The Fed's Solution To Income Stagnation: Make Everyone A Speculator

Tyler Durden's picture

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

The elimination of low-risk interest income in favor of risky speculative credit/asset bubbles has led to a monumental misallocation of capital and the institutionalization of perverse and highly corrosive incentives.

The stagnation afflicting advanced economies has several fundamental causes.

1. The dynamic between rising productivity, higher labor costs and technology replacing human labor has shifted decisively in favor of labor-saving technology: the low-risk, high-yield way to increase productivity and profitability is to replace high-cost human labor with software, automation and robots.

This is true whether the labor being replaced costs $10 a day or $100 a day: the machine can produce the output faster, better and cheaper.

This leads to a conclusion that undermines all existing capitalist/socialist models:wages are no longer a practical means of distributing the surplus generated by the economy.

2. Another is the tectonic shift of energy costs: as the cheap, easily accessible oil is depleted, it costs more to extract and refine substitute fuels from unconventional sources. That pushes the cost of energy to consumers higher for structural reasons. The more a household has to spend on energy, the less disposable income is available to spend on other goods and services.

3. The decades-long postwar rise in prosperity naturally led to more demands for government services and income security. These demands are essentially open-ended--there can never be enough money spent on health, education, old age income security, public security, etc.

Since taxes are levied on income, the stagnation of wages means there are limits on how much more income can be diverted to taxes without negatively impacting household disposable income.

The Powers That Be conjured up a solution to these limitations: debt. The central state filled the gap between tax revenues and spending with borrowed money. Companies and households were encouraged to borrow money (i.e. borrow from future income) to spend in the present.

This credit/debt boom was fueled by financialization, a term for the broadening commoditization of debt and debt instruments. Financialization took off in the early 1980s, with the relaxing of restrictions on credit and credit instruments. It was no accident that the stock and real estate markets quickly reached escape velocity as debt filled the coffers of government, corporations and households with cash.

The essence of financialization is turning debt into a tradeable security that can be leveraged into speculative pyramids. If I loan you $100,000 to buy a house, that loan is called a mortgage. The collateral for the mortgage is the property. In the pre-financialization era, I held the mortgage to maturity (30 years) and collected the interest and principal. This trickle of earnings from interest was the entire yield on the loan.

In the securitized economy, I divide the loan into tranches that are sold to investors like stocks and bonds. I can "cash out" my entire gain in the present, and then sell derivatives on the securitized debt as a form of "portfolio insurance" to other buyers.

Clever financiers can pyramid security on security and debt on debt, all collateralized by debt on one property.

This enables the generation of vast profits not from producing goods and services but from financial churning. The more debt I underwrite, the more I can securitize and the more debt instruments I can conjure out of thin air.

The key ontological (inherent) dynamic of speculative financialization is that pyramiding credit expansions lead to bubbles which eventually pop, wiping out the phantom wealth created by the bubble.

In effect, the central state's (the Treasury, regulatory agencies and the Federal Reserve) policies of low interest rates, easy money and limitless liquidity sought to compensate for the decline of real income by generating speculative income on a vast scale.

The problem is that speculative financialization only benefits speculators with access to nearly free money and the securitization markets--Wall Street financiers, corporate raiders, hedge funds and other financial Elites. These Elites pocketed immense fortunes but very little of this wealth trickled down to households for the simple reason that there is no mechanism for such a transfer except taxes--and this mechanism is controlled by the central state, which is easily influenced by wealth (campaign contributions, lobbying, etc.)

The Federal Reserve and Federal agencies' solution to stagnating household income was to make every homeowner into a speculator. The Great Housing Bubble of the 2000s was the perfection of this strategy: as every home in the nation was floating higher in valuation as the result of an enormous credit/financialization bubble, homeowners were granted a form of "free income" via home equity lines of credit (HELOCs) and second mortgages.

That this increase in home equity was a form of phantom wealth that would necessarily vanish was not advertised as being an intrinsic feature of the solution.

