The Fed can’t save the rest of us

It’s tempting to say there are four branches of government. In addition to the Executive, Legislative and Judicial branches, there is effectively a fourth branch of government: the Federal Reserve.

Often called the Federal Reserve Bank, it’s not a bank at all. You can’t deposit money into it, withdraw money from it or take out a loan with it. Many Americans have a vague idea what it does but almost no one knows where it’s actually located (Eccles Building, corner of 20th Street and Constitution Avenue in Northwest D.C.). More often referred to as “The Fed”, it is an institution that controls the supply of U.S. dollars. It also controls the banking system in the United States and has since 1913 when the Federal Reserve Act was passed by Congress.

The Fed has seven governors, most famously its chairman, currently Jerome Powell. While you may not pay much attention to the Fed, the financial world certainly does. When the Fed chair testifies or speaks, it can move markets instantly, often severely. Your portfolio can crash or soar depending on what these seven governors decide. They indirectly affect huge swaths of the economy, including interest and unemployment rates.

The curious thing about the Fed is that unlike the rest of our government it operates largely independently of politics. It’s mostly controlled by Republicans, since Republican presidents appointed most of the governors, currently with a 6-1 Republican lean. Each governor gets a four-year term, but once appointed, there’s not much anyone can do to remove a governor. It’s basically unaccountable.

The Fed’s special sauce is to control the money supply of U.S. dollars. It can create dollars as needed and doesn’t need to actually print them. For those few who still need paper or coins, the U.S. Treasury makes them. Lately, the Fed has created trillions of dollars in response to the pandemic. It does have a mission: maximizing employment, stabilizing prices, and moderating long-term interest rates. But really its only tool to do these things is to control the supply of U.S. dollars and then to figure out what to do, if anything, with that supply.

Before the Great Recession, its only real tool was to set a benchmark interest rate for banks to get money from the Fed or each other. In that recession they invented a new tool: quantitative easing. It gave itself permission to buy a lot of quasi-public debt, specifically U.S. housing debt in mortgage-backed securities in government managed institutions like Freddie Mac. This had the effect of flooding the market with cheap cash. The Fed hoped the money would be used to create stuff, but a lot of it was used by companies to buy back their own stock, inflating share prices without adding any value. As a result, the stock market had a slow recovery.

During our more recent pandemic recession, the markets weren’t calmed much by moving interest rates to near zero again and quantitative easing. Been there, done that. So the Fed invented new policies. This time they would use dollars it created to buy corporate debt outright, and in unlimited supply. This had the effect of flooding major companies with money, which again was mostly used by companies to buy back their own stock. It over-inflated the stock market.

One indirect effect was to push up the value of people’s portfolios, at least those who had portfolios. This gave them trickle down money to spend. Unfortunately, there wasn’t much to spend it on as the economy was in the tank and most people were home, but at least there were houses to buy with the money. It caused a run on housing prices, which is counterproductive if you are a renter.

But it’s good we had the Fed. In the Great Recession, particularly after Republicans took the House in the 2010 election, the White House and Congress were at loggerheads on new spending to stimulate the economy. Sensing it was good for the party if they were obstacles, Republicans didn’t allow much of it. The Fed’s actions did allow a slow recovery, but it was needlessly slow and painful because of inaction in Congress.

In the pandemic recession, Congress was able to get relief to a lot of Americans, so the Fed’s actions were more ancillary. The Fed succeeded in calming then boosting stock prices and making money cheap to borrow again, which helped the economy. It also inflamed inflation concerns.

My point is that the Fed has limited tools at its disposal. To the extent that it can lower unemployment, its actions are indirect at best. It’s much easier for it to move markets up than it is to bring down unemployment rates. The latter is a problematic outcome of the former.

There is the perception that the Fed has saved us in the last two recessions. But mostly it succeeded in pushing up asset prices, deciding that our country as a whole was too big to fail. But the stock market is not the economy. It can’t fix the economy. That can only happen if the White House and Congress work together to take necessary actions.

We saw some of that while Trump was president: expanded unemployment benefits, rental assistance, etc. That has continued under the Biden Administration, which got additional stimulus into the economy as one of its first priorities. This is money that largely went to everyday people for things like child care. This money allowed people to avoid some poverty but also to stimulate the economy. This way, along with spending bills like Biden’s Build Back Better proposal, affects ordinary people and the economy as a whole. The Fed’s effect is indirect, at best.

There aren’t many tricks left in the Fed’s toolbox to use in the next recession. Instead, what we need is functioning government in Washington where legislation that actually meets the needs of the people occurs. But if Republicans win back one or more houses of Congress in 2022, it seems they will be more preoccupied with Biden losing a 2024 election than doing what’s in the interest of the American people.

Is inflation really a problem?

Prices are up, in some cases by a lot. These include food, gas, rent, rental cars, and airline tickets, to name a few. Why is this? Is it going to be a lasting thing? What does it all mean?

I ask the latter question because most Americans have never had to deal with significant inflation. You have to be an oldster like me growing up in the 60s and 70s to remember significant inflation. The funny thing is that it seemed kind of normal at the time. Generally wages kept up with inflation and even home mortgage rates close to twenty percent didn’t seem to deter too many home buyers. Yes, there were periodic gas lines that no one liked, but while inflation seemed pretty bad, at least assets tended to keep up with inflation. I remember renting a room in a house in 1979. Its absentee owner lived across the river in Leesburg, Virginia. The house was an investment and something of a hedge against inflation.

Something like that is underway right now, as real estate prices are one of the leading signs of inflation. Stocks too, although yesterday’s two percent selloff in the markets may indicate the days of double-digit stock growth are over. Prices are up, but wages are often up too, certainly on the low end. The federal minimum wage may be $7.25/hour, but almost no employers are paying it.

