posted August 17, 2009
Green Shoots or Stinkweeds: Why Economic Recovery Has Not Yet Begun

In April-May a chorus of public announcements trumpeted the beginning of the end of the economic crisis. At last both the banking-financial crisis had stabilized, it was argued by government officials and business press pundits alike. The real economy’s collapse had finally bottomed out. The U.S. Federal Reserve chairman and U.S. Treasury secretary announced recovery had begun. The President noted economic growth was again on the horizon. CEOs of banks trotted out and declared their institutions were solvent and recovery and profitability lay ahead. I am not referring to April-May 2009 but to the year earlier, April-May 2008.

In spring 2008, to recall, the investment bank, Bear-Stearns, had just been ‘rescued’. Remaining banks were now going to raise enough private capital to offset continuing losses and write downs due to collapsing residential mortgages, i.e. the notorious ‘subprimes’. Congress had just passed a $165 billion stimulus bill a few months earlier. Rising unemployment had appeared to slow. Exports were still strong. Oil and commodity prices were experiencing a bubble in anticipation of future growth, it was argued.

Fast forward one year to spring 2009. The US Government’s ‘stress tests’ of the big 19 banks holding 70% of all assets in the banking system showed only a handful were in need of further assistance. Banks were once again now raising sufficient private capital, it was noted, thus proving they were not insolvent. The Obama administration and Congress had again just passed a stimulus bill, this time providing $180 billion for 2009 in new government spending.

The financial crisis is ending! Private capital is stabilizing the banks! Fiscal stimulus ($165 v. $180) is jump-starting the economy! Job losses are abating! As they say in France, ‘everything changes and nothing changes’.

What follows is an explanation why—once again—the current economic crisis is not over, why Federal Reserve Chairman, Bernanke’s, talk of economic ‘green shoots’ are more like financial stinkweeds and crabgrass, and why Obama’s ‘glimmers of hope’ may more resemble the flickering of a worn out light bulb before it goes permanently dark.

There are at least ten good reasons why the real economy in the U.S. is experiencing a ‘false recovery’. There are additionally nearly as many reasons why the financial side of the economy is also still very much unstable and could very well experience a second financial-banking crisis in 2010.

Ten Reasons Why the Real Economy Will Deteriorate

At the heart of the decline of the real economy are two primary forces which the Obama administration has hardly addressed to date: Rising joblessness and continuing deterioration of the residential mortgage markets.

1. 22 Million Jobless by Year End 2009

As predicted by this writer, in November-December 2008 the economy began to experience massive layoffs. With 7.1 million officially unemployed at the beginning of the current recession in December 2007, by November 2008 more than 10 million were jobless when properly calculated to account for the involuntary part time underemployed, discouraged workers who had given up looking for jobs but were not counted as officially unemployed by the government, and other so-called ‘marginally attached’ unemployed not counted. Starting in November, mass layoffs at the rate of nearly 1 million a month, properly calculated, began to occur. As this writer predicted at that time, there would be more than 20 million unemployed by year end 2009.

By the end of the first quarter 2009, however, the jobless trend was clearly running well ahead of the 20 million. By March 2009 in excess of 16 million were jobless. Then in April-May the government statistics reported the unemployment losses had slowed, citing this as evidence of ‘bottoming out’ and recovery around the corner. But a closer look at April-May jobless shows a quite different picture.

Officially ‘only’ 539,000 new jobs were lost in April. The actual number, however, was really more than 700,000 for several reasons. For one, the federal government added 72,000 temporary census takers for the 2010 census. This one time event could hardly represent recovery in the general economy. Then there were more than 225,000 statistically ‘adjusted’ to the jobless numbers representing a clever manipulation of what is called the ‘business birth-death model’ adjustment. The US Dept. of Labor assumes every month, based on long term historical averages, that new business formations (small businesses mostly) occur—even though small businesses may be laying off workers in massive numbers in the short term (which is the actual case for at least the last eight months). The government uses historical averages, in other words, not actual figures of small business closures. Considering just the ‘birth-death model’ and temporary census hires, it means the unemployment for April totaled more than 825,000—and that not including underemployment, discouraged and others jobless but not counted.

