Within Germany’s top political circles fear is growing of a second international financial crash exceeding in intensity and impact that of autumn 2008.

At the weekend, Chancellor Angela Merkel and Finance Minister Wolfgang Schäuble (both Christian Democratic Union—CDU) warned that the economic crisis was far from over. “We have initially succeeded in limiting the effects of the crisis on people, but difficulties remain in front of us,” Merkel told a CDU meeting.

Schäuble compared the present financial crisis with the fall of the Berlin Wall twenty years earlier. “The financial crisis will change the world as powerfully as did the fall of the [Berlin] Wall. The balance between America, Asia and Europe is shifting dramatically,” he told Bild am Sonntag. He also appealed to bankers to exercise restraint when it came to their bonus payments.

Jean-Claude Trichet, president of the European Central Bank, expressed fears about a social collapse if there is a new round of bank failures. “It is surely too early to say the crisis is over,” he told a European congress of bankers in Frankfurt, adding the warning: “Our democracies will not accept twice giving such extensive support to the financial sector with taxpayers’ money.”

The enormous stock market bubble that has formed over the past eight months is seen as the biggest source of danger of another crash. The most important share indices—the Dow Jones, the Japanese Nikkei and the German DAX—have risen by around 50 to 60 percent since March. The prices of crude oil, copper and other raw materials have also more than doubled. These enormous increases are not based upon any corresponding economic growth. On the contrary, economic activity has fallen in numerous countries and many firms are still posting losses.

The rally in stock prices is due to the enormous liquidity that governments and central banks have pumped into the economy. Financial establishments are able to borrow unlimited sums of money from the central banks at virtually zero interest, and thus make high profits from their speculative deals. The trillions in taxpayers’ money that are being spent to revive the economy do not flow into investments, but into speculative deals, high payouts to shareholders, and exorbitant bonus payments for the bankers.

“The stock markets are rising because so much money has to go somewhere—because shares per se are valued attractively,” writes Wirtschaftswoche, the German business weekly, in an analysis of the current stock exchange boom. According to the magazine, the price-earnings ratio—comparing the market value per share to the annual earnings per share of the respective enterprise—has reached a historic maximum of 133. A price-earnings ratio of 14 or more is considered to mean shares are valued excessively.

As a consequence of the crisis, hundreds of thousands of workers in the US alone are losing their jobs each month, workers are being forced to forgo wages, and social programs are being cut on a massive scale. At the same time, the orgy of enrichment of those at the top of society has reached the same level as prior to the crisis, or even higher.

The large investment banks and hedge funds will this year disburse over $100 billion in bonuses to their staff. Goldman Sachs, the US bank, has set aside $17 billion for this purpose. In Germany, the 30 largest enterprises listed on the DAX plan to transfer over 20 billion euros to their shareholders in the spring of 2010. That is 71 percent of their net profits. In the previous record year, 2007, the corresponding figure was only 45 percent. Proportionately less will be available for new investment.

This is the background to the warnings of Merkel, Schäuble and Trichet. They fear that the shameless enrichment of the financial oligarchy, linked with a new crisis on the financial markets, could unleash an uncontrollable social rebellion.

Many experts consider another financial crash to be inevitable. This week’s edition of Der Spiegel, the weekly newsmagazine, ran the following sensationalized headline, comic book-style, on its front page: “The trillion-bomb.” The 12-page accompanying article begins by asserting that the question is not whether the present stock market bubble bursts, but when…

There follows a devastating picture of the present state of capitalist society: “In the midst of a world economy still gripped by crisis, the financial elite is again accumulating billions,” the article states. “The old greed is there again, and the old hubris too.” Never before in modern economic history has “the finance industry had such unfettered access to the finances of the state.” Der Spiegel warns expressly of the “risk of hyperinflation—a breakneck rapidly progressing monetary depreciation, as Germany experienced at the beginning of the 1920s.”

At the same time, citing Adair Turner, chair of Britain’s Financial Services Authority, the article points to the ideological effects of the crisis. It not only involves a crisis of individual banks, but also a crisis of “intellectual thought”: “Our conception that prices bear important information, that markets behave rationally and correct themselves in cases of irrationality, all that has been placed in question.” In other words, capitalism and the free-market economy are thoroughly discredited.

Der Spiegel directs its principal fire against the US government. “The finance industry in the US is regulated by the finance industry, not by the finance minister [treasury secretary],” it notes disapprovingly, and lists the numerous individuals whose careers have extended from the executive offices of banks such as Goldman Sachs to the offices of the treasury department, or to the close environs of President Barack Obama, and back again.

“If one looked at the US with the same analytic coolness as [one looks at] Russia,” observes the American economist James Galbraith, cited in the article, “one could not avoid speaking of the rule of an oligopoly comprised of politicians and bankers. The powerful individuals on Wall Street and in Washington are no less closely interlinked than Prime Minister Vladimir Putin and the magnates controlling Russia’s raw material empire.”

Der Spiegel speaks for that section of the German ruling elite that wants to end the state-financed reflationary measures and the policy of cheap money as quickly as possible, pleading instead for a lowering of business taxes and severe budget cuts. Although that would entail a substantial dismantling of social programs and a short-term increase in bankruptcies and job cuts, this is considered the lesser evil compared to a sudden economic collapse with incalculable social consequences.

The attitude of Der Spiegel essentially corresponds to that of the government in Berlin. The outgoing coalition of the Christian Democrats and the Social Democratic Party had already enshrined a “debt brake” in the constitution shortly before September’s parliamentary elections, which now forces the new government onto a drastic austerity course. New state debt must be reduced from the present 86 billion euros to 10 billion in 2016 . Finance Minister Schäuble has repeatedly insisted that he will keep applying the debt brake and adhere to the European Union stability pact, which limits new debt to three percent of Gross Domestic Product.

But taking into account various internal and external political pressures means this austerity course is to be delayed by about one year. Chancellor Merkel fears a further erosion of support for the CDU and the loss of her government majority in the Bundesrat (upper house of parliament) if, immediately after the elections, she were to begin implementing social cuts. On an international level, there are sharp differences with Washington and London over financial policy, which already led to conflicts before the G20 summit in Pittsburgh.

The US and Britain, which have sacrificed a large part of their industrial base to the financial sector, have far fewer interests in a restrictive monetary policy than Germany, whose export trade and industry rank among the strongest in the world, and which fears the effects of a weak dollar on its competitive position. The vehemence with which Der Spiegel now attacks the American finance sector expresses the acuteness of the mutual tensions that are seldom openly addressed.

A recent poll shows that most economists now believe that the recession, which began in December 2007, will end in the third quarter of 2009. There's been an uptick in manufacturing and consumer confidence, and the decline in housing prices appears to be flattening out. Unfortunately, the return to positive GDP will likely be short-lived. The current surge in production is mainly the result of President Obama's fiscal stimulus and the rebuilding of inventories that were slashed after Lehman Bros defaulted in September, 2008. These factors should boost GDP for two or perhaps three quarters before the economy lapses back into recession. The most serious problems facing the economy have not yet been addressed or resolved. Consumer spending and bank lending are still contracting, and the banks are buried beneath $1.5 trillion in toxic assets and non-performing loans. Also, the wholesale credit system, (securitization) which provided up to 40 percent of the credit flowing into the economy, is barely operating.

No one really knows whether the system is salvageable or not. On a fundamental level, the financial system is broken and neither the Fed's zero percent interest rates nor Obama's gigantic fiscal stimulus has reversed the prevailing downward trend. Capital has stopped moving; the velocity of money has slowed to a crawl. It's true, things are getting worse slower, but the signs of "recovery" are as faint and irregular as a dying man's breath.

The financial media has played a key role in restoring consumer confidence. Negative reports are air-brushed or shuffled to the back pages while modest improvements in housing, corporate earnings or "clunker" sales are splashed boldly across the headlines. Naturally, most of the media's attention has focused on the 6 month rally in the stock market. The S&P 500 has lunged ahead 52 percent from its March 9 low. But equities are merely reacting to the ocean of liquidity the Fed has poured into the financial system through its quantitative easing (QE) and liquidity swaps. Market analyst Andy Xie explains how it all works in his article "New Bubble Threatens a V-shaped Rebound":

"Central banks around the world, although they haven't done so deliberately, have created another liquidity bubble. It manifested itself first in surging commodity prices, next in stock markets, and lately in some property markets....

"A pure bubble tied to excess liquidity that affects one or many financial assets cannot last long. Its multiplier effect on the broad economy is limited. It could have a limited impact on consumption due to the wealth effect. As it neither stimulates the supply side nor boosts productivity, whatever story it is based on will have holes that become apparent to speculators. It doesn't take long for them to flee. Furthermore, a pure liquidity bubble without support from productivity can easily lead to inflation, which causes tightening expectations that trigger a bubble's burst.

What we are seeing now in the global economy is a pure liquidity bubble. It's been manifested in several asset classes. The most prominent are commodities, stocks and government bonds. The story that supports this bubble is that fiscal stimulus would lead to quick economic recovery, and the output gap could keep inflation down. Hence, central banks can keep interest rates low for a couple more years. And following this story line, investors can look forward to strong corporate earnings and low interest rates at the same time, a sort of a goldilocks scenario for the stock market.

What occurred in China in the second quarter and started happening in the United States in the third quarter seems to lend support to this view. I think the market is being misled. The driving forces for the current bounce are inventory cycle and government stimulus." Andy Xie, "New Bubble Threatens a V-Shaped Rebound" http://english.caijing.com.cn/2009-08-20/110227359.html

Fed chair Ben Bernanke's low interest rates and monetization programs have flooded the markets and created the illusion of economic recovery. But investors and consumers remain skeptical. In fact, (according to zero hedge) less than $400 billion has moved from Money Markets into stocks in the last 6 months even though the index value has increased by more than $2.7 trillion. So, where did the money come from? The Fed has taken trillions in toxic securities onto its balance sheet, thus, providing financial institutions with the liquidity they need to goose the stock market. With securitization in a shambles, the banks have fewer opportunities to meet earnings expectations. Lending is down, but speculation is up. Way up.

Bernanke knows that neither stimulus nor liquidity will fix the economy. That's because many of the financial institutions that took out loans from the Fed are technically insolvent. (Borrowing more money won't help if you're already drowning in red ink) Even so, he is committed to keeping the big banks afloat and patching together the flawed wholesale credit system any way he can. This is why Bernanke should never have been reappointed. True, he demonstrated impressive imagination and skill in pumping liquidity into the financial system, but he's done nothing to role up insolvent institutions or to purge toxic assets and non performing loans from the system. The Fed has merely provided enough taxpayer-funded scaffolding to keep a rotten system propped up a little longer. What good does that do?

As early as 2006, the Bank for International Settlements (BIS) warned that loose monetary policy and complex debt-instruments were increasing systemic risk and could trigger a 1930s-type slump. In June 2008, the UK Telegraph wrote:

"A year ago, the Bank for International Settlements startled the financial world by warning that we might soon face challenges last seen during the onset of the Great Depression. In a pointed attack on the US Federal Reserve, it said central banks would not find it easy to "clean up" once property bubbles have burst...

The fundamental cause of today's emerging problems was excessive and imprudent credit growth over a long period....The Fed and fellow central banks instinctively cut rates lower with each cycle to avoid facing the pain. The effect has been to put off the day of reckoning...

