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Joseph Stuber
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Joseph has been an analyst, investor, and student of economic theory; money and banking; and statistical methods for evaluating and implementing risk/reward trading algorithms since 1972. Joseph is also an occasional contributor to financial publications and his essays are frequently cited by... More
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  • Are We Really This Stupid? Well, Maybe So.

    Who owns the Federal Reserve? The banks, and as a practical matter, just the big banks. Who regulates the Federal Reserve? Since 2000, and thanks to Bill Clinton and the Clinton Congress, the answer is nobody. Could the Fed have had a malevolent plan all along? If so, what was it?

    The Fed's long term plan - a thesis in support of a malevolent intent

    In 1981 Paul Volcker raised the Fed Funds rate to 19%. That produced a recession that lasted until the end of 1982. Since then the Fed has engaged in a steady policy of lowering the Fed Funds Rate, but with occasional interruptions in the trend. Each recession - 5 in total - was ended when the Fed lowered the Fed Funds rate.

    That policy tool was of no further value when the Fed lowered Fed Funds to zero in 2008. Household debt had reached peak. There was no more fuel in the tank for that driver of economic growth.

    (click to enlarge)

    The red line is the benchmark Fed Funds rate. It fell steadily until it hit zero in 2008. The blue line is household debt. It increased steadily until 2008. We were able to borrow and spend until 2008, even without incomes increasing, since lower interest rates allowed us to keep spending. In 1982 a 30 year mortgage P&I payment of $730 serviced a $50,000 loan. Today a $730 P&I payment services a loan of $150,000. We got a lot of GDP growth from this economic policy model while it lasted. But, with income growth stalled out, and actually on the decline, and interest rates as low as they could go, there was no driver of economic growth left in that model.

    A new plan emerged - drive GDP growth by deficit financed public spending.

    The red line shows that household debt peaked in early 2008 and began to actually contract for the first time in over 40 years. The blue line shows that the government's response was to borrow and spend at unprecedented levels, and all we got out of it was an economy operating at just above stall speed.

    For one who has a very solid grasp of macroeconomics coupled with a very solid grasp of the fractional reserve money creation system, it was obvious back in 2012 that the Federal Reserve's monetary policy had virtually no way to impact economic growth. When the Fed began their unconventional monetary policy of buying government securities from primary dealer banks there was simply no benefit whatsoever to the broad economy. All the Fed was doing was pumping money into the banks excess reserves account, not the economy.

    In hindsight many will be able to see these points, but not yet. All the pundits are still asking for more QE. But, it was an absurd process to start with, and it is over. What is most disconcerting for me is that the Fed expanded money supply in the risk asset system in ways we've never seen while reducing the supply of risk assets in the system. They created inflation in the risk asset system, and did nothing for economic growth.

    But why would they do that? I've been asking myself that question since the Fed initiated QE3. It made no sense if the Fed's goal was to stimulate economic growth. Expanding money supply is the best way to create economic growth and it has been the way we've always created economic growth. Here's why:

    GDP = Money Supply (M2) X Money Velocity (M2V)

    QE3 didn't expand M2 money supply. It did expand bank reserves though. And to fully develop this thesis one needs to understand how this worked.

    The Fed's plan all along - indebt the world and foreclose. Sound conspiratorial? It is, but that doesn't make it less true. First bury the private sector in debt; then bury governments in debt trying to keep GDP growth in positive territory; then bury corporations in debt by getting them hooked on stock buybacks; and then foreclose on the world by stepping aside and letting the market crash.

    (click to enlarge)

    As of yesterdays close, the S&P (NYSEARCA:SPY) is almost 6 standard deviations below mean. I'm not sure you will find a precedent for that except for the 1987 crash. Here is what that one looked like:

    (click to enlarge)

    The difference between 1987 and today is reflected in this chart:

    (click to enlarge)

    A 30 year conventional mortgage rate was 10.65% in the 4th quarter of 1987. There was a lot of GDP growth left in the private sector "borrow and spend" model with interest rates at 10.65%. Just keep lowering rates which lowered payments allowing private sector borrowers to borrow and spend more and more even without income growth. Today we don't have that option. The benchmark Fed Funds rate was lowered to .07% in 2008.

    What's most frustrating for me is that we continue to speak of the United States as doing better economically. That is nonsense. We have only been able to maintain GDP in positive territory due to deficit financed government spending since 2008. Again, when the Fed buys assets from primary dealer banks they don't do anything at all to increase M2, and therefore do nothing to expand GDP.

    Without the $9 trillion in government spending we've seen since 2008 GDP would never have been above the zero line - not one time. The government has pumped an average of $1.2 trillion per year into the economy since the beginning of 2008. That means the government's deficit spending has contributed 8% per year on average to GDP growth (and that is without accounting for M2 velocity), and GDP growth has averaged 3.2% since 2008.

    The question from the title - "are we really this stupid" - is a reasonable question considering pundits still talk about the need for more Fed intervention to halt the market sell-off. If we want more GDP growth, more top line sales, and more corporate profits then we need to be asking this question - when will Congress agree to up the debt ceiling so we can get back to $1.2 trillion a year in deficit spending? That made a difference, but the Fed's QE policy never, ever, ever made a difference. Not ever.

    Monetary policy worked when the Fed could lower interest rates. And, every time we went into recession that is what they did to come out of recession. They lowered interest rates. And why did that matter? Because with lower rates private sector borrowers could borrow and spend more money and that is what drives GDP.

    (click to enlarge)

    Readers may not get this point, but I assure you those who set monetary policy get it. The Fed's ability to impact economic metrics ended when the Fed Funds rate hit zero. And, the chart above that shows household debt stalled out when the Fed went to ZIRP proves that fact. So, again why do the pundits keep talking about the need for the Fed to do something?

    I guess they mean the Fed should do more QE. But with Congress intent on reducing the deficit one wonders what exactly they will be buying? This is pretty basic stuff for economists - or at least it should be - so why do we keep up the rhetoric about the Fed doing more? And, more importantly, why did the Fed engage in a policy they knew would have no impact on economic growth? And don't tell me they didn't know that unless you can also tell me how QE translates into economic growth.

    But it is really much worse than that. The Fed did have a plan, and their plan worked. The plan - create a bubble in risk assets. But the question is why would they do that? And the answer, to me at least, seems obvious in hindsight. Look at this chart of excess reserves:

    (click to enlarge)

    A good analyst should look at these things. And, they should ask the question - why is this happening. Unfortunately nobody does, at least nobody I know of but me. Cash is king in a crash. It is directly, and inversely proportional to any asset you might choose to buy with that cash. If you have $100,000 and choose to buy a stock with it, and that stock falls in value by 50%, had you stayed in cash you could have bought twice as many shares after the crash. Despite all the pundits who say you must stay invested for the long term, that is not always true, and in fact there are times where the very best investment you can make is in cash.

    That is where the banks are today. On the other hand, the private sector reached peak debt in 2008; sovereign governments are at peak debt today; corporations have chosen to engage in trillions of dollars of stock buybacks at market peaks, and borrow money to do so; and the banks are massively long cash. And, now the bubble has burst. Who is the winner here? The banks. Who is the loser? Everybody else.

