Time to Burst the Economic Bubbleheads

by Tula Connell, Aug 10, 2007

One day after George W. Bush asserted that the “fundamentals” of the U.S. economy are strong, the Dow Jones stock index plummeted by 387, for its second worse drop this year, when our nation’s subprime mortgage disaster spread to Europe, where banks fear they can’t accurately value these sinking loans.

Yesterday, a few days after Treasury Department Secretary Henry Paulson returned from yet another trip to China, where he again failed to win any significant increase in the value of China’s yuan or an iota of trade concessions, a top Chinese academic wrote an op-ed essentially warning that if China is forced to boost the value of its yuan, China could call in a good chunk of the $407 billion in loans this country owes China.

Disconnect, dishonesty, incompetence—or all three?

Now, the U.S. Federal Reserve has joined European banks in scrambling to pump money into our respective economies. Europeans are pushing $130 billion into their financial systems and the Fed added an extra $25 billion in temporary reserves to the U.S. banking system. Credit crunch fears have spread to Asia, where the Bank of Japan added $8.5 billion to the financial system. The Reserve Bank of Australia also lent the most in more than three years, $4.2 billion.

Back in China, the academic, He Fan, noted that China has accumulated “a large sum of U.S. dollars” and that its holdings contribute “a great deal to maintaining the position of the U.S. dollar as an international currency.” According to The Washington Post:

If the yuan’s exchange-rate against the dollar does not remain stable, he said, China could be forced to take strong action.

China has $1.33 trillion in foreign-exchange reserves, with $407 billion in U.S. Treasuries, the second-largest holder after Japan. A substantial sell-off of the reserves could spark a recession in the U.S. economy, which is already experiencing a housing slump, financial analysts said. 

And it gets worse. Today comes word that China’s trade surplus soared 67 percent in July from a year ago, to its second-highest monthly level on record. July’s surplus totaled $24.4 billion, the Chinese customs agency reported. That beat every previous month except June’s all-time high of $26.9 billion. 

China’s continually skyrocketing trade surplus means the U.S. trade deficit is on course to be even worse than last year, when it reached a whopping $233 billion. The U.S. trade deficit with China between 1997 and 2006 has displaced production that could have supported some 2.2 million U.S. jobs, according to the research group the Economic Policy Institute (EPI). Most of these jobs (1.8 million) have been lost since China entered the World Trade Organization (WTO) in 2001.  

AFL-CIO, domestic manufacturers and many economic experts maintain that one key reason the U.S. trade deficit with China is so high is because China deliberately undervalues its currency, the yuan, to keep the value artificially low so it can boost exports and discourage imports—running up the U.S. trade deficit and costing good American jobs.  

An AFL-CIO report shows China’s fixed currency rate artificially lowers the price of its goods by 40 percent, effectively subsidizing China’s exports and putting U.S. companies at a competitive disadvantage. 

Days before yesterday’s concerns about our credit market spread overseas, a blog writer on The Agonist predicted the global spread of the subprime mess: 

The shock waves emanating from the subprime mortgage earthquake are now spreading around the financial world. The collateral damage is being unveiled so quickly that it is difficult keeping up with all the collapsed hedge funds, injured banks, and defaulting mortgage brokers. It is difficult to make sense of all of this, partly because financial reporting in today’s business publications is almost non-existent.  

Reporters usually repeat what is in some company’s press release, and only a few with experience and investigative instincts can really go below the surface and make sense of things. To be fair to the reporters, this crisis is a bit different, because the hedge fund industry is deliberately and obstinately opaque. Hedge funds reveal little about what they own or how much they borrow. That iron curtain of information about hedge fund exposures is making this crisis much worse.

The denial in U.S. financial markets (and the mainstream media) over the extent of the mortgage crisis, which is rapidly spreading from the subprime market to less risky loans, and the refusal of the Bush administration to acknowledge the trade crisis with China, parallel Bush’s claims about a strong economy. Parallel, that is, in the sense of parallel universe. 

The economy is strong—for the rich. In Bush World, that’s all that counts.  

Writing on TPM Café this week, EPI economist Jared Bernstein sums it up nicely:

The sad part about this is that most working people haven’t gotten squat out of this productivity-rich, wage-poor economic cycle. Since 2000, the economy’s productivity is up 21 percent, while the real earnings of the median worker are up only a couple of percent. It’s no secret that the lion’s share of the growth has gone to those highly-placed top of the income scale, but what if these developments bringing down the financial markets and slowing overall growth persist or even deepen? Is this as good as it gets for working families in the 2000s? Do we pass out T-shirts that say “I helped boost productivity in the 2000s and all I got was a 2 percent pay hike?” 

After the July jobs report came out last week, which showed a weak growth of 50,000 jobs and an increase in the unemployment rate from 4.5 percent to 4.6 percent, Dean Baker, co-director of the Center for Economic and Policy Research wrote that “on the whole, the July report shows a picture of an economy that is slowing down.”  

Job growth is not fast enough to keep pace with the growth of the workforce and this is leading to declining employment rates among prime age workers and modest increases in unemployment.

We’ll leave it to an outside observer, Paul Harris, to describe how those outside the United States view this nation. Like Alexis de Tocqueville, that famous observer of early 19th century America who is endlessly quoted for his commentary on the early years of our nation, the views of disintersted parties offer valuable insight. Here’s an excerpt from Harris’s piercing piece in the British daily, the Observer, which was reprinted on Alternet. 

America’s super-rich have returned to the days of the Roaring Twenties. As the rest of the country struggles to get by, a huge bubble of multi-millionaires lives almost in a parallel world. The rich now live in their own world of private education, private health care and gated mansions. They have their own schools and their own banks. They even travel apart—creating a booming industry of private jets and yachts. Their world now has a name, thanks to a new book by Wall Street Journal reporter Robert Frank which has dubbed it “Richistan.” There every dream can come true. But for the American Dream itself—which promises everyone can join the elite—the emergence of Richistan is a mixed blessing. “We in America are heading towards ‘developing nation’ levels of inequality. We would become like Brazil. What does that say about us? What does that say about America?” Frank said.

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