These days, the effective minimum wage is closer to $15/hour because if you want to hire workers that’s about the wage floor that employees will accept. Arguably though $15/hour is not what its proponents once hoped it would be: a living wage. In part because food and rent cost more, the price of a real living wage just keeps going up. On average, you would need to make $20.40/hour to be able to afford a one bedroom apartment in this country, assuming you have only one full-time job.

The premise is that inflation is bad. By that logic, deflation is good, but no economist I know of wants deflation. For one thing, in a deflationary period there is no incentive to spend as your money tomorrow will buy more than it will today. What economists really mean is that significant inflation is bad. Ideally they want to see it in the 2% – 3% per year range.

Right now prices are up 5.4% compared to June 2020. Obviously certain costs, like rent and rental cars are up a whole lot more than that, but there are other costs that have risen a lot less than that. Assuming your income grows by at least this amount too, you are at least treading water. A year ago it was pretty hard to find a job if you needed one. Now it isn’t and at least on the lower end of the wage scale you may be better off. “Better off” though is pretty relative. Things likely sucked terribly a year ago, if you remain employed and worked a low wage job. So with rising wages and more jobs available, they are likely to suck less today. It may feel like a skinnier elephant has decided to sit on you.

Low inflation though tends to mask other problems. If wages creep up 2% – 3% a year, who is better off? Probably not you, as it keeps you in pace with inflation so your standard of living doesn’t really increase. The Federal Reserve has the primary tools to manage the inflation rate. It does this principally by setting benchmark interest rates banks use to borrow money from each other.

The practical effect though is to keep the economy from growing too quickly, so if they judge inflation is becoming a problem they will raise interest rates. Higher than usual economic growth though should raise wages if the labor pool is relatively stable. In short, whoever is on the Federal Reserve and the interest rates they set have a huge impact on your life and standard of living. But the Fed is independent from the federal government. In effect, Congress has delegated a lot of its powers to a bunch of unelected people.

Some have argued that the Fed has done a lot of money printing during the latest recession and that’s the cause of the inflation. The Fed is the sole institution charged with creating new dollars and it’s been liberal in its money creation. It hasn’t been using its ability to impact your bottom line, at least not directly. One unique action it has taken this time is that it has been buying corporate bonds with money it’s created. This stabilized financial markets and allowed my portfolio to grow by about twenty percent last year. But arguably its policies have also created the inflation now increasingly seen as a problem. Low Fed rates have spurred low mortgage rates, which helped spur the huge rise in real estate prices.

I’m betting most of you reading this don’t have much in the way of a portfolio and live paycheck to paycheck. In which case, these actions by the Fed don’t mean a whole lot, except maybe it helped the country get out of a recession faster than it would have otherwise. Federal government spending in the form of one-time payments and expanded unemployment benefits likely had more of an effect on most of my readers. In most case, the effect was to keep a lot of people from descending into poverty, which was only partially successful.

For relatively rich people like me with portfolios, the recession was in many ways great! We got a lot of unearned income that significantly padded our already pretty sizable wealth. All these actions then had the effect of further widening the wealth gap, marginally helping those who needed it most while greatly enriching those of us who were already very comfortable.

What may actually help are temporarily child tax credits, $300 per child per month, passed as part of the American Rescue Plan. These credits are now starting to go out. If you have two kids, that’s $7200 more a year in income than your family had before, assuming these credits become permanent benefits. That’s the proposal now in front of Congress which looks likely to pass as part of a budget reconciliation package in the Senate. How would it be paid for? The proposal is to raise taxes on the wealthy, essentially redirecting income from the wealthy to those who actually need it. It’s old fashioned income redistribution, something we haven’t seen changed in a long time. The trend has been to end or cap benefits like these.

As long as inflation is kept low, it becomes harder to address the income gap because leaders assume the economy is under relative control. It is, just not necessarily in a way that benefits the most people. The Fed’s policies in many ways exacerbates and encourages income inequality, in part because of their limited toolset.

Don’t you be fooled: the bottom line is not a low inflation rate, but who controls the wealth and whether the those with less of it have a realistic path to get more of it. The tight reins by the Fed are actually a big part of our problem.

The stock market is in a sugar high so expect another sell off

Retirement leaves me with a lot of surplus time, time I manage to fill reasonably well with consulting and other activities. But there is still plenty of time for leisure. Instead of watching Netflix, I tend to watch YouTube.

Since the pandemic, recession and the election are in, I watch a lot of videos with these themes. But I’ve been mostly concentrating on watching videos on the stock market. Against all odds it has made a spectacular recovery in just a couple of months. I’ve delved into some of the reasons in previous posts, but it mostly amounts to the Fed not letting the economy fail. It is injecting trillions of dollars into the economy into what are arguably junk bonds to push up stock prices. No major publicly traded company in the USA has become too big to fail, in the Fed’s eyes.

In doing so though the Fed is walking into a trap. It’s the trap that the Japanese government walked into in the 1990s and still hasn’t gotten out of. The basic issue is that by not letting businesses fail, you generate a lot of zombie companies that hang around and provide some benefits like keeping people employed but no real value. Their survival is predicated on an endless supply of cash bailouts, right now indirectly provided through the Fed. In other words, they would have failed without these payments, and arguably should have failed. The Fed is essentially not allowing capitalism to work. This means that trillions of dollars are going toward companies that deserve to die so something that useful and productive that meets our new economy can grow in its place.

There are some companies that are very cash rich where this isn’t a problem: Apple, Google and Walmart to name a few. They are thriving and have the resources to emerge more profitably in our new age, mainly because they offer goods and services for these challenging new times that are likely to persist and thrive. Many of the rest though acted stupidly over the last decade, facilitated by the Fed. The Fed kept interest rates artificially low, making it inexpensive to acquire debt. These companies used cheap debt mostly to back their own stock, which further overvalued these companies. Now the Fed is doing essentially the same thing.

