When Prices Fall

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

            "Real and Illusory Credit" bridged the destruction of phony, 1920s, Federal-Reserve wampum to Bernard Connolly's evaluation of today's deadly path. The aftermath of the twenties, as described in David A. Stockman's The Great Deformation: The Corruption of Capitalism in America, crippled capital spending. Plant and equipment investment tumbled by nearly 80 percent between 1929 and 1933. Inventories were liquidated. There were no buyers. Employment and wages collapsed.

An ameliorating tendency is never mentioned by Bernanke, "the Great Historian of the Great Depression." Prices also dropped, which had traditionally been true in depressions. This was well known and understood as inevitable to rebalancing an economy that had produced beyond what could be bought at then-current prices. Bernanke and his comrades have destroyed history, at least until history rebounds and destroys them.

Bernard Connolly explained that today's central bankers have decided consumption must not flag despite the necessity - history shows this - of a decline in consumption after a business peak. If the professors had understood their limits, not taken control of prices, especially the price of money (interest rates), industries, companies, and products that grew faster than could be sustained would have already been combined or liquidated.

Quoting Connolly, the current dynamic inefficiency "reduces future consumption possibilities; and this, in turn, means that much of the recent and current capital formation, notably in the United States, has been based on excessively optimistic expectations of future demand."  Such attempts "to bring spending forward and to avoid a near-term collapse simply reduce the (realistically) anticipated rate of return on capital still further, in a vicious downward spiral."

Note the historical precedent in Stockman's book. This must happen but will be more painful than if academics had never entered central banking. The protracted issuing of unproductive debt and sustained, false prices (the market signals to businesses and buyers alike) will cascade. Assets, and their prices, will take note.

An attempt to interpret this fate adds another layer in the valuation of companies. For instance, in the May 2, 2013, High-Tech Strategist, Fred Hickey wrote: "EMC, the world's biggest supplier of computer storage equipment, slightly missed sales and earnings estimates for Q1. EMC's revenue growth (5.6%) was the slowest pace of growth since the 2009 recession. According to CEO Joe Tucci on the conference call, customers are 'still being cautious with their IT spending to be sure.' 'The customers are for sure 'sweating their assets' more - it's a term we use. They are keeping them longer,' Tucci explained. Tucci also noted that many enterprise customers are now requiring higher executive approvals before signing off on contracts."

The May, High-Tech Strategist issue contains a litany of technology companies fighting a battle against an uncooperative world economy. This presents the question of how companies will fare after central banking funny-money and illusory-credit schemes fail. This is not "if," but "when."

Just how useless, wasteful and destructive is Bernanke's gizmo? Gary Shilling's May 2013 Insight shows the increase in real GDP per dollar of incremental debt was $4.62 (of additional GDP for each additional dollar of debt) from 1947-1952; $0.64 from 1953-1984; $0.24 from 1985-2000; and $0.09 for each dollar from the fourth quarter of 2001 through the fourth quarter of 2012: an extra nine cents of production for every dollar of debt. Not a fraction of this will ever be paid off, short of a Weimer inflation. (Shilling used Ned Davis Research and Federal Reserve data.)

EMC sales and profits have been artificially lifted by businesses that can borrow at 3% but should no longer exist. Their recalibration remains in the future. Those businesses employ workers who buy products produced by P&G. And so on. Government transfer payments have prevented the economy from sky diving. "Policymakers" have employed this modus operandi since the millennium.

After the tech bust in 2000, the percentage of sales by tech companies to the government rose sharply. That saved them. Despite the recent attempt to brainwash the electorate into believing the U.S. budget deficit is no longer a problem, that is only true as long as the Federal Reserve continues to buy the majority of U.S. Treasury auctions.

Parenthetically, the TIC (Treasury International Capital) data released May 15, 2013, for the month of March 2013, shows China, Japan, Taiwan, Singapore, and India were net sellers of dollars. Andy Lees AML Macro Ltd. writes: "Japanese holdings were down USD0.5bn and have gradually been falling since October last year. This may just be rotation into other assets, but it may also be a reflection of a current account swinging into deficit in Japan and question marks over the Chinese data." Whatever the case, if the New York Fed trading desk takes a lunch break in Battery Park, the dollar will slip to 40 on the dollar (DXY) index (currently 83.61).

Not to pick on EMC, "the world's biggest supplier of computer storage equipment" bears advantages during the worst of depressions, but the loss of central-banking support will sharply reduce its sales, thus inventory, thus capital equipment (or, R&D, for a software company). The consequent loss of jobs, consumption, and falling asset prices will slide "still further, in a vicious downward spiral."

Correction: In Real and Illusory Credit, it was in 2012, not 2013, when the Federal Reserve released its Survey of Consumer Finances that showed the wealth of American family was $77,000 in 1992, rose to $126,000 in 2007, and fell back to $77,000 in 2010.

Real and Illusory Credit

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

 "When Ro-Ro goes No-No" expounded upon the ultimate futility of conjuring illusory wealth. Bernard Connolly's analysis, "Rethinking the Rogoff-Reinhoff Thesis," made the case. Connolly wrote This Time is Different: Eight Centuries of Financial Folly, "is largely an exercise in measurement rather than theory (while many of the data in the book are new, little or none of the theory is), it can give rise - and has given rise - to dangerously misleading popular interpretations of the data which its authors had so painstakingly assembled." Connolly then offered the theory; what follows is complementary data.

