Wednesday, May 6, 2009

Follow the Leader...

Greetings good citizen,

Many of the commentors on Barry Ritholtz’s blog are traders, I found it very telling that not one of them had a clue as to why the markets rose yesterday…which tells us something all by itself. It tells us that playing the market is more like ‘follow the leader’ than ‘King of the hill’.

Once again we learn (after the trading day ended) that ‘volume’ was ‘light’ in yesterday’s markets so the ‘rally’ wasn’t ‘broad based’.

Perhaps more disturbing is the ‘green shoots’ they keep yapping about. I’m not seeing them and I’m reasonably sure no one else is either…our friend Mr. Williams over at Shadowstats calls ‘em like he see’s em!

Flash Update Subscription required May 4th, 2009
• No Recovery, As Employment Conditions Weaken
• Systemic Solvency Crisis Intensifies As Broad Money Growth Softens Further
• U.S. Dollar Selling Could Pick Up Along with Fed's Ongoing Dollar Debasement Efforts

There it is good citizen! People without jobs have a tough time meeting their expenses. If that ‘lost’ job barely ‘cracked your nut’ then chances are good you don’t have a ‘cushion’ to fall back on.

Worse, if you manage to keep your job it’s not likely your paycheck will remain ‘intact’. The loss of customers will drive employers to dip into their ‘most reliable’ income stream…your pay.

Workers everywhere are being asked (or threatened) to choose between pay cuts or lay-offs…which is bizarre in itself. If they ‘need’ all of their workers then pay cuts make no sense. If they don’t need all of their workers, why keep them hanging around if there is not enough for them to do? You’d like to think the boss is being ‘merciful’ but the events of the recent past, when the boss handed out shitty little raises if you got one at all tells a different story.

Are pay cuts an opportunity too good for greedy employers to pass up?

With the job market being flatter than a pancake for the past two years…most will accept the pay cut.

Which is pretty strange because when the economy was ‘doing good’ (quarter after quarter of ‘record profits’) your employer didn’t give out raises in a ‘patriotic effort’ to keep inflation in check.

What do you suppose the employer is going to tell you when things ‘pick up’ again? (Not that there is much chance of that happening anytime soon.)

The times are well beyond ‘interesting’, they have become downright bizzare!

So we arrive at tonight’s offering from none other then Henry C.K. Liu…

The burden of elitism
By Henry C K Liu

This report is the second in a series.
Part 1: Monetarism enters bankruptcy

From its founding in 1913, the dominant guiding principle of US central banking had been monetary rather than economic, notwithstanding that the Federal Reserve's founding charter directed it to conduct monetary policy to "accommodate the needs of commerce and industry".

There is an extensive field of monetarism economics that attempts to define the causal relationship of economic growth to monetary conditions and policies, but this body of work has yielded mostly selective positivism to support ideological preferences for the importance of money. A positive analysis is supposed to yield a description of what is if left alone without intervention. Yet "what is" in economics is generally the outcome of policy. Central bank policymakers have since focused on monetary policies designed to prevent inflation in order to counter investor fears about money defaulting on its role as a reliable storer of value. Maximizing the role of money as a storer of value is often accomplished by sacrificing the role of money as a facilitator of the maximization of economic value.

Sorry good citizen but money was not created to be a ‘storehouse of value’, it was invented as a ‘medium of exchange’. I am not gainsaying Dr. Liu for he is correct, money has been turned into a ‘storehouse of value’ by those who trade in it rather than in ‘real wealth’.

The ‘value’ of a thing is relative to the scarcity/demand for that item. Housing is a good illustration of this concept. The only reason your house ‘appreciates’ in value (rather than ‘depreciates’ like your car) is because the population continues to grow, increasing the demand for housing.

With this as a given, it is not ‘money’ that acts as the ‘storehouse’ but the ‘asset’ itself. As we have seen over the past thirty years, saving money has been an ‘exercise in futility’ because the interest your savings earned has been consistently below the rate of monetary inflation. Even if the official inflation figures don’t bear this out (due to ‘hedonics’)

Worse, ‘traditional’ investment vehicles have proven not to be reliable ‘storehouses of value’…ask anyone with a 401k.

