The Great Deformation (121 page)

Accordingly, the central banking branch of the state remains hostage to Wall Street speculators who threaten a hissy fit sell-off unless they are juiced again and again. Monetary policy has thus become an engine of reverse Robin Hood redistribution; it flails about implementing quasi-Keynesian demand–pumping theories that punish Main Street savers, workers, and businessmen while creating endless opportunities, as shown below, for speculative gain in the Wall Street casino.

At the same time, Keynesian economists of both parties urged prompt fiscal action, and the elected politicians obligingly piled on with budget-busting tax cuts and spending initiatives. The United States thus became fiscally ungovernable. Washington has been afraid to disturb a purported economic recovery that is not real or sustainable, and therefore has continued to borrow and spend to keep the macroeconomic “prints” inching upward. In the long run this will bury the nation in debt, but in the near term it has been sufficient to keep the stock averages rising and the harvest of speculative winnings flowing to the top 1 percent.

The breakdown of sound money has now finally generated a cruel end game. The fiscal and central banking branches of the state have endlessly bludgeoned the free market, eviscerating its capacity to generate wealth and growth. This growing economic failure, in turn, generates political demands for state action to stimulate recovery and jobs.

But the machinery of the state has been hijacked by the various Keynesian doctrines of demand stimulus, tax cutting, and money printing. These are all variations of buy now and pay later—a dangerous maneuver when the state has run out of balance sheet runway in both its fiscal and monetary branches. Nevertheless, these futile stimulus actions are demanded and promoted by the crony capitalist lobbies which slipstream on whatever dispensations as can be mustered. At the end of the day, the state labors mightily, yet only produces recovery for the 1 percent.

THE GREENSPAN AXIOM:

HOW THE FED GIFTS THE 1 PERCENT

The financial market rebound since March 2009 is replete with evidence that bubble finance leads to a profoundly destructive perversion of free markets. We are in the Fed's third wealth effects levitation of financial assets and the resulting gift to adroit speculators has now become crystal clear. In each cycle the Fed has eventually lost control of the speculative Furies, resulting
in a spectacular bust and thumping decline in the price of the most risky asset classes; that is, junk bonds, growth-oriented commodities (e.g., copper), emerging market currencies, commercial real estate, high-beta equities, and endless Wall Street wagers embedded in over-the-counter swaps.

In the bust phase there is a bonfire of losses which are mainly absorbed by slow-footed Main Street investors and their proxies including pension funds, mutual funds, and other institutional fiduciaries. Within the circle of hedge funds and trading houses further losses are absorbed by the most reckless and leveraged punters among them, along with true believers who are too slow to let go of losing trades.

The key feature of the bust phase is that it is short and violent. Approximately 95 percent of the stock market sell-off in 1998, for example, occurred during just four trading days. Likewise, 80 percent of the dot-com-NASDAQ meltdown in 2000 transpired within fifteen weeks. Even more dramatically, 90 percent of the 45 percent sell-off between the Lehman event and the March 2009 bottom occurred during just eight trading days when risk assets were crushed by waves of panicked selling.

Following hard upon the capitulation sell-offs came massive liquidity injections by the Fed and elongated periods of bottom fishing that generated spectacular returns to adroit and usually leveraged speculators. Needless to say, the objects of their speculations were exactly those risk-asset classes which had been taken to the woodshed and beaten to a pulp during the short intervals of panic. In this respect, the violently erratic run over the past decade of the Russell 2000 index of small-cap (mainly) domestic stocks provides a striking example of the manner in which the Fed's arbitrary cycling of the financial markets and the macroeconomy creates fantastical windfalls to the 1 percent.

The Russell 2000 composite index is about as close a proxy for Main Street America's small-business sector as can be found on the public markets. Hundreds of companies in the index have market caps of only $100–$200 million, and the median is just $500 million; only a small slice of the Russell 2000 companies have market caps of over $1 billion, and 95 percent of its composite sales and earnings are US based.

