Monday, September 29, 2008

Howard S. Katz on the Bailout

Howard S. Katz has written a noteworthy blog on the banking bailout. I excerpt from it below. Howard's point is that the claim of a "crisis" is nonsense. Firms fail all the time. Fractional reserve banking causes instability. There is no need for fractional reserve banking. Inflation, which is due to monetary expansion, has caused real wages to decline 18% over the past 36 years. That is a crisis. Monetary expansion has unrealistically caused the stock market to go up, addicting Americans to easy gains through speculation at their fellow Americans' expense. That is a crisis. The failure of AIG, Bear Stearns, Washington Mutual and other financial firms is not a crisis.

>"Our current financial system is quite unstable, and all of this instability results from the commercial banks...

>"The so-called business cycle of the 19th century in America resulted from the fact that all of the commercial banks were expanding their money and making more loans. If a bank started out with a 1:1 ratio against gold and expanded to a 4:1 ratio, it would find itself in a position in which a bank run was a possibility. Therefore it would reduce its lending. When the banks as a whole got too over-expanded, the most exposed bank would be hit with a run. The other banks would see this and reduce their loans. Then there would be a cycle of loan contraction. These cycles of loan expansion and contraction were incorrectly attributed to the nature of a free economic system. This is not true. In a free economy, each person must keep his promises, and the privileges accorded to commercial banks of making promises and then not having to keep them are a violation of a free market.

>"Note that these were cycles of money and credit expansion, but since they were good for the bankers, those economists sympathetic to the bankers called them economic growth. Correspondingly, the cycle of money and credit contraction was called a recession or a depression by the banker-economists. The implication here is that what is good for the banker is good for the whole country, and what is bad for the banker is bad for the country. But this is an outrageous lie. When the banker expands money and credit, there is a rise in prices, and everyone else in society has to pay higher prices for the necessities of life. When the banker is contracting, things are reversed, and the average person benefits.

>"The people of the early 19th century were a lot smarter than the people of today, and there was a political movement to eliminate the privilege of commercial bankers to break their promises. The full expression of this principle was found in a group called the LocoFocos. A compromise version of the LocoFoco movement developed into the Democratic Party and in 1828 won the presidential election with Andrew Jackson as its candidate. In 1832, Jackson vetoed the charter renewal of the second central bank, and this set the stage for the greatest economic growth of any nation in the history of the world.

>"The central bank did not return until J.P. Morgan and Woodrow Wilson teamed up in 1913 to create the Federal Reserve. The original idea was that it would be a banker’s bank and lend to the commercial banks when they had gotten up to the dangerous 4:1 ratio. If the Fed could expand up to 4:1 to the commercial banks and they could expand by 4:1 to the public, then the bankers as a whole could get a credit expansion of 16:1 – more money for the bankers and their big loan customers. The creation of the Fed led to the money/credit expansion of WWI and the 1920s, and this was offset by the money/credit contraction of the 1930s.

>"But this was small potatoes compared with the very first action F.D.R. took after assuming office in March 1933. In one day, he rammed through Congress a bill which gave the Federal Reserve the power to create money out of nothing. Instead of multiplying money by 16 this made it possible to multiply it infinitely. The nation started out on one giant money/credit expansion which continues today.

>"At first, the expansion was slowed down by the conservatives with their old fashioned idea that the budget should be balanced. The Fed is the lender to the Government and requires a Government deficit to do its evil work. But Reagan converted the conservatives to Keynesian economics (using the names “supply side” and “Reaganomics”); and since that time the money/credit expansion has increased its speed.

>"In a free market economy, the stock market moves sideways. The companies whose products gain the public’s favor go up, and the companies which lose favor go down. The stock averages move sideways. Measuring from the first Dow stock index, in 1885 to 1932, one finds that the market moved sideways. The 18-fold stock market gain from 1982-2007 was due to 2 factors: 1) As the Reagan Fed lowered interest rates, the competitive stock yield was also lowered; but the only way to accomplish this is by stock P:E ratios going up. 2) As the interest rate declined, the debt burden of these companies went down; lower costs mean higher profits. The combination of higher earnings and higher P:E ratios made for much higher stock prices.

>"So over the past 26 years a class of very rich has been created. Unlike the traditional American rich these people do nothing to earn their enormous salaries and bonuses. They are pure and simple beneficiaries of the money and credit expansion engineered by the Federal Reserve Bank and the nation’s private banks.

>"Corresponding to the gains of this class of rich there are corresponding losses to the vast majority of Americans. For example, real wages fell by 18% from 1972-2002. That has never happened to any generation in American history, not since 1623.

>"Now the fall in real wages is an economic crisis. And the rise in housing prices of 1997-2007 (which made homes unaffordable to the average person) is another crisis. But both of these real crises are ignored by the nation’s media. Indeed, the media is now bending every effort to convince people that the fall in housing prices which began in 2007 is a crisis.

>"No, the crisis you read about in the newspapers is a crisis for the bankers and their associated vested interests (loan customers, debtors in general, etc.). You see, interest rates started out at 16% (nominal T-bill) and have declined to virtually 0 (T-bill nominal) and badly negative in real terms. Negative real interest rates are a concept so absurd that they perfectly illustrate the insanity of our age. A negative interest rate means that, if you take a loan, there is no interest charge; instead they pay you for the privilege of lending to you. A negative 5% rate of interest means that, if you borrow $1000, then at the end of a year when you repay the loan, they give you $50.

>"Why would anybody lend under such terms? And yet the people who created these conditions are designated as economic experts by the media.

>"But the handwriting is on the wall for the bankers and their friends. Things just went too far, and unthinking conservatism is bringing it to a halt. In 2004, with the T-bill rate at 1%, the New York Times suggested a tightening of credit. Greenspan, always anxious to please the Times, complied. The small tightening of 2004-06 cut the paper aristocracy to the quick. Over the quarter century, they had gotten soft. Profits had come too easy. Just a tiny bit of tightness, and several big Wall Street firms were driven to the wall.

">But these people have never had to work for their money. They expect to be made rich by big daddy government. And so they go running, hat-in-hand to big daddy. And that is the source of the current “crisis.” It is a pack of lies made up by Henry the effect that the whole economic system (whatever that means) will collapse unless the government robs from the American people and bails out Paulson’s Wall Street friends.

>"Here is the challenge for the American people of our day. Faced with a similar challenge in the early 19th century the American people rallied behind Andrew Jackson and fought the bankers. They were largely successful, and America became the greatest economy in the world. What will Americans do today? Will they accept the word of Henry Paulson on faith? Will they pay his demanded $17,000? (Actually no one knows the exact figure.) If they do, there will be another demand on them tomorrow, and Americans will sink into a form of economic slavery to their new masters.

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