December 4, 2022

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Why The Emerging Recession Will Be Deeper And More Painful Than You Know

Economists are in agreement that the coming recession will be deep, lengthy and painful.

Make no mistake, a recession has already begun. The general
definition of a recession is two consecutive quarters of negative economic
growth. We’re past that.

And we all know it.

Recent consumer surveys show that average people expect inflation to get worse and last longer than what we’ve been told. This round of inflation has never been “transitory”, like President Biden, Treasury Secretary Janet Yellen and Federal Reserve Chairman Jay Powell arrogantly assured us last year.  

But the Biden Admisntration is evading admission of an economic downturn to avoid disaster at the midterms next month. Confirming what is obvious – that the economy has failed to grow for the last two quarters, meeting the definition of a recession – is going to lead to political disaster for the Democratic Party and an extended period of economic pain for all of us.

Right now mouthpieces for various economic and political parties
are telling anyone who will listen that the reason for the recent explosion of
inflation is the COVID stimulus checks distributed to people in dire economic
straits during the pandemic.

That idea might have some merit, but not much…

It’s easy to blame the “burden of the poor” for our economic problems, especially when understanding the causes of the coming economic downturn require a little technical knowledge and critical thinking. It wasn’t just sending relief checks to people struggling to feed their kids and avoid eviction during the pandemic that is generating the highest inflation we’ve seen in 40 years.

During the depths of the COVID recession, people were not
using their stimulus checks to buy typical consumer goods. Instead they were
just trying to get by.  Most people were
buying food, catching up on rent, repairing cars and buying work clothes. Big
screen TVs and European vacations were far down the list.

That’s not to say greed and dishonesty took a holiday.

But all of that money – the desperately needed as well and
the greedily taken – is only a drop in the bucket compared to the oceans of
money pumped into the stock market, like financial heroin into the veins of a
currency addict.

We’re talking trillions
and trillions
of dollars

More in that in a minute. First, a word on inflation.

Like everything else money is subject to the laws of supply
and demand. When there is a lot of money sloshing around in the economy its
value goes down.

When money is scarce its value goes up.

For example…

When the economy recovers from a recession there will be
some modest inflation. A little inflation is not a bad thing. In fact it is a sign
of good times.

That’s because during a recovery jobs are created, people go
back to work, working hours increase and wages go up. People have more money
than they did and buy things they could not afford during the recession. That
means increasing demand. When demand increases prices go up.

That is why a little inflation is a good thing.

It shows that the economy is healthy, people are making
money and creating demand because they are buying more than they did. Times are
good.

Sometimes people save money instead of spending it. (China
happens to be a country in which saving is very popular.) That too is a good
thing because it creates a supply of money banks can lend to businesses to start
new companies, create jobs and expand goods and services. All those things
contribute to keeping the business cycle going and spreading prosperity.

But there is another much less healthy way that inflation
can start and get entrenched. That is simply by giving money away…

It’s called Quantitative Easing, and it is the brainchild of Ben Bernanke, the former chairman of the Federal Reserve. Although the original idea came up in the middle of the 20th century Bernanke is the one who turned on the firehoses of finance in the years following the Great Recession.

Jay Powell has kept those spigots open ever since.

Simply put, quantitative easing means
flooding the stock market with unimaginable
amounts of money that has
been created out of thin air. It is done by buying US Treasury bonds from the
Federal Reserve.

It used to be called “printing money”, but
most of our money is electronic now, which makes it much easier to create vast
amounts of cash.

The Federal Reserve is the personal bank of
the United States. It sets interest rates between banks, regulates the money
supply and sells US Treasury Bonds.

A treasury bond is a debt instrument…

Treasury bonds are used by the Federal
government to raise money to fund the government. After Congress agrees on a
budget funded by a tax rate just short of the amount needed to avoid armed
rebellion they look to borrowed money to finance promises to voters they hope will
ensure their re-election.

This is where Treasury bonds come in.

They are called Treasury bonds because they
are issued by the US Treasury. When you hear about the national debt you are
hearing about how much money the federal government owes, mostly in Treasury
bonds.

US Treasury bonds are very popular throughout
the world because they are a safe bet — the United States is the richest
country in the world and has never defaulted on its debts.

International banks and corporations buy US
Treasuries, as do other countries, sometimes in huge amounts. Financial
advisers suggest that 40% of your investment portfolio should be in US Treasury
bonds because they are a very safe investment.

