Debate? What Debate?

I can’t imagine a more sophomoric attempt at moderating a Presidential primary debate than what occurred last night under the direction of CNBC. Apparently there was no clear winner as much as an overwhelmingly clear loser: CNBC. One wonders when the media elites will address the real challenges and issues the American polity faces. I won’t hold my breath.

The last fiscally responsible adult we had in public service in Washington was Paul Volcker, and he was a Democrat. And elites wonder why the average American is fed up with national politics. Kudos to Cruz.

David Stockman eviscerates the pathetic performance in his blog reposted below:

The Fed’s elephantine $4.5 trillion balance sheet represents the greatest fiscal fraud ever conceived.

The fact is, the monetary madness in the Eccles Building is destroying free market capitalism by systematically and massively falsifying the prices of financial assets, and fueling a relentless, debilitating accumulation of debt throughout the warp and woof of the American economy and the rest of the world; and it’s simultaneously extinguishing political democracy by deeply subsidizing our crushing $19 trillion national debt.

Yet not one of three moderators during the entire two hour period asked a question about the elephant in the room.

The Debate: GOP Candidates Elevated, CNBC Eviscerated

by  • October 29, 2015

Well now. We actually got our money’s worth last night.

Almost with out exception the GOP candidates conveyed a compelling message that the state is not our savior, while the CNBC moderators spent the night fumbling with fantasy football and inanities about which vitamin supplements Ben Carson has used or endorsed.

But this was about more than tone. The interaction between the candidates and the CNBC moderators revealed the yawning gap between the bubble world at the intersection of Washington and Wall Street and the hard scrabble reality of economic stagnation and political alienation on main street America.

Yes, the CNBC moderators engaged in a deplorable display of gotcha journalism punctuated by a snarky self-righteousness that was downright offensive. John Harwood is surely secretly on the payroll of the Democratic National Committee and it was more than obvious why Becky Quick excels at serving tea to blathering old fools like Warren Buffett.

So they deserved the Cruz missile that came flying at them mid-way through the debate.

At that point the Senator from Texas had had enough, especially from Carl Quintanilla. The latter has spend years on CNBC commentating about the “market”, but wouldn’t know honest capitalism is if slapped him upside the head, and has apparently never meet a Washington intervention that he didn’t cheer on as something to help the stock averages go higher:

Let me say something at the outset. The questions that have been asked so far in this debate illustrate why the American people don’t trust the media. This is not a cage match. And if you look at the questions—Donald Trump, are you a comic book villain? Ben Carson, can you do math?… Marco Rubio, why don’t you resign? Jeb Bush, why have your numbers fallen? How about talking about substantive issues?”

Nor did the Texas Senator let up:

“Carl, I’m not finished yet. The contrast with the Democratic debate, where every thought and question from the media was ‘Which of you is more handsome and wise?”

As one pundit put it afterwards, “given the grievous injuries inflicted on Team CNBC”  by Cruz and the rest of the candidates, the only thing left to do was “to shoot the wounded”.

Actually, there is rather more. Last night was billed as a debate on domestic issues and the economy and CNBC is the communications medium of record about the daily comings and goings of the US economy and the financial markets at its center. Yet not one of three moderators during the entire two hour period asked a question about the elephant in the room.

They had to bring in from the sidelines the intrepid Rick Santelli to even get the Federal Reserve on the table. Its almost as if the CNBC commentators work on the set of the Truman Show and have no clue that it’s all make believe.

In the alternative, call this condition Bubble Blindness. It’s a contagious ideological disease that afflicts the entire corridor from Wall Street to Washington, and CNBC is the infected host that propagates it.

The fact is, the monetary madness in the Eccles Building is destroying free market capitalism by systematically and massively falsifying the prices of financial assets, and fueling a relentless, debilitating accumulation of debt throughout the warp and woof of the American economy and the rest of the world; and it’s simultaneously extinguishing political democracy by deeply subsidizing our crushing $19 trillion national debt.

The GOP politicians appropriately sputtered last night about the bipartisan beltway scam rammed through the House yesterday by Johnny Lawnchair, but they were given no opportunity by their clueless moderators to explore exactly why this kind of taxpayer betrayal happens over and over.

Well, there is a simple answer. The Fed’s elephantine $4.5 trillion balance sheet represents the greatest fiscal fraud ever conceived. Last year it paid the Treasury approximately $100 billion in absolutely phony profits scalped from its massive trove of Treasury debt and quasi-government GSE paper.

That is, over time Uncle Sam has purchased $4.5 trillion worth of real economic resources——in the form of goods, services, salaries and transfer payments——from the US economy, which were paid for with IOUs. These obligations to be redeemed in equivalent goods and services were eventually purchased by the Fed, but with merely fiat credits it conjured out of thin air.

And then the monetary charlatans behind the curtain at the Fed send back to the US treasury the coupons earned on these airballs, causing the politicians to think the national debt is no problem; and that they can buy aircraft carriers and GS-15 salaries indefinitely while booking a “profit” on their borrowings.

Folks, this is just plain madness. Back 1989 when the real median household income first hit its current level of about $54,000, this entire monetization scam would have been considered beyond the pale by even the inhabitants of the Eccles Building, and most certainly by everyone else in Washington——from the US Treasury to the Congressional budget committees to the summer interns in the Rayburn Building.

But after 25 years of central bank induced financialization of the US economy, there has developed a cult of the stock market and a Wall Street regime of relentless financial gambling in the guise of “investment”. Consequently, the massive aritificial inflation of financial asset values is not even recognized by CNBC and its fellow travelers in the main stream financial press—to say nothing of the gleeful punters who inhabit the casino.

But here’s the thing. How did the real median household income stagnant at $54,000 while the real value of the S&P 500 soared by nearly 4X? market cap of US debt and equity issues soared from 200% to 540% of GDP, and now weigh in a $93 trillion?

Real Median Household Income Vs. Inflation Adjusted S&P 500 - Click to enlarge

Likewise, how did the aggregate “market cap” of US debt and business equity soar from 200% to 540% of GDP when main street living standards were not rising at all? Could it be that something rotten and deformed has been injected into the very financial bloodstream of American capitalism—-something which the CNBC cheerleaders dare not acknowledge or even allow conservative politicians to explore in a public forum?

Total Marketable Securities and GDP - Click to enlarge

Worse still, this entire Fed-driven regime of Bubble Finance has inculcated in the casino and its media megaphones the insidious notion that the arms and agencies of government exist for one purpose above all others. Namely, to do “whatever it takes” to keep the bubble inflated and the stock market averages rising—–preferably every single day the market is open.

There was no more dramatic demonstration of that proposition than after the Wall Street meltdown in September 2008 when the as yet un-house broken GOP had had the courage to vote down TARP.

But when they were dragged back into the House chambers by Goldman Sachs and its plenipotentiaries in the US Treasury, the message was unmistakable. On one side of the CNBC screen was the House electronic voting board and on the other side was the second-by-second path of the S&P 500.  And delivering the voice-over narrative were the same clowns who could not even mention the Fed last night. The US Congress not dare to vote down TARP again, they fulminated.

It obviously didn’t. Yet right then and there the conservative opposition was broken, and the present statist regime of Bubble Finance was off to the races.

During the coming decade the nation will be battered and shattered by a monumental fiscal crisis and the bankruptcy of the bogus “trust funds” which now pay out upwards of $2 trillion per year to 70 million citizens. At length, the bearers of pitchforks and torches descending on Washington will surely ask how this all happened.

But they will not need to look much beyond last night’s debate for the answers. The nation’s fiscal process has been literally shutdown by the Fed and the Wall Street gamblers and media cheerleaders who insouciantly and relentlessly demand of Washington that it do “whatever it takes” to keep the bubble inflated.

As a result, we have had the absurdity of 82 months of ZIRP and a orgy of public debt monetization that has driven the weighted average cost of the Federal debt to a mere 1.75%.  And when a few courageous remnants of fiscal sanity like Senators Cruz and Rand Paul have had the courage to resist still another increase in the public debt ceiling, they have been treated as pariahs by Wall Street and the kind of snarky financial media types on display last night.

The fact is, the President has clear constitutional powers to prioritize spending in the absence of an increase in the debt ceiling. That is, he can pay the interest on the debt, keep the Veterans hospitals open, send out the social security checks and prioritize any other category of spending that he chooses from the current inflow of tax revenues, and for as long as it takes to legislate an honest fiscal retrenchment.

Needless to say, that would create howls of pain from the Federal vendors who wouldn’t get paid, the state and local governments which would have to wait for their grant payments and the Federal employees who would be put on furlough.

But that is not the reason that Mitch McConnell and Johnny Lawnchair have capitulated every time a debt ceiling crisis has reached the boiling point. That kind of action-forcing circumstance was managed by Washington innumerable times in the pre-Bubble Finance world, including upwards of a dozen times during my time in the Reagan White House.

But back then no one thought that Wall Street would have a hissy fit if the government shutdown for a few days or if the fiscal gravy train was temporarily put on hold; nor did politicians much care if it did.

My goodness. Paul Volcker had taught Wall Street a thing or two about the requisites of financial discipline in any event.

No, what is different now is that the establishment GOP politicians are petrified of a stock market collapse, and have been brow-beaten into the false belief that a government shutdown will create severe political costs.

Baloney. Even the totally botched affair in October 2013 created no lasting damage—-as attested to by the GOP sweep in the 2014 elections.

At the end of the day, all the hyperventilation about the political costs of a government shutdown or the forced prioritization of spending in the absence of a debt ceiling increase is pure Wall Street propaganda; and its an untruth amplified and repeated endlessly, loudly and often hysterically by its financial media handmaidens.

At least last night some GOP politicians gave it back to them good and hard.

Maybe there is some hope for release from the destructive pall of Bubble Finance, after all.

The Debt Driven Economy

mtdebt

The problem is that like all Keynesians they do not know the difference between fiat credit, which is manufactured out of thin air by fractional reserve commercial banks or money-printing central banks, and honest debt that is funded out of genuine savings from current income by households and business.

