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February 05, 2008

The brave new world of finance-2: Further indicators of insanity

(For previous posts in this series, see here.)

The current weird situation in which the stock market rises on what you or I might think is bad news can also be seen with labor figures. When reports are released that unemployment is low (which ordinary people would think is a good thing), the stock market tanks. When unemployment figures rise, the stock market also rises. Why? We are told that if unemployment is low, that means that workers are in demand and thus have more clout in negotiations and their wages are likely to rise. Again, you and I might think it is a good thing for working people to be earning more. But for investors, this is bad because rising wages means lower profits for companies and an increased possibility of rising prices, which means the possibility of inflation, which means that the Federal Reserve might raise interest rates to reduce the money supply and thus lower the risk of inflation. And we know the love affair that investors have with low interest rates. Hence the stock market goes down.

All this may be perfectly rational behavior within the weird world of finance. But to me there is something profoundly disturbing, immoral even, about an economic value system that is so committed to low interest rates that it even cheers on news that by any measure is not good for ordinary people. As Barbara Ehrenreich writes yesterday: "So thoroughly is the economy decoupled from ordinary experience that according to a CNN poll, 57 percent of Americans thought we were already in a recession a month ago. Economists may complain that this is only because the public is ignorant of the technical definition of a recession, which specifies at least two consecutive quarters of negative growth. But most of the public employs the more colloquial definition of a recession, which is hard times. And -- far removed from whatever happens on Wall Street, the Nikkei, Dax, or the curiously named FTSE -- most Americans have been living in their own personal recession for years."

You or I might think that it would be desirable to have an economy in which almost everyone was working and putting money away in savings for their future and the future of their children. But such a scenario seems to give the financial sectors and investors in Wall Street nightmares. And unfortunately, they are the ones who seem to control monetary and fiscal policies.

We seem to be living with a financial system has lost touch with human needs.

Why is it that our sense of what is a healthy economy has been overturned? One reason is that the US economy has switched from one that was dominated by the manufacturing sector (i.e., where companies actually made and sold stuff like steel and cars) to one that is dominated by the co-called FIRE sector (finance, insurance, and real estate).

The US is rapidly ceasing to be the country that makes things that people in other countries want to buy. The US has been running up huge trade deficits since 1970, with the rapidly increasing deficit in goods exported to other countries failing to compensate for the (small) surpluses in the services sector.

The FIRE sector, rather than actually manufacturing goods, essentially uses money to make more money and this change in activity has profound consequences. One negative consequence of the dominance of the interests of the financial sector over the general economy is that economic policy seems to be now driven to serve the needs of investors, not actual manufacturers. As a result of the desire to placate the Wall Street investors, we now have a situation where the goal of the Federal Reserve seems to be not to maintain the long-term health of the nation through careful management of long-term fiscal policy, but to shore up the value of the stock market in the short term.

We saw this desire to placate Wall Street brutally on display just recently. The week ending on Friday, January 18 had seen stocks plunge worldwide on reports of further massive losses incurred by American financial institutions due to the sub-prime mortgage debacle (more on that fiasco later). Monday, January 21 was the Martin Luther King holiday in the US where the exchanges were closed but stocks dropped sharply that day worldwide, and dropped again on Tuesday, January 22 in the far east before the US markets opened on Tuesday morning. Everyone was braced for a massive plunge in the stock market when the US markets opened on Tuesday. But in an effort to prevent this, the Federal Reserve did something it very rarely does, and that was to have an emergency conference call among its governors and decide to slash interest rates by a huge amount (0.75%) before the US markets even opened, as an emergency move on a day when it does not usually make changes in interest rates. This news struck me as a bad sign, that the Fed thought the situation was serious. But the stock market responded with cheers, because low interest rates make money cheaper to borrow and this enables financial speculators to make even more money. The only thing Wall Street loves more than low interest rates is a surprise lowering of interest rates. Then on Wednesday, January 30, at its regular meeting the Fed lowered the interest rates again by another 0.5%. The Dow Jones stock index, which had been in negative territory, suddenly shot up nearly 300 points within an hour of the announcement, before sinking back into negative territory.