A cheat sheet: The annual increases in U.S. non-financial credit - 1995: $654 billion; 1997: $793 billion; 1998: $999 billion; 1999 $1.012 trillion; 2002: $1.429 trillion; 2004: $2.096 trillion; 2006: $2.388 trillion: 2007: $2.552 trillion. Between 1995 and 2007, non-financial credit in the U.S. inflated from $13.141 TN to $32.621 trillion, or 148%. (From the Prudent Bear "Credit Bubble Bulletin," May 3, 2013.

This is what Federal Reserve Chairman Ben S. Bernanke calls "The Great Moderation." He and his comrades have attempted to erase what we have learned since the dawn of time. We await their proclamation that the months have been changed to Vendemaire, Brumaire, and Frimaire. In the end, they cannot pin nature under their tommyrot research, that will decay to dry rot.    

The 1920s bubble is instructive. From David Stockman's The Great Deformation: The Corruption of Capitalism in America: "[T]he financial bubble was not just domestic. It began way back in 1914 when the 'guns of August' suddenly transformed the United States into the arsenal and granary of the world and an instant, giant global creditor."

America had been a debtor nation for 300 years. American citizens owed Europeans $3 billion in 1914; Europeans owed Americans $3 billion in 1919. The U.S. bustled with commercial activity before the War; Europe was in ruins after the peace. In the words of historian William E. Leuchtenburg: "These figures represent one of those great shifts in power that happens but rarely in the history of nations."

Stockman continues: "A crucial element of the postwar stabilization process, especially in central Europe and commodity-producing nations of Latin America, was the $10 billion of foreign loans underwritten by Wall Street. That was the equivalent of $1.5 trillion in today's economy, and went to borrowers ranging from the Kingdom of Denmark and German industrialists to municipalities from Hamburg to Rio de Janeiro."

Wall Street bond houses played a role not much different from the People's Bank of China in recent years (or Cisco and Intel during the Internet years). This was vendor financing: lending currency so that others would have the funds to buy the lenders' products. Foreigners, for the most part struggling or devastated by the Great War, received Wall Street funding to buy U.S. crops, cars, and radios. On the home front, booming foreign sales spurred capital investment, consumer spending, an unsustainable real-estate escapade, and, of course, the Crash That Made the Decade Famous, in stocks.

Credit flowed. The credit system had been nationalized during World War I, through the fortuitous creation of the Federal Reserve System. In outline, the Fed boosted credit through two initiatives.

First, it greatly reduced reserve requirements of the banks. The average reserve requirements of all banks prior to the Federal Reserve Act were estimated at 21.09%. By the 1920s, the Fed, having distinguished between demand and time deposits, had reduced the reserve ratio against demand deposits (to 7% - 13%) and against time deposits (to 3%).

Banks lent as one might expect. Demand deposits did not grow in the 1920s. Between 1921 and 1929, commercial loans - those loans for commerce and industry that fulfill the traditional function of banks - fell, from $12,844,000 to $12,814,000. Time-deposit lending, with lower reserve requirements, boomed. Real-estate speculation and securities lending were part-and-parcel to degenerate gambling propensities encouraged by Prohibition. Between 1921 and 1929, loans on securities rose from 19% to 28% of bank assets; loans on real estate rose from 3% to 8%. (Commercial loans fell from a 53% composition of all Federal Reserve member banks' balance sheets to 36%.)

Mortgage debt rose through the decade, from $8 billion in 1919 to $27 billion in 1929. The fastest acceleration in new mortgage debt was between 1924 and 1927 (even though construction peaked in 1926) when mortgage debt rose from $15.5 billion to $24.2 billion - a 57.4% rise, or, a 16.3% annual rise. (Not all of this was bank lending.) Are you paying attention Canada? (See "Time to Go Short: Here Come Those Experts Again." Yep, any minute now.

A second Fed initiative was open-market operations. Today, the Fed enters the market every day, fixing interest rates while electronically transferring dollars it has created. These are open-market operations. Benjamin Strong grew addicted to more and bigger open-market operations through the decade. (Don't they all?). He had initially opposed such personal intervention most vehemently: "What I can't understand is the willingness of thoughtful, studious men who presumably have been brought up in the spirit of American institutions and should be imbued with their principles, proposing a scheme to Congress which in effect delegates avowedly and consciously this vast power for price fixing to a small group of men who, in an economic sense, might come to be regarded as nothing short of a super-government. It is undemocratic, absolutely contrary to the spirit of America institutions, and so dangerous in its possible ultimate developments that I cannot see the slightest merits for its proposal."

Such shenanigans were not contemplated when the Federal Reserve System was rushed into law. Only "real bills" were accepted for rediscount. Government bonds need not apply. By 1927, Benjamin Strong was freelancing as America's super-government. Federal Reserve governor Adolph Miller testified to Strong's mad-scientist scheme in 1932: "[T]he Federal Reserve [put] money into the markets, not because member banks asked for it by offering paper for rediscount, but in pursuance of a policy of our own which in effect said, 'We shall not wait to be asked to provide increased money through rediscounts; we will operate upon our own responsibility....'"

Returning to Bernard Connolly's interpretation of This Time is Different, today's fantasy credit will crumble. It is backed by fanciful dreams, but not by money. James P. Warburg, a financial adviser to President Franklin Roosevelt who then became a fierce opponent of FDR's whimsical schemes, wrote in The Money Muddle (1934): "Credit cannot create money for capital investment. The credit machinery can only direct the flow of capital into productive investment, but the capital must be there - it must have been created, or be in the process of creation, by the savings out of incomes. Credit can, and frequently does, anticipate the creation of capital, but when it does, the capital it creates 'out of thin air' will again vanish into the air, if the anticipated savings do not materialize."

