Sunday, April 3, 2011

Real Estate, debt, interest rates, monetary policy, and gold/silver - Part 1

The title of today's post is a snapshot of what this blog talks about virtually every day.

For months I have ruminated about a post that ties them all together, that shows the concerns about Real Estate and how they are tied to debt, which is tied to interest rates, which has been heavily manipulated by monetary policy, which begets the strong interest in gold/silver I talk about.

Yesterday I read another great post by the blogger Gonzalo Lira. And he has articulated a number of pertinent points which I am going to borrow on for this post.

As I have said repeatedly, we still do not fully appreciate - nor do we fully comprehend - the depth and breadth of the financial earthquake that hit us in September, 2008.

The problems that triggered that collapse, and government attempts to manage it, are merely the latest acts in a play that really got underway almost 30 years ago.

As Lira notes, you can clearly see that specific policies were implemented, decisions made and actions taken which set us on the path that brought us to where we are today.

And while some will argue that it was the very invention of the Federal Reserve back in the early 20th century that set us on the current path we are on, a serious look at the policies, decisions and actions carried out in our own lifetimes gives us a clear picture about the path we are on.

It starts in 1975 when the US Congress consistently fails to deliver a balanced budget. This is followed by the US Federal Reserve giving both the U.S. economy and the Federal government a massive subsidy by way of its artificially low interest rates, starting in 1987.

Begining in 1975, the United States has had an uninterrupted string of yearly deficits as the American Federal government has routinely spent more money than it has brought in.

Deficit spending satisfied the ideologies of both sides of the economic divide:

  • For the economic Right, cutting taxes satisfied its notion that more money in the hands of the citizenry and corporations guarantees greater economic growth.
  • For the economic Left, more government spending every year satisfied its notion that more money spent by the government guarantees greater economic growth.
And since 1975, both sides of the political divide have failed to resolve the US fiscal incoherence.

The economic Right wanted lower taxes. The economic Left wanted more fiscal spending. Rather than thrash out their differences and come to a compromise, they resorted to the national credit card: rather than either/or — it’s been both. Both lower taxes and higher Federal government spending — bought and paid for with fiscal debt.

And as each year passed, the Americans have resorted to issuing Treasury bonds to cover the difference. As a result the overall debt has became greater and greater.

It has become so great that total fiscal debt that exceeds 100% of GDP. Yearly deficits for the next five years will exceed 10% of GDP each year.

The US Government has been able to get away with this deficit year after year because of the cheap interest rates it has had to pay for its debt.

Enter the Federal Reserve.

The price of a good is the intersection of its supply and its demand — this is Economics 101. Money is a good like any other — and like any good, it has a price: Its interest rate. Ordinarily, the price of money is fixed by suppliers of credit—that is, banks. They create money via credit—and they sell this money to their customers, the price of this sale being the interest rate that they charge.

Starting in 1987, the Federal Reserve went beyond its mandate of price stability and full employment, and instead went into the business of goosing along the economy.

In other words, it focused on mindless growth — and focused specifically on the blunt, club-like metric of GDP growth — and goosed along the economy in order to raise that mindless metric.

It did this by usurping the role of banks, and providing cheap money by way of low interest rates; low interests rates carried out with the explicit aim of gaming the GDP.

The economy slowing down?

Cut interest rates.

Momentary market panic?

Flood the market with liquidity.

The economy (as measured strictly by GDP) slowing down again?

Cut interest rates some more.

GDP booming?

Very very very slowly and predictably raise rates — then cut ‘em again the instant the GDP looks like it’s starting to slow down.

This was, in a nutshell, what Federal Reserve Chairman Alan Greenspan did during his tenure: he subsidized money for the sake of gaming a single metric, the GDP.

Everyone knew it.

There was even a name for it: The Greenspan Put.

For such an avowed free-marketeer Greenspan was, in reality nothing of the sort. Rather than allow the market to dictate the price of money, he subsidized it like a Socialist Pricing Board. And just like a Soviet apparatchik of old, Greenspan focused on one number — GDP — irrespective of all the other subtle qualifiers that define a healthy economy.

