Exclusive: The ?Father
of Reaganomics?
Speaks Out on the Bailout
By Jon
Herring
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Dear
IDE Reader,
In
today's issue, we are proud to present an exclusive interview with
Paul Craig Roberts, Ph.D. As a former Assistant Secretary of the
Treasury in the Reagan administration, Roberts first earned fame as
the ?Father of Reaganomics.?
Dr.
Roberts also served as Associate Editor of the Wall Street
Journal and he has held numerous academic appointments and
research fellowships. He was a Distinguished Fellow at the Cato
Institute as well as a Senior Research Fellow at the Hoover
Institution.
Very
few people are more knowledgeable about economic and monetary policy
and the inner workings of Washington than Paul Roberts. That is why
on behalf of IDE's newest research service,
The
21st Century Prosperity Report,
I asked him to comment on the recent bailouts, America's financial
health, and the prospects for the U.S. dollar.
Jon
Herring
Editor
21st
Century Prosperity Report
Jon Herring: You have been very critical of
the Paulson bailout plan, suggesting that the Bush regime has
transferred billions into the coffers of its financial donor base,
that the plan does not address the source of the crisis, and that
billions more will soon be needed. What do you propose would have
been a better solution?
Paul Craig Roberts: According to what
we have been told, the problem is mortgage defaults. The defaults
reduce the interest flows through to the derivatives.
Purchasing the derivatives with the bailout money or giving it to
the banks to boost their capital position does not stop the
defaults.
The
money should have been used to refinance the mortgages and to pay
off the ones already foreclosed. That would have stabilized
the derivatives and kept the other instruments, such as debt swaps,
from coming into play.
The
next step would have been to unwind all the leverage in which a debt
instrument becomes collateral for another debt instrument, assuming
that this could be done. Obviously, there was massive
regulatory failure.
JH: While you strongly opposed the financial
bailout, as it was structured, you support a bailout for the
automakers. How do you respond to those who say that GM is a ?failed
business model? and is unworthy of a bailout? Why do you feel that
bailing out the automakers is so important and what would be the
greater consequences of letting them fail?
Roberts: The financial sector is an even
greater ?failed business model,? and it got $700 billion. The
automakers asked for $25 billion and are being refused, indicating a
preference for bankers over workers.
If the
US loses the automakers, it also will lose all the suppliers, thus
closing down a large chunk of what remains of a
manufacturing/industrial economy. A country that doesn't make
anything doesn't need a financial sector. Three million
manufacturing jobs cannot be replaced. Moreover, the failure
of the automakers would be likely to leave retirees without pensions
and health care. If the banks are worth $700 billion, the
carmakers are worth $25 billion.
JH: As a former U.S. Treasury official in
the Reagan administration, you have been very outspoken against the
Bush administration. Bush has now served his terms. Obama campaigned
on a platform of ?change?. How much ?change? are we likely to see,
particularly from Obama's economic team?
Roberts: Change in Washington is blocked by
the revolving door. The same people are recycled from
administration to administration. Obama seems about to
reemploy the Clinton administration. The policymakers who fill
sub-cabinets are associated with the interest groups who maintain
them in law firms, think tanks, and universities while they are out
of office. These people who staff administrations have careers
dependent on special interests. They shape the
administration's policies to serve the special interests. Real
outsiders who might bring change would have trouble being confirmed
by the Senate, as the interest groups would object.
The
change that is coming has nothing to do with Obama. It is
resulting from US military over-reach, from economic hubris that has
produced massive budget and trade deficits and a financial crisis,
and from the fact that US military and economic missteps have eroded
US authority and credibility and have resulted in the rest of the
world asserting independence from US hegemony.
JH: Over the last year, we have witnessed a
tsunami of debt deflation that is being met with an unprecedented
wave of monetization. Inflation vs. Deflation. How do you see this
battle of the titans transpiring?
Roberts: First, we will experience asset
deflation from falling house and stock prices and from declining oil
and commodity prices as consumer demand contracts. If the US
government is unable to borrow abroad, it will resort to printing
money to pay its bills, which implies high inflation and a falling
exchange value of the dollar.
The US
is simultaneously experiencing a recession resulting from the
exhaustion of consumer demand and the inability of consumers to
spend more by borrowing more, a financial crisis resulting from
highly leveraged financial institutions with investment portfolios
of troubled instruments, and erosion of trust in the US dollar as
the world reserve currency. These three crises feed into one
another, making a solution difficult.
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JH:
You have stated that
you believe we are headed for an ?inflationary depression?. How
would that differ from the ?deflationary depression? of the 1930s?
Roberts: The depression of the 1930s was
caused by the Federal Reserve allowing the money supply to shrink.
The smaller money supply could not maintain the same level of
employment and prices. The Fed is on guard against monetary
contraction this time. The problem is how will the US finance
its budget and bailout deficits? If foreigners don't lend by
purchasing yet more Treasury bonds and bills, the Treasury will have
to sell the bonds to the Fed, which will pay for the bonds by
creating money. The resulting inflation could finish off the dollar
as reserve currency and disrupt international trade.
