We are in a bubble economy created by our plutocrats for their extraordinary profits. The Fed in its primary function of facilitating and managing instability has helped create this bubble with a 2.5 trillion money creation account hidden in depository institutions’ excess reserves. Our total nonfinancial debt has increased beyond our capacity to repay. And, bubbles burst.
December 23rd was the 100th birthday of the Fed. Congress as its supervising authority should once again review and amend the Fed’s systems and delegated authority.
Outline: Intro
Current stats
Economics theory 1A/1B
History - S&L crisis, GRs I, and GRs II
The Fed - protecting us from deflation and affordable housing
- Fed accounting
Predictions
Miscellaneous additional recommendations
Sources and Footnotes
Intro
The American economy is once again a bubble intentionally created by our plutocrats and their cronies. Our plutocrats are the flesh and blood people who own and operate our large corporations including banks. Corporate welfare is plutocrat welfare; corporatism is plutocracy. Our plutocrats want the instability that comes with bubbles to create opportunities for extraordinary profits. Normal profits from a job creating, sustainable, stable economy are simply insufficient. The Fed was created by our plutocrats not to provide stability but to facilitate and manage instability. The Fed now has 2.5 trillion in a money creation account hidden in excess reserve deposits. This magic money was/is used to purchase long term LT securities to keep LT interest rates artificially low and thereby facilitate the creation of another bubble economy.
Lower LT interest rates increase the value of bonds, increase the price earnings PE ratios in the stock market, and increase the price of housing by lowering mortgage interest. All these markets are now volatile bubbles. Their volatility was evident in the quick 100 basis point rise in LT rates resulting from Fed Chairman Bernanke’s May announcement on future tapering - in quantitative easing QE 3/4, the Fed’s current LT bonds purchasing programs.
Unnaturally low interest rates over extended periods negatively affect other areas not normally considered. Lower returns have contributed to growing deficits in our pension funds. Lower returns on insurance company investments have likely increased our insurance premiums. Low interest rates have encouraged our excessive borrowing…
Current stats
Total domestic, nonfinancial debt is 248% of GDP - 41,431.9 B in debt to 16,695.7 B in GDP (a). This is the highest or one of the highest debt/GDP ratios in our recorded history. We cannot service such indebtedness. Continued debt forgiveness with concomitant losses to creditors is unavoidable. This annual ratio has stayed above 247% since 2009 in spite of a growing GDP and a trillion dollar reduction in household mortgages with over four million foreclosures (b). Federal debt has seen the most growth, growing from 5.1 trillion in 2007 to 12 trillion at the end of September. Yet, all areas but household mortgages have increased debt. Note - this discussion is of nonfinancial debt and excludes financial debt such as debt the federal government owes itself in the Social Security trust funds.
Source: http://www.federalreserve.gov/... See the 12/09/2013 release pages 5 and 12.
Corporate debt increased 1,910.1 B from the end of 2009 to 9/2013. During the same period American corporations purchased 1,880 B in treasury stock per Birinyi and Bloomberg data (c). From a macro perspective, our corporations replaced 1.9 trillion in MV equity with 1.9 trillion in debt. It is true this increased current earnings per share and selling shareholders did well given rising, high stock values, but remaining shareholders received overvalued treasury stock and are stuck with excessive debt which will reduce future earnings when interest rates rise – more proof their treasury stock was overvalued.
Our debt will continue to be a drag on our economic growth. In the past we have inflated GDP to reduce our debt/GDP ratio and paid back our debt with inflated dollars. This may not be as acceptable to creditors as it was in the past.
Inflation – has been 1.2% over the last year well below the Fed’s latest general goal of 2.0%. The Fed is normally concerned with keeping inflation low but is currently, allegedly more concerned with the possibility of deflation.
Source: http://www.bls.gov/...
