How Elon Musk's Purchase of Twitter Explains Financial Crashes
The richest man in the world borrowed money to buy Twitter. Borrowing to buy an overpriced asset is the seed of recessions and financial crises.
There’s an old saying that, “the rich didn’t get rich giving their money away,” and in 2022, when “the world’s richest man” Elon Musk bought Twitter for $44-billion, he didn’t dip into savings. He borrowed it.
The Wall Street Journal is reporting that:
Twitter is now estimated to be worth $19-billion.
A recent lawsuit also revealed the Investors’ in Musk’s Twitter:
A federal judge ordered the social-media platform to unseal the list of shareholders of X Holdings on Tuesday after a journalism nonprofit filed a motion in July to view the records.
The document was first made public by The Washington Post.
It includes some of Silicon Valley's biggest names, such as Andreessen Horowitz and Sequoia, alongside asset managers like Fidelity. Wealthy people also invested, including Saudi Prince Alwaleed bin Talal bin Abdulaziz Al Saud, the American rapper Sean "Diddy" Combs, and Jack Dorsey, X's founder and former CEO.
Because Sean “Diddy” Combs is an American rapper and celebrity who is facing seven civil suits for sexual assault, the involvement of Saudi Arabia and two sanctioned Russian oligarchs.
“A U.S.-based venture capital firm known as 8VC was one of the 100 largest investors in Musk's Twitter deal. What makes this significant is that 8VC employs individuals who are closely connected to two prominent Russian oligarchs, Petr Aven and Vadim Moshkovich. Both Aven and Moshkovich are well-known figures in Russia's business and political scenes, and both have been subject to Western sanctions due to their ties to the Russian government.”
If you have never been on Twitter, count yourself lucky. Back in 2017, the comedian Joe Mande quit the site, writing:
“It’s basically become a place we all go to scream about, and thereby indulge, the mental illness of a demented 71-year-old comic book villain [then-US President, Donald Trump]. If it’s not that, then we’re screaming at someone we don’t agree with, or screaming at someone we do agree with, because that person did something that we don’t agree with enough…
Years ago, I watched a CNN report hosted by Serena Altschul about a group of people in New Haven, Connecticut, who all did a drug they called “Wet.” Doing “wet” was the act of smoking cigarettes, or blunts, that had been pre-dipped in embalming fluid. It was a super depressing piece of journalism. But what I learned is that smoking embalming fluid is terrible for two notable reasons: first, it’s incredibly addictive, and second, the high it produces was described as “dysphoric.” As in, the opposite of euphoric. People who smoked embalming fluid were guaranteed to have a horrible, nighmarish experience every single time… and they couldn’t stop doing it. Twitter is the internet’s version of smoking embalming fluid.”
That was seven years ago, and Twitter has not improved. Quite the opposite. Like so many sites on the internet, it started off as a fun party, then ended up getting crashed by Nazi bikers.
Musk fired a lot of moderators and loosened the rules, including letting various individuals with a well-earned reputation for spreading poisonous lies, like Alex Jones, back on the site. Jones, if you’re lucky enough not to know, claimed that 22 elementary school children who were shot to death in a school weren’t actually killed, and that their parents were actors. He perpetrated this despicable fraud while claiming it was done to justify gun control in the U.S. He finally lost a lawsuit for nearly $1-billion US.
Users have fled because Twitter is a product, and it is a product that Musk made worse for its users by exposing them to even more unmoderated hatred, contempt, threats and lies, including allowing Jones back on the site.
Advertisers didn’t appreciate the shrinking audience, nor did they appreciate being featured next to neo-Nazis, convicted criminals, and a growing proliferation of “influencer/accused sex criminals”.
When asked about advertisers’ objections, in November, 2023, Musk told advertisers to “go f—— themselves,” More recently, he has tried to sue advertisers for not advertising with him, accusing them of breaking the law. The non-profit group of advertisers shut down.
Back in the old days, people would be shamed for, and ashamed to buy advertising next to videos of beheadings, and videos of crimes and abuse, Holocaust denial. We made the distinction between unreliable news and stuff that was routinely inaccurate. Now, we can not only can not avoid it, we will be sued if we don’t want to support it with our dollars.
