Global Post-Crisis Economic Outlook
Henry C.K. Liu

Part I:   Crisis of Wealth Destruction   
Part II:  Two Different Banking Crises - 1929 and 2007
Part III: The Fed’s No-Exit Strategy
Part IV: The Fed’s Extraordinary Section 13(3) Programs

Part V: Public Debt, Fiscal Deficit and Sovereign Insolvency
This article appeared in AToL on April 30, 2010 as Too Big to Save

It is sometimes said that war’s legitimate child is revolution and war’s bastard child is inflation. World War I was no exception. The war heralded the emergence of social democracy as a legitimate political institution to replace monarchism in the Europe.  Among the underdeveloped colonial economies of the world, communism emerged to replace Western imperialistic colonialism. In Europe, socialism was the platform on which democracy flowered. Outside of Europe, in the colonized world, communism was the platform on which nationalism gained state power from the feudal elite who had become compradors of Western capitalism. Nationalistic communism was the political weapon with which the oppressed masses used to combat Western colonialism.
As a result of WWI, two of the world’s great nations, Russia and China, found communism to be the effective vehicle for creating a new society to carry out the revival of their past glory and to launch a new historical socio-economic-political development. But in China, Western imperialism continued to dominated the weaken nation even after the decrepit feudal monarchy was overthrown in 1911 by a social democratic revolution to establish a republic patterned after Lincoln’s ideal of government of the people, by the people and for the people; and even as the imperialistic West evolved into liberal social democracy at home. Western imperialism continued in republican China for 38 years until Chinese communists gained state power in 1949, four years after WWII ended in Asia.
Six decades after the founding of the People’s Republic of China, communism had failed in the Soviet Union in 1991 while communism with Chinese characteristics continues to prosper in China. The reason Chinese communism has not failed is because socialist concepts have always been operative throughout Chinese history and the import of Marxism from the West did not replace Chinese socio-political culture of communal harmony derived from prescribed social rites and hierarchical relations.
Chinese culture has always placed community at its core in contrast to Western post-Reformation culture of centering on individualism. The Confucian philosopher Mencius (372-289 BCE) warned that a nation that operates by profit motives will endanger its own wellbeing; a better foundation would be renyi (仁义), a Chinese concept with no exact counterpart in the West, loosely translated as observance of proper human relationship, support for justice, fidelity and humanity, as embodied in the socialist ideal. Marxism merely adds a contemporary dimension to indigenous Chinese socialist philosophy of renyi that enables China to interact with the expansionist capitalism of the West and to effectively repulse Western imperialism and resist neoliberalism.
The Post-Civil-War Populist Movement
In the US, the Civil War was not followed by a union of mutual fraternal forgiveness and reconciliation, as Lincoln had hoped by his speech: “With malice toward none; and charity for all.” The victorious North treated the defeated South as a conquered territory more harsh than the victorious US treated defeated Germany and Japan after WWII. Rather than reconstructing the war-damaged South, Northerners were bent on reconstructing Southern institutions to keep the South from ever again considering rebellion.
The North was undeniably the aggressor, a role clearly evidenced by the fact that all of the fighting was on Southern territory. As a result, the Southern economy was destroyed by war while the Northern economy industrialized and prospered from war production. War debts issued by the Confederacy became worthless after the war. Not a single bank in the South was solvent as Southern savings had been spent on financing the war. After the war, the Federal Treasury ordered the confiscation of Confederate government property but refused to assume its war debts. Corrupt Northern agents looted the South indiscriminately. In contrast, Northern war debts were honored by the taxing whole economy, including the South.
Two years into the Civil War, Congress passed the National Banking Act in 1863. While its immediate purpose was to sell war bonds to finance military cost for the North, it served also to create a national paper currency. Banks which bought war bonds equaling up to one third of their capital were invited to apply for Federal charter. Since the Jacksonian period, bank supervision was the province of the states. In 1860, more than 1,500 banks issued bank notes, many of which were accepted only with high discounts.
The new banking regime was far from perfect. The currency it provided was insufficiently elastic for the needs of the expanding economy. As the Federal government redeemed it war bonds after the war, the quantity of money in circulation decreased, causing deflation that created hardship for debtors, such as Southern and Western farmers. Also, money capital tended to be concentrated in the Northeast. The farming regions in the South and the West continued to suffer from a chronic scarcity of cash and credit. This situation continued until the establishment of a central bank in 1913, in the form of the Federal Reserve.   
