Jim Kunstler's GeoPolitics 101 Forecast 2009 || Exponential Fiat Currency: The Dangers of Printing Money

Jim Kunstler's GeoPolitics 101 Forecast 2009

ClusterFuck Nation

Introduction

There are two realities "out there" now competing for verification among those who think about national affairs and make things happen. The dominant one (let's call it the Status Quo) is that our problems of finance and economy will self-correct and allow the project of a "consumer" economy to resume in "growth" mode. This view includes the idea that technology will rescue us from our fossil fuel predicament -- through "innovation," through the discovery of new techno rescue remedy fuels, and via "drill, baby, drill" policy. This view assumes an orderly transition through the current "rough patch" into a vibrant re-energized era of "green" Happy Motoring and resumed Blue Light Special shopping.

The minority reality (let's call it The Long Emergency) says that it is necessary to make radically new arrangements for daily life and rather soon. It says that a campaign to sustain the unsustainable will amount to a tragic squandering of our dwindling resources. It says that the "consumer" era of economics is over, that suburbia will lose its value, that the automobile will be a diminishing presence in daily life, that the major systems we've come to rely on will founder, and that the transition between where we are now and where we are going is apt to be tumultuous.

My own view is obviously the one called The Long Emergency.

Since the change it proposes is so severe, it naturally generates exactly the kind of cognitive dissonance that paradoxically reinforces the Status Quo view, especially the deep wishes associated with saving all the familiar, comfortable trappings of life as we have known it. The dialectic between the two realities can't be sorted out between the stupid and the bright, or even the altruistic and the selfish. The various tech industries are full of MIT-certified, high-achiever Status Quo techno-triumphalists who are convinced that electric cars or diesel-flavored algae excreta will save suburbia, the three thousand mile Caesar salad, and the theme park vacation. The environmental movement, especially at the elite levels found in places like Aspen, is full of Harvard graduates who believe that all the drive-in espresso stations in America can be run on a combination of solar and wind power. I quarrel with these people incessantly. It seems especially tragic to me that some of the brightest people I meet are bent on mounting the tragic campaign to sustain the unsustainable in one way or another. But I have long maintained that life is essentially tragic in the sense that history won't care if we succeed or fail at carrying on the project of civilization.

The Humpty Dumpty Economy | The Collapse of '09 | The Quiet Coup: The Wall Street-Washington Corridor Banana Republic

"We are out of money." Barack Obama May 23, 2009: Obama openly says what anyone with common sense has known for quite some time: the US is broke, and will not be able to honor its financial and fiduciary obligations.

“Quantitative Easing” it is called. As a refresher for readers with real lives and better things to do, QE is how central banks describe what is essentially an act of counterfeiting. They buy bonds with money created – electronically – specifically for that purpose. Abracadabra – “money” comes into being.

We thought the Bubble Epoch was the peak in claptrap and illusions. But we were only in the foothills. The feds now pretend to bail out the economy by giving money to companies that pretend to be concerned, run by people who pretend to know what they are doing. And when they run short of money, they create more of it, pretend it is real…and pretend they can tell it what to do.
~ Germany launches Gold-To-Go ATM's | Ladies & Gentlemen: the US Is Insolvent: “We are out of money.” Obama May 23, 09 | Avalanche of Claptrap Illusions ~

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Forecast 2005: The Humpty Dumpty Economy

Jesse's Café Américain

The current trend in the United States economy is not sustainable. This is a realization that will penetrate the national consciousness slowly and unevenly. Most economists agree on how this cycle will end (even if it is only privately), but the great debate is in the details of how, and most importantly, when.

If one does not accept that the situation is unsustainable, and believes that things can continue on endlessly just as they are, with the United States consuming the bulk of the world’s savings and production because of who we are, then perhaps this is symptomatic of the national epidemic we now suffer which the ancient Greeks called hubris.

"Where else will they put their surplus if not our debt? To whom will they sell their goods if not to us? Who will teach them how to live, and govern them?" History shows that even if such trends last far beyond most expectations, eventually a day of reckoning arrives, in some frequently repeated patterns of systemic failure....

Things rarely reach a turning point when we expect it. A true sea change is slow to permeate the mentality of most people, because our experience is that what happened yesterday will happen again tomorrow, and a long cyclical turn occurs gradually and incrementally. We forget what happened even a few years ago.

Predictions of a continuance of recent trends are the common currency of most pundits...

However, and this is a common sense notion that has been nearly forgotten by our generation, we have the ability to act in such a way so as to make the improbable more likely to occur, to tempt fate by our actions. For example, there is a certain probability of sustaining an automobile accident in the normal course of our daily activities. High risk behaviors, such as speeding excessively or drinking while driving, increase the chance of an accident. If one engages in high risk activity, and nothing unusual happens, we become emboldened and think that since we were able to drink moderately and drive last month, so we can drink and drive this month and thereafter. Perhaps next month we drink a little more for an indulgence, and again nothing happens. This cycle continues until something changes our behavior, or simply ends when we literally hit the wall.

It would be our contention that the US is like such a driver, and we have been economically tempting fate with increasingly risky behaviors. We are persuaded that there is almost nothing we cannot do, almost nothing that can happen, that is beyond our control. It is the propensity for people to increase and repeat what they have been doing over time, to tempt fate through repeated and increasingly risky behavior, and to forget the possibility of a sequence of unfortunate events if you will, that gives rise to memorable events in history...

Predicting the failure of a complex system is not easy. One can examine it as a whole, and determine that it will fail, and often calculate what must change in order to allow the system to function more reliably. But it is often beyond our power to calculate exactly how it will fail, and consequently when it will fail.

This does not invalidate the observation that the system will ultimately fail. It merely underscores the unpredictability of timing a failure with the degrees of freedom inherent in a calculation with a large number of exogenous variables. It is not easy to predict exactly when a chronic DWI will demolish their automobile, but it
remains relatively predictable to say that they will do so as long as they maintain
their current mode of behavior....

There are four major types of tipping points:

• Demand: a break in the level of consumption in the US caused by the unwillingness or ability of households to incur further debt to support consumption beyond real wage growth
  
  
• Supply: a major disruption in the supply of an essential commodity like energy, food, or raw materials, or even the realization that a major commodity is in shorter supply than expected, such as silver or oil.
  
  
• Monetary: an inability of foreign central banks to continue to monetize the US trade deficit and budget deficit through the recycling of
  their trade surplus into US debt securities.
  
  
• Systemic failure: the failure of a major counter party that threatens the US financial system, particularly in the hugely leveraged derivatives market.

Two of the seals, Demand and Systemic Failure, have been broken, and the horsemen unleashed. Next comes Monetary, and then Supply, which is a Pale Horse.

There is still time to end this spiral of decline.

Source: Jesse's Americain Cafe

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The Collapse of ‘09

Daily Reckoning | By Gerald Celente

03/19/09 Rhinebeck, New York The "Panic of ‘08" will be followed by "The Collapse of ‘09." In 2008, when the world’s largest financial firms and equity markets crumbled, Wall Street’s woes preoccupied the media.

In 2009, the focus will broaden to include a range of calamities that will leave no sector unscathed. Next in line is retail, which accounts for some 70 percent of consumer spending, 26 percent of which is holiday sales.

After the numbers are tallied to reveal a dismal retail Christmas, more big chain bankruptcies will follow. Besides leaving masses unemployed, defunct retailers will leave behind thousands of empty stores. Who will rent them? Nobody!

Add to these empties commercial space vacated by defunct financial firms and an array of troubled businesses, from restaurants to architectural firms, to high tech operations, to offset printers, etc., etc. The inescapable result (that we predicted over a year ago and is only now being discussed in the business media) is a commercial real estate bust that will be costlier, wreak greater havoc and prove more intractable than the residential market decline.

Because most people don’t live and shop on Wall Street, the "Panic of ‘08" was viewed by Main Street as if from afar - even though many were losing money. But when commercial real estate crashes it will hit much closer to home. The depressive atmosphere of thinly shopped, half-vacant malls will strike emotional chords and all the senses.

In office buildings, vacant floors and empty cubicles will dampen the workday spirit of the still-employed; ever present reminders of laid-off friends and colleagues and of the fragility of employment.

Abandoned, untended business and industrial parks will highlight the already mournful scene. In cities studded with soaring towers and new construction predicated on eternal economic growth, streets lined with "For Rent/For Sale" signs will complement stilled cranes and uncompleted buildings.

As retail and commercial real estate collapse, the credit card sector and all its interrelated processing and back office support businesses will suffer and be forced to scale back. Hordes of consumers who have been living off credit cards and racking up debt to the limit will lack the funds to service their debt… much less pay it off, and they will be forced to default. Given the nearly $3 trillion in consumer debt at risk (excluding auto and mortgage) an inevitable default snowball will add momentum to the in-progress Collapse of ‘09.

