With the kind permission of the author/cartoonist. I highly recommend this book for all things, it is both witty and covers an amazing amount of history. One of my very favorite books.
May 21, 2008
Elaine Meinel Supkis
Today we visit Dr. Fekete's University of Sanity. He tries to explain some strange paradoxes of interest rates and the rate of wealth destruction. As usual, I back him up with today's news stories about our collapsing banking system. The US absolutely refuses to correct course and cease crazy lending at insanely low rates of interest. There are a thousand reasons why we must stop doing this but it will cause pain. So the Fed and the government unite in trying to drive us deeper and deeper into debt. Even as the price of oil now is over $132 a barrel and gold is now climbing rapidly back to the $1,000 per ounce levels. This dynamic cannot run much longer without the US falling into a total economic collapse. We have to stop the mad Funny Money™ machine before it is too late.
It may be insensitive to capital destruction
There is cause for concern in this regard. For the past 75 years the West has been fed the propaganda line, attributed to John Maynard Keynes, that the gold standard is a “barbarous relic”, ripe to be discarded. The unpleasant truth, one that propagandists have ‘forgotten’ to consider, is that the gold standard is merely a proxy for sound accounting and, yes, for sound moral principles. It is an early warning system to indicate erosion of capital. It was not the gold standard per se that politicians and adventurers wanted to overthrow. They wanted to get rid of certain accounting and moral principles, especially as they apply to banking, that had become an intolerable fetter upon their ambition for aggrandizement and perpetuation of power. Historically, accounting and moralprinciples had been singled out for discard before the gold standard was given the coup de grâce.
It is not widely recognized that the chief eminence of the gold standard is not to be found in stabilizing the price structure (which is neither desirable nor possible). It is to be found in stabilizing the interest-rate structure. By ruling out capricious and disturbing swings, the Wealth of the Nation is maximized.
Gold is NOT wealth. Gold is a REGULATOR. Gold is LIBRA. Gold, when used as a restrictor, a curb, a control, is not part of the Cave of Death anymore. Instead, it becomes a GUARDIAN at the Gates of Death! In other words, a goddess or a Watcher. Its function is to protect OTHER WEALTH. The things that are 'real'. Like labor, rice, oil, wheat, land, trade, ships and armies. Hoarding gold doesn't work. It has to be harnessed in the role of regulator, not be a commodity that is just as uncertain as all other things. The chaos, the total chaos we see today is a dynamic of running a system with NO CONTROLS. NO BALANCE. Libra hates this.
The only way gold can perform as a guardian deity is for the central bankers to bow to Her and sacrifice to Her and to understand Her rules and tempers. This is a very ancient role, by the way. From the first pharaohs. For some reason, humans can control the desire to be greedy if they have a system that has this sort of exterior restrictions. Isn't that funny?
When the US had a Treasury with some treasure in the form of gold and silver, the US fell into a huge Civil War. Funding this war via taxes made it very unpopular so the government, like all governments, decided to fund it via making money out of thin air by lending to itself. Gold dealers went crazy and the value of gold began to climb in NYC. The more the government lent to itself, the higher the gold shot up. This was ended rather brutally with gold collapsing in price as the government quarantined gold by restricting trade and other means. Including isolating the bonds, or so they hoped, by forwarding the debt in time. Moving debts forward is a common 'solution'. People who buy these and hold them want a return for this favor. So the longer these are held, the more they contribute to future inflation via the added money flowing from these bonds. In other words, taxes of some sort are levied and handed over to the people who bought the bonds during the war.
Governments must keep track of this forward moving financial hazard. This is why wars must be spaced out carefully. If they happen too frequently or worse, last a long time, the hazards shoot upwards. Since there is no pause to refill the financial tanks, the accumulating responsibility to pay the extra funds for the interest due on these bonds grows. Eventually, it wipes out all monetary growth via capitalist profits. When the capitalist profits are based on military manufacturing, this is twice as destructive as war spending with a solid industrial profit base.