We have reached a new and ludicrous stage in entitlement, wealth and privilege where billionaires can sue for damages if you don’t want to give them money. That’s like truckstop bathroom owners suing Dairy Queen for not wanting to advertise its Peanut Buster Parfaits in their toilet stalls.
All of this drama and nastiness has contributed to financial problems at Twitter/X.
The way this relates to how market crashes and financial crises happen is what happens in the lead-up to a crash.
Leveraged Buyouts: Using Debt to Speculate
“Leverage” is finance-speak for “debt.” The role of borrowed money in takeovers is not always understood. If it were understood, people might be very angry: because it is an example of Wall Street firms using financial loopholes and debt they don’t have to pay back to destroy functioning companies.
The accepted — or promoted — story is that these firms find struggling companies, take the risk of borrowing to buy them, turn them around by trimming the fat and make them profitable, then resell them for a profit. This is sometimes the case.
As Joshua Kosman tells it, the story is different. Leveraged buyout firms use a tax loophole similar to the mortgage interest deductibility. The idea is to make it easier for startup companies to borrow as they are getting off the ground.
Private equity firms can acquire companies like a homeowner buying a house with a down payment of the purchase price — perhaps 20%. The resemblance to a home purchase ends there, because the remainder of the deal — the remaining 80% of the purchase price — is financed not by the purchaser, but by the company being purchased, which takes out debt to buy itself. The company has to take on debt to pay for its own purchase — not to refinance debt, not to train employees or invest in new capital to improve productivity — new debt to buy itself.
Normally, taking on debt that does nothing to improve competitiveness would be bad for the bottom line, but a loophole in the U.S. tax code flips this on its head. Higher debt means more interest on debt payments, and interest paid is tax deductible. Taking on debt has suddenly made the company profitable, but only because it isn’t paying taxes.
What’s more, some of the borrowed money is used to pay “dividends” to the investors of the private equity firm. It is like taking out a “Chip reverse mortgage” on someone else’s house. If you own your house, you can take a loan out on its equity, and convert its value into cash. Because it is a loan, it isn’t taxed as income.
Kosman uses the example of the two top companies in the mattress market, Sealy and Simmons, which were bought by a private equity firm in the early 1990s. They stopped competing with each other, eliminated the middle range of products and raised prices at twice the rate of inflation, and were sold back and forth between private equity firms. In 2009, Simmons, which had been in business since the 1870s, declared bankruptcy with debts of $1.3 billion. In 1991, it had owed $164-million. 1,000 people, more than a quarter of the work force, were laid off. Bondholders stood to lose $575-million. In the intervening years, during which time it was sold seven times, its private equity owners took $750-million in profits.
In an interview, Kosman said that the strategy of private equity firms was short term gain at the expense of the long term. “The company is more profitable in one sense: its earnings increase, usually because the private equity firm is starving it a bit of capital. The private equity firm is in the business of buying and selling companies in four or five years, so there is no long-term interest. A Davos study shows this: private equity eliminate more workers than their direct competitors and they typically decrease research and investment and capital expenditures.”
With an effective interest rate near 0% in the U.S., borrowing money was incredibly cheap in the early 2000s. The strategy of maximizing profits through accumulated debt as a write-off failed with the global economic meltdown: no one was lending anymore and sales sagged. More than half the 220 U.S. companies that defaulted on their debt in 2009 had been owned by private equity firms.
When Interest Rates Go Down, so does the Quality of Debt,
When central banks drop interest rates, it has radically different impacts across the economy, because it changes who qualifies for loans, and for how much.
After the 2008 financial crisis, it was largely blamed on “sub-prime” mortgages, which are mortgages whose terms are worse than prime rates - often much worse. While it was blamed on subprime borrowers, this really twists the story.
First, there were was widespread criminality in fraud applied in persuading people to take loans, and the borrowers were sometimes swindled through fraud and forgery into taking larger loans on worse terms than they qualified for.