Krugman’s Dopey Diatribe Deifying The Public Debt

Actually, dopey does not even begin to describe Paul Krugman’s latest spot of tommyrot. So here are his own words—–least it appear that the good professor is being unfairly caricaturized. In a world drowning in government debt what we desperately need, by golly, is more of  the same:

That is, there’s a reasonable argument to be made that part of what ails the world economy right now is that governments aren’t deep enough in debt.

Yes, indeed. There is currently about $60 trillion of public debt outstanding on a worldwide basis compared to less than $20 trillion at the turn of the century. But somehow this isn’t enough, even though the gain in public debt——-from the US to Europe, Japan, China, Brazil and the rest of the debt-saturated EM world—–actually exceeds the $35 billion growth of global GDP during the last 15 years.

But rather than explain why economic growth in most of the world is slowing to a crawl despite this unprecedented eruption of public debt, Krugman chose to smack down one of his patented strawmen. Noting that Rand Paul had lamented that 1835 was the last time the US was “debt free”, the Nobel prize winner offered up a big fat non sequitir:

Wags quickly noted that the U.S. economy has, on the whole, done pretty well these past 180 years, suggesting that having the government owe the private sector money might not be all that bad a thing. The British government, by the way, has been in debt for more than three centuries, an era spanning the Industrial Revolution, victory over Napoleon, and more.

Neither Rand Paul nor any other fiscal conservative ever said that public debt per se would freeze economic growth or technological progress hard in the horse and buggy age. The question is one of degree and of whether at today’s unprecedented public debt levels we get economic growth—–even at a tepid rate—–in spite of rather than because of soaring government debt.

A brief recounting of US fiscal history leaves little doubt about Krugman’s strawman argument.  During the eighty years after President Andrew Jackson paid off the public debt through the eve of WWI, the US economy grew like gangbusters. Yet the nation essentially had no debt, as shown in the chart below, except for temporary modest amounts owing to wars that were quickly paid down.

In fact, between 1870 and 1914, the US economy grew at an average rate of 4% per year——the highest and longest sustained growth of real output and living standards ever achieved in America either before or since. But during that entire 45 year golden age of prosperity, the ratio of US public debt relative to national income was falling like a stone.

In fact, on the eve of World War I, the US had only $1.4 billion of debt. That is the same figure that had been reached before the Battle of Gettysburg in 1863.

That’s right. During the course of four decades, the nominal level of peak Civil War debt was steadily whittled down; the Federal  budget was in balance or surplus most of the time; and at the end of the period a booming US economy had debt of less than 5% of GDP or about $11 per capita!

In short, nearly a century of robust economic growth after 1835 was accompanied by hardly any public debt at all. The facts are nearly the opposite of Krugman’s smart-alecky insinuation that today’s giant, technologically advanced economy would not have happed without all of today’s massive public debt.

Indeed, on a net basis every dime that was added to the national debt between Jackson’s mortgage burning ceremony in 1835 and 1914 was 100% war debt that never contributed to domestic economic growth and was mostly repaid during peacetime. In effect, Rand Paul was right: In a modern Keynesian sense, the US was “debt free” during the 80 years when it emerged as a great industrial powerhouse with the highest living standard in the world.

Thereafter, there were two huge surges of wartime debt, but those eruptions had nothing to do with peacetime domestic prosperity;  and they were quickly rolled back after the war-time emergencies ended. Its plain to see in the graph below.

During WWI, for example, the national debt soared from  $1.4 billion to $27 billion, but the great Andrew Mellon, as Secretary of the Treasury during three Republican administrations, paid that down to less than $17 billion, even as the national income nearly doubled during the Roaring Twenties. That meant the public debt was back under 20% by the end of the 1920s.

To be sure, for the last 70 years the Keynesian professoriate has been falsely blaming the severity and duration of the Great Depression on Herbert Hoover’s balanced budget policies during 1930-1932. But none has ever charged that paying down the WWI debt had actually caused the Great Depression. Nor have the Keynesian economic doctors ever claimed that had Mellon not paid down the peak WWI debt ratio of about 45% of GDP that the Roaring Twenties would have roared even more mightily!

Likewise, the national debt did soar from less than 50% of GDP in 1939, notwithstanding the chronic New Deal deficits, to nearly 120% at the 1945 WWII peak. But this was not your Krugman’s beneficent debt ratio, either. Nor is it proof, as per his current diatribe, that the recent surge to $18 trillion of national debt has been done before and has proven helpful to economic growth.

Instead, the 1945 ratio was a temporary and complete artifact of a command and control war economy. Indeed, the total mobilization of economic life by agencies of the state during WWII was so complete that Washington had essentially banished civilian goods including new cars, houses and most consumer durables, and had also tightly rationed everything else including sugar, butter, meat, tires, shoes, shirts, bicycles, peanut brittle and candied yams.

With retail shelves empty the household savings rate soared from 4% of disposable income in 1938-1939 to an astounding 35% by the end of the war.

Consequently, the Keynesians have never acknowledged the single most salient statistic about the war debt: namely, that the debt burden actually fell during the war, with the ratio of total credit market debt to GDP declining from 210 percent in 1938 to 190 percent at the 1945 peak!

This obviously happened because household and business debt was virtually eliminated by the wartime savings spree, dropping from 150 percent of GDP in 1938 to barely 60 percent by 1945, and thereby making vast headroom for the temporary surge of public debt.

In short, the nation did not borrow its way to victory via a Keynesian miracle.  Measured GDP did rise smartly because half of it was non-recurring war expenditure. But even then, the truth is that the American economy “regimented” and “saved” its way through the war.

Once the war mobilization was over Washington quickly reduced it massive wartime borrowing, and set upon a 35 year path of drastically reducing the government debt burden relative to national output. Looking at the chart’s veritable ski-slope from 120% of GDP in 1945 to barely 30% of GDP when Reagan took office in 1980 you would think that the US economy should have been buried in depression during that period if Professor Krugman silly syllogisms are to be given any credit.

Of course, just the opposite is true.  The greatest sustained period of post-war real GDP growth occurred between 1955 and 1973, with real output growth averaging nearly 3.8% per annum. But after that, as shown by the relative growth rates of real final sales in the chart below, the trend rate of growth steadily eroded. Thus, economic prosperity actually reached its highest level precisely when the national debt ratio was speeding down that ski-slope.

Capture5-480x305

Indeed, during the very period when the fiscal deficit got out of control during the early 1980’s owing to the Reagan Administration’s impossible budget equation of soaring defense, deep tax cuts and tepid restraint on domestic spending, young professor Krugman was toiling away in the White House as a staff member of the Council of Economic Advisors.

During the dark days of the 1981-1982 recession when the economy was collapsing and the deficit was soaring I heard some pretty whacky ideas from the White House economists on how to reverse the tide. But never once did I hear professor Krugman argue that with the GDP at about $3.5 trillion while the public debt stood at less than $1.5 trillion or about 40% of GDP that it was time to turn on the deficit spending after-burners and get the national debt up to 100% of GDP forthwith.

No, this whole case for mega-public debt has emerged since 2008. For crying out loud,  before the great financial crisis Krugman was one of the noisiest voices in the chorus denouncing George Bush’s massive tax cuts on the grounds that they would add to the national debt, which was then $6 trillion, not $18 trillion.

The fact is, the financial crisis was caused by the massive money printing campaigns of the Fed in the years after Greenspan assumed the helm in 1987. The resulting falsification of money market interest rates and distortion of prices and yields in the capital markets gave rise to serial booms and busts on Wall Street. But these financial market deformations had virtually nothing to do with fiscal policy and most certainly did not reflect an insufficiency of public debt.

These destructive busts——the dotcom crash, the 2008 mortgage bust and Wall Street meltdown and the stock market plunge just now getting underway——-are owing to the fact that Wall Street has been turned into a gambling casino by the Federal Reserve and the other major central banks.

But rather than acknowledge that obvious reality, Krugman actually manages to turn it upside-down. To wit, he argues that repairing the nation’s busted financial markets after September 2008 required the creation of  “safe assets” in the form of government debt so that investors would presumably have a place to hide from Wall Street’s toxic waste:

Beyond that, those very low interest rates are telling us something about what markets want. I’ve already mentioned that having at least some government debt outstanding helps the economy function better. How so? The answer, according to M.I.T.’s Ricardo Caballero and others, is that the debt of stable, reliable governments provides “safe assets” that help investors manage risks, make transactions easier and avoid a destructive scramble for cash.

Now that puts you squarely in mind of the young boy who killed his parents and then threw himself on the mercy of the courts on the grounds that he was an orphan. That is, having experienced a runaway financial bubble owing to excessive monetization of the public debt during the Greenspan era, the nation’s economy now needed even more public debt in order to subdue the very Wall Street gamblers that the Fed’s printing presses had unleashed.

Every phrase in the above quoted passage is nuts, even if it is attributable to an MIT rocket scientist, who is apparently handsomely paid for publishing pure drivel. After all, investors on the free market have known how to manage genuine financial risk from time immemorial; they didn’t need today’s vast emissions of public debt to help them.

In fact, treasury notes and bonds have no logical relationship to honest hedging in the first place. The most salient case of treasury based hedging was the spectacular blow-up of Long Term Capital in 1998. In that particular instance, the gamblers who ran a trillion dollar book of speculative assets including tens of billions of high yield Russian debt blew themselves up shorting the treasuring market to hedge their interest rate risk. Then, during the panicked investor flight to safety in August 1998, their giant losses on risky assets were compounded by even larger losses on their short treasury hedge.

In fact, the real point about the government debt market in today’s central bank rigged financial system is that it has become a venue for state sponsored thievery. That is to say, when the Fed pegs the front end of the curve at zero for 80 months running and then pours $3.5 trillion of fiat purchasing power into buying the rest of the treasury curve, including mortgage-backed agency securities, in order to boost bond prices and lower yields, it is creating a  virtually risk free arbitrage for Wall Street gamblers. And that serves no public purpose whatsoever, except to transfer massive windfall profits to the most adept gamblers among the 1%.