Moreover, a random sample of Russell 2000 company names literally resonates its broad diversity of Main Street business addresses. Covering the waterfront from manufacturing to transportation, retail, banking, and services, it includes Alaska Air, American Axle, Applied Micro Devices, Bank of the Ozarks, and Beaver Homes. Moving down the list there is also Bob Evans Farms, Carmike Cinemas, Freight Car America, Ethan Allen Interiors, James River Coal, Maidenform Brands, Red Robin Gourmet Burgers, and Vanda Pharmaceuticals.

Needless to say, the Russell 2000 index was a winner during the Second Greenspan bubble, rising from 340 at the bottom in October 2002 to 820 exactly five years later at the market peak in October 2007. This amounted to nearly a 20 percent compound return for the 401(k) investor; and for Wall Street speculators employing leverage, options, and advanced market-timing algorithms, returns ranged between 50 and 100 percent annually for a half decade running.

These giant gains did not reflect a Main Street economy which was getting 2.5 times better. As has been seen, this five-year period was one of Fed-engineered faux prosperity where there were no new breadwinner jobs and much inflated consumer spending owing to trillions of MEW. There was also a veritable hemorrhage in the nation's current account with deficits totaling $3 trillion and a corresponding enfeeblement of the tradable goods sector. So, too, the Greenspan bubble period witnessed tepid investment in capital assets outside of commercial real estate, the accumulation of $7 trillion of new household and business debt, and a drastic deterioration of public finances owing to the two Bush wars and tax cuts.

None of this mattered, of course, because the market was trading off the liquidity injections of the Fed, the Greenspan Put, and the daily chatter of economic data “prints” which were falsely spun to suggest a robust and sustainable recovery. Accordingly, when the Lehman event unexpectedly shattered the bubble illusions, the Russell 2000 violently plunged back close to its October 2002 bottom, reaching a level of about 360 on March 9, 2009. This was a thundering 55 percent loss from the pre-crisis peak, but it was not the result of price discovery on the free market.

Instead, it was the consequence of an inside job: the temporary loss of confidence in the Fed's money machine by the inner ring of Wall Street traders and hedge funds. These fast money traders liquidated giant positions with lightning speed, leaving Main Street home gamers and their mutual fund proxies grasping at straws before they could even turn on their trade stations. Indeed, the fast money was quickly on the other side of the trade, pouring into short positions with malice aforethought and quietly duplicating a thousand times over the windfall gains being made on the “big short” in subprime mortgages so famously publicized by financial journalists.

The astounding truth is that nearly all of this ruinous 55 percent decline in the Russell 2000 index occurred during just twelve brutal trading days between the Lehman event and the March 2009 bottom. Worse still, during most of those days the correlation within the index reached 0.95, meaning that two thousand companies with vastly divergent business prospects traded sharply lower in exact lockstep. Laughably, the Nobel Prize for
economics had been awarded to nearly a dozen glorified math modelers over the last decades who have espied in such moments the glories of “efficient markets” at work.

This is balderdash. Only a financial system addicted to and whipsawed by central bank money printing can produce such erratic, capricious, and correlated results. What is implicated here is not the doings of the free market but the corruption of free money. For that reason, the Greenspan axiom that financial bubbles can't be prevented but only punctured and then bailed out afterward is downright perverse. Now in its third iteration, this policy is, in fact, the backstage mechanism by which society's income and wealth are being redistributed to the top 1 percent.

It goes without saying that during the Russell 2000 crash the fast money traders did not lose 55 percent—not by a long shot. It was the Main Street “investors” and their proxies—mutual fund managers like Bill Miller—who got fleeced, owing to the naïve belief that they were investing in stocks for the long run and that picking good companies mattered. So the true evil of the Fed's financial bubble-making sits right here: Main Street investors had no clue that their cherished “stock picks” could drop 55 percent in a matter of months because in an honest free market share prices wouldn't inflate to absurd heights in the first place, nor plunge irrationally during a monetary panic afterward.

