posted April 19, 2018
Book Review of Jack Rasmus, ‘Systemic Fragility in the Global Economy’, Clarity Press, 2016

SYSTEMIC FRAGILITY IN THE GLOBAL ECONOMY
BY DR. JACK RASMUS
Institute for Critical Thought (ICT), Beijing, China

INTRODUCTION

Most major monetary, fiscal, and macroeconomic economists, and financial institution and capital market experts agree, the global economy and financial system is more systemically fragile than ever before: $10 trillion bank NPLs, $13 trillion Negative Interest Rate Policy (NIRP), rotating financial bubbles – China (private loans $30 trillion), and $152 trillion global debt ($100 trillion private) – 225% GDP.

According to Dr. Rasmus, Global Financial Fragility (FF) is positively related to: total financial asset investment in the system, and with interest rate maturity optimization, elasticity of inside (shadow banking) credit, and available income to service total debt levels; with inflation expectations to the change in total debt levels; with credit default and reinvestment risk; and with fiscal and monetary government subsidies, support, credit facilities, QE, bailouts, etc. (See Appendix).

Financial instability in the global system is reflected in: dueling QEs and currency wars, trouble with large systemic banks (Italian/Deutsche), government and corporate bond bubbles, emerging markets dollarization of corporate debt/liabilities, oil and commodity deflation, energy junk bonds, massive flows into ETFs and U.S. equity markets, flash crashes and high speed trading systems, on-line and peer-to-pear shadow banking-lending networks, Yuan/U.S. dollar devaluation-revaluation-appreciation-depreciation volatilities, BREXIT, EU Entropy, U.S. populous election outcomes, South China Sea aggression, global GDP and trade volume secular downward decline, CAPEX under investment, labor productivity collapse, real wage-income decline-stagnation, commodity goods deflation, etc.

Dr. Jack Rasmus book, “Systemic Fragility in the Global Economy” is another example of the continuing growth of literature showing how fragile the global economic and financial system really is. Dr. Rasmus builds a methodical case of the systematic fragility of the global financial-economic system, and how current central bank economic ideologies and orthodoxy have been deficient and unorthodox.

Their financial-real cycle analysis is poor, their reliance on the Phillips Curve as a policy rule is flawed, they have a linearity bias, measurements of debt-income feedback effects are underdeveloped, they have a misunderstanding of financial asset price determination, their models are missing finance transmission mechanisms, etc.

Their policies have made matters worse, by driving the cost of capital to zero (negative), replacing real assets for financial assets, printing trillions to bail out and purchase bad debt and defective financial products, allowing massive leakage of capital to flow unregulated (shadow banking) across globe platforms, etc.; and all with no real affect on real economic growth, wage growth, labor participation rates, inflation rates, and more importantly standards of living or social welfare.

OVERVIEW

The first part of the book is an overview of the five major economies as of 2016; the second part addresses the nine major variables that drive systematic fragility.

These factors are the definition of fragility:

1) The relationship between debt (levels, rates of change, etc.),
2) The ability to service debt (forms of income and price as a determinant of income),
3) Terms and conditions of debt servicing (covenants and term structure of rates).

Dr. Rasmus defines fragility as: the mutual inter-determination of these three variables; moreover, the variables function within the three main sectors of the economy: household consumption, business (financial and non-financial), and government sector.

The debt-income-terms of servicing, mutually determine each other within the three sectors. The three sectors are also mutually determinative of each other; there are feedback effects between the three sectors, as well as within them.

Fragility is measured as a quantitative index variable. By producing a leading index of fragility, it can forecast imminent systemic instability events. A time series (cross-section, factor analysis, data mining, simultaneous equation) regression analysis is needed of all nine (three within each of the three sectors) to determine the weights, and causal interactions. This can be done via machine learning (AI) and neural network analysis. This work is being prepared, and is ‘a work in progress’.

OUTLINE

In the first part of the book, Chapters 1 -to- 6, are an overview of the degree of fragility as of 2016, in the major economies: Europe, Japan, China, Emerging Markets, and U.S.; and Chapters 7 -to- 15 are a consideration of the main drivers of financial instability: slowing investment and deflation, explosion of money-credit-debt, shift to financial assets and restructuring of financial markets, structural change in labor markets, and central bank and government fragility, the key being the change in financial structure and investment.

The third part of the book, Chapters 16 -to- 18, is a critique of mainstream economics, Keynsian and Classical economic theory, Marxist and Minskyan economics, and the failure of these theories to address financial variables in post-modern macroeconomic-monetary policy theory, models and analyses.

In Chapter 19, Dr. Rasmus, offers his own Theory of Systematic Fragility, as of 2016; where it is Central bankers and massive liquidity injections that are fundamental originating causes of systemic fragility, but these alone do not completely explain fragility.

Stagnation and Instability in the Global Economy

In the U.S., China, Japan, Europe there is a coordinated effort to correct the failures of capitalism (under investment, employment, consumption, price stability, etc.), and the response by all central banks have been the same, a constant injection of massive amounts (trillions of U.S. Dollars, Yen, Euros, Pounds, Yuan, Peso, Rubble, etc.) of liquidity (credit) to back-stop, set a support, and prop up asset prices.

However, this leads to asset price bubbles and asset price collapse (financial/currency crisis/stagnation/deflation/under employment-investment), crisis more frequent since 1995 (Peso Crisis, Thai Baht, Russian Default, Y2K/911, Housing Bubble, Financial Crisis, etc.), and global central bankers (governments) now do not have the balance sheets to deal with future crisis; and have not fixed the real problem underlying the economy, they have only created a monetary illusion of policy effectiveness: dead-cat bounce recoveries, emerging market currency collapse, Japanese perpetual recessions, Europe’s stagnation, and China’s asset price hyper-inflation and debt crisis.

The perfect example of this financial-economic fragility is Japan.

Japan’ Perpetual Recession

Over the last 17 years (1990 – 2017), the Bank of Japan (BOJ) implemented aggressive forms of unorthodox monetary policy (Negative – Nominal/Real – Interest Rate Policy/Quantitative Easing): printing massive amounts of money, buying massive amounts of sovereign-corporate (infrastructure) bonds, driving bonds yields negative, and driving domestic investors/savers (negative effective rates), and financial institutions (disintermediation), literally crazy.

Japan will be the ultimate experiment in monetary-fiscal policy mistakes, as they will have to resort to even more extreme measures to try to get themselves out of their existential structural crisis. The ultimate fiscal-monetary response could be, with unintended political-economic-cultural consequences, from a massive and coordinated debt forgiveness, by both fiscal/monetary authorities, is unknown and untested in modern monetary history.

Japan is extremely fragile, as at some point they will not have the tax revenues to service the sovereign debt payments, and will theoretically fall into default, and will ask for forgiveness, not from bond holders, but from the BOJ, that owns the majority of the debt.
Not only is Japan’s economy and financial system extremely fragile, but so is Europe.

Europe’s Chronic Stagnation

The actual European Central Bank (ECB) structure (dominated by Germany – Bundesbank) is a major impediment in its ability to respond to current crisis: fiscal austerity, inability to devalue the Euro, fear of hyper-inflationary trends, and misspecification of monetary policy targets (inflation, productivity, employment, wages, and exchange rates).

Poor performance (contagion), bank crisis (runs on banks), social unrest (extreme right-wing populism), massive debt issuance, and deflation (liquidity trap/collapse of money velocity) is the costly (stagnation) result of policy mistakes. This – along with the lack and hesitant response to bank runs in Spain-Greece-other EU countries – has had a significant negative impact on ECB independence and credibility, in regards to the ability to respond to future financial and economic crisis.

Not only is Europe’s economy and financial system extremely fragile, but so is China.

China: Bubbles, Bubbles, Debt and Troubles

The Asian Contagion of the late 1990s required massive bank and corporate bailouts (recapitalizations). The 2000s, witnessed a modernization of the Peoples Bank of China (PBOC), as a central banking institution through banking reforms, conversion of State Owned Entities (SOEs) to private-public firms (privatization toward a more Japanese Keiretsu system), pushing for more export-oriented policies (higher-value commodities-services), and larger government sponsored infrastructure projects (commercial-residential-dams-roads-power plants, etc.).

Excessive industrial and monetary policy is unsustainable, and will have significant negative externalities on the global economy. The next financial crisis, in China, will come from the excessive extension of credit from both fiscal and monetary authorities, and will come from government and corporate bond market defaults, as the system is severely over-leveraged. China is using more and more debt to fix bad debt problems, and the simulative multiplier-accelerator effect on the economy is deteriorating (decelerating) quickly.
Systematic fragility is not only experienced at the microeconomic (country/market) level, but manifests at the macroeconomic (systemic/systematic/institutional) level.

Trends in Systematic Fragility

Systematic fragility is made up of financial, consumption and government fragility; and intra-sector fragility, is caused by debt levels (rate of change), income (servicing of debt), and terms and conditions of servicing of debt. Transmission mechanisms between these factors and sectors are price systems (financial/commodity), government policy (monetary/fiscal), and psychological expectations (investors/consumers).

What is important, is fundamental forces and enabling factors driving fragility are: the end of Bretton Woods, central bank managed float systems, ending of international capital controls, the liquidity explosion, debt escalation, financial asset investment shift, and the rise of the new global finance capital elite; and financial deregulation, global digital-network technology, financial engineering (derivatives) revolution, highly liquid financial markets, financial restructuring and emergence of the shadow banking system.

Globalization, technologicalization and deregulation/integration is accelerating capital flows and accumulation, and concentration of capital to targeted and non-targeted markets across the world, fundamentally restructuring markets and institutions. This process is continuing at a rapid pace, and depending on the recipients, is economically, financially and politically (institutionally) destabilizing, destructing and deconstructing liberal-democratic-capitalism.

Financial product innovation and advancements in the use of technology for trading purposes, is accelerating the shift from real to financial asset investment – and with the rise of global equity, debt, and derivative markets – is changing the institutional structure, and exacerbating the fragility and instability, of the global financial system.

Central Banks and Fragility

Central banks bailed out the private banking system, and will again – along with other strategic affiliated institutions, corporations, businesses and brokerages – by printing massive amounts of fiat currency (seigniorage), to buy (defective/defaulted) securities product (derivatives), accumulate more sovereign-corporate-personal debt, with even more crowding out effects, and with no real eventual long-term impacts on real economic growth, wages, and productivity; and social welfare or standards of living.
Only asset prices bubbles and a massive redistribution and concentration of wealth will occur. Global capital markets, financial institutions, governments, businesses, and consumers are sitting on an extremely fragile system. This is obvious when looking at the level of government debt, service.

Government Debt and Government Fragility

It is estimated, between the U.S Federal Reserve Bank, Bank of England, and European Central Bank, $15 trillion direct liquidity injections, loans, guarantees, tax reductions, direct subsidies, etc. have been used. If you add in China and Japan, the total gets to as high as $25 trillion, and if you add in other emerging country (Asian, Latin America, and Middle-East) central banks, the total gets as high $40 trillion. Add in inter-temporal substitution (opportunity costs) over 40 years, we are looking at hundreds of trillions of debt, and debt service.

What perpetuates this reliance on debt, and debt service, is the misconception of valid economic theory and analysis, and its real application.

Failed Conceptual Frameworks of Contemporary Economic Analysis

It is obvious, global monetary and fiscal policy responses have made the global financial and economic system even more fragile, and eventually insolvent and bankrupt, and modern central banking is ineffective and has put us into a perpetual liquidity trap, the velocity of money has collapsed. There is no money going into real long-term (capital budgets) assets, only short-term financial assets (equity, fixed-income, ETFs, derivatives, structured products, crypto-currencies, etc.).

This has led us into the contradiction of macroeconomic theory, monetary policy and central banking: liquidity-debt-insolvency nexus, the moral (immoral) hazard of perpetual bail-outs, growing concentration of wealth at the extremes, growing perception that Negative/Zero Interest Rate Policy (N/ZIRP) can fix under-investment in capital (human/physical) and deflationary (disinflationary) trends, and that current banking regulation-supervision is bad for the economy, financial services (institutions) industry, and for institutional and retail investors (savers) in the long run.

And unfortunately, these techniques and tools have been used by other Global Central Governments and Banks (BOJ/ECB/BOE/PBOC), with similar, disastrous, and disappointing outcomes. The focus is on saving the financial institutional system in the short-run, using extreme and un-orthodox monetary policies (tools), with a lack of concern or understanding of long-run economic, social, cultural, and political consequences and outcomes. This is the true reflection, of failed conceptual frameworks, of contemporary economic analysis.

A Theory and Application of Systematic Fragility

Dr. Rasmus presents a true theory (model), of Systematic Fragility, a proxy for instability, a measure and quantitative score, used to forecast financial instability events, measuring pre-post-crash-recession cycle phases, it is a simultaneous equation-solution, the weights and factors are non-linear relationships, and are determined through the use of machine-learning (AI) algorithms, that adjust the factors, equations, and outcomes in real (continuous) time.

For example, over the last 10 years, the Fed accumulated over $4.5 trillion in bank reserves/balance sheet (bonds), made up mostly of mortgage backed securities and U.S. government Treasury notes and bonds, the average size of the balance sheet prior to the financial crisis was $500-to-$800 billion. Since these were mainly reserves creation, and an addition to the monetary base, and not really the money supply, the policy effects (QE/(Zero-Negative Real Interest Rate policy) have been mute.

The real cause of deficient real-macroeconomic performance, is a collapse in the velocity of money, driven by alternative forms of money creation and flows across the globe (cryptic-digital currencies-shadow banking, etc.); the lack of fiscal labor market policy to lower under-employment and raise labor market participation rates; and resolve to solve other social, cultural, political and economic disruptions. Making it now impossible to conduct monetary policy.

With the U.S. fiscal debt totaling over $22 trillion (interest payments +$1.0 trillion per year), the Feds Balance Sheet totaling $4.3 trillion, the potential for continued -perpetual war (defense spending) and entitlement expenditures, and political and policy uncertainty (next Federal Reserve President) there is little room for monetary and fiscal solutions to fight the next financial and economic crisis.

Neoliberal new-classical macroeconomic theory is flawed, at best, as it relies on the primacy of central bank monetary policy, tax structure shifts, free trade theory, running of twin deficit systems, allows for major labor market restructuring, leading to wage compression, drives toward privatization of public goods and institutions, and fiscal austerity, and financialization-fiscalization of elites, institutions and products.

CONCLUSIONS

Most major monetary, fiscal, and macroeconomic economists, and financial institution and capital market experts agree, the global economy and financial system is more systemically fragile than ever before.

According to Dr. Rasmus, shows us that global Financial Fragility (FF) is positively related to total financial asset investment in the system, and with interest rate maturity optimization, elasticity of inside (shadow bank) credit, and available income to total debt levels; with inflation expectations to change in total debt levels; with credit default and reinvestment risk; and with fiscal and monetary government subsidies, support, credit facilities, QE, bailouts, etc. (See Appendix).

Government policies have made matters worse, by driving the cost of capital to zero (negative), replacing real assets for financial assets, printing trillions to bail-out and purchase bad debt and defective financial products, allowing massive leakage of capital to flow unregulated (shadow banking) across the globe, etc.; all with no real effect on real economic growth, wage growth, labor participation, inflation, standards of living or social welfare.

These failures and fragility are reflected in increased volatility in social and economic indicators, capital market pricing and investment risk, and resulting reductions risk-adjusted returns, inefficient allocation investment capital and resources, and falling employment and real income growth rates, standards of living and overall social welfare.

The conclusion, if this system of unorthodoxy continues – and I believe it is too late to address the systemic and systematic risks associated with the economy, government, and central banking – exposes the economy, financial institutions and capital markets, to failure, again, at an ever higher social price.

The reality is our economic and financial system are extremely fragile, and we are facing ever higher systematic-systemic credit default (illiquidity) risk, and another severe financial crisis, great recession and depression, as our tools and system are ineffective and broken.

By Dr. Larry Souza
April 1, 2018
Dr. Souza has 27 years of experience in commercial and residential real estate economic research; and is Real Estate, Financial and Investment Economist for: Pillar6 Advisors, LLC; Johnson Souza Group, Inc.; CapitalBrain.co, and GreenSparc. Dr. Souza holds degrees in: accounting, finance, economics, public administration, information systems and political science; and Doctorate in Business Administration (DBA) with a concentration in Corporate Finance, and his dissertation is titled: Modern Real Estate Portfolio Management (MREPM): Applications in Modern (MREPT) and Post-Modern (PMREPT) Real Estate Portfolio Theory. He has been teaching college level finance, economics and real estate courses for the past 22 years, and is currently a full-time adjunct professor in the School of Economics and Business Administration (SEBA) at Saint Mary’s College (SMC) of California.

posted April 19, 2018
Book Review of Jack Rasmus, ‘Systemic Fragility in the Global Economy’, Clarity Press, 2016

SYSTEMIC FRAGILITY IN THE GLOBAL ECONOMY
BY DR. JACK RASMUS
Institute for Critical Thought (ICT), Beijing, China

INTRODUCTION

Most major monetary, fiscal, and macroeconomic economists, and financial institution and capital market experts agree, the global economy and financial system is more systemically fragile than ever before: $10 trillion bank NPLs, $13 trillion Negative Interest Rate Policy (NIRP), rotating financial bubbles – China (private loans $30 trillion), and $152 trillion global debt ($100 trillion private) – 225% GDP.

According to Dr. Rasmus, Global Financial Fragility (FF) is positively related to: total financial asset investment in the system, and with interest rate maturity optimization, elasticity of inside (shadow banking) credit, and available income to service total debt levels; with inflation expectations to the change in total debt levels; with credit default and reinvestment risk; and with fiscal and monetary government subsidies, support, credit facilities, QE, bailouts, etc. (See Appendix).

Financial instability in the global system is reflected in: dueling QEs and currency wars, trouble with large systemic banks (Italian/Deutsche), government and corporate bond bubbles, emerging markets dollarization of corporate debt/liabilities, oil and commodity deflation, energy junk bonds, massive flows into ETFs and U.S. equity markets, flash crashes and high speed trading systems, on-line and peer-to-pear shadow banking-lending networks, Yuan/U.S. dollar devaluation-revaluation-appreciation-depreciation volatilities, BREXIT, EU Entropy, U.S. populous election outcomes, South China Sea aggression, global GDP and trade volume secular downward decline, CAPEX under investment, labor productivity collapse, real wage-income decline-stagnation, commodity goods deflation, etc.

Dr. Jack Rasmus book, “Systemic Fragility in the Global Economy” is another example of the continuing growth of literature showing how fragile the global economic and financial system really is. Dr. Rasmus builds a methodical case of the systematic fragility of the global financial-economic system, and how current central bank economic ideologies and orthodoxy have been deficient and unorthodox.

Their financial-real cycle analysis is poor, their reliance on the Phillips Curve as a policy rule is flawed, they have a linearity bias, measurements of debt-income feedback effects are underdeveloped, they have a misunderstanding of financial asset price determination, their models are missing finance transmission mechanisms, etc.

Their policies have made matters worse, by driving the cost of capital to zero (negative), replacing real assets for financial assets, printing trillions to bail out and purchase bad debt and defective financial products, allowing massive leakage of capital to flow unregulated (shadow banking) across globe platforms, etc.; and all with no real affect on real economic growth, wage growth, labor participation rates, inflation rates, and more importantly standards of living or social welfare.

OVERVIEW

The first part of the book is an overview of the five major economies as of 2016; the second part addresses the nine major variables that drive systematic fragility.

These factors are the definition of fragility:

1) The relationship between debt (levels, rates of change, etc.),
2) The ability to service debt (forms of income and price as a determinant of income),
3) Terms and conditions of debt servicing (covenants and term structure of rates).

Dr. Rasmus defines fragility as: the mutual inter-determination of these three variables; moreover, the variables function within the three main sectors of the economy: household consumption, business (financial and non-financial), and government sector.

The debt-income-terms of servicing, mutually determine each other within the three sectors. The three sectors are also mutually determinative of each other; there are feedback effects between the three sectors, as well as within them.

Fragility is measured as a quantitative index variable. By producing a leading index of fragility, it can forecast imminent systemic instability events. A time series (cross-section, factor analysis, data mining, simultaneous equation) regression analysis is needed of all nine (three within each of the three sectors) to determine the weights, and causal interactions. This can be done via machine learning (AI) and neural network analysis. This work is being prepared, and is ‘a work in progress’.

OUTLINE

In the first part of the book, Chapters 1 -to- 6, are an overview of the degree of fragility as of 2016, in the major economies: Europe, Japan, China, Emerging Markets, and U.S.; and Chapters 7 -to- 15 are a consideration of the main drivers of financial instability: slowing investment and deflation, explosion of money-credit-debt, shift to financial assets and restructuring of financial markets, structural change in labor markets, and central bank and government fragility, the key being the change in financial structure and investment.

The third part of the book, Chapters 16 -to- 18, is a critique of mainstream economics, Keynsian and Classical economic theory, Marxist and Minskyan economics, and the failure of these theories to address financial variables in post-modern macroeconomic-monetary policy theory, models and analyses.

In Chapter 19, Dr. Rasmus, offers his own Theory of Systematic Fragility, as of 2016; where it is Central bankers and massive liquidity injections that are fundamental originating causes of systemic fragility, but these alone do not completely explain fragility.

Stagnation and Instability in the Global Economy

In the U.S., China, Japan, Europe there is a coordinated effort to correct the failures of capitalism (under investment, employment, consumption, price stability, etc.), and the response by all central banks have been the same, a constant injection of massive amounts (trillions of U.S. Dollars, Yen, Euros, Pounds, Yuan, Peso, Rubble, etc.) of liquidity (credit) to back-stop, set a support, and prop up asset prices.

However, this leads to asset price bubbles and asset price collapse (financial/currency crisis/stagnation/deflation/under employment-investment), crisis more frequent since 1995 (Peso Crisis, Thai Baht, Russian Default, Y2K/911, Housing Bubble, Financial Crisis, etc.), and global central bankers (governments) now do not have the balance sheets to deal with future crisis; and have not fixed the real problem underlying the economy, they have only created a monetary illusion of policy effectiveness: dead-cat bounce recoveries, emerging market currency collapse, Japanese perpetual recessions, Europe’s stagnation, and China’s asset price hyper-inflation and debt crisis.

The perfect example of this financial-economic fragility is Japan.

Japan’ Perpetual Recession

Over the last 17 years (1990 – 2017), the Bank of Japan (BOJ) implemented aggressive forms of unorthodox monetary policy (Negative – Nominal/Real – Interest Rate Policy/Quantitative Easing): printing massive amounts of money, buying massive amounts of sovereign-corporate (infrastructure) bonds, driving bonds yields negative, and driving domestic investors/savers (negative effective rates), and financial institutions (disintermediation), literally crazy.

Japan will be the ultimate experiment in monetary-fiscal policy mistakes, as they will have to resort to even more extreme measures to try to get themselves out of their existential structural crisis. The ultimate fiscal-monetary response could be, with unintended political-economic-cultural consequences, from a massive and coordinated debt forgiveness, by both fiscal/monetary authorities, is unknown and untested in modern monetary history.

Japan is extremely fragile, as at some point they will not have the tax revenues to service the sovereign debt payments, and will theoretically fall into default, and will ask for forgiveness, not from bond holders, but from the BOJ, that owns the majority of the debt.
Not only is Japan’s economy and financial system extremely fragile, but so is Europe.

Europe’s Chronic Stagnation

The actual European Central Bank (ECB) structure (dominated by Germany – Bundesbank) is a major impediment in its ability to respond to current crisis: fiscal austerity, inability to devalue the Euro, fear of hyper-inflationary trends, and misspecification of monetary policy targets (inflation, productivity, employment, wages, and exchange rates).

Poor performance (contagion), bank crisis (runs on banks), social unrest (extreme right-wing populism), massive debt issuance, and deflation (liquidity trap/collapse of money velocity) is the costly (stagnation) result of policy mistakes. This – along with the lack and hesitant response to bank runs in Spain-Greece-other EU countries – has had a significant negative impact on ECB independence and credibility, in regards to the ability to respond to future financial and economic crisis.

Not only is Europe’s economy and financial system extremely fragile, but so is China.

China: Bubbles, Bubbles, Debt and Troubles

The Asian Contagion of the late 1990s required massive bank and corporate bailouts (recapitalizations). The 2000s, witnessed a modernization of the Peoples Bank of China (PBOC), as a central banking institution through banking reforms, conversion of State Owned Entities (SOEs) to private-public firms (privatization toward a more Japanese Keiretsu system), pushing for more export-oriented policies (higher-value commodities-services), and larger government sponsored infrastructure projects (commercial-residential-dams-roads-power plants, etc.).

Excessive industrial and monetary policy is unsustainable, and will have significant negative externalities on the global economy. The next financial crisis, in China, will come from the excessive extension of credit from both fiscal and monetary authorities, and will come from government and corporate bond market defaults, as the system is severely over-leveraged. China is using more and more debt to fix bad debt problems, and the simulative multiplier-accelerator effect on the economy is deteriorating (decelerating) quickly.
Systematic fragility is not only experienced at the microeconomic (country/market) level, but manifests at the macroeconomic (systemic/systematic/institutional) level.

Trends in Systematic Fragility

Systematic fragility is made up of financial, consumption and government fragility; and intra-sector fragility, is caused by debt levels (rate of change), income (servicing of debt), and terms and conditions of servicing of debt. Transmission mechanisms between these factors and sectors are price systems (financial/commodity), government policy (monetary/fiscal), and psychological expectations (investors/consumers).

What is important, is fundamental forces and enabling factors driving fragility are: the end of Bretton Woods, central bank managed float systems, ending of international capital controls, the liquidity explosion, debt escalation, financial asset investment shift, and the rise of the new global finance capital elite; and financial deregulation, global digital-network technology, financial engineering (derivatives) revolution, highly liquid financial markets, financial restructuring and emergence of the shadow banking system.

Globalization, technologicalization and deregulation/integration is accelerating capital flows and accumulation, and concentration of capital to targeted and non-targeted markets across the world, fundamentally restructuring markets and institutions. This process is continuing at a rapid pace, and depending on the recipients, is economically, financially and politically (institutionally) destabilizing, destructing and deconstructing liberal-democratic-capitalism.

Financial product innovation and advancements in the use of technology for trading purposes, is accelerating the shift from real to financial asset investment – and with the rise of global equity, debt, and derivative markets – is changing the institutional structure, and exacerbating the fragility and instability, of the global financial system.

Central Banks and Fragility

Central banks bailed out the private banking system, and will again – along with other strategic affiliated institutions, corporations, businesses and brokerages – by printing massive amounts of fiat currency (seigniorage), to buy (defective/defaulted) securities product (derivatives), accumulate more sovereign-corporate-personal debt, with even more crowding out effects, and with no real eventual long-term impacts on real economic growth, wages, and productivity; and social welfare or standards of living.
Only asset prices bubbles and a massive redistribution and concentration of wealth will occur. Global capital markets, financial institutions, governments, businesses, and consumers are sitting on an extremely fragile system. This is obvious when looking at the level of government debt, service.

Government Debt and Government Fragility

It is estimated, between the U.S Federal Reserve Bank, Bank of England, and European Central Bank, $15 trillion direct liquidity injections, loans, guarantees, tax reductions, direct subsidies, etc. have been used. If you add in China and Japan, the total gets to as high as $25 trillion, and if you add in other emerging country (Asian, Latin America, and Middle-East) central banks, the total gets as high $40 trillion. Add in inter-temporal substitution (opportunity costs) over 40 years, we are looking at hundreds of trillions of debt, and debt service.

What perpetuates this reliance on debt, and debt service, is the misconception of valid economic theory and analysis, and its real application.

Failed Conceptual Frameworks of Contemporary Economic Analysis

It is obvious, global monetary and fiscal policy responses have made the global financial and economic system even more fragile, and eventually insolvent and bankrupt, and modern central banking is ineffective and has put us into a perpetual liquidity trap, the velocity of money has collapsed. There is no money going into real long-term (capital budgets) assets, only short-term financial assets (equity, fixed-income, ETFs, derivatives, structured products, crypto-currencies, etc.).

This has led us into the contradiction of macroeconomic theory, monetary policy and central banking: liquidity-debt-insolvency nexus, the moral (immoral) hazard of perpetual bail-outs, growing concentration of wealth at the extremes, growing perception that Negative/Zero Interest Rate Policy (N/ZIRP) can fix under-investment in capital (human/physical) and deflationary (disinflationary) trends, and that current banking regulation-supervision is bad for the economy, financial services (institutions) industry, and for institutional and retail investors (savers) in the long run.

And unfortunately, these techniques and tools have been used by other Global Central Governments and Banks (BOJ/ECB/BOE/PBOC), with similar, disastrous, and disappointing outcomes. The focus is on saving the financial institutional system in the short-run, using extreme and un-orthodox monetary policies (tools), with a lack of concern or understanding of long-run economic, social, cultural, and political consequences and outcomes. This is the true reflection, of failed conceptual frameworks, of contemporary economic analysis.

A Theory and Application of Systematic Fragility

Dr. Rasmus presents a true theory (model), of Systematic Fragility, a proxy for instability, a measure and quantitative score, used to forecast financial instability events, measuring pre-post-crash-recession cycle phases, it is a simultaneous equation-solution, the weights and factors are non-linear relationships, and are determined through the use of machine-learning (AI) algorithms, that adjust the factors, equations, and outcomes in real (continuous) time.

For example, over the last 10 years, the Fed accumulated over $4.5 trillion in bank reserves/balance sheet (bonds), made up mostly of mortgage backed securities and U.S. government Treasury notes and bonds, the average size of the balance sheet prior to the financial crisis was $500-to-$800 billion. Since these were mainly reserves creation, and an addition to the monetary base, and not really the money supply, the policy effects (QE/(Zero-Negative Real Interest Rate policy) have been mute.

The real cause of deficient real-macroeconomic performance, is a collapse in the velocity of money, driven by alternative forms of money creation and flows across the globe (cryptic-digital currencies-shadow banking, etc.); the lack of fiscal labor market policy to lower under-employment and raise labor market participation rates; and resolve to solve other social, cultural, political and economic disruptions. Making it now impossible to conduct monetary policy.

With the U.S. fiscal debt totaling over $22 trillion (interest payments +$1.0 trillion per year), the Feds Balance Sheet totaling $4.3 trillion, the potential for continued -perpetual war (defense spending) and entitlement expenditures, and political and policy uncertainty (next Federal Reserve President) there is little room for monetary and fiscal solutions to fight the next financial and economic crisis.

Neoliberal new-classical macroeconomic theory is flawed, at best, as it relies on the primacy of central bank monetary policy, tax structure shifts, free trade theory, running of twin deficit systems, allows for major labor market restructuring, leading to wage compression, drives toward privatization of public goods and institutions, and fiscal austerity, and financialization-fiscalization of elites, institutions and products.

CONCLUSIONS

Most major monetary, fiscal, and macroeconomic economists, and financial institution and capital market experts agree, the global economy and financial system is more systemically fragile than ever before.

According to Dr. Rasmus, shows us that global Financial Fragility (FF) is positively related to total financial asset investment in the system, and with interest rate maturity optimization, elasticity of inside (shadow bank) credit, and available income to total debt levels; with inflation expectations to change in total debt levels; with credit default and reinvestment risk; and with fiscal and monetary government subsidies, support, credit facilities, QE, bailouts, etc. (See Appendix).

Government policies have made matters worse, by driving the cost of capital to zero (negative), replacing real assets for financial assets, printing trillions to bail-out and purchase bad debt and defective financial products, allowing massive leakage of capital to flow unregulated (shadow banking) across the globe, etc.; all with no real effect on real economic growth, wage growth, labor participation, inflation, standards of living or social welfare.

These failures and fragility are reflected in increased volatility in social and economic indicators, capital market pricing and investment risk, and resulting reductions risk-adjusted returns, inefficient allocation investment capital and resources, and falling employment and real income growth rates, standards of living and overall social welfare.

The conclusion, if this system of unorthodoxy continues – and I believe it is too late to address the systemic and systematic risks associated with the economy, government, and central banking – exposes the economy, financial institutions and capital markets, to failure, again, at an ever higher social price.

The reality is our economic and financial system are extremely fragile, and we are facing ever higher systematic-systemic credit default (illiquidity) risk, and another severe financial crisis, great recession and depression, as our tools and system are ineffective and broken.

By Dr. Larry Souza
April 1, 2018
Dr. Souza has 27 years of experience in commercial and residential real estate economic research; and is Real Estate, Financial and Investment Economist for: Pillar6 Advisors, LLC; Johnson Souza Group, Inc.; CapitalBrain.co, and GreenSparc. Dr. Souza holds degrees in: accounting, finance, economics, public administration, information systems and political science; and Doctorate in Business Administration (DBA) with a concentration in Corporate Finance, and his dissertation is titled: Modern Real Estate Portfolio Management (MREPM): Applications in Modern (MREPT) and Post-Modern (PMREPT) Real Estate Portfolio Theory. He has been teaching college level finance, economics and real estate courses for the past 22 years, and is currently a full-time adjunct professor in the School of Economics and Business Administration (SEBA) at Saint Mary’s College (SMC) of California.

posted April 9, 2018
Part 5 & Conclusion: A Theory of Systemic Fragility in the Global Economy

A Brief Recapitulation of Key Trends & Systemic Fragility

To understand how the nine trends contribute to, or are associated with, systemic fragility it is necessary to define further what is meant by contribution. How do the nine trends differently cause fragility and therefore financial instability? What are the qualitative differences among the trends in the determination of systemic fragility? To begin with, some causal factors are precipitating a crisis. Other causal factors are best understood as enabling, both in the build up to the financial crash and in the immediate post-crash contraction. Still other causes are fundamental and originating in nature. And not only the nine trends but fragility itself becomes a cause of fragility, as the development of systemic fragility results in feedback effects described in more detail shortly.

Of the nine trends, those that qualify as ‘fundamental’ are the explosion of liquidity within the global economy since the 1970s, the accompanying escalation of debt, the relative shift to financial asset investing that follows as real investment slows and financial asset investing and speculation in financial securities rises, and the accelerating disparity between incomes of the several hundred thousand new finance capital elite and those of the hundreds of millions of wage earners.

The important ‘enabling’ trends and factors would include the restructuring of both financial and labor markets globally and the contribution of government policy (fiscal, monetary, and other)—as both restructuring and policy enable, encourage and assist the expansion of debt and stagnation of incomes.

‘Precipitating’ causes of financial instability events (market crashes, banking system crashes, severe credit crunches, major financial institution insolvency and bankruptcy events, wars, natural crises, etc.) are not among the nine trends. What precipitates, or sets in motion, a major financial crisis is typically associated with a major shift in investor-agents’ psychological mindset and expectations. Here the price system, especially the acceleration of financial asset price deflation, plays a close supporting role in that expectations shift by investors.

To briefly recapitulate the nine trends and their relationship to fragility and financial instability: the explosion of liquidity since the 1970s, attributable to central banks creation of ‘money credit’ plus internal changes in the financial structure that has increased ‘inside credit’ liquidity, has led to a corresponding excess growth of debt, especially private sector debt. The availability of debt has led to its general leveraging in the purchase of financial assets. Financial asset investment profitability has diverted money capital from real asset investment alternative opportunities. Excess liquidity has become far greater in any event that might be employed in real asset investment. Fragility is a basic function of rising debt and slowing or declining growth of incomes required to pay for debt, plus a set of group variables that affect payment capabilities as well. Financial restructuring has produced a corresponding new structure comprised of shadow banks, deep shadow banks, and integration of commercial and shadow banks, an expanded global network of highly liquid markets for transacting financial assets, and proliferating forms of financial securities traded in these markets. This new structure and the unprecedented financial incomes it has generated for professional investors has created a new finance capital elite of no more than 200,000 very high net worth individuals. This new structure, the new elite, and the development of systemic fragility are components which must be included in the proper definition of ‘financialization’. Concurrent with the financial restructuring has been a fundamental restructuring of labor markets on the real side of the economy. Labor market restructuring has produced a stagnation and decline of real wages and therefore household consumption fragility from falling incomes and related rising household debt. This occurs simultaneously as financial restructuring has raised debt and financial fragility. These are long term secular trends. However, financial crises and consequent real economy contractions intensify the mutual effects of financial and consumption fragility on each other in the post-crash period and deep contraction period. Government fragility also rises long term secularly due to policies that reduce government income sources even as government subsidizes the private sector and government debt rises. Government debt accelerates with cyclical crises, financial instability and real contractions, as government transfers private debt to its own balance sheets as well. Systemic fragility renders government fiscal-monetary policies less effective as it negates multipliers and reduces elasticities of interest rates on consumption and investment. In crises and post crises periods, the mutual feedback effects between three forms of fragility intensify as well. Financial asset price volatility plays a key role in the growth of systemic fragility, in intensifying the financial and real crises when they erupt, and in reducing the effectiveness of traditional government fiscal-monetary policies from stabilizing the crises.

Measuring the Three Forms of Systemic Fragility

As already noted, the three forms of fragility are financial fragility that affects private sector investment, consumption fragility that impacts households, and government balance sheet fragility that has consequences for government policy effectiveness and government ability to prevent deeper than normal real economic contractions and to generate a sustained recovery from those deeper contractions.

The three forms of fragility may be aggregated to estimate systemic fragility. Since debt levels and liquidity are potentially measurable, each of the three forms of fragility should in theory be capable of producing a fragility index. Systemic fragility in turn should be capable of representation by means of an aggregated index based on the three indices. However, the aggregation of the three forms of fragility cannot be created by a simple addition of each of the three fragility forms. Systemic fragility is more than just the ‘sum of the parts’. The magnitude of systemic fragility is the product of the many, complex interactions and feedback effects that occur between the three forms of fragility. This feedback contribution makes the creation of a systemic fragility index more problematic.

Within each of the three forms of fragility the major determining variables are debt, income available for debt payments, and a group variable of elements that affect payment of debt from available incomes.

The debt and income variables include not only levels or magnitude of debt but the rate of change in levels and magnitudes. How thoroughly debt and income is defined is also important.

For example, forms of basic income with which to pay debt may include cash flow for financial institutions and businesses and wage income for households. While these are the basic definitions as per Minsky’s analysis of fragility, they are not sufficient.

For determining financial fragility, Minsky’s cash flow variable is too narrow a concept. The income variable influencing financial fragility should be defined as cash flow plus other forms of near liquid assets held by businesses that may in a crisis be relatively quickly converted to cash in order to make debt payments. Moreover, the rate of change in this broader income variable, and not just its level, should also be considered.

For households and consumption fragility, the proper income variable should be wage earning households’ real disposable income plus income in the form of transfer payments to these households. Both levels and rates of change of income are important. Since the vast majority (90% or more) of households’ income is from wages and transfer sources, adopting the real disposable income as the wage income variable is acceptable. However, insofar as the wealthiest households (especially the top 1% and the even more especial 0.1%) constitute a share of overall investor households whose income derives in part (rising with income level) from financial investment and capital gains incomes, a distinction might also be made between the two when assessing the development of consumption fragility.
And for government units, it is not just tax revenues that constitute ‘income’ but the ability to quickly sell bonds in markets as well. Another major factor related to government fragility is the ability of the national or federal government to essentially create substitute income quickly and when necessary in the form of printing of money that it can then ‘lend’ to itself when income from tax revenue and bond sales to private investors (and other governments) is insufficient. Since only national governments are legally allowed to ‘create income’ for themselves, it is probably important to distinguish between national government fragility and state-province-local government unit fragility, where in the case of the latter direct income creation is not an option.

Minsky’s approach is also undeveloped in assuming that financial fragility’s internal variables of debt and income operate for financial institutions (banks, shadow banks, etc.) in the same way as for other non-bank businesses. Insufficient distinction is made between the two, given that financial asset deflation impacts banks more severely and rapidly in a crash than it does non-bank business. Financial asset price collapse causes a collapse of bank cash flow + near liquid assets, and thus raises bank real debt much faster than for non-banks whose cash flow is affected negatively by falling real goods prices which decline much slower. This is a critical distinction. Minsky’s failure to account for it reflects his general underdevelopment of the two-price theory factor, as he himself acknowledges. Also undeveloped is the intermediate form of bank-nonbank business institution—i.e. the multinational corporation that today is a hybrid of bank and nonbank, or what we’ve called ‘deep shadow’ bank, where its business model is based on both real asset and significant financial asset investing activity. And then there is the related question of whether, and if so how, shadow banks in general are potentially more fragile than commercial banks and how is that explained by the basic variable duality of debt and income?

On the debt side of the fragility definition, the sources and kinds of debt incurred are probably important as well, not just the total debt levels or rates of change. For example, there are a number of different kinds of business debt (corporate bonds, paper, bank loans, etc.) that are important due to the terms and conditions associated with payments in the different instances. In the case of banks and financial institutions, bank fragility may be higher when there is a greater weight of ‘repurchase agreements or repos’ in their total debt portfolio while the proportion of junk bond debt to total debt impacts non-bank fragility. Similarly, composition of debt is important for consumer households (mortgage, credit card, student loan, payday loans, etc.) And even government debt, especially at the local government level where debt composed of derivatives like interest rate swaps is involved.

Here is where the third key variable defining fragility becomes important—i.e. what might be called the ‘terms and conditions’ of debt servicing (T&C variable) that interacts in important ways with both debt and income to jointly determine fragility.

Minsky’s view is undeveloped with regard to the T&C variable. T&C is a group variable that is composed of various elements that may exist in different combinations and ‘weights’ associated with a particular debt. T&C as a group variable may include elements such as the level of interest charged on the debt; the term structure of the debt (short term v. longer term debt); whether the debt interest payment is fixed or variable and thus subject to volatility in interest amount; penalties, fees and other charges on missed payments; provisions of the debt that define under what conditions default may occur when principal and/or interest is not paid on time; post-default obligations; time limits for defining default (30, 60, 90 days?); powers of the lender of the debt when default is declared; bankruptcy processing, and other provisions that are called ‘covenants’ that define payment options for the borrower; alternatives to payment (e.g. option to pay ‘in kind’), refinancing conditions, and so on.

The T&C variable is thus complex, and its composition and effects may vary considerably between different forms of debt (e.g. investment grade v. high yield ‘junk’ corporate bond debt, corporate commercial paper debt, securitized debt, national government sovereign (T-bond) debt, local government municipal debt, household installment, credit card, or student loans, leverage loans made by private equity shadow banks to businesses, and so on). The difficult to quantify character of the T&C variable makes estimating a fragility index for each of the three constituent forms of fragility especially difficult. But the T&C variable’s important and influence on fragility nonetheless increases greatly when a financial instability event is precipitated and a rapid change in financial asset price deflation occurs.

Thus within the three forms of fragility—financial, consumption, and government—that determine systemic fragility are three critical variables—debt, income, and terms and conditions of debt servicing. The interaction between debt, income and T&C variables determine what might be called a first approximation of the level of each form of (financial, consumption, government) fragility. But this would be a first approximation only, since the levels of fragility—and their aggregate summation as systemic fragility—are the consequence as well of the various feedback effects between the three fragility forms. And those feedback effects are enabled, in turn, by transmission mechanisms or processes that also constitute the equation of systemic fragility.

Fragility Feedback Effects

A major differentiation between the theory of systemic fragility introduced here, compared to other theories based on fragility as a determinant of financial instability, is the acknowledgement of what might be called ‘feedback effects’. The term is shorthand for the recognition that fragility is a dynamic and not a static concept. And that its development does not occur in a linear manner.
By ‘feedback’ and dynamic is meant that there exists a complex web of mutual determinants involved in the development of the aggregate condition called Systemic Fragility. Mutual causations between variables are at work, occurring at various levels.
As several examples have already indicated, there are mutual determinations between the three forms of fragility—financial, consumption, and government balance sheet. The internal variables of debt, income, and T&C also mutually impact each other—in some cases offsetting and reducing fragility and in other cases exacerbating it within each of the fragility forms. And there is a third, still more general level of interaction and determination—between financial asset and real asset investment as a consequence of growing fragility in general.

Within each form of fragility, the three variables involved—debt, income, and T&C—interact in various ways. For example, slowing or declining income with which to pay debt may result in higher debt, as a nonbank business resorts to borrowing more in order to service the debt. Or, its T&C may worsen as it rolls over the debt at a higher interest rate and/or shorter payback term, or with a loss of previously favorable ‘covenants’. Rising debt in turn reduces available income for investment, as more of future income must be assigned to paying the higher debt. When debt term expires, lower income flow and higher debt levels may result in debt refinancing on worse terms than previously, which reduce the ability to make future payments. There are various combinations of mutual interactions between debt, income, and T&C over time.

A similar scenario applies to consumption fragility. Declining consumer real disposable income and/or reduction in transfer payments may force households to take on more debt to maintain living standards. Debt levels rise, and in turn higher total interest and principal must be paid on the debt. That means less future real disposable income after the higher payments are made. The higher a consumer’s debt load and debt payments as a percent of disposable income, the worse the credit terms that consumer receives when borrowing. Higher indebtedness and lower income results in having to pay a higher interest rate for a home mortgage or auto loan. The quality of that indebtedness also affects payment terms. Excess credit card debt, for example, may force a household to resort to payday loans, obtainable only at excessive interest rates.

And within government units, especially local government, a fall-off in tax revenue affects a credit rating so that the municipality, school district, or other government agency is forced to pay higher interest rates on bond issues it offers. Higher interest payments due to more debt and higher rates means a reduction in future income. Income and debt mutually exacerbate each other, and government fragility rises.

Even national level governments may face similar difficulties. A good example is Greece.
In the Greek case, like many Euro periphery governments after 1999 and after the creation of the Euro currency, Greece borrowed heavily from northern European banks. Its sovereign debt levels rose steadily from 2000 to 2008. When the great recession in 2008-09 depressed Greece’s real economy, its tax revenue income declined. Its ability to finance past debt therefore was not possible. Northern European governments, and cross-government institutions, thereafter restructured and refinanced (rolled over and added to) Greek debt in 2010. That added further to the total debt levels to be paid. T&C were made more unattractive as well. As part of restructuring, Greece was forced to divert its tax income to pay for the higher debt. So its debt rose and its income available for the higher debt payments simultaneously declined. Debt and income decline were exacerbating each other and fragility growing for all three reasons, including deteriorating T&Cs. Government income diverted for debt payments, as a consequence of austerity policies, had the further effect of reducing Greek GDP, which further lowered tax income, and made Greece even more fragile. A second European recession in 2011-12 repeated the process, and debt was restructured a second time in 2012 with the same general effects. A third debt restructuring in 2015 is in progress. It too will raise debt levels, total debt payments due, and reduce Greece’s income from tax sources still further as Greek GDP collapses once again.

