Wednesday, March 31, 2004

Gaming The Fed - Auerback

Well, a lot of people think the markets are doing just fine. Let's see who turns out to be right, as I for one agree with Marshall's position. There's $874trillion of derivatives transactions out there adding considerable aggregate cost to capitalism's very survival. There's also all the extra interest cost, arbitrage costs, hedging, and other speculative aggregate system costs. This is a lot of extra weight for capitalism to viably carry. What do you think?

Gaming The Fed

The basis of the much of today’s unbridled speculation in stocks, bonds, commodities, real estate, etc., fundamentally lies in an unqualified conviction the government can and will, "by any means necessary" to quote Governor Bernanke's seminal November 2002 speech, drive the economy, corporate profits, and asset prices higher. As global strategist Marc Faber notes in a recent Financial Times piece, “[O]ver the last 18 months U.S. monetary policies have boosted all asset classes. This is most unusual since it ought to be obvious that in the long run commodities inflation and real estate inflation are incompatible with a bond bull market.” While this conviction was sorely tested last summer by the Fed’s apparent withdrawal of the “Bernanke Put”, it appears that such earlier expressed diffidence has been laid aside and with it, banishment of bearishness to the sidelines…at least, until recently.

As Faber observes, a multiplicity of bubbles has been created over the last year in virtually every asset class: stocks, bonds, commodities, real estate. With constant reassurance by the Fed, professional investors essentially have been gaming the likelihood that, confronted with catastrophic losses, policy makers would effectively socialize the risk, and thereby thwart the disciplines of the free market. In the event that such calculations went awry, many professional investors reasoned they would have gone out of business anyway, so virtually nothing was lost in betting the ranch (at least with other people's money) on a deeper policy response. If it worked, you got to play again another day; if it failed, at least one failed in a conventional fashion (to paraphrase Keynes's famous quip). ...Link

Currency Theory - Senior Currency

I have published this entire article as it offers some important currency theory not offered by others. Bob has a unique historical perspective of our money system and possible direction. We may be in worse shape than many think.

How a currency can fight the Fed

Bob Hoye is a market historian and editor of Institutional Advisors, a provider of research to financial institutions, mining, and petroleum companies internationally.

At a time when the Fed has promised and threatened to depreciate the currency and when everyone knows that China is going to buy commodities forever, the call for a strong dollar may be unacceptable.

In order to get over the hurdle of orthodoxy, it is necessary to return to first principles. One is that the senior central bank has to have a soaring asset class against which to inflate its portion of a credit expansion. The notion that its "stimulation" of credit forces a business expansion is just plain wrong. In logic, it's called a primitive syllogism, which considers that because two events occur at the same time they are causally linked.

Yes, credit does expand with the business cycle, but this is well documented back to Roman times – well before interventionist economists modernized the ancient, and we mean ancient, notions of mercantilism.

The classic causal relationship is that the rooster crowing "causes" the sun to rise.

For decades, our case has been that the Fed would aggressively accommodate virtually every aspect of a great financial mania and would never voluntarily do anything to curb it. No matter how reckless and absurd the speculation became, this was the case. Some would claim that the Fed tightened as administered rates increased to 6% in 2000.

As with the senior central bank's behaviour through the culmination of previous bubbles, increases in the discount rate followed the rise in short rates normal to any bubble. The other measure of officialdom being swept up by universal speculation has been the decline in real interest rates.

In 1966, Alan Greenspan correctly condemned the 1920s' Fed for being too "easy" during that obvious mania. On that one, real long rates fell from 9% to 4%. During the late 1990s' bubble, rates plunged from 9% to 1.8%. The low was recorded in 1 Qtr. 2001, well after the collapse of speculation was underway.

When the street was becoming gravely concerned about increasing short rates, our observation in July, 2000 was that such rates soaring was part of the boom and, ironically, that there was no need to "worry" until treasury bill rates declined. Chronically plunging market rates with the senior central bank following the action down with a series of discount rate cuts has been one of the key signatures of the post-bubble condition.

This explains why the Fed hasn't raised administered rates in the face of the most outstanding speculation in commodities since the early 1980s. Short-dated market rates of interest don't want to go up so the Fed, with its usually lagging behaviour, has had no guidance to raise its rate, which is curious as it has been threatening the "print" to prevent deflation.

On this one, our position has been that the Fed would not voluntarily tighten but, as with any speculative bout, the phenomenon has its own ability to tighten. This is better understood by considering that most of the so called "liquidity" apparent during a boom is actually money borrowed against the convictions that soaring asset prices will continue forever.

The consequence of this manic condition before or during the construct of central banking has been that the moment prices turn down the real power shifts from promoters to margin clerks, whose job description is vastly different to that of a central banker.

Quite simply, soaring asset prices permit an equivalent credit expansion and, with the exhaustion of speculative abilities, prices turn down, which forces a credit contraction. This is clearly described in an editorial in the July 11, 1932 edition of Barron's: "The Federal Reserve policy of cheapening credit through the purchase of government bonds has been unable to make a dent in the conservatism of borrower or bank lender, in short, every anti-deflationary effort has yet to provide positive results. The depression is sucking more and more bonds into its vortex."

With adequate to ample evidence, this has been the pattern of booms and contractions since one of the earliest recorded examples hit the Roman Forum in 34 A.D. What's more, as with that one, there have always been attempts by officialdom to prevent or ameliorate the consequences natural to rampant speculation – always without material significance.

The now short-term uptrend in the dollar is part of the exhaustion being displayed in the hot action in both tangible and financial assets ranging from low-grade bonds to international shipping rates.

The key question is – can the Fed continue to "print" and thereby force asset speculation to even greater heights? Part of the answer would include the distinctive contraction in the money supply since August.

First of all, the 1990s' bubble recorded the greatest recklessness by the senior central bank since the first one in 1720 when the Bank of England was quite naïve about market furies. History's record is that no matter how responsible the senior bank has been, "New Financial Eras" have not run shorter than nine years. Going the other way, no matter how accommodative, the party has never extended beyond nine years.

For example, the duration of the 1990s' example was 116 months, which compares with the 116-month duration for the mania that ended in September, 1929.

The next point is that, and again using previous examples, the third year out from the climax of a bubble can be a good one and this has been the case. As the good times returned beginning in October, 2002, our position has been that it would be a cyclical bull market within a secular post-bubble contraction.

The top for the remarkable speculation in tangible and financial assets has been accomplished along with the low in the dollar index and the big question is – how long can the dollar strengthen and can it deny the Fed's ambition to depreciate? (That through the nonsense of a "flexible" currency it has depreciated the dollar by some 90% and seems intent to accomplish the final 10% will be left to another review.)

Fortunately, history provides a sound argument that this ambition may be thwarted. Since the 1500s, the record is fairly complete and during a financial boom that follows the "old" era of inflation, confidence soars such that lenders in the financial capital seek higher yields from risky borrowers in other countries.

As with all subsequent examples since the "classic" 1560s' liquidity collapse (this was comprehensively described by Thomas Gresham), once the party is over the monumental concern is the problem lower credits have in servicing their debt in the financial capital.

As with more recent times, the collapse of speculation is followed by a contraction in business and tax revenues so the return of sobriety changes the mood from borrowing as much "low-cost" money as possible to a compulsion to pay it down. Often this required selling raw materials, goods, or other countries' currencies to obtain the amounts of senior currency so necessary to meet obligations in the financial capital.

Essentially, Gresham's letters were concerned about the problem of servicing England's debt when sterling was weak into Antwerp, with a strong guilder the senior currency. In particular, this becomes very acute in the liquidity vacuum that is the consequence of any big speculative boom.

On every example since, the mechanism seems to be best explained in street terms (or, as it was spelled in Elizabethan times – streat). Following a period of great financial recklessness, all that is needed to make the senior currency relentlessly strong is to have most of the debt expanded during the boom to be contracted in the senior currency.

Such money owed can be described as a short position in the senior currency and since the 1930s it has been the U.S. dollar. During our boom, it is reasonable to conclude that by far the largest amount of debt has been financed in New York, with both interest and principal payable in dollars in New York.

The world has experienced the biggest financial boom in history and this has included the biggest debt issuance in recorded history. And the majority of this in "street" terms is equivalent to a huge short position in the senior currency. The eventual problems in servicing debt, which in a world of traders can be construed as "short covering", in the past became intolerable.

The recurring pattern starts with the euphoria of issuance, then doubt and consternation follows, and finally, with seemingly insurmountable debt and foreign exchange problems, a revulsion for debt develops.