While we alone predicted the "Panic of ‘08" (and even took out the domain name "Panicof08.com" on 7 November 2007), we are not alone in predicting a Depression.

The "D" word is being uttered - in some cases by those who have the most to lose and whose best interests are not served by spreading gloom and doom. "The world and country are in a depression," said celebrity tycoon Donald Trump. He then later softened the blow, downgrading it to a "virtual depression."

"Virtual" to the few who will never have to worry where the next dollar will come from, it will be painfully real and hardly virtual to the multitudes who are and will be worrying. The virally proliferating Greatest Depression is the Trend of Trends for 2009.

Even so, beware! Over the course of free-falling 2009, the word from most official sources will be "recession," and from the few mainstream trophy pessimists,
"deep recession."

For example, the oft-quoted naysayer, Nouriel Roubini, New York University professor of economics, forecasts a two year recession … not Depression. On the sunnier side of Wall Street, the Federal Reserve predicts the US economy will contract only through the middle of 2009 and pledged, "In any event, the Committee agreed to take whatever steps were necessary to support the recovery.”

What "steps?" The Bernanke Two-Step? Adjust interest rates or print more money? Neither stopped the credit crisis from worsening, the real estate market from tanking or the stock markets from crashing.

It was Fed finagling, Washington deregulation and Wall Street’s compulsive gambling that created the crisis. To trust or to seriously consider pronouncements, analyses and predictions made by any of these sources is an exercise in willful self-deception. Yet, with pensions, IRAs, 401ks, stocks and mutual funds evaporating, many of those most affected deny reality and take hope that forecasts made by proven incompetents will miraculously restore their losses.

Throughout the many years leading up to what we term the "Greatest Depression," The Trends Research Institute provided copious data and Globalnomic analysis to support our forecasts of economic upheaval. In the past year alone, we have provided so much hard evidence (housings starts, home sales, foreclosures, bankruptcies, bank failures, unemployment figures, stock indices, leading economic indicators, retail sales, etc.) that further elaboration should be superfluous.

Those waiting to hear the "D" word from economic experts, talking heads and TV anchors before taking action will most certainly regret their indecisiveness.

Absent from the economic scenarios ranging from second quarter recovery, deep recession and "virtual" depression are the multiplicity of social, environmental, health, political, emotional/psychological and geopolitical factors that point beyond just Depression. They point to The Decline and Fall of Empire America.

Well before Inauguration Day, Barack Obama was cast as the next Franklin Delano Roosevelt. If he follows in FDR’s footsteps he could freeze deposits by declaring a "holiday" to stop a run on the banks. While FDIC insurance may cover deposits, even after banks reopen, withdrawal amounts may be restricted. (As the Argentine government did in 2001-2002.)

Author’s Note: Suspicious of the soundness of the banking system, I requested to withdraw a substantial sum from our Key Bank account, leaving funds sufficient to cover ongoing business operations. First they tried to dissuade me, then they stonewalled me, and finally they turned openly hostile.

I was forced to sign a series of documents, including one acknowledging that since I was carrying a large sum I could be the target of a robbery. To enhance that possibility, the teller slammed down the bag of cash on the counter and publicly announced the sum.

Despite repeated requests in the days preceding my withdrawal to get the cash in hundreds, they gave it to me in twenties, making for a bag five times the size and more robber-friendly. When I complained to the bank manager who had processed the request, the response amounted to "take it or leave it."

This will not be an isolated event. If you attempt to withdraw a large chunk of money from your account, negotiate the details in advance and anticipate possible hassle and obstruction.

We’ve heard similar accounts from clients and Trends Journal subscribers who, over the past several months, tried to close out mutual funds, 401ks and assorted sinking equities. They were dissuaded, cajoled, belittled and arm-twisted by brokers desperate to keep their accounts. Many caved in under the pressure, didn’t close them and lost most of what they had.

So, we leave you with a Greatest Depression consideration: How safe is your money? How sound is your bank? At the end of November, Citigroup, once America’s largest bank, was on the rocks. Fifty-two thousand employees were laid off. In just three days its stock lost more than half its value. Rumors swirled that Citi was so desperate they were looking to sell or split up the company.

Is your money deposited in a local bank whose reputation you can bank on? Are you with a teetering giant or a poorly-managed regional? If either of the latter, it would be in your best interest to assess the risks.

Take some out if you think there is risk; take it all out if you think there’s high risk. You may consider spreading it around and even banking abroad … after all, this is the Global Age.

Source: Daily Reckoning

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The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time.

The Quiet Coup: The Wall Street-Washington Corridor Banana Republic

The Atlantic | Simon Johnson

Image credit: Jim Bourg/Reuters/Corbis

One thing you learn rather quickly when working at the International Monetary Fund is that no one is ever very happy to see you. Typically, your “clients” come in only after private capital has abandoned them, after regional trading-bloc partners have been unable to throw a strong enough lifeline, after last-ditch attempts to borrow from powerful friends like China or the European Union have fallen through. You’re never at the top of anyone’s dance card.

The reason, of course, is that the IMF specializes in telling its clients what they don’t want to hear. I should know; I pressed painful changes on many foreign officials during my time there as chief economist in 2007 and 2008. And I felt the effects of IMF pressure, at least indirectly, when I worked with governments in Eastern Europe as they struggled after 1989, and with the private sector in Asia and Latin America during the crises of the late 1990s and early 2000s. Over that time, from every vantage point, I saw firsthand the steady flow of officials—from Ukraine, Russia, Thailand, Indonesia, South Korea, and elsewhere—trudging to the fund when circumstances were dire and all else had failed.

Every crisis is different, of course. Ukraine faced hyperinflation in 1994; Russia desperately needed help when its short-term-debt rollover scheme exploded in the summer of 1998; the Indonesian rupiah plunged in 1997, nearly leveling the corporate economy; that same year, South Korea’s 30-year economic miracle ground to a halt when foreign banks suddenly refused to extend new credit.

But I must tell you, to IMF officials, all of these crises looked depressingly similar. Each country, of course, needed a loan, but more than that, each needed to make big changes so that the loan could really work. Almost always, countries in crisis need to learn to live within their means after a period of excess—exports must be increased, and imports cut—and the goal is to do this without the most horrible of recessions. Naturally, the fund’s economists spend time figuring out the policies—budget, money supply, and the like—that make sense in this context. Yet the economic solution is seldom very hard to work out.

No, the real concern of the fund’s senior staff, and the biggest obstacle to recovery, is almost invariably the politics of countries in crisis.

Typically, these countries are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit—and, most of the time, genteel—oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon—correctly, in most cases—that their political connections will allow them to push onto the government any substantial problems that arise.

In Russia, for instance, the private sector is now in serious trouble because, over the past five years or so, it borrowed at least $490 billion from global banks and investors on the assumption that the country’s energy sector could support a permanent increase in consumption throughout the economy. As Russia’s oligarchs spent this capital, acquiring other companies and embarking on ambitious investment plans that generated jobs, their importance to the political elite increased. Growing political support meant better access to lucrative contracts, tax breaks, and subsidies. And foreign investors could not have been more pleased; all other things being equal, they prefer to lend money to people who have the implicit backing of their national governments, even if that backing gives off the faint whiff of corruption.

But inevitably, emerging-market oligarchs get carried away; they waste money and build massive business empires on a mountain of debt. Local banks, sometimes pressured by the government, become too willing to extend credit to the elite and to those who depend on them. Overborrowing always ends badly, whether for an individual, a company, or a country. Sooner or later, credit conditions become tighter and no one will lend you money on anything close to affordable terms.

The downward spiral that follows is remarkably steep. 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.

Eventually, as the oligarchs in Putin’s Russia now realize, some within the elite have to lose out before recovery can begin. It’s a game of musical chairs: there just aren’t enough currency reserves to take care of everyone, and the government cannot afford to take over private-sector debt completely.

So the IMF staff looks into the eyes of the minister of finance and decides whether the government is serious yet. The fund will give even a country like Russia a loan eventually, but first it wants to make sure Prime Minister Putin is ready, willing, and able to be tough on some of his friends. If he is not ready to throw former pals to the wolves, the fund can wait. And when he is ready, the fund is happy to make helpful suggestions—particularly with regard to wresting control of the banking system from the hands of the most incompetent and avaricious “entrepreneurs.”

Of course, Putin’s ex-friends will fight back. They’ll mobilize allies, work the system, and put pressure on other parts of the government to get additional subsidies. In extreme cases, they’ll even try subversion—including calling up their contacts in the American foreign-policy establishment, as the Ukrainians did with some success in the late 1990s.