    Concluding comments

    On August 6 of this year I made this comment in A Brief Respite Before Surging To New Highs? Maybe Not This Time.

    As I noted above, with the exception of my call in 2013, my market commentary has been very negative, but I have not made a top call. As far as I am concerned the answer to the question - is this a distribution top or merely a consolidation - is that it has all the characteristics I would require to call it a distribution top.

    And, I think it is important to make note of the fact that I haven't been as wrong as my detractors like to claim in terms of market calls. My message has been a consistent one - don't trust this rally, be cautious, hedge, don't assume cash is a bad place to be, and don't become complacent.

    My biggest detractor for the last several years made this comment the other day:

    I had to amend many items for this weeks missive as the swiftness of the market downturn was simply mind boggling. It is at times like these, that an investor needs to look at the situation, stay grounded, and not let their emotions take over.

    Mind boggling to who is my question? Here are a few more of my August 6 comments:

    Investing is all about allocating money, and the goal is, or should be, to reduce risk and maximize return. Bubble markets always produce great returns for as long as they last, and so it is relatively easy for those steeped in the bull market always mindset to revel in their acumen while the bubble continues to inflate. Those who claim great wisdom during market bubbles are quick to point out that they have been right. But when bubbles burst they tend to simply retreat from the scene.

    They are one dimensional, and beat their chest about how they have been right and those who disagree with them have been wrong. There is a problem with that though when they disparage those who disagree with them by misstating the truth. The comment above about the "author's history" is an example, and again one dimensional. My history needs to be viewed in total, not just a single wrong call. I have pointed out a number of articles that set forth my thesis for why this is a bubble; why it is not a long term trend in stocks based on economic growth; why it is a manufactured market much like we saw with the housing bubble; and why it is highly risky to take a long term buy and hold position in this market. I have also pointed out that I made a bad call in early 2013, but since that date have consistently stated that we could see more upside in stocks, but that the economy is in real trouble. Those comments are part of the "author's history", and those comments haven't been wrong.

    What is most ironic is that my latest article, published just a few weeks ago, and pointing out that the top looked to be in, only had 960 page views, and the one prior to that on July 30 of this year received even fewer page views. By contrast, my article in September of last year - Anatomy of a Market Bubble - received many thousands of page views and over 500 comments.

    Maybe readers just got tired of my warnings. I don't know, but I do find it disheartening to say the least. My warning was so important to me that I actually requested that Seeking Alpha feature the article as an editor's pick. They chose not to do so. On August 6 the S&P 500 put in a high of 2103, and closed at 2083. Yesterday it closed at 1867 - 11% lower in just two weeks - and wiping out 18 months of gains in that very short window of time.

    I will close with this - at some point we will retrace a portion of this market sell off. We always do. But, when markets crash this bad, and this fast, they don't bounce back that fast. My guess is we will continue to fall, with some up days in the mix, clear back to the 2012 highs before we find sufficient support for a spike higher. At that point a 50% retrace would seem probable, but that retrace may not even bring us back to yesterdays close.

    If this bull market were based on anything but a Fed induced bubble I would be less pessimistic, but it isn't, and it never was. We are at a seminal moment in our history where we must make change. Growing economies based on a debt model that is dependent on lowering interest rates simply doesn't work when interest rates are already at zero. The Fed never was your friend. They engaged in policy that enhanced the position of their owners, and the people don't own the Fed. One must ask this question - why has the Fed gone silent this time? And, for my money the reason seems apparent, they are now ready to allow the bubble they created to burst.

    Consider this - if the market reverts to its long term 100 quarter mean (a level we last saw in March of 2009) - we will fall by over 50%. At that point the big banks could simply use their excess reserves to create trillions of dollars in new money, and then lend the money to their subsidiaries allowing them to buy every single share of publicly traded stock in the United States. That is mathematically possible today. It wasn't possible in 2008.

    Aug 26 7:46 AM | Link | 5 Comments
  • A Solution For Creating Stable Economic Growth And Why We Will Never Implement It - Part 2 Defining The Solution

    Reading Part I of this two part series - A Solution For Creating Stable Economic Growth And Why We Will Never Implement It - Part 1 Defining The Problem - seems a necessary prerequisite to reading this second part so if you missed Part 1 you might want to check it out before reading Part 2.

    I concluded Part 1 with this statement and it seems a good starting point for Part 2:

    The second part of this two part series has to do with one issue - restoring a balance of power to the middle class. The ideas presented will be perceived by some as radical. In fact I find them very radical myself and will readily admit that I have been very slow in coming to these conclusions - especially the one that relates to our system of fractional reserve banking.

    The truth of the matter is this - we are so heavily burdened with debt today that we simply can't overcome it by growing the economy. The magnitude of unfunded liabilities is so extreme and the demographic structure that these unfunded liabilities are dependent on are so out of kilter that there is no way we can continue to kick the can without dire consequences. The situation calls for radical change and that is what I would like to see happen. Will anybody listen? Probably not - at least not until all other measures have proven futile.

    This problem is not unique to the United States though. It is global in scope but with that caveat properly explained I would still suggest that the following comment from Winston Churchill states the course we will follow:

    You can always count on Americans to do the right thing - after they've tried everything else.

    The solution as I see it is multi-faceted but the primary focus is on the nature of the fractional reserve bank system that we are so dependent on today and the courts interpretation of the Sherman Antitrust Act that presumes corporations will be allowed to grow unfettered so long as the consumer gets a good price on goods and services. I readily admit that the solutions proposed here are merely a framework or foundation but I am not at all convinced that the solutions are not in fact very simple. As one close associate of mine stated:

    "The ideas are so simple and so logical that they will never be implemented."

    What's wrong with a fractional bank system?

    There are many pundits and politicians who are highly critical of the Fed and think we should do away with the central bank altogether. There are others who attribute way to much power to the Fed in the first place. Many are convinced that QE is either a magic elixir for all our economic ills or a tool that is certain to lead to massive inflation and economic destruction at some point.

    For the most part these views are formed more as a result of the esoteric and abstruse nature of our banking system that leaves most in the dark rather than any substantive proof of either position. The Fed's QE program has done almost nothing except keep a lid on interest rates. The empirical support for that view is substantial but only if you really understand QE and the fractional bank system in the first place.

    I cringe when I hear pundits say the Fed is flooding the system with money. As with all conspiracy theories - and the idea that the Fed is printing money and destroying the dollar is in fact a conspiracy theory - there is an element of truth to it but the fact remains the Fed can't just create money out of thin air as many think. They can however, initiate the process whereby the banks do create money out of thin air but it is the banks - not the Fed - that are creating the new money.

    I have to qualify that statement by first defining the term money. For purposes of this discussion money shall mean M2. M2 is substantially comprised of bank deposits and represents a liability to the bank. M2 is also what feeds inflation and inflation - up to a point - is a good thing.

