Why the Government Is Desperately Trying to Inflate a New Housing Bubble

The Federal government and Federal Reserve are trying to inflate another housing bubble to save the "too big to fail" banks from a richly deserved day of reckoning.

If we want to understand why the U.S. government is doing its best to inflate another housing bubble, we must start with the Devil's Pact partnership of the government and the "too big to fail" banks. Simply put, the TBTF banks would not exist without the Federal Reserve and Federal government bailouts, subsidies and protection from transparent marked-to-market pricing of the banks' collateral and risk.

The basis if this partnership is simple: the banks' enormous profits and financial power have enabled them to capture the regulatory machinery of the government (the Central State) and the political machinery controlled by its elected officials.

To understand the true meaning of the housing bubble, we need to understand how banks reap outsized profits. In classic capitalism, banks earn profits by maximizing the allocation of capital. In practical terms, this means lending money to low-risk, high-growth, high profit-margin enterprises, and avoiding lending to high-risk, low-margin enterprises.

In the industrial era, banks reaped profits by funding large, centralized industrial corporations. In the post-industrial economy, banks began skimming huge profits from credit cards and other consumer loans. Mortgages remained a low-risk, low-yield business that operated more like a utility than an investment bank.

When domestic opportunities for profit shriveled in the stagflationary 1970s, U.S. banks went international, loaning billions of dollars to South American nations at high rates of interest. The money-center banks assumed that sovereign debt (i.e. loans to governments) were low-risk. These loans generated enormous profits for the banks, until the unthinkable happened: the debtor-nations defaulted on their sovereign debt.

The Federal government and the Federal Reserve had to step in and save the banks from the consequences of their faulty risk assessment and rapacious pursuit of high-risk, high-yield profits.

By the 1990s, the new knowledge economy corporations had little need for bank credit. 

Technology companies generated so much cash, they either didn't need bank loans or if they chose to borrow money, they did so via the corporate bond market. Having already tapped almost every qualified borrower with a mortgage, auto loan or credit card, the big U.S. banks had once again run out of highly profitable markets to exploit.

The government and Fed-created housing bubble handed the big banks a new market to exploit: high-yield mortgages to marginally qualified buyers guaranteed by Federal agencies (Fannie Mae, Freddie Mac, FHA, VA, etc.), i.e. subprime mortgages.

Federal agencies loosened lending standards so those who by prudent risk-management would not qualify for mortgages were now able to borrow vast sums with little or no money down, and the Fed pushed interest and mortgage rates down to lows not seen in generations in the wake of the dot-com bust of 2000.

For PR purposes, this vast expansion of bank lending was sold as a high-minded extension of the "ownership society" (i.e. homeownership) to those households who had previously been denied the opportunity to become debt-serfs due to unfairly tight lending standards. In reality, the entire "ownership society" campaign masked the true intent, which was to open new and unexploited territory for the big U.S. banks to plunder.

Even better (from the bankers' point of view), loosened regulations and oversight enabled banks to carve up mortgages into tranches that were then bundled into mortgage-backed securities (MBS) that could be peddled worldwide as "safe" investments for pension funds, townships, insurance companies, etc.

The housing bubble enabled big banks to skim tens of billions of dollars in profits from originating mortgages to marginal buyers and securitizing mortgages into MBS. This is the heart of what I call the Neocolonial Model of Financialization: rather than make risky sovereign-debt loans to international borrowers, the big U.S. banks came home and exploited the low-risk domestic housing/mortgage market.

When the bubble burst, as all speculative bubbles eventually do, the banks were rendered insolvent: their collateral (the mortgaged housing) had lost much of its value, and mortgages that had been sold as essentially risk-free were revealed as defaults waiting to happen.

The Fed and Federal government immediately stepped in to save their treasured partner, the parasitic banking sector, from righteously earned destruction. The bailouts, guarantees and backstops totaled about $23 trillion, roughly 150% of the entire American Gross Domestic Product (GDP), and roughly twice the 2008 value of all U.S. residential mortgages (almost $12 trillion).

The housing index has yet to decline to an inflation-adjusted pre-bubble level: valuations are still higher than they were before the bubble.

