Why Those Looking for the Next Crisis May be Looking in the Wrong Places

Despite, or more accurately, because so many markets are at high levels, often on thin trading volumes, many investors are edgy. Even though markets famously climb a wall of worry, I can’t recall a time when there have been so many skeptical long investors.

For instance, even though the famed FAANG keep racing to even loftier levels, a US stock market crash would be unlikely to do a lot of damage. Unlike the 1929 crash, this rally isn’t fueled mainly by money borrowed from banks. And unlike the dot-com bust, speculative stocks are not being used as a form of payment. Recall that companies that should have known better, such as Lucent (this BTW was Carly Fiorina’s doing) and McKinsey were taking equity instead of cash, meaning as consideration for services. Informed insiders say McKinsey had to write off $200 million of stock it took in lieu of fees; the actual number may be higher given that McKinsey could have discounted its fees. That practice was sufficiently widespread to give the dot-com crash a tad more sting than it might otherwise have had. Even so, there was no blowback to the payment system, and the early 2000s recession was not terrible by historical standards.

This is far from a complete list, but investors are worried about ETFs, Deutshe Bank, festering banking problems in Italy, and China’s debts, and a longer than usual list of exogenous risks, including nasty events resulting from increasing hostilities with North Korea, Russia, and Iran, perhaps a nuclear disaster resulting from wild weather, and further down the road, a disorderly Brexit doing more damage to Europe and it not-so-solid banks.

The reason this situation is so striking is that historically, crises that did real damage hurt financial institutions. In the Great Depression, banks all over the world failed, wiping out depositors’ funds, big chunks of the payment system, and the resulting downdraft correctly made the survivors too fearful to lend. In the US, a lot of traditional lending has been displaced by securitization, so investors taking losses or simply getting nervous could damage credit creation.

If one were to step back, and this is hardly a novel though, the root of investor nervousness is the sustained and extreme intervention by central banks all around the world in financial markets. No one in 2008 would have thought it conceivable that less than a decade later, one quarter of the world economy would have set negative policy interest rates. Even though markets only occasionally pay attention to fundamentals, sustained super low interest rates, by design, have sent asset prices of all kinds into nosebleed territory.

The Fed seemed to be the first to recognize that its monetary experiments had done little for the real economy, save allow for some additional spending via mortgage refis. It had done more to transfer income and wealth to the top 1%, and even more so to the top 0.1%, and enrich banks, all of which are hindrances to long-term growth. Yet Bernanke announced his intention to taper in 2014, and how far has the Fed gotten in getting back to normalcy? The answer is not very. And that’s because central bankers fear that their policies are asymmetrical: they can do more to dampen activity by increasing rates than they can to spur growth by lowering them. As we’ve repeatedly pointed out, businessmen do not go out and expand because money is on sale. They expand when they see commercial opportunity. The exception is in industries where the cost of money is one of the biggest costs of production…such as in financial services and levered speculation.

However, from what I can tell, the Fed’s desire to raise rates is driven by its perception that it need to have short term rates meaningfully higher, as in 2% or higher, so as to have room for cuts if the banking system gets wobbly. That is why it keeps treating a flaccid but less terrible than in the past labor market as robust.

But the potentially more interesting contradiction is in the posture of conservative businessmen. Higher interest rates will hurt their stock portfolios and the value of their homes. It will also hurt fracking, which is very dependent on borrowed money. Yet Republicans are more eager than Democrats to raise interest rates, apparently out of the misguided belief that low interest rates help labor, as opposed to capital (the Fed’s using the state of the labor market as its indicator as to whether to increase interest rates or not no doubt feeds this belief). Similarly, Republicans are far more exercised about the size of the Fed’s balance sheet and want it smaller. Again, there’s no logical reason for this move. The Fed’s assets will liquidate over time. They may not do much additional good sitting there (save the remittance payments back to the Treasury), but they aren’t doing any harm either.

In other words, the varying views about what to do about central bank interest rates and their holdings in many, too many, cases have to do with political aesthetics that often run counter to economic interests. A big reason that conservatives don’t like the Fed’s big balance sheet, even though the Fed is the stalwart friend of banks and investors, is that they still see the Fed as government, and government intervening in the economy offends them, even when it might benefit them. (Mind you, this is not the same as business exploiting government via “public private partnerships” or other approaches where commercial interests have their hand on the steering wheel).

Let me quote a seminal essay by Michal Kalecki, which even though it was written in 1943, sets forth the drivers of this line of thinking as well as anything I’ve seen since:

2. The above is a very crude and incomplete statement of the economic doctrine of full employment. But it is, I think, sufficient to acquaint the reader with the essence of the doctrine and so enable him to follow the subsequent discussion of the political problems involved in the achievement of full employment.

In should be first stated that, although most economists are now agreed that full employment may be achieved by government spending, this was by no means the case even in the recent past. Among the opposers of this doctrine there were (and still are) prominent so-called ‘economic experts’ closely connected with banking and industry. This suggests that there is a political background in the opposition to the full employment doctrine, even though the arguments advanced are economic. That is not to say that people who advance them do not believe in their economics, poor though this is. But obstinate ignorance is usually a manifestation of underlying political motives.

There are, however, even more direct indications that a first-class political issue is at stake here. In the great depression in the 1930s, big business consistently opposed experiments for increasing employment by government spending in all countries, except Nazi Germany. This was to be clearly seen in the USA (opposition to the New Deal), in France (the Blum experiment), and in Germany before Hitler. The attitude is not easy to explain. Clearly, higher output and employment benefit not only workers but entrepreneurs as well, because the latter’s profits rise. And the policy of full employment outlined above does not encroach upon profits because it does not involve any additional taxation. The entrepreneurs in the slump are longing for a boom; why do they not gladly accept the synthetic boom which the government is able to offer them? It is this difficult and fascinating question with which we intend to deal in this article.

The reasons for the opposition of the ‘industrial leaders’ to full employment achieved by government spending may be subdivided into three categories: (i) dislike of government interference in the problem of employment as such; (ii) dislike of the direction of government spending (public investment and subsidizing consumption); (iii) dislike of the social and political changes resulting from the maintenance of full employment. We shall examine each of these three categories of objections to the government expansion policy in detail.

