The Automatic Earth Gets It

In a post entitled "Bill Gross, Master of Monetary Psy-Ops," the Automatic Earth lays it out for all to see:

The systemic fear generated from crumbling markets worldwide will first serve to attract scared capital into the Treasury market, as it still remains the only place to go for people with sums of money that won't fit under any mattress. Besides, the only real difference between the U.S. dollar and short-term Treasury bills or notes is that the latter could potentially give you a fixed income over their duration. The fear will then serve to further justify Treasury asset purchase operations by the Fed, the ongoing sociopolitical destruction in the Middle East be damned. So how does Pimco and Bill Gross fit into all of these deceptive monetary tactics? Well, the fact that TRF currently holds a record 38% of its assets in dollar-denominated cash is a telling one. [5].

Every investor knows that the best and quickest way to make money is to own something that virtually no one else does, right before it gets hot and takes off towards the moon and the stars. An unexpected end to QE operations will send the dollar soaring, and as mentioned before, all asset markets plunging except for the U.S. Treasury market. Bill Gross may have dumped all of his Treasury exposure for now, but has any other major financial institution or money manager followed his suit? Has the Fed announced any plans to sell its Treasury holdings back into the primary or secondary markets?

Of course not. These institutions are not worried about rates surging outside of their control anytime soon, and will be glad to make a few extra bucks from higher interest payments (paid by taxpayers) before the "rush to safety" really gets underway. I suspect that, by that time, there would have been a significant reversal in the Treasury holdings of TRF and the superficial justifications for the investment decisions of the omniscient Bill Gross. Perhaps he will continue to have minimal exposure to U.S. Treasuries throughout the year, as a partial hedge to his fund's enormous cash holdings, but that certainly should not be taken as an absolute bet against the Treasury market.

We're nowhere near the endgame.  There is no checkmate in sight.  This is managed deflation, with the Fed and its minions acting out a play to manipulate the emotions that the "investing" public believes to be market signals.  The rules of investing were written by the financial elites to fleece everyone else. 

And the fleecing won't stop until everybody stops playing the game.

Charles Hugh Smith Is On a Roll!

CHS says "You Want Inflation?  Here's How to Get It."

In the very first line, he gets it:

Rising prices driven by speculation is not the same as organic inflation, and diverting national income to the banks will not create organic inflation.

He goes slightly off-course when he accepts the Federal Reserve's stated goal of creating "modest inflation" as its actual goal (which I think is to induce a political crisis in the U.S. in response to the 1970s-style stagflation that the Fed is purposefully fostering), but I can forgive him for that.  Skipping to the end:

The Fed's policies cannot create organic inflation, because all the Fed is doing is transferring wealth to the nation's Elites. Their spending on luxuries and fine dining are not broadbased enough to generate organic inflation in the entire economy.

Borrowing money does not drive organic inflation: higher incomes and free cash drive organic inflation. If you want inflation, then you have to increase the incomes and assets of 60% of the households, not just the top sliver who own most of the financial assets.

Unlike most other Austrian-inspired people, Smith is taking care to use the term "inflation" as it is actually defined by the Austrian school, which is in terms of the quantity theory of money, which conveniently lays the blame for inflation at the feet of labor for demanding and getting higher wages.  "Silly wage slave, if you demand higher wages, I'll just have to raise the prices you pay for stuff."

One thing that Smith has done that I think works well is to embrace the misuse of the term inflation and relable it as "speculative inflation" so it can be compared and contrasted to correct usage of the term in economics according to the quantity theory of money, now relabeled "organic inflation."  As much as I demand and appreciate this kind of rigorous thinking, I do so in part because it calls the quantity theory of money into question.

Remember that Chicago neoliberals blamed rising labor wages for the stagflation of the 1970s.  If what we have today is the same as the stagflation of the 1970s (I think it is), and what we have is being caused by financial speculators, shouldn't we revisit the 1970s and reassess what caused the stagflation in the 1970s?  When you do, you'll see that financial speculation caused that, too, and when you dig a little deeper, you'll see that the quantity theory of money entirely fails to explain inflation.  Inflation is, always and everywhere, caused by financial speculators.

Two Views of The Role of Speculation In Creating Food Price Inflation

Predictably, Krugman says "nothing to see here; move along."

Dylan Ratigan begs to differ:

Visit msnbc.com for breaking news, world news, and news about the economy

You can see the same video at zerohedge along with Tyler Durden's commentary.

At the beginning of the video, Ratigan features Ben Bernanke's response to the accusation that the Fed's QE2 policy is driving food price inflation, which Bernanke scoffs at in response. 

I think Krugman's piece was, in fact, a defense of Bernanke's position.  While I actually agree that QE2 is not the direct cause of the clear and rampant speculation in staple commodities, I cannot agree with Krugman that such speculation is not, in fact, happening, that the increase in food prices is actually due to organic supply and demand. 

QE2 is not the proximate cause of what is currently happening to in the commodity markets.  First, QE2 is really just another way of shoring up the banks' balance sheets (something else Krugman denies).  It just doesn't require the American people to borrow the bailout money from the banks and pay them back interest on the money we give them.  Second, QE2 just isn't large enough to explain what is happening in the commodity markets.

That being said, leveraged speculation IS the proximate cause of what is currently happening in the commodity markets.  The problem with the analyses of both Krugman and Ratigan is that they do not consider the amount of existing money that is pouring into the commodity markets seeking yield.  The equity markets are a total joke.  They're completely simulated by robot traders, who currently account for 50-70% of all trades on a daily basis, and they're exhibiting very low trading volume and no trend whatsoever (a big reason why a lot of hedge funds are getting out of the game).  QE2 intentionally took the bond markets off the table.  The real estate market continues to slide, and we're only at the beginning of what will be an ugly commerical real estate market.

All this leaves the commodity markets as the only game in town, and it is a game easily rigged because it influences the availability of real-world supplies of materials.

Rethinking the Function of Taxation

I've come to the realization that taxation determines whether an economy is capitalist or financialist.  Let me explain what I mean and the implications of viewing the world this way.

In a prior post, I stated:

The focus of this "checkpoint" post is tax policy, which many claim redistributes wealth. This is incorrect. Tax policy, against the broader background established by monetary, fiscal and industrial policies, does not so much affect one's wealth as how one's wealth is distributed among wages, entrepeneurship and rent-seeking.

I've emphasized "wages, enterpeneurship and rent-seeking" because implicit in this statement is the classical economic triumverate of labor, capital and rents, which I think (mostly) accurately describe what one would find in a capitalist economy.  There is a trick here, however, and that is the composition of "rents." 

Classical economics was developed at a time when both land rents and pure financial speculation existed.  Since both rents and the gains from speculation are "money from nothing," I have to believe that speculative gains (which I will call "winnings" from here on at)  were folded into the conception of rents as used by classical economists.  I'm sure that I could quickly confirm my intuition, but it is a secondary issue.  I understand from, oddly enough, an amazon.com reviewer, that Adam Smith viewed speculators as a particular problem and even made recommendations similar to mine that money should not be lent to them for the purposes of speculation (I'll have to read the pages the reviewer identifies from Wealth of Nations). 