For example, when England went to war with Germany in 1914 and 1939, each time Germany prevented trade with England via submarine warfare. Each time, England responded by going very deeply into debt to the US. Lend/Lease which was set up by Roosevelt for political reasons, was a certain sign, Britain was totally bankrupt. The US first lent the money and then took it back with a lease on equipment which was doomed to destruction. No sane government 'lends' war equipment. The nature of war is, destruction.
Dr. Feteke is very good because he takes care to mention the role wars have in the development of banking and how wars are the ultimate outcome of modern banking. After all, banking began in the West, after the Dark Ages, via the Crusades. The bonds sold by the Church were promisorry notes which supposedly gave believers a free pass to Heaven instead of waiting in line in Purgatory. All war bonds are promises of Heaven after winning a war. All nations that lose wars go immediately into economic chaos and the costs of the lost wars are paid via destruction of assets held by the losers.
Winners also get hammered! The financial birds set free by the government to pay for wars fly home in the form of either inflation or higher taxes leading to depression. Assets that ballooned during the free spending war years drop in value and wealth created during the war is destroyed as interest rates drop and war bonds become illiquid. If we look at the history of all nations, we see very, very clearly that depressions/inflation flare ups ALWAYS follow wars for winners and losers, both! This is due to both parties inflating the monetary markets with lots of new Funny Money™.
For example, when Russia couldn't afford to continue fighting in Afghanistan, they retreated. But this meant admitting the war was over. Instantly, the fires of inflation and the ice of depression hammered Russia's domestic markets. Very quickly, Russia fell off the economic cliff. When Russia surrendered in the Cold War, a very long war, the economic losses were so tremendous, the nation collapsed and huge hunks fell away. Rebellions and insurrections flared. People starved to death and the population of Russia began to fall. After 15 years of destruction of wealth, Russia had rebounded. For this is the harsh reality of wealth destruction: out of the ruins springs, like the Phoenix, a new wealth! Nations that evade this end up in long, long depressions.
For example, the Roman Empire: when it rotted, it rotted very slowly. Its rise was rapid. Its fall was slow. As Rome fell, the collapse slowed down to a crawl. So civic activity at the heart continued as if nothing was wrong all the way up until 400 AD. Then the final collapse via military defeat at the core finally wiped out the remaining wealth of Rome. The fall went from approximately 100 AD to 600 AD. That is 500 years. The Dark Ages lasted from 600 AD to 1100 AD. Note the balance of time here. All recoveries last as long as the collapses. Give or take a hundred years.
England's collapse ran from 1920 to 1950. The recovery really began, and this was with tremendous help from the US, in 1980, roughly speaking. In other words, the collapse was thirty years long. The recovery was also thirty years long. The US began to rot and fall beginning in roughly 1970. We struggled to keep up our military machine spending for the Cold War and now for more and more hot wars since 1970. Our economic condition has rapidly deteriorated during this phase. Which is now nearing 40 years long! Again: no nation that loses a war gets out scot-free. They pay a heavy price in wealth destruction. Even nations that win wars, pay this price. But losers pay double.
England won WWI and got greater territory from it. But due to the depression that followed, England couldn't hang onto its territories and Iraq successfully fought off the British invaders. So even though Britain won the major war, they began losing the minor wars. Then Ireland managed to free herself partially from British rule. The accumulating war losses meant Britain started WWII much weaker than Germany who won all their minor wars between WWI and WWII.
The US won the Cold War. But this was a very hollow victory since we lost the Vietnam War. As usual, we went into a small tail spin when both wars ended. Military spending had to decrease. This was fixed by going to war in Iraq with Gulf War I. We won that one, too. Only the following recession hammered the US pretty severely considering that we won. This was a warning that our accumulating war debts in the past were catching up. Bush Sr. claimed the war cost us nothing since the Arab oil rulers paid for all of it. Still, government spending went up so the debts continued to climb.
