bernanke

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Should the Rich Pay More Taxes?

It’s a multi-dimensional question.

The left says yes — income inequality has soared in recent years, and the way to address it (supposedly) is to tax the rich and capital gains at a higher rate. The right says no — that the rich already create more jobs and wealth, because they spend more money, and why (supposedly) should they pay more tax when they already pay far higher figures than lower-income workers?

Paul Krugman made the point yesterday that the tax rate on the top earners during the post-war boom was 91%, seeming to infer that a return to such rates would be good for the economy.

Yet if we want to raise more revenue, historically it doesn’t really seem to matter what the top tax rate is:

Federal revenues have hovered close to 20% of GDP whatever the tax rate on the richest few.

This seems to be because of what is known as the Laffer-Khaldun effect: the higher rates go, the more incentive for tax avoidance and tax evasion.

And while income inequality has risen in recent years, the top-earners share of tax revenue has risen in step:

So the richest 1% are already contributing around 40% of the tax revenue, taxed on their 34% share of the national income. And even if the Treasury collected every cent the top 1% earned, America would still be running huge deficits.

Yet the Occupy movement are still angry. A large majority of Americans believe the richest should pay more tax. More and more wealthy Americans — starting with Warren Buffett, and most recently Stephen King are demanding to pay more taxes.

King writes:

At a rally in Florida (to support collective bargaining and to express the socialist view that firing teachers with experience was sort of a bad idea), I pointed out that I was paying taxes of roughly 28 percent on my income. My question was, “How come I’m not paying 50?”

How come? Well, the data shows pretty clearly that it’s unlikely that revenues would increase.

They may have a fair point that capital gains above a certain threshold should probably be taxed at the same rate as income, because it is effectively the same thing. And why should government policy encourage investment above labour by taxing one more leniently?

But more simply, people like King think the status quo  is unjust far beyond the taxation structure. A lot of people are unemployed:

A lot of people are earning less than they were five years ago:

28% of homeowners are underwater on their mortgages. Millions of graduates face a mountain of student debt, while stuck in dole queues or in a dead end job like Starbucks.

We live in dark times.

From Reuters:

Nearly 15 percent of people worldwide believe the world will end during their lifetime and 10 percent think the Mayan calendar could signify it will happen in 2012, according to a new poll.

With all this hurt, there’s a lot of anger in society. Those calling for taxing the richest more are not doing the same cost-benefit analysis I am doing that suggests that raising taxes won’t raise more revenue.

But they’re not unfairly looking for a scapegoat, either. While probably the greatest culprits for the problems of recent times are in government Americans are right to be mad at the rich.

Why?

This isn’t about tax. This is about jobs, and growth.

The rich, above and beyond any other group have the ability to ameliorate the economic malaise by spending and creating jobs, creating new products and new wealth. The top 1% control 42% of all financial wealth. But that money isn’t moving very much at all— the velocity of money is at historic lows. It should not be surprising that growth remains depressed and unemployment remains stubbornly high.

And every month that unemployment remains elevated is another month that the job creators are not doing their job. Every month that the malaise festers, the angrier the 99% gets.  It is, I think, in the best interests of the rich to try and create as many jobs and as much wealth as they can.  A divided and angry society, I think, will find it even more difficult to grow and produce.

America needs the richest Americans to pay more tax dollars — but as a side-effect of producing more, and creating growth.

If the private sector doesn’t spend its way out of the current depression, eventually the government will have to, of course. But it can do that with borrowed money, not taxed money.

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Krugman, Diocletian & Neofeudalism

The entire economics world is abuzz about the intriguing smackdown between Paul Krugman and Ron Paul on Bloomberg. The Guardian summarises:

  • Ron Paul said it’s pretentious for anyone to think they know what inflation should be and what the ideal level for the money supply is.
  • Paul Krugman replied that it’s not pretentious, it’s necessary. He accused Paul of living in a fantasy world, of wanting to turn back the clock 150 years. He said the advent of modern currencies and nation-states made an unmanaged economy an impracticable idea.
  • Paul accused the Fed of perpetrating “fraud,” in part by screwing with the value of the dollar, so people who save get hurt. He stopped short of calling for an immediate end to the Fed, saying that for now, competition of currencies – and banking structures – should be allowed in the US.
  • Krugman brought up Milton Friedman, who traversed the ideological spectrum to criticize the Fed for not doing enough during the Great Depression. It’s the same criticism Krugman is leveling at the Fed now. “It’s really telling that in America right now, Milton Friedman would count as being on the far left in monetary policy,” Krugman said.
  • Paul’s central point, that the Fed hurts Main Street by focusing on the welfare of Wall Street, is well taken. Krugman’s point that the Fed is needed to steer the economy and has done a better job overall than Congress, in any case, is also well taken.

I find it quite disappointing that there has not been more discussion in the media of the idea — something Ron Paul alluded to — that most of the problems we face today are extensions of the market’s failure to liquidate in 2008. Bailouts and interventionism has left the system (and many of the companies within it) a zombified wreck. Why are we talking about residual debt overhang? Most of it would have been razed in 2008 had the market been allowed to liquidate. Worse, when you bail out economic failures — and as far as I’m concerned, everyone who would have been wiped out by the shadow banking collapse is an economic failure — you obliterate the market mechanism. Should it really be any surprise that money isn’t flowing to where it’s needed?