2. We shall deal first with the reluctance of the ‘captains of industry’ to accept government intervention in the matter of employment. Every widening of state activity is looked upon by business with suspicion, but the creation of employment by government spending has a special aspect which makes the opposition particularly intense. Under a laissez-faire system the level of employment depends to a great extent on the so-called state of confidence. If this deteriorates, private investment declines, which results in a fall of output and employment (both directly and through the secondary effect of the fall in incomes upon consumption and investment). This gives the capitalists a powerful indirect control over government policy: everything which may shake the state of confidence must be carefully avoided because it would cause an economic crisis. But once the government learns the trick of increasing employment by its own purchases, this powerful controlling device loses its effectiveness. Hence budget deficits necessary to carry out government intervention must be regarded as perilous. The social function of the doctrine of ‘sound finance’ is to make the level of employment dependent on the state of confidence.

3. The dislike of business leaders for a government spending policy grows even more acute when they come to consider the objects on which the money would be spent: public investment and subsidizing mass consumption.

The economic principles of government intervention require that public investment should be confined to objects which do not compete with the equipment of private business (e.g. hospitals, schools, highways). Otherwise the profitability of private investment might be impaired, and the positive effect of public investment upon employment offset, by the negative effect of the decline in private investment. This conception suits the businessmen very well. But the scope for public investment of this type is rather narrow, and there is a danger that the government, in pursuing this policy, may eventually be tempted to nationalize transport or public utilities so as to gain a new sphere for investment.3

One might therefore expect business leaders and their experts to be more in favour of subsidising mass consumption (by means of family allowances, subsidies to keep down the prices of necessities, etc.) than of public investment; for by subsidizing consumption the government would not be embarking on any sort of enterprise. In practice, however, this is not the case. Indeed, subsidizing mass consumption is much more violently opposed by these experts than public investment. For here a moral principle of the highest importance is at stake. The fundamentals of capitalist ethics require that ‘you shall earn your bread in sweat’ — unless you happen to have private means.

4. We have considered the political reasons for the opposition to the policy of creating employment by government spending. But even if this opposition were overcome — as it may well be under the pressure of the masses — the maintenance of full employment would cause social and political changes which would give a new impetus to the opposition of the business leaders. Indeed, under a regime of permanent full employment, the ‘sack’ would cease to play its role as a ‘disciplinary measure. The social position of the boss would be undermined, and the self-assurance and class-consciousness of the working class would grow. Strikes for wage increases and improvements in conditions of work would create political tension. It is true that profits would be higher under a regime of full employment than they are on the average under laissez-faire, and even the rise in wage rates resulting from the stronger bargaining power of the workers is less likely to reduce profits than to increase prices, and thus adversely affects only the rentier interests. But ‘discipline in the factories’ and ‘political stability’ are more appreciated than profits by business leaders. Their class instinct tells them that lasting full employment is unsound from their point of view, and that unemployment is an integral part of the ‘normal’ capitalist system.

Notice the emphasis that Kalecki places on businesses preferring the “laissez-faire system,” meaning the market system, to create that essential elixir, “confidence”. We now have central banks for years not merely quietly and unobtrusively creating “sound money” in the background so that captains of industry can take credit for “confidence,” ten years after the start of the crisis, we still have central banks openly in the “confidence” game. That epitomizes why the outsized role of central banks so bothers conservatives. They see them as encroaching on their prerogatives even when the central banks are far more allied with the top economic strata, both culturally and by virtue of their main duty of keeping the banking system healthy, than with the great unwashed masses.

Now you might ask, how does this relate to the original question, that market mavens might be looking for the next crisis in all the wrong places?

The first is that despite widespread worries about a crisis, you don’t need to have a crisis to have a bubble deflate. In the runup to 2008, I expected the unwind of reckless lending spree to look like that of Japan’s. Japan’s joint commercial and residential real estate bubbles were much larger relative to the GDP than those in the US. Yet instead of a dramatic bust, the economy contracted like a car with no wheels banging down a steep slope. A mini-crisis of sorts did occur in 1997, when the authorities made the mistake of thinking the economy was strong enough to take some tightening, which kicked off a series of financial firm failures. So even if it turns out things do end badly, you can have the real economy suffer without having the financial system have a heart attack.

The second is that with some significant exceptions like Deutsche Bank, the authorities have succeeded in moving risk out of the financial system and more and more onto the backs of investors. That means the rich, but it also means pension funds, insurance companies, endowments, foundations, and sovereign wealth funds. Investors have already taken a toll via super low interest rates; economist Ed Kane estimated that in the US alone, that represented a $300 billion per annum subsidy to banks.

So even if we were to have something crisis-like, as in a sudden ratchet down in asset prices that stuck, it isn’t clear that the damage to critical financial plumbing would be significant.

That means the best guess, even with the ECB’s taper set to start this Thursday, that the effects of the crisis aftermath and any new upheaval are likely to create more instability in the political system and society, and that that may be more destabilizing than any immediate market/banking system impact. Admittedly, political times moves more slowly than financial time, so the authorities may congratulate themselves even as their ship has taken even more damage below the water line.

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66 comments

  1. UserFriendly

    I love this Kalecki essay so much. It is by far the clearest most concise well written thing I’ve ever read. One question on your intro:

    But the potentially more interesting contradiction is in the posture of conservative businessmen. Higher interest rates will hurt their stock portfolios and the value of their homes. It will also hurt fracking, which is very dependent on borrowed money. Yet Republicans are more eager than Democrats to raise interest rates.

    Wouldn’t increases in the Fed funds rate automatically induce higher interest rates throughout the economy, generally increasing investor returns? Or are you just assuming that most investors have been playing around in commodities which are overdue for a correction as soon as QE gets down sized?

    Reply
    1. Samuel Conner

      Higher interest rates would tend to deflate asset prices, the converse of the asset-price support that the Fed seems to have intended (confidence promoted through a wealth effect) as part of the hoped-for efficacy of its low interest rate policy.