In May the official job losses were even less, at 345,000. But the number of losses were in fact much greater. Once again the government ‘added’ nonexistent 220,000 jobs due to the ‘business birth-death model’. So the actual numbers for May were really 565,000 not 345,000. It is important to note that the 565,000 number comes from one of the two surveys used by the government to estimate unemployment. It is called the ‘Establishment Survey’ and excludes entire categories of unemployed. In other words, it ‘low balls’ unemployment. The other source, the ‘Current Population Survey’ is the survey from which actual unemployment rates are calculated. So why does the government give us the jobless results from the survey that doesn’t calculate unemployment? Because in May, for example, while the Establishment Survey registered only 345,000 new unemployed, the Current Population Survey indicated 787,000 new unemployed.

In short, jobless ranks have continued to rise in April-May at a rate of at least 700,000 to 800,000 when properly accounted for. Hardly a major ‘bottoming out’ or evidence of recovery underway.

The central point of all this is that the increase of the ranks of the unemployed has hardly abated from late 2008 through mid-year 2009. This writer’s prediction of more than 20 million unemployed by year end 2009 is probably much too conservative. The more likely number of jobless may be as high as 22 million by year end. There simply cannot be a recovery in the real economy with that kind of chronically rising unemployment. That’s up to 15 million more unemployed, in addition to the official 7.1 million at the beginning of the recession in late 2007.

That 15 million represents a loss of economic output, or what is called Gross Domestic Product, in the US of around at least $30,000 per worker or around $500 billion. That represents a loss of around two and a half times the $180 billion the Obama stimulus bill is projected to inject into the economy in 2009. Put another way, the Obama stimulus in 2009 will not even make up half of the loss from the continuing rise in unemployment. But that’s just the beginning of the picture of why recovery will not occur. There’s more.

2. Foreclosures Rising to 8-10 Million

The second continuing major drag on recovery is the housing market collapse. Foreclosures and delinquencies in the residential housing market are continuing to rise. More than 350,000 foreclosures were recorded in March alone. More than 5.4 million have occurred or are in progress to date. The corporate rating agency, Moody’s Inc., predicts foreclosures will rise to eight million. Our prediction is more than 10 million. That’s 18-22% of the outstanding 45 million mortgages in some stage of foreclosure in the U.S. As a result, housing prices will also continue to fall another 20% beyond the already 25-30% (and higher in some markets). It is clear that a second wave in foreclosures is now hitting the market, no doubt driven primarily by the rising joblessness. Now it’s not only subprime mortgages (of which $500 billion in losses by banks still remain to be written off). But now the less risky ‘Alt-A’ and even prime mortgages, the latter representing the fastest rising defaults currently.

This is hardly the stuff recovery is made of! Both the rising joblessness and foreclosures translate into two major negative impacts on consumption and consumption constitutes 70% of the US economy. There simply can be no recovery without a definitive resolution to the massive job loss still underway, or the continuing collapse of the housing sector.

Much has been made recently that there are finally signs that new home construction has turned the corner. But the minor recovery in new housing starts reflects the Obama administration decision last spring to subsidize new home building companies, and their mortgage lenders and servicers, with $75 billion injection from the Obama administration’s recently passed Housing Affordability Act last February. Virtually nothing of this $75 billion is being spent, however, to aid the rising millions of households entering foreclosure. The one crumb thrown to those 8-10 million in foreclosure—i.e. a provision authorizing judges to negotiate mortgage loan modifications—was in turn quickly thrown out by the Senate after intense banking lobbying this past May. In other words, the $75 billion is pork targeting the builders, lenders and mortgage servicers (80% of which is handled by the top five banks). Foreclosed and delinquent homeowners are being left to fend for themselves.

3. Continuing Fall in Home Equity Value

The collapse of consumer spending that began last October, which is now accelerating due to rising joblessness and foreclosures, is being driven as well by a host of other factors in addition to rising joblessness and foreclosures. One such additional factor depressing consumption still further is the continuing fall in home values. More than 15.4 million—more than a third of all homeowners—are currently ‘underwater’ on their mortgages. In other words, more than 25% owe more on their home loans than their homes are worth. That kind of collapse in home values has a proven negative wealth effect on consumers with mortgages, who respond in turn by spending less.

