[OPE-L] The Second Great Depression?

From: glevy@PRATT.EDU
Date: Wed Feb 28 2007 - 08:44:11 EST

The second Great Depression
By Mike Whitney
Online Journal Contributing Writer

Feb 22, 2007, 00:45

"The US economy is in danger of a recession that will prove unusually long
and severe. By any measure it is in far worse shape than in 2001-02 and
the unraveling of the housing bubble is clearly at hand. It seems that the
continuous buoyancy of the financial markets is again deluding many people
about the gravity of the economic situation." --Dr. Kurt Richebacher

"The history of all hitherto society is the history of class struggles."
--Karl Marx

This week's data on the sagging real estate market leaves no doubt that
the housing bubble is quickly crashing to earth and that hard times are on
the way.

"The slump in home prices from the end of 2005 to the end of 2006 was the
biggest year over year drop since the National Association of Realtors
started keeping track in 1982." (New York Times)

The Commerce Dept announced that the construction of new homes fell in
January by a whopping 14.3 percent. Prices fell in half of the nation's
major markets and "existing home sales declined in 40 states." Arizona,
Florida, California, and Virginia have seen precipitous drops in sales.
The Commerce Department also reported that "the number of vacant homes
increased by 34 percent in 2006 to 2.1 million at the end of the year,
nearly double the long-term vacancy rate." (Marketwatch)

The bottom line is that inventories are up, sales are down, profits are
eroding, and the building industry is facing a steady downturn well into
the foreseeable future.

The ripple effects of the housing crash will be felt throughout the
overall economy; shrinking GDP, slowing consumer spending and putting more
workers in the growing unemployment lines.

Congress is now looking into the shabby lending practices that shoehorned
millions of people into homes that they clearly cannot afford. But their
efforts will have no affect on the loans that are already in place. One
trillion dollars in ARMs (adjustable rate mortgages) are due to reset in
2007, which guarantees that millions of over-leveraged homeowners will
default on their mortgages putting pressure on the banks and sending the
economy into a tailspin. We are at the beginning of a major shake-up and
there's going to be a lot more blood on the tracks before things settle

The banks and mortgage lenders are scrambling for creative ways to keep
people in their homes, but the subprime market is already teetering and
foreclosures are on the rise.

There's no doubt now, that former Federal Reserve Chairman Alan
Greenspan's plan to pump zillions of dollars into the system via "low
interest rates" has created the biggest monster-bubble of all time and set
the stage for a deep economic retrenchment.

Greenspan's inflationary policies were designed to expand the "wealth gap"
and create greater economic polarization between the classes. By the time
the housing bubble deflates, millions of working class Americans will be
left to pay off loans that are considerably higher than the current value
of their homes. This will inevitably create deeper societal divisions and,
very likely, a permanent underclass of mortgage-slaves.

A shrewd economist and student of history like Greenspan knew exactly what
the consequences of his low interest rates would be. The trap was set to
lure in unsuspecting borrowers who felt they could augment their stagnant
wages by joining the housing gold rush. It was a great way to mask a
deteriorating economy by expanding personal debt.

The meltdown in housing will soon be felt in the stock market, which
appears to be lagging the real estate market by about 6 months. Soon,
reality will set in on Wall Street just as it has in the housing sector,
and the "loose money" that Greenspan generated with his mighty printing
press will flee to foreign shores.

It looks as though this may already be happening even though the stock
market is still flying high. On Friday, the government reported that net
capital inflows reversed from the requisite $70 billion to AN OUTFLOW OF

The current account deficit (which includes the trade deficit) is running
at roughly $800 billion per year, which means that the US must attract
about $70 billion per month of foreign investment (US Treasuries or
securities) to compensate for America's extravagant spending. When foreign
investment falters, as it did in December, it puts downward pressure on
the greenback to make up for the imbalance.

