We can see that this whole system relies primarily on the ability of taxpayers, which include businesses, consumers and homeowners, to continue to pay taxes to service a rising level of debt. It also relies on the willingness of foreigners to provide those credits by buying Treasury notes and bonds (Foreign credits). If the government borrows and spends to excess, this mechanism eventually must freeze up. The only policy option then will be to pay off all debts with money newly created by the Federal Reserve. Money creation risks hyper-inflation followed by a severe depression. Avoiding such dire consequences would entail a combination of fiscal austerity and monetary depreciation, which would translate into years of stagflation. The true consequence of runaway debt is that it will depreciate the real value of everything we own, diminishing our standard of living.
Obviously, the rational choice is to avoid excess borrowing and spending. Why is this so hard to achieve?
For the answer we need to consider the incentives of the major actors in the game. First, government spending is authorized by politicians who are eager to get re-elected by delivering public goods to their constituents. To ask politicians to cease and desist from formulating and funding government spending programs is like asking lions to stop eating gazelles – it’s a form of political suicide.
Second, the banking and shadow banking industries feed at this same trough by providing the needed credit at a price. The more debt issued and credits provided to the government, the more the banks make in the difference between what they pay for credit and what they make in interest on loans or investments. In other words, they can borrow from the Fed at 0-1% and lend out to businesses, consumers, and homeowners at 5-18%. (Technically, this is like a form of modern seignorage – an arcane monetary concept that denotes the banking authority’s ability to collect the difference between interest earned on securities acquired in exchange for bank notes and the costs of producing and distributing those notes.) The banking system’s stake in credit creation and debt has enabled it to grow its profits from $32.4 billion to $427 billion in 25 years. These profits provide an enormous war chest for political lobbying and for placing financial industry alumni in government policymaking jobs. It’s difficult to imagine anyone in a position of financial or political power desiring to reform this system.
Lastly, we can see that the people who pay the bills—the taxpaying businesses, consumers, workers and homeowners—have little political input into this process. We might then label this system a blatant case of ‘taxation without representation.’ As hard as it may be to change the debt-based monetary system, its current practice is unsustainable. The recent debt ceiling political crisis is evidence of the growing awareness of this fact among voters. Perhaps the best way to convey the gist of what has transpired is with a story. Let’s call it the Washington Road Trip.
Imagine a car—a big fat gas-guzzling, over-powered U.S. luxury car or SUV—barreling down the highway. It’s picking up speed under the driver’s lead foot. The guys in front are in control, while those seated in back just came along for the ride. But now the car is careening recklessly and still picking up speed, giving them all second thoughts. One little guy is cowering against the door thinking about how Thelma and Louise ended.
The driver looks at the fuel gauge and says, “Hey, we need more gas. Somebody back there give me a credit card.” (For the sake of the analogy, let’s assume the car doesn’t have to stop or slow down to refuel.)
Each of the poor folks in back says, “Not me. I’m tapped out. Over my limit. Can’t even afford to pay down the balance I owe now.”
The guys in front then focus on the little guy. “Hey, don’t you have your rich uncle’s credit card? Hand it over.”
In a weak voice he replies, “Can’t. He said if I used it again he would cut me off. Listen, can’t we just put on the brakes and slow down a bit?”
At which point the guys in front start castigating and rebuking the little guy as a selfish, ignorant, lowly coward. Meanwhile the car is still picking up speed and the Grand Canyon looms dead ahead.
So, can we put some names to the actors in this tale? The driver is the chief executive and the guys in the front seat are the policymaking elites in the Senate, Fed, and Treasury. The joyriders in the back are the Congress and the little, fearful guy with a tight grip on his uncle’s credit card is the Tea Party caucus. The guys too happy to pump the gas (at a price) are the bankers and financial industry. The sleeping Highway Patrolmen that just clocked the car’s accelerating speed is Standard & Poor’s and Moody’s.
What we don’t know yet is how the Washington Road Trip ends.
Appendix D
Casino Capitalism and Crapshoot Politics Blog
Most Popular Posts: (click on links for full posts)
Inequality, Power Laws, and Sustainability: Part I
If you navigate to the Wikipedia link on economic inequality, you’ll find a list of hypothetical causes, including declining wages, education, technology, globalization, tax structures, racism, and gender, among others. I will argue that none of these factors are determinant, nor are they, in toto, sufficient to explain the divergence of wealth and income in the world.
Inequality, Power Laws, and Sustainability: Part II
In Part I of this post I discussed power laws and how they describe the distribution of wealth and income. I employed the clearest example of the Pareto principle, or 80-20 rule, where 20% of the population controls 80% of the resources. More generally, the Pareto Principle is the observation that most things in life are not distributed evenly because most inputs (effort, reward) and outputs are not distributed evenly – some contribute and receive more than others. Why is this so and how does that explain the power law’s occurrence in nature? Why do 20% of the pea pods produce 80% of the peas?
