Attorney Steve Grow
April 13, 2012
John Maynard Keynes taught that it helps our economy when the government borrows so it can spend more than it is taking in. Generations of spendthrift politicians, economists, and ordinary citizens, who enjoyed government benefits beyond the means of the present generation, funded by borrowed money, have been very eager to believe in it. Many have questioned this view. If Keynes were right, then the massive deficit spending represented in the $10 Trillion plus in new official US debt since Bill Clinton left office early in 2001 ($5 trillion during Bush IIs 8-year watch, and another $5 trillion in just over 3 years of Obama’s watch), not to mention all the off budget promising, would have produced massive improvement in the economy. It hasn’t. QED: Keynes is wrong. See my previous article “The Central Fallacy of Keynes and Our Politicians.”
Even for Keynesians, however, the party has to end when people will no longer loan to the government by purchasing US Government debt. Recent news reports make clear that that day arrived some time ago, but that the government and Fed are doing everything they can to disguise the fact.
As reported by Lawrence Goodman in his March 27, 2012 Wall Street Journal article, the recently released Federal Reserve Flow of Funds report for all of 2011, reveals that the Fed (not real buyers) purchased a stunning 61% of all new US Debt issued during 2011, up from negligible amounts prior to the 2008 financial crisis. This not only creates the false appearance of limitless demand for U.S. debt but also blunts any sense of urgency to reduce supersized budget deficits.
This is a crucial fact.
Real buyers willing to buy US Treasuries at the interest rates on offer have already headed for the exits, and have been out of the market for some time. This includes foreign and domestic governments and private buyers (the Chinese, for example, have been reducing their holdings of dollars and US Debt, according to several reports in recent months). See Lawrence Goodman’s article, “Demand for US Debt is Not Limitless,” in Wall Street Journal Online (April 27, 2012).
I would not assume that the Fed’s source of money for these bond purchases was anything more tangible than issuing it electronically, then carrying the newly purchased bonds, for which it paid too much, at face value on its books as an asset. I don’t know that their shenanigans were that brazen, but I certainly don’t know that they weren’t. I leave them where I find them.
Two other recent articles make clear that the politicians and central bankers, here and in Europe, are running out of tricks to keep the game going. Two recent articles report that the disappointing Spanish bond sales during early April, coupled with the decline of the market for Spanish government bonds generally, have more than wiped out all the bailout measures that European Central banks provided to the Spanish government recently. See Tommy Stubbington and Neelabh Lhaturvedi’s article, “Spain’s Borrowing Costs Soar,” in Wall Street Journal Online (April 5, 2012). Also, the Fed has indicated that it may not continue to purchase US Government bonds to stimulate the economy, and European Central banks have given similar indications with regard to stimulus measures there. See Jonathan Cheng and Charles Forelle’s article, “Markets Fear End of Stimulus,” in Wall Street Journal Online (April 5, 2012).
In both cases, I assume, until proven otherwise, that the central banks cannot do much anymore more to prop things up—even though they seem to be pretending that they could, but just don’t want to. If I remember my Winnie-the- Pooh, I believe Roo once asked Tigger if Tiggers can fly. Tigger said they were wonderful flyers, but they don’t want to.
The Fed purchases tend to deceive people who are loaning money to the government into expecting a lower interest rate than the government’s rapidly declining creditworthiness merits. It deceives people into overvaluing US Government securities they already hold.
The manipulating of the US Government Bond market through the purchases of US Debt also keeps interests rates down (both on government and private borrowing), and affects rates at which ordinary loans such as real estate loans are made. It probably also enables banks to pay bank customers less interest on their deposits than they would have to in an unmanipulated free market.
As a related matter, the Fed’s purchases of mortgage-backed securities over the last several years, through the TARP program and otherwise, have also been artificially propping up a market in those, while making various institutions seem sounder than they are. Indirectly (not too indirectly) this props up real estate prices at artificially high levels. This, too, artificially props up the real estate market.
Only a free and unmanipulated market can clear and cause prices to settle to economically sensible levels. Once the manipulation stops, look for the government to have to pay more interest on new borrowing than it has been.
Both the present Fed chairman, and his immediate predecessor, have been fond of half truths and evasions. (“Half-truth” is an unnecessarily polite term for a kind of lie.) But, of course, that’s what the politicians who put them into those positions wanted of them—and what many of us citizens wanted of both our politicians and their appointees. So, in the end we have only ourselves to blame, and should not be unduly harsh with our recent Fed chairmen.
