Countdown to a Meltdown

America's coming economic crisis. A look back from the election of 2016
2. Pulling the Trigger

The 2008 election, like those in 2000 and 2004, could have gone either way. If Fidel Castro had died two years earlier, the second Bay of Pigs tragedy and related "regime change" difficulties might have been dim memories by Election Day. Or if he had died a year later, the Cuban-American bloc of Florida voters would have been as reliably Republican in 2008 as in the previous fifty years. Since the red state-blue state divide was otherwise the same as in 2000 and 2004, if the Republicans had held Florida they would presumably have held the White House as well—despite mounting unease about debt, deficits, job loss, and rising U.S. casualties in Pakistan.

But by dying when he did, at eighty-two, and becoming the "October surprise" of the 2008 campaign, Castro got revenge on the Republicans who had for years supported the Cuban trade embargo. Better yet, he got revenge on his original enemies, the Democrats, too.14 Castro couldn't have planned it, but his disappearance was the beginning—the first puff of wind, the trigger—of the catastrophe that followed.

Or perhaps we should call it the first domino to fall, because what then happened had a kind of geometric inevitability. The next domino was a thousand miles across the Caribbean, in Venezuela. Hugo Chavez, originally elected as a crusading left-winger, was by then well into his role as an outright military dictator. For years our diplomats had grumbled that Chavez was "Castro with oil," but after the real Castro's death the comparison had new meaning. A right-wing militia of disgruntled Venezuelans, emboldened by the news that Castro was gone, attempted a coup at the beginning of 2009, shortly after the U.S. elections. Chavez captured the ringleaders, worked them over, and then broadcast their possibly false "confession" that they had been sponsored by the CIA. That led to Chavez's "declaration of economic war" against the United States, which in practice meant temporarily closing the gigantic Amuay refinery, the source of one eighth of all the gasoline used on American roads—and reopening it two months later with a pledge to send no products to American ports.

From the archives:

"The Fuel Subsidy We Need" (January 2003)
Oil dependence is still the Achilles' heel of the American empire. It doesn't have to be—and if we don't want to lose economic ground to Europe, it can't be. By Ricardo Bayon

That was when the fourth—and worst—world oil shock started.15 For at least five years economists and oilmen alike had warned that there was no "give" in the world oil market. In the early 2000s China's consumption was growing five times as fast as America's—and America was no slouch. (The main difference was that China, like India, was importing oil mainly for its factories, whereas the United States was doing so mainly for its big cars.16) Even a temporary disruption in the flow could cause major dislocations.

All the earlier oil shocks had meant short-term disruptions in supply (that's why they were "shocks"), but this time the long term was also in question. Geologists had argued about "peaking" predictions for years, but the concept was on everyone's lips by 2009.17

The Democrats had spent George Bush's second term preparing for everything except what was about to hit them. Our forty-fourth president seemed actually to welcome being universally known as "the Preacher," a nickname like "Ike" or "Honest Abe." It was a sign of how much emphasis he'd put on earnestly talking about faith, family, and firearms to voters in the heartland, in his effort to help the Democrats close the "values gap." But he had no idea what to do (to be fair, the man he beat, "the Veep," would not have known either) when the spot price of oil rose by 40 percent in the week after the Chavez declaration—and then everything else went wrong.

Anyone who needed further proof that God is a Republican would have found it in 2009. When the price of oil went up, the run on the dollar began. "Fixed exchange rates with heavy intervention—in essence, Bretton Woods Two] have enormous capacity to create an illusory sense of stability that could be shattered very quickly," Lawrence Summers had warned in 2004. "That is the lesson of Britain in 1992, of Mexico in 1994, of emerging Asia in 1997, of Russia in 1998, and of Brazil in 1998." And of the United States in 2009. It didn't help that Hugo Chavez had struck his notorious then-secret deal with the Chinese: preferential future contracts for his oil, which China needed, in return for China's backing out of Bretton Woods Two, which Chavez wanted.

There had been hints of how the falling dominoes would look as early as January of 2005. In remarks made at the World Economic Forum in Davos, Switzerland, Fan Gang, the director of China's nongovernmental National Economic Research Institute, said that "the U.S. dollar is no longer seen as a stable currency."18 This caused a quick flurry in the foreign-exchange markets. It was to the real thing what the World Trade Center car bomb in 1993 was to 9/11.

