The United States faces profound risks in the way its financial markets continue to operate. As I wrote last week, Ben Bernanke's latest stimulus effort smacks of desperation. If we are to find real solutions to our domestic problems, we need to open our minds to rethink what the core problems might be.
The videos below are of a speech Michael Hudson made several weeks ago to the American Monetary Institute. I hope you find time to watch it. Some of his examples are simplified to serve an explanatory purpose. So let's not quibble about every detail. Let's see where these explanations correspond with our reality and use that as a starting point to understand our reality.In the first segment he correctly points out at about the 3:30 mark that banks do not lend for productive purposes (in general). They lend on existing assets and cash flow streams. This is particularly the case with large banks that have much standardization and centralization of functions. As Amar Bhidé states in his book:
The financial system has been giving up, albeit unwittingly, on the decentralization of judgment and responsibility. Case-by-case judgments by many, widely dispersed financiers with the necessary 'local knowledge' have been banished to the edges, to activities such as venture capital, which accounts for a useful, but tiny proportion of financing activity.Without this decentralized judgement and responsibility, banks are simply incapable of providing productive risk capital as Hudson describes. Instead, capital is consistently deployed to increase the values of existing assets, much like Bernanke proposes to do today.
All Tea Party supporters should watch this speech because it explains how America is becoming the new Latvia and how labor (90% of us) is and will continue to pay the freight. The greater public has been co-opted by a blind faith in the Neo-Classical economic paradigm. They believe that their angst, created by flat to decreasing real incomes for those still employed, high unemployment, and extreme volatility in perceived wealth, has been caused essentially by too much regulation and too much government. While I agree that inefficient or ineffective government is a problem, it pales relative to the effects of the power structures dividing up the wealth in a way the average citizen cannot grasp.
Further in the speech, Hudson refers to this increasingly debt based system and how all cash flow streams and assets are ultimately "capitalized". In other words, debt is issued against them and profits are extracted by those able to do so. Perhaps you have seen this as we have more and more toll roads, red light cameras, and prisons run by private companies for profit. Those who outsource these things see one part of the picture, the part where government outlays are supposedly reduced. They do not see the part of the picture where those assets and cash flow streams are used to move wealth to the top of the social structure. Tea Party favorite Rand Paul unwittingly plays into this with his ideas on privatization. From an interview this weekend comes this quote:
When pressed on This Week about which programs the he would cut, Paul declined to identify individual programs. "All across the board," the senator-elect said.
Amanpour challenged Paul, saying, "But you can't just keep saying all across the board." Still, the newly elected senator refused to budge. "No, I can. I'm going to look at every program, every program." He later continued on the theme: "You need to ask of every program -- and we take no program off the table. Can it be downsized? Can it be privatized? Can it be made smaller?"
This things that are privatized will then be leveraged and the profits will be extracted up front. Any change in the cash flow stream will then create future losses on that leverage and those losses will be allocated to taxpayers or the most unwary investors who bought the residuals after all the fees and equity dilutions for management have been stripped.
While John Hussman is writing on a different topic, the Bubble Crash cycle, his points tie in as well. After acknowledging that the markets already rose on the Fed action, Hussman effectively makes it clear that this has little to do with real wealth.
As a result of Bernanke's actions, investors now own higher priced securities that can be expected to deliver commensurately lower long-term returns, leaving their lifetime "wealth" unaffected, but exposing them to enormous risk of price declines over the intermediate (2-5 year) horizon. This is not a basis on which consumers are likely to shift their spending patterns. What Bernanke doesn't seem to absorb is that stocks are nothing but a claim on a long-term stream of cash flows that investors expect to be delivered over time. Propping up the price of stocks changes the distribution of long-term investment returns, but it doesn't materially affect the cash flows. This reckless policy has done nothing but to promote further overvaluation of already overvalued assets. The current Shiller P/E above 22 has historically been associated with subsequent total returns in the S&P 500 of less than 5% annually, on average, over every investment horizon shorter than a decade.
With no permanent effect on wealth, and no ability to materially shift incentives for productive investment, research, development or infrastructure (as fiscal policy might), the economic impact of QE2 is likely to be weak or even counterproductive, because it doesn't relax any constraints that are binding in the first place. Interest rates are already low. There is already well over a trillion in idle reserves in the banking system. Businesses and consumers, rationally, are trying to reduce their indebtedness rather than expand it, because the basis for their previous borrowing (the expectation of ever rising home prices and the hope of raising return on equity indefinitely through leverage) turned out to be misguided. The Fed can't fix that, although Bernanke is clearly trying to promote a similarly misguided assessment of consumer "wealth."
My final point before leaving you to this treasure trove of speechmaking is this. Today we have what we have. We cannot change it overnight. Evolutionary change is our only viable option until more dramatic shifts in our culture enable bolder political action. Right now the regulators are in the process of determining how to implement the provisions of Dodd-Frank. Simon Johnson penned a strong statement. It is essential to win these little battles on the regulatory front.
The Volcker Rule is not a panacea but if designed and implemented appropriately, it would constitute a major step in the right direction. The effectiveness of our financial regulatory system declined steadily over the past 30 years; it is time to start the long process of rebuilding it.
Rebuilding the financial sector must be done a one step at a time. We must hope to rebuild it before we become the American Latvia and must sacrifice whole segments of our society to feed our parasite.
Please watch Professor Michael Hudson.