countries; a currency that is fully convertible into other currencies and a currency that is supported by large money and capital markets.

The euro’s major weakness comes from its political base. If the entire 27-country strong European Union (EU) were backing the euro, its long-term international standing would be considerably enhanced. With only half of the E.U countries backing it, the euro zone is vulnerable in the future to a possible dissolution under the pressures of economic hardships. This is more so since the statutes of the European Central Bank are unduly rigid, not only freezing exchange rates between member states, which is OK, but also de facto freezing their fiscal policies, while the central bank itself has the goal of fighting inflation as its only objective. It seems that the objective of supporting economic growth was left out of its statutes, with the consequence that it may be unable to ride successfully future serious economic disturbances. For example, how long do you think countries like Spain are going to tolerate 17.9 percent levels of unemployment? Nevertheless, already one quarter of the world’s official reserves are in euros, as compare to a bit less than two-thirds in U.S. dollars. Baring any mishap, the dollar and the euro should share a more equal proportion of international finance in the future.

It is also said that the Chinese renminbi could be called to play the role of a global currency. Since 2005, China has adopted a managed floated exchange rate system for its currency, allowing the yuan to slowly appreciate vis-à-vis other currencies, as a partial reflection of its large foreign trade surpluses. It is pointed out that by 2020, China intends to designate the city of Shanghai as an international financial center, and that would mean that the renminbi could become fully convertible into other currencies. Already, some transactions between Hong Kong and Macau, and Mainland China, are being settled in renminbis.

Realistically, however, it is most unlikely that a Chinese currency could play a large international role, at least not for decades to come. Indeed, even though the Chinese government has some $2 trillion in official foreign reserves, China, itself as a country, has a very limited moral international stance. It is still a totalitarian, authoritarian and repressive state regime that does not recognize basic human rights, such as freedom of expression and freedom of religion, and which crushes its linguistic and religious “minority nationalities”. It is a country that imposes the death penalty, even for economic or political crimes. This is not an example to the world. Only a fundamental political revolution in China could raise this country to a world political and monetary status. This is most unlikely to happen in the foreseeable future and, therefore, no Chinese currency is likely to play a central role in financing international trade and investment.

It is one thing to wish to replace an international key currency, it is quite another to implement such a wish. It’s not that a series of bad policies has weakened the U.S. economy and the U.S. dollar, possibly for many years to come. But the requirements for a national or international currency to be used as an investment vehicle are such that there is currently no credible successor to the U.S. dollar as a key currency. There are three fundamental characteristics that a reserve currency must have: it must inspire confidence, it must be fully convertible into other currencies, and it must have a high degree of liquidity. With the possible exception of the euro, no other currency meets these criteria, although creditor countries will likely increase the share of gold in their official reserves, pushing the price of gold way up in the coming years.

Therefore, for better or for worse, the world economy needs the U.S. dollar and will keep using the U.S. dollar for the foreseeable future, before a new international monetary system can be designed many years down the road. Therefore, you may ask where do I think the U.S. dollar is heading? With $2 trillion fiscal deficits under Treasury Secretary Geithner’ watch, a zero interest rate (negative real interest rate) and an open bar printing monetary policy by the Bernanke Fed, there is currently an oversupply of U.S. dollars. This should herald a period of continued weakness for the U.S. dollar, possibly for a year or two. Then, the U.S. dollar should reach an important and secular climax low vis-a-vis the other fiat currencies, but not vis-a-vis gold whose future looks brighter by the day.

I almost went down on my knees to beg [President] Herbert Hoover to veto the asinine Hawley-Smoot Tariff. …That Act intensified nationalism all over the world.

– Thomas Lamont, banker and economic adviser, June 1930

Now is a time where we have to be very careful about any signals of protectionism.

– President Barack Obama, February 19 2009

From the purely economic point of view nothing speaks against free trade and everything against protectionism.

– Ludwig von Mises (1881-1973), Austrian economist

When the economy is booming, foreign borrowings and imports of goods and services from other countries are most welcome. They allow for more spending without inflation and they raise living standards. It is a version of having your cake and eating it too. In an economic downturn, however, the political reflex of populist politicians is to turn protectionist and to become economic isolationists by raising trade barriers. In such an environment, foreign competition becomes a convenient scapegoat for the crisis, even though the causes of such crisis are most often purely domestic in nature.

Regarding trade, the Obama administration seems to have adopted the “good cop, bad cop” routine, extolling the virtues of free trade in presidential speeches while letting Congress pass protectionist measures in series. The fear here is a repetition of the 1930s when American politicians rushed to pass the infamous Smoot-Hawley Tariff act of 1930 that triggered an international trade war and which accelerated the worldwide economic downturn. World trade plummeted into a spiral downward and domestic production for exports contracted everywhere. Normal trade links were disrupted and intricate inter-country production arrangements were dismantled.

Indeed, in a misguided attempt to fight the economic downturn, governments all over the world rushed to adopt self-destructive “beggar-thy-neighbor” policies, in a futile attempt to devalue each other’s currencies and to reduce their imports in retaliation, forgetting that one country’s imports are the other country’s exports. The consequence was that from 1929 to 1933, the value of world trade contracted by two-thirds, going from $5.3 billion to $1.8 billion.

The world economy went down with world trade and every country was worst off as a consequence. A severe recession was then turned into a worldwide economic depression. This is because trade protectionism in the modern world is the equivalent of “cutting off your nose to spite your face” and its main consequences are to spread poverty and economic dislocations.

Some seventy years later, the same mistakes risk being repeated. Most modern economies are interrelated and if politicians begin to unravel such an economic integration, the consequences may be even worst than in the 1930s, because economic integration is much more advanced and prevalent than it was then.

World trade is already contracting due to the current global financial crisis, a decline in commercial bank trade credits and a drop in private investments. According to the World Bank’s projections, total world trade in goods and services this year is expected to fall 6.1 percent. The decline will particularly hurt large export-led economies such as Mexico, Germany and Japan.

The issue of protectionism is also particularly important for Canada, the U.S.’s most important trade partner. The United States and Canada not only share this continent, but they also have a mutually beneficial trading relationship that has been enhanced with the signing of the Canada-U.S. Free Trade Agreement on October 12, 1987. This treaty was enlarged in 1994 to include Mexico with the implementation of the North American Free Trade Agreement (NAFTA). As a consequence, there are no tariffs on most goods that pass between Canada and the United States.

In 2008, Canada’s trade with the United States accounted for about 76 percent of its total international exports and 63 percent of its imports, while U.S. exports to Canada represented about 20 percent of total American exports. A lot of American jobs are tied to American exports to Canada. In fact, Canada is the leading export market for 36 of the 50 U.S. States and Canada is a larger market for U.S. goods than all 27 countries of the European Community combined.

Moreover, Canada is the single largest exporter of total petroleum to the United States, supplying the U.S. with more than 2.5 million barrels per day. What is more, this oil supply is guaranteed under Nafta. There is also an important and growing cross-border trade of electricity between Canada and the United States that links the two economies.

This does not mean, however, that trade frictions between Canada and the United States do not exist. Sometimes politicians behave as if the trade agreement between the two countries did not exist. A case in point is the routine inclusion of “buy American” provisions in spending bills voted by the U.S. Congress, which can be considered overt protectionist trade-distorting measures and contrary to the spirit and the letter of the free trade agreement.

If the lessons of the past have been learned, governments should resist the temptation to export their economic problems abroad and should work instead to stimulate their economies without resorting to protectionist measures. What is needed now is to avoid sending the world economy into a self-reinforcing contraction that would hurt everyone.

There are three kinds of lies: lies, damned lies, and statistics.

– Mark Twain, (1835-1910)

The Cost of Living [has been] replaced by the Cost of Survival. The old system told you how much you had to increase your income in order to keep buying steak. The new system promised you hamburger, and then dog food, perhaps, after that.

– John Williams, private economist

The consumer price index is being understated by at least 1 percent per year.

– Bill Gross, professional investor

… The development of credit derivatives has contributed to the stability of the banking system by allowing banks, especially the largest, systemically important banks, to measure and manage their credit risks more effectively. In particular, the largest banks have found single-name credit default swaps a highly attractive mechanism for reducing exposure concentrations in their loan books….

– Alan Greenspan, Fed Chairman, May 5, 2005

Last February 20th, the U.S. Department Of Labor Bureau of Labor Statistics announced that, on a seasonally adjusted basis, the U. S. Consumer Price Index (CPI) increased by 0.3 percent during the month of January. Some independent economists, however, think that the real inflation rate is much higher, possibly as high as 7.52 percent. Why is that so?

The CPI is a measure of how much the price level of a basket of representative consumer goods and services, adjusted for predictable seasonal shifts, is supposed to have varied during a month or a year. Such a measure has been provided by the Bureau of Labor Statistics since 1919, covering the period between 1913 and today.

For many people, the CPI is less a measure of inflation than an imperfect measure for adjusting cost of living allowances. It is a technique that plays a central role in computing increases in the Cost Of Living Allowances (COLAs) of various money disbursements, incomes and wages. Some incomes, for example, such as Social Security payments and other entitlements, are statutarily adjusted upwards when the CPI goes up, and such adjustments have a direct influence on one’s standard of living.

Economists have long debated the best methods of measuring inflation, especially as it affects the cost of living of various categories of consumers. This is a complex issue that involves statistical methods in calculating price indices, economic principles and notions of social justice. Moreover, not everyone is impacted equally by a rise in the overall level of consumer prices, depending on one’s economic and financial situation. For example, for people living in a city and who are renters, a rise in the price of cars or of houses would not have the same predictable effect on them as it would on folks living in a rural area and who own their own homes. And it is not everyone who can deflect the negative impact of a rise in the price of consumer goods on their standard of living by substituting less costly items.

For the period between 1913 and 1982, the formula for measuring consumer inflation in the U. S. was pretty much straightforward. Government statisticians would periodically collect prices in certain identified areas with which the Bureau of Labor Statistics would then construct price indexes. Over time, surveys of consumer expenditures were conducted and the weight of different goods in the index would be adjusted accordingly to reflect people’s new buying habits.

In the early 1980s, the Reagan administration feared that the standard CPI index overstated the impact of overall inflation on the cost of living of many recipients of government payments, the most important ones being Social Security outlays. The decision was then made to move away from the objective of having a general consumer price index measuring overall consumer inflation and adopt instead the policy of constructing a cost-of-living index that more closely reflected the true impact of inflation on different categories of consumers. That is why, since 1982, the CPI measurements that the Bureau of Labor Statistics publishes relates more to the cost of living, as defined and periodically revised, than to providing accurate information about the level of general inflation. [As a matter of fact, another government agency, the Bureau of Economic Analysis (BEA), has the responsibility to calculate a price deflator for consumption expenditures and other expenditures as part of the National Income and Product Accounts (NIPA).]

Indeed, in the mid-1990s, substantial changes were made to the CPI index which had the net result of lowering the official measure of consumer inflation. First, increases in asset prices, such as in housing, were only indirectly taken into account. For example, the 2002-2006 real estate bubble hardly registered at all in the CPI because only ‘imputed’ home rents for home owners were used in the index. At that time, rents were virtually stagnant in many cities due to overbuilding. Secondly, arbitrary downward adjustments were made in the prices of certain goods to reflect their enhanced quality. It is true that cars, TV sets or cellular phones are more performing today than their alternatives in the past, and this raises people’s standard of living. However, such goods cost more, and the higher prices are not fully recorded in the CPI. Thirdly, and maybe more debatably, in order to concentrate on the impact of price increases on the true cost of living, it was assumed that consumers adjust to higher prices of certain items by substituting relatively less costly goods when relative prices change. For instance, buyers would be assumed to switch from steaks to hamburgers or from beef to chicken when the price of steaks or beef increases. Similarly, people would tend to switch from high-priced stores to discount stores when their incomes do not follow inflation. It can also be assumed that such forced substitutions are not without inconveniences or hardships for the consumers, and thus could indicate a lowering in their standard of living. Nevertheless, these modifications that lowered the official measure of the CPI were incorporated into new statistics from 1982 on.

Consequently, it has become somewhat risky to rely on official CPI figures to obtain a true assessment of inflation. Because of all the changes made in the CPI index since 1982, the CPI has become less and less a true measure of consumer inflation, even though it may or may not more closely reflect the true impact of inflation on people’s cost of living. For the overall economy, it is fair to assume that the true inflation rate is substantially higher than what is reflected in official CPI announcements, and this has a compounding effect overtime.

For its part, since February 17, 2000, the Fed uses a “core” chain-type price index for personal consumption expenditures (CTPIPCE), i.e. a price measure for all items less price increases in food and energy. What is at stake here is the danger that government officials may begin to believe their own official inflation figures which are understated, maybe for good reasons as far as cost of living issues are concerned, but nevertheless severely understated as far as the true inflation rate is concerned. This has the potential for disastrous consequences, not only for the public in correctly judging inflation pressures for investment purposes, but also for public officials in framing policy, especially monetary policy.

The most recent example is provided by the pronouncements that Fed officials made during the crucial 2003-2005 period, when a dangerous housing bubble was building up speed and when financial firms were embarking upon riskier and riskier financial schemes. To a man, Fed officials denied there was any risk of inflation and, contrary to what everybody could see, declared that there was no housing bubble going on.

For instance, on March 1, 2003, the No. 2 man at the Federal Reserve, Fed Gov. Donald Kohn insisted that the extremely low short-term interest rates that the Fed was keeping down had not created a speculative bubble in real estate.

In 2004 and in 2005, Fed Chairman Alan Greenspan echoed Mr. Kohn and repeated many times that there was no inflation and that he was in no hurry to raise short-term interest rates from their 46-year low level of 1 percent. In April 2004, for example, in remarks on the economic outlook to the Joint Economic Committee, Greenspan remained unconcerned about inflation, declaring that “as yet, the protracted period of monetary accommodation has not fostered an environment in which broad-based inflation pressures appear to be building”, just at a time when the housing bubble was but one year from its final top.

