Stock Markets

As the economists keep telling us, the market isn't the economy.  True, I suppose, but if you're a retiree living on a 401K or a 403B, it sure as hell is your economy.

Some are blaming recent market losses on China.  Some are blaming low oil prices.  Some are blaming the Fed's .25% increase in the Federal Funds Rate last month.  (It wasn't the Fed.  There's no way a quarter per cent above, essentially, zero, could have such an impact.)

Others are pointing to "volatility," suggesting that January's big dip in prices is just a temporary glitch.  We'll see.  On the other hand, there are things that can be done to reduce "volatility" and its impact in the future.

One surefire policy choice would be passing a Tobin Tax, sometimes called a "Robin Hood tax" — a very small tax on every financial transaction.  It would probably put the brakes on a lot of the high-frequency trading that exacerbates volatility.  Bernie says the proceeds would be enough to finance free college tuition for all.*

The other change would be policies to encourage a return to fixed-benefit pension systems, so retirees don't have to ride the market roller coaster.  Professional money managers would be in charge of their pension funds, just as they are with 401K funds, but pensioners would be freed of the stresses of market swings.  Needless to say, this would require that pension funds be fully funded, and not subject to raids by municipal and state governments nor corporate fat cats.

Any money manager who is a consistent winner in the markets either is preternaturally lucky or engaged in insider trading, so with proper regulation, fund incomes should average out over time.  Requiring contributions to an insurance fund that could bail out funds that are managed by the preternaturally unlucky would provide a safety net.

I know it all sounds highly unlikely, but most of it is feasible if the political will can be found.

*Those who claim we can't have free tuition because we don't want to subsidize rich people are talking out of their asses.  The rich will continue to send their kids to top-ranked private schools.  Donald Tr*mp's son will not be attending CUNY!

0.25%

Let's face it: adding a quarter per cent to the Federal Funds Rate is no big deal.  Yes, the greedy bankers, as expected, are raising their prime rates — making some loans more expensive — while letting interest rates on CDs and savings accounts stay the same.  They're increasing prime because they can.  They're leaving the interest they pay low for the same reason: because they can.

Really, though, the change is minimal.  Granted, the increase really wasn't justified by higher inflation, because inflation remains very low.  Some think the Fed was anticipating higher inflation based on possibly higher oil prices in the future, but as long as everywhere in the world except the USofA is stuck in slowdown, oil prices will stay low.  So why the increase in the rate?

Mostly, I believe, as an indicator that the recovery really is happening, and because its impact is beginning to be seen in wages as well as asset values.  If the Fed succeeds in instilling greater confidence, it may be that corporations will begin investing their very substantial profits in expanded production, rather than in mergers, acquisitions, and stock buybacks.

If rate increases come as slowly as Dr. Yellen has suggested, no economic slowdown need be anticipated, and the Fed will begin to regain some of the leverage it needs to respond to future crises.

Briefly...

The Fed
Face it: the potential increase in the Federal Funds Rate of one quarter of one per cent is purely symbolic.  While it may "roil" the markets, it will have virtually no impact on the real economy.  Assuming you're not a hedge fund manager, you really shouldn't give a damn.

The Iran Deal
Britain, France, China, Russia, and Germany made it perfectly clear that they would not maintain sanctions on Iran if the USofA failed to approve the deal, so all the opposition came down to Republicans determined to foil every Obama initiative and Democrats sucking up to AIPAC.  Thank you Barbara Mikulsky for finally dampening the bullshit, and screw you both, Chuck Schumer and Robert Menendez.

"Female Viagra"
Flibanserin, aka Addyí™, is not "female Viagra."  Viagra is just a boner pill, which allows older men with declining sex drive to fake it.  Flibanserin actually increases libido in some women willing to risk a long list of possible side effects.  Women don't need a Viagra-like drug because they already are quite capable of faking it without medical assistance.  If Valeant actually intends to pay Sprout Pharma a billion bucks for the rights to flibanserin, I'd sell my Valeant stock ASAP. 

Trump v. Sanders
Now wouldn't that be amusing, in a scary sort of way!

QE2

So, Ben Bernanke has all but formally announced another round of quantitative easing. I know I promised to stop making predictions, but this one is a no-brainer.

Quantitative easing will not decrease the unemployment rate. If done exactly the wrong way, it might help the banks survive their latest round of self-inflicted trauma. Ignore the Fed's history of putting the interests of banks before the interests of human beings, and we might be able to convince ourselves that another round of quantitative easing might be another desperate stab at reviving the economy (albeit the equivalent of drawing to an inside straight.) Well, maybe the Fed governors are well-intentioned — but before we evaluate their intentions, we'll have to wait and see just how badly QE2 is done. Then we'll have a better idea.