In the book and the movie “The Big Short” they made a big deal about the fact that people were getting what were called “NINJA” loans - which stood for “No Income, No Job, No Assets”. (So, technically NINJNA).
The thing is, when interest rates are foced to zero, or close to it, people who have no income, no job and no assets start qualifying for loans. Interest is a price on risk, and then central banks drop them that low, they send a signal to the market that lending and borrowing is effectively risk-free, which it never has been.
Since the actual world is filled with real unknowns, real uncertainty, and real destruction of value, it means that central bank policy is effectively breaking with reality, which is why markets do too, shortly thereafter.
When people are lending, they are making an investment, and they lend based on what they think you can pay back. People who earn millions a year or who own billions in collateral can afford pretty massive payments.
So while the blame falls on hundreds of thousands or millions of low income people with NINJA loans, that is a huge number of relatively small loans.
By contrast, people who already could borrow and were eligible for credit, qualify for much more borrowing. While homeowners get mortgages, corporations buy stock.
Rather than creating new value, which will generate future returns, it is mostly invested in bidding up the prices of existing assets.
It does not have to be “speculation” by investors looking for a quick buck. Adair Turner notes that, Keynes called transactions in already existing assets “speculation”.
If you’re buying an asset that’s already been owned from another investor, that’s speculation.
And that brings us back to Elon Musk.
Musk borrowed money to buy Twitter, and that money isn’t being paid back.
And despite the drama, it’s not just a management issue - there’s a really important lesson here.
Musk and other investors may well have paid too much for it in the first place, abetted by easy access to large low-interest loans made possible by central banks dropping their interest rates so low. .
The fundamental problem that is being ignored - which is impossible to escape - is that when the more you pay for an asset, the harder it will be and the longer it will take to recoup your investment.
People are so focused on the fact that interest rates are low, that they ignore that people are quite clearly massively overpaying for assets.
If they’re investments in an actual company that is productive and generates revenue or dividends, paying top dollar for shares that were already on the market means that the company is expected to generate better returns when, as a “second-hand” shareholder, none of the money you’ve put into shares is actually going to the company to drive results.
Roger L. Martin, Dean of the Rotman School of Management at the University of Toronto wrote an outstanding book on the problems with this singular focus on shareholder value, called Fixing the Game.
He gives the example of a problem for companies and investors alike: a stock that was initially offered and sold to the public at $20 is sold, and re-sold, eventually rising to $100. The company only got $20 from selling its share to the first investor, but the investor who buys it at $100 is going to expect it to perform much better.
Writes Martin:
“The company needs to earn 15 percent on $100 per share of expectations capital, even though it only has $20 of real capital with which to do it. Rather than a 15 percent return on its real equity (or $3/share) it has to earn a 75 percent return on its real equity (or $15/share), a deeply challenging task and one that even the best companies are unlikely to achieve over time.”
In other words, even if interest on the money you borrowed to buy a stock is really low, if you paid too much for it, you paid too much for it. And squeezing the company isn’t going to help, it’s going to make things worse.
The timing is also important. When the pandemic struck in 2020, central banks around the world dropped interest rates and then did “quantitative easing” which meant they created about $8-trillion in various currencies, and put it into propping up the prices of existing of assets. Investors like private banks and even corporations got newly created central bank money in exchange for the assets they were holding. This was sold as “addressing a liquidity crisis” and providing banks with cash to lend out for new growth and investment, but it was really a repeat of the bank bailouts of 2008-2009-2010 in the U.S., Canada and the EU.
Those interest rates were ultra-low, for a couple of years, enough to collosally distort the housing market. Average borrowers could suddenly borrow more, but people with better credit or collateral could borrow orders of magnitude more to snap up both private residences and commercial rental properties and - this is really important - easily outbid people in the market.
This is what exploded the housing market in Canada, the U.S., and other countries. We have had what business reporters call a “15-year bull market” in housing, in Canada and the U.S. It’s because of these massive central bank interventions in the economy.
When you make a fortune speculating, it is in part because you are lucky. That it is why it is speculation, and not work. The economist Hyman Minsky argued that private debt causes financial crises “especially when debt is driving an asset bubble.”
