Washington’s Dilemma

washington-by-ike-morganWashington is bluffing that it will not bail out California, and every other state suffering from collapsed revenues and massive job losses. If cuts in police and schools don’t force DC off from its current position, then the math will. Because in many states the aggregate revenue losses and looming cuts to state payrolls will largely render the intended effects of federal stimulus as moot. Frankly, unless Washington prints money and bails out every state that needs capital, including California, federal power will decline amidst this severe economic recession, and the process of a soft American devolution will begin. If you think this idea is outrageous, then you’ve still not come to terms with a core reality of our current situation: the structure of this financial crisis is wholly different than any in our post-war era. This isn’t a recession. This is collapse.

In Recession vs. Collapse published in March, this blog explained that in a normal recession existing savings are used to support government debt issuance and that those who remain employed increase their savings to also support government debt issuance. Neither phenomenon is at work today. Yes, the savings rate has soared in the US.  But this has not resulted in any actual accrued savings. Because private sector debt came to define the internal structure of the US system, savings currently is little more than debt service. Also, bank purchases of US Treasuries are really just a result of the circularity of monetization. It’s just money from the FED being recycled into Treasuries. There is no privately driven growth of bank deposits, in the aggregate. Americans as a class are broke. What the savings rate more accurately measures is a collapse of consumer spending.

The internal composition of the US economic and financial system when it hit 2007/8 was very different than in previous recessions, even the severe recession of 1980/82. It’s this internal composition that’s now determinative, to the outcome. The sawdust of debt, and the monetization of assets rather than the production of goods, continually came to define the internal composition of the system. The economy cannot, therefore, express the same kind of resilience it has done so often, since WW2.

This is the core problem of this collapse and why the prospect for recovery is dim. Americans can’t actually rebuild the savings that the banking system needs to escape from the current mess. Individually, Americans are trapped by debt and cannot spend. In The Seigniorage Curse, I explain that one of the primary mechanisms for the hollowing out of the American economy over many years was the dollar advantage, which at first was earned. And then, came to be un-earned. By the time the US reached the 21st century, our primary manufactured product was debt, and dollars. Is it any wonder that once that system collapsed, that we quickly gave up 100% of the phantom job growth that had been sitting on top of the debt bubble? The current level of employment in the United States has now returned to the levels of June 2000. Enough said.

obama-the-swing-without-the-clubWashington apparently has a fresh dilemma on its hands, just inside of 6 months after the new administration came to power. Clearly the economic team, even though they were given almost 18 months to study the nature of the current crisis (starting in the Summer of 2007), incorrectly judged this recession to be of the post-war variety. Is that any surprise? Nothing in the public record since the year 2000 indicates that Larry Summers, Ben Bernanke, or Tim Geithner understood that we had been building a skycraper of private sector debt in textbook blow-off style, since the deflation scare of 2001. Now, two years after FED repair operations began on the broken credit system, and over 3 years since US real estate topped in price, major portions of the country are staring at further home price declines in most major markets. Indeed, it appears that the same macro cycle of the last two Autumns is about to repeat, with more waves of foreclosure, more withdrawals from savings and investment to pay for living expenses, and the attendant bailouts of financial institutions that comes around each time.

Washington can’t really take a pass on this situation. If the federal government decides it can wait while “the states rebuild their balance sheets and clean up their payrolls” (as in past recessions) they’ll be waiting forever. None of that is underway. It’s no surprise therefore that the country is already being prepped for a second stimulus. Sure, Washington would like to act tough and tell the States to clean up their act. This is the moral hectoring version of Ben Bernanke saying in 2006 he doubts US real estate will ever decline year over year, or Treasury Secty Paulson saying that the front-end of the crisis was just a problem contained to sub-prime. We’ve seen this script before. If California issuing IOUs in a state where banks refuse to accept them doesn’t get the message across, nothing will. We are on the front end, not the back end, of a crisis within the States.

fdr-via-the-smithsonianUnless Washington prints up dollars and bails out the States, of what use is Washington? Exactly what services can Washington provide, if California is let go? Left on its own, there would no doubt come an initial hooray from rubber-neckers and I-Told-You-So-ers. A newly broken relationship between Washington and the states might also quicken the pulse of anti-federalists, who feel we are long overdue for a tip in the balance of power. Perhaps it would all work out well. For the best, even? In Washington today the annual budget deficit crossed the one trillion mark. In Sacramento, there is a 26 billion dollar shotgun hole in their budget. (One hopes that CALPERS is marking to market, because if they’re not, that would be a new liability for Sacramento to deal with). Meanwhile, Autumn approaches and whole range of rather nasty choices looms over the school system. Imagine living in a prime area of California and watching your house decline by 40%, your houshold income knocked for an initial 30%, and the after-school programs and town services get cut. Now throw some fees and tax hikes on top that mess. For the coup de grace, imagine Calfornia voters sitting down each night to another wave of bailouts from Washington to financial corporations. Under those circumstances it seems quite unlikely Washington can say no, to the States.