Rediscounted commercial bills are backed by trade or inventory. It's the real thing. Strong and Bernanke's bilge is backed by faith or absent-mindedness.

The populace at large was party to the imbalances. Between 1923 and 1929, worker's wages rose 11%, which did not keep pace with corporate profits (up 62%) and dividends (up 65%). Radio sales rose from $60 million to $852 million. Along with cars, vacuum cleaners, refrigerators, silk stockings and movie tickets (by 1918, the movie business was already one of the ten largest industries in America) there was a lot more money spent than earned.

How was all this purchased? "Installment" debt financed 75% of all radio purchases and 60% of all automobiles and furniture. [Margaret Mitchell wrote of 1926: "Everyone I knew had a car, a radio, an electric ice box and a baby that they were buying on time (everybody except me!)."] Over 40% of department store sales were purchased on credit by 1926. Margin loans blossomed in the second half of the decade. At $16 billion in October 1929, this source of instability equaled about 18% of stock market capitalization. Rising demand for credit raised borrowing rates.

Bank customers, both individuals and corporations, instructed banks to lend their deposits in the call-loan market. It has been estimated that corporations (including U.S. Steel, General Motors, AT&T, and Standard Oil of New Jersey) had lent $5 billion to New York Stock Exchange purchases by September 1929. They were drawn to the call-loan market as rates rose to 10%. In consequence, total securities loans increased from $12.4 billion on October 3, 1928 to $16.9 billion a year later. Foreign banks also lent in New York, while neglecting the local tool-and-die manufacturer in Linz or Pinsk or Omsk.

This has a modern ring to it. The Internet years. The mortgage scramble. And now, the central bankers' Disney dust. Assets far and near are bubbling. What will happen to inventory chains and their suppliers when those buying on time falter?

Reading the weekly list of international issuers in Doug Noland's Credit Bubble Bulletin could be interpreted as a shift of wealth from the west to the east or bubbleitus spread to countries with oddly distributed consonants.

A comparison:

Week of April 10, 2009:

"International debt issues this week included Korea $3.0bn, KFW $3,0bn, Suncorp $2.5bn, and Hutchinson Whampoa $1.5bn."

Week of April 26 2013:

"International issuers included African Development Bank $2.17bn, Boligkreditt $1.0bn, Costa Rica $1.0bn, Neder Waterschapsbank $900 million, Toronto Dominion Bank $2.25bn, Transport de Gas Peru $850 million, Schaeffler Finance $850 million, Panama $750 million, Turkiye Bankasi $750 million, Uralkali $650 million, Sinochem $600 million, Promsvyazbank $600 million, Saci Falabella $600 million, Andrade Gutier $500 million, Korea Resources $500 million, Credit Bank of Moscow $500 million, Far Eastern Shipping $500 million, Banco Sudameris $300 million and International Bank of Reconstruction & Development $250 million."

            After 1929, the phony credit evaporated. Stockman writes: "[T]he trouble was that this prosperity was neither organic nor sustainable. In addition to the debt-financed demand for American exports, stock market winnings and the explosion of consumer debt generated exuberant but unsustainable purchases of big-ticket durables at home. So, when the stock market finally broke, this financially fueled chain of economic explosion snapped and violently unwound.

            "The first victim was the foreign bond market, which was the subprime canary in the coal mine of its day. Within a few months of the crash, new issuance had dropped 95 percent from its peak 1928 levels, causing foreign demand for U.S. exports to collapse. Worse still the price of the nearly $10 billion of foreign bonds outstanding also soon plunged to less than ten cents on the dollar, meaning the collapse was of the same magnitude as the subprime mortgage collapse of 2008."

            The interlinking relationships of the economy were now collapsing in unison rather than inflating. Stockman continues: "Needless to say, [the] 75 percent shrinkage of auto sales cascaded through the auto supply chain, including metal working, steel, glass, rubber, and machine tools.... The collapse of these 'growth' industries also caused a withering cutback in business investment. Plant and equipment spending tumbled by nearly 80 percent between 1929 and 1933, while nearly half of all the production inventories extant in 1929 were liquidated over the next three years. The unprecedented liquidation of working inventories - from $38 billion to $22 billion - amounted to nearly a 20 percent hit to GDP before the cycle reached bottom.  

            "Overall, nominal GDP had been $103 billion in 1929 but by 1933 had shrunk to only $56 billion. Yet the overwhelming portion of this unprecedented contraction was in exports, inventories, fixed plant and equipment, and consumer durables. [Bernanke and Yellen claim open-market money printing in 1931 would have sparked an economic recovery. This is their foundation for quantitative easing. - FJS] These components declined by $33 billion during the four years after 1929 and accounted for fully 70 percent of the decline in nominal GDP."

            In this spirit, it is worth looking further into Bernard Connolly's critique of Rogoff-Reinhart's non-theory: "The underlying problem is dynamic inefficiency, which reduces future consumption possibilities; and this, in turn, means that much of the recent and current capital formation, notably in the United States, has been based on excessively optimistic expectations of future demand. To prevent a hole from emerging as today becomes tomorrow, more and more incentives to keep on bringing spending forward from the future have to be given, whether in the form of reduced 'risk-free' bond yields, or attempts to ease credit conditions, or fiscal 'stimulus." Such attempts "to bring spending forward and to avoid a near-term collapse simply reduce the (realistically) anticipated rate of return on capital still further, in a vicious downward spiral."

