The Alberta Social Credit League, Constitution and By-Laws, 1958

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The original photo files of a much higher quality are available
from helgenome@hotmail.com

Mother of all Carry Trades Faces an Inevitable Bust

Articles on this blog are intended to introduce the reader to the nature and shortcomings of our financial system and ways to change it to free us from debt slavery


Posted: Sun, 01 Nov 2009 21:22:33 -0600
From the FT: By Nouriel Roubini

Since March there has been a massive rally in all sorts of risky assets – equities, oil, energy and commodity prices – a narrowing of high-yield and high-grade credit spreads, and an even bigger rally in emerging market asset classes (their stocks, bonds and currencies). At the same time, the dollar has weakened sharply, while government bond yields have gently increased but stayed low and stable.

This recovery in risky assets is in part driven by better economic fundamentals. We avoided a near depression and financial sector meltdown with a massive monetary, fiscal stimulus and bank bail-outs. Whether the recovery is V-shaped, as consensus believes, or U-shaped and anaemic as I have argued, asset prices should be moving gradually higher.
But while the US and global economy have begun a modest recovery, asset prices have gone through the roof since March in a major and synchronised rally. While asset prices were falling sharply in 2008, when the dollar was rallying, they have recovered sharply since March while the dollar is tanking. Risky asset prices have risen too much, too soon and too fast compared with macroeconomic fundamentals.
So what is behind this massive rally? Certainly it has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fuelling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions.

Let us sum up: traders are borrowing at negative 20 per cent rates to invest on a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade. Every investor who plays this risky game looks like a genius – even if they are just riding a huge bubble financed by a large negative cost of borrowing – as the total returns have been in the 50-70 per cent range since March.

People’s sense of the value at risk (VAR) of their aggregate portfolios ought, instead, to have been increasing due to a rising correlation of the risks between different asset classes, all of which are driven by this common monetary policy and the carry trade. In effect, it has become one big common trade – you short the dollar to buy any global risky assets.

Yet, at the same time, the perceived riskiness of individual asset classes is declining as volatility is diminished due to the Fed’s policy of buying everything in sight – witness its proposed $1,800bn (£1,000bn, €1,200bn) purchase of Treasuries, mortgage- backed securities (bonds guaranteed by a government-sponsored enterprise such as Fannie Mae) and agency debt. By effectively reducing the volatility of individual asset classes, making them behave the same way, there is now little diversification across markets – the VAR again looks low.

So the combined effect of the Fed policy of a zero Fed funds rate, quantitative easing and massive purchase of long-term debt instruments is seemingly making the world safe – for now – for the mother of all carry trades and mother of all highly leveraged global asset bubbles.

While this policy feeds the global asset bubble it is also feeding a new US asset bubble. Easy money, quantitative easing, credit easing and massive inflows of capital into the US via an accumulation of forex reserves by foreign central banks makes US fiscal deficits easier to fund and feeds the US equity and credit bubble. Finally, a weak dollar is good for US equities as it may lead to higher growth and makes the foreign currency profits of US corporations abroad greater in dollar terms.

The reckless US policy that is feeding these carry trades is forcing other countries to follow its easy monetary policy. Near-zero policy rates and quantitative easing were already in place in the UK, eurozone, Japan, Sweden and other advanced economies, but the dollar weakness is making this global monetary easing worse. Central banks in Asia and Latin America are worried about dollar weakness and are aggressively intervening to stop excessive currency appreciation. This is keeping short-term rates lower than is desirable. Central banks may also be forced to lower interest rates through domestic open market operations. Some central banks, concerned about the hot money driving up their currencies, as in Brazil, are imposing controls on capital inflows. Either way, the carry trade bubble will get worse: if there is no forex intervention and foreign currencies appreciate, the negative borrowing cost of the carry trade becomes more negative. If intervention or open market operations control currency appreciation, the ensuing domestic monetary easing feeds an asset bubble in these economies. So the perfectly correlated bubble across all global asset classes gets bigger by the day.

But one day this bubble will burst, leading to the biggest co-ordinated asset bust ever: if factors lead the dollar to reverse and suddenly appreciate – as was seen in previous reversals, such as the yen-funded carry trade – the leveraged carry trade will have to be suddenly closed as investors cover their dollar shorts. A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a co-ordinated collapse of all those risky assets – equities, commodities, emerging market asset classes and credit instruments.

Why will these carry trades unravel? First, the dollar cannot fall to zero and at some point it will stabilise; when that happens the cost of borrowing in dollars will suddenly become zero, rather than highly negative, and the riskiness of a reversal of dollar movements would induce many to cover their shorts. Second, the Fed cannot suppress volatility forever – its $1,800bn purchase plan will be over by next spring. Third, if US growth surprises on the upside in the third and fourth quarters, markets may start to expect a Fed tightening to come sooner, not later. Fourth, there could be a flight from risk prompted by fear of a double dip recession or geopolitical risks, such as a military confrontation between the US/Israel and Iran. As in 2008, when such a rise in risk aversion was associated with a sharp appreciation of the dollar, as investors sought the safety of US Treasuries, this renewed risk aversion would trigger a dollar rally at a time when huge short dollar positions will have to be closed.

