The World Economy is Out of Balance

Over the last several decades the rewards of productivity have gone to owners of capital, not labor. Automation has reduced the need for labor in manufacturing industries, driving down wages.  Producers have moved production offshore to reduce labor costs even further. At the same time, the financial sector share of GDP has tripled. This has happened not only in the US, but in other developed countries as well.

What has been forgotten is what Henry Ford knew at the beginning of the twentieth century, namely that a thriving middle class is the source of most of the demand in consuming countries. When wages stagnate as they have in the last several decades, middle class buying power is destroyed. This may be in the producers interest if they can find buyers in other markets. But, when it happens all over the world in developed countries that supply 70% of world demand, it results in a sustained decline in the world economy.

No amount of money sloshing around in the pockets of a few wealthy people looking for a place to invest it will solve the problem. The only solution is to rebalance world wealth and incomes to put more money in the hands of people who will spend it, not people who save to invest. Until producers realize that that they need the spending power of wage earners to create demand, they are planting the seeds of their own failure. It’s time to start paying workers that spend their income a decent wage to rebalance the need of demand with the need for capital. If producers won’t do it, governments need step in and increase taxes of capital and reduce taxes on labor.

The Underlying Cause of Depressions

There has been a lot of study of the cause of the Great Depression and now of the current Great Recession. But, answers are clouded by studying primarily what happens after banks get into trouble. This overlooks underlying causes which may be more important. Nobel economist Joseph Stiglitz and Bruce Greenwald of Columbia University have been studying the underlying causes. Stiglitz has presented the results in a recent article in Vanity Fair. It’s a good read.

The scenario goes something like this. Technology improvements take place which increase productivity. This, in turn results in less labor being needed to produce the commodity. Too much labor leads to low wages, lost jobs, and reduced demand. The rewards of increased productivity go increasingly to the providers of capital. As capital accumulates, the return on capital is reduced, so capitalists look for ways to increase it. This usually results in buying up assets that can produce a revenue stream. Asset prices escalate and seeing this, investors buy up more assets to take advantage of increasing asset prices. This is the beginning of a bubble in asset prices.

Seeing a chance to make easy money, more people start investing in the asset bubble. Financial institutions are making money hand or fist from the new lending and capital is freely available from increased productivity and asset investments. The opportunity seems a sure thing so leverage is increased to increase profits dramatically. These profits must be invested to earn income, so banks seek to place new debt with less credit worthy debtors, and so are willing to take higher risks, which they offset by buying credit default swaps, a form of unregulated insurance not fully backed by the assets. Eventually the bubble bursts when these risky investments start to fail and the whole economic system is put in jeopardy by the threat of bank failures.

Only now does the analysis of what happened start. The first place analysts look is why excessive risk was taken on and why not enough liquidity is available to prevent a collapse of the economy. Governments are looked to for bailouts of failing banks. And we know the story from that point on. It’s a battle between people who think government spending is needed to sustain the economy and people who think it all happened because people and governments were irresponsible and what is needed is austerity measures to teach the irresponsible a lesson. The underlying problem has been long forgotten in the process.

The Underlying Problem in the Great Depression

Prior to the banking problems in the great depression, the economy was largely based on agriculture. As technology advanced, farmers were able to produce more food with less labor and the same size farm, so farm commodity prices fell and fewer farmers were needed. But switching from farming to an industrial job was not easy. Most farmers had only an elementary school education, so they continued to do what they knew how to do, farm. With less income per acre, they needed more acreage and loans to buy the acreage. But, this just compounded the problem. More production meant even lower prices and now they had bigger loans to pay off. And a drought in many parts of the country made things even worse. So many of these farmers ended up losing their farms and ended up unemployed. The unemployment among farmers, a large segment of the economy at the time, meant reduced demand for products and service produced elsewhere in the economy, resulting in unemployment there. Banks foreclosed on the farms, but with more production than was needed, banks took losses on the loans. And, the excess of labor and lack of new projects to employ them meant a drop in demand for all goods and services, driving the economy into depression.

The Underlying Problem in the Great Recession

In our current recession the underlying problem was increased productivity in manufacturing, hence less required labor, and moving much of the manufacturing sector overseas where labor costs were much lower. Again the rewards of productivity increases went to capital and wage income stagnated. Capitalists, flushed with newfound wealth looked for places to invest. And consumers, whose wages had stagnated looked for other ways to make ends meet. Investment in land and construction soon supplied the answer.  Average homeowners soon saw the opportunity to increase their income by taking loans on the increasing equity in their homes, and banks, flushed with cash saw another opportunity to make a killing leveraging up on riskier and riskier loans and unregulated insurance. The rest is history, and we know who governments bailed and who is picking up the tab.

So, What is the Solution?

Stiglitz seems to think the solution is to put people to work by embarking on new projects to employ them and education to equip them for new jobs. Just as the war economy pulled us out of the Great Depression by creating new jobs for the unemployed, we can create new jobs for the current unemployed by investing in infrastructure which has deteriorated for lack of maintenance and in research on promising new transportation, communication, and energy technology. But, just as the war required massive government spending and increased government debt, we need to accept greater debt now to ensure a healthy future economy that can pay off the debt. And,  just as the economy after the war required higher taxes on those who could afford to pay them, the same will be required now from people who have profited handsomely from years of productivity rewards, the bubble and the ensuing bailout.

The Herman Cain Phenomena

People are wondering how a candidate with no previous political experience, no organization to speak of, and a series of conflicting messages can be leading in the polls. I think it’s perfectly understandable. People are sick and tired of professional candidates who adjust their message or say different things to different groups simply to get elected. They also are wary of the slicksters with a pocket full of money whose main aim is fame and fortune, but who can turn a phrase without ever making a mistake. Cain says it like he sees it, even if it doesn’t make much sense. And, he doesn’t attack people or get nasty. He comes across as a sincere, nice guy. That can be very attractive in a campaign where’s he competing with a bunch of old polls who play politics with everything that comes out of their mouths and have flip-flopped on many issues.

Democrats wonder how Republicans can be so interested in a guy whose policies seem so outrageous to them. Well, they don’t seem so outrageous to many Republicans, who vote their feelings on religion and other social wedge issues, not analytical or scientific constructs about the economy or the environment. Their judgment of the person’s character and his similarity to their way of thinking trumps a lot of policy issues.

Democrats should look at why candidates like Dennis Kucinich and Ralph Nader have gotten nowhere in their party. I would conclude it’s because they aren’t afraid to say it like they see it. They aren’t polished enough, or acceptable enough to the in crowd. Their pronouncements seem too far from the status quo promoted in the press. For this, they are marginalized.

If we still had a Republican president at this time, I think we would be seeing similar behavior from the Democratic Party that we are now seeing from the Republican Party. We are in a major economic and political crisis, and people are looking outside the box for new and more extreme measures to correct the problems. If it were the Democrats with a large field of candidates running against an incumbent Republican president, I think we would be seeing candidates like Kucinich and Nader leading in some polls against more establishment oriented candidates. And, the Republicans would be wondering how the Democrats could be so interested in them.

Occupy Wall Street to the Rescue

In the last post I was urging Bernie Sanders to run against Obama to force him to identify what he would do in a second term. Well, there is no longer a need for an opponent to do this. Occupy Wall Street has spread around the country is a good indication that many are disappointed with a system that defers to wealth and corporations while exploiting middle class workers. Mr. Obama will be as much a target of this movement as anyone else if he continues to try to finesse his way back in the White House by being the great compromiser. If there is one thing OWS doesn’t want it is compromise with those seeking to maintain the status quo.

If winter comes and the cold weather results in a retreat of the protesters to warmer quarters, Obama may think he doesn’t need to think big. But, he will be mistaken. The country is ready for deep reforms and any half measures will result in low turnout for progressives and a win for Republicans. On the other hand, if he embraces the discontent demonstrated by protesters and the many who share their discontent, and lays out a program of real reform, he could be on his way to another term. So far, he has been a disappointment as a leader and a man of vision. But, fortunately, none of his likely opponents seem well equipped with those qualities either. Obama has begun to talk the talk, but is it all election hype or the real deal? The OWS crowd and their supporters can help smoke him out and make him take a stand.

Run, Bernie, Run!

I’m speaking of Bernie Sanders, the Senator from Vermont, of course. He can’t run in the Democratic primary because he’s an independent, not a Democrat. But, he probably won’t run in the general election either, because he caucuses with the Democrats and probably doesn’t want to become a political pariah like Ralph Nader. But, he should run. And, here’s why.

