THE PERFECT STORM, PT. 2

Originally published by Gather.com on March 16, 2008
By Sean Kennedy

Earlier this week, in an article titled "The Perfect Storm," I noted how a confluence of factors could portend serious consequences for the American Economy. I focused primarily on the tumbling U.S. dollar and the spiking cost of oil and gasoline.

In this installment, I'll try to outline, in further detail, the numerous other red flags that are threatening our economic well being and way of life.

The harsh reality is that our economy has been a sort of house of cards for quite some time; it has been built on a bad foundation and a lot of delusion.

Incredibly, 72 percent of the U.S. economy is based on consumer spending. This has numerous associated problems.

The kind of spending that Americans have been engaging in for decades has come to its inevitable conclusion. That's because most of us were spending money we didn't have and burdening ourselves with ever-greater debt. Americans don't save money anymore; instead we spend it all. In fact, our national savings rate has been negative for the past couple of years.

The spending frenzy of this decade was based largely on the premise that home values would continue to increase indefinitely. Many Americans seemed to believe that double-digit annual appreciation was a norm that would go on forever. False.

By now, we all know the resulting story; people bought homes they couldn't afford based on this mistaken notion, with the belief they could then flip these homes for a handsome profit or use the appreciation and resulting equity to refinance. Millions were using their homes like ATMs to fuel their obsessive spending. Then it all fell apart.

Now millions of people have lost, or are about to lose, their homes, while banks and other mortgage lenders have been caught holding the bag. This has led to a credit crisis in which banks are hesitant to lend, or in some cases don't even have the means to lend.

Bear Stearns, the nation's fifth largest investment bank, just collapsed under the weight of bad mortgages — or mortgage securities — and was bought out in a fire sale by rival JP Morgan Chase. The venerable financial institution was acquired for less than 7 percent of what its market value had been just two days earlier.

Bear is not alone in its troubles. Other financial institutions – Lehman Brothers, Citigroup, Merrill Lynch, Morgan Stanley – have had to write off billions in losses and seek billions more from foreign investors.

The fear is that the implosion of this financial giant could create a domino effect and set off a tidal wave of defaults in the banking industry. The Fed would be significantly challenged in any effort to avert this, though it would surely try. Who wants to jump on a sinking ship?

Quite naturally, all of this has made businesses very leery and they have recently stopped hiring. Though the unemployment rate of 4.8 percent is still historically low, there is plenty of reason for concern. The economy unexpectedly lost 63,000 jobs in February — the most in five years — after declining by 22,000 in January. These job losses could further weaken consumer spending.

Moreover, the number of jobs being created is not keeping up with population growth. Economists say the U.S. needs to add about 250,000 jobs per month to keep pace. That's not even close to happening right now. Another concern is that, according to the Department of Labor, the jobs that have been created in recent years pay, on average, $9,000 less per year than the jobs that have been lost.

One of the fundamental problems with our runaway spending habits is that we buy almost everything from overseas. Relatively speaking, we don't make much here in America anymore. This creates a significant challenge for exports and makes our massive $705 billion annual trade deficit essentially inevitable. If we don't sell much abroad, where will we continue to get the money to buy all this stuff? In fact, U.S. exporters account for only 12 percent of the economy and the Business Roundtable reports that just 10% of all U.S. jobs currently depend on exports.

Despite Asia's red-hot growth, consumers in China and India accounted for only $1.6 billion of the world's spending in 2007, a tiny fraction of the $9.5 trillion spent by Americans.

Just 7 percent of the world's oil is produced in the U.S., yet crude is traded in U.S. dollars. Other oil producing nations are paid in dollars, which are now worth less and less each week. As a result, these nations make less per barrel as the dollar drops — unless they raise prices. Though the market — not individual countries — sets the price of oil, controlling production does affect price. That's the sort of power that OPEC wields.

Since oil prices affect the truckers who transport our goods, the heating that warms factories, businesses and homes, as well as product packaging, even those who don't own or drive a car are indirectly affected.

Since raising interest rates makes borrowing money more difficult for businesses and individuals, it therefore slows inflation. That's how the Fed controls the economy. But raising interest rates also serves to push the dollar down even further because the return on the dollar declines. Why invest in dollars if you can get a better return elsewhere? If you still think the dollar is worth investing in simply for patriotic reasons, try telling that to foreign governments and investment funds.

In the previous installment, I noted the absolutely massive costs of two simultaneous wars; $12 billion per month, according to the nonpartisan Congressional Research Service.

And the total cost of these wars is now expected to exceed $2 trillion, according to Joseph Stiglitz, a professor of economics at Columbia and his associate, Linda Bilmes, a Harvard professor. If credentials are important here, Stiglitz is a Nobel Prize winner and the former chief economist of the World Bank, while Bilmes has a PhD in economics. In short, these people know what they're talking about and we ought to listen and be concerned.

According to the pair, the costs of our engagements in Iraq and Afghanistan will exceed the costs of both World War II and the Vietnam conflict. That's rather stunning. What this means for the U.S. economy in the long-term is quite sobering, if not downright frightening.