(I am indebted to Professor Steve Keen for his excellent work, especially his book “Debunking Economics” which dismantles neoclassical economics and shows its failings on the basis of mathematics, logic and evidence.)
As the people who are willing to lend billions of dollars to Elon Musk demonstrates, when interest rates are low because people who are already much wealthier can borrow incredible sums. This is why dropping interest rates low amplifies inequality, with the amplification going up on an incredibly steep curve, due to already-existing differences in the concentration of wealth and income.
When wealth and income go up exponentially - as they do - so does the capacity to service debt.
In the last 15 years economies around the world have been knocked sideways by many shocks, of which three were colossal - the 2008 global financial crisis, the oil price war of 2014-2022, and the pandemic.
2008 Global Financial Crisis
In 2008, the global financial crisis was the system collapsing under its own weight. The fundamental cause was mortgages, which, like a display of falling dominoes, propagated their risk through markets, governments and banks around the world.
This is how it happened. Central banks dropped interest rates really low after the dot-com crash and 9/11. Banks wrote bigger and bigger mortgages that the homeowners didn’t actually have the money to pay. The banks then sold those mortgages to Wall Street, to be packaged together as securities. Ratings agencies then rated these investments as AAA, which is the same quality as buying a bond and investing in the U.S. government, when that was absolutely false. That’s because no matter what mortgages were packed into that bundle, they could not guarantee the same offer of repayment as the U.S. government, which not only has the power of taxation to raise funds if required, the U.S. has monetary sovereignty, which means the government has the capacity to create money in its own currency.
This is a very important aspect of the mortgage market that is overlooked. Your house is not the investment - you are. Investment banks and the stock market are investing in your mortgage.
So, say, your mortgage and a whole bunch of other mortgages are packaged up into a bundle that provide a steady stream of income to investors. The thinking may have been that the it has so many people’s mortgages means it spreads the risk. Its assumed that only a few people are likely to default, making it somehow safer and less risky. The thing is, the value of that investment is dependent on people being able to keep borrowing more and more money to afford housing, even when their incomes aren’t going up.
Another thing they thought they were doing to “reduce risk” was to sell insurance against defaults. These “Credit default swaps” were private deals, not on regulated stock exchanges, and companies bought insurance against each other, where a couple of million in premiums could result in a payout 200 times that, when no one actually had money to draw on. So they would go broke - triggering another default, and another massive claim, and so on.
Instead of containing risk, these credit default swaps were part of a series of financial structures that was the path for the unfolding wave of defaults and risks going wrong, like a nuclear chain reaction of financial destruction. That is how Warrn Buffett described them.
The other thing about the global financial crisis is that when central banks put interest rates really low, it means that there is no really secure way to earn a return on your investment. When you buy bonds from the U.S. government in U.S. dollars, or from the Canadian government in Canadian dollars, you may not know what inflation and other factors will hold, but you can be damn sure you’ll get your money back with interest.
When interest rates drop near zero, or when governments aren’t offering bonds (because they are breaking even or running a surplus), that creates a problem for private investors. If government bonds have a return that low, buying a five-year bond at 0% is like putting money under your mattress for five years. You’ll lose purchasing power to inflation.
So private investors have to look to riskier investments. Higher interest rates mean higher returns, but also a higher risk of things going wrong. When investments consisting of bundled mortgages as classified as AAA, it meant that banks around the world started using those investments instead of government bonds. So when the defaults were rolling in, it meant that banks reserves were evaporating.
That is one of the reason why bank bailouts happened, including in Canada. The value of the banks’ assets had just plummeted, and they were technically insolvent. In Canada, some banks received a bailouts of more than $25-billion - more than their entire market value at the time - from the Bank of Canada, Canada Mortgage and Housing Corporation and the U.S. Federal Reserve.
So here’s the thing - the people who got bailed out were the investors, whose investment was in people’s mortgages. The people who defaulted and lost their houses were not bailed out, or given relief.
Short story long, people wrote cheques with their mouths that they their butts couldn’t cash.
