Unconventional Monetary Policy, Financialization & Economic De-Industrialization

October 8th, 2013


Financialization involves a shift in economic gravity from production & from the service sector to the financial sector. Similarly, financial assets are diverted away from the private sector to the public sector as deficits remain high & debt accumulates at a worrying rate.

What should be seen is that what we are witnessing is a monetary-policy induced de-industrialization of the US economy.

Knowing that all this is happening is one thing, but it is important to know what is the fundamental cause behind this transformation. There are many that would blame globalization or economic liberalization & reply by suggesting that there must be more regulations or government interventions. Alas, those that believe this tend to be in the majority of economic advisers.

What they overlook is that the process of financialization of the US economy is driven by non-conventional monetary policies that have kept interest so low for so long and financial markets awash with excess liquidity. In turn, these monetary policies are also the culprit behind a sluggish & incomplete recovery from the Great Recession of 2007-2008.

Whereas such artificially-low interest rates were justified as a means to encourage business investments or home purchases, banks face weak incentives to offer credit to either firms or households. The reason is that it is more costly & risky to make loans to start-up businesses or households than to trade financial assets.

To issue new loans, banks must hire more loan managers to review applications, other staff to assess value of collateral (or to collect it & dispose of it) & accountants to keep track of all this. The above graph clearly indicates that there is very little loan growth.

And low interest rates also discourage saving by firms & households that are more likely to seek a “flutter” in placing surplus income in more risky & (hopefully) more remunerative financial assets, like bonds or stocks. Inasmuch as there have been fewer IPOs for new companies, most of the trading of shares is of companies that already exist.

Despite the slow growth in new lending, many of the largest banks are earning record profits, especially those banks that are “primary dealers” & act as exclusive counter-parties to support the Feds open market operations. “Quantitative easing” programs involved the New York Fed purchasing Treasuries from primary dealer banks, including Goldman Sachs, J.P. Morgan and 18 others.

These banks receive payment for Treasures they received as part of the bailouts in exchange for toxic assets that came off of their balance sheets, all of this done at taxpayer expense.

Before the introduction of “unconventional” monetary policy, financial assets served as contingent claims such that expanding the scope of financial markets and instruments would tend to increase overall efficiency. In turn, markets could do a better job pricing future outcomes to improve current allocation of resources relative to anticipated future needs and economic actors could seek portfolios with higher returns relative to risks.

With central bankers around the world following the lead of the FED, financial assets are busy chasing bubbles around the world with little left to spark a solid economic recovery and sustainable new job creation. As long as these bubble opportunities exist & yield high rates of returns, earnings will continue to be skewed in favor of the already-rich with little growth real wages of workers, worsening income disparities.

There are those that think that increased concentrations of income, diversion of resources to the financial sector & an AWOL recovery require more regulations, more stimulus & perpetuation of current monetary policy. But all of these are symptoms of the same cause: “unconventional” monetary policy.

I often suggest that had I described the current policy as a sensible scenario during my doctoral-level studies on monetary policy during the 1970s, the professor would have failed me on the spot. (And probably thought I was a candidate for the looney-bin!) But today, these policy choices go unquestioned despite their perpetual failures.

It is imperative that we begin reversing the ruinous course that is being plotted that is disrupting investments in sustainable industrial projects as the basis for long-term economic growth. This can & will only begin when central bankers stop acting like central planners in setting interest rates.

Ironically, economic recovery might only return when interest rates begin to rise toward their higher natural rate.

The Amount & Proportion of Public-Sector Debt is VERY Important

September 30th, 2013

Does Debt Matter? Yes, it matters in a BIG way whether it is public-sector (government) debt or private-sector debt. Both the absolute amount & the debt-to-earnings ratio matter. And they matter a LOT!

And so, it is a good thing that there is so much discussion about the rising level of federal government debt in the USA.

Several unhelpful refrains are that public-sector debt is not big deal since, unlike private-sector debt, it can be endlessly rolled over or can be repaid with freshly-printed money.

And, never mind. We only owe it to ourselves & it is dutifully being held in our pension accounts! Anyway, interest rates are so very low that the cost of borrowing is negligible.