The one remaining asset the South still possessed was the fertility of its soil. There was hope that economic recovery could begin with the first harvest of the cotton crop. But large scale cotton production was not possible until the financial system was restored and the liberated former slaves return to work as paid labor.  Hundred of thousands of former slaves had joined the Northern army and were informed that they were freed by the Civil War. They now wandered aimless in the North and the new territories in the West. They had interpreted the new freedom to mean they no longer had to work for their former masters. Many were disappointed that their expectation that the Union government would grant them free land to farm for themselves was merely fantasy. Illiterate and totally unprepared for survival as independent workers, many died of starvation and homeless exposure in the cold early spring of 1865 in the North. In March, a month before the South surrender on April 9, 1865, the Unionl government set up the Freedmen’s Bureau to provide food, shelter and medical attention to the indigent, but did not provide job opportunities for workers. White workers in the North did not want competition from Southern Blacks who were willing to work for low wages. Southern attempts to put the former slaves back to work were interpreted by Northern Radicals as schemes to restore slavery.
The North was divided on policy towards the South, whether to the South its full constitution state rights or to take measures to prevent the recurrence of sectional conflict and future attempts of secession. The Northern Radical wanted to subdue to the South permanently by destroying the traditional power structure of the plantation and by establishing racial equality. Yet while the constitutional States Right issue was the cause of the secession, it was not the cause for the Civil War. In practice, minority sections in the Northeast, such as New England during the War of 1812, had use state rights arguments to limit Federal power.
The reason for the Southern secession was distinctly different for the reason for the North to launch the Civil War. The South by its own statement seceded to maintain the institution of slavery which was vital to its socioeconomic structure. Official Southern statements placed secession as a legitimate response to the North’s violation of the rights of Southerners by excluding them from the new territories, refusing to restore fugitive slaves and threatening the institution of slavery itself.
The North resorted to prevent secession by force to preserve the Union for political and economic reasons, not to abolish slavery, even though its abolition might be the result of the war. Lincoln himself repeatedly made the distinction and he personally was not an abolitionist. To Northern industrial interests, an independent Confederacy closely linked to Britain would deprive the North of a big part of its protected domestic market. 
Congress did not meet until December 1865, nine months after the fighting ended. Until then reconstruction was under the exclusive control of the executive branch. Andrew Johnson succeeded the assassinated Lincoln in April and continued Lincoln’s conciliatory reconstruction program which was opposed by the Republican Radicals.
Some radicals were ideologues who saw the Civil War as a war to abolish slavery. Other Radicals were merely using abolition was a pretext to hold on to Republican political dominance and to strengthen the North’s control of the economy. If the South were to be permitted to return to the Union on Lincoln’s terms, then the pre-war dominance of the Democratic Party would be restored to win the next election to dislodge Republican control of the Federal government.
Northern industries and banks were concerned that the tariff would then be lowered to allow foreign competition. Free trade would allow the South to sell more cotton to Britain and form economic alliance with British capital to oppose the North. Northerners feared that the national debt held by Northern banks might be repudiated by a Democratic Congress controlled by Southern politicians the same way Confederate debt was repudiated by the Republican Congress controlled by Northerners. Congress would then be controlled again by the Agrarian South and stripped the North of all economic benefits of having won the war. Electoral politics required Republican support for enfranchising former slaves in order to win votes in Southern states with large Black population.
Still, despite less than pure moral incentives, the Republican Radicals pushed through the Fourteenth Amendment to the Constitution on July 9, 1868, a year after the Civil War ended. The Amendment provides a broad definition of citizenship, vacating the Supreme Court decision in Dred Scott v. Sandford (1857), which had excluded slaves and their descendants from possessing Constitutional rights. The relevant question before the Court was whether, at the time the Constitution was ratified, former slave Scott could have been considered a citizen of any state within the meaning of Article III of the Constitution.
According to the Court, the authors of the Constitution had viewed the “Negro” race as:
“beings of an inferior order, and altogether unfit to associate with the white race, either in social or political relations, and so far inferior that they had no rights which the white man was bound to respect.”