At that time, the old pre-1982 CPI formula, as calculated by private economists, indicated that U.S. consumer inflation was above 8 percent and that a housing bubble and a concomitant stock market bubble were in full swing. Future Fed Chairman Ben Bernanke, then a Fed Board member, echoed his mentor in late 2005 by saying that there was no housing bubble to go bust and that the fact that U.S. house prices were rising four times faster than the economy was “largely [a reflection of] strong economic fundamentals.”

But, it is now generally agreed that from 2002 to 2004, the American central bank pursued a monetary policy that was too expansionary and that—plus the lack of government regulation of the derivative market—contributed greatly to create the conditions for a major financial crisis. Let us keep in mind that in 2004, the Fed Chairman was publicly recommending that people buy adjustable rate mortgages (ARMs), especially interest-only adjustable-rate mortgages, and other subprime loans instead of safer fixed rate loans.

As a matter of fact, most economists agree that interest rates should have been raised as early as 2002. But Mr. Greenspan implied later that he was forced to play politics with his monetary policy, when he declared on September 17, 2007, in an interview with the Financial Times, that “raising interest rates sooner and faster would not have been acceptable to the political establishment given the very low [official] rate of inflation”.

There you have it. What is suggested here is that the push to reelect President George W. Bush, in the fall of 2004, may have played an important role in letting the housing bubble become bigger, thus paving the way for a housing bubble burst in 2005-2006. This is, by the way, on top of the confession that Mr. Greenspan made in his Memoirs (The Age of Turbulence) that he had personally lobbied the Bush-Cheney administration in favor of the unprovoked 2003 U.S. war against Iraq, and that consequently, he was personally tied to the overall political agenda of the Bush-Cheney administration.

When the history of this financial and economic crisis is written, it shall be recorded that the Fed and other government agencies, such as the Securities and Exchange Commission (SEC), did little or nothing to prevent the debt pyramid from reaching the dangerous levels it attained and which is now crashing down, dragging down with it the entire U.S economy and most of the world economies.

The [financial] crisis was not a failure of the free market system and the answer is not to try to reinvent that system. …Government intervention is not a cure-all.

– President George W. Bush, Thursday November 13, 2008

There is no cause to worry. The high tide of prosperity will continue.

– Andrew W. Mellon, Hoover’s Secretary of the Treasury. September 1929

While the crash only took place six months ago, I am convinced we have now passed the worst and with continued unity of effort we shall rapidly recover. There is one certainty of the future of a people of the resources, intelligence and character of the people of the United States – that is, prosperity.

– President Herbert Hoover, May 1, 1930

Tuesday, February 10, may be the date when the U.S. economy officially entered into an economic depression. This was when President Obama’s Treasury Secretary, Timothy Geithner, announced that the Obama administration was about to expand Bush’s Secretary Paulson’s $700-billion plan to rescue large U.S. banks from insolvency, euphemistically called the Troubled Assets Relief Program (TARP). The purpose now, as it was previously, is to use public capital, loans and guarantees to remove toxic financial assets from private banks’ balance sheets and to transfer them to the Government and/or to willing private investors (hedge funds, private equity firms and other investors). One must keep in mind that Mr. Paulson and Mr. Geithner were the principal architects of last October’s original plan. This was then, and it is now, a plan designed primarily to use hundreds of billions of taxpayer dollars to prevent banks from declaring bankruptcy, while in fact doing little to accomplish its presumed primary objective of getting banks to resume normal lending. Such a cure has failed in the past and is likely to fail now. Saving insolvent banks is not the same as fixing them and making them viable.

Indeed, when Mr. Geithner announced on Tuesday, February 10, that he was expanding the Paulson plan to make it a $1.5 trillion bailout plan, financial markets saw it as simply rearranging the chairs on the deck of the Titanic, and they sold off. I believe the markets are right and the Obama-Geithner plan only makes the Bush-Paulsen plan worse. Both are misguided and do little to address the root cause of the financial crisis, which is a mountain of unsustainable bad debts that was allowed to expand recklessly over the last ten years, and which is now crumbling down, dragging the entire economy down with it.

With more public money thrown at the problem with little strings attached, large U.S. banks will only use the new cash to de-leverage themselves and pay off their debts, buyout smaller banks and find a way to reward their incompetent executives with large bonuses, but little will trickle down to the real economy. We are back to the discredited Reagan era’s economic trickle-down theory, the rich helping themselves first and the poor getting the crumbs.

Let’s look coldly at the situation. The ratio of total debt to the U.S. Gross Domestic Product (GDP) is now higher than it was in 1933, when it reached the lofty and unsustainable level of 299.8 percent. It took nearly twenty years to bring down the debt/GDP ratio to below 140 in 1952. In the second quarter of 2008, all debt records were broken when the total debt ratio in the U.S. registered at 356,7 percent of GDP. If the same process of unwinding of excessive debt level plays itself out this time, this could translate into a debt deflation process lasting possibly until 2027!

It all depends on the problem being recognized for what it is, that is to say a mountain of unsustainable and insolvable debts and bets that have to be cancelled and erased from the books. Transferring such bad debts from the banks and other entities to the government will not solve the problem. It will only displace the it from one place to another and potentially create new and even more serious problems, such as horrendous future tax increases or an onset of hyperinflation down the road.

There exists a state of denial in Washington D.C. regarding the excessive debt problem, essentially because the same people who are responsible for creating the mess are in power. It doesn’t matter whether a Republican or a Democratic administration is in place, they remain in charge and they rely on the same failed economic policies. The Geithner plan is the son of the Paulson plan. Both are destined to fail because they are based on a flawed diagnosis.

To deflate the mountain of bad debts and unclog the credit system in an orderly fashion, and to prevent a deflationary spiral from taking hold, the Obama administration should take the advice of L. William Seidman, chairman of the S&L Resolution Trust Corp. (RTC), [http://en.wikipedia.org/wiki/Resolution_Trust_Corporation] the agency created in the 1990s to manage hundreds of insolvent thrifts. At that time, the RTC seized the assets of troubled savings and loans and resold them to bargain-seeking investors. The Obama administration should bite the bullet and create a similar Banking Restructuring Trust to temporarily take over the large insolvent American banks, streamline their operations, liquidate their bad debts and bets, and reorganize them on a firmer financial basis. I myself proposed such a restructuring trust last September. This would be more efficient and less costly than throwing trillions of dollars down a black hole without even solving the structural problem at hand.

The creation of such a Trust to unify government intervention has also been proposed by former Federal Reserve Chairman Paul A. Volcker and by former Treasury Secretary Nicholas F. Brady. This would entail, of course, that many of the banks’ illiquid assets in CDOs (”Collateralized Debt Obligations”) and in CDS (“Credit Default Swaps”) and other shaky assets, would have to be written off or cancelled in a chapter 11-like process. Such a process would cleanse the banks from the excesses accumulated in previous years and prepare them to meet credit demand as the economy recovers. But, above all, it would mark an end to incremental, complicated and improvised ‘ad hoc’ government interventions to solve the banking crisis. I would bet that there would be a powerful rally of financial markets if such a take-charge and decisive approach were to be adopted.

The Geithner bank bailout plan must not be confused with the $800 billion-plus fiscal stimulus plan for the entire economy that Congress is about to adopt. The latter, contrary to the former, is designed to cushion the fall of real spending in the economy and is likely to have a net positive impact. Indeed, as households increase their savings rate and curtail their discretionary spending to compensate for the loss of housing and financial wealth, government spending has to take up the slack.

However, it should be realized that the multiplier effect on aggregate spending of each dollar of fresh public spending is not very high because national economies nowadays are globalized. Indeed, as domestic spending is being sustained, imports increase but exports may decline as world demand contracts. It is only if all governments adopt expansionary fiscal policies that all economic boats can be lifted. With European and Chinese economies weakening, this may take some time before world demand stops contracting.

All this is to say that while the Geithner bank rescue plan is misguided and should be re-engineered, Obama’s fiscal stimulus package is most likely too timid and should be enlarged, considering the scope of the problem at hand. All in all, let us hope that a prolonged economic depression can be avoided.

In a crisis, discount and discount heavily.
– Walter Bagehot (1826-1877), British economist

I believe that banking institutions are more dangerous to our liberties than standing armies. Already they have raised up a monied aristocracy that has set the government at defiance. The issuing power (of money) should be taken away from the banks and restored to the people to whom it properly belongs.
– Thomas Jefferson (1743-1826), 3rd U.S. President

By this means [printing money] government may secretly and unobserved, confiscate the wealth of the people, and not one man in a million will detect the theft.
– John Maynard Keynes (1883-1946), British economist

Last Tuesday, December 16 (2008), the Bernanke Fed took the most unusual step of lowering the overnight inter-bank lending rate, the federal funds rate, to a level never reached before, i.e., zero percent with an upside limit of 0.25 percent. It also announced that it will buy “large quantities of” mortgage-backed securities and is considering doing the same thing with Treasury bonds of longer maturities, in order to lower the entire yield curve. What it did not say explicitly is that the Fed is ready to debase the U.S. dollar to artificially low levels in order to reflate the U.S. economy. What the Fed wants is to trigger monetary inflation and change deflation expectations at all costs through large-scale debt monetisation and thus floating excess debts in a sea of newly created money.

Overall, what the Fed has done, in effect, is to announce that it is suspending the normal functioning of private credit and capital markets, according to supply and demand, and has decided to micro-manage such failing markets for the foreseeable future, that is to say as long as deflationary pressures, in its own view, persist in the U.S. economy. The Fed is also taking big chunks of ownership in large private U.S. banks in order to recapitalize them and to let them deleverage themselves in an orderly way.

People may want to know why the Fed went to that “socialist” extreme and what will be the financial and economic intended and unintended consequences?

First of all, let’s keep in mind that the Fed is the only central bank in the world that is partly public-owned and partly private-owned. Bankers sitting on the Fed board can make decisions to lend new money to themselves at whatever rate they choose. The entire American financial and fiscal system is run by bankers, either at the Fed or at the Treasury. Indeed, beginning on January 20 (2009), the Obama administration’s Treasury Secretary will be the current president of the New York Fed, Mr. Timothy Geithner, who will be replacing Secretary Henry Paulson, himself a former CEO of the Wall Street investment bank Goldman Sachs.

Although the U.S. President initiates and Congress approves the nominations of the seven members (currently only five in exercise) of the Federal Reserve Board of Governors (for a 14-year term), the de facto managing of the Fed is left to bankers. This is done through the Federal Open Market Committee (FOMC) which implements monetary policy through open market operations and other discounting policies and discount loans. It is comprised of the seven members of the Board of Governors and five presidents of the twelve Federal Reserve District Banks. The Chairman of the Fed Board is also the Chairman of the FOMC. The President of the New York Fed is always on the FOMC and acts as its Vice Chairman. (The remaining 4 fed member slots are shared and rotated among the remaining 11 District Banks. In fact, the presidents of all twelve Federal Reserve District Banks are present at the FOMC meetings, but only five are enabled to vote at any given time. But, since members of the Fed board often originate from the regional Fed banks or from private banks, bankers are often in the majority in deciding American monetary policy.)

Second, by taking over private financial markets, the Fed is, in effect, covering its own mistakes (and those of the SEC and of the U.S. Treasury) for having allowed the building up of a shaky pyramid of asset-backed securities (ABS), not the least being the toxic mortgage-backed securities, and the gambling-prone credit default swaps (CDS) that has been crumbling to the ground.

It is my feeling that the Fed, by creating a bond bubble, at this time is only postponing the day of reckoning and is buying time. When the bond bubble bursts, and believe me, it will burst, as all bubbles do, this will push the U.S. economy further down. For instance, when this happens, many capitalized pension funds could fail and many retirees could be then pushed toward poverty. Future spikes in interest rates will hurt investments and damage the economy even more.

Meanwhile, a bout of competing currency devaluations has been launched, since other governments and other central banks will have to try to debase their own currencies if they want to avoid importing the worst of the U.S. economic downturn. This will be reminiscent of what happened during the 1930s economic depression. Not a pretty perspective for the future of fiat currencies.

It seems that the Fed has an uncanny talent for creating financial and economic bubbles. In the late 1990s, after the Asian financial crisis and after the near failure of the hedge fund Long-Term Capital Management (LTCM), in September 1998, the Greenspan Fed flooded the U.S. economy with liquidity and created the 2000 tech bubble. The same Greenspan Fed aggressively lowered the Federal Funds rate from 6.5 percent to 1 percent in 2004, thus paving the way to the worst housing bubble in American history. Now, the Bernanke Fed is at it again, and, by lowering the federal funds rate to close to zero and by announcing that it stands ready to monetize U.S. Treasury debt, it is actively blowing into what has the appearance of one of the worst bond bubbles ever.

Of course, the Fed has bestowed so much money on banks in exchange for their bad debts while the banks themselves are unwilling to lend, that U.S. banks’ excess reserves at the Fed have exploded to more than half a trillion (November ‘08), which is ten times what is required. This is a sign that the U.S. economy is currently in a liquidity trap.

There is a lot of money in the system, but it is not circulating. The velocity of money is down. In such a situation of excess liquidity, when the Fed creates more liquidity, it is like pushing on a string. Therefore, by lowering short-term interest rates to close to zero, the Fed is helping itself before helping others, since it will be paying less interest on Banks’ excess reserves, most of which came from the Fed anyhow. Some of the excess liquidity can spill into the stock market and lift all boats for a while. However, the true test of the Fed’s recent desperate move will be if banks increase their lending. We shall know in due course.

Obviously he [Rahm Emanuel] will influence the president to be pro-Israel, why wouldn’t he be? What is he, an Arab? He’s not going to clean the floors of the White House.
– Binyamin Emanuel (father of President Obama’s Chief of Staff Rahm Emanuel)

I don’t want to just end the [Iraq] war, …I want to end the mindset that got us into war.
– Candidate Sen. Barack Obama (January 31, 2008)

What Washington is really telling you is that you should keep doing the same old things over and over and over again and somehow expect a different outcome. And that’s the definition of madness, doing the same thing over and over again and expecting something different.
– Candidate Sen. Barack Obama (December 27, 2007, to a crowd in Carroll, Iowa)

Plus ça change, plus c’est pareil! [The more things change, the more they remain the same!]
– Old French dictum

Democratic presidential candidate Barack Obama ran a successful campaign on an anti-Iraq war, anti-Washington establishment and pro-change platform. With the assistance of a rapidly deteriorating economic situation, he prevailed in obtaining a clear governing mandate. Most Americans have no other choice than to want him to succeed in delivering on his promises. But the issuance of vague political promises and the hard reality of governing while relying on an efficient decision-making process, are two different things.

