COMMENTARY: THE EUROPEAN CENTRAL BANK, THE ECB, IN THE PAST FEW DAYS PUMPED ANOTHER $1 TRILLION OR SO INTO THE EUROPEAN BANKING SYSTEM, AN INDICATION THAT THE SO-CALLED EURO DEBT CRISIS IS FUNDAMENTALLY A EURO BANK CRISIS. THE ECB IS FOLLOWING IN THE FOOTSTEPS OF THE US FEDERAL RESERVE, THE BANK OF ENGLAND, AND THE BANK OF JAPAN: ALL HAVE PUMPED TRILLIONS INTO THE GLOBAL BANKING SYSTEM TO PREVENT A SECOND GLOBAL BANKING CRISIS. BUT THE CONSEQUENCES OF “FREE MONEY” IS A GROWING ADDICTION BY THE BANKS AND EVEN NON-BANKS ON THAT FREE MONEY, A REPEATED STOCK AND COMMODITY BUBBLES CYCLE, AND COMMODITY INFLATION (ESPECIALLY OIL) THAT LOWERS REAL INCOMES FOR HUNDREDS OF MILLIONS OF HOUSEHOLDS, CONSTRAINS CONSUMPTION GROWTH, AND PREVENTS A SUSTAINED ECONOMIC RECOVERY.
Growing sectors of Capital are becoming addicts—dependant on virtually free money from central banks, from Europe to the USA to Japan. That means, in particular, banks, financial intermediaries, stock market and commodities institutional speculators, and even a growing segment of non-bank corporations.
Since 2008 the US central bank, the Federal Reserve, has pumped more than $9 trillion into the banking and financial system to prevent it from collapsing. It has done this at great cost, however. The trillions of dollars of liquidity injections from the Fed have not eliminated the original problem that that liquidity was supposed to resolve: i.e. removal of the bad assets on financial balance sheets. Those bad assets still remain for most part, especially for institutions like Citigroup and Bank of America that – were it not for phony bank stress tests and suspension of normal accounting rules since 2009 – would be technically bankrupt today. The Fed has not ‘removed’ those bad assets, which have only in part been written off as losses; the Fed has merely mirrored them by adding them to its own balance sheet. In so doing, it has bought some time. But that is all. It has not resulted in sustained recovery of the US economy in any real sense.
For the past three years since February 2009, the Obama administration and supporters have argued that the Fed’s $9 trillion bailouts would generate recovery for the rest of the U.S. economy. But in this objective, it has clearly failed. Except for stock and bond markets, large company corporate profits, CEOs pay and bankers’ bonuses, and the wealthiest 10% households, nearly all economic indicators today still remain below their level when the recession began. And some indicators—especially jobs, housing, and local governments’ finances—are significantly below pre-recession levels.
The Fed’s virtually zero interest loans to banks, and its more than $2.7 trillion in direct purchases of bonds from the private financial sector using printed money (called ‘Quantitative Easing’ or QE), has not revived the economy. What that massive injection of liquidity to banks and investors has accomplished is a hand-stuffing of the capitalist goose with free money. That liquidity has financed stock and commodity market booms, that in turn have provoked inflation which reduces the real incomes of a 100 million US working and middle class households. That process, moreover, has occurred on three separate occasions in the US since 2008.
There have been three stock and commodity market booms since 2008. Remember gas prices hitting nearly $5 in the spring of 2008, then again in the spring of 2011, and now once more this spring 2012? Stock market and commodity price boomlets accompanied the massive liquidity injections during each of those same periods. Both stock market and commodities booms, and the resultant inflation, were immediately ‘fed’ by the Federal Reserve’s QE policies: The 2008 event was highly correlated with the Fed’s bailout of Bear Stearns and rescue auctions of the shadow banks in 2008. The 2010 stock-commodity boom was similarly set off by the Fed’s QE1 $1.75 trillion direct bond purchases and zero interest loans to banks in 2009. When the QE1 bond buying stopped in late spring 2010, the stock and commodity markets immediately collapsed. When the Fed announced another $600 billion QE2 in the fall 2010, the stock-commodity booms took off again in late 2010 and into the spring of 2011. When that QE2 buying binge finished in late spring 2011, the stock-commodity markets quickly fell back once again. Banks and investors once more demanded another round of Fed bond buying and free money. That led to the Fed’s ‘operation twist’ bond buying in late 2011, as well as demands for even more generous QE3 money injection since late last year. With that, the stock market surged again from late 2011 continuing today into 2012. Highly correlated with all the QE1, 2 and 3 and free money have been three corresponding bouts of stock and commodity – especially oil – price expansion and speculation. In other words, there’s an almost perfect correlation between Fed monetary bailouts, QE, and zero loan policies ‘coming and going’ and corresponding stock and commodity speculation ‘stop-go’ since 2008 to the present.