Thus strict construction view of the Constitution held by Southern Democrats would deny Blacks all constitutional and civil rights despite changing conditions. Richard Nixon, as Republican president co-opted the term and concept to described conservative Republican politics and judicial philosophy.
The Amendment’s “Due Process Clause” has been used to apply most of the Bill of Rights to the states. This clause has also been used to recognize substantive due process rights, such as parental and marriage rights, and procedural due process rights, which require specific legal steps before a person’s right to life, liberty, or property can be infringed.
The Amendment’s “Equal Protection Clause” requires states to provide equal protection under the law to all people within their jurisdictions. This clause later became the basis for Brown v. Board of Education (1954), the Supreme Court decision which precipitated the dismantling of racial segregation in the United States and the Civil Rights Bill of 1964.
The Agrarian Revolt
By the late 1880s, two decades after the Civil War ended, the small farmers of the South were beginning to organize resistance against the dominance of the landlords and industrialists from the North. The Southern farmers wanted to keep more of the wealth they produced from farming to pay for local schools, roads, and other improvements plus a more democratic political system. Farmer discontent was caused by Northern financial control and exploitation of the Southern farming economy, manipulating the commodities market to cause cotton prices to fall by half to 5.8 cents per pound during 1894-97.
The National Farmer’s Alliance, also known as the Southern Alliance, was formed in Texas in 1875, a decade after the war ended. It grew quickly to a membership of over 3 million. A separate organization, the Colored Farmer’s National Alliance has a membership of over one million.  These alliances advocated measures for the benefit of farmers and sought support from Northern industrial workers. A People’s (Populist) Party was formed from support of the farmer alliances.
The populist platform of the People’s Party demanded a series of reforms designed to break the control of political bosses in municipal politics and to give back to the people effective control of their urban governments. It also aimed at restoring a more equitable economic system through nationalization of the railroads, communication networks, a graduated income tax, shorter work days and work weeks and a stable currency to ward off inflation that repeatedly outpaced wage increases.  To address the problem of farm credit, the party platform proposed a “sub-treasury” plan by which the government would store non-perishable farm produce in national warehouses and give loans to farmers to whom it belonged up to but not more than 80% of its value. Populism was essentially a resurgence of the spirit of Jeffersonian agrarian democracy that had shaped American ideals and institutions at the founding of the republic.
The Currency Issue

The issue that aroused the most controversy was that of currency. Southern and Western farmers were convinced that the main reason for the fall of farm prices was the policy of deflation adopted by the Federal government after the Civil War to punish Southern debtors. By limiting the quantity of greenbacks and silver dollars, making them redeemable in gold, the Treasury had increased the value of money held by Northern money trusts and correspondingly deflated prices of commodities produced by farmers and miners. Farmers saw the product of their labor decrease in value while their debts to Northern banks increased in value. They felt it unfair that they had to repay the loan they took out earlier when wheat was selling for $1 a bushel with money that could later buy wheat at 60 cents a bushel. 
Many homeowners today also feel unfair that they have to repay loans they took out two years earlier when their homes were selling for $700,000 with money that now can buy the same homes for $300,000.
The Populists demanded an increase in the quantity of money in the form of paper currency or unrestricted coinage of silver at the constant ratio of 16:1. The silver coin proposal received strong support from the silver miners.  The Populists were convinced that the maintenance of the gold standard was a conspiracy of international financiers, for whom the Northeastern banks were agents, to impoverish the masses. This attitude was a foundation of isolationist sentiment in the US, particularly in the rural regions of the South, the West and the Middle West.
Today, many borrowers are upset that their pension funds are getting low return as a result of Federal Reserve monetary stance of keeping interest rate near zero while the old mortgages taken out two year keep rates fixed at high levels. They have strong incentives to default on their mortgage loans. 
Populism Reduced to a Sectional Movement

The 1892 election showed US populism reduced to mostly a sectional movement. Democratic candidate Grover Cleveland, having lost the White House in 1888 to Republican Benjamin Harrison despite a popular vote majority but a 168 to 233 loss in electoral votes, recaptured the presidency from Harrison with both a popular vote and electoral majority. People’s Party candidate James B. Weaver won 1,041,028 popular votes and 22 electoral votes, all of which from states west of the 95th meridian, with support mostly from Western farmers and miners. Populist appeal to Northern industrial labor was not successful. 