The distortive effects that Greenspan’s money subsidy brought to the US economy are clear to all... serial bubbles. There was:

  • the Dot-com bubble,
  • the Tech bubble,
  • the Bio-Tech bubble,
  • the Collateralized Debt Obligation bubble,
  • the Real Estate bubble,
  • and now the Treasuries bubble
All of these serial bubbles have been blown by the Federal Reserve’s relentless subsidy of the price of money.

Now of course, if you are using the subsidized price of money to goose along an economy, there comes a moment when it doesn’t work anymore.

Enter Ben Bernanke. His Zero Interest Rate Policy (ZIRP) and Quantitative Easing 1, QE lite and QE2 are the perverted policies he has had to pursue in order to keep up the Greenspan Put.

All of The Bernank’s recent policies are aimed at shoring up the “growth” that the U.S. economy has experienced over the last 24 years.

But as Lira points out, that “growth” isn't real. It's steroid-induced bubble muscle. An illusion.

If you measure gross GDP adjusted for inflation, which has been Greenspan’s sole metric, there has been "growth".

However, if measured by median and average wages, per capita incomes adjusted for purchasing power, or any other such metric that measures the well-being of the average, and the below-average,citizen, there has been no growth whatsoever.

People are less well off. The middle class in the United States has shrunk drastically. Sure, the average income might be higher, but that’s the distortive effect you get from having tremendous, inorganic wealth disparities.

It’s not merely that the disparity between the wealthy and the rest of the population is obscene — the disparity skews the results. Remove the top 15% of the population, and the average income in the United States drops below Slovenia’s.

Furthermore the sort of growth the American economy would have experienced since 1987 without this money subsidy would likely have been very different from the growth we have actually experienced.

The growth we have experienced has been speculative. Cheap (ie. subsidized) money that Greenspan made available was set to chase returns via trading, not production.

Had money been expensive, yields that beat savings would have been harder to come by and thereby encouraged savings instead of speculation.

Expensive money would have also kept banks from the insane speculation of the real estate markets: On the one hand, expensive money would have kept low quality buyers from access to credit, and on the other, expensive money would have dissuaded banks from expanding their businesses into riskier territories, in order to reap higher returns.

In other words, risk would have been accurately priced.

In other words, there wouldn’t have been a Global Financial Crisis.

Now, obviously, it’s a fool’s game to try to go back over the 24 years since Greenspan took office and try to deduce what would have been the organic price of money without his and Bernanke’s subsidy.

But clearly, had the Greenspan Put never existed, there would likely have been less growth than has been had.

Would there have been less money for venture capital and the financing of new businesses? Yes, no question. Would those new businesses therefore never have existed? Again, yes.

However: How many ridiculous, fairy-tale businesses would have been financed, as happened during the various bubbles of the last 24 years?

Very few. Capital would have been much more efficiently allocated in a world where there was no subsidy on money. It would have been too expensive for the economy to throw away capital on clearly nonsensical businesses.

Would the solid businesses have gotten financing? The ones that actually did something for the economy, like Google, Ebay, and so on?

Clearly, it would have been tougher for them, and their growth would have been slower — but just as clearly, they would indeed have gotten financing, because they are obviously good businesses.

Anyway, even if many good businesses would have failed to raise financing in a world of more expensive credit, the good outweighs the bad: There would not have been any serial bubbles.

But most importantly... the US Federal government would not have had access to cheap financing. And it is the cheap financing which encouraged the accumulation of back-breaking debt.

Had Greenspan not subsidized money, it would have been far too expensive for the US Federal government to continue increasing its yearly deficits, and adding to the national debt.

A fiscal day of reckoning would have happened a lot sooner and therefore would have been a lot less painful.

It would have been bad (all days of reckoning are bad), but it wouldn’t have been mind-crunchingly destructive as the coming crisis will be.

We are in a world where first Greenspan, and now Bernanke, have keep money at absurdly, unsustainably low prices. The US Federal government was allowed to balloon its fiscal debt to monumental proportions: over 100% of GDP, with future yearly deficits in the +10% of GDP range as far as the eye can see.

The Federal Reserve’s subsidized money has postponed the day of reckoning, insofar as the Federal government debt is concerned. And it is making that day of reckoning much worse than it needed to be.

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1 comment:

  1. Plus the same nutty policy across the pond. It's a Ponzi world.