Trumped! A Nation on the Brink of Ruin... And How to Bring It Back

by David Stockman

  Indeed, the cascade of the China “labor price” through the warp and woof of the entire US economy is so pervasive and subtle that it cannot possibly be measured by the crude instruments deployed by the Census Bureau and BLS.

  In short, Janet Yellen doesn’t have a clue as to whether we are at 30% or 20% or 5% unemployment of the potential adult labor hours in the US economy. But three things are quite certain.

  First, the real unemployment rate is not 5.5%—the U-3 number is an absolute and utterly obsolete relic that belongs in the Smithsonian, not the Eccles Building.

  Secondly, the actual employment rate of America’s 420 billion potential labor hours is overwhelmingly a function of domestic social policy and global labor markets, not the rate of money-market interest.

  And finally, under conditions of Peak Debt, the Fed is powerless to do anything about the actual labor-utilization rate, anyway. The only tub its lunatic money-printing policies are filling is that of the Wall Street speculators.

  AN UNNECESSARY HISTORICAL DETOUR: THE CARTER GLASS “BANKERS BANK” VERSUS KEYNESIAN CENTRAL BANKING

  If Warren Buffett and his ilk weren’t so hideously rich, Main Street America would be far more prosperous. I must hasten to add, of course, that this proposition has nothing to do with the zero-sum anti-capitalism of left-wing ideologues like Professors Piketty and Krugman.

  Far from it. Real capitalism cannot thrive unless inventive and entrepreneurial genius is rewarded with outsized fortunes.

  But as we demonstrated in Chapter 3, Warren Buffett’s $73 billion net worth, and numerous like and similar financial gambling fortunes that have arisen since 1987, are not due to genius; they are owing to adept surfing on the $45 trillion financial bubble that has been generated by the central bank Keynesianism of Alan Greenspan and his successors.

  The resulting massive redistribution of wealth to the tiny slice of households, which own most of the financial assets, is not merely collateral damage. That is, it is not the unfortunate byproduct of continuous and extraordinary central bank “stimulus” policies that were otherwise necessary to keep the U.S. economy off the shoals and the GDP and jobs on a steadily upward course.

  Just the opposite. The entire regime of monetary central planning is a regrettable historical detour; it did not need to happen because massive central bank intervention is not necessary for capitalism to thrive.

  In fact, today’s style of heavy-handed monetary central planning destroys capitalist prosperity. It does so in a manner that is hidden at first—because credit inflation and higher leverage temporarily goose the reported GDP.

  But eventually they visibly and relentlessly devour the vital ingredients of growth in an orgy of debt and speculation.

  To appreciate this we need to turn back the clock by 100 years—to the early days of the Fed and ask a crucial question. Namely, what would have happened if its charter had not been changed by the exigencies of Woodrow Wilson’s foolish crusade to make the world safe for democracy in 1917?

  The short answer is that we would have had a “bankers’ bank” designed to provide standby liquidity to the commercial banking system. Moreover, that liquidity would have been generated not from fiat central bank credit conjured by a tiny posse of monetary bureaucrats, but from self-liquidating commercial collateral arising from the decentralized production of inventories and receivables on the Main Street economy.

  That is to say, the 12 Federal Reserve Banks designed by the great Carter Glass in the 1913 act were to operate through a discount window where good commercial paper would be discounted for cash at a penalty spread above the free-market rate of interest.

  The job of the reserve banks was to don green eyeshades and assess collateral based on principles of banking safety and soundness. So doing, they would enable the banking system to remain liquid based on the working capital of private enterprise, not the artificial credit of the state.

  Accordingly, there would have been no central bank macro-economic policy or aggregate targets for unemployment, inflation, GDP growth, housing starts, retail sales or any of the other litany of incoming economic metrics. The curse of Humphrey-Hawkins would have never happened.

