Facing the Financial and Economic Blow-Out
The financial systems have become based on the financialization and securitization of consumer spending and consumer debt.
If you stay at a hotel, your room payment goes through a whole series of companies or financial vehicles you’ve never heard of, some of which exist entirely to take a cut of that payment.
The same is true when you buy food, pay your utility bills, or buy a car. Your rent or mortgage payments, your car loan payments, are securitized and split up among scores of financial operations. Fifty years ago, financial speculation began to be far more profitable than investing in capital goods to produce anything, especially to produce it here in America. And your nation has become dependent on cheaper global value-added chains for the produced devices and goods it once produced.
Now what happens if we have to impose major quarantine in one economy after another—to save lives, which will most probably have to be done. Some of these so-called global supply chains will quickly become empty; it will be temporary, but it will disrupt every globalized national economy. As in China, production can come back. But consumption will be massively lost—demand will be quarantined—and will come back much more slowly.
Mass quarantine has now come to Italy, one of the G7 leading industrial economies. In the hope of containing an outbreak of Covid-19 in Lombardy, the region around Milan, and Veneto, around Venice, over 55,000 in the so-called Red Zone have been told not to leave the area for at least two weeks.
As this reality breaks through the illusions fed by central bank money-printing, the stock markets have fallen from record highs, taking massive plunges more rapidly than at any other time except the summer of 1929. Leading the collapse are consumer goods stocks, auto stocks, stocks of banks, and stocks of insurance companies. The plunge in bank and insurance company stocks points to the fact that U.S. Treasury interest rates are falling so fast that the immense mass of $600-700 trillion in derivatives contracts—which are overwhelmingly bets on interest rates—could blow big holes in these banks and their counterparties, the insurance companies.
With a $30 trillion worldwide corporate debt bubble, not simply a historic high but an all-time high relative to GDP, there will be masses of corporate bankruptcies and a financial and economic breakdown—unless we act, and get the appropriate action from world leaders to create a new world credit system.
Symptoms of a broken Monetary System: Abundant Speculation and Fraud
- Libor scandal was a series of fraudulent actions connected to the Libor (London Inter-bank Offered Rate) and also the resulting investigation and reaction. Libor is an average interest rate calculated through submissions of interest rates by major banks across the world.
- Wells Fargo account fraud scandal is an ongoing controversy brought about by the creation of millions of fraudulent savings and checking accounts on behalf of Wells Fargo clients without their consent. News of the fraud became widely known in late 2016 after various regulatory bodies, including the United States Consumer Financial Protection Bureau (CFPB), fined the company a combined US$185 million as a result of the illegal activity. The company has faced and faces additional civil and criminal suits reaching an estimated $2.7 billion by the end of 2018.
- Citibank Fined $100 Million for Manipulating Key Global Interest Rate
- Goldman Sachs: 1MDB is the name of a Malaysian state investment fund from where several billion dollars was stolen in an audacious fraud. The money was spent on luxury property, expensive art and even financing the Oscar-nominated film The Wolf of Wall Street — itself a tale of financial excess. At its heart is Jho Low, a 38-year-old Malaysian financier accused of masterminding an extraordinary looting of the fund. Mr Low has denied wrongdoing in the scandal, which has been labelled “kleptocracy at its worst” by US officials.
- 2008 Financial Crisis: The crisis began in 2007 with a depreciation in the subprime mortgage market in the United States, and developed into a full-blown international banking crisis with the collapse of the investment bank Lehman Brothers on September 15, 2008. Excessive risk-taking by banks such as Lehman Brothers helped to magnify the financial impact globally. Massive bail-outs of financial institutions and other palliative monetary and fiscal policies were employed to prevent a possible collapse of the world financial system. The crisis was nonetheless followed by a global economic downturn, the Great Recession.
- Dot Com Bubble: As a result of these factors, many investors were eager to invest, at any valuation, in any dot-com company, especially if it had one of the Internet-related prefixes or a “.com” suffix in its name. Venture capital was easy to raise. Investment banks, which profited significantly from initial public offerings (IPO), fueled speculation and encouraged investment in technology. A combination of rapidly increasing stock prices in the quaternary sector of the economy and confidence that the companies would turn future profits created an environment in which many investors were willing to overlook traditional metrics, such as the price–earnings ratio, and base confidence on technological advancements, leading to a stock market bubble.
The Beginning & End: The Great Depression
The unemployment rate went from under 4 percent in 1929 to 25 percent in 1933. Real GNP did not recover to its 1929 level until 1937. The unemployment rate did not fall below 10 percent until World War II.
