Author Archive for Hunter Lewis

Further to Julian Adorney on the Maximum Wage

It is worth recalling that Congress during the first Clinton administration passed legislation limiting cash compensation for CEO’s of public companies to $1 million. The result was that compensation swung to stock options. This in turn encouraged CEO’s to borrow in order to buy in company stock, which helped stoke the subsequent stock market bubble.

When the accounting profession then sought to rein in the use of options, which at the time did not have to be treated as corporate expenses, several congressmen and senators, Joe Liberman in particular, publicly threatened them with legislation that would take away their authority over options.

The actions of the Fed were far more important in creating the stock market bubble that subsequently popped in 2000, but Congress certainly made it worse with its unwise legislative interference with executive compensation. This was just one more example of government fixing, manipulating, or nudging prices that should be set by the market, that is, by consumers.

Thomas Piketty’s Sensational New Book

This 42 year economist from French academe has written a hot new book: Capital in the Twenty-First Century. The US edition has been published by Harvard University Press and, remarkably, is leading the best seller list, the first time that a Harvard book has done so. A recent review describes Piketty as the man “who exposed capitalism’s fatal flaw.”

So what is this flaw? Supposedly under capitalism the rich get steadily richer in relation to everyone else; inequality gets worse and worse. It is all baked into the cake, unavoidable.

To support this, Piketty offers some dubious and unsupported financial logic, but also what he calls “a spectacular graph” of historical data. What does the graph actually show?

The amount of U.S. income controlled by the top 10% of earners starts at about 40% in 1910, rises to about 50% before the Crash of 1929, falls thereafter, returns to about 40% in 1995, and thereafter again rises to about 50% before falling somewhat after the Crash of 2008.

Let’s think about what this really means. Relative income of the top 10% did not rise inexorably over this period. Instead it peaked at two times: just before the great crashes of 1929 and 2008. In other words, inequality rose during the great economic bubble eras and fell thereafter.

And what caused and characterized these bubble eras? They were principally caused by the U.S. Federal Reserve and other central banks creating far too much new money and debt. They were characterized by an explosion of crony capitalism as some rich people exploited all the new money, both on Wall Street and through connections with the government in Washington.

We can learn a great deal about crony capitalism by studying the period between the end of WWI and the Great Depression and also the last twenty years, but we won’t learn much about capitalism. Crony capitalism is the opposite of capitalism. It is a perversion of markets, not the result of free prices and free markets.

One can see why the White House likes Piketty. He supports their narrative that government is the cure for inequality when in reality government has been the principal cause of growing inequality.

The White House and IMF also love Piketty’s proposal, not only for high income taxes, but also for substantial wealth taxes. The IMF in particular has been beating a drum for wealth taxes as a way to restore government finances around the world and also reduce economic inequality.

Expect to hear more and more about wealth taxes. Expect to hear that they will be a “one time” event that won’t be repeated, but that will actually help economic growth by reducing economic inequality.

This is all complete nonsense. Economic growth is produced when a society saves money and invests the savings wisely. It is not quantity of investment that matters most, but quality. Government is capable neither of saving nor investing, much less investing wisely.

Nor should anyone imagine that a wealth tax program would be a “one time” event. No tax is ever a one time event. Once established, it would not only persist; it would steadily grow over the years.

Piketty should also ask himself a question. What will happen when investors have to liquidate their stocks, bonds, real estate, or other assets in order to pay the wealth tax? How will markets absorb all the selling? Who will be the buyers? And how will it help economic growth for markets and asset values to collapse under the selling pressure?

In 1936, a dense, difficult-to-read academic book appeared that seemed to tell politicians they could do exactly what they wanted to do. This was Keynes’s General Theory. Piketty’s book serves the same purpose in 2014, and serves the same short-sighted, destructive policies.

If the Obama White House, the IMF, and people like Piketty would just let the economy alone, it could recover. As it is, they keep inventing new ways to destroy it.

The Hidden Motive Behind Quantitative Easing

220px-Marriner_S._Eccles_Federal_Reserve_Board_Building Foreign individuals and businesses long ago cut back on their purchases of U.S. bonds. Their place was taken by foreign central banks. The central banks simply created money in their own currency and used it to buy our bonds.