4. Continuing Loss in 401k Pension Value

In addition to home equity values falling, consumers have experienced the loss of more than $4 trillion to date on their 401k personal pension plans. Like the fall in home values, the collapse of pension balances also translates into less consumption and therefore a negative drag on economic recovery. And it’s not just 401k plans. Many defined benefit pension plans are also increasingly in trouble. One estimate is that even the largest, supposedly most stable companies—those constituting the S&P 500—have on average lost a third of their pension values. The same applies for most public sector (state and local government) defined benefit pensions. Defined benefit pensions are a ‘ticking time bomb’ that will eventually explode in 2010-11. Much like falling home equity values, falling 401k balances and fears about bankruptcy of defined benefit pensions, will continue to depress spending, and will thus inhibit economic recovery as well, for some months to come.

5. Credit Card Spending Retreat

Still another drag on consumer spending and recovery is the retreat of spending gaining momentum via use of credit cards. Not only have credit card rates risen from single digit to as high as 29.99% on balances owed to credit card companies, but credit card companies have raised fees and penalties dramatically as well. Millions of cards have been terminated. U.S. Federal Deposit Insurance Corp. data indicate credit card ‘lines of credit’ were reduced by credit card companies by $406 billion alone in the first quarter of 2009. Credit card losses and write offs have been averaging nearly $40 billion a quarter since late 2008. Credit card spending has fallen the last seven consecutive months, for the longest drop on record since reporting began in 1968. In short, consumption via credit cards is in freefall as well and constitutes an additional force that will hold back economic recovery.

6. Falling Hours of Work and Wages

Still another factor driving declines in consumption—and preventing recovery—is the continuing fall in hours worked and weekly earnings. Hours of work have declined to their lowest average level on record since the 1970s, to barely 33 hours per week. That’s so-called full time employment. More than six million workers have been ‘converted’ to part time work since the recession began. That’s the equivalent of 3 million more unemployed. And that’s in addition to the millions more full time workers laid off. But those still with jobs are working fewer hours. That means less take home pay for those still working, just as loss of jobs for the unemployed translates into less income to spend.

In addition to hours and earnings reduction, there’s the additional factor of direct wage cuts for those working. Government data on average hourly wages is misleading and grossly underestimates the extent of ‘wage cutting’ underway. First of all, ‘Wages’ according to government data include two thirds of the income of business proprietors. That means two thirds of earned income of doctors, business consultants, single business owners is included in the government’s definition of wages. That boosts the average wage significantly. So it is necessary to look at average hourly wage gains for the 110 million nonsupervisory production and service employees, not wages in general. But even that more accurate category doesn’t cover at all reductions in ‘compensation’ due to higher costs of health care premiums, deductibles, and the like. Benefit cuts are part of ‘pay cuts’. Today there is also a growing trend, both in public sector and private sector, employment toward mandatory ‘furloughs’; that is required days off without pay every month or week. This amounts to a wage reduction for workers as a group that is not reflected in hourly wage data. In short, in various and forms wages, defined broadly and more accurately, are continuing to be reduced, which will result in less spending and consumption in the coming months apart from and in addition to the other factors previously noted driving a continuing collapse of consumption. This declining wage and earnings trend will spread and deepen, serving as yet another drag on the recovery in the months ahead.

7. Business Capital Spending

Points 1 to 6 represent major factors depressing consumption at present and into the foreseeable future, and thus fundamental reasons to doubt claims that economic recovery is underway. Consumption represents around 70% of the economy. Another 15% or so of the economy comes from business capital spending—i.e. spending on structures, equipment, inventories and the like. Surveys for the coming year show business plans to reduce capital spending by somewhere between a fourth to a third. The Obama administration and the Federal Reserve have made much of the fact that business spending on inventories began to rise in the spring of 2009. But recoveries from a recession as deep as today’s cannot occur based on inventory spending alone. Also, it was to some extent inevitable that inventory spending would rise in recent quarters, given the record $132 billion collapse in inventories in the fourth quarter of 2008. By simply falling less than the $132 billion in subsequent quarter, according to government GDP accounting, a ‘rise’ occurs in inventory spending, thus giving the appearance of a rise in inventories and recovery.

