The Unraveling of the U.S. Economy

Since I posted “Bankrupt America” here ten days ago, major pillars of America’s financial edifice have come crashing down. First, the federal government had to take control of Fannie Mae and Freddie Mac, the nation’s two largest mortgage finance companies. Then the prominent securities firm Lehman Brothers declared bankruptcy, and the even more venerable Wall Street firm, Merrill Lynch avoided the same by selling itself to Bank of America. Today the Federal Reserve announced that it was taking over the insurance giant, A.I.G., in a bailout that will cost taxpayers $85 billion.

These are all huge companies—mainstays of the U.S. economy. It is difficult to make much sense of Senator John McCain’s assertion that “the fundamentals of our economy are strong.” These companies were the fundamentals, and they are all bankrupt. Most people, even most financial analysts, I think, do not quite grasp how elemental these developments are. They signal a shift that is as fundamental for the United States as global warming is for the planet.

The collapse of these financial institutions are part of the bigger picture of economic weakness that I describe in The End of the American Century. The United States has been overspending and under saving for a generation or more, and this has led to borrowing, deficit spending, and debt inside and outside the government. As I write near the end of Chapter One of the book, “where the U.S. once drove the world economy through economic growth, invention, and productivity, now it is doing so almost entirely by consumption but at levels it cannot pay for.”

The consumer spending and borrowing binge has been fueled by the growth of the financial services industry, which has increasingly replaced manufacturing as the mainstay of the U.S. economy. The shrinking manufacturing sector now accounts for only about 10 percent of corporate profits in the U.S., compared to 44% of such profits from the financial sector. Banks, mortgage companies, loan agencies and credit card companies make their money by making loans, and they are constantly seeking new customers and encouraging existing ones to borrow more.

It is this symbiotic relationship between binging consumers and profit seeking financial companies that has created the piles of consumer debt—the largest in U.S. history. All of this is starting to unravel now. People borrowed more than they could afford; the mortgage crisis undercut their ability to repay loans and mortgages; the banks and loan agencies faced mounting defaults and declining profits and stock prices. And as goes the financial sector, so goes the rest of the economy.

This is not some episodic financial downturn. The chickens are coming home to roost, and they have nowhere to land. The U.S. government has record budget deficits and is deeply in debt; Social Security is unfunded; households have zero savings (literally); the dollar is at record lows; energy at record highs; and now the stock market is taking a bashing. Former Fed chief Alan Greenspan told ABC that this is a “once-in-a-century type of event.” And former Commerce Secretary Peter Peterson, who I invoke in my “Bankrupt America” post, admitted that “these are the most extraordinary events I’ve ever seen.” (NYT 9/15/08).

In The End of the American Century, first written a year ago, and appearing next month, I wrote this at the conclusion of my Chapter One on “Imperial Overstretch and Economic Decline”:

A serious recession, perhaps even a depression, is the probable outcome. Such a recession will actually be necessary, however, for the long-term viability of the American economy. It will cause unemployment in the short run and declining wages and incomes in the long run, but this is inevitable if balance is to be restored. The U.S. economy will shrink, as will the country’s standard of living. This will simply reflect the actual economic situation in the U.S., which for so many years has been obscured by mortgaging the future with deficits and debt. The U.S. will no longer be the dominant economic power in the world, and with economic decline will come military, diplomatic, and political decline.”

What does all this mean for us? Stay tuned. (And your comments and thoughts are welcomed).