Defending Fed Policy
The last thirty-five or so years have seen one of the purest experiments in ‘market’ economics possible. Since the waning days of the (Jimmy) Carter administration the West has seen an ascendance of finance capitalism that has increased in ideological purity as its institutions have been systematically embedded into modern political economy. This isn’t to suggest that the ‘market’ in market economics is more than ideological cover for a patronage system for connected insiders. But it is to challenge the perpetual storyline of capitalist heroics, of the brave Central Bankers who bucked the system to fight the good fight for the ‘little man.’ Remember when demonstrated serial economic catastrophe generators Alan Greenspan, Robert Rubin and Larry Summers were ‘the committee to save the world?’ How about when the group of cadaverous white guys lost a few nights’ sleep ‘saving’ Wall Street from certain calamity in 2008? Now it turns out that none other than former Fed Chair Ben Bernanke is a working class hero, champion of we ‘little people’ against whom the reigning plutocracy has aligned its ‘hard money’ intents. Who would have thought it?
The back-story here at first glance appears an economic snore-fest over ‘inflation.’ The reason why it may be a tad more interesting lies in the utter irreconcilability of competing view of banks and money. So here’s a puzzle for those who like puzzles: how can the price of ‘everything’ rise while inflation, defined by economists as a rise in the price of ‘everything,’ doesn’t budge? Here’s another: if the cost of borrowing is reduced but the price of what is bought with the borrowed money has been pushed higher are corporations and people being encouraged to buy things or not? And one more: if corporate executives use lower interest rates to load ‘their’ companies up with debt to enrich themselves (to raise the value of the stock they’ve granted themselves) is ‘the economy’ made better off or worse? We’re getting close now: if the tiny group of people who own ‘everything’ is made fabulously wealthy through monetary policy while most people see no benefit or are economically diminished by it is this policy a success or failure? Finally, if central bankers themselves claim that banks ‘create’ money by making loans— that ‘savings’ have little if anything to do with it, why would allegedly informed economists continue to insist that a ‘savings glut’ is behind asset price inflation?
Graph (1) above: the stock market is a proxy for the broader ‘financialized’ economy that includes commercial, and increasingly residential, real estate, ‘art,’ and anything else that can serve as speculative object and store of economic value. Mainstream economists tend to consider only ‘real’ inflation, a rise in the price of a broad ‘basket of goods and services,’ because financial assets are a form of quasi-money, claims that have not yet been realized in ‘real’ demand. However, as the rise in commercial and residential real estate prices coincident with Fed policy suggests, the line between ‘real’ and financial assets becomes less clear as ‘the economy’ becomes increasingly financialized. Also, the ‘fundamental’ basis of financial asset prices, corporate earnings, has risen far less than stock prices. The (Robert) Shiller CAPE (cyclically-adjusted prices earnings) ratio has risen from 15 to 25 since 2009. Source: St. Louis Fed.
The inspiration for this cavalcade of questions is the liberal response to a New York Times piece by Neil Irwin (top link above) about the extraordinary rise in global asset prices since 2009. The core thesis of the piece, that the monetary policies undertaken by Western Central Banks have caused the rise, is itself unremarkable. What is remarkable, even inspiring in a dismal sort of way, is the insistence that rising asset prices benefit ‘the economy’ in a broad sense when the only conclusive evidence is that it benefits the tiny minority that own the assets whose values are being pushed higher. The claim (link above) is that plutocrats favor low inflation because it preserves the purchasing power of the debt that they have invested in. Here’s the rub: since the Federal Reserve began QE (quantitative easing) in 2009 U.S. stocks have nearly tripled in value. Conversely, a two percent rise in interest rates to dampen ‘inflation’ on a bond portfolio with maturity of about ten years (duration = 7) would result in roughly a fourteen percent loss. So, a 300% gain in stocks versus a fourteen percent loss in bonds— do we think plutocrats care more about rising interest rates or rising stock prices? (They are related, but that is a different story). The people who do care about protecting the purchasing power of the loans that they’ve made from inflation are bankers. Did I mention that Central Bankers are bankers who work for banks and bankers?
Graph (2) above: the question of precisely who the plutocrats in question are is partially answered by looking at who ‘owns’ financial assets? Corporate executives use captive Boards of Directors to award themselves lavish stock options that rise in value as the broad stock market rises. They then load ‘their’ companies up with debt in order to buy back company stock. Buying back company stock in turn boosts the value of the stock options that they have awarded themselves (more below on this). The effect of this in terms of executive compensation can be seen in Graph (2) above. Wall Street, and banks and bankers more generally, benefits from rising asset values both directly from the increase in the value of the assets they hold and indirectly through underwriting fees and lending against the assets held by others. Source: Forbes.
The question of what Fed policy actually accomplishes remains more contentious than makes sense unless obfuscation is part of the goal. Former Fed Chair Ben Bernanke claimed that QE (quantitative easing) raises the value of financial assets and lowers interest rates through the ‘portfolio balance channel.’ The Bank of England confirms Mr. Bernanke’s account. Regardless, depending on the degree of financialization in an economy lowering interest rates by itself raises asset prices by reducing the cost of financial leverage and it raises corporate profits by lowering borrowing costs. Additionally, by reducing the price of borrowing corporations and people are encouraged to borrow more. Given that excessive private debt was a key contributor to financial and economic calamity in 2008 encouraging more debt, as the Fed has done, seems the opposite of enlightened public policy. But the banks like it because it means more business for them. And given that the combination of cheap debt and inflated asset prices can inspire either capital investment or insider looting by corporate executives and the payoff to capital investment is uncertain but the payoff to looting is relatively well defined, Fed policy once again appears the perfect inspiration for corporate looting. The precise mechanics of this corporate looting are explained here and below.
