Originally published in The Village Voice, December 1990, by Curtis Lang
It was the best of times, but now the best of times threatens to turn into the worst of times. A season of light, the end of the Cold War, has been transformed into a season of darkness, as Americans prepare for the largest tank war in the history of the Mideast desert. A spring of hope has been turned into a winter of despair.
In short, the period is so far like the topsy-turvy turbulence of the late 19th century that New Yorkers face a Charles Dickens-style Christmas season. The unemployed and the homeless multiply while the upper classes grow ever wealthier. The Empire wages war abroad while its grand cities gradually decay. Economic seers forecast gloom and doom while ever-diminishing numbers of Wall Street stock and bond brokers reap huge profits by betting on bad times ahead. In the 1980s we were all going direct to free-enterprise Heaven, but now we seem headed directly the other way. Consumer confidence has plunged to its lowest point since the 1982 recession. New York City has been losing jobs at the rate of 7000 per month since June, and the city and state budgets face growing shortfalls.
Oil prices have doubled. Middle-class home values are dropping. The cost of the $500 billion S&L bailout could easily double next year. The U.S. banking industry stands poised on the brink of its worst decade since the 1930s.
Alan Greenspan, the Dr. Pangloss of the Bush administration, admitted almost a month ago that the U.S. has entered a recession. In this, we are not alone. Economist Robert J. Barbera of Shearson-Lehman Brothers figures that recessions have begun in Canada, Britain, New Zealand and Australia, while Easter Europe's economy has all but collapsed into old-fashioned depression. France, Spain, and Italy all appear to be headed into the tank as well.
As the world gears up for a possible world-wide re-enactment of the Great Depression, the 90 per cent of New York's taxpayers and consumers who did not reap millions of dollars in paper profits thanks to the Reagan revolution are staying away from the department stores in droves. They're in shock from contemplating the gigantic hole in their Christmas stockings, courtesy of their Uncle Scrooge in Washington.
During the 1990s, the legacy of Reaganomics, in the form of hundreds of failed S&Ls, banks and other government-sponsored enterprises will force Uncle Scrooge to soak taxpayers for trillions of dollars in bailouts for troubled U.S. financiers and wheeler-dealers, who are suffering a world-class debt-abuse-induced hangover from ten years of orgiastic overindulgence. If Uncle Scrooge continues his present policy of paying mainly for military toys, it will be impossible for the federal government to invest the $130 billion per year that the Center for Community Change reports must be spent to begin to solve worsening problems of inadeqauate U.S. health care, grinding poverty, lousy education, housing shortages and aging infrastructure. Nor will Uncle Scrooge be able to pay the $300 billion the National Toxics Campaign etimates will be needed to clean up chemical toxic waste sites around the country.
Fire or Ice?
"Objectively, looking at the situation, the downturn could be very severe in the United States," counsels Howard Wachtel, professor of economics at American University. A cyclical downturn in the economy, massive real estate overbuilding nationwide, and a crushing burden of consumer, business and government debt could interact with unpleasant consequences -- not unlike a simultaneous overdose of booze, diet pills and cocaine. "You get a simultaneous intersection of those three factors and you can get an implosion," Wachtel explains. "A big recession."
"You're looking at something nationwide which is like what Texas has been going through," predicts Shearson Lehman's Michael Moffitt, author of The World's Money . "Kind of just a four-to five-year freeze, where there's lots of overhang in the market and growth is pretty narrow." But he goes on to admit: "All of the elements of the long-term economic decline of the U.S. are rather firmly in place."
Dr. Henry Kaufman, former head of financial analysis for Salomon Brothers, says that the U.S. must "rehabilitate" its entire financial system before we can recover from the present recession fully. That is a process that could take years and will almost certainly result in a banking bloodbath. U.S. banks currently hold some $600 billion in "highly risky" loans according to a McKinsey & Co. management consulting report, and respected financial analyst Dan Brumbaugh says that more than half of the ten largest banks in the country are dangerously undercapitalize, thanks to high-risk loans made during the "Crazy Eighties."
Kaufman lays the blame for the perilous decay of our financial system squarely on the laissez-faire policies of the Reagan-Bush years. "My own view is that the proof of the dangers of overly extensive deregulation is demonstrated by how much our financial fabric has been weakened during those same years when the fervor to have a freer set of institutions gained momentum," Kaufman argues.