Here’s how it works: The Fed pumps no cost money into the banks. The banks then loan it at 5%-10% to speculators like hedge funds, private equity firms, ‘dark pool’ stock buying consortia, and other institutional and wealthy individual speculators. The latter then funnel the money into large block stock purchases, into commodity futures, speculate with credit default swaps on Euro sovereign bonds in Greece, Spain, etc., further exacerbating those crises, or into currency speculation (one favorite: the Brazilian currency, the Real), Hong Kong and Chinese property, etc. Where the Fed money doesn’t go, however, is into loans to small and medium businesses in the US for which it was originally purportedly intended or to aid the recovery of the collapsed housing and commercial property markets in the U.S.
After three years, 2009-12, it appears the U.S. financial system is becoming increasingly addicted to this Free Money from the Fed, increasingly (QE) money printed by the Fed instead of traditional Treasury bond open market operations.
But when the Fed stops, the stock and commodity markets flop.
The fundamental question therefore: if the Fed ever permanently ceases providing free money, can the stock, commodity, and even bond markets function on their own any more without that prop of multi-trillions of dollars? And there’s a converse to all this, of even greater importance: what happens when the Fed tries to retrieve those trillions of free money by cutting off the free money and raising interest rates? If it takes the recent massive liquidity injection just to keep the Capitalist financial system barely functioning, what happens should the Fed try to retrieve that liquidity? The Capitalist system may be ‘super sensitive’ to attempts to slow an economy, as well as ‘super insensitive’ to attempts to stimulate an economy. What that means is that it takes an ever-increasing massive liquidity injection to keep the system from collapsing in a recession phase, but that it will take very little Fed shift from free money and raising interest rates to choke off a nascent recovery of the economy in an early expansion phase. Stated differently in economists’ parlance, this means the financial system today may have now become ‘liquidity and interest rate inelastic’ in efforts to stimulate recovery, but conversely ‘liquidity and interest rate elastic’ given attempts to slow a recovery.
This addiction is not limited to the US financial system. It appears to be spreading as well to the non-banking sector. Large corporations increasingly do not appear eager today to invest their massive earnings and cash now on hand, estimated at more than $2.5 trillion, nor even to distribute most of it to their shareholders. They prefer to hoard it. The super-cheap Fed money means they either borrow it, through their financial subsidiary if they have one, directly from the Fed, or borrow from banks at today’s super low interest rates. Or they issue cheap corporate bonds, take on more debt, and use the borrowed funds to buy back their company stock and pay dividends to their shareholders. In other words, they borrow money at the super low rates and pay themselves the unearned capital gains ‘profits’. They don’t have to ‘make’ profits; they just transfer the free money from the Fed to their shareholders.
Among smaller and medium sized businesses, the main ‘play’ is to issue a mountain of high risk, ‘junk bond’ debt on their companies’ assets. Often, they issue new junk bonds to roll over and payoff old junk bonds, compounding the debt on their balance sheets. Junk bond issuance hit record levels in 2010 and now again in 2012. But the junk bond booms are made possible by the Fed’s free money. Much of this junk bond debt is set to come due in 2013-14. But should interest rates rise, small-medium business defaults will almost certainly escalate to record levels for those non-financial companies now addicted, it appears, to junk bond debt.
Another way to look at the addiction to free or super low cost money is that it is being made available because banks, speculators, and even non-bank companies are increasingly unable to generate profits from traditional normal business activities. So the central bank in a crisis must spoon-feed them the money to prevent their collapse. Capitalist companies are less interested today in making money by making things than in turning speculative profits, based on Fed free money availability and by borrowing in lieu of real profits creation. Of course, there are exceptions—in emerging markets infrastructure investment, making cars and iPads in China, and so forth. But I’m talking here about a growing trend and growing apparent dependency—that is, an addiction.
And the phenomenon increasingly is not limited to the US economy today. We now see this same development and trend occurring in the Eurozone with the European Central Bank, ECB.