Professors Krugman and Caballero  actually think this helps?

The problem is that like all Keynesians they do not know the difference between fiat credit, which is manufactured out of thin air by fractional reserve commercial banks or money-printing central banks, and honest debt that is funded out of genuine savings from current income by households and business.

Allocating genuine savings to public versus private capital investment almost always results in a diminution of productivity and efficiency, thereby reducing society’s wealth and living standards, not raising them. That’s because governments are invariably controlled by squeaky wheel special interest groups and lobbies which succeed in gaining in the halls of Congress what they cannot justify in the private market. Amtrak, subsidized mass transit and bus services, corps of engineers water projects and export subsidies to Boeing and GE are obvious cases in point.

But our Keynesian professors have no sense of allocative efficiency. They think that any spending—-including having the unemployed dig holes with tablespoons and fill them up with teaspoons—– adds to GDP:

One answer is that issuing debt is a way to pay for useful things, and we should do more of that when the price is right. The United States suffers from obvious deficiencies in roads, rails, water systems and more; meanwhile, the federal government can borrow at historically low interest rates. So this is a very good time to be borrowing and investing in the future……..

You can’t make this stuff up. And here’s the rest of it for the purpose of any remaining doubt.

The Greek Tragedy Enters the 3rd Act

stock_market_bubbleDavid Stockman will be wrong until he’s right.

The only thing in this utterly broken “market” which is really priced-in is an unshakeable confidence that any disturbance to the upward march of asset prices will be quickly, decisively and reliably countermanded by central bank action.

It Is NOT Priced-In, Stupid!

by  • July 6, 2015

Among all the mindless blather served up by the talking heads of bubblevision is the recurrent claim that “its all priced-in”. That is, there is no danger of a serious market correction because anything which might imply trouble ahead—-such as weak domestic growth, stalling world trade or Grexit——is already embodied in stock market prices.

Yep, those soaring averages are already fully risk-adjusted!

So the “oxi” that came screaming unexpectedly out of Greece Sunday evening will undoubtedly be explained away before the NYSE closes on Monday. Nothing to see here, it will be argued. Today’s plunge is just another opportunity for those who get it to “buy-the-dip”.

And they might well be right in the very short-run. But this time the outbreak of volatility is different. This time the dip buyers will be carried out on their shields.

Here’s why. The whole priced-in meme presumes that nothing has really changed in the financial markets during the last three decades. The latter is still just the timeless machinery of capitalist price discovery at work. Traders and investors in their tens-of-thousands are purportedly diligently engaged in sifting, sorting, dissecting and discounting the massive, continuous flows of incoming information that bears on future corporate profits and the present value thereof.

That presumption is dead wrong. The age of Keynesian central banking has destroyed all the essential elements upon which vibrant, honest price discovery depends. These include short-sellers which insure disciplined two-way markets; carry costs which are high enough to discourage rampant leveraged speculation; money market uncertainty that is palpable enough to inhibit massive yield curve arbitrage; option costs which are burdensome enough to deny fast money gamblers access to cheap downside portfolio insurance; and flexible, mobilized interest rates which enable imbalances of supply and demand for investable funds to be decisively cleared.

Not one of these conditions any longer exists. The shorts are dead, money markets interest rates are pegged and frozen, downside puts are practically free and carry trade gambling is biblical in extent and magnitude.

So a vibrant market of atomized competition in the gathering and assessment of information relevant to the honest pricing of financial assets has been replaced by what amounts to caribou soccer. That is, the game that six-year old boys and girls play when the chase the soccer ball around the field in one concentrated, squealing pack.

The soccer ball in this instance, alas, is the central banks. Until Sunday the herd of speculators was in full rampage chasing the liquidity, word clouds and promises of free money and market “puts” with blind, unflinching confidence.

The only thing in this utterly broken “market” which was really priced-in, therefore, was an unshakeable confidence that any disturbance to the upward march of asset prices would be quickly, decisively and reliably countermanded by central bank action. But now an altogether different kind of disturbance has erupted. It is one that does not emanate from short-term “price action” of the market or an unexpected macroeconomic hiccup or lend itself to another central bank hat trick.

Instead, the Greferendum amounts to a giant fracture in the apparatus of state power on which the entire rotten regime of financialization is anchored. That is, falsified financial prices, massive, fraudulent monetization of the public debt and egregious and continuous bailouts of private speculator losses, mistakes and reckless gambling sprees.

What has transpired in a relative heartbeat is that one of the four central banks of the world that matter is suddenly on the ropes. In the hours and days ahead, the ECB will be battered by desperate actions emanating from Athens, as it struggles with a violent meltdown of its banking and payments system; and it will be simultaneously stymied and paralyzed by an outbreak of public confusion, contention and recrimination among the politicians and apparatchiks who run the machinery of the Eurozone and ECB superstate.

Yes, the Fed will reconfirm its hundreds of billions of dollar swap lines with the ECB, and the BOJ and the Peoples Printing Press of China will redouble their efforts to prop-up their own faltering stock markets and to contain the “contagion” emanating from the Eurozone.

But this time there is a decent chance that even the concerted central banks of the world will not be able to contain the panic. That’s because the blind confidence of the caribou soccer players will be sorely tested by the possibility that the ECB will be exposed as impotent in the face of a cascading crisis in the euro debt markets.

Here are the tells. If the Syriza government has any sense it will nationalize the Greek banking system immediately; replace the head of the Greek central bank with a pliant ally; refuse to heed any ECB call for collection of the dubious collateral that stands behind its $120 billion in ELA and other advances; and print ten euro notes until the plates on the Greek central bank’s printing presses literally melts-down.

If the Greeks seize their banking system and monetary machinery from their ECB suzerains in this manner—- out of desperate need to stop the asphyxiation of their economy—– those actions will trigger, in turn, pandemonium in the PIIGS bond markets. From there it would be only a short step to an existential crisis in Frankfurt and unprecedented, fractious conflict between Berlin, Paris, Rome and Madrid.

Either all of the Eurozone governments fall in line almost instantly in favor of a massive up-sizing of the ECBs bond buying campaign to stop the run on peripheral bond markets, or the Draghi “whatever it takes” miracle will be obliterated in a selling stampede that will expose the naked truth. Namely, that the whole thing since mid-2012 was a front-runners con job in which the ECB temporarily rented speculator balance sheets in order to prime the PIIGS bond buying pump, thereby luring the infinitely stupid and gullible managers of bank, insurance and mutual fund portfolios into loading up on the drastically over-valued public debt of the Eurozone’s fiscal cripples.

Needless to say, there is likely to emerge a flurry of leaks and trial balloons from the desperate precincts of Brussels, Berlin and Frankfurt. These will be designed to encourage the Greeks to leave their banking system hostage to “cooperation” with their paymasters, and to persuade traders that Draghi has been greenlighted to buy up the PIIGS debt hand-over-fist——-and to do so without regard to the pro-rata capital key under which the current program is straight-jacketed.

But that assumes that the Germans, Dutch and Finns capitulate to an open-ended and frenzied bond-buying campaign that would make the BOJ’s current madness look tame by comparison. Yet if they do, its only a matter of time before the euro goes into a terminal tail-spin. And if they don’t, collapsing euro debt prices will infect the entire global bond market in a tidal wave of contagion.

Either way, its not priced-in. That’s been the real stupid trade all along.

The Bull Market Bull

bullx-large

From David Stockman’s blog:

Never has there been a more artificial—-indeed, phony—–gain in the stock market than the 215% eruption orchestrated by the Fed since the post-crisis bottom six years ago today. And the operative word is “orchestrated” because there is nothing fundamental, sustainable, logical or warranted about today’s S&P 500 index at 2080.

In fact, the fundamental financial and economic rot which gave rise to the 672 index bottom on March 9, 2009 has not been ameliorated at all. The US economy remains mired in even more debt, less real productive investment, fewer breadwinner jobs and vastly more destructive financialization and asset price speculation than had been prevalent at the time of the Lehman event in September 2008.

Indeed, embedded in Friday’s allegedly “strong” jobs report is striking proof that the main street economy is the very opposite of bullish. In January 2015 there were still 2 million fewer full-time, full-pay “breadwinner” jobs in the US economy than there were before the crisis in December 2007.

breadwinner

Read more

 

Why You Should be INTERESTed

fed-rate-zero

My policy primer, Common Cents, explains why the interest rate(s) is the most important price in a free market economy. Distorting it has far-reaching consequences, as David Stockman explains in this post from his blog, Contra Corner, from which I quote below:

The single most important price in all of capitalism is the money market interest rate. That is the price of poker in the Wall Street casino; it is the cost of production for the carry traders and gamblers who provide the marginal “bid” for risk assets.

By supplanting free market price discovery with an artificially pegged price of zero, the Fed is unleashing the furies of greed and reckless speculation in the financial system once again. So it has truly become a serial bubble machine headed by a babbler who apparently believes in make pretend.

Read full article here.

 

The Sinister Evolution Of Our Modern Banking System

Fed

Repost from Peak Prosperity blog. (Link to podcast and blog here.)

Because we’re all about those banks, ’bout those banks…
Saturday, January 31, 2015

I quit Wall Street and decided that it was time to talk more about what was going on inside it, as it had changed. It had become far more sinister and far more dangerous. ~ Nomi Prins

Today, the ‘revolving door’ connecting our political and financial systems is evident to anyone with eyes. But this entwined relationship between Washington DC and Wall Street is nothing new, predating even the formation of the Federal Reserve.

To chronicle the evolution to where we find ourselves today, we welcome Nomi Prins, Wall Street veteran turned financial industry reformist, and author of the excellent expose All The Presidents Bankers.

In this well-detailed interview, Nomi goes into depth of the rationale and process behind the creation of the Federal Reserve, and more important, how its mandate — and the behavior of the banking system overall — metastasized into the every-banker-for-himself regime of sanctioned theft we now live with.

