Aaron's Real Opinions:

Take a Deep Breath and Count to Three
by Aaron Harber
September 23, 2008- Print Article

Part 1: Hold Your Horses (And Your Wallets and Purses)

As financial markets headed downward, the Bush Administration and the Democratic-controlled Congress decided they needed to “save” those markets by promising to intervene with up to $700 billion of taxpayer dollars. This is in addition to the $200 billion already committed to date prior to the $700 billion bailout.

With a National Debt of $10 trillion already crushing the U.S. Economy and sending the dollar into a gradual decline which, in turn, negatively impacts most Americans by making goods and services more expensive, the idea of adding another $1 trillion almost overnight seems irrational, despite the pleas of sinking financial titans.

The Government’s “solution” could be the end of the U.S. dollar as we know it today if these budget deficits result in an aversion to dollar assets among foreigners. Foreign investors already have lost billions in their dollar asset investments, and many believe the dollar’s almost century-long reign as the world’s leading “reserve” currency is seriously threatened.

Because the dollar is still the leading reserve currency, the U.S. can finance its government and businesses in dollars, and is not forced to borrow in perceived sounder currencies such as the euro, Japanese yen, or, maybe soon, even the Chinese renminbi.

The U.S. also pays lower interest rates than would be possible if the desire to own dollar-based assets were limited among foreigners. That may be about to change dramatically.

A cheaper dollar also accelerates the sale of interests in U.S. companies to foreign investors. And these investors already own a sizable percentage of the corporate assets of the United States.

Part 2: The Bush Administration & The Democratic Congress Have It All Wrong Again

Just as the Patriot Act had serious flaws because it was rushed through and the decision to go to war against Iraq was equally defective from a policy-making perspective due to the hurried nature of its approval by Congress (and misinformation from multiple sources), one should recognize that barreling through what are truly extraordinary decisions rarely is the best route to go. Congressional Democrats should have learned from these lessons and not be rushed to judgment.

Why not simply say the Government is committed to helping find a solution but is going to take its time to figure out the best course of action? Then Congress and the Administration should take their time and properly vet all the proposals being made to save the financial world.

Keep in mind the War in Iraq may have an ultimate cost to taxpayers of $3 trillion. One of the key concepts in Economics is Opportunity Cost. It simply means if you spend $3 trillion on one endeavor, you won’t have that $3 trillion to meet other needs.

Part 3: $1 Trillion Might Only Be The Beginning

If the Congress authorizes $700 billion today in bailout funds, it could easily evolve into $2 trillion or more once the commitment is made to save private financial markets. Just this summer, Congress authorized the bailout of government sponsored entities ("GSE's") Fannie Mae and Freddie Mac, saying they did not expect the authorized funds to be spent, and, if they were, it would be for a cost not to exceed $25 billion. Soon after the Treasury seized the GSEs, however, the ultimate price tag now was placed at $200 billion to $1 trillion, or perhaps even more, according to some pessimists.

If Federal Government dollars are used for bailouts, those funds will not be available to help solve the health care crisis, repair aged transportation systems, educate children, head our foreign policy in a new direction, or revitalize our military. Rather than bailout those who already have a lot of money, perhaps these resources should be directed to those who truly need help. At the minimum, our leaders should take their time and carefully consider all of the options and tradeoffs before making such momentous decisions.

Part 4: Can We Even Afford To Spend $1 Trillion Under Today’s Financial Conditions?

Many economic commentators expect the commitment of almost $1 trillion to the purchase of debt instruments from U.S. financial institutions to severely weaken the U.S. dollar. Indeed, since the announcement of the bailout, the prices of oil and gold immediately spiked upwards from recent lows, suggesting another surge in the stealth inflation that has so ravaged American households in recent years.

It is “stealth” inflation because the U.S. has changed its methods of calculating inflation in recent decades. John Williams of Shadow Government Statistics estimates U.S. inflation today would be over 12 percent, not the 5 percent reported by the Federal Government, if inflation were calculated today using the same methods employed by the Federal Government as recently as 1990.

Some economic commentators expect the dollar to crash in value as foreigners decide to slow down or even stop lending the U.S.A. the money needed to maintain our standard of living and our level of government spending --- which certainly includes military expenditures.

The U.S. is running a Current Account Deficit of over $700 billion annually. This is the sum of our deficit in trade goods and services and the sum of our deficit in dividends and interest payments to other countries. We are forced to borrow from foreigners to finance this deficit, and this borrowing represents well over 50 percent of the world’s entire annual savings.

The worry is that the U.S. will need to borrow additional sums from foreigners to fund the $1 trillion needed to finance all the proposed bailouts because some portion of the money paid for the assets purchased will not be invested in U.S. dollar assets. Instead, some of the money received will be invested in foreign countries or in oil, metals, grains and other commodities to be consumed in foreign countries.

Part 5: The Bailout Will Result In More Dollars Leaving The U.S.A.

Some of this money will leave the U.S. because U.S. investors will decide to diversify out of U.S. dollar assets. Some of the proceeds will flow into the hands of foreigners, despite the Federal Government’s intention to buy assets only from U.S. financial institutions.

Unless the bailout legislation restricts the assets purchased in some way so as to minimize the flow of funds into foreign hands, some U.S. financial institutions likely will “arbitrage” the bailout plan to allow foreigners to cash out their underwater investments. This means U.S. financial institutions will attempt to buy eligible assets from foreigners at a lower price than they can sell them to the Federal Government under the bailout plan.