Neither the Bush administration nor The New York Times has learned a thing from the $1 trillion S&L meltdown, the decay in our banking system, or the warnings of economic Cassandras like Dr. Kaufman. Politicians and editorialists alike have decided that there's one sure cure for the banking industry's ills -- you guessed it! More deregulation.
Why does George Bush continue to swear allegiance to an ideology he derided as "voodoo economics" in 1980? How can responsible journalists continue to blindly adhere to an outworn and dangerous economic philosophy in the face of its manifest bankruptcy? Where did we take a wrong turn as a nation, stumbling somehow out of our post-World War II American dream of economic preeminence and into the middle stages of a Bleak House nightmare of imperial decline?
Safe Capitalist Playpen
The foundations for the U.S. economic miracle of the 20th century were laid in the 1930s New Deal of Franklin Roosevelt. In response to a decade of wild speculation and runaway criminal activity on Wall Street and among the nation's bankers -- which culminated in the Crash of 1929 and the Great Depression -- the New Deal enacted a variety of laws, restricting bankers from acting as stockbrokers or operating nationwide. This was done to prevent conflicts of interest, to diffuse economic power widely, and to insure community control of the nation's banking system. Newly created federal deposit insurance protected depositors from losses and shielded banks from the disastrous depositor runs which decimated the unregulated banking system. In return, banks allowed the federal government to look over their shoulders.
These reforms were based upon the theories of British liberal economist John Maynard Keynes, who believed that the free marketplace of capitalism worked best when governments intervened to set ground rules, provide safety nets, and police the wealthy and workers alike. Government regulations created a safe capitalist playpen to replace the 19th century-style free-market jungle in which powerful economic predators could create monopolies, buy political influence at will, and squeeze workers and consumers alike "until the pips squeaked."
In the 1930s, most Americans had no money, and millions had no jobs. The country learned what Henry Ford had understood years before -- manufacturers cannot sell what workers cannot afford to buy. This insight led Ford to pay his workers a living wage so they could buy his cars. The same insight led Keynesians in the Roosevelt administration to advocate minimum wage laws, full employment, Social Security, protections for labor unions, and, as a last resort, a set of government programs designed to employ down-and-out Americans in the construction of a new American infrastructure of roads, parks and buildings.
The New Deal programs stimulated the American economy and eased suffering, but World War II intervened, and by 1944, the U.S. had established global leadership as the only nuclear military power and the only industrialized nation with its factories and farms intact.
Nonetheless, the Roosevelt and Truman administrations feared a replay of the Great Depression, and fought signs of deflation, unemployment and a stagnant economy. In a global extension of Henry Ford's vision, America's leaders realized that this country could not be prosperous while the rest of the world went begging. The U.S. stood ready to underwrite the cost of creating and maintaining a prosperous global economy. The Marshall Plan put dollars into European hands through grants and loans, and these dollars immediately found their way back into the U.S., stimulating productiion and profits at home.
The results in the United States were enormously successful. Americans rode on a cresting wave of prosperity from the late 1940s through the early 1970s. U.S. workers enjoyed one of the highest standards of living in the world -- median family income (in 1987 dollars) rose from $15,422 in 1947 to $30,820 in 1973. U.S. corporations became global giants and U.S. techniques of mass production provided the model for countries around the world. For most American citizens, it was a wonderful life.
The Seeds of Decline
Perpetual military mobilization against the threat of international communism became official government policy during the period of the post-World War II economic miracle, and many thought that military spending stimulated the economy. But the permanent militarization of the U.S. economy had its downside, as well.
"During the Cold War era, while the government remained permanently mobilized (and waged several real wars), the federal budget simultaneously promoted all the satisfying activites of peace," recounts journalist William Greider, author of Secrets of the Temple . By the mid-1960s, "the nation could no longer afford to fulfill all its ambitions -- both war and peace. But neither could the political system bring itself to choose between the two."
