The Fall Of Modern Finance
Let's get a post up that I didn't get up last October when the article highlighted was printed. The post remains extremely relevant.
We have discussed before Modern Finance is going to be proven significantly wrong on many levels this cycle. And, no one is at the heart of Modern Finance's movement any more than the monetarists Anna Schwartz and Milton Friedman. In fact, Bernanke is following a roadmap of what he believes is sound science, espoused by Friedman and Schwartz, to avert a significant crisis in the economy. Obviously, if the Fed can save many bank deposits, it will have a positive impact but the largest determinant of future economic activity is not the supply of money determined by the Federal Reserve. Far from it. And, an outcome as negative as the 1930s will not be determined by the Federal Reserve. In fact, much of the FDIC insured deposits are going to disappear anyway. Instead of these deposits disappearing with bank failures and no depositary insurance as we saw in the 1930s, we will witness them disappear as they are deployed in the economy in acts of subsistence and to pay down debts. Many of these deposits will simply not be replaced as unemployment and wealth creation in the economy continues to deteriorate until we reach a steady state. FDIC insurance, while constructive for individuals, doesn't necessarily impact bank financial positions in a positive fashion. In other words, bank capital positions are eroding not only because of bad assets but their balance sheets are shrinking because the balance sheet of society is shrinking. This is a recursive process that has shown no signs of abating. It is what we wrote of time and again that would happen in our posts about The Game.
While the world was still worried about inflation, one of my favorite bloggers commented that it would be nice if a new CEO to a troubled financial institution would come in and simply clear all of the toxic assets off of the books. A great act of transparency. A noble hope but I responded that this was impossible. Because the problem with deflation is there is no end to the deterioration of both bad and shrinking assets over time. That is, until the deflation has ended. This is one reason why recapitalizing banks will be a never-ending process. It is why we now see more and more injections into the same banks and soon new banks will suffer the same issues. This will continue until the deflationary forces in the economy have stabilized. The monetarist position of Modern Finance cannot solve this dilemma. Although it can be mitigated using other methods eschewed by Modern Finance and the economics community.
The concept that the Federal Reserve caused the Great Depression because it removed liquidity is and always has been a silly revisionist notion. A revisionist notion of the Great Depression that Schwartz and Friedman adopted thirty odd years after the economic collapse. The Fed was a "no show" at times but that they caused it by removing liquidity can only be true if monetarism is indeed an accurate theory. While we have been one of the most concerned voices over the last three years, there are still solutions to this crisis that can mitigate a 1930s style outcome for the U.S. But, time is running out. That's for another discussion. We'll have plenty of time to get a post up on this because policy makers and politicians are groping in the dark. And, they aren't even groping in the right universe.
Anyway, back in October Schwartz gave her perspective on the current crisis and policy decisions by the Treasury and Federal Reserve. It's an interesting read. Not because she is correct. But, because Modern Finance and the associated monetarism Schwartz was so instrumental in formulating is going to be proven wrong. So then is the economic hocus pocus taught at our finest institutions of knowledge. Hocus pocus that is pawned off as science.
While Schwartz may be critical of current governments and central banking tactics, many of which appear as cronyism, it is important to remember it is her research and conclusions for the cause of the Great Depression that central bankers are using as a guiding principal. Schwartz's remarks imply a plan to save the banking system has turned out to be a bailout for particular banks. In other words, cronyism. Of course, that is obvious to anyone watching from afar. Goldman Sachs, Morgan Stanley, Citigroup, JP Morgan, Wachovia or any other mega monopoly represents such systemic risk that there is little we can do other than play an interventionist role on some level. But should the intervention be to maintain systemic risks in the economy or to dismantle them in an orderly fashion? Our position on here has always been to dismantle them in an orderly fashion. In the end we shall probably see the markets do what government won't.
But, while Wall Street was cheering the Federal Reserve's early actions as the Fed started cutting rates, we were commenting that it is utter nonsense to believe central bankers can plan an economy. It is completely unfounded faith that has no scientific backing. That politicians, Wall Street and society should sit on the edge of their seat waiting to hear the next words from a central banker in the U.S., Europe or anywhere else simply wastes time that could be used to adopt real solutions. The Federal Reserve cannot fix what ails the economy. They can provide the conduit for credit. That's it. That doesn't mean deposit insurance or the role of lender of last resort does not play an important role in the economy. But, no one can wave a magic wand and make the world a better place.
