Debt-to-GDP

Economic expansion is not limited to, for example, the amount of gold in reserve. If it were, the Great Recession would have been the Great Depression all over again.

Now we have the Federal Reserve system. Economic value (expansion and contraction) is held in reserve and centrally managed independent of the political system, although in practice it serves a critical, political function as well.

To expand, the central bank buys bonds from banks in the system (it prints money, which is value held in reserve). To contract, the Fed sells its bonds back to the banks (reducing the supply of money, which puts the value back in reserve). The risk (the value being produced and consumed, or the risk-value) is either "on" or "off." It is binomial because dummy variables are unambiguous, easy to measure, and easy to manage.

While expanding the money supply should render a competitive, pluralistic economy in which inflation and unemployment are the least of our problems, the Fed reports that both will be critically problematic for years. The Fed is essentially just buying and selling bonds (sovereign debt), which gives basic value to the risk (basis points), but what the private sector does with the money determines the effect (the risk-value).

The Fed does not create risk. Risk is coefficiently constant, but it can be structured and restructured to accumulate value. If the marketplace is continuously consolidating with each boom-bust (risk on-risk off) cycle (with big firms being fittest to survive), the private sector is determined to consolidate the risk and consume the value (the GDP) it produces. The result is the crisis we have now with GDP being consumed by debt. This is not something grandma did by going to the doctor or needing hip-replacement surgery..., but because Wall Street overleveraged the risk into a crisis proportion (it expanded the money supply to consolidate rather than deconsolidate the risk). The probability grandma can afford her health care has been consumed by Wall Street (the value has been consolidated, putting grandma at the mercy of the so-called fittest to survive--"the smartest" by virtue of uncompromised self-interest).

Wall Street overleveraged the money supply so extensively, but with slow growth, that fiscal stimulus, QE-1 and QE-2 were not enough to cover it, and it looks like QE-3 will be needed to cover the extended debt proportion.

Without a third round of accommodative easing, the slow growth experienced during the Bush administration's throwback to reaganomics will keep us in a deflationary trend because the monetary expansion (the leveraging) did not trickle-down the income to pay for the homes or the second mortgages that were sold, or anything else for that matter. Consumer demand is consumed with debt, and this is not the paradox of thrift. It is a deliberate--knowing and willing--deprivation of income needed to prevent the current crisis and the consolidation of assets and income still to be consumed (foreclosed) in a crisis proportion going forward.

Keep in mind that, given the current political will in the representative form, a distribution on the accumulation will not occur until there is no one left to pay the debt but rich people. Thus, the long, deflationary tail of the cycle, and the S&P downgrade.

The downgrade occurred because the "paradox of thrift" is not what is in operation here. It is the deliberate consumption of equity by means of an over-extended (over-leveraged) risk proportion intended to force us into default and foreclosure (increased debt-to-GDP). Instead of increasing supply, supply is consolidated and sold with an increasing debt proportion.

The economy (GDP) did not expand in proportion to the amount of money leveraged by the private sector. Income, rather than being expanded to pay the debt, accumulated at the top, which causes deflationary crises and the need for the Fed to expand the money supply from its reserve (ex nihilo).

When the private sector over-leverages into crises, the Fed steps in and provides the liquidity to cover it. This, you see, provides our economy with millionaires and billionaires (a lot of money to trickle down according to the Hamiltonian model, and plenty of aspiring ideologues) but not a lot of GDP. Since being rich is supposed to be exclusive, ideologues press to turn off the spigot to consolidate their gains--and so while the rich trot off with all the booty, the Fed gets all the blame for a declining GDP ratio.

With the model of over-leveraging being successfully applied with virtually no liability, it will be replicated. That is, we will keep increasing debt at the expense of GDP. As long as the Fed is doing its job of preventing full-blown depression, entrepreneurs can be in the business of making money without risk (without creating jobs and the income to sanction them in the marketplace).