Obviously, the final of the sequence is a long way off, but in the meantime investors should be aware that the U.S. dollar can, despite policymakers opposing ambition, become chronically strong. ...Link

Monday, March 29, 2004

China - Oil Pipelines & Train to W. Europe

China Moves Toward Another West: Central Asia

LASHANKOU, China — With its dozen blue-roofed villas, a brand-new sauna house, casino and three-star hotel constituting the heart of what this frigid outpost at the border of Central Asia fancies as downtown, this would seem an unlikely spot for the economic and political reordering of an entire region.

An agreement this month to build a oil pipeline through this tiny hamlet makes it the center of an explosion of economic activity in what only recently was one of the most backward corners of China. The pipeline will traverse Alashankou as it snakes its way past the snowbound mountain ranges of Central Asia, still filled with tribal horsemen driving herds of goats and camels, on its way to China's industrialized east.

China's western ambitions do not end with the purchase of huge amounts of energy, the main products that Central Asia has to offer, international political analysts, Chinese and regional officials agree. Beijing's bid to secure vital fuel supplies is part of a bold but little noticed push to increase its influence vastly in a part of the world long dominated by its historic rival in the region, Russia.

China's thrust into Central Asia comes as an almost natural extension of its ambitious efforts to populate and develop Xinjiang, a far-western region the size of Texas with 18 million people, which seems underpopulated compared with much of China. In doing so, China hopes to neutralize a threat of separatism by the region's Uighur minority, whose Turkik language and Islamic faith draw them toward kinsmen in Kazakhstan and other former Soviet republics of the region.

With Russia in sharp relative decline, a booming China looms as the economic locomotive, and even the model, for the entire region. That means China finds itself in a position to call the tune in a way that it has scarcely felt confident about in the past. Most immediately, this means being able to hold China's neighbors to pledges not to support Islamic militancy or Uighur separatism.

Increasingly, there are signs that Chinese influence is spreading. In November, at an international conference on Kazakhstan's financial reforms, representatives of the International Monetary Fund and the World Bank found that the governor of the People's Bank of China was the most sought-out guest.

Recently, analysts say, Uzbekistan and Turkmenistan have followed the Kazakh example in looking toward China, rather than to Western-dominated international financial institutions, for new economic thinking. China's authoritarian politics and central planning also have a strong appeal for many of the former Soviet republics of the region.

Meanwhile, China has been busily building new security relationships in Central Asia to match its growing economic ties in that region, an area of increasing strategic competition involving China, Russia, India, Pakistan, Iran and Turkey. The United States has not been absent from this competition, having acquired a military base, known as Camp Stronghold Freedom, in Uzbekistan, as well as a presence in Afghanistan.

"Everybody is trying to secure access to this region's oil," said Stephen J. Blank, a professor of national security studies at the Strategic Studies Institute of the United States Army War College, in Carlisle, Pa. "The Chinese are very nervous about American bases in the region. The Russians are trying to set up an OPEC-like cartel to tie down gas in Central Asia, and the Indians have acquired a base in Tajikistan.

"It is not Kipling's `Great Game' yet," Dr. Blank said, "but it is a hell of a contest in its own right: military and economic and everything else."

China has increased its security ties through the Shanghai Cooperation Organization, a six-member group founded in 2001 that includes Russia, Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan. China has committed itself for the first time to a regional collective security agreement focused on enforcement of borders. Beijing has followed up with joint military maneuvers with Kyrgyzstan, and with the continued development of rapid deployment forces based in western China, which could be used to put down trouble in Tibet or Xinjiang, or to help enforce border security along with other members of the Shanghai group.

Beijing's growing security involvement to its west is something of a change for a nation that has tended to look inward. China has tried to allay the suspicions about its intentions, among far weaker neighbors, by focusing on antiterrorism as a common goal, and it has worked hard in official rhetoric and in diplomacy to promote a view of itself as a new kind of superpower, one supposedly lacking aggressive intent.

"There is a big difference in the size of our economies," said Zhang Deguang, secretary general of the Shanghai group, in an interview at his Beijing headquarters. "Tajikistan, for example, is a very small country, but even Russia's economy is only a third the size of ours."

The difference in gross domestic products "shouldn't be reflected in relations between us, however," he added.

Elaborating on a theme that has become a mantra among China's leaders, Mr. Zhang spoke of his country's "peaceful rise," which he said would create "benefits and opportunities for China's neighbors."

Bates Gill, a China specialist at the Center for Strategic and International Studies in Washington, said of China's push into the region, "The Chinese are sending people all the time to meet prime ministers and presidents and generals and all the way down the diplomatic ladder."

"This is all about soft power, and strategic and diplomatic relationships," Mr. Gill said. "Central Asia is a fantastic lens, or model for what China is trying to do all over its periphery: reaching out and settling old scores, and trying to establish a benign kind of hegemony."

Other experts say China's approach is as much dictated by realism as any idealistic notions of a new-style superpower. "Many Central Asians still feel a visceral hatred for China fed by old Soviet propaganda about Mongol and Chinese hordes and about Chinese `intentions' toward the region," said Dru C. Gladney, an expert on China at the University of Hawaii. "The Central Asians are poor and weak. They are very sensitive to China elbowing them around on issues like borders, terrorism or water."

Acknowledging a bitter past, which included a fierce, if brief, border conflict between China and the Soviet Union that intruded on Kazakh soil in 1969, a diplomat at the Kazakh Embassy in Beijing said bad feelings toward China were mostly forgotten, eased in part by fast growth in bilateral trade.

"China is now regarded as a friendly country in Kazakhstan," said the diplomat. "You have concerns when you don't know the other party, but in the case of China, we have more and more shopping tourists, who come here to buy goods and sell them back home." Along with the pipeline, Kazakhstan agreed this month to build a $3.5 billion, 1,900-mile rail project linking China to Western Europe.

"We are destined to become a very important region," said Hua Dingchuan, a trade official in Bole, a city that 10 years ago had virtually no private cars, and now is as densely developed and busy as any American suburb. "Our neighbors have the same kind of opening-up policies that we do. They love Chinese money, Chinese products, Chinese expertise and Chinese technology." ...Link

Are Bubbles Set To Burst? / Business / US

Be braced for a bust as bubbles look set to burst By Marc Faber

Credit has to be given to Alan Greenspan, the Federal Reserve chairman.

He is the first head of a monetary authority who has not only managed to create a series of bubbles in the domestic economy but has also managed to create bubbles elsewhere - in the New Zealand and Australian dollars, emerging market debts, government bonds, commodities, emerging market equities and capital spending in China.

In fact, over the last 18 months, US monetary policies have boosted all asset classes. This is most unusual since it ought to be obvious that in the long run commodities and real estate inflation is incompatible with a bond bull market.

Mr Greenspan's monetary tribulations mark an achievement no one else in the history of capitalism has accomplished. It is also one investors will never forget once this credit-driven, universal bubble bursts and it will fill entire chapters of financial history books with economic and financial horror stories.

We simply don't know how the end game of the current speculative wave will be played out and when the bust will occur but a painful resolution of the current asset inflation and global imbalances is as certain as night follows day.

I used to believe that sometime in 2004 we would see the beginning of diverging trends in the performance of different asset classes, since bonds, commodities and real estate cannot continuously rally in concert.

After all, one characteristic of a strong secular bull market in one asset class is the simultaneous occurrence of a bear market in another. The commodities bull market of the 1970s was accompanied by a vicious bond bear market. The equities and bond bull markets of the early 1980s were accompanied by a persistent bear market in commodities and, in the 1990s, stocks of developed Western markets soared while Japan and emerging stock markets collapsed.

So, I was leaning towards the view that some assets would continue to increase in value in 2004 while others, such as bonds, would begin to fall by the wayside and enter longer-term bear markets. After further consideration, I am now increasingly concerned that sometime soon "everything" could begin to unravel. When interest rates rise, it is conceivable that bonds, stocks, commodities and real estate will all decline in value at the same time.

In the past I have had the tendency to dismiss the deflationist views of some reputed economists and strategists as unlikely. I now feel the current universal asset inflation and overheated Chinese economy will be followed by a serious bust and asset deflation, which will kill consumption in the US. The only question is when.

I'm at a loss as to when this bust will occur. But given the overbought condition of the US stock market, the extremely high bullish consensus (indicative of market tops in the past), the rising commodity markets and the tendency of markets to defeat central bankers who entertain the same erroneous beliefs that central planners under the socialist ideology had when they thought they could plan the best possible economic outcomes, the bust could come sooner rather than later.