The possible feedback effects between the three key variables within each of the forms of fragility are numerous. The intensity of these interactions serves to raise the level of fragility within each form. Moreover, that intensity rises during and immediately after a financial instability event, which accelerates the development of fragility within each form.

Increasingly fragility within each form leads in turn to greater feedback effects between the three forms of fragility as well.
Several examples have been shown previously of how financial fragility may interact and intensify household consumption fragility—and vice-versa. When a financially precipitated recession occurs, interactions between forms of fragility intensify and the processes become generalized. A ‘race to the bottom’ then ensues, leading to generalized price reduction (goods deflation), labor cost cutting and more household consumption fragility.

In the case of the financial fragility of banks and financial institutions, this feeds back on both nonbank businesses and households, raising the fragility of both. This typically occurs as collapsing financial asset prices for banks results in a freezing up of bank lending, both to nonbank businesses and consumer households. With new loans frozen banks’ new income generation does not occur. They cannot sell financial securities, since no one wants to buy securities when financial asset prices are collapsing. Bank fragility then translates into nonbank fragility, as nonbank businesses, unable to obtain day to day business operating loans from banks, must resort to the cost cutting with the effects previously noted. In this way a nonbank business, that is not necessarily fragile to begin with, may be quickly forced into a fragility condition by the banking system and have to cut costs and/or take on more debt from other sources at less attractive rates and terms. The freezing up of bank lending has a similar effect on households. Bank layoffs mean declining income and rising fragility for employees associated with the banks. Nonbank cost cutting due to lack of bank loans produces the same effect for households. Bank financial asset price collapse may mean loss or reduction of pension retirement income to households. It also typically results in a decline in interest income earned by households. Mortgage refinancing as a means of increasing household income also dries up as banks freeze lending. There are various conduits by which bank fragility translates directly or indirectly (via nonbank fragility) to household income stagnation, decline, and therefore rising consumption fragility. Bank lending freeze up may also force households, like nonbank businesses, to seek credit elsewhere on worse T&C arrangements, also contributing to household consumption fragility.

Bank fragility also feeds back, directly and indirectly, on government balance sheet fragility. The freezing up of bank lending results in a decline in real investment and household consumption that slows economic growth and thus government tax revenue. Government also ends up spending more in recession situations (discretionary and non-discretionary spending typically rise). The combination of more spending and less tax income means rising budget deficits which must be ‘financed’ by raising more government debt. Thus government fragility rises due to both declining income and rising debt.

Government also transfers debt from the private sector—especially from banks and strategic nonbank businesses it bails out—following financial crashes and deep recessions. Government may buy the bad assets on bank balance sheets and transfer it to its own—either its central bank or to what is called a nationalized ‘bad bank’ which holds the various toxic assets until the government can resell them. Massive government direct loans, subsidies, and loan guarantees to strategic nonbank businesses may also occur. Banks’ ability to sell bad mortgage debt to government agencies also amounts to an offloading and transfer of debt, and fragility to an extent, to government. By enacting deep bank and business tax cuts, government indirectly also transfers private sector debt and fragility to itself. Banks and business income is raised as a consequence of less taxes to pay, while government income declines and thus its own fragility is raised.

Government units may also absorb debt from households in a similar fashion, in effect subsidizing mortgage refinancing for homeowners facing foreclosure or experiencing ‘negative equity’ value in the homes. However, this occurs far less than the much more numerous and generous debt transfer programs provided to banks, financial institutions and investors. More typical is government subsidizing household income, in effect reducing its own income, transferring debt and fragility to its own balance sheet. Secularly over the long term, but especially in post-financial crash crises, government may fund an increase in its transfer payments to households bolstering household income at the expense of its own deficits and debt. The rise in household consumption fragility is to an extent thus offset, while government’s own fragility from more spending, deficits and debt is in turn raised.

Thus far the examples of ‘feedback’ direction have been from financial fragility, and especially bank fragility, to household consumption fragility and even government balance sheet fragility. But consumption fragility may also ‘feedback’ on both financial and government fragility.

As household income stagnates or declines due to many of the labor market structural changes noted, there is less consumption and therefore less household demand for nonbank business goods and services. That may result in less business revenue and therefore less business income. This feedback effect may be reduced to the extent that households, despite declining income, do not reduce their consumption but instead take on more consumer debt to maintain consumption levels. However, there is a limit to how much extra debt households are able, or may want, to take on to maintain consumption. Household debt accumulation has upper limits.
Consumer debt reduces future disposable income, as more interest on the debt must be paid. Stagnating-declining household incomes (and fragility) feed back to both further nonbank financial fragility as well as more future household consumption fragility.
Consumption fragility also feeds government balance sheet fragility. Reductions in household income and/or rising debt have the consequence of less consumer spending. Less household spending means less sales tax revenue; that especially impacts local governments highly dependent on this particular form of tax revenue income. In the US economy, deep recession conditions are associated with significant loss of household incomes due to layoffs, wage cuts, etc., which may translate into mortgage failures, foreclosures, and falling local property values. That results in less property tax revenue income for local governments, raising their fragility. Dependent on local government and property tax revenues, Public Education services are then cut unless national governments spend more in order to maintain such services. In this manner, rising consumption fragility indirectly forces an increase in local government fragility via tax revenue income decline as well as national government fragility via more spending, deficits, debt and national government balance sheet fragility. Less household consumption impacts income tax—as well as local sales and property tax—revenues similarly. Less consumption means less business production and less hiring, both of which reduce taxable income that would otherwise accrue to governments. And there is a secondary, derivative effect on government fragility. Not only may government debt levels rise, as government has to borrow more in order to offset tax income loss, but the terms on which the additional debt is borrowed may raise debt costs as well. State and local governments running large budget deficits pay higher rates of interest for the municipal bond debt they sell in order to finance their high deficits due to tax income decline.

Financial fragility feeds into consumption fragility, and vice-versa. Financial and consumption fragility feed government balance sheet fragility in various ways. But the feedback direction may also occur from government balance sheet fragility to financial and household consumption fragility. This is where fiscal austerity policies play a particularly significant role. Austerity is about offloading actual, and/or potential, government debt onto households. Government balance sheet fragility is reduced at the expense of rising consumption fragility. Austerity means a deep reduction in government spending. That means more retained government income. But spending in the form of household transfer payments means less household disposable income. Less government spending means lower deficits and less debt to finance as well. Austerity also means government selling off public assets, which raises temporarily government income levels. But it forces households to turn to private, higher priced, alternatives to the once government provided services and programs. What were once perhaps free public services and goods must now be paid for by households, reducing their disposable income and raising household fragility. Austerity also means raising taxes and reducing government pensions and retirement payments, or national healthcare services or payments. All that raises government income or reduces government costs, while lowering household disposable income and raising household costs. In austerity, most of the tax increases are local government fee increases, sales taxes, and other ‘regressive’ taxation impacting median and below households the most. Occasionally, the tax hikes also affect investors and businesses. And the pension, retirement, and health care cuts are significantly directed at middle income households.

What the foregoing reflects is that there are numerous ways and ‘paths’ by which fragility in each of the three forms in turn ‘feeds back’ upon one or more of the other forms. Sometimes the feedback is direct—i.e. from government to households, or banks to nonbank businesses and households, or households to government or nonbank businesses. Sometimes it is transmitted via income declines, sometimes debt, or other times both simultaneously more or less. The feedbacks may also occur indirectly: i.e. rising financial fragility leading to consumption fragility and thereafter to government fragility as the latter responds. Or financial to government to households. Or many of the other possible combinations involving two or more.

But the major point is that feedback effects do occur. Fragility does not develop within each of the three forms independently of the other. It ‘accelerates’ overall as the intensity of the feedback effects grows during periods of financial instability events and subsequent deep and rapid decline in the real economy. There are not only ‘accelerator’ effects, but also what might be called ‘elasticities of response’ between the different forms of fragility feedbacks. Perhaps a minor change in financial fragility generates a significant feedback effect on consumption fragility—i.e. a big further rise in consumption fragility. But a rise in consumption fragility produces less of a significant change on financial fragility.

Transmission Mechanisms of Systemic Fragility

A final, but very important, topic to consider is the importance of ‘Transmission Mechanisms’ (TXMs) or processes with regard to fragility. This is an area that has been left particularly undeveloped in other analyses that attempt to explain the relationship between fragility, financial instability, and economic cycles.

Transmission mechanisms operate at several levels in the process of determination of systemic fragility. Feedback effects—i.e. mutual determinations—occur between the three internal variables—debt, income, T&Cs. At a higher level, between the three forms of fragility—financial, consumption, government balance sheet. And at the most general level between financial asset investment and real asset investment. All the mutual determinations require some kind of transmission mechanism between them.

At least three key transmission mechanisms appear essential to Systemic Fragility. They are: 1) the price system, 2) government policy, and 3) investor agents’ psychological expectations.

Price Systems as TXM

The neoclassical view is that there is only one price system and all prices behave the same—that is, all prices respond in the same way to supply and demand forces. Whether financial asset prices, goods & services prices (output prices), input prices (wages as price for labor, real capital goods, land), or money prices (interest rates) are involved, the response to supply and demand is similar. Supply interacting with demand adjusts prices to return the economy back to equilibrium. In other words, one price system thus fits all and the price system is the key to economic system stabilization.

This neoclassical view does not conform to reality, however. In the case of financial assets, demand plays a much greater role; the role of supply is almost negligible. With financial asset price inflation, demand induces still more demand, driving prices ever higher so long as prices continue to rise. Supply does not moderate asset price inflation. And financial asset prices ‘adjust’ rapidly and abruptly downward (i.e. deflate) only when investors conclude that further price appreciation is not possible and price stagnation or decline is imminent. It is thus a psychological perception or expectation of imminent price shifting that precipitates the reversal and price deflation, not supply side forces. The shift to deflation is unrelated to extra supply or rising costs, as in goods prices, since ‘cost of goods’ for producing financial securities is virtually negligible.

Financial asset price deflation is a mechanism within a form of fragility that intensifies and exacerbates the effect of one fragility variable upon another—i.e. debt on income, income on debt, T&C on debt, and so on. Take the example of growing financial fragility among banks. Financial asset deflation reduces bank income available to make bank debt payments to another bank from which it may have borrowed. When asset deflation begins, investors do not buy new assets from the bank. Bank revenue falls. Income from the sale of bank equity declines as well. This general income decline occurs, moreover, at a time when banks actually need to increase their income in order to cover the asset losses from falling asset prices as well as make payment on their own debt. Less income plus falling asset values plus rising real debt translate into an increase in bank financial fragility.

How then does this greater bank fragility transmit to another form of fragility, i.e. from financial to consumption and/or government fragility? Here again the price system serves as transmission mechanism, as financial asset deflation spills over into goods deflation and even to wage deflation thereafter. Here’s one scenario of bank to nonbank to household fragility transmission enabled by price systems:

Banks are capitalist businesses like any other, but they are also different in that they are the capitalist institutions that provide credit to the rest of the system. They function based on a ‘fractional reserve’ basis. When bank asset prices deflate and bank losses grow, banks stop lending to ensure they retain sufficient reserves. They hoard available income (cash assets) as much as possible in an asset deflation situation in order to offset losses. When financial asset deflation is moderate, banks respond with what’s called a moderate ‘credit crunch’ (lending interest rates escalate); when asset deflation is more serious, a ‘liquidity crunch’ occurs (bank lending dries up temporarily as banks impose administrative obstacles to prevent lending as well as raise lending rates); when banks default on a debt payment due it’s an even more serious scenario, a ‘solvency crisis’. An insolvent bank is a candidate for bankruptcy and court distribution of its remaining assets at auction.

The degree of bank financial asset collapse thus corresponds roughly to the degree of bank lending contraction. And as bank lending contracts, so too does the real economy. Nonbank businesses cannot obtain operating loans to keep their businesses going. Banks just won’t lend. Nonbanks are then forced to raise more revenue income by lowering their product prices and/or by reducing their labor prices (wages) to cut costs, or both. In this scenario, what starts as financial asset deflation for banks ‘transmits’ to the rest of the economy as nonbank businesses institute goods and/or wage deflation. That goods and wage deflation reduces income for nonbanks and for households, in turn raising their fragility. The transmission is from asset prices to goods prices to wage prices. But the process starts with financial assets.

An alternative to nonbanks lowering their goods and/or labor prices is to cut production and/or layoff workers. The production cuts and layoffs result in less government tax revenue and thus raises government fragility. The layoffs amount to an aggregate wage reduction, with the same effect on consumption fragility.

Transmission by price system can also occur in the opposite causal direction. Forces behind declining goods or labor prices unrelated to financial asset deflation can transmit nonbank or household fragility to banks and financial asset deflation. However, that reverse direction of causation does not typically precipitate financial asset deflation as often or as dramatically as the latter precipitates goods and wage deflation. That’s because financial asset prices are, by their nature, far more volatile for reasons stated. So what is more often observed is financial asset deflation transmitting financial fragility to nonbanks and consumption fragility to households.

Just as there are multiple ‘feedback’ effects between forms of fragility, so too are there multiple ways price systems can transmit income decline and debt rise, and thus fragility, between the three different forms of fragility. The steeper the asset price deflation that occurs after a financial crisis erupts, the more intense the transmission from one form of fragility to another. Also, the more fragile the other forms are when the crisis and asset deflation begins, the stronger the transmission from one fragility form to another. For fragility grows secularly and steadily over the long term, and then accelerates when a financial crisis erupts and the real economy contracts sharply in response to the crisis.

Government policy changes also function as transmission mechanisms, causing fragility to intensify among variables within a form of fragility as well as between forms of fragility. Here one might argue that government ‘prices’ serve as a transmission mechanism.
In the wake of a major financial instability event like a stock market crash or banking insolvency crisis, for example, the government central bank takes monetary action to pump massive liquidity into the banks to offset their financial asset collapse and losses. To do this the central bank drives down its lending rate to banks and bank-to-bank lending rates to zero, as has happened throughout the advanced economies since 2008 and continues now for the seventh year. Lowering the ‘price’ of money (i.e. interest rates) by government action lowers costs for banks and raises bank incomes by means of cost cutting. Banks can also rollover and refinance their previous debt by borrowing new debt at virtually no cost. That income support and debt interest (T&C) reduction together reduces banks’ fragility. However, it also reduces income for households and raises therefore consumption fragility. Interest income previously earned by households from higher interest savings rates disappears. Households’ fixed income is reduced and consumption fragility thus rises due to the lower income. In effect, central bank zero interest monetary policy results in a de facto transfer of income from households to the banking sector. Households subsidize the banks. From a fragility analysis standpoint, it means fragility is transmitted from banks to households.

The lower interest rates also reduce central banks-government fragility by lowering the government’s debt financing costs. So both banks and governments like a zero interest policy. That’s one key reason why it has continued for so long and is favored over fiscal policy throughout the advanced economies still, after seven years. Greater reason, no doubt, is that keeping rates low for a long duration simply provides low-no cost liquidity with which to invest in accelerating financial asset prices or to use to leverage to finance expanding offshore real investments by multinational corporations. The purely economic reasons also provide geopolitical advantages as well. Low rates in order to stimulate the real economy are more a justification, and certainly a secondary objective.
The shift in government monetary and interest rate policy is a fragility transmission mechanism enabling feedback from one form (bank financial) to another form (household consumption). Or, it might be argued that the price for money is the transmission mechanism.

Another government price mechanism by which fragility is transmitted from one fragility form to another is government taxation—i.e. taxes as the ‘price’ for government services. By reducing taxes on banks or nonbank businesses, the government in effect frees up more income for business (reducing its fragility) while lowering its own tax revenue income and raising its own fragility. Lower tax revenue and income may have a ‘knock-on’ effect requiring the government to take on more debt to offset the business tax cut and government revenue income loss. So government debt rises, income declines, and its fragility rises as that of business falls. This amounts to a transfer of fragility from the business-bank side (i.e. financial fragility) to government balance sheet fragility.

Government might do the same for households. However, such parallel fragility transfer is often only token in magnitude and effect. More often since 2008, governments have responded with austerity, shifting its greater debt and lower income (fragility) due to bank and nonbank bailouts to households. In other words, austerity tax policy amounts to a transfer of debt/income and fragility from banks and nonbanks to households and consumers, through the medium of the government.

Other types of government policy may also serve as transmission mechanisms bringing about a shift of fragility from one of the three forms to the other by lowering debt/raising income in one form and lowering income/raising debt in another. For example, free trade policies raise business revenue income at the expense of households’ wage income. That means a shift of fragility from business to households, all things equal.

Government policies that aim at privatizing pensions and retirement systems, or privatizing and de-collectivizing (Obamacare in the US) health insurance systems, result in major cost savings for business that reduces their fragility, but also results in lower deferred wage incomes and benefits compensation for wage earning households.

The trend throughout the advanced economies in recent years is to implement what is called ‘labor market reforms,’ policy that aims at reducing unions, collective bargaining, and employment rights to help business cut costs and raise income. It also results in lower wage income. Fragility is offloaded from business and on-loaded to wage earning households.

A third transmission mechanism that increases fragility within a particular form, as well as between the three forms, is Investor-Agents Expectations.

Expectations among the global finance capital elite as to where financial asset prices are going in given markets are critical to the direct transmission of fragility between financial and consumption, and indirectly to government fragility as well. Consensus expectations among the elite as to whether financial asset prices in a given market are about to peak typically set in motion the selling of assets in that market. The selling then accelerates as second tier investors follow suit. Asset price deflation may thereafter turn into a rout, as ‘retail’ investors then provide further momentum and financial asset deflation accelerates. Members of the finance capital elite thus precipitate a reversal of asset price inflation.

This may occur by collusion between major shadow bank institutions or even commercial banking institutions. For example, in recent years evidence of such collusion has repeatedly appeared—as in the case of fixing of Libor interest rates and derivatives trading on London exchanges. Or it may occur as the result of more tacit signals by major buying or selling by well known traders of the big institutions, shadow or commercial. A pattern appears to repeat, where money capital and credit flows from shadow banks and big investors into a particular market, where the asset prices rise appreciably, then assets are sold in growing volume, financial profits are taken, and the global money parade moves on to another financial securities market.

One day it’s Asian stock and equity markets, then its corporate junk bonds, then Exchange Traded Funds, then oil commodity futures price changes, then it’s Japanese or Euro currency speculation as QE programs are about to be introduced. The sea of liquid capital awash in the global economy sloshes around from one highly liquid financial market to another, driving up asset prices as a tsunami of investor demand rushes in, taking profits as the price surge is about to ebb, leaving a field of economic destruction of the real economy in its wake. Financial asset bubbles build and then collapse, accelerating financial fragility. When the pullout occurs, financial losses negatively impact the availability of money capital and credit for nonbank businesses, raising fragility among nonbank enterprises and the households dependent on them for wage income. Investor-agents’ expectations alternately drive financial asset prices to bubble ranges, and then cause them to collapse as money is moved out again and sent elsewhere, almost instantaneously and electronically to other liquid markets which now have more asset price appreciation potential.

What results is stock markets appreciating to levels that have nothing to do with fundamental earnings of the companies in them, an unrelenting chasing of yield by investors in ever riskier markets, and a growing volatility of currency exchange rates—to name but a few of the more recent negative effects. What moves the markets in terms of major shifts and swings are not the common investor, but the major ‘institutional’ (read: shadow bank) investors who buy and sell in large blocks of securities.

Decisions of the big investors, the finance capital elite, are at the center of these major shifts in direction (up or down) involving financial securities prices. And their decisions are heavily influenced by their expectations as to where a given financial market’s price level is reaching a top or approaching a nadir. Investors outside this elite may trade once a shift in direction has occurred (thus making few profits or taking major losses for ‘getting in late’ and ‘getting out late’). But it is this global elite that drives the major shifts in asset prices, which is where the real money is made.

Their expectations and decisions have implications for financial fragility and its transmission to nonbanks, households and even government balance sheets.

posted March 25, 2018
Yellen’s Twin Legacies; Powell’s Dilemmas’

This past February 2018 Janet Yellen, chair of the US Federal Reserve bank since 2014, was replaced by the Trump administration with the new Fed chair, Jerome Powell. Yellen leaves the Powell Fed with two contradictory legacies. The question of the day is which will the Powell Fed now follow? What role will the Trump administration’s tax cuts and spending programs play in influencing the choice? And is the Powell Fed now in a ‘no win’ situation, regardless which policy direction it takes?

Yellen’s Fed represents a continuation of the policies of her predecessor, Ben Bernanke—just as Bernanke’s policies continued Alan Greenspan’s, his predecessor. All three Fed regimes are defined by their shared policy of decades-long, massive liquidity injections—beginning with Greenspan’s assumption of the Fed chair in 1987 and continuing through the third of Yellen’s four year term in 2016.
The legacy of their thirty years of unremitting liquidity injection has been excessively leveraged, debt-fueled investment in financial markets that generated asset demand driving financial asset prices into unsustainable bubble territory. With Greenspan it was the savings & loan industry bust in the late 1980s, the US contribution to the Asian currency bubble of the late 1990s, then the US tech stock bubble of 1999-2000, and, together with Bernanke at his side, thereafter the subprime mortgage bond and derivatives twin bubbles of 2004-07.

Yellen’s First Legacy

Like her predecessors, in her first three years at the Fed helm Yellen chose to continue the Greenspan-Bernanke policy of excess liquidity. As the following Table 1 shows, Yellen continued the Bernanke QE program of Fed direct bond buying in her first year as chair.

TABLE 1
Fed QE Bond Buying Through 2014

Type of Security June 2013 February 2014 December 2014
Mortgages $1.3 trillion $1.5 trillion $1.7 trillion
US Treasuries $1.9 $2.2 $2.4

In 2015-16 thereafter, she continued to ‘rollover’ prior debt that was maturing, thereby keeping the Fed balance sheet at $4.5 trillion instead of allowing it to decline. The net liquidity injected into the economy by the Yellen Fed during its first three years, composed of new and rolled over debt, was thus likely in excess of $500 billion.

A comparison of Yellen vs. Bernanke money supply growth further illustrates the Yellen continuation of the Greenspan-Bernanke excess liquidity policy and its effect on the US money supply. The virtual free money from the Fed clearly continued during the first three years of her term, as Table 2 indicates. The Fed benchmark rate remained in the 0.25%-0.5% range through 2016

When measured in terms of the M2 money supply, more of the Fed’s liquidity actually entered the US economy on an annual basis during Yellen’s first three years than had even under her predecessor, Bernanke. Vast amounts of that liquidity flowed into financial markets, both in the US and abroad.

TABLE 2
M2 Money Supply
Bernanke v. Yellen Fed($ Trillions)

Bernanke Fed Yellen Fed
12/05 12/13 $chg/yr. %chg/yr. 12/13 04/17 $chg/yr. %chg/yr.
M2 $6.6 $10.6 $.5 7.6% $10.6 $13.5 $.87 8.3%

In 2017 the Yellen Fed began seriously raising its benchmark rates—albeit gradually. That policy shift of ‘rate hike gradualism’ is also a legacy—the second—of the Yellen Fed. Excess liquidity initially, the first legacy, followed by gradualism in rate hikes constitute the Yellen Fed’s ‘twin legacies’.

The policy shift to gradually higher rates actually began under Bernanke, announced in 2013 but never implemented. Bernanke in 2013 no doubt remembered the consequences of his prior shift and rate hikes in 2006-07—a shift which contributed toward precipitating the 2007-08 housing-derivatives bubbles implosions. Bernanke announced his intention to raise rates in mid-2013 but then ‘blinked’ amidst widespread market negative reactions, in the US and across emerging markets. He likely did not want to leave a legacy that on his watch the Fed’s policy shifts precipitated two—not one—market crashes. The 2007-09 was enough. Let someone else preside over the second.

Bernanke’s legacy was threefold: continuing his mentor, Greenspan’s policy, excess liquidity, followed by too high and too rapid rate hikes in 2006-07, thereafter by still even more excess liquidity post-2008. If excess liquidity was the fundamental source of the bubbles and crisis, in some perverse logic then still more liquidity was envisioned as the solution short term.

Yellen’s legacies would be continuing the three decade long ‘Great Liquidity Put’ set in motion by Greenspan and Bernanke, and then to actually implement the Bernanke ‘rate gradualism’ policy shift in 2017, announced by Bernanke in 2013 but quickly shelved for the rest of his term. The differences between the Bernanke and Yellen legacies were thus minimal: both contributed to the GLP and, whereas Bernanke announced his intention to raise rates gradually in 2013 but didn’t, Yellen began doing so in her last year. The Yellen Fed was thus but an addendum to the Bernanke—except for the latter’s disastrous accelerate rate hikes in 2006-07 that helped precipitate the crash. That experience now looms large on the horizon for the Powell Fed.

The Bernanke Put: Greenspan’s on Steroids

Assuming the Fed chair in 2006, Bernanke attempted to reverse the prior two decade long policy of excess liquidity. By 2007 Bernanke he had quickly raised the benchmark federal funds rate to 5.25%. However, after years of artificially low 1% rates under Greenspan’s Fed, raising rates too high and too quickly, to 5.25%, played a central role in precipitating the housing and derivatives bubble busts—the first commencing in 2007 and the latter in 2008.

The lesson of 2006-07 was clearly: after years of artificially low rates around 1% fueling debt-driven financial asset bubbles, rates could not rise to 5% or more, and certainly not that quickly in 2006-07. Today rates have been low, at 0.25% for almost eight years. And it’s unlikely that rates will have to rise anywhere near 5.25% to precipitate a similar markets’ response.

In the six years that followed the 2008 crash Bernanke would absorb the lesson of decades of excess liquidity, followed by too rapid rate hikes in 2006-07 only partially. To contain the 2008 crisis (fundamentally caused by excess liquidity enabled debt driven financial bubbles) he would resort to injecting even more liquidity in 2008-09. The ‘Bernanke Put’ would succeed the Greenspan’s Put by magnitudes. As a consequence, the Fed’s benchmark rate came down from a high of 5.25% to 0.25% in just months, and would remain there for eight more years.

The Fed rate collapse of 2008-09 was enabled by means of quantitative easing (QE) injections of $4.5 trillion (and more if refinancing debt maturity rollovers are counted), special Fed auctions, central bank currency swaps, and traditional bond buying open market operations. Per some estimates, perhaps as much as $8 to $10 trillion in liquidity was added by collective means to the global banking system by Bernanke during his tenure at the Fed.

If Bernanke failed to heed the dangers of excess liquidity and debt driving financial bubbles, by 2013 he apparently did absorb the lessons of 2006-07—i.e. not to raise rates too high-too fast in an effort to try to retrieve excess liquidity. In 2013, instead of raising rates too rapidly once again, he carefully suggested publicly that the Fed might begin raising rates once again in the near future—albeit very gradually and slowly. He also announced the Fed might even consider selling off some of its bloated $4.5 trillion debt.

However, just the talk of rising US interest rates in the US precipitated a near panic in emerging market economies (EMEs). EME currencies quickly depreciated, in turn accelerating capital flight from EME markets. Bernanke backtracked quickly in the face of what was called then the ‘taper tantrum’. But as he reversed his announcement he made it clear in late summer 2013, up until leaving office in February 2014, that it still was the Fed’s intention to eventually raise rates—as well as begin selling off the Fed’s bloated balance sheet (which would further raise rates)—at some yet undefined future date and at a slow rate. His Fed thereafter ‘marked time’ until his departure in February 2014 and replacement by Yellen. However, in the interim he had laid the groundwork for the Yellen Fed to implement his policy of rate hike gradualism.

Yellen’s Second Legacy

The Yellen Fed began clearly as a virtual extension of the Bernanke Fed: in the early years it continued to provide excess liquidity, like the Greenspan and Bernanke Feds before. Moreover, the Yellen Fed continued to do so for three more years, and only in the last year of her term cautiously began to seriously implement the Bernanke policy of gradual rate hikes.

It took the Yellen Fed two years before it would make even a token increase in rates, and then only a tepid 0.25% hike at the end of 2015. It took another full year before another token hike occurred, in December 2016. Neither together was sufficient to discourage the financial asset bubbles that were growing, still being fueled by the prior eight year policy of continued liquidity provided by the central bank.

It was only in 2017 that the Yellen Fed started to rise noticeably, in hikes of 0.25% well spread out over the year. From 2014 through 2016, the excess liquidity policy continued to feed financial asset markets expansion. The 2017 rate gradualism policy was modest and slow and clearly intended not to discourage financial markets from their steady run up that was set in motion back in 2010. The 2017 rate increases, which raised Fed rates to a level of 1.5%, were thus a cautionary hike in anticipation of potential aggressive Trump fiscal policy on the horizon, as well as a response by the Fed to the emergence of what was called the ‘Trump Trade’—i.e. rising financial markets, especially equities, in anticipation of business-investor tax cuts coming and the release of ‘animal spirits’ boosting business investment.

However, clearly the Bernanke-Yellen policy of rate hike gradualism was becoming less gradual by 2017. Gradualism was being slowly redefined. It was not 2014-16 token gradualism, but nor was it yet 2006-07 of rapid rate hikes! However, signs began to appear in 2017 that perhaps a repeat of 2006-07 (and perhaps its consequences) was not too far away.

Trump promises of accelerating fiscal policies—tax cuts and spending alike—were being taken seriously by financial markets in 2017. The so-called ‘Trump trade’ was boosting financial asset markets. In the face of that, the additional 1% hike in the Fed benchmark rate in 2017 did little to dampen financial asset market speculation and inflation. Stock markets in particular were now being driven by the new ‘animal spirits’ based on little but expectations of a great windfall in profits and capital gains from the Trump tax cuts.

By year end 2017, the thirty year, 1987 through 2016, ‘Grand Liquidity Put’ of Greenspan-Bernanke-Yellen clearly had come to an end. Fiscal policy would now drive monetary. Unlike the preceding period when monetary policy by central banks was the lead and fiscal austerity followed in its wake. By early 2018 it now appears the gradualist Fed rate hikes policy—announced and aborted by Bernanke in 2013 and begun to be implemented 2016-17 by Yellen—will soon be replaced with more accelerated rate hikes 2018-19. That raises the new scenario that future Fed policy may consequently look more like 2006-07—with all its consequences—overlaid with a new taper tantrum in emerging markets that will dwarf the aborted reaction of 2013.

Yellen’s Legacies; Powell’s Dilemma

The Powell Fed now faces a dilemma: Does it continue Yellen’s policy of relatively slow and occasional rate hikes, allowing financial markets to escalate still further into bubble territory, driven now by new forces of fiscal stimulus and the release of global investor ‘animal spirits’? Or does it raise rates faster, and in increments more than 0.25% as in the past, to confront the new fiscal stimulus and investor expectations? More important, what might be the effects of more rapid rate hikes on financial markets? Will it be 2006-07 all over again? How high must rates go until it does? The Fed says it doesn’t care about financial markets. But it is expected to say that. In truth, its past track record shows it clearly does care.

The Powell dilemma may be answered not by the Fed. Not by central bank monetary policy. In 2018 monetary policy may be relegated to a secondary role and forced to follow fiscal once again—something that has not been the case for decades. The Powell Fed may have its direction chosen for it—i.e. by the Trump-Congress fiscal policy already set in motion. By the Trump tax cuts, the accelerating US war spending, possible infrastructure spending, etc.

Yellen’s legacy of ‘rate gradualism’ will likely be abandoned—as trillion dollar annual US budget deficits loom now for years to come as a result of Trump tax cuts and spending plans. That fiscal policy shift already means the Fed will now have to borrow significantly more—in the next two years alone at least $600 billion more to fund the $300 billion in Trump tax cuts and $300 billion in additional budget deficit spending (and perhaps more if defense spending continues to rise as projected next year or Congress itself funds more than Trump has requested).

Beyond the next two years, in the longer run, perhaps $10 trillion more in US deficits over the coming decade, should certain assumptions by Trump and Republicans prove erroneous: i.e. should US GDP not exceed the projected 3% plus annual growth rates; should a recession occur sometime in the next decade which is highly likely; should foreign buyers of US Treasury debt slow their purchases, should US defense spending continue to accelerate; and should the Trump tax cuts cost more than initially reported.
Estimates of next year’s US budget deficit by JP Chase Bank research is already $1.2 trillion, and other sources project even higher. Most independent sources estimate average annual deficits of $1 trillion or more for a decade to come. That’s more than the $10 trillion, to be added to the current US national debt of $20 trillion. And that’s a mountain of Treasury bonds to be sold by the Fed, which will no doubt require more rapid, significant, and sustained Fed rate hikes to finance. The 30 year ‘Grand Liquidity Put’ is over. Central bank Fed monetary policy is henceforth the tail on the fiscal dog.

The question now being asked by ‘Fed watchers’, bankers, and business press pundits is whether Powell will continue Yellen policy of gradually raising Fed rates (not likely) or will he raise Fed short term benchmark rates even faster, perhaps four times or more in 2018, as has been signaled—and even further thereafter in 2019? And will the Fed under Powell accelerate the sell off of its balance sheet—announced by Yellen, but not yet really begun, thus driving rates higher even faster?

A next set of questions is whether a flattening yield curve now underway, and a slowing real US economy by late 2018-early 2019, bring the new rate hike and tightening Fed policy to a halt? Could it even mean, in the medium term, a return to a policy of rate reduction and cheaper money once again? How soon before rising rates precipitate another financial instability event?
Put alternatively: how high (and fast) will Fed rates rise in the short run, 2018-19, before the prior liquidity fueled financial asset bubbles of 2009-18 created by Greenspan, Bernanke, and Yellen begin to burst? The 10% February 2018 stock market corrections may be but a harbinger of things yet to come—a dress rehearsal correction that often occurs before the more sustained corrections that follow weeks, sometimes months, later.

Three to four rate hikes in 2018 may lead to history repeating itself. The Fed’s rate hiking in 2007-08—from a 1% Fed funds rate to more than 5%—precipitated the crash of the bubble in subprime mortgages that spread via derivatives contagion to the rest of the credit system. A similar experience in 2018-19 may be in the making, albeit with new causal transmission mechanisms and other financial asset markets. It won’t be mortgages and credit default swaps next time. Fed rate hikes may burst the current bubbles in stocks and junk bonds—this time transmitted by derivatives in the form of exchange traded notes & products linked to passive investing and quant hedge fund algorithm-induced automated selling. Or it may come from emerging markets, now overloaded with dollar denominated corporate debt, that collapse with massive capital flight and recessions provoked by rising domestic rates that shut down their own economies. It may even originate in China where, even if contained there, will send unknown psychological contagion effects across the rest of the global economy.

When rising rates driven by fiscal policy inevitably meet the financial fragility that exists in key sectors of the US economy, it may bring about the abrupt termination of the Fed rate hike policy about to accelerate at the Fed.

The last time the Fed reversed course and raised rates in 2006-08, rates rose beyond 5% before the bubbles imploded. Given the fundamentally more fragile US economy today, it may take far less a hike to precipitate the same!

As this writer has been arguing elsewhere recently, what’s different today from 2006-07 is that it will almost certainly not take a 5% Fed funds rate to precipitate another crisis. A Fed funds rate of 2%-2.5% may prove sufficient. A 10 year Treasury bond rate of 3.5% could provoke the same. Either could set in motion a serious contraction of bond or stock Exchange Trade Funds’ prices, accelerated by Quant hedge fund algorithmic trading, and amplified by the mass influx of passive index investing in recent years.

While that may not be the immediate short term scenario, it may not be far from the midterm truth, circa 2019-20!

Dr. Jack Rasmus is the author of the recently published book, ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression’, Clarity Press, August 2017, which has been previously reviewed on this magazine. He blogs at drjackrasmus and his twitter handle is @drjackrasmus.

posted March 15, 2018
Part 4: Concluding Chapter from ‘Systemic Fragility in the Global Economy’ book

Liquidity As Brake on Real Growth

The excess liquidity created since the 1970s—over and above what real investment has been able to absorb—has been flowing into financial asset investment. It has become far easier to create additional liquidity than it has been to find real investment outlets for it. The amount of liquidity has been so massive, and the growth of related debt levels so rapid, that governments and their central banks have been losing control of both—excess liquidity and incessant debt creation. Not surprisingly, the shift to financial investing has followed.

After having unleashed finance capital in the 1970s and 1980s to address the crisis of the 1970s, to expand capital globally to open new markets, to establish the unstable alternative to the Bretton Woods international monetary currency and trading regime, the system has not been capable of containing, managing or regulating the excess liquidity nor the excessive debt creation that has erupted in turn.

The historic contradiction is that the liquidity explosion set in motion in the 1970s is becoming a brake on economic growth it is supposed to generate. The massive liquidity and the ever-rising debt it has created have become a destabilizing force for the system, as financial asset investing crowds out real asset investment, and in turn is generating a host of related problems like chronic low job creation, stagnant wage income growth, weak consumption trends, slowing productivity, drift toward goods deflation, rising income inequality, and constantly emerging financial asset bubbles worldwide.

Restructuring Financial and Labor Markets

The trends associated with liquidity, debt, the shift toward financial asset investment and speculation, the slowing of real asset investment, the growing spread between the two forms of investment, the consequences for income growth to pay debt, the drift toward goods deflation amidst proliferating financial asset price bubbles—all together contribute toward fragility in the system. But this fragility does not occur in a vacuum. There is an institutional framework that is both the product of these trends and simultaneously a determinative factor of the trends themselves. Minsky referenced the institutional factor as relevant to financial fragility. Keynes spoke of the professional investor as responsible in part for instability in enterprise (real asset) investment. Both left room for further development of these contributions to understanding financial instability.

Financial Market Structural Change

The financial structure of global capitalism has changed tremendously and fundamentally since the 1970s. There has been an explosion of financial institutions that have played a key role in channeling the massive liquidity and credit injected into the global economy over the past four decades into investment projects—most of which have been financial asset in nature. New financial securities and products have been created for this excess liquidity to purchase. That means new, liquid financial markets have been created in which to buy and sell these financial securities. But investment is made by investors, i.e. by agents, who are both collective and individual. Financial institutions, old and new, buy and sell the new securities in the new markets. So do super wealthy individuals, who do so directly or else place their money capital in the hands of these institutions to invest on their behalf. They constitute the new ‘finance capital elite’ in the global economy—i.e. the inheritors of Keynes’ notion of the ‘professional speculator’ and of Minsky’s notion of the institutional framework behind financial fragility.

By new financial structure we mean this network of financial institutions sometimes called shadow banks, the liquid financial asset markets in which they speculate worldwide, and the new finance capital elite composed of the management of these shadow institutions and the 200,000 or so global very high and ultra high net worth individuals who invest either through the institutions or directly themselves in the financial markets. Conservative estimates indicate this network of global shadow banks and high net worth investors today control approximately $100 trillion in investible liquid and near liquid assets.

It is this new financial structure of institutions, markets, asset products, and agent investor-elites that together constitute the definition and meaning of ‘financialization’. Other narrow definitions based on share of total profits or employment, or the ‘FIRE’ (Finance, Insurance, Real Estate) sector, or influence in government quarters, or other variables are but ‘symptoms’ of financialization further defining the term.

Shadow banking expansion is a concomitant institutional expression of the key trends and growth of systemic fragility. The shadow sector continues to grow, evolve in form, and deepen within the global capitalist economy. Commercial, regulated banks have become integrated with the shadow sector in various ways, including institutionally. That was one of the problems that led to the generalized credit and banking collapse in 2007-09. It was the investment banks (Bear Stearns, Lehman Brothers), the dealer-brokers (Merrill Lynch), insurance companies (AIG), mortgage companies (Countrywide), GE Credit, GMAC, Fannie Mae-Freddie Mac, and others—all shadow banks—that first collapsed. Because of their integration with the commercial banks, these too were dragged down. Major banks like Citigroup, Bank of America, WaMu, RBS and others in the UK, and Eurozone banks in Belgium, Ireland, Iceland and elsewhere went ‘bankrupt’ or were put on life support by governments even though technically insolvent (e.g. Citigroup and Bank of America).

Shadow banking has also spread into non-bank multinational corporations. GE, Ford, GM, and others have themselves long operated ‘finance company’ shadow banks. And today a growing percentage of multinational companies are de facto, in house, shadow banks as well—what might be called ‘Deep Shadow’ banks. Shadow banking is spilling out into new corners of the economy all the time, pioneering new ground in online finance and what’s called ‘crowd funding’. All these institutions would not exist, however, were it not for the excess liquidity available for them, and their elite investors, to invest and for the proliferating liquid markets in which they invest. Nor would they exist without the financial innovation that has created the financial products which they buy and sell in those markets.

Considering just the history of the US economy, every serious ‘great’ recession and depression since the early 19th century has been associated with some form of shadow banking engaging in speculative financial asset investing. Excess liquidity and debt have always been a prelude to a financial banking crash that then dragged down the real economy. In the wake of each crisis, banks and shadow banks were regulated. However, after a period new forms of shadow banking arose again and the shift toward financial speculation and instability resumed.

The restructuring of the financial sector in the US and UK economies did not just happen. It was the outcome of conscious policy initiatives that began in the late 1970s and early 1980s, and continued to evolve thereafter. Changes came slower and later in Europe and Japan. And the penetration of shadow banking and financial speculation in China only dates from the end of the 2009 global crash, but has accelerated there the fastest to date. Policies included not only pushing financial deregulation but enacting special tax privileges, ease of institution start up, permitting opaque trading of securities (especially derivatives), and other measures.
Although a number of ‘official’ reports on shadow banking have appeared in recent years, most have defined it narrowly by focusing on a few selective characteristics. Some associate the institutions with certain financial markets and instruments. But none tie the institution, instruments and markets involved with the ‘agents’ element—i.e. the finance capital elite of professional investors and speculators worldwide.

Creating and expanding the ‘markets’ and financial instruments traded was even easier. With the exception of equity, commodities, and bond ‘exchanges’ most markets are virtual and electronic. And even those are increasingly redirected in part to what are called ‘dark pools’, where only the financial elite and institutions get to trade stock and other securities, in total secret, invisible to the rest of the John Doe trading public. As for financial engineering of new securities, hire a couple of ‘whiz kids’ from the Wharton School of Finance and they develop the new ‘games’. It all begins to resemble less a form of investment per se, and more a form of financial ‘consumption’ by the very high net worth financial elite.

As the financial sector restructuring continued to evolve through the 1980s and 1990s, the number and size of shadow banks, of liquid markets, and of securities increased several fold—as did their profits and the total investible assets under their control. As the structure developed so too did the scope of the financial investing. Innovations like ‘securitization’ of various financial asset classes and the rapid expansion of derivatives accelerated the investing in financial assets. The great returns fed the continuing structural change, which encouraged even greater returns. By the 2000s, financial assets were being created out of anything that might have some kind of income stream—like bonds issued based on a rock star’s concert tour or from a UK pub chain’s beer sales. And securities were merged with other securities to create a third security, which was then ‘marked up’ and resold. For example, mortgages on homes were merged into mortgage bonds, marked up and sold. The mortgage bonds were then ‘securitized’ by being merged with, say, Asset Backed Securities (ABS), marked up and resold again as a ‘collateralized debt obligation’ (CDO). CDOs were combined with other CDOs to create a synthetic CDO and resold. And credit default swaps (CDS) were then issued as insurance contracts sold on the CDOs in the event this shaky edifice of securities might somehow tumble.

All along the way, debt was increasingly leveraged in the purchases of the various tiers of products. Financial returns rose so long as asset prices did, and more debt and leverage occurred. Escalating debt meant rising financial fragility. But the fragility from debt was offset, shielded and obscured by rising income streams from the price appreciation—so long as prices continued to rise. Once the price of financial assets began to slow, the income stream vanished. But the debt remained. And as asset prices turned down, the offset to fragility from rising price and profit income evaporated. Now financial fragility was driven not only by high debt levels but by the second variable, income, rapidly falling as asset prices collapsed. All that was 2007-09.

Today the financial structure continues to evolve. New online forms of shadow banks are rapidly evolving. New derivatives are being created. Asset management products are the hot item in China, for example. And the financial elite continue to move their money around the numerous global liquid financial markets. Out of Euros, pesos, and Canadian and Australian dollars into US dollars. Out of commodity futures into US and Euro junk bond debt. Out of China stocks into high end US and UK real estate property. Out of emerging market stocks into Exchange Traded Funds (ETFs). Out of betting on Chinese stock price rises into betting on a Chinese stock price collapse.

What the preceding describes is how financial fragility, to use Minsky’s term, has continued to rise since 2009. The private business debt levels have escalated, as perhaps five trillions of dollars in junk bonds and corporate investment grade debt, leveraged loans, and other securities have been issued since 2009. That debt will remain unless defaulted or written off. But the income or cash flow (to use Minsky again) can easily evaporate should asset prices fall—i.e. should a major China-precipitated global stock market correction occur, or bond prices rise too rapidly once the US and UK start raising interest rates, or oil prices fall below $40 a barrel and commodity prices continue to tumble further. Then both debt and income decline begin to reinforce each other. Then fragility accelerates, perhaps to a point that may ‘trigger’ a financial instability event of global proportions.

Minsky, Keynes and others focused on the financial side of fragility, i.e. on bank and non-bank business fragility driven by the debt-income relationship just noted. Minsky mentions household fragility, but sees it occurring as a consequence of spillover effect from deteriorating financial fragility. But this is incorrect. Spillover may occur. But there is a separate dynamic of structural change—in labor markets and impacting wage incomes—that has been developing in parallel to financial structure change. Labor market change also began in the late 1970s and has continued to develop ever since.

Labor Market Structural Change

Similar to financial sector structural change, labor market change has not occurred by accident or by some natural process. It too has been the consequence of conscious policy decisions made by politicians, government, and industry business leaders since the late 1970s. And since 2000 those changes have been further intensified.

The rise of wage incomes has slowed significantly throughout the advanced economies due to the general shift from hiring full time, permanent workers to hiring part time and temporary workers—the latter at lower rates of pay and weekly total earnings due to shorter hours. Everywhere in the advanced economies this has been a major trend. It is a practice that dates from the 1980s but has accelerated after 2000. Additional wage compression has occurred as these workers are denied normal retirement eligibility or have their retirement benefits reduced and, in the US, are forced to pay more for less healthcare benefit coverage. Workers either must pay out of pocket for the loss, or do without retirement income, thus lowering their real wage income further.