Should governments feel it necessary to take direct actions to alleviate debt burdens, it is crucial that they understand one thing beforehand. If asset prices are unrealistically high, they must fall. If savings rates are unrealistically low, they must rise. If debts cannot be serviced, they must be written off. To deny this through the use of gimmicks and palliatives will only make things worse in the end." (UK Telegraph)

Far from heeding the BIS's warning, Bernanke headed in the opposite direction, doing everything in his power to avoid price discovery and keep the price mortgage-backed securities (MBS) and other toxic assets artificially high by providing full-value, rotating loans to underwater financial institutions. At the same time the Fed was using public funds to prop up financial markets, Bernanke was shrugging off Congress's attempts to find out which companies secured the loans; how much the loans were worth, the terms under which they were issued, and the true "mark-to-market" value of the collateral accepted by the Fed. On Aug 24, 2009, a federal judge ruling on a case brought by Bloomberg News against the Fed decided that " The Federal Reserve must make public reports about recipients of emergency loans from U.S. taxpayers under programs created to address the financial crisis, a federal judge ruled." There's no doubt that the Fed will refuse to provide the relevant information as it would surely expose the Fed's cozy and collusive relationship with the nation's biggest banks. The Fed's stonewalling in the Bloomberg case and refusal to let Congress audit its books stands in sharp contrast with Bernanke's professed commitment to "transparency", a handy buzzword typically invoked by confidence men and charlatans when they feel noose tightening around their necks.

GREEN SHOOTS OR "SUGAR-HIGH"

The bond market has not been duped by the "green shoots" hype. As Paul Krugman points out on his blog,
"Net yields on most longer-term Treasury securities are lower today than they were at the end of May, even as the economy has shown signs of recovery. The 10-year T-note yield is at 3.45% today, down from 3.74% on May 27....There’s no hint in the data of fears about (a) crowding out (b) inflation (c) default." In other words, bonds are priced for deflation, which casts doubt on the rally in the stock market.

Deflation is now visible in every sector of the economy. The banks are facing major losses from dodgy assets and non performing loans (A recent article in US News and World Report predicted that the loss rate on bank loans could rise to 9.1 percent, worse than the 1930s.) financial institutions and households are continuing to deleverage and pay down debt, business investment is a record lows, and unemployment is soaring. Rising defaults, foreclosures and bankruptcies all add to the massive debt liquidation that has brought about a steady decline in economic activity.

Exports are down, so is trucking. Railroad freight is off 18 percent year-over-year. Department stores, building materials, restaurants, furniture sales, appliances, travel, retail, outdoor equipment, tech; down, down, down, down, down and down. You name it; it's down. Consumer credit is plummeting and personal savings are up. Industrial production is down, PPI down. Capacity utilization has slipped to 68.5 percent.(another record) There's so much slack in the system, inflation could be low for years. Commercial real estate--a $3.5 trillion industry--is plunging faster than residential housing. Corporate bond defaults are at record highs, Treasury yields are flat, and the dollar index is teetering at the brink. It's a wasteland.

The main problem is falling demand from stagnant wages. 30 years of anti-labor hysteria and trickle down economics has produced a system where GDP depends on ever-increasing amounts of personal debt. But that only works for so long. When the housing bubble burst in 2006, asset prices began to tumble, and the debt-to-equity ratio for millions of households slipped into the red. Now comes the digging out phase.

It is mathematically impossible for the economy to recover without a strong consumer, but consumer spending will continue to fade until household leverage returns to its long-term trend. (Household borrowing is presently 27 percent above normal trend; about $3 trillion) Economists Martin N. Baily, Susan Lund and Charles Atkins have written an invaluable "must read" analysis of the plight of the US consumer for McKinsey Global Institute titled: "Will U.S. Consumer Debt Reduction Cripple the Recovery?". Here's an excerpt:

"Between 2000 and 2007 US households led a national borrowing binge nearly doubling their outstanding debt to $13.8 trillion. The amount of US household debt amassed by 2007 was unprecedented whether measured in nominal terms, as a share of GDP (98%) or as a ratio of liabilities to personal disposable income (138%) But as the global financial and economic crisis worsened at the end of last year, a shift occurred; US households for the first time since WW2 reduced their debt outstanding......We show that the hit to consumption from household debt reduction, or "deleveraging" will depend on whether it is accompanied by personal income growth."

Over the past decade US household spending has served as the main engine of US economic growth. From 2000 to 2007 US annual personal consumption grew by 44%, from $6.9 trillion to $9.9 trillion--faster than either GDP or household income. Consumption accounted for 77% of real US GDP growth during this period--high by comparison with both US and international experience. The US spendthrift ways have fueled global economic growth as well. The US has accounted for one-third of the total growth in global private consumption since 1990....Powering the US spending spree through 2007 were three strong stimulants; a surge in household borrowing, a decline in saving, and a rapid appreciation of assets." (Martin N. Baily, Susan Lund and Charles Atkins, "Will U.S. Consumer Debt Reduction Cripple the Recovery?" McKinsey Global Institute. http://www.zerohedge.com/sites/default/files/McKindsey%20On%20Consumer%20Debt.pdf 

To repeat: "Consumption accounted for 77% of real US GDP growth during this period."..."The US has accounted for one-third of the total growth in global private consumption."

It should be fairly obvious by now that US consumers are undergoing a generational shift and will not be able to lead the way out of the recession as they have in the past. Nor will they miraculously "bounce back" and provide demand for products made abroad. In fact, the export-driven model (Germany, South Korea, Japan, China) is sure to be challenged in ways that were unimaginable just two years ago. With credit lines being cut, and outstanding credit shrinking by trillions in the past year alone, and unemployment nudging 10 percent (16 percent in real terms) the consumer will not be the locomotive driving the global economy. Credit destruction, asset firesales, defaults, and foreclosures will continue for the foreseeable future choking off growth and pushing unemployment higher. Consumption patterns are changing dramatically, although their impact won't be fully-felt until government stimulus programs run out. That's when the signs of Depression will reappear once more.

This is why Bernanke should never have been reappointed as chairman. Bernanke understands the issues---underwater banks, overextended consumers, exotic debt-instruments (derivatives), and an out-of-control financial system--but he's refused to do anything about them. He's made no effort to re-regulate the financial system, but (oddly enough) wants Congress to reward his inaction by elevating him to "Chief Regulator". Go figure? He's also done nothing to determine which institutions can be saved and which should be taken into conservatorship and have their assets put up for auction. Instead, he's given a blanket guarantee to every brokerage house on Wall Street; their garbage paper can be easily traded for US Treasuries or liquidity at any of the Fed's handy-dandy lending facilities. That's not a sign of sound judgment; it's a sign of "regulatory capture". Bernanke is a push-over; Chairman Milquetoast. That's why Wall Street loves him; he gives them cheap capital with one hand and a pat on the back with the other.

It's no secret what's wrong with the economy; the banks are struggling and consumers are broke. But there are remedies, they simply require fresh thinking about regulation and how to maintain aggregate demand. (A boost in pay would be a good start) The real problem is the institutional bias of the Fed itself. The Central Bank's policies are shaped by its allegiance to its constituents, particularly the big banks. Anything that doesn't advance the objectives of the financial establishment, is just not on the Fed's radar. That's why Bernanke's lame efforts to revive the economy will continue to sputter, because we've gone as far as we can without fixing household balance sheets and purging the excessive debt from the system.

The Fed is an obstacle to change, which is why more and more people are starting to figure out that the Fed has got to go.

 Source: ICH

The multiple failures that beset the country, from our mismanaged economy to our shredded constitutional rights to our lack of universal health care to our imperial debacles in the Middle East, can be laid at the feet of our elite universities. Harvard, Yale, Princeton and Stanford, along with most other elite schools, do a poor job educating students to think. They focus instead, through the filter of standardized tests, enrichment activities, advanced placement classes, high-priced tutors, swanky private schools and blind deference to all authority, on creating hordes of competent systems managers. The collapse of the country runs in a direct line from the manicured quadrangles and halls in places like Cambridge, Princeton and New Haven to the financial and political centers of power.

The nation’s elite universities disdain honest intellectual inquiry, which is by its nature distrustful of authority, fiercely independent and often subversive. They organize learning around minutely specialized disciplines, narrow answers and rigid structures that are designed to produce certain answers. The established corporate hierarchies these institutions service—economic, political and social—come with clear parameters, such as the primacy of an unfettered free market, and with a highly specialized vocabulary. This vocabulary, a sign of the “specialist” and of course the elitist, thwarts universal understanding. It keeps the uninitiated from asking unpleasant questions. It destroys the search for the common good. It dices disciplines, faculty, students and finally experts into tiny, specialized fragments. It allows students and faculty to retreat into these self-imposed fiefdoms and neglect the most pressing moral, political and cultural questions. Those who defy the system—people like Ralph Nader—are branded as irrational and irrelevant. These elite universities have banished self-criticism. They refuse to question a self-justifying system. Organization, technology, self-advancement and information systems are the only things that matter.

“Political silence, total silence,” said Chris Hebdon, a Berkeley undergraduate. He went on to describe how various student groups gather at Sproul Plaza, the center of student activity at the University of California, Berkeley. These groups set up tables to recruit and inform other students, a practice know as “tabling.”

“Students table for Darfur, no one tables for Iraq. Tables on Sproul Plaza are ethnically fragmented, explicitly pre-professional (The Asian American Pre-Law or Business or Pre-Medicine Association). Never have I seen a table on globalization or corporatization. Students are as distracted and specialized and atomized as most of their professors. It’s vertical integration gone cultural. And never, never is it cutting-edge. Berkeley loves the slogan ‘excellence through diversity,’ which is a farce of course if one checks our admissions stats (most years we have only one or two entering Native Americans), but few recognize multiculturalism’s silent partner—fragmentation into little markets. Our Sproul Plaza shows that so well—the same place Mario Savio once stood on top a police car is filled with tens of tables for the pre-corporate, the ethnic, the useless cynics, the recreational groups, etc.”

I sat a few months ago with a former classmate from Harvard Divinity School who is now a theology professor. When I asked her what she was teaching, she unleashed a torrent of obscure academic code words. I did not understand, even with three years of seminary, what she was talking about. You can see this absurd retreat into specialized, impenetrable verbal enclaves in every graduate department across the country. The more these universities churn out these stunted men and women, the more we are flooded with a peculiar breed of specialist. This specialist blindly services tiny parts of a corporate power structure he or she has never been taught to question and looks down on the rest of us with thinly veiled contempt.

I was sent to boarding school on a scholarship at the age of 10. By the time I had finished eight years in New England prep schools and another eight at Colgate and Harvard, I had a pretty good understanding of the game. I have also taught at Columbia, New York University and Princeton. These institutions, no matter how mediocre you are, feed students with the comforting self-delusion that they are there because they are not only the best but they deserve the best. You can see this attitude on display in every word uttered by George W. Bush. Here is a man with severely limited intellectual capacity and no moral core. He, along with “Scooter” Libby, who attended my boarding school and went on to Yale, is an example of the legions of self-centered mediocrities churned out by places like Andover, Yale and Harvard. Bush was, like the rest of his caste, propelled forward by his money and his connections. That is the real purpose of these well-endowed schools—to perpetuate their own.