A whole host of previously illiquid zombie banks, corporations and shadow banks are holding onto trillions of dollars as a liquidity buffer. So instead of being used to finance useful and productive endeavours, the money is just sitting there. This is reflected in the levels of excess reserves banks are holding (presently at an all-time high), as well as the velocity of money, which is at a postwar low:

Krugman’s view that introducing more money into the economy and scaring hoarders into spending more is not guaranteed to achieve any boost in productivity.

As I wrote last month:

The fundamental problem at the heart of this is that the Fed is trying to encourage risk taking by making it difficult to allow small-scale market participants from amassing the capital necessary to take risk. That’s why we’re seeing domestic equity outflows. And so the only people with the apparatus to invest and create jobs are large institutions, banks and corporations, which they are patently not doing.

Would more easing convince them to do that? Probably not. If you’re a multinational corporation with access to foreign markets where input costs are significantly cheaper, why would you invest in the expensive, over-regulated American market other than to offload the products you’ve manufactured abroad?

So will (even deeper) negative real rates cause money to start flowing? Probably — but probably mostly abroad — so probably without the benefits of domestic investment and job creation.

Nor is it guaranteed to achieve any great boost in debt relief.

As Dan Kervick wrote for Naked Capitalism last month:

Inflation only reduces debt overhang in a significant way for households who are fortunate enough to see their nominal wages rise along with the general rise in prices. In today’s economy, workers are frequently not so fortunate.

Again, I have to bring this back to why we are even talking about debt relief. The 2008 crash was a natural form of debt-relief; the 2008 bailouts, and ongoing QE and Twist programs (which contrary to Professor Krugman’s apologetics really do transfer wealth from the middle classes to Wall Street) crystallised the debt burden born from a bubble created by Greenspan’s easy money policies. There would be no need for a debt jubilee (either an absolute one, or a Krugmanite (hyper)inflationary one) if we had simply let the market do its work. A legitimate function for government would have at most been to bail out account holders, provide a welfare net for poor people (never poor corporations) and let bankruptcy courts and markets do the rest. Instead, the central planners in Washington decided they knew best.

The key moment in the debate?

I am not a defender of the economic policies of the emperor Diocletian. So let’s just make that clear.

Paul Krugman

Actually you are.

Ron Paul

Ron Paul is dead right. Krugman and the bailout-happy regime for which he stands are absolutely following in the spirit of Diocletian.

From Dennis Gartman:

Rome had its socialist interlude under Diocletian. Faced with increasing poverty and restlessness among the masses, and with the imminent danger of barbarian invasion, he issued in A.D. 301 an edictum de pretiis, which denounced monopolists for keeping goods from the market to raise prices, and set maximum prices and wages for all important articles and services. Extensive public works were undertaken to put the unemployed to work, and food was distributed gratis, or at reduced prices, to the poor. The government – which already owned most mines, quarries, and salt deposits – brought nearly all major industries and guilds under detailed control.

Diocletian explained that the barbarians were at the gate, and that individual liberty had to be shelved until collective liberty could be made secure. The socialism of Diocletian was a war economy, made possible by fear of foreign attack. Other factors equal, internal liberty varies inversely with external danger.

While Krugman does not by any means endorse the level of centralism that Diocletian introduced, his defence of bailouts, his insistence on the planning of interest rates and inflation, and (most frighteningly) his insistence that war can be an economic stimulus (in reality, war is a capital destroyer) all put him firmly in Diocletian’s economic planning camp.

So how did Diocletian’s economic program work out?

Well, I think it is fair to say even without modern data that — just as Krugman desires — Diocletian’s measures boosted aggregate demand through public works and — just as Krugman desires — it introduced inflation.

Diocletian’s mass minting of coins of low metallic value continued to increase inflation, and the maximum prices in the Edict were apparently too low.

Merchants either stopped producing goods, sold their goods illegally, or used barter. The Edict tended to disrupt trade and commerce, especially among merchants. It is safe to assume that a gray market economy evolved out of the edict at least between merchants.

And certainly Rome lived for almost 150 years after Diocletian. However the long term effects of Diocletian’s economic program were dire:

Thousands of Romans, to escape the tax gatherer, fled over the frontiers to seek refuge among the barbarians. Seeking to check this elusive mobility and to facilitate regulation and taxation, the government issued decrees binding the peasant to his field and the worker to his shop until all their debts and taxes had been paid. In this and other ways medieval serfdom began.

Have the 2008 bailouts done the same thing, cementing a new feudal aristocracy of bankers, financiers and too-big-to-fail zombies, alongside a serf class that exists to fund the excesses of the financial and corporate elite?

Only time will tell.

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Anything the Government Gives You, the Government Can Take Away

From the Guardian:

A majority of doctors support measures to deny treatment to smokers and the obese, according to a survey that has sparked a row over the NHS‘s growing use of “lifestyle rationing”.

Some 54% of doctors who took part said the NHS should have the right to withhold non-emergency treatment from patients who do not lose weight or stop smoking. Some medics believe unhealthy behaviour can make procedures less likely to work, and that the service is not obliged to devote scarce resources to them.

