Sen. Elizabeth Warren this weekend called on federal officials to investigate the causes of recent bank failures and urged President Joe Biden to fire Federal Reserve Chair Jerome Powell, whom she has criticized for intensifying financial deregulation and imposing job- and wage-destroying interest rate hikes.
Asked on Sunday by Chuck Todd of NBC‘s “Meet the Press” about the possibility of Powell imposing yet another interest rate hike despite ongoing market turmoil, Warren (D-Mass.) said, “I’ve been in the camp for a long time that these extraordinary rate increases that he has taken on, these extreme rate increases, are something that he should not be doing.”
Powell “has a dual mandate,” said Warren. “Yes, he is responsible for dealing with inflation, but he is also responsible for employment. And what Chair Powell is trying to do, and he has said fairly explicitly, is that they are trying to, in effect, slow down the economy so that, this is by the Fed’s own estimate, two million people will lose their jobs. And I believe that is not what the chair of the Federal Reserve should be doing.”
Since the Covid-19 pandemic and Russia’s invasion of Ukraine disrupted international supply chains—rendered fragile by decades of neoliberal globalization—powerful corporations in highly consolidated industries have taken advantage of these and other crises such as the bird flu outbreak to justify profit-boosting price hikes that far outpace the increased costs of doing business.
“Raising interest rates doesn’t do anything to solve” a cost-of-living crisis driven primarily by “price gouging, supply chain kinks, [and] the war in Ukraine,” Warren said Sunday. “All it does is put millions of people out of work.”
“Jay Powell… has had two jobs. One is to deal with monetary policy, one is to deal with regulation. He has failed at both.”
Powell, an ex-investment banker, was first appointed by then-President Donald Trump in 2018 and reappointed by Biden in 2021. Warren noted that she opposed Powell’s nomination in both cases “because of his views on regulation and what he was already doing to weaken regulation.”
“But I think he’s failing in both jobs, both as the oversight and manager of these big banks, which is his job, and also what he’s doing with inflation,” said Warren.
Asked by Todd if Biden should fire Powell, Warren said: “My views on Jay Powell are well-known at this point. He has had two jobs. One is to deal with monetary policy, one is to deal with regulation. He has failed at both.”
“Would you advise President Biden to replace him?” Todd inquired.
“I don’t think he should be Chairman of the Federal Reserve,” the Massachusetts Democrat responded. “I have said it as publicly as I know how to say it. I’ve said it to everyone.”
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Meanwhile, in a Saturday letter, Warren asked Richard Delmar, Tyler Smith, and Mark Bialek—respectively the deputy inspector general of the Treasury Department, acting inspector general of the Federal Deposit Insurance Corporation (FDIC), and inspector general of the Fed’s board of governors—to “immediately open a thorough, independent investigation of the causes of the bank management and regulatory and supervisory problems that resulted in this month’s failure of Silicon Valley Bank (SVB) and Signature Bank (Signature) and deliver preliminary results within 30 days.”
Until the Treasury Department, the Fed, and the FDIC “intervened to guarantee billions of dollars of deposits,” the second- and third-biggest bank failures in U.S. history “threatened economic contagion and severe damage to the banking and financial systems,” Warren noted. “The bank’s executives, who took unnecessary risks or failed to hedge against entirely foreseeable threats, must be held accountable for these failures.”
“But this mismanagement was allowed to occur because of a series of failures by lawmakers and regulators,” Warren continued.
In 2018, several Democrats joined Republicans in approving Sen. Mike Crapo’s (R-Idaho) Economic Growth, Regulatory Relief, and Consumer Protection Act, which weakened the Dodd-Frank Wall Street Reform and Consumer Protection Act passed in the wake of the 2008 financial crisis. Crapo’s deregulatory measure, signed into law by Trump, loosened federal oversight of banks with between $50 billion and $250 billion in assets—a category that includes SVB and Signature.
“As officials sought to develop a plan responding to SVB’s failure, Chair Powell muzzled regulators from any public mention of the regulatory failures that occurred under his watch.”
Moreover, the Fed under Powell’s leadership “initiated key regulatory rollbacks,” Warren wrote Saturday, echoing criticisms that she and financial industry watchdogs voiced earlier in the week. “And the banks’ supervisors—particularly the Federal Reserve Bank of San Francisco, which oversaw SVB—missed or ignored key signals about their impending failure.”
It is “critical that your investigation be completely independent and free of influence from the bank executives or regulators that were responsible for action that led to these bank failures,” Warren stressed. “I am particularly concerned that you avoid any interference from Fed Chair Jerome Powell, who bears direct responsibility for—and has a long record of failure involving—regulatory and supervisory matters involving these two banks.”
“I have already asked Chair Powell to recuse himself from the Fed’s internal investigation of this matter, but he has not yet responded to this request,” wrote Warren. The progressive lawmaker said “this silence is troubling” in light of recent reporting that “as officials sought to develop a plan responding to SVB’s failure, Chair Powell muzzled regulators from any public mention of the regulatory failures that occurred under his watch.”
“Bank regulators and Congress must move quickly to close the gaps that allowed these bank failures to happen, and your investigation will provide us important insight as we take steps to do so,” added Warren, who has introduced legislation to repeal a vital provision of the Trump-era bank deregulation law enacted five years ago with bipartisan support.
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In appearances on three Sunday morning talk shows, Warren doubled down on her demands for an independent investigation into recent bank failures, stronger financial regulations, and punishing those responsible.
After lawmakers from both parties helped Trump fulfill his campaign promise to weaken federal oversight of the banking system, Powell “took a flamethrower to the regulations, saying, ‘I’m doing this because Congress let me do it,’” Warren toldABC‘s “This Week” co-anchor Jonathan Karl. “And what happened was exactly what we should have predicted, and that is the banks, these big, multi-billion-dollar banks, loaded up on risk; they boosted their short-term profits; they gave themselves huge bonuses and big salaries; and they exploded their banks.”
“When you explode a bank, you ought to be banned from banking forever.”
“When you explode a bank, you ought to be banned from banking forever,” said Warren, who acknowledged that criminal charges could be coming. “The Department of Justice has opened an investigation. I think that’s appropriate for them to do. We’ll see where the facts take them. But we’ve got to take a close look at this.”
Not only did former SVB chief executive officer Greg Becker, who lobbied aggressively for the 2018 bank deregulation law, sell millions of dollars of shares as recently as late last month, but until federal regulators took control of the failed bank on March 10, he was on the board of directors at the San Francisco Fed—the institution responsible for overseeing SVB.
On Saturday, Independent Sen. Bernie Sanders of Vermont announced that he plans to introduce legislation “to end this conflict of interest by banning big bank CEOs from serving on Fed boards.”
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“We’ve got to say overall that we can’t keep repeating this approach of weakening the regulation over the banks, then stepping in when these giant banks get into trouble,” Warren said Sunday, arguing for stronger federal oversight to prevent the need for bailouts.
This post was originally published on Common Dreams.
The Federal Reserve was the primary regulator of both Silicon Valley Bank and Signature Bank, whose back-to-back collapses sparked panic in financial markets and concerns about cascading impacts on the U.S. economy.
But despite immediate questions about the possible supervisory failures that allowed the banks’ crises to fester, Fed Chair Jerome Powell personally intervened over the weekend to block any mention of regulatory slipups in a joint statement on the federal government’s response to the situation.
The New York Timesreported late Thursday that some Biden administration officials “wanted to include that lapses in bank regulation and supervision had contributed to the problems that helped fell” Silicon Valley Bank, whose collapse marked the second-largest bank failure in U.S. history.
But Powell, an ex-investment banker originally nominated by former President Donald Trump, “pushed to take the line on regulation out of the statement because he wanted to focus on the actions being taken to shore up the financial system,” according to the
Times, which cited an unnamed person familiar with the matter.
The resulting
statement issued Sunday by the Fed, the Treasury Department, and the Federal Deposit Insurance Corporation (FDIC) appeared to conform to Powell’s demand, not mentioning what Sen. Elizabeth Warren (D-Mass.) and watchdogs have described as glaring failures in supervision by the central bank.
The joint statement vaguely highlights “reforms that were made after the financial crisis that ensured better safeguards for the banking industry”—but neglects to mention that the Fed and Congress rolled back some of those rules in subsequent years, decisions that experts say set the stage for SVB and Signature Bank’s collapse.
“That sounds a lot like putting the institutional interests of Fed and personal interests of the chair above financial stability,” Americans for Financial Reform (AFR)
said in response to news of Powell’s intervention, which—according toThe American Prospect‘s David Dayen—ended up delaying the release of the statement for “an indeterminate period of time.”
Dayen also reported Friday that the Fed “tried to influence” President Joe Biden’s statement on the bank failures and
bailout that followed.
Jeff Hauser, director of the Revolving Door Project,
wrote on Twitter that “Biden should have never renominated Powell,” calling the Fed chair “an abomination.”
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While Biden’s Sunday
statement doesn’t specifically mention regulatory failures, the president—who renominated Powell in late 2021—said in prepared remarks the following day that “there are important questions of how these banks got into these circumstances in the first place.”
“During the Obama-Biden administration, we put in place tough requirements on banks like Silicon Valley Bank and Signature Bank, including the Dodd-Frank Law, to make sure the crisis we saw in 2008 would not happen again,” Biden said. “Unfortunately, the last administration rolled back some of these requirements. I’m going to ask Congress and the banking regulators to strengthen the rules for banks to make it less likely that this kind of bank failure will happen again and to protect American jobs and small businesses.”
Biden was referring to a
2018 measure passed by the then-Republican-controlled Congress with the support of dozens of Democrats—and with a public endorsement from Powell.
Emboldened by the Republican-authored law—which weakened regulations for banks with between $50 billion and $250 billion in assets—the Fed under Powell’s leadership proceeded to go well beyond the measure’s mandates “by relaxing regulatory requirements for domestic banking institutions that have assets in the $250 to $700 billion range,” then-central bank governor Lael Brainard
noted in October 2018.
Brainard went on to caution, presciently, that the Fed’s deregulatory actions would “weaken the buffers that are core to the resilience of our system” and result in “increased risk to financial stability and the taxpayer.”
“Make no mistake: your decisions aided and abetted this bank failure, and you bear your share of responsibility for it.”
As Dayen wrote Friday, “Silicon Valley Bank had billions in unrealized losses on its balance sheet that it hoped to avoid having to surface.”
“It also had a tightly correlated, mostly uninsured depositor base, all largely from one industry and connected to each other, that represented significant flight risk if there were any signs of trouble,” he added. “The rapid growth at the bank and its significant mismatch for liquidity purposes should have had the system flashing red.”
Dennis Kelleher, the president of Better Markets,
expressed a similar sentiment earlier this week, noting that “the Fed has much more and superior knowledge, information, expertise, and access to banks than short sellers, rating agencies, and the media, yet they all appear to have done a much better job at identifying the very serious risks at SVB than the Fed.”
In a
letter to Powell on Thursday, Warren—one of the Fed chair’s most outspoken critics in Congress—laid out in detail what she characterized as the central bank’s “astonishing list of failures” that contributed to the collapse of Silicon Valley Bank and Signature Bank.
“As chair of the Fed, you have led and vigorously supported efforts to weaken the regulations that would have subjected banks like SVB and Signature to stronger liquidity requirements, more robust stress testing, and routine resolution planning obligations,” the Massachusetts Democrat wrote. “Make no mistake: your decisions aided and abetted this bank failure, and you bear your share of responsibility for it.”
In response to the Times‘ reporting, Warren tweeted Friday that “the Fed chair’s outrageous attempt to muzzle the rest of the government about his role in contributing to this current crisis is completely inappropriate—and it won’t work.”
“Congress needs to step in to fix these mistakes before things get even worse,” added Warren, who introduced legislation earlier this week that would repeal a key section of the 2018 bank deregulation law.
This story has been updated to include Sen. Elizabeth Warren’s reaction to the reporting on Fed Chair Jerome Powell’s intervention.
This post was originally published on Common Dreams.
Every systemic banking crisis has a trigger that sets it off. In the case of SVB, the reason for its bankruptcy is twofold.
Responding to worried questions raised by many about the ongoing banking crisis that started in the US with the bankruptcy of the Silicon Valley Bank (SVB), and is now affecting Japan and other countries, I can offer the following brief analysis.
The trigger
Every systemic banking crisis has a trigger that sets it off. In the case of SVB, the reason for its bankruptcy is twofold.
The fall in prices in the secondary market for bonds – basically, US government bonds (treasuries) – which was caused by the Fed rate hike which, in turn, was “imposed” on all central banks by inflation.
The plummeting in the share prices of Big Tech and of the entire digital ecosystem of small tech start-ups around Big Tech – a decline caused by the Fed’s termination (due to inflation) of money printing.
In more detail, SVB took two hits at the same time.
The first hit its funds, which were mainly invested in US treasuries. This happened as the rise in interest rates reduced the resale price of these bonds (Why buy “second hand” an older bond that yields 0.5% when you can buy a “new” one that yields 3%?). In itself, this development was not sufficient to bankrupt SVB. As long as SVB was not obliged to sell at a reduced price the older bonds it held, there was no problem. However, because of the second hit, SVB was forced to sell at a large discount. And that’s where the problem started.
When inflation forced the Fed to stop printing new money (i.e. no more quantitative easing), the flow of funds that were keeping the shares of Big Tech companies in the stratosphere also stopped. Thus, Big Tech shares deflated. As these companies (Google, Amazon, Meta, Twitter, Netflix, Airbnb, Uber, etc.) based their funding on loans taken out by putting up their overvalued stock prices as collateral (e.g., that’s how Elon Musk bought Twitter), Big Tech suddenly ran out of cash. That’s why they started pulling their deposits from banks like SVB.
In short, at the same time as SVB’s capital base was being reduced, depositors were asking for their deposits back. As soon as the news got out that SVB was late in returning depositors’ funds, a classic bank run began.
The cause
The underlying reason why the failure of a medium-sized bank in California created so much angst worldwide is that international capitalism has never been able to get back on its feet after 2008.
In more detail: Central banks (the FED, the ECB, etc.) have one basic tool – the interest rate. When they want to put a brake on economic activity to keep inflation in check, they raise the interest rate, and vice-versa. But, in addition to price stability, central banks have two other goals: the stability of the banking system, and the balancing of liquidity with investment. The interest rate chosen by the central bank is one. That same number (e.g. 3%) must achieve three objectives simultaneously: price stability, banking system stability, and balancing between liquidity and investment.
What could be done as an alternative? The exact opposite: austerity for the banks, with nationalisation of those who cannot survive.
And herein lies the reason why I argue that, after 2008, capitalism cannot recover: There is no longer one interest rate that can achieve all three of these objectives simultaneously. This is the tragedy of central bankers: If they want to tame inflation (at a high enough interest rate), they trigger a banking crisis and, as a result, they are forced to bail out the oligarchs who, despite being bailed out, drive investments below liquidity. If, on the other hand, they impose a lower interest rate to avoid triggering a banking crisis, then inflation gets out of control – with the result that businesses expect interest rates to rise, which discourages them from investing. And so on and so forth.
Back to 2008, then?
No, for two reasons. First, the problem for US banks today is not that their assets are junk (e.g. structured derivatives based on red loans) as they were in 2008, but that they own government bonds which they are simply forced to sell at a discount. Second, the Fed bailout announced yesterday is different from the one in 2008 – today it is the banks and depositors who are being bailed out, but not the bank owners-shareholders. These two reasons explain why bank stocks are falling but there is no total collapse of stock markets.
The fact that there is no total collapse of the stock markets does not, of course, mean that the crisis of capitalism – which has been developing continuously since 2008 – is not deepening. It simply does not have the characteristics of an instantaneous, heavy-handed fall.
What does this development mean for Europe?
In 2008, Berlin and Paris were rejoicing that the banking crash was American and did not concern them – or so they thought. Until they realised that Franco-German banks were loaded with the toxic US derivatives that bankrupted Lehman.
Today, Franco-German banks don’t seem to have the same problem – rather, they are being spared due to the antiquated structure of the European economy. What do I mean? Franco-German banks have not lent large amounts to European Big Tech for the simple reason that European Big Tech doesn’t exist – they still lend to car manufacturers and extraction companies. So, I don’t see a European SVB on the horizon.
That doesn’t mean, of course, that European banks are safe. Their own funds are also invested in bonds whose prices have fallen. A large deposit flight will create the same problems here as we are seeing in the US. Such a flight could come from parts of the financial system that one cannot imagine – for example, from the insurance sector (as in Britain last autumn) or from a collapse of the weak Credit Suisse, which has long been suffering.
What should have been done?
Since 2008, governments and central banks have been trying to prop up the banks through a combination of socialism for the banks, and austerity for everyone else. The result is what we see today: The metastasis of the crisis from one “organ” of capitalism to another, with the magnitude of the crisis increasing with each such metastasis.
What could be done as an alternative? The exact opposite: austerity for the banks, with nationalisation of those who cannot survive. And socialism for workers – a basic income for all, a return to collective bargaining and, further out, new forms of participatory ownership of high- and low-tech companies. In other words, nothing short of a political revolution.
To those who fear the idea of a political revolution, my message is simple: Prepare to pay the price of the escalating crisis of a capitalism determined to take us all to its grave.
This post was originally published on Common Dreams.
I hadn’t intended to spend so much time this week on the banking crisis. I’m old enough to remember a time when banking was boring. But since the 1980s, banking has become hugely profitable for bankers and wildly dangerous for the rest of the economy. This week shows why.
At this moment, the Federal Reserve Bank is sitting on the horns of a dilemma.
On one horn are legitimate fears that smaller banks won’t have enough capital to meet their depositors’ needs if the Fed continues to raise interest rates when it meets next week.
Raising rates will slow the economy and possibly imperil banks—especially those that used depositors’ money to purchase long-term bonds when interest rates were lower, as did Silicon Valley Bank.
In other words, raising interest rates next week could cause an even bigger run on the banks.
Besides, inflation is receding, albeit slowly. So why take the risk?
But on the other horn are the Fed’s legitimate fears about inflation becoming entrenched in the economy, requiring more interest rate hikes.
But the two objectives—avoiding a bank run and raising rates—are in conflict. As the song goes, Something’s got to give. What will it be?
This week’s goal was to stabilize the banks enough so the Fed can raise interest rates next week without prompting more bank runs.
This required the Fed to bail out uninsured depositors at three banks and signal it will bail out others—in effect, expanding federal deposit insurance to cover every depositor at every bank.
On top of this, 11 of America’s biggest banks yesterday agreed to contribute a total of $30 billion to prop up First Republic Bank, another smaller bank caught in the turmoil. This “show of support” (as it was billed, without irony) elicited a cheer from the Fed’s Jerome Powell and Treasury Secretary Janet Yellen, who called it “most welcome.” (Of course it was welcome. They probably organized it.)
But consumers and depositors are still worried.
Meanwhile, on the other side of the Atlantic, the European Central Bank has raised interest rates by half a percentage point, saying it’s as committed as ever to fighting inflation.
The financial system is facing a crisis of confidence. Finance ultimately depends on confidence—confidence that prices are under control, and confidence that banks are sound.
But ever since the near meltdown of Wall Street in 2008, followed by the milquetoast Dodd-Frank regulation of 2010 and the awful 2018 law exempting smaller banks, confidence in America’s banks has been shaky.
November’s revelation that the bitcoin giant FTX was nothing but a Ponzi scheme has contributed to the fears. Where were the regulators? Last Friday’s revelation that Silicon Valley Bank didn’t have enough capital to pay its depositors has added to the anxieties. Where were the regulators?
Credit Suisse has been battered by years of mistakes and controversies. It is now on its third CEO in three years. Why? Swiss banking regulations are notoriously lax, but American bankers have also pushed Europeans to relax their financial regulations, setting off a race to the bottom where the only winners are the bankers. As Lloyd Blankfein, then CEO of Goldman Sachs, warned Europeans, “operations can be moved globally and capital can be accessed globally.”
One advantage of being a bank (whether headquartered in Silicon Valley or Switzerland) is you get bailed out when you make dumb bets. Another is you can choose where around the world to make dumb bets. Which is why central banks and bank regulators around the world must coordinate with each other to ensure that instead of a race to the bottom, it’s a race to protect the public.
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Banking is a confidence game. If the public loses confidence in banks, the financial system can’t function.
In the Panic of 1907, when major New York banks were heading toward bankruptcy, Secretary of the Treasury George B. Cortelyou deposited $35 million of federal money in the banks. It was one of the earliest bank bailouts, designed to restore confidence.
But it wasn’t enough. J.P. Morgan (the man who founded the bank) organized the nation’s leading financiers to devise a private bailout of the banks, analogous to yesterday’s. They redirected money between banks, secured further international lines of credit, and bought up the plummeting stocks of healthy corporations.
Confidence was restored, but the underlying weaknesses of the financial system remained. Those weaknesses became painfully and irrevocably apparent in the Great Crash of 1929.
This post was originally published on Common Dreams.
Sen. Elizabeth Warren (D-Massachusetts) is calling for Federal Reserve Chair Jerome Powell to recuse himself from his agency’s investigation into the Silicon Valley Bank failure because his actions directly contributed to the collapse, she says. The Federal Reserve announced on Monday that it is opening up a review into the “supervision and regulation” of Silicon Valley Bank after the bank failed…
On Friday, March 10, Silicon Valley Bank (SVB) collapsed and was taken over by federal regulators. SVB was the 16th largest bank in the country and its bankruptcy was the second largest in U.S. history, following Washington Mutual in 2008. Despite its size, SVB was not a “systemically important financial institution” (SIFI) as defined in the Dodd-Frank Act, which requires insolvent SIFIs to “bail in” the money of their creditors to recapitalize themselves.