8. Global Exports Collapse

The third sector of the economy is called ‘Net Exports’ (the difference between export sales to other countries by US companies and the sales of companies in other countries to the US). One of the hallmarks of the current economic crisis, however, is the synchronization of economic downturns across countries. That synchronization represents a collapse of world trade and exports that has been underway for some months. Some countries, like Japan, Germany, and even China, are highly dependent on exports to the US. Japanese exports in early 2009 actually fell by 50%. Germany and China registered similar mammoth drops in exports. U.S. export sales have fallen accordingly as well. In short, it means production on exports will continue to fall in the U.S. as global trade falls. That will mean still further negative pressures on the US economic recovery as well.

9. State & Local Government Fiscal Crisis

A mere $27 billion of the Obama $787 billion stimulus package passed earlier this year was earmarked for job creation in 2009. Funding to the states in the stimulus is similarly unimpressive given the scope of the current crisis. For example, it is projected that only $130 billion of the $787 is designated for the states; moreover, that $130 billion is distributed over the next three years. A fiscal crisis of the states not seen since the 1930s is rapidly deepening. Collectively, state governments anticipate budget shortfalls of $230 billion according to a June 3, 2009 report by the Wall St. Journal. Virtually all states’ tax revenue sources across the board are falling faster than originally projected. This will mean higher state and local taxes and fees that will depress consumption still further. At the same time, a larger percentage of total future layoffs will inevitably come from state, local government and school districts in the remaining months of 2009, while hours, wages, and take home pay for public sector workers will fall as well. The net total of government spending—federal, state and local, and schools—may actually turn out negative despite the $787 billion stimulus. The Obama stimulus may not be sufficient to offset the declines in spending at the state-local government and school district levels. In other words, the fourth ‘engine’ of economic recovery—government spending—may prove a drag on economic recovery rather than a stimulus in the months immediately ahead.

10. Federal Stimulus Package: Too Little Too Late

A thorough analysis of the Obama stimulus package was provided by this writer in an issue of this publication earlier this year. For purposes of assessing its impact on ‘green shoots’ and claims of economic recovery, it should be noted that it is inevitable there will be some minor effect on the economy from the stimulus from the $180 billion of spending this year. But ‘some effect’ is not what is needed. The $180 billion government spending this year, like the $165 billion stimulus in 2008, will slow the economic decline a little but only for a few months. Perhaps to the end of the summer. But it will not have a major or a permanent impact. It will dissipate in 2009, as it did in 2008. It should not be forgotten that only $487 billion of the $787 billion is actual government spending. The $300 billion tax cut portion of the total stimulus package will have virtually no immediate impact on the economy. It will be hoarded by consumers and businesses alike, used to retire debt, saved, or held until claimed at later dates.

That $487 billion by the Obama administration compares to a stimulus package introduced by China of more than $500 billion. But China’s economy is only $3 trillion a year, while the U.S. is $14 trillion. Were the U.S. to introduce a government spending stimulus equivalent to China’s in terms of GDP, the U.S. would need to spend $2.5 trillion. Of course, the U.S. is actually spending that—but on bank bailouts rather than the real economy. A third U.S. stimulus bill will likely be required sometime within the next twelve months.