Many IMF programs “go off track” (a euphemism) precisely because the government can’t stay tough on erstwhile cronies, and the consequences are massive inflation or other disasters. A program “goes back on track” once the government prevails or powerful oligarchs sort out among themselves who will govern—and thus win or lose—under the IMF-supported plan. The real fight in Thailand and Indonesia in 1997 was about which powerful families would lose their banks. In Thailand, it was handled relatively smoothly. In Indonesia, it led to the fall of President Suharto and economic chaos.

From long years of experience, the IMF staff knows its program will succeed—stabilizing the economy and enabling growth—only if at least some of the powerful oligarchs who did so much to create the underlying problems take a hit. This is the problem of all emerging markets.

Becoming a Banana Republic

In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn’t be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn’t roll over their debt did, in fact, become unable to pay. This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the U.S. financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people.

But there’s a deeper and more disturbing similarity: elite business interests—financiers, in the case of the U.S.—played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.

Top investment bankers and government officials like to lay the blame for the current crisis on the lowering of U.S. interest rates after the dotcom bust or, even better—in a “buck stops somewhere else” sort of way—on the flow of savings out of China. Some on the right like to complain about Fannie Mae or Freddie Mac, or even about longer-standing efforts to promote broader homeownership. And, of course, it is axiomatic to everyone that the regulators responsible for “safety and soundness” were fast asleep at the wheel.

But these various policies—lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership—had something in common. Even though some are traditionally associated with Democrats and some with Republicans, they all benefited the financial sector. Policy changes that might have forestalled the crisis but would have limited the financial sector’s profits—such as Brooksley Born’s now-famous attempts to regulate credit-default swaps at the Commodity Futures Trading Commission, in 1998—were ignored or swept aside.

The financial industry has not always enjoyed such favored treatment. But for the past 25 years or so, finance has boomed, becoming ever more powerful. The boom began with the Reagan years, and it only gained strength with the deregulatory policies of the Clinton and George W. Bush administrations. Several other factors helped fuel the financial industry’s ascent. Paul Volcker’s monetary policy in the 1980s, and the increased volatility in interest rates that accompanied it, made bond trading much more lucrative. The invention of securitization, interest-rate swaps, and credit-default swaps greatly increased the volume of transactions that bankers could make money on. And an aging and increasingly wealthy population invested more and more money in securities, helped by the invention of the IRA and the 401(k) plan. Together, these developments vastly increased the profit opportunities in financial services.



Not surprisingly, Wall Street ran with these opportunities. 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. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007.

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.


The Wall Street–Washington Corridor

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.

One channel of influence was, of course, the flow of individuals between Wall Street and Washington. Robert Rubin, once the co-chairman of Goldman Sachs, served in Washington as Treasury secretary under Clinton, and later became chairman of Citigroup’s executive committee. Henry Paulson, CEO of Goldman Sachs during the long boom, became Treasury secretary under George W.Bush. John Snow, Paulson’s predecessor, left to become chairman of Cerberus Capital Management, a large private-equity firm that also counts Dan Quayle among its executives. Alan Greenspan, after leaving the Federal Reserve, became a consultant to Pimco, perhaps the biggest player in international bond markets.

These personal connections were multiplied many times over at the lower levels of the past three presidential administrations, strengthening the ties between Washington and Wall Street. It has become something of a tradition for Goldman Sachs employees to go into public service after they leave the firm. The flow of Goldman alumni—including Jon Corzine, now the governor of New Jersey, along with Rubin and Paulson—not only placed people with Wall Street’s worldview in the halls of power; it also helped create an image of Goldman (inside the Beltway, at least) as an institution that was itself almost a form of public service.

Wall Street is a very seductive place, imbued with an air of power. Its executives truly believe that they control the levers that make the world go round. A civil servant from Washington invited into their conference rooms, even if just for a meeting, could be forgiven for falling under their sway. Throughout my time at the IMF, I was struck by the easy access of leading financiers to the highest U.S. government officials, and the interweaving of the two career tracks. I vividly remember a meeting in early 2008—attended by top policy makers from a handful of rich countries—at which the chair casually proclaimed, to the room’s general approval, that the best preparation for becoming a central-bank governor was to work first as an investment banker.

A whole generation of policy makers has been mesmerized by Wall Street, always and utterly convinced that whatever the banks said was true. Alan Greenspan’s pronouncements in favor of unregulated financial markets are well known. Yet Greenspan was hardly alone. This is what Ben Bernanke, the man who succeeded him, said in 2006: “The management of market risk and credit risk has become increasingly sophisticated. … Banking organizations of all sizes have made substantial strides over the past two decades in their ability to measure and manage risks.”

Of course, this was mostly an illusion. Regulators, legislators, and academics almost all assumed that the managers of these banks knew what they were doing. In retrospect, they didn’t. AIG’s Financial Products division, for instance, made $2.5 billion in pretax profits in 2005, largely by selling underpriced insurance on complex, poorly understood securities. Often described as “picking up nickels in front of a steamroller,” this strategy is profitable in ordinary years, and catastrophic in bad ones. As of last fall, AIG had outstanding insurance on more than $400 billion in securities. To date, the U.S. government, in an effort to rescue the company, has committed about $180 billion in investments and loans to cover losses that AIG’s sophisticated risk modeling had said were virtually impossible.

Wall Street’s seductive power extended even (or especially) to finance and economics professors, historically confined to the cramped offices of universities and the pursuit of Nobel Prizes. As mathematical finance became more and more essential to practical finance, professors increasingly took positions as consultants or partners at financial institutions. Myron Scholes and Robert Merton, Nobel laureates both, were perhaps the most famous; they took board seats at the hedge fund Long-Term Capital Management in 1994, before the fund famously flamed out at the end of the decade. But many others beat similar paths. This migration gave the stamp of academic legitimacy (and the intimidating aura of intellectual rigor) to the burgeoning world of high finance.

As more and more of the rich made their money in finance, the cult of finance seeped into the culture at large. Works like Barbarians at the Gate, Wall Street, and Bonfire of the Vanities—all intended as cautionary tales—served only to increase Wall Street’s mystique. Michael Lewis noted in Portfolio last year that when he wrote Liar’s Poker, an insider’s account of the financial industry, in 1989, he had hoped the book might provoke outrage at Wall Street’s hubris and excess. Instead, he found himself “knee-deep in letters from students at Ohio State who wanted to know if I had any other secrets to share. … They’d read my book as a how-to manual.” Even Wall Street’s criminals, like Michael Milken and Ivan Boesky, became larger than life. In a society that celebrates the idea of making money, it was easy to infer that the interests of the financial sector were the same as the interests of the country—and that the winners in the financial sector knew better what was good for America than did the career civil servants in Washington. Faith in free financial markets grew into conventional wisdom—trumpeted on the editorial pages of The Wall Street Journal and on the floor of Congress.

From this confluence of campaign finance, personal connections, and ideology there flowed, in just the past decade, a river of deregulatory policies that is, in hindsight, astonishing:

• insistence on free movement of capital across borders;
  
  
• the repeal of Depression-era regulations separating commercial and investment banking;
  
  
• a congressional ban on the regulation of credit-default swaps;
  
  
• major increases in the amount of leverage allowed to investment banks;
  
  
• a light (dare I say invisible?) hand at the Securities and Exchange Commission in its regulatory enforcement;
  
  
• an international agreement to allow banks to measure their own riskiness;
  
  
• and an intentional failure to update regulations so as to keep up with the tremendous pace of financial innovation.

The mood that accompanied these measures in Washington seemed to swing between nonchalance and outright celebration: finance unleashed, it was thought, would continue to propel the economy to greater heights.


America’s Oligarchs and the Financial Crisis

The oligarchy and the government policies that aided it did not alone cause the financial crisis that exploded last year. Many other factors contributed, including excessive borrowing by households and lax lending standards out on the fringes of the financial world. But major commercial and investment banks—and the hedge funds that ran alongside them—were the big beneficiaries of the twin housing and equity-market bubbles of this decade, their profits fed by an ever-increasing volume of transactions founded on a relatively small base of actual physical assets. Each time a loan was sold, packaged, securitized, and resold, banks took their transaction fees, and the hedge funds buying those securities reaped ever-larger fees as their holdings grew.

Because everyone was getting richer, and the health of the national economy depended so heavily on growth in real estate and finance, no one in Washington had any incentive to question what was going on. Instead, Fed Chairman Greenspan and President Bush insisted metronomically that the economy was fundamentally sound and that the tremendous growth in complex securities and credit-default swaps was evidence of a healthy economy where risk was distributed safely.

In the summer of 2007, signs of strain started appearing. The boom had produced so much debt that even a small economic stumble could cause major problems, and rising delinquencies in subprime mortgages proved the stumbling block. Ever since, the financial sector and the federal government have been behaving exactly the way one would expect them to, in light of past emerging-market crises.

