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What Happened To All Of That Money?

Saturday 12 January 2013

By Jeffrey Snider

Since the first onset of systemic crisis in August 2007, as the eurodollar market shrieked in abject terror at the prospects of collateral repudiation, central banks in almost every major market have undertaken radical expansionary policies. The Bank of England actually leads the debasement race, having gone first and farther than her kindred peers. The balance sheet at the British central bank has grown about four and half times since that fateful month when financial innocence was violently lifted. The Federal Reserve, Swiss National Bank and European Central bank have come in just behind, debasing their asset collections by factors of about 4, 3, and 2.5, respectively.

The initial criticisms of each of these piecemeal expansions have centered on inflationary concerns, particularly in that most of that newly printed "money" has sat idly awaiting some prospective trigger to "unanchor" expectations and unleash the worst. On the other side, monetarists remain bewildered by the lack of follow through into the real economy - these money stock measures, according to orthodox theory, should be producing a global panacea of good economic fortunes.

Of course, those two sentiments are highly linked in that inflation and nominal GDP growth are one and the same in the context of textbook economics. Even the Federal Reserve’s own vaunted models are confounded that inflation (narrowly defined) and GDP growth are not significantly greater. By most accounts, all of that new money should be doing something tangible.

Relatedly, European commission president Jose Manuel Barroso proclaimed an official end to the euro currency crisis. Unfortunately for Europe, crises, including those of a monetary nature, are not under the purview of unelected parliamentary procedures and conjectures. If it was in line of authority that central governments may outlaw reality, it would have been tried somewhere between iterations of quantitative easing and outright monetary transactions. For palpable results of all this monetary interference, however, the missing money is found in the wrong places under the wrong circumstances.

Automobile sales in France, for example, declined a not-at-all pedestrian 28% in November 2012 over November 2011. France, one of the expected pillars of the European economic "core", must have missed the currency proclamations, which should certainly have meant not a 28% collapse in industry sales, but to the same degree in the opposite direction. ECB promises to purchase unlimited quantities of Spanish debt must somehow have missed translation into French automobile purchases.

Opel, a GM subsidiary, confirmed in December that it was closing its plant in Bochum, Germany, the country’s first plant shutter in decades. While it certainly could be attributed to the idiosyncratic lack of industry acumen at GM, I think it is far more likely that Opel’s actions fit the reality of the European car market. Ford already announced in October that it will shutter plants in the UK and look to downsize operations in other countries. Peugot’s financing arm was indirectly bailed out by the French government, suffering under the weight of nothing more than the fact that its parent is a maker of cars in this economic climate.

Even automobile markets in the UK and US have experienced a massive shock in the years since the financial bubble burst. Both markets have seen impressive rebounds since 2009, but in a wider context remain rather far below pre-crisis levels in terms of both production and sales. Cars are not being produced or demanded like they were, as if the global system has experienced a paradigm shift.

Governments all over the developed world are essentially broke and bankrupt by any rational standard. Tax rate increases are the order of the day, and everywhere they are tried they feel the wrath of Arthur Laffer’s simplicity. Spain ups its VAT rate, and revenue from the VAT falls in almost perfect synchronicity. The UK implements a millionaire tax that finds fewer millionaires filling out tax forms. Whether they moved or stopped making millions (perhaps self-limiting taxable incomes to only 999,999), they disappeared from the realm of potential confiscations.

Despite all the oceans of "money", there is not a ducat to fill the tax coffers anywhere. Perhaps a platinum, multi-trillion dollar coin would do the trick. Maybe a multi-trillion euro coin made out of iron pyrite?

What ails all these bankrupted systems is not a shortage of money nor a shortage of wistful, imaginative and foolhardy monetary solutions. The lack of tax success and the reduced demand for automobiles are the symptoms of the same lacking element. What is missing is relatively simple and straightforward: wealth.