    Some readers understand what happens with QE but others don't so for those who do my apology but I think the best way to explain this is to use a simple T-account presentation of the process. The graphic below starts with a simple transaction - a customer of a bank makes a deposit.

    As with any transaction in a double entry accounting system a debit and a credit is required. When a customer makes a bank deposit the debit side of the entry is bank cash and the credit side is customer deposits. The debit is to a bank asset account and the credit is to a bank liability account. Understand this - your deposits in the bank are a general and unsecured liability in most instances and the bank is free to do what it wants with your money within the limits of the law.

    Some assume that banks lend that money to other bank customers but that is not really true in a fractional bank system. The banks don't need your money to create a loan. I will get to that transaction in a minute but first let's move to the next step. The bank can't make much money simply sitting on your cash so they decide to invest it. If they leave it in cash the Fed will pay them .25% on the cash but a quarter of a percent is not a good deal. Let's say the bank decides to buy a 10 year US Treasury bond with that money.

    The above transaction is a simple one. The bank doesn't want to sit on the cash as they can earn no income on cash so they buy a US Treasury bond - maybe a 10 year that is currently earning roughly 2.9% - a lot better than .25%. The accounting entry is a simple credit to bank cash and a debit to the banks Securities account.

    What's important here is that M2 did not increase on the banks books but M2 did increase and here is why. The money the bank spent was from their cash reserves and not part of M2 but once they pay for the bond and remit the cash to a third party then that third party will deposit those funds in a bank account and that then becomes new money - new M2.

    The above statement is true but with one caveat - if the bank buys a new issue bond from the Fed or a bond from another bank that does not increase M2. It is only when the money the bank spends for the bond ends up in a bank checking account that M2 increases.

    More to the point though is if M2 increased it had absolutely nothing to do with the Fed or QE at all. Now what happens when the Fed buys the bond from a bank under QE.

    The entry to record QE is nothing more than an asset exchange on the books of the bank. The debit account is bank cash bringing the bank's total cash right back to the starting point at $100,000. And the bank's Securities account goes right back to the starting point at zero. The only accounts that have balances in them under this simplistic example are the bank's cash account - an asset - and the banks customer deposit account - a liability. QE itself did nothing to increase M2 money supply.

    However if the bank then buys another bond from a 3rd party then M2 will once again be increased by the amount of the bond purchase as the recipient of that cash will deposit it in a bank somewhere and the aggregate amount of customer deposits will go higher. The point is the bank can do this over and over and the Fed is not a necessary part of this expansion in M2. It is just the way the system works and it is in no way dependent on the Fed's QE.

    Now to the matter of lending. The bank also has the right to make loans but they don't lend the money that they have in their cash account. Here is the entry if a bank makes a loan for $100,000.

    Here is the really cool part if you are a bank. The entries to record the loan are a debit to an asset account - Loans - and a credit to a liability account - Customer deposits. The banks cash account was not affected at all in this transaction and that is the beauty of the fractional bank system if you are the bank.

    When we started out the bank had $100,000 in assets and $100,000 in liabilities. Then the bank bought a bond with bank cash. We still had $100,000 in assets and $100,000 in liabilities. Then the Fed bought a bond from the bank. Still $100,000 in assets and $100,000 in liabilities. Then the bank made a loan to a customer. Now the bank has $200,000 in assets and $200,000 in liabilities.

    What is particularly advantageous in this scenario is that the liabilities in this instance earn the bank a small service fee while the loan earns an interest rate - perhaps 3.5% if it's a prime rate loan. The bank can do this over and over again and the only limit is that the bank maintain a cash (reserve) balance of at least 10% of customer deposits. Under the example above the bank has $100,000 in cash and $200,000 in deposits so they have excess cash reserves of $80,000. If they make another loan then the banks interest earning assets jump to $300,000 and their excess reserves go to $70,000. The next time the banks interest earning assets go to $400,000 and their excess reserves drop to $60,000.

    That is how the fractional reserve system works and the truth is the Fed can facilitate an expansion in M2 but cannot actually create money (M2) but the banks can create money and they don't need the Fed's assistance through QE to do so. All the Fed has done with QE is put massive downward pressure on rates as they have been aggressive buyers of US Treasuries. It is a supply/demand function and impacts interest rates but has nothing to do with expanding money supply. That is a function of the banks - not the Fed - and the banks don't need the Fed to expand money supply.

    One more distinction that seems particularly relevant here is what happens to the new money under these scenarios. If a bank buys a bond from a non-bank 3rd party that third party is likely to buy another investment - stocks or bonds for instance. In that situation the newly created money does almost nothing to stimulate economic growth as it is never spent on goods and services and therefore has no impact on demand and therefore no impact on unemployment.

    That is distinctly different from the more traditional approach to money creation that involves a loan to a consumer or a business. In that instance the money created is spent to drive economic growth. In the QE fueled money creation scheme the money is simply reinvested in risk assets and inflates the price of these assets.

    That is a very flawed business plan if one's goal is as the Fed states which is to improve employment levels and stimulate economic growth. What's most disturbing to me in this situation is that the Fed knows this and yet they have continued the process. In fairness to the Fed it can be argued that they were simply keeping a lid on interest rates and providing a very big market for US Treasuries which has allowed the government to engage in massive deficit spending which has been a positive for GDP growth.

    So back to the question - what's wrong with a fractional reserve bank system? Nothing in an environment where fiscal stimulus is not needed and the banking system is focused on economic growth. Everything if the banking system is used to exploit the middle class by creating boom/bust cycles as they have done pretty much from the beginning.

    Going back to the creation of the Fed 100 years ago we've had 18 recessions - one recession every 5.5 years. That means that most of the time over that 100 year period fiscal stimulus has been needed to keep the economy in positive territory and that stimulus was only possible through the government's deficit spending. We know that because we can look at a debt to GDP chart and see it.

    The chart above shows both metrics as opposed to the single line ratio that we usually see and demonstrates that we have driven GDP at an ever accelerating rate beginning in the early 80's by debt financed fiscal stimulus. That is a problem in that the debt burden must fall on the taxpayer and it is that taxpayer that fuels 70% of GDP growth.

    So back to the question of what's wrong with a fractional reserve bank system. The answer is simple enough - the United States delegated their constitutional right to print money to the fractional reserve banks meaning that rather than the government simply creating money out of thin air and spending it we allow the banking system to create the money out of thin air and loan it to the government who then spends it.

    The debt burden that the government incurs falls on the taxpayer and requires at some point an increase in tax revenues which shrinks disposable income and dampens GDP growth resulting in more lay offs and a smaller tax payer base to absorb the payment obligations of an ever increasing debt. The math doesn't work and the winners in this process are the banks who get bigger as their interest bearing assets grow.

    The following graphic illustrates how this all works - just follow the money. We start with the bank lending the government money by buying a bond. As the government spends the money it moves into the hands of the consumers and they deposit the money moving it back into the banks. At this point the bank has the cash back that it spent to buy the bond and they still have the bond. Then the consumer spends the money but it still remains in the banking system in the aggregate and the process is repeated.