Greider pins the blame for this failure of will on liberal Keynesian Democrats. Keynes had said that the government should act to correct imbalances in the economy. If the economy slowed, the government would cut taxes and increase spending, but if the economy overheated, government must take steps to cool growth down. Liberals could not bring themselves to do what their own economic doctrine called for -- cutting spending and raising taxes. The subsequent run-up of inflation did much to discredit Keynesian theory. (When inflation persisted into the 1970s, President Jimmy Carter would find that deficit spending did more damage by increasing inflation than it did good by stimulating economic growth. Thus the Keynesian liberals planted the seeds of their own destruction.)
By 1971, the U.S. was mired in a no-win war in Vietnam and, under President Richard Nixon, morbid symptoms of imperial overstretch began to appear in the economic order. The postwar U.S. policy of exporting capital to the rest of the world resulted in a successful rehabilitation of the European economies, which now produced products that competed with America's. The net result? Declining American share of the world marketplace, declining U.S. profits, and an overabundance of dollars in European bank accounts.
These dollars collected in "Eurodollar" accounts in branches of European banks and in newly created offices of Chase Manhattan, Citibank, the Bank of America, and others. "If a European bank lent in dollars, it was outside the jurisdiction of American bank regulators; since its loans were denominated in dollars, it was not subject to regulation by European government authorities," recounts John Cavanagh of the Institute for Policy Studies.
In all industrialized countries, government regulations forced banks to maintain reserve capital against loan losses, but bank branches holding Eurodollars could make as many loans as they wished against their Eurodollar deposits. This was good for short-term profits, if somewhat risky.
"National borders are no longer defensible against the invasion of knowledge, ideas, or financial data," exulted Citibank's president Walter Wriston, who at one time had been in charge of European operations. "The Eurocurrency markets are a perfect example. No one designed them, no one authorized them, and no one controlled them."
This marked the beginning of the rise to power of multinational banks and the infancy of what is now called "the global marketplace", which exists outside the safe playpen Roosevelt had constructed -- indeed, outside the control of nation-states altogether, for the benefit of international businessmen answerable only to their own desires for maximum profit-taking.
By 1971, holders of Eurodollars began to cash in their paper holdings for gold at such a rate that President Nixon chose to take the U.S. off the gold standard. This marked the end of the postwar system of currency exchange stability. Entrepreneurs around the world began to speculate in currencies, shifting their investments from one currency to another to gain a small profit each time they felt one currency was overvalued relative to another. This attracted capital into speculative activities unrelated to the production of goods and services, and marked the first stage of the "casino economy" of the Crazy Eighties. By 1986, currency movements around the world amounted to 25 times the total world trade in goods, as currency traders speculated feverishly in the 24-hour-a-day global marketplace.
The U.S. realized that Nixon's move heralded the end of the postwar order. In response to the new global realities, U.S. politicians created a new model for world order.
The world economy would be sustained by three powers -- the U.S., Germany, and Japan. The new "Trilateral" global economy would be built on a new set of assumptions similar to those popular in the 19th century.
In the wake of a decade of U.S. economic superheating, the Trilateralists worried more about inflation and overconsumption. The 1974 and 1979 oil price run-ups increased inflation, and led to a vast flow of OPEC oil profits into the Eurodollar market and the deposit accounts of New York money center banks. They proceeded to loan vast sums of money to Third World countries -- which invested the loan money in oil, guns and graft.
Citibanks' Walter Wriston and Chase Manhattan's David Rockefeller initiated the drive to make Third World loans, which had deliciously high profit margins. In 1974, Citibank earned 40 percent of its total profits from the developing countries, which amounted to only 7 percent of total loans. Wriston announced that the loans were completely safe, because "countries do not fail to exist." Bankers began a race to see who could push the most loans off on Third World debtors.
Wriston and the Trilateralists had forgotten the wisdom of Henry Ford. In a global marketplace where the weakest countries become loaded up with debt, the "workers" in the global economy would be unable to buy any goods, and the profts of the rich countries would be sure to suffer in the end.
In the U.S., unions fell out of favor. They supposedly prevented manufacturers from realizing gains in productivity. Full employment imposed unnecessary costs on employers. Banks were thought to need new freedom to compete in the global economy, where the biggest players already could do business without government regulators looking over their shoulders.
During the reign of Trilateralism, in the 1970s, real wages in the United States fell 15 percent, and unemployment doubled in Europe. This triumph of Trilateralism was supposed to lead to higher growth rates, a more stable international currency system, and even lower rates of inflation. But it failed to produce the desired results in every case.