To enable the TBTF banks to once again skim billions in profits, the Federal government and Federal Reserve immediately began trying to reflate the housing bubble. Tax credits were lavished to new home buyers, mortgaged rates were driven even lower, and the Fed began buying $1+ trillion of private mortgages.

The first tax-credit frenzy faded once the credits expired, but the Fed's zero-interest-rate policy (ZIRP) gave investors no choice but to put their money in risky assets: stocks, high-risk corporate bonds or residential housing. As we can see in this year-over-year percentage chart of the Case-Shiller Index, these policies have sparked another spike up in housing prices (restricting inventory played a key role in this, of course).

As a result, the housing bubble is alive and well in markets such as Los Angeles:

If you have any doubts that the banking sector dearly loved the housing bubble, take a look at this chart and note that mortgage debt more than tripled during the bubble. For context on the enormity of that $8.2 trillion expansion of mortgage debt:that $8.2 trillion is three times the 2005 GDP of Europe's largest economy, Germany. (The GDP of Germany in 2005 was $2.7 trillion.)

Thanks to writeoffs and writedowns, mortgage debt has declined in recent years, but we need to remember that if pre-bubble growth trends in population and housing valuations had remained in place, total mortgage debt in the U.S. would be around $5 trillion, not $10 trillion. The $1 trillion writedown in mortgage debt is just the start; we only need to write down another $5 trillion to get back to a non-bubble level of debt.

Meanwhile, total consumer debt has barely budged. In other words, that $1 trillion reduction in mortgage debt has been offset with rising student loans, auto loans and other consumer debt. 

The total debt load on U.S. households remains at bubble levels, more than twice the debt owed in 2000. Population growth since 2000 accounts for 9.7% of this additional debt, meaning that if debt had risen at pre-bubble rates, total debt would be around $6.5 trillion rather than $13 trillion.

Recall that adjusted income for most households has declined sharply since 2000.So the Fed's zero-interest rate policy is simply a holding action that enables over-indebted households to keep making their debt payments to the banks.

Many people claim the Federal government and Federal Reserve are trying to inflate a new housing bubble to trigger a new "wealth effect," i.e. people seeing their home equity rising once again will feel encouraged to borrow and blow money like they did in 2001-2008.

But if we look at current income (down) and debt levels (still high), there is little hope for a renewed wealth effect from housing. That leaves us with this conclusion:

The Federal government and Federal Reserve are trying to inflate another housing bubble to save the "too big to fail" banks from a richly deserved day of reckoning.

To read more on this subject:

The E.U., Neofeudalism and the Neocolonial-Financialization Model (May 24, 2012) 

---

Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

1. Debt and financialization
2. Crony capitalism and the elimination of accountability
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

Kindle edition: $9.95       print edition: $24 on Amazon.com
To receive a 20% discount on the print edition: $19.20 (retail $24), follow the link, open a Createspace account and enter discount code SJRGPLAB. (This is the only way I can offer a discount.)

Thank you, David B. ($50), for your splendidly generous contribution to this site -- I am greatly honored by your support and readership.

Thank you, Richard C. ($5), for your most generous contribution to this site --I am greatly honored by your support and readership.

Read more...

Part 43: Finally Free to Live Large (serialized fiction)

Here is this week's chapter of my serialized comic novel "Four Bidding For Love."(Those who find absurdist humor and adult situations offensive, please read no further.)

