Tuesday, September 30, 2003

Currency & Marshall Auerback

Auerback as lucid as ever:

John Snow Lights the Fuse

“Be careful what you wish for” is an aphorism on which US Treasury Secretary John Snow might care to reflect in light of the foreign exchange market’s latest trashing of the dollar. Consider last weekend’s G7 communiqué from Dubai:

"We reaffirm that exchange rates should reflect economic fundamentals. We continue to monitor exchange markets closely and cooperate as appropriate. In this context, we emphasize that more flexibility in exchange rates is desirable for major countries or economic areas to promote smooth and widespread adjustments in the international financial system, based on market mechanisms."

The statement may well help to placate US domestic manufacturers (what’s left of them), who have been complaining loudly about competition from China, but such rhetoric from the G7 does not come without a cost.

Despite subsequent British denials that the statement reflected a change in policy, the G7 ministers have with this language attacked not only the Chinese currency peg but also the Japanese strategy of flooding the market with yen to forestall its appreciation. That policy has been critical to jacking up the Nikkei and generating a more accommodative global set of financial conditions because Bank of Japan Governor Fukui, in marked contrast to his predecessor, has left such sales of the yen unsterilised.

That is, until just a week ago, when the Yen cracked the important 115 to the dollar barrier, a sign, posits PIMCO’s CIO, Bill Gross, that the Asian appetite for dollars and U.S. Treasuries might be sated, and that the long enamored and widely held “Yen carry trade” might be on its last legs.

If true, it means a very important source of financing for the US external imbalances may be drying up, which is something the US can ill afford at this juncture. In the words of Paul Donovan, an international economist at UBS, “The precarious funding situation means the US administration needs to be delicate with any rhetoric on the currency or it risks accelerating what should ideally be a gradual fall in the dollar. If Asian support for the dollar or the Treasury market is no longer forthcoming, they would have a serious economic problem.” A serious economic problem which would have ramifications in Asia as well, notably Japan and China. ...{article link continued}


Traitors in the Bush Administration

A little news from Jim Hightower's blog:

The Most Insidious of Traitors
By William Rivers Pitt
t r u t h o u t | Perspective
Tuesday 30 September 2003

"Even though I'm a tranquil guy now at this stage of my life, I have nothing but contempt and anger for those who betray the trust by exposing the name of our sources. They are, in my view, the most insidious of traitors."
-- George Herbert Walker Bush, 1999


Karl Rove, senior political advisor to George W. Bush, is a very powerful man. That is not to say he has never been in trouble. Rove was fired from the 1992 Bush Sr. campaign for trashing Robert Mosbacher, Jr., who was the chief fundraiser for the campaign and an avowed Bush loyalist. Rove accomplished this trashing of Mosbacher by planting a negative story with columnist Bob Novak. The campaign figured out that Karl had done the dirty deed, and he was given his walking papers.

Demonstrably, Rove is back in the saddle again. The January 2003 edition of Esquire magazine carried an article by Ron Suskind which quoted comments from John DiIulio, a domestic policy advisor to the White House who had just retired from his post. On October 24, DiIulio had sent a letter to Suskind describing what he had seen while working for the Bush administration. The meat of the letter described an administration far, far more interested in raw political triangulation and ruthless spin than in actual policy and government functionality. Some excerpts from DiIulio's letter:

"Some are inclined to blame the high political-to-policy ratios of this administration on Karl Rove...some staff members, senior and junior, are awed and cowed by Karl's real or perceived powers. They self-censor lots for fear of upsetting him, and, in turn, few of the president's top people routinely tell the president what they really think if they think that Karl will be brought up short in the bargain. Karl is enormously powerful, maybe the single most powerful person in the modern, post-Hoover era ever to occupy a political advisor post near the Oval Office." ...{article link continued}

Adam Smith & Corporate Globalism

I though it was time for a fresh perspective on Adam Smith, and corporate globalism. If your looking for the best perspective on corporate globalism, this is it. David Korten is one of the most intelligent, interesting men in the world, at present. He has a massive following of diverse groups, all over the world. He presents the complex in plain language with an interesting style. I recommend his view to everyone.

This is economics with a social conscience at its highest level:

David C. Korten Ph.D.

THE BETRAYAL OF ADAM SMITH
Excerpt from
When Corporations Rule the World
2nd Edition
by David C. Korten
It is ironic that corporate libertarians regularly pay homage to Adam Smith as their intellectual patron saint, since it is obvious to even the most casual reader of his epic work The Wealth of Nations that Smith would have vigorously opposed most of their claims and policy positions. For example, corporate libertarians fervently oppose any restraint on corporate size or power. Smith, on the other hand, opposed any form of economic concentration on the ground that it distorts the market's natural ability to establish a price that provides a fair return on land, labor, and capital; to produce a satisfactory outcome for both buyers and sellers; and to optimally allocate society's resources.

Through trade agreements, corporate libertarians press governments to provide absolute protection for the intellectual property rights of corporations. Smith was strongly opposed to trade secrets as contrary to market principles and would have vigorously opposed governments enforcing a person or corporation's claim to the right to monopolize a lifesaving drug or device and to charge whatever the market would bear. ...{article link continued}


Sunday, September 28, 2003

Infectious Greed

All economists must read this new derivatives book:

Infectious Greed

All investers must read this book. All policy makers and politicians must read this book. All people interested in political economic truth and reality must read this book. All people should read this book.... I don't know how I can emphasize it any more. I just finished reading the book. I have never read a more thorough book about our nation and the world than this, and I have read and/or researched thousands, and thousands. It is from the perspective of the real mechanics of the derivatives market and all associated entities of all markets, politics, and policy. You must read it. Frank Partnoy, of Enron testimony fame, has thoroughly explained the derivatives market to its fullest and minutest detail possible. If you ever wanted to truly understand gambling, and market gambling fully {making book} here it is.

Infectious Greed

Review


Get this book if you want to understand Wall Street antics.
This book is an absolute must read if you want to understand Wall Street shenanigans. Partnoy has done a phenomenal job of demystifying the world of swaps, derivatives and other exotic financial instruments. Even better, he shows how investment banker antics have affected Main Street inhabitants including yourself. How did Orange County and so many other municipalities get so deeply in trouble? The author explains.

I {Srikumar S. Rao } have a Ph.D in business and many finance courses under my belt, but I never quite understood the systemic dangers of the 'financial innovation' that is sweeping our markets. Now that I have, I will sleep much less well at night.

Partnoy describes the evolution of exotic instruments and the characters involved in this evolution. How CS First Boston made securites of virtually any type of debt, Salomon pioneered the CMO and so on. He details the specific wrongdoings of companies like Enron, Global Crossing and WorldCom. He shows you the enabling role played by gatekeepers like accounting firms, law firms, analysts and credit rating agencies.

Even more important, he shows you exactly how the collusion happened and why. He gives you both an aerial view of the markets and a down-in-the-trenches description. I often wondered why, in efficient markets, participants voluntarily involved themselves in such convoluted transactions that had high costs in terms of record-keeping and fees. The answer, as Partnoy shows, is that virtually all of these arrangements permit some set of parties to subvert law or regulation or both. This is true domestically and internationally.

He graphically describes how lobbying keeps regulators at bay and the venality and ineffectuality of politicians. The chairperson of the Commodities Futures Trading Commission, for example, exempted important parts of Enron's business from regulation and, just weeks later, joined Enron' board. There are many such stories that show exactly how self-serving our legislators and regulatory guardians are. ...{article link continued}


Frank Partnoy Link

Tuesday, September 23, 2003

BUILDING A WIN-WIN WORLD

Been searching the web for an opposing or alternative view to all the orthodox center left thinking, and I found a good one. I love this lady's style. She says it all in such an easy dialogue, that it embarasses the many, but I think it's quite a breath of fresh air. She is a welcome addition to those of us fighting for a center left position, or I probably should say, to the rest of us joining her, since she has been espousing these positions for over thirty years or more.

Hazel Henderson is a giant in her field of the leadership in common sense and profound ideas made plain. I think only Molly Ivins can come close to this plain talking lady. Economists and others who fear this wonderful spirit should rethink their insecure positions, and truly embrace her. She is a major spirit the center left really needs.


By Hazel Henderson - {Link}

When Jim Fournier asked me to come and speak at this conference, I soon realized that I had been waiting to be here and play with a group like this for 40 years! Some of you may even remember my electronic democracy scenario from my 1978 book Creating Alternative Futures: The End of Economics, which was an underground best seller before many of you were born. My scenario of electronic democracy was based on an article I did for an early computer magazine FORUM70 in, yes, 1970! My article was titled "Citizens + Computers + Communications = Community" - very similar to the vision we are all sharing today as we consider the work of the Link Tank and The Augmented Social Network. Naturally, I'm psyched to be here!

My scenario back in 1970 was for enhancing the machinery of democracy by linking the power of computers to simulate social conditions and map dynamic complex interactive problems and issues and include feedback from citizens (later examples include SIM CITY, DAISY WORLD and later, SUGARSCAPE, which was a perversion - captured by economists, mathematicians and mis-guided foundations). My scenario included voting in elections using telephony and smart-cards (there was no internet, no PCs, no windows, no worldwide web).

Neither was globalization an issue then - even though the world impinged on everyone's lives - in the cold war threats of nuclear annihilation. What I tried to envision was how US national politics - still based on 18th Century conditions - could be augmented to accommodate a vastly larger electorate with exploding information requirements to help manage regional issues, watersheds and whole ecosystems undreamed of by our country's founding fathers and mothers. I updated these scenarios in Building a Win-Win World, Chapter 10 "Perfecting the Machinery of Democracy (1996).

How the world has changed in the intervening 40 years!