As I noted in my last post, new investors are doing a lot to pump up prices too, doing arguably insane investments like buying stock in bankrupt companies. You know this can’t last. At some point, reality will catch up with stocks again. We got a taste of it on June 11 when the DJIA nose-dived 1800 points. Calm and rising share prices quickly returned when Big Daddy Fed came to the market’s financial rescue again.

Some analysts have noticed a pattern of false market rallies that occurred after similar past financial crises. This has happened in every recession since at least 1992. Stocks drop dramatically, but within a few months there is a rally, only until investors realize they were buying based on hope, not reality. So it’s not hard to see that we’re in for another of these soon. Another correction is going to happen. The Fed can delay it for a while, but it’s coming.

Since like February’s crash I can see this one coming, you might want to do what I am doing: selling when it is high again and husbanding the cash, not necessarily to get by, but to await a time when stocks are fairly valued again. Right now the market is on a sugar high, propped up by the Fed throwing trillions at the market. The market has the unwarranted belief that a vaccine for COVID-19 is nigh, and things will magically go back to normal.

An effective vaccine later this year is possible, but unlikely. There are a few reasons for this. First, typically it takes at least a year to find and field an effective vaccine. It’s generally more like four years. Second, any vaccine for COVID-19 is likely to take longer than one year to develop, because it is more complex than typical new viral diseases. Third, even if one is found, you can’t manufacture 300 million doses instantly; it will take months at best. Fourth, the USA is shooting itself in the foot, by not properly mitigating the spread of the disease. To the surprise of no one paying attention to the issue, it’s spreading in the USA and gaining strength. Moreover, it’s likely to generate a second wave of the disease later this year, which will need to be managed along with the seasonal flu. It’s not hard to infer that we’ll be wearing masks for years. From that inference you can figure out in 2021 and 2022 things will look a lot like they do today. You still probably won’t be taking vacations, going to movies or eating out. Which means the real economy is going to keep sucking.

An unemployment rate of 14.6% that is unlikely to get below ten percent by the end of the year, and with both businesses plus state and local governments running out of money, means that a V-shaped recovery amounts to a Hail Mary, which means it’s unlikely to happen. At some point Wall Street is going to figure out its exuberance is irrational and that predictable bear market is going to return.

Even if the Fed continues its strategy of printing money, eventually investors are going to realize that since assets are valued in dollars, and there are so many new dollars in circulation, that effectively their stocks are overvalued because the dollar is overvalued.

To me, it makes sense to sell while the market is irrationally high again and husband the cash. I’m not suggesting dumping all stocks for bonds or cash, but to change the balance of your portfolio to be much more weighted toward bonds and cash. If you selectively hold onto stocks, hold onto those with big cash balance sheets and who are optimized to thrive in this changed economy.

The 2008 recession was largely due to people buying homes for little or nothing down on adjustable rate mortgages. This house of cards came tumbling down predictably when it was placed under stress. The Fed is shimmying up our new house of cards as best it can, but that doesn’t change the underlying dynamic that our current financial system is yet another house of cards, is fundamentally unstable, and needs reengineering so money can go toward more productive uses.

The Fed’s actions are keeping this from happening. In the long run, this could make us the next Japan as we fruitlessly try to keep companies we think are too big to fail from the failure they so richly deserve.

Note: you way want to watch these two videos, two of the more convincing ones of the ones I’ve watched on YouTube.

The dangers of free stock trading

I noted recently the crazy things being done to inflate the stock market. It’s good in a way that the Fed and Congress are trying to keep Americans from feeling the oppressive weight of our economic collapse. We may have gotten a $1200 one-time payment and perhaps some extra unemployment compensation. But the biggest beneficiaries of government largess are clearly businesses, generally the large types.

But it’s not just any businesses. Small businesses may have gotten some short-term loans, but those that are publicly traded are getting huge shots of adrenaline thanks to government. The government has decided that markets are apparently too big to fail, so it’s going to insulate investors from its risks.

When markets begin to notice the actual underlying economy, the Fed usually comes to the rescue and creates a whole lot of money used to buy assets. This happened again just yesterday when the markets started to slip. With the supply of these stocks reduced, the price will artificially go up. This mostly explains why the stock market has nearly fully recovered from February and March’s downturns.

Along the way a lot of rich people got a whole lot richer. America’s billionaires added an estimated $434 billion to their fortunes during the pandemic. A lot of rich people were like me and saw the crisis coming when the first COVID-19 case was diagnosed. So they sold high and bought when prices were deeply discounted in March. The Fed was so alarmed by falling stock prices they righted the situation for them by buying stocks at inflated prices.

Most of us don’t directly own stocks. If we do, they are in retirement accounts and not easy to manipulate. I don’t own any stocks directly. They are all mutual funds and EFTs. Why? It’s because I seek safety in market trends. Buying in a pool limits risks, even if it may flatten rewards. Part of this strategy also includes not getting too overleveraged in any type of asset. Previously I was 50-50 on bonds and stocks. Now I am 60-40 bonds and stocks. So I made some profit from all of this, but it was a modest one.

Not so for our more moneyed class. Confident that the Fed will come to their rescue if things turn south, they are willing to buy and sell stocks directly. They look for drops like last week’s five percent plunge as a buying opportunity. They know the Fed will respond.

But there is arguably a new factor at work: millions of new day traders most of who arguably don’t know what the hell they are doing. Brokerages have generally stopped charging a commission to sell stocks. So anyone can now buy and sell stocks at no charge from their local smartphone. You don’t even have to buy full shares anymore. These companies will also allow you to buy fractional shares. So if you want to own just $5 in Amazon stock, you can do that. Since it’s currently trading around $2600 a share, fractional shares allow anyone to buy in.

