People who are involved with international finance have been using a phrase for several years now, that phrase is "global imbalances." What that phrase means is that the United States consumes too much, and a few nations are really good at feeding that consumption addiction. The result is that a few nations have large surpluses, most have dragging deficits or are close to break even, and the US sinks farther and farther into debt. This drives the global financial crisis, because the surplus nations know that someday the US will have to either raise taxes, which means a dollar shortage, or go down, which means the chance to buy up key US assets. Thus, they are in an REH (Ricardan Equivalence Hypothesis) situation, and want to park the money. This is the "paper for oil" economy.

However, since the beginning of the paper for oil economy, they have not been content with a simple break even REH strategy. They don't just want to park money with enough interest to pay the expected tax event. They want to be ahead of that, especially since, over the long term, dollars must devalue relative to key commodities. Since their straight dollar holdings must decline in relative value, as the US share of GDP declines, they want their portfolios as a whole to gain value. Hence the problem of the paper for oil economy. How to generate paper that yields ahead of AAA, but is as safe as AAA. Reagan, Clinton, and Bush have all had their means to do it. This means was expressed as a bubble, that bubble popped, and then there was a clean up. As long as the losses from the bubble believers was larger than the bubble clean up, the game could go on.

The first bubble was the American blue chip and bond bubble. The US paid higher interest rates on treasuries and munis than the market actually priced as the risk free rate of interest, and lowering marginal tax rates and destroying labor pricing power moved money from wages to profits. This was expressed as an increase in the profitability of brands, and therefore the blue chips that ran them. The second prong of the bubble was a first wave of financial deregulation, which became an attempt to run "development arbitrage." The US would open capital markets, particularly in Latin America, and then sell the debt and the assets. Insurance companies and money center banks participated in this. However, what broke the system was allowing Saving's and Loans to participate, and these generated a US domestic paper which was also vacuumed up into the insurance company system. When Latin America's consumption bubble popped, and when the oil bubble popped, it produced a cascading series of bank failures, and required a monetary policy re-adjustment. But the system was unstable: it was an S&L in Ohio, not Texas, that broke first.

The problem was that the system relied on spreads within transactions to pay the people at each stage of the way to run the system. Each of these slight pushing of spreads added up, and created situations where dollars were selling for slightly less than a dollar in one place, and slightly more than a dollar in another. Enter computerized trading and options, and computers able to find the path from the, probably, .99999 cent dollars in one place and the, probably, 1.0001 dollars in another place, took down the market.

That was the crash of 1987.

For several years America entered clean up mode.

The Clinton era bubble was different: it was to create a gold rush. A gold rush does not have to be AAA secure, it rests, instead, on the reality that no one who is sunk deeply in rent can afford to miss out on buying the next Ford, Xerox, Radio Corporation of America, or Microsoft. However, just as with the Reagan bubble, it rested on development arbitrage internationally, this time with the former Soviet Union. The generation of "AAA+" paper was accomplished by using financial option strategies and leverage. More than the 1980's had even allowed.

This AAA+ paper was kept in place by US fiscal discipline, and by bail outs of places where liquidity grew short. In a nutshell, Rubinomics was to create dollars, spread them more widely, and therefore more thinly, and to ladle them out where ever there was a pinch. The structure fell apart when the tech bubble unravelled. As with the 1980's bubble, there was an underlying superstructure of fraud. Once a bubble is established, it is more profitable to attract hot bubble money and then cash out even a small fraction of that bubble money, than it is to produce whatever the gold rush of the bubble is, which, by definition, is actually quite limited.

The Bush Bubble cut in the opposite direction. Rather than relying on a strong dollar, and using the power of the threat of a dollar shortage, it went with a weak dollar strategy, and created a bubble based on US mortgage based assets. The mechanics of turning sand into gold involved a great deal of complexity, but in the end how it was done was merely a matter of how a stage magician distracts the audience. A great deal of attention was paid after each of the two previous bubbles to how the misdirection occured, but it was the palming off of risk as safety, in each case, that was the real problem. Each of these created arbitrage, and when the market mechanism found enough short pressure to execute that arbitrage, no force on earth could stop it. At the point that the REH players - the "deep money" - realized that the game was over, they stopped buying, deal flow dried up, and the entire chain of people who lived, whether they knew it or not, on either creating the illusion of a sure thing - that means insurance salesmen, web administrators, and mortgage processors - or on the chain of passing money from hand to hand until it's origin was obscured enough, were suddenly out of work.