It may well be that classical economics was developed to paper over the dangers of speculative bubbles due to debt-financed asset speculation, which Smith (apparently) clearly identified and discussed in 1776.  Perhaps one way to think about things is that Smith viewed the economy was in terms of labor, capital, rents and winnings, and the classical economists came along and "disappeared" winnings into rents, just as neoclassical economists came along and disappeared rents (including winnings) into capital, just as neoliberal economists through direct financialization of the real economy have disappeared labor into capital, thus abstracting the real economy away entirely.

Regardless whether this theory actually pans out, I feel compelled to consider the real economy in terms of four factors, not three: labor, capital, rents and winnings.

Our current tax system is heavily skewed in favor of rents and winnings and against labor and capital.  Although speculation in the secondary markets is not considered an investment in productive capital for GDP purposes, the tax code treats winnings from longer-term speculative trades as "capital gains."  Similarly, our tax code encourages the destruction of domestic capital and investing in foreign capital by allowing domestic corporations to shield profits made and sold entirely offshore from taxation.  The destruction of domestic capital is commonly known as offshoring jobs because that is the immediate effect on workers (and it plays well in the news), but I think the destruction of capital is the real harm because productive capacity that potentially spans decades is lost.

The current tax system was put in place piece by piece since the days of Ronald Reagan (with some foundational acts by Nixon and Carter).  Another important change was the shift in 1975 to targeting monetary aggregates, which is best viewed as form of inflation targeting.  At the time, stagflation had set in, and monetarists like Milton Friedmand and Paul Volker were complaining that the Fed only focused on managing interest rates and not on the true cause of inflation, i.e., an increasing money supply (specifically, I believe, M0 and M1).  If we apply the key insight of Prospect Theory, which is that loss aversion dominates economic decision-making, and it is easy to see how inflation-targeting results in a strong (if not manic) desire by those who have accumulated wealth to put there money into something that GUARANTEES a return greater than that of constantly compounding rates of inflation. 

Did you catch that?  Inflation-targeting creates a strong demand for "investments" that perpetually and exponetially grow faster than inflation.  (FYI - to make my life easier, I'm going to assign the acronym "PEG" concept of perpetual exponetial growth.)  The result has been a categorical shift away from capitalism and towards financialism as the tax system was skewed to clear the way to meet the demand for PEG investments. 

This suggests that to shift back to capitalism from financialism requires (1) removing the artificial demand for PEG returns on existing wealth caused by inflation targeting  and (2) adjusting tax policy to encourage investment in capital and discouraging speculation.

The first point deals more with monetary policy, which I have not thought through yet within the context of financialism and will save for another time.

Regarding the second point, it makes some sense to start with Henry George.  Henry George proposed his Single Tax as a way of preventing land speculation and doing away with land rents in one fell swoop.  The problem with attempting to apply George's solution today is that, with financialization, pretty much all asset classes have become prone to speculation, relegating land speculation to a bit player.  Indeed, when you consider that the housing bubble was driven by speculation in the derivatives market, we've reached a point where the real economy dog is being wagged by the financialist tail.

Given the ability of financial speculators to innovate around laws and regulations (i.e., cheat), I think it makes sense to apply different tax rates based on the type of income (returns on capital, wages from labor, rents and winnings), with capital income (including dividends) being taxed the least (perhaps even not at all), wage income being taxed modestly more (and most likely less than they are today), rents being taxed moderately more, and winnings being taxed out the wazoo.   

Goodbye debt-financed asset speculation.  Goodbye destruction of domestic capital and job offshoring.  Goodbye average people complaining about income taxes (and thus being coopted to vote against their own best interests).  Goodbye banksters. 

Hello domestic capital investment.  Hello full employment.  Hello American capitalism.

I definintely need to put more thought into this, but I wanted to put a stake in the ground.  I suspect that CAPM itself provides the basis for constructing tax and monetary policy so as to render CAPM inoperative and unattractive.  One key thing to do is use tax and monetary policy to twist the dials of the Miller and Modigliani equations to make it clear that actual investment provides a far better return than speculation.

Economic Theory Is a Pathological Lie Carefully Constructed to Normalize Evil

Earlier today I was pushed by a regular correspondent and reader of my blog to explain my position regarding malinvestment more fully.  I always appreciate this person's insights and probing, and this time it is no different.

From the first e-mail:

You have written a few times, regarding malinvestment. From its common usage, I think malinvestment is thought to mean investment outside a competitive dynamic, where price discovery should be allowed to match supply with demand and malinvestment inhibits that process.

I incorporated my initial response as the update to this post from earlier today.  This prompted another email asking for further clarification and providing what I think is fair (and constructive) criticism.  Here are the two most important paragraphs, which have prompted this more open discussion:

If inclined, you might consider a post, with strong references, supporting your claim, the contents in the last email. This has been a central tenet of yours, I have noticed. Before, I was not sure how to understand it, because of the use of "malinvestment" throws a monkey-wrench into the equation, for me. You should understand that this view and some (some) of your views, although nuanced, complex and perhaps correct, I believe, are somewhat esoteric, eclectic, if not inaccessible or technical.

. . .

Your email reply, as it is written is clear. It is just the thesis is unusual. Perhaps that is what you might think legitimizes the position. However, without context or without some corroborating analysis, its form is un-integrable, I believe; or, it has a myriad of problems for various people.

I think the title of this post nicely brings my thesis "right down to earth in a language that everybody here can easily understand," as Malcom X once said. 

A Quick Disclaimer

Before I get rolling, I want to make clear that I don't believe that economic theory must always be a pathological lie.  I believe it is possible, in theory, to develop a mathematical model that accurately reflects how the economy really works.  Indeed, some have argued that people like John Maynard Keynes and Hyman Minsky have already done so, and Steve Keen and other Post Keynesians continue to build on their work, the bulk of which has been ignored by the Chicago and Austrian schools, among others.

Unfortunately, as a practical matter, I believe it is impossible to overcome the underlying political nature of economics (which used to be called "political economics") and the interests that economic discipline serves (i.e., the "rentiers" that were disappeared from economic discussion by the creation of neoclassical economics as an answer to Henry George's criticism of classical economics).  What history has shown us is that the fallacious mathematical models of economic theory are never replaced with accurate models.  At best, additional fallacious mathematical models of economic theory are layered onto the old ones, often while claiming that the new models incorporate the theory of a critic while not doing so at all (e.g., the so-called Keynesian-neoclassical synthesis and the later Neo-Keynesians and New Keynesianism).  At worst, criticism of the fallacious mathematical models of economic theory are used elsewhere in the socio-political arena to persuade the masses that the mathematical models are not, in fact, fallacious but sound (e.g., applying Gunnar Myrdall's insights to form neoliberal social institutions that turn citizens into sociopaths). ** Due to the political forces at work, economic theory will always be a set of  clothes tailored for a non-existent emperor. 

Explaining My Thesis By Breaking It Into Its Constituent Parts

Now, let's break the title of this post into its constituent parts:  economic theory is (1) a pathological lie (2) carefully constructed to normalize "evil."  As to the fallaciousness of mathematical models in economics, people like Steve Keen have done a great job of explaining how the math of orthodox (and related heterodox) economic theory doesn't work.  See here, here and here.  The first link is to a blog post that links to complete set of lectures and video/audio of a course he taught in behavioral finance.  Highly recommended.  The second link is to his book at mobi.com (superior PC-based reader to Kindle's), and the final link is to supplementary material for the book and includes additional lectures. 