Then 9/11 struck right when the stock market bubble from easy lending in Japan, hammered our economy. We lost that war and the wars we started in retaliation, we are losing. We are now entering a 40 year down cycle. During this period, we can't get out from under past war spending except by debasing the currency. This, in turn, is a huge asset destroyer. It eats off of savings of any sort. The last struggles of the US to INCREASE our obligations, is doomed to failure.
Say, we keep dropping interest rates to 0% like Japan. We can't do this and keep our wealth since the only way this works is to debase the currency. So even if it looks like we are 'gaining ground' in that we have an 'economy', it will be, as Fekete so carefully explains, all fake. And it will actively destroy wealth like acid eating marble. This cheap credit is counter-intuitive. We say, 'So long as the Bank of Japan lends to us, so long as the Chinese hold our dollars in their FOREX reserves and buy our bonds, so long as offshore investment banks set up to evade taxes buy our bonds and Treasuries, we can spend in the red.'
Note who is supporting this debt: people who are not good for us. When the citizens are tapped to pay for war debts, the destruction of wealth still is building a future base. The holders of this debt are SAVERS. And also SAVIORS. The wealth they accumulate re-enters the system and wealth that was tied up in this time-frame reenters the economy but NOT ALL AT ONCE. Time is important. Time is money. The US, by flooding the markets with free Funny Money™ this year, encouraged lending....based on bad money! Not savings. Since not a soul was saving anything especially our businesses, the government and the entire populace, the present lending going on is TWICE as evil as normal. For it has no savings at the base! It is all lending being used to lend!
Impossible in the long run. Perhaps, in the short run, too.
Japan and Germany both recovered from WWII so rapidly because, unlike England, France and the US, they didn't fight either the Cold War or any hot wars since. Japan is mired in a domestic depression but NOT an international depression. In this regard, they went from destroyed nation to the world's #1 or #2 export power. And not exporting commodities. Exporting value-added industrial output. Germany is Japan's closest rival for the #1 spot with China closing in. And China has not fought a hot war since the Vietnam border war back in the late 1970's. China's military forces are purely for domestic use so they are not destroying the wealth of the nation.
The US patrols the planet and now has four navies! All of which are total red ink. We have expanded our foreign bases even as our economic condition worsens. So whatever system we use for accounting purposes, whatever the interest rate we use, whatever schemes we cook up to run things for some more time, the worse our FUTURE condition. NONE of this will help us at all. ALL of this will prolong our recovery time. Every hour we go deeper into debt and this means it takes another hour to clear the books in the future.
Superficial thinking may suggest that if the rise of interest rates is bad, then their fall is good for the economy. Not so. A falling rate is even more damaging than a rising one. I am aware that my thesis is highly counter-intuitive. I have been challenged by many other economists who deny the validity of my contention. They argue that if the present value of future income is lower when discounted at a higher rate, then it must be higher when discounted at a lower rate of interest. We may admit that this statement is true. However, obviously, the firm has to be around to collect the higher income. Many of them won’t be, as they succumb to capital squeeze caused by falling rates. My critics hold that falling rates are always beneficial to business and it is preposterous to suggest that they aggravate deflation. These critics confuse a falling structure of interest rates with a low structure. While the latter is beneficial, the former is lethal to producers. When interest rates are falling, the low rates of today will look like high rates tomorrow. A prolonged fall creates a permanently high interest-rate environment. This paradox explains the reluctance of the mind to admit that falling rates spell deflation and, in an acute case, depression.