    A solution to the problem

    The solution to the problem is simple - the US government creates the money out of thin air instead of allowing the fractional bank system to do so. Who benefits - the consumer/tax payer. Who loses - the banks.

    Some might suggest this could lead to high inflation but not if the M2 creation was formulaic and dependent on a combination of GDP and M2 velocity. Here is the formula:

    M2 = (GDP/M2 velocity) x 1.05

    Using the 3rd quarter of 2013 to arrive at the M2 cap the calculation would be as follows:

    (16.9 trillion/1.57) x 1.05 = $11.3 trillion

    As of the end of the 3rd quarter of 2013 the actual M2 level was $10.709 trillion meaning that the cap on M2 allowed for an increase of $600 billion.

    Keep in mind we are talking fiscal stimulus here so the idea would be to get the extra $600 billion in the hands of consumers in order to increase aggregate disposable income. The distribution could be treated as a direct tax credit with each taxpayer receiving a pro-rata share of the disbursement. In 2012 the numbers of taxpayers was 239 million meaning the payout would be $2510 per taxpayer.

    The banking system would undergo a major transformation under this scenario in that the fractional reserve provision would go away. Banks would still be required to maintain reserves equal to a percentage of deposit liabilities but they would no longer be able to create money through a bookkeeping entry.

    Assuming a bank had $10 billion in deposits and the reserve requirement was 10% the bank would be allowed to loan $900 million. That would mean the banking system could not expand or contract money supply and that would be a necessary provision of the system for the simple reason that the private sector banking system could effectively expand or contract money supply at will under the fractional reserve arrangement bringing us right back into the boom/bust cycle of the last 100 years.

    The check valve would be controlled by the US Treasury and total money supply would be regulated through the tax system with tax credits issued periodically when M2 needed to be increased and tax increases being imposed when M2 needed to be reduced.

    The overall tax burden would fall appreciably over time as fiscal stimulus would no longer be funded by credit and the national debt would in time disappear as US Treasuries were very, very slowly phased out. The reason I say very slowly is that retirement of Treasury debt would push M2 higher and would necessarily produce unwanted inflation - not in consumer prices but in investment assets.

    One way to deal with outstanding Treasury debt is to convert all short term debt to 30 year terms as the short term debt matures. The new issues would be 30 year duration and set to fully amortize over the term with say a 6% interest rate. Annual payments to fully amortize $17 trillion in debt over 30 years would be roughly $100 billion a year.

    To insure that this additional M2 expansion would be used to drive GDP the denominations could be very small - perhaps in the $5,000 to $10,000 range. That would attract small investors looking for income rather than large investors looking for capital appreciation. The income would be spent and work as a driver of GDP whereas those who currently hold Treasuries simply re-invest the cash in other investment assets and the increased M2 inflates and drives investment assets higher - not GDP.

    A progressive tax structure would need to be implemented. The goal would be focused on one thing - increasing demand for goods and services. Since lower income households spend a much higher portion of their income than the higher income group the greatest good in a tax structure arrangement would be to leave as much income as possible in the hands of those in the lower income strata.

    That arrangement may seem to punish success and perhaps there is some truth to that but it is still the best arrangement provided it isn't to excessive. Some have floated the idea of a national sales tax or a flat tax as a good solution but from a macro economic perspective such an arrangement would work to inhibit GDP growth.

    Consider one household earning $250,000 after tax income and spending 65% of that income compared to 5 households earning $50,000 and spending 90% of their income. The $250,000 household is adding $162,500 to GDP whereas the 5 households earning $50,000 each are adding $225,000 to GDP.

    To fully appreciate the magnitude of the problem we are faced with today one need only look at the gap between government expenditures and government tax receipts. The blue line is the expense side and the red line the receipts side.

    Here's a novel idea though - what happens if a tax holiday were put in place for those in the lower income strata. The goal would be to reduce tax receipts by $1 trillion. The impact to GDP assuming M2 velocity of 1.5 is that the added disposable income would increase GDP by $1.5 trillion.

    Applying the M2 expansion formula to GDP the new GDP would be $16.9 trillion + $1.5 trillion = $18.4 trillion. So the new M2 cap would be calculated as follows:

    ($18.4 trillion/1.5) x 1.05 = $12.9 trillion

    The old M2 cap was $11.3 trillion so that would allow the government to add an additional $1.6 trillion into the system through tax credits. One could argue that the gap isn't being closed between government expenditures and government receipts with this strategy and that is true but does it really matter? After all the government debt level remained flat and we are seeing more disposable income in the hands of those in the lower income strata that will spend most of that money and in so doing push demand higher.

    Admittedly this is a hard leap to make for most people but keep this in mind - personal income tax in a situation where the government doesn't borrow money takes on an entirely new role. Taxes in this paradigm are increased or decreased as needed to speed up or slow down GDP growth and to keep inflation in check - not fund an ever growing government spending machine.

    Here is the elegance of such a scheme - the overall tax burden would fall for everyone and debt levels would still fall. Under the scenario above our debt to GDP ratio would drop by about 8% merely as a result of the $1 trillion tax holiday in the first year and about 10% in the second year.

    Keep in mind the tax credits in no way impact government spending levels - they just impact government receipt levels and some provision would be needed in this new paradigm to define the appropriate level of government contribution to total GDP. Ideally we would set a ratio of public/private employment that expanded the private sector rate from current levels and contracted the government sector rate. Again a formulaic relationship would be established between public and private sector just as the M2 formula would establish the level of M2 expansion based on GDP levels.

    The arguments of those who would oppose this arrangement

    The primary argument against those who would oppose restoring the right to print money to the government and taking it away from the fractional reserve banks is that it would remove the checks and balances of the current system and produce massive inflation. My response to that is why would things be any different if the government held the reins of control instead of the banks?

    The fact is the banks can and do produce periods of inflation and disinflation with an occasional period of deflation. The chart below demonstrates that fact:

    The most important element of the proposal offered here is the idea that M2 would be set at a level that is formulaic and printing of money in excess of the cap would be prohibited. My own view is that M2 adjusted by M2 velocity needs to be a little larger than the previous years GDP to produce growth; a little smaller than the previous years GDP to contract growth; and ideally M2 left unchanged from the previous year would produce a flat line on GDP.

    The 1.05 multiplier allows for an increase of just 5% and no more which should produce the desired GDP growth that would support an increasing population adequately. That said the tools would exist - and in a much simpler and direct form than is currently in place - to suppress inflation if it were to become problematic by simply raising the tax rate on income and in so doing reduce M2 and disposable income.

    It is an incredibly simple concept and there is simply no reason to assume inflation would become more prevalent under this arrangement than under the current system. More importantly the almost immediate impact to M2 and GDP would be preferable to the system that is currently in place. Under the present system the only way to contract M2 and put the brakes on inflation is to deleverage. Deleverage in this sense means the banks must reduce the numbers of outstanding loans.

    The banks typically have no appetite for deleveraging as it impacts their bottom line. There is a definite conflict of interest at work here between the banks desiring profits and the need to keep economic growth on a stable path without significant swings in inflation or disinflation.

