Bailing Out the Rich


Thank you sir! May I have another.

“You can’t have a liquidity crisis when the stock market is setting record highs for an entire week. Those two things just don’t correlate.”

Pam Martens

Like the furor over last week’s outrage (the Soleimani assassination), last year’s repo frenzy seems to have evaporated. The Fed stuffed the market with hundreds of billions before year’s end, there was no panic, afterward the Fed soaked up excess liquidity with a reverse-repo operation. Meanwhile, the Fed is still purchasing Treasury bills (less than one-year maturity) which is part of its ordinary business; conducting open market operations to keep short term interest rates below 2%.

There is still no ready answer for why there was a crisis in repo in the first place. Besides bailing out the banks, or the dollar funding system generally, the Fed might have been wasting its time, practicing or more likely bailing the too big to fail billionaires for political reasons, mindful that practically everything the Federal Reserve does- or might do provides elites with an (invisible) helping hand. Along with fighting endless (losing) wars and cannibalizing our resource base, bailing out our betters has been our national project since the founding of the country.

One would think after all this time they wouldn’t need any more support, right?

One of the many concepts economists fail to explain clearly is how people become rich. One would think in a capitalist-friendly system such as the one we live under, how wealth begets itself would be well understood. The popular narrative suggests tycoons are heroic, farsighted innovators who will into existence products and services that people don’t realize they need. They offer these in enormous quantities at a profit. which occurs when returns exceed factor expenses. Given enough profits entrepreneurs reward themselves with luxury cars, mansions, drug habits and mistresses. And pay cash. This is the narrative found in economic doctrine, outlined in excruciating detail by Adam Smith to Friedrich Hayek to John Maynard Keynes and it’s nonsense.

At scale industrial enterprises don’t create profits because they are unable to. That this is so is self evident: if firms were productive there would be no debt because business returns would retire it. Instead, commercial expansion carries along with it an almost unimaginable accumulation of unpaid loans; a metaphoric Everest amounting to hundreds of trillions of dollars. The only thing that can even service this amount is continual additional borrowing and the reduction of debt’s burden by inflation.

Default or repudiation does not cure indebtedness but passes repayment obligations onto third-parties as well as lenders, themselves.

All Earthly processes produce entropy, a topic conveniently absent from mainstream economics. The real, physical sum-total of all sector inputs is always greater than the sum of outputs. Regardless of what we do, including nothing, there are losses. That economists claim the opposite is a myth, enabled the purposeful mischaracterisation- and underpricing of inputs.

Because industrial enterprise is fundamentally unprofitable, debt is required for us to ‘fake it’. Debt is ubiquitous, it is a ‘factor in production’ along with land and labor. A gigantic, interconnected finance sector needed to create- and manage it. All money is debt, even the kind that is dug out of the ground or cryptoed into existence on a computer. Cash paid in hand is a loan made by a bank somewhere to someone which proceeds may have changed hands hundreds of times subsequently. There is no ‘investment’ that did not begin its existence as a loan.

People become tycoons by borrowing their fortunes and having third parties service and retire the loans. The technical term for this process is ‘theft’: I buy the house, you pay for the house … you can’t live in it. This sort of thing is possible because the unremarkable taking on of debt allows entrepreneurs to divert some of it to themselves. Another reason is social orders are built around shared narrative myths that have compulsive power, such as the heroic innovator myth, the profitable large business myth or the efficacy of technology. Abandoning these narratives represents an enormous risk, after all, it’s unthinkable what might happen if people stop believing in entrepreneurs or the moral necessity of repaying debts or the ability of technology to solve our problems? (There is no debt-repaying technology in the pipeline, by the way.)

The conventional wealth model has worked for a few individuals, allowing them to satisfy their outlandish financial dreams by way of invention, mass production and sales. How few?

Hey, hey we’re the Monkees!

