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GUEST: Eileen Applebaum, labor economist at Rutgers University

More news of the weakening U.S. economy surfaced yesterday as reports indicated slumping factory production and rising unemployment claims. According to new data, factory activity in the Mid-Atlantic region of the U.S. economy has continued to shrink for the fourth consecutive month. This has been the worst downturn since the start of the Iraq war five years ago. Moreover, recent government figures point to the highest rate of jobless benefit claims since the aftermath of Hurricane Katrina in 2005. This latest news has led some economic research institutes to proclaim that the U.S. is firmly in a recession. The latest USA Today/Gallup poll shows that three-quarters of Americans are in agreement with that assessment. Respondents were overwhelmingly pessimistic about the future of the economy with nearly eighty-percent worried about a looming depression. But, those poll opinions were compiled even prior to the Bear Stearns collapse last week and the subsequent Federal Reserve Board-sponsored takeover of the company by JP Morgan Chase. News from Wall Street’s rocky week resulted in a fall in stock prices in the Asian market coupled with a further weakening of the U.S. dollar.

Rough Transcript

Sonali Kolhatkar: Thanks so much for joining us. Let’s start with the Bear Stearns takeover. I want to quote Gretchen Morgensen of the New York Times, who said “What are the consequences of a world in which regulators rescue even the financial institutions whose recklessness and greed helped create the titanic credit mess we are in? Will the consequences be an even weaker currency, rampant inflation, a continuation of the slow bleed that we have witnessed at banks and brokerage firms for the past year?“ I want to ask you. What is your opinion of what the Fed did? It may help in the short term, perhaps, but what about the long term?

Eileen Applebaum: Well, what we are experiencing now is what some people in the past have called lemon socialism, when the companies are making all those booming profits and the stock price is rising and the managers and shareholders are selling those shares of stock and making millions and millions of dollars, they pocket it for themselves and say how brilliant they are, and the minute that things go bad and it turns out that they were taking undue risk and were selling and buying financial derivates and other financial instruments that they neither understood nor knew what it was all about and the losses pile up, then they want the tax payer to step in and rescue them. And that is what is happening now. To the larger question, I mean we need to come back and think about what would be an appropriate kind of a bailout and to the larger question, the economy is about as fragile as it has ever been since the great depression. We face a crisis in financial markets at the same time as we face a recession in the mainstream economy. And that combination is extremely, extremely dangerous, which is the reason that the Fed is doing all of these unusual kinds of bailouts. Bear Stearns is not a bank as we think of a bank. It’s not a bank that is regulated by the Fed. It is an investment bank. It is free of regulation. And nevertheless, for the first time, the Fed has stepped in to save a bank that it does not regulate. So, does it need to be saved? Yes, because we cannot have a knockdown in the financial system. Is this kind of bailout in which the Fed puts up 30 billion of taxpayers’ money to get JPMorgan Chase to take over that bank, is that the right kind of bailout? And then I would say no to that, because this kind of bailout only encourages more risky behavior by people who will get wealthy on the upswing and do not have to face the consequences on the downswing.

Sonali Kolhatkar: How has the international market responded to the US economy?

Eileen Applebaum: Well, that’s another complicated question. We have had an overvalued dollar since the early 1990s. And the results of an overvalued dollar is that we cannot export our goods on the one hand an on the other hand, everything that we used to import, anything that came in from China, anything that came in from countries in Southeast Asia, from Latin America and so on, where very cheap for Americans to buy. And the effect of that was to really, it’s one of the factors that helped to decimate the manufacturing sector in the US and all that loss of good-paying manufacturing jobs that we lament so much, is at least in part due to this overvalued dollar. So, as a result of that, we are importing a lot, we are exporting a little. We have been running huge, huge trade deficits. If we were not the United States of America, we would have had to face the piper and pay the cost much, much earlier than this. We cannot get our economy to be healthy again without the dollar coming down. What would have been better is if we had faced up to this, if our leaders in Washington had said ok, we need to do something about this, and we could have had an orderly decline in the dollar over a period of time. And that would have been better.

But there is no question that the dollar has to come down in order for our economy to get back on a solid footing. So yes, what has happened is, for a decade or more, other countries have been willing to lend us money so that we can buy their products, and that has contributed to our trade deficit. And now, when they are concerned about us going into a recession, perhaps not being able to buy their products anymore, turmoil in our financial markets, they are much less willing to lend us money and our dollar is falling. It is coming down. Anybody who has tried to take a trip to Europe knows that it is costing them 50% more than what it would have cost them just a few years ago to take that very same trip, so people are now vacationing in the US instead of going to Spain, because of the increased cost. And it also means that the things that we buy at Walmart, those prices are going to rise. There will be some pain attached to the falling dollar, but on the other hand, we cannot put the economy back on a strong footing without that.

Sonali Kolhatkar: I want to step back a little bit and see how far we can trace back the policies that have currently led us to where we are today. I want to quote Richard Blair blogging for the All Spin Zone, who said “what we’re experiencing is a direct result of GOP fiscal policies that began during Ronald Reagan’s reign, and that were elevated to the high art of social theft during the Bush years. The GOP pyramid scheme is collapsing.” Do you agree with him?