Of course, the fact that the mathematical underpinnings of economic theory are provably false does not make economic theory a "pathological lie."  No, what does that is the fact that economists persist in perpetuating the falsehoods while knowing that they are, in fact, a falsehoods.  This one place where I break from Keen, who views his fellow economists' behavior as irrational and "mad", primarily because he incorrectly believes that his profession exists to explain the world as it really is when, in fact, it exists as a propaganda arm of rentier interests to rationalize their behavior as just the magical market doing its work.  In this sense, as I've noted elsewhere (and here, too, I believe), economics codifies-- in very different terms-- a modern version of feudalism's "divine right of kings": the wealthy are wealthy because the market chose them as winners.   The recasting of the divine right of kings in "free market" terms is particularly evident in Hayek's conception of the market, which forms the cornerstone of neoliberal economics and policy in both the Chicago and Austrian schools of economics.

If you can agree that the repetition of a known falsehood as the truth is, in fact, a lie, then I don't need to prove that the lie is, in fact, pathological.  Indeed, my assertion as a whole is that "economic theory is a pathological lie carefully constructed to normalize evil," but the definition of "pathological" implies that the lie is involuntary or compulsory.  The fact is that I chose the term "pathological" to refer to the effect of economic theory on society as a whole rather than to describe the mental state of economists and others who repeat the lie, many of whom do so earnestly and honestly.  As I've stated here and elsewhere, I believe a direct consequence of neoliberal economics and policy is a society of sociopaths, i.e., individuals without a conscience.  This was the entire point of mangling Smith's Invisible Hand.

Turning to the assertion that the pathological lie was carefully constructed to normalize evil, I have several posts that discuss the history of the neoliberal political movement, including who was behind it, how it was initially constructed and how it morphed over time.  Generally, you can find these posts by looking for the "Neoliberalism" label, but good examples can be found here, here and here.  You can also see Robert Vienneaus's thoughts on Milton Friedman, the Austrians, and some of the problems with certain aspects of economic theory.  Robert is a non-economist economist who earnestly and in his own way is marching on the same path as Steve Keen trying answer bad math with good math.  I cannot say that I agree with everything he says, but that's because I have not read everything he has said.  I believe he is a computer scientist by profession, which probably explains why he and I (trained in CS/EE) arrived at many of the same conclusions regarding neoliberal (like everybody else, he calls it neoclassical) economic theory.

I cannot expect anyone to merely accept my conclusion that economic theory is a purposeful lie, but I think a careful reading of history, on the one hand, and the huge known disparity between economic theory and the reality it supposedly describes will convince everyone of good conscience that this didn't happen by accident.  Neoclassical economics was created to avoid the valid criticisms of Henry George, who first identified debt-financed speculation as the true cause of industrial depressions in the late 19th century.  The neoclassical-Keynesian synthesis, New Keynesianism and Neo-Keynesianism all purported to adopt and follow Keynes when, in fact, all of them disappeared the part of Keynes' General Theory that would euthanize the debt-financed speculator (i.e., the "rentier").  Neoliberal Chicago School economics were on hand and at the ready to take over when "Keynesianism failed," as it did when, according to Hyman Minsky, debt-financed speculators created the "stagflation" phenomonen, something that had only been theorized by a Chicago School economist shortly before the theory, which made no sense on its face, became reality.  And then there's the Chicago School's theories of finance, the effect of which was to financialize the real economy in its entirety, allowing the debt-financed speculators to blow bubbles in all asset classes, not just in land, as was the case in Henry George's day.

My conclusions regarding the true nature and purpose of economic theory are based in part on my professional experience in negotiating complex and difficult deals, which often devolved into litigation.  These negotiations had an average duration of 18-24 months, typically involving a lot of travel and many meetings internally and with the other side.  In several cases, hundreds of millions of dollars were at stake.  One of the things the experience taught me was to pay careful attention to what the other side actually did and compare it to what they claimed they were going to do.  Trust but verify.  I discovered that whenever there was a significant difference between the two, the other side was lying.  Plain and simple.

Turning Back to the Correspondence that Prompted This Attempted Response.

Recapping:

You have written a few times, regarding malinvestment. From its common usage, I think malinvestment is thought to mean investment outside a competitive dynamic, where price discovery should be allowed to match supply with demand and malinvestment inhibits that process.

I've highlighted the phrase "competitive dynamic" because that's a term that applies to capitalism, but what we currently practice-- thanks to neoliberal economics and its neoclassical foundations-- is not capitalism but what I've started calling "financialism."  As I stated previously here:

If competition were good for the economy, we'd have it.  We don't.  The reality is that competition is BAD for a financialized economy because real competition disrupts the illusion of perpetual growth that makes the FIRE sector a lot of money.  J.P. Morgan realized in the late 19th century that competition is bad for business, if you're an investment banker.   Monopoly is a feature of neoliberal policy.

What did I mean by this?  As I explain here, although not in precisely the same terms, finance drives economic decisionmaking by firms because firms are managed to meet the expectations of CAPM financial models that express the stock price of a company in terms of its future cash flow according to its balance sheet.   That is, corporate executives don't manage their businesses to maximize profits, they manage their balance sheets to simulate a financial instrument that, on a quarterly basis, demonstrates an exponential and perpetual increase in value at a rate faster than inflation. Yet another way of putting it is that corporations are managed to maintain the illusion of a bond having infinite duration that perpetually compounds interest at a rate faster than the rate of inflation.  Why?  Because of the incentive structures provided to executives, CAPM is not merely descriptive but is actually normative.

Steve Keen's lectures on behavioral finance explain the economic hierarchy quite well: microeconomic theory supposedly models the behavior of consumers, individual firms and their respective aggregating industries; macroeconomic theory supposedly models how these various industries and consumers interact in the larger economy building, of course, on microeconomic foundations; and finance supposedly models the value of firms by building on macroeconomic foundations.  If microeconomic theory fails, so does the entire edifice of economics fails as the hierarchy is flattened down into finance.

As Keen discusses in the first few lectures of his course, a fundamental assumption of microeconomics is its theory of the firm in which every firm is managed to maximize profits.  As discussed above, this assumption is false.  (FYI -- Keen uses math to debunk the neoclassical theory of the firm, but his math starts from the same basic starting point as what he is debunking without recognizing that finance is normative).  

How did I reach the conclusion that finance drives corporate decision-making?  I used to be an executive at a public company, and there were several instances during my career working in corporations (starting with Intel) where I was struck by economic decisionmaking that was driven primarily by the balance sheet and not by actual cash flow (i.e., profit maximizeing) concerns.  At the time, I really did not understand why this was the case, but as I taught myself finance and valuation theory in order to contribute to discussions regarding M&A etc., I learned about the models that analysts used to estimate the value of our company.  Still, it took another year of studying economics (and the economic history of the United States) outside of the corporpate environment to understand the implications of CAPM on the real economy and on economic theory, as well.  If you understand net present valuation methodology, you'll quickly recognize that the rules of that methodology (e.g., the selection of the discount rate, growth assumptions, terminal value, etc.) ultimately express the value of the firm as bond of infinite duration that exponentially grows in value over time.  If you accept that providing executives incentive stock options and restricted shares aligns their interests with those of the shareholder, which is to have a financial asset that grows in value infinitely and perpetually at a rate greater than that of inflation, then you should have no problem in accepting my conclusion that financial theory is normative, not merely descriptive.  FYI -- I have recently discovered that there is some literature on this topic.