A lot fewer than you think! There was a remarkable and singular array of circumstances that enabled the rise of the Beatles. The post- World War Two demographics of the English-speaking world were favorable. The infrastructure to produce large amounts of Beatles records existed before the band held their first rehearsal. Barriers to entry were low: talent (free, for those who have it), time and space to practice and play, plus the cost of some guitars and amplifiers. The individual products they sold were inexpensive: five dollars or less for a long-playing record, about a buck for a two-song ‘single’. Marketing was TV and radio airplay driven by a frenzy of demand by teenaged girls which also cost the band little or nothing. Selling records did not require provision of consumer credit like cars or smartphones, the band didn’t have to obtain land, build factories or fit them out with machinery. Musicians scale: they can start like the Beatles did by selling a few thousand records, or they can sell 600 million LPs and altogether be worth over $2 billion plus publishing rights (held by Sony) worth another $3 billion. The cost to the Beatles for all this was the time to write and record the songs.

Entertainers, professional athletes and celebrities can adhere to the capitalist model and bootstrap themselves because they are marketing avatars for the industrial status quo and ‘lifestyle’. They don’t invent goods and services as much as narratives that rationalize consumption. Providing goods and services at a scale able to translate into great wealth requires significant up-front money investment for facility and equipment, human resources, R & D, management, training and marketing. For some kinds of goods like smartphones, a vast expensive support infrastructure must be in place else the phones themselves are useless: repeater stations and cell towers, data centers, fiber optic trunk lines; grid electricity to power everything along with spares and upgrades and the means to ship these things where needed. Railroads require rolling stock and locomotives, miles of trackage and marshaling yards which in turn require expensive rights of way. Cars and trucks need roads that are paid for by government borrowing, a massive fuel supply and distribution system, insurance and consumer finance plus a military to break heads overseas. These kinds of things — and the galaxy of factories needed to make them — must be entirely in place before a company’s first product can be offered for sale. This investment requires loans, how could it be otherwise? If firms and their infrastructure are able to somehow meet expenses how can they provide for expansion of firms and infrastructure going forward, particularly of competitors? If an entrepreneur lacks products to sell how does he come up the means to will them into existence? There muse be the addition of new money, this being the case then profit or gain in excess of expenses for investment purposes must be borrowed.

Had the Beatles been first required to buy a recording- and distribution business or start one from scratch, there would have been no band. They would have had to borrow tens of thousands of pounds; the four mop-haired schoolboys from Liverpool would have been unable to do so.

Entrepreneurs craft narratives used to inflate public expectations with the actual product or service becoming a kind of accessory or prop. The narrative is usually worth more than the good, a kind of abstract collateral offered to creditors who don’t want to left behind or miss ‘next big thing’. For some, such as ride-sharing, co-working, ‘fake’ meat and social media, the narrative itself is the entire business. As long as their narratives remain fashionable tycoons borrow as much they can; from investors or venture capital, then shareholders or by way of them as well as from their own customers. They also tap into the endless stream of funds borrowed by governments. Because of the positions tycoons hold in our society and the immense size of their leveraged positions, almost everything else is in line to be sacrificed so tycoons’ (borrowed) wealth remains intact.

When tycoons cast about for repayment options their first targets are their own employees. Monies not paid to workers are funds that can be directed toward creditors. So are funds from workers who overpay for the entrepreneurs’ goods and services. The best way to look at our economy is as a gigantic cost-shifting regime: debts taken on by the wealthy become the obligations of workers around the world. Even as those on the fringes in the developing world lift themselves up from destitution, they can only lift so far. Much of what they might earn in a perfect world is hived off and handed over to creditors to retire the obligations of their betters … which in turn provides incentives for tycoons to ‘accumulate’ (borrow) some more.

The borrowing-theft process allows tycoons to get rich quickly rather than building businesses and waiting for returns which, without the borrowing, would never appear! The process is used by dictators and government officials, share brokers, hedge fund managers, ordinary criminals and Ponzi scheme promoters. Obviously, tycoons who for one reason or another must repay their own loans are no longer rich. Who exactly bears the tycoons’ burden is irrelevant to them as long as the payments are made. It is reasonable the repo ‘crisis’ was an excuse for the Fed to preemptively bail out the rich.