Alas, such silliness has been passed off as wisdom when uttered by Nobel Laureates & other mainstream economists. In turn, journalists & opinion makers have been co-conspirators in peddling this nonsense.

There are many reasons to worry about the continued expansion of fiscal deficits & government debt. Eventually, the amount & proportion of debt will reach a tipping point whereby an additional unit of debt cannot generate additional economic growth. At this point, stagnation will set in.

When debt (private or public) is used to support non-productive current spending, instead of promoting growth, it sets into motion a cycle of wealth destruction in the real economy. In other words, borrowing is used to repay interest or to cover operating expenses without adding to future revenue streams.

According to a Deutsche Bank study, the G-7 spent $18 to generate $1 of GDP over the past 5 years. For their part, G7 countries added almost $18 trillion of debt, including almost $5 trillion new liabilities on the balance sheets of their central banks, that generated only about $1 trillion of nominal GDP. Now the total debt of these countries is at a record high of $140 trillion so that their total consolidated debt-to-GDP ratio is 440%.

All the spending led to mushrooming deficits, debt and a troubling expansion of central bank balance sheets with little to show in terms of economic growth. In turn, the economic & financial systems have become increasingly fragile with small upward movements of interest rates likely to cause a massive adjustment.

Concerning the cost of debt, bond yields cannot remain artificially-low forever. Unfortunately, such low interest rates have encouraged an irresponsible accumulation of outstanding debt that will lead to enormous funding problems when unsustainably-low yields eventually increase.

Meanwhile, government borrowing has diverted funds away from private investing while the painfully-low interest rates have discouraged saving. This ongoing “financial repression” accompanied by attempts to impose new taxes or raise rates on existing ones to finance public spending comes at the expense of shrinking disposable household income & savings.

In sum, it ain’t a pretty picture.

A clearer way to look at the ongoing accumulation of debt is that has increased the accumulation of risk.

The most obvious risk is that the inevitable increase in servicing costs of public-sector debt will leave less for governments to spend out of existing tax revenues. And it is unlikely that the private sector can absorb an increased burden of taxes since higher interest rates are likely to trigger more foreclosures or bankruptcies, leading to lower tax revenues.

Examining the Logic Behind Class Warfare & the “Soak-the-Rich” Mentality

September 25th, 2013


Support for imposing ever-increasing tax rates (or new taxes), especially on the “rich”, reveals a twist of logic that contradicts many precepts of economic analysis.

Consider President Francois Hollande that would increase the marginal tax rate on French citizens to 70%. Such proposals are made as though incentives don’t matter; that actions do not have consequences.

How naive is he to imagine that taxpayers will not respond by either engaging in evasion or finding legal means for avoidance. And then there is the extreme act of avoidance. emigration, an act undertaken by France’s richest person, Bernard Arnault, who filed for citizenship in Belgium.

Punitively-high tax rates suggest that public officials should judge the limits to success. Earnings within a competitive market economy can only occur by providing goods or services that are valued by the broad community. In this sense, earnings are rewards granted by consumers to those that add value to their life & are a matter of merit.

Imposing different tax rates on individuals based upon income violate a basic premise of the “Rule of Law” that all laws should apply equally to all individuals, Basing differential tax rates on income is no less arbitrary than requiring women to pay higher rates than men; tall people to pay higher rates than short people, etc.

If the purpose is to boost revenues for government, coercive redistribution is a poor substitute for passing laws that facilitate increased opportunities for exchange that can lead to higher economic growth rates. As it is, much of the recent reduction in the size of the fiscal deficit of the US federal government has come from higher tax revenues due to economic recovery, however weak it has been.

In all events, governments that would demand a right to impose higher tax burdens on productive individuals ought first provide good-faith efforts to curb waste & fraud in existing public spending programs.

Further, demonizing certain group by creating “them-versus-us” categories (e.g., 99% versus 1%) does nothing to promote social harmony. It is primarily a game that encourages citizens to identify with particular political parties & is a distraction from economic realities.

Finally, assertions that the “rich” do not pay their fair share & should shoulder a greater burden supposes that governments have first claim on citizens’ incomes.

Central Bankers Only Have Hindsight Concerning Asset Bubbles

September 23rd, 2013

We economists like to explain things using highly stylized models. We build make-believe worlds, populate them with creatures that act according to strictly prescribed rules, and analyze what happens. Or, as my wife said after I described one of my research papers to her: “You really never did stop playing Dungeons and Dragons, did you?”