Everbank's Chuck Butler put it like this: "Not only did the buying stop by
foreigners in December, but the outflows were huge! Domestic investors
increased their buying of long-term overseas securities from $37 billion
to a record $46 billion. This is a classic illustration of 'lack of
funding.' So, the question I asked the desk was . . . 'Why isn't the euro

Why, indeed? Why would central banks hold onto their flaccid greenbacks
when the foundation that keeps it propped up has been removed?

The answer is complex but, in essence, the rest of the world has loaned
the US a pair of crutches to bolster the wobbly dollar while they prepare
for the eventual meltdown. China and Japan are currently holding over $1.7
trillion in US currency and US-based assets and can hardly afford to have
the ground cut out from below the dollar.

There are, however, limits to the "generosity of strangers" and foreign
banks will undoubtedly be pressed to take more extreme measures as it
becomes apparent that Team Bush plans to produce as much red ink as
humanly possible.

December's figures indicate that foreign investment is drying up and the
world is no longer eager to purchase America's lavish debt. The only thing
the Federal Reserve can do is raise interest rates to attract foreign
capital or let the dollar fall in value. The problem, of course, is that
if the Fed raises rates, the real estate market will collapse even faster
which will strangle consumer spending and shrivel GDP. In other words, we
are at the brink of two separate but related crises: an economic crisis
and a currency crisis. That means that the unsuspecting American people
are likely to be ground between the two mill wheels of hyperinflation and
shrinking growth.

In real terms, the economy is already in recession. The growth numbers are
regularly massaged by the Commerce Department to put a smiley face on an
underperforming economy. Industrial output continues to flag (in January
it was down by another .5 percent) while millions of good-paying factory
jobs are being airmailed to China where labor is a mere fraction of the
cost in the USA. Also, automobile inventories are up while factory
production is in freefall.

In addition, new jobless claims soared to 357,000 in the week ending
February 10. Forty-four thousand more desperate workers have been given
their pink slips so they can join the huddled masses in Bush's Weimar

December's net capital inflows are a grim snapshot of the looming disaster
ahead. As the housing bubble loses steam, maxed out American consumers
will face increasing job losses and mounting debt. At the same time,
foreign investment will move to more promising markets in Asia and Europe,
causing a steep rise in interest rates. This is bound to be a stunning
blow to the banks that are low on reserves ($44 billion) but have
generated $4.5 trillion in shaky mortgage debt in the last 6 years.

It's all bad news. The global liquidity bubble is limping towards the reef
and when it hits it'll send shockwaves through the global economic system.

Is it any wonder why the foreign central banks are so skittish about
dumping the dollar? No one really relishes the idea of a quick slide into
a global recession followed by years of agonizing recovery.

Maybe that's why Secretary of Treasury Hank Paulson has reassembled the
Plunge Protection Team and installed a hotline to his Chinese counterpart,
so he can quickly respond to sudden gyrations in the stock market or a
freefalling greenback; two of the calamities he could be facing in the
very near future.

Greenspan successfully piloted the nation into virtual insolvency. In
fact, the parallels between our present situation and the period preceding
the Great Depression are striking. Just as massive debt was accumulating
in the market from the purchase of stocks "on margin," so too, mortgage
debt between 2000 and 2006 soared from $4.8 trillion to $9.5 trillion. In
both cases the "wealth effect" spawned a spending spree which looked like
growth but was really the steady, insidious expansion of debt which
generated economic activity. In both periods wages were either flat or
declining and the gap between rich and working class was growing more
extreme by the year.

As Paul Alexander Gusmorino said in his article, "Main Causes of the Great
Depression": "Many factors played a role in bringing about the depression;
however, the main cause for the Great Depression was the combination of
the greatly unequal distribution of wealth throughout the 1920s, and the
extensive stock market speculation that took place during the latter part
of that same decade."

