Jim Willie CB September 28, 2004
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In ancient Greek and Roman times, mythology served a strange but valuable service. First, it channeled pervasive belief in spirituality and deity in general, beyond the mortal world. Second, it cooperated with the sense of individual human helplessness by putting structure to the higher powers. In today's day and age, we have become fixated on the spirit of money and what it buys in the way of possessions, entertainment, and leisure. Here too, the individual is dwarfed more than ever. The powers that be have assembled a structure. The apparatus consists of a truly bizarre and frightening intertwined network of derivative gears, intervention devices, bank lending methods, mortgage finance centrifuges, stock equity conversion means, promotion systems, and advertisement conflict of interest. The spin for the system is a complex series of economic myths, not unlike the great Greek mythology that endured centuries. The American version is certain not to last as long.
When complex systems begin to fail, as the US Economy surely has since the 1980 decade, the system absolutely requires a convincing mythology to serve as unquestionable dogma. Ponzi outlined the importance of dogma to perpetuate a system gone awry. In the United States, a complex system has emerged with irrational beliefs which have no bearing on reality. We have the Oracle of Delphi in the Federal Reserve, whose spokesman is Chairman Alan Greenspan. Despite his constant stream of errors and fallacious analysis, he is looked to for counsel as a precious seer. Mount Olympus is the Austrian School, whose teachings have been ignored since the Bretton Woods divorce in 1981 with tragic consequences. That divorce opened Pandora's Box, without question. Partygoers rarely visit the mountain, too busy in celebration. Zeus is Robert Rubin, architect of the Strong Dollar, whose power and luster has surely diminished. His wife Hera might be the Japanese central bank, which lifts him whenever he falls on his face, and stumbles in sleep walking overnight. Achilles, the great warrior, is the US Military ready to do battle to defend Greece, the US-centric world of commerce. Powerful Atlas might be JPMorgan, unable to hold the world of derivatives atop his strong shoulders. The many nymphs prancing about, exploiting their sexuality, are the money lenders, whether bank leaders or car dealers or electronics merchants with their sexual front. Chief among them is beautiful Aphrodite, embodied in Fanny Mae after it rose from the 1989 Savings & Loan debacle out of its restructured ocean foam. Helen of Troy might be the wonderful US mfg base, long gone, not exactly taken, but not yet desired back. Poseidon, god of the ocean, clearly is Wall Street which governs the sea of capital and debts. Brokerage houses urge money infusions from the public much like the Sirens, as they lured sailors to the rocks and wreckage. Diana, the goddess of the hunt, might appear with corporate initial public stock offering launches, arrows flung into the equity markets. The satyrs chasing nymphs are household consumers, who find themselves thoroughly spent after satisfying the loan terms. Ulysses is Joe SixPack, who struggles mightily, and less certain to enjoy the success of the ancient Greek sailor. Medusa, the serpent lady with snakes as hair, turns men to stone in much the same way that bankruptcy does. The grand odyssey involves negotiation between Scylla and Charybdis. The multi-headed monster dog Scylla lurks like inflation, easily dragging its prey into the cave of value erosion and debt writedowns. The dreaded giant whirlpool Charybdis has already begun to show its power, as secular deflation circulates in its cycles. China commands the whirlpool's bamboo stirring spoon, as it limits wages and prices. The Chinese yuan currency peg serves as a Trojan Horse, taken in by our economy, only to wreak horrendous damage, but not yet recognized. The modern American economic mythology is soon to turn into a Greek tragedy. The system has become unsustainable and begs for correction.
THE NATURE AND ROLE OF MYTHS
Today, the Macro Economy Myth is under siege, a certain quiet attack. Currently at work is the third in a long list of myths used as mental glue to hold together the internal mechanisms of the US financial system, to maintain foreign confidence in our markets, and to attract enormous sums of capital on a daily basis to keep both Wall Street and the US Economy going. The petro-dollar foundation, the basis of world commerce, has been shaken in the last two years. It is fortified at irregularly timed interventions by foreign central banks, without which sudden swoons in currency exchange rates and sudden rises in interest rates would deliver massive shocks to real economies around the globe. The petro-dollar is complex, fully intertwined with geopolitics, with banking & monetary system, with financial markets, and with international commerce. A quick dismissal of its importance by economic pundits is absurdly shallow and recklessly na´ve. It is most likely linked with military motives.