~John C. Williams. “Bubbles Tomorrow, Yesterday, but Never Today?”~

Such a foolish claim really only depicts what passes for economic analysis of Mainstream (neoclassical) economists. As such, it is not surprising that the bibliographic data for this article does not list a single reference to work by Austrian economists, many of whom anticipated the most recent bubble.

Also unsurprisingly, Williams, President & CEO of the San Francisco Federal Reserve Bank, turns to “pop psychology” that puts the blame on “human nature” rather than the misbehavior of central bankers.

Contrast Williams’ comment with the great pains that Austrian economists take to depict economic activities in their full complexity & dynamic nature.

Can the Sovereign-Debt Bubble Last Forever? A Focus on China

September 20th, 2013

I await a trigger that will start a great unraveling of the bond market bubble & a (slightly–less) inflated stock market bubble created by “quantitative easing” (QE) that provided liquidity in support of the continuation of excessive borrowing, especially by governments, including China.

China’s debt-led stimulus to offset the global economic crisis contributed to a massive public-sector debt bubble.

According to Liu Yuhui of the Chinese Academy of Social Sciences, heavy borrowing to fuel investment-driven growth caused local government debt to double in just 2 years to about 20 trillion yuan ($3.3 trillion). He also suggests that the amount of government debt at all levels as a percentage of GDP may have risen by about 16 percentage points last year, up from 182% at the end of 2012 & 167% at end of 2011.

But there are also problems with private borrowing. According to Fitch, China’s private-sector debts rose from 129% of the size of the economy in 2008 to 214% at the end of June 2013.

This dependence on borrowings to drive economic growth is unsustainable.

At some moment, this madness must & will stop. Predicting the timing is impossible. It will come as a complete surprise to most when it does. As it is, most people think that central bankers saved the world from an economic & financial meltdown with their meddlesome ways, without questioning the end-game of their ongoing “unconventional” monetary policies.

In actual fact, central bankers have merely set the stage for a worse set of outcomes than if they had let the too-big-to-fail banks go under in 2007-08.

The reason this Ponzi Scheme has been able to survive so long is that almost every country is in on it. In the past, most governments pursued economic and monetary policies based on their own domestic agenda. Internal imbalances (e.g., relatively-high rates of price inflation; balance of trade deficits; etc) would eventually lead to market-driven adjustments (e.g., capital flight; exchange rate revaluations).

Since all countries that matter are doing pretty much the same stupid things, these adjustments have not yet occurred (maybe in India or Indonesia).

There will be a “The-Emperor-Has-No-Clothes” moment when lenders realize that government borrowing cannot go on forever. Greece alone was not the trigger.

But at some point, there will be an interest rate spike in a significantly–large economy that will prompt something like a contagion effect that will affect rates in many others.

Massive Bubble in Government Securities Threatens Global Financial Stability

July 7th, 2013

As the FED begins to taper off from its massive monthly purchases of $85 billion worth of securities, it is likely to trigger a rise in interest rates. In turn, this could lead to panic selling of interest-bearing assets as investors try to avoid capital losses due to the inverse relationship between bond prices & yields (i.e., interest rates).

“If I were to single out what for me would be biggest risk to global financial stability right now it would be a disorderly reversion in the yields of government bonds globally.”

“Let’s be clear. We’ve intentionally blown the biggest government bond bubble in history.”

“We need to be vigilant to the consequences of that bubble deflating more quickly than [we] might otherwise have wanted.”

~Andy Haldane~ (director of financial stability for the Bank of England)

According to BIS, there are financial derivative worth $441 trillion betting on interest rates (Table 4).

Read that again, $441 TRILLION!

If interest rates rise even a few percentage points, to say 3%, the specter of catastrophic losses could add to panicked selling.

A word to the wise: Beware stampeding bears.

Politics versus Economics

June 7th, 2013

The role of economists is to explain the difference between the possible & the desirable while politicians deny that there is a difference.

Who is Winning the “War on Drugs” … ?

