Push Versus Pull

Whether foreign capital is “pushed” or “pulled” into a country has important implications. Money that is pulled into a country does so because its investments are attractive. Money that is pushed into a country does so for a variety of factors extraneous to the host country. In this case the host country, the US, is getting money not because of the investment opportunities it provides but rather because foreign countries want to stimulate Americans to buy their goods. History shows that money pushed into a country can lead to financial bubbles and borrowing binges in the host country as it must readjust to the inflow. Think of it like giving your college age child large sums of money each week.

Economists may argue over whether money has been pushed or pulled into the US. There is no arguing that starting in the early 1980’s when the Reagan administration began dismantling regulations that foreign central banks started aggressively buying US treasuries($2.7 trillion held in the Fed’s custody account alone and does reflect Eurodollars, bank deposits, Foreign exchange swaps, Eurobonds, etc. held). We have consistently adjusted to this inflow by running record trade and current account deficits, ones that have historically brought calamity. Former Federal Reserve Chairman Greenspan remarked over four years ago how America’s ability to run deficits had gone well beyond historical norms. We have not been forced to pay the piper yet because foreign governments continue to “push” money into the US to maintain growth of their economies at our expense.

This massive inflow of capital (dollar purchases) over the last two decades has not caused a surge in our economic growth which has chugged along at only a modest rate. It has led to a host of speculative bubbles beginning with the 1987 stock market bubble and the innumerable crashes and ensuing bailouts that followed. It has also led to a borrowing binge by US consumers who are now saddled with massive debt($2.6 trillion). In other words, all this money flowing into the US has not led to a commensurate surge in US growth but has significantly deteriorated our country’s and citizen’s balance sheet and made us vulnerable. Within a few decades we have gone from being the world’s largest creditor to being its largest debtor.

The long term consequence of letting a country continue to “push” money into a host country can be devastating. China, for example, has consistently intervened in foreign exchange markets by buying dollar denominated bonds and paying for it by selling its own currency to keep its value low and prop up the dollar (“push” money in). By letting the Chinese and others keep the value of the dollar artificially high and their currency value low, US exports have been made non-competitive in foreign markets. This has prevented us from exporting our way out of our trade deficit which is the mechanism by which trade imbalances are corrected. Over time this has meant the gutting of US exporting industries and a significant loss of jobs.

Fighting the Last War

Economists and politicians are notorious for fighting the last war rather than understanding the current predicament. Today, fearing a repeat of the Great Depression, the Federal Reserve is pumping money into the system and Washington is bailing out financial institutions. The problem is not a policy choice, albeit regulation would help, it is viewing the world from a lens of the 20th century instead of the 21st century.

Technology and globalization are altering the world at an increasingly rapid rate. In 2007, Russia redefined war when it waged cyber war on Estonia by flooding its Internet servers with so many requests that their whole system crashed. Similarly, we have been attacked by foreign countries that have given us a Trojan horse of money that has deteriorated our financial health and given us a false feeling of superiority and security, thereby making us vulnerable.

Washington needs to collar Wall Street, not further indulge it. Wall Street was the architect in creating the financial structures, products and the liquidity that was necessary to enable large sums of money to breech our borders. For its collaboration, Wall Street has profited handsomely, from the shill selling stocks, to foreign exchange traders, to participants in the US bond & money markets, to investment bankers, to the mutual fund industry to players in derivatives markets and all have profited from the financial invasion of the US.

Time For a Change

Instead of bailouts and easy money, we need bold initiatives from a government that understands that we live in world that is smaller and increasingly linked by cross-border capital flows and the Internet. If the financial system is an integral part of our well being and national security, then the government should move swiftly to seize control of banking institutions and remove our vulnerability to the whims of foreign central banks and speculators. We need to nationalize financial institutions to insure that they act in America’s interest, not their own self-interest that has no allegiance except to the bottom line.

