Central Banks Recruit from Wall Street, Wall Street Runs Central Banks

Central banks have been captured by Wall Street through revolving door politics: (Wikipedia) movement of personnel between roles as legislators and regulators and the industries affected by the legislation and regulation

From the Bloomberg:

Wall Street is again leading to the corridors of central banks.

From Minneapolis to Paris, investors and financiers are increasingly being hired to help set monetary policy less than a decade since the banking crisis roiled the world economy and chilled their public-sector employment prospects.

Academic studies of historical voting records at central banks suggest the new trend may mean an increased bias towards tighter monetary policy.

Last week’s appointment of Neel Kashkari to run the Federal Reserve Bank of Minneapolis as of January means a third of the Fed’s 12 district banks will soon be run by officials with past ties to Goldman Sachs Group Inc.

Kashkari also worked for Pacific Investment Management Co. and managed the U.S. Treasury’s $700 billion rescue of banks during the financial crisis.

The New York Fed’s William Dudley was Goldman’s chief U.S. economist for almost a decade before joining the central bank in 2007, while recently appointed Dallas Fed President Robert Steven Kaplan spent 22 years at Goldman and rose to become its vice chairman of investment banking.

Although Patrick Harker joined the Philadelphia Fed from the University of Delaware he also served as an independent trustee of Goldman Sachs Trust.

It’s not just the Fed. Bank of England Governor Mark Carney and European Central Bank President Mario Draghi both famously worked for Goldman before entering central banking, yet they have recently been joined by others with financial backgrounds.

The new head of the Bank of France, Francois Villeroy de Galhau, spent 12 years at BNP Paribas SA, becoming its chief operating officer in 2011. Meanwhile, in September, Gertjan Vlieghe joined the BOE’s Monetary Policy Committee from hedge fund Brevan Howard having also previously worked for Deutsche Bank AG.

Even if one argues that these officials have noble intentions and have not been tacitly supporting the interests of Wall Street, their policies will most likely be based from perspectives that have been shaped by their previous work experiences. What you see depends on where you stand. In other words, instituted policies will likely manifest on the official's path dependency—FT Lexicon—idea that decisions we are faced with depend on past knowledge trajectory and decisions made, and are thus limited by the current competence base.

So the more recruits from Wall Street, the larger the tendency for policies to be biased in favor of Wall Street.

In the past I enumerated how the FED promotes its interest through underhanded—conflict of interest—ways

1. Self-publication or by influencing the materials that are published in mainstream Journals 

Cato’s Steve Hanke writes, ``One of the reasons the Federal Reserve gets so much good press is that it’s publishing most of it itself” (italics mine)... 

2. Outsource jobs and offer privileges 

Aside from having a say on the articles published on mainstream economic journals, Ryan Grim of the Huffington Post says that the US Federal Reserve has outsourced many of its work to the academia and has equally bestowed intangible benefits and privileges to them... 

3. Influencing public policies through the mainstream networks

One of the advantages of the Fed’s employment of a large external network is to be able to put pressure on public policies that favors its interests.

Huffington Post’s Mr. Grim addresses such conflict of interest issues by citing anew Robert Auerbach work, ``Auerbach concludes that the "problems associated with the Fed's employing or contracting with large numbers of economists "arise"when these economists testify as witnesses at legislative hearings or as experts at judicial proceedings, and when they publish their research and views on Fed policies, including in Fed publications."(all bold emphasis mine)...

Why stop at just self-promotion, outsourcing or influencing mainstream networks?

Why not recruit directly from Wall Street and from academia? (ex-Fed chair Ben Bernanke was a Princeton University professor)

This makes the fourth factor:

To reinforce or strengthen these dynamics, leaders of the central banks have to be recruited from the mainstream financial institutions (Wall Street)/ academia.

At the end of the day, all these converge to point out why central bank policies have been biased towards Wall Street.

Volkswagen scandal: Unintended Consequence from Climate Change Politics

Prolific science author Matt Ridley explains why the Volkswagen scandal represents the unintended consequence from the politicization of Europe's auto industry due to climate change politics. [bold mine]

The Volkswagen testing scandal exposes rotten corruption at the core of regulation. Far from ushering in a brave new world of cleaner air, the technologies adopted by European car makers, driven by policy makers in Brussels, have been killing thousands of people a year through an obsession with lowering emissions of harmless carbon dioxide, at the expense of creating higher emissions of harmful nitrogen oxides. 

There is a lesson here that goes much wider than the car industry, the clean-air debate and even the regulation of business. The scandal is a symptom of the political world’s obsession with directing and commanding change, rather than encouraging it to evolve.

The great European switch to diesel engines was a top-down decision as a direct result of exaggerated fears about climate change. Convinced that the climate was about to warm rapidly, and extreme weather was about to get much worse, European governments signed the Kyoto protocol in 1997 and committed to reducing emissions of carbon dioxide in the hope that this would help. In the event, the global temperature stopped rising for 18 years, while droughts, floods and storms also showed no increase.

But in 1998, urged on by EU transport commissioner Neil Kinnock, welcomed by environment secretary John Prescott and acted on by chancellor Gordon Brown, Britain happily signed up to an EU agreement with car makers that they would cut carbon dioxide emissions by 25% over ten years. This suited German car makers, specialists in Rudolf Diesel’s engine design, because diesel engines have 15% lower CO2 emissions than petrol engines.

The EU agreement was “practically an order to switch to diesel”, says one clean-air campaigner. As subjects of Brussels, Britain obediently lowered tax on diesel cars, despite knowing that they produce four times as much nitrogen oxides as petrol, and 20 times as many particulates, both bad for human lungs.

The story is almost a textbook case of why top-down regulation can be so dangerous. It lets single-issue pressure groups set targets with no thought to collateral damage, and imposes regulation that inevitably gets captured by those with a vested interest. Regulation also often stifles innovation. We may never know just how much innovation in cleaner petrol engines was prevented.

