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Jim Cook



Every once in a while I switch the TV channel from Fox to CNBC to see what the liberals are saying.  After listening awhile I get a deep sense of hopelessness and foreboding for our country.  The most important thing for the left is giving money to people.  They are happy to see the growth of food stamps, disability payments, housing subsidies, free healthcare and all the other welfare benefits.  They utterly fail to see the damage it is doing to the recipients.  Whole cities that once flourished have deteriorated into rotting eyesores populated with shambling hulks of chemically dependent drones.  These people are no longer employable.  They have become incompetent and helpless and the liberals can’t see that it’s their doing.

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Decmber 22, 2011
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December 30, 2011

Bill Gross penned a discerning op-ed for this past Monday’s Financial Times, “The Ugly Side of Ultra-Cheap Money.”  From Gross:  “Ultra low, zero-bounded central bank policy rates might in fact de-lever instead of relever the financial system, creating contraction instead of expansion in the real economy… Historically, central banks have comfortably relied on a model which dictates that lower and lower yields will stimulate aggregate demand and, in the case of financial markets, drive asset purchases outward on the risk spectrum as investors seek to maintain higher returns. Near zero policy rates and a series of ‘quantitative easings’ have temporarily succeeded in keeping asset markets and real economies afloat in the US, Europe, and even Japan. Now, with policy rates at or approaching zero yields and QE facing political limits in almost all developed economies, it is appropriate to question not only the effectiveness of historical conceptual models but entertain the possibility that they may, counterintuitively, be hazardous to an economy’s health.”

I agree that current ultra-loose monetary policy is having ill-effects and unintended consequences.  I believe, however, that this predicament has much more to do with accumulated debt structures, previous speculative excess and economic maladjustment - than it does with our dovish central bank having finally landed flat on the zero rate floor.  Within his analysis, Mr. Gross made an extraordinary statement deserving of serious contemplation:  “Capitalism would not work well if Fed funds and 30-year Treasuries co-existed at the same yield, nor if commercial paper and 30-year corporates did as well.  It is not only excessive debt levels, insolvency and liquidity trap considerations that delever both financial and real economic growth; it is the zero-bound nominal yield, the assumption that it will stay there for an ‘extended period of time’ and the resultant flatness of yield curves which are the culprits.”

The virtues of free trade, free markets and Capitalist economies of course predate Fed funds and the U.S. long-bond.  The great English economic thinker David Ricardo referred to “the capitalist” almost 200 years ago, and the benefits of free trade were appreciated centuries earlier.  Yet it is as strange as it is accurate these days to recognize that Capitalism as we know it has somehow become dependent upon both an ultra-accommodative securities funding marketplace and speculative profits garnered from Treasury and corporate “carry trades”  (borrow short-term to lend long; and short higher quality to finance holdings of lower quality/higher yielding).  Reading Mr. Gross’s thought-provoking line of analysis, my thinking jumped immediately to my notion of “Financial Arbitrage Capitalism” from some years back.  The analysis is near and dear to my analytical heart.  When I went to re-read my piece, I found, coincidently, that it was posted almost 10 years ago to the week. 

I rarely partake in the cringe-inducing exercise of reading old CBBs.  I am this week excerpting liberally (gluttons for punishment see below) from my article from a decade ago, believing the analysis has become more relevant over time.  Old readers know my analytical framework owes a huge debt to the great Hyman Minsky.  Over the years, many have cited Minsky’s work, although too often too superficially.  Minsky was focused on finance - financial players, financial structures, financial incentives, financial evolution and speculative dynamics.  Late in his life (he passed in 1996), Minsky brilliantly appreciated the profound changes unfolding throughout the financial world.  I’ve over the years attempted to build on Minsky’s framework, incorporating the transformational evolution of securitization markets, derivatives, the government-sponsored enterprises (GSEs), the hedge fund community, Wall Street proprietary trading, unprecedented risk intermediation and financial leveraging, and policymaking doctrine that essentially pandered to these contemporary financial operators and structures.

I believe the vast majority of the modern financial apparatus over the years gravitated to speculative spread trading and various leveraged risk arbitrage strategies – especially at the expense of funding sound investment in the U.S. and other advanced economies.  The system’s focus turned to financing the securities and asset markets, an extremely lucrative business that so dwarfed opportunities available from financing capital investment.  The intense focus on Credit market spread/arbitrage “profits” – as our central banking incentivized leveraged speculation - made real economic returns virtually irrelevant to the broader economy's development (home mortgages were much preferred over business investment loans as fodder for risk intermediation and financial arbitrage).   Never before had the possibilities for Credit creation – and resulting fees and speculative profits – been so unfettered and incentivized.  That is, as long as asset prices continue to inflate.  Over time, this resulted in “money” and Credit becoming dangerously and increasingly detached from real economic wealth and wealth-producing capacity.

“Gresham’s law needs a corollary. Not only does ‘bad money drive out good,’ but ‘cheap’ money may as well,’ began Mr. Gross’s FT writing.  I would strongly argue that this deleterious process of bad “money” driving out the relatively better commenced decades ago - and then proceeded to accelerate momentously during the nineties.  Over the past decade, both U.S. household and federal debt more than doubled, as consumption boomed and deindustrialization gathered momentum.  GSE assets tripled to $6.7 TN.  Hedge fund assets quadrupled to surpass $2.0 TN.  The global over-the-counter (OTC) derivatives market ballooned from about $100 TN to exceed $700 TN.   Global central bank balance sheets ballooned uncontrollably.  “Bad money” took the world by storm.

I’ve always equated “Financial Arbitrage Capitalism” to an unsustainable financial mania.   Inevitably, a point would be reached where the quality of the underlying mountain of Credit obligations would prove incompatible with highly leveraged speculative positions and deeply maladjusted economic structures.  Global fiscal and monetary policymakers have worked inexhaustibly to bolster increasingly vulnerable debt structures, through the unprecedented issuance of sovereign debt and government guarantees; by imposing ultra-low interest rates; and by massive purchases (monetization) of marketable debt instruments.   And especially post-2008, this fragile structure (and associated mania) has been buttressed by the perception that policymakers retained the necessary tools to ensure the situation remained under their control.  From Mr. Gross: “Conceptually, when the financial system can no longer find outlets for the credit it creates, then it de-levers.”  True enough.  I would add that a system will find it increasingly challenging to find “outlets for Credit” once premises behind – and confidence in – the mania in Credit instruments begins to break down.