O'er the Land of the Fraud and Home of the Brazen

Several bloggers, many economists, a small but growing number of journalists, and at least two TV personalities in Dylan Ratigan and Glenn Beck, have now grasped the sad reality that the entire American economy is underpinned by a mafia-like oligarchy that stretches from Wall Street through Corporate America, to Washington D.C. The last vestige of free market capitalism has been replaced. America is now a welfare state where over $2.3 trillion of the $3.8 trillion dollar budget is spent on entitlements. But that is only the tip of the iceberg. Although $2.3 trillion annually and growing is an awesome figure, this basically represents crumbs fed to placated masses.

In the mid 1990's, the six largest banks held assets worth less than 20% of the gross national product. Now, these six banks hold assets valued at approximately 60% of the gross national product. How did this happen? Due to powerful lobbying, the banking industry, as well as big pharmaceuticals, and  monopolistic agriculture giants captured the government. Wall Street was particularly effective in their efforts. By placing key figures within the Treasury department and hiring a multitude of lawyers who, combined with lobbying dollars, rewrote  laws which enabled Wall Street banks to escape (and evade) regulation, create new, unregulated financial products, and leverage their investments by multiples of anything considered safe.

While the large investment banks were taking over the government, corporate America accelerated the process of off shoring industries in order to take advantage of cheap labor and less punitive taxes. Slavery  in America was outlawed with the end of the Civil War, and decades later the practice of exploiting child labor ended. However, with  the onset of globalization, corporations were no longer bound to fair labor practices and could once again cut costs by replacing American labor with a global workforce in the billions. Certain industries that remained within the borders of the country, such as construction and big agriculture, could simply pay illegal aliens lower wages with no benefits because the federal government was unwilling to enforce the law. Jobs that used to pay well, such as bricklaying, were now  low paying jobs that "Americans won't do." 

Both political parties were complicit with respect to the failure to enforce laws already on the books. Additionally, both parties allowed campaign contributions from special interest groups to write laws favorable to their respective industries. This trend resulted in a consolidation of power as smaller, law biding businesses and citizens were unable to compete and eventually forced out of business or into lower wage paying positions. Congress increasingly abdicated responsibilities to the Executive branch of government. As bureaucracies expanded, from the Department of Education to the new Office of Homeland Security, Congress and the citizens whom they ostensibly represent, had less oversight and knowledge of the policies implemented through the various bureaucracies. 

And here we are today. Accounting rules have been changed in order to give insolvent institutions the appearance of strength. The unaudited Federal Reserve purchased $1.25 trillion dollars of assets  of unknown quality from the financial system over the past year. These same banks park the proceeds of their sales at the Federal Reserve which pays interest back to them. What a sweet deal. The interest provides free profits which help to continue the payout of multimillion dollar bonuses to the banking executives.

The ongoing dismantling of the industrial base, combined with the lawless and corrupt practices of Wall Street are steadily weakening the country. But these practices are now systemic, and if they were abruptly ended, it's likely the nation would quickly collapse. Madoff ran a ponzi scheme. If the SEC had done their job when alerted to the fraud by Markopolous years ago, the losses would have been limited to the tens of millions. By turning a blind eye, investors were able to watch their portfolio grow. Eventually, the truth came out and the losses were astronomical. It's much that way with the American economy. Once reality shines the light on what is happening, there will be much carnage.

In just the past week, quite a few articles have been written about this theme. Below are links to some of them. Read 'em and weep.

How We Get Ahead Now: Gaming the System

Michael Krieger - This is the Last Dance

Fraudonomics: 10 Fun Fraud Facts

Fraudonomics

Limbaugh Gets it Wrong

Just before noon today, I turned on my car radio and caught a portion of Rush Limbaugh's broadcast. Rush was lambasting Obama's financial reform agenda, but he caught my ire when he attempted to buttress his argument by defending Goldman Sachs role in marketing securities which were composed of shoddy loans hand picked by hedge fund investor John Paulson. Limbaugh stated that every deal has a winner and a loser, that the suit brought by the SEC was nothing more than representing whiners upset about losing, and that the parties involved were all sophisticated investors that understand what is at stake. No harm, no foul.