Populism Co-opted by Both Major Parties 
The long term impact was the growth of populist influence within the two major parties. Populist candidates ran on Democratic and Republican tickets. The most notable was John P. Altgeld, a German immigrant who became Democratic governor of Illinois, giving the state a progressive administration.  Shortly after the 1892 election, the country plunge into a severe and long depression in which unemployment grew to over 4 million or 18.4%, with double-digit unemployment from 1893 to 1899. (Please see my March 2008 AToL series: The Shape of US Populism)
Progressivism and the Federal Reserve
The Progressive Movement in US politics emerged during the first decade and a half of the 20th century out of the intellectual and political ferment of final two decades of the 19th century. It was primarily a reform movement represented in national politics by two presidents: Theodore Roosevelt and Woodrow Wilson.  Progressives were against the growth of political corruption and a captured government that favored organized wealth at the expense of the general public.
Progressives of this era believed in the ideals of democratic government, individual liberty, the rule of law and the constitutional protection of private property. But they argued that the maintenance of these ideals in the new industrial era required new political procedures and governmental regulations.
Progressives emphasized traditional ethical and humanitarian values of fairness and equal opportunity. Marxist concepts of class struggle were inoperative for US conditions as the concept of class never took hold in US political discourse. American politics revolved around economic issues outside of the class context. Almost all giants of industry in the US had worked their way up as young apprentices from the factory floors or as errand boys for big banks. The American Revolution had cut European imperialism on US soil at its root at the founding of the new nation. Not being a victim of imperialism, the US as a nation did not feel oppressed by capitalism.
Most socialists in the US were later immigrants from Europe who landed in urban ghettos and never experienced first hand conditions that naturally supported Jeffersonian democracy. In the half century between 1870 and 1920, the US absorbed 26.3 million immigrants, more than three times as much as during the whole of the previous two and a half centuries. After 1890, unlike immigrants who came before who were generally economically self-sufficient and culturally advanced and educated with professional skills, the new immigrants tended to come from the lower classes of less developed countries of Europe.  A good number of the new immigrants in urban ghettos failed to find the economic liberation they had hoped to be waiting for them in their new home. Some with more financial resources went on to rural areas in Pennsylvania and the Midwest and did better. The successful immigrants, usually ones with education or disciplined drive, qualities that were generally deprived of the lower classes in the old countries, provided concrete, albeit token evidence of a classless society in the new land.
Progressives at first were mostly reformer in city politics, as their influence on the national level was limited. Reformers such as Tom Johnson of Cleveland had made a fortune as a street car owner and became interest in the reform movement through the writings of Henry George. Johnson became mayor of Cleveland in 1901 and served until 1907 and made Cleveland the best government city in the nation. But despite the efforts of reformists, other big cities such as New York, Chicago and Philadelphia continued to be governed by corrupt political machines.
On the state level, John P Altgeld in Illinois and Hazen S Pingree of Michigan were accomplished reformers.  But the champion was Robert M LaFollette of Wisconsin whose progressive governance came to be known as the Wisconsin idea that influenced a block of Midwestern farm states that included Iowa, Minnesota, Kansas, Nebraska,and the Dakotas. In New York, Charles Evan Hughes won the governorship based on his investigation as Attorney General of corruption in big insurance companies. Hugh path of political success was followed by Mario Cuomo, Elliot Spitzer and possibly Andrew Cuomo. Hugh went on to be secretary of state and Chief Justice of the Supreme Court.  In New Jersey, Woodrow Wilson went from the governorship to be the 28th President on March 4, 1913.          
In the US, the spring of 1910 saw the Progressives winning a major victory in the mid-term election of the William Howard Taft presidency for seats in the House of Representatives. In the election of 1912, Democratic candidate Woodrow Wilson, a leading Progressive intellectual, won the presidency with only 43% of the popular vote, but carried forty states due to the split of the Republicans between Progressive Theodore Roosevelt and conservative William Howard Taft.
The election also marked the greatest relative strength ever achieved by socialism in US political history.  Socialist candidate Eugene Debs received 6% of the vote, a record not since reached by other socialist candidates. During the Cold War, socialists were officially viewed as national security risks in the US.