Inequality, Power Laws, and Sustainability: Part III
In this post I will discuss the policy ramifications of inequality. Power laws in economic exchange markets lead to instability because of the inter-temporal breakdown of the necessary feedback processes. Let me explain that in English.
(The Illusion of) The Perpetual Money Machine
This is an excerpt from an excellent paper by Didier Sornette and Peter Cauwels on the state of our world financial economy. Your can download a pdf of the entire paper here. It’s worth a read. The layman’s version can be found here.
Gambling on the Welfare State
State-sponsored gambling is the one acceptable way of raising taxes on lower-income folks to help fund the welfare state. …Dancing in [politicians'] heads are visions of new state-sponsored gambling empires built on online poker, online slot machines and online lottery-ticket sales, with politicians collecting most of the vig. …With or without federal regulation, legalized online poker is likely coming your way in 2013.
The Soviet Banking System—and Ours
The symbiosis between the Fed and the Treasury is unsustainable. (View graphic here.) Neither creates value, but they sure can destroy it. The financial sector is skimming its 3% or gambling house money on bigger payoffs, but eventually they will end up on the menu. Our policymakers are short-timers.
So Long Price-Earnings, Hello Price-Expectations
Casino anyone? These are the consequences of boundless credit and QE 1234ever. This juicing of the asset markets with easy money has been going on for a couple of decades. Sooner or later we must pay the piper… I’m guessing the present culprits will be long gone by then and the citizens stuck with the bill.
For the Fed, There’s No Easy Exit
The crash of Zero Mostel’s quasi-Ponzi scheme in 1968′s “The Producers” left his partner Gene Wilder muttering, “No way out. No way out.” Federal Reserve Chairman Ben Bernanke is in a somewhat similar position.
The Worst Economic Recovery in History
This gets to the heart of the policy arguments offered in the Citizen’s Survival Guide concerning long-term economic sustainability and stability. In addition to “growing” the
economy, we will have to pay attention to the distributional consequences of market exchanges. Winner-take-all is not sustainable.
Preparing for the Apocalypse?
Federal Reserve policy must seem pretty arcane to most people, which is why I try to liven it up with a bit of sarcasm and wit. There was a lead article in this week’s Barrons illustrating how the public equity markets are shrinking (instead of the Wilshire 5000, it’s now the Wilshire 3666).
What, Me Worry?
Central bank strategy, and what we refer to now as “forward guidance” is a never-ending puzzle. In divining future Fed policy we may also need to consider the international ramifications. The three major currency blocs in the free world today are the Japanese yen, the Euro and the US dollar.
Stuck Inside the Box
The president’s recent economic address reveals that we’re still stuck inside the box on thinking about economic policies. The linchpin of his address was to advocate for an increase in the federal minimum wage and another 99-week extension of unemployment benefits. These are rather innocuous and bankrupt ideas – notable for their insignificant and contentious economic effects.
Red-faced or Blue-blooded: Exploding the Myths of American Party Politics
In recent years American politics has become highly polarized, making democratic governance less amenable to compromise and more gridlocked. After a generation of conflict and heightened partisanship during the Obama presidency, as we careen from budget battles to periodic government shutdowns, we seem no closer to bridging the gap. One reason for this impasse stems from a misunderstanding of our politics driven by a popular media narrative that perpetuates cultural stereotypes, political myths, and partisan hyperbole.
One Big Reason You Can’t Find a Job: Zero Interest Rate Policy
This isn’t rocket science, it’s fairly simple: zero interest rates are a sign of a very sick economy. The occurrences should be short and temporary. A healthy economy must price the time-value of money and risk at a range somewhere between 1-3% real interest rates, depending on the term structure and liquidity. Instead, the Fed has hampered the recovery of capital markets on which the real economy depends. So we have a casino where the bettors are subsidized and the asset markets become where all the action is. They once called this “irrational exuberance,” but under this Fed policy it’s perfectly rational.
Liberty, Politics, and Justice…
As readers well know, this blog focuses primarily on economic policy and monetary issues, but policies are not made in a political vacuum. The legacy of the post-60s period in American politics has been distilled down to momentous Supreme Court decisions, which have become the tail that wags the dog of our collective lives. But politicizing court decisions is not really the way “rule by the people” (democracy) was meant to work. No wonder our democracy has become so dysfunctional: as we raise irreconcilable issues such as race, abortion, and sexual preference to the level of national politics, we become divided by emotions or distracted by ‘bread and circuses.’ Meanwhile, the political class runs the government in their own narrow interests. We the citizens become the losers by our own design. Whether winning or losing in this judicial lottery, nobody should be real content with the present state of affairs.
Money Delusions
An important issue that the Fed has not discussed in detail is the idea that rising asset values in housing and the stock market will translate into more economic activity, and a speedier economic recovery—the impact of wealth effects.
Wealth effects are determined by changes in asset prices. In the U.S., two asset classes determine the intensity of wealth effects. They are housing prices and the stock market. (Read the rest of the article here.)