Rush is wrong on so many levels it's incomprehensible. Let's start at the top with the investors. The buyers of these securities included pension funds and similar organizations looking for a decent yield on safe investments (the bonds were rated AAA). Even if the purchasers of these products were sophisticated investors, they had no skin in the game. The pools of money at risk belong to people in the general public who are for the most part interested in protecting their life savings - not speculators looking to risk discretionary income. 

Secondly, the products were rated AAA, the safest rating awarded. But the loans that made up these packages were liars loans. The ratings agencies, influenced by the megabanks that pay their fees, failed to do their job. Loan originators and appraisers knowingly accepted and manufactured false numbers in order to process the loans which generated income to them. The entire chain was full of corruption. The system failed and no one has been punished.

Unfortunately, any reform bill that passes is going to be diluted and most likely even written by representatives of the financial industry of which the bill is designed to regulate. That is a shame. Perhaps a bigger shame however is the fact that millions of listeners turn in to Rush Limbaugh and are led to believe that the billions of losses suffered by millions of Americans is solely due to liberal politicians. Liberalism is part of a big problem we face in America,  but that isn't even an issue here. What we have is a financial oligarchy that commits fraud on the American public with impunity, and in fact controls the government by virtue of political contributions and a revolving-door system where members of Wall Street, politicans, and policy makers  are now interchangeable. Limbaugh doesn't get it.

Slave Trade Alive; America is Losing

The Daily Mail is reporting that more than 1,000 female employees are working 15-hour shifts, six days a week inside a factory at Dongguan, China. While the official employer is KYE Systems, the products (computer mice and webcams) are built for Microsoft. In addition to Microsoft, which accounts for approximately 30% of the factory's work, KYE also produces orders for Hewlett-Packard, Samsung, Foxconn, Acer, Logitech, and Asus. It seems everyone is using the Walmart model. Without overtime, the worker is paid the the equivalent of about $0.70 per hour. The end result is cheaper products for consumers in America and elsewhere, and higher profits for corporations. How do workers survive?

The workers also sleep on site, in factory dormitories, with 14 workers to a room. They must buy their own mattresses and bedding, or else sleep on 28in-wide plywood boards. They 'shower' with a sponge and a bucket.

For at least two decades, globalization has pushed production of goods formerly done inside the United States into developing countries. Underwear is made in Honduras, steel is made in China, customer service outsourced to India, and computer parts made all over southeast Asia. The cost of closing old factories and constructing new facilities, in addition to shipping goods around the globe are high, but the savings in labor more than makes up for the expenses. The positive result for consumers has been lower prices than would otherwise be the case. Corporations have seen their bottom line grow, and compensation for executives is multiples higher than it has ever been.

But there is an enormous downside to globalization. Ignoring the moral aspect for a moment, the financial impact of globalization is devastating to the United States.  In exchange for lower consumer prices, America has lost millions of high paying jobs. Dollars that once circulated throughout the economy now end up overseas. Many of the dollars which wind up overseas are used to purchase US Treasury bonds (government debt) which enable the government to finance entitlement and defense spending which now grows at a far greater rate than does our gross domestic product.

A sobering look at the mathematics behind the globalization that underpins both our economy and finances much of our national budget reveals that the current system is unsustainable. Much of the consumer spending over the past decade was accomplished on credit. Credit simply means receiving something now in exchange for paying later. With America's equity (property values) having fallen greatly and high paying jobs gone for good, there is no possibility that Americans will be able to afford to purchase goods at the same rate as before. The standard of living must fall.

With a falling standing of living caused by lower wages, Americans were temporarily able to get by as a result of drawing on credit. This is what occurred from the end of the tech bubble until the housing collapse. Now, the government is making up the difference for the American citizen by increasing spending in areas such as unemployment compensation, increased tax credits such as the earned income credit, food stamps (now over 39 million recipients), and stimulus bills which pass money to the states in order to fund public schools and other services.

To oversimplify the transformation that is occurring, here is the sequence of what fueled our economy since World War II:

Phase 1

From the end of the war to somewhere in the 1970s, the economy thrived because of capital and production. Credit standards were high and for the most part people purchased only what they had saved up for or could afford. Products were made within the United States and the country was a net exporter. During the decade of the 1970s, the United States experienced peak oil production and increasingly looked to oil imports to fuel the economy. The United States was running large deficits and Richard Nixon took the dollar off of the gold standard. This move, coupled with the fact that the dollar as the world's reserve currency, enabled the United States to continue running large deficits. The rest of the world, having recovered from World War II began to catch up in terms of industrial production. Japanese cars are an example.