In addition, the government should do everything in its power to control and preferably outlaw derivative securities. Derivatives are securities whose value derives from another security and require a minimal amount of money down to buy. They are a financial innovation of the last 30 years that have been behind every financial crisis and bailout of the past few decades from the 1987 stock market crash (stock index futures), to Long Term Capital Management in 1998 (interest rate derivatives) to our current $700 billion buyout of banks precipitated by their purchases of toxic derivatives (credit/sub prime/mortgage derivatives). Derivatives give speculators enormous power and leverage that they used to attack the British pound in 1992, to attack the Asian currencies during the Asian contagion in 1997/98 and recently to push the price of oil higher. If it were not for derivatives that allow for speculation in oil and basic foodstuffs the price of food and oil would be much, much lower. Remember, it was margin buying (leverage) that led to the stock market crash of 1929 and margin buying was a precursor to modern derivatives (leverage).

No doubt financial institutions, speculators and other special interest would be against draconian measures to seize control of financial institutions and outlaw derivatives. But bold initiatives are needed at this time of national crisis. The world is changing and unless we see and understand this we are doomed. Bailouts have not worked since 1987 and will continue to fail. We the people in the form of government need to reassert ourselves if democracy is to survive. People need to rule, not money!

The bailout is an attempt to bring confidence back to the lending market that has seized up in fear and is not making loans. The concern is that the cessation of liquidity and lending will exacerbate the meltdown on Wall Street and ripple broadly into the economy. The Paulson plan fails to address the issue of fear that is behind the crisis.

History Shows the Plan is Doomed to Fail

Over the past few weeks we have been consistently told that we face an epic crisis comparable to the 1929 stock market crash with its ensuing Great Depression of the 1930’s. So why are the lessons of the Great Depression being ignored?

During the Great Depression lending similarly dried up and confidence swooned. Lending and borrowing came to a standstill. The Lesson of the Great Depression was that it is next to impossible to get institutions to lend and companies/consumers to borrow once fear sets in. Renowned economist John Maynard Keynes said that trying to get banks to lend and borrowers to borrow during a banking crisis is like trying to “push on a string”; in other words it is impossible. Similarly in the 1990’s, the Bank of Japan found trying to resuscitate lending in the wake of the Japan’s stock market collapse was impossible. The Bank of Japan even went to the extreme of making interest rates negative, in other words they paid you to borrow, and it proved ineffectual.

While pushing on a string refers to monetary policy, which the Fed has kept loose, and the Paulson plan is about buying assets, they are similar because they are attempts to get banks to lend. Buying the bad assets of institutions is going to at best provide a temporary return to lending. Ultimately you can lead a horse to water, but you cannot make him drink.

“All We Have to Fear is Fear Itself”

In his first inaugural speech, FDR voiced the greatest challenge facing America and the world at the time when he said, “All we have to fear is fear itself”. Today fear has again set into the financial markets and is beginning to spread. Turning this tide is next to impossible.

The market runs from the extremes of greed to fear and once a mentality sets in its stays for a very, very long time. Nobel Prize winning economist Robert Mundell described the reticence of consumers to buy things in the 1930’s as a deflation (falling prices) mentality. Because demand fell off a cliff, retailers were forced to reduce prices to sell their products. Consumers eventually realized that by postponing their purchases they could save money. As they held off buying, retailers were forced to reduce prices further to entice buyers. This created a self-fulfilling spiral pushing prices lower that eventually had many buyers forgoing buying totally.

Admit that Reaganomics and Free Markets Don’t Work

The unfortunate thing is that the Bush Administration and Republicans refuse to admit that the problem we are suffering from today is the failure of free market and Reaganomic ideology. The cause of our current problems from the meltdown on Wall Street, to higher gas prices, to higher food prices can be traced squarely to the failure of free market/neoliberalism/Reaganomics ideology.¹

Government needs to regulate and get rid of the excesses created by the free market’s binge of the past few decades. Bold and aggressive initiatives such as the government seizing control of financial institutions are needed at this time. Fear has set in and throwing good money at bad as we have done successively with bailouts since the 1987 stock market crash has not worked. Bailouts create a moral hazard and reckless behavior that necessitate further bailouts where eventually you reach a point that the size of the bailout bill is insurmountable. Today we are being forced to fork over a massive $700 billion.

