how the economy was lost, doomed by free trade myths

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How the Economy was Lost, Doomed by the

Myths of Free TradeBy Paul Craig RobertsCreated 03/16/2010

The American economy has gone away. It is not coming back until free trademyths are buried six feet under.

Americas 20th century economic success was based on two things. Free tradewas not one of them. Americas economic success was based onprotectionism, which was ensured by the union victory in the Civil War, and on

British indebtedness, which destroyed the British pound as world reservecurrency. Following World War II, the U.S. dollar took the role as reserve currency, a privilegethat allows the U.S. to pay its international bills in its own currency.

World War II and socialism together ensured that the U.S. economy dominated the world at themid 20th century. The economies of the rest of the world had been destroyed by war or werestifled by socialism [in terms of the priorities of the capitalist growth model. Editors.]

The ascendant position of the U.S. economy caused the U.S. government to be relaxed aboutgiving away American industries, such as textiles, as bribes to other countries for cooperatingwith Americas cold war and foreign policies. For example, Turkeys U.S. textile quotas were

increased in exchange for over-flight rights in the Gulf War, making lost U.S. textile jobs anoff-budget war expense.

In contrast, countries such as Japan and Germany used industrial policy to plot theircomebacks. By the late 1970s, Japanese auto makers had the once dominant American autoindustry on the ropes. The first economic act of the free market Reagan administration in 1981was to put quotas on the import of Japanese cars in order to protect Detroit and the United AutoWorkers.

Eamonn Fingleton, Pat Choate, and others have described how negligence in Washington DCaided and abetted the erosion of Americas economic position. What we didnt give away, the

United States let be taken away while preaching a free trade doctrine at which the rest of theworld scoffed.

Fortunately, the U.S.s adversaries at the time, the Soviet Union and China, had unworkableeconomic systems that posed no threat to Americas diminishing economic prowess.

This furlough from reality ended when Soviet, Chinese, and Indian socialism surrenderedaround 1990, to be followed shortly thereafter by the rise of the high speed Internet. Suddenly,American and other first world corporations discovered that a massive supply of foreign laborwas available at practically free wages.

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cost.

Thus, free trade has also destroyed the employment prospects of older workers. Forced out oftheir careers, they seek employment as shelf stockers for Wal-Mart.

I have read endless tributes to Wal-Mart from libertarian economists, who sing Wal-Martspraises for bringing low price goods, 70 per cent of which are made in China, to the Americanconsumer. What these economists do not factor into their analysis is the diminution of

American family incomes and government tax base from the loss of the goods producing jobs toChina. Ladders of upward mobility are being dismantled by offshoring, while California issuesIOUs to pay its bills. The shift of production offshore reduces US GDP. When the goods andservices are brought back to America to be sold, they increase the trade deficit. As the tradedeficit is financed by foreigners acquiring ownership of US assets, this means that profits,dividends, capital gains, interest, rents, and tolls leave American pockets for foreign ones.

The demise of Americas productive economy left the US economy dependent on finance, inwhich the US remained dominant because the dollar is the reserve currency. With the departureof factories, finance went in new directions. Mortgages, which were once held in the portfolios ofthe issuer, were securitized. Individual mortgage debts were combined into a security. The

next step was to strip out the interest payments to the mortgages and sell them as derivatives,thus creating a third debt instrument based on the original mortgages.

In pursuit of ever more profits, financial institutions began betting on the success and failure ofvarious debt instruments and by implication on firms. They bought and sold collateral debtswaps. A buyer pays a premium to a seller for a swap to guarantee an assets value. If an assetinsured by a swap falls in value, the seller of the swap is supposed to make the owner of theswap whole. The purchaser of a swap is not required to own the asset in order to contract for aguarantee of its value. Therefore, as many people could purchase as many swaps as theywished on the same asset. Thus, the total value of the swaps greatly exceeds the value of theassets.*

The next step is for holders of the swaps to short the asset in order to drive down its value andcollect the guarantee. As the issuers of swaps were not required to reserve against them, andas there is no limit to the number of swaps, the payouts could easily exceed the net worth of theissuer.

This was the most shameful and most mindless form of speculation. Gamblers were bettinghands that they could not cover. The US regulators fled their posts. The American financialinstitutions abandoned all integrity. As a consequence, American financial institutions and ratingagencies are trusted nowhere on earth.

The US government should never have used billions of taxpayers dollars to pay off swap betsas it did when it bailed out the insurance company AIG. This was a stunning waste of a vastsum of money. The federal government should declare all swap agreements to be fraudulentcontracts, except for a single swap held by the owner of the asset. Simply wiping out thesefraudulent contracts would remove the bulk of the vast overhang of troubled assets thatthreaten financial markets.

The billions of taxpayers dollars spent buying up subprime derivatives were also wasted. Thegovernment did not need to spend one dime. All government needed to do was to suspend themark-to-market rule. This simple act would have removed the solvency threat to financialinstitutions by allowing them to keep the derivatives at book value until financial institutions


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could ascertain their true values and write them down over time.

Taxpayers, equity owners, and the credit standing of the US government are being ruined byfinancial shysters who are manipulating to their own advantage the governments commitment tomark-to-market and to the sanctity of contracts. Multi-trillion dollar bailouts and banknationalization are the result of the governments inability to respond intelligently.

The other serious problem is the status of the US dollar as reserve currency. This status has

allowed the US, now a country heavily dependent on imports just like a third world or lesser-developed country, to pay its international bills in its own currency. We are able to import $800billion annually more than we produce, because the foreign countries from whom we import arewilling to accept paper for their goods and services.

If the dollar loses its reserve currency role, foreigners will not accept dollars in exchange for realthings. This event would be immensely disruptive to an economy dependent on imports for itsenergy, its clothes, its shoes, its manufactured products, and its advanced technology products.

If incompetence in Washington, the type of incompetence that produced the current economiccrisis, destroys the dollar as reserve currency, the unipower will overnight become a third world

country, unable to pay for its imports or to sustain its standard of living.

How long can the US government protect the dollars value by leasing its gold to bullion dealerswho sell it, thereby holding down the gold price? Given the incompetence in Washington and onWall Street, our best hope is that the rest of the world is even less competent and even indeeper trouble. In this event, the US dollar might survive as the least valueless of the worlds fiatcurrencies.

Dr. Roberts was Assistant Secretary of the Treasury in the Reagan administration. His latest

book, "How The Economy Was Lost," has just been published by CounterPunch/AK Press.

To find out more about Paul Craig Roberts, and read features by other Creators Syndicate writers

and cartoonists, visit the Creators Syndicate web page at www.creators.com.

COPYRIGHT 2009 CREATORS.COM

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3/17/2010

how the economy was lost, doomed by free trade myths

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