In the 1970 decade, the United States began on a course which altered modern history. Following the Bretton Woods divorce between the USDollar and gold, commitment toward social programs, war effort, and collectivist sponsored home ownership deepened the departure from true money. Public and world embrace of myths are of central importance in order to buttress a foundation of false money. World commerce is undermined if only the masses recognized the foundation of the unbacked USDollar as untenable. Since when does US Treasury bond issuance provide a legitimate countervailing force to physical crude oil? Buying energy supplies with gold might be impractical. Buying energy with debt securities, however, goes beyond insanity.
Myths perpetuate because the monetary system cannot stand on its own merits. The USDollar, since 1971, has not been backed by gold. By default, it has in practicality been backed by USTBond debt. The flipside of the USDollar is a USTBond, which is a soft sand foundation for any economic house to be built. The first great myth was motivated by the need for stimulus, to remove the US Economy from the worst recession endured since the Great Depression. Saddled by enormous ground swell of costs from higher energy prices, amplified by growing head winds from the rising costs of federal social programs, the nation and its Congress had to be convinced of the first myth. We have proceeded from one myth to another, hopelessly unwilling and unable to accept the tragedy of the divorce of the USDollar from its golden anchor. All world financial crises can be traced to the Bretton Woods divorce.
Public economic policy has become commandeered by adolescent guesswork, abandoning a century of European experience, making it up as we go along, experimenting with the world as its oyster, in a reckless game where economists cannot prove their theories. They have done nothing but destroy the system.
#1 -- SUPPLY SIDE ECONOMIC MYTH (TRICKLE DOWN)
Eight years later, President George H. W. Bush would get it right, when he called it "Voodoo Economics." During its day, it was embraced with some hesitation, as few options seemed available on the political table.
President Reagan, armed by theories from Laffer, urged on by Pentagon defense contractors, convinced Congress, tacitly approved by the public, to sponsor tax cuts of magnificent size and to recommend unprecedented military buildup known as the Strategic Defense Initiative (aka Star Wars). The reasoning was that massive stimulus in money supply, both in the private corporate sector and in the public defense sector, would engineer economic growth, lift wages, and pull us out of recession. Eventually, demand would match supply, stride for stride. Myth #1 is the Supply Side Economics known as Reaganomics. While the US Economy did emerge from the tight grasp of economic stagnation in the mid-1980's, the myth was unmasked a fateful day called Black Monday. Stocks, housing values, and the USDollar had all continued to rise for well nigh a full year, even as interest rates had ratcheted upward to serve warning. The warning was not heeded; the system built upon debt was sent reeling. A Pyrrhic Victory had been won. We did emerge from recession, but with crippling federal debt, which had risen by $2000 billion under Reagan. Many regard the price as worth it, since its investment buried the Soviet Union.
Little did Supply Siders realize that seeds were being planted to trigger secular deflation, as debt collapsed and production came into over-supply. Asia was the grand beneficiary of an acceleration in trade surpluses, used fractional banking practices, built up it manufacturing base in magnificent style, and prepped the day for the Asian Meltdown ten years later. Supply Sider principles had earned the nation an extra $2 trillion in federal debt, huge Asian production capacity, and a fresh troublesome lingering recession from 1988 to 1992. A stock bear market, coupled with a housing decline, left the economy in tatters. Yet the myth prevails to this day as a success.
Underpinning the Supply Side myth were several construct beliefs, all laughable but held firm. We had the NAIRU, non-accelerating inflation rate unemployment, which claimed that a jobless rate under 5% was innately tied to higher price inflation. The Phillips Curve put a mathematical face on this absurdity, as it formalized the mythical relationship between the two factors. When that failed, the line was drawn at 4%. We employ better methods now. We simply measure a participation rate, which counts the number of people excluded from the employed. The jobless rate merely measures those receiving state benefits. By removing federal extensions for jobless benefits when those benefits become exhausted, the jobless rate fell, a certain political benefit. The Laffer Curve expects higher tax revenue from higher tax rates in a direct response with no reaction. It also expects higher tax revenue from much lower tax rates in an exercise in powerful elasticity. In other words, tax collection receipts benefit regardless, have the cake and eat it too. How incredibly silly, but widely accepted. Budget Director David Stockman was a certain charlatan, as he sold the idea, later changed his numbers, but Reagan used an erroneous numbers anyway in an historically hilarious Keystone Cop event.
