Since I wasn't invited to Treasury's confab of bloggers yesterday (there's no surprise there, given how critical I've been of them and how Obama's administration is no less of an echo chamber than was Bush's!) I thought I'd loose this on the blogosphere - a post I've been sandbagging for about a week now.
There has been much discussion over whether the generally-Keynesian approach, along with Bernanke's "Depression Thesis", have in fact staved off Armageddon in the financial world, or simply played "extend and pretend" on the fuse, clearing and solving nothing.
It is my position that we have in fact not only solved nothing we have made the situation materially worse than it would have been if we had left things alone.
Two days ago Ambrose Evans-Pritchard opined that Japan is staring down a dramatic implosion in their economy and government:
Japan is drifting helplessly towards a dramatic fiscal crisis. For 20 years the world's second-largest economy has been able to borrow cheaply from a captive bond market, feeding its addiction to Keynesian deficit spending – and allowing it to push public debt beyond the point of no return
Right. But then he goes on to close with:
Japan's terrible errors are by now well known. It failed to jettison its mercantilist export model in time. It resisted the feminist revolution, leading to a baby strike by young women. It acquiesced in a mad investment bubble (like China now) in the 1980s, stealing growth from the future.
It wasted its immense fiscal firepower, scattering money for 20 years on half-baked spending projects to keep the economy afloat. QE was too little, too late, and this is the lesson for the West. We must cut borrowing drastically over the next decade, and offset this with ultra-easy monetary policy. Does Downing Street understand this? Does the White House? Does the European Central Bank? Clearly not.
What?
No, Japan's error was not "being less than properly forceful in their printing of money" (which is what "Quantitative Easing" really is.)
Japan's error was in papering over bad debt with more debt, transferring defaults that had already taken place but were being hidden to the public treasury and, as a consequence, to the taxpayer.
This in turn put in place a structural drag on GDP that cannot be jettisoned, as that debt did not go to build a road or bridge over which commerce flows, but instead went to bail out oligarchs who successfully persuaded lawmakers to kneel before them and perform obscene acts.
Bernanke's and Treasury's gambit has and will continue to fail because they refuse to honestly discuss and operate upon the actual failure that occurred in the marketplace.
That failure was lending money to people on obscenely-easy terms with no reasonable expectation that they would be able to pay as agreed, creating a churning business out of a legitimate lending business.
If I loan you money at a ridiculously low original interest rate with a built-in "jack it up" escalator in the deal I strongly encourage you to come back from another bite. This is extremely profitable, as these fees are not "interest" and yet they amount to a huge mark-up on the market.
Let's posit a $200,000 mortgage. If I make one 30 year mortgage and you pay it off over 30 years, I make one set of fees. Application, processing and similar fees might total $2,000 - $3,000 for the bank, with another $1,000 paid in title insurance and of course the other fees that are larded into the pie (e.g. doc stamps for the county, etc.)
The point here is that the bank makes perhaps as much as 2% of the gross face amount of the loan right here and now on the mortgage.
Let's assume that the bank borrows money at 5% and lends it at 7%. They thus have a NIM, or "net interest margin", of 2% on the transaction. "Turned" via fractional reserves they might be able to crank out a 20-25% gross pretax operating margin on lending operations. Not a bad profit margin for what is essentially a utility function.
Now let's presume that the bank is able to somehow force you to come back into their office every couple of years and refinance that mortgage. Suddenly they can take what is a 2% NIM and add on another 1% (annually, since it's every two years) in fees and costs. Oh, now we're getting somewhere, right? That's an instantaneous 50% improvement in their gross money, and cranks up that 20% pretax margin to 30%!
This is not a small increase, and is in fact why the banks pulled this nonsense.
Variations on this theme played out in the credit card space. You would get a "0% balance transfer for 12 months" deal in the mail. All fine and well. But the amount you charged today on that card was paid last, and it carried a 15% interest rate. So if you transferred $10,000 to that card then charged a $1,000 computer you'd pay 15% interest on that $1,000 for a couple of years - or forever - since the entire $10,000 transfer had to be retired before any of your current charges would begin to be paid down. The CARD law passed this spring ended this charade, forcing payments to go to the highest interest rate charge first (when it goes into effect.)