Technically, the cutoff for SIFIs is $250 billion in assets. However, the reason they are called “systemically important” is not their asset size but the fact that their failure could bring down the whole financial system. That designation comes chiefly from their exposure to derivatives, the global casino that is so highly interconnected that it is a “house of cards.” Pull out one card and the whole house collapses. SVB held $27.7 billion in derivatives, no small sum, but it is only .05% of the $55,387 billion ($55.387 trillion) held by JPMorgan, the largest U.S. derivatives bank.
SVB could be the canary in the coal mine foreshadowing the fate of other over-extended banks, but its collapse is not the sort of “systemic risk” predicted to trigger “contagion.” As reported by CNN:
Despite initial panic on Wall Street, analysts said SVB’s collapse is unlikely to set off the kind of domino effect that gripped the banking industry during the financial crisis.
“The system is as well-capitalized and liquid as it has ever been,” Moody’s chief economist Mark Zandi said. “The banks that are now in trouble are much too small to be a meaningful threat to the broader system.”
No later than Monday morning, all insured depositors will have full access to their insured deposits, according to the FDIC. It will pay uninsured depositors an “advance dividend within the next week.”
The FDIC, Federal Reserve and U.S. Treasury have now agreed on an interim fix that will the subject of another article. Meanwhile, this column focuses on derivatives and is a followup to my Feb. 23 column on the “bail in” provisions of the 2010 Dodd Frank Act, which eliminated taxpayer bailouts by requiring insolvent SIFIs to recapitalize themselves with the funds of their creditors. “Creditors” are defined to include depositors, but deposits under $250,000 are protected by FDIC insurance. However, the FDIC fund is sufficient to cover only about 2% of the $9.6 trillion in U.S. insured deposits. A nationwide crisis triggering bank runs across the country, as happened in the early 1930s, would wipe out the fund. Today, some financial pundits are predicting a crisis of that magnitude in the quadrillion dollar-plus derivatives market, due to rapidly rising interest rates. This column looks at how likely that is and what can be done either to prevent it or dodge out of the way.
“Financial Weapons of Mass Destruction”
In 2002, mega-investor Warren Buffett wrote that derivatives were “financial weapons of mass destruction.” At that time, their total “notional” value (the value of the underlying assets from which the “derivatives” were “derived”) was estimated at $56 trillion. Investopedia reported in May 2022 that the derivatives bubble had reached an estimated $600 trillion according to the Bank for International Settlements (BIS), and that the total is often estimated at over $1 quadrillion. No one knows for sure, because most of the trades are done privately.
As of the third quarter of 2022, according to the “Quarterly Report on Bank Trading and Derivatives Activities” of the Office of the Comptroller of the Currency (the federal bank regulator), a total of 1,211 insured U.S. national and state commercial banks and savings associations held derivatives, but 88.6% of these were concentrated in only four large banks: J.P. Morgan Chase ($54.3 trillion), Goldman Sachs ($51 trillion), Citibank ($46 trillion), Bank of America ($21.6 trillion), followed by Wells Fargo ($12.2 trillion). A full list is here. Unlike in 2008-09, when the big derivative concerns were mortgage-backed securities and credit default swaps, today the largest and riskiest category is interest rate products.
The original purpose of derivatives was to help farmers and other producers manage the risks of dramatic changes in the markets for raw materials. But in recent times they have exploded into powerful vehicles for leveraged speculation (borrowing to gamble). In their basic form, derivatives are just bets – a giant casino in which players hedge against a variety of changes in market conditions (interest rates, exchange rates, defaults, etc.). They are sold as insurance against risk, which is passed off to the counterparty to the bet. But the risk is still there, and if the counterparty can’t pay, both parties lose. In “systemically important” situations, the government winds up footing the bill.
Like at a race track, players can bet although they have no interest in the underlying asset (the horse). This has allowed derivative bets to grow to many times global GDP and has added another element of risk: if you don’t own the barn on which you are betting, the temptation is there to burn down the barn to get the insurance. The financial entities taking these bets typically hedge by betting both ways, and they are highly interconnected. If counterparties don’t get paid, they can’t pay their own counterparties, and the whole system can go down very quickly, a systemic risk called “the domino effect.”
That is why insolvent SIFIs had to be bailed out in the Global Financial Crisis (GFC) of 2007-09, first with $700 billion of taxpayer money and then by the Federal Reserve with “quantitative easing.” Derivatives were at the heart of that crisis. Lehman Brothers was one of the derivative entities with bets across the system. So was insurance company AIG, which managed to survive due to a whopping $182 billion bailout from the U.S. Treasury; but Lehman was considered too weakly collateralized to salvage. It went down, and the Great Recession followed.
Risks Hidden in the Shadows
Derivatives are largely a creation of the “shadow banking” system, a group of financial intermediaries that facilitates the creation of credit globally but whose members are not subject to regulatory oversight. The shadow banking system also includes unregulated activities by regulated institutions. It includes the repo market, which evolved as a sort of pawn shop for large institutional investors with more than $250,000 to deposit. The repo market is a safe place for these lenders, including pension funds and the U.S. Treasury, to park their money and earn a bit of interest. But its safety is insured not by the FDIC but by sound collateral posted by the borrowers, preferably in the form of federal securities.
This banking system (the “shadow” or “parallel” banking system) – repo based on securitization – is a genuine banking system, as large as the traditional, regulated banking system. It is of critical importance to the economy because it is the funding basis for the traditional banking system. Without it, traditional banks will not lend and credit, which is essential for job creation, will not be created.
While it is true that banks create the money they lend simply by writing loans into the accounts of their borrowers, they still need liquidity to clear withdrawals; and for that they largely rely on the repo market, which has a daily turnover just in the U.S. of over $1 trillion. British financial commentator Alasdair MacLeod observes that the derivatives market was built on cheap repo credit. But interest rates have shot up and credit is no longer cheap, even for financial institutions.
According to a December 2022 report by the BIS, $80 trillion in foreign exchange derivatives that are off-balance-sheet (documented only in the footnotes of bank reports) are about to reset (roll over at higher interest rates). Financial commentator George Gammon discusses the threat this poses in a podcast he calls, “BIS Warns of 2023 Black Swan – A Derivatives Time Bomb.”
The Perverse Incentives Created by “Safe Harbor” in Bankruptcy
In The New Financial Deal: Understanding the Dodd-Frank Act and Its (Unintended) Consequences, Prof. David Skeel refutes what he calls the “Lehman myth”—the widespread belief that Lehman’s collapse resulted from the decision to allow it to fail. He blames the 2005 safe harbor amendment to the bankruptcy law, which says that the collateral posted by insolvent borrowers for both repo loans and derivatives has “safe harbor” status exempting it from recovery by the bankruptcy court. When Lehman appeared to be in trouble, the repo and derivatives traders all rushed to claim the collateral before it ran out, and the court had no power to stop them.
So why not repeal the amendment? In a 2014 article titled “The Roots of Shadow Banking,” Prof. Enrico Perotti of the University of Amsterdam explained that the safe harbor exemption is a critical feature of the shadow banking system, one it needs to function. Like traditional banks, shadow banks create credit in the form of loans backed by “demandable debt”—short-term loans or deposits that can be recalled on demand. In the traditional banking system, the promise that the depositor can get his money back on demand is made credible by government-backed deposit insurance and access to central bank funding. The shadow banks needed their own variant of “demandable debt,” and they got it through the privilege of “super-priority” in bankruptcy. Perotti wrote:
Safe harbor status grants the privilege of being excluded from mandatory stay, and basically all other restrictions. Safe harbor lenders, which at present include repos and derivative margins, can immediately repossess and resell pledged collateral.
This gives repos and derivatives extraordinary super-priority over all other claims, including tax and wage claims, deposits, real secured credit and insurance claims. [Emphasis added.]
The dilemma of our current banking system is that lenders won’t advance the short-term liquidity needed to fund repo loans without an ironclad guarantee; but the guarantee that makes the lender’s money safe makes the system itself very risky. When a debtor appears to be on shaky ground, there will be a predictable stampede by favored creditors to grab the collateral, in a rush for the exits that can propel an otherwise-viable debtor into bankruptcy; and that is what happened to Lehman Brothers.
Derivatives were granted “safe harbor” because allowing them to fail was also considered a systemic risk. It could trigger the “domino effect,” taking the whole system down. The error, says Prof. Skeel, was in passage of the 2005 safe harbor amendment. But the problem with repealing it now is that we will get the domino effect, in the collapse of both the quadrillion dollar derivatives market and the more than trillion dollars traded daily in the repo market.
The Interest Rate Shock
Interest rate derivatives are particularly vulnerable in today’s high interest rate environment. From March 2022 to February 2023, the prime rate (the rate banks charge their best customers) shot up from 3.5% to 7.75%, a radical jump. Market analyst Stephanie Pomboy calls it an “interest rate shock.” It won’t really hit the market until variable-rate contracts reset, but $1 trillion in U.S. corporate contracts are due to reset this year, another trillion next year, and another trillion the year after that.
A few bank bankruptcies are manageable, but an interest rate shock to the massive derivatives market could take down the whole economy. As Michael Snyder wrote in a 2013 article titled “A Chilling Warning About Interest Rate Derivatives:”
Will rapidly rising interest rates rip through the U.S. financial system like a giant lawnmower blade? Yes, the U.S. economy survived much higher interest rates in the past, but at that time there were not hundreds of trillions of dollars worth of interest rate derivatives hanging over our financial system like a Sword of Damocles.
… [R]ising interest rates could burst the derivatives bubble and cause “massive bankruptcies around the globe” [quoting Mexican billionaire Hugo Salinas Price]. Of course there are a whole lot of people out there that would be quite glad to see the “too big to fail” banks go bankrupt, but the truth is that if they go down, our entire economy will go down with them. … Our entire economic system is based on credit, and just like we saw back in 2008, if the big banks start failing, credit freezes up and suddenly nobody can get any money for anything.
There are safer ways to design the banking system, but they are not likely to be in place before the quadrillion dollar derivatives bubble bursts. Snyder was writing 10 years ago, and it hasn’t burst yet; but this was chiefly because the Fed came through with the “Fed Put” – the presumption that it would backstop “the market” in any sort of financial crisis. It has performed as expected until now, but the Fed Put has stripped it of its “independence” and its ability to perform its legislated duties. This is a complicated subject, but two excellent books on it are Nik Bhatia’s Layered Money (2021) and Lev Menand’s The Fed Unbound: Central Banking in a Time of Crisis (2022).
Today the Fed appears to be regaining its independence by intentionally killing the Fed Put, with its push to raise interest rates. (See my earlier article here.) It is still backstopping the offshore dollar market with “swap lines,” arrangements between central banks of two countries to keep currency available for member banks, but the latest swap line rate for the European Central Bank is a pricey 4.83%. No more “free lunch” for the banks.
Alternative Solutions
Alternatives that have been proposed for unwinding the massive derivatives bubble include repealing the safe harbor amendment and imposing a financial transaction tax, typically a 0.1% tax on all financial trades. But those proposals have been around for years and Congress has not taken up the call. Rather than waiting for Congress to act, many commentators say we need to form our own parallel alternative monetary systems.
Crypto proponents see promise in Bitcoin; but as Alastair MacLeod observes, Bitcoin’s price is too volatile for it to serve as a national or global reserve currency, and it does not have the status of enforceable legal tender. MacLeod’s preferred alternative is a gold-backed currency, not of the 19th century variety that led to bank runs when the banks ran out of gold, but of the sort now being proposed by Sergey Glazyev for the Eurasian Economic Union. The price of gold would be a yardstick for valuing national currencies, and physical gold could be used as a settlement medium to clear trade balances.
Lev Menand, author of The Fed Unbound, is an Associate Professor at Columbia Law School who has worked at the New York Fed and the U.S. Treasury. Addressing the problem of the out-of-control unregulated shadow banking system, he stated in a July 2022 interview with The Hill, “I think that one of the great possible reforms is the public banking movement and the replication of successful public bank enterprises that we have now in some places, or that we’ve had in the past.”
Certainly, for our local government deposits, public banks are an important solution. State and local governments typically have far more than $250,000 deposited in SIFI banks, but local legislators consider them protected because they are “collateralized.” In California, for example, banks taking state deposits must back them with collateral equal to 110% of the deposits themselves. The problem is that derivative and repo claimants with “supra-priority” can wipe out the entirety of a bankrupt bank’s collateral before other “secured” depositors have access to it.
Our tax dollars should be working for us in our own communities, not capitalizing failing SIFIs on Wall Street. Our stellar (and only) state-owned model is the Bank of North Dakota, which carried North Dakota through the 2008-09 financial crisis with flying colors. Post-GFC (the Global Financial Crisis of ’07-’09), it earned record profits reinvesting the state’s revenues in the state, while big commercial banks lost billions in the speculative markets. Several state legislatures currently have bills on their books following the North Dakota precedent.
For a federal workaround, we could follow the lead of Jesse Jones’ Reconstruction Finance Corporation, which funded the New Deal that pulled the country out of the Great Depression. A bill for a national investment bank currently in Congress that has widespread support is based on that very effective model, avoiding the need to increase taxes or the federal debt.
All those alternatives, however, depend on legislation, which may be too late. Meanwhile, self-sufficient “intentional” communities are growing in popularity, if that option is available to you. Community currencies, including digital currencies, can be used for trade. They can be “Labor Dollars” or “Food Dollars” backed by the goods and services for which the community has agreed to accept them. (See my earlier article here.) The technology now exists to form a network of community cryptocurrencies that are asset-backed and privacy-protected, but that is a subject for another column.
The current financial system is fragile, volatile and vulnerable to systemic shocks. It is due for a reset, but we need to ensure that the system is changed in a way that works for the people whose labor and credit support it. Our hard-earned deposits are now the banks’ only source of cheap liquidity. We can leverage that power by collaborating in a way that serves the public interest.
The result is that Europeans are experiencing an energy crisis, and Germany in particular faces deindustrialisation. The Ukraine situation is not just a NATO proxy war with Russia. It is also a trade and energy war inflicted by the US on Europe.
Although the impact of the war is acutely felt by Europe, inflation continues to increase across the Western countries, including the US, and their economies are in crisis.
While the sanctions and war are having an inflationary impact, they serve as convenient cover for the effects of a massive increase in ‘quantitative easing’ that occurred in late 2019 and in 2020. The US Federal Reserve created almost a fifth of all US dollars ever created in 2020. According to economist Professor Richard Werner, central banks around the world also pumped more money into their economies during this period. He concludes that central banks are largely responsible for the inflation we now see.
Financial markets were collapsing in October 2019, and the crisis reached a head in February 2020 with a massive crash. Prior to COVID and then under cover of this bogus public health crisis, trillions of dollars were pumped into the economy and lockdowns were imposed to prevent an immediate hyperinflation shock. The global economy was shut down.
Much of the inflation currently being experienced is a result of this. COVID lockdowns were not a cause of economic collapse. They were a symptom of it. A temporary band aid for an imploding neoliberalism that now requires a radical restructuring of economies and societies.
And that restructuring is brutal. Neoliberalism has been on life support for some time and has resorted to various strategies (expansion consumer credit, speculative finance, debt, etc) to keep it alive. But these strategies have to a large extent run their course.
In response, we are witnessing a controlled demolition of large parts of the economy and a shift towards authoritarian governance to deal with the growing resentment and dissent that governments fully expect. While lockdowns can be regarded as extraordinary monetary policy measures for addressing short-term inflation risk, they also did much to accelerate the restructuring of economies, not least by closing down small independent businesses.
The effects of the current sanctions regime on Russia may be regarded as an extension of this restructuring. We must not assume that the people implementing the sanction policies were too ignorant to see what the outcome would be for the Western economies.
So, for ordinary people, what’s the end game?
Soaring inflation means your money will lose value. Your savings could evaporate. And rising interest rates will intensify hardship – both for ordinary people and for businesses. Increased interest rates in a debt-ridden economy could well precipitate economic collapse.
Enter central bank digital currencies (CBDCs). It seems likely that these will eventually be brought in as part of a new monetary system. When people have lost almost everything (the WEF mantra – own nothing and be happy), many might well be desperate enough to want a (programmable) digital universal basic income from the government.
But this – in the longer term – would lead to a digital prison: your carbon credit score and social credit score linked to your ability to use your digital currency, your freedom of movement and so on.
The fiat currency system is dying. De-dollarisation is now underway and the US’s longstanding partner – Saudi Arabia – is turning to China and accepting non-dollar payment for oil.
The world is increasingly trading in currencies other than the US dollar. Global US hegemony rests on the dollar being the world reserve currency. This is coming to an end.
What CBDCs will base their value on remains to be seen. A return to a gold standard perhaps. But the strategy appears to involve a process of economic restructuring (or demolition) leading to the impoverishment of populations then the rollout of CBDCs.
COVID was an accelerator that saw entire populations cajoled into submission thanks to a crisis narrative. Integral to the plan is the eventual imposition of digital IDs.
Whether it is immigration, war, food shortages, fear of pandemics, potential cyberattacks, climate emergency or some other crisis narrative, one way or another, circumstances will be manipulated to engineer the introduction of digital IDs – precursors to CBDC servitude. A servitude linked to ‘smart’ city surveillance technology, net zero ideology and 15-minute de facto lockdown cities.
Can this be prevented? What can ordinary people do?
We can, for instance, grow our own food (if we have access to land), use farmer markets, boycott the retail giants and cashless stores, use cash whenever possible, create our own credit unions and so on. But to act in unison, it is essential that we come together and do not feel isolated in a world in which division is encouraged.
Many instinctively knew from the start that there was something seriously amiss with the COVID narrative and the lockdowns. But the vast majority of people – at least at the beginning of the COVID exercise – went along with the narrative. Dissenters tended to feel isolated and came together online. As the weeks passed, they began to attend protests in person.
At these gatherings – the speeches aside – it felt uplifting simply to be in the company of like-minded people. But after the protests, many returned home and were again surrounded by friends, family and colleagues who still kept faith in the narrative and the relentless media propaganda.
COVID might have receded into the background at this point, but the end goal is clear. That’s why it remains important to continue to stand together – in person, in solidarity. From small acorns, movements grow.
With this in mind, Fifi Rose, who helped initiate the A Stand In The Park movement in the UK, describes as a non-hierarchal people’s collective of autonomous groups, tells an inspiring story on a recent edition of the Locked & Loaded podcast with Rick Munn on TNT radio.
The podcast shows how one man’s resistance – which involved standing alone in a Sydney park for weeks on end – helped create a growing global movement based on face-to-face interaction.
The U.S. Supreme Court on Monday agreed to hear arguments in a case challenging the constitutionality of the Consumer Financial Protection Bureau’s funding, a move that was welcomed by some advocates as an opportunity for the nation’s highest court to protect American consumers from a lower court ruling.
At issue is whether the CFPB’s annual funding via the Federal Reserve and not Congress violates the Appropriations Clause of the Constitution. Critics of the October ruling argued that the CFPB’s funding mechanism was designed to ensure the agency’s independence.
The Biden administration, backed by Democratic attorneys general in 21 states, argues that the 5th Circuit Court’s ruling “threatens the validity of all past CFPB actions.”
\u201cDespite years of desperate attacks from Republicans & corporate lobbyists, the constitutionality of @CFPB & its funding structure have been upheld. \n\nIf the Supreme Court follows precedent, it will strike down the Fifth Circuit\u2019s decision before it throws our economy into chaos.\u201d
First proposed by then-Harvard law professor Elizabeth Warren, the CFPB was established in 2010 under the Dodd-Frank Wall Street Reform and Consumer Protection Act in the wake of the 2007-08 global financial crisis. Consumer advocates warn that the 5th Circuit’s ruling threatens the constitutionality of the Federal Reserve, as well as agencies including the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the National Credit Union Administration, the Federal Housing Finance Agency, the Farm Credit Administration, and the Office of Financial Research.
Consumer advocates reacted to Monday’s news by saying the U.S. Supreme Court now has an opportunity to correct what they say is the mistaken logic of the lower court ruling.
“There is no judicially cognizable limiting legal principle that distinguishes between the 5th Circuit’s harebrained assault on the CFPB and potential challenges to Social Security or other financial regulators which are funded outside of the annual appropriations process,” warned Jeff Hauser, executive director of the watchdog group Revolving Door Project.
Maria Langholz, communications director at the online advocacy group Demand Progress, welcomed the high court’s acceptance of the case.
“We are pleased to see that the Supreme Court has agreed to hear this important case and expect a correction of the 5th Circuit’s misguided attacks on the CFPB,” she said in a statement. “In the past twelve years, the CFPB has proven itself as a fierce defender of consumers against unscrupulous creditors that decimated our economy and wreaked havoc on people’s lives. The Supreme Court should reject the Fifth Circuit’s unprecedented ruling, restoring stability to the marketplace and preserving the CFPB’s ability to protect the American people.”
\u201cIf the 5th Circuit is correct that the CFPB is funded unconstitutionally, many other federal agencies\u2014including the Federal Reserve\u2014are also unconstitutional. \n\nSo are federal programs like Social Security and Medicare that are funded in perpetuity. https://t.co/qjVIeiQ465\u201d
— Mark Joseph Stern (@Mark Joseph Stern)
1677508306
Morgan Harper, director of policy and advocacy at the American Economic Liberties Project, called the 5th Circuit’s decision “a direct attack on the nation’s economy.”
“Now that it has taken up the case, SCOTUS must move swiftly to overturn this dangerous opinion that could prevent financial regulators, including the Federal Reserve, from doing their jobs to protect American businesses and consumers.”