Recapping the follow-up correspondence:

If inclined, you might consider a post, with strong references, supporting your claim, the contents in the last email. This has been a central tenet of yours, I have noticed. Before, I was not sure how to understand it, because of the use of "malinvestment" throws a monkey-wrench into the equation, for me. You should understand that this view and some (some) of your views, although nuanced, complex and perhaps correct, I believe, are somewhat esoteric, eclectic, if not inaccessible or technical.

. . .

Your email reply, as it is written is clear. It is just the thesis is unusual. Perhaps that is what you might think legitimizes the position. However, without context or without some corroborating analysis, its form is un-integrable, I believe; or, it has a myriad of problems for various people.

I admit that my explanation of my thesis, which can be summarized into a pithy ad hominem attack on economic theory as a whole, is nevertheless difficult to explain without resorting to an explanation of concepts that are foreign to most people.  Here's the problem, and it's something that I learned a long time ago: the person who determines the starting assumptions of a debate usually wins the debate.  To start by assuming that economic theory is right and trying to explain why it is wrong is a losing proposition because economic theory is based on centuries of layered lies, and attacking all of the lies (as people like Keen tend to do) makes you look weak: if you had a killing blow, you'd deliver it and not seek the death of your foe by a thousand cuts. 

I think my insight about finance as normative can be developed into a killing blow, but it still needs further work to persuade the masses who are stuck with iconic words and useful fictions inflicted on them by neoliberal social institutions that sprang into existence to put the insights of the rival institutional economists and neutral cognitive scientists to work to their advantage (e.g., neoliberal think tanks construct their policy messaging by applying Kahneman's Prospect Theory, even as neoliberal economists construct their policy messaging by applying Benthamite Utility Theory; not surprisingly, both reach the same conclusion, even though Prospect Theory is based on empirical evidence that proves Utility Theory to be wrong).

In the meantime, I'll stand on my outright rejection of economic theory as politics, something that categorically cannot be integrated into people's current understanding of how the world works.  I fully understand how people are most persuaded by things that seem to confirm what they already know, but that's not the route I plan to take because cognitive biases tend to smudge important differences out of existence, much as an eraser smudges graphite off a sheet of paper.  Sometimes you need to challenge first, then engage.

Anyway, thanks go once again to my email buddy for prompting me to attempt to explain my thesis in one place, and apologies for probably failing in my first attempt.


**FYI -- I have a working theory that the Nobel Prize in Economics is awarded based primarily on the extent to which a recipient advances rentier interests in applying economics as a control mechanism over the masses, regardless of whether the recipient purposefully set out to do so.  Gunnar Myrdal (an institutional economist and critic of neoclassical theory) and Daniel Kahneman (a cognitive scientist whose Nobel prize-winning work forms the basis of behavioral economics) are two examples of unwitting participants.

"Complexity" and What It Means to What We Think We Know

This post is a placeholder/teaser for a more complete post that I plan to write up later.

We're taught to think of monetary policy, fiscal policy, industrial policy and tax policy as four completely different things.  In fact, they are each part of a complex political topography that manipulates the human nature of individuals to produce a collective result in the broader political economy.

The focus of this "checkpoint" post is tax policy, which many claim redistributes wealth.  This is incorrect.  Tax policy, against the broader background established by monetary, fiscal and industrial policies, does not so much affect one's wealth as how one's wealth is distributed among wages, entrepeneurship and rent-seeking. 

The current policy of relatively low tax rates for the highest wage earners and favorable capital gains treatment for financial speculation exaltts non-productive rent-seeking over true investment in the productive economy.  If the goal is to encourage investment in the real economy (domestic entrepeneurship), one way to do that is to discourage rent-seeking by providing relative incentives for investing in domestic businesses that create jobs in the United States, which would funnel unneeded earned income into productive businesses as opposed to non-productive financial speculation.  Both productive businesses and non-productive financial speculation throw off wealth, if managed properly (and losses, if not), so no wealth or opportunity is lost by choosing to invest in productive businesses over non-productive speculation.  Indeed, as we're learning with the continuing collapse of our debt-financed speculative economy, speculation is actually destructive in the long term.

The point is that we need to think of these various policies together and not in isolation.  I'd go further to say that we need to reconstruct these policies in parallel to provide the appropriate incentives for creating a self-sustaining political economy that is not subject to the boom-bust cycles caused by debt-financed speculation.

The Postcatastrophe Economy: A Summary

I recently finished reading Eric Janszen's The Postcatastrophy Economy: Rebuilding America and Avoiding the Next Bubble.

While I continue to believe that Janszen's book is the best I've read regarding the ongoing economic crisis, I find myself strangely disappointed.  The reason?  The book starts out amazingly strong, but it fails to carry the same levels of energy and clarity into the second half.  In fact, I'd argue that towards the end, Janszen undermines some the clarity of the first half of the book.  Nevertheless, as a whole, the book represents quite an achievement for an entrepeneur turned investment advisor. 

The book is divided into three sections.  First, he describes the FIRE (finance, insurance, real estate) economy that caused the current crisis.  Second, he describes his solution and alternative to the FIRE economy, which he calls the TECI (transportation, energy, communication, infrastructure).  Finally, he provides his "midterm macro forecast."

The first section, which spans a little over half the book, details the FIRE economy, how it operates, and how it led to the crisis that began in 2007 and continues today.  Janszen is clearly familiar with the economics of Michael Hudson, which form the foundation of Janszen's analysis of the FIRE economy, but Janszen extends Hudson's economic theories and synthesizes them into something that is far more accessible to the lay person than Hudson's original works.  He also introduces the interesting metric of "dollar-of-debt" per "dollar-of-GDP."

Things start to break down in the second section, which presents Janszen's vision of a solution to the FIRE economy, which I find compelling but not fully baked.  Janszen is clearly speaking from a position of legitimacy as a technology entrepeneur, and it is clear that his experience shades his judgment of what needs to be done.  This is when some of his blindspots become apparent.  First, his vision is one that caters to people like him, which is a common failing whenever somebody tries to plot a course for the future.  The good news is that his vision is complete enough that it can easily be extended to be more inclusive.  Second, while he understands the economics of the FIRE sector, it is not clear that he grasps how many of our laws, regulations and "rules of thumb" would have to fundamentally change in order to fully break free of the FIRE economy and the embrace the TECI economy.  This is not fatal to implementing his vision, it just means that this is a much larger undertaking than he realizes.  That's why I call his solution merely a vision of a solution.

Things almost fall apart in the final section, primarily because he puts on his investment advisor hat.  I'm not saying that his predictions about things like "peak cheap oil" or gold will prove wrong.  What I'm saying is that, in spite of his understanding of the FIRE sector, he does not seem to truly he understand that he is actually a "speculation advisor" not an investment advisor, and in that role he actually perpetuates the financialization of the real economy by the FIRE sector.  When he cannot see his role in perpetuating the FIRE economy, how can he be correct that the FIRE economy is already over?  Answer: he can't be.