I also assume that at least some of the 39% of new 2011 borrowings by the US government that was not purchased by the Fed itself, was forced (or allowed), through financial institution “oversight” and “regulation”, to be purchased and held by banks and other financial institutions as part of their reserves. Now these reserves help back your bank deposits, to assure that you can get your money out of the bank when you want it. Some was probably purchased by the Social Security Trust Fund – which I think holds only US Government securities. More was undoubtedly sold to hapless members of the public, here and overseas, who still believe US Government debt is safe (as it once was).
Due to the manipulations, those items are probably overvalued on bank books. If they had to be marked to a free, unmanipulated market price, haircuts would be necessary.
If you think the shenanigans of Enron Corporation, or of Nixon Administration officials in Watergate, represented major scandals, you are right. But what has been going on in plain view before us this last several years dwarfs Enron and Watergate—and the damage already done, and likely to ensue, is enormous. This is Enron to the nth power, Watergate promoted to Niagara Falls levels, if I may put it that way. But we have all been in on it.
Before we can solve our problems, we must quit pretending, and also quit pretending that we, and those we pretend to rely on for information and oversight, are not pretending.
During the real estate bubble, the scope and depth of what I regard as gross political, real estate industry, banking, consumer and investment banker malpractice, by citizens, consumers, businesses, experts and officials, that deservedly brought to their knees many of the self-described financial wizards and the investment banks and regular banks that they headed or staffed, was almost unbelievable. Even the bailout measures implemented after the fan was hit, just allowed the pretending to continue, while further weakening us. People should have been allowed to bear the consequences of their foolishness. Bailing people out just encourages further risky behavior by people not having to bear the full consequences of the risks they are taking.
In the real estate bubble, all sorts of people put together trillions of dollars of very risky real-estate based investments and touted them to people, here and abroad, wanting safety as good investments--extracting huge fees in the process. They also tricked lots of buyers into paying way too much for houses, and borrowing way beyond their means to pay for them. In some politicians minds, this was helping ordinary citizens to become homeowners. Making me the owner of an overpriced home with an underwater mortgage is hardly doing me a favor. God protect me from such benefactors!!!
That is exactly what the Fed’s recent actions with regard to the government bond market and US government borrowing and financial institution “regulation” are doing to US Government bonds, and (not too indirectly) to bank and other financial institution stocks.
Rating agencies failed utterly during the real estate bubble, but some have at least downgraded US government debt (probably not enough, though).
Way too many of the politicians and economists in Washington, in both parties, from Presidents Bush and Obama to the Fed to Capitol Hill (especially the leaders of the most relevant financial services oversight committees and the House and Senate leaders), functioned during the real estate bubble as if no one with any common sense was home or gave a darn. The most gross acts of political malpractice have been committed, both during (and since) the real estate bubble.
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Fortunately, there now are some Congressional leaders, particularly in the House of Representatives, with sense and authority to help things get better. Congressman Paul Ryan of Wisconsin, for example, has for many years been the Winston Churchill of this entire mess. He, and those working with him, have seen and studied in depth the gathering mess—and have considered means and measures we can take to improve things, and keep them from deteriorating even further, as soon as enough people wake up and realize that major, painful changes must be made. He, and those working with him, have already done us a great service. For part two of this article, click below.
Click here for part -----> 2,
© 2012 Steve Grow - All Rights Reserved
Steve Grow holds degrees in physics, law and philosophy. He is a retired lawyer who practiced business law for many years. He studied philosophy and cognitive psychology at the graduate level, including working with one of the world’s leading scholars on the work of Aristotle. He was co-editor in chief of his college newspaper. He has observed and wondered about history, psychology, religion, politics, journalism and good (and bad) government since childhood.
He believes that, now and always, the central problem in politics is monitoring and governing those in political positions—so that ordinary people are the ultimate governors and can hold those in office fully accountable. Ordinary people deserve, and need, full legal protection of their privacy. In contrast, all activities of those in government should be open to full scrutiny at all times. In a certain sense, ordinary people should be “ungovernable” and accorded a broad measure of privacy – on the other hand, politicians and their actions should be open to monitoring, closely watched and constrained. Anyone with a contrary view, he believes, is an enemy of freedom—wittingly or unwittingly.