After explaining the necessity of the $700 billion economic rescue plan, Treasury Secretary Henry Paulson goes on to say, “I wouldn’t bet against the long-term fundamentals of this country,” he said on NBC’s Meet the Press. “But this is a humbling experience to see so much fragility in our capital markets, and ask how did we ever get here.”
May I propose a suggestion?
Since it is apparently not obvious what my point is in the post, I’ll elaborate. We’ve been at war for 5 years and seen almost zero economic impact – until this year. Wars are always very expensive and their impact on an economy is always felt. Always.
During WWII in Nazi Germany, workers wives would come to their factories to collect and spend their paychecks. That was a smart practice because the value of their checks would have dropped as much as 10% during the 4 hours their husband was at work.
During the Persian and Peloponnesian wars, the campaigns were usually fought during the summer, after the crops were planted. The campaigns typically ended before fall, at harvest time. Even so, the wars constantly emptied the treasuries of both warring parties.
How could America have felt no economic impact during 5 years of war in which we’re spending hundreds of billions of dollars? A housing bubble, perhaps? Who would have stood to gain in such a situation? Particularly if that chicken hadn’t come home to roost until we got a new President?
Please explain a little further. I think I am seeing where you are headed but not quite sure. also I see your graph good info. but who stands to gain the most in this?and it really is not a comparable expense because who is the other warring party and where does the funds come from?
The economic issues Americans are facing are due mainly to the cost of war. No economy is so robust that its members would not feel the loss of $600 billion. Our economy should have felt some impact of the war in 2003 and every year since. We didn’t, largely because the costs were masked by the housing bubble.
When the government prints more greenbacks to pay for the $600 billion we’ve spent, they are devaluing the dollar bills in our wallets, just like the workers paychecks in Germany during WWII. Everybody holding US dollars bears the cost. You and I, and every other member of the global economy that has US dollars in their possession. Instead of having it spread out over 5 years, we’re feeling that impact all at once.
Now that the housing bubble has burst, we’re feeling the economic effects of the war compounded by the losses of banks. When the Fed dropped interest rates after 9/11, they eroded banks primary source of income (interest), leaving them to search elsewhere. Some of them shunned prudent lending practices in their search. The same thing happened during the roaring 20s when credit was cheap. History has a way of repeating itself.
After considering that, have a look at the housing price graphs on this page: http://en.wikipedia.org/wiki/Housing_bubble . The curves are obviously an enormous bubble which cannot be accounted for simply because lenders relaxed standards. There are few possible explanations for a graph like that. Housing affordability is based upon wages, house prices, and interest rates. The average American can afford to spend 35-48% of their income on housing. Since house prices skyrocketed, either wages increased to compensate, or interest rates declined.
I haven’t seen anything suggesting wages have increased during the past five years. However, we do know that interest rates have been held artificially low since 9/11. The idea was to encourage lending (it did), goose the economy (it did), and prevent a recession. Artificially low interest rates allowed millions of Americans to make payments on houses that would ordinarily be out of their price range.
I’d expect a graph comparing historical house prices versus interest rates to show that when interest rates rise, house prices decline and vice versa. Thus, when interest rates finally do rise, house prices will decline. We have a large housing market decline in store for us when the Fed allows interest rates to rise to market rates.
Despite keeping rates low, after 5 years house prices are falling on their own. The decline began in earnest last year when the first round of rate resets on 5 year ARMS came due. Homeowners were faced with spending hundreds more each month when their interest rate went from 3.5% to 5.5%. When that happens, their house ceases to be affordable. For many, their only options were to sell or default.
For a while, the bubble absorbed those early casualties as the housing market softened. But the rate resets continued and house prices finally started to decline. When that happened, many homeowners found themselves upside down on their mortgages. As house prices continued dropping, some homeowners were both upside down and facing rate resets. Unable to sell and walk away free and clear, default became an increasingly attractive option.
Now we have the economic impact of the war and the implosion of the housing bubble hitting us at the same time. It’s further compounded by credit scarcity because banks don’t want to lend money at obscenely low rates. Their business is generating a profit off interest. The solution for liquidity in the credit markets is letting interest rates rise. Do that, and I guarantee that the problem of scarce credit goes away. Just remember, that will also cause house prices to fall.