    The second argument would be from the gold backed/real money advocates. Those in that camp think currency should be fixed and based on a ratio of units of currency to ounces of gold. One must ask how does such a money system accommodate population growth and the need for GDP growth.

    The US operated under a gold fix to the US dollar of $35 an ounce for about 27 years from 1944 to 1971. The problem was readily apparent - the amount of gold is relatively stable and the idea that total money supply would only increase as more gold was acquired presented a wholly untenable situation. Technically it lasted for about 27 years before we reneged on our pledge but if the truth be known our inability to honor that promise occurred many years prior to the time we acknowledged it publicly.

    If we were able to maintain GDP in positive growth territory which would be crucial to maintaining full employment and we were to do that without expanding the money supply as the population grew it would be an amazing feat indeed. Such an arrangement would have an incredibly deflationary effect as the price of everything began to drop and just kept falling. It was a bad idea when we actually tried it in the years following WWII and nothings changed - it is still a bad idea.

    The problem's not just big banks - it's also really big international corporations

    Judge Robert Bork's book - The Antitrust Paradox - led to case law precedent that overlooks the tendency of corporations to attempt to create monopolistic environments that work to the detriment of the populace in the area of wages in favor of low prices that work to the favor of the populace in terms of cost of goods. Here is how Wikipedia explains Bork's views:

    Bork argued that the original intent of antitrust laws as well as economic efficiency make consumer welfare and the protection of competition, rather than competitors, the only goals of antitrust law. Thus, while it was appropriate to prohibit cartels that fix prices and divide markets and mergers that create monopolies, practices that are allegedly exclusionary, such as vertical agreements and price discrimination, did not harm consumers and so should not be prohibited. The paradox of antitrust enforcement was that legal intervention artificially raised prices by protecting inefficient competitors from competition.

    Bork was right of course on the price side argument but there is more to the argument than just price. The break up of AT&T in the early 80's was perhaps the last major initiative enacted under the Sherman Antitrust Act. AT&T had a virtual monopoly at the time.

    The break up of AT&T had both bad and good consequences. On the bad side some rates did indeed increase but on the good side a number of companies eventually sprung up and now compete with AT&T and those companies employ people.

    Bork's focus was on price and at the exclusion of competition. On the surface it is hard to argue against the efficiencies of scale that allow mega corporations to offer goods and services at low rates but there is - as with most things - an unintended consequence that surfaces. In this case the unintended consequence is the impact on jobs and wages.

    Redundancy it seems has some benefits in that if several companies are delevering the same dollar level of services that one company could deliver each of those companies needs to staff up in a way that is redundant and would not be necessary were those services being provided by just one company.

    There was a purpose behind the enactment of the Sherman Antitrust Act and yet we have fully ignored that purpose for about 30 years now. To sustain economic growth in the coming years we are going to be faced with a dilemma and it is this - should we fully exploit the technological advancements that we have achieved that produce significant efficiencies and major productivity gains?

    Perhaps the best answer is that we should in fact fully exploit those technological advances but move back to a more vigorous enforcement of the antitrust provisions of the Sherman Antitrust Act that allow for the smaller players to compete more effectively with the larger players. The redundancy produced by enforcement of the antitrust provisions would do a lot to improve the employment climate in the US - perhaps as much as an increase in consumer demand resulting from a revamping of the banking system.

    What I find troubling is the degree of control large banks and large companies have assumed in recent decades. As I noted in Part 1 of this series a comparison of large companies and sovereign countries where total sales for the companies and total GDP for the countries are compared the large international companies hold 51 spots and the countries hold 49 spots. In other words of the top 100 economies of the world 51 of them are actually companies - not countries.

    One can only ask - where will we be in another 20 years if this trend continues. As I noted in Part 1 the numbers of banks has declined by almost 2/3rd's in the last 30 years. The same consolidation of control and power has occurred in the corporate realm while the international companies - with no sovereign allegiance - have been allowed to gain greater and greater control.

    Why these ideas will never be implemented

    The reason why these ideas or any other ideas that would work to deprive the big banks and the big corporations of their exorbitant advantage is perhaps best explained by this quote from Nathaniel Rothschild back in 1912:

    The few who could understand the system (cheque, money, credits) will either be so interested in its profits, or so dependent on its favours, that there will be no opposition from that class, while on the other hand, the great body of people, mentally incapable of comprehending the tremendous advantage that capital derives from the system, will bear its burdens without complaint, and perhaps without even suspecting that the system is inimical to their interests.

    Nathaniel Mayer Rothschild, 1912

    Who are the "few who could understand"? The political class - or at least a significant portion of that group - is the right answer. And who are "the great body of people, mentally incapable of comprehending the tremendous advantage that capital derives from the system"? That would be all the rest of us and it is indeed hard to make a case for the idea that the people today do understand the "tremendous advantage" afforded those who control the banking system.

    I am not sure in times past the people had any greater understanding of the matter than the people do today but one thing is certain - our political class in times past did indeed understand. Andrew Jackson had this to say on the matter of central banks:

    The bold effort the present (central) bank had made to control the government … are but premonitions of the fate that await the American people should they be deluded into a perpetuation of this institution or the establishment of another like it. I am one of those who do not believe that a national debt is a national blessing, but rather a curse to a republic; inasmuch as it is calculated to raise around the administration a moneyed aristocracy dangerous to the liberties of the country.

    It was not only "dangerous to liberties of the country" it was also dangerous to the health of those who stood in opposition to those who would attempt to control through the manipulation of the system to their advantage. The following excerpt from Wikipedia explains the attempted assassination of Jackson:

    On January 30, 1835, what is believed to be the first attempt to kill a sitting President of the United States occurred just outside the United States Capitol. When Jackson was leaving through the East Portico after the funeral of South Carolina Representative Warren R. Davis, Richard Lawrence, an unemployed housepainter from England, aimed a pistol at Jackson, which misfired. Lawrence pulled out a second pistol, which also misfired. Historians believe the humid weather contributed to the double misfiring.[60] Lawrence was restrained, and legend says that Jackson attacked Lawrence with his cane. Others present, including David Crockett, restrained and disarmed Lawrence.

    Wikipedia explains the reason for the assassination attempt this way:

    Lawrence told doctors later his reasons for the shooting. He blamed Jackson for the loss of his job. He claimed that with the President dead, "money would be more plenty" (a reference to Jackson's struggle with the Bank of the United States) and that he "could not rise until the President fell".

    Here are a few more quotes - this time from Jefferson and Adams:

    There are two ways to conquer and enslave a nation. One is by the sword. The other is by debt.

    - John Adams

    If the American people ever allow the banks to control issuance of their currency, first by inflation and then by deflation, the banks and corporations that grow up around them will deprive the people of all property until their children will wake up homeless on the continent their fathers occupied.

    - Thomas Jefferson

    I believe that banking institutions are more dangerous to our liberties than standing armies…The issuing power should be taken from the banks and restored to the Government, to whom it properly belongs.