As hard as it is for most people in today’s modern era to grasp, as evidenced by the coin gambit, money is not wealth. Money can represent wealth, and, at times, even become a workable but temporary substitute, but money will never be able to replace true wealth as the central object, subject and foundation of the capitalist system. Of course, the capitalist system has found itself fettered by this modern obsession with money (included in the usage of debt as a centralized lever of control) and the political approval of economic central management, but, by and large the developed world still finds itself in some hybrid form of capitalism. While every major system continues to move to disproportion away from free markets and into the heavy handed, centralized approach, what is needed is less hybrid and more capital.

The central agency of true wealth is that it distributes economic success without the need for nudging or control. Debt, on the contrary, is the very embodiment of economic slavery - the overconsumption of current needs at the expense of encumbrance on future prosperity. Unfortunately for the developed world, that encumbrance began collecting rent in August 2007.

Much of the balance sheet expansion sold as economic elixir has simply been used to pay the freight of a debt-addled system. The cost of debt is interest, but the penance to the interest rate system lies in the multi-national banking system’s schizophrenic function. Comprised as nothing more than a cartel of interconnected behemoths, central banks have used these creations of debased monetary units to maintain the financial status quo. In the mechanics of central banking, these balance sheet expansions really amount to nothing more than risk transformations. Unusable financial collateral is exchanged out of the international banking system by central bank asset purchase programs, to be replenished by new issuance of "approved" security issues.

As an example, the ECB in its first OMT program bought up Spanish and Italian debt from the "market". Because these purchases were worrisome in the inflationary context, the ECB decided to "sterilize" the balance sheet expansion by offsetting weekly deposit auctions. For every euro used to buy "bad" government debt clogging the lines of rehypothecation, the ECB would extract an equivalent euro by offering a risk-free certificate of deposit paying some marginal rate.

In reality, the interbank market was flushed of some "bad" collateral now lingering on the books of the ECB, credit risk fully institutionalized, and substituted with these new deposit certificates (which were/are eligible to be used as hypothecation tools in repos). At considerable risk, the ECB managed the interbank money supply of acceptable collateral. The Fed’s QE 1 was of similar purpose and function.

Behind every monetary tool and program is the textbook theoretical foundation that banks and debt are the primary pillars of the economic system. The cost of servicing banks that create debt is enormous in the case where fractioning "reserve" assets has gone way too far - done so because monetary flow depended on growth of collateral regardless of tangible relation to cash flow or "value". For the past few decades, the banking system has layered monetary and credit expansion on too many bad assets. The nature of these bad assets is not just that they are experiencing pricing difficulties (liquidity problems), but that there is not enough cash flow to satisfy obligations. This imbalance was hidden in the complexity of the interbank operation, but absolutely necessary for the rapid and global financial expansion before 2007.

Central banks see pricing and liquidity as permanent and workable solutions to the pyramid of debt over wealth, and thus expend an enormous amount of effort and "money" to maintain nothing more than pricing and liquidity. Balance sheet expansions, and the "money" that is "printed", simply disappear into the liquidity rabbit hole. Prices are firmed or reaffirmed and nothing changes except the size of the respective central bank balance sheets. Money seems to vanish into the opaque and complex ether of wholesale rehypothecation and synthetic credit systems. The Keynesian multiplier of all of these trillions in new currency units must be a small fraction, at the very least proving that current monetary efforts are supremely inefficient means to economic ends.

What is holding back recovery is not the recession of debt and credit, but the ongoing lack of genuine income streams and opportunities. Good assets, those that can and do generate positive and sustainable cash flow, are what remain in short supply. Recreating old channels for credit production does absolutely nothing to remedy that central economic problem. Sustainable jobs do not come from Wall Street speculation or London trading of derivatives and rehypothecated central bank certificates.