Given the complexity of modern financial contracts and the ingenuity of investment bankers, it will be extremely difficult to keep bailout funds out of the hands of foreigners unless Congress demands radical changes to the Bush Administration’s proposed bailout plan. Even such demands may be insufficient. Financial experts who can find loopholes in the Internal Revenue Code likely will have no problem finding ways to take advantage of a quickly-drafted bailout plan passed without much public scrutiny or public hearings.

Commentators suggest rising federal deficits and borrowing with consumers already hard-pressed to maintain their current living standards are unlikely to attract foreign capital investments to the U.S. After all, how long can the current Federal Government profligacy continue before some combination of major tax increases and budget cuts becomes inevitable?

Part 6: Are We Getting The “Bum’s Rush?”

The Bush Administration is trying to rush this through because its term is coming to an end. If action is not taken before the upcoming Election Recess, the Administration knows it will become increasingly unlikely to get its way because the added time will (a) result in greater scrutiny of any proposals and (b) allow Democrats, if they win the White House, to wait so they can unilaterally shape their own solution.

Democrats in the House and Senate want to appear they are addressing the crisis so, unfortunately, they are almost as overeager to act as the Bush Administration. Cooler heads not only are failing to prevail --- they’re not even in the discussion. This also is illustrated by both presidential candidates failing to rein in their respective party’s enthusiasm for spending more taxpayer dollars.

Contrary to their own advertising, both Barack Obama and John McCain are more than willing to go to the public trough once again. Rather than arguing for a “change” which puts an end to subsidies for the wealthiest Americans, both candidates have endorsed the concept of a massive bailout at the expense of the average American citizen, although each differ over the terms of the bailout.

Of course, plummeting markets terrify politicians, who worry about the economic carnage and possible economic fallout in the “real,” “Main Street” economy. Such worries are extraordinarily terrifying to politicians with an important national election just weeks away.

Part 7: Have We Abandoned The Free Market?

Sometimes it makes more sense to move cautiously rather than be rushed into a bad decision. This has been proven time and time again when the Federal Government has rushed to judgment. One immediate question to ask is, “If the Government takes its time --- over a period of several months --- to determine exactly what to do to assist in resolving the financial crisis and how to invest taxpayer dollars, if at all --- why would that be a good or bad idea?” Perhaps an even more important question to first ask is, “If the Government does nothing, what will happen and who gets hurt the most?”

If the Government did not intervene in the financial markets any more than it has to date, a number of financial institutions would falter. They then would have to find buyers for their depressed stock or assets. Those who failed to find buyers would declare bankruptcy. Their shareholders would suffer considerable losses. New investors would come in, they would value assets appropriately, and then they would pick up the pieces.

That is exactly how the Free Market is supposed to work. Those who are successful are rewarded by the Market and those who fail are punished. Why should the rules be changed now by the Federal Government? Why should business failures --- especially on such a large scale --- suddenly be rewarded? Isn’t that principle in diametric opposition to capitalist theory?

Part 8: How Quickly Capitalists Become Socialists When It’s Not Their Money

Federal Reserve Chairman Ben Chairman and Treasury Secretary Henry Paulson argue the bailout is necessary to prevent the Economy from tumbling downwards. If economic stimulus is needed, why not commit hundreds of billions of dollars to rebuilding the nation’s crumbling infrastructure --- roads, bridges, water and sewer systems, even providing tax credits for improved power systems.

All of these would employ hard-pressed American workers, who would spend their wages, creating even more jobs. This “multiplier” effect, as economists call it, not only would steady the Economy but would result in the avoidance of massive costs that result when our infrastructure fails, such as when bridges collapse or electricity blackouts freeze economic activity.

Part 9: Why Should The Public Buy The Worst Assets?

Some economic commentators argue the Federal Government should not be buying “toxic” assets from financial institutions, despite assertions from many in the investment community who will profit if the bailout proceeds that the government will make money on the assets it will purchase. What is never discussed when these assertions are made is that the U.S. Economy currently has extremely low interest rates which could be changed by a bailout.

Today the U.S. is experiencing negative real interest rates. This means many persons are paying rates below the rate of inflation. The Federal Reserve already allows banks and even highly leveraged firms such as Morgan Stanley and Goldman Sachs to borrow from it at just a 2 percent rates.

This is well below the official 5% inflation rate, let alone the 12% inflation rate calculated by John Williams of Shadow Government Statistics, who claims to use the calculation method used by the Federal Government in 1990 to calculate inflation. That method was changed two decades ago to make the statistics look better.

Part 10: The Interplay Of Inflation And Interest Rates

Considering the inflation in the American Economy --- much of it caused by the Federal Reserve’s expansion of the money supply at rates in excess of the Economy’s growth rate, current mortgage rates available to those who can obtain them were perceived as a bargain. In the early 1980’s, a single digit mortgage rate was considered a valuable financial asset, as individuals could buy U.S. Treasury paper with double-digit yields as well as tax-exempt investment grade paper also yielding in double digits.

If, within a few years, interest rates are much higher than current levels, the Federal Government could lose hundreds of billions of dollars on its proposed asset purchases because housing prices likely will fall, borrowers would default on their mortgages, and the cost of financing the bailout plan could mushroom to levels not being disclosed by its champions.

The Federal Government, due the Federal Reserve’s pump-priming and the high level of fear among investors, currently is able to borrow money for 30 years at an interest rate below five percent, and for very short-term borrowings at less than one-half percent. Yet the Federal Government’s fiscal condition and the competitive condition of the American Economy arguably are much weaker than they were in the early 1980s when the Federal Government was paying double digit rates on new borrowings.

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