The 1979 oil price spike and Carter's recession marked the turning point. With an election coming, inflation in double digits and climbing fast, and challenger Ronald Reagan using the word "Trilateralist" like an obscenity, it was clear that strong medicine would be required to get the U.S. economy moving again.
The Turning Point: Bonfire of the Bond Salesmen
"In 1979," recalled economist Robert Reich in The Atlantic in 1988, "RCA Corporation complained publicly that it lacked the $200 million that would be needed to develop a video-cassette recorder, although recorders are the fastest-growing device of the decade. RCA thereby ceded the video-cassette market to the Japanese. But RCA had no qualms about spending $1.2 billion to buy a lackluster finance company that same year. In 1979, U.S. Steel decided to scrap its plan for building a new steel plant. Instead, it began building a cash reserve to acquire some other, more promising company, such as Marathon Oil."
"By the 1980s, the core industries of the [U.S. post-World War II] management era-- steel, automobiles, petrochemicals, textiles, consumer electronics, electrical machinery, metal-forming machinery -- were in trouble," Reich argued.
The profit rates of American non-financial corporations had entered into a period of severe decline, beginning in the mid-1960s -- around the time when liberal Keynesianism had its failure of nerve -- and continued to slump throughout the 1970s, while American workers' wages stagnated. Dr. Anwar Shaikh, professor of economics at New York's New School for Social Research, charted the falling profit rate, and found a pattern that looks a lot like a roller-coaster going downhill.
Dr. Shaikh points out that as the great Keynesian postwar boom turned downward, "more and more economists now began to put the blame on the state." But Dr. Shaikh believes that the decline in profitability reflected a systemic flaw in the U.S. capitalist system rather than mistakes made by politicians in Washington.
Reich argues that the central reason for the decline of the U.S. economy during the period is the obsolescence of the industrial infrastructure. U.S. industries met with stiff global competition during the late 1970s, particularly from Japan, which introduced "flexible production processes" (requiring skilled laborers) that operated in a partnership with their management to produce high value-added products such as precision castings, specialty steel products, special chemicals, fiberoptic cable, high-tech sensory devices, lasers, large-scale integrated circuits, and other products. American industry could not produce these sorts of products on its old-fashioned, high-volume factory floors -- particularly with its poorly skilled, highly paid labor force overseen by multiplying layers of redundant, overpaid managers who removed themselves further and further from the realities of the shop floor into the solipsistic world of computerized management control systems. Reich points out that between 1965 and 1975, the ratio of staff positions to production workers in U.S. manufacturing companies jumped from 35 per 100 workers to 41 per 100 workers.
As the global economy expanded during the same period, American multinational corporate executives in their computerized office suites realized they could build new plants in low-wage countries with few labor or environmental regulations and continue to produce their old-fashioned products at a profit; best of all, this meant they could retain their old-fashioned pyramidal corporate structures and their corporate perogatives.
This resulted in workers around the world receiving a smaller and smaller share of global income, as high-wage jobs fled to low-wage countries. America's industrialists had turned their backs completely on the old wisdom of Henry Ford, and no longer cared whether or not the world's workers could buy their products. The result? An inevitable glut of industrial proiducts that increased competition among industrialists, who proceeded to cut costs by replacing factories in high-wage countries with factories in Third World countries, which were also more productive, because they were newer than aging American factories. A vicious cycle of overproduction and underconsumption was established worldwide.
Why such shortsighted behavior on the part of America's best and brightest?
Reich sees a generation of American managers totally lacking in new ideas and wedded to number manipulating and legal maneuvering by their training, rendering them intellectually incapable of restructuring their corporations -- or their country -- to match the Japanese and the Europeans.
"Between 1940 and 1960, only about one American in 600 was a lawyer," Reich contends. "Between 1971 and 1981, the number of practicing attorneys increased by 64 percent." During that same period, the number of U.S. engineers increased 15 percent and the number of laborers increased 25 percent. In Japan, only one of 10,000 citizens are trained in law, but one in 25 are trained in science or engineering.
To Reich, it's not surprising that U.S. executives trained as number-crunchers or legal eagles turned to the creation of conglomerates in the 1970s to bolster their profitability, focusing their attention on bending accounting and tax rules, manipulating balance sheets to manufacture the appearance of health, and threatening lawsuits or corporate takeovers to extract concessions from other players. "Huge profits are generated by these ploys. They are the most imaginative and daring ventures in the American economy," Reich contends. "But they do not enlarge the economic pie; they merely reassign the slices."