In its first round of quantitative easing, the Fed spent about $1.5 trillion on longer term T-bills from Treasury and a big batch of toxic assets from the largest banks. Buying the T-bills probably held down long-term interest rates, like mortgages — not that anybody's buying houses at the moment. Buying the toxic assets — mortgage backed securities — was just another bailout to the banks. The money used to pay for it all, of course, was created by the Fed out of thin air. It wasn't all bad — the value of the dollar dropped against most other currencies (but not the renmimbi), and whatever growth we've seen since then has come from exports.

Girls and boys, we are not going to export our way out of disaster — certainly not when every other developed or developing country in the world is simultaneously trying to do the same thing. What's needed is a genuine and concerted redistribution of wealth, so that our working and middle classes can afford to buy the products we produce. More demand equals more products equals more employment equals more demand. It's a virtuous circle, and one we sorely need.

But, getting back to quantitative easing, we'd best have a look at how it might be done.

If the Fed bought all T-bills with the new money it creates, the banks would not be especially happy. On all their outstanding loans, the money they collected would be worth less than the money they loaned to debtors. It would be kind of like going back to William Jennings Bryant and free coinage of silver. Other losers would include people living on fixed incomes, whose money would buy less than before.

More likely, of course, would be another round of Fed purchases of mortgage-backed securities — inevitably for considerably more than they're worth, since their value is approximately zilch. Yes, America, another bank bailout.

Okay, I'm making my usual pessimistic predictions. Sorry. I sincerely hope I'm wrong this time.

Just the same, I actually was paying attention during the Japanese "lost decade," and noticed just how well quantitative easing worked for them. Yes, I know, some economists today say they just didn't do enough of it, and that's why it accomplished nothing — but nobody seems to know how much is enough.

Right now, banks are awash in cash, but still not lending to small businesses. Heavens! It's just too risky! At the same time, they're borrowing money at near-zero interest and charging 18% and more on credit cards. Other corporations are also hoarding cash, hoping to survive if everything nose-dives again. Any new money the Fed pumps into the economy is likely to go straight into speculation in the commodities markets, not into job creation.

Yes, the threat of deflation is scary — but creating new money and tossing it at the banks by buying their worthless CDOs will not do a damned bit of good. Unfortunately, the Fed has no means —even if it had the will — to direct its newly created bucks to the people who actually would spend it on goods and services, thereby lifting the economy. The only institution capable of shifting wealth from the elite groups to those of us in the lower classes is Congress — and you know what that means.

We're fucked.

Are you stimulated yet?

The Fed, apparently, believes we've been stimulated enough, and finally has ended it's orgy of rate cutting. A hint that interest rates might even be going up in the not too distant future was enough to panic the stock market into bear country, although word of more write-downs by major banks certainly contributed to that panic.

Consumer spending has been flat at best, despite $152,000,000,000 in stimulus checks -- and even the habitual optimists are expecting the current economic malaise to be with us for another three quarters. At the same time, higher rates of inflation are inevitable as ballooning energy costs are passed along by businesses to their customers. What's a Fed governor to do?

The answer, apparently, is to try to restrain inflation rather than trying to goose a little more life into a moribund economy. As we learned in the seventies, monetary policy is not particularly good for addressing stagflation, so you address the greater threat.

Yes, yes, I know! There's no wage-price spiral this time, so we won't be getting the double-digit inflation of the seventies, and so I shouldn't be characterizing the current mess as stagflation -- but what else do you call simultaneous recession and inflation? Ralph?

Whatever you call it, the pain is likely to be the same. In the seventies, at least the union workers -- the wage part of the wage-price spiral -- were managing to stay even. This time, the inflationary pressures won't come from wages, and the pain of higher prices may be distributed more equitably. After thirty years of contraction, the unions still with us don't have much bargaining power left. Lately, all labor seems able to do is trade wages and benefits for a little more job security -- then discover that the "job security" was an illusion all along.

Along with energy, the force driving inflation this time will be the futures markets -- not because "speculators" are out of control, but because investors are looking for safer places to put their money than the stock market. If somebody is willing to pay 75 bucks for a pork belly delivered in August, you can bet that come August bacon will cost more.

When the banks finally are finished writing down all the bad loans, and house prices have bottomed out, and the wave of personal and business bankruptcies subsides, things will get better. Higher interest rates and higher credit standards will restore some value to the dollar, and people will learn to get by on a lot less gasoline. Until then, we just have to ride it out.