Evidence of the failure of the first myth is the abandoned mfg base, a 1987 Black Monday stock bust, a 1989 Savings & Loan disaster, and the birth of the Plunge Protection Team. The most damaging symptom to this myth was the rise in the USDollar in the middle of the 1980 decade. In reaction, the US manufacturing base gradually went sent offshore to Asia, first to Japan, later to the Pacific Rim where the Asian Tigers reside. Back then our cast of economists was much more competent. They realized the removal of the mfg base meant lost jobs, lost wages, and national impoverishment. Today we know better !?!?! The Plaza Accord was agreed upon by the industrial power finance ministers. It was intended to reduce the value of the USDollar, in order to encourage a return of the US mfg base. While the US$ was steered lower, the labor cost difference between Asian and the USA could not be addressed by currency adjustment alone. Their labor costs are between 5 and 20 times lower than inside the USA. The mfg offshore movement continued, only to accelerate ten years later.
#2 -- NEW ECONOMY MYTH
(TECHNOLOGY MIRACLE VIA PRODUCTIVITY)
Unlike the previous cycle, the Federal Reserve played a major role in what came next. The name Clintonomics never caught on, nor did it have much meaning, for good reason. No significant planks of public policy were urged on by President Clinton. The entire nation was gripped, nay infected, by the notion that advances in technology had paved a path to greater corporate profitability through enhanced productivity. Financial markets and new patterns of investment behavior were the dominant themes. The tech miracle had really changed lives, lowered prices, but not aided earned greater profits. Myth #2 is the New Economy powered by technology and productivity. Not only was the trend in corporate earnings in a severe downtrend, but productivity had been superior in the previous decade. Stock valuations were unsustainable, unjustified, and ultimately collapsed. Savings disappeared, as stock accounts were considered savings. We bought on credit, powered up our credit card debt, and considered ourselves all wealthy from inflated assets. We earned ourselves the greatest stock bust since the Great Depression. In the wake of the 2000 stock bust, a recession came soon afterwards. The Fed, led by Chairman Greenspan, had been the myth's greatest proponent and cheerleader. To this day, his reputation and public confidence in him have not been marred, which is an even greater miracle.
Rubin Strong Dollar Policy was reckless, totally in contradiction to prudent Plaza plan, and a firm betrayal of the American working class. Of course, he and the Fed represent interests of the banking aristocracy. Household debt rose all through the decade. Dependence upon inflated asset values grew. Imports from Asia became a constant fixture in our economic landscape. More to the point though, the heart of the myth was false. Corporate profits peaked in 1985 and have trended down for two decades. Productivity, the real surprise, actually has been falling since 1990 despite certain technological developments. We all know about cell phones, fiberoptics, broadband connectivity, internet commerce, fast PC's, cavernous storage devices, and breakthroughs in medical research. It has not translated into greater corporate profit nor productivity. Instead, it has resulted in lower consumer prices, cemented by Asian production dominance. The US public saw the technological marvels, as did the tech-ignorant Chairman Greenspan. As a cheerleader for our financial markets, the good chairman worked overtime to sell US stocks and bonds. He operated as the champion over price inflation and the advent of perennial prosperity. Almost all his claims were revealed as a sham during the stock bust, but to this day they are still widely believed as part of a productivity miracle. Today, that miracle is closely aligned with job loss through Asian outsourcing. We now import that same productivity from Asia and its cheaper labor. The scourge of three decades of monetary inflation is seen in the form of heavy debts, lost jobs, and Asian excess production. In other words, secular deflation and its massive forces.
Evidence of the failure of the second myth is the 2000 stock bust, the telecom debt bust, the sharp rise in household debt, the Enron, Arthur Anderson, WorldCom, and other scandals. The bubbles have been replaced with bigger bubbles, and the accounting & brokerage scandals have not ended.
#3 -- MACRO ECONOMY MYTH
(INTL CREDIT FLEXIBILITY & ASSET INFLATION WEALTH)
Greenspan boasts that the Federal Reserve has successfully dealt with the symptoms of the 2000 stock bust, rather than provide a lasting authentic remedy to its underlying problem. This is pure heresy by a central bank, since a stock and telecom debt bubble has been replaced by a Treasury bond bubble, a mortgage finance bubble, a housing bubble, and a deep dependence by the US Economy upon housing values and equity extraction. This he calls "wealth generation" which any central banker worth his or her salt rejects summarily. Chairman Greenspan speaks like a hedge fund manager, not a central banker. He has become the banking system chief political spokesman, as he justifies a record of reckless inflation and debt explosion.