May 24th, 2013

When Richard Nixon initiated the “war on drug” in 1971, nonviolent drug offenders counted for less than 10% of inmates of state & federal prisons. But they now constitute more than 25% of a much-larger prison population.

Despite the US government spending billions on expensive, flashy “toys” used by cops & the DEA, drug cartels are enriched to the point that they either enfeeble foreign governments or keep the streets awash in blood.

Who is winning this war other than sanctimonious talking-heads that believe it is a moral struggle or rent-seeking jailers & enforcers whose status & income depends on a policy that is so destructive … ?

Is this a war that really needs fighting … ?

Assigning Blame for Factory Deaths in Bangladesh (and Elsewhere … ?)

May 23rd, 2013

As details of the tragedy unfolded live on TV, fingers began to be pointed at the factory owners, the builders & US multinationals, as well as American consumers that prefer low-priced clothing.

The presumption of those that rushed to judgment seems to be that there is something peculiar about the nature of profit seeking or bargain hunting when it comes to Bangladesh.

It seems to have occurred to few of them that much of the blame can be traced to the government & civil authorities of Bangladesh. As it is, the building containing the factory was constructed illegally since it takes many months to obstain a construction permit in Bangladesh.

To get some insights into this, check out Bangladesh’s standing in the Transparency International polls on corruption, its rank on the Economic Freedom Index & the World Bank’s “Doing Business” report.

In all these, Bangladesh scores poorly in terms of facilitating business operations, including receipt of business licenses or building permits, etc.

This all matters inasmuch as excessive “red tape” due to extensive regulation & corruption contribute to, indeed insure, that individuals or firms will operate outside the law.

In turn, reducing regulation, making it more transparent or reducing graft are a better way forward than heeding the call to impose more labor force regulations that will most likely lead to higher unemployment.

A quick survey of where such disasters occur will reveal a common thread of “government failure” in that there is an insufficient institutional infrastructure to minimize the risk of such catastrophes. Besides the most fundamental problem is the lack of the “Rule of Law”.

As such, the mechanisms to hold malefactors accountable are weak or are blocked by political privileges.

There are several ways for labor conditions to improve in Bangladesh or any other less-developed economy. One is for there to be more open global trade so that there is broader access to foreign markets for all their goods. Similarly, more open capital flows that allow foreign ownership of productive means (e.g., factories) will improve working conditions. And lastly, more open immigration will lead to an increased scarcity of labor that will cause wages to rise.

Apple Inc., Tax Compliance & the Democratic Disconnect

May 22nd, 2013

Lost amidst the flap over the fact that Apple Inc. did not pay much in taxes, anywhere, is the nature of the claims of governments on the rightfully-earned incomes of their citizens.

The notion of a “tax gap”, the difference between what tax collectors think they should receive & what taxpayers willfully submit, implies a democratic disconnect.

It turns out that the sums can be substantial. For example, the IRS estimates this gap in tax revenues for the US federal government is about $290 billion each year.

Many public officials suggest that shortfalls in tax revenues reflect a tendency toward criminality or unprincipled greed of citizens that ignore their legally-imposed obligations. While pubic officials have in mind what they deserve to receive, citizens assess whether their tax bill is reasonable in relation to the quality of the services they receive.

Most politicians insist that closing the tax gap is a good way to fund new spending. Indeed, increasing compliance is often prescribed by the IMF to governments that turn to it for assistance in sorting out fiscal imbalances.

Several issues are being overlooked in those that would seek to close this gap.

First, there is the problem of corruption, inefficiency & waste associated with government spending. As such, many taxpayers balk at paying more to the tax authorities. No one should anyone feel compelled to pay more until government officials curb waste & fraud. (The losses to fraud involving MediCare & MediCaid are about the same as the reduced spending due to the so-called “sequester”!)

Second, the increased vigilance by tax authorities to close the tax gap would inevitably lead to a reduction in freedom of action.

Third, the focus tends to be on the presumed social benefits of more funds being handed over to government. As such, the increased costs incurred by taxpayers in complying more fully with the tax code tend to be overlooked. If the gains in tax revenues from increased compliance are less than the higher costs incurred by citizens, there would a net social loss.

Taxes are not about funding “essential” government goods or services that might not be provided through private actions in markets. Tax policies are part of a redistributive game that allows political support to be purchased or rewarded.