By now, the princes of the financial world have of course been stripped naked as leaders and strategists—at least in the eyes of most Americans. But as the months have rolled by, financial elites have continued to assume that their position as the economy’s favored children is safe, despite the wreckage they have caused.

Stanley O’Neal, the CEO of Merrill Lynch, pushed his firm heavily into the mortgage-backed-securities market at its peak in 2005 and 2006; in October 2007, he acknowledged, “The bottom line is, we—I—got it wrong by being overexposed to subprime, and we suffered as a result of impaired liquidity in that market. No one is more disappointed than I am in that result.” O’Neal took home a $14 million bonus in 2006; in 2007, he walked away from Merrill with a severance package worth $162 million, although it is presumably worth much less today.

In October, John Thain, Merrill Lynch’s final CEO, reportedly lobbied his board of directors for a bonus of $30 million or more, eventually reducing his demand to $10 million in December; he withdrew the request, under a firestorm of protest, only after it was leaked to The Wall Street Journal. Merrill Lynch as a whole was no better: it moved its bonus payments, $4 billion in total, forward to December, presumably to avoid the possibility that they would be reduced by Bank of America, which would own Merrill beginning on January 1. Wall Street paid out $18 billion in year-end bonuses last year to its New York City employees, after the government disbursed $243 billion in emergency assistance to the financial sector.

In a financial panic, the government must respond with both speed and overwhelming force. The root problem is uncertainty—in our case, uncertainty about whether the major banks have sufficient assets to cover their liabilities. Half measures combined with wishful thinking and a wait-and-see attitude cannot overcome this uncertainty. And the longer the response takes, the longer the uncertainty will stymie the flow of credit, sap consumer confidence, and cripple the economy—ultimately making the problem much harder to solve. Yet the principal characteristics of the government’s response to the financial crisis have been delay, lack of transparency, and an unwillingness to upset the financial sector.

The response so far is perhaps best described as “policy by deal”: when a major financial institution gets into trouble, the Treasury Department and the Federal Reserve engineer a bailout over the weekend and announce on Monday that everything is fine. In March 2008, Bear Stearns was sold to JP Morgan Chase in what looked to many like a gift to JP Morgan. (Jamie Dimon, JP Morgan’s CEO, sits on the board of directors of the Federal Reserve Bank of New York, which, along with the Treasury Department, brokered the deal.) In September, we saw the sale of Merrill Lynch to Bank of America, the first bailout of AIG, and the takeover and immediate sale of Washington Mutual to JP Morgan—all of which were brokered by the government. In October, nine large banks were recapitalized on the same day behind closed doors in Washington. This, in turn, was followed by additional bailouts for Citigroup, AIG, Bank of America, Citigroup (again), and AIG (again).

Some of these deals may have been reasonable responses to the immediate situation. But it was never clear (and still isn’t) what combination of interests was being served, and how. Treasury and the Fed did not act according to any publicly articulated principles, but just worked out a transaction and claimed it was the best that could be done under the circumstances. This was late-night, backroom dealing, pure and simple.

Throughout the crisis, the government has taken extreme care not to upset the interests of the financial institutions, or to question the basic outlines of the system that got us here. In September 2008, Henry Paulson asked Congress for $700 billion to buy toxic assets from banks, with no strings attached and no judicial review of his purchase decisions. Many observers suspected that the purpose was to overpay for those assets and thereby take the problem off the banks’ hands—indeed, that is the only way that buying toxic assets would have helped anything. Perhaps because there was no way to make such a blatant subsidy politically acceptable, that plan was shelved.

Instead, the money was used to recapitalize banks, buying shares in them on terms that were grossly favorable to the banks themselves. As the crisis has deepened and financial institutions have needed more help, the government has gotten more and more creative in figuring out ways to provide banks with subsidies that are too complex for the general public to understand. The first AIG bailout, which was on relatively good terms for the taxpayer, was supplemented by three further bailouts whose terms were more AIG-friendly. The second Citigroup bailout and the Bank of America bailout included complex asset guarantees that provided the banks with insurance at below-market rates. The third Citigroup bailout, in late February, converted government-owned preferred stock to common stock at a price significantly higher than the market price—a subsidy that probably even most Wall Street Journal readers would miss on first reading. And the convertible preferred shares that the Treasury will buy under the new Financial Stability Plan give the conversion option (and thus the upside) to the banks, not the government.

This latest plan—which is likely to provide cheap loans to hedge funds and others so that they can buy distressed bank assets at relatively high prices—has been heavily influenced by the financial sector, and Treasury has made no secret of that. As Neel Kashkari, a senior Treasury official under both Henry Paulson and Tim Geithner (and a Goldman alum) told Congress in March, “We had received inbound unsolicited proposals from people in the private sector saying, ‘We have capital on the sidelines; we want to go after [distressed bank] assets.’” And the plan lets them do just that: “By marrying government capital—taxpayer capital—with private-sector capital and providing financing, you can enable those investors to then go after those assets at a price that makes sense for the investors and at a price that makes sense for the banks.” Kashkari didn’t mention anything about what makes sense for the third group involved: the taxpayers.

Even leaving aside fairness to taxpayers, the government’s velvet-glove approach with the banks is deeply troubling, for one simple reason: it is inadequate to change the behavior of a financial sector accustomed to doing business on its own terms, at a time when that behavior must change. As an unnamed senior bank official said to The New York Times last fall, “It doesn’t matter how much Hank Paulson gives us, no one is going to lend a nickel until the economy turns.” But there’s the rub: the economy can’t recover until the banks are healthy and willing to lend.


The Way Out

Looking just at the financial crisis (and leaving aside some problems of the larger economy), we face at least two major, interrelated problems. The first is a desperately ill banking sector that threatens to choke off any incipient recovery that the fiscal stimulus might generate. The second is a political balance of power that gives the financial sector a veto over public policy, even as that sector loses popular support.

Big banks, it seems, have only gained political strength since the crisis began. And this is not surprising. With the financial system so fragile, the damage that a major bank failure could cause—Lehman was small relative to Citigroup or Bank of America—is much greater than it would be during ordinary times. The banks have been exploiting this fear as they wring favorable deals out of Washington. Bank of America obtained its second bailout package (in January) after warning the government that it might not be able to go through with the acquisition of Merrill Lynch, a prospect that Treasury did not want to consider.

The challenges the United States faces are familiar territory to the people at the IMF. If you hid the name of the country and just showed them the numbers, there is no doubt what old IMF hands would say: nationalize troubled banks and break them up as necessary.

In some ways, of course, the government has already taken control of the banking system. It has essentially guaranteed the liabilities of the biggest banks, and it is their only plausible source of capital today. Meanwhile, the Federal Reserve has taken on a major role in providing credit to the economy—the function that the private banking sector is supposed to be performing, but isn’t. Yet there are limits to what the Fed can do on its own; consumers and businesses are still dependent on banks that lack the balance sheets and the incentives to make the loans the economy needs, and the government has no real control over who runs the banks, or over what they do.

At the root of the banks’ problems are the large losses they have undoubtedly taken on their securities and loan portfolios. But they don’t want to recognize the full extent of their losses, because that would likely expose them as insolvent. So they talk down the problem, and ask for handouts that aren’t enough to make them healthy (again, they can’t reveal the size of the handouts that would be necessary for that), but are enough to keep them upright a little longer. This behavior is corrosive: unhealthy banks either don’t lend (hoarding money to shore up reserves) or they make desperate gambles on high-risk loans and investments that could pay off big, but probably won’t pay off at all. In either case, the economy suffers further, and as it does, bank assets themselves continue to deteriorate—creating a highly destructive vicious cycle.

To break this cycle, the government must force the banks to acknowledge the scale of their problems. As the IMF understands (and as the U.S. government itself has insisted to multiple emerging-market countries in the past), the most direct way to do this is nationalization. Instead, Treasury is trying to negotiate bailouts bank by bank, and behaving as if the banks hold all the cards—contorting the terms of each deal to minimize government ownership while forswearing government influence over bank strategy or operations. Under these conditions, cleaning up bank balance sheets is impossible.

Nationalization would not imply permanent state ownership. The IMF’s advice would be, essentially: scale up the standard Federal Deposit Insurance Corporation process. An FDIC “intervention” is basically a government-managed bankruptcy procedure for banks. It would allow the government to wipe out bank shareholders, replace failed management, clean up the balance sheets, and then sell the banks back to the private sector. The main advantage is immediate recognition of the problem so that it can be solved before it grows worse.