      If you have cash on the sidelines, you might hope for higher interest rates for the sake of higher percentage income returns, bond interest or share dividends, as you mention. But if you are already long any asset whose price tends to move in the opposite direction of interest rate changes, and you might want or need to liquidate that asset before its price recovers, FED policy normalization might be a bit hair-raising.

      Reply
      1. Lee

        But if you are already long any asset whose price tends to move in the opposite direction of interest rate changes, and you might want or need to liquidate that asset before its price recovers, FED policy normalization might be a bit hair-raising.

        Yes. A portion of my retirement income is derived from a bit of my retirement savings in a junk bond fund. The NAV has been unchanged for weeks. My greed for the year-end bonus dividend is tempered by my fear of a significant drop the in bond price.

        Reply
    2. clinical wasteman

      & I love this Yves Smith essay. (Apologies if that sounds like unwelcome flattery, it’s really just an honest immediate response.)

      Many of us on ‘the left’ (manifold, erratic) think we understand that the political opinions of ‘business’ are ultimately about labour discipline, but it’s much harder to show (as is shown here) the relevance of that insight with reference to the last 5 minutes’ apparently extraterrestrial behaviour of financial markets and capital at large.

      What struck me in particular here was the suggestion of a new twist on ‘privatized profit/socialized loss’ in crises, in which that “outcome” is set up pre-emptively: i.e. the possibility that the real “response” of political & central/bank management to the last (or ongoing) crisis was to ensure that the effects of the next one would do most damage at social and political, as opposed to financial, level. Considering the social damage done last/this time around, that’s a frightening as well as a plausible nightmare.

      Another peripheral question arising — but only for your consideration Yves or anyone else’s when you (pl) have the time to consider it, is:
      to what extent do financial market “players” (obviously not a homogeneous group) privately believe in their own rhetoric? Do they convince themselves when they say markets as they currently function are “free” and yearning for more “freedom”, rather than deeply co-dependent with the states & policies that facilitate their looting while ruthlessly policing everything that might threaten it?
      Or more simply, do Musks & Bezoses, let alone the directors of, say, the funds owning privatized European utilities, know what would happen to them in an actual “free market”*?
      [*NB: definitely not a Manuel DeLanda or (occasional & only implicit) Chomsky-type insinuation that an “actual free market” might be desirable in some sort of ideal world. What would happen to the grandstanders and fund managers might be fun to watch from a safe distance, but there would be no safe distance.]

      Reply
      1. clinical wasteman

        please forgive yet more of this, but 3rd paragraph above is hopelessly garbled.
        Was trying to say: the original insight that most struck me in your essay, Yves, is the one about the pre-emptive transfer of crisis risk from the financial sector to the social/political level, i.e. ordinarily vulnerable lives. Last time around the riskowners had to rush to do a lot of that (not all of it) after the fact; Yves makes a scary case that this time they might be much better prepared. And then when it happens they can say: “see, we did ‘learn our lesson’!”

        Reply
  2. doug

    Thanks for this excellent summary. One quick note with regard to this part of Kalecki’s reasoning:

    “The economic principles of government intervention require that public investment should be confined to objects which do not compete with the equipment of private business (e.g. hospitals, schools, highways). Otherwise the profitability of private investment might be impaired, and the positive effect of public investment upon employment offset, by the negative effect of the decline in private investment.”

    Extensive financialization and privatization have now narrowed the ‘objects which do not compete with … private business”. Or, put in the reverse, ‘private business’ now includes prisons, schools, hospitals, policing, courts ….. even toll roads and so forth. Which means, of course, that this political objection to the ‘public option’ has expanded both ideologically and practically.

    Reply
  3. Bugs Bunny

    Great original piece Yves. Thanks for the introduction to Kaleki.

    Perhaps we’re seeing the second phase of the political crisis in the gradual proliferation of increasingly viable separatist movements.

    Reply
      1. visitor

        I admit I am lost here.

        How do you connect the “austerity fetish” to “increasingly viable separatist movements”?

        Reply
        1. Eustache De Saint Pierre

          I actually believe I was not connected it, just commenting on what might be described as the apparent sadistic pleasure that some appear to possess in forcing others to their knees.

          ” One might therefore expect business leaders and their experts to be more in favour of subsidising mass consumption (by means of family allowances, subsidies to keep down the prices of necessities, etc.) than of public investment; for by subsidizing consumption the government would not be embarking on any sort of enterprise. In practice, however, this is not the case. Indeed, subsidizing mass consumption is much more violently opposed by these experts than public investment. For here a moral principle of the highest importance is at stake. The fundamentals of capitalist ethics require that ‘you shall earn your bread in sweat’ — unless you happen to have private means “.

          Austerity in the sense of government cuts that directly lead to losses in income for the mass of people whose spending mainly fuels an economy & probably the long term stifling of rises in the real wage levels leading to the ever increasing vicious circle of household debt, which taken together with other factors, I suppose leads to more people looking desperately for any port in a storm.

          Reply
          1. Bugs Bunny

            That’s sort of what I meant – I see your point and moreover these separatist movements all seem to be based in prosperous regions where citizens understandably are even more confused by austerity policies than elsewhere.

            Reply
            1. Eustache De Saint Pierre

              A bit of confusion caused by myself as the Thank You was meant for Yves as a stand alone comment. Slightly fuzzy this morning due to celebrating ( if that is the correct word ) my 60th last night.

              Reply
              1. Eustache De Saint Pierre

                I think I would add Trump & Brexit to the phenomenon for those who feel that they had no voice who up until the above events, appeared to be stuck in a state of apathy. Interesting article called ” When Austrian’s Ate Dogs ” based on the ” Marienthal Study ” from Bill Mitchell which seems to point to the fact that populations tend to just stew in their own juices when things get really bad, until that is someone turns up & offers them something to clutch at.

                I’m not sure about the prosperous part which strikes me as being a relative position, as with Spain’s 40% child poverty rate & very high youth unemployment, Catalonia might be better off than say Seville which has an immigrant favella on it’s outskirts, or the rest of Spain, but as is the case it seems almost everywhere many are being left behind & the overall GDP etc figures do not reflect that reality.