            In June 2012, the Federal Reserve released its Survey of Consumer Finances. It showed the wealth of American family was $77,000 in 1992, rose to $126,000 in 2007, and fell back to $77,000 in 2010. The Fed is responsible for this Ferris wheel. Quoting page 2 of Panderer to Power: "From the time Greenspan was named Federal Reserve chairman until he left office, the nation's debt rose from $10.8 trillion to $41.0 trillion. He usually referred to the "debt" as "wealth." This image matched what he was selling - first stocks, then houses. He expanded money and credit; he oozed praise for derivatives. The larger volume of credit shrunk the consequences of immediate losses. It was easy to overlook areas of the economy that had shriveled and the instability of finance that compounded over the past half-century. In early 2007, this massive inflation of paper claims, many of which were claims on abstractions rather than on material assets, tottered then collapsed: the first to go was the subprime mortgage market."

            On April 24, 2013, the Republic of Rwanda issued a $400 million, 10-year Eurobond with a yield of 6.875%. The issue attracted more than $3 billion, "allowing bankers to tighten the yield to just 6.875 per cent, comfortably below the 7 per cent to 7.5 per cent that had initially been expected." (Financial Times) Some potential buyers of this single-B issue were deterred because of its small size. Bonds below a $500 million limit are excluded from "influential" bond indices. Half of the foreign currency flowing into Rwanda last year came from foreign remittances. (Rwandans working abroad.) Ten percent of GDP is foreign aid.

            Except for the (suspect) higher coupon, the symmetrical return to Earth of the Rwandan bond issue will not differ much from 10-year U.S. Treasuries.

When Ro-Ro Goes No-No

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

            A book finds favor when public opinion is willing to accept its proposition. This Time is Different: Eight Centuries of Financial Folly (2009) by Carmen Reinhart and Ken Rogoff funneled the debate of whether post-2008-crisis governments should increase spending ("fiscal stimulus") or cut it ("austerity"). The media's interpretative abilities further refined the on-off debate into a single interpretation of Rogoff and Reinhart's book. A country where public debt exceeds 90% of GDP is walking the gangplank. There is no shortage of such countries; the most heated debate has been in Europe. It is at emergency meetings among the world's acronyms where bureaucrats decide whether formerly sovereign nations are to be hexed with "austerity," or not.

            At the moment, there is a hiccup over the book's interpretation. That is not the topic here. The ruckus among noted economists concerns some re-regurgitation of the authors' data. Some new computer output aids the anti-austerity forces, who believe central bankers can eventually produce enough money on a keyboard to restore world prosperity. This accumulated phony wealth accompanied by asset-price targeting is the reason these institutional has-beens still control the public forum and weary us with recreational mathematics.

Outlined below is an interpretation that matters. The Summer 2012 edition of The International Economy published "Rethinking the Rogoff-Reinhoff Thesis," by economist Bernard Connolly, author of The Rotten Heart of Europe, and proprietor of Connolly Insight, his economic consulting firm in New York.

Connolly recognizes that the parties above (Rogoff, Reinhardt and all the categories of data interpreters mentioned) have mishandled This Time is Different. They have done so because the data has "not been set within a theoretical framework." The reason for such ignorance is "straightforward. The world, or at least the United States, became dynamically inefficient in the second half of the 1990s (perhaps for the first time since the 'roaring twenties'): the real interest rates tended to be less than the expected trend real growth rate. The culprits? Fed Chairman Alan Greenspan, European monetary union, the academic macroeconomics industry as a whole and its worse-than-useless DSGE models, and central banking theology as a whole with its dangerous inflation-targeting obsession. Over-financialization and excessive risk-taking by financial institutions were the consequence of this mess, not the cause."

Cutting to Connolly's point of illusory wealth, central bankers believe they can right any economic disturbance: the heart of their DSGE model. Why did Ben Bernanke claim sub-prime was "contained" in 2007 and wave off bubble concerns presented to him (February 2013) by the new bureaucracy he commissioned to warn him of bubbles? Because his dynamic stochastic equilibrium model is correct. It is always correct. He is the "A" student.

Except, it is wrong when the economy is dynamically inefficient, characteristics of which (see examples above) are exactly those being chased by central bankers today. Connolly quotes from "the magnificent, awe-inspiring Foundations of International Economics" (1996), written by Rogoff and Maurice Obstfeld: "The behavior of dynamically inefficient economies wreaks havoc with much of our intuition about the laws of economics." (Connolly explains the economic problems currently being exacerbated by official policy cause a reduction in future consumption possibilities, meaning, much of the capital formation is based "on excessively optimistic expectations of future demand." This is explained in his paper.)

Connolly corrects a possible misunderstanding of how the illusion of wealth will end: "It is very important, in thinking about the implications of the Reinhoff-Rogoff research, to realize that what deters new participants in a Ponzi scheme is not an accumulation of debt, but a destruction of wealth, or more accurately, a realization that the wealth supposedly backing debt is illusory.... [I]f the wealth of debtors is illusory, the wealth of creditors must also be illusory."

The illusory wealth will be extinguished. Capital formation based on excessively optimistic expectations of future demand will end where it started. This may happen quite fast. I tend to think Bill Fleckenstein, my co-author of Greenspan's Bubbles, is correct. Bill has written on his "Daily Rap," that, "in today's money printing world, as I have noted, problems don't matter until they do, as the discounting process essentially fails to function."("Daily Rap," April 3, 2013)

Current market prices are controlled, or, at least significantly altered, by central-bank interference. Investors who enjoy the latitude of investing or not investing, and choose to hold "risk assets" (discussion for another day) believe, or hope, that central banks will continue to boost prices. There is no question that boosting asset prices is the top goal of central banks today.