At the end of the day, I do not believe these relatively minor flaws detract from the genius of the book, which is found in the first two sections.  Janszen probably felt it necessary to tack on the third section to treat the preparation of the book as a business expense (advertising), and some people will find the third section alone justifies buying the book.

Shorter Milton Friedman: "Never Mind the Man Behind the Curtain"

Milton Friedman often said: "inflation is always and everywhere a monetary phenomenon."

Except when it isn't, which is never.

Speculation in commodities can and does cause inflation without an increase in money supply (i.e., a monetary phenomenon).  It did so in the 1870s, the 1900s, the 1920s, the 1970s, and it does so now.

If you compare the change in commodity prices year to date versus the change in the dollar's value compared to the Euro, you'll find something remarkable.  Using copper as an example, both the value of copper (in dollar terms) and the value of the dollar (in Euro terms) are up since the beginning of the year, but the value of copper is up by A LOT more.  According to Uncle Miltie, this isn't supposed to happen.  Commodity prices and the value of money are supposed to move inversely to one another, not together, and not in a manner that commodity prices move in the same direction as the value of a dollar but as a multiple of it.

I've seen some data from Karl Denninger that suggests the same thing is true in agricultural commodities, and if it isn't it soon will be.  The FIRE sector is a parasite on the productive sector, and their rent-seeking in consumer staples is going to cause a lot of pain and probably a few deaths.

'Nuff said.

Neoclassical Economics Are to Henry George What Neoliberal Economics are to John Maynard Keynes

I recently learnd about Henry George, a 19th century thinker who figured out in the 1870s that the boom-bust cycle is caused by debt-financed speculation and rent seeking.  At the time, he limited his conclusion to debt-financed land speculation, but that's because the secondary equity and bond markets weren't nearly as established in the 1870s as they were in 1907 and later in 1929.  (Note: there are a number of 19th century investing texts available at Google Books, and they show that the stock exchanges even in the 1890s were nowhere near what they became by the 1920s.  Take a look around there, you'll find it fascinating.)

As Keynes would later do, George proposed his own solution for euthanizing the rentier, which he called the "Single Tax."  (My understanding of George's proposal are admittedly cursory, so I'm not going to try to explain them in any kind of detail.)

The response by the rentiers was to fund political economists to develop a new doctrine of political economy, and neoclassical economics was born (at least, this is what Mr. George believed motivated the establishment of this new doctrine).

The key feature of neoclassical economics was that it treated land as capital.  According to the classical economics of Smith, Ricardo, Say et al., there were three players in (or drivers of) the economy: labor, land and capital.  Essentially, George's Single Tax sought to tax land rents out of existence to leave only labor and capital standing.  The neoclassical economists obliged George by "disappearing" land from their lexicon and treating it merely as another form of capital.

Neoclassical economics came to dominate the scene, and George's Single Tax proposal ultimately went nowhere.

Then we had the Great Depression, and John Maynard Keynes offered his own solution to the rentier problem (although he was politic enough to not explicitly assign blame for the Great Depression to the financial speculators). 

The first step in undermining Keynes was the so-called "neoclassical synthesis," that grafted some of Keynes' ideas onto neoclassical doctrine.

The second step in undermining Keynes was to repeat what had been done to Henry George: the rentiers funded the founding of the neoliberal movement and its economics in the Chicago and Austrian schools. 

Today's "neoclassical" orthodoxy is, in fact, the Chicago School, which is distinctly neoliberal.  Thus, as much as Steve Keen still labels the orthodoxy neoclassical, it is more appropriate to label it neoliberal.

Where neoclassical economics whittled the economic drivers from three (labor, land and capital) to two (labor and capital), neoliberal economics left us with only capital.  There is no labor any longer.  There are only consumers.  And the rentier segment of capital is the only part of it that continues to grow.

I'll Take Stagflation for $100, er $150, er $200, er . . .

With the Federal Reserve maintaining its zero interest rate policy (ZIRP) and promising more quantitative easing (QE), I'm beginning to fear that we will see stagflation in the United States over the next several years.  Here's why.

The Fed has proven that the combination of ZIRP and QE can't spur borrowing by an already overleveraged consumer.  The housing market is dead, and the foreclosure mess is likely keep it dead for awhile longer.  And it's not like there are any jobs out there, and there's a downward pressure on wages, so we won't be seeing price inflation due to wage inflation.

This puts the Fed into quite a pinch.  It can't rely on the consumer increasing demand for either goods or debt, so there's no inflation to be found there.  Non-financial businesses aren't borrowing, either, certainly not at their traditional levels (yes, there was an increase in borrowing by the non-financial business sector in the last two quarters, but the increase was paltry and nowhere near normal).  So, no inflation there, either.  And financial businesses have been leading the way in deleveraging.

The banks are in their own pickle.  They need to rollover debt by getting new borrowing ASAP.  In spite of the continuous backdoor bailouts (e.g., getting paid 3% to hole onto reserves) and "record" profits, some of them have already frozen hiring and are signalling that there may be layoffs.

If only there were a way for the banks to help themselves and the Fed.  But wait, there is! Debt-financed speculation in the commodity markets would be a perfect solution!  The banks get to extend new debt to financial speculators, who use the leverage to drive up the prices of consumer staples like sugar, wheat and corn, and industrial metals like copper, gold and aluminum.  Voila!  You have rolled over debt, created inflation for consumers and industry, and you get to make a tidy profit, all in one fell swoop.

Increased speculation in commodities has already driven their prices up by a multiple of 1.5-2x compared to the drop in the value of the dollar, while stock prices have pretty much gone up by as much as the dollar has gone down.

The only question is whether this is a temporary aberration or the new normal.  Given the greed of the FIRE sector, I'm betting that this is the new normal, that the financial speculators are going to ravage our economy just as they did in the 1970s.  Things will play out differently, however, in part because we no longer have a vibrant manufacturing sector, and in part because various laws and regulations shape the decisionmaking in a different way than it was done in the 70s.  I need to put some more thought into how things play out.

Public Company M&A: Good for Wall Street, Bad for the Real Economy

There has beeen a spate of mergers and acquisitions among publicly traded companies, including some apparently puzzling moves by Intel and others. 

Today's announcement of Southwest Airlines' proposed acquisition of AirTran Airways provides an excellent opportunity to discuss why such acqusitions are actually a bad thing for the economy.  Although this particular deal, which looks like a relative bargain for Southwest in view of the fact that AirTran has one quarter the top line revenue and the same net income after taxes, does not seem to have the hallmarks of "stupid accounting tricks" (i.e., cost arbitrage through accounting rules) that provide the illusion of increasing shareholder value, the deal is a horizontal combination that will clearly reduce competition and lead to increased costs for consumers while shedding jobs due to "consolidation."

While we're at it, we might as well discuss other attempts to prove shareholder value, such as MSFT's recent move to borrow money to pay dividends in order to avoid paying taxes on repatriated funds.

The fact is that corporate behavior is being shaped by tax laws and accounting rules, and the Obama administration really needs to think about ways to at least temporarily change that behavior to revitalize the economy.

