Inflation is often called a tax on the working class. The well-heeled have much of their wealth in assets and stocks, which tend to rise with inflation, while the rest of us see the strength of our wages eroded by the inflation of the dollar. Since 1913, when the creation of the Fed launched our current financial system, the dollar has lost 93% of its value. That would be irrelevant if wages kept pace with the dollar’s value. They don’t. Wages for the individual worker, adjusted for inflation, are up less than 1% since the late 70s, while the top 1% of earners have seen their income rise over 700% in the same period (source: Bloomberg)
The economy is working great for the wealthy, not so much for the middle class, terribly for the working poor. The current recession is a stark wake-up call for what some call the largest transfer of wealth in history. Banking bailouts have transferred trillions in corporate debt to the taxpayer. And more than ever, fingers are pointing at the Fed. Conventional civics class wisdom and Fed press conference sound bites would lead one to believe that the Fed and its monetary policies revolve around protecting the dollar from the ravages of inflation and stabilizing the money supply for the benefit of all. Now a clearer picture is emerging: a Fed obsessed with steering our wealth toward the Wall Street elite. Its primary tools are: (1) maintaining “just the right amount” of inflation, like a low-grade fever, and (2) the use of asset bubbles to extract wealth and drive it upward.
Inflation is low now mainly because of the massive asset devaluation from the economic meltdown. The hyperinflation that would normally happen withthe Fed’s current huge (many say reckless) expansion of the money supply is said to be not in the cards. At least not in the next few years, but after asset values stabilize, who knows? The money supply has never been expanded this far, this fast, and only fools dare predict the consequences. If hyperinflation does happen, it will come on fast, hit hard, and will be difficult to stop.
The big problem now is the pressure on the dollar to drop in value in relation to other currencies, which is really just another form of inflation. The monetary regulators say they are presiding over an orderly devaluation of the dollar to relieve the pressure, and in fact devaluation is the only possible way we can deal with a debt that totals, with unfunded future mandates, 80-100 trillion dollars. Can’t pay the debt? Devaluing the dollar makes the debt worth less (or worthless) to the debt holders.
The surge in the price of gold is the surest sign of flight from the dollar. Although gold recently fell while the dollar is enjoying a small surge, all the trends are stacked against the dollar. Sadly, the only hope the dollar really has is the huge and mounting government debt of just about every other G20 nation.
Hyperinflation discounters say don’t worry about it, it won’t happen. Debt apologists are out there also, and there are Nobel laureates among them. They claim debt this high is not such a crisis either. They point to the huge debt after WWII, which ushered inthe longest period of sustained growth ever. But that is a very leaky analogy. First hole: The WWII money was spent for a good reason, to defeat the Axis war machines and free the world from tyranny. Second hole: That debt was released into a frugal, motivated, and productive workforce. To counter that, this debt was spent to have good times in relative prosperity, and I’m not at all sure how much self-sacrifice we have in us these days. Increasingly, we don’t produce much of value that the world wants. Our biggest export to the world over the last decade was Wall Street’s bizarre new financial wizardry, which amounted to bullpucky.
The apologists point to governments like Japan and say its debt to GDP is three times higher than ours, and it’s still a functioning country. True, but why would we aspire to be a basket-case economy like Japan? I don’t deny the value of American ingenuity, which always finds a way to turn adversity around. The problem is that we are piling up adverse economic trends one on the other, and I worry we may be building an insurmountable hill.
Even moderate financial writers like Newsweek’s Robert Samuelson are starting to worry about whether the US would default on its debt. As Samuelson says, “the question is so unfamiliar that the past provides few clues to the future.” He goes on to point out that governments of superpowers can always borrow money…at least ”until confidence that they can do so evaporates.” The result, if that were to happen: a run on the dollar. Hyperinflation would then be not unlikely, but inevitable. Samuelson concludes his recent Newsweek piece by saying “even the remote possibility underlines the precariousness and novelty of our situation.”As Warren Buffet says, “we are in uncharted territory.” Don’t believe anyone who thinks they know how this will play out.
Already, China is making moves to uncouple itself from the dollar, even though they hold 3.5 trillion dollars. The move would devalue the dollar debt they hold, but at this point they seem willing to cut their losses. Saudi Arabia wants to start trading oil in Euros, not dollars. That would be a huge blow to the world’s confidence in the dollar.