We’re not going to get cost push inflation from higher costs in our resource/factor markets until interest rates rise and, of more importance, labor costs rise. Though labor costs are shrinking as a percentage of national income, labor costs at 64% remain a much higher percent of national income than the cost of financial capital (d).
GDP gap – is the gap between a full employment GDP and the current GDP with current unemployment. Full employment is defined as an unavoidable 4% unemployment. November unemployment was reported at 7.0% and is in line with the Fed’s QE target, but this measure only counts people still looking for work and does not measure underemployment. We have been in an extended downturn. Labor market participation is near a 35 year low at 63.0%. I submit the current GDP gap is much more than the difference between 4% and 7% unemployment, and we need a full employment GDP to maximize our ability to pay our debts.
Source: http://www.bls.gov/... 12/06/2013 report
Economics theory 1A/1B
Free market – is a lie. We are a corrupt monopoly/ oligopoly capitalist system not a free competition capitalist system which would allow competitive effects to self regulate markets. The government regulation we most need is anti trust regulation to reestablish free competition by breaking up our monopolies/ oligopolies and the too big to fail. Competition is the only way markets can self regulate. Such self regulation would preempt the need for other more onerous, micro managing regulations.
Liquidity trap – In classical theory savings and investments always moved toward equilibrium. Given the correct interest rate, savings would equal investments. Keynes made the case that there was no such natural equilibrium. Savers and investors were different people with differing motivators. During down times savings would increase to cover future uncertainties. The trap was that increased savings/ liquidity was funded by decreased consumption spending which led to reduced economic activity with concomitant uncertainties leading to increased savings in a continuing, viscous circle.
Keynes reasoned that savings would lead to lower interest rates but not necessarily increased investment. Business investors must consider all costs and benefits in a business investment, not just interest rates, and during down times potential profits are low. Regardless of how much or how long the Fed lowers interest rates, low rates will not necessarily increase job-creating, business investment.
Keynes theorized a solution in which government could replace private business investment with public investment. Deficit spending could lead to increased economic activity in a beneficial circle which would eventually create increased taxes to pay off the deficit debt. It worked. Deficit spending helped make the bad times better. It also made the good times better leading to unending deficits and high debt. This outcome is not what Keynes intended. Keynes is not responsible for our fiscal irresponsibility.
Public investment, in spite of high debt, could still be used to stimulate our economy and meet long neglected public needs like our crumbling infrastructure. America needs value adding jobs more than we need transfer payments and plutocrat/ corporate welfare.
Wealth effect – is the increase in consumption spending attributable to the perception that one is wealthier. It is a double edged sword in that consumption spending will decrease from the perception one is poorer. There was a positive wealth effect from the increase in home prices before their peak in July 2006. There was a negative wealth effect from the drop in home prices after their peak. We now appear to have regained the net worth we lost in the great recession. (Source: 12/09 Z-1 release pages 113-115.) I submit this is bubble wealth. Our wealth was bubblicious before the Great Recessions GRs I, and it is bubblicious now before the Great Recessions GRs II. Just like our plutocrats, in order to recognize this bubble wealth, you will have to sell your bubble assets well before the GRs II.
History
Deregulation and regulatory forbearance have repeatedly lead to booms and busts in our real estate RE markets, but the only thing we learn from history is that we don’t learn from history.
Savings and Loan S&L Crisis
Deregulation in the early eighties gave new powers to S&Ls such as making commercial RE loans, making construction RE loans, selling mortgages, etc. S&L bankers and examiners had little experience in these areas and were ill equipped to manage them. This was followed by regulatory forbearance in that the Reagan administration refused to fund adequate numbers of FSLIC examiners to meet the needs of this fast growing industry and refused to fund their reeducation to deal with the industry’s expanded powers.
RE values went up then down creating selling and buying opportunities for those who were aware of what was happening. I did not assume this was a manipulation until it happened again.
Great Recessions GRs I
Deregulation and regulatory forbearance lead to another RE boom and bust.
