Thoughts on the current financial scene


The last quarter century has witnessed an extraordinary revolution in capital markets. Nearly any economic asset can be turned into a financial instrument and traded any where in the world. The globalization of financial markets effectively liberates the speculator from government regulation. If the state threatens to oversee securities markets with too heavy a hand, speculators simply take their business elsewhere. “We’ll eventually be financial organizations headquarted on a ship floating on mid-ocean,” one intransigent speculator boasted.

While the globalization and regulatory liberation of speculative finance has received as least some attention from business journalists, another innovation in high finance has pretty much remained unnoticed by even the most astute observers of the current financial scene: namely, the ability of non-banking institutions to create money. Detailing how this is accomplished goes well beyond the scope of this essay. I will merely note that the very shrewdest financial analysts, such as Doug Noland, the market strategist for David Tice and Associates, regard this innovation as critical to grasping the brave new world of speculative finance. Those economists and financial analysts who continue to assume that only banks can create money will fail to understand the extent to which the Federal Reserve has lost control of the money supply. Yet that is what has appeared to have taken place. The Federal Reserve does not have as much control over the money supply as it once did.

Even under the best of circumstances, this would be a cause for concern. But the governors of the Federal Reserve have to worry about more than just non-banking money creation. They also must come to grips with the increasing immesurability of money. With the exceedingly rapid development of new and immensely complicated financial instruments, money is becoming harder and harder to measure. No one, not even Alan Greenspan (he has admitted as much) knows how much money is out there. The banking authorities have not merely lost control of the money supply; they have blinded to its size as well.

Under such circumstances, is it any wonder that markets have become prey to illusions of quixotic dimensions? The bursting of the tech and dotcom bubbles apparently left the illusions of most investor intact. For how else can we explain the recovery of the stock market in the face of the most collosal debt in human history. The United States has amassed more than 37 trillion dollars worth of debt. Even more worrisome is the rate at which this debt accumulates. In 2003, household debt, grew faster than the economy—an unsustainable trend fraught with sinister implications and unpleasant consequences. But most critically of all is the debt of the financial sector, which in recent years has accelerated at an alarming rate—with a debt to growth rate 26 times that of general economic growth. (For more info, go here .)

Debt levels of this magnitude have prevented the economy to from fully recovering from the recession of 2001. They impose burdens on consumers and businesses which hamper investment and spending. Until we begin to clear a good portion of this debt, the U.S. economy will remain in the doldrums.

Clearing the debt, however, poses some serious problems of its own. Normally, during a recession, the economy cleanses itself of all the bad debt accumulated during the preceding boom. But in the 2001 recession, debt levels were so high that it became impossible to clear the debt. Such clearing would have led to an economic catastrophe. So the authorities at the Federal Reserve, in league with financial speculators, pumped fresh debt into the economy to keep the whole thing from blowing to pieces. They contrived to use government sponsored institutions like Fannie Mae and Freddie Mac to recycle bad debt and turn it into a fresh source of liquidity via home mortgages. Unfortunately, this source of debt is fast drying up, so that the wizards of high finance now must scramble to find ever new sources. At some point, a day of reckoning must bring this process to an abrupt and catastrophic conclusion. Either the economy will experience a severe debt crisis leading to the sort of deflation experienced during the Great Depression, or it will descend into a long and protacted episode of intense stagflation.

If we examine the U.S. economy impartially, intent upon seeing things as they are, not as we might wish them to be, I don’t see how this conclusion to be evaded. It is not even a question on which reasonable people can disagree. In 2004, total debt in U.S. was $37.5 Trillion, or $129,513 per capita. Another $44 trillion, representing contingent social security and medicare, could easily be added to this figure. Does anyone seriously believe that the economy can grow itself out of this debt burden?

What, then, does the future have in store? While we can never be certain what will happen in the years to come, we can make several educated guesses as to what might happen. I believe the following three conjectures are well founded and more than probable:

1. The U.S. economy—and the world economy in general—will experience either castrophic inflation or a severe debt crisis leading to general world-wide depression. I doubt there is any way, short of a major war, that this can be avoided.

2. The welfare state as it currently stands is doomed. According to the Congressional Research, by 2014 the Social Security trust fund will require other federal receipts to help pay benefits. By 2050, the ratio of workers to Social Security recipients could be as low as one to one. The system will obviously not be sustainable on such a basis. The burden of supporting Social Security and Medicare will impact the entire welfare system, placing an insupportable strain on government finances. Raising taxes might help a little bit, but raising them too much could prove counter-productive, as the law of diminishing returns would almost certainly, at some point, begin to kick in. The fact that the federal government is currently running up huge deficits only makes the situation more pregnant with disastrous consequences. Serious reform of the welfare system, especially of the Social Security and Medicare systems, will be forced upon us whether we like it or not.

3. Income inequality will worsen, placing great stress on the viability of American democracy. The globalization of commerce is gradually undermining the manufacturing based of the U.S. economy. If the trend continues, the country will become divided between high paid professionals in information related jobs on the one side, and low paying service-related jobs on the other. Computer automation could eventually render a large section of the working population useless. What need for clerks and manufacturing labor when computers can do the work for so much less? In California, the occupations with the highest projected declines are order clerks, sewing machine operators, and typists. What will these people do? The occupations with the projected most openings in California are retail salespersons, cashiers, food preparation, and waiters and waitresses. In other words, degrading service jobs. We are heading toward a society which exemplifies the worst sort of elitism imaginable: a cognitive elite of information workers and professionals on the top, with a horde of service people, tending the needs of the elites, on the bottom. It doesn’t take much insight into human nature to understand that such an arrangement would lead to an intensification of social conflict and resentment. It is unlikely that a democratic, consensual system of government can last long in a society split between a small elite of information professionals on the one side and a large mass of service workers on the other.

Posted: Tue - November 23, 2004 at 02:10 AM          

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