I predict the Republicans will pick Governor Rick Perry of Texas to be their candidate. He’s the perfect candidate for the Republican Party.  He’s religious, a southerner, has better looks and more charisma than the last Republican president, and can speak in complete sentences that his constituency understands. He's also very acceptable to the sane wing of the party, unlike most of the other contenders. And, he's not the recent Mormon governor of a blue state. What more could the Republicans ask of a candidate? If he is the candidate, his party will be energized and, unlike the Democrats and a lot of progressive independents, many of whom can't stand Obama and will sit out the election, will turn out for him in big numbers at the polls. In that situation, Obama, the Republican lite, will be toast.

Even if Obama were to win, do the Democrats really want four more years of Obama continuing to cave to the Tea Party agenda of austerity and no new taxes? Or would they be more successful as an energized opposition party? Look how successful the Republicans have been as the opposition party. With the distinct likelihood of another meltdown due to the austerity measures being pushed by both parties now, won’t the Democrats be better off laying it off on a one term Republican president as the Republicans are now doing with Obama?

If  progressive Democrats had a good spokesperson stumping for their progressive agenda including reducing wealth and income disparities, a single payer health insurance program, investments in education and infrastructure, etc. they would be on a good path to being a successful opposition party and have better prospects for winning in 2016. An energized progressive electorate would also get people to the polls to elect more of their constituency to the Congress.

Bernie Sanders is such a spokesperson. If you haven’t heard him, take a listen to him on the Senate floor here. There is no Democrat that comes close to him in stumping for the progressive agenda.

Why the Government has to Spend when the Private Sector decides to Save

What is necessary for a healthy, stable economy is a balance between savings to provide capital for new productive activity, and spending to sustain demand for goods and services. When these forces get out of balance instability happens.

If everyone decides to save more all at the same time, spending is reduced and economy goes into recession. If everyone decides save less at the same time, spending increases demand and prices go up. If the new spending is to buy assets rather than consumables, asset bubbles develop.

If the balance shifts to to0 much saving of capital, there is more capital chasing a limited number of investment opportunities, rates of return on capital drop, and owners of capital seek ways to stimulate demand for credit, or turn to leverage and speculation to increase returns. This is what happened prior to the current recession. Owners of capital turned to derivatives and leverage to increase returns. When that wasn’t enough, they turned to liar loans in the housing industry to stimulate demand for credit. As the housing bubble built, housing investors got the idea that the housing market could only continue to go up, and started using their home equity as a piggy bank for spending, driving themselves ever deeper in debt. This is what caused the housing bubble. When the loans could no longer be serviced as variable rates went up the bubble burst.

When the bubble burst, the piggy bank closed, the markets dropped, and the rush was on to deleverage and pay down debt. This required spending less and saving more by nearly everyone around the world. So we return to first scenario where there is too much saving and too little spending, and into recession we go.

The difference between this and milder recessions is that this time it happened to nearly everyone, even around the world, because of the strong linkage between financial institutions worldwide, due to the mitigation of risk through investment insurance like credit default swaps on collateralized debt sold as stock. Credit rating agencies were paid by the banks issuing the collateralized debt to give it a high rating so it could be easily sold around the world. All this was done to increase returns on capital because there was way too much capital for the investment opportunities that existed.

Instead of restructuring the banks that had issued the junk debt, allowing the owners and stock holders to take the hit, the government bailed out the banks and allowed them to keep the junk loans, now deeply devalued, on their books at face value rather than market value. So instead of destroying the junk debt, they put repayment in full on the backs of taxpayers. Now everyone is panicked, no one wants to spend, lend, or investment. This is what’s called a liquidity crisis.

Returning to the theme presented at the outset, when everyone in the private sector decides to save at the same time, the government is the only source of spending available to maintain the balance between spending and saving that is required to stabilize the economy. Instead, we now have a bunch of politicians who think they’re at a Tea Party and the government is just another private budget manager that needs to save like the rest of us. They don’t understand the basic need to balance spending and saving overall to stabilize the system. To make things even worse, they think that the wealthy capitalists who created the problem should be exempt from participating in the solution. In fact they think their taxes should be reduced even further. Until taxpayers and politicians understand the basics of how an economy functions, we will continue to be mired in the quagmire and things will only get worse.

Some Long Range Consequences of the World Economic Crisis

It’s a sad day when a single company can cause world economic turmoil by downgrading the credit worthiness of the world’s only superpower. Standard & Poor’s, the same company that gave junk collateralized debt obligation a AAA rating to cause the current crisis, has downgraded the USA rating to a AA+, and the world goes along with it. This raises the question of whether or not the world has gone seriously off the rails.

How did we come to this point? How did the developed nations of the world become deeply indebted to an oligarchy of private financiers? How did the leading developed democratic nation in the world, the USA, become indebted to a developing authoritarian nation, China to the tune of several trillion dollars? The answer lies in letting wealth become concentrated in the hands of a few wealthy individuals and institutions and allowing a colluding central bank to create credit by simply making entries in its accounting journals.

The creation of credit and the abundant supply of cheap energy are the main ingredients that have lead to the rapid development of the developed nations in the  last several centuries. This has allowed the standard of living in these countries to advance way beyond that of undeveloped and developing countries. Accompanying this phenomena has been the emigration of labor from undeveloped to developing countries where this is possible.

But, advances in transportation and communication, and trade agreements in the last several decades, have allowed the free flow of goods and capital across international borders. This has directed the flow of private capital to countries with low production costs and away from developed countries. Businesses have become multinational, reducing the loyalty of their home countries and accelerating relocation to developing countries.

If international agreements were in place, this could have led to increasing the standard of living in developing countries to to the level of developed countries without reducing the standard of living in developed countries. But, instead, the way this has happened has been left mainly to private interests, resulting a decline of labor rates and employment, and increased debt, in developed countries while developing countries like China have become creditors. Instead of allowing the standard of living of  Chinese workers to rise to the level of developed countries, the Chinese government has accumulated the wealth from its development and used it to fund debt in the countries buying its products.

What remains to be seen is how this will all work out. In ancient times, wealth became concentrated in the hands of kings and their aristocratic cohort and debt in those outside the ruling circles. Periodically, there were Debt Jubilees, where debts would be forgiven and a new cycle of wealth and debt accumulation started. Since, in the modern world, wealth accumulates in private hands, and narrow private interests control government through contributions to politicians, there is no possibility of debt forgiveness.

All signs point to protecting wealthy private interests at the expense of working people. Eventually, debt service eats up all the resources that are needed to sustain productive enterprise and the system collapses. The question people should be asking is whether humans are smart enough to make corrections before the system collapses? The second ingredient of development, energy, may make the decision for us sooner rather than later. As fossil fuel resources decline and debt grows we face a double threat to the world economy and the standard of living of its citizens.

Obama, a Disaster for Progressives

Obama’s appointments and actions during his presidency have shown him to be a moderate Republican. His substituting of mediation with Republicans for leadership in fighting for progressive policy ceded the high ground to Republicans and caused the catastrophe that was the 2010 election. Since then he has ceded even more ground to Republican policy, including the disaster of cutting federal spending in the middle of a deep recession.

He has actually adopted Republican talking points in many of his speeches about the economy, buying into the false comparison between what voters should do in a recession, and what the federal government should do. As Obama has moved to the right in his policy decisions, the Republicans have moved even further to the right, until now Republican policy is essentially wacko Tea Party policy.

It is hard to see what he will do differently in a second term. It is not that he’s fought the good fight for progressive policy and been blocked by Republicans. He has actually agreed more with Republicans than with his progressive constituency. And, it is even harder to see how he will motivate progressive voters, which he needs to win, to the polls in 2012.

On the Republican side, if they win the presidency and both houses in 2012 will they continue their radical Tea Party policies when the results will be laid wholly to their doorstep? Not likely. Having a weak Democratic president that can be easily pushed around, and with their stated paramount objective being to make Obama a one term president, the Republican party has become radicalized. If they should win it all with a candidate like Romney, who is not a Tea Party wacko, they would likely return to a more responsible way of governing, especially if Democrats in Congress kept their feet to the fire and used the filibuster in the Senate the way Republicans have used it.

The time when a president can ignore his own constituency and get reelected has passed. Unless the Democrats field a viable candidate to oppose Obama in the primary, the energy on the Democratic side of the election will be so low it’s hard to see how voters will turn out in the large numbers needed to win. All the excitement will be on the Republican side of the election. If Obama were to win a challenging primary, that made him spell out how he is going to govern, it would give his constituency renewed energy to elect him. If not, it might result in a better candidate, or at least increase the turnout in the general election, which is necessary to maintain control of the Senate as a minimum.