The more frequent and deeper recession cycles and the slower job recoveries that have typically followed have also reduced wage incomes. Secularly for decades now, tax incentives for moving companies and jobs offshore have gutted formerly higher paying jobs and thereby also reduced incomes in the United States.

Minimum wage and overtime pay laws have atrophied over the period with the same effect. Forms of wage theft by service sector employers have also increased. More young workers are desperately undertaking ‘wage-less’ internships with employers in the false hope of someday being hired to a real job. Meanwhile, employers turn over and ‘churn’ them in order to continue to get others to work without having to pay them. The so-called ‘sharing’ economy (Uber, Lift and other transport companies) is destroying jobs and income for taxi drivers and public transport workers, and this trend threatens to break out into other industries enticing more employees to work part time for less and with no benefits. The net income declines, as those who gain income realize less additional income than is lost by others losing their jobs.

Unions have been increasingly decimated or destroyed since the 1980s, thus eliminating union wage differentials that provided more income for unionized workers. The institutional vehicle for unions achieving wage differentials—i.e. collective bargaining—has been chipped away for decades. The main tactical weapon, the right to strike freely, has been circumscribed and all but effectively prohibited. Laws and agency rules have wrapped a legal web around union organizations and their activities, funneling unions and their members into an ever narrowing field of permissible activity.

The reduction of what were once ‘export-import’ wage differentials has been added to the elimination of union wage differentials with the same effect. Free trade has replaced the export-import wage differentials in advanced economies, with new jobs with lower wages. Meanwhile, no firm evidence is provided that shows net wage incomes from free trade has risen to equal or offset the net wage income loss in advanced economies.

All these developments reflect major changes in labor markets, especially in the advanced economies. Many of the above labor market changes originate in the production process, introduced by employers as cost saving initiatives to offset declining productivity and profits. But governments have been totally complicit in the process, passing legislation and rules that encourage employers to introduce the labor market changes. Governments then subsidize those changes with tax incentives, and eliminate previous legal limits and restraints on the practices that previously existed.

Occurring first most intensively in the ‘core’ of the advanced economies, US, North America, and the UK, similar changes in labor market conditions that reduce wage incomes have since been introduced or proposed in Europe and Japan under the cover of what’s called ‘structural reforms’ or, more explicitly, labor market reforms. These structural reforms are designed to compress wage incomes in order to make exports more competitive to steal growth from competitors. Japan and Europe are today particularly engaged in introducing and expanding labor market reforms—aka wage and benefit compression—to boost exports and domestic production at the expense of other competitors. Labor market change along the lines introduced by the core advanced economies, in effect now for decades and intensifying, are therefore also spreading geographically. They are becoming one of the several defining characteristics of 21st century global capitalist economy.

Labor market structural changes thus have the consequence of reducing real wage incomes for the majority of households and consumers. Stagnant or declining real wages means a rise in consumption fragility, all things equal. But wage stagnation also results in a rise in consumer household debt, as households attempt to maintain living standards under pressure from stagnating and falling wage incomes by taking on more consumer debt. Fragility grows more or less simultaneously from two directions—from slowing consumer incomes and rising consumer debt. The result is reflected in the growing share of debt financed consumption, compared to consumption growth reflecting income gains, in total household consumption.

The growing share of debt-induced consumption by households in recent years not only raises consumption fragility. Household debt also has the effect of dampening government fiscal multipliers, making traditional fiscal policies less effective. It is one reason why economic recovery since 2009 has been so anemic. In that sense, residual household debt after 2009 is similar to business and bank debt, which dampens the effect of money multipliers on non-bank borrowing, and in turn lowers actual and potential real investment.

Structural Change and Fragility

Both financial restructuring and labor market restructuring have steadily raised fragility over time. Both lead to excessive debt. Financial restructuring has enabled and assisted the shift to financial asset investing, facilitating the leveraging of increasing amounts of debt. Independently, labor market restructuring has resulted in stagnating and declining wage incomes, requiring households to turn to more debt in order to maintain living standards and consumption. While both financial restructuring and labor market restructuring have their own independent dynamic contributing toward fragility, the fragility they create in their respective sectors—financial and households—also feedback on each other and thus intensify the fragility of each.

A final observation is that financial sector debt has played a larger role in generating financial fragility than household debt has toward consumption fragility. For example, in the US data shows that escalation of total debt—business, banking, consumer and government—has been mostly business debt and most of business debt has been financial institutional debt. Data by the Bank of International Settlements corroborates this trend worldwide. It is private sector debt that has accelerated fastest since 2009 and that has been mostly corporate debt, not consumer debt. Since 2000, and 2009 in particular, government policies have restored income to business and financial sectors. So declining income has not been a major contributing factor to financial fragility.

However, this has not been similarly true for households and consumption fragility, where governments have not restored incomes to the majority of households. Consequently, declining income has been a contributing factor, along with rising debt, to households. Non-government policy forces also contribute to this decline. Financial asset prices recover and accelerate after a financial crash much faster than labor prices (i.e. wages). Financial institutions recover more quickly than households after a crash and recession. Unlike the business and financial sector, households cannot raise their prices—i.e. wage—incomes. Continued labor market restructuring holds down wages even in the recovery from recession phase, whereas continued financial market restructuring serves to raise financial asset prices and therefore incomes during the recovery phase. That is a fundamental difference between financial restructuring and labor market restructuring.

A consequence is that households remain more consumption fragile in recovery due to the dual effect of stagnating wage incomes and rising household debt than financial institutions, banks, shadow banks, etc., that experience debt escalation in recovery but also income (cash flow) recovery as well that serves to postpone financial fragility. That is, until financial asset prices (and incomes) collapse in another crisis. Then financial fragility accelerates for financial institutions as well. It is only then—in the immediate crash and contraction phase—that the two forms of fragility—financial and consumption—begin to feed off of each other and each causes the fragility of the other to worsen in tandem.

Fiscal-Monetary Policy: From Stabilizing to Destabilizing

Both fiscal and monetary policy must be considered among the nine key trends that are associated with rising systemic fragility and therefore instability.

Mainstream economic theory views fiscal and monetary policies as serving to restore stability in the system once a financial crisis and/or recession occurs. Fiscal policy—i.e. government spending and tax measures—are viewed as providing a necessary stimulus when either a financial crash or real contraction occurs. Taxes are cut. Spending is increased. GDP recovers. For monetary policy, the central bank increases the money supply through what are called ‘open market operations’, or by reducing reserves private banks must keep on hand and not lend, or lowering the central bank’s interest rate at which private banks may borrow from it. Mainstream theory explains this leads to lower interest rates that stimulates borrowing from banks. This all seems logical, but it’s not how the system works—not since 2009 or even 2000 in the advanced economies especially. The question at this point is how and why do traditional forms of fiscal and monetary policies today, especially in the advanced economies, contribute to systemic fragility.

The tendency of monetary policy to lead to more fragility not less, is the most obvious. Take central banks’ pumping excess liquidity into the global economy ever since the end of Bretton Woods in 1973, followed by the elimination of controls on global capital flows in the 1980s, and the technology revolution in the 1990s that accelerated money flows electronically by many fold. The massive liquidity injections have contributed significantly to debt, financial asset speculation, and other structural factors that have resulted in escalating fragility. Central bank supervision of the private banking (and shadow banking) sector has proved a colossal failure. That too has allowed, even encouraged, the almost unaltered rise of financial asset investing and speculation. Bank policy of more than seven years of near zero, and real zero or lower, interest rates has contributed mightily to household consumption fragility as tens of millions of households dependent on fixed interest income have witness their income streams from interest virtually disappear. Zero interest rates policy amounts indirectly to a transfer of income from retirees and others on fixed incomes to banks, shadow banks, and speculators.

Monetary policies, both traditional (open market operations, etc.) and emergency (special auctions, quantitative easing, QE, and zero-bound rates) have bailed out the private banks since 2009, at least in the US and the UK, but have done little or nothing for stimulating the real economy. Estimates are that it now takes four dollars of central bank money injection to get one dollar of real GDP growth, compared to two dollars for every dollar in previous decades. That’s a ‘multiplier effect’ of only 0.25. That’s true not only in the advanced economies, like the US, but apparently, by latest estimates, in China as well. Central bank policies of massive liquidity injection as the primary policy response to a crisis may bail out the banking system, but only temporarily. That same liquidity that bails out the banks in the short run, also adds to the excess liquidity that simply leads in the long run to more debt and more financial speculation that ends up creating another crisis again. So monetary policy has been, and remains, only a temporary palliative to the fundamental causes of the crisis and, in fact, actually exacerbates those same causes over the longer term. Such monetary policy is like giving a terminal cancer patient a massive dose of chemotherapy, which only buys time for the patient, makes him sicker, destroys his immune system, and weakens him for when the patient’s condition worsens once again.

Fiscal policy fares no better so far as reducing fragility is concerned. In theory, government spending targeting consumer households should raise household income and thus reduce consumption fragility. But the composition and timing of the spending is what counts, not just the magnitude of government income support. If the spending is in the form of subsidies it only provides a temporary stimulus that disappears as soon as the subsidies run out. If spending is on long term infrastructure projects, especially if capital intensive instead of labor intensive, then such spending also has little effect for the same reason. And if the stimulus is in the form of tax cuts, in a high debt and fragile household scenario most of the tax cuts will be hoarded or used to pay down past debt—thus adding little to the economic recovery.

What Can Be Done

What is needed is government spending or programs that eliminate household debt directly, and also result in creation of (non-terminating) jobs directly by the government. Only job creation produces an income stream that doesn’t dissipate, but continues after the initial spending occurs. But recent economic history shows that, in the advanced economies at least, even poorly composed and timed fiscal policies were only dabbled with in the immediate post-2008 crisis period. Thereafter, actual policies with regard to government spending were just the opposite. What happened, and continues to happen, was not fiscal stimulus but fiscal austerity.
Fiscal austerity policies result in a significant reduction in household wage incomes and therefore a rise in consumption fragility. So where austerity policies have been most pronounced—i.e. in Europe and Japan—consumer spending has not recovered. Policy makers and press pundits then wonder, amazingly, why that is the case. However the explanation is simple and evident: as household income stagnates or declines, consumers turn toward more debt. Together the declining wage incomes—caused in part by fiscal austerity policies—and rising debt loads add doubly to consumption fragility.

Even when occurring in the form of fiscal spending designed to stimulate the economy, government spending effectiveness has declined. Government consumer spending and tax multipliers have had a declining influence. High levels of household debt have the effect of blunting and reducing government spending multipliers, as consumer households use government spending injections to pay down past debt instead of finance new current consumption. And stagnating wage incomes have the effect of blunting multipliers as well, as government spending results in more hoarding of the spending for ‘rainy days’ they expect are more likely to occur again instead of spending the added in come on new consumption.

Government spending and tax cutting that target corporations (bank and non-bank) also get ‘bottled up’ instead of resulting in more real asset investment. Much of the business tax cuts in particular are redirected to offshore investment projects, if they exist; to more profitable financial asset investing; to stock buyback and dividend payouts; to purchasing, merging and acquiring competitors; or are just hoarded on company balance sheets.

Whether targeting consumer households or business, traditional fiscal policy has a declining effect on generating incomes—and that means more fragility. But in any event, traditional fiscal policy has hardly even been used since 2000 and especially since 2009 in the US, UK and other advanced economies. What’s been employed is fiscal austerity—and that definitely has exacerbated consumption fragility, while encouraging more financial asset investing and therefore business debt and more fragility on the financial side.
Evidence is therefore abundant, and increasingly so, that monetary policy definitely causes an acceleration in financial fragility by encouraging bank and non-bank debt build up, while chronic low interest rate consequences of monetary policy reduce household income and raise debt that exacerbates consumption fragility as well. Simultaneously, fiscal austerity policies even more strongly negatively impact household income and debt, while fiscal stimulus policies targeting bank and business tax cuts encourage still more financial asset investing, stock and dividend buybacks, mergers & acquisitions, etc., all of which encourage more business debt.
Actual fiscal-monetary policy thus has become a cause of financial, consumption, and therefore systemic fragility in the system over time, rather than serving to reduce that fragility. Policy is an important contributing cause of systemic fragility.

by Dr. Jack Rasmus
Excerpt #4, Chapter 19, Systemic Fragility in the Global Economy
Clarity Press, 2016

posted March 8, 2018
A Theory of Systemic Fragility, Part 3 (from Chapter 19 of book, ‘Systemic Fragility in the Global Economy, Clarity Press, 2016

Financial v. Real Investment

Business economists and media commentators like to reference the ‘spread’ between long term and short term interest rates as indicative of the ageing business cycle and equity market expansion. The ‘spread’ between financial asset and real asset investing may represent a more important long run indicator of the economy’s trajectory.

The excess liquidity that leads to greater usage and leveraging of debt results in a convergence and thereafter subsequently a growing gap between financial and real asset investing over time. Liquidity, debt and leverage may expand real asset investment, when the periodic ‘fits and starts’ of such investment opportunities arise internally or externally. But the shift to financial asset forms of investing has proved to be more sustained over the last quarter century. Since 2000, financial asset investing has continued to accelerate, notwithstanding the abrupt ‘correction’ that occurred in 2008-09.

In contrast, real asset investing has continued to drift lower steadily since 2000, except for relatively brief surges related to oil-related capital spending, the opening of China to western investment capital inflows after 2000, and the emerging markets investment boom that followed. However, all these examples of real investment cycles have proved short-lived. The real asset investment that occurred after 2000 has been largely concentrated in these three areas—oil and energy, China, and emerging markets infrastructure and commodity development. By 2014-15, however, all three have clearly reversed and either slowed or contracted. Real asset investment is likely to slow even more over the coming decade.

In contrast, financial asset investment accelerated steadily and rapidly until 2008, only briefly contracted 2008-09, and then surged to further record levels since 2010 to the present. Should another financial crisis occur in the next five years, it may be deep but will likely be short again, as it was in 2008-09. Further liquidity injections by central banks and governments will no doubt occur in order to bail out the financial system, temporarily stabilizing it but in the process of bailing it out creating the conditions for another financial crisis later. But bailing out and jump-starting real investment and the real economy will not be as easy, even in the short run.

The ‘external’ or geographic expansion opportunities for restoring even the modest real asset investment growth rates of the past decade do not appear as likely as in previous decades. The former Soviet bloc, Chinese, and emerging markets opportunities for real investment are not repeatable. Perhaps Africa’s resources and the development of its infrastructure will fill that role, but the African potential is nowhere near as large as the others have been. As for ‘internal’ expansion opportunities, the physical assets needed for the new industries do not appear as great in terms of structures, equipment, inventories and other assets that will be required. The digital technology-internet-communications investment revolution that began in the mid-late 1990s was far more real physical asset intensive compared to the social networking, bio technology, and other candidates for real asset investment. Nor will the alternative energy investment opportunities result in a real investment surge similar to the tech surge. Alternative energy will have to be financed in large part by the government sector, as part of the predicted growth of government as share of GDP from around 20%-22% (in the US) to the 30%-35%. That will take longer and occur more slowly.

In contrast to this modest scenario for real asset investing, financial asset investment will continue to grow relatively, and in some cases absolutely, in size and total assets compared to real asset investing.

Facilitating that faster financial asset growth will be the new financial structures of institutions, liquid markets, and new financial securities, continuing financial product innovation, and the global network of the incredibly wealthy new finance capital elite that are now globally widespread and entrenched. It is estimated more than $100 trillion in investible assets are available in this global structure of institutions-markets-investor agents. Much of this wealth has been created from financial investing and speculation in the past. And it is not about to disappear or remain idle.

At the same time, central banks and governments have little alternative to continuing to pump more liquidity into the system in order to prevent the global banking system from collapsing. The system is now addicted to more or less free money. It cannot function if central banks raise interest rates to 4% or more. It remains simply too fragile.

Once envisioned as a brake on the shift to financial investing, the financial sector re-regulation that was launched in the wake of the 2007-09 global crash has been a dismal failure. What remains of token banking regulation in what were formerly, but no longer, the weakest sectors of global banking—the US and UK—have been and will continue to be dismantled piecemeal over time. It is a myth therefore that global finance capital can be regulated by any one country or government. Finance capital is like water running down hill; it eventually finds a way around government regulators.

Financial regulation is futile for another reason: the political changes in the advanced economy countries in particular have reduced general democratic influence while the influence of corporations, including bankers and investors, has continued to rise. That makes it even less likely that regulation of financial institutions will prove significant enough to check the next financial crisis, let alone slow the continued expansion of financial investing in the interim.

Liquidity injections by central banks will continue, as will more inside credit through the shadow bank system. Both will ensure the continued expansion of debt, and that means continuing debt will raise fragility in the system for years to come.

Given the almost certain long term continuing expansion of financial asset investing, and the corresponding continued slowing of real asset investing in the 21st century, the question arises: what are the consequences of this dual trend—for theory, for policy, and the trajectory of the global economy?

For theory, the dichotomy of investment raises the question: what is the causal relationship between financial asset and real asset investing? Is the slowing of real asset investing due to causes other than financial? Is the slowing driving the shift to financial asset investing; or is the rise of financial investing resulting in a slowing of real asset investing? Is it causality in both directions? If so, is it equal in determination? What is the process by which financial determines real, and real the financial? And what are the identifiable transmission mechanisms or variables. Transmission variables and processes are critical. Otherwise there is only a correlation between slowing real asset investment and rising financial asset investment, and correlations are too often misrepresented as causation.

The dichotomy of investment has significant implications for economic policy. If there is a shift from real investment toward financial assets that means less employment as well as employment at lower wage incomes. Real asset investment is more heavily weighted toward construction, manufacturing of producer and consumer goods, mining, industrial production, transport equipment and services, the inventorying and warehousing of goods, and research & development related services. Financial investing involves more professional services. The number of employed per dollar of investment is far less in financial than in real asset investing.

Consequently, the total income created is less as well. This means less household consumption as the household sector receives less of the total income created from financial asset investing—so insofar as the ‘bottom 90%’ receive little or no income from financial capital gains. Since financial transactions are hardly taxed, the slowing of real investment and subsequent decline of wage income and consumption translates into less tax revenue for government units as well. In other words, the shift to financial investing means a shift in income—from wage earning households and government units to financial institutions and wealthy investors.

Both households and government become more ‘fragile’, since fragility is a function of slowing or declining income from which to make payments on principal and interest from debt. This has a negative feedback effect. The slowing wage income gains for households means households often end up taking on more debt in order to maintain standards of living that otherwise fall from less earned income. Thus, consumption fragility rises for double reasons—slowing income and rising household debt. The same process takes place for government units, especially on the local level. Lower tax revenue collected leads to government units having to assume more debt (selling muni bonds by local government and Treasury bonds by national government).

These examples show that fragility can breed fragility within a sector (households or government) as declining income results in rising debt; and that the opposite may also occur—i.e. rising debt leading to declining income as future debt payments reduce future income streams. Whether due to rising debt loads, declining incomes, or both, fragility may also breed fragility between sectors. Should declining incomes lead to less consumption, it means less tax revenue income for government units and therefore an increase in that sector’s fragility factor as well. And if tax income slows, government units face a deficit and may have to borrow more to maintain spending levels. That means more debt and thus even more fragility.

One can immediately see the implications of all this slowing income growth and rising debt for government policy. Does the government raise taxes to restore income loss and avoid having to raise debt? If so, it may reduce its fragility factor, but only at the expense of raising fragility in the sector where taxes are raised (i.e. households or businesses).

More on these, and other, examples of feedback effects in policy and transmission mechanisms within and between fragility categories shortly. For the moment, it is evident that the growing dichotomy between real and financial asset investing that occurs as financial asset investing rises relative to real assets, has major policy implications.

Inflation-Deflation and the Two Price Theory

As for the implications of the financial shift for the trajectory of the global economy over time, the financial investing shift means not only important income inequality trends develop–with implications in turn for future economic growth that income inequality brings—but also important price trends result from the financing shift.

Slowing real investment means slowing productivity in goods production, cost cutting, further job cuts, slower wage gains, and less income. Less income suggests less consumption demand. At the end of this string of effects is goods deflation, which eventually emerges as consumption demand declines due to lower wages and income.

In contrast, the financial shift means more demand for financial asset products and therefore more asset price inflation. The demand-driven character of pricing for financial assets tends to feed on itself. Demand leads to price increases resulting in still further demand and price increases. In the case of financial securities, unlike goods prices, there are few offsetting supply and cost restraints to slow or dampen the inflationary tendency. Therefore, while goods prices tend to dis-inflate, and then eventually deflate, as a consequence of the financial shift, conversely financial assets tend to inflate and accelerate as financial bubbles emerge.

There is the added element, moreover, that financial asset price behavior appears more prone to inflationary expectations, compared to goods prices and expectations. Inflationary expectations appear to accelerate faster in the case of financial assets. The converse is also true, deflationary expectations play a larger role with financial assets.

The even more important question is how do changes in financial asset prices affect goods prices? And do changes in goods prices affect financial asset prices similarly?

So far as equity asset prices are concerned, it does appear that a rise in the price of a product for a particular goods producing company may reflect in a rise in that company’s stock price, at least to the extent the goods price rise results in greater profit. But we are talking here about aggregates, not individual prices for this or that product or even company. The question is whether the general price level for goods rises when financial asset prices rise. Since 2009, at least in the advanced economies, this does not appear the case. Goods prices have been disinflating and drifting toward deflation, while financial asset prices have been accelerating in stocks, bonds, and other financial securities. Nor does there appear to be strong correlations between financial asset inflation driving up the general price level for goods.

So during the boom phase, neither price system seems to determine the other very much. Financial asset prices may rise as the availability of credit in general expands. But after a point financial asset prices develop a dynamic of their own, rising as demand drives further demand, even as goods inflation slows. On the downside, in the case of deflation, however, financial asset deflation and goods deflation do appear to have a stronger mutual effect on each other.

For example, in the event of a financial or banking crash, as occurred in 2007-09, financial asset prices across the board—i.e. mortgage bonds, stock prices, municipal bonds, derivatives securities, etc.—declined rapidly. Liquidity froze up. Financial institutions withheld loans and corporate debt issuance dried up. With collapsed asset values on their balance sheets, banks and financial institutions refused to lend to non-banks and hoarded available cash and liquid assets, which were still insufficient to cover their deep financial asset price deflation and accounting losses. With no sources of lending for even their every-day operational loans, non-bank businesses cut costs—mostly wage costs via mass layoffs and other compensation freezes and reductions—aggressively and immediately. Suppliers were also cut off from payment, and had to follow with the same. At the same time as the severe cost cutting, non-bank companies attempted to generate more short term income by dumping their inventories and trying to undersell competitors by lowering their product prices. Just as the financial asset price collapse became a generalized phenomenon at the time, so too did the mass layoffs, cost cutting, and goods price cutting. The financial crash thus set in motion the process of real economic contraction that led to goods price deflation as well.

The opposite deflation effect—from goods to financial assets—is also more likely in the wake of a financial crash and consequent steep contraction of the real economy. This may occur directly and indirectly. In direct terms, declines in goods prices may reduce profits or other key business indicators, which may result in a decline in stock prices; or, reduced cash flow may raise concern by investors whether the company can make its debt payments. That causes the company’s bond prices to fall in turn, as its interest rate for obtaining new debt rises.

The process of goods deflation provoking financial asset deflation may occur more indirectly as well. For example, non-bank companies’ access to borrowing with which to finance operations declines rapidly during the initial recession contraction. Their available ‘income stream’ from sale of products serves as the main source from which to make continued debt payments, since further borrowing and debt is not available in this phase. But the mass layoffs that accompany the recession downturn sharply and quickly reduce household wage income and consumption. To entice demand from households, and ensure the necessary continued income-cash flow stream with which to pay debt, price reductions for goods becomes the remaining primary source of cash flow for continuing debt payments. And when many companies are attempting to do the same, goods price decline leads to more good price declines—i.e. to goods deflation. In this indirect manner, financial asset deflation can ultimately translate into goods deflation as well.

What’s further important to note is that these two processes—i.e. of financial asset price deflation eventually provoking goods price deflation and goods price deflation ultimately causing further financial asset deflation—is a mutual interaction. Both processes feed back on the other in a contractionary phase. There are two price systems and the two intensify their mutual reaction under certain conditions.

In other words, there is a dynamic and even dialectical process by which deflation in the one price system drives deflation in the other. This mutual deflationary process occurs primarily in the post-financial crash real economic contraction phase. The greater the mutual effect, the more the two price systems together intensify the contraction, each feeding off the other. When the deflation in financial assets becomes especially severe, it results in defaults. Financial asset prices may then virtually collapse, as courts and bankruptcy proceedings sell off the remaining assets by auction. Should enough defaults simultaneously occur, or defaults for highly visible companies occur, the psychological effect of fear of asset price collapse and contagion spreads to other companies causing other financial assets to decline more rapidly as well.

Understanding these mutual feedback processes is possible, however, only if one recognizes the fact of a ‘two price theory’ where financial asset price behavior is different than goods price behavior. Not all prices behave the same in relation to supply and demand. Not all price movements restore equilibrium, which requires the ‘supply and demand’ equilibrating assumptions based on pure competitive markets which do not exist. Mainstream economic theory, which does not recognize the ‘two price system’ idea, fails to explain how financial asset and goods prices interact, especially in the contraction phase. Nor does it address why, in the boom phase, financial asset inflation develops an independent dynamic of its own from goods price movements. But this is not the only error that mainstream economic analysis makes with regard to the role of price in financial instability and in precipitating great recessions and depressions in turn.

From Stagflation to ‘Definflation’

Economics has a term for declining real growth amidst rising inflation: it’s ‘stagflation’. It became common during the crisis of the 1970s. The term refers to ‘real’ variables—both GDP and goods prices. ‘Stagflation’ occurred when GDP slowed and declined while price inflation accelerated. That inverse relationship between GDP and inflation has reappeared, although this time the variables are not GDP and goods prices but goods deflation, on the one hand, and financial asset price inflation and aggregate valuation on the other. Perhaps another new term is necessary to represent the new ‘inverted relationships’, where financial asset prices inflate while goods prices disinflation and deflate. For lack of a better suggestion, perhaps ‘Definflation’ might be appropriate.

The emergence of stagflation in the 1970s posed a serious policy dilemma for economists. Prior to stagflation, if fiscal-monetary policy focused on economic stimulus and growth, then GDP could be expected to rise and unemployment decline. The trade-off was that goods inflation would also rise. If the policy focus was on reducing inflation, then fiscal-monetary policy would aim to contract the economy, reducing income and therefore demand for goods and lowering goods prices. The trade-off was more unemployment. But 1970s stagflation discredited that theory. Fiscal-monetary stimulus would not reduce unemployment but would increase inflation further, and fiscal-monetary policies seeking to slow the economy, made unemployment worse without reducing prices. Policy was stymied. Something similar is the problem today. Monetary policy is attempting but failing to prevent the slowing of real investment and the drift to deflation in goods prices, while simultaneously boosting financial asset investment and inflation.

The consequences for the long term trajectory of the global economy are serious. How can we halt the drift toward goods deflation if monetary policy primarily boosts financial asset investment and inflation and not only does little to halt goods deflation, but may actually contribute to it? How can we restore real asset investment to prior growth rates when increasing liquidity leads to financial investing since it is potentially more profitable and holds other advantages as well? Can the growing problem of income inequality be resolved by token adjustments to wage incomes, even as real investment is slowing and financial capital gains and capital incomes from financial profits are accelerating? How is it possible to slow and reverse the shift to financial asset investing, inflation, and redistribution of national income to capital incomes at the expense of wage incomes, without a fundamental change in the size and class policy orientation of government? And without major damage to financial sectors?

Economists are at a loss to explain how to get out of the policy dilemma of deflation amidst inflation today in 2015, just as they were in the prior crisis in the 1970s as to how to get out the ‘stagflation’ policy contradiction. That leads to a related subject and debate that is also associated with the shift from real to financial asset investing worth briefly commenting upon.

The Irrelevant ‘Money Causes Inflation’ Debate

Just as in the 1970s when they debated somewhat futilely whether there was in fact a policy tradeoff between inflation and employment, since 2008 mainstream economists have been continuing to debate whether the excess money supply (i.e. liquidity) injections by central banks will lead to excessive inflationary pressures at some point.

The one wing of mainstream—who are called in chapter 16 ‘Retro-Classicalists’—argue that Federal Reserve policy will eventually result in runaway inflation. The other wing—the ‘Hybrid Keynesians’—argue there is no evidence this is occurring or will occur. Both are wrong, and both are right. Which means both are confused. The ‘Hybrids’ (liberals like Paul Krugman) are correct that the massive money injections have not led to goods inflation. In fact, goods prices continue to drift lower in the US, are still lower in Europe and Japan, and are even slowing in China. Krugman of course refers to goods inflation. But Krugman’s error lies in not addressing financial asset inflation, which has accelerated rapidly due to the record liquidity injections. The ‘Retros,’ (conservative Monetarists like John Taylor), insist on goods inflation coming around the corner (or the next, or next). But Taylor is also ignoring financial asset inflation. In other words, both Hybrids and Retros are fixated on goods prices and ignore financial asset prices, when it is the shift to financial investing that is ultimately responsible for both financial asset inflation and goods disinflation-deflation. Both continue to debate the effects rather than the causes, in other words.

Neither wing of mainstream economics—Hybrids or Retros—understands that the explosion of liquidity and debt that is driving mostly financial investing, and less so real asset investing, is leading to a drift toward deflation in goods prices, while stoking inflation on the financial side. The goods deflation trend suggests not only that most of the central bank-provided liquidity in recent years is flowing to financial investing, but that it is also likely redirecting a certain amount of central bank liquidity away from real investment to financial, for reasons previously explained.

Liquidity As Brake on Real Growth

The excess liquidity created since the 1970s—over and above what real investment has been able to absorb—has been flowing into financial asset investment. It has become far easier to create additional liquidity than it has been to find real investment outlets for it. The amount of liquidity has been so massive, and the growth of related debt levels so rapid, that governments and their central banks have been losing control of both—excess liquidity and incessant debt creation. Not surprisingly, the shift to financial investing has followed.

After having unleashed finance capital in the 1970s and 1980s to address the crisis of the 1970s, to expand capital globally to open new markets, to establish the unstable alternative to the Bretton Woods international monetary currency and trading regime, the system has not been capable of containing, managing or regulating the excess liquidity nor the excessive debt creation that has erupted in turn.

The historic contradiction is that the liquidity explosion set in motion in the 1970s is becoming a brake on economic growth it is supposed to generate. The massive liquidity and the ever-rising debt it has created have become a destabilizing force for the system, as financial asset investing crowds out real asset investment, and in turn is generating a host of related problems like chronic low job creation, stagnant wage income growth, weak consumption trends, slowing productivity, drift toward goods deflation, rising income inequality, and constantly emerging financial asset bubbles worldwide.

posted February 24, 2018
Trump’s Tax Cuts, Budget Deficits, …Trump’s Recession 2019

“Lies and misrepresentation of facts have become the hallmark of American politics in recent years more than ever before. Not just lies of commission by Trump and his crew, but lies of omission by the mainstream media as well.

In Trump’s recent package of tax cuts for corporations, investors and millionaires, the lie is that the total cuts amount to $1.5 trillion—when the actual amount is more than $5 trillion and likely even higher. And in his most recent announcement of budget deficits the amounts admitted are barely half of the actual deficits—and consequent rise in US national debt—that will occur. Even his $1.5 trillion so-called infrastructure spending plan, that Trump promised during his 2016 election campaign, and then throughout 2017, amounts to only $200 billion. The lies and exaggerations are astounding.

The mainstream media, much of it aligned against Trump, has proven no accurate in revealing the Trump lies and misrepresentations: They echo Trumps $1.5 trillion total tax cut number and provide no real analysis of the true total of the cuts; they low-ball the true impact of Trump’s budget on US annual budget deficits and the national debt; and they fail to expose the actual corporate subsidy nature of Trump’s ‘smoke and mirrors’ infrastructure plan.

Trump’s multi-trillion dollar tax cuts for business, investors and the wealthiest 1%, plus his annual trillion dollar deficits as far as the eye can see, plus his phony real estate industry handouts that parade as infrastructure spending together will lead the US economy into recession, most likely in early 2019. Here’s the scenario:

The massive deficits will require the central bank, the Federal Reserve, to raise short term interest rates. What’s called the benchmark federal funds interest rate will rise above 2% (currently 1.5%). The longer term 10 year US Treasury bond rate will rise to 3.5% or more. Those rates have already been rising—and their rise already provoking stock and bond market corrections in recent weeks which should be viewed as ‘dress rehearsals’ of more serious financial asset market retreats and contractions yet to come.

As this writer has argued repeatedly in recent publications, both the US real economy and financial markets (stocks, junk bonds, derivatives, etc.) are ‘fragile’ and increasingly susceptible to a significant downturn. In 2007-08 central bank interest rates rose to 5% and that precipitated a crash in subprime mortgage bonds and derivatives that set off the contraction in the economy. With the US economy not fundamentally having recovered from 2008-09 still to this day, and with household and corporate debt well above levels of 2008, it will take less of a rise in interest rates to provoke another similar reaction.

The US real economy is already weak. GDP numbers don’t reflect this accurately. Important sectors like autos and housing are softening or even stalling already. Consumption will falter. Consumers have loaded up on household debt. At $13.8 trillion, levels are equal or greater than 2007. They have also been depleting their savings to finance consumption in 2017-18. And despite all the recent media hoopla, there’s been no real wage gains occurring for 80% of the workforce in the US. Moreover, renewed inflation now occurring will reduce households’ disposable income and buying power even more this year. Rising taxes for tens of millions of households in 2018-19 will also negatively impact consumption spending. Don’t expect consumption to rise in 2018 as interest rates, taxes, and prices do. Just the opposite. Consumption makes up 70% of the US economy and it is now nearly exhausted. It will stagnate at best, and even retreat steadily beginning in the second half 2018.

Like the real economy, the US financial markets are fragile as well. They are in bubble territory and investors are getting increasingly edgy and looking for excuses to sell—i.e. take their super capital gains of recent years and run to the sidelines. A rise in rates much above the 2% and 3.5% noted will provoke a significant credit contraction (or even freeze). Money capital (liquidity) will dry up for non-bank companies, investment and production will be scaled back, layoffs will rise rapidly, and consumption will collapse—together bringing the economy down. It’s a classic scenario the forces behind which have been steadily building. And it won’t take too much more to provoke the next recession—likely in early 2019. The Federal Reserve’s plans to hike rates four more times this year will almost certainly set the scenario in motion.

Trump’s $5 Trillion Business-Investor Tax Cuts

Trump & Congress—with the mainstream media in train—say the Tax Cut Act just passed amounts to $1.5 trillion. But that’s not the true total value of the business tax cuts. That’s what they claim is the deficit impact of the tax cuts. (But even that deficit impact is grossly underestimated, as will be shown shortly).

Here’s the true value of the business-investor tax cuts:

1. $1.5 trillion cut due solely to reducing the corporate nominal tax rate from 35% to 21%.

2. Another $.3 trillion for the new 20% tax deduction for non-corporate businesses (lowering their effective tax rate from 37% to 29.6%).

3. $.3 trillion more for ending the business mandate for the Affordable Care Act

4. Still another, at minimum, $.5 trillion for a combined accelerated business depreciation writeoffs (a form of tax cuts for writing off all equipment added by business in the year purchased instead of amortized over several years); plus repeal of the Alternative Minimum Tax for Corporations: and a roughly halving of the AMT for individuals. But that’s not all.

5. The wealthiest 1% households, virtually all investor class, get their nominal individual income tax rate reduced from 39.6% to 37%. Moreover, the 39.6% did not kick in until an income level of $426,000 was reached. Now the threshold for the even lower 37% does not start until $600,000 income is reached. All that amounts to at least another $.5 trillion in tax cuts.

That’s a total of $3 trillion so far in tax cuts in the Trump Plan. But the further, really big tax cuts come for US Multinational Corporations. Their ‘take’ will be another $2 trillion in tax reduction over the next decade.

The Multinationals have hoarded between $2-$2.7 trillion in cash offshore in order to avoid paying taxes on their earnings. But that $2 trillion is a gross underestimation. First of all, it’s a figure for only the 500 largest US multinationals. What about the hundreds of thousands of other US corporations that also have foreign subsidiaries in which they park their cash to avoid taxes? And what about the unreported cash and assets they’re hoarding in offshore tax havens in the Cayman Islands, Bermuda, Vanuatu and elsewhere? That too is not part of the $2.-$2.7 trillion. Another reason to doubt the $2 trillion is accurate is that they already had $2 trillion stuffed away offshore back in 2011-12. According to the business periodical, Financial Times, the largest US corporations by January 2012 “are collectively sitting on an estimated $2,000bn of cash”. Does anyone believe they stopped diverting profits and cash offshore after 2011-12 for the past five years?

If one conservatively estimates there’s $4 trillion in cash stuffed offshore to avoid taxes (accumulating since 1997 when Bill Clinton conveniently allowed them to begin doing so), the new Trump tax act allows them to pay a tax of only 10% on average if they ‘repatriate’ (bring back) that cash. If they paid the prior 35% tax rate, it would cost them $1.4 trillion in 2018-19, the first year of the Trump tax. But estimates of this provision in the Trump bill show they plan to pay only $339 billion. So they will be saving approximately $1.061 trillion in the first year alone. Thereafter for the next nine years they pay only 8% to 15.5%, instead of the 35%. That amounts to at minimum another $1 trillion in tax savings for multinational US corporations under the Trump tax.

6. In short, US multinational corporations will get a tax reduction of at least $2 trillion

The Trump tax cuts for businesses and investors thus total $5 trillion over the next decade!

So how do Trump, Congress, and the media get to only $1.5 trillion? Here’s how they do it:

They raise taxes on the middle class by $2 trillion in the Trump tax plan. That leaves the $5 trillion in business-investor cuts, minus the $2 trillion in middle class tax hikes, for a net $3 trillion in cuts. But they admit to only $1.5 trillion in net tax cuts. So where’s the difference of the other $1.5 trillion? That difference is assumed to be ‘made up’ (offset) by the US economy growing at a GDP rate of 3-3.5% (or more) for the next ten years—i.e. more than 3% for every year for ten more years without exception!

That 3-4% annual overestimated economic (GDP) growth for the US economy is based on ridiculous assumptions: that slowing long term trends in US productivity and labor force growth will someone immediately reverse and accelerate; that the US will now grow at double the annual rate it did the previous decade; and that there’ll be no recession for another decade when the historical record shows the typical growth period following recession is 7-9 years and the US economy is already in its 8th year since the last recession. (If there’s a recession, then the annual GDP growth for nine years will have to average close to 5% a year—a figure never before ever attained!).

It’s all Trump ‘smoke and mirrors’, lies and gross misrepresentations. But no matter, for its really all about accelerating the subsidization of corporations and capital incomes for the wealthiest 1% by means of fiscal policy now that the central bank’s 9 years of subsidization of capital incomes by monetary policy (i.e. near zero rates, QE, etc.) is coming to an end.

Trillion $Dollar US Deficits for Years to Come

The US budget deficit consequences of the Trump tax cuts are therefore massive. Instead of averaging $150 billion a year on average (the $1.5 trillion) the effect will be three to four times that, or around $300 to $400 billion a year!

On top of that there’s Trump’s latest US budget, which projects another $300 billion for the next two years alone. With the majority of that total $150 billion a year caused by escalation of the Defense-War budget as the US builds up its tactical nuclear, naval and air forces in anticipation of more aggressive US moves in Asia. Last year’s budget deficit was $660 billion. The Congressional Budget Office estimates deficits of $918 billion by 2019. Independent estimates by Chase bank put it at $1.2 trillion. And that’s just the early years and assuming there’s no recession, which will balloon deficits by hundreds of billions more in reduced tax revenues due to a contracting US economy.

Independent projections are for US deficits to add $7.1 trillion over the next decade. But that’s an underestimate that assumes not only no recession, but also that defense-war spending will not rise beyond current projection increases, and that government costs for covering price gouging by the healthcare and prescription drug industries (for Medicaid, Medicare, CHIP, government employees) will somehow not also continue to accelerate. The likely true hit to US deficits—and therefore the US national debt—will well exceed $12 trillion! The US could easily see consecutive annual budget deficits of $1.5 trillion. That will mean a US debt total rising from current $20 trillion to $32 trillion (or more) over the coming decade.

From Tax Cuts, Deficits & Debt to the Next Recession

How does this potentially translate into recession? Here’s a very likely scenario:

The US central bank, the Fed, has already begun raising interest rates. That has already begun slowing key industries like auto and housing. It will soon impact consumers in general, who are near-maxed out with credit card, auto, student loan, and mortgage debt, and facing further accelerating inflation in rents, healthcare costs, transport, state and local taxation, and prices for imported goods.

The massive deficits will require the central bank to raise interest rates perhaps even faster and higher than before. Slowing foreigners’ purchases of US government bonds to pay for the accelerating debt, may require the Fed to raise rates still further. It’s 2007-08 all over again!

Rising Fed interest rates and inflation will also continue to depress bond prices. That has already begun, and to spill over to stock prices as the major contraction in stock prices in February 2018 has revealed. Both bond and stock prices are headed for further decline.

Should stock market prices correct a second time this year, this time by 20% or more, the contagion effects across markets will result in a general credit crunch for non-financial corporations and businesses. US corporate debt has risen even more than US household or government debt since 2009. The corporate junk bond markets will experience a crisis, as US Zombie companies (i.e. those in deep debt, an estimated 12% to 37% of all US corporations, depending on the source) cannot get new financing and begin to go bankrupt.

These stock and bond market effects, and emerging Zombie company defaults, will result in a general investment pullback by non-financial corporations. That will mean production cuts that result in layoffs and further wage stagnation and slowing consumption spending. The next recession will have begun.

The Central Bank (FED) Will Precipitate the Next Recession—As It Did in 2007

This scenario is all the more likely if the general argument that the US economy is both financial and non-financially weak and fragile is accurate. The weakness in the real economy and fragility in the financial markets mean that Fed interest rate hikes cannot exceed 2.0%, and longer term rates (10 year Treasury bonds) cannot exceed 3.5%, before the system ‘cracks’ once again and descends into recession. With the Fed rates at 1.5% and approaching 2% and the Treasury at 3% and approaching 3.5%, the US economy today is well on its way to approaching its limits.

Just as it was interest rates peaking in 2007 that precipitated (not caused) the crash in (subprime) mortgage bonds, that then spilled over through financial derivatives to the rest of the credit system—today the bond markets may once again be signaling the ‘beginning of the end’ of the current cycle. The new contagious derivatives may not be mortgage based bonds and CDO and CDS financial derivatives, as in 2008; the new financial contagion will be driven by the new financial derivatives—i.e. Exchange Traded Funds(ETFs), and related ETNs and ETPs—with their effects amplified by Quant hedge funds’ automated algorithm-based trading.

In summary, Trump tax cuts and Trump’s budget will exacerbate US budget deficits and debt and cause the central bank to raise interest rates even faster and higher. Those rate hikes cannot be sustained. They will lead to another credit crisis—this time even sooner than they did in 2007 given the even weaker US economy and more fragile financial markets. The next recession may be sooner than many think.

Dr. Jack Rasmus

Dr. Rasmus is author of the recently published books, ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression’, Clarity Press, August 2017, and ‘Systemic Fragility in the Global Economy, Clarity, 2016. His forthcoming book later in 2018 is ‘Taxes, War & Austerity: Neoliberal Policy from Reagan to Trump’, Clarity Press. He blogs at jackrasmus.com and tweets at

posted February 9, 2018
The Global Stock Market Implosion–Some Causes & Predictions

(Article 2) US Stocks ‘Dead Cat Bounce’ and Second 1000 point Drop, by Dr. Jack Rasmus, Feb. 8, 2108

Today the US stock market plummeted another 1,000 points. As this writer forewarned after last monday’s 1175 pt. fall, the recovery would be a classic ‘dead cat bounce’. Well, the cat bounced the past two days–just not very high or for very long. And now it’s flopped again. The Question: will it roll over on its back, legs up? Or get up and run around a little more, before flopping again? Make no mistake, the cat is tired and can no longer jump. It may not even be able to get back up on its feet.

Investors’ psychology will now have changed. Now it’s clear, the financial markets’ last weekend collapse was not a ‘one off’ event. This realization will have a big effect going forward. It’s all a different level now. And all the talk by pundits this week trying to pump the market back up, i.e. go ‘buy on the dip’, now look quite stupid and self-serving. Should investors now ‘buy on every dip’ as each dip goes down further and further? It’s a 10% correction in less than a week, well on the way to 20% (and who knows how much more).

In the intervening days since last weekend, reports also began to emerge (somewhat) that the markets were responding to problems with the new derivatives–i.e. Exchange Traded Funds/Products (ETF-Ps)–that were being dumped automatically by what are called ‘quant sellers’ (aka professional investors) in big volumes. This automated selling was responsible for the big movements in price. But all this was quickly hushed up in the mainstream business media.

Last Monday’s collapse was also followed by China currency (Yuan) beginning to fall precipitously. Clearly, China investors are dumping Yuan, buying foreign currencies, and trying to get out in anticipation of more financial instability in China. Capital flight from China is ‘on again’. This could lead to competitive currency devaluations throughout Asia economies. (Shades of 1998’s Currency Crisis!).

And what about other Emerging Market economies? They are extremely fragile and capital flight will almost certain emerge there again, once the US Fed raises rates in March, as it has promised to do. (The Fed also promised to raise rates three more times this year. As I have predicted, however, if the stock markets keep falling, that will not happen, as it will almost certain result in a global credit crunch.) For eight years the Fed has propped up the stock markets with free money; it won’t abandon that fundamental policy at this point. It only backed off temporarily because of fiscal-tax cuts in the trillions taking up its (Fed’s) prior role of subsidizing capital incomes.

And what about Europe (and the even weaker UK) with its $2 trillion in non-performing bank loans? Watch out Italy.

And then there’s the junk bond markets in the US, where some estimates are that nearly a fifth of junk bond borrowing companies are ‘zombies’. They’ve been put on life support by borrowing to repay interest and principal on past debt, laying ever more debt on debt. At some point defaults will appear as the free money from the Fed lowers the liquidity level and the rocks appear in the junk bond market.