The Federal Reserve always knew that we couldn’t rely on foreign central banks to buy our bonds forever. This may be the main reason it began the program called quantitative easing, in which the Fed created money out of thin air specifically to buy back U.S. debt.

Quantitative easing may have been intended to be a kind of insurance policy. If foreign central bank buying of U.S. bonds collapsed, the Fed would already have a program in place to buy them back itself.

The Fed  said that quantitative easing was meant to create U.S. jobs, but this never made much sense. Even a hard core proponent of QE, Fed official William Dudley ( formerly of Goldman Sachs), admitted that the Fed’s own economic models could not explain how creating money out of thin air and using it to buy U.S. bonds would increase employment. Some link to rising stock prices could be demonstrated, if only through the cheap financing of corporate stock buy-backs, but then rising stock prices could not be shown to create jobs either.

One inference from this was that chairman Ben Bernanke, and now new chairman Janet Yellen, were just taking wild stabs in the dark. A more reasonable inference is that they had another reason for QE, one which they did not want to acknowledge.

Viewed in this way, the 2008 bail-out should be viewed not as a bail-out of Wall Street, but rather  as a bail-out of Washington. The Federal Reserve feared that the market for government bonds was about to collapse, which would lead to soaring interest rates, and a complete collapse of our bubble financed government.

The Fed did not have the option of creating money and buying debt directly from the Treasury. That would be illegal. The Treasury must first sell its bonds to Wall Street, after which the Fed can then use its newly created money to buy them back. Hence, in order to rescue the Treasury, the Fed felt it had to rescue Wall Street.

This is a simplification of what happened, and only part of the story, but it is the untold part of the story, and in all likelihood the most important part. The Fed was in a panic in 2008, but not primarily about what might happen to Wall Street, and certainly not about what might happen to Main Street. It was in a panic over what might happen to government finance.

This interpretation is strengthened by new information contained in former Treasury secretary Hank Paulson’s recent book. He revealed that Russia tried in 2008 to persuade China to join in a collaborative effort to dump U.S. bonds in order to bring down the U.S. financial system. Although China refused to do so at the time, its government would clearly like to end dollar dominance, and has  been paring U.S. bond purchases.

At the moment,  Janet Yellen’s worries about finding buyers of government bonds can only be getting worse. For much of last year, foreign central bank purchases of U.S. bonds in aggregate fell. As of October of 2013, they had been negative for three and six months. Then they turned up a smidge, only to fall again, so that the last three months show a decrease of just over 12%.

It is known that Russia withdrew its U.S. bonds from custody of the Fed after the Crimea invasion, and has either been selling or could sell at any time. It will no doubt try again to persuade other countries to join in undermining the U.S. bond market and replacing the dollar as the mainstay of world trade.

Under these circumstances, it should not be surprising that the Fed is today taking only baby steps to reduce its program of creating new money to buy U.S. bonds. This program is probably not just meant to revive the economy, which it has not done and cannot do. It is more likely designed as a desperate and in the long run counterproductive effort to finance the U.S. government and save today’s dollar dominated financial system.

The Fed Is Not Following The Law

799px-Handcuffs01_2003-06-02Some of the games being played behind closed doors by the Fed are not only troubling. They are not even legal.

It was a clear violation of Section 14 (B) of the Federal Reserve Act for the Fed to respond to the Crash of 2008 by buying $1.5 trillion of mortgages not guaranteed by the federal government. The agency hid behind Section 13.3 language allowing a broad scope of action under “unusual and exigent circumstances,” but the statute states clearly that Section 13.3 loans can only be short term and backed by high quality collateral, a requirement that was blatantly ignored.

It was also a violation of both the Fed statute and the Constitution to offload potential Fed losses from its hedge fund-like operations onto the Treasury, as was done stealthily via a note to the Fed’s Statistical Release H 4.1 dated January 6, 2011. The notion of the Treasury (i.e. The taxpayers) having to bail out the Fed is not just a theoretical possibility. The Fed’s annual report just released shows a $53 billion unrealized loss.

It would also appear to be a violation of the Constitution to locate the new Consumer Financial Protection Bureau created by the Dodd-Frank Act inside the agency. The Constitution requires that all government expenditures be authorized and funded by Congress. The Fed has always been treated as an exception. It uses income on securities it has bought with newly created money to pay its bills and has not even been subject to Congressional oversight.

