3.9 United States Economic Prospects

The USA emerged from WWII as the richest country in the world, its industries unscathed and unemployment of the Depression years finally over. {1} Personal betterment in the American dream became a reality in the 1945-71 period as the middle class swelled in wealth and numbers, aided by measures introduced by Congress to promote high employment, high profits and low inflation. The Eisenhower administration (1953-1961) adopted Keynesianism, accelerating public works programs, easing credit, and reducing taxes. {2} {5}

The postwar boom ended with the soaring costs of the Vietnam War, which couldn't be covered by gold. {3} The 1944 Bretton Woods accord was replaced by a system of floating currencies, agreed by governments but increasingly dictated by markets. Also restraining the economy were the trade imbalances from imported manufacturing goods from Japan, and possibly the costs of President Johnson's Great Society. {4} In 1973 came the oil crisis and increased energy costs, and then the 1973-4 stock market crash. Keynesian policies were replaced by monetarist economics and market deregulation. {6}

Performance was mixed in the period to 1997: recovery, the 1980 recession which shed 1.1 million jobs, tax breaks and increased military spending under Reagan, de-industrialization, increased free trade and globalization. Productivity increased in the 1990s, but so did the national debt. {6-8}

Nonetheless, the American economy in 2007 was the largest and most diverse in the world. Total output of US goods and services (GDP) was $14 trillion in 2007, a shade under that of the EEC bloc, but nearly three times the size of Japan's economy and five times China's. The finance industry accounted for 41% of corporate profits. {17} With just 5 percent of the world's population, the United States was responsible for 20 percent of total economic output. Its GDP per capita was nearly $45,000, four times the world average of $11,000. The average American worker produced more than $92,000 worth of products and services per year — nearly 20% more than that of the average of a dozen leading European countries and 85% higher than that of China. US productivity expanded by an average 2% a year from 2000 through 2006, twice the gain in most of Europe. In one study of 16 major industrial nations, only South Korea, Sweden, and Taiwan had higher productivity growth than the United States over the 2000-2006 period. {9}

The long-gathering storm struck a year later. Housing bubbles burst in California and Florida. Lehman Brothers went bankrupt. Leading banks, insurance and mortgage companies had to be bailed out by the government. The stock market plunged 40%, wiping out tens of trillions of dollars. A $700 billion plus Troubled Assets Relief Program (TARP) was made available to banks and leading businesses, {150} and Obama announced a $787 billion in stimulus in February 2009. {10-18}

Current Status

The US is currently in recession, or under a 'jobless recovery', {19} and has seen its status diminish, both as an economic powerhouse and the champion of the free world. {20} The country is still extraordinarily productive, efficient and resilient, however, and the mainstream press does not expect that to change in the short term. {9} {21} {97}

The table below {22} predates the financial crash, and it may be wise to reduce estimates for 2003-30 GDP growth in the USA, Germany, France and the UK to Japan's 1.3%.

Strengths

World's largest GNP, over twice size of next (China).
Democratic, and active advocate of world freedoms.
Large population (310,232,863 in July 2010).
Well-trained and disciplined workforce.
Market-orientated, consumer economy.
World's largest army, well-funded.
World leader in educational standards: universal literacy.
World leader in technological systems: computers, medical, aerospace, military supplies, etc.
Abundant natural resources, including water, coal, phosphates, lead, zinc, copper, uranium and gold.
Highly efficient agriculture: wheat, barley, rice, sugar, oats, cotton, tobacco and potato.
World leader in many industries: chemicals, iron & steel, metal products, electronic equipment, machinery, petroleum products, fertilizers and plastics.
High efficiency in major sectors of GDP: mining, real estate, rental and leasing services, finance and insurance, manufacturing, transportation and wholesale trade.
Extensive R&D, much financed by university and government initiatives.

