April 05, 2012

In whiich we delve into the strange world of the American economy

It was about two years ago that Charles Biderman, a Sausalito-based financial guy, stated rather boldly that the New York stock markets were completely manipulated by the money-printing games of the Federal Reserve and nothing more. He was denounced, of course, as a conspiracy theorist, and, also of course, since he lived on the West Coast rather than in the Capital of the World, he was seen as small-time and an attention-seeking parvenu. Or something like that.

Now Mr. Biderman's views seem to be the conventional wisdom on Wall Street. When the Fed engages in quantitative easing, or the conjuration of money out of thin air, the markets tend to rise, and when the Fed turns off the spigot, the markets tend to fall. More and more people seem to be saying the same thing. They came to mock Mr. Biderman and stayed to praise him. Sic semper economicus nonsensicus.

I don't really know why there has ever been any serious doubt about this. Reminding ourselves of the engineering dictum that "the power flowing through a system defines the system," the first point of analysis is to find the source of power, if any, in the American economy. There would seem to be two: (1) The dollar is the world's reserve currency, thus other nations have traditionally been desirous of acquiring dollars, particularly to participate in the world's oil trade, which has up until now been conducted almost exclusively in the dollar; and (2) Certain American multinational companies have been well-placed to take advantage of the capital flows between the United States and the rest of the global economy.

To give an example of the second point, consider the trade in mortgage backed securities (MBS) which enriched Wall Street banks and the shadow banking system during the great housing boom between about 1998 and 2006. How did that work? Essentially, it was a conveyor belt running on (temporary) perpetual motion, and I apologize for the contradiction in terms. Americans bought Chinese and other Asian crap. The Asians (principally Japan and China) used the capital flows into their country to buy Treasury bonds. This reciprocal flow allowed the Federal Reserve and Treasury to keep interest rates very low, including on the ten-year bond which influences mortgage rates. This potentiated the housing market, since the absolute price of a house is less important to the buyer than the servicing cost of the mortgage. The creation of ballooning equity in houses (as the bubble expanded) allowed Americans to use their houses as ATMs, enabling further commerce in Asian gizmos and automobiles, giving another push to the conveyor belt. Meanwhile, the avaricious Houses of Deceit on Wall Street came up with novel ideas about packaging all these new, cheap mortgages together into securities (replacing the old retail trade in stocks which had died because of internet competition and the fact the stock market had been flat for about 10 years). These mortgage-backed securities "spread the risk" and allowed an expansion of the mortgage market into dicier markets, such as "subprime," and gave a further boost to skyrocketing housing prices.

Toward the end of this, in legendary testimony to Congress in October, 2005, Ben Bernanke, who presently runs monetary policy at the Federal Reserve, had this to say about the housing bubble, as reported by the Washington Post:

U.S. house prices have risen by nearly 25 percent over the past two years, noted Bernanke, currently chairman of the president's Council of Economic Advisers, in testimony to Congress's Joint Economic Committee. But these increases, he said, "largely reflect strong economic fundamentals," such as strong growth in jobs, incomes and the number of new households.
25% in two years simply reflects "strong fundamentals?" It was after this epic gaffe that Bernanke was appointed (by Bush) as Federal Reserve Chairman, and he was retained by Obama, of course. Raising the question: exactly how far off would you have to be in order to disqualify yourself from a top Washington, D.C. job? Sitting in the very apogee of the huge housing bubble, Ben Bernanke was unable to see that anything was strange.

Such obtuseness is not the indicator of a keen or comprehensive mind (such as that possessed by Charles Biderman, or your Uncle Leo, for that matter), in my humble opinion. Bernanke was unable to see the circularity of his logic: the "strong fundamentals" were the result of the excesses of the "consumer society," and the consumerism was enabled by the house-as-ATM paradigm. The "jobs and incomes" depended on the housing bubble itself, the creation of a massive surplus to make possible all the "discretionary jobs" of the bubble years, not to mention the jobs directly related to the housing industry itself.

And now this is the same guy calling the shots on monetary policy. This was a serious mistake on the part of our naive and unschooled President, to retain this guy at the Federal Reserve. For even if Bernanke had extraordinary acumen, which he clearly does not, keeping Bernanke on the payroll, in such a critical role, set up a situation where Bernanke, drenched in flop sweat from his gigantic blunder in 2005, was determined to demonstrate that he was right all along, that the American economy is "fundamentally strong," and that the total bust of the economy was due solely to the excesses of a few big Wall Street banks and not to the underlying anemia of a hollowed-out industrial base.

No, Benji, that's not it. The Wall Street banks took huge advantage of America's swan song, in their avaricious, sociopathic way, all of that is true. But that's because America's housing stock was the only thing left to play games with, to commoditize, and they rushed into the breach as fast as they could and made money hand over fist before the bubble popped. Then Wall Street was bust-o, too.

Until you came along, Mr. Chairman. Determined to prove that America remained vibrant, you slapped the defib paddles to the corpse of the economy and yelled "Clear!" You began printing money and injecting it into the economy, using the same big Wall Street operators, the "Primary Dealers," as your "transmission mechanism." You used every trick in the book: you took mortgage-backed securities (those that were government-guaranteed by Fannie & Freddie) off the hands of big banks and other holders at their face value, you made massive buys of Treasury bonds from these same PDs while the Treasuries were still hot in their hands from the auction immediately before the "purchase," then you pivoted into Operation Twist, where the Fed sold its short-end Treasuries and used the proceeds to buy up virtually every long-dated bond on the market (about 91% over the last two years). While all of this was going on, you held interest rates at virtually zero, which allowed the same Big Players with access to the Fed's free money machine to borrow for nothing and play the market, or earn the small spread between the Treasury coupon rates and the 0% they had borrowed at.

The net effect of all this money-printing is that the Fed itself is now the largest holder of Treasuries in the world. The Fed's policies have catalyzed the wealth disparity between the American financier class and the rest of the booboisie, who do not enjoy the same borrowing privileges. The Fed-Treasury Complex is now a joke, since it is so clearly a matter of a snake eating its tail. The foreigners are dropping out of the game of buying Treasuries because they were using actual cash while the Fed just hits the "Create Money" key on its computer.

All of these games have been in the service of one primary function: we must not allow ourselves to see the true state of the American economy. The political class, from the President on down, is locked into a rigid narcissism of Reality Denial. Telling the truth can get you thrown out of office. The stock markets have been goosed by the Fed for three purposes: (1) To make the economy look much better than it really is, (2) to sustain the leaky government pension funds which have become completely reliant on stock appreciation for their survival and (3) to prop up the federal deficits, which now run at 40% of all money spent by Congress. Along the way, there is the occasional feeble gesture in the direction of restoring the housing bubble, but that's obviously too daunting a task. The Fed and Obama have done what they could, but the truth is the housing market will not hit bottom until prices are commensurate with what Americans can afford with actual income. That's pretty scary because it reflects reality, the very thing we have been trying to avoid.

If the Fed has in fact decided to cease and desist from money-printing, as some commentators report, one can only wonder about what signs the Fed has begun to see that indicate the dangers its reckless activities have engendered. I don't believe it's because Ben Bernanke really believes that the American economy is now in "recovery" and is in self-sustaining mode. Even Bernanke would not make the same mistake twice in exactly the same way. Who is he, Ned Racine? Do the Federalistas now see hyperinflation coming their way, that as soon as the Euro crisis passes (67% of the relative value of the dollar depends on the euro), the dollar will be exposed for its true value on the open market?

The center is not likely to hold. Some rough beast slouches its way toward Washington, D.C.

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