The cold war superpower rivalry has given way to mostly guerilla and civil warfare, distributed terrorism by non-state actors, global mafia, cyber attacks and hacker crime. The world now must deal with a single neurotic military superpower waging global war on evil, while teetering on a failing democracy, a tanking economy and a rapidly falling currency.

Regional environmental problems and local crises have morphed into worldwide issues of ecological sustainability, human-caused climate change, desertification, species extinction and ozone depletion.

Globalization of technology, markets and $1.5 trillion of daily currency trading has eroded the sovereignty of nation states. Driven by laissez faire market fundamentalism, these unregulated markets have become the flywheels of ecological, social and cultural disruption.

Democracies are both spreading and being corrupted by money. The governance gap is becoming critical in every part of the world. The machinery channeling feedback from citizens lags behind accelerating social and technological change. Both of the key feedback mechanisms from individuals to decision-makers - votes and prices are failing. Votes and elections must be undistorted by money and prices must include all social and environmental costs. Thus, both governments and markets are steered perversely in unsustainable directions.

Oligopolies and special interests have hijacked our politics. Corporations dominate our market choices and, together with five commercial conglomerates, own all our media, shape our choices and culture - increasingly even on the Internet. A corrupt Federal Communications Commission oversees the giveaway of more of the electromagnetic spectrum - a public commons - to these media giants. And, now Microsoft, by agreeing to license SCO's UNIX technology, seems to be trying another sabotage attack on LINUX!

Moore's Law is colliding with Murphy's Law as heat becomes the problem of ever more transistors on a single chip. Even if Intel can continue doubling transistor density for another decade, does it still matter? Or is The Economist right in saying that the IT industry has entered its "post-technological period"? (May 10, 2003) ...{continued link}

The Coming Dollar Crisis - Interview

Richard Duncan has been interviewed by Christopher W. Runckel about his new book, "THE : CAUSES CONSEQUENCES CURES." This book will become the defining work in real world economics, though the world does not know it yet, and many will not until the future makes it overwhelmingly evident through a cataclysmic financial event, other's and I do.

Before going to the article I have entered a letter I wrote to Treasury Secretary Benson, back in the `90's, to show how my thinking was and is in line with Richard Duncan's. I had predicted the very cataclysmic financial events that took place from 1997 to the present day, as did he. He has an accurate mind as to what the global transactions' credit ball is all about. I join the chorus to sing the same song once again.

If you really want to know what is going on, and will be going on, please read Richard Duncan's new book. We are in grave danger of a final collapse of the planet's entire credit and monetary structure, now. It will not be a pretty picture. No one can truly imagine the horror of such an outcome. Later this winter I will publish a complementary paper to mathematically prove his and my points about an imminent credit collapse, due to the aggregate non-productivity of said global credit structures. There is a great deal of agreeing articles already posted about many other authors on the rest of this blog. Take a look at {C.H.I.P.S.}[clearing house interbank payments system] to see the true size of world transactions. Notice 1998 to 2000's big downturn in total global transactions. I wrote years ago that when CHIPS shows a shrinkage, that a major global contraction will have started, and can only end in an inflationary/deflationary prolonged real global depression. Sorry to be the bearer of bad news.

OFFICIAL BUSINESS
August 24, 2003
February 24, 1993

DEPT. OF TREASURY 15th St. and Pennsylvania Ave. N.W., Washington, DC 20220
Attention: Mr. Lloyd Benson
SUBJECT: AMERICA'S ECO. NATIONAL SECURITY

Dear Mr. Benson:

I have been trying all means possible to bring attention to America's most urgent problem. I am writing you as my last hope in understanding the importance of my concerns. I have watched you for years, and long ago decided you were the most intelligent Democrat. I am not stating this to flatter you. I say this so you may realize the importance of the power you actually hold - having control of the Treasury, makes you the most powerful man in the nation. The Federal Reserve is a small power compared to your awesome responsibilities. For these reasons, and since your authority controls the currency, I am addressing you.

Aristotle stated long ago, "It makes little difference what laws are passed when a nation loses control of its currency." America lost control of its currency in 1971, with the death of the Bretton Woods system. This central most important, controlling, economic and monetary factor, must be rectified. If America fails to correct its currency and exchange rate problem, there is no possible way for all your, and the entire administration's ideas, taxes, spending, laws, and best intentioned investment strategies, to work, long term.

The exchange rate, currency, and monetary system have been a raging inferno of cross-contradictory ideas for over twenty years. Historically, it has raged in varying degrees since Plato first introduced his exchange clearing thesis, some 2400 years ago. Presently, we see Russia heading into hyper-inflation, while the currency problem fills French fish markets to the point of destruction by angry fishermen. This is only one example of thousands, that could be cited over the last twenty years. This is the currency, exchange rate, and monetary issue; the same issue that has filled America's shores with foreign goods, and driven her business offshore, over the last two decades. Please, try to realize, this is only a currency problem that must be rectified before America, and the entire world, are destroyed.

There are hundreds of good books, and thousands of quotations, on this very issue in total agreement with my feelings. It is only the recent flurry of ill informed and misguided academics, intellectuals, and economists who preach the false road of totally destructive long term floating exchanges. They are wrong, as all history records them to be wrong. Yes, I will agree that such a monetary system fills the pockets of many wise and rich speculators, but at what cost to taxpayers? The increasing debt of America, and all world nations, easily answers this question.

America's problems, over the last two decades, are not totally attributable to such ballyhooed causes as entitlements, oil shock, war costs, and excess local spending. If all these issues are put aside, America's debt and desperation will continue increasing; due to the overall world transactions' increase costs [C.H.I.P.S.]. These costs are widening, yearly, as exchanges widen; creating massive currency speculation, capital flight, and hyper-inflations; reciprocating back into this country. These problems can only be resolved with major monetary reform.

I have already written President Clinton twice, and many other senators, representatives, academics, economists, and national leaders. I will enclose much of the material I sent the President, along with some new. I believe you can much better understand the material, as it is very complex. I have made it as plain as possible with new graphs and diagrams.

The central point of my thesis; which is a manuscript I have been working on for over twenty years; is that America, and the world, must go to either fixed, pegged, balanced, or cleared exchanges. My preference is INTERNAL EXCHANGE CLEARING, although external exchange clearing is better understood. External exchange clearing can be made palatable to the international banking community by linking it to a purchasing price parity, bond insurance policy. The details are too intricate to go into in a letter.

The reasons the above is necessary can best be explained by the first three or four diagrams. Further explanations exist in the other diagrams, graphs, and accompanying text. The first diagrams show the present problem. Total world transactions have increased from fifty trillion dollars since 1980 to $222 trillion in 1990; as recorded by {C.H.I.P.S.} (Clearing House Interbank Payments System). I simply ask, "How do you think the local economy can be improved, until we deal with the overwhelming international speculative problem at the top?" I tell you frankly, "We must deal with the international monetary and currency problems to solve the local economic troubles of America, and the world. No other solution is viable." The exostructure must be improved to improve the infrastructure... Please, for the future of our children, try to understand me.

I love my country greatly, as I love the entire world. I would gladly testify before the Senate about any of the massive problems and solutions to America's troubles. I am even going to ask you to make it possible for me to testify. I assure you, I hold the best interests of my nation in my heart. I do not mean to be unkind, but I know I am the only one writing in this vein. I have made major economic discoveries over the last twenty years. These discoveries must be shared with the nation, and the world.

You do not know me, and I have no degreed certificates, but I assure you I am more thoroughly self-educated than most Ph.D.'s, in the entire land. I do not mean to brag; I am simply trying to let you know the importance I feel for the discoveries I have made. I have developed many new, major economic laws. I was able to do this by joining the two diverse fields of economics and physics. The results, at first, even astounded myself. I am positive you would be extremely appreciative of my total information capacity. I am willing to offer everything free, for the good of my nation.

In closing, I will send what I can afford to mail at this time. I am just a penniless hillbilly, originally from the tiny town of Meddybemps, Maine. I will also enclose a resume, with references, for your convenience. I hope I will be able to impress you with the absolutely, necessary, importance of my mission. I thank you very much for your time, and if you have time, please respond. We could reach a much closer understanding, with direct questions and answers to the very complex and intricate topics involved.

Sincerely,
L.A. Gillespie C.E.O.
Competition Engineering
Enclosure:Diagrams, Letters, Graphs, Text, and Resume



INTERVIEW WITH RICHARD DUNCAN ON
THE DOLLAR CRISIS: CAUSES CONSEQUENCES CURES




Question 1: Your new book was recently released by J. Wiley & Sons. In the book you argue that the current International monetary system is in danger of collapse. Could you explain why you believe the present international trade system is a danger to all of us?

Answer: It is the imbalances in the international trade system rather than the system itself that poses the danger. The United States; Current Account deficit is now $60 million AN HOUR! It increased 28% in 2002 to half a trillion dollars, an amount roughly equivalent to 5% of US GDP. This unprecedented trade imbalance has created extraordinary disequilibrium in the global economy. The countries that build up large stockpiles of international reserves due to large current account or financial account surpluses;such as Japan in the 1980, the Asia Crisis countries in the 1990s and China today;develop bubble economies. When those bubbles pop, as they inevitably do, they leave behind banking crises and excess capacity. The governments of those countries must then go deeply into debt to bail out the depositors of the failed banks. At the same time, the excess capacity in the economy results in deflation. Economic bubbles and systemic banking crises can be expected to reoccur and deflationary pressure can be expected to persist so long as the US Current Account deficits continue to flood the world with dollar liquidity.

Question 2: In your book you write that the current system is neither good for the countries who export goods to the U.S. nor ultimately to the U.S. How can a system that has brought such growth to so much of the world be bad?