The easy money that defined the housing bubble is now defining our response to the bursting of that bubble: more easy money. “Cash for clunkers” is providing easy money to convert people’ paid-for cars into a car payment they didn’t have before. Ditto with first-time homebuyer credit. We’ve lived off debt for so long we don’t even know what real prosperity looks like anymore. The so-called 2.8% growth in the GDP was 90% the result of government programs. It’s not growth, and it’s not a recovery, it’s an increase in debt. It’s another bubble. Can the economy still grow when the government pulls out the feeding tubes?
Paolo Pellegrini, the stock analyst who made ultra-wealthy hedge fund guy John Paulson $3.5 billion richer by correctly predicting the sub-prime bust, calls the Fed’s easy money, low-interest rate policies “sheer lunacy.” The effort to jump-start the economy is just creating another asset bubble, namely the stock market surge, that he calls a “one-way trip to oblivion” for investors. Pellegrini says the only way out would be an end to easy money and a return to thrift and savings. But for self-indulgent people, corporations and governments addicted to debt, the withdrawal from easy money would be the hangover of the century. It’s not likely to happen of our own free will. The party’s got to end at some point, but more likely precipitated by forces beyond our control.
This dollar bubble is clearly the result of all the cheap money coming off the Fed’s printing presses and being shipped out to banks at just over 0% interest. With rates like that, the money is not being saved to improve balance sheets, it’s going straight into the speculation markets. A recent report states that some banks still have 50% of their losses in hidden, off-balance-sheet investments. Prudence would dictate adding the new money to reserves to offset these losses, which will eventually surface. Or heaven forbid they would use the Fed’s cheap moneyto lend to small businesses to get kick-start some job creation. “Quantitative easing,” the Fed policy of feeding more money to banks to stimulate lending is not working. The amount of money being loaned out fell more in the third quarter than any quarter since such records were kept. Banks would rather take the money to the speculative markets, it’s the only place there is a healthy return.
Of course that healthy return comes with a lot of risk right now. PIMCO’s CEO, Mohamed El-Erian, who oversees one trillion in assets is expecting a large correction shortly, and is adjusting accordingly. He is hardly alone in that thinking. The lack of fundamentals makes the stock market rally unsustainable. But for the big banks, why worry about risk when the Fed will backstop whatever precarious predicament they get themselves into? You talk about your “moral hazard.”
The business fundamentals that have gone awry can’t be fixed by government edict or throwing money at wealthy bankers. That’s why they are called fundamentals. The debt binge cannot ultimately be cured without an increase in real productive activity and the restoration of savings.
The Fed’s image recently took a big hit with Special Inspector General Neil Barofsky’s recently-released report on the botched AIG bailout. The report details how the Fed and the Treasury fleeced taxpayers to reimburse bankers’ risky investments. The bankers, who had dangerous and mysterious derivative contracts with AIG, should have been the ones to get cleaned out when AIG went insolvent. Instead they were reimbursed for these contracts 100% when the Fed bailed out AIG. The contracts were Credit Default Swaps written on sub-prime mortgage investments. When AIG imploded because the underlying investments they were insuring were worthless, the counterparties would otherwise have lined up at the teller window for a pennies-on-the-dollar payout.
Our Treasury Secretary Tim Geithner, who was then head of the New York Fed, brokered the rotten deal, with Bernanke’s input. Geithner claims now it was the best he could negotiate at the time, even though he held all the cards and the bankers had none. The Truth is Geithner didn’t have the inclination, the skills or the backbone to stand up to Wall Street or Bernanke, from whom his marching orders surely came.
Barofsky’s report will not go down well for the Fed’s bid (supported by the Obama administration) to become Wall Street’s sole financial regulator.
Goldman Sachs, a huge recipient of these unnecessary counterparty payouts, something like $13.5 billion, also went on to receive billions in bailout money. Not long after these windfalls, they went on to post the largest quarterly profit in their history, and will pay out record bonuses this year-end. What did the taxpayers get? Taxpayers made out OK on the Goldman stock the government bought, but they still own hundreds of billions of Goldman’s toxic mortgage investments. And that market is not likely to come back soon, if ever.