Pls read the rest here

I can't resist a good quote when I see one...more from Mr. Ridley 

Dirigisme often does real harm. Telling people to eat less fat, based on a few dodgy studies in the 1950s that purported to find a link to heart disease, has probably worsened obesity by encouraging high-carbohydrate food. Discouraging electronic cigarettes, in the demonstrably wrong belief that they increased rather the decreased smoking, is slowing progress in the fight against smoking. Deliberately mandating that banks and government-sponsored enterprises (Fannie Mae and Freddie Mac) make or purchase sub-prime loans, as Bill Clinton and George Bush both did as a way of trying to raise home ownership among ethnic minorities, was a major contributor to the crash of 2008.

Equating order with control retains a powerful intuitive appeal, as the American social theorist Brink Lindsey has pointed out: ‘Despite the obvious successes of unplanned markets, despite the spectacular rise of the Internet’s decentralized order, and despite the well-publicized new science of “complexity” and its study of self-organizing systems, it is still widely assumed that the only alternative to central authority is chaos.’

That's because economic and political myths are popularized by media, political agents and their cronies.

Video: Special Interest Groups and Not Voters Influence Political Landscape in America

The following video, originally entitled “Corruption is Legal in America” by represent.us, trenchantly describes not only how corruption is legal in the US, but more importantly, how corruption has endemically been embedded into the system from which corruption became legal.

It is also interesting to see how the popular concept of representative government (seen from academic theory) works in complete departure from reality where voters have little influence on the legal landscape. Instead, the current political economic environment has been dominated by special interest groups via public choice, regulatory capture and revolving door politics.

Because of the enormous windfalls or colossal return of investments when political mandates have been enacted on their favor, many corporations resort to them.

The lesson here shouldn’t be seen only in the frame of US politics but also applies to other representative governments as the Philippines.

(hat tip Gary North/LewRockwell.com)

A Study on Crony Capitalism: How the Geithner Connection boosted Wall Street Stocks

Interesting study from distinguished mainstream economists.

From the Wall Street Journal Real Times Economic Blog

Want to boost your stock prices during a financial crisis? Build ties to the next Treasury secretary.

A research paper published by the National Bureau of Economic Research finds that investors bid up shares of a handful of financial firms after news leaked that Timothy Geithner would be nominated for the top post at Treasury in 2008.

“This return was about 6% after the first full day of trading and about 12% after 10 trading days,” Massachusetts Institute of Technology economists Daron Acemoglu and Simon Johnson, University of California at Berkley economist Amir Kermani,University of Connecticut professorJames Kwak and Brigham Young University professor Todd Mittonwrote.

The reason for outperforming shares was a unique set of circumstances — the financial crisis — coupled with the revolving door between Wall Street and Washington that investors expected would bring officials to Mr. Geithner’s side, the authors write.

“Excess returns for being connected to Geithner reflect the market’s expectation that, during a period of turbulence and unusually high policy discretion, the new Treasury secretary would need to rely on a core group of employees and a small social network for real-time advice — and that these employees were likely to be hired from financial institutions with which Geithner had connections,” the authors surmise.

Click on this link to the paper

I have noted in July 2012 how the New York Fed bragged about the influence of their policy in pushing up US Stocks, the GAO audit which found the Fed’s largesse of $16 trillion in bailouts have benefited Wall Street and foreign banks during the 2007-8 crisis and lately how QE 3.0 continues to bailout foreign banks (by $1 trillion in cash as of April 2013—according to the Zero Hedge)

In the meantime, former Treasury Secretary Tim Geithner today has been reported to have taken a job in one of Wall Street’s companies. The regulator is now the regulated. This is an example of the Wall Street-US government revolving door phenomenon in action.

The above serves as more proof of legalized insider trading by means of unilateral policies designed to boost the interest of special groups with deep political connections at the expense of society.

Let  us not forget that the US government’s vast tentacles influences mainstream ‘expert’ opinion indirectly via job contracts and career opportunities.

In terms of the US Federal Reserve’s clout, according to a Huffington Post article in 2008 (bold mine)

The Federal Reserve's Board of Governors employs 220 PhD economists and a host of researchers and support staff, according to a Fed spokeswoman. The 12 regional banks employ scores more. (HuffPost placed calls to them but was unable to get exact numbers.) The Fed also doles out millions of dollars in contracts to economists for consulting assignments, papers, presentations, workshops, and that plum gig known as a "visiting scholarship." A Fed spokeswoman says that exact figures for the number of economists contracted with weren't available. But, she says, the Federal Reserve spent $389.2 million in 2008 on "monetary and economic policy," money spent on analysis, research, data gathering, and studies on market structure; $433 million is budgeted for 2009.

That's a lot of money for a relatively small number of economists. According to the American Economic Association, a total of only 487 economists list "monetary policy, central banking, and the supply of money and credit," as either their primary or secondary specialty; 310 list "money and interest rates"; and 244 list "macroeconomic policy formation [and] aspects of public finance and general policy." The National Association of Business Economists tells HuffPost that 611 of its roughly 2,400 members are part of their "Financial Roundtable," the closest way they can approximate a focus on monetary policy and central banking…

The Fed keeps many of the influential editors of prominent academic journals on its payroll. It is common for a journal editor to review submissions dealing with Fed policy while also taking the bank's money. A HuffPost review of seven top journals found that 84 of the 190 editorial board members were affiliated with the Federal Reserve in one way or another.

In short, the Wall Street-US Government ties run deep and have not been limited to revolving door political relationships, but likewise in the realm of dissemination of information.

Video: Revolving Door Relations Between Pentagon and Defense Contractors

The following investigative video is another wonderful example of crony capitalism. This can be seen through the lens of the political relationship between the military industrial complex and the Pentagon.  