President-elect Obama has so far concentrated on not repeating former president Jimmy Carter’s mistakes in his difficult relations with Congress, and he has surrounded himself with people who are directly connected with the Democratic congressional majority. However, in so doing, he has given the impression that he has enthusiastically joined the Washington political establishment that he so vehemently decried only a short while ago. The real question is whether he has brought Washington insiders into his own political tent, or whether he has simply joined the same corrupt Washington establishment that he himself decried. Only the future will tell for sure.

It is indeed understandable that a young and relatively inexperienced President-elect Barack Obama would feel obliged to surround himself with people who know how to steer Congress, who have close ties to Wall Street and the media, or who have assisted him closely during his political ascension. After all, the efficiency of a new president depends very much on having Congress, especially members of his own party, solidly on his side, if he wants to accomplish anything important.

That is probably why he chose an old run-of-the-mill senator in the person of Sen. Joe Biden as his vice-presidential running mate in the first place. It was undoubtedly also the main factor in his selection of Illinois Rep. Rahm Emanuel as his Chief of Staff. These two political workhorses will facilitate the necessary collaboration between the White House and Congress.

I would therefore not place too big an emphasis on the personae of these two well-connected individuals, i.e., their close association with the American-Israel Public Affairs Committee AIPAC, considering their strategic role with Congress.

Also, the need to move quickly in forming a new administration, unless this has been planned otherwise long in advance, makes it a necessity to call on people who have experience and competence in government affairs. And, for a new democratic administration, the reservoir of experienced public servants can be found in the 1992-2000 Clinton administration. This may explain why President-elect Obama’s transition team is so heavily staffed with individuals who served in the former Clinton administration. Similarly, such people can be expected to recommend former acquaintances as candidates for important government positions.

Similarly, after the closely fought election, there is a practical need to reward the important constituencies that were the backbone of the winning coalition with hard work and money. Some high-profile nominations can be expected to fall in that category. This is to be expected.

For instance, the symbolic gesture of naming the first black Attorney general, the former No. 2 Justice Department official in the Clinton administration, Eric Holder, is a case in point. The expected nomination of Washington insider Sen. Hillary Clinton as Secretary of State falls in the same category, i.e., the need to unite the Democratic Party behind the new administration. Ditto for the nomination of New Mexico Gov. Bill Richardson as Commerce secretary, a former U.N. ambassador and Energy secretary under President Bill Clinton.

The enlarged Obama economic team is technically competent and is designed to inspire confidence and to create a feeling of active involvement, with a hands-on approach. This is important to understand the nomination of a high profile financier as Treasury Secretary, in the person of New York Federal Reserve Bank CEO Timothy Geithner. As a question of routine, the Treasury Secretary-to-be should be asked whether he was in favor of letting the investment bank Lehman Brothers fail in mid-September, and why Citigroup, the second largest Wall Street megabank, is still paying dividends to its shareholders after it has been saved from bankruptcy with hundreds of billions of dollars of public money? Indeed, let’s keep in mind that Timothy Geithner, as president of the New York Fed, was directly involved in many recent generous bailouts to Wall Street banks and insurance companies, including Bear Stearns, Merrill Lynch, Citigroup and American International Group. He is not new at the job and he surely does not represent a break with the past.

Geithner was under secretary for international affairs during the Clinton administration under former Treasury Secretary Robert Rubin (later a director of Citigroup in 1999 and its chairman in 2007) and under Lawrence Summers, who succeeded Rubin as Treasury chief. (Summers is to lead the National Economic Council in the Obama administration.)

The arrival of legendary inflation-fighter Paul Volcker among Obama’s economic advisers, however, is an indication that the new administration intends to be a problem-solving administration. This would seem to be required in order to repair the structural damage done to the U.S. economy over the last eight years. Nevertheless, a question lingers on: Will the ongoing mammoth bailout of Wall Street banks, with insufficient quid pro quo returns and protections for U.S. taxpayers, continue unabated under the Obama administration? If yes, these huge financial bailouts may turn out to be the largest transfer of wealth from the poor to the rich in the history of the world.

Economically, however, it can be said that the coming Obama administration finds itself in a somewhat enviable position. Indeed, if there were to be an economic depression in the coming years, such a depression would still be called the “George W. Bush depression”, just as the last one was known as the “Herbert Hoover depression.” The current economic and financial ordeals are justly part of the Bush administration’s dismal legacy.

However, the same benefit of the doubt can hardly be extended when it comes to rewarding Sen. Joe Lieberman for siding against his own party, and for supporting the Republican Presidential Ticket (that he nearly joined) in 2008, and for filling other important cabinet posts. Let us remember that, in 2006, Sen. Lieberman was openly rejected by Democratic voters in a Connecticut primary, but ran as an independent candidate against the official Democratic anti-Iraq war candidate, Ned Lamont, in his own state of Connecticut. Could any other American politician, other than this fanatically pro-Iraq war and pro-AIPAC senator, have received the same generous accolade after being rejected by Democratic voters and after switching party lines twice, in both 2006 and 2008 elections?

Why then was Sen. Joe Lieberman allowed to keep his chairmanship of the all-important Senate Homeland Security Committee, with the implicit backing of President-elect Barack Obama, despite his high profile support for GOP presidential nominee John McCain during the 2008 presidential campaign? (N.B.: For the record, Sen. Barack Obama initially supported Lieberman over Lamont in 2006.) It is fair to say that if Sen. John McCain had won on November 4, Joe Lieberman would have gotten a high cabinet position in the new McCain Republican administration. Now that Lieberman is back in his powerful position in the Democratic-run Congress, it is also fair to say that this politician cannot lose, whatever he does. For him, at least, the Democrats and the Republicans are just two wings of a single large Establishment Party, in Washington D.C., between which some politicians are free to move at will.

What’s going on over there? Does the desire to have a filibuster-proof threshold of sixty Democratic senators—and the good old-buddy system—explain and justify everything? Obviously, people are entitled at least to an explanation, lest rumors start to circulate that President Obama is de facto the stooge of powerful special money interests. The worst thing that could happen to a politician is to give the impression that he or she is in the pockets of rich special interests. This could be devastating to his credibility, not only domestically but also internationally.

Indeed, after the above revealing incident and after paying his political debts to supporting constituencies, things got even worse with some other nominations to the Obama cabinet, such as the choice of the crucial Defense secretary. Indeed, president-elect Obama—his promise of ending the Iraq war and changing the mindset in Washington that led to it, and the echo of his slogan “Change You Can Believe In” still ringing in our ears—is said to have decided to leave the Pentagon in the hands of Robert Gates, a Bush appointee who does not believe in ending the Iraq war, who believes in the unlawful concept of preventive war and who says that America has the right to “act violently and alone” in the world! Many may see in this nomination a kind of betrayal of his campaign rhetoric and an overt attempt on Obama’s part to please the industrial-military complex.

If the President-elect had wanted to bring Republicans into his administration, while marking a break with the recent past, he could have called on Sen. Chuck Hagel (R-NE), a decorated war veteran, to act as Secretary of Defense. He did not. Alternatively, President-elect Obama could have asked Sen. Jim Webb (D-VA), a former Secretary of the Navy and a critic of Bush’s Iraq war, to run the Pentagon. He did not, preferring a member of Bush’s team, and this reveals more than anything else Obama’s fundamental priority, i.e. to make himself acceptable to the Washington establishment.

This comes in tandem with the expected nomination of pro-war “stay the course” retired Marine Gen. Jim Jones as national security adviser, even though the general initially resisted Bush’s rush to war with Iraq. The message here could be that, “as far as U.S. foreign policy is concerned, with Obama, it’s business as usual.” Is this so? When a politician aims at pleasing everybody, he usually ends up pleasing nobody.

So far, even though he ran on an anti-Iraq war platform, President-elect Obama has not filled any important government position with individuals who are known to have opposed the war. Therefore, the question must be asked: Was he really sincere when he pretended to be opposed to Bush’s war, or was he simply playing politics?

In any case, too many decisions of the Lieberman-Gates-Jones variety, and people will start to think that a few faces may change in Washington D.C., but things really stay the same, no matter the grandiose promises of “change”. Indeed, people are not far from having the impression that President-elect Obama has quickly “gone native”, even before taking office, and that he has been embraced by the more or less corrupt Washington and Wall Street establishments. He seems to want to fit in. If true, President Obama will make speeches, give press conferences and reign, but he won’t govern.

Indeed, was the November 4 U.S. presidential election anything more than a narrow choice between a third term Bush administration and a third term Clinton administration, …or a mixture of the two?

The basis for optimism is sheer terror.

– Oscar Wilde

[After the March 2008 Bear Stears bailout]

As more firms lost access to funding, the vicious circle of forced selling, increased volatility, and higher haircuts and margin calls that was already well advanced at the time would likely have intensified. The broader economy could hardly have remained immune from such severe financial disruptions.

– Ben Bernanke, Fed Chairman (March 2008)

In accounting 101 we learn that high yields equal high risk. We know the CEOs had an incentive to disregard this because they were getting huge bonuses.

– David Hartzell, dean of the University of Delaware’s business college and a former vice-president of Salomon Brothers

Intensifying solvency concerns about a number of the largest U.S.-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown.

– Dominique Strauss-Kahn, Head of the IMF (October 11, 2008)

The Bush administration’s way of dealing with the ongoing financial crisis has been frantic, but probably less than adequate. In fact, tragic errors may have been made that must be remedied as quickly as possible.

The most damaging error may have been to let the global investment bank Lehman Brothers fail ($691 billion of assets at the end of 2007), on Monday, September 15. This fateful date may have to be remembered in the future. This was the largest failure of an investment bank since the collapse of Drexel Burnham Lambert in 1990. In contrast, the Fed and the U.S. Treasury moved quickly in mid-March (2008) to save a similar global investment bank in distress (but half the size of Lehman), Bear Stearns, by quickly lending and guaranteeing $29 billion to the large universal J. P. Morgan Chase bank in order to absorb it. (N.B.: Let us keep in mind that it was the collapse in June 2007 of two internal Bear Stearns hedge funds that had been heavily invested in mortgage securities that kicked off the full-fledged market panic that unfolded in August 2007, and which today has turned into a full-fledged international financial crisis).

Why was the same treatment not offered to Lehman? Possibly because of a personal lack of empathy between Treasury Secretary Henry M. Paulson Jr. (a former chief executive of rival investment bank Goldman Sacks) and Lehman’s CEO Mr. Richard S. Fuld Jr., or possibly because the Bush administration wanted to make an example that all investment banks, no matter how large, could not count on being rescued by the government. The Bush administration did not even bother to appoint a trustee to supervise Lehman’s liquidation in order to make it orderly.

Such a liquidation of a large international bank, known for its worldwide interconnections and unsound banking practices, was nearly a repeat of the mistake made in letting the large Vienna-based Creditanstalt bank fail, on May 13, 1931. This was a bank that had borrowed large amount of money in London and in New York to finance its activities. Its failure created a domino effect among other international banks that had lent to each other in the international credit chain. So much so that the failure of the Creditanstalt forced them to severely tighten their lending to absorb their sudden losses.

Seventy-seven years later, in 2008, the Bush administration’s decision to let the Lehman Brothers bank fail has produced a similar ripple effect throughout the international financial system. And, perhaps more important politically, it signaled to the markets that the Bush administration was willing to let a dangerous debt deflation and an ominous credit crunch proceed. This may turn out to have been a most tragic mistake.

Indeed, Lehman’s bankruptcy forced the global investment bank to quickly write down its huge portfolio of debt, a fair amount of it in derivative products. But since banks are creditors of each other, especially Lehman which dealt with large institutions, this had the consequence of spreading the American financial disease all over the world, and especially in Europe. Why? Because Lehman’s London office was a huge center of sale and distribution for its more or less toxic derivative products all over Europe. Indeed, many European banks had invested in Lehman’s securitized paper, and when it failed, they were left with large losses. As a consequence, they had to curtail their domestic lending and that’s the reason the credit crunch is now moving to Europe.

The second mistake was to address the “liquidity problem” of American investment and mortgage banks without tackling at the same time their underlying “solvency problem”.

As we wrote right at the very beginning, on August 24, 2007, the financial crisis in the U.S. is not only a classic “liquidity problem”, when banks find themselves short of cash to pay immediate redemptions and withdrawals while their longer term loans are secure, but also and above all a “solvency problem”, because the huge losses that banks had to absorb when they wrote down the value of their toxic assets-backed securitized paper, eroded their capital base to an extent that they became de facto insolvent. Market operators saw that and they sold the banks’ shares short and the price of these shares plummeted.

With many banks’ solvency now in doubt, inter-bank lending has nearly stopped, and because of a ‘flight to safety’, the Ted spread [the difference between three-month U.S. Treasury bills yields and yields on three month eurodollar contracts, as represented by the London Inter Bank Offered Rate, called Libor] exploded, and banks cut down their lending. Credit became tight and scarce. Because banks as a whole ordinarily lend between 10 and 12 times their capital base, the most liquid money supply (M1) began to contract in real terms. Even money market funds suffered heavy losses, and a run on them was in full swing when the Treasury stepped in a month ago to offer an emergency $50 billion guarantee.

The U.S. economy may be approaching what can be called a classic “liquidity trap” situation, wherein the Fed is lowering interest rates while lending through its discount window and printing money on a high scale, however the liquid money supply figures, in real terms, are not increasing, but are rather falling. Thus, there is no immediate inflation, but the money supply is contracting as banks reduce their lending and make a rush to T-bills (their yields nearly fell to zero). The short-term result is a net deflationary effect for the overall economy and on the stock market (although the long term bond market sees inflation ahead, and long term rates are rising). The result is stock market crashes in repetition.