Mr. Kotok is likely correct in explaining why the Fed wants higher housing and stock prices, but neglects to mention the negative externalities of its policies. Seeking positive wealth effects by recapitalizing asset prices is like putting the cart before the horse: rising incomes drive asset prices, not the reverse, so asset price increases that depart from fundamental income flows are unsustainable, as every financial analyst knows.
To Consume or Not to Consume?
THAT is the question. In fact, it is the defining question for an exchange economy. Let’s dissect exactly what it means. “To consume” seems fairly obvious, like the question you ask your kid at the dinner table, “Are you gonna eat that?” But “Not to Consume” offers all kinds of confusing options. To not consume means to save. Save for what? To invest? Invest for what? More stuff? Yes, more stuff to consume in the future. There’s really no other option: “Not to consume now” merely means to defer consumption to some indefinite future time period. (If you die before then, your heirs will consume whatever you saved.)
About the Author
Michael Harrington is a political economist, public policy analyst, and author. He holds advanced degrees in political science, finance, and economics. His academic scholarship has garnered several national awards, including the American Political Science Association’s Harold D. Lasswell Prize for best research in policy studies. His research interests encompass trade policy; capital markets; the politics of finance; risk, uncertainty and social insurance; voting patterns in American politics; agent-based modeling techniques; and the economics of inequality. He has worked in the securities and venture capital industries as an investment portfolio manager, financial analyst, and consultant. In more recent years he has taught political science as a lecturer at the University of California and worked as a research fellow and public policy analyst. He currently writes on economic policy and politics on the blog, Casino Capitalism and Crapshoot Politics.
Harrington has harbored a life-long fascination with the art, culture, and politics of the Italian Renaissance, and has lived and studied in Italy, near Florence. His enduring interest in the social movements and artistic creativity of this period led him to study the life stories of Girolamo Savonarola, Niccolò Machiavelli, Michelangelo, and Leonardo da Vinci. As a visiting scholar to the Bridwell Library at Southern Methodist University in Dallas, he conducted research with primary Renaissance materials for his dramatized history-fiction trilogy on Savonarola and Machiavelli. This work, titled The City of Man: Inferno, Purgatorio, Paradiso, has been an Amazon Kindle bestseller for more than four years running.
An early convert to digital technology, Harrington is a pioneer in the development of digital book formats, or eBooks. His eBooks are programmed to take full advantage of the search and link capabilities of digital text, as well as incorporating the enhancements of images, illustrations, tables, and indexes. These features give the reader the freedom to pursue their own path through the story with direct access to historical information on the Internet. Michael can be contacted through his Authors Guild website or his Wordpress weblog.
Other books by Michael Harrington:
The City of Man: A Trilogy
Inferno
Purgatorio
Paradiso
Saving Mona Lisa
In God We Trust
Trade and Social Insurance:
The Development of National Unemployment Insurance in
Advanced Industrial Democracies
Acknowledgments
I would like to express my gratitude for those who have helped add invaluable clarity and comprehension to this presentation. Without such generous assistance I’m sure the ideas expressed here would be understood fully by the author alone, if I may be so presumptuous. The list will grow as the book circulates, but I will mention here David Magee, Jon Fitzsimmons, and Todd Mittleman. I’ve had many fine teachers in economics, finance, political science, and public policy. I will spare them unsolicited publicity, but no blame can be laid at their feet.
As always, my inestimable gratitude is reserved for my wife, unpaid editor, and best friend, Tushara Bindu Gude, who, as an art historian, labored over these pages to make sense of, and correct, my convoluted thoughts. I dedicate this book to her and hope she is
never embarrassed for it! Any errors are mine alone.
Reading List
Books/films on the recent financial crisis:
Cassidy, John. How Markets Fail.
Fox, Justin. The Myth of the Rational Market.
Lewis, Michael. The Big Short.
Morgenson, Gretchen. Reckless Endangerment.
Ritholtz, Barry. Bailout Nation
Stiglitz, Joseph. Freefall: America, Free Markets, and the Sinking of the World Economy.
Tett, Julian. Fool's Gold.
Inside Job – Academy-Award winning documentary film.
Books investigating the study of economics, politics, and finance:
Derman, Emanuel. Models. Behaving. Badly.
Farmer, Roger. How the Economy Works: Confidence, Crashes and Self-Fulfilling Prophecies
Greider, William. Secrets of the Temple: How the Federal Reserve Runs the Country
Ip, Greg. The Little Book of Economics
Mandelbrot, Benoit. The Misbehavior of Markets.
Minsky, Hyman. Stabilizing an Unstable Economy
Paul, Ron. End the Fed
Rajan, Raghuram. Fault Lines.
Rajan, Raghuram and Luigi Zingales. Saving Capitalism from the Capitalists
Rickards, James. Currency Wars: The Making of the Next Global Crisis
Rothbard, Murray. The Case Against the Fed
Common Cents Page 20