Planet Ponzi

by Mitch Feierstein

  Take tax, for example. We live in an era of fiscal crisis, yet it’s a crisis in the midst of abundance: high company profits, exceptional incomes among the very rich. Plenty of people are suffering in this recession and will suffer more before it’s over, but Wall Street bonuses are still huge, executive pay still riding high. In any rational political system, taxation revenue would flow from all that abundance to mitigate the distress elsewhere. But that’s no longer how politics operates in Washington. We’ve already seen how successful corporations have been in avoiding tax. The same is true of the very rich. Over the same period in which their incomes were quadrupling in real terms, they saw their effective tax rates come down by vastly more than the seven percentage points or so by which median households saw their tax rates fall. Around 50% of those with incomes over $200,000 face tax rates of less than 20%.11

  In a time of rapidly mounting federal debt, those figures are bad enough, but I suspect them of being somewhat less than accurate. Anyone earning more than $1 million a year has ways to shelter their income from the taxman’s scrutiny. Just as corporations find ways to shift their profits to the most friendly overseas location, so too do the very wealthy. Banks on Wall Street and in the City of London create elaborate schemes to ensure that the bonuses they pay aren’t taxable or can be tax-deferred. And those schemes relate to onshore money‌—‌the stuff the taxman has some chance of learning about. Meanwhile, the International Monetary Fund estimates that some $18 trillion in assets are being held in offshore tax havens beyond the reach of any tax authority.12 The result is that the tax rates visible from the official statistics are almost certainly overstated. The rich are richer than we think and pay less tax than we can credit.

  The position has become so extreme that even the billionaires are protesting. In a bold, truthful, un-Ponzi-ish op-ed for the New York Times, Warren Buffett wrote:

  Our leaders have asked for ‘shared sacrifice.’ But when they did the asking, they spared me. I checked with my mega-rich friends to learn what pain they were expecting. They, too, were left untouched.

  While the poor and middle class fight for us in Afghanistan, and while most Americans struggle to make ends meet, we mega-rich continue to get our extraordinary tax breaks …

  Last year my federal tax bill … was only 17.4 percent of my taxable income‌—‌and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent …

  Since 1992, the I.R.S. has compiled data from the returns of the 400 Americans reporting the largest income. In 1992, the top 400 had aggregate taxable income of $16.9 billion and paid federal taxes of 29.2 percent on that sum. In 2008, the aggregate income of the highest 400 had soared to $90.9 billion‌—‌a staggering $227.4 million on average‌—‌but the rate paid had fallen to 21.5 percent …

  My friends and I have been coddled long enough by a billionaire-friendly Congress. It’s time for our government to get serious about shared sacrifice.13

  He’s right. Of course he is. No one who looks without prejudice at the facts could draw any other conclusion; yet Congress still shows no sign of listening. In any case, our billionaire-friendly tax regime is hardly the most egregious offence against common sense and decency. Take, for example, the case of AIG, an insurance company that took to insuring various financial risks on a humungous scale without making any realistic provision against possible losses. When those losses were realized in the course of 2008, the firm became insolvent. As far as I’ve always understood things, the rules of the capitalist game are simple: if you lose, you lose. Anyone who takes a credit risk on a failing firm will lose money and deserves to do so: it’s those losses which act as a reminder that credit risk matters.

  Hank Paulson, the Secretary of the Treasury, presumably knew those rules, since before coming to Washington he had been the CEO of Goldman Sachs. (In 2006, Forbes estimated Mr Paulson’s personal holdings of Goldman stock at $632 million. Luckily he wasn’t obliged to live off his dividend checks, however, as his compensation over the previous five years amounted to some $40 or $50 million.14)