     Upstairs, Ross was putting the last hurried touches on the evening meal: spaghetti tossed with olive oil, steamed eggplant and parmesan cheese, served with plump scallops pan-fried in butter.
     His mood, already bolstered by the arrival of the much-anticipated invitation to display his collection at the Vintage Appliance World extravaganza in Las Vegas, was further raised by his happy anticipation of Alexia's pleasure with the meal he'd prepared for her.
     A bottle of crisp chilled sauvignon blanc on the counter sweated in the steamy atmosphere of the kitchen, and as Ross rushed to smooth the red tablecloth and set the table, the front door opened and Alexia offered a warm greeting at the savory scent filling her home.
     Ross dropped Hanover the last of his allotted scallop, and then Alexia swept in to kiss his cheek and peek into the pot on the stovetop. Just as she's hoped, Ross could not avoid gazing at the enticing curves celebrated by her tight green dress.
     "Do you cook like this every night?" she marveled, and Ross took off the borrowed striped green apron with a shrug. "No, but you're inspiring me."
     Taking in his wildly cheerful Jamaican-themed shirt and bashful expression, she murmured, "And you're inspiring me—to forget my diet."
     "It's all healthy," he protested, and she replied, "I know. It's just—"
     Unable to give voice to her happiness, she turned to the counter and poured the white wine into the waiting glasses. "To our health," she said, and after wiping his damp brow Ross turned to meet her toast.
     Still worried that she might find him unattractive in the unforgiving glare of fluorescent bulbs, Ross lit the candles and turned off the overhead light, never sensing that despite the success of the little green dress Alexia welcomed the dim flickering illumination as much as he, for much the same reason. Was the magic of the previous evening still theirs to claim?
     As the wine, seared scallops and savory eggplant worked their soothing magic, Ross's mood lightened and then left the clay of Earth in a rising expansiveness.
     "I know this sounds incredibly foolish, but getting burned out of my home was immeasurably the best thing that ever happened to me," he confided.
     As Alexia's eyes widened in surprise, his sauvignon-blanc-infused enthusiasm broke whatever feeble restraints discretion had offered, and he avowed, "The first and most important reason, of course, is you. Without the fire I would never have found the amazing person that is you."
     His tablemate blushed at this wine-soaked but sincere praise and he continued in a low voice animated by the tingling fibers of his core being. "But the fire also freed me from the. . . I don't know, prison sounds harsh, but constraint is too weak . . . the shackles of the ordinary."
     Stuffing a fat scallop glistening with butter into his mouth, Ross chewed contentedly for a moment and then set his fork down to stare contemplatively at his condensation-beaded chilled glass of sauvignon blanc.
     "You see, I'm finally free to live large. And I mean everything: starting a new business, living in the Alaskan wilds for a summer, kayaking on the open sea, learning how to make dim sum from a Chinese master—nothing is off the boards. Everything I'd let slip away will be taken to new levels—starting with cooking." He raised his wine glass in a salute, took a long draught and then leaned across the table with conspiratorial glee. "I'm heading to a trade show which will catapult me out of the doldrums."
     "Really?" Alexia asked politely. "In what field?"
     With unsuppressed triumphalism Ross replied, "Toasters. Just as you've put together an outstanding collection of dolls and film posters, I've assembled a kitchen appliance collection which will cut through the field like a welding torch through cardboard."
     Alexia's expression of gentle sympathy sharpened and she asked, "That wouldn't be the vintage show in Las Vegas, would it?"
     "Yes, that's the one—the Vintage Appliance World. Don't tell me you're interested in small appliances, too?"
     The odds of happening upon a man who shared her interest in kitchen collectibles seemed low to Alexia, and with an uneasy alarm she recalled that the hatchet-wielding menace Ross Suchard shared the same hobby. It was unfair to assign a worrisome eccentricity to every guy who collected small appliances, she reminded herself, and with a slight, coy grin she replied, "We seem to stumble upon serendipity at every meal. I do have an interest in collectable kitchenware."
     "I'd love to see your collection," Ross responded, and though his intuition sparked once again at the peculiar parallel of her interests with the loathsome GreenDollGal, the candlelit mood and wine softened this alarming similarity.
     "Oh, it's just a few items," she said dismissively, and then added as if by after-thought, "You don't happen to have an interest in knives or axes, do you?"
     "None whatsoever," Ross replied with a shiver of disgust. "I have absolutely zero interest in collecting sharp pointy things."
     Thus reassured, Alexia enthused, "I found the most adorable vintage butter molds recently, hand-carved in wood."
     "You must show me," Ross declared, and after some additional coaxing Alexia arose to retrieve the elongated wooden molds from the cupboard. "Beautiful," Ross murmured as he examined the old implements, but his frown was not one of concentration. For he'd instantly recognized them as Chinese mooncake molds, not butter molds, and he debated whether to illuminate his love with this knowledge or let it lie as a trivial but potentially annoying show of superior knowledge. Sitting back in a contemplative pose, he said, "You must have your own living-large dreams."
     Alexia smiled in shy hesitation, and Ross said encouragingly, "They're safe with me, for I think it's stupendously important to share one's dreams."
     "Well, I do have one small hope," Alexia began uncertainly. "If I can sell my little appliance collection at the show, then I'll have enough money to buy that trove of rare film posters I mentioned. And from that—" she paused to sigh—"I might just be able to make enough to pay off the mortgage on this flat."
     Raising his glass in a toast, Ross gushed admiringly, "An excellent goal and I'm sure you will succeed."
     Alexia allowed herself an embarrassed smile. "It's a small dream."
     "No dream is small," Ross said with heartfelt sincerity, and the two continued their meal in the intimacy of secret hopes revealed.