Weaknesses

Excessive dependence on services: 79.6% of the GDP, with industry at 19.2% and agriculture less than 1%. {21-22}
World's largest and still growing fiscal deficit: $13.6 trillion in 2008 (93.2% of GDP, $45,000 per capita).
Government interference in energy and agriculture sectors, possibly also banking and stock markets.
Large and growing disparities in wealth.
Reduced opportunities in poor and black communities.
High rates of unemployment and job insecurity.
Harsh penal code and expanding prison system.
Cult of violence, in movies and on the streets.
Gradual curtailment of civil liberties.
Inefficient and expensive medical care.
Unsustainable expansion of military at expense of public services.
Corruption of political process by big money.
Widespread tax avoidance by corporations and the wealthier.
Offshoring of US industry to China, India and elsewhere.
Energy dependence.

Internal/External Opportunities

Reform to banking, medical and political systems.
Closure of corporation tax loopholes.
Rethink of foreign policy and recapture of 'leader of the free world' status, currently tarnished by Iraq war, Guantanamo, rendition and Wall Street raiders.

Internal/External Threats

Unemployment.
Debt: personal, state, federal and institutional.
Deepening recession: business failures, house repossession, unemployment.
Another collapse of Wall Street-led banking systems.
Supremacy threatened by China and its foreign exchange holdings.
Blowback terrorists attacks from wars in the Islamic middle east and Asia.
West coast Caesium contamination from Fukishima.

Strengths: Hegemony

The US still largely controls the pattern of world trade. Keynes, for example, had suggested a basket of currencies (Special Drawing Rights) be employed as the international currency unit at the 1944 Bretton Woods accord, but America opted for the dollar. The economic strength of the country, the volumes traded on the NY stock exchange, and the sums deployed by Wall Street ensured that the country had its way. {3} {23} Britain was also dependent on US aid, and in no position to argue. {84} When Nixon took America off the gold standard in 1971, the rest of the world accepted floating exchange rates. When large trade imbalances developed with Japan, that country was told to revalue its currency, which led to regearing of the Japanese economy, and then overproduction, euphoria, recession and deflation of the 'lost decade'. When Paul Volcker curbed US inflation over the 1981-3 period, {24} and so strengthened the dollar, {25} debtor countries found it more costly to repay loans. Mexico {26} and Chile {27} in particular were pushed into difficulties, which turned into bankruptcy as investment fled overseas. {28} Though these actions have made the larger trading blocks (China and the eurozone) rethink their strategies, and perhaps create an undeclared currency war between the US, China and the EEC, {3} the advantage still lies with America, if only just. {189}

Weaknesses: Unemployment

Unemployment is a persisting worry. The financial crisis has been contained, the stock market is booming again, but jobs are not returning to the US. Congress does not expect full employment to return before 2014, and the public are equally gloomy. {29} As the current recession lengthens, lessons are being drawn from the Great Depression, and these are not encouraging. Lowered exchange rates, government deficits, trades union actions and time itself were not successful then, nor were overseas Fascist solutions unless accompanied by rapid rearmament as in Germany. Today's employment recovery may be years away, {30} and students leaving universities now may suffer as the 'lost generation' of Japan, overlooked when the economy finally picks up again.

Debt servicing is not a problem, {30} and China shows no sign of dumping the dollar. {31} The problem may lie in the level of private debt. There are three measures of importance: a. ratio of debt to GDP, b. the rate at which a. changes, and c. the rate at which b changes (i.e. the acceleration of private debt/GDP levels). Modeling by Keen {32} suggests that b correlates with unemployment levels, and c. with changes in unemployment level. The relationship holds for the current recession in America, the anemia 'recovery' in Japan and the Great Depression. Private debt rose 50% over the 1920s, from $106 bn in 1920 to $161 bn in 1930. Private debt rose from $17 tn to $ 42 tn over the 1999-2009 period. The debt/GDP ratio was 175% when the Great Depression began, and 298% when the current recession began, falling 19% in 2010. As every econometrician knows, correlation does not mean causation, but the correlation is close, and makes intuitive sense. Unlike countries, households have to repay debt, and do so by reducing spending when debt reaches high levels, especially in a recession when employment prospects are threatened.