And that’s the trouble with services and institutions run from the taxpayer’s purse, administered by centralists and bureaucrats. It becomes a carrot or a stick for interventionists to intervene in your life. Its delivery depends on your compliance with the diktats and whims of the democracy, or of bureaucrats. Your standard of living becomes a bargaining chip. Don’t conform? You might be deemed unworthy of hospital treatment.

It seems innocuous to promise all manner of services in exchange for taxes. Citizens may welcome the convenience, the lower overheads, the economies of scale. They may welcome a freebie, and the chance to enjoy the fruits of someone else’s labour. They may feel entitled to it.

Many words have been spent on the problems of dependency; that rather than working for an honest living, the poor may be sucked into a vortex of entitlement, to such an extent that they lose the desire to produce. A tax-sucking multi-generational underclass can develop. Individuals can live entirely workless lives, enjoying a semi-comfortable existence on the teat of the taxpayer, enjoying the fruits — financial handouts, free education, free healthcare, a free home — of social engineers who believe that every problem under the sun can be remedied by government largesse and throwing money at problems. And who can blame them? Humans have sought out free lunches for as long as there have been humans.

Welfare dependency is generally assumed to be viewed negatively in the corridors of power. After all, broad welfare programs mean greater spending, and that very often means great debt. And why would a government want to be in debt? Surely governments would prefer it if more of the population was working and productive and paying taxes?

But it is easier to promote behaviour desired by the state when a population lives on state handouts. And for states that might want to influence the behaviour of their citizens — their resource consumption, their carbon footprint, their moral and ethical beliefs, or their attitude toward the state — this could be an attractive proposition. It might cost a lot to run a welfare system, but it brings a lot of power to influence citizens.

And increasingly throughout the Western world, citizens are becoming dependent on the state for their standard of living. In the UK, 92% of people are dependent on the socialist NHS for healthcare. 46 million Americans receive food stamps. That gives states a lot of leverage to influence behaviour. First it may be used in a (relatively sensible) attempt to curtail smoking and obesity. Beyond that, the sky is the limit. Perhaps doctors or bureaucrats may someday suggest withholding treatment or dole money from those who exceed their personal carbon or meat consumption quota? A tyrant could even withhold welfare from those who do not pledge their undying allegiance or military service to a regime or ideology (it happened many times last century). An underclass of rough and hungry welfare recipients is a fertile recruiting ground for military and paramilitary organisations (like the TSA).

With the wide expansion of welfare comes a lot of power, and the potential for the abuse of power. Citizens looking for a free lunch or an easier world should be careful what they wish for. Welfare recipients take note: you depend on government for your standard of living, you open yourself up to losing your liberty.

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Gold’s Value Today

Way back in 2009, I remember fielding all manner of questions from people wanting to invest in gold, having seen it spike from its turn-of-the-millennium slump, and worried about the state of the wider financial economy.

A whole swathe of those were from people wanting to invest in exchange traded funds (ETFs). I always and without exception slammed the notion of a gold ETF as being outstandingly awful, and solely for investors who didn’t really understand the modern case for gold — those who believed that gold was a “commodity” with the potential to “do well” in the coming years. People who wanted to push dollars in, and get more dollars out some years later.

2009 was the year when gold ETFs really broke into the mass consciousness:

Yet by 2011 the market had collapsed: people were buying much, much larger quantities of physical bullion and coins, but the popularity of ETFs had greatly slumped.

This is even clearer when the ETF market is expressed as a percentage of the physical market. While in 2009 ETFs looked poised to overtake the market in physical bullion and coins, by 2011 they constituted merely a tenth of the physical market:

So what does this say about gold?

I think it is shouting and screaming one thing: the people are slowly and subtly waking up to gold’s true role.

Gold is not just a store of value; it is not just a unit of account; and it is not just a medium of exchange. It is all of those things, but so are dollars, yen and renminbei.

Physical precious metals (but especially gold) are the only liquid assets with negligible counter-party risk.

What is counter-party risk?

As I wrote in December:

Counter-party risk is the external risk investments face. The counter-party risk to fiat currency is that the counter-party — in this case the government — will fail to deliver a system where that fiat money will be acceptable as payment for goods and services. The counter-party risk to a bond or a derivative or a swap is that the counter-party  will default on their obligations.

Gold — at least the physical form — has negligible counter-party risk. It’s been recognised as valuable for thousands of years.

Counter-party risk is a symptom of dependency. And the global financial system is a paradigm of interdependency: inter-connected leverage, soaring gross derivatives exposure, abstract securitisations.

When everyone in the system owes shedloads of money to everyone else the failure of one can often snowball into the failure of the many.

Or as Zhang Jianhua of the People’s Bank of China put it:

No asset is safe now. The only choice to hedge risks is to hold hard currency — gold.

So the key difference between physical metal and an ETF product is that an ETF product has counter-party risk. Its custodian could pull a Corzine and run off with your assets. They could be swallowed up by another shadow banking or derivatives collapse. And some ETFs are not even holding any gold at all; they may just be taking your money and buying futures. Unless you read all of the small-print, and then have the ability to comprehensively audit the custodian, you just don’t know.