Main Street investors thus inexorably become “bottom bait” as the fast money feverishly forces bursting bubbles to capitulation lows. Eventually overcome by desperation and fear, these “investors” are the last ones off the boat, selling into the bottom layer of losses and retreating to the sidelines measurably poorer. It is no wonder then that Wall Street has a bad name and that with each round of financial boom and bust fewer and fewer real money investors come back to the casino.

LEVITATION WITH SHADOW BANKING CREDIT, NOT REAL SAVINGS

It doesn't really matter, however, because the liquidity bailout phase of the Fed's bubble finance cycle generates unlimited fuel for the carry trades. Indeed, virtually free short-term money means that stocks and other risk assets can be margined, optioned, and re-hypothecated over and over. Thus, when the fast money regains confidence in the central bank “put” the market can be reflated on shadow banking system credit. Real savings from Main Street households are essentially unnecessary.

During the Bernanke bubble the reflation has been fast, furious, and absurdly unwarranted, as underscored by the phony recovery evidence highlighted above. Yet this time it took the Russell 2000 only twenty-five months
to scream past its former high, reaching 850 by early April 2011. This meant that vanilla traders generated 50 percent annual returns during the period, and state-of-the-art hedge funds employing leverage, options, and charting algorithms easily tripled or quadrupled their money.

The data make abundantly clear that in goosing the “risk on” trade the nation's central bank was doing no favors for the Main Street rank and file. The second thundering financial market crash within a decade had been more than enough to keep the home gamers on the sidelines and mutual fund managers begging for investors. During the twenty-five months of the miraculous Bernanke reflation, in fact, domestic equity mutual funds experienced a $200 billion outflow and daily share volume collapsed, especially when robotic HFT (high frequency trading) volume is removed from the figures.

There is not much doubt, therefore, that the overwhelming bulk of the $1.5 trillion gain in the Russell 2000 during the short interval between March 2009 and April 2011 was captured by Wall Street traders and hedge funds. And it is also evident why Wall Street has loudly brayed for more quantitative easing (QE), ZIRP, and other liquidity injections ever since; namely, these massive gains in the index of Main Street businesses represent liquidity-driven momentum trading, not the repricing of a fundamental improvement in small-company profitability.

In fact, the great fiscal contraction ahead owing to Peak Debt means that small-business profits are heading south. The fact that the Russell 2000 was sitting at another all-time high just under 900 in early 2013, was thus striking evidence that the stock market is being massively propped up by speculators counting on the Fed to continue to juice the “risk on” trade.

Needless to say, the 2012 election outcome bolstered hopes for new rounds of money printing and Wall Street coddling from the Eccles Building; that is, the top 1 percent ended up with the best friend they ever had returned to the White House. After all, Bernanke is now Obama's Fed chairman and the open market committee is increasingly populated with raging money printers, like Vice Chairman Janet Yellen, who were appointed by the current White House.

While this is seemingly ironic given that Obama was reelected essentially on a platform of “fairness” for the middle class, that was content-free campaign rhetoric. The true irony is that political progressives are so indentured to Keynesian theories of demand stimulus that they have eagerly turned the nation's central bank over to Wall Street lock, stock, and barrel.

Under this perverse arrangement, the ministerial work of keeping interest rates at zero and Wall Street flooded with fresh cash from massive Fed bond buying is performed by befuddled academics like Bernanke and
career policy apparatchiks like Yellen. So in the name of encouraging the people to borrow and spend, these hired hands keep the carry trades well lubricated and generate continuous opportunities for speculators to extract vast economic rents from deformed financial markets.

JUNKYARD OF WINDFALLS

In this respect the Bernanke bubble since September 2008 has been a fantastic moveable feast which conferred upon speculators innumerable opportunities to scalp windfalls from the crash-and-reflation template described above with respect to the Russell 2000. As previously indicated, the junk bond market was an especially egregious case. In May 2008 the $950 billion of junk bonds outstanding traded to a yield of about 10 percent according to the leading (Merrill Lynch) market index, but by the bottom of the financial crash in March 2009 yields had soared to 23 percent.