These stock brokerages still make money. They make it from the cash balances in your accounts. This money gets loaned out, and I doubt it is FDIC insured. Some pay a tiny interest rate on these balances, like .01% APR. You could do a lot better keeping this cash in FDIC-insured banks instead, and there are some like Ally Bank (that I use) that pay a respectable interest rate.

Some Americans, particularly those doing reasonably well, saw their $1200 stimulus check as a reason to dabble in day trading. This “play money” has become investment money and may also be contributing to the high valuation of stocks at the moment. It’s arguably led to some crazy things. Lots of people are investing in bankrupt companies like JC Penney and Hertz, pushing up these stock prices when they may be dissolved and the stock could become worthless. “Sexy” stock tracking symbols also seem to be disproportionately overvalued. Some investors see a sexy stock symbol and with no other analysis figure they should own some of it.

So I’m not too surprised given that the Fed won’t let markets collapse and that people can now easily buy and sell stocks with no fees that markets are doing so well. At some point though you have to wonder if this house of cards will collapse.

Last week’s drop shows that investors occasionally wake up and realize, “Gosh, these stocks I own are risky and way overvalued! COVID-19 is not going away and we are in a deep recession that seems to be here for the long term. I should sell!” And they do until the Fed comes to the rescue again.

But at their core many of these assets are minimally wildly overpriced and are arguably junk. I sure wouldn’t be buying in financially stressed companies like Carnival, Delta Airlines or Hertz right now. Maybe I would buy some Delta stock if I were looking twenty years down the road. It is the world’s largest airline carrier so if any airline is likely to survive the crisis, it will. Some are betting the same with Hertz: it’s one of the original car rental brands, and it’s everywhere so even though it’s in bankruptcy court, it has to survive somehow and eventually be profitable, right? The government won’t let it fail, right? Well, maybe. But it remains a risky investment because demand has collapsed and the company is wildly overleveraged.

Or it could be that our economy is being wholly upended and that includes our markets too. It makes sense that some companies, like Amazon and Walmart, are doing so well. They are relatively well positioned to prosper in a new economy where delivery to the home can be done profitably. Investing in companies should be based in part on their agility, as well as a healthy cash balance sheet.

Yet so many companies are overleveraged with debt and offer a business model equivalent to the milkman of a hundred years ago. Investing in these companies is risky. I wouldn’t do it, but our smartphones let us make micro mistakes like this every day, at no obvious short-term cost.

The Fed is doing some very alarming stuff

Should you care about the Federal Reserve? Sometimes called the Federal Reserve Bank (it’s not a real bank), but generally just “The Fed”, the Fed basically controls our money supply. It does this with virtually no oversight by those who ultimately hold the bag when it makes mistakes: us taxpayers.

I am most alarmed by what the Federal Reserve has been up to lately. It looks both completely sane and completely crazy. To start, the Fed cut interest rates banks can charge to borrow from each other, or the Fed itself, to zero. This happened in 2008 too and it’s their way of stimulating the economy. I noted in an earlier post that this seemed to be the last trick in their toolbox. Since both consumers and companies were already in hoc to the maximum, this wasn’t a viable way to stimulate growth anymore. But it was what they knew how to do, so they did it.

But the Fed has invented some new tricks they haven’t done before. The Fed has basically decided to bail out any business, at least those that are publicly traded. In the last recession, a lot of large businesses were too big to fail. Now it looks like most businesses in the United States that are publicly traded are too big to fail, in the eyes of the Fed.

Most of these businesses got in trouble because of the cheap money the Fed has promulgated since the previous recession. With no rules, businesses borrowed instead of investing and saving. Mostly they used borrowed money to buy back their own stock. When the stock price invariably went up due to supply and demand, its executives (whose pay is largely based on stock prices, which they get at a discount) sell them and profit. In short, the Fed’s policies of making money so cheap in many ways made this new depression so much worse.

During the Great Recession the Fed also bought a lot of corporate stock too, to show faith in the market. It helped stabilize things and turned the market around, although it took a very long time. Now the Fed is buying corporate debt in unlimited quantities. Basically a business tells the Fed gets to say how much their debt is worth as a share of their company, and the Fed will buy it, no questions asked. Essentially the Fed is paying inflated prices for very shaky corporate debt that no one else wants to buy.

In exchange, companies get some ready cash to help them tie things over. Maybe the Fed will recoup its investment and eventually even make a profit for us taxpayers. But this money was created and doled out with essentially no oversight. The Fed is not accountable to anyone. While there are certain things the Fed cannot do, anything not specifically prohibited is in theory legal.

If I were to load up my family’s portfolio with junk bonds, my spouse would likely divorce me. But when the Fed does the same, there’s no spouse to object, and no oversight to worry. You have to hope the Fed knows what it’s doing, and Donald Trump appointed many of them. God help us.

I don’t have much trust in the Fed. These tactics strike me as desperate. Moreover, they are letting the rich reap a huge windfall. Many of them were like me: smart enough to sell at peak market when we knew it wouldn’t last due to COVID-19. They bought more stock at low market, toward the middle of March. And now with the stock market reaching their pre-crash highs again — due to the Fed buying so much stock that supply and demand is inflating their prices artificially again, despite the ruined economy — they are cashing in again. It appears that the Fed is exacerbating income inequality in the name of keeping the economy from collapsing even more. The Fed is becoming a wealth distribution mechanism that seems to favor the rich.

A rational government should not tolerate this. The Fed is basically trying to keep American capitalism, as we have known it, going. It’s just that it looks like American capitalism is in its death throes. A model of capitalism that is inured from the consequences its actions like the environment costs it inflicts on the rest of us deserves to die. If it is to be replaced at all, it should be with a version of capitalism that works in the interests of the people, not against it.

In short, the Fed’s actions strike me overall as desperate and very chancy. It needs oversight and reigning in. Consumer advocates, and not Wall Street insiders should oversee it. It needs to be accountable.