This unraveling may not occur for a while, as easy money and excessive global liquidity can push asset prices higher for a while. But the longer and bigger the carry trades and the larger the asset bubble, the bigger will be the ensuing asset bubble crash. The Fed and other policymakers seem unaware of the monster bubble they are creating. The longer they remain blind, the harder the markets will fall.

The writer is a professor at New York University’s Stern School of Business and chairman of Roubini Global Economics

Alberta Social Credit Platform In The Early WWII Years

In order to comfortably read the text in this flyer, please click on the photos below

The flyer from the early war years, reproduced below, gives a snapshot of the "Alberta Experiment" during its heyday and provides an interesting view of the issues of the day. The flyer was kindly provided by an elderly farm couple in West Central Alberta

Portrait Of A Reformer - Social Credit Founder Clifford Hugh Douglas

Articles on this blog are intended to introduce the reader to the nature and shortcomings of our financial system and ways to change it to free us from debt slavery

The following notes are taken from Major Clifford Hugh Douglas’s book Social Credit (originally published in 1924), Douglas Centenary edition, an Institute of Economic Democracy publication, 1979.
IBSN: 0-920392-26-1
Library of Congress Catalogue Card No. 66-26837

About the author . . . .

The late Clifford Hugh Douglas, M.I.Mech.E., M.I.E.E., consulting engineer, economist, author and founder of the Social Credit movement, was born in 1879 and died in 1952. Among other posts which he had held in his earlier years were those of engineer with the Canadian General Electric Company, Peterborough, Canada, Assistant Engineer, Lachine Rapids Hydraulic Construction, Deputy Chief Electrical Engineer, Buenos Airies and Pacific Railway, Chief Engineer and Manager in India, British Westinghouse Company, Assistant Superintendent, Royal Aircraft Factory, Farnborough (England). During the First World War he was a Major in the Royal Flying Corps and later in the R.A.F. (Reserve).

After retiring from his engineering career, he and his wife ran a small yacht- building yard on Southampton Water for several years. The combination of beauty with functional efficiency in a successfully designed racing yacht had a special appeal for him. When he lived in an old water mill in Hampshire he used the waterwheel to turn a dynamo which lit and warmed the house as well as providing power for lathes and other tools. Later, when he moved to Scotland, many of his friends and followers remember helping to build his small hydroelectric powerhouse, sited on the local burn which ran through his land. Since decentralization of economic power was of the essence of his teaching, it should be put on record that he practiced what he preached.

One of his most interesting jobs, just before the 1914 war, was that of conducting preliminary experimental work and preparing plans and specifications for the electrical work on the Post Office Tube in London, with later supervision of the installation of plant in what was to be one of the earliest examples of complete automation in the history of engineering. While there were no physical difficulties about the work, he used to get orders from time to time to slow it up and pay off the men. When the War came however, he noticed that there was no longer any difficulty about getting money for anything the government wanted.

It appears that he was sent to Farnborough 1916 to sort out ‘a certain amount of muddle’ in the Aircraft Factory’s accounts, so that he had to go very carefully into the costing. This he did by introducing what were then known as ‘tabulating machines’ – an approach which anticipated the much later use of computers, and which drew his attention to the much faster rate at which the factory was generating costs as compared with the rate at which it was distributing incomes in the form of wages and salaries. Could this be true of every factory or commercial business?

Douglas then collected information from over 100 large businesses in Great Britain, and found that, in every case except in businesses headed for bankruptcy, the total costs always exceeded the sums paid out in wages, salaries and dividends. It followed that only a part of the final product could be distributed through the incomes dispersed by its production, and, moreover, a diminishing part as industrial processes lengthened and became more complex, and increased the ratio of overheads to current wages. Unless this the defect in monetary bookkeeping were corrected (which in his view was perfectly practicable), the distribution of the remainder must depend increasingly on work in progress on future products (whether wanted or not), financed by loan credit, export credits, sales below cost leading to bankruptcies and centralization of industrial power, or by consumer borrowing. The result must be predictably disastrous – in fact, the modern dilemma between mass poverty through unemployment and growing inflation, debt and monopoly, with waste of human effort and the earth’s resources to maintain ‘full employment’, requiring continuous economic ‘growth’ and economic warfare between nations leading towards military war.

This original engineer’s approach, which regarded the monetary system much as Douglas, a former railway engineer, had regarded the ticket system, as a mere book-keeping convenience for the efficient distribution of the product, was completely alien and unacceptable to the economic theorists of the day. Only one Professor of Economics (Professor Irvine of Sydney, Australia) expressed agreement with it, and he resigned his position shortly afterwards. This general condemnation by the economists was, however, along two different and contradictory lines, viz., 1. That the cost-income gap was an illusion due to Douglas’s failure to realize that the costs all represented sums paid out at a previous date as wages, salaries, etc. – ignoring the time factor which was the essence of his analysis; and, 2. that it was, on the contrary, a glimpse of the obvious, of no significance whatever, since this was the immutable way in which the monetary and economic system must work for the stimulation of new production and maintenance of the level of employment – i.e., ignoring Douglas’s radically different objective of production for the consumers’ use and not for ‘employment’ or other monetary objectives.