The downward momentum in US stock prices will also be fueled in the next stage by the massive buildup in margin buying of US stocks that has been occurring since 2014, and the even more rapid rise in margin buying since Trump took office. Debt balances on margin accounts has risen from an annual average of less than $10 billion a year from 2009 to 2013, to $200 to $300 billion a year the last four years. That’s the greatest margin buying bubble since 1980. Margin buyers will prove desperate stock sellers, driving stock prices even lower in coming weeks, entering yet another new phase.

(Article 1) Stock Markets Implode Worldwide–What’s Next?, by Dr. Jack Rasmus, Feb. 5, 2018

Today, February 5, 2018 the main US stock market, the DOW, fell another 1,175 points, the largest drop in its history. That followed a major decline of 665 points the preceding Friday. The total two day decline amounts to 7.5%. The other major US stock markets, the Nasdaq and S&P 500 also registered significant declines of similar percentages. Markets in Japan and Europe followed suit over the weekend in response to Friday’s US drop; and are expected to fall comparably to the US when they open for Tuesday, February 6. What’s going on? More important still, what will go on—in the next few days and in the weeks to come?

The business press and media trotted out all the experts today. The ‘spin’ and message was “don’t panic” folks. This is to be expected, they say, given the bubble price run-up through 2017, and especially since last November 2017, after which the bubble accelerated still faster. In the month of January alone, the DOW rose nearly 7%. That’s considered a good ‘year’s gain’ in ordinary times. Yet mainstream economists say it hasn’t been a bubble, while they give no definition of what a bubble exactly is—because they don’t know. But certainly a DOW run-up from around 16,000 lows in 2016 to more than 26,000 in little more than a year constitutes as a bubble.

But the media talking heads parading in front of cameras today sing the same song, “don’t panic”. It comes in various keys: “It’s a welcome pullback”, a “constructive sell off”, an “opportunity to buy on the dip” and other such nonsense. But when asked why now the collapse, they have nothing to add.

What it represents, however, is professional institutional investors decided to ‘take their money and run’, leaving the small investors to take the losses. And more are coming. The professionals realize that the central bank, the Fed, is going to raise interest rates 3-4 times this year. That has already begun to send the bond markets into a tailspin. And now stocks are following suit. The stock markets have risen to bubble territory for several reasons:

One is the 9 year massive injection of free money by the Fed and other central banks. More than necessary to invest in real production, so it flows into financial markets in the US and worldwide. Corporate profits since 2010 have nearly tripled, and capital gains taxes have been steadily reduced by trillions of dollars since 2010 as well. Corporations have kept a steady flow of money capital to their shareholders with 7 years of stock buybacks and dividend payouts—averaging a trillion dollars a year for seven years! Profits, dividends, buybacks, capital gains tax cuts resulted in trillions flowing into financial markets. Add to that record levels of margin buying of stocks by small investors (always a sign of bubbles) and that’s the source of the record price appreciation of stock markets. And, of course, let’s not forget the Trump business-investor tax cuts of more than $4 trillion (not $1.5) that are coming on top of it all—that will subsidize profits with an immediate 10%-31% profits boost, on top of the record profits that US corporations had already attained. Massive money capital injections surging into stock and other financial markets. That’s why the bubble.

But what of the bust? Why now—not before or later? It’s because of changes in the markets themselves: the advent of what’s called ‘momentum trading’ by big institutions like quant hedge funds and others; by the shift to passive investing and what’s called index funds; by derivatives like ETFs driving stock prices as well. All the above result in rising prices sucking in more money capital just because prices are rising….which results in still more prices rising.

Until of course the central bank convinces them that the ‘punchbowl of free money’ is being drained. Then the professionals take their money and run, leaving the ‘herd’ of small investors holding the empty bag.

What’s most interesting is that the Fed’s interest rates haven’t even reached 2% and the system has cracked. In 2007, Fed rates had to exceed 5% before the credit crash was set in slow motion. But this writer predicted that would be the case, i.e. that the Fed rates could not rise above 2-2.25% (and the 10 year Treasury bond much above 3%) without precipitating another credit crisis.

But the stock crash of February 2 and 5 is not the beginning nor the end of what’s coming. There may be a further decline in coming days but it will stabilize. There will be a recovery or sorts. But it will be a ‘dead cat bounce’, as is always the case in such events. Some weeks, or even months later, the real contraction will begin. And that will be the real one.

To recall events of 2008, it was the collapse of Countrywide Mortgage and Bear Stearns investment bank in early 2008 that were the warning signs. Recovery temporarily followed, until Fannie Mae and then Lehman Brothers set the real forces in motion. The precipitating events may not even originate in the US but outside. Japan and Emerging Market economy stock markets are especially vulnerable. But financial markets are global and tightly integrated in today’s capitalist system. Contagion is built into the system globally. And investors move their money around worldwide in an instant. They will eventually pull back, wait and see, and the markets temporarily restabilize. Is it an opportunity to scoop up the losses of the smaller herd investors that will have lost trillions this week? That’s what the professional investors, the big institutional investors, the hedge funds, private equity, the big capitalists will now be asking themselves. Or is it the real contraction that will drive the markets down at least 20% in coming days and weeks? They will also ask themselves will the Fed hold to its plan to continue to raise rates? If it does, the they’ll decide the great stock bull run of 2010-18 and its bubble is over and they’ll move to the sidelines for the foreseeable future, not temporarily. They’ll take their trillions of dollars and run. And when they do, the real contraction will begin….and the road to the next recession.

In the meantime, watch the dead cat as it bounces. How high. And when it lands will it flop over dead or get up and run again?

Dr. Rasmus is author of the 2017 book, ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression’, Clarity Press, August 2017, and Systemic Fragility in the Global Economy, Clarity Press, 2016

posted February 3, 2018
US Central Bank (Federal Reserve) Under Yellen

It’s been three and a half years since Janet Yellen assumed the role as chair of the Federal Reserve bank. What has the Yellen bank tried to achieve over this period? And has it in fact achieved what it said it would?

Bernanke-Yellen Indulge the Children: The Taper Tantrum

One of the first tasks of the Yellen Bank, which began in early 2014 with Yellen assuming the chair of the Fed that February, was how to respond to the Taper Tantrum that arose in the preceding spring 2013 when Bernanke was still at the helm of the Fed. Should the Yellen bank embrace the Bernanke bank’s response as it was? Slow it? Abandon it? Or accelerate it?

‘Taper’ refers to the reduction in stages of the Fed’s rate of massive money liquidity injections of 2009-12 created by the QEs and ZIRP programs. ‘Tantrum’ refers to the negative reaction by offshore emerging markets, US and global investors who had committed heavily to those markets, as well as US multinational corporations (MNCs) that had shifted investment and production to the EMEs.

The Fed gave the first indication it might taper in May 2013. This was officially confirmed by Bernanke’s press conference in June 2013, when the Fed noted it planned to start ‘tapering’ its QE3 bond buying program later that year. QE tapering also strongly implied that once QE3 had been ‘fully tapered’ it was likely the Fed would next begin raising interest rates from the excessively low 0.1% federal funds rate that had been in effect from the summer of 2009.

Even though the inflation level in 2013 was projected to rise to only half the 2% official Fed target, in his press conference Bernanke nevertheless forecast that prices would rise to 2% by early 2015 due to accelerating US GDP and growth driving prices higher. According to Bernanke, US GDP would rise 2.6% in 2013 and accelerate to an extraordinary 3.6% in 2015. The faster real growth and rising price level were cited as justification for beginning the ‘taper’. The forecasts for both price level and GDP growth would of course prove grossly inaccurate. The price level in 2013 would rise to only 1.4% and even lower to 0.6% in 2015. GDP forecasts would prove even worse, with 1.7% growth (not 2.6%) for 2013 and 2.6% (not 3.6%) for 2015. But such failed forecasting was hardly new for the Bernanke Fed.

The prospect of a tapering of the QE3 $85 billion a month in liquidity injection, followed by a possible further reversal of the Fed’s zero rate program (ZIRP), set off a mini-panic among global investors, especially those betting on offshore emerging markets and by US MNCs, as well as by EME governments and domestic producers. But it was investors and MNCs that raised the loudest cacophony of protest and alarm.

Since a large part of the Fed’s massive liquidity injections from QE and ZIRP after 2008 had flowed out of the US and into the EMEs, contributing significantly to financing the global commodity boom and China’s economic growth surge of 2009-12, US and global investors betting on offshore markets and MNCs located in the EMEs potentially had a lot to lose from a ‘taper’. The Fed’s QE and ZIRP programs had a lesser impact on the US economy due to the outflow. As a Forbes business source admitted in 2014, “The data show a very strong correlation between the level of gross inflows to emerging markets since 2009 and the size of the Fed’s balance sheet. A simple regression for the 2011-13 period suggests that for every billion dollars of QE, flows to major emerging market economies like the BRIC countries rose by about $1.4 billion.” Rising Fed rates thus threatened continued money capital outflow to the EMEs, with potential major negative consequences for both financial and real investment profits for investors and MNCs..

The beginning of the end of ‘free money’ would raise the credit costs of investing in EME markets and thus reduce profitability. For US MNCs directly producing in the EMEs, their costs of imported resources and other inputs needed for production in their EME facilities would also rise while their prices received for exporting their finished products simultaneously declined due to EME currency decline. MNCs planning to repatriate their EME profits back to the US parent company would also experience a paper profit decline due just to the exchange rate effect. Converting profits in foreign currency to the rising dollar would result in less dollar-denominated profit. Declining EME currency exchange rates were thus decidedly bad for MNC profits. For US and global investors who had invested heavily into EMEs financial markets’ expansion in 2009-12, profitability would be reduced further as the rise in US rates inevitably translated into a rising US dollar and declining value of currencies of those EME economies; their profits too would be reduced for those planning to ‘repatriate’ earnings back to their US accounts. And for those US and global financial speculators who had invested heavily in EME financial markets and planned no ‘repatriation’, collapsing EME currencies nonetheless would register a corresponding collapse of the value of their financial investments in the EME stock and bond markets. Rising rates in the US might also provoke a retreat of stock and bond prices in US financial markets, offsetting the prior QE-liquidity escalation effect on US financial asset prices. In short, a good deal of money might be lost for broad sectors of US investors and producers as a consequence of a Fed ‘taper’ of QE followed by a rate hike.

EME domestic producers and investors would of course also experience profits compression due to rising import inflation, exports revenue decline, domestic stock, bond and foreign currency exchange market losses, etc. Their EME governments would have to deal with growing problems of capital flight and slowing economies resulting in unemployment, declining government tax revenues, and rising government deficits. Ultimately, in the worst case scenario, they would be unable to borrow from advanced economy bankers and investors to cover their rising deficits, or borrow at ever rising costs. The potential for government debt defaults might eventually become more serious in turn.

But it was US investors and MNCs, who together represented a powerful interest group that reacted negatively most strongly to Bernanke’s proposal to slow liquidity and thus raise rates. While EME governments and their domestic producers raised complaints to Washington in the wake of Bernanke’s announcement, louder still were the complaints by US multinational corporations (MNCs) that had moved operations and production to the EMEs, beginning with Reagan policies promoting offshoring of manufacturing and the expanding of US foreign direct investment (FDI) abroad under Clinton, Bush and Obama’s free trade policies.

It is incorrect therefore to describe the taper tantrum as purely a response by EME governments and producers. The Fed no doubt cared less about the losses that might be incurred by EME producers and their governments than about the political pressures that US MNCs and investors might exert on the Fed, through their friends and lobbyists in Congress and the US government. Complaints were already beginning to rise about Fed policies and calls for ‘reforms’ of the Fed itself during Bernanke’s term.

The mini-panic over just the potential of a liquidity reversal by the Fed resulted in Bernanke quickly backtracking on his trial proposal to begin reducing liquidity and raising rates. The taper proved mostly Fed talk and no action. The Fed continued its buying of both mortgage securities and US Treasuries under the QE3 program through Bernanke’s term, including after June 2013. The bond buying would continue unabated under Yellen after February 2014 until the end of that year. QE3 would not be suspended until December 2014. And it would be another full year before the Yellen Fed would even begin to test raising the federal funds rate, with a minimal 0.25% rate hike in December.

The decision by the Bernanke and Yellen banks to indulge investors and MNCs by not ending liquidity injections via QE for another 18 months after June 2013 is illustrated by the following Fed purchases of Treasuries and mortgage securities during that period:

Fed QE3 Purchases After Taper Announcement

Type of Security June 2013 February 2014 December 2014

Mortgages $1.3 trillion $1.5 trillion $1.7 trillion
US Treasuries $1.9 $2.2 $2.4

The EME taper tantrum by investors, MNCs, and EME governments and producers continued nonetheless throughout the remainder 2013, until it became clear the Fed was not going to discontinue QE or raise rates under Bernanke. Long-term US bond rates, an indicator of the tantrum, rose in 2013—and EME currency declines, capital flight, and financial markets stress continued. Once Yellen was made Fed chair, within weeks it was clear even to EME investors that their fears over the taper were unfounded. By spring 2014 EME currencies again began to rise; money capital flight reversed and began flowing back into the EMEs once again—all but reversing previous trends of 2013.

The taper tantrum was thus a tempest in a teacup. Neither the Bernanke nor the Yellen Fed ever had any real intention of quickly reducing the massive US central bank liquidity injections in 2013 or 2014. Nor any intent to soon begin raising Fed rates. Their real intent was to boost US stock and bond market prices ever further. That meant continuing to inject liquidity by increasing the money supply. Even when the QE bond buying program was halted in December 2014, Bernanke/Yellen planned to keep interest rates otherwise near zero for an extended period. It was no longer necessary to have both QE and ZIRP to do so. Traditional Fed bond buying tools were sufficient after 2014 to ensure US interest rates remained near zero and free money kept flowing to banks and investors—i.e. to keep prices rising in financial asset markets while ensuring an undervalued US dollar aided US exports.

The primary Fed strategy under both Bernanke and Yellen has been, and continues to be, to keep interest rates artificially low by a steady increase in liquidity to banks and investors. Low rates would subsidize US exports by ensuring an undervalued dollar, while simultaneously providing ‘free money’ for investors to pump up stock and bond markets. The Fed assumed that some of the surging stock and bond prices would result in a spillover effect into real investment in the US. That was how economic recovery was primarily to occur. And it was acceptable that for every four dollars going into financial asset investment and capital gains, perhaps one dollar would result in real investment expansion. At least some liquidity would maybe find its way into creating real goods and services; that was the Fed logic.

That logic summarizes the essence of 21st century capitalist central bank monetary policy: flood the financial markets with massive excess liquidity in the expectation that some of the escalation in stock and bond prices will overflow into real investment; simultaneously, the excess liquidity will also reduce currency exchange rates, thereby subsidizing export costs, and boosting real growth by expanding exports and real GDP as well. The problem with this ‘monetary primacy’ strategy, however, is that most of the boost in financial asset values results in corporations issuing bonds to fund their stock buybacks and shareholder dividend payouts. Or it results in diversion of liquidity by investors that borrow to invest in financial asset markets easily accessible worldwide. Or it ends up as cash hoarding of the excess liquidity on institutions’ and investors’ balance sheets. Very little spills over to real investment. Nor does it boost exports in a global economy characterized by slowing global trade overall. The excess liquidity flows into multiple forms of debt and non-productive financial asset investment or accumulates on the sidelines.

These actual developments mean central banks and monetary policy have become the new locus for a 21st century form of competitive devaluations. While in the 1930s nations engaged in competitive devaluations, amidst a slowing global economy, in a futile effort to obtain a temporary export cost advantage over their competitors as a means to grow their real economies, today it is central banks that drive the competitive currency devaluations process via QE, ZIRP, and massive liquidity injections.

Add to this futile money supply-driven export strategy the financialization of the global economy, and the central bank liquidity injections result in slowing real asset investment. Just as central bank money policies fail to boost exports due to competitive devaluations, so too do central bank-provided free money flows. Financial institutions increasingly divert the liquidity from real investment into their global network of shadow banks, their proliferating financial asset markets, and their ever-growing financial securities products.

The 21st century capitalist economy is reflected in a similar financialization of government and the capitalist State, which ensure the implementation and administration of the strategy. Bankers and investors prevent government from introducing alternative fiscal policies in order to ensure they enrich themselves first and foremost through a central bank monetary strategy for economic recovery. Making central bank monetary policy primary is far more profitable to their interests than a ‘fiscal government spending’ strategy. The latter results in a ‘bottoms up’ stimulation of the real economy and real investment first, with subsequent boosting of financial asset prices and markets as an after-effect and consequence of real economic growth.

The Yellen bank thus represents a continuation of the Bernanke Fed in terms of liquidity injection and excess money supply generation. QE may have been suspended under Yellen, but the schedule for such had already been intended under Bernanke. Moreover, the nearly $4.5 trillion of QE-related liquidity still sits on Yellen Fed balance sheets as of mid-year 2017—more than 8 years after the Fed embarked on its QE experiment.

QE is therefore just a tool to inject especially excessive liquidity quickly into the economy, accompanied by other radical Fed measures post 2008. The suspension of QE in December 2014 did not mean that the policy of excess money ended. Money supply and liquidity injections still continued to flow into the US economy at above historical averages under the Yellen regime—i.e. continuing again the trend set under Bernanke. The injections simply continued using traditional central bank monetary policy tools. And as under Bernanke, the Yellen official justification for the continued excessive expansion of the money supply remains the need to attain a price level of 2%.

But the Fed’s 2% price target is a fiction. The official objective of Fed excess money and liquidity injection was, and remains, to boost financial asset markets and hope for a spillover effect; to keep the dollar low to subsidize US exports; and to hope somehow to generate a real investment spillover effect and exports surge that will raise GDP growth. But if it doesn’t, then at least investors, bankers and MNCs will have recovered nicely nonetheless.

The Fiction of Price & Other Targets

The Bernanke/ Yellen Fed has repeatedly failed to attain its 2% official price target. Secondary targets—both official and unofficial– have been suggested in recent years as an alternative, leaving it increasingly unclear what targets the Yellen Fed has been actually trying to achieve. Is it really a 2% price level? Is it to reduce the official unemployment rate to 4.5%? Is it to get wages growing again in order to boost household consumption? Is it to ensure that financial system instability does not erupt again like, or even worse than, it did in 2008-09?

Price Stability Targeting

The $3.2 trillion QE under Bernanke (plus more from traditional monetary policy tools) clearly failed to achieve the Fed’s official 2% price target. But the Yellen Fed has not done any better as it added another roughly $1.0 trillion to the Fed’s balance sheet.

2% Fed Price Target Attainment.
Bernanke v. Yellen Fed
Bernanke Fed (60 mos.) Yellen Fed (36 mos.)
1/09 12/13 Avg%chg/yr 12/13 12/16 Avg%chg/yr

PCE Price Index 1.00 108.2 1.6% 108.2 111.6 1.0%

CPI Price Index 0.98 1.07 1.8% 1.07 1.11 1.2%

GDP Deflator 99.9 107.6 1.5% 107.6 112.8 1.6%

If one compares and contrasts the Bernanke and Yellen Fed in terms of the 2% price target, it is clear that neither Fed came close to the target. This was especially true of the Fed’s preferred price indicator, the Personal Consumption Expenditures Index (PCE). But also true for the Consumer Price Index (CPI), and even the broader price indicator for all the goods and services in the real economy, the GDP Deflator index. As of April 2017, over the three and a third years of the Yellen Fed, the PCE still averaged only 1.2%.

Despite some evidence of the PCE beginning to rise faster in early 2017, the PCE index for April 2016 to April 2017 was still only 1.5%–still well below the 2% target. If the price index were really the key target for deciding on Fed rate hikes in 2017 and beyond, that target was certainly not achieved. The fact that the Fed began raising rates after December 2016 nonetheless, thus confirms price targets have little to do with Fed decisions to raise rates or not. They are a fiction to justify and obfuscate other real reasons.

Unemployment Rate Targeting

As the 2% price level slipped from view, the Bernanke Fed indicated its policies would continue unchanged until the unemployment rate had declined to what was called the Non-Accelerating Inflation Rate of Unemployment (NAIRU). NAIRU was a fictional assumed rate of unemployment at which an equally fictional price level was assumed to stabilize at 2%. NAIRU was also a constantly moving variable and target, depending on who defined it, assumed to be somewhere around 4.4% to 4.9%. Another problem with it is that the 4.4-4.9% measure was based on what was called the U-3 unemployment rate. And the U-3 ignored 50 million or more jobless—the underemployed part time and temp workers, plus what was called the ‘missing labor force’, plus the number of grossly underestimated ‘discouraged’ workers who gave up looking for a job (but were no less unemployed). It also overlooked the collapse of the labor force participation rate, which had declined by 4% of the labor force in the past decade. At 157 million, that meant 6 to 6.3 million have dropped out of the labor force altogether and, given the way the US calculates unemployment rates, were never counted as unemployed for purposes of determining the U-3. Adding in these ‘actual jobless’ categories raises the U-3 official rate to around 10%. And even that figure fails to account accurately for joblessness in the ‘underground economy’, and among urban youth, undocumented workers, workers on permanent disability, and itinerant labor. The real unemployment rate today is thus around 12-13%. The Fed’s informal shift to targeting a U-3 unemployment rate should therefore be considered as just as fictional a ‘political placeholder indicator’ as the 2% price level target. Neither could nor would be attained.

So the Yellen Fed’s performance in price targeting was no improvement over Bernanke’s. It was therefore not surprising that the Yellen Fed continued to search for some alternative indicator of ‘success’ for its policies after 2013, like the U-3 unemployment rate, or even flirted with the idea of wage growth as proof of Fed monetary policy success. It suggested perhaps wage growth was an alternative and better measurement than the unemployment rate, since it took an extended period even for the U-3 to recede to 4.5%.

Wage Growth Targeting

The Yellen Fed left the measure of wage growth vague quantitatively, however, since it was never offered as an official alternative target and the U-3 unemployment rate target of 4.7% was eventually achieved in 2016. But a look at various indicators of real wage growth reveal a general stagnation or worse, whether under Bernanke or the Yellen Fed.

Instead of acknowledging failure to achieve the 2% price level target, both Fed’s publicly diverted attention to alternative ‘targets’ to prove their QE-ZIRP, and excessive liquidity programs in general, were ‘successful’. But it wasn’t any of the targets—however defined—that were the key. It was the liquidity itself that was the objective. It was all about providing virtually free money to the banks and investors, and the boosting of the financial markets—stocks, bonds, etc.—that was the true target of Fed monetary policy and strategy. And the Yellen Fed was no different than the Bernanke in that regard. Formal targets were secondary and fictional; liquidity injections were primary and what Fed monetary policy was really all about—i.e. boosting financial markets to record levels and only secondarily, keeping the US dollar depressed in the false expectation that somehow it might stimulate real investment and growth a little even though it exacerbated capital gains income and accelerated income inequality trends.

The Money Supply Function

Comparing money supply management and liquidity between the two Feds shows that the Yellen Fed was moderately more aggressively injecting liquidity when measured by the M2 money supply, although less so when the M1 is considered. Comparing Bernanke’s full eight-year term to Yellen’s three and a third years to date, shows the following comparisons in money supply and liquidity..

M1 & M2 Money Supply
Bernanke v. Yellen Fed($ Trillions)

Bernanke Fed Yellen Fed

12/05 12/13 $chg/yr. %chg/yr. Tot%chg 2/13 04/07 $chg/yr. %chg/yr. Tot%chg
M2 $6.6 $10.6 $.5 7.6% 60% $10.6 $13.5 $.87 8.3% 27%
M1 $1.4 $2.7 $.16 11.6% 93% $2.7 $3.4 $.21 7.9% 26%

Even with the ending of QE3 under Bernanke in late 2013, the money supply and liquidity continued to grow under Yellen’s Fed. M2 has actually grown faster at an annual rate under the Yellen Fed. What that suggests is that Yellen’s central bank has perhaps made greater use of traditional Fed tools like open market operations to inject liquidity and ensure that short term rates remained near zero (ZIRP) even after QE was terminated. In this sense, the Yellen bank represents something of a partial shift in terms of monetary tools. The QEs may have been wound down as Bernanke left office, but the Bernanke policy of ZIRP was carried forward by Yellen’s bank just as aggressively by other means.

From the beginning of 2006 to the present, both the M2 and M1 money supply have more than doubled under the Bernanke/Yellen Fed! The US banking system was effectively bailed out in 2010—quite some time ago. But the QEs and ZIRP and liquidity have just kept coming. If the Fed’s liquidity policy has been as aggressive as it has in order to bail out the banks, why then did the bailout continue for the next seven years?

It is therefore incorrect to describe Fed policies as a bank bailout after 2010. It is more correct to identify Fed policy since 2010 as an unprecedented historical subsidization of the financial system by the State, implemented via the institutional vehicle of the central bank.

Financial Subsidization as New Primary Function?

Central bank financial subsidization policy raises the question as to whether the primary function of the central bank in the 21st century is more than just lender of last resort, or money supply management, or bank supervision, as has been the case in the past before 2008. Certainly those primary functions continue. But a new primary function has demonstrably been added: the subsidization of finance capital rates of return and profitability—regardless of whether the financial system itself is in need of bailout or not. Globalization has intensified inter-capitalist competition and that competition compresses prices and profits. So the State, in the form of the institution of the central bank, now plays an even more direct role in ensuring prices for financial assets are not depressed (or prevented from rising) by inter-capitalist global competition; and that global competition is more than offset by central banks becoming a primary source of demand for private sector financial assets. Excess liquidity drives demand for assets, which drives the price of assets and in turn subsidizes price-determined profitability of financial institutions in particular but also of non-financial corporations that take on the characteristics of financial institutions increasingly over time as well.

Long after banks were provided sufficient liquidity, and those in technical default (Citigroup, Bank of America, etc.) were made solvent once again, the Yellen Fed has continued the Bernanke policy of massive and steady liquidity injection. Whether the tools are QE or open market operations, modern central bank monetary policy is now about providing virtually free money (i.e. near zero and below rates). Targets are mere justifications providing an appearance of policy while the provision of money and liquidity is its essence. Tools are just means to the end. And while the ‘ends’ still include the traditional primary functions of money supply and liquidity provision, lender of last resort and banking system supervision—there may now be a new function: financial system subsidization.

The ideological justification of QE, ZIRP and free money for banks and investors has been that the financial asset markets need subsidization (they don’t use that term however) in order to escalate their values in order, in turn, to allow some of the vast increase in capital incomes to ‘trickle down’ to perhaps boost real investment and economic growth as a consequence. They suggest there may be a kind of ‘leakage’ from the financial markets that may still get into creating real things that require hiring real people, that produce real incomes for consumption and therefore real (GDP) economic growth. But this purported financial trickle down hardly qualifies as a ‘trickle’; it’s more like a ‘drip drip’. It’s not coincidental that the ‘drip’ results in slowing real investment and therefore productivity and in turn wage growth. This negative counter-effect to central bank monetary policy boosting financial investment and financial markets now more than offsets the financial trickle-drip of monetary policy. The net effect is the long term stagnation of the real economy.

The Fed’s function of money supply management may be performing well for financial markets but increasingly less so for the rest of the real economy. That was true under Bernanke, and that truth has continued under Yellen’s Fed as well. Central bank performance of the money supply function is in decline. The Fed is losing control of the money supply and credit—not just as a result of accelerating changes in global financialization, technology, or proliferation of new forms of credit creation beyond its influence. It is losing control also by choice, as it continually pumps more and more liquidity into the global system that causes that loss of control.

The Yellen Fed’s 5 Challenges

The Yellen Fed (and its successor) face five great challenges. Those are: 1) how to raise interest rates, should the economy expand in 2017-18, without provoking undue opposition by investors and corporations now addicted to low rates; 2) how to begin selling off its $4.5 trillion balance sheet without spiking rates, slowing the US economy, and sending EMEs into a tailspin; 3) how to conduct bank supervision as Congress dismantles the 2010 Dodd-Frank Banking Regulation Act; 4) how to ensure a ‘monetary policy first’ regime continues despite a re-emergence of fiscal policy in the form of infrastructure spending; and 5) how to develop new tools for lender of last resort purposes in anticipation of the next financial crisis.

1. Suspending ZIRP and Raising Rates

A major challenge confronting, and characterizing, the Yellen bank has been whether, how much, and how fast to raise US interest rates.

The Fed’s key short term interest rate, the Federal Funds Rate, was reduced from 5.25% in 2006 to virtually zero at 0.12% by June 2009. In fact, it was effectively lower since the Fed even subsidized this by paying banks 0.25% to keep their reserves (now growing to excess) with the Fed. So it was slightly negative in fact.

The Bernanke Fed kept the rate at around 0.1% until Bernanke left office in January 2014. When the taper tantrum erupted in the summer 2013 and Bernanke sharply retreated on QE tapering, he calmed the markets by promising not to raise rates until 2015 even if QE was eventually slowly reduced. And that promise Bernanke, and his successor Yellen, effectively kept. That meant the Fed ensured seven years of essentially zero rates and therefore free money to bankers and investors from early 2009 through 2015. During those seven years, while bankers got free money more than 50 million US retiree households, dependent on bank savings account interest, CDs, and other similar fixed income accounts, realized virtually nothing in interest income. Over the period more than $1 trillion was lost. In effect, it was a transfer of trillions from retiree households to bankers, and accounts for a good deal of the accelerating income inequality trend since 2009. While average income retired households lost the $trillion, bankers and investors invested and made $trillions more—so income inequality was exacerbated by two inverse conditions: lost income for retired, mostly wage and salary former workers, and escalating profits and capital incomes for bankers, shareholders, and investors.

The Fed’s Minneapolis district president, Narayana Kocherlakota, who often disagreed with Bernanke and Yellen’s policy of continuing low rates, upon leaving the Fed in December 2015 remarked that the near zero (ZIRP) Fed rate policy was planned to be that way from the beginning—i.e. to have a long period of zero rates regardless of publicly announced targets. The Fed from the beginning planned to engineer a slow recovery after November 2009. It was no accident of economic conditions. As the outgoing Fed president, Kocherlakota, put it,

“We were systematically led to make choices that were designed to keep both employment and prices needlessly low for years”…the Fed “was aiming for a slow recovery in both prices and employment”.

Kocherlakota’s comments represent a ‘smoking gun’, from a Fed insider who was in on all the major deliberations on Fed interest rate policy. Neither price nor employment targets were apparently important. Rates would be kept near zero no matter what, and for an indefinite period. But if not to achieve price and employment targets, then for what reason? The only other objective had to be to pour money into financial asset markets, equities, bonds, and other securities for an open-ended period, regardless of how slow and halting the real recovery that produced and whatever the negative economic consequences for jobs, wages, tax revenues and deficits, accelerating income inequality, and all the rest.

The first hint of possible interest rate hikes emerged in August-September 2015. But the Yellen Fed postponed action due, as it noted, to increasingly unstable global economic conditions. Global oil and commodity prices were plummeting. China’s stock markets had just imploded and the potential contagion effects globally were uncertain. Greece had just barely avoided a default with unknown effects on global bond markets. And concerns were growing that US government and corporate bond markets were facing a possible liquidity crisis. Corporate bond issues in the US had doubled since 2008 to $4.5 trillion, but banks were holding only $50 billion to handle bond transactions, down from $300 billion in 2008. The fear was if Fed rate hikes pushed up bond rates as well, investors might not be able to sell their bonds. That could lead to a bond price crash. At least that was the logic bandied about in Fed circles at the time. So the Yellen Fed put off raising rates in September 2015.

The first Fed rate hike in a decade finally came in December 2015, albeit a very timid 0.25% increase. But even that minimal hike precipitated a big drop in US stock prices. The DOW, NASDAQ and S&P500 all contracted in a matter of weeks in January-February 2016 by -7.5%, -14%, and -12%, respectively, in expectation of possible additional Fed rate hikes in 2016. The extreme sensitivity of stock price swings to even minor shifts in interest rates and liquidity injections thus further confirms the tight relationship between Fed rates and liquidity policies and financial markets. After eight years of free money, financial markets had become dependent upon—if not indeed addicted to—Fed liquidity availability in the form of QE and zero rates.

But the Yellen Fed would not follow up the December 2015 rate hikes with further increases throughout 2016, even though in December it was projected to have four more rate hikes in 2016. China once again appeared unstable in early 2016. Europe and Japan were expanding their portfolio of bonds at negative interest rates and their QE programs, putting downward pressure on interest rates everywhere. The dollar was rising. For the first time ever global trade was growing more slowly than global GDP. Global oil prices slipped below $30 a barrel in January. The US economy in the first quarter of 2016 slumped to a 0.8% low. And on the horizon loomed the unknown consequences of the UK Brexit event on global markets. Not least, by the summer of 2016 the US was in the final legs of its national election cycle. With the growing anti-Fed sentiment rising in the US at the time—both from the right and the left—the Fed did not dare to change any policy just before the US national elections—especially as the US economy, in the months immediately preceding the election, was again growing weaker. Consumption was slowing. Producer prices were declining. Business spending was again faltering. Bank loans had declined for the first time in six years. Manufacturing had begun to contract. Fed rate hikes in the first half of 2016 were no longer on the agenda.

In testimony before Congress in February 2016 Yellen indicated the Fed had instead now adopted an outlook of ‘watchful waiting’. That signaled to stock markets that near zero rates and free money would continue mostly likely for the remainder of the year. Having retreated by -7.5% to 14% in the preceding six weeks, stock markets again took off. The Dow, Nasdaq and S&P 500 surged, respectively, by 14%, 23% and 19% for the rest of 2016.

What the Yellen Fed reveals with this timing of the first rate hike, before and after, of December 2015 is that the US central bank has become the ‘central bank of central banks’ in the global economy. Today, its decisions have as much to do with global economic conditions as they do with the US economy. It takes into consideration the effects of its actions on US capitalist institutions offshore as well as on. It co-operates with the other major central banks in Europe and Asia, which becomes a key factor in its ultimate rate decisions. Its mandate may be the US economy, and Fed chairs often declare they don’t care about the consequences of their decisions on other economies, but that’s simply not true. At times the Fed is more concerned about the impact of decisions on offshore markets, US MNCs’ profits, and US political allies’ currencies than it is concerned about the needs of the US economy itself. The two considerations often also contradict.

In short, the Fed looks ‘outward’ not just ‘inward’ on the needs of the US economy and the effect of rate decisions it makes on the US economy. The hesitations and decisions of the Fed as it considered raising interest rates in the months preceding December 2015, and subsequent decision not to raise rates again for the entire next year until December 2016, is testimony to the fact the Fed considers itself the ‘central bank of central banks’ in the capitalist global economy.

Although the Yellen bank would not act to raise rates in the months immediately preceding the 2016 election, pressures continued to mount at the time in favor of a second rate hike. Regardless of who might have won the 2016 presidential contest, the Fed was therefore poised to raise rates immediately thereafter. And it quickly did. The Fed Funds Rate had already risen to 0.24% due to the first rate hike in December 2015. In a second decision in December 2016 the Fed raised it further to 0.54%. Subsequent hikes in early 2017 pushed the short term rate to 0.90% as of May 2017.

While the Fed in early 2017 had signaled the possibility of three more rate hikes in 2017, followed by still further hikes in 2018, as the US economy enters the summer of 2017 it is highly unlikely that many further increases will actually occur. That is because both the US and global economy by late spring 2017 began to appear not as robust as business and media circles had thought, or as the majority on the Fed’s FOMC had apparently assumed as well.

Much of the boost to business investment and the stock markets that occurred after the November 2016 US election was the consequence of expectations by business of major fiscal stimulus and business-investor tax cuts coming quickly from the new Trump administration—the so-called ‘Trump Trade’ (stocks and financial assets) and the related ‘Trump Bump’ (real GDP economy). But it was a post-election real bounce built upon euphoria and expectations. It was the release of business and investor ‘animal spirits’ based more on wishful thinking than real data. Moreover, significant soft spots still permeated the US economy and were once again beginning to emerge in 2017. The global business press began to note that “more investors and analysts are questioning whether an expected rise in the US interest rate is warranted in the face of subdued inflation and signs of weaker growth.”

By late spring it increasingly appeared the ‘Trump Effect’ was beginning to fade, as more political analysts predicted the fiscal stimulus would be delayed until 2018, and that whatever stimulus did occur would produce less in real net terms than assumed by business, investors, and the Trump administration. Furthermore, the contribution of China’s mini-economic resurgence in early 2017, which has provided much of the impetus behind modest growth in Japan and Europe, had by late spring 2017 also begun to show signs of weakening. Chinese manufacturing data showed contraction once again and its government’s 2017 crackdown on speculation in housing and stock markets was once again likely to produce more slowdown later in the year.

In short, a fading of the Trump effect and China growth slowing again might very well make the Fed pause before raising rates further after June 2017. The combined Trump Fade/China slowdown is further buttressed by a third force likely to constrain the Fed from following through with more rate hikes after June 2017 or in 2018: the rapidly deteriorating US trade deficit, now at -$760 billion a year and growing. It is highly unlikely, therefore, that the Fed would risk two more rate hikes in 2017, let alone three more in 2018. That would accelerate the US dollar’s rise and push the US trade deficit toward $1 trillion a year. There are further unknowns with the pending US debt ceiling extension. While the Yellen leadership is almost certainly coming to an end in February 2018, as Yellen is replaced by Trump, the Fed will likely hold on further rate hikes unless the US and global economies reverse direction and grow rapidly in late 2017.

Addendum: Revisiting Greenspan’s ‘Conundrum’

A corollary of sorts to the Fed’s short term (federal funds) rate policies is what is the effect of such policies on longer term bond yields (i.e. rates)? Neither the Fed nor any central bank for that matter are able to directly influence the direction or magnitude of long-term bond rates much, if at all. And it appears that ability, as minimal as it has ever been, is now growing even less so in the global financialized economy. That brings the discussion back to the question of the so-called ‘conundrum’ of short- vs. long- term rates raised by Greenspan. What then can be concluded about the ‘conundrum’ under the Yellen Fed?

Given that the Yellen Fed continued unchanged for three years the Bernanke Fed’s policy of keeping short term rates near zero, and only in the last six months of its term did the Yellen Fed begin to raise rates consistently, what can be said of the ‘conundrum’ under the Yellen Fed? Have longer term bond rates followed the rise in short term federal funds rate in turn. The conundrum certainly was in effect under Yellen. Bond rates rose modestly after the November 2016 elections as the Fed reduced the federal funds rate starting December 2016. But after the Fed’s March 2017 hike, long-term rates began to decline once again as short-term rates were raised. In other words, no correlation between long and short and the ‘condundrum’ returned.

Is then the conundrum a fiction of Greenspan’s imagination—i.e. a concocted excuse to justify his failure at Fed rate management? An ideological construct created to provide cover for Greenspan’s failed policies? Or does it take significant and rapid shifts in Fed generated short term rates to even begin moving longer term rates? Perhaps there is a correlation but it has grown increasingly weak as the global economy has financialized. Perhaps central banks, most notably the Fed, have nearly totally lost all ability to influence long-term rates by short-term rate changes in an increasingly globalized and financialized world economy. Whichever is the case, so much for Greenspan’s conundrum—i.e. another of the various ideological constructs created by central bankers to justify and obfuscate the real objectives of their monetary policies. ‘Condundrum’ is thus a conceptual creation belonging in the same box as central bank independence, price targeting, and ‘dual mandates’ to address unemployment.

2. Selling Off the $4.5 Trillion Balance Sheet

From 2008 through May 2017, QE and other Fed liquidity programs raised the Fed’s balance sheet from $800 or so billion to $4.5 trillion. The QE programs ended in October 2014. Since then payments on bonds to the Fed could have reduced the Fed’s balance sheet. However, the Fed simply reinvested those payments again and kept the balance sheet at the $4.5 trillion level. In other words, it kept re-injecting the liquidity back into the economy—in yet another form indicating its commitment to keep providing excess liquidity to bankers and investors.

Throughout the Yellen Fed discussions and debates have continued about whether the Fed should truly ‘sell off’ its $4.5 trillion and stop re-injecting. That would mean taking $4.5 trillion out of the economy instead of putting it in. It would sharply reduce the money supply and liquidity. It has a great potential to have a major effect raising interest rates across the board, with all the consequent repercussions—a surge in the US dollar, reducing US exports competitiveness and GDP; provoking a ‘tantrum’ in EMEs far more intense than in 2013, with EME currency collapse, capital flight, and recessions precipitated in many of their economies. It would almost certainly also cause global commodity prices to further decline, especially oil, and slow global trade even more.

Finally, no one knows for sure how sensitive the US economy may be, in the post-2008 world, to rapid or large hikes in interest rates. Over the past 8-plus years, the US economy has become addicted to low rates, dependent on having continual and greater injections. Weaning it off the addiction all at once, by a sharp rise in rates due to a sell-off of the Fed’s $4.5 trillion, may precipitate a major instability event. The US economy may, on the other hand, have become interest-rate insensitive to further continuation of zero rates, or even forays into negative rates(as in Europe and Japan) as a result of the 8 year long exposure to ZIRP.. In contrast, that same addiction may mean the economy is now also highly interest rate sensitive to hikes in interest rates. As economists like to express it, it may have become interest-rate inelastic to reductions in rates but interest-rate highly elastic to hikes in rates. But it is not likely that Fed policymakers, or mainstream economists, are thinking this way. Their ‘models’ suggest it doesn’t matter if the rates are lowered or raised, the elasticities are the same going up or going down. But little is the same in the post-2008 economy.

In an interview in late 2014 Bernanke was queried what he thought about shrinking (selling off) the Fed’s balance sheet. (A sell-off is a de facto interest rate increase). He replied he thought that interest rates should be raised by traditional means first, before considering shrinking the balance sheet. But it is quite possible that in today’s global economy, long-term US bond rates can’t be raised much above 3% before they start to cause a serious slowing in the real economy. Or short-term rates by more than 1.5%. So should rates be raised by traditional means to push Treasuries to 3% and then shrink the balance sheet, which would raise rates still further? Or should the rate increase effect from selling off be part of a combined approach to attain the 3%? It is likely the Fed can’t have it both ways: it must either raise rates by selling off its balance sheet in lieu of traditional operations, or retain its balance sheet and raise rates by traditional monetary operations. The maximum level of bond rates in today’s US economy, at around 3% to 3.5%, can’t sustain the effect of a double rate hike by traditional means followed by a balance sheet sell-off. It would result in too much instability.

However, Bernanke believes if the sell-off is ‘passive and predictable’ it would not destabilize. And he refers to normalization first of short term, federal funds rates. But any such policy will have a corresponding psychological effect on long-term bond rates as well, which can’t sustain any increase beyond 3.5% before the economy seriously contracts.

How should the balance sheet be shrunk? Here are some options. The Fed could have auctions to sell the $4.5 trillion in Treasuries and mortgage securities it holds, just as it held auctions to buy many of them back in 2009. Or it could withdraw the liquidity through the Fed’s participation in the Repo market where banks use Treasury bonds as collateral to borrow and loan money to each other short term; the Fed could administer what it calls ‘reverse repos’ and withdraw liquidity from the economy through repo market operations. As a third option, it might discontinue its practice of re-investing the bonds as they are paid off and mature and let the balance sheet naturally ‘run off’. Or, as others have suggested, the Fed should adopt a policy of maintaining the $4.5 trillion on its books. Or even add to it by buying student debt. Or corporate bonds, as in Japan and Europe.

Talk of selling off the balance sheet became more prominent in 2017, as the Fed began to raise short term rates more frequently. Think tanks, like the Brookings Institute, began to hold conferences. Fed district presidents began to call in March 2017 for a formal discussion and consideration of the subject, which Fed minutes show was raised and discussed at its May 2017 FOMC meeting. Concern was increasingly expressed that sell-off would not only raise rates but raise the dollar’s value as well, with negative effects on exports and on manufacturing production, given both were already showing signs of slowing. Advocates for sell-off respond that keeping the balance sheet at current $4.5 trillion levels by re-investing would mean rising interest payments by the Fed to banks and investors as interest rates rose.

But with Yellen more likely than not to be replaced in February 2018 by Trump, the Fed will focus predominantly on traditional approaches and tools to try to raise rates. However, if the US economy falters, as the euphoria over the yet to be realized Trump fiscal stimulus fades, or is inordinately delayed, then even Fed short-term rates may not increase much after June 2017. Yet another unknown factor is the outcome of the US budget and need to raise the US government debt ceiling. All these events and developments make it highly unlikely the Fed will commence with any sell-off until well into 2018.

Notwithstanding all the possible negative economic consequences of disposing of the $4.5 trillion, this past spring 2017 the Fed reached an internal consensus of to begin doing so. That consensus maintained that an extremely slow and pre-announced reduction of the balance sheet would not disrupt rates significantly. But as others have noted, “such an assessment is complacent and dangerously incomplete”. Selling off the $4.5 trillion would mean lost interest payments to the US Treasury amounting to more than $1 trillion, according to Treasury estimates. That’s $1 trillion less for US spending, with all it implies for US fiscal policy in general as the Trump administration cuts taxes by $trillions more and raises defense spending. In other words, sell-off may result in a further long-term slowing of US GDP and the real economy.

At its mid-June 2017 meeting the Fed announced a blueprint outline of that consensus and the Fed’s long-term plan for selling off $4.5 trillion. In her press conference of June 14, 2017 Yellen announced the Fed would stop reinvesting the bonds as they matured at a rate of $6 billion a month for US Treasuries and $4 billion a month for mortgage bonds. That’s $10 billion a month. However, no set date to start the sell-off was announced. Just sometime in the future. At that rate of sell-off, it would take the Fed 37.5 years to dispose of its balance sheet. This token reduction of Fed debt from the last crisis means it is largely for public consumption and to head off critics who now argue the Fed is a profit-making institution (again), making interest off of securities that otherwise private banks might be earning. Another explanation for the token debt reduction, however, is that the Fed doesn’t intend to reduce its balance sheet all that much. In reality, in the end it will retain most of it.

3. Bank Supervision amid Financial Deregulation

Banking supervision in the US has always been fragmented, with the central bank assuming just part of that general responsibility. It is likely this fragmentation has been purposely created. Sharing the responsibility of bank supervision with the Fed have been the Office of the Comptroller of the Currency, OCC, with origins back to mid-19th century. The OCC was the original agency tasked with bank supervision for at least a half century before the Fed was created. Its record of effectiveness includes allowing four major financial crashes after the Civil War (and consequent depressions) up to the creation of the Fed. Another important bank regulatory agency is the Federal Deposit Insurance Corporation, FDIC, created in the 1930s in the depths of the Great Depression, which is responsible for smaller regional and community banks. The Office of Thrift Supervision (OTS) is another; it failed miserably to prevent the Savings & Loan crash in the 1980s and was the official regulator of AIG, the big insurance company and derivatives speculator at the heart of the 2008 banking crash. The Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) are also part of the bank supervision structure, responsible for brokerages and stock and commodity markets. There’s a parallel credit union regulatory agency. Fifty States also have their own regulatory agencies for state-chartered banks, creating a yet further byzantine regulatory structure.

