In an effort to avoid another 1970’s style malaise the Federal Reserve is steering us towards a 21st century version
Economists are coming to increasing agreement that a recession is on the way, probably early in 2023. And inflation is raging, outpacing recent wage increases by about 5%.
This isn’t any surprise; it’s been on the way since the Great Recession of 2008.
That’s when our economy was fundamentally changed by Wall Street financiers and the Federal Reserve. In an effort to avoid another calamity like 2008 these men and women monkeyed with our money system, artificially inflating stock values and made borrowing money cheaper than saving money. This led to the devaluation of the dollar — another way of saying inflation.
Ironically, they may have lit the fuse on a new economic meltdown…
The most powerful weapon they use is quantitative easing. It’s the modern version of printing money. (The Weimar Republic offers an example of how money printing can spiral out of control.)
You may have heard the phrase, or its acronym, QE followed by a number for each iteration. Simply put, quantitative easing means flooding the stock market with unimaginable amounts of money that has been created out of thin air. It is done by buying US Treasury bonds from huge banks.
A bond is a debt instrument…
You may have heard about school bonds. School districts raise money by issuing bonds that promises to pay back the issuer the amount of the bond, plus interest at a future date. The bond goes on the market and investors buy portions of it. Anyone can buy bonds.
Treasury bonds are used by the Federal government to raise money to fund the government. They are called Treasury bonds because they are issued by the US Treasury. When you hear about the national debt you are hearing about how much money the federal government owes, mostly in Treasury bonds.
US Treasury bonds are very popular throughout the world because they are a safe bet — the United States is the richest country in the world and has never defaulted on its debts. International banks and corporations buy US Treasuries, as do other countries, sometimes in huge amounts. Financial advisers suggest that 40% of your investment portfolio should be in US Treasury bonds because they are a very safe investment.
The Federal Reserve uses US Treasury bonds to inject cash into the economy. Here’s how…
A bond trader at the Federal Reserve calls his counterpart at one of the gigantic banks like JP Morgan Chase, Wells Fargo or Citibank and offers to buy Treasury bonds. Say 50 million dollars’ worth. The bank representative says “Sure”. The Fed trader makes an entry into a computerized ledger and 50 million dollars — created out of thin air — appears in the banks’ reserve account held by the Fed. The bank can loan to big Wall Street players at little or no interest who use that money to buy stocks, bonds and derivatives (more on derivatives in a moment).
Before 2008 large corporations were using Treasury bonds to park their money instead of investing in new businesses or expanding their operations and creating new jobs. Buying back Treasuries was intended to encourage economic expansion and generate widespread prosperity.
It’s not working out that way…
Large corporations had tons of free cash and used it to buy back their own stocks, driving up the value of the remaining shares. They also bought out competitors, creating near monopolies in many industries. That kind of concentration raises prices, lowers employment and stifles innovation.
They also got involved in risky and complex financial shenanigans. After all, with all that free money coming from the Fed the consequences of a deal going bad were nonexistent. If they lost a pile of cash the Fed would soon be announcing another round of quantitative easing.
Things quickly changed in the stock market…
First, stocks became highly inflated. They are worth far less than their posted value. That’s because the money used to buy them appeared because of a few keystrokes, not because of underlying value of the stock.
That’s called a bubble when it happens any place else. The Dow Jones average quadrupled from 8,700 in 2008 to 36,000 in 2022, largely because of the hundreds of billions of dollars the Fed created and injected into it.
(The Dow Jones Stock Exchange is one of several stock markets often used to measure the health of the commercial economy. Others are Standard and Poor’s — also called the S&P 500 — and the New York Stock Exchange, the biggest in the world.)
Another development was the rise of “shadow banking”…
Private corporations spring up offering loans and insurance for all sorts of creative financial ventures, largely unfettered by the regulations in the commercial banking industry. This sparked a new word describing the creation and trading of new instruments, “financialism”.
(Rana Foroohar covers financialism in her book Makers and Takers.)
Here is a simple example of how shadow banking works…
Let’s say you and your wealthy friends chip in, create a fund of a million dollars give it a name. Let’s call it ShadowVentures. Next, loan the money out to Wall Street players, then package those loans into groups according to risk. Sell portions of those loans to other Wall Street players.
Most of us think of loans as a liability — a bill to pay. But loans are assets for those who own them. They have future value. Buying a loan is an entitlement to payments that creates a steady income stream. It’s a great way to make money, but there is a risk. Sometimes people can’t pay their loans.
So you and your partners offer insurance to the owners of the loans. The riskier the loan package, the higher the premium. Now sell shares of the insurance operation.
And so it goes. That’s derivatives.
You and your partners in ShadowVentures make a ton of money in a short time, thanks to the Fed making saving and traditional investment a losing game. Lots of money is poured into these kinds of ventures. But at the same time it’s a house of cards. As soon as the economy slows down a bit the whole scheme collapses and the Fed starts pumping more money into the market to prevent huge losses or possibly even a widespread collapse in overall market value.
So here we are. Quantitative easing and cheap money have led to…
…an inflated stock market, no saving or investment, out of control inflation, lack of consequences for risky ventures, financialism, shadow banking…
Sooner or later the bill on all this comes due. That’s why a recession is on the horizon.
If we want to correct these excesses, our financial system has to change at a very basic levels. Those radical changes would involve long term pain. Many people would become impoverished. Our standard of living would decrease even more than it already has before getting better.
But it might be the only way to reform our financial system to a place where it can stimulate general prosperity again.
To learn more about how we got to where we are check out these books. You don’t need a PhD in Economics to get through them.
Inflation: What It Is, Why It’s Bad, and How to Fix It
The Lords of Easy Money: How the Federal Reserve Broke the American Economy
Makers and Takers: How Wall Street Destroyed Main Street
Crisis Economics: A Crash Course in the Future of Finance
The Only Game in Town: Central Banks, Instability, and Recovering from Another Collapse
Read more at VicNapier.com and my Medium.com page.
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