Natural Recovery Mechanisms

Since political gridlock in the country has precluded much government intervention to facilitate recovery from the financial crisis, we will have to rely on natural mechanisms to recover over an extended period, just as the Japanese have been trying to do for the last couple decades.

So what caused the crisis and what are these natural mechanisms that will allow recovery? For the economy to be healthy, there has to be a balance between saving and spending. Capital and labor are the ingredients for growth. The relatively few, more wealthy, people do most of the saving and middle class labor provides most of the spending. As I have previously discussed here, over the last several decades more of the rewards of productivity have been going to the savers. As the spenders are squeezed, demand wanes and there are fewer opportunities for investment, so the return on investment falls. This results in a search for ways to stimulate demand and increase returns, like easy credit, leverage, and creating derivative instruments that hide risk.

Eventually these mechanisms lead to bubbles of ever increasing asset prices and create a euphoria that perpetuates the growth of the bubble until it bursts, resulting in a financial crisis. First we had the saving and loan crisis, then the dot com bubble and now the housing bubble, which nearly brought the country to ruin. This has resulted in high unemployment, fear of further crises, and stagnated demand because the problem is really that the debt left over from the bubble never has never been addressed. Banks and their investors,  being the primary holders of the debt, have refused to take losses on their bad debts, and the government has stepped in to bail them out, increasing the public debt.

The solution lies in first reducing the debt overhang in the private sector because the private sector is the primary source of demand. Demand must be increased first because the revenue from increased growth is needed to address the public debt. Political gridlock will not allow the government intervention necessary to make this happen. So other mechanisms must be relied upon to correct the problem, stretching out the recovery over the decades ahead.

The primary means for addressing normal recessions is monetary policy, that is, lowering interest rates by increasing the money supply. Lower interest rates means less income is going to savers, and the spendable income to spenders increases because their debt service is reduced. Neither of these these things happen automatically. So it has fallen to the Federal Reserve to insure that low interest rates are maintained. This has not been an altruistic move on their part. Their main interest is in keeping the banks afloat by easing credit and pumping up asset markets, since the government has been reluctant to restructure them. But, a byproduct of the policy has been to ease the burden of homeowners and other private debtors. But, as interest rates approach zero, this mechanism is no longer effective.

The first natural mechanism the comes into play is private loan default. As homeowners and other private borrowers default on their loans, the lenders and their investors are forced to absorb the losses.  Those that don’t default are forced to continue paying off debt rather than spending their income, which reduces the demand necessary for recovery. This prolongs the recovery period. So, defaulting on private debt becomes a mechanism for reducing the recovery time. To the extent that artificial means and deception were used to induce borrowers to borrow, this is a just action and should be encouraged, rather than disparaged.

The second natural mechanism for reducing debt is inflation. As inflation occurs, debts can be paid off in cheaper dollars, erasing debt faster, and promoting a quicker recovery. Controlling inflation falls to the Fed in implementing monetary policy. To reduce the recovery time the Fed needs to allow more inflation in times of crisis, and usually does. The Fed has recently raised inflation targets for this purpose.

The final natural mechanism occurs when flight to safety and political pressure drives funding from institutional investors into public debt at low interest rates. This allows governments to reduce their debt service and spend to increase demand and reduce the burdens of unemployment. These latter two mechanisms are referred to as “financial repression” by savers organizations like the Pete Peterson foundation, who have the most to lose by it. It was practiced extensively after the second world war when large debts had to be liquidated in a timely manner.

It’s unfortunate that these natural mechanisms must be relied upon to get us out of the economic doldrums. They extend the length of the recovery process, when a positive restructuring  of debt by government would have shortened it. But, money is power and it talks in many ways, so we must suffer longer to appease those who refuse to take the hit on their bad investments.

Historical Limits to Progress

A classic example of history limiting progress is exemplified by the mobile carrier industry. These old telcos have no incentive to innovate because they own the lines and charge by the minute. They all spend millions of dollars every day advertising in media all over the country, when there’s not a dime’s worth of difference between the services they provide. How is it that you can make unlimited free VoIP calls over the internet at speeds much faster than the cell phone networks which charge an average of $50 a month for the same service?

If it weren’t for the extreme hostility between government and industry due to free market ideology we could have had fiber and hot spots along ever interstate highway in the country now and data and VoIP calling services everywhere for little or nothing. Countries like Korea and Japan, where government and industry cooperate, are decades ahead of us.

If you compare progress in bandwidth and technology on the internet to cell phone transmission technology the gap is obvious. Now the telcos want to buy off the government to latch onto the new spectrum freed up by HDTV technology to waste it on their outdated network and retro development practices.

There are some signs that Microsoft, Google, and Apple aren’t going to put up with this much longer. They are getting interested in bidding on spectrum and have developed voice network technology. Google has Google Voice and Microsoft has recently purchased Skype at a very high price. Already, much of the traffic that would normally be on the cell network has moved to WiFi when phone users are near a hot spot or have a home network. You don’t even need a phone. I make free nationwide calls on my iPod Touch at any hot spot using Google Voice.

I’m not holding my breath for things to change because the cable companies and telcos own the Congress, but sooner or later we are going to seen broadband internet carrying the bulk of voice calls, as they are video calls now.

The Roots of American Decline

The decline of the US economy has its roots in the deregulation of business and finance and automation of complex manufacturing processes. The decline is aggravated when wealth becomes concentrated in the hands of a few who use it to capture control of the government. As control of government by capital interests increases, regulation further decreases.

A good measure of the how far the loss of democratic control of government has progressed is the income and wealth disparity between the owners of capital and the working classes. The more control wealthy elites have over the government, the greater will be the concentration of wealth and income in the their hands.

As democratic control of government is lost to the owners of capital, the rewards of productivity increases through automation go increasingly toward the owners of capital and away from labor. Only if countries retain democratic control of their government can equity be maintained.

Domestic jobs are lost through automation and the opening of financial flows across borders, which allows factories to be moved offshore.  Allowing foreign labor into the country through lax immigration and border control policies and the liberal use of visas to educated foreign workers further exacerbates the problem.  As the labor supply increases relative to the demand for labor, wages are driven down, allowing a further increase in wealth to the owners of capital and a degradation of the living standards of the working class.

As the standard of living of labor falls, the need for income security, health care, and retirement increases, necessitating greater government involvement, setting up a growing battle between labor and capital for control of the government.

The recent collapse of the economy has demonstrated that the financial industry does not police itself and will go to extreme lengths for its own short term interest at the expense of the national interest.

To sustain domestic demand when working and spending class incomes are decreasing, requires spending from borrowing. This was enabled by the creation of a housing bubble, allowing workers to spend from the ever increasing equity in their homes. The financial sector drove the bubble higher and higher with leverage, derivatives, and liar loans, reaping short term riches at the expense of long term calamity.

When the bubble burst, homeowners and savers lost trillions, causing a severe drop in demand as they turned to saving instead of spending. With millions of bad mortgages on their balance sheets, banks stopped lending. Heavily leveraged, many found themselves bankrupt if loans were marked to market.

In steps the government, itself now starved for tax revenue, but the only entity large enough to rescue the economy. Instead of restructuring many banks that could be restructured, and making those who made bad investments take some of the losses, they allowed the banks to keep the loans on their books at face value and bailed out all but one bank, Lehman Brothers, some at 100 cents on the dollar. This put the government in deficit and further in debt, while working people faced heavy unemployment and depletion of their savings, and while banks were still heavily in debt with bad loans on their books.

Now we face losing the working class safety net and sustained unemployment, while the government provides banks with nearly free money to work off their bad debts buying treasuries and speculating in foreign currencies.

With diminished domestic demand and tax revenue from the working class it is doubtful whether government deficits can ever be eliminated through taxation of this sector, particularly if their safety net is destroyed. The only source of revenue that can be tapped to do this is the income from investors and corporations who are prospering with their factories in developing nations. That’s where the growth will be. But, these are the very people that have control of the government and refuse to impose such taxes.

You may ask, how can this be, when capitalist elites are only a minority of the populace? The answer is propaganda. By keeping enough working people hood-winked regarding where their real interests lie, and by keeping the press in the their elite circle this is easily accomplished.