Banks, which earn their profits from debt, are again the main culprits, plus society at large which encourages lavish spending habits. But the era of citizens living beyond their means has come to an end, and the quantitative easing measures in the USA, Japan, Britain and the EEC are probably making matters worse. The remedy is debt reduction, probably by debt redemption in measured steps. Since that would ruin many banks, and reduce the wealth of powerful players on the political scene, Keen is not hopeful of its early adoption, and expects the world's economies to follow the Japan experience of extended unemployment and sluggish growth, with many cycles of small improvements and relapses. Only China, where private debt is low (and possibly Russia, India and Brazil) could reasonably expect to escape. {33} {158-9}

Weaknesses: Offshoring

Offshoring of jobs to countries with cheap labor and lax environmental standards has received a mixed press. Most {34} argue that increased company profits return to America in the form of foreign investment, or company savings. Developing countries are provided with much-needed employment, and manufactures made cheaper to US customers, allowing savings to be invested elsewhere in the country. Economists generally believe the overall loss of American jobs is small, and Global Insight estimate offshoring created a net 90,000 jobs in the 2003 IT industry alone by bringing down costs. {35} The process works in reverse, moreover, as several hundred American companies make parts for the Japanese car industry.

Others point to the social cost {36} and that increased spending power does not flow to manufacturing industries but to services, on which America is overly dependent. {37} More importantly, returned profits are also small compared to labor costs (i.e. overseas salaries), and not dispersed widely into the economic spectrum. Indeed the tide is turning, and more companies are now questioning the offshoring model. {38}

Research on offshoring identifies 'hidden costs', which can be extensive or even crippling: relocation, management complexities, quality control, documentation and shipment. {39} {40} Key is management: how the increased revenues and capital productivities are employed and risk contained. {41} Offshoring to countries where salaries are 10% of America's does not cut labor costs to the same extent, and savings are commonly 20% at best, and only after a long teething period. {42}

Nonetheless, the IT industry commonly outsources help desks, security, ecommerce systems, and the development, and maintenance of applications. Most companies seem satisfied with results, and outsourcing results in poorer services in only 6% of cases for IT security and 8% for disaster recovery. {43}

Weaknesses: Energy Dependence

America uses far more oil than any other country in the world, and twice that per capita of northern Europe. Coal supplies are sufficient to last 250 years, but some 60% of its oil was imported, a figure once predicted to rise to 75% by 2030. Much comes from countries that are politically unstable— requiring support of repressive regimes, covert action, armed intervention or the threat of intervention to maintain supplies and supply routes, most notably through the Straits of Hormuz, Malacca and Panama. {165} The recent development of shale fracking technology is beginning to eliminate the energy deficit, though some have questioned its long-term viability. {195}

Strengths: Military

The military is an inescapable part of the America economic model. {161} The country had 1,366,000 military personnel in 2011, {100-101} and arms sales contributed 4.7% to its GDP. {102}

Besides providing employment, much needed in the current recession, the military machine helps enforce use of the dollar. {133} {136} Few would question the desire to serve their country which informs the vast majority of men and women employed in the armed forces, nor the many selfless rescue missions that are undertaken worldwide by those forces, but the military also serves — critics of 'imperialism' allege {103} {109} {128} — economic realities by defending, and if necessary imposing, foreign governments favorable to American interests. Military spending would otherwise be excessive — diverting funds away from local needs, exacting high costs in blood and economic effort, and making America more feared than admired. {103-104} Military objectives are becoming more costly and difficult to achieve, however, and America may be in danger of turning a strength into a weakness by overreach. {174}

WII left two superpowers. The USSR had paid dearly for victory: 24 million dead, much of its manufacturing base destroyed, and a continuing dictatorship under Stalin, whose first actions were to erect a wall of satellite states around Russia and impose subservience through rigged elections and the Red Army. The war had cost the USA some 418 thousand dead, but its industry was unscathed and the country enjoyed great prestige as the champion of freedom, justice and democracy. {99} Indeed the war had brought the country out of Depression, and help develop its phenomenal mass production techniques {105} that were widely adopted, though possibly not with such wealth-generating results as claimed. {106} America was certainly rich, however: its 10% of world population owned 35% of world GDP. {107}