Money was not invented to solve/serve as the answer to this problem. Only assets/commodities fill the function of ‘storehouses of value’ and then only to those who hold those items and control their supply.

Back to the article…

Ironically, asset appreciation is viewed by monetarists as growth and not inflation. Inflation is supposed to be caused primarily by wage increases. While the preservation of the value of money is not an unworthy cause, neoclassical economic theory has given the Federal Reserve, the central bank of the US, doctrinaire justification to ignore policies that promote full employment. Anti-inflation bias has also prevented the central bank from reversing the falling income of working families, particularly wage earners and farmers. Central bankers speak of "liquidation of labor" to detach economic demand for labor from the natural demand of labor in a growing population. As a result, monetarists subscribe to stabilization of the nominal money supply rather than total aggregate nominal demand. [Strangely, this is what keeps the rich, rich…the practice of making money ‘scarce’ for a majority of the population.]

Joseph Schumpeter argues that monetary measures do not allow policymakers to eliminate economic depression, only to delay it under penalty of more severity in the future. In a market economy, economic depressions are painful but unavoidably recurring. Counter-cyclical monetary measures to provide more money to keep ill-timed investment on a high level in a depression are not creative destruction but are positive destruction. And such measures will ultimately be detrimental to the general welfare. [Such measures lead to hyper-inflation and the only remedy for hyper-inflation is a ‘new/revalued’ currency.]

Artificially high asset prices absorb liquidity to stall economic activities that lead to high unemployment. High unemployment in a depression is merely a sign that the market economy is performing its prescribed function. It is the natural socio-economic mechanism for stabilizing production and consumption. Unemployment needs to be eliminated, but it cannot be eliminated by monetarist measures designed to hold up asset prices in a depressed market economy.

Counter-cyclical fiscal measures are indispensable for the elimination of unemployment in an economic downturn. In a depression, unemployment can only be eliminated by fiscal-driven demand management, that is, providing deficit-financed money through increased work with high wages to the working population so that they have enough money to buy what they produce without inflation. [But this is not what’s being done…]

Herbert Hoover wrote in his memoirs about mainstream liquidationist sentiments after the 1929 crash:

The "leave-it-alone liquidationists" headed by Secretary of the Treasury [Andrew] Mellon [1921-1932] ... felt that government must keep its hands off and let the slump liquidate itself. Mr Mellon had only one formula: 'Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.'… He held that even panic was not altogether a bad thing. He said: 'It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.' [Sadly, it’s not the ‘rotten people’ that pay the price, it is the virtuous that take it up the backside!]

Out of Mellon's equalitarian liquidationist formula, only liquidating labor has become an essential part of monetary economics. Theories behind monetary economics harbor an ideological bias toward preserving the health of the financial sector as a priority for maintaining the health of the real economy. It is a strictly elitist trickle-down approach. Take good care of the moneyed rich with government help and the working poor can take care of themselves by market forces in a market economy. All are expected to swim or sink in a sea of caveat emptor risk, but bankers can swim with government-issued life jackets filled with taxpayer money on account of a rather peculiar myth that without irresponsible bankers, there can be no functioning economy.

The fact is: while banks are indispensable for a working economy, badly-run banks ignoring sound banking principles are not. What is needed in a depression is not more central bank money for distressed banks suffering losses on loans from collapsed assets prices, but government deficit money to sustain full employment with living wages. [Amen!]

In popular parlance, the Fed is the government-paid doctor of Wall Street through taking care of the banking system it regulates, with unlimited state power to create money backed by the full credit of the United States, a nation founded as a democratic republic in which sovereign wealth is supposed to belong to the people, not the banks. Yet the Fed is not the doctor of Main Street where the nation's wealth is created through full employment and living wages. [Seems pretty basic but show me one economist that understands this?]

