I’ve been able to keep up with little snippets of the news when I’m not fishing, hiking or canoeing up here in the north woods. There’ve been several items of interest this week.
First of all, Treasury Undersecretary Ryan pronounced that it may be in our best interest to let some financial institutions fail. What this means is that the Federal Reserve is out of ammo for Bear-Stearns like bail-outs for stockholders. One of my long-shot predictions for 2008 (see “2008 Predictions“) was the failure of a major financial institution. Well, hold onto your hats because there may be more than one coming! The mortgage default mess has ravaged the balance sheets of banks. Only a day or so later, Citigroup announced that it will have to take yet another $9 billion in write-offs. By and large, these mortgage defaults and foreclosures are by average folks like you and me who just can’t make ends meet anymore, thanks to the failure of wages to keep pace with inflation, thanks to the millions of job losses due to our enormous trade deficit.
Then came the Federal Reserve’s decision to leave interest rates unchanged, and the accompanying announcement that it’s worried about inflation. The Fed has found that it’s interest-cutting campaign of the past few months has been totally ineffective in restoring the economy because the low rates haven’t translated into reduced lending rates at the consumer level. Why? Because treasury yields didn’t drop a bit. Why? Because the Fed’s bond auctions have gone poorly. Investors won’t buy them when they can get better interest rates elsewhere which, currently, is almost anywhere. This is why credit is drying up, seizing up the economy. Why does the government need to keep selling more and more treasury bonds? To finance its budget deficit, largely due to programs to offset the negative consequences of our trade deficit.
So if the Fed’s interest cutting has all been illusory, will the Fed now raise rates to fight inflation? It may, but it knows that it’s equally powerless here as well. The inflation we’re experiencing is due to the decline in the dollar. Interest rate moves by the Fed will do virtually nothing to affect this. The decline in the dollar is due to our persistent, enormous trade deficit. We’ve been flooding the world with dollars and the over-supply is steadily eroding their value. One third of the trade deficit is due to oil imports and two thirds is due to imports of manufactured goods. You may ask, “won’t the decline of the dollar help reverse the trade deficit?” That’s what economists would have you think, but it’s not true because the value of the dollar has nothing to do with the trade deficit. The trade deficit is due almost entirely to the collision of economic forces I warned of in Five Short Blasts – the inability of overpopulated nations to bring to the trade table an equivalent market in exchange for access to ours. The fact that the trade deficit has held steady while the dollar has declined dramatically is proof of this.
So the Fed is caught between a rock and a hard place. It’s only recourse to affect the direction of the economy is the one that its chairman, Ben Bernanke, may find the most distasteful (for him) of all: admit that free trade (what I call blind trade) is a failed economic model and press the President and Congress to begin imposing tariffs as necessary to eliminate the trade deficit. Failing this, the U.S. economy will continue to unravel, which is now happening at an alarming rate as the financial, manufacturing and construction sectors of the economy are simultaneously nearing collapse.
One final item of interest is that Barack Obama had a meeting with CEO’s of major U.S. companies. This is significant because the deteriorating economy assures that Obama will soon be president. Such a meeting calls to mind a similar meeting that Dick Cheney held with energy industry leaders soon after election to seek advice in formulating energy policy. We all know how that turned out. Let’s hope Obama’s meeting doesn’t yield similar results. What did the CEO’s tell Obama? Only Ford CEO Alan Mulally (sp?) was talking afterwards and made some vague reference to emphasizing the importance of government and industry working together.
So no one’s talking, but I can tell you exactly what each one of them told Obama: 1) “We need tax breaks,” and 2) “Beware of protectionist trade sentiment. Everything will be alright if we just have more free trade.” Frankly, I don’t worry that much about tax policy. It takes a certain amount of revenue to run an orderly society and, regardless of how it’s collected, in the end it will be paid by you and me, either directly to the government or indirectly, in the form of higher prices paid for goods. But, regarding the second item above, we can only hope that Obama can see through the smoke and mirrors of free trade pushers and cheerleaders and put the nation’s interests ahead of those of global corporations. He’d better. He certainly doesn’t want to leave the economy in far worse shape than he found it, as his predecessor has.