Agenda for a New Economy
Page 9
Monarchs often found it advantageous to grant a license to privately owned, financed, and captained armed vessels to engage in this profitable enterprise. These privateers offered important advantages to cash-strapped rulers. They provided revenue with no cash outlay, and official responsibility could be disavowed more easily than if the warships of the Crown had pillaged the victim vessels.
Monarchs often found it advantageous to grant a license to privately owned, financed, and captained armed vessels to engage in this profitable enterprise. These privateers offered important advantages to cash-strapped rulers. They provided revenue with no cash outlay, and official responsibility could be disavowed more easily than if the warships of the Crown had pillaged the victim vessels.
Crew, captain, private investors, and the commissioning king divided the revenues from the booty while the king’s license lent a patina of legality to the acts of plunder and granted the ships safe harbor in their home ports. A new era was in gestation, from which Wall Street eventually emerged.
Some privateers operated powerful naval forces. In 1671, Sir Henry Morgan (yes, appreciative kings did grant favored privateers titles of nobility in recognition of their service) launched an assault on Panama City with thirty-six ships and nearly two thousand brigands, defeating a large Spanish force and looting the city as it burned to the ground.3
Tax records for 1790 indicate that four of Boston’s top five taxpayers that year obtained their income in part from investments in privateering — they included John Hancock, famed for his outsized signature on the Declaration of Independence.4
In 1856, the major European powers, with the exception of Spain, signed the Declaration of Paris, declaring privateering illegal. The United States, which relied heavily on privateers as its primary source of naval power and as a major source of commercial profits in its early years, did not stop commissioning privateers until the end of the nineteenth century.5
CHARTERED CORPORATIONS
Eventually, the ruling monarchs turned from swashbuckling adventurers and chartered pirates to chartered corporations as their favored instruments of colonial expansion, administration, and pillage. It is instructive to note that in England this transition was motivated in part by the country’s incipient step toward democracy.
By the beginning of the seventeenth century, the English parliament, whose establishment was one of the first modern efforts to limit the arbitrary power of the king, had gained the authority to supervise the Crown’s collection and expenditure of domestic tax revenues. Chafing under this restriction, sovereigns such as Elizabeth I, James I, and Charles I found that by issuing corporate charters that bestowed monopoly rights and other privileges on favored investors, they could establish an orderly and permanent source of income through fees and taxes that circumvented parliamentary oversight. They also commonly owned personal shares in the companies to which they granted such privileges.6
In addition, chartered corporations sometimes assumed direct responsibility for expenses that otherwise would have fallen on the state, including the costs of maintaining embassies, forts, and other naval, military, and trade facilities. English corporations were at times even given legal jurisdiction over Englishmen residing in a given territory.
Corporations chartered by the British Crown established several of the earliest colonial settlements in what later became the United States and populated them with bonded laborers — many involuntarily transported from England — to work their properties. The importation of slaves from Africa followed.
The East India Company (chartered in 1600) was the primary instrument of Britain’s colonization of India, a country the company ruled until 1784 much as if it were a private estate.7
In the early 1800s, the East India Company established a thriving business exporting tea from China, paying for its purchases with illegal opium. China responded to the resulting social and economic disruption by confiscating the opium warehoused in Canton by the British merchants. This precipitated the Opium War of 1839–42, which Britain won.
The Dutch East India Company (chartered in 1602) established its sovereignty over what is now Indonesia and reduced the local people to poverty by displacing them from their lands to grow spices for sale in Europe. The French East India Company (1664) controlled commerce with French territories in India, East Africa, the East Indies, and other islands and territories of the Indian Ocean.
The new corporate form was a joint stock company, which combined two ideas from the Middle Ages: the sale of shares in public markets and the protection of owners from personal liability for the corporation’s obligations. These two features enabled a single firm to amass virtually unlimited financial capital, assured the continuity of the firm beyond the death of its founders, and absolved the owners of personal liability for the firm’s losses or misdeeds beyond the amount of their holdings in the company.
Furthermore, separating owners from day-to-day management allowed for a unified central direction that was difficult when management control was divided among a number of owner-partners.
It is no exaggeration to characterize these forebears of contemporary publicly traded limited liability corporations as, in effect, legally sanctioned and protected crime syndicates with private armies and navies backed by a mandate from their home governments to extort tribute, expropriate land and other wealth, monopolize markets, trade slaves, deal drugs, and profit from financial scams.
Publicly traded limited liability corporations of gigantic scale now operate with substantial immunity from legal liability and accountability even in the countries that issue their charters. They have become the defining institutions of our day. Wall Street is their symbolic seat of power, and they have reversed their relationship to the state.
Wall Street now commissions the state to finance and field the armies that protect its interests and to staff the diplomatic establishment that negotiates treaties in its favor. From time to time, using its ability to crash the economy at will, it extorts protection money in the form of bailouts and Federal Reserve cash infusions. To maintain the state’s loyalty, it begrudgingly shares a fraction of its booty in the form of taxes and offers tribute to its politicians as travel perks and campaign contributions.