Answer: Ultimately, the imbalances in the system are harmful to the United States; trading partners and to the United States itself. The countries with overall balance of payments surpluses are destabilized through the rise and collapse of economic bubbles. Ironically, the US current account deficits also helped fuel the New Paradigm Bubble in the United States . The surplus nations earn their surpluses in US Dollars. They must either invest those dollars in US dollar denominated assets or else convert the dollars into their own currencies. If they convert such large amounts of dollars into their own currencies, those currencies would appreciate sharply, putting an end to their trade surpluses and perhaps driving their economies into recession. Consequently, they park their surpluses in US dollar denominated assets instead. By investing their dollar surpluses in US dollar assets, the trading partners of the United States helped fuel the stock market bubble, facilitated the incredible misallocation of corporate capital, and, by acquiring Fannie Mae debt, contributed to the dangerous rise in US property prices.

The imbalances in the current international monetary system are also bad because they are unsustainable. The United States cannot continue going into debt to the rest of the world at the rate of $1 million a minute indefinitely. The net indebtedness of the US to the rest of the world is already approximately $3 trillion or 30% of US GDP;and its now growing at roughly 5% of GPD per annum. The economies of most of the United States; major trading partners have grown dependent on exporting much more to the US than the US imports from them. When the United States current account imbalance returns to equilibrium, and it eventually must, the era of export led growth will come to end and the world will find itself without an engine of economic growth.......{continued link} - Banking & global debt charts

About the Author: Richard Duncan has worked as a financial analyst in Asia for more than 16 years, conducting research and publishing investment reports on companies, industries, and economies from India to Korea.


In 1993, Mr. Duncan was one of the first to warn of the impending collapse of the Thai economy and the Thai stock market in a series of published reports and speeches directed at institutional investors. At the height of the Asian crisis, he worked as a consultant for the International Monetary Fund in Thailand. Subsequently, he joined the World Bank in Washington DC as a Financial Sector Specialist focusing on issues related to the economic crisis in Asia.



Monday, September 22, 2003

Dollar Crisis?

Well, everyone's been waiting for today, and the question now is how irrational will the rest of the world's investors and speculators react to today's realities. I've been working all day on the derivatives markets, that is trying to piece together enough honest information to comment on, when along comes today's drop in the dollar. Nice fit, this article and the next on "The Derivatives Bubble."


Weak Dollar Pulls Down Stocks


By REUTERS


Filed at 4:31 p.m. ET

NEW YORK (Reuters) - U.S. stocks sank on Monday after a call from the world's richest nations for more flexible exchange rates sparked a sharp drop in the dollar that ignited fears overseas investors would flee U.S. assets.

The Group of Seven industrial nations -- the United States, Britain, Canada, France, Germany, Italy and Japan -- said on Saturday that a flexible currency rate ``is desirable for major countries or economic areas'' in order to iron out global economic imbalances.

The G7 comments sparked speculation that Japan would not be as aggressive about selling yen and buying dollars to keep down the value of its currency.

While a softer dollar makes U.S. exports more competitive overseas, it also raises the risk that foreign investors will suffer currency losses on their dollar-denominated assets, making them less attractive.

``The weaker dollar will probably benefit U.S. manufacturing, but the big worry is that we're heavily dependent on foreign capital inflows, and you don't want to see everyone start dumping U.S. investments,'' said Ozan Akcin, chief investment strategist at Puglisi & Co.

The Dow Jones industrial average (.DJI) dropped 109.41 points, or 1.13 percent, to 9,535.41, while the broader Standard & Poor's 500 Index (.SPX) fell 13.51 points, or 1.3 percent, to 1,022.79. The technology-laced Nasdaq Composite Index (.IXIC) sagged 31.23 points, or 1.64 percent, to 1,874.47, based on the latest available data.

About 1.25 billion shares changed hands on the Big Board, while on the Nasdaq, about 1.71 billion shares were traded. Decliners outnumbered advancers on the NYSE by a ratio of about 24 to 9, while on the Nasdaq, about 21 stocks fell for nearly every 11 that rose.

Among stocks in the spotlight, Motorola Inc. (MOT.N) rose after it said late Friday that its chairman and chief executive officer, Christopher Galvin, would retire.

The departure of Galvin, who had clashed with Motorola's board over strategy, will end three generations of family control at the world's No. 2 mobile phone maker. Separately, Merrill Lynch said it raised its investment rating on the company to ``buy'' from ``neutral.'' Motorola shares rose 97 cents, or 9 percent, to $12.06.

Among decliners, chip equipment makers Applied Materials (AMAT.O) and KLA-Tencor (KLAC.O) were hit after a report in financial weekly Barron's said their shares are at ``extreme bubble valuations.'' Applied Materials dropped 81 cents, or 4 percent, to $19.67, and KLA-Tencor fell $1.57, or 3 percent, to $55.10.

But the focus of the day was the G7 statement, which was viewed as criticism of persistent intervention by Asian countries to keep their currencies weak to make their exported goods more affordable to consumers, especially to Americans.

The United States has been particularly critical of Japan and China for intentionally weakening their currencies since it puts U.S. goods and services at a disadvantage.

The dollar fell to a near-three year low against the Japanese yen, touching 111.41 yen, before rebounding to 112 yenThe sliding dollar also whacked U.S. Treasury prices, pushing the yield on the benchmark 10-year Treasury note up to 4.25 percent -- after rising to an intraday high above 4.32 percent -- from 4.16 percent late on Friday.

Asian central banks, in particular, have been massive buyers of U.S. Treasuries and agency debt in recent years, and the worry is that could decline with the dollar's drop. Investors further fret that rapidly rising interest rates could stifle the fledgling U.S. economic recovery.

``Any weakness in the dollar could push those fickle investors to take money out of Treasuries and repatriate it into either euro-denominated or yen-dominated securities,'' said Peter Gottlieb, president of Gottlieb Investment Management Corp. ``To the extent that one of the markets is undergoing some turmoil, I don't think that's good for any financial asset class.''

Article Link:

Nice opening for my next post. I've done a lot of work on this blog over the past week. I have tried to use the best intellectual sources in the world for my posts. If you were to check it all out I think you may see it paints a pretty clear picture of where we're headed.

The Derivatives Bubble

Been searching everywhere to try and make more sense of the hugely expanding derivatives market. I first wrote about the dangers and risks in this market some fifteen years ago. My concerns are now beyond overwhelming to my senses, and I am one who has been following and writing about such similar developments for years. I urge everyone to familiarize themselves thoroughly with the derivatives, as well as all other speculative global markets, and their associated transactions. I fear there's much trouble ahead. C.H.I.P.S. LINK{clearing house interbank payments system} B.I.S. LINK{bank of international settlements - use search - derivatives} THE DOLLAR CRISIS LINK - Warren Buffet's interview on DERIVATIVES LINK - Tho OCC DERIVATIVE FIGURES 2003 - OCC CHARTS/GRAPHS - BANKING SYSTEM CHARTS -- Nobel Author MERTON MILLER on derivatives -- Adam Hamilton - The JPM Derivatives Monster{older article but excellent explanation - Adam's essay is second post down} - See what a trillion pennies looks like.

Frank Partnoy's Complaint


Infectious Greed

A Leading Critic of the Excesses That Led to Enron and Other Recent Financial Scandals Provides an Exclusive Interview with Financial Engineering News, and Discusses His Soon to be Published Book "Infectious Greed: How Deceit and Risk Corrupted the Financial Market ".

Editor’s Note: Professor Frank Partnoy has made a name for himself as a keen observer and commentator on current issues and trends in the financial markets. His testimony before the U.S. Senate Committee on Governmental Affairs one year ago about the Enron debacle (see Financial Engineering News, June/July, 2002 for the full text of his testimony) was described by many as the most insightful and descriptive analysis of what happened, why, and how changes were needed to avoid future Enron’s. During the latter half of 2002, he worked on and completed a new book titled “Infectious Greed: How Deceit and Risk Corrupted the Financial Markets” to be published by Henry Holt in March, 2003. His previous books include “F.I.A.S.C.O. The Inside Story of a Wall Street Trader”. This interview with Financial Engineering News was conducted on December 9, 2002.

Finnegan: Let’s begin by talking about your new book which is about to go on sale. Can you give our readers an overview of it?

Partnoy: Sure. The title is Infectious Greed. A recent comment by Alan Greenspan gave me a title. We were trying to come up with a pithy title that would combine both the notion of greed in the market and all of the nefarious behavior that has been uncovered at various companies; we also were looking for a metaphor of a virus spreading through financial markets. My wife came up with the title Market Pox, but I wasn’t sure that would sell very many copies. When Alan Greenspan used the term “infectious greed” in testimony before Congress, we decided to use that phrase as our main title; the subtitle is How Deceit and Risk Corrupted the Financial Market. The book looks back fifteen years and traces the major changes in markets, laws, and the culture of finance in order to try to understand how we got to Enron, WorldCom, Global Crossing and all the other financial failures and scandals that have come to the public’s attention over the past 3 years. The book is my attempt to try to connect the dots of the various major events over the last fifteen years leading up to the current wave of financial scandals.

Finnegan: So the book actually provides a much broader perspective than just Enron?

Partnoy: Right. It started out as trying to understand Enron at a time when a number of other people were also writing Enron books. And I soon realized that while Enron is very interesting story, ultimately the real story is going to take several years to write, after the criminal cases are concluded. So these books that are coming out now will not be able to get into the important detail because the witnesses are all embargoed, and a lot of the documents are still confidential. So I tried to expand the scope of what the book would cover, and it was actually my agent and publisher’s idea to attempt to explain how we got here as part of the Enron story. And the more I started thinking about it, the more I became interested how, in order to understand Enron, you have to go back a decade or more to get perspective.

Finnegan: If I go back to testimony you gave before the U.S. Senate, I remember there were three major themes you talked about: One was failure of “the gatekeepers”- the auditors and credit rating agencies among others- for a variety of reasons; the second one was unregulated use of new financial derivatives; and the third was criminal behavior on the part of individuals. Are these themes also discussed in your new book?

