If You Build It, They Will Come

This election season is dominated by class conflict: the 1% vs. the 99%; big business vs. union labor; who built this and who built that, etc. While this is mostly political theater and white noise, there is some truth to the importance of who controls capital in a democratic capitalist society. But to make sense of our politics, advocate for change, and not be herded like sheep by our political class, we’re going to have to cut through the nonsense and understand how we each helped create the world in which we live.

The title of this post, famously paraphrased from the film Field of Dreams, illustrates a useful metaphor for understanding the financial banking system we have “built” on a foundation of misguided policies. The name of this blog, Casino Capitalism and Crapshoot Politics, is indicative of what we have built in this country and around the world. It’s a Casino because wealth is redistributed and accumulated through excess price volatility in asset markets, rather than broad-based economic growth. (Note: asset markets are comprised of commodities like oil, gas and precious metals; housing and real estate; art and rare collectibles; and financial assets like stocks, bonds, currencies, and their derivatives.)

Managing the uncertainty and risk associated with fluctuating financial asset prices is the business of financial markets. It’s a useful and necessary function for the efficient allocation of capital. The financial sector mediates between savers and investors to match up capital with other resources, like labor, to foster economic production and wealth creation. Public financial markets allow individual citizens of all stripes to share in the bounty of capitalism. All good.

But now we are experiencing a world where our national policies, passed by both parties, have turned financial markets into a casino. Wall St. today is not so much about financing innovation and business expansion through public corporations as it is about trading. In fact, it’s almost all about the trade because that’s where the big money is.

But gambling in a casino creates no wealth; it merely redistributes wealth from losers to winners. And the House (the Washington-Wall St. cabal) takes its cut on every trade. What has made the whole game a tragic con on the taxpayer is that we have granted the gamblers free money with which to place their highly-leveraged bets (zero interest rates); then, when these bets go bad, we provide taxpayer-guaranteed bailouts under the oxymoronic logic of too-big-to-fail! Is it any wonder this casino has attracted the best and brightest gamblers? So, instead of soft-shoe bankers extending loans, making a decent living, then honing their golf game, we have massive hedge fund traders and investment banking houses where billions of dollars change hands betting on the direction of asset markets. The winners are the new power elite and, together with their agents in government, they are the ones making up the rules. Is it any wonder the rules favor the concentration of their success? What a country!

This sounds like 19th century robber-baron capitalism or the latest Russian oligarchy. How did this happen?

I will try to explain how we – you, me, and our political representatives – inadvertently made it happen. In effect, we created the hedge fund industry and the too-big-to-fail banks with deliberate policies. Today we perpetuate the casino by persistently sticking with the same policies. This is not a Republican or Democrat plot; it’s an abject failure of ideas. The idea that has failed is a simple one: that we should never have to suffer the consequences of our own mistakes if we can plausibly deny personal responsibility.

In the realm of national economic policy this means we must never tolerate a recession, we should never lose a job or suffer bankruptcy, never see our financial assets go down in price, never see incomes contract or home values decline, always have access to cheap medical care, and, yeah, never lose an Olympic gold medal in basketball. One can easily understand why this idea is a childish fantasy, but it’s more difficult to see how we have pursued the fantasy relentlessly through our free-wheeling democracy.

There were several markers along this road to perdition:

