CHAPTER 7
THE HIGH COST OF PHANTOM WEALTH

Financial capitalism is a system of irresponsibility and…is amoral. It is a system where the logic of the market excuses everything.…Either we re-found capitalism or we destroy it.

PRESIDENT NICOLAS SARKOZY OF FRANCE

“We have always known that heedless self-interest was bad morals,” said Franklin Delano Roosevelt in 1937. We know now that it is bad economics.

PAUL KRUGMAN

Wall Street’s relentless drive to have it all not only has had devastating economic, social, and environmental consequences but also has destroyed the integrity of money, created expectations that society has no means to fulfill, and sacrificed the health and happiness of nearly everyone. The full costs are beyond comprehension.

PHANTOM EXPECTATIONS

It is a curious thing that, unless we stuff it in a mattress, we expect whatever money we don’t immediately spend to grow in perpetuity without effort on our part. We do not expect the same of real wealth. Buildings must be maintained. Machinery must be replaced. Knowledge must be updated. The trust and caring of a community must be continuously renewed. Skills must practiced. Even wild spaces must be protected from predators, particularly human. All of these require a real investment of time and life energy. Effortless perpetual growth defies the physical law of conservation of energy. Only phantom wealth can grow effortlessly and perpetually.

As our phantom wealth grows, so too do our expectations regarding what constitutes our rightful claim to society’s real wealth. Unless we are voluntary simplicity initiates, we are inclined to increase our consumption in tandem with growth in our income, placing an ever-greater burden on the planet. So often, we say with pride, “I can afford it,” without asking whether Earth can afford it.

Because our economic system gives priority to creating phantom wealth, presumed entitlements now far exceed the real wealth available to satisfy them. This can create quite a shock when those of us with financial assets decide to convert our share of the phantom-wealth pool into payments for rent, food, health care, and other needs, if a lot of others make the same decision at the same time.

The financial planner Thornton Parker has pointed out that this is likely to be an issue for baby boomers who built up financial assets during the stock market boom in anticipation of a comfortable retirement. Just as their collective decision to put money into the stock market during their working years helped inflate share prices, so their collective decision to take it out during their retirement will deflate those prices, leaving these retirees in potentially desperate straits.¹

Wall Street’s phantom-wealth machine has created prospective claims and related expectations far out of proportion to the real wealth available to satisfy them.

The problem is not confined to prospective retirees and retirement accounts. It applies as well to the endowments of foundations, universities, and other nonprofits. It applies to the public trust funds of libraries and municipalities, college savings funds, the reserve accounts of insurance companies, personal trust funds, and much else.

Perhaps the major challenge to the call to shut down the Wall Street phantom-wealth machine is the understandable and serious cry, “But what about our 401(k)s and our university and foundation endowments?” The answer is that so long as these funds are invested with Wall Street institutions engaged in phantom-wealth creation, they rest on nothing more than financial bubbles and creative accounting, and their value can evaporate overnight.

We must build our old-age security and our crucial nonprofit organizations on more solid foundations. In chapter 14, I’ll say more about better options for dealing as a society with such things as retirement, home purchases, and insurance than those offered by Wall Street. As for the American dream of living off financial returns in work-free luxury, it is a fantasy that can be achieved by the very few at the expense of the many.

There is no way to tell by how much the claims of financial-asset holders exceed the real wealth available to fulfill them, but the evidence suggests the difference is considerable. No one is even asking how the inevitable loss of unfulfillable expectations might be fairly distributed. A given dollar doesn’t come with a marker that identifies it as a phantom dollar or a real one.

DELINKED FROM REALITY AND OUT OF CONTROL

The financial figures that get thrown around in relation to the credit crash and financial bailout of 2008 defy both reality and imagination. The financial assets of the richest 1 percent of Americans before the crash totaled $16.8 trillion.² This represents what they understood to be their rightful claim against the world’s real wealth. To put that in perspective, the estimated 2007 U.S. gross domestic product was $13.8 trillion, and the total federal government expenditures that fiscal year were $2.7 trillion.³

These sums all seem trifling, however, compared with the $55 trillion in credit default swaps outstanding at the time of the subprime mortgage meltdown, to which they made a major contribution.⁴ These are essentially insurance contracts that presumably eliminate the risk from the toxic mortgage derivatives. They involve bets and counterbets that may partially cancel each other out if anyone can untangle them — but many of the parties to them have gone bankrupt. Because the transactions were never reported to any central clearinghouse and many of them are carried off the books of the institutions that hold them, no one really knows how much is actually at risk or who owes what to whom.