Partnoy: Yes, these are some of the major themes in the book. The book tries to tell broader story, and from more of a narrative perspective than my testimony did. My testimony was a bit dry.

Finnegan: In other words, the book doesn’t get into the details of mis-marking forward curves like your Enron testimony did? Our readers of Financial Engineering News loved that.

Partnoy: Well, there’s plenty of discussion of forward curves, so your readers will be excited about that. But there also is an attempt to understand the people, and how it is that the behavior of human beings in the financial markets and at companies whose stock traded in the markets changed over the time. One of the major drivers of this change was- and is- financial innovation. Prior to the early 1980’s, most people didn’t even use calculators on Wall Street; they didn’t have computers; if there was a Radio Shack TRS 80 on someone’s desk, he or she was considered to be a “rocket scientist”. The Black Scholes formulas were there but very few people, especially at banks understood them. Traders on the auction exchanges knew how to use the formula, but most investment bankers didn’t. Investment bankers were English majors and philosophy majors, not MBA’s. Occasionally English majors on Wall Street got MBA’s, although this wasn’t common. More often, daddy knew someone, so you got the job that way. It was a very different culture. So one of the major themes of my book is how financial innovation forced that culture to change and resulted in banks hiring a completely different breed of individual: Financially sophisticated, mathematically literate people who could do the sophisticated finance. It wasn’t enough to be an English major having gone to the right schools and having the proper family and social connections. You had to have the technical and financial skills. And, by the way, this is when MBA programs also changed. They became and are now much more financially sophisticated than they were prior to the early 1980’s....
Article Link {continued}

This, I feel, will become the most important development in all of capitalist market history. No one knows where this rapidly advancing market will go, what its consequences will be, or how huge it will grow? Large enough to engulf capitalism? It's anyone's guess!

Saturday, September 20, 2003

THE IFI QUESTION?

Listed below are three or four different sections of thought about IFI's{international financial institutions}. I am interested to know serious peoples' opinions/facts about reforming the world monetary system and depending on IFI's as a viable eco-political theme or not. What do you think? You can either "e-mail me or use my send comment site{must join} here or at the top side of my blog.{at bottom of links} or use my new mirror site add comments, at bottom of open post.

The first article is by Plato some 2500 years ago, so the idea is far from new. He recommended an exchange clearing house of international operations much like one of Keynes' and White's ideas in 1944. Of course it's never been instituted, although many other forms of currency management have been tried with varying success. The second article is by Jane D'Arista about the similar and yet expanded subject to fit the modern world. In fact it seems to be the most evolved set of ideas I can find on the subject. If I'm wrong, let me know. The third article is an e-mail of my own about related ideas to possibly circumvent the need of IFI's. I am writing a paper to show beyond the shadow of a doubt that credit productivity can be improved with conventional means enough to drastically improve the human eco-political-health-conditions of our sick warring planet. The fourth article is another e-mail about world politics, economics, institutions, deflation, and productivity, etc. The four of these together should be enough information to give some idea of what I am interested in being commented on.

{1}Plato & Exchange Clearing

"The citizen of the ideal state will require a currency for the purpose of every day expenses; This is practically indispensable for workers of all kinds and for such purposes as the payment of wages to wage earners. To meet these requirements, the citizen will possess a currency which will pass for value among themselves, but will not be accepted outside their own boundaries. But a stock of some currency common to the Hellenic world generally i.e., of international currency, will at all times be kept by the state for military expenditures or official missions abroad such as embassies and for any other necessary purposes of state. If a private citizen has occasion to go abroad, he will make his application to the government and go; and upon his return if he has any foreign currency left over in his possession, he will hand it over to the state receiving in exchange the equivalent in local currency." Plato


If you have time let me know what you think of external exchange clearing as listed below, and also known since the time of Plato, yet never implemented. Jane D'Arista has done the defining work for a modern form of what White and Keynes also had on their plate in 1944, at Bretton Woods.{sort of repeated as was in original e-mail}

complete text of Jane D'Arista

{2}INTERNATIONAL FINANCE AND GLOBAL GOVERNANCE:

WHAT ROLE FOR THE IMF?

By Jane D'Arista*


Criticisms of the International Monetary Fund (IMF) by progressives and nongovernmental organizations (NGOs) currently focus on six issues: (I) the need for debt relief; (ii) the need to democratize the Fund's governance; (iii) the need to increase transparency; (iv) issues related to bailing-out and/or bailing-in private investors; (v) the Fund's future mission; and (vi) the need to reform the policy paradigm that countries must accept to qualify for borrowing. First I will provide a brief overview of progressive critiques on these issues. Then I will discuss other areas that also should be a focus of concern and criticism. I will conclude with some proposals for alternatives.



Alternative Proposals

In addition to the reorientation of IMF and World Bank loans as a means to achieve social and environmental goals, progressives support a variety of ideas, both old and new, for reforming the international financial and monetary architecture. They argue for using capital controls to moderate pro-cyclical private flows seeking short-term profits.

Many support instituting some form of the securities transaction tax proposed by Tobin, that would discourage short-term turnover of investments in source countries (Pollin and Baker, 2000). Palley (2000) proposes extending asset-based reserve requirements to all financial sectors and assets, so as to reestablish monetary control over the supply of credit in national markets. Eatwell and Taylor (2000) propose the establishment of a World Financial Authority (WFA) to provide global oversight of international financial institutions, on the grounds that the monitoring of global markets via national regulation is inadequate. They argue that the IMF should not be involved in financial regulation, and that a WFA is needed both to reestablish the primacy of stability and soundness as regulatory objectives and to reverse the current push for deregulation.

Elsewhere (D'Arista, 1999), I have offered three proposals to reform the international financial and monetary systems. The first is a proposal for a closed-end international investment fund for emerging markets, with investment decisions based on development goals rather than short-term profit opportunities. The fund would be financed through private institutional investors' purchases of marketable World Bank securities. As a closed-end fund, investors could sell shares without triggering sales of underlying assets.

This structure would serve to insulate underdeveloped markets from volatile flows of foreign portfolio investment, while providing a highly-rated, guaranteed investment asset for institutional investors.

My second proposal is to issue new special drawing rights (SDRs) that would augment the international reserves of developing countries and reduce their debt burdens. SDRs were originally intended to become a primary reserve asset and to give the IMF limited powers to act as a lender-of-last resort (IMF, 1987). The most recent allocation, however, was in 1981, and only $28 billion in SDRs are currently outstanding, compared to $1.6 trillion of foreign exchange reserves. Moreover, as of yet, none have been issued to Russia and other new member countries. Yet, SDRs represent an existing mechanism for relieving the liquidity squeeze that has affected developing countries since the Mexican crisis in 1995. A new allocation, targeted to highly indebted and crisis-affected countries, could be even more effective than debt relief in re-igniting global growth.

My third proposal calls for the creation of an international clearing agency to address the basic problem in the global economy: the unraveling of the international monetary system. Failures of exchange-rate regimes and the push for dollarization and other currency blocs are symptoms of international monetary fragility. Under the privatized, post-Bretton Woods system, the volatility of changes in the valuation of currencies has widened their impact and deepened the economic damage they cause. The fact that only a few countries issue currencies that can be used in international transactions greatly exacerbates this instability. The primary objectives of the proposed clearing agency would be to allow all currencies to be used in international transactions and to shift control of international payments from private to public institutions.

This system would replace the current system of foreign exchange that is based on oligarchy. Resources would be valued in terms of the entire basket of currencies of member countries. All international reserves would be held by the international clearing agency. Changes in exchange rates would be tied to changes in the reserves of member countries and adjusted at two-week to four-week intervals. The clearing agency would also have the means and authority (on the basis of a majority vote of its member countries) to create reserves by conducting open market operations in national markets.

This power would create a true lender-of-last resort for the global economy, responsive not only to balance-of-payments problems stemming from trade and investment flows, but also to the often greater problems that can result from natural disasters and the devastation of war.

Creating an international clearing system that reestablishes public control over crossborder payments is necessary to end the pro-cyclical rule of market forces and to restore sovereign control over policy determination. It would allow national central banks to reintroduce the use of credit allocation and countercyclical policies; it would also allow governments to pursue development and growth as objectives of economic policy. Furthermore, since it would allow developing countries to pay their transactions and service their debts with wealth created in their own national economies, such a system would end the export-led growth imperative of the current system and reinstate demandled growth as an alternative policy paradigm for developing countries.

The reform of the international financial and monetary architecture requires a democratic basis for governance. The clearinghouse proposal envisions a rotating council composed of member countries that would represent half the world's population and half the world's wealth at all times. The EU has taken steps in a similar direction by weighing both population and monetary contributions to determine voting shares within the European Central Bank. Similar criteria must be applied to shaping the governing structures of international institutions, old and new. Whatever the specifics, the issue of democratic governance must be addressed.


{3}Credit Productivity and Full Employment

One query. One of the problems I have when reading Keynes these days is the whole problem of 'full employment'. What the hell does this mean in today's world. Can you help me?


As far as Keynes `full employment'; this is one of the main points to be made in my future paper. In my humble opinion present classical economic opinion does not understand credit productivity nearly as clearly as did J.M. Keynes{and he lacked in some areas also, as Hayek pointed out}. There are five main points I will make in my paper and possibly a few more, as I also evolve. I will mention just a few, for now, to allow a clearer understanding of my view of full employment credit productivity. These will be very concise, as full explanation would take more time than I have at present.

