Wall Street vs. the Middle Class

by Gary North - Oct 10, 2007

Anyone who thinks that the super-rich, the rich, and the wanna-be rich who comprise Wall Street are defenders of prosperity in the name of the middle class is terminally naïve. He is confusing Wall Street with the free market.

The free market is the great friend of all classes. Through the division of labor engendered by private ownership, the free market supplies ever-increasing quantities of goods and services for all classes, but especially the middle class. People in the lower classes can legitimately hope to enter the middle class. A few will become rich.

There is a price for this upward access to greater wealth: the possibility of a fall into poverty. This is a greater threat to the rich than to the middle class. The rich are at the far right edge of the bell-shaped curve. There are few of them. Their position is insecure, for good reason. The free market rewards those sellers who serve consumers efficiently, wasting few scarce resources. Consumers are a fickle bunch. They keep asking sellers, "What have you done for us lately?" There are always many competitors trying to get rich. They are ready to replace today’s rich people. Today’s rich people know this. They are therefore ready and willing to pull up the ladder that enabled them to replace yesterday’s rich.

The free market’s ladder of mobility – upward and downward – is based on these legal principles: open entry of new buyers and new sellers, the predictable enforcement of contracts, and the absence of government favoritism of any special-interest group.

These principles should also govern the monetary system. They have never done so perfectly, and ever since 1914, hardly at all. Because of the tremendous profitability of legalized counterfeiting, fractional reserve banking has always been based on two principles: (1) keeping out new counterfeiters, who would debase the currency through price competition – mass paper money inflation – and thereby end the game of wealth-redistribution from depositors to bankers; (2) the creation of a central bank that protects today’s commercial banks from bank runs by depositors.

The fractional reserve banking system is engaged in a war against depositors and also a war against people on fixed incomes, who are unable to hedge their assets against monetary depreciation. The depositors get their pittance, based on the money they deposited. The bankers then multiply these small deposits through fractional reserve banking and thereby enjoy income from many interest-paying borrowers.

The threat to bankers arises when depositors realize that a bank is insolvent – lent long and borrowed short – and start demanding their money back in currency. This is the nightmare scenario for bankers. They do not want depositors to catch on to the obvious: their money is being used to create multiple loans, meaning multiple new income streams for banks. They do not want depositors to kill the goose that lays the fiat money eggs for bankers. How? By pulling out their money in currency and not redepositing this currency in another bank. Bankers know what happened to over 6,000 small, federally unprotected banks, 1929–32, and they never want to see it again.

Enter the Federal Reserve and the FDIC, semi-private, profit-seeking protectors of the little guy! And just how is the little guy protected? By the full faith and credit of the United States government.

When you think of "full faith and credit," think of the scene in the first "Superman" movie. Lois Lane has just fallen from the top of the Daily Planet’s building. Superman flies upward just in time and grabs her. "Don’t worry, miss. I’ve got you." To which she replies, "Who’s got you?"

As in the case of the cosmic elephant, which is standing on the cosmic turtle, what is the turtle standing on? It’s turtles all the way down.

With the Federal government and the FDIC, their full faith and credit stand on two factors: taxation and the Federal Reserve System. What holds up the Federal government when it can no longer collect enough taxes from the coalition of the unwilling to pay the bills? The Federal Reserve’s fiat money. It’s digits all the way down.

FIAT MONEY AND STOCK MARKET BOOMS

If you follow the financial news media, you will notice how much attention is paid to the Federal Funds rate, which is the overnight bank rate. This is the rate that the Federal Open Market Committee can control directly. The media reports concentrate on this issue: the expectation of another rate cut.

Whenever the FED is raising this rate, the media never warn the public that this policy could send the U.S. stock markets into a bear market phase. The words "bear market" are cited only in sentences that contain the words "little possibility of." But when there is even the slightest possibility that the FOMC might lower the FedFunds rate, market commentators get all twiterpated over the possibility of another upward move of stocks.

This is what I call the asymmetric nature of the financial press: "upward rate move = no problem; downward rate move = boom ahead."

Whenever there is news of slowing employment, the media start talking about the possibility of the FOMC’s lowering the FedFunds rate: "That’s good news for the stock market!" Whenever the employment rate rises, the media start talking about economic growth: "That’s good news for the stock market."

What is bad news for the stock market? Officially speaking, nothing.

Why is the financial press asymmetrical? First, the middle class reads the financial press and dreams of getting rich. Second, Wall Street and its large corporations advertise in the financial press, and therefore shape the content. Financial editors are careful to exercise self-censorship. Unlike the non-financial press, which flourishes on bad news – "If it bleeds, it leads" – the financial press is dependent on the flow of good news: "Buy your piece of the American dream," not "buy your piece of the American nightmare."

For evidence, watch the networks’ evening news shows. The lead stories are bad news for someone. Local news shows love a fire. National news shows love a political scandal. The "bad news leads" format hooks you in the first seven minutes. Then the ads start coming. After the ads, you will get a financial report. If it’s anything significant (Dow up or down over 150 points), NBC’s Brian Williams will interview either the 40-year-old visibly fading woman from CNBC or the 30-year-old rising CNBC starlet with the premature bags under her eyes. He never interviews some grizzled survivor of 40 years of popped bubbles and shattered dreams. They assure the viewers that "time will tell," which means "tune in to CNBC tomorrow."

The FED dominates discussion these days. Will it lower rates? Will it let rates sit? By "rates," the media mean the FedFunds rate.

