For the first time in our modern history, the United States is vulnerable to the destruction of its currency and the end of its role as a world power. The last time the US currency was as vulnerable was when the British invaded during the War of 1812, but at that time the dollar was very far from being the world’s reserve currency, and the country would have survived its collapse easily enough.

Now we are a vast and overextended empire, and we are absolutely reliant on the viability of our currency to maintain our power. Every great empire since Rome has collapsed abruptly and always for the same reason: they went broke.

With our national debt at 11% of GDP this vitally productive economy is far from broke, but our power is vulnerable to attack, and there are people to blame for what has happened to us.

So, what has happened, and what should have been done? The answers to both questions are far simpler than Wall Street would like us to believe.

There has been a noble fiction for many years that it would be safe to grant mortgages to the financially unstable because people will hold onto their homes at any cost. The story was that the last thing a person would give up would be their home.

Using this rationale, banks justified selling outrageous mortgages that required either a gigantic increase in monthly costs or refinancing to remain viable. As long as home prices kept rising, this actually worked pretty well. People simply kept refinancing and, in fact, not only kept their monthly payments low, many of them were able to actually pull cash out of their properties.

However, the US was not the only country enjoying unprecedented prosperity in the early part of this decade. As we prospered, we bought, which meant that Asian supplier economies also thrived. The result of this was that more food, more oil and more mineral resources began to be consumed.

In late 2006, commodity prices began to rise. By 2007, food shortages were terrifying people around the world. Even here in the US, there were sporadic rice shortages in various areas. At the same time, oil prices rose dramatically. The cost of gasoline rose from around a dollar a gallon during the last years of the Clinton Administration to five dollars a gallon or more in some areas.

It then became clear that people will not put their homes before food and fuel. They will choose to eat and go to the store to get food for their children first, then pay their mortgage later. The result was absolutely inevitable: as runaway gas prices sucked cash out of the economy, mortgages began to go into arrears and house prices began to fall.

In late 2007, a number of bankers realized that a terrible problem was soon going to become known: all of those mortgages had been bundled into securities and sold by the banks to all sorts of customers, from private individuals, to hedge funds, pension funds and even sovereign nations. They had then been guaranteed with a form of fake insurance called credit default swaps, wherein large insurance organizations like the American International Group guaranteed to pay the holders the value of the securities if they ever defaulted.

The problem was that the government had not required insurers to carry any capital reserve as a cushion if this insurance should be needed. It’s as if life insurance companies did not need to have the capital needed to pay off their policies, and could instead rely on an ever smaller number of people dying each year.

Then something so incredible happened that it is almost beyond belief. It has been reported in only a few places, but it remains the greatest single financial crime in human history, and the greatest theft, and, quite possibly the trigger for the collapse of the dollar, and, along with it, our role as a world power.

To give you an idea of what life would be like if the dollar lost, say, 40% of its value, just increase the cost of all imports by that amount. You would see gas go from, say $2.25 a gallon to $3.15 a gallon in a matter of days. Shoes from China that cost $39.95 one day might be marked up to $55.90 the next. In fact, everything we buy abroad would follow the same catastrophic trajectory. At a stroke, our country would be impoverished and the government would have to do three things at once: withdraw from its foreign commitments; raise taxes; and reduce entitlements such as Medicare and Social Security upon which millions rely for their survival.

At a time when prices were rising dramatically, people reliant on fixed income of all kinds would, quite simply, face starvation. .

This has happened before many times. In fact, most empires have collapsed because of a lack of money. The Roman Empire in the 5th Century endured the loss of so many revenue producing provinces to Gothic invaders that it ceased to be able to field an army. Over just 50 years, it completely ceased to exist, plunging the western world into the worst depression ever recorded, which history knows as the Dark Ages.

In the 1770s, France found it expedient to support the young United States against British power. As a result of the expenditures this involved, the government became short of money–in fact, nearly penniless–by 1785. The Estates-General were called in 1786 and by 1789 the oldest and most powerful kingdom in the western world had disappeared like a puff of smoke.

After World War One, all the middle European empires collapsed into bankruptcy, and the Germans endured the most fantastic currency devaluation the world has ever known, with the mark becoming completely worthless.

After World War Two, Great Britain found itself nearly broke, and by 1960 had entirely lost the greatest empire mankind has ever seen. It took just 15 years.

The Russia-Afghanistan war bankrupted the Soviet Union, which collapsed so quickly that the CIA did not realize it had happened until after it was over.