When the Great Depression of the 1930’s grimly confirmed Douglas’s diagnosis and gave him a worldwide reputation and following, his critics explained that he had mistaken a temporary lapse for a permanent defect in the monetary system; but subsequent events have, by now, so continuously fulfilled his predictions that this criticism is no longer credible. Despite rejection by the Economic Establishment of the day, Douglas was called upon to give evidence before the Canadian Banking Inquiry in 1923 and the Macmillan Committee in 1930, and undertook several world tours in which he addressed many gatherings, especially in Canada, Australia and New Zealand, and also at the World Engineering Congress in Tokyo in 1929. In 1935 he gave an important address before the King of Norway and the British Minister at the Oslo Merchants Club, and in the same year he was appointed Chief Reconstruction Adviser to the ‘United Farmers’ Government of the Province of Alberta, Canada, which later in the year elected the first Government to bear the title ‘Social Credit’. The Canadian Federal Government, however, frustrated all attempts to implement Douglas’s advice by disallowing the legislation, some of which was passed, and disallowed, twice; after which although the Party remained in power for over 30 years, it progressively abandoned the principles on which it was first elected. It should be placed on historical record, as a precedent, that two provincial ‘dividends’ of little more than token value, were nevertheless paid at one period to the citizens of the Province, and that, while still acting under the advice of Douglas’s representative, the Province paid its way without further borrowing, and drastically reduced the Provincial debt.

This diversion of Douglas’s ideas into the dead-end of Party politics has received far more publicity than the original and experimental approach to politics which is signposted in his later speeches and writings from 1934 onwards, notably in his five major speeches in England: The Nature of Democracy, The Tragedy of Human Effort, The Approach to Reality, The Policy of a Philosophy, and Realistic Constitutionalism. In 1934 a Social Credit Secretariat was formed under his Chairmanship, which started an Electoral Campaign involving the use of the vote for purposes desired by the electors rather than by Parliament or the Political Parties. This was followed by a highly successful Local Objectives Campaign along similar non-party lines, and a Lower Rates and Assessments Campaign which saved the British taxpayers many millions of pounds without loss of services, by reducing loan charges. The Second World War put an end to these activities on an organized national scale, and dispersed them, with the Social Credit Movement, into a decentralized force, better adapted to the present crisis of World centralization.

In the final phase of his life, roughly from 1939 to his death in 1952 Douglas consolidated his ideas in depth, contrasting very clearly the philosophy which underlies them with that which activates the Monopoly of Credit. Although the best known of them, which has already exercised considerable influence in the World, lie in the economic sphere: the concepts of real credit, the increment of association and the cultural inheritance, and the proposals of the National Dividend and the Just or Compensated price – his political ideas, though as yet little known, are if anything of greater importance. They were always worked out with a characteristic practicality, taking account of the feedback from the course of events. No one else has thrown so much light on the true nature of democracy, as distinct from the numerical product of the ballot box; on the need for decentralized control of policy and hierarchical control administration; on the freedom to choose one thing at a time, on the right to contract out, on the Voters’ Policy and the Voters’ Veto. In his last address given in London to the Constitutional Research Association in 1947, he put forward his last proposal for the rehabilitation of democracy: the Responsible Vote, in which the financial consequences of his open electoral choice would be, for a time, differentially paid for by the voter in proportion to his income – a literally revolutionary suggestion which demands an inversion of current ideas about anonymous, irresponsible, numerical voting.

Hugh Gaitskell, a former Leader of the Labour Party once sarcastically described Douglas as a ‘religious rather than a scientific reformer’. Perhaps he was more right than he knew! It may be that Douglas’s thinking on the subjects of philosophy, policy and religion, and the special meaning he gave to those words, will turn out to be his most valuable contribution to the restoring of the link between religious belief and principles which govern society. In his view, a ‘philosophy’, i.e., a conception of the universe, always expresses itself as a ‘policy' – a distinctive long-term course of action directed towards ends determined by that ‘philosophy’. ‘Religion’ (from the Latin religare, to bind back) is not just a set of beliefs such as are expressed in the Christian creeds (which constitute a ‘philosophy’) but is precisely the ‘binding back’ of these ideas to the reality of our lives, not only individually, but in the political and economic relationships of our society.

The policies of centralization and monopoly now being imposed upon the World through the closely related agencies of Finance-Capitalism and Marxist Socialism derive from a ‘philosophy’ fundamentally different from, and opposed to, that of Trinitarian Christianity, which was, however imperfectly, expressed in our Constitution, our Common Law, and the progress towards personal freedom which had been made, especially, in Britain and the Commonwealth. At the time Douglas first put forward his ideas and proposals for carrying forward this traditional policy to its next stage, its Christian basis could be taken for granted as mere ‘common sense’. Now, that can no longer be taken for granted and it has become necessary consciously to distinguish the policies at work in our society, and to relate them to the fundamental beliefs which gave rise to them. In this sense, therefore, ‘Social Credit’ is the social policy of a Christian ‘philosophy’, and before the end of his life, its founder made this explicit, rather than, as in the beginnings, implicit.

