Euro Summit Still Trying to Sort Out Greenspanism
The world has been captured by the unending and unfolding drama in the European theatre of dysfunction. Just a little over a month ago the Grand Bargain of European salvation, the European Financial Stability Fund (EFSF), had been proposed to cheering stock markets and commentators. It was breathlessly proclaimed that a comprehensive solution had been found, planned and was ready for implementation. The aligning lights of undemocratic integration would once again triumph over the messy, unseemly free market. Because the economies of the earth had been saved by the mathematical genius of the current financial elite, markets should have been so much less curious about things like details and fine print. Now the fund can barely raise 3 billion euros (out of an expected 440 billion) and is threatened with downgrades, and the bailout needs a bailout.
So the tenth European summit takes place today and it is likely the EFSF will barely get mentioned. Instead, the embattled leaders of a battered system will soldier on to find another way to save their respective economies - and therefore world's. Global financial integration leaves no safe economic harbor, so we are told.
The financial and mainstream media have swallowed that "logic" without question or pause. The myth of the supremacy of modern banking in the temple of modern economics has become wholly ingrained into the fabric of 21st century society. We have been conditioned to accept that banks are the economy. To lose the former means to lose the latter.
That is the drama of Europe, where the fight about their collective economy is really an indirect assumption. The details of any bailout actually relate only to how they are going to shield the banking system from its current insolvency, resurrecting the credit machine that everyone accepts as the lifeblood of any modern economy. Without credit, supposedly the economy dies and all sorts of apocalyptic phenomena flow forth and ruin the whole of modern civilization. If the constant rumors of Credit Agricole's imminent failure are proven true, like the rumors of Dexia and MF Global were, the next Hitler will rise to enslave and destroy.
It is often difficult to unravel conventional wisdom that is intertwined into the unchallenged fabric of the civilization of the developed world. In this case, however, it is rather straightforward. Everyone knows the problem is debt, but not everyone seems to grasp that debt is a symptom of a corrupted system. Wall Street and its European cousins are accepted as capitalists because their operations seem to have something to do with markets.
But if we examine the real economy as it has changed through the last economic age, we can see the banking system and economy as separate pieces in their proper places and proportions. The age of central bank/credit supremacy (which encompasses the Great Inflation, the Great "Moderation" and the Great Recession - a lot of Greats that were so far from it the entire age might be better termed the Great PR) was really nothing more than financial economy domination, a long-term campaign of economic mastery cloaked in the "success" of economic growth that, toward the end, became solely dependent on household impoverishment.
Going back to the fourth quarter of 1960, gross "Personal Outlays" of the household sector in the United States were estimated by the Bureau of Economic Analysis (BEA) to be about $342 billion (in annualized current dollars; that is, not adjusted for some estimate of inflation). To "pay" for these expenditures, there was about $297 billion dispersed in the form of wages and benefits, $51 billion added as proprietor income from owning a business, $17 billion in rental income from owning property, $27 billion in government transfers, minus $16 billion for FICA-type taxes and minus $46 billion for "Personal Current Taxes". These sources of income total about $330 billion.
Since personal spending was greater than these forms of income, which I will call "Fundamental" income for lack of a better term, there was a shortfall of about $12 billion, or 3.7%. Fortunately for households there is another source of income: asset income from interest and dividends on accumulated savings. In Q4 1960, asset income was a nice $38.5 billion, meaning households really had a $26 billion cushion over total expenses. The overall personal savings rate, then, was a robust 7.1%.
Now these statistics are in no way comprehensive or exact. Personal outlays include all Personal Consumption Expenditures (PCE), including the phantom imputation of owner occupied rent (in 2011 this element of PCE accounted for about 9% of GDP!) which is not even a real expense. Asset income is not evenly distributed either, but it does reach into most of the economy, especially at the margins. For our purposes, however, this incomplete and inexact data helps to define trends, which is what we are really looking for here.
Importantly, these calculations leave out other sources of cash flows, including capital gains from asset price increases and the net accumulation of debt. While these marginal sources of spending are not included, we can infer their relative importance from the difference between what I have called "Fundamental Income" and Personal Outlays.
By the fourth quarter of 1974, right in the middle of the Great Inflation epoch of the Great PR, the economic dynamic of the consumer economy had largely remained the same. Nominal "Fundamental Income" had grown to $955 billion, mostly through inflation, but the shortfall to Personal Outlays was still only about 3.5%. Consumer spending, despite that growing onslaught of inflation, was still marginally dependent on wages and other fundamental forms of income. This makes sense in the context of that age since the brunt of inflationary forces were, at least in the late 1960's and early 1970's, wage driven. This dynamic changed in 1975, becoming more of a purely financial phenomenon.
If we again fast forward, through the double-digit consumer price inflation of the late 1970's, past the double dip recession of the early 1980's, all the way to the fourth quarter of 1989, the dramatic shift in consumption is perfectly clear. In the final quarter of 1989, just as the S&L crisis was coming into focus and right before the early stages of the 1990/91 recession, Fundamental Income had grown to $3.2 trillion, while Personal Outlays totaled $3.8 trillion. This meant that there was as a startling shortfall of $619 billion, or a massive deficit of 19.3%!