All we know for sure is that $55 trillion is a great deal of money. It pales into insignificance, however, when compared with the $648 trillion that the Bank for International Settlements reports as the total notional value of all outstanding over-the-counter derivatives as of June 2008.⁵ That renders insignificant even the $16 trillion that evaporated between mid-September and the end of November 2008 as the market value of the world’s publicly traded corporations’ share prices fell by 37 percent.⁶

Is your head spinning? Is your brain shouting, “This doesn’t make any sense”? Trust your brain. It is working. Welcome to the Alice in Wonderland world of phantom wealth.

A quick note is in order here on the Wall Street bailout figure of $12.8 trillion noted at the beginning of chapter 1. Perhaps you recall the public outrage in October 2008 when the U.S. Congress passed a bill authorizing the Treasury Department to spend $350 billion to bail out Wall Street financial institutions, with another $350 billion in the pipeline subject to congressional approval. So what is this $12.8 trillion?

Some of it is in established government guarantee and insurance programs, including other Treasury Department programs. The FDIC was on the hook for $2.0 trillion, and the Federal Housing Administration for $0.3 trillion. The bulk of it, $7.8 trillion, was from the Federal Reserve,⁷ which acts independently and which routinely makes massive financial commitments to the banking system without any congressional approval or oversight process.

Mostly, the Fed creates its own money as it sees fit, with a few simple accounting entries. In most instances, no one seems to know where any particular funding comes from, where it is going, or how it is being used. Indeed, the Fed has stood firm against bipartisan calls from Congress for a federal audit and Freedom of Information lawsuits by Bloomberg News and other news agencies seeking a release of records on who has received what commitments and on what terms. The Fed argues that making such information public would endanger public faith in the banking system. Given how low public faith in the banking system is now, that is an alarming admission.

If you don’t understand how Wall Street really works, don’t feel bad. I’ve come to doubt that anyone really understands it. The accounting involves so much smoke and mirrors it may be beyond understanding.

It isn’t necessary to know the details to recognize that we are dealing with a system that is delinked from reality and is operating with no one at the helm. Nor does it take special genius to recognize that when folks are moving around trillions of dollars in secret transactions and cannot explain in a credible way where the money is coming from or where it’s going, and cannot make a credible case that it is serving a beneficial purpose, they are probably up to no good.

Now I want to turn to what I believe to be the most important of all the many design flaws of Wall Street’s phantom-money machine.

PERPETUAL GROWTH ON A FINITE PLANET

The unrealistic expectation that money should grow perpetually and effortlessly is more than a cultural issue. It is built into the design of the Wall Street money machine. Do you recall the description in chapter 2 of how banks create money with a few computer strokes when they issue a loan? Recall that 32 percent of all outstanding U.S. debt is money that financial institutions owe to each other. By making such loans, banks bulked up their financial statements, expanded the total amount of money in play in the Wall Street casino economy, and increased the number and size of the transactions that generated the management fees that paid the bonuses. Recall also that when banks issue loans, they are creating money with simple accounting entries. Yes, much of the phantom-wealth thing is mainly fancy accounting.

GROWTH AND JOBS

There is a connection between growth and jobs, but only because Wall Street has the system gamed to assure that all the gains from increased productivity go to managers and shareholders rather than to labor.

Thus, the total number of jobs will decline and unemployment will increase over time if the economy is not growing at a rate at least equal to the increase in productivity. This problem is easily avoided if productivity gains instead translate into greater time for working people to devote to family, community, and other quality- of-life pursuits.

Banks were in fact creating money so fast that the Federal Reserve stopped reporting the most meaningful index of the amount of money in circulation, what economists call M3, on March 23, 2006. Some observers believe the Fed stopped reporting it because the amount of money had begun to grow so fast as to cause public alarm and undermine confidence in the dollar.

Phantom Money and Unreported Inflation

John Williams, a consulting economist who has spent years studying the history and nature of economic reporting, tracks economic statistics that the government has either stopped issuing or has seriously distorted. Using the same methodology the Fed once used to compile its M3 index, Williams reports that the rate of growth was running from 5 to 7 percent in 2005. It then began a steady acceleration to a peak annual rate of over 17 percent at the beginning of 2008, just before the credit collapse kicked in.⁸

When the money supply expands faster than productive output, price inflation usually results. According to the official Consumer Price Index, inflation was running at a rate of 2 to 4 percent at the beginning of 2008. Williams compiles his own consumer price index using the same methodology that the government used up until the 1980s, when it decided to start cooking the books to hide evidence of economic mismanagement and hold down automatic wage and Social Security indexing. According to Williams the actual rate of inflation at the beginning of 2008 was in the range of 12 to 13 percent. What you experience every time you go shopping is true.