If any group has prospered since the turn of the millennium it is the world’s financial elites. The aggregated assets of this group represent about half of the world’s wealth. Their gains outstrip those of the rest, gains which appear to increase by themselves. It’s hard to see how the rich are in any need of rescue. At the same time, they are hostage to the industrial economy as a whole, to uncertain and volatile markets and, most importantly, to the status of those tasked with repayment obligations. As the world’s resources are stripped, its citizens are becoming poorer as evidenced by the declining affordability of fuel. If people cannot buy fuel they can’t pay off others’ debts, either.

Figure 1: Cost and price trends heading in opposite directions: Graphic by TFC Charts, click on for big.

Consumers become incrementally poorer while the fuel the entire economy relies upon becomes scarcer and more costly. The red line indicates the highest price our economy can pay without credit seizing up. The black line represents drilling industry cost which is largely a function of geology and depletion. This rising cost trend suggests the oil industry needs $120/barrel or more to meet expanses, while the price trend indicates a price higher than $70/barrel will cause another energy/credit crisis. As depletion continues the ‘spread’ between cost and price widens meaning more loans are needed by drillers … credit that is unavailable to customers. What’s clear is the deflating price signal — the level that causes a reduction in economic activity — continues to fall over time. At some point, even an historically low price such as US$20/barrel will be unaffordable. Before that point is reached the pricing mechanism we rely on to allocate resources will be broken.

Tycoons appear wealthy, but only in abstract. Their holdings are shares of their own businesses: Bill Gates’s fortune is his Microsoft shares, Warren Buffett owns Berkshire-Hathaway, Jeff Bezos holds Amazon, etc. Shares are a form of private money. Like ordinary currencies, they are derivative claims against purchasing power, which itself is a claim against capital, the world’s remaining non-renewable natural resources. As capital is exhausted so is the worth of claims including the physical work that purchasing power represents. Looked at this way, industry itself is a kind of ‘money’, one whose inherent wastefulness tends itself toward insolvency. Yet the myth of profitability sits at the center of economics; capitalism, even Marxism and industrialization itself.

The tycoons are trapped but they hold us hostage as well. Undermining their heroic myth also undermines industrial economy and all those whose livelihoods depend on it. Meanwhile, in the background, the value of tycoons’ claims relentlessly evaporates — under their noses — leaving them with what amounts to spare change: some used cars, alimony payments and drug habits; the signifiers of nothing, trite and useless symbols, diversions and waste, the real ‘products’ of industrialization.

At least the Beatles left us with some nice songs to listen to.

‘Rich’ is not what it used to be, it is another bubble, a form of asset inflation. Like the banks, billionaires are tightly bound to the credit regime and dependent upon it. Tycoons’ market positions are so large, converting them to currency and reducing them would effectively be the same as liquidation. At half the world’s wealth, the assets vastly exceed available liquid funds. Conversion could be ruinous of the system the tycoons themselves rely on, a reason for the flood of loans from the Fed to the banking system. That the rich are beneficiaries would be the reason for the central bankers’ silence.

It is possible we are undergoing a kind of ‘wealth crisis’, something hidden. Instead of an onrushing recession or the usual turning of the business cycle, inventory excess, balance sheet irregularities or fuel shortages. Surplus wealth like the other kinds are subject to The First Law, whereby the costs of managing any surplus increase along with it until at some point costs exceed what the surplus is worth. How these surplus-related costs emerge can be hard to discern. A billionaire cost crisis might include riots in the streets, or the Fed bailing out the repo market when stock prices are at an all time high. It’s also hard to say is how this particular kind of ‘crisis’ might play out. The recent shift from negative interest rates and the massive losses that shift represents to bondholders might have been a trigger for central bank action. Yet the costs might include the banks losing control over policy interest rates. Time will tell but, in an environment that is defined by debt, any billionaire in trouble reflects on the others who are similarly situated.

Part 1: The Gift That Keeps on Giving

Part 2: Bailing Out the Rich

19 thoughts on “Bailing Out the Rich

  1. Volvo740...

    Thanks Steve. Great article! For us non Tycoons, how do you see coming fuel crisis play out in practical terms here in the US? Does the system break catastrophically once the oil price drops too low, or will continued war efforts be able to keep the price up?