Moreover, we know from the experience of Japan in the late 1980s and Hong Kong in the mid-1990s that consumption booms, driven by asset inflation, end with a colossal bust. That can result from rising interest rates, or because stagnating household incomes no longer support the asset bubble as affordability diminishes, or additional supplies coming to the market and exceeding demand.

So, given that consumption driven by asset inflation is unsustainable in the long run and always ends badly, what should the contrarian investor do?

The least desirable asset in the world is US dollar cash. The investment community can take everything in stride - even a 70 per cent decline in Nasdaq stocks. But interest rates, as low as they are now, compel people to speculate on everything from commodities, homes and bonds to equities.

Therefore, investors in the current speculative environment should be extremely defensive and not be tempted by short-term gains, which could be swiftly erased. Daily moves of 5 per cent in investment markets will become common. Nickel recently fell 8 per cent in a day, copper by 5 per cent, and the euro by 5 per cent within a week. Gold and, especially, silver may offer some protection but, once the current asset inflation bubble ends, they could also be in for a rough time.

Obviously, as I experienced in Asia in the 1990s, it wasn't important to be "asset-rich" before the crisis of 1997 but to be "cash-rich" after the crisis when financial asset values had tumbled by 90 per cent and when incredible bargains across all asset classes were available. ...Link
Banks Exploit China's New Rules On Derivatives

Sunday, March 21, 2004

BIS Derivatives - Mixed Messages

I read this report as a considerable global slowdown. Check it out and see what you come up with. Even though contracts and values expanded, they expanded in opposite areas to what could be interpreted as anything close to real growth. {aggregate global derivatives' cashing costs are mounting - they fall on the nations where cashed, not where written}

BIS - Derivatives

Derivatives markets
The aggregate turnover of exchange-traded financial derivatives contracts monitored regularly by the BIS shrank further in the fourth quarter of 2003. The combined value of trading in interest rate, stock index and currency contracts amounted to $207 trillion, a 7% decline from the third quarter (Graph 4.1). Activity was uneven across the major market risk groups, with turnover in interest rate contracts falling substantially and that in stock index and currency contracts growing at a moderate pace. The overall decline in the turnover of interest rate instruments, the largest of the broad market risk categories, resulted from a drop in both money market and government bond contracts. Nonetheless, for 2003 as a whole the aggregate value of turnover in financial contracts rose considerably. Transactions during the year reached $874 trillion (see the box on page 44). This represented a 26% increase, which compares with increases of 17% and 55% in 2001 and 2002 respectively. Business was brisk in all of the broad market risk categories. Activity in the small market for currency contracts was particularly buoyant after a long period of stagnation.

Fixed income contracts slow down in calmer markets
Aggregate trading in exchange-traded interest rate contracts declined in the fourth quarter of 2003. The volume of transactions fell by 9% to $184.5 trillion, compared with a decline of 10% in the third quarter. This overall slowdown in fixed income business resulted from a drop in the two major market segments, namely money market and government bond contracts. Turnover in short-term interest rate contracts, including eurodollar, Euribor and euroyen, fell by 9% to $157.7 trillion, while business in longer-term instruments, including US Treasury notes, German government bonds and Japanese government bonds, weakened by 10% to $26.7 trillion (Graph 4.3). Trading in fixed income contracts declined across most geographical regions. In North America, business weakened by 9% to $93.7 trillion. Money market contracts fell by 8% to $84.7 trillion and longer-term instruments by 15% to $9 trillion. In contrast to earlier quarters in 2003, there was little difference in the behaviour of the various money market and government bond contracts or in that of futures and options. ... across most regions ... Activity in fixed income contracts declines ...Link

Thursday, March 18, 2004

The Elastic Limit of X-Rate Productivity

BonoboLand ? Germany's 'Great Depression'

"And another one hits the elastic limit of floating exchange rate productivity. ...When will the world start Learning? The world is up against the Samuelson, Friedman, Mundell floating exchange limit."

Daniel asked, "Would you mind unpacking this comment for me? What's the floating exchange rate limit and how is it linked to productivity?"

I am planning a post for next week that should set the groundwork for explaining my comment. For now I can give you maybe enough to have some understinding of my thoughts. Much of what I deal with is completely new economic theory outside the traditional subject's history. Many years ago I came to the conclusion that currency law was the most crucial law of all the laws and theories of nations and economics. As Aristotle said, "When a nation loses control of its currency, it matters not who makes the laws." Nothing could be more true. Floating exchanges is loss of currency control - plain and simple. The foundations for my productivity of exchange rates is based on my own theory of global aggregate credit productivity. If you look at all global aggregate public debt you must realise that all public debt is a private profit. My problem with this is the blind markets of tax havens, derivatives, and other speculation as to the direction and dates of the short and long positions, and how much actually ends up in the tax havens. There is no way to truly know these numbers or to really ever know them fully, as to know the forward positions and expiration dates of speculators would open the system to tremendous new speculative pressures, therefore I try to reverse engineer the entire global capitalist system from what major national, corporate, and global figures are available, and estimate the rest by mathematical ratios.

As you might expect this is a massive undertaking, however it is not without merit. By doing the above I have been able empirically and semi-mathematically to arrive at a deeper understanding of global aggregate credit productivity which easily translates to exchange rate productivity, due to increased currency and trade costs - trade costs reduce for consumers on the one hand, but on the other increase through hidden tax haven hoarding. Credit is most productive when nations exchange rates are in true equilibrium, although the condition seldom exists today, as it did under the Bretton Woods System. Just as an example, if all nations were in perfect ppp equilibrium and stayed in said equilibrium, no nation would experience speculation against its currency, and only minor speculation/arbitrage against its products, commodities, services, etc., which could skip the tax man into the tax havens as is today's reality. Under the existing system the nation states are more in debt to the corporate virtual state of tax havens than any other nation or nations. {The Euro-dollar system, which used to produce its figures, held over $5trillion - a known amount in some tax havens in 1993.} This situation creates the non-productivity of credit and transfers into exchange rate non-productivity, as exchanges widen ever further yearly. Now the explanation to this is highly complex, but I will give you a general synopsis of why it is caused by floating exchanges.

In case you haven't come across it on Bonobo I'll repost what could be a clearer explanation:

"Globalism is dead" - Now, to explain what my cryptic remark was about. Many nations are already rejecting the classical school's "Washington Elite Consensus" of liberalized markets and free trade. This has been an ongoing historical event since Malaysia told the IMF what to do with its policies and went its own way. Now we have Brazil's Lula wrecking the FTAA talks in Miami, and still others rebelling in secret or public. There are many other failures of the "Elite Consensus" from the MAI treaty to recent rejections of CAFTA by some nations. The people and nations lining up against the "one liberalization shoe size fits all" of the IMF, World Bank and WTO is expanding rapidly. Economists, historians, and social philosophers like John Ralston Saul {Saul} are mounting a global attack against the post `73 insanity of classical economics and their beliefs in anti-Keynesianism, disguised as a pseudo-post Keynesianism and neo-conservatism. The truth of the matter is the classical school believes in three unprovable axiomatic math models - the neutrality of money - equilibrium - and corporate wages, prices, and profits. The two I am most concerned with here are the neutrality of money and equilibrium. Dr. Paul Davidson {Paul} has done the definitive critique of classical economics in these areas and I and many others agree. The historical evidence is mounting against the classical schools and the books and articles being published is overwhelmingly a massive critique of market liberalization and its failures. {ie., floating exchanges}

Here's a further excerpt pieced together:

`Without a full understanding of the functioning of forward markets, all discussion of exchange rate policy must remain seriously deficient.' Egon Sohmen

... 13.`When there are many nations with steady depreciating and appreciating currencies, bankers have plenty of short and long opportunities to cover their forward commitments in other nations - until debt entropy...' {and hide profits in tax havens}

... Of the above quotes #13 is the one I wish to draw more attention to - how banks and other financial interests cover forward contract/derivative costs. U.S. law states that all long and short positions must balance at the end of each business day, as do many nations' laws. The trouble is even though these transactions may be in balance nationally they can be massively out of balance internationally. Herein lies one of the origins of the problem. Most all parties involved can, do and will book their long positions in strong currency nations, and most all their short positions in weak currency nations, thus pushing exchange rates further and further out of equilibrium the longer we have been and are on a floating standard, as mentioned above in the quotes. This disequalibrium, in turn, through the major shocks we've witnessed since Mexico, in the`90's, have added tremendously to overall capitalist system costs, and in turn creating overproduction and global deflationary pressures - real and feared. One of the flaws we must throw away, as Keynes also did and Paul Davidson does, is the classical school's misguided belief in the neutrality of money. The truth is obvious in the above that money is not neutral. It is often long term destructive through floating exchange's ever increasing disequalibrium and its associated increasing costs. Central bankers can only play a very crude market maker in such a massively imbalanced system. They often have to take great losses or pawn these losses off on their unsuspecting taxpayers. From the above you may be able to see why Japan is in such a deflationary quandry. The speculative realities between the lesser nations and the developed nations continues to push Japan's and others currency high/low when it needs to go low/high, yet the global currency competition situation and specualtion is now at such a critical stage nothing works as should - nor will it under the continuation of the classical school's other often deluded ideas of floating exchanges and never existing free markets.