The politics of special interests and values is a convenient tool to do this. By keeping the electorate distracted with wedge issues like religion, ethic and sexual preference, and demonizing people on welfare, the elites can convince enough people that these are the real problems, while they pay the bills of politicians to get them elected and do their bidding.

By allowing a professional working class, and their retirees, to have sufficiently high incomes to be comfortable, they can keep them in a state of concern for only their personal affairs and a lack of concern for what is happening politically and economically in the country. By promoting the identification of this group with the controlling elites, rather than with the struggling masses they can keep them voting for the candidates they put up.

Businesses organizations like the National Chamber of Commerce and private business owners like the Koch brothers contribute heavily to conservative think tanks to generate such propaganda based on ideology rather than practical considerations. Such propaganda over the last several decades has brought the country back to where it was prior to the Great Depression and there is no sign that things will change until more and more people are pushed into poverty, to the point where the hurt causes them to wake up and vote their real interests. Only when most people identify with the plight of their fellow citizens, rather than aspiring to join the elite oligarchy, will things change.

Between a Rock and a Hard Place

I can’t see any way we can avoid another crisis that is even bigger than the one we are in. Basically, what we have is a lot of money sitting on the sidelines waiting for things to get better, and they’re not going to get better. The government and the Fed know this and they don’t have a lot of choices what to do about it.

The basic problem is still the banking crisis. If things get worse the banking system is subject to collapse. So what is happening is the Fed is printing money to buy treasuries. This money ends up in banks, who use it to buy treasuries instead of investing it, because businesses are not expanding domestically so have no need for investment. There is some business expansion but it is overseas. So banks are getting money without interest and investing it treasuries where they earn interest on these reserves. That’s a good deal for banks. It keeps them afloat and provides an income stream to deleverage their bad debts and pay the big bonuses.

The bad part is that the government is running up debt like crazy with no prospect of a revenue stream big enough to pay it back. Its normal obligations are huge and growing. We’re still fighting two wars and assisting in a third while the baby boomers are beginning to retire, increasing the Social Security and Medicare outlays. To compound the problem, we are on the downslope of the peak oil curve where demand from developing countries is still growing and supply has peaked. Since our economy runs on oil for almost everything, this alone spells crisis in the current decade or the next.

I don’t see a way out, and neither does the government or the Fed, although they don’t say much about it because it would just add panic to an already bad situation. Ultimately what will happen is we will be forced into another crisis due to increased cost of commodities like gasoline and food, the production of which is heavily dependent on oil.

There is no way to reduce the federal deficit substantially from the current or future revenue streams. Projections showing this is possible project revenues that can’t be achieved with the problems outlined above. We are in for really bad times this decade and the next. Current legislation puts a large part of the burden on those already overburdened. We don’t let people starve or deprive them of needed shelter and medical care so eventually wealth will be redistributed in one way or another and the overall standard of living will decrease. Meanwhile, we’re fiddling while Rome is burning, not unlike the legendary frog in the pot of soon to be boiling water.

Absorbed in the Present, Ignoring the Future

When was the last time you heard the word “sustainability” uttered? The general concern, the world over these days, is debt and growth. It’s as if the only thing important to the first world in the current crisis is getting back on the conspicuous consumption curve. Meanwhile, the big threat, the one that will require a major adjustment in the way we live,  is creeping up on us: PEAK OIL.

Many pundits have pointed out how a 50% increase in the price of oil has affected commodity prices and aggravated the current financial crisis. This is nothing compared to what we will face when oil doubles or triples, and it will. It’s just a matter of time.

Instead of going into even greater debt to sustain an unsustainable lifestyle, why aren’t we considering what’s really necessary to be to be happy with less and planning for the time when this change will be forced upon us. Over-consuming isn’t necessary to live a worthwhile, rewarding life. And, it’s downright unhealthy. Two recent movies have brought this message home in a major way: King Corn and Blind Spot. Watch these two and decide whether you still want to stay on treadmill we’ve been on for a couple hundred years. What has it really gotten us? And, in any event, it’s coming to an end over this century, so why not use the current crisis to change our ways and plan for our grandchildren’s future?

Simplifiying Economic Priniciples

There is a current debate going on between Paul Krugman, Nobel Laureate of Princeton and the New York Times and Paulina Tcherneva, an economist at New Economic Perspectives (NEP). NEP is run by people from the University of Missouri, Kansas City, and its contributors include people like Bill Black, who put a lot of shysters in jail after the Savings and Loan crisis; Michael Hudson, an economist who has been helping many foreign countries facing austerity crises; and many other from UMKC that are listed at the blog.

Both parties agree that creating money to stimulate the economy can lead to a devaluation of the currency. But, they disagree on whether or not this can lead to a government default and what the the money should be spent on. To date, essentially all the money has been spent on buying junk bonds from banks to increase their reserves so they can ride out the storm, while taxpayers pick up the tab in the form of higher taxes and reduced services later. Little or nothing has been spent on employing idle labor and other productive resources. Both parties have favored stimulus, but Krugman seems more accepting of what has been done than Tcherneva.  She believes the money should have been spent on putting people back to work with government programs. Tcherneva contends that the government will always be able to pay all its bills, including Social Security benefits, because it can print money. It’s just a question of what that money will be worth in purchasing real goods at a later time.

So, the bottom line is, what is the right course in the long run. If we continue to just bail out the banks we’ll have to continue buying  consumer products from overseas. To do so we’ll have to exchange those inflated dollars for the yen or yuan, so they won’t buy as much. But, if we invest now in putting the unemployed to work  restoring our domestic infrastructure and production capacity, later we can produce those goods ourselves and don’t need to take the hit on the currency exchange to buy them from foreign countries. Tcherneva makes the point in a quite wonkish way, but I think she wins the argument.

The Distorted Picture of Tax Equity

I would like to see a tax analysis organization initiate a project to present a true picture of tax equity which I have been unable to find anywhere.

There is a lot of misunderstanding and controversy over tax policy in this country because people don't have a clear picture of who is paying the taxes and whether or not it comports with their share of income. Most of the interest centers on the income tax, whereas payroll, sales, and property taxes have an equally important role in fairness. If people knew that taxes were being levied fairly and used properly they would more easily see and understand the need for taxes.

What organizations that analyze taxes need to do is present a complete picture of the total taxes people pay vs. their income. Current presentations of this picture use only the income tax and broad categories, the smallest being the top one percentile. Other taxes need to be included and the picture at very high incomes to 0.1 to 0.01 percentile brackets need to be shown.

Consideration also needs to be given to the disparity between taxes on earned income and capital gains. If capital is in short supply capital gains taxes should be lower. If consumer demand is low taxes on earned income need to be lower. In the present situation we have glut of capital and a shortage of demand, yet capital gains taxes have remained much lower than taxes on earned income.

Tax analysts need to do a better job of presenting a true picture of tax equity if we expect to minimize tax avoidance and prevent tax revolts.

As an example compare the two tables below. The top one is from the Tax Foundation. Looking at the shares of income and taxes you would think people in high tax brackets are overpaying their taxes. But, if you assume that taxes should be paid on net income rather than gross income the picture looks much fairer as shown in the bottom table. In this case it is assumed that it is necessary for a taxpayer to be making at least $33,000, the income of the median return, to hold a job, provide a home, transportation, and other expenses necessary to stay employed. Since other taxes are less progressive than income taxes the picture will appear even less fair if these taxes are included. We need fresh thinking on tax policy.

You may argue about what income it takes stay healthy and hold a job, so $33,000 may not be the right number. But, it’s certainly closer to the truth than the exemptions and deductions we now allow for low income people, while corporations get to deduct their martini lunches and other expenses that could hardly be considered necessary in the normal course of business. If everyone below the median tax return were taken off the tax rolls and all the deductions and exemptions were removed think of the money that could be saved on wheel spinning to avoid taxes. This together with higher taxes on the highest 0.1 percent of earners would go a long way to making up the taxes lost by taking everyone below the median return off the tax rolls.

Is a Depression Inevitable?

We find ourselves in a situation where capitalists and the financial industry run our country and many other countries in the world. Over the last several decades the industry has deregulated itself and reduced its tax rates to allow it too concentrate the wealth of the country in its hands. At the same time it has allowed, through globalization, labor rewards to seek a level set by the lowest wage worldwide.  In the process, it has destroyed the buying power of the great masses of the world population. To compensate, it has stimulated the demand for debt and hidden risk through the use of collaterization and derivative insurance products. This was a prescription for asset and debt bubbles and ultimate failure of the financial system, which has been prevented from collapsing totally only by the offloading of the debt onto governments.