Few segments of the economy were unscathed. Personal and firm bankruptcies rose to unprecedented highs. In 1932 and 1933, aggregate corporate profits in the United States were negative. Some 9,000 banks, with $6.8 billion of deposits, failed between 1930 and 1933. Since some suspended banks eventually reopened and deposits were recovered, these figures overstate the extent of the banking distress.5 Nevertheless, bank failures were numerous and their effects severe, even compared with the 1920s, when failures were high by modern standards. Much of the debate about the causes of the Great Depression has focused on bank failures.
Were they merely a result of falling national income and money demand? Or were they an important cause of the Depression? Most contemporaries viewed bank failures as unfortunate for those who lost deposits, but irrelevant in macroeconomic significance. Keynesian explanations of the Depression agreed, including little role for bank failures. Monetarists like Friedman and Schwartz (1963), on the other hand, contend that banking panics caused the money supply to fall which, in turn, caused much of the decline in economic activity. Bernanke (1983) notes that bank failures also disrupted credit markets, which he argues caused an increase in the cost of credit intermediation that significantly reduced national output. In these explanations, the Federal Reserve bears much of the blame for the Depression because it failed to prevent the banking panics and money supply contraction.
A few economists, like Irving Fisher (1932), applied the Quantity Theory of Money, which holds that changes in the money supply cause changes in the price level and can affect the level of economic activity for short periods. These economists argued that the Fed should prevent deflation by increasing the money supply. At the other extreme, proponents of “liquidationist” theories of the cycle argued that excessively easy monetary policy in the 1920s had contributed to the Depression, and that “artificial” easing in response to it was a mistake. Liquidationists thought that overproduction and excessive borrowing cause resource misallocation, and that depressions are the inescapable and necessary means of correction: In the course of a boom many bad business commitments are undertaken. Debts are incurred which it is impossible to repay. Stocks are produced and accumulated which it is impossible to sell at a profit. Loans are made which it is impossible to recover. Both in the sphere of finance and in the sphere of production, when the boom breaks, these bad commitments are revealed. Now in order that revival may commence again, it is essential that these positions should be liquidated. . . .
One implication of the liquidationist theory is that increasing the money supply during a recession is likely to be counterproductive. During a minor recession in 1927, for example, the Fed had made substantial open market purchases and reduced its discount rate. Adolph Miller, a member of the Federal Reserve Board, who agreed with the liquidationist view, testified in 1931 that:
It [the 1927 action] was the greatest and boldest operation ever undertaken by the Federal Reserve System, and, in my judgment, resulted in one of the most costly errors committed by it or any banking system in the last 75 years. I am inclined to think that a different policy at that time would have left us with a different condition at this time. . . . That was a time of business recession. Business could not use and was not asking for increased money at that time.8 In Miller’s view, because economic activity was low, the reserves created by the Fed’s actions fueled stock market speculation, which led inevitably to the crash and subsequent depression.
During the Depression, proponents of the liquidationist view argued against increasing the money supply since doing so might reignite speculation without promoting an increase in real output. Indeed, many argued that the Federal Reserve had interfered with recovery and prolonged the Depression by pursuing a policy of monetary ease. Hayek (1932), for example, wrote: It is a fact that the present crisis is marked by the first attempt on a large scale to revive the economy. . . by a systematic policy of lowering the interest rate accompanied by all other possible measures for preventing the normal process of liquidation, and that as a result the depression has assumed more devastating forms and lasted longer than ever before.
Several key Fed officials shared Hayek’s views. For example, the minutes of the June 23, 1930, meeting of the Open Market Committee report the views of George Norris, Governor of the Federal Reserve Bank of Philadelphia: He indicated that in his view the current business and price recession was to be ascribed largely to overproduction and excess productive capacity in a number of lines of business rather than to financial causes, and it was his belief that easier money and a better bond market would not help the situation but on the contrary might lead to further increases in productive capacity and further overproduction.
While the liquidationist theory of the business cycle was commonly believed in the early 1930s, it died out quickly with the Keynesian revolution, which dominated macroeconomics for the next 30 years. Keynesian explanations of the Depression differed sharply from those of the liquidationists. Keynesians tended to dismiss monetary forces as a cause of the Depression or a useful remedy. Instead they argued that declines in business investment or household consumption had reduced aggregate demand, which had caused the decline in economic activity. Both views, however, agreed that monetary ease prevailed during the Depression.
During the early 1920s, the Fed developed a strategy of using open market operations and discount rate changes to affect the level of member bank discount window borrowing. Fed officials observed that, when the System purchased government securities, member bank borrowing tended to decline by nearly the same amount and, similarly, that open market sales led to comparable increases in member bank borrowing. But, while the Fed’s operations had little impact on the total volume of Fed credit outstanding, they appeared to have a significant impact on money markets.