It’s time for a jubilee

Seems like our world is going to hell in a corona basket.

I remember at the end of 2019 all my friends were saying they were never so glad to see a year end. 2019 was a miserable year. Now, most of us would prefer to be back to 2019. A recession that looks like it will become a depression and COVID-19, which may kill a million or more of us, seems like the beginning of the Armageddon that so many so-called Christians are looking forward to. Perhaps that’s why many of them were cheering Trump’s suggestion that everything go back to normal on Easter Sunday.

On that last point, I was going to make a blog post just on that, but I can’t possibly restate any better what so many others have already said about Trump’s unbelievable narcissism. Trump wants us to die so he can get reelected. The smart ones though are going to take a pass and will keep sheltering in place and obsessively washing hands and surfaces. I know we are. Evolution is not called “survival of the fittest” for nothing. For those happy to place emotion or devotion to an insane leader over rational behavior, well, you’ll be one of hundreds of thousands of candidates for the 2020 Darwin Awards. Clearly you weren’t reading my blog, but don’t say I didn’t warn you.

So rather than restate what so many others have already said, let me talk about something that isn’t being much talked about: the way our economy works appears to be crumbling. What do I mean by that? I mean the way we have been running an economy where the rich continue to get richer, the poor more desperate and in debt, and our government more dysfunctional is ripe. It’s not only not working, it’s not working badly for us. We are ripe for revolutionary changes. This upcoming depression (which it looks likely to be) should make us anxious for another New Deal.

It won’t look quite the same as the New Deal and hopefully any depression will be short lived. But our economy is loaded to the maximum with debt. Pretty much everyone, except the rich, holds it. That’s individuals and corporations, made possible by low interest rates since the Great Recession. The Federal Reserve’s recovery plan is to cut interest rates to zero or even lower, trying to coax us to take on even more debt. That’s because they don’t have any other tools to use. Trying to grow out of a depression based on taking on more debt that we already couldn’t afford doesn’t sound very sound to me. It feels desperate, as if we are desperately trying to keep the rules of our old sinking economy alive. The so-called $2T recovery bill signed into law today is an attempt to keep this hamster wheel turning.

I don’t think this will work. First, look how long it took us to emerge from the Great Recession. When we did emerge, our growth rate was always anemic. You’d be hard-pressed to find any quarter where our GDP increased by more than three percent annually. Our economy was like an overloaded subcompact running on three cylinders trying to merge onto the Interstate. It took a long time to get up to highway speeds. And while we technically recovered, we never really felt we recovered because we never fundamentally solved the problems that got us into it in the first place. The half-hearted attempts by Democrats in 2009 and 2010 were not nearly enough.

In fact, we went back and made the same stupid mistakes all over again, such as getting rid of much of Dodd-Frank banking regulation that was supposed to prevent it from happening again. The fundamentals of our recovering economy were never sound, but were propped up by low interest rates which had the side effect of causing markets to rise. Companies used cheap credit to buy back their own stocks, inflating their stock prices to surreal levels. The bubble would have burst anyhow; the coronavirus thing just made the hole gaping instead of possibly manageable.

What would really make the economy roar back when this pandemic is contained is a big haircut to a lot of creditors. Because an economy can’t roar back if overleveraged people have no cash to buy stuff. What we really need is a jubilee. This is where we force creditors to wipe their debt slates clean.

Take, for example, student loans. Last I checked, there were about a trillion dollars in outstanding student loans, owed by people the least able to pay them back. Desperate for an education instead of flipping burgers for forty years, they didn’t have much choice but to pay usury interest rates for educations whose costs were vastly inflated. Let’s declare all that debt insolvent. The creditors will scream, but a lot of people will have money to spend again on things that matter like food and housing.

It could be done for lots of debts. Write off, say, 25% of mortgage debt on housing purchased for up to $500,000. Wipe out 50% of credit card debt. If you want to encourage thrift, revert the debt if more is incurred over the next five years.

And tax the rich. They’ve been bleeding the rest of us dry for too long, in the process allowing infrastructure and services to degrade. Institute Elizabeth Warren’s proposed 2% wealth tax. Raise rates just to where there were for rich households during the Reagan Administration. Tax dividends the same as ordinary income, or higher. Make work pay again.

Then do what we all know we need to do: make Medicare available to all. Much household debt and personal bankruptcies are due to medical costs that are out of control. Controlling medical costs frees up all sorts of money for more productive use. Institute living wages for everyone with annual increases that keep pace with inflation. Overturn right to work laws.

This is probably beyond a President Biden. But without it, I suspect a President Biden will discover what President Obama discovered: the system will work in counterproductive ways against the needs of the people instead.

Our election, if it can be held fairly, will likely put Democrats in control of government plus give them the margins needed to make real change happen. The question is whether Democrats have learned their lesson, and can institute the changes we need to make the economy work for everyone again.

If not, election 2022 will look a lot like Election 2010, and the crazy cycle will continue to repeat and move us into second world status.

The wizards of Wall Street are no wizards

During our recent cruise, we at least got grainy MSNBC satellite TV. When I watched it, I watched the stock market yo-yo back and forth pretty much every day: the DJIA down a thousand one day, and it would often recover it the next day. The general trend though was down, a lot.

In a way, it was good to be on one of the last cruises because I was mostly insulated from this madness unless I sought it out. (Our cruise turned out fine. No passengers developed COVID-19 symptoms, but berthing in Fort Lauderdale we learned that the half dozen ships in port weren’t going anywhere for a month. I felt sorry for the staff, many of who were likely facing unemployment and a one-way ticket home.)

Today though takes the cake, with the DJIA having its worst day since the crash of 1987, down more than 3000 points in just one day. It all feels so predictable by now. I’m just wondering why the wizards of Wall Street are so late to this party. All the signs were there for those with clear eyes. I’m no Wall Street wizard, but I saw it coming. And I took some steps before the crash to mitigate our risk.