Considering the present interdependence of economic activity,
the flow of productive inputs from abroad would be disrupted as
would the sale of exports, thus leading to layoffs despite an
abundant supply of money. Unemployment with rising prices is
more devastating than unemployment with falling prices.
JH: More than 200 years ago, Thomas
Jefferson described a situation that is eerily similar to the
situation we face today, when he wrote:
?If the American people ever allow banks to issue their
currency, first by inflation and then by deflation the banks and
corporations which will grow up around them will deprive the
people of all property, until their children wake homeless on the
continent their fathers conquered.?
In a
recent article, you referred to Alan Greenspan's ?inexplicable low
interest rate policy? which allowed the systemic threat to develop.
Do you believe that Greenspan's policy was ?inexplicable??
Roberts: I have no information about any
secret plot to enrich a cabal of bankers by impoverishing the
people. The outcome of impoverishing the people is political
instability and the mass of the people with nothing to lose. A
responsible cabal is likely to be hung from lamp posts.
I have
speculated that the interest rates were low to cover up the jobs
lost to offshoring with a real estate boom. Also, by using
debt instruments as collateral on which to create more debt
instruments, credit was easily expanded. I think a no-think
free market ideology and a belief that mathematical models
controlled risk also played a role.
JH: Do you believe, as Jefferson predicted,
that the financial elite are able to manipulate and capitalize on
the boom and bust cycles, resulting in a consolidation of power and
wealth and an upward flow of ?real stuff? for worthless paper?
Roberts: Financial wealth is paper, and it
is collapsing. All the independent investment banks are now
history. Even Citigroup has had to be rescued. In the absence
of careful regulation, speculation runs away. It generates
short-term massive profits for a few at the expense of wealth
destruction for the overall economy. ?Real stuff? is not
flowing upward. Real stuff is closing down.
JH: The U.S. government's burden of debt is
unfathomable. From ongoing wars, to the financial bailouts, to the
tens of trillions of dollars in foreign debt and promises to our
retirees ? the U.S. is beyond tapped out.
At some
point, the blank check privileges from foreign countries must end.
The world could easily bring us down by not lending anymore. This
would end the dollar standard, but it would also destroy the value
of their trillions in dollar assets.
You
believe it is not too late for the U.S. to save itself and the
dollar standard, if we would just go to the world with a plan. What
must that plan be? And what would the benefits be to America and the
world?
Roberts: The US needs to renounce its
hegemonic goals. The US needs to reduce its budget deficit by
stopping its gratuitous wars and slashing the military budget.
The US needs to address the trade deficit by restructuring the
corporate income tax. Corporations should be taxed on the
basis of the value added in the US to their output. The higher the
value added in the US, the lower the tax rate, which would be an
incentive to keep high productivity manufacturing and engineering
jobs in the US.
The US
needs to regulate short-selling of shares and commodity market
speculation and it needs to prohibit selling short national
currencies. It is uneconomic to permit a few people to make
themselves rich by causing widespread hardships. These items
amount to a plan that the US can take to the world in exchange for
loans in place of money creation to see it through its present
difficulties. This would save the dollar standard and preserve
values of foreign owned dollar-denominated assets.
JH: If America does not change our financial
course ? immediately and dramatically ? it is hard to imagine a
scenario that does not end in severe pain. And if that's the case,
then the real crisis hasn't even begun.
What do
you see coming in the next five to ten years if we do not make
drastic changes? What would be the financial and societal
implications? And what advice would you give to American families to
plan and prepare for what may come?
Roberts: The future is not predictable,
because policymakers can surprise us with new mistakes.
Neither monetary nor fiscal policy is likely to succeed in turning
the economy around. Interest rates are already low, money
growth high, and the consumer is swamped with mortgage and credit
card debt. The consumers' inability to service more debt puts
a limit on credit expansion. The budget deficit is huge and
the economy is declining. It is not an easy matter at this
point to finance a larger deficit.
Since
the onset of offshoring, the US economy has been kept going by an
expansion of debt, not by rising productivity resulting in rising US
real incomes. Debt has outrun income. Generally, when
debt grows beyond the ability to service it, debt is inflated
away. In a modern economy it is difficult to protect oneself
from government mismanagement. The bulk of the population no
longer has farms, livestock, and agricultural skills. Few
people can store food stocks or hoard gold.
Strategies for surviving deflation are different from
strategies for surviving inflation or hyper-inflation. We
might be confronted with both, either one after the other or in
combination. Americans
trusted their government, and it failed them. Perhaps the next
generation of Americans will spend more time being informed and
guarding their liberties, savings, and incomes, and less time
entertaining themselves.