As did their swashbuckling forebears, Wall Street’s buccaneers and privateers seek self-enrichment by plundering wealth they had no part in creating, enjoy substantial legal immunity, and acknowledge no duty or accountability other than to themselves. Their success carries a heavy price tag for the rest of us.
CHAPTER 7
THE HIGH COST OF PHANTOM WEALTH
Financial capitalism is a system of irresponsibility and…is amoral. It is a system where the logic of the market excuses everything.…Either we re-found capitalism or we destroy it.
PRESIDENT NICOLAS SARKOZY OF FRANCE
“We have always known that heedless self-interest was bad morals,” said Franklin Delano Roosevelt in 1937. We know now that it is bad economics.
PAUL KRUGMAN
Wall Street’s relentless drive to have it all not only has had devastating economic, social, and environmental consequences but also has destroyed the integrity of money, created expectations that society has no means to fulfill, and sacrificed the health and happiness of nearly everyone. The full costs are beyond comprehension.
PHANTOM EXPECTATIONS
It is a curious thing that, unless we stuff it in a mattress, we expect whatever money we don’t immediately spend to grow in perpetuity without effort on our part. We do not expect the same of real wealth. Buildings must be maintained. Machinery must be replaced. Knowledge must be updated. The trust and caring of a community must be continuously renewed. Skills must practiced. Even wild spaces must be protected from predators, particularly human. All of these require a real investment of time and life energy. Effortless perpetual growth defies the physical law of conservation of energy. Only phantom wealth can grow effortlessly and perpetually.
As our phantom wealth grows,
so too do our expectations regarding what constitutes our rightful claim to society’s real wealth. Unless we are voluntary simplicity initiates, we are inclined to increase our consumption in tandem with growth in our income, placing an ever-greater burden on the planet. So often, we say with pride, “I can afford it,” without asking whether Earth can afford it.
Because our economic system gives priority to creating phantom wealth, presumed entitlements now far exceed the real wealth available to satisfy them. This can create quite a shock when those of us with financial assets decide to convert our share of the phantom-wealth pool into payments for rent, food, health care, and other needs, if a lot of others make the same decision at the same time.
The financial planner Thornton Parker has pointed out that this is likely to be an issue for baby boomers who built up financial assets during the stock market boom in anticipation of a comfortable retirement. Just as their collective decision to put money into the stock market during their working years helped inflate share prices, so their collective decision to take it out during their retirement will deflate those prices, leaving these retirees in potentially desperate straits.1
Wall Street’s phantom-wealth machine has created prospective claims and related expectations far out of proportion to the real wealth available to satisfy them.
The problem is not confined to prospective retirees and retirement accounts. It applies as well to the endowments of foundations, universities, and other nonprofits. It applies to the public trust funds of libraries and municipalities, college savings funds, the reserve accounts of insurance companies, personal trust funds, and much else.
Perhaps the major challenge to the call to shut down the Wall Street phantom-wealth machine is the understandable and serious cry, “But what about our 401(k)s and our university and foundation endowments?” The answer is that so long as these funds are invested with Wall Street institutions engaged in phantom-wealth creation, they rest on nothing more than financial bubbles and creative accounting, and their value can evaporate overnight.
We must build our old-age security and our crucial nonprofit organizations on more solid foundations. In chapter 14, I’ll say more about better options for dealing as a society with such things as retirement, home purchases, and insurance than those offered by Wall Street. As for the American dream of living off financial returns in work-free luxury, it is a fantasy that can be achieved by the very few at the expense of the many.
There is no way to tell by how much the claims of financial-asset holders exceed the real wealth available to fulfill them, but the evidence suggests the difference is considerable. No one is even asking how the inevitable loss of unfulfillable expectations might be fairly distributed. A given dollar doesn’t come with a marker that identifies it as a phantom dollar or a real one.
DELINKED FROM REALITY AND OUT OF CONTROL
The financial figures that get thrown around in relation to the credit crash and financial bailout of 2008 defy both reality and imagination. The financial assets of the richest 1 percent of Americans before the crash totaled $16.8 trillion.2 This represents what they understood to be their rightful claim against the world’s real wealth. To put that in perspective, the estimated 2007 U.S. gross domestic product was $13.8 trillion, and the total federal government expenditures that fiscal year were $2.7 trillion.3
These sums all seem trifling, however, compared with the $55 trillion in credit default swaps outstanding at the time of the subprime mortgage meltdown, to which they made a major contribution.4 These are essentially insurance contracts that presumably eliminate the risk from the toxic mortgage derivatives. They involve bets and counterbets that may partially cancel each other out if anyone can untangle them — but many of the parties to them have gone bankrupt. Because the transactions were never reported to any central clearinghouse and many of them are carried off the books of the institutions that hold them, no one really knows how much is actually at risk or who owes what to whom.
