Financial Engineering for The People
Debt, once accumulated, constrains
demand.
By J.M. Hamilton (7-31-2015)
The global economy is
swimming against a tide of an ocean of debt and interest payments, and the tide
and the ocean…. Well, they’re winning.
As recently mentioned in my piece, the Downward Spiral, debt among the
Western democracies has actually increased, since the 2008 financial crisis,
and it’s having a stagnating impact upon economies, and weighing heavily upon
aggregate demand. Lower aggregate demand
and consumption feeds upon itself, and when combined with the forces of
globalization and automation, mean fewer jobs, depressed wages, and sub-par economic growth. In major economies
around the globe (China, Japan, Europe, and the U.S.), we see that combined
private and public sector debt is at 200% of GDP, or greater (especially, when
we add in unfunded or underfunded future liabilities).
As a result, central banks –
always ready for action – have stepped into the breach, and printed an ocean of liquidity (aka debt), in attempt to spur inflation and kick start economies. But with nearly every central bank printing
money and/or manipulating currencies, the macro impact tends to be zero sum,
particularly when it comes to aiding exports.
Major corporations, in the
face of lower aggregate demand, have taken the flood of easy money, and
resorted to financial engineering. Among
the tricks of the trade, financial engineering has led to: stock buy backs to
goose earnings per share; mergers and acquisitions to increase market share; the
formation of monopolies and cartels to enhance pricing power; the use of
derivatives, swaps and repos (aka off balance sheet accounting, often utilized
for betting, obscuring debt, and to enhance leverage); and central banks' easy
money policies have made it easier for corporations to engage in reorganizations,
and labor, tax, and regulatory arbitrage.
With multinationals, banks,
and shadow banking turning to financial engineering to increase profits, less
money is spent on R&D, production growth, CAPEX, and enhancing and training
human capital. Candidate Clinton has
drawn attention to the short-term focus of financial engineering, vis a vis, the long-term focus of sound
business fundamentals and top line growth.
But with everyone swimming against the same tide of debt, and facing
lower aggregate demand, how do CEOs and government policymakers go about
shifting focus, from the myopic to the long term? More importantly, can the drag and weight of
private sector debt – even public debt -
be addressed?
Moreover, can financial
engineering, that has been such a boon to the elite and the one percent, be turned
to the benefit of the global economy and utilized to increase higher aggregate
demand? That’s exactly the point of today’s piece,
but first a paragraph or two on paper currencies and the nature of debt.
Pull a dollar out of your
purse or wallet, or if you don’t carry any currency, look at your checking account on
line, and tell me what you see? If you’re
looking at the American dollar, you are looking at paper, or more precisely -
cotton or linen, and it’s backed by absolutely nothing….. other than the
willingness of our government to print more of it. The same can be said of most, if not all, global
currencies. They are all untethered from
gold and precious metals, and many free float against each other (that is, when
the banking cartel isn’t colluding to fix FX and LIBOR, or a country doesn’t
peg their currency to another). Ultimately,
a currency’s value is a reflection of the government’s fiscal and monetary
policies, as well as, said country’s macro fundamentals. History, too, plays no small role in the
perception of a currency’s value as a storehouse of wealth.
In short, the purchasing
power of the dollar is faith based.
Those who hold dollars believe that their purchasing power will remain
relatively stable, vis a vis, alternative
currencies.
Who said faith is in decline
in America?
The same can be said of
debt. It’s an accounting entry, and
recognition that the borrower will payback the lender the principal at an
agreed upon interest rate.
Debt too, is faith based.
What has been shocking too
many fiscal conservatives, myself included (at times), is that the Fed’s
printing presses has not set off massive paroxysms of inflation; but the lack of
inflation (admittedly, there is some inflation out there; look at the price of
higher education) has less to do with the Fed’s glowing printing presses, and
has more to do with the record numbers of unemployed, the large number of
citizens who have given up looking for work, and the resulting, diminished
aggregate demand. There’s that ginormous public and private sector debt again, killing animal spirits, growth, opportunity, and demand.
Arguably, what gives the
dollar its resiliency, in the face of The Fed’s myriad machinations, is that
there are fewer and fewer alternative currencies for consumers and businesses
to turn to; and the key alternative currencies face the same plight as the
dollar. In short, the printing presses
churn and smoke in Japan, China, Russia, and the E.U. With central banks engaged in economic and financial warfare around the globe, with beggar thy neighbor policies, it’s not
entirely surprising that the dollar is still in demand. In short, the U.S. dollar is the leper among
global currencies, with the fewest spots.
So what have we learned,
since ’08?
-
We’ve learned
that a cartel of currencies, and central banks, can manipulate their currencies
with minimal harm to the currencies' value, as long as the central banks,
directly or indirectly, behave in a coordinated fashion (and as long as the
global economy and aggregate demand are in a slump).
-
We’ve learned
that in crisis after crisis, private bank lending, and loose underwriting
standards, have set off manias, madness, and bubbles (fueled by central bank
easy money policies). And that
governments and centrals banks, particularly in governments where democracy is
for sale, will, often, willingly ride to the private banking cartels rescue. In short, not only is the government
responsible for public sector debt, but ultimately, thanks to TBTF, the
government is responsible for private sector debt in many instances, as well.