[Ed. Note:Are you prepared for a tidal wave
of paper dollars? The storm of the century is raging in the
financial markets. Wealth has been destroyed on an unprecedented
scale. And what most don't understand is that the ?solutions? will
eventually make the problems even worse. But what will be hardship
for many could prove to be a windfall for those who are prepared.
Let The 21st Century Prosperity Report be your
guide to solutions, profits and protection in the coming
years.]
P.S. To let me know what you thought of today's
article, send an e-mail to: feedback@xxxxxxxxxxxxxxxxxxxxxx.
Is It Worth Saving the U.S.
Auto Industry?
By Andrew
Gordon
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My
first car was a Dodge Dart. I inherited it from a distant uncle I
never met. When I picked it up, its interior smelled like stale
cigar smoke and, sure enough, in the ash tray I found a butt of
perhaps the last stogie my late Uncle Henry ever smoked.
For the
entire time I had that car, I never removed that butt. My wife
thought it was gross. But I insisted. That butt brought Uncle Henry
to life for me. I imagined him with a big fat cigar in his mouth,
puffing away, while listening to Rosemary Clooney or Doris Day on
his favorite AM station.
The car
was a late 1970's model and an awful shade of green. It sure didn't
move like a dart. It moved more like a ship. You'd turn the steering
wheel and wait a couple of seconds for the car to respond. It was a
challenge to avoid the parked cars on some of the narrow winding
streets of Washington DC. But it was my first car and I loved it. I
nicknamed it the ?Green Steed? despite its klutzy styling and poor
pickup.
Ten
years and two kids later, my wife and I bought a Toyota Camry
station wagon. We loved the smooth ride. And when we heard that the
sedans came from Toyota's plant in the U.S., but the station wagons
came from their Japanese plants, we were even more
pleased.
U.S.-made cars had that bad of a reputation for quality and
durability. If we followed the car industry more closely, we
probably would have drawn a distinction between those cars made in
Ohio and Michigan and those made in South Carolina, Alabama, and
other southern states by Toyota and Honda.
You
see, those 16 foreign-owned assembly plants in the South enjoyed
more advanced production lines. Plus their quality-control standards
were much more rigorous than anything Detroit had. They also had
other advantages...
- Non-union labor force. The difference in wages is
astounding. UAW workers at the Big Three make an average of $78 an
hour (including benefits). The non-union workers make an average
of $28 an hour (including benefits).
- State government incentives amounting to over $1 billion
for Volkswagen, Toyota and KIA Motors Corp. (to locate in those
southern states).
- Manufacturing flexibility. Many of those southern plants
can switch their production lines from one model to another in a
matter of minutes. For the older plants operated by the Detroit
Three, it's more a matter of weeks.
- Hiring and firing flexibility. These southern states have
looser labor rules which allow the local companies to respond to
downshifts in demand faster than the unionized Detroit Three. For
example, German automaker BMW is laying off up to 733 employees at
its S.C. plant by the end of the year.
- Sleeker cars and smaller lineups. GM uses eight brands, for
example, compared to Toyota's three. Detroit is behind Asian car
makers in offering small cars and midsize sedans.
It's
not as if the Asian auto companies didn't make their share of
mistakes. They started to make SUVs around 2005 -- around the time
Hurricane Katrina sent oil prices soaring and sales of big guzzlers
plummeting. But higher gas prices hurt the Detroit Three with their
reliance on trucks and SUVs much more than foreign auto makers.
Nor is
the UAW solely responsible for bringing down America's car industry.
They do what unions do and did it very well ... okay, maybe too
well. According to a report published in the Wall Street
Journal, for each active worker the Detroit Three has on their
payrolls, they are paying pensions for as many as three former
workers and dependents. That's a huge burden that the southern auto
industry doesn't have to deal with.
Nor is
it the current recession that has brought the Detroit Three to its
current desperate situation. An over-reliance on SUVs and trucks
that caught up to them by 2005 locked in the Detroit Three on its
current downward path.
Nor are
Japanese, Korean and other foreign auto makers immune to the
downturn in the global economy. They're cutting back production in
the U.S. and around the world. But if one or more of the Detroit
Three goes under, the foreign-owned plants in the South will be in a
position to take over.
We will
still have cars ?made in U.S.A.? and a downsized U.S.
car-manufacturing industry. But it will be owned by foreigners.
That
shouldn't matter in a global economy. Michigan and Ohio produced 38
percent of all vehicles in 2007. They employed 240,000 workers. Some
2.4 million workers owe their jobs to the Detroit assembly plants.
That's a big chunk of our manufacturing capacity and jobs going down
a sinkhole.
With
new smaller models coming on board and the UAW taking over much of
the benefit payments of its membership in 2010, the Detroit Three
are asking for a lifeline that needs to last them less than two
years.
We all
know that the government could save them if it wanted to. And it's
unfathomable why the government should be throwing money at bankers
who make a living by shuffling financial paper and not be willing to
throw money at a part of the economy which actually makes something
real.
Akron
is no Wall Street. All the more reason to save it.
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