Anyway, I plan to update this post today or tomorrow to flesh out the discussion.

There Is More Household Deleveraging Than the Data Show

As I suspected, the banksters are not writing off what appear to be worthless second mortgages and home equity lines of credit. 

For example, the top four banks (BofA, Citi, JPM and Wells Fargo) hold at least $423 billion in home equity loans, and over a third of that amount is for homes that are either worth less than the first mortgage or close to it (i.e., there's no hope of getting any money out of foreclosure, and the likelihood that people defaulting will be able to pay the difference).  Given the amount of leverage that the financial sector created in the derivatives market off of mortgage debt, if they were to write off that $150 billion in second mortgages, it could easily translate into write-offs of financial sector debt on the order of $1 trillion or more.

Check out this post from Larry Doyle of Sense on Cents for the details.

Income Inequality: A Necessary But Insufficient Condition for Financial Instability

Recently, a lot of people (including the IMF) have been looking to income inequality as a potential cause of the current economic situation.  There are certainly a lot of data that indicate a correlation between periods of severe income inequality and financial crises.

While income inequality certainly played a roll in the recent credit crisis, financial speculation caused it. What income inequality did was (1) increase demand for household debt for those in the lower 90% of household incomes and (2) increase demand for financial speculation for those in the top 10% of household incomes.

When income and specifically wages are spread more evenly across all income levels, more people are able to accumulate savings and, therefore, are able to avoid incurring debt.  On the other hand, fewer people accumulate savings of sufficient size that they are willing to risk some or all of their savings by engaging in financial speculation.

When income inequality is as high as it is now, it aligns the interests of both the savers and the non-savers with those of the financial sector.  The non-savers in the bottom 90% of households earn 65% of the wages, which provides a diversified base across which to extend credit at the highest rates possible (the top decile won't pay a premium for access to credit).  On the other hand, the top 10% are confronted with the possibility that their savings are a wasting asset in face of potential inflation.  As we know from Prospect Theory, losses "loom larger" than gains, and inflation is perceived as a certain loss, so "putting your money to work" making more money is a no-brainer.  Add to the mix things like hedge, which can make outsized gains due to leverage, and it is very easy for a high net-worth individual to be enticed to participate in financial speculation (which he has been taught to think of as just a higher risk form of "investing"). 

Things got really dangerous when asset-backed derivatives coupled the increased debt of the bottom 90% of households to the financial speculation of the top 10% of households and the financial sector.  Ever increasing savings increased the demand for asset-backed derivatives, which increased the demand for new borrowers, which further incrased savings, and so on.

The primary reason that I think we need to consider finance (or speculators) as separate and distinct from capital and labor in economics is that finance's interests compete with both capital (who must choose between investing capital in increasing productive output and speculation) and labor (whose stagnant wages encourage taking on an increasing debt burden to maintain the illusion of making progress).  Because finance ostensibly serves both capital (through investment banking) and labor (through commercial banking), they bridge the gap and provide a feedback loop that can potentially be self-reinforcing, particularly as demand for financial speculation becomes large enough due to the increased concentration of wealth in a small portion of households.  Classifying finance as part of either capital or labor prevents its influence on the economy from being adequately understood (all we can understand now are aggregates of debt and income after the fact).

Financial Speculators Caused the Housing Bubble, Not Policy

One of the primary reasons for recognizing financial speculators as a primary (and currently dominant) force in our economy is to put an end to inane discussions of how bad things mysteriously happen due to "policy" (e.g., monetary policy).  As long as we pretend that financial speculators are affected by things like monetary policy (which history shows they aren't), we won't be able to develop methods for directly measuring and, therefore, understanding, the real effects of speculation on the economy.  Many of the convenient duologies of economics need to be replaced with trilogies (e.g., supply and demand becomes supply, demand and speculation; capital and labor becomes capital, labor and speculation; etc.)

Policy may have created the housing bubble, but which policy is to blame?

There is little dispute that misguided policy choices led to the housing boom-bust cycle from which we are still recovering. The debate about which policies were most culpable, however, rages on. The latest chapter in this dispute is now available in the proceedings from this year's edition of the Kansas City Fed's Jackson Hole Economic Policy Symposium.
In defense of monetary policy, Charles Bean, Matthias Paustian, Adrian Penalver, and Tim Taylor—all of the Bank of England—write this:

"We argue that while relatively low policy rates compared to past experience contributed to the growth in credit and the rise in house prices in the run-up to the crisis, they played only a modest direct role."

Stanford University's John Taylor (still) isn't buying it:

"Their conclusion differs from mine for several reasons. First, they do not take account of much empirical work completed since the 2007 Jackson Hole conference. For example, Jarocinski and Smets (2008) of the European Central Bank estimated a VAR [vector autoregression] for the United States and found evidence that 'monetary policy has significant effects on housing investment and house prices and that easy monetary policy designed to stave off perceived risks of deflation in 2002-04 has contributed to the boom in the housing market in 2004 and 2005.' In a more recent study focusing directly on deviations from policy rules, Kahn (2010) of the Federal Reserve Bank of Kansas City finds that ‘When the Taylor rule deviations are excluded from the forecasting equation, the bubble in housing prices looks more like a bump.' "

I added the links to the papers cited by Taylor because they are thoughtful challenges by thoughtful people, and they deserve to be considered (though the Jaroconski and Smets article requires some tolerance of relatively sophisticated econometrics). That insightfulness, of course, does not mean they are completely persuasive; I still have my doubts.

Shorter Rebuke: Don't Hate the Playa'

What the financial sector did by peddling derivatives based on sub-prime and alt-A loans was bet big on a perennially losing team to win.  To blame the team that everybody expected to lose for not winning is nonsense. 

The financial sector, through its debt-financed speculation, has been driving the economy for decades, and there is nobody else to blame but the financial sector for the financial crisis and the current economic situation.

Unless and until the economics profession comes to grips with the effect of debt-financed financial speculation on the economy, it will remain useless as anything other than a propaganda tool.  Of course, until we start tracking granular data regarding debt, how it is allocated and for what purpose, the economics profession won't be able to rise to my challenge.

Rebuking Economics: The Clothes Have No Emperor

Economics is often called the dismal science, but it is, in fact, a spectacularly brilliant and methodical lie.  Tailored to fit a reality that does not exist, economics nevertheless manages consistently to point the finger of blame at the ordinary citizen (now the “consumer” in America) whenever a completely foreseeable “unforeseeable” economic disaster occurs.  But the consumer is no more sovereign in economics than he in business.  While consumer sovereignty in business has been called a form of “innocent fraud,” consumer sovereignty in orthodox economics cannot be:  fraud, yes; innocent, no.  The cloth of economics has been carefully spun to fit a straw man while hiding the true sovereign from sight.

Orthodox Economics "Disappears" Debt-Financed Speculation (and the Instability it Causes)

Steve Keen is a heterodox Post-Keynesian economist who has committed himself to debunking orthodox neoclassical economic theory, which dictates economics policy in the United States and his native Australia.  In his book, Debunking Economics: The Naked Emperor of the Social Sciences, Keen lays bare the absurdity of neoclassical microeconomics.  At his blog, Debtwatch, Keen routinely lambastes neoclassical macroeconomics and its adherents, primarily using dynamic mathematical models based on Hyman Minsky’s Financial Instability Hypothesis as extended by Keen’s own work.  In a nutshell, orthodox economic theory ignores money in microeconomics, debt in macroeconomics, and banks entirely.  Since banks and debt don't exist, debt-financed financial speculation doesn't exist.