Chris Martenson:   To me, it couldn’t have been more obviously obscene then in 2010, and I believe maybe 2009, right after the big banks had been handed just vast, huge, very favorable handouts and bailouts during the Great Recession — and then they handed themselves record bonuses. I thought optically that was just horrible. As somebody who was inside the banking system: Are they that tone deaf? What’s behind that sort of behavior?

Nomi Prins:   Indeed, they have become very isolated.

It began with the period before the 1970s when different people were rising to leadership in banks, and worsened in the 80s when we started seeing people who had more sociopathic tendencies or less ability to appreciate the idea of the public’s economic stability being beneficial to growing their institutions. They no longer viewed it as necessary.

And with the advent of the larger futures market, the options market, the derivatives market, and all the off-shore elements of banking that were able to be developed, so much capital was now available and off of the books that the idea of maintaining some sort of a connection to stability policy — or even to whatever the Presidency might want — dissolved. At the same time, all the Presidents that were involved in running the country around that time didn’t ask or require accountability towards financial stability from them.

So there was a bunch of things that were happening at the same time, and that’s why the media does a poor job of critiquing this because they’re not looking at all the strands. None of this is simple. A lot of things happened at the same time to create these kinds of shifts. On the one hand, you have no restraint: you don’t have the Gold Standard anymore, so you have less of a strain on having something physical be reserved against your leverage. You now have this ability of petrodollars being recycled. You have the ability to leverage more debt. You have less humility. You have a more technologically-advanced, less transparent global financial system, so you can make and hide money easier. And then you have ascendancies of leadership in banks and in the government that are OK with all this, and allow it to fester.

It’s all defended as some sort of example of a free market and competition — “the best gets the best”, and so forth — when the reality is it just destabilizes the entire system and creates an artificiality. We see central banks supporting all of this mess, as opposed to figuring out what the exit policy is — which none of them have a clue about. That’s really where we’ve evolved to.

Listen to the entire podcast.

The Machines Are Coming

This is a long, but interesting repost from Nouriel Roubini’s blog. I’m posting it here because it raises a number of important issues that transcend our temporal politics and economic policies.

In particular is the section on the subject of work and labor in the machine world (Work in the Machine Age: Humans Need Not Apply?). Machines have long replaced human labor, from plows to car assembly lines to bank clerks and supermarket checkers. This presents a real problem for the labor-centered political paradigm we’ve been operating under since the beginning of the industrial age. Until recently, the wages of work is how the product of capitalism has been widely distributed to the population. When workers are no longer needed, production of the machines continues, but there is no distribution mechanism of the product except through government tax and transfer mechanisms. We already know how limited that policy is because it was tried for 75 years in the USSR and we know what happened with that experiment.

The important question in a world where capital is replacing labor as the means of production is: who gets to own the machines? Will it be multinational corporations? If so, the distribution of profits will be concentrated even more in those corporations. But corporations actually are people (despite what Citizen United objectors claim); take away the people and a corporation is nothing more than a legal charter on so many pieces of paper. The corporate agency problem revolves around who owns the corporate assets (the shareholders) and more important, who controls those assets (usually management).

If machines are replacing labor, the costs of production become embodied in the price of the machines and whoever controls that physical capital. As labor has been minimized, only the owner-shareholders and management remain to divvy up the returns to investment in those machines. So, if we’re not on the receiving end of those payouts, we’re basically out of the capitalist wealth-creating production equation. Not a good place to find oneself.

There is a recourse for labor in this picture, which is to quickly buy some equity in those machines and then defend its ownership interests in concert with other shareholders. The new paradigm is about ownership of productive assets and control of those assets through corporate governance. We had better adjust to this new reality before the cookie jar is empty. The machines won’t wait.

‘Make No Mistake: The Machines Are Coming’

by Nouriel Roubini

Last Friday night, I attended the Bloomberg BusinessWeek 85th Anniversary Dinner. The party was held at the American Museum of Natural History, where Seth Meyers, the former Saturday Night Live star, hosted the evening beneath a massive, life-sized replica of a blue whale.

The party was packed with the usual collection of highly polished New York media and business types. (The entertainment highlight of the night for me was a charming duet by Lady Gaga and Tony Bennett.)

It was a great honor to be asked by Bloomberg and BusinessWeek to give an official toast during the event, along with my fellow toastmasters Henry Kissinger, Henry Kravis, and Melody Hobson. For my toast, I was asked to select the innovation that I thought created the most disruptive change during the last 85 years.

I decided to speak about the microchip—because the microchip may well replace the human race.

Yes, I’m being intentionally provocative here: but it isn’t just because of my nickname (“Dr. Doom”) that I’ve chosen to find the dark shadow in the silver lining of technical progress.

A few weeks ago, Stephen Hawking, the greatest astrophysicist of our time, gave a provocative speech of his own: Hawking suggested that humans should start thinking about colonizing other planets, because eventually artificial intelligence and robots will replace the human race.

It may sound crazy now—but what seems crazy today may not sound so crazy 25, 50, or 100 years from now.

This wave of technological innovation began in 1947 with the invention of the transistor. A little over 10 years later, the microchip appeared; and, soon after that, computers followed. From these basic roots, the rate of innovation simply exploded.

We now live in a digital age where personal computers, supercomputers, robotics, and artificial intelligence are everyday features of our world.

All of these new labor-saving technologies are cheap to deploy—and each will likely play a role in further automating and digitizing our economy.

Without further ado, let’s take a look ahead to what many are calling the Third Industrial Revolution.

Looking back as 2014 winds to a close, I see that a lot has changed in the world economy this year. For example, there is a new perception of the role of technology. Innovators and tech CEOs both seem positively giddy with optimism. And while it is true that some wondrous opportunities may lie ahead, there are also dangers to be wary of as we look to the future.

Technologists claim that the world is on the cusp of a series of major technical breakthroughs. The excitement in this sector isn’t coming just from information technology. It’s also being generated in the fields of biotechnology, energy technology, nanotechnology, and especially from the manufacturing technologies of robotics and automation.

These new manufacturing technologies have spawned a feverish excitement for what some see as a coming revolution in industrial production.

This “Third Industrial Revolution” will provide many investment opportunities—such as green energy development and new kinds of direct investment in those nations most likely to benefit—as well as the potential for a steep rise in returns.

These are life-changing developments, and the consensus among experts is that we will all witness their impact very soon.

The Coming Manufacturing Revolution

In the years ahead, technological improvements in robotics and automation will boost productivity and efficiency, which will translate into economic gains for manufacturers.

It will also benefit highly skilled workers—principally software developers, engineers, and those who work in material science and research. (If you’re a parent or a grandparent, you should encourage the younger generations to explore any talents they possess in these fields.)

Consumers and individuals should also benefit from lower retail prices caused by lower production costs to manufacturers. In short, things will be cheaper.

The quick growth of smart software over the past few decades has been perhaps the most important force shaping the coming manufacturing revolution. The extraordinary rise of the computer software industry has led many of the world’s best minds to focus on the challenges of developing better, smarter, more efficient computer code.

As software development becomes more “glamorous,” the number of bright youngsters studying software engineering increases, creating a virtuous cycle for the software industry.

In addition to software services, a number of new technologies driving the next manufacturing revolution are just now beginning to be felt. They’re like foreshocks, early tremors of the coming earthquake.

On the vanguard of this revolution we find 3D printing. Sometimes 3D printing is called “additive manufacture,” because the process involves computer-controlled robots adding layers of materials to create new things. (Traditional manufacturing usually removes layers from raw material, for example the way a lathe cuts away metal.)

3D printing and related technologies will open the door to advances in manufacturing that have never before been possible:

  • Mechanical engineers will be able to prototype new products more rapidly. New product designs can be created and tested in days rather than months.
  • Manufacturing can be distributed globally to create the greatest efficiencies in marketing and distribution.
  • Finally, customization of products for individual consumers can occur at a price point that was never possible in the past. Not only will things be cheaper, they’ll be your way, right away.

On the plus side of the equation, these changes promise a great boom in productivity. Products will be created more cheaply than ever before. Early adopters of new technology will reap a windfall by perfecting the new techniques. Highly skilled jobs will be created for those educated enough to participate in the new tech-savvy manufacturing world. A few new high-tech manufacturing billionaires may be added to the ranks of the software barons of old.

However, for those workers not fortunate enough to participate in the gains of the new economy, it may feel as though the whole revolution is happening somewhere else. Entire economies risk being destabilized in countries that rely on advanced manufacturing and on service sector jobs. (If you’re reading this, chances are you live in one.)

But remember the dark shadows of those silver linings: with each new gain comes the potential loss of something else.

We know what we have to gain from this automated future. But what, specifically, do we stand to lose?

A Rather Shaky Foundation

In my view, from the economic perspective, the technological forces driving this revolution tend to have the following three downside biases. That is, advances in technology tend to be:

  • capital intensive (favors those who already have money and other resources);
  • skills biased (favors those who already have a high level of technical skill); and
  • labor saving (reduces the total number of jobs in the economy).

The risk is that workers in high-skilled, blue-collar manufacturing jobs will be displaced by machines before the dust settles at the end of the Third Industrial Revolution. We may be heading toward a future where factories consist of one highly skilled engineer running hundreds of machines—with one worker left sweeping the floor.

In fact, the person who sweeps the floor may soon lose that job to a faster, better, cheaper, industrial strength Roomba Robot!

For the last 30 years, emerging-market economies have increasingly displaced developed-market economies in the manufacturing sector as a base of production. This is a story we all know: the transition from the old industrial powers of Western Europe and North America to the new ones in Asia. But despite this shift, developed-market economies have somehow made up for those losses in their labor markets.

Over the last 20 years, the overall unemployment rate in the United States has hovered around 5% on average—except during periods of economic recession, when it has spiked upward for short periods of time.

In general, however, the loss of those manufacturing jobs has not caused catastrophic levels of unemployment.

How? Well, the short answer is the service economy.