                I think that that the below could be applied to modern day equivalents, it is also I believe makes a good case for a job guarantee rather than UBI :

                http://bilbo.economicoutlook.net/blog/?p=36298

                Reply
  4. financial matters

    Excellent points. The austerity focus magnifies this effect. It increases the power of these captains of industry and makes the serfs more unstable. But as you suggest there may be a political breaking point. Hopefully it is towards more socialism rather than towards more fascism.

    The instability of austerity also tends to fuel the anti-immigration sentiment.

    Government created jobs would definitely be a stabilizing force but can also be a tough sell to the public.

    Even something as desired as universal health care can be derailed as ‘too much socialism’ or ‘how are we going to pay for it’.

    Lee Camp has done some excellent tweeting on this.

    Lee Camp [Redacted]‏ @LeeCamp 12 hours ago

    Our govt is militarizing space, developing nukes, and has military bases in 70% of nations on earth. No money for healthcare or education.

    Lee Camp [Redacted]‏ @LeeCamp 16 hours ago

    Why do we blame victims of poverty, yet any criticism of the real villain, inequality, is dismissed as “communist?” Corporate brainwashing.

    Reply
    1. Altandmain

      Hopefully it is towards more socialism rather than towards more fascism.

      Unfortunately there is no assurance.

      While Establishment Democrats do moan about Trump and frequently compare him to Hitler inaccurately, they do have one similarity. They were elected due to a sustained and deep economic recession along with well justified anger towards their nation’s respective Establishments.

      On the American side, I suppose that Roosevelt, although far from perfect was a far better response. The rise of Bernie Sanders and Jeremy Cobryn are encouraging in that regard.

      Reply
    2. Jim Thomson

      Exactly. The huge military budget translates to government funded jobs. They are just in the various defense industries, which are always justified as good and necessary, rather than in other jobs, healthcare, education, whatever we might really want and need.
      Furthermore, as Kalecki alludes to, the real issue is control. Defense industry spending is now controlled by a large set of private interests who intimately interact with Congress and public officials in a massive (mis)-appropriation of public funds.
      This is much better than spending the same, or lesser, amounts of public funds, on what I mentioned above.

      Reply
      1. Anon

        Yes, spending on health care and education would allow/encourage more folks to study nursing/therapy/medicine w/ tuition re-imbursement and student loan forgiveness in fields that have a shortage of personnell. Fewer jobs for nuclear bomb makers and drone pilots is a good thing.

        Reply
  5. Carolinian

    ‘discipline in the factories’ and ‘political stability’ are more appreciated than profits by business leaders. Their class instinct tells them that lasting full employment is unsound from their point of view, and that unemployment is an integral part of the ‘normal’ capitalist system.

    In other words these economic arguments are really about power and status rather than money with the “rational pursuit of self-interest” serving as a smokescreen for the irrational pursuit of higher status at all costs.

    An analogy might be the antebellum US South where many cold blooded arguments were advanced for the necessity of slavery (only Africans could work the malarial regions etc) but where the reality was that plantation owners were unwilling to give up the vast personal power of owning other human beings, being able to rape at will, even the power to take life with impunity. They were so unwilling to give up these privileges or even accept criticism that a terrible war was the result.

    At any rate thanks for the above, a very informative post.

    Reply
    1. diptherio

      I think it was Kali Akuno, of Cooperation Jackson, who commented on this, i.e. that a lot of the elites and business owners down South are more than willing to make less money than they otherwise could, so long as they get to keep their power. So trying to work with these people to improve the working conditions of their employees, by showing how doing so would be good for their bottom-line, just turns out to be a waste of time. They don’t actually care about making more money…or at least not as much as they care about maintaining their privileged status in terms of social power.

      Reply
      1. flora

        ” that a lot of the elites and business owners down South are more than willing to make less money than they otherwise could, so long as they get to keep their power.”

        I’ve a hunch that the non-elites are willing to make less money than they desire if they think the current competitive system is fair; the playing field is mostly level; the govt isn’t letting the “other side” (big business, banks) get away with cheating.

        Currently, it’s widely assumed that the “other side” does cheat and the govt helps in the cheating of the middle class and the working class; that it’s the cheating and fraud that explains the economic outcomes of the past 20-30 years. The current competitive game is rigged.

        Reply
        1. clinical wasteman

          and perhaps the most ‘impressive’ of present-day elite accomplishments will turn out to have been:
          keeping non-elite fury just short of outright revolt by making it manifestly obvious that the current competitive system is unfair/rigged, thereby channeling all that anger into the demand for a fair, unrigged competitive system (that mythical creature)

          Reply
    2. Altandmain

      It shows just how greedy the ruling class is I am afraid.

      This was never about profits as much as it was about their complete domination over the rest of us.

      This is also why there is so much resistance to change. Even if it makes business more revenue, they hate the idea of full employment.

      Reply
      1. Lee

        There are few freedoms more precious or greater pleasures in life than being able to fearlessly say “take this job and shove it.”

        Reply
        1. Edward E

          About 1.7 million workers in the transportation industry may get told, ‘You’re Fired’, they will not be happy campers. Adjusted for inflation they should be making $130k. I don’t know what to say, terminals, ports and warehouses could soon become like military fortresses. Even if you own your own standard equipment, if rates go down there goes your profits.

          Self-Driving Trucks Tractor-trailers without a human at the wheel will soon barrel onto highways near you. What will this mean for the nation’s 1.7 million truck drivers? Availability: 5 to 10 years https://www.technologyreview.com/s/603493/10-breakthrough-technologies-2017-self-driving-trucks/

          Reply
  6. Mike R.

    A couple of comments.
    The Fed seemed to be the first to recognize that its monetary experiments had done little for the real economy, save allow for some additional spending via mortgage refis.
    I don’t necessarily agree with this. I think QE did a tremendous amount to stabilize the economy. It wasn’t perfect by any means and the fact that it benefited the wealthy more than the average person, while true, is less a function of it’s need and more a function of the economic environment that had been established prior to the crash. To me, in a very real sense, QE was needed to sustain faith in the dollar, even though that seems (and is) contradictory in a manner.

