Don't Look Now, There's a Huge Wave of Inflation Coming Toward Us

By Kevin Phillips, Huffington Post. Posted October 29, 2008.

The time has come to review how back in 2005-2006 George W. Bush -- now increasingly perceived as another Herbert Hoover -- picked two top appointees who helped steer him towards his fateful 2008 rendezvous with a second Great Crash.

One of them, a top level financier, insured that Washington's eventual rescue policies would concentrate on trying to bail-out Wall Street while ignoring the gnawing cancer of its warped ambitions and financial malpractices. The second, a professor, misapplied dogma about how to guard against severe downturns into a disastrous attempt to refight the onset of the 1930s depression -- his academic specialty. He did not understand the very different context of our own era of cyber-spatial financial recklessness and gathering global inflation.

Henry Paulson, Bush's pick as treasury secretary, was not your ordinary gray-flannel investment bank CEO. One 2006 Business Week article spotlighted the new secretary as a high-roller: "Think of Paulson as Mr. Risk. He's one of the key architects of a more daring Wall Street where securities firms are taking greater and greater chances in their pursuit of profits." That, the magazine added, "means taking on more debt ... it means placing big bets on all sorts of exotic derivatives and other securities." That means stuff like collateralized debt obligations (CDOs) and credit default swaps (CDSs), innovations we now know to have spread toxicity, opacity and paralysis.

Economics professor Ben Bernanke, before replacing Alan Greenspan as Federal Reserve Board chairman in early 2006, had served almost three years as the Chairman of George W. Bush's Council of Economic Advisers. There he had been a cheerleader for Bush economic policies, including upper-bracket tax cuts, Social Security privatization, "securitization" of assets and "safe" financial derivatives. On top of which, he was an academic and theoretical specialist in monetary policy and economic depressions - a man who boasted of understanding downturns' critical preventative. The Fed should pump up the money supply or liquidity which would overcome any credit crunch. As a card-carrying monetarist, he also insisted there was no meaningful inflation during the 2005-2007 period even though global commodity price indexes had been soaring.

Thus, and without knowing it, did an inept George W. Bush assemble his two chief architects of neo-Hooverism. They would pick up where the original Disasterman, Alan Greenspan, Fed Chairman between 1987 and early 2006, had left off. Together, alas, the two would steer U.S. policy towards false pretenses, panic and economic disaster - Old Hoover outcomes re-achieved through new biases, ideology and myopia.

Wall Street's "Mr. Risk," calling the shots at Treasury, would focus the Bush administration's 2008 economic "rescue" policies not on the broad national interest but on bailing-out the "Frankenstein Fifteen" top U.S. financial institutions - the big five investment firms, the five largest commercial banks, the four mortgage biggies, and AIG, the rogue insurance giant. Along with the buccaneering hedge funds, these were the big firms that borrowed huge sums, merged grandiosely,, experimented with all "the exotic derivatives and other securities" and led the multi-trillion-dollar metastasis through which finance ballooned to take over domination of the U.S. economy by 2004 with 20-21% of the U.S. Gross Domestic product. Although in mid-2007, Paulson pretended that the emerging crisis involved no more than bad real estate lending practices, the cynical observer can assume that "Mr Risk," the arch-insider, knew what he was covering up - how deeply the malpractice and deception ran -- and on whose behalf.

If Paulson wanted to keep the spotlight off the real culprits -- the Frankenstein financial and mortgage banker laboratories, with their several trillions of exotic mortgages, toxic CDOs and Las Vegas-like credit swaps -- then narrow-gauge academician Bernanke at the Fed was the perfect sidekick. The economic ivory-tower theory in which Bail-out Ben had immersed himself for thirty years ignored 21st century mega-innovations and looked back seven decades to the Crash of the 1930s and how that long-ago debacle might have been prevented.

Alas, poor Ben -- his economist heroes have long been Milton Friedman and the latter's wife, Anna Schwartz, who some four decades ago co-authored a landmark volume entitled A Monetary History of the United States. On October 18, in a prominent interview published by the Wall Street Journal, Anna Schwartz opined that Bernanke was simply getting Fed policy wrong. The problem does not lie with the money supply or liquidity as it did in the 1930s. It lies with all these toxic securities the Wall Street geniuses dreamed up, gorged on, and sold around the globe in huge quantities between 2003 and 2007. "They're toxic," says Ms. Schwartz, "because you cannot sell them, you don't know what they're worth, your balance sheet is not credible, and the whole market seizes up." In fact, by giving transfusions to otherwise insolvent banks, Paulson and Bernanke have prolonged the crisis: "They should not be recapitalizing firms that should be shut down ... Firms that made wrong decisions should fail." That, of course, was how it worked in the old days when "creative destruction" kept capitalism on its toes. Now, of course, it's on its butt.

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Kevin Phillips's new book is Bad Money: Reckless Finance, Failed Politics and the Global Crisis of American Capitalism, published in April by Viking.

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