The limit of exchange rate productivity exists when nations can no longer productively service their debt obligations without severe national austerity, deflation, or outright defaults and depressions, which only adds further to the existing problem. Too many nations have already crossed this line thus throwing the burden of uncollectible debts on other nations and their creditors, further increasing global deflationary forces. If we continue to worship ever widening costly floating exchanges the world will enter a global depression. I see no way for floating exchanges to truly rebalance and solve its massive debt/deflation problem, as shown above by the fact that the longer we stick with floating exchanges the wider they fluctuate - reducing, through debt and speculation increases, the productivity of global aggregate credit and debt. The only answer, as I have already posted on Bonobo in the Global Finance section, is complete structural reform in the form of exchange clearing, either external or internal. This is simply a system of narrower bands of true ppp exchange rate realities - laws must be written to slowly arrive at a general equilibrium over a number of years. I don't know exactly how much the system can handle and be productive, maybe 10% to 20% either side of a true ppp exchange rate system. That would be 40% total. I do know it is not productive at 300% exchange rate variance as Japan's history of market collapse and debt/liquidity trap is clear evidence of exchange rate non-productivity - and now we have China, one of the lowest ppp currencies, with from 500% on the coast to 1500% inland verses Euroland - one of the highest ppp currency areas. These are deffinitely unworkable ppp exchange rate realities, pushing the world up against the limit of exchange rate productivity, through ever mounting unrepayable outsourcing debt and deflation, globally. Germany, in this post by Edward, is an excellent example, with projected GDP decrease for a forseeable future - not good. ...Link

Wednesday, March 17, 2004

Global Energy War?


Global Energy War Looms

by Seung-Jin Kim Hyung-June Park

As China consumes more and more oil, a silent energy war has broken out on a full scale. China's thirst for oil is now to the point that a direct pipeline between China and Saudi Arabia, the world's largest, simply won't quench it.

The U.S. and Japan, the number 1 and number 2 energy consumers of the world respectively, are on alert as the more oil China wants, the less they can take. This shortage would hurt their economies.

Large energy consumers have begun to woo producers in order to gain an upper hand in the competition. Oil market watchers opined, "The energy issue will become an important aspect of national security."

Energy War Triggered by China? ...Link

The FED's Real Currency Policy Agenda

Here's some of the possible reasons and intracacies for what's happening in Japan's, China's and America's currency markets.

The Fed Loves Power and Creating Profits for Finance Companies

Richard Benson is president of Specialty Finance Group, LLC , offering diversified investment banking services.

In February, when the Federal Reserve’s Monetary Policy Report to the Congress was presented by the Fed Chairman, Alan Greenspan, he made the goals of his legacy crystal clear: For the core business of Wall Street, investment banking and banking (the “carry trade”), he wants to be remembered in the Hall of Fame for having made the finance business the greatest profits in the history of our nation.

The carry trade, for those who are not Wall Street insiders, is the business of borrowing short and lending long. This business is executed by institutions that have access to borrowing directly at the Fed funds rate, or the ability to borrow by using security Repurchase Agreements (“REPO”), most commonly using U.S. Treasury, mortgage-backed, asset-backed, and GSE securities. The carry trade has created the United States finance economy, and about 30% of all profits for S&P companies come from financing activities. The business of borrowing short and lending long has allowed the unprecedented increase in mortgage and consumer borrowing. This has been used by the Fed Chairman to pump up housing prices 45% in the past 4 years so that they can claim household net worth, at $44 Trillion, is the greatest it has ever been.

What has the Chairman actually said and exactly what is it that he wants to accomplish? First, in his speech to the New York Economic Association, he stated that at some point interest rates in the United States will rise. Certainly, Wall Street firms and bank hedge funds engaged in the carry trade care more about a rise in long-term interest rates, than a rise in short-term interest rates. A rise in long-term interest rates can quickly wipe out not only a year’s worth of carry profit, but it can wipe out a financial institution’s capital (the carry trade offers leverage of over 20 to 1). Currently, Fed funds are locked at 1 percent, and the 10-year Treasury note is locked around 3.7 – 4 percent, which offers about a 3 percent carry profit. If short-term rates only went up one-half percent, or 50 basis points, the carry profit would still look okay, unless long-term interest rates rose.

Last year the Fed was talking about fighting deflation by pegging long-term interest rates. Talk was turned into action by cutting deals with the central banks in Japan and China to do just this. Japan and China currently “peg” the 10-year note yield by buying incredible volumes of United States Treasuries. (Japan, China, and other Asian central banks are flooding their markets with new money. This holds the value of their currencies down while these Asian central banks finance the U.S. budget and trade deficits. In return, Asia gets the new factories and new jobs.) This financing of our trade and budget deficits by foreign central banks is the only reason the U.S. carry trade has not collapsed.

The Bush Administration is getting nervous that unless Japan and China revalue their currencies up, we will have virtually no growth before the November Presidential election. For President Bush, this is very bad. However, Greenspan has just said that while Japanese intervention at some point will be problematic, that time is not now. Moreover, Greenspan has also indicated that it would be unwise for China to revalue now because money might flee China. While neither statement on face value is credible, what is obvious is that the only reason the carry trade has not “blown up” is because of Japan and China “pegging the 10-year Treasury” and if they were forced to revalue, they would stop buying U.S. Treasuries. Since our country has no savings and a $550 billion government deficit to finance, when Asia stops buying, our mortgage market will no longer be able to finance equity extraction from homes. Moreover, since wages and salaries are growing at less than the inflation rate, home equity extraction is the only source of unending cash to the U.S. consumer. If the consumer stops spending, not only would it mean that George Bush might not be elected President in November, but the whole world might enter recession. America is the buyer of last resort. ...Link

Monday, March 15, 2004

Threats To China's Economic Growth

Prime Minister warns of threats to China's economic growth

By James Kynge and Mure Dickie in Beijing

China's economy is at a "critical juncture", Wen Jiabao, prime minister, said in his annual news conference on Sunday, pointing to the threat that over-investment, inflation and shortages of energy pose to the country's rapid growth.

Speaking after the closing session of the National People's Congress (NPC), China's legislature, Mr Wen warned: "Deep-seated problems and imbalances in the economy over the years have not been fundamentally resolved."

Mr Wen, who became premier a year ago, did not offer new strategies to deal with these problems, which he avoided calling "overheating". Analysts have warned that GDP growth of more than 9 per cent last year, with fixed-asset investment rising by 27 per cent, could create inflationary pressures.

Beijing has said it wants to slow investment by curbing bank lending this year through administrative fiat. It also plans to address transport bottlenecks by building more rail lines and roads, allowing more coal to be shipped to energy-starved power stations. ...Link

Staggering challenges ahead for China

..."The Chinese economy comes up with a bubble whenever it has a chance," Andy Xie, a Hong Kong-based economist with Morgan Stanley, said in a research note Monday.

"Chinese people have a high preference for gambling. If you want to verify, just check out the casino nearest to you," he said.

While China's economy grew by 9.1 percent last year, the 800 million people living in the destitute countryside only saw limited gain.

It could be costly for the government to seek to suddenly lift the incomes of two-thirds of the population, with measures such as a reduction in taxes that have so far provided a reliable income for the government.

But analysts agree reforms in the rural areas are long overdue, after more than a decade of exclusive focus on development along the prosperous eastern seaboard.

Rural incomes rose just four percent last year, half the increase in the cities, and farmers now on average make less than one third of the city dwellers.

Scattered reports of unrest in the countryside -- sometimes involving thousands of protesters -- may have motivated the government to act.

"Dissatisfaction in rural areas has reached an unparalleled level," said Chen Xingdong, chief economist with BNP Paribas Peregrine in Beijing.

"It's like a balloon, if you keep inflating it, it will eventually explode," he said. ...Link

Friday, March 12, 2004

Comparative Advantage

Here's how comparative advantage works in our economy today!

Reflections in the Fun House Mirror

Max Fraad Wolff is a Doctoral Candidate in Economics at the University of Massachusetts, Amherst.:
One hundred and thirty years ago, after visiting Wonderland, Alice stepped into a mirror and discovered the world of the looking glass. If Alice were born today, she’d only have to peek out the window.
- Eduardo Galeano 1998.