Thank you, dear doctor. You are correct. There are several reasons why Feteke is correct: when viewing money creation powers, we must never forget the nature of the Cave of Death. For it is, by definition, the place where all things are widdershins, reversed, counter-intuitive. A wise person, when in this dire place, has to keep their head and realize what looks good may be very evil. What looks good to eat is poison. The beautiful apple presented to the hidden Princess is really a poisoned apple from the Evil Queen who wants to kill her. What looks like a savior is really a pirate out to steal everything. I have crunched the numbers over and over again and concluded some time ago, low to 0% interest rates are PURE POISON. For the people offered this can take on INFINITE amounts of debt, especially, as Fekete points out in his fine article, if this debt is never paid off but is rolled over and over into the future!
The horrors of the 0% interest rate/0%principal payment/0% down regime is the COMPLETE destruction of ALL wealth! This includes gold. In this terrible world, roaming bands of mercenaries, barbarians and looters use the oldest wealth-creation tools, weapons, to gain profits. Palaces are burned. Cities laid to waste. Livestock slaughtered, people murdered in their beds. History is totally adamant about this. But if you ask people if they would want this 0%/0%0% regime they react with joy. The desire for this is overwhelming.
This is why the gold basis for lending is a fine bar: it prevents the temptation. Except when government override this during wars. Which is why wars are in the end, destructive. Now to go to today's news [sorry about all the long postings here!]:
It was Robert Rubin, special economic assistant to Clinton and later Treasury secretary, who worked out what has come to be known as Rubinomics, the strategy of dollar hegemony through the promotion of unregulated globalization of financial markets based on a fiat dollar that also forced deregulation on the US financial market. (See US dollar hegemony has got to go, Asia Times Online, April 11, 2002.)
The argument that financial market regulation would reduce US competitiveness because it would force US financial institutions to relocate overseas had assumed an air of immaculate logic in the ideological context of neo-liberal globalization during the Clinton years. That neo-liberal mentality set the stage for US government abdication of regulatory responsibility over the financial sector and allowed the free market to move towards the inescapable path of eventual self-destruction, despite historical experience of the Roaring Twenties and the New Deal having shown the need for regulation to rein in the suicidal excesses of financial free markets.
The neo-liberal strategy was set in motion with the help of an ever-accommodating Federal Reserve to supply more liquidity to foil even the slightest stock market correction on what Fed chairman Alan Greenspan observed as "irrational exuberance". Since for almost two decades the finance sector had grown faster than the real economy, most of the excess liquidity injected by the Fed went to develop serial debt bubbles that simply got bigger and bigger each time through financial innovations.
Next to Fekete, Liu is a great writer who has a far-vision look at the daily news. The Asia Times is heads and shoulders above all the American financial media. They are talking, of course, to the nations that will be taking over the running of this planet in the near future. The oil pumping nations are getting richer, of course. But this is not going to last the century and it gives them little dynamic power like industrial power gives the West or Asia. Also, China is one of the few countries like Russia, the US and Brazil, which can suffer a war but not be run over thanks to sheer size.
The number of high-flying investment bankers moving from the US to Asia is set to increase, experts have said, as a result of the credit crunch. A senior Credit Suisse executive is the latest in a string of "dealmakers" to relocate from New York to Hong Kong. Big takeover deals are scarce in the US and Europe as the credit squeeze has made it hard for firms to source funds.
For 30 years, the US has confined most of the wealth destruction to the lower classes. Our inner cities mostly fell to ruin except for a very few, the ones which funneled Funny Money™ into the economy such as DC, NYC, Boston, LA, etc. The cities that funneled foreign goods into the nation as well as export items which in vain, sought to balance this flood, these places flourished too. But anyone visiting any of the manufacturing cities sees mostly ruins. The lower working class has coped with this destruction of their collective wealth by sending family members into the workforce and going into debt. At first, the cost of this was small. But over time, as debt climbs, they have been forced into longer and longer debt frames. Instead of paying off all debts by age 55 and then saving money rapidly until retirement, family debts have grown greatly and people reach retirement now, completely in debt with no possible way of paying this off, ever.
