Stanley Fischer’s big bubble

In September 2008 the Bank of Israel raised interest rates. In the face of the global financial chaos all around the world, this was an extremely bold move. For the economy of the State of Israel, the small rise in the rates worked as a stabilizer. For within a year, Israel’s economy showed a growth rate of four-and-a-half percent. The person responsible for the bold move was Stanley Fischer. But Fischer’s actions were isolated; the rest of the world did not fare as well. Now, nearly six years later and trillions of printing-press dollars into the crisis, Stanley Fischer has returned to the mother ship of global finance– the US Federal Reserve.

As a dual citizen (Israel and the US), Stanley Fischer was appointed by President Obama to be second in command at the Fed behind the new chairwoman, Janet Yellen. But this commentary is not specifically about either Mr. Fischer or Ms. Yellen, or any other financial personality, for that matter. This commentary is about a bubble, a gigantic balloon, seventeen trillion dollars in the making (and still growing) with financial implications far beyond September 2008. I call this giant of all bubbles, the global central bank bubble.

It’s not easy to exactly date the start of the bubble. The system began to unravel in the late 1960’s and proceeded throughout the next decade and a half. At that time, the 1970’s was characterized as the worst crisis of capitalism since the “Great Depression”. But unlike the 1930’s, by the the time of the Cold War nuclear weapons had been invented, and a global war in order to cure a deep economic malaise was simply out of the question.

To complicate the situation, the severe recessions of the 1970’s were triggered by a glut of dollars and an inflation which exceeded double digits in the US. Like now, the US dollar was the reserve currency of the world. Because of this fact, large or small national current account deficits could be paid with printed money and not hard, earned currency.

As central banker to the world, the US Federal Reserve could simply print “greenbacks” to its heart’s delight, and as the world’s reserve currency, this money was accepted on the “faith” that it had “backing”. In the post WWII world, this “faith” was established by the US having the dominant position in both the global military and economic realms. As the largest economy in the world, the US also “backed” its privileged currency position with a string of US military bases that spanned the entire globe. To its friends and trading partners, these military bases provided assurance that global commerce could proceed protected and unimpeded.

However, in the 1980’s the inflationary bias of the US economic predicament (the global glut of dollars, caused by the military expansion) became acute. The inflation needed to be purged. During the first Reagan Administration, the Federal Reserve cleansed the system of its dollars by raising interest rates to unprecedented levels. This triggered a huge recession in hopes that wages and prices would decline. Along with this strong medicine, the conservative anti-labor Reagan presidency advanced the structural mechanisms needed to break the workers’ unions by a global expansion of the US manufacturing network. But by the fall of 1987, Wall Street’s financial psychology still remained entrenched in the previous two decades of inflation-recession crises.

With only the slightest hint of an interest rate rise in the air, the stock market speculators (on New York’s famous street) panicked.
The 1987 stock market crash and the defeat of US labor through the globalization of the US manufacturing sectors changed the world. With the reserve currency in place, trade and current account deficits meant nothing to the US Federal Reserve because inflation could be “cured” by simply off-shoring US goods production. Cheap products manufactured overseas meant low inflation at home. Low inflation at home meant that any time there was a financial problem, anywhere in the world, US dollars could ride to the rescue without a domestic inflationary hit. In the aftermath of the “crash of ’87”, the Fed merely engineered a drop in the interest rates, and voila`, problem solved.

The financial world miraculously did not come apart after Alan Greenspan applied his famous “put” on the world’s finances. On the contrary, the inflation-recession crises of the ’60s, ’70s and ’80s morphed into the casino economy of a financial sector. This sector was now insured by the world’s most important central bank, the Federal Reserve. The banks knew that if there was ever a hint of trouble, artificially cheap money could now always bail them out. As US factory production shifted to China, money flowed into the bloated and profitable canyons of Wall St. and the emerging markets of Asia and Latin America. As more and more money is created by lowered interest rates (through loans in the banking system), more and more debt is created.

Most of the new debt went to the wealthy speculators and traders who used their new easy leverage to hedge and arbitrage throughout a global open monetary system. This open-market monetary system had been engineered by the US Government with the creation of such institutions as the GATT (General Agreement on Trade and Tariffs) and the WTO (World Trade Organization). Every economy in the world was now open for business. This included the “communist” economy of China, where US workers were forced to compete against the wages of former peasants.