Revolving Door Project researcher Vishal Shankar called the 5th Circuit’s ruling “a naked attempt by corporate fraudsters to destroy the only cop on the beat protecting consumers.
Shankar continued:
The case was originally brought by predatory payday lenders and is being supported by giant lobbying groups like the Chamber of Commerce, whose members and executives have a shameless history of breaking the law and ripping off consumers. Multiple Republican lawmakers who have praised the 5th Circuit’s ruling—and the far-right judge who wrote it—have taken large financial contributions from these corporate rip-off artists and lobbying giants.
“Following the money confirms what we all know to be true: this case has nothing to do with the constitutional separation of powers and everything to do with destroying an overwhelmingly popular law enforcement agency that has already returned over $13.5 billion in relief to consumers from corporate fraudsters,” Shankar added.
“If the Supreme Court has any respect left for the rule of law,” he said, “it should overturn the 5th Circuit’s radical act of right-wing judicial activism.”
This post was originally published on Common Dreams.
Financial podcasts have been featuring ominous headlines lately along the lines of “Your Bank Can Legally Seize Your Money” and “Banks Can STEAL Your Money?! Here’s How!” The reference is to “bail-ins:” the provision under the 2010 Dodd-Frank Act allowing Systemically Important Financial Institutions (SIFIs, basically the biggest banks) to bail in or expropriate their creditors’ money in the event of insolvency. The problem is that depositors are classed as “creditors.” So how big is the risk to your deposit account? Part I of this two part article will review the bail-in issue. Part II will look at the derivatives risk that could trigger the next global financial crisis.
From Bailouts to Bail-Ins
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 states in its preamble that it will “protect the American taxpayer by ending bailouts.” But it does this under Title II by imposing the losses of insolvent financial companies on their common and preferred stockholders, debtholders, and other unsecured creditors, through an “orderly resolution” plan known as a “bail-in.”
The point of an orderly resolution under the Act is not to make depositors and other creditors whole. It is to prevent a systemwide disorderly resolution of the sort that followed the Lehman Brothers bankruptcy in 2008. Under the old liquidation rules, an insolvent bank was actually “liquidated”—its assets were sold off to repay depositors and creditors.
In an “orderly resolution,” the accounts of depositors and other creditors are emptied to keep the insolvent bank in business. And even if you are getting only a few cents a month on your deposits, you are a creditor of the bank. As explained in a December 2016 article in the University of Chicago Law Review titled “Safe Banking: Finance and Democracy:”
A general deposit is a loan made to a bank. This means that the bank is the general depositor’s debtor, but that the bank has legal title to the funds deposited; these funds may be commingled with the bank’s other funds. All the general depositor has is a general, unsecured claim against the bank …. [T]he bank is free to use the deposit as it sees fit. [Emphasis added.]
Fortunately, bail-ins do not apply to deposits under $250,000, which are protected by FDIC insurance. That is true in theory, but as of September 2021, the FDIC had only $122 billion in its insurance fund, enough to cover just 1.27% percent of the $9.6 trillion in deposits that it insures. The FDIC also has a credit line with the Treasury for up to $100 billion, but that still brings the total to just over 2% of insured deposits.
If just one or a few banks become insolvent, the FDIC fund should be sufficient to cover the insured deposits (those under $250K). But under the 2005 Bankruptcy Act, derivatives creditors (which are considered “secured”) are first in line to recover the assets of a bankrupt bank; and the Dodd-Frank Act followed that practice. So if a bank with major derivatives risk collapses, there might be no bank assets left for the non-insured creditors; and a series of major derivative cross-defaults could wipe out the whole FDIC kitty as well.
As of May 2022, according to the most recent data from the Bank for International Settlements (BIS), the total notional amounts outstanding for contracts in the derivatives market was an estimated $600 trillion; and the total is often estimated at over $1 quadrillion. No one knows for sure, because many derivatives are “over the counter” (not traded on an exchange). In any case it is a bubble of ominous size, and pundits warn it is about to pop. Topping the list of U.S. derivatives banks are J.P. Morgan Chase ($54.3 trillion), Goldman Sachs ($51 trillion), Citibank ($46 trillion), Bank of America ($21.6 trillion), and Wells Fargo ($12.2 trillion). A full list is here.
The FDIC and Disclosure
On Nov. 9, 2022, the FDIC held a 3.5 hour webcast discussing the bail-in process among other topics. In a clip raising alarm bells in the alternative media, Donald Kohn, former vice chairman, Board of Governors of the Federal Reserve System, said, “…it’s important that people understand they can be bailed in. But you don’t want a huge run on the institution. But they’re going to be…”
Richard J. Herring, co-director of The Wharton Financial Institutions Center said, “I would think your strategy ought to be to disclose as much as possible to people who professionally need to know about it …”
Gary Cohn, former director of the National Economic Council, said, “I almost think you’d scare the public if you put this out — like, ‘Why are they telling me this? Should I be concerned about my bank?’ … I think you’ve got to think of the unintended consequences of taking a public that has more full faith and confidence in the banking system than maybe people in this room do …we want them to have full faith and confidence in the banking system. They know the FDIC insurance is there, they know it works, they put their money in, they get their money out…”
This was followed by some laughter, which critics have interpreted as a cynical agency warning the wealthy while leaving the smaller investors to eat the losses, similar to the phone calls to the favored few before the 1929 stock market crash. But the clips have to be taken in context. Here is that whole section (taken from the video transcript beginning at 1 hr. 15 min):
SUSAN BAKER (Division of Complex Institution Supervision and Resolution): … So what we want to think about today is, “What should we be transparent about now that would help improve confidence in the event that we’re called to use our Title II authorities?”…
RICHARD J. HERRING (Co-Director, The Wharton Financial Institutions Center and Professor of Finance, The Wharton School, University of Pennsylvania): I would think your strategy ought to be to disclose as much as possible to people who professionally need to know about it, and that would certainly include the ratings agencies and the people within the banks who are responsible for these judgments, and simply have publicly available a place where people can go if they need to know more; because we’re dealing with a society where people are getting their information in tweets. There’s just no patience I think for going through the elaborate and careful planning that has gone on. It should be accessible when people need to know but I don’t think you have much hope of reaching a public that doesn’t have a professional need to know.
MEG E. TAHYAR (Partner and Co-head of Financial Institutions, Davis Polk LLP): … I do think there’s more that could be put out in the public … in a way that isn’t scary to folks. I mean … There’s a timing question, right? We’re at a delicate moment now, so if it goes out tomorrow it might have a different impact than if … it goes out as we’re moving out of the recession. But I’m very big on transparency. I think transparency leads to accountability.
DONALD KOHN (Former Vice Chairman, Board of Governors of the Federal Reserve System and Senior Fellow, Economic Studies Program, Brookings Institution): … It’s a little bit conflicted, right? I mean it’s important that people understand they can be bailed in, but you don’t want a huge run on the institution. But … they’re going to be ….
MICHAEL J. HSU (Acting Comptroller of the Currency): … I think we have to sit down and talk to long-term debt investors and make sure that they as a stakeholder group fully understand. Bank debt today is not what it was before. It is not principal protected, by design.
The FDIC staff were engaged in the delicate act of balancing the need to inform the public against the risk that the disclosure itself could trigger a systemic collapse due to widespread bank runs. The “need to know” stakeholders were the long-term investors with more than $250,000 in the bank, whose funds would be at risk. But smaller depositors, who would be protected by FDIC insurance, might panic from mischaracterized tweets and precipitate the very run the FDIC staff were trying to avoid. To their credit, they were trying to be transparent and accountable; it does seem the public should know what risks are hidden in the economy. The first step to solving the problem is understanding what is going on.
Bank Runs and Systemic Risk
Not just the speculative investments of the SIFIs but bank runs themselves are systemic risks. Nationwide bank runs were the sort of “disorderly resolution” seen in the Great Depression of the 1930s.
In 1913, the Federal Reserve became the settlement agent for private banks, and settlement funds for clearing transactions were held in gold. The Fed was required to hold gold reserves valued at 40% of the Federal Reserve Notes (paper dollars) it issued, and to redeem withdrawals in gold at a fixed price. The reserves were sufficient to backstop withdrawals in normal times, but the years following the 1929 stock market crash were not normal times. Domestic and foreign depositors rushed to withdraw their gold; the banks ran out; and they had to close their doors.
In 1933, Pres. Franklin D. Roosevelt declared a national bank holiday; and when the banks reopened, domestic deposits were no longer backed by gold. They were backed only by the “full faith and credit of the United States.” But that is actually quite solid backing, something neither gold nor cryptocurrencies can claim to have. You can’t pay your electric bill or your credit card bill with gold or cryptocurrency. People are willing to accept dollars in payment because they know vendors will take them, and so will the IRS.
After 1933, the funds held at the Fed for settling transactions became simply data entries called “reserves,” which were created by the Fed and held by the banks in Fed accounts. Most of the circulating money supply is now created by private banks by writing loans as deposits into the accounts of their borrowers. But banks cannot create the reserves needed to clear withdrawals through the central bank. Those reserves must be acquired from the Fed, either directly or from another financial institution that has acquired them. Besides the bank’s own incoming deposits, options include borrowing from other banks in the fed funds market, the Fed discount window, or the repo market. Until recently, depository banks could borrow from each other or the Fed at 0.25%. That rate has now gone up to 4.5-4.75%. The only cheap, readily available source of liquidity left to a bank today is its own pool of incoming deposits, from paychecks, credit card payments, mortgage payments and the like.
Traditionally, banks had to hold only about 10% of their deposits in reserve. That percentage was considered sufficient to cover transfers and withdrawals because most people left their money in the bank, and withdrawals were largely netted against incoming deposits. In March 2020, the Fed removed the reserve requirement altogether; but banks still need to hold enough reserves to meet withdrawals. With a reserve of only the standard 10%, however, they will not have enough liquidity (readily accessible funds) to meet a nationwide bank run of the sort seen in the early 1930s.
The FDIC is therefore right to be concerned about warnings that can be misinterpreted. Distrust of big banks is rampant today, but collapsing them suddenly through a “disorderly” nationwide bank run would be as catastrophic as it was in the 1930s. Before the FDIC was founded through the Banking Act of 1935, depositors routinely lost their money when their banks went bankrupt. But we don’t want to lose our deposits to a bail-in either. Better would be for the regulators to unwind the speculative SIFI bets in a “soft landing” if possible. More on that in Part II of this article.
Meanwhile, the banks clearly need our deposits, and today they are scrambling to compete for depositsand reserves. According to a Feb. 7 article on Wall Street on Parade, Goldman Sachs is now offering an interest rate on its savings accounts that is 350 times the interest rate being offered by JPMorgan Chase and Bank of America. Why isn’t stated, but both of those major competitors have already amassed huge deposit bases. When the Global Financial Crisis hit in 2008, Goldman was an investment bank like Lehman Brothers, which barely escaped Lehman’s fate by becoming a bank holding company. This allowed it to acquire deposits and gave it access to the Fed’s discount window, but it obviously came in late to the deposit-collecting game.
How, Then, to Protect Your Deposits?
One popular alternative is to move your money to a credit union. With respect to deposit insurance, according to the FDIC, credit unions are no safer than banks, but they are also no less safe. Whether the institution is insured by the FDIC or by the National Credit Union Share Insurance Fund (NCUSIF), your deposits are guaranteed up to the $250,000 limit per depositor. More to the point here, credit unions and other small local banks are not subject to bail-ins.
Some commentators recommend moving your money out of the banking system altogether – into cash, cryptocurrencies or precious metals. Having enough cash on hand to cover perhaps three months’ worth of expenses in a crisis is certainly a good idea. But many people don’t have even that much in savings, and people with large sums in the bank probably won’t be able to withdraw them all at once. Changing banks is also a slow and cumbersome process. Many people won’t do it or will be caught unaware when the next crisis hits.
In theory, the Federal Reserve could step in as lender of last resort to save the creditors and depositors if necessary, calling on the same emergency powers it exercised for the SIFIs in 2008-09. It could provide cheap liquidity for the banks in the form of quantitative easing, alleviating the need to bail in depositor funds. The Fed is not required to act – it is “independent” – but that means it does not need authorization from Congress, and it does not need taxpayer funds. It can create its own reserves.
The question is whether the Fed would see depositors as “systemically important,” but the rush to compete for deposits shows that they are. Arguably deposits are the people’s weapons of mass destruction: pull them and the banks go down. The banks need our deposits; and we need the sort of self-sustaining financial system in which money, credit and banks are treated as public utilities, accessible by and accountable to the people whose full faith and credit backs them.
Part II of this article will look at the systemic risks currently facing the banking system, and at how it could be reengineered to deal with those risks and restore the trust of the people sustaining it.
The recent widely acclaimed report of 517,000 jobs created in January by the Biden administration placated the recession-phobic instincts of the corporate media into another state of torpor.
All the dismal predictions of an imminent recession by an array of economists were just momentary glitches proven useless by the “spectacular” creation of jobs.
Unsurprisingly, Americans are not feeling quite as sanguine as the Biden administration. Recent polls report a sizable and increasing discontent with the economic direction of the country.
A Gallup
poll this February reported a significant number of Americans were pessimistic about inflation and the stock market.
Another Gallup
poll in the same month reported that over 50% of Americans stated they were “worse off” economically since 2009.
A
Washington Post-ABC Newspoll reported also this February that 58% of Americans disapproved of President Joe Biden’s economic policies.
Even former secretary of labor in the Clinton administration, Robert Reich, a benign corporate
Democrat, was baffled that Americans were still pessimistic despite the 517,000 jobs claim.
Mr. Reich conveniently forgot that the hoopla around the many
jobs created back then that were predominantly from the lower end of the wage brackets of each job grouping as pointed out by economist Robert Pollin in 2016.
Moreover, Clinton’s terms in office saw the explosion of “contingent” jobs. These were part-time, temporary, and contracting jobs that usually paid 60% of full-time jobs with almost no benefits as reported by economist Jack Rasmus in February 2016. Consequently, low-paid, tentative
jobs increased from 22 million in 1995 to 27 million by 2000.
It appears Biden’s job creation claim has parallel results.
Bureau of Labor Statistics Reports
The Biden administration like every administration relies on the Bureau of Labor Statistics (BLS) to report unemployment and job creation numbers.
The BLS releases two principal monthly reports on the economy:
1. The Current Employment Survey (CES), or “establishment survey,” or “payroll survey” reports monthly data collected from 122,000 business and government agencies, and 666,000 worksites. It provides data on all ages of nonfarm employment, hours, and earnings based on payroll records with industry and geographic details. The CES is revised twice before a final report that accounts for seasonal adjustments and variable data collection rates.
2. The Current Population Survey (CPS) or “household survey” reports monthly data collected by the U.S. Census Bureau on 60,000 eligible households. It provides data on the civilian noninstitutional population age 16 and older, the labor force, employment, unemployment, and associated rates with demographic details.
What often goes unreported by the corporate media are the two CES revisions that present a more accurate report of job creation.
For example, during the Trump administration, the corporate media and mainstream economists responded exuberantly to the 209,000 new jobs in July 2017.
However, when the CES reported the revised job numbers in September, it declined to 189,000
jobs; it was revised again in October down to 138,000 jobs, which was met with utter silence from the Trump administration and the corporate media.
The Biden administration’s 517,000 jobs claim is unlikely to be maintained by future revisions.
Important Economic Indicators
The BLS also reports two other important indicators of our economic model:
1. The employment-population ratio is a private sector measure. It represents the number of employed people age 16 and older as a percentage of the civilian noninstitutional population. In other words, it is the percentage of the population that is currently working. The employment-population ratio indicates how efficiently an economy provides jobs for people who want to work. It is valuable because it is not affected by seasonal variations or voluntary changes in labor force participants.
According to
economists at Bloomberg, the BLS adjustments in this January’s numbers raised the estimated population size by nearly 1 million and the civilian labor force by 871,000 resulting in employment to population ratio of 87%. They asserted this was a misrepresentation; the actual employment-to-population rate was much lower.
2. The labor force participation rate is an important economic measure because it consists of those who are age 16 and older working at any job or actively seeking work. Its advantage is that it reports the supply of labor available to work in the production of goods and services. It is a simple calculation: Total Labor Force/Civilian Noninstitutional population x 100.
According to the Federal Reserve Bank of St. Louis (FRED) the labor force participation
rate in December 2022 was 65.1%. In January 2023, the month of the Biden administration’s claim of 517,000 jobs, the labor force participation rate declined to 62.4%. Moreover, the labor force participation rate is still below pre-pandemic levels.
New Jobs Reality
The Biden administration’s fanciful claims of job creation also did not describe the type of jobs created. According to FRED, part-time
jobs are dramatically increasing. That means low wages and no benefits.
The BLS
report released this February classified the types of jobs created in January. The largest number of job gains were predominantly in lower-paid sectors of the economy. The leisure and hospitality sector added 128,000 jobs. Other lower-paid jobs added were healthcare at 58,000, education services and state government (notably not in the private sector) at 35,000, partially reflecting the return to work by tens of thousands of striking graduate student employees in California. Other low-paid jobs added were social assistance jobs at 21,000.
Consider that more than 5 million manufacturing jobs and 91,000 plants have been
lost since 1998 due to our economic model that allowed corporations to move to foreign countries. Corporations did this to avoid paying a fair share of taxes and pesky regulations that protected employees, the environment, and labor unions.
Manufacturing
jobs historically compensate employees with high wages and benefits.
According to the BLS initial monthly
report, the Biden administration added only 19,000 manufacturing jobs in January 2023.
Working People’s Economic Reality
The economic predicament of working people who comprise most Americans continues its deterioration.
FRED reported that personal savings
rates are diminishing for most Americans.
FRED also reported a significant spike in credit card
debt.
The BLS reported that real
wages are still down 1.8% from last year. Housing costs are up 7.9% from 2022. Prices of groceries increased 11.8%.
U.S. Economic Model
President Biden’s claim of creating 517,000 jobs clearly does not adequately improve the living conditions for most working people.
The underlying exploitative economic relationship between the dominant economic class, or
oligarchs, and most of the middle-working class and working-class Americans continues. The oligarchs’ inherent consolidation of their massive wealth is accrued at the expense of all working people.
The oligarchs’ brilliantly malevolent plan also continues. Billionaires pour millions of dollars into conservative
organizations to perpetuate cultural issues designed to distract working people from the real source of their discontent; that source is the economic dominance of the oligarchs.
Predictable scapegoats are “big government,” labor unions, immigrants, racial and ethnic minorities, women’s healthcare, gun control, and LGBTQ issues. They are all mashed up into one deceptive quagmire that keeps working people distracted from recognizing their common economic interests.
Certainly, reasonable people can disagree on cultural issues from a spiritual to a secular perspective. However, when those issues are used by insanely wealthy power brokers to distract and divide working people, the process is categorically cynical.
They become political obstacles to building a moral economic model based on economic democracy that transcends those narrow cultural issues.
This post was originally published on Common Dreams.
Surprising most analysts and forecasters, employers added a whopping 517,000 jobs in January, according to Friday morning’s monthly labor report from the Bureau of Labor Statistics. This was almost twice the growth from December’s 260,000 jobs. The unemployment rate fell to 3.4 percent, the lowest since 1969.
What does this mean?
It may mean very little. The Bureau of Labor Statistics’s monthly report can bounce around a lot, depending on seasonal weights and samples. Next month’s job number could be far lower.
Also, keep your eye on wage growth. Average hourly earnings climbed in January at a slower pace than in December — by an annualized 4.4 percent, down from 4.8 percent in December. With prices still rising faster than wages, most workers continue to suffer declining real wage – that is, declining purchasing power.
But the strength of the labor market is likely to worry the Fed, which last Wednesday raised interest rates for the eighth time in a year – although only by a quarter of a percentage point this time.
“The labor market continues to be out of balance,” Jerome Powell, the Fed chair, said earlier this week. He stressed that we won’t have a return to his target 2 percent inflation in the service sector “without a better balance in the labor market,” adding “I don’t know what that will require in terms of increased unemployment.”
As I’ve said many times over the past year, this worry is misplaced. Most of the upward pressure on prices domestically is coming from big corporations with the market power to raise prices faster than their costs are rising. Much of the rest is coming from continuing supply shocks abroad, including Putin’s war’s effects on global energy and food prices, and China’s lockdowns followed by COVID.
And, as Friday’s report shows, wage gains are slowing and they lag behind price increases.
The basic reality is American workers don’t have the power to raise their wages. Big American corporations have the power to raise their prices. The Fed should not be aiming to increase unemployment as a means of slowing prices.
This post was originally published on Common Dreams.
Progressive economists and advocates on Wednesday blasted the U.S. Federal Reserve for hiking the federal funds rate an eighth consecutive time despite
fears of a recession and impacts on working people.
“With today’s rate hike, the Fed is pushing us dangerously close to an unnecessary recession that would spell disaster for low-wage workers, workers of color, and vulnerable communities,” the Groundwork Collaborative
declared. “Workers and families shouldn’t have to pay the price for inflation.”
The Federal Open Market Committee
rose the benchmark interest rate to a range of 4.5%-4.75%. The 25-basis-point increase was the smallest hike since March and came amid signs that the U.S. economy is cooling off.
“Chair Powell should pause his interest rate hikes and remember his dual mandate: Fight inflation without throwing millions out of work.”
Fed Chair Jerome Powell
said that “while recent developments are encouraging, we will need substantially more evidence to be confident that inflation is on a sustained downward path,” so “we expect ongoing hikes will be appropriate.”
