classical economics
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Concrete Boots for Bush
By Wayne Jett
© July 9, 2008

I come to bury Caesar, not to praise him.
Julius Caesar, Act III, Scene II, line 53.
Wm. Shakespeare

    Henry M. Paulson Jr. could not be doing a better job of burying the last remnants of the Bush economic recovery of 2003. True, the economic team of the George W. Bush administration was inept from the beginning. The May, 2003, tax cuts that gave birth to economic growth after the Federal Reserve’s 1996-2002 deflationary debacle actually was fashioned by then-chairman of House Ways & Means Bill Thomas (R-CA) after White House ideas lost pulse. Nonetheless, President Bush deserves credit for instinctively recognizing something good when Thomas did his thing. The president threw his support behind the bill and signed it with relish.
    Quibblers on Bush fiscal policy find fault in his accommodative attitude towards congressional spending, with some Republican conservatives condemning overspending as the president’s primary breach of trust with his electors. Compared to the sins of the Federal Reserve, this is a minor stub-toe. Even Congress’ aggressive spending would be entirely submerged by economic growth and federal revenues had the Federal Reserve not shut down economic growth that was finally ignited by the Bush/Thomas tax cuts.
Finding Fault
    Yet, as dismal data of declining jobs and rising unemployment arrived July 3, the press pilloried a hapless Treasury assistant secretary for the failing “Bush economy.” Does this mean Federal Reserve monetary policy is actually set by Treasury, rather than by the “independent” Fed? Or, does it mean Fed policy has had no role in determining the economy’s pitiable condition? Neither is true, of course, despite the Washington Post presentation of the economy as entirely the president’s fault.
    The Federal Reserve’s mercantilist interest rate manipulation during 2004-2006 skewed liquidity flows away from small business and towards higher-risk loans to investment banks, leveraged buyout firms and hedge funds. The result was an orgy of derivative securities speculation followed by a collapse of confidence in credit markets. To relieve the banks of their risk exposure to investment banks, the Fed recently took the unprecedented step of lending to investment banks from its own funds.
    Need the recital of Fed transgressions be extended by mentioning that the dollar is worth less now than at the very bottom of its value in 1980 during the Volcker Fed’s spectacular boondoggle with Keynesian monetarism?
    Regardless, the media story-line remains that Bush policies cause the private economy to struggle, leaving it to the Federal Reserve to rectify problems and crises as best it can. This misperceives or misrepresents reality.
Charming the Federal Reserve
    As a federally chartered but privately owned entity, the Federal Reserve System holds unique powers granted by Congress and previous presidents to issue and manage U. S. currency. Shares issued by each regional federal reserve bank are owned by its member banks, which vote as shareholders to elect directors who, in turn, elect officers. The Federal Reserve Bank of New York has special standing among the regional reserve banks. All Fed open market operations are conducted through the New York Fed and its president is the only regional president with a vote at every meeting of the Federal Open Market Committee. Other regional bank presidents participate in FOMC policy decisions on a rotating basis.
    Through this ownership and management structure, private banks (particularly New York banks) have effective means of influencing policy and practices of the U. S. monetary system. This is true although all seven members of the board of governors are appointed by the president, confirmed by the Senate, and serve staggered terms of 14 years. Ownership of the regional reserve banks provides private bankers as much a platform, probably an even better one, for knowing and influencing monetary policy as nomination of governors affords the president.   
    Still, of those who would influence the Federal Reserve chairman, private banks in New York have only one potentially serious competitor: the U. S. president. Presidential influence of the Fed ordinarily is exerted through the treasury secretary.
Paulson’s Mission
    On July 10, 2006, Henry Paulson Jr. relinquished his office as CEO of Goldman Sachs, the largest and most profitable investment bank on Wall Street, and became secretary of the treasury. Media reports said Paulson got powers of “economic czar” to control economic policy for the Bush administration before accepting the post.
    As when President Bill Clinton selected Goldman Sachs co-chairman Robert E. Rubin as his treasury secretary for 1995-1999, New York banking (and Goldman Sachs, in particular) has been positioned since 2006 to influence Federal Reserve conduct both through the Fed’s ownership structure and through Treasury. Paulson’s selection may be fairly characterized as obtaining skills and knowledge of Wall Street for the benefit of Treasury as adviser to the president. Another fair characterization of Paulson’s appointment is Wall Street co-opting presidential influence of Federal Reserve and other economic policy.