To me, the Fed taking such remarkable and dramatic steps meant that they thought the economy was in serious trouble and heading for recession. Recessions are awful things, shutting down companies and throwing lots of people out of work. But for Wall Street investors, all that seems to matter is lower interest rates, whatever the cause. They are already putting renewed pressure on the Fed for further and deeper cuts in interest rates since the last one did not really work as far as they were concerned and merely kept the status quo. They are circling like wolves, essentially demanding that the Fed lower the rates even more, perhaps by even larger amounts. If the Fed does not keep lowering rates, the stock market is likely to decline. We seem to have reached the stage where it is taken for granted that the main role of the Fed is to please Wall Street investors by keeping stock prices high by manipulating interest rates. As long as they do that, the long-term health of the economy seems to be ignored.

Next: The crazy 'stimulus package' – Get your free money here!

POST SCRIPT: The lobbyists' preferences

See which candidates have garnered the support of lobbyists.

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Comments

That Barbara Ehrenreich article is just fantastic. I cannot wait to see what you write about the stimulus package.

Posted by Joshua Terchek on February 5, 2008 03:32 PM

Right now, I'm in a macroeconomics class, doing business cycles. Basically, the reason that the classical economic definition of a recession is still in use is that there is nothing better that's in any way accurate; "hard times" is extremely relative as well as liable to be limited in area.

According to Chalmers Johnson (Blowback, The Sorrows of Empire, and Nemesis), 83% of the manufacturing in this country was strictly military in nature by 1990. We still build a fair amount, but it's all things that very few customers actually want to buy and those things don't themselves produce goods and services.

Posted by Rian on February 5, 2008 06:16 PM

good series. on the general insanity of financial systems and the threat of a meltdown, see the recent writings of the brilliant social scientist gabriel kolko.

memorable paragraph: "What are credit derivatives? The Financial Times' chief capital markets writer, Gillian Tett, tried to find out but failed. About ten years ago some J. P. Morgan bankers were in Boca Raton, Florida, drinking, throwing each other into the swimming pool, and the like, and they came up with a notion of a new financial instrument that was too complex to be easily copied (financial ideas cannot be copyrighted) and which was sure to make them money."

http://www.d-n-i.net/fcs/kolko_global_economic.htm

Posted by disgruntled goat on February 5, 2008 07:10 PM

Rian,

Thanks for reminding me. I had neglected to talk about the weapons industry. You are right, that is a kind of production but a useless kind. Cynics have plausibly argued that the US needs to periodically get involved in wars so that weapons can be destroyed so that new ones will be made. So we now have the permanent wartime economy, producing stuff meant to be destroyed.

Posted by Mano on February 5, 2008 08:08 PM

DG,

Thanks for the link to the Kolko article. It is very sobering. What is worse is that he wrote this in June 2006, before the current subprime meltdown.

Posted by Mano on February 5, 2008 08:12 PM

Johnson calls it 'military Keynesianism'. Basically, most of the growth in the economy has been channeled into public deficit spending, concentrated on the military.

Evidence of this is given by Reagan's speeches at the Rockwell plant when Carter cancelled the B-1 bomber. The Air Force didn't even particularly want the plane because it wouldn't have been very survivable in the strategic bombing of the Soviet Union and it cost about a hundred million dollars apiece. However, that put ten thousand aerospace workers out of work. Rather than those employees finding other gainful employment not building intercontinental bombers, Reagan bought their votes by vowing to reopen the production line.

Now, we have almost 100 B-1B bombers at a total price tag of at least $20 billion. But boy those nice Rockwell workers are still employed!

Posted by Rian on February 5, 2008 10:14 PM