The government needs to inspect the balance sheets and identify the banks that cannot survive a severe recession. These banks should face a choice: write down your assets to their true value and raise private capital within 30 days, or be taken over by the government. The government would write down the toxic assets of banks taken into receivership—recognizing reality—and transfer those assets to a separate government entity, which would attempt to salvage whatever value is possible for the taxpayer (as the Resolution Trust Corporation did after the savings-and-loan debacle of the 1980s). The rump banks—cleansed and able to lend safely, and hence trusted again by other lenders and investors—could then be sold off.

Cleaning up the megabanks will be complex. And it will be expensive for the taxpayer; according to the latest IMF numbers, the cleanup of the banking system would probably cost close to $1.5 trillion (or 10 percent of our GDP) in the long term. But only decisive government action—exposing the full extent of the financial rot and restoring some set of banks to publicly verifiable health—can cure the financial sector as a whole.

This may seem like strong medicine. But in fact, while necessary, it is insufficient. The second problem the U.S. faces—the power of the oligarchy—is just as important as the immediate crisis of lending. And the advice from the IMF on this front would again be simple: break the oligarchy.

Oversize institutions disproportionately influence public policy; the major banks we have today draw much of their power from being too big to fail. Nationalization and re-privatization would not change that; while the replacement of the bank executives who got us into this crisis would be just and sensible, ultimately, the swapping-out of one set of powerful managers for another would change only the names of the oligarchs.

Ideally, big banks should be sold in medium-size pieces, divided regionally or by type of business. Where this proves impractical—since we’ll want to sell the banks quickly—they could be sold whole, but with the requirement of being broken up within a short time. Banks that remain in private hands should also be subject to size limitations.

This may seem like a crude and arbitrary step, but it is the best way to limit the power of individual institutions in a sector that is essential to the economy as a whole. Of course, some people will complain about the “efficiency costs” of a more fragmented banking system, and these costs are real. But so are the costs when a bank that is too big to fail—a financial weapon of mass self-destruction—explodes. Anything that is too big to fail is too big to exist.

To ensure systematic bank breakup, and to prevent the eventual reemergence of dangerous behemoths, we also need to overhaul our antitrust legislation. Laws put in place more than 100 years ago to combat industrial monopolies were not designed to address the problem we now face. The problem in the financial sector today is not that a given firm might have enough market share to influence prices; it is that one firm or a small set of interconnected firms, by failing, can bring down the economy. The Obama administration’s fiscal stimulus evokes FDR, but what we need to imitate here is Teddy Roosevelt’s trust-busting.

Caps on executive compensation, while redolent of populism, might help restore the political balance of power and deter the emergence of a new oligarchy. Wall Street’s main attraction—to the people who work there and to the government officials who were only too happy to bask in its reflected glory—has been the astounding amount of money that could be made. Limiting that money would reduce the allure of the financial sector and make it more like any other industry.

Still, outright pay caps are clumsy, especially in the long run. And most money is now made in largely unregulated private hedge funds and private-equity firms, so lowering pay would be complicated. Regulation and taxation should be part of the solution. Over time, though, the largest part may involve more transparency and competition, which would bring financial-industry fees down. To those who say this would drive financial activities to other countries, we can now safely say: fine.


Two Paths

To paraphrase Joseph Schumpeter, the early-20th-century economist, everyone has elites; the important thing is to change them from time to time. If the U.S. were just another country, coming to the IMF with hat in hand, I might be fairly optimistic about its future. Most of the emerging-market crises that I’ve mentioned ended relatively quickly, and gave way, for the most part, to relatively strong recoveries. But this, alas, brings us to the limit of the analogy between the U.S. and emerging markets.

Emerging-market countries have only a precarious hold on wealth, and are weaklings globally. When they get into trouble, they quite literally run out of money—or at least out of foreign currency, without which they cannot survive. They must make difficult decisions; ultimately, aggressive action is baked into the cake. But the U.S., of course, is the world’s most powerful nation, rich beyond measure, and blessed with the exorbitant privilege of paying its foreign debts in its own currency, which it can print. As a result, it could very well stumble along for years—as Japan did during its lost decade—never summoning the courage to do what it needs to do, and never really recovering. A clean break with the past—involving the takeover and cleanup of major banks—hardly looks like a sure thing right now. Certainly no one at the IMF can force it.

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.

Boris Fyodorov, the late finance minister of Russia, struggled for much of the past 20 years against oligarchs, corruption, and abuse of authority in all its forms. He liked to say that confusion and chaos were very much in the interests of the powerful—letting them take things, legally and illegally, with impunity. When inflation is high, who can say what a piece of property is really worth? When the credit system is supported by byzantine government arrangements and backroom deals, how do you know that you aren’t being fleeced?

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. Creditors take further hits and confidence falls further. The Asian economies that export manufactured goods are devastated, and the commodity producers in Latin America and Africa are not much better off. 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.


Simon Johnson, a professor at MIT’s Sloan School of Management, was the chief economist at the International Monetary Fund during 2007 and 2008. He blogs about the financial crisis at baselinescenario.com, along with James Kwak, who also contributed to this essay.

Source: The Atlantic

Pentagon Prepares for Economic Warfare | US Army War College: Constant Conflict: Information & Culture Warfare

"We are out of money." Barack Obama May 23, 2009: Obama openly says what anyone with common sense has known for quite some time: the US is broke, and will not be able to honor its financial and fiduciary obligations.

“Quantitative Easing” it is called. As a refresher for readers with real lives and better things to do, QE is how central banks describe what is essentially an act of counterfeiting. They buy bonds with money created – electronically – specifically for that purpose. Abracadabra – “money” comes into being.

We thought the Bubble Epoch was the peak in claptrap and illusions. But we were only in the foothills. The feds now pretend to bail out the economy by giving money to companies that pretend to be concerned, run by people who pretend to know what they are doing. And when they run short of money, they create more of it, pretend it is real…and pretend they can tell it what to do.
~ Germany launches Gold-To-Go ATM's | Ladies & Gentlemen: the US Is Insolvent: “We are out of money.” Obama May 23, 09 | Avalanche of Claptrap Illusions ~

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Pentagon preps for economic warfare

Politico | EAMON JAVERS; 4/9/09 4:18 AM EDT

The Pentagon sponsored a first-of-its-kind war game last month focused not on bullets and bombs — but on how hostile nations might seek to cripple the U.S. economy, a scenario made all the more real by the global financial crisis.

The two-day event near Ft. Meade, Maryland, had all the earmarks of a regular war game. Participants sat along a V-shaped set of desks beneath an enormous wall of video monitors displaying economic data, according to the accounts of three participants.

“It felt a little bit like Dr. Strangelove,” one person who was at the previously undisclosed exercise told POLITICO.

But instead of military brass plotting America’s defense, it was hedge-fund managers, professors and executives from at least one investment bank, UBS – all invited by the Pentagon to play out global scenarios that could shift the balance of power between the world’s leading economies.

Their efforts were carefully observed and recorded by uniformed military officers and members of the U.S. intelligence community.

In the end, there was sobering news for the United States – the savviest economic warrior proved to be China, a growing economic power that strengthened its position the most over the course of the war-game.

The United States remained the world’s largest economy but significantly degraded its standing in a series of financial skirmishes with Russia, participants said.

The war game demonstrated that in post-Sept. 11 world, the Pentagon is thinking about a wide range of threats to America’s position in the world, including some that could come far from the battlefield.

And it’s hardly science fiction. China recently shook the value of the dollar in global currency markets merely by questioning whether the recession put China’s $1 trillion in U.S. government bond holdings at risk – forcing President Barack Obama to issue a hasty defense of the dollar.

“This was an example of the changing nature of conflict,” said Paul Bracken, a professor and expert in private equity at the Yale School of Management who attended the sessions. “The purpose of the game is not really to predict the future, but to discover the issues you need to be thinking about.”

Several participants said the event had been in the planning stages well before the stock market crash of September, but the real-world market calamity was on the minds of many in the room. “It loomed large over what everybody was doing,” said Bracken.

“Why would the military care about global capital flows at all?” asked another person who was there. “Because as the global financial crisis plays out, there could be real world consequences, including failed states. We’ve already seen riots in the United Kingdom and the Balkans.”

The Office of the Secretary of Defense hosted the two-day event March 17 and 18 at the Warfare Analysis Laboratory in Laurel, MD. That facility, run by the Johns Hopkins University Applied Physics Laboratory, typically hosts military officials planning intricate combat scenarios.

A spokesperson for the Applied Physics Laboratory confirmed the event, and said it was the first purely economic war game the facility has hosted. All three participants said they had been told it was the first time the Pentagon hosted a purely economic war game. A Pentagon spokesman would say only that he was not aware of the exercise.