The overlapping and conflicting bank regulatory centers makes it difficult to coordinate regulation and simultaneously easy for banks to whipsaw and play agencies against each other. In other words, the fragmentation is purposeful and has been intentionally created. The complexity and overlap favors the banks and not the public, allowing private financial institutions to deflect, minimize, and delay regulatory efforts to check and reform risky bank practices after periodic financial crises erupt. The delays provide time to allow public demands and legislative action for stronger bank supervision to dissipate.

The US Dodd-Frank Act is a good example of the ‘delay and dissipate’ history of US bank supervision and regulatory reform. Passed in 2010 with great fanfare by the Obama administration it had built into its legislation a four-year delay period for developing specific details. During that four years Bank lobbyists had numerous opportunities to defang the Act, which they cleverly did, after four years leaving the initially weak Act a shell of what was intended. “Year in and year out, the financial sector spends more on lobbying than any other industry. During 2009-10, the interests most concerned about financial regulatory reform—banks, insurance companies, mortgage banks and brokers, securities and investment firms, credit and finance companies, and credit unions—spent considerably more than $750 million on lobbying the government. Together those industries retained more than 2,700 individual lobbyists”.

To provide a complete assessment of bank supervision in the US in the post-1945 period is beyond the scope of this book. The intent is to assess the Fed’s role in bank supervision under the Yellen Fed since the 2010 Dodd-Frank Banking Supervision Act finally took effect in 2014.

The Dodd-Frank Act attempted to expand bank supervision in five specific ways by establishing: a systemic risk assessment process and regulation of the biggest (8 too big to fail banks and 3 insurance companies) overseen by a new 9-member council of regulators chaired by the Treasury; an authority to wind down banks that fail; a consolidation of existing bank regulators; new regulations for some shadow banks previously outside the regulatory framework (i.e. hedge funds, mortgage companies, etc.); and a new Consumer Financial Protection Bureau (CFPB) to protect households from financial institutions’ predatory practices.

As of late 2016, a full two years into the Yellen Fed term, the issue of how much capital the too big to fail banks needed to keep in the event of another crisis had still not been resolved. The big 8 banks’ equity to total assets (i.e. liquid funds to use to offset losses to prevent bankruptcy in another crisis) was still only 6.6%. Incoming president of the Minneapolis Fed district, Neel Kashkari, declared the banks would need 23.5% of equity to assets to be safe. Banks that failed that requirement and were considered a risk to the financial system would thereafter need to maintain a 38% level. If they couldn’t, they should then be broken up. Kashkari subsequently further proposed that excess debt (leverage) held by financial institutions should be taxed. Like his previous suggestion, that too fell on deaf ears within the Fed. The point is that, after three years of the Yellen term, the question of ‘too big to fail’ was still fundamentally unresolved.

In its initial drafts the Act did not envision expanding the bank supervision authority of the Fed. In fact, full supervision of banks and other financial institutions with less than $50 billion in assets was transferred to the FDIC. The Fed was thus stripped of authority to supervise the roughly 8000 or so remaining state-chartered banks. However, it retained authority over the largest 44 banks and bank holding companies.

Nor was a consolidation of the various US regulatory agencies accomplished by the Act. Only the OTS was consolidated, within the OCC. A new Federal Insurance Office (FIO) was created under the supervision of the Treasury. And the SEC was given authority to regulate over the counter derivatives and credit rating agencies like Moody’s, Inc. and hedge funds were required to register with the SEC. Thus the problem of fragmented institutional bank supervision across multiple overlapping agencies continued and in ways actually expanded, with 225 new rules across 11 different regulatory and banking supervisory institutions.

The 9-member regulatory committee, the Financial Stability Oversight Council (FSOC) also gave the Fed authority, upon a 2/3 FSOC vote, to oversee non-bank financial institutions that were deemed potentially risky to system stability. This brought a small part of the shadow bank sector under its supervisory authority as well, in particular hedge funds and private equity firms.

While the Fed gave up bank supervisory authority in some areas, it assumed new authority in others. It now supervised national thrift savings institutions, assuming some of the authority of the former OTS and was given rule-making authority related to proprietary (derivatives) trading by banks (Volcker rule). The 2010 Act created a consumer protection agency, the Consumer Finances Protection Bureau (CFPB), which was put under the Federal Reserve. Initially the CFPB was to be an entirely independent agency, with its own financing. Its director would act independent of the Fed’s Board of Governors. Its single director could be removed by the President not at will, but only if proven negligent. Consumer matters related to credit cards, mortgage and auto loans, payday and other loans were subject to CFPB rules and actions. The CFPB was funded by the Fed, not Congress. Decisions by the CFPB that were initially intended to be independent of the Fed were eventually, however, made subject to veto by a special committee of the other traditional bank regulators, which included the Fed. On paper it appeared as if the CFPB’s regulatory successes since its implementation in 2011 were the product of the Fed. But its aggressive retrieval of funds on behalf of consumers—$12 billion for 29 million—was in spite of the Fed, which kept itself at arm’s length from the operations of the CFPB.

A contrast between the Fed and the CFPB as supervisors was revealed in the event involving Wells Fargo Bank in September 2016. CFPB investigations reported the bank was charging 2 million customers fees for fake credit card and other accounts, and it issued them without customers’ knowledge or permission. It appeared as if it were déjà vu of big bank misbehavior during the 2008 subprime mortgage fiasco. Wells Fargo is one of the 8 too big to fail banks supervised by the Fed, which meets with the bank’s CEO at least four times a year. Where was the Fed, many asked? “The core of the case against Wells Fargo has been well-known since a remarkable investigative report by the Los Angeles Times in 2013, and hints of the troubles were already apparent in a Wall Street Journal article in 2011.” When asked why the Fed did not know of such practices, Yellen replied the Fed was not responsible for regulating this side of Wells’ operations. If it failed to identify subprime-like practices at one of its largest 8 banks it supervised, what else might the Fed be overlooking?

Another development suggesting the Fed was dragging its feet on bank supervision involved what was called ‘merchant banking’. This is where financial institutions in effect act like private equity shadow banks by buying up non-bank operating companies. If non-bank companies owned by commercial banks with household deposits went bankrupt, the potential was greater for crashing the banking side as well. The Fed was tasked with establishing rules to prevent this back in 2012. But it only issued a study of the potential problem four and a half years later.

But perhaps the most visible indicator of actual Fed bank supervision is the periodic ‘stress tests’ of the big banks that the Fed has conducted since early 2009. The test itself is somewhat a misnomer. What the Fed does is release scenarios, hypothetical situations, of recession or extreme unemployment or collapse of housing prices which it gives to the banks. They then predict to the Fed how they would perform under such conditions, indicating if they believe they have enough capital to weather the crisis. Not surprising, they report they can survive. The Fed then decides whether it believes them or not. If it does, it allows the banks to pay dividends and give themselves bonuses. Only on rare occasions has the Fed decided it didn’t agree with the bank, as it did with Citigroup. In other words, the scenarios are typically set up to enable nearly all the banks to pass the test. Until 2016 the banks subject to the stress test included those with assets above $50 billion and should have no more than $10 billion foreign exposure. Under Yellen’s Fed these rules have been significantly liberalized, however. The cutoff now is $250 billion in assets and the foreign exposure rule has been discontinued. As a result, 21 big banks, like Deutschebank and others foreign banks (who do business in the US and are therefore subject to the tests if they qualify by size) are now exempt from the stress testing.

Apparently new district Minneapolis Fed president, Neel Kashkari’s, warning noted above that banks need to increase their capital buffer to survive the next crisis from current 6.6% to 23.5% has not been adopted as part of the stress testing.

Instead of increasing Fed and other regulatory institutions’ bank supervision authority, what remains of the Dodd-Frank Act of 2010 and regulation is about to be reduced even further. In 2017 the US House of Representatives introduced The Financial Choice Act of 2017, which virtually dismantles the CFPB, puts FSOC activity on hold, reduces regulation of big insurance companies like AIG, exempts many financial institutions from vestiges of bank supervision by the Fed and other agencies, and eliminates many penalties for high risk behavior.

If the Fed’s bank supervisory track record since 2010 has been dismal, what might it be under a Trump regime pushing for yet more banking deregulation? The 2017 scenario seems and feels very much like the Bush-Paulson initiatives of 2006-07: deregulate everywhere.

4. Monetary Policy First vs. Infrastructure Spending

Yet another major challenge on the horizon for the Yellen Fed is how the Fed will respond to a new fiscal spending stimulus, should it occur. The Trump administration continually declares it plans a $1 trillion infrastructure spending program. The form that spending takes is yet to be determined. It most likely will not look like direct government spending on roads, bridges, ports, power grid, and other similar infrastructure projects. It will more likely appear as some kind of Private-Public investment program, where commercial property speculators and builders will strike deals with local governments. The speculators-builders will get government real estate in the urban areas at fire sale prices, and will build new structures that local governments will lease back. The Private partner gets a leasing income stream and tax concessions, plus high value land and property that appreciates rapidly. The beneficiary big time is the real estate developer. This model is already being piloted.

The key question is whether the Fed will support and en

posted February 3, 2018
Trump’s 1st State of the Union Speech–Long on Theater; Short on Policy

“Presidents’ State of the Union speeches used to report on accomplishments of the past year and proposals for new programs and policy changes for the next. Just as the country we once knew, those days are long gone.

In the 21st century the format is mostly theatrical: The president offers a short sentence about how wonderful America is, cuts his sentence short, and waits for applause. The Congress rises and claps longer than the spoken sentence that brought them to their feet. This goes on every 15 seconds. Sometimes less. Up and down, up and down. Turn off the volume, and it’s similar to canned laughter in a TV situation comedy—with the visual effect of bouncing butts replacing the canned laughter. Except it’s all more tragic than it is comedic.

A stranger viewing for the first time must conclude that something anatomically must be wrong with their backsides. Up-down, up-down. But when the incessant pattern of ‘short phrase, rise and clap too long, sit down’ threatens to become too repetitive, a new theatrical effect is introduced. Now it’s the president introducing staged character actors in the gallery above the floor, each introduction providing an appeal to the tv audience’s emotions. In the Trump speech tonight, there were no fewer than twelve such ‘gallery scenes’ to break up the mesmerizing stop-rise-clap-sit down nonsense.

First there was ‘Ashley the helicopter lady’, then ‘Dolberg the firefighter’, Congressman Scalise, whose only claim to fame was he got himself shot (definitely not on the level of the other ‘heroes’), followed. And how about the 12 year old ‘Preston the flag boy’, with whom Trump said he had a great conversation before the speech. (I’m sure it was of comparable intellect).
But clever by far was the next gallery event, the four parents whose kids were killed by MS13 gang members in Long Island, NY. All four were black, apparently to blunt the racist appeal by Trump injected into the scene, suggesting that all immigrants were gang members who came here as a result of ‘chained migration’ family policy. I guess MS13 gangsters never killed whites.
Not surprisingly, the next gallery scene was the ICE agent, a guy named Martinez who heroically smashed the MS13 gangsters. Of course, he too was Hispanic.

Both theatrical scenes dealing with ‘immigrant gangsters arriving by chained migration’ provided Trump a nice segway into describing his ‘4 pillars’ immigration bill, the only policy proposal he actually spelled out in his nearly hour and a half speech.

For a pathway to citizenship that would take 12 years for ‘Dreamer’ kids, Trump would have his $30 billion plus border wall, a new immigration policy based on ‘merit’ (welcome Norwegians), as well as an end to family ‘chained migration policy’ (which somehow would also protect the nuclear family, according to Trump). The message: white folks’ nuclear families good; immigrant folks’ (especially Latino) extended families bad, was the suggested logic. What it all added up to? If Democrats agreed to his pillars 2-4 right now, maybe there would be citizenship for Dreamers sometime by 2030! What a deal. But who knows, maybe the Democrats will take it, given that they retreated from their prior ‘line in the sand’ of pass DACA and dreamers or they’ll shut down the government.

The next theater event was no less interesting than the immigration scenes in the Trump play that was the presidential State of the Union address last night. In typical Trumpian worship of the police and military, Trump (the draft dodger) introduced an Albuquerque policeman in the gallery who had talked a pregnant woman on drugs from committing suicide. Seems the woman was desperate about bringing a kid into the world she’d be unable to afford to raise. The solution by the policeman was to offer to adopt her baby if she didn’t kill herself. It worked. The kid and mother were saved, and the policeman adopted the child. The policeman’s wife accompanied him in the gallery—with an infant in her arms of course. Not sure whose it was but no matter. Now that was double theater, a scene within a scene. Shakespeare would have been proud.

That impressive bit of theater, perhaps the high point of all the ‘gallery effects’ of the evening, was the intro to Trump’s solution to the Opioid crisis in America, where 60,000 a year now die from overdoses. In his speech, Trump’s solution to the opioid crisis was ‘let’s get tougher on drug dealers’. He failed to mention, of course, that the drug dealers in question most responsible for launching the opioid crisis were the prescription drug companies themselves who pushed their products like Fetanyl and Percoset on doctors a decade ago, telling them the drugs weren’t addictive.

As for the even larger prescription drug problem in American—i.e. the runaway cost of drugs that is killing unknown thousands of Americans who can’t afford them because of price gouging—Trump merely said “prices will come down substantially…just watch!” That solution echoed his press conference of several weeks ago when he publicly addressed the opioid crisis…but offered no solution specifics how. Watching Trump solve the opioid crisis will be slower than watching grass grow…in winter!

Trump’s speech was not all theater. Much of it was factual—except the facts were mostly misrepresentations and outright lies.

Like unemployment is at a record low. But not when part time, temp, contract and gig work is added to full time. More than 13 million are still officially jobless. The rate is still close to 10%. And that doesn’t count the 5-10 million workers who have dropped out of the labor force altogether since 2008, leading to record lows in labor force participate rates and employment to population ratios. That rate and ratio hasn’t changed under Trump.

Another lie was that wages are finally starting to rise. Whose wages? If you want to count average wages and salaries of the 30 million managers, supervisors, and self-employed, maybe so. But according to US Labor department data, real average hourly earnings for all non-farm workers in the US in 2017 rose by a whopping 4 cents!

Trump cited again his Treasury Secretary, Mnuchin’s, ridiculous figure that the average family income household would realize $4,000 a year in tax cuts. But no economist I know believes that absurd claim.

Perhaps the biggest facts manipulation occurred with Trump’s references to his recent tax cuts. He cited a list of so-called middle class tax cuts, leaving out wealthy individual tax cuts measures. Typical was his claim of doubling the standard deduction, worth $800 billion in tax cuts for the working poor below $24k a year in income. But he failed to mention the additional $2.1 trillion hikes on the middle class. (Or the $2 trillion in corresponding cuts for wealthiest households.) Independent studies show the middle class may get some tax cuts initially, but those end by the seventh year, and then rise rapidly thereafter by year ten. In contrast, the corporate, business, and wealthy household cuts keep going—beyond the tenth year.

What Trump conveniently left out in his speech regarding taxes also qualifies as lie by omission. He noted the corporate tax rate was reduced from 35% to 21% and the non-corporate business income deductions were increased by 20%. That was $1.5 trillion and $310 billion, respectively. Or that the Obamacare mandate repeal saved businesses another $300 billion. And multinational corporations would reap the lion’s share of $1 trillion in tax cuts, at minimum. And all that still doesn’t account for accelerated depreciation under the Act. Or abolition of the corporate Alternative Minimum Tax. Or continuation of the infamous corporate loopholes, like carried interest, corporate offshore ‘inversions’, or gimmicks that corporate tax lawyers joke about—like the ‘dutch sandwich’ and ‘double Irish’.

Then there were the Trump jokes. I don’t mean anything actually funny. Nonsense statements like “beautiful clean coal” (the oxymoron statement of the year). Or that US companies offshore are “roaring coming back to where the action is”. And car companies are bringing jobs back (while laying off in thousands). “Americans (white) are dreamers too”. Or the phony infrastructure program that’s coming, where companies will be subsidized by the federal government in ‘public-private partnership’ deals. And his unexplained reference to ‘prison reform’ (really?). Perfunctory references to trade, job training, another non-starter.

Hidden between the lines were other serious references, however. Like his ominous threat to “remove government employees” who ‘fail the American people’ or ‘undermine American trust’, which sounded like a warning from Trump to the bureaucracy not to cross him or else. Or his slap at National Football League players for not saluting the flag. Or plans to expand Guantanamo and the US nuclear arsenal. Or reaffirmation of the definition of ‘enemy combatants’ (which may include US citizens). Trump re-established the fact of his threat to civil liberties.

On the foreign policy front it was mostly threats as well, new and old: To withhold UN funding. Renewed support for new sanctions against Cuba and Venezuela. But North Korea was left for last. Here the return to theater was among the most dramatic. The last ‘gallery scene’ involved a legless defector from North Korea, Seong Ho, brought all the way from So. Korea just for the speech. This was theater with props; applause was sustained as Mr. Ho raised and shook his crutches above his head after Trump’s introduction.

Trump then rode the emotional wave to conclusion with his closing theme that the American people themselves are what’s great about America. Too bad he doesn’t mean all Americans.

So far as Trump speeches go, it was a ‘safe speech’, a teleprompter speech. But typically Trump. Lots of false facts. Emphasis on dividing the country. Long on Theater and emotional appeals to ‘enemies within and without’. And short on policy specifics. But after all, apart from tax cuts and deregulation for corporations and the rich, and a failed Obamacare repeal, not much was achieved in 2017 for him to talk about. And so far as new ideas for 2018 are concerned, there’s ‘no there there’ as well. ”

Jack Rasmus is author of the just published book, ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression’, Clarity Press, August 2017

posted January 25, 2018
Trump, Shadow Bankers & The Federal Reserve

Trump & the Fed: US Shadow Bankers About to Deepen Control of US Economy

January 24, 2018 by jackrasmus | Edit

What’s sometime referred to as ‘shadow bankers’ have been running the economy and drafting US domestic economic policy since Trump took office. ‘Shadow’ banks include such financial institutions as investment banks, private equity firms, hedge funds, insurance companies, finance companies, asset management companies, etc. They are outside the traditional commercial banking system (e.g. Chase, Bank of America, Wells, etc.) and virtually unregulated. Shadow banks globally now also control more investible liquid assets than do the world’s commercial banks.

It was the shadow banks–investment banks like Lehman, Bear Stearns, insurance giant AIG, GE credit and others that precipitated the 2008 financial crisis that then froze up the entire credit system and led to the 2008-09 collapse of the real, non-financial economy. None of the CEOs of the shadow bank system went to jail for their roles in the collapse. And now they are back–not only reaping record profits and asserting even greater influence over the US and global economy; but have penetrated the political institutions of control in the US and other advanced economies even more than they did pre-2008.

Shadow Bankers On the Inside

In the US, shadow bankers from Goldman Sachs, the giant investment bank, took over the drafting of US economic policy when Trump took office. (Trump himself, a commercial property speculator, is part of this shadow banker segment of the US capitalist elite). Running the US Treasury is ex-Goldman Sacher, Steve Mnuchin. On the ‘inside’ of the Trump administration is Gary Cohn, chair of Trump’s key advisory, ‘Economic Council’. Together the two are the original drafters (which was done in secret) of the recent Trump Tax cuts that will yield a $5 trillion windfall for US businesses, especially multinationals. (More on this in my forthcoming article, to be posted here subsequently).

Mnuchin is leading the charge for the Trump deregulation offensive, especially financial deregulation. Mnuchin recently took the offensive as well with public statements indicating it was US policy that US dollar exchange rates remain at record low levels. Why? To ensure US multinational corporations’ offshore profits are maximized when they convert their profits in local currencies back to the dollar, before they repatriate those profits back to the US at the new lower Trump tax rates (12% instead of 35% repatriation tax rate) and, even more lucratively, when they pay no taxes on offshore profits virtually at all starting 2019.

Goldman Sachs and the shadow banker crowd’s economic influence extends beyond the US Treasury and Economic Council. The New York Federal Reserve’s district president, Dudley, is also a former Goldman Sach employee. He announced he’ll be resigning this year. The New York Fed is the key district of the Fed responsible for US Treasury securities buying and selling. Watch for another Goldman Sacher to replace him, or some other former high level senior exec from private equity or hedge fund industry.(For my analysis of the rising global shadow banking sector and its destabilizing role, check out my 2016 book, ‘Systemic Fragility in the Global Economy‘, Clarity Press, and specifically chapter 12, ‘Structural Change in Global Financial Markets’).

Shadow Bankers Will Run the Fed

Trump and fellow shadow bankers are about to further solidify their control of US economic policy at the Fed as well. The Fed’s chair will soon be Jerome Powell. But several Fed governor positions have been vacant for some time, as is the vice-chair of the Fed. Watch for appointees from the shadow banks here as well.

Fed governors are officially supposed to serve 14 year terms. (They, along with Fed district presidents constitute the important FOMC, Federal Open Market Committee, that make day to day decisions at the Fed on matters of short term interest rate changes and such). But the Fed governors in recent decades never remain the 14 years. In fact, recently they remain around 3-4 years, if that. They leave early to take senior positions in the banking and shadow banking world. It’s a ‘revolving door’ problem.

Bankers get appointed to Fed governor and Fed district president positions, make decisions beneficial to their former banker buddies, and then leave early to return to their banker roots, with highly remunerative positions once again (often ‘do-nothing’ sinecures). As former governors they also go on the speech circuit, speaking at banker and business conferences, for which they’re paid handsomely, in the tens of thousands of dollars for a 20 minute speech. (Former Fed chairpersons, like Ben Bernanke and soon Janet Yellen get even more generous handouts, paid in the several hundreds of thousands of dollars a speech. They also get nice book contracts as they leave, with prepayments in the millions of dollars upfront, with guaranteed book purchases by corporations, and the best promotional efforts by publishers).

Trump’s appointment, and recent approval by the US House and Senate, of Jerome Powell to head the Fed is only the beginning. The vice-chair and several open Fed governor positions will enable Trump and Mnuchin to stack the deck at the Fed with their appointees. That will solidify Trump’s, and the shadow banker community’s, control of the Fed and ensure its policy direction will reflect Trump’s economic objectives of boosting business incomes, especially multinational corporations.

Central Bank Independence–But from Whom?

Mainstream economists write incessantly about the need to ensure ‘central bank independence’ (Fed) from elected government representatives. But they miss the more fundamental fact that it is the bankers themselves (especially now shadow bankers) that ultimately control the Fed. While mainstream economists talk about independence from government representatives, they ignore the deeper control (often through those representatives) of the Fed, and all central banks, by the bankers themselves.

Are Mnuchin, Cohn, Dudley and others really government ‘representatives’? Or are they shadow bankers first and foremos, who have managed to capture key positions in the government apparatus? Do the ‘revolving door’ former Fed governors act independently? Or do they decide with a keen eye on a lucrative offer from the private banks after a few years in office during which they ‘prove’ their value to the bankers? Do the Fed chairs and vice-chairs make decisions solely in the public interest at all times? Or are they perhaps too aware of the opportunity to become quick multimillionaires themselves once they leave office, recompensed nicely in various ways once they leave? And why is it that at the 12 Fed districts, the district president selection committee of 9 district board directors are almost always ‘stacked’ by 5-6 former regional bankers or banker business friendly former CEOs?

In my just published book, ‘Central Bankers at the End of Their Ropes’, Clarity Press, August 2017, I examine this ‘myth of central bank independence’ in detail, and show how central banks, including the Fed, from their very origins have always been dependent (not independent) on the private banks rather than from elected government representatives. Central banks emerged from the private banks and have always been an appendage of sorts of that private banking system. This fact is supported today more than ever by the fact that Fed and central banks’ policy since 2000, and especially since 2008, has been to ensure the subsidization of financial institutions’ profitability. It’s no longer just serving as ‘lender of last resort’ to bail out the private banks periodically when they get in trouble (which chronically occurs). Now it is permanent subsidization of the private banking system.

A Constitutional Amendment to Democratize the Fed

In the book I also propose in the addendum a constitutional amendment and enabling legislation that will sever the relationship of the central bank, the Fed, from the banking industry (and its government representatives) for good. (see the reviews and information re. the book,’Central Bankers at the End of Their Ropes‘ on this blog, my website, kyklosproductions.com, and at Amazon books. See the book’s addendum for the amendment and enabling legislation).

The trend in banker control of the Fed–and thus US economic policy–is about to deepen as Trump fills the open governor, chair, and vice-chair positions at the Fed in coming months. This will begin immediately after Jerome Powell assumes the chair position from Janet Yellen in early February 2018.

Economic Consequences of a Trump Fed

The shadow bankers, who gave us the last financial crash in 2007-09, will then be in total control–at the Treasury, in the White House, at the New York Fed, and in a majority of the Fed governorships. They will support Treasury Secretary Mnuchin’s policies–keep US rates at levels to ensure that the US dollar’s exchange rate is low versus other key world currencies. That will ensure that US multinational corporations’ profits offshore are not threatened, as they bring back those profits in 2018 at lower tax rates, and then can bring back profits thereafter without paying taxes on offshore profits at all for the next nine years.

The next financial crisis and crash is coming. It is not more than two years away, and could come sooner. The Fed will be totally unprepared and unable to lower interest rates much in response. It will then re-introduce its massive free money injections into the banking system, as it did with ‘QE’ for seven years starting with 2009. The Fed and other central banks provided ‘free money’ in the amount of at least $25 trillion to bail out the private banks over the last 9 years. How much more will they give them next time? And will it be enough to stabilize the US and world financial system? And will the Fed and US government then legitimize and legalize the private banks’ taking the savings of average depositors and converting those savings to worthless bank stocks? UK and US government preparations are already underway for that last draconian measure. For even today, when one deposits one’s money in a bank, that money legally becomes ‘owned’ by the bank.

Trump’s imminent appointments of Fed chairs, vice-chairs, and governors may prove historically to be the first step in the total capture of the US central bank by the shadow banker element in the US economy–by the Goldman Sachers, the private equity firms, the hedge fund vultures, and the commercial real estate speculator that is Trump itself.

We now have government by the bankers unlike ever before in the US. And their policies will inevitably lead to another financial crisis. Only this next time, the rest of US will be even less prepared and able to endure–given the decade of stagnant wages, new record in household debt, collapsing savings rates, greater reliance on part time/temp/gig employment, decline of pensions, loss of social benefits and safety net, higher cost of healthcare, and all the rest of the economic decline that is afflicting more than 100 million households in the US today.

Meanwhile, Trump will soon go to Davos, Switzerland, to party with the rest of the World Economic Forum’s multimillionaire-billionaire class. They will celebrate and pat themselves on the back about how well they’ve done for themselves in 2017: record profits, record stock markets’ price appreciation, record dividend payouts to wealthy shareholders, new tax laws that mean they can keep more of those profits and capital gains, continuing austerity for the rest, further destruction of unions (called ‘labor market reform’), decline and co-optation of remaining social democratic parties, etc. At Davos Trump will bask his ego and give an ‘American First’ speech, largely for public consumption to his base in the US. ‘America First’ means Trump, and his more aggressive wing of US capital, are signalling they plan to squeeze the rest of the world’s capitalists for a US larger share. So they’ll have to take even more out of their workers with austerity, wage compression, social benefits reduction, and even more ‘labor market reform’.

The Davos crowd may think they are sitting on their mountain in Switzerland, but they are really partying on the Titanic, as they steam on oblivious to what’s coming, unable to foresee the approaching economic icebergs below the surface. And as their mainstream economists, asleep on the bridge, almost in unison declare ‘steam on’, all is well and getting better.

Dr. Jack Rasmus is author of the recently published, ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression‘, August 2017, and ‘Systemic Fragility in the Global Economy‘, 2016, both by Clarity Press.

posted January 10, 2018
A Theory of System Fragility: Part 2 (from Chapter 19 of ‘Systemic Fragility in the Global Economy’, Clarity Press, 2016

Excess Liquidity at the Root of Debt Accumulation

Systemic fragility is rooted first and foremost in the historically unprecedented explosion of liquidity on a global scale that has occurred since the 1970s. That liquidity has taken two basic forms: First, money provided by central banks to the private banking sector—i.e. ‘money liquidity’ as it will be called. Second, a corresponding explosion of forms of ‘inside credit’ by banks and shadow banks that allow these unregulated financial institutions to expand credit independent of, and beyond, the money credit provided by central banks—i.e. referred hereafter as ‘(inside) credit liquidity’ or just ‘credit liquidity’.

Centuries ago, when gold and other metals were the primary form of money, the problem was the actual and potential production of goods was greater than the availability of money (as gold, etc.) to finance the production and enable the circulation of those goods. Today, however, in the 21st century, the growing problem is the opposite: money and credit are being created far more easily and rapidly and in greater volume than is necessary to finance the production and circulation of real goods and services. Just as the development and expansion of currency and bank bills of credit forms of paper liquidity eventually rendered gold and metal forms of money less important in terms of total money creation, so too will new forms of money liquidity creation eventually surpass older forms of money creation now provided by institutions of central banks and the commercial banking system. Liquidity expansion will accelerate even faster.

Excess liquidity has therefore been a major and growing problem within the global capitalist economy and this will continue and grow as a problem in the foreseeable future. The problem, however, is not liquidity per se or even its excess; the problem is the transformation of that excess liquidity into debt, and the consequences of that debt for fragility and financial instability.

Money Liquidity

As earlier chapters noted, the collapse of the Bretton Woods system gave central banks the green light to embark upon generating their own particular form of excess ‘money liquidity’ creation. The decision by US and other advanced economy economic and political elites in the late 1970s and early 1980s to eliminate controls on global money capital flows enabled the liquidity explosion, engineered by the central banks, to disseminate globally. With the collapse of Bretton Woods in 1971-73, central banks were now responsible for ‘regulating’ and stabilizing currency exchange rate fluctuations in order to facilitate world trade and capital flows. That required injections of liquidity periodically to maintain stability for the world’s various currencies within an acceptable range of fluctuation against the US dollar and a few other key currencies. That currency stabilization task used to be done by the gold standard, and then the dollar-gold standard that was Bretton Woods system from 1944 to 1973. But all that changed with the 1971-73 collapse of the Bretton Woods system. Thereafter, currencies were free to fluctuate widely and volatilely, unless central banks intervened to maintain relative stability, which they began to do in the late 1970s.

The growing frequency of recessions and financial instability events in the 1980s and 1990s continued to destabilize economies, currencies, and banking systems, and in turn threaten world trade and economic growth for the many countries highly dependent on trade. That called for more liquidity injections to check the periodic recessions and financial instability events. So growth and severe disruptions to growth both called for and received more central bank liquidity injections, in addition to that needed for currency stabilization.

There was another factor. In response to the crisis of the 1970s, the US capitalist elite in the early 1980s decided to focus on expanding US capital more globally instead of focusing primarily on internal growth. This also called for the provision of more money capital, as US businesses accelerated their global expansion in that decade. With the collapse of the Soviet Union the opportunities for still more global expansion arose in the 1990s. More liquidity was necessary. With the integration of China into the global economy in the early 2000s, even more liquidity was necessary. With new digital technology and networking in the 1990, new industries and products appeared, requiring still more liquidity. Expanding free trade beginning in Europe and the US in the late 1980s, which accelerated throughout the 1990s and has done so ever since, demanded still more liquidity.

In short, the end of Bretton Woods, the globalization of money capital flows, the expansion of capitalist trade and economy both externally and internally, the growing frequency and magnitude of financial instability events and recessions, etc.,—i.e. all called for more money, more liquidity. And the central banks and private banking system provided it for more than a quarter century from the mid-1970s into the 21st century. Massive amounts more would be needed, however, to bail out the financial system when the general global financial crash occurred in 2007-09.

Central banks have been pumping increasing amounts of money liquidity into the economy through commercial banks since the 1970s and the collapse of the Bretton Woods system. However, central banks do not actually create money. They indirectly enable private banks to do so, by providing private banks excess reserves on hand that the banks can then lend, which does increase money liquidity in the economy when lending occurs.

But this too has been changing, resulting in even more liquidity injection into the system, as central banks’ recent revolutionary policy innovations like ‘quantitative easing’(QE) have been introduced since 2008. QE represents central bank direct money creation, not just the indirect liquidity injections through the commercial banking system. With QE, central banks print money (electronically) and use it to purchase back financial assets from private investors. The assets purchased are then registered on central banks’ balance sheets as debt (in effect transferring the debt from private banks and investors to the central banks’ balance sheets), and the printed money used to buy the assets from investors is injected into the economy, adding to the general liquidity.

As previously noted, since 2008 more than $9 trillion in QE liquidity has been injected into the global economy and more is likely to follow soon from Japan and the Eurozone. In addition, indirect central bank policies (name a few in brackets?) over the past quarter century have injected tens of trillions more, of which only a small proportion has been retracted. Traditional central bank policies since 2008, which have reduced bank interest rates to virtually zero in the advanced economies for seven years now, have injected an additional ten to fifteen trillion dollars as well.

While central banks have been responsible for the growth of both indirect and direct (QE) liquidity expansion, other new forms of money and credit were, and are, being created as well. For example, ‘digital currencies’ like bitcoins and other forms of digital money that are proliferating within the private economy. These forms are created neither by central banks, private commercial banks, or shadow banks. The new money forms remain outside the control of central banks and even the commercial banking system. Changes in technology under capitalism will almost certainly enable the expansion of additional new forms of money liquidity in years to come in increasing volume. All foregoing examples represent the creation of excess money liquidity that is likely to escalate from all the above sources. Central banks today have little control over the parallel trend of expanding non-money forms of inside credit liquidity. And credit liquidity generation is where the shadow banking system in particular has been playing a major role.

Inside Credit Liquidity

While shadow banks also extend credit in the form of money to their wealthy investor clients, the unregulated shadow banking sector also extends credit to investors where no money is involved, thus enabling their investor clients to purchase more financial assets and securities. This ‘credit liquidity’ is based simply on the price and value of previously purchased products. If the price of previous purchased securities rises, so does its value as collateral, on the basis of which further credit is extended to investors. No money in the traditional sense is necessary or provided. The credit is based on exchange values of existing securities, not on new money loaned to purchase more securities.

While credit liquidity may not expand in this way as frequently where real assets are concerned, it works especially well with financial securities and other financial assets. Credit is extended, and more financial assets are purchased, simply based on the rising price and market value of previously purchased securities. Margin buying of stocks is one such example of inside credit creation. Many forms of derivatives securities are purchased in this way. Corporations also obtain credit based on the value of their retained assets. And banks are extended credit in the form of ‘repurchase agreements’, or repos, for the short term based on the value of banks’ assets put up as collateral. It all works, until the value of the assets used as collateral for the additional credit begins to collapse. Then the inside credit extended has to be paid with real money. In the meantime, however, in periods of economic expansion and thus rising financial asset prices, technology and financial innovation continues to expand forms of (inside) credit liquidity which finances investment—especially in financial securities.

From Excess Liquidity to Excess Debt

Whether commercial, shadow, or deep shadow, banks provide credit to other businesses. By far the largest segment of debt growth in the US economy since 1980 has been business debt. According to the Bank of International Settlements, the fastest growing debt sector by far since 2008 globally has been the business sector—not government or households. This is in part due to the fact that business is able to ‘leverage’ investments with debt more easily and to a greater extent than households or government units. By leverage here is meant the ability to obtain credit from financial institutions and reinvest it, matching it with only a small fraction of their own money capital. For example, borrowing $9 of money and adding only $1 of their own capital, for a $10 total investment.

Leveraging is also more conducive to financial asset investing than physical or real asset investing. Since financial asset prices tend to rise more rapidly and higher compared to prices of goods and services, credit is more available for further purchases of financial assets. For example, an initial stock offering price per share may average $20-$30 on initial offering, but if successful may rise into the hundreds of dollars per share within a year. That is not how goods prices behave. A successful real product when introduced, like a smartphone for example, will almost never rise in price, but instead begin to decline within a year. That means the market value of financial assets may rise as rapidly as the price of the asset rises. That market value increase in turn enables more leveraging of debt in order to purchase more of the financial asset.

Excess liquidity not only translates into more debt for financial investing. It also means more credit is available for household consumption based on borrowing. The availability of cheap credit to households plays a role in wage income growth slowdown. Employers can afford not to raise wages as frequently, or not at all, since wage income households address their income shortfalls by accessing credit to offset the lack of wage growth. Standards of living are defended not by demanding higher wages, or organizing into unions to get wage increases, or demanding minimum wage increases. Debt instead is the vehicle for maintaining living standards that previously were supported by wage gains that reflected annual productivity.

The excess liquidity also contributes to rising total government debt, both federal and local, as well as agency and central bank. The excess liquidity means interest rates have been kept low. That provides an incentive for government to issue more debt. In the US, for example, that means at the state and local government level more issuance of municipal bond debt. At the agency level, the lower rates are reflected in more mortgage debt that is guaranteed and purchased by federal housing agencies like Fannie Mae and others. And by buying up mortgage bonds by means of its QE policies, the central bank in effect transfers private sector bad debt to its own central bank balance sheet.

The lion’s share of government debt occurs at the federal or national level, however. The US federal debt has now exceeded $18 trillion, most of which has been accumulated since 2000. Federal government debt accumulates in several ways. Deficit spending increases and tax cutting raises debt. That spending increase may be attributed either to social programs or defense spending. In the US example once again, defense spending has accelerated as the US has conducted wars in the 21st century for which it has not only not raised taxes, for the first time in its history, but actually cut them.. Estimates of the cost of wars thus far since 2000 for the US range from $3 to $7 trillion. And the 21st century wars are continuous, without end. Tax cuts amounted to nearly $4 trillion under George W. Bush, more than $2 trillion more under Obama’s first term, 2009-12, and another $4 trillion over the following decade, 2012-2022, as part of the ‘fiscal cliff’ legislation of January 2013.

On the social spending side, government spending on healthcare related programs has also soared, as the health insurance, private hospital chains, pharmaceutical companies, and health services sector has concentrated, established deep financing from Wall St. for acquisitions. This has raised prices at double digit annual levels for years since the mid-1990s. The consequence has been escalating costs in Medicare, Medicaid, and most recently the Affordable Care Act (Obamacare) programs. The passage in 2005 of Part D, the prescription drugs program, alone has added more than $500 billion to the US deficit and debt in the last decade, in part due to skyrocketing drug prices and also as a consequence of the US government refusing to pass a tax to pay for it, preferring to fund it totally out of deficits.

Government deficits and debt accumulation has also been due to cyclical causes, and not just the secular trends just noted. The growing frequency of financially induced real contractions of the economy has led to government bailout costs. While the federal reserve has been the source for bank bailouts that have raised its share of total government debt to approximately $4 trillion, parallel bailouts of non-bank companies impacted by the financial crashes since the 1980s has also raised government non-bank debt. This source of debt especially escalated after 2008.

All this increase in government debt could not have been possible, however, without the development of what is termed the ‘twin deficits’ solution, which has been described in more detail in chapter 15. Briefly once again, the ‘twin deficits’ is the neoliberal solution created in the 1980s in which the US allowed a trade deficit to develop so long as trading partners (Europe, Japan, petrodollar economies, and then China after 2000) agreed to recycle the dollars they accumulated from the trade deficit back to the US by buying US Treasury bonds in the trillions of dollars. That recycling allowed the US in turn to run a budget deficit of ever growing dimensions—resulting in the $18 trillion plus debt.

Much of the total government debt—both central bank, national government, and even local government—represents the transfer by various means of private sector debt onto government agency balance sheets. Thus, as private debt—primarily bank, corporate, and investor—has risen since the 1970s for reasons explained, government debt has followed. Without the State having thus absorbed the private debt, and continuing to do so, the financial instability and crashes to date would have been significantly more frequent and more serious. Action by the State has thus kept the global capitalist system afloat, and ensured the patient remains on ‘life support’ even as its condition continues to fundamentally deteriorate.

So in a host of ways, the excessive liquidity creation leads to more debt creation at all levels—i.e. financial institutional, households, and government debt in various forms. And excessive debt creation is an important component of fragility at all levels—business financial fragility, household consumption fragility, and government balance sheet fragility. Debt is just the mirrored reflection of excess liquidity, and together excessive debt/ liquidity drive the system toward systemic fragility and instability. The vehicle is escalating the trend toward financial asset investing, and its corresponding negative influence on real asset investment.
Debt and the Shift to Financial Asset Investing

Financial Asset v. Real Asset

Financial asset prices are far more volatile to the upside than goods prices, especially in a boom phase of a business cycle. With financial assets, ‘demand creates its own demand’, one might say, driving up prices while supply factors play a lesser role in dampening price swings. The more the price of the financial asset rises, the more buyers will enter the market to make further purchases of the financial asset, thereby driving its price still higher. Conversely, since the ‘cost of goods’ for making financial asset products is extremely small, rising supply costs do not discourage or lower the demand for the asset.

The opposite behavior occurs with goods prices, where demand plays a less volatile role and supply a more dampening role. Should the price rise, fewer buyers will purchase the product, unlike financial securities where rising prices attracts more buyers. That’s because goods themselves are not as highly liquid as financial securities. Goods cannot as easily or quickly be resold and, if they are, are almost never resold at a higher price but instead at a lower one. In other words, there is no profit from price appreciation with goods prices whereas for financial assets profits are mostly determined by price appreciation. That means there is significant potential for profit from price appreciation for financial assets, which is another feature attracting buyers.

There is also more profit potential related to production costs, since there is virtually no ‘cost of goods’ involved in producing financial securities—little raw materials required, no intermediate goods, very little in the way of labor costs, no transport costs since nothing is physically delivered to the buyer, no inventory carrying costs, and so on. Financial assets are electronic or paper entries created originally with a small team of ‘financial engineering’ experts. This lack of production and therefore supply costs makes financial assets more profitable to produce.

There is a third factor that also makes financial asset prices more profitable. Because they are sold online, by phone, or by some other communications media, a large and costly sales force is not needed. Distribution costs are negligible. Moreover, the potential market reach—i.e. what is called the addressable market in business jargon—is the worldwide network of financial investors who are generally ‘savvy’ enough to seek out the sellers, rather than having sellers ‘go to the buyers’. At most, minimal advertising costs are involved for the sellers of financial assets and securities.

In the simplest terms, then, financial assets have an advantage over the production of real goods—whether autos, clothing, food, machinery, or whatever—in all three categories of profit origination: price appreciation, cost minimization, and volume sales potential. They are simply more profitable—providing that prices are rising. In a contraction phase, the potential losses from falling financial asset prices are correspondingly greater compared to goods prices. But while the contraction may be steep in the short run, financial asset prices typically recover the losses much faster than goods prices in the recovery phase.

Another reason that financial assets are more attractive than real assets is that financial assets are traded (bought and sold) in highly liquid markets. That means an investment may be made and then quickly withdrawn (sold) if the asset price is not rising sufficiently or begins to fall. This is not possible with real investment and real goods. The real asset or company invested in must produce the good, and then sell it, over a longer cycle and time period. If costs rise and market prices fall in the meantime, the investor cannot withdraw to reduce losses as quickly. There is thus greater risk in real asset investing and goods production and sales. On the other hand, with financial assets, losses can be minimized faster as well as profit opportunities taken advantage of more quickly.

The ability of investors to purchase financial securities by leveraging purchase with debt, the various ways financial assets are potentially more profitable, plus the greater flexibility in quickly moving investment around as new opportunities emerge, all together provide a significant incentive for investors to direct their money capital and available credit toward investment in financial assets.

Conversely, investing in real assets means less profitability potential, given that price appreciation is negligible and that costs of production tend to rise significantly over the boom phase of the cycle. It means an additional costly distribution channel where the seller of goods must ‘go to or seek out’ the buyer. And it means less flexibility to move one’s money capital around, to minimize losses and maximize gains. Why then would not the professional investor—i.e. the new finance capital elite—who cares only for short term, maximized capital gains not redirect his money capital from real asset into financial asset investing? He is not interested in building a company, becoming the biggest, gaining market share, acquiring and thus eliminating competitors. He is interested in short term, price appreciating capital gains. And for that financial asset investing is by far more attractive.

In short, because financial asset investing is typically more debt leveragable, because it is potentially more profitable in the shorter run, and because it is more liquid, flexible, and therefore less uncertain—investors can and do move in and out financial markets more easily and quickly. They take price appreciated capital gains profits in a short period, and then move on to other short term, liquid, financial asset market opportunities. Or, if prices fail to appreciate, move just as quickly out of the liquid markets and minimize losses. Within a given year, for example, an investor may move a given amount of money capital from stock investing in Asia, to shale gas junk bond debt in the US, to derivatives in the UK, to speculating in Euros and Swiss francs, and so on. Money capital is not tied up long term as in the case of real asset investment, nor with as great uncertainty of outcomes.

(Financial Asset Investing Shift)

To sum up: the greater opportunity to leverage with debt, the greater relatively profitability, the shorter investment cycle and therefore the less uncertainty that is associated with investing in highly liquid markets—all provide investors a much greater relative incentive to invest in financial assets and securities instead of real assets. Given all these advantages, it is not surprising that a relative shift toward financial asset investing has been taking place for decades now. The relative profitability potential is simply greater. And in a world economy in which professional investors have grown in number and now control an unprecedented volume of investible money capital, that shift to financial assets investing is not surprising. Keynes’ warning eighty years ago about the rise of the professional investor who prefers financial assets and securities, compared to the enterprise owner-investor who prefers real asset investing, has become the rule, not the exception.

The shift to financial assets does not mean that real asset investment disappears. Some of the explosion in excess liquidity and debt is directed to real asset investment and the production of real goods. And periodically major opportunities for real investment arise internally with the coming of new technologies like the internet, wireless communications, social networking, etc. Other external opportunities for real asset investing also emerge from time to time: the opening up of investment in Russia and east Europe in the 1990s; the significant real investment opportunities in China and emerging market commodities production that arose after 2000; or the North American shale gas and oil boom after 2008. But the time frame for profit generation from real asset investment is typically relatively short. Real asset investment becomes saturated after a few years, or after a half decade or so at most. Overproduction occurs. Costs rise and price increases are difficult to sustain. Competition provides more supply and dilutes demand. Sales peak and then decline. The boom is relatively short and the downside that follows is generally protracted.