California, Take Heart!

Articles on this blog are intended to introduce the reader to the nature and shortcomings of our financial system and ways to change it to free us from debt slavery

California Dreamin': How the State Can Beat Its Budget Woes
By Ellen Brown

As goes California," says the adage, "so goes the nation." All eyes are therefore on the Golden State as it attempts to solve its $26 billion budget deficit. The world's eighth largest economy is not going quietly into that pit of debt and devastation that has devoured Third World countries whole. The State's voters have drawn a line in the sand against further tax hikes, while Democratic leaders have drawn a line at further cuts in services or selloff of public assets. State legislators are deadlocked, caught between the rock of tax ceilings and the hard place of debt limits.

"Expect the best and accept nothing less," says another adage that typifies the attitude sometimes called "California dreaming." You create your own reality. Instead of trying to prop up an old model that has failed, you can dream up a new one. If anyone can come up with an original solution to the problem, Californians should be able to. But what? While waiting for developments, Governor Arnold Schwarzenegger has started paying the State's bills with IOUs ("I Owe You"s evidencing debt, technically called "registered warrants").

Hmm . . . Pay the bills with IOUs. Not a bad idea! That was, in fact, the original innovation that got the American colonists out of their financial straits back in the 18th century, when they lacked the silver and gold used in the Old World for conducting trade. Money, after all, was just a medium of exchange, an acknowledgment of goods and services delivered or a debt owed. The notion that the government could pay in paper receipts was first hit on by the governor of the province of Massachusetts in 1691, when he needed money to fund a local war. The use of a paper currency had been suggested in an anonymous British pamphlet in 1650, but the proposal was modeled on the receipts issued by London goldsmiths and silversmiths for the precious metals left in their vaults for safekeeping. The problem for the colonies was that they were short of silver and gold. The Massachusetts Assembly therefore proposed a different kind of paper money, a "bill of credit" representing the government's "bond" or IOU. The paper money of Massachusetts was backed only by the "full faith and credit" of the government.

Other colonies followed suit with their own issues of paper money. Some were considered government IOUs, redeemable later in "hard" currency (silver or gold). Others were issued as "legal tender" in themselves. They were "as good as gold" in trade, without bearing debt or an obligation to redeem the notes in some other form of money later. The new paper money not only made the colonies independent of the British bankers and their gold but actually allowed the colonists to finance their local government without taxing the people. Colonial assemblies discovered that provincial loan offices could generate a steady stream of revenue in the form of interest income by taking on the lending functions of banks.

The same solution was employed in other countries later. When Argentina's government workers were faced with massive layoffs, their unions persuaded six state governments to pay them instead with state bonds or IOUs in small denominations. The IOUs could then be used to pay for state services and taxes, and everyone in the local economy accepted them in trade.

There's Just One Problem . . .

Why couldn't California do the same thing? The problem with calling its IOUs "legal tender" today is that the ruse violates the U.S. Constitution. Article I, Section 10, says, "No State shall . . . coin money [or] emit bills of credit." The Cornell University Law School Annotated Constitution gives this definition:

Within the sense of the Constitution, bills of credit signify a paper medium of exchange, intended to circulate between individuals, and between the Government and individuals, for the ordinary purposes of society.
U.S. Supreme Court cases are cited from the 1830s, in which "interest bearing certificates, in denominations not exceeding ten dollars, which were issued by loan offices established by the State of Missouri and made receivable in payment of taxes or other moneys due to the State, and in payment of the fees and salaries of state officers, were held to be bills of credit whose issuance was banned by this section."

That all seems pretty clear cut, until you read a bit further. Article I, Section 10, also says that no State shall "make any Thing but gold and silver Coin a Tender in Payment of Debts." When was the last time any State paid its bills only in gold and silver coin? The States could argue that the Constitution needs to be updated.

They could make some other compelling arguments. The States agreed to give up their right to issue their own currencies because they delegated that power to Congress. Article I, Section 8, enumerates among the powers given to Congress, "To coin Money [and] regulate the Value thereof." Scholars continue to argue about the meaning of "to coin money," but the Constitution clearly gives no entity except Congress the power to create money and regulate its value, and Congress failed to properly husband that authority. It issued coins, but it allowed privately-owned banks to issue "banknotes," which soon made up the bulk of the nation's money supply. Bankers, not Congress, thus "regulated the value" of the currency, through the laws of supply and demand: the more notes they created, the smaller the value of each. In 1913, Congress went so far as to allow a privately-owned central bank called the Federal Reserve to issue its own Federal Reserve Notes and call them the exclusive national paper currency. These notes were then lent to the U.S. government, at interest.

