Friday, April 1, 2011
The Causes of The Mess We’re In
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| “But I just wanted a pony!” |
Lots of people have been pointing to the various signs of the coming crisis: A U.S. Federal government deficit that’s over 12% of GDP, to be repeated in fiscal years 2012, ’13, ’14 and possibly ’15, if not surpassed; abnormal rises in commodity prices; European disintegration; a Federal Reserve that is printing money like there’s no tomorrow; the largest bond fund in the world—PIMCO—exiting Treasuries (that’s like Baskin & Robbins exiting chocolate); a complete inability of the political leadership class to do anything about the fiscal mess of the United States, at the Federal, State and local levels.
But though everybody points to the signs of the coming crisis, no one can yet make out its true shape. I’ve posited that it’ll be hyperinflationary, while other very clever people have claimed it’ll be deflationary.
However, these different interpretations about the coming crisis are interpretations of what’s coming up in the future.
As we sit here waiting for the next Apocalypse, let’s forget about tomorrow and instead consider the past. Let’s ask ourselves the obvious question:
What got us here?
What policies were implemented—decisions made—actions taken—which would set us on such a path to oblivion? Because that is our ultimate destination—oblivion. It’s coming to the American economy—and American society—as surely as if it had been FedExed last night. So if we’re going to hell, might as well figure out how we got there.
Some people claim it was the very invention of the Federal Reserve back in the early XX century that set us on the path to ruin. Others claim it was the Hamiltonian desire for a central bank. If we play the causal game at these focus lengths, then we might as well go back to Adam and Eve—they’re the reason for all our macroeconomic misery!
Patently absurd.
But if we get serious and look at the policies, decisions and actions carried out in our own lifetimes, then I’d have to say that there were two things that set us on the road that we’re on:
• One, the failure of Congress to deliver a balanced budget since 1975, and
• Two, the subsidy the Federal Reserve gave both the U.S. economy and the Federal government by way of its artificially low interest rates, starting in 1987.Starting in 1975, the United States has had an uninterrupted string of yearly deficits—that is, the Federal government has routinely spent more money than it has brought in, barring a few exceptional years in the 1990’s.
Deficit spending satisfied the ideologies of both sides of the economic divide:
For the economic Right, cutting taxes satisfied its notion that more money in the hands of the citizenry and corporations guarantees greater economic growth.
For the economic Left, more government spending every year satisfied its notion that more money spent by the government guarantees greater economic growth.
As per my Democratic Bankruptcy Paradox, starting in 1975, both sides of the political divide in the United States failed to resolve the fiscal incoherence of the United States, except in a couple of exceptional years in the 1990’s.
The economic Right wanted lower taxes. The economic Left wanted more fiscal spending. Rather than thrash out their differences and come to a compromise, they resorted to the national credit card: Since 1975, the political equation insofar as Federal government money is concerned has not been either/or—it’s been both/and.
Both lower taxes and higher Federal government spending—an achievement bought and paid for with fiscal debt. The fiscal incoherence I have posited, and which the American Congress proved in spades.
With each year that the fiscal incoherence was unresolved—that is, with each year that the political factions failed to hammer out their differences and balance the Federal government budget, and instead issued Treasury bonds to cover the difference—the overall debt became greater and greater—
—to the point where we are now: Total fiscal debt that exceeds 100% of GDP. Yearly deficits for the next five years that will exceed 10% of GDP each year.
Now, the Federal government has failed to resolve its fiscal incoherence starting in 1975—but it’s been able to get away with deficit year after deficit year because of the cheap interest rates it has had to pay for its debt.
The low interests the Federal government—and the rest of the U.S. economy—was able to take advantage of? Brought about by the Federal Reserve’s money subsidy.
Yes: The Federal Reserve’s money subsidy—with all the market distortions that a subsidy implies.
The price of a good is the intersection of its supply and its demand—this is Eccy 101. Money is a good like any other—and like any good, it has a price: Its interest rate. Ordinarily, the price of money is fixed by suppliers of credit—that is, banks. They create money via credit—and they sell this money to their customers, the price of this sale being the interest rate that they charge.
However, starting in 1987, the Federal Reserve went beyond its mandate of price stability and full employment (the latter part of which it has never really paid much attention to), and instead went into the business of goosing along the economy.
In other words, it focussed on mindless growth—and focussed specifically on the blunt, club-like metric of GDP growth—and goosed along the economy in order to raise that mindless metric.
It did this by usurping the role of banks, and providing cheap money by way of low interest rates—low interests rates carried out with the explicit aim of gaming the GDP.
The economy slowing down? Cut interest rates. Momentary market panic? Flood the market with liquidity. The economy (as measured strictly by GDP) slowing down again? Cut interest rates some more. GDP booming? Very very very slowly and predictably raise rates—then cut ‘em again the instant the GDP looks like it’s starting to slow down.
This was, in a nushell, what Federal Reserve Chairman Alan Greenspan did, during his tenure at the Eccles Building: Greenspan subsidized money for the sake of gaming a single metric, the GDP.