Having a secretive, self-funded, extra-constitutional agency inside government was bad enough when the Fed consisted of seven governors and a few staff members. The new Consumer Bureau already employs an estimated 1,359 people and keeps growing. Many of these employees were transferred from other government agencies where they formerly had been counted as part of the federal budget, but are now suddenly off-budget. If this is allowed to stand, what other federal agencies will be slipped inside the Fed in future in order to reduce the reported Federal deficit?

Some of the Fed’s actions since the Crash have been perfectly legal, but also designed to escape detection by the press and public. For example, in the dark days of the 2008 crash, a provision was buried deep in the TARP bill passed by Congress authorizing the Fed to pay interest to banks on their lending reserves. This made it legal for the Fed to print money and hand it over to the banks in unlimited amounts. One wonders how many members of Congress were aware they were passing this?

Today the Fed pays ¼ of 1 percent interest on trillions of dollars of unused bank reserves. An estimated 37% of that is paid to foreign banks. This is a grey area legally. One wonders how many members of Congress know about it.

During the Crash itself, as much as 70% of Fed discount window loans seem to have gone to foreign banks at rates as low as 0.01%. In other words, we made huge gifts to foreign banks.

If the economy gets overheated, the Fed says that it will simply increase the interest it is paying on bank reserves to ensure that those reserves aren’t turned into loans to business and consumers. But the more money that is created to pay interest on unused reserves, the bigger the unused reserves become. In typical government style, a problem will be alleviated short term only at the cost of making it worse in the future.

After reading this post, you might conclude that someone should sue the Fed over its illegal actions. Unfortunately taking the Fed to court is easier said than done. Under federal law, you must have “standing” to sue. Ordinary citizens are deemed not to have standing. Under recent court decisions, even banks do not seem to have standing, despite their being regulated by the Fed.

Fed illegality can best be addressed by Congressional action. Congress created the Fed and can reform it or even shut it down. There are critics of the Fed in Congress, but not nearly enough of them. And there are reasons why Congress mostly leaves the Fed alone.

It is the Fed that backstops federal deficit spending. Without the Fed, government could not continue indefinitely spending more than its tax revenue. So long as politicians think they benefit from the expansion of government and runaway spending, they will not want to reform the Fed.

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What David Hume ( 1711-76) Has To Teach Us Today

Painting_of_David_HumeReading David Hume on economics, one has the feeling that he is rebutting current Keynesian policies. How could that be, since Keynes lived hundreds of years later? The explanation is simple: Keynesianism is not new. It is just a revival of the  old mercantilist ideas that Hume was targeting.

Keynes even admits at the end of the General Theory that he is reviving mercantilism, apparently having forgotten his claim at the beginning of the same book to be staking out new ground in economics. Whatever the reason, much of Hume seems highly relevant to today’s debates:

1. On deficit spending

“…Our modern expedient, which has become very general, is to mortgage the public revenues, and to trust that posterity will pay off the encumbrances contracted by their ancestors:  …[This is] …a…ruinous… practice….

“It is very tempting to a minister to employ such an expedient, as it enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamors against himself. The practice, therefore, of contracting debt, will almost infallibly be abused in every government. It would scarcely be more imprudent to give a prodigal son a credit in every banker’s shop in London, than to empower a statesman to draw bills, in this manner, upon posterity.

“What, then, shall we say to the new paradox, that public encumbrances are, of themselves, advantageous, independent of the necessity of contracting them. . . .  [These]… absurd maxims [ are] patronized by great ministers, and by a whole party among us. . . .

“It must, indeed, be one of these two events; either the nation must destroy public credit, or public credit will destroy the nation. It is impossible that they can both subsist. . . .” [ Of Public Credit]

2.  On money and banking

“… A government has great reason to preserve with care its people and its manufactures. Its money, it may safely trust to the course of human affairs….

“ We fancy, because an individual would be much richer, were his stock of money doubled, that the same good effect would follow, were the money of every one increased; not considering that this would raise as much the price of every commodity, and reduce every man in time to the same condition as before. . . .” [Of the Balance of Trade]

“It is also evident, that the prices do not so much depend on the absolute quantity of commodities and that of money, which are in a nation, as on that of the commodities, which come or may come to market, and of the money which circulates….