    Having said all this, I do believe that once entered, it will be near impossible for the Fed to extract itself from QE. And, the move/desire to reduce the balance sheet is nothing more than the Fed trying to convince the world that “normalization” back from QE is possible, desirable, etc. I think they know it’s not going to work but they have to put the makeup on the pig to at least make us think all of this can be undone.

    When interest gets high enough (not much further from here), the slowdown in lending will slam down the current continuing boom in apartment construction, house purchases, refis, etc. Additionally, the debt on corporate balance sheets used to prop up earnings per share will start to weigh. And of course, US governement debt payments will increase. Everyone knows this at some level, but we all are being led into magical thinking that reduction of QE can be done.

    Once things slow up sufficiently and very possibily markedly, The CB’s will have to pause and likely reinstitute an increase in QE.

    Thanks for the opportunity to comment. Great site!

    Reply
    1. Yves Smith Post author

      The Fed’s emergency programs like TALF stabilized the financial system. You don’t give any reason why QE stabilized the economy. Contrary to popular misrepresentation, it was not “printing money” and hence not monetary stimulus. It was an asset swap that by targeting quantities instead of yields, may have lowered them in the maturities and in the instruments the Fed bought (Treasuries and high grade MBS, almost entirely government guaranteed MBS). We don’t even know that for sure but we can give it credit for having some impact.

      So how would lower long term rates and lower MBS yields “stabilize the economy”? I don’t see it. It did increase asset prices. Tell me how that “stabilized the economy”. Empirically, there’s perilous little evidence supporting the wealth effect:

      http://www.slate.com/articles/news_and_politics/hey_wait_a_minute/2008/06/debunking_the_wealth_effect.html

      It also didn’t work when first tried, by the Bank of Japan in the 1980s.

      In fact, it if anything has effects the opposite of those widely attributed to it. I didn’t want to belabor this is the post, but see more for Warren Mosler:

      http://moslereconomics.com/2014/05/02/qe-is-a-tax/

      https://www.youtube.com/watch?v=CO6GS13rEuE

      https://www.youtube.com/watch?v=zqgo31Y-Ld4

      Reply
      1. whine country

        I think the answer to your question is that Mike R. like many others believes in the bogey man. The only argument used ad nauseum by those who agree with him is: “You don’t want to know how bad things would have been had we not used our mojo to keep the bogey man under the bed”. When one is afraid of the bogey man, evidence is not an issue.

        Reply
      2. JF

        Yves, it was printing money. What indeed did they give to the party who sold them a bond?

        Reserves are money.

        Now on the other party side there was little compositional change at least in simple views. A bank, for instance, swept its accounts to gather the cash to buy the bond from Treasury. So monies, somewhat idle in the bank’s accounts, one might say, was swept up and given to Treasury (who turnstiled it right back into the economy to pay the claims due; for example, for an aircraft carrier built last year).

        In selling the bond to the Fed they got cash back, and they distributed the cash across their own accounts. No change in composition for this bank.

        Look at the comments on the other atrticle on this blog.

        As for the topic of this article, I do think that central banks buying securities and then redeeming debt principals or selling the securities in the open markets but at these now massive scales, this may be the cause of the next crisis as people will see all this in practice better, and taper-tantrum at the least.

        Reply
          1. whine country

            Yves – I’m shocked that you would cite an article on CNBC by an investment type. Since I find the chance of you seeing this and responding to be negligible I will be brief. Neither of you understand double entry accounting. As to my CV, I’m just an very old, retired CPA who fortunately never got to the point where I asked my client: “What time to you want it to be” Unfortunately, both economists and accountants are fine with the status quo. I won’t encroach on your turf if you give me the same consideration – that’s the deal. It’s just easier to keep picking the low hanging fruit and say: “Hey, I’m whichever one and I leave that other stuff to the other guy.” I’m living proof that the accounting is not all that hard to understand with just a little bit of effort, but why spoil a good thing? Just for kicks. add up all three balance sheets before and after. What, there’s more assets in the aggregate after the deck chairs were re-arranged. An asset was created out of thin air – but, hey, it’s not money so…. Just keep thinking that that was a non-event.

            Reply
          2. Collins

            Thanks for the instructive link. QE and the wealth effect actually has ‘printed money’ , but only for the financial and rent-seeking sectors. Saying “reserves are not money ” is like saying Eric Clapton’s 300 foot yacht and Ferrari collection are not money. They’re still ‘wealth’ and can be recycled to money at his discretion.

            Reply
      3. Chauncey Gardiner

        Thanks for the links, which I will watch. A bit off-topic from the thrust of the main article, but I also want to belatedly thank you for the brief link you provided some months ago to this succinct 2013 piece by Marshall Gittler that used T-accounts to describe how QE works and that it is an asset swap. I had earlier been struggling to understand QE mechanics:

        https://www.cnbc.com/id/100760150

        QE appears to me to have been largely about interest rate suppression to facilitate debt servicing, temporary expansion of the banks’ net interest margins and capital base restoration, increasing financial asset and real estate valuations for collateral purposes and to support private credit expansion (liquidity)… all without causing a material increase in inflation.

        However, I am puzzled whether systemic liquidity will be affected going forward by central banks’ maintenance of their balance sheets at static levels, or if their replacement securities purchases will merely be sufficient to maintain current levels of liquidity in the financial system as run-off in the central banks’ portfolios of securities is replaced with other securities in exchange for increasing the Reserve accounts of the primary dealers at the central bank.

        Reply
      4. Mike R.

        Contrary to popular misrepresentation, it was not “printing money” and hence not monetary stimulus.
        If the Fed bought mortgage backed securities, how could it not be printing money?

        So how would lower long term rates and lower MBS yields “stabilize the economy”?

        To allow individuals, businesses and corporation to refinance their debt, and in the case of corporations, buy cheap debt to reduce equity.

        Reply
    2. Jim Haygood

      ‘Once entered, it will be near impossible for the Fed to extract itself from QE’

      This maxim should be engraved into the marble door lintel of the Eccles Building.