    - Thomas Jefferson

    Others who were opposed to central banks and the fractional bank system include Abraham Lincoln, James Garfield, William McKinley and John Kennedy. Is it just coincidence that these 4 presidents - all assassinated - shared at least one thing in common - an opposition to the central bank/fractional reserve system?

    Perhaps these narcissistic statements from David Rockefeller best describe the mindset of those who favor a continuation of the status quo:

    We are grateful to the Washington Post, The New York Times, Time Magazine and other great publications whose directors have attended our meetings and respected their promises of discretion for almost forty years... It would have been impossible for us to develop our plan for the world if we had been subjected to the lights of publicity during those years. But, the world is now more sophisticated and prepared to march towards a world government. The supranational sovereignty of an intellectual elite and world bankers is surely preferable to the national auto-determination practiced in past centuries.

    David Rockefeller, Bilderberg Meeting, June 1991 Baden, Germany

    For more than a century, ideological extremists at either end of the political spectrum have seized upon well-publicized incidents to attack the Rockefeller family for the inordinate influence they claim we wield over American political and economic institutions. Some even believe we are part of a secret cabal working against the best interests of the United States, characterizing my family and me as "internationalists" and of conspiring with others around the world to build a more integrated global political and economic structure - one world, if you will. If that's the charge, I stand guilty, and I am proud of it.

    David Rockefeller Memoirs

    Concluding thoughts

    Even the most optimistic stock market bull has to concede that an economy dependent on increasing government debt can't be sustained indefinitely. We have created significant distortions in so many metrics since the end of the recession as a result of this massive and unprecedented accumulation of debt. Withdraw it and GDP moves into recession territory. Continue to accumulate it and the tax burden needed to service the debt necessarily shrinks disposable income and contracts GDP.

    We are at a point where few who really understand these dynamics can sincerely argue in favor of a positive ending. The math just doesn't work. And the problem only gets worse as the unemployment levels of the young are much worse than the overall unemployment rate.

    There are two ways to deal with unfunded entitlements - borrow the money or feed the system from the bottom up. In other words those entering the market will need to provide contributions at sufficient levels to cover the payouts and the prospects for that happening don't look good. What that means is more debt.

    The problem is debt - both existing debt and the continuously accumulating debt. A solution does exist and the ideas I have set forth above would go a long way toward resolving the problem. These ideas are so simple and straightforward and they would work if properly implemented.

    That said - I hold out little hope for such an outcome. As Nathaniel Rothschild said about 100 years ago . . .

    . . . . the great body of people, mentally incapable of comprehending the tremendous advantage that capital derives from the system, will bear its burdens without complaint, and perhaps without even suspecting that the system is inimical to their interests.

    Jan 22 6:18 AM | Link | 8 Comments
  • A Solution For Creating Stable Economic Growth And Why We Will Never Implement It - Part 1 Defining The Problem

    We've experienced 18 recessions since the creation of the Federal Reserve in 1913. That works out to one recession every 5.5 years on average - hardly what one would call a stellar success in terms of managing the economy. The chart below is the Fed's version of the inflation adjusted Dow dating back to the period just prior to the creation of the current Federal Reserve central bank system.

    Perhaps most significant is the period of time we have spent in a secular bear market if one defines a secular bear market as the period of time spent after an all time high in real terms before a new all time high in real terms occurs. Using that definition we have spent considerably more time in secular bear market territory than we have in secular bull market territory. The periods reflected inside the red boxes are those sideways trends that constitute a secular bear market by the definition I am using.

    I don't want to start a debate on the definition of a secular bull/bear market here so would ask that readers understand that I recognize my definition is certainly not universally accepted. It does however, allow me to illustrate the point that in real terms the impact of inflation creates a situation where most of the time real gains are not being realized through stock ownership.

    That statement is certainly not intended to imply that stock ownership is ill advised and in fact stock ownership is one of the best ways to at least negate the impact of inflation on one's purchasing power and produce real gains over time as the inflation adjusted chart above reflects. One who bought the Dow in the early 80's at the inflation adjusted low of roughly 2000 would have been in pretty good shape even at the 2009 trough in inflation adjusted dollars. In fact one would have experienced a 4 fold increase in value expressed in real terms even after the market crash.

    That said, timing is of some significance here as one who had bought the bubble peak in 1929 would have waited around 30 years to register any real gains. The same situation applied to the early 60's peak. If one had bought that peak he would again waited almost 30 years to realize any real gains. In both instances a long term investment strategy where one is constantly making contributions over the course of the full cycle would lower the average cost of stocks and produce real gains on the aggregate holdings in a significantly shorter time frame than 30 years.

    Notwithstanding the fact that a long term strategy of investing in stocks would have produced significant real dollar gains over time the recessions become very problematic. Stocks are driven higher by increasing profits and that is a function of GDP growth in the aggregate and GDP growth is stalled out in a recession.

    It is generally agreed that roughly 70% of GDP is consumer driven and most of that consumption comes from the middle class. In a recession companies necessarily must cut costs and the biggest cost in most companies is labor. The conundrum is this - as unemployment climbs higher there are fewer dollars being spent and that exacerbates the problem of GDP growth. The result is a feedback loop with more and more consumers being laid off thus reducing GDP and necessitating even more lay offs.

    If government action isn't taken the situation would get progressively worse and at some point anarchy would ensue. The solution in part is to increase disposable income and there are a number of ways to accomplish that through policy. One of course is to reduce taxes leaving the consumer with more disposable income.

    Another solution is for government to do what companies won't do - pay consumers even though they are contributing nothing of value. Extended unemployment benefits, food stamps, Medicaid and cash welfare payments are examples of initiatives the government can embark on that will keep GDP positive even though unemployment levels are moving higher.

    Effectively implemented these programs can negate the impact of higher levels of unemployment - at least in the short term. That is exactly what occurred as a response to the Great Recession - the government stepped in to fill the void with massive levels of deficit spending.

    A look at a couple of charts shows that this is exactly what has occurred.

    The chart above shows that plunging GDP was turned around by a significant increase in government spending that was fully financed by the issuance of US Treasuries - in other words the government borrowed the money and spent it in order to prevent a further drop in GDP. The reaction to GDP was delayed but it did turn back higher and as the result of the governments fiscal policy action. Hard to criticize Congress for taking this step as the result absent the fiscal stimulus would have been that feedback loop that makes things get progressively worse as the consumer pool continues to shrink producing a devastating level of demand destruction that would most certainly end up in a prolonged depression.

    The chart above can be deceptive though in that the red line reflecting government debt growth appears to indicate that the government stopped spending after the initial surge in 2008. That is not the case at all - they merely slowed down the rate of growth in the US debt but each successive year since 2008 shows an increase over the prior year - just a smaller increase.

    A look at debt to GDP better reflects that dynamic:

    The chart above shows that government debt has been a major driver of GDP since the Great Recession as debt to GDP moved back to post WWII levels. Periods where government debt and deficit spending is a significant economic driver don't produce economic growth in real terms though. A look at the chart below identifies the two periods of real economic growth in the last 100 years. Both periods are identified by significant reductions in debt to GDP as the chart below illustrates.

