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Daily Archives: August 18, 2013

Government Finance Quasi-Capitalism

From Doug Noland …..

Bond yields shoot to two-year highs and equities take notice …….

Minsky saw the evolution Capitalist finance as having developed in four stages: Commercial Capitalism, Finance Capitalism, Managerial Capitalism and Money Manager Capitalism. “These stages are related to what is financed and who does the proximate financing – the structure of relations among businesses, households, the government and finance.”

Commercial Capitalism: “The essence of commercial capitalism was bankers providing merchant finance for goods trading and manufacturing. Financing of inventories but not capital investment.”

Early economic thinkers focused on seasonal monetary phenomenon. Credit and economic cycles were prominent, although relatively short in duration.

Finance Capitalism: “Industrial Revolution and the huge capital requirements for durable long-term capital investment… The capital development of these economies mainly depended upon market financing. Flotations of stocks and bonds – securities markets, investment bankers and the Rothchilds, JP Morgan and the other money barons… The great crash of 1929-1933 marked the end of the era in which investment bankers dominated financial markets.”

Managerial Capitalism: “During the great depression, the Second World War and the peace that followed government became and remained a much larger part of the economy… Government deficits led to profits – the government took over responsibility for the adequacy of profits and aggregate demand. The flaw in managerial capitalism is the assumption that enterprise divorced from banker and owner pressure and control would remain efficient… As the era progressed, individual wealth holdings increasingly took the form of ownership of the liabilities of managed funds…”

Money Manager Capitalism: “The emergence of return and capital-gains-oriented block of managed money resulted in financial markets once again being a major influence in determining the performance of the economy… Unlike the earlier epoch of finance capitalism, the emphasis was not upon the capital development of the economy but rather upon the quick turn of the speculator, upon trading profits… A peculiar regime emerged in which the main business in the financial markets became far removed from the financing of the capital development of the country. Furthermore, the main purpose of those who controlled corporations was no longer making profits from production and trade but rather to assure that the liabilities of the corporations were fully priced in the financial market…”

Late in life Minsky wrote “Today’s financial structure is more akin to Keynes’ characterization of the financial arrangements of advanced capitalism as a casino.”

The above quotes were from a Minsky paper published in 1993. That year was notable for the inflation of a major bond market speculative Bubble. This Bubble began to burst on February 4, 1994 when Fed raised rates 25bps.

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In 2001, developments compelled me to update Minsky’s “stages of development of Capitalistic Finance:” “Money Manager Capitalism” had evolved into what I termed “Financial Arbitrage Capitalism.” Traditional money management had given way to the rise of sophisticated market-based financial instruments and financing arrangements. In particular, the new financial and policy backdrop had created auspicious market incentives and financial rewards for leveraging in high-yielding ABS and MBS. This fostered a proliferation of spread trade and myriad sophisticated derivative strategies – all working to fuel asset inflation and Bubbles. Importantly, enormous easy-money speculative profits were increasingly divorced from economic returns in the real economy. Finance, generally, was becoming progressively detached from the real economy.

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In an April 2009 CBB, I began chronicling the “global government finance Bubble.” This Bubble has made it to the foundation of contemporary “money” and Credit – to the perceived safest Credit instruments. At home and abroad, governments and central banks have assumed prevailing roles in both the markets and real economies.

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After much contemplation, I’ve decided it’s again appropriate to update Minsky’s “Stages of development of Capitalist finance.” A couple decades of Financial Arbitrage Capitalism left deep scares in the financial system. The federal government was compelled to essentially nationalize mortgage Credit. To sustain market confidence in the massive overhang of private-sector Credit has required ongoing unprecedented fiscal and monetary stimulus.

Financial Arbitrate Capitalism has also left a deeply maladjusted economic system. It’s an economic structure that requires enormous ongoing Credit expansion (neighborhood of $2 TN annually). The economy is highly unbalanced, with ultra-loose “money” spurring record securities prices and the return of bidding wars in some housing markets – while Detroit files for bankruptcy and 47 million receive food stamps. It’s an economy that runs perpetual trade and Current Account Deficits. The financial backdrop incentivizes stock buybacks, special dividends and cost cutting – as opposed to investment in productive plant and equipment.

I’ll posit that evolution to a consumption and services-based economic structure is an evolution to Credit gluttony. With households highly leveraged and the private sector unable to expand Credit sufficiently to power our structurally deficient economic structure, Credit expansion/inflation it is left to the federal government and the Federal Reserve.

This backdrop has spurred massive Federal deficits, zero interest rates, and unprecedented central bank monetization. Washington policies spur further wealth redistribution and, I would argue, wealth destruction. I’m going to call the new “Minsky Stage” – “Government Finance Quasi-Capitalism” (GFQC).

The government now essentially determines market yields throughout the entire Credit system. The government now basically insures system mortgage Credit and sets mortgage borrowing costs. Massive federal deficits and low Fed-dictated borrowing costs sustain inflated corporate earnings and cash-flows. The Fed has come to believe it is within its mandate to inflate securities and asset prices. It has crushed returns on saving instruments. Amazingly, the Fed believes it is within its mandate to dictate that savers flee the safety of deposits and other “money” for the risk markets.

“Government Finance Quasi-Capitalism” exacerbates fragilities. It fosters ongoing Credit excesses including a historic expansion of non-productive government debt. GFQC and the resulting flow of finance exacerbate imbalances and economic maladjustment. Accordingly, resulting financial and economic fragilities ensure an even bigger role for Washington in the real economy and for the Federal Reserve in the financial markets.

Source: Safe Haven