We see how regulatory capture has evolved into revolving door relationships--former regulators (military officers) end up as officials for defense contractors, and where intense lobbying in shaping public policies, channeled through these former insiders, has reaped enormous "rent" profits for politically privileged firms. 

The implication is that the interventionist US "imperial" foreign policies (warfare state) are likely manifestations of the advancements of the interests of such clique.  

The Goldman Sachs-Central Banking Connection

Ever wonder why policy directions trends have increasingly been skewed towards promoting the interests of the bankers? 

EPJ’s Bob Wenzel writes,

With the appointment of Mark Carney to head the Bank of England, three major central banks will be headed by former Goldman Sachs banksters. Mario Draghi is ECB president, and William Dudley is the head of the Federal Reserve Bank of New York. Both, like Carney, are ex-Goldmanites.

More evidence of Revolving door politics.

Quotes of the Day: How QE ‘Forever’ Represents Regulatory Capture and Crony Capitalism

Both quotes from Randall Holcombe at the Independent Institute

On regulatory capture

The basic logic behind the capture theory of regulation is that while the general public is largely ignorant of the regulator’s activities, those in the regulated industries are well-informed, and pressure regulators for favorable regulation. Furthermore, information about regulated industries is largely under the control of those in the industry, and personal connections between regulators and the regulated also influence regulatory outcomes. The result is that regulatory agencies act as agents for those they regulate, not the general public.

The Federal Reserve Bank’s recent QE3 announcement that they will be buying $40 billion in mortgage-backed securities a month for an indefinite period of time is an excellent example of regulatory capture. Under Chairman Bernanke, the Fed has successfully pushed to increase its regulatory role over the financial industry, and Stigler’s capture theory would predict that the Fed, as a financial regulator, would act to benefit the financial industry it regulates…

Just like the government’s purchase of Chevy Volts, the Fed is creating demand for a product (morgtage-backed securities) that is in weak demand, for the benefit of the industry it regulates.

On Cronyism

The Fed is buying the products of the financial industry—the mortgage-backed securities—just like the Defense Department is buying Volts that are the product of GM. In both cases, the purchases are designed to increase the demand for a product the government wants to support, for the benefit of the producers of the product.

If there are any differences, they are (1) that, as I noted above, the Defense Department may actually have a use for automobiles, but the Fed has no use for mortgage-backed securities, and (2) the scale of the operation. There’s a big difference between a purchase of $60 million in total and on-going purchases of $40 billion a month. So, looking at these two examples, QE3 is much more clearly an example of crony capitalism—designed to benefit cronies in the real estate and financial industries—and QE3 is crony capitalism on a much more massive scale.

How Italian Renaissance Bankers Bought off the Church

From at Mary Tao at the New York Fed Research Library (hat tip Bob Wenzel)

What do the Italian Renaissance and the Great Depression have in common? Commissioned works of art, Italian Renaissance methods of fresco painting, and themes of banking and money.

During the fourteenth through the sixteenth centuries, many Florentine bankers hired artists to produce devotional paintings and then donated those pieces to the Catholic Church to offset the Church’s disapproval of interest-bearing loans. Since usury was very much frowned upon, this practice of buying penance did not sit well with one Friar Girolamo Savonarola. He was such a vocal critic of the donations that he arranged for bonfires of “vain, lascivious, or dishonest things” (including many Renaissance artworks) in 1497 and 1498. The Medici Bank, the largest bank at that time, had much success in evading the ban on usury; its collapse in 1494 gave Savonarola leverage in his cause. The recent Florentine exhibit Money and Beauty. Bankers, Botticelli and the Bonfire of the Vanities depicts “how the modern banking system developed in parallel alongside the most important artistic flowering in the history of the Western world.”

Buying penance is as relevant today as it has been during the Renaissance. Many wealthy citizens indulge in huge donations to their respective churches or lavish on pilgrims in the hope of acquiring spiritual salvation.

While the activities of Italian bankers in the renaissance may not be about salvation, it had been about political influence peddling. It could also be seen as the natural impulse to arbitrage politics.

Of course flourishing of trade has been a critical factor in the “artistic flowering” or the “rebirth of learning” in the history of the Western world.

To quote the late Professor Sudha Shenoy,

It was the Muslims who saved the Latin and Greek texts during the European dark ages. This led to the Renaissance in due course. The Italian merchants learned their business methods from Islam. There is a commercial history, and a history of tolerance, that needs to be recaptured.

Ron Paul: Federal Reserve System is the Epitome of Crony Capitalism

Here is the gist of US congressman Ron Paul’s courageous talk before the Committee on Financial Services, Subcommittee on Domestic Monetary Policy & Technology, United States House of Representatives, May 8, 2012 (From Lew Rockwell)

Much confusion exists over what the Federal Reserve System actually is. Some people claim that is a secret cabal of elite bankers, while others claim that it is part of the federal government. In reality it is a bit of both. The Federal Reserve Board is a government agency, while the Federal Reserve Banks are privately-run government-chartered institutions, and monetary policy decisions are made by the Federal Open Market Committee, which has members from both the Board and the Reserve Banks.

The Federal Reserve System is the epitome of crony capitalism. It exemplifies the collusion between big government and big business to profit at the expense of the taxpayers. The Fed's bailout of large banks during the financial crisis propped up poorly-run corporations that should have gone under, giving them an advantage that no other business in the United States would have received. The bailouts continue today, as banks maintain $1.5 trillion worth of excess reserves at the Fed, reserves which were created through the Fed's purchase of worthless securities from banks. The trillions of dollars that the Fed has injected into the system have the goal of forcing down interest rates. But the Fed fails to realize that interest rates are a price, the price of money and credit, and that forcing interest rates down will only create an even bigger bubble and an enormous economic depression when this entire house of cards comes falling down.