“There’s a certain kind of student at these schools who falls in love with the mystique and prestige of his own education,” said Elyse Graham, whom I taught at Princeton and who is now doing graduate work at Yale. “This is the guy who treats his time at Princeton as a scavenger hunt for Princetoniana and Princeton nostalgia: How many famous professors can I collect? And so on. And he comes away not only with all these props for his sense of being elect, but also with the smoothness that seems to indicate wide learning; college socializes you, so you learn to present even trite ideas well.”

These institutions cater to their students like high-end resorts. My prep school—remember this is a high school—recently built a $26-million gym. Not that it didn’t have a gym. It had a fine one with an Olympic pool. But it needed to upgrade its facilities to compete for the elite boys and girls being wooed by other schools. While public schools crumble, while public universities are slashed and degraded, while these elite institutions become unaffordable even for the middle class, the privileged retreat further into their opulent gated communities. Harvard lost $8 billion of its endowment over the past four months, which raises the question of how smart these people are, but it still has $30 billion. Schools like Yale, Stanford and Princeton are not far behind. Those on the inside are told they are there because they are better than others. Most believe it.

The people I loved most, my working-class family in Maine, did not go to college. They were plumbers, post office clerks and mill workers. Most of the men were military veterans. They lived frugal and hard lives. They were indulgent of my incessant book reading and incompetence with tools, even my distaste for deer hunting, and they were a steady reminder that just because I had been blessed with an opportunity that was denied to them, I was not better or more intelligent. If you are poor you have to work after high school or, in the case of my grandfather, before you are able to finish high school. College is not an option. No one takes care of you. You have to do that for yourself. This is the most important difference between them and the elites.

The elite schools, which trumpet their diversity, base this diversity on race and ethnicity, rarely on class. The admissions process, as well as the staggering tuition costs, precludes most of the poor and working class. When my son got his SAT scores back last year, we were surprised to find that his critical reading score was lower than his math score. He dislikes math. He is an avid and perceptive reader. And so we did what many educated, middle-class families do. We hired an expensive tutor from The Princeton Review who taught him the tricks and techniques of taking standardized tests. The tutor told him things like “stop thinking about whether the passage is true. You are wasting test time thinking about the ideas. Just spit back what they tell you.” His reading score went up 130 points. Was he smarter? Was he a better reader? Did he become more intelligent? Is reading and answering multiple-choice questions while someone holds a stopwatch over you even an effective measure of intelligence? What about those families that do not have a few thousand dollars to hire a tutor? What chance do they have?

These universities, because of their incessant reliance on standardized tests and the demand for perfect grades, fill their classrooms with large numbers of drones. I have taught gifted and engaged students who used these institutions to expand the life of the mind, who asked the big questions and who cherished what these schools had to offer. But they were always a marginalized and dispirited minority. The bulk of their classmates, most of whom headed off to Wall Street or corporate firms when they graduated, starting at $120,000 a year, did prodigious amounts of work and faithfully regurgitated information. They received perfect grades in both tedious, boring classes and stimulating ones, not that they could tell the difference. They may have known the plot and salient details of Joseph Conrad’s “Heart of Darkness,” but they were unable to tell you why the story was important. Their professors, fearful of being branded political and not wanting to upset the legions of wealthy donors and administrative overlords who rule such institutions, did not draw the obvious parallels with Iraq and American empire. They did not use Conrad’s story, as it was meant to be used, to examine our own imperial darkness. And so, even in the anemic world of liberal arts, what is taught exists in a moral void.

“The existence of multiple forms of intelligence has become a commonplace, but however much elite universities like to sprinkle their incoming classes with a few actors or violinists, they select for and develop one form of intelligence: the analytic,” William Deresiewicz, who taught English at Yale, wrote in “The American Scholar.” “While this is broadly true of all universities, elite schools, precisely because their students (and faculty, and administrators) possess this one form of intelligence to such a high degree, are more apt to ignore the value of others. One naturally prizes what one most possesses and what most makes for one’s advantages. But social intelligence and emotional intelligence and creative ability, to name just three other forms, are not distributed preferentially among the educational elite.”

Intelligence is morally neutral. It is no more virtuous than athletic prowess. It can be used to further the rape of the working class by corporations and the mechanisms of repression and war, or it can be used to fight these forces. But if you determine worth by wealth, as these institutions invariably do, then fighting the system is inherently devalued. The unstated ethic of these elite institutions is to make as much money as you can to sustain the elitist system. College presidents are not voices for the common good and the protection of intellectual integrity, but obsequious fundraisers. They shower honorary degrees and trusteeships on hedge fund managers and Wall Street titans whose lives are usually examples of moral squalor and unchecked greed. The message to the students is clear. But grabbing what you can, as John Ruskin said, isn’t any less wicked when you grab it with the power of your brains than with the power of your fists.

Most of these students are afraid to take risks. They cower before authority. They have been taught from a young age by zealous parents, schools and institutional authorities what constitutes failure and success. They are socialized to obey. They obsess over grades and seek to please professors, even if what their professors teach is fatuous. The point is to get ahead. Challenging authority is not a career advancer. Freshmen arrive on elite campuses and begin to network their way into the elite eating clubs, test into the elite academic programs and lobby for elite summer internships. By the time they graduate they are superbly conditioned to work 10 or 12 hours a day electronically moving large sums of money around.

“The system forgot to teach them, along the way to the prestige admissions and the lucrative jobs, that the most important achievements can’t be measured by a letter or a number or a name,” Deresiewicz wrote. “It forgot that the true purpose of education is to make minds, not careers.”

“Only a small minority have seen their education as part of a larger intellectual journey, have approached the work of the mind with a pilgrim soul,” he went on. “These few have tended to feel like freaks, not least because they get so little support from the university itself. Places like Yale, as one of them put it to me, are not conducive to searchers. Places like Yale are simply not set up to help students ask the big questions. I don’t think there ever was a golden age of intellectualism in the American university, but in the 19th century students might at least have had a chance to hear such questions raised in chapel or in the literary societies and debating clubs that flourished on campus.”

Barack Obama is a product of this elitist system. So are his degree-laden Cabinet members. They come out of Harvard, Yale, Wellesley and Princeton. Their friends and classmates made huge fortunes on Wall Street and in powerful law firms. They go to the same class reunions. They belong to the same clubs. They speak the same easy language of privilege and comfort and entitlement. They are endowed with an unbridled self-confidence and blind belief in a decaying political and financial system that has nurtured and empowered them.

These elites, and the corporate system they serve, have ruined the country. These elite cannot solve our problems. They have been trained to find “solutions,” such as the trillion-dollar bailout of banks and financial firms, that sustain the system. They will feed the beast until it dies. Don’t expect them to save us. They don’t know how. And when it all collapses, when our rotten financial system with its trillions in worthless assets implodes and our imperial wars end in humiliation and defeat, they will be exposed as being as helpless, and as stupid, as the rest of us.

Source: Truthdig

The 1970s British Broadcasting Corp comedy show Monty Python's Flying Circus once did a skit about a new way that council flats - public housing - were being built near the town of Peterborough in England. Instead of building these 25-story towers through the conventional employment of construction workers, concrete and steel, this council was employing the services of El Mystico (Terry Jones), a magician in cape and top hat, along with his curvaceous assistant, in her sequined leotard, the Amazing Janet.

All it took for El Mystico and the Amazing Janet to put up a block of flats was a wave of his magic wand. According to a council spokesman, Ken Verybigliar, "Well, there is a considerable financial advantage in using the services of El Mystico. A block, like Mystico Point here, would normally cost in the region of 1.5 million pounds [US$3 million]. This was put up for 5 pounds, and 30 bob [shillings] for Janet."

These flats constructed with the black arts were just as reliable and sturdy as those conventionally constructed - with one exception. According to Clement Onan, identified as an architect to the council, "They are as strong, solid and as safe as any other building method in this country - provided, of course, people believe in them."

If tenants did start to doubt the actual existence of the buildings they were then living in, the building would fall down, until their faiths were restored, then the buildings would magically reassemble themselves.

Of course, unlike Monty Python's Britain, this sort of thing could not happen these days - because since the Margaret Thatcher/Ronald Reagan revolution of the late 1970s and early 1980s, neither the British nor the US government has done much investment in public housing, even with the dramatic cost advantages available with construction by El Mystico.

If you want a contemporaneous example of something held up only by the faith of its participants, take a look at the corporate debt markets of the past few years. And if you want an example of what happens when that faith evaporates, look at the world's stock markets last week.

It has been the worst two weeks for the world's equities since the corporate-scandal-ridden summer of 2002 (I wrote about the scandals of 2002 in my Asia Times Online article of May 10, The decline of US equity markets). In the US, the S&P 500 stock index has declined 6%, Britain's FTSE 100 is down more than 8%, Japan's Nikkei 225 almost 6%, Germany's XETRA-DAX almost 9%.

The financial media and, as the losses accelerated late last week, the general media (with the exception of Fox News, which is pinning the blame squarely on the proposal by US Democratic candidate for president John Edwards to repeal the 2001 cuts in capital-gains tax for those with incomes over US$250,000), have taken to blaming the selloffs on what they call "the subprimes".

This refers to the part of the market for US housing finance that specializes in lending to those with poor credit histories, what the industry calls "subprime borrowers". The media use this phrase so often it almost seems it has become a sort of tantric mantra for them; without even knowing what it means, they say it and it makes them feel better - probably because it presents the illusion that they know what they're talking about.

Four times this year [1] I've written about the subprimes; those who want background on how the subprime crisis developed can read these articles. However, it is is no longer accurate to describe the current world equity-market selloff on the suprimes as if it were the case that if only that problem would go away everything would be fine. That's like a man going to the doctor with gangrene from his toe to his hip expecting all will be fine if only the splinter he got in his toe six months ago and ignored were excised. It's too late for that; as for the markets, this problem has gone well beyond what started out in the subprime housing-finance market.

Much more so than any politician or ideology, savvy commentators on what's going on in the world economy point out that most of this decade's remarkable run of global prosperity can be traced to what has been called the tremendous "wave of liquidity" that has crashed up against the shores of most of the world's economies lately. (The wave has not yet managed to wash up against most of sub-Saharan Africa; hence that region's continuing grinding poverty.)

Liquidity is, of course, econospeak for just plain old money; "wave of liquidity", in its simplest terms, just means that there's a whole lot of money sloshing around the world. I tell my students that in a free economy it's as if the quantity of money and prices of assets are on either side of an apothecary scale; if the quantity of money goes up that platform gets weighed down, driving the value of the physical assets on the other side up. Hence the tremendous run in global equity markets over the past few years.

There are ever-changing attempts to explain how the wave of liquidity was created. Some credit or, depending on your perspective, blame the US Federal Reserve; in response to the bursting of the dot-com boom in 2000-01 it reduced its key short-term lending rate from 6.5% in 2001 to 1% in 2003-04, before raising them back to the current 5.25%.

With rates this low it meant that banks were practically giving loans away; as that money circulated through the economy, from lender to borrower, from producer to consumer, over and over again, that began the wave of money. Low Japanese interest rates also get part of the credit/blame. Interest rates in Japan have been on the decline since the pricking of Japan's Nikkei stock index bubble in the late 1980s.

Japanese interest rates have been 1% or lower since 1995; from 2001 until recently, the Bank of Japan held its official discount rate at around 0.1%, making it virtually cost-free for international currency speculators to borrow funds in yen, convert them into other, higher-yielding currencies (this is what's referred to as the "carry trade"), thus increasing these countries' money supply, their "wave of liquidity".