In fact, this is precisely what has happened over the last few weeks, not only in the United States, but also in the U.K and in other European countries. This is a very dangerous development for the real economy, because money data in real terms are a leading indicator of the future course of the economy. Six or nine months down the road, the consequences of the credit crunch will appear in production and employment declines, because the credit crunch has the effect of placing a serious squeeze on most companies. Since the credit contraction really began in June (2008), the early part of 2009 is bound to show severe economic weakness.

On Friday, September 19 (2008), the Bush administration announced its solution to the growing banking crisis. It made public the $700 billion Paulson plan (US Emergency Economic Stabilisation Act, EESA) that primarily focused on creating a government market for some of the bad mortgage-backed securities on the banks’ books. But this was only half of the problem. The other half of the problem was the need to stop the money supply from declining, by restoring bank credit lending and allowing companies to have access to working capital financing. The goal here is to prevent banking problems from morphing into a general contraction of consumption and capital investment plans, thus slowing down production and raising unemployment in the coming months.

For this to happen, however, banks must be allowed to find badly needed new capital. But in a time of crisis, with stock markets declining, it is doubtful that much private capital can be found. The recent association of Warren Buffett with Goldman Sachs may be more of an exception than a rule.

When private capital is not available, the government has no other choice but to inject equity (by buying the banks’ preferred shares) into the national banking system, while taking steps to safeguard the public interest by obtaining common share warrants that can be resold profitably later, when the situation stabilizes.

In conclusion, we may ask if it is possible to avoid a repetition of the U.S. Great Depression of the 1930s or the more recent Japan’s protracted recession of the 1990s, both the result of a similar severe banking crisis? The answer is yes, if the vicious cycle of asset price decline, banking credit crunch and money supply contraction can be avoided, or, at the very least, stopped and reversed. In economics, as in medicine, it is never too late to do the right thing.

[NATO's goal is] to keep the Russians out, the Americans in, and the Germans down.

– Lord Ismay, first NATO Secretary-General

We should immediately call a meeting of the North Atlantic Council to assess Georgia’s security and review measures NATO can take to contribute to stabilizing this very dangerous situation.

– Sen. John McCain, (August 8, 2008)

If we would have preemptively worked with Russia, with Georgia, making sure that NATO had the kind of ability and the presence and the engagement, we could have perhaps avoided this [the invasion of S. Ossetia by Georgia and the subsequent Russian response].

– Tom Daschle, former Senate Majority Leader and adviser to Sen. Barack Obama, (August 17, 2008)

Of all the enemies to public liberty, war is perhaps the most to be dreaded because it comprises and develops the germ of every other.

– James Madison (1751-1836), fourth American President

The North Atlantic Treaty Organization (NATO) is a relic of the Cold War. It was created on April 4, 1949 as a defensive alliance of Western Europe countries plus Canada and the United States to protect the former countries from encroachments by the Soviet Union.

But since 1991, the Soviet empire no longer exists and Russia has been cooperating economically with Western European countries, supplying them with gas and oil, and all types of commodities. This has increased European economic interdependence and thus greatly reduced the need for such a defensive military alliance above and beyond European countries’ own self-defense military system.

But the U.S. government does not see things that way. It would prefer keeping its role as Europe’s patronizing protector and as the world’s sole superpower. NATO is a convenient tool to that effect. But maybe the world should be worried about those who go around the planet with a can of gasoline in one hand and a box of matches in the other, pretending to sell fire insurance.

As of now, it is a fact that the U.S. government and the American foreign affairs nomenklatura see NATO as an important tool of American foreign policy of intervention around the world. Since many American politicians do not anymore support de facto the United Nations as the supreme international organization devoted to maintaining peace in the world, a U.S.-controlled NATO would seem to be, in their eyes, a most attractive substitute to the United Nations for providing a legal front for their otherwise illegal offensive military undertakings around the world. They prefer to control totally a smaller organization such as NATO, even though it has become a redundant institution, than to have to make compromises at the U.N., where the U.S nevertheless has one of the five vetoes on the Security Council.

That is the strong rationale behind the proposals to reshape, reorient and enlarge NATO, in order to transform it into a flexible tool of American foreign policy. This is another demonstration that redundant institutions have a life of their own. Indeed, when the purpose for which they have been initially established no longer exists, new purposes are invented to keep them going.

Regarding NATO, the plan is to turn it into an aggrandized offensive imperial U.S.-dominated political and military alliance against the rest of the world. According to plan, NATO would be enlarged in the Central-Eastern European region to include not only most of the former members of the Warsaw Pact (Poland, the Czech Republic, Slovakia, Bulgaria, Romania, Albania and Hungary) and many of the former republics of the Soviet Union (Estonia, Lithuania, Latvia, Georgia and Ukraine), but also in Asia to include Japan, Australia, New Zealand, South Korea, and possibly admit Israel in the Middle East. Today the initially 12-member NATO has mushroomed into a 26-member organization. In the future, if the U.S. has its way, NATO could be a 40-member organization.

In the United States, both the Republicans and the Democrats see the old NATO transformed into this new offensive military alliance as a good (neocon) idea to promote American interests around the world, as well as those of its close allies, such as Israel. It is not only an idea actively promoted by the neocon Bush-Cheney administration, but also by the neoconservative advisers to both 2008 American presidential candidates, Sen. John McCain and Sen. Barack Obama.

Indeed, both 2008 presidential candidates are enthusiastic military interventionists, and this is essentially because both rely on advisers originating from the same neocon camp.

For instance, the rush with which the Bush-Cheney recklessly promised NATO membership to the former Soviet republic of Georgia and American military support and supply is a good example of how NATO is viewed in Washington D.C. by both main American political parties. For one, Republican presidential candidate John McCain envisages a new world order built around a neocon-inspired “League of Democracies” that would de facto replace the United Nations and through which the United States would rule the world. Secondly, Sen. Barack Obama’s position is not that far from Sen. McCain’s foreign policy proposals. Indeed, Sen. Obama advocates the use of U.S. military force and multilateral military interventions in regional crises, for “humanitarian purposes”, even if by so doing, the United Nations must be bypassed. Therefore, if he ever gains power, it is a safe bet that Sen. Obama would not have any qualms about adopting Sen. McCain’s view of the world. For example, both presidential candidates would probably support the removal of the no “first strike” clause from the NATO convention. It can be taken for granted that with either politician in the White House, the world would be a less lawful and a less safe place, and would not be more advanced than it has become under the lawless Bush-Cheney administration.

However, it is difficult to see how this new offensive role for NATO would be in the interests of European countries or of Canada. Western Europe in particular has everything to fear from a resurgence of the Cold War with Russia, and possibly with China. The transformation of NATO from a North Atlantic defensive military organization into a U.S.-led worldwide offensive military organization is going to have profound international geopolitical consequences around the world, but especially for Europe. Europe has a strong economic attraction for Russia. Then why embark upon the aggressive Bush-Cheney administration’s policy of encircling Russia militarily by expanding NATO right up to Russia’s doorstep and by placing a missile shields right next to Russia? Wouldn’t it be better for Europe to develop harmonious economic and political relations with Russia? Why prepare the next war?

And as for Canada, under the neocon minority Harper government, it has sadly become a de facto American colony as far as foreign affairs are concerned, and this, without any serious debate or referendum to that effect within Canada. The last thing Canada needs is to go further on that mined road.

In conclusion, it would seem that the humanist idea of having peace, free trade and international law as the foundations of the world order is being cast aside in favor of a return to great power politics and gunboat diplomacy. This is a 100-year setback.

It is a shame.

War prosperity is like the prosperity that an earthquake or a plague brings.

War… is harmful, not only to the conquered but to the conqueror.

To defeat the aggressors is not enough to make peace durable. The main thing is to discard the ideology that generates war.

The root of the evil is not the construction of new, more dreadful weapons. It is the spirit of conquest.

– quotations from Ludwig von Mises (1881-1973)

There are people in charge who think that provocation and aggression can be acceptable government policy. The sudden conflict between the former Soviet province of Georgia and Russia in the Caucasus in Eurasia is a good case in point.

What’s behind this conflict that erupted last Friday at the outset of the Beijing Olympic Games? First and foremost, let us keep in mind that the real and first aggressors in this conflict is the belligerent government of Georgia, led by an impulsive politician named Mikhail Saakashvili, who is openly supported by the governments of the U.S. and of Israel. Early Friday, August 8, Georgian tanks and infantry, assisted by American and Israeli military advisers, launched an early morning massive artillery and rocket barrage on the capital of breakaway South Ossetia, Tskhinvali, thus directly provoking Russia, which had soldiers in that province.

At first blush, most people could easily arrive at the conclusion that Saakashvili is completely out of his mind for having declared war against its neighbor Russia, a country more than 50 times larger, with the goal of reoccupying the Russian-speaking province of South Ossetia, de facto independent since 1992. The only logical explanation would seem to be that the Georgia President believed, or had some form of assurance, that the Bush-Cheney administration would side militarily with him. Did he really believe that the Bush-Cheney administration, already deeply involved in two military conflicts in Iraq and in Afghanistan, would risk a world war to salvage an oil pipeline and a newly acquired colony in that far away part of the world? This would seem to be another insane idea.

It is a little known fact that the U.S. and Israel have been training and arming the Georgian military since 2002. This situation is tantamount to risking a restart of the Cold War with Russia. It has also sown the seeds of a much larger conflict in that part of the world by encouraging Georgia to embark on military maneuvers. Little Georgia (4.5 m. inhabitants) even has 2,000 troops in Iraq, soldiers that the U.S. is now quickly flying back to Georgia. This goes a long way towards explaining how involved the Bush-Cheney administration and its Israeli surrogates have been in sticking it in the eyes of Russia. And now, the Russian bear is reacting. This is brinkmanship at a high level.

In the summer of 1914, a similar miscalculation resulted in igniting World War I.

This was a conflict that started with a single death (the assassination of Archduke Franz Ferdinand on June 28, 1914) but which resulted, in the end, in 40 million deaths. The catastrophe was the result of a chain reaction of war declarations by various countries involved in the affairs of other countries. This remains an example of how relatively minor regional conflicts can escalate into conflagrations when hotheads are in command.

The Georgia-Russia spat represents a good opportunity for the U.N. Secretary-General, Mr. Ban Ki-moon, to show leadership and not to let things degenerate. Indeed, there is always the possibility that one politician after another will try not to lose face by escalating things. For example, the U.N Secretary-General should obtain from the Security Council the mandate to visit immediately the two capitals directly involved, and he should attempt to broker an immediate face-saving end to the hostilities. He should persuade the Russian leaders not to overreact to the Georgian President’s provocations. As for the latter, he has demonstrated that he is not worthy of occupying his functions.

Time is of the essence in such circumstances, because there are always some interests that stand to profit from a worsening situation.

For one, the presumptive Republican presidential candidate John McCain, who never met a war he didn’t like, has already tried to stoke the fire of conflict by calling for the 26-country NATO to get involved in what is essentially a local ethnic conflict. On the campaign trail, John McCain said: “We should immediately call a meeting of the North Atlantic Council to assess Georgia’s security and review measures NATO can take to contribute to stabilizing this very dangerous situation.”

Incredibly, the republican candidate is attempting to profit politically from this faraway crisis by advancing the frightening prospect of turning a small regional conflict into a world war. This could have something to do with the fact that Mr. McCain’s main foreign policy adviser is a former lobbyist for the government of Georgia and is a former neocon lobbyist for the U.S. military invasion of Iraq. This would seem to be a direct conflict of interests and reason enough for Mr. McCain to refrain from throwing oil on the fire.

I have said it before, and this incident confirms it; this man would seem to be unfit to be in charge of a heavily armed country.

I think the [US financial] system is basically sound, I truly do.
– George W. Bush, July 15, 2008

Since 1951, the budget of the Department of Defense each year exceeds the net profits of all U.S. corporations. So, in finance capital terms, that means that the management of that budget controls the largest single block of finance capital resources.
– Seymour Melman (1917–2004)

The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.
– Ernest Hemingway (1899-1961), (September 1932)

There have been many policy missteps over the last twenty some years, and this has amounted to a mismanagement of the U.S. economy. The result has been an unhealthy mixture of greed, shortsightedness and market manipulation. And now, all the chickens are coming home to roost and the crisis is deepening. This does not mean that the private side of the U.S. economy is not resilient and strong. It only means that government policies have often been misguided and have damaged the private economy and hurt the people economically.

Essentially, at the government level, each new economic crisis seems to have been “solved” by creating the conditions for the next one. This is particularly true in regards to regulation policy, monetary policy, and fiscal policy. Each time a policy choice had to be made, it seems that short-term benefits were often privileged at the expense of long-term costs.

First, let us consider regulation policy for the crucial financial sector.

Over the last twenty years, U. S. deregulation of the financial sector has been based on developing what I would call predator financial capitalism, that is to say the systematic encouragement of excessive risk taking (moral hazard) and of corporate greed in general, the development of the pyramidal $2.5 trillion hedge fund industry, the practice of highly-leveraged buyouts (LBOs) of healthy companies with their own high-yield debt, also know as “bootstrap” investments, and the practice of program trading. Moreover, this was a system that was not only risky but also fraught with shady activities.

To accomplish this deregulation or non-regulation of the financial sector and to encourage the over-indebtedness of the U.S. economy, a whole series of safeguards that had been wisely established to prevent a repeat of the financial and economic disasters of the 1930’s were dismantled and cast aside. The last one in line was the reckless abolishment by the U.S. Securities and Exchange Commission (SEC) of the speculative prevention rule called the downtick-uptick rule (which prohibited short-selling when stock prices were falling), in July 2006. Such safeguards had been put in place in order to avoid systemic financial instability, to make financial institutions more responsible to users and to avoid costly government bailouts when large financial institutions fail. Today, we are back to the 1930s with large financial institutions reaping huge profits and paying obscene salaries to their CEOs in good times and with government bailing them out with public money when things turn sour.

During the Reagan-Bush era of the 1980’s, deregulation encouraged unsound real estate lending by Savings and Loans financial institutions (S&Ls) and this led to the 1986-1995 Savings and Loan associations crisis, when about $160 billion was lost, most of it through a $124.6 billion bailout by the U.S. Government.