The Glass-Steagall Acts of 1932/1933 separated commercial banks, investment banks, and stock brokers thus eliminating conflicts of interest and the potential for abusive self dealing. In 1999 Glass-Steagall was repealed. I was still working as a bank examiner at the time, and I remember thinking there must be people much smarter than me to calculate we would be better off without this legislation which had served us well for over 65 years.
Brooksley Born in 1998/1999, as chairperson of the Commodities Futures Trading Commission CFTC, lobbied to give the CFTC oversight authority over off-exchange, over-the-counter OTC markets for derivatives in addition to its authority over exchange-traded markets for derivatives. These OTC derivatives were known only to their counterparties and those counterparties’ regulators if any. There was no way to assess systemic risk. This systemic risk was made apparent in the 1998 collapse of Long Term Capital Management LTCM which had leveraged itself into an extreme risk position with the extensive use of unregulated OTC derivatives. Even their investors could not assess LTCM’s risk exposure.
Born’s position was opposed by other regulators and plutocrat cronies including Treasury Securities Rubin and Summers, Fed chairman Greenspan, SEC chairman Levitt, and Congress.
Congress in December 2000 passed the Commodities Futures Modernization Act CFMA within a FY 2001 appropriations bill. The CFMA legislation excluded financial derivatives including credit default swaps CDSs from supervision under the Commodities Enforcement Act. It reasserted and strengthened their exemption from state laws which could construe them to be gambling.
CDSs were used as insurance against defaulting securities, but while Insurers are precluded from underwriting policies for persons with no insurable interest in the subject property, naked CDS allow parties to have no interest in the contract referenced security. It’s a very sophisticated hedge or, more likely more often, plain and simple gambling. Naked CDSs made up as much as 80% of the CDSs market (e). Insured commercial banks and other “too big to fail” institutions should not have been allowed to use them to speculate/ gamble.
Deregulation combined with regulatory forbearance to facilitate a massive world wide securities fraud. Terrorism played a role in this forbearance. On 9/11 all SEC records in New York were eliminated with the destruction of WTC 7. More important, law enforcement resources were transferred from addressing corruption to addressing terrorism. Regulators allowed banks to securitize sub prime, liar loans into fraudulently AAA rated securities and their derivatives.
You could make the case bankers and others were not gambling in their use of CDSs because in fact they had rigged their games. It wasn’t gambling; it was stealing. SNL Financial reports America’s six largest banks have agreed to pay 65 billion in settlements related to their mortgages and the financial crisis. Further claims were projected to increase that figure to 85 billion. (11/02/2013 Economist p. 81) Bloomberg reported our six largest banks, between 1/2008 and 6/2013, paid 56 B in legal fees and 47 B to mortgage investors (12/8/2013 SDUT p.C3).
Just one indicative example was Abacus 2007-AC1. Investment bank Goldman Sachs colluded with John Paulson to create, sell, and bet against a synthetic collateralized debt obligation CDO Abacus-2007 AC1. The contract referenced securities in this transaction were intentionally picked to default. Goldman Sachs paid 550 million in settlements on this transaction but admitted no wrongdoing, and no one went to jail. Paulson made 1 billion from this transaction (f) and apparently suffered no legal consequences.
We are the most incarcerated country on earth. Though we are only 5% of the world’s population, we have 25% of the world’s prison population. There is room for victimless criminals like marijuana smokers, but no room for our plutocrats and their cronies who cheated the world of hundreds of billions.
Great Recessions GRs II
The lack of correct, adequate reregulation and, I believe, improper regulator interference has created another RE boom soon to be bust.
The repeal of Glass-Steagall allowed conflicts of interest and self dealing. During the run up to the GRs I, our bankers abused those conflicts of interest. Since the GRs I, the abuse continued. Our large banks are too large, have too much power in too many areas, are willing to abuse those powers, and are willing to collude in abusing those powers.