Today, however, Federal Reserve Notes compose only about 3% of the money supply (M3). The other 97% is issued by private banks in the form of loans. "Bank credit" is created simply by entering numbers into the accounts of borrowers, as many authorities have attested. One of the most clear statements of this process came from Graham Towers, Governor of the Bank of Canada from 1935 to 1955, who acknowledged:

Banks create money. That is what they are for. . . . The manufacturing process to make money consists of making an entry in a book. That is all. . . . Each and every time a Bank makes a loan . . . new Bank credit is created -- brand new money.
Congress has not only reneged on its agreement to create the national money supply, but it has refused to front the funds to bail out California from its relatively modest $26 billion budget shortfall. Californians are justifiably upset, since Congress hardly batted an eye before earmarking some $700 billion in bailout money for the private banking system, and the Federal Reserve has committed trillions more for that dubious purpose. Nearly ten times the sum needed by California was allotted to bailing out AIG, a private insurance company; and half the sum needed by California went to pay off the gambling debts of AIG to Goldman Sachs, a single bank. California underwrites a substantial portion of the federal government's budget, sending a dollar in tax revenue for every 80 cents it gets back. Yet the federal government has even rejected California's request for a loan guarantee, which could have saved the State hundreds of millions of dollars in interest. The clear message is, "You're on your own."

Creative Problem Solving

The situation looks pretty dire, but it may just need some thinking outside the box. The law does not allow the States to issue "bills of credit," but it does allow them to create another form of money called "checkbook" money. All a State has to do is to form its own bank. Quoting again from the Cornell University Law School Annotated Constitution:


Bills issued by state banks are not bills of credit; it is immaterial that the State is the sole stockholder of the bank, that the officers of the bank were elected by the state legislature, or that the capital of the bank was raised by the sale of state bonds.

If private banks can create credit on their books, so can the world's eighth largest economy. Indeed, there is longstanding precedent for this approach. The State of North Dakota has owned its own bank for nearly a century. North Dakota is one of only two States (along with Montana) that are not currently facing budget shortfalls. North Dakota has beaten the Wall Street credit freeze by generating its own credit. By law, ever since 1919 the State's revenues have been deposited in its own bank, the Bank of North Dakota (BND). Using the "fractional reserve" lending scheme open to all banks, these deposits are then available to be used as the "reserves" for creating many times their face value in loans. Other banks in the State do not see the BND as a threat, because it partners with them and backstops them, serving as a sort of central bank for North Dakota. BND's loans are not insured by the Federal Deposit Insurance Corporation (FDIC) but are guaranteed by the State.


If California followed suit, it would not need to meet the FDIC's capital requirements but could designate state-owned property (parks, buildings and so forth) as its capital base. Applying the "multiplier effect" by which capital is lent and relent many times over, this base could then generate hundreds of billions of dollars in "credit." The State could deposit its revenues in the State bank and pay its payroll through it, generating an even larger deposit base for making new loans. Enough credit could be generated to allow the State not only to meet its short-term budget needs but to buy back its outstanding bonds (or debt). Bond interest and redemption costs on California's General Fund for the current year are estimated at nearly $5 billion -- about 20% of the budget shortfall. All of that money could be saved in interest, since the State would be paying interest to itself.

The State could do more than just chase the wolf from its door. It could generate enough credit to engage in the sort of economic "stimulus" being undertaken by the federal government. It could create jobs for the 11.5% of the State's population that are currently unemployed, augmenting the tax base and supplying the incomes necessary to prop up the languishing housing market. Loans for income-producing projects (transportation, energy, housing) could be repaid with the profits generated by the funded projects. And if some of the newly-issued loans were not paid back, they could simply be refinanced. The federal government has been rolling over its loans ever since 1835, the last time the federal debt was actually paid off (under Andrew Jackson).

In boom times, this approach could result in unwanted inflation. But today the economy is suffering from a serious shortage of money, because virtually all of our money comes from bank loans, and bank lending has dried up. Since neither the federal government nor the Federal Reserve has stepped in to fill the void, the States must do it themselves; and like the 18th century colonial governments, they can do it by taking on the lending functions of banks.

California's taxpayers and legislators are doing the right thing digging in their heels and drawing the line at further austerity measures. California is being watched not only by the nation but by the world. We the people did not precipitate this credit crisis; the banks did. We should not have to pay for the damage with increased taxes or decreased services or our public parks and parking meters. Like the American colonists, we can replace the old model with something better. If California legislators act quickly, they can have a State-owned bank up and running before their 45-day IOUs run out. With today's new online banking possibilities, the State would not even need to invest in a "brick and mortar" building. The whole business could be done by computer. Weary legislators trying to agree on a budget could all shake hands and go home, without budging an inch from their respective platforms. They could have it all, and so could we the people.

Follow Ellen Brown on Twitter: www.twitter.com/ellenhbrown

Debt Deflation in America‏

Articles on this blog are intended to introduce the reader to the nature and shortcomings of our financial system and ways to change it to free us from debt slavery



From: Global Research E-Newsletter (crgeditor@yahoo.com)
Sent: June 30, 2009 4:10:35 AM
To: helgenome@hotmail.com
Debt Deflation in America
What the Jump in the U.S. Savings Rate Really Means

By Michael Hudson

URL of this article: www.globalresearch.ca/index.php?context=va&aid=14153

Global Research, June 29, 2009

Happy-face media reporting of economic news is providing the usual upbeat spin on Friday's debt-deflation statistics. The Commerce Department's National Income and Product Accounts (NIPA) for May show that U.S. “savings” are now absorbing 6.9 percent of income.