  2. Mister Roboto

    This is a very good summary of the primary things I have learned from reading this blog over the years. I summed it up with a somewhat over-simplified syllogism in a comment on JMG’s blog: When Republicans are the minority party, they harp on the accumulation of unpayable debt as a primary evil, and when Democrats are in the minority, they harp on climate-change as the primary evil. Yet regardless of which party is in power, the increased accumulation of unpayable debt and increased burning of fossil fuels proceeds unabated. And this is because both of those things are necessary conditions for the continuation of industrial society.

  3. sp gp

    Quiz. What is a word that starts with J, ends with s, is not the name of a famous shark movie, but is highly relevant to the financial system, but can’t be mentioned by anybody, and even Steve doesn’t want to, despite his all seeing narrative?

  4. Front Range Mike

    As a former wannabe rock drummer during the 1980’s I can relate to your story about making music. As it is, there are tons of talented musicians and song writers out there that we never hear of. (I was quite capable, but really that talented, but I have played with a few hidden true talents.) If they had to add on the expense of having their own recording studio and distribution, we would have much less music. Although that has changed a bit in today’s world with the internet and software like Garage Band.

    On another note, I would add that it is extremely rare to have a musically, artistically or athletically talented person who also is talented in business. From my observations over the years actual creativity does not run rampant through business minded people. Hence the reason they resort to hiring marketing and advertising people, who are the creative people in that realm. And, the marketing and advertising agencies hire artists who really don’t want to sell out, but have to if they want to eat. Look at many of out huge businesses and many of their products essentially were stolen from talented people; or the paid the real talent a pittance while having them under contract. This system is built to serve the corporate masters.

    Thanks for another good essay Steve.

  5. ellenanderson

    Has the repo situation really resolved? I followed the link to the Martens’ article. It seemed to suggest that the stock market is being pumped up to help support Trumps re-election. If that is true they will have to keep pumping!

  6. Ken Barrows

    Let’s abolish the Fed. Banks cover their own ass in the repo market. Frackers fail unless oil price skyrockets. Hedge fund managers have to get a real job. The banks will have to continue creating money. If they don’t, no (very few) cars. No triangle of doom discussion anymore. Emissions plummet, slowing CO2 rise and ocean acidification. It’s a win win! Except for the contraction.

  7. ellenanderson

    Can’t help checking out ZH every now and then. Here is the penultimate paragraph in an article about Repo.
    “And there you have it: while the September repo crisis was fundamentally represented by the Fed as one of insufficient reserves, and the resultant QE4 was painted by Powell merely as an exercise in “reserve management” the real reason why the Fed stepped in so decisively was to prevent a cascading sequence of hedge fund failures that would have not only sent the market crashing as funds were forced to liquidate all positions once leverage as high as 10x (see chart above) was yanked, but would culminate in the failure of one or more clearinghouses. Which is also why now that the Fed has stepped in, and backstopped this weakest link, stocks keep hitting new all time highs.

    As for Mr Kashkari’s childish “needling of critics”, if after reading the above he still doesn’t understand what is going on, we have a suggestion: announce on Monday the Fed will no longer inject $100 billion in liquidity each month via repo and POMO, and see what happens to the stock market. After all, the Fed’s actions – or in this case the lack thereof – do not lead to “equity repricing”, right?”

    https://www.zerohedge.com/markets/944-trillion-reasons-why-fed-quietly-bailing-out-hedge-funds

    1. steve from virginia Post author

      I don’t believe what they’re saying.

      “3: The Fed has yet to address the “demand side” of the Sept repo crisis, namely the market transmission mechanism which is intermediated by hedge funds. And it is here that, as the WSJ reported, the Fed is currently contemplating providing liquidity directly to hedge funds to prevent a systemic collapse during the next repo crisis, whenever it may strike.”

