September 28, 2011

Abra-cadabra, you're rich again

This flow-chart diagram of the Eurozone bailout plan is fun in the same way that plotting the flow of the Federal Reserve's conjuration of money is fun; to wit, it raises the question and riddle: at what precise point is the money created?

The European scheme is really a doozy in this regard, but that's the whole purpose of the complexity. When you're reaching into your silk top hat and pulling out a trillion or two, you want to make sure the audience is watching the pretty blonde in the leotard as you do so.

I've been giving a lot of thought to the whole business of "fiat money regimes" and sovereign indebtedness lately. In some ways, it seems that "money" is to economics what "energy" is to physics. It's the basic unit of everything, but it's not possible to define it precisely. "Money" has had this quality since the abandonment of the gold standard during World War II and the substitution of floating fiat currencies in its place. Pegging the amount and distribution of paper money according to how much gold was available was itself certainly arbitrary as well (what's so special about gold, other than Spanish explorers used to kill a lot of Native Americans, north and south, to get the stuff?), but at least there was an anchoring principle to the issuance of fiat. Bretton Woods (1944) changed all that, but the emerging dominance of the United States as the world's great military and economic power probably disguised the fundamental nature of the change. The dollar was as good as gold, in effect, and the issuer of the world's reserve currency had no great motivation to debase its own fiat; quite the contrary.

So a kind of "gentlemen's agreement" arose by which the world's central banks agreed that international monetary regimes would keep it down to a roar, as far as wild printing of money was concerned. Unbridled issuance leads to hyperinflation and debasement, and pretty soon it's 1922 in Germany again, and people are burning their marks for fuel because it's cheaper than trying to buy firewood with the stuff.

But now, but point made forcefully in Richard Heinberg's The End of Growth was that the great spawning and proliferation of debt, both public and private, over the last fifty years, which have brought the modern industrial world to the brink of bankruptcy, were enabled by the belief that economic growth would always allow these nations to catch up to the exponential functions of interest-bearing debt. So it didn't matter if we went in the hole now; these debts were an "investment" in future growth of national GDP, and it would all even out. Countries running at a big deficit, the United States chief among them, would simply borrow now and grow our way back to prosperity. And underlying this belief was that cheap and abundant fossil fuel energy, which finds it way into practically every aspect of a modern economy, would remain cheap and abundant.

It isn't going to work out that way. The demand for petroleum and its distillate liquid fuels keeps going up at a rate exceeding the ability of the oil industry to keep pace, driving the price higher (despite the Depression we're mired in) and stymieing all efforts to emerge from the Depression. The United States, as the most oil-dependent nation on Earth, feels the effects most acutely. 90% of our passenger-miles, our just-in-time delivery systems for food outlets and Big Box stores, our international import dependency, our massive, inorganic agri-business practices, the airline industry, the military-industrial complex, all depend for profitability on cheap, abundant oil. Which increasingly doesn't exist. But if growth isn't possible, how can the locked-in costs of the entitlements and the exploding future burdens be paid for?

Thus, whatever that gentlemen's agreement may have been, the Federal Reserve (which is a fine institution, founded in 1913 and dedicated to the prosperity and well-being of all Americans - h/t: Dan - maybe that will throw the Fed's new spy program off the scent, depending on the algorithm) was faced, after 2007, with cratering housing, jobs and stock markets. Such things do not play well in America. One way we could have dealt with such problems would have been a frank and honest assessment of the actual standard of living of the American middle class. If you have borrowed massive amounts of money in the past in order to pay for your "requirements," and it turns out you're going to have to pay all that money back in the future, with interest, and you can't do that because you don't have the money, then it's somewhat unrealistic to say that you were as rich in the past as you said you were. The same thing can be said about the federal government, which has a $3.8 trillion lifestyle based on $2.2 trillion in income.

This is America, however, and whether these are the Days of Awe or not, we don't go in for that kind of truth-telling. It doesn't fit our narcissistic style. My back-of-the-envelope calculations usually arrive at a figure of about 60%; that is, America, across the board, is about 60% as wealthy as it claims to be. This number (like some sort of totemic pi of the national economy) has a way of showing up everywhere; for example, tax receipts furnish about 60% of the federal government's revenue. When the stock market fell in 2007-2008, it fell about 40%. When all the water has been wrung out of the housing market, prices will have fallen to about 60% of their peak level. This symmetry is not accidental, in my opinion. It's reflective of an underlying reality.

Be that as it may, Ben Bernanke's first order of business was to see if he could not re-inflate the housing bubble, the source of imaginary wealth for the American commoner. No go there. Ben was so desperate to do so, however, that he kind of dropped his top hat as the rabbit jumped out of his pants. There was very little artifice in how he went about money conjuration in that case. He declared the existence of about $1.3 trillion and used it to buy mortgage-backed securities from Fannie, Freddie and banking institutions, placing all that dodgy stuff on the balance sheet of the Hallowed Federal Reserve. Blatant, you could say, but unavailing. The next time around, Bernanke was more indirect; in order to goose the stock market, Ben launched QE II, the bond-buying program where he used the Primary Dealers as fronts to purchase Treasury bonds, then relieved the PDs of their temporary burden through the "POMO" routine. All in all, Bernanke has conjured more money out of thin air in the last 3 or 4 years than the Federal Reserve had in its previous almost 100-year history.

Somewhere in that Rube Goldberg contraption up above, the Europeans are planning to do something similar. I haven't found the Sweet Spot yet, but it's there. I commend them on their Old World, Baroque complexity. I'm disappointed they would copy the Americans so obviously, but they got the idea from Tim Geithner, so what do you expect? McDonald's, Disneyland, and now this. Soon there will be no point in going over there at all.

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