The housing bubble is a market response to a government policy (artificially low interest rates). Under whose influence was the policy implemented? Who stood to gain by preventing Americans from “feeling” the effects of the war on our economy? Could this result of that choice been predicted? Was the policy made knowing this would happen, but hoping it wouldn’t occur until after he left office?
As with most government interventions in our economy, it has merely postponed and worsened the recessive effects of the war. What is most concerning is we are still keeping interest rates artificially low. I cannot fathom how that is helping this problem in the long term.
Part II
I made no mention of the costs of the war to the other party. In this case, the costs of the war have been devastating to Al Qaeda and the Taliban. We haven’t done very well for the people of Iraq or Afghanistan yet, but that wasn’t a goal of the war. (I would agree that it should have been, but that’s a different topic). It is easy to forget, but the main point of the war was to prevent another Al Qaeda attack against us.
Taking off our shoes at the airport should serve as a reminder of just how hard it is to prevent terror attacks on our soil. Policies such as the ones imposed after 9/11 do little more than help the naive “feel” more secure. The only way to secure America against further attacks was to dismantle the financial conduits America built for the Afghan mujahedeen during the Soviet occupation of Afghanistan.
Those financial conduits allowed money to flow freely between wealthy arabs (mainly Saudis) and Osama bin Ladin. Those conduits were the backbone of Al Qaeda. The mujahedeen were largely ineffective against the Soviet occupiers, even with CIA training and support. In order to support them without directly intervening, we built a financial network that funneled money to bin Ladin. After that, the Afghan “Freedom Fighters” became very effective. This is something the book, and subsequent movie, Charlie Wilson’s War, illustrates very well.
As long as the money flowed in to fund training camps and buy weapons, Al Qaeda and the Taliban would remain powerful political forces in the middle east. As long as they had political power, they would be able to find refuge and launch terror attacks against us. In that sense, we have scored a major victory.
The means used to achieve those ends have left a sour taste in everyone’s mouth. Bush should not have manufactured the charges against Sadaam as a pretext for the invasion of Iraq. I’m not sure that we could have dismantled the financial networks supporting Al Qaeda without occupying Iran or Iraq. But doing it the way Bush did caused the loss of support from his people and our allies.
> During WWII in Nazi Germany, workers’ wives would come to their (husbands’)
> factories to collect and spend their paychecks.
Actually, this happened during the inflation-era of 1923.
During WW2, prices were essentially capped by the government (that’s why I get a bad feeling everytime the government wants to cap the price of something – like they want to cap manager-salaries now – and I say that even though I’m not a manager and don’t earn a million a year. Nowhere near that sum. Idiots should just be fired, but not “capped” and kept).
Anyway, don’t you find it absurd in some way that one of the things that essentially helped create this disaster (governments taking influence on banks to also lend to poorer people) is now hailed as way out of the crisis?
In any case, the inflation created by the ballooning of the money in circulation is _very_ dangerous.
Thanks Rainer, for the correction. I just love German precision!
And yes, price controls are absolutely absurd in practically every context. America has toyed with price controls in various contexts (commodities during WWII, rents in some communities, etc) and it always end poorly. The problem with price controls is they just sound so good to the masses when politicians propose them as being more “fair.” My favorite example of price controls is this one:
Until the recent banking and insurance deregulation (with special thanks to John McCain’s economic advisor, Phil Gramm), our system was quite sound. It’s quite ironic that McCain, whose hands were smacked for his involvement during our S&L crisis during the 80’s is so closely connected to “Foreclosure Phil.”
And yes, the initial Paulson bailout plan was absurd. I’m not sure how much better the current proposal is. But if you think either is bad, our house Democrats are proposing giving money directly to the “middle class” to solve the crisis.
Personally, I wish they’d just not do anything. Sure, a few more banks would fail, but the price on assets would drop fast and furious. Once prices dropped to the point where value investors are confident they are underpriced, we’ll start buying. All this non-sense is just postponing the price drops.