Wednesday, December 30, 2009


This is an older article by Marshall Auerback, but one of the best about what was done by FDR, and what should now be done.

But consider the historic precedents. In the words of Professor Paul Davidson:

Let us look at a historical example where if this type of “what will cost to the tax payer and/or the economy?” question were asked, one of the most desirable government policies would never have been undertaken. At the Bretton Woods conference it was recognized that the European nations would need significant aid to help rebuild their economies after the war. Keynes estimated that the need would be between $12 and $15 billion. U.S. representative Harry Dexter White indicated that Congress could not ask the taxpayers to provide more than $3 billion. Accordingly, the Keynes Plan was defeated at Bretton Woods, and the Dexter White proposals were adopted:

Suppose that in 1946 it was recommended that U.S. give a gift of $13 billion dollars over four years to various European countries to help them rebuild their war-ravaged economies (in 1940s current dollars, this sum would be well over $150 billion in 2007 dollars). Obviously if Dexter White was correct, the Congress would never have approved the Marshall Plan. Since the Marshall Plan did not reveal in advance that it would provide foreign governments $13 billion over a period of four years, Congress approved the Marshall Pan. The Marshall Plan gave foreign nations approximately two percent of the United States’ GDP each year for four years. Was the Marshall Plan costly to U.S. taxpayers and the U.S. economy?

The statistics indicate that, during the Marshall Plan years, for the first time in history the U.S. did not experience a serious economic slowdown immediately after a war. And this despite the fact that federal government expenditures on goods and services declined by approximately 57 percent between 1945 and 1946. Furthermore, four years after World War II, federal government expenditure was still approximately half of what it had been in 1945.

When the U.S. emerged from World War II, the federal debt was more than 100 percent of the GDP. Accordingly, there was great political pressure to reign in federal government spending to make sure that the federal debt did not grow substantially. Clearly, then, it was not “Keynesian” deficit spending that kept the U.S. out of recession in the immediate post-World War II years.

What was the cost of the Marshall Plan to the U.S. economy and the U.S. taxpayer? In 1946, the GDP per capita was 25 percent higher than it had been in the last peace years before the War. GDP per capita continued to grow during the Marshall Plan years. Despite giving away two percent of U.S. GDP, American residents (and taxpayers) experienced a higher standard of living each year. – (Paul Davidson, “How to Solve the US Housing Problem and Avoid a Recession: A Revived HOLC and RTC” - Schwartz Center For Economic Policy Analysis: Policy Note, January 2008)

Saturday, December 19, 2009

The recession is over but the depression has just begun...

Edward Harrison here. This is an updated version of a post I wrote about two-and-a-half months ago over at Credit Writedowns. When I wrote it, I had been looking for bullish data points as counterfactuals to my bearish long-term outlook. I found some, but not nearly enough.

Early this year, I wrote a post “We are in depression”, which called the ongoing downturn a depression with a small ‘d.’ I was optimistic that policymakers could engineer a fake recovery predicated on stimulus and asset price reflation – and this was bullish for financial shares if not the broader stock market. But, we are witnessing temporary salves for a deeper structural problem.

So my goal was to find data which disproved my original thesis. But, I came away more convinced that we are in a tenuous cyclical upturn. This post will discuss why we are in a depression, not a recession and what this means about likely future economic and investing paths. I pull together a number of threads from previous posts, so it is pretty long. I have shortened it in order to pull all of the ideas into one post. So, please read the linked posts for background as I left out a lot of the detail in order to create this narrative.

Let’s start here then with the crux of the issue: debt.

Deep recession rooted in structural issues

Back in my first post at Credit Writedowns in March 2008, I said that the U.S. was already in a recession, the only question being how deep and how long. The issue was and still is overconsumption i.e. levels of consumption supported only by increase in debt levels and not by future earnings. This is the core of our problem – debt.

I see the debt problem as an outgrowth of pro-growth, anti-recession macroeconomic policy which developed as a reaction to the 1970s lost decade trauma in the U.S. and the U.K.. The 70s was a low growth, high inflation ride that generated poor market returns. The U.K. became the sick man of Europe and labor strife brought the economy to its knees. For the U.S., we saw the resignation of an American President and the humiliation of the Iran Hostage Crisis.