Now some consumers took good advantage of this balance transfer game, putting the card (wisely) in the drawer and never activating it. They thus got what amounted to a 2 or 3 year "free loan" (0% interest) on that $10,000 balance! Nice, right? Well, maybe. But if you were late just one time with a payment, suddenly that entire balance got hit with a 29% default rate.
The banks, on a statistical basis, never lose this game. Yes, some people could (and did) game it successfully, but far more of the population lost. Those who could game it did so only because of asset price appreciation - they HELOC'd the house when they missed a payment and covered the card!
The fundamental problem here is that sound lending went out the window - the entire economy became based on one and only one thing - complex bets placed in the capital markets on asset price appreciation.
That's all it was.
But those bets are never sustainable, because asset prices go down as well as up! Indeed, they have to, because asset prices over time cannot grow faster than incomes, net-on-net over long periods of time. And real disposable personal income has basically not grown at all since 2000 for anyone not in the top 5% of earners - everyone else actually lost ground during the last decade.
This of course only supports lower prices for assets, not higher ones. The imbalance became more and more ridiculous with each passing year as we went into the middle of the decade, supported not by wages but by ever-more complex (and obfuscated) securities where the creator had gamed the system to be a "never lose" for him, and "always lose" for whoever was on the other side. These "features" were of course not disclosed (would YOU buy a "must lose" security?) but provided a convenient means of continuing the game - for a little while.
When the game collapsed TARP was allegedly going to provide for "restarting and supporting lending." This was a lie and I believe Paulson knew it - he's not stupid, and neither is Bernanke. In point of fact the consumer had taken on more debt that they could service (witness the collapsing lending numbers), but it was the only way to "sell" the program to Congress.
Capital will always go where the holder believes they can make the best return given the environment they have. The big trading and investment houses have inside information that they use daily in making their bets, with most of it being shady but legal, coming from their conveyor-belt style access to Washington. As they demand fealty (and an obscene act of 8 letters beginning with the letter "f") from their bought-and-paid-for Congressfolk, they of course get to both dictate actions and are fed "inside baseball", allowing them to place bets in the capital markets with a far better chance of success than you, the ordinary American. Even better, in the instant case they were gambling not with their money but yours!
The outcome was both predictable and obvious - the banksters bet on "asset reflation" in the equity markets and got it - to the tune of a P/E in the S&P 500 of 140 (as of the end of September.) This "ramp job" is, in fact, nearly identical to what happened in the Nikkei following their collapse, and it occurred for the same reason!
But neither Bernanke or Geithner can fix an over-levered consumer. Doing that would require either massive debt defaults (bankrupting both lenders and borrowers) or the erection of trade barriers worse than anything ever seen in the history of America, forcing manufacturing (and thus high-wage jobs) home. That in turn would fuel price inflation as wages and prices both rose.
There is no way out of the box that Geithner and Bernanke face. Bernanke concluded in this famous speech on deflation that:
We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.
Notice that Bernanke confuses higher prices (the result of a devalued currency) with higher spending.
Under a paper-money system a determined government can always generate higher prices by deprecating the currency but generating higher spending net of that currency devaluation requires that the aggregate purchasing power increase or that sufficient slack between income and mandatory spending (e.g. that on food, fuel, etc) exists to increase expenditures.
A determined government can only do that by either driving productivity higher or incenting companies to locate their high-paying jobs here rather than abroad - that is, inhibiting global wage arbitrage. Absent that all higher prices do is impoverish a greater portion of the population and that in turn destroys debt carrying capacity among the very same people.
Since all modern monetary systems are debt-based the consequence of such a program is in fact the exact opposite of that which Bernanke (and Treasury) expected.
Leave it to the ivory tower folk to forget that in the real world (the one where you have to go to both the grocery store and gas station and buy your own stuff as opposed to having it all handed to you on a silver platter) consumption is driven by the spread between wages and mandatory spending (that on food, fuel, medical care, etc.)
Ramping prices through currency deprecation in an environment where global wage arbitrage has capped the feedback mechanism into earnings capacity destroys credit capacity instead of adding to it.
Oops.
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