      QT (Quantitative Tightening) is at least the cousin of efforts to repeg currencies under the gold standard after war-related balance sheet expansions.

      Reversing A. Lincoln’s 1860s greenback experiment cost the US a brutal quarter-century of deflation from 1871 to 1896. Likewise repegging pound sterling to gold after WW I cost Britain a lost decade during the 1920s, which were boom times in America.

      As Mike R asserts, QT will end when the economy smacks the wall. Then chastened central planners will be obliged to QE4 the Fed’s balance sheet to $10 or $15 trillion, with Orange Jesus enthusiastically egging them on with tweetstorms (and even claiming it was his idea all along).

      Reply
      1. flora

        an aside:
        ” Likewise repegging pound sterling to gold after WW I cost Britain a lost decade during the 1920s, which were boom times in America.”

        Beginning with the “Chicago Boys” advising Russia in the 1990’s the way to sound currency was to buy US Treasuries, and through the last 10 years’ economic recession when buy-US T’s-at-any- minuscule-rate was seen as a smart flight to safety, I wonder if T’s have become a defacto gold standard, with all the opportunities and peril that brings.

        Reply
      2. clinical wasteman

        ah, the gold standard! Heroic Churchill’s second-finest hour after the Dardanelles invasion! Or third if you count the Bengal famine, or… or….

        Reply
  7. Louis Fyne

    —more interesting contradiction is in the posture of conservative businessmen—

    before there was Trump Derangement Syndrome there was Obama Derangement Syndrome.

    Reply
  8. Jamie

    Forgive me if this is not the place, but reading this makes me wonder why we endlessly analyze and have stopped talking about breaking up the TBTF banks. Yes I know there are ideological and political obstacles to doing so, but do we even know how to do it if those obstacles could be surmounted? Would we, 1) make a more or less arbitrary list of the x largest institutions (the 10 largest? the 50 largest?) and split them each in half? 2) determine the optimum size of an ideal large financial institution and impose that size restriction on all institutions? Do we even know, in theory, how to determine the optimum size of a financial institution? Do we not talk about this because waiting for the DoJ to “do something!” about the problem has inculcated too much hopelessness and powerlessness… do we no longer perceive it as within our sphere of influence, or do we simply have no clue how to proceed? Or are our efforts better spent promoting the Post Office Bank idea? If it’s going to be TBTF, let it at least be one giant, publicly owned institution?

    Reply
  9. Sylvia Demarest

    Yves, thank you so much for taking the time to write this detailed piece. I wonder if the next crisis might start with a geopolitical issue that produces serious economic impacts. I see the US dollar’s global role as a potential spark.

    I’ve read up on financial history especially the Great Depression. The mantra I came up with from all that reading was: At the start of the last depression no on WOULD stand as the lender of last resort, but in the next depression no one would be ABLE TO. Boy was I wrong, as, led by the US Fed, the Fed first dealt with a huge global dollar shortage, and then, along with other global central banks, spewed out over $15 trillion in liquidity. Some of that spewing is still going on as it’s estimated that central banks have purchased almost $2 trillion in assets over the last year. Increasingly these purchases include stocks especially by the Japanese and Swiss central banks.

    What made this extraordinary fiscal operation possible with out causing larger knock on effects? Could the dollar’s role as the world’s reserve currency have played a central role? The ability to issue unlimited dollars is one of the most beneficial aspects of dollar hegemony. Today, I see the dollar’s role as coming increasingly under assault. Russia objects–China objects–Iran objects, and the US is no longer the leading purchaser of OPEC oil–China holds that position especially with Saudi Arabia. Several deals with the Saudi’s, beginning in 1945 offered US protection in return for the pricing of oil in US dollars.

    It’s beyond the scope of this comment to discuss what the impact of a reduction or decline in US dollar hegemony would or could be–but in my estimation it would lead to serious economic impacts in the US–on the US economy in general, on our ability to pay for our huge military in particular, and could constrain the Fed’s ability to deal with the next crisis. The military budget pumps almost $300 billion a year into the US economy–mostly for the production of weapons. It’s a huge stimulus and jobs program. Not only that, we are increasingly dependent on imports. What if we suddenly had to “earn” the money to pay for all this?

    What do you think?

    Reply
    1. Urizenik

      Very much a scenario just envisioned by Alfred W. McCoy, In the Shadows of the American Century: The Rise and Decline of US Global Power (pp. 238 ff.).

      Reply
    2. Vatch

      The military budget pumps almost $300 billion a year into the US economy . . .

      In recent years, the U.S. government spends more than $600 billion on the military and defense, and on related functions in the Energy Department, Homeland Security Department, and the Veteran Affairs Department. For examples, see:

      https://en.wikipedia.org/wiki/2018_United_States_federal_budget#Department_and_program_changes

      https://en.wikipedia.org/wiki/2015_United_States_federal_budget#Outlays_by_budget_function

      Reply
    3. Mark P.

      Where’s the viable replacement currency? That’s what it comes down to — we’ve been hearing about ‘baskets of currencies, etc.’ for decades. Fifteen years ago most of us would have sworn that the day the petrodollar started going away would be the day the dollar as the global reserve currency endded. It wasn’t.

      Short of imperial mismanagement by Washington and Wall Street that’s so abusively stupid that the world turns away from the dollar — and it’s hard to imagine what would be worse than what already occurred with the GFC in 2008 — inertia and the lack of a viable replacement could conceivably preserve global dollar hegemony another twenty or thirty years. Hard as that is to believe.

      Reply
      1. Mark P.

        Good original post by Yves, not incidentally.

        I’ve always assumed the punitive, disciplinary aspect of employer-paid healthcare — since the vast majority of bankruptcies among Americans are the result of medical costs, people will put up with crap to keep their jobs — was why US employers not only hadn’t rebelled from bearing these costs, but seemed pretty supportive of the whole system despite the giant handicap in terms of non-competitiveness it imposes globally.