The following are a few indicative examples:
Banks which are supposed to compete with each other colluded to fix the Japanese benchmark rate, Euribor, and Libor. Bloomberg News reported global fines had totaled 6 billion by 12/4 (g).
JP Morgan, the country’s largest deposit bank, paid a settlement of 410 M to FERC for Enron style manipulation of energy prices. In 2003 an exemption was passed which allows Wall Street banks to enter into transactions in physical commodities that are complementary to their financial activities (8/17/2013 Economist p.59).
I submit we don’t need feel good PR in an unnecessary, new consumer protection agency or a thousand pages of regulations and interpretations on the Volcker rule prohibiting banks from proprietary trading. We need to reestablish and enforce Glass-Steagall and anti-trust regulations. We are micro managing when we should be macro managing.
The Fed - protecting us from deflation and affordable housing
Fed management states it has kept interest rates low to stimulate the economy and stop deflation. As noted above, this will not necessarily increase business investment. It has been temporarily successful in fighting deflation given the rise in our bond, stock, and homes markets. But, if as I believe we are in a bubble, then the coming GRs II will eliminate this temporary success. I believe Fed management is aware of these points and is pursuing other purposes.
The S&P Case-Shiller US national home price index was 100 in 3/2000, 189.93 in 6/2006 peak, 124.20 in 3/2012 low, and 150.92 in 9/2013. The homes market peaked nationally in July 2006. It then dropped dramatically reaching a market low in early 2012 but that low was still much higher than the homes market in 2000. The homes market in 2000 was not deflationary, and the homes market at the 2012 low was also not deflationary. Source: http://us.spindices.com/...
The unnatural state of our homes market is apparent in the fact that 42% of all residential sales in November were to buyers who paid cash – investors/ speculators (h). They’re bidding up the prices of our homes; they’re blowing bubbles.
There has been a campaign to get people to refinance their homes at lower rates to help keep them in their homes. All the reporting about refinancing never mentions that once you refinance you cannot use your state’s anti deficiency laws. Most states prohibit creditors from pursuing borrowers personally for deficiency balances in foreclosures on purchase money mortgages. Creditors can only move against the collateral. Once you refinance, you become personally liable for your loan beyond the value of your collateral. When this bubble bursts, refinanced borrowers will not be able to walk away from their mortgages on underwater homes and escape personal liability.
California changed its laws in January 2013 to allow anti deficiency laws to apply to the portion of a refinancing used to pay off a prior, purchase money mortgage, but this law is not retroactive.
Whether the price of your home is 1 million or 200,000, you still need a home to live in. You must sell your home to recognize an increase in value. I submit higher home prices do not increase our standard of living if we simply stay in our homes, and certainly reduces the standard of living of new buyers and indirectly increases rents, reducing living standards of renters.
Federal Reserve Accounting
12/31/2012 Federal Reserve Combined Financial Statement
Depository Institutions 1,491,045 M
Footnote m. Deposits, Depository Institutions
Depository institutions’ deposits represent the reserve and service-related balances, such as required clearing balances, in the accounts that depository institutions hold at the Reserve Banks. The interest rates paid on required reserve balances and excess balances are determined by the Board of Governors, based on an FOMC-established target range for the federal funds rate. Interest payable is reported as a component of “Interest payable to depository institutions” in the Combined Statements of Condition.
Source: http://federalreserve.gov/...
See pages 5 and 16.
Never before in accounting history, has so much money been explained by so few words. And, I believe it’s a lie. Most of this account balance is not reserve balances.
We are supposed to believe, as of 12/11/2013, institutions have left 2.5 trillion in excess reserves at the Fed to be paid 25 basis points interest. And, excess reserves increase by 85 billion every month paid the same 25 basis points interest. Further, would not short term rates rise if 2.5 trillion in funds were taken out of circulation in excess reserve deposits?
Source: http://federalreserve.gov/...