In contrast, with financial asset investment the boom may extend and prices continue to rise over the longer term. So long as prices rise steadily and don’t over-accelerate, financial asset investing grows. There is no ‘overproduction’. As for the downside, while it may be deep on occasion, it is relatively short term. In 2008-09, for example, financial assets like stocks and bonds contracted sharply but then ‘snapped back’ quickly and attained new record levels in just months following the crisis. In contrast, prices and sales of real assets like homes and other goods contracted less initially, but have yet to attain prior levels of price and sales volumes six years after the recession ended. Prices for equities, bonds, and other financial securities have risen steadily since 2009, whereas prices for goods have been disinflating and even deflating throughout the advanced economies—and now in China and emerging markets—since 2009.

Despite the growing importance of financial compared to real asset investing, mainstream economic theory still does not recognize or give appropriate weight to this financial asset investing shift. Investment is measured in real terms, based on real data obtained from national income accounts. There’s little place for financial variables in their General Equilibrium Models. How financial variables impact and determine the trajectory of the real economy is not explained in sufficient detail. At the same time, Marxist economists also continue to dismiss financial assets, referring to them as merely ‘fictitious’ capital and considering their role even more irrelevant.
Both mainstream and Marxist make little distinction between financial asset investing and real asset investing, or how they mutually determine each other. Investment is investment, as indicated in the Gross or Net Private Domestic Investment category of the National Income Accounts. If GDP is a measure of the performance of the real economy, financial investment variables have no effect on GDP level outcomes. It is the real side that drives the economy, and financial instability in turn.

The view from both the mainstream and Marxist analysis is that other non-financial forces are responsible for the slowing of real asset investment. And because of that slowing, investors are turning more toward financial asset investing. The real side is what is driving the ‘financialization’ of the economy (which is usually defined narrowly, and incorrectly, as a rising share of total profits going to banking and finance). Mainstreamers argue what is causing the slowdown of real investment is slowing productivity, excessive benefits compensation, too high federal taxation, and other costs. Marxists argue it is the falling rate of profit due to a rising ratio of fixed to variable capital, workers resisting employer exploitation, or growing capitalist competition that is responsible.

Neither acknowledge that the shift to financial investing may be due to the easier and higher profits from such investing—an outcome of the financial sector restructuring that has occurred the past four decades. Neither accept the notion that perhaps the higher and more certain profitability from financial investing is what is driving available money and credit more toward the financial side of the global economy, reducing money and credit that otherwise would have gone to real asset investment.

While it is apparent that money and credit is flowing increasingly into financial assets and financial securities investing, their argument is that the decline in real investment is causing the rise in financial. But the observable correlation—with real investment slowing and financial investment accelerating—may have an alternative causal explanation. It may be that financial asset investing is ‘crowding out’ real asset investing simply because the former is more profitable than the latter. It may not be only an excess of liquidity that is driving financial investment; it may be that the financial side is not simply getting the excess available liquidity and debt left over after real investment occurs. It may be the greater attractiveness of financial investing is diverting money and credit from real investment to financial investment. It may be real investment is slowing—not because of slowing productivity, or rising compensation costs, or too high government taxes, but because financial side and financial investing is just more attractive and potentially profitable in 21st century global capitalism.

As a final comment on the financial investing shift, it should be noted that as the shift grows over a longer period following a crash of financial assets, financial investing tends to assume more of a speculative character. By ‘speculative’ here is meant investing in highly price volatile financial asset classes and for an even shorter term duration than average for financial asset investing in general. Speculative investing focuses on quick ‘in and out’ purchases of assets in highly liquid markets, in expectation of a fast price appreciation (or depreciation) and consequent capital gain profit. It may also employ a greater amount of debt leverage in the investing. Speculative investing appears as chasing ‘yield’—i.e. seeking higher returns than average by investing in more risky asset classes like corporate junk bond and leveraged loan debt, distressed sovereign debt, more ‘naked’ short selling of stocks where bets are placed on stock price declines and no actual purchases are made, or on the most unstable currencies in expectation of currency exchange swings.

Speculative investing not only tends to rely relatively more on debt leverage but is more likely to be incurred via inside credit. A good example in 2015 has been the growing reliance on margin buying of stocks in the China equity bubble of 2014-15. That was followed by shadow bank investors then taking advantage of the significant stock financial asset deflation by engaging in short selling of Chinese equities. In the case of margin buying, the heavy debt inflow drove up China equity prices faster and higher than could be sustained for long, while the short selling had the effect of driving those same asset prices down faster than otherwise would have occurred.
In summary, couched within the shift to financial asset investing is the more unstable element of financial speculation. This tendency toward the more speculative forms of financial asset investing is generally an indication of growing financial fragility within financial asset markets in general. However, in the Chinese example, neither the uncontrolled margin buying nor the subsequent short selling of equities could have been possible without the extraordinary run-up in liquidity and debt in China since 2008 that made the shift to financial asset investing possible, leading to the escalation of financial fragility within China to dangerous levels.

posted January 1, 2018
(3rd) Review of Dr. Jack Rasmus’s book, ‘Central Bankers at the End of Their Ropes’, by Dr. Larry Souza

“INTRODUCTION

If you talk to some monetary, fiscal, macroeconomic, and financial institutional and capital market economists, some would argue that Central Banks are at the end of their rope; have lost their credibility and risk losing their independence.

Dr. Jack Rasmus book, “Central Bankers at the End of Their Rope? Monetary Policy and the Coming Depression” is the latest in a growing literature building the case against the U.S. Federal Reserve (the Central Bank of Central Banks), European Central Bank, Japanese Central Bank, The Bank of England, People’s Bank of China, etc.; their unorthodox monetary policy response to the financial crisis; policy response to asset price bubbles, financial (market) crisis (crashes), and recessions since 1995; lack of macro-prudential supervision and oversight; and consistent policy mistakes based on their lack of understanding of how the world and economy works, dating back as far as 1929 (See supporting Literature in the Appendix).

In Dr. Rasmus book, he looks at:

1. Problems and Contradictions of Central Banking
2. A Brief History of Central Banking
3. The U.S. Federal Reserve Bank: Origins and Toxic Legacies
4. Greenspan’s Bank: The Typhon Monster Released
5. Bernanke’s Bank: Greenspan’s Put (Option) on Steroids
6. The Bank of Japan: Harbinger of Things That Came
7. The European Central Bank under German Hegemony
8. The Bank of England’s Last Hurrah: From QE to BREXIT
9. The People’s Bank of China Chases Its Shadows
10. Yellen’s Bank: From Taper Tantrums to Trump Trade
11. Why Central Banks Fail
12. Revolutionizing Central Banking in the Public Interest: Embedding Change Via Constitutional Amendment

Dr. Rasmus builds a methodical case against historical and current central bank ideologies and orthodoxy; and makes prudent and wise recommendations for structural and institutional macroeconomic, monetary policy and political change.
The conclusion, is not too late to address the systemic and systematic risks to central banking, regulation and supervision, financial institutions and capital markets, and the real economy and labor markets.

However, considering the real economic realities of the current political, party and policy environment, along with the Wall Streets control over monetary (Federal Reserve), fiscal (Treasury) and regulatory (Comptroller/SEC/FDIC/etc.) policy in Washington, that a political solution could actually be accomplished. Dr. Rasmus is correct in his recommendations and his analysis.

We are all at the end of our rope, and thank you Dr. Jack Rasmus from bringing another critical analysis of the current and future state of global central banking, and for proposing bold policy recommendations to avert another severe financial crisis, great recession and depression.

REVIEW

Rapid technological, demographic, economic, cultural, sociological and political change has changed the way central banks analyze, manage and respond to business cycle peaks, troughs (recessions), financial crisis, and macro-prudential bank supervision; and central bank policy responses have failed consistently over time, due to limitations of their data, models, ideology, epistemology, bureaucracy, and politics.

But one modern response to these limitations has been consistent over time, inject or try to inject massive amounts (trillions of U.S. Dollars, Yen, Euros, Pounds, Yuan, Peso, Rubble, etc.) of liquidity (credit) to back-stop and set a support under asset prices. Since these asset price bubbles and asset price collapse (financial/currency crisis) have become more frequent since 1995 (Peso Crisis, Thai Baht, Russian Default, Y2K/911, Housing Bubble, Financial Crisis, etc.), global central bankers do not have the intellect, culture, knowledge, data, models, tools, resources, balance sheet, etc. to deal with crisis going forward.
Dr. Rasmus recommends limiting the independence (ad hoc decision making) of central banks by instituting a (rules based) Constitutional Amendment defining new functions for the central bank, new monetary targets and tools to modernize and drive global central banks into the 21st century.

Chapter: Problems and Contradictions of Central Banking

Globalization, technologicalization and deregulation/integration has accelerated capital flows and accumulation, and concentration to targeted and non-targeted markets across the world. This process continues at a rapid pace, and depending on the recipient, can be economically, financially and politically (institutionally) destabilizing, destructive and deconstructive. It is not a matter if this will happen, but when, again! Which country? Industry? Company? Demographic? will be affected, disrupted, destroyed, and wrecked.

In response to these economic and financial disruptions, central banks have responded consistently by injecting massive amounts of liquidity into the system, with no limitations due to their misunderstanding of how the economic and financial system really works, and has become, through the use of unorthodox monetary policy tools and targets, in the face of total deregulation and free flow of capital (shadow banking and derivatives trading), is at this point, where they cannot control or manage the system. We are in unchartered territory.
Only to bail it out the private banking system — other strategic affiliated institutions, corporations, businesses and brokerages — again and again, by printing massive amounts of fiat currency (seigniorage), to buy (defective/defaulted) securities product (derivatives), accumulate more sovereign-corporate-personal debt, with even more crowding out effects, has had no real eventual long-term impacts on real economic growth, wages, and productivity; and social welfare or standards of living. Only asset prices bubbles and a massive redistribution and concentration of wealth.

It is estimated, between the U.S Federal Reserve Bank, Bank of England, and European Central Bank, $15 trillion direct liquidity injections, loans, guarantees, tax reductions, direct subsidies, etc. have been used. If you add in China and Japan, the total gets to as high as $25 trillion, and if you add in other emerging country (Asian, Latin America, and Middle-East) central banks, the total gets as high $40 trillion.

This is only the present value (cost basis), if you project the total cost (interest and principal payments) out over a 30-to-40 year period, the estimate total cost is as high as $80-to-$100 trillion. Thereby, making the global financial and economic system eventually insolvent and bankrupt, and central banking ineffective and perpetually in a liquidity trap, as the velocity of money has collapsed. There is not money going into real long-term (capital budgets) assets, only short-term financial assets.

This is the contradiction of Central Banking: liquidity-debt-insolvency nexus, the moral (immoral) hazard of perpetual bail-outs, growing concentration of wealth at the extremes, growing perception that Negative/Zero Interest Rate Policy (N/ZIRP) can fix under-investment in capital (human/physical) and deflationary (disinflationary) trends, and that bank regulation-supervision is bad for the economy, financial services (institutions) industry, and for institutional and retail investors (savers) in the long run.

Chapter: A Brief History of Central Banking

A Brief History of Central Banking, walks us through the origins of central banking, from the Bank of England (1694) as the lender of last resort for private banks, and its monopoly position in issuing government bank notes and currency (1844/1870s), and bailing out the banking system due to crashes and development of new types of currencies (paper, gold, notes, etc.).

An uncontrolled growth in the money supply in the U.S. led to financial speculation in gold and bonds (1830), and depression (1837-43). No central bank was established, not even after banking crashes (1870/1890s/1907-08), but only by 1914 as the U.S. entered WWI, and needed to decouple its currency from gold, raise tax revenues, and be able to monetize its sovereign debt through the use of a fractional reserve banking system, did the government then decide that they needed a central bank.

The role of the central banks were to maintain monopoly control over the production of money, act a lender of last resort and fund raising agents, provide a clearing-payment services system between banks, and supervise bank behavior.
The goal, was price stability, supply of money growth targets, full employment, interest rate and currency exchange rate determination. They were to do this though the use of tools (rules): reserve requirements, discount rates, and Open Market Operations (OMO); and now, Quantitative Easing (QE)/Tightening (QT) and special auctions and re-purchase agreements.

The U.S. Federal Reserve Bank(s) was also given this monopoly position, along with tools and independence. This has led to some toxic legacies (credibility issues).

Chapter: The U.S. Federal Reserve Bank: Origins and Toxic Legacies

The U.S. Federal Reserve Bank system was originated from a consortium of private banks looking to centralize the Federal Reserve System: JP Morgan, Kuhn, Loeb, Chase, Bankers Trust, First National, etc. Particularly after financial instability (illiquidity/capital/reserves), bank crashes (lack of supervision) – 1890s/1907, and the rise of the U.S. as a global economic power.

Congress passed the Federal Reserve Act on December 13th 1913: twelve district banks and national board located in Washington D.C. The real power resided in the member banks that owned their respective districts. They could issue their own currency and notes, exchange for gold and foreign currency, invest in agricultural and industrial loans, and received dividends from earnings.

After the Great Depression and bank reform acts (1933/1935), the Federal Reserve Board of Governors and the Open Market Committee became the two powerful institutions within the Federal Reserve System.

However, the Fed experienced two decades of failure (1913-1933) due to lack of supervision, stock market and loan speculation, asset price bubbles/crashes, depressions, bank closures and bailouts, excessive extension of liquidity (margin), protection of government finance and wealthy investors, hyperinflation (deflation/disinflation), false targets (gold peg/production/employment), inaction and incompetence (discount rate/open market operations), institutional narcissism and egotism, power and elitism, bureaucratic control, etc.

Bank acts were put in place by Roosevelt, and other regulation and operations were put in place through the 1970s and 1980s: Glass-Stegall, 1935 Bank Act, Reg U, tax reform, policy, Treasury-Fed Accord, Operation Twist, Bretton Woods, Humphrey-Hawkins/Resolution 133, fighting hyperinflation-stagflation-recessions, Reg D, Plaza Accords, state and shadow bank regulatory efforts, international banking (currency/note) issues, liquidity escalations, and eventually the Greenspan typhon.

From 1913 to 1933, the two decades of failure after the Federal Reserve was created; it continued into the 1940s-1950s, 1960s-1970s, 1980s-1990s, 1990s-2000s, it continued and continues to this day, and looks like it will continue into the future.

Chapter: Greenspan’s Bank: The Typhon Monster Released

Greenspan, influenced by Ian Rand — liberal-post-modern philosophy – set in motion an un-orthodoxy in Federal Reserve, Monetary Policy, and Macro/Political Economic rationalization, a stark contrast to the Volker era. Greenspan believed in markets, and lase fair-free hand economic ideology (deregulation); and did not believe in limits to the Market and Technology-Labor Productivity, limits to the Federal Reserve’s power to dictate markets and the economy, and limits — in the end – to the ability to inject massive amounts of liquidity into the financial system to drive (support) asset price bubbles. This believe, or lack of, lead to multiple crisis and bailouts of the system.

The continual mismanagement, ideological mistakes, and lack of understanding of how the real world works, was witnessed again under Bernanke, now Yellen, and who knows who is next.

Chapter: Bernanke’s Bank: Greenspan’s Put on Steroids

Bernanke was minted from the same Greenspan mold, a true believer that excessive liquidity injections cold solve massive capital market and economic failures with little cost. It was the financial crisis and the coordinated efforts between the Federal Reserve and the Treasury (and other hidden interests), that was the test case in the Federal Reserve ability to manage severe man-made financial-economic crisis. The result, a new nationalization-corporatist-financial oligopoly industrial model, leveraged through Zero Interest Rate Policy (ZIRP)/Negative Real Interest Rate Policy (NRIRP), Quantitative Easing (QE), and Credit Enhancements/Liquidity Injections.

However, the outcomes from these efforts were disastrous:

1. Political Populism (Political-Economic Institutional Deconstruction/Destruction)
2. Massive Capital-Labor Substitution (Productivity Lag)
3. Massive Concentrations of Wealth (Inter-Generational Wealth Transfer)
4. Flat-Declining Real Wages (Social Welfare/Standards of Living/Poverty)
5. Unfunded Pension Liabilities (Crisis)
6. Recession(s) Twice as Deep/Twice as Long (Structural)
7. Rising Un-Funded Pension Liabilities
8. Collapse in Labor Participation Rates (High Under-Employment)
9. Collapse in Velocity of Money (Currency Turnover)
10. Rise of Shadow (Unregulated) Banking System (Disintermediation)
11. Massive Use-Trading of Un-Collateralized (Over-The-Counter/OTC) Derivative Trading
Excessive Use of Financial Engineering to Support Asset Prices
12. Global Economic-Political Instability (Global Cyber-Cold War)
13. Global Hyper-Inflation/Banking Crisis/Credit Defaults (Sovereign)
14. Massive Over-Leveraging of Government, Corporate and Personal Balance Sheets
15. Over Accommodative Monetary/Fiscal Policy (Negative Nominal/Real Interest Rates/Change Accounting Rules/Low Effective Tax Rates)
16. Global Tax Evasion (Avoidance)
17. Ballooning of the Federal Reserve Balance Sheet (Bonds/Reserves)
• Ballooning of the Federal Budget Deficit and Debt ($500-800 Billion Per Year/+$20 Trillion)
• Continuous Belief in Supply Side Economics (Trickle Down Theory/Deregulation)
• Continuous Belief in Monetary System/Real Economy Aggregates (Inflation/Interest)
• Continuous Bail-Outs of Financial/Economic System (Insolvency/Bankruptcy)
• Etc. Etc. Etc.

All of these beliefs, techniques and tools have been used by other Global Central Governments and Banks (BOJ/ECB/BOE/PBOC), with similar, disastrous, and disappointing outcomes. A focus is on saving the financial institutional system in the short-run, using extreme and un-orthodox monetary policies (tools), with a lack of concern or understanding of long-run economic, social, cultural, and political consequences and outcomes.

A perfect example, are policy responses of the Bank of Japan (BOJ).

Chapter: The Bank of Japan (BOJ): Harbinger of Things That Came

Over the last 17 years (1990 – 2017) the BOJ has implemented an aggressive form of unorthodox monetary policy (Negative – Nominal/Real — Interest Rate Policy/Quantitative Easing): printing massive amounts of money, buying massive amounts of sovereign-corporate (infrastructure) bonds, driving bonds yields negative, and driving domestic investors/savers and financial institutions literally crazy.

With no real effect on the Real Business Cycle (RBC), resulting in perpetual recessions and disinflation/deflation. These unorthodox monetary policies (mistakes/failures) have had the effect of causing asset price bubbles/busts (banking crisis), negative effects on standards of living, and negative effects on financial (dis)intermediation and fiscal policy (mistakes).

The BOJ has responded to these failures by introducing more accommodative (QE) policies, along with over accommodative fiscal policies (sovereign debt levels at historical levels) with no real positive effects. Fiscal policy mistakes (tax increases in a recession), have only exacerbated economic outcomes.

Japan will be the ultimate experiment in monetary-fiscal policy mistakes, as they will have to resort to even more extreme measures to try to get themselves out of their existential structural crisis. The ultimate fiscal-monetary response could be, with unintended political-economic-cultural consequences, associate with a massive and coordinated debt forgiveness, by both fiscal/monetary authorities.
At some point they will not have the tax revenues to service the sovereign debt payments, and will theoretically fall into default, and will ask for forgiveness, not from bond holders, but from the BOJ, that owns the majority of the debt.

Monkey see, monkey do. The BOJ has set the (bad) model for other central banks to follow, not only the U.S., but also the European Central Bank (ECB).

Chapter: The European Central Bank (ECB) under German Hegemony

Years after the financial crisis, the ECB finally started the process of cleaning up its banking system, and started and aggressive process of Quantitative Easing (QE), introduction of other unorthodox policies (Refinance Options/Covered Bond Purchase/Securities Markets, etc.), and drove nominal interest rates as far out as 10 year maturities, negative; with a limited effect of driving down the value of the Euro to stimulate exports, economic growth, and hit inflation and unemployment targets.

The actual ECB structure (dominated by Germany – Bundesbank) was a major impediment its ability to respond to the crisis: fiscal austerity, inability to devalue the Euro, fear of hyper-inflationary trends, and misspecification of monetary policy targets: inflation, productivity, employment, wages, and exchange rates.
Poor performance (contagion), bank crisis (runs on banks), social unrest (populism), massive debt issuance, and deflation (liquidity trap/collapse of money velocity) was the costly (stagnation) result of these policy mistakes. This — along with their lack and hesitant response to bank runs in Spain-Greece-other EU countries — has had a negative impact on the central bank’s independence and credibility, in regards to their ability to respond to future financial and economic crisis.

When the ECB was dealing with the aftermath of the financial crisis, the Bank of England (BOE) across the pond, was trying to immunize itself from the global crisis and its aftermath, only to vote itself into another existential crisis of national identity (BREXIT from the European Union), with long-term economic consequences, testing the limitation of the BOE.

Chapter: The Bank of England’s (BOE) Last Hurrah: From QE to BREXIT

The Bank of England (BOE) was founded in 1694, the first central bank, and in 1844 under the Bank Charter Act, was given independent monopoly control over bank notes and currency, money supply, bank supervision, lending of last resort, and fiscal government bond-placement agency. By the 1990s, monetarism took hold and the main target was inflation (price stability), and the Monetary Policy Committee was established to conduct open market operations, set interest rates, and reserve requirements.

Globalization, and having London as the center of money center global trading — currency, credit and interest rate derivatives and floating rate Euro notes and bonds – created excessive liquidity/credit and asset price bubbles, particularly in the U.S. commercial property markets from 2004-2007, eventually led and met with an asset price (housing/mortgage/RMBS/CMBS/equity) bubble and banking collapse (insolvency/QE, nationalization, etc.), similar to the other industrialized economies.

The total cost of these QE (negative real and nominal interest rates) programs, in addition to other credit facility programs, is well over a trillion pounds, with no real ability to achieve their inflation, Gross Domestic Product (GDP), or employment/labor participation targets. The global push toward deregulation (giving Wall Street back its ability to lever up and take down the system, again) and BREXIT, is certainly making the BOE’s job of conducting monetary policy problematic, leading to policy ineffectiveness (failure), lack of credibility and jeopardizing its independence.

These events, have contributed to the significant devaluation of the pound; yes, making U.K. exports cheaper, stimulating export growth as a contribution to GDP; but has caused political-populous parliamentary uncertainty and economic stagnation (high deficits/debt levels); and import price inflation, pushing down consumer purchasing power, standards of living and social welfare in the short and long run.

The big worry, not only for the BOE, but also for the Fed, ECB, BOJ, etc., is the coordinated unwinding of the bank balance sheets (sovereign and MBS bond portfolios), one mistake, could shift and invert global yield curves, pop asset price bubbles in stocks, bonds and real estate, and send us all into a global recession-depression.

Similar policy responses to the global economic-banking crisis, is also being witnessed in Asia. Yes, we already talked about the BOJ being the first mover in applications of unorthodox monetary and fiscal policy, with no real outcomes on wages, growth or inflation, other than fiscal debt levels and continued stagnation, the other, is the People’s Bank of China (PBOC).

The real difference between the PBC and the rest of the global central banks, is total lack of transparency (opaque) into the balance sheets of the government, financial institutions, government (State-Owned Enterprises – SOEs) owned corporations, public and private Multinational Corporations (MNC), and state and local finance.

Chapter: The People’s Bank of China (PBOC) Chases Its Shadows

The modern era of the PBOC started in the early 1980s – as a fiscal agent (under Ministry of Finance), public-private bank, clearing foreign currency exchange transactions, etc. in coordination with the China Construction Bank, Industrial and Commercial Bank of China, and Agricultural Bank of China.

Opening up the economy to massive (speculative) extension of credit and Foreign Direct Investment (FDI), under a neo-liberal model, resulted in speculative asset price (real estate, equity and debt) bubbles and busts (defaults) in the 1980s and 1990s, resulting in government intervention and deflation.
The Asian Contagion of the late 1990s required massive bank and corporate bailouts (recapitalizations). The 2000s, have seen a modernization of the PBOC as a central banking institution through banking reforms, conversion of SOEs to private-public firms (privatization toward a more Japanese Keiretsu system), push for more export oriented policies (higher-value commodities-services), and large government sponsored infrastructure projects (commercial-residential-dams-roads-power plants, etc.),

Prior to the Financial Crisis (FC), the PBOJ was moving to a modern rules-tools oriented application of monetary policy: interest rate and price targeting, constant growth in the money supply, and use of open market operations. Low borrowing costs spurred massive amounts of lending and borrowing (money supply growth) by both fiscal institutions, government and state-private owned enterprises, leading to asset price bubbles.

Which also lead to over-capacity, miss-allocation of resources, inflation, environmental degradation, political-economic corruption, currency manipulation (peg), etc. Since the China economy was still at this time decoupled from the Western global financial system, it was able to avoid most of the damage caused before the Financial Crisis.

But after the Financial Crisis, the PBOC had to accelerate the move toward liberal monetary finance, driving interest rates extremely low (real interest rates negative) to keep government and corporate (personal) borrowing costs low, to stimulate the economy/consumption/investment, to keep it from falling into a severe recession (depression/deflation), and had to deal with Non-Performing bank Loan (NPL) portfolios to avert a banking crisis. Rapid growth helped to mask these problems, but these were only land mines, waiting to be found and dealt with at a future date.

Banks and asset management companies had to be bailed out, dissolved, liquidated, etc. Trillions and trillions monetary liquidity and fiscal stimulus had to be injected to the economy, targeted toward housing, infrastructure and manufacturing, causing asset prices again to inflate. By 2014, only to deflate again by 2016. These injections of fiscal and monetary stimulus exacerbated asset price volatility (real estate/equities/bonds).

The next financial crisis in China will come from the excessive extension of credit from both fiscal and monetary authorities, and will come from government and corporate bond market defaults, as the system is severely over-leveraged. China is using more and more debt to fix bad debt problems, and the simulative multiplier-accelerator effect on the economy is deteriorating (decelerating) quickly.

Global central banks have been coordinating their monetary policy efforts over the past 10 years, and the U.S. Federal Reserve Bank has become the de facto Central Bank of Central Banks (CBCB). Based on new disclosures, we have found out that the U.S. Federal Reserve conducted global QE by buying other foreign sovereign debt during the financial crisis, and provided credit-liquidity facilities to global banks.

Chapter: Yellen’s Bank: From Taper Tantrums to Trump Trade

There was Paul Volker, then there was Alan Greenspan, then Ben Bernanke, now Janet Yellen, and who knows who is next (Jerome Powell). All of these Fed presidents dealt with extraordinary conditions (some self-inflicted), wars, financial crisis, recessions, asset price bubbles/bursts, etc.

It was not till Alan Greenspan, that the Federal Reserve decided excessive accommodation and liquidity was the solution to all crisis, and asset price bubbles were not a concern if they were real, and not a monetary illusion. However, he now admits that he was wrong in the way he understood how the world really works, which means he made policy errors and mistakes.
Bernanke was a protégé of Greenspan, and responded to the Financial Crisis with the largest monetary response (QE Infinity) in modern monetary history combined; and Yellen, continued his legacy of over accommodation, to escort us into one of the biggest debt-asset price bubbles in modern Fed history.

And if history is any indicator of the future, once the Fed(s) decide to conduct a coordinated unwind of their balance sheets, the popping of asset price bubbles will be like balloons at New Year’s Eve party in Time’s Square, only everyone will walk away from the party with the worst hangover of their life, and no one will be able to sober up fast enough to drive to the next party.

In the end, the Fed accumulated over $4.5 trillion in bank reserves/balance sheet (bonds), made up mostly of mortgage backed securities and U.S. government Treasury notes and bonds, the average size of the balance sheet prior to the financial crisis was $500-to-$800 billion. This is the largest subsidization, and theoretically (and really) the largest nationalization (Fed implemented) process, of the financial system and the economy in modern post-WWI history.

This could also be considered Fascist Finance (FF), as it involves the largest global money center banks, multinational corporations, and governments in the world — now a Global Corporatist System — operating under unorthodox monetary policy, outside pluralistic-democratic institutional oversight. As we can now see, again, the systematic dismantling, deconstruction and destruction of financial institutional governmental regulatory oversight, is in place.

Since these were mainly reserves creation, and an addition to the monetary base, and not really the money supply, the policy effects (QE/(Zero-Negative Real Interest Rate policy) have been mute.

The Fed has not been able to hit its inflation or GDP targets for the past 10 years (well below potential), there is secular and cyclical productivity declines, extremely low labor participation rates (high under employment rates), real wages are stagnant and still declining, and we are in a disinflationary/deflationary secular trend.

The cause is a collapse in the velocity of money, driven by alternative forms of money creation and flows across the globe (cryptic-digital currencies-shadow banking, etc.); the lack of fiscal labor market policy to lower under-employment and raise labor market participation rates; and other social, cultural, political and economic disruptions. Making it now impossible to conduct monetary policy.
The real risk going forward will be from a series of financial deregulation, coming from the Trump Administration and the Republican controlled House and Senate; along with a coordinated effort to unwind (Quantitative Tightening – QT) the Feds (and other global central banks) balance sheet, and a race toward interest rate normalization, sucking liquidity out of the system, only to lead to a stock, bond and real estate bubble burst.

With the Fiscal Debt totaling over $20 trillion, the Feds Balance Sheet totaling $4.5 trillion, the potential for continued -perpetual war (defense spending) and entitlement expenditures, and political and policy uncertainty (next Federal Reserve President) there is little room for monetary and fiscal solutions to fight the next financial and economic crisis. Leading to the conclusion of continued stagnation, crisis, recession, wars and depression.

It is now obvious why Central Banks fail.

Chapter: Why Central Banks Fail

After reading Dr. Jack Rasmus book, “Central Bankers at the End of Their Rope?” and if you read his book, “Systematic Fragility in the Global Economy,” along with other books and interviews surrounding this literature, it has been clear, and it is now crystal clear, why central banks fail, they:

• Are a creature of the global capitalist system;
• Support, promote and protect financial institutions and companies;
• Use myopic (static) intellectual and epistemological frames (models) to analyze economic data, markets, and institutions to develop and implement monetary policy;
• Are influenced by political (executive/legislative) parties and lobby when making and communicating policy;
• Are expected to support (moral hazard) and coordinate national fiscal policies (debt) and priorities (compromising their independence and credibility);
• And be the lender, portfolio manager, and market maker of last resort to mitigate capital market (economic) failures;

Their failures emanate from the fact that they are given (have been given over) the monopoly power and authority (independence) to control the money supply, clearing system, exchange rates, interest rates, supervision, etc. However, we are finding out, that they are not as in control as we think, and are not looking out for our best interest.

There is a mythology surrounding the Fed, and illusion of omnipotence, and control, this is evident when measured by its balance sheet, lack of understanding how the world really works, and inability to hit monetary and real economic targets: inflation, labor participation rates, real wage growth, and higher broad based social welfare and standards of living.

We are finding that our Keynesian (Keynes) and Monetarist (Fisher/Friedman) economic ideologies are not correct, and are not working, deregulation and printing of massive amounts of money to bail out and subsidize inefficient and corrupt financial institutions (lobby), after every man-made and self-inflicted crisis, is not working, and we are at the end of our rope.

We now, cannot keep doing this, we are out of money. However, with Crypto-currencies, and other unproven systems of monetary accounting, could set the stage for monetary collapse, if this experiment turns out wrong.

The solution to the existential crisis in global central banking is not a technological solution, but a democratic-pluralistic political solution. Based on moral philosophy and ethical outcomes.

Chapter: Revolutionizing Central Banking in the Public Interest: Embedding Change Via Constitutional Amendment

What is needed is a revolution in central bank thinking.

There are many excuses for monetary (central bank) failures:

• Too much discretion (money supply growth/credit expansion/asset price bubbles), and not enough adherence to monetary policy rules (money growth targets);
• Conflicting fiscal (expenditures/spending) vs. monetary (inflation/interest rate) policy;
• Asymmetric information (capital) flows (bottleneck) through banking system (adverse selection/moral hazard/principal agent problem);
• Wrong monetary targets (inflation); dual mandates (production/employment/inflation/wage trade-off);
• Global savings glut (uncontrollable off shore capital inflow);
• Need for new monetary tools (open market operations/QE/QT/discount rates/reserve requirements, etc.);
• Executive/legislative intrusion in monetary policy functioning;
• Etc.
However, the real reason why central banks fail are:
• Mismanagement of money supply (credit) growth and allowing banks, and other near- bank institutions, to access Federal Reserve credit/liquidity facilities;
• Fragmented, failed and non-existent systemic and macro-micro prudential systemic bank supervision (Dodd-Frank);
• Inability to achieve (real-nominal wage) inflation (labor participation) rates;
• Failure to address, mitigate and/or control run-away asset (real estate/equity/bond/commodity) price inflation (bubbles/bust);
• Deterioration, decomposition, and failure in the elasticity of (zero-negative) interest rates (liquidity trap/technology) to stimulate real economic growth (employment/wages);
• Re-direction of investment capital away from higher yielding real (long-term) capital investments to lower yielding-speculative monetary (short-term) financial investments (derivatives/floating-rate notes);
• Ineffectiveness of traditional monetary policy tools (federal funds rate/discount window/reserve requirements), and reliance on non-traditional un-orthodox (QE/credit-liquidity facilities) monetary policy tools with unintended negative consequences (deflation/asset price bubbles);
• Myopic political-economic monetary policy ideologies and errors in epistemological thinking (Taylor Rules/Philips Curve/Zero-Negative Interest Rate Policy/unlimited balance sheet expansion).
• Etc.

What is needed is a revolution in central bank thinking.

Chapter: CONCLUSIONS

A revolution is needed, in main-stream ideological thought, in regards to Global Central Banking. A revolution in accepted institutional norms and beliefs of how central banking actually works. There needs to be a dialectical shift from the established and accepted thesis of central banking authority. If there is not, there will be a revolution against central banks, and a battle will occur to wrestle authority, control and independence from central banks. And this battle will no doubt be destructive and deconstructive, leading to economic and financial crisis, and eventually lead to some anti-thesis (executive or legislative branch control) over the central bank(s) for the next 30-to-60 years.

Currently, the Federal Reserve is

• Controlled by private sector banker interests,
• Control of the Federal Reserve Bank of New York (Open Market Operations),
• Private sector banker selected leadership of Federal Open Market Committee,
• Private sector bank access to insider information on monetary policy,
• Iron-Triangles between Fed staff and private banking sector and lobby,
• Circularity between Fed private sector banks,
• Influence of private sector bank lobby in Fed Chair selection,
• Record campaign finance contributions to congressional committee members,
• Revolving door between the Fed, bank supervisors, Treasury, and banks,
• Etc.

Regulatory and legislative proposals have been brought, only to be blocked and abandoned, due to pressure from Wall Street lobby. And those policies that have been enacted (Dodd-Frank), the bank lobby has systematically reversed and repealed oversight other the years, or implemented bank friendly legislation. This legislation, and lack of supervisory regulatory oversight, has been passed through (and ignored by) executive and congressional initiatives, and the public administrative bureaucracy.

The solution, is the democratization of the central bank, bringing it into pluralistic (public) oversight, with a focus on real, not financial, economic outcomes.

Chapter: Proposed Constitutional Amendment

The solution, a proposed constitutional amendment to require the democratic election of the national Fed governors by U.S. citizens, serving six years; and the Treasury secretary shall decide monetary policy in the public interest; and be proactive in achieving stability for labor, households, businesses, local governments, and financial institutions and industry, etc.

Dr. Rasmus, recommends a constitutional amendment enabling legislation through five sections, and 20 articles:

SECTION #1: Democratic Restructuring

Article #1: Replace 12 Fed districts with four, presidents elected at large.
Article #2: FOMC replaced by National Fed Council (NFC), members limited to six-year terms, and 10 year limit on returning to private banking sector.
Article #3: Fed districts to not be corporation, and issue stock, pay dividends, retain no profits. Taxes to be levied on Fed transactions to pay for operating costs.
Article #4: No additions to Fed districts by legislative or executive orders, or appointments.

SECTION #2: Decision Making Authority

Article #5: NFC and Treasury Secretary to determine monetary policy (tools).
Article #6: QE to be used to invest in real assets.
Article #7: NFC purchase of private sector stocks and bonds, and derivatives, prohibited.
Article #8: No Fed bank supervision, a new consolidated banking institution created.

SECTION III: Banking Supervision

Article #9: Same as Article #8.
Article #10: Separate supervisory departments by banking and financial services industry segments.
Article #11: Separate legislation by depository from non-depository institutions.
Article #12: Supervision includes all markets and companies in derivative industry.
Article #13: Conduct regular stress tests on banks and non-banks.
SECTION IV: Mandates and Targets
Article #14: Replace current Fed targets with those targeting real wage growth.
Article #15: Expand authority of NFC to lend directly to businesses and households.
SECTION V: Expand Lender of Last Resort Authority
Article #16: Expanded to include non-banks businesses, local-state governments, etc.
Article #17: Non-bailout of Non-U.S. domiciled banks and financial institutions.
Article #18: Create a Public Investment Bank (PIB) as lender of last resort to provide liquidity to households and non-banks.
Article #19: Create a National Public Bank (NPB) for direct lending to households and non-banks.
Article #20: Bain-ins thresholds and limits protect depository diluted from bail-outs.

FINAL COMMENTS

In the post-World War II (WWII) era the economy and financial markets and institutions have gone through nine cycles. Over time the amplitude and volatility of these cycles have narrowed as our cultural, social, political and economic institutions developed. However, the most recent business, financial institution and credit cycle experienced a significant drop – and volatility — in aggregate demand and asset prices, not seen since 1949, a point in history when our central banking and financial institutions were developing.

The reality is we have witnessed the systematic deconstruction of pluralistic, democratic and capitalistic institutions — through the political process — by private interest in society and economy, creating perverse redistribution of wealth and resources, to the point of massive social and cultural, and economic and capital market failures.

It is believed by most neo-post Keynesian economists, that the current economic, institutional, and capital market failures could have been avoided through centrist political, monetary and fiscal policies, and that the recent financial crisis could have been averted through the separation of investment and commercial banking activities, and enforcement of public and private property rights through effective enforcement.

The long-term goal of effective formulation and administration of public, monetary and fiscal policies is efficient allocation of capital and resources, higher risk-adjusted returns, social and economic stability, and high and rising standards of living and social welfare.

Dr. Jack Rasmus’s book, Central Bankers at the End of Their Rope?: Monetary Policy and the Coming Depression, enables us to understand historical and recent economic and capital market crisis, and how to recognize and understand the development, administration and deconstruction of financial institutions and markets.

Institutions were built on pluralistic political and capitalistic economic ideologies, and when these ideologies are confronted, come under attack by private interests, policy outcomes are distorted or destroyed.

The process of pluralistic, democratic and capitalistic institutional construction and development has taken 80 years; however, it took 30 years, and particularly the last ten years, to deconstruct these institutions to the point of systematic failure.

The process associated with institutional destruction, deconstruction and distortion, manifests in the extreme redistribution of political power, social benefits and economic wealth, and can reach the point where redistributions become so extreme, they cause systematic social, economic and market failure.

These failures are reflected in increased volatility in social and economic indicators, capital market pricing and investment risk, and resulting reductions risk-adjusted returns, inefficient allocation investment capital and resources, and falling employment and real income growth rates, standards of living and overall social welfare.”

Dr. Larry Souza
European Financial Review
December 15, 2017

posted January 1, 2018
(3rd) Review of Dr. Jack Rasmus’s book, ‘Central Bankers at the End of Their Ropes’, by Dr. Larry Souza

Here’s Dr. Souza’s extended 6,000 word long review, which provides the best review of my ‘Central Bankers at the End of Their Ropes’ book to date:

“INTRODUCTION

If you talk to some monetary, fiscal, macroeconomic, and financial institutional and capital market economists, some would argue that Central Banks are at the end of their rope; have lost their credibility and risk losing their independence.

Dr. Jack Rasmus book, “Central Bankers at the End of Their Rope? Monetary Policy and the Coming Depression” is the latest in a growing literature building the case against the U.S. Federal Reserve (the Central Bank of Central Banks), European Central Bank, Japanese Central Bank, The Bank of England, People’s Bank of China, etc.; their unorthodox monetary policy response to the financial crisis; policy response to asset price bubbles, financial (market) crisis (crashes), and recessions since 1995; lack of macro-prudential supervision and oversight; and consistent policy mistakes based on their lack of understanding of how the world and economy works, dating back as far as 1929 (See supporting Literature in the Appendix).

In Dr. Rasmus book, he looks at:

1. Problems and Contradictions of Central Banking
2. A Brief History of Central Banking
3. The U.S. Federal Reserve Bank: Origins and Toxic Legacies
4. Greenspan’s Bank: The Typhon Monster Released
5. Bernanke’s Bank: Greenspan’s Put (Option) on Steroids
6. The Bank of Japan: Harbinger of Things That Came
7. The European Central Bank under German Hegemony
8. The Bank of England’s Last Hurrah: From QE to BREXIT
9. The People’s Bank of China Chases Its Shadows
10. Yellen’s Bank: From Taper Tantrums to Trump Trade
11. Why Central Banks Fail
12. Revolutionizing Central Banking in the Public Interest: Embedding Change Via Constitutional Amendment

Dr. Rasmus builds a methodical case against historical and current central bank ideologies and orthodoxy; and makes prudent and wise recommendations for structural and institutional macroeconomic, monetary policy and political change.
The conclusion, is not too late to address the systemic and systematic risks to central banking, regulation and supervision, financial institutions and capital markets, and the real economy and labor markets.

However, considering the real economic realities of the current political, party and policy environment, along with the Wall Streets control over monetary (Federal Reserve), fiscal (Treasury) and regulatory (Comptroller/SEC/FDIC/etc.) policy in Washington, that a political solution could actually be accomplished. Dr. Rasmus is correct in his recommendations and his analysis.

We are all at the end of our rope, and thank you Dr. Jack Rasmus from bringing another critical analysis of the current and future state of global central banking, and for proposing bold policy recommendations to avert another severe financial crisis, great recession and depression.

REVIEW

Rapid technological, demographic, economic, cultural, sociological and political change has changed the way central banks analyze, manage and respond to business cycle peaks, troughs (recessions), financial crisis, and macro-prudential bank supervision; and central bank policy responses have failed consistently over time, due to limitations of their data, models, ideology, epistemology, bureaucracy, and politics.

But one modern response to these limitations has been consistent over time, inject or try to inject massive amounts (trillions of U.S. Dollars, Yen, Euros, Pounds, Yuan, Peso, Rubble, etc.) of liquidity (credit) to back-stop and set a support under asset prices. Since these asset price bubbles and asset price collapse (financial/currency crisis) have become more frequent since 1995 (Peso Crisis, Thai Baht, Russian Default, Y2K/911, Housing Bubble, Financial Crisis, etc.), global central bankers do not have the intellect, culture, knowledge, data, models, tools, resources, balance sheet, etc. to deal with crisis going forward.
Dr. Rasmus recommends limiting the independence (ad hoc decision making) of central banks by instituting a (rules based) Constitutional Amendment defining new functions for the central bank, new monetary targets and tools to modernize and drive global central banks into the 21st century.

Chapter: Problems and Contradictions of Central Banking

Globalization, technologicalization and deregulation/integration has accelerated capital flows and accumulation, and concentration to targeted and non-targeted markets across the world. This process continues at a rapid pace, and depending on the recipient, can be economically, financially and politically (institutionally) destabilizing, destructive and deconstructive. It is not a matter if this will happen, but when, again! Which country? Industry? Company? Demographic? will be affected, disrupted, destroyed, and wrecked.

In response to these economic and financial disruptions, central banks have responded consistently by injecting massive amounts of liquidity into the system, with no limitations due to their misunderstanding of how the economic and financial system really works, and has become, through the use of unorthodox monetary policy tools and targets, in the face of total deregulation and free flow of capital (shadow banking and derivatives trading), is at this point, where they cannot control or manage the system. We are in unchartered territory.
Only to bail it out the private banking system — other strategic affiliated institutions, corporations, businesses and brokerages — again and again, by printing massive amounts of fiat currency (seigniorage), to buy (defective/defaulted) securities product (derivatives), accumulate more sovereign-corporate-personal debt, with even more crowding out effects, has had no real eventual long-term impacts on real economic growth, wages, and productivity; and social welfare or standards of living. Only asset prices bubbles and a massive redistribution and concentration of wealth.

It is estimated, between the U.S Federal Reserve Bank, Bank of England, and European Central Bank, $15 trillion direct liquidity injections, loans, guarantees, tax reductions, direct subsidies, etc. have been used. If you add in China and Japan, the total gets to as high as $25 trillion, and if you add in other emerging country (Asian, Latin America, and Middle-East) central banks, the total gets as high $40 trillion.

This is only the present value (cost basis), if you project the total cost (interest and principal payments) out over a 30-to-40 year period, the estimate total cost is as high as $80-to-$100 trillion. Thereby, making the global financial and economic system eventually insolvent and bankrupt, and central banking ineffective and perpetually in a liquidity trap, as the velocity of money has collapsed. There is not money going into real long-term (capital budgets) assets, only short-term financial assets.

This is the contradiction of Central Banking: liquidity-debt-insolvency nexus, the moral (immoral) hazard of perpetual bail-outs, growing concentration of wealth at the extremes, growing perception that Negative/Zero Interest Rate Policy (N/ZIRP) can fix under-investment in capital (human/physical) and deflationary (disinflationary) trends, and that bank regulation-supervision is bad for the economy, financial services (institutions) industry, and for institutional and retail investors (savers) in the long run.

Chapter: A Brief History of Central Banking

A Brief History of Central Banking, walks us through the origins of central banking, from the Bank of England (1694) as the lender of last resort for private banks, and its monopoly position in issuing government bank notes and currency (1844/1870s), and bailing out the banking system due to crashes and development of new types of currencies (paper, gold, notes, etc.).

An uncontrolled growth in the money supply in the U.S. led to financial speculation in gold and bonds (1830), and depression (1837-43). No central bank was established, not even after banking crashes (1870/1890s/1907-08), but only by 1914 as the U.S. entered WWI, and needed to decouple its currency from gold, raise tax revenues, and be able to monetize its sovereign debt through the use of a fractional reserve banking system, did the government then decide that they needed a central bank.