So appeared — it is alleged {128} {131-132} {191} —the postwar US economic model which required continuing expenditure on armaments (especially nuclear), a world kept open to US goods, a dominant role in the UN, the IMF, the World Bank, the World Trade Organization, and the USIA, and some 1000 US bases across the world. {108} Japan was occupied, democracy reintroduced and manufacturing of cheap electronic components for US industries encouraged through trade alliances. Europe accepted US protection and its impoverished industries (Britain alone owed US$ 4.3 bn at 2% p.a. in war loans) were given their Marshall plan, {22} a generous grant of US$ 13 billion that put Germany and others back on their feet, and prevented a lapse to totalitarian government. US-friendly governments were supported in Latin America and the middle east, many of them undemocratic or even repressive. The CIA conducted secret operations in over 40 countries {109} to aid US interests. {181}

The model began unwinding when America supported the south Korea and south Vietnam governments against communist aggression. Local parties to the conflict were repressive, and not squeamish about murdering their equally unsqueamish opponents. The 1950-3 Korean War saw a north Korean invasion of the south, a counterattack, Chinese support for north Korea and finally, despite the tactical brilliance of General MacArthur, a stalemate. The uneasy settlement drew the border in its prewar position. The war cost America $320 bn and took the lives of some 3 million soldiers and civilians, but south Korea {110} survived to become a US-friendly manufacturing center for electronics, cars and shipping.

The 1955-75 Vietnam War, where the US took over the French colonial position and prevented free elections that would have united the country under communist rule, was as bloody {162} as Korea but less successful. The USA lost 58,000 soldiers. Vietnam and surrounding countries lost 1-3.8 million soldiers and civilians, {111} and several million more when the Khmer Rouge and the Vietnam governments took control. {112} The countries were devastated by heavy bombing, and the recovery has seen open trade more with China, Japan and Australia than America.

Even less successful has been the 'war on terror': Iraq, Afghanistan and Pakistan. El Qaida was intially funded by America, first to destabilize Afghanistan by supporting the mujahideen prior to the Russian invasion (to give Russian its own Vietnam) {113} and then to foment trouble in Jugoslavia. {114} {135} {160} {188} 9/11 allowed the administration to curtail civil liberties {145} and extend military budgets and operations. Events were ostensibly planned in Germany and financed by Saudi money, but America attacked Afghanistan and then Iraq. The Taliban offered to hand over bin Laden after 9/11 if the usual extradition papers were served, but the US resorted to heavy bombing of the country and installation of a pliant regime. Iraq was invaded to neutralize atomic/biological weapons, and then to remove El Qaida terrorists the regime was believed to be harboring. When both proved illusory, the reason morphed into 'regime change', an act illegal under the UN Charter and international law. Like the earlier Desert Storm operation, the invasion was carefully planned and executed, but insufficient troops for occupation led to security lapses, sectarian violence, insurgency and ethnic cleansing. {127} {152}

The widespread solidarity with America after 9/11 was eroded by invasions, rendition and torture, the large loss of life serving to radicalize Muslim opinion and ensure a supply of enemies for years to come. {116} {172} Basic facilities in Iraq have been destroyed, and contracts to rebuild/develop the oil industry won by the Chinese. {129} {156} Afghanistan, formerly a secular country with modest freedoms and educational levels, has become a failed state. Pakistan approaches social breakdown, and hostility to US drones and military action reduces opportunities for US investment and trade.

Arms Spending

The US spends 4.7% of GDP on military expendures, a percentage only exceeded by Saudi Arabia (8.7%). That 4.7% represents 40% of the world's military expenditures, however, and is larger by an order of magnitude than its foreign aid programs. {117} Indeed global spending on armaments in 2011 exceeded that at the peak of the Cold War (£561 bn to £547 bn) and was 17 times the amount earmarked for alleviating world hunger. {118}

Security Costs

US markets were defended at great cost to all parties:

To place matters in context, bloodshed has been higher in communist regimes, and the twentieth century may have seen some 262 million citizens lose their lives to their own government actions. {119}

Threats: Collapse of the Banking System

US Crisis 2007-2012

The financial crisis of 2007-2012 — which brought about the near-collapse of large financial institutions, the bailout of banks by national governments, stock market downturns, housing evictions, business failures, the European sovereign-debt crisis and unemployment across the world — wiped out several trillion dollars in consumer wealth. The story is well known through films, articles and books, though the remedial actions are still controversial.

