Robert Samuelson urges us to change the focus of our attention from the business cycle to the financial cycle:
The Great Recession has inflicted enduring economic damage. Business investment has lagged; many workers have dropped out of the labor force. By early 2014, calculates the BIS, U.S. gross domestic product — the economy’s output — was 13 percent below where it would have been if pre-crisis growth trends had continued. In Britain, the gap was 19 percent; in France, 12 percent; even Germany had a shortfall, 3 percent.
Conventional business-cycle analysis didn’t anticipate these steep losses. It also missed other features of the post-crisis economy. Unlike earlier recessions, countercyclical policies — especially low interest rates by the Fed and other government central banks — have only modestly helped recovery. Low rates fail if borrowers don’t want to borrow or lenders don’t want to lend.
It is flabbergasting to me that we could adopt a whole set of policies including housing and transportation policies, immigration policies, trade policies, and inheritance policies, all of which tend to benefit the upper middle class and wealthiest at the expense of the poor and struggling working people and be surprised when incomes are increasingly concentrated in fewer hands. A century ago the poor and the rich lived side by side, inheritance taxes made it harder for the rich to transfer their wealth to their children, imported goods were a tiny fraction of what we consumed, and poorly run or profligate businesses were allowed to fail.
Nowadays the upper middle class rarely see the poor, people with advanced degrees almost invariably marry other people with advanced degrees, and we subsidize banks and large companies. How far we’ve advanced@!
Once you understand fiat money and fractional reserve lending, it becomes clear how the economy expands, and why it stalls.
Fiat money is the attempt to divorce value from money and to graft it onto currency. Those who are able to acquire this fiat money first are able to obtain the full value, but subsequent users are able to obtain less and less value from it.
Fractional reserve lending allows fiat money to be created through borrowing, and there are few limits. Capital requirements and asset quality are two, and these are regulated.
In addition, there are additional financial instruments, and these may or may not be actual credit. These may or may not be public, and if public, they may or may not be regulated. If regulated, they may or may not be regulated as credit. Much of this additional credit is leveraged off the original credit created through fractional reserve lending.
None of this is necessarily nefarious, but it is complex. The complexity is due to the various instruments having various purposes, and some having multiple purposes. The complexity does allow for nefarious uses such as money laundering type transformations of assets.
Vigorous regulation can limit this, but not if the regulators are working for the industry. In the leadup to the 2008 Financial Crisis, Timothy Geithner at the NY Fed “fought tooth and nail” to keep the capital requirements low and the assets highly rated for the institutions he regulated.
The combination of fiat money and fractional reserve lending is like steroids and human growth hormone times ten. It allows the economy to expand well beyond anything natural, but it comes with a price.
The problem starts when the illusionist begins to believe he really is a magician. The only way for the illusion to work is for the credit supply to not outstrip the asset plus money supply.
In 2008, primary assets crashed, and they took down second, third, fourth, fifth, nth level assets leveraged off of them. There were/are also many assets that were propped up to keep the leveraged assets from crashing. What is visible is the tip of the iceberg. The majority is either private, or it is interwoven into a leveraged instrument.
This is what needs to be cleared, and until it is equalized, the economy will drag along. Also, attempts to increase credit through government borrowing will not work unless it is offset by actual asset creation, but unless those assets are able to generate more value than the amount borrowed, it will only prolong the problem.
As to proof of my thesis, I offer the past 6 years plus a stimulus package, and I will add the time it takes until the economy and employment pick-up.
The first solution to the financial cycle problem is hard money and hard lending, but the problem is slower growth. These could be overcome, but it would be easier to convince people Apple is evil.
The second solution is the semi-hard money, vigorous bank regulators, and our old friends Glass and Steagall.
The business cycle would not be repealed. Businesses could and should be able to make stupid business decisions including borrowing, and creditors could and should be able to make stupid lending decisions. The impact of those decisions would not be amplified as much.
In a system where creditors are lending money they do not possess, they must abide by the regulations of the entity that controls that money. Conservatives and libertarians either do not understand or refuse to understand this simple fact. Yes Virginia, banks lend that which they do not possess, and that is the rest of the story.
It isn’t flabbergasting at all if you assume they’re lying when they say they want the opposite outcome of what they claim to want. If they didn’t want these concentrations of wealth and income then they’d stop doing the things that got us here, instead of constantly pushing for more of the same.