But both the Bank of Japan's and the US Federal Reserve's interest-rate policies are basically on hold; they don't explain what happened in world equities in the past couple of weeks.

In William Shakespeare's Hamlet, Lord Polonius advised that one should "neither a borrower nor a lender be". It follows, then, that Polonius, a chief adviser in the court of King Claudius, might be particularly piqued at a phenomenon of today's finance capitalism where many banks, brokerages and other financial institutions are simultaneously both lenders and borrowers

American economist and historian Edward Luttwak calls the new globalized economy turbo-capitalism; applied to finance, it means an essential blurring between the distinction between borrower and lender. Where once the distinction was very clear (the lender lends, the borrower pays back with interest), these days a borrower might turn around and lend the money he just borrowed from the lender to another borrower, who just might be doing the same with another borrower further down the line.

Every successive round of borrowing and lending acts to increase the global money supply; the tops of the "wave of liquidity" grow ever higher. There are a few limitations on this process, but not many. Under an agreement brokered under the auspices of the transnational banking regulatory agency the Bank for International

Settlements, the lenders must meet what are called capital reserve requirements of what are called the Basel II accords.

This means that the amount they can lend is limited by the value of whatever actual assets the bank has in its portfolio. How much the bank can lend out is dependent on what kind of asset the bank actually has, but whatever the underlying asset is, the bank

can lend many times its actual value. Hence money is created.

For the borrowers, it's the same process, but in a mirror. Borrowers need collateral to borrow. If they get the loan, that loan becomes their capital reserves to lend to someone else.

When asset prices rise, it's as if El Mystico has waved his wand. Both the values of the reserves for the lenders and the collateral for the borrowers are rising; that means that commensurately more can be lent and borrowed based on these newly inflated prices. The mechanism becomes virtually self-reinforcing: higher asset prices leading to more borrowing and lending, more liquidity creation, higher asset prices, and so on.

Until, as the residents of Mystico Point were warned not to do, somebody begins to doubt whether this is all real.

Yes, this did all start with the subprimes. It was obvious to everybody (especially the realtors and mortgage brokers) but the prospective buyers that a lot these people were not going to be able to afford the monthly payments on a no-down-payment $1 million ranch house in Orange county, California. When these people started to fall behind on their mortgages, the great money engine ground to a halt and, slowly, went into reverse.

The subprime mortgages had been pooled and sold as interest-paying bonds called collateralized debt obligations (CDOs). As many of the mortgage borrowers were not paying their mortgages back, these CDOs, as measured by the ABX subprime indexes, fell in value. With their decline in value, banks and other financial institutions that had been using the CDOs as either capital reserves or collateral found that the fall in the value of the CDOs meant they could not lend or borrow as much as they could previously. Under the hot, glaring sun of reality, the global wave of liquidity starts to dry up.

Many of the banks and brokerages with a presence in the subprime/CDO market also had a presence in other aspects of the capital markets. The contractionary effects of the withdrawal of liquidity from subprimes is starting to take its toll there, as well.

Many have noted that it is the rise in corporate buybacks and private-equity buyouts (see my February 22 article The highs and lows of buyouts) that has greatly supported US, and more recently world, equity prices these past few years. This is not surprising; if one company in a particular sector gets bought out at, say, a 25% premium to current market prices, stock investors come to believe that the rest of the companies in the sector might be similarly bought out by other, greater fools - sorry, canny entrepreneurs.

The whole private equity/buyout phenomenon would not have been possible without the wave of liquidity. The supply of shares is, at least in the short term, fixed; if the supply of money keeps growing exponentially, more of it will be employed to drive stock values up. As the wave of liquidity recedes, so does the argument that you must own stocks so as to profit from the next buyout. No financing means no buyouts, and without buyouts, stocks are just not thought of as valuable as they were previously.

The news that really got the selloffs rolling last week were the reports that banks were having trouble arranging financing for the $7.4 billion buyout of Chrysler by the private-equity firm Cerberus. Across the Atlantic, similar problems were being faced in the leveraged buyout of the UK drugstore chain Alliance Boots by Kohlberg Kravis Roberts (of 1988's Nabisco/Barbarians at the Gate fame). The initial public offering of the Blackstone Group, considered a bellwether for the worldwide private-equity business in general, has sunk like a rock; it's down 17% from its offer price.
Without the belief, the faith, that there will be more forthcoming liquidity to support these deals, stock prices are reverting to what they would be based on - just the companies' fundamental prospects for further growth in earnings from these levels.

That was last week. It wasn't pretty.

Greed drives stock prices up, and fear takes them down. Here, the big fear is that of the unknown - nobody knows just how much bad and/or deteriorating debt these banks and brokerages have on their portfolios. "Transparency", financial-market jargon for information, might help the situation; the banks and brokerages could report just what they do have on their loan books. This could help through calming some nerves here.

The banks and brokerages will never do this individually, for the companies that open their trading books put themselves at a significant competitive disadvantage against those that do not. You would need some greater power, like the US secretary of the Treasury, perhaps acting in concert with financial officials from other countries, to get everyone to do this simultaneously.

That is unlikely; the administration of US President George W Bush does not want to tarnish the image of its one success, the strong economy, and thus have the public realize that the administration's failure to oversee and regulate the US debt markets properly is, just like Iraq, Afghanistan, the inability to capture Osama bin Laden and the response to Hurricane Katrina, just another among its many failures. Besides, just as then-defense secretary Donald Rumsfeld once said his Pentagon doesn't do quagmires, Hank Paulson's Treasury Department doesn't do market intervention.

Or the US Federal Reserve could intervene and supply extra reserves to the banking system, either directly through lending from its discount window or by lowering interest rates. This is the approach that has been employed in previous financial crises and panics, among them the 1982 bailout of Mexico, the 1987 stock-market crash, the 1989-90 implosion of the US savings-and-loan industry, the 1998 bailout of hedge fund LTCM, and the 2000-01 dot-com bubble burst. Here too pride goeth before the fall. This probably will happen eventually, but only once the crisis deepens and intensifies so greatly that US populist politicians, such as Ron Paul on the political right and Dennis Kucinich on the left, start to get a serious hearing in the popular media on their charges that the US political structure is way too dominated by the interests of finance capital.

That'll get the Fed moving.

In the meantime, let's look at El Mystico's assistant, the Amazing Janet (Carol Cleveland). According to the Monty Python skit, "as Napoleon has his Josephine ... so Mystico has his Janet. An honors graduate from Harvard University, American junior sprint record holder, ex-world skating champion, Nobel Prize winner, architect, novelist and surgeon. The girl who helped crack the Oppenheimer spy ring in 1947. She gave vital evidence to the Senate Narcotics Commission in 1958 ... In 1967 she became suspicious of the man at the garage, and it was her dogged perseverance and relentless inquiries that two years later finally secured his conviction for not having a license for his car radio. He was hanged at Leeds a year later despite the abolition of capital punishment and the public outcry."

Maybe a young lady this talented is what we need to tell Ben Bernanke that his phone is ringing.

Note
1. Rocking the subprime house of cards, Asia Times Online, March 6; The subprime dominoes in motion, March 16; Of termites and index mania, July 3; and Soothing words for panicky markets, July 13.

On July 24, 2006, World Trade Organization (WTO) Director-General Pascal Lamy was forced to halt the five years of negotiating of the so-called Fourth WTO Ministerial Doha Round that began in Doha, Qatar in November, 2001 and ended (for now, at least) in Geneva, Switzerland. The talks had been ongoing to strike a trade deal but broke down because the US, as usual, demanded all take and little give in return expecting it could strong-arm developing nations to accept whatever it proposed as it's always been able to do in the past.

No longer, apparently, as nations with growing clout like Brazil, India and others justifiably refused to knuckle under. Even European (EU) Trade Commissioner and US ally, Peter Mandelson expressed his ire when he accused the US of trying to exact a "disproportionate" price from developing countries. He added: "Surely the richest and strongest nation in the world, with the highest standards of living, can afford to give as well as take." Mandelson is right, of course, but he also understands the US considers itself the de facto ruler of the world and claims the right in that status to make all the rules and expect all other nations to agree to and obey them. It wasn't to be this time in Geneva and may never be again as a growing number of nations are fed up with Washington's notion of trade that's "free" in words but never "fair" in fact. The tone of frustration was expressed by India's Commerce and Industry Minister in his concluding comment that Doha is "definitely between intensive care and the crematorium." He and others thought it would be months to years before further talks could be restarted and likely never again on same basis as the current round that broke down.

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The questions regarding U.S. macroeconomic policy these days come down to whether the country can keep borrowing. Can consumers keep spending by increasing their debt level? Can the federal government keep running a large budget deficit without serious problems developing? Can the U.S. current account deficit keep growing? Will foreigners keep buying government bonds to cover this growing debt? If the answer is no to such questions, we can expect serious trouble and not just for the United States but for the rest of the world, which has grown used to the United States as the consumer of last resort. The United States buys 50 percent more than it sells overseas, enough to sink any other economy. In another economy, such a deficit would lead to a severe devaluation of the currency, sharply inflating the price of imports and forcing the monetary authorities to push interest rates up considerably.

The United States started to run annual trade deficits in 1976 and has done so every year since. In 1985, this country became a net debtor nation, owing more to the rest of the world than is owed to it. By 1987, it became the world’s largest net debtor nation. The debt has grown and grown since, to the point where economists Nouriel Roubini and Brad Setser suggest that “The current account deficit will continue to grow on the back of higher and higher payments of U.S. foreign debt even if the trade deficit stabilizes. That is why sustained trade deficits will set off the kind of explosive debt dynamics that will lead to financial crises.”

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In September 2000, at the United Nations Millennium Summit, the 191 member countries in the United Nations agreed to a set of eight Millennium Development Goals for the world’s poor nations. These goals, targeted for fulfillment by 2015, have since become the fulcrum for public policy discussions and actions concerning economic and social development. Meetings and conferences on the goals under the auspices of the United Nations and the governing bodies of member countries have been held regularly since 2001, most recently at the 2005 Millennium+5 Summit. The aim of these meetings and conferences has been to reiterate the goals and to reaffirm the commitment of countries to them, as well as to assess the extent to which progress has been made toward their fulfillment.

Most of the Millennium Development Goals may seem at first sight unobjectionable. Nevertheless, they were not the result of an initiative from the South itself, but were pushed primarily by the triad (the United States, Europe, and Japan), and were co-sponsored by the World Bank, the International Monetary Fund, and the Organization for Economic Cooperation and Development. All of this has raised the question of whether they are mainly ideological cover (or worse) for neoliberal initiatives. Samir Amin’s systematic and revealing critique of the Millennium Development Goals is therefore of the utmost significance. The goals themselves are appended to this article. The declaration adopted by the general assembly is available at http://www.un.org/millennium/declaration/ares552e.pdf.
—Ed.

The Millennium Development Goals (MDGs) were adopted by acclamation in September 2000 by a resolution of the United Nations General Assembly called “United Nations Millennium Declaration.” This procedural innovation, called “consensus,” stands in stark contrast to UN tradition, which always required that texts of this sort be carefully prepared and discussed at great length in committees. This simply reflects a change in the international balance of power. The United States and its European and Japanese allies are now able to exert hegemony over a domesticated UN. In fact, Ted Gordon, well-known consultant for the CIA, drafted the millennium goals!