Next: A Shocking Revelation (Chapter 12)

To read the previous chapters, visit the "Four Bidding For Love" home page. 

Read more...

Read This Blog or the Puppy and Kitten Get It

Shameless blackmail is now the standard response of the political class because it has been brilliantly effective at coercing the masses.

Internet mythology is replete with stories of canny blackmailers exploiting our natural empathy for puppies and kittens by running web campaigns that claimed the blackmailer would kill the adorable kitten/puppy displayed if 5,000 people didn't send him $1 each.

It was all a hoax, of course, a shameless ruse that played melodramatically on our fears and sympathies. In the mythology, people responded by sending cash and rewarding the blackmailer.

We see the same effectiveness of melodramatic blackmail everywhere in Status Quo responses to the debt/phantom collateral endgame. If your city faces a shortfall of tax revenues, rest assured the first response of overpaid bureaucrats in City Hall frantic to keep their jobs, pensions and perks will be to slash the hours the library is open.

A 2% reduction in the Federal budget, we're told, will push orphans onto the frigid streets, send our troops into battle without ammo ("gee, Sarge, I coulda taken out that terrorist but we were only issued one clip this month"), and generally shut down every service the public cares about.

The alternative you will never hear about is a reduction in the multiple layers of overpaid bureaucrats in City Hall, the White House staff, the Pentagon, the local school district, etc., etc., etc., or any reduction in funding the parasitic cartels that have captured the machinery of governance. Sickcare remains fully funded, of course, so the cartels can continue to feast on needless duplicative tests, medications that don't work as advertised, $70,000 biopsies, $100,000 hospital visits, and so on.

The Pentagon/National Security State budget has essentially doubled in a decade, but a 2% cut never touches the sclerotic administrative layers of useless meetings, under-assistants to the assistant director, cost over-runs to bloated defense contractors, etc.Instead we're treated to the equivalent of the same old shrill melodrama: give us money or the puppy/national defense/widow/orphan dies!

The same blackmail ruse is being played out again and again in Europe. The European Union is essentially telling Greece, Cyprus, et al. "either pay off our banksters and bondholders or we'll kick you out of the eurozone."

Confounding all reason, the citizens of these indebted countries shrivel in terror at this dread prospect, when they should be cheering that they can exit a neocolonial, neofeudal system of exploitation and extraction.

Political games of blackmail abound. When did this puerile, pathetic melodrama of threatening puppies and kittens (library closures, government shutdowns, closure of useful services to leave the unproductive, overpaid, bloated bureaucracy intact) become standard operating procedure?

It became standard operating procedure when politicos discovered it worked. The public has effectively "trained" the political class to shamelessly frighten and blackmail us at every turn, because we cave into their demands to protect their own power, perquisites and fiefdoms.

Look how easy it is. Consider City Hall, filled with overpaid people plotting their escape to fat pensions and lifetime healthcare coverage, and all they have to do to keep their share of declining tax revenue is close the libraries half the week and order the street repair crews to stand down and let the potholes multiple for a few weeks.

Voila, the taxpayers cave in and re-elect the scoundrels and wastrels, and vote in higher taxes to "save our libraries." Next time, why not ask how many cuts is City Hall taking? How many cuts to bloated pensions and healthcare benefits are being absorbed to save the libraries?

The blackmailers have no skin in the game. The cuts and sacrifices are all imposed on others, and if the house of cards collapses due to their mismanagement, the losses won't fall on the portfolios and pensions of the political class and their Upper Caste of technocrats: others will absorb the losses.

The only way to limit shameless political blackmail is to re-train the politicos by ejecting them all from office. It appears at least a third of Italian voters now understand that, having voted for a true outsider (Grillo); now the rest of the nominal democracies need to follow the same path.

Vote down all tax increases until the political class absorbs 40% cuts in staffing, salaries, pensions and healthcare coverage.

