Four Solutions to the Economic Train Wreck

Here is a good piece by Meredith Whitney, Managing Director of Oppenheimer & Company, that appeared in the Financial Times today. (Joe, her first proposal below about re-instating regional banks as the source of mortgages is just what you were thinking :) )

By Meredith Whitney

Published: November 30 2008 18:42 | Last updated: November 30 2008 18:42

As an analyst, it is my job to do fundamental research and call it as I see it, and my bailiwick is financials. My outlook has been negative for over a year and, technically, I have been “right” on my calls. Seeing massive capital destruction has brought me no pleasure, but unfortunately I see little on the horizon that would change my outlook. In fact, after observing the US economy so derailed, I feel that I must act as a citizen of this great country to attempt to offer solutions to this economic train wreck we are all involved in.

First, I am more bearish today than I have been in the past 18 months. In so far as the market has impacted on the economy, capital destruction has been so intense that multi-trillions in capital raised by institutions through both private and public capital has gone to plug holes and not stabilize the effects of shrinking liquidity to corporations and consumers. More than $3,000bn (€2,365bn, £1,955bn) of available credit has been expunged from the markets and therefore corporate and consumer borrowers so far this year.

I estimate that the mortgage market will shrink for the first time in US history and that the credit card market will be 18 months behind it. While just over 70 per cent of US households have access to credit cards, 90 per cent of these people use credit cards as a cash-flow management vehicle, or revolve payments at least once a year. While the credit card market is small relative to the mortgage market, it has grown to play a key role in consumer liquidity. Declining liquidity here will have disastrous effects on consumer spending and the economy. My primary concern is preserving liquidity to consumers, who command more than two-thirds of gross domestic product.

There is no doubt that time will be the greatest healer, but there is a strong argument for putting the financial system through a methadone-clinic-sty le rehabilitation as opposed to the “cold sweats” rehab that we face. The US government appears to feel the same, which is why various versions of direct government lending and quasi- as well as real bail-outs have been announced. Certainly, credit was extended to unworthy borrowers, but the baby is now being thrown out with the bath water. I expect more broad-based credit contractions but, specifically, more than $2,000bn in credit lines to be cut in reaction to risk aversion, constrained capital and regulatory change.

Here are some easily adoptable changes that would make a difference.

First, re-regionalize lending. Since the early 1990s, key bank products, mortgages and credit card lending were rapidly consolidated nationally. Banking went from “knowing your customer” or local lending, to relying on what have proven to be unreliable FICO credit scores and centralized underwriting. The government should now motivate local lenders (many of which have clean balance sheets) to re-widen their product offering to include credit cards and encourage the mega banks to provide servicing and processing facilities to banks that sold off these capabilities years ago.

Second, expand the Federal Depos it Insurance Corporation’s guarantee for bank debt. Banks need to know they can access reasonably priced credit for an extended period to continue to extend new credit lines. Any semi-conscious bank management team knows that capital and liquidity are precious and therefore is hoarding both.

Third, delay the introduction of accounting rule FAS 140 until 2011 or 2012. These moves to bring off-balance-sheet assets back on balance sheet for the sake of transparency are a mirage. The primary assets that will come back on to balance sheets are credit card loans. Frankly, there is more transparency in off-balance-sheet master trust data than in on-balance-sheet accrual accounting. Banks cannot afford it now and it will further constrain credit.

Fourth, amend the proposal on Unfair and Deceptive Lending Practices that is set to be adopted in 2010. The proposal includes one major change that will lead to a severe unintended consequence – pulling credit from consumers. Restricting lenders’ ability to reprice an unsecured loan will cause them to stop lending or to lend less. This change could cut over $2,000bn in unused credit card lines, or over 40 per cent of unused credit lines. With so many Americans relying on their credit cards as a major source of liquidity, it would be equivalent to a major pay cut.

This is no time for partisanship. The situation is too dire. These changes are ones I would never have imagined endorsing a year ago, but these are extraordinary times.

The writer is managing director of Oppenheimer & Co

Copyright The Financial Times Limited 2008

Here is a link to a brief interview clip with Meredith Whitney.

Although Michael Lewis called Meredith Whitney an "obscure, unknown woman" in his piece I previously sent you in the email entitled, "Post Mortem on Wall Street," she is anything but that. She regularly appears as an analyst on business shows, and writes for various financial publications. Apparently she was unknown to him. This is what Lewis said about her in his very interesting piece on inside Wall Street:

Then came Meredith Whitney with news. Whitney was an obscure analyst of financial firms for Oppenheimer Securities who, on October 31, 2007, ceased to be obscure. On that day, she predicted that Citigroup had so mismanaged its affairs that it would need to slash its dividend or go bust. It’s never entirely clear on any given day what causes what in the stock ma rket, but it was pretty obvious that on October 31, Meredith Whitney caused the market in financial stocks to crash. By the end of the trading day, a woman whom basically no one had ever heard of had shaved $369 billion off the value of financial firms in the market. Four days later, Citigroup’s C.E.O., Chuck Prince, resigned. In January, Citigroup slashed its dividend.