“Though the high price of commodities be a necessary consequence of the increase of gold and silver, yet it follows not immediately upon that increase; but some time is required before the money circulates through the whole state, and makes its effect be felt on all ranks of people. At first, no alteration is perceived; by degrees the price rises, first of one commodity, then of another till the whole at last reaches a just proportion with the new quantity of specie which is in the kingdom.

“Institutions of banks, funds, and paper credit, with which we in the Kingdom are so much infatuated,…render paper equivalent to money,  [and] circulate it through the whole state…. What can be more short -sighted than our reasoning on this head… .

“It must be allowed that no bank would be more advantageous, than such alone as … never augmented the circulating coin.” [ Of Money].  (Hume pointed with admiration to the Bank of Amsterdam that was run at the time on 100% reserve lines.)

3. On trade

“Nothing is more usual, among states which have made some advances in commerce, than to look on the progress of their neighbors with a suspicious eye, to consider all trading states as their rivals, and to suppose that it is impossible for any of them to flourish, but at their expense. In opposition to this narrow and malignant opinion, I will venture to assert, that the increase of riches and commerce in any one nation, instead of hurting, commonly promotes the riches and commerce of all its neighbors; and that a state can scarcely carry its trade and industry very far, where all the surrounding states are buried in ignorance, sloth, and barbarism. . . .” [ Of the Balance of Trade]

4. On the theory of Value

When Hume received a copy of Adam Smith’s Wealth of Nations during his final illness, he immediately saw the error of Smith’s labor theory of value:

“If you were at my fireside, I should dispute some of your principles. I cannot think…but that… price is determined altogether by the quantity and the demand.” [ Letter to Adam Smith, April 1, 1776, Hume’s Correspondence, Writings on Economics, E. Rotwein, 1955. P. 217]

5. On the need for better economic reasoning

“Mankind are, in all ages, caught by the same baits: the same tricks played over and over again, still trepan them.” [ Of Public Credit]

“. . . It must be owned, that nothing can be of more use than to improve, by practice, the method of reasoning on these subjects, which of all others are the most important, though they are commonly treated in the loosest and most careless manner.” [ Of Interest]



Obama’s Latest Fed Appointments

387px-Marriner_S._Eccles_Federal_Reserve_Board_BuildingPresident Obama has named three more nominees to the Fed and the Senate has had a chance to interview them. The first and most important is Stanley Fischer, aged 70, nominee for vice chairman as well as a regular member.

The most curious thing about Fischer’s resume is that, having been born in Zambia, and naturalized as an American in 1976, he accepted Israeli citizenship in 2005 in order to become head of Israel’s central bank. Today he holds dual citizenship. Prior to living in Israel, he worked as a vice chairman of Citigroup from 2002-5, the years leading to the bank’s bail-out, and prior to that was deputy director of the International Monetary Fund, chief economist of the World Bank, and professor at MIT, where he taught Ben Bernanke among others. Somewhere along the way, he acquired a personal fortune of between $14 and $56mm.

We are thus to understand that President Obama, having searched the entire length and breadth of our land, could find nobody better than a 70 year old with Wall St. and International Monetary Fund baggage who had most recently worked for a foreign government.

The second nominee after Fischer is Lael Brainard, who has recently worked at the Treasury as an undersecretary. Ms. Brainard told senators that the Fed should protect “the savings of retirees.” She did not bother to explain how refusing to allow interest to be paid on savings, or seeking to foster inflation higher than interest would do so.

The final nominee, Jerome Powell, would be a reappointment. Although not a Phd economist and nominally a Republican from the George H. W. Bush administration, he fits the Obama mold in other ways, notably by being from Wall Street, and by being willing to keep quiet and go along. His most daring moment came when he called the Fed’s money creation machine under Bernanke and now under Janet Yellen “innovative and unconventional” and added that “likely benefits may be accompanied by costs and risks.” He has been a reliable vote for Bernanke and likely will be for the Yellen/Fischer regime as well.

Senator Corker ( R-Tenn.) waxed enthusiastic about this group of three, saying “I’m impressed,” and leading bond manager Mohamed El-Erian describes them as a “dream team” together with Yellen.