The primary benefit of securitization was the virtualization of the bank's balance sheet. Through securitization, banks were able to underwrite a vast amount of risk relative to their balance sheet capacity, by selling off the risk to the open markets. Despite this, banks have steadily increased the amount of risk kept on (and off, through SPEs) their books over the last 20 years, with a forced increase of this concentration in 2007 when the securitization market simply shut down - cutting off the liquidity spigot for these assets. Starting at about 2004 near the height of the securitization bubble , banks increased the pace of securitized asset retention.
At the same time the banks increased the pace of asset retention, the debt service ratio of the lending products backing the securities started climbing very quickly. Thus, not only were the banks increasing risk from a concentration perspective, they were increasing risk from a credit quality perspective simultaneously. This was all occurring during the near peak of a bubble. Unfortunately, for most of those involved in bubbles, it is nigh impossible to see the bubble until after it is too late! With debt service ratios so high, levels will trend down to the mean, either through increased income or decreased debts (charge offs).
Very good graphs here. This article details the ballooning debts in the US. This was directly due to the low interest easy lending put into motion by the Federal Reserve. Going back to Fekete's excellent article, the accounting used by the Fed to justify their cheap rates were all based on false premises. Just as they artificially jigger the consumer inflation statistics, they also ignore obvious red ink when figuring out how much our debts may grow.
By ignoring the huge, huge Federal debt, the huge budget deficits and the M3 statistics, the Fed could pretend there was no inflation and thus, they could EXPAND LENDING. Right when the US was overspending frantically, they decreed that the problems was LACK OF LOANS not OVERSPENDING. This decree was a blatant lie. Which is why I have been yelling myself hoarse for the last 40 years! We are digging our graves with cheap debts.
I proved in the past that debts grow whenever rates drop too low and savings grow when rates are high. Many economists and Americans absolutely hate and despise as well as fear Volcker because he drove down lending and upped savings for a key 5 year span. Following which, we enjoyed great wealth creation! What a shock! I remember that time well, I lived in a mansion and did very well indeed.
Money was no problem. Anyone holding the CDs and bonds at 18% were happy! The government had to retire debts because of the high rates made it hard to get loans. Once this was all paid off, the easy lending regime was reinstated. And the national debt which was only $1 trillion in Volcker's day has shot upwards to $10 trillion and climbing fast.
So what we need is a national recognition that we MUST pay off our debts before we can ask for more lending. This consensus has to cut across all lines: the government must stop deficit spending, the public must stop, and so must Wall Street. The rest of the world will hate this but we have no choice. Right now, we see a scramble for wealth even as it vanishes. There is NO system that can hide wealth from this process unless we re-establish savings again. The US is negative savings now and this is further proof the ability to take on more debt has reached its upper limit.
The downward spiral of a Citigroup Inc. hedge fund has caused steep losses for at least three large U.S. banks that hoped it would rev up returns on a controversial type of employee life insurance.
Besides triggering a lawsuit against an insurer and brokerage firm that arranged the hedge-fund investment for Fifth Third Bancorp, the losses may pressure Citigroup to give the banks some of their money back, as it has agreed to do for individual investors. Such a bailout would be costly, because the clobbered banks sank more than $1.6 billion into the hedge fund, according to the lawsuit and people familiar with the matter.
The problems stem from Citigroup's Falcon Strategies hedge fund, a fixed-income vehicle whose value has plunged more than 75%. Many of the fund's investors were retail clients at the New York financial giant's Smith Barney unit, including some who were told Falcon was a haven.
This is why I probably stand alone in saying, this harsh truth: THERE IS NO SAFE HAVEN. None. When the demonic forces of wealth destruction are unleashed, nothing is safe, anywhere. No matter how deep one buries one's wealth, it vanishes. History tells us this. Say, we park it in a castle. The castle will be stormed. Or protecting it costs so much, all the money is used for that purpose and you have to leave the castle and go to war, seeking loot. Constantinople shut up all its wealth at the capital city and put up huge walls. Yet it was looted twice: once, by allies, the second time, the Ottoman armies. The fall of the Eastern Empire of Rome lasted from 1,000 AD to 1450 AD. This was 450 years of decline. The balance was settled very quickly via the Ottoman looting. They began to rot in 1800 and the decline lasted for 150 years. The elements of the Ottoman Empire are now rising from the ashes very rapidly despite wars and chaos. Wealth creation is growing even as ours is declining.