The deficit, however, was easily absorbed by the $898 billion in asset income, most of which was in the form of interest receipts. In terms of overall GDP, interest income had grown to be as high as 13.5% at the end of 1984, staying near that lofty level through the end of the 1980's. By that fourth quarter of 1989, interest income was still about 13% of GDP, meaning the conditions that allowed for such a massive gap between Fundamental sources of income and household consumption could easily continue.
The accumulation of savings balances in the household sector (the largest proportion was in traditional deposit account form) was no doubt a function of the high interest rates still left over from the last days of the Great Inflation. That overall deposit balances had so disconnected from the real economy to drive such a disparity between Fundamental Income (or GDP) and Personal Outlays was the residue of money creation itself. Though this was a definitive departure from the traditional capitalist economy, these imbalances had yet to take on the more dangerous elements that we see today.
By the technical end of the 1990/91 recession in the first quarter of 1991, the household sector had accumulated $5.1 trillion in deposit balances and credit market assets. Though debt usage had begun to stir, it was still very manageable at that time, only $3.6 trillion (this includes household mortgages and the various forms of consumer credit), yielding a "Stable Net Worth" of $1.53 trillion (deposit balances and credit market assets minus household debt).
The main risks to this form of net worth (which was the primary driver of net worth growth in the period) were default risk of the banks in which deposits were held (above and beyond normal FDIC coverage), default risk in any idiosyncratic credit instruments (which were largely government bonds, but had begun to shift to corporate bonds) and interest rate risk. Because most of these default risks were well known and in some cases mitigated, interest rate risk was the primary consideration driving asset preferences at that time.
So the monetary philosophy of "stimulating" the economy by reducing interest rates during Alan Greenspan's early tenure at the Fed meant directly risking this economic dynamic of interest income as the marginal source of the growing proportion of consumerism. It also meant a willful attempt to shift preferences out of the "safe" investments that households had long favored (for good reason). Ostensibly, low interest rates were sold as a method to reduce the cost of funding for the banking system, allowing it to create marginal activity through credit production. But the Fed's relatively newfound affinity for "rational expectations" management offered monetary policy far more potency.
The dangerous historical nexus of cheap bank funding, the move to equity-based banking and the desire to "enhance" economic growth through artificially stimulating consumers through debt and asset prices made 1991 an inflection point in monetarism. Up to that point marginal consumption was still largely a reflection of individual consumer preferences that were not so easily manipulated by the levers of monetary policy, ensconced within generations-old patterns. From 1989 through 1992, the shortfall of Fundamental Income to Personal Outlays fell all the way back to 13.4%, as households cut back on spending in a period of uncertainty.
This was/is normal, rational behavior, but not acceptable to a managerial Federal Reserve high on its ability to move the economy and defeat the business cycle. Weak economic results were not acceptable no matter how much sense they might have made to individuals (the insipid "fallacy of composition"). The economy stopped being the aggregate activity of individual actors and started to be a target where individual actors had to be pushed to. The entire meaning of the word economy was lost somewhere in here within the scientific process of economic stewardship (the etymology of the word economy was from the Greek for "household management").
Household balance sheets still were in very good shape despite the creep of money creation and asset inflation up to that time. When interest rates were reduced by Alan Greenspan's Fed to near-record lows starting in mid-1990 (the Fed funds rate were pushed from around 8.25% in April 1990 to 3.25% by July 1992), households began the long shift out of deposits and credit market assets. Successful stimulation of rational expectations necessarily meant getting households out of their comfortable net worth position, and systemically lowering the price of risk, thus increasing the appetite for it. It was a simple matter of investment alternatives, but it has been mis-characterized as "animal spirits", intentionally commingling this new financial definition with the true capitalist meaning.
Households began to follow the growing asset bubbles into stocks, decomposing their marginal net worth growth from its more stable, traditional form into price action. The dynamic of net worth and monetarism's wealth effect had changed to the easier lure of asset price inflation, but this came with risks that would never had taken place had they been priced correctly. The dramatic shift in manipulated price-driven perceptions of systemic risk in the early 1990's changed the very character of the more subtle monetaristic corruption of capitalism into something far more hazardous.
By the time the stock bubble was hitting its apex in the second quarter of 2000, the trend of consumerism had moved even further away from Fundamental Income. The shortfall of Fundamental Income to Personal Outlays had surpassed the 1989 peak, now reaching an astounding 21%.
Asset income, marginally shrinking as interest rates were held artificially low for the whole of the 1990's, was no longer even close to adequate for a stable savings rate. The savings rate that was still a healthy 6.8% in 1989 had fallen to 2.4% by 2000. In other words, households kept spending growth constant, breeding and feeding growing consumerism, shifting both their marginal sources of net worth growth and spending to stock prices and debt, respectively. This was a devastating development, especially as that asset inflation proved to be illusory (inflation always is, in any form).