Corporate chieftains realized that whenever the stock market price of a given company fell below the amount that could be gained by selling off the firm's total assets (book value), a raider could acquire that company, consolidate the two sets of balance sheets, and award itself the higher of the two sets of values, showing immense new profits.
The numbers racket led to a boom in the business of mergers and acquisitions, as American business turned from productive capitalism to "paper entrepreneurialism", and the U.S. as a whole entered the first stage of today's "casino economy", with industrialists joining American bankers in a brave new world order where financial manipulations would count for far more than the mere production of goods and services. In 1977, American companies spent $22 billion acquiring one another, and in 1979, another $43.5 billion.
Meanwhile, in 1979, the U.S. industrial base continued to age, U.S. profit margins continued to shrink, and U.S. global market share continued to erode. Inflation accelerated rapidly in the wake of OPEC oil price hikes, reducing the value of dollars held by wealthy Americans, increasing their resentment of Washington, and inducing small and large investors alike to speculate wildly in tangible assets such as real estate, precious metals, and artwork, which presumably would hold their value better than paper money.
President Carter appointed Paul Volcker Chairman of the Federal Reserve Board in 1979. In October, Volcker announced a fundamental shift in policy designed to curb decades of inflation and end the speculative mindset among investors, who pursued short-term profits and inflation hedges without any long-term benefit for the economy. The Fed would now control the growth of the money supply to control interest rates, rather than set rates to affect the money supply, as had been done previously. This was a smokescreen behind which Volcker raised inflation-adjusted interest rates to stratospheric levels by choking the money supply, while claiming that "the magic of the marketplace" had done the dirty work. Bankers and wealthy bondholders would now receive vastly increased profits from industrialists, retailers, and consumers, and they would be paid back in dollars worth more and more rather than less and less. This was called "the revenge of the bondholders."
Within a month, the Dow lost 100 points. Bond prices fell sharply. The Federal Funds rate began a zig-zag pattern of ups and downs that seemed to vary from day to day. The prime rate rose by two full percentage points during the first 30 days of "monetarist" policy-making.
"The shift in the focus of monetary policy meant that interest rates would swing wildly. Bond prices would move inversely, lock-step, to rates of interest. Allowing interest rates to swing wildly," explains former Salomon Brothers bond trader Michael Lewis in Liar's Poker . "Before Volcker's [October] speech, bonds had been conservative investments, into which investors put their savings when they didn't fancy a gamble in the stock market. After Volcker's speech bonds became objects of speculation, a means of creating wealth rather than storing it. Overnight the bond market was transformed from a backwater into a casino."
In the new get-rich-quick atmosphere at Salomon Brothers investment bank, hordes of young business school graduates were hired at starting salaries of $48,000 a year. The Crazy Eighties had begun. The stage was set for a grade-B actor to preside over the 10-year long experiment in "voodoo economics" that would create a horde of financial Frankensteins -- robber barons whose gaudy new wealth surpassed the wildest dreams of predatory nobles in the days of the Roman Empire.
The Reagan Revolution
The U.S. business community had rallied throughout the late 1970s, under the leadership of the Business Roundtable and the U.S. Chamber of Commerce. By 1979, corporate leaders had successfully derailed all the populist projects of the Carter administration and created a public atmosphere that was "increasingly responsive to the needs and desires of industry", as Philip Shabecoff noted in The New York Times .
American industries threatened by foreign competition increasingly found a willing sugar daddy in their Uncle Sam. In 1950, the annual cost to the federal government of special credits and tax breaks for beleaguered U.S. industries was only $7.9 billion, but by election year 1980, the amount had skyrocketed to $62.4 billion. Subsidized loans and guarantees to businessmen had jumped from $300 million in 1950 to $3.6 billion in 1980, and outstanding federal loan guarantees stood at $221.6 billion. The magic of the marketplace seemed to work a little better when bolstered by handouts from Washington.
Business leaders and their Washington allies had decided that governmental regulation of their activities was now counterproductive; business wanted government guarantees wihtout obligations to the public interest. Into this reactionary atmosphere stepped Ronald Reagan, with a new conservative coalition and a radically new conservative agenda.
