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Editor's note: In this groundbreaking analysis, Shah reveals how quantitative easing - a misguided multi-trillion dollar central bank policy and the greatest financial disruptor of our time - has distorted the global economy, made many traditional investments unprofitable, and stoked wealth and income inequality. But Shah says there are steps we can take to limit some of the damage - if we act now.
The growing income and wealth gap between the rich and poor, most of whom used to be called middle class, has many fathers. But behind the scenes one primary cause emerges. It's the greatest financial disruptor of modern times: Quantitative Easing (QE).
While the jury's out on whether QE will eventually be the step-ladder that lifts us out of the lingering Great Recession, as its proponents argue, the facts demand that the verdict on QE's egregious enrichment of the rich and subjugation of everyone else is: "guilty."
And the trouble won't stop now that the United States has begun winding down its quantitative easing - the Eurozone and Japan each have massive QE programs.
Here are the facts. Policymakers and struggling middle class and poor people must take a strong stand to fight this financial plague. Here's how...
A Chicken and Egg Story
Quantitative easing is the term America's central bank, the U.S. Federal Reserve, came up with for its experimental policy of buying trillions of dollars' worth of U.S. government bills, notes and bonds (Treasurys), and mortgage-backed securities (MBS) from banks.
This was new. Typically, when financial or economic troubles befall the U.S., the Fed lowers interest rates in order to make more money available to financial institutions and the public, providing liquidity to banks and capital to consumers and producers.
The Fed lowers interest rates by offering banks cheap loans. The idea is that if banks have more money to lend, lower rates will work their way into the economy and stimulate consumption and production.
When the credit crisis hit in 2008, the Fed lowered its target rate to zero, essentially making loans between banks free. But banks still wouldn't lend to each other - they were afraid borrowing banks could go toes up at any time. Big banks were virtually insolvent.
The Fed's response to this emergency? It cooked up QE.
The Fed was able to pump money directly into ailing banks by buying bank loans, Treasurys, and mortgage-backed securities from them.
The banks eventually made out like bandits because in later rounds of QE they bought Treasurys and MBS in the open market, knowing they were just going to flip them to the Fed at inflated prices.
Fed purchases from big banks started in 2008 and continued throughout 2009. That wasn't enough to save the banks. In 2010 the Fed stepped up its purchases under the banner QE2, buying $600 billion worth of assets that year. That still wasn't enough.
Meanwhile, the economy, which had shown signs of perking up, slipped backwards. So in September 2012, the Fed began QE3, purchasing $85 billion a month of assets ($45 billion of Treasurys, $40 billion of MBS) for the next 24 months.
By the time it was done, the Fed's balance sheet had ballooned from $750 billion in 2007 to more than $4.25 trillion dollars, and big banks were making record profits again.
The Greatest Wealth Redistribution Ever Conceived
The Fed's ZIRP, or zero interest rate policy, restored banks' balance sheets, grossly enriching them in the process. Low rates allowed corporations to borrow cheaply to buy back their shares and eventually raise dividends. Low rates allowed well-heeled speculators to margin and leverage their bets on rising financial asset prices.
Cheap money fed private equity companies and venture capital firms' ambitions, backing start-ups like Uber, AirBnB, Snapchat, and others. Financial intermediaries, once again, reaped big fees from arranging loans, orchestrating mergers and acquisitions, and taking companies both public and private.
Pre-existing owners of financial assets and financial intermediaries have enjoyed a windfall at the expense of the middle class and the poor. And it was planned that way.
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.
Mr. Gilani,
I’ve never, and I mean NEVER, agreed with you more.
In the past, it seemed that you were advocating more government to solve our problems. In this instance, I realize the government would have to get involved in order to break up the largest banks. But the government probably needs to do this, as those banking monsters are their creations, after all.
When a banker, like our friend Jamie Dimon becomes a billionaire, as explained in yesterday’s Bloomberg article, we clearly have a serious problem.
It's been interesting to see the progression of your thoughts once you read "The Creature from Jekyll Island." After you wrote of it, your opinion of central banks has evolved significantly. Maybe you were a central bank detractor before then, but I didn’t notice it nearly as much as I do now.
The one thing you don't mention in today’s missive is how our currencies will need to be backed by something at some point, as the dollar was after Bretton Woods in 1945, which is the only reason it became the world's reserve currency. Otherwise, simply eliminating central banks will lead to further monetary debauching via fiscal policy by vote-seeking politicians. That will make consumer inflation a much worse problem than when reserve creation causes asset inflation.
Regardless what happens, whether the government does the right thing, or the market forces it upon us, the pain is going to be very, very, very great. You and Money Morning will hopefully help us navigate through the coming turbulence. I, for one, will be listening attentively.
The only way to save the most indebted nation in the world (If you don't know it, it is the U.S.) and the world economy is to:
1. Replace representative democracy by Direct democracy because most of our problems comes from the Power Triad (corporations, special interest groups, and the military industrial complex) control over the Congress through election campaign funding.
