Bailout for Laymen

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The below comes from the blog “green with a gun” and its the most accessible recap of the U.S. Financial bailout from a few weeks ago that I’ve seen, and generally about the state of the great American Empire. The emperor has changed this week, and that’s a big deal, but he knows as well as us permaculture, climate change, environmental justice activists do, that the change and the crisis facing this land can only be adequately confronted by individuals, by each of us, taking up responsibility for the construction of our reality, and making it something habitable for our grandchildren.  Sharon over at on Casaubon’s Book has got another great post talking about the changes we must all deal with today :

At fundamental levels, our structures must change – we must take back the power that has been stripped from the people over the last decades, and particularly over the last eight years.  We must find new ways to organize ourselves in order to meet basic needs, and in order to find a way to live that keeps at its center, the future of the next generations.

What we make of our coming decline/crash/change remains to be seen. History and geopolitical observers and the reality of peak oil point to a future where the USA can no longer be considered a “super power”. I think this is ok, and that it is THE opportunity for our generation to redefine and live humility, morality, justice and sustainability.

Bailout for Laymen: Actual title:

The USA’s decline as a Great Power

As I write this, the US Congress has rejected the Administration’s plan to have $700 billion to buy the bad debts of US banks. [Edit on 04Oct2008- and now they’ve accepted it. Apparently they couldn’t afford $700 billion, but they could afford $700 billion + $100 billion tax cuts – so they increase the national debt while decreasing the revenue they’ll use to pay it back. Hmmmm…. brilliant forward planning!] This rejection is a bit surprising, though perhaps it shouldn’t be. No doubt the Congresspeople are being bombarded by their constituents telling them to vote against it. The people imagine that the bailout is to protect the rich, but in fact it’s to protect everyone. Of course it won’t work, but that’s the intention.

As I see it, the US banking mess is like the war in Iraq, in that they shouldn’t be in this mess in the first place, but now that they’re in it there are no easy solutions.

Debts bad and good
It all began with CDOs, Collateralised Debt Obligations, where they mixed bad debts with good and called the package good, high credit rating. It’s a bit like getting pet mince and premium mince, mixing them together and calling them premium. The crisis has come from everyone finally admitting it was partly pet mince – and they’re not sure how much of the stuff is spread around other meats. How do you separate the edible mince from non-edible afterwards? Well, this bailout plan was a plan to do that – the US government would buy the bad debts and take them all on.

The banks are made up of good debts, bad debts, and deposits. Once the bad debts get too big, the deposits dissolve, too, as people lose faith in the bank and withdraw their money, then the interest the bank can pay to those with deposits drops, which causes more people to withdraw money, which means the bank has to call in some of the good debts to cover it all, or perhaps the bank has to put a freeze on deposits… bye-bye bank. Some people are cheering the failure of the bailout package. They perhaps won’t be cheering when they find their deposits are no longer available to them, or only ten cents on the dollar is still around. It’s happened in many other countries in the past.

The reason for the government to take on the bad debts is that governments are different to individuals and corporations in that they can default on or even entirely repudiate and write off debts without ceasing to exist financially. Usually people use the law to get you if you toss aside a debt, but a government is the law, so… Now, the government may not actually write them all off – and they certainly won’t say they’ll do that – but the mere possibility stabilises the system, since the government can renegotiate things. For example, up in Canada they exchanged the dodgy stuff for bonds which would mature in seven or nine years – the interest paid to investors would be much less, but it’d be stable and predictable.

The problem is that while buying up the bad debts to write them off is a good idea, since the banking regulations haven’t been changed we’d just see the same or similar problems again in a few years. It’s like removing a cancerous lung from a patient who then goes on to keep smoking. What was really needed was a package where the banks which accept the bailout must also accept new regulations, lessening the chances of their needing a bailout in future.

Unfortunately, that’s not likely to happen in the US, because in the past two decades their primary export has been debt. Now, money, whether currency or debt, it has to be backed by something. Doesn’t have to be gold or silver, but there has to be the promise of some tangible goods or services at the end of it all. That is why you’ll accept an IOU from Jennifer Smith, QC, of the old law firm Smith, Jones & Daughter, but won’t accept an IOU from Mildred Smith, smelly alcoholic living on the street. That’s what it means to be bankrupt, that your debts exceed your perceived ability to ever pay them all back.

The US government, corporations and people haven’t really considered this. In the end, you have to have something tangible behind it all.

The US$ is an oil-backed currency
Until the early 1970s the US backed its currency, gave it something tangible, with gold. After that, it appeared to be backed by nothing but good faith (like Ms. Smith, QC – backed only by her reputation and your trust in her), but in fact they’d got OPEC to price oil in US dollars. Thus world demand for oil also created a demand for US dollars; this meant that the US currency went from being backed by gold to being (effectively) backed by oil. For as long as the world wants oil and it’s priced in dollars, that provides a base for the US dollar. Whatever else happens to the US economy, at least you can buy oil – which everyone wants – with their dollar.

It’s not a coincidence that Iraq was invaded a year after Saddam Hussein suggested to OPEC that they change to using the Euro, and that the other country they’re talking about invading – Iran – has made similar suggestions. Nor is it a coincidence that they’ve been climate change deniers, and peak oil deniers, for so long – because if we burn less stuff, the demand for oil drops, and then what is the US currency backed with? Nothing.

Trade deficits
A “trade deficit” is a fancy way of saying “we’re spending more than we’re earning.” If my woman and I become unemployed but go and buy a plasma screen tv, then our household has a trade deficit – we are taking in more stuff in dollar terms than we send out. Well, the US has had a massive trade deficit for some years now. Trade deficits typically lead to economic depressions or wars. We can look back in history for examples.

