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The chart to the left is of non-borrowed reserves of Depository Institutions (h/t CD.) Which, in English, means "bank reserves". As Chicago Dyke pointed out, what that chart indicates is that the banks are, well, bankrupt. Or, more technically accurate, since they're still in business, insolvent.(1)
Wall Street's acting like the credit crisis is over. What that chart tells you is that it isn't. As folks were saying at the time, it was never a liquidity crisis, it wasn't about just not having enough cash or near cash equivalents around but rather a solvency crisis. Institutions were insolvent.
Are insolvent.
Nonetheless things have calmed down in the last couple months despite the fact that, well, US banks not only have no money, they're so deep in a hole they're close to digging to China. But even China doesn't have enough money to bail them out.
The reason things have calmed down is simple enough. With his actions, Bernanke told the world that the full faith and credit of the US government is behind both banks and Wall Street firms. Let me translate that into English.
Bernanke said "I am going to make Americans pay to clean up this mess. The huge amount of money that was transfered to rich people will not be paid for by the rich, instead it will be paid for by ordinary Americans".
The Fed saying that it will take any crap paper the banks care to give it at near par, even if they aren't worth anything, even if they are such garbage that no one but the Fed would take them, is a massive government bailout.
But government, in this case, means "American citizens". There are only two ways the US can pay for the trillions of dollars of losses. You can tax and directly bailout, or you can print money. Neither of these is free - the cost of taxation is obvious, the cost of printing money is inflation.
Let's run a little further with that. It's Memorial Day weekend, the first day of spring. And Americans are driving hither and yon, all the time bemoaning gas prices.
Why are gas prices high?
Well, a large part of it is indeed supply and demand. But, at the same time, it is also true that there aren't actual shortages. No one who needs gas isn't able to get it. As Shell's CEO Jeroen van der Veer said:
There are no tankers waiting in the Middle East, there are no cars waiting at gasoline stations because they are out of stock. This has to do with psychology in the markets and you cannot forecast psychology.
Except that der Veer is wrong about why the market is high. Oh, not that it isn't about psychology, that's part of it, no question. But most of it is about what Stirling Newberry likes to call the world's investment shortage.
See, there's a lot of loose money floating around in the world. Not only are the rich richer than anytime since the Gilded age, but due to the miracle of leverage you can easily take one million and turn it into, no joke, 100 million worth of speculative cash through the joy of leverage. Once you've got all that leveraged cash, however, you need to find something to do with it.
In the nineties that money went mostly into stocks. And so we had the dot-com bubble and the attendant frenzy.
Since then stock prices, if you measure them in Euros, have remained pretty close to flat. There have been some rises and falls, but basically, movement has been minor and soon lost.
Instead, in the 2000's that money split largely between four types of plays.
Labor arbitrage plays in which you move production from the 1st world to 3rd;
Real Estate plays, largely through the vehicles of mortgage backed Collateralized Debt Obligations (though there are other kinds of CDOs which also got great play) and other chopped up securities packages;
Currency speculation; and, Commodity speculation.
Labor arbitrage plays are still ongoing but they're slowing down a great deal as the US economy moves into recession and as costs in China and the core areas of India increase.
Real Estate plays are over. All types of real-estate markets are collapsing.
The other two types of plays - currency speculation and commodity speculation remain available. So you've still got your billions and trillions of money floating around, because rather than allowing deleveraging to occur properly the Fed and other central banks are sweeping the junk into trash bins, and that money is still looking for returns. There are no great new industries or technologies to invest in that can soak all that money up doing useful things. Sure, you can put a few hundred billion into alternate energy, but that's peanuts. The rest of it has no where productive to go.
But it still needs to make returns. And there's nowhere for that money to go but into currency speculation (against the US dollar, not that the US dollar shouldn't be collapsing based on fundamentals) and into commodity speculation. And since there are some fundamental reasons why food and oil supply are down, those are good places to pile that money into.
Oil and food prices, based entirely on fundamentals, would have risen. China and India coming on line is raising the demand for oil significantly. Climate instability and stupid government policies like ethanol price support are amongst the factors decreasing supply relative to demand for food.
But neither of them would have risen as fast or high as they did without speculative excess.
So. How do you fix this? As with many problems the world and the US has, it isn't a problem we don't pretty much know how to solve, we just don't have the willpower to wring speculative excess out of the system.
1) You put the major banks and Wall Street Brokerage, which are insolvent, into receivership. You sue for the return of all bonuses. You let the investors, who took the profits, take a full 100% loss on their stock holdings. You start, slowly, unraveling the swaps, CDOs and so on, and you force people to take their losses.
2) You have the government, in effect, take over the mortgage market.
