Remember when the Berlin Wall fell in 1989 and Republicans claimed that Ronald Reagan's aggressive policies toward the Soviet Union had won the Cold War. In particularly they claim that Reagan's fabulously expensive "Star Wars" anti-missile system had forced the Soviets to spend so much on their own military projects that it bankrupted them.
Well, there's truth in that. Between trying to compete with Reagan's military spending and their own misadventure in Afghanistan the Soviet Union went bust. Decades of over-spending on its military, under-spending on critical domestic needs and saddled with a flawed and increasingly corrupt economic dogma all collided at once, ending in utter and complete collapse.
Nearly 20-years later America is building its own wall along our southern border, spending $12 billion a month fighting twin wars in Iraq and Afghanistan, while not investing in our aging, crumbling infrastructure and -- finally -- free-market radicals in this administration allowed the economy to be run into the ground by increasingly corrupt and self-indulgent players.
In the days and weeks ahead you're going to hear a lot from Washington about how they've got a handle on all this. But they really don't, not even close. Because, you see, there's no money in the national bank account and our favorite lenders, the Chinese, Japanese and, increasingly, Middle East oil producing states, have been dragged into this economic morass themselves. The last thing of those lending nations need or want right now are a few hundred billion in USA IOUs.
But even if those lending nations were willing to continue to drop spare change into America's tin cup, there's not enough dimes on earth to fill the hole that's been created by Wall Street's Frankenstein creations called "derivatives." (See chart)
According to the International Swaps and Derivatives Association, the notional value of CDS totaled $63 trillion at the end of last year. Estimates for this year are more like $67 trillion.
Alan Blinder, the former Fed vice chairman, who holds a doctorate in economics from M.I.T. admits that even he doesn't understand derivatives. “I know the basic understanding of how they work,” he said, “but if you presented me with one and asked me to put a market value on it, I’d be guessing.”
The point everyone misses," wrote economist Robert Chapman a decade ago, "is that buying derivatives is not investing. It is gambling, insurance and high stakes bookmaking. Derivatives create nothing."
Today, the outstanding "value" of derivative swaps stands at about $50 trillion. (By the way, that's up from $900 billion in 2001.) But the values investors and institutions placed on their books for these derivatives bears little connection to their actual value. And no one -- I mean NO ONE -- really knows what those things are really worth. First regulators and investors will have to determine a current real market value for each of them. To do that they have to untangle each of these Rubic Cubes; how they are amortized, who has claims on all or part of each, when they're due, etc. Only then will they learn what all these underlying assets are truly worth. They may be worth only pennies on the dollar. In many cases regulators -- and taxpayers now backing these instruments-- will learn they are not worth the cost of the electricity to put them through a document shredder.
All the activity you see at the White House in recent days has only one goal; to avoid a total collapse on Bush's watch. By the time the next President takes office the current administration will have eaten all the nation's remaining seed corn, leaving the next administration virtually nothing to re-grow the economy.
With the US consumer and financial system gutted and our military stretched far beyond its limits, the next Commander-in-Chief will be left with only one choice; to end military operations in Iraq and let the chips fall where they will between waring Sunnis and Shiites. And then to move some of those military resources to the real threats to the world, Afghanistan and nuclear-armed Pakistan.
Even then it will be difficult to maintain full-scale military operations there unless our NATO allies increase their commitments. Unfortunately Europe also finds itself being dragged down by the US financial market collapse.