The Federal Reserve is statutorily required to focus on three aims when engaged in monetary policy: full employment, stables prices, and moderate long-term interest rates. In practice, only the first two have received any attention, the so-called "dual mandate." Some reformers have called for the full employment mandate to be repealed, in order to allow the Fed to focus solely on stable prices. But these critics ignore the fact that stable prices are not a desirable goal. After all, with increasing productivity and technological innovation, the natural trend for most goods is for prices to decrease. By calling for the prices of goods to remain stable, the Fed would have to inflate the money supply in order to counteract this trend towards price declines, pumping new money into the system and creating economic distortions. This is exactly what happened during the 1920s, as the Fed's monetary pumping was masked by rising productivity. The result was stable prices, but the malinvestment caused by the Fed's loose monetary policy became evident by 1929. There is no reason to expect that focusing on stable prices today would have a dissimilar outcome.

Other reformers have called for changes to the composition of the Federal Open Market Committee, the body which sets the Fed's monetary policy objectives. On Constitutional grounds, the FOMC is undoubtedly problematic, as government appointees and the heads of the private Federal Reserve Banks work together to set monetary policy objectives that directly impact the strength of the dollar. While all of the members of the FOMC ought to be confirmed by the Senate, debates about the size of the FOMC or whether Reserve Bank Presidents should make up a majority of the members or whether they should even serve at all are largely a sideshow. While the only dissent to monetary policy decisions in recent years has come from Reserve Bank Presidents, there is no reason to think that expanding the FOMC to include more Reserve Bank Presidents would lead to any greater dissent or to any substantive changes to the conduct of monetary policy.

Another proposal for reform is for outright nationalization of the Fed or its functions. No longer would the Fed create money; that function would be taken up by the Treasury, issuing as much money as it sees fit. No longer would the Treasury issue debt to cover fiscal deficits, it would just issue new money to cover budget shortfalls. If what the Fed does now is bad, allowing the Treasury to print and issue money at will would be even worse. These types of proposals hearken back to the days of the first greenbacks, which the U.S. government began issuing in 1863. A pure fiat paper currency, unbacked by silver or gold, the greenbacks were widely reviled. Only once the greenbacks were made redeemable in gold were they accepted by the American people. The current system of Federal Reserve Notes is even worse than the greenback era in that there is no hope that they will ever be redeemable for gold or silver. The only limiting factor is that the Federal Reserve System only creates new money when purchasing assets, normally debt securities. Allowing the federal government to print money without at least a nominal check on the amount issued would inevitably lead to a Weimar-like hyperinflation.

So what then is the solution? The Fed maintains that a paper standard can be adequately managed without causing malinvestment, inflation, or other economic distortions. If the Fed were omniscient and knew the wishes, desires, and future actions of all Americans, this might be possible. But the Fed cannot possibly aggregate or act on the information necessary to engage in monetary policy. The actions of hundreds of millions of individuals, all seeking to better their position in life, acting purposefully towards that aim, cannot possibly be compiled into aggregates or calculated through mathematical equations or econometric models. Neither a single person, nor the members and staff of the FOMC, nor millions of people with millions of computers working in a new Goskomtsen will ever be able to accumulate, analyze, and act upon the information required to create a centrally planned monetary system. Centrally planned fiat paper standards such as the one currently in place in this country are doomed to failure.

This brings us to the question of the gold standard. The era of the classical gold standard was undoubtedly one of the greatest eras in human history. For a period of several decades in the late 19^th century, largely uninterrupted by war, the West made enormous advances. Economic productivity increased, art and culture flourished, and living standards rose so that even the poorest citizens lived a life their forebears could have only dreamed of.

But the problem with the gold standard is that it was run by the government, which exercised a monopoly over monetary affairs. The temptation to suspend gold redemption, so often resorted to by governments throughout history, reared its head again with the outbreak of World War I. Once the tie to gold was severed and fiscal restraint thrown to the wind, undoing the damage would have required great fiscal austerity on the part of governments. Emancipated from the shackles of the gold standard, the Western world proceeded to set up a gold-exchange standard which lasted not even a decade before the easy money policies it enabled led to the Great Depression. While returning to the gold standard would certainly be far better than maintaining the current fiat paper system, as long as the government retains the power to go off gold we may end up repeating the same mistakes that occurred from 1934 to 1971 as the government went first off the gold coin standard and finally off the gold bullion exchange standard.

The only viable solution for monetary stability is to get government out of the money business permanently. The way to bring this about is through currency competition: allowing parallel currencies to circulate without any one currency receiving any special recognition or favor from the government. Fiat paper monetary standards throughout history have always collapsed due to their inflationary nature, and our current fiat paper standard will be no different. The Federal Reserve is currently sowing the seeds of its own destruction through its loose and reckless monetary policy. The day of reckoning may still be many years in the future, but given the lack of understanding on the part of the Federal Reserve's decision makers, it is quickly coming upon us.

Incidentally and ironically archrivals Ron Paul and Fed Chair Ben Bernanke had a face to face breakfast meeting the following day.

Here’s the Wall Street Journal Blog reporting on what transpired.

Still, Wednesday’s breakfast brought together two figures who publicly agree on very little. A longtime critic of paper currency and fan of the gold standard, Mr. Paul’s fiery Fed-bashing has enthused his campaign trail supporters, who often start rallies with loud chants of “end the Fed!”

Mr. Bernanke, meanwhile, dedicated a significant chunk of his first lecture at George Washington University in March to enumerating the flaws associated with a system in which the dollar is valued at a fixed price per unit of gold.

So did Wednesday’s meeting overturn any deep-set beliefs?

“He’s for the gold standard now,” joked Mr. Paul.

End the Fed. End Central Banking. End the politicization of money.