  1. When the international currency regime (called Bretton Woods) lost its anchor to the gold-backed dollar in 1971 under the directive of President Nixon. This was necessary due to the deficit spending on both “guns and butter” with the Vietnam War and Great Society programs. This meant that currency values became based solely on government fiat. The US$ is favored in a floating currency regime because it is the international reserve currency and unit of account in international trade. This means there is no real constraint on how many dollars the US government can print and thus drive its value down. The result has been volatile fluctuations in currency values and an explosion in currency trading: a gamblers paradise, backed up by government policies to defend national currency values. Remember, George Soros made his billions by betting against the British pound.
  2. Economic liberalization and globalization under the leadership of Thatcher and Reagan with the integration of developing economies in international trade. This was followed up by the political and economic liberalization of the two most populous countries in the world: India and China. (These are positive developments that unfortunately facilitated a lot of bad policies.)
  3. The successful wringing out of dollar inflation by the Federal Reserve under Paul Volcker. 1970s dollar inflation was the result of misguided monetary policies under both Nixon and Carter, facilitated by deficit spending under a floating currency regime. Commodity prices exploded, then crashed when Volcker constrained the money supply and engineered a sharp recession in 1982. The result was a short-term spike in unemployment, but a long-term decline of interest rates that led to an explosion of new debt issuance. This new debt helped fuel the leveraged buy-out craze, junk bonds and the S&L crisis. Debt is an elixir for gamblers as it allows them to leverage their bets, pocket all the winnings or stick the lender with the losses. Wow.
  4. The recurring injection of dollar liquidity into the economy by the Greenspan Fed that started in 1987 and continues today under Bernanke. Initially, this liquidity helped fund the technology revolution but at the cost of currency crises across the developing world. These included Mexico in 1994; Asia in 1997; Russia in 1998; Argentina in 2001, and almost comically, Iceland in 2008 (not so funny for Icelanders). The “Greenspan Put,” as it was called, was accommodated by a world savings glut and explosion of low-priced labor from the developing world that held inflation in check and kept real interest rates low.  Ultimately, Greenspan’s monetary policies led to the Y2K-dotcom stock bubble and crash, commodity bubbles in precious metals and energy, and finally a housing bubble based on securitized debt that led to a worldwide financial crisis. All of these market bubbles and crashes provided ample opportunity for traders to make large bets on price movements. We now live in the age of hedge funds, private equity firms, and large banks funded by the Fed that mostly trade on their own accounts. As this recent headline attests, who needs commercial banking and public financial markets when there’s ample access to private funds?

Goldman boosts private loans to wealthy
The private bank of Goldman Sachs is quietly beefing up its lending to wealthy individuals with a host of new loan products and credit offerings.

So, this is where we’re at and nothing repeated in either national party convention suggests any real change on the horizon. Obama has perpetuated the policies under the guidance of investment bankers in his administration and Romney has been a successful participant in the private equity business. But it would be a mistake to fault these politicians; they are only presently winning at the craps table. We demanded that politicians pursue policies to protect us from any possibility of loss, so this is what we’ve reaped.

The sad ending to this tale is that these policies are unsustainable in the long run. Most of the smart players know this and the preferred strategy is to make your number and get out intact – maybe buy an island in the Caribbean or South Pacific or buy into a fortified community of fellow elites in places like Dubai or Las Vegas.

We less fortunate folk could demand policy changes to turn this around and return to a semblance of social and economic justice. We first need to accept that the key to capitalist success is not using politics to extort a bigger piece of the pie, but participating in the process of production and sharing in the rewards of successful risk-taking. So, the real secret of capitalism (which anyone who’s read Rich Dad, Poor Dad knows) is the ownership and control of capital. One needs to control capital to combine with other resources, such as labor and ideas, to successfully create wealth. We could demand tax policies that reward private saving, investing and capital accumulation, but this will require us to abandon class warfare policies that penalize productive activity out of envy. We could demand an end to monetary policies that reward the few at the cost to many, but this will  mean rising interest rates and more dislocation. We should end tax favoritism for debt over equity as debt concentrates the returns to success. One should note that a healthy economy is marked by positive real interest rates of 2-4% depending on the term. We’re a long way from such health and probably headed in the wrong direction.

Lastly, taking control of our economic fates means rejecting centralized control and government redistribution schemes, as we’ve seen these fail (see Europe). I don’t have much hope this will happen voluntarily. How many of us would be willing to see our home values decline to fundamental values determined by income or rent multiples? How many of us would be willing to end health care subsidies? Or retirement benefits that far exceed our contributions? How many of us would be willing to save and pay our own educational costs?

No, the unsustainable trajectory of casino capitalism is more likely to lead to more crises, perhaps more serious as governments run out of options to forestall the inevitable. Perhaps then we will stop the nonsense of partisan politics that merely divides and conquers us as citizens of one nation sharing similar fates. Perhaps then we will stop pretending that this is being done to us and take control of our fates through the democratic process.

We should remember that the history of the American experiment is one of adaptability and resilience in the cause of liberty and justice. This history should always offer us hope, even in the grimmest of times.


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