If the FED lowers "rates" by waving its magic wand – sorry, scratch that – if the FED debases the dollar more rapidly than today, the broad middle class will receive a lower rate of interest in its bank savings accounts. This is great for banks, which can now borrow short at a lower rate, such as 3%, while lending money at 10% to 30% to other members of the middle class and the poor, who are addicted to credit card debt. The spread between borrowed funds and loaned funds widens. This is the dream of the financial sector.

Why don’t credit card rates fall? Because consumers who use credit card debt are not sophisticated. They do not shop for better rates. Even when they do, they do not read the fine print of the new contract, which allows the card company to double or triple the introductory rate if the borrower falls behind on a payment, even a payment to a company in no way connected to the credit card.

Conclusion: a free market society enforces contracts. It does not protect those people who refuse to read their contracts or cannot understand them.

Lesson: if you don’t understand the fine print, don’t sign the contract, e.g., the credit card application.

Lower rates produce an economic boom. Businessmen borrow from banks to take advantage of the expected boom. Banks make more money. But if long-term rates are not higher than short-term rates, banks don’t make much money. Today, long rates are barely above short rates.

Meanwhile, large banks are still losing big money in the subprime mortgage market. The Bank of America and J. P. Morgan Chase are expected this month to declare a combined $3 billion write-down because of subprime mortgages. This brings the total to $20 billion at the world’s largest banks since this summer. This has only just begun. MarketWatch has just started a Subprime Today e-letter option. They see a new trend coming, and they plan to take advantage of it!

Wall Street flourishes when the central bank creates fiat money to buy assets – any assets – that can legally be monetized. This does not include furniture or new cars. It does include the debts of furniture companies and auto companies. It even includes their market-listed shares.

So, when you hear about the "good news" that the FED is about to lower rates, it is not good news if you have money in a bank account or a money market fund.

Wall Street does not care about the plight of the middle-class lender who deposits money at 3% in his bank, only to suffer 2% to 3% price inflation, after paying 20% or more to various governments on the interest received.

The middle-class saver is the loser when Wall Street screams its way into the thinking of the FOMC. Jim Cramer threw a tantrum. The FOMC responded.

The dependence of Wall Street on a continuing stream of new fiat money is very high. If this flow of funds were to cease, Wall Street would go into withdrawal seizures. The various stock markets would plummet. This cannot be allowed, say Wall Street’s many spokesmen. This would "harm America." So, the FED is called on to continue the flow of counterfeit funds, multiplied through the fractional reserve process.

The losers are those people who trust the banking system and deposit their money. The other losers are those who are on fixed incomes or close to fixity. They pay higher prices for whatever they buy. The resulting boom on Wall Street comes out of their lifestyles.

When Wall Street and its media mouthpieces call for another cut in the FedFunds rate to "keep the American dream alive," they mean the dream of corporate insiders whose stock option plans are being threatened by the readjustment in capital values posed by stable money. They do not mean the broad mass of Americans, whose savings, if any, pays 3%, which barely equal their credit card debt, which charges 15%.

MOST AMERICANS WEAR THREE HATS

Most Americans wear three hats: their thrift hats, their debt hats, and their wage hats.

Their thrift hats are today almost an afterthought. Only 56% of American households actually saved any money in 2004. They don’t have large retirement funds. The average American, as of 2004, had a net worth of under $95,000. That was the median figure: half of Americans above, half below. Of this value, well over 60% was the value of their residences. Retirement? Living on Social Security? Those in the 50 to 75 age range had a median net worth of $171,000. But most of this was the value of their homes. They will have to pay for space somewhere. In terms of liquid assets to invest and live off the earnings, they are in very bad shape. For the data, see the report, "Recent Changes in U.S. Family Finances: Evidence from the 2001 and 2004 Survey of Consumer Finances," Federal Reserve Bulletin (Feb. 2006).

Their debt hats pressure them monthly. They have to pay the bills. They are hard-pressed to save. They worry about meeting their monthly expenses. This gets their attention. If they were to lose their jobs for two months, they would be in trouble. Rising interest rates threaten them. So they are with Wall Street’s call for the FED to lower rates.

They wear wage hats. They are far more worried about losing their jobs than they are about price inflation under 3%. They don’t understand that the means for lowering rates – monetary expansion – threatens to raise prices.

These hats are all present hats. They take precedence over future hats. Retirement is way off in the distance. They’ll think about it tomorrow.

Or the day after tomorrow.

So, when the Wall Street wizards perceive a looming decline in their stock portfolios, they call for the FED to intervene and save the various stock markets. The voters like low interest rates, so they don’t complain.

The wizards get support from the broad masses, who are threatened by the return of monetary expansion. The wizards have their futures tied to the stock market and bond market. They are not interested in the plight of the average American. The fact that price inflation is a threat to the average American’s way of life is of no concern to the wizards.

CONCLUSION

We see today a clash between the long-run interests of the middle class and the short-run interests of those who make their living in the financial markets. Because the process of economic cause and effect is not understood by the media, and because it is not understood by the average American, the wizards of Wall Street get away with their endless pleas to the Federal Reserve System to lower interest rates. Nobody in the mainstream media ever asks: "But how can the FED lower rates, year after year?" The world really does believe in magic. They believe that the FOMC committee merely has to issue a press release promising to lower the FedFunds rate and, wonder of wonders, the rate is lowered cost-free. Nobody asks: "Why not just reduce it to zero?"

My sense of the FED today is that it will not lower the FedFunds rate again at the end of October. In late August, I was sure the FOMC would lower the rate by half a point on September 18. It did. I don’t think they are facing equal pressure from Wall Street today.

For the sake of the U.S. dollar, let us hope I am correct.