The 1980s also saw the flourishing of vulture or predatory capitalism when financial operators were allowed to raid profitable companies and saddle them with the debt incurred to take them over. In 1989, for example, the corporate raider firm of Kohlberg Kravis Roberts (KKR) closed in on a $31.1 billion dollar hostile takeover of RJR Nabisco. It was, at that time, the largest hostile leverage buyout in history. The event was chronicled in the book (and later the movie), Barbarians at the Gate: The Fall of RJR Nabisco. To this day, nothing has been done to stop this practice that rewards irresponsible gambling and punishes prudent behavior. For the time being, however, it can be said that the practice of leveraged finance and of high-yield debt was somewhat stalled last August (2007) when the subprime crisis began to unfold.

At the center of current financial problems is the failure to adapt standard financial regulation to new financial institutions, such as broker-investment banks, off-shore based hedge funds and large derivatives markets that remain, for the most part, outside of the traditional authority of regulators. However, when things go wrong, as they did with Bear Stearns last March, their demise threatens to destabilize the entire financial system and handy government bailouts are quickly called in.

Second, let us consider monetary policy.

Over the last few years, U.S. monetary policy has resulted in a massive wealth transfer from savers, retirees and money holders in general to banks, mortgage lenders and debtors in general as the purchasing power of the dollar has plummeted. Last September, after the Bernanke Fed decided to drop interest rates as the U.S. dollar was already in the downtrend, I wrote, “foreign (dollar) investors have been ‘taxed’ by the American Fed’s policy of benign neglect regarding the dollar.”

Since then, the Bernanke Fed has gone much further. It has pushed the Federal funds rate to the 2 percent level from the 5.25 percent level it was in mid-September 2007. In so doing, by pushing real interest rates deep into negative territory and by depreciating the U.S. dollar, the Fed has heavily taxed retirees and savers in its rush to shore up American financial institutions. Indeed, it can be said that the semi-private Fed has been floating American financial problems in a sea of new money by running the printing press.

The act of printing excessive amounts of bills is the worst enemy of sound money. It is a way to destroy fiat currencies. It is the main source of inflation and, sometimes, of hyperinflation. In the end, we know that it robs people of their savings and lowers their standards of living.

Paradoxically, while the Fed is lending heavily to financial institutions in trouble by discounting their bad subprime loan paper through its so-called new special lending facilities (at 2% annual interest rate), banks become more selective in extending credit to borrowers, forcing companies and consumers alike to cut down on their investment and consumption projects.

The economy is thus placed in a sort of “liquidity trap” where everybody wishes to remain short term and liquid. There is a lot of money around, as the monetary base, or “High-powered money”, is increasing rapidly, certainly enough to feed inflation, depreciate the U.S. dollar and push long term bonds down (long term interest rates are on their way up), but banking credit as such remains scarce and may be getting more scarce as banks attempts to recapitalize themselves.

What the Bernanke Fed is doing nowadays is a continuation, although at a much higher level, of what the Greenspan Fed did in the late 1990’s. At that time, then Fed Chairman Alan Greenspan reacted to the collapse of an investment firm specializing in hedged funds, Long-Term Capital Management, by pumping large amounts of liquidity into capital markets and by lowering interest rates. This approach was called a “Greenspan put” because it had the effect of guaranteeing the profitability of many risky financial operations that otherwise would have failed. That policy paved the way for the dot-com stock market bubble of 1999-2000.

In the same spirit, some refer to the Fed’s bailouts of troubled investment banks as a sort of Bernanke put, because of the Fed’s aggressive policy of reducing interest rates to fight market falls or to bail out financial companies in trouble.

Because of the current economic slowdown, the inflationary consequences of such a policy is not apparent yet, but it could be the foundations of future inflation down the road. Let us keep in mind that historically-low interest rates, lax lending standards, and inadequate regulation were behind the U.S. housing bubble. The seeds are now sown for the next bubble.

Third, let us look quickly at fiscal policy.

The Bush-Cheney administration’s fiscal policy has been characterized by budget deficit upon budget deficit, whatever the state of the economy. In its entire eight years in office, in fact, it has never balanced the budget. On the contrary, it has even spent the budget surplus that it inherited from the Clinton administration. And it has announced that it plans to leave the coming administration with a record 2009 deficit of half a trillion dollars. Indeed, the previous Bush-Cheney administration’s record was its 2004 $413 billion deficit.

Although such deficits at about 3.3 percent of the gross national product (GDP) are lower than the 6.0 percent of GDP we saw in the early 1980’s, they are cumulative, and they have occurred at a time when U.S. foreign indebtedness is much higher and the U.S. dollar much weaker. It can be said that they have contributed to weakening the United States and making it more vulnerable to economic and financial shocks.

Conclusion

In economics, bad decisions and bad policies do not always result in immediate negative consequences. It takes time for them to work their way through the economy and produce their corrosive effects. Many of the current economic and financial problems of today are the result of bad policies of the past.

[U.S.] strategy should aim, above all, at the removal of Saddam Hussein’s regime from power. …[His removal is absolutely vital to] the security of the world in the first part of the 21st century [and for] the safety of American troops in the region, of our friends and allies like Israel and the moderate Arab states, and a significant portion of the world’s supply of oil.

– Neocons’ January 26, 1998 letter to President Bill Clinton

[About the Iraqis] If they turn on their radars we’re going to blow up their goddamn missiles. They know we own their country. We own their airspace… We dictate the way they live and talk. And that’s what’s great about America right now. It’s a good thing, especially when there’s a lot of oil out there we need.

– U.S. Air Force Brig. General William Looney, head of the US-UK flying operation south of the 32nd parallel over Iraq (no-fly zones), interview reproduced in the Washington Post, August 30 1999,¹

Focus your operations on the oil, especially in Iraq and in the Gulf, as this would mean [the West's] death.

– Osama bin Laden, December 2004

The high crude oil prices do not have any relation to production or consumption,… [It is] because of the decrease in the value of the dollar.

– Mahmoud Ahmadinejad, Iran President, April 2008

The American economy seems to be going from bubble to bubble: in 2000, it was the tech bubble; in 2005, it was the housing bubble; and now, it is the oil and commodities bubble. In fact, the entire world of investment is now a giant casino where speculators are in charge and where governments look the other way. For many basic marketable staples (rice, wheat, and corn) and commodities (oil, gas, metals), prices have no relation to the underlying values of what is being traded. Such prices are mostly driven by bad policies and by the pyramidal “greatest fool” technique by which large off-shore speculators navigate through unregulated derivatives to push prices up ever further, until the bubble burst. Meanwhile, a lot of disruptions may be created and people’s lives may have been endangered or lost. The current famine in many countries is the end result of such government approved manipulation of markets, by OPEC and a host of other cartels and so-called speculative hedge funds.

Is it possible for an economy to grow and prosper without always being on a roller coaster? Indeed, does the current explosion in oil and commodities prices reflect real supply and demand shifts, such as supply disruptions, or is it also or even mainly driven by geopolitical factors and financial speculation that fuel an ever larger insatiable artificial demand?

It is my feeling that the plummeting U.S. dollar is having serious unintended economic consequences worldwide. Indeed, such a panic devaluation of the most widely used key currency is fueling a major rush out of dollar holdings into hard assets, such as oil, gold and other commodities. Central banks, companies and individuals are losing faith in the dollar paper currency, which has been depreciating fast against other currencies, but whose intrinsic value is also expected to be eroded further by the coming inflation that will inevitably follow the Fed’s current liquidity creation. All these problems are interconnected.

Let us remember that the oil problem in the U.S. is largely a self-inflicted predicament since the U.S. government opted to move away from a self-sufficiency and a renewable-energy based economy. In 1982, for example, the U.S. daily consumption of oil had been brought down to about 9 million barrels a day, from 14 million barrels a day before the 1973 OPEC-initiated oil shock. Since the U.S. was producing about 9 million barrels of oil a day, it can be said the American economy was then self-sufficient in that form of energy needs. The Reagan administration changed all that: No more 55-mile-an-hour driving limits; reduced obligations for car manufacturers to raise gas mileage; no more restrictions, fiscal or otherwise, on the purchase of gas guzzlers, etc. The result is that the United States, with less than five percent of the world population, now consumes 25 percent of the daily world oil output, roughly 22 million barrels a day out of about 88 million barrels produced daily worldwide. And, here’s the gist, 60 percent of that oil has to be imported. What’s more, for the world as a whole, also 60 percent of oil imports come from the unstable Middle East. That’s what we can call playing with fire!

Therefore, since oil access under American control played an important part in the Bush-Cheney’s decision to launch an unprovoked war against Iraq in the spring of 2003, in order to turn that sovereign country into an American oil protectorate under management by a few major Anglo-American oil companies, it can said that the seeds for this illegal war were sown way back, during the Republican Reagan administration. That was when the philosophy of deregulation was rampant and was then hailed as a success. But, as a consequence, twenty-five precious years have been lost in preparing the U.S. economy for the time when oil would become a scarce energy source. Now, this time has arrived, but this is still the era of Hummer type vehicles that can only run on large quantities of costly and risky imported oil.

Indeed, in the U.S., there are now three cars for four adults and those cars are larger and have more powerful engines than anywhere else in the world. If only a few countries, such as China and India, were to emulate the United State in that regard, as their income levels rise, world oil consumption would more than double. But with no known oil reserves to meet such an expanded demand, oil prices would skyrocket, crushing the purchasing power of consumers and raising inflation. The result would be a major worldwide economic crisis before economically viable alternative energy sources could be developed. This could take ten to twenty years.

Are we there now? If not, we are moving fast toward that day of reckoning, while do-nothing or complicit governments hope for a miracle or some magic solution. The main consequences will be rising inflation, 19th century wars for securing resources, and a worldwide economic slowdown in production and trade. The next twenty years should prove to be interesting for a few, but taxing for the many.

1. Quoted in William Blum’s book, Rogue State, Common Courage Press, 2005, p. 159

The power to determine the quantity of money… is too important, too pervasive, to be exercised by a few people, however public-spirited, if there is any feasible alternative. There is no need for such arbitrary power… Any system which gives so much power and so much discretion to a few men, [so] that mistakes — excusable or not — can have such far reaching effects, is a bad system. It is a bad system to believers in freedom just because it gives a few men such power without any effective check by the body politic — this is the key political argument against an independent central bank.

– Milton Friedman (1912-2006)

The system of banking [is] a blot left in all our Constitutions, which, if not covered, will end in their destruction… The issuing power should be taken from the banks and restored to the people to whom it properly belongs.

– Thomas Jefferson, (1743-1826), 3rd U.S. President

If the American people ever allow private banks to control the issue of their money, first by inflation and then by deflation, the banks and corporations that will grow up around them (around the banks), will deprive the people of their property until their children will wake up homeless on the continent their fathers conquered.

– Thomas Jefferson, (1743-1826), 3rd U.S. President

In 1989, the U.S. government created the Resolution Trust Corp., in effect nationalizing many savings and loans banks that were in financial difficulties. Similarly, on February 16, 2008, the British government nationalized the Northern Rock bank and rescued this bank with about £55 billion ($107 billion) in public loans and guarantees.

During the weekend of March 14-16, 2008, the Federal Reserve, a semi-public and semi-private American central bank organization, accepted to create a Delaware-based corporation in partnership with a (regulated) private bank, the JP Morgan Chase bank, in order to buy and manage $30 billion of distressed mortgage-backed securities acquired from a New York-based global but unregulated investment bank, Bear Stearns, about to go bankrupt. JP Morgan Chase put $1 billion in the new corporation, while the Fed invested $29 billion, an amount that was quickly transferred to JP Morgan Chase, the new owner of Bear Stearns.

In so doing, the Fed has de facto nationalized a portion of the portfolio of Bear Stearns, and become an “investor of last resort” rather than a “lender of last resort”, besides facilitating the take-over of this investment bank by JP Morgan Chase. A private company, BlackRock Financial Management, [http://en.wikipedia.org/wiki/BlackRock] was also hired to administer the new Delaware-based corporation and will attempt to liquidate the acquired securities gradually over time. The Fed could then recuperate part or all of its non-recourse “loan” to JP Morgan Chase, and would retain any excess amount on its unusual “investment”, in the event there is a profit.

There you have it. For the first time since its creation in 1913, the Fed has turned itself into a government of the banks, and has invested risky public capital in a business that was in need to be saved quickly from bankruptcy and liquidation. Thus, the Fed has not only decided that it is its duty to solve “liquidity crises” but also “solvency crises” in the regulated and non-regulated banking sector. In other countries, such public investments to resolve a solvency crisis are decided and handled by the Treasury and the Government, and are later voted into law. Even in the U.S., that is the way the Resolution Trust Corp. was created by the Reagan administration in the late 1990s. In fact, the current banking crisis is very reminiscent of the U.S. Savings and Loan crisis of the 1980s and 1990s, although this time the banking crisis is much more severe and much more widespread.

I personally do not question the need for avoiding a panic liquidation of the subprime and other exotic assets of Bear Stearns, in order to avoid a contagious domino effect of bank failures and a worldwide credit crunch, which could have duplicated the failure of the Creditanstalt bank in September 1931, an event that precipitated the 1930’s depression. After all, the Fed was established in 1913 to avoid banking panics. What can be questioned is the way this has been done, the end result being in effect to subsidize the U.S. banking sector by privatizing most of the profits derived from the rescue operation in the hands of a private bank, and nationalizing the most likely losses in the hands of the Fed and its backer, the U.S. government. The U.S. Treasury should have played a much larger role in this bailout, so as to protect the public interest.

Make no mistake about it. This transaction may turn out to be enormously profitable to JP Morgan Chase, if the actions of the Fed were to stabilize the market for mortgage-backed financial assets in the coming months, while the Fed guarantees that the new owner of Bear Stearns would not suffer any loss on a vulnerable portion of its acquired portfolio.

A more transparent and a more democratic approach would have called for the Treasury to establish the equivalent of the old Resolution Trust Corp. to acquire insolvent Bear Stearns and gradually liquidate its mortgage-backed and other risky financial assets over time. The salvaged investment bank could have later on be sold to an existing bank at a fair market value, or reinstated as an independent viable financial entity. The public good could have been protected by avoiding a financial panic, while simultaneously precluding a massive liquidation of jobs at Bear Stearns, and a possible private enrichment of a private entity under the umbrella of an unusually risky public investment by the Fed.