2. Revoke the Federal Reserve Act, and have the Federal Reserve Bank OWNED by the Federal Government (i.e., all of us rather being owned by private bankers). In this case, the government does not have to pay interest on its $18 trillion dollars because the interest on $18 trillion could drive the U.S. to bankruptcy.
2. Financial policy has to be planned by the people representatives (the Congress) not by the beneficiaries of the policy (bankers) as happened with QE. It was designed by the bankers for the bankers.
3. Restore the Taxation marginal rate of the 60s and the inheritance tax to put a ceiling on how much wealth a person or a corporation could have. it is too dangerous to have a corporation wealthier than the state itself as happened in the U.S. before its independence.
4. Fund election campaigns from the public purse because we pay the cost of election campaign funding back to the Power Triad 100s of times in tax exemptions, subsidies, and other privileges.
Sorry Andy,
I have to disagree w/you. The reason we are in so much trouble is not because we are not *enough* of a direct democracy but because we have moved so far *toward* direct democracy. Throughout history democracies failed when the populace (including your Triads) found they could get stuff by voting for the people who would give it to them. Funding the campaigns of those people can have the same effect. Companies "put money in" so to speak in order to get money out of the federal govt later, by way of contracts, legislation, regulation etc or just by simply being left alone. Masses of people vote for an individual who promises to give stuff back to them. That has been the case for centuries and it is still the case today.
We were founded as a representative republic expressly to circumvent that. We no longer have strong states competing in the power struggle w/the federal govt. Why? Because Senators are no longer sent to the Congress by the State Legislators. They are directly elected by the populations of the states, which is redundant to Congressional Representatives. The State Legislations no longer have a representative there to stop things like unfunded mandates so the federal government has grown well beyond it's bounds. All of the "goodies" coming from the federal govt increase the incentive for campaign funds in order to vie for those give aways. The less the federal govt has to "give" away, the less money you will see in campaigns for those offices. Research how much money Microsoft spent on political campaigns before and after they were sued by the federal govt. The less power the federal govt has to "give" money away or to take money away (ie punish) from a business, the less incentive they will have to focus on supporting campaigns.
If we are going to restore the promise of America then I think we have to go back to the fundamental principals of small, representative, republican (meaning the States have representation) government.
RE 2) We are essentially monetizing our debt now. Your suggestion is monetizing our debt. As far as the history I know, that is always bad.
RE 3) Who gets to decide how much any individual or corporation can have? You? Some elite group? No thanks. Earnings should belong to the earners, not the government.
RE 4) See above. If you take away the opportunity for government to "give" stuff by taking it from one place in order to direct it back to someone/something that helped them, then there is less incentive for your Triad, and everyone else, to participate. No, you can't completely remove that but you certainly can diminish it.
I support the notion that a move toward a more direct form of democracy is a mistake. Certain groups have already learned they can vote themselves money from the treasury. More direct democracy will exacerbate that behavior in to complete destruction of any national treasure.
Raybdau – Well said!
"We will need fiscal policies designed to reduce government debt and automatically expand and contract the money supply and credit extension to levels appropriate to the rate of economic growth."
Money supply should be set and adjusted, only for population growth. Fix it now by dividing the National Wealth by the population number, then ONLY increase it by that sum as the population number increases. OK, that doesn't "fix" the excess of the super rich, but it will put the brakes on them getting richer!
It would be interesting to see the result of a "washup" – i.e. eliminating the central banks.
Yes definitely the Fed should be owned by the state but financial change should go much further. The banks should be prohibited from creating 97% of our currency out of thin air and the sole right to create money restored to the state.
Politicians can not be trusted with the tap of an endless money supply so some body of experts should be tasked with the decision of how much new money should be created each year. In other words the decision on how much new money to create will be separated from political decisions on what the money should be spent on.
Banks would then become true intermediaries collecting existing funds and loaning them out instead of being procyclical creators and destroyers of our money supply.
David, I suggested the best mechanism for " – how much new money should be created each year". In Aus we have been suffering from excessive supply of money from abroad, poured into mining developments.
Wages and costs of everything exploded by at least 1000% in my lifetime. Now self funded retirees cannot afford to live like they should – certainly not like the working generation now do. Yes a lot of that investment is from USA, not only here but also in other places. Is it any wonder America is on the nose in certain places (& getting worse).
Fat chance! That would be asking an alligator to bite off its own tail
Great ideas, but let's face it none of that will ever happen.
I understand QE a bit differently from that expressed here.
I would not have thought QE included T- securities. After all they are hardly non performing assets. Also they are not "debt" as the sums are always present in reserve accounts at the FRB, and repayment is just reversing the figures. I understood QE was aimed at taking non or poorly performing assets off commercial bank books which would allow banks more freeboard to stimulate lending, since lending is not capital constrained any longer, just limited to the total worth of each bank. It was one step shy of TARP [toxic assets] which the FRB "bought" for the same motive.