The Trigger Man Wore A Suit

Before I continue from yesterday's post about the "debt gun" I would like to offer a short comment about this story making the rounds:

The Fed is looking for ways to entice banks to borrow from its Discount Window and thus ease the "liquidity crisis" currently taking place. They believe that lowering the Discount Rate will shrink the gap between it and Fed Funds and therefore remove the stigma attached to borrowing from the Window, i.e. directly from the Fed.

This is a fallacy.

The stigma - which is very real - is related to having to use the Fed as lender of last resort, not the interest rate. If a bank has to borrow from the Fed, it means its peers in the interbank money market don't want to lend to it, i.e. its credit is no good amongst the professionals that know it best. In other words, it's in trouble.

Certainly, I am not referring to using the Window on an occasional basis because of some last minute liquidity need - that's perfectly OK. But if a bank has to borrow considerable sums from the Fed on a regular and extended basis... it's in trouble, period. Bankers know this and that's why they avoid the Window like the plague. The Fed officials are aware of this, of course; the fact that they are trying to entice banks to use the Window is a sign of how concerned they have really become. It confirms what we all know already: we are facing a full blown credit crisis and not a mere shortage of liquidity.

I will repeat: Mr. Bernanke is erroneously using 1929-32 as his model, or at least he's interpreting it erroneously. He's trying to start a fire during a rainstorm by lighting one match after another (i.e. cutting rates) and wonders why they are snuffed out by the heavy rain.

I respectfully submit that Mr. Bernanke first needs to get an umbrella.
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And now, we return to our regularly scheduled program...

Continuing from yesterday's post:

Who were the trigger men that held a debt gun to the American family's head? Who caused prices for "assets" like a college education, housing and medical care to rise, whilst keeping wage increases to a minimum?

It all started with the neo-liberal economists of the Thatcher - Reagan era, who initiated the process of decimating wage income by attacking labor unions - by then rather easy targets who had disgraced themselves by acting as Big Labor. To be fair, the neo-lib actions should be interpreted in context: The Cold War was still in full swing, leading to ideological clashes between "capitalism and freedom" a la Milton Friedman vs. the "socialist nanny-sate" of the Eurosclerotics. The Chicago School theorists were heavily influenced by their understandable revulsion for totalitarianism and planned economies, echoes of which were reflected from Nazi Germany to the nominally socialist Soviet state. Their intentions were good, but their teachings ultimately became bound by ideology, i.e. dogma.

And with dogma came dogmatics who could not see past their noses, buried as they were in the literal interpretation of their masters' theories: laissez-faire, individual responsibility, freedom of choice, unfettered markets - they were all interpreted in extremis, not contained by common sense. Soft-drink companies were allowed to install vending machines in schools, in exchange for money that was cut from their budgets. Markets were deregulated... and deregulated... and deregulated, until Enron got its hands on the electricity grid and black-outs occurred in California's cities more frequently than in Mogadishu.

Employment experienced a radical shift. Lower level workers were turned into versions of disposable salaried contractors, while the top filled with a caste of itinerant managers whose only concern was to hit their stock option targets. And why not? Milton Friedman had already proclaimed that the only social responsibility of business was to increase profits.

So profits increased.

After-tax corporate profits as a percentage of GDP have now grown to an all-time high (see chart below). Because a very small percentage of Americans own stock directly or indirectly, the benefits accrue to a very narrow segment of the population, greatly widening income disparities. More money is being made, but fewer people are getting it. Bill Gates walks into a bar and everyone turns into a multi millionaire - on average.

Data: BEA

But that's not the whole story, because it wasn't the entire corporate sector that made such record profits. Rather, it was the financial industry that made out like bandits (see chart below). They saw their share of GDP quintuple, whereas non-financials only recently managed to recoup amid the general rise in profitability.

Data: BEA

In the past 25 years profits of the financial sector went from 25% of total corporate profits to 50% (see chart below), a condition frequently called the "financialization of America". Lending and shuffling money around has become by far the biggest business in America, even eclipsing that perennial target of the populist press, the oil companies.


Aha! you may point out: Think of all those jobs the finance industry creates. Good jobs, highly paid jobs - heck, even the secretaries at Goldman make triple figure bonuses - and they are members of the B&T crowd, not Greenwich debutantes. But you would be wrong; because, according to the Labor Department, of the 41.5 million new private sector jobs created in the US since 1980, only 3.5 million were in financial activities. The entire financial industry today employs a mere 5.4% of all Americans working in the private sector, even less than the 6.6% in 1980. Those fat bonuses are going to very few people, after all.

By contrast, during the same time period the leisure and hospitality sector added 7 million jobs and retail trade 5.1 million. Those two sectors account for some of the lowest-paid workers in America, i.e. waiters, hotel maids and store attendants and their combined share of total private sector employment increased from 22.8% to 25%. More people are making less money than before.

Most people get employed where they can, not necessarily where they want: if GM lays off tens of thousands, the next job for a skilled machinist is unlikely to be at another car factory. Some go straight from the shop floor to tending bar. In the last 30 years GM has reduced its workforce in the US from 600.000 to around 100.000. What are people supposed to do? Slash their wrists? Or get a home equity loan to meet expenses, while working at a job that pays 50% less with no benefits, hoping things will improve?

Schumpeter fans will by now be thinking: creative destruction. True, very true. The only problem is that good jobs that were destroyed in America were replaced by good jobs (relatively speaking) in China and India, whose vast pools of peasants turned into factory and service workers. In a globalized economy, there is nothing that cannot be done equally well in China, India or both, at a huge discount. Not even securities research, as some investment bank employees are discovering to their dismay. In the meantime, what are Americans (and Europeans) supposed to do? Borrow, spend and hope the theoretical benefits of globalization materialize before the repo man comes.

Was there a Grand Conspiracy to create debt slaves in America? No, I don't believe so. But the profit motive as a sole driving force in business was more than enough - and stupid in the extreme. Any fool of a manager can increase profits for a short period of time - all it takes is a sharp axe and a dull conscience. We see now what happens when we let loose a whole pack of smart operators and financiers upon the US economy offering them billions, if only they boost share prices from X to Y.

We have bamboozled ourselves into hiring trigger-men in suits to "rub out" entire sections of the economy, selfishly thinking that they will only "hit" the other guy. Well... guess what? We are ALL the other guy.