Heterodox Economics Recognizes Instability Caused byDebt-Financed Speculation But Seeks Only to Contain It

While Keen is to be admired for his earnestness and perseverance in attacking the economic orthodoxy, his own economic theory suffers from an “innocent fraud” in that it relies too heavily on the concepts of aggregate supply and demand originally developed by John Maynard Keynes.  Such aggregates tell only part of the story while discouraging a deeper analysis of available data.  For example, in an excellent recent post, Keen sets forth his theory that annual aggregate demand is determined not by GDP alone, but by GDP plus the aggregate annual change in private debt.  He then proceeds to explain the correlation that he has discovered between unemployment rate and the rate of change in aggregate private debt.  There was only one problem with using the aggregate, and that is the underlying assumption that a dollar borrowed is a dollar spent in the economy.  The problem with this assumption is that a dollar boworred to speculate in the secondary bond or equity markets (or the tertiary derivatives market) only translates to pennies on the dollar in GDP, and the VAST MAJORITY of the recent aggregate reduction in outstanding private debt is found in the financial sector debt, of which most if not all was used for gambling in the financial casino.  This does not mean that Keen's theory is wrong, but it does suggest that unemployment may be even more sensitive to deleveraging in the household and non-financial business sectors than he concludes.

(NOTE: My previous post, which is linked to above, only discusses year-over-year change from 2008 to 2009, but Table D.3 of the Federal Reserves Flow of Funds Report shows that from Q1 '08 through Q2 '10 shows the financial sector has reduced its outstanding debt by $1.7 trillion compared to $472.8 billion by the household sector, while non-financial businesses have increased their outstanding debt by $94.2 billion.)

Keen cannot be blamed for focusing on aggregate because he started where Keynes and Minsky left off.  Keynes, however, knew better.  He understood full well that the rentier (i.e., the financial speculator) was the cause of the Great Depression, yet his General Theory does not explicitly take aim at preventing financial speculation (except to hope that implementing the general theory would lead to the euthanasia of the rentier).  Minsky, on the other hand, at least provided a complete policy prescription for curtailing financial instability caused by financial speculation.

Popular Narratives Focus on the Consumer, Not Financial Speculators

Before the Great Depression, the prevailing theory was that rising wages cause inflation and, ultimately, unemployment and deflation (the idea being that wage deflation is necessary to get back to full employment).  Although some persist in making this kind of argument implicitly with respect to the current crisis, few attempt to make the argument explicitly in face of the fact that real median U.S. wages have been largley stagnant for at least thirty years (particularly if you exclude the top decile of households). 

The new meme is that it is not the rising wages of workers that cause cause unemployment and deflation, but rising consumer debt.  For example, at the very beginning of the current financial crisis, the most popular theory was that poor people who were not credit worthy caused the crisis by failing to pay back their debts.  In spite of valiant efforts by people like Barry Ritholtz who correctly point out the many fallacies of the "CRA did it" narrative, it persists.

The most recent incarnation of "the consumer did it" story is that the average American consumer is a profligate, strung-out debt junkie that is continuing to leverage up even as the economy burns.  This is silly talk. 

First, while there is no doubt that most Americans have far too high a debt-to-income ratio in view of the uncertainty of an unstable economy, the fact is that most Americans who have a job make enough money to service the debt that they already have and are not taking on new debt. 

Second, table D.3 of the most recent Federal Flow Funds report shows that outstanding household debt has fallen every quarter since Q1 2008, and it now stands at $472 billion less than at its peak. 

Third, arguments that outstanding household debt must fall at the same rate as household net worth fail to recognize that a major decrease in home value has wiped out unrealized home equity, a major component of net worth for the bottom 90% of American households, while mortgage balances remain unchanged. 

Fourth, how exactly are the bottom 90% of American households supposed to substantially pay down their debts when the aggregate real savings rate was negative from 1998 through 2007 and the top 10% earned 35% of the wages?

Fifth, to the extent that people are defaulting on non-recourse mortgage debt, any new debt they take on for the purchase of goods will not, in real terms, increase their total debt burden, especially given that any late mortgage payments are likely to be a red flag in new credit applications. 

Finally, because financial institutions that hold household debt are in control of whether non-performing loans are, in fact, written down or marked-to-myth, and their decision is influenced by the fact that writing down household mortgage debt will also require writing down a multiple of that debt debt in the financial sector's outstanding debt, we can't really tell exactly how much household debt has effectively been reduced.

Reality: Financial Speculators Are Driving "The Consumer Dit It" Meme to Cover Their Tracks

The most recent meme is being driven by major media outlets like CNBC and the Wall Street Journal, handmaidens to debt-financed financial speculators.  You can believe them even less than orthodox economists, many of whom actually believe what they were taught in school. 

The Invisible Emperor of the Real Economy: Debt-Financed Financial Speculators

The sector of the economy that levered up at the fastest rate over the last 30 years is the financial sector.  Since 1998, financial sector debt has exceeded household debt (and non-financial business debt and government debt).  As discussed above, the sector of the economy that has deleveraged at the fastest rate since the peak of overall outstanding private debt in July 2008 has been the financial sector.  Interestingly, the outstanding debt of the financial sector actually climbed until Q1 2008.  It seems that hedge funds were levering up for fun and profit betting on the real economy.

If the financial sector levered up the fastest and has deleveraged the fastest (mostly through write-downs), doesn't that seem to compel the conclusion that the financial sector is the true cause of the current economic situation?  The financial sector does nothing productive, it merely bets on the performance of the real economy in the secondary bond and equity markets (stock and bonds purchased and sold on the secondary markets are bets, not investments), and on the performance of the American consumer in the derivatives market.  But by fueling asset bubbles to increase the number of opportunities to bet (e.g., by extending credit to high-risk individuals in order to sell derivatives based thereon), the financial sector made its bets less and less likely to pay off.  Since many of those losing bets were leveraged with debt, the financial sector's own debt is a multiple of the underlying household debt. 

Coming at it from another angle, while outstanding debt for the bottom 90% of American households is historically outrageously high compared to income, it is high because the financial sector substanitally loosened its credit standards in order to sustain the illusion of perpetually growing profits.  Clearly, we must apportion blame for the current economic situation between both profligate American households (surely a minority) and greedy financial institutions (surely the vast majority) because they were both negligent.  Just as clearly, the bulk of the blame must go to the financial institutions who took risks that endangered all of us and not the individual households who took risks that merely endangered each of them alone.

Bush Tax Cuts Had Severe Negative Impact on Economy

Bruce Bartlett by way of Mark Thoma:

Bruce Bartlett notes that the Bush tax cuts did little to stimulate growth, and that tax cuts of this type are very poor at what we need the most right now, countercyclical stabilization:

Bush Tax Cuts Had Little Positive Impact on Economy, by Bruce Bartlett, Commentary, Fiscal Times: Republicans are heavily invested in permanently extending the tax cuts enacted during the George W. Bush administration, all of which expire at the end of this year exactly as the legislation was written in the first place. To hear Republicans, one would think that the Bush tax cuts were the most powerful stimulus to growth ever enacted and only a madman would even think of allowing any of them to expire.