I put the word “savings” in quotation marks because this 6.9% is not what most people think of as savings. It is not money in the bank to draw out on the “rainy day” when one is laid off as unemployment rates rise. The statistic means that 6.9% of national income is being earmarked to pay down debt – the highest saving rate in 15 years, up from actually negative rates (living on borrowed credit) just a few years ago. The only way in which these savings are “money in the bank” is that they are being paid by consumers to their banks and credit card companies.

Income paid to reduce debt is not available for spending on goods and services. It therefore shrinks the economy, aggravating the depression. So why is the jump in “saving” good news?

It certainly is a good idea for consumers to get out of debt. But the media are treating this diversion of income as if it were a sign of confidence that the recession may be ending and Mr. Obama's “stimulus” plan working. The Wall Street Journal reported that Social Security recipients of one-time government payments “seem unwilling to spend right away," 1 while The New York Times wrote that “many people were putting that money away instead of spending it.”2 It is as if people can afford to save more.

The reality is that most consumers have little real choice but to pay. Unable to borrow more as banks cut back credit lines, their “choice” is either to pay their mortgage and credit card bill each month, or lose their homes and see their credit ratings slashed, pushing up penalty interest rates near 20%! To avoid this fate, families are shifting to cheaper (and less nutritious) foods, eating out less (or at fast food restaurants), and cutting back vacation spending. It therefore seems contradictory to applaud these “saving” (that is, debt-repayment) statistics as an indication that the economy may emerge from depression in the next few months. While unemployment approaches the 10% rate and new layoffs are being announced every week, isn't the Obama administration taking a big risk in telling voters that its stimulus plan is working? What will people think this winter when markets continue to shrink? How thick is Mr. Obama's Teflon?

We are living in the wreckage of the Greenspan bubble

As recently as two years ago consumers were buying so many goods on credit that the domestic savings rate was zero. (Financing the U.S. Government's budget deficit with foreign central bank recycling of the dollar's balance-of-payments deficit actually produced a negative 2% savings rate.) During these Bubble Years savings by the wealthiest 10% of the population found their counterpart in the debt that the bottom 90% were running up. In effect, the wealthy were lending their surplus revenue to an increasingly indebted economy at large.

Today, homeowners no longer can re-finance their mortgages and compensate for their wage squeeze by borrowing against rising prices for their homes. Payback time has arrived – paying back bank loans, whose volume has been augmented to include accrued interest charges and penalties. New bank lending has hit a wall as banks are limiting their activity to raking in amortization and interest on existing mortgages, credit cards and personal loans.

Many families are able to remain financially afloat by running down their savings and cutting back their spending to try and avoid bankruptcy. This diversion of income to pay creditors explains why retail sales figures, auto sales and other commercial statistics are plunging vertically downward in almost a straight line, while unemployment rates soar toward the 10% level. The ability of most people to spend at past rates has hit a wall. The same income cannot be used for two purposes. It cannot be used to pay down debt and also for spending on goods and services. Something must give. So more stores and shopping malls are becoming vacant each month. And unlike homeowners, absentee property investors have little compunction about walking away from negative equity situations – owing creditors more than the property is worth.

Over two-thirds of the U.S. population are homeowners, and real estate economists estimate that about a quarter of U.S. homes are now in a state of negative equity as market prices plunges below the mortgages attached to them. This is the condition in which Citigroup and AIG found themselves last year, along with many other Wall Street institutions. But whereas the government absorbed their losses “to get the economy moving again” (or at least to help Congress's major campaign contributors to recover), personal debtors are in no such favored position. Their designated role is to help make the banks whole by paying off the debts they have been running up in an attempt to maintain living standards that their take-home pay no longer is supporting.

Banks for their part are slashing credit-card debt limits and jacking up interest and penalty charges. (I see little chance that Congress will approve the Consumer Financial Products Agency that Mr. Obama promoted as a flashy balloon for his recent bank giveaway program. The agency is to be dreamed about, not enacted.) The problem is that default rates are rising rapidly. This has prompted many banks to strike deals with their most overstretched customers to settle outstanding balances for as little as half the face amount (much of which is accrued interest and penalties, to be sure). Banks are now competing not to gain customers but to shed them. The plan is to offer steep enough payment discounts to prompt bad risks to settle by sticking rival banks with ultimate default when they finally give up their struggle to maintain solvency. (The idea is that strapped debtors will max out on one bank's card to pay off another bank at half-price.)

The trillions of dollars that the Bush and Obama administration have given away to Wall Street would have been enough to buy a great bulk of the mortgages now in default – mortgages beyond the ability of many debtors to pay in the first place. The government could have enacted a Clean Slate for these debtors – financed by re-introducing progressive taxation, restoring the full capital gains tax to the same rate as that levied on earned income (wages and profits), and closing the tax loopholes that effectively free finance, insurance and real estate (FIRE) sector from income taxation. Instead, the government has made Wall Street virtually tax exempt, and swapped Treasury bonds for trillions of dollars of junk mortgages and bad debts. The “real” economy's growth prospects are being sacrificed in an attempt to carry its financial overhead.