The economic crisis today has two great dimensions: financial and the non-financial real economy. Thus far a skewed focus has been on the financial side—that is on the banks, insurance companies, the shadow banking system of hedge funds, private equity, mutual funds, credit card companies, and the like. This skewed and distorted attention to the finance side reflects the Bush and Obama administrations’ misplaced strategy that the key to recovery is ‘to get the credit system and banks lending again’. As a consequence of this misplaced strategy, thus far more than $4 trillion has been spent on bailing out the banks and less than $300 billion in spending in both 2008 and 2009 aimed at resuscitating the real economy. Moreover, the Federal Reserve and Treasury have indicated commitments to spend another $8 trillion if necessary. That’s $12 trillion, and equal to a tax bill for every taxpayer of around $19,500. This misplaced ‘banks come first’ strategy focusing on the financial side of the crisis will prove disastrous in the long run. For the locus of the general crisis has clearly shifted to the real, or non-financial, side of the economy. And if left unaddressed by policymakers, the real economy’s continuing collapse will eventually feedback into yet another, even more serious, financial-banking crisis in 2010-2011.

II. Why Financial Instability Has Also Not Abated

Which brings this analysis to a consideration of why the financial side of the economy is also still very much in crisis, despite all the proclamations to the contrary.

11. Phony Stress Tests and Continuing Bank Insolvency

Last spring’s bank industry stress tests were simply designed to buy time. They were clearly engineered by mutual agreement between the banks and the government in a series of back room dealings. Several iterations of stress test results were quietly undertaken before the official results announced. At least fifteen of the nineteen ‘too big to fail’ banks are still technically insolvent despite the tests. Germany’s finance minister, Peer Steinbruck, for example, publicly stated the tests were “worthless? because their results were altered by negotiations behind the scenes between the banks, the Federal Reserve and Treasury prior to public announcement. The idea of the stress tests in the U.S. was to create the appearance of stability so that the banks could appear profitable, which would give their stock prices a temporary boost as result, and thereby allow the banks to raise new private capital which they couldn’t so long as investors thought they were insolvent. To enable the appearance of profitability, various accounting practices were also suspended or altered by the government, not least of which was the ‘mark to market rule’ that previously required banks to report their collapsed securitized assets at true market values. But the stress tests essentially just covered up the problems facing the banking system in the U.S., the big 19 banks as well as the thousands of smaller banks. In fact, despite the rosy public picture concerning the 19 stress tested banks, even one Federal Reserve scenario estimates the 19 banks could face losses of $599 billion more. And that no doubt is conservative. The banking system, in other words, is still incredibly fragile and some unforeseen crisis event could easily ‘come out of left field’ and cause yet another banking panic. Some of such possible events are as follows.

12. Coming Bust in Commercial Property Markets

The financial sector also remains fragile because three big ‘financial bombs’ coming will have eventual negative impact on the banking sector that will prove at least as equivalent in magnitude as the subprime mortgage bust. The first of these is the developing implosion in commercial property markets. These are property mortgages associated with office buildings, malls, apartments, hotels, resorts and the like. Commercial property prices have fallen 30% as of June 2009 and are projected to fall at least another 20%. The big 19 banks alone hold $600 billion of such assets on their books. It is not unreasonable to assume they will soon lose at least $100 billion of that $600 billion exposure. Harder hit potentially will be the thousands of regional and community banks even more exposed to this market. According to the business research firm, Foresight Analytics, the banking sector could suffer losses as high as $250 billion, and more than 700 banks could fail, as result of commercial real estate losses in the coming months.

13. Regional and Community Banks Deteriorating

While the big 19 ‘too big to fail’ banks hold 70% of bank assets, there are additionally more than 8200 regional and community banks. These banks are particularly heavily exposed to the commercial property and residential mortgage markets. They are deeply involved in auto loans, personal loans, and small business loans. The number of ‘problem’ banks among these regionals rose by 21% (to 305 banks) in the first quarter of 2009 alone, according to the FDIC. Analysts estimate at least another $200 billion in losses are coming for 900 small and medium banks in this sector with severe loan exposure to mortgages for malls, offices, apartments and hotels that are projected to fail in the coming months.