While markets manage to be shocked and disappointed by job numbers every month, they are not upset by the downward revision of these numbers. We ignore the estimated 8 million jobs that should have been, but were not, created in this “recovery”- that is if this episode were like the past. Apparently this time it is different for those seeking work. Never you worry; it will be an above average recovery for investors. Clearly the rising duration of long term unemployment - now 5 months - is of no concern. The Fed keeps rates at five-decade lows while proclaiming the strength of the economy. The regulator of financial excess assures us that the nation's $22 trillion debt is not an issue. It turns out that 10% annual debt growth from consumers and 11% annual debt growth for the government is just as unimportant as a weak and falling dollar alongside half trillion dollar current account deficits.

As this little commentary goes to press, the S&P 500 and Dow are at or above their suspiciously lofty 90-day moving averages. From Alice's window, this view is justified by the underlying economy and the fact that double-digit credit creation and debt growth at near zero real interest rate levels is able to generate 4% annual GDP growth. Let's try something novel, strange and rarely called for these days.

Moving away from the window, we see from Census Bureau's Economic Roundup that January 2004 manufactured goods production fell along with construction spending, new home sales, durable manufactured goods, housing starts and retail and food service sales. Labor force participation rates - particularly among the young - keep falling. Median household income fell by $500 from 2001-2002. On the upsides were asset prices, materials prices, energy prices, discouraged workers and the poverty rate. Also on the rise are protectionist stirrings, WTO sanctioned tariffs against the US, resentments about US foreign policy adventures and rage about out-sourcing. In passing one might pause to consider the instability generated by a deeply divided nation heading into a rancorous Presidential Campaign. Obviously, that would be silly. All of the above are either positive or just plain invisible in the fun house mirror.

Lou Dobbs is not the only American deeply concerned by the out-sourcing trend. As higher paying white collar jobs follow their blue collar cousins out of the US, voters are angered. Comparative Advantage trade theory tells us we should be losing low tech labor intensive jobs and gaining high tech and high skilled jobs in our trade with the lower wage developing world. In today's American Wonderland economy, the few jobs created (but still net negative) are low tech, low paying service work. We are losing higher skilled and higher tech employment to lower wage developing India, China and beyond. The two parties are split over which protectionist tact to take. The Bush administration favors protecting American firms with “illegal” export tax credits, Commerce Department assistance, exclusive rebuilding contracts and protectionist restrictions on foreign imports of wood, sugar, steel, textiles and food. The Democratic Party flirts with protecting jobs and barring some forms of profitable employment out-sourcing. Give them some time, the election season is young. ...Link

Tuesday, March 09, 2004

Nationalism, Internationalism, and Globalism


Here's a comment I posted on BonoBoLand:

Nationalism, Internationalism, and Globalism

Ah...Edward, you are quite right in pointing out the blindness with which America allowed itself being duped into electing politicians who walked a foolish road. We have been walking this same foolish road since the death of The Bretton Woods System. You and others are also quite right in pointing out America missing the boat of sight about the power of the web in changing global economic dynamics beyond anyone's conception, by being lead by such foolish perceptions of economists like Roach and others throughout the entire period, especially the `80's and `90's. The `70's may be excusable as all nations were adrift to the new realities of floating currencies and oil shock. But the latter two decades should have been a time of awakening - it was not and now we are where we are at - in trouble.

In my deffinitions, nationalism is nations having constitutional contract law control over their destinies, rights, and currencies. Internationalism is similar, in the fact that this structure is extended to international trade laws that sustain these national rights through fair trade treaties benefiting nationalism as did internationalism under The Bretton Woods System from 1946 to 1973 - the greatest global growth period in history. Globalism on the other hand, as beginning in 1973 in my view - and reducing global growth, Nixon overthrew all nations legally binding national and international legal structures of democratic protections in the currency and trade rights areas, for that of globalism's corporate treaties' rights over governments' constitutional rights. Herin lies the root of the problem.

By all nations being forced by Nixon's, maybe unavoidable, actions - the world was drastically legally changed from a status of constitutional contract law controlling democratic destinies and rights to globalism's international treaty law usurping nations national constitutional contract law and rights in the currency and treaty areas.

Now, since 1998 we have a world that is walking away from these globalism treaties for nationalism again. This started happening in Malaysia and has spread throughout the world. Many nations have now joined the clamor to reject the WTO and other treaties and create regional treaties and currency areas. Even the Euroland experiment is one of these examples. China, Japan, S.E. Asia, some in Africa and S. America, etc, on and on are rejecting globalism in total or part in favor of either outright nationalism or internationalism. Many of these nations have either instituted market, trade, and currency controls or exchange clearing practices of one sort or another. This is a bigger macroeconomic dynamic than anyone, but John Ralston Saul seems to be aware of or writing seriously about.

So you see Edward, I don't see the sustainability of globalism you are writing about. I agree if the theory were correct it would be great, but the theory is not the entire picture. I see, as Saul does, the rebirth of nationalism and internationalism. Already Europe has experienced much of this. This trend will continue as imbalanced currency systems are an impossible entity of globalism to sustain, as they were in the thirties. By many nations going to nationalist and internationalist currency systems, this must force a result of more and much more drastic imbalances on a world that can little afford said imbalances. The dollar is not rebalancing the euro, etc., etc.

So while we write glowing utopian reviews, the world marches toward globalism and nationalism - good and bad. I think we should change the global oligarchic unconstitutional treaty laws back to our original constitutional democratic contractual principles, and rights - updated of course. Many nations are - all will in the end.

John Ralston Saul - Audio

Debtor nations need a financial system that allows them to work their way to prosperity

Paul Davidson

The global economy is at a crossroads. We can try to muddle through with the existing defective international financial system, while hoping that minor tinkering will quarantine the devastating depressionary forces experienced by developing nations and avoid contagion spilling over to developed nations. Or we can produce a new financial architecture that not only protects all nations from experiencing the devastation of currency crises but also eliminates the persistent global depressionary pressures of the current system and therefore makes possible the potential of global full employment.

All prudent nations (except the United States) desire a surplus of exports over imports to obtain a net positive financial savings position on their internationally earned income. This surplus is added to the nation's foreign reserves. Since the global economy is on a dollar standard, additions to a nation's foreign reserves are held primarily in the form of US treasuries.

The effect of all nations attempting to accumulate foreign reserves is to create persistent high rates of unemployment, and liquidity problems for the global economy - and this is true whether the global economy is on either a fixed or a flexible exchange rate system. In essence, when any nation runs persistent export surpluses to accumulate foreign reserves, it is playing a game of Old Maid and passing the Black Queen of unemployment and indebtedness to its trading partners.

Any nation stuck with the Black Queen must use a combination of previously saved foreign reserves and/or additional international loans to pay for their current excess of imports and service existing international debts. As foreign reserves dwindle and international indebtedness increases, a deficit nation finds it increasingly difficult, if not impossible, to service its outstanding international debt obligations.

To prevent default, the International Monetary Fund can make new loans to the indebted nation allowing it to meet current obligations by increasing future debt service obligations.

These IMF loans require deficit nations to adopt "Washington Consensus" reforms where (1) all domestic financial, labour and product markets must be freed of institutional rigidities (including a government social safety net), and (2) the nation must tighten its belt, by running a primary fiscal surplus and high interest monetary policies.

Belt tightening depresses the nation's economy, forcing impoverished residents to reduce their purchases of all goods and services including imports. Belt tightening also tends to depress the export industries of its trading partners, creating unemployment abroad.

Any decline in the deficit nation's exchange rate encourages domestic residents and foreign investors to move their funds to a safe haven in another country. Almost inevitably, the indebted nation cannot free itself from the increasing weight of its hard currency international debts except by default. The result is a moribund economy, for example, Argentina in 2002.

The main failure of the international financial system is its inability to foster continuous global expansion. The main burden of adjustment to an export-import imbalance is always on the deficit nation.

Nevertheless because the major trading nations have accepted a dollar standard, the US can print dollars with abandon and avoid this burden.

Since the 1980s the US has happily neglected its huge annual import surpluses, which creates as much as $500bn (£290bn) in demand for the export industries of its trading partners.

America's benign neglect of its annual import surplus has prevented the global economy collapsing into a great depression. Can the rest of the world rely on the world's greatest debtor to continue to promote demand for other nation's export industries?