  To the contrary, the level and rate of change in national economic output and wealth would have been entirely a passive outcome on the free market resulting from the interactions of millions of producers, consumers, savers, investors, entrepreneurs, inventors and speculators.

  Stated differently, Washington’s monetary authorities would have had no dog in the GDP hunt. Whether the macro economy slumped or boomed—and whether GDP grew by 4%, 2% or -2% would have been the collective verdict of the people, not the consequence of state action.

  Likewise, honest price discovery would have driven the money and capital markets. That’s because there would be no FOMC at the Eccles Building pegging the overnight interest rate or manipulating the yield curve by purchasing longer-term public debt and other securities.

  In fact, under its original statutory charter, the Fed was not even allowed to own government debt or accept it as collateral against advances to its member banks.

  That is a crucial distinction because it means that the Fed would not have ventured near the canyons of Wall Street nor have had any tools whatsoever to falsify financial-market prices. Speculators wishing to ply the carry trades and arbitrage the yield curve—that is, make money the way most of Wall Street does today—would have done so at their own risk and peril.

  Indeed, the infamous “panics” of the pre-Fed period usually ended quickly when the call money rate—the overnight money rate of the day—soared by hundreds of basis points a day and often deep into double digits.

  Free-market interest rates cured speculative excesses. The very prospect of a 29-year bubble, which took finance (credit-market debt outstanding plus the market value of non-financial corporate equities) from $13 trillion to $93 trillion, as occurred between 1987 and 2015, would not have been imaginable or possible.

  Indeed, the great speculators of the day like Jay Cooke ended up broke after 10 years, not worth $73 billion after three decades.

  Notwithstanding the inherent self-correcting, antibubble nature of the free market, defenders of the Fed argue the U.S. economy would be forever parched for credit and liquidity without the constant injections of the Federal Reserve.

  But that is a hoary myth. In a healthy and honest free market, credit is supplied by savers who have already produced real goods and services, and have chosen to allocate a portion to future returns.

  Indeed, the difference between fiat credit conjured from thin air by central banks and honest savings is the fundamental dividing line between Bubble Finance and healthy capitalist prosperity.

  Needless to say, the claim that the economy would be worse off if it was based on real savings is the Big Lie on which the entire regime of monetary central planning is based. It is also the lynchpin of the Warren Buffett economy.

  It is not surprising, therefore, that free-market finance is an unknown concept in today’s world and that Carter Glass’ bankers’ bank has been lost in the fog of statist historiography. All of the powers of Wall Street and Washington militate against it.

  HOW TO RESTORE HONEST CAPITAL MARKETS: ABOLISH THE FOMC

  The approximate hour Janet Yellen spends wandering in circles and spewing double talk during her post meeting pressers is time well spent. When the painful ordeal of her semi-coherent babbling is finally over, she has essentially proved that the Fed is attempting an impossible task.

  And better still, that the FOMC should be abolished.

  The alternative is real simple. It’s called price discovery on the free market; it’s the essence of capitalism.

  After all, the hotshot traders who operate in the canyons of Wall Street could readily balance the market for overnight funds. They would do so by varying the discount rate on short-term money.

  That is, they would push the rate upwards when funds were short, thereby calling-in liquidity
from other markets and discouraging demand, especially from carry-trade speculators. By contrast, when surplus funds got piled too high, they would push the discount rate downward, thereby discouraging supply and inciting demand.

  Under such a free-market regime, the discount rate might well be highly mobile, moving from 1% to 10% and back to 1%, for example, as markets cleared in response to changing short-term balances.

  So what?

  Likewise, the world is full of long-term savers like pension funds, insurance companies, bond funds and direct household investors on the supply side, and a long parade of sovereign, corporate and household borrowers on the demand side.

  Through an endless process of auction, arbitrage and allocation, the yield curve would find its proper shape and levels. And as with the case of a free market in money, the yield curve of the debt market would undulate, twist, turn and otherwise morph in response to changing factors with respect to supply of savings and demands for debt capital.