Instead, under market capitalism, the fate of Main Street is left to the manipulated workings of market forces shaped by central bank money freely available to the financial elite beyond the understanding, control and even awareness of most retail-market participants. Thus market forces are manipulated to favor those institutions deemed too big to fail, and at the expense of the general public who are hapless participants in a manipulated financial market. [Getting pissed yet?]

Central bankers are savvy enough to know that while they can create money, they cannot create wealth. To bind money to wealth, central bankers must fight inflation as if it were a financial plague. But the first law of growth economics states that to create wealth through growth, some inflation must be tolerated. The solution then is to make the working poor pay for the pain of inflation by giving the rich a bigger share of the monetized wealth created via inflation, so that the loss of purchasing power from inflation is mostly borne by the low-wage working poor, and not by the owners of capital, the monetary value of which is protection from inflation.

Inflation is deemed benign as long as wages rise at a slower pace than asset prices. The monetarist iron law of wages worked in the industrial age, with the resultant excess capacity absorbed by conspicuous consumption of the moneyed class, although it eventually heralded in the age of revolutions. But the iron law of wages no longer works in the post-industrial age, in which growth can only come from demand management because overcapacity has grown beyond the ability of conspicuous consumption of a few to absorb in an economic democracy.

That has been the basic problem of the global economy for the past three decades. Low wages have landed the world in its current sorry state of overcapacity masked by unsustainable demand created by a debt bubble that finally imploded in July 2007. The whole world is now producing goods and services made by low-wage workers who cannot afford to buy what they make except by taking on debt on which they eventually will default. [When phrased thusly, the situation is not too complex for our feeble minds to grasp!]

By its role of lender of last resort to an irresponsible, dysfunctional banking system, the Fed has essentially banished free markets from the financial sector. Worst yet, the Fed has in the past two decades mutated into a lender of first resort, by providing high-power central bank money to commercial banks to create bank money based on fractional reserve to feed a debt bubble the eventually burst in 2007. Structured finance enabled banks to securitize risky loans and remove them from their balance sheets by selling them in globalized credit markets. Non-bank financial institutions in the so-called shadow banking system could monetize their liabilities through debt securitization and sell the collateralized debt obligation as risk-compensatory securities to investors. [snip]

Normally, in a free market, when a financial institution gets itself into financial trouble, the party coming to its rescue would have the right to take over ownership of the distressed institution and be entitled to all future profit after the rescue. That is the basic rule of the game of capitalism: you default on your liabilities; you lose your company to the party that bails you out. Only when no private party steps in as rescuer because of the unappetizing prospect of future profit would the government act as a rescuer of last resort with taxpayer money. It is not nationalization; it is just business, albeit for the common good.

But the Treasury when it functioned under secretary Henry Paulson last year gave the distressed banks taxpayer money from the Trouble Asset Relief Program (TARP) with no specific requirement for the banks to make loans to revive the stalled economy. This allowed the banks to use taxpayer money not to help the economy with making new loans but to de-leverage by paying off liabilities the banks could not otherwise service. Subsequently, the bailed-out banks began to show profits on the following quarters on de-leveraged balance sheets, but with little impact on the still-impaired economy.

Yet this profit is unsustainable unless the banks continue to receive more TARP money every subsequent quarter. Instead of the government collecting the banks' post-rescue profit, banks are allowed to merely pay back the TARP money at below market rates at their convenience. This gave cause to the now popular saying that the best way to legally rob a bank is to own one and run it to the ground. [Snip]

Next: Stress tests for banks

Henry C K Liu is chairman of a New York-based private investment group. His website is at

As I have stated before, money isn’t in itself ‘evil’, it is how money is ‘used/defined’ that is the source of the problem.

One of the most fundamental flaws in economic theory is that we meet in the marketplace at anything approaching ‘equals’. If you aren’t born to tons of ‘capital’, you are and will remain behind the ‘Eight Ball’, there is no legal way for you to overcome that ‘disadvantage’.

As it says in the beginning of the epic work ‘The Godfather’, “Behind every great fortune lies a greater crime.”

Until you wake up to the fact that your perpetual enslavement to the owners of ‘capital’ is a crime, there is no hope for civilization.

Thanks for letting me inside your head,


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