If the global economy abandons the dollar and adopts a euro standard, global aggregate demand would fall by more than $500bn. The US could no longer avoid reducing its import demand to a level of export earnings as creditor nations no longer extend credit by adding additional US treasuries to their foreign reserves.

The cure lies in creating new international financial architecture, as President Clinton called for after the 1998 Russian debt default.

A big financial architectural change will require developing a system where the creditor nations accept a large share of the responsibility for making adjustments by spending their excessive reserve holdings on imports or direct foreign in vestment. This will allow the debtor nations to sell more abroad and thereby work their way out of their debtor position.

In my recent book, Financial Markets, Money and the Real World, I have proposed the creation an international clearing union that is designed (1) to prevent a lack of global effective demand due to nations oversaving liquid foreign reserves (2) to induce the surplus nation to contribute to resolving the import-export imbalance, since the surplus nation has the economic wherewithal and is in the better economic position and [3] to encourage debtor nations to work their way out of debt rather than await handouts or bailouts, or to default on their international obligations.

Some think that this clearing union plan, like Keynes's bancor plan a half century earlier, is utopian.

But if we start with the defeatist attitude that it is too difficult to change the awkward system in which we are trapped, then no progress will be made.

The health of the world's economic system will simply not permit us to muddle through.

· Paul Davidson is editor of the Journal of Post Keynesian Economics ...Link

Monday, March 08, 2004

FRB: Speech, Bernanke--Money, Gold, and the Great Depression

I do not agree with all that Bernanke writes in this article, but I thought it important to post as he may be our next replacement for Greenspan. There are some dangerous implications here.

"The second monetary policy action identified by Friedman and Schwartz occurred in September and October of 1931. At the time, as I will discuss in more detail later, the United States and the great majority of other nations were on the gold standard, a system in which the value of each currency is expressed in terms of ounces of gold. Under the gold standard, central banks stood ready to maintain the fixed values of their currencies by offering to trade gold for money at the legally determined rate of exchange."

The above and the entire article shows a very superficial understanding of the workings of our exchange mechanisms and currency system, from someone who may be in a future position of such awesome power. If he had read enough of Keynes' or Davidson's real currency and exchange history he would know that the inter-war period was actually one of floating exchanges, not fixed gold standard, as when some are on the gold standard and others are not, and especially when the post war rates were set at wrong values, you have a floating exchange system by default. The same was true leading up to WWI. The empire clashes in many outlying colonial nations pre WWI had destabilized the entire world system of gold and silver structures, actually leading to the defacto floating exchange creation of WWI, and later `29. By legal default, we are repeating the same mistakes of the earlier history, today.

Bernanke had ought to at least get his history straight if he is to lead us. The currency question is the crucial sole point of law concerning all global economies, just as it always has been, and will always be. The world needs a global single balanced standard of law, it is sorely lacking.

FRB: Speech, Bernanke--Money, Gold, and the Great Depression

Remarks by Governor Ben S. Bernanke
At the H. Parker Willis Lecture in Economic Policy, Washington and Lee University, Lexington, Virginia

I am pleased to be able to present the H. Parker Willis Lecture in Economic Policy here at Washington and Lee University. As you may know, Willis was an important figure in the early history of my current employer, the Federal Reserve System. While he was a professor at Washington and Lee, Willis advised Senator Carter Glass of Virginia, one of the key legislators involved in the founding of the Federal Reserve. Willis also served on the National Monetary Commission, which recommended the creation of the Federal Reserve, and he went on to become the research director at the Federal Reserve from 1918 to 1922. At the Federal Reserve, Willis pushed for the development of new and better economic statistics, facing the resistance of those who took the view that too many facts only confuse the issue. Willis was also the first editor of the Federal Reserve Bulletin, the official publication of the Fed, which in Willis's time as well as today provides a wealth of economic statistics. As an illustration of the intellectual atmosphere in Washington at the time he served, Willis reported that when the first copy of the Bulletin was presented to the Secretary of the Treasury, the esteemed Secretary replied, "This Government ain't going into the newspaper business."

Like Parker Willis, I was a professor myself before coming to the Federal Reserve Board. One topic of particular interest to me as a researcher was the performance of the Federal Reserve in its early days, particularly the part played by the young U.S. central bank in the Great Depression of the 1930s.1 In honor of Willis's important contribution to the design and creation of the Federal Reserve, I will speak today about the role of the Federal Reserve and of monetary factors more generally in the origin and propagation of the Great Depression. Let me offer two caveats before I begin: First, as I mentioned, H. Parker Willis resigned from the Fed in 1922, to take a post at Columbia University; thus, he is not implicated in any of the mistakes that the Federal Reserve made in the late 1920s and early 1930s. Second, the views I will express today are my own and are not necessarily those of my colleagues in the Federal Reserve System. ...Link

Friday, March 05, 2004

BonoboLand ? Auerback's Segacious Perception

BonoboLand ? Auerback's Segacious Perception

I thought I'd add a little more thought to my earlier post on Bonobo, and this blog, by posting a few paragraphs I e-mailed to others earlier this month. I am not trying to be offensive, only creating awareness.

"Globalism is dead" - Now, to explain what my cryptic remark was about. Many nations are already rejecting the classical school's "Washington Elite Consensus" of liberalized markets and free trade. This has been an ongoing historical event since Malaysia told the IMF what to do with its policies and went its own way. Now we have Brazil's Lula wrecking the FTAA talks in Miami, and still others rebelling in secret or public. There are many other failures of the "Elite Consensus" from the MAI treaty to recent rejections of CAFTA by some nations. The people and nations lining up against the "one liberalization shoe size fits all" of the IMF, World Bank and WTO is expanding rapidly. Economists, historians, and social philosophers like John Ralston Saul {Saul} are mounting a global attack against the post `73 insanity of classical economics and their beliefs in anti-Keynesianism, disguised as a pseudo-post Keynesianism and neo-conservatism. The truth of the matter is the classical school believes in three unprovable axiomatic math models - the neutrality of money - equilibrium - and corporate wages, prices, and profits. The two I am most concerned with here are the neutrality of money and equilibrium. Dr. Paul Davidson {Paul} has done the definitive critique of classical economics in these areas and I and many others agree. The historical evidence is mounting against the classical schools and the books and articles being published is overwhelmingly a massive critique of market liberalization and its failures.

Here's a further excerpt pieced together:

`Without a full understanding of the functioning of forward markets, all discussion of exchange rate policy must remain seriously deficient.' Egon Sohmen

... 13.`When there are many nations with steady depreciating and appreciating currencies, bankers have plenty of short and long opportunities to cover their forward commitments in other nations - until debt entropy...'

... Of the above quotes #13 is the one I wish to draw more attention to - how banks and other financial interests cover forward contract costs. U.S. law states that all long and short positions must balance at the end of each business day, as do many nations' laws. The trouble is even though these transactions may be in balance nationally they can be massively out of balance internationally. Herein lies one of the origins of the problem. Most all parties involved can, do and will book their long positions in strong currency nations, and most all their short positions in weak currency nations, thus pushing exchange rates further and further out of equilibrium the longer we have been and are on a floating standard, as mentioned above in the quotes. This disequalibrium, in turn, through the major shocks we've witnessed since Mexico, in the`90's, have added tremendously to overall capitalist system costs, and in turn creating overporduction and global deflationary pressures - real and feared. One of the flaws we must throw away, as Keynes also did and Paul Davidson does, is the classical school's misguided belief in the neutrality of money. The truth is obvious in the above that money is not neutral. It is often long term destructive through floating exchange's ever increasing disequalibrium and its associated increasing costs. Central bankers can only play a very crude market maker in such a massively imbalanced system. They often have to take great losses or pawn these losses off on their unsuspecting taxpayers. From the above you may be able to see why Japan is in such a deflationary quandry. The speculative realities between the lesser nations and the developed nations continues to push Japan's and others currency high/low when it needs to go low/high, yet the global currency competition situation and specualtion is now at such a critical stage nothing works as should - nor will it under the continuation of the classical school's other often deluded ideas of floating exchanges and never existing free markets. ...Link

Thursday, March 04, 2004

Comparative Advantage - Destruction of American Industry?

Here's another author's comments on China/America, markets, currency and humor. Just Think! Labor Arbitrage is Alan Greenspan’s Real Productivity Miracle!

Comparative Advantage

Richard Benson is president of Specialty Finance Group, LLC , offering diversified investment banking services.