I believe the mistakes all capitalist governments of recent years have made is not understanding the advantages of workfare public works over straight welfare and or unemployment compensation. The only way we are going to solve the world's dynamic problems is to solve the growing lack of decent paying jobs to improve national and global credit productivity. Keynes was well aware of this and suggested massive public works in recessionary/deflationary times.{got to be careful here, as Hayek pointed out} Now the point is, decent paying public works jobs have the benefit of access to real credit markets, whereas welfare and unemployment drawees usually do not. The bankers will extend credit to public works workers as they did in the `30's, but will not to most welfare and unemployed. Due to the multiplication factors of the banking system being able to create credit out of thin air, such credit will expand many times over as it does for the truly working classes. This state engineered credit expansion is able to repay itself as Henry Ford, in 1914, found out when he created the $5.00 day for his own employees to purchase his new assembly line cars, as no one else had the funds to buy. The multiplication factor in the banking system multiplied by the expansion of individual credit access will repay what is lent short term{as freshly spent funds circulate} in the long term cycle of repayment, thus enriching the individuals, the company as then, or the state as today. It's just the simple fact of what goes around comes around, as John Reed of CitiBank said years ago. Credit extended to reputable people will repay itself due to the true dynamics of real credit multiplication. This national dynamic, as verses the international, must be understood, and it is not. Old man Rothschild understood this well when he started his bond market out of an old trunk in his ghetto basement. I further believe the Egyptians, Greeks, and Romans, with their giant public works empires experienced the same by accident. War booty and slavery are very incomplete economic explanations. Forward letters of credit go clear back to even these ancient empires, as Paul Einzig pointed out in his `Ancient Money' book and others.

The second example I would give is the giant public works project called WWII. America pulled itself and the rest of the world out of the last major depression by almost nothing other than credit extended in massive amounts. We went in debt 100% of gdp, and at present we are only about 70% of gdp. We have plenty of room to maneuver. This massive and even partially wasteful credit extension repaid itself in a very short amount of time through almost nothing other than the multiplication dynamics of credit mechanics and double entry fractional reserve banking.{I am discounting all the other trade and market realities to be concise, because the main dynamic at work was and is credit mechanics, even other nations credit mechanics, as they also multiply the same} If I am correct at guessing, I believe we had paid the national debt down by 1960. Now, if this isn't an example of full employment credit productivity, I don't know what is.{sorry, carried away a bit} America even employed many of her female workers in the war effort, in public works jobs building the war machinery along with many other fields of public service. Now, I admit we may have taxed heavily, but the taxes also were contributed greatly by the original massive credit expansion, not only in America, but Europe and elsewhere through the Marshall Plan and other government loans. All was repaid mainly by the original credit extension productivity resulting, and the banking system dynamics involved. We didn't rob anyone after WWII. We got rich from the original massive public works project called WWII.

This can still be done in today's world, and without war. Money and real credit productivity work the same in peace as war. "The higher the production and credit productivity of the pariffery over the center, or the further from speculation credit is, the higher real aggregate credit and production productivity will be." I hope I have helped some to understand this profound deeply esoteric subject. My paper will explain much more of national and global aggregate credit productivity and full employment possibilities, of conventional classical economics, in much deeper detail. You may disagree for now, that is fine, but when my paper is finished, I feel I will be able to persuade. As you said; "Dialogue is often fruitful. Anyway being disagreed-with is preferable to being ignored."



{4}The World Financial Crisis

Thought you may be interested in this link of global labor statistics{many graphs and charts}: Link
It reveals a great deal about demographics, labor, and eco-geo-politicism.

Rudiger Dornbush Link - The World Financial Crises

As far as Rudi Dornbusch's link I sent you, I didn't mean I agreed with currency boards, either. My main vision of that particular piece was about the major economic problems being most political in nature, as verses, other, economic views. I don't believe Rudi meant to convey the message of currency boards for all nations either. He simply mentioned it about Argentina and the point of being discussed for nations with completely incompetent political systems.

As far as demographics being 90% and IMF 10%, I can not agree. In my view next to China and Japan exporting deflation, is much of the third world also exporting deflation, due to the IMF destructive bulldozer of hyper-deflation after many of their hyper-inflations, and I am discounting exchange rates exporting deflation, which of course would be even more. As many of the charts and graphs above show, there has been a massive destruction of unions, labor, wages, i.e., the middle classes and poor of many of the entire world's nations, over the last 10 years or so. Some grew, but few. This means there has been upwards of a 10% real reduction in consumption capacity in the nations hardest hit. In my view this reveals a very sizable over-production capacity for the entire world, as these nations hardest hit over the last 10 or so years must now export their excess productive capacity wherever they can at whatever deflated price they can attain, since they have smaller home markets. This, in my view, is as big a dynamic of deflation as China and Japan combined. Now you may call this a demographic problem, but I call it a global aggregate credit productivity problem, in the old Keynesian fashion.{full credit productivity is attained at full employment} We can't keep decreasing jobs and increasing production. We are going to have very big deflationary egg on our face if this continues. So in my final analysis, eco-politically, national and global aggregate credit productivity are the real world problems. This is just as true here in the U.S. We are presently still losing close to 100,000 jobs a month as the market bubble builds. This may be a false asset bubble? Many here think both the dow and the nasdaq are still quite overvalued, as do I.

I am presently working on a paper about national and global aggregate credit productivity. "The higher the productivity of the pariffery over the center, or the further from speculation, the higher the productivity is." It will take some time to finish as I am slimming down some 200 pages to 20 or 30. It should be completed later this winter, as I am quite busy now with many projects. I plan to send all the macroeconomic economists copies when finished, and I will then send you one also.

Friday, September 19, 2003

Back To The Future

Anyone wondering what the real motives of Bush & Co. truly are is made very plain by this excellent piece:

William Greider:

"Rolling Back the 20th Century
The Right's Grand Ambition

by William Greider

George W. Bush, properly understood, represents the third and most powerful wave in the right's long-running assault on the governing order created by twentieth-century liberalism. The first wave was Ronald Reagan, whose election in 1980 allowed movement conservatives finally to attain governing power (their flame was first lit by Barry Goldwater back in 1964). Reagan unfurled many bold ideological banners for rightwing reform and established the political viability of enacting regressive tax cuts, but he accomplished very little reordering of government, much less shrinking of it. The second wave was Newt Gingrich, whose capture of the House majority in 1994 gave Republicans control of Congress for the first time in two generations. Despite some landmark victories like welfare reform, Gingrich flamed out quickly, a zealous revolutionary ineffective as legislative leader.
George Bush II may be as shallow as he appears, but his presidency represents a far more formidable challenge than either Reagan or Gingrich. His potential does not emanate from an amiable personality (Al Gore, remember, outpolled him in 2000) or even the sky-high ratings generated by 9/11 and war. Bush's governing strength is anchored in the long, hard-driving movement of the right that now owns all three branches of the federal government. Its unified ranks allow him to govern aggressively, despite slender GOP majorities in the House and Senate and the public's general indifference to the right's domestic program.

The movement's grand ambition-one can no longer say grandiose-is to roll back the twentieth century, quite literally. That is, defenestrate the federal government and reduce its scale and powers to a level well below what it was before the New Deal's centralization. With that accomplished, movement conservatives envision a restored society in which the prevailing values and power relationships resemble the America that existed around 1900, when William McKinley was President. Governing authority and resources are dispersed from Washington, returned to local levels and also to individuals and private institutions, most notably corporations and religious organizations. The primacy of private property rights is re-established over the shared public priorities expressed in government regulation. Above all, private wealth-both enterprises and individuals with higher incomes- are permanently insulated from the progressive claims of the graduated income tax.

These broad objectives may sound reactionary and destructive (in historical terms they are), but hard-right conservatives see themselves as liberating reformers, not destroyers, who are rescuing old American virtues of self-reliance and individual autonomy from the clutches of collective action and "statist" left-wingers. They do not expect any of these far-reaching goals to be fulfilled during Bush's tenure, but they do assume that history is on their side and that the next wave will come along soon (not an unreasonable expectation, given their great gains during the past thirty years). Right-wingers-who once seemed frothy and fratricidal- now understand that three steps forward, two steps back still adds up to forward progress. It's a long march, they say. Stick together, because we are winning." Continued: William Greider:


We truly need to organize like never befor in history to rid our nation of this great danger, and I mean great danger!

There is also an interview here about Paul Krugman and his new book "The Great Unraveling".

The Coming Dollar Crisis

I just keep finding these great articles that represent my view almost to a tee. Since Richard can write much better than I, here's the excellent information, charts, and tables in his eloquent words:

PrudentBear.com - The One-Stop Shop for the Bear Case - Richard Duncan:

Asia, its reserves and the coming dollar crisis


Richard Duncan a former Salomon banker, and World Bank staffer and author of The Dollar Crisis: Causes, Consequences, Cures (John Wiley & Sons, 2003).

During the 30 years since the breakdown of the Bretton Woods International Monetary System, the global economy has been flooded with dollar liquidity. International reserves are one of the best measures of that liquidity. During the quasi-gold standard Bretton Woods era, international reserves expanded only slowly. For example, total international reserves increased by only 55% during the 20 years between 1949 and 1969, the year Bretton Woods began to come under strain. Since 1969, total international reserves have surged by more than 2000%. This explosion of reserve assets has been one of the most significant economic events of the last 50 years.

Today, Asian central banks hold approximately $1.5 trillion in US dollar-denominated reserve assets. Most of the world's international reserves come into existence as a result of the United States current account deficit. That deficit is now $1 million a minute. Last year, it amounted to $503 billion or roughly 2% of global GDP.Full Article - Richard Duncan:

Debt & Deflation Theory

After finding this and reading, I just had to post it. This is truly a paper by a genius student. She has taken Irving Fisher to new heights. Anyone wishing to know more about our possible economic future must read this entire paper. I am impressed.

Debt & Deflation Theory
Debt Stats - C.H.I.P.S.{clearing house interbank payments system}


Debt-deflation and the future of the American Economy

Introduction by Steve Keen:

The subject Financial Economics at the University of Western Sydney introduces students to the proposition that the money supply is endogenous—determined by interactions between the finance sector and the economy rather than being independently determined by the Federal Reserve. Irving Fisher’s analysis of the causes of the Great Depression figures prominently in this subject, and in this year’s essay students were asked to:

"Explain Fisher's Debt Deflation Theory of Great Depressions, and in the light of it provide an evaluation of the economic history of America for the past two decades, and predict the USA's economic performance till 2010."