While Progressives wanted to reform the political regime by having government assume broader responsibility for economic affairs, they differed in how this objective could be achieved. One group as represented by Theodore Roosevelt accepted the growth of big corporation was an inevitable economic trend and that government should regulate them rather than dissolve them. Another group as represented by Woodrow Wilson laid more emphasis on prohibiting monopoly, protecting small businesses and promoting and enforcing competition and nurturing innovation. The fundamental question harks back to the Jefferson-Hamilton dispute and later in the debate over the New Deals and today on the direction of regulatory reform to prevent future financial crises.
The rise of Muckrakers, a derogatory name given to investigative journalists and reform writers by Teddy Roosevelt at one of his frequent moments of irritation, helped drive the progressive movement. Henry Demarest Lloyd wrote in 1894 a fierce denunciation of trusts in Wealth Against Common Wealth. The popular low price magazine McClure ran The Shame of the Cities (1902), an exposé on corruption in city government, The Struggle for Self-Government (1906) and The Traitor State, which criticized New Jersey for patronizing incorporation, all by editor/writer Lincoln Steffens, and Ida Tarbell’s articles that later was published as History of the Standard Oil. Upton Sinclair’s The Jungle (1906), a report of the fifth of the meat packing industry was influential in enabling the reformers to bring about the Meat Inspection Act of 1906.    
In his first term as president, Wilson helped persuade a Democratic Congress to pass the Federal Reserve Act of 1913, the Clayton Antitrust Act and the Federal Farm Loan Act. Wilson also established the Federal Trade Commission. Wilson signed the first-ever federal progressive income tax into law in the Revenue Act of 1913 to make up for revenue lost by the reduction of tariffs.
A Northern progressive Democrat, Wilson nevertheless brought many white Southern Democrats into his administration, and tolerated their expansion of segregation in many federal agencies and in Washington D.C., a practice later forbidden by the Civil Rights Act of 1964, a legislation introduced by Democratic President John F Kennedy in his civil rights speech of June 11, 1963, in which he asked for legislation “giving all Americans the right to be served in facilities which are open to the public—hotels, restaurants, theaters, retail stores, and similar establishments,” as well as “greater protection for the right to vote.” President Lyndon B Johnson signed it into law in 1964 after Kennendy's assasination on November 22, 1963.
The US military was segregated until after WWII when Truman signed an executive order to desegregate the Army but actual integration did not take place until the Korea War after the segregated Eighth Army suffered disastrous setback and field commander, in desperate need for replacements accepted Black soldiers to fight along side White ones. In the Navy, First Lady Eleanor Roosevelt’s push for an integrated navy was ridiculed by Navy brass as “Eleanor’s folly”. 
The 1964 Civil Rights Act emulated the Civil Right Bill of 1875 was introduced by Republican Senator Charles Sumner and Republican Congressman Benjamin M. Butler, and signed into law of Republican president Grant but declared unconstitutional by the Supreme Court in 1883.
The first presidential task Wilson presented to Congress was a revision of the high tariff policy. Yet it was not a move towards globalization. Wilson sought to use foreign competition to breakup US big business from its monopolistic hold on the economy.
The Republicans in Congress passed the Morrill Tariff Act which was signed into law by Democrat James Buchanan in March 1861, a few days before Lincoln took office. The Act marked the first increase in tariff since 1842. During the war, there were further rises in ad valorem import duties, with the average reaching 47%. The primary purpose was to raise revenue for war spending, but the high tariff also protected domestic industry from superior foreign competition. Domestic industries succeeded in keeping tariffs high after the war even though government revenue was no long an issue. Throughout most of its economic history, the US benefited from protectionism until the US economy became a dominant power. Free trade was not decidedly a US policy until after WWII.
The Underwood Tariff became law in October 1913, eliminating import duties on more than 100 articles and reducing the average rate of more than 1,000 others to 27% from 37%. In order to compensate for the loss of Federal revenue from tariffs, an income tax was introduced. The constitutionality of an income tax had been recently authorized by the Seventeenth Amendment passed by the Senate on June 12, 1911, the House of Representatives on May 13, 1912. It was ratified by the states by April 8, 1913. However, the anticipated economic effect of the tariff reduction on US competitiveness could not be assessed by actual data because international trade was disrupted by the outbreak of World War I in 1914. War monopoly strengthened the US economy in manners that free market competition could not.