When we read histories of the late 1920s, we practi- cally want to scream, Stop! Don't buy all that stock on credit! Get out of the market before it's too late! When we read histories of the dot-com boom in the late 1990s, we have the same agonizing sense of not being able to save the victims from themselves: Don't take out that home-equity loan to buy stocks at their peak! For God's sake, sell your Cisco shares when they hit 70, don't wait till they're back at 10!

In retrospect, the ugly end is so obvious and inevitable. Why didn't people see it at the time? The same clearly applies to what happened in 2009. Economists had laid out the sequence of causes and effects in a "hard landing," and it worked just as they said it would.

Once the run on the dollar started, everything seemed to happen at once. Two days after the Venezuelan oil shock the dollar was down by 25 percent against the yen and the yuan. Two weeks later it was down by 50 percent. By the time trading "stabilized," one U.S. dollar bought only 2.5 Chinese yuan—not eight, as it had a year earlier.19

As the dollar headed down, assets denominated in dollars suddenly looked like losers. Most Americans had no choice but to stay in the dollar economy (their houses were priced in dollars, as were their savings and their paychecks), but those who had a choice unloaded their dollar holdings fast.20 The people with choices were the very richest Americans, and foreigners of every sort. The two kinds of assets they least wanted to hold were shares in U.S.-based companies, since the plummeting dollar would wipe out any conceivable market gains, and dollar-based bonds, including U.S. Treasury debt. Thus we had twin, reinforcing panics: a sudden decline in share prices plus a sudden selloff of bonds and Treasury holdings. The T-note selloff forced interest rates up, which forced stock prices further down, and the race to the bottom was on.

Because interest rates had been so low for so long, much of the public had forgotten how nasty life could be when money all of a sudden got tight.21 Every part of the cycle seemed to make every other part worse.

Businesses scaled back their expansion or investment plans, since borrowed money was more expensive. That meant fewer jobs. Mortgage rates went up, so buyers who might have bid on a $400,000 house could now handle only $250,000. That pushed real-estate values down; over time the $400,000 house became a $250,000 house. Credit-card rates were more onerous, so consumers had to cut back their spending. Some did it voluntarily, others in compliance with the Garnishee Amendments to the Bankruptcy Act of 2008. Businesses of every sort had higher fixed costs: for energy, because of the oil-price spike; for imported components, because of the dollar's crash; for everything else, because of ripple effects from those changes and from higher interest rates. Those same businesses had lower revenues, because of the squeeze on their customer base. Early in Bush's second term economists had pointed out that the U.S. stock indexes were surprisingly weak considering how well U.S. corporations had been doing.22 The fear of just these developments was why.

Americans had lived through a similar self-intensifying cycle before—but not since the late 1970s, when many of today's adults were not even born. Back in those days the sequence of energy-price spike, dollar crash, interest-rate surge, business slowdown, and stock-market loss had overwhelmed poor Jimmy Carter—he of the promise to give America "a government as good as its people." This time it did the same to the Preacher, for all his talk about "a new Democratic Party rooted in the oldest values of a free and faithful country." When he went down, the future of his party almost certainly went with him.

The spate of mergers and acquisitions that started in 2010 was shocking at the time but looks inevitable in retrospect. When the CEOs of the three remaining U.S. airlines had their notorious midnight meeting at the DFW Hilton, they knew they were breaking two dozen antitrust laws and would be in financial and legal trouble if their nervy move failed. But it worked. When they announced the new and combined AmFly Corporation, regulators were in no position to call their bluff. At their joint press conference the CEOs said, Accept our more efficient structure or we'll all declare bankruptcy, and all at once. The efficiencies meant half as many flights (for "fuel conservation") as had been offered by the previously competing airlines, to 150 fewer cities, with a third as many jobs (all non-union).23 Democrats in Congress didn't like it, nor did most editorialists, but the administration didn't really have a choice. It could swallow the deal—or it could get ready to take over the routes, the planes, the payrolls, and the passenger complaints, not to mention the decades of litigation.