Blackmail has even seeped into spheres like Public television, where we're threatened with another week of retread 1950s music, ways of dodging dementia and other Baby Boomer material designed to force us to donate lest we get another week of the Three Tenors and endless pitches from earnest PBS boosters.

Give us money or your favorite program dies. Fair enough, but how tight a ship are you folks running at the top? How many expense accounts and travel junkets do you at the top enjoy? What sort of cuts are you absorbing first before blackmailing us with re-runs of gray-haired ponytailed guys jiggling their spare tires?

One last thing: buy my book Why Things Are Falling Apart and What We Can Do About It or the puppy and kitten get it. I really really mean it.

---

Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

1. Debt and financialization
2. Crony capitalism and the elimination of accountability
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

Kindle edition: $9.95       print edition: $24 on Amazon.com
To receive a 20% discount on the print edition: $19.20 (retail $24), follow the link, open a Createspace account and enter discount code SJRGPLAB. (This is the only way I can offer a discount.)

Thank you, Steven N. ($50), for your monstrously generous contribution to this site -- I am greatly honored by your steadfast support and readership.

Thank you, Amy C. ($56), for your monumentally generous contribution to this site --I am greatly honored by your steadfast support and readership.

Read more...

What Could Cause Interest Rates to Rise?

There is an interesting paradox at work as central banks suppress interest rates.

Correspondent Mark H. recently asked: "What is your take on what the outcome will be if/when interest rates start rising?" Let's break this excellent question into two parts: 

1) what might cause rates to rise, and
2) what consequences will likely result from rising rates/yields?

There are two articles of faith in the central-bank religion:

1) We can keep interest rates near-zero for as long as we deem necessary, and

2) We can suppress inflation at will, too.

The question is: can they do both at the same time for as long as they wish?

If either interest rates or inflation (and they are correlated) start rising, the central banks' claims of control evaporate.

There is an interesting paradox at work here:

The only way central banks can keep interest rates low is to buy the bonds issued by their respective governments, i.e. monetize the sovereign debt. They do this by creating money out of thin air, i.e. expanding their balance sheet with government bonds and other debt instruments such as home mortgages.

Theoretically, the Federal Reserve could continue to artificially suppress rates by expanding its $3 trillion balance sheet to $30 trillion.

Since there is an unlimited buyer for low-yield bonds (the central banks), there is no market pressure for higher rates. Why raise yields when you can sell trillions of dollars of low-yield bonds to the Federal Reserve, Bank of Japan, etc.?

By buying the new debt with newly created money, the central banks have marginalized the market's ability to transparently price risk and credit: the bond market has in effect been captured by the central banks, who can counter any reduction in demand with newly created money.

But the central banks don't control where all this newly issued money goes. If it goes into the real economy, it triggers inflation; if it goes into assets, it inflates asset bubbles.

Inflation and bubbles have consequences. Inflation eats away at the purchasing power of wages, and since interest rates are already near-zero, the central banks' game of enabling lower payments by lowering interest rates has run out of room. Once inflation kicks up, the central banks will not be able to fight it except by raising rates, which will quickly choke off consumer spending and the auto and housing markets.

If the central banks keep pumping money into asset bubbles, they are playing with a ticking time bomb, as every asset bubble in history eventually pops: the bigger the bubble, the more spectacular the implosion. The more the central banks inflate assets, the deeper the eventual crash.

Inflation and asset crashes share one characteristic: they undermine the credibility of the central state and central bank. The Federal Reserve and other central banks have claimed monetary omnipotence for years, and they have staked their credibility on keeping inflation and interest rates low and boosting the prices of assets such as stocks and bonds.

Higher rates undermine both stocks and bonds. Every existing bond loses market value as rates climb, and the reason to own a stock paying a 2% dividend fades rather quickly when bonds start paying 5+%. Needless to say, rising rates that choke off consumption won't be positive for corporate profits, either.

In other words, the central banks can't have it both ways. If they keep printing money (expanding their balance sheets), the new money will go somewhere. If it goes into the real economy (no sign of that yet), the flood of new cash will spark inflation in at least those resources and goods where labor costs are not the primary factor (oil and agricultural commodities, for example).