Today’s crash was because Wall Street suddenly discovered that the Federal Reserve had essentially used up all its ammunition, which means in effect that there is no steady hand on our financial system anymore. On Sunday, it dropped the Federal Funds Rate to 0%. Soon predictably it will probably go negative, charging banks to temporarily give them money to insulate them from even graver financial calamity. It probably won’t calm markets.

These same wizards of course were cheering companies that bought back their own stock with borrowed money. It gave the market a sugar rush and made stock prices worth way more than they were actually worth. Now many of these same companies, in debt to the max, are discovering the downside: they don’t have a whole lot of liquidity to ride out an economic downturn. In short, expect a lot of these companies, including some of the biggest of the blue chips, to go into bankruptcy.

The coronavirus is going to cause a recession, if not a depression. The virus though is just the trigger that revealed the larger problem, which has been sinking markets. Margins are gone. Businesses are in hoc up to their eyeballs, as are most consumers. Layoffs have already started and are inevitable. When public gatherings of fifty or more are not allowed, restaurants and many public-facing businesses like theaters close down for the interim. This takes money out of the economy and with predictable results. People living on the margins won’t be able to pay rent, or afford to see a doctor, and there are plenty of them thanks to a gig economy that Wall Street just loved but which added immensely to our overall financial fragility.

Stock market declines show that people are sobering up. Donald Trump of course is making things much, much worse by his lack of leadership and counterproductive strategies. He’s also making it worse for himself by continuing to shake hands with people. Most of his supporters still haven’t figured out what a fraud the guy is and are doing really stupid stuff like licking toilet seats to “prove” coronavirus is a myth. Sadly, it is likely that in a few weeks they need to only go to their local hospital’s morgue to see how wrong they are, if they are not victims themselves.

Children are out of school, day care centers will probably just pass on the virus, so parents predictably will stay home with their kids and fret. For many of them, this will collapse their house of cards. Social distancing should help reduce the number of cases, but it’s likely that there will be far more patients in need of critical care than our hospitals can handle. Our wonderful private health care system will prove unable to handle the coming crush of cases, which will kill lots of people needlessly as well as probably feed a mostly downward economic spiral.

It’s Republican government that will prove bankrupt once again, as it did in 2008, in 1987 and of course during the Great Depression. We never learn. The fall in the stock market proves these stocks were wildly overvalued and did not factor in the risks that are now obviously manifest. Having come off a cruise ship on Saturday and now home, I got to experience it first hand at our local supermarket where the meat counter and frozen food aisles were mostly empty. So far people seem to be soldiering on, but there is the pervasive undercurrent of social disorder. Things could get ugly not just medically, but civilly. We may be seeing the partial collapse of civilized behavior.

So we’re doing what we did before: hunkering down. We can’t count on our medical establishment, so we have to look out for ourselves. We wash our hands regularly. We take calculated risks going to the store. We wipe surfaces. We reflexively do social distancing. We also try to handle things soberly, mindful of the risks but realizing that we’ll likely survive this; it’s not really the big one. Lots of people won’t though, mostly the elderly and infirmed, and we are approaching our elderly years.

We can’t stop all pandemics and likely we could not stop this one either. But it could have been managed much better. Similarly, the collapse on Wall Street was entirely predictable. We just chose not to keep in place the regulations we needed to cushion this fall. And in search of short-term profits we refused to provide sick leave for workers, raise wages, invest in our public health or do the sensible stuff that government is supposed to do. It’s all so pointless and unnecessary.

We can control only what we can control. We can hunker down. Our pensions should provide a steady income in good times and bad. Moving to bonds at peak market insulated our losses. We are fortunate. We will also likely thrive in this challenging time because we didn’t do the stupid stuff. Unlike Wall Street, we acted logically as best we could best on a sober assessment of the world as it actually is. It was smart of us to do it, but it didn’t have to be this way for the rest of us. As a society we chose to ignore the obvious risks right in front of us.

Am I a financial genius?

My recent post I’m betting on a recession didn’t get a lot of reads. There was no reason it should because I was just some nobody opining that a recession was imminent who decided to make a six-figure decision to lessen the impact if it happened.

We won’t know officially if we’re in a recession for about six months, but based on four days of major stock market declines and increasing numbers coronavirus cases, it’s looking like it will arrive sooner rather than later. In fact, it may be here already, we just can’t measure it yet.

Anyhow, yes, on February 14, I moved $106,144 in my retirement account from stocks to bonds. Before it was 60% stocks, 40% bonds. After it was 40% stocks, 60% bonds. My timing was just about perfect, as markets crested about a week later.

Mind you that all this didn’t make me any money. I am still invested 40% in stocks and those took a hit. We lost money overall. But if I hadn’t, we would have lost $89,439. Instead we lost $19,249, as of the close of markets today.

Perhaps I could get lucky twice. Just maybe when stock prices reach their nadir, I’ll move back to 60% stocks, 40% bonds and reap the rewards some years later. But who knows? Growth has been mediocre across the world for years. The main reason stocks were going up at all is because of the cheap credit the Federal Reserve made available. This caused a lot of stock buybacks, which due to supply and demand pushed up stock prices to artificial highs. Perhaps we’ll never go back to peak market again.

To answer my question: no, I’m not a financial genius. No one can time the market. What I did was likely very well timed but mostly luck. I shouldn’t count on luck twice in a row.

But I can watch the fundamentals of the overall economy, and periodically make decisions like this based on my analysis. If my assumptions are sound and I buy into categories of stocks, it could work again, this time on the way up.

With markets now officially entering correction territory due principally to coronavirus scares, a recession looks a whole lot more likely. It’s the supply chain disruption caused by the virus, not to mention its impact on the travel industry that is likely to take big hits that should make it official.