-
Moreover, Western democracies and central banks create and reaffirm moral hazard and the crony economy, not only by bailing out the banking cartel, but also by swapping out
toxic assets/toxic debt, and by placing said debt on government and central
bank balance sheets. Essentially placing
the taxpayer on the hook for private banking institutions worst excesses. (See the Federal Reserve and the European/U.S.
troika.)
It’s just another form of
financial engineering, and the manifestation of the crony economy, at a macro
level.
So what to do?
An idea came to me recently
when I saw German Bunds cross over into negative yield territory.
Why can’t central bankers
engage in financial engineering for the people, instead of the elite?
Since currency and debt are
made up of ether anyway, and faith, why not in a coordinated fashion park some
of that debt in an offshore special purpose vehicle (SPV), at a negative yield
in perpetuity, and let the debt wind down off central banks’ and governments’
balance sheets?
What better way to create new
stimulus for the economy?
Think about it, what’s
holding up the global economy?
Answer: Over indebted consumers
and governments. So why can’t central
banks purchase said debt (e.g. quantitative easing); place same debt in a SPV
at a negative yield; and the debt is effectively off government, central bank,
and consumer’s balance sheets.
“Ah,” but my critics will
argue, “Citizens will flee to stronger currencies.”
“What ‘stronger currencies’
would that be?” Say I. “Particularly if
this is executed in a coordinated fashion by all key central banks, globally.”
“Moral hazard!” Critics
shriek.
“Like the moral hazard we saw
in 2008, when banks (who caused the crisis), and the plutocracy, were bailed
out, globally, at the expense of everyone else?” I respond.
Think about it… with a SPV
destined, or set up for bankruptcy, trillions in government debt could be wiped
out globally, with just a few accounting entries.
Children could be fed and schooled, infrastructure could be rebuilt, aggregate demand could rise, and
corporations would be reinvigorated by top line growth, and wouldn’t need to
resort to financial engineering? Such
an experiment/program would need to start small, say a trillion per central
bank, to learn what the ramifications are.
Admittedly, bond yields might be driven lower, as investors chased yield
on fewer bond offerings. With cleared up
government and central bank balance sheets, bond yields would fall further;
participating governments might actually see their currencies appreciate and
grow in strength, creating negative short to intermediate treasury yields
(based upon the belief the currency would grow stronger as national debt was
eliminated over time).
Those who would object most to
such a scheme would be banks, mutual funds, shadow banking, investors, and pension
funds. But with a reinvigorated economy,
unencumbered by debt, this would create demand for new private sector financing,
additional debt, and would be a boon to the stock market. Counter-intuitively, and as stated above, the
value of currencies might actually rise, as government balance sheets were
cleared.
Such a scheme would need to
focus on expunging and resolving government debt and consumer debt, in order
for it to be successful. Global
governments and central banks have tried bailing out the elite, to the
exclusion of everyone else, and the effects of trickle down fiscal and monetary policy surround us (including, but not limited to: gross wage and wealth inequality, stagnation,
unsustainable debt, nation states indentured to banks and shadow banking, sovereignty destroyed by
central banks and the IMF, fewer employment opportunities, and suppressed
wages). Eliminating government and
consumer debt would free up aggregate demand, generated by governments and the
99%. Governments would be free to
increase social spending, and may even be able to keep tax rates down, as unsustainable
debt loads would no longer have to be serviced.
Consumer debt could be purchased as well – by central banks, say
mortgages, and sent to the SPV as well.
The U.S. government already holds the vast majority of residential
mortgages in GSEs, Freddie and Fannie.
Austerity might even become a
historical artifact, a footnote in economic history.
Keys to success are: Few global
currencies or a cartel of currencies; coordinated efforts among all central
banks to send a proportionate amount of government and consumer debt into
oblivion, at negative yields in perpetuity; containing and monitoring aggregate
demand so as to not outstrip supply (hence, preventing insipient and pernicious
inflation); and in regards participating currencies, central banks maintaining
full faith in their value.
Corporations and big
business, might cry out initially; but like most government social programs (like
the MIC, Medicare –Part D, Romneycare, the Surveillance State, etc.),
corporations with a vested interest would likely come around pretty quickly. And by removing debt off the
99%’ balance sheet, many consumers would be free to save and spend again. The pick up in aggregate demand could create
a boom in profits, hiring, and cause wages to rise higher.
Further down the road, governments
might begin to pay citizens a living wage, without a labor obligation. Such a scheme might prove most timely, as
robots and automation replace humans, and the demand for human labor is mitigated and ultimately, eliminated. Our debt
based economy would turn right side out, and quite possibly, become an economy
based upon manufacturing, production and services, again (with banking
providing a supporting, not the lead role).
P.S.
And while we are dreaming.... global coordination, and enforcement, of tax, regulatory, carbon emissions, and
labor policies will prevent nation states from being played off upon one
another, so as to level the playing field among all nations, and place the 99%
on equal footing with the 1% for a change.
Copyright JM Hamilton Publishing 2015