With gold in your vault or your basement you know what you’re getting. There are other risks, of course — the largest being robbery, alongside the small danger of being sold fake (tungsten-lined) bullion. But the hyper-fragility of the modern banking system, the debt overhang, and the speculative and arbitrage bubbles don’t threaten to wipe you out.

Paper was only ever as good as the person making the promise. But increasingly in this hyper-connected world, paper is only ever as good as the people who owe money to the person making the promise. As we saw in 2008, the innovations of shadow banking and the derivatives system intermesh the balance sheets of companies to a never-before-seen extent. This often means that one failure (like that of Lehman brothers) can trigger a cascade that threatens the entire system. If you’re lucky you’ll get a government bailout, or a payout from a bankruptcy court, but there’s no guarantee of that.

Physical gold sits undaunted, solid as a rock, retaining its purchasing power, immune to counter-party risk.

I think more and more investors — as well as central banks, particularly the People’s Bank of China — are comprehending that reality and demanding the real deal.

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We’re All Nixonians Now

People have got to know whether their President is a crook

Richard M. Nixon

I often wonder who is worse: George W. Bush — the man who turned a projected trillion dollar surplus into the greatest deficits in world history, who bailed out the profligate Wall Street algos and arbitrageurs, who proceeded with two needless, pointless and absurdly costly military occupations (even though he had initially campaigned on the promise of a humble foreign policy), who ignored Michael Scheuer’s warnings about al-Qaeda previous to 9/11, who signed the Constitution-trashing PATRIOT Act  (etc etc ad infinitum) or his successor Barack Obama, the man who retained and expanded the PATRIOT Act powers under the NDAA (2011), who claimed the right to extrajudicially kill American citizens using predator drones, who expanded Bush’s expensive and pointless occupations (all the while having run on a promise to close the Guantanamo Bay detention centre and reverse Bush’s civil liberties incursions), who proceeded with Paulson’s Wall Street bailouts, authorised the NSA to record all phone calls and internet activity, and continued the destructive War on Drugs (even though he had in the past been a drug user).

The answer, by the way, is Richard Nixon. For almost forty years after that man’s resignation, it is arguable that almost every single administration (with the possible exception of  Carter as well as Reagan’s first year in office) — but especially that of Bush and Obama — has been cut from his cloth. It was Richard Nixon who inaugurated the War on Drugs — that despicable policy that has empowered the drug gangs and obliterated much of Latin America. It was Richard Nixon who so brazenly corrupted the White House and tarnished the office of the Presidency through the Watergate wiretapping scandal.  It was Nixon’s administration that created the culture of government surveillance that led directly to the PATRIOT Act. It was Nixon who internationalised the fiat dollar, so trampling George Washington’s warnings about not entangling alliances, and of course setting the stage for the gradual destruction of American industry that continued apace under NAFTA and into the present day, where America runs the greatest trade deficits in human history. It was Richard Nixon who set the precedent of pointless, stupid, blowback-inducing militarism, by continuing and expanding the Vietnam war. It was Richard Nixon whose administration authorised the use of chemical weapons (or as George W. Bush might have put it, “weapons of mass destruction”) against the Vietcong.

Presidents since have followed — to a greater or lesser extent — in his mould. This is particularly acute this election cycle; you vote for Obama and you get Richard Nixon, or you vote for Romney and you get Richard Nixon. Nixon’s words: “we’re all Keynesians now” have a powerful resonance; not only has every administration since Nixon retained the petrodollar standard and spent like a drunken sailor in pursuit of Keynesian multipliers, but every President since has followed in the Nixonian tradition on civil liberties, on trade, on foreign policy. Henry Kissinger — the true architect of many Nixonian policies, and Obama’s only real competition for most bizarre Nobel Peace Prize recipient — has to some degree counselled each and every President since.

It is hard to overstate the magnitude of Nixon’s actions. The demonetisation of  gold ended a 5,000 year long tradition. It was a moment of conjuring, a moment of trickery; that instead of producing the goods, and giving up her gold hoard to pay for her consumption habits (specifically, her consumption of foreign energy), America would give the finger to the world, and print money to pay her debts, while retaining her (substantial) gold hoard. The obvious result of this policy has been that America now prints more and more money, and produces less and less of her consumption. She has printed so much that $5 trillion floats around Asia, while the American industrial belt rusts. Industrial production in America is where it was ten years ago, yet America’s debt exposure has ballooned.

America has had not one but two Vietnams in the past ten years.

First, Afghanistan, in the pursuit of the elusive Osama bin Laden (or, “in the name of liberating women”, presumably via blowing their legs off in drone strikes), where young Western soldiers continue to die (for what?), even after bin Laden’s supposed death in a Pakistani compound last year.

Then, Iraq, presumably in the interests of preventing Saddam Hussein from using non-existent Weapons of Mass Destruction, or liberating more women by blowing their legs off (or as Tom Friedman  put it: “SUCK! ON! THIS!”).