Graph (3) above: excessive private debt has been widely cited as a root cause of the Great Recession, even by economists who support the Fed policy of encouraging more private debt. While the level of mortgage debt is lower than it was in 2008, this is in fair measure due to the combination of banks writing off un-recoverable loans and people making mortgage payments on underwater mortgages for the last six years— a real drag on the economy. The rise in corporate debt barely took a breather in 2008 and combined (non-financial) private debt is higher now than it was at the start of the Great Recession. Optimists see the rise in corporate debt as investment in future economic production. What the optimists overlook is that much of this new corporate debt is being used for stock repurchases to raise the value of the stock options that corporate executives have granted themselves. Source: St. Louis Fed.
In a broad sense some sympathy for the liberal case is due: if public policies benefit most people by reducing unemployment and raising wages then some of the asymmetries in economic distribution can be set to the side. The theoretical case put forward, that low interest rates reduce the debt service costs of corporations and people and provide incentive for productive investment, makes intuitive sense if the issues are framed tightly enough. The rub comes at the intersection of the available policy choices and one’s assessment of the nature of capitalist political economy. The Federal government can directly affect economic outcomes for the broad populace through fiscal policies and / or it can leave economic distribution to the vagaries of market forces through controlling the price of money (monetary policy). Given the de facto abandonment of fiscal policies in recent decades in favor of monetary policies the shift in political economy is brought into clear focus— the bi-partisan political response to market failures like unemployment and increasing poverty is more markets. This leaves the ‘better than nothing’ caucus of liberal economists ‘explaining’ policies to raise financial asset prices as good for all when they are at best a slight variation on plain old (Ronald) Reagan era trickle down economics.
Graph (4) above: the recent rise in house prices is widely perceived to be a good thing— more middle-class wealth is tied to house prices than to financial assets. What is less well understood is that the rising prices are concentrated in areas that have seen repeated boom-bust cycles, that much of the lower priced housing has been bought by hedge funds using cheap money from the Federal Reserve to turn these houses into rental properties and that rising prices are now concentrated in the most expensive housing. This very expensive housing is by and large being used to hide money looted by a global plutocracy that may need to make a quick getaway. Additionally, whatever the vagaries of defining ‘inflation,’ a rise in house prices above the rate of inflation that lacks a fundamental explanation is a bubble. Source: Robert Shiller.
The as-yet unstated punch line in all of this is that given the degree of financialization across the global economy any tendency toward higher interest rates will have a much-magnified impact. The left-right critique of Fed policies tends toward the intentional enrichment of connected insiders— crony capitalism, further instantiation of finance into global political economy following the economic catastrophe of the Great Recession, the commitment of openly criminal acts to save Wall Street at all costs in 2008 – 2009 and generally serving as a tool of the global plutocracy under the guise of acting in the public interest. The mainstream case in support of accommodative Fed policy assumes away its distributional consequences in favor of the improbable view that if one of ‘us’ is made richer ‘we are all’ made richer. In contrast, a class-based view aligns economic power with political power to suggest that the more asymmetrical income and wealth distribution are the further away from any meaningful notion of democracy is the result. And all of this leaves aside the distance between the effects of Fed policy in theory and in fact. In theory corporate executives act as agents in the interests of the corporations they manage. In fact Fed policy has perfectly aligned executive and self-interests— cheap debt and inflated stock markets are a formula for looting. In theory low interest rates and rising asset prices allow bankers to repair their balance sheets against future crises. In fact Wall Street has used Fed policy to re-leverage and the too-big-to-fail guarantee to award itself huge payouts knowing that when the next inevitable crisis hits it will once again be bailed out.
Graph (5) above: lest it remain unclear who benefits from Fed policies to raise asset values, it is the very rich who own most assets. Corporate executives use stock market returns to boost their incomes (Graph (2) above) on the backs of company employees whose labor is being leveraged. The otherwise very wealthy have their fortunes tied to stock market returns as well. Illustrated above is the close relationship between the average wealth of the top ten percent richest families in the U.S. and movements in stock prices. This is confirmed in the much larger percentage of stocks than bonds owned by this group in the Fed Survey listed below. Were bond returns predominant there is no possibility that the correlation between the net worth of the richest and stock market returns would be what it is. R^2 is the squared correlation coefficient. The difference R^2 = .32. Source: Fed Survey of Consumer Finances.
One likely reason for the rush to defend Fed policies is the upcoming mid-term elections. This isn’t to suggest insincerity in mainstream economic assertions of the benevolent intentions of the Fed. These folks have to sit in rooms together and make public proclamations about how the Fed’s banker economics are ‘economics.’ And liberal support for ‘dovish’ monetary policies is longstanding. But President Barack Obama and former Fed Chair Ben Bernanke made a deal with the devil by resurrecting Wall Street’s murder-suicide ‘business’ practices. Raising interest rates in current circumstance— with a re-financialized, highly leveraged, economy just before an election that will be in some measure a proxy for Mr. Obama’s performance in office risks as radical a repudiation of the Democrats’ Wall Street- plutocrat friendly policies as met the Bush Republicans in 2008. Should Wall Street reap some of the unpleasantness it has so prolifically sown in recent years things could get very ugly real fast. To be clear, this isn’t doom and gloom prognostication but simply working through the mechanics of the impact of rising interest rates on a highly leveraged economy. That monetary policy is a central point of contention at this point in history demonstrates the complete capture of Western political economy by moneyed interests.
Rob Urie is an artist and political economist. His book Zen Economics is forthcoming.