Banking was once a safe occupation earning modest profits, around half that of the non-financial sector in America through the 1960s and 70s. Following deregulation in the 1980s, however, it rose to 4-12%, considerably more than the 2-5% of non-financial firms. {44} Many companies turned themselves into finance houses, and the ratio of financial to non-financial assets in US corporations rose from around 0.4 in the 1970s to nearly 1 in the early 2000s. {45}

Banking also became more enterprising in the 1970s, addressing the housing needs of disadvantaged Americans: women, blacks, and the self-employed. When a larger downpayment was required, and/or higher interest rates applied, the opportunity existed for creative lenders {46} to craft 'subprime' loans at competitive rates. To aggressive selling was added easy credit, deregulation, financial status fraud and financial complexity. Loans were often sold as a second mortgage, {15} and often again to those who didn't read the fine print on the higher repayments being charged after year two. Defaults weren't the problem of the originating mortgage company because the loans were securitized, i.e. branded as assets (secure streams of income) and sold on as complex financial products, often through a chain of intermediaries. Many observers were aware of the risks but said little, being unwilling to spook the markets or interrupt its moneymaking powers. The regulators assumed that Wall Street knew what it was doing, and Wall Street assumed the market was self-regulating: indeed their (faulty) models assured them they were fully covered. But when mortgage holders began to default in droves, those revenue streams became problematic. Good and bad loans had been complexly diced together, often several times over, which made all such assets suspect ('toxic'), and so untradeable. The rating agencies had recklessly branded the financial instruments as safe investments, and guarantees had been issued by large insurance houses (often through CDSs, credit default swaps), though these guarantees became worthless when the houses could not meet the increasing extent of their commitments. The insurance houses were indeed linked to other investment companies, which in turn were interlinked further, creating a complex web of commitments whose ramifications often eluded the understanding of their own managements.

The mortgage market reached saturation around 2005, and when the higher payments began to kick in, and the Fed several times upped interest rates, the bubble burst. Real estate values fell as properties were repossessed, devaluing the assets which had been sold to banks round the world. Banks had little collateral in many cases, sometimes only a few percent of loans, so that asset devaluation effectively bankrupted them. Potential losses were not confined to investment banks because repeal of the US Glass-Steagall Act in 1999 placed even high street customers deposits at risk. Banks refused to deal with each other. Nor would they lend without a proper assessment of their financial standing, which was impossible in many cases: no one could value the assets, or indeed wanted to. Banks were nonetheless complexly indebted to each other and to countries across the world. All were damaged. Businesses suffered. Companies cut staff or folded altogether. Stock markets crashed.

Lehman Brothers went bankrupt, as did many mortgage companies. Meryll Lynch was taken over by Bank America. AIG, Fannie Mae and Freddie Mac, and others had to be bailed out by the government — plus a host of non-finance companies, including General Motors — with TARP (Troubled Assets Relief Program) for $700 billion, with another $13 trillion earmarked for relief, of which $6.8 tn had been spent by June 2009. {47}

Protection from undue government regulation had been purchased through political campaign donations and lobbying. Countries seeking safe homes for trade surpluses (China, Japan, the Gulf oil states) invested in US treasury bills, or (less safe) financial products offered by the Wall Street banks. These were zero sum plays: the sums lost by some investors would equal profits made by others. Wall Street was preferred as the dollar is the world's currency. America enforced dominance by 'agreements' with trading nations (e.g. 1985 'Plaza agreement') and by exploiting weaknesses ( Mexico peso crisis of 1994, {48} the Asia crisis of 1997). {176}

World Financial Crisis

Other countries suffered their own defaults. A share in Northern Rock, Barclays and RBS had to be acquired by the UK government. {49} There were serious bank failures in France, Iceland, Spain, Greece and Italy. {50} Contagion proved hard to contain, but countries faring best were those with conservative banking regulations and a variety of measures to improve foreign currency financing. {51}

Problems

Many culprits have been named:

1. Traders were greedy and reckless, made necessarily so by competition and payment by commission.
2. The rating agencies were funded by the institutions they were supposed to regulate, and so had reason to set aside their scruples in seeking business.
3. Banks were highly leveraged, with insufficient deposits to cover risky loans.
4. To escape regulation, banks held assets in a range of shadow accounts, which prevented government, other banks and sometimes themselves from assessing the true state of affairs.
5. Parties were complexly interlinked, ensuring ruin for all when any major unit went down.
6. Financial instruments or derivatives were often unethical, and too complex to be understood properly, even by their authors.
7. Economic theory was faulty: markets were held to be efficient and a standard distribution apply to risk: in fact markets are not static or self-regulating but complex systems: crisis is not a rare event but built in.