Everyone knew it, by the way. There was even a name for it: The Greenspan Put.
For such an avowed free-marketeer, Greenspan was quite the Socialist apparatchik: Rather than allow the market to dictate the price of money, he subsidized it like a Socialist Pricing Board. And just like a Soviet apparatchik of old, Greenspan focussed on one number—GDP—irrespective of all the other subtle qualifiers that define a healthy economy.
The fucker was a Soviet goon—his Ayn Rand, “Free-Markets Forever!” bullshit was just for show.
The distortive effects that Greenspan’s money subsidy brought to the US economy are clear to all—serial bubbles: Dot-com, tech, bio-tech, CDO’s, real estate, and now Treasuries—all these serial bubbles were blown by the Fed’s relentless subsidy of the price of money.
Now of course, if you are using the subsidized price of money to goose along an economy, there comes a moment when it doesn’t work anymore. Poor Ben Bernanke, he’s living that unhappy life: His Zero Interest Rate Policy (ZIRP) and Quantitative Easing-1, -lite and -2 are the perverted policies he has had to pursue in order to keep up the Greenspan Put.
All of The Bernank’s recent policies are aimed at shoring up the “growth” that the U.S. economy has experienced over the last 24 years.
But the thing is, that “growth”? It wasn’t real—it was steroid-induced bubble-muscle. It was an illusion.
You don’t agree? You think there has been actual growth over the last 25 years?
By measuring gross GDP adjusted for inflation—“Red Al” Greenspan’s sole metric—the answer is “yes”.
However, if measured by median and average wages, per capita incomes adjusted for purchasing power, or any other such metric that measures the well-being of the average- and the below-average-citizen, the answer is a resounding “no”.
People are less well off. The middle class in the United States has shrunk—drastically. Sure, the average income might be higher—but that’s the distortive effect you get from having tremendous, inorganic wealth disparities, as we have today.
It’s not merely that the disparity between the wealthy and the rest of the population is obscene—the disparity skews the results. Remove the top 15% of the population, and the average income in the United States drops below Slovenia’s—and no, I’m not kidding.
Furthermore—and this is germane insofar as our current situation is concerned—the sort of growth the American economy would have experienced since 1987 without this money subsidy would likely have been very different from the growth we have actually experienced.
The growth we have experienced has been speculative. Why was it speculative? Because cheap (ie. subsidized) money Greenspan made available was set to chasing returns via trading, not production.
Had money been expensive, yields that beat savings would have been harder to come by—and thereby encouraged savings instead of speculation.
Expensive money would have also kept banks from the insane speculation of the real estate markets: On the one hand, expensive money would have kept low-quality buyers from access to credit, and on the other, expensive money would have disuaded banks from expanding their businesses into riskier territories, in order to reap higher returns.
In other words, risk would have been accurately priced.
In other words, there wouldn’t have been a Global Financial Crisis.
Now, obviously, it’s a fool’s game to try to go back over the 24 years since Greenspan took office and try to deduce what would have been the organic price of money without his and Bernanke’s subsidy.
But clearly, had the Greenspan Put never existed, there would likely have been less growth than has been had.
Would there have been less money for venture capital and the financing of new businesses? Yes, no question. Would those new businesses therefore never have existed? Again, yes.
However: How many ridiculous, fairy-tale businesses would have been financed, as happened during the various bubbles of the last 24 years? Very few: Capital would have been much more efficiently allocated, in a world where there was no subsidy on money. It would have been too expensive for the economy to throw away capital on clearly nonsensical businesses.
Would the solid businesses have gotten financing? The ones that actually did something for the economy, like Google, Ebay, and so on? Clearly, it would have been tougher for them, and their growth would have been slower—but just as clearly, they would indeed have gotten financing, because they are obviously good businesses.
Anyway, even if many good businesses would have failed to raise financing in a world of more expensive credit, the good outweighs the bad: There would not have been any serial bubbles—
—and the Federal government would not have had access to cheap financing, which encouraged its back-breaking debt.
Had Greenspan not subsidized money, it would have been far too expensive for the Federal government to continue increasing its yearly deficits, and adding to the national debt. A fiscal day of reckoning would have happened a lot sooner—and therefore would have been a lot less painful. It would have been bad, sure—all days of reckoning are bad. But it wouldn’t have been mind-crunchingly destructive—as we all sense the coming crisis will be.
As it is—as we live in a world where Greenspan and now Bernanke keep money at absurdly, unsustainably low prices—the Federal government was allowed to balloon its fiscal debt to monumental proportions: As I said, over 100% of GDP, with future yearly deficits in the +10% of GDP range as far as the eye can see.
The Fed’s subsidized money postponed the day of reckoning, insofar as the Federal government debt is concerned—but it has made that day of reckoning much worse than it needed to be.
That’s why we’re sitting here, waiting for the next financial Apocalypse, and pondering the causes that led us here.
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