Quote of the Day: Unintended Consequences of Regulations

Unregulated, a business’s reputation is its most valuable asset. A regulated business does not have the same problem, so long as it obeys the regulations. Regulations replace the overriding need for a business to protect its reputation, and it is no longer solely concerned for its customers: the rule book has precedence. And the more regulation replaces reputation, the less important customers become. Nowhere is this more obvious than in financial services…

The regulators assume the public are innocents in need of protection. They have set themselves up to be gamed by all manner of businesses intent on using and adapting the rules for their own benefits at the expense of their customers. These businesses lobby to change the rules over time to their own advantage and hide behind regulatory respectability, as clients of both MF Global and Bernie Madoff have found to their cost.

That’s from Alasdair Macleod at the GoldMoney.com

Actually this has represented more of the anatomy of crony capitalism and too big too fail corporations. Interventions upon interventions, through regulations, ultimately leads to politically captured industries.

The Illusions of Technocracy

Professors Daron Acemoglu and Simon Johnson writes,

In 1979 Paul A. Volcker became chairman of the Fed and tamed inflation by raising interest rates and inducing a sharp recession. The more general lesson was simple: Move monetary policy further from the hands of politicians by delegating it to credible technocrats.

I hope the world operates in such simplicity. We just hire the right persons of virtue and intellect and our problems would vanish.

But that’s not the world we live in.

First of all, too much credit has been given to the actions of ex-US Federal Reserve chief Paul Volcker, who may just be at the right place at the right time.

Here is Dr. Marc Faber on Paul Volcker, (bold emphasis mine)

In the 1970s, the rate of inflation accelerated, partly because of easy monetary policies, which led to negative real interest rates, partly because of genuine shortages in a number of commodity markets, and partly because OPEC successfully managed to squeeze up oil prices. But by the late 1970s, the rise in commodity prices led to additional supplies and several commodities began to decline in price even before the then Fed chairman Paul Volcker tightened monetary conditions.

Similarly, soaring energy prices in the late 1970s led to an investment boom in the oil- and gas-producing industry, which increased oil production while at the same time the world learned how to use energy more efficiently. As a result, oil shortages gave way to an oil glut, which sent oil prices tumbling after 1985.

At the same time, the US consumption boom that had been engineered by Ronald Reagan in the early 1980s (driven by exploding budget deficits) began to attract a growing volume of cheap Asian imports, first from Japan, Taiwan, and South Korea, and then, in the late 1980s, also from China.

I would therefore argue that even if Paul Volcker hadn't pursued an active monetary policy that was designed to curb inflation by pushing up interest rates dramatically in 1980/81, the rate of inflation around the world would have slowed down very considerably in the course of the 1980s, as commodity markets became glutted and highly competitive imports from Asia and Mexico began to put pressure on consumer product prices in the USA.

Then, markets had already been signaling the unsustainability of Fed induced inflation which had been underpinned by real market events as oversupply and globalization. Thus, Paul Volcker’s actions may have just reinforced an ongoing development.

In short, lady luck may have played a big role in Mr. Volcker’s alleged feat.

Next, looking at the world in a static frame misleads.

Conditions today are vastly dissimilar from the conditions then, as I recently wrote,

Circumstances during Mr. Volker’s time have immensely been different than today. There has been a vast deepening of financialization of the US economy where the share of US Financial industry to the GDP has soared. In short, the financial industry is more economically (thus politically) important today than in the Volcker days. Seen in a different prism, the central bank-banking cartel during the Volcker era has not been as embedded as today.

Yet how did this came about?

According to Federal Reserve of Dallas Harvey Rosenblum

Banks have grown larger in recent years because of artificial advantages, particularly the widespread belief that government will rescue the creditors of the biggest financial institutions. Human weakness will cause occasional market disruptions. Big banks backed by government turn these manageable episodes into catastrophes

Put differently, public policies or regulations spawn a feedback mechanism between regulators and the regulated through human interactions.

Laws and regulations don’t just alter the incentives of the market participants, they foster changes in the relationship between political authorities and the regulated industry.

More laws tend to increase or deepen the personal connections and communications between authorities and the regulated. This magnifies opportunities to leverage personal relationships where market participants seek concessions or compromises from their regulatory overseers, which leads to political favors, corruption, influence in shaping policies and the ‘captured’ regulators. And such relationships bring about the insider-outsider politics as evidenced by revolving door syndrome.

As human beings we live in a social world. The idea where “virtue” and knowledge are enough to shield political authorities from the influences of the regulated and or the political masters of public officials and or from personal ties, represents a world of ivory towers, and simply is fiction.

The true reason behind the illusions of technocracy as stated by Murray N. Rothbard, (bold emphasis added)

There are two essential roles for these assorted and proliferating technocrats and intellectuals: to weave apologies for the statist regime, and to help staff the interventionist bureaucracy and to plan the system.

The keys to any social or political movement are money, numbers, and ideas. The opinion-moulding classes, the technocrats and intellectuals supply the ideas, the propaganda, and the personnel to staff the new statist dispensation. The critical funding is supplied by figures in the power elite: various members of the wealthy or big business (usually corporate) classes. The very name "Rockefeller Republican" reflects this basic reality.

While big-business leaders and firms can be highly productive servants of consumers in a free-market economy, they are also, all too often, seekers after subsidies, contracts, privileges, or cartels furnished by big government. Often, too, business lobbyists and leaders are the sparkplugs for the statist, interventionist system.

What big businessmen get out of this unholy coalition on behalf of the super-state are subsidies and privileges from big government. What do intellectuals and opinion-moulders get out of it? An increasing number of cushy jobs in the bureaucracy, or in the government-subsidized sector, staffing the welfare-regulatory state, and apologizing for its policies, as well as propagandizing for them among the public. To put it bluntly, intellectuals, theorists, pundits, media elites, etc. get to live a life which they could not attain on the free market, but which they can gain at taxpayer expense--along with the social prestige that goes with the munificent grants and salaries.