Like Nixon’s Presidency, the Nixonian political system is highly fragile. Debt is fragility, because it enforces the inflexibility of repayment, and the Nixonian political system has created staggering debt, much of it now offshore. The Nixonian economic policy has gutted American industry, leaving America uncompetitive and dependent on foreign productivity and resources. The Nixonian foreign policy has created a world that is deeply antipathetic to America and American interests, which has meant that America has become less and less capable of achieving imperatives via diplomacy.

Future historians may finger George W. Bush as the worst President in history, and the one who broke the American empire. But smarter scholars will pinpoint Nixon. True, the seeds of destruction were sown much earlier with the institution of permanent limited liability corporations. This allowed for the evolution of a permanent corporate aristocracy which eventually bought out the political echelon, and turned the Federal government into an instrument of crony capitalism, military Keynesianism and corporate welfare. Nixonianism has been the corporate aristocracy’s crowning achievement. And to some extent, this period of free lunch economics was a banquet, even for middle class Americans. The masses were kept fat and happy. But now the game is up — like Nixon’s Presidency — its days are numbered.

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The Truth About Excess Reserves

Tyler enquires about excess reserves:

While the current iteration of the Fed, various recent voodoo economic theories, and assorted blogs, all claim that excess bank reserves are never an inflationary threat, it is precisely two Federal Reserve chairmen’s heretic claims that reserves will light an inflationary conflagration, that forced then president Truman to eliminate not one but two Fed Chairmen, and nearly result in the “independent” Federal Reserve being subsumed by the Treasury to do its monetization and market manipulation/intervention bidding. Which then begs the question: who is telling the truth about the linkage of reserve accumulation to inflation — the Fed of 1951, or every other Fed since, now firmly under the control of the Treasury-banker syndicate?

This is of course a live question. Excess reserves are at never-before-seen levels:


That’s right — throughout the postwar period, banks have almost always lent out all the way up to the reserve requirement.

So, does the accumulation of excess reserves lead to inflation?

Only so much as the frequentation of brothels leads to chlamydia and syphilis.

Excess reserves are only non-inflationary so long as the banks — the people holding the reserves — play along with the Fed-Treasury game of monetising debt and trying to hide the inflation . The banks don’t have to lend these reserves out, just as having sex with hookers doesn’t have to lead to an infection.

But eventually — so long as you do it enough — the condom will break.

As soon as banks start to lend beyond the economy’s inherent productivity (which lest we forget is around the same level as ten years ago) there is likely to be inflation.

So, will they?

I think that would mean biting the hand that has fed them. The financial complex owes a great deal to the Fed for bailing them out in 2008, and throwing a pig’s ear of slush money their way in 2009 and 2010 in the form of QE. Like any Fat Tony, Bernanke commands the allegiance of his minions. But even the most enduring mafia bosses sometimes get shot. There is no status quo that a black swan cannot shatter.

But there are greater inflationary risks (which also, we must note, may set alight the inflationary potential of the excess reserves). A severe oil shock — caused by (say) Iran closing the Strait of Hormuz, something that America, NATO and the UN seem totally set upon — is one. So too could be a global trade shock caused by a regional war — there are lots of danger zones (North Korea, Pakistan, Iran, Syria, Egypt, Libya, Lebanon, etc, etc, ad infinitum).

And how about the return of some of the trillions of dollars now floating around Asia?


As more Asian nations ditch the dollar for bilateral trade, more dollars will end up getting dumped back into the American market.

So while the amassing of excessive reserves perhaps does not pose quite the same inflationary risk as collapsing reserve currency status, I think it is safe to say that while the 00s securitisation bubble was akin to juggling dynamite, this trend of amassing excess reserves (done, lest we forget, as a stability measure to protect primary dealers against another shadow banking collapse) is closer to going to sleep upon a bed of dynamite. 

Now, maybe the broader deflationary trends from deleveraging in the economy dampen this threat significantly. Maybe high inflation in the next five to ten years is a tail-risk event. And perhaps the Fed has little choice about significantly, massively increasing the size of the monetary base to counteract these deflationary forces. On the other hand given the context of deflationary trends, maybe the world is becoming complacent about inflationary risks. We shall see.

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Why the Left Misunderstands Income Inequality

There is a widely-held notion on the political left that the key economic problem that our civilisation faces is income inequality.

To wit:

America emerged from the Great Depression and the Second World War with a much more equal distribution of income than it had in the 1920s; our society became middle-class in a way it hadn’t been before. This new, more equal society persisted for 30 years. But then we began pulling apart, with huge income gains for those with already high incomes. As the Congressional Budget Office has documented, the 1 percent — the group implicitly singled out in the slogan “We are the 99 percent” — saw its real income nearly quadruple between 1979 and 2007, dwarfing the very modest gains of ordinary Americans. Other evidence shows that within the 1 percent, the richest 0.1 percent and the richest 0.01 percent saw even larger gains.

By 2007, America was about as unequal as it had been on the eve of the Great Depression — and sure enough, just after hitting this milestone, we plunged into the worst slump since the Depression. This probably wasn’t a coincidence, although economists are still working on trying to understand the linkages between inequality and vulnerability to economic crisis.

I mostly agree that income inequality is a huge problem, although I believe that it is a symptom of a wider malaise. But income inequality is an important symptom of that wider malaise.

Here’s the key chart:

However it is just as important, perhaps more important to identify the causes of the income inequality.