        Reply
      2. animalogic

        China & Russia have been buying up physical gold hand over fist for years to strengthen their currencies. Every day Yaun becomes a more important mans of carrying out global trade. The US dollar is not “over” … yet.

        Reply
  10. Wukchumni

    If safeguards such as oodles of free money are what’s keeping the financial markets going, then it’s already broken. The things we’re perhaps looking for in terms of a crash, are based on an honest system, not an inherently dishonest one.

    Reply
  11. tegnost

    kalecki in 1943…” But obstinate ignorance is usually a manifestation of underlying political motives.”
    The more things change the more they stay the same
    I’ll highlight this also from the same above reflecting the bizarro world we now inhabit because while food stamps are a consumption subsidy it’s true, their main purpose in the recent downturn was to help grocers keep prices higher than they would be if there were no customers with cash, a point I think the author was trying to make back in 1943 and is clearly a policy designed to benefit the wealthy while claiming to help the poor (who no doubt are happy to get a meal regardless)
    One might therefore expect business leaders and their experts to be more in favour of subsidising mass consumption (by means of family allowances, subsidies to keep down the prices of necessities, etc.)

    Reply
  12. Wukchumni

    The reason this situation is so striking is that historically, crises that did real damage hurt financial institutions. In the Great Depression, banks all over the world failed, wiping out depositors’ funds, big chunks of the payment system, and the resulting downdraft correctly made the survivors too fearful to lend.
    ~~~~~~~~~~~~~~~

    In the amazing book, The Great Depression: A Diary, author Benjamin Roth related that passbooks on banks that weren’t allowing their customers to make withdrawals, traded for 40 to 65 cents on the dollar, depending on the bank. Now why would anybody want to buy funds you couldn’t get?

    Well, the banks were sitting on a ton of foreclosed real estate, and were only to happy to sell it, and buyers of said passbooks could use the funds they bought for 1/2 price to buy real estate from the banks on the cheap, as yes, they did accept somebody else’s money in that fashion.

    Reply
  13. Jim A.

    Well it is perfectly rational for the wealthy to fear inflation more than the rest of us do. OTOH the loose money policies have mostly boosted asset prices rather than the CPI.

    Reply
  14. Jeremy Grimm

    Skipping over Kalecki and looking down to the conclusion of this post:
    If “the authorities have succeeded in moving risk out of the financial system and more and more onto the backs of investors” and if a collapse in asset prices will cause little damage to “critical financial plumbing” — then ” the effects of the crisis aftermath and any new upheaval are likely to create more instability in the political system and society, and that that may be more destabilizing than any immediate market/banking system impact.” The Ship of State may suffer this “damage below the water line.”

    As a pensioner a little collapse in ” pension funds, insurance companies, endowments, foundations, and sovereign wealth funds” would seem something of a crisis to me — whether it left “critical financial plumbing” intact or not — and though it might not matter in the Keynesian long term. Be that as it may — I am not at all clear what sort of damage to the political system and society may be looming. If I were carpenter on the Ship of State what sort of damage should I be preparing and watching for “below the water line”?

    Reply
  15. Altandmain

    As a side note, Michal Kalecki may very well be one of the greatest economic minds in history.

    He had quite a following in the UK. In America, he was denounced as a Communist sympathizer during the McCarthy era.

    One can see though why American business interests would want to keep the memory of Kalecki from getting more scrutiny. He tells the truth that they dare not admit.

    If you read the article again. Read point 4 again. Even if business could earn more revenue and profits, the rich still would fiercely oppose it. That is just how bad it is. They would rather have less money if it meant keeping the rest of society relatively more poor. That is what we are up against.

    Reply
    1. clinical wasteman

      one later writer who makes good use of Kalecki (although I never saw a passage of his as good as the one quoted here) is Beverly J. Silver in ‘Forces of Labor’ (Cambridge U.P., 2003). Although there’s much that’s at least open to query in her taxonomy of various labor struggles and use of NYT-type clippings as privileged sources, the genuinely global scope of her overview of the 2nd half of the 20th century — using the car industry as example, but with wider implicit reference — is a rare and precious thing, most of all in her emphasis on the migration of ‘industrialized world’ class conflict into supposedly ’emerging’ economies.
      My Genossen/innen at Wildcat (Germany) interviewed Silver here (English version):
      http://www.wildcat-www.de/dossiers/forcesoflabor/bs_interview.htm
      and translated the book into German, but neither the original nor the translation seems to be up on the site right now, probably for reasons to do with the original academic copyright.
      But! here’s another link, or rather chain of links, all unverified because only found right now, but they appear to lead directly to PDF versions of the book, with some sort of Smithsonian provenance claimed (whatever that implies):
      http://warbithy.com/book/forces-of-labor-beverly-silver-pdf

      Reply
    2. animalogic

      “They would rather have less money if it meant keeping the rest of society relatively more poor. ”
      Right. It’s all about power. Money is the best, but not only means of obtaining & exercising power.

      Reply
  16. fresno dan

    The Fed seemed to be the first to recognize that its monetary experiments had done little for the real economy, save allow for some additional spending via mortgage refis. It had done more to transfer income and wealth to the top 1%, and even more so to the top 0.1%, and enrich banks, all of which are hindrances to long-term growth.

    https://www.linkedin.com/pulse/our-biggest-economic-social-political-issue-two-economies-ray-dalio
    To understand what’s going on in “the economy,” it is a serious mistake to look at average statistics. This is because the wealth and income skews are so great that average statistics no longer reflect the conditions of the average man. For example, as shown in the chart below, the wealth of the top one-tenth of 1% of the population is about equal to that of the bottom 90% of the population, which is the same sort of wealth gap that existed during the 1935-40 period.

    There has been no growth in earned income, and income and wealth gaps have grown and are enormous. Since 1980, median household real incomes have been about flat, and the average household in the top 40% earns four times more than the average household in the bottom 60%. While they’ve experienced some growth recently, real incomes have been flat to down slightly for the average household in the bottom 60% since 1980 (while they have been up for the top 40%). Those in the top 40% now have on average 10 times as much wealth as those in the bottom 60%. That is up from six times as much in 1980.
    =============================================
    I’ve gone on and on about inequality – Dalio, not being an academic, just gives another vantage point to what seems to me just to confirm that no matter the perspective, the conclusion is that the majority has been getting worse off for years.
    Despite, or more accurately, because so many markets are at high levels, often on thin trading volumes, many investors are edgy.
    When no one can afford to buy the products/services , what will support the valuations…maybe we all become realtors and live off the commissions of selling 2 million dollar houses.