3) Don't allow leverage beyond 10X max. Don't allow already leveraged money to be leveraged again.
4) Implement a Tobin tax, that is a tax on every single transaction. Tobin originally suggested it just for foreign currency transactions but at this point putting it on anything but plain vanilla bond and stock transactions would be wise. This will raise hundreds of billions very quickly, will make speculation less profitable and will take money out of the hands of the rich.
5) Implement a strong progressive tax which taxes income, all income, over 1 million dollars, at at least a 90% rate. This must include taxing unearned income at the same rate as earned income. Again, the idea is to get money out of the hands of the rich who have no productive use for it.
All of these actions, except the first, require international cooperation or the willingness to unilaterally impose currency controls. However they require less international cooperation than you might think - if, say, Japan, the US and the EU were to agree to these rules and were to slap currency controls on transactions with nations outside of the compact, the rest of the world would come into compliance very quickly. And since everyone has the same problems, only the extent varying, it's more possible than one might think.
If, and only if, you're willing to reign in speculative excess.
Of course, a number of other steps would be needed, including anti-usury laws, breaking up the telecom monopoly, reworking financial markets to support new energy technologies, and more besides.
Will this be done? My best guess is no. I think we're going to take one more round at the gambling table. I think that those who control the system now are going to do everything they can to hold onto their ill-gotten gains from the past thirty years, and that they will crash the system rather than allow real reform.
But I could be wrong. Pressures are going to be very strong on the next couple of Congresses and on the next President, to do something. This recession is only starting and it is going to get much worse. Deleveraging is going to continue. Housing prices are going to keep dropping for a few years at least. And the losses may be more than the Fed and the rest of the world's central banks can print their way out of without causing either hyperinflation in necessities, or, paradoxically, winding up in a deflationary spiral.
But rest assured that if they do manage to keep it together, they are only kicking the can down the road. And I think this will be the last time they can do so.
--------------------------------------------------------------------------------
(1) Technical note: the chart doesn't indicate anything suddenly changed. What has happened is that money borrowed from the Fed has been classified as borrowed reserves, rather than non-borrowed reserves, because, well, it's borrowed. Now to borrow that money each bank gave the Fed some securities. So if those securities are worth face, everything's good. If they aren't, things aren't ok. Just from a general eyeball of the chart, if the securities are worth about 65cents to 70cents on the dollar, the system is probably (barely) solvent. This is no different than two or three months ago, it's just that this puts a number (and a picture) to the situation
Wall Street's acting like the credit crisis is over. What that chart tells you is that it isn't. As folks were saying at the time, it was never a liquidity crisis, it wasn't about just not having enough cash or near cash equivalents around but rather a solvency crisis. Institutions were insolvent.
Are insolvent.
Nonetheless things have calmed down in the last couple months despite the fact that, well, US banks not only have no money, they're so deep in a hole they're close to digging to China. But even China doesn't have enough money to bail them out.
The reason things have calmed down is simple enough. With his actions, Bernanke told the world that the full faith and credit of the US government is behind both banks and Wall Street firms. Let me translate that into English.
Bernanke said "I am going to make Americans pay to clean up this mess. The huge amount of money that was transfered to rich people will not be paid for by the rich, instead it will be paid for by ordinary Americans".
The Fed saying that it will take any crap paper the banks care to give it at near par, even if they aren't worth anything, even if they are such garbage that no one but the Fed would take them, is a massive government bailout.
But government, in this case, means "American citizens". There are only two ways the US can pay for the trillions of dollars of losses. You can tax and directly bailout, or you can print money. Neither of these is free - the cost of taxation is obvious, the cost of printing money is inflation.
Let's run a little further with that. It's Memorial Day weekend, the first day of spring. And Americans are driving hither and yon, all the time bemoaning gas prices.
Why are gas prices high?
Well, a large part of it is indeed supply and demand. But, at the same time, it is also true that there aren't actual shortages. No one who needs gas isn't able to get it. As Shell's CEO Jeroen van der Veer said:
There are no tankers waiting in the Middle East, there are no cars waiting at gasoline stations because they are out of stock. This has to do with psychology in the markets and you cannot forecast psychology.
Except that der Veer is wrong about why the market is high. Oh, not that it isn't about psychology, that's part of it, no question. But most of it is about what Stirling Newberry likes to call the world's investment shortage.
See, there's a lot of loose money floating around in the world. Not only are the rich richer than anytime since the Gilded age, but due to the miracle of leverage you can easily take one million and turn it into, no joke, 100 million worth of speculative cash through the joy of leverage. Once you've got all that leveraged cash, however, you need to find something to do with it.
