intervention into credit markets to artificially support asset prices above
market levels carries no fundamental market implication, save the impact of
future inflation. The market knows that asset prices assigned by the central
bank are not real and will be adjusted downward as soon as central bank
intervention ends. And until central bank intervention ends, the market remains
in suspension.
This explains why, despite central bank intervention, and perhaps even because
of it, inter-bank lending stayed halted, with Libor rising high above normal
spreads over the target Fed Funds rate. In the non-banking financial sector,
new commercial paper
issuance, the short-term funding source of choice for financial and
non-financial corporations, cannot find buyers. In sum, global credit markets
continue to fail despite escalating and increasingly desperate government
intervention measures.
One of the key objections behind the House of Representatives initial rejection
of the Treasury's $700 billion rescue package was that at the end of the rescue
term of 30 years, the public might not be paid back on account that the
illiquid collateral might still not yield returns that match after-inflation
face values. The overvaluation of such illiquid assets cannot be made whole
through inflation because de-leveraging made possible by inflation will keep
the market value of such assets below their after-inflation face value. The
congressional opposition wanted prearranged authority to tax the finance
industry to recoup the investment for the public whose tax money was being used
for the rescue of distressed institutions.
The market was more honest than most paid pundits and special interest
policymakers. Market participants knew the crisis was not merely a passing
liquidity crunch but a widespread insolvency created by excessive asset value
unsupported by compensatory revenue. Insolvency will translate into sharp
declines in asset price. The government can destroy the market in the name of
saving it but the laws of market cannot be negated by government intervention.
Some critics have mistakenly complained that the US government has turned to
socialism for a solution to the current financial crisis in a capitalistic
system. Yet what the US government has done is merely turn failed market
capitalism into state capitalism. Nationalization alone does not lead to
socialism. Socialism is not merely collective ownership of the means of
production. It must also subscribe to an operative goal of fair sharing of the
fruits of the economy through collective ownership of the means of production.
In a socialist state, state-owned enterprises are the venue of socialist
ownership of the means of production which is deployed to support the interests
of workers. But in a capitalist state, state-owned enterprises do not entertain
such populist goals. State capitalism continues to oppress workers for the
benefit of capital while the state represents the interest of capitalists
rather than workers. State capitalism subscribes to the trickle-down theory -
saving the banks to save the citizenry. What is needed is for government to
save the citizenry by direct assistance with job creation and wage guarantees,
not inter-bank loan guarantees.
Incoming data for September showed US unemployment at 6.1% and still climbing,
above the non-accelerating inflation rate of unemployment (NAIRU) of 6%.
Non-farm payroll employment declined by 159,000; in a civilian labor force of
154.7 million with a labor force participation rate of 66%. Total employment
was 145.3 million and the employment-population ratio was 62%. Since a recent
high in December 2006, the employment-population ratio has declined by 1.4
percentage points.
The number of people who worked part time for economic reasons rose by 337,000
to 6.1 million in September, an increase of 1.6 million over the past 12
months. This category includes persons who would like to work full time but
were working part time because their hours had been cut back or because they
were unable to find full-time jobs. These data suggests an extremely weak
economy going forward.
The entire global market economy, fueled by decades of excess liquidity and
debt denominated in fiat dollars imprudently released by the US Federal
Reserve, had turned even prudent debt to equity ratios in normal times into
precariously over-leveraged debt structures. Asset price inflation, defined as
growth by central banking doctrine, had allowed the global market economy to
assume debt levels that could not be serviced by relatively stagnant or even
falling wage income. In an asset price bubble unsupported by corresponding rise
in wage income, even normally prudent debt-equity ratios will result in
precarious debt leverage.
Either wage income must rise or asset prices must fall to restore financial
equilibrium. Government intervention to prop up inflated asset prices without
compensatory wage rise will only end in hyperinflation.
Shadow of bankruptcies
A sharp decline in assets prices will unavoidably spell widespread bankruptcy
for many financially overextended companies and individuals. This will
constrict demand temporarily to delay inflation effects but hyperinflation will
result as certainly as the sun will rise because modern democracies cannot
allow deflation to cause widespread bankruptcy even in a debt bubble. In
January 2006 (see
Of debt, deflation and rotten apples, Asia Times Online, January 11,
2006) I wrote (Central banks fear deflation more than inflation): "Although
Greenspan never openly acknowledges it, his great fear is not inflation, but
deflation, which is toxic in a debt-driven economy. 'Price stability' is a term
that increasingly refers to anti-deflationary objectives, to keep prices up
rather than down."
By now, it is becoming clear that government policy has been mostly focused on
maintaining asset prices at levels that the market has rejected. Logic suggests
that such a policy will result in hyperinflation at the end of the day, which
will lead to more bankruptcies down the road in a protracted downward spiral.
The government's attempt to save overextended financial institutions may well
cause the total destruction of market capitalism. And if past experience is any
guide, unless wage income is indexed to inflation, the dilution of asset value
through inflation will only hasten the arrival of total market failure and the
total meltdown of the market economy.
So far, not much is heard from official circles that suggest the solution to
the current credit crisis can only come from an immediate and substantial rise
in wage income. Instead of bailing out insolvent financial institutions, the
government should use sovereign credit to maintain full employment and boost
wage income to catch up with inflated asset prices. If the Fed must print new
money to save the system, the new money should go to job creation and wage
increases rather than to recapitalize insolvent corporations. Full employment
and rising wages will halt the fall of asset prices with a rising floor.
The approach adopted by the Bush administration is not designed to rescue a
collapsing global economy from total meltdown but to resurrect free market
capitalism from ideological bankruptcy with state capitalism.
Henry C K Liu is chairman of a New York-based private investment group.
His website is at http://www.henryckliu.com.
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