I have my own pet theory:

The growth in income inequality seems to be largely an outgrowth of giving banks a monopoly over credit creation. In 1971, Richard Nixon severed the link between the dollar and gold, expanding the monopoly on credit creation to a carte blanche to print huge new quantities of dollars and give them to their friends.

Unsurprisingly, this led to a huge growth in the American and global money supplies. This new money was not exactly distributed evenly. A shrinking share has gone to wage labour.

However the dominant explanation on the left is that this is down to the tax structure. I can’t falsify this theory, because the data supports it:

But why has the government chosen to tax corporations less, and payrolls more?

Who owns the government? Political donors — they finance the political system. Before one vote is cast candidates tailor their platforms to meet the criteria of donors. Who are political donors? Well, they are people with spare capital to expend in the name of getting politicians elected.

Here’s a side-by-side comparison of the presumptive 2012 Presidential nominees:

(Even bigger money flows through the Super PACs. A full breakdown of Super PAC donors can be found here; the same donor profile emerges).

So who are the biggest donors? Banks & large corporations: the very people who have benefited most from the post-1971 tidal wave of fiat credit creation.

So not only has an exorbitantly high proportion of new credit gone into corporate and financial profits, but the beneficiaries have used these fruits to buy out the political system, thus ensuring that they keep an even higher proportion of their incomes, while making up for this slump with greater borrowing, and greater taxation of payrolls.

The political left — epitomised, I suppose, by the Occupy movement — often call for “taking the money out of politics”. By this, they seem to mean holding elections that are not funded by private money, where all candidates are given the same resources. The reality of this, of course, is that such a measure would require a change in the Constitution, as privately-funded political advertising is protected speech under the First Amendment.

But let’s assume — just for the sake of argument — that a law “taking the money out of politics” could be enacted by simple majorities in the House, the Senate, and a Presidential signature (after all, President Obama’s legislative program has not maintained much respect for the original intent of the U.S. Constitution). Even under those implausible circumstances, why would Congress pass such a law when the entire political system is dominated by financial donors who want their money to very much be in politics? After all, it is not just for the sake of tax avoidance — government largesse produces lucrative contracts for contractors. The more money the government has to redistribute, the more incentive there is to spend money to get your people into office redistributing it, and government has more money to distribute — both in absolute terms, and as a percentage of GDP — than at any time since World War II.

The other (and simpler) proposed solution from the left is raising taxes on the rich, so that they pay a “fair share”. There are two problems with this. Firstly, that raising taxes during an economic depression is contractionary, and will (like the misguided and destructive European austerity programs, which of course include tax hikes) depress economic conditions further. And even if this was a good proposal (it isn’t), the political class will fiercely resist such proposals. Today, the Democratic-controlled Senate voted down the so-called Buffett Rule, that would have imposed a 30% floor on taxation for incomes over $250,000. (Buffett — as a top recipient of Federal Reserve bailout cash — would have no problem paying such a rate, unlike those far poorer than him who never took a penny of bailout money. Buffett would do well to spend less time in the bath thinking about Becky Quick, and more time using his capital to create jobs, to end this depression.)

Income inequality is a symptom of a grave problem: corporatism.

From Professors Ammous and Phelps:

Now the capitalist system has been corrupted. The managerial state has assumed responsibility for looking after everything from the incomes of the middle class to the profitability of large corporations to industrial advancement. This system, however, is not capitalism, but rather an economic order that harks back to Bismarck in the late nineteenth century and Mussolini in the twentieth: corporatism.

In various ways, corporatism chokes off the dynamism that makes for engaging work, faster economic growth, and greater opportunity and inclusiveness. It maintains lethargic, wasteful, unproductive, and well-connected firms at the expense of dynamic newcomers and outsiders, and favors declared goals such as industrialization, economic development, and national greatness over individuals’ economic freedom and responsibility. Today, airlines, auto manufacturers, agricultural companies, media, investment banks, hedge funds, and much more has at some point been deemed too important to weather the free market on its own, receiving a helping hand from government in the name of the “public good.”

The costs of corporatism are visible all around us: dysfunctional corporations that survive despite their gross inability to serve their customers; sclerotic economies with slow output growth, a dearth of engaging work, scant opportunities for young people; governments bankrupted by their efforts to palliate these problems; and increasing concentration of wealth in the hands of those connected enough to be on the right side of the corporatist deal.

A realistic program to  “take the money out of politics” — in other words, to return America’s form of government to its original constitutional intent, like the program advocated by Ron Paul — would do a lot to decapitate corporate power and the military-industrial-financial-corporate complex, who are mostly dependent upon government largesse, favourable regulation, bailouts, and moral-hazard-creating fictions like limited liability — for their very existence. But that won’t fly with either the political kingmakers, or the welfare-loving hordes of  voters (and often for good reason — many of us have paid taxes toward welfare all our lives, and don’t want to lose out of something we have paid for).