Late last year, as the Eurozone economy and financial system began approaching a crisis stage with Greece, Spain, Portugal, Italy, etc. and, beneath the surface, the private banking systems throughout Europe. To prevent a run on the Euro private banking system, the European Central Bank, ECB, embarked upon a strategy almost exactly like the U.S. Federal Reserve’s. Last week alone, the ECB pumped 530 billion euros, or $777 billion, into the banks at 1% interest. That follows a previous 489 billion euros injected late last year, i.e. another $700 billion. (Which followed another $500 billion in 2010). That’s a total of more than $1.5 trillion in just six months of virtually free money pumped into the euro banking system, no doubt in anticipation of bank failures occurring in the wake of the Greek and other European bond crises. That massive recent ECB injection has temporarily stabilized the banking system in the Eurozone, much as this writer predicted last December would happen. However, ‘temporary’ is the operative term here. It is not likely another such liquidity injection will occur prior to a string of bank collapses taking place first, given growing opposition by the Germans to the ECB ‘printing money’ like the Federal Reserve. Meanwhile, the Greek debt crisis will almost certainly erupt once again before year end 2012. And Spain and Portugal and other Euro periphery economies are not far behind. The point is: massive liquidity injections by central banks may temporarily stabilize a banking crisis, but not permanently. Furthermore, they do not result in economic recovery—and in ways actually serve to constrain that same general economic recovery by precipitating inflation and reducing consumption. Here’s how massive liquidity injections, ‘free money’, restrain recovery:
The massive liquidity injections now commencing in Europe, just as they have been in the US since 2009, have not to date resulted in the European economies avoiding recession. Nor will the Fed’s ‘free money’ prevent the coming of another recession in the US by 2013. Today’s European recession train has left the station and Europe is now well on its way toward a generalized downturn. It’s only a question of how deep and how long. That rapid Euro slowdown has already begun impacting the rest of the global economy, as exports to Europe from China, India, and Japan are now falling, in turn slowing growth in China, India, and the rest of the global economy. The European recession will also mean fewer US exports and a further slowdown of the U.S. economy as U.S. manufacturing pulls back, which is already underway. Contrary to business pundits and the Obama administration, there is no way manufacturing can lead the US economy to a sustained recovery this year, next, or ever!
The joint Federal Reserve and ECB massive injection of free money into the global economy will continue to set off stock and commodity price inflation worldwide. For the rest of us non-professional investors that translates into more inflation, which is already happening, as commodity prices like gasoline and food escalate in both Europe and the U.S. In the U.S. gasoline prices alone in some places rose by 40 cents a gallon in a matter of just two weeks last month. And that’s well before the spring take-off in gasoline prices kicks in. That inflation means a further fall in household income, already declining for the past three years, less consumption in turn, more household credit card spending to try to make up for it, and especially severe stress on retiree fixed income households. It will also mean the recent passage of the extension of the payroll tax cuts will be largely absorbed by the oil companies—just as half of the same payroll tax cut in 2011 was absorbed by rising gas prices. The overall consequences for the US economy in turn later this year could prove negative.
To sum up, a real question remains whether the global capitalist system today, in particular in the northern tier of Europe, North America, and Japan—can function any longer as it once had. It may have become so addicted to, and so dependent upon, free central bank money, that it is questionable whether it can wean itself off that ‘fire hose’ injection of free money. Europe looks much like the US now in that regard, and both look very much like their predecessor capitalist invalid, Japan.
Like true addicts, attempts at some point to return to pre-crisis arrangements may result in such severe ‘withdrawal symptoms’ that the US and Euro economies may rapidly contract at the first attempt to shake the addiction. Going ‘cold turkey’ could result in a more severe economic contraction and recession than even that experienced during the 2007-09 initial downturn. Some form of ‘monetary methadone medical’ injection may have to continue. The patient may prove permanently in need of assistance—paid for by the rest of the economy. That means us. It also means more or less permanent ‘austerity’ blood transfusions. But blood transfusions cannot go on indefinitely. As some point the donors will shout, ‘I’m not going to die’ to save them and will tear off the hyperdermic needle.
However, before that occurs, in the interim the Eurozone’s current massive money injection by the ECB to the euro banks, and the U.S. Federal Reserve’s continuing liquidity injection to US banks, will no doubt continue. Continuing as well will be repeated stop-go cycles of stock market and commodity bubbles that stifle economic recovery, gasoline and food price inflation, further pressure on real incomes, hesitant consumption spending, and weak, unsustained economic recovery.
Jack is the author of the forthcoming, April 2012 book, OBAMA’s ECONOMY: RECOVERY FOR THE FEW, Palgrave-Macmillan (US) and Pluto books, (UK). His website is http://www.kyklosproductions.com and his blog, jackrasmus.com