  It goes without saying that under such a regime, savers would be rewarded with high rates when demands for business investment, household borrowings and government debt issuance were large. At the same time, financial punters, business speculators, household high-livers and deficit-spending politicians alike would find their enthusiasm severely dented by high and rising yields when the supply of savings was short.

  What would be the harm, it must be asked, in letting economic agents in their tens of millions bid for savings in order to find the right price of debt capital at any given time?

  Why concentrate the task among 12 people who, as Janet Yellen’s endless babbling so thoroughly demonstrates, can’t possibly figure it out, anyway?

  There are three reasons given as to why capitalism’s monumental and crucial tasks of setting the price of money and debt cannot be trusted to the free market. But all of them are wrong; all of them are a variation of the giant Keynesian error that capitalism self-destructively tends toward entropy absent the ministrations of the state, and especially its central banking branch.

  The first of these is the notion that debt is the keystone to prosperity and that a central bank fueled credit pick-me-up is warranted whenever economic growth begins to falter or business-cycle conditions weaken.

  In fact, the truth is more nearly the opposite as we demonstrate at length in Chapter 6. The U.S. economy’s leverage ratio today is triple its historic pre-1970 level, while the trend rate of real GDP growth has fallen by 80%.

  Likewise, the second argument for activist central banking—the notion that the business cycle is inherently unstable and bleeds the economy of growth and wealth—is flat-out untrue. As we demonstrated above, every business-cycle downturn since the creation of the Fed in 1913 was the result of state action, not the inherent instabilities of the free market.

  THE “FINANCIAL CONTAGION” MYTH AND THE FALSE CASE FOR ACTIVIST CENTRAL BANKING

  At the end of the day, however, it is the fear of financial contagion and catastrophe of the type that allegedly arose in September 2008 that is the bogeyman ultimately undergirding the current cult of Keynesian central banking.

  Yet the truth of the matter is that we didn’t need Ben Bernanke and his self-proclaimed courage to print—and, as it happened, wildly and excessively so—to forestall an alleged Armageddon. As I documented in The Great Deformation, there was no run on the retail banks of America, and the post-Lehman meltdown in the financial markets would have burned out in the canyons of Wall Street had Washington not bailed out the gamblers.

  So let’s recall what actually happened, not the urban legends that arose at the time.

  The Fed’s balance sheet was about $900 billion before the Lehman meltdown, and it had taken 94 years to get there. The Bernanke Fed printed another $900 billion in just seven weeks after Lehman and $1.3 trillion more before Christmas Eve that year.

  In the process, any crony capitalist within shouting distance of the canyons of Wall Street got bailed out with ultra-cheap credit from the Fed’s alphabet soup of bailout lines.

  Among these was the $600 billion AAA balance sheet at General Electric where CEO Jeff Imelt’s bonus would have been jeopardized by spiking interest costs on his imprudently issued $90 billion in short-term commercial paper.

  Ben had the courage to save Imelt’s bonus by funding him at less than 4% for no good reason whatsoever. General Electric could have readily raised the funds through a dilutive issue of common stock or long-term debt.

  He also had the courage to fund Morgan Stanley to the tune of $100 billion in cheap advances and guarantees. That gift kept this insolvent Wall Street gambling outfit alive long enough for CEO John Mack to jet down to Washington where he got short-sellers outlawed and collected a $10 billion TARP bailout—and all in less than two weeks!

  Well, there is a better answer, and it requires no FOMC, Ben Bernanke or specious courage to rescue crony capitalist bandits like John Mack and Jeff Imelt.

  It is called “mobilizing the discount rate.” Implementation only takes green eyeshades.

  That’s right. Just a small number of competent accountants could do the job. Indeed, no Harvard, Princeton or even University of Chicago PhDs need apply.

