Forget Free Markets, Finance Is a Policy Tool of the State

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In December 2008, the Federal Reserve's two policymaking bodies got together in a joint meeting to decide to go where they never thought they would. It was such a bitter disappointment then as the events of summer and fall were wholly unexpected because the FOMC totally and blindly believed its actions through Bear Stearns had settled the matter for good. That was supposed to be the bottom.

When the GSE's failed, followed closely by Lehman and all the rest, especially AIG, the unthinkable became not only realistic but reality. To fight such failure meant moving far beyond "rules based" policy and into total discretion. That included strong-arming banks where necessary and creating even larger institutions; and not just creating them but aiding that process widely both directly and indirectly. In one important aspect, bigger was the only way out for them.

To some, it was briefly an unsettling proposition. Dallas Fed President Richard Fisher noted in the weeks after Lehman Brothers that,

"Mr. Chairman, this may be a conversation for another day, but it seems to me that we're ending up with more and more concentration-Bank of America, Citicorp, Morgan-and I'm curious as to what we plan longer term so as not to displace the ability of other institutions to play their role in the financial markets and grow their businesses-the super-regionals that are healthy and so on."

There was no question then as to who policy was favoring, just as there was no indecision as to why. Where it was thought even in the smallest possibility of being illegitimate, there was no dissent because of what was transpiring. We can quibble about its immediate necessity now, but that was the path chosen then by the orthodoxy as it related to circumstances that were never supposed to happen; in fact a panic that they were sure was impossible in such an advanced system.

Setting aside the contemporary debate about emergencies and "saving the world", surely in the past five and a half years the idea of "too big to fail" (TBTF) has been addressed? The emergency has passed, at least that is the party line from the only party in attendance at policy meetings (orthodox economists). Surely we have progressed enough to undo that which was "necessary" but unsettling and remove concentration in the financial industry. A release from the tight grip of crisis should at least impart the basic capitalist, arcane concepts like competition and failure.

To put a fine point on it, also in 2008, Kansas City Fed President Thomas Hoenig identified a large piece of the setting for TBTF.

The problem has been very lax lending and, obviously now, weaknesses in some of the oversight. Also a history of our reacting from a monetary policy point of view to ease quickly to try to take care of the problem and, therefore, to create a sense in the market of our support has raised some real moral hazard issues that we now need to begin to remedy as we look forward in dealing with future receiverships. We are in a world of too big to fail, and as things have become more concentrated in this episode, it will become even more so.

I doubt such sentiment is controversial, nor has it really been in any way given the history since Greenspan's ascension. However, notwithstanding these minor objections noted above, nothing has really changed, panic or not. Monetary policy has clearly favored financial institutions, and size continues to be among the primary factors. Indeed, the size of top financial firms and the increasing role of finance are wholly proportional to the need of policymakers toward "steering" the economy. What is the current brand of soft central planning if not totally committed to debt, debt and more debt? To create economic activity out of "nothing" requires a system to create money out of "nothing", and, despite popular imagination, the "printing press" resides deep inside the balance sheets of the largest of banks.

To gain economic "stimulus" means to afford banks the room to dominate. What the discussion in 2008 amounted to, if you really hear what they are saying, is only a small indenture of buyer's remorse. The cost of acquiring such power is sometimes, if not almost always, catastrophic.

The fact that nothing has been done to address TBTF in the many years since those regrets were proffered speaks volumes about the nature of control in the economy, and how much finance means to it. Interest rate targeting without deep and committed financial growth is nothing but a silly and inane computer simulation. The system of finance is fully captured by the idea of economic management - they are one and the same.

Given the role of TBTF in the economy even after the financial disaster in 2008, it is somewhat interesting, if not comically restive, to see the use of the stock market in current politics. Every time some major market index hits new all-time highs, defenders of statism appeal to it as some exoneration of all the commandeering. On November 7, 2013, MSNBC ran an article, highlighted in many places, proclaiming in the headline, "Wall Street Soars Under Obama's Socialism." Only four days later (perhaps the message was intended toward coordination) the Huffington Post ran a near copy, "Obama's Socialist Plot To Ruin America Sends Stocks Soaring."

