Whitley's Journal

Gas Prices Explode as the Dollar Falls--so Why is This Happening?

You're not going to see much, if anything about this in the dumbed-down U.S. media--not because they're trying to hide it, but because they can't understand. But there is a reason that the United States and the American Dollar are in the trouble that they are in. It isn't only that demand from Asia is putting pressure on supplies. Far from it, oil supplies are adequate worldwide, which is what OPEC keeps saying. So what's happening?

To understand, we need to go back a few years, to a fundamental and catastrophic decision that was made in 1988 by the President's Working Group on Financial Markets. While the record of its discussions remains--understandably--secret, the effect of its decision can be seen clearly all around us. No matter where you live in this country, it is likely that there is an abandoned manufacturing facility within a few miles from your home. It is also likely that, if you are able to find any US manufactured shoes, clothing, soft goods or small appliances, they will be more expensive than similar items imported from abroad, and far less numerous. This is true not just of consumer goods, but of machine tools, equipment, parts--you name it. Manufacturing has gone abroad.

Absent the minutes of the Working Group, what its policy has been can only be inferred, but the inference must be accurate, given that the economic consequences are so obvious. What has happened is that a co-ordinated policy of financial mercantilization has been enacted in this country, and a conscious decision made to allow the abandonment of America's manufacturing base.

This was done to increase the profitability of corporations and enable them to compete by outsourcing rather than increasing efficiency and productivity here at home. Precisely the same process unfolded in Great Britain throughout the latter half of the nineteenth century, with the result that British power failed, just as American power will.

Let's be very clear about what the change from a manufacturing economy to an economy based on debt as value means. It means that the value of American lives is no longer measured by work output, but by debt potential. It isn't how many things you can build that matters now, it's how much debt you can repay.

What has been done, as you have ceased to have any tangible manufacturing output, is that your value, measured as the value of your debt, both that collateralized by property, such as your mortgage debt, and your uncollateralized debt, such as credit card debt, has been mercantilized. This process is called the 'securitization' of debt. Your debt, restated as securities, is what the United States now sells, instead of shoes, tractors and trousers.

Of course, we still have a large manufacturing component in our economy. We make automobiles here, and airplanes, for example. But these industries are no longer locally vertical. Parts are outsourced from all over the world. In fact, there are few manufactured goods that are entirely American made, and American manufacturers, in general, always outsource rather than investing in infrastructure here at home. This denial of the value of American lives is deeply, profoundly unpatriotic, and arises from the incorrect focus of American industry on capturing near term profit rather than building long-term value.

This has been true of government, too. Our term-limited presidency means that the only meaningful time span to all but the best presidents is the near term. Unfortunately, a defining characteristic of late twentieth century American politics has been mediocrity in the White House. In fact, I don't really see any exceptions to this rule, not in the past fifty years.

The result is that the quick fix has always been the only fix. So we have an economy that is, essentially, based on pretending that something--debt--has a type of value that it does not, in fact, have.

An economy based on the buying and selling of its own debt suffers from many vulnerabilities, the most important of which is that the quality of that debt depends on the ability of individuals to service it.

This ability is dependent upon the price of essential goods and services--things like food and gasoline--being low enough to enable debt service to continue.

Since 2002, and accelerating in 2007 and, even more dramatically in 2008, this has become less and less true. Prior to mid-2006, the problem was concealed in two ways. First, alterations to the statistical methods used to compute the Consumer Price Index created a false impression that prices were not rising. In reality, of course, they were and they are. The first signs of a problem appeared in 2007, when the so-called "sub-prime" crisis began to affect financial markets.

In fact, it turned out that many people could not both eat and pay their mortgages. They chose, oddly enough, to eat, and many lower-rated mortgages began to go into default. The result of this was forced sales, and more housing began to appear on the market than the market could absorb.

The rest is known to everybody, except for the outcome, which will be as follows: first, if the price of oil doesn't decline relatively dramatically and quite soon, the American economic infrastructure is going to collapse. Energy costs will mean that America has become, in effect, illiquid, and thus unable to buy goods from abroad. Subsequently, the Chinese, Indian and Japanese economies will suffer profound dislocations as well. So also will elements of the European economy that are dependent upon exports to Asia and the United States for their profitability.

Once we abandoned our manufacturing base, the United States ceased to be a viable economy, for the simple reason that it is no longer adding enough value to increase prosperity. If you feel poorer, it's because you are. Your money is worth less, so your work is worth less. This is the core definition of economic decline.

Precisely the same thing happened to ancient Rome, when, after a long war with the Parthians (Persians, now Iranians) the emperor Philip the Arab paid the Parthian king Shapur fifty million sesterces to buy peace.

This payment exported so much silver and gold out of the western Roman world that it led to the debasement of the Roman currency, and resulted in a financial crisis from which the western empire never recovered. Over the next hundred and fifty years, manufacturing moved away from areas where the debased currency was in circulation, and into regions where good coinage was available.