I have been an adviser to central banks over my career, and that is what I would have recommended.

The issue today is the same as it has been throughout all history, whether man shall be allowed to govern himself or be ruled by a small elite.

– Thomas Jefferson (1743-1826), 3rd U.S. President

I have learned to hold popular opinion of no value.

– Alexander Hamilton (1755-1804)

Those who cannot remember the past are condemned to repeating it.

– George Santayana (1863-1952)

PART I *

I have been a student of cycles, both of economic cycles and of political trends, for a very long time. To try to understand the economy or politics for that matter without having a knowledge of cycles and trends is like sailing without a compass, a weather report or a GPS (Global Positioning System).

There are four main types of cycles in economics, some relatively short, such as the slightly less than four year long inventory cycle, or the standard 10-year technology cycle, and some longer, such as the 18-year long real estate cycle (N.B.: We are presently in the downward part of this cycle, which should last until 2010-11), and some called long waves, such as the 54- to 60-year long Kondratieff cycle of a debt and price inflation-then disinflation-followed by a debt and price deflation (N.B.: We are presently in the deflation phase of this long cycle, a good example being the debt deflation of heavily levered banks and hedged funds and of price deflation in housing) such a deflation phase expecting to last also until 2010-11.

As I mentioned, the shorter cycle is the inventory cycle (Kitchin), which lasts slightly less than four years. This cycle has become very much less pronounced in recent years for two reasons. 1) First, the service sector as a percentage of the entire economy is much larger than it was 100 or even 50 years ago. In the United States, the service sector accounts for approximately three quarters of GDP. Today, four out of every five private sector non-farm jobs (80 percent) are in the economy’s service sector (federal, state and local government, wholesale trade, retail trade, transportation, public utilities, construction, finance, insurance, real estate, telecommunications, computer and related services, energy services, distribution, express delivery and audio-visual services, etc.). 50 years ago, the service sector accounted for about 60 percent of U.S. output and employment. Today, the information age has generated new forces that have driven the shift to a more services-oriented economy.

For the U.S., services exports represent approximately 30 percent of the total value of America’s exports, and it is in surplus. This sector of the economy is much less volatile than manufacturing, agriculture or mining.

2) Second, over the years, businesses have embraced the use of the computer and the digital revolution to manage inventories. This has lead to the “Just-in-time” inventory management method, which has considerably reduced fluctuations in the inventory stocks of distributors, thus smoothing the production cycle of producers.

During the entire twentieth century, as the economy moved from agriculture and industry and more and more toward service industries, the volatility of the US economy became less and less pronounced. As a consequence, recessions have been shallower and of shorter duration. And, of course, there has not been another economic depression, like the 10-year Great Depression that lasted from 1929 to 1939.

There was another structural development on the inflation side. Indeed, the internationalization of national economies has acted as a damper on price increases, as new low cost producers, such as China and other emerging economies, have entered the markets. For instance, exports and imports used to represent 20 percent of the U. S. economy; nowadays, it is 30 percent.

Sometimes we measure these cycles from bottom to bottom, and sometimes from top to top. For the 10-year cycle (the Juglar cycle), it often coincides with normal recurring recessions. In the U.S., there were recessions, for example, in 1969, in 1973-75, in 1980 and 1981-82, in 1990-91 and in 2001, most of them within about a 9-10 year interval. According to this cycle, there could be a somewhat severe recession in 2010-11, possibly following the slowdown or recession expected to occur this year.

What is of interest is that the real estate cycle or housing cycle (the Kuznets cycle) is also scheduled to bottom in this period. This is a cycle of about 12 years of price increase and of 5 or 6 years of price decline. The previous cycle, from top to top went from 1987 to the spring of 2005. A bottom would therefore be normal in 2010-11 and a future top around 2023.

But the multi-generation Kondratieff cycle is perhaps even more ominous in its influence on the economy. From bottom to bottom, this very long cycle began in 1949, when wartime prices were unfrozen, reached a top in inflation in 1980 at 13-14 percent levels, and is expected to bottom between 2003 and 2010. The current financial crisis and the credit crunch that accompanies it are the main players in this long cycle.

As you see, the table is set for an important economic bottom in the next two years. That is why I recommend being careful and alert financially during this turbulent period.

There are also cycles and trends in politics, and they sometimes coincide with economic cycles. For example, it would surprise no one to know that during the early inflationary phase of the Kondratieff cycle, a philosophy of government social spending would tend to prevail. In the U.S., this would be a period where the Democrats would be expected to be in power. When there is a need to fight inflation, a conservative philosophy of government would tend to prevail, and this would favor the Republicans. The Kennedy-Johnson administration of the 1960s is a case in point, while the Reagan-Bush Sr. administration is the other.

(To be continued)

* N.B.: This article is drawn from a conference to be pronounced by Dr. Tremblay before the Florida Renaissance Academy, Marco Island Yacht Club, on April 4, 2008. Those wishing to attend can call: 239-394-3089 or 239-434-4737.

The problem [of loan defaults] will be significantly bigger next year [2008] because 2006 [mortgages] had lower… standards.
– Henry Paulson, U.S. Treasury Secretary

The best way to destroy the capitalist system is to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.
– John Maynard Keynes (1883-1946)

Questions from the Turkish Daily News, Istanbul, Turkey:

Question 1: What triggered the US subprime crisis? Can you compare it to past crises such as the 80s crisis?

Answer Dr. Tremblay: Four interrelated factors are responsible for creating the ongoing [subprime mortgage] financial crisis that is raging in the United States today.

First, monetary policy. After the technology dotcom bubble burst in 2001 and brought about the March to November 2001 recession, the Greenspan Fed aggressively lowered the Federal Funds rate from 6.5% to 1% in 2004, the lowest it had been since 1958. it is considered now that this was excessive, and that the Fed should not have lowered the Federal funds rate below 2%, and that it should have begun to raise it sometime in 2002. Indeed, from 2002 to 2004, the American central bank pursued a monetary policy that was too expansionary. Former Fed Chairman Alan Greenspan has argued to explain his policies that he was afraid of an onset of deflation, but few economists agree with him. Between 2002 and 2004, the Fed had no need to keep real short term interest rates so negative for so long, especially as the Bush administration was cutting tax rates and increasing military expenditures with its military invasion of Iraq.

Second, the housing boom. Abnormally low interest rates in the U.S., but also elsewhere because of the interconnections between money and capital markets, fed a housing boom world-wide which was unsustainable because partly based on price speculation. Indeed, mortgage rates in the U.S. remained low, even after the Fed started to raise the Federal funds rate from 1% in mid-2004 to 5.25% in June 2006. This was brought about by Americans borrowing huge amounts abroad. —In 2006, the U.S. current account deficit even reached 6% of GDP. China, Japan and oil-producing countries were the main buyers of U.S. Treasury bills and bonds.

Third, new banking rules. With ever rising house prices, lending institutions relaxed their lending rules as the housing collateral behind the loans was gaining in value. Mortgage banks and other lenders began to accommodate subprime borrowers with dubious credit by extending mortgage loans to homebuyers who would not have qualified in other times. Nontraditional home loans were advanced to borrowers who had no documented incomes. Some loans were interest-only loans with down payments of 5% or less. Some were adjustable rate loans (ARMs), with low rates for one or two years to be reset later at much higher rates. In 2006, about 25 percent of American mortgages were subprime and close to 20 percent were adjustable rate loans.

Fourth, new financial instruments. With the demand for mortgage loans increasing, large banks resorted to some inventive financing of their own in order to economize their capital. They began repackaging loans and slicing them into some exotic new types of securities, and in so doing, shifted their lending risk to the buyers of such securities. Thus came into being a new class of securities—often rated AAA by credit rating agencies —that money market funds, insurance companies, pension funds and other investors could purchase.

These new “structured investment vehicles” (SIVs) came under various names such as “Collateralized Bond Obligations” (CBOs) or “Collateralized Debt Obligations” (CDOs). They had the characteristics of unfunded short-term asset-based commercial paper (ABCP). It is this ABCP market which is unraveling presently in the United States and elsewhere, and which is at the center of the current financial crisis. At its peak in the summer of 2007, the U.S. ABCP market was valued at some $1.170 trillion. It has fallen now to some $900 billion and is still contracting, as banks write down bad debts. [N.B.: This process of financial disintermediation may last many years.]

The savings-and-loans crisis of the early 1980s was also a serious blow to the U.S. economy. Over 1,000 savings and loan financial institutions failed, and losses were estimated to have totaled around $150 billion. As well, the crisis was a contributing cause to the 1990-1991 recession. This time around, the financial crisis is at the very least as bad, if not worse, because it involves the integrity of the entire American banking sector. The extent of the losses this time is not yet fully known, but everybody agrees that it will be very substantial.

[Another 1990 example is the near failure of the hedge fund Long-Term Capital Management (LTCM), in September 1998. The Federal Reserve (FED) had to intervene in panic and provide liquidity in order to prevent a forced liquidation of the large positions held by LTCM, which would have depressed bond prices and hike interest rates, at a time there was a financial crisis in Asia. — N.B.: Hedge funds are essentially speculative private entities that take risky financial positions in interest rate, currency and commodity derivatives, and in financial markets in general.]

Question 2: How will the average American be affected?

Answer Dr. Tremblay: Since home ownership is a large portion of the average American’s net worth, declining house prices and foreclosures on delinquent mortgage loans are bound to reduce private consumption spending in the coming months through a negative “wealth effect”. The loss of jobs and incomes in the construction and financial industries is also going to negatively impact consumption spending. Above all, the average American may have to reduce his debt load. Together, mortgage debt and consumer debt account for some 125 percent of disposable income. These are historically high levels.

Question 3: How do you assess Fed’s policies after the outbreak? What is your opinion about the scepter of inflation?

Answer Dr. Tremblay: Well, as I wrote on my blog of last September 21, I think the Bernanke Fed panicked when it announced a larger than expected half percentage point cut in both the federal funds rate and in the discount rate, and this after having slashed its discount rate by a half point, on August 17 (2007). The purpose was to facilitate distress borrowing by America’s largest banks and to facilitate the bailout of their affiliates (known as conduits) and other operators, such as hedge-funds, caught in the sub-prime loans crisis. In so doing, the Bernanke Fed is, to a certain extent, following Walter Bagehot’s advice for aggressive discounting in a situation of financial crisis. The only problem is that Bagehot’s rule calls for the central bank to lend copiously in times of critical credit stringency … but at a high rate of interest. By lending to troubled lenders at reduced preferential rates, the Fed has been acting as their “government” or their ‘insurer”, i.e. subsidizing their risky loans operations and innovative finance, while taxing anybody else who holds American dollars. It is not only attempting to make the banks more “liquid”, but also more “solvable” and less likely to fail.

In so doing, and especially with its policy of abandoning the dollar in foreign exchange markets, the Bernanke Fed is sowing the seeds of future inflation. All the new money that has been injected into the financial system will be difficult to retrieve and inflationary pressures should begin to show in a few years, after an expected economic slowdown. The more so that the 54-year average long inflation-disinflation-deflation Kondratieff cycle is about to run its course by 2010-11. A new inflation phase should begin thereafter.

Question 4: When the US coughs, the world gets flu, they say. What will happen when the US gets a flu such as this? What are the prospects for emerging market such as Turkey, which rely on exports, plus have seen massive foreign capital inflows during the past 5 years?

Answer Dr. Tremblay: The U.S. economy accounts for about one quarter of the world economy, so it is reasonable to expect that an American slowdown will impact other economies. As of now, Europe and Asia are still booming. However, the decline in the U.S. dollar and the concomitant appreciation of the euro and most other currencies, coupled with the rise of the price of oil, is bound to have a negative impact on these economies. In fact, it can take as much as two years for a currency over appreciation to impact the real economy.

The danger for Turkey is to be caught with an overvalued currency while pursuing an export-led growth strategy. Indeed, in the last few years the (new) Turkish lira has risen against the U.S. dollar and even against the euro. This has had beneficial effects in the fight against inflation, but this also could hurt future growth. The most recent example of such a predicament was Argentina, in the late 1990s, which was forced to abandon its peg to the U.S. dollar.

Question 5: Do you perceive a difference of approach between the Anglo-Saxon economies and continental Europe economies, which have, for the most part, come out unscathed?

Answer Dr. Tremblay: As you know, some European banks had to be bailed out after suffering huge losses coming from their asset-backed commercial paper operations. As a consequence, the Bank of England and the European Central Bank have injected huge sums of new money in their banking sectors. In the U.S., the Fed has a double mission, which is to contain inflation but also to accommodate economic growth. In Europe, the ECB’s central mission is to contain inflation. This does not mean that there are not political pressures to abandon the fight against inflation in order to spur growth, as Mr. Sarkozy’s campaign against Mr. Trichet’s policies well illustrates. On the whole, however, it would seem that the rush toward irresponsible banking practices was less prevalent in Europe than in the United States, and that the negative impact should be less prevalent in Europe than in the USA.

Question 6: What is the lesson to be learned from this crisis, and what kind of precautions should be taken?

Answer Dr. Tremblay: Obviously, there was a lack of diligence and supervision on the part of central banks and of other regulatory agencies, especially in the United States. Former Fed Chairman (1951-1970) William McChesney Martin once said that “The job of the Federal Reserve is to take away the punch bowl just when the party starts getting interesting.” — As the subprime financial crisis was getting up steam, the Greenspan Fed seemed to have been too close to the Bush administration and its political objectives and not enough aware of the danger that new financial rules were creating for the health of the financial system and of the economy as a whole. The Fed should have taken the monetary punch bowl away in 2003-04, but it did not. We still do not know the extent of the damage that has been done to the real economy. I hope it can be contained and will not spread.

Question 7: Do you foresee a US recession?

Answer Dr. Tremblay: Fed Chairman Ben Bernanke and U.S. Treasury Secretary Henry Paulson do not see a recession in the U.S. in 2008. As for myself, I think an economic slowdown is unavoidable in 2008. I do hope that the worst-case scenario will not materialize. However, I expect nevertheless a mild American recession in 2008, to be followed by a more severe one in 2010-2011 (at the trough of the 10 year cycle).