Phase 2

Beginning in the 1980s, large oil discoveries in the North Sea and Alaska brought down the price of oil. This was a boom for western economies. Corporations, looking to maximize profits, realized that the supply of a global workforce would reduce labor costs and the push for globalization was on. Granting "most favored nation" status to China, NAFTA, and the lack of enforcement of immigration laws ended up lowering labor costs and transferring employment from American citizens to other countries are non-citizens within the United States. The 1990s saw an erosion of lending standards - anyone breathing could receive a credit card - and people began to run up debt. The technology innovations of the 1990s was the last industrial boom for the country. The boom ended with the bursting of the NASDAQ stock market and then the outsourcing of technology jobs overseas. The article referenced above is indicative of this phenomena.

To overcome the bursting of the NASDAQ, the outsourcing of technology and other industries, and finally the attack of 9-11, the Federal Reserve lowered interest rates far lower and far longer than had ever been done. Wall Street managed to force Congress to change laws making it possible to market gigantic securities based on lending of homes, student loans, auto loans, and virtually every kind of credit. As a result of low interest rates, low or zero lending standards, very few regulations, and zero enforcement of the remaining regulations, the American standard of living managed to hold course and even rise in the 2000s but unlike in the decades of the mid 1900s, this time the standard of living was based on credit and fraud. Finally, beginning in 2008, the credit had maxed out.

Phase 3

With the end of cheap credit in the fall of 2008, Americans saw asset values plummet. With a diminished industrial base, and capacity to draw on credit, the economy would collapse and the lifestyle Americans have become accustomed to would evaporate. Government has now come to the rescue. Government cannot  create productive jobs but, at least for the time being, can provide credit. Trillion dollar deficits are now the means for funding public sector functions such as schools, maintaining roads and bridges, law enforcement, and sewage. These are public services normally provided for by states and municipalities, but increasingly these services must be funded by the national government.

In addition to services, entitlement spending such as social security and medicare, pensions, and defense spending must be funded. The production of the United States economy cannot even come close to funding these obligations, hence the government must run exponentially increasing deficits to honor these obligations. Of course, this is not sustainable, and over time, there will be drastic reductions and probably default. Along the way, the governments at all levels (local, state, federal) will increase fees and taxes in order to pay for some of the expenses as well as protecting the various fiefdoms within each level of government.

Taxes, Wealth Redistribution, and Wage Destruction

Let's begin with a graph:

From 1990 to 2008, the percentage of filers (red line) with no liability has increased from just over 20% to almost 40%. (Another article) lists the percentage at 47% for 2009. Not only do most of these filers have no tax liability, they usually are recipients of refundable tax credits worth thousands of dollars from EIC, additional child tax credit, and now, the First Time Home Buyer Credit. 

This is disturbing on many fronts. The more people that are dependent on payouts from Uncle Sam, the more difficult it becomes to wean the populace from the government teats. Aside from the tax system being used as a means of wealth distribution, other Americans receive unemployment benefits often lasting well over a year, food stamps, subsidized housing vouchers, and other federal goodies.

Probably the most sobering thing about the graph is the realization that without federal subsidies, probably about 30-40% of the population couldn't make it on their income. As a matter of fact, an article was penned recently (link here) that  breaks down the median household income of $50,300 in terms of median housing, food, and other costs. Alarmingly, the conclusion is that the median income can no longer support median expenditures. Wow!

We tend to hear about statistics like those of the above graph and think of the recipients of government largess as moochers. While this is true in many cases, I think the greater truth is that many of these people are willing to work hard, but their skill set simply doesn't demand the same kind of wages as it did a generation ago.

As the trend for businesses and industries to outsource quality jobs overseas in exchange for favorable labor costs and less burdensome tax rates continues, America will see a declining standard of living. Quite simply, the wages in America have been and will continue decline as the global competition for wages forces salaries downward. Politicians will be expected to make up for the declining standard of living by increasing taxes on those individuals who have greater incomes. As the bottom half of the income pyramid becomes the bottom two-thirds, the public will ask for increasing taxes as long as it's the rich guy that gets hit.