U.S. Sen. Elizabeth Warren (D-Mass.), a major
critic of the wave of increases, tweeted that “we want to bring down inflation, but that means landing the plane not crashing it. Chair Powell should pause his interest rate hikes and remember his dual mandate: Fight inflation without throwing millions out of work.”
University of California, Berkeley professor and former Labor Secretary Robert Reich explained in a recent video that “the Fed is wrongly obsessing about a wage-price spiral—wage gains pushing up prices—when it should be worried about a profit-price spiral—corporate profits driving up prices.”
\u201cThe Federal Reserve is continuing to raise interest rates in an effort to slow the economy. \n\nLower-wage workers and the poor bear most of the pain of these rate hikes.\n\nMeanwhile, corporate executives, Wall Street, and the wealthy get away scot-free.\u201d
Longtime opponents of the Fed’s strategy on Wednesday renewed calls for not only the U.S. central bank to halt its hikes but also federal lawmakers to get to work battling corporate greed.
Liz Zelnick, director of the Economic Security and Corporate Power program at Accountable.Us, warned that “while the Fed continues to stick to their obsession with job-killing interest rate hikes, the livelihoods of working families are on the line.”
“Key indicators show inflation is slowing as our economic recovery remains fragile, which means the Fed’s higher rates are only pushing the economy closer to a recession,” she said. “Meanwhile, Fed economists have admitted corporations are the real culprit of high costs yet have still refused to relax rate hikes. It’s time for the Fed to back down and let policymakers rein in corporate greed rather than risk it all on another rate increase.”
\u201cRoses are red \ud83c\udf39\nThe Fed wants a recession \ud83d\udcc9\nJerome Powell’s gotta stop \ud83d\uded1\nWith this job loss obsession \ud83d\ude29\n\nSlower rate hikes are not enough – the Fed needs to hit pause before we tip over the edge and put millions of workers at risk of joblessness.\u201d
Patriotic Millionaires chair Morris Pearl, former managing director at BlackRock, offered a similar critique of Fed policy.
“Today’s interest rate hike by the Fed is bad news for the American economy. It’s true that raising rates is meant to solve inflation, but that doesn’t mean it’s the correct course to take right now. Raising rates may cool inflation, but it does so by making everything from mortgages to credit card payments more expensive, which hurts those already suffering the most in today’s cost-of-living crisis,” he said. “In this case, the cure may be worse than the disease.”
“If the federal government is truly committed to slowing inflation without heaping extra pain on the vulnerable, they should go after greedy, ultraprofitable corporations and their C-suite executives,” he argued. “Many corporations have used the hype over inflation in recent months to raise prices on consumers and line their pockets. Why else would corporate profits be at a
70-year high?”
“Many corporations have used the hype over inflation in recent months to raise prices on consumers and line their pockets.”
Pearl pointed out that “everyone’s been complaining lately about how expensive eggs are. The fact that Cal-Maine, the largest egg producer in the U.S., experienced a
10-fold increase in their profits over the last year might just have something to do with it.”
As
Common Dreamsreported last month, Farm Action raised concerns about “apparent price gouging, price coordination, and other unfair or deceptive acts or practices by dominant producers of eggs” and urged the Federal Trade Commission to investigate the sector, “prosecute any violations of the antitrust laws it finds within, and ultimately, get the American people their money back.”
Pearl said Wednesday that “the Fed raising interest rates won’t do anything to stop corporations like Cal-Maine from exploiting American consumers, unless they raise them so much as to cause a massive rise in unemployment.”
“It is hard to see a scenario where this kind of action does not cause immense pain to the worst off in America,” he added. “The Fed needs to back off, and let Congress step in to tackle corporate greed.”
This post was originally published on Common Dreams.
On Friday, Jan. 13, Treasury Secretary Janet Yellen wrote to Congress that the U.S. government will hit its borrowing limit on Jan. 19, forcing the new Congress into negotiations over the debt limit much sooner than expected. She said she will use accounting maneuvers she called “extraordinary measures” to keep U.S. finances running for a few months, pushing the potential date for default to sometime in the summer. But she urged Congress to get to work on raising the debt ceiling.
Lifting it above its current $31.385 trillion limit won’t be easy with a highly divided and gridlocked Congress. As former Republican politician David Stockman crowed in a Jan. 11 article:
15 [House] votes and the slings and arrows of MSM opprobrium were well worth it. That’s because the GOP’s anti-McCarthy insurrection obtained concessions which just might slow America’s headlong rush to fiscal armageddon. And just in the nick of time! We are referring, of course, to the Speaker elect’s promise that there will be no more debt ceiling increases without off-setting spending cuts; and that in the event of a double-cross a single Member of the House may table a motion to vacate the Speaker’s chair.
Even if Congress succeeds in raising the debt ceiling, the Federal Reserve’s aggressive interest rate hikes are likely to push interest on the federal debt to unsustainable levels. The problem was detailed by the House Republican Policy Committee like this:
As of December 8, 2022, the U.S. gross national debt stood at nearly $31.5 trillion, $8.5 trillion higher than it was just three years before and the highest level in our nation’s history. Last year [in March 2021], the Congressional Budget Office (CBO) projected the federal government would spend $282 billion servicing our debt in 2022, but that projection ballooned to nearly $400 billion as the Federal Reserve tightens monetary policy and the debt continues to grow. … While interest rates have been low by historical standards, if interest rates rose to 5 percent, where they were as recently as 2007, net interest payments on the current debt level held by the public would be over $1 trillion, more than the federal government spends annually on everything but Social Security [emphasis added; endnotes omitted].
San Francisco Fed President Mary Daly said during a live-streamed interview with The Wall Street Journal that she expects policymakers to raise interest rates to somewhere above 5%, and JPMorgan CEO Jamie Dimon said it “may very well” raise rates to 6%.
The global debt cycle has reached the stage where, historically, a major “monetary reset” has been required. In 1913, it was done by instituting the Federal Reserve to backstop a banking system unable to meet withdrawals in gold. In 1933, it was done by taking the dollar off the gold standard domestically; in 1969, by taking the dollar off the gold standard internationally; and in 2008-09, by bailing out the banks with quantitative easing.
Resetting the Game Board in Line with the Constitution
What about today? In a Jan. 11 article in Forbes, after discussing the limitations of the “extraordinary measures” to which the Treasury can resort, investment advisor Simon Moore wrote:
Some have also argued that the government could go further, perhaps invoking the 14th Amendment, or minting an enormously high-value coin as further strategies to sidestep debt ceiling issues. However, these ideas are untested …
The 14th Amendment says the validity of the government’s debt shall not be questioned. Fixing the budget deficit by minting some trillion dollar coins would be a radical monetary “reset,” but the approach is not actually untested. Abraham Lincoln did something similar to avoid a usurious national debt at 24 to 36% interest during the Civil War, and he was drawing from the playbook of the American colonists a century earlier.
Article 1, Section 8, of the U.S. Constitution says, “The Congress shall have Power … To coin Money [and] regulate the Value thereof …“ When the Constitution was ratified, coins were the only officially recognized legal tender. By 1860, coins made up only about half the currency; and today, they make up only about $1.19 billion of a $21.352 trillion circulating money supply (M2). These coins, along with about $239 million in U.S. Notes or Greenbacks originally issued during the Civil War, are all that are left of the Treasury’s money-creating power.
The vast majority of the money supply today is created privately by banks as deposits when they make loans, usurping the power to issue the national money supply from the people to whom it constitutionally belongs. Lincoln avoided a massive debt to private British-backed banks by restoring the government-issued money of the American colonists. In the 1860s, these newly-issued U.S. Notes or Greenbacks constituted 40% of the national currency. Today, 40% of the circulating money supply would be $8.5 trillion. Yet, this massive money-printing during the Civil War did not lead to hyperinflation. Greenbacks suffered a drop in value as against gold, but according to Milton Friedman and Anna Schwarz in A Monetary History of the United States, 1867-1960, this was not due to “printing money.” Rather, it was caused by trade imbalances with foreign trading partners on the gold standard.
The Greenbacks aided the Union not only in winning the war but in funding a period of unprecedented economic expansion. Lincoln’s government created the greatest industrial giant the world had yet seen. The steel industry was launched, a continental railroad system was created, a new era of farm machinery and cheap tools was promoted, free higher education was established, government support was provided to all branches of science, the Bureau of Mines was organized, and labor productivity was increased by 50 to 75 percent.
Congress could avoid its debt crisis today by calling for a new issue of debt-free U.S. Notes. That, however, would require legislation, probably a greater uphill battle in the current Congress, even than getting the debt ceiling lifted.
Reducing the Federal Debt
Another way to alleviate the debt crisis with government-issued money was proposed by Republican presidential candidate Ron Paul and endorsed by Democratic Representative Alan Grayson during the last debt ceiling crisis: the Federal Reserve could be ordered to transfer to the Treasury the federal securities it has purchased with accounting entries through “quantitative easing.” The Treasury could then just void this part of the debt, which stood at $6.097 trillion as of Dec. 2, 2022. That alternative would be legal, but it would require persuading not just Congress but the Federal Reserve to act.
A third alternative, which could be done very quickly by executive order, would be for the federal government to exercise its constitutional power to “coin money and regulate the value thereof” by minting one or more trillion dollar platinum coins.
The idea of minting large denomination coins to solve economic problems was first suggested in the early 1980s by a chairman of the Coinage Subcommittee of the House of Representatives. Not only does the Constitution give Congress the power to coin money and regulate its value, he said, but no limit is put on the value of the coins it creates.
In 1982, Congress chose to choke off this remaining vestige of its money-creating power by imposing limits on the amounts and denominations of most coins. But it left one exception, the platinum coin, which a special provision allowed to be minted in any amount for commemorative purposes (31 U.S. Code § 5112). When Congress was gridlocked over the debt ceiling in 2013, attorney Carlos Mucha proposed issuing a platinum coin to capitalize on this loophole; and the proposal the proposal got picked up by Paul Krugman and some other economists as a way to move forward.
Philip Diehl, former head of the U.S. Mint and co-author of the platinum coin law, confirmed that the coin would be legal tender. He said:
In minting the $1 trillion platinum coin, the Treasury Secretary would be exercising authority which Congress has granted routinely for more than 220 years . . . under power expressly granted to Congress in the Constitution (Article 1, Section 8).
What about Inflation?
Prof. Randall Wray explained that the coins would not circulate but would be deposited in the government’s account at the Fed, so they would not inflate the circulating money supply. The budget would still need Congressional approval. To keep a lid on spending, Congress would just need to abide by some basic rules of economics. It could spend on goods and services up to full employment without creating price inflation (since supply and demand would rise together). After that, it would need to tax — not to fund the budget, but to shrink the circulating money supply and avoid driving up prices with excess demand.
An alternative for stabilizing the money supply and avoiding inflation without resorting to taxes was developed by the Pennsylvania colonists in Benjamin Franklin’s day. The American colonies were then printing paper scrip, following the innovative lead of Massachusetts in 1691. This paper money was considered an advance against taxes, but it was easier to issue the scrip than to collect it back in taxes; and the result was to inflate and devalue the currency.
The Pennsylvania colonists avoided price inflation by forming a “land bank.” The colonial government issued paper scrip in return for goods and services, and it lent scrip to the farmers at a reasonable rate. The interest returned to the colonial treasury, balancing the budget.
Today we could do the same: we could offset the money issued for government expenses with interest instead of taxes. But that would effectively mean nationalizing the banking system, again not something that is likely or even desirable in a major economy with many competing economic interests. As U.K. Prof. Richard Werner observes, nationalizing the banking system in Soviet Russia did not work out well. But the Chinese approach, involving many small local public banks, proved to be very efficient and effective; and German local bankers developed such a system long before the Chinese, with their network of local public Sparkassen banks. We could follow suit with a network of public banks spreading to local needs, thus turning banking into a public utility while keeping credit under local management and distribution.
We Could Go Further…
As the chairman of the Coinage Subcommittee observed in the 1980s, the entire federal debt could actually be paid with some large denomination coins. Again, the concern will be that it will inflate the money supply and devalue the currency; but the Federal Reserve showed after the “Great Recession” that it could issue trillions of dollars in accounting-entry quantitative easing without triggering hyperinflation. Indeed, the exercise did not trigger even the modest inflation for which it was designed.
As with QE, paying off the federal debt with trillion coins deposited in the Treasury’s account would just be an asset swap, replacing an interest-bearing obligation (bonds) with a non-interest-bearing one (bank deposits paid to the bond sellers). The market for goods and services would not be flooded with “new” money that would inflate the prices of consumer goods, because the bond holders would not consider themselves any richer than before.Joseph Wang, a former senior trader on the Fed’s open market desk, explained the difference between QE and direct payment of stimulus checks in a Jan. 9, 2023 article. He wrote:
The enormous fiscal stimulus in 2020 created a few trillion out of thin air and just gave it away to the public – predictably supercharging growth and inflation. Note that fiscal stimulus is very different from QE, which merely exchanges Treasuries for cash. QE changes the composition of liquid assets held by non-banks (fewer Treasuries, more cash), but not their purchasing power. In contrast, stimmy checks and forgivable loans are essentially free “helicopter money” that increase potential demand.
“QE changes the composition of liquid assets held by non-banks (fewer Treasuries, more cash), but not their purchasing power.” The non-bank holders of Treasuries could have sold their securities at any time if they had wanted cash. They had their money in government securities in the first place because they wanted to save it rather than spend it. If they were cashed out, they would presumably continue to save the money, probably by investing it in other interest-generating securities.
Something to Think About at Least
Granted, those proposals are unlikely to pass now, and it would take unusual courage just to introduce them; but we are living in unusual times. The time will soon come for bold leaders to take the reins and do something radical. The alternative that is barreling down on us is the World Economic Forum’s “Great Reset,” in which “you will own nothing and eat bugs” (basically neo-feudalism).
The status quo is clearly unsustainable, and the Fed’s current tools cannot set it right. The inflation problem has been thrust in its lap, although fiscal spending and supply shortages are key drivers of today’s price hikes; and the Fed’s traditional tools won’t fix those problems. The higher that interest rates are raised, the harder it will be for people and businesses to pay their credit card debts. That means businesses will go bankrupt, people will get laid off, and tax receipts will go down, further driving up the budget deficit.
We need a new approach, at least one that is new in modern times. We would do well to return to the solution of our forefathers – a monetary system backed by “the full faith and credit of the United States,” a government “of the people, by the people, and for the people,” as Lincoln intoned. That may not be the government we have now, but it could be and should be. Before we can have a trustworthy national currency, we need a transparent and accountable government that is responsive to the will of the people. When the old system finally breaks and we are primed for a new one, those are the principles that should guide us in its development.
This post was originally published on Common Dreams.
Our forefathers turned their debts into currency. That Constitutional approach could work today.
On Friday, Jan. 13, Treasury Secretary Janet Yellen wrote to Congress that the U.S. government will hit its borrowing limit on Jan. 19, forcing the new Congress into negotiations over the debt limit much sooner than expected. She said she will use accounting maneuvers she called “extraordinary measures” to keep U.S. finances running for a few months, pushing the potential date for default to sometime in the summer. But she urged Congress to get to work on raising the debt ceiling.
Lifting it above its current $31.385 trillion limit won’t be easy with a highly divided and gridlocked Congress. As former Republican politician David Stockman crowed in a Jan. 11 article:
15 [House] votes and the slings and arrows of MSM opprobrium were well worth it. That’s because the GOP’s anti-McCarthy insurrection obtained concessions which just might slow America’s headlong rush to fiscal armageddon. And just in the nick of time!
We are referring, of course, to the Speaker elect’s promise that there will be no more debt ceiling increases without off-setting spending cuts; and that in the event of a double-cross a single Member of the House may table a motion to vacate the Speaker’s chair.
Even if Congress succeeds in raising the debt ceiling, the Federal Reserve’s aggressive interest rate hikes are likely to push interest on the federal debt to unsustainable levels. The problem was detailed by the House Republican Policy Committee like this:
As of December 8, 2022, the U.S. gross national debt stood at nearly $31.5 trillion, $8.5 trillion higher than it was just three years before and the highest level in our nation’s history. Last year [in March 2021], the Congressional Budget Office (CBO) projected the federal government would spend $282 billion servicing our debt in 2022, but that projection ballooned to nearly $400 billion as the Federal Reserve tightens monetary policy and the debt continues to grow.
… While interest rates have been low by historical standards, if interest rates rose to 5 percent, where they were as recently as 2007, net interest payments on the current debt level held by the public would be over $1 trillion, more than the federal government spends annually on everything but Social Security [emphasis added; endnotes omitted].
San Francisco Fed President Mary Daly said during a live-streamed interview with the Wall Street Journal that she expects policymakers to raise interest rates to somewhere above 5%, and JPMorgan CEO Jamie Dimon said it “may very well” raise rates to 6%.
The global debt cycle has reached the stage where, historically, a major “monetary reset” has been required. In 1913, it was done by instituting the Federal Reserve to backstop a banking system unable to meet withdrawals in gold. In 1933, it was done by taking the dollar off the gold standard domestically; in 1969, by taking the dollar off the gold standard internationally; and in 2008-09, by bailing out the banks with quantitative easing.
Resetting the Game Board in Line with the Constitution
What about today? In a Jan. 11 article in Forbes, after discussing the limitations of the “extraordinary measures” to which the Treasury can resort, investment advisor Simon Moore wrote:
Some have also argued that the government could go further, perhaps invoking the 14th Amendment, or minting an enormously high-value coin as further strategies to sidestep debt ceiling issues. However, these ideas are untested …
The 14th Amendment says the validity of the government’s debt shall not be questioned. Fixing the budget deficit by minting some trillion dollar coins would be a radical monetary “reset,” but the approach is not actually untested. Abraham Lincoln did something similar to avoid a usurious national debt at 24 to 36% interest during the Civil War, and he was drawing from the playbook of the American colonists a century earlier.
Article 1, Section 8, of the U.S. Constitution says, “The Congress shall have Power … To coin Money [and] regulate the Value thereof …“ When the Constitution was ratified, coins were the only officially recognized legal tender. By 1860, coins made up only about half the currency; and today, they make up only about $1.19 billion of a $21.352 trillion circulating money supply (M2). These coins, along with about $239 million in U.S. Notes or Greenbacks originally issued during the Civil War, are all that are left of the Treasury’s money-creating power.
The vast majority of the money supply today is created privately by banks as deposits when they make loans, usurping the power to issue the national money supply from the people to whom it constitutionally belongs. Lincoln avoided a massive debt to private British-backed banks by restoring the government-issued money of the American colonists. In the 1860s, these newly-issued U.S. Notes or Greenbacks constituted 40% of the national currency. Today, 40% of the circulating money supply would be $8.5 trillion. Yet, this massive money-printing during the Civil War did not lead to hyperinflation. Greenbacks suffered a drop in value as against gold, but according to Milton Friedman and Anna Schwarz in A Monetary History of the United States, 1867-1960, this was not due to “printing money.” Rather, it was caused by trade imbalances with foreign trading partners on the gold standard.
The Greenbacks aided the Union not only in winning the war but in funding a period of unprecedented economic expansion. Lincoln’s government created the greatest industrial giant the world had yet seen. The steel industry was launched, a continental railroad system was created, a new era of farm machinery and cheap tools was promoted, free higher education was established, government support was provided to all branches of science, the Bureau of Mines was organized, and labor productivity was increased by 50 to 75 percent.
Congress could avoid its debt crisis today by calling for a new issue of debt-free U.S. Notes. That, however, would require legislation, probably a greater uphill battle in the current Congress, even than getting the debt ceiling lifted.
Reducing the Federal Debt
Another way to alleviate the debt crisis with government-issued money was proposed by Republican presidential candidate Ron Paul and endorsed by Democratic Representative Alan Grayson during the last debt ceiling crisis: the Federal Reserve could be ordered to transfer to the Treasury the federal securities it has purchased with accounting entries through “quantitative easing.” The Treasury could then just void this part of the debt, which stood at $6.097 trillion as of Dec. 2, 2022. That alternative would be legal, but it would require persuading not just Congress but the Federal Reserve to act.
A third alternative, which could be done very quickly by executive order, would be for the federal government to exercise its constitutional power to “coin money and regulate the value thereof” by minting one or more trillion dollar platinum coins.
The idea of minting large denomination coins to solve economic problems was first suggested in the early 1980s by a chairman of the Coinage Subcommittee of the House of Representatives. Not only does the Constitution give Congress the power to coin money and regulate its value, he said, but no limit is put on the value of the coins it creates.
In 1982, Congress chose to choke off this remaining vestige of its money-creating power by imposing limits on the amounts and denominations of most coins. But it left one exception, the platinum coin, which a special provision allowed to be minted in any amount for commemorative purposes (31 U.S. Code § 5112). When Congress was gridlocked over the debt ceiling in 2013, attorney Carlos Mucha proposed issuing a platinum coin to capitalize on this loophole; and the proposal the proposal got picked up by Paul Krugman and some other economists as a way to move forward.
Philip Diehl, former head of the U.S. Mint and co-author of the platinum coin law, confirmed that the coin would be legal tender. He said:
In minting the $1 trillion platinum coin, the Treasury Secretary would be exercising authority which Congress has granted routinely for more than 220 years … under power expressly granted to Congress in the Constitution (Article 1, Section 8).
What about Inflation?
Prof. Randall Wray explained that the coins would not circulate but would be deposited in the government’s account at the Fed, so they would not inflate the circulating money supply. The budget would still need Congressional approval. To keep a lid on spending, Congress would just need to abide by some basic rules of economics. It could spend on goods and services up to full employment without creating price inflation (since supply and demand would rise together). After that, it would need to tax — not to fund the budget, but to shrink the circulating money supply and avoid driving up prices with excess demand.