Surprised? Yes, successive Wall Street–dominated presidential administrations, both Republican and Democratic, have been cooking the books on inflation, money, unemployment, and the GDP for decades. Our economy is in far worse shape than the official statistics reveal. But I stray from our topic.

Inflation of the money supply far in excess of real economic expansion — and the resulting real rate of inflation in consumer prices — is yet another cost of Wall Street’s phantom-money orgy. The inflationary phantom money that banks have been creating to fund Wall Street gamblers is one of the several vehicles by which Wall Street takes money out of Main Street pockets and puts it in Wall Street pockets.

Credit Crunch in a World Awash in Money

It is odd that we experienced an economic collapse in 2008 because of a credit crunch, an inability to borrow, at a time when the world has been awash not only in debt but also in money. BusinessWeek’s July 11, 2005, cover story shouted “Too Much Money” and spoke of a savings glut. Its June 11, 2008, European issue reiterated the theme, “Too Much Money, Inflation Goes Global.”

Most discussion of the financial crisis focuses on the details and misses the big picture. The problem is twofold. The economic system is awash in money, but this money is in the wrong places. Second, virtually every dollar in the system is borrowed, because we rely on banks to create our money by lending it into existence. No debt, no money.

As wages fall relative to inflation, the bottom 90 percent of the population is increasingly dependent on borrowing from the top 10 percent to cover daily consumption. But when the less fortunate can’t repay their loans, the rich people stop lending. Most loans continue to be repaid, but because the default rate is rising and the crazy system of derivatives trading makes it impossible to separate good debts and responsible borrowers from bad debts and deadbeats, banks are afraid to lend to anyone. As the good loans are repaid, the supply of money shrinks because new loans are not being issued.

In turn, the demand for real goods and services begins to fall because people don’t have the money to pay for them. Businesses lay off workers, who consequently cannot repay their debts or even put food on the table. The problem appears to be a lack of money, even though the total money in the financial system is far more than enough to cover real-wealth exchanges in a rational real-wealth economy. The money, however, is locked up in the Wall Street casino economy rather than circulating in the real Main Street economy. Pouring bailout money into Wall Street does zilch for Main Street.

It all traces back to a system that issues money as debt to the casino economy rather than to the productive economy.

Why Debt and the Economy Have to Grow

Because of how our financial system is designed, the economy has to grow or collapse. The growth may or may not provide employment, meet real needs, or reduce poverty — it must only meet the demand of the banking system for its pound of flesh.

Because the bookkeeping entry a bank makes when it issues a loan creates only the principal, the economy must grow fast enough to generate sufficient demand for loans in order to create the money required to make the interest payments in an ever-escalating spiral. Otherwise, debts go into default and the financial system and the economy collapse. The demand for the eventual repayment with interest of nearly every dollar in circulation virtually assures that the economy will fail unless the GDP and income inequality are constantly growing. If you are a Wall Street banker competing for points in the power game, it does not get sweeter than this.

Unfortunately for the rest of us, this demand for perpetual growth simply to keep the bankers happy results in a serious distortion of priorities. To avoid an economic collapse, policy-makers base their choices not on what will maximize the well-being of all but on what will create sufficient demand for additional borrowing to put enough money in circulation to pay the interest due to bankers on the loans already outstanding. The result is ever-increasing debt and the accelerating destruction of the natural environment and the human social fabric.

It gets even worse. Given Earth’s material limits and the amount of debt already in play, there is no way that the productive economy can expand at sufficient rate to keep the game going. The necessary growth in debt must therefore come from the casino economy and its seemingly limitless ability to create phantom wealth by pumping up financial asset bubbles and loan pyramids — the ultimate Ponzi scheme.

It is illogical and deeply destructive to design an economic system in a way that creates an artificial demand for perpetual growth on a finite planet. It is even more pernicious when the defining purpose is to make the already rich even richer relative to everyone else.