If the risk can be profitably offset to all the other poor suckers in the world, it will. As long as the means to sanction (the application of risk for consumption) is allowed to consolidate for redistribution, the value it produces will be retributive (negative GDP). The sanctioned (the non-elite who are forced to take all the risk rather than apply it) have no recourse but big government to counter the power of big business. Government, of course, is then falsely valued as being the source of the problem (the source of the retributive value).

We have to seriously question whether government has caused record budget deficits and public debt (the value to be retributed). If we attribute government to the retributive value of the risk, then the basis for future asset valuation and economic performance is determined to be contractionary (the uncertainty is effectively zero). The risk, then, is really high (it is fully gamma), and so then is the value of the reward.

If economic contraction is the model of success, income will not be available to ensure a free-market consensus. Hence, the Fed prints it "out of nothing" to hedge the inevitable, political risk, which at the same time supports economic entities that are modeled to gobble-up GDP with debt. The printed money (the potential, alpha risk of the free market) is turned into debt (kinetic risk of overwhelming force) that is "too big to fail" in a gamma-risk proportion.

Without adequate income (expansion of GDP-to-debt) the gamma risk is fully proportioned. Politics becomes the risk determinant, not economics, and the Fed is the perfect foil for what fails us in a too-big-to-fail proportion.

Now, for example, after the Great Recession, we can fallaciously blame the Fed, post hoc, for causing the problem when it is mitigating the effect of turning equity into debt (rising debt-to-GDP and likely default). Since, however, the private sector is responsible for adding GDP, but is not, the ex-nihilo funds are indeed producing next to nothing (except millionaires and billionaires by default). The added liquidity is being used to inflate commodity prices for capital gains which are reaganomically taxed at the lowest rate. The combination of high liquidity but low GDP, along with declining revenues against the need to spend, is trending us toward default. Dump reaganomics and this trend will quickly reverse!

We should reverse reagonomic tax incentives not because it is fair, but because, as Reagan proponents argue in support of marginal rate reduction, it is practical. It is the best way to achieve economic growth, reduce the need for government spending and the need to monetize an overwhelming debt burden despite record profits.

The reason equities get support on bad economic metrics is because the Fed is there to expand the money supply. Although the Fed is fingered to be the cause of the problem, it is there to "accommodate" it (manage the risk), not cause it.

At this point in our political-economic history, if we did not have a policy of accommodative easing we would be in the depths of another depression. Instead of wrangling over tax rates we would be looking squarely at the fundamental legitimacy of capitalism.

The accommodative policy of the Federal Reserve offsets the risk into a bureaucratic model (a stable, routine, quasi public-private management of risk and the distribution of its value). Risk is managed by a power elite in the gamma dimension not to deconsolidate it (to keep it in the alpha dimension where risk is divisibly controlled by The People), but to keep it consolidated, which defeats the free-market legitimacy of capitalism (accumulation of value only by the consent of the governed who solely own the value of the risk).

Much safer to argue about "fairness" of the tax code than to directly examine the legitimate (fundamental, alpha risk) distribution of income and, thus, the power to control the risk. Remember that during the boom phase, risk is on. If an expanding money supply does not produce alpha risk (GDP), the gamma risk is too high. The value is too consolidated and presents as high debt-to-GDP. When the gamma risk is switched on, the alpha risk is effectively off (equity is liquidating into debt) and the system is critically unstable no matter how hard we try to ignore it with ambiguous issues that tend to be safely symptomatic if related at all.

So, if reducing debt-to-GDP is the magic bullet, what's keeping us from killing the "job killer?"

Over-Extension of the Risk (Bubble Bonds)

The Fed has managed to keep money cheap and readily available. So how come it has downgraded the economy?

Low yields (high bond prices) indicate a deflationary trend (a declining rate of profit). Since the rate of profit indicates the probability of growth (investment that exceeds the low yield), the Fed sees a low probability for organic growth.

Cash being horded by large, economy-of-scale firms will be used for inorganic growth, which causes a further extension of the risk. Over-extension of the risk not only consolidates market share (alpha risk), but renders small firms less creditworthy.

While inorganic growth reduces risk for big firms (rendering them "too big to fail"), it extends the risk to the rest of the economy. Anything not too big to fail is stuck with maximum risk and minimal reward. Conversely, the reward is maximized by big economy-of-scale firms over-extending the risk.

