Monday, August 20, 2007

How Excessive Debt And Supply-Side Economics Together Transformed America Into The World's Largest Debtor Nation

The emerging sub-prime mortgage crisis, which threatens to abruptly deflate the housing bubble and take us into a recession, has exposed the American economy as a gigantic Ponzi scheme to the rest of the world, according to an Iranian banker whose views were published on August 17th, 2007 in the International Herald-Tribune. And he believes it could take down much of the world's economy as well. Summarized highlights along with personal analysis presented below.

According to Hamid Varzi, a Tehran-based Iranian economist and banker, the ongoing sub-prime mortgage crisis, a result of irresponsible lending policies designed to generate windfall commissions for unscrupulous brokers, presages far deeper problems in a U.S. economy that is beginning to resemble a giant smoke-and-mirrors Ponzi scheme. And this has not been lost on the rest of the world.

The effects go far beyond economics. As a banker working in the heart of the Muslim world, Varzi is amazed by the depth and breadth of anti-Americanism, even among U.S. allies, manifested in reactions ranging from fierce anger to stoic fatalism. Muslims outside the United States interpret America's policies in the Middle East not as an effort to spread democracy but as a blatant neocolonialist attempt to solve its economic problems by force. Arabs and Persians alike argue that America's fiscal irresponsibility has forced it to seek solutions through military aggression. This generates a growing belief that the Iraq War was a desperate attempt to capture both a reliable source of cheap oil and a major export market for the United States. Varzi apparently is too polite to mention the other major reason - Israel; however, his country's President makes up for that deficiency.

Varzi points out that the United States borrows a whopping $2.5 billion daily from abroad to service this growing debt. In order to continue borrowing at reasonable interest rates, America needs to retain credibility with its overseas creditors, especially Far Eastern nations running huge trade surpluses. A cessation of foreign lending would force the Fed to raise interest rates to attract money, precipitating a collapse of the already weak housing market and pushing the economy into recession. This is why the Chinese, in particular, have threatened to retaliate against proposed U.S. trade sanctions by reducing their $1.3 trillion in dollar holdings.

However, Varzi claims that the U.S. debt situation is so grave that the Chinese would not even need to "dump dollars" to precipitate a meltdown but could simply refuse to extend further credit: They could cease purchasing additional Treasury Bonds and Treasury Bills, without selling any excess inventory. China has the far stronger hand, because a run on the dollar would merely reduce China's gigantic cash surplus while increasing America's debt burden to astronomical levels.

Hamid Varzi apportions a major share of blame to America's supply-side economists who consistenly aregue that there is nothing wrong with going into debt. However, but this is valid only as long as a nation and its consumers are gaining something in return. Supply-siders ignore the crucial distinction between using debt merely as a transitory catalyist to promote intial investment and enhance competitiveness versus using debt to pay off current expenses and to create even more debt. Perhaps this is because an entire industry of financial parasites make healthy livings from the servicing of debt. When business school graduates can walk into a New York investment house and make $100,000 their first year on the job, it generates pressure to encourage consumers to take on even more debt to create more opportunities to profit from that debt.

The limitations of supply-side economics have been well-known for over 25 years and were publicized as early as the 1980 Republican Presidential nomination campaign, when George H.W. Bush, running against Ronald Reagan, characterized Reaganomics as "voodoo economics". President Reagan, in one of his very few errors in judgment, embraced supply-side economics, doing so with such passion that not even the protest resignation of his first OMB Director, David Stockman, could deter him from this course.

But what has America as a whole gained from its mountain of debt? A crumbling infrastructure, a manufacturing base that has declined 60 percent since World War II, a rise in the wealth gap, the lowest consumer-savings rate since the depths of the Great Depression, 50 million Americans without health insurance, an educational system in decline and a shrinking dollar that makes foreign travel a luxury. And current tensions between the United States and the rest of the world will continue as long as America's military bark is louder than its economic bite.

But Varzi doesn't consider the situation hopeless, if the U.S. government is prepared to consider some radical measures. He recommends the elimination of corporate tax loopholes, a reversal of tax breaks for the ultra-rich, a bipartisan campaign to eliminate budget "pork," imposition of stringent limits on corporate debt and speculative lending, a vast reduction in military expenditure and, finally, an additional 50 cent per gallon gasoline tax that would slash the federal deficit, curtail energy waste and spur technological breakthroughs. But he questions the resolve of Congress and the Bush Administration to enact these measures.

And the short-term prognosis? According to the Scotsman, markets are braced for renewed volatility during the upcoming week after last week's rollercoaster ride which ended with sharp equity rallies on both sides of the Atlantic. The late rallies followed the Federal Reserve's sudden decision to cut interest rates. Central banks will not only remain under pressure to keep a lid on interest rates, but the Federal Reserve might cut rates below 5.25 percent to stabilize the market and implement damage control.

In addition, the crisis has seen the FBI increase probes into mortgage fraud, with 1,200 cases under investigation so far this year compared with 818 in all of 2006 and only 436 in 2003. Federal prosecutors said an increase in foreclosures was "providing criminals with the opportunity to defraud vulnerable homeowners".

While there has been no major mortgage fraud cases in Alaska recently, the State Line Star blog reports on a case recently prosecuted in the Kansas City area as typical of the type of corruption taking place. Many of the targets of sub-prime mortgages have been blacks who otherwise would not have qualified for home ownership. This outreach was partially in response to previous complaints from the civil rights racket that blacks weren't qualifying for loans in "proportionate numbers".

Commentary: Hamid Varzi's proposed remedies are sound. Fat chance of getting our elected officials to take action, though. The only Presidential candidate in the race who would enact such measures is Ron Paul, although Tom Tancredo is strong on immigration, and Mitt Romney might be beneficial in some ways.

In an essay published on VDare back in 2006, Paul Craig Roberts defends "supply-side economics" as a corrective response to Keynesian economics. He claims Keynesian economics overemphasized "demand" in the supply-and-demand equation. Since many Keynesian economists were influenced by the Great Depression, they grew up believing that maximizing the availability and flexibility of employment was the most important economic function. He further claims that other distortions like global labor arbitrage may be making supply-side economics look worse than it really is.

However, the website presents a contrasting point of view. While they acknowledge that economic growth occurred during the Reagan Adminstration as a result of supply-side economics, it was offset by the additional debt incurred. This website also presents the Achilles heel of supply-side theory; the assumption that those with means will automatically be willing to invest. The problem is that when things begin to go sour, the first instinct is to hunker down and "stuff the money under the mattress", so to speak. Supply-side theory has no answer to this problem.


  1. I work for, a foreclosures site and have seen a huge increase in the number of foreclosures in the past 7 months. I believe it is a combination of not only sub-prime and ARM mortgages, but also the high number of people who have gotten loans with interest rates at an all time low... in addition to the rapid depreciation in some areas and the difficulty some are experiencing in selling their homes.




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