I think we’ve had quite enough of the Fed’s benevolent protection.
Ron Paul has a bill before Congress to open the books on the secretive Fed for the first time. He has introduced this bill in one form or another many times before, but now the level of outrage is finally sufficient for the bill to get major bipartisan support. It just passed a major hurdle in the Senate banking committee, against stiff opposition from the Obama administration, and just about anyone connected with Wall Street or the Fed. The committee’s chairman, Barney Frank, a previous supporter of the bill, turned coat at the last moment.
Another bill in the Senate, rather than granting the Fed’s request for more regulatory power, would strip the Fed of most of the power it now has. In fact, Fed rage is boiling on Capitol Hill, even though the house just passed Bernanke’s reappointment 16-7.
In a piece published in the Washington Post, Bernanke blasts the measures, saying “they would seriously impair the prospects for economic and financial stability in the United States…Now more than ever, America needs a strong, nonpolitical and independent central bank with the tools to promote financial stability and to help steer our economy to recovery without inflation.” I would argue it was the Fed itself who seriously impaired the economy by cheering on, while a delusional mega-bubble was built on the Fed’s easy money policies. The Fed wants to steer the economy? They steered the economy off the road and now they want a bright shiny new car?
Bernanke’s pleas may fall on deaf ears. The voice of ordinary Americans, fed up with the Fed and Wall Street, is coming through loud and clear, even through the millions in campaign contributions Wall Street funnels toward Congress. The Fed quickly and enthusiastically reimbursed the wealthy for grossly mismanaged risk. For homeowners who mismanaged their mortgage risk, there has been little help. For the average innocent bystander with retirement savings in the stock market, there was nothing but contempt. There will be a price to be paid for that, as Bernanke will eventually find out. The Senate will probably also vote for reappointment, but may require something in return, like the Fed audit.
How Bernanke gets to be a hero for putting out fires the Fed itself started, is beyond me. The argument that the “fire” was decades of prosperity that got out of control due to unforeseen forces is a thin argument. Forensic analysis reveals nothing more than a pack of fools getting wildly wealthy building a house of cards with volatile financial schemes that could never work. Bernanke watched the residential sector go from $12 trillion to $22 trillion in 6 years and didn’t recognize it a dangerous bubble? The Fed was the sole regulator in charge of putting on the brakes by raising interest rates.
Never mind that. What about Bernanke and former Treasury Secretary Paulson committing securities fraud in the sale of Merrill Lynch to Bank of America? Bernanke and Paulson ordered Merrill CEO John Thain and BAC president Ken Lewis not to disclose Merrill’s real losses to shareholders until after the sale closed. BAC shares lost two thirds of their value once disclosure was made. That extent of malfeasance in high places should make Watergate look like a picnic. Plenty of eyebrows were raised but ultimately no one had the guts to go after them in the middle of an economic crisis. For more, read my blog post on the subject: http://ageofentitlement.wordpress.com/2009/06/
Time Magazine’s naming of Bernanke as “Man of the Year,” and various sycophants in government and media, gushing about how Bernanke “saved the world,” will only briefly forestall the judgment of history and the growing groundswell of Fed rage.
The Obama administration (and Bush before it),the Fed, the Treasury, and the Securities and Exchange Commission, peppered as they are with Wall Street alums, have miserably failed to protect us from being ravaged by the robber barons of today.
Brad Delong, Professor of Economics at UC Berkeley, who declared previously there was zero chance of the US slipping into a great depression, says now there is a chance. His reason? The government and financial regulatory institutions have squandered what little public trust they had. God help the person who tries to sell another bailout or stimulus to a wary and ticked-off public, even if it became desperately necessary in the event of a “double-dip” or new financial calamity. And there are an uncomfortable number of ticking time bombs out there, everyone knows what they are.
Nobel economist Paul Krugman concurs that this breakdown in public confidence could have serious consequences should future economic interventions become necessary. I agree with much of his thinking, even though I count him as a debt apologist. Krugman says a great depression or double-dip recession probably won’t happen, but a Japanese-style “lost decade” is more likely. He puts those odds at 50/50.
So, those of you who believe the financial system is fixed and recovery is happening, line up over here. The rest of us have a world to fix.
Doug Friesen 12/18/09