The event was unclassified but has not been made public before. It is regarded as so sensitive that several people who participated declined to discuss the details with POLITICO. Said Steven Halliwell, managing director of a hedge fund called River Capital Management, “I’m not prepared to talk about this. I’m sorry, but I can’t talk to you.”

Officials at UBS also declined to comment.

Participants described the event as a series of simulated global calamities, including the collapse of North Korea, Russian manipulation of natural gas prices, and increasing tension between China and Taiwan. “They wanted to see who makes loans to help out, what does each team do to get the other countries involved, and who decides to simply let the North Koreans collapse,” said a participant.

There were five teams: The United States, Russia, China, East Asia and “all others.” They were overseen by a “White Cell” group that functioned as referees, who decided the impact of the moves made by each team as they struggled for economic dominance.

At the end of the two days, the Chinese team emerged as the victors of the overall game – largely because the Russian and American teams had made so many moves against each other that they damaged their own standing to the benefit of the Chinese.

Bracken says he left the event with two important insights – first, that the United States needs an integrated approach to managing financial and what the Pentagon calls “kinetic” – or shooting – wars. For example he says, the U.S. Navy is involved in blockading Iran, and the U.S. is also conducting economic war against Iran in the form of sanctions. But he argues there isn’t enough coordination between the two efforts.

And second, Bracken says, the event left him questioning one prevailing assumption about economic warfare, that the Chinese would never dump dollars on the global market to attack the US economy because it would harm their own holdings at the same time. Bracken said the Chinese have a middle option between dumping and holding US dollars – they could sell dollars in increments, ratcheting up economic uncertainty in the United States without wiping out their own savings. “There’s a graduated spectrum of options here,” Bracken said.

For those who hadn’t been to a Pentagon event before, the sheer technological capacity of the Warfare Analysis Laboratory was impressive. “It was surprisingly realistic,” said a participant.

Still, the event conjures images of the ultimate Hollywood take on computer strategizing: the 1983 film “War Games” in which a young computer hacker nearly triggers a nuclear apocalypse.

The film and the reality had one similarity: The characters in the movie used a computer called WOPR, or War Operation Plan Response. The computer system used by the real life war-gamers? It was called WALRUS, or Warfare Analysis Laboratory Registration and User Website.

Source: Politico.com

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Constant Conflict

Parameters, Summer 1997, pp. 4-14. | Ralph Peters

The de facto role of the US armed forces will be to keep the world safe for our economy and open to our cultural assault. To those ends, we will do a fair amount of killing.

Culture is fate. Countries, clans, military services, and individual soldiers are products of their respective cultures, and they are either empowered or imprisoned. The majority of the world's inhabitants are prisoners of their cultures, and they will rage against inadequacies they cannot admit, cannot bear, and cannot escape.

We have entered an age of constant conflict. Information is at once our core commodity and the most destabilizing factor of our time. Until now, history has been a quest to acquire information; today, the challenge lies in managing information. Those of us who can sort, digest, synthesize, and apply relevant knowledge soar--professionally, financially, politically, militarily, and socially. We, the winners, are a minority.

For the world masses, devastated by information they cannot manage or effectively interpret, life is "nasty, brutish . . . and short-circuited." The general pace of change is overwhelming, and information is both the motor and signifier of change. Those humans, in every country and region, who cannot understand the new world, or who cannot profit from its uncertainties, or who cannot reconcile themselves to its dynamics, will become the violent enemies of their inadequate governments, of their more fortunate neighbors, and ultimately of the United States. We are entering a new American century, in which we will become still wealthier, culturally more lethal, and increasingly powerful. We will excite hatreds without precedent.

We live in an age of multiple truths. He who warns of the "clash of civilizations" is incontestably right; simultaneously, we shall see higher levels of constructive trafficking between civilizations than ever before. The future is bright--and it is also very dark. More men and women will enjoy health and prosperity than ever before, yet more will live in poverty or tumult, if only because of the ferocity of demographics. There will be more democracy--that deft liberal form of imperialism--and greater popular refusal of democracy. One of the defining bifurcations of the future will be the conflict between information masters and information victims.

In the past, information empowerment was largely a matter of insider and outsider, as elementary as the division of society into the literate and illiterate. While superior information--often embodied in military technology--killed throughout history, its effects tended to be politically decisive but not personally intrusive (once the raping and pillaging were done). Technology was more apt to batter down the city gates than to change the nature of the city. The rise of the modern West broke the pattern. Whether speaking of the dispossessions and dislocations caused in Europe through the introduction of machine-driven production or elsewhere by the great age of European imperialism, an explosion of disorienting information intruded ever further into Braudel's "structures of everyday life." Historically, ignorance was bliss. Today, ignorance is no longer possible, only error.

The contemporary expansion of available information is immeasurable, uncontainable, and destructive to individuals and entire cultures unable to master it. The radical fundamentalists--the bomber in Jerusalem or Oklahoma City, the moral terrorist on the right or the dictatorial multiculturalist on the left--are all brothers and sisters, all threatened by change, terrified of the future, and alienated by information they cannot reconcile with their lives or ambitions. They ache to return to a golden age that never existed, or to create a paradise of their own restrictive design. They no longer understand the world, and their fear is volatile.

Information destroys traditional jobs and traditional cultures; it seduces, betrays, yet remains invulnerable. How can you counterattack the information others have turned upon you? There is no effective option other than competitive performance. For those individuals and cultures that cannot join or compete with our information empire, there is only inevitable failure (of note, the internet is to the techno-capable disaffected what the United Nations is to marginal states: it offers the illusion of empowerment and community). The attempt of the Iranian mullahs to secede from modernity has failed, although a turbaned corpse still stumbles about the neighborhood. Information, from the internet to rock videos, will not be contained, and fundamentalism cannot control its children. Our victims volunteer.

These noncompetitive cultures, such as that of Arabo-Persian Islam or the rejectionist segment of our own population, are enraged. Their cultures are under assault; their cherished values have proven dysfunctional, and the successful move on without them. The laid-off blue-collar worker in America and the Taliban militiaman in Afghanistan are brothers in suffering.

It is a truism that throughout much of the 20th century the income gap between top and bottom narrowed, whether we speak of individuals, countries, or in some cases continents. Further, individuals or countries could "make it" on sheer muscle power and the will to apply it. You could work harder than your neighbor and win in the marketplace. There was a rough justice in it, and it offered near-ecumenical hope. That model is dead. Today, there is a growing excess of muscle power in an age of labor-saving machines and methods. In our own country, we have seen blue-collar unions move from center stage to near-irrelevance. The trend will not reverse. At the same time, expectations have increased dramatically. There is a global sense of promises broken, of lies told. Individuals on much of the planet believe they have played by the rules laid down for them (in the breech, they often have not), only to find that some indefinite power has changed those rules overnight. The American who graduated from high school in the 1960s expected a good job that would allow his family security and reasonably increasing prosperity. For many such Americans, the world has collapsed, even as the media tease them with images of an ever-richer, brighter, fun world from which they are excluded. These discarded citizens sense that their government is no longer about them, but only about the privileged. Some seek the solace of explicit religion. Most remain law-abiding, hard-working citizens. Some do not.

The foreign twin is the Islamic, or sub-Saharan African, or Mexican university graduate who faces a teetering government, joblessness, exclusion from the profits of the corruption distorting his society, marriage in poverty or the impossibility of marriage, and a deluge of information telling him (exaggeratedly and dishonestly) how well the West lives. In this age of television-series franchising, videos, and satellite dishes, this young, embittered male gets his skewed view of us from reruns of Dynasty and Dallas, or from satellite links beaming down Baywatch, sources we dismiss too quickly as laughable and unworthy of serious consideration as factors influencing world affairs. But their effect is destructive beyond the power of words to describe. Hollywood goes where Harvard never penetrated, and the foreigner, unable to touch the reality of America, is touched by America's irresponsible fantasies of itself; he sees a devilishly enchanting, bluntly sexual, terrifying world from which he is excluded, a world of wealth he can judge only in terms of his own poverty.

Most citizens of the globe are not economists; they perceive wealth as inelastic, its possession a zero-sum game. If decadent America (as seen on the screen) is so fabulously rich, it can only be because America has looted one's own impoverished group or country or region. Adding to the cognitive dissonance, the discarded foreigner cannot square the perceived moral corruption of America, a travesty of all he has been told to value, with America's enduring punitive power. How could a nation whose women are "all harlots" stage Desert Storm? It is an offense to God, and there must be a demonic answer, a substance of conspiracies and oppression in which his own secular, disappointing elite is complicit. This discarded foreigner's desire may be to attack the "Great Satan America," but America is far away (for now), so he acts violently in his own neighborhood. He will accept no personal guilt for his failure, nor can he bear the possibility that his culture "doesn't work." The blame lies ever elsewhere. The cult of victimization is becoming a universal phenomenon, and it is a source of dynamic hatreds.