In the nineties that money went mostly into stocks. And so we had the dot-com bubble and the attendant frenzy.
Since then stock prices, if you measure them in Euros, have remained pretty close to flat. There have been some rises and falls, but basically, movement has been minor and soon lost.
Instead, in the 2000's that money split largely between four types of plays.
Labor arbitrage plays in which you move production from the 1st world to 3rd;
Real Estate plays, largely through the vehicles of mortgage backed Collateralized Debt Obligations (though there are other kinds of CDOs which also got great play) and other chopped up securities packages;
Currency speculation; and, Commodity speculation.
Labor arbitrage plays are still ongoing but they're slowing down a great deal as the US economy moves into recession and as costs in China and the core areas of India increase.
Real Estate plays are over. All types of real-estate markets are collapsing.
The other two types of plays - currency speculation and commodity speculation remain available. So you've still got your billions and trillions of money floating around, because rather than allowing deleveraging to occur properly the Fed and other central banks are sweeping the junk into trash bins, and that money is still looking for returns. There are no great new industries or technologies to invest in that can soak all that money up doing useful things. Sure, you can put a few hundred billion into alternate energy, but that's peanuts. The rest of it has no where productive to go.
But it still needs to make returns. And there's nowhere for that money to go but into currency speculation (against the US dollar, not that the US dollar shouldn't be collapsing based on fundamentals) and into commodity speculation. And since there are some fundamental reasons why food and oil supply are down, those are good places to pile that money into.
Oil and food prices, based entirely on fundamentals, would have risen. China and India coming on line is raising the demand for oil significantly. Climate instability and stupid government policies like ethanol price support are amongst the factors decreasing supply relative to demand for food.
But neither of them would have risen as fast or high as they did without speculative excess.
So. How do you fix this? As with many problems the world and the US has, it isn't a problem we don't pretty much know how to solve, we just don't have the willpower to wring speculative excess out of the system.
1) You put the major banks and Wall Street Brokerage, which are insolvent, into receivership. You sue for the return of all bonuses. You let the investors, who took the profits, take a full 100% loss on their stock holdings. You start, slowly, unraveling the swaps, CDOs and so on, and you force people to take their losses.
2) You have the government, in effect, take over the mortgage market.
3) Don't allow leverage beyond 10X max. Don't allow already leveraged money to be leveraged again.
4) Implement a Tobin tax, that is a tax on every single transaction. Tobin originally suggested it just for foreign currency transactions but at this point putting it on anything but plain vanilla bond and stock transactions would be wise. This will raise hundreds of billions very quickly, will make speculation less profitable and will take money out of the hands of the rich.
5) Implement a strong progressive tax which taxes income, all income, over 1 million dollars, at at least a 90% rate. This must include taxing unearned income at the same rate as earned income. Again, the idea is to get money out of the hands of the rich who have no productive use for it.
All of these actions, except the first, require international cooperation or the willingness to unilaterally impose currency controls. However they require less international cooperation than you might think - if, say, Japan, the US and the EU were to agree to these rules and were to slap currency controls on transactions with nations outside of the compact, the rest of the world would come into compliance very quickly. And since everyone has the same problems, only the extent varying, it's more possible than one might think.
If, and only if, you're willing to reign in speculative excess.
Of course, a number of other steps would be needed, including anti-usury laws, breaking up the telecom monopoly, reworking financial markets to support new energy technologies, and more besides.
Will this be done? My best guess is no. I think we're going to take one more round at the gambling table. I think that those who control the system now are going to do everything they can to hold onto their ill-gotten gains from the past thirty years, and that they will crash the system rather than allow real reform.
But I could be wrong. Pressures are going to be very strong on the next couple of Congresses and on the next President, to do something. This recession is only starting and it is going to get much worse. Deleveraging is going to continue. Housing prices are going to keep dropping for a few years at least. And the losses may be more than the Fed and the rest of the world's central banks can print their way out of without causing either hyperinflation in necessities, or, paradoxically, winding up in a deflationary spiral.
But rest assured that if they do manage to keep it together, they are only kicking the can down the road. And I think this will be the last time they can do so.
--------------------------------------------------------------------------------
(1) Technical note: the chart doesn't indicate anything suddenly changed. What has happened is that money borrowed from the Fed has been classified as borrowed reserves, rather than non-borrowed reserves, because, well, it's borrowed. Now to borrow that money each bank gave the Fed some securities. So if those securities are worth face, everything's good. If they aren't, things aren't ok. Just from a general eyeball of the chart, if the securities are worth about 65cents to 70cents on the dollar, the system is probably (barely) solvent. This is no different than two or three months ago, it's just that this puts a number (and a picture) to the situation