I offer the following estimate as an alternative accounting. It is oversimplified and not accurate, but it is certainly more accurate than the Fed’s disclosed accounting:
12/31/2012 Institutions’ Deposits (M) -Debits Credits
Required Reserves 60,000
Excess Reserves 447,541
Money Creation Account 1,712,327
Money Elimination Account -728,823
Total 1,491,045
Required reserves were estimated to be 60 billion. Gross required reserves for the two weeks ended 1/9/2013 were 114 billion from which we can subtract eligible vault cash of 54 billion. See 1/10/2013 Fed Report H.3 (502). Note – Total institutions’ deposits were 21 billion in 1951 and 19 billion in 2006.
Excess reserves were 447,451 M equal to 507,541 M in total reserves less 60,000 M in estimated required reserves.
Right or wrong the source for the 507,541 M:
http://federalreserve.gov/...
Money creation account balance was 1,712,327 M equal to total securities of 2,838,988 M less Federal Reserve notes in circulation of 1,126,661 M.
Money elimination account balance was -728,823 M equal to the combination of 447,451 M offsetting excess reserves plus 281,282 offsetting funds primarily from sources outside of institutions’ deposits.
I do not believe the Fed would subject itself to the interest rate risk involved with funding trillions in long term assets with trillions in short term funds – ergo the need for the money elimination account. If as I believe LT assets are not funded by reserve deposits, whatever happens to the future level of reserves is irrelevant. The Fed is still subject to interest rate risk in that LT securities will depreciate as LT interest rates rise. The Fed has stated it will not sell its mortgage backed securities, if so, their depreciation will be irrelevant. The Fed will still have more than enough interest earnings to fund its operations and continue to refund unspent interest earnings to the Treasury.
One way or another, these accounts are manipulated. If the public and Congress understood the magic used to create money the Fed uses to purchase LT securities, they would lose whatever faith they may still have in the Fed.
Predictions: Our next, wholly avoidable crises will arrive in late spring/early summer. Look for significant events on or around 5/22/2014.
Fed QE 3/4 tapering is set to begin in January with a mere 10 B reduction in securities purchases. The longer they extend tapering, the larger will be the financial collapse.
• Fed Taper Day, December 18th, was the beginning of the end. The bond, stock, and then home market bubbles will begin to collapse into the Great Recessions II.
The troop level in Afghanistan is projected to be down to 34,000 by the end of February 2014 as promised by Obama in his 2013 State of the Union Address. Long term plans call for force levels to drop to between 20,000 and 10,000 in 2014. April 5, 2014 is the next presidential election in Afghanistan.
• Karzai or the new President will sign a status of forces agreement with the US.
• Force levels will stay around 30,000 as they were during the Bush years for possible use in Iran and to protect illegal drug profits. The UN Office on Drugs and Crime 2008 report showed the potential metric tonnage of Afghan opium production rose from 185 metric tons during its ban in 2001 to 8,200 metric tons in 2007. UNODC 2013 report showed potential metric tonnage at 5,500. 80% of drug profits are made in the country of consumption i.e. America. The loss of these profits would hurt our plutocrats and deepen our recession. (i)
The end of April will be the end of nine months of peace negotiations between Israel and Palestine.
• Negotiations will end without a final agreement. The collaboration will continue between greater Palestine terrorists and greater Israel Zionists. Terror and occupation will continue to rationalize each other.
• Israel/Palestine will explode in violence. The UN will recognize Palestine without borders as a full member state by the end of 2015.
• Terror threats against the US will skyrocket with a concomitant negative effect on markets.
The end of May will be the end of the initial six months delineated in the interim, nuclear agreement with Iran. Iran will have had another six months to comply with International demands and will be deemed just months away from the capability of producing a nuclear device.
• Congress will push for war. Our war plutocrats and their cronies will attempt to sell the war as an economic necessity. WWII brought us out of the depression, but given our current high debt, this war would deepen the coming recession.