Screen Shot 2014 12 09 at 7.47.27 AM

(Of course, this replacement of manufacturing jobs with service jobs has not been equally distributed. Some regions have suffered more than others. For example, the so-called Rust Belt in the upper Midwestern section of the United States has experienced more economic pain than most other regions. But while the local suffering has been great in those regions hardest hit, the overall trend throughout most developed-market economies is that lost manufacturing jobs have been absorbed largely by new jobs created in the service sector.)

In my view, however, there’s no guarantee that this positive scenario—of service-sector jobs making up for lost manufacturing sector jobs—will continue.

In fact, some of the trends mentioned earlier imply that the Third Industrial Revolution will unleash forces that threaten the relatively benign status quo. In addition to the job losses in the manufacturing sector, these trends also threaten the very service-sector jobs that have so far helped us avoid an employment crisis.

To put the coming changes into context, think of what e-books have already done: with a click, you can now download almost any book for about $10 on your iPad or Amazon Kindle.

This is a great service and convenience for consumers. But most of the jobs in the printing and distribution of books—and soon in the newspaper and magazine industry—are already gone. (And so are tons of jobs in the pulp paper industry—though that may come as a relief to environmentalists).

Yet this is all just the tip of the iceberg. The powerful forces unleashed by technology that will radically slash jobs in the future are already upon us. Industries affected will range from health care to retail, education, finance, transportation, real estate, and even government.

One of the affected industries may even be your own.

It’s a Small Step from Offshoring to Automation

Think of the potential risks to service-sector jobs in the context of what I call the “Automated Checkout Economy.” Several decades ago, few people thought that low-paying jobs in the retail sector would be outsourced or eliminated. Technological progress may soon change their tune.

While grocery and checkout jobs cannot be entirely eliminated, at least not quite, technology can assist in drastically reducing the number of human beings needed to fill the remaining positions. A trip into a drug store in New York City, my home for the last several years, will often reveal a single pharmacy clerk watching over four automated checkout terminals, where customers scan and pay for their own purchases. I imagine that you’ve probably seen something similar in your own town.

Other low-wage and labor intensive jobs in retail, such as stocking the shelves of supermarkets with food, will soon be replaced by machines that can do those jobs better and faster than humans could.

This has already begun to happen in traditional brick-and-mortar stores, while automation at online “e-tailers” has gone even further. Giants like Amazon have already built massive robot-staffed warehouses to distribute their orders. One day soon, your friendly neighborhood UPS or FedEx driver delivering those Amazon packages may even be replaced by a drone. And it may be sooner than you think.

In retail, the slashing of middle management jobs has already begun, as computers have become more efficient not just at crunching numbers but at providing managers with the right information at the right time.

Another trend that may result in a decrease in service-sector jobs is something we might call “The Offshoring Pathway to Automation.”

During the first phase of the transition to a truly globalized labor market, New York Timescolumnist Thomas Friedman and others popularized the narrative of high-skilled jobs being outsourced from developed markets to emerging markets. (Friedman’s book The World Is Flat is highly recommended reading on this topic.)

While this trend continues, it supports potential for a still greater transition.

Think, for example, about the process now in place for offshoring medical services. A patient in New York or London may have his MRI sent digitally to, say, Bangalore, where a highly skilled radiologist reads the scan. However, that highly skilled radiologist in Bangalore may only be paid a quarter of what a New York radiologist would earn for reading tests.

It raises the question: how long before a computer can read those images faster, better, and cheaper than that Bangalore radiologist can?

Such a transition is not far off. The offshoring process has already broken down reading an MRI into a series of simple steps resulting in digital output. That digital output can then easily be turned into an input in a fully automated process. This kind of transition, from offshoring to automation, may become a factor in reducing service-sector jobs in developed and emerging markets in the near future.

Work in the Machine Age: Humans Need Not Apply?

The Third Industrial Revolution also coincides with other systemic changes taking place in the economy. Entire industries in the service sector will have to shrink massively for reasons initially unrelated to advances in technology.

Let’s take two of the most obvious examples: the financial-services sector and real estate.

In the years leading up to the economic collapse of 2008-‘09, market bubbles fueled huge run-ups in the prices of financial assets and real estate. With a bubble in asset prices came an explosion in compensation, causing new workers to flood into those sectors. As the last remnants of those bubbles deflate, job cuts in those industries may become inevitable.

But over time, technology may allow even the jobs in real estate and finance to be first outsourced and then totally eliminated.

Today, hundreds of thousands of back-office jobs in the financial sector are outsourced to India and other emerging markets. But tomorrow, a piece of computer code may be able to generate the same sophisticated analytics that some of Wall Street’s highly paid professionals now create.

Real estate—which is now highly labor intensive, with a plethora of agents and brokers—is experiencing a revolution. 12 years ago, in 2002, I was able to buy my first apartment in New York without a real estate agent by using the online New York Times listings. Today, even more sophisticated online tools reduce the need even further for expensive middlemen.

A revolution is also underway in education, which is also currently a very labor-intensive field.

With the growth of ever-more sophisticated online courses, will we still need hundreds of thousands of teachers in the decades to come? And what will all those former teachers do to earn a living instead?

It becomes possible to imagine a future where the top 100 economists in the world, for example, can provide high-quality and cheap online courses in their field. Those changes, however, would mean displacing the jobs of hundreds of thousands of other economics professors in the process.

Indeed, in places like emerging-market Africa, where building brick-and-mortar schools is expensive and where training high-quality teachers is difficult, online courses and cheap tablet computers could gradually begin to replace traditional education, making it even more affordable. Ironically, this would lead to some unemployment, as the demand for highly educated people to fill teaching positions declines.

Governments are shedding labor too, particularly governments burdened by high deficits and debts.

The e-government trend can also lead to labor savings in the way in which government services are provided to the public. You can find tons of public services online and avoid spending hours standing in line in an overcrowded office just to request a few government forms.

Even transportation is being revolutionized by technology. Today a friendly Uber driver or a car-sharing service like Zip Car can replace the need to buy your own car or even rent one. But in a matter of years, driverless cars—courtesy of Google and others—may render the job of a driver or chauffeur obsolete.

So, whether it’s retail or finance, education, health care, transportation, or even government, a massive technological revolution will sharply reduce jobs over time. Low-skilled jobs and medium-skilled white collar jobs will be the first to go, as they have always been.

Industrial Revolutions—Past and Future

In order to better understand the future, it’s helpful to take a look back at the past. During the First Industrial Revolution, which began around the same time as American independence from Great Britain, life began to shift away from agriculture toward increasing industrialization. Farmers moved to cities, and farms became industrialized.

Factories became widespread. A factory owner could take a farmer, perhaps a farmer who could not read or write, and give him a job. New methods—like the division of labor—and new machines allowed that farmer to become more productive. In fact, farmers were able to generate more “output” in a factory than on a farm.

But unlike modern automation, the machines needed to be run by a new generation of workers: Men and women needed to “man” those machines.

Productivity increased—and so did wages.

The Second Industrial Revolution, during the end of the 19th century and the beginning of the 20th, was an extension of the first. During those years, there was an explosion in technology and methods of communication. Thanks to the telegraph, the world became “wired” for the first time.

The new advances in technology, however, cut both ways.

Take the case of Frederick Winslow Taylor, a major figure in the Second Industrial Revolution. Taylor, known as the father of scientific management, once wrote that the brawn required for handling pig iron was proof in itself of the intellectual unfitness of ironworkers to manage their own work. This is hardly a democratic sentiment, and it was more or less the common one.

While new “scientific” methods of management increased the productivity of workers, improvements in working conditions lagged behind. (Taylor’s views didn’t help matters.)

Perhaps the takeaway lesson is that it’s easier to improve technical methods of production than workers’ opportunities.

But despite these challenges, the Second Industrial Revolution created a higher demand for labor.

As we sit on the cusp of a Third Industrial Revolution, a revolution that is both industrial and digital in nature, it’s not certain that the demand for labor will continue to grow as technology marches forward—unless the proper policies to nurture job growth are put in place.

The world began to change during the first Digital Revolution—during the rise of the Internet in the late ‘90s. Then, the digital divide between those who knew how to use computers and those who didn’t led to an income gap between more-skilled workers and less-skilled workers.

At the extreme, as I mentioned in my introduction, some serious thinkers are even worried about technology not only replacing humans in jobs—but actually replacing humans entirely.

The implications of artificial intelligence, not just for jobs, but human life, are now being pondered by some of the best minds in technology.

There used to be a science fiction term for a state where human beings were no longer able to control technology: It was called “the Singularity.”

In the future, this Singularity may no longer be just science fiction.

Will There Be a Green Revolution?

Of course, there are more optimistic sides of this story. Some of those perspectives show a much rosier picture. The green revolution in technology is a perfect example.

(Jeremy Rifkin is a believer in this view. In his 2011 book The Third Industrial Revolution, he makes a case for his bullish outlook. Rifkin is optimistic about a great many things: green renewable energy, urbanization of structural power plants, hydrogen cells, and an Internet grid for power transmission and distribution.)

These new technologies carry with them the promise of cleaner and more efficient energy.

This objective, of course, could not be more crucial. The search for green energy technology has become a global goal. The evidence of environmental damage, caused by pollution and the burning of fossil fuels, is now beyond question.To cite just one sobering example of the size of the challenge, a study by the World Health Organization (WHO) recently concluded that one in eight deaths were caused by air pollution. This is especially true in the developing world, where environmental hazards tend to be significant.

As an example, air pollution in Beijing, where senior Chinese government officials live and work, has reached dangerous levels. The pollution in Beijing is now a practical threat to the Chinese economy and to China’s plans for future development.

The Chinese government has begun to come down hard on its domestic polluters by enhancing the power of the state to regulate pollution. In light of the growing pressure to restrict environmental pollution, it seems reasonable to expect that there will be intensified research of green technologies. Hopefully, this research will address the environmental challenges at their root, rather than just fixing the damage of their effects.