The $1.5 trillion of "Stable Net Worth" that households had in 1989 had vanished in a still-growing tide of debt accumulation related to those stock-fueled rosy net worth perceptions the Fed intentionally courted. By early 2000, households had seen their holdings of deposits and credit market assets rise at a slowing rate to $6.6 trillion, but at the same time net debt had also risen to $6.6 trillion. That meant marginal net worth, for the first time in history, was now entirely a function of risky asset prices.
Even at this point, a relative recovery back toward a more Fundamental Income-based system was possible. It would have been difficult since it would have required both a nasty recession and slow growth afterward, but households could have withstood it given the still adequate proportion of stable assets and income. This "retrenchment" would also have required a necessary diminishment of the financial economy and a return of economic control back to the boring calculations of household Fundamental Income. The Fed did not want that to happen since it would have meant both discrediting its newfound abilities (it was the Great Moderation after all) and giving up economic control.
Instead, the Federal Reserve, drinking its own Kool-Aid, doubled down and we got the housing bubble. It preserved and nurtured its economic mastery through Wall Street and credit production, but it also saved (temporarily) its own philosophies and methodologies from the failure of the dot-com bust. This was nothing more than a deal with the financial devil since it meant that economic growth would continue to move away from its capitalist, fundamental roots, setting up the household sector and the global economy for panic and chaos.
By the middle of 2007, the shortfall of Fundamental Income to Personal Outlays had grown to a ridiculous 24%. Since interest rates were again at then record lows through much of the period, asset income had dwindled even further, taking the savings rate with it. At the height of the housing bubble the savings rate officially fell below 1% (and might have actually been negative depending on the arcane calculations of the data series) meaning marginal debt accumulation had become the primary marginal source of funds for over-consumption.
Earned income and productive capacity lagged through intentional neglect in the financial glow of rising asset inflation. Everyone was happy because there was plentiful money , and risk had been completely forgotten as even a financial concept, let alone a real economy variable. Capitalism functions on calculations of risk; monetarism seeks to erase all perceptions of it, functioning like an economic snake oil.
Just before the credit markets finally froze in August 2007, households held $10.7 trillion in deposits and credit market assets, but were now indebted to the tune of $13.3 trillion - a massive $2.6 trillion hole that was made all the worse by the crash of reversing asset inflation in both stocks and real estate.
The Great "Moderation" was a period of economic growth and marginal activity based not on earned income or even growing government transfers. It was based on the mirage of paper transfers of asset income giving way to debt accumulation, all through willful money and credit creation. Consumption in a capitalist system follows success in productive activities, a symptom not a cause. The U.S. economy turned into one based on consumers largely because of the 269% increase in net outstanding debt balances between 1990 and 2007, nearly $10 trillion in what was supposed to be a period of low inflation. Credit Agricole's ability to create credit through its eurodollar balance sheet equity capacity was one of the main sources of this American tragedy. And so the Europeans have to meet.
While I have focused on the household sector within the U.S., you can simply substitute any one of the PIIGS here. The sovereign crisis is nothing more than a parallel impoverishment of nations as they pursued debt-fueled levels of activity that were sustainable only through monetaristic expansion within the banking system. None of this can fairly be called real intermediation since it never really sought to match the pool of real savings to productive uses. Instead, central bank policies created credit from nothing to push the level of economic activity far above traditional potential out of political expediency, borne on the eternal hubris of economics and monetary "science".
Now the system desperately clings to some magical hope of saving itself, and thus this kind of artificial economy. An economy where activity is not marginally predicated on productive endeavors of work and earned income, but of the shifting and constant transference of paper currency and claims, created by the whims of flawed mathematical calculations. Banks must be bailed out because their failure means the monetarist system fails with them. The economy does not fail if the banks fail, THEIR economy fails if the banks fail.
Had the Federal Reserve, and its fellow global central banking cartel participants, stayed out of the economic management business global growth would necessarily have been slower, but would that have been such a bad thing? The tortoise and the hare are a lasting parable for good reason. Consumer spending would not have reached 70%+ of the economy, but that would necessarily have meant a larger proportion of marginal economic activity based on productive production. Production usually leads to jobs, and it is no coincidence that our current dearth of jobs is coincident to the neglect of productive capacity in favor of financial innovation.
The indebted and impoverished households of the developed world have finally seen through the façade of monetarism, now demanding actual jobs, boring earned income and a solid foundation of traditional financial stability to lead us into a future of prosperity. It is no coincidence that retail stock investors are fleeing price markets while real estate remains mired in depression. The system is devolving (or re-learning if you want to see it as the positive transformation that it is) on its own, finally and mercifully impervious to the central control of credit production.
The central economic authorities have tried their best, but the real free market is trying to assert the real price of risk. The economy is now caught between diametrically opposed forces - the return to true productive potential vs. another fit of money inflation and its obligatory crash.
Equities cheer the latter, hoping for a rerun of dysfunction and inefficiency. The real economy hopes for the former, now informed about the dangers of an artificial system. The body politic is awash in discussions and fears of jobs and the lack of income opportunities, but curiously there doesn't seem to be any angst about a lack of credit card or mortgage availability. Preferences are still returning to their natural state, so there is no possibility for stability as long as the system's masters continue to hold on to their monetary dream of maintaining the current banking system as their pet tool. Something will have to give in the near future.