Full disclosure – Given the extraordinary rise in home prices in the early 2000s, I predicted a negative wealth effect from a bursting bubble home market would result in a recession in the spring 2004 then the spring 2005. I was several years premature.
Additional miscellaneous recommendations
Refinance our short term ST nonfinancial federal debt into 20/30 year maturity bonds before LT rates skyrocket.
End our war economy by any just means necessary.
Stop aggressor Americans from unnecessarily killing tens of thousands of Iranians as they/we killed hundreds of thousands of Iraqis.
Support a military option against those who support an Iran military option.
Next war, civil war – Prepare for a war to end all America’s unjust wars.
Corruption - Reestablish honesty, integrity, and trust in American business and financial markets. As recently made evident, markets cannot function in their absence. I suspect during the Lehman Bros 2008 Panic, banks would not lend to each other for fear that other banks were as dishonest as they were. Don’t bail ‘em, jail ‘em.
We must all stand up to the corruption in our individual lives and workplaces. Risk your job or risk your country.
Employment - If you are receiving transfer payments such as welfare, unemployment, or social security, and you are either able bodied or able minded, recognize an obligation to work part time as a volunteer. We all need to help reestablish a sustainable, stable economy.
If your job is not adding value, get a new job.
Do Good.
Raise the federal minimum wage to $10/ hour 50% of average hourly wage of nonsupervisory personnel at $20.31/ hour. This is also in a reasonable 40-45% of national average hourly wage at $24.15/ hour. Such a raise would reduce these workers need for aid, increase consumption spending given these workers high propensity to consume, and would moderately help fight deflation. Source: http://www.bls.gov/... 12/06/2013 report
Keep a six months supply, no more no less, of gin and tonic for the coming hard times. If you keep less, you may be overcome by depression. If you keep more, you may think you have enough to drink yourself to death - and then attempt to do so.
Sources and Footnotes:
Primary sources: The Economist magazine, San Diego Union Tribune SDUT, www.wikipedia.com, www.federalreserve.gov, www.bls.gov
http://www.federalreserve.gov/... See the 12/09/2013 Z-1 statistical release.
(a) The GDP figure used was the average annualized figures for the first three quarters of 2013 from the 12/09/2013 Z-1 release. Gross domestic product GDP indicates our capacity to service our debt. It is the market value of the products and services produced in one year in our product markets. The flip side of this figure is what our producers pay for labor and financial capital in our resource/factor markets. GDP in the product markets roughly equals national income and fixed capital consumption in the resource/ factor markets.
(b) 9/16/2012 SDUT p.C1 from Nation’s Housing article by Kenneth Harney – “1.2 million families across the country are now at some stage of foreclosure, 3.8 million homeowners have been foreclosed upon since September 2008…” This was in September 2012.
(c) Bloomberg News in the 12/17/2013 SDUT p. C4 and the 12/09 Z-1.
(d) Source: 11/2/2013 Economist p.12. The 12/9 Z-1 release p.13 shows 3rd quarter annualized compensation of employees/ national income was 60.9%, 8,889.1 B/ 14,596.7 B. I maintain a portion of proprietors’ income is compensation for proprietors’ labor. See also footnote (a).
(e) http://www.bloomberg.com/... 7/24/2009 article “Banning Naked Default Swaps…” As much as 80 percent of the credit-default swap market is traded by firms that don’t own the underlying debt, Eric Dinallo, the former superintendent of the New York State Insurance Department, estimated in a January (2009) interview.
(f) http://www.sec.gov/... p.3
(g) 12/05/2013 SDUT p.C4 from Washington Post article by Danielle Douglas
(h) 12/29/2013 SDUT p.C1 from Nation’s Housing article by Kenneth Harney
(i) Sources: American War Machine by Peter Dale Scott p.227 and p. 235 and http://www.unodc.org/...