14. Consumer Credit Markets At Crossroads

These markets are in a similar condition as the Commercial Property markets. They include auto loans, student loans, and credit cards. Once a trillion dollar market for securitized assets, that market collapsed in 2008 to less than $50 billion. With the collapse, many banks and shadow banks were stuck with holding onto essentially worthless investments, worth on average ten cents on the dollar. Values continue to collapse, as rising unemployment and the collapse of consumption results in further rising delinquencies and defaults. Credit card financing has been particularly hard hit, with auto loan delinquencies rising sharply. Credit card write offs are running at $150-$200 billion a year. Auto loans could be at least as great. The Federal Reserve set aside $1 trillion in the spring of 2009 to try to resurrect these markets via its Term Auction Lending Facility, or TALF. The Fed hopes to do this by getting the shadow banking sector—hedge funds, private equity, and the like—to come back into the market and purchase the bad securities. The shadow banking folks were the same who caused much of the current financial instability in the first place by excessive speculation in securitized assets; and now, according to the Fed’s plan, they are going to bail us out! But there has been little interest thus far on their part in the TALF program.. The Fed will therefore probably fail in its effort to resurrect these markets, resulting in hundreds of billions of more losses hitting bank balance sheets within the next eighteen months.

15. The Imploding PIPP Rescue Program

While the Fed fails with TALF, the other cornerstone of the Obama administration’s Bank Rescue program announced last March, the ‘Public-Private Investment Program’, or PPIP, is also already on its last legs. The PPIP program had two elements. One was to have the FDIC provide subsidies to banks to sell their bad loans (not to be confused with the ‘bad securitized assets’ above being handled by the Fed through TALF). Per the PPIP the FDIC makes up what banks might lose as result of selling bad loans at market prices. But, once again, as has been the case since the financial crisis began, the banks simply do not want to sell the bad loans despite FDIC subsidies. Having raised in April-May some fresh capital through stock issues, and thus fattened their balance sheets a little, banks now want to hold onto the bad loans still on their books. The reasons for so doing are several, but primarily their desire to avoid restrictions on their executive pay if they take government, FDIC, subsidized funding. So Banks rather continue business with the bad loans still on their books. This means that once additional losses from developments noted above erode that newly raised capital once again, they’ll be right back where they were in terms of the need to record still further losses, further write downs, and still deeper technical insolvency.

16. Record Corporate Defaults Coming

Despite the remaining tremendous instability in the banking-finance sector due to anticipated losses and write downs continuing in residential mortgage, commercial property, auto and student loans, credit cards, and pensions—an even greater financial tsunami is gathering in the non-financial corporate sector. Hit by unavailable, or high cost of credit for almost two years now, on the one hand, and collapsing demand for their products on the other, record numbers of businesses are predicted to default and go into bankruptcy in the near future. That will mean even further, still unestimated major losses and write downs for banks. High on the list will be thousands of companies dependent on the Junk Bond markets. These are companies already ‘on the brink’ or they wouldn’t be borrowing for extended periods in this high interest rate market. Some now pay up to 20% interest for such borrowing. Moody’s Inc., the business rating agency, predicts defaults by junk bond dependent companies will rise from current 5% levels to 15.9% in the next twelve months. According to a June study published by the research department of Allianz, the giant global finance company, there was a 27% increase in corporate bankruptcies in 2008 that will be exceeded in 2009 by another 35% increase. Corporate bankruptcy figures rarely record more than a 10% increase a year. Two years of 27% and 35% are thus unprecedented. This historic increase business defaults and bankruptcies will translate into still further losses and write downs for banks and other financial institutions.

17. Euro Banks and Sovereign Debt Default

Turning to the international scene, serious banking instability could very easily re-ignite in the US in the wake of a major collapse of a large European bank or a default by a sovereign investor in eastern europe. Banks in the Euro periphery—i.e. Ireland, Iceland, Spain, Greece, etc.—have been among the most exposed. However, to date the EU has been able to contain the crises in those locales. The EU and US have indicated they will fund the International Monetary Fund, the IMF, with more than $1 trillion to bail out eastern Europe banks and economies. But raising that amount has proved difficult. The U.S. Senate will likely not approve the U.S.’s $100 billion plus contribution. This failure increases the likelihood of serious Euro-banking crises. At present banking instability continues in the U.K, and German banks face more than $1 trillion in potential write downs. The most unstable developments, however, include the eastern European and Baltic countries’ financial systems. Still further east, Austrian banks are exposed very heavily in terms of loans to the Ukraine, while Swedish banks are similarly heavily exposed to Latvia, the Baltic countires, and its banks. A chain effect of bank collapses could easily arise in Europe in the next twelve months, repercussions of which would eventually be felt as well in the U.S. in terms of renewed financial instability of unknown magnitude.