Just like champagne at a wedding, the bubbles started to flow. In the mid 1990’s, one of the first bubbles to burst was in Mexico. Low interest rates in the US meant that speculators could borrow cheaply in the US and invest in Mexican government bonds which paid a much higher premium due to their higher inflation. This so-called “carry trade” was a sure thing, borrow in the US at a low interest rate for a foreign bond paying a higher return. The world of global financial speculation had arrived. But like all bubbles and “sure things”, sooner or later they had to burst. Once again the Fed came to the rescue, because so many US banks and investors had been involved. The US Federal Reserve was now a global institution. The same thing happened in Asia just four years later. At first the cheap hot money of the speculators advanced the Asian economies, and then the money retreated overnight when better interest-rate returns presented themselves elsewhere.

As the financial sector in the US rose, the manufacturing sector declined. This had become perfectly clear by the year 2000, when the second stock market bubble in thirteen years burst. The so-called dot-com bubble had been a decade in the making and its crash was extremely severe. Money had poured into the US stock market as internet companies (most with limited earnings) took off. The prices on these stocks were outrageous. The cheap money regime at the US Fed meant that the stock price on the tech companies had been bid up so high, that when the crash came five trillion dollars in phony priced shares were lost. Certainly, an economic depression had to follow such a collapse. But not so– once again, the Fed rode to the the rescue. In the aftermath of the crash, interest rates were forced lower and the next bubble began to take form.

But this time the effect of the lost manufacturing took hold. Along with the housing bubble there came a decade of lost employment. Everyone now knows about the global bundling of the bad mortgages and the bursting of US housing prices, which nearly caused the meltdown of the world’s financial system. But what had been less well known, was the complete stagnation of US workers’ income and employment since the aftermath of the last two bursting bubbles, both dot-com and housing. By 2012, the total dominance of the global financial sector had become obvious to everyone. The downturn in jobs and real working incomes (as opposed to investment income) since 2002 had placed the economy in a position of total reliance on financial speculation (bubbles).

Since the near meltdown in 2008, interest rates have been at zero. The balance sheet at the Fed has risen eight times from five hundred billion to four trillion. The US central bank has injected eighty billion dollars of newly printed money into the banking sector on a monthly basis for the last two years. This unprecedented amount has been called “quantitative easing”. Central banks, in emerging markets all over the world, have followed the Fed’s lead. They have done this in order to protect their own fragile export markets. Domestic “easy money” has meant greater debt to finance local third-world housing bubbles. Financial speculators have poured money into countries from Brazil to South Africa to Turkey and beyond. This global “carry trade” (borrow cheap in the US, and buy securities overseas) has propelled an emerging market import bubble (most of it produced in China) and with it a US stock market bubble. Global corporations have sold goods and equipment to overheated economies abroad, but production in the US has not advanced. Meanwhile, US workers are currently mired in the worst jobs and income depression since the 1930’s.

After the last global bubble burst in 2008, Queen Elizabeth II of Great Britain asked why hadn’t even one economist seen the crisis coming? No one could answer her question. This does not bode well for the current predicament. Interest rates cannot remain at zero forever. Sooner or later the reality of the situation will set in. Bubbles are meant to burst. All the financial manipulation in the world cannot allow for any kind of permanence to an economy adrift on greed and the limitless growth of central bank paper. Without a jobs and income recovery for US workers, the “faith” and “backing” of the US dollar cannot be protected at zero interest. Eventually interest rates must rise, and the central bank bubble must burst.

Economic history is littered with the corpses of great powers. In the last two hundred years, they rose as industrial powerhouses and fell as financial dwarfs. Perhaps this could be the answer that the Queen of “little” England could understand. But here, in the US, the closest thing that we have to a royal class are the Wall St. billionaires and their almost self-appointed plutocrats on the Federal Reserve. As the saying goes (and it has been repeated daily in the global economic press): “When it comes to global monetary policy, we are now in uncharted waters”. Could another bubble be about to burst? But more importantly, who will be blamed and what will be the geopolitical ramifications? This is the stark reality of Stanley Fischer’s big bubble.