The open and reform policy introduced by Deng Xiaoping in China in 1978 also included in large measure the objective of using foreign capital from advanced Western economies to break up the stagnant monopoly enjoyed by inefficient state-owned-enterprises operating under uninspired management in the context of socialist central planning, struggling to revive a backward economy greatly weakened by 3 decades of US embargo following a century of Western imperialistic exploitation.
Over a span of three decades since 1978, the open and reform policy succeeded in energizing the Chinese socialist economy, yet it has unleashed a host of collateral socioeconomic problems such as income disparity, developmental imbalance and environmental deterioration that may take subsequent leaders decades to correct. The current global financial crisis in market economies is also causing China to reexamine its blind rush towards market economy. 
Wilson fundamentally altered the monetary system of the US by establishing the Federal Reserve System when he signed into law the passage by Congress of the Glass-Owen Federal Reserve Act of 1913. The main objective of establishing a central bank was to provide monetary elasticity in support of a growing economy. Prior to the establishment of the central bank, the system set up by the National Bank Act of 1863 left the money supply tied to the amount of government bonds held by banks, with no direct relationship to the monetary needs of the economy. A central bank was expected to manage the money supply to serve the needs of the economy and to control inflation by setting interest rates.
Monetary reform had long been demanded by farmers who saw the National Bank Act of 1863 as having failed to protect their interests by allowing Northeastern banks to keep money scarce when farmers needed loans to finance their spring planting, by keeping interest rates high in the farm belts in the South and West, and to keep money scare in autumn when farmers brought their harvest to market to keep farm produce prices low. In between, banks would ease the money supply so that general inflation would eat away the purchasing power of the sales proceeds of farm produce. 
Farmers wanted a central bank not controlled by the private bankers in the Northeast along Hamiltonian lines, but controlled by government along Jacksonian populist tradition, and decentralized away from the money elite of the Northeast.
Wilson set up 12 regional Reserve Banks to balance regional interests and to serve seasonal needs, to be supervised by a Federal Reserve Board in Washington in the context of a national monetary policy.

Too-Big-to-Fail Banks get Bigger

One of the outcomes of government bailout of big banks in the current financial crisis may be that a large number of the more than 8,000 small community banks will be absorbed by four super banks.  JP Morgan Chase is now reportedly holding more than $1 of every $10 on deposit in the US. The four biggest super banks (JP Morgan Chase, Bank of America, Wells Fargo and Citibank) now issue one of every two mortgages and about two of every three credit cards in the US.
Since the financial crisis began in mid 2007, these four super banks have been allowed to hold each more than 10% of the nation’s deposits, having been exempted from a longstanding rule barring such market dominance by any one single bank. In several metropolitan regions, these new super banks are now permitted to take market share beyond what the Department of Justice’s antitrust guidelines previously allowed. The American banking system is now one of a handful of large global conglomerate of hedge funds pretending to be banks, taking huge profit from high risk proprietary trades with government-backed money, instead of one of a network of small conservative local institutions serving their domicile communities merely as intermediaries of money through local deposits for nominal fees. In 2009, the 10 largest banks in the US accounted for 60% of all banking assets, up from 26% 20 years ago.
Progressive are promoting the break up of big banks as institutions that serve no good social purpose and to prevent big banks from exploiting the too-big-to fail syndrome to hold the economy and tax payer hostage.
Latest FDIC data reveal that the new super banks now can borrow more cheaply than their smaller peers because creditors assume these too-big-to-fail institutions to be fail safe. This trend will leave the financial market dominated by a gigantic trust of interlocking super banks. Such concentration of market share will hurt consumers in two ways. It will keep cost of credit high to borrowers for lack of competition even when cost of fund for banks remains artificially low. It will also force regulators to push bank reserves upward to force banks to pass on the cost to borrowers. Worse, such a gigantic monopolistic trust of large interlocking super banks will lead to a financial structure too big to save without voiding the normal characteristics of a market economy.
April 25, 2010
Next: Public Debt and Other Issues