Since labor is in over-supply (see How I Became a Trillionaire (and Some Thoughts on Inflation), this will not be the sort of inflation where wages will rise along with the cost of goods and services: wages will continue to stagnate as costs of essentials rise. That is a recipe for stagflation and recession.

If the flood of central-bank money continues flooding into assets, eventually it chases essential commodities such as oil and grain, sparking inflation via the back door, not from supply-demand issues but from money-printing-driven speculation.

All the central-bank inflated asset bubbles will pop, impoverishing those who gambled with debt (margin) and triggering yet another financial crisis.

Only this time, the shell-shocked survivors will know who created the crisis: the supposedly omnipotent central banks. With their credibility shredded and the failure of their policies visible to all, the central banks' will no longer have the political power to prop up a parasitic financial sector and monetize every debt in sight.

Many commentators take the dazzling "independence" of central banks at face value, but central banks are like any other political institution: their independence is contingent on their success at propping up and enriching the status quo Elites and their armies of well-paid apparatchiks and suppressing rebellion of the lower 90%. Should they fail, their independence will be revealed as illusory as the collateral on their balance sheets.

In other words, what will cause interest rates to rise is central banks' failure to permanently suppress market forces, and the loss of credibility that will result from their failure to do so.

As to the consequences of higher rates: in a debt-dependent economy, they will be about as welcome as a chunk of Kryptonite under Superman's Christmas tree.

New podcast: Charles Hugh Smith on Income Levels & Structural Changes in the US Economy: a conversation with Mike Swanson of Wall Street Window. 

---

Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

1. Debt and financialization
2. Crony capitalism and the elimination of accountability
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

Kindle edition: $9.95       print edition: $24 on Amazon.com
To receive a 20% discount on the print edition: $19.20 (retail $24), follow the link, open a Createspace account and enter discount code SJRGPLAB. (This is the only way I can offer a discount.)

Thank you, William M. ($50), for your monstrously generous contribution to this site -- I am greatly honored by your support and readership.

Thank you, Steve S. ($5/month), for your hugely generous subscription to this site --I am greatly honored by your support and readership.

Read more...

How I Became a Trillionaire (and Some Thoughts on Inflation)

Some thoughts on being a trillionaire and inflation.

Reader gratitude is always appreciated here at oftwominds.com, but imagine my delight when correspondent Paul Wegzyn gifted me with $100 trillion. Wow--I'm a trillionaire! Since Paul was visiting the San Francisco Bay Area, he presented me with my $100 trillion bill in person. Paul is holding up another form of paper money, a $100 Federal Reserve note:

These photos illustrate the fundamentally arbitrary nature of fiat (paper) money.Why do we prefer the $100 greenback over the $100 trillion note issued by the Reserve Bank of Zimbabwe? The purchasing power of the Benjamin far exceeds the purchasing power of the $100 trillion bill.

But the Benjamin is not immune to inflation; the dollar has lost about 95% of its 1900 purchasing power.

Why hasn't this massive reduction in purchasing power impoverished us? All other things being equal, such a massive reduction in purchasing power means we can buy a lot less with our money.

The answer is that our incomes rose even faster than inflation. If it now takes $20,000 to buy what $1,000 bought in 1900, and we earn $30,000, despite the horrendous decline in the purchasing power of the dollar, the purchasing power of our income has gone up by 50%.

If wages rise along with inflation, then we don't experience any loss of purchasing power as zeroes are added to our fiat currency. If wages increase at a rate above that of inflation, we gain purchasing power. If wages increase at a rate below that of inflation, we lose purchasing power.

It is generally accepted that official measures of inflation do not reflect the "real" decline in purchasing power. Nonetheless, it's instructive to ponder the consequences of understated official inflation on the purchasing power of income. Let's turn to the Bureau of Labor Statistics (BLS) inflation calculator.

It now takes $1.35 to buy what $1 bought in 2000. Many wage-earners have received modest increases in their earnings over the past 12 years. Let's say someone received a cumulative wage increase of 15% since 2000. Measured in purchasing power, their income has declined by roughly 20% in a mere 12 years.

If we use alternative measures of inflation, the decline is more on the order of 30%.

Consider the rising costs of higher education and healthcare: These major lifetime expenses have skyrocketed far above the modest 35% official inflation rate since 2000.