Toyota's acquisition of General Motors and Ford, in 2012, had a similar inevitability. Over the previous decade the two U.S. companies had lost money on every car they sold. Such profit as they made was on SUVs, trucks, and Hummer-style big rigs. In 2008, just before the oil shock, GM seemed to have struck gold with the Strykette—an adaptation of the Army's Stryker vehicle, so famous from Iraq and Pakistan, whose marketing campaign attracted professional women. Then the SUV market simply disappeared. With gasoline at $6 a gallon, the prime interest rate at 15 percent, and the stock and housing markets in the toilet, no one wanted what American car makers could sell.24 The weak dollar, and their weak stock prices, made the companies a bargain for Toyota.25

For politicians every aspect of this cycle was a problem: the job losses, the gasoline lines, the bankruptcies, the hard-luck stories of lifetime savings vanishing as the stock market headed down. But nothing matched the nightmare of foreclosures.

For years regulators and financiers had worried about the "over-leveraging" of the American housing market. As housing prices soared in coastal cities, people behaved the way they had during the stock-market run-up of the 1920s: they paid higher and higher prices; they covered more and more of the purchase price with debt; more and more of that debt was on "floating rate" terms—and everything was fine as long as prices stayed high and interest rates stayed low.

When the market collapsed, Americans didn't behave the way economic theory said they should.26 They behaved the way their predecessors in the Depression had: they stayed in their houses, stopped paying their mortgages, and waited for the banks to take the next step. Through much of the Midwest this was a manageable problem: the housing market had gone less berserk to begin with, and, as in the Great Depression, there was a longer-term, more personal relationship between customers and financiers. But in the fastest-growing markets—Orlando, Las Vegas, the Carolina Research Triangle, northern Virginia—the banks simply could not wait. The deal brokered at the White House Security-in-Shelter Summit was ingenious: federal purchase of one million RVs and mobile homes, many of them built at idle auto or truck factories; subsidies for families who agreed to leave foreclosed homes without being evicted by marshals, such that they could buy RVs with no payments for five years; and the use of land at decommissioned military bases for the new RV villages. But it did not erase the blogcam live broadcasts of families being evicted, or the jokes about the "Preachervilles" springing up at Camp Lejeune, the former Fort Ord, and the Philadelphia naval shipyard.

Here is how we know that a sitting president is going to lose: he is seriously challenged in his own party's primaries.27 So if the economic tailspin had left any doubts about the prospects for the Preacher and his party, they were removed by the clamor to run against him in the Democratic primaries of 2012. The party's biggest names were all there: the senators from New York, Illinois, and Florida; the new governors of California and Pennsylvania; the mayor of New York, when it looked as if the Olympic Games would still be held there that fall; and the actor who in his three most recent films had captured Americans' idea of how a president should look and sound, and who came closest to stealing the nomination from the incumbent.

He and the rest of them were probably lucky that their campaigns fell short—not that any politician ever believes that. The Democratic nomination in 2012 was obviously a poisoned chalice, but a politician can't help thinking that a poisoned chalice is better than no chalice at all. The barrier none of them could have overcome was the financial crisis of state and local government.

All that befell the federal budget during the collapse of 2009-2012 happened to state and local governments, too, but more so. They had to spend more—on welfare, Medicaid, jails, police officers—while taking in less. One by one their normal sources of funding dried up.28 Revenues from the multi-state lottery and the FreedomBall drawings rose a bit. Unfortunately, the surge of spending on casino gambling in forty-three states and on legalized prostitution in thirty-one didn't benefit state and local governments, because except in Nevada those activities were confined to Indian reservations, and had only an indirect stimulative effect.

And many governors and mayors faced a reality the president could avoid: they operated under constitutions and charters that forbade deficit spending. So they had no practical choice but to tighten the clamps at both ends, cutting budgets and raising taxes. The process had begun before the crash, as politicking in most state capitols was dominated by "intractable" budget disputes.29 When the downturn really hit, even governors who had never heard of John Maynard Keynes sensed that it was a bad idea to raise taxes on people who were being laid off and evicted. But they were obliged by law to balance their budgets. All mayors and governors knew that it would be dicey to renege on their basic commitments to education, public safety, public health, and public infrastructure. But even in hindsight it is hard to know what else they could have done. California did too much too fast in closing sixty-three of its 110 community colleges30 and imposing $9,500 annual "user fees" in place of the previous nominal fees. Its solution to the financing crisis on its high-end campuses was defter—especially the "Great Pacific Partnership" between the University of California and Tsinghua University, in Beijing. This was a win-win arrangement, in which the Chinese Ministry of Education took over the funding of the UC Berkeley physics, computer-science, and biology laboratories, plus the genomics laboratory at UC San Francisco, in exchange for a 51 percent share of all resulting patents.