The extent of the risk is measured by the rate of interest. The risk is scored against the ability to pay (creditworthiness). The less creditworthy, the more interest paid, if you can get it.

When credit extends to match the over-extension of risk, a bubble forms. Thus, the bond rally (the so-called flight to security) is a bubble.

Bubble bonds are secure only because they are backed by the federal government (The Federal Reserve). It measures the risk over-extended into a gamma (crisis) proportion.

In order to avoid the crisis dimension, risk cannot be allowed to extend without the full measure of the reward; and budget deficits, rather than filling the deficit of reward, just extends the risk and bonds it into a bubble that cannot be repaid without the extension of credit--over-extending the risk.

Public Policy and the Art of Arbitrage

The announcement of Federal Reserve chairman, Bernanke to adjust mark-to-market accounting rules employs a financial tool that determines asset valuations at a particular time. When he suggested that the rule would be eased to facilitate selling the bad assets with a quick and favorable valuation, the stock market rallied on what made the assets bad to begin with.

Bernanke is acting to make good the organizational model that makes the assets bad by making the assets good, manipulating an abstract accounting trick that gives the assets arbitrage value. The fundamental value of the assets--the lack of value due to a lack of income to pay the underlying mortgage debt obligation--is still bad because that value was leveraged into a securitized debt obligation and sold, marked to market, when it was overvalued. The investment made was an arbitrage that did not give value to the fundament. When the leverage unwound, the debt renderred worthless was being hidden off balance sheet to avoid being marked to the market valuation. By easing the rule, the Federal Reserve Bank is attemting to reveal the hidden valuation, give it value and liquidity.

The measure is Hamiltonian. It operates to save the organized dimension of "too big to fail" argued as the result of a free market mechanics, rewarding success in the marketplace with the large size that defeats the function of the free market in which firms inimical to the public welfare will fail. It is a measure that causes the demand for government, not prevent the need for government that the premise of his action advances in support of the free-market mechanism.

While it is politically elegant to lend survivability to a failed model of organizational power, within the Ivy-League list of possible alternatives, economically it is pure junk!

Public policy that confirms the practices of private power that has led to the current crisis will not save it. It will make it worse and the effect will be to discredit what will both prevent crises and the need for government--free-market economics.

When the Federal Reserve announces it will only act to promote ensuring a competitive multiplicity (pluralism) of the marketplace, organizing the economy to prevent economic entities that are too big to fail and threaten the stability of the entire economic structure, is when we will have a technical support for solving our problems rather than saving them.

The Federal Reserve's announcement to increase oversight of banking and lending will combine with Treasury's announcement next week on what will be done to dispose of the bad assets.

Treasury secretary, Geitner looks to attract private capital to buy the bad debt, rather than a public debt to be paid with a more progressive tax code, which will need to be more than worthless at the time of sale and resale. That will be by manipulation of the accounting rules at any particular time or point of the arbitrage transaction that determines the taxable gain on the capital invested in the banks by buying their bad debt, giving liquidity to the leverage that caused the bad debt, and giving us the political-economic phenomenology of successfully failing (see the article, "Restructuring the Elements of Power" at griffithlighton.blogspot.com).

At the same time, congressman, Barney Franks has proposed reactivating the "uptick rule." If arbitrageurs must wait for an uptick to sell short, there is an indication that values are being manipulated on the bid and shorting the bad assets is less likely to occur. That would help give value to the bad debt the taxpayer bought that is essentially worthless because the fundament of its value--the income necessary to pay the debt--has not been supported. Its secondary, derivative value--its leveraged, arbitrage value--is getting the technical support.

Citigroup's report of a quarterly profit provided technical support for equities that, combined with the possibility of favorable accounting rules for valuing the remaining bad debt and diminished capacity for the false technical indicators of short selling practices, comes at a time when equity ownership (the capital) has been largely consolidated.