I did notice that someone recently read my Riding the recession’s wave post from January 2008, before stocks really tanked that fall. Back then I explained that a recession could be perversely good for those with steady incomes and significant savings. This definitely proved true for us. During a recession, prices come down, including inflated stock prices that can often be snatched at bargain prices, providing you hold onto them until markets recover. When money gets tight, you can get all sorts of deals. Already, home mortgage rates are dropping. That, with some decline in real estate prices, might make it a good time to buy a home.

If you are retired like we are, recessions make you appreciate the value of a pension, if you are fortunate enough to have them. This makes us recession immune. The portion of our income that comes from selling retirement assets though takes a hit while the recession lasts. You just have to hope that when markets recover your portfolio won’t be too severely impacted.

They say not to put all your eggs in one basket. By moving more of our assets to bonds, I can get a predictable rate of return, albeit half or less compared to what stocks have returned recently. To supplement our income, we sell some of these bonds periodically, husbanding the declining value of the stocks in the portfolio for a better day.

Meanwhile, while I hate the suffering a recession brings, I’m glad I bet on a recession. Let’s see if it actually arrives. We won’t know officially for about six months, but if we see the unemployment rate creep up, that will be a sign. Recent high stock prices have been signaling a false economy, but that appears to be changing.

The negatives of negative interest rates

Donald Trump wants the Federal Reserve to drop interest rates to zero or to even allow them to go negative. It’s pretty obvious why: so he can avoid being at the wheel if a recession inconveniently hits before Election Day. He’s clearly freaking out about the election still more than a year away, as also evidenced by his decision to suspend some tariffs on Chinese goods.

Why should negative interest rates matter to you? It’s not like you can set up a Federal Reserve bank account. The Fed Funds Rate is currently 2.25%. This is the interest rate the Fed requires that one bank charges another bank to park its funds in their bank. It usually parked there only overnight. Any excess reserve a bank has on hand is money they cannot earn interest on. So parking it overnight at another bank allows them to make some money on it.

So what does this mean if the reserve rate is set to 0%? It effectively means there is no reason for a bank to park its excess reserves because it will not earn the bank any money. They might as well lend it. What happens if it’s a negative number, say -1%? Then effectively a bank takes a hit to park its money elsewhere. It would be stupid not to lend it.

A bank could pass its lower profitability from these lower rates onto its depositors. This happens routinely when the Fed Funds Rate changes. We bank at Ally Bank. When the Fed cut its rate by .25%, my savings and money market interest rates were cut by this amount too. Anticipating a rate cut, we at least did one thing smart: we took out a certificate of deposit for one year, which locked in our rate. We’ll earn 2.47% on it after one year, but not before. In general though most people don’t like to tie up their cash like this, so when the Fed Funds Rate drops, they will lose interest income. Better to take that money and risk it on investments is the hope.

Banks could in theory charge depositors’ negative interest rates, i.e. charge them for holding their money. (Considering all the bank fees we pay, some of us in effect already are!) They probably won’t, but accounts that effectively draw little to no interest at least one advantage: safety. Or do they?

Most accounts are fully insured because they don’t pass the threshold of $250,000 per depositor per bank. So yes, if a bank goes under you are likely to get your money back. But since the Glass-Steagall law (passed as a result of the Great Depression) was repealed in 1999, things have loosened. Banks can now invest in speculative investment with depositors’ money. This resulted in the Great Recession when banks loaded up on toxic assets to chase their bottom line. For them, the worst thing that can happen is they declare bankruptcy, which is what happened to so many banks in the Great Recession. The government got to clean up the mess and shoulder any financial losses, i.e. you and me assumed the risk.

Now, as the economy improved and Republicans controlled government again, these financial rules were loosened even further. In 2018, Trump signed into law new regulations that eased oversight on the largest banks, by raising the criteria for what comprises a very large bank. This results in less regulator oversight.

Add in low or negative interest rates though and we add a lot more risk to our financial system. Trump of course is hoping these low rates will incentivize banks to loan money, pumping up the economy. (It might also save him boatloads of money, if he can renegotiate interest rates on his loans.) But by incentivizing banks, we are in effect incentivizing risky loans. In short, we risk another Great Recession, or possibly another Great Depression by doing this.

Some countries are trying negative interest rates to stem deflation or deflation fears. Deflation occurs when money you have today is worth more tomorrow. In that case, there is no incentive to invest the money. Rather, you want to hold onto it, which means it’s not available for others to use. By making savers pay negative interest, it encourages them to loan out the money to stimulate the economy instead.

As a tactic for stopping deflation, maybe it has some merit. It’s working marginally in Japan, which has experienced years of deflation. But the United States is not in a deflationary environment. Hopefully though the Fed is instead trying to prevent deflation from happening in the first place.

Negative interest rates don’t have to lead to financial calamity, at least if they are properly overseen and regulated. But in this country it would be a very nervy thing to do at present. The Fed’s toolset though is very limited and well tried. The Fed’s policy of quantitative easing (imitated by lots of central banks) was one tactic of desperation after the Great Recession when the economy was still a mess even after virtually zero interest rates. Quantitative easing is essentially the Fed buying up investments others don’t want to buy with money the Fed creates out of thin air. They control the money supply, and can create money willy-nilly. That and low interest rates are about all the tools they have left.

A negative interest rate policy looks like the next and more desperate step to keep an economy from sinking into depression. It is basically a tool to use for deflation, which is what happened in the Great Depression. It’s like a fire extinguisher alarm: break glass only in case of emergency.

If investors though figure deflation is going to happen, they have an option: take the money out of the banking system and figuratively put it in the mattress. That way no one can use it but at least it’s safe, unless someone looks in the mattress. It’s more likely though they will move it to currencies and economies that are not deflating.