    In retrospect, the latter viewpoint appears more accurate. Results of Paulson’s performance could hardly be more damaging to the president’s economic aspirations. The Fed’s weakening of the dollar that began in 2004 with gold at $380 and reached $650 in July, 2006, continued on Paulson’s watch to an historically low (highly inflationary) value with the gold price above $1,035 per ounce in 2008 before it declined into a range now above $925. Through his tenure, Paulson professed support of a “strong dollar” while doing nothing to establish credibility for the currency.
The Goldman Sachs Plays
    Under Paulson, Goldman Sachs created billions in sub-prime mortgage derivatives, selling them into markets worldwide, but also selling them short. Within six months after Paulson’s move to Treasury, the Federal Reserve stopped injecting new liquidity into the economy. Goldman heavily sold short the ABX index of sub-prime securities. Simultaneously in 2007, the crisis of confidence in sub-prime debt congealed and Goldman’s short-side profits soared into the billions. Timing was perfect, or at least it appeared to be. We can’t be sure because such trading information is treated as confidential and proprietary.
    When the “Enron clause” enacted by Congress in December, 2000, permitted institutions to trade crude oil futures without reporting large transactions to the Commodities Futures Trading Commission, Goldman Sachs pounced immediately with Morgan Stanley and others to organize Intercontinental Exchange (ICE). ICE exploited the opportunity very well, buying a London trader to gain even greater regulatory latitude. ICE profits were so good that its organizers sold some of their shares to the public in an IPO. With ICE’s success has come the rise in price of crude oil from $28 per barrel in January, 2004, to $68 in July, 2006, to $145 in July, 2008.
    Since July, 2006, gasoline prices in the U. S. have risen from $3 per gallon to $4.15, as President Bush’s political standing has tanked. Secretary Paulson assures that nothing other than supply and demand is at work in the markets. Other administration spokesmen parrot those views. Speaking of being at work, unemployment is 5.5 per cent, up from 4.7 per cent in July, 2006, although total employment added about 1.5 million jobs during that interval.
What Might Have Been
    What might Secretary Paulson have done differently to serve the president and the nation better?
1.    He should have given hard-headed, practical Wall Street advice that manipulation of the overnight interest rate destabilizes the dollar, causing inflation and deflation, and ought to be stopped.
2.    He should have genuinely championed free trade by stopping the Fed’s intentional weakening of the dollar as a tactic of trade war. Instead, he tacitly aided Senator Charles Schumer (D-NY) and his allies who threaten higher tariffs if currency manipulation does not achieve their objectives.
3.    He should have heeded the Senate’s report (published as he took office) that trading of crude oil futures in the dark, unmonitored futures markets had caused oil prices to depart historic norms in relation to supply and demand. With encouragement from Paulson, CFTC might actually have done its job on a timely basis.
4.    Since “economic czar” has authority transcending financial regulators such as CFTC and SEC, Paulson should have ordered SEC to stop illegal trading tactics by investment banks, prime brokers and hedge funds. Bear Stearns is only the biggest and most notorious  victim (so far) of intentional failure-to-deliver (counterfeit shares, called “watered stock” in the Roaring Twenties). Many companies have fallen to such attacks and many firms are presently under siege, with little or no sign the SEC is riding to the rescue.
5.    He should have recommended regulatory reform to invigorate criminal prosecution of financial fraud. The SEC presently deflects criminal prosecution through its primary jurisdiction of civil enforcement, again playing its role as Wall Street’s captive regulator. Instead, Paulson proposes to make matters considerably worse by eliminating the SEC and existing law, and granting all financial regulatory authority to the Federal Reserve – the central bank owned by Wall Street!
    The list could go on. Actual results to date are impossible to describe as success, unless the Treasury secretary’s objectives are defined as something other than the best interests of President Bush and the American public. If his goals are to maximize Wall Street influence and profits, and to fit the president’s economic legacy with a pair of concrete boots before slipping it quietly into the East River, Secretary Paulson has succeeded beyond all expectations. ~