An alternative for stabilizing the money supply and avoiding inflation without resorting to taxes was developed by the Pennsylvania colonists in Benjamin Franklin’s day. The American colonies were then printing paper scrip, following the innovative lead of Massachusetts in 1691. This paper money was considered an advance against taxes, but it was easier to issue the scrip than to collect it back in taxes; and the result was to inflate and devalue the currency.
The Pennsylvania colonists avoided price inflation by forming a “land bank.” The colonial government issued paper scrip in return for goods and services, and it lent scrip to the farmers at a reasonable rate. The interest returned to the colonial treasury, balancing the budget.
Today we could do the same: we could offset the money issued for government expenses with interest instead of taxes. But that would effectively mean nationalizing the banking system, again not something that is likely or even desirable in a major economy with many competing economic interests. As U.K. Prof. Richard Werner observes, nationalizing the banking system in Soviet Russia did not work out well. But the Chinese approach, involving many small local public banks, proved to be very efficient and effective; and German local bankers developed such a system long before the Chinese, with their network of local public Sparkassen banks. We could follow suit with a network of public banks spreading to local needs, thus turning banking into a public utility while keeping credit under local management and distribution.
We Could Go Further…
As the chairman of the Coinage Subcommittee observed in the 1980s, the entire federal debt could actually be paid with some large denomination coins. Again, the concern will be that it will inflate the money supply and devalue the currency; but the Federal Reserve showed after the “Great Recession” that it could issue trillions of dollars in accounting-entry quantitative easing without triggering hyperinflation. Indeed, the exercise did not trigger even the modest inflation for which it was designed.
As with QE, paying off the federal debt with trillion coins deposited in the Treasury’s account would just be an asset swap, replacing an interest-bearing obligation (bonds) with a non-interest-bearing one (bank deposits paid to the bond sellers). The market for goods and services would not be flooded with “new” money that would inflate the prices of consumer goods, because the bond holders would not consider themselves any richer than before.Joseph Wang, a former senior trader on the Fed’s open market desk, explained the difference between QE and direct payment of stimulus checks in a Jan. 9, 2023 article. He wrote:
The enormous fiscal stimulus in 2020 created a few trillion out of thin air and just gave it away to the public – predictably supercharging growth and inflation. Note that fiscal stimulus is very different from QE, which merely exchanges Treasuries for cash. QE changes the composition of liquid assets held by non-banks (fewer Treasuries, more cash), but not their purchasing power. In contrast, stimmy checks and forgivable loans are essentially free “helicopter money” that increase potential demand.
“QE changes the composition of liquid assets held by non-banks (fewer Treasuries, more cash), but not their purchasing power.” The non-bank holders of Treasuries could have sold their securities at any time if they had wanted cash. They had their money in government securities in the first place because they wanted to save it rather than spend it. If they were cashed out, they would presumably continue to save the money, probably by investing it in other interest-generating securities.
Something to Think About at Least
Granted, those proposals are unlikely to pass now, and it would take unusual courage just to introduce them; but we are living in unusual times. The time will soon come for bold leaders to take the reins and do something radical. The alternative that is barreling down on us is the World Economic Forum’s “Great Reset,” in which “you will own nothing and eat bugs” (basically neo-feudalism).
The status quo is clearly unsustainable, and the Fed’s current tools cannot set it right. The inflation problem has been thrust in its lap, although fiscal spending and supply shortages are key drivers of today’s price hikes; and the Fed’s traditional tools won’t fix those problems. The higher that interest rates are raised, the harder it will be for people and businesses to pay their credit card debts. That means businesses will go bankrupt, people will get laid off, and tax receipts will go down, further driving up the budget deficit.
We need a new approach, at least one that is new in modern times. We would do well to return to the solution of our forefathers – a monetary system backed by “the full faith and credit of the United States,” a government “of the people, by the people, and for the people,” as Lincoln intoned. That may not be the government we have now, but it could be and should be. Before we can have a trustworthy national currency, we need a transparent and accountable government that is responsive to the will of the people. When the old system finally breaks and we are primed for a new one, those are the principles that should guide us in its development.
The U.S. Labor Department released data Friday showing that wage and job growth slowed in December as the Fed explicitly targets the labor market and worker pay in its push to tamp down inflation, which has been cooling in recent months.
According to the new figures, wages grew at a slower-than-expected rate of 0.3% last month, and November’s hourly earnings number was revised down from 0.6% to 0.4%—a trend that one observer called “bad news for workers.”
Pointing to the “huge downward revision to November wage growth,” Dean Baker of the Center for Economic and Policy Research wrote, “Hold the rate hikes please.”
“Hold the rate hikes please.” —Dean Baker, CEPR
While CEO pay has continued to surge, many ordinary workers across the U.S. have seen their wages lag behind inflation as living costs have risen sharply over the past two years.
Elise Gould, an economist at the Economic Policy Institute (EPI), said slowing wage growth is critical for Fed policymakers to consider as they mull additional interest rate hikes, which risk unnecessarily hurling the economy into recession.
“Wage growth decelerated in December no matter how it’s measured,” Gould noted. “Annualized wage growth between November and December was 3.4%. It is decidedly not driving inflation.”
Job growth, meanwhile, remained strong in December even as it cooled compared to the torrid pace of early 2022. The Bureau of Labor Statistics said the U.S. added a better-than-anticipated 223,000 jobs in the last month of 2022, the fifth consecutive month of slowing growth.
The new jobs data comes days after the Fed released the minutes of its mid-December meeting, after which the central bank raised interest rates to their highest level in 15 years despite growing warnings from a range of experts about the potential for a damaging recession and mass layoffs.
According to the minutes, Fed officials are not yet satisfied with evidence showing that inflation is slowing significantly and intend to stay the course with higher rates. Central bankers also suggested they believe the labor market is still too tight and wage growth is too strong, reiterating their goal of “bringing down” the latter even as they admitted there are “few signs of adverse wage-price dynamics.”
“You know the Fed’s priorities are warped when they suggest too many Americans have jobs,” Liz Zelnick, director of the Economic Security and Corporate Power program at the watchdog group Accountable.US, said Friday. “It seems the more Americans find work, the more the Fed embraces job-killing interest rate hikes that disproportionately hurt low-income workers and struggling mom-and-pop shops. And for what?”
“The Fed’s single-minded strategy has done little to blunt the real driver of inflation—corporate greed,” Zelnick added. “Across industries, corporations continue to mark up prices on working families despite posting record profits and rewarding wealthy investors with billions in giveaways. Raising interest rates only hurts American families in the long run by pushing the economy toward a cliff. Recession is not inevitable, but that depends largely on deliberate decisions made by the Federal Reserve and Chairman Jerome Powell.”
Michael Mitchell, director of policy and research at the Groundwork Collaborative, echoed that warning ahead of Friday’s jobs report, cautioning that “as workers and families are struggling with higher prices, Chair Powell is hell-bent on bringing down wages and pushing more people out of work with his aggressive interest rate hikes.”
“If the Fed continues with its dangerous interest rate hikes,” Mitchell said, “we should brace ourselves for more hardship for working people and an unnecessarily painful recession.”
This post was originally published on Common Dreams.
After numerous warnings in recent months from economists and economic justice advocates alike that repeated interest rate hikes could help send the world into a recession, the International Monetary Fund is warning that a third of the global economy will likely face a downturn in 2023.
With the world’s three largest economies—the United States, European Union, and China—”all slowing down simultaneously,” IMF Managing Director Kristalina Georgieva toldCBS‘s “Face the Nation” Sunday, “even countries that are not in recession, it would feel like recession for hundreds of millions of people.”
“It is likely that the world economy will face recession next year as a result of the rises in interest rates in response to higher inflation.”
The IMF is currently projecting that the world economy will face its weakest year since 2001, excluding the beginning of the coronavirus pandemic in 2020 and the 2007-08 global financial crisis.
In October, the financial institution announced that global economic growth was projected to fall to 2.7% in 2023 as the war in Ukraine continues and central banks including the U.S. Federal Reserve repeatedly raise interest rates, as Chairman Jerome Powell has indicated the Fed will likely do once again in the coming months.
“It is likely that the world economy will face recession next year as a result of the rises in interest rates in response to higher inflation,” Kay Daniel Neufeld, director and head of forecasting at the Center for Economics and Business Research (CEBR), toldCNN last week.
Georgieva noted that the U.S.—as its central bank’s actions increase debt burdens and cost-of-living crises in developing countries—may escape the worst of the global economic downturn, saying that “we see the labor market remaining quite strong” in the United States.
“This is… a mixed blessing because if the labor market is very strong, the Fed may have to keep interest rates tighter for longer to bring inflation down,” she told CBS.
Research firm Capital Economics is forecasting a 90% chance that the U.S. will be in a recession in the next six months, saying that it is “likely to be mild,” while Europe is expected to have “a larger downturn due to the huge hit to its terms of trade caused by the Ukraine war.”
U.S. Sen. Elizabeth Warren (D-Mass.) is among the critics who have warned in recent months that the Federal Reserve risks throwing the U.S. into a recession if it continues hiking interest rates, which it last did in mid-December.
\u201cFed Chair Powell\u2019s extreme interest rate hikes risk pushing our economy into a recession that costs millions of Americans their jobs. The Fed needs to remember it has a dual mandate: fight inflation and protect jobs.\nhttps://t.co/jXlErQ6nUW\u201d
As a United Nations Conference on Trade and Development report released in October warned, “The current course of action is hurting the most vulnerable, especially in developing countries, and risks tipping the world into a global recession.”
This post was originally published on Common Dreams.
New data shows that the gap between the top wealthiest Americans and the working class reached new heights last year as multimillionaires in the top 1 percent experienced the highest wage raises in real, inflation-adjusted dollars while the wages of the bottom 90 percent fell. In 2021, the top 1 percent of earners saw their annual wages rise by 9.4 percent. The raise for the wealthiest of the 1…
“There is no sense that inflation is coming down,” said Federal Reserve Chairman Jerome Powell at a November 2 press conference, — this despite eight months of aggressive interest rate hikes and “quantitative tightening.” On November 30, the stock market rallied when he said smaller interest rate increases are likely ahead and could start in December. But rates will still be increased, not cut. “By any standard, inflation remains much too high,” Powell said. “We will stay the course until the job is done.”
Fixing supply chains is of course beyond any central bank’s power. What the Fed can do is reduce spending levels, which would in turn exert downward pressure on prices. But this would be a mistaken response to shortages. It would answer a scarcity of goods by bringing about a scarcity of money. The effect would be to compound the hit to living standards that supply shocks already caused.
So why is the Fed forging ahead? Some pundits think Chairman Powell has something else up his sleeve.
The Problem with “Demand Destruction”
First, a closer look at the problem. Shrinking demand by reducing the money supply – the money available for people to spend – is considered the Fed’s only tool for fighting inflation. The theory behind raising interest rates is that it will reduce the willingness and ability of people and businesses to borrow. The result will be to shrink the money supply, most of which is created by banks when they make loans. The problem is that shrinking demand means shrinking the economy – laying off workers, cutting productivity, and creating new shortages – driving the economy into recession.
It is not just activity in shopping malls and factories that has taken a hit. The housing market has fallen sharply, with pending home sales dropping 32% year-over-year in October. The stock market is also sinking, and the cryptocurrency market has fallen off a cliff. Worse, interest on the federal debt is shooting up. For years, the government has been able to borrow nearly for free. By 2025 or 2026, according to Moody’s Analytics, interest payments could exceed the country’s entire defense budget, which hit $767 billion in fiscal 2022. That means major cuts will be needed to some federal programs.
Breaking the “Fed Put”
In the face of all this economic strife, why is the Fed not reversing its aggressive interest rate hikes, as investors have come to expect? Former British diplomat and EU foreign policy advisor Alastair Crooke suggests that the Fed’s goal is something else:
The Fed … may be attempting to implement a contrarian, controlled demolition of the U.S. bubble-economy through interest rate increases. The rate rises will not slay the inflation “dragon” (they would need to be much higher to do that). The purpose is to break a generalized “dependency habit” on free money.
Danielle DiMartino Booth, former advisor to Dallas Federal Reserve President Richard Fisher, agrees. She stated in an interview with financial journalist and podcaster Julia LaRoche:
Maybe Jay Powell is trying to kill the “Fed put.” Maybe he’s trying to break the back of speculation once and for all, so that it’s the Fed – truly an independent apolitical entity – that is making monetary policy, and not speculators making monetary policy for the Fed.
The “Fed put” is the general idea that the Federal Reserve is willing and able to adjust monetary policy in a way that is bullish for the stock market. As explained in a Fortune Magazine article titled “The Stock Market Is Freaking Out Because of the End of Free Money – It All Has to Do with Something Called ‘The Fed Put’”:
For decades, the way the Fed enacted policy was like a put option contract, stepping in to prevent disaster when markets experienced serious turbulence by cutting interest rates and “printing money” through QE [quantitative easing] .
… Since the beginning of the pandemic, the Fed had supported markets with ultra-accommodative monetary policy in the form of near-zero interest rates and quantitative easing (QE). Stocks thrived under these loose monetary policies. As long as the central bank was injecting liquidity into the economy as an emergency lending measure, the safety net was laid out for investors chasing all kinds of risk assets.
… The idea that the Fed will come to stocks’ aid in a downturn began under Fed Chair Alan Greenspan. What is now the “Fed put” was once the “Greenspan put,” a term coined after the 1987 stock market crash, when Greenspan lowered interest rates to help companies recover, setting a precedent that the Fed would step in during uncertain times.
But the “free money” era seems to be over:
The regime change has left markets effectively on their own and led risk assets, including stocks and cryptocurrencies, to crater as investors grapple with the new norm. It’s also left many wondering whether the era of the so-called Fed put is over.
Killing the Parasite That Is Killing the Host
The Fed put favors the rich – investors in the stock market, the speculative real estate market, the multi-trillion dollar derivatives market. It favors what economist Michael Hudson calls the “financialized” or “rentier” economy – “money making money,” formerly called “unearned income” – which drives up prices without adding productive value to the “real” economy. Hudson calls it a parasite, which is sucking out profits that should be going toward building more factories and other economic development.
By backstopping the financialized economy, the Fed has been instrumental in widening the income gap of the last two decades, pushing housing prices to heights that are unaffordable for first-time homebuyers, driving up rents and educational costs, and crushing entrepreneurs. DiMartino Booth explains:
Fed policy feeds passive investing … because you don’t have to carefully allocate your resources. You simply have to be long the NASDAQ and sit there with your money. What does that feed? It feeds the monopolization of America. The largest companies, the companies such as Google and Microsoft … if there is a competitor in their world they simply absorb them. They acquire them, which quashes … the entrepreneurial spirit that made this country so great.… If the Fed succeeds, Main Street will be the main winner.
… [T]he trick here is for the Fed to not break anything big, and that’s the delicate balancing act, … if … they can slowly, methodically take the rot out of the system without breaking anything big that forces them to pull back.
The “rot” in the system is particularly evident in the housing market:
Since the financial crisis, there’s been a lot of private equity that’s entered the space and snapped up all these homes and they’re renting them … It’s definitely exacerbated this housing cycle. It’s added an element of speculation because so many of them are all cash buyers. Don’t get me wrong, they’re levered — it is borrowed money — but they’re coming in as all cash buyers, and that I think created a lot of these massive bidding wars …
During the financial crisis … we rescued AIG because we didn’t want to actually see what it looked like on the other side of that cliff had derivatives actually been unwound, and what that contagion might have looked like.… We never tested the derivatives market, so that risk continues to lurk out there…. I’m not a cheerleader for there being some kind of a systemic risk event, and I do hope again that the Fed succeeds in managing this unwind, in seeing risk pulled out of the system, but one company at a time, not something that makes the global financial system implode.
Financial blogger Tom Luongo takes this argument further. He maintains that Fed Chair Powell is out to break the offshore eurodollar market – the speculative, unregulated offshore money market where the World Economic Forum and “old European money” (including mega-funds Blackrock and Vanguard) get the cheap credit funding their massive spending power. That is a complicated subject, which will have to wait for another article; but the principle is the same. Without the backstop of the Fed’s virtually free dollars to satisfy a surge in demand for them, these highly-leveraged dollar investments will collapse. (“Leverage” is an investment strategy that uses borrowed capital to increase potential returns. The risk is that if the investment sours, losses are also increased.)
Pushing “Until Something Breaks”
Whether or not popping these raging speculative bubbles is the goal, the Fed’s interest rate hikes are having that effect. According to a November 25, 2022 article on CNBC.com, “Interest rate hikes have choked off access to easy capital ….” As a result, “Investors have lost roughly $7.4 trillion, based on the 12-month drop in the Nasdaq.”
House prices are also tumbling. The third quarter of 2022 saw the biggest home equity drop ($1.3 trillion) ever recorded. Fortune Magazine quotes Moody’s Analystics: “Before prices began to decline, we were overvalued [nationally] by around 25%. Now, this means prices will normalize. Affordability will be restored.”
In 2021, 25% of all real estate purchases were being made by institutional investors. In the third quarter of 2022, investor buying of homes tumbled 30%. Blackstone, a real estate income trust notorious for buying up homes and turning them into rentals, was reported on December 2 to be limiting withdrawals from its $125 billion property fund as investors rush for the exits. George Cipolloni, portfolio manager at Penn Mutual Asset Management, said the U.S. Federal Reserve’s sharp interest rate increases have not “worked all the way through the economy yet,” and that he expects to see “more Blackstone-type news events coming forward in the next year.”
In May 2022, BlackRock stock (BLK) was down 30% for the year. And by November, the cryptocurrency market cap had plummeted from $3 trillion to $900 billion, with Bitcoin, its largest component, down 77% year-over-year.
Currently featured in the news is the crypto exchange FTX and its 30-year-old billionaire owner Sam Bankman-Fried. FTX was exposed as a Ponzi scheme by the receding tide of dollar liquidity, catching Bankman-Fried and team “swimming naked when the tide went out.” According to Swiss bank UBS’ chief of investment, “FTX’s collapse shows Federal Reserve tightening is crushing speculative assets.” Outing FTX is thought to be only the beginning of a succession of exposures of financial frauds to come.
The Delicate Balancing Act
Looked at in that light, breaking the Fed put sounds like a good idea. But can it be done without breaking the whole economy? More reputable establishments than FTX are at risk. Rate hikes seriously impact local retailers and wholesalers. In September, risky leveraged bets brought UK pension funds near to collapse, forcing the Bank of England to reverse course and lower its interest rates. And there is the stress in the U.S. Treasury, which is dealing with an enormous interest tab on its debt.
Other disturbing outcomes are being envisioned. One podcaster posits that the economy is intentionally being driven to collapse, at which point the government will declare a “bank holiday”as Pres. Roosevelt did in 1933. When the banks reopen, he says, we will have a “currency reset” in the form of a central bank digital currency (CBDC). The concern is that it will be a “programmable” currency, one that can be regulated or turned off altogether based on the user’s “social credit” score, as is already happening in China.
Alarmed observers note that the New York Fed recently embarked on a pilot project for a CBDC (Central Bank Digital Currency). But defenders point out that it is a “wholesale” CBDC, used just for transfers between banks, particularly overseas transfers. Settlement times of foreign exchange transactions typically take two days. Project Cedar, the New York Innovation Center’s pilot project, found that settlement for foreign exchange transactions using distributed ledger technology can happen in 10 seconds or less, significantly reducing risks. Whether that technology will be developed and used by the Fed has not yet been determined. DiMartino Booth observes that Powell and other Fed officials have frequently questioned the need for a “retail” CBDC, in which Fed accounts would be opened directly with the public.In a Substack article titled “A Grand Unified Theory of the FTX Disaster,” author and educator Matthew Crawford lays out a darker possibility – that the end goal of the powerful network of players behind the FTX scheme is not just a U.S. CBDC but a “Global Digital Central Bank” run by international powerbrokers. Whether or not the Federal Reserve intended it, aggressive interest rate hikes could expose this sort of parasitic corruption and remove the money machine that is its power source.
Rising from the Ashes
Meanwhile, the supply-side issues inflating the prices of food, energy and other key resources need to be addressed. Those are matters for federal and state legislatures, not the Fed. In the 1930s, a federal financial institution called the Reconstruction Finance Corporation pulled the economy out of the Great Depression, put people back to work, and crisscrossed the country with new infrastructure, including the dams and power lines that brought electricity to rural America. (See my earlier article here.) The government acted quickly and decisively because times were desperate.
A bill for a National Infrastructure Bank modeled on the Reconstruction Finance Corporation is now before Congress, H.R. 3339. For a local government bank, a viable model is the publicly-owned Bank of North Dakota, which pulled that state out of a regional agricultural depression in the 1920s. (See here.) As an iconic Depression-era poster declared, “We can do it!” We just need to roll up our sleeves and get to work.
The specter of inflation is haunting the world’s economies. Surging prices since 2020, especially in food and energy, have eroded global living standards, though inflation varies considerably across countries. However, inflation is hitting the working class and lower-income people harder than wealthier households, triggering protests around the world, especially in countries with strong trade unions and left-wing political parties. In Europe, governments fearful of social unrest have spent hundreds of billions of euros in an attempt to cushion the impact of inflation. The conservative government in Greece has even sought to restrain the increase in prices in more than 50 basic goods with a “household basket” plan. Meanwhile, in the United States — the richest country in the world — government policies to assist those suffering disproportionately from the surge in prices do not even exist.