In essence, after the inflationary outcome that many saw as an outgrowth of the Samuelson-Keynesianism of the 1960s and 1970s, the Reagan-Thatcher era of the 1990s ushered in a more ‘free-market’ orientation in macroeconomic policy. The key issue was government intervention. Policy makers following Samuelson (more so than Keynes himself) have stressed the positive effect of government intervention, pointing to the Great Depression as animus, and the New Deal, and World War II as proof. Other economists (notably Milton Friedman, and later Robert Lucas) have stressed the primacy of markets, pointing to the end of Bretton Woods, the Nixon Shock and stagflation as counterfactuals. They point to the Great Moderation and secular bull market of 1982-2000 as proof. This is a divisive and extremely political issue, in which the two sides have been labeled Freshwater and Saltwater economists (see my post “Freshwater versus saltwater circa 1988”).

However, just as the policy of the 1950s to the 1970s was not really Keynesian ( see what Richard Posner says about Keynes’ General Theory and you will see why), the 1980s-2000 was not really an era of ‘free markets.’ I call it deregulation as crony capitalism. What this has meant in practice is that the well-connected, particularly in the financial services industry, have won out over the middle classes (a view I take up in “A populist interpretation of the latest boom-bust cycle”). In fact, hourly earnings peaked over 35 years ago in the United States when adjusting for inflation.

The 1970s was a difficult period in which the U.K. and the U.S. saw jobs vanish in key industrial sectors. To stop the rot and effectively mask the lack of income growth by average workers, a new engine of growth had to be found. Enter the financial sector. The financialization of the American and British economies began in the 1980s, greatly increasing the size and impact of the financial sector (see Kevin Phillips’ book “Bad Money”). The result was an enormous increase in debt, especially in the financial sector.

This debt problem was made manifest repeatedly during financial crises of the era. Not all of these crises were American – most were abroad and merely facilitated by an increase in credit, liquidity, and international capital movement. In March 2008, I wrote in my third post on the US economy in 2008:

From the very beginning, the excess liquidity created by the U.S. Federal Reserve created an excess supply of money, which repeatedly found its way through hot money flows to a mis-allocation of investment capital and an asset bubble somewhere in the global economy. In my opinion, the global economy continued to grow above trend through to the new millennium because these hot money flows created bubbles only in less central parts of the global economy (Mexico in 1994-95, Thailand and southeast Asia in 1997, Russia and Brazil in 1998, and Argentina, Uruguay, and Brazil in 2001-03). But, this growth was unsustainable as the global imbalances mounted.

Eventually, the debt burdens became too large and resulted in the housing meltdown and the concomitant collapse of the financial sector, a problem that our policymakers should have foreseen and the reason my blog is named Credit Writedowns. Make no mistake, the housing and writedown problems are only symptoms; the real problem is the debt – specifically an overly indebted private sector (note the phrase ‘private sector’ as I will return to this topic).

This is a depression, not a recession

When debt is the real issue underlying an economic downturn, the result is either Great Depression-like collapse or a period of stagnation and short business cycles as we have seen in Japan over the last two decades. This is what a modern-day depression looks like – a series of W’s where uneven economic growth is punctuated by fits of recession.

A garden-variety recession is merely a period of recalibration after businesses get ahead of themselves by overestimating consumption demand and are then forced to cut back by making staff redundant, paring back inventories and cutting capacity. Recessions can be overcome with the help of automatic stabilizers like unemployment insurance to cushion the blow.

Depression is another event entirely. Back in February, I highlighted a blurb from David Rosenberg which summed up the differences between recession and depression pretty well.

Recessions are typically characterized by inventory cycles – 80% of the decline in GDP is typically due to the de-stocking in the manufacturing sector. Traditional policy stimulus almost always works to absorb the excess by stimulating domestic demand. Depressions often are marked by balance sheet compression and deleveraging: debt elimination, asset liquidation and rising savings rates. When the credit expansion reaches bubble proportions, the distance to the mean is longer and deeper. Unfortunately, as our former investment strategist Bob Farrell’s Rule #3 points out, excesses in one direction lead to excesses in the opposite direction.

The day after I highlighted Ray Dalio’s version of this story which added some more color. Notice the part about printing money and devaluing the currency if the debt is in your own currency.

… economies go through a long-term debt cycle — a dynamic that is self-reinforcing, in which people finance their spending by borrowing and debts rise relative to incomes and, more accurately, debt-service payments rise relative to incomes. At cycle peaks, assets are bought on leverage at high-enough prices that the cash flows they produce aren’t adequate to service the debt. The incomes aren’t adequate to service the debt. Then begins the reversal process, and that becomes self-reinforcing, too. In the simplest sense, the country reaches the point when it needs a debt restructuring…

This has happened in Latin America regularly. Emerging countries default, and then restructure. It is an essential process to get them economically healthy.