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Here is a very good piece on a serious subject by Dr. Stephen Roach, Head of Morgan Stanley Asia. From the apex of the 40-to-1 leveraged credit binge, consumer spending is falling like a rock. We haven't seen two back-to-back quarterly 3.5% declines in real consumer demand ever in our post WW II history. As a bridge to a more subdued rate of consumer demand growth, the forthcoming stimulus package might temper the fall. Let's hope that the Congress and President won't give tax cuts to perpetuate unsustainably high levels of consumption, but instead will focus the stimulus package on infrastructure investment, alternative energies, worker retraining, education, and provide savings incentives to Americans to make the country whole again. NOT a consumption stimulus----if we go back to the well and try to binge out on consumption again, what have we learned from this horrible crisis we are in?

In dismantling our industrial base of production, what a trap we made for ourselves-----Consumer spending now constitutes 70% of GDP. Only bad could come from that---the destruction of consumer demand will, a fortiori, reduce the GDP. The model by which we live is fatally broken: The earth cannot sustain anywhere near that level of human consumption activity. We are choking to death on junk. I'm afraid that all that superfluous stuff out there must go away, as well as demand-creating marketing. We don't need a ll that crap, and it has lead us into a heap of economic pain.

Is any one else just completely sick of being hawked 24/7 what to want, need, BUY, by pushers of the trendy, hot, "must-have wares?" Cannot tune it out, it's all over my computer, it creeps into every corner of my sight like a virus....Cannot escape the inundation of this mercantile cacophany unless I live like Proust did, hermetically sealed.

Message to marketers: Drop dead; we know where the stuff is, and can find it without assistance, if we want it, but for now we will forbear. Thanks, but no thanks, please disappear your wares from might sight.

November 28, 2008

Op-Ed Contributor

Dying of Consumption

By STEPHEN S. ROACH

Hong Kong

IT’S game over for the American consumer. Inflation-adjusted personal consumption expenditures are on track for rare back-to-back quarterly declines in the second half of 2008 at a 3.5 percent average annual rate. There are only four other instances since 1950 when real consumer demand has fallen for two quarters in a row. This is the first occasion when declines in both quarters will have exceeded 3 percent. The current consumption plunge is without precedent in the modern era.

The good news is that lines should be short for today’s “first shopping day” of the holiday season. The bad news is more daunting: rising unemployment, weakening incomes, falling home values, a declining stock market, record household debt and a horrific credit crunch. But there is a deeper, potentially positive, meaning to all this: Consumers are now abandoning the asset-dependent spending and saving strategies they embraced during the bubbles of the past dozen years and moving back to more prudent income-based lifestyles.

This is a painful but necessary adjustment. Since the mid-1990s, vigorous growth in American consumption has consistently outstripped subpar gains in household income. This led to a steady decline in0Apersonal saving. As a share of disposable income, the personal saving rate fell from 5.7 percent in early 1995 to nearly zero from 2005 to 2007.

In the days of frothy asset markets, American consumers had no compunction about squandering their savings and spending beyond their incomes. Appreciation of assets — equity portfolios and, especially, homes — was widely thought to be more than sufficient to make up the difference. But with most asset bubbles bursting, America’s 77 million baby boomers are suddenly facing a savings-short retirement.

Worse, millions of homeowners used their residences as collateral to take out home equity loans. According to Federal Reserve calculations, net equity extractions from United States homes rose from about 3 percent of disposable personal income in 2000 to nearly 9 percent in 2006. This newfound source of purchasing power was a key prop to the American consumption binge.

As a result, household debt hit a record 133 percent of disposable personal income by the end of 2007 — an enormous leap from average debt loads of 90 percent just a decade earlier.

In an era of open-ended house price appreciation and extremely cheap credit, few doubted the wisdom of borrowing agai nst one’s home. But in today’s climate of falling home prices, frozen credit markets, mounting layoffs and weakening incomes, that approach has backfired. It should hardly be surprising that consumption has faltered so sharply.

A decade of excess consumption pushed consumer spending in the United States up to 72 percent of gross domestic product in 2007, a record for any large economy in the modern history of the world. With such a huge portion of the economy now shrinking, a deep and protracted recession can hardly be ruled out. Consumption growth, which averaged close to 4 percent annually over the past 14 years, could slow into the 1 percent to 2 percent range for the next three to five years.

The United States needs a very different set of policies to cope with its post-bubble economy. It would be a serious mistake to enact tax cuts aimed at increasing already excessive consumption. Americans need to save. They don’t need another flat-screen TV made in China.

The Obama administration needs to encourage the sort of saving that will put consumers on sounder financial footing and free up resources that could be directed at long overdue invest ments in transportation infrastructure, alternative energy, education, worker training and the like. This strategy would not only create jobs but would also cut America’s dependence on foreign saving and imports. That would help reduce the current account deficit and the heavy foreign borrowing such an imbalance entails.

We don’t need to reinvent the wheel to come up with effective saving policies. The money has to come out of Americans’ paychecks. This can be either incentive driven — expanded 401(k) and I.R.A. programs — or mandatory, like increased Social Security contributions. As long as the economy stays in recession, any tax increases associated with mandatory saving initiatives should be off the table. (When times improve, however, that may be worth reconsidering.)