The role of the central banks were to maintain monopoly control over the production of money, act a lender of last resort and fund raising agents, provide a clearing-payment services system between banks, and supervise bank behavior.
The goal, was price stability, supply of money growth targets, full employment, interest rate and currency exchange rate determination. They were to do this though the use of tools (rules): reserve requirements, discount rates, and Open Market Operations (OMO); and now, Quantitative Easing (QE)/Tightening (QT) and special auctions and re-purchase agreements.

The U.S. Federal Reserve Bank(s) was also given this monopoly position, along with tools and independence. This has led to some toxic legacies (credibility issues).

Chapter: The U.S. Federal Reserve Bank: Origins and Toxic Legacies

The U.S. Federal Reserve Bank system was originated from a consortium of private banks looking to centralize the Federal Reserve System: JP Morgan, Kuhn, Loeb, Chase, Bankers Trust, First National, etc. Particularly after financial instability (illiquidity/capital/reserves), bank crashes (lack of supervision) – 1890s/1907, and the rise of the U.S. as a global economic power.

Congress passed the Federal Reserve Act on December 13th 1913: twelve district banks and national board located in Washington D.C. The real power resided in the member banks that owned their respective districts. They could issue their own currency and notes, exchange for gold and foreign currency, invest in agricultural and industrial loans, and received dividends from earnings.

After the Great Depression and bank reform acts (1933/1935), the Federal Reserve Board of Governors and the Open Market Committee became the two powerful institutions within the Federal Reserve System.

However, the Fed experienced two decades of failure (1913-1933) due to lack of supervision, stock market and loan speculation, asset price bubbles/crashes, depressions, bank closures and bailouts, excessive extension of liquidity (margin), protection of government finance and wealthy investors, hyperinflation (deflation/disinflation), false targets (gold peg/production/employment), inaction and incompetence (discount rate/open market operations), institutional narcissism and egotism, power and elitism, bureaucratic control, etc.

Bank acts were put in place by Roosevelt, and other regulation and operations were put in place through the 1970s and 1980s: Glass-Stegall, 1935 Bank Act, Reg U, tax reform, policy, Treasury-Fed Accord, Operation Twist, Bretton Woods, Humphrey-Hawkins/Resolution 133, fighting hyperinflation-stagflation-recessions, Reg D, Plaza Accords, state and shadow bank regulatory efforts, international banking (currency/note) issues, liquidity escalations, and eventually the Greenspan typhon.

From 1913 to 1933, the two decades of failure after the Federal Reserve was created; it continued into the 1940s-1950s, 1960s-1970s, 1980s-1990s, 1990s-2000s, it continued and continues to this day, and looks like it will continue into the future.

Chapter: Greenspan’s Bank: The Typhon Monster Released

Greenspan, influenced by Ian Rand — liberal-post-modern philosophy – set in motion an un-orthodoxy in Federal Reserve, Monetary Policy, and Macro/Political Economic rationalization, a stark contrast to the Volker era. Greenspan believed in markets, and lase fair-free hand economic ideology (deregulation); and did not believe in limits to the Market and Technology-Labor Productivity, limits to the Federal Reserve’s power to dictate markets and the economy, and limits — in the end – to the ability to inject massive amounts of liquidity into the financial system to drive (support) asset price bubbles. This believe, or lack of, lead to multiple crisis and bailouts of the system.

The continual mismanagement, ideological mistakes, and lack of understanding of how the real world works, was witnessed again under Bernanke, now Yellen, and who knows who is next.

Chapter: Bernanke’s Bank: Greenspan’s Put on Steroids

Bernanke was minted from the same Greenspan mold, a true believer that excessive liquidity injections cold solve massive capital market and economic failures with little cost. It was the financial crisis and the coordinated efforts between the Federal Reserve and the Treasury (and other hidden interests), that was the test case in the Federal Reserve ability to manage severe man-made financial-economic crisis. The result, a new nationalization-corporatist-financial oligopoly industrial model, leveraged through Zero Interest Rate Policy (ZIRP)/Negative Real Interest Rate Policy (NRIRP), Quantitative Easing (QE), and Credit Enhancements/Liquidity Injections.

However, the outcomes from these efforts were disastrous:

1. Political Populism (Political-Economic Institutional Deconstruction/Destruction)
2. Massive Capital-Labor Substitution (Productivity Lag)
3. Massive Concentrations of Wealth (Inter-Generational Wealth Transfer)
4. Flat-Declining Real Wages (Social Welfare/Standards of Living/Poverty)
5. Unfunded Pension Liabilities (Crisis)
6. Recession(s) Twice as Deep/Twice as Long (Structural)
7. Rising Un-Funded Pension Liabilities
8. Collapse in Labor Participation Rates (High Under-Employment)
9. Collapse in Velocity of Money (Currency Turnover)
10. Rise of Shadow (Unregulated) Banking System (Disintermediation)
11. Massive Use-Trading of Un-Collateralized (Over-The-Counter/OTC) Derivative Trading
Excessive Use of Financial Engineering to Support Asset Prices
12. Global Economic-Political Instability (Global Cyber-Cold War)
13. Global Hyper-Inflation/Banking Crisis/Credit Defaults (Sovereign)
14. Massive Over-Leveraging of Government, Corporate and Personal Balance Sheets
15. Over Accommodative Monetary/Fiscal Policy (Negative Nominal/Real Interest Rates/Change Accounting Rules/Low Effective Tax Rates)
16. Global Tax Evasion (Avoidance)
17. Ballooning of the Federal Reserve Balance Sheet (Bonds/Reserves)
• Ballooning of the Federal Budget Deficit and Debt ($500-800 Billion Per Year/+$20 Trillion)
• Continuous Belief in Supply Side Economics (Trickle Down Theory/Deregulation)
• Continuous Belief in Monetary System/Real Economy Aggregates (Inflation/Interest)
• Continuous Bail-Outs of Financial/Economic System (Insolvency/Bankruptcy)
• Etc. Etc. Etc.

All of these beliefs, techniques and tools have been used by other Global Central Governments and Banks (BOJ/ECB/BOE/PBOC), with similar, disastrous, and disappointing outcomes. A focus is on saving the financial institutional system in the short-run, using extreme and un-orthodox monetary policies (tools), with a lack of concern or understanding of long-run economic, social, cultural, and political consequences and outcomes.

A perfect example, are policy responses of the Bank of Japan (BOJ).

Chapter: The Bank of Japan (BOJ): Harbinger of Things That Came

Over the last 17 years (1990 – 2017) the BOJ has implemented an aggressive form of unorthodox monetary policy (Negative – Nominal/Real — Interest Rate Policy/Quantitative Easing): printing massive amounts of money, buying massive amounts of sovereign-corporate (infrastructure) bonds, driving bonds yields negative, and driving domestic investors/savers and financial institutions literally crazy.

With no real effect on the Real Business Cycle (RBC), resulting in perpetual recessions and disinflation/deflation. These unorthodox monetary policies (mistakes/failures) have had the effect of causing asset price bubbles/busts (banking crisis), negative effects on standards of living, and negative effects on financial (dis)intermediation and fiscal policy (mistakes).

The BOJ has responded to these failures by introducing more accommodative (QE) policies, along with over accommodative fiscal policies (sovereign debt levels at historical levels) with no real positive effects. Fiscal policy mistakes (tax increases in a recession), have only exacerbated economic outcomes.

Japan will be the ultimate experiment in monetary-fiscal policy mistakes, as they will have to resort to even more extreme measures to try to get themselves out of their existential structural crisis. The ultimate fiscal-monetary response could be, with unintended political-economic-cultural consequences, associate with a massive and coordinated debt forgiveness, by both fiscal/monetary authorities.
At some point they will not have the tax revenues to service the sovereign debt payments, and will theoretically fall into default, and will ask for forgiveness, not from bond holders, but from the BOJ, that owns the majority of the debt.

Monkey see, monkey do. The BOJ has set the (bad) model for other central banks to follow, not only the U.S., but also the European Central Bank (ECB).

Chapter: The European Central Bank (ECB) under German Hegemony

Years after the financial crisis, the ECB finally started the process of cleaning up its banking system, and started and aggressive process of Quantitative Easing (QE), introduction of other unorthodox policies (Refinance Options/Covered Bond Purchase/Securities Markets, etc.), and drove nominal interest rates as far out as 10 year maturities, negative; with a limited effect of driving down the value of the Euro to stimulate exports, economic growth, and hit inflation and unemployment targets.

The actual ECB structure (dominated by Germany – Bundesbank) was a major impediment its ability to respond to the crisis: fiscal austerity, inability to devalue the Euro, fear of hyper-inflationary trends, and misspecification of monetary policy targets: inflation, productivity, employment, wages, and exchange rates.
Poor performance (contagion), bank crisis (runs on banks), social unrest (populism), massive debt issuance, and deflation (liquidity trap/collapse of money velocity) was the costly (stagnation) result of these policy mistakes. This — along with their lack and hesitant response to bank runs in Spain-Greece-other EU countries — has had a negative impact on the central bank’s independence and credibility, in regards to their ability to respond to future financial and economic crisis.

When the ECB was dealing with the aftermath of the financial crisis, the Bank of England (BOE) across the pond, was trying to immunize itself from the global crisis and its aftermath, only to vote itself into another existential crisis of national identity (BREXIT from the European Union), with long-term economic consequences, testing the limitation of the BOE.

Chapter: The Bank of England’s (BOE) Last Hurrah: From QE to BREXIT

The Bank of England (BOE) was founded in 1694, the first central bank, and in 1844 under the Bank Charter Act, was given independent monopoly control over bank notes and currency, money supply, bank supervision, lending of last resort, and fiscal government bond-placement agency. By the 1990s, monetarism took hold and the main target was inflation (price stability), and the Monetary Policy Committee was established to conduct open market operations, set interest rates, and reserve requirements.

Globalization, and having London as the center of money center global trading — currency, credit and interest rate derivatives and floating rate Euro notes and bonds – created excessive liquidity/credit and asset price bubbles, particularly in the U.S. commercial property markets from 2004-2007, eventually led and met with an asset price (housing/mortgage/RMBS/CMBS/equity) bubble and banking collapse (insolvency/QE, nationalization, etc.), similar to the other industrialized economies.

The total cost of these QE (negative real and nominal interest rates) programs, in addition to other credit facility programs, is well over a trillion pounds, with no real ability to achieve their inflation, Gross Domestic Product (GDP), or employment/labor participation targets. The global push toward deregulation (giving Wall Street back its ability to lever up and take down the system, again) and BREXIT, is certainly making the BOE’s job of conducting monetary policy problematic, leading to policy ineffectiveness (failure), lack of credibility and jeopardizing its independence.

These events, have contributed to the significant devaluation of the pound; yes, making U.K. exports cheaper, stimulating export growth as a contribution to GDP; but has caused political-populous parliamentary uncertainty and economic stagnation (high deficits/debt levels); and import price inflation, pushing down consumer purchasing power, standards of living and social welfare in the short and long run.

The big worry, not only for the BOE, but also for the Fed, ECB, BOJ, etc., is the coordinated unwinding of the bank balance sheets (sovereign and MBS bond portfolios), one mistake, could shift and invert global yield curves, pop asset price bubbles in stocks, bonds and real estate, and send us all into a global recession-depression.

Similar policy responses to the global economic-banking crisis, is also being witnessed in Asia. Yes, we already talked about the BOJ being the first mover in applications of unorthodox monetary and fiscal policy, with no real outcomes on wages, growth or inflation, other than fiscal debt levels and continued stagnation, the other, is the People’s Bank of China (PBOC).

The real difference between the PBC and the rest of the global central banks, is total lack of transparency (opaque) into the balance sheets of the government, financial institutions, government (State-Owned Enterprises – SOEs) owned corporations, public and private Multinational Corporations (MNC), and state and local finance.

Chapter: The People’s Bank of China (PBOC) Chases Its Shadows

The modern era of the PBOC started in the early 1980s – as a fiscal agent (under Ministry of Finance), public-private bank, clearing foreign currency exchange transactions, etc. in coordination with the China Construction Bank, Industrial and Commercial Bank of China, and Agricultural Bank of China.

Opening up the economy to massive (speculative) extension of credit and Foreign Direct Investment (FDI), under a neo-liberal model, resulted in speculative asset price (real estate, equity and debt) bubbles and busts (defaults) in the 1980s and 1990s, resulting in government intervention and deflation.
The Asian Contagion of the late 1990s required massive bank and corporate bailouts (recapitalizations). The 2000s, have seen a modernization of the PBOC as a central banking institution through banking reforms, conversion of SOEs to private-public firms (privatization toward a more Japanese Keiretsu system), push for more export oriented policies (higher-value commodities-services), and large government sponsored infrastructure projects (commercial-residential-dams-roads-power plants, etc.),

Prior to the Financial Crisis (FC), the PBOJ was moving to a modern rules-tools oriented application of monetary policy: interest rate and price targeting, constant growth in the money supply, and use of open market operations. Low borrowing costs spurred massive amounts of lending and borrowing (money supply growth) by both fiscal institutions, government and state-private owned enterprises, leading to asset price bubbles.

Which also lead to over-capacity, miss-allocation of resources, inflation, environmental degradation, political-economic corruption, currency manipulation (peg), etc. Since the China economy was still at this time decoupled from the Western global financial system, it was able to avoid most of the damage caused before the Financial Crisis.

But after the Financial Crisis, the PBOC had to accelerate the move toward liberal monetary finance, driving interest rates extremely low (real interest rates negative) to keep government and corporate (personal) borrowing costs low, to stimulate the economy/consumption/investment, to keep it from falling into a severe recession (depression/deflation), and had to deal with Non-Performing bank Loan (NPL) portfolios to avert a banking crisis. Rapid growth helped to mask these problems, but these were only land mines, waiting to be found and dealt with at a future date.

Banks and asset management companies had to be bailed out, dissolved, liquidated, etc. Trillions and trillions monetary liquidity and fiscal stimulus had to be injected to the economy, targeted toward housing, infrastructure and manufacturing, causing asset prices again to inflate. By 2014, only to deflate again by 2016. These injections of fiscal and monetary stimulus exacerbated asset price volatility (real estate/equities/bonds).

The next financial crisis in China will come from the excessive extension of credit from both fiscal and monetary authorities, and will come from government and corporate bond market defaults, as the system is severely over-leveraged. China is using more and more debt to fix bad debt problems, and the simulative multiplier-accelerator effect on the economy is deteriorating (decelerating) quickly.

Global central banks have been coordinating their monetary policy efforts over the past 10 years, and the U.S. Federal Reserve Bank has become the de facto Central Bank of Central Banks (CBCB). Based on new disclosures, we have found out that the U.S. Federal Reserve conducted global QE by buying other foreign sovereign debt during the financial crisis, and provided credit-liquidity facilities to global banks.

Chapter: Yellen’s Bank: From Taper Tantrums to Trump Trade

There was Paul Volker, then there was Alan Greenspan, then Ben Bernanke, now Janet Yellen, and who knows who is next (Jerome Powell). All of these Fed presidents dealt with extraordinary conditions (some self-inflicted), wars, financial crisis, recessions, asset price bubbles/bursts, etc.

It was not till Alan Greenspan, that the Federal Reserve decided excessive accommodation and liquidity was the solution to all crisis, and asset price bubbles were not a concern if they were real, and not a monetary illusion. However, he now admits that he was wrong in the way he understood how the world really works, which means he made policy errors and mistakes.
Bernanke was a protégé of Greenspan, and responded to the Financial Crisis with the largest monetary response (QE Infinity) in modern monetary history combined; and Yellen, continued his legacy of over accommodation, to escort us into one of the biggest debt-asset price bubbles in modern Fed history.

And if history is any indicator of the future, once the Fed(s) decide to conduct a coordinated unwind of their balance sheets, the popping of asset price bubbles will be like balloons at New Year’s Eve party in Time’s Square, only everyone will walk away from the party with the worst hangover of their life, and no one will be able to sober up fast enough to drive to the next party.

In the end, the Fed accumulated over $4.5 trillion in bank reserves/balance sheet (bonds), made up mostly of mortgage backed securities and U.S. government Treasury notes and bonds, the average size of the balance sheet prior to the financial crisis was $500-to-$800 billion. This is the largest subsidization, and theoretically (and really) the largest nationalization (Fed implemented) process, of the financial system and the economy in modern post-WWI history.

This could also be considered Fascist Finance (FF), as it involves the largest global money center banks, multinational corporations, and governments in the world — now a Global Corporatist System — operating under unorthodox monetary policy, outside pluralistic-democratic institutional oversight. As we can now see, again, the systematic dismantling, deconstruction and destruction of financial institutional governmental regulatory oversight, is in place.

Since these were mainly reserves creation, and an addition to the monetary base, and not really the money supply, the policy effects (QE/(Zero-Negative Real Interest Rate policy) have been mute.

The Fed has not been able to hit its inflation or GDP targets for the past 10 years (well below potential), there is secular and cyclical productivity declines, extremely low labor participation rates (high under employment rates), real wages are stagnant and still declining, and we are in a disinflationary/deflationary secular trend.

The cause is a collapse in the velocity of money, driven by alternative forms of money creation and flows across the globe (cryptic-digital currencies-shadow banking, etc.); the lack of fiscal labor market policy to lower under-employment and raise labor market participation rates; and other social, cultural, political and economic disruptions. Making it now impossible to conduct monetary policy.
The real risk going forward will be from a series of financial deregulation, coming from the Trump Administration and the Republican controlled House and Senate; along with a coordinated effort to unwind (Quantitative Tightening – QT) the Feds (and other global central banks) balance sheet, and a race toward interest rate normalization, sucking liquidity out of the system, only to lead to a stock, bond and real estate bubble burst.

With the Fiscal Debt totaling over $20 trillion, the Feds Balance Sheet totaling $4.5 trillion, the potential for continued -perpetual war (defense spending) and entitlement expenditures, and political and policy uncertainty (next Federal Reserve President) there is little room for monetary and fiscal solutions to fight the next financial and economic crisis. Leading to the conclusion of continued stagnation, crisis, recession, wars and depression.

It is now obvious why Central Banks fail.

Chapter: Why Central Banks Fail

After reading Dr. Jack Rasmus book, “Central Bankers at the End of Their Rope?” and if you read his book, “Systematic Fragility in the Global Economy,” along with other books and interviews surrounding this literature, it has been clear, and it is now crystal clear, why central banks fail, they:

• Are a creature of the global capitalist system;
• Support, promote and protect financial institutions and companies;
• Use myopic (static) intellectual and epistemological frames (models) to analyze economic data, markets, and institutions to develop and implement monetary policy;
• Are influenced by political (executive/legislative) parties and lobby when making and communicating policy;
• Are expected to support (moral hazard) and coordinate national fiscal policies (debt) and priorities (compromising their independence and credibility);
• And be the lender, portfolio manager, and market maker of last resort to mitigate capital market (economic) failures;

Their failures emanate from the fact that they are given (have been given over) the monopoly power and authority (independence) to control the money supply, clearing system, exchange rates, interest rates, supervision, etc. However, we are finding out, that they are not as in control as we think, and are not looking out for our best interest.

There is a mythology surrounding the Fed, and illusion of omnipotence, and control, this is evident when measured by its balance sheet, lack of understanding how the world really works, and inability to hit monetary and real economic targets: inflation, labor participation rates, real wage growth, and higher broad based social welfare and standards of living.

We are finding that our Keynesian (Keynes) and Monetarist (Fisher/Friedman) economic ideologies are not correct, and are not working, deregulation and printing of massive amounts of money to bail out and subsidize inefficient and corrupt financial institutions (lobby), after every man-made and self-inflicted crisis, is not working, and we are at the end of our rope.

We now, cannot keep doing this, we are out of money. However, with Crypto-currencies, and other unproven systems of monetary accounting, could set the stage for monetary collapse, if this experiment turns out wrong.

The solution to the existential crisis in global central banking is not a technological solution, but a democratic-pluralistic political solution. Based on moral philosophy and ethical outcomes.

Chapter: Revolutionizing Central Banking in the Public Interest: Embedding Change Via Constitutional Amendment

What is needed is a revolution in central bank thinking.

There are many excuses for monetary (central bank) failures:

• Too much discretion (money supply growth/credit expansion/asset price bubbles), and not enough adherence to monetary policy rules (money growth targets);
• Conflicting fiscal (expenditures/spending) vs. monetary (inflation/interest rate) policy;
• Asymmetric information (capital) flows (bottleneck) through banking system (adverse selection/moral hazard/principal agent problem);
• Wrong monetary targets (inflation); dual mandates (production/employment/inflation/wage trade-off);
• Global savings glut (uncontrollable off shore capital inflow);
• Need for new monetary tools (open market operations/QE/QT/discount rates/reserve requirements, etc.);
• Executive/legislative intrusion in monetary policy functioning;
• Etc.
However, the real reason why central banks fail are:
• Mismanagement of money supply (credit) growth and allowing banks, and other near- bank institutions, to access Federal Reserve credit/liquidity facilities;
• Fragmented, failed and non-existent systemic and macro-micro prudential systemic bank supervision (Dodd-Frank);
• Inability to achieve (real-nominal wage) inflation (labor participation) rates;
• Failure to address, mitigate and/or control run-away asset (real estate/equity/bond/commodity) price inflation (bubbles/bust);
• Deterioration, decomposition, and failure in the elasticity of (zero-negative) interest rates (liquidity trap/technology) to stimulate real economic growth (employment/wages);
• Re-direction of investment capital away from higher yielding real (long-term) capital investments to lower yielding-speculative monetary (short-term) financial investments (derivatives/floating-rate notes);
• Ineffectiveness of traditional monetary policy tools (federal funds rate/discount window/reserve requirements), and reliance on non-traditional un-orthodox (QE/credit-liquidity facilities) monetary policy tools with unintended negative consequences (deflation/asset price bubbles);
• Myopic political-economic monetary policy ideologies and errors in epistemological thinking (Taylor Rules/Philips Curve/Zero-Negative Interest Rate Policy/unlimited balance sheet expansion).
• Etc.

What is needed is a revolution in central bank thinking.

Chapter: CONCLUSIONS

A revolution is needed, in main-stream ideological thought, in regards to Global Central Banking. A revolution in accepted institutional norms and beliefs of how central banking actually works. There needs to be a dialectical shift from the established and accepted thesis of central banking authority. If there is not, there will be a revolution against central banks, and a battle will occur to wrestle authority, control and independence from central banks. And this battle will no doubt be destructive and deconstructive, leading to economic and financial crisis, and eventually lead to some anti-thesis (executive or legislative branch control) over the central bank(s) for the next 30-to-60 years.

Currently, the Federal Reserve is

• Controlled by private sector banker interests,
• Control of the Federal Reserve Bank of New York (Open Market Operations),
• Private sector banker selected leadership of Federal Open Market Committee,
• Private sector bank access to insider information on monetary policy,
• Iron-Triangles between Fed staff and private banking sector and lobby,
• Circularity between Fed private sector banks,
• Influence of private sector bank lobby in Fed Chair selection,
• Record campaign finance contributions to congressional committee members,
• Revolving door between the Fed, bank supervisors, Treasury, and banks,
• Etc.

Regulatory and legislative proposals have been brought, only to be blocked and abandoned, due to pressure from Wall Street lobby. And those policies that have been enacted (Dodd-Frank), the bank lobby has systematically reversed and repealed oversight other the years, or implemented bank friendly legislation. This legislation, and lack of supervisory regulatory oversight, has been passed through (and ignored by) executive and congressional initiatives, and the public administrative bureaucracy.

The solution, is the democratization of the central bank, bringing it into pluralistic (public) oversight, with a focus on real, not financial, economic outcomes.

Chapter: Proposed Constitutional Amendment

The solution, a proposed constitutional amendment to require the democratic election of the national Fed governors by U.S. citizens, serving six years; and the Treasury secretary shall decide monetary policy in the public interest; and be proactive in achieving stability for labor, households, businesses, local governments, and financial institutions and industry, etc.

Dr. Rasmus, recommends a constitutional amendment enabling legislation through five sections, and 20 articles:

SECTION #1: Democratic Restructuring

Article #1: Replace 12 Fed districts with four, presidents elected at large.
Article #2: FOMC replaced by National Fed Council (NFC), members limited to six-year terms, and 10 year limit on returning to private banking sector.
Article #3: Fed districts to not be corporation, and issue stock, pay dividends, retain no profits. Taxes to be levied on Fed transactions to pay for operating costs.
Article #4: No additions to Fed districts by legislative or executive orders, or appointments.

SECTION #2: Decision Making Authority

Article #5: NFC and Treasury Secretary to determine monetary policy (tools).
Article #6: QE to be used to invest in real assets.
Article #7: NFC purchase of private sector stocks and bonds, and derivatives, prohibited.
Article #8: No Fed bank supervision, a new consolidated banking institution created.

SECTION III: Banking Supervision

Article #9: Same as Article #8.
Article #10: Separate supervisory departments by banking and financial services industry segments.
Article #11: Separate legislation by depository from non-depository institutions.
Article #12: Supervision includes all markets and companies in derivative industry.
Article #13: Conduct regular stress tests on banks and non-banks.
SECTION IV: Mandates and Targets
Article #14: Replace current Fed targets with those targeting real wage growth.
Article #15: Expand authority of NFC to lend directly to businesses and households.
SECTION V: Expand Lender of Last Resort Authority
Article #16: Expanded to include non-banks businesses, local-state governments, etc.
Article #17: Non-bailout of Non-U.S. domiciled banks and financial institutions.
Article #18: Create a Public Investment Bank (PIB) as lender of last resort to provide liquidity to households and non-banks.
Article #19: Create a National Public Bank (NPB) for direct lending to households and non-banks.
Article #20: Bain-ins thresholds and limits protect depository diluted from bail-outs.

FINAL COMMENTS

In the post-World War II (WWII) era the economy and financial markets and institutions have gone through nine cycles. Over time the amplitude and volatility of these cycles have narrowed as our cultural, social, political and economic institutions developed. However, the most recent business, financial institution and credit cycle experienced a significant drop – and volatility — in aggregate demand and asset prices, not seen since 1949, a point in history when our central banking and financial institutions were developing.

The reality is we have witnessed the systematic deconstruction of pluralistic, democratic and capitalistic institutions — through the political process — by private interest in society and economy, creating perverse redistribution of wealth and resources, to the point of massive social and cultural, and economic and capital market failures.

It is believed by most neo-post Keynesian economists, that the current economic, institutional, and capital market failures could have been avoided through centrist political, monetary and fiscal policies, and that the recent financial crisis could have been averted through the separation of investment and commercial banking activities, and enforcement of public and private property rights through effective enforcement.

The long-term goal of effective formulation and administration of public, monetary and fiscal policies is efficient allocation of capital and resources, higher risk-adjusted returns, social and economic stability, and high and rising standards of living and social welfare.

Dr. Jack Rasmus’s book, Central Bankers at the End of Their Rope?: Monetary Policy and the Coming Depression, enables us to understand historical and recent economic and capital market crisis, and how to recognize and understand the development, administration and deconstruction of financial institutions and markets.

Institutions were built on pluralistic political and capitalistic economic ideologies, and when these ideologies are confronted, come under attack by private interests, policy outcomes are distorted or destroyed.

The process of pluralistic, democratic and capitalistic institutional construction and development has taken 80 years; however, it took 30 years, and particularly the last ten years, to deconstruct these institutions to the point of systematic failure.

The process associated with institutional destruction, deconstruction and distortion, manifests in the extreme redistribution of political power, social benefits and economic wealth, and can reach the point where redistributions become so extreme, they cause systematic social, economic and market failure.

These failures are reflected in increased volatility in social and economic indicators, capital market pricing and investment risk, and resulting reductions risk-adjusted returns, inefficient allocation investment capital and resources, and falling employment and real income growth rates, standards of living and overall social welfare.”

Dr. Larry Souza
European Financial Review
December 15, 2017

posted December 17, 2017
A Theory of System Fragility (Chapter 16 of ‘Systemic Fragility in the Global Economy’, Clarity Press, 2016

One of the central themes of this book is that the global economic crisis that erupted in 2007-08 did not end in 2009. It simply shifted in 2010, both in geographic location and form: from the USA and UK to the Eurozone and its periphery and to Japan. The crisis began to shift again, a second time, in late 2013, to Emerging Market Economies and then China. That most recent phase continues to unfold and intensify in mid-2015. In terms of ‘form’, the shift has been from mortgage bonds, derivatives, and equity markets in 2007-09, to sovereign debt markets in 2010-12, and, since 2014, increasingly to forms of private corporate debt, commodities and oil futures, Chinese and emerging markets equities, and currency exchange markets.

The Historical Context

In 2007-09 virtually the entire global economy was affected by the financial crash and then experienced a subsequent deep contraction of the real economy on a global scale as well. Certainly the financial crash of 2007-09 at minimum precipitated the deep real economic contraction that followed, sometimes known as the ‘Great Recession’. It obviously enabled that contraction in a host of ways. And it was most likely also fundamental to the contraction in important ways as well. This generalized financial and real crisis of 2007-09 was clearly the first such event since the late 1920s-early 1930s in which financial cycles and real cycles clearly converged and then mutually amplified each other in various negative ways. It will not be the last.

Financial crises and recessions from the 1960s up to 2007 have been localized geographically and/or limited to specific financial asset markets. There was little convergence and amplification. During that period real economic contractions—i.e. recessions—were localized and were the outcome in most cases of supply or demand ‘shocks’, or else were conscious government policy-induced recessions, rather than financial crisis precipitated contractions. They were what might be called ‘normal’ recessions. They were therefore relatively short and shallow in terms of their contraction, and were thus relatively responsive to traditional fiscal-monetary recovery policies introduced by governments and central banks. Such normal recessions are almost never precipitated by major financial instability events, although moderate financial instability may have followed the real contractions. But financial instability was almost always limited and contained to a particular financial market, type of financial security, or an occasional financial institution default.

This localized financial instability and short and shallow recessions began to change in the 1990s, however. The first notable case was Japan’s financial crash and subsequent ‘epic’ real recession that followed, a combined financial-real event from which its economy still has not fully recovered a quarter century later.

However, even Japan’s recession in the early 1990s was not yet a generalized global financial crash or a consequent global real contraction event. That kind of generalized, combined financial and real crisis would not come until 2007-09. The 2007-09 event would prove not only quantitatively more severe than prior financial and real crises, but qualitatively different as well. So too would the trajectory of the global economy post-2009—i.e. a faltering global recovery that proved both quantitatively and qualitatively different from prior recoveries from normal recessions.

Like the 2007-09 crash and the ‘great’ (epic) recession itself, the post-2009 period thus represents something quite new. If the 2007-09 crash and deep contraction was an event diverting the global economy in a new direction, then the 2010-13 period represents the initial stage or phase—itself giving way to a subsequent second phase that has been emerging since late 2013.

In the 2010-13 first phase of global ‘recovery’ following the crash of 2007-09, the core Advanced Economies (AEs)—the USA and United Kingdom—were able to stabilize their banking systems with massive liquidity injections by their central banks. This achieved, however, only a partial and a historically weak recovery of their real economies. The other two major sectors of the AEs—Europe and Japan—neither restored financial stability quickly nor were able to achieve sustainable real economic growth. The Japanese and European real economies stagnated at best and fell into double-dip recessions once again while experiencing renewed financial instability in certain sectors and/or regions of their financial systems. In sharp contrast to the AE experience, during the same 2010-13 period China and the Emerging Market Economies (EMEs) experienced a rapid recovery in both financial and real economic terms. Both Chinese and EME economies boomed during this initial 2010-13 phase, China’s growing at a rate of 10%-12% and other key EMEs nearly as fast. Money capital from the AEs flowed in at record rates and financial and commodity markets rose to record levels.

What then explains this dramatic difference between the AEs and China-EMEs during the first recovery phase of 2010-13? Real economic conditions? Financial conditions? Major differences in policy choices compared to the AEs? Indeed, what explains the notable differences within the AE regions during this period—US and UK stabilizing (albeit partially and incompletely) while Europe-Japan regressed economically and financially again? Was it just a matter of policy responses or something more fundamental?
This unbalanced global scenario of AEs compared to China-EMEs, during the first 2010-13 recovery phase, began to change by late 2013. The uneven and unbalanced conditions between AEs vs. China-EMEs did not correct; they simply shifted: The rapid real growth in China and the EMEs, which characterized the 2010-13 period, began to slow significantly starting 2013. By late 2015 China’s real growth rate was reduced by half, and a growing number of key EME economies had slipped into recession by 2014. Global oil and other commodity markets began to deflate rapidly beginning mid-2014. Financial bubbles and instability began to emerge, especially in China. The global money capital flows into China-EMEs began to reverse, this time away from China-EMEs toward the AEs. Currency volatility rose worldwide. To forestall renewed financial market instability, both Japan and Europe introduced quantitative easing (QE) policies and accelerated their central bank money-liquidity injections—while the US and UK discontinued theirs. Both central bank and fiscal austerity policies became more congruent across all the AE regions, as the US and UK followed Europe and Japan in the direction of fiscal austerity starting 2011 and as Japan and Europe followed US and UK central bank quantitative easing policies, starting in 2013 in Japan and 2015 in Europe. What were thus previously divergences in monetary and fiscal policies between the AE core regions and the Europe-Japan regions now began to converge by 2013-14.

AEs as a group thus settled into slow to stagnant real growth by 2015, just as both real growth slowed rapidly and financial instability rose in China-EMEs. The US economy experienced repeated, single quarter negative GDP relapses in 2014 and 2015 and the UK’s induced property investment brief recovery of 2013-14 came to an end by 2015 and it stagnated once again. Japanese and European growth stagnated as well, in the 0%-1% annual range.

Although the second phase of 2013-2015 is still evolving, a comparison of it and the preceding first phase, 2010-13, shows the following main characteristics:

The AEs stabilized their banking systems in the first phase but failed to generate sustained recovery in their real economies during that period. Never having really recovered in real terms since 2009, both Japan and Europe continue to stagnate by mid-2015, as the US and UK economies also show growing signs of renewed weakness in their real economies as well. More than six years after the officially declared end of the recession in mid-2009, the AE economies appear weaker in real terms today despite having stabilized their banking systems. China and the EMEs, moreover, appear decidedly weaker in 2015 than in 2010—both in terms of financial instability and real economic performance. In both AEs and China-EMEs, total debt—business, financial, household, government, central bank—has continued to rise as real income sources are undergoing growing pressure. Should financial and real economic events occur that produce a significant contraction of real incomes in one or several of these sectors—even if temporary—systemic fragility could easily and quickly deteriorate further as the feedback effects between financial, consumption, and government balance sheet fragility exacerbate each other. Coming off a much weaker economy today compared to 2007, another financial instability event and a potentially worse ‘great recession’, will find both central bank and government policymakers even less prepared or able to confront the next crisis. All sectors—households, corporate-financial, and government are more fragile—except for the big banks and big multinational corporations, and the top 10% wealthiest consumer households, who have been able to reduce their fragility as a consequence of record recent income gains. But the vast majority of businesses, households, and local and regional governments have not been able to build a liquid income cushion. And even for those narrow sectors with sufficient income cushion, in the event of another financial implosion, and subsequent real economic contraction, those income gains will be quickly offset by the collapse of financial asset wealth—thus leaving the excessive debt levels to be serviced from insufficient income and on unattractive debt refinancing terms.

In other words, systemic fragility on a global scale is worse, not better, after more than six years of so-called ‘recovery’ from the official ending of the previous financial crash and severe economic contraction in mid-2009.

Some Queries from History

The preceding short scenario raises important theoretical questions: why was the crisis that erupted in 2007-08 on a global scale a generalized event? Why was it clearly precipitated by a financial crash? How did the financial crisis enable the extraordinary deep and rapid contraction of the real economy, and prevent a normal recovery of it for more than six years? How are financial conditions and variables ‘fundamental’ to the general crisis? In other words, how does one distinguish causes that were merely precipitating and enabling from causes more fundamental—both real and financial? Were the financial forces and conditions that have been responsible for growing fragility fundamental to the ‘great recession’ and weak global recovery that followed—or just precipitating and perhaps enabling? How do financial conditions and events drive real economic contractions—i.e. ‘great recession’ or worse, depressions? Why are financial instability events over the last four decades apparently becoming more frequent and severe, and what is happening in the real economy that may be making it more sensitive to the growing frequency and severity of financial instability events in recent decades?

These queries lead to another set of related critical questions: why have government policies since 2009—i.e. more than $20 trillion in central bank liquidity injections, trillions more in business-investor tax cuts, and still hundreds of billions more in direct and indirect non-bank business subsidies and bailouts—proven largely ineffective in generating a sustained global recovery and been unable to prevent a return of financial asset bubbles that continue to grow and expand and have now begun to unravel again?
Not least, what are the fundamental changes in the 21st century global capitalist economy that are responsible for the new, more intense interactions between the financial and real sectors of the economy? Or, put another way, how and why are financial cycles exerting a relatively greater effect on real cycles today than in the past? And why will they continue to do so?

Thus far, contemporary mainstream economic analysis has been unable to convincingly answer these questions. As a major theme of this book argues, that inability is due in large part to its outmoded conceptual framework.

The material origins of systemic fragility were addressed in the 9 major trends addressed in chapters 7 to 15 of this book. They represent the historical markers or forces, i.e. the fundamental determinants that are developing, evolving, and in the process raising global systemic fragility and leading to a generalized financial instability once again, as in 2007-09. The 9 trends were described separately in chapters 7-15. But what’s needed for analysis is an explanation of their interactions and how they combine to contribute to the development of systemic fragility.

What follows in the remainder of this chapter is a literary summary of the main ideas associated with systemic fragility. For data and evidence in support of the ideas, the reader is encouraged to reference back to chapters 7-15.

posted December 12, 2017
Is the Bitcoin Bubble the New ‘Subprime Mortgage Bomb’?

Is Bitcoin the new ‘Subprime Mortgage Bond?’ Just as subprimes precipitated a crash in the derivative, Credit Default Swaps (CDS), at the giant insurance company, AIG, in September 2008, setting off the global financial crash that year—will the Bitcoin and crypto-currency bubble precipitate a collapse in the new derivative, Exchange Traded Funds (ETFs) in stock and bond markets in 2018-19, ushering in yet another general financial crisis?

The U.S and global economy are approached the latter stages in the credit cycle, during which financial asset bubbles begin to appear and the real economy appears to be at peak performance (the calm before the storm). This scenario was explained in my 2016 book, ‘Systemic Fragility in the Global Economy.’ And in my follow-on, just published August 2017 book, ‘Central Bankers at the End of Their Ropes’, I predict should the Federal Reserve raise short term U.S. interest rates another 1 percent in 2018, as it has announced, that will set off a credit crash leading to Bitcoin, stock, and bond asset price bubbles bursting. How likely is such a scenario?

Is Bitcoin a Bona Fide ‘Bubble’?

What’s a financial asset bubble? Few agree. But few would argue that Bitcoins and other crypto currencies are today clearly in a global financial asset bubble. Bitcoin and other crypto currencies are the speculative investing canary in the global financial asset coalmine.
One can debate what constitutes a financial bubble—i.e. how much prices must rise short term or how much above long term average rates of increase—but there’s no doubt that Bitcoin price appreciation in 2017 is a bubble by any definition. At less than US$1000 per coin in January, Bitcoin prices surged past US$11,000 this past November. It then corrected back to US$9,000, only to surge again by early December to more than US$15,000. Given the forces behind Bitcoin, that scenario is likely to continue into 2018 before the bubble bursts. Some predict the price for a Bitcoin will escalate to US$142,000, now that Bitcoin trading has gone mainstream on the CME and CBOE, and offshore, commodity futures exchanges.

Bitcoin and other crypto currencies are the speculative investing canary in the global financial asset coalmine.

The question of the moment is what might be the contagion effects on other markets?

What’s Driving the Bitcoin Bubble?

If Blockchain and software tech company ICOs are driving Bitcoin and other crypto pricing, what’s additionally creating the bubble?…..Who is buying Bitcoin and cryptos, driving up prices, apart from early investors in the companies? ……the absence of government regulation and potential taxation of speculative profits from price appreciation has served as another important driver of the Bitcoin bubble bringing in still more investors and demand and therefore price appreciation. No regulation, no taxation has also led to price manipulation by ‘pumping and dumping’ by well positioned investors….. Another factor driving price is that Bitcoin has become a substitute product for Gold and Gold futures……But what’s really driving Bitcoin pricing in recent months well into bubble territory is its emerging legitimation by traditional financial institutions………futures and derivatives trading on Bitcoin just launched in December 2017 in official commodity futures clearing houses, like CME and CBOE…..Bitcoin ETFs derivatives trading are likely not far behind……….big U.S. hedge funds are also poised to go ‘all in’ once CME options and futures trading is established…… Declarations of support for Bitcoin has also come lately from some sovereign countries………While CEOs of big traditional commercial banks, like JPM Chase’s Jamie Dimon, have called Bitcoin “a fraud,” they simultaneously have declared plans to facilitate trading in the Bitcoin-Crypto market.

Bitcoin as ‘Digital Tulips

Bitcoin demand and price appreciation may also be understood as the consequence of the historic levels of excess liquidity in financial markets today. Like technology forces, that liquidity is the second fundamental force behind its bubble. To explain the fundamental role of excess liquidity driving the bubble, one should understand Bitcoin as ‘digital tulips’, to employ a metaphor.
The Bitcoin bubble is not much different from the 17th century Dutch tulip bulb mania. Tulips had no intrinsic use value but did have a ‘store of value’ simply because Dutch society of financial speculators assigned and accepted it as having such. Once the price of tulips collapsed, however, it no longer had any form of value, save for horticultural enthusiasts.

What fundamentally drove the tulip bubble was the massive inflow of money capital to Holland that came from its colonial trade in spices and other commodities in Asia. The excess liquidity generated could not be fully re-invested in real projects in Holland. When that happens, holders of the excess liquidity create new financial markets in which to invest the liquidity—not unlike what’s happened in recent decades with the rise of unregulated global shadow banking, financial engineering of new securities, proliferating liquid markets in which securities are exchanged, and a new layer of professional financial elite as ‘agents’ behind the proliferating new markets for the new securities.

Bitcoin Potential Contagion Effects to Other Markets

A subject of current debate is whether Bitcoin and other cryptos can destabilize other financial asset markets and therefore the banking system in turn, in effect provoking a 2008-09 like financial crisis………….Deniers of the prospect point to the fact that Cryptos constitute only about US$400 billion in market capitalization today. That is dwarfed by the US$55 Trillion equities and US$94 trillion bond markets. The ‘tail’ cannot wag the dog, it is argued. But quantitative measures are irrelevant. What matters is investor psychology. ……For example, should cryptos develop their own ETFs, a collapse of crypto ETFs might very easily spill over to stock and bond ETFs—which are a source themselves of inherent instability today in the equities market. A related contagion effect may occur within the Clearing Houses themselves. If trading in Bitcoin and cryptos as a commodity becomes particularly large, and then the price collapses deeply and at a rapid rate, it might well raise issues of Clearing House liquidity available for non-crypto commodities trading. A bitcoin-crypto crash could thus have a contagion effect on other commodity prices; or on ETFs in general and thus stock and bond ETF prices.”

Jack Rasmus is author of the just published, ‘Central Bankers at the End of Their Ropes?:Monetary Policy and the Coming Depression’, Clarity Press, August 2017, and the prequel, ‘Systemic Fragility in the Global Economy, Clarity Press, January 2016.He blogs at jackrasmus.com and tweets @drjackrasmus.com. His website is http://kyklosproductions.com.

posted December 5, 2017
The Real Causes of US Deficits and US Debt

With the Senate and House all but assured to pass the US$4.5 trillion in tax cuts for businesses, investors, and the wealthiest 1 percent households by the end of this week, phases two and three of the Trump-Republican fiscal strategy have begun quickly to take shape.

Phase two is to maneuver the inept Democrats in Congress into passing a temporary budget deficit-debt extension in order to allow the tax cuts to be implemented quickly. That’s already a ‘done deal’.

Phase three is the drumbeat growing to attack social security, Medicare, food stamps, Medicaid, and other ‘safety net’ laws, in order to pay for the deficit created by cutting taxes on the rich. To justify the attack, a whole new set of lies are resurrected and being peddled by the media and pro-business pundits and politicians.

Deficits and Debt: Resurrecting Old Lies and Misrepresentations

Nonsense like social security and Medicare will be insolvent by 2030. When in fact social security retirement fund has created a multi-trillion dollar surplus since 1986, which the U.S. government has annually ‘borrowed’, exchanging the real money in the fund created by the payroll tax and its indexed threshold, for Treasury bonds deposited in the fund. The government then uses the social security surplus to pay for decades of tax cuts for the rich and corporations and to fund endless war in the middle east.

As for Medicare, the real culprit undermining the Medicare part A and B funds has been the decades-long escalating of prices charged by insurance companies, for-profit hospital chains (financed by Wall St.), medical devices companies, and doctor partnerships investing in real estate and other speculative markets and raising their prices to pay for it.

As for Part D, prescription drugs for Medicare, the big Pharma price gouging is even more rampant, driving up the cost of the Part D fund. By the way, the prescription drug provision, Part D, passed in 2005, was intentionally never funded by Congress and George Bush. It became law without any dedicated tax, payroll or other, to fund it. Its US$50 billion plus a year costs were thus designed from the outset to be paid by means of the deficit and not funded with any tax.

Social Security Disability, SSI, has risen in costs, as a million more have joined its numbers since the 2008 crisis. That rise coincides with Congress and Obama cutting unemployment insurance benefits. A million workers today, who would otherwise be unemployed (and raising the unemployment rate by a million) went on SSI instead of risking cuts in unemployment benefits. So Congress’s reducing the cost of unemployment benefits in effect raised the cost of SSI. And now conservatives like Congressman Paul Ryan, the would be social security ‘hatchet man’ for the rich, want to slash SSI as well as social security retirement, Medicare benefits for grandma and grandpa, Medicaid for single moms and the disabled (the largest group by far on Medicaid), as well as for food stamps.

Food stamp costs have also risen sharply since 2008. But that’s because real wages have stagnated or fallen for tens of millions of workers, making them eligible under Congress’s own rules for food stamp distribution. Now Ryan and his friends want to literally take food out of the mouths of the poorest by changing eligibility rules.