The gist of these, and many others like them, is to discredit economic critiques against socialism and statism. The logical axis upon which they all pivot is that conventional wisdom believes Wall Street and socialism are at odds, if not polar opposites. Therefore new highs and booming stocks confirm that either Obama's economy is not as bad as he is blamed for, or that if he is embedding socialist tendencies they aren't as harmful as suggested. But rather than end the debate there, it only advances the inquiry to stock prices themselves.

By far the best performing market anywhere continues to be Venezuela. Despite being down almost 15% YTD, the Caracas Exchange Index is up an impressive 245% in the past 12 months. Since 2009, the index has risen just over 5,200%, handily beating either the Dow Jones or S&P 500, or even US biotechs, meaning even heavy socialism is not necessarily an impediment to stock prices.

But it is very interesting that "real" socialists are decrying the current state of the economy. The prime target for criticism is exactly the financial world. The World Socialist Web Site, an avowed Marxist organization of the International Committee of the Fourth International, was not at all happy about "five years of Obama's recovery."

Yesterday, at the end of stock trading for the week, the Dow Jones average closed at 16,452, up a colossal 10,000 points over five years, or 154 percent. The S&P 500 stood at 1,878, rising even faster than the Dow, gaining 170 percent over five years.

These are only the most striking of a barrage of numbers reported in recent weeks demonstrating that the Crash of 2008 has been used to engineer a historic redistribution of wealth in favor of the US financial aristocracy.

The wealth of the parasites who own the bulk of stocks, bonds, hedge fund shares and other financial instruments has never been greater, and is growing at a record pace. The wealthiest 1 percent of the US population raked in 95 percent of all income gains between 2009 and 2012. As reported by the WSWS earlier this week, the world's billionaires saw their combined wealth soar more than $1 trillion last year alone.

Given that the major campaign theme this year from one side (particularly those on MSNBC and the Huffington Post) is to be income inequality, there is more than a little dissonance between all these conclusions. Socialists use Wall Street on the one hand to burnish economic credentials, while on the other appealing to massive and rising inequality. The bright spotlight of attention in this area has been focused steadily on Piketty's Marxist update. According to all the fuss, there is little doubt about where his sentiments fall (I have not read his book, nor do I intend to since I once was forced to read Das Kapital, Kritik der politischen Ökonomie, though fortunately not in German).

The modern update through Piketty, and the "revelation" that has brought him American fame, is that the return on "capital" has exceeded economic growth for some time, exceeding any possible productive proportion - dating back curiously to the early 1970's without mention of the major event that took place in August 1971. That can only mean, so they believe, inequality is due to a rigged capitalist system, one in which the "financial aristocracy" gains solely at the expense of the worker.

That isn't quite what the actual data says, however, according to other French economists critical of Piketty's methodology. These economists pull apart his idea and measure of capital to find that only one component is actually responsible - housing. It is more than odd to include home prices in the calculation for the return on capital across the economy as it plays no real role as to what capital actually is. There is, of course, the limited sense of it as when owners of homes rent out shelter, but the vast majority of homes do not fall under what would fairly be called capital.

Take out housing and the reduced definition of capital shows no such tendency to stretch inequality so far.

"It is worth noting that "productive" capital, excluding housing, has only risen weakly relative to income over the last few decades. Over the longer run, the "productive" capital/income ratio has not increased at all."

If that is indeed the case, and these French economists make a very good one, then the primary culprit of all this socialist angst is housing finance. As if we needed a reminder, orthodox literature assigns housing as the primary channel through which monetary policy flows - or at least once did.

But that is not necessarily the same thing as the argument over capital, though it is so very close. In reality, the ownership of housing is predicated on credit; so too is the eventual price trajectory (housing more so than even stock prices). It is not enough, monetarily speaking, for home prices to rise, there has to be a parallel growth in credit to not only facilitate that rise (create it in the first place?) but to open a credit channel so that home owners may turn home equity into the "wealth effect."

It is an incredibly inefficient arrangement, one that I have likened to the weakest of all the fundamental physical forces: gravity. It takes an immense credit explosion just to see only minor "leakage" into the real economy - that was the whole story of the housing bubble.