As value left Rome, so did power, and by 350 AD, Constantinople on the Bosporus was the center of the empire. In another two hundred years, the population of Rome had declined from around a million to a few thousand, and shepherds tended their flocks in what had once been the forum of the Caesars.

To understand why currency debasement is now also in the process of befalling the United States, we must go to the year 2002, and the beginning of the Iraq war. This war was the death-knell. It has added vast public debt to our country's vast private debt, in effect debasing the currency. Prior to the appearance of the Bush administration, American politicians, without being entirely clear about the reasons, sensed that, as private debt exploded before their eyes, additional public debt would make the currency vulnerable--in effect, debase it. They made efforts to reduce federal indebtedness as much as possible. This is why the Clinton Administration strove for a balanced budget.

The United States economy, deprived by the Working Group's decisions of the ability to add real value through increasing productivity, was extremely vulnerable to debt. And yet, Vice-President Cheney repeated a shibboleth often stated during the Reagan years, that governmental debt "didn't matter." This was a gamble during the Roosevelt Administration, a mistake during the Reagan Administration, and a catastrophic error during the Bush Administration.

Roosevelt's gamble with debt paid off because of the way it was used: to build infrastructure that supported the economy. By the time Reagan came along, debt was being put to use for a very different purpose: to increase the money supply without regard to infrastructure or anything else. It was, in other words, empty debt. Gasoline, in fact, on a fire. The result of this is that the cycle of infrastructure improvement that was needed in the 1980s never happened, with the consequence that efforts to increase productivity and efficiency face just one more hurdle.

Even more cynically, the Bush administration chose to curry public favor by using debt to cut taxes. Unfortunately, instead of following the tax cuts with promised reductions in the size of government, it increased government massively, and went into debt to finance the tax reductions.

This increase in public debt, added to the increase compelled by the war in Iraq, caused the dollar's decline to intensify. In other words, the Bush administration, knowing nothing of Philip the Arab and the consequences of his debasement of the Roman currency to solve a middle eastern problem, repeated history.

As the currency declined, the price of oil increased. As people had to spend more money on fuel, they had less to spend on housing, with the result that home sales declined, and with them property values. Thus, the tax cuts were taken right out of the value of homes. Most people have paid far more in declining home values than they have received in reduced taxes, largely because the cuts benefited the wealthy, while the decline in home prices has affected the median incomes only. So far.

The less original manufacturing in an economy, the more problematic its debt becomes. The moment it becomes unable to service its debt, there is nothing left but the abyss. This is because, in an economy that is not firmly based in a healthy manufacturing sector, all debt is, in effect, uncollateralized and only as valuable as this month's service.

As US public debt began to rise uncontrollably in 2002 and 2003, OPEC, realizing that the dollar was therefore becoming vulnerable, began to reduce the percentage of foreign currency reserves kept in dollars. Until then, this had been pegged at 75%, based on a 1974 agreement that had allowed a substantial price increase in return for a guarantee that the dollar would remain the primary currency of exchange.

As of 2008, OPEC is keeping only 61.5% of its reserve in dollars, and has ended all price controls. This has caused vast economic destruction world wide and has, as will become evident over the next few years, destroyed the American economy as we have known it.

To some extent, this is due to a lack of growth in oil supply at a time when demand is increasing, but it is much more due to the decline of the dollar that is associated with the abandonment of manufacturing in the U.S., and the mercantilization of debt that is proving not to have any dependable economic value at all.

The lesson is clear: if you're going to go to war, don't close all of your factories first. The mercantilization of debt isn't an alternative. Debt is not value, and it has no business being used as the basis of securities. A factory is a factory, and as long as it has the potential to produce goods, it has measurable value, as do the goods themselves. But what value does a promise have, in the real, tangible and permanent terms that should be demanded of a security? The answer is clear.

So, where are we now? For one thing, the price of oil has been bid up unrealistically, as have other commodities as large institutional entities, awash in cash, have frantically shifted from securitized debt into something more tangible.

All they have done, though, is to stave off the inevitable. As commodity prices have escalated across the board, demand worldwide is plummeting, as will be seen in statistics due to appear over the next few months. The result of this will be that any commodity in normal supply, like oil, for example, or meat and soybeans, is due for a terrific temporary plunge in price, followed by a gradual regularization.

During this plunge, many financial institutions that have been trying to escape into value will finally be bankrupted, and there will follow a general contraction of debt in the U.S.

In other words, a profoundly damaged market enconomy will strive, as markets always do, to correct itself. But, absent a viable manufacturing base, the effort will, in the end, fail, and continuing basic commodity supply problems will further erode the value of U.S. debt, both public and private.

Until and unless manufacturing returns to American shores, the U.S. economy will remain fundamentally unhealthy. Whether or not sheep will eventually graze on the mall in Washington, beneath the shadow of a teetering Washington Monument, I cannot say. But I can say this: without the creation of real value as its basis, an economy is an illusion.

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