The only real safe haven is to suffer the pains of destruction of debt and once this is done, there is a solid foundation for building wealth again. Canada, Mexico and the US are actually blessed places! We have many resources, good people. We can, in the long run, recover completely. But we have to change and we won't change if we can use debt to buy our way forwards in this insane red-ink style. So don't despair. The future can, if we refuse nuclear war, is actually not so terrible at all.
A normal U.S. economy is likely to look a lot different, and worse, after the credit crisis is over and financial markets settle down.
Companies will continue to struggle to raise cash for expansion and innovation as investors and lenders remain focused on conserving capital. Workers, too, may have less flexibility to go after new opportunities, because many will be stuck where they are -- in homes worth less than the balances on their mortgages.
``Once you've made terrible, overly optimistic errors, that paralyzes you for some time,'' says economist Paul Samuelson, a Nobel laureate.
See? The pros are all saying what I am explaining only a little less colorfully. Note that the economist gives no time frame. And neither does he explain that our problems are made much, much worse by our ongoing Cold War domination of the planet or our hot wars are destroying our wealth. McCain cheerfully talks about a 100 years war. Bush did this too. All the neocons like to talk about this 100 years war. This is pure insanity. The Democrats vote money without question for these wars. No one seems very interested in drawing up a graph showing how we will pay for this 100 years of wars by 100 years of complete destruction of our wealth!
The credit crunch is continuing and it is not evident that the worst is over, the head of the European Central Bank has told the BBC.Jean-Claude Trichet said we were seeing "an ongoing, very serious market correction," during an interview with the BBC business editor Robert Peston. He warned that if central banks were tempted to cut interest rates now, more serious problems could follow.
Note the word 'correction'. HAHAHA. See? We are CORRECTING and ERROR. The over lending was wrong. It was naughty. It caused the forces, the denizens of the Outer Darkness to begin eating our wealth we got from the Caves of Death. By increasing our deadly penetration in this cave, we will not get richer, we will become poorer over time. We have been warned and have time to CORRECT OUR COURSE. We can leave this cave and go out into the real world and work and regain our wealth through the sweat of our brows. This is what works. This is what always works.
The gears of the mortgage market are starting to unlock for borrowers needing big loans. In expensive markets such as Washington, that covers most people looking to refinance or move up from an entry-level home.
Just in the past two weeks, interest rates on the new "conforming jumbo" mortgages -- for amounts between $417,000 and $729,750 -- have come down enough to make a difference to borrowers. And mortgages allowing down payments of just 3 to 5 percent are coming back to the market for borrowers who have good credit.
And look at the solutions! ARGH. People who can't afford the ludicrous prices for assets will be allowed to break the rules and not put down any money for these things. Then they will get 97% financing which they promise to pay in the future. Well, if they can't save even a few dollars, how on earth can they promise to pay back? And if the price drops, the bank won't make back the money lent. It will be out there in the form of inflation. Unfortunately, this is due to the government making it possible for people with no savings to live in nice houses while savers scrimp and sweat to put aside money. Which is destroyed by inflation caused by too much easy lending at 3% down/3% loans/30 years to pay. Hell, 50 years to pay! Indeed, the horror of all this is obvious: the vast majority of homes to go into receivership are ones bought just in the last 2 years at these very rates! Or worse, the homes bought on loans that NEVER paid off the principal.
So, rather than correct our course, we are going more and more off course. The government is bent on making lending as easy as possible even as it is going under due to too much debt. Russia knows what will happen next. History is crystal clear, what will happen next.