Here’s how the Federal
Reserve uses US Treasury bonds to inject cash into the economy …

A bond trader at the Federal Reserve calls
his counterpart at one of the gigantic banks like JP Morgan Chase, Wells Fargo
or Citibank and offers to buy Treasury bonds. Say 50 million dollars’ worth.
The bank representative says “Sure”. The Fed trader makes an entry into a
computerized ledger and 50 million dollars — created out of thin air — appears
in the banks’ reserve account held by the Fed. Another 50 million dollar entry,
this time a debit in the form of a Treasury bond, is made into the computerized
national debt ledger.

(Christopher Leonard will tell you all about the details of Quantitative Easing in his recent book, The Lords of Easy Money: How the Federal Reserve Broke the American Economy.)

The bank is loaning money to big Wall Street
players at little or no interest who use that money to buy stocks, bonds and
derivatives (more on derivatives in a moment). Taxpayers, of course, are on the
hook for the national debt.

Speaking of the national debt, it’s been
skyrocketing.

Here is what it looks like in a simple graph:

Source: U.S. Office of Management and Budget and Federal Reserve Bank of St. Louis, Federal Debt: Total Public Debt as Percent of Gross Domestic Product [ GFDEGDQ188S ], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/GFDEGDQ188S, October 14, 2022.

As a nation, we owe about 20% more than what
we make.

(Visit Committee for a Responsible Federal Budget for non-partisan analysis and information.)

Before 2008 large corporations were using
Treasury bonds to park their money instead of investing in new businesses or
expanding their operations and creating new jobs. Buying back existing Treasuries
and issuing new ones was intended to encourage economic expansion and generate
widespread prosperity.

It’s not working out
that way…

It used to be that increasing value of corporations
in the stock market meant having the funds to invest in new factories that
create more jobs, or launching a new product line that would benefit the lives
of consumers.

No longer…

Zero interest rates and Quantitative Easing
has given rise to a new word – “finacialism”. It means manipulating finance of large
corporations to show value that doesn’t really exist or benefit anyone except stockholders
and high level executives.

(For more on finacialism read Rana Foroohar’s wonderful 2017 book Makers and Takers: How Wall Street Destroyed Main Street)

Large corporations have tons of free cash and
are thinking up all sorts of new and creative ways to get rich. They buy back
their own stocks, driving up the value of the remaining shares, for example. Nothing
new is created — no jobs, no products, no consumer goods. But corporate officers
receive huge bonuses.

They also buy out competitors, creating near
monopolies in many industries. That kind of concentration raises prices, lowers
employment and stifles innovation.

They also got involved in risky and complex
financial shenanigans called derivatives.  

After all, with all that free money coming
from the Fed the consequences of a deal going bad are nonexistent. If they
lose a pile of cash the Fed would soon be announcing another round of
quantitative easing.

Here’s  how it works…
Let’s say you and your wealthy friends chip in, create a fund of a million dollars give it a name. Let’s call it ShadowVentures and announce that it will loan money to Wall Street high rollers. Next, loan the money out to Wall Street players, and demand stock for collateral. Package those loans into groups according to risk. Sell portions of those loans to other Wall Street players.

Most of us think of loans as a liability — a
bill to pay. But loans are assets for those who own them. They have future
value. Buying a loan is an entitlement to payments that creates a steady income
stream. It’s a great way to make money, but there is a risk. Sometimes people
can’t pay their loans.

So you and your partners offer insurance to
the owners of the loans. The riskier the loan package, the higher the premium.
Now sell shares of the insurance operation.

Notice that nothing of value is being
created. Also not that the operation is a house of cards. One scheme fails and
everything fails.

And so it goes. That’s derivatives. Not to
worry. Another Quantitative Easing will soon be on the way.

So there is no risk. That’s called “moral
hazard”. If we lose money on an investment – maybe we can’t make our car
payment – nobody bails us out. So we have to be careful and responsible.

These things quickly changed the stock
market…

First, stocks became highly inflated. They
are worth far less than their posted value. That’s because the money used to
buy them appeared because of a few keystrokes, not because of underlying value
of the stock.

That’s called a bubble when it happens any
place else. The Dow Jones average quadrupled from 8,700 in 2008 to 36,000 in 2022,
largely because of the hundreds of billions of dollars the Fed created and
injected into it.

And that’s a huge contributor to the
inflation we are now experiencing.

Here is what Larry Summers, highly respected
economist, former Treasury Secretary and former President of Harvard University
thinks about the situation we are facing:

“The Fed’s idea used to be that it removed
the punchbowl before the party got good. Now, the Fed’s doctrine is that it
will only remove the punchbowl after it sees some people staggering around
drunk…We are printing money, we are creating government bonds, we are
borrowing on unprecedented scales…In a super permissive fiscal environment, if
inflation expectations are allowed to rise, the process of putting them back
and restoring normality is likely to be uncontrolled, expensive and costly…”

A bubble is bursting. That bubble is a huge
part of our economy.


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