The same factors are at work today except that the speculation is in real
estate rather than stocks. Just as in the 1920s the equity bubble was not
created by wages keeping pace with productivity (the healthy formula for
growth) but by the expansion of personal debt. Also, one could buy stocks
without the money to purchase them, just as one can buy a $600,000 or
$700,000 house today with zero down and no monthly payment on the
principle for years to come. The current account deficit ($800 billion)
could also weigh heavily in any economic shake-up that may be forthcoming.

Bob Chapman of The International Forecaster made this shocking calculation
about America's out-of-control trade deficit: "US debt was up 10.1 percent
to $4.085 trillion and accounts for 58.8 percent of all the credit issued
globally last year. That means the US expanded credit at a much faster
rate than the economy grew. This was borrowing to maintain a higher
standard of living and attempt to pay for it tomorrow."

Think about that; the US sucked up nearly 60 percent of ALL GLOBAL CREDIT
in one year alone. That is truly astonishing.

There are many similarities between the pre-Depression era and our own.
Paul Alexander Gusmorino says: "The Great Depression was the worst
economic slump ever in U.S. history, and one which spread to virtually all
of the industrialized world. The depression began in late 1929 and lasted
for about a decade. . . . The excessive speculation in the late 1920s kept
the stock market artificially high, but eventually led to large market
crashes. These market crashes, combined with the misdistribution of
wealth, caused the American economy to capsize."

"[The income disparity] between the rich and the middle class grew
throughout the 1920s. While the disposable income per capita rose 9
percent from 1920 to 1929, those with income within the top 1 percent
enjoyed a stupendous 75 percent increase in per capita disposable income .
. . A major reason for this large and growing gap between the rich and the
working-class people was the increased manufacturing output throughout
this period. From 1923-1929 the average output per worker increased 32
percent in manufacturing. During that same period, average wages for
manufacturing jobs increased only 8 percent (This ultimately causes a
decrease in demand and leads to growth in credit spending)

"The federal government also contributed to the growing gap between the
rich and middle-class. Calvin Coolidge's (pro business) administration
passed the Revenue Act of 1926, which reduced federal income and
inheritance taxes dramatically . . . (At the same time) the Supreme Court
ruled minimum-wage legislation unconstitutional.

"The bottom three quarters of the population had an aggregate income of
less than 45 percent of the combined national income; while the top 25
percent of the population took in more than 55 percent of the national
income . . . Between 1925 and 1929 the total credit more than doubled from
$1.38 billion to around $3 billion."

Just like now, the growing wage gap has spawned massive speculative
bubbles as well as a steady up-tick in credit spending. Wage stagnation
forces workers to seek other opportunities for getting ahead. When wages
fail to keep pace with productivity then demand naturally decreases and
business begins to flag. The only way to spur more buying is by easing
interest rates or expanding personal credit, and that is when equity
bubbles begin to appear. That's what happened to the stock market before
1929 as well as to the real estate market in 2007. The availability of
credit has kept the housing market afloat but, ultimately, the result will
be the same.

On Monday October 21, 1929, the over-valued stock market began its
downward plunge. It managed a brief mid-week comeback, but seven days
later, on Black Tuesday, it plummeted again; 16 million shares were dumped
and there were no buyers.

The game was over.

Confidence evaporated overnight. People stopped buying on credit, the
bubble-economy collapsed, and the mighty locomotive for growth, the
American consumer, hobbled into the Great Depression. Tariffs were thrown
up, foreigners stopped buying American goods; banks closed, business went
bust, and unemployment skyrocketed. Ten years later the country was still
reeling from the implosion.

Now, 77 years later, Greenspan has led us sheep-like to the same
precipice. The economic dilemma we're facing could have been avoided if
the expansion of personal credit had been curtailed by prudent monetary
policy at the Federal Reserve and if wealth were more evenly distributed
as it was in the '60s and '70s. But that's not the case; so we're headed
for hard times.

Mike Whitney lives in Washington state. He can be reached at:

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