The British bought tea from China in the 19th century, and China insisted on being paid in silver. Britain’s currency was backed by silver – you could, by law, take a pound note into the bank and receive a pound of silver. But all the silver was going into China, so the British appetite for tea threatened their own currency’s strength – the day someone took a note into the bank and couldn’t get silver for it, the currency would lose all its value and the economy collapse. So the British had to get the silver back – or they had to drink less tea. Well, no-one was going to get elected to the House of Commons telling the British to drink less tea, so they had to sell something to the Chinese to get their silver back.

The problem was, they didn’t sell anything the Chinese wanted – except opium. And the Chinese government wasn’t very happy about its people being stoned all the time, and they also didn’t like silver flowing out of their country, so they tried to stop the trade. Thus the British went to war with China over “free trade”… in drugs. A depression at home, or kill a few thousand dirty foreigners, the choice was clear!

The Americans have got a similar problem. They want lots of stuff from the world, but the world doesn’t want as much stuff from them. What have the Americans got to offer? All the raw materials they produce they consume themselves, and they’ve sent all their manufacturing overseas, too. The only exports they have are grain and guns. Well, the grain is being sucked up by biofuels, and their guns are overpriced and don’t work very well. “Um… we’ll pay you later.” In order to keep living their rather well-off lifestyles they had to create yet more debts so they could afford to keep buying stuff.

But that debt-creation reaches a limit, because in the end the debt has to be backed by something tangible. Our wealthy solicitor Ms Smith, QC, her IOU doesn’t look so good once you realise she has earnings of $130,000, spends $150,000 each year and has debts of $500,000. The perceived value of her IOUs goes down.

The first crisis of many
So whatever the Americans do about their domestic banking problems, in a few years they’ll be facing foreign banking problems. At the moment the US is a $13.3 trillion economy, but foreign countries have $4 trillion of US currency and debts. China alone has $1 trillion. What do they do if those guys sell off US Treasury bonds cheap? At the moment they won’t do that, because they’d knock back US ability to buy their stuff, so they’d be hurting themselves. But they’re diversifying their trading partners.

There comes a point where the US has to either buy back all its debts from these countries, or they have to… well, become their bitch. And what could they buy the debts back with? More debts?

Rise and fall of Great Powers
It’s essentially the decline of the US as a Great Power. This began when they invaded Iraq, and will take a few decades to play out. I think I’ve said before, reading Paul Kennedy’s Rise and Fall of Great Powers, basically a Great Power is a country which has (say) 5% of the world’s population but uses 25% of the world’s resources. That leaves other countries short. Traditionally some middle-ranking power with (say) 5% of the world’s population and 10% of the world’s resources decides to compete economically or militarily with the Great Power.

The Great Power often finds itself unable to compete economically, so resorts to military means. So the share of military spending rises to match their share of the world’s resources. But this just pisses off the middle-ranking countries more, and there are conflicts, lots of little wars on the periphery of the empire. The Great Power senses a decline.

At this point they have a choice: accept decline more or less gracefully (as did Britain after WWII) or go down fighting (as did Germany in the 1914-45 period). If they choose to fight, they increase their military spending, until they’ve got Population 5% – Resources 25% – Military 50%. An increasing amount of the resources the country uses go to its military. This undermines and weakens the rest of their economy. While their share of world resources may even increase to 30 or 40%, much of that’s going to the military, so the people are actually worse off than before.

Eventually it all collapses. Economic troubles and military defeats pile up until the Pop 5% – Res 30% -Mil 50%, the latter two decline. Usually the country doesn’t go down to Pop 5% – Res 5% – Mil 5%, because the things which made it a Great Power in the first place are still there (high domestic resources, lots of educated people, an industrious mindset, etc), but to something like Pop 5% – Res 10% – Mil 10%.

So right now the US is at population 4.5%, resources 33%, and military 50+%. They’ll be going down from here. They’re obviously not going to accept their decline gracefully. Most Great Powers don’t, and it’s certainly not in the American character. They’re a nation of “winners”, didn’t you know? The only question is how much damage they do on their way down.

Conclusion
I mean, obviously that’s a simplified picture of things. Lots of other things complicate it. Like in previous years to military spending could be quickly changed to domestic spending, and vice versa. The factory which made kitchen pots could be changed to make artillery shells. The factory making tanks could make cars. But things are more specialised now, we have factories just for the interior trim on cars. And the fact that because of peak fossil fuels, not only your share of resources, but the total amount of resources available, that’ll drop. And because of climate change we’ll ideally change things voluntarily anyway.

Nonetheless, there are some broad patterns in history, because for all the fuss we make about the wonders of DVD players or whatever, in the end it all comes down to wanting your own people to live in the best comfort possible, and have your country be the butch while others are the bitch. So I think the Americans are on the way down.

Again, this doesn’t mean the US is going to decline so far it breaks up into warring states, or become a Third World country. That is possible, but is extremely unlikely, macho Mad Maxian or Wild West fantasies of guys like Kunstler notwithstanding.

The USA, as much as its leadership and people try to undermine it by general apathy, laziness and idle whinging, has many fundamental strengths – it’s large geographically, has land borders with only two countries both of which are much weaker than it in population, economy and military, has large natural resources, an excess of agricultural production, a large educated populace and even larger pool of people willing to work productively for low wages, has good internal communications for transport and information, and so on. Its fundamental strengths mean it won’t decline to its fair share of the world’s resources and military.

But the USA will decline from being a Great Power. They can go gracefully, or go down fighting. Normally I’d be betting on China and India to take their place, but they have the misfortune to be rising powers in a time of decreasing resources, so who knows.


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