Fiscal policy must also be aimed at providing income support for newly unemployed middle-class workers — particularly expanded unemployment insurance and retraining programs. A critical distinction must be made between providing assistance for the innocent victims of recession and misplaced policies aimed at perpetuating an unsustainable consumption binge.

Crises are the ultimate in painful learning experiences. The United States cannot afford to squander this opportunity. Runaway consumption must now give way to a renewal of saving and investment. That’s the best hope for economic recovery and for America’s longer-term economic prosperity.

Stephen S. Roach is the chairman of Morgan Stanley Asia.

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Total Breakdown of Responsibility

All Fall Down

By THOMAS L. FRIEDMAN

I spent Sunday afternoon brooding over a great piece of Times reporting by Eric Dash and Julie Creswell about Citigroup. Maybe brooding isn’t the right word. The front-page article, entitled “Citigroup Pays for a Rush to Risk,” actually left me totally disgusted.

Why? Because in searing detail it exposed — using Citigroup as Exhibit A — how some of our country’s best-paid bankers were overrated dopes who had no idea what they were selling, or greedy cynics who did know and turned a blind eye. But it wasn’t only the bankers. This financial meltdown involved a broad national breakdown in personal responsibi lity, government regulation and financial ethics.

So many people were in on it: People who had no business buying a home, with nothing down and nothing to pay for two years; people who had no business pushing such mortgages, but made fortunes doing so; people who had no business bundling those loans into securities and selling them to third parties, as if they were AAA bonds, but made fortunes doing so; people who had no business rating those loans as AAA, but made fortunes doing so; and people who had no business buying those bonds and putting them on their balance sheets so they could earn a little better yield, but made fortunes doing so.

Citigroup was involved in, and made money from, almost every link in that chain. And the bank’s executives, including, sad to see, the former Treasury Secretary Robert Rubin, were clueless about the reckless financial instruments they were creating, or were so ensnared by the cronyism between the bank’s risk managers and risk takers (and so bought off by their bonuses) that they had no interest in stopping it.

These are the people whom taxpayers bailed out on Monday to the tune of what could be more than $300 billion. We probably had no choice. Just letting Citigroup melt down could have been catastrophic. But when the government throws together a bailout that could end up being hundreds of billions of dollars in 48 hours, you can bet there will be uninte nded consequences — many, many, many.

Also check out Michael Lewis’s superb essay, “The End of Wall Street’s Boom,” on Portfolio.com. Lewis, who first chronicled Wall Street’s excesses in “Liar’s Poker,” profiles some of the decent people on Wall Street who tried to expose the credit binge — including Meredith Whitney, a little known banking analyst who declared, over a year ago, that “Citigroup had so mismanaged its affairs that it would need to slash its dividend or go bust,” wrote Lewis.

“This woman wasn’t saying that Wall Street bankers were corrupt,” he added. “She was saying they were stupid. Her message was clear. If you want to know what these Wall Street firms are really worth, take a hard look at the crappy assets they bought with huge sums of borrowed money, and imagine what they’d fetch in a fire sale... For better than a year now, Whitney has responded to the claims by bankers and brokers that they had put their problems behind them with this write-down or that capital raise with a claim of her own: You’re wrong. You’re still not facing up to how badly you have mismanaged your business.”

Lewis also tracked down Steve Eisman, the hedge fund investor who early on saw through the subprime mortgages and shorted the companies engaged in them,20like Long Beach Financial, owned by Washington Mutual.

“Long Beach Financial,” wrote Lewis, “was moving money out the door as fast as it could, few questions asked, in loans built to self-destruct. It specialized in asking homeowners with bad credit and no proof of income to put no money down and defer interest payments for as long as possible. In Bakersfield, Calif., a Mexican strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy a house for $720,000.”

Lewis continued: Eisman knew that subprime lenders could be disreputable. “What he underestimated was the total unabashed complicity of the upper class of American capitalism... ‘We always asked the same question,’ says Eisman. ‘Where are the rating agencies in all of this? And I’d always get the same reaction. It was a smirk.’ He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S.& P. couldn’t say; its model for home prices had no ability to accept a negative number. ‘They were just assuming home prices would keep going up,’ Eisman says.”

That’s how we got here — a near total breakdown of responsibility at every link in our financial chain, and now we either bail out the people who brought us here or risk a total systemic crash. These are the wages of our sins. I used to say our kids will pay dearly for this. But actually, it’s our problem. For the next few years we’re all going to be working harder for less money and fewer government services — if we’re lucky.

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China is America's Only Banker

In order to finance our stimulus deficits, China MUST buy U.S. debt. Insecurity for us. Read this good Newsweek piece:

November 22, 2008
A Path Out of the Woods

We need China to see that its interests are aligned with America's. If not, things could get very, very ugly.

By Fareed Zakaria

For weeks the world has eagerly awaited word from the Obama transition team about the people who will head up the next American administration- the new secretaries of state and Treasury, the attorney general. But one of the more crucial positions in the Obama administration probably isn't going to be filled for months and will likely get little attention when it is—the post of U.S. ambassador to China.

