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Thursday, February 02, 2012

Doppleganger economy

Bernanke's testimony today on the Hill gave some reason for hope that a nascent recovery is occurring. Readers here know I've been a bear on the markets.

There's no denying hiring is making a rebound. But are we really the same economy we used to be, back before financialization of our economy began.

Financial services companies--banks, insurers, hedge funds, brokerages--comprised less than 10% of the nation's overall GDP in 1980. Today, they control a stake equivalent to 1/3 or more of our Gross Domestic Product.

Look at what's happened to the Middle Class over the intervening period: incomes stagnant after inflation. The jobs once freely available have dried up across much of the Rust Belt, victims of downsizing and industrial decline. Do jobs remain? Of course they do, but they're of the "service economy" variety, paying less and offering fewer benefits than manufacturing, which has been drained as a result of offshoring.

And many of the jobs offered in the financial services sector have been lost.

Countries in East Asian are experiencing rapid growth as they expand manufacturing. Our money flows to them as we run trade deficits.

Sooner or later, the Chinese won't work for pennies. They'll demand more dollars for their manufactured goods. A decline in the value of our dollar could bring an era of cheap imports to an end overnight.

Back home, we heard in Obama's most recent State of the Union address rumblings of trade fricition with China. The President is trying to side with voters eager to blame Asia for what are structural deficits and competitive weaknesses arising within in our economy. Stemming the flow of jobs will require revitalization of our manufacturing base. Yet the Federal government has a lousy track record of sustaining industries through federal spending alone.

As an example, Obama proposed over $50 billion to develop America's nuclear power industry. That was before Fukushima. Federal funding to keep the nuclear power industry has fostered an industry wholly dependent on direct subsidies. Good luck with that. Read Solyndra, the recipient of direct aid. Coverage of the scandal is rare exception to the mainstream media's willingness to ignore cronyism and sweetheart deals. For that, we have traditional partisanship thrusting the issue forward, based on political motives,

Many of our pending difficulties can be traced back to our excessive government spending. Like the chronic hard luck gambler, we've abused our national credit card. It's been maxed out.

Now if the rules of the game weren't rigged, then it'd be lights out. We'd be done with our reckless spending since our access to money would be cut off. As an addict, our options would be either 1) rehab or 2) denial and a life of crime or prostitution to feed our habit.

Fortunately for our debt-addicted government, there is another option: print or create money out of thin air, then give it to the Federal Reserve, which will then in turn use it to buy our Treasury bonds. In this way the government can keep going on for a little while longer. Not forever--mind you--the inflation will make an end of the system, by making the government print and create dollars at a faster and faster rate, til they've been debased.

What's the Fed got to do with it?

The Federal Reserve is tasked with a "dual mandate" to fight inflation and unemployment, but are the two goals mutually exclusive. I mean, if by some reason more people were working, wouldn't we have more inflation?

Let's not assume the two mandates can be achieved simultaneously. Being skeptical of Fed dealings is a healthy exercise, at least for people who don't readily accept what the government tells them.

At a minimum, the policy objective to reduce unemployment skews the unemployment rate. People unemployed for six months disappear from the roles. We've seen the unemployment rate drop in percentage terms even when the number of unemployed grows!

Whatever the unemployment numbers, good paying jobs are scarce. Excess wages tend to be found in the financial sector, but even there, mass firings are possible.

A pyramid, our new economy has very little need of many people at the top. The pyramid has been described as neo-feudal, where people in the lower wage brackets slave away, indebted to the hilt, while tiny numbers at the top reap limitless benefits.

It's not so much that the wealthiest in our society got there on merit, though of course market fundamentalists relentlessly plug the Horatio Alger rags-to-riches myth which is at the center of preserving the status quo.

Another symptom of a pyramidal structure is the systematic elimination of unions. A "right-to-work" wave is sweeping state legislatures across the country. The plan, executed by neo-liberals, is to so weaken the wages of the workers that they'll be unable to challenge the status quo through organized labor. God forbid the peasants lift their heads from their fields long enough to storm the castle...