A political consensus emerged in Washington that year that deregulation was inevitable in the new global economy, and that the entirety of American 20th century social gains and the social contract that had produced the American dream must be scrapped in favor of a return to the "leaner and meaner" world of the Dickens novels, in which the government would aid the rich at the expense of the poor, and robber barons would once again be allowed to work their will unopposed.
In Washington, the long stalemate on deregulation of financial services was coming to an end. Wall Street investment brokers were anxious to compete directly with commercial banks, while the American Banker's Association lobbied for deregulation so they could compete with the fast-growing Wall Street "money market" funds that were suddenly draining their deposits. In large part, bankers had Wall Street chieftain Don Regan to thank for conjuring the spectre of disintermediation out of thin air.
In the 1970s, Don Regan, an ex-Marine Colonel who had become chairman and CEO of Merrill, Lynch, Pierce, Fenner & Smith, pioneered the idea that Wall Street brokerages should become "financial department stores". Regan spearheaded Wall Street's drive to compete with commercial banks by creating money market accounts, allowing Merrill Lynch's customers to write checks on their stock brokerage accounts. Not only that, but customers could receive higher rates of interest on the money in these money market accounts than depositors at commercial banks receive, because no federal regulations limiting returns on such instruments existed, while banks had to comply with interest rate ceilings mandated by law.
This put incredible pressure on banks and thrifts, as hundreds of millions of dollars fled into these new Wall Street instruments. This capital flight was widely viewed in Washington in 1980 as proof that deregulation of interest rates was necessary to preserve the nation's banking system.
In 1980, for the first time in memory, all major segments of the financial services industry reached a consensus -- they all wanted to be free to pay more for deposits than they had ever paid before. Deregulation legislation became a no-lose congressional formula for solving the thrift industry's problems, which were becoming acute. Bankers, thrift owners, and stockbrokers yearned for a return to the banking wars of the 1920s, which had ultimately led to a complete collapse of the banking system. Congress deregulated the interest rates banks and S&Ls could pay depositors in the fall of 1980.
Ronald Reagan was elected President that same year by a landslide vote. The Federal Reserve choked inflation, but never brought interest rates back to inflation-adjusted levels comparable to previous decades. In short, the price of money increased dramatically, empowering holders of capital over the captains of industry and other borrowers. The "real" interest rate earned by bankers and other lenders after subtracting inflation was the highest in 50 years. High-cost "hot money" flooded the financial markets, as banks and thrifts and Wall Street firms competed for customers.
A two-year recession ensued, punishing industrial manufacturers, farmers and other borrowers. Don Regan, who had been appointed Reagan's Secretary of the Treasury, and Fed Chairman Paul Volcker took credit for a "strong dollar" policy that acted as an inducement for U.S. manufacturers to accelerate their flight to Taiwan, Mexico and Korea, where the currency differentials made investment much cheaper. Reagan got Congress to pass tax cuts for the rich and began the largest military build-up in world history. Reagan's budget director David Stockman took a budget ax to the social safety net while he used ridiculous assumptions to make it appear that Reagan's "voodoo economics" would generate a balanced budget rather than record-setting deficits. This was the ultimate demonstration that the legalistic and accounting gimmickry which now passed for strategic vision among America's corporate sector would now be used to sell Washington's Neanderthal economic policies to a gullible press and public. Reagan busted the air traffic flight controllers' union, initiating the long, slow demise of the American labor movement.
Computerized financial speculation mushroomed worldwide. Money center banks continued to lend to Third World debtors, who were increasingly punished by the world-wide recession and high real interest rates. Investors and other lenders went on a global shopping spree, hunting for the highest immediate yields, then parking their money in different short-term investments around the world .
A one-trillion dollar Eurodollar bubble of hot money moved from one short-term, speculative investment fad to another in country after country around the globe. Antitrust enforcement became obsolete, and mergers and acquisitions driven by desire to break up and sell off companies suddenly undervalued in the new, casino economy of digital global markets continued at a feverish pace. The break-up value of a company became more important than its market share, long-term prospects, or the quality of its products, in many cases. The price of money remained high, fueling a secular bond rally and enriching investors and bankers at the expense of manufacturers, farmers, and other borrowers. All these factors contributed to the ascendancy of the financial sector of the global market, and the slow decline of all those sectors of the economy that produce tangible goods for consumption.