Why are prices rising, and why do experts think that high inflation isn’t going away anytime soon? Moreover, what type of policies would we expect from a truly progressive government in an effort to curb inflation and bring wages in line with inflation?
Two leading leftist economists from the University of Massachusetts at Amherst, Gerald Epstein and Robert Pollin, shed light on these questions in this exclusive interview for Truthout. Epstein and Pollin are also co-directors of the Political Economy Research Institute (PERI) at UMass-Amherst, which on December 2-3 will host an international conference to explore the causes of inflation and what can be done about it.
C.J. Polychroniou: Bob, the war on Ukraine has not only set back global recovery from the COVID-19 pandemic but also seems to have caused inflationary expectations to soar. Indeed, inflation is haunting most economies around the world, and there seems to be no end in sight for high prices. Why is inflation rising, and what are the main forces behind the creation of large price increases in food, the energy sector and even in housing?
Robert Pollin: Sharply rising inflation rates emerged throughout the world coming out of the 2020-2021 COVID lockdown. According to the International Monetary Fund, the average inflation rate for the overall global economy rose from 3.8 percent in 2019, the year prior to the COVID pandemic onset, to 6.4 percent in 2021, as lockdown conditions from COVID started loosening, and 9.1 percent as of October 2022. For the large high-income economies (G-7 economies), inflation rose from 1.6 percent in 2019 to 5.6 percent in 2021 and to 6.8 percent as of October 2022. The comparable figures for the U.S. economy specifically are 2.1 percent in 2019, 7.4 percent in 2021 and 6.4 percent as of October 2022.
Clearly, the first driver of inflation globally has been the unique economic conditions globally coming out of the COVID lockdown. In particular, the global economy emerged out of the lockdown with supply shortages for a wide range of goods, including oil, food and computer chips, since production of goods had been cut back sharply during the lockdown. On top of that, the shipping industry itself contracted during the lockdown, and has not been able to bounce back quickly. Within the U.S., a major drag has been that there has been, very simply, a shortage of truck drivers to deliver supplies. This has resulted because truck drivers are badly paid. Under COVID conditions, the job also became less safe. One easy solution here would be to raise the pay and improve the safety precautions for the drivers. More people would then want to show up and take these jobs. That still hasn’t happened. Russia’s invasion of Ukraine led to further global supply shortages, in particular for energy and food. This in turn created still more inflationary pressures.
Right-wing commentators like to claim that large government spending levels caused inflation. This position is not entirely wrong, though it is misleading in the way that the right-wing pundits present it. In fact, government spending levels to counteract the COVID lockdown were historically unprecedented throughout the world, amounting to between 15 percent and 30 percent of all economic activity in all major economies. These were government spending levels equal to, if not greater than, World War II. They succeeded in creating a global floor on overall demand — that is, people did still have money in their pockets and bank accounts even while unemployment was spiking with the economic lockdown.
In other words, overall demand did not fall as much as overall supply. This created a version of the classic mantra on inflation, as resulting from “too much money chasing too few goods.” But consider this problem relative to the alternative that would have resulted under the COVID lockdown in the absence of these government spending injections — i.e., “too little money and too many goods.” That would have produced a major deflation — i.e., falling prices, wages and incomes, along with huge increases in mass unemployment, bankruptcies and a global depression. I have lots of criticisms of the specific ways in which these COVID bailouts were executed. But we are far better off as a result of this government spending, even recognizing how inflation has followed, then to have allowed a global deflation and depression to result.
Under these circumstances of COVID-lockdown and war-related supply shortages, corporations in turn seized the opportunity to mark up their prices and pad their profits margins. Focusing on the U.S. economy, the Financial Timesreported on November 28 that, “Margins of retailers and wholesalers have exploded in the past two years. The basic story here is that a combination of broken supply chains, rising input costs, and high demand created pricing power for producers, who raised mark-ups. Those mark-ups … are fueling inflation.” The economist Josh Bivens at the Economic Policy Institute has confirmed this pattern for the U.S., calculating that 54 percent of the price increases for corporations has been due to rising profit margins.
Polychroniou: Can inflation in today’s world be controlled by the actions of national governments? If so, what might a progressive government in the United States be able to do to make prices go down, or otherwise, to increase benefits and wages in line with inflation?
Pollin: The first issue to consider here is how much we should need or want prices to come down. In a paper that I will be presenting at the PERI conference, my coauthor Hanae Bouazza and I show that, considering 130 countries over the 61-year period from 1960-2021, economies have consistently grown at faster rates when inflation ranges between 5 percent and 15 percent as opposed to between 0 percent and 2.5 percent. Generally, this is because when an economy is operating at a high level of activity — with low unemployment rates and strong public sector support — inflation will tend to be somewhat faster. This is not a serious problem as long as workers’ wages and living standards are at least keeping pace with inflation. And as I noted above, this is a far less serious problem than when unemployment is high and wages and living standards are eroding, even while inflation may be at 2 percent or less.
In fact, since the mid-1990s, all high-income countries have been operating under what is termed an “inflation targeting” policy framework. These economies have all set their “inflation targets” at 2 percent inflation. The premise here is that economies perform better when inflation is negligible to nonexistent. But in fact, we have seen in the U.S. that, along with low-to-zero inflation between the early 1990s until the COVID reopening, the buying power of workers’ wages remained stagnant, while the pay for corporate CEOs rose exorbitantly, from being 33 times higher than the average worker in 1978 to 366 times higher in 2019. This is a more than tenfold increase in relative pay for corporate CEOs. So, the 2 percent inflation target has primarily been a means of keeping workers’ bargaining power weak and enabling profits and CEO pay to explode.
Within this context, it is not surprising that the primary response of policy makers to the global inflationary spike has been to try forcing their economies’ inflation rate down to the 2 percent target rate. Specifically, this has entailed central banks raising the short-term interest rates that they control for the purpose of weakening overall demand in the economy and raising mass unemployment. With mass unemployment rising, worker bargaining power — and along with it, the labor costs faced by businesses — would be expected to decline. Federal Reserve Chair Jerome Powell acknowledged these policy aims clearly, if demurely, in a major speech last August. Powell predicted then that there would “very likely be some softening of labor market conditions” resulting from the Fed raising interest rates.
Despite this singular focus by the Fed and other central banks on raising interest rates and unemployment, this is by no means the only policy tool available that could effectively manage inflation. The Biden administration itself has proposed enacting windfall profit taxes and stricter enforcement of regulations already in place to control corporations monopolistic pricing power. These would counter the excessive mark ups over costs that corporations have been able to impose over the past two years. Additional policy tools could include direct controls in the short term of some key prices, such as oil, along with tighter enforcement of speculation trading on futures markets for oil and food. Still more, increasing infrastructure investments can serve to loosen supply-chain bottlenecks in the short run while raising productivity over the longer term. Advancing a green energy transition — including investments in both energy efficiency and renewable energy — will reduce dependency on volatile fossil fuel markets while also driving down CO2 emissions.
It is possible that these other measures do not operate as forcefully as raising interest rates and unemployment for bringing inflation down to the 2 percent target rate. But the evidence shows that it is not typically necessary to force down inflation to such low levels. Moreover, all of these alternatives offer the critical advantage that they can reduce inflationary pressures without forcing up unemployment rates. It is also critical to note that inflation has been coming down since July. In the U.S., the average rate for the past four months has been 2.7 percent (expressed on an annual basis). At the least, this pattern demonstrates that there is no further need for the Fed to continue trying to force up unemployment in the name of inflation control. Rather, the combination of less stringent inflation-control policies should be more than sufficient now to continue bringing inflation down to an acceptable level.
Polychroniou: Jerry, there are some economists who argue that monetary policy has been the neglected factor behind the recent surge in inflation. Is this a valid argument, especially with regard to inflation in the United States? Moreover, how do central banks control inflation, and how do you assess the role, so far, that central banks and the Fed in particular have played in combatting inflation? It appears that working-class people, globally, are getting the short end of the stick with the policies pursued by central banks in the fight against inflation.
Gerald Epstein: The Federal Reserve has two broad areas of responsibility: one is with regard to monetary policy and the second involves financial regulatory policy, which includes both the monitoring and enforcement of financial regulations. When it fails to implement or enforce its regulations sufficiently, then it bails out the financial institutions and markets that have engaged in reckless behavior and are teetering on the edge. Here it is playing its role as “lender of last resort” or more accurately, as the “bailor-in-chief.” To bail out these banks and markets, the Fed tries to keep interest rates very low so they can borrow money cheaply. This also gives banks and wealthy financiers the opportunity to borrow money cheaply and buy and trade financial assets, leading to the massive increases in financial wealth we have observed until recently in the period following the great financial crisis of 2007-2009. Up until the time when Russia invaded Ukraine, the Federal Reserve’s mixture of monetary policy, regulatory (non-) policy and bail-outs led to a gigantic “asset inflation,” but not much of an inflation in the cost of goods and services. The one exception to this may have been in the case of housing and real estate, whose increase in prices were probably partly driven by these low interest rates.
But when supply chain problems from the pandemic hit and Russia’s invasion took hold, then commodity inflation took off. Now the Fed saw that its game of inflating the wealth of the wealthy with low interest rates and bailouts would no longer suffice. The problem: The accelerating inflation was harming the real value of wealth held by the top 1 percent and richer strata. The Fed responded by significantly raising interest rates to slow inflation and to try to protect the wealth of the wealthy. But as Bob Pollin explained, this came at the expense of slower employment growth and even higher unemployment for workers.
As Bob explained, the standard of living of workers and the poor have been significantly hurt by increases in the cost of living associated with the war and supply problems, but higher interest rates, designed to help the wealthy, will only hurt the workers more. Home mortgage costs, interest rates on credit cards and slower wage growth will be the result.
Polychroniou: Assuming you were in a position to affect policymaking in the fight against inflation, what measures would you recommend as an economist of the left?
Epstein: Since Bob discussed this in general, I will focus here on what the Federal Reserve could do. It is often said that the Fed has only one tool — interest rates — and so that is what it is using to fight this inflation. But this is not correct. As the Fed amply showed during the great financial crisis and the onslaught of the COVID pandemic — as well as in previous periods such as during World War II — the Fed has a number of tools in addition to interest rates: these include subsidized lending, asset buying, direct lending for productive purposes, and other more technical tools like asset-based reserve requirements designed to subsidize some lending and penalize other types. If the Fed had the notion (and the political will to pull it off in the face of a potentially hostile Congress), it could lend subsidized credit or buy assets from specialized nonprofit banks devoted to providing low-cost housing; it could provide working capital or buy longer term assets from organizations in communities providing subsidized solar energy and insulation for residences and community buildings; it could provide subsidized credit for farmers and rural communities that are producing healthy food and developing distribution networks that bypass the mega-middle men — buyers, grocery stores etc. that are using their market power to rise food prices. These are just a few examples.
The point is that the Federal Reserve has a huge amount of creative lending and investment strategies during the recent crises mostly to help banks and other financial institutions, but also municipal governments, small businesses and the like, and they could do this again to do two things: Help subsidize key commodities for the working class and poor, and also help increase the supply of key commodities — green energy, healthy food, etc. — that will improve the standard of living of workers in the medium to longer term.
Punishing increases in interest rates are not the only tool the Fed can use, but it is the tool it is choosing.
A new report from House Oversight Committee lawmakers confirms that corporate “profiteering” has been a major factor fueling inflation in the past two years, as executives have hid under the guise of inflation to fleece the public — all while bragging about it to their shareholders.
The report was released Friday by the Oversight Committee’s Subcommittee on Economic and Consumer Policy. It found that many industries have increased their profits precipitously within the last two years, taking advantage of uncertainty caused by the pandemic and other factors that set the stage for “excessive corporate price hikes,” like Russia’s invasion of Ukraine, the report reads.
Four major meat processors more than doubled their profits between 2019 and 2021, the report found, while two large rental car companies nearly multiplied their profits by six times. In the oil and gas industry, four major companies increased their profits by 62 percent.
Underscoring much of the instability across the global economy was the shipping industry, which saw disruptions due to supply chain issues. Still, these companies were able to profit from the issues nonetheless: the report found that three of the largest five shipping companies increased their profits by a staggering 29,965 percent, an increase of nearly 300 times their pre-pandemic profits.
These findings are staggering, even if they have become relatively normalized under runaway capitalism. They represent, as progressive analysts have said for months now, a failure of political forces to attempt to rein in such price hikes and provide much-needed relief to the public.
“Today’s analysis reaffirms what an overwhelming 80 percent majority of Americans already recognize according to a recent poll: under the guise of inflation, certain corporations excessively hiked prices far beyond what their costs necessitated, further driving inflation,” subcommittee Chairman Rep. Raja Krishnamoorthi (D-Illinois) said in a statement. “It is unacceptable that certain companies and industries are engaged in extreme price hikes under the cover of inflation.”
Corporate executives have been openly touting this strategy to shareholders, the report finds. Executives at companies like Hormel Foods, Tyson Foods, Autozone, and others have explicitly drawn the line between inflationary conditions and raising prices and profits in calls with shareholders, as the report points out.
“[A] little bit of inflation is always good in our business,” one Kroger executive said in June 2021. A Tyson official said in February that “Our pricing actions and strength in the beef segment … more than offset the higher [costs of goods and services].”
“Inflation is going to be a big factor for us next year,” one executive at beverage company Constellation Brands said early this year. “We’ll take as much pricing as we think the consumer can absorb.”
In other words, while the working class has struggled to afford basic needs like rent, food and energy in recent years, corporations have viewed such conditions as an opportunity to even further squeeze the public for their money. Further, they’re not afraid to admit as such, openly discussing these plans in shareholder calls.
The report is drawn from testimony and evidence from left-leaning organizations like the Economic Policy Institute and the Roosevelt Institute, which have indeed found that corporations are in large part responsible for inflation.
However, even economists in traditionally conservative spaces have been citing corporate greed as a driver of high prices. Paul Donovan, the chief economist at UBS Global Wealth Management, strongly urged the Federal Reserve to recognize this fact in an op-ed last week, writing that, because of inflation, “real wage growth is catastrophically negative” and that companies “have also taken advantage of circumstances to expand profit margins.”
The economy added 261,000 jobs in October, somewhat faster than most analysts had expected. Despite the rapid job growth, unemployment edged up slightly to 3.7 percent. Perhaps most importantly, it seems wage growth is settling down to a level consistent with the Fed’s 2.0 percent inflation target. Over the last three months, it has increased at a 3.9 percent annual rate. That compares to a 3.4 percent rate in 2019, when inflation was comfortably below the Fed’s target.
Job Growth Led by Health Care and Manufacturing
Job growth was strong across sectors, but it was especially strong in health care and manufacturing. Health care added 52,600 workers in October, and it has added 298,800 workers since May. This is largely catch-up since the sector’s employment had lagged earlier in the recovery. It is now 0.5 percent above the pre-pandemic level.
Manufacturing added 32,000 jobs in October, and employment in the sector is now 1.1 percent above the pre-pandemic level. Manufacturing is usually hit hard in a recession, but to date does not seem to have been much affected by the Fed’s rate hikes.
Construction Employment Edges Up, Jobs Related to Mortgage Financing Fall
Higher interest rates have certainly taken a toll on construction, as is most evident in the plunge in housing starts. Nonetheless, employment in the sector increased by 1,000 in October, with residential construction showing a small gain. Employment is now 1.3 percent above pre-pandemic levels. Workers are still needed to finish the many homes that are still under construction.
The impact on the credit intermediation sectors that are involved in mortgage issuance is easier to see. The number of people working in these sectors fell by 4,400 in October and is now down 36,600 from its April peak.
Airlines Add Jobs, Internet Retailers Lose Jobs
The airline industry added 4,200 jobs in October. Employment is now 10.6 percent above its pre-pandemic level, even though air travel is still below pre-pandemic levels. Employment at Internet retailers fell by 300 in October, as people are switching back to in-store shopping and also buying fewer goods. It is now down 0.6 percent from its peak last November, but still 10.6 percent above the pre-pandemic level.
Sectors Having Trouble Hiring Are Now Adding Jobs
Nursing homes added 4,100 jobs in October, while childcare centers added 4,900. Employment in the sectors is still down by 13.7 percent and 8.4 percent, respectively. The low pay in these sectors have made it difficult to get workers.
Local governments added 29,000 jobs in October, while state governments lost 7,000. They are now 3.3 percent and 1.1 percent below pre-pandemic employment levels, respectively.
Restaurants added just 6,000 jobs in October, but this followed an increase of 69,000 in September. This is likely just an error in the data rather than a sharp plunge in job growth. Employment is still 4.6 percent below the pre-pandemic level. Hotels added 19,900 jobs in October, but employment is still 17.1 percent below its pre-pandemic level.
Women Accounted for 66.1 Percent of Payroll Employment Growth in October
Women again accounted for the bulk of payroll job growth in October. They have accounted for 59.3 percent of job growth since May. They now are 49.91 percent of payroll employment. There were some months before the pandemic when women held more than 50.0 percent of payroll jobs.
Weekly Hours Stable in October
Average weekly hours were stable at 34.5 in October. This is down from a peak of 35.0 earlier in the recovery. This is another sign of the labor market normalizing. It suggests employers are not making workers put in more hours due to an inability to hire new workers.
Wage Growth Nears Noninflationary Pace
The annual rate of wage growth over the last three months is just 3.9 percent. This rate is very close to being consistent with the Fed’s 2.0 inflation target. (It is somewhat higher at 4.4 percent, using my preferred measure of taking the average wage for the last three months, compared to the average of the prior three months.)
Hourly wage growth was 3.4 percent in 2019, when inflation was comfortably below the Fed’s 2.0 percent target. By this measure, the Fed’s work is largely done.
Labor Force Participation Edges Down, Prime Age Participation Drops 0.2 Percentage Points
The overall labor force participation rate edged down 0.1 percent to 62.2. The participation rate for prime age workers fell 0.2 percentage points to 82.5 percent. This is 0.6 percentage points below the pre-pandemic peak, but equal to the average for 2019.
Share of Unemployment Due to Voluntary Quits Falls
The percentage of unemployment due to voluntary quits fell sharply in October to 14.6 percent. This number is erratic, but the October figure is consistent with a strong, but normal labor market.
Employment Rate for Workers with Disabilities Hits a New Record High
The employment rate for people with disabilities rose to 22.0 percent in October. This is a new record high. This is likely due to a combination of a strong labor market and a huge expansion in opportunities for work from home.
Average Duration of Unemployment Spells Rises
For the first time since April, both the average duration of unemployment spells and the share of long-term unemployed (more than 26 weeks) rose. The average duration rose from 20.2 weeks to 20.8 weeks, while the share of long-term unemployed rose from 18.5 percent to 19.5 percent. This is consistent with the modest rise in recent weeks in the number of people receiving unemployment benefits.
Strong Jobs Report With Inflationary Pressures Waning
On the whole, this is a very positive report. The job growth is somewhat higher than can be sustained over the long term, but not hugely so. Most importantly from an inflation perspective, wage growth is now very close to being at a noninflationary pace. Other items in this report, such as the drop in the share of unemployment due to voluntary quits and the stabilization of average weekly hours at pre-pandemic levels, are also consistent with a strong, but normal labor market.
We should never make too much of a single month’s data, but as the rate of wage growth falls back near a noninflationary pace, there is a reasonable case for the Fed pausing rate hikes to get a better picture of their impact to date.
A group of Democratic lawmakers led by Sen. Elizabeth Warren (D-Massachusetts) is pressuring the Federal Reserve to explain why it’s continuing to raise interest rates at such a rapid pace when economists across the political spectrum say that rate hikes will only hurt the working class with little upside for the economy at large.
In a letter sent to Fed Chair Jerome Powell on Monday, 11 members of Congress lay out a wide swath of evidence from both Powell himself and from economists that American families will be in for “pain” in the coming months, as Powell has said, as the Fed plans to raise interest rates by 75 basis points, or 0.75 percent, for the third consecutive time this year.
The letter, signed by progressive lawmakers like Sen. Bernie Sanders (I-Vermont) and Representatives Jamaal Bowman (D-New York) and Rashida Tlaib (D-Michigan), expresses “concern” about the Fed’s “alarming” plans and “disturbing warning” to American families about what to expect in coming months.
As the lawmakers point out, the Fed has predicted that as it continues raising rates through next year, unemployment will rise from its current rate of about 3.5 percent to 4.4 percent in 2023 and 2024. This means that about 2 million people will lose their jobs as economic growth slows and the labor market grows weaker, Powell has said.
Other experts’ estimates of the impact on the economy are more dire. Bank of America estimates that unemployment could jump as high as 5.6 percent, which could mean the loss of over 3 million jobs. Meanwhile, according to a survey released last month by The Wall Street Journal, economists predict that there is a 63 percent chance that the U.S. will enter a recession in the next 12 months, in large part due to the Fed’s relentless rate hikes.
Economists, who have been raising warnings about the damage that the rate hikes could cause for months, have been puzzled about Powell’s decisions, the letter points out. The United Nations Conference on Trade and Development has said that whether or not there will be a global recession comes down to “policy choices and political will,” economists are unclear on what the Fed’s goals are.
“The Fed clearly wants the labor market to weaken quite sharply. What’s not clear to us is why,” one economist wrote in a report earlier this year, as the letter writers pointed out. Economists have also questioned whether or not the rate hikes could have as much impact on inflation as they’re supposedly meant to have, saying that the impacts on the working class could outweigh any supposed benefits.
Memo to the Fed: Your rate hikes aren’t slowing inflation because inflation is coming from big corporations using the cover of inflation to increase their prices more than their costs.