Keynesians have viewed the rescue of the financial system, through large government expenditures, as paramount, but is it just delaying the inevitable? As long as we have the financial system running governments are we ever going to correct the problem of financial system running governments and bailing themselves out on the backs of the masses? This appears to be a question that answers itself in the negative. Keynesianism, the philosophy of the government stepping in to prop up demand as private sector demand wanes may work for normal business cycles, but does it really work to correct structural problems caused by lack of government control by the people?

A couple recent articles have shown that the incentives are all in the wrong direction, and that concentrated wealth in the hands of a few leads to control of all physical resources and inflation of commodity prices. In a recent article by Henry Blodgett in the Wall Street Journal, he demonstrates how the incentives perpetuate the problem. A recent post to The Economic Collapse blog show how commodity prices are skyrocketing. And, lately there have been reports of the buying up of agricultural land in Africa to take advantage of the rising cost of agricultural products. Where will it all end. Are the masses of the world’s population doomed to be serfs to a small percentage of wealthy capitalists? Or, is another depression necessary to wrest control of governments back from the financial industry? Pick your poison.

The Solution to the Housing Problem

“Henry George (September 2, 1839 – October 29, 1897) was an American writer, politician and political economist, who was the most influential proponent of the land value tax, also known as the "single tax" on land. He inspired the philosophy and economic ideology known as Georgism, which is that everyone owns what he or she creates, but that everything found in nature, most importantly land, belongs equally to all humanity. His most famous work is Progress and Poverty written during 1879; it is a treatise on inequality, the cyclic nature of industrial economies and possible remedies.”  (Ref: Wikipedia)

This was a good idea that could never be implemented because all the property was in private hands.

Instead of pouring taxpayer money into banks to keep them from imploding from the devalued loans on their books, why not use the money to buy the land under their homes from the property owners. The homeowner could then use the money to buy down the value of their mortgage to the value of the structure, giving them a monthly payment they could afford, thus enabling them to keep their home. The bank balance sheet problems would be relieved by these buyouts. When the economy recovers and home owners are able to afford a higher monthly payment, the government could then start charging them for the lease of the land. In this way, government revenue will increase to pay off the debts incurred to make the purchase of the land.

If this practice is continued, eventually the government will own enough revenue producing land to pay off the government debt and begin to reduce other taxes. In this way, the Henry George land based economy could be implemented over time.

The program would have a side benefit in that it would allow government to prevent or offset future recessions by reducing rents instead of increasing spending, when private spending wanes in a recession. In boom times, rents could be increased to take some steam out of asset bubbles that were developing.

The program would also limit speculation in land by banks, hedge funds, and other investors, thus slowing the development of asset bubbles and the attendant crises when they burst.

The housing and real estate markets would be stimulated because the cost of a home would only be the cost of the structure, requiring less funding on credit.

The main entities that would suffer would be banks and speculators. Now isn’t that a shame!

The Henry George economy is discussed fully in the link cited above.

The Oil Boom in North Dakota

North Dakota family and friends know all this, but it might be of interest to others. As most of you know, North Dakota is the state that has been least affected by the financial crisis, and it is in no small part due to the oil boom going on there. And, the area where I grew up is right in the center of it.  The first well drilled in North Dakota by Murex Corporation, a company started by two North Dakota residents who became petroleum engineers at North Dakota State University, was drilled right on the farm where I grew up. It was one of the first horizontal wells drilled in the Bakken formation, one of two major new formations being tapped by new oil drilling technology. The Tioga Tribune, the newspaper of the small town where I went to high school has published a pamphlet called, "The Oil Can Extra" that documents the history of Murex and presents other information on oil development in the area. There is a picture of the first Murex well in the document. The Fargo Forum, the newspaper of the largest city in North Dakota, has done a wider ranging project on the state oil industry called, “Running with Oil”.

If you have further interest, click on the links in the text.

What is driving the stock market these days?

I’ve noticed a strong correlation between the daily changes in the Dow Jones Industrial Average (DJIA) and and the changes (against the dollar)  in high yielding currencies used in the carry trade. (The carry trade is the practice of borrowing money in a low yielding currency like the US dollar or Japanese yen and investing it in a high yielding currency.)

The correlation is not true for low yielding currencies like the Japanese yen. To see the correlations visit the following links.

Australian Dollar

New Zealand Dollar

Japanese Yen

The first two are often used on the high side of the carry trade. When these currencies follow the market up it means the dollar is depreciating against these currencies, countering a portion of the dollar gains on the stocks.

The reason this is at all of interest to investors is that, if the correlation is strong, it suggests that the market is being driven largely by very large investors like big banks, hedge funds, institutions, etc, because the great mass of small investors seldom use the carry trade. It raises a further question regarding whether the coordination of these large investors is a form of market manipulation. It would be possible for large investors with real time trading and front running tools and acting a coordinated way to move the stock market and currency market up and down to continuously skim profits from investors not so equipped. A low correlation between the carry trade currency changes and the DJIA would suggest that this is not happening.

Eliminating Welfare and Developing a Mixed Economy

It’s been fairly well proven that both totally state controlled or totally free market economies don’t work. Why don’t we just admit it and define what roles government and free enterprise should play in the economy?

People have lost track of what the depression era programs really were. I won’t go through all the details here because they are spelled out in the government document,  Job Creation Programs of the Great Depression.  But, they were carefully thought out programs that were designed not to compete with private enterprise and had control over worker behavior far beyond just the work environment. At the beginning of the depression there was no safety net to speak of so the CCC, WPA, and PWA became the safety net. When workers can’t get work in the private sector, they are willing to settle for less freedom in their lives and lower wages to make a basic living. Conversely, if private sector jobs are available that pay higher wages and give them more freedom they will gravitate toward them. This insures that the private sector will always have a pool of available workers.

What I am proposing is that welfare and unemployment compensation be replaced with permanent versions of the depression era workfare programs and others like them. These programs would be limited to paying the minimum wage and would include government supplied health care similar to Medicare and pensions for retirees similar to Social Security. They would involve closer control over people’s lives, as was the case in the depression era workfare programs. With such a safety net, regulations on business could be relaxed, and businesses that are too big to fail now because they would jeopardize the welfare of the citizenry, could be allowed to fail. The incentive to return to the private sector would always be there due to the higher wages and greater freedom.

In prior posts here I have shown how periodic failures of our economic system, manifested by recessions, depressions, and asset and debt bubbles which collapse, are due to the imbalance of wealth and income between investors and wage earners. The broad middle class creates the demand for products and services which is needed for business to create jobs. Since business and capital sit atop the economic pyramid and decide how the fruits of productivity are allocated they periodically succeed in diverting more and more of the fruits of productivity to investors and managers and less to wage earners. This happened in the late nineteenth century, again in the first half of the twentieth century, and has now happened again in the first part of the twentyfirst century. This happens because the wealth accumulation results in a takeover of government by a wealthy oligarchy. Unless wage earners rebel, there is not much they can do about it.

If a safety net of the type I propose is put in place, any attempt to short change workers, as wealth is transferred to investors and managers, will result in more people ending up on the workfare programs and higher taxes for business and people in the private sector. The workfare workers will still be earning an income to sustain demand, but the private sector will soon see a shortage of workers. They will realize that they will need to pay their workers more to get them off  the workfare rolls and reduce their taxes. This will cause wages to rise again in the private sector allowing taxes to be cut, and rebalancing the income and wealth that is necessary for a healthy economy that is less subject to cyclical crises.

If you have further question about the workfare programs or the interaction of inequality and economic instability read the government document cited above and my prior posts on the subject.

Underlying Problems of the World Economy

We are in a catch 22. Economies of the world need to grow themselves out of the looming deflation that is on the horizon. But, private spending is collapsing, so public spending has to take its place until the economy is turned around. But, public spending is reaching its limits, because private sources of financing are losing confidence in governments ability to meet its obligations. Normally, what would happen under such circumstances, if the problem existing in only one country, is that the country would be forced into austerity measures, all the while being propped up by loans from outside sources such as the IMF, and by devaluation of their currency to stimulate exports,  thereby improving their economic outlook. But, this a worldwide crisis. All countries can’t devalue their currencies simultaneously, and where will the money come from to prop them up while they recover?

The underlying problem is that our productive resources, labor and capital are being employed unproductively in wars and economic endeavors that do not increase our standard of living. In the US we have shifted from an industrial economy that makes useful products to one that imports everything and all we do is sell things to one another. To add to this dilemma, our capital resources are being concentrated in the hands of fewer and fewer people, who hoard them rather than employ them productively. The broad middle class earning and spending power has stagnated as a result.