    In all fairness to government fiscal policy one can't conclude from the above charts that the withdrawal of deficit financed fiscal stimulus produced real growth - to the contrary - it was real growth that allowed the withdrawal of fiscal stimulus in the first place.

    So back to the conundrum - we have for the most part throughout the last 100 years been dependent on fiscal stimulus to keep GDP in positive territory. The two periods that standout as exceptions are the post WWII period lasting roughly 15 years and the period from the mid 80's to the market peak just prior to the turn of the century - again roughly 15 years.

    The rest of the time has been identified by deficit spending that has driven debt levels higher. Therein lies the conundrum in that higher debt levels imply higher levels of taxation in order to service the debt and the larger the tax bite the less disposable income which works to dampen GDP growth. That means that over time the levels of deficit spending need to increase by a magnitude sufficient to offset the increase in tax receipts and then a little more to produce GDP growth.

    What we see today is that the increase in the level of deficit financing needed to maintain GDP in positive territory has taken on a parabolic look. But for the first time in 100 years the fiscal stimulus is not really working. One can look at the unemployment rate and assume that is not true - in other words unemployment levels are coming down meaning more and more are moving into the consumer pool and that will drive demand. That is after all what has happened in times past. Fiscal stimulus has provided the needed jump start to push unemployment levels down and the offshoot - higher numbers of employed and higher GDP.

    It just hasn't happened this time around though. A close look at the debt to GDP chart above since the end of the recession shows a parabolic almost vertical shot higher on debt to GDP while the total numbers of people employed is hovering at about the same level it was pre-recession. That is a lot of stimulus and for very little in real gain. The blue line in the chart below shows the actual numbers of those employed. The red line is the total population showing that even though we are growing the population at a relatively steady pace and a pace that is no different today than pre-recession we are flat lining on jobs.

    Look at this chart - the official unemployment rate - if you want to feel good about the prospects for growth going forward. Looking at the chart below one would think we were doing great things as the unemployment rate has fallen sharply since the end of the recession.

    Look at this next chart if you want to know what's really going on. The only reason the unemployment rate chart looks good is because this one looks so bad. The Labor Force Participation Rate has fallen to a 35 year low.

    The truth is we are in real trouble and brings me back to the conundrum. We are keeping GDP in positive territory because we are doing what we've always done in times of trouble - borrow and spend. The problem this time around is that it is taking a lot more to just maintain the status quo and at some point very soon the law of diminishing returns must kick in.

    How long can we stay on this path? A point I tried to make in a previous article and will make again is that the burden of the increasing debt falls squarely on those remaining in the work force - a rapidly shrinking work force.

    A look at the chart below is telling. In 2008 personal tax receipts were roughly $1.18 trillion. Today personal tax receipts are just a little less than the 2008 level but the debt since the recession is just short of double what it was in 2008.

    The chart below shows tax receipts - both personal and corporate. Lest anyone get the idea that corporations bear a significant portion of the tax burden in the US the chart below will clear that misunderstanding up quickly.

    And here is the debt level the tax payer is ultimately responsible for and even though the tax payer has been given an extension on payment of the obligation - out of necessity - it will ultimately have to be dealt with.

    The fact is personal tax receipts are essentially the same today as they were pre-recession but the money borrowed on behalf of the tax payer has almost doubled. That is just not a business model that works. And it all boils down to this - a debt driven economy based on ever increasing government debt levels will eventually blow up.

    The truth is we are much closer to that blow up point than most are willing to acknowledge. The reason I know that is the magnitude of the deficit spending and what we are getting for it in return. And we aren't getting much if one looks at the data objectively. We have no historical perspective for what we've seen post recession.

    Some will argue that the debt to GDP levels post WWII were as high as we are today and I would agree with that. However, after the war the debt to GDP ratio began a rapid descent. That ratio fell by roughly 65% in the 15 years following the end of WWII. If we were to repeat that today we would need to expand GDP to roughly $45 trillion without any increase in government debt. The only way that will happen is for nominal GDP to spike higher based on a massive expansion in M2 that produces the most severe inflationary environment the nation has ever known - a move that would literally destroy the US dollar and life as we know it.

    A capitalist with a populist perspective

    In a recent article entitled Why We Are Not OK And Not On A Sustainable Trajectory I made the following comment that sets the stage for the balance of this discussion:

    The truth is we are in a "beggar thy neighbor" market dynamic today but it is not so much a matter of one sovereign country gaining at the expense of another. It is more a matter of big banks and big corporations - with no sovereign allegiance at all - gaining at the expense of the masses in all sovereigns.

    Lest one question that a look at the chart below should remove any doubt. The chart is after tax corporate profits as a percent of GDP.

    Corporate profits as a percent of GDP did take a hit after the stock market bubble burst in the late 90's but it wasn't long before those profits as a percent of GDP put in a new all time high. Then we had the second crash and profits once again fell sharply before being reinflated again to new all time highs.

    Here's another look at corporate profits - this time before tax - compared to Proprietors Income - a proxy for small business. The chart is courtesy of Ed Dolan and the full article is found here:

    Now to the banks or should I say the big banks. The following chart is of the total asset base of all commercial banks.

    It was in fact the big banks reckless behavior that produced the Great Recession in the first place but as the chart above shows the big banks have just gotten bigger. In fact what disturbs me the most is the parabolic spike in bank assets during the recession. A look at the chart above suggests that the big banks actually benefited by the recession and indeed they did. It is the way the system is set up and the focus of Part II of this two part series.

    For now though let me sum it up this way. I am a fervent believer in capitalism but also recognize that for capitalism to work it must work for all of us. Wealth begets more wealth and taken to it's extreme it will eventually collapse upon itself.

    When a disproportionate share of the wealth is concentrated in the hands of a few to the detriment of the many the many are prone to revolt and that must be the real fear of those at the top of the rung. More importantly though is the fact that the middle class is the driver of the economy including corporate profits and a systematic process of destroying the middle class almost presents itself in a way that seems to suggest the big companies, the big banks and the political class have an almost masochistic death wish mindset.

    And unfortunately we are moving at a very rapid rate toward the destruction of the middle class and it is the middle class that is the foundation of a well oiled capitalistic machine. Today we see a major consolidation of wealth in the hands of a few. The numbers of banks in the United States has fallen from 14,427 in 1985 to 6,012 in 2012 per the FDIC.

    More importantly - the big banks just keep getting bigger. Here's how Pat Garofolo explained it in an article he wrote about a year ago:

    As the nation slowly ground its way out of the Great Recession, the biggest banks in the country (whose malfeasance played a large role in creating the downturn) grew even larger. According to data from the Dallas Federal Reserve, the largest 0.2 percent of all banks now control nearly 70 percent of all banking assets:

    As of third quarter 2012, there were approximately 5,600 commercial banking organizations in the U.S. The bulk of these-roughly 5,500-were community banks with assets of less than $10 billion. These community-focused organizations accounted for 98.6 percent of all banks but only 12 percent of total industry assets. Another group numbering nearly 70 banking organizations-with assets of between $10 billion and $250 billion-accounted for 1.2 percent of banks, while controlling 19 percent of industry assets. The remaining group, the megabanks-with assets of between $250 billion and $2.3 trillion-was made up of a mere 12 institutions. These dozen behemoths accounted for roughly 0.2 percent of all banks, but they held 69 percent of industry assets.