The real conclusion of this is that the status quo is not sustainable. Corporatism and oligopoly is almost never sustainable, because of the dire social consequences. Today, almost 20% of young people are unemployed, wasting on the scrapheap. The median net worth of the young is lower than it was 30 years ago. The number of long-term unemployed has spiked to an all-time-high. Prison populations are at all time highs — and the highest in the world, both proportionally, and in absolute terms. America’s former industrial belt rusts; American manufacturing (what’s left of it) has often been reduced to re-assembling foreign components. America is heavily dependent on foreign oil. The American imperial machine is suffering from a lack of manpower. America’s strengths are melting away in a firestorm of misguided central planning, imperial waste, and corporate corruption. America’s social culture is fiery and combustible and individualistic. Young people denied opportunity by a broken system will do something about it. Occupy Wall Street and the 2012 Ron Paul Presidential campaigns were the first manifestations of the jilted generation dabbling in politics.

The political left misunderstands the causes of income inequality — confused by the belief that government can somehow challenge the corporate and financial power it created in the first place — and thus proposes politically unrealistic (non-) solutions, particularly campaign finance reform, and raising taxes on the rich and corporations. Yes, the left are well-intentioned. Yes, they identify many of the right problems.  But how can government effectively regulate or challenge the power of the financial sector, megabanks and large corporations, when government is almost invariably composed of the favourite sons of those organisations? How can anyone seriously expect a beneficiary of the oligopolies — whether it’s Obama, McCain, Romney, Bush, Gore, Kerry, or any of the establishment Washingtonian crowd — to not favour their donors, and their personal and familial interests? How can we not expect them to favour the system that they emerged through, and which favoured them?

In reality, the system of corporatism that created the income inequality will inevitably degenerate of its own accord. The only question is when…

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Treasuries Still Not Cracking

Tyler Durden pointed out yesterday that just three weeks after Goldman made the case for equities relative to bonds, the muppets who had listened to their advice were getting skewered:

I wrote a while back that (unlike some others) I didn’t believe it was likely that  this was going to be a cataclysmic rate spike. Readers who want to detect one need to watch whether sovereign creditors especially Russia and China are selling, and at what pace — the faster the liquidation, the more rates may spike.

Of course, I am still convinced that the real fragility to America’s economy isn’t actually a rate spike or inflation.The Fed has a very good handle on both of these things (but not, perhaps on unwanted side effects. They can effectively do QE without really inflating the currency much; simply shoot the money to primary dealers for treasuries.

When volatility is artificially suppressed, there are always unwanted side effects. And that — the unwanted side effects, not the widely-reported fears of inflation and rate spikes — I believe, is the true danger.

One unwanted side effect could be provoking a damaging trade war with China, from which the West imports so much. That is my pet theory, and one I’ve devoted a few thousand words to over the last few months. But the trouble with side-effects is that it is very hard to tell what the weakest link (i.e. the point that will break) in a volatility-suppressed system is. Tyler Durden reports that systemic financial fragility (as measured by CDS) is at a recent-high, too:

Believers in technical analysis (I am very sceptical) are pointing to a head-and-shoulders top in the “recovery” (to go with the bigger head and shoulders top that is very much one of the stories of the last ten years):

I don’t know when the black swans will come home to roost and the strange creature that we call the present global economic order will go ka-put. I don’t even know if they ever will! But I see the fragilities caused by central planners suppressing the system’s natural volatility.

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Bernanke vs Greenspan?

Submitted by Andrew Fruth of AcceptanceTake

Bernanke and Greenspan appear to have differing opinions on whether the Fed will monetize the debt.

Bernanke, on behalf of the Federal Reserve, said in 2009 at a House Financial Services Committee that “we’re not going to monetize the debt.”

Greenspan, meanwhile, on Meet the Press in 2011 that “there is zero probability of default” because the U.S. can always print more money.

But they can’t both be true…

There is only 0% probability of formal default if the Fed monetizes the debt. If they refuse, and creditors refuse to buy bonds when current bonds rollover, then the U.S. would default. But Ben said the Fed will never monetize the debt back on June 3, 2009. That’s curious, because in November 2010 in what has been termed “QE2” the Fed announced it would buy $600 billion in long-term Treasuries and buy an additional $250-$300 of Treasuries in which the $250-$300 billion was from previous investments.

Is that monetization? I would say yes, but it’s sort of tricky to define. For example, when the Fed conducts its open market operations it buys Treasuries to influence interest rates which has been going on for a long time — way before the current U.S. debt crisis.

So then what determines whether the Fed has conducted this egregious form of Treasury buying we call “monetization of the debt?”

The only two factors that can possibly differentiate monetization from open market operations is 1) the size of the purchase and 2) the intent behind the purchase.

This is how the size of Treasury purchases have changed since 2009:

Since new data has come out, the whole year of 2011 monetary authority purchases is $642 billion – not quite as high as in the graph, but still very high.

Clearly you can see the difference in the size of the purchases even though determining what size is considered monetization is rather arbitrary.

Then there’s the intent behind the purchase. That’s what I think Bernanke is talking about when he says he will not monetize the debt. In Bernanke’s mind the intent (at least the public lip service intent) is to avoid deflation and to boost the economy – not to bail the United States out of its debt crisis by printing money. Bernanke still contends that he has an exit policy and that he will wind down the monetary base when the time is appropriate.

So In Bernanke’s mind, he may not consider buying Treasuries — even at QE2 levels — “monetizing the debt.”