The "realization that the wealth supposedly backing debt is illusory" (paper currencies are a liability of the issuer) will end. Connolly writes: "traditional 'fundamentals' have now largely been transformed into one overarching 'fundamental': the assessment of solvency. As a result, markets are exhibiting binary behavior ('risk-on' and 'risk-off'.)"

This is another way of saying: "the discounting process essentially [is] fail[ing] to function." When ro-ro goes no-no, the currency of choice will be real money: gold and silver.

As it happens, Bill Fleckenstein quoted Paul Singer of Elliott Management (who has been quoted here before), in this afternoon's "Daily Rap":

"The world is on a seemingly one-way trip to monetary debasement as the catchall economic policy, and there is only one store of value and medium of exchange that has stood the test of time as 'real money': gold. We expect this dynamic to assert itself in a large way at some point. In the meantime, it is quite frustrating to watch the price of gold fall as the conditions that should cause it to appreciate seem more and more prevalent. Gold may not exactly be a 'safe haven' in the sense of an asset whose value is precisely known and stable. But it surely is an asset that, in a particular set of circumstances, becomes a unique and irreplaceable 'must-have.' In those circumstances (loss of confidence in governments and paper money), there are no substitutes, and the price of gold may reflect that characteristic at some point." ("Daily Rap" April 30, 2013) 

Preface for Chinese translation of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

To be published by Fudan University Press

I thank Fan Zhiqiang for his decision to translate Panderer to Power. His great attention to detail in asking me to explain dozens of phrases and terms for a Chinese audience reminded me of how the book concentrates on the United States. The influence of Federal Reserve Chairman Alan Greenspan's actions spread around the world. It would have been a much longer book, though, if I wrote of how United States' policy influenced China (for example), other than writing of it in reference to the United States.

             That being said, Panderer to Power was written with foreign readers in mind. There are universal tendencies in how the United States changed from 1950 to the present. Lessons might be applied in other countries.

Alan Greenspan embarked on his career at the mid-century mark. His story is thus intertwined with that of the United States from its post-World War II peak. In 1950, four million automobiles were built in the U.S. while the rest of the world produced about one-half million cars. Most ambitious young men went to work at manufacturing companies such as General Motors. Alan Greenspan followed a different route. He became an economist. This was either far-sighted or lucky, or both. The field produces non-tangible products, unlike the automobiles made in Detroit.

A few economic numbers give a sense of how much the country has changed. By 1956, a majority of the U.S. population was not engaged in production. This was the first time, in any country, when more people worked in administration than in agriculture or industrial production. In 1950, 59% of U.S. corporate profits were in manufacturing, 9% were from financial activities. During the period from 2000 to 2008, 18 percent of profits were from manufacturing and 34 percent were from finance.

The 34 percent underestimates how the larger distribution of profits has changed the habits of Americans. In the 1950s, most Americans' investments were simple. They saved for their retirement. The money was deposited in a local bank where it collected interest year-after-year. The annual interest never exceeded the mid-single digits, but, consumer price inflation never exceeded 2 percent a year and was generally well below that.

In the mid-1960s, the United States government and the economists advising the government started to live in a world of make-believe. This fit the times. Walt Disney and other fantasies were becoming more popular, not only with children but with adults. President Lyndon Johnson decided to fight an expensive war in Vietnam at the same time Congress passed his "War on Poverty." This included greatly expanded programs of food and medical care provided by the government.

Johnson surrounded himself with advisers who were more inclined to write scripts fit for Walt Disney than for reality. Despite what they told him, the U.S. could not fight a large war in Vietnam and a big war against poverty at the same time the country was de-industrializing. The latter was noted by Alan Greenspan in his autobiography. The steelworkers went on strike in the late 1950s. Compared to industrial workers anywhere else in the world they lived like princes. In addition to owning their houses, the workers often owned large boats and winter vacation houses in Florida or Arizona. In his autobiography, Greenspan wrote that American companies that were forced to import steel during the strike often found it was both of higher quality and less expensive than domestic steel. Many never turned back from their Japanese and German suppliers. This pattern repeated itself thousands of times over the next half century until industrial production had been hollowed out.

The United States' economy veered more and more out of balance. It could no longer balance its fiscal budget. It was running greater trade deficits with foreign countries. The median family income reached a peak around 1971 and it has been a struggle to attain that standard of living ever since.

The United States was bound by the Bretton Woods Agreement of 1944. A foreign government (central bank) could convert $35 U.S. dollars into an ounce of gold with the U.S. Treasury. On August 15, 1971, President Richard Nixon announced the U.S. had closed the gold window. The importance of this goes beyond the mechanics of monetary arrangements. In The Fate of the Dollar Martin Mayer wrote about the weekend meeting at Camp David 1971 when the decision to sever the gold link was reached. Quoting Mayer: "The fact that this procedure would violate American treaty obligations does not seem to have been mentioned by anyone..."

That nobody even mentioned the United States was acting dishonorably, unilaterally walking away from obligations to foreign countries, was a sign of the times - and, of the times ahead. For instance, until the early 1970s, bonds sold by corporations to the public were issued to finance large construction projects or to invest in power generation. These were bonds backed by a constant flow of revenues to the issuer. There was no law or rule against selling bonds backed by automobile loans or mortgages, but the Bretton Woods agreement itself restricted behavior.

After August 15, 1971, currencies issued by countries were no longer bound by a physical restriction. In time, and never more than in 2013, governments, and their central banks, print unlimited amounts of currency. This has unleashed an avalanche of debt a thousand times greater than in 1971 and an unstable financial structure that has forced the savers of the 1950s into a whirlpool of fast-buck investing that confuses the best minds. In 1978, Federal Reserve Governor Henry Wallich told an audience these distortions were a means "by which the strong can more effectively exploit the weak. The strategically positioned and well-organized can gain at the expense of the unorganized and aged."