Everyone knows that China is a major power and our representation there is important. But right now, we need Beijing like never before. China is the key to America getting through the worsening economic crisis. The American ambassador in Beijing (OK, this is a metaphor for all those officials who will be managing this relationship) will need to make sure that China sees its interests as aligned with America's. Or else things could get very, very ugly.

There is a consensus forming that Washington needs to spend its way out of this recession, to ensure that it doesn't turn into a depression. Economists of both the left and right agree that a massive fiscal stimulus is needed and that for now, we shouldn't be worrying about deficits. But in order to run up these deficits—which could total somewhere between $1 trillion and $1.5 trillion, or between 7 and 11 percent of GDP—someone has to buy American debt. And the only country that has the c ash to do so is China.

In September, Beijing became America's largest foreign creditor, surpassing Japan, which no longer buys large amounts of American Treasury notes. In fact, though the Treasury Department does not keep records of American bondholders, it is virtually certain that, holding 10 percent of all U.S. public debt, the government of the People's Republic of China has become Washington's largest creditor, foreign or domestic. It is America's banker.

But will the Chinese continue to play this role? They certainly have the means to do so. China's foreign-exchange reserves stand at about $2 trillion (compared with America's at a relatively puny $73 billion). But the Chinese government is worried that its own economy is slowing down sharply, as Americans and Europeans stop buying Chinese exports. They hope to revive growth in China (to levels around 6 or 7 percent rather than last year's 12 percent) with a massive stimulus program of their own.

The spending initiatives that Beijing announced a few weeks ago would total almost $600 billion (some of which include existing projects), a staggering 15 percent of China's GDP. Given their focus on keeping people employed and minimizing strikes and protests, Beijing will not hesitate to add tens of billions more to that package if need be.

At the same time, Washington desperately needs Beijing to keep buying American bonds, so that the U.S. government can run up a deficit and launch its own fiscal stimulus. In effect, we're asking China to finance simultaneously the two largest fiscal expansions in human history—theirs and ours. They will probably try to accommodate us, because it's in their interest to jump-start the American economy. But naturally their priority is likely to be their own growth.

"People often say that China and America are equally dependent on each other," says Joseph Stiglitz, winner of the 2001 Nobel Prize in Economics. "But that's no longer true. China has two ways to keep its economy growing. One way is to finance the American consumer. But another way is to finance its own citizens, who are increasingly able to consume in large enough quantities to stimulate economic growth in China. They have options, we don't. There isn't really any other country that could finance the American deficit."

In his fascinating new book, "The Ascent of Money," Niall Ferguson describes the birth of a new nation after the cold war. He calls it Chimerica—and it accounts for a tenth of the world's land surface, a quarter of its population and half of global economic growth in the past eight years. "For a time it seemed like a marriage made in heaven," he writes. "The East Chimericans did the saving, the West Chimericans did the spending." The Easterners got growth, the Westerners low inflation and low interest rates.

Like Stiglitz, Ferguson believes that China has options. "They will certainly try to keep American consumption going, but if it becomes clear that it isn't working, they do have a plan B," he said to me last week. Plan B would be to focus on boosting China's own consumption through government spending and easing credit to their own people.

"The big question today," Ferguson said, "is whether Chimerica stays together or comes apart because of this crisis. If it stays together, you can see a path out of the woods. If it splits up, say goodbye to globalization."

In recent years the most important and difficult ambassadorial posting has unquestionably been the one to Baghdad. Over the next decade, the toughest and most crucial assignment may well be in Beijing.

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Debtor Nation

Almost two years ago, Peter Schiff, author of The Little Book of Bull Moves in a Bear Market, predicted that the financial markets were heading for crisis. At the time, he said, "We're on the verge of a major, major recession that's probably going to start by the end of this year, maybe early next year. The housing market is just beginning to unravel. We're seeing the tip of the iceberg here.”

In fact he went on to compare the economy to the Titanic, then added, “I am here with the lifeboat trying to get people to leave the ship.”

According to Schiff, investors believed asset prices, real estate prices, and stock prices would go up indefinitely. But, as you know, it was a bubble. Now, markets are correcting for these imbalances.

The housing glut with no buyers, the collapse of the mortgage & debt markets, which about to spread to commercial real estate, student loans, credit card and auto debt, the implosion of 40-to-1 leverage in financial derivatives instruments, credit default swaps with no underlying collateral, the freezing of the credit market, all have combined to bring us to the brink of an economic collapse, not just a financial crisis. For the past several years there has been a whole phony economy which is now collapsing around us--people thought we had a real economy and we didn’t. Instead, Schiff says, we had a bubble. All we did was borrow trillions of dollars from the rest of the world & we blew all the money on consumption. Now we cannot pay the bills. The asset bubbles that were inflated by reckless monetary policy are deflating around us and we are going to have to rebuild a viable economy, & it20won’t be easy to do. A lot of companies will go bankrupt & a lot of people will lose their jobs. During the deleveraging process, we have to go back to a sane economy where we actual make things.