The problem with dropping interest rates ultra-low as “monetary stimulus” to help an economy that’s been knocked sideways wheter by a financial crisis and string of bank failures, is that it is all in the form of debt, and the more money you already have, the more you can access. Of course it makes the rich richer: it is literally “supply side” or “trickle down” economics where the one prescription is to keep giving more money to people who already have it, because they will then reinvest it in new businesses that will create jobs, when it is used to bid up existing assets.
But that is what the central bank did after the 2008-09 crash.
2014+ Oil Price War
I’ve written about this elsewhere, but this is one of the most disruptive global events of the last decade. Prior to 2014, the price of oil had been over $100 a barrel for years. The “shale revolution” in the U.S. and Canada was transforming the North American energy market. For the first time in decades, the U.S. became a net exporter of oil. Canada was predicted to be an energy superpower.
Then in 2014, Saudi Arabia decided to launch a price war, and use their market dominance to drive the price of oil down under $50/a barrel. It was an instant disaster for the oil industry. There were brutal immediate losses, followed by cancellation of countless massive projects. There were lost jobs, lost investment, lost income, revenue. Devastating for oil-producing regions in Canada, and totally unforeseen.
The response of the Bank of Canada, again, was to lower interest rates, to try to boost the economy.
The price of oil actually went “negative” around the time of the beginning of global pandemic, and it started to soar in 2022 and 2023.
While the elevated price was blamed on the war on Ukraine, what had actually happened was that there had been a truce in the oil price war, and the price had soared because U.S. oil companies were colluding with OPEC - Saudi Arabia, Russia and others - to restrict production.
What was blamed on “money printing” was actually the direct result of oil industry profit taking and price-fixing. The result were record profits that contributed substantially to inflation around the world. In the U.S. over a quarter of inflation was driven by the industry choice to jack up oil prices.
The economic models that central banks run on don’t include shocks like this. The assumption that has been baked into the model that it’s always the government’s fault. The model assumes that the market is series of interactions that are in balance, whose workings are only thrown off by government. This is a ludicrous fantasy that fails to describe the actual economy, and it why we are in the mess we are in today.
The neoclassical / neoliberal / fiscally conservative economic paradigm can no longer said to be based in evidence. It is a series of rigid recommendations that are to be applied, as if by a medieval religious bureaucracy, based on morality, punishment and reward. It is not an exaggeration to say that the Catholic church often had a greater openness and commitment to rationality and critical thinking than neoclassical economics.
(Former Chief Economist of the World Bank Paul Romer said as much in 2016, in an essay where he described the discipline of macroeconomics as “post-real”.)
The Pandemic Shock
There were already serious tremors in the economy in late 2019 going into 2020. In the fall of 2019, there had been some serious instability and the U.S. Fed had started injecting billions of dollars into the overnight lending market, where there had been sudden and massive spikes in interest rates.
Overnight lending is critically important to keeping the economy going. Companies use it to cover payroll and other expenses. It is usually the safest, least risky market. People lend a large amount of money one day, it’s all returned with a little extra the next. It is where the 2008 global financial crisis began, because when the safest market isn’t safe anymore, that’s scary. When overnight interest rates spike, it’s also hard to deal with. If you’re the borrower, you suddenly have to come up with a lot more money to pay it back.
William White, who was a central banker and advisor to the Bank for International settlements and the OECD, who has been warning about excess private debt levels for years, argued that the latest “interest cycle” was coming to an end - which is to say, debt levels were so high that the economy was starting to cave in. This was reflected in growing political unrest - violent rhetoric, and intensifying and disruptive protests in the weeks and months before the pandemic was declared.
White writes that :
Now, such a pandemic was warned about for decades, because we live in a world where infectious disease and evolution both exist. Viruses and bacteria reproduce in the hundreds of billions and trillions at a rapid rate, which means that new strains are continually emerging. That’s life - literally. Once in a while, a new and highly infectious strain of disease that also has severe complications will emerge and spread.