One of the outstanding essays was written by Karol Gellert.

Steve Keen is Associate Professor, School of Economics and Finance, University of Western Sydney, and author of Debunking Economics.

"Irving Fisher developed The Debt-Deflation Theory in 1933 in order to explain the economic mechanism that can lead to a Great Depression such as the one experienced by the US economy from 1929 to 1933. The main point of the theory is that over indebtedness acts in conjunction with deflation to produce a contracting economy causing bankruptcies, rising unemployment and falling profits. Over the last 20 years, one of the US economic policy makers’ goals has been to lower the rate of inflation. However a recent downward trend in the already low inflation, together with an impressive growth in debt, has brought to light Fisher’s theory and triggered fears of a debt-deflation induced depression.

The Debt-Deflation Theory of Great Depressions is an explanation by Fisher of the apparent boom bust pattern prevailing in the economy. He divides the theory into four sections. In the first section, “Cycle Theory in general”, Fisher defines different types of economic cycles and their possible causes. In the second section, “The Roles of Debt and Deflation”, he provides a theory of how excess debt and the consequent deflation play a major role in the boom bust cycle. The third section provides an overview of the Great Depression in light of his new theory and introduces the concept of inflation as a cure to depression and deflation. The last section explores the possible “Debt Starters” that initially triggers a boom economy."Full article: Debt & Deflation Theory

America; Hyper-Inflation/Hyper-Deflation?

Excellent
Deflation Blog

Prudent Bear
Steven Roach

I came across this article months ago, but it has recently caused some new interest and concern to me. After reading much new and very reasonable material, in agreement with my own views, about real world economics, I have started to wonder how serious the rest of the Fed insiders and others may be taking Bernanke's remarks about possibly using crude printing as a way out of our future mess. This is something we all should be considering seriously, if for no more than the sake of understanding theorizing about it.

Say we do go the route of Argentina, as one of the three possible courses Paul Krugman has mapped out in his new book? What might the possible outcomes be? Surely not that of Argentina? Just think about it. America experiences a massive currency attack by the rest of the entire world,[I'm making this very brief] possibly started by China ridding herself of U.S. Treasury bonds and bills, etc. Japan sees this and follows suit, then the Europeans, then the rest of the world. How's your world now Bush?[Will they crude print as Bernanke has alluded?] So the dollar declines viciously fast and inflation takes off followed by hyper-inflation requiring hyper-deflation by the wonderful IMF?

Has anyone considered that this may not even be possible by a country the size and importance of the U.S.? Even if all the above happens, can the rest of the world, or will the rest of the world have the capacity to absorb, or will they allow the flood of exports from America to enter their countries? Just think of the real capacity we have to flood the rest of the world. I don't believe we can have hyper-inflation. Yes, we can have inflation, but hyper-inflation seems out of the question to me. I don't believe the rest of the world could or would allow it.

This still leaves me very disturbed about Bernanke's crude printing remarks below, yet, would we be punished as smaller countries are, for using crude printing? Is it possible, by our shear size, to get away with crude printing, since most of our external debt is denominated in dollars, and we can't hyper-inflate? Or, am I thinking crazy? I don't think so..........

"Remarks by Governor Ben S. Bernanke

Deflation: Making Sure "It" Doesn't Happen Here

Ben Bernanke

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation." Article Link: Ben Bernanke


Paul Krugman interview of his new book "The Great Unraveling; Losing Our Way In the New Economy" is here.

Thursday, September 18, 2003

The Trillions/Dollars Trading Game

Here's a good story of how the big boys in the tall buildings steal all the money. To be fair though, speculation is a very necessary entity of capitalism's workings by bringing prices more into equalibrium... Anyway, that's supposed to be how it works. Judge for yourself. The article is several years old, but very pertinent to today's world.

frontline: the crash: interviews: rob johnson


"He was a top portfolio manager for George Soros's Quantum Fund, a private investment fund, from 1992 to 1995. He left the money management business in 1996. (Interview conducted in the spring of 1999.)

Can you explain the importance of exchange rates? ...

Sure. The exchange rate is essentially the price at which you exchange goods between one society and another ... The way in which it tends to affect you ... [is] your life as an employee. People all around the world are producing. They receive a wage rate in their domestic currency. How that competes with your wage in your own domestic currency, say, Indonesian rupiah vs. U.S. dollars, depends on the exchange rate. The exchange rate's, say at 2,000, which it was before the crisis, then you have a relative sense of wages and wages adjusted for differences in productivity in the labor force.


When the exchange rate goes to 16,000, the relative cost of labor of any given quality type in the two societies changes. That sets in motion pressures to relocate employment to where things are cheap and to divest or lay off or cut wages in places where things are now relatively expensive. So at the first level, the competition for employment around the world, the terms in some sense, are set by the combination of the domestic labor costs in each place as translated to put on a comparable footing by the exchange rate.
If the rupiah was at 2,000 to a dollar, what does the investor want vis-à-vis the exchange rate, and what happens when the rupiah begins to lose value?

Well, the exchange rate to the investor is integral to how you value his investments. So it's nice to buy a foreign asset when you think the exchange rate is going to strengthen. For instance, a number of years ago, a guy I know bought a timber farm in New Zealand only because he thought the currency relative to the dollar was going to strengthen by 20% and that the timber farm wouldn't lose money ... A strengthening currency implies that the plant that you bought will be revalued higher in successive periods ...

So if you bought into a country ... and suddenly there are rumors that the currency is going to devalue, what happens?

Well, in the first instance, many of these developing countries institute exchange rate regimes like the peg to the dollar, a peg to a basket of currencies, to inspire confidence that that won't happen; meaning a devaluation will not happen, and therefore, inspire capital to flow in.

So you start the rumors of devaluation after a long period of stability when a lot of people have been inspired to go in. If there's nothing that's gone in, nothing has to come out. But generally when your question starts, a lot has already gone into the markets, so there can be a stampede. The things you think about at a time like that are, number one, other guys will be afraid, too, so even if [you] don't think they need to devalue, if lots of people run on the currency, it may be a self-fulfilling prophesy.

The second dimension is generally domestic interest rates in the economy skyrocket, because there's been a lot of foreign short-term capital that's gone into the country, like a Thailand or a Korea, that when it gets scared it runs. In essence, what you're doing is borrowing in that currency, transferring through the foreign exchange market and landing somewhere else to cover your exposure. Unfortunately, when those interest rates skyrocket, they often weaken the fabric within the economy.

Because?

Construction gets depressed, high interest rates make working capital expensive for businesses, and many, many companies come under stress, consumer durable purchases slow down ... Many times, when the economy starts to stagnate investors and speculators say, "Well, now the economy is weakening. They're going to need a weaker exchange rate to stimulate exports and come out of their slump." But if that belief is reinforced, then the currency gets weaker still, which means interest rates go higher still, and the devaluation almost becomes self-fulfilling.

And the smart traders have figured that out ahead of everybody else?

The smart traders and investors will have studied what you might call the vulnerability of the economy, and they will say, "Is this economy in the jaws of the lion?" where the lion is this process we've just discussed. If they feel it is a candidate for that, they may withdraw their investments, so-called removing long positions.

Alternatively, they may take a short position. Now, it's not costless to take a short position because, for instance, in Thailand when people got scared, interest rates might be 40% or 50%. So if you're borrowing at 50%, hypothetically, and lending in the United States at 5% and you wait a year and you don't have a devaluation, you lost 45% of your money, just the difference between the two interest rates.

Who would be borrowing at 40% and investing at 5%?

Anybody that's taking a short position in the currency ...

What are you betting on? ...

I'm betting the Thai baht will devalue against the dollar to which it's pegged, and when I make that bet, I need to essentially borrow Thai baht, go to the foreign exchange market, sell my Thai baht and buy U.S. dollars, and then I deposit the U.S. dollars in the bank. The borrowing of the Thai baht that precedes the foreign exchange transaction, comes at an interest rate and the deposit in the U.S. bank receives an interest rate. If you sit there for a year after putting that transaction on, and you paid 50% to borrow, and you've earned 5% in the U.S. bank, you've lost 45% of your money. If there is no exchange rate devaluation.

But if there is?

... let's say you held it for a year, you would net out 45% and then whatever you gained on the other side. But the art of being a good speculator is not to pay 45% for a whole year, it is to pay it for about 72 hours, so that you're just on the train before things go and then you cover the position subsequently, meaning you then take the money out of the U.S. bank, go back through the foreign exchange market, and then buy back the Thai baht and retire the debt that you took out.

So you retire the debt and because the currency has devalued, you've made ...

Yes. If the Thai baht is at 24 when I sell it and it's 40 when I buy it back, I've made 16 baht in the round trip. Then that offsets ... that interest rate.

So that's what's called ... shorting the currency.

Shorting the currency and then covering the short is the retirement of that position ... The dynamic is when people sense that an exchange rate is vulnerable. The people who are so-called long in the Thai baht, or have investments that have currency exposure to the Thai baht, are alerted to the potential to lose money, and they do what's sometimes called hedging the currency exposure. It's identical in transaction to shorting by a speculator, but it's shorting against something that's already long. Or the equivalent would be liquidating the position. If you own a plant that produces shoes in Thailand, you could sell the plant, but the other thing you could do is short the currency to insulate yourself from the currency risk while continuing to own the operating business.

So you have a plant.