The truth is that there is virtually no evidence in support of the Bush tax cuts as an economic elixir. To the extent that they had any positive effect on growth, it was very, very modest. Their main effect was simply to reduce the government’s revenue, thereby increasing the budget deficit, which all Republicans claim to abhor.

Saying that the Bush tax cuts had "little positive impact" on the economy is being excessively charitable.  The Bush tax cuts helped ruin the economy by generating free cash flow to fuel more and more financial speculation. 

Wealthy Americans no longer invest in creating productive American businesses, so the primary way to "protect" the value of the money they earn is to engage in financial speculation (i.e., "investing" in the stock market).  Many wealthy Americans sought outsized gains by speculating through hedge funds, who leverage up through factional reserve borrowing.  With so much money seeking yield, asset prices were driven higher and higher, until the point was reached where the only way to keep the bubble going was to extend credit to people who could not afford to pay it back (derivatives must be "derived from" something).

To be fair, Bush's tax cuts could have been a very big positive if the tax and accounting rules encouraged investment into the productive output of the United States.  Unfortunately, our de facto industrial policy does the opposite.

He Who Sets the Rules Gets the Gold: The Financialization of the Real Economy

The primary conclusion of the Pujo Committee in its 1913 report was that there existed a "money trust" that had a community of interest that exerted control over American industry through interlocking boards of directors and modulating the access to credit.  The Pujo report ultimately led to the Federal Reserve Act of 1913, which some proclaimed would break the money trust through government oversight.

A major conclusion of the Pecora Commission of 1934 was that nothing about the "money trust" had changed, that, if anything, it had become more brazen in its abuses since the passage of the Federal Reserve Act.  Unlike the Pujo Committee report, the report of the Pecora Commission led to major legislative reforms including the Glass-Steagall Act, which barred investment banks from operating as commercial banks, and vice versa.

Although the Glass-Steagall Act was not repealed until 1999, the financial sector had substantially undermined it by the early 1980s.  The Graham-Leach-Blilely Act was helpful in hastening the arrival of the current depression, but not necessary.

Financial innovators had already figured out ways to avoid things like reserve requirements (e.g., through repurchase agrements, swap agreements, and, later, derivatives) and naked shorting (e.g., through derivatives again).  With innovations like high frequency trading and dark pools, they were able to avoid the prohibition of pooling arrangements that prevented price discovery.

A major enabler of the financial innovators (i.e., the cheaters) was the Chicago School of Economics, which, for whatever reason, applied some of its best minds to establishing that the stock market shark tank was once again safe for the recreational swimmers.  When I read Justin Fox's The Myth of the Rational Market, I was shocked that economists would concern themselves with speculation in the secondary markets, but there they were doing exactly that!

One of the things that Chicago School economists (and their neoliberal brethren of Austrian stripe) accomplished is the financialization of the real economy.  With the concerted return of monopoly capitalism beginning in the Reagan era, the marked increase in IPOs in the 1990s, and the consolidation of investment banks and commercial banks in the oughts, more of the American economy than ever before was subject to economic decision making driven by "maximizing shareholder value."

But what does that really mean, "maximizing shareholder value?"  With all of the "rules" of valuation in the secondary equity market established through things like the Capital Asset Pricing Model, the "M&M" equations, and discounted cash flow analysis, maximizing shareholder value means maintaining, on a quarterly basis, the illusion of perpetual profit growth beyond the pace of inflation and at or above current consensus expectations. 

In short, the management of publicly traded companies must run their companies to simulate a financial instrument that exhibits perpetual growth that meets or exceeds expectations.

There are only four things that management can do to exhibit the expected growth.  First, it can grow the business organically by increasing sales in existing markets or branching out to new markets.  Second, it can acquire other companies.  Third, it can engage in cost arbitrage (e.g., wage arbitrage, accounting arbitrage, or tax arbitrage).  Finally, it can "cheat," a term that I use broadly to refer to things as relatively inconsequential as timing orders to hit in a desired quarter or as malignant as Enron or S&L-level control fraud. 

Governments are subject to similar pressures through the secondary bond market and are similarly limited in what they can do to meet the expectations of "the market" and maintain the viability of its economy (and currency). 

For all intents and purposes, these objective "rules" for the valuation of stocks and bonds on the secondary market accomplish exactly what the alleged "money trust" did, which is control of American industry and, therefore, the American economy.  The net result is that we are all at the mercy of financial speculators who demand the impossible: perpetual growth in a world of finite resources. 

Damon Vrabel had a great post today about the implications of how the current monetary system run by the rules of financial speculators has pushed debt levels to the saturation point.  A version of Damon's post appears at Max Keiser, but be sure to check out the much meatier original.

Keynes' Real Sin

Many negative things have been said about John Maynard Keynes, most of them with regard to the school of economic thought that bears his name but little resemblance to his actual work: Keynesianism.  Most recently, people have laid the blame for Nixon closing the gold window at Keynes' feet (in spite of the fact that it was Chicago School monetarists Milton Friedman and Paul Volcker who championed that move) as well as the blame for the ongoing financial crisis (in spite of the fact that it was brought on by financial deregulation urged by Chicago School economists like Milton Friedman). 

In spite of all the breathless accusations of Keynes' evil influence over Washington elites, remarkably little of Keynes' work remains publicly available or accessible.  Only a couple of his books remain in print, although biographies by people like Hyman Minsky provide some sense of what these lost works say.  The fact is that Washington D.C. abandoned Keynesianism in 1980 to embrace the neoliberal Washington Consensus, which is informed by Chicago School economic thought (what I call "ponzinomics").

So why has Keynes become a political pinata, his legacy taking a beating for something he had no hand in?

The answer most likely found in Chapter 24 of The General Theory, in which he wrote: 

Now, though this state of affairs would be quite compatible with some measure of individualism, yet it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity-value of capital. Interest today rewards no genuine sacrifice, any more than does the rent of land. The owner of capital can obtain interest because capital is scarce, just as the owner of land can obtain rent because land is scarce. But whilst there may be intrinsic reasons for the scarcity of land, there are no intrinsic reasons for the scarcity of capital. An intrinsic reason for such scarcity, in the sense of a genuine sacrifice which could only be called forth by the offer of a reward in the shape of interest, would not exist, in the long run, except in the event of the individual propensity to consume proving to be of such a character that net saving in conditions of full employment comes to an end before capital has become sufficiently abundant. But even so, it will still be possible for communal saving through the agency of the State to be maintained at a level which will allow the growth of capital up to the point where it ceases to be scarce.

Many economists before Keynes had deplored the rentiers and financial speculators, including Adam Smith, but no mainstream economist had taken aim at euthanizing them for fear of being euthanized.  Economists before and since Keyenes studiously ignore the rentier class and its deliterious effect on the real economy, pretending instead that there is only labor and capital, only supply and demand, only two parties who barter, in the "free market."

Keynes' real sin was naming the monster that caused the Great Depression, the same monster that caused the current depression.