Many Federal Reserve transactions are initiated by commercial banks. When the United States was on the gold standard, the Fed held substantial gold reserves, and transactions in gold were common. For example, suppose gold coin was deposited by a customer of a member bank. The bank could send the coin to its Federal Reserve Bank and receive an increase in its reserve deposit of that amount. The Fed’s gold reserves and member bank deposits would increase by the same amount. Suppose instead that a member bank was experiencing large cash withdrawals and needed extra currency. It could request currency, in the form of Federal Reserve notes, from its Reserve Bank and pay for the currency with a reduction in its reserve deposit. Hence, as Federal Reserve notes outstanding increased, bank reserves would decline by the same amount.
The Fed ended its purchase program in July 1932, largely because officials believed it had done little good.Bank reserves continued to increase, however, as gold inflows were not offset by a corresponding reduction in Fed credit outstanding. Although the money supply ceased to fall, it also failed to rise significantly. In early 1933, large gold and currency outflows caused a renewed money supply decline. On this occasion, the crisis was stopped by Franklin D. Roosevelt’s decision to declare a Bank Holiday and suspend gold shipments. In essence, the Fed’s failure to insulate the banking system from gold outflows and panic currency withdrawals had caused the president to act to prevent further reserve losses.
The Fed’s failure to fully offset the gold and currency outflows suffered by banks permitted the money supply contraction to accelerate. Fed officials claimed that the Reserve Banks’ lack of reserves precluded government security purchases to offset the reserve losses suffered by banks.45 The Reserve Banks were required to maintain gold reserves equal to 40 percent of their note issues and reserves of either gold or “eligible paper” against the remaining 60 percent.46 Since gold outflows had reduced the System’s reserve holdings, and since the System lacked other eligible paper, Fed officials asserted they could not increase Fed credit by purchasing government securities, which were not eligible collateral.
Fed officials did feel constrained by a lack of gold. Fed officials feared that open market purchases would weaken confidence in the Fed’s determination to maintain gold convertibility and thereby renew the gold outflow. In any case, the Glass-Steagall Act of 1932 removed the constraint by permitting government securities to serve as collateral for Federal Reserve note issues. In March 1932, the System began what was then the largest open-market purchase program in its history.47 Between February 24 and July 27, 1932, the Fed bought $1.1 billion of government securities. Member bank reserves increased only $194 million in these months, however, because of renewed gold and currency outflows and a reduction in member bank borrowing. Moreover, the supply of money continued to fall because of a sharp decline in the money multiplier (see figure 10).48
The Fed ended its purchase program in July 1932, largely because officials believed it had done little good. Bank reserves continued to increase, however, as gold inflows were not offset by a corresponding reduction in Fed credit outstanding. Although the money supply ceased to fall, it also failed to rise significantly. In early 1933, large gold and currency outflows caused a renewed money supply decline. On this occasion, the crisis was stopped by Franklin D. Roosevelt’s decision to declare a Bank Holiday and suspend gold shipments. In essence, the Fed’s failure to insulate the banking system from gold outflows and panic currency withdrawals had caused the president to act to prevent further reserve losses.
The Fed’s actions in 1924 mark its first use of open market operations to achieve general policy objectives. In that year, the Fed purchased $450 million of government securities and cut its discount rate (in three stages) from 4.5 percent to 3 percent.
The Fed undertook a second large purchase program in 1927, purchasing $300 million of government securities and reducing the discount rate again.
In 1933, President Franklin D. Roosevelt cut the dollar’s ties with gold, allowing the government to pump money into the economy and lower interest rates.
Excessively easy monetary policy during recessions in 1924 and 1927. They argued that the Fed’s actions had promoted stock market speculation and led inevitably to the crash and Depression.
There was also little deviation from either the gold sterilization or the countercyclical policy rules that Strong had developed during the 1920s—at least until the fourth quarter of 1931, when maintenance of the gold standard became the overriding goal of policy. Thus, while leadership changes and interest group pressure probably had some effect, monetary policy during the Depression was not fundamentally different from that of previous years. Federal Reserve errors seem largely attributable to the continued use of flawed policies.
What is the gold standard?
It’s a monetary system that directly links a currency’s value to that of gold. A country on the gold standard cannot increase the amount of money in circulation without also increasing its gold reserves. Because the global gold supply grows only slowly, being on the gold standard would theoretically hold government overspending and inflation in check. No country currently backs its currency with gold, but many have in the past, including the U.S.; for half a century beginning in 1879, Americans could trade in $20.67 for an ounce of gold. The country effectively abandoned the gold standard in 1933, and completely severed the link between the dollar and gold in 1971. The U.S. now has a fiat money system, meaning the dollar’s value is not linked to any specific asset.
The current monetary system has broke and cannot be repaired. The Federal Reserve has lost total credibility as well as all other Central Banks around the world. Fiat Currency will become worthless.
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