  Yet in 2008–9, the rules suddenly changed. AIG was reprieved, thanks to some $183 billion of taxpayer support. AIG took that money and used it to pay off its creditors, who would otherwise have incurred serious losses. Chief among those creditors were Goldman Sachs, Merrill Lynch, Société Générale, Deutsche Bank, and UBS. Collectively, those five banks received payments worth $32.7 billion from the US government at the munificent rate of 100 cents on the dollar.15 Some of that money was passed on to further counterparties, but some appears to have stuck to those firms themselves, thereby bolstering profits and making it easier for them to pay huge bonuses. Goldman Sachs alone paid out $16.2 billion for its 2009 fiscal year.16

  So, to summarize: when a group of investment banks make errors of judgment that threaten to cost them or their clients $32.7 billion, a Goldman alumnus funnels enough government money their way to cover their costs in full, supporting the banks’ efforts to maintain their extravagantly large bonus payments. And all this takes place at a time when the US Treasury is tipping over into insolvency, in significant part owing to a crisis precipitated by those selfsame banks.

  And yet no one involved in this whole process did anything illegal. It all happened in plain view; no one ended up in jail or being hounded from the country. This is just how things work on Planet Ponzi. It’s the classic Ponzi three-step. Step One: you create phony profits (in this case, via the mortgage markets) and pay yourself huge bonuses. Step Two: You push the accumulating losses on to another firm (in this case, AIG) and pay yourself huge bonuses. Step Three: When that firm goes bust and those losses look like returning to haunt you, you cash in your lobbying chips and push the losses on to the (insolvent) US government, thereby allowing you to pay yourself some more huge bonuses. Even Bernie Madoff himself was never that barefaced.

  Goldman itself has contended that it did not benefit directly from the government bailouts.17 Since we can’t inspect their books directly, it’s hard to be sure; but the bailout money was only one of the ways the government supported these institutions. According to documents obtained by Bloomberg, Morgan Stanley received a stunning $107 billion in loans from the Federal Reserve, Citigroup almost $100 billion. Goldman Sachs itself was in debt to the Fed for a total of 438 days and to a maximum of $69 billion.18 That money was repaid, but it might not have been. Your money was placed at risk to protect Wall Street bonuses. How do you feel about that?

  These tales point to one further moral. Ponzi schemes are, by their nature, vastly wasteful; it’s almost as though their boastful extravagance provides them with camouflage. In AIG’s case, the US taxpayer found $183 billion, so that $32.7 billion of payments could be made to Wall Street, so that Goldman Sachs and its peers could pay out billions in bonuses. Three of the five beneficiaries named above are foreign-owned. Compared with the economic waste involved in these payments, the Pentagon looks like the world’s most penny-pinching spender, Obamacare like the Scrooge of healthcare plans. And AIG, of course, will never repay its bailout money.

  But it’s time to step away from the federal government and fiscal policy, and turn to the Federal Reserve and monetary policy. If you’re anything like most people, even the words ‘monetary policy’ will be sufficient to induce mild drowsiness, but this is not a soporific story. It’s about the prices in your shopping basket and the value of the currency in your pocket. Those two things are moving fast, neither in the way you want.

  6

  The $50,000,000,000 egg

  On July 18, 2008, the British Guardian newspaper reported that ordinary hen’s eggs were selling at an average price of $50 billion. These eggs were not particularly expensive, however, since the dollars in question were issued by the Reserve Bank of Zimbabwe. In US dollar terms, each egg was retailing for a perfectly reasonable $0.32.1 Even in Zimbabwe, it wouldn’t be long before Z$50 billio
n would seem strangely cheap for an egg. In January 2009 the Bank of Zimbabwe, making a determined effort to address the country’s hyperinflation problem, issued currency in a new range of denominations, of which the most valuable was the new $100 trillion note. I have one of those notes beside me as I write. Valued at about US$30 when it was issued, it’s essentially worthless today, except as a curio.2 You can buy them on eBay for around US$5.