Question 8: What will be the impact on (a) The dollar?

Answer Dr. Tremblay: Well, the U.S. dollar has been declining for many years and is hitting all-time lows against the euro. In 2000, the euro was worth less than 83 cents, but it is now close to $1.50, a 45 percent depreciation for the dollar. I think the current phase of the dollar decline is close to have run its course. Baring some big geopolitical shock, the U.S. dollar could rebound in the months ahead. It is presently very much oversold.

Over the long run, we have entered a period where the demand for energy and resources is going to be strong relative to supplies. This should favor the currencies of resource-based economies, such as Canada, Australia and the emerging economies in general.

and (b) On oil prices?

Answer Dr. Tremblay: Oil prices have been the mirror image of the decline of the U.S. dollar. At close to $100 a barrel, the oil market is either close to a top, or is factoring in a Bush-Cheney bombing of Iran and a resulting serious disruption in oil shipping in the gulf of Hormuz. If there were to be a conflict between the United States and Iran, oil prices could go much higher, before plummeting down due to a worldwide recession. If it turns out that there is no hot conflict with Iran and no disruptions in the supply of oil, the present high prices would logically ratchet down.

Justice is as strictly due between neighbor nations as between neighbor citizens. A highwayman is as much a robber when he plunders in a gang as when single; and a nation that makes an unjust war is only a great gang.
– Benjamin Franklin (1706-1790)

[Iran will react to a bombing attack by the Bush-Cheney administration] by intensifying the conflict in Iraq and also in Afghanistan, their neighbors, and that could draw in Pakistan. We will be stuck in a regional war for twenty years.
– Zbigniew Brzezinski, former national-security adviser to President Jimmy Carter

Israel made a large contribution to the decision to embark on this war. I know that on the eve of the war, [Ariel] Sharon said, in a closed conversation with senators, that if they could succeed in getting rid of Saddam Hussein, it would solve Israel’s security problems.
– Robert (Bob) Novak, veteran American reporter

I am saddened that it is politically inconvenient to acknowledge what everyone knows: the Iraq war is largely about oil.
– Alan Greenspan, former Fed Chairman 1987-2006

There are people in Washington … who never intend to withdraw military forces from Iraq and they’re looking for ten, 20, 50 years into the future … the reason that we went into Iraq was to establish a permanent military base in the Gulf region, and I have never heard any of our leaders say that they would commit themselves to the Iraqi people that ten years from now there will be no military bases of the United States in Iraq.
– Jimmy Carter, former American President (February 3, 2006)

How do you get out of a hole?

First of all, you stop digging. This is the simple lesson that the Bush-Cheney White House has so much trouble understanding. For Bush and his neocon crowd, they are militarily occupying Iraq and they intend to remain there, no matter what. It doesn’t matter that this immoral and illegal occupation has caused the death of more than one million Iraqis and killed more than 3000 American soldiers. And now, they want to escalate the Iraq war into a wider Middle East conflict involving Iran, thus making sure the United States will be involved militarily in that region of the globe for the next twenty years.

In 2002, immoral neocon officials in the Defense Department considered Iraq to be a “low-hanging fruit,” ripe for picking for its huge oil reserves, for the opportunity to displace French and Chinese oil companies, for increasing Israel’s security, for moving American military bases from Saudi Arabia to Iraq and for pleasing politically the end-times religious right in the U.S.—thus killing five birds with one stone. According to former CIA Director George Tenet—and this has been confirmed by former Secretary Paul O’Neill and many other insiders—the very idea of taking control militarily of Iraq was improvised and was unjustified because “There was never a serious debate that I know of within the administration about the imminence of the Iraqi threat.”

Nevertheless, the Bush-Cheney-Libby-Wolfowitz-Feith-Perle team, and their allies at the American Enterprise Institute and at the neocon Jewish Institute for National Security Affairs (JINSA), thought it was a win-win situation. They had decided they wanted a war under the clouds of 9/11, and nothing—truth, morality, reason or facts—could deter them from it. They were ready to lie a thousand times to achieve their goal. And they got it. But now the apprentice sorcerers do not know how to stop the infernal machine of destruction they have set in motion. They only know how to push forward and make a larger mess of it.

That type of improvisation and political wickedness is all too well confirmed by newly released transcripts of talks George W. Bush had with then-Spanish Prime minister Jose Maria Aznar, in February 22, 2003, a few weeks before the onset of the March 20, 2003 Iraq war. In these transcripts, it is shown that Bush had a criminal intent to launch a war of aggression against Iraq, no matter what, and that he turned down every Iraqi offer that would have avoided a murderous war that has killed more than one million people so far. This includes Saddam Hussein’s offer to go into exile, and for Iraq to hold free and internationally-supervised elections as well as allowing armed foreign troops to conduct unfettered inspections for weapons of mass destruction. But the Bush-Cheney regime of Neocons wanted war, and nothing could stop them. They wanted, above all, to put their hands on Iraq’s oil wealth. This is a prime example of historical grand theft, political wickedness and moral bankruptcy. Thus, this war has nothing to do with the morality of the “Just War” theory. In fact, it violates all the canons of a just and unavoidable war.

Confronted with the abysmal cowardliness, moral corruption and incompetence of the Bush-Cheney administration, Americans, on the whole, are more intelligent and more moral than their current leaders, and a large majority of them (63%) think it’s time for the United States to stop occupying illegally the country of Iraq and to stop murdering its citizens. Moreover, a good majority of them (54%) reject the blanket Bush-Cheney policy of aggression abroad, under the pretext of “preventive war.”

Similarly, the U.S. Congress, the only government branch empowered by the U.S. Constitution to declare war, is officially on record as being against maintaining American troops in Iraq. First, the House of Representatives, on July 12, passed a bill, by a vote of 223 to 201, to withdraw American combat troops from Iraq by next April 1st. Second, in a July 18 vote, a majority of U.S. Senators voted 52 to 47 to bring home most American combat troupes from Iraq by May 1, 2008. So, both the American people and the American Congress want this war to end, and soon.

But the truth is that Bush II does not give a hoot about American democratic opinion, as he openly demonstrated recently. And, he does not much care for the U.S. Congress either, or the courts for that matter. In fact, Bush has a deeply ingrained tendency to disregard the truth, the law and the U.S. Constitution.

In Iraq, the Bush-Cheney regime is still building “enduring” military bases in order to occupy Iraq militarily for decades to come. They even talk openly about the half-century American military presence in South Korea, as if this were a useful analogy.

At the end of the day, as Bush has said: “I do not need to explain”. As the British magazine The Economist has warned, the world should beware of a President “who has little left to lose,” the more so if he has hardly any moral principle and is indifferent to the opinions of the majority of Americans.

It is doubtful that a George W. Bush in denial and his delusional neocon advisors for permanent war will ever listen to reason and morality. To the contrary, the lame-duck president is still firing anybody who does not agree with him, while listening to chief Neocon Dick Cheney. The American people see that, and that is why nearly half of them want President George W. Bush to face impeachment, while about 54 percent of American adults now want the US House of Representatives to begin impeachment proceedings against Vice President Dick Cheney, because he is seen as the chief spreader of lies to launch the illegal Iraq War. As of now, there are twenty-one Congressmen who support the articles of impeachment against Vice President Dick Cheney contained in bill H Res 333. If and when American troops leave Iraq, there will be fewer deaths because there will be fewer killers, both official soldiers and mercenaries.

The latest victim of Bush’s pigheaded approach to foreign policy is General Peter Pace as chairman of the Joint Chiefs of Staff. Having started a war of aggression on his own, against the advice of most thinking people within the military, political, legal and intelligence communities, and having placed himself squarely against international law, George W. Bush is reduced to shifting the blame for his failures to others. Bush is afraid of having honest people around him, especially a man of the caliber of General Pace, who is a moral man. General Pace, in the spirit of the Nuremberg Charter, has publicly said, “It is the absolute responsibility of everybody in uniform to disobey an order that is either illegal or immoral” (Feb. 17, 2006). And since General Pace thinks it is immoral to be the first to use nuclear weapons, one wonders if Bush has fired General Pace because he intends to use nuclear weapons in the coming months.

The U.S. Congress should wake up before it is too late. When armaments are in the hands of immoral people, the danger is high that a nuclear war could be launched. Indeed, people in power who have no morality and no judgment can be expected to do anything, including killing millions of people, to save face.

In the book The New American Empire, I asked this fundamental question: Why is the Bush-Cheney administration so bent on using lies and distortions in order to justify a war whose end result would be predictably to eliminate from power the Iraqi Sunnis in favor of Shi’ites allied with Shi’ite Iran, thus automatically making Iran the dominant power in that unstable region? One has to remember that Sunnis make up 85 percent of all Muslims around the world and are dominant in the Arab world. Now that they have realized their error in creating a Shia-dominated Iraq, the Neocons behind the Bush-Cheney team want them to up the ante and to attack Iran, thus turning the Middle East into an even larger murder scene than it is now.

The American people have never received an answer to that simple question. That is why they are so dissatisfied with George W. Bush, but also with the Republicans and the pro-war neocon Democrats in Congress. This indicates that there is a huge void of leadership in the United States today. On this score, the most moral Democratic 2008 candidate for president is, by far, former senator Mike Gravel from Alaska. The very fact that the mainstream media boycott him should be a good indication that this man stands on the side of the people.

According to polls, Americans are very dissatisfied with both major political parties because of their inability or their unwillingness to reflect the wishes of the people and to stop the immoral and illegal occupation of Iraq. In fact, more than two-thirds of Americans believe their country is on the wrong track, but nothing is being done about it. In fact, average Americans are losing hope that they will ever be heard by the Washington D.C. political nomenklatura that runs the government while paying scant attention to the people.

Manias, panics, and crashes are the consequence of an economic environment that cultivates cupidity, chicanery, and rapaciousness rather than a devout belief in the Golden Rule.
-– Peter L. Bernstein, Foreword to Manias, Panics, and Crashes (4th ed.) by C. P. Kindleberger

In a crisis, discount and discount heavily.
– Walter Bagehot (1826-1877), British economist

The job of the Federal Reserve is to take away the punch bowl just when the party starts getting interesting.
– William McChesney Martin (1906-1998), Fed Chairman (1951-1970)

The dysfunctional state of American politics does not give me great confidence in the short run.
– Alan Greenspan, Fed Chairman

The mismanagement of money and credit has led to financial explosions over the centuries. The causes, cures and consequences of such financial catastrophes are most often repetitive. Indeed, such financial collapses are usually the result of the unbridled greed and cupidity of financial operators and of the lack of necessary supervision by public institutions designed to protect the public and the common good. For example, after the October/November 1907 financial crisis in the United States, the idea initially advanced by banker Paul Warburg to establish a partially private and partially public Federal Reserve system of banking was finally adopted, in 1913. The Fed thus became the lender of last resort for banks that find themselves in an illiquid position. It is only after the stock market crash of 1929, however, that the Security and Exchange Commission (SEC) was established, in 1934.

But even with institutions and regulations in place, when they are inoperative, corrupt or ill-adapted, financial crises can still occur. And the current financial crisis is there to remind us of this fact.

On September 18 (2007), the Fed showed some panic and announced a larger than expected half percentage point cut in both the Federal funds rate and in the discount rate, and this after having slashed its discount rate by a half point, on August 17, in order to facilitate borrowing by America’s largest banks and to facilitate the bailout of their affiliates and other operators, such as hedge-funds, caught in the sub-prime loans crisis. In so doing, the Bernanke Fed is following Bagehot’s advice for aggressive discounting in a situation of financial crisis. The only problem is that Bagehot’s rule calls for the central bank to lend copiously in times of critical credit stringency … but at a high rate of interest. By lending to troubled lenders at reduced preferential rates, the Fed is acting as their “government”, i.e., subsidizing their risky loans operations and taxing anybody else who holds American dollars. It is not only attempting to make them more “liquid”, but also more “solvable” and less likely to fail.

This raises three interesting questions. First, who pays for the bailout of U.S. financial institutions; second, what are the longer-run consequences of the massive bailout undertaken by the Fed; and third, why did the Fed let the financial situation deteriorate to such an extent that an entire sector of the economy is being clobbered and its collapse is threatening the whole economy.

First, we must consider that the U.S. dollar is still a key reserve currency, although loosing ground to the euro, and it is still being held in massive amounts by most central banks in their foreign reserves, and also by private banks, commercial and economic entities and individuals around the world. For example, in early 2007, foreign central banks alone held some two and a quarter trillion in U.S. dollars reserves, which represented about 66 percent of their total official foreign exchange reserves, with a bit more than 25 percent being held in euros.

Since the dollar is loosing its purchasing power, both in absolute and relative terms, central banks and other foreign investors have been “taxed” by the American Fed’s policy of benign neglect regarding the dollar. In real terms, the seigneurage tax on foreign holders of the dollar can be measured by taking the difference between the annual rate of depreciation of the dollar vis-à-vis major convertible currencies and the short-term rate of interest on these reserves. For example, if the annual rate of depreciation of the dollar is five percent and the short-term rate of return on U.S. T-bills is four percent, central banks are loosing annually some $22.5 billion on a yearly basis. Since private foreigners hold more than two trillion in dollar denominated debt, the net annual loss of foreign holders of U.S. dollars can easily reach $50 billion a year. The conclusion is easy to see: Not only have foreigners been heavily financing the large U.S. government’s deficits over the last six years, but they are now being called upon to help finance the generous bailout of American financial institutions.

Investors both abroad and in the U.S. know that official inflation figures are tilted on the low side for many people, essentially because they are designed to reduce the weight given in the indexes to goods and services whose prices increase the fastest, but also because housing costs and asset prices are only partly taken into consideration. This could explain why inflation expectations are on the rise, even though official inflation figures do not register an increase in inflation. Too much easy money as experienced over the last few years at first fuel asset inflation, but sooner or later it shows its ugly head in the prices of all commodities and in the prices of all goods and services. With the current drop of the dollar, Americans can be expected to pay more for a lot of items, such as fuel and food. This will translate to a lower standard of living.