    Reply
  17. marku52

    Drat. Can’t find it. But I had a link where Kalecki was forecasting that with the inevitable decline in profits from late stage capitalism, capital would intrude itself into areas that were previously the province of government.

    In other words, he was foreseeing privatization back in the 1940s.

    Pretty sharp guy.

    Reply
  18. flora

    Great post, Yves.
    ‘Notice the emphasis that Kalecki places on businesses preferring the “laissez-faire system,” meaning the market system, to create that essential elixir, “confidence”. ‘

    This sounds like a financial mumbo-jumbo religion instead of sound financial reasoning. Maybe our august bankers and businessmen need a course on the Enlightenment and the dangers of acting in locum rege.

    Reply
  19. Jeremy Grimm

    Kalecki puts the politics into political economy. But the lumpen public has little or no impact on politics. Will the next crisis be a tussle between elephants which we ants might enjoy from well-stomped grass? Are ”pension funds, insurance companies, endowments, foundations, and sovereign wealth funds” the only potential losers in a little collapse to come?

    I am ignorant of the extent of Corporate borrowing to buy back shares but is it of great enough magnitude that a financial crisis might shift even more control of our productive economy into the hands of finance?

    Reply
  20. Tuan

    Jesus weeps.

    What part of AGGREGATE DEMAND these business overlords don’t understand???

    With high unemployment, stagnant/declining income, exorbitant totally unnecessary federal payroll taxes, stratospheric private debt burden, who beside the 1%, can SPEND on anything?? When 99% of the population don’t spend, there ain’t ANY demand for goods and services, and businesses DIE, AND NO AMOUNT OF CHEAP MONEY WILL FIX THAT.

    The bleedingly obvious remedy is to set the federal payroll taxes to ZERO for a start, and watch the aggregate demand climbs. And a federal Job Guarantee Scheme will do wonder to increase the productivity of the economy, by mobilising the underemployed people. I am sure that Stephanie Skelton would be more than happy to advise on the design and funding of such a Job Guarantee scheme.

    Reply
    1. JBird

      I suspect The Powers That Be either believe that their good buds in the government will save them, or that the possible economic, governmental, and social problems will never get from unrest, which shouldn’t affect them, to collapse, which would. Any reasonable study of history would should otherwise. Not much reading really as any decent textbook on modern history would do.

      Take a pick – willfull stupidity, arrogance, or my choice of folly.

      Reply
      1. somecallmetim

        With mobile capital and efficient supply lines aggregate demand is global, and the rising middle classes in south and east Asia will replace maxed out US / western consumers.

        Reply
  21. John k

    Great post, hadn’t read it.
    Gold standard was a. 150- yr sequence of great deprecessions, some deeper and longer than GD. A nasty recession/depression every three years.
    Fiat means no more of that because banks can and will always be saved.
    Fiat could mean a lot more than that, supplying demand and useful infra spending whenever the business cycle turns down, kalecki explains the ideological resistance.
    So next crisis will not be another GD, but dominoes have nevertheless been hoisted into position.
    Household debt very high, cannot borrow and spend more, higher rates bring this forward. Recession can only remove some of this thru bankruptcy, and meanwhile spending slows. Loans already crashing, consider it took 8% loan growth to produce 2% GDP, already loan growth down 40%.
    The scarier debt is margin debt, this record amount will go to zero in the next recession.
    Dot com was small because dot com corps employed few people… losses were to speculators, and newly rich principals compensated.
    But now nearly all companies p/e ridiculous, r2k at 100.
    Widespread losses. What happens to pensions?
    The trigger? Maybe just rising rates, slowing spending, crashes profits, unemployment rises, GDP goes negative for a while, I.e. The usual. But QT too? Does that cut asset values? There you have it…
    and or, Fed might respond too late… or a bad trade deal could always be worse…

    Reply
    1. nothing but truth

      With P/E ratios touching infinity and rents taking 50% of income Fiat money did create some different problems.

      And what does P/E ratio at infinity mean? Infinite purchasing power to asset owners and none to labour.

      ie, extreme inequality.

      And what have the asset owners done to get this windfall?

      Reply
  22. VietnamVet

    It is clear the wealthy will keep the system functioning to their benefit; until it doesn’t anymore. The NBC Weekend News reader was incredulous that his tax free 401(k) would be cut from $18,000 to $2400 a year. The problem is government austerity and there is no economic multiplier from money spent on an endless Holy War and a revived Cold War. How astonishing dangerous is it that 55+ year old nuclear armed B-52s are about to be placed on 24/7 alert. The alternative is peace, rebuilding infrastructure, strong borders and a people’s militia to guard it. All it would take is a 80% tax on the five oligarchs who now own half of the world’s wealth to defend North America from outsiders and provide jobs, healthcare and shelter for everyone who needs it. On the 100th anniversary of the Bolshevik Revolution, you’d think the global elite would recognize that Brexit, Catalonia and Donald Trump; are signs that the scum are working up the nerve to give it another try.

    Reply
  23. Scott

    I read all of the comments & they all covered or touched on things that came to my mind from reading the essay.
    Only thing I wondered about was why the increases in rents aren’t called inflation?
    Far as revolution, well, Sanders used the code “Political” in front of that word, since anything like the Russian Revolution is impossible, and that didn’t work out so well at all anyway.
    Moving to Uruguay appeals to me.
    Founding another nation entirely drives my modeling.
    Thanks to Yves & all the commentators.
    P.S. Just read The Price of Peace by Keynes. He could well see the attempt to make Germany pay for the War to End All Wars, forever, was going to mean more war.
    While the rich salivate over more debt laid upon the majorities, & think they cannot be touched by anything, Trump means war.

    Reply

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