Automation and Rising Inequality

While the odds for a green technology breakthrough during the Third Industrial Revolution may be good, it seems very highly likely that serious challenges will follow in the wake of further developments in labor-reducing technologies.

As more and more workers are displaced, governments will need to search urgently for new solutions to the problems of automation.

During the First Industrial Revolution, some of the worst forms of winner-take-all capitalism festered in the newly industrialized cities of Europe and the United States. The rate of social and economic inequality increased rapidly. Despite the political opposition to change, a series of economic shocks ultimately convinced enlightened people in the US and Europe of the necessity of the social-welfare state.

The benefits that workers take for granted in developed markets—restrictions on child labor, pensions, retirement benefits, unemployment benefits—were all created out of necessity.

Enlightened social-welfare policies were ultimately vindicated, not just morally but practically. In places where social reform was not enacted, on the other hand, more destructive forms of change took place. (The most extreme case of this destruction was, obviously, the rise of Bolshevism in Russia.)

Now the concern is that technology, together with other factors, is leading to a sharp rise in income and wealth inequality. There is a further risk that inequality will also lead to social and political instability.

The redistribution of wealth—from labor to capital and from wages to profits—may even undermine growth. This makes perfect sense when we consider that the concentration of wealth in the hands of a few tends to reduce household consumption. In the United States, household consumption makes up more than two-thirds of our total GDP.

The rise in inequality was initially the result of trade and globalization, such as jobs being offshored to emerging markets. However, the technological innovation we’re witnessing now has the potential to seriously worsen that inequality—especially when those innovations are, as we discussed earlier, capital intensive, skills biased, and labor saving.

The view is even more pessimistic when you factor in the winner-take-all effects—also known as the so-called “superstar phenomenon.”

Thanks to these winner-take-all effects, the top earners in any field now get the lion’s share of the compensation. After making a windfall profit, the “winners” are then able to use those riches to influence politicians and write their own legislation, which creates even more inequality.

In the 1930s, John Maynard Keynes had a more optimistic view of the impact of technology: he argued that eventually we could all work 15 hours a week and spend the rest of our time in leisure—like creating art and writing poetry.

But in the Brave New World of labor-saving technology, it seems, 20% of the labor force will work 120 hours a week while the other 80% will have no jobs and no income.

So the ideal world of Keynes may turn out to become a nightmare.

Despite the rapid rate of change and the many uncertainties that lie ahead, the past can help to serve as a model for the future. Governments have a decided role to play in making that future livable—as they once understood. In that spirit, we must search for political and policy solutions to the coming challenges of the Third Industrial Revolution and promote them where we can.

This is not, after all, the first time we’ve faced such problems. At the end of the 19th and the beginning of the 20th centuries, world leaders stepped up to the plate and came face to face with the horrors of industrialization. Child labor was abolished throughout the developed world, work hours were made humane, and a social safety net was put in place to protect both vulnerable workers and the larger (often fragile) economy.

The Past as Prologue

Former Treasury Secretary Larry Summers observed not long ago that we don’t yet have an Otto von Bismarck or a Teddy Roosevelt or a William Gladstone to mediate the current revolution now underway in the technology sector. The Canadian writer and politician Michael Ignatieff picked up on a similar theme in a Financial Times op-ed called “We need a new Bismarck to tame the machines.”

The references to these political giants of the 19th and 20th centuries are revealing. Otto von Bismarck, the father of the unified German state, is usually credited with the creation of the modern social-welfare state in the 1880s. (He’s also credited with militarizing Germany as he unified it—but let’s stick with his good works for now.)

At about the same time as Bismarck in Germany, British Prime Minister William Gladstone was reforming the most archaic aspects of the British electoral system. Ultimately, Gladstone’s work led to a great democratization and distribution of economic benefits in what was then the world’s leading industrial nation.

Here in the United States, Theodore Roosevelt is perhaps best remembered for breaking up the large industrial monopolies then known as trusts. And we could also add Franklin Roosevelt to the list who, in the tradition of his older cousin, sought to reform the worst excesses of capitalism during the Great Depression.

As we begin the search for enlightened solutions to the challenges that the Third Industrial Revolution presents, some of the overall themes begin to emerge. The first and most important characteristic is that the solution must channel the gains of technology to a broader base of the population than it has done so far. [The information age monetizes the value of data. So, the question is whether each of us will be paid for the data we provide to the ‘social network.’ Another way of putting this is how can you get your piece of the Google-Facebook-Alibaba pie? A free browser seems a pittance. How about a share of Google?]

To make that happen, the solution must have a major educational component. In order to create broad-based prosperity, workers need the skills to participate in the wealth that capitalism generates. That is a major challenge in a world where technology is changing the labor markets at a dizzying and increasing pace.

Workable solutions must address the world as it is, not as we wish it to be.

The way ahead cannot be a naïve “Great Leap Forward”: it must embrace the dynamics and creativity of free markets. On the other hand, while the solutions we must pursue can leverage the ideas of enlightened capitalists, those solutions must not rely solely on the generosity of capitalists to succeed.

That most fragile balance—between the freedom of markets and the prosperity of workers—must be sought and found.

Make no mistake: The machines are coming. The question for us is what kind of welcome to prepare for them.

This article originally appeared at Roubini’s Edge. Copyright 2014.

How We Finance (Blow) Bubbles

stock_market_bubbleEconomist and fund manager John Hussman outlines some basic economic truths in his weekly market comment (full text here). All bubbles in history have one thing in common: excess liquidity (usually through credit creation but also through the acquisition of gold under the gold standard, or some other fungible commodity discovered in abundance, such as oil).

Excess liquidity funds all kinds of unproductive boondoggle investments, such as tulip bulbs and South Sea Island land speculation. Hussman outlines how the Fed, in consort with other central banks such as the BoJ and ECB, are pumping up our fragile global economy with credit created out of whole cloth.

On Friday (Oct 31), the Bank of Japan promised a fresh round of quantitative easing, prompting a collapse in the yen, a surge in the U.S. dollar, and marginal new highs in several stock market indices.

At present, the entire global financial system has been turned into a massive speculative carry trade. A carry trade involves buying some risky asset – regardless of price or valuation – so long as the current yield on that asset exceeds the short-term risk-free interest rate. Valuations don’t matter to carry-trade speculators, because the central feature of those trades is the expectation that the securities can be sold to some greater fool when the “spread” (the difference between the yield on the speculative asset and the risk-free interest rate) narrows. The strategy relies on the willingness of market participants to equate current yield (interest rate or dividend yield) with total return, ignoring the impact of price changes, or simply assuming that price changes in risky assets must be positive because low risk-free interest rates offer “no other choice” but to take risk.

The narrative of overvalued carry trades ending in collapse is one that winds through all of financial history in countries around the globe. Yet the pattern repeats because the allure of “reaching for yield” is so strong. Again, to reach for yield, regardless of price or value, is a form of myopia that not only equates yield with total return, but eventually demands the sudden and magical appearance of a crowd of greater fools in order to exit successfully. The mortgage bubble was fundamentally one enormous carry trade focused on mortgage backed securities. Currency crises around the world generally have a similar origin. At present, the high-yield debt markets and equity markets around the world are no different.

Hussman also explains why the Fed’s assumptions about liquidity by subsidizing zero interest rates are not yielding risk-taking investment:

The fact is that financial repression – suppressing nominal interest rates and attempting to drive real interest rates to negative levels – does nothing to help the real economy. This is certainly not a new revelation. In part, this fact can be understood by thinking about how interest rates are related to the productivity and quantity of real investment in the economy. 

…depressed real interest rates are symptomatic of a dearth of productive investment opportunities. When central banks respond by attempting to drive those real interest rates even lower to “stimulate” interest-sensitive spending such as housing or debt-financed real investment, they really only lower the bar to invite unproductive investment and speculative carry trades. 

Here we have the intuitive logic that eludes the Fed:

As the central bank creates more money and interest rates move lower, people don’t suddenly go out and consume goods and services, they simply reach for yield in more and more speculative assets such as mortgage debt, and junk debt, and equities. Consumers don’t consume just because their assets have taken a different form. Businesses don’t invest just because their assets have taken a different form. The only activities that are stimulated by zero interest rates are those where interest rates are the primary cost of doing business: financial transactions.

What central banks around the world seem to overlook is that by changing the mix of government liabilities that the public is forced to hold, away from bonds and toward currency and bank reserves, the only material outcome of QE is the distortion of financial markets, turning the global economy into one massive speculative carry trade. The monetary base, interest rates, and velocity are jointly determined, and absent some exogenous shock to velocity or interest rates, creating more base money simply results in that base money being turned over at a slower rate.

To sum up Hussman’s outlook he writes: From a full-cycle perspective, we continue to view present conditions as among the most hostile in history. 

That, my friends, is our central bank and Federal government at work.

ZIRP’s Perps and Those They Fleece

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This is reposted from money manager John Mauldin’s mauldineconomics.com

***THIS IS WORTH READING***

The Unintended Consequences of ZIRP
By John Mauldin | Nov 17, 2013

McKinsey estimates that households in the US have lost a cumulative $360 billion. Meanwhile, banks and businesses have done very well… Wall Street makes a bundle, and Main Street gets stuck with higher risks and lower returns.

Yellen’s coronation was this week. Art Cashin mused that it was a wonder some senator did not bring her a corsage: it was that type of confirmation hearing. There were a few interesting questions and answers, but by and large we heard what we already knew. And what we know is that monetary policy is going to be aggressively biased to the easy side for years, or at least that is the current plan. Far more revealing than the testimony we heard on Thursday were the two very important papers that were released last week by the two most senior and respected Federal Reserve staff economists. As Jan Hatzius at Goldman Sachs reasoned, it is not credible to believe that these papers and the thinking that went into them were not broadly approved by both Ben Bernanke and Janet Yellen.