By contrast, nothing in the design of the formal economic system allows those with little or no access to money even to give voice to their needs, much less fulfill them. They survive only by scratching out their living at the extreme margins of society in informal or “underground” economies of their own creation. These are design failures of the first order. To heal our sick society, we must redesign our economic system to remove these and other glaring defects, not only to secure our collective survival but also to achieve health and happiness.

HEALTH, HAPPINESS, AND KEEPING UP WITH THE JONESES

In a society defined by extreme inequality, our perception of our worth and our relationships with others are almost inevitably shaped by our position in the prevailing hierarchy of power and privilege. In this situation, we easily fall into the trap of valuing ourselves by our net worth and material possessions rather than by our intrinsic self-worth.

Once in the trap, we will likely seek to endear ourselves to those above us even as we scheme to displace them and occupy their more elevated chair. Likewise, we may display contempt, whether overtly or subtly, for those below as a way of affirming and justifying our own status. Because financial fortunes are fluid and great phantom-wealth fortunes can evaporate overnight for reasons wholly beyond our control, even those in a position of financial advantage experience continuous, sometimes extreme, anxiety, with serious consequences for physical and emotional health.

In an equitable society in which all people are valued for who they are rather than what they own, our natural concern is for the well-being of the group rather than for our particular position within it, because we truly rise or fall together. Seeking our place of service to the well-being of the whole thus becomes more important than defending and improving our position in a power hierarchy. Rather than anxiety, we feel calm exhilaration. Our blood pressure falls and our health and happiness improve. This is all confirmed by a wealth of scientific studies that document the benefits of equality for individual well-being.⁹

When Ed Diener and his colleagues at the University of Illinois compared the life-satisfaction scores of groups of people of radically different financial means, they found four groups clustered at the top, with almost identical scores on a 7-point scale. One cluster of respondents, which comprised people on Forbes magazine’s list of the richest Americans, had an average score of 5.8. Ah, so money does bring happiness — at least when you are at the very tip-top of the hierarchy.

The other three top-scoring clusters, by contrast, were groups known for their modest, egalitarian lifestyles and strength of community. These were the Pennsylvania Amish (5.8), who favor horses over cars and tractors; the Inuit of northern Greenland (5.9), an indigenous hunting and fishing people; and the Masai (5.7), a traditional herding people in East Africa who traditionally live without electricity or running water in huts fashioned from dried cow dung. These are all communities in which people care for one another and share their resources, and in which economic distinctions are minimal.¹⁰

By definition, the Forbes 400 list is limited to four hundred people. We cannot all be on it. We could all, however, be living in equitable, caring, sharing communities and enjoying the associated health and happiness benefits. We need only to create societies that put less emphasis on making money and more on cultivating caring place-based communities that distribute wealth equitably.

Wall Street is bad for our health and happiness, not only because it has given us a health care system that places greater priority on Wall Street profits than on our well-being, but even more because it destroys a sense of community, creates a narcissistic culture, and rewards predatory competition.

REAL WEALTH WITH NO LIMITS

It is time to stop managing the economy for the benefit of Wall Street bankers and speculators, to ask what we really want from life, and to redesign our economic institutions accordingly. In so doing, we should look very closely at evidence demonstrating that once a basic level of material well-being is achieved, the major improvements in our health and happiness come not from more money and consumption but rather from relationships, cultural expression, and spiritual growth.

These forms of real wealth are most valuable and fulfilling when they are dissociated from money and financial transactions — and they make little or no demand on environmental resources. The title of the classic ballad comes to mind: “The Best Things in Life Are Free.” Those words carry a lot of truth. What are the things that give you enduring pleasure? The material needs of people who are secure in their identity and sense of self-worth can be met in quite modest ways, freeing our energy for the things that bring us real joy.

The cover story of the winter 2009 issue of YES! Magazine is about Dee Williams, a young woman who loves her life in an 84-square-foot house on wheels. It cost her $10,000 to build, including the photovoltaic panels that generate her electricity.¹¹

I’d give you odds that she is happier than most of the billionaires that Robert Frank writes about in Richistan, who spend their lives rushing between gigantic homes and estates in their private jets and yachts, occupied all the while with making deals by phone and computer to pay the bills.¹²

Our economy needs a serious makeover. It is a design issue. We have for too long put up with an economic system designed to make money for rich people and maintain them in a condition of obscene excess by confining billions to lives of desperation and reducing Earth to a toxic waste dump. We can do better. And it’s about time we do so. We’ve put up with such nonsense for five thousand years. Finally, we have the means to choose a different way.