Capitalism is failing again as it did during the 1930’s with the Great Depression. They say “fool me once shame on you, fool me twice shame on me.” How many more times will we allow ourselves to be fooled? Free market ideology does not work! Bold initiatives that empower “we the people” are needed.

1. See “Higher Gas Prices: The Failure of Free Markets and Reaganomics.”

We are not just talking about bad policy choices by the Fed. We all make poor decisions, and as a former global money manager I am all too familiar with how the best analysis can at times lead to the worst of results. I am talking about something more insidious. The Fed, particularly under Greenspan, not only made poor policy choices, but pursued a radical free markets agenda and an experiment in financial alchemy from which we now suffer.

Who gave Greenspan the authority to push his agenda and have average Americans serve as guinea pigs for his experiments in free markets and financial sorcery? No one!

Fed 101

Greenspan was able to pursue his whims because the Federal Reserve exists as an independent entity unencumbered by rules that govern other government agencies.

The Fed is free from the checks and balances that are the backbone of the US constitution. The Fed is free from GAO reporting and Freedom of Information Act scrutiny. Its meetings are kept secrecy until long after the fact. It was mandated to report to Congress by the Humphrey Hawkins Full Employment Act until it expired in 2000. Although no longer required to report to Congress the Fed chairman still does. Arguably it is only beholding to its board of directors made up of primarily the largest financial institutions in America ; a classic example of the industry supervising the regulator.

The Fed is responsible for conducting monetary policy, overseeing financial institutions and financial markets. In other words the Fed not only sets policy but oversees itself, a clear conflict of interest. Because the Fed can print its own money it is free from Congressional oversight. No need to worry about a budget, just turn on the presses; and don’t worry no one can audit you.

It is difficult for people outside the world of finance to understand the scope and power of the Fed since we are so used to thinking of line authority that gives certain powers to individuals. The Fed’s power rests in a mix of monetary policy tools and confidence in the institution; but in a world ruled by money, the one that controls money is the king. Bob Woodward’s book on Greenspan, Maestro: Greenspan’s Fed and the American Boom expressed the perspective of many that Greenspan was the most powerful person in the world when he said, “On January 20, 2001, a new president takes the oath of office. He assumes the presidency in a Greenspan era.”

Amity Shlaes of the Financial Times similarly commented on the enormity of Greenspan’s power and the inherent failure of the design of the Federal Reserve system:

How can it be, at a time of unprecedented faith in free markets, that we even think a government authority might have such strength? And how can it be that the world’s monetary order rests on the shoulders of an individual, much admired but still fallible economist?

The answer is America ’s uniquely flawed and outdated monetary law, which gives the nation’s monetary chief the sort of discretion of which his peers in other developed countries can only dream. Mr. Greenspan is so powerful that today he is perceived as a loving dictator. This is only natural. For as we know from history, wherever the law is weak-in any area of politics-public credibility tends to vest itself in an individual.

A Radical Agenda

Greenspan is an ardent devotee of the most radical element of capitalism and free markets. As William Greider notes, “His thinking is still anchored by Ayn Rand’s brittle social philosophy: Let the strong prevail, let the weak pay for their weakness.”

Throughout his career beginning with the 1987 stock market crash Greenspan has bailed out the rich while ignoring the plight of average Americans. During the Fed engineered bailout of the speculative hedge fund, Long Term Capital Management, the Wall Street Journal’s op-ed page would lament (“Decade of Moral Hazard,” 2/25/98):

“As moral hazard grows you get a market so skewed by the expectation of bailouts that vital signals about genuine risk no longer get through. Eventually, the danger turns into one of systemic collapse…”

The bailouts have only increased in frequency and size of money needed for rescue that today we face the “systemic collapse” the Wall Street Journal forecast.