It is fashionable among world intellectual elites to decry "American culture," with our domestic critics among the loudest in complaint. But traditional intellectual elites are of shrinking relevance, replaced by cognitive-practical elites--figures such as Bill Gates, Steven Spielberg, Madonna, or our most successful politicians--human beings who can recognize or create popular appetites, recreating themselves as necessary. Contemporary American culture is the most powerful in history, and the most destructive of competitor cultures. While some other cultures, such as those of East Asia, appear strong enough to survive the onslaught by adaptive behaviors, most are not. The genius, the secret weapon, of American culture is the essence that the elites despise: ours is the first genuine people's culture. It stresses comfort and convenience--ease--and it generates pleasure for the masses. We are Karl Marx's dream, and his nightmare.

Secular and religious revolutionaries in our century have made the identical mistake, imagining that the workers of the world or the faithful just can't wait to go home at night to study Marx or the Koran. Well, Joe Sixpack, Ivan Tipichni, and Ali Quat would rather "Baywatch." America has figured it out, and we are brilliant at operationalizing our knowledge, and our cultural power will hinder even those cultures we do not undermine. There is no "peer competitor" in the cultural (or military) department. Our cultural empire has the addicted--men and women everywhere--clamoring for more. And they pay for the privilege of their disillusionment.

American culture is criticized for its impermanence, its "disposable" products. But therein lies its strength. All previous cultures sought ideal achievement which, once reached, might endure in static perfection. American culture is not about the end, but the means, the dynamic process that creates, destroys, and creates anew. If our works are transient, then so are life's greatest gifts--passion, beauty, the quality of light on a winter afternoon, even life itself. American culture is alive.

This vividness, this vitality, is reflected in our military; we do not expect to achieve ultimate solutions, only constant improvement. All previous cultures, general and military, have sought to achieve an ideal form of life and then fix it in cement. Americans, in and out of uniform, have always embraced change (though many individuals have not, and their conservatism has acted as a healthy brake on our national excesses). American culture is the culture of the unafraid.

Ours is also the first culture that aims to include rather than exclude. The films most despised by the intellectual elite--those that feature extreme violence and to-the-victors-the-spoils sex--are our most popular cultural weapon, bought or bootlegged nearly everywhere. American action films, often in dreadful copies, are available from the Upper Amazon to Mandalay. They are even more popular than our music, because they are easier to understand. The action films of a Stallone or Schwarzenegger or Chuck Norris rely on visual narratives that do not require dialog for a basic understanding. They deal at the level of universal myth, of pre-text, celebrating the most fundamental impulses (although we have yet to produce a film as violent and cruel as the Iliad). They feature a hero, a villain, a woman to be defended or won--and violence and sex. Complain until doomsday; it sells. The enduring popularity abroad of the shopworn Rambo series tells us far more about humanity than does a library full of scholarly analysis.

When we speak of a global information revolution, the effect of video images is more immediate and intense than that of computers. Image trumps text in the mass psyche, and computers remain a textual outgrowth, demanding high-order skills: computers demarcate the domain of the privileged. We use technology to expand our wealth, power, and opportunities. The rest get high on pop culture. If religion is the opium of the people, video is their crack cocaine. When we and they collide, they shock us with violence, but, statistically, we win.

As more and more human beings are overwhelmed by information, or dispossessed by the effects of information-based technologies, there will be more violence. Information victims will often see no other resort. As work becomes more cerebral, those who fail to find a place will respond by rejecting reason. We will see countries and continents divide between rich and poor in a reversal of 20th-century economic trends. Developing countries will not be able to depend on physical production industries, because there will always be another country willing to work cheaper. The have-nots will hate and strive to attack the haves. And we in the United States will continue to be perceived as the ultimate haves. States will struggle for advantage or revenge as their societies boil. Beyond traditional crime, terrorism will be the most common form of violence, but transnational criminality, civil strife, secessions, border conflicts, and conventional wars will continue to plague the world, albeit with the "lesser" conflicts statistically dominant. In defense of its interests, its citizens, its allies, or its clients, the United States will be required to intervene in some of these contests. We will win militarily whenever we have the guts for it.

There will be no peace. At any given moment for the rest of our lifetimes, there will be multiple conflicts in mutating forms around the globe. Violent conflict will dominate the headlines, but cultural and economic struggles will be steadier and ultimately more decisive. The de facto role of the US armed forces will be to keep the world safe for our economy and open to our cultural assault. To those ends, we will do a fair amount of killing.

We are building an information-based military to do that killing. There will still be plenty of muscle power required, but much of our military art will consist in knowing more about the enemy than he knows about himself, manipulating data for effectiveness and efficiency, and denying similar advantages to our opponents. This will involve a good bit of technology, but the relevant systems will not be the budget vampires, such as manned bombers and attack submarines, that we continue to buy through inertia, emotional attachment, and the lobbying power of the defense industry. Our most important technologies will be those that support soldiers and Marines on the ground, that facilitate command decisions, and that enable us to kill accurately and survive amid clutter (such as multidimensional urban battlefields). The only imaginable use for most of our submarine fleet will be to strip out the weapons, dock them tight, and turn the boats into low-income housing. There will be no justification for billion-dollar bombers at all.

For a generation, and probably much longer, we will face no military peer competitor. Our enemies will challenge us by other means. The violent actors we encounter often will be small, hostile parties possessed of unexpected, incisive capabilities or simply of a stunning will to violence (or both). Renegade elites, not foreign fleets, should worry us. The urbanization of the global landscape is a greater threat to our operations than any extant or foreseeable military system. We will not deal with wars of Realpolitik, but with conflicts spawned of collective emotions, sub-state interests, and systemic collapse. Hatred, jealousy, and greed--emotions rather than strategy--will set the terms of the struggles.

We will survive and win any conflict short of a cataclysmic use of weapons of mass destruction. But the constant conflicts in which we selectively intervene will be as miserable as any other form of warfare for the soldiers and Marines engaged. The bayonet will still be relevant; however, informational superiority incisively employed should both sharpen that bayonet and permit us to defeat some--but never all--of our enemies outside of bayonet range. Our informational advantage over every other country and culture will be so enormous that our greatest battlefield challenge will be harnessing its power. Our potential national weakness will be the failure to maintain the moral and raw physical strength to thrust that bayonet into an enemy's heart.

Pilots and skippers, as well as defense executives, demand threat models that portray country X or Y as overtaking the military capability of the United States in 10 to 20 years. Forget it. Our military power is culturally based. They cannot rival us without becoming us. Wise competitors will not even attempt to defeat us on our terms; rather, they will seek to shift the playing field away from military confrontations or turn to terrorism and nontraditional forms of assault on our national integrity. Only the foolish will fight fair.

The threat models stitched together from dead parts to convince Congress that the Russians are only taking a deep breath or that the Chinese are only a few miles off the coast of California uniformly assume that while foreign powers make all the right decisions, analyze every trend correctly, and continue to achieve higher and higher economic growth rates, the United States will take a nap. On the contrary. Beyond the Beltway, the United States is wide awake and leading a second "industrial" revolution that will make the original industrial revolution that climaxed the great age of imperialism look like a rehearsal by amateurs. Only the United States has the synthetic ability, the supportive laws, and the cultural agility to remain at the cutting edge of wealth creation.

Not long ago, the Russians were going to overtake us. Then it was oil-wealthy Arabs, then the Japanese. One prize-winning economist even calculated that fuddy-duddy Europe would dominate the next century (a sure prescription for boredom, were it true). Now the Chinese are our nemesis. No doubt our industrial-strength Cassandras will soon find a reason to fear the Galapagos. In the meantime, the average American can look forward to a longer life-span, a secure retirement, and free membership in the most triumphant culture in history. For the majority of our citizens, our vulgar, near-chaotic, marvelous culture is the greatest engine of positive change in history.

Freedom works.

In the military sphere, it will be impossible to rival or even approach the capabilities of our information-based force because it is so profoundly an outgrowth of our culture. Our information-based Army will employ many marvelous tools, but the core of the force will still be the soldier, not the machine, and our soldiers will have skills other cultures will be unable to replicate. Intelligence analysts, fleeing human complexity, like to project enemy capabilities based upon the systems a potential opponent might acquire. But buying or building stuff is not enough. It didn't work for Saddam Hussein, and it won't work for Beijing.