State and local governments across the country did what they could. Fee-for-service became the norm—first for "enrichment" programs in the schools, then to underwrite teachers' salaries, then for emergency police calls, then for inclusion in routine police and fire patrols. First in Minnesota, soon after in Michigan, New York, and Pennsylvania, there were awkward moments when the governor, exercising his power as commander in chief of the state National Guard, ordered the Guard's medical units to serve in hospitals that had furloughed nurses and emergency-room doctors. The Democratic president decided not to force the question of who had ultimate control over these "citizen soldiers." This averted a showdown in the short term, but became one more attack point for the Republicans about weak and vacillating Democrats. Cities within 150 miles of the Mexican border opened police-service and trash-hauling contracts to companies based in Mexico. The state of Georgia, extending a practice it had begun in the early 2000s, said that it would hire no new public school teachers except under the "Partnership for Excellence" program, which brought in cut-rate teachers from India.31

The chaos in public services spelled the end for the administration, and for the Democratic Party in the long run. The Democrats couldn't defend the unions. They couldn't defend pensioners. They couldn't even do much for their limousine liberals. The nation had never been more in the mood for firm leadership. When the "Desert Eagle" scored his astonishing coup in the Saudi Arabian desert just before Christmas of 2011, America knew who its next leader would be. For a four-star general to join his enlisted men in a nighttime HALO32 special-operations assault was against all established practice. The Eagle's determination to go ahead with the stunt revealed him to be essentially a MacArthuresque ham. But the element of surprise was total, and the unit surrounded, captured, and gagged Osama bin Laden before he was fully awake.

The general's news conference the next day had the largest live audience in history, breaking the record set a few months earlier by the coronation of England's King William V. The natural grace of this new American hero was like nothing the world had seen since Charles Lindbergh landed in Paris. His politics were indistinct, but if anything, that was a plus. He was strong on defense; urgent (without details) about "fighting smart against our economic enemies"; and broadly appealing on "values"—a devout Catholic who had brought the first openly gay commandos into a front-line combat unit. ("When we were under fire, I never asked who they loved, because I knew they loved our flag.") Political pros had always assumed that America's first black president would be a Republican and a soldier, and they were right. He just didn't turn out to be Colin Powell.

The only suspense in the election was how big the win would be. By Labor Day it was clear that the Democrats might lose even the District of Columbia, whose rich residents were resentful about their ravaged stock portfolios, and whose poor residents had been cut off from Medicaid, welfare, and schools. As the nation went, so went the District, and after fifty-seven presidential elections the United States had its first across-the-board electoral sweep.

Presented by

James Fallows, a national correspondent for The Atlantic, has written three cover stories on U.S. foreign policy and Iraq: "Bush's Lost Year" (October 2004), "Blind Into Baghdad" (January/February 2004), and "The Fifty-first State?" (November 2002). More

James Fallows is based in Washington as a national correspondent for The Atlantic. He has worked for the magazine for nearly 30 years and in that time has also lived in Seattle, Berkeley, Austin, Tokyo, Kuala Lumpur, Shanghai, and Beijing. He was raised in Redlands, California, received his undergraduate degree in American history and literature from Harvard, and received a graduate degree in economics from Oxford as a Rhodes scholar. In addition to working for The Atlantic, he has spent two years as chief White House speechwriter for Jimmy Carter, two years as the editor of US News & World Report, and six months as a program designer at Microsoft. He is an instrument-rated private pilot. He is also now the chair in U.S. media at the U.S. Studies Centre at the University of Sydney, in Australia.

Fallows has been a finalist for the National Magazine Award five times and has won once; he has also won the American Book Award for nonfiction and a N.Y. Emmy award for the documentary series Doing Business in China. He was the founding chairman of the New America Foundation. His recent books Blind Into Baghdad (2006) and Postcards From Tomorrow Square (2009) are based on his writings for The Atlantic. His latest book is China Airborne. He is married to Deborah Fallows, author of the recent book Dreaming in Chinese. They have two married sons.

Fallows welcomes and frequently quotes from reader mail sent via the "Email" button below. Unless you specify otherwise, we consider any incoming mail available for possible quotation -- but not with the sender's real name unless you explicitly state that it may be used. If you are wondering why Fallows does not use a "Comments" field below his posts, please see previous explanations here and here.


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