Absence and abandonment of a manufacturing base, long dispatched to Asia and other parts of the world in search of lower costs, resulted in massive trade gaps. Those gaps have remarkably escalated (a prediction of mine in spring 2002) despite a declining USDollar index. Federal deficits have risen, partly from the economic stimulus of tax cuts, partly from a war to resist terrorism and to secure foreign oil supplies. Foreign capital needs have reached crisis proportions, currently running at $1.8 billion per day. Credit needs are minimized in feeble arguments by our Fed Chairman in what he describes as "flexibility" of the macro economy. Myth #3 is the Macro Economy powered by asset inflation and funded by the flexibility enabled by foreign savings. It attempts to justify a horribly imbalanced US Economy, dangerously dependent on foreign capital, which lacks valid income generation from capital investment, actual production, and wage growth, rather than financial investment which hopes for continued price inflation.
Several miracles are in progress:
- housing prices rose 30% or more nationally instead of falling their customary 15% following recessions, as buyers seize on cheap money in mortgage finance
- foreign central banks purchase over 35% of USTBonds in order to continue to support an overly indebted and crippled US Economy
- stock valuations continue to march to the beat of the Fed Valuation Model which employs a multiplier inversely related to interest rates\
- the public still believes we benefit from productivity gains
No system can survive for long as it depends on foreign credit supply in the present magnitude. Asia has its own credit needs, growing to be sure, and surely in conflict with their willingness to supply the US and its voracious appetite. No system can survive for long when its depends upon asset inflation as the primary wealth generating power source. Natural corrections surely come, and when they do, immense problems will come to the US Economy. The foundations of the current myth are far more laughable than the previous two myths.
Recently, Greenspan speeches center on social programs being scaled back. He recognizes that
Social Security, Medicare, Medicaid, and other entrenched programs cannot be funded. He cites a growing federal budget deficit, which causes neither alarm nor desire for reduction. In my opinion, he is actively engaged in a publicity campaign to create an alibi for upcoming failures and systemic shocks. Backroom cleanup efforts must be intense, as the JPMorgan hedgebook and Fanny Mae balance sheet require full-time attention. Such undertakings are kept quiet though, and far from the undiscerning public eye. JPMorgan and Fanny Mae stand as vivid evidence of the failure of the previous two myths.
Evidence of the failure of the third myth is the constant flow of jobs in Asian outsourcing, the Fanny Mae mortgage finance faulty foundation, dependence upon the housing bubble to continue consumer spending, growing trade gaps, and growing federal deficits. Denial is reaching unprecedented epidemic proportions. To be sure, many symptoms of failure are being hidden from the public, like the sanitization of the JPMorgan hedgebook. How could bond revolts in summer 2003 and spring 2004 have escaped the world's largest holder of bond derivatives?
Far too little scrutiny has been focused upon the foundation of the world monetary system, the petro-dollar. The name "petro-dollar" is used to convey the critical transaction whereby energy is priced and purchased in USDollars. All prevailing myths, both past shattered myths and current exposed myths, are essential to maintain the system, to urge on confidence, to confuse the public, and to deceive foreigners. The real problem is that the world monetary standard, the USDollar, has no intrinsic value. It is not backed by gold or any other hard asset. The world's largest economy, in the United States, has become an inflationary engine, with significant abandoned manufacturing base, and vanishing income producing machinery. Its once powerful wealth production apparatus has been systematically dismantled in search of lower costs. What happened to its awesome mfg base is now in the process of being duplicated in the vast service sector. The US Economy has become tragically dependent upon inflation as a primary power source. In order to keep the charade going, the nation, its trading partners, and investors worldwide must be fooled, tricked, and deceived by myths. Without such myths, we would be forced to endure a painful correction to inflated assets, and be subjected to a severe debt downgrade. The consequence would be a grand decline in the standard of living for most American households and citizens. The world economy depends too much on our spending, even if that spending is led by evermore debt in an overly burdened debt environment. In all likelihood, the world economy would enter a deep recession, or worse. So maintaining and perpetuating myths is essential.
The better questions remain:
When will our inflated assets (stocks, bonds, housing) correct downward in price ???
When will Asians grow tired of exchanging their industrial output for risky debt securities ???
What will the next economic myth be, sold to the world ???
Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a PhD in Statistics. His career has stretched over 23 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com.
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