As a consequence, we are setting up a major run on the dollar. We have to pay for our imports. We like these consumer products but how do we pay for them? As a nation we are broke. We cannot expect the rest of the world to produce all this stuff & then give them nothing in return. We have to be able to export to pay for our imports. Manufacturing goods is real wealth, but we have foolishly dismantled the industrial base of U.S. and sent manufacturing jobs overseas in a relentless race to the bottom seeking the cheapest labor markets (outsourcing), all with a misguided eye to short term profits at the expense of long-term economic gains (wealth creation). We manufactured ourselves into becoming the wealthiest nation in the world, and now we have consumed ourselves into bankruptcy.

We cannot expect people in other countries to do all the heavy lifting, nor can we expect the world to make all t he sacrifices, to do all the saving, to do all the production, and we just step up and eat the fruits of their labor. It does not work that way. The world is finding out that we cannot pay back our bills, and this phony economy is unraveling.

The dollar is rallying not because of fundamentals. The rally is temporary; it cannot last and the dollar is going to collapse. Look at the trillions and trillions of dollars that are being hoarded by foreign central banks. Importantly, China has announced it wants to do a $600 billion stimulus package. How are they going to finance it? They will start selling treasuries and they will stop lending us money. China has become America’s banker, and if it would stop buying our debt and lending us money, the United States would face disaster. The world has learned this valuable message: don’t lend America any more money.

The United States could not have maneuvered itself into a more dangerous position of dependency, completely against self-interest, and that we did it for the love of things (often junk), and spending beyond our means, is stupefying. We traded away our economic security for….nothing of any consequence, certainly nothing of comparable value. That a smart nation would do such a thing is astonishingly incomprehensible.

*****

Does Wall Street's meltdown presage the end of the American century? Many commentators have warned that the past weeks' financial mayhem signaled a major political setback for the United States as well as an economic one. "Why should the rest of the world ever again take seriously the American free-market model after this debacle?" a leading British journa list asked Niall Ferguson. This crisis, he argued, was to economics what the Iraq war was to U.S. foreign policy: a fatal blow to the credibility of American claims to global primacy

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To the New Administration: Have Past Crises Taught us Anything?

A scholar who has studied the relationship between political and financial fortunes suggests that we take a good, hard look at the aftermath of the Great Depression -- and learn.

By Jon Markman

American banking titans Citigroup (C, news, msgs), Goldman Sachs (GS, news, msgs) and Morgan Stanley (MS, news, msgs) are each down 30%-plus this month despite emergency rescue efforts by two branches of the federal government and the infusion of tens of billions of taxpayer dollars.

They are down 75% for the year despite executives' protests that business is fine. They are down despite massive job cuts and asset sales to save costs, and the personal endorsement of everyone's favorite rich uncle, Warren Buffett. They are down even though they have plenty of cash flow and millions of customers, many of whom are the envy of other banks the world over.

Investors must be nuts, right? I mean, they must not have gotten the message that the Treasury and the Federal Reserve will use all means at their disposal to recapitalize the banking system. They didn't see the memo that says the feds have never failed in their efforts to pump the system full of money until it bursts like a piñata, spilling profits in every direction.

Yet according to research by Niall Ferguson, a Harvard professor of economic history, there is ample reason for investors to thumb their noses at the conventional wisdom: All that taxpayer money is acting more like embalming fluid than artificial respiration, he says, keeping the banks looking eerily lifelike while they stiffen.

Turning Japanese

"You can stick money into every orifice of the big banks -- their mouth, their nose, their ears, wherever -- but if they can't make loans because they have to reserve against=2 0future losses, and if they won't make loans because there's a recession, it won't do any good," Ferguson says. "If they can't lend, there's no money multiplier -- they're stuck, they're zombies. It's Japan all over again."

That sounds about right. It's the night of the living dead on Wall Street these days, a few weeks past Halloween, as the horror of asphyxiated credit that has plagued Japan since a debt bubble burst in 1990 is playing out all over again here. While it's bad enough that our banks aren't lending and private fund managers are shunning corporate bonds, it's doubly concerning because U.S. policy experts have sworn they would never repeat Japan's mistakes.

Ferguson, a fellow at Stanford and Cambridge universities when he's not lecturing at Harvard, is not surprised to see this fate befall U.S. banks because he has documented a similar set of circumstances that played out in a dozen financial crises of the past 10 centuries. In his new book, "The Ascent of Money," he tells how the bipolar moods of the credit cycle -- the expansion and contraction of money and lending -- explain much of the political history that is more widely studied.

Every time governments and bankers figure out how to create money from thin air -- or out of the ground, for that matter -- they get carried away, running a thousand miles an hour until they hit a brick wall. Then the old world of finance shatters into a thousand pieces, and despite the best efforts of the smartest minds at the time, it takes many years, at best, for institutions and psyches to heal.

It happened in the 15th century after Spain discovered silver in South America and used it to finance endless wars that ended in ruin. It happened in the 1870s when U.S. banks suffered a depression after railroad and agricultural financing went bust. And it happened in Japan in the 1980s when loans on real-estate speculation went bust.

Ferguson observes that the experts of each era swear they will never repeat their predecessors' mistakes, yet they always end up making new errors of hubris and find that some old missteps are unavoidable. The U.S. Treasury and the Fed both know, for instance, that one key error made in the 1930s was the passage of a set of protectionist laws that prevented a free exchange of goods among countries, and they have overtly sworn to prevent that from happening. Yet20at times of stress, new populist leaders always emerge, and they find it politically useful to blame foreigners for the country's economic problems and try to protect jobs in the homeland.