As it stands, the U.S. already has a staggering $9.4 trillion debt, which amounts to $31,000 for every single man, woman and child in this country. Since Americans no longer save money, or have any significant means to invest, our government is reliant on foreign governments – such as China, Japan, and Saudi Arabia – to buy Treasuries in order to finance our massive and out-of-control spending. These are simply IOUs that eventually need to be repaid.

Before these wars even started, our government didn't have the means to pay for its future obligations, according to David Walker, the nation's top accountant. Walker, who just resigned his position as the Comptroller General of the United States, says the Medicare program is on course to possibly bankrupt the U.S. treasury.

The problem is that people keep living longer, and medical costs keep rising at twice the rate of inflation. The U.S. spends 50 percent more of its economy on health care than any nation on earth, says Walker.

As he sees it, the survival of the republic is at stake.

"I would argue that the most serious threat to the United States is not someone hiding in a cave in Afghanistan or Pakistan but our own fiscal irresponsibility," he told 60 Minutes.

Walker isn't just some hysterical, partisan government bureaucrat. The Government Accountability Office website says he "has earned a reputation for professional, objective, fact-based, and nonpartisan reviews of government issues and operations."

And this expert says the US. cannot afford the massive entitlement programs promised to 78 million Baby Boomers who, over the next 20 years, will become dependents of U.S. taxpayers.

At present, the government is already borrowing money to pay for the healthcare of its senior citizens. According to Walker, the system is unsustainable. The only way out, he says, is through additional taxes, restructuring the entitlement programs or by cutting other spending.

That last suggestion would be rather difficult. Right now, 80 percent of the federal budget is allocated to just five areas; Social Security, Medicare, Medicaid, the military and interest on the national debt.

What gives credibility to Walker's projections and analysis is that virtually everyone on the left and the right agrees with him. Federal Reserve Chairman Ben Bernanke and ranking Republicans and Democrats on the Senate Budget Committee back his assessments. Everyone knows he's right; they're just afraid to admit it publicly.

But even with Walker's testimony and warnings, and a fiscal problem that everyone in Washington acknowledges, Congress still behaves like a drunken sailor on shore leave. It just keeps raising the federal debt limit so that it can continue spending money it doesn't have, which only serves to drive us continually further into debt. Each year since 1969, Congress has spent more money than it has taken in.

These costs are already being repaid to the governments who've lent us many billions and the interest payments on that debt account for the fifth biggest piece of the federal budget. Call it money for nothing.

In Fiscal-Year 2007, the U. S. Government spent $430 Billion of our tax dollars on interest payments to the holders of the National Debt. Again, most of them are foreign governments. Compare that to the budgets of NASA – $15 Billion; the Department of Transportation – $56 Billion; and the Department of Education- $61 Billion.

So what does this all mean? Well, I hate to sound alarmist, but it doesn't look good. This is a very ugly picture and we have a government that has ignored these manifold problems for many years.

Politicians are afraid of giving voters bad news for fear of getting voted out of office. Who's ever won an election by telling people he or she plans to raise taxes or cut entitlement benefits?

Our reliance on foreign oil is a very old problem that has been ignored for decades. We have an insane energy policy that was essentially written by Big Oil and Big Energy. This doesn't serve the public good. How about a focus on clean, renewable energy and energy independence?

The massive size of our national debt and our continuous federal deficits have been ignored for decades. This is a form of national suicide. And our massive trade deficit has also been ignored for many years.

Meanwhile our leaders have asked us to soothe ourselves by buying as much as we possibly can, amassing ever-greater personal debt along the way.

This mortgage meltdown, which has turned into a full-fledged institutional crisis, was entirely avoidable. No-money-down loans? Stated-income loans? Interest-only loans? How was this stuff ever allowed?

It's because some in government think that any regulation is a bad thing and that we're all better off without it. But capitalism without regulation just leads some to some sort of Darwinian nightmare, in which only the strongest – or the richest, or the most cunning – survive.

What can we do about our do-nothing Congress?

Well, Democracy is participatory sport, not a spectator sport. It's time for everyone on the sidelines to get in the game.

Call your Senators and Representatives. Write them letters and let them know that you are aware of our bewildering array of economic problems and that you expect them to take action. If you don't know who your representatives are, find out!

Write a letter to the editor of your local paper.

Join a citizens group that is dedicated to progress and to making our politicians accountable to the people. It's time we hold their feet to the fire. In order to be considered leaders, our elected representatives must actually lead.

Get out and vote. Hold your government accountable! Ultimately, we end up with the government we deserve.

Let's just hope, for the sake of all Americans, that it's not too late to right the ship. We've taken our greatness, and our place in the world, for granted for far too long. It's not a right or a guarantee. It has to be earned and maintained.

None of the fixes will be easy, but we can't hide our heads in the sand any longer. Our government must know that we are aware and that they can't try to hide these problems from us, or ignore them, any longer. Then we have to be ready for some rather bitter medicine.

The taste will be harsh, but it will save us in the end.