Too big to jail and no penalty for ‘moneycide’: our economy after the Great Vaporization

When governments reflate an economy after a financial crisis, a market crash and a recession, we are supposed to get higher inflation and the values of reflated currencies are supposed to go down. Interest rates are supposed to go up. This is what many economists continue to tell us.

But none of this is happening – we are into the fifth year and still waiting. What’s happening?

I am going to try to provide a different answer to this question since economists don’t seem to be doing too good a job. They don’t seem to want to talk about money getting killed even though it is the missing piece of the puzzle. I don’t know why economists won’t talk about it but since I am not an economist, I am free to tell the story of how the murder of money got us to where we are today.

This is largely an American story. But it is in part a Canadian story because of the size and proximity of  Canada to the US, the fact that the US is our closest trading partner and the fact that the US currency is the world’s reserve currency.

The story starts in the first years of the new millennium. Three gangs who were trying to make money in new ways rode into the economy and murdered a lot of money.  They took an unbelievably large bag of money out behind the barn – amount unknown – shot it, set it ablaze and left it for dead. Five years later, it turns out that these gangs were not just too big to fail, they were also too big to jail. There seems to be no law protecting an economy from ‘moneycide’.

The way they did this is a matter of public record. The first gang sold mortgages to people they knew would not be able to pay them. The second created their own securities bundling these bad mortgages into something called collateralized debt obligations (CDO’s or funny money) and sold them for real money. A third gang insured this money through something called credit default swaps and tried to set fire to the CDO’s since that’s the only way they could collect on their insurance.

To make a long story short, when the whole thing blew up in 2008-09 causing what I call the ‘Great Vaporization’, there was a whole lot less money around. Why? Because no one would any longer use real money to buy funny money once they realized it was funny money, insurance policies wouldn’t pay off when arson was suspected and you can’t use a house as collateral to pay off a debt if the house is worth less than the money owed on it.

With that, there was no longer enough real money in town to run the economy. So the usual things happened: liquidity dried up, unemployment shot up, markets crashed, and GDP plummeted.

The US Federal Reserve reacted by doing the usual things one step at a time. First they moved interest rates to near zero but this time that was not enough. Too much money had been murdered (vaporized, set ablaze, or shot).

It was at this point that Federal Reserve detective Ben Bernanke rode into town and quickly discovered that a lot of money had been murdered.  His biggest problem was that no one had done any accounting and he did not know how much had been killed off.

He reasoned that since hardly anyone had run away with the money[1] (however much it was) and the economy and the nation was still working, he wondered if maybe he could settle things by replacing some of the murdered money with replacement money.   What would be the problem with that?

Mr. Bernanke probably realized that it would create chaos if he simply printed money and rode it out into the streets in big wheelbarrows giving it out to people that happened to pass by. It was also politically difficult to simply send people checks (although the US did try that for a time).

So the US Federal Reserve made a decision to do something different and started to buy two trillion dollars in securities and paid for them

“…by crediting the bank accounts of the people who sold them to us (the fed). And those accounts at the banks showed up as reserves that the banks would hold with the Fed”[2]

This reflation of the US economy is known as Quantitative Easing and has come in tranches popularly known as QE1, QE2 and slowing it down has come to be known as tapering or ‘the taper’.

With all this new money, liquidity problems were solved, money started to flow and everything started to get back on track.

Yet two problems still dogged detective Bernanke. He still didn’t know how much murdered money he had to replace. Two trillion was a lot but still he hadn’t replaced it all. He knew that because there was no inflation to speak of and the US dollar had not gone down. If he had replaced too much, inflation would have gone up and the value of the dollar would have deteriorated.

‘Wow’ he must have thought…. Two trillion and we still haven’t replaced it all.

Then another thing didn’t go quite as planned. With the replacement money in place, what was supposed to happen in theory was that governments and businesses would spend and consumers would save to pay off their mortgage and other debts.

Trouble was, the exact opposite began to happen. Governments cut back and businesses started to treat the new money in the same way as the money that got murdered.

In Canada, Governor of the Bank of Canada for a time and also our chief money detective, Mark Carney, called the money that got offered to businesses ‘dead money’[3] once he realized that businesses were not investing. What he meant was that even though it was real money, it might as well be dead.

From the point of view of the businesses that got offered the money, they reasoned that if money could get murdered before and the murderers got away with it, then it could happen again. Maybe it would happen in Europe or somewhere else. From Mr. Carney’s point of view, he gave governments and businesses low interest rates making it cheap to borrow and put cash on their balance sheets. Their job was to spend and invest it.

But business couldn’t see anything worth buying so they started to buy themselves up (through share repurchases of their own publicly traded stocks). They reasoned that the purpose of any publicly traded business is to ‘increase shareholder value’ so if you buy your own shares, there are fewer of them, they become scarcer and the price of the shares go up. When this happens a lot, you get a stock market rally.  But the big problem with buying back one’s own shares as the best possible place to invest is that the practice is the equivalent of putting money under the company mattress.  It’s not very productive and eventually not a good way to save.

All of this also has the added effect of creating huge pay packets for the people that run the companies creating enormous inequality which in turn causes Tea Parties and Occupy movements.

Governments also hunkered down and stopped spending. They reasoned that they are like ordinary families that have to balance their books.   But families don’t create their own money nor do they issue bonds and if they tighten their belts, they don’t necessarily put a member of their family out of work.

But none of this mattered and the age of real austerity got going in earnest. The law of the instrument says that if a five year old boy is given a hammer, then everything he sees is a nail. Give some politicians and finance bureaucracies a pairs of scissors and everything they see is a cut.

But as luck would have it, just when the economy was set to back into recession again, the consumer came along and said “I’ll take that offer. I’ll borrow that money you’re offering and I will go out and spend it creating higher GDP and lower unemployment. And so they did and continue to do so.  And housing prices came back (and went up) easing the pressure on mortgages and insurance.

But the economy is still fragile because there will come a day when the consumer is no longer able to borrow and will no longer be able to spend. This great reckoning following the Great Vaporization is near at hand ‘coming to an economy near you’ in part because Canadian consumers owe a$1.60 for every dollar they make. It will also happen soon because the US is getting to the finish line as it relates to fully replacing the money that was murdered. And of course, this explains why our dollar is going down.

To sum it all up, the story ‘reads’ like a western with a twist. Instead of robbing the bank and taking the money, the robbers shot and burned it. Like other people, economists watch westerns and expect the bank robbers to either get away with it or get caught. When neither happens – just like everyone else – they get confused. With the story of the murder and the subsequent Great Vaporization now told, we might not like it but everything starts to make sense.

JS/January 8, 2014


[1]  Some early insurance policies were cashed in – John Paulson in the US redeemed a few.

[2] Ben Bernanke, (Outgoing) US Federal Reserve Chairman, The Federal Reserve and the Financial Crisis, Princeton University Press, 2013, p.105