In the whole spectrum of possible economic projects and activities, those at the lowest end are solely dependent on the flow of new money and debt. At the highest quality level are jobs and income streams that can operate independent of monetary intrusions and disruptions because they perform a service or need that pre-exists the level of money. On the downslope of the housing bubble in the US, for instance, millions of jobs (construction, mortgage financing, real estate churning) were lost simply because money stopped flowing into the housing sector. They were unsustainable and any downstream economic activity (such as automobiles) that was dependent on them was susceptible to not only cyclical reversal but permanent structural decline in the absence of replacement monetary flow.

The central effort of central banks should not be to spend trillions on liquidity and pricing in order to restart low quality economic activity, but to allow high quality, sustainable activity to take its place. That would happen if pricing and liquidity were allowed to demonstrate value - the very signal capitalists use to allocate resources. Further, the monetary system should be allowed to reorient itself back toward actual intermediation instead of flow-addicted speculation. But that would mean disruption and change, two parameters not suited to modern central bankers. Incorporated into such disruptions would be an implicit admission of bad theory since aggregate demand makes absolutely no distinction between high or low quality activity. For a central banker, a housing bubble is indistinguishable from real innovation and advancement.

Even in the areas where monetary success has the greatest chance of engendering and fostering the right mix of high quality economic patterns, the very presence of overwrought monetarism spoils and sours the potential. Capital investment is the most efficient pathway of economic expansion and the central foundation of the capitalist system. Given that corporate profits have been extremely robust in this "recovery" period, it should follow that the economic system arrives in a new Golden Age of expansion. Yet we have seen the most uneven distribution of profitability (favoring large over small) and the continuation of the distressing trend toward "investment" of corporate "capital" into stock repurchasing and M&A activity; thus transforming potential good capital back into merely money for the churn of inefficient asset prices.

Corporate profits have not led to sustainable jobs through capital investment, but rather dividend payments under the thumb of ZIRP and the monetarist goal of rising stock prices over all else. And where there has existed a tendency toward good investment, the weak dollar and currency instability sewn into the fabric of current domestic economic management favors offshore investment (accounting translations of a falling dollar are powerful lures to the multinational corporate business). Prices may be rising, but wealth is left behind. The system appears, at least from a cursory perspective, to be regaining solid form, but it is all an unsustainable illusion.

The current global problem of taxation is fundamentally a problem of economic growth, as is the fractional pyramid of bad debt to good assets. Economies that are actually growing would not be fighting for the monetary scraps left in the wake of persistent instability. Balance sheet debasement is the stuff of currency crises and currency wars, the opposite of what is actually demanded by wealth generation. In trying to find the sclerotic textbook answer central banks find themselves in a zero sum game of currency chicken because central banks cannot, no matter how much they proclaim the opposite through their mathematically modeled multipliers, create real wealth.

While some, such as the unelected government figurehead of Europe, see the absence of obvious crisis as a signal of good fortune, the reality is that the symptoms of dysfunction carry onward ever-present and lurking. Maybe the economic collapse of entire industries or countries is unmoving because we have become numb to the decay or now prefer our crises to be presented only through asset prices, but the Siren’s song of central banking does nothing to keep the economic ship from hitting the rocks; we are only distracted from the inevitable collision. Stock prices, like those in the middle of the last decade, cheer the hollowing of capital and willingly assist in the suicide of systemic wealth because managed speculation just feels so good. The most powerful of anesthesia can numb even the worst and most painful afflictions.

The economies of Spain, Greece and even France are warning what a world with decreasing wealth looks like, as does general labor participation closer to home. Because of the intentional stasis brought about by monetary interventions, the world’s economic system actually goes nowhere, yet hardly anyone wants to notice until some academic agency of some government retroactively declares an official start date. Trillions of dollars and euros appear out of the thin air of academic monetary theory, but never make their way into either the real economy or the tax coffers of the fiscally profligate, a distressingly obvious signal that something very big is amiss and askew. The political powers are left in bewilderment to resort to the "easy" solutions of divide and confiscate to go along with de facto monetization through bond or coin.


Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor.

See online: What Happened To All Of That Money?