A Dollar-Denominated, Debt-Default, Deflationary Death Spiral for our Economy – Part II

Part II: Contributing factors to the Great Recession, and why “The Fix” fixed nothing.

In Part I, we defined the characteristics of a “deflationary economy” as derived from the inadequate wages and other income of the “non-elite workers” in the economy, those being 90% of our workforce in the USA.  In this Part II, we’ll see if we can make the case that this set of conditions is what led up to the “Great Recession” which is said to have begun in December, 2007 and “officially ended” in June, 2009 (New York Times headline, Sep. 20, 2010.

See Part I here

Let’s call this a “working hypothesis” and see if we can dig up evidence from the financial press, mass media in general, alternative economics (alt-econ) and other sources. Perhaps even some studies from academia.
Wikipedia seems as good a place to start as any on “Causes of the Great Recession,” wherein the entry describes a “balance-sheet recession or

One narrative describing the causes of the crisis begins with the significant increase in savings available for investment during the 2000–2007 period when the global pool of fixed-income securities increased from approximately $36 trillion in 2000 to $80 trillion by 2007. This “Giant Pool of Money” increased as savings from high-growth developing nations entered global capital markets. Investors searching for higher yields than those offered by U.S. Treasury bonds sought alternatives globally.[1]

The temptation offered by such readily available savings overwhelmed the policy and regulatory control mechanisms in country after country, as lenders and borrowers put these savings to use, generating bubble after bubble across the globe.

While these bubbles have burst, causing asset prices (e.g., housing and commercial property) to decline, the liabilities owed to global investors remain at full price, generating questions regarding the solvency of consumers, governments, and banking systems.[2] The effect of this debt overhang is to slow consumption and therefore economic growth and is referred to as a “balance sheet recession” or debt-deflation.[3]

The fall in asset prices (such as subprime mortgage-backed securities) during 2007 and 2008 caused the equivalent of a bank run on the U.S., which includes investment banks and other non-depository financial entities. This system had grown to rival the depository system in scale yet was not subject to the same regulatory safeguards.[3] Struggling banks in the U.S. and Europe cut back lending causing a credit crunch. Consumers and some governments were no longer able to borrow and spend at pre-crisis levels. Businesses also cut back their investments as demand faltered and reduced their workforces. Higher unemployment due to the recession made it more difficult for consumers and countries to honor their obligations. This caused financial institution losses to surge, deepening the credit crunch, thereby creating an adverse feedback loop.[4]

Kimberly Amadeo had this article, “What was the bank bailout bill?” updated on Aug 22, 2019 on The-Balance-dot-com, which gets to the heart of why the “Fix” for the credit crisis did not “fix” the credit crisis but only set the stage for a much greater crisis down the road. It did nothing to “bail out” the non-elite workers who we discussed in Part I. Everything was geared, in autumn 2008, towards rescuing the rentier capitalist class.

Why the Bailout Bill Was Necessary

On September 16, 2008, the $62.6 billion Reserve Primary Fund was under attack. Investors were taking out money too fast. They worried that the Fund would go bankrupt due to its investments in Lehman Brothers. The next day, businesses pulled a record $140 billion out of money market accounts. They were moving the funds to Treasury bills, causing yields to drop to zero. Money market accounts had been considered one of the safest investments.

To stem the panic, the U.S. Treasury Department agreed to insure money market funds for a year. The SEC banned short-selling financial stocks until October 2 to reduce volatility in the stock market.

The U.S. government bought these bad mortgages because banks were afraid to lend to each other. This fear caused Libor rates to be much higher than the fed funds rate. It also sent stock prices plummeting. Financial firms were unable to sell their debt. Without the ability to raise capital, these firms were in danger of going bankrupt. That’s what happened to Lehman Brothers. It would have happened to the American International Group and Bear Stearns without federal intervention.

(Kimberly Amadeo has 20 years economic analyst experience and is the U.S. Economy Expert for The Balance)

Once Barack Obama had been inaugurated, he set to work on the “stimulus package” which became known as the ARRA, American Recovery and Reinvestment Act of 2009.  Did this Act do anything to address the actual foundational causes for our economy to have become “deflationary?” There are a number of voices in the sphere of economics and alt-economics (the “Global South of economics”) who say,  No, not it did not.


Larry Beinhart contributed this piece in Huffington Post–Larry Beinhart, Contributor
Author, “Wag the Dog”

Why the Stimulus Package Failed

11/09/2010 04:41 pm ET Updated May 25, 2011

The stimulus package failed because it consisted mostly of tax cuts. Tax cuts are among the very worst ways to create jobs and certainly the most expensive.

The stimulus package authorizes 787 billion dollars. According to the official website (recovery.gov) $565 billion has actually been spent or credited. There are three categories of “stimulus.” Citing amounts spent, they are:

    1. $243.4 billion in tax cuts.
    2. $154.5 billion in contracts, grants, and loans. This is what we actually think of as a stimulus, construction and research projects.
    3. $166.8 billion in entitlements. This is mostly money to the states to help with unemployment insurance.

The whole story is here (click for link)

What the Stimulus Package did not do, and wasn’t intended to do, was to raise the real wages of the non-elite working class, as we described in Part I, nor to put substantial income into the hands of the non-working class, nor labor-force nonparticipants, either.  The demand destruction process ushered in with the onset of the Great Recession in December 2007 continues to this day, as the real wages of workers continue to stagnate.  If you’ve been following the non-progress of the nation’s labor force out of the recession, you’ve probably seen a number of charts that look like this one below:


The yellow line on the graph shows productivity gains. This is where you can clearly see the growth of wealth inequality, as productivity gains contributed to the incomes and the wealth of the wealthiest, the “1%”, the capitalist class, while the income (and resulting wealth) of the “99%” have stagnated.