A Little Terminology

OTC

Over the Counter is stock (commonly debt securities and other financial instruments such as derivatives) traded through a dealer network rather than over a centralized exchange. ETDs (exchange-traded derivatives) are traded via specialized exchanges

Derivatives

Derivatives are simply contracts between two parties that specify the conditions (date, quantity, price) under which payments are to be made. Derivatives often have special legal exemptions, making them an attractive way to extend credit, but their complex and opaque nature can underprice credit risk, which indeed contributed to the financial crisis. All have useful aspects, however, and business would be scarcely possible without them. Common groupings: {52}

1. Forwards: contracts to buy at a specific time in the future at today's predetermined price.
2. Futures: contracts to buy or sell before a future date at a price specified today.
3. Options: contracts that give the the right, but not the obligation, to buy (call option) or sell (put option) at a specified (strike) price. How long the right exists is specified by the maturity date.
4. Binary options: contracts that provide the owner with an all-or-nothing profit profile.
5. Warrants: long-dated options (maturity date generally over a year): generally OTC.
6. Swaps: contracts to exchange cash (flows) on or before a specified future date, based on the underlying value of currency exchange rates, bonds/interest rates, commodities, stocks or other assets prices.
7. Swaption: option on a forward Swap.

Hedge Funds

Hedge funds are large investment vehicles used by wealthy individuals, pension funds and insurance companies, which probably account for half the daily turnover on the London and New York stock markets. Hedge funds invest internationally in anything that makes a profit, and are naturally secretive about their activities. Many charge high fees and do better for their managers than investors. {53}

By using complex strategies, hedge funds aim to produce a positive return whatever way the market goes. Four main types are often recognized:
1. Market neutral or relative value, which try to exploit market inefficiencies or mispricing.
2. Event driven, which invest on anticipated mergers, bankruptcy or corporate reorganizations.
3. Long/short, which allow fund mangers to buy some assets but sell others they do not yet own.
4. Tactical trading, perhaps the most volatile of all, which speculate on the future direction of markets.

Hedge funds are regulated by the appropriate authority (SEC in America, FSA in the UK), and tend therefore to be based offshore where tax and other liabilities are less onerous.

Hedge funds are not merely passive beneficiaries of market changes, but have the financial clout to make the changes, often through 'shorting'. Shares, bonds or currencies are 'borrowed' through a compliant broker, often without money actually changing hands. The market is influenced with rumors and/or a short selling spree, and the shares are 'sold back' at a lower price. The difference (less broker commissions) is profit. Naked shorting (borrowing without paying for the stock, i.e. not actually owning it) is illegal in many countries, but not in tax havens where many hedge funds are located. {54}

Credit Default Swaps

A credit default swap (CDS) is a form of insurance, a financial agreement in which the seller of the CDS will compensate the buyer in the event of a loan default or other credit failure. To receive this protection, the purchaser of the CDS makes a series of payments (the CDS 'fee' or 'spread') to the seller. Credit default swaps began in the early 1990s, and increased in use after 2003, rising to a total of $62.2 trillion at the end of 2007. CDS are unregulated but extremely useful, providing a measure of how the market views the credit risk of sovereign states, corporations and financial institutions. Since they can be purchased by anyone, even those without an insurable interest in the loan ('naked' CDSs), they may be used by large hedge funds to profit when their influence has been sufficient to trigger payment. In December 2011, the European Parliament banned naked CDSs in sovereign nation debt transactions. {55}

Asset-Backed Security

An ABS is a security (revenue stream) whose value and income payments are derived from (backed or 'collateralized') from a pool of underlying assets. The pool is typically small and illiquid assets (credit card, mortgages, auto loans, leases, royalty payments, student loans and movie revenues) that are bundled together ('securitization') to make a financial instrument attractive to investors. In this way, the credit risk of the underlying assets is transferred to another institution, the originating bank can remove the value of the underlying assets from its balance sheet, receive cash, improve its credit rating and reduce the amount of capital that it needs to hold. {56} The disadvantage is moral hazard: the mortgage originator has little interest in the borrower once the loan is sold on. (Nor could the householder negotiate with the mortgage company, incidentally, which no longer existed: a current legal tangle.) ABSs are usually awarded a rating by a credit rating agency: another conflict of interest if the agency puts profit above principle.

