Last June I published a post which describes The Money World as opposed to the Real World where you and I live.
This diagram [below] is simpleminded, but I made it so deliberately. More and more, it is the connections between the Treasury, the Federal Reserve and the Big Banks that count in the markets. Gamblers (traders, hedge funds, private investment firms, etc.) depend on and feed off of those connections...
What happened to the old story in which zero interest rates and massive bank bailouts and the Fed's quantitative easing and enormous Treasury deficits would somehow benefit Main Street? That story is dead.
What is striking about all this is the degree to which the Money World is detached from the Real World...
Note: Treasury includes Fannie Mae, Freddie Mac, Ginnie Mae, etc.
With all the talk about the Fed's QE2, it's a good time to revisit this subject because my original remarks (stated just above) are now more pertinent than ever. Unfortunately for us, the Money World is not completely detached from the Real World. In fact, ordinary Americans are being screwed in new & creative ways that would have been unimaginable before the meltdown in 2008. Keep the simple Money World graph in mind as you read along below.
In reading Chris Whelan's The Fed's Zero Rate Policy Is Destroying America, I ran across this claim—
Non-commercial demand for dollars is collapsing in much of the global economy, in part because the Fed is transferring something like three quarters of a trillion dollars annually from individual and corporate savers to the Wall Street banks. And even this vast subsidy will be insufficient to prevent the ultimate restructuring of the top three U.S. banks. What will Fed Chairman Ben Bernanke and the other members of the FOMC say to Dianna and the millions of other Americans impoverished by their policy errors when we have to break up the top-three U.S. banks anyway?
I was inclined to believe that such a wealth transfer from the Fed to the Big Banks was ongoing, but I wondered how the $750 billion number had been arrived at. I contacted Whelan, who directed me to his article Bernanke Conundrum Is Obama's Problem—
Over at the Federal Reserve Board, a different kind of policy gridlock persists. The Federal Open Market Committee thinks low interest rates are helping the economy, but the opposite is the case. The monetary policy mechanism that provided liquidity to households when the Fed lowered the cost of credit [before the crisis] is broken. Both the central bank and the White House need to recognize this fact and act to address it with effective policy.
Offit Capital Advisors noted in an August 1, 2010 commentary entitled “The Invisible Tax” that the zero rate policies by the Fed are draining hundreds of billions of dollars in income each year from the U.S. economy. Offit estimates that $350 billion per year is being foregone by investors in state and federal obligations and transferred to the government due to Fed low rate policy. The income foregone by individual and corporate savers and transferred to the banks is something closer to $600 billion annually or nearly $1 trillion in total.
When theses subsidies from low interest rates are added to the huge mortgage banking profits being taken by the top four banks from Fannie Mae and Freddie Mac, the largest U.S. banks are literally draining a large portion of the income from the American economy.
The fact that these large banks and GSEs are refusing to refinance many residential mortgages in order to preserve their profit margins only adds insult to injury, a political fact that will be made clear at the polls in November.
So we see that the Fed's zero interest rate is punishing savers or government bond holders (through interest income foregone) to the tune of about $900 billion annually. This money has been effectively transferred to the Big Banks, who can take advantage of free money via the Fed's zero interest rate policy to restore their tattered balance sheets. Even if interest rates on bonds are at historical lows, the Big Banks, which having been buying tons of government paper, still make money because simple mathematics tells us that a positive number (rate of return) is greater than zero (graph below).
Source: FRED
Needless to say, ordinary people living in the Real World can not borrow money at no cost or 0.25%.
We can add to this tally the money that flows from the Treasury (including the agencies Fannie & Freddie in my graph) to the Big Banks because the agencies buy mortgage paper from the banks for 100 cents on the dollar, which is usually more than the paper is worth. This is another subsidy for the Big Banks, pure and simple. The agencies, which are now owned by the government, or in theory owned by the taxpayers, take the losses.
Let's turn now to the effects QE2. Former Treasury Secretary John Snow explains (hat tip, Tim Iacono) how it works—
The idea behind quantitative easing is you buy government paper that’s held by financial institutions or individuals. And then they have the money. And then they go out and buy some other financial assets, stocks. And they drive up the value of those other financial assets so we get an increase in the value of financial assets which means an increase in the value of lots of peoples’ household wealth. And the idea is if household wealth goes up, then that will be a spur to spending...
If their assets go up in value, if the stocks and bonds they hold go up in value, they will be inclined to feel wealthier and more confident about the world. That’s the theory.
That's the theory. I appreciate Snow's candor. Of course, I destroyed this theory in The Fed's QE2 — Speeding Our Demise, but let's look at a different aspect of it today.
Note that Snow says that the Fed will buy Treasuries. This reduces the "borrowing" costs of the government by creating more "demand" for government bonds, which raises their value but reduces the interest rates paid on them. The Fed has created more "demand" for bonds by printing money to buy them. This adds to the estimated $350 billion "being foregone by [American] investors in state and federal obligations." And in so far as the Big Banks are now big bond holders because of the Fed's largess, they can sell their bonds for more than they might have gotten for them before QE2 was implemented.
Financial institutions or individuals sell their bonds at a considerable profit, and are then free to invest that money in other "financial assets," which basically means stocks (or commodities like oil). In fact, the stock market has been rising—the Dow is now over 11,000—in anticipation of QE2. If the Fed actually does start buying Treasuries, it looks like the sky's the limit for the stock market.
Thus we will have another bubble in stocks. And who benefits from bubbles? The answer is obvious—the wealthy financial institutions and individuals who own about 80% of stock market's current capitalization. Thus we have an indirect transfer of the Fed's freshly printed money to the Big Banks (and hedge funds, etc.) and the wealthy. It's clear that the 77% of American households living paycheck to paycheck will not benefit from QE2 and the resulting bubble in the stock market.
I don't the time today to cover all the shenanigans that go on in the Money World. For example, Larry Summers and Tim Geithner are very proud that the TARP will show only a small loss because heavily subsidized banks have been able to pay back their original bail-outs with interest.
You will note in all of the above that all these moves in the Money World have either 1) a negative impact on ordinary people in the Real World (savers) or 2) a marginal (but temporary) positive impact on those suckers ordinary people holding stocks. These latter can save themselves if they get out while the getting is good—that is, before the newly inflated bubble in the stock market crashes.
And all the while, the Fed will be converting dollar bills into toilet paper. I suggest you take out your wallet, take out a one dollar bill, and take a good, hard look at it. Now, ponder what I just said. If those dollars are losing their value, and you have no way to get more and more of them, you are up shit creek without a paddle. On the other hand, if you operate in the Money World, there is no problem getting your hands on more and more of those dollars even if they are becoming toilet paper. The smart people are buying gold, commodities and other hard assets.
Of course, if you're living paycheck to paycheck, how many ounces of gold can you buy at over $1300 an ounce? Or barrels of oil at $83 a barrel? You see the problem. So it is clearer than ever before how the Money World relates to the Real World where you and I try to eke out a living. And ask yourself this question, which I posed in my original post—
And one more thing: in mainstream media reporting, the Real World (or "the economy") is often conflated with the Money World. When you hear this bullshit, you need to ask yourself is this story about the actual economy, or is this story about the Money World?
Good luck.
I have another way of looking at this. We are in a period of stagnation/decline, and capitalism as we know it needs perpetual growth to work. Could this $750 billion be in effect a subsidy to the capitalist system to keep the paradigm (supposedly) working?
Posted by: John Dyer | 10/14/2010 at 11:52 AM