Yesterday, we were explaining how the US empire and the Fed-induced credit bubble depend on each other. To make a long story short, after the 1970s there was not enough juice in the US economy to pay for a welfare state at home … and an imperial juggernaut all over the world. The solution? More credit.

Borrowing by the private sector created some $33 trillion in excess (above the traditional level of debt to GDP) economic activity. It fueled sales … spending … jobs … corporate profits (heavily concentrated in the financial sector) and investment profits.

All of these things gave voters the feeling they were making progress. And they gave the government tax revenues, which it badly needed. Debt grew. We’ve been over the numbers so often we don’t need to repeat them. More important, the economy – and the US empire – became more and more dependent on debt just to continue doing business as usual.

Debt no longer provided a big boost to economic growth; it was necessary just to stay in the same place. Take it away, the stock market crashes… and the economy goes into recession or depression. That was what happened in 2008-09. The private sector stopped taking on debt. And all Hell broke loose.

It was just a tiny dip in total credit market debt outstanding– but it went hand in hand with a major crisis – by St. Louis Fed, click to enlarge.

Hog Wild on Spending

The background: The Bush II Administration went hog wild on spending. It did so largely because it was the most overtly pro-empire US administration ever. Covertly, it was also the most pro-welfare state administration in history. Guns and butter – the Bush team liked them both. It never met a country in which it didn’t want to meddle … never found a trap into which it didn’t want to put its big foot … and never saw a spending bill it wanted to veto. Under cover of “security” spending, it blundered into the biggest deficits in history.

After the 9/11 attacks, jingoism clouded budget discussions. “Security” depended on a strong economy … which depended on continuing credit expansion. Then … and again after the crisis of 2008-09 … the credit expansion seemed in danger of coming to an end. But the Fed came to the rescue; and its chiefs were hailed as Scipios and Caesars.

Alan Greenspan and Ben Bernanke got their mugs on the cover of TIME magazine, as though they were conquering heroes, rather than nerdy economists with dubious theories. In 1999, TIME labeled Greenspan, along with Robert Rubin and Larry Summers, “The Committee to Save the World.” And later, The Atlantic labeled Bernanke “The Hero” … and TIME named him “Person of the Year.”

Their real contributions?

They helped Americans go further into debt … which in turn helped unproductive industries keep their grip on a large part of the nation’s resources.

More Rules

And now, the feds exert more and more control over the way money is spent … and invested. The Economist reports:

“Ever since Lehman Brothers went bankrupt in 2008 a common assumption has been that the crisis happened because the state surrendered control of finance to the market. The answer, it follows, must be more rules.

The latest target is American housing, the source of the dodgy loans that brought down Lehman. Plans are afoot to set up a permanent public backstop to mortgage markets, with the government insuring 90% of losses in a crisis.

Which might be comforting, except for two things. First, it is hard to see how entrenching state support will prevent excessive risk-taking. And, second, whatever was wrong with the American housing market, it was not lack of government: far from a free market, it was one of the most regulated industries in the world, funded by taxpayer subsidies and with lending decisions taken by the state. But… the more the state protected the system, the more likely it was that people in it would take risks with impunity.

That danger was amply illustrated in 2007-08. Having pocketed the gains from state-underwritten risk-taking during the boom years, bankers presented the bill to taxpayers when the bubble went pop. Yet the lesson has not been learnt. Since 2008 there has been a mass of new rules, from America’s unwieldy Dodd-Frank law to transaction taxes in Europe. 

Some steps to boost banks’ capital and liquidity do make finance more self-reliant: America’s banks face a tough new leverage ratio. But overall the urge to regulate and protect leaves an industry that depends too heavily on state support. Since investors know governments will usually bail out big financial firms, they let them borrow at lower rates than other businesses. America’s mortgage giants, Fannie Mae and Freddie Mac, used a $120 billion funding subsidy to line shareholders’ pockets for decades. 

The overall subsidy for banks is worth up to $110 billion in Britain and Japan, and $300 billion in the euro area, according to the IMF. At a total of $630 billion in the rich world, the distortion is bigger than Sweden’s GDP – and more than the net profits of the 1,000 biggest banks. In many cases the rationale for the rules and the rescues has been to protect ordinary investors from the evils of finance. Yet the overall effect is to add ever more layers of state padding and distort risk-taking.”

Predictably, the return on investment falls … and growth slows. As it does, current output is less able to keep up with debt service costs and current spending. The need for more credit increases.

But now we hear the federal budget situation is improving. Tax receipts are up. Expenditures are down. Alas, this is a temporary phenomenon. Congressional Budget Office estimates show the federal deficit bottoming out this year and next – still at over $500 billion! – and then turning up again.

This is good news for the empire … and for the credit-dependent economy. Debt can’t grow unless someone is foolish enough to borrow. So, the Fed has become the borrower of last resort. It will continue to borrow to fund the empire… and its zombie industries … until they all blow up.

The above article is from Diary of a Rogue Economist originally written for Bonner & Partners. Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.