Collateralized Debt Obligation

CDOs are a form of ABS with multiple 'tranches'. Each tranche offers a different of risk and return, from pension fund holders (low return and low risk) to high growth assets (high risk but also high returns). The 'senior' tranches are the safest securities, and the junior the most risky. Interest and principal payments are made in order of seniority, so that junior tranches offer higher coupon payments (and interest rates) or lower prices to compensate for the higher risk of default.

Synthetic CDOs are a step further: there being no collateral behind the ABS, only 'exposure' to events. The financial product is thus a form of gambling on the performance of investments, though a relatively safe one unless there is massive default. Some synthetic CDOs were also traded as normal bonds.

Finally (in this very brief summary: financial products are complex) {57} came derivatives in which CDSs (credit default swaps) were bundled with CDOs or synthetic CDOs and sold by banks to their more trusting clients. A top rating by one of the rating agencies was essential as the products were difficult to assess. Because the banks owned the CDSs, and the clients the CDOs, the banks were able to unload their riskiest assets onto clients and still profit when the CDSs failed (as most did). Many of these products were deemed unethical in the investigations that followed the financial crash, but not illegal.

Current Situation

Little has been done to make another financial collapse impossible or even improbable. {144} {163} {178} {185} The new act (Dodd-Frank Wall Street Reform and Consumer Protection Act of July 2010 {58} ) gives the Fed more investigative powers. Regulators can ferret out systemic risk. A new consumer agency will see fair play and help borrowers withdraw from loans they cannot pay. {15} Otherwise, the changes are largely cosmetic, although banks must now submit contingency plans. {59} Shadow banking continues, bank scandals multiply, {60} {61} and the bonus culture is alive and well. Through Wall Street banks, the Fed is thought to be supporting the US stock markets, a policy driving away the smaller investor, and further increasing debt levels. {62} {63} The US Attorney General has admitted that some banks' operations are too big and complex to police {153} — leaving management to their own devices (but perhaps monitored by the PRC if Chinese cyber-espionage reports are to be believed. {154}) Banks are indeed using their 'excess' deposits — the excess of deposits over loans — as collateral for borrowing in the repo market, increasing the risk of default by entering into businesses that greatly extend their purported role: acquiring airports, toll roads, and ports, power plants and the like. {180} Some view their growth as not merely parasitic but a dangerous cancer on the capitalist system, which must ultimately destroy even itself. {187}

Given the financial sector's influence on government, skeptics doubt that reform will be implemented soon, {193} though the proposals are not unreasonable: break up the bigger banks, make them less interdependent, outlaw synthetic CDOs and make other derivatives more transparent, regulate shadow banking, protect deposits at high street banks, provide incentives in the form of partnerships rather than bonuses, and encourage banks to be more socially responsible. {64}

Prior to the financial crash of 2008, the world GDP and population was forecast as: {22}

Some commentators would now reduce the prospects for the US, {65} while still believing the country will remain the wealthiest in the world for the immediate future. America's GDP will give precedence to China's within 20 years, probably sooner, with India's and Brazil's further down the road.