The solution will ultimately be forced upon us as the middle class is driven into poverty. We will either become more like Mexico or we’ll change our ways by reducing our expenditures for foreign wars and products that are of marginal utility and get back to basics. We will have to rebuild our industrial base and contract our financial base to balance capital with the need for capital and to employ our population productively. This will require a  more progressive tax structure like we had in the fifties, enabling workers to share in the prosperity of the country. We can either plan for this, or go the way of Mexico, where the wealth is concentrated in the hands of a few and the population flees to other countries to make ends meet.

Leisure World

Sometimes it helps to understand a concept by considering what would happen in the extreme. Suppose, for example, what would happen if technology allowed us to do all normal work without human interaction. The first objection to such an assumption would be that this is impossible. Some human interaction would be needed to monitor the automated system. But, let’s take that up later.

In a society, there are people that are employed or whose time must be devoted to work, and those who live off investments. Of course, those who live off investments must monitor their investments just as there must be people to monitor a fully automated system. But, again lets take that up later.

For the moment, the question is, who should reap the rewards of a fully automated system? Should all share equally in them, or do some deserve more than others. Should those with greater needs, such as people with larger medical expenses be allotted more than people without such needs? Should people who are talented and admired by people for their personal traits be  allotted more? Should people who are already wealthy get less than people who are not? These are questions that must be answered when faced with the prospect of a fully automated system.

We can now draw parallels with what is happening in the society now, that is only partially automated. As robots have taken over many of the functions that people used to perform in the automotive industry, what has happened to the people that have been displaced? And, where have the rewards of greater automation gone. Have investors received most of the rewards, or have prices of the cars gone down so consumers can participate in the rewards. Judging by the rising inequality in the last several decades,  the sustained or increased prices of automobiles, and the reduced incomes of displaced workers forced to migrate to other work, it appear investors and management have gotten the best of the deal.

Going back to our idealized automated society, obviously the people necessary to monitor the automated system must be compensated. And, investors must be compensated for the time they spend monitoring their investments. But, we have not answered any of the questions raised regarding how the rewards of automation should be shared. This is the dilemma was face in our current society and that we are not addressing. We seem content to just let the money flow to the people that are closest to the source and who control the process, namely investors and managers. Is it any wonder that wages have stagnated, capital has accumulated beyond the need for it, assets are bid up to artificially high levels, and average people are forced into debt to survive. The resulting assets and debt bubbles have burst and we are facing a collapse of whole system.

Isn’t it time to reconsider tax policy to balance the accumulation of capital with the need for it, and to address the need for a redistribution of income resulting from the rewards of automation? As we have seen, in the limit of full automation, we should all be better off, not just a few people who happen to control the process in getting to a more automated society.

A Project for the UN and WTO

The Kyoto environmental accords failed and little progress has been made on world poverty. The US administration is pushing cap and trade as an alternative to Kyoto and has no defined program to reduce world poverty.

Cap and trade is a corporate program, subject to market manipulation that we’ve seen in other commodity markets, and that is pushing marginal farmers into survival mode in Brazil as corporations buy up large tracts of land for it’s carbon trade potential.

Maria Cantwell has a better idea: Cap and Dividend. It would add a carbon fee on all hydrocarbon products and rebate the collected funds to individuals to compensate them for the increased prices of petroleum products. The only problem is, it’s only a national program. American consumers would continue to buy the products at the same rate  if they are compensated for the increase in price.

A better answer is an international program, where rebates would go to many people living on a dollar a day and not using any petroleum products. Such a program would fight carbon buildup while at the same time fighting poverty, a win-win for the world.

Instead of beating their heads against the wall trying to sell climate change to people who won’t get interested until it affects them, environmentalists should be working in a world forum like the UN and the WTO to sell the benefits of carbon reduction in, not only improving the environment, but reducing world poverty.

Petroleum products have a world market. Petroleum producers are multinational corporations. The world is suffering wars in the name of petroleum resources and third world countries are benefiting little from them. It’s time for an international efforts to combat climate change and world poverty in a unified program.

The Tea Party Doublethinkers

Doublethink is the ability to hold two contradictory thoughts simultaneously. The credo of the Tea Party is lower taxes and smaller government. By shrinking the structure that was designed to protect them they are committing economic suicide. The business community has been successful in duping quite a large number of people into thinking that government is the problem, but it certainly hasn’t been a problem for business. They have been successful in turning the people against the government,  while at the same time lobbying to capture the government for themselves.

Business promotes expenditures and taxation for the military industrial complex and for bailing out banks while condemning them for any purpose benefitting people. It has successfully perpetuated an inefficient private health care system that rations health care by ability to pay rather than by need for care.  And, it is trying hard to destroy Social Security and Medicare. Yet, it has been able to convince the Tea Party that the solution is to further reduce taxes and limit the government’s power to protect the people.

What is needed is to bring government back to its original mission of promoting the general welfare, and not that of business and banking. There is a reason that taxes on the highest incomes were high and regulations were strong during the most prosperous period in the country’s history. Over the last several decades regulations have been decimated and taxes on high incomes and capital have been reduced dramatically, to the point where we are again experiencing an age of robber barons while aggregate demand atrophies and wages stagnate. Unless the people in organizations like the Tea Party realize they are working against their own interests, there is little hope of correcting the problem.

An Alternative to Unemployment Payments

Fundamentally, economies thrive when everyone is engaged in productive work in the most efficient way. As disturbing forces arise to create unemployment, the most prevalent solution has been to pay unemployment benefits to workers until they can find employment. There has been no other course, since there has been no facility to employ them beyond the private sector. This is where it might pay to make a fundamental change in national policy.

The government is always engaged in funding projects to improve national infrastructure and defenses. These projects could be structured so that the pace of activities can be adjusted relatively quickly to accommodate the increase or decrease in employment needs. If a segment of the private sector is temporarily slumping, public projects could be accelerated to employ people facing layoffs in the slumping sector. Obviously, there will be mismatches in qualifications and mobility problems, but keeping people productively employed may be better than paying them to do nothing and then having to encourage them to seek other employment or forcing them off the unemployment rolls when they’ve been out of work for some time and their skills have deteriorated.

The Basic Conflict Between Balanced Budgets vs Incurring National Debt or Printing Money

Putting an economy largely in the hands of a central government or unregulated private enterprise have been shown to have different, but comparably troublesome, problems. Central government control destroys initiative and retards the accumulation of private capital that is necessary for growth.  Unregulated private enterprise concentrates wealth in the hands of a few and destroys opportunity for the broad mass of citizens. Both government and private enterprise are authoritarian in nature and take measures to advantage themselves, if checks and balances or regulations are not in place to control them.

Historically, management of economies has become complicated, particularly by the introduction of fiat currencies, making national economies issuing fiat currencies very different from local and personal economies which don’t have that power. The latter must operate under budgets which balance incomes with expenditures, while the former can simply borrow or print money with only devaluation of its currency as the controlling factor. Unless this difference is recognized, there is always a battle between forces that want to treat national economics like local or personal economics and the forces that want to use the national power to borrow or print money to counter instability. Over the years, the forces that want to balance income and expenditures have prevailed except in times of great crisis.

This is the crux of the problem we face. We have two choices, either demand austerity measures or tax increases in times of recession, in a attempt to rebalance budgets, or use the federal government’s power to borrow or print money to prop up the slumping economy.  The first hurdle we must get over is that these are real alternatives. One or the other is not the only course. And, depending on the circumstances, one or the other may be the more advantageous. We must not let preconceptions or past policies prejudice one alternative or the other.

If it can be shown that national budgets have become wasteful or bloated, programs have become obsolete, or lobbying pressures have caused expenditures to become excessive, austerity programs can be very useful. If taxes have become excessive or unbalanced among different segments of society, changes may be required. But if the country faces a crisis of instability due to natural sources or accumulated risks, austerity measures or tax policy changes may not be the best answer. When faced with reduced demand, government stimulation of demand to replace lost private demand may be a better alternative.

If the national government borrows to increase demand as a result of a reduction in private demand, it is subject to its ability to borrow and at what rate. If rates become sufficiently high it may become advantageous to simply print money and pay the price in a devalued currency. These are real alternatives that must be weighed. If a country is disadvantaged in its trade relations with the rest of the world because of the value of its currency it may be more advantageous to print money. If the rest of the world is awash with capital and borrowing can be done at a low rate it may be advantageous to borrow.