  For all the false jawing about Walter Bagehot’s rules for stopping a financial crisis, a mobilized discount rate, not a hyperactive FOMC running around with hair afire and monetary fire hoses spraying randomly, is actually what the great English financial thinker had in mind.

  To wit, Bagehot actually said that during a crisis central banks should supply funds freely at a penalty spread on top of a market rate of interest secured by sound collateral.

  You don’t need macroeconomic modelers with PhDs in econo-algebra to do that. You need accountants who can drill deep into business balance sheets and examine the collateral; and then clerks who can query the market rate of interest, add say 300–400 basis points of penalty spread, and hit the send bottom to eligible banks that have posted approved collateral.

  Indeed, as we have seen, this was the sum and substance of the Fed’s original design by Carter Glass, the great financial statesman who authored it. That’s why he had 12 Reserve Banks domiciled in the different economic regions of the country and an essentially honorific but powerless board in Washington, DC.

  As I indicated above, the 12 regional banks had no remit to target macroeconomic variables. They were not charged with managing, countering, flattening, or abolishing the business cycle. They could not even own government debt, and 91.7% (11/12) of their operations were to be conducted in the 11 regional banks away from Wall Street.

  In short, the purpose of the Fed was actually to be a classic lender of last resort. The job of Carter Glass’ “bankers’ bank was liquefying the banking system on a decentralized basis, not monetary central planning or Keynesian macro-economic management.

  Accordingly, the balance sheet of the Federal Reserve System was not intended to be a proactive instrument of national economic policy. It was to passively reflect the ebb and flow of industry and commerce. The expansion and contraction of banking system liquidity needs would follow from the free enterprise of business and labor throughout the nation, not the whims, guesstimates, confusions, and blather of a 12-person FOMC.

  Needless to say, under the mobilized discount rate regime and bankers’ bank that Carter Glass intended, the outcomes during the 2008 financial crisis would have been far different.

  Bear Stearns was not a commercial bank, and would not have been eligible for the discount window. It would have been liquidated, as it should have been, with no harm done except to the speculators who had imprudently purchased its commercial paper, debt and equity securities.

  Likewise, Morgan Stanley was insolvent and its doors would have been closed on September 25, 2008. That is, long before John Mack could have gotten the short-sellers of his worthless stock banned or collected his $10 billion gift from Hank Paulson.

  Needless to say, the world would have little noted nor long remembered the
chapter 11 filing of what was (and still is) a notorious gambling house. Likewise, GE would have paid higher rates for long term debt or new equity to refund its commercial paper, thereby dinging its earnings by a quarter or two and Jeff Imelt’s’ bonus that year.

  Yet, exactly what does that matter to the Main Street economy?

  In a word, what happened in the run-up to the great financial crisis and its aftermath never would have occurred under a mobilized discount rate regime conducted by a bankers’ bank.

  Funding costs in the money markets would have soared to 10% or even double digits. That would have caused speculators who had invested long and illiquid and borrowed cheap and overnight to be carried out on their shields, thereby accomplishing the exact historic function of interest rates—a crucial function that the Bernanke Fed destroyed when it essentially nationalized the federal-funds market in September 2008.

  The magnitude of Bernanke’s financial crime is best illustrated by its opposite. That is, what happened a century earlier during the great financial panic of 1907 when interest rates soared to 20% and even 60% on some days of extreme money-market stress.

  As it happened, volatile and soaring money-market rates cleared out the speculators and the hopelessly insolvent, like the copper kings, real estate punters and trust-bank pyramid artists of the day.

  At the same time, JP Morgan and his syndicate of bankers with their own capital on the line, re-liquefied the solvent supplicants who came to Morgan’s library on Madison Avenue—–but only after their green eyeshades had spent long nights proving up solid collateral for liquidity loans from the Morgan syndicate.

  After all, it was their capital, which was one the line—not fiat credits issued by hitting the send button at the New York Fed.

  In any event, by 1910 American capitalism was again booming. No Fed. No Bernanke. No harm done.