Essentially the papers make an intellectual and theoretical case for an extended period of very low interest rates and, in combination with other papers from both inside and outside the Fed from heavyweight economists, make a strong case for beginning to taper sooner rather than later, but for accompanying that tapering with a commitment to an even more protracted period of ZIRP (zero interest rate policy). In this week’s letter we are going analyze these papers, as they are critical to understanding the future direction of Federal Reserve policy. Secondly, we’ll look at what I think may be some of the unintended consequences of long-term ZIRP.

We are going to start with an analysis by Gavyn Davies of the Financial Times. He writes on macroeconomics and is one of the more of the astute observers I read. I commend his work to you. Today, rather than summarize his analysis, I feel it is more appropriate to simply quote parts of it. (I will intersperse comments, unindented.) The entire piece can be found here.

While the markets have become obsessively focused on the date at which the Fed will start to taper its asset purchases, the Fed itself, in the shape of its senior economics staff, has been thinking deeply about what the stance of monetary policy should be after tapering has ended. This is reflected in two papers to be presented to the annual IMF research conference this week by William English and David Wilcox, who have been described as two of the most important macro-economists working for the FOMC at present. At the very least, these papers warn us what the FOMC will be hearing from their staff economists in forthcoming meetings.

The English paper extends the conclusions of Janet Yellen’s “optimal control speeches” in 2012, which argued for pre-committing to keep short rates “lower-for-longer” than standard monetary rules would imply. The Wilcox paper dives into the murky waters of “endogenous supply”, whereby the Fed needs to act aggressively to prevent temporary damage to US supply potential from becoming permanent. The overall message implicitly seems to accept that tapering will happen broadly on schedule, but this is offset by super-dovishness on the forward path for short rates.

The papers are long and complex, and deserve to be read in full by anyone seriously interested in the Fed’s thought processes. They are, of course, full of caveats and they acknowledge that huge uncertainties are involved. But they seem to point to three main conclusions that are very important for investors.

1. They have moved on from the tapering decision.

Both papers give a few nods in the direction of the tapering debate, but they are written with the unspoken assumption that the expansion of the balance sheet is no longer the main issue. I think we can conclude from this that they believe with a fairly high degree of certainty that the start and end dates for tapering will not be altered by more than a few months either way, and that the end point for the total size of the balance sheet is therefore also known fairly accurately. From now on, the key decision from their point of view is how long to delay the initial hike in short rates, and exactly how the central bank should pre-commit on this question. By omission, the details of tapering are revealed to be secondary.

Yellen said as much in her testimony. In response to a question about QE, she said, “I would agree that this program [QE] cannot continue forever, that there are costs and risks associated with the program.”

The Fed have painted themselves into a corner of their own creation. They are clearly very concerned about the stock market reaction even to the mere announcement of the onset of tapering. But they also know they cannot continue buying $85 billion of assets every month. Their balance sheet is already at $4 trillion and at the current pace will expand by $1 trillion a year. Although I can find no research that establishes a theoretical limit, I do believe the Fed does not want to find that limit by running into a wall. Further, it now appears that they recognize that QE is of limited effectiveness with market valuations where they are, and so for practical purposes they need to begin to withdraw QE.

But rather than let the market deal with the prospect of an end to an easy monetary policy (which everyone recognizes has to draw to an end at some point), they are now looking at ways to maintain the illusion of the power of the Federal Reserve. And they are right to be concerned about the market reaction, as was pointed out in a recent note from Ray Dalio and Bridgewater, as analyzed by Zero Hedge:

“The Fed’s real dilemma is that its policy is creating a financial market bubble that is large relative to the pickup in the economy that it is producing,” Bridgewater notes, as the relationship between US equity markets and the Fed’s balance sheet (here and here for example) and “disconcerting disconnects” (here and here) indicate how the Fed is “trapped.” However, as the incoming Yellen faces up to her “tough” decisions to taper or not, Ray Dalio’s team is concerned about something else – “We’re not worried about whether the Fed is going to hit or release the gas pedal, we’re worried about whether there’s much gas left in the tank and what will happen if there isn’t.”

Dalio then outlines their dilemma neatly. “…The dilemma the Fed faces now is that the tools currently at its disposal are pretty much used up, in that interest rates are at zero and US asset prices have been driven up to levels that imply very low levels of returns relative to the risk, so there is very little ability to stimulate from here if needed. So the Fed will either need to accept that outcome, or come up with new ideas to stimulate conditions.”

The new ideas that Bridgewater and everyone else are looking for are in the papers we are examining. Returning to Davies work (emphasis below is mine!):

2. They think that “optimal” monetary policy is very dovish indeed on the path for rates.

Both papers conduct optimal control exercises of the Yellen-type. These involve using macro-economic models to derive the path for forward short rates that optimize the behavior of inflation and unemployment in coming years. The message is familiar: the Fed should pre-commit today to keep short rates at zero for a much longer period than would be implied by normal Taylor Rules, even though inflation would temporarily exceed 2 per cent, and unemployment would drop below the structural rate. This induces the economy to recover more quickly now, since real expected short rates are reduced.

Compared to previously published simulations, the new ones in the English paper are even more dovish. They imply that the first hike in short rates should be in 2017, a year later than before. More interestingly, they experiment with various thresholds that could be used to persuade the markets that the Fed really, really will keep short rates at zero, even if the economy recovers and inflation exceeds target. They conclude that the best way of doing this may be to set an unemployment threshold at 5.5 per cent, which is 1 per cent lower than the threshold currently in place, since this would produce the best mix of inflation and unemployment in the next few years. Such a low unemployment threshold has not been contemplated in the market up to now.

3. They think aggressively easy monetary policy is needed to prevent permanent supply side deterioration.

This theme has been mentioned briefly in previous Bernanke speeches, but the Wilcox paper elevates it to center stage. The paper concludes that the level of potential output has been reduced by about 7 per cent in recent years, largely because the rate of productivity growth has fallen sharply. In normal circumstances, this would carry a hawkish message for monetary policy, because it significantly reduces the amount of spare capacity available in the economy in the near term.

However, the key is that Wilcox thinks that much of the loss in productive potential has been caused by (or is “endogenous to”) the weakness in demand. For example, the paper says that the low levels of capital investment would be reversed if demand were to recover more rapidly, as would part of the decline in the labor participation rate. In a reversal of Say’s Law, and also a reversal of most US macro-economic thinking since Friedman, demand creates its own supply.

This concept is key to understanding current economic thinking. The belief is that it is demand that is the issue and that lower rates will stimulate increased demand (consumption), presumably by making loans cheaper for businesses and consumers. More leverage is needed! But current policy apparently fails to grasp that the problem is not the lack of consumption: it is the lack of income. Income is produced by productivity. When leverage increases productivity, that is good; but when it is used simply to purchase goods for current consumption, it merely brings future consumption forward. Debt incurred and spent today is future consumption denied. Back to Davies:

This new belief in endogenous supply clearly reinforces the “lower for longer” case on short rates, since aggressively easy monetary policy would be more likely to lead to permanent gains in real output, with only temporary costs in higher inflation. Whether or not any of this analysis turns out to be justified in the long run, it is surely important that it is now being argued so strongly in an important piece of Fed research.

Read that last sentence again. It makes no difference whether you and I might disagree with their analysis. They are at the helm, and unless something truly unexpected happens, we are going to get Fed assurances of low interest rates for a very long time. Davies concludes:

The implication of these papers is that these Fed economists have largely accepted in their own minds that tapering will take place sometime fairly soon, but that they simultaneously believe that rates should be held at zero until (say) 2017. They will clearly have a problem in convincing markets of this. After the events of the summer, bond traders have drawn the conclusion that tapering is a robust signal that higher interest rates are on the way. The FOMC will need to work very hard indeed to convince the markets, through its new thresholds and public pronouncements, that tapering and forward short rates really do need to be divorced this time. It could be a long struggle.

On a side note, we are beginning to see calls from certain circles to think about also reducing the rate the Fed pays on the reserves held at the Fed from the current 25 basis points as a way to encourage banks to put that money to work, although where exactly they put it to work is not part of the concern. Just do something with it. That is a development we will need to watch.

The Unintended Consequences of ZIRP

Off the top of my head I can come up with four ways that the proposed extension of ZIRP can have consequences other than those outlined in the papers. We will look briefly at each of them, although they each deserve their own letter.

  • The large losses from the continued financial repression of interest rates on savers and pension funds

Simply put, ultra-low interest rates mean that those who have saved money in whatever form will be getting less return on that money from safe, fixed-income investments. We’re talking about rather large sums of money, as we will see. Ironically, this translates into a loss of consumption power when the Federal Reserve is supposedly concerned about consumption and requires increased savings at a time when the Fed is trying to boost demand. This is robbing Peter to favor an already well-off Paul.

A new report from the McKinsey Global Institute examines the distributional effects of these ultra-low rates. It finds that there have been significant effects on different sectors in the economy in terms of income interest and expense. From 2007 to 2012, governments in the Eurozone, the United Kingdom, and the United States collectively benefited by $1.6 trillion, both through reduced debt-service costs and increased profits remitted by central banks (see the chart below). Nonfinancial corporations – large borrowers such as governments – benefited by $710 billion as the interest rates on debt fell. Although ultra-low interest rates boosted corporate profits in the United Kingdom and the United States by 5% in 2012, this has not translated into higher investment, possibly as a result of uncertainty about the strength of the economic recovery, as well as tighter lending standards. Meanwhile, households in these countries together lost $630 billion  in net interest income, although the impact varies across groups. Younger households that are net borrowers have benefited, while older households with significant interest-bearing assets have lost income.

McKinsey estimates that households in the US have lost a cumulative $360 billion. Meanwhile, banks and businesses have done very well.

This loss of household income requires tightened spending by retirees and means that those facing retirement have to spend less and save more in order to make sure they will have enough to live on. It also requires the older generation to work longer, which is demonstrably keeping jobs away from the younger generation, as I’ve documented clearly in past letters.

ZIRP means that the pension funds and insurance companies responsible for your annuities are making significantly less on their portfolios than they had hoped. There are lots of ways to express this loss, but I will offer three charts that will give us some indication of the magnitude of the loss over a period of 30 years.