I take $100. I go in and I buy $100 plant in Thailand. But I had to go through the foreign exchange market, convert it at 24 to 1 into 2,400 baht. I buy a plant. For five or six years I produce tennis shoes. All of a sudden, I catch wind that there might be a currency crisis. I'm an American-based company, and I have a valuation on the book for my plant. I go into the foreign exchange market. I borrow baht, sell and deposit in dollars so that when I look at my balance sheet as a company, my foreign plant in Thailand has no currency risk associated with it, because I have hedged my currency exposure to Thailand in anticipation of the devaluation.

So when you show your balance sheet to your stockholders, it doesn't look like you're in trouble. ...

In fact, you're not. You insulate yourself from the currency risk. But the point is when you smell risk in those markets, speculators are shorting. Investors who are long may be selling what they have. People who owned businesses through direct investment may be hedging their currency exposure. But each and every one of those transactions is pulling money out of Thailand and bringing it back to the United States, putting downward pressure on the Thai baht.

A speculator, in addition to thinking about the transaction and the pressure and whether the spike in interest rates will be self-fulfilling is also looking at things like: Did a lot of Thai banks borrow dollars, because dollars had a 5% interest rate, and in tranquil times Thailand had a 12% interest? So the banks were all funding themselves off shore. Well, you know once they get scared, they've got to cover their positions, too. So, many times what you'll look at as a speculator is, number one, what is the structure of financing in the country? Do corporations and financial institutions have a lot of off-shore borrowing? ... If you know a lot of domestic institutions have been borrowing abroad to finance domestic business, they're going to get scared and they're going to have to short the baht to cover their exposures, retire their foreign debt, and so forth.

You watch for those kinds of structural situations. You then look at the macro-economic fundamentals: Is this an economy which will come into ... a realm where it has a policy dilemma, where in order to defend the currency they have to let interest rates go up? If interest rates go up and it weakens the fabric of the economy, which makes it more likely that they will relinquish defense of the currency regime. It makes it more likely that they'll let interest rates and let the currency weaken ...

A speculator will look for that kind of phenomena. It doesn't mean he created it, but it does mean it's not synthetic. It's a real situation that's going to happen. My own feeling is that most speculative crises are accelerated in time by speculators. Because they see it, they anticipate, and they start to act early, which intensifies the interest rate pressure and causes the thing to play out and rupture. But they don't cause it. It would just take place several months later.

But they do, arguably, make [moves] that can turn it into a stampede ... there's not time for a government to take moderate steps or figure out what to do.

I think that there is some truth in that. The officials in most countries do what's called intervening in the foreign exchange market. They have foreign exchange reserves at the central bank ... sometimes they resist the level of the exchange rate or they try to keep it at a certain level. But many in floating rate countries, like the United States and Japan, are not as concerned about the level as they are about the violence of the rate of change. So they will intervene to slow down or give pause or make more orderly the transitions ... In essence, the capital market has gotten so large and so forceful that the scale of the capital market relative to the scale of the central bank's tools and reserves has gotten enormous. The markets can gobble up the attempt of the authorities to smooth the transitions, to slow down that velocity of change almost instantly ...

What was your life like when you were making these trades--hour by hour, minute by minute. Is it possible to explain it?

A little bit. By the time you're active as a portfolio manager in that world, you have read about the data, what election schedules there are, who's strong and who's weak in politics, what potential there is for policy change, government minister speeches, and all the context. It's like an information overload from all around the world.

It's continuously coming at you, but you learn to assess probabilities, probabilities of change, detecting changes in tax policy, interest rate policy, and so forth, and so you get to the point where each day you're watching prices. Prices are either contradicting or they're confirming hypothesis you have about what's happening in the world. Many times, rather than reading something in the newspaper or figuring something out because I've talked to a government minister or what have you, I'll see a price movement. And I know that I don't know that much.

Your entire life is unclear when you're a trader because you're watching, and prices sometimes tell you somebody knows something you don't, you'd better jump on the telephone, talk to people through telecommunications, e-mail, what have you, get over there and find out what's going on that's making those prices change.

Another thing you become very conscious of, this underlying sense of politics is the grid, but a sense of where everybody's positions are. Have people been long and enthusiastic about Internet stocks recently? Well, you know they have. You know there are a lot of people who've bought a lot of it. If you believe there's no more good news, you know that positions are, how we say, vastly accumulated in those Internet stocks. Bad news may cause them to fall very abruptly.

So you're trying to sense, in some sense, the psychology of what people will react to, what positions they have, so the capacity for asset prices to change through volume of changing portfolios, and you're trying to discern what truth is underneath about the world around you. It's not just a question of discerning what's going on, on the political grid or the economic business cycles. It's also understanding how that will inspire action by other people.

John Maynard Keynes once had an analogy that he talked about, and he said, "It's like a beauty contest where you're not judging the pictures of the 10 most beautiful girls; you're judging from the 10 beautiful girls what the other people will think is most beautiful in trying to predict who will win the beauty contest ..." Some of what you do during the day, then, is talk to other investors and see what they're reacting to in the newspaper, what makes them afraid, what they seem inspired by, what hypotheses they have.

The other thing that's kind of tortuous is when you have a portfolio like this that you're responsible for, you spend almost all your time, even some of your dreaming time, thinking of things that could help you and how you would react. Contingencies--this is called risk management. How am I going to react if this happens or, alternatively, what can I imagine that could happen that could hurt me that I haven't thought of yet? When I sit at the pool on Saturdays with my kids, sometimes they think I'm not there, because in my mind I'm off playing these scenarios through, in my mind. It's very abstract thinking, but it's all about trying to stay a couple of steps and anticipate and understand what's coming up.

So the best traders figure out ... that something is going to change sooner than everybody else does.

Well, they think about what could change. They detect things that are changing sooner. They have imagined both about what changes and what you do with your portfolio. So they're able to predict artfully what will happen to asset prices contingent on something happening. Some guys may be great at predicting what'll happen, but they don't know how that translates into asset valuation. It's the latter dimension that really requires an artfulness and experience and talent ...

You told me that George Soros has a sense or a nose for political instability in the future ...

Well, in my view, the value of an asset is intermingled with politics. The whole, what I might say, legal regime and sense of trust and how the government sets the rules affects the value of currencies, bonds and equity markets, and if you think if there's going to be a big change in corporate taxes, it's going to affect the stock market. So the government plays a big role in setting expectations of what value will be ... A man like Soros, who in his own writing has talked about fleeing Nazi persecution in Hungary and in the very formative part of his life, understanding political instability, seems to sense when political regimes are gathering strength, under stress, coming unstuck, and that gives him almost like a divining rod to discern when big changes in asset prices are in the offing. I don't think everybody is endowed with that level of sensitivity.

But when somebody like George Soros begins to make a move on a currency, that's not a secret anymore, is it?

Well, there is a very rational process going on in the financial markets. It goes kind of like this, "I know I'm not that smart. But I know Soros is. So I'll watch what he's doing, and I'll go along for the ride." They're drawing inference from his actions that he knows something. Just as I spoke earlier about detecting from prices that something must be going on, people know that Soros's organization has an extremely sophisticated information-gathering and interpretative capability, and so they draw inference about what's about to change in the world based on the fact that he's got a reputation for early action. Now, in that case, you can go along with the Soros organization or any other fund and be on board for their mistakes, as well as their successes. No one has a perfect batting average.

And I don't think it's just about the scale of money. George Soros has ... more than $15 to $20 billion under management and that's very large at this day. But it's more important to be smart than to be large. In other words, if I'm choosing who to imitate, I'll imitate a smart guy before I'll imitate a large guy just because, how would I say, you're trying to draw inference about what's happening that you don't know about ...

If Soros or one of his funds decides to either buy a currency or dump a currency, physically how does that happen ....

Let's say the Soros organization, or someone of similar reputation, the Tiger Fund or Moore Capital Management ... If they start to transact, what you'll see on the screen is just evidence of change in prices. But it will not be identified with the person who was selling; it will just be a price change. But they're buying and selling vis-à-vis some dealer or broker and that dealer or broker will know. That dealer or broker may also have his own proprietary trading arm and may choose to buy or sell along with the Soros or Tiger, and they may also have other customers, some of whom have been attracted to dealing with them because they know those guys know about Soros.


So it's a bit ... like your ear to the ground kind of thing. People who are trying to figure out what Soros is doing, try to figure out who he's dealing with ... Then you go to those dealers and you promise them your order flow if they'll let you peak under the tent and get a sense--not moment by moment--but just a sense of the transaction ...

But the Soros organization and the other high reputation funds also think about the strategies of how do you deal with that. In other words, if you know somebody's a real loud mouth and you want to go long $10 million, what you do is you go to the loud mouth and you sell $500 million, let them tell everybody that you're going short, then you step in with a quieter buy, and everybody's selling to you, thinking that you're selling, while you're buying.


... But by and large when a large entity that's made excellent returns ... Warren Buffet is another good example. There are people who sell newsletters about who flies in and out of the Omaha airport. There are people who try to map what Fidelity Magellan Fund is doing and sell it as a consultative service. There are people who watch Buffet's portfolio, always go to his annual meetings. There's a continuous effort to draw inference from smart people about what they're doing in the markets.

So tell me the kind of things that you look at on these [computer] screens.

When you're watching a combination of news, prices and volume, you're looking at where the current prices are, because those indicate where you could approximately transact if you call a dealer. You look at news to understand what is stimulating other people and try to infer what you think is interesting yourself. You also look at charts, which are a combination of price, high and low, and close from previous periods as well as the current price and the high and low on a given day. I tend to work better as a graphics interpreter than I do analytically or with numbers. So I can look at a picture. A picture's worth a thousand words to me ...

How do you figure out how to make a play?

Well, you have to be very simple. You have to say, "What makes money or loses money as movement in prices?" So you have to start with a very simple premise. What's going to make prices move? What makes prices move is actions by other people in the market. What causes or inspires those actions is usually a change in perception.