Dammit!

(Yes, another "dammit" post.)

I guess when everybody's expecting a cut in the federal funds rate, it just has to be cut. The expectations were for a cut between half-a-percent and one percent, so the Fed split the difference. Me, I'm with Fed governors Fisher and Plosser (Dallas and Philly, respectively), who favored a smaller cut. The two were characterized by the Times as "hawkish" on inflation.

Hawkish? I'm not hawkish. I'm scared.

The discount rate also was dropped by three-quarters, which is a good thing because the Fed may be the only place left for American banks to acquire capital. Low interest rates are sure to mean low interest by foreign lenders, especially when the dollars that get paid back will be worth so much less than the dollars invested. If I were the Sheik of Araby with a vault full of petrobucks, I guess dollars might be all I had to lend, though -- making the U.S. the only game in town. On the other hand, at the next meeting of OPEC, the notion of valuing a barrel of crude in euros rather than dollars might seem like a pretty good idea.

Action on the economy! (Well, sort of.)

First, the monetary policy: the overnight rate was reduced by 75 basis points in a "surprise" action by the Fed, and another half-percent cut is expected at the next regular meeting. The main impact is that Wall Street will momentarily stop screaming, "You're our bitch, Ben, and don't you forget it!"

Next comes the fiscal policy: the House and the Administration agreed to "compromise" on an "economic stimulus" bill. Certain Democratic members of the Senate will bloviate on the need for an extension of unemployment insurance before they take their seats and vote for "the best package we could get." Certain Republicans will bloviate on the intolerable expansion of the federal deficit, then vote to further expand that deficit with continued funding of the Iraq fiasco.

Neither the monetary policy nor the fiscal policy will bail our economy out of the mess its in, and the best we can hope is that they do nothing at all rather than make things worse. Let's begin by looking at monetary policy, and save the fiscal policy for another day.

Who controls the money supply?

Traditionally, a cut in the overnight rate ripples through credit markets and leads to generally lower interest rates, expanding the money supply by making it easier to borrow. Businesses and individuals use easier credit to buy more goods and services, which stimulates the economy. Sadly, these are not traditional times. Because of government's growing failure to regulate financial markets, the Federal Reserve lost control of the money supply.

The origin of the current credit crisis is not that it was too hard to get credit, but too easy. We're all familiar with the subprime mortgage fiasco -- banks extended credit to people who had no chance of making their mortgage payments once their adjustable rates reset at higher levels, then repackaged those flawed mortgages as supposedly "safe" securities which were sold to investors. The banks took their profits, the investors were left with the bad paper, and the increased demand for housing over-inflated its price -- the "housing bubble." Many who actually could afford their first mortgages borrowed against the inflated values of their homes with second mortgages and home equity lines of credit. When the bubble began to burst, and housing prices fell, some found they owed more than their homes were worth.

Less a focus of the media, but obvious to anybody who wasn't asleep, standards for other sorts of loans also declined rapidly. Our mailboxes were filled with "pre-approved" credit card applications, and auto loan offers bragged, "Bad credit? No credit? No problem!" While it's true that the 2005 change in the bankruptcy law gave the banks more protection from defaults on credit card debt, you still can't get blood from a stone. More and more families, including many who hold conventional mortgages or none at all, have debts they cannot pay.

Financial institutions like Citigroup and Merrill-Lynch have been "writing down" billions of dollars in debts they never will collect. So far, the losses come from subprime mortgages they were unable to securitize before the housing bubble burst, but we can expect even more write-downs from credit card defaults and other debts. A write-down represents a loss of liquidity. Every write-down means there is less money to lend.

Citigroup, for one, has been raising new capital by selling preferred stock to foreign investors, including sovereign wealth funds. Preferred stock is not voting stock, but it pays a guaranteed dividend. We don't know how much Citigroup will be paying for its bailout funds, but no matter how far the Fed cuts the overnight rate, interest rates at Citi will have to be high enough to cover its new expenses.

Also, no matter how far the Fed cuts rates, banks will not go back to the kinds of lending practices that caused their current problems. Quite probably they will be extremely conservative for a while, and credit will remain tight. New mortgages are being written for those with good credit, but primarily to refinance existing mortgages at lower, fixed rates -- not to buy refrigerators, second homes, and Hummers.

The recession is here, and it won't be going away very soon. Our central bank and our government, by failing to regulate the financial industry, relinquished control of the money supply to a self-serving, greed-driven corporate culture. We'll see if those elected next November have the strength of character to restore the regulation necessary to avoid this kind of market failure in the future -- no matter how much of their campaign funds came from Wall Street.