A global race to the bottom

Ferguson says he recently appeared on a CNN show hosted by anti-immigration demagogue Lou Dobbs and found the scorching critique of free trade, bankers and immigration to be eerily similar to screeds that ultimately led Congress to pass the Smoot-Hawley Tariff Act in 1930. That law backfired by smashing world trade and catalyzing a decade-long depression.Think history can't repeat?

• President-elect Barack Obama pledged during his campaign to withdraw from the North American Free Trade Agreement until he has a chance to overhaul it.
• Leaders of the top 20 world economies met in Washington, D.C., last weekend and emerged with no firm plan to coordinate on interest-rate cuts or currency balances.
• Russia has sworn to prevent its banks from making good on obligations to the United States and the EU.
• And Ecuador's president has said he would ignore "illegitimate" Wall Street claims for bond repayments.

Ferguson says that if history is any guide, the next steps taken by countries in an attempt to revive domestic economies will be to weaken their currencies. This makes exports cheaper, boosting sales, but it cannot be done by every country at the same time, or chaos ensues -- and sometimes land grabbing.

"We will have a race to the bottom as every country tries to avoid depression," Ferguson says.

Policymakers throughout history have found few good choices once the unwinding of debt, known as deleveraging, replaces debt creation as the central theme of global trade. Debt buildup is a raucous party that makes borrowers happy and rich on paper; debt unwinding is a wake that leaves ex-borrowers bummed and truly poorer. Because the Fed has probably not figured out how to outlaw the credit cycle, we might think of the last 25 years as rock 'n' roll and the next decade as Mahler.

Japan has been able to withstand the past 18 years of extremely slow growth or contraction without social unrest because it was already a homogenous, orderly welfare state in which people were avid savers and accustomed to living in small apartments. Ferguson expects the transition to a credit famine in the United States to be a lot harder.

Although there won't be Hoovervilles, a dust bowl or ex-executives selling pencils, he says, there could well be a lot of angry nationalism and disorderliness as Americans shake their fists at Wall Street and Washington, battle each other, bristle at the world and learn unhappily to save instead of borrow.

Ferguson concludes that "unless we're careful, it'll be the late 1930s re-enacted," by which he means a path to world war. Yet he's optimistic that policymakers will avoid that mess by learning from history that they must cooperate instead of isolate.

"We have to stare at this possibility and say, 'Oh, my God, we cannot go there,'" he says. Let's hope the market gods are listening.

Fine print

GEOPOLITICAL CONSEQUENCES OF THE CREDIT CRUNCH:

"Does Wall Street's meltdown presage the end of the American century? Many commentators have warned that the past week's financial mayhem signaled a major political setback for the United States as well as an economic one. 'Why should the rest of the world ever again take seriously the American free-market model after this debacle?' a leading British journalist asked me [Furgason] last Thursday. This crisis, he argued, was to economics what the Iraq war was to U.S. foreign policy: a fatal blow to the credibility of American claims to global primacy..."

To learn more about Ferguson's views, visit his Web site. He's a prolific and good writer; check out his journalism. Learn more about Japan's post-1990 depression here and here and here

Recommend Niall Ferguson's new book: The Ascent of Money

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Cannot help but wonder....Had Al Gore Been President these last 8 years...

May be of Interest, this Interview with Al Gore
November 23, 2008
Fareed Zakaria GPS

ZAKARIA: We've all talked endlessly about the historic nature of Barack Obama's election. But there was another historic election not so long ago -- the year 2000, the election in which Vice President Al Gore was declared the president-elect, at least for a while.

There are many who wish that Al Gore's temporary victory had lasted longer. But as we all know, the story ended differently, and for the former vice president, perhaps happily. He got busy saving the planet, making an Academy Award-winning movie, and then winning a Nobel Peace Prize in the process.

And he's not done yet.

Al Gore, welcome.

AL GORE, FORMER U.S. VICE PRESIDENT, NOBEL PEACE PRIZE WINNER: Well, thank you, Fareed.

Winston Churchill once said, early in his career after he lost an election, someone said that was a blessing in disguise. He said, "Damned good disguise."

(LAUGHTER)

ZAKARIA: Let me ask you about this election. Do you think -- you're a student of American politics, obviously -- is this a great realignment? Do you think that historians will look back on this election as the moment that the era of Republican supremacy ended?

GORE: Well, I think it is a realignment. But I'm not sure that it falls neatly into the categories that we call Democratic and Republican.

I think it's partly a generational realignment. This was never a close election among voters who were under 30. It was a landslide among the younger voters.

And I can barely contain my excitement about his election. I just think that it's a fabulous new development.

And you know, for those in your international audience, which is quite large, I want them to know that right after the election, Republicans who had campaigned strongly against Barack Obama were interviewed everywhere in the United States right after the election, saying, "I'm so proud of my country."

You know, regardless of the differences over issues and politics, this was a watershed election that really just gave every American a feeling of great pride in our nation's ability to transcend our past and redeem the revolutionary promise of our Declaration of Independence that every human being is created equal. And it's electrifying to redeem that declaration.