In economic and business terms, the pandemic was like an asteroid of uncertainty hitting the markets. It should not be a surprise that, in March 2020, when no one knew what the impact would be, or how long it would affect the economy, investors and lenders had nowhere to put their money, and many had no idea how the money they had already been loaned out would be paid back.
The global credit markets effectively locked up, and central banks in countries around the world (the US Federal Reserve, the Bank of Canada, the Bank of England and more) stepped up with more “QE” or quantitative easing, and in Canada Canada Mortgage and Housing Corporation (CMHC) was also involved.
Central banks once again created money. In Canada, an initial $50-billion was created with the claim it would address “liquidity” and help banks lend. From investors who held them, they created new money in exchange for provincial and federal government bonds, even corporate bonds.
The argument was by injecting these funds and taking assets off investors’ hands, the Bank of Canada was giving more money to these investors to lend out. Buying provincial and federal debt from investors was supposed to send a signal to the market and bring down interest rates, encouraging lending to government to resume.
This rather complicated Rube-Goldberg arrangement needs to be considered for a moment. In Canada, public health and the entire health care system is run by provincial governments, who were all facing intense financial pressures.
The Bank of Canada and other central banks gave billions of dollars in new cash to investors (including Canada’s banks) so that they could lend it out - including to government.
Now, getting free money that you can lend out with interest is “nice work if you can get it”. The reason those private assets are dropping in value is because customer’s aren’t able to pay their bills. Governments faced the same challenge - their revenues were dropping because the businesses, people and companies wouldn’t be able pay their taxes.
Governments that needed to provide health care and economic support in a global state of emergency were making panicked cuts, while central banks created an estimated $8-trillion.
This is because of a number of economic assumptions that amount, at this point, to superstition.
One neoclassical assumption is the belief government spending causes inflation, based on a mathematically simple but totally false model of the economy that treats the economy as a pressure vessel where inflation goes up when new money is pumped in.
The actual economy is really a massive and interconnected network of quite separate recorded accounts and obligations. It’s not a big pool of money that flows from place to place. It’s distinct and discrete records, accounts, bundles and registries.
Another is that “supply-side” (AKA trickle-down/voodoo economics/fiscal conservatism/neoliberalism) takes it as a tenet of economic faith that in order to drive investment, new growth and jobs, funds need to be directed to people and institutions who already have money.
“You have to build wealth to distribute it” is the idea - but the actions of central banks in propping up the financial sector show that it’s obviously and clearly totally false. Central banks publicly and clearly state that they are creating new money for banks so that banks can lend more.
The money Central Banks are distributing is not being drawn from savings. It is being created from nothing. Central banks open accounts for banks, investors and corporation, and create money in them, totalling trillions of dollars around the world.
So there is no saving necessary before investment. The banks don’t require deposits, because the deposits are being created for them.
And people looking to invest in a new business and create jobs don’t need to save either, because they can take out a loan.
The other reason that’s used to justify QE is a baked-in ideological assumption that the market is always better at allocating capital efficiently than government, or “some government bureaucrat” as people like to grunt.
Perhaps it’s time for us to re-evaluate the argument that the markets are truly the best to allocate capital, when they are receiving tens or hundreds of billions of dollars in public money in exchange for investments they’ve made that aren’t working out.
Ultra - low interest rates, then ultra fast hikes
One of the most important things to point out is that none of the underlying problems have actually been addressed. The same solutions keep being applied and the same problems keep coming up, and they keep making things worse, which is exactly what William White said:
Perhaps the most effective way of showing the need for fundamental monetary reform is to point out the negative implications of the monetary policies followed by the major central banks in the advanced economies over the last few decades.
First, the general adoption of a positive (+2%) inflation target has prevented the downward adjustment of prices that would be the natural product of increases in productivity and positive supply shocks. As a result, prices have been drifting upwards (and significantly) for decades. Second, the recurrent use of monetary easing to spur demand and raise inflation has become increasingly ineffective. Current monetary policy faces a fundamental problem of temporal inconsistency: solving today’s problems also makes tomorrow’s problems worse. Third, stimulative monetary policy has had a variety of unintended and unwelcome consequences that can only worsen; credit “booms and busts”, potential financial instability, fiscal unsustainability, a progressive loss of central bank “independence”, growing inequality of wealth and opportunity and a slower growth rate of potential output. Fourth, as the threat posed by these unintended problems have cumulated over time, “exit” and the “renormalization” of policy has become ever harder to achieve.