I would be the first to champion the benefits of Free Trade based on legitimate Comparative Advantage. As a graduate student at Harvard, I had the privilege to pass on Wisdom of the Ages and Sages to the bright undergraduate youth. David Ricardo had a beautiful idea and classic cases of his vision of Comparative Advantage were carefully used in every economic text, such as: Country A has lush farm land with fertile soil and lots of sun and rain, but is landlocked. Country B has rocky land and a cold climate but happens to be close to some of the richest fishing grounds imagined. Low and behold, Country A has grain and dairy farmers and Country B has fishermen. They trade and everybody is clearly better off! Case closed, QED!".....

.....Finally, the European politicians are in agony and threatening in the press that they will do something about the dollar. With the Euro having tested 1.30 and likely to test 1.40 - 1.50 against the dollar in the future, the European leaders are also facing the full frontal assault of Asia’s factories and 100 million unemployed workers. Europe doesn’t need or want this currency war. America’s trade and budget deficits may be our deficits, but we have made them Europe’s problem! It look’s to me like before the summer is over, Europe will be cutting interest rates and using their new high speed Euro printing press too! If that doesn’t work, I wonder if they will be the ones to go for tariffs on China. After all, Europe has workers who vote, too! ...Link

Wednesday, March 03, 2004

Auerback's Segacious Perception

Marshall Auerback has really hit the nail on the head with this article. He correctly points out the faults of the Chicago classical school's ideas about speculation as well as the failure of freely floating exchange markets. The dollar is now devalueing against the wrong nations' currencies - the wrong nations. We are more than certainly headed into an untenable mammoth global currency crisis. How long do you suppose it's going to take the classical schools to awake? My main point is as Marshall's is, ie., you can't have the floating developed nations in currency battle while the fixed currency nations reap the benefits of our blindness of adjustment and balance impossibilities, under their false abstract thinking. The classicals still believe in failed Samuelson/Friedmanism while much of the world markets have moved to crude Keynesianism/Schachtianism. How much shock and debt do you suppose we'll pile up befor the Rip-Van-Winkle right opens its eyes? Time for Keynes' `True Middle Way' - Exchange Clearing?

The Perils of Protectionism - Currency Visions

...In the meantime, the clock continues to tick away, punitive tariffs are about to be introduced, and America remains highly dependent on US speculative capital flows. The “deficits don’t matter” apologists would have us believe that this is irrelevant, so long as the US continues to provide superior returns to capital, even if such capital is highly speculative in nature.

The traditional repast to any of us who raise questions about the “virtues” of unbridled speculation can be found within the so-called “Chicago School”, where speculation is viewed as fundamentally stabilising (Friedman, 1953). This Chicago point of view is predicated on the argument that there exists a market price which is warranted by economic fundamentals. When the actual price exceeds this warranted price, speculators realize that the market is over-valued. They therefore sell, and drive the market down to its warranted price. Conversely, when the actual price is below the warranted price, speculators realize the market is under-valued. They therefore buy and drive the market up to the warranted price.

This argument can be challenged in a number of ways. One challenge comes from the Chicago School’s own rational expectations theory of behaviour which shows how asset price bubbles can be rationally self-fulfilling. All that is needed is that market participants expect that the future price will be higher, and they will then buy now on anticipation of this higher future price. In this fashion “market beliefs” become the driving fundamental, and if speculators share and shape this belief they can drive prices away from the level warranted by economic conditions. In effect, one has what Lawrence Summers once described as “rational destabilising speculation”.

More importantly, the Chicago school’s benign view of speculation does not appear to have been borne out by the history of financial markets over the past few decades. In 1994 Mexico was hit by a major financial crisis. Not only did this crisis hurt the Mexican economy, it also hurt all of Latin America which was infected by a process of financial contagion (the “Tequila” effect). In 1997 financial crisis again erupted in East Asia, this time pulling down the economies of South Korea, Thailand, Indonesia, and Malaysia. In 1998 Russia was hit by financial crisis, and this was followed by a financial crisis in Brazil in 1999. The belief is that all of these crises were either triggered or exacerbated by financial speculation, and that measures to reduce speculation, such as capital controls (introduced by Malaysia, for example, in 1998) would have helped avoid the crises or reduced the extent of resulting damage.

It is not only developing countries that have been hurt by currency speculation. Developed countries, including the U.S., have also been injured. In the wake of the Russian financial crisis of summer 1998, Wall Street was rocked by a crisis of its own. The Russian crisis generated a wave of unpredictable movements in interest rates which pulled down the hedge fund Long Term Capital Management (LTCM). The crumbling of LTCM’s financial position in turn threatened to pull down the entire market owing to the extent of LTCM’s borrowings and the exposed nature of its financial positions, and this necessitated the Federal Reserve intervening to co-ordinate a private sector funded bailout of LTCM.

U.S. manufacturing industry was also badly injured by the East Asian financial crisis. U.S. exports to the region fell as East Asian currency values plummeted relative to the dollar and East Asian economies went into recession, while U.S. imports from the region surged. The result was a massive increase in the U.S. trade deficit that was accompanied by the loss of half a million manufacturing jobs and a huge loss of future trade competitiveness, the full effects are being manifested today in the form of a hemorrhaging trade deficit and yet more reliance on the very sort of speculative capital that wrought so much havoc on the economies of the emerging world. Ironically, in pursuing a more protectionist agenda, the US risks bringing on an Asian-style financial crisis.

Protectionism, however, attacks the symptoms, rather than tackling the underlying problem of US competitiveness. In the 1980s, the US dollar soared against the currencies of Europe and Japan and subsequently crashed against these same currencies. Many emerging nation currencies stayed linked to the dollar, at least in real terms. In any case, at the time the emerging world was a far less important part of the global economy and US trade than it is now.

With its embrace of a strong dollar policy during the latter part of the 1990s, a conspicuous feature of this cycle has been the rise in the real value of the dollar against the emerging world – particularly emerging Asia – in spite of mounting external indebtedness (the normal solution for which would be devaluation). This is in sharp contrast with the past, when higher domestic inflation plus a fixed real exchange rate caused the nations of emerging Asia to experience an ongoing real appreciation of their currencies against the dollar. This real appreciation partially offset their rapidly improving abilities to compete with the US in more and more markets. The resultant improvement in American competitiveness in turn enabled the US to improve its current account position and thereby forestall growing protectionist sentiment.

By contrast, since the Asian financial crisis, despite continued higher increases in productivity in tradeables relative to the US, these countries have undergone massive devaluations against the dollar. Even with the strong economic recoveries from the crisis-induced lows of 1998, these countries’ currencies still linger well below levels sustained throughout most of the early 1990s, as they persist in neo-mercantilist policies to ensure that they never again run large current account deficits (and thereby expose themselves to volatile Western portfolio capital flows). And in some instances, such as China, Malaysia and Hong Kong, the countries concerned have directly pegged their currencies against the dollar and are therefore now reaping yet further competitive benefits as the US has shifted away from its strong dollar policy.

We have always believed that this huge departure from the trend path of these currencies would create the potential for quantum increases in competitiveness at the expense of the US and the continuing deterioration of the American trade account seems to bear this out. The misplaced focus on Asia’s alleged “unfair trading practices” or China’s “undervalued currency” is akin to the carrier of a disease blaming the infected recipient.

Consider the case of Malaysia. Malaysia's gross domestic product expanded by 5.2 per cent last year, making it the third fastest growing economy in south-east Asia after Thailand and Vietnam.

The growth rate, released last week, exceeded a government forecast of 4.5 per cent but was in line with market expectations. It was the economy's best performance since 2000. It posted 4.2 per cent growth in 2002. Growth in the fourth quarter accelerated to 6.4 per cent, after a revised 5.2 per cent rate in the third quarter, due to increased electronics exports. Exports have clearly been helped by Malaysia's currency peg to the US dollar.

Today’s American protectionists would undoubtedly proclaim (as they do with China) that Malaysia has achieved an “unfair” trade advantage through the deliberate embrace of an “undervalued” currency by virtue of its maintenance of the peg against the greenback. What they forget is that the imposition of this currency peg was a direct consequence of the country’s ultimately successful battle against speculative capital flows during the 1997/98 financial crisis. The deterioration in of America’s trade balance, and corresponding rise in protectionism that it has engendered in US policy circles, in effect represents economic blowback from that period.

As we come into the 21st century, it is said that the US has largely become a service economy, although as the President’s chief economic advisor, Gregory Mankiw, has noted, such neat distinctions are becoming increasingly hard to make. Even whilst broadly conceding Mankiw’s point, it is also clear that the embrace of a strong dollar policy in effect wiped out the last vestiges of serious American manufacturing. This has left the US with an economy increasingly dominated by services firms, which are now responding to these profound competitive pressures by outsourcing. Outsourcing is also a logical consequence of this loss of US competitiveness. It has aided the service sector’s ability to deal with stubborn cost pressures such as benefits cost inflation (medical and insurance being two of the biggest). Those politicians who would block this avenue for cost containment are implicitly forcing the service industry to find other mechanisms for generating these same cost savings, or else lose their profit margins.