Even the Fed itself admits that the rate hikes may have little impact on inflation, considering the vast amount of other factors at play, like corporate price gouging and Russia’s invasion of Ukraine, the letter reads. The lawmakers list a variety of times that Powell has admitted that the Fed’s power over commodity prices is limited.
“As one economist noted, the Fed can’t ‘click its heels three times, raise rates and have inflation drop. There’s a myriad of factors going on now, and it’s a mistake to think the Fed controls any more than a handful of those,’” the letter says. “Nevertheless, you continue to double down on your commitment to ‘act aggressively’ with interest rate hikes and ‘keep at it until it’s done,’ even if ‘[n]o one knows whether this process will lead to a recession or if so, how significant that recession would be.’”
“These statements reflect an apparent disregard for the livelihoods of millions of working Americans,” the lawmakers wrote, “and we are deeply concerned that your interest rate hikes risk slowing the economy to a crawl while failing to slow rising prices that continue to harm families.”
While progressives warn that the Fed’s rate hikes would be at best a band aid on the problem, they say that raising interest rates to suppress demand is a neoliberal policy that passes economic pain onto the consumer at any cost — even a recession. Progressive advocates say, instead, that providing relief to the public while targeting corporations who are using inflation to raise prices would be a good start.
President Joe Biden appears to agree that corporate price gouging is an important underlying cause for inflation, at least in part. On Monday, he warned oil and gas companies that, if they don’t take action to lower gas prices at the pump, they could face a corporate windfall tax that would capture excess profits. Indeed, the oil and gas industry — and corporations as a whole — have been enjoying huge profits as inflation has soared, while Americans are increasingly having to take out predatory loans for basic expenses.
In the late summer of 2021, mortgage rates fell to near-all-time lows, even as the rate of inflation picked up. A borrower with good credit could borrow hundreds of thousands of dollars for 30 years at under 2.9 percent, despite the fact that the rate of inflation had already ticked up to above 5 percent.
Fourteen months later, that same 30-year mortgage is going for not far shy of 6.5 percent, with analysts predicting it could hit 7 percent within weeks. The average mortgage in the U.S. is just over $400,000. Thus, a hike in mortgage rates of 4 percent in the span of 15 months means that the average family with a new house will have to come up with $16,000 more in interest payments in late 2023 than they would have, had they locked in place a mortgage a year earlier.
And, because where the Federal Reserve goes, the rest of the world follows, interest rates are also soaring globally. Many international observers are worried. Indeed, in a report released earlier this week, the United Nations Conference on Trade and Development (UNCTAD) warned that rapidly tightening monetary conditions could impose a worse cost on the global economy than did either the 2008 crash or the COVID pandemic. Not surprisingly, it suggested that low-income families would bear the brunt of this downturn. UNCTAD called on the Fed to hit the pause button on interest rate hikes.
Inflation creates a climate uncertain for businesses, and when combined with the low unemployment levels currently seen in the U.S., it leads to wage increases that eventually have the potential to recalibrate the economy in organized workers’ favor. Since the Fed is determined to re-establish certainty for businesses and to rein in inflation at all costs, it is unlikely to heed UNCTAD’s warnings, and is likely to plow ahead with its regimen of rate increases.
In the U.S. — and, by extension, much of the rest of the world — two things are happening to the housing market in response to these hikes: the number of homes being bought and sold (and consequently the number of mortgages being taken out) is falling, and housing prices are starting to decline as purchasers feel more pinched by the cost of borrowing. Both will disproportionately hit lower-income families and new homeowners looking to move up the housing ladder.
For seven consecutive months now the number of home sales has declined. This means fewer people are currently able to enter the world of homeownership. It also means that it’s becoming harder for those who already own homes to sell in order to move either to a different city or into better or bigger accommodations in the cities they already live in.
And, while average home prices were still rising modestly into the early summer, in many high-cost cities, a fall-off in prices has now begun. Indeed, some studies have shown that in more than three-quarters of cities, home prices over the past month have retreated from their COVID-era highs. In Seattle, San Diego, Sacramento, San Jose and Las Vegas, Redfin data suggest double-digit drops in what homes are selling for as the Fed’s interest rate hikes ricochet through the broader economy.
Moody’s Analytics now predicts that over the next two years, housing prices will fall in just over half of the 414 major markets that it surveys. In the majority of these markets, especially in cities in the Sunbelt and in the West, it finds that home prices are overvalued by at least 25 percent, meaning that homeowners who bought in the last few years when interest rates were at rock-bottom levels and home prices were soaring are facing huge risks in getting stuck underwater as their real estate investments go south just at the same time as mortgage rates soar.
What makes this more infuriating is that this was an avoidable tragedy. Homeowners don’t make decisions in a vacuum; they buy and sell at least in part because of a financial environment determined by the monetary decisions of the Federal Reserve and the policy decisions of the U.S. government. The housing market was overheated in the last few years by a conscious effort to make money as cheap as possible for as long as possible; now, that housing bubble is being rapidly punctured by a panicked response to inflation by central bankers applying the lessons of the past several inflationary cycles to a pandemic- and war-impacted environment that looks nothing like the recent past. The interest rate hikes embraced by central banks essentially punish home buyers for the failure of expert economists to correctly game out inflationary pressures in the era of COVID and of Russian expansionist military adventures. Whether that punishment will even work, by the Fed’s own terms, and reduce inflation is very much an open question.
The Federal Reserve has gone on an interest-rate-raising spree in recent months as it belatedly attempts to put the inflation genie back in the bottle. There is, in this, an irony. The talking heads and maestros of finance — the experts whose every word markets hang on — spent months trying to calm rattled markets and investors by promising that inflation was transitory, that the fundamentals of the global economy were fine, and that once COVID-related supply chain glitches got sorted out, the world’s major economies would rapidly revert back to inflation in the desired 2 percent range.
They were, of course, hideously wrong. In hindsight, they ought to have gently raised interest rates and tapped the breaks on the housing market before the inflationary spiral took hold, instead of waiting until it was a crisis of such urgency that the massive and rapid interest rate hikes came to be seen as the only tool left in the Fed’s anti-inflation toolkit. But, of course, hindsight is everything. In the moment, their analysis of inflation in 2021 and early 2022 was ultimately as misguided as analyses made 15 years ago by those who waved off the increasingly urgent signs that the housing market was about to crash and pull down key pillars that propped up the global financial system.
In 2006 through 2008, as the housing market grew increasingly volatile, policy makers and those controlling monetary policy ignored the problem until it was too late to make only mild interventions and modest tweaks. When vast numbers of people started to default on their mortgages, and lenders began to suffer a liquidity crisis, it took trillions of dollars of coordinated international interventions to keep the world’s financial system from entirely seizing up and to stop the major industrial economies from sliding into a depression.
Now, in 2022, a similarly inept response by experts who should have known better threatens to crash the housing market in which tens of millions of American families have invested their life savings, following the encouragement of policy makers who kept interest rates artificially low for more than a decade.
The political repercussions from the crash of 2008 are still playing out today; it’s hard to imagine Trump’s ascendancy absent the aftereffects of the crash: the collapse in confidence in government agencies and elected officials, the distrust of self-proclaimed experts, the immiseration of millions of families, and the rage triggered by banks being bailed out while homeowners and ordinary workers were largely left to fend for themselves.
Today, the Fed is stampeding toward a regimen of ever-escalating rates. It is essentially declaring that large increases in unemployment are acceptable — possibly even desirable so as to curb worker power — as a way to rein in an economy it let overheat for years. As a result, the potential exists for a 2008-style sudden and calamitous failure of the housing market, a contraction in employment, and an unleashing of vast political furies in the wake of this.
Sometimes, as UNCTAD seems to have concluded, the medicine is worse than the ailment. In putting both the stability of the U.S. housing market and the employment of large numbers of Americans at risk with a rigid anti-inflation regimen that doesn’t take into account the very particular reasons for rising prices in 2022, the Fed risks fueling growing immiseration, and, in consequence, increased levels of societal upheaval. For months now, the Federal Reserve has talked up its ability to create a “soft landing” for the overheated economy. Now, in dramatically raising the costs of borrowing over the past few months, it has essentially accepted the necessity of a “hard landing” that triggers misery for millions of existing homeowners and puts the ability to purchase a home further out of reach for growing numbers of would-be first-time home buyers. That’s not sound economic policy making; rather, it’s decision-making via panic.
Yes, the Fed’s interest rate-raising frenzy of 2022 may ultimately curb inflation, but the collateral damage this time around, in terms of housing access and unemployment, could rival that of 2008. It could, if things really head south, be as unpleasant as the early 1980s, when monetary policy makers in Reagan’s U.S. and Thatcher’s U.K. sent interest rates and unemployment skyrocketing, in their efforts both to break the power of organized workers and also to tamp down inflation. That’s hardly the mark of a well-thought-out and humane monetary policy.
The political and media representatives of the rich continue to promote maximum confusion on the economy. No coherent perspective on the economy is permitted under the existing political order. Everyone is expected to go along with what the rich and their allies repeat about the economy. Everyone has to use the same terms, the same framework, and the same outdated outlook when approaching the economy. Alternative vantage points are not tolerated.
False choices, bad options, and mixed messages abound. Week after week, one news source claims that everything is great while another says that the economic forecast looks gloomy for the next decade. Economic concepts like inflation, interest rates, costs, prices, and unemployment are rendered in the most tortured manner over and over again, with different representatives of the rich constantly making unscientific and confusing claims about what is “the real problem” and how to “get us back on track.”
Anticonsciousness has produced a stubborn refusal on the part of the superfluous political and economic elite to provide a concrete and lucid description, explanation, and evaluation of what is actually unfolding, leaving people disinformed and marginalized. This tiny ruling elite is plagued with old ideas and concepts about the economy. It has no interest in consciously investigating phenomena and reaching warranted conclusions.
This August 21, 2022 headline from The Register-Herald from West Virginia is one of endless examples of the mainstream media failing to empower people: “U.S. economy flashes signals of hope and concern in mixed data.” Like so many news items, this article leaves people riding the fence and unable to decipher real developments in the economy and society. This is usually done in the name of “balance,” which is really an attempt to conceal a multifaceted reality that can be grasped only when investigated consciously and objectively. One is left as powerless at the end of the article as when they started the article. Half-truths, incorrect information, hedging and waffling here and there—such common tactics leave people with no bearings or direction. It is not a serious approach.
Another confused source, The Nation, carries this headline: “Looming recession in 2023” (September 7, 2022). The article relies on capital-centered discourse with all its limitations. It provides no integrated coherent view on what is happening in the economy or why. It ignores the fact that the long depression started 12 years ago and that most economies have been running on gas fumes since then, if not before then. The “economic slowdown” started many years ago and will continue for years to come. Years later there is still no meaningful recovery and resilience in most countries, just worse living and working conditions for the majority year after year. Living and working standards are not rising in the U.S. and elsewhere. Endless chatter by the elite and their representatives about “recession” serves mainly to confuse and distract people. It seeks to embroil them in debates that do not serve their interests.
Conflating different concepts and trends, this September 1, 2022 headline from Bloomberg News, “Strong Economy Is Bad News for Fed’s Inflation Fight,” also leaves readers with no coherence about the economy. What “strong economy”? Why is a so-called “strong economy” a bad thing? And what about the fact that the Fed ran out of ammunition long ago and is only exacerbating things?
Other bizarre news headlines look like this one from the New York Times: “America’s Dueling Realities on a Key Question: Is the Economy Good or Bad?” (September 13, 2022). The presentation of the economy to the public in this irrational manner can be found everywhere today. Objectivity of consideration is absent and everything is reduced to what a handful of “registered voters” think. Everything is reduced to subjective interpretations, as if the economy does not exist independent of the will of individuals. On top of all this, the article openly admits that economists and journalists are bad at predicting economic phenomena. In other words, they are not scientific.
Many other examples of media disinformation on the economy can be given. Desperate attempts to find something positive in a dying and decaying economy are not going anywhere any time soon. Such efforts continue because the ruling elite are terrified of more people recognizing the illegitimacy, bankruptcy, and dysfunction of current arrangements and uniting with others to usher in a fresh new alternative.
Research and experience show that most Americans are very worried about the state of the economy. 1 Millions feel insecure. Everyone knows we have a bad economy, whether you call it a recession or not. High prices are everywhere and interest rate increases by the Federal Reserve and other central banks around the world are only creating more problems. Today many people have to work two full-time jobs just to survive. Millions live pay-check to pay-check, including many who make six figures. On top of all this, price-gouging, bankruptcies, evictions, hunger, homelessness, inequality, debt, anxiety, and crime are increasing. The fact is that “Rising costs force millions of Americans to choose between paying health care and utility bills” (August 31, 2022).
Yet Jerome Powell, head of the U.S. Federal Reserve, recently promised “more pain” for millions. More agony and unemployment, we are told, is the way forward.
Why? How is this a responsible and acceptable approach in 2022? Why should there be more suffering for everyone centuries after the scientific and technical revolution made it possible to meet the needs of all several times over? Why more pain for everyone when objectively there is an overabundance of wealth in society produced by workers? Is the public to believe that the approach embraced by economic “leaders” is the only viable approach to the problems confronting the economy, society, and humanity? And whose economy are we talking about? There is nothing bright or human-centered about the approach, outlook, and agenda of the rich and their representatives, which is why they have not solved any major problems in decades.
It is clear that what the rich mean by “economy” bears no resemblance to what an economy actually is: the relations people enter into with each other in the course of reproducing themselves and society. For the rich, the economy is anything that makes rich people richer, including war, price-gouging, wage cuts, stock buy-backs, aggressive advertising, and wild speculation on the stock market. These are not things the producers of wealth in society support. Working people are interested in using socially-produced wealth to advance society, not narrow private interests.
The ruling elite and their representatives view the economy in the most narrow and distorted way. They do not see the economy as an integrated whole whose many parts are run by millions of working people that produce all the wealth of society. Major owners of capital look at the world from their own narrow private interests and protect their “own turf” as they compete intensely with other owners of capital to maximize their profit, regardless of how damaging this might be to the natural and social environment. They do not care about how the economy as a whole operates. They do not look at the parts in relation to the whole or strive to ensure the proper extended reproduction of society. Chaos, anarchy, and violence prevail in this outdated set-up in which greed is cynically normalized as a virtue.
From a capital-centered perspective, workers are not seen as the source of value. Their labor-time is not recognized as the source of new value. Workers are viewed instead as a derogatory cost of production, a liability, a loss, a burden, a nuisance, a negative consequence; something to be suffered or grudgingly tolerated. In reality, though, it is owners of capital, those who “legally” seize the surplus value produced by workers, that are a burden and liability to society. They are a historically-exhausted force that drags society backward. They are a block to progress.
In this fractured context it is also troubling that humans and citizens are constantly reduced to consumers, and consumerism is given as that which defines the modern human personality. Buying and subordinating oneself to objects, things, and commodities is given as the core of the modern individual—a phenomenon further exacerbated by social media.
Capitalist ideology turns reality upside down. It mixes up who exploits who. It conceals the irreconcilable antagonistic interests between workers and the financial oligarchy. It hides the fact that wage-slavery is the main mode of profit maximization for owners of capital. It obscures severe contradictions between workers and the rich.
People can expect no clarity or guidance from the rich and their media, which is why they must rely on their own conscious acts of finding out and undertake their own efforts to disseminate information, analysis, and perspective.
There is no reason for today’s economies to be as chaotic, anarchic, and fragmented as they are. They must be brought under conscious human control and organized to advance the general interests of society, not a tiny ruling elite that uses its power to get richer while disinforming and marginalizing people.
Rather than making money harder to get, the U.S. government needs to focus on the other side of the demand vs. supply equation.
In prescribing cures for inflation, economists rely on the diagnosis of Nobel laureate Milton Friedman: inflation is always and everywhere a monetary phenomenon—too much money chasing too few goods. But that equation has three variables: too much money (“demand”) chasing (the “velocity” of spending) too few goods (“supply”). And “orthodox” economists, from Lawrence Summers to the Federal Reserve, seem to be focusing only on the “demand” variable.
M2 money supply surged [in 2020] as the Fed pumped out liquidity to replace businesses’ lost sales and households’ lost paychecks. But bank reserves account for nearly half of the cumulative increase since 2020 began, and the vast majority seem to be excess reserves sitting on deposit at Federal Reserve banks and not backing loans. Excluding bank reserves, M2 money supply is now growing more slowly than it did for most of 2015 – 2019, when inflation was mostly below the Fed’s 2% y/y target, much to policymakers’ chagrin. Weak lending also suggests money isn’t doing much “chasing,” a notion underscored by the historically low velocity of money. US personal consumption expenditures—the broadest measure of household spending—have already slowed from a reopening resurgence to rates more akin to the pre-pandemic norm and surveys show many households used stimulus money to repay debt or build savings they may not spend at all. It doesn’t look like there is a mountain of household liquidity waiting to do more chasing from here. [Emphasis added.]
In March 2022, the Federal Reserve tackled inflation with its traditional tools – raising interest rates and tightening the money supply by selling bonds, pulling dollars out of the economy. But not only have prices not gone down since then, they are going up. As observed in a July 15 article on Seeking Alpha titled “Fed-Induced Recession Looms As Rate Fears Roil All Markets”:
On Wednesday, the Consumer Price Index came in at a 9.1% annual rate. The higher-than-expected reading puts the CPI at a new 41-year high.
The biggest contributors to rising consumer prices are the basic necessities of food, fuel, and shelter. As households struggle to make ends meet, they are trimming discretionary spending, burning through savings, and running up credit card balances.
Businesses are also getting squeezed. On Thursday, the Producer Price Index showed wholesale costs rising at a massive 11.3% year-over-year.
When their own costs go up, producers must raise the prices of their products to cover those costs, regardless of demand. Less money competing for their products won’t bring producer costs down. It will just drive the companies out of business, as happened in the Great Depression. The Seeking Alpha article concludes:
… As both businesses and consumers are forced to tighten their belts, a slowdown looms.
And if the Federal Reserve makes another major policy misstep, then a severe recession and financial crisis may also be coming.
Recession is already evident. The stock market has lost a cumulative $7 trillion in value this year, while the crypto market has lost $2 trillion since last November. Emerging markets are in even worse straits. According to a July 14 article by Larry McDonald on ZeroHedge, “Emerging and frontier market countries currently owe the IMF over $100 billion. US central banking policy plus a strong USD is vaporizing this capital as we speak.… A quarter-trillion dollars of distressed debt is threatening to drag the developing world into a historic cascade of defaults.”
Every time the Fed raises rates, borrowing becomes more expensive. That means higher interest costs not only for governments but for borrowers with mortgages, home equity lines of credit, credit cards, student debt and car loans. For both large and small businesses, loans also get pricier.
To be clear, this is not the same sort of inflation that Paul Volcker was taming in 1980 when he raised the Fed funds rate to 20%. McDonald observes, “In 2021, global debt reached a record $303T, according to the Institute of International Finance .… Volcker was jacking rates into a planet with about $200T LESS debt.” [Emphasis added]
Volcker was also not dealing with the supply shortages we have today, generated by lockdowns that put more than 100,000 U.S. companies out of business; sanctions and war that cut off global supplies of fuel, food and resources; and farming crises such as that in the Netherlands, generated by overly stringent regulations.
Higher interest rates don’t alleviate cost/push inflation caused by supply crises; they make it worse. Rather than making money harder to get, the government needs to focus on the supply side of the equation, stimulating local production to bring supply levels up. Rather than Volcker’s solution, what we need is that pioneered by Alexander Hamilton, Abraham Lincoln, and Franklin D. Roosevelt, who pulled us out of similar crises with public banking institutions designed to stimulate infrastructure and development.
For foreign models, we can look to the infrastructure-funding central banks of Australia, New Zealand and Canada in the first half of the 20th century; and to China, which salvaged the global economy following the 2008 banking crisis with massive infrastructure and development funded through its state-owned development banks.
China Did It
In the last 40 years, China has exploded from one of the world’s poorest countries to a global economic powerhouse. Among other notable achievements, from 2008 to 2022 it built 23,500 miles of high-speed rail, at a time when U.S. infrastructure projects were stalled for lack of funding. How did China pull this off? Rather than relying on taxpayer funds or foreign debt, it borrowed from its own banks.
China has three massive state-owned infrastructure and development banks – the China Development Bank, the Export-Import Bank of China, and the Agricultural Development Bank of China. Called “policy banks,” they get their liquidity either (a) directly from the People’s Bank of China (PBOC) in the form of “Pledged Supplementary Lending,” or (b) by issuing bonds, which have higher credit ratings than commercial bank bonds and are in demand because they can be used as collateral to borrow from the central bank. China’s policy banks are limited to funding certain specific government policies; and these policies are all productive and public-purpose-driven, unlike the short-term private profit-maximization driving Wall Street banks.
Besides its big state-owned banks, China has an extensive network of local banks, which know their local markets. The PBOC website lists seven tools it can use for adjusting monetary policy, including not just a short-term lending facility like the U.S. Fed’s discount window, but a facility to inject liquidity into banks for medium-term loans, as well as the “pledged supplementary lending” to fund long-term loans from the three policy lenders for specific sectors, including agriculture, small businesses, and shanty town re-development.
Yet all this stimulus has not driven up Chinese prices. In fact, consumer prices initially fell in 2008 and have hovered around 2% ever since. [See chart below.]
Prices are creeping up now, as is happening everywhere; but they have reached only 2.5%—far below the 9.7% seen in the U.S. in July.