Instead of balancing the needs of the well to do (inflation) with the interest of working Americans (jobs) as mandated by the Humphrey Hawkins Full Employment Act, Greenspan consistently championed the rich. The Fed has almost exclusively focused on keeping the rate inflation low and ignored the needs of working Americans’ for a strong economy to create jobs. Generally speaking low inflation benefits financial assets and modest, or higher inflation stimulates the economy. The decision to focus almost exclusively on keeping inflation low sent the value of financial assets rocketing higher. Since the advent of Reaganomics and the Greenspan Fed, the PE ratio of the stock market tripled from its historical range of 10 to 15 to 30 to 45. The PE ratio (Price Earning Ratio) is the price of stock divided by its earnings per share. The higher the PE the greater the value.

This explosion in the value of financial assets was a boon to the wealthy that own the bulk of the stock market. Having the value of their investments triple in value by having the Fed simply wave a wand and put the onus on average Americans meant that they had more money to spend on funding conservative think tanks and lobbyists, both of which have dramatically increased. The Fed’s decision to hoist the value of stocks at the expense of average Americans underscores what James Livingston argued in Origins of the Federal Reserve System: Money, Class, and Corporate Capitalism, 1890-1913, that the creation of the Federal Reserve was part of an effort to create a new ruling class of ‘corporate-industrial business elite.’

The Financial Experiment Gone Bad

One of the incipient factors behind our current financial maelstrom is financial derivatives. Derivatives are financial assets whose value is based upon the price performance of some underlying asset. They usually entail leverage.

Greenspan has consistently championed and protected government oversight of derivatives. On 9/11/00 the NY Times, in “Greenspan Urges Congress To Fuel Growth of Derivatives,” reported that:

“The Federal Reserve chairman, Alan Greenspan, urged Congress today to encourage the growth of complex financial contracts known as derivatives before the United States share of that market and associated benefits are lost to other countries.”

One must wonder if we would be suffering today if Congress had not been railroaded?

One of the other financial innovations in derivative products creating havoc is subprime mortgages. The subprime market developed as a response to Reagan’s deregulation of the banking system. Banks were allowed to depart our inner cities where the most vulnerable in our country live. Greenspan stood by while this void was filled by loan sharks and shysters who found creative means to circumvent state usury laws and created the fringe banking market. New and innovative financial products were created to prey on the less well to do such as sub prime mortgages, payday loans, auto title loans, check cashing stores, tax refund anticipations loans and others all of which charged exorbitant interest rates.

Many community groups correctly pointed out that fringe banking preyed on the poor, the elderly and people of color. The Fed turned a blind eye to this abuse and did nothing to prevent or even regulate this industry!

Reform the Fed

New Humphrey Hawkins Act — A new Humphrey Hawkins Full Employment Act needs to be passed that has the Fed focusing primarily on creating jobs, the real economy and the interests of average Americans. The Fed’s mandate must be to focus on all Americans.

New Board of Directors — The Fed needs a new board of directors who is primarily made up of individuals and organizations that serve the common good. They need to have the power to rein in the chairman.

Supervision needs to be separated from oversight — The policy arm and oversight functions of the Fed need to be separated.

Fed Head Should be Elected — The head of the Federal Reserve needs to be an elected official.

Congressional Oversight — The head of the Fed has to report to Congress on a regular basis. Congress should receive a detailed plan as to Fed’s policy objectives.

No More PKO’s for the stock market — Since the 1987 stock market crash it is widely rumored that the Federal Reserve, like the Bank of Japan before the precipitous decline of the Japanese market, has been pursuing an active “Price Keeping Operation” (PKO) to buy stocks during dramatic price declines. This must stop! Congress needs to investigate the books of the Fed to determine whether it holds any stocks in its portfolio.

Member Services — Financial institutions that are members of the Federal Reserve system have to offer basic checking, savings and cash checking at minimal cost to our most vulnerable communities.

No more bailouts.

For more information on the Fed go to:

Federal Reserve Links: www.jubileeinitiative.org/FedInfo.htm

Fedhead Blog

William Greider’s Secrets of the Temple: How the Federal Reserve Runs the Country after two decades since publication remains the authoritative text on the Fed. Greider has written a plethora of excellent articles on the Fed that can be accessed here.