This begs the question: if real wages remained stagnant, how were consumers able to keep driving the GDP higher, assuming that consumer spending indeed contributes 70% of the measured GDP?  Once again, let’s look at Wikipedia’s entry on “Cause of the Great Recession.”

Consumer and household borrowing

U.S. households and financial institutions became increasingly indebted or overleveraged during the years preceding the crisis. This increased their vulnerability to the collapse of the housing bubble and worsened the ensuing economic downturn.

  • USA household debt as a percentage of annual disposable personal income was 127% at the end of 2007, versus 77% in 1990.[66]
  • U.S. home mortgage debt relative to gross domestic product (GDP) increased from an average of 46% during the 1990s to 73% during 2008, reaching $10.5 trillion.[67]
  • In 1981, U.S. private debt was 123% of GDP; by the third quarter of 2008, it was 290%.[68]

Several economists and think tanks have argued that income inequality is one of the reasons for this over-leveraging. Research by Raghuram Rajan indicated that: “Starting in the early 1970s, advanced economies found it increasingly difficult to grow…the shortsighted political response to the anxieties of those falling behind was to ease their access to credit. Faced with little regulatory restraint, banks overdosed on risky loans.”[69]

Given that the “Stimulus Package” did not elevate the real wages of the non-elite American workers, and that the Great Recession had been caused by over-leveraging (taking on too much debt relative to income) by consumers, how would we expect the economy to have looked six years after the supposed ending of the Great Recession and the beginning of “recovery?”

Ilargi, writing in The Automatic Earth in August, 2015, offered this rather gloomy assessment of the condition of the working class in the global economy  (using the case of Greece in the EU as the horror story/dystopian warning signal to a better-off nation such as the USA).

The reason why Greece is where it is today, and why we will all be there tomorrow, we can by now for good reason call ‘deceptively simple’. That is to say, the global banking system that orchestrated the financial crisis refuses to take the losses on its extravagant bets, and it has the political clout to get its way, all the way. That’s all you need to know.

The losses are therefore unloaded upon the citizens of our respective nations. But the losses are far too massive for those citizens to bear. They, or rather we, will see our societies stripped of most things, most of the social fabric, that hold them together. Any service that costs money will be cut, progressively, until there’s very little left.

It happened in Greece, and it will happen all over the world. Mind you, this is nothing new; third world nations have undergone the same treatment for decades, if not forever. Disaster capitalism wasn’t born yesterday. What’s new is that it now takes place in the supposedly well-off part of the world, in this case the European Union. And it will spread.

The successive Greek bailouts that have now ruined the entire nation were “needed” to stem the losses on wagers, derivatives and other, incurred by global banks, French, Dutch, German, Wall Street, the City. The first bailout in 2010 also served the purpose of allowing the banks time to shift away from their exposure to Greek debt.

All bailouts, be they directly for banks, or indirectly through a country like Greece and then for the banks, have been set up according to the exact same MO. Greece’s economic reserves just happened to be a bit tighter, and moreover, the country was a convenient lab rat and scarecrow to prevent others from protesting the bailout system too loudly.

The whole system of bailouts, be it in Greece or in the US, was never anything else than a transfer of public money to private interests, with the express aim of making good on the lost wagers of that private sector. With impunity, no less.

And no, the losses have not disappeared. Nor have they been written down. They have instead been transferred to fester in dark vaults, hidden behind swaps and other derivatives, and on central bank balance sheets. But that won’t last either.

The Automatic Earth has warned of the imminent deleveraging and deflation for years, and now everyone is talking about deflation. No worries, guys. As you were. But do please try and understand how this works.

There’s all these losses, with no-one prepared to write down any of them (see Germany vs Greece), and the elites behind the banks unwilling to absorb any -the elites instead insist on getting richer even in a depression-. There is only one outcome left then: that you and me will have to become much poorer. They are our losses now.

The only way the rich can keep getting richer is if the rest of us keep getting poorer. Economic growth is a thing of the past. Deleveraging has started for real. Huge amounts of zombified ‘money’ are disappearing as we speak.

The quote is from the piece “Deflation, Debt and Gravity” appearing on the compilation The Automatic Earth Primer Guide 2017.

So we’ve reached a dead-end stage in our economic system, where the people in economic and political power are determined to maintain and increase the wealth and income inequality disparity to levels which are surely setting the stage for the next collapse.  Let’s call the next one, the Much Greater Recession.

None of the “Fixes” or “bail-outs” offered in the Much Greater Recession to come, will be aimed at “bailing-out” the working class with a much higher wage scale, nor the not-in-the-labor force population with a much higher social welfare payments scale. The 2020 elections round is bound to bring to the fore the Austerity Juggernaut which has been on hiatus while the Congress wrestled with the question of the President’s fitness for office, over the past 30 months. Austerity will be back, and it will bring on the next round of the Dollar-Denominated, Debt-Default, Deflationary Death spiral of our political economy.

In Part III we’ll examine the problem of the hyper-productivity gains in the economy which have left real wages flat. We’ll cast a nervous eye towards the sky and wonder when the Fragment of the Machines, the Robotics and A.I. Asteroid, will strike our working and non-working populations, and how this will contribute to a much faster economic death-spiral.

Stay tuned, and cheer up, won’t you?