Until we can agree as a nation that we have these alternatives we will be unable to reach the best solution when confronted with recession or other forms of instability.

CompuVision is the Future

The migration of television channels like MSNBC to the internet illustrates why television will ultimately give way to CompuVision, the fusion of television and the internet. If you compare the interactive format from MSNBC on the internet above to the the linear television format, the latter pales by comparison. In the internet format you pick the shows you want see, then pick the segments that interest you, and finally click an icon to watch the segment in full screen format. You are interrupted by a commercial only when you are switching to another segment and to display ads only when you are selecting shows and segments, not when you're engrossed in watching the segment. It makes so much more sense than watching a whole show, or multiple shows, only a small portion of which you have an interest.

There will come a time when the display market will stand alone and the CompuVision unit you buy will be a combination of the current set top box/DVR and a full blown computer with a wireless keyboard, mouse, and a remote control that will look more like an iPod with touch screen input. This unit will interface with the appropriate modem/router on the input side and the large screen display unit on the output side. Peripherals such as scanners and printers will be wireless and communicate with the CompuVision unit through the router. If sufficiently fast wireless communication can be developed, the display unit could also have built-in wireless. This would completely eliminate cables. Media like DVDs could be eliminated completely with all media being streamed or downloaded over the internet. I hope I'm still around when this happens.

How to see a stock market bubble

This chart will tell you how to detect a bubble in the stock market. It's available at: http://www.bullandbearwise.com/SPEarningsChart.asp
As you see, the real S & P P/E went sky high during the housing bubble. Now it's down to where it was on September 30, 2007. It's still not down to historic norms, so the current bubble is still not completely deflated. If it starts going up again, it's time to get out of the market.
This chart is not be be confused with the annualized P/E chart for the S & P. That one uses old data over the previous year to come up with the P/E so it is late on predicting both the start and end of a bubble.

Time for a transaction tax on derivative trades

A one percent transaction tax on derivatives trade would pay for the entire US budget. If congress wasn't being paid off by these same big banks there would be no federal budget deficit.

JPMorgan, Bank of America Corp., Goldman Sachs, Morgan Stanley and Citigroup Inc. executed 96 percent of the $293 trillion in over-the-counter derivatives trades made by the top 25 U.S. bank-holding companies and their customers as of Sept. 30, according to the Office of the Comptroller of the Currency.

A Note About Leverage and Credit Default Swaps

Leverage is only possible if there are funds available at low interest rates, compared to what money managers think they can get somewhere else, usually involving some high risk speculation scheme. This is so only because there is too much capital available compared to the need for capital. If there were productive uses for the funds at reasonable rates why would holders of the funds being willing to lend them out at low rates to money managers who want to lever up some speculative scheme?

Our financial problems today are largely a result of money managers using leverage to increase yield at great risk, and then buying phony insurance in the form of credit default swaps (CDS) to guarantee their risky investments. Unlike real insurance, CDS don't require any reserves to pay off if the investments go bad. Also, they don't require that the purchaser own the asset being insured. So an outfit like Goldman Sachs can buy a CDS on some collateralized asset they don't own, and then proceed to drive the price of that asset down so that they can collect on the CDS.

Talk about Ponzi schemes, this one doesn't even require convincing investors to give you their money.

How Wealth and Income Inequality Causes Unstable Credit and Asset Price Bubbles

Income and wealth inequality is the root cause of financial instability. Capital, and the need for capital must be balanced for an economy to function stably.  

If the accumulation of capital exceeds the need for capital to fund growth, the taxes on wealth and capital gains must be increased, and that on consumption and consumer income decreased .

If consumer demand, and the attendant capital needs, outpace capital accumulation, the reverse is required. Taxes then should be shifted from capital gains to consumption and consumer income.

Over the past several decades capital accumulation has outpaced the demand for capital, largely due to reductions in top bracket tax rates and stagnation of middle class incomes. The discussion that follows shows what happens when this occurs.

Enterprises need capital to expand and take advantage of new opportunities. This allows economies to grow to accommodate increases in population and the attendant need for new jobs.

If too little capital is accumulated, growth will be curtailed. If  the effect is severe enough, sufficient growth will not be achieved to accommodate population increases and the need for additional jobs, and the standard of living will fall. 

If too much capital is accumulated, rates of return on capital drop.  As rates of return drop,  capitalists seek ways to improve them through the use of leverage or through the use of techniques to increase the demand for credit. 

If leverage is used ,  risk increases, necessitating even larger rates of return. This leads to a potentially unstable situation. So there is a limit to the amount of leverage that can be used.

As the limits of leverage are reached, investment banks and hedge funds will look for ways to stimulate demand for credit. This can be done by relaxing the standards for issuing credit, and compensating by using techniques to hide risk.

By collateralizing debt and issuing insurance on debt capitalists can be made to feel more comfortable with less secure investments. Debt issued with relaxed credit standards can be mixed with more secure debt making it harder for rating agencies to correctly assess risks. If regulation does not keep up with these measures, or decreases, the value of the collateralized assets and insurance instruments will be jeopardized.

Excess capital can also result in additional risky speculation. When returns on productive investments are low and approaching inflation levels, capitalists will be willing to take larger risks in short term speculation on valuable assets and commodities, caused prices to rise. In turn, the rise in prices creates an upward momentum in asset prices that attracts even more speculation. Such price bubbles tend to be self sustaining as more and more capitalists are willing to take advantage of the upward momentum in prices, until eventually that trend cannot be sustained and the bubbles burst.

All of these measures are driven by the need to increase returns on capital, when there is just too much capital for the real investment needs of the country. This is the situation that has developed over the last few decades largely because returns have been going more and more to capitalists while workers wages have stagnated. With stagnating wages, the demand for goods and services has not kept up with the accumulation of capital.

The stagnation of wages has been caused largely by shrinkage in the manufacturing sector, causing consumers to seek returns in the financial sector and to tap available credit to sustain consumption. This is evidenced by the excessive growth of the financial sector. At the same time, high income and capital gains tax rates have been reduced, accelerating the income and wealth gap between capitalists and middle class consumers.

Unless taxes are shifted to wealth and capital gains from consumption and consumer incomes, this increasing spread in income and wealth will continue to cause instability and the kind of financial crises we are now experiencing.

The Free Market Myth

You hear a lot of noise from conservatives about how the free market is the be all and end all of all things good. This is far from the case when government is in bed with private industry. Here are a few cases where the free market isn't free.

1) Cell Phone Service
Every day in almost every newspaper in the country there are full page ads from cell phone companies offering essentially the same type of service with the exception that the instrument that you can use is in the exclusive domain of one company. Cell phone users are paying for all this advertising and hardware exclusivity. The price of cell phone service is outrageous compared to internet phone service. Had the government invested in the infrastructure for high speed internet service in cities and along interstate highways, mobile telephone service would have been nearly free everywhere, as it is on the internet now.

2) Cable TV
Here again we have multiple companies charging high prices for nearly identical services, where you have little choice in what is available for purchase. Services are bundled for the convenience of the supplier and investor, instead of the consumer. If you're interested in only HBO you can't get it without subscribing to a whole raft of channels you don't want. HBO now has HBO Go which allows streaming of content on the internet, but it's not available unless you pay around $100 a month for HBO and a bunch of junk you don't need from a cable company.

3) Commercial Television
We are still locked into an outdated system where programming is interrupted by commercials. Now commercial channels don't even allow you to watch the program without pasting animated advertising at the bottom of the screen during the program. If you prefer to watch the same program uninterrupted and are willing to pay for it, it's not available.

Where is the free market that is supposed to be the best way to satisfy consumer needs? It's a myth. What is sold is determined by what is best for the companies selling it. This happens because politicians are owned by corporations. Ala carte cable TV services aren't available because cable companies write the laws that control cable TV. And, cell phone companies write the laws that control mobile phone service. And, commercial TV companies write the laws for commercial TV.

Recently there have been articles in the news about building high speed internet infrastructure. Cities are looking at 100 Mbps, Google at 1000 Mbps. This is ten to one hundred times the fastest service available now. It will enable phone, data, and TV in HD over the internet. It is the future, but will it come to pass. It is unlikely, because it would deny commercial TV, cable TV and cell phone companies the profits they now make due to laws written for them.

What we have now is not capitalism. It's state capitalism. They used to call it fascism. And, people seem to be the proverbial frog in the heating water, accepting more and more intrusion into the decisions they should be making as consumers.