The fraud chain once revealed, was nothing more than a means of connecting three sets of junkies. Consumption junkies, with control junkies in mercantile economies, through elite junkies in the US. From consumers to bankers to rentiers. Each one wanted something more than they could possibly produce, in each case the group set about finding a way to get what it wanted, and the final structure was about rentiers letting consumption junkies run riot, on the belief that when the collapse came, the ultimate result would be that the consumption junkies would have their saving's raided, and that more control would pass to the rentiers. Since the rentiers had all the physical luxury they wanted, and perhaps then some, control, not numbers in accounts, was the ultimate measure of financial success. What mattered then, was an increase in the global gini coefficient, not in the nominal numbers that created it.

The elements of a bubble then, rest on a kernel of fraud: palming off something other than ultimate fiat of government, that is the government's ability to force payment even if all else fails, as fiat. It also rests on some form of development arbitrage: with an intermediary packaging together risky investments as a single not risky investment. In the case of our recently closed decade Iraq was part of the new model. It finally rests on US domestic savings reaching zero. Basically the bottom 99% of society owns nothing but simply passes through on their way to being mulch.

Right now there are a large number of people jumping up and down demanding that "surplus nations" such as Japan and China, start spending. The response to this is "are you nuts?"

Both China and Japan have nominal surpluses, however, both have real deficits. China's 1.9 trillion in currency reserves may seem huge, but compared to what China needs to develop, this amount is tiny. Consider that the United States is about to embark on a 300 billion dollar spending spree just to repair our infrastructure. The PRC, to reach American levels of defense, energy, transportation, and social infrastructure needs tens of trillions of dollars. They see no logical reason to spend their surplus now on consumer goods, particularly since this will exacerbate their own internal political pressures and jealousies. They realize what the US does not: that they have a concentration of capital, not a surplus to spend.

II. The anti-bubble

But each bubble relies upon the anti-bubble. The anti-bubble is the process of selling pain to the ordinary public, and shearing them of present real wages, while propping up present real consumption. The key then is to increase the public's marginal propensity to consume, while decreasing their income. The way this has been done is to make promises about future returns which were impossible, and to create the incentive to rely on impossible returns: the "Social Security Surplus," 401k plans, pensions, and housing values. In each case, as the cliche goes, Lucy pulls the football away.

The next step is consumption taxes: raising payroll taxes, flattening taxes, shifting taxes from progressive federal taxes and corporate profits taxes, to flat and regressive state taxes, property taxes, and sin taxes. Every anti-bubble brings renewed calls for consumption taxes. Specifically on gasoline, because this is the hole that feeds the rentiers in OPEC, and general consumption taxes. This is across the political spectrum, because clearly over-consumption is part of the problem. It would seem that disincentivizing consumption would be the solution. However, the consumers do not like this, and will not stand for all that much of it, especially if it is visible. They will pay high credit spreads, but not gasoline taxes.

This is why Chu's backing off on his energy statements proves that once you become an O-botic creature, there is no turning back. Chu knows that there is no way to have the US reach energy equilibrium, and have low gasoline prices, and reduce carbon emissions. If he doesn't know that, then he's been smoking something stronger than they grow in any state of the US. Yet, today, he has done just that. We are going to see a great deal of this: intellectuals drawn into Obama's administration, and then required to say or do something which warps the numbers to the Rahm/Schumer/Obama view of the centrist universe. It's like saying that it is possible to divide by zero. It's not, but Obama is going to demand it as proof of loyalty. We saw this with conservatives going into the Bush executive too - and while what Obama wants isn't as obviously crazy, it isn't physically possible either.

The village is of course going to at first pretend that these things aren't what they are, and academics will give other academics free passes - the right being too far in the realm of fantasy to put forward anything resembling an intellectually coherent critique, and the left too star struck to allow any of their own members to do so. This means we are about to go, as a friend of mine puts it "Down the O-Hole" - a place where a chase for redoing a decade that is gone.

Since the compromise between crazy and deluded - that is crazy right wingers and deluded "unity" centrists is not physically possible, and reaching that cone of acceptability is first, we are going to see policies which cannot be made to work have enormous amounts of national effort thrown at them, and the reduction in consumption that will pay for them dumped forward. It is the death throes of empire: when the powers that run it try and save themselves from catastrophe, at any cost.

Any cost, that is, except relinquishing their own system of power. Obama's plan is war and tax cuts with dollar devaluation. It is the same plan that Bush had, only without the potential for oil in Iraq, and with more energy savings here. However, in neither case does the basic plan work. There isn't enough energy savings to be had when, on one hand gas prices must be kept low and we are building more roads and bridges, to pay for a war in Afghanistan that is at similar intensity to Iraq during the surge. In fact, now that we are basically swapping strategies, Iraq is likely to begin to disintegrate slowly, as Afghanistan did while we fought Iraq. Fight - lose - fight - lose - fight - lose. It can go on for a while.

The basic problem is that there is no way to solve this problem while handing more autonomy to the rentiers. None. However, no one is yet willing to pay the price to deal with that.