It's usually the middle class that leads sociopolitical movements capable of destroying the existing order and replacing it with something more egalitarian. The rich of course want the status quo to continue. And most of the poor aren't well enough educated to lead political movements, or have the luxury of actually sitting down to think about how the world or their lives could be bettered.

What can they do?

With interest rates, it's not like Bernanke can do anything. The Federal Reserve committed to maintaining interest rates at near zero through 2014. Do they know something about the recovery that the rest of us don't? I mean, why be so sure that inflation won't be climbing?

My guess is that the Federal Reserve knows the recovery will be slow because of persistent unemployment. If the unemployed were to suddenly find jobs, there'd be a massive increase in spending and labor costs would rise. Rising labor costs are of course the number one indicator of rising inflation.

Now, it's possible interest rates could rise regardless of the Fed policy position. If owners of Treasury debt were eager to sell, the interest rates might rapidly climb.

The Federal Reserve is the number one holder of our government's debt. That won't be likely to change. The reason the Federal Reserve is the top holder of our debt is that they, as a central bank, have a limitless supply of credit.

Of course much of the money borrowed through the Fed goes to buy U.S. Treasury bonds which, combined with the interest they pay, gets fed back to the Federal Reserve and banks holding our debt.

Unlike the Chinese, Japanese , or anyone in the private sector, the Fed needn't derive profits for a Board of Directors or shareholders eager for higher returns. Instead the Fed serves the financial oligarchy governing the financial system of this country.

In addition to rewarding shareholders--banks--with dividends, banks are granted access to the Federal Reserve's numerous credit facilities. The quid pro quo is made secure, even from such eccentricities as the mortgage debt debacle, with access to infinite quantities of Federal Reserve credit.

This closed loop system has increasingly less and less to do with the real economy (RE.) Instead it serves the interests of the benefactors of the Financial Economy. Essentially the F.E. is a parasitic attachment to the mechanics of stable and orderly growth through market democratization, i.e. the maximum possible gain to the broadest segment of the economy: the middle class.

Under the new paradigm, the gains of economic growth increasingly are allotted to those with the most capital. Indeed, the imbalance between rich and poor is so wide now in this country that it may have crossed a threshold associated in history with times of great social instability, and even revolutions.

The FE hurts the RE. The FE drains capital away from where it can be invested into making real things. Instead capital goes towards speculation, and excess wages (a concept which always refers to what others get paid, not me.) The money that the Fed lends so eagerly actually just gets buried into debt securities.

The idea is that future cash flows can be monetized (turned into profit now) through a process called securitization. Once debt is bundled into marketable securities, it can be used as collateral which can then be used to--you guessed it--buy more debt.

So convoluted is the system that the total value of mortgage derivatives in 2007-8 far exceeded the value of the entire outstanding housing stock of the country! In other words, instead of the $13 trillion bailout with its myriad of Federal Reserve discount lending windows and other facilities, the government could have bought out every mortgage in America.

One has to ask why they didn't. I mean, if the assets underlying the mortgage debt are only worth $4-5 trillion, why then do the banks need to be recompensed three times as much?

The answer is obvious to me: cronyism. Turns out the same people who lend, trade, and profit from the debt securities have the most political influence in Washington. Through a process called "regulatory capture," regulators and their supervising agencies become infiltrated by lobbyists from the companies being regulated.

At one end of this, we see the Madoffs--outright thieves--who were able to sustain a Ponzi scheme. At the other end, well connected former senators like New Jersey's Corzine are able to get away with outright theft, a transfer of funds in the last days of MF Global from private customer accounts to the corporate body responsible for safeguarding them.

Then of course the response is that the MF Global funds are "unaccounted for," a euphemism for "stolen" given in the niceties of our media glitz age. And if popular fervor over the misplaced funds were to rise high enough, chances are our government will elect to refund the stolen money either through an existing (albeit underfunded) program like the FDIC, or grant it outright, essentially enabling those who stole the money to remain anonymous and unaccountable.


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