They want to cut and end benefits and take an already shredded social safety net completely apart–while giving US$4.5 trillion to their rich friends (who are their election campaign contributors). The rich and their businesses are getting $4.5 trillion in tax cuts in Trump’s tax proposal—not the $1.4 trillion referenced in the corporate press. The $1.4 million is after they raise $3 million in tax hikes on the middle class.

Whatever financing issues exist for Social Security retirement, Medicare, Medicaid, disability insurance, food stamps, etc., they can be simply and easily adjusted, and without cutting any benefits and making average households pay for the tax cuts for the rich in Trump’s tax cut bill.

Social security retirement, still in surplus, can be kept in surplus by simply one measure: raise the ‘cap’ on social security to cover all earned wage income. Today the ‘cap’, at roughly US$118,000 a year, exempts almost 20 percent of the highest paid wage earners. Once their annual salary exceeds that amount, they no longer pay any payroll tax. They get a nice tax cut of 6.2 percent for the rest of the year. (Businesses also get to keep 6.2% more). Furthermore, if capital income earners (interest, rent, dividends, etc.) were to pay the same 6.2% it would permit social security retirement benefits to be paid at two thirds one’s prior earned wages, and starting with age 62. The retirement age could thus be lowered by five years, instead of raised as Ryan and others propose.

As for Medicare Parts A and B, raising the ridiculously low 1.45 percent tax just another 0.25 percent would end all financial stress in the A & B Medicare funds for decades to come.

For SSI, if Congress would restore the real value of unemployment benefits back to what it was in the 1960s, maybe millions more would return to work. (It’s also one of the reasons why the labor force participation rate in the U.S. has collapsed the past decade). But then Congress would have to admit the real unemployment rate is not 4.2 percent but several percentages higher. (Actually, it’s still over 10 percent, once other forms of ‘hidden unemployment’ and underemployment are accurately accounted for).

As for food stamps’ rising costs, if there were a decent minimum wage (at least US$15 an hour), then millions would no longer be eligible for food stamps and those on it would significantly decline.

In other words, the U.S. Congress and Republican-Democrat administrations have caused the Medicare, Part D, SSI, and food stamp cost problems. They also permitted Wall St. to get its claws into the health insurance, prescription drugs, and hospital industries–financing mergers and acquisitions activity and demanding in exchange for lending to companies in those industries that the companies raise their prices to generate excess profits to repay Wall St. for the loans for the M&A activity.

The Real Causes of Deficits and the Debt

So if social security, Medicare-Medicaid, SSI, food stamps, and other social safety net programs are not the cause of the deficits, what then are the causes?

In the year 2000, the U.S. federal government debt was about US$4 trillion. By 2008 under George Bush it had risen to nearly US$9 trillion. The rise was due to the US$3.4 trillion in Bush tax cuts, 80 percent of which went to investors and businesses, plus another US$300 billion to U.S. multinational corporations due to Bush’s offshore repatriation tax cut. Multinationals were allowed to bring US$320 billion of their US$750 billion offshore cash hoard back to the U.S. and pay only a 5.25 percent tax rate instead of the normal 35 percent. (By the way, they accumulated the US$750 billion hoard was a result of Bill Clinton in 1997 allowing them to keep profits offshore untaxed if not brought back to the U.S. Thus the Democrats originally created the problem of refusing to pay taxes on offshore profits, and then George Bush, Obama, and now Trump simply used it as an excuse to propose lower tax rates for repatriated the offshore profits cash hoard of US multinational companies. From $750 billion in 2004, it’s now $2.8 trillion).

So the Bush tax cuts whacked the U.S. deficit and debt. The Bush wars in the middle east did as well. By 2008 an additional US$2 to US$3 trillion was spent on the wars. Then Bush policies of financial deregulation precipitated the 2007-09 crash and recession. That reduced federal tax revenue collection due to collapse economic growth further. Then there was Bush’s 2008 futile $180 billion tax cut to stem the crisis, which it didn’t. And let’s not forget Bush’s 2005 prescription drug plan–a boondoggle for big pharmaceutical companies–that added US$50 billion a year more. As did a new Homeland Security $50 billion a year and rising budget costs.

There’s your additional US$5 trillion added by Bush to the budget deficit and U.S. debt–from largely wars, defense spending, tax cuts, and windfalls for various sectors of the healthcare industry.

Obama would go beyond Bush. First, there was the US$300 billion tax cuts in his 2009 so-called ‘recovery act’, mostly again to businesses and investors. (The Democrat Congress in 2009 wanted an additional US$120 billion in consumer tax cuts but Obama, on advice of Larry Summers, rejected that). What followed 2009 was the weakest recovery from recession in the post-1945 period, as Obama policies failed to implement a serious fiscal stimulus. Slow recovery meant lower federal tax revenues for years thereafter.
Studies show that at least 60 percent of the deficit and debt since 2000 is attributable to insufficient taxation, due both to tax cutting and slow economic growth below historical rates.

Obama then extended the Bush-era tax cuts another US$803 billion at year-end 2010 and then agreed to extend them another decade in January 2013, at a cost of US$5 trillion. The middle east war spending continued as well to the tune of another $3 trillion at minimum. Continuing the prescription drug subsidy to big Pharma and Homeland Security costs added another $500 billion.
In short, Bush added US$5 trillion to the US debt and Obama another US$10 trillion. That’s how we get from US$4 trillion in 2000 to US$19 trillion at the end of 2016. (US$20 trillion today, about to rise another US$10 trillion by 2027 once again with the Trump tax cuts fast-tracking through Congress today).

To sum up, the problem with chronic U.S. federal deficits and escalating Debt is not social security, Medicare, or any of the other social programs. The causes of the deficits and debt are directly the consequence of financing wars in the middle east without raising taxes to pay for them (the first time in U.S. history of war financing), rising homeland security and other non-war defense costs, massive tax cuts for businesses and investors since 2001, economic growth at two thirds of normal the past decade (generating less tax revenues), government health program costs escalation due to healthcare sector price gouging, and no real wage growth for the 80 percent of the labor force resulting in rising costs for food stamps, SSI, and other benefits.

Notwithstanding all these facts, what we’ll hear increasingly from the Paul Ryans and other paid-for politicians of the rich is that the victims (retirees, single moms, disabled, underemployed, jobless, etc.) are the cause of the deficits and debt. Therefore they must pay for it.

But what they’re really paying for will be more tax cuts for the wealthy, more war spending (in various forms), and more subsidization of price-gouging big pharmaceuticals, health insurance companies, and for-profit hospitals which now front for, and are indirectly run by, Wall St.

Jack Rasmus is the author of the recently published book, “Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression.” He blogs at jackrasmus.com and his twitter handle is @drjackrasmus.

posted November 16, 2017
Review of ‘Systemic Fragility in the Global Economy’, by Dr. Jack Rasmus, Clarity Press, 2016

BOOK REVIEW of: Dr. Jack Rasmus, Systemic Fragility in the Global Economy
(Atlanta, GA: Clarity Press, 2016), ISBN: 978- 0-986769-4-7, 490 pp., $29.95

“Advanced economies are in a rut of slow growth, the new normal (El-Erian), or is it the end of normal (Galbraith, 2014)? Growth was slim before the 2008 crisis and recovery after the crisis has been sluggish as well, with growth around 2 percent in the United States (2.2 percent in 2017, by International Monetary Fund estimates), 1.5 percent in the European Union (EU) (2017), 0.9 percent in Japan (2017). An ordinary period headline is, “U.S. in weakest recovery since ‘49” (Morath, 2016).

Emerging economies and developing countries face a “middle-income trap” and “premature deindustrialization”; energy exporters see oil prices collapse from above $100 per barrel to below $50 (2014) and advanced economies are in a “stagnation trap.”

Explanations of the conundrum are perplexingly meager. Many accounts
are merely descriptive, such as secular stagnation (Summers, 2013) and the “new mediocre” (IMF, Harding, 2016) —noted, but why? (Secular stagnation derives from Alvin Hansen’s 1938 adaptation of Marx’s tendency of the rate of profit to decline, hence real interest rates decline, therefore policy interest must decline, notes Sinn [2016].)Or, uncertainty—which is odd because policies have not changed for years. Or, corporate hoarding—corporations, particularly in the United States, are sitting on mounds of cash, buy back their own stock, buy other companies and reshuffle, but are not investing—noted, but why? Or, a general account is that advanced economies are on a technological plateau, broadly since the 1970s (Cowen, 2011; Gordon, 2016). With the rise of the knowledge economy and the digital economy (along with the gig economy as in Uber, Airbnb, and freelance telework), contributions of Silicon Valley (Apple, Google, etc.), innovations in pharma and military industries, also in emerging economies, and the “fourth industrial revolution,” innovations abound. However, as Martin Wolf (2016) notes, “today’s innovations are narrower in effect than those of the past.” Besides, the shift to services in postindustrial societies means a shift toward sectors (such as health care, education, and personal care) where it is hard to raise productivity. If we consider policies, the picture gets worse because (a) implemented year after year, they clearly do not work, and (b) indications are that they make things worse.

Fiscal policy is generally ruled out because of fear of deficits. The policy instrument that remains is monetary—low interest rates and quantitative easing (QE), implemented in the United States, United Kingdom (UK), (EU), and Japan. Other standard policies are, in the EU, austerity—which may cut deficits but obviously does not generate growth (and, by depressing tax revenues over time, worsens deficits)—and structural reform. Besides privatization, the main component of reform is labor market flexibilization, in other words depressing wages and incomes. This has been implemented in the United States since the 1970s and 1980s, in the UK in the 1990s, in Germany and South Korea in the 2000s, and is now on the scaffolds in Japan, France, and Spain (and possibly Italy). The objective is to boost international competitiveness by depressing wages and benefits, which (a) ceases to have an effect when every country is doing the same, (b) assumes the key problem is cheap supply, whereas supply is actually abundant and what is lacking is demand, and © by depressing wage incomes, it further reduces domestic demand. No wonder these policies make matters worse. Thus, explanations of slow growth fall short and policies have been counterproductive. This is where Jack Rasmus’s book comes in. It offers the most pertinent analysis of the stagnation trap I have seen.

There are many steps to the analysis but it boils down to his theory of systemic fragility. I review the main points of his approach, for brevity’s sake in bullet form.

• Taking finance seriously, not just as an intermediary between stations of the “real economy” (as in most mainstream economics) but with feedback loops and transmission mechanisms that affect the real economy of goods directly and indirectly.

• A three-price analysis—beyond the single price of neoclassical economics (the price of goods), the two-price theory of Keynes and Minsky (goods prices and capital assets prices), Rasmus adds financial assets and securities prices.

• The long-term, secular slowdown of investment in the real economy (chapter 7) and the shift to investment in financial assets (chapter 11). This has been occurring because financial asset prices rise faster than the prices of goods; their production cost is lower; their supply can be increased at will; the markets are highly liquid so entry and exit are rapid; new institutional and agent structures are available; financial securities are taxed lower than goods; in sum, they yield easier and higher profits. Financial asset investment has been on the increase for decades, has expanded rapidly since 2000, and “from less than $100 trillion in 2007 to more than $200 in just the past 8 years” (p. 212).

• In government policy there has been a shift from fiscal policy to monetary policy. “Central banks in the advanced economies have kept interest rates at near zero for more than five years, providing tens of trillions of dollars to traditional banks almost cost free” (p. 220). Low interest rates and zero interest rate policies (ZIRP) benefit governments (by lowering their debt and interest payments) and banks (by affording easy money) while they lower household income (by lowering return on savings and lower value of pensions), so in effect households subsidize banks (p. 471).

• Quantitative easing policies, massive injections of money capital by the US ($4 trillion), UK ($1 trillion), EU ($1.4 trillion), and Japan ($1.7 trillion) since 2008, or “about $9 trillion in just five years” (pp. 185, 262). Add China ($1–4 trillion) and add government bank bailouts over time and, according to Rasmus, the total global liquidity injected by states and central banks is on the order of $25 trillion (p. 263). The injections of liquidity into the system allegedly aim to stimulate investment in the real economy (by raising stock and bond prices), which raises several problems: a) Investment in the real economy is not determined by liquidity but by expectations of profit. b) Funds that are invested in the goods economy leak overseas via multinational corporations (MNCs) investing in economically more developed countries (EMDC), where returns are higher (and more volatile). c) Most additional liquidity goes into financial assets, boosting commodities, stocks, and real estate, and leading to price bubbles (p. 177). “The sea of liquid capital awash in the global economy sloshes around from one highly liquid financial market to another, driving up asset prices as a tsunami of investor demand rushes in, taking profit as the price surge is about to ebb, leaving a field of economic destruction of the real economy in its wake” (p. 473).

• The post-crisis attempts at bank regulation overlook the shadow banks, even though the 2007–8 crisis originated in the shadow banks rather than the banks. (Shadow banks include hedge funds, private equity firms, investment banks, broker-dealers, pension funds, insurance companies, mortgage companies, venture capitalists, mutual funds, sovereign wealth funds, peer-to-peer lending groups, the financial departments of corporations, and so on; a typology is on p. 224.) The integration of commercial and shadow banks is a further variable. Shadow banks control on the order of $100 trillion in liquid or near liquid investible assets (2016, p. 446).

• Add up these trends and policies and they contribute to several forms of fragility, which is the culmination of Rasmus’s argument. Rasmus distinguishes fundamental, enabling, and precipitating trends that contribute to fragility (p. 457).

• The explosion of excess liquidity goes back to the 1970s and has taken many forms since then. QE policies amplify this liquidity and have led to financial sector fragility, which has been passed on to government balance sheet fragility (via bank bailouts, low interest rates, and QE), which have been passed on to household debt and fragility (via austerity policies). “Austerity tax policy amounts to a transfer of debt/income and fragility from banks and nonbanks to households and consumers, through the medium of government” (p. 472). This in turn leads to growing overall system fragility.

While Rasmus aims to provide a theory of system fragility, in the process
his analysis gives an incisive account of the stagnation trap. Many elements are not new. Note work on austerity and finance (Blyth, 2013, Goetzmann, 2016) and note, for instance: “The world has turned into Japan,” according to the head of a Hong Kong-based hedge fund.“When rates are this low, returns are low. There is too much money and too few opportunities” (Sender, 2016). However, by providing an organized and systemic focus on finance and liquidity, Rasmus makes clear that the policies that aim to remedy stagnation (low interest rates, QE, competitive devaluation, and bank bailouts) and provide stability are destabilizing, act as a break on growth, and worsen the problem. According to Karl Kraus, psychoanalysis is a symptom of the diseasethat it claims to be the remedy for, and the same holds for the central bank policies of crisis management.

This does not mean that the usual arguments for stimulating growth (spend on infrastructure, green innovation, etc.) are wrong, but they look in the wrong direction. For one thing, the money is not there. Courtesy of central banks, the money has gone by billions and trillions to banks, shadow banks, and thus to financial elites and the 1 percent. Surprise at corporations not investing is also beside the point when government policies at the same time are undercutting household income and consumer demand, reproducing an environment of low expectations. Criticism of QE has been mounting, even in bank circles (“it’s the real economy, stupid”). Yet the role of finance remains generally underestimated. Rasmus’s analysis of central bank policies overlaps with that of El-Erian (2016), but his critique of economics is more fundamental and his theory of fragility and its policy implications are more radical. A turnaround would require fundamentally different policies and, in turn, different economic analytics.

Let me note some reservations about Rasmus’s approach. One concerns the unit of analysis—the global economy. His analysis overlooks or underestimates the extent to which East Asian countries stand apart from general financial fragility. Asian countries have been less dependent on western finance than Latin America and Africa and having learned from the Asian crisis of 1997, have built buffer funds against financial turbulence, stand apart from general financial fragility, and tend to ring-fence their economies from Wall Street operations. Of course, this remains work in progress.

Second, Rasmus adds China’s stimulus spending to the liquidity injections of western central banks. However, the bulk of China’s stimulus funding has been invested in the real economy of infrastructure, productive assets, and urbanization, which has led to overinvestment, but has next led to major initiatives of externalizing investment-led growth in new Silk Road projects in Asia and far beyond (One Belt, One Road, Maritime Silk Road, Asian Infrastructure Investment Bank, Silk Road Fund, etc.; Nederveen Pieterse, 2017). Even so, China also faces a huge debt overhang (Pettis, 2013, 2014).

It may be appropriate to add notes about the trend break of the Trump administration. First, a general ongoing shift from monetary to fiscal policies and the shift toward protectionism in advanced economies have been in motion regardless of the election of Trump. In the case of the United States, this includes rejection of the Trans-Pacific Partnership (TPP) as well as the Transatlantic Trade and Investment Partnership (TTIP). The Trump administration represents “a bonfire of certainties,” yet in macroeconomic policy in many respects the likely scenario is back to the old normal of supply-side economics and trickle down, the Reagan-era package. Deregulation now goes into overdrive. What institutional buffers there are to rein in banks, shadow banks, and corporations will shrink further. Those who advocate dismantling government agencies are appointed to head the agencies (such as labor, education, energy, environment, housing, and justice) to better implement deregulation from the inside. Corporate tax cuts come with attempts to bring back funds from overseas. American corporations are hoarding cash already and corporate tax cuts adding more will boost stock buybacks and chief executive officer stock options, but investment? The American middle class is shrinking, malls are closing, and department stores are downsizing. The Trump cabinet of billionaires, a return to the Gilded Age with generals for muscle, is an entrepreneurial state, not in an ordinary sense but the entrepreneurialism of plutocracy, the state apparatus placed in the service of capitalism with a big C. A no-pretense version of the anti-government ethos adopted since the Reagan administration (“get government off our backs”), anti-government government, gloves off. Pundits have sternly criticized emerging economies for disrupting the liberal international order, but now an American government changes the rules by sliding to transactional deal making. If the old problem was double standards, the new problem is no standards.

This is part of a slow deterioration of institutions that has been in motion since the Reagan era. A cover headline of the Economist is “The debasing of American politics” (2016), but it is the debasing of institutions that matters more. If market incentives lead and everything is for profit—health care, utilities, prisons, media, education, and warfare—institutions gradually decline, such is the logic of liberal market economies bereft of countervailing powers. Corporate media are a major factor in the decline of the public sphere. Part of the profile of emerging economies and developing countries is rickety institutions. Investigations and trials for corruption in several emerging economies indicate that norms and standards have been rising during recent years, while in the United States, the reverse is happening and the country may be slipping to emerging economy status. Several emerging economies no longer tolerate Big Boss behavior (e.g., South Korea, South Africa) while in the United States it becomes the new normal. Meanwhile, Rasmus has made a signal contribution to contemporary economics and provided a vitally important X-ray of the political economy of stagnation.

References

Blyth, M. Austerity: The History of a Dangerous Idea. New York, NY: Oxford University Press, 2013.

Cowen, T. The Great Stagnation. New York, NY: Dutton, 2011.

The Economist. “The Debasing of American Politics.” October 15–21, 2016.

El-Erian, M.A. The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse. New York, NY: Random House, 2016.

Galbraith, J.K. The End of Normal. New York, NY: Simon and Schuster, 2014.

Goetzmann, W.N. Money Changes Everything. Princeton, NJ: Princeton University Press, 2016.

Gordon, Robert J. 2016 The rise and fall of American growth. Princeton University Press

Harding, R. “Lagarde warns of ‘new mediocre’ era.” Financial Times, October 2, 2014.

Morath, E. “U.S. in Weakest Recovery Since ‘49.” Wall Street Journal, July 30–31, 2016.

Nederveen Pieterse, J.
Multipolar Globalization: Emerging Economies and Development. London, UK: Routledge, 2017.

Pettis, M. Avoiding the Fall: China’s Economic Restructuring. Washington, DC: Carnegie Endowment for International Peace, 2013.

———. The Great Rebalancing. Princeton, NJ: Princeton University Press, 2014.

Sender, H. “Short-term Relief for Hedge Funds Belies Tough Search for Yield.”
Financial Times, July 12, 2016.

Sinn, H.-W. “Secular Stagnation or Self-inflicted Malaise?.” Project Syndicate, September 27, 2016.

Summers, L. “Why Stagnation Might Prove to Be the New Normal.”
Financial Times, December 15, 2013.

Wolf, M. “An End to Facile Optimism About the Future.”
Financial Times, July 13, 2016.

Jan Nederveen Pieterse
University of California, Santa Barbara, Global Studies

posted November 9, 2017
The Trump-Ryan $4.6 Trillion Tax Cut–Who Pays?

“Last month Trump and released his initial proposals for cutting taxes on the rich. The proposals were developed behind closed doors by his key economic policy makers, Steve Mnuchin, Treasury Secretary, and Gary Cohn, director of the Trump Economic Council—both former senior managers of the Goldman Sachs investment bank. (see my prior article this blog, ‘The Trump-Goldman Sachs Tax Cut for the Rich’).

The initial Trump-Goldman Sachs proposal defined only the broad outlines of the Trump tax plan, but still clearly benefiting the wealthy and their businesses. But the proposal said little how the multi-trillion dollar handout would be paid for. This past week the tax plan was further revised and clarified by the Republican run US House of Representatives.

The Trump-Goldman Sachs-Paul Ryan Tax Plan

The Trump-Goldman Sachs proposals have been melded with tax cuts proposed by US House speaker, Paul Ryan, who has led the effort for years to use the tax system to transfer wealth to the rich and their corporations. This past week’s Trump-Ryan proposals now clarify further ‘who pays’—i.e. mostly the middle class and especially working class households earning less than $50,000 annual income.

How exactly are they paying, in this latest iteration of the tax cuts and income transfer for the rich that’s been going on since Reagan in the 1980s, accelerating under both George W. Bush and Barack Obama?

The Trump-Republican latest iteration of the tax handouts will cost about $1.5 trillion, according to the Trump administration. That’s what they say it will cost the federal government budget deficit and thus will add to the federal debt. But the total tax cuts are actually around $4.5 trillion. The $1.5 trillion number is only the estimated final impact of the cuts on federal budget deficits. By Congressional rules, if the Trump-Ryan version can keep the budget impact to $1.5 trillion, it needs only 50% votes (plus one) in Congress to pass; but if the hit to the deficit is more than $1.5 trillion, it takes 60%.

The $2.6 Trillion Corporate-Business Tax Cuts

It’s estimated the corporate tax cut measure in the Trump-Ryan bill alone—cutting the nominal tax rate from current 35% to 20% and the corporate Alternate Minimum Tax–will together reduce tax revenue and raise deficits by $1.5 trillion, according to the Congress Joint Committee on Taxation. But that’s only the beginning of the total tax cuts to businesses. That’s just for corporate businesses, and just one of the several big corporate tax cut windfalls in the plan.

There are tax reductions for non-corporate businesses as well. By reducing the nominal tax rate for non-corporate businesses from 39.6% to 25% (affecting what’s called ‘pass through business income’) the result, according to the Joint Committee on Taxation, is an additional $448 billion tax reduction for businesses that are proprietorships, partnerships, S corporations, and other non-traditional corporations. And this cut goes to the wealthiest, high end of non-corporate companies. Small businesses (mom and pop businesses) whose owners earn less than $260,000 a year would see nothing of this proposed ‘pass through’ reduction. Half of all ‘pass through’ business income is earned by the wealthiest 1% non-corporate businesses.

Back to the corporate tax cutting, then there’s the daddy of all big corporate tax cuts for US multinational corporations. Trump, Ryan and other business interests claim that US multinationals—i.e. Apple, Google, big Pharma companies, global banks, oil companies and their ilk—pay the highest corporate taxes in the world and therefore cannot compete with their offshore counterparts in Europe, Asia and elsewhere. But that’s a lie. Studies have shown that US MNCs pay an effective tax rate (i.e. actual and not just ‘on paper’ nominal rate) of only 12.5%. Add to that 12.5% a mere 2-4% additional tax they pay in offshore countries, and another 2% or so they pay to US States with corporate income tax laws, and the true, total global tax rate is around 17%–not 35%.

US MNC’s currently hoard at least $2.4 trillion in their offshore subsidiaries (what they publicly admit to) that they have been refusing pay taxes on for years. Apple Corp., one of the worst tax avoiders, currently has $268 billion in cash; 95% of that $268 billion is stashed away in its offshore subsidiaries in order to avoid paying US corporate taxes. That’s just the legally admitted number. No one knows how much Apple, other MNCs, and wealthy individual investors sock away in offshore tax havens and shelters in order to avoid even reporting, let alone paying, taxes on.

The Trump-Ryan plan for this $2.4 trillion tax avoided money hoard is to cut the tax rate for cash held offshore from 35% to 12%. But that 12% is really 5%, since the 12% applies only to cash offshore; other forms of corporate ‘liquid’ assets are taxed at only 5%. That means it will be easy for corporations like Apple to ‘game’ the system by temporarily converting cash to liquid assets and then back again after the lower 5% rate is paid. They’ll pay 5%, not the 10%. Another measure calls for a 10% tax on future profits earned, but only on ‘excess offshore profits’ held by subsidiaries. If it’s not ‘excess profits’, then the tax rate is 0%. Just the latter measure, referred to as the ‘territorial tax’, is estimated to reduce MNC’s taxes by $207 billion.

A variation of this very same tax shell game was played previously, in 2005. Under George W. Bush, US multinational corporations were hoarding about $700 billion offshore by 2005. They were given a special ‘one time’ deal of a 5.25% tax rate if they brought the money back to the US and reinvested it in jobs. They brought about half of the $700 billion back—but didn’t reinvest in production. Instead they used it to buy back stock and pay more dividends that didn’t produce any jobs, and finance mergers and acquisitions of their competitors which actually reduced jobs. US MNCs got away with a 35% to 5.25% tax cut in 2005, so they began repeating the practice of shifting US profits to their offshore subsidiaries immediately after once again in order to avoid paying taxes. Now Congress is cutting them a similar deal—i.e. for a second time while calling it once again, as in 2005, a ‘one time’ deal. This so-called ‘repatriation tax’ measure results in is an incentive to shift even more production and operations to offshore subsidiaries, which reduces jobs in the US even further.

All this amounts to a total tax cut windfall for US multinational corporations of at least $500 billion, and likely even hundreds of billions of dollars more over the coming decade.

And there’s still more, however, for corporations in the Trump-Ryan plan. The tax plan’s ‘depreciation’ provision, which is another name for tax cuts for investment, are also liberalized to the tune of $41 billion new tax cuts. Companies can deduct from their tax bill the cost of all the new equipment they buy in the same year. And they can do that for the next five years. As that paragon advocate of economic justice, Larry Summers, former champion of bank deregulation, recently admitted recently in the business daily, Financial Times: “Effective tax rates on new investment is reduced to zero or less, before even considering the corporate rate reduction.” And there’s another roughly $50 billion in miscellaneous business tax cuts involving limits on business expensing and other provisions.

How Trump Personally Benefits

The commercial real estate industry—i.e. where Trump made his billions and continues to do so—gets a particularly sweet deal. It is exempt from any cap the Trump plan places on its deduction of business expenses. Commercial real estate companies are also allowed to continue deferring taxes when they exchange properties. And the industry’s numerous tax loopholes remain unchanged in the Trump-Ryan bill. Yet Trump himself says he will not benefit personally from the tax proposals—even though the tax returns he released for one year back before 2005 show his company realized billions in tax relief from the special loopholes enjoyed by the commercial real estate industry. And Trump himself paid $35 million in the corporate AMT, which is now projected to go away as well.

In summary, there’s at least $2.6 trillion in total corporate-business tax cuts in the Trump-Ryan plan. That’s well above the $1.5 trillion limit mandated by Congressional rules, however. And the $2.6 trillion does not include personal income tax reduction for wealthy households and investors. The corporate-business tax cuts alone amount to almost twice the $1.5 trillion allowed by Congressional rules. But the personal income tax cuts for the wealthy will cost another minimum $2 trillion, just for changes in top personal income tax rates and for limiting, then ending, the Alternative Minimum Tax and the Inheritance Tax. That’s $4.6 trillion and three times the $1.5 trillion!

The Personal Income Tax Cuts for the Wealthy

While personal income taxes will rise for the middle and working classes to cover the tax cuts for business, the hikes will also have to cover simultaneous tax cuts for wealthy individuals, 1% households, and investors. There are three big ways wealthy individuals and investors get tax cuts in their personal income tax in the Trump-Ryan bill: (1) reducing of personal tax brackets and lowering of rates; (2) reducing and then eliminating altogether the Alternative Minimum Tax (AMT); and (3) exempting and then ending the Inheritance (Estate) tax.

The top personal tax rate is currently 39.6%. The cutoff occurs for those earning $466,000 a year or more. They pay the 39.6%. But many more now will not under the bill. The Trump-Ryan bill raises the threshold at which they pay the 39.6% to $1 million. Those now earning between $466,000 and $1 million will now pay a lower rate of 33%. Those previously paying 33% are now reduced to 25%. Those at 25%–i.e. the middle class—stay at 25% and thus get no cut. So the personal tax rate on the middle class rate is not reduced, but the higher income levels are significantly reduced. The total tax cut from lower tax brackets for the wealthy has been estimated at $1.1 trillion, according to the Congress’s Joint Committee on Taxation.

The Inheritance, or Estate, tax is paid by only 0.2% of households. Nonetheless, the exemption will double from the first $5.5 million value of the estate to $11 million per person. And it will be completely repealed by 2024. The gift tax, through which the wealthy pass on much of their estates before dying, will also enjoy a $10 million exemption. That all amounts to a $172 billion tax cut for the 1% wealthiest households.

The other ‘biggie’ tax cut for the rich is the reduction and subsequent elimination of the Alternative Minimum Tax, AMT. This was designed to get the rich to pay something in taxes, after they exploited all their available tax loopholes and/or stashed their money offshore in tax shelters and havens, both legally and illegally. (Note: the just released so-called ‘Paradise Papers’, show how much and where they hide their wealth offshore to avoid taxes—from Queen Elizabeth of Britain to entertainment celebrities like Madonna, Bono, and a long list). 60% of the AMT is paid by individuals earning more than $500,000 a year, and another 20% by those earning adjusted income of more than $200,000. The AMT measures in the Trump-Ryan bill will amount to a $696 billion tax cut for the wealthy, according to estimates by the Joint Committee of Congress last week. And that’s not even counting the changes to the AMT paid by businesses as well.

Just the ‘big 3’ personal income tax cuts amount to nearly $2 trillion in total reductions. Add to that the estimated additional $2.5 trillion in corporate-business tax cuts and the total is $4.5 trillion—not the $1.5 or even $1.75 trillion currently referred to in the business and mainstream media.

How the Middle and Working Classes Pay for it All

• Personal Exemptions and Standard Deductions

The personal exemption for a family of four current reduces taxable income by $16,600 a year. This is ended under Trump-Ryan and replaced with an increase in the Standard Deduction, from current $13,000 a year to $24,400. So the Standard Deduction rises by $11,400 but is less than $16,600. So the net result is an increase in $5,200 in taxable income for a family of four.

The increase is even greater for a family of four that itemizes its deductions. For total itemization of $15,000, they will find their taxable income increasing by $7,200 a year. These gaps will also rise over the 10 year period and result in even higher taxes over time.

Repeal and changes to the Personal exemption and Standard deductions amount to a $1.6 trillion tax hike.

• Elimination of Itemized Deductions

Nearly half of all tax filers with annual income between $50,000 and $75,000—i.e. the core of the middle and working classes—currently itemize deductions to reduce their total taxable income and taxes paid. So it’s not true that only the rich itemize. And here is where the Trump-Ryan tax proposals take their biggest whack at the middle class.

-All State and Local income tax deductions are ended under the Trump plan. That’s a roughly $186 billion tax hike—a measure that will mostly hit ‘blue’ Democratic states where state income taxes exist. Contrary to Trump-Ryan propaganda, only 27% of state-local tax deduction is claimed by the wealthiest 1% households. The majority of the deduction is by the middle class.

-Limits on the property tax deduction will result in a further tens of $billions of tax hikes. Limits on this deduction will also reduce property values and thus have a negative wealth effect on middle class homeowners—especially in the ‘blue’ coastal states where home prices are highest.

-Deductible interest on first mortgages are reduced by half. This will reduce new home construction, and result in an indirect effect of escalating apartment rental costs, reducing middle and working class real incomes.

-Ending the extraordinary medical expenses deduction will hike taxes by $182 billion. These expenses are incurred by families with extraordinary medical expenses, as health insurance coverage pays less and less of such coverage. Previously they could deduct up to 10% of their income. This is now ended.
Expenses formerly deducted for personal casualty losses, un-reimbursed employment expenses for teachers, alimony, moving to a new job expenses, equity home loans interest, are all totally eliminated under the Trump-Ryan plan.

Limits and elimination of deductions are estimated at a tax hike of another $1.3 trillion, according to the Joint Committee on Taxation.

That’s $2.9 trillion to offset the $4.6 trillion in tax cuts for corporations, businesses, and the wealthiest households!

In addition are further miscellaneous tax hikes on the Middle Class in the following ways:

• Alternative Energy Credits

Current credits for installing solar and other alternative energy end, raising taxes by $12.3 billion.

• Adoption Credits

Credits for families adopting children end, raising taxes of $3.8 billion

• Flexible Health Savings Accounts and Elderly Dependents Expenses

Currently, workers may reduce taxes from gross wages by setting aside some income in a flexible health savings account. Business also enjoy a tax deduction for payments they make into health insurance plans and pensions. The total amounts to $540 billion a year. Businesses can continue their tax deduction for health payments, but workers will not. Nor may they deduct expenses for elderly dependents’ care. Their costs also tens of billions of dollars.

• Education Credits

Students and colleges take a big hit under the Trump-Ryan plan. Several education credit programs are ended, leaving one education credit. The result is a cut and tax hike of $17 billion. Student loan interest deductions are also ended, costing $13 billion. Companies that assisted higher education programs for employees with $5,250 tax free tuition aid for employee and company are ended; now they are taxable. May companies will now reduce their tuition assistance programs. Education tuition costs deductions for low income households are ended. So are tax free interest higher education savings bonds and savings accounts. It’s a total tax hike of $65 to $95 billion over the decade.

• New Price Index and Reduced EITC

The Trump-Ryan bill brags that it reduces taxes for the near and working poor who now pay an income tax rate of 15% and 10%, by consolidating the two brackets to a combined 12% rate. The former 10% group will of course get a 2% tax hike. But the increase in the income limit at which taxes are paid, from current $12,000 to $24,000, will offset this hike, according to Trump-Ryan. But the plan’s shift to a new, lower consumer price index will reduce the amount increasingly over time the working poor may claim tax reimbursement under the Earned Income Tax Credit, EITC. And it’s highly likely in any final bill that the $24,000 will be significantly reduced.

The foregoing is just a short list of the many ways the middle and working classes will pay for the Trump-Ryan tax bill. We’re talking about approximately $3.5 trillion in tax hikes in the Trump-Ryan bill negatively affecting mostly middle and working class households.

Closing 3 Big Capital Income Tax Loopholes

If Trump-Ryan really wanted to raise taxes, instead of targeting the middle class, they could have easily raised $2 trillion by ending just two other programs: Eliminating the preferential tax rate for long term capital gains taxation, which would bring in $1.34 trillion by 2024; and ending the practice of foregoing all taxation on stocks transferred at death, for which recipients of the stock pay no taxes whatsoever. That would generate another $644 billion. That’s $2 trillion.

Another at least $2.5 trillion could be raised by ending corporate tax deductions for payments into company pension and health insurance plans. Workers don’t get to deduct their contributions to these plans. Why should employers?

In other words, just three measures alone targeting corporate and capital incomes would raise $4.5 trillion in tax income over the coming decade. The three could pay for all the corporate-business-wealthiest 1% tax cuts in the Trump-Ryan bill, without raising any taxes on the middle and working classes! But that’s targeting capital incomes of the rich and their corporations, and politicians elected and paid for by the same won’t ‘bite the hand that feeds them’, as they say.

Concluding Comments

My prediction is that the Senate version, and final joint House-Senate version, of the bill that will now follow in coming weeks will have to pare down the tax cuts for wealthy individuals and raise some more the tax hikes on the middle class. Cutting the corporate tax rate is the priority for the Trump administration. After that ensuring US Multinational corporations get to shield even more of their profits from taxation. Congress will take it out of the personal income tax provisions which will be scaled back from the current Trump-Ryan proposals. Tax breaks for wealthy individuals will be softened, and new ways to quietly raise taxes on the middle class households may be found.

But the main solution will be to offset the more than $1.5 trillion net tax breaks with more spending cuts on social programs. In 2011 Congress and Obama cut spending by $1 trillion on education, health, transport, etc. Another $500 billion was cut in 2013. They will therefore try to repeat the ‘fiscal austerity’ solution to enable tax cutting for corporations. But that’s not new. The process of spending cuts to finance corporate-wealthy tax cuts has been going on since Ronald Reagan. It’s one of the main causes of the growing income inequality in the US that is the hallmark of Neoliberal policy since the 1980s.

The Trump-Ryan proposals are just the latest iteration of Neoliberal fiscal policy that has been making the rich richer, while destroying the economic and social base of the USA. Neoliberal policies associated with tax and spending programs, free money for bankers and investors provided by the central bank (the Federal Reserve), industrial policy deregulating everything and destroying unions, and trade policy enabling offshoring of production and jobs and free re-entry of US goods produced overseas back to the US (aka free trade) have been together ripping a gaping and ever-growing hole in the social fabric of the country. That has in turn been giving rise to ever more desperate radical right wing politics and solutions—i.e. the political consequences of the Neoliberal economic policies.”

Dr. Jack Rasmus is author of ‘Central Bankers at the End of Their Ropes: Monetary Policy and the Coming Depression’, Clarity Press, August 2017, and ‘Systemic Fragility in the Global Economy’ and ‘Looting Greece’, also by Clarity Press, 2016. He blogs at jackrasmus.com and his website is http://www.kyklosproductions.com and twitter handle, @drjackrasmus.

posted November 4, 2017
China Shifts Policy, Predicts ‘Minsky Moment’ of Global Financial Instability

The past year the US and global ‘real’ economies have enjoyed a moderate recovery. Much of that has been due to China stimulating its economy to ensure real growth in anticipation of the Communist Party’s convention, which has just ended. China’s president Xi and central bank (Peoples Bank of China) chair, Zhou, have announced, post-convention, that China’s real growth will slow and have warned a global ‘Minsky Moment’ (i.e. financial crisis) may be brewing. China will now try, once again, to tame its shadow bankers and speculators who have been feeding China’s debt and bubbles, and prepare for the global financial instability that is brewing.

The global financial bubbles–in stocks, bonds, currencies (crypto and real), derivatives, real estate, etc.– have been fueled since 2008 by capitalist central banks–led by the US Federal Reserve and followed even more aggressively by the European Central Bank and Bank of Japan. Central bank ‘free’ money has boosted stock and other financial asset prices into bubble territory and produced historic capital gains profits for corporations, professional investors, and the wealthiest 1% households in the US and worldwide. The world’s approximately 1500 billionaires’ wealth now totals more than $6 trillion–and that is only the officially admitted figure. More is not accounted for in the dozens of tax havens worldwide in which they park their money away from public and tax collectors’ view. US and other governments meanwhile are feverishly trying to pass even more tax cuts for billionaires and multi-millionaires, so they can keep even more $ trillions for themselves. Financial speculation has become the primary means by which the super-rich enrich themselves even more–with the help of central bankers and their paid-for Congressional government tax cutters.

Central banks have enabled their wealth acceleration by providing virtually free money for them to invest in financial markets through borrowing (debt) and leverage. Government tax cutters also let them keep more and more of the free money, profits, and their financial capital gains. Financial bubbles are the consequence. More and more financial writers have begun lately to write articles in the mainstream business press forewarning of the growing bubbles that are the engines of the the super-rich wealth acceleration.

The central banks and their policy of free money have created their own contradictions however. They have enriched the rich as never before, but in so doing have enabled and fueled the bubbles that threaten it all. After 8 years of pumping free money into private banks, corporations, and investors, the US central bank has this past year begun a desperate effort to raise interest rates and try to slow the flow of liquidity from the ‘free money firehose’ since 2008 that have produced a tripling of corporate profits, a quadrupling of US stock prices, bitcoin and crypto-currency bubbles, and $6 trillion of corporate bond debt issuance, much of which has been passed on to shareholders in dividend and stock buyback payouts. But the massive money and capital income growth has also produced financial asset bubbles that are now growing alarmingly as well. So the Fed over the past year has tried to raise interest rates a little to slow down the bubbles. It will be too little, however, as I have argued elsewhere that the Fed cannot raise rates much higher without precipitating a financial credit crunch that will generate the next recession. So the Fed talks tough on rates but does very little. The central banks of Europe and Japan do even less. Global banks and investors are addicted to the free money from the central banks and that policy will change little apart from token adjustments and talk.

The Fed’s (and all central banks’) dilemma is that raising rates and selling off its balance sheet (that will also raise rates) will cause the dollar to rise in global markets, cause in turn currency collapse in emerging markets that will sharply reduce US multinational corporations’ profits offshore. The Fed will not jeopardize US multinational corporations’ offshore profits therefore by raising rates too much. Higher rates will also shut down the US construction sector, already weak (new residential housing is declining), and reduce US consumption spending that is also barely growing, as it is based on debt and savings reductions instead of real wage growth. So the Fed is engaged in a charade of raising rates. And whomever Trump reappoints to the Fed chair after Janet Yellen won’t matter. The same free money policies will continue. For the system is addicted to free money and low rates for years to come–and that will continue feeding financial bubbles.

The Fed, like all central banks today, has become an institution whose main task is to continue subsidizing capital and capital incomes. As the Fed raises rates tokenly, other State institutions (Congress, Presidency) are also embarking on massive tax cuts for corporations and investors to offset the moderate hikes in interest rates coming from the Fed. More than $10 trillion in corporate-investor tax cuts occurred under Bush-Obama. Trillions $ more is coming under Trump.

In the 21st century, advanced capitalist economies are increasingly being subsidized by their states–monetarily by their central banks with free money and fiscally by their governments with more and more tax cuts for corporations and investors. Via both central banks and legislatures, the State is increasingly engaged in reducing capital costs and thus subsidizing capital incomes. This is the primary emphasis of ‘neoliberal’ policy in the 21st century capitalist economy.

The weaker capitalist sectors–Europe and Japan–are engaged in even more aggressive central bank free money provisioning. Europe’s central bank has just announced a ‘sleight of hand’, fake change in monetary policy: reducing its monthly free money injection (which has been benefiting mostly going to Germany and France bankers and corporations), while extending the period over which it will continue its program. It will provide less per month but for longer. Just moving the money around, as they say. Not really reducing anything.

The Bank of Japan has been even more generous to its bankers, investors and businesses. The Bank of Japan has refused to engage in a free money/higher rates charade (US) or language manipulation to fake a reduction in the free money flow (Europe). Japan’s central bank has announced it will continue buying and subsidizing corporate bonds, private stocks, and other financial assets, at an historic pace, thus contributing to propping up financial markets with no end in sight. Not suprisingly, Japan stock and financial markets are also on a tear, rising to levels not seen in 20 years. Similarly, financial asset markets have begun to escalate as well in Europe.
As I have indicated in my just released book, Central Bankers at the End of Their Rope, capitalist central banks are the original primary culprits of the free money policies adopted by all advanced capitalist economies–a policy that has been fueling debt and leverage, and stoking financial asset markets now entering bubble territory once again–i.e. creating the ‘Minsky Moment’ of financial instability about which China’s PBOC central bank chair, Zhou, has just forewarned.

Two big decisions will occur in the US in the first week of November: Trump will announce his new nominee for the chair of the US Federal Reserve Bank and the right wing-dominated US House of Representatives will define the Trump corporate-investor tax cuts further.

But whoever leads the Fed, there will be no real change in policy set in motion decades ago by Greenspan, continued by his protege, Ben Bernanke, and extended by Janet Yellen. Free money will continue to flow from the Fed (and even more freely from the central banks of Europe and Japan). Whether Powell, Taylor, Cohn or whoever are appointed, the policy of free money will continue. Rates will not be allowed to rise much. The private bankers and investors want it that way. And their ‘bought and paid for’ politicians will ensure it continues. Meanwhile, the Trump tax cuts will additionally subsidize corporations and investors at an even greater rate with Trump’s multi-trillion tax cuts. The Trump tax cuts (which follow more than $10 trillion under Obama and Bush) will enable US Corporations to continue paying record dividends and stock buybacks to enrich their shareholders. The $6 trillion in dividends and stock buybacks since 2010 will be exceeded by even trillions more. Income inequality trends in the US will therefore continue to accelerate unabated.

It is true the global economy has ‘enjoyed’ a brief and mild growth spurt in 2017, as noted previously. That growth has been driven by China’s stimulus and by US business inventory investing in anticipations of Trump tax and other deregulation (also cost reduction) policy driven changes. But the growth of the summer of 2017 will soon slow significantly. Now China will purposely slow, as policy shifts to rein in its own financial bubbles and in part prepare for a global ‘Minsky Moment’ crisis that is coming.

Meanwhile, the Trump bump in US economic growth will also fade in 2018, driven up until now largely by inventory investing by business that won’t be realized in sales and revenue in 2018. Working-middle class household consumption has been based on debt and savings reduction instead of real wage income recovery this past year. That is not a basis for longer term growth. Household consumption cannot be sustained. US autos and housing are already fading. Simultaneously, escalating costs of healthcare insurance premiums will cut deeply into consumer spending in 2018 as well. And government spending, now stagnant, will also slow, as Congress cuts social programs in order to offset deficits created by the massive tax cuts for corporations and investors.

In Europe, political instability forces will keep a lid on economic recovery there (a ‘hard’ Brexit looking increasingly likely, Catalonia independence uncertainty, new breakaway regions in Italy soon also voting for independence, the rise of right wing governments in eastern europe, etc.). In Japan, business interests will continue to ignore prime minister Abe pleas to raise wages, as they have for years, while Japan gives the green light to become the global financial center for crypto-currency speculative investing.
Consequently, odds are rising there will be a recession in the US, and globally, by late 2018 or early 2019. That will likely be accompanied soon, before or after, by a new ‘Minsky Moment’ of financial instability that will exacerbate the real economic downturn.

Jack Rasmus is author of ‘Central Bankers at the End of Their Ropes: Monetary Policy and Coming Depression’, Clarity Press, August 2017; and ‘Systemic Fragility in the Global Economy’, Clarity Press, January 2016. He blogs at jackrasmus.com and his twitter handle is @drjackrasmus.

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