Our national welfare is not threatened only by a systemic fault or a geopolitical miscalculation. Certainly the vast wealth expended in Iran and Afghanistan are part of the problem. But they are not the main problem.

The main problem is a crime that was committed between 2005 and 2008, that has only recently come to light. It is that the same banks that created the subprime securities bought credit default insurance on them. Now, this is not, in itself, a crime. It’s just unethical. However, what is criminal here is that they did it after they already knew that the securities were essentially worthless, and, incredibly, so did AIG, the company that sold the insurance.

It is as if, with the full knowledge of the insurance company involved, you bought life insurance on somebody who was already dead–and then, when the insurance company got stuck with the bill it already knew it would get stuck with, it went running to the government for help.

The bankers knew that they were failing, so they engineered a situation that would force the government to foot the bill by dropping it into the lap of a company, AIG, that was literally too big to fail. Had it collapsed, there would have been a vast worldwide financial catastrophe, and we would right now be looking not at 10% unemployment, but at something closer to 20%. The European Union would have failed and along with it the Euro. Asia’s markets would have dried up so completely that countries like China might well have gone into default. Certainly, with its monstrous national debt, Japan would have.

The result of all this is that the Bush Administration was presented with a financial emergency, and responded with the bailout, which was then inherited by the Obama Administration.

What should have been done is that the government should have guaranteed all mortgages, which would have restored order to the securities market by revaluing the worthless securities and making it unnecessary for AIG to pay off its credit default swaps.

This would also have meant that the government would not have had to engage in these massive bailouts, but rather would have seen a much slower and more controllable process of adjustment in the mortgage market. Instead of using our credit to shore up the banks, it should have used its own creditworthiness to shore up the mortgages.

However, this was not done and now we must live with the consequences–a national debt as large as it has been in 60 years, and the danger, always, that a tipping point of some kind will be reached and the dollar will collapse.

There are many such potential tipping points. A national disaster could do it, such as a massive west coast earthquake, or even sufficiently damaging terrorist action–if, for example, the Port of Los Angeles was destroyed by a nuclear device, and 40% of our national port facilities were rendered unusable.

A run on the dollar could occur for many reasons. The trigger could be too many buyers of our debt deciding to invest elsewhere. As an example of this process already beginning, India recently bought 30 billion dollars worth of gold instead of US treasuries. China is working hard to improve its local markets, and all the Asian economies are seeking to minimize their dependence on exports to the US, in anticipation of an eventual dollar collapse.

So, what should we do?

The first thing must be to reduce defense spending by around 20%. This can be done by closing foreign bases outside of the middle east, and cutting back on existing materiel procurement programs, without endangering our troops and without a radical revision to our foreign policy.

The reason is that this is the only area where we can make reductions of the size needed without causing extraordinary disruption in the lives of ordinary Americans. As this is being written, a 21% reduction in the fees Medicare pays doctors may go into effect in a few weeks. This means only one thing: our elderly are going to get less care, and less good care. As always, the first place the government goes is to we the people, not to its real constituency, the big corporations and banks that fund campaigns and, in fact, own congress.

We also need to change our tax structure. Specifically, there needs to be an alternative minimum tax for banks and large corporations. In 2008, Goldman Sachs paid taxes at a rate of under one percent. An alternative minimum tax for these organizations, coupled with reduced defense spending, would enable us to balance our budget within a reasonable time. But, more importantly, it would lead to a continuous reduction in debt, a factor which would make the collapse of the greenback impossible. It could also be done at no direct cost to the American people. Our taxes would not go up. The small business, which is the heart of the American economy, would not be impacted.

But, of course, nothing like this is going to happen, no more than there would ever have been a rational approach to the mortgage crisis. Nobody in finance or in government is in the least interesting in bailing out anyone as trivial as American families with anything as uninteresting as a federal guarantee, when vast amounts of cash can change hands.

That cash came from somewhere, though. It came out of our lives and the lives of our children and grandchildren. We will sweat and labor for a generation to repay it. That, in itself, is an extraordinary crime. But an even greater crime belongs to the bankers and government officials who engineered both the banking crisis and the bailout that it made necessary.

They will never be prosecuted. Few people can even understand their how they have been cheated. And, while not a crime, this ignorance is certainly a terrible shame.

To learn more about the way the bailout was engineered, click here.

NOTE: This Journal entry, previously published on our old site, will have any links removed.

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