A Bender of an Era: Bush made Iraq so big he couldn't lift it

The essential problem of the neo-liberal era is a broken triangle:

1. It has to have low inflation and volatility in the real economy, as well as in the macro-economy, otherwise, those who generate excess profits will not put them back into circulation as liquidity.

2. It has to have low interest rates and low liquidity preference by a sizable share of consumers.

3. It has to have greater volatility for individuals.

These three parts are not stable at the same time. The fundamental assertion of the economic policies, of both parties, for the last 30 years, was destined to blow up. The Japanification thesis was that elites could not permanently juggle the contradictions, and would then seek an endgame, a way to remove these points of volatility. The cost of the play that was chosen, is staggering. Virtually the entire federal budget deficit is caused by the aftermath of the Iraq play.

When people look at the deficit, they tend to break down the sources of the deficit into Iraq, tax cuts, and the economic crisis. However, these three parts are not different, but were part of the same play: tax cuts to bail out the wealthy, the housing bubble to create a new ride, and the war to get the oil that would eventually make the housing bubble sustainable. But all plays have a hedge, "what happens if." The answer is that in the case of failure, the US would Japanify: the banks would be bailed out, long term stagnation tax would be imposed, and, crucially, there was no moral hazard to the political class. No important people would be convicted of anything.

Since the play, the Iraq War and the Bubble, were unworkable, from the beginning, the hedge was always the end result. Always. This is because the economics of Iraq are simple: if the oil is worth 'X' then by hook or by crook, the price will rise to 'X' minus the customary level of profit. If we stood to make trillions taking the oil, then it was worth a great deal to stop us from doing it. Much less than the final cost as it turns out.

To be blunt: our entire fiscal crisis in the Federal Budget Deficit, is because the Tea Party is just where the GOP goes after the hang over from the Texas Tea Party we held in Iraq. The very people who were the edge of the sword to go to Iraq, are now trying to avoid paying for it. "Iraq Where?"

America, from December 11th, 2000, was on cruise control for a Bright Depression. The buildings still stand, the lights still go on, but people never have a future again. In Japan, because they do not allow immigration for all practical purposes, cities are being closed down, as the satellites of their industrial system become unprofitable. In the US, because we do allow immigration, our population grows, but it grows as an under-class.

The Neo-Liberal Paradox

The driver of the Iraq Play however, is the neo-liberal paradox. The entire basis for economic policy, over the last 30 years, is in mathematical contradiction.

The steps for this are simple:

1. For a market to be efficient, and be of any size, there must be one, and only one, price for everything. This is a classic proof of mathematical economics.

2. For savers to save, the rate of return on offer has to be higher than their ambient risk from inflation, else, why save?

3. For the financial economy to grow, inflation has to be low for consumer goods, but high for assets. The spread between the two is the financial industry.

4. Since, for the wealthy their ambient rate of inflation is asset inflation they must be offered comparatively high rates for saving. At the same time, they must be able to borrow at low rates, to have the leverage needed to produce the asset inflation that is required.

5. Therefore, there must be two prices for money: the government price from the Federal Reserve to the financial system, and the rate the system pays to "savers."

6. By (1) that means that either: the economy must be inefficient, since it has two prices, or it must be too concentrated to reach the requirements of (1). Two people can be efficient with multiple prices, because there is no one else to take advantage. But with many actors, if there are such differences, they will be taken advantage of. The world of finance had to be composed of too few actors to be a market, if it were to be efficient. However, any such closed market must be less efficient than an efficient market. Which amounts to the same thing.

The second part is more exotic:

1. To make money the financial system had to have static prices and low volatility of the economy, since correlated events produce run away losses, and uncertainty reduces the appetite for risk.

2. To make money the financial system had to have high volatility inside the economy.

3. This means that even though total risk was going down, individual risk was going up.

4. To do this requires that more and more exchanges be zero sum. However, this is again in contradiction. For profits to grow in the economy, more and more has to be win/win. For finance to profit more things have to be win/lose, otherwise total will rise.

This is why risks were shifted to individuals: the more risk, the more profits from an individual. This lead to the Sweat Box of debt. However, if more people blow up, then eventually more will blow up all at once, as one person's bankruptcy, costs the next person their job. The more correlated the economy, the lower the pressure the economy exerts to prop up the financial economy. When a critical point is reached, hope evaporates, and the finance of fear takes over. One cannot price hope in terms of fear.

The fundamental contradiction of neo-liberalism, is that it demands marketization of everything, but requires that the market for liquidity be rigged. This requires constant juggling: circuit breakers on markets, shadow banking systems, bail outs of crooked deals, subsidies for the most profitable corporations.

This is what drove the Iraq Play: Saddam was not merely an irritant, he was an opportunity, the chance to remove the driver of money into the hands of resource producers, if he were removed, and the ability to move much more of it into domestic resource producers, if the removal failed. Heads the rich won, tails the rich won.

That the economics community failed to follow through on fundamental neo-classical proofs, which showed a basic contradiction of the entire regime, is a failure, not of politics, but of economics.

Part III tomorrow.