Congratulations, Fed!

One of the most extraordinary economic marvels of the past decade is the astounding 50% leap in corporate profits, from $2.4 trillion (pre-tax) pre-pandemic lockdown to $3.6 trillion (pre-tax) in the years since the lockdown ended.

Strangely, few seem to ask the source of this astounding 50% leap. Wall Street has certainly cheered this vast increase, but few analysts ponder the source, or ask if the source is a net plus for the economy and nation.

As shockingly heretical as it sounds, the interests of corporate America often diverge from the interests of the citizenry, overall economy and nation. For example, the wholesale gutting of the U.S. industrial base in the mad rush to lower costs and quality by shipping entire supply chains to China.

As I’ve often pointed out, the meager savings that trickled down to the consumer were more than offset by the collapse of quality and durability in the globalized goods that now line the shelves of every retailer in the U.S.

Capitalism at Work?

Corporate PR and its well-paid army of toady analysts and pundits would have us believe this is “capitalism” busily at work as pent-up consumer demand naturally pushed prices higher, and corporations were — sadly — forced to pass along these higher costs to consumers.

Recall that “higher costs” don’t show up as higher profits.

If the “cost of goods” is $1, and I charge the consumer $2, I reap $1 profit. If my costs double to $2 and I charge the consumer $3, I reap the same $1 profit as I did before the cost spike pushed my production costs up.

The higher corporate profits are the direct result of profiteering and price-gouging. Oh boo-hoo, our costs went up and we were forced to pass them along was simply the cover story. If the cost of a $1 item went up $1 to $2, corporate America merrily doubled its profit margin from $1 to $2.

This is what happens when you allow your economy to be dominated by quasi-monopolies and cartels. They all raise prices and diminish quality as a unified concentration of financial and political power.

What the Fed Has Really Accomplished

Zooming out a bit, let’s summarize what the Federal Reserve accomplished since embarking on its massive interventions to control volatility, risk, bond yields, interest rates, the mortgage market, bank subsidies and liquidity, all of which can be summed up as the cost of credit-capital, that is, capital that is borrowed into existence based on some form of collateral or income stream.

By artificially suppressing the cost of capital to less than inflation, the Fed succeeded in:

1. Fatally distorting the economy.

2. Greatly enriching the already-rich at the expense of the bottom 90%.

3. Crushing the middle class and reducing the bottom 90% to debt-serfs.

Let’s consider how the Fed fatally distorted the economy by suppressing the cost of capital to less than inflation.

Recall that the Fed crammed ZIRP —zero interest rate policy — down the throat of the economy from 2009 to 2020, while official inflation ate up 22% of the purchasing power of the dollar. Inflation was never 0%, so the cost of capital for corporations and financiers was actually negative, i.e. less than inflation.

Reducing the cost of capital had multiple distorting effects. A useful analogy is the critical role of “keystone species” in maintaining healthy, diverse ecosystems.

Ecosystems and Economies

Risk and competition are the vital forces enabling a diverse ecosystem. Once the keystone predators have been eliminated (starfish, wolves, et al), the species freed from risk and competition overwhelm the ecosystem and crowd out healthy diversity. These species end up destroying the ecosystem via overgrazing, destruction of forests, etc.

The same dynamic, enforced by the Fed, has gutted the U.S. economy.

Corporations and financiers with virtually unlimited access to near-zero cost capital were freed to buy up hundreds of smaller competitors, buy back trillions of dollars of their own shares to enrich the already-rich managers and large shareholders and leverage their assets and cash flow into Empires of Debt which could be sold or taken public (WeWork, et al.) reaping enormous profits — profits unavailable to wage earners and those who did not have the opportunity to acquire assets before ZIRP inflated the Everything Bubble.

It’s been estimated that the majority of the S&P 500/stock market’s rise from 667 in 2009 to current levels around 4,700 was solely the result of corporate buybacks that reduced the number of shares. This artificially increased the revenues and earnings per share. (Buybacks were once illegal, for good reason.)

All these trillions in near-zero cost capital flowed into manipulation, speculation and the reduction of competition, not into boosting productivity, efficiency or innovation. The net result of the Fed’s ZIRP is an economy stripped of diversity, an economy dominated by bloated monopolies, cartels and platforms generating low-quality, addictive goods and services which reduce productivity on multiple fronts.

Perverse Incentives

Lowering the cost of capital to near-zero also changed the incentives of corporate and banking leaders. The enormous profits flowed not from developing higher-quality goods and services or improving customer service; they flowed from manipulating markets with near-zero cost capital, borrowing fortunes against corporate commercial real estate and distributing the gains to shareholders and managers.

Near-zero cost capital rewarded speculators and CEOs who leveraged financier plays, not those investing for the long-term in America. The Fed’s distortions are fatal because they stripped the economy of incentives that are positive for the nation, not just for corporations and the already-wealthy.

Lowering the cost of capital to zero also distorted the balance between labor and capital in favor of capital, as the already-wealthy, i.e. those who already owned collateral and cash flows, could leverage up their assets and income to borrow vast sums at near-zero interest to scoop up income-producing assets. Mere wage earners could not compete and so wealth and income flowed to the top 0.01%, top 1% and top 10%:

This concentration of wealth and income came at the expense of the middle class, whose share of the nation’s wealth plummeted.

Debt Serfdom

Suppressing the cost of capital also incentivized over-borrowing/the runaway expansion of debt as interest payments are so cheap, why not borrow as much as possible and invest the money in higher returns and “shovel-ready” government projects?

This fueled global carry trades and the runaway expansion of both government and private-sector debt, debt loads which are increasingly crushing as interest rates slowly return to historic norms.

In effect, we’ve borrowed $3.50 to eke out $1 in GDP expansion — $3.50 that will accrue interest until it is paid off, something that never happens in government debt and rarely happens in corporate/commercial real estate debt. Rather than being paid off, debt is simply rolled over into new debt.

The Fed’s cover stories were bringing demand forward and goosing the wealth effect: Lowering interest rates to near-zero encouraged enterprises, agencies and households to borrow and spend money now rather than in the future, and dropping interest rates inflated asset bubbles, making the already-rich feel even richer, on the theory that this emotional response would generate more borrowing and spending.

The fatal flaws in these policies are becoming apparent. Bringing demand forward eventually soaks up all available income, over-leverages assets such as commercial real estate and increases inflation as limitless capital chases limited goods and materials.

As for the wealth effect, only the top 10% who own 90% of all assets and reap 50% of all income felt the wealth effect. Everyone else simply dug themselves a deeper hole of debt to service, what’s known as debt serfdom.

The mainstream holds the Fed is busy planning a return to the glory days of zero interest rates, but ZIRP is on the downside of the S-Curve; it’s done, gone, history.

Higher rates are built into an economy that was stripped of risk, competition and diversity by the Fed’s fatal distortions.

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