      If clearinghouses are neutral marketmaking facilitators, they would be threatened when the interest rate market moves either way not just one way, that is, both sides of an interest rate position have the same risk, liquidity requirement and collateral. Plus, hedge funds don’t intermediate anything, they’re passive as possible … because the banks including the central banks have made it so, by providing credit at ridiculously low cost.

      If the Fed wants to bail out hedge funds there’s nothing anyone can do except laugh. It’s stupid, but the establishment lost its mind a long time ago. The real crisis is the absence of returns from economy as a whole not insufficient imaginary ‘wealth’.

  8. ellenanderson

    The interest rates haven’t been moving very far in either direction compared to what they used to do.
    I think you are saying that this analysis is wrong? Or do you think it might be correct and that the Fed may be planning to bail out the hedge funds and is, therefore, laughably crazy?
    Is this really about the contradictions of capitalist system beginning to become so severe that the system comes apart? Or is it about the lack of resources vs the demands upon them making any civilization of 7 billion people a losing proposition? How much conservation do we need at this point? If you know…..

    1. steve from virginia Post author

      The interest rates haven’t been moving very far in either direction compared to what they used to do.

      More or less stuck near the zero bound since 2008. Can a slightly above-zero rate be problematic? Maybe, but the low (or negative) rates are likewise a problem. Then again, what will the central banks do when the next recession arrives?

      I think you are saying that this analysis is wrong? Or do you think it might be correct and that the Fed may be planning to bail out the hedge funds and is, therefore, laughably crazy?

      I think it’s wrong because the funds in question — the ‘liquidity’ hasn’t gone anywhere. Funds loaned in exchange for collateral don’t disappear but change hands. The only way funds can vanish is if the loans are repaid (and the collateral discharged), which is certainly not happening. Nobody repays anything, in fact they borrow more. ‘Liquidity’ might not be where the various players might like but I suspect the problem is uncertainty as to whom to make loans to. The pundits make it out to be a matter of whom to borrow from (and choosing the New York Fed).

      I’m likely wrong due to my own limitations. I don’t have any special insight into a sector that has decided to keep silent. I do think the problem is severe, more so than the Long Term Capital Management panic, much more so than everyone involved lets on. The clue is the silence. One thing I do observe pretty consistently is that energy problems since the 1980s tend to emerge in credit rather than in gas stations. There is an argument that can be made the central banks are trying to head off an incipient recession, an incipient energy crisis of some kind.

      Is this really about the contradictions of capitalist system beginning to become so severe that the system comes apart?

      The system has been failing since the turn of the millennium. We don’t have the energy to do the work our finance system has committed our children and grandchildren to performing. So finance decides to solve the issue by issuing more and more loans and hoping for a miracle.

      Or is it about the lack of resources vs the demands upon them making any civilization of 7 billion people a losing proposition? How much conservation do we need at this point? If you know …

      We need more conservation than we have now. What’s underway is ‘automatic’ conservation, the product of breakdown.

  9. sp gp

    My point is merely that we should be willing to discuss everything.
    Steve’s specialty is the intersection between a diminishing, high cost economy, in particular the car based one, and the spread needed to finance such an economy, which keeps on growing. Ergo, spiraling consumption combined with spiraling debts. Energy deflation.

    But even then, some differences remain the same between peoples, cultures, etc., that were true long ago and will continue to be true into the future. We should also be willing to discuss evolutionary biology, demographics, the fact that humanity is actually split up and competitive between individuals and tribes, etc.

    Nothing is truly fungible. We are not the same. Completely independently of whatever energy we do or do not use, the United States is not Canada is not Britain, is not Mexico is not Russia is not Nigeria is not India, is not China is not Japan. Men are not women, children are not adults, elderly are not children. But this type of discussion is not allowed here or anywhere else. We are merely “homo economicus” that are neatly inserted into a globalized production/consumption economy.

    If it’s true that this economy is failing, it follows naturally that we will revert back to earlier forms of organization.

