The United States As A Banana Republic

The Atlantic has a very important piece written by former IMF chief economist Simon Johnson entitled “The Quiet Coup.” The author is one of the world’s foremost experts on dealing with countries that are suffering from massive amounts of debt and ineffectual governance. What he has to say about our current crisis is scathing, driven not from bombastic proclamations, but a quiet steady tone.

His thoughts about the US are clear: right now we have a system that seems more like an emerging market about to collapse completely than an industrial country undergoing a natural economic correction. He assigns primary blame not on regulators per se, nor on excessive liquidity or stupidity by the masses, but on the financial oligarchy that has been one of the largest political players for the past thirty years and permeates government across all levels. His critique is not about the instruments of our problems, nor the inept way in which they were used, but about the country’s priorities and power structure on a fundamental level.

The great wealth that the financial sector created and concentrated gave bankers enormous political weight—a weight not seen in the U.S. since the era of J.P. Morgan (the man). In that period, the banking panic of 1907 could be stopped only by coordination among private-sector bankers: no government entity was able to offer an effective response. But that first age of banking oligarchs came to an end with the passage of significant banking regulation in response to the Great Depression; the reemergence of an American financial oligarchy is quite recent.

Of course, the U.S. is unique. And just as we have the world’s most advanced economy, military, and technology, we also have its most advanced oligarchy.

In a primitive political system, power is transmitted through violence, or the threat of violence: military coups, private militias, and so on. In a less primitive system more typical of emerging markets, power is transmitted via money: bribes, kickbacks, and offshore bank accounts. Although lobbying and campaign contributions certainly play major roles in the American political system, old-fashioned corruption—envelopes stuffed with $100 bills—is probably a sideshow today, Jack Abramoff notwithstanding.

Instead, the American financial industry gained political power by amassing a kind of cultural capital—a belief system. Once, perhaps, what was good for General Motors was good for the country. Over the past decade, the attitude took hold that what was good for Wall Street was good for the country. The banking-and-securities industry has become one of the top contributors to political campaigns, but at the peak of its influence, it did not have to buy favors the way, for example, the tobacco companies or military contractors might have to. Instead, it benefited from the fact that Washington insiders already believed that large financial institutions and free-flowing capital markets were crucial to America’s position in the world.

He points out that nationalization of the banking system — far from being a radical solution — is the preferred solution that would be recommended by the IMF for countries of lesser political power, and indeed would most likely be a precondition for aid. But to him nationalization is not enough; nay technocratic solutions are meaningless without political reform. It’s not enough for the Fed or the Administration to make the right financial moves, they must be willing to make the right political moves, and that includes breaking the back of the oligarchical power structure. Until we do so, the financial structure will be a disease that prevents our economy from recovering. To him, the sector is a cancer that consumes too much of the country’s resources, and has much in common with resource oligarchies in emerging markets. He points out, “From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent.” Forty-one percent of profits to a sector that doesn’t actually contribute production, but merely facilitates it!

When a country has severely misallocated its capital, it is guaranteed that its wealth will decrease. This can either be through inflation or deflation, currency collapse or expensive foreign loans, from the rich or from the poor. A lot of my posts have pointed out that the government is trying to manage the technical aspect of our wealth decrease to minimize its overt appearance, but that they cannot get around it occurring.

Enormous companies teeter on the brink of default, and the local banks that have lent to them collapse. Yesterday’s “public-private partnerships” are relabeled “crony capitalism.” With credit unavailable, economic paralysis ensues, and conditions just get worse and worse. The government is forced to draw down its foreign-currency reserves to pay for imports, service debt, and cover private losses. But these reserves will eventually run out. If the country cannot right itself before that happens, it will default on its sovereign debt and become an economic pariah. The government, in its race to stop the bleeding, will typically need to wipe out some of the national champions—now hemorrhaging cash—and usually restructure a banking system that’s gone badly out of balance. It will, in other words, need to squeeze at least some of its oligarchs.