"The strong," Wallich explained, "are smart enough to understand [distortion] introduces an element of deceit into our economic dealings." Contracts are no longer made to "be kept in terms of constant values."

To achieve the public's acquiescence when most Americans were falling behind, economists have turned all of what we have learned since antiquity on its head. It was always understood that investment is the bedrock of an economy. Consumption follows. It was always understood that imbalances - of budgets, in trade - must revert and balance again. It was always understood that a currency, the medium of exchange for trade, must be issued in limited quantities, a gold or silver standard often acting as a brake on issuance. A forgotten American essayist Alfred Jay Nock (Americans are expert at burying essayists critical of themselves) said: "It is an economic axiom as old as the hills that goods and services can only be paid for in goods and services."

The economists who run the world today have turned all such knowledge inside out and upside down. Their every decree defies common sense.

This is where Alan Greenspan came along at exactly the right time. He provided economic advice to companies from the early 1950s. He has been wrong at every turning point of the economy through his entire Wall Street and government career. Not once has he foreseen a change in the economy (for instance, when a recession or recovery was ahead). But: he was known on Wall Street as willing to provide whatever service a client wanted. As finance became more abstract and misleading after 1971, his advisory role to duplicitous firms and banks flourished. He also spent a large amount of his time courting the media. He deserves credit for anticipating that plastering one's face on television would come to define one's importance.

He served first in government as Chairman of the Council of Economic Advisers to President Gerald Ford in the 1970s. He served as Chairman of the Federal Reserve Board from 1987 to 2006.

The man who was willing to provide Wall Street with any service it wanted was more than willing to tell the U.S. Senate that it did not matter if the U.S. produced nothing (in 2003). He was more than willing to exhort Americans to buy adjustable-rate mortgages when the rates were at one percent (February 2004). Four months later, he was the man who started increasing rates.

Panderer to Power is the story of a bad economist with a shady reputation who reached the most powerful position in the United States. That the chairman of the Federal Reserve became more powerful than the President of the United States is part of that tale. I think it also important in understanding how power operates in our media-saturated time, to note the dynamic of how the entire, non-stop noise ensemble (newspapers, television, books), almost every economic department in every university in the country, and most of Wall Street, worshiped whatever Greenspan stated. It is little wonder then, that the American people, to their financial regret and destruction, bought (literally) what Greenspan told them to buy. That is the story you will read in this book.

We, the people in every country, are suffering from the spell of the same dynamic under Federal Reserve Chairman Ben S. Bernanke. This former head of the Princeton University economics department makes Greenspan look like a genius. He has led the world (forced the world, if you like) into the maddest and most destructive money printing scheme that has ever been attempted across every country on every continent.

As this is written on April 18, 2013, most Wall Street analysts and economists gleefully support central bank policies. Just listen to them: our celebrity central bankers can double the supply of currency, yet price inflation is dead. As long as consumers spend, we need not concern ourselves with mounting debt. The United States has consistently lost production jobs since 2000, but that does not matter. The only areas that have produced new jobs during that time are in education and health; where job growth has been produced by much higher government spending. The United States is only collecting 60 cents in tax revenues for every one dollar it spends. Somehow, this will continue. So, they tell us. They haven't been right in decades.

            Panderer to Power was written to help the reader understand this incredible inversion of common sense. May it provide a means to anticipate and act before the reversion to a sustainable future.

The Time is for Turning

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

The Economist published a sketch of Margaret Thatcher's political career in its April 8, 2013, edition.  "No Ordinary Politician" (subscription may be required) is a reminder of how, when there is a great change in store, it is evident to few. So it is with gold.

            When Thatcher was elected head of the Conservative Party in 1975, she may have been grateful the Labour Party was in power. Inflation, the Economist writes, "had reached 25% and people began to hoard food. It was then that Mrs. Thatcher became a Thatcherite. She was led there by [Keith] Joseph, who argued that only a free-market approach would save the country. These policies, extremely daring for 1975, became her agenda for the next 15 years."

            "Extremely daring" is not an exaggeration: "The country shifted significantly to the left during the second world war, leading to a landslide victory for Clement Attlee's Labour Party in 1945. Building on the forced collectivism of the war years, the Attlee government embarked on industrial nationalization and introduced the welfare state. To a generation of politicians scarred by the mass unemployment of the 1930s, full employment became the overriding object of political life."

            Most of the nationalizations long pre-dated the 1970s but the machinery of state tied the country in knots: "[T]o keep employment 'full', successive governments, Labour and Conservative, had to intervene ever more minutely in the economy, from setting wages to dictating prices." The atmosphere in Britain was tense. The unions were militant and frightening. One did not dare test their authority, which was ubiquitous.

            It was obvious the policies of the past 30 years had failed, but no one in politics was willing to address them. From the previous paragraph: "successive governments, Labour and Conservative, had to intervene ever more minutely in the economy...." To prevent the intrusive apparatus of state from unraveling, politicians in both parties intruded all the more.

To set wages and dictate prices was not a great disadvantage in either party since any debate echoed within a very, narrow channel. (As seems always to be the case, at least in recent decades, the two parties, say, Democrats and Republicans, are not really debating anything beyond the brand of mouthwash stocked in the Senate men's room.) The public debate did not wander much beyond these divined parameters since "an urgent return to the values of enterprise and self-help" (from the Economist's description Thatcherism) was - literally - unheard of.