The claim is made that the MDGs follow up on the conclusions reached in the cycle of summits organized in the 1990s. That’s going a bit too far. The preparatory meetings to these summits had tried something new by organizing assemblies of so-called civil society representatives parallel to the official conferences where only state representatives were seated. Although things had been organized to reserve the best places for the charitable NGO’s, which are beneficiaries of financial support from large foundations and states, and largely to exclude popular organizations fighting for social and democratic progress (authentic popular organizations are always poor by definition), the voices of the latter were sometimes heard. In the official conferences themselves, the points of view of the triad and of the South often diverged.

It is often forgotten that the triad’s proposals were rejected in Seattle not only in the streets, but also by states from the South. It is also important to remember that the reconstruction (or at least the first signs of reconstruction) of a group (if not a front) of the South took place at Doha. All of these divergences were smoothed away by the supposed synthesis of the MDGs. Instead of forming a genuine committee for the purpose of discussing the document, a draft was prepared in the backroom of some obscure agency. The only common denominator is limited to the expression of the pious hope of reducing poverty. In what follows, I will examine how these goals are formulated and the conditions required to reach them.

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The nomination of Ben Bernanke, head of US President George W. Bush's Council of Economic Advisers (CEA), as successor to Federal Reserve Chairman Alan Greenspan has sparked a hot international discussion about the future course of US monetary policy.

The academic world fiercely debates whether Bernanke will be a "hawk" who is not afraid to fight inflationary pressures with higher interest rates or a "dove" who prefers to let the stuttering economy rumble ahead on a cushion of cheap credit. But gyrating capital markets obviously fear the latter.

Ben "Printing Press" Bernanke's reputation is engraved in stone with weary asset managers since he said in a speech in November 2002,"the US government has a technology, called a printing press - or, today, its electronic equivalent - that allows it to produce as many US dollars as it wishes at essentially no cost."

Such a stance certainly pleases Bush who has been running up more debts than any other president in US history and is for this reason actually the biggest enemy to a sound monetary policy in times of rising inflation. Public debt jumped from US$5.8 trillion to more than $8 trillion (that is $8,000,000,000,000) since he took office in 2001, and he is the first president who has never vetoed any costly bill Congress has presented to him.

Be it $80 billion per year for the war in Iraq on top of the $430 billion the Pentagon needs to keep its war machine running on idle, $225 billion for a renovation of the US highway system (including a $220 million bridge to an uninhabited island in Alaska) or some $200 billion for rebuilding efforts after the hurricanes in the southern US, Bush has always been a happy spender. At the same time he has aggravated the fiscal situation by numerous tax cuts benefiting the upper crust of America's society. By the time Bush goes home, the US debt will scratch the $10 trillion level.

A Free-Spending Bush Is Bernanke's Worst Enemy

Uncertain times lie ahead. The man who gave Bernanke the job is actually his worst enemy. While Greenspan is trying to save his legacy as the Fed chairman who oversaw the longest peacetime expansion of the US economy from 1987 to 2001 by notching up the leading interest rate in baby steps of quarter percentage points and has difficulties keeping energy-induced inflation in check, Bernanke has a lot of work at hand to build a reputation of being as independent of the White House administration as Greenspan was.

Being groomed in the White House before his return to the Fed, where he served as a governor for three years before his current tenure into Bush's innermost circles, is certainly not of help. At his post in the White House Bernanke missed the chance to caution Bush against a continuation of the explosive growth of US government debt.

Greenspan Did Too Little, Too Late

US inflation, meanwhile, has already accelerated to an annual rate of 4.7% in September, up from 3.3% at the end of 2004, a trend that could derail Greenspan's reputation from being "The Maestro" to simply "Easy Al" who will be remembered for doing "too little, too late", his predecessor, Paul Volcker, said in April.

The mandate of the Fed is a delicate issue, as the world's most-important monetary authority has not only to guard against inflation - which it does by raising interest rates - but also has to keep employment at the highest-possible level, which is achieved by low interest rates that encourage businesses to invest.

While Greenspan came from the private sector and was described by his colleagues as a data-driven chairman with little regard for ideology while on the job, Bernanke's last position at the CEA certainly puts him much closer to the happy spenders in the White House and Congress, where most Republican politicians see no problem in keeping the money-tap wide open. They trust that China and the other Asian exporters will stay forever happy selling their goods for evermore American debt paper, which are just an obligation to pay later.
The US itself has little left that it can export save for the US dollar and ATPs - Advanced Technological Products, a euphemistic term for a combination of weapons and computers used in the trade-deficit statements. But even as the biggest arms dealer in the world, US sales of killing devices no longer outweigh the imports of computers manufactured mostly in Taiwan and China.

In the first eight months of 2005 the trade deficit widened from $427 billion to $500 billion compared to the same period a year earlier. A nation once envied for its textiles (jeans), big cars and computers, "Made in the USA" has become a second choice for the same products now manufactured by the new industrial giants, China and India.

The game has worked so far because the rest of the world could rest assured, knowing their dollars would always be a stable reserve currency happily accepted by all.

Rising Inflation Is The Biggest Threat

Rising inflation has changed this picture altogether. China is building up a strategic petroleum reserve financed by selling part of its gigantic dollar holdings, which is a result of the fact that commodities are becoming reserve currencies these days.

Russia has quietly lowered the dollar part of its total foreign-exchange reserves from 90% to 70%. South Korea's announcement to diversify out of the dollar sent the dollar into a free fall for a day until its central bank issued a statement that it did not plan such a move, only again to renounce this statement a day later. Japan, with $800 billion the biggest holder of US debt papers, just remains silent as it knows it has no cheap way out of the dollar-devaluation dilemma. If markets get the idea that Japan is starting to sell its dollar papers, the US currency would certainly start a tumble that could turn into a crash that would lead to global impoverishment since 75% of all investments are denominated in greenbacks.

Problems On Several Fronts

Now Bernanke faces problems on several fronts, and the world, especially capital markets, will watch his every move closely. If he is to keep the dovish Greenspan policy of baby interest-rate steps he risks losing on the inflation front, with energy prices surging anew in the face of a growing supply-demand gap. This can lead to a devaluation of the dollar as its holders will try to get rid of a currency that buys less and less every month.

Playing the hawk, on the other hand, and propping up the dollar with higher rates could lead the US economy into a low- to no-growth environment, a situation Bush will probably try to prevent at literally all costs before the mid-term elections in 2006.

Taking from his first remarks at Monday's news conference, which were a kowtow to Bush, I am more willing to gamble on a dovish Bernanke. The world has seen enough examples of how the White House wipes out critical voices at all levels.

Gaining the same credibility as Greenspan, whose words can make markets turn on a dime, will be a tough task for Bernanke, whose bio shows a long list of academic credentials but not that much on-the-job experience. Skeptics fear he will rely too much on economic models and to a lesser extent on current data.
But there are also enthusiastic endorsements of him. James D. Hamilton, professor of economics at the University of California in San Diego, wrote in an initial reaction: "I've disagreed with Bernanke on a number of specific issues over the years ... But I will be doing so from a position of respect for the new office holder". Hamilton called him a first-rate mind.

The former economic adviser to president Bill Clinton, Brad Setser, wrote that Bernanke "probably appeals more to the center and the center-left than the supply-side right".

Interestingly Republicans voiced more concerns. The National Review, a haven for dyed-in-the-wool conservatives, has been launching hit-pieces against Bernanke, although little validity can be attributed to their frothy criticism.

A Sad Place In History?

Bernanke, 51, will certainly try his best to serve the maximum term of 14 years at the top of the Federal Reserve Board and keep the American economy in the best shape possible. But the son of a pharmacist and a teacher from South Carolina could be handed a sad place in history and it will not be his fault.
Not even the most brilliant head at the Federal Reserve Board will be able to prevent the decline of the American empire as long as we see a continuation of the policies made by the persons currently residing in the White House.

The questions of the future are not so much whether Bernanke will be a hawk or a dove. The question is whether the US government will find out soon enough that in an interconnected world they can no longer follow a petro-theist foreign policy financed with the money of others.

Looking at the numerous problems the US government faces - and taking into account that not one of them has yet been addressed - the major problem is not whether one brilliant economist with loads of academic credentials replaces another. Rather, it lies much more with the future course of American policy and the results of it on its economy. Or let me say it this way: The problem is not A(lan Greenspan) or B(en Bernanke) - it is (George) W (Bush).

How much longer can the imbalances in the world economy continue to grow before they give rise to a major crisis? That is the question being increasingly asked in leading financial, academic and government circles.

Earlier this month the Financial Times published an eight-page supplement on the world economy, in which it warned that despite seemingly strong growth and low interest rates there were increasing causes for concern.

“The world economy,” it noted, “continues to grow strongly. Interest rates are low. Financial markets show few signs of stress. And the world’s economic future seems bright. After the best growth in 30 years, the International Monetary Fund expects growth to remain healthy at 4.3 percent in 2005 and 2006.

“But all is not well. Growth and trade flows in the world’s economy have never been as imbalanced as they are today. Global growth is concentrated in China and the US. Asia, Germany and oil exporting countries have record surpluses. Correspondingly the US has the largest current account deficit ever, which the IMF estimates will reach $760 billion or 6.1 percent of GDP [gross domestic product] in 2005.”

One of the most striking imbalances is the rapid growth in foreign currency reserves of Asian central banks as they buy up US financial assets—often at low rates of interest—in order to prevent their currencies rising against the dollar. This process, which began after the Asian financial crisis of 1997-98 when Asian central banks sought a financial buffer against future turbulence, has accelerated in the recent period.

Pointing to the “extraordinary” build-up of Asian reserves, the Financial Times noted: “Just over a decade ago, the seven leading Asian economies held $509 billion foreign exchange reserves or 36 percent of the global total excluding the US. At the end of 2004 the same economies held 2,300 billion, 60 percent of the global total.” Asian reserves, which were once similar in quantity to those of the seven biggest industrial nations (G7), are now 10 times their size.

The growing imbalances, which are being exacerbated by rising oil prices, have not escaped the attention of the leaders of the IMF and the G7. They were high on the agenda at the annual meeting of the IMF held last September.

“If the autumn meetings were judged by numbers of police, size of delegations or number of documents produced, the world was getting to grips with the subject,” the Financial Times commented.

“However, little changed and an increasing number of participants—central bankers and finance ministers—publicly or privately expressed frustration with the current crop of international financial institutions’ ability to co-ordinate the global economic environment.

“While countries and institutions pay lip service to the need for co-ordinated action, they cannot resist the urge to blame others for the risks in the global economy. The US bangs the drum, for example, about how it is doing its part to foster good growth, while Europe and Japan highlight the dangers of unsustainable US budgetary policies.”

One of the biggest dangers overhanging the world economy is that at some point the financial inflows from the rest of the world into the US will dry up or at least start to decrease, leading to a fall in the value of the dollar, a sharp increase in interest rates and the rapid onset of a US and global recession.

A paper published last month by economists from the Levy Economics Institute posed the question: The US and her creditors: can the symbiosis last? According to the report’s authors, the “strategic problems now facing the US and world economies can only be achieved via an international agreement.” However, there is no immediate pressure to bring about such a change because of the “symbiosis” in the present situation.