To sum up, the current monetary system has trapped us on a path we do not wish to follow because it leads inevitably to ever bigger problems. This is why fundamental reform is needed.
That has not happened.
These pandemic measures unleashed vast new quantities of debt that bid up prices of existing assets - stocks and housing, and drove up housing and rents beyond what people could afford. (In Canada, provincial governments lifted eviction bans during the pandemic, which accelerated rent hikes and property flipping.)
This brings us to vitally important problem of using monetary policy and lowering interest rates to “juice” the economy. Because it has the effect of driving up housing and property prices, that raises the cost of overhead for the entire economy.
The winners from this strategy are the FIRE economy - finance, insurance, real estate. They all get to make more money without having to do more work. But it costs everyone else - including the rest of the private economy, workers and business alike.
When people talk about inequality getting worse, or the rich getting richer and the poor getting poorer, it’s not just workers. It’s all the businesses who are not in the FIRE economy. One of the major pressures for higher wages comes because workers need raises to pay their rent and mortages, which keep going up to cover the interest payments on the massive loan used to buy or re-mortgage the property.
Those higher wages are being used to pay back the investments of a people who for decades have been gambling that the middle and working class will be able to keep making their mortgage payments.
Because so much of those higher wages are being siphoned off in mortgage payments, hundreds of billions of dollars that could be invested in productive industry with future returns all goes to what is effectively rent on the entire economy instead.
That is the central problem with our economy, both before and after the pandemic.
The situation now has been made much worse by central banks' decision to respond to inflation with rapid interest rate hikes, effectively choosing “monetary austerity” for the economy.
It is absolutely bizarre that we don’t acknowledge that when central banks start really cranking interest rates because they want to “cool down” the economy, their goal, which they are deliberately choosing, is to cause people to lose their jobs and businesses to close, because they think that will reduce prices.
Then, people blame elected politicians for doing what central banks have said, out loud, that they are choosing to do.
The issue with central bank independence here is that central bank accountability is non-existent. By hiking interest rates, central banks are causing people to lose their homes and businesses, when Canada and the world’s economy and societies were shattered and battered by a pandemic that has left deep scars and open wounds that are going completely unacknowledged.
The idea that in 2024, we don’t have a more effective way of addressing inflation than by tipping random borrowers into bankruptcy and distorting lending across the entire economy is both moral and intellectual bankruptcy on its own.
The reason we are in this crisis really is for profoundly ideological reasons. While people scream about partisan political differences, the fundamental operating system is the problem, and it doesn’t change, even when governments do.
Here’s the thing. Just like Elon Musk’s purchase of Twitter, there are a lot of people who have borrowed money to buy things, and things have changed. Interest rates have led to job losses and bankruptcies.
Hiking interest rates means that banks won’t extend as much credit to you, even if you’re still making the same amount of money. A whole bunch of people who qualified for loans at lower interest rates no longer qualify when they go up. So it has a “distributional impact” - but it also reduces the amount of credit flowing into the economy in the form of mortgages, so real estate prices may drop. The higher the interest rate, the smaller the loan.
Though it was important to normalize interest rates to bring sanity back to the market, here again the solutions make no sense.
Because the theory is that prices are going up because there’s too much government money going around, that you’ll take that money out of circulation by hiking interest rates. This cuts off some borrowers, and “takes money out of circulation” by increasing debt payments being made to private investors.
This, again, is an application of “trickle down” economics, because it’s profoundly regressive. It’s a given with lending and credit risk that the worse off you are, the more you pay, the better off you are, the less you’ll pay.
There is another problem with this entire strategy of hiking interest rates to fight inflation. First, it means that borrowers will suddenly face increased debt costs. Even though neoclassical economists believe that inflation is caused by excess public spending, they don’t want the public to take it back. Instead, that extra “inflation-causing” money they think exists is taken out of circulation by being placed in private investors’ accounts. And when people are bankrupted and their “distressed” property is auctioned, they can be snapped up at lower cost. It is a mechanism that extracts wealth and redistrubutes it upward, all in the name of lowering prices.