  10. ellenanderson

    “….The problem is uncertainty as to whom to make loans to….The clue is the silence.”
    That certainly is a credible explanation. I like its simplicity. When things blow up people may be slapping their faces and wondering how they missed it.
    I guess you are saying is that it is hard to pick a credit worthy borrower when you are handing out trillions. As long as the assets are only on paper and the federal accounting standards are suspended there is no need to stop playing – to foreclose and grab the collateral.
    The collateral as you say, is really energy, plus resources like soil and water and the productive capacity of humans. How will those be redistributed in the upcoming great foreclosure? Will it be a jubilee or a bloody conflict? Or come combination? The great recessions and depressions can always be described as foreclosures, can’t they?
    Please let us know if you hear some whispers! Thank you!!

    1. steve from virginia Post author

      Interesting article over at the NY Review of Books:

      https://www.nybooks.com/articles/2020/02/13/how-big-law-makes-big-money/

      In seeking to mark her position off against Marxist arguments that the capitalist state creates inequality by sanctioning “primitive accumulation” and exploitative labor practices, Pistor claims that her focus on the process through which private law is used to code capital allows her to “explain the political economy of capitalism without having to construct class identities, as Marxists feel compelled to do.” But any Marxist would surely reply that this is a sleight of hand. If one confines the thrust of one’s analysis to issues like derivatives regulation and intellectual property, class identities are, indeed, unlikely to play an important part. What is at stake in those deals is the distribution of surplus within the capitalist class. When that goes wrong, it can have a disastrous impact on the entire economic system. As we saw in 2008, it can even cause an enormous financial heart attack.

    1. steve from virginia Post author

      Repo never sleeps.

      Wildcard isn’t the Chinese flu but whether the US government is going to break.

  11. ellenanderson

    I had not thought about a distinction between left wing economic populism and Marxism. That NY Review of Books piece is very interesting. So leftist populism focuses only on distribution and not on production? That makes sense. As Sundance Kid said “It’s a good start.” (But likely not at all good for the environment.)
    Also it makes sense that such an approach is doomed to fail if Marx’s analysis is correct. Dialectical materialism is the foundation of Marxist analysis of history. Real stuff, resources and production are in the substructure. Corporations and their toadies (representatives in the real world aka lawyers) are in the superstructure. So as energy and resources become scarce and human labor is replaced by more efficient machines, the only way to keep the concentration of capital from blowing everything up is to distribute some of the surplus to the people. But of course it needs to be real stuff and we know there will be less and less of that to go around. The corporations, the nation states and their attorneys will turn themselves into pretzels trying to figure things out. No sense trying to reform the corporate system.
    Here is a link to an older blog that claims corporatism is already declining. It is a fun read though the author could really benefit from adding Capital to his reading list. It is well written and has some statements that are worthy of Steve from Virginia. For example from https://www.ribbonfarm.com/2011/06/08/a-brief-history-of-the-corporation-1600-to-2100/
    “The Black Hills Gold Rush of the 1870s, the focus of the Deadwood saga, was in a way the last hurrah of Mercantilist thinking. William Randolph Hearst, the son of gold mining mogul George Hearst who took over Deadwood in the 1870s, made his name with newspapers. The baton had formally been passed from mercantilists to schumpeterians. This divide between the two models can be placed at around 1800, the nominal start date of the Industrial Revolution, as the ideas of Renaissance Science met the energy of coal to create a cocktail that would allow corporations to colonize time.”

    Of course most Marxists believe that the extreme concentration of capital will eventually deprive the owners of capital of their power and thus of their control of the narrative. Marx suggested it would lead to the withering away of the state but, of course, we don’t really know what will happen in the superstructure where industrial workers, peasants, unemployed, managers, teachers, artists etc are beavering away trying to make ends meet and find some meaning in their lives.
    In any case, corporations are creations of the state. Back several years ago David Barsamian had someone who discussed how they were limited in America in earlier times and had to prove that they were worthy of their charters. I can’t find the link anymore. It is amazing to me that more people don’t get the connections between debt, corporations and war. People focus on Facebook, Twitter and Amazon – all of them time wasters, while the real powerhouses are the energy companies, the arms dealers and the drug runners. Everyone is trying to buy a little more time.

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