The US enjoys a short-term advantage as the inflow of foreign capital enables it to consume 6 percent a year more than it produces. On the other hand, Japan and Europe receive a boost to their economies from exports to America as China and the other east Asian countries undergo rapid industrialisation while at the same time accumulating a huge stock of liquid assets. So while the imbalances worsen, “those hoping for a market solution may be chasing a mirage.”

The Levy Institute report predicted that even if the US trade position does not worsen, the deficit in the current account could reach as high as 8.5 percent of GDP, compared to the present level of around 6 percent. Once the housing market peaks and household indebtedness stops growing and consumption spending tapers off, increased spending by the government will be needed to prevent a recession—rising to as much as 8.5 percent of GDP compared to the present level of around 4 percent.

If nothing happens to improve the US net export position and if the government is “unwilling to apply this huge fiscal stimulus, the US economy will enter a period of stubborn deficiency in aggregate demand with serious disinflationary consequences at home and abroad.”

While it is impossible to make any hard and fast predictions, there are increasing concerns that what the Financial Times characterised as a “bizarre world,” in which relatively poor countries supply money to the US economy at low rates, cannot continue indefinitely and that when an “adjustment” does take place it will have far-reaching consequences.

wsws.org

TWO AND A HALF YEARS AND $202 BILLION into the war in Iraq, the United States has at least one significant new asset to show for it: effective membership, through our control of Iraq's energy policy, in the Organization of the Petroleum Exporting Countries (OPEC), the Arab-dominated oil cartel.

Just what to do with this proxy power has been, almost since President Bush's first inaugural, the cause of a pitched battle between neoconservatives at the Pentagon, on the one hand, and the State Department and the oil industry, on the other. At issue is whether Iraq will remain a member in good standing of OPEC, upholding production limits and thereby high prices, or a mutinous spoiler that could topple the Arab oligopoly.

According to insiders and to documents obtained from the State Department, the neocons, once in command, are now in full retreat. Iraq's system of oil production, after a year of failed free-market experimentation, is being re-created almost entirely on the lines originally laid out by Saddam Hussein.

Under the quiet direction of U.S. oil company executives working with the State Department, the Iraqis have discarded the neocon vision of a laissez faire, privatized oil operation in favor of one shackled to quotas set by OPEC, which have been key to the 148% rise in oil prices since the beginning of 2002. This rise is estimated to have cost the U.S. economy 1.5% of its GDP, or a third of its total growth during the period.

Given this economic blow, and given that OPEC states account for 46% of America's oil imports, it may seem odd that the United States' "remaking" of Iraq would allow for a national oil company that props up OPEC's price gouging. And in fact the original scheme for reconstruction, at least the one favored by neoconservatives, was to privatize Iraq's oil entirely and thereby undermine the oil cartel. One intellectual godfather of this strategy was Ariel Cohen of the Heritage Foundation, who in September 2002 published (with Gerald P. O'Driscoll, Jr.) a post-invasion plan, "The Road to Economic Prosperity for a Post-Saddam Iraq," that put forward the idea of using Iraq to smash OPEC. Cohen explained to me how such an extraordinary geopolitical feat might be accomplished. OPEC maintains high oil prices by suppressing production through a quota system effectively imposed on each member by Saudi Arabia, which reigns by dint of its overwhelming reserves. The Saudis, to maintain their control on pricing, must keep a lid on production from other members-particularly Iraq, which has the second greatest proven reserves.

Under Saddam Hussein, Iraq adhered to the OPEC quota limit (historically set to equal Iran's, now 3.96 million barrels a day) via state ownership of all fields. Cohen reasoned that if Iraq's fields were broken up and sold off, a dozen competing operators would quickly crank up production from their individual patches to the maximum possible, swiftly raising Iraq's total output to 6 million barrels a day. This extra crude would flood world petroleum markets, OPEC would devolve into mass cheating and overproduction, oil prices would fall over a cliff, and Saudi Arabia-both economically and politically - would fall to its knees.

By February 2003, Cohen's position had been enshrined as official policy, in the form of a hundred-page blueprint for the occupied nation titled, "Moving the Iraqi Economy from Recovery to Sustainable Growth"-a plan that generally embodied the principles for postwar Iraq favored by Defense Secretary Donald Rumsfeld, Deputy Secretary Paul Wolfowitz, and the Iran-Contra figure Elliott Abrams, now Deputy National Security Adviser. Nominally written by a committee of Defense, State, and Treasury officials, the blueprint was in fact the brainchild of a platoon of corporate lobbyists, chief among them the flattax fanatic Grover Norquist. From overhauling tax rates to rewriting copyright law, the document mapped out a radical makeover of Iraq as a free-market Xanadu-a sort of Chile on the Tigris-including, on page 73, the sell-off of the nation's crown jewels: "privatization... [of] the oil and supporting industries."

Following the U.S. military's swift advance to Baghdad, those skeptical of the neocon plan were summarily brushed aside. Chief among the castoffs was General Jay Garner, the shortlived occupation viceroy who on the very night he arrived in Baghdad from Kuwait received a call from Rumsfeld informing him of his dismissal. When I met with Garner last March at the Washington offices of L3 Corporation's giant security subsidiary he now heads, the general told me that he had resisted imposing on Iraqis the plan's sell-off of assets, especially the oil. "That's just one fight you don't have to take on right now," he said. "You don't want to end the day with more enemies than you started with."

In plotting the destruction of OPEC, the neocons failed to predict the virulent resistance of insurgent forces: the U.S. oil industry itself. From the outset of the planning for war, U.S. oil executives had thrown in their lot with the pragmatists at the State Department and the National Security Council. Within weeks of the first inaugural, prominent Iraqi expatriates-many with ties to U.S. industry-were invited to secret discussions directed by Pamela Quanrud, an NSC economics expert now employed at State. "It quickly became an oil group," one participant, Falah Aljibury, told me. Aljibury, an adviser to Amerada Hess's oil trading arm and to investment banking giant Goldman Sachs, who once served as a back channel between the United States and Iraq during the Reagan and George H. W. Bush administrations, cut ties to the Hussein regime following the invasion of Kuwait.

The working group's ideas about the war had been far less starry-eyed than those of the neocons. "The petroleum industry, the chemical industry, the banking industry-they'd hoped that Iraq would go for a revolution like in the past and government was shut down for two or three days," Aljibury told me. "You have a martial law . . . and say Iraq is being liberated and everybody stay where they are . . . Everything as is." On this plan, Hussein would simply have been replaced by some former Baathist general. One candidate was General Nizar Khazraji, Saddam's former army chief of staff, who at the time was under house arrest in Denmark pending charges for war crimes. (Khazraji was seen in Iraq a month after the U.S. invasion, but he soon disappeared and has not been heard from since.)

Roughly six months before the invasion, the Bush Administration designated Philip Carroll to advise the Iraqi Oil Ministry once U.S. tanks entered Baghdad. Carroll had been CEO of both Fluor Corporation, now a major contractor in Iraq, and, earlier, of Royal Dutch/Shell's U.S. division. In May 2003, a month after his arrival in Iraq, Carroll made headlines when he told the Washington Post that Iraq might break with OPEC: "[Iraqis] have from time to time, because of compelling national interest, elected to opt out of the quota system and pursue their own path. . . . They may elect to do that same thing. To me, it's a very important national question." Carroll later told me, though, that he personally would not have been supportive of privatizing oil fields. "Nobody in their right mind would have thought of doing that," he said.

Soon after Carroll resigned his post in September 2003, the new provisional government appointed an oil minister, Ibrahim Bahr al-Uloum. Uloum (who had been maneuvered into the job by then-neocon favorite Ahmad Chalabi) quickly fired Muhammad al-Jiburi, chief of Iraq's State Oil Marketing Organization, and Thamer Ghadhban, the expert in charge of the southern oil fields, both of whom had been trusted by the Western oil industry. Production faltered from a combination of incompetence, wholesale theft (Iraq's oil was unmetered), sabotage, and corruption that one oilman told me was "rampant," with "direct payoffs to government officials by commercial operators."

With pipelines exploding daily, the fantasy of remaking Iraq's oil industry also went up in flames. Carroll was replaced by another Houston oil chieftain, Rob McKee, a former executive vice-president of ConocoPhillips and currently the chairman-even during his tenure in Baghdad-of Enventure, an oil-drilling supply subsidiary of the Halliburton Corporation. McKee had little tolerance for the neocons' threat to privatize the oil fields. A close associate of McKee's and the executive adviser to Hess's trading arm, Ed Morse, told me that "Rob was very promotive of putting in place a really strong national oil company," even if he had to act over the objections of the Iraqi Governing Council. Morse, who says he takes as many as six calls a day from the Bush Administration regarding Iraq, is one of the men to whom Washington turns to obtain the views of Big Oil. Like Carroll and McKee, Morse sneers at what he calls "the obsession of neo-conservative writers on ways to undermine OPEC." Iraqis, says Morse, know that if they pump 6 million barrels a day, i.e., 2 million above their expected OPEC quota, "they will crash the oil market" and bring down their own economy.

In November 2003, McKee quietly ordered up a new plan for Iraq's oil. The drafting would be overseen by a "senior adviser," Amy Jaffe, who had worked for Morse when he held the formidable title of Chairman of the Council on Foreign Relations-James Baker III Institute Joint Committee on Petroleum Security. Jaffe now works for Baker, the former Secretary of State, whose law firm serves as counsel to both ExxonMobil and the defense minister of Saudi Arabia. The plan, nominally written by State Department contractor BearingPoint, was guided, says Jaffe, by a handful of oil industry consultants and executives.

For months, the State Department officially denied the existence of this 323-page plan for Iraq's oil, but when I identified the document's title from my sources and threatened legal action, I was able to obtain the complete report, dated December 2003 and entitled "Options for Developing a Long Term Sustainable Iraqi Oil Industry." The multi-volume document describes seven possible models of oil production for Iraq, each one merely a different flavor of a single option: the creation of a state-owned oil company. The seven options ranged from the Saudi Aramco model, in which the government owns the whole operation from reserves to pipelines, to the Azerbaijan model, in which the state-owned assets are operated almost entirely by "IOCs" (International Oil Companies). The drafters had little regard for the "self-financing" system, such as Saudi Arabia's, which bars IOCs from the fields; they prefer the production-sharing agreement (PSA) model, under which the state maintains official title to the reserves but operation and control are given to foreign oil companies. These companies then manage, fund, and equip crude extraction in exchange for a percentage of sales receipts.

While promoting IOC control of the fields, the authors take care to warn the Iraqi government against attempting to squeeze IOC profits: "Countries that do not offer risk-adjusted rates of return equal to or above other nations will be unlikely to achieve significant levels of investment, regardless of the richness of their geology." Indeed, to outbid other nations for Big Oil's favor will require Iraq to turn over quite a large share of profits, especially when competing against countries such as Azerbaijan that have given away the store. The Azeri government, notes the report, has "been able to partially overcome their risk profile and attract billions of dollars of investment by offering a contractual balance of commercial interests within the risk contract." This refers to the fact that Azerbaijan, despite its poor oil quality and poor location, drew in the IOCs via scandalous splits of revenue allowed by the nation's corrupt government.