In the wake of the implosion of the housing bubble, the Fed and other central state agencies acted to repeat the exact same strategy of inflating speculative bubbles in widely held assets: stocks, bonds and real estate.

The problem with these current bubbles is that the assets are no longer widely held enough to compensate for stagnant household income. Few households directly own enough stocks and bonds to push the needle of income higher, and the Fed's policy of zero interest rates (ZIRP) has actually deprived middle-income households with savings of hundreds of billions of dollars in interest that once flowed into household coffers.

This elimination of low-risk interest income in favor of risky speculative credit/asset bubbles has led to a monumental misallocation of capital and the institutionalization of perverse and highly corrosive incentives. The policy of incentivizing speculation as the mechanism to compensate for stagnating earned income has been a disaster for households and the nation.

Needless to say, the current bubbles in stocks, bonds and real estate will implode, and the phantom wealth that the bubbles temporarily generated will vanish.

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Boris Alatovkrap's picture

Ivory tower economist is creative describe economic event, but "Stagnation" has only one cause,

Trust is disintegrate.

Not solution by print more money, not solution by lower interest rate, not solution by distribute more wealth, but is time seize bankster-robber and complicit member of political class, and demand justice according to rule of law.

TeamDepends's picture

Our solution:  End the Fed.

Hippocratic Oaf's picture

It's ok, we'll just get one of those many shovel-ready jobs.


Boris Alatovkrap's picture

After 5 year of Barry Boy King fiat handle economy, many shovel-ready job is create... all involve removal of excess accumulation of bovine excrement in Washington, capitol.

101 years and counting's picture

When this bubble pops, then what?  The clueless twit bitch is going to lead the US out of the debacle?  Not a chance.  Once this bubble pops, the depression will finally be realized.....

Bangin7GramRocks's picture

Bullshit! My shineboy says his tips are a sure thing.

RaceToTheBottom's picture

Why worry about risk when you can offload it to Fanny/Freddy?

Risk is for taxpayers....

Banks don't do risk

dick cheneys ghost's picture

synthetic debt.....another example of american exceptionalism

One And Only's picture

All debt is a derivative of future productivity. In a sense, aquring debt is a lot like writing a call option on your future productivity - or synthetic productivity.

It is not exlusive to America.

Harbanger's picture

Socialist states always end up borrowing from bankers to maintain their inefficient govt systems. Most people forget that the Soviet Union collapsed from financial debt.  They had to fork over 100 tons of Gold to the IMF as security for emergency loans.  Here's a 1991 LA Times arcticle describing this,

Flakmeister's picture

Remind us what Debt to GDP for the real socialist states, e.g Sweden and Denmark...

Playing semantics whilst claiming the USSR was a modern social democracy is disingenuous at best and only show that you have no interest in understanding what is actually going on in the world...

Johnny Cocknballs's picture

it's about 43% for Sweden.  What's your point here?  I'll agree that applying "socialist" to the USSR vis a vis Sweden doesn't make much sense, but I think the point being made regards centralization/government planning of the economy, semantics about what "socialism" really means aside.  No?

Ghordius's picture

Johnny, not everybody on ZH uses the "socialist" label in a commonly comprehensible manner. BTW, I have another example to disprove that theory: Romania under the dictatorship of Ceaucescu. A communist regime that paid all of it's sovereign debt back. A very expensive way of telling the IMF... "Fuck You"

Harbanger's picture

So, can we say Romania is a good example of Socialism?

Ghordius's picture

I'd hazard to say that most self-declared socialists would say that Old Nick was not a good socialist, or perhaps even no socialist at all

believe it or not, I'm an old Cold Warrior. I hated and did my (little) part against Communism and the Iron Curtain. yet I studied my enemy

a good example of Socialism? LOL. perhaps China in the last 20 years...

Dr Benway's picture

You all have some good points here. I agree that the term 'socialist' is egregiously misused on ZH, largely as a childish pejorative.