This raises another question: what causes money to lose purchasing power? The basic answer is that all fiat money--paper, electronic, credit-money, etc.--is ultimately a claim on a real-world income stream, resource, good or service.

If we print/create ten times more money, we cannot print ten times more oil, cans of beans, concrete, etc., and so the nominal price of the real-world goods rises ten-fold.

If the money supply rises along with the increase in production of goods and services, then inflation is close to zero. This was the case for much of the 19th century in Great Britain.

If there is insufficient money in circulation to fund new enterprises and trade, the economy stagnates. The solution to this is credit: trade credit, loans, etc.

Used wisely, credit leverages productive growth in a cash-starved economy. When credit is expanded in near-infinite quantities at low interest rates, however, borrowed money flows into unproductive mal-investments. These go bust and the debtor is left with the interest payments. As a result, massive expansion of credit also leads to stagnation as more income is devoted to debt service and capital accumulation dwindles.

Since the Federal Reserve has been "printing money" by expanding its balance sheet, why aren't we experiencing higher inflation? Setting aside the possibility that the official statistics are rigged to suppress the real rate of inflation, there are several other factors at work:

1. If money is being destroyed by bankruptcies, writedowns, etc. at the same time it is being created, the money supply will only expand if the new money exceeds the money that has vanished. Indeed, if $10 trillion has disappeared from the net-asset ledger, then printing/creating $3 trillion isn't going to do anything but replace a portion of the destroyed money.

2. It depends on who gets the freshly created money. If all the new money/credit is flowing to the top 5% who already own most of the financial wealth, then it's difficult for demand from this small slice of society to create widespread inflation.

If the interest rate is near-zero, then all those owning money are losing purchasing power, as official inflation is running at 3% and their yield on savings is less than 1%.

As a result, those with money are seeking a higher yield. They are buying high-dividend stocks, rental housing, high-yield corporate bonds, etc. This generates asset bubbles in all asset classes that pay a yield above 1%.

In other words, if the new money flows to the wealthy, then all it does is inflate asset bubbles.

If the Federal Reserve created $1 trillion and distributed it in cash to 100 million households, it might increase demand for goods and services and spark inflation. But if the $1 trillion is only available to a handful of corporations and super-wealthy families, then it can't spark demand-driven inflation in anything but a handful of ultra-luxury goods.

3. It depends on the capacity to produce goods and services. The global economy is burdened with over-capacity: the capacity to produce steel, autos, flat-screen TVs, etc., far exceeds demand. Even if the Fed ordered 10 million new TV sets to be given away, this would not generate much inflation because existing factories could churn out the extra 10 million without even reaching full capacity.

As for services--there is an over-supply of labor in virtually every sector, even ones that have traditionally been restricted: the demand for more lawyers is low, dentists' waiting rooms are often empty, and so on. In other words, a vast over-capacity also exists in most of the service sector.

4. It depends on values and priorities. Let's say the Fed created enough money to give each household $10,000 in cash--the famed "helicopter drop" of money. If most households saved the windfall or used it to pay down existing debt, very little of it would flow into the economy as demand for goods and services. The inflationary effect of all this new money would be essentially nil.

We can use the velocity of money as a measure of this dynamic:

5. Cartels raise prices at will; this is not inflation. Cartels by definition have extinguished real competition (i.e. exposure to market discovery of price), and as a result they raise prices across their industry with impunity. In the U.S., healthcare, education, and defense (to name but three of many) are all cartels. As a result, costs in these industries never go down, they only skyrocket.

This is not inflation due to an increase in money supply, it is a transfer of purchasing power and wealth from households to the cartels that superficially looks like inflation.

If 95% of households are experiencing a loss of purchasing power and most of the new money and credit are flowing to the top 5%, you get asset bubbles, not demand-driven inflation. When 95% of the households are poorer in terms of purchasing power and financial wealth, where can demand-driven inflation arise in a global economy of massive manufacturing and labor over-capacity?

The rise in costs within industries controlled by cartels (healthcare, higher education, defense, etc.) may look like demand-driven inflation, but are actually transfers of wealth and purchasing power from households to the government-protected cartels.

Thank you, Paul, for the thrill of being a trillionaire, and for generously treating me to lunch. 

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Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

1. Debt and financialization
2. Crony capitalism and the elimination of accountability
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

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