18. The Dangerous Bubble in U.S. Treasuries

In late May 2009, U.S. Treasury Secretary Geitner made a trip to China. The specific purpose was to allay growing Chinese Central Bank and government concern that the U.S. dollar was headed for a major, long run decline. Holding more than $1 trillion in US assets, mostly US Treasuries, China was understandably concerned its holdings would collapse in value along with the dollar. What was the US going to do to ensure this would not happen was the pre-eminent question no doubt on the mind of Chinese central bankers and government. To fund the US deficit of more than $2 trillion in the coming year, the US Federal Reserve had declared it was prepared to ‘print money’ if necessary to cover the deficit. In addition, the Fed had declared months earlier it would enter the mortgage markets to buy up to $300 billion in long term bonds in the US in order to keep interest rates on mortgages low. The Fed intimated as well it might commit up to $1 trillion more if necessary to get mortgage interest rates to fall. But this kind of injection of money raised the spectre of a major bout of inflation in the future. That would translate into a serious fall of the dollar, which meant in turn the growing China concern. In his June visit Geitner assured the Chinese he would not let this happen. The US still needed China to continue to buy US Treasuries. Indeed, the US has become increasingly dependent on the Chinese to do so. Either get China to continue to buy US bonds and notes, or print the money is the current dilemma facing the Fed and Treasury. While Geitner was assuring the Chinese, Federal Reserve chairman, Ben Bernanke, was testifying before Congress reiterating Geithner’s message to the Chinese. Bernanke declared the US would reign in the coming U.S. deficits, projected to exceed $1 trillion a year on average for the next decade.

The above scenario represents the major contradiction faced by US policymakers today with regard to stabilizing either the real economy at the expense of destabilizing the financial system, or stabilizing the financial system at the expense of the real economy.

By refusing to purchase the $300 billion in long term Treasuries in US markets that the Fed said earlier in 2009 it would do to bring down mortgage interest rates, by supporting Geithner in China and thus the U.S. dollar the FED in effect gave the green light for residential mortgage rates to rise, cutting off any economic recovery in that market. But if the FED had not chose that option, and decided to monetize the deficit, then China likely would not in the future continue to purchase as many US bonds necessary to finance the deficit.

The choice, and contradiction, is support the dollar or spend to resuscitate the mortgage markets and the real economy. Faced with a fundamental contradiction, US policymakers Geitner-Bernanke chose once again to support the banking and financial system at the expense of the real economy.

But one should not be surprised. That has been the case and primary policy choice since the current economic crisis began two years ago. One should not be surprised that the two bankers—Geithner and Bernanke—would choose the banks and financial system over the rest of the economy. It’s the basic strategy that US policymakers have been pursuing since the crisis first erupted with the subprime mortgage bust in the summer of 2007, two years ago. That strategy has been simply: keep the banks afloat by whatever means and at whatever cost until the crisis passes. Throw whatever liquidity is necessary at the banks to keep them alive, even if they are zombies, or, in some cases, even if cadavers. Fill the banks’ ever expanding losses and write-downs, that is their balance sheet black hole, with government-taxpayer money transfers until the system stabilizes itself. This strategy has been expressed in the oft-repeated statement, the ‘most important thing is to get credit flowing again’. Which is simply another version of ‘trickle down’ economics, except now writ large in terms of trillions of dollars.

But that basic, failed strategy is why the current economic crisis, both in its financial and real economic dimensions, has continued to drag on so long. It is also why it cannot sustain itself over the long run. Why the current crisis is far from over. And why, in some ways, it may have only just begun.

Jack Rasmus
Jack is the author of the forthcoming book, EPIC RECESSION AND FINANCIAL CRISIS: Prelude to Global Depression?, published by Pluto Books later this year.

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