Squeezing the oligarchs, though, is seldom the strategy of choice among emerging-market governments. Quite the contrary: at the outset of the crisis, the oligarchs are usually among the first to get extra help from the government, such as preferential access to foreign currency, or maybe a nice tax break, or—here’s a classic Kremlin bailout technique—the assumption of private debt obligations by the government. Under duress, generosity toward old friends takes many innovative forms. Meanwhile, needing to squeeze someone, most emerging-market governments look first to ordinary working folk—at least until the riots grow too large.

Needless to say, he thinks our actions thus far are depressingly similar.

Something that amazes me about this crisis is the behavior of those in the financial sector and how those outside of it have supported it. The sense of entitlement amongst people that are little more than paper pushers (ah but they have to push them at the right time!) is astonishing. It’s the whining of traders that aren’t getting a bonus on top of their $200k salary, saying they did nothing wrong so they shouldn’t be punished…as if half million dollar bonuses are the same as cleaning your plate at dinner. It’s the idea that we have to pay millions in retention bonuses to people that have messed up, because they are the only ones that know what the details are. “If we don’t pay them, then they’ll go home and we’ll be ruined!” people say, as if the only reason why those people should stay is because they are receiving so much money, not because they have a duty to correct their wrongs for the greater good and atone for their mistakes. Where there should be honor, compassion and pride about correcting past wrongs, there is only vanity and avarice.

Above all, there is arrogance. Arrogance not only on a personal level, but on a systemic level…that this system is the “cause” of our prosperity, and that the world “needs” our dollars. It’s astonishing hubris and leads to priorities that I cannot understand. It’s confusing money as the ends, not as a means. Over the years I’ve learned to read the market, see how the “big boys” are playing, and take advantage. At certain times it is very easy to make a high probability trade that will be highly profitable, and over the last couple of weeks I’ve turned a few thousand dollars into more than my entire yearly salary…with only a few clicks of the mouse. A paper pusher, but a timely one. There is no glee in it for me; I am just forced to do so because I have decided to work in basic research and make a pittance. That society rewards the former more than the latter (or teachers, so on and so forth) is perverse.

Mr. Johnson might use a different tone, but he is saying the same thing. The proximate cause of our crisis is too much debt, but that debt is merely a result of a society that has its priorities out of whack and we must change those if we are to recover. The change will be painful, and delayed by financial oligarchs that have much to lose, so it comes down to political will.

He points out that the end game for emerging markets is when they run out of foreign reserves, and that is often times what creates the political will necessary for change. His outlook for the United States is grim since we can just print our wealth and are the lynchpin of the global economy.

In my view, the U.S. faces two plausible scenarios. The first involves complicated bank-by-bank deals and a continual drumbeat of (repeated) bailouts, like the ones we saw in February with Citigroup and AIG. The administration will try to muddle through, and confusion will reign…confusion and chaos [are] very much in the interests of the powerful—letting them take things, legally and illegally, with impunity…

Our future could be one in which continued tumult feeds the looting of the financial system, and we talk more and more about exactly how our oligarchs became bandits and how the economy just can’t seem to get into gear.

The second scenario begins more bleakly, and might end that way too. But it does provide at least some hope that we’ll be shaken out of our torpor. It goes like this: the global economy continues to deteriorate, the banking system in east-central Europe collapses, and—because eastern Europe’s banks are mostly owned by western European banks—justifiable fears of government insolvency spread throughout the Continent…A dramatic worsening of the global environment forces the U.S. economy, already staggering, down onto both knees. The baseline growth rates used in the administration’s current budget are increasingly seen as unrealistic, and the rosy “stress scenario” that the U.S. Treasury is currently using to evaluate banks’ balance sheets becomes a source of great embarrassment.

Under this kind of pressure, and faced with the prospect of a national and global collapse, minds may become more concentrated.

The conventional wisdom among the elite is still that the current slump “cannot be as bad as the Great Depression.” This view is wrong. What we face now could, in fact, be worse than the Great Depression—because the world is now so much more interconnected and because the banking sector is now so big. We face a synchronized downturn in almost all countries, a weakening of confidence among individuals and firms, and major problems for government finances. If our leadership wakes up to the potential consequences, we may yet see dramatic action on the banking system and a breaking of the old elite. Let us hope it is not then too late.

Something tells me that this won’t make him very happy.