Culture, industriousness, knowledge, technology, invention, the arts and most importantly the people represent irreplaceable assets in the economy. Does a loan from Citigroup have a different ability to help Google or the local business thrive more effectively than a loan from JP Morgan Chase? Wall Street and banking offers nothing other than a source of lending for drivers of the underlying economy - commerce. That's it. Period. Lending can come from the government, from a bank, or from the Gambino crime family. It matters not. The distribution of money is such a commodity that were any bank to fail, it would easily be replaced by another similar institution or even the government as we see today. There is no sustainable economic value in banking or finance. There is economic value in the aforementioned variables of commerce. There never has been and there never will be any sustainable value in banking per se. That is except for value derived by protecting the savings of society. That is the furthest up the value chain banking goes. In fact, as I wrote some time ago in a comment to a post, this country would operate just fine were the government to nationalize these mega banks. And, even if we had a not-for-profit banking system. In fact, our capitalist model has nothing to do with a particular view of banking. It never has. The imbalances in our economy are much more because we have a f0r-profit banking system that continually corrupts our government than any of the timeless incompetences in government regulators or the Federal Reserve or fractional reserve banking. Those are incompetences that have and always will exist. Those are incompetences that can easily be managed.
Instead of supporting the underlying economy, the finance sector has crowded out the underlying economy and this has only happened due to the drivers of profit and greed in the banking system. That impact has rewritten our laws, our regulations and driven nonfinancial companies to seek profit over investment, greed over concerns for society, short term gratification versus long term innovation.
Now, compare this to the economy's underlying commerce and businesses that are in jeopardy because of this crisis that is caused by banking. The concept of "creative destruction" is not at work in the failure of GM or other companies. There is no "new" technology obviating the role of GM. There is no economic winner at the expense of GM being a loser in the market. All global car companies will most assuredly fail without government involvement at some point. Wait and see. Failure to realize that neither superior competition nor creative destruction is at work here and, therefore, allowing these firms to fail will have dire and lasting consequences on society. Because, where there is creative destruction, there is new economic opportunity. With this environment we simply have economic destruction caused by the financialization of the industrial economy's management. Caused by the financialization of the economy. This is the virus at work in the failure of commerce. Bailing out poor decisions or poor management isn't a winner either but when I actually hear people on Wall Street or on financial television state that GM should be allowed to fail because the crown jewels of the American economy are the finance sector, I have to wonder what planet these people live on. There is absolutely no truth in that statement. Not one iota.
Government, when representative of the sovereign, is the true lender of last resort. It's decisions should be made for the people not to save the existing apparatus. Government needs to be focusing on how we stabilize commerce and worry less about the misguided beliefs developed under Modern Finance. Modern Finance is dead.
We have discussed before Modern Finance is going to be proven significantly wrong on many levels this cycle. And, no one is at the heart of Modern Finance's movement any more than the monetarists Anna Schwartz and Milton Friedman. In fact, Bernanke is following a roadmap of what he believes is sound science, espoused by Friedman and Schwartz, to avert a significant crisis in the economy. Obviously, if the Fed can save many bank deposits, it will have a positive impact but the largest determinant of future economic activity is not the supply of money determined by the Federal Reserve. Far from it. And, an outcome as negative as the 1930s will not be determined by the Federal Reserve. In fact, much of the FDIC insured deposits are going to disappear anyway. Instead of these deposits disappearing with bank failures and no depositary insurance as we saw in the 1930s, we will witness them disappear as they are deployed in the economy in acts of subsistence and to pay down debts. Many of these deposits will simply not be replaced as unemployment and wealth creation in the economy continues to deteriorate until we reach a steady state. FDIC insurance, while constructive for individuals, doesn't necessarily impact bank financial positions in a positive fashion. In other words, bank capital positions are eroding not only because of bad assets but their balance sheets are shrinking because the balance sheet of society is shrinking. This is a recursive process that has shown no signs of abating. It is what we wrote of time and again that would happen in our posts about The Game.
While the world was still worried about inflation, one of my favorite bloggers commented that it would be nice if a new CEO to a troubled financial institution would come in and simply clear all of the toxic assets off of the books. A great act of transparency. A noble hope but I responded that this was impossible. Because the problem with deflation is there is no end to the deterioration of both bad and shrinking assets over time. That is, until the deflation has ended. This is one reason why recapitalizing banks will be a never-ending process. It is why we now see more and more injections into the same banks and soon new banks will suffer the same issues. This will continue until the deflationary forces in the economy have stabilized. The monetarist position of Modern Finance cannot solve this dilemma. Although it can be mitigated using other methods eschewed by Modern Finance and the economics community.
The concept that the Federal Reserve caused the Great Depression because it removed liquidity is and always has been a silly revisionist notion. A revisionist notion of the Great Depression that Schwartz and Friedman adopted thirty odd years after the economic collapse. The Fed was a "no show" at times but that they caused it by removing liquidity can only be true if monetarism is indeed an accurate theory. While we have been one of the most concerned voices over the last three years, there are still solutions to this crisis that can mitigate a 1930s style outcome for the U.S. But, time is running out. That's for another discussion. We'll have plenty of time to get a post up on this because policy makers and politicians are groping in the dark. And, they aren't even groping in the right universe.
