In the movie the Wizard of Oz, the protagonist, Dorothy Gale recognizes her new landscape and remarks to her dog, Toto, “We're not in Kansas any more.” We can probably say the same thing today with respect to our economic condition. We have entered into a fairytale land of financial wizardry. The identity of the Wizard is debatable and in fact, there is not one wizard but many.  Those wizards occupy the offices of government and central banks.

Excessive consumption and flawed money led us to the financial Land of Oz. A period of conspicuous consumption manifested in real estate, bonds, and stocks. Facilitating that consumption was our money system and the ease with which banks and other institutions create credit. 

Beginning in the period of 2005 - 2007, the equation changed when consumption debt reached unsustainable levels and so began the wave of declines in both the stock and real estate market. The wealth that so many thought they had evaporated quicker than a lightning bolt from the Wicked Witch of the West. For many, this became a lesson in the definition of true wealth. Wealth was not the perceived equity in a home nor was it the paper gains in the stock market. Regrettably, the public treated home equity and stock paper gains as wealth and leveraged more speculation.

At the stock market bottom in the Spring of 2009, the public felt, and simply was, poorer. The residential real estate market experienced pronounced declines. The sub-prime market was the first catalyst for this decline. The public's 401(k) accounts plummeted. Job losses accumulated.

The public was off to see the one of the Wizards for help out of the economic nightmare. The government appeared from behind the curtain. The United States Government (USG) attempted to replace the spending not occurring in the economy. Unfortunately, the money for that spending had to be borrowed into existence.  Government also has a wealth of experience in misguiding the allocation of capital.

Deflation reared its ugly head during the depths of the financial crisis. Deflation is a contraction or reduction in the amount of outstanding credit available.In a credit-based society, the reduction of credit is fatal to expansion and the continuing rise of prices. The absence of this credit caused the plunge in residential real estate prices.When securitized mortgages were not valued as before, the real estate market cratered.Consumers got tapped out and curtailed revolving credit.

The public next came to the throne of the central bank Wizards who obliged them with unprecedented intervention. The stock market got reflated. Real estate experienced a recovery. Corporations acquired debt in order to purchase their own shares. In countries like Japan, the central bank is a large participant in the stock market. When the economy did not respond according to their pronouncements, the Wizards tried more of the same (lower short-term rates and bond purchases). When it still did not respond, the Wizards, undaunted, invented negative interest rates.

Unfortunately, economic realities cannot be repealed. Economies in our time expand and contract resulting from credit cycles and social optimism or pessimism. The cycles are exacerbated with our flawed money. Attempting to fight these cycles only prolongs the eventual outcome. 

While some battles may be won, the war cannot. One such battle was the effort to rid banks of bad assets. The Market spoke on this issue and was not receptive to acquiring these assets, thus calling to mind the term, "zombie bank." The banking industry was not solely to blame for their zombie status. In the middle of the consumptive mania, the USG brought us the repeal of the Glass-Steagall Act. Enacted during the Great Depression, the act forced the separation of commercial and investment banking whose combination was blamed for excessive speculation in the 1920s (sound familiar?). Additionally, the USG encouraged relaxed lending standards in the late 1990s, contributing to the sub-prime debacle. Government is never an agent of sound economic policy.

We have not reached the end of this journey in the financial Land of Oz. We must wait for Dorothy to tap her shoes and say, “There’s no place like home.” Unfortunately, the Wizards are not letting her escape from the Emerald City.