This does indeed seem to be a “dream team” for Wall Street, for corporations boosting profits to record levels with the help of government deficits, for other special interests feeding off the stimulus trough, and for government employees. For everyone else, it just promises more and eventually even worse economic misery.

US Government Will Continue Interfering With Apple Pricing Decisions

220px-Red_AppleA federal court has ruled that a US Department of Justice “monitor” will remain inside Apple Computer to supervise all the company’s pricing decisions.

The “monitor,” Michael Bromwich, was appointed when Apple lost an anti-trust case involving E-books. He bills for his time at $1,100 an hour and charged $138,432 for his first two weeks of “work.”

Apple has filed an appeal which labels Bromwich’s appointment “unprecedented and unconstitutional.” This “monitor” is a particularly dangerous precedent because court appointed. But by now “monitors” established through “settlements” are common.

Joseph Covington, who headed the Justice Department’s Foreign Corrupt Practices Act Division in the 1980’s, told Forbes, in reference to monitors appointed to enforce settlements under that act: “This is good business for Justice Department lawyers who create the marketplace [for monitors] and then get…a job there [after they leave government].”

Nor is it limited to the Justice department. If a company gets into the sights of the Federal Trade Commission (FTC) or even the Food and Drug Administration (FDA), the terms of settlement increasingly include “monitoring” by highly paid lawyers, who are typically former FTC or FDA employees.

This is not just the small time corruption it might seem. The collapse of the Soviet Union should have demonstrated once and for all how important free and unimpeded prices are for an economy. Can Apple really be expected to continue its past success if it cannot even control its own pricing?

How did Apple get into this mess? Didn’t Apple give enough money to the Obama administration? Apple employees gave 93 percent of their contributions to Obama in 2012 and only 7% to Romney. Wasn’t that good enough? Perhaps not. Google employees gave 98 percent of their money to Obama and it was a whole lot more money ($727,702 versus $338,752). Apple CEO Tim Cook failed to max out (give to the legal limit) in his own contribution.

Politico mocked Apple during the election year for being “naive” in failing to hire enough Washington lobbyists to protect its interests. And, importantly, Jeff Bezos, owner of Amazon and de facto”winner” of  the anti-trust case against Apple, bought the Washington Post. Owning the Post makes him a key Washington player and provides his company a great deal of political protection.

Lack of campaign contributions may not be the only factor driving the politicized Justice Department in its pursuit of Apple. There is also the Patriot Act. Apple announced that it would both reveal any government request to gain access to people’s private information and oppose it. That would not have been well received by the administration.

Henry Waxman: “Legislative Genius” or Corrupt Crony Capitalist?

George_Bush_signs_the_Federal_Funding_Accountability_and_Transparency_Act_of_2006President Obama described his fellow Democrat, who just announced his retirement after four decades in Congress, as “one of the most accomplished legislators of his or any era.” The Washington Post’s Harold Meyerson calls him a ” legislative genius” who “decisively consigned the Republican right’s favored ideology—libertarianism—to history’s dustbin.” He did so, Meyerson went on, by proposing “common sense” laws. “Who could be against “ Waxman?

In order to answer this question, one must look at what he actually did. One of the reasons that Waxman was so powerful was that he operated behind the scenes. Few people outside of his district ever heard about him. He was the acknowledged master of underhanded legislative tricks, and was especially skilled at writing amendments that not even a lawyer could understand and then slipping them into unrelated bills when nobody was watching.

For example, he drafted a bill written in no known human language that was intended to restrict the sale of dietary supplements, a longtime crusade of his. He then waited until House and Senate were about to reconcile their massive Wall Street reform bills and at the last moment dropped in his supplement bill posing as an amendment to the finance bill. Fortunately the totally unrelated amendment was discovered just before one of Waxman’s famous all night conference committee meetings, and after heated discussion was rejected by the other conferees.

The odd part of this story is that Waxman’s district, which included part of Hollywood, must have teemed with health food stores selling dietary supplements. It is doubtful that many of the voters supporting him even knew about this and similar behind-the-scenes gambits.

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Does Barack Obama Realize How Indebted He is to Herbert Hoover?

HDid you notice this line in the president’s recent State of the Union address: “ I ask… America’s business leaders to…raise your employees’s wages.”

