Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009), which was translated and republished in Chinese (2014). He is researching a book about Ben Bernanke. He writes a blog at www.AuContrarian.com.
“Groups of women were crushing each other…, a real mob, more brutal for covetousness….the furnace-like heat with which the shop was ablaze came above all from the selling, from the bustle at the counters… There was the continuous roar of the machine at work, of customers crowding into the departments, dazzled by the merchandise and then propelled towards the cash-desk. And it was all regulated and organized with the remorselessness of a machine: the vast horde of women were as if caught in the wheels of an inevitable force.”
Émile Zola: The Ladies’ Paradise (1883)
The furnace-like roar to prevent financial immolation must move faster all the time. The Wall Street Journal reported in April that “Xie Daoliang’s business survives by trading almost exclusively in a virtual currency, but not by choice. Mr. Xie makes bulldozer treads and other parts for heavy machinery. These days, when he makes a sale he seldom gets paid in cash. Instead, he gets a piece of paper with a value printed on it and a promise from a bank that it will pay at an arranged point in the future. In China’s economic slowdown, businesses are having troubles paying suppliers, and banks are getting shy about lending, so cash is scarce. The notes-a form of IOUs known as acceptance drafts – are increasingly being used instead, and Mr. Xie says they really get around… ‘At the moment, there’s no cash. It’s all just bills,’ says Mr. Xie… ‘It’s unreasonable.’ Acceptance drafts, which are similar to postdated checks but are guaranteed by a bank or state-owned enterprise, have been a fixture of trade in China for years. But corporate treasurers, chief financial officers, people at small loan firms and analysts say that as the economy slows, cutting into companies’ sales, the bills are being passed around more and more. Driving the exchange of paper, analysts say, is an unwillingness, or inability, by banks to meet demand for cash loans, especially from smaller companies. ‘The credit transmission mechanism is breaking, or even broken,’ said Leland Miller, president of the China Beige Book, a quarterly survey of Chinese businesses and banks. ‘Firms are having a difficult time getting access to funding, and for small firms it’s extraordinarily difficult.'”
A “credit transmission mechanism [that] is breaking, or even broken,” is no way to run a financial economy. A constant infusion, whirling at a faster pace, sustains the world’s flagging non-financial economy.
Two weeks before the stock market crash in 1929, the New Yorker described to its readers the feverish levels of real-estate speculation and desperation: “[M]any contractors of estimable standing are ready to take over the ‘secondary financing’ of not-too-large operations, meaning they will put up most of the cash necessary to complete the building, over and above what the first mortgage provides. They do this in order to keep their operation from falling apart. This loan for the building, which is really a second mortgage, is discounted at some ‘big, friendly bank’, so that the contractor’s money is not tied up after all…”
Without further knowledge it is not possible to know the terms under which the big, friendly bank made the loan. What was the collateral? It is almost certain the collateral booked by the bank received less scrutiny than in 1925 or 1935. The loan for the building (which may never have been built) was expected to move off the books at a profit and at a speed that would prevent the censure of an internal or external audit.
Regarding Mr. Xie’s cashless world; it is in a fix: “Trouble in Chinese property also has implications for the country’s financial system, in particular the shadow banking sector, which has lent huge amounts to developers and relies on highly-priced land for collateral… In an indication of just how exposed China’s economy is to a property downturn, Moody’s… estimates that the building, sale and outfitting of apartments accounted for 23% of Chinese gross domestic product in 2013.” (Financial Times, May 13, 2014)
The October 1929 furnace-like roar was past the commercial building credit peak (though, not past the building peak.) Sources from the time can be contradictory, but support that conclusion. Estimates showed $675,000,000 of real estate bonds had been sold in the United States in 1925. That was “an increase of more than 1,000 per cent since 1920.” Later, calculations would show $54 million were issued in 1921, $752 million in 1925 and $833 million in 1928 – the peak: before $395 million in 1929.
When mortgage-making was accelerating in 2005, faster securitization and deal-making prevented the “real” economy from collapsing. The real economy was missing all the fun. The Bank for International Settlements (BIS – the central bankers’ central bank) made this clear in a 1993 report: “Financial liberalization, innovation and other structural changes in the 1980s created an environment in which excess liquidity and credit were channeled to specific groups and markets. These include large institutions, high-income earners and wealthy individuals, who responded to the incentives associated with the changes. These groups borrowed to accumulate assets in global markets – such as real estate, corporate equities, art, commodities, silver and gold – where the excess credit was apparently recycled several times over.”
On Nov. 12, 2013, in London, “Francis Bacon’s three-paneled painting ‘Three Studies of Lucian Freud’ became the most expensive work of art ever sold at auction on Tuesday when it soared to $142.4 million at Christie’s.” Two days later, in New York, Andy Warhol” set a new all-time record in the pop-artist field, when his “Silver Car Crash (Double Disaster)” sold at NYC auction for $105 million.
On the same day, Narayana Kocherlakota, President of Federal Reserve Bank of Minneapolis spoke on his home turf. He did his best to boost Christie’s stock price: “The Federal Open Market Committee is currently buying $85 billion of long-term assets per month. Recently, there has been an ongoing public conversation about the possibility that the FOMC might reduce its current flow of long-term asset purchases over the next year. The FOMC’s asset purchases push down long-term interest rates, and encourage consumers to spend….” Kocherlakota lost the $85 billion battle. When the stock market falls 20%, the FOMC will double the wager.
Eight days after Kocherlakota fired his salvo at battered consumers, he fired his top two researchers for speaking the truth. That was the indictment of the Minneapolis Star Tribune: “President Narayana Kocherlakota fires his best economists because they spoke the truth.” The newspaper reported: “The departing economists are Patrick Kehoe and Ellen McGrattan, both highly regarded researchers with long tenures in Minneapolis.” (From Bloomberg Economic Briefs: “Minneapolis Fed departing economists Patrick Kehoe and Ellen McGrattan collaborated on a 2008 Minneapolis Fed paper that challenged the efficacy of New Keynesian models in conducting monetary policy analysis. ‘Some macroeconomists think that New Keynesian models are on the verge of being useful for quarter-to-quarter quantitative policy advice. We do not. We argue that the shocks in these models are dubiously structural