Our Forebears Did It Too
State-owned infrastructure banks are not unique to China. In the United States, a similar model was initiated by Alexander Hamilton, the first U.S. Treasury Secretary. The “American System” of government-issued money and credit was key both to winning the American Revolutionary War and to transforming the nation from a collection of agrarian colonies to an industrial powerhouse. But after the War, the federal government was $70 million in debt, including $44 million from the colonies-turned-states.
Hamilton solved the debt problem with debt-for-equity swaps. Debt instruments were accepted in partial payment for stock in the First U.S. Bank. This capital was then leveraged into credit, issued as the first U.S. currency. Loans were based on the fractional reserve model. Hamilton wrote, “It is a well established fact, that Banks in good credit can circulate a far greater sum than the actual quantum of their capital in Gold & Silver.”
The BOE was chartered to fund a national war and was capitalized exclusively by public debt. The government would pay private lenders, who controlled what policies could be funded. Hamilton’s BUS, by contrast, was to be a commercial bank, funding itself by generating credit for infrastructure and development.
Under Hamilton’s system of “Public Credit,” the primary function of the BUS would be to issue credit to the government and private interests for internal improvements and other economic development. Hamilton said a bank’s function was to generate active capital for agriculture and manufactures, increasing the quantity and quality of labor and industry. The BUS would establish a sovereign currency, a banking system, and a source of credit to build the nation, creating productive wealth, not just financial profit.
The BUS was chartered for only 20 years, after which it lapsed. When economic hardships and monetary pressures followed, the Second Bank of the United States was founded in 1816 under President John Quincy Adams, basically on the Hamiltonian model. It funded one of the most intense periods of economic progress in history, investing directly in canals, railroads, roads, and coal and iron enterprises; lending money to states and cities engaged in such projects; and managing credit so that it continually flowed into needed productive activities.
After the Second BUS was shut down, Abraham Lincoln’s government issued Greenbacks (U.S. Notes) directly, funding both the Civil War and extensive infrastructure and development. The National Banking System was also established, under which national banks would be partially capitalized with federal securities.
An International Movement Is Born
The American System and its leaders not only allowed the American colonists to break free of British control but inspired an international movement. Other British colonies revolted, including Australia, New Zealand and Canada; and other countries rebelled against the British imperial free-trade doctrines and developed their own infrastructure and manufacturing, including Germany, Ireland, Russia, Japan, India, Mexico, and South America.
The Commonwealth Bank of Australia (CBA), founded in 1911, followed the Hamiltonian model. It was masterminded by an American named King O’Malley, who called Hamilton “the greatest financial man who ever walked the earth.” The CBA funded major national development and Australia’s participation in World War I, simply with national credit issued by the bank.
In Canada from 1939-74, the government borrowed from its own Bank of Canada, effectively interest-free. Major government projects were funded without increasing the national debt, including aircraft production during and after World War II, education benefits for returning soldiers, family allowances, old age pensions, the Trans-Canada Highway, the St. Lawrence Seaway project, and universal health care for all Canadians.
Meanwhile in the U.S., we got the Federal Reserve – and the worst banking crisis and economic depression ever in 1929-33. Pres. Franklin D. Roosevelt then rebuilt the U.S. economy financed through the Reconstruction Finance Corporation, again funded on the Hamiltonian model. Initially capitalized with $500 million, from 1932 to 1957 it lent or invested over $40 billion for infrastructure and development of all kinds; funded the New Deal and World War II; and turned a net profit to the government of $690 million.
Solving Today’s Price Inflation
That could be done again, assuming the political will. Some pundits predict that the Fed will back off its aggressive interest rate hikes when the carnage from that approach becomes painfully evident, but it seems to be a phase we have to go through to convince policymakers that the Fed’s current tools are not able to curb the price inflation we have today. We need to stimulate local development with a national infrastructure and development bank like China’s; and for that, Congress needs to pass an infrastructure bank bill.
Four such bills are currently before Congress. Only one, however, is capable of generating the nearly $6 trillion that the American Society of Civil Engineers says is needed over the next decade for U.S. infrastructure investment. This is HR 3339: The National Infrastructure Bank Act of 2021, which would effectively be self-funded on the American System model – a critical feature given that the federal debt is at record levels. The bank would be capitalized with federal debt acquired in debt-for-equity swaps – federal securities for non-voting bank shares paying a 2% dividend. This capital would then be leveraged at 10 to 1 into low-interest loans, essentially at cost. The bank would be anti-inflationary, by bringing supply up to meet demand; would not require new taxes but would rather increase the tax base, by increasing GDP; and would require only a small Congressional outlay for startup costs, which would quickly be repaid. For more information on HR 3339, see the National Infrastructure Bank Coalition website.
The Fed’s decision to raise interest rates for the fourth time this year threatens to loosen the tightest U.S. labor market in decades. What would it look like if policymakers consolidated workers’ recent gains instead?
High inflation has returned after more than two decades of very low and stable inflation rates. While in the past, central banks were struggling to bring inflation up to a target of 2 percent, they are now confronted with the opposite task. Raising the interest rate is one way to combat inflation, which is why the Federal Reserve announced in mid-June its largest interest rate since 1994.
Will a hike in interest rates fix the real reason behind today’s inflation, which is now a global problem? What does the Fed rate hike mean for average workers and the poor? What other ways are there to combat surging inflation? And why do capitalist governments worry more about inflation than they do about unemployment or inequality? Progressive economist Gerald Epstein sheds light on these and other questions about today’s inflationary economy. Epstein is professor of economics and founding co-director of the Political Economy Research Institute at the University of Massachusetts-Amherst and a leading authority in the areas of central banking and international finance. He is the author of many books, including, most recently, The Political Economy of Central Banking and What’s Wrong with Modern Money Theory? A Policy Critique.
C.J. Polychroniou: In an attempt to combat high inflation, which rose in the U.S. by 8.6 percent in May, the Fed hiked its interest rate by three-quarters of a point. This is the highest interest rate hike in decades, but it wouldn’t be surprising if the Fed took even more aggressive actions in the months ahead as part of its war against inflation. How much of an impact can higher interest rates expect to have on inflation?
Gerald Epstein: It partly depends on how high interest rates are jacked up and how long they are kept up. In general, moderate increases in interest rates — say, 1 or 2 or even 3 percentage point increases — cause only small reductions in the inflation rate, which is defined as the percentage rate of increase of the price of a market basket (collection) of goods and services over a period of time. There are many reasons for this. For one thing, in the first instance, as Wright Patman, the populist congressperson from Texas in the 1950s repeatedly pointed out, increases in interest rates actually increase prices! The reason is that interest costs are, among other things, a cost of doing business for companies that borrow money to fund their operations. So, like wages, or gas or other costs, increased interest costs are likely to be passed onto customers by businesses that rely heavily on credit.
As for the price reducing impacts of interest rate increases — these occur only indirectly. The main channels are by raising the cost of borrowing by families for houses (mortgages), or credit card purchases, and by raising the cost of borrowing by companies that are planning to build new factories or buy new capital equipment. These reduce the demand for goods and services — houses, appliances, cars, new factories and capital equipment — and the workers that produce them.
It is the next step where possible reductions in prices and the rate of inflation comes in. Companies and workers are very reluctant to lower prices, or even to reduce the rate of increase of their prices and wages. So, what happens next depends on the power that workers and capitalists have to keep their wages and prices up — to wait out the reduced demand for their products and services until demand goes back up.
Typically, firms have a lot of ability to wait out the cutbacks without greatly reducing their prices. This is especially true when firms have a lot of pricing power if they are monopolies or have a big share of the market, as mega corporations often do. Workers, much less so. So as demand for products go down and unemployment goes up, we typically begin to see wages either go down or stop going up. Perhaps housing prices begin to slide or soften. Over time the inflationary pressures might subside.
But this can take a substantial amount of time. Estimates by well-known Yale economist Ray Fair, for example, indicate that a 1-percentage point increase in short-term interest rates reduce the inflation rate by one-half percentage point, but only after 15 months. So, as estimated by macroeconomist Servaas Storm, it would take a 4-percentage point increase in the Fed’s interest rate to reduce the inflation rate by only 2.5 percentage points — say from 6 percent to 3.5 percent — far above the Fed’s target of 2 percent. And the price tag for this modest drop in inflation would be an increase in the unemployment rate by 1.5 percentage points and a significant fall of GDP.
Even these weak anti-inflation impacts are probably an overestimate of the impact of interest rate increases on current inflation. The reason is that so much of this inflation is due to production disruptions outside the U.S. that increases in U.S. interest rates will have, at best, weak effects.
The libertarian economist Milton Friedman famously said that inflation is caused by “too much money chasing too few goods.” He assumed that the culprit here was “too much money” — typically printed by the Central Bank (the Federal Reserve in the U.S. case).
But, historically, most really serious inflations are caused by “too few goods,” not too much money: that is, serious disruptions in the supply of goods. Typically, these are associated with wars, droughts and political instability. And this is largely true with our current inflation.
Most of the drivers of our current inflation come from disruption in the supply of key commodities such as oil, gas and food, and other key parts of the “supply-chain” such as microchips for automobiles. Some of these disruptions are still resulting from the COVID pandemic and the shutdowns associated with that disaster; and now, added on are the sharp increases in fuel and food prices stemming from the Russian invasion of Ukraine and the Russian blockage of Ukraine food exports to the world.
According to Servaas Storm, increased prices of imported products to the U.S. account for upwards of one-third of the increased inflation we are experiencing.
In addition to the external sources of production and distribution (i.e., “supply-side”) disruptions, the U.S. has domestic disruptions as well. Some of the better-known ones include shortages of truckers, inefficient ports and a decline in the labor force relative to pre-COVID trends. The latter is very important but is poorly understood. It could be a combination of COVID health issues, poor pay and working conditions, more family obligations, and other factors.
The point, though, is that interest rate increases will do nothing to solve these problems, and might even exacerbate them by making it more difficult for families to get the health care, child care, etc. that would allow them to go back to work.
In short, even when we are experiencing “plain vanilla” inflation due to too much demand (“demand-pull” inflation), interest rates must be raised significantly and for a long period of time to reduce it, at considerable cost in lower economic growth and higher unemployment. But when the main causes of inflation are supply side factors and, especially, those occurring abroad, the potency of interest rate increases to fight inflation are much, much weakened. This means much more pain needs to be foisted on workers to extract the same gains in terms of lower inflation.
Who wins and who loses from the Fed’s interest rate hike?
The current inflation, which is caused by significant disruptions in the supply of key commodities, such as gasoline and food, among other goods, is very negatively impacting poor and working-class people in the U.S. These price increases are like a big hike in sales taxes, which is a “regressive” tax: That is, it most negatively impacts those groups who spend a high percentage of their incomes on these goods. And given that these are necessities, these represent a high percentage of the purchases of these groups. Very rich people spend more on these goods than do working-class people, but this represents a much smaller percentage of their incomes. So, bringing down the cost of these necessities would certainly help poor and working-class people and families.
However, as we have seen, increases in interest rates will not do this, at least not without hurting these very same groups. Raising interest rates will increase unemployment, reduce economic growth and raise mortgage interest rates, which makes housing even more expensive for these people.
The increase in interest rates will primarily help two groups: those with significant amounts of financial wealth, and financial institutions that lend money and will now be able to charge higher amounts of interest and whose financial assets will retain more of their value if inflation falls.
Now, those who have seen the stock market drop in recent years will question whether wealthy investors will benefit from higher interest rates. It is true that one impact will be a reduction in the value of financial assets like stocks; at the same time, the rates of return on newly invested income will be higher. Moreover, to the extent that, in the longer run, the higher interest rates limit inflation, it will reduce the possible erosion of the real value of the wealthy’s considerable wealth.
There is another group that potentially benefits from the high interest rates that will raise the unemployment rate: the capitalists who employ workers.
The Fed and capitalist governments in general worry more about inflation than they do about unemployment, poverty and economic inequality. Why is that?
The simple answer to this question is that capitalists of various stripes tend to be harmed by substantial inflation, and they tend to benefit from unemployment, poverty and economic inequality. All of these reduce the power of workers and increase the power and wealth of capitalists. The Fed and capitalist governments, who tend to be disproportionately influenced by (if not controlled by) various capitalist segments, conduct policies that reflect these preferences. An (overly) simple way to think about this is to think of capitalists as being divided between two groups: financial capitalists (bankers, rentiers, financial operatives) and non-financial capitalists (auto producers, internet, agrobusiness, etc.). Of course, this is overly simple since there is often a big overlap among these groups.
But to continue: The financial capitalists and rentiers are especially phobic about inflation because unexpected increases in inflation erode the purchasing power of their financial assets. The non-financial capitalists, for their part, are phobic about their workers having too much power which they can wield to get higher pay, better working conditions and even more control over the decisions of the firms. Karl Marx noted the fact that capitalists adore the ability to “discipline” workers so they can’t exercise their power, and the main mechanism that capitalism has to do this is to throw workers out of work — that is, create unemployment. Marx called this the “Reserve Army” of the unemployed. In Das Kapital, Marx noted that capitalism requires the periodic replenishment of the reserve army of the unemployed to keep the workers in line.
The non-financial and financial capitalists typically are united with respect to monetary policy when unemployment is low and inflation is high: the Fed should raise interest rates to throw workers out of work, prevent them from raising wages, and thereby put downward pressure of prices and inflation in order to protect the real value of their wealth and increase capitalists’ profits.
So, the previous question asked who benefited from higher interest rates in this current situation? The bankers and the non-financial capitalists.
What does today’s inflation and Fed policy teach us about capitalism?
The bankers, banker-friendly economists such as Larry Summers and his associates, and pundits in the press are all pressing the Fed to take extreme measures to reduce inflation, even if those measures will significantly injure those that they purportedly are designed to help by throwing them out of work. Summers, among others, has been claiming that the Fed must raise interest rates dramatically in order to stem a “wage-price spiral,” blaming workers’ wage increases for sustaining the higher inflation rates. This is false since workers’ average wage increases have only been a small fraction of the increases in prices.
The implication of this is that workers in the U.S., who have basically had a very little if any pay raise in 40 years, cannot be allowed to have any pay raise now, despite the fact that the incomes and wealth of the top 1 percent has gone up more than 10-fold in the last several decades. This call for higher interest rates is particularly damaging to African Americans and other people of color who only are able to get ahead during periods of very low unemployment. These calls are taking place in the context of what economists at the Roosevelt Institute, Economic Policy Institute, and elsewhere have identified as a significant “profit push” component to our current inflation: Mega companies with substantial pricing power are using the supply chain shocks and Russian war in Ukraine as excuses to flex their pricing muscles and raise their profit margins to 70-year highs.
In other words: this says that American capitalism seems incapable of delivering increases in the standard of living to the bulk of its population. Critics often refer U.S. capitalism as “neoliberal capitalism.” I think of it as “rapacious capitalism.”
Now, this is a statement in particular about U.S. capitalism, not necessarily all capitalist countries. Capitalist countries, such as the Nordic countries (Norway, Sweden, Denmark) where workers, unions and social democratic parties have had significant power in the aftermath of the Second World War, have, for a number of decades, been able to “tame capitalism” to the extent that income distribution was more equal and real gains have been made by the working class and poor. To some extent, these gains have been recently eroded, but they nonetheless remain.
But this drive to have the Federal Reserve raise interest rates to bring down this inflation no matter what the cost reflects the “rapacious capitalist chorus” which has far too many powerful members.
What other methods are available to fight inflation besides contractionary monetary policy?
There are numerous other tools which are available to fight this mostly supply- and profit-driven inflation, but most require some coordination between the Federal Reserve and the government overall. Clearly, something must be done. This supply-driven disruption is having significant negative impacts on the standards of living of millions of people — in the United States and around the world — because it is raising the cost of a number of key goods that people need to live and thrive: fuel, food, housing, transportation.
So, what to do? I have already noted what the Fed should not be doing: raising interest rates sky high. To figure out what the Federal Reserve can contribute is to identify what the goal of policy should be. The goals of Federal Reserve Policy should be three-fold:
To protect the standard of living of the bulk of the population, and especially those who are most vulnerable, not primarily the bankers or the non-financial capitalists.
To help where possible to relieve the supply-side problems, and certainly not do anything to make them worse.
To facilitate where possible the needed transition to a non-fossil fuel-based economy, and not do anything that makes that transition slower or more difficult. This will help deal with the longer-term causes of inflation, namely climate change.
To achieve these goals, the Fed will not be able to operate on its own. Just as it did during the great financial crisis and then, even more so, in the wake of the COVID pandemic, the Fed should cooperate with a general government plan to deal with this cost-of-living problem. In those instances, the Fed developed multiple new and creative mechanisms primarily to bail out the banks and financial markets.
This time, the Fed should use the same effort and creativity to control inflation without imposing the costs on workers or the future possibility of controlling catastrophic climate change.
The Biden administration has attempted to lower the cost of fossil fuels. A better approach, suggested by Jim Boyce and Bob Pollin, among others, is to tax oil profits and return the receipts to people. This will retain the incentive to switch from fossil fuels to green energy, while helping workers and the poor with the hit to their standard of living.
The government should tax excessive corporate profits and use the returns to expand subsidies for food and other necessities for the poor and working class.
Isabella Weber and James Galbraith, among others, have suggested temporary price controls on key commodities to break the inflationary dynamics in these commodities.
Among the pressures affecting these dynamics has been an increase in financial speculation that has driven up these prices faster and higher than would be the case from simple supply and demand. Here the Federal Reserve, along with other financial regulators, should monitor and enforce rules to limit such speculation that is helping to drive some of this commodity inflation.
As I indicated before, the Fed allocated billions of dollars to bail out the banks and financial markets in 2008-2009, and again in the spring and summer of 2020. Now the Fed should devise special credit facilities to provide financing for the expansion of green energy, credit to expand day care and community health facilities, to help expand the effective labor force, and new initiatives for ecologically appropriate farming to provide foodstuffs. All of these would help to reduce bottlenecks. The Fed could do this by providing lines of credit, insurance and other facilities from community banks, special agricultural loan funds, affordable housing institutions and other similar financial institutions that have experience and a track record in funding these key goods… all of which are implicated in the current inflation.
In other words, since this is primarily a supply-side problem, the Fed should focus on helping to expand the supply, rather than on throwing workers out of work to limit demand at their expense.
On Wednesday, at the end of a two-day Federal Open Market Committee (FOMC) meeting, Federal Reserve chair Jerome Powell announced a tightening of monetary policy in response to the highest U.S. inflation in 40 years. The burden of this measure will fall disproportionately on the working class, both in the U.S. and abroad.
In a press release the FOMC said the current inflation rate reflected “supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.” The Fed raised its benchmark policy rate by 0.75 percentage points, the first increase of this magnitude since 1994. This raises the target range for the federal funds rate to 1.5 to 1.75 percent. The Fed will also “continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities.”
The Fed is maintaining the course it has adopted since the end of last year as a way out of the pandemic’s economic effects, reaffirmed this year by the Russia’s invasion of Ukraine, which has caused energy and commodity prices to sharply increase. These tightening measures have already caused a drop in U.S. stock prices, but the effects will go much further, harming the working class both in the United States and internationally.
The U.S. and International Working Class Will Pay the Price
At first glance, the Fed’s aim is to curb inflation — which sits at 8.6 percent — by cooling the economy. Higher interest rates strongly affect the working class, since they make credit more expensive, and it becomes more expensive to spend money, thus reducing people’s disposable income. Higher interest rates also often cause governments to impose austerity measures, since it becomes more expensive for them to borrow money.
In the United States, the Fed’s aggressive plan could also increase unemployment by discouraging investment and hiring. This would set the stage for lowering wages. Powell argued weeks ago that wages are rising too quickly and that the labor market is “tight to an unhealthy level” — in other words, employment is too high. But as we have previously argued, wages and employment are not to blame for the inflation rate.
In fact, inflation has been eating into real wages, part of a pattern of workers losing ground in terms of pay for several decades. Powell, of course, says nothing about growing inequality and sees no problem with billionaires enjoying explosive wealth growth during the pandemic while millions were plunged into extreme poverty.
To make matters worse for the working class, there are indications that the global economy is headed toward a new recession. The climate crisis and threats of famine add fuel to this fire.
The U.S. GDP composes 25 percent of world GDP, and the country has important trade relations with almost every country. For dependent countries in regions like Latin America, the Fed’s moves to curb inflation threatens to have serious international ramifications, exacerbated by an increasing subordination to the IMF.
For example, there may be slower economic growth internationally. The rate hike has already caused a decline in U.S. output prospects and could lead to a more sustained decline. This would put the same pressure on the rest of the world, endangering the jobs and incomes of millions of people, especially in the most fragile economies.
Increasing the interest rate also favors the movement of capital toward the dollar as a safe haven. This means that to dollarize, investors will reduce their holdings in local currencies, adding pressure on the demand for the U.S. currency. In fact, both the Brazilian real and the Chinese yuan have devalued by 6.3 percent in the last quarter, and the pressure on the Argentinean peso is growing. These devaluations can then cause price increases. The increase in the price of imports — both of final and intermediate goods — raises inflation in local economies.
Finally, the Fed’s moves can increase the cost of international credit. In other words, access to credit will be restricted, and the cost of foreign debts in dollars will increase. This raises the risk of default in some emerging economies, such as Argentina.
In this context, the Fed’s interest rate hikes aren’t just abstract monetary policy; they will reverberate far beyond the U.S. economy. And, as always, capitalists and their institutions are interested in self-preservation, stability, and continuing exploitation — workers and the poor, both in the U.S. and in dependent and semicolonial countries, will be forced to shoulder the burden of these measures. This means it’s more important than ever for the working class to organize to confront these attacks.