In fact, the obsession with inflation is yet another a form of investor protectionism baked into the neoclassical idea. Since the “classical” economics part of the neoclassical idea was from the 1800s, when there was barely any government, date was bad and the model of society was basically a few aristocrats who own everything, supported by many serfs who own virtually nothing.
The obsession with inflation at its core is not about grocery store prices - it’s about the price of assets and investment. Inflation has been called “a tax” but the reality of life and the world is that some investments decline in value for market reasons, including conpetition, innovation, market distortions and fads.
While we need to pursue policies that keep inflation low, we should be having political, economic and policy debates about these huge central bank interventions in the economy in order to prevent asset prices from going down. This is not Keynesian stimulus. This is Alan Greenspan stimulus, and Volcker austerity.
It’s evident from the data that a huge chunk of recent inflation was caused by price ficing on the part of oil companies. In May, the FTC announced they had evidence that a US oil executive had been colluding with OPEC - including Saudi Arabia and Russia - to fix oil prices, by coordinating together, limiting the flow of oil by restricting new development. Aside from hundreds of texts and Whatsapp messages, there were statements that people who invested in new production and brought down the price at all would be punished made in public.
This resulted in soaring prices at the pump and the largesr profits in history for the oil industry. Matt Stoller estimated that it was responsible for more than a quarter of all US inflation in 2022-23, and the impact was similar in Canada.
When it’s price-fixing and collusion by oil cartels driving inflation, how is hiking interest rates supposed to help that?
So, the problem in countries across the world right now is that all this debt has really distorted societies in ways that frankly are tipping them into chaos.
And of course there is a risk of another financial crash, because none of problems have been addressed. The New Deal wasn’t just deficit spending on infrastructure and jobs. It was also a ton of laws and regulation to address a system failure that occurred in part because a total lack of oversight and enforcement of rules and regulations to protect people from being swindled and from exploding the economy again.
After a financial crash, individuals end up like the investors in Elon Musk’s Twitter. They bought high, and their property is worth less now. If they were able to sell now, they will “lock in their losses” and lose money. Even if prices are going down, their debt is going up. It’s “Debt-deflation” and it is the trap that the U.S. and Canada found themselves in during the Depression, and that Japan found itself in in the 90s. In the end, what Japan did was have its central bank buy up the debt to get its economy going again. It worked.
The next time there’s a crash, before everyone reflexively makes the same panicked mistakes of 2009 and 2020 over again, (bailing out private investors with billions in newly created money) while the public face cuts, what is required is:
A plan for orderly personal and farm debt restructuring to remedy the colossal debt distortions created by past mistakes in monetary policy
Providing better access to capital in the form of equity for new businesses and start-ups to create new local business
Ensuring that the public sector is funded specifically for investments that will deliver real-world improvements in efficiency and productivity on a long-term basis - infrastructure, energy, education, R & D, health care, and environmental restoration. Those are public investments that increase the common wealth - including private sector wealth.
It’s also how Canada and the U.S. escaped the Depression and built the North American middle class. Economics and politics grounded in reality.
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DFL
Wow. Just .... wow. This is the best summary of our macroeconomic predicament that I have read in a long, long time. Well done!
Just as there are two Chinas, Bad China and actual China, there are two Twitters. On Bad Twitter, which I have never seen, is a place we all go to scream about, and thereby indulge, the mental illness of a demented 71-year-old comic book villain [then-US President, Donald Trump]. If it’s not that, then we’re screaming at someone we don’t agree with, or screaming at someone we do agree with, because that person did something that we don’t agree with enough"…
There's plenty of pro-Trump and anti-Biden stuff, of course, but not enough to balance their absence from the MSM.
Musk bought the site to preserve some vestige of free speech in America, not to make money. He failed to stop Jewish censoriship but, otherwise, Twitter is by far the world's #1 news site–and for good reason.