Eileen Applebaum: Well, there is a lot to be said about that. I think there is a lot of truth in that and, in addition to having really poor public policies, we also have an economy with deep structural problems. At the root of this crisis is the fact that 70% of Americans have seen their wages flat or falling over the last 30 years. And they have maintained their standard of living in the ‘80s, they maintained their standard of living by sending a second earner into the workforce. As you know, women entered the workforce, or they increased their hours of work. And once we had reached the limit on that, people began using the equity in their homes as an ATM and they maintained their consumption, they maintained their standard of living, they sent their kids to college, they dealt with emergencies by taking money out of their homes. They mortgaged their homes. And that was fine as long as housing prices were rising, but of course, as a result of Alan Greenspan and previous rounds of monetary policy, we have had a housing bubble and the bubble, now, the air is going out of it, most especially in L.A., where you are, I think you must really feel the pain of the deflation of this housing bubble now, but the result of it is that people are unable to, two things have happened. One is that people are unable to use their homes that way, which contributes to the recession, and the other is that their homes are now in many cases worth less than what they owe on the home.

So people are walking away from their homes and from their mortgages, even if they can afford to pay them. If you owe $500,000 on your mortgage and your property is only worth $400,000, you might just think to yourself “I don’t know if I need this. I can just walk away from it.” And the result is that all of those mortgage-backed securities, it’s these mortgages that are backing all these fancy derivatives and collateralized bonds and so on, these special new financial vehicles that no one knows what they are worth, because no one knows which mortgages will go bad. It’s not a subprime mortgage market problem. It’s been advertised as subprime mortgages. In the beginning, they said it was going to be small, because how many people really are in the subprime mortgage market, not very many. But what really is at the root of this is that low or non-existent wage increases have led people to take money out of their houses, we have a housing bubble, the bubble has collapsed, people can’t borrow anymore, their houses are not worth what their mortgage is, and all of these securities that were backed by mortgages throughout the entire mortgage market, no one knows what they are worth, no one knows who will pay and who won’t pay. And that is what is at the root of the financial crisis.

Sonali Kolhatkar: Eileen, is there any correlation, in this week, when people are commemorating the 5th anniversary of the Iraq war, is there any correlation between the state of the US economy and the trillions that the Bush administration has spent on the Iraq war?

Eileen Applebaum: Well, in my view, there really isn’t a direct correlation between the expenditure on the war in Iraq and the recession. However, this goes back to the point earlier about fiscal policy. We have just shrunk and shrunk and shrunk many, many programs that benefit people especially at a time when you are loosing your job.

Sonali Kolhatkar: So that’s, the social safety net has shrunk more and people are in a dire strait.

Eileen Applebaum: That’s exactly right. In order to pay for the Vietnam war, I mean for the Iraq war. Sorry about that. But in order to pay for the Iraq war, we are shrinking social programs, the social safety net. That’s where we are feeling it.

Sonali Kolhatkar: And so, as people begin to suffer in terms of being able to make ends meet, there are fewer and fewer ways for them to stay afloat in terms of government assistance. So in human cost, we are going to see it really hitting people hard rather than necessarily in the stock market.

Eileen Applebaum: That’s exactly right. That’s my view of it.

Sonali Kolhatkar: Eileen, what about what the candidates are saying about the economy, those who are running, particularly for the Democratic nomination – Hillary Clinton and Barack Obama – as we are leading up toward an important primary election in Pennsylvania on the 4th of April.

Eileen Applebaum: Yes, well, both of the Democratic candidates have been much, much better than Senator McCain, who is really touting the Herbert Hoover line, so we have to hope that he is not the one who is elected, because we saw what happened when we had Herbert Hoover. This is a serious, serious economic situation and we are going to need to have a president able to give the kind of leadership that Franklin Delano Roosevelt gave in the early ‘30s. And, at the moment, there is not a whole lot of difference between the positions of Senator Clinton and Senator Obama. They both have recognized that there is a problem here, they both have begun to speak about it, but they have not really been totally candid with the American people about the seriousness of it, the depth of it. My view is that when the March employment figures come out, they come out on Friday April 4th, that there is going to be another drop. It will be the third drop in a row in private sector employment. We lost 101,000 private sector jobs last month, and I think we are going to see equally large job losses. They will be campaigning in Pennsylvania, a state that is much affected by this downturn. And, it’s my hope at least, and I think perhaps it will turn out to be true, that each of them will speak out when those numbers come out, putting forth to the American people just how serious this situation is.

Sonali Kolhatkar: Finally, Eileen, do you advise our listeners to basically get ready for a very bumpy ride over the next few years, just tighten belts, reevaluate budgets, don’t get into any new debts etc.?

Eileen Applebaum: That’s what I am doing personally. I’m not a financial advisor, so I can’t advise other people, but that’s my personal approach to all of this. I would say that I don’t think inflation will be a problem. I know there is a lot of talk out there about the fact that all of this money coming into the system will be inflationary. I don’t think that that’s the case. We have unemployed resources. If the money comes in and the banks actually lend it out, I think it will put people to work and it will be good for the economy. So I don’t think inflation is a big problem. I mean there will be some. I don’t want to say that there will not be some. The falling dollar will cause some inflation. But we are not going to see runaway inflation, and some things are going to get a lot cheaper. If you are planning to buy a car this year, I would say wait for the end of the model year, those inventories are going to pile up on the dealers’ lots, and you are going to get a really good price. But in terms of undertaking new debt, you know, belt-tightening, I think if you have the ability to save at this point, if you have the ability to put away for your future, this is a good time to do it.

Special Thanks to Claudia Greyeyes for transcribing this interview