The Financial Markets Center focuses on the Fed and has a rich archive of informative articles.

The solution to reducing the price of gas and basic foodstuffs begins with educating the public about the failure of free market ideologies. As progressives, we need to show how Reaganomics and free markets have created the mess in which we now find ourselves. We can do this by pointing out how people spouting off the benefits of Reaganomics are responsible for higher gas prices, higher food prices, war and other economic hardships.

Reawakening the Industrial Giant

The progressivism of the New Deal that brought the US to greatness in the post-World War II period began unraveling in the 1970s with the advent of free markets. In 1973 President Nixon abandoned the Bretton Woods Fixed Exchange system that had regulated trade and exchange rates since 1944. This tied the determining of exchange rates to the markets and de facto transferred decision making from government to the markets. Money, no longer tethered to governments or to gold, was free to do as it would, and it immediately began setting the tone in global markets. Our current modern era of hyper-capitalism was unleashed.

In the 1980s President Reagan accelerated the shift to free markets and the transfer of power from “we the people” to corporations and the wealthy. In his inaugural speech he said, “[G]overnment is not the solution to our problem… It is time to reawaken this industrial giant, to get government back within its means, and to lighten our punitive tax burden.”

What Reaganomics did was give greater strength to markets and reduce the power of government to govern, regulate and protect. This made both government and its citizens increasingly vulnerable to exploitation. It did not take long for the effects of Reaganomics to be felt. Within his two terms the US went from being the world’s largest creditor to becoming its largest debtor.

Rationale for Free Markets

The idea behind Reaganomics is that the market is the best arbiter of decisions; the market knows best how to efficiently allocate resources for the greater good. As Adam Smith said, “By [man] pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”

Reagan claimed that getting rid of oversight and regulations governing corporations would lead them to innovate and expand, benefiting the US overall. By reducing taxes, capital would be freed up for investment and spur economic growth, creating jobs and wealth and benefiting the whole of society.

Selfishness and Predatory Policies

Instead of society benefiting from self-interest and deregulation “we the people” have been held hostage by special interests and speculators. With government being dismantled, corporations found it in their “self-interest” to buy influence in Washington so that they could limit competition, overturn consumer safeguards that hurt their bottom line, win perks and garner lucrative contracts with little oversight.

By transferring power to the private sector the Reagan Administration reduced the power of fiscal policy (taxes) in favor of monetary policy and in doing so gave enormous power to the Federal Reserve. Monetary policy uses interest rates and money supply to affect the economy versus fiscal policy that uses taxes to influence growth. The problem comes, as it did with the Greenspan Fed, when monetary policy focuses exclusively on keeping inflation low to the benefit of wealthy stock owners versus increasing the money supply to spur growth and create jobs.

Since the 1970s the number of lobbyists on K Street in Washington has mushroomed to over 30,000, and the capitol is awash with special interest money. The only comparable period that comes close according to ex-Republican strategist Kevin Phillips was the Gilded Age. It is this, what Phillips calls plutocracy, and rule of money that has helped precipitate the rising prices of oil and basic commodities.

“Big Three” AutoMakers: The Demand Side

In the 1980s General Motors, Ford and Chrysler, “the Big Three,” decided that instead of making fuel efficient cars that would have reduced our foreign dependence and demand for oil, they opted to maximize profits by pushing Sport Utility Vehicles (SUVs). SUVs are considered trucks and are not used in determining an auto manufacturer’s mandated Corporate Average Fuel Economy (CAFE) for its fleet. Consequently, manufacturers could promote gas guzzling trucks and SUVs and not worry about the impact on the CAFE average of their fleet. Nor did they have to increase spending on research and development in creating new fuel-efficient cars. That is why beginning in the 1980s there was a big marketing push by the Big Three for people in the US to buy trucks and SUVs. They succeeded: by the end of the 1990s their sales of SUVs and light trucks were overwhelmingly higher than cars.