The complex human-machine interface developing in the US military will be impossible to duplicate abroad because no other state will be able to come from behind to equal the informational dexterity of our officers and soldiers. For all the complaints--in many respects justified--about our public school systems, the holistic and synergistic nature of education in our society and culture is imparting to tomorrow's soldiers and Marines a second-nature grasp of technology and the ability to sort and assimilate vast amounts of competitive data that no other population will achieve. The informational dexterity of our average middle-class kid is terrifying to anyone born before 1970. Our computer kids function at a level foreign elites barely manage, and this has as much to do with television commercials, CD-ROMs, and grotesque video games as it does with the classroom. We are outgrowing our 19th-century model education system as surely as we have outgrown the manned bomber. In the meantime, our children are undergoing a process of Darwinian selection in coping with the information deluge that is drowning many of their parents. These kids are going to make mean techno-warriors. We just have to make sure they can do push-ups, too.

There is a useful German expression, "Die Lage war immer so ernst," that translates very freely as "The sky has always been falling." Despite our relish of fears and complaints, we live in the most powerful, robust culture on earth. Its discontinuities and contradictions are often its strengths. We are incapable of five-year plans, and it is a saving grace. Our fluidity, in consumption, technology, and on the battlefield, is a strength our nearest competitors cannot approach. We move very fast. At our military best, we become Nathan Bedford Forrest riding a microchip. But when we insist on buying into extended procurement contracts for unaffordable, neo-traditional weapon systems, we squander our brilliant flexibility. Today, we are locking-in already obsolescent defense purchases that will not begin to rise to the human capabilities of tomorrow's service members. In 2015 and beyond, we will be receiving systems into our inventory that will be no more relevant than Sherman tanks and prop-driven bombers would be today. We are not providing for tomorrow's military, we are paralyzing it. We will have the most humanly agile force on earth, and we are doing our best to shut it inside a technological straight-jacket.

There is no "big threat" out there. There's none on the horizon, either. Instead of preparing for the Battle of Midway, we need to focus on the constant conflicts of richly varying description that will challenge us--and kill us--at home and abroad. There are plenty of threats, but the beloved dinosaurs are dead.

We will outcreate, outproduce and, when need be, outfight the rest of the world. We can out-think them, too. But our military must not embark upon the 21st century clinging to 20th-century models. Our national appetite for information and our sophistication in handling it will enable us to outlast and outperform all hierarchical cultures, information-controlling societies, and rejectionist states. The skills necessary to this newest information age can be acquired only beginning in childhood and in complete immersion. Societies that fear or otherwise cannot manage the free flow of information simply will not be competitive. They might master the technological wherewithal to watch the videos, but we will be writing the scripts, producing them, and collecting the royalties. Our creativity is devastating. If we insist on a "proven" approach to military affairs, we will be throwing away our greatest national advantage.

We need to make sure our information-based military is based on the right information.

Facing this environment of constant conflict amid information proliferation, the military response has been to coin a new catchphrase--information warfare--and then duck. Although there has been plenty of chatter about information warfare, most of it has been as helpful and incisive as a discussion of sex among junior high school boys; everybody wants to pose, but nobody has a clue. We have hemorrhaged defense dollars to contractors perfectly willing to tell us what we already knew. Studies study other studies. For now, we have decided that information warfare is a matter of technology, which is akin to believing that your stereo system is more important to music than the musicians.

Fear not. We are already masters of information warfare, and we shall get around to defining it eventually. Let the scholars fuss. When it comes to our technology (and all technology is military technology) the Russians can't produce it, the Arabs can't afford it, and no one can steal it fast enough to make a difference. Our great bogeyman, China, is achieving remarkable growth rates because the Chinese belatedly entered the industrial revolution with a billion-plus population. Without a culture-shattering reappreciation of the role of free information in a society, China will peak well below our level of achievement.

Yes, foreign cultures are reasserting their threatened identities--usually with marginal, if any, success--and yes, they are attempting to escape our influence. But American culture is infectious, a plague of pleasure, and you don't have to die of it to be hindered or crippled in your integrity or competitiveness. The very struggle of other cultures to resist American cultural intrusion fatefully diverts their energies from the pursuit of the future. We should not fear the advent of fundamentalist or rejectionist regimes. They are simply guaranteeing their peoples' failure, while further increasing our relative strength.

It remains difficult, of course, for military leaders to conceive of warfare, informational or otherwise, in such broad terms. But Hollywood is "preparing the battlefield," and burgers precede bullets. The flag follows trade. Despite our declaration of defeat in the face of battlefield victory in Mogadishu, the image of US power and the US military around the world is not only a deterrent, but a psychological warfare tool that is constantly at work in the minds of real or potential opponents. Saddam swaggered, but the image of the US military crippled the Iraqi army in the field, doing more to soften them up for our ground assault than did tossing bombs into the sand. Everybody is afraid of us. They really believe we can do all the stuff in the movies. If the Trojans "saw" Athena guiding the Greeks in battle, then the Iraqis saw Luke Skywalker precede McCaffrey's tanks. Our unconscious alliance of culture with killing power is a combat multiplier no government, including our own, could design or afford. We are magic. And we're going to keep it that way.

Within our formal military, we have been moving into information warfare for decades. Our attitude toward data acquisition and, especially, data dissemination within the force has broken with global military tradition, in which empowering information was reserved for the upper echelons. While our military is vertically responsible, as it must be, it is informationally democratic. Our ability to decentralize information and appropriate decisionmaking authority is a revolutionary breakthrough (the over-praised pre-1945 Germans decentralized some tactical decisionmaking, but only within carefully regulated guidelines--and they could not enable the process with sufficient information dissemination).

No military establishment has ever placed such trust in lieutenants, sergeants, and privates, nor are our touted future competitors likely to do so. In fact, there has been an even greater diffusion of power within our military (in the Army and Marines) than most of us realize. Pragmatic behavior daily subverts antiquated structures, such as divisions and traditional staffs. We keep the old names, but the behaviors are changing. What, other than its flag, does the division of 1997 have in common with the division of World War II? Even as traditionalists resist the reformation of the force, the "anarchy" of lieutenants is shaping the Army of tomorrow. Battalion commanders do not understand what their lieutenants are up to, and generals would not be able to sleep at night if they knew what the battalion commanders know. While we argue about change, the Army is changing itself. The Marines are doing a brilliant job of reinventing themselves while retaining their essence, and their achievement should be a welcome challenge to the Army. The Air Force and Navy remain rigidly hierarchical.

Culture is fate. Countries, clans, military services, and individual soldiers are products of their respective cultures, and they are either empowered or imprisoned. The majority of the world's inhabitants are prisoners of their cultures, and they will rage against inadequacies they cannot admit, cannot bear, and cannot escape. The current chest-thumping of some Asian leaders about the degeneracy, weakness, and vulnerability of American culture is reminiscent of nothing so much as of the ranting of Japanese militarists on the eve of the Pacific War. I do not suggest that any of those Asian leaders intend to attack us, only that they are wrong. Liberty always looks like weakness to those who fear it.

In the wake of the Soviet collapse, some commentators declared that freedom had won and history was at an end. But freedom will always find enemies. The problem with freedom is that it's just too damned free for tyrants, whether they be dictators, racial or religious supremacists, or abusive husbands. Freedom challenges existing orders, exposes bigotry, opens opportunity, and demands personal responsibility. What could be more threatening to traditional cultures? The advent of this new information age has opened a fresh chapter in the human struggle for, and with, freedom. It will be a bloody chapter, with plenty of computer-smashing and head-bashing. The number one priority of non-Western governments in the coming decades will be to find acceptable terms for the flow of information within their societies. They will uniformly err on the side of conservatism--informational corruption--and will cripple their competitiveness in doing so. Their failure is programmed.

The next century will indeed be American, but it will also be troubled. We will find ourselves in constant conflict, much of it violent. The United States Army is going to add a lot of battle streamers to its flag. We will wage information warfare, but we will fight with infantry. And we will always surprise those critics, domestic and foreign, who predict our decline.

Major (P) Ralph Peters is assigned to the Office of the Deputy Chief of Staff for Intelligence, where he is responsible for future warfare. Prior to becoming a Foreign Area Officer for Eurasia, he served exclusively at the tactical level. He is a graduate of the US Army Command and General Staff College and holds a master's degree in international relations. Over the past several years, his professional and personal research travels have taken Major Peters to Russia, Ukraine, Georgia, Ossetia, Abkhazia, Armenia, Azerbaijan, Uzbekistan, Kazakhstan, Latvia, Lithuania, Estonia, Croatia, Serbia, Bulgaria, Romania, Poland, Hungary, the Czech Republic, Pakistan, Turkey, Burma, Laos, Thailand, and Mexico, as well as the countries of the Andean Ridge. He has published widely on military and international concerns. His sixth novel, Twilight of Heroes, was recently released by Avon Books. This is his eighth article for Parameters. The author wishes to acknowledge the importance to this essay of discussions with Lieutenant Colonels Gordon Thompson and Lonnie Henley, both US Army officers.

Source: U.S. Army War College: Parameters