    On the corporate front I am puzzled at the comments I hear about the little Ma and Pa proprietors being crushed. Is there really any Ma and Pa operations in existence today? A few I guess but how long do they last? I don't have data on this but my guess is that most Ma and Pa operations are started by people who have the naive assumption that they will capture a part of the American dream by starting a little shop somewhere and building it up over time.

    What are the chances of that occurring though? You just can't compete today against the big guys. I always try out the little Ma and Pa restaurants when they first open up and invariably find that many of them are far superior in quality than the international chains but a persistent theme in most of these cases is that they go out of business at that point where they've lost all their seed capital.

    The same applies to hardware stores, clothing stores, niche supermarkets and other small operations - they just can't compete with the big corporations. And the big corporations are international in scope with no sovereign allegiance. McDonald's is just as content selling a hamburger to the Japanese as they are to those in the US. The same applies to Apple or IBM or Caterpillar - well you get the point.

    In an article by Sarah Anderson and John Cavanagh entitled Top 200: The Rise of Corporate Global Power the authors make the following points:

    • Of the 100 largest economies in the world, 51 are corporations; only 49 are countries (based on a comparison of corporate sales and country GDPs).
    • The Top 200 corporations' combined sales are bigger than the combined economies of all countries minus the biggest 10.
    • While the sales of the Top 200 are the equivalent of 27.5 percent of world economic activity, they employ only 0.78 percent of the world's workforce.
    • A full 5 percent of the Top 200s' combined workforce is employed by Wal-Mart, a company notorious for union-busting and widespread use of part-time workers to avoid paying benefits. The discount retail giant is the top private employer in the world, with 1,140,000 workers, more than twice as many as No. 2, DaimlerChrysler, which employs 466,938.

    I am all for capitalism but recognize the importance of the consumer in that paradigm. What we've seen going on for decades now is a slow but focused process that has relegated the working class to the back of the bus. And it can't end well.

    We have a political class that struggles between giving us what we want to retain votes and giving those who are working against us what they want to enrich themselves. Some of you may be familiar with this quote. You will find it in the book of Matthew:

    No one can serve two masters, for either he will hate the one and love the other, or he will be devoted to the one and despise the other. You cannot serve God and money.

    Regardless of your beliefs the words tend to ring true. I would like to suggest that our political class has chosen to serve the money by succumbing to the lobbyists of the big corporations and at the expense of their constituents.

    One area in particular where our political class has caved in to the will of the big corporations is in the area of antitrust laws. The consensus view today as it relates to anti-trust actions is that the primary focus must be on the consumer and that means this - does the price the consumer pays to those who effectively hold semi-monopolies benefit or hurt the consumer?

    The answer in most cases is that it helps the consumer. Wal Mart is a great example. So is Home Depot or McDonald's. The list is long of companies that crush competition by selling goods at very low prices and that is what has allowed them to thrive. But the efficiencies of scale that help the consumer in one respect tend to hurt them in another and perhaps more important respect. Wal Mart for example offers the consumer very low prices but they do so by maintaining a very low labor cost.

    Interpretation of The Sherman Antitrust Act is one of many major shifts in policy that has allowed the systematic transfer of power into the hands of a few. Judge Robert Bork's book - The Antitrust Paradox - formed the views of the courts since the early 80's and has played an instrumental role in allowing this massive consolidation of power. Here is how Wikipedia explains the consensus view:

    Bork argued that the original intent of antitrust laws as well as economic efficiency make consumer welfare and the protection of competition, rather than competitors, the only goals of antitrust law.[3] Thus, while it was appropriate to prohibit cartels that fix prices and divide markets and mergers that create monopolies, practices that are allegedly exclusionary, such as vertical agreements and price discrimination, did not harm consumers and so should not be prohibited. The paradox of antitrust enforcement was that legal intervention artificially raised prices by protecting inefficient competitors from competition.

    The book was cited by over a hundred courts.[1] From 1977 to 2007, the Supreme Court of the United States repeatedly adopted views stated in The Antitrust Paradox in such cases as Continental Television v. GTE Sylvania, 433 U.S. 36 (1977), Broadcast Music Inc. v. Columbia Broadcasting System, Inc., NCAA v. Board of Regents of Univ. of Oklahoma, Spectrum Sports, Inc. v. McQuillan, State Oil Co. v. Khan, Verizon v. Trinko, and Leegin Creative Leather Products, Inc. v. PSKS, Inc., legalizing many practices previously prohibited.

    The Antitrust Paradox has shaped antitrust law in several ways, prominently by focusing the discipline on efficiency and articulating its goal as "consumer welfare." Many lawyers and economists, however, have pointed out that Bork was wrong in his analysis of the legislative intent of the Sherman Act and have criticized him for incorrect economic assumptions and analytical errors. One of the key criticism focuses on Bork's use of the term "consumer welfare," which became the stated goal of American antitrust law.

    For what it's worth I am not against Wal Mart or McDonald's or Home Depot or any of the big international corporations who have managed to exploit their advantage for profit. That is what capitalism is all about and were I in a position to establish policy at any of these companies I too would argue that the companies are doing a fantastic job of delivering goods at very low prices and that helps consumers.

    However, if I were a legislator I would see my role as balancing the issue between helping the consumer on the one hand and hurting a significant portion of that consumer base on the other hand with poverty level wage structures. There is a very pragmatic argument to be made for why protecting and improving the financial condition of the middle class is beneficial to even the large corporations. As the methodical process of demand destruction continues those international corporations will suffer along with the rest of us.

    And in the sense of fairness as it relates to the obligations that big corporations have to society one must conclude that they are where they are today because of the middle class and because of the political class who has facilitated their rise. And are they bearing a proportionate part of the burden? Well a look at corporate tax contributions in the chart above attests that they clearly are not doing so.

    The second part of this two part series has to do with one issue - restoring a balance of power to the middle class. The ideas I will present will be perceived by some as radical. In fact I find them very radical myself and will readily admit that I have been very slow in coming to these conclusions - especially the one that relates to our system of fractional reserve banking.

    The truth of the matter is this - we are so heavily burdened with debt today that we simply can't overcome it by growing the economy. The magnitude of unfunded liabilities is so extreme and the demographic structure that these unfunded liabilities are dependent on are so out of kilter that there is no way we can continue to kick the can without dire consequences. The situation calls for radical change and that is what I would like to see happen. Will anybody listen? Probably not - at least not until all other measures have proven futile.

    This problem is not unique to the United States though. It is global in scope but with that caveat properly explained I would still suggest that the following comment from Winston Churchill states the course we will follow:

    You can always count on Americans to do the right thing - after they've tried everything else.

    Jan 22 4:58 AM | Link | 1 Comment
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