In 1982, when Mexico defaulted on its bank debt, it became obvious to Fed Chairman Paul Volcker that the world financial system could no longer sustain the high real interest rates that the rich and the bankers loved so much. So rates dropped. That same year, a Democratic Congress passed another bill to further deregulate troubled financial institutions, hungry to escape the oversight of federales in green eyeshades. The Garn-St. Germain Act allowed the crisis-ridden thrift industry to act as real estate developers and speculate wildly with U.S. insured dollars. States such as California and Texas passed laws allowing S&L high-fliers to buy casinos, oil wells or junk bonds with the bulk of their federally insured deposits, which had until then by law been restricted severely to home mortgage lending and related activities.
In August of 1982, Wall Street exploded in one of history's most dramatic stock and bond market rallies. Hordes of foreign investors rushed their money into the U.S., which was convenient for the Reagan administration, whose policies had created a burgeoning trade deficit as U.S. industry fled offshore and Americans increasingly bought foreign goods at subsidized prices, thanks to the "strong dollar".
Through a combination of Keynesian deficit spending on military hardware and lower interest rates, the Reagan administration had stumbled on a formula for economic recovery that had nothing to do with the administration's policies of deregulation, tax cuts for the rich, and warfare on the welfare state.
By 1985, the U.S. had become the computerized global command post for a speculative money flow cascading in torrents from country to coumntry. In its relative decline, the U.S. had retained its leadership in financial innovation, telecommunications and information processing -- making it ideally situated for its role as croupier in the new global casino.
Young executives at Fortune 500 companies watched their Wall Street peers jetting around the world, enjoying the lifestyles of the rich and infamous (which $1 million per year could provide), and decided they wanted to play the speculative games as well. That's why $1 trillion was invested in mergers and acquisitions during the Crazy Eighties. The speculative mania trickled down to the masses, even as wealth was transferred steadily upward from the middle and lower classes to the extremely wealthy. Small time S&L depositors in Florida retirement communities shopped their savings around the country in search of the most desperate or overleveraged or unscrupulous financial institution paying the highest rates of interest for their cash.
The entrepreneurial mindset may have trickled down successfully, but the new wealth did not. The average income of families in the poorest fifth of all American citizens fell nearly 10 percent from 1979 to 1987, while the richest fifth gained more than 15 percent.
Meanwhile, middle-class jobs were cut in half from 1979 to 1986. Low-wage jobs expanded by one-third and high-wage jobs by ten percent. Falling wages were increasingly offset by consumer debt, contracted by those members of the middle class still deemed credit-worthy. Thus consumer debt doubled during the period from 1980 to 1986, soaring from $371 billion to $740 billion.
Housing became increasingly unaffordable. From 1981 on, less than one-tenth of American families could afford to buy a home. This marked the effective end of the American Dream. The middle class had to send two wage-earners into the marketplace in order to make ends meet.
Tax breaks for corporate America allowed General Electric to obtain $283 million in refunds from Uncle Sam on 1981 to 1983 profits of $6.5 billion, and the proportion of federal taxes paid by corporate America declined by one-half between 1980 and 1983. Federal income taxes were reduced, but payroll taxes continued to increase. From 1977 to 1988, the total tax bite on the poorest fifth of families increased while taxes on the richest one-fifth declined. America was well on its surreal journey "back to the future" of Victorian capitalism unchained.
Like many strapped American borrowers, Third World countries, which had amassed about $1 trillion in debt by the mid-1980s, were unable to pay back principal, and increasingly forced to borrow money from the International Monetary Fund to pay back the interest on bank loans to money-center banks that would no longer support their debt habits. The International Monetary Fund and the World Bankacted as strong-arm collectors for the big bankers, who fattened off the continuous flow of interest money from Third World debtors. The IMF prescribed 19th century-style medicine for the Third World debtors: they should crush their unions, slash social spending and deregulate working conditions and environmental standards.
Come to think of it, that was the same prescription being meted out in reduced dosage to the United States itself by the Reagan administration and a Democratic Congress unable or unwilling to stand up for the legacy of F.D.R. and John Maynard Keynes.