Of course, as taxes rise, the economy will continue to suffer and the national debt will grow larger. Small businesses get squeezed out, and the large businesses will for the most part produce their products overseas and import them back here to market them; in essence the Walmart model as it applies to IBM, DELL, US Steel, GE, and any global player. How many years can the system hold up? At some point, the citizens will either passively become debt slaves or actively revolt against the government. Even if decent, intelligent men like Paul Ryan eventually assume a leadership position, is it too late to reverse the trends? How do you bring back high paying jobs to America? What happens if entitlements are cut, now that tens of millions of Americans are now dependent on government for survival?

Debt, Higher Taxes, and a Crumbling System

The first pie chart illustrates expenditures which comprise the national budget. Mandatory portion of outlays (Social Security, Medicare/Medicaid, and interest on the debt) are colored red and gray.  The revenue  taken in by the government (2nd chart) which includes income tax, payroll taxes, corporate taxes, etc., now only approximates the mandatory portion of the budget. Discretionary spending, labeled as defense and non-defense, total more than $1.4 trillion dollars and cannot be paid for. The Treasury issues debt in order to fund these programs.

(Graphs originated at ChrisMartenson.com)

Because of demographics, Social Security and Medicare payments are projected to expand at a much greater rate than the economy for several decades. The third largest component of the budget is defense spending. The United States military currently operates in over 130 countries. Partially because of our dependence on oil and the instability of regions that export oil, spending on defense will continue to be astronomical. As trillion dollar deficits mount, the interest on the debt will increase dramatically. At some point down the road, perhaps very soon, servicing the debt will become a mathematical impossibility; especially if interest rates rise.

Government officials have begun to acknowledge this predicament. Federal reserve chief Ben Bernanke made this statement earlier this week:

"To avoid large and ultimately unsustainable budget deficits, the nation will ultimately have to choose among higher taxes, modifications to entitlement programs such as Social Security and Medicare, less spending on everything else from education to defense, or some combination of the above." 

Just a few days prior to Bernanke's remark, former federal reserve chairman Paul Volker made the following point:

The United States should consider raising taxes to help bring deficits under control and may need to consider a European-style value-added tax.

Volker was not talking about replacing the current income tax system, but adding a value-added tax on top of what we already pay. Everyone knows, including Bernanke and Volker, that raising taxes leaves people less money to save or spend. As a result of increasing taxes, the economy would expand more slowly (or perhaps contract), unemployment levels would rise, and the standard of living would shrink.

Bernanke mentioned that modifications to Social Security and Medicare are necessary. In fact, President Obama has already appointed a commission to make recommendations that would accomplish just that. But just as raising taxes takes away money from citizens, withholding or postponing entitlements to seniors would also result in a reduction of spending and inevitibly contract the economy.

So, why raise taxes and cut promised benefits if it hurts the economy?

Quite simply, the power brokers are willing to shrink the economy in order to preserve the status quo as long as possible. Without raising taxes and/or curtailing entitlements, the national debt and the growing interest would become unserviceable. Eventually, there would have to be a default. Think Iceland, and not too far from now, Greece. By forcing austerity measures on to the public, the government and the banking system can continue to prosper even as the general populace starves - at least for longer a period of time than if these measures were not taken.

If measures such as those proposed by Bernanke and Volker are not taken, the financial system and political system of the United States will collapse. The flip side is that if these measures are implemented, the destruction of the individual wealth of America's citizens will follow.

Given the choice of postponing the collapse of the system at the expense of the citizenry, or allowing the broken system to collapse, thereby displacing the corrupt leaders that now control the system, which path is the better one for the population as a whole? If the people do not allow the politicians and their handlers to implement burdensome taxes and cuts, thus causing the system to fail, could the people of America then rise up from the ashes and begin anew? Could people implement a system of governance more reminiscent of the one formed over two hundred years ago, rather than the oligarchic controlled welfare state we have mutated into?

The vast majority of the people in America still believe, or at least hope, that the system can be still be saved (restored to the former state) via the political process without atrophy in our standard of living. This is a fantasy. It's now a matter of mathematics. The powerful elite realize this. Even as the system crumbles they are taking advantage of the people who support them. The system is collapsing, yet like lemmings, the populace continue to follow the lead of those making decisions for them. We continue to position the military in countries all over the globe, and soon we will begin to pay more of our income to the government, the banks, and the foreign countries that hold our debt. This country was founded on the principle of individual freedom, where the government serves the people. We have been transformed into a country of debt slaves where the people serve the government. Sadly, too many of us think that is the way it is supposed to be.