            As opposition leader in the late 1970s, Thatcher "proceeded slowly, appointing her supporters to a few key posts, but otherwise doing little to suggest a radical break with the past. She relied more on the mounting unpopularity of the Labour Party, unable to control the trade unions during the 'winter of discontent' of 1978-79, to win the election of 1979."

            Central bankers today play the part of the Labour Party. They are doing whatever it takes to control us. The absurdities grow. At the Grant's Interest Rate Observer conference on April 9, 2013, Sean Egan spoke. Head of Egan-Jones Rating Company, he predicted European central banks will announce they are transferring sovereign bonds to Special Purpose Vehicles (SPVs). The asset will be the countries' bonds and the liability will be the euros that are whipped into existence at the moment they enter the SPV. The countries will then report their sovereign debt has been reduced from (let's say) $200 billion to $100 billion.

            Sean's forecast was met with skepticism, not, I think, because Lewis Carroll copyrighted it. Instead, the skeptics seemed to believe the scheme would be so self-evidently nonsense that the EU and ECB would lose all credibility. I think the skeptics will (would) be wrong.

Having seen central bankers state and do the incredible for so long, and noting their disregard for the law and plausible finance, an SPV announcement will probably not stir passions.

It is easy to picture: The press conference is held. TV people find pro and con experts who argue whether the SPV is better for stocks or bonds. The print media reports on the front page: "The ECB today announced..." The twelfth paragraph on page 41C: "Harry Hothead from the Lucifer Institute claims the SPV is 'simply a shell game' and 'should be ignored. It does not reduce the debt on national balance sheets by a single euro.'" On his blog, The Krugster will claim "the SPV has the same qualities as the trillion dollar platinum coin I proposed to close the U.S. national debt. It's time to revive that debate." And now, the orbit of central banking and common sense having passed Alpha Centauri 100,000 miles ago, some - maybe not enough, but some - former detractors of the platinum coin will be persuaded the idea is very similar to Europe's SPV, so "let's not dismiss it out of hand." Note the L.N.D.I.O.O.H. ploy followed the bait-and-switch of comparing the coin to Europe. The complete idiocy of the idea has, therefore, been extracted from discussion. The P.R. people will then enlist all the regulars for op-ed duty: repeat and repeat "very similar to Europe's SPV," until that becomes commonly acknowledged. The anatomical process of adapting platinum coins would continue - unless it didn't. There will be a moment when The Emperor Wears No Clothes. If that happened here, the skeptics at the Grant's conference would be correct: this is a step too far.

That's the point we are approaching. Gold is the refuge from the wildly out-of-balance world that central bankers are given credit for bequeathing upon us. Gold, silver, oil, and Johnny Walker Black are money, more awkwardly employed than paper currency, but the thing to hold when The Emperor...etc.

There are cracks and they are growing. Margaret Thatcher's ascendancy shows the opening, then development, of a change in thinking across the country, from roughly 1975 to 1983.

Permitting the Economist speak: "Once in power [in 1979 - FJS]... she revealed her true colours. Government spending was curbed to control the money supply, exchange controls were abolished and the currency was allowed to continue to float (rather than joining the new European Monetary System)-all decisive breaks with post-war orthodoxies. Industrial subsidies were cut, sending many firms to the wall. Against the background of a world recession, the result was a sharp rise in unemployment. By 1981, when joblessness stood at 2.7m, police were battling Molotov-cocktail-throwing protesters on many city streets in Britain.

"This was Mrs. Thatcher's low-water mark. She was, for a time, the most unpopular prime minister on record. Most of her colleagues expected her to retreat, but instead she ploughed on. 'U-turn if you want to, the Lady's not for turning,' she had cried the year before. She sacked all those ministers, the 'wets', who wanted to change course, and stocked her cabinet with ideological fellow-travelers. The 1981 budget contained more spending cuts, further depressing demand, in the teeth of the recession; 364 economists condemned her policies in a letter to the Times. This, more than anything, saw the birth of her reputation for ruthless decisiveness."

Having visited England for the first time in 1981, I can attest that the 364 economists were attempting to freeze the nation into a world only they, with their woefully inadequate imaginations, yellow bellies, pathetic efforts to stiff students with Ouija boards as science, and tenure to contribute less of importance than the Ames, Iowa, roller-derby team, could have found attractive. A hotel room in Mayfair cost the equivalent of $29, but it was cold. Theatre-goers wore old overcoats since there was no heat. There were so many strikes or rumors of strikes over the course of a day one needed a scorecard to keep track. The people looked awful. Was this Moscow? Will they get out of bed tomorrow morning? Why?

Margaret Thatcher is rightly celebrated for "not turning," but her time would not have arrived except for the bunglers who ditched their country to preserve their personal sanctuary. After the people have said "enough" to central banking, there will be such conversations: "Oh, yeah, Ben Bernanke was a terrible man. What did he do, again?" 

Let's Not Think

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

            On April 2, 2013, Peter Orzag, former director of President Obama's Office of Management and Budget, debated David A. Stockman, former director of President Reagan's Office of Management and Budget. Stockman is the author of The Great Deformation: The Corruption of Capitalism in America, a book that doses out unwelcome prescriptions for mending America. (Also a book that Amazon pledges to deliver within 3 weeks, a testament to the book's resonance with the reading public or publisher short-sightedness, the latter condition being practically redundant.) Orzag, who wanted to bury this uncomfortable debate, told Stockman and the TV audience: "The discussion has to happen within the bounds of what's, from a political economy perspective, remotely feasible. It does no good to be so far off from what's practical in terms of what could actually happen that it's a completely academic exercise."