-Gregor

Photos:

George Washington by Ike E. Morgan, Outsider Folk Art Gallery.

Barack Obama, Golf Swing Without a Club, Reuters.

FDR, via the Smithsonian.

14 July 2009: Updating with other high quality commentary on this very subject of Washington power, devolution, and IOU/currency issues: (an astonishing example of collective mind-meld as many writers touched this subject all within a 24 hour period)

Marshall Auerback: California Currency? A taste of things to come unless Percora II helps us leave discredited economic dogma behind.

Felix Salmon: When IOUs become currency (good round-up).

Ilya Somin: Should California Be Broken Up?

Paul Starobin: Divided We Stand.

Mathew Yglesias: A Currency for California.

22 Comments ↓

  1. benjie t. writes:

    Gregor:

    Your comment recently about the Portlands (OR: recently blue) Denvers (CO: newly blue) and Austins (TX: watch this space!) of the USA struck me. I'm quite interested in hearing more of your thoughts on this sort of thing, particularly how the legacy political baggage shapes the range of futures. Boston, Albany and Sacramento seem fated to gridlock at this point, don't they?

    -benjie t.

  2. benjie t. writes:

    Gregor:

    Your comment recently about the Portlands (OR: recently blue) Denvers (CO: newly blue) and Austins (TX: watch this space!) of the USA struck me. I'm quite interested in hearing more of your thoughts on this sort of thing, particularly how the legacy political baggage shapes the range of futures. Boston, Albany and Sacramento seem fated to gridlock at this point, don't they?

    -benjie t.

  3. benjie t. writes:

    Gregor:

    Your comment recently about the Portlands (OR: recently blue) Denvers (CO: newly blue) and Austins (TX: watch this space!) of the USA struck me. I'm quite interested in hearing more of your thoughts on this sort of thing, particularly how the legacy political baggage shapes the range of futures. Boston, Albany and Sacramento seem fated to gridlock at this point, don't they?

    -benjie t.

  4. TJGodel writes:

    WOW!! I makes total sense to me. We have to “produce” something besides securitized assets. I knew most of what is said in this post, but somehow here it worst.

  5. TJGodel writes:

    WOW!! I makes total sense to me. We have to “produce” something besides securitized assets. I knew most of what is said in this post, but somehow here it worst.

  6. TJGodel writes:

    WOW!! I makes total sense to me. We have to “produce” something besides securitized assets. I knew most of what is said in this post, but somehow here it worst.

  7. TJGodel writes:

    WOW!! I makes total sense to me. We have to “produce” something besides securitized assets. I knew most of what is said in this post, but somehow here it worst.

  8. TJGodel writes:

    WOW!! I makes total sense to me. We have to “produce” something besides securitized assets. I knew most of what is said in this post, but somehow here it worst.

  9. joshfactor writes:

    sorry but a federal bailout is the wrong answer to a well described problem. you point out the feds themselves are a trillion in the hole this year. How does more deficit spending help the economy? instead it allows states to continue to pass the buck of runaway public costs down the road for a harder day of reckoning. its true that the country needs substantial infrastructure & education investment to build for the future. but there is no future when mega corporations ship professional US jobs overseas, hire illegal immigrants instead of american labor for blue collar jobs, health care insurers making fortunes on the backs of sick people they deny coverage to, wall street banks gouging consumers on their credit cards, & public sector costs inflated by public employee unions. There are a lot of problems to fix, & more deficit spending is not a solution, but a a problem in of itself.

  10. joshfactor writes:

    sorry but a federal bailout is the wrong answer to a well described problem. It allows states to continue to pass the buck of runaway public costs down the road for a harder day of reckoning. its true that the country needs substantial infrastructure & education investment to build for the future. but there is no future when mega corporations ship professional US jobs overseas, hire illegal immigrants instead of american labor for blue collar jobs, health care insurers gouge businesses & deny coverage to the sick, wall street banks gouge consumers on their credit cards, create a derivatives bomb & pass it to the taxpayers, & public sector costs are inflated by public employee unions. Not to mention the powerful lobbies who have more power than presidents to effect changes in the law. There are a lot of problems to fix, & more deficit spending is not a solution, but a problem in of itself. Obama will have to beat very powerful interests who are making these problems, & so far we do not see the gumption in him to do so, as evidenced by the mortgage bankruptcy reform defeat.