This is not to deny that the intellectuals, therapists, media folk, et al., may be "sincere" ideologues and believers in the glorious coming age of egalitarian collectivism. Many of them are driven by the ancient Christian heresy, updated to secularist and New Age versions, of themselves as a cadre of Saints imposing upon the country and the world a communistic Kingdom of God on Earth.

Bottom line: Technocrats are no different than everyone else. They are human beings. They may have specialized knowledge covering certain areas of life, but they don’t have general expertise over the complex world of interacting human beings and of nature.

Technocrats have not been bestowed with omniscience enough to know and dictate on how we should live our lives. Instead, technocrats use their special ‘knowledge’ to advance their personal interests, by short circuiting market forces through politics, and who become tools for politicians or vested interest groups.

And that's why they are technocrats, they are afraid to put their knowledge to real tests by taking risks at the marketplace and rather hide behind the skirt of politics.

Thus, the idea of political efficacies from the philosopher king paradigm through modern day technocratic governance is a myth.

Transparency Issues on the US Federal Reserve

Former IMF chief Economist Simon Johnson takes the US Federal Reserve to task for their lack of transparency,

The Wall Street Journal reported on Tuesday that during the 1980s the Fed’s board held 20 to 30 public meetings a year, but these dwindled during the Greenspan years to fewer than five a year in the 2000s and “only two public meetings since July 2010.” At the same time, “the Fed has taken on a much larger regulatory role than at any time in history” — including “47 separate votes on financial regulations” since July 2010, The Journal said.

This high level of secrecy is a concern. It is particularly alarming when combined with the disproportionate access afforded to industry participants in the arguments about what constitutes sensible financial reform.

Just on the Volcker Rule — the provision in Dodd-Frank to limit proprietary trading and other high-risk activities by megabanks — Fed board members and staff members apparently met with JPMorgan Chase 16 times, Bank of America 10 times, Goldman Sachs nine times, Barclays seven times and Morgan Stanley seven times (as depicted in a chart that accompanies the Wall Street Journal article).

How many meetings does a single company need on one specific issue? How many would you get?

For example, Americans for Financial Reform, an organization that describes itself as “fighting for a banking and financial system based on accountability, fairness and security,” met with senior Federal Reserve officials only three times on the Volcker Rule. (Disclosure: I have appeared at public events organized by Americans for Financial Reform, but they have never paid me any money. I agree with many of its policy positions, but I have not been involved in any of their meetings with regulators.)

Americans for Financial Reform works hard for its cause, and it produced a strong letter on the Volcker Rule — as did others, including Better Markets and Anat Admati’s group based at Stanford University.

Based on what is in the public domain on the Fed’s Web site, my assessment is that people opposed to sensible financial reform — including but not limited to the Volcker Rule — have had much more access to top Federal Reserve officials than people who support such reforms. More generally, it looks to me as though, even by the most generous (to the Fed) account, meetings with opponents of reform outnumber meetings with supporters of reform about 10 to 1.

According to those records, for example, the Admati group has not yet managed to obtain a single meeting with top Fed officials on any issue, despite the fact that the group’s members are top experts whose input is welcomed at other leading central banks. To my definite knowledge, they have tried hard to engage with people throughout the Federal Reserve System; some regional Feds are receptive, but the board has not been – either at the governor or staff level…

I do not understand the Fed’s attitude and policies — if it is serious about pushing for financial reform. No doubt they are all busy people, but how is it possible they have time to meet with JPMorgan Chase 16 times (just on the Volcker Rule) and no time to meet Anat Admati – not even for a single substantive exchange of views?

People’s actions are driven by incentives or purpose behavior. So are the actions of those running government bureaucracies. The fundamental difference is that the incentives of bureaucrats are prompted for by political exigencies against market participants who are guided by profits and losses.

Researcher Jane Shaw expounds on the public choice theory

Their incentives explain why many regulatory agencies appear to be "captured" by special interests. (The "capture" theory was introduced by the late George Stigler, a Nobel Laureate who did not work mainly in the public choice field.) Capture occurs because bureaucrats do not have a profit goal to guide their behavior. Instead, they usually are in government because they have a goal or mission. They rely on Congress for their budgets, and often the people who will benefit from their mission can influence Congress to provide more funds. Thus interest groups—who may be as diverse as lobbyists for regulated industries or leaders of environmental groups—become important to them. Such interrelationships can lead to bureaucrats being captured by interest groups.

The political relationship between the regulator and the regulated always impels for a feedback mechanism, such as lobbying, as the regulated will always find ways to circumvent or to relax on the rules which restricts or inhibits their actions. And the typical outgrowth to such relationship has always been the lack of transparency, revolving door relationships (Wikipedia: movement of personnel between roles as legislators and regulators and the industries affected by the legislation and regulation and on within lobbying companies), logrolling and corruption. Such "conflict of interests" relationships frequently make regulatory agencies “captured” by special interest groups.

And what is the ultimate cause for this?

To quote Milton Friedman in Capitalism and Freedom

Any system which gives so much power and so much discretion to a few men that mistakes – excusable or not – can have such far-reaching effects is a bad system. It is a bad system to believers in freedom just because it gives a few men such power without any effective check by the body politic – this is the key political argument against an "independent" central bank. But it is a bad system even to those who set security higher than freedom. Mistakes, excusable or not, cannot be avoided in a system which disperses responsibility yet gives a few men great power, and which thereby makes important policy actions highly dependent on accidents of personality. This is the key technical argument against an "independent" bank. To paraphrase Clemenceau, money is much too serious a matter to be left to the Central Bankers.

In short, the kernel of the transparency issues surrounding the US Federal Reserve has been about the negative ramifications from the centralization of power. Conflicts of interests and regulatory capture signifies as issues which won’t go away for as long political power (in relation to money, but applies elsewhere) remain concentrated to a few men. The more the power assumed by central bankers, the greater the risks of political indiscretions and secrecy.