In New York, the changes were most visible as shabby men and women pushing shopping carts full of tin cans or carrying shopping bags containing all their earthly belongings slept in subway stations and begged on street corners.
The Plaza Accord
In 1985, after Ronald Reagan's landslide election to a second term of office, James Baker replaced Donald Regan as secretary of the treasury and Regan became White House chief of staff. In September, Baker met with his counterparts from the major industrialized nations at the Plaza Hotel in New York to admit that the policies of Reagan's first term were no longer sustainable.
The U.S. was running a trade deficit of around $100 billion, and total federal debt had spiraled to an unthinkable $1.8 trillion . Worldwide demand for the increasing surplus of increasingly devalued farm products and other commodities had shrunk as a byproduct of Reaganomics. Many of the countries that had previously bought U.S. farm products and capital goods had to spend every last dollar they could beg, borrow or steal to pay the interest on their crushing debt burden. One-third of U.S. world exports, which normally flowed to these countries, dried up. By 1985, the U.S. had lost somewhere between 800,000 and 2.4 million jobs in export industries ranging from agriculture to farm equipment to construction machinery to civilian aircraft, and farm debt had climbed to a well-nigh unpayable $215 billion.
Meanwhile, between 1974 and 1982 one-third to one-half of the increase in Latin American debt had disappeared into offshore bank accounts. This suited New York money center bankers just fine, because they were regaining the money they had loaned Third World countries as deposits from corrupt politicians and the upper classes of those same countries, while interest payments continued to flow. America's European and Japanese allies were unhappy with the fact that America, the former lender of last resort, had transformed itself into a major debtor, and become the world's "consumer of last resort" -- a spendthrift that needed to be propped up with their capital reserves, because their growth rates were stagnating and high unemployment in Europe remained intractable.
Against this backdrop, Baker recommended a plan only a Texan could have imagined. According to journalist Walter Mead, Baker promised to "talk the dollar down" in co-operation with Japan and Germany, and to engage in future far-reaching co-operative ventures. Just as many Texan wheeler-dealers have discovered, if you owe the bank enough, you get to own the bank. Baker was getting the Germans and the Japanese to agree to accept devalued dollars in return for America's debt -- something no other country could achieve.
In return, Baker promised that the U.S. would reduce its debt by exporting more and more goods and services around the world. Baker also wanted Germany and Japan to invest in new factories in the U.S., and for our two Trilateral partners to "buy American" and replace their trade surpluses with trade deficits, in order to open up world markets for U.S. goods. Although our allies agreed at the time, this "beggar-thy-neighbor" brand of economic nationalism disguised as multi-lateral Trilateralism could not help but have the effect of increasing animosity toward the U.S. over the long term, and might eventually lead to trade wars, as in the 1930s.
Much worse, Baker put the third world debtor nations in a tragic double bind. They were told they must increase exports to pay off their debts, but that they must also decrease exports to make room for America's goods in the world economy. The last time a debtor nation was put in this double bind was in the 1930s, when victorious European powers put Germany in a similar straitjacket. The result at that time was the collapse of German democracy and the rise of Hitler.
None of Baker's strategies really worked to reduce debt, but he did succeed in devaluing the dollar on world markets, with the result that European tourists now find a week in Disneyland quite attractive while American tourists can barely afford lunch in London or Paris. By 1990, the federal deficit rocketed to over $3 trillion, and Third World debt stood at $1.5 trillion , or double what it had been at the time Mexico defaulted in 1982. U.S. corporate debt reached $1.8 trillion in 1987, triple what it had been in 1976, forcing U.S. corporations to consume over 50 percent of pretax profits in interest payments. American consumers also managed to pile up more and more debt during the late Eighties, partly in an effort to maintain standards of living in the new, more brutal world financial order Reaganomics ushered into being, so that by year-end 1988 the total stood at an awesome $725 billion , or 21 percent of their total after-tax disposable income. All this federal debt resulted in the transfer of over $1.25 trillion from U.S. taxpayers to rich individuals and financial institutions -- who own the bulk of U.S. treasury bonds! Not to mention the gargantuan interest payments on corporate and consumer debt, which also accrue to wealthy investors and bankers.
(Continued in The Trillion Dollar Hole in America's Stocking, Part II)