The most likely stealth monetization tactics Bernanke can use — while still keeping a straight face — while saying he will not monetize the debt, will be an extreme difference between the Fed Funds Rate and the theoretical rate it would be without money printing, and loosening loan requirements/adopting policies that will get the banks to multiply out their massive amounts of excess reserves.

If, for example, the natural Fed Funds rate — the rate without Fed intervention — is 19% and the Fed is keeping the rate at 0%, then the amount of Treasuries the Fed would have to buy to keep that rate down would be huge — yet Bernanke could say he’s just conducting normal open market operations.

On the other hand, if the banks create money out of nothing via the fractional reserve lending system and a certain percentage of that new money goes into Treasuries, Bernanke can just say there is strong private demand for Treasuries even if his policies were the reason behind excessive credit growth that allowed for the increased purchase of Treasuries.

Maybe Bernanke means he will not monetize a particular part of the debt that was being referred to in the video. Again, though, he could simply hide it under an open market operations 0% policy or encourage the banking system to expand the money supply.

Whatever the case, if you ever hear Bernanke say “the Federal Reserve will not monetize the debt” again, feel free to ignore him. When he says that, it doesn’t necessarily mean he won’t buy a large quantity of Treasuries with new money created out of nothing.

Remember, Greenspan says there’s “zero probability of default” because the U.S. can always print more money. Does Greenspan know something here? There’s only zero probability if the Fed commits to monetizing the debt as needed. If Greenspan knows something there will be monetization of the debt, even if Bernanke wants to call it something else.

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Sterilised QE Analysis

I write this post rather hesitantly.

From the WSJ:

Federal Reserve officials are considering a new type of bond-buying program designed to subdue worries about future inflation if they decide to take new steps to boost the economy in the months ahead.

Under the new approach, the Fed would print new money to buy long-term mortgage or Treasury bonds but effectively tie up that money by borrowing it back for short periods at low rates. The aim of such an approach would be to relieve anxieties that money printing could fuel inflation later, a fear widely expressed by critics of the Fed’s previous efforts to aid the recovery.

This confirms four important points that relatively few economic commentators have grasped.

First, if QE was intended — as Bernanke always said it was — solely to lower the interest rates on government debt, and force investors into “riskier” assets, rather than to directly stimulate the economy, why were the first two rounds of QE not sterilised? Is Bernanke making it up as he goes along? No — the first two rounds of QE were undoubtedly reflationary:


While the S&P slumped, the monetary base was dramatically increased. This — even as confidence remained weak — allowed the (debt-based) money supply (M2) to keep growing, and thus avoiding Bernanke’s bugbear deflationary spiral.

Second, that Bernanke— unlike Paul Krugman — is concerned about inflation expectations. Given that the money supply could theoretically still triple without any new money printing, I would be too. How might banks respond to an oil shock or some other negative supply shock? We have no real idea. Would all those reserves quickly get lent out, as more and more money chases fewer and fewer goods? We can speculate (I would say this eventuality is quite unlikely) but we just don’t know. Simply, the Fed has created a bed of inflationary dynamite, and we have no real means to predict whether or not it will be set alight, or whether the Fed would be able to temper such an explosion.

Third, that if the Fed is not willing to continue pumping money into the wider economy, the current reinflationary bubble is over. But the money supply has surged ahead of industrial production:


Without a surge in real productivity (I don’t see one coming) price levels will not be sustainable, which may force the Fed back for another round of unsterilised QE.

Fourth, the Fed seems completely and defiantly intent on driving interest rates on Treasury debt into the ground. The supposed justification — that investors are avoiding riskier (but productive) assets seems completely irrelevant. If investors do not want to put their money into equities, they will find a way not to — either by investing in commodities and futures, or in alternative monetary instruments like gold and silver. The real justification — at least for this round of QE — seems to be to cheapen the Treasury’s liabilities, especially in light of the fact that America’s biggest external creditors are getting cold feet. That takes the pressure off the Treasury, but for how long? How much leeway does the Fed have to act as a price ceiling on Treasury debt?

The hope is that the Fed will have much more leeway as a result of sterilised QE. And of course, Bernanke is hoping that there is a real economic recovery down the line so that all these emergency measures can be retired.

The trouble is that the problem in the United States was never that of too little money, but rather that of a broken economy: broken infrastructure, broken energy infrastructure, corporatism, financialisation and diminishing productivity. The Corporatocracy and their cronies in government seem to have no interest in addressing the real problems. That is fundamentally unsustainable — and no amount of QE, or demand for iThingies, NFLX, LULU or corporatist Obamacare will fix it. The real American economy is dependent on foreign goods, foreign energy, foreign components, and foreign resources and there is no guarantee that the free flow of goods and resources will be around forever. In fact, the insistence on not fixing anything — and instead of throwing money at problems — almost guarantees a future breakdown. The era of the American free lunch is over.

What we now know for sure is that the trigger for the coming breakdown is extremely unlikely to be domestic. Bernanke is a can-kicking genius, and will invent new can-kicking apparatuses as they become needed (up to the point of systemic breakdown). America must hope that he — or someone else — has a similar genius for foreign policy, and for negotiating with hostile powers upon which America has rendered herself economically dependent.