naked capitalism

By Matt Stoller, the former Senior Policy Advisor for Rep. Alan Grayson. His Twitter feed is @matthewstoller

The Federal Open Market Committee releases its transcripts on a five year time lag. Last week, we learned what they were saying in 2005. Dylan Ratigan blogged an interesting catch: Dallas Fed President Richard Fisher expressed his frustration about Chinese imports. Not, of course, that there were too many imports, but that our ports weren’t big enough to allow all the outsourcing American CEOs wanted.

Fisher is just the latest Fed official to applaud this trend. Here’s the backstory. In the 1970s, there was a lot of inflation. The oligarchs of the time didn’t like this, because it made their portfolios worth less money. So they decided they would clamp down on inflation by no longer allowing wage increases. To get the goods they needed without a high wage work force, they would ship in everything they needed from East Asia and Mexico. The strategy worked. Inflation collapsed. Wages stopped going up. There were no more strikes. Unemployment jumped.

There were all sorts of excuses for why this was a good idea – we would do the ‘high value add’ work in America, like research and development, while the ‘low quality work’ like manufacturing went abroad. And everyone would benefit – sure you wouldn’t get a raise, but you’d get low prices at Walmart (Walmart shows up all the time in FOMC meeting transcripts). But basically this was a way of ensuring that banks and creditors could make a lot of money that would instead go to workers. It was known as ‘the great moderation’, a term coined by Bernanke, and was considered a great success.

As late as 2005, Richard Fisher was celebrating this trend. In that same meeting where he complained about too few Chinese goods coming into the US, he bragged about the weakness of one of the most significant employers in the United States: “My most delicious irony is the fact that similarly dated Vietnamese debt now trades on a price basis richer, and on a yield basis lower, than that of Ford Motor Company. [Laughter]”

The Fed’s strategy is not without cost to the elites, and the bill will come due. The problem is that if you want to consume stuff from abroad, someone has to make it. And if it’s not going to be American workers, it’s going to be foreigners. But whoever it is, they wind up taking dollars when they sell it to the US. So pretty soon, these foreigners had a lot of dollars that they got in return for all the crap we were buying at Walmart and our rich were buying to fuel their private jets. For instance, China is believed to hold about 60% of its foreign exchange reserves, or well over a trillion dollars, in US currency (and oil producers have even more). There aren’t very many places you can put a trillion dollars, so rather than keep it in cash, China simply lent that money back to us. And that enormous flow of money recycled back into the US (through the big banks) helped create our massive debt pile-up. This process is known in econo-speak as ‘recycling global trade imbalances.’

As Jane D’Arista and Korkut Erturk, point out in a penetrating analysis of the financial crisis, this had a lot to do with causing financial instability. To fill our Walmarts and private jets with stuff, we had to borrow money from the Chinese and Arabs to buy it from the Chinese and Arabs. As D’Arista and Erturk said, “US households came to absorb an ever larger part of these global surpluses over time and thus became the epicentre of debt build up.“ And household debt, in this case mortgage and credit card debt, is the least productive kind of debt. It’s not as if the US was borrowing to invest in its future; the US was borrowing to create an illusion of prosperity while it was actually hollowing out of its economy.

Hot pools of money flowing around the globe are a pervasive source of global instability. It’s something Keynes thought hard about this problem and sought to fix it after WWII, though we ended up not with his intended stable regime for managing trade imbalances but a crippled and narrow IMF and a creaky system of public recycling of these flows. Since American economic dominance was so profound after the war, the weaknesses of this system were masked until the early 1960s. As the instability became more and more obvious, the American financial elite began pushing for deregulation to compensate for the loss of American economic strength. They could profit from the boom times, and get bailouts during the bad.

Since the 1970s, the bailouts have become progressively larger; the Latin-American debt crisis made the money center banks insolvent, the S&L crisis was massive, and of course, the 2007-2009 crisis crashed us into a depression. This deregulation is how elites reacted to an increasingly imbalanced set of trade flows, which were themselves caused by declining American competitiveness. They crushed unions, and the public mechanisms for intermediating financial flows gradually were privatized into large private TBTF institutions. Citigroup’s payment system is now simply an essential piece of infrastructure for global commerce, and the bank itself has $500B of foreign deposits that sit in the bank in a constructive zone of ambiguity as to who insures them.

This instability is leading to declining standards of living around the world, which is resulting in civil unrest in Europe, increasingly nationalistic rhetoric, global lawlessness in the form of cyber-attacks and piracy, and military build-ups. The big banks that intermediate these flows like this situation. So does China, whose mercantilist policies are allowing the acquisition of a massive industrial base. And the oil producers do as well, because of the wealth and power they acquire through a global dependence on their resource.

The only way out of this box is to establish a new international order of trade, which both handles balance of payments problems effectively, ends the arbitrage of labor, and directs resources into common global problems like pollution, energy deficits, pandemics, and extreme poverty. This means, though, that the big banks simply must become less important. Trading flows have to be managed by trusted public entities, new business sectors that drive value from innovation must supplant the exist outsource predatory model, and workers must find representation in some sort of forum to allow them some economic power.