But any discussion of debt levels must include private debt, because in a world with TBTF banks, private debt in effect IS public debt too. The Nordic countries look less rosy if you look at total debt, and will look even worse when the accompanying property bubbles burst.

Harbanger's picture

Over 70% of their GDP is service industry.  Did you forget their financial crisis of the 90's?  The Swedish Model"they previously had, proved not to be sustainable in the long term.  Now their ability to continue to finance their welfare state is tied to the fate of the EU.

Ghordius's picture

which "fate of the EU"? the org in Brussels? the treaties? the free trading zone? meanwhile Sweden is cutting back on welfare since years

Harbanger's picture

Yes, The fate of Brussels that's hinging on being financed by the Fed.  They had to cut their spending in the past because it was unsustainable, it may still be unsustainable, I would like to see them separate from the EU.

Ghordius's picture

completely wrong. I presume you are talking about the Big Trillion Swap between the FED and the ECB. nothing to do with the EU, btw, that's a different club

first, the swap was reversed not long ago. second, it was made so that the FED could bail out the American biz of big megabanks, including "europe based" ones. you know, US Mortgage pyramids that had to be phased out of their humungus leverage, causing an immense short-term need for USDs

buddy, we europeans are net payers/contributors to the American Dream since 1946 and even more blatantly after 1971. and I'm telling you this as an ally and friend

Sweden out of the EU? well, do the Swedes want to?

Harbanger's picture

"buddy, we europeans are net payers/contributors to the American Dream since 1946 and even more blatantly after 1971."

Keep your knickers on buddy. The American dream is only that yall learn to love each other.  European net Payers to the US in what way? war reperations?  Marshall plan?

Ghordius's picture

yes you are pointing to half of the reason why we did it. The Marshall plan (the other being the Soviets). And we opened all our borders for all things American, remember? As part of the payment for it. Another part being a decades long support of a trade imbalance, in form of empty ships and Treasury Bonds coming back to our shores

have you never wondered how it comes that in the 50's and 60's the US was able to shrink it's budget, shrink it's debt, enjoy a huge expansion of it's companies and everybody was able to afford a (leveraged) home? new markets. new buyers of USTs

check on the Marshall Plan's money again. how much did the US Taxpayer really have to pay? how much profited American companies from Hollywood to Disney to Coca Cola to whatever?

I don't expect you to believe me. But you can check on your assumptions and my little claims. From 1946 to 1971, for example, you can even make the gold-backed calculation.

alangreedspank's picture

"Real socialist" states appear so only to outsiders, like you. Otherwise, they are your plain ol' mixed economies with areas that have more, or less freedom than your non-scandinavian model countries depending on the situation you are looking at. You may pay less income tax in the US, but Swedes have school vouchers, for example.

They were "truer" socialist countries back in the 50-70s. They cut back quite a bit since, but you still have mandatory military service...

Flakmeister's picture

Really, please give examples of "truer" socialist contries in the 50s-70s...

Command economies of the Soviet mold don't count as "real socialist" states... Those would the social democracies, you know the ones, higher quality of life, higher happiness by any meausure, and of late those having significantly higher economic freedom than the U.S.. Do you need to google it for you too?

BTW, just because a Fascist state has a few "social" perks like Social Security doesn't make it a socialist state (Big S or little s).... 

alangreedspank's picture

Scandinavian-model countries were more socialistic back in these times (50-mid 70s) than they are now is what I meant.

And socialism does not mean "good outcomes". ie: "The USSR was not a good experiment, therefore, not a socialist country" is wrong. It just means state ownership. The word itself does not entail good, or bad outcomes.

Flakmeister's picture

Now we are on to something...

Hate to break it to you but Socialism is not the equivalent of "state ownership"...

BTW, just how were they "more" socialist back then?

Dr Benway's picture

He's absolutely right, you know. Fiscal difficulties lead Sweden to cut back many of its welfare programs in recent years, there has been privatization, a center-right government is in power and so forth.