Thus, the transparency issue can be resolved by the abolishment of central banks.

This means, yes, End the Fed.

Video: Explaining Regulatory Capture

The following video from EconomicFreedom.org features the fundamental concept of Regulatory Capture as explained by George Washington University professor Susan Dudley.

(Hat tip Frank Stephenson Division of Labour)

Chart of the Day: More Crony Capitalism

More diagrams showing revolving door crony capitalism in the US (hat tip: Bob Wenzel) Part 1 here.

Update:

I'd like to add (or forgot to say earlier) that I hope to see the revolving door relationship between the US Federal Reserve and Wall Street. The previous chart exhibited relationship between the US Federal government and Goldman Sachs.

Also, I hope that Filipinos will get the idea and try to establish the same revolving door crony relationship with today's big firms and the incumbent (or past) government.

Finally, all these goes to show how governments have been "captured" by special interests groups and how public choice theory have been very relevant in today's political environment.

Chart of the Day: Crony Capitalism

This fantastic Venn diagram from Professor Mario Rizzo shows of the conflict of interests, particularly the US government's revolving door relationship with the too big too fail, Goldman Sachs.

This also serves as a good example of regulatory capture or when a “regulatory agency created to act in the public interest instead advances the commercial or special interests that dominate the industry or sector it is charged with regulating” (Wikipedia.org).

Occupy Wall Street: President Obama’s Stealth Re-election Strategy?

There has been a brewing grassroots discontent at Wall Street, and they are partly right, Wall Street has been party to America’s social woes.

But the political solution to this has been divided; on the one hand, one camp blame Wall Street as inextricably tied to the US government and the US Federal Reserve. The other believes in the socialist resolution.

As Anthony Gregory writes,

Although there is no single ideology uniting the movement, it does seem to have a general philosophical thrust, and not a very good one at that. OccupyWallStreet.org has a list of demands, and while the website does not represent all of the protesters, one could safely bet that it lines up with the views of most of them: A "living-wage" guarantee for workers and the unemployed, universal healthcare, free college for everyone, a ban on fossil fuels, a trillion dollars in new infrastructure, another trillion in "ecological restoration," racial and gender "rights," election reform, universal debt forgiveness, a ban on credit reporting agencies, and more power for the unions. Out of over a dozen demands there is only one I agree with — open borders — and, ironically, many on Wall Street probably favor that as well.

All in all, this wish list is a terrible recipe for moving far down the road toward socialism. On the way to achieving these goals, totalitarian controls on the population would be necessary. Some of these demands are merely horrible ideas that would injure the economy severely — such as the huge expansion of public infrastructure. But others are so fancifully utopian — such as a living wage guaranteed to all, especially when combined with free immigration — that their attempted implementation would confront the many disasters and horrors we have seen in every nation that has seriously attempted socialism. Such policies would vastly expand the government, including its manifestations in the corporate state and police power that these protesters find so unsavory. All of the corruption and brutality they think they oppose are symptoms of the same essential political ideology they favor.

It must NOT be forgotten that Wall Street’s political and economic privileges emanates from the role it plays in the current political economy of the US.

Fundamentally, Wall Street functions as the major conduit in the financing of the US government.

As explained by Professor Philipp Bagus,

For governments, the mechanism works out pretty well. They usually spend more than they receive in taxes, i.e., they run a deficit. No one likes taxes. Yet, most voters like to receive gifts from their governments. The solution for politicians is simple. They promise gifts to voters and finance them by deficits rather than with taxes. To pay for the deficit, governments issue paper tickets called government bonds such as US Treasuries.

An huge portion of the Treasuries are bought by the banking system, not only because the US government is conceived as a solvent debtor, thanks to its capacity to use violence to appropriate resources, but also because the Fed buys Treasuries in its open-market operations. The Fed, thereby, monetizes the deficit in a way that does not hurt politicians.

In other words, the incumbent architecture of the welfare state applies Financial Repression by channeling the savings of the private sector to the US government via the banking system which has been backed, coordinated and supervised by the US Federal Reserve.

I would like to add that capital adequacy laws have likewise been designed to designate US sovereign liabilities as ‘risk free’ which ‘incentivizes’ banks to hold government securities as its main assets.

Not only that, major Too Big to Fail Banks of Wall Street are the chief conductors of the US Fed’s monetary policy, which goes to show the depth of their intertwined relationships. A list of Primary dealers here.

And further proof that Wall Street benefits from the welfare state is the example of JP Morgan’s role as processor of food stamp benefits.

From the Economic Collapse Blog

JP Morgan is the largest processor of food stamp benefits in the United States. JP Morgan has contracted to provide food stamp debit cards in 26 U.S. states and the District of Columbia. JP Morgan is paid for each case that it handles, so that means that the more Americans that go on food stamps, the more profits JP Morgan makes. Yes, you read that correctly. When the number of Americans on food stamps goes up, JP Morgan makes more money.

And it is no doubt that such cozy relationship represents a classic text book example of regulatory capture —when a state regulatory agency created to act in the public interest instead advances the commercial or special interests that dominate the industry or sector it is charged with regulating (Wikipedia.org)

And an ostensible symptom of this has been the revolving door relationships—the movement of personnel between roles as legislators and regulators and the industries affected by the legislation and regulation and on within lobbying companies (Wikipedia.org)—between Wall Street and the US government.

The Business Insider shows 29 famous revolving door cases where Wall Street personalities went on to work for the government and vice versa, and the list includes Hank Paulson, Robert Rubin, Lawrence Summers, Martin Feldstein and many more

Bottom line: While it would seem right to put the load of the blame to the financiers of the government, solutions that further socializes Wall Street would only serve to perpetuate the current malaise or even worsen them.

And given the penchant of the emerging grassroot’s movement for bigger government, it would seem that such actions could signify as a stealth political strategy to promote President Obama’s re-elections. After all, Wall Street as scapegoat has been used before and at the end of the day had been settled amicably.