It is Orzag who both ardently and fearfully attempted to lasso the debate within faculty parameters. Orzag is now a vice chairman of Citigroup. His attempt to live in the past resembled Citicorp Chairman Walter Wriston's (circa 1982) declaration that sovereign nations never default.

            Chapter 31 of The Great Deformation ("No Recovery on Main Street") shows how far the United States has wandered from a functioning economy. To those who are perplexed at the state of the union, this chapter is illuminating. What follows is a quick etching of how this trillion-dollar-a-year, deficit-financed economy has departed from sustainable reality despite the protestations of such establishment figures as Peter Orzag.

            One strand is the 21^st century swing towards HES jobs: health, education, and social services. They do not produce high-paying salaries. Stockman isolates these from "breadwinner" jobs, which, "on average paid about $50,000 per year - just enough to support a family." There were 72 million breadwinner jobs in the American economy in 2000. By September 2012, there were 66.4 million. Such jobs fell by an average of 35,000 each-and-every month over those 12 years.

            From the time the recent recession bottomed in December 2007 (not to be mistaken with the long-running ever-worsening Silent Depression), 5.6 million breadwinner jobs have been lost. Only 200,000 had been recovered by September 2012.

            Since the official recession ended in June 2009, three million jobs, of all types, have been recovered. More than half of those have been in what is often called the "part-time economy" including "retail, hotel, restaurants, shoe-shine stands, and temporary help agency" positions. The "part-time" shoe-shine boys and dish washers were positions restored after layoffs during the recession.

About 40% of the three million are HES positions. These are new jobs. Daunting is the recognition these positions have been deficit- and debt-fueled. Jarring is the recognition they could vanish if U.S. government spending is constrained.

HES jobs serve the economy. They are made possible by production. The current U.S. economy does not fit this mold. It is an economy boosted by rising debt rather than increased production. Stockman writes that HES job growth "was possible only so long as government and health plans could keep spending at rates far higher than the growth rate of the national economy."

From the turn of the century until 2007 (end of the housing-boom era), nominal GDP grew by $4 trillion. Total debt rose $20 trillion: $5 of new debt for every dollar of growth. More to the point, federal spending on Medicare rose from $300 billion in 2000 to $800 billion by 2012. Stockman writes: "Having gone from a modest surplus (the federal budget was in surplus in 2000 - FJS) to a $1.2 trillion deficit (annual - FJS) during the same 12-year time frame, it was evident the robust growth of federal health spending and the consequent bonanza of new jobs, on the margin, had been deficit financed."

Of education, from 2000 to 2012, student debt rose from $150 billion to $1 trillion. "The job count in nonpublic higher education had risen nearly 45 percent during the same twelve-year time frame..."

The reader may be forming a parallel picture to bulging mortgage credit, a building bonanza, and the associated growth in construction jobs.

Maybe Orzag is right. It's more comfortable not to think about where we, or these jobs, are headed.

Take Your Money and Run

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

            It is a wonder of the times that, in matters of money, such trust endures when those in whom it is invested work so hard to demonstrate they will squander or confiscate it. Both money and trust. At the very least, the mandarins have made no attempt to hide their inability to think and act beyond today's headlines. Every day is writ anew, with complete ignorance of previous decrees and assurances.

"Why Cyprus Is a Special Case" - March 25, 2013, Bloomberg

Cyprus 'Bail-In' Not a Special Case After All - March 25, 2013, ITV News:  "If we want to have a healthy, sound financial sector, the only way is to say, 'Look, there where you take on the risks, you must deal with them, and if you can't deal with them, then you shouldn't have taken them on.'" - Dutch Finance Minister, Jeroen Dijsselbloem.

 

ECB Repeats That Cyprus is a Special Case to No Effect. - March 26, 2013, City A.M: "The European Central Bank's Ewald Nowotny has repeated that Cyprus is a special case, but markets aren't paying attention. The euro remains stubbornly low."

 

"Merkel Says Greece is Special Case" - January 9, 2012, Reuters: "We have said time and again that Greece is a special case...."

 

"Ireland is a Special Case" - German Chancellor Angela Merkel and Irish Taoiseach Enda Kenny - October 21, 2012

"Portugal's Problems: The Next Special Case?" Renewed optimism about the euro zone has passed Portugal by - Feb 4, 2012, The Economist

"Cyprus Was a Very Special Case, Everyone Knew That. And We Found the Right Solution." - March 28, 2013, Wolfgang Schaeuble, German Finance Minister

"German Finance Minister Wolfgang Schaeuble Has Said Savings Accounts in the Eurozone are Safe." - March 30, 2013, Reuters

"Germany Remains A Special Case"-December 13, 2012 - Der Spiegel

OH, NO!:

 

"Britain is a somewhat special case" -Paul Krugman, New York Times - March 29, 2013

"So the question is whether Japan is a special case" - Paul Krugman, New York Times, February, 24, 2013

            The March 2013 edition of the Edelweiss Journal includes an essay by Dylan Grice in which he sorts through the confusion of this untethered world. The obvious locus is central bankers and their "crackpot monetary ideas." After quoting from Richard Cantillon's timeless essay on those closest to new money seeing their purchasing power rise the most, he notes those who pay are "furthest away from the newly created money." Today, the money created by crackpot monetary ideas is inflation, in assets, goods, and accumulating beliefs. Grice's investment quest is to find scarcity: "But the scarce substance we prize above all is trustworthiness. Aware that we worry too much in a world growing more wary and distrustful, it is here we place an increasing premium, here that we seek refuge from financial folly and here that we expect the next bull market."