(I generally think you have good points though, Flakmeister, and I didn't downvote you if you care about such things.)

Cursive's picture

It's worse than CHS estimates.  It would be fine if the money were sound, but it's not.  It matters nothing if individual investors/speculators lose the value of their debt or equity "investments," but the lifeblood of our economic activity is the currency.  Unfortunately, the Fed has put it all on red in one last gamble at the craps table....

Seasmoke's picture

Think red is the roulette wheel. 

Cursive's picture


Thx.  I'm in the middle of a polar vortex and you want me to stay coherent?  Nothing like a mixed metaphor to really drive home the point!

Oldwood's picture

Tax productivity. That should really make things "go".

Flakmeister's picture

The real problem with financialization is that it enabled demand to be brought forward and new organic demand is dead... You know, that limits to growth thingie...

Ask Uncle Miltie if he still thinks greed is a beneficial driver of macro economics...

One And Only's picture

The REAL problem is not debt per se but the misuse of it.

If I own a company and borrow money (debt) to buy new machinery to help my business grow... well, that's good.

If I run a country and borrow money (sovereign debt) to pay voters to sit at home and collect welfare entitlements...well, that's a bad thing.

The FED ultimately is responsible for creating the inefficiencies like long-term UE, disability recipients, and income inequality. After all - debt =money and the FED has a monopoly of both.

Spastica Rex's picture

I guess free will is a bitch, after all.

Don't tell me how to spend my money.

Flakmeister's picture

So are you claiming that the "welfare state" is responsible for the current American fiscal situation? If so, could you point to any source that supports your claim by breaking down the expenditures?

BTW, it is news to me that the FED has any say in long term UI benefits...

Did it occur to you that that there is currently to much idle capacity worldwide and the the world economy is getting squeezed by oil prices (the sector where all that money being thrown at it is incapable of increasing production capacity) 

Oldwood's picture

Surely not! Just because a huge number of Americans are being paid to sit at home, have kids and buy crap online, should never be construed as anything but positive for the future of our country. We really, really care now, don't we. Onward utopia, where we are free to pursue our love of the arts while not having to worry about things like food, shelter and HEALTHCARE. We have rights now!

alangreedspank's picture

"Idle capacity" is a government construct. It assumes the resources are perfectly in line with what the market needs, but somehow, just don't do much, but really should.

Obviously, that can't be the case after a bubble burst (bubbles burst because of misallocation of resources going on for too long) and while governments are making sure resources are not being reallocated, and repriced.

Flakmeister's picture

Do you actaully believe the nonsense you just wrote?

Remind us of what global car manufacturing capacity is? How does that compare with demand?

alangreedspank's picture

I think my "nonsense" that I "actaully" wrote is actually answering the last paragraph of your sentence. Your inability to process data != nonsense.

Read it again, and let it sink in.

Flakmeister's picture

No, you claim that idle capacity is a gubbmint creation....

That is pure nonsense...

Now if you want to argue that the cleanup of the financial sector was botched and TARP was the equivalent of a financial coup d'etat, you may be on to something...

Living on the oil plateau changes all the rules... And a lot of people are in denial about it..

Dingleberry's picture

the welfare state (like the corporate welfare state ) contributed mightily to our current mess.

There aren't enough zeros in the universe to calculate the cost of liberals gone wild.

Go to any inner city and live there for 5 minutes. See for yourself.

If you dare.

At least liberals get lifetime voters. Too bad those voters will live their lifetimes in misery.


"None are more hopelessly enslaved than those who falsely believe they are free".


Flakmeister's picture

Dingleberry is perfect for you...

Show me the data that backs your claim...

Spastica Rex's picture

You want to see a "lifetime voter?" Go visit a Raytheon factory.

Johnny Cocknballs's picture

Are you arguing that medicaid, medicare, and social security aren't the biggest non-d expenditures?


I'm not being snarky {at the moment} but what is your point?