This is not the first time a president has made this “request” of employers.

After the stock market crash of 1929, President Hoover began talking about wages. They needed to be protected from cuts, he said, and preferably increased, so that consumer demand would increase. More consumer demand would supposedly get the economy through the storm.

As the economy sputtered and prices began to fall, Hoover acted on his pet theory. He began lobbying businesses not to reduce wages. He did more than lobby. He sent a clear signal that if his directive was ignored, the government might step in and legislate wages.

Businesses listened. But they also had their backs against a wall. With consumer prices falling, wage reductions were needed to protect profits. Without profits, a business fails and everyone loses their job.

Faced with this reality, but afraid to make any reduction in wages, businesses did the only thing they could do to try to stay afloat: they cut jobs. Millions were thrown out of work who might have kept their jobs at reduced pay but for Hoover’s intervention. All of this is described fully in Murray Rothbard’s masterful account of the Great Depression.

When the new Roosevelt administration came in, it embraced the same bogus economic theory. Both prices and wages were tightly controlled by the National Recovery Act. In a famous incident, a New Jersey immigrant worker, Jacob Maged, was sentenced to jail for three months on a charge of pressing a suit for 35 cents instead of the legislatively required 40 cents.

These policies had the paradoxical effect of making some Americans newly affluent even while throwing millions out of work. Since prices had fallen sharply, those who kept their jobs at the old wages could in many cases buy twice as much with the same money.

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Where Is The Inflation Today?

4161629227_6a52154cf3People often ask today: if the Fed has created so much new money, why hasn’t it produced more inflation?

When the Fed creates masses of new money, it initially flows to Wall Street, which profits from  it in a variety of imaginative ways, but from there its path is unpredictable.

The Fed inserted into the TARP bill in 2008 the authority to pay interest on bank reserves. Of course this interest is paid by creating even more new money, but it provides an incentive for banks to leave reserves idle.

On the other hand, the reserves are not as idle as they look. For example, they support derivatives activity. The total amount of derivatives held by the top four US banks is estimated at the moment to be $217 trillion. And keep in mind that it was derivatives exposure that brought Lehman Brothers down in 2008.

To the degree that the new money does get out into the economy, it will flow in different directions and have different effects. If it reaches the average consumer, it will produce consumer price inflation. This does seem to be happening. Consumer price inflation calculated as it was in the past would be much higher than today’s reported 1%.

If the new money  reaches rich people, it will drive up the prices of what rich people buy. We see this today when a single townhouse in Manhattan is listed for over $100 million. If it flows into the stock market, it will raise stock prices. If enough flows in this direction, it will create an asset bubble, which seems to be happening once again today. Asset bubbles are followed by crashes, which in turn bring recession and unemployment.

Wherever the new money flows, it may increase demand in the short run, only to reduce it in the long run. This is because the new money created by the Fed is not just given away. It is made available to banks to lend, which means that it enters the economy as debt. A little debt, especially if spent or invested wisely, may help an economy. But too much will strangle it.

As consumers, businesses, and governments become weighed down with more and more debt from the past, especially debt that was spent unwisely, the interest and principal payments become increasingly burdensome. Dollars that might have been spent on new investments with the potential to create new jobs and new income are instead siphoned off to pay for past mistakes. We end up with a zombie economy, still breathing, but just barely.

Historically we can measure how many dollars of economic growth we get from each new dollar of debt. At the moment, it seems to be negative. In other words, more new debt makes it worse, not better.

Despite this plain evidence, the Fed continues to try to persuade consumers and businesses to increase their borrowing and spending and also underwrites government borrowing and spending. It holds interest rates very low, which for now keeps the debt house of cards from tumbling down.

Will the Fed’s feckless money creation end in inflation or depression? It could go either way, which is potentially confusing. Insofar as it stokes demand, it could lead to inflation. Insofar as it increases an already too heavy debt burden, it could lead instead to recession, joblessness, and depression. Or it could lead first to the one and then to the other.

It could also lead to a third possibility: stagflation. In this scenario, consumer prices advance even while unemployment increases. We had this in the 1970’s. If we measured inflation as we did in the 1970’s, it would be apparent that this already exists today.

( Photo credit: Gage Skidmore)