The Big Three have consistently lobbied against increases in federal miles per gallon standards and higher pollution standards. The strategic decisions of the Big Three to focus on currying favor in Washington and to rely on loopholes to circumvent CAFE regulations over the last few decades have contributed to higher gas prices by not helping reducing our demand.

“Big Oil”: The Supply Side

Big Oil has a long history of money influence in Washington. It is widely reported that within months of taking office Vice President Cheney led a task force to determine the nation’s oil policy by enlisting the oil behemoths. In 2006 the Wall Street Journal reported that Big Oil’s lobbying efforts paid off in the form of no tax increases and the retention of incentives. Many believe that the war in Iraq was about oil.

Big Oil has no incentive to increase the supply of oil because it would help reduce prices at the pump and hurt its bottom line. Democrats have begun pointing out that a lot of the federal land available for exploration of natural gas and oil remains unexplored. Similarly, it has been decades since the last gas refinery was built.

What is telling about Big Oil is that the industry’s research and development (R&D) spending as a percentage of revenues has been consistently in single digits for over a decade. As the Financial Times of London noted, “Relative to revenues, oil companies’ R&D expenditures are strikingly low.” In April oil executives balked at Congressional requests to use part of their windfall profits from higher oil prices to increase R&D spending on finding alternative energy sources and other measures to reduce our dependence on foreign oil. Instead they opted to buy back shares and increase dividends to the benefit of their shareholders.

Speculators

Nowhere have the effects of removing what Reagan referred to as the impediments of government been felt more than in the financial markets. The emphasis on deregulation has been heavily in favor of corporations and large pools of capital. Deregulation has spawned new industries and financial products such as derivatives (financial products like options whose value is based upon the underlying value of another security such as a stock) which were nonexistent in the early 1970s and today are valued over $596 trillion. In the foreign exchange market alone – where only currencies are traded – the daily trading volume is 16 times the amount of goods and services created daily and a multiple of that for the goods traded globally each day. Talk about the tail wagging the dog. Add privatization, securitization and new commodity products and you now have a world where anything and everything is traded. Arguably it was President Reagan who accelerated the cross border movement of capital when he ran the US deep into the red and eliminated taxes on treasury bonds to entice foreigners to buy them.

Speculators are why the price of oil has recently spiked. As the Times of London noted, it has been speculators that have been able to do what the Organization of the Petroleum Exporting Countries could not do — raise the price of oil.

Markets are fickle, but they can sense blood (opportunity). They have also become so large that they can themselves drive prices regardless of the underlying supply and demand equation. For example, speculators overwhelmed the United Kingdom in 1992 and forced it to drop the Pound’s link to European currencies, and in 1997 Asian currencies were attacked.

We are told that the story line behind oil’s recent rise is increased demand from China and India. No doubt this is true. More importantly, speculators believe this, so they have been buying. There has also been a diversification of portfolios to commodities that has contributed to higher demand for oil.

Large price increases always draw in new buyers. There has been a rush of speculators and others looking for profit. Corporations dependent upon gas to operate their businesses have begun to trade oil. All of this has helped raise prices and in doing so has securitized our lives and basic needs, unknowingly making us all part of a world casino.

Reducing our Vulnerability

Reaganomics and the push to free markets has securitized our lives and made us vulnerable to the whims of speculators and special interests. Reducing the price of oil and basic foodstuffs is about ending the cannibalistic push for deregulation.

To bring democracy back to the US and free ourselves from the chains of special interests we need to educate people about the hypocrisy and evils of free markets and deregulation. We do this by exposing the conservatives, Reaganites and their ilk for the mess they put us in. We need to show all those that have party or group affiliations to Reagan principles for what they are — a failed parasitic policy.

We must not be swayed by false short-term delusions of hope such as offshore drilling. The surge of deregulation and free markets is what put us in the mess we are in.

Reaganomics has been an abysmal failure. Only by addressing the fundamental causes can we hope to find a solution.

The preceding is from Syracuse Peace Council’s September Peace Letter.