Looks and smells like the same old trick.

Quote of the Day: Agency Problem in the Mutual Fund Industry

From Investment guru David F. Swensen of Yale University

The companies that manage for-profit mutual funds face a fundamental conflict between producing profits for their owners and generating superior returns for their investors. In general, these companies spend lavishly on marketing campaigns, gather copious amounts of assets — and invest poorly. For decades, investors suffered below-market returns even as mutual fund management company owners enjoyed market-beating results. Profits trumped the duty to serve investors…

This churning of investor portfolios hurts investor returns. First, brokers and advisers use the pointless buying and selling to increase and to justify their all-too-rich compensation. Second, the mutual fund industry uses the star-rating system to encourage performance-chasing (selling funds that performed poorly and buying funds that performed well). In other words, investors sell low and buy high.

Read the rest here

This has been a dynamic which I have repeatedly been talking about, see here and here

I agree with Mr. Swensen that EDUCATION has to be in the forefront in the campaign to protect investors against such conflict of interests

But I strongly disagree with the suggestion that the SEC has to play a greater role in regulation and enforcement.

One of the reasons why investors have become vulnerable has been due to the complacency derived from the expectations that the nanny state will do the appropriate due diligence and provide protection in behalf of the investors.

Such smugness reduces individual responsibilities and increases the risk taking appetite. Yet for all the regulations and bureaucracy added over the years, why has Bernard Madoff been able to pull one off over Wall Street and the SEC?

Romanticizing the role of arbitrary regulations and bureaucrats won’t help.

Two, unquestionably putting clients ahead is an ideal goal. But this is more an abstraction in terms of implementation. The ultimate question is always how? The devil is always on the details. Has more regulations led to greater market efficiency or vice versa?

Or to be specific in terms of the industry's literature how should these be designed, should they encourage short term trades or long term investments? How does the regulators determine which is which?

Three, it would be wishful thinking to believe that regulators know better than the participants with regards to the latter’s interest. Yet giving too much power to regulators would translate to even market distortions, more conflict of interests, corruption, regulatory arbitrages and benefiting some sectors at the expense of the rest. For example, the shadow banking industry, which has played a crucial role in the 2008 crash, has been a collective byproduct of myriad regulatory arbitrages.

Lastly, since regulators are people too, conflict of interest with the regulated is also likely to occur. This means that the risk of the agency problem dynamic will not vanish but take shape in a different form; the difference is that conflict of interest will shift from the marketplace to the political realm. This is known as regulatory capture.

Quote of the Day on Rent Seeking and Regulatory Capture

You think that the predicament of crony capitalism through the unholy stealth relationship between government agencies and big corporations, which results to revolving doors, corruption, regulatory capture and rent-seeking are about ethics or virtues?

It’s not.

Professor Steve Horwitz explains, (bold emphasis mine)

The problem is not regulatory or ethical, but institutional. If you want to change the pattern of outcomes, change the rules. The only possible way to end the corporate control over the state is to reduce the state's sphere of influence down to as little as possible and ideally nothing. As long as there's the dead animal of the state (really: the citizenry) to feed on, the vultures of the private sector will keep showing up to get their share.

President Aquino’s Cabinet Appointments: The More Things Change, The More They Remain The Same

As the Aquino Administration matures, current developments seem to be confirming my predictions that there will hardly be any change in the administration’s political direction.

This from the Philippine Inquirer, (bold emphasis mine)

“President Benigno Aquino lll’s decision to pick executives from big business for key Cabinet posts has placed his administration in potential conflict-of-interest situations, particularly in state-regulated enterprises, such as power, water, telecommunications and toll roads, lawmakers noted Tuesday.

They said the big business appointments were a growing public concern because they were identified with four of the most influential business conglomerates in the country – the Ayala, Lopez, Aboitiz and Metro Pacific groups – to positions with powers to make or unmake business empires.”

Some thoughts

1. It’s payback time. Election campaign bills come due.

2. Conflicts of interests depend on the definition. Every person sitting on a regulatory agency or bureaucracy has an interest which will always come in conflict of the interest of the regulated. (Yes, I mean personal interest. Political leaders and bureaucrats are not gods nor are they supposed to embody our perception of interest)

In the above, what is clearly being defined as conflict of interests is regulatory capture or as defined by Wikipedia.org as “when a state regulatory agency created to act in the public interest instead acts in favor of the commercial or special interests that dominate in the industry or sector it is charged with regulating. Regulatory capture is a form of government failure, as it can act as an encouragement for large firms to produce negative externalities. The agencies are called Captured Agencies.”

In other words, regulatory agencies function to advance the interest of select or favoured groups at the expense of the rest of society.

By the use of the regulatory body as legal barrier, competition is therefore restrained, and thus, economic opportunities are allotted based on political concessions via the arbitrary application of regulations or what is known as economic rent.

3. Insider versus outsider game. Insiders are those who comprise the economic-political elite class. Outsiders are those in the periphery who are made to believe that genuine change is in the offing. And outsiders are the majority and wielded by the insiders for election purposes.

The Aquino appointments clearly demonstrate this deeply rooted Insider based relationship in the context of the Philippine political economy.

Hence, the only thing that has changed are the personalities involved in manning the bureaucracy, and not the anti market political patronage system. The net effect is a status quo.

And as we previously predicted, ``The rule of the entrenched political class means 'the more things change the more they remain the same'.”

We also anticipated the kingmaker role of the personalities involved in the Meralco takeover in the recently concluded elections, which apparently has emerged in the appointments.

Elections are, therefore, a vehicle which grants a mantle of legitimacy to the immoral alliances of vested interest group and the political class.

As H.L. Mencken rightly labeled, “[Democracy] has become simply a battle of charlatans for the votes of idiots."