So we tend to watch very closely what's happening in news and evolution. One comes to the trading day with a perspective on what's happening. Then you look for things that either contradict or affirm that perspective. You also come to the trading day having had many conversations with other traders. So you understand what they already perceive. Because the only way prices move--it's not if your perspective is correct, but if there is a change in the perspective on the part of other people.

So you're always trying to arbitrage. You're trying to look for, what do other people feel? What do you feel? If there is a difference, how they will change their mind? What will be the catalyst that makes them change their mind? When you put on a play is when you feel like you know something that the world doesn't and they will come around to your point of view. The danger, of course, is that you may come around to their point of view and lose money

But if you make a play before the world knows what's going on, and you're right, then you make a lot of money. That's the theory.

Yes, but it's interesting. It isn't about truth, because you can be wrong. As long as the world changes their opinion to feel that what you perceive is true, even if you're all wrong, you still make money. So it's about the migration of their perceptions, more than it is about the underlying truth. One hopes that there is a correspondence between underlying truth and perceptions ... In most cases, there is. So that if you can discover what's happening in the economy or infer from the comments of leading officials what changes in policy will take place or by diagnosing the earning statements of many companies, what's happening in the business cycle will effect bond prices and equity prices. A lot of it's about doing homework before you get to the trading day ...

Let's talk about the phase you used that this stuff can be like a "video game" ...

Well, I think the analog to a video game is that you're looking at electronic screens. When I watch my children playing Nintendo or Sega or Pokeymon or whatever the current game is, it's analogous. There's an electronic screen. At some level, the video game is like a virtual reality. You're playing with this game with your imagination.In essence, you're not out in the field experiencing the changes in employment and agricultural harvests and things like that. You're looking at a distillation of all the indicators about that process over an electronic screen. You're removed from the actual economy, all trying to interpret the economy through electronic means. It can take on that video game-like tone because you're sitting in an air conditioned room.

I said that somewhat facetiously because a video game that my son plays, he just plays in the living room and then goes to bed. A video game that international speculators play has a very profound effect of the well being of people through the effect on interest rates, exchange rates, asset prices, commodities prices.

... at the time I said that I was hoping to inspire people to be a little bit angry, because at one level, if you view it in that lobotomized fashion, that insensitive way, you say with all of these countries and all of this information and all of these things that you can do, it's a tremendous mental exercise, and it is a tremendous game.

But, at another level, it is not a game, because the consequences of what's happening in the world, and prices and the interaction between investors and the livelihood and well being of people, is much more serious and much more important than just a game. When my son and I played the table 64, it doesn't have any adverse side effects for society. When you're involved in large-scale speculation, there are very real consequences.

How many people in the business ... can think about the consequences and still do what they do?

The most successful ones can. There's a very interesting tradeoff. The more sensitive you are, the more you can take on board in terms of awareness, the capacity to anticipate change and therefore make money. On the other hand, the more sensitive you are to the pain and suffering and other dilemmas of how the world operates, the more it fatigues you, or wears you down.

You know, people often talk about, "Do people feel guilty?" There's a difference between feeling guilty ... and feeling a sense of empathy, tragedy, and shame when people in Indonesia are suffering like they're suffering right now. People who can stay within the video game might be quite resilient and not care and not understand what's happening in the world. Those people lack a certain sensitivity, awareness that may cause them to miss a lot of opportunity. A man like Soros is fabulously sensitive to the consequences of his actions and the market's actions and the impact on humanity, and that's both his ability and his burden, in my opinion.

But at a moment when some trader sees prices changing and an opportunity to make a good bet, you're not thinking, "If I do this it's going to help start a stampede and the Indonesian people are going to suffer ..."

You might think about that. The question of whether that awareness of the consequence for the Indonesian people that you described, causes you to refrain from action, is a different thing. Many times, if you will, the rules of the system exist, and if you don't play or if George Soros doesn't play, it doesn't mean the game won't take place. It just means you won't make the money, because somebody else will ... You understood it earlier and you could have had the opportunity, but you withdraw from that opportunity; therefore, other people go forward and make the money, and the same suffering takes place ...

... Sometimes people feel both like a citizen and like an actor in a game, and they're almost compelled to continue to play in the game role, even when it hurts their soul, because they can see the consequences of what this systemic action is producing ...

What effect has the explosion in the computers and the information age have on this world?

It's enlarged the scope of what you can cover, monitor, and so forth. If I'm looking for 10 opportunities in asset markets, which is talking about the price, I can set alarms now on my computer so that when the price touches that point, it alerts me that it's time for action. I can put together files on a Reuters system, where if I'm following 28 companies, every item of news about that company that comes through Reuters worldwide system can be brought up onto my screen. So I don't have to go hunt for it; it comes to me. The sorting, the filtering, the distillation of information has become much less costly ...

So the capacity to make good judgments is enhanced by that technology. On the other hand, it's the old saying about computers: Garbage in/garbage out. People who don't know how to sort facts into meaningful constructs, they don't have interpretive skills, are just overwhelmed ... just like a wave washes over them of all this information. But it's really about making actions that are correlated with successful investments and whether all that information helps or doesn't help. There's a thing they call analysis paralysis, when you're scared to do anything, you just study. But you miss all kinds of opportunities in the market.

What about speed ... you can act instantaneously?

You've always been able to pick up the telephone and ask a dealer for a price. It's not that much different now. The access to the market--I see it as changing quite a lot in individual stocks. These companies like E-trade and, I believe Fidelity and others, have now electronic mechanic mechanisms where you can sit at home and trade stocks directly rather than having to call the broker, get a price, and so forth. That's probably making it less expensive for the end user, the end investor, to make these transactions and make these changes.

So the speed ... has not noticeably changed?

... I don't think that's changed a lot. You know, Alexander Graham Bell helped. They talk about the old days when J. P. Morgan used to stand with binoculars on the top of his building and look at what boats were coming in to the harbor, and then he would go down and speculate in commodities, based on what he knew was going to be unloaded from the boat. I think we've progressed since then. The carrier pigeons in Europe. They used to discuss what had happened in Napoleon's battle, so the Rothschilds could then invest in it. It's always being about faster to learn what's the truth. Not just what's the truth, but what others will come to perceive shortly, and that time frame has narrowed considerably since the Rothschilds's heyday.

But you also said that your business wasn't about truth, it was about perception.

That's correct ... it's the same idea as the beauty contest. If I know something is true in Thailand, but it doesn't inspire other investors to act, it's an irrelevant truth in terms of the money-making business. If it's a truth that either learn about or don't care about it, they don't see any structural significance, or it's a truth--they never learn about. Other things will inspire their investment activity. So you're trying to guess what things--some of which are true, some of which are not--will inspire other investors to take action. It's more about how will their perceptions change, and whether those perceptions will converge with the truth.

It's like we're talking about some chess game in the sky. Most of us don't even have any idea ... that this game is going on.

Yes, I think that's partially true. The nature of the abstract thinking that's going on in the investment community is sometimes discernible through comments you see in the financial pages. But the way in which all of these prices that affect employment and how goods are bought and sold and what countries experience boom and which countries are in stagnation, I don't think that that connection between how the investor-trader world is setting prices and then the real consequences is well established.

Or well known to ordinary folks.

That's right. Right now when we began to talk was about the very violent consequences going on around the world. We're seeing Russia, much of Latin America, most of Asia, go through episodes in their economies, in their economic life, that are as deep and damaging and painful and profound as the Great Depression was in the United States.

At the same time, the United States is an economy which is characterized by its proportionately smaller exposure to international trade and international influences, and our stock market's at an all-time high. We're at a time when people are almost religious in their worship of markets. The market is now our master. If you espouse a social goal in America today, someone will say to you, "No, the market won't support that."

The market is a tool. We should have a political and social consensus on what our objectives are as a society and use markets to facilitate that. But now the servant's the master. It's almost as if the market is a religious icon. I see that mirrored in the very, very high valuation of the United States stock market and the tremendous conviction that citizens have throughout the country that the United States is good, is right. The free market is great, and the stock market is where you put your money.People used to put their bank balances into gold or bank accounts or CDs, so-called safe things. The stock market was considered risky. Now the stock market is where everybody puts their money 'cause that's considered safe and lucrative. That's a bothersome notion to me. As I mentioned earlier, making money is about changes in perception. Our society has such conviction now that the stock market is a good place. That perception is reflected in prices. The change in perception that's going to make stocks go up further is becoming even more optimistic.

... The ability for perception to change and change valuation in the stock market seems to me approaching the time when the only news that will be meaningful is bad news. That will change your perception. That will make my dentist stop lecturing me about how I have to be in the stock market with all of my wealth because, four out of five years, it's better than bonds. We're at a dangerous point with regard to equities in the United States, and I mentioned it's a little bit like fiddling while Rome burns 'cause the world is struggling all around us right now. And if the United States runs into a downward spiral, declining stock prices ...

Soros has said if things don't change, there is the real danger and possibility that we are headed for a worldwide recession, if not depression.

Yes.

Do you share that fear?

I think that George is accurate. There's an old saying by a now deceased journalist, American, named Christopher Lash, and he said, "Meritocracies are only stable if a large number of people are winners. Otherwise they change the rules."

In the economic outcome, if the United States is successful and the rest of the world goes through the kind of transitions and violence that they have in recent years, and that persists, and for instance if the U.S. slows down, we've talked about it, and it amplifies the pain in other areas, they will not view themselves as bad performers in this system. They will try to change the system.

The nature of the trading system in the world and commerce is at risk in the current time, because large number of people are suffering; large numbers of people have had their lives disrupted and had their expectations about the continuity for growth and progress and employment and wealth accumulation shaken to its foundation. And that sows the seeds of political dissent and the impetus to a change in the way the world is organized."


frontline: the crash: interviews: rob johnson


I thought this was enlightening enough to share. To me a very clear and accurate picture of world market mechanics.