Both measures, and the timing, to change the technical rules to support asset valuation are Hamiltonian, avoiding support at the fundament of the value--the income to pay the mortgage so that all the parties (the class elements of the power structure) benefit. Rather, the system is maintained in zero-sum in keeping with the Hamiltonian model and recovery will occur to recycle the consolidation of fundamental value with the art of the trage leading the way.

The political economy, rather than lending regulatory stability to the market, operates to add volatility, providing the medium for the art of arbitrage that gains the capital and gives liquidity to the leverage (see the article, "Rebuilding the Economy" at griffithlighton.blogspot.com).

Independents Called to Action

Restructuring the Elements of Power

Big business, bypassing the element of bureacratic power, has stagflated the economy in spite of the Federal Reserve. Prices and profits are supported while labor costs and competitive market forces get resistance. It is a needless restructuring of power that is not even in the best interest of a power elite.

Correcting for this consolidation of power will at first protect a power elite from itself, as a bureaucratized pluralism of power tends to do, and will at least help avoid a prolonged deflationary period.

Whatever independent bureaucratic diffusion of power the Federal Reserve had is now secondary to the Exxon-Mobils of the world. It has been co-opted. The price of oil has been used to consolidate the wealth of our nation and leads the direction of our economy. The Federal Reserve is a reactive, rather than a proactive, element of the power structure.

Independent voters can provide a needed check by demanding government operate to primarily ensure a more free and unconsolidated marketplace, a progressive individual and corporate income tax, and strategic reinvestment of revenue into consolidated markets like energy and healthcare.

Market forces--a competitive multiplicity in the marketplace--is the solution to much of what government agency labors to prevent or eliminate. Reinvestment of value-added revenues that comes from a progressive tax structure would operationalize the efficiency of markets to control costs, and externalities, both public and private in a way that a regulatory bureaucracy can only approximate.

For private capital, value-added reinvestment, the reinvestment of profits, is a function of consolidation: buying the competition. This is referred to as growth. However, the effect is to limit supply and discourage economic growth, supporting prices, profits, and the ability to engage in abusive practices without fear of losing market share and being forced out of business. The result is a proliferated demand for government and all the costs associated with it. Profits, the value added, is continuously reinvested in consolidating markets, and while economic growth will occur by creating an incentive for new markets, growth will not occur in strategic markets, like energy and healthcare, to control costs, quality and abusive practices.

The argument that consolidation promotes the proliferation of new markets is false. Investment in new markets is just as likely to occur without a consolidated marketplace.

Value-added reinvestment through means of progressive taxation is a function of optimizing investment in strategic markets and economic growth, controlling costs and abusive practices with less need for government.

Private capital discourages progressive taxation because it can be used to finance the competition (the value-added market solution), which is economic growth and optimally full employment which, again, reduces the need for government, producing growth with low inflation without the need for reactive bureaucratic interventions.

Private capital much prefers to have a proliferation of bureaucratic power than progressive taxation. It creates a revolving door, barriers to market entry, and can be co-opted, all with the force and legitimacy of public authority while, at the same time, consolidation of the marketplace can be blamed on government interventions.

While proliferation of the bureaucracy is a pluralistic diffusion of power, and can be added to the analytical models of power, it operates at first, as it did for 18th Century despots, to protect a power elite from itself. The EPA operates as much to keep the self-interest of a power elte from polluting itself to death as it does to protect and serve in the public interest. The same is true economically. The Federal Reserve operates more to protect private capital from itself, which in turn is called the general welfare.

The bureaucracy is just as easily operationalized for the general welfare as it is for the administration of a power elite.

Independents will function to ensure freedom.

The two parties are but a playground for its wealthiest contributors. The results tend to verify. The stakes are not very high with a binary system and provides the perfect playground for cultivating party loyalty and the utility of organized hierarchy and membership, win or lose. The result is a party system that functions to reward party satraps of the status-quo and a nepotism of power both public and private.

The party system is not operationalized for any kind of improvement. It is operationalized to give the false potential for change. That is why democratic party rhetoric tends to be full of "hope."

The time is right to act. Independents are called to action!

Copyright 2008 by Griffith Lighton.