Already, the price of gold, the price of oil and the prices of other commodities are on their way up and can serve as inflation bell-weathers. The behavior of long-term interest rates that incorporate inflation expectations is also a good indicator of future inflation. With the Fed printing money and increasing the money supply on a high scale as if it was dropping money from an helicopter, thus the nickname of Fed Chairman Ben “Helicopter” Bernanke, short term interest rates will drop for a while, but long term interest rates will be edging up, unless a deep recession steps in.

Second, a massive bailout as the Bernanke Fed has undertaken raises the question of moral hazard present in any massive central bank rescue intervention, after it has failed to properly regulate the risky activities of the banks it supervises. Indeed, by accepting mortgage-backed securities as collateral for huge, more or less, longer term loans to American banks and brokers, at reduced interest rates, the Fed is in effect rewarding the very institutions which acted the most irresponsibly over the last four or five years, while saving its own face for having failed in its regulatory mission. The message is loud and clear: American financial institutions can indulge in creating “innovative” risky artificial credit instruments, shifting the risks to unsuspecting borrowers and investors while reaping juicy fees and rewards, and when things turn sour, as can be expected, the Fed will come to their rescue and bail them out with cheap and extended loans. That is a good way to carelessly encourage a greedy and out-of-control financial institution to create successive disorderly and disruptive financial crises.

Indeed, the Bernanke Fed is presently taking the pain of the consequences away from financial institutions that acted irresponsibly, and for some, as former Fed Chairman Alan Greenspan has said, which have acted criminally. This is a clear case of moral hazard.

If old regulations are not implemented or if no new regulations are put into place, such a massive bailout will insure that American financial institutions will continue in the future to pursue the fast buck in creating risky artificial capital, without due regard to the risks involved for small borrowers and small savers, while the Fed will take responsibility for shifting losses partly on itself but mainly to holders of American dollars. In effect, the Fed is suspending market discipline for the big financial players it puts under its protection, while letting market discipline crush small homeowners and small investors who bought now foreclosed houses on shaky mortgages or who invested their savings in fraudulent and risky collateralized debt obligations (CDOs). That is the net result of applying Bagehot’s rule only in part.

The third question is why both the Greenspan and the Bernanke Fed did not remove the punch bowl of easy money and easy credit sooner when things began getting ugly in the sub-prime mortgage market during the 2003-2007 period. Why did they appear paralyzed and do nothing? Former Fed Chairman Alan Greenspan has an easy and self-serving explanation. Before 2003, he was afraid of an onset of deflation and that is why the Fed brought its key lending rate to 1 percent (from June 2003 to June 2004) for only the second time in history. He also says that there was too much “global savings” around the world and that is what pushed interest rates down. This is a sleight of hand’s explanation, because if globalization and global savings kept inflation low and term interest down, short term interest rates and money supply increases were under the Fed control at all times. The Fed had no obligation, after 2003, to keep real short term interest rates so negative for so long. Indeed, as the Bush administration was cutting tax rates to enhance its 2004 reelection prospects and was spending money like a drunken sailor in wars waged in remote lands, the Fed should have taken the contrary route to counterbalance the fiscal impetus this created for the macro economy. In other words, it should have taken the punch bowl away. It did not.

As a consequence, mortgage debt as a percentage of disposable income in the U.S. is at the highest level it has been in seventy-five years, reaching 100 percent, while consumer debt has risen to its highest level in history. All this makes the economy more vulnerable than it has been since the 1929-39 depression. Another consequence of this binge of easy money has been the frenzy of leveraged buy-outs and industrial concentration that we have observed over the last few years.

Finally, let’s put the cherry on the cake. Indeed, there is a most disturbing piece in former Fed Chairman Alan Greenspan’s recent Memoirs (The Age of Turbulence) and in the explanations he gave in interviews granted to promote his book, and it is his confession that while he was acting chairman of the Fed he actively lobbied Vice President Dick Cheney for a U.S. attack on Iraq. If this was the case, it was most inappropriate for a central banker to act this way, especially when he had other things to do than lobbying in favor of an illegal war. Does it mean that Mr. Greenspan was an active member of the pro-Israel Lobby within the U.S. government and joined the Wolfowitz-Feith-Abrams-Perle-Kissinger cabal? It would seem to me that such behavior would call for an investigation.

Indeed, to what extent was the pro-Israel Lobby responsible for the Iraq war and the deficits it generated? Already, polls indicate that forty percent of American voters believe the pro-Israel Lobby has been a key factor in going to war in Iraq and that it is now very active in promoting a new war against Iran. This figure is bound to rise as more and more people confront the facts behind this most disastrous and ill-conceived war. Indeed, how many wars can this lobby be allowed to engineer before being stopped? And, to what extent can the current financial turmoil in U.S. and world markets be traced back to the influence of this most corrosive lobby?

The U.S. government is on a ‘burning platform’ of unsustainable policies and practices.

– David Walker, U.S. Comptroller General

Modern society, based as it is on the division of labor, can be preserved only under conditions of lasting peace.

– Ludwig von Mises, Austrian economist

People know that inflation erodes the real value of the government’s debt and, therefore, that it is in the interest of the government to create some inflation.

– Ben Shalom Bernanke, Fed Chairman

Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.

– Ben Shalom Bernanke, Nov. 8, 2002 (Fed Chairman, talking to economist Milton Friedman)

Ordinary investors and people in general will have to get accustomed to hearing a lot about financial terms they never heard before, such as the subprime mortgage market, aggressive underwriting, asset securitization, repackaged loans, subprime loans, “no-doc” loans, adjustable rate mortgage interest rate adjustment (ARM) loans, collateralized debt obligations (CDOs), asset backed securities, mortgage-backed securities, closed-end second-lien loans, subprime second-lien loans, alternative-A (Alt-A) mortgage loans, piggyback loans, asset-backed commercial paper (ABCP),…etc. As a general definition, “subprime” or “high-risk” loans are those made to people with poor credit and at lax conditions. Second-lien loans are loans that are placed in second place for any potential recovery after the primary lender on a property. Residential mortgage-backed security (RMBS) are created when mortgage lenders sell their loans (and the risks associated with such loans) to banks, which package them together and slice them into different classes before selling them to (gullible) investors. This process, called “asset securitization” is the method whereby interests in mortgage loans and other receivables are packaged, underwritten, and sold in the form of “asset-backed securities”. This is financial alchemy, through which subprime mortgage loans are transformed into AAA-rated paper for unsuspecting investors.

Some of these artificial or derivative securities are low-grade quality, and when their prices fall because borrowers cannot meet their interest or capital payments, such financial instruments become quickly “illiquid” or unsalable, since nobody wants to touch them. They become fictitious capital. Those who hold them, investors, banks or other types of lenders, are stuck with them: they cannot sell them and they cannot borrow while placing such shaky assets as collateral. These are the imprudent lenders and investors that central banks now are trying to bail out.

During the French Revolution (1789-1799), the Jacobins (the Neocons of the day) had the brilliant idea of issuing securities, called “assignats,” based on the properties (buildings and lands) the government had taken away from the Church and its religious orders. The new securities were quickly “monetized” into fiat money and transformed into readily available cash. This caused a massive hyperinflation and a subsequent deflation.

Mind you, this was not the first time that 18th-century France lived an experience of inflationary finance, since a similar incident took place three quarters of a century before, between 1716 and 1720, when Scottish banker and businessman John Law (1671-1729) led France into a fiat money fiasco and engineered a land-backed securities scheme known as the Mississippi Bubble. John Law’s earlier experiment and the French Revolution assignats debacle should be clear reminders of the danger and folly of “monetizing” illiquid assets-based securities.

Like all “Ponzi schemes,” such pyramidings of debts with no liquid assets behind them are bound to implode sooner or later. And that is what we are witnessing today, i.e., the implosion of unfunded credit derivatives-based “Ponzi schemes”. In 1998-2000, we got an idea of what could happen when portfolios are highly leveraged and laden with derivative financial products with the collapse of one large hedge fund, the Long-Term Capital Management.

This should have been a warning sign to regulators of financial markets. But hedge funds and other financial operators’ greed — and political corruption — were too strong, and no one stopped the march to disaster. Now, things are getting worse, because central banks, led by the Fed, are following the assignats route and have been aggressively “monetizing” the unfunded derivative debts, lending new cash not for a day or two, and not against T-bills, but for months on end against illiquid and partly unsolvable and artificial derivative debts. Who knows where this could lead?

One possibility is the complete collapse of the U.S. dollar and an uncontrollable burst of inflation in the years ahead if the salvaging operation were to increase money supply on a permanent basis. Indeed, if central banks continue to shore up the artificial financial houses of cards to prevent them from going bankrupt, they may end up monetizing mountains of unsolvable debts with the potential of creating a monstrous inflation. A dollar panic may be just around the corner. Thus, the cure for fighting a credit crisis could be a tremendous push of inflation in a few years, if the Fed cannot withdraw the new cash fast enough from the system. This surely can be the case, since it has announced that it is discounting non-government home mortgages and mortgage-backed securities, jumbo mortgages, and asset-backed commercial paper, and a broad range of collateral for discount-window loans, besides the typical Treasury and government agency paper. The problem is that some of these so-called “securities” may be worthless in a few months, thus making it difficult for the Fed to sell them back and retrieve its cash.

Over the past few weeks, central banks worldwide have supplied hundreds of billions of fresh loans to banks and other financial dealers, to make cash available for lending and they have lowered interest rates amid signs that credit was drying up. The partly privately-owned Fed, for example, has accepted billions in “repos,” by which it bought billions in illiquid securities from dealers, who then deposited the money into commercial banks, thus “liquifying” the entire financial system. This is a short-term measure designed to alleviate the “liquidity crisis,” even if it is pursued for a few months.

It alleviates the “liquidity crisis”, for sure, but this does nothing to cure the underlying “solvency crisis” of institutions holding large chunks of non-performing mortgage-based assets. Sooner or later, such low valued derivatives will have to be written off, and this will necessarily lead to an erosion of these institutions’ capital base. Bankruptcies of the most leveraged and imprudent institutions are to be expected. For a few weeks, the Fed’s interventions and buying by the Treasury’s special division, the “Working Group on Financial Markets”, also commonly known as the “Plunge Protection Team” (PPT) will sustain the financial markets. But come mid-September and early October, the law of gravity is likely to regain its importance.

As I explained in my blog of last October 16 (2006), (“Headwinds for the US Economy”), macroeconomic conditions made it a “matter of months, not years”, before the U.S. economy and the U.S. dollar begin to experience some downward pressures. And, as I repeated on May 5 (2007), (“A Slowdown or a Recession in the U.S. in 2008?”), we are “approaching [the] point of reckoning.”

As I said in May, we could expect “the collapse of one and possibly several major financial institutions under the pressures of bad loans and record foreclosures. Particularly at risk is the some $2.5 trillion mountain of debt concentrated in subprimes and Alt-A loans. Already, one major sub-prime lender (New Century Financial) has filed for Chapter 11 bankruptcy protection. Others are likely to follow, because 2007 is the year when a large number of sub prime real estate loans have to be renegotiated at higher interest rates. The rate of foreclosure is bound to spike in the coming months, possibly culminating in the next two years into a financial hurricane.”

The practice of sub-prime loans and the creation of even more creative and artificial “derivative financial products” is much more widespread in the USA than in other countries. For example, such risky loans represent as much as 20 percent of mortgage loans in the U.S., while the incidence is only 5 percent in neighboring Canada. (Indeed, out of the U.S. $10 trillion mortgage market, about $2 trillion constitute the sub-prime mortgage market.) But where were the American central bank, the Fed under Alan Greenspan and B.S. Bernanke, the Security and Exchange Commission (SEC) under former congressman and venture capitalist Christopher Cox, and the Bush-Cheney Treasury Department when this mountain of shaky real estate debt was being built by unscrupulous and ruthless financial operators?

Why did they not intervene — first, to protect mortgage borrowers by putting a stop to mortgage loans that require no or not much documentation about a borrower’s income (so-called “no doc” or “low doc” loans), — second, to prevent a solvency dilution of the capital base of American financial institutions and, — third, to prevent an unsustainable real estate bubble that sooner or later was going to burst and drag down the rest of the economy? It is indeed the duty of a lifeguard to prevent people from jumping into a swimming pool that is without water. But when you have a Treasury Secretary who is a former president of deal-making and hedge-funds-famous Goldman Sacks, a SEC chairman who is a former venture capitalist and a chairman of the Fed who is on record as saying he favors inflationary policies, you may have part of the answer. When the fox is put in charge of the chicken coop, you cannot expect the chickens to be safe. One has to remember that President Herbert Hoover’s Secretary of the Treasury, in 1929, was financier Andrew W. Mellon, with his far right economic policies of lowering taxes for the rich. We have the uneasy feeling that history repeats itself.

Since the Bush-Cheney White House wanted the economy to keep bubbling before the 2004 and 2006 elections, there was nobody to whistle the end of the recreation. As the French King Louis XIV said, “Après moi, le déluge!” (”When I am gone, I don’t care what happens!). In fact, U.S. regulators not only did not intervene to stop the madness of no-interest, no questions asked, no down payment loans, but they encourage unbridled speculation by abolishing the Roosevelt era crash-preventing “uptick rule” designed to force short sellers to wait for an uptick in the price of a stock before they could complete their short trade. Indeed, it will be an historic irony that on July 6 (2007), the Security and Exchange Commission (SEC) removed the protection in order to allow hedge fund operators to short stocks on down ticks, thus making sure that market volatility would increase tremendously.

It is said that London financiers, greedy speculators and incompetent central bankers were responsible for the 1929-1939 worldwide financial crisis and economic depression. This came after a domino effect of financial collapses, starting with the failure in September 1931, of the big Austrian CreditAnstalt bank, owned by the Rothschild family. The crisis spread throughout the German, the British and the global financial system. This time, the financial infection has started in the United States. If the current financial collapse in the U.S. were to stall the real economy, as it has already begun to do in many sectors, the Bush-Cheney administration would have to carry a lot of blame because of its lax regulatory policies.