  11. joshfactor writes:

    sorry but a federal bailout is the wrong answer to a well described problem. It allows states to continue to pass the buck of runaway public costs down the road for a harder day of reckoning. its true that the country needs substantial infrastructure & education investment to build for the future. but there is no future when mega corporations ship professional US jobs overseas, hire illegal immigrants instead of american labor for blue collar jobs, health care insurers gouge businesses & deny coverage to the sick, wall street banks gouge consumers on their credit cards, create a derivatives bomb & pass it to the taxpayers, & public sector costs are inflated by public employee unions. Not to mention the powerful lobbies who have more power than presidents to effect changes in the law. There are a lot of problems to fix, & more deficit spending is not a solution, but a problem in of itself. Obama will have to beat very powerful interests who are making these problems, & so far we do not see the gumption in him to do so, as evidenced by the mortgage bankruptcy reform defeat.

  12. joshfactor writes:

    sorry but a federal bailout is the wrong answer to a well described problem. It allows states to continue to pass the buck of runaway public costs down the road for a harder day of reckoning. its true that the country needs substantial infrastructure & education investment to build for the future. but there is no future when mega corporations ship professional US jobs overseas, hire illegal immigrants instead of american labor for blue collar jobs, health care insurers gouge businesses & deny coverage to the sick, wall street banks gouge consumers on their credit cards, create a derivatives bomb & pass it to the taxpayers, & public sector costs are inflated by public employee unions. Not to mention the powerful lobbies who have more power than presidents to effect changes in the law. There are a lot of problems to fix, & more deficit spending is not a solution, but a problem in of itself. Obama will have to beat very powerful interests who are making these problems, & so far we do not see the gumption in him to do so, as evidenced by the mortgage bankruptcy reform defeat.

  13. RHondo writes:

    I don't believe the federal government will use taxpayers dollars to bail out or maintain the standard of living that Californians enjoy. The fact that they don't want to pay for that standard themselves and wish the nation to pick up the tab says a lot about how far we have fallen.

  14. RHondo writes:

    I don't believe the federal government will use taxpayers dollars to bail out or maintain the standard of living that Californians enjoy. The fact that they don't want to pay for that standard themselves and wish the nation to pick up the tab says a lot about how far we have fallen.

  15. RHondo writes:

    I don't believe the federal government will use taxpayers dollars to bail out or maintain the standard of living that Californians enjoy. The fact that they don't want to pay for that standard themselves and wish the nation to pick up the tab says a lot about how far we have fallen.

  16. Chris writes:

    I think that you hit the nail on the head in pointing out that too much “production” is simply leveraging past production. Not sure about this though:

    “savings currently is little more than debt service.”

    On a typical $60k household income, the current 7% savings rate has $4200 annual run rate. I believe this is after debt service expense. So there is considerable precautionary savings being built. As well there should as high unemployment looks to be with us a while.

    How do you arrive at the statement that savings is little more than debt service? Maybe I am misinterpreting it.

  17. I will have to quote [hopefully with your blessing]…..Sarcasm is the new analysis. Love it!

  18. wagelaborer writes:

    It's not called debt forgiveness. It's called bankruptcy, and it's the usual end to speculation and bubbles. Citigroup, Bank of America, etc., are overextended and should be allowed to fail. Instead, taxpayers are bailing them out.
    This is unprecedented. The dot-com bubble wasn't bailed out. The railroad bubble wasn't bailed out. The Wall St bubble of the 20s wasn't bailed out.
    I get that allowing bankruptcy will collapse the economy. But those of us on the bottom are screwed either way.

  19. edvaard writes:

    In 2006 I was asked how bad it could get. My answer made people choke. Here was my answer.
    If it is bad, you will pimp out your wife.
    If it is worse, you pimp your sister.
    If it is really bad,you pimp your daughter.
    But you probably won't be pimping your mother.
    Notice the wife goes first.

    The first to go will likely be young women to the middle east on Emirates Airlines — they just got the A380. If this isn't a reality for you as the Russians what happend 15 years ago.

  20. findnannyjobs writes:

    Nanny To You is a free nanny jobs search service

  21. ChristopherBPurrowes writes:

    Banks will also charge customers if they have to write to them about an infraction of bank rules, such as exceeding the union bank california overdraft limit or defaulting on loan repayments. This means that defaulting customers have to repay the debt as well as the additional charges.

  22. Grainy Eva writes:

    Well, what happened to the first two major fields that needs proper budget funding in order to keep all things on the right track: health and education? How are these people supposed to make it if the health insurance doesn`t cover their needs for medical assistance, in an environment threatened by recession and unemployment? I am telling you, this is where the collapse makes way into the nation`s life. More and more people turn to Narconon programs because they live in a system that has made them weak and vulnerable. I am not saying this is the system`s fault and the people are entitled to fall vulnerably in front of vices, it`s just that this weakness chain is going on up to the further consequences that we see nowadays.

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