Most public pension funds work with some variation of the traditional 60-40 portfolio, that is to say, 60% in equities and 40% in fixed income. They also target anywhere from 7 to 8.5% returns from their portfolios over the next 30 years in order to be able to generate the money they will need to pay retirees. The amount of assets they have today in their accounts is quite small in comparison to future requirements, and thus they are depending upon the magic of compound interest in order to be able to deliver the needed pension funds to their clients.

The next three graphs show what happens if interest rates are held near zero for 3 more years, 6 more years, and 10 more years. I assume that in the low-interest-rate environment returns from investment portfolios will be less than 3.5% after expenses and then rise back to the more typical (but optimistic) 7% level. What we see is that there are significant cumulative return shortfalls after 30 years because of the initial period of low interest rates, with the shortfalls ranging from 9% to 28% of the final needed assets, depending on how long ZIRP persists. Those losses can be made up only by additional contributions from retirees and/or governments or by some magical increase in expected returns.

Please note that there is nothing critical about the assumptions of 3.5% or 7% – you can make whatever assumptions you like, but the simple fact is that there will be a cumulative shortfall in later years as a result of a ZIRP environment in the initial years. Thus pensions will require more funding by the pensioners at some point, which means that their future consumption will be reduced. Once again we are borrowing from our future in order to finance ephemeral consumption today.

  • The creation of a carry trade and misallocation of capital

There is no question in my mind that many of my friends in the hedge fund and investment world will see an extended zero interest rate policy as a gift horse. If you tell a rational investor that he or she will be able to borrow money at very low rates for four or five years, then you are inviting all manner of financial transactions to take advantage of low borrowing rates. If, as an investor, you can borrow at 3% and get a 6% return, then a modest four times leverage gets you a 12% return on your capital. The financial engineering made possible by guaranteed low rates is really rather staggering. Whole books could be (and probably are being) written about all the ways to take advantage of such an environment. But also, the overall return from risk assets will be reduced as investors look to create carry trades and leverage up. So the very policy of encouraging investors to move out the risk curve in fact reduces the returns on the risks taken, especially for the average investor who can’t take advantage of the financial engineering available to sophisticated investors. Wall Street makes a bundle, and Main Street gets stuck with higher risks and lower returns.

This is simply a trickle-down monetary policy by another name. The Federal Reserve hopes to inflate wealth assets and thereby encourage the wealthy to spend more, which will somehow trickle down to the average investor and worker on Main Street. This approach exacerbates the rich/poor divide even further. This is not a design flaw or an unintended consequence; it is the very essence of the policy. The fact that significant research shows that the wealth effect is minimal seems to be lost in the policy debates. This is infuriating beyond my ability to adequately express my frustration, but it is a clear result of the capture of the Federal Reserve by academic economists and the implementation of the interesting theory that 12 people can make better decisions than the market can about the value of money and the proper environment for investments. This is the philosopher king writ large.

As Dylan Grice wrote so eloquently this week in the Outside the Box I sent you, “From these observations can be derived a straightforward corollary on economic policy makers: trying to control a variable you can’t measure (inflation) with a tool you don’t fully understand (money) in a complex system with hidden, unobservable and non-linear interrelationships (the economy) is a guaranteed way to ensure that most things which happen weren’t supposed to happen.”

  • What happens when the velocity of money turns around?

We have no credible idea what drives movement in the velocity of money. As the chart shows below, it topped out in the ’90s and has been dropping rather precipitously ever since. Charts that estimate the velocity of money back to the beginning of the 20th century show that we are close to all-time lows. One of the things we do know is that the velocity of money is mean-reverting. It will begin to go back up. The fact that it is been dropping has allowed the Federal Reserve to print money in a rather aggressive fashion without stimulating inflation. When the velocity of money starts back up, inflation could become a problem rather quickly. I have no idea when that might happen or why it would start to happen anytime soon. But one day it will happen. That’s just the way of things. Central banks that might be comfortable with 2-3% or even 4% inflation will find themselves dealing with much higher inflation than they had anticipated. Janet Yellen told us she would be capable of raising rates to fight inflation if need be, just as Volcker did. Let’s hope she doesn’t have to prove it.

  • The misallocation coming from rates being held below the natural rate of interests

I have written on this in the past. When interest rates are held lower than the “natural rate of interest,” it becomes more efficient for companies and investors to use money for financial transactions such as buying other companies rather than for productive purposes such as increasing capacity and competing for customers and sales. Why take the risk of competition, which is fraught with problems, when it is so much cheaper to simply borrow money and buy your competition? There is a reason that so many industries have effectively ended up as duopolies since the advent of low rates 12 years ago. While ZIRP makes money for those who have access to capital and for those who can sell their assets, it does not create new productive capacity and thus jobs, let alone help to create more efficient markets and pricing.

Psst, Buddy, Would You Like to Buy a Model?

As Jonathan Tepper and I write in Code Red, the Fed has elaborate models of the economy, which they use to make projections about its performance. Sadly, the Fed’s forecasting track record is very poor. Now, they are giving us models in the papers we reviewed that suggest the proper direction of monetary policy is toward an extended regime of ZIRP.

Think about that for a minute. We are about to base our monetary policy once again on models built by a Fed that has repeatedly struck out in the forecasting game and whose models do not inspire great confidence. Like previous policy approaches, this new one is almost sure to produce unintended consequences and market disturbances.

The best and the brightest assure us they have the situation under control. How’s that working out with regard to Obamacare?

The Effect of Monetary Policy on the Real Economy or Who Moved (Stole?) My Cheese???

Federal_Reserve_Casino2

The Fed can’t do much to grow the economy and create wealth, but it can do an awful lot to screw it all up. Remember the iron-clad rule: a healthy economy must have 2-4% real positive interest rates. Currently ours are at zero or in negative territory.

The following excerpt is a repost from Charles Hugh Smith’s blog Of Two Minds.

Innovation and the Fed

Innovation is often a meaningless buzzword (think “financial innovation”), but it is also the key driver of wealth creation in the real economy.

The Federal Reserve could be shut down and all its asset bubbles could pop, and innovations in energy, agriculture, transportation, education, media, medicine, etc. would continue to impact the availability and abundance of what really matters in the real world:  energy, knowledge, water, food, and opportunity, to name a few off the top of a long list.

It is rather striking, isn’t it? The supposedly omnipotent Fed has virtually no positive role in the key driver of wealth creation.  On the contrary, the Fed’s policies have had an actively negative influence, as its monetary manipulations have distorted the investment landscape so drastically that capital pours into unproductive speculative bubbles rather than into productive innovation because the return on Fed-backed speculation is higher and the risk is lower (recall the Fed’s $16 trillion bailout of banks; including guarantees, the total aid extended by the Fed exceeded $23 trillion; the landscape looks different when the Fed has your back).

Profits from speculative gambling in malinvestments are yours to keep, while losses are either transferred to the public or buried in the Fed’s balance sheet. Why bother seeking real-world returns earned from real innovations?

Apologists within the Fed Cargo Cult’s gloomy hut (repetitive chanting can be heard through the thin walls—humba, humba, aggregate demand!) claim that the Fed’s financial repression of interest rates boosts innovation by making money cheap for innovators to borrow.

But this is precisely backward: cheap money fuels unproductive speculative bubbles and siphons resources away from innovation, while high interest rates reward innovation and punish malinvestments and financial gambling.

Two thought experiments illustrate the dynamics:

The Free Lunch

Let’s say J.Q. Public has the opportunity to borrow $1 billion at 0% interest rate from the Federal Reserve.  It costs absolutely nothing to keep the $1 billion. How careful will J.Q. be with the $1 billion? There’s a casino open; why not bet a few thousand dollars at roulette? Actually, why not bet a couple of million? If J.Q. loses the entire $1 billion, there’s no recourse for the lender, while J.Q. gets to keep the winnings (if any).

With essentially free money, there is little incentive to seek out long-term real-world investments that might pay off in the future, and every incentive to seek financial carry trades that generate short-term profits with little risk. In other words, if you can borrow money at 1%, then shifting the funds around the world to lend at 4% generates a 3% return with modest risk.  Since 3% guaranteed return beats the uncertain return of investing in innovative real-world companies, the carry trade is the compellingly superior choice.

The Square Meal

If we can only borrow money at an annual rate of 10%, there aren’t many carry trades available, and those that are available are very high-risk. At 10%, we have to sharpen our pencils and select the very best investments that offer the highest returns for the risk.

Let’s say you’re an entrepreneur and it costs 10% per annum to borrow money to pursue a business opportunity. The only investments that make sense at this rate are the ones with outstanding risk-return characteristics.

In other words, cheap money doesn’t incentivize risky investments in high-return innovation; it incentivizes carry trades and financial speculation, which actively siphon off talent and capital that could have been applied to real-world enterprises.  High real interest rates force entrepreneurs to choose the best investments, a process that favors high-risk, high-return innovations. [Casino Cap note: remember the rule.]

Avoiding the Bill

The Fed isn’t supporting innovation in the real economy; rather, it is actively widening the moat that protects the banking sector from disruptive innovation.

Thanks to innovations in technology, it is now possible to bypass borrowing entirely and raise money for innovative ventures with crowdsourcing. It doesn’t take much insight to look ahead and see that the crowdsourcing model could expand to the point that the economy no longer needs Too Big to Fail Banks at all: Virtually all lending, from commercial paper to home mortgages, could be crowdsourced, managed, and exchanged online.

This sort of real financial innovation is anathema to the Federal Reserve, of course, as its primary task (beneath the PR about maintaining stable prices and employment) is enriching and empowering the banks.

There are only two ways to deal with innovation: either dig a wider regulatory moat to protect your cartel, monopoly, or fiefdom from disruptive innovation, or get on the right side of innovation and evolve amidst the inevitable disruption.

Unfortunately for centralized institutions like the Fed, innovation always jumps the moat and disrupts the Status Quo, despite its frantic efforts to protect the perquisites of those skimming cartel-rentier profits as a droit de seigneur.

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