One possible response if “outsourcing” becomes too hot a political issue is more aggressive domestic labour cost squeezes, which would likely mean lower aggregate service employment levels, greater reliance on temps (for whom benefits are not an issue), more severe limitations on benefits for those who remain on the payroll, and so forth. The result would be a further rise in the percentage of US working-age people who either lack benefits or whose access to good private sector benefits is restricted to a greater degree. For an economy already reaching the limits of sustainable domestic demand, this would be a recipe for disaster in terms of its future implications for US consumption.

When the financial health of a nation shifts as dramatically as it did in the United States from 1996 to now, the recent past seems not so much gone as completely transformed. Comfortable government surpluses and millions of jobs have abruptly vanished almost as though they never existed. And yet the US still conducts trade policy as if it were 1996 all over again, treating its creditors like vassals, whilst failing to recognise the grave economic vulnerabilities it now faces. The classic remedy for a chronic balance of payments problem, as the US has today, is a steady devaluation of the currency. But for this policy to be successful, it presupposes that the “right” counterparties can be found against which one can devalue. As the Malaysian experience demonstrates, that is easier said than done. But can one really blame Malaysia, which adopted a currency peg as its sole defence against the depredations of speculative global capital? Devaluation also presupposes an embrace of open markets which, for all of the sins of the previous Clinton administration, was pursued in a more consistent manner than the Bush Presidency has done.

Of course, it is also conceivable that the dollar bear market has run its course, in which US authorities seriously have to worry, since there is little else that can be achieved in the way of policy stimulus to sustain current growth. On the other hand, were the dollar’s devaluation to continue ultimately, the presumed improvement to external trade could be undermined by the persistent resort to trade protectionism. The US may, as a last gasp desperate measure, make use of non-selective tariffs conditionally under Article 12 of the World Trade Organisation, but this recourse to protective tariffs (tried – and failed – under steel) would more likely do more to highlight the country’s precarious economic position, thereby triggering precisely the sorts of capital flight that it has so far conspicuously managed to dodge. It would indeed be ironic if this speculative flight was triggered by America’s own championing of what it has long opposed – a persistent resort to trade protectionism, but the country is clearly closer than ever to reaping what it has sown in economic policy. ...Link

Tuesday, March 02, 2004

Yuan Float Pose Threat To World Economy: Greenspan - March 2, 2004

Herein lies the rub. The free floaters want the yuan floated but the Chairman of the Fed has the same point I have. The danger in floating the yaun too early without the necessary banking and exchange precations in place could place grave harm on the global economy. Macroeconomics is not as simple as "The Washington Consensus" would have us think. At least one of their own is willing to point out the truth. I commend Mr. Greenspan for his candor.

Yuan float pose threat to world economy: Greenspan

WASHINGTON - A decision to float the yuan could weaken the Chinese banking system and threaten the world economy, the chairman of the US Federal Reserve central bank Alan Greenspan has warned.

Mr Greenspan said in a letter to the US senate that flotation of the yuan, a move wanted by many in the United States, could cause a heavy flow of capital out of China, undermining Chinese banks and destabilising the world economy.

The letter, reported on the Wall Street Journal web site on Tuesday, was published by US senate banking committee chairman Richard Shelby, who had asked Mr Greenspan to expand on his views on the yuan.

Mr Greenspan had warned that up to 50 per cent of Chinese bank loans were non-performing and that this was sustainable only if depositors did not withdraw their funds.

'Many in China fear that removal of capital controls that restrict the ability of domestic investors to invest abroad and to sell or to purchase foreign currency, which is a necessary step to allow a currency to float freely, could cause an outflow of deposits from Chinese banks, destabilising the system.'

Financial instability in a big emergent economy, such as the Chinese economy, 'would present a risk to the global economic outlook', he warned. ...Link

Monday, March 01, 2004

Heading For A Fall, By Fiat?

Heading for a fall, by fiat?

The trouble with paper money

IS THE problem with the dollar only that it is falling? It has certainly been doing that. This month, it fell to $1.29 against the euro. This is its lowest-ever rate against the euro, and represents a decline of 19% since the beginning of 2003. In trade-weighted terms, the dollar has fallen less over the same period (15%), but mainly because Asian central banks have been intervening heavily to stem their currencies' rise against it. Of late, it has been wobbling around unconvincingly: America needs a weaker dollar to correct its current-account deficit. But given the dollar's role as a currency of last resort, some wonder if its decline heralds not just an economic adjustment by the United States, but a crisis of sorts in the value of paper money itself.

Money in its present form is a relatively new invention. For most of human history money meant either gold or silver, either directly, or indirectly by means of the “gold standard” which meant, at least in theory, that all paper money was backed by gold. Enthusiasm for the gold standard evaporated in the 1930s, when it made dreadful conditions worse. But it was adopted in a watered-down version after the second world war, when only the dollar was backed by gold. This arrangement made some sense, since America held three-quarters of the world's gold stock. But it came to an end in 1971, when inflationary pressures in America caused the country's manufacturers to become uncompetitive and forced the country off the gold standard. Since then the world has relied on “fiat money”, so-called because it is created by government fiat and is backed only by the promises of central bankers to protect the value of their currencies. It is the value of those promises that some are now questioning.

Promises, promises
Certainly, those promises have only been worth much in recent years. In the early years of fiat money, inflation took off, especially in America, in part because of the two oil shocks of the 1970s. This debased the value of the dollar, and the price of gold climbed from $35 an ounce to $850.

It was only in 1979, in his famous “Saturday night special”, that Paul Volcker, then chairman of the Federal Reserve, raised interest rates sharply to clamp down on inflation. The gold price subsequently fell sharply and in its place came a bull market in government bonds that has, with a few sharp interruptions, continued to this day. Although central banks around the world still hold about 30,000 tonnes of gold in their reserves, many have been offloading their stocks over the years. They can earn only a nugatory rate of interest on these stocks (by lending them out) compared with what they can earn on government bonds. For most people, gold has been relegated to the status, in the words of Keynes, of a “barbrous relic”; its price has risen only feebly when investors have fretted about inflation.

Those who doubt the continued worth of paper money as a store of value point to two things. The first is that the price of gold has been rising even though official inflation is low. From $253 an ounce in the late 1990s, gold now fetches just over $400 an ounce, and it rose as high as $430 an ounce earlier this year. It is not just the price of gold that has been rising: so, too, have the prices of precious and base metals. There may, of course, be many other reasons for these rises. China's rapidly expanding economy is gobbling up metals and other commodities for its factories. Moreover, the rise in the price of commodities also reflects the weakness in the dollar: these rises look much less impressive when quoted in euros or yen. But the rise in the price of gold in particular has raised questions.

The biggest of these—and the second main reason for concern—is the amount of debt that rich-country governments have been running up. America's official budget deficit has surged in the three years since George Bush became president, to around $520 billion and climbing. But this is just the shortfall this year. The government's total future liabilities are much larger. In fact, according to a forthcoming book by Laurence Kotlikoff, an economist, the present value of the American government's future obligations, taking into account promised pensions and health-care benefits, is a staggering $45 trillion. European governments are only slightly better at managing their budgets—witness the breaching of the single currency's growth and stability pact. Japan's attempts to coax its economy back to life have left it with a gross national debt of some 160% of GDP, the highest of any big country. No country has tried harder to debase its currency.

In theory, such debts would not be tolerated for long by investors, since the easy way out for central banks is to “monetise” them with inflation. Bond prices would fall (and thus yields rise) as investors worried that they would be paid back in a debased currency. But capital markets currently seem oblivious to spiralling debts. At some 4%, yields on ten-year American Treasury bonds are close to their lowest in two generations, although this is partly explained by huge purchases by Asian central banks. Yields elsewhere are also very low, nowhere more so than in Japan, where ten-year government-bond yields are now 1.3%.

The problem may be that bond investors, far from being far-sighted, are in fact myopic, and are perhaps being fooled by the temporary disinflationary effects of excess capacity and debts built up over the bubble years in both Japan and America. Perhaps, too, investors have been lulled into a false sense of security by the performance of central banks in recent years, and the independence that has been granted to many of them by governments. But this very aura of inviolability may be storing up problems, since it means that governments can borrow still more at cheap rates. And if governments then find themselves crushed by debt, you can rest assured that this independence will be taken away. And then, once again, the paper in your pocket will only be as good as a politician's promise. ...Link