So hopefully the Fed will take a pass on Trump’s idea. In reality, the problems of our economy are structural and these tactics of the last ten years are basically stopgap measures. The Fed should have been doing more modest increasing of interest rates instead, as our economy, at least if it’s not in a recession, should be able to handle it. Mostly our economy is showing every sign of being over-leveraged and fragile again. If your economy is truly strong, you don’t need to even think about using these tools.

If this house of cards collapses again, it will be felt the way it was last time: soaring unemployment, wiped out savings. A lot of it will be due to risky investments, just like the Great Recession. If you are looking for a true revolution, another Great Recession or Great Depression is a good way to start one.

Monetary policy and the danger of revolution

My recent post on quantum computing and its impact on cyber currencies like BitCoin have taken me exploring the world of money some more. This exploration took me to this video, which discusses who controls money and how it is created.

I think this video is meant to be shocking. Most of us are painfully aware of how important money is, because we cannot survive without it. While vital, money is also completely abstract. We like to think money is a form of permanent liquid value. This video points out the “shocking” fact that money is not this and that it is created almost universally by central banks, the Federal Reserve in the case of the United States.

As you get on in the video, you also learn that banks create money when they issue loans. If you were hoping to trade in your dollars for gold bullion, those days are gone. President Nixon turned the U.S. dollar into a fiat currency. This essentially means that the dollar has value because the government says it does. If it’s backed up by anything, it’s backed up by your faith that our government can manage money intelligently.

But really, the only ones managing money is the Federal Reserve, since they are the sole suppliers of money. The degree to which the Fed controls the spigot of money generally determines the health of the economy. Quantitative easing, which the Fed (and other central banks) have been doing since the Great Recession is basically the creation of lots of money which are then used to buy assets. Doing this helped pick up the economy and over many years took us out of recession.

So one might extrapolate that it’s not how much money that gets printed that is important, but how frequently it gets circulated. If circulated a lot, the production of goods and services continues apace. If it gets circulated too much, you end up with inflation, which means the same money buys fewer goods and services. If it’s not circulated enough, you may end up with deflation, which seems worse than inflation, in that the same money tomorrow buys more than it will today. In a deflationary environment, you would rather hold onto money than spend it, and that tends to stifle economic activity.

Lots of people like Ron Paul don’t like the way money actually works, which is why they would prefer the dollar be based on a gold standard, or some standard which equates a dollar to some amount of something precious. These people are probably economic Don Quixotes chasing electronic money windmills that may have existed at one time but which are probably gone for good. They look for impartial standards of value instead, which is why they turn dollars into BitCoin and similar electronic currencies.

The video says that central banks, being run by bankers, are a system that essentially pumps money from the lower classes to the upper classes. There’s a lot of recent evidence that they are right, as our middle class seems to be disappearing. Americans owe a lot more than they used to and in general earn a lot less in real wages than they used to. It used to be that wage increases followed productivity increases, but for decades that has not been the case. Today, the level of personal debt is staggering. Without meaningful raises, it gets harder and harder to pay off debt or do things we used to take for granted, like buy cars and homes. The Uber/Lyft phenomenon may be in part a reaction to these new facts of life.

Something ought to be done. In part, Donald Trump’s election was due to these economic anxieties. Trump was going to be our fixer to these various problems by bulldozing his way through all obstacles. Of course, he has done just the opposite. There is more than $1 trillion in outstanding student loan debt, but Trump’s education secretary Betsy DuBois is actually making it harder for people to pay off their student debts, and is promoting pricey private education at the expense of relatively affordable public education. So Trump is turning the screws even tighter on the working class.

Democratic presidential candidates have all sorts of ideas for addressing these problems. My senator, Elizabeth Warren, is distinguishing herself by having the most comprehensive set of policies for addressing these issues, including a lot of student loan debt forgiveness. All these policies though are basically ways of trying to solve the fundamental problem of more of our wealth going to the wealthiest and to put more money into those who need it the most. They all depend on redistribution of income from the wealthy toward the poor.

This “socialism” of course has the wealthy up in arms, since maintaining and increasing their wealth is all they seem to care about. So they are dead set against any of these ideas. Based on how our money supply works though, all this will do is keep pushing more of the wealth toward the wealthy.

It makes me wonder how all of this economic anxiety ends. And that gets me to figuring out what money really means. Money is essentially a social compact for the exchange of wealth, and whoever sets the rules controls the flow of wealth. The Fed is essentially accountable to no one. At best, all you can do is wait for someone’s term to expire. Trump’s inability to get people like Herman Cain on the Fed speaks to Republicans true values: they want the Fed to be populated with people that think like them, and that’s not Herman Cain. He’s too out of the mainstream.

To cut to the chase, the real threat to the wealthy is revolution. That’s exactly what happens if you screw the working class for too long. Revolution is upsetting the whole apple cart and starting over because the system is fundamentally broken and cannot be fixed. I believe this is the root of the partisan tensions we see these days. It’s not about value, or whether you are white or not; it’s about money and who gets to control it and how it should be distributed and used. Revolution though is very dangerous. It brings severe economic disruption, likely civil war, complete upheaval and a fundamental reordering of society. Hopefully when it is over the new system is more fare, but as we watch these things play out in places like Brazil it doesn’t look like that’s likely.

Ideally, rich Americans would understand that giving more back to society is in their interest. Sucking ever more wealth from the lower classes exacerbates tensions and increases the likelihood of revolution. They don’t seem to believe it though, and want to maintain control of the levers of power. If they succeed they will likely bring about the real revolution that will destroy their wealth, because wealth is predicated on connected economic systems that work. Unfortunately, the rich seem to be deliberately tone deaf, increasing the likelihood of the exact outcome they fear the most. Should it occur, BitCoin is not going to save them.

As billionaire Nick Hanauer puts it, the pitchforks are coming.