  If the first duty of any government is to protect the country, the first duty of any central bank is to protect the currency. Particularly when a government’s treasury department has lost hold of the reins, the central bank needs to act as a fierce guardian of value. For it to do so effectively, it needs an accurate measure of the value destruction being inflicted on the currency by inflation. In Zimbabwe, accuracy in measuring inflation simply meant figuring out the right number of zeroes. In the United States, however, you’d expect the measurement of inflation to be simple, uncontroversial‌—‌and right. Yet to say there’s room for doubt on the US government’s figures is to be far too kind.

  Inflation, at root, is a simple concept. If you buy a basket of goods in March for $100, then buy the same basket the following month for $101, you’d want to say that inflation had been 1% over the course of the month. (The annual inflation rate, of course, would be higher.) That, surely, is what we think inflation is: the rate at which a basket of good increases over time.

  But that’s not how the US statistical department (as guided by Congress) cares to measure it. The issue is as follows. Let’s suppose that in March, your selected basket of goods contains a carton of orange juice, priced at $1.00. In April, you find that that carton has increased in price to $1.20. Because you aren’t a passive consumer, obliged to buy the same items you bought last month, you’re likely to reject that carton as being unacceptably expensive. Perhaps you trade sideways and buy grapefruit juice at $1.10. Or if all juices have risen in price, maybe you leave them aside and just add candy or a pound of apples or bag of salad. Naturally, consumers are astute shoppers. If they notice a good deal on apples, they’ll likely stock up on apples. If there’s a buy-one-get-one-free offer on salads, they’ll walk out of the store with plenty of salad in their baskets.

  The problem for statisticians is how to handle this consumer behavior. The older, more rigorous methodology was clear. If the price of a fixed basket of goods went up by 1%, then inflation was 1% over the period in question. Government statisticians prefer to avoid this clarity and this rigor, and reweight the basket of goods each month in a way that reflects consumer efforts to avoid price increases.3 In effect, we have a measure of inflation which deliberately exploits the inflation-avoiding behavior of consumers to generate an inflation rate far lower than the one we actually experience. In the words of economist and statistician John Williams, a long-time critic of official statistics, ‘The fact that switching the CPI concept to a substitution-based basket of market goods from a fixed-basket violated the original intent, purpose and concept of the CPI, never seemed to be a concern to those in Washington.’4 Let’s be more frank. Washington chose to switch in order to conceal the truth. That’s how you do things on Planet Ponzi. Needless to say, a host of other methodological adjustments have been made, which cumulatively tend to reduce the extent of reported inflation‌—‌to the bemusement of consumers, who know things are getting dearer faster than they used to.

  Fortunately, however, the politicians don’t have it all their own way. Williams has attempted to reconstruct US inflation data as they would have appeared if the old rigorous methodology still operated. According to his results, inflation is currently running at over 10% and has been consistently higher than government figures for as far back as he’s been able to measure.5 I haven’t been able to review his precise calculations, so I can’t say for certain that his data are correct. Nevertheless, there’s no question that consumers don’t feel like they’re in a low-inflation environment any time they go to the grocery store or gas station. Inflation is fierce and rising. We can mitigate the effect of that inflation rate through ever more careful shopping, but the reality is brutal and getting worse.

  Mention of the grocery store and the gas station raises another presentational concern. Government figures like to focus our attention on ‘core’ inflation, a measure which excludes the ‘volatile’ components of food and energy prices. And sure, those things are volatile‌—‌the way Wall Street bonuses are volatile: variable, but heading upwards. In February of 2011, food prices experienced the highest monthly increase for almost forty years. A Department of Agriculture spokesman‌—‌presumably too low down in government to have had the memo from the White House‌—‌commented bluntly: ‘Food prices have been rising a lot faster, because underlying costs have really shot up. You’re seeing some ingredients up 40%, 50%, 60% over last year. When you see wheat prices close to 80% up, that’s going to ripple out to the public.’6 He’s completely right, except in his choice of metaphor. An 80% increase in the price of wheat isn’t going to feel like a ripple to less well-off consumers. It’s going to be yet another economic wave, breaching defenses, ruining lives.