ZAKARIA: Do you think that Biden should maintain the vice presidential structure that Dick Cheney has put in place? You know, a lot of people feel Cheney has effectively changed the nature of the vice presidency forever, that these institutional aggrandizations of power never shrink.

How should Joe Biden think about the vice presidency? GORE: Well, the -- I mean, I don't think that's going to happen, because that's really a function of what the president wants.

And I hesitate to comment on Bush and Cheney, because I've recently begun to fear that I'm losing my objectivity on them.

(LAUGHTER)

But actually, if you look at the history of the vice presidency -- it's a very arcane field of history -- it was Walter Mondale who really elevated the office to what it is now. And I learned a lot from him in designing a partnership with President Clinton.

And I think Dick -- I think it's good to have an active, powerful vice president who can help the president carry a lot of the burden.

ZAKARIA: You just don't think that person should be Dick Cheney.

GORE: Well, not only that. I think that the nature of the delegations in this present administration were unhealthy for the country.

But there's a way to do it right that will give Joe Biden a huge amount of power and influence, which I think he should have. And one of the many things that I admire about President-elect Obama is that he is comfortable and confident in sharing the limelight, sharing responsibility.

And I'm certain that you'll see Joe Biden playing a very active and productive role. He's a terrific guy. He has an enormous capacity, as you know, and I think -- not only in foreign policy, which is one of his specialty areas along with law enforcement and justice and so forth -- I think he's going to have a lot of influence across the board.

ZAKARIA: You worked with Hillary Clinton for eight years.

GORE: Yes.

ZAKARIA: Do you think she'd be a good secretary of state?

GORE: I think she'd be very good at it. I don't know what the current status of that is, but I think she would be very effective. Sure.

ZAKARIA: Let me ask you about what's going on in Washington right now. You're watching the auto industry ask for a massive bailout.

This must tug at different sides of you. I mean, as a Democrat, you must have some sympathy for the unions, and for the plight of people who are going to be laid off. On the other hand, as the world's foremost environmentalist, you must look at the U.S. auto industry as having been too late and insufficient in its climate -- in its efforts on energy.

Would you bail out the auto industry?

GORE: Well, I think the whole industry should be transformed. It's really tragic that General Motors, for example, allowed Toyota to get a seven-year head start on the hybrid drive train in the Prius that is now positioned to really be a dominant feature of the industry in this century.

I personally believe that the U.S. auto fleet should make a transition as quickly as possible toward plug-in hybrid electric vehicles. I think that the twin problems of the climate crisis and the economic crisis can both be addressed by investing in a transformation of our energy and transportation infrastructure to focus on renewable sources of energy.

And at the same time, our security vulnerability to a potential cutoff of the world's access to Persian Gulf, Middle East oil should be addressed, at long last, without delay. And shifting to electric vehicles instead of petroleum vehicles is the best way to do that.

ZAKARIA: If you look at the situation right now with oil prices down to $50 a barrel -- the lowest in two or three years -- are we back to a familiar cycle where once the price of oil gets back down, the impetus for these alternate energies will dissipate?

GORE: Well, I don't think we're going to fall for it this time.

And I was very impressed with the language used by President- elect Barack Obama in his "60 Minutes" interview. He used a phrase that I hadn't heard before, that I think summed it up really well.

(BEGIN VIDEO CLIP)

PRESIDENT-ELECT BARACK OBAMA: We go from shock to trance. You know, we -- oil prices go up, gas prices at the pump go up, everybody goes into a flurry of activity.

And then the prices go back down, and suddenly we act like it's not important, and we start filling up our SUVs again. And as a consequence, we never make any progress.

(END VIDEO CLIP)

GORE: We cannot allow ourselves to be vulnerable to that anymore. We should learn from history.

ZAKARIA: When you look at the challenges facing the United States, particularly in foreign policy -- you've studied some of these issues for three decades. Iraq -- you warned early on that the war would be, would probably be very difficult, very expensive and were against it.

Do you think that the United States should get out as fast as President Obama had -- President-elect Obama -- has campaigned suggesting?

GORE: Well, I warned that the invasion would go smoothly, and then the aftermath would be difficult. And I like the phrasing that Barack Obama has used. We should get out as carefully and thoughtfully as we got -- as the ...

ZAKARIA: The opposite ...

GORE: ... as the opposite was true in going in.

And I think that, in his discussions with General Petraeus, when he was there -- Joe Klein had a great article in TIME Magazine that captured part of the dialogue. I'm sure you saw that. I thought it was very impressive.

And I think that people should have confidence that he is going to fulfill his pledge to get American troops out of Iraq as soon as it's feasible to do so safely -- and that he will do it in a very thoughtful and careful manner.

ZAKARIA: What about Afghanistan? A war that seems to be going badly, the Taliban seem to be regrouping. What should we do there?

GORE: Well, I think we have to play the whole keyboard. I think that, first, we need more military personnel there. And one of the concerns that I raised back when I opposed the invasion of Iraq was what it was going to do to our efforts in Afghanistan.

We should have learned from the aftermath of the Soviet experience in Afghanistan. We should have been all over that situation and make sure that transition went well.