"We know unambiguously that the recovery and "boom" period after the 2001/dot-com recession was, by far, the worst in American history to that point - particularly with regard to the labor market. Yet, that occurred directly alongside an asset bubble of biblical proportions. In other words, it took asset inflation on an immense scale to generate even the relatively weak economy that we saw last decade."

Who was impoverished by the net results of that bubble? Those that actually engaged in the "wealth effect" were disproportionately dragged down by debt. Those in the upper income tiers were far more likely to simply "benefit" from the rising tide of housing prices without suffering the downside of over-indebtedness. In other words, the housing bubble, as all asset bubbles, is disproportionate in its boost both before and after collapse. The "little guy" is left on the short end every time.

Opposite those net losers was the entire bulwark of finance. The banks went through an undoubtedly rough and uncertain period during the crisis, but there are very few remnants of it in their current operations and outlooks. The profits of financial firms peaked in the fourth quarter of 2006 at about $400 billion. That was surpassed easily by the end of 2011, and profits in the last quarter of 2013 totaled a new record high of $472 billion. While financial firms have roared back, jobs remain ridiculously elusive - we still have not returned to the 2008 peak in employment (and remain several million behind in full-time positions). Financialism, as I said above, is incredibly inefficient in the real economy, but now moving even further in that direction.

Before 1981, financial profits only exceeded 20% of total corporate profits on one occasion, and that was due to the 1970 recession's effects of depressing business. From 1947 until 1980, financial profits averaged less than 14% of total corporate profitability. That ratio rose steadily throughout the 1980's, from about 14% in 1980 to about 30% just before the 1990-91 recession. From 1993 until the peak of the housing bubble, financial profits averaged just less than 30%. And since 2010, the ratio has averaged just above 27%. The economic system as it has existed since the early 1980's has now oriented to financial saturation to the point that from one-fourth to one-third of all business profits are derived via financials.

The ascendancy of financial domination to such a degree carries with it the very same ideas that were expressed by the FOMC members in 2008. It can lead to nowhere but concentration; such is inevitable. If you want to classify it as income inequality, fine. In truth, it is a mixture of cronyism and fascism, the sum total of intense monetarisms. The inefficiency to which it all infects the real economy is what ends up as socialists' collective ire. What it is not is capitalism.

To look past the obvious link between such monetarism via credit and stock prices is to be blind to the almost perfectly linear relationship between corporate credit and repurchase activity. It is a direct pipeline between the Fed's brand of central planning (controlling the price of risk is not capitalism) and asset inflation. That it fits within former Fed Chairman Bernanke's espoused policy goals for the broader "wealth effect" only confirms in words what is common sense and intuition. What are stock prices telling us, as bubbles, that capitalism is alive and well and wreaking havoc on the "working class", or that perhaps stock prices are a policy tool of a different brand of socialism?

The founding concept of the current state of monetarism is that the economy is not an aggregation of individual decisions and desires being acted out freely in various markets. Rather, monetarism posits, as do socialists, that the economy is a social concept that "belongs" to us all, and therefore must be guided by the "prudent" stewardship of the preferable technocrats produced by Ivy League economic schools. That view overrides any considerations for individual agents and actors, and opens the door to endless abuse in the name of "for your own good." That includes repression in savings and prudent individualism, and, when paired to rational expectations theory, purposeful misdirection and even outright lying to you about the state of the economy or any markets (FAS 157). It is now a fundamental precept of economic and financial reality that you must be fooled into acting according to the "optimal" pathway assigned by the PhD calculations and models.

In that paradigm, every financial factor is a policy tool of the state. They have appropriated the language and mannerisms of free markets and capitalism, and they even think themselves of it, but it is nothing of kind. Apologists can proclaim that the Fed is independent of the government, but that misses the broader point here. Whatever its relationship with the government, it is an accumulation of economic and financial power of immense proportions that seeks control over the economy, using the tools of financialism to attain and maintain it. That the results of that concentration are horrible and offend everyone's sensibilities and designs of fairness, enduringly so it seems, is not the fault of markets or freedom.


Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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