  It’s the same with oil. In November 2008, in the wake of economic meltdown, oil briefly traded for less than $50 a barrel on the New York Mercantile Exchange. By April 2011 the price had doubled, to over $110. It’s come back a few dollars since then, but it’s still acutely vulnerable to upward pressure. As I write, there’s revolution in Libya, civil war in Yemen, violence in Syria, brittle peace in Iraq, tense (and possibly nuclear-armed) calm in Iran, simmering unrest in the Gulf kingdoms, increasing militancy in Nigeria, and worsening maladministration of oil assets in Venezuela.7 Those are not, to put it mildly, conditions which suggest that the oil price is likely to float gently back down to its historic levels.

  And it’s the same again, more broadly, with commodities. I’m looking at a screen that reports twelve-month changes in major commodity prices. The good news is that fishmeal and oranges are both cheaper than they were this time last year. The bad news is that the prices of crude oil, coal, diesel, gasoline, natural gas, jet fuel, heating oil, coffee, tea, barley, maize, rice, wheat, beef, pork, shrimp, sugar, coconut oil, palm oil, peanut oil, soybeans, wool, logs, sawn wood, hides, rubber, aluminum, copper, gold, iron ore, lead, nickel, silver, steel rod, reinforcement steel, tin, uranium, zinc, fertilizer, potassium chloride, rock phosphate, urea, and various other commodities related to those on this list have increased by at least 10% and in many cases much more than that over the course of a year. To a government statistician, these data provide firm evidence of the need for a fishmeal-and-oranges inflation index. To the rest of us, they’re evidence of a serious, underreported, and dangerous tide of inflation.8

  Threat is one thing; response is another. There are some inflationary pressures not even the most vigorous action by the Federal Reserve can just wipe out‌—‌China’s rapid growth and consequent demand for raw materials, for example. You can’t expect Ben Bernanke, chairman of the Fed, to be able to do anything about that. On the other hand, the Fed’s response to the rapidly declining value of the dollar has been to assist that decline in every way possible. I pointed out in chapter 1 that the Fed has allowed its balance sheet to inflate by some $2,000 billion, largely as a result of quantitative easing (to use the technical term) or printing money (to use the descriptive one). This ‘easing’ has taken place at a time when the Fed has already forced down short-term interest rates as low as they can possibly go, lower than they’ve been for generations.9 It has come at a time when long-term interest rates are as low as they’ve been since Japanese bombs were falling on Pearl Harbor.10 In addition, it’s come at a time when the threat of deflation (an admittedly serious possibility) has long, long retreated.

  I’m not the only one to worry about these matters. Here are the wise words of one other worried soul, Richard Fisher, head of the Dallas Fed:

  I was skeptical about many of the presumed benefits of further asset purchases
[i.e. printing money]. I was more certain of some of the potential costs.

  One cost is the risk of being perceived as embarking on the slippery slope of debt monetization [i.e. printing money to support government borrowing]. We know that once a central bank is perceived as targeting government debt yields at a time of persistent budget deficits, concern about debt monetization quickly arises.

  I realized that two other central banks were engaging in quantitative easing—the Bank of Japan and, most notably, our friends at the Bank of England. But the Bank of England is offsetting an announced fiscal policy tightening that out-Thatchers Thatcher. This is not the case here. Here we suffer from fiscal incontinence and regulatory misfeasance. If this were to change, I might advocate for accommodation. But that is not yet happening. And I worry that by providing monetary accommodation, we are reducing the odds that fiscal discipline will be brought to bear.11

  Fisher puts his finger on precisely the right issue. If the federal government were hacking back at spending‌—‌if it were seeking to ‘out-Thatcher Thatcher’ in its fiscal rigor‌—‌the Fed might well want to soften the blow of the ax. But as we’ve seen, the government in Washington is acting with so little fiscal discipline that the president of the Dallas Federal Reserve Bank can speak openly of ‘fiscal incontinence and regulatory misfeasance.’