Banks and credit-card companies are girding for economic shrinkage. It was in anticipation of this state of affairs, after all, that they pushed so hard from 1998 onward to make what finally became the 2005 bankruptcy laws so pro-creditor, so cruel to debtors by making personal bankruptcy an economic and legal hell.

It is to avoid this hell that families are cutting their spending so as to keep current on their debts, against all odds that they can avoid default in today's shrinking economy.

Working off debt = “saving,” but not in liquid form

People are putting more money away, but not into savings accounts. They are indeed putting it into banks, but in the form of paying down debt. To accountants looking at balance sheets, savings represent the increase in net worth. In times past this was indeed the result mainly of a buildup of liquid funds. But today's money being saved is not available for spending. It merely reduces the debt burden being carried by individuals. Unlike Citibank, AIG and other Wall Street institutions, they are not having their debts conveniently wiped off the books. The government is not nice enough to buy back their investments that had lost up to half their value in the past year. Such bailouts are for creditors and money managers, not their debtors.

The story that the media should be telling is how today's post-bubble economy has turned the concept of saving on its head. The accounting concept underlying balance sheets is that a negation of a negation is positive. Paying down debt liabilities is counted as “saving” because one owes less.

This is not what people expected a half-century ago. Economists wrote about how technology would raise productivity levels, people would be living in near utopian conditions by the time the year 2000 arrived. They expected a life of leisure and prosperity. Needless to say, this is far from materializing. The textbooks need to be rewritten – and in fact, are being rewritten.3

Keynesian economics turned inside-out

Most individuals and companies emerged from World War II in 1945 nearly debt-free, and with progressive income taxes. Economists anticipated – indeed, even feared – that rising incomes would lead to higher saving rates. The most influential view was that of John Maynard Keynes. Addressing the problems of the Great Depression in 1936, his General Theory of Employment, Interest, and Money warned that people would save relatively more as their incomes rose. Spending on consumer goods would tail off, slowing the growth of markets, and hence new investment and employment.

This view of the saving function – the propensity to save out of wages and profits –viewed saving as breaking the circular flow of payments between producers and consumers. The main cloud on the horizon, Keynesians worried, was that people would be so prosperous that they would not spend their money. The indicated policy to deter under-consumption was for economies to indulge in more leisure and more equitable income distribution.

The modern dynamics of saving – and the increasingly top-heavy indebtedness in which savings are invested – are quite different from (and worse than) what Keynes explained. Most financial savings are lent out, not plowed into tangible capital formation and industry. Most new investment in tangible capital goods and buildings comes from retained business earnings, not from savings that pass through financial intermediaries. Under these conditions, higher personal saving rates are reflected in higher indebtedness. That is why the saving rate has fallen to a zero or “wash” level. A rising proportion of savings find their counterpart more in other peoples' debts rather than being used to finance new direct investment.

Each business recovery since World War II has started with a higher debt ratio. Saving is indeed interfering with consumption, but it is not the result of rising incomes and prosperity. A rising savings rate merely reflects the degree to which the economy is working off its debt overhead. It is “saving” in the form of debt repayment in a shrinking economy. The result is financial dystopia, not the technological utopia that seemed so attainable back in 1945, just sixty-five years ago. Instead of a consumer-friendly leisure economy, we have debt peonage.

To get an idea of how oppressive the debt burden really is, I should note that the 6.9% savings rate does not even reflect the 16% of the economy that the NIPA report for interest payments to carry this debt, or the penalty fees that now yield as much as interest yields to credit-card companies – or the trillions of dollars of government bailouts to try and keep this unsustainable system afloat. How an economy can hope to compete in global markets as an industrial producer with so high a financial overhead factored into the cost of living and doing business must remain for a future article to address.

Notes

1 Kelly Evans, “Americans Save More, Amid Rising Confidence,” Wall Street Journal, June 27, 2009.

2 Jack Healy, “As Incomes Rebound, Saving Hits Highest Rate in 15 Years,” The New York Times, June 27, 2009.

3 Four years ago at a post-Keynesian “heterodox economics” conference at the University of Missouri at Kansas City (on whose faculty I have been for some years now), I outlined the shift from over-saving to debt deflation. Michael Hudson, “Saving, Asset-Price Inflation, and Debt-Induced Deflation,” in L. Randall Wray and Matthew Forstater, eds., Money, Financial Instability and Stabilization Policy (Edward Elgar, 2006):104-24.


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COMMENT: MONEY MATTERS

Articles on this blog are intended to introduce the reader to the nature and shortcomings of our financial system and ways to change it to free us from debt slavery

Banking time bombs

Samah El-Shahat, Al Jazeera's resident economist, will be writing a regular column analysing key elements that have contributed to the global financial downturn and its impact across the world.

The trickle-down effect don't work
As a development economist, I have seen many economics theories or so called 'magic bullets' for the world's ills come and go.
No, I am not that old, but economics, like fashion, has many theories that come and go and then make a come back retro style.