And great nations don't go from one half-finished task, lurching to something else. We should have stayed there, and we should have done it right at the time. It's going to be more difficult now.

But one of the elements we need are more troops on the ground. But we need more than military activities. I think we have to have activities across the board. We have to open dialogues in places that might feel uncomfortable.

But we have to be clear-eyed about the nature of the government that we're dealing with there. We have to pay very careful attention to what's going on in the border areas and the tribal areas, and our relationship with Pakistan. It's an immensely complex problem.

But I do think that it's not an insoluble problem. I think that if we try to solve it only with military force, it might be insoluble. But I do think that, if we use all the tools available, this can be resolved.

ZAKARIA: And we will be right back with Al Gore.

(COMMERCIAL BREAK)

ZAKARIA: And we're back with Al Gore.

One of the solutions to the problem of climate change and the problem of CO2 emissions has often been presented as clean coal, that what we should be doing is essentially making coal emit many fewer -- you know, much less CO2 -- through various ways of capture and sequestration.

But in a "Wall Street Journal" article, you seem doubtful. You don't think this is a good idea?

GORE: Well, I think if they can do it, it is a good idea. But what I am greatly concerned about is that they talk as if it's already here.

And as a practical matter, what many in the industry are proposing is to go forward with the construction of thousands of new coal-fired generating plants, on the assumption that they will at some point be retrofitted with this technology that does not yet exist.

There is not a single, large-scale demonstration plant anywhere in the United States. There is one in the North Sea that the Norwegians are running. There's one in the Algerian desert that BP is running. And they show some promise. But it is not anywhere near a stage that justifies building new coal-fired generating plants on the promise that it'll soon be available.

If the industry can make good on its promise, then I'm all for it. But it's beginning to resemble something that the auto companies did for years.

Every few years they would show the cars of the future that run on hydrogen, or whatever, and it's going to be magical and pollution- free. And they put them in the showroom, but then they never build them. And you just keep cranking along. And it's led to a disaster for that industry.

We cannot allow an illusion to be the basis of a strategy for human survival. We are really facing a very serious existential threat to the future of human civilization.

And I know that language sounds shrill and dire, and people instinctively say that that can't be so. But it is so.

And the scientific community, the IPCC -- the Intergovernmental Panel on Climate Change ...

ZAKARIA: Which are thousands of scientists.

GORE: Three thousand of the very best scientists in the world from 130 countries, who have studied this for 20 years, and have issued four unanimous reports, the last of which said the evidence is unequivocal -- unequivocal. We have to act.

ZAKARIA: One of the key objections that President Bush has always had to the Kyoto Protocol, and to all that kind of climate change activism, was you're leaving out China and India. And if you leave out China and India, you're not going to solve the problem.

GORE: Yes.

ZAKARIA: You started to work on this issue, to try to convince the Chinas and Indias of the world that this is their problem, too.

GORE: Yes. I just came back from China two days ago. And as you know, I'm on my way to India after the holiday, and looking forward to it.

China and India, and other developing countries, all have exactly the same excuse for not moving on the climate crisis. Their common excuse is, "Wait a minute. The United States hasn't done anything. It's the wealthiest country in the world, the natural leader of the world. Why doesn't the U.S. act?"

And I think that when the U.S. acts, it will be by far the most effective way to improve the odds that China and India, and other smaller developing economies, will also act. They know that it's in their own interest to tackle this problem.

ZAKARIA: What about India? Talk about India, where you're going, and what you're going to do.

GORE: Well, I'm very excited to be hosting Live Earth India on December 7th. And all of the greatest stars of Bollywood are going to gather in your hometown, Mumbai. And a lot of the greatest Western artists are coming over to join, as well.

You know, the Indian government now subsidizes kerosene -- probably the dirtiest fuel you can use. But they need alternatives. And these solar lanterns and solar cookers are very cost-effective. And we're doing everything to raise money for it -- and to build awareness.

ZAKARIA: Let me ask you about this election, finally. If you had one piece of advice to Obama, to consolidate these forces of realignment, what would it be? How should he govern? From the center, from -- you know, you hear all this advice given to him.

GORE: Well, again, you know, just as with the categories that we label Democratic and Republican, I think center, left, right -- you hear this a lot. It's almost a cliche to say we need to move forward, not left or right. But in fact, that is the case. And I think he has an awfully good, innate sense of that.

I feel, you know, me offering him advice doesn't feel right, because he's doing so well. But if I did offer him advice I would say, make more of the thoughtful, long, expository speeches, because in this new media age, people are listening.

Maybe they don't get through all of the television and radio outlets. Maybe you'll still have only a little sound bite. But people are downloading these speeches now, if they're good ones.

You know, it's remarkable that the paid advertisement, the 30- minute paid advertisement that he had four or five days before the election, was one of the highest-rated programs of the year.

And I think people are now hungry for a thoughtful treatment of how we can solve the problems that we face. And I would go back to that strength. And I'm sure that he will without me advising him to do so.

ZAKARIA: And if you want a thoughtful discussion with Al Gore, you can download this one. Al Gore, thank you very much.

GORE: Thank you.

ZAKARIA: A pleasure.

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