Digging a Hole


Bad Money is a short book by a practiced artist who specializes in identifying the defining trends of American life. Here Kevin Phillips takes on financial practice in the age of Robert Rubin, Henry Paulson, and the global rule of Goldman, Sachs. It’s not meant to be pretty, and it isn’t.

Phillips argues that financial recklessness, combined with peak oil and the rise of Asian economic power, will doom-has already doomed-American world leadership and our standard of living, which depend on the value of the dollar. The leading edge of collapse, in the form of the subprime mortgage and banking crises, is already on us, and the consequences will make future imperial adventures untenable, in Iraq and elsewhere.

The problem begins with private debt. According to a chart early in the book, total private credit market debt was nearly constant, as a share of national income (measured as GDP), from the end of World War II until the rise of Reagan. It then started growing, passing the 1929 peak in the early part of the 21st century and continuing upward to well over three times GDP by 2006-more than double the value of the golden years. Most of that was mortgage debt. And a vast share in 2005 and 2006 was subprime mortgage debt: ticking financial bombs, carefully packaged and marketed to pension funds, hedge funds, sovereign wealth funds, and gullible foreigners.

Phillips correctly notes the roles of former Federal Reserve Chairman Paul Volcker’s radical high-interest policy and of financial deregulation in starting us down this road. He might have said more about Reagan’s tax policy. “Supply-side economics” gave corporate chiefs huge incentives to divert retained earnings, until then the mainstay of business investment, into executive pay. Alan Greenspan’s 1983 Social Security “reform” squeezed workers by raising the payroll tax. And then came the 1986 Tax Reform Act, which for political reasons left mortgage interest as the only type that could be deducted. This created a huge incentive to expand home ownership, and so to financialize the housing sector.

Bad Money

There followed a shift in the means of payment for consumption from income to borrowing-what I’ve called a “Keynesian Devolution”-as the power to borrow passed from governments to households. That wasn’t all bad; in the 1990s, the debt boom fostered prosperity, full employment, and even a briefly balanced federal budget. But it could not be sustained. As Clinton exited, the information technology bubble collapsed. Under Bush, it was replaced by a vast housing bubble, rendered toxic by resettable subprime mortgages and their securitization. That too was destined to collapse, once interest rates rose and the debt trap closed. The prophet of disaster in these matters was Hyman Minsky, a Keynesian strongly focused on financial instability-a fringe topic whose very existence mainstream academic economists blithely deny. A book almost as shocking as this one could be written about the intellectual failure of economists in this field. That failure, even to the present hour, leaves the vast majority of them oblivious, or willfully indifferent, to what’s going on.

Minsky distinguished three steps on the path to doom. The first is “hedging,” when agents expect to service their debts with income. The second is “speculation,” when borrowers enter into debts they know they must later refinance. The third is “Ponzi,” when debts start piling up faster than they can be handled, and collapse becomes inevitable. Minsky saw the 1980s as a transition in the U.S. from a hedge to a speculative position. The Bush era saw the move into Ponzi finance, which we recognize only now, as the scheme unravels.

Inflation is one symptom of the unraveling. Prices of housing, college, health care, food, and fuel have soared. But Phillips calls attention to what is practically a conspiracy, in his view, to keep much of this information from turning up in official data. Particularly, the government has revised inflation calculations in two ways, as efforts to measure quality introduced rapid price declines in the computer sector, and taking account of the fact that consumers substitute for goods whose prices rise rapidly. Thus as the price of steak rises and you switch to chicken (as who has not?) there appears to be no inflation, because beef is no longer being consumed. The effect of both these steps is to reduce the reported rate of inflation-and therefore to reduce required cost-of-living increases in wage contracts and social security benefits.

Bad Money is particularly good on the relationship between the rise of oil and the rise of the United States, as against coal-burning Europe. Phillips stretches this point to a striking insight: that for the past generation the United States has operated on an “oil standard.” With U.S. power backing price stability for black gold, inflation was limited by the role of oil in everything we make or buy. But now that source of stability is gone. It was broken by the advent of peak oil, the geophysical reality that supply cannot keep up with demand. This has eliminated the spare capacity of the Saudi oil fields, and therefore the power of the United States to bargain for a stable price. We have entered an age of monopoly power. And for that reason, perhaps more than any other, the dollar is coming unhinged.

Thus we come to Phillips’ closing argument: the rise of Asian power, in his eyes best seen as an emerging, interconnected hyper-power, linking energy sources in the Persian Gulf to the military might (and nuclear arsenal) of Russia, and the technical prowess of Japan and Korea to the limitless manpower of China. As Asia develops a unified political voice, it will, in Phillips’ view, overshadow Europe and eclipse the United States. Nothing in the experience of empires, from Rome to Spain to Britain, suggests that the grip of finance and militarism on the U.S. can be broken soon enough to prevent a crack-up here at home.

This is an important book. It ranges with stunning clarity over terrain that most political writing, including that of the most prominent voices of the American left, simply ignores. It also highlights the two most serious failings of neoconservative militarists: on the one hand their economic illiteracy, and on the other their inability to grasp that military power itself has been neutered in the modern world, as Iraq should have demonstrated to all by now. It is the combination of these failings-not either one in isolation-that makes the continuation of neoconservative power so dangerous for the future of these United States.

Should we share Phillips’ pessimism? Certainly there’s not much in our present politics of militarist Republicans and Wall Street Democrats to offer grounds for hope. But as a professional reformer, I hope anyway. There were reasons beyond raw military power that the postwar world entrusted leadership to the United States. One was that we represented an ideal that much of the world shared: rule of law, international cooperation, and the aspiration to sustained peace. The other was that we had the demonstrated capacity to generate new technologies and economic transformations, and this gave hope for prosperity and development to the entire world.

We have squandered the first advantage and damaged the second. But so far, no country or region-not even Europe-has made a convincing bid to replace us on either count. For this reason, much of the world continues to look to the United States, not for salvation or protection, but as a country that had, at one time, a historical sense of obligation to the planet. If we could now come to grips with the duty ahead-to transform our energy budget and cope with climate change-then perhaps there is a chance to recover that role. In that case, perhaps the rest of the world would continue to finance us. If so, our fundamental advantages might remain intact.

It’s a long shot. But you take the long shot when it’s the only one you’ve got.

James K. Galbraith’s next book, The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too, is forthcoming in August from the Free Press.