The realization of how foreign central banks contributed to our current financial maelstrom has been lost in the debate over resuscitating the US economy and saving failing financial institutions. For over two decades foreign central banks, particularly Japan’s and China’s, have been pumping money into America, de facto loaning us money, so that we could buy their goods, thereby stimulating their economies. This deliberate policy choice, to build their economies on the backs of US consumers not only led to a deterioration of our country’s balance sheet but contributed to the excesses we are know suffering from.

Push Versus Pull

Whether foreign capital is “pushed” or “pulled” into a country has important implications. Money that is pulled into a country does so because its investments are attractive. Money that is pushed into a country does so for a variety of factors extraneous to the host country. In this case the host country, the US, is getting money not because of the investment opportunities it provides but rather because foreign countries want to stimulate Americans to buy their goods. History shows that money pushed into a country can lead to financial bubbles and borrowing binges in the host country as it must readjust to the inflow. Think of it like giving your college age child large sums of money each week.

Economists may argue over whether money has been pushed or pulled into the US. There is no arguing that starting in the early 1980’s when the Reagan administration began dismantling regulations that foreign central banks started aggressively buying US treasuries($2.7 trillion held in the Fed’s custody account alone and does reflect Eurodollars, bank deposits, Foreign exchange swaps, Eurobonds, etc. held). We have consistently adjusted to this inflow by running record trade and current account deficits, ones that have historically brought calamity. Former Federal Reserve Chairman Greenspan remarked over four years ago how America’s ability to run deficits had gone well beyond historical norms. We have not been forced to pay the piper yet because foreign governments continue to “push” money into the US to maintain growth of their economies at our expense.

This massive inflow of capital (dollar purchases) over the last two decades has not caused a surge in our economic growth which has chugged along at only a modest rate. It has led to a host of speculative bubbles beginning with the 1987 stock market bubble and the innumerable crashes and ensuing bailouts that followed. It has also led to a borrowing binge by US consumers who are now saddled with massive debt($2.6 trillion). In other words, all this money flowing into the US has not led to a commensurate surge in US growth but has significantly deteriorated our country’s and citizen’s balance sheet and made us vulnerable. Within a few decades we have gone from being the world’s largest creditor to being its largest debtor.

The long term consequence of letting a country continue to “push” money into a host country can be devastating. China, for example, has consistently intervened in foreign exchange markets by buying dollar denominated bonds and paying for it by selling its own currency to keep its value low and prop up the dollar (“push” money in). By letting the Chinese and others keep the value of the dollar artificially high and their currency value low, US exports have been made non-competitive in foreign markets. This has prevented us from exporting our way out of our trade deficit which is the mechanism by which trade imbalances are corrected. Over time this has meant the gutting of US exporting industries and a significant loss of jobs.

Fighting the Last War

Economists and politicians are notorious for fighting the last war rather than understanding the current predicament. Today, fearing a repeat of the Great Depression, the Federal Reserve is pumping money into the system and Washington is bailing out financial institutions. The problem is not a policy choice, albeit regulation would help, it is viewing the world from a lens of the 20th century instead of the 21st century.

Technology and globalization are altering the world at an increasingly rapid rate. In 2007, Russia redefined war when it waged cyber war on Estonia by flooding its Internet servers with so many requests that their whole system crashed. Similarly, we have been attacked by foreign countries that have given us a Trojan horse of money that has deteriorated our financial health and given us a false feeling of superiority and security, thereby making us vulnerable.

Washington needs to collar Wall Street, not further indulge it. Wall Street was the architect in creating the financial structures, products and the liquidity that was necessary to enable large sums of money to breech our borders. For its collaboration, Wall Street has profited handsomely, from the shill selling stocks, to foreign exchange traders, to participants in the US bond & money markets, to investment bankers, to the mutual fund industry to players in derivatives markets and all have profited from the financial invasion of the US.

Time For a Change

Instead of bailouts and easy money, we need bold initiatives from a government that understands that we live in world that is smaller and increasingly linked by cross-border capital flows and the Internet. If the financial system is an integral part of our well being and national security, then the government should move swiftly to seize control of banking institutions and remove our vulnerability to the whims of foreign central banks and speculators. We need to nationalize financial institutions to insure that they act in America’s interest, not their own self-interest that has no allegiance except to the bottom line.

In addition, the government should do everything in its power to control and preferably outlaw derivative securities. Derivatives are securities whose value derives from another security and require a minimal amount of money down to buy. They are a financial innovation of the last 30 years that have been behind every financial crisis and bailout of the past few decades from the 1987 stock market crash (stock index futures), to Long Term Capital Management in 1998 (interest rate derivatives) to our current $700 billion buyout of banks precipitated by their purchases of toxic derivatives (credit/sub prime/mortgage derivatives). Derivatives give speculators enormous power and leverage that they used to attack the British pound in 1992, to attack the Asian currencies during the Asian contagion in 1997/98 and recently to push the price of oil higher. If it were not for derivatives that allow for speculation in oil and basic foodstuffs the price of food and oil would be much, much lower. Remember, it was margin buying (leverage) that led to the stock market crash of 1929 and margin buying was a precursor to modern derivatives (leverage).

No doubt financial institutions, speculators and other special interest would be against draconian measures to seize control of financial institutions and outlaw derivatives. But bold initiatives are needed at this time of national crisis. The world is changing and unless we see and understand this we are doomed. Bailouts have not worked since 1987 and will continue to fail. We the people in the form of government need to reassert ourselves if democracy is to survive. People need to rule, not money!