Anyway, back in October Schwartz gave her perspective on the current crisis and policy decisions by the Treasury and Federal Reserve. It's an interesting read. Not because she is correct. But, because Modern Finance and the associated monetarism Schwartz was so instrumental in formulating is going to be proven wrong. So then is the economic hocus pocus taught at our finest institutions of knowledge. Hocus pocus that is pawned off as science.
While Schwartz may be critical of current governments and central banking tactics, many of which appear as cronyism, it is important to remember it is her research and conclusions for the cause of the Great Depression that central bankers are using as a guiding principal. Schwartz's remarks imply a plan to save the banking system has turned out to be a bailout for particular banks. In other words, cronyism. Of course, that is obvious to anyone watching from afar. Goldman Sachs, Morgan Stanley, Citigroup, JP Morgan, Wachovia or any other mega monopoly represents such systemic risk that there is little we can do other than play an interventionist role on some level. But should the intervention be to maintain systemic risks in the economy or to dismantle them in an orderly fashion? Our position on here has always been to dismantle them in an orderly fashion. In the end we shall probably see the markets do what government won't.
But, while Wall Street was cheering the Federal Reserve's early actions as the Fed started cutting rates, we were commenting that it is utter nonsense to believe central bankers can plan an economy. It is completely unfounded faith that has no scientific backing. That politicians, Wall Street and society should sit on the edge of their seat waiting to hear the next words from a central banker in the U.S., Europe or anywhere else simply wastes time that could be used to adopt real solutions. The Federal Reserve cannot fix what ails the economy. They can provide the conduit for credit. That's it. That doesn't mean deposit insurance or the role of lender of last resort does not play an important role in the economy. But, no one can wave a magic wand and make the world a better place.
Culture, industriousness, knowledge, technology, invention, the arts and most importantly the people represent irreplaceable assets in the economy. Does a loan from Citigroup have a different ability to help Google or the local business thrive more effectively than a loan from JP Morgan Chase? Wall Street and banking offers nothing other than a source of lending for drivers of the underlying economy - commerce. That's it. Period. Lending can come from the government, from a bank, or from the Gambino crime family. It matters not. The distribution of money is such a commodity that were any bank to fail, it would easily be replaced by another similar institution or even the government as we see today. There is no sustainable economic value in banking or finance. There is economic value in the aforementioned variables of commerce. There never has been and there never will be any sustainable value in banking per se. That is except for value derived by protecting the savings of society. That is the furthest up the value chain banking goes. In fact, as I wrote some time ago in a comment to a post, this country would operate just fine were the government to nationalize these mega banks. And, even if we had a not-for-profit banking system. In fact, our capitalist model has nothing to do with a particular view of banking. It never has. The imbalances in our economy are much more because we have a f0r-profit banking system that continually corrupts our government than any of the timeless incompetences in government regulators or the Federal Reserve or fractional reserve banking. Those are incompetences that have and always will exist. Those are incompetences that can easily be managed.
Instead of supporting the underlying economy, the finance sector has crowded out the underlying economy and this has only happened due to the drivers of profit and greed in the banking system. That impact has rewritten our laws, our regulations and driven nonfinancial companies to seek profit over investment, greed over concerns for society, short term gratification versus long term innovation.
Now, compare this to the economy's underlying commerce and businesses that are in jeopardy because of this crisis that is caused by banking. The concept of "creative destruction" is not at work in the failure of GM or other companies. There is no "new" technology obviating the role of GM. There is no economic winner at the expense of GM being a loser in the market. All global car companies will most assuredly fail without government involvement at some point. Wait and see. Failure to realize that neither superior competition nor creative destruction is at work here and, therefore, allowing these firms to fail will have dire and lasting consequences on society. Because, where there is creative destruction, there is new economic opportunity. With this environment we simply have economic destruction caused by the financialization of the industrial economy's management. Caused by the financialization of the economy. This is the virus at work in the failure of commerce. Bailing out poor decisions or poor management isn't a winner either but when I actually hear people on Wall Street or on financial television state that GM should be allowed to fail because the crown jewels of the American economy are the finance sector, I have to wonder what planet these people live on. There is absolutely no truth in that statement. Not one iota.
Government, when representative of the sovereign, is the true lender of last resort. It's decisions should be made for the people not to save the existing apparatus. Government needs to be focusing on how we stabilize commerce and worry less about the misguided beliefs developed under Modern Finance. Modern Finance is dead.
<< Home