Given how easily the interests of OPEC and those of the IOCs can be aligned, it is certainly understandable why smashing the oil cartel would not strike oilmen as a good idea. In 2004, with oil approaching the $50-a-barrel mark all year, the major U.S. oil companies posted record or near record profits. ConocoPhillips, Rob McKee's company, this February reported a doubling of its quarterly profits from the previous year, which itself had been a company record; Carroll's former employer, Shell, posted a record-breaking $4.48 billion in fourth-quarter earnings. ExxonMobil last year reported the largest one-year operating profit of any corporation in U.S. history.

When I talked to Ariel Cohen at Heritage, his dream of smashing OPEC in shambles, he blamed the State Department for acquiescing to the Saudis and to Russia, which also benefit s from selling oil at high OPEC prices. The poisonous policies were influenced, he said, by "Arab economists hired by the State Department who are basically supporting the witches' brew of the Saudi royal family and the Soviet ostblock . . . because the Saudis are interested in maximizing their market share and they're not interested in fast growth of the Iraqi output."

According to Morse, the switch to an OPEC-friendly policy for Iraq was driven by Dick Cheney himself. "The person who is most influential in running American energy policy is the Vice President," who, says Morse, "thinks that security begins by . . . letting prices follow wherever they may."

Even, I asked, if those are artificially high prices, set by OPEC? "The VP's office [has] not pursued a policy in Iraq that would lead to a rapid opening of the Iraqi energy sector . . . so they have not done anything, either with producers or energy policy, that would put us on a track to say, 'We're going to put a squeeze on OPEC.'"

Opposition to OPEC was handled in a style that would have made Saddam proud. On May 20, 2004, Iraqi police raided Ahmad Chalabi's home in Baghdad and carted away his computers and files. Chalabi was hunted by his own government: the charge was espionage, no less, for Iran. Chalabi's Governing Council was soon shut down and, crucially, Bahr al-Uloum was yanked from the Oil Ministry and replaced by the very men he had removed: Thamer Ghadhban, who took al-Uloum's job at the oil ministry and Chalabi rival Muhammad al-Jiburi who was made minister of trade.

But just when you thought the fat lady sang for the neo-cons, who should rise from his crypt eight months later but Ahmad Chalabi. In January 2005, Chalabi cut a deal with his former oil minister's father, a Shia power broker, and rode that religious ethnic vote back into office. Chalabi landed himself the post of Second Deputy Prime Minister and, in addition, the tantalizing title of interim oil minister. The espionage investigation was dropped; the King of Jordan offered to pardon Chalabi for the $72 million missing from Chalabi's former bank; and Chalabi once again turned over his oil ministry to Sheik al-Uloum's son. The Texans' OPEC man Ghadhban, was again kicked downstairs.

But Chalabi had learned his lesson: don't mess with Texas, or the Texan's favorite cartel. A chastened Chalabi now endorses Iraq's cooperation with OPEC's fleecing of the planet's oil consumers.

And Dick Cheney, far from "putting the squeeze on OPEC," has taken his de facto seat there, assenting by silence to the oil monopoly's piratical price gouging. But hasn't OPEC's stratospheric crude prices choked the life out of America's auto industry and bankrupted half a dozen airlines? In the Vice-President's bunker the elimination of jobs of Democratic-leaning union members is likely seen as a bonus for the good deed of boosting oil industry profits far above the ozone layer.

Greg Palast is the author of the New York Times bestseller, The Best Democracy Money Can Buy. This is his fourth investigative report for Harper's Magazine. Leni von Eckardt was chief researcher with Palast on this project. This is the Palast team's fifth Project Censored award from California State University's school of journalism.

Courtesy of Greg Palast . First published in Harper's magazine October 24, 2005

1. Outstanding Stories of the Week

Many Contracts For Storm Work Raise Questions
Eric Lipton and Ron Nixon
New York Times, September 26, 2005, Page A1

This article reports on a number of no bid contracts, issued as part of the Hurricane Katrina recovery effort, where the government appears to have overpaid politically connected contractors. 

Implant Program For Heart Device Was a Sales Spur
Barry Meier
New York Times, September 26, 2005, Page A1

This article examines the practices of Guidant Corporation in marketing a heart implant that it manufactures. According to the article, the company paid doctors $1000 to use the device in their patients and monitor their progress. The article reports that the company devised this as a marketing strategy, which was apparently hugely successful in boosting sales. 

2. The Chinese Yuan

China Loosens Limits on Trading Against Other Currencies but Keeps Rein on Dollar
Keith Bradsher
New York Times, September 24, 2005, Page B6

This article reports on a change in China’s central bank policy under which it will supposedly allow its currency to fluctuate more against currencies other than the dollar, although it does not plan to change its link to the dollar. It really is not possible to maintain a rigid link to two floating currencies, which this article implies was the pre-existing policy. 

Suppose that the euro is equal to 1.25 dollars and that the exchange rates honored by the Chinese central bank are 8 yuan to the dollar and 10 yuan to the euro. Imagine the dollar then rose relative to the euro, so that just 1.2 dollars were equal to the euro. If the Chinese central bank held its exchange rates constant, then it would be possible for someone to trade 1 euro for 10 yuan. At the official exchange rate, someone could buy 1.25 dollars with 10 yuan. That would mean that someone could still effectively exchange 1 euro for 1.25 dollars through China’s central bank, even though the market rate had fallen to 1.2 dollars to the euro.

While the yuan is not a freely traded currency, it would be very difficult to sustain an exchange rate between currencies that is substantially different from the market rate since the incentives to exploit these differences would be enormous. Therefore, China’s central bank really had little choice but to adopt the sort of policy described in this article, if it ever in fact had a different policy.  

This article reports on a speech by Alan Greenspan in which he argued that the United States economy is well prepared to deal with shocks because it is so flexible. He praised what he described as the lowering of trade barriers over the last two decades. Greenspan also touted the fact that the 2001 recession was the mildest recession since World War II.

It is actually not clear that the United States has on net reduced barriers to trade over the last two decades. It has substantially reduced trade barriers in manufactured goods, thereby putting manufacturing workers in direct competition with low paid workers in the developing world. However, it has substantially increased trade barriers in other areas, most notably by increasing the length and scope of patent and copyright protections. The United States has also maintained or increased the protections for highly paid professionals, like doctors and lawyers. 

In principle, the economic distortions that result from protecting these professionals would be far larger than the distortions from protecting a worker in manufacturing. Doctors in the United States earn an average of $200,000 a year (net of malpractice fees); this is approximately $100,000 more than doctors earn on average in west Europe. By comparison, a textile worker earns an average of $20,000 a year. While this is considerably more than what textile workers receive in developing counties, the gaps are not nearly as large as the gap between the pay of doctors in the United States and doctors in west Europe. 

Anyone who is actually concerned about the economic distortions created by trade barriers should be much more troubled by the distortions created by protections for doctors and other professionals than barriers to trade in manufactured goods. It is worth noting that protectionist barriers for highly paid professionals shift the distribution of income upward, whereas protectionist barriers for manufactured products would lead to a more equal distribution of income.

It is also worth noting that the recovery from the 2001 recession has been by far the weakest of the post-war period. While Mr. Greenspan is correct in saying the recession was milder than any prior post-war recession, because the recovery was so much weaker than any prior recovery, the country had its longest period of negative job growth since the great depression. The economy still has not gotten back to the same rates of employment that it had prior to the recession. In terms of its impact on the ability of workers to get jobs and secure higher wages, given the weakness of the subsequent recovery, the 2001 downturn was the most severe of the post-war period.   

7. The IMF and Protectionism

IMF Chief Pressured On Trade Imbalances
Paul Blustein
Washington Post, September 29, 2005, Page D1

This article reports on pressure being put on the IMF to play a more active role in resolving global trade imbalances. According to the article the Bush administration has been trying to get the IMF to pressure China to revalue its currency.

It is worth noting that if the Bush administration felt strongly that China’s currency should be revalued, it could effectively bring this about immediately by announcing that it would redeem the currency in dollars at a higher exchange rate than is being offered by the Chinese central bank. For example, the U.S. Treasury could announce that it will buy yuan at the rate of 6 to a dollar, compared to the official rate of 8 yuan to a dollar. If the Treasury committed itself to this policy, it would be very difficult for the Chinese government to maintain its exchange rate.

The article also reports that “many economists” fear that current trade imbalances could lead to a “protectionist backlash.” There seems very little concern among economists about protectionism in general, since they are rarely troubled by the protectionist barriers that sustain high salaries for doctors or lawyers, or patent and copyright protection that raise the price of protected items by several hundred percent above the competitive market price. The concern of economists seems to be focused exclusively on protectionist barriers that might improve the bargaining situation of workers at the middle and the bottom of the wage distribution.

The article also describes the managing director of the IMF as the “chief steward of the global economy.” The basis for this description is not clear. The IMF was originally established to support the system of fixed exchange rates put in place after World War II. In the last three decades it has acted primarily as the leader of a creditors’ cartel that has sought to ensure that the interests of creditors are fully protected when countries face financial crises. There is nothing in the IMF’s charter nor in its conduct that would suggest that its managing director has responsibility for maintaining the health of the global economy.

8. Italy

A Normal Political Crisis in an Abnormal Country
Ian Fisher
New York Times, September 29, 2005, Page A4

This article discusses the current political crisis in Italy. At one point it describes Italy’s current malaise and lists signs that include “an aging population.” Actually, the immediate causes of an aging population are better health care and higher living standards that allow people to live longer. Most economists consider these to be positive developments, not evidence of malaise. 

1. Outstanding Stories of the Week

Whoops! There Goes Another Pension Plan
Mary Williams Walsh
New York Times, September 18, 2005, Section 3, Page 1

This article discusses the pattern by which many major companies have been able to return to profitability by declaring bankruptcy and passing their pension liabilities off to the Pension Benefit Guarantee Corporation. While this practice has proved very profitable for some of the financiers that carried through the process, it has left the government with tens of billions of dollars of additional liabilities.


Possible Conflicts for Doctors Are Seen on Medical Devices
Reed Abelson
New York Times, September 22, 2005, Page A1

This article discusses the possibility that doctors may be influenced in their decisions on which medical devices to recommend for patients by the large consulting fees that they often receive from the manufacturers of these devices. It is worth noting that this is another case where the market distortions created by patent monopolies are likely to lead to bad medical outcomes. If medical devices were sold in a competitive market, where firms made normal profits, they would have little incentive to attempt to bribe doctors with consulting fees.


2. Germany

Europe's Direction Is Unclear, Much as Germany's Is After Vote
Craig Smith
New York Times, September 20, 2005, Page A7

This article discusses the implication of the German elections for the rest of Europe. At one point the article asserts that "many Europeans had also hoped that a clear mandate for Mrs. Merkel's ambitious pro-business plans would add momentum to much needed economic restructuring on the Continent."

While many Europeans may have hoped that the German elections would hasten cutbacks in the European welfare state elsewhere, many Europeans consistently vote against politicians who advocate such cuts. It would have been useful to include their views in this article. The article does not explain how it determined that economic restructuring in Europe is "much needed." This claim is strongly disputed among economists.

Siemens Plans to Cut 2,400 Jobs in Already Stagnant Germany
Mark Landler
New York Times, September 20, 2005, Page A10

This article reports on a recent round of layoffs in Germany. At one point it asserts that "economists and business people argue that the government needs to adopt policies that make it cheaper and more attractive to hire workers. It also needs to weaken the unions, they say, to make it easier to dismiss workers or renegotiate labor contracts."