All we know for sure is that $55 trillion is a great deal of money. It pales into insignificance, however, when compared with the $648 trillion that the Bank for International Settlements reports as the total notional value of all outstanding over-the-counter derivatives as of June 2008.5 That renders insignificant even the $16 trillion that evaporated between mid-September and the end of November 2008 as the market value of the world’s publicly traded corporations’ share prices fell by 37 percent.6
Is your head spinning? Is your brain shouting, “This doesn’t make any sense”? Trust your brain. It is working. Welcome to the Alice in Wonderland world of phantom wealth.
A quick note is in order here on the Wall Street bailout figure of $12.8 trillion noted at the beginning of chapter 1. Perhaps you recall the public outrage in October 2008 when the U.S. Congress passed a bill authorizing the Treasury Department to spend $350 billion to bail out Wall Street financial institutions, with another $350 billion in the pipeline subject to congressional approval. So what is this $12.8 trillion?
Some of it is in established government guarantee and insurance programs, including other Treasury Department programs. The FDIC was on the hook for $2.0 trillion, and the Federal Housing Administration for $0.3 trillion. The bulk of it, $7.8 trillion, was from the Federal Reserve,7 which acts independently and which routinely makes massive financial commitments to the banking system without any congressional approval or oversight process.
Mostly, the Fed creates its own money as it sees fit, with a few simple accounting entries. In most instances, no one seems to know where any particular funding comes from, where it is going, or how it is being used. Indeed, the Fed has stood firm against bipartisan calls from Congress for a federal audit and Freedom of Information lawsuits by Bloomberg News and other news agencies seeking a release of records on who has received what commitments and on what terms. The Fed argues that making such information public would endanger public faith in the banking system. Given how low public faith in the banking system is now, that is an alarming admission.
If you don’t understand how Wall Street really works, don’t feel bad. I’ve come to doubt that anyone really understands it. The accounting involves so much smoke and mirrors it may be beyond understanding.
It isn’t necessary to know the details to recognize that we are dealing with a system that is delinked from reality and is operating with no one at the helm. Nor does it take special genius to recognize that when folks are moving around trillions of dollars in secret transactions and cannot explain in a credible way where the money is coming from or where it’s going, and cannot make a credible case that it is serving a beneficial purpose, they are probably up to no good.
Now I want to turn to what I believe to be the most important of all the many design flaws of Wall Street’s phantom-money machine.
PERPETUAL GROWTH ON A FINITE PLANET
The unrealistic expectation that money should grow perpetually and effortlessly is more than a cultural issue. It is built into the design of the Wall Street money machine. Do you recall the description in chapter 2 of how banks create money with a few computer strokes when they issue a loan? Recall that 32 percent of all outstanding U.S. debt is money that financial institutions owe to each other. By making such loans, banks bulked up their financial statements, expanded the total amount of money in play in the Wall Street casino economy, and increased the number and size of the transactions that generated the management fees that paid the bonuses. Recall also that when banks issue loans, they are creating money with simple accounting entries. Yes, much of the phantom-wealth thing is mainly fancy accounting.
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GROWTH AND JOBS
There is a connection between growth and jobs, but only because Wall Street has the system gamed to assure that all the gains from increased productivity go to managers and shareholders rather than to labor.
Thus, the total number of jobs will decline and unemployment will increase over time if the economy is not growing at a rate at least e
qual to the increase in productivity. This problem is easily avoided if productivity gains instead translate into greater time for working people to devote to family, community, and other quality- of-life pursuits.
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Banks were in fact creating money so fast that the Federal Reserve stopped reporting the most meaningful index of the amount of money in circulation, what economists call M3, on March 23, 2006. Some observers believe the Fed stopped reporting it because the amount of money had begun to grow so fast as to cause public alarm and undermine confidence in the dollar.
Phantom Money and Unreported Inflation
John Williams, a consulting economist who has spent years studying the history and nature of economic reporting, tracks economic statistics that the government has either stopped issuing or has seriously distorted. Using the same methodology the Fed once used to compile its M3 index, Williams reports that the rate of growth was running from 5 to 7 percent in 2005. It then began a steady acceleration to a peak annual rate of over 17 percent at the beginning of 2008, just before the credit collapse kicked in.8
When the money supply expands faster than productive output, price inflation usually results. According to the official Consumer Price Index, inflation was running at a rate of 2 to 4 percent at the beginning of 2008. Williams compiles his own consumer price index using the same methodology that the government used up until the 1980s, when it decided to start cooking the books to hide evidence of economic mismanagement and hold down automatic wage and Social Security indexing. According to Williams the actual rate of inflation at the beginning of 2008 was in the range of 12 to 13 percent. What you experience every time you go shopping is true.