Outlook

The US hegemony model after 1945 was of shared worldwide prosperity, led by the US through world government organizations, trade, the dollar as the international currency, diplomacy, covert action, and — if necessary — military force. {66} Initially, the model was enormously successful, raising millions from poverty and giving many in western democracies a standard of living unknown before. {67} From the 1970s, however, the model came under pressure from three developments: 1. High levels of debt (institutional, federal and private) arising from trade imbalances and unfettered spending, which placed American fortunes in the hands of banks and trading partners. 2. Increasingly costly military action {68} {81}, and 3. unregulated globalization, which drained resources from developing countries, and then jobs from middle-class America, concentrating wealth in the richer echelons of American society. {69} {70} {79} {146} {177} {184} {186}

Nonetheless, that model still remains implicit in the many solutions offered for America's current ills:

1. Respect the power of American business, and do not bail out the losers. {18} {149} {157}
2. Reduce the debt regardless of the unemployment and medical relief programs that could be reduced. {71} {82}
3. Change the banking system and replace the fractional reserve system by a full reserve one. {72-73}
4. Increase the stimulus packages, which has been a partial success {74} {130} but pay the stimulus more directly, i.e. not to banks, public works or through tax breaks.
5. Write off the debt, not completely (which would bankrupt banks and pension funds) but progressively to manageable levels. {32}
6. Set up state banks. {173}

Many seem utopian, and unlikely to be implemented by a political system {70} so closely identified with wealth and big business. {75} {164} {182-3} {194} Most predictions are for employment to remain depressed for a while, perhaps a year or two if this recession is similar to previous ones, {134} or for a decade or more if private debt is the controlling factor. {98} Rising defense costs, social relief programs and commercial espionage are further issues, now heavily politicized.

Europe is tied to NATO, and faces serious funding difficulties. China has time in hand, with little to gain from upsetting the present power balance. Though the threats of military overreach, {155} another banking crash and/or social impoverishment {147-148} are real, America will likely only slowly decline while the world continues to accept the dollar as its international currency. The country has changed markedly since 9/11, and further erosion of civil liberties, increasing inequalities {137-140} and centralization of power may well turn America into something closer to the old Soviet model, {145} {169} but few foresee a breakdown in the social order. The status quo is remarkably resilient, the recent occupy movement lacked political focus, internal security has been much increased, {141} and disquiet is largely limited to the contrarian press {142} {192} and a few libertarian groups.

Banking Model

As the model indicates, the Wall Street banks were able to dump their toxic assets through American taxpayer bailouts. Some products, although worthless, (synthetic CDOs) and indeed created 'out of thin' air, were monetized and added to the US debt burden. Public services were cut to balance budgets, and the resulting recession made banks even less inclined to invest. Quantitative easing (printing money) devalued the dollar, but recovery has not come through an improving trade figures. Finding its large dollar holdings under threat, China has diversified into resource development, in the country itself, and increasingly in Africa, Latin America and elsewhere. {143}

eBusiness Implications

Events of 9/11 have placed America on high alert, {170} and led to an increase in surveillance equipment, programs and legislation — in which the Internet plays a key role. Surveillance images of home and business premises can be viewed over computers or smart phones. {77} Images from body scans at airports are being stored. {90} The FBI is installing a $1 billion face recognition system across the country. {78} In many US states, police may now retrieve and store information from mobile phones of motorists stopped at will. {91}

The US Patriot Act {87} and the creation of Homeland Security (with a $99 bn annual budget {88}) have greatly increased state powers, and all records, business and individual, can be accessed without warrants, owners' permissions or the access being divulged for a year. {89} {190} Telephone conversations are monitored, {92} and current technology allows the authorities not only to pick up key words but immediately identify individuals from acoustic and learned patterns of their voice. {93} All emails are stored, and suspect content flagged for further investigation. {94} Banks must report on US customer activities, {95} and foreign banks refusing to do so may be subject to a withholding penalty on US-sourced funds. {96} Electronic surveillance grows in penetration, {86} and Google reports that government requests for information have further increased under the Obama administration. {85}

The continuing disclosure that intelligence services have funded software companies, {166} programs {167} and services {168} calls into question the real nature of the larger Internet companies — i.e. the quid pro quo received for cooperation, or the possibility they act largely as fronts for NSA (171} — but, in the absence of information to the contrary (which is classified), business models and their apparent successes have to be taken at face value.

Points to Note

1. Political appeal of the US hegemony model, despite its problems.
2. Inability/unwillingness of all parties to intervene and correct financial services excesses until too late.
3. Failure of the Internet, vaunted as 'freedom of information' channel, to widen perspectives.
4. The parasitic nature of a money-centric society. {80}

Sources and Further Reading

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180. The Leveraged Buyout of America by Ellen Brown. Global Research. August 2013.
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