While some economists argue that it is necessary to follow these policies, some economists argue that it is necessary for the European Central Bank to adopt more expansionary monetary policies in order to foster growth in Germany. It is inaccurate to present the views of economists employed by banks and manufacturers as representing the views of all economists, as this article does.


3. The I.M.F. and the European Welfare State

I.M.F. Warns of Imbalance In World Consumption
Edmund L. Andrews
New York Times, September 22, 2005, Page C3

This article reports on the main items in the I.M.F.'s new World Economic Outlook (WEO). The article quotes Raghuram Rajan, the fund's director of research, as saying that "it is a failure of politics that people have not come to see that the more they want to retain the attractive European way of life, the more the way they work will have to change."

Mr. Rajan's statement appears to contradict almost every known economic theory. Economic growth (and in principle globalization) makes countries richer, not poorer. That means that it should be easier through time for Europeans to maintain their way of life, not harder as Mr. Rajan asserts. It would be interesting to see what economic theory Mr. Rajan uses to support his assertion.

This is not the first time that the I.M.F has sought to push European countries to rollback their welfare state with little evidence to support their claims. The 2003 edition of the WEO also made extravagant claims for the benefits to Europe in the form of lower unemployment that would result from adopting measures that would make its economy more like the U.S. economy. A closer examination of their evidence, showed that the data really did not support their claims (see "Labor Market Protections and Unemployment: Does the IMF Have a Case?").

The article also cites complaints by the IMF that Europe's domestic demand is too low. The complaint that domestic demand is too low means that savings is too high. The World Bank is actively promoting Social Security privatization in Europe, a main purpose of which is to increase saving. In other words, the Social Security privatization agenda being promoted by the World Bank (and many prominent economists) would actually worsen the main problem of excess savings identified by the IMF. It would be worth noting the apparent confusion in the IMF/World Bank, since they cannot seem to decide whether it would be better for Europe to save less or save more.


4. Hurricane Katrina

Bush Proposes Private School Vouchers
Nick Anderson
Washington Post, September 17, 2005, Page A12
Published online with "Bush Proposes Private School Relief Plan"

Plan Will Pay 90% of Costs For Students Hit by Storm
Michael Janofsky
New York Times, September 17, 2005, Page A10

These articles report on a proposal by President Bush to provide federal aid to pay for school for children displaced by Hurricane Katrina. According to the Times article, the plan would provide $1.9 billion in aid for approximately 372,000 school children, an average of $5,100 a student. However, President Bush proposed paying up to $7,500 towards the tuition of children placed in private schools.

In other words, President Bush's proposal would effectively pay more money to educate children whose parents could afford to send them to private schools, than it would pay to educate children in public schools. In addition, by subsidizing the costs of private schools, President Bush's plan will provide a strong incentive for more affluent parents to remove their children from public schools.

It is worth noting that the Bush administration put forward this proposal, which will disproportionately benefit white and upper middle class children, at the same time that he was attending a church service with a congregation composed largely of lower income African Americans (see "Bush Says Spending Cuts Will Be Needed," Washington Post, September 17, 2005; A1). At the service President Bush spoke about how the country needed to address the legacy of racism and inequality and to eliminate poverty.

Bush Says Spending Cuts Will Be Needed
Michael A. Fletcher and Jonathan Weisman
Washington Post, September 17, 2005, Page A1

This article reports on President Bush's plans for the reconstruction of the Gulf Coast and his intention to pay for it with spending cuts. At one point the article describes President Bush's proposals as "unprecedented effort to attack poverty in the region." It is not clear at this point that President Bush's efforts to address poverty will be very large, nor that they are any larger than prior efforts, such as the Great Society programs of the sixties.

The items listed as part of the anti-poverty effort are not necessarily helpful to the poor, nor very large. For example, President Bush has proposed a new round of tax breaks for small businesses in the area. While this will benefit small business owners, the vast majority of whom are not poor, it is not clear that the poor will be helped because these people pay less money in taxes. The President has a vaguely developed proposal for urban homesteading, but most poor people may lack the resources to benefit from this measure, even if they do win a lottery assigning them a parcel of land. The third proposal is a $5,000 grant for job training. While this one-time grant would prove helpful to low income families, it is unlikely to boost many out of poverty, especially if it is paid for by cuts in Medicaid or other programs that benefit the poor. In short, there is little evidence presented in this article of anything that could be described as a large scale plan to reduce poverty in the region.


5. The Federal Reserve Board and Inflation

Interest Rate Hike Appears Likely
Nell Henderson
Washington Post, September 17, 2005, Page D1

This article discusses the Fed's likely future strategy on interest rates. At one point, the article notes the possibility that the Federal Reserve Board may "have to raise the rate" because of large hurricane reconstruction spending. The Fed never "has" to raise rates. The decision to raise rates is a policy choice. If the Fed chooses to raise rates, then it is presumably due to the fact that the members of the open market committee believe that the damage to the economy would be greater from not raising rates than from raising them, but this will still be a policy decision, not something forced on the Fed by outside events.

The article also includes a comment from a Fed official dismissing the impact of higher energy prices, since gasoline accounts for only 3 percent of consumer spending. Actually energy spending more generally (e.g. home heating oil and natural gas) account for 5 percent of spending. If the cost of energy rises by 50 percent, then this drains an amount equal to 2.5 percent of income from consumers' pockets. This increase is far larger than the growth in aggregate real wages over the last year.


6. Gasoline Prices and Gas Prices

Lawmakers In Many States Look To Suspend Gas Taxes
Anne Berryman
New York Times, September 18, 2005, Page A21

This article reports on a number of proposals across the country that would temporarily suspend gasoline taxes in the wake of the recent sharp run-up in energy price. The article only mentions in passing the possibility that a reduction in taxes will not necessarily be passed on to consumers. In fact, it is quite likely that the major impact of a tax reduction will be to raise profits for the oil industry.

In the short-term, there is very little that can be done to change the supply of gasoline. This means that the price to the consumer must rise enough to keep demand in step with supply. If the gas tax is reduced, there is still the same amount of gasoline available. Therefore if the reduction in gas prices were passed on to consumers, there would be a shortage of gasoline. This means that gas prices are likely to be little changed by the elimination of the gas tax, but the oil industry will earn higher profits.

Archived Reviews. Date: September 12-18, 2005
Archived Reviews. Date : September 5-12, 2005

In a sign of financial turmoil ahead, the day after the presidential election the Bush administration announced that it will have to ask Congress to raise the debt ceiling in order that it can organise the government’s massive borrowing needs.

The current debt ceiling of $US7.384 trillion was reached on October 14, but fearful of the political consequences of increasing the national debt in the lead-up to the elections, the administration undertook a series of manoeuvres to keep financing government activities without breaching the debt ceiling. However these measures can only be continued until the middle of this month, necessitating a new authorisation from Congress.

The need to raise the debt ceiling stems from the record budget deficits of the past two years. The deficit for the 2004 budget year, which ended on September 30, was $413 billion, following a deficit of $377 billion in 2003.

The growing fiscal debt is only one of the indicators of growing imbalances in the financial position of the US. The other major sign of disequilibrium is the balance of payments deficit, now running at just under $600 billion per year, or almost 6 percent of gross domestic product (GDP).

In a study published just before the elections, well-known economists Maurice Obstfeld and Kenneth Rogoff warned that the risk of what they called a “current account collapse” sparked by the withdrawal of funds from international investors, had to be “problem number one on the new president’s international financial agenda.”

However, they doubted that it would be because of the “proliferating versions of the revisionist theory that there is simply no problem.” According to this view, the US international debt presents no problem because foreign investors, particularly official ones such as central banks, will continue to finance it, and even if the value of the dollar did fall dramatically the consequences would not be severe.

“We are very sceptical,” Obstfeld and Rogoff wrote in a Financial Times article. “When one looks closely at the US twin deficits (current account and fiscal) in the context of open-ended security costs, geopolitical tensions, rising old age pensions, higher energy costs and extraordinarily stimulative macroeconomic policies, we see stronger parallels to the early 1970s than to the late 1980s. The years following Richard Nixon’s 1972 re-election were not pretty for the dollar or for the world economy. If current accounts are forced towards balance in the context of a difficult global economy, the effects could include financial crises, higher interest rates and a big drop in global output.”

The US dollar is at the centre of a series of processes that are contributing to global financial imbalances. On the one hand, the growing US balance of payments gap threatens to bring about a collapse in the dollar’s value. On the other hand, action to close the balance of payments gap would almost certainly set off a global recession as the US is the chief market for the export industries of China and East Asia, many of them US-based firms.

So far intervention by the Asian central banks which have sold their own currencies in order to purchase US financial assets, including a growing amount of government debt, has prevented a precipitous decline in the dollar’s value. But they need to keep the money flowing in and with the US needing around $2 billion a day the amounts are not small. In 2003 dollar purchases by foreign central banks were $616.6 billion, compared to $351.9 billion the year before. The total reserves of the countries of so-called “emerging Asia” rose by more than $350 billion in the year to March 2004, with the central bank of China the biggest buyer of US dollar assets.

While some economists have argued that this system of “recycling” can go on virtually indefinitely, it does have objective limits. For example, the continued dollar purchases by the central bank of China are helping to fuel a financial bubble in the property market and generate financial speculation in the economy as a whole. So far the Chinese authorities have sought to contain the expansion of credit with so-called administrative measures, but the recent decision to lift interest rates indicates that these measures are not working and stronger action may be needed. The danger is that action to prick the bubble can set off a financial crisis in China, leading to a withdrawal of funds from the US in order to help prop up the banking system.

There are also objective limits to this “recycling” process on the US side. The continued inflow of foreign funds has allowed US monetary authorities to pursue a low-interest rate regime. This in turn has produced a rise in the housing market, facilitating in turn an expansion in consumer debt which has helped sustain US economic growth.

But in the face of slow growth in incomes this process cannot continue indefinitely. National accounts figures for the third quarter show that the US economy expanded at a less-than-expected rate of 3.7 percent, below the 4 percent level considered necessary to ensure an increase in job numbers.

Consumers, however, increased spending at a rate of 4.6 percent, well above the 1.4 percent increase in after-tax personal income. This has been the trend for at least the past three and half years with consumption spending growing at a rate of 3.2 percent while pre-tax income has grown at a rate of 1.3 percent, and after-tax income at 2.6 percent.

The upshot of these trends is that there is a rising ratio of household debt to income.

In a recent speech Federal Reserve Board chairman Alan Greenspan pointed to this process and acknowledged that the ratio of household debt to income had risen “especially steeply over the past five years and, at 1.2, is at a record high.” But he concluded that “measures of household financial stress do not ... appear overly worrisome.”

Greenspan based his assessment on the fact that property values have continued to rise and therefore the debt does not represent an increasing financial burden. In other words, the process can continue so long as money keeps flowing into the property market. But that depends on whether the US can continue to attract a sufficient inflow of foreign funds.

According to Morgan Stanley chief economist Stephen Roach, Greenspan’s argument reflected the circular thinking that now pervades financial markets. Greenspan’s assessment, he insisted, “ducks the key risk factor—interest rates” and whether “rates can stay low for a saving-short US economy with massive current account and budget deficits.”

Noting that the increase in household liabilities over the 2000-2003 period was 65 percent faster than the cumulative growth of GDP over the same interval, he warned that “America’s consumer debt bomb is ticking louder and louder in a climate where the artificial depressants to interest rates and debt service are on thinner and thinner ice.”