The problem is some of them have been largely discredited but they still make a return becaue they serve the interests of those with influence and power. So it has always been politically convenient to dress up self interest in intimidating and opaque economics jargon.

During the 1980s and 1990s, the World Bank and the IMF believed that something called the 'trickle down effect' could save the world's poor.
In rough terms, 'trickle down' means if you give the rich tax breaks and support their industries, the wealth they create will ultimately benefit poorer people.
That is, money, just like rain, will start trickling down to us all. A theory that never worked, and African and South American countries that were made to pursue it got poorer not richer, and the poorer of those countries ended up paying a very high price

John Kenneth Galbraith, another economist, calls this the horse and sparrow theory: "If you feed the horse enough oats, some will pass through to the road for the sparrows."

So how does this apply to today's banking crisis?

Well, it is very relevant because governments across the world, but particularly the US and British administrations, are solving the financial crisis with a top-down approach.
They are hoping if they shower rich bankers with money and use taxpayers' cash to underwrite their banks then, ultimately, some money will flow down to us.
Over optimistic William Cohan, a well-known American journalist, questioned this recently in the New York Times.
"Why is so much effort being put into propping up those at the top of the economic pyramid — the money-centre banks, the insurance companies, the hedge funds and so forth — when, during a period of deflation like the one we are in, any recovery will come only by restoring the confidence of the people down at the bottom of the pyramid."

But given that a lot of these banks are ZOMBIES - and by this I mean they are dead, but are walking among the living thanks to taxpayers' money.

I believe resting our economic futures on their resurrection is taking optimism a step too far. Look how much bad debt they have on their balance sheets.
Economists such as Ann Pettifor and John Kenneth Galbraith believe that the banks will use all the taxpayer money that comes their way to recapitalise themselves.
The banks will try to cover huge holes in their balance sheets due to the toxic debt they have. They should, instead, be using this money to start lending to us again - you know the real economy. This is what the banks are supposed to be doing.


Unemployment in the US is rising, fuelling fears more homes will be repossessed [AFP]

The 'trickle down' has been captured by the banks and this will continue slowing down our recovery, and I find that very frightening.

So how could this happen?

Governments are trying to find solutions to this problem that are dictated by the interests of the banking and financial sectors.

But when did the interests of the financial sector become the interest of the country?

Particularly when unemployment in America is estimated to go over ten per cent. Has anyone asked a person who is losing their home how they feel about this?

Simon Johnson, a former IMF chief economist, recently said: "Throughout the crisis, the government has taken extreme care not to upset the interests of the the financial institutions or to question the basic outlines of the system that got us here.

"In September 2008, Henry Paulson asked Congress for $700 billion to buy toxic assets from banks with no strings attached and no judicial review for his purchase decision.

"Many observers suspected that the purpose was to overpay for those assets and thereby take the problem off the banks’ hands, indeed that is the only way that buying toxic assets would have helped anything.

"Perhaps because there was no way to make such a blatant subsidy politically acceptable, that plan was shelved."

'Business as usual'

So I am still astonished that that governments are still hell-bent on maintaining the status quo, the business as usual approach that got us into this mess in the first place.

Has a single bank management been made to change despite being the source of the mess? Has a single bank been truly nationalised in the real sense of the word? Has any real clean audit of a bank happened? And please let's not bring up stress tests that were made to make sure everyone passes...

For every one of those questions the answer is a loud and resounding NO.

Some of the banks are now being allowed to payback some bailout money - banks such State Street and JP Morgan Chase. But they are being allowed to do so without revealing the extent of the toxic assets on their balance sheets.

"I fear these banks are walking time bombs... freed from any noose or hold the government had over them because they have paid back their bailout"

We are none the wiser than we were at the start of this crisis as to how truly 'insolvent' they are.

Yes, I hate to bring up that word but just because they are paying back some Treasury Asset Relief Program money doesn't make them healthy. Remember, they are using taxpayer money to pay the taxpayer back.

The Obama administration had a plan to get rid of these toxic assets called the Public Private Partnership Investment Partnership - the PPIP.

And even though the PPIP gave investors and Wall Street incredible inducements, and huge taxpayer subsidies to buy and sell these toxic assets, the banks did not play ball.

The plan was laid to rest last week, which is extraordinary because it was the central plank of the Obama administration's plan to rescue the banks.

I think this is disastrous. Not because I liked the PPIP, I thought it was grossly unfair and I agree with the economists Paul Krugman and Joseph Stiglitz when they said it transferred taxpayers money to the banks.

But at least the PPIP tried to deal with the toxic assets that got us into this mess in the first place.

Now I fear that these banks are walking time bombs, which are now walking away, freed from any noose or hold the government had over them because they have paid back their bailout.

And if we do not get an economic recovery soon, the toxic assets on the banks' balance sheets will detonate and bring us all down with them.

The banks are gambling on the green shoots of a miraculous economic recovery, which I think is delusional and shame on those in power for allowing them yet another chance to gamble with our economic futures.

Samah El-Shahat also presents Al Jazeera's People & Power programme.
The views expressed in this column are the author's own and do not necessarily reflect Al Jazeera editorial policy.

Source: Al Jazeera