Signs of a Declining Empire

Sometimes it appears that the country is stuck in a quagmire from which it cannot remove itself. We are a divided country along partisan lines. The Republican Party is controlled by the right wing, moderates having almost completely disappeared. The Democratic Party is controlled by the coalition developed during the Clinton administration which is in bed with commercial and banking interests, not unlike the GOP of old. Neither party can muster a controlling majority and candidates who would bring about real change cannot get elected. Obama is the classic example of a candidate that can get elected. He is charismatic, a good orator, and continuously triangulates in an attempt to please everyone. Unfortunately, that means perpetuating the stasis with which we are confronted. This stasis has led to several disheartening consequences.

1) We have become a nation of consumers, not producers, dependent on foreign countries for most of our consumer goods. Trade decisions are heavily influenced by international corporations that profit from favorable trade agreements. The economy is heavily influenced by a Federal Reserve Bank that does the bidding of Wall Street at the expense of average people. Trickle down is the modus operandi, and promoting the general welfare is on the back burner. Laws to limit speculation and prevent excesses are undone. Speculative bubbles are left to burst with catastrophic consequences.

2) We no longer can pass any real reform legislation, due to our inability to overturn the filibuster rule in the Senate. With the country nearly equally divided, with few prospects of sixty percent majority, legislation is watered down to where it is just nibbling at the margins of real reform. Major decisions boil down to catering to a few Senators from small states who are riding the political fence.

3) There is no will in either party to confront the dangers of the military industrial complex. The Republican Party never met a war it didn’t like and the Democrats are scared to death of being labeled weak on defense. We have supported a client state, Israel, in the Middle East that has resulted in our not being able to be an unbiased arbiter of thorny issues there.

4) We have left the prosecuting of military adventures around the world to a small group of volunteer service people, largely from the poorer segment of society, while the children of the rich and powerful are safe at home to pursue their personal ambitions. This has led to a lack of appreciation of the horrors of war and the terrible after effects on the participants in combat.

5) Foreign policy, heavily affected by multiple foreign wars and threats of war, has been been delegated to the military command structure to a large extent. What the generals want they get, so as not to anger the Republican right wing and make the Democrats appear weak. The money for war and the number and length of wars is increasing dramatically. Congress seems incapable of limiting war spending of any kind, while scrutinizing every penny spent to promote the general welfare.

Unfortunately, there are few signs that anything will change for the better in the future. We seem resigned to letting the system drift downward, like lemmings going over a cliff. There is no great outrage toward the intractability of our problems. The old don’t seem to be concerned about the state of affairs they are leaving their children and grandchildren. And, the young seem content to wile away their time in the fantasy of video games and reality television, rather than in preparing themselves to tackle the problems ahead of them. It’s all very disheartening.

Our UnRepresentive Democracy

Some aspects of our constitution have constricted us in adapting to changing circumstances over time. Other western countries with parliamentary systems have been able to adopt programs such as universal health care, while we have been unable to do so because our system allows a minority to block major legislation. This is primarily due to how our Senate operates.

Consider the chart below which shows how many people are represented by each senator from the several states. The average number of constituents represented by a senator, that is, the total population less Washington DC, divided by 100, is about 3 million people. In contrast, Wyoming senators each represent only 266,334 people while California senators represent 18,378,333 people each.

To compound the problem people in overrepresented states are more Republican. From the House representation which is nearly one person, one vote, there are 59.1% Democrats and 40.9% Republicans in the country. The overrepresented small states have 46% Republican senators vs. 54% Democrats, while the underrepresented large states have only 35.3% Republicans and 64.7% Democrats.

To compound the problem even further it only requires 40 senators to stop key legislation due to the filibuster rule. This enables lobbyists to concentrate their time and money on 40 people to block any legislation. And, if a Republican president is in office there is no hope of overriding a veto. This phenomena enabled Bush to get almost anything he wanted while the Republicans had a slim majority in congress, whereas the Democratic legislation can be easily blocked even with Democratic majorities in both houses. Since small conservative states are overrepresented in the Senate, it is nearly impossible to get a majority necessary to prevent legislation from being blocked.

A recent poll showed that the country supports the Obama health care program by a sizeable majority.

From Reuters:

“A Times/CBS poll found 85 percent of respondents wanted major healthcare reforms and most would be willing to pay higher taxes to ensure everyone had health insurance. An estimated 46 million Americans currently have no coverage. Seventy-two percent of those questioned said they backed a government-administered insurance plan similar to Medicare for those under 65 that would compete for customers with the private sector. Twenty percent said they were opposed.”

Yet the latter program has been taken off the table by a small state senator from Montana, Max Baucus because he said it’s a non-starter in the Senate.

A similar situation exists in the effort to reregulate banks. The powerful banking lobby can easily round up 40 senators to block the effort, in spite of the fact that the majority of Americans want it done.

A few words in support of our government

Our government has made the decision that there will be no more Lehman's. That's probably a decision forced upon them by the specter of a complete collapse of the financial system if a big bank like Citi were to go under. Furthermore, our government has concluded that it can't convince Congress to provide the funds to bail out the banks without some help from private sources. But, private funds sit on the sidelines, too afraid to invest in the toxic waste.

The government has given the banks bailouts at little or no interest to beef up their balance sheets. And, since the government has driven down interest rates to near zero, the banks are also getting deposits from private sources at near zero rates. The government has noticed noticed that the banks have developed a strong revenue stream from these sources of funds, due to the huge spreads between the cost of funds and the rates they can charge on new, healthy loans. Both Warren Buffet and John Hempton have provided evidence for this.

These revenue streams will enable the banks to write down their toxic loans against income, if they withhold dividends. The government can apply pressure to ensure this gets done. As the loans are written down they can be sold off to private buyers, who, in turn, can renegotiate the terms with the distressed borrowers and make a reasonable profit on the deal.

But private buyers are wary that the downside risk is too great to be buying up the toxic loans, even at a discount. To reduce the downside risk and bring buyers into the market, the government is willing put a floor under the losses on prospective buyers of problem loans and are willing to make low interest loans to the buyers to leverage the investment and increase their return. This all is part of the Geithner plan.

So the question arises, why should the government do this? The government is essentially using taxpayer resources to bail out the system? True, but if the system will collapse if it's not done, what is the alternative?

There are a couple remaining question to be answered. First, where is all this bailout money coming from. And, second, can the taxpayers be made whole, or at least partially compensated. To answer the first question, we must ask what private investors are doing with their money if they are not spending it to stimulate the economy or investing in, or lending to, businesses, including banks. Mostly, they are buying treasuries at little or no interest. So, if the investors won't spend or invest, and are giving the money to the government, all the government has to do is spend and invest it for them, which is what they are doing by bailing the banks and funding the stimulus. What better use could the government put this money toward than saving the country from the calamity that could arise if the system crashed?

Now, is there a way to make the taxpayers whole, or at least partially compensate them? If the government really wants to compensate the taxpayers who did not contribute to the problem they first have to identify who these taxpayers are, as opposed to the ones that contributed to the problem. This shouldn't be that hard. If we look at who profited from the bubbles, it was clearly the investor class, particularly high income investors and speculators, and the financial and insurance sectors that were so busy profiting that they overlooked the fact that what they were doing was putting the whole country in jeopardy. Some investors have already suffered from losses on their investments, but others have still prospered more than they suffered.

Obama has already taken steps to try to correct the problem. He has proposed raises taxes on the high income investor class, and taxing profits from investments at higher rates than currently are in effect. This is not soaking the rich. It's just taxing them to pay for the trouble they've caused with their hedge funds and derivative investments that have nearly driven the country into a second depression. This is one way of partially compensating low income people who have not profited from the bubbles over the last couple decades, who have seen their paychecks stagnate, and now are losing their jobs. They have suffered enough. And, their children and grandchildren don't need to be saddled with debt that more properly belongs to those who have profited from the growth in the financial sector over the last several decades.

Further measures may need to be taken. A financial transactions tax may need to be implemented after the crisis to make taxpayers whole. The whole financial and insurance industry may need to be restructured to prevent the development of businesses that are to big to fail. Laws to reign in greed and irrational exuberance seem not to have worked, so it may be time for the government to take a more active role in the financial and insurance industries which have caused this crisis. When finance grows from 19% of GDP to 30% in a couple decades it saps the talent from other industries that actually produce goods and services that are necessary to the economy. It's time to reign in these industries to a more reasonable size relative to the rest of the economy.