We will go through a giant debt-restructuring, because we either have to bring debt-service payments down so they are low relative to incomes — the cash flows that are being produced to service them — or we are going to have to raise incomes by printing a lot of money.

It isn’t complicated. It is the same as all bankruptcies, but when it happens pervasively to a country, and the country has a lot of foreign debt denominated in its own currency, it is preferable to print money and devalue…

The Federal Reserve went out and bought or lent against a lot of the debt. That has had the effect of reducing the risk of that debt defaulting, so that is good in a sense. And because the risk of default has gone down, it has forced the interest rate on the debt to go down, and that is good, too.

However, the reason it hasn’t actually produced increased credit activity is because the debtors are still too indebted and not able to properly service the debt. Only when those debts are actually written down will we get to the point where we will have credit growth. There is a mortgage debt piece that will need to be restructured. There is a giant financial-sector piece — banks and investment banks and whatever is left of the financial sector — that will need to be restructured. There is a corporate piece that will need to be restructured, and then there is a commercial-real-estate piece that will need to be restructured.

The Fake Recovery

So where are we, then? We are in a fake recovery that could last as long as three or four years or could peter out very quickly in a double dip recession. You may have seen my April post on the fake recovery. Read it. I won’t cover that ground here. However, I will highlight how I came to believe in the fake recovery and how asset prices have played into this period (the S&L crisis played out nearly the same way). I see writedowns as core to the transmission mechanism of debt and credit problems to the real economy via reduced supply and demand for credit. Again, this is why my site is called Credit Writedowns.

In March, at the depths of the downturn I wrote:

The problem is the writedowns. You see, if you get $30 billion in capital from the government, but lose another $40 billion because of credit writedowns and loan losses, you aren’t going to be lending any money. To me, that says the downturn will only end when the massive writedowns end, not before.

The U.S. government has finally realized this and is now moving to stem the tide. Their efforts point in four directions:

Increase asset prices. If the assets on the balance sheets of banks are falling, then why not buy them at higher prices and stop the bloodletting? This is the purpose of the TALF, Obama’s mortgage relief program and the original purpose of the TARP.
Increase asset prices. If assets on the balance sheet are falling, why not eliminate the accounting rules that are making them fall? Get rid of marking-to-market. This is the purpose of the newly proposed FASB accounting rule change.
Increase asset prices. If asset prices on the balance sheet are falling, why not reduce interest rates so that the debt payments which are crushing debtors ability to finance those assets are reduced? This is why short-term interest rates are near zero.
Increase asset prices. If asset prices on the balance sheet are falling, why not create Public-Private partnerships to buy up those assets at prices which reflect their longer-term value? This is what Geithner’s Capital Assistance Program is designed to do.
So I lied, there is only one direction the government is headed: increase asset prices (or, at least keep them from falling). Read White House Economic Advisor Larry Summers’ recent prepared remarks to see what I mean. (Summers on How to Deal With a ‘Rarer Kind of Recession’ – WSJ)

I was more on target in my thinking here than I could have known. The mark-to-market model died and mark-to-make believe began. It was then that I knew a recovery was likely to take hold. And it was going to be bullish for bank stocks and the broader market. What you should realize is that, despite the remaining problems in credit cards, commercial real estate or high yield loans, limiting credit growth, the changes instituted by government definitely have meant 1. that banks will earn a shed load of money and 2. that house price declines have stalled, underpinning the asset base of lenders. This necessarily means an end to massive writedowns, a firming of banks’ capital base, and a reduction in private sector deleveraging. And the recent brouhaha over Citi’s favorable tax deal in exiting TARP should tell you the government will stop at nothing to keep accounting favorable for the big banks.

As for the recent asset-based economic reflation, be under no illusion that these measures ‘solve’ the problem. The toxic assets are still toxic and banks are still under-capitalized. But increased asset values and the end of huge writedowns has underpinned the banks and led to a rise in the broader market in a feedback loop that has been far greater than I could have imagined at this stage in the economic cycle.

The double dip or the economic boom?

So what’s next? A lot of the economic cycle is self-reinforcing (the change in inventories is one example). So it is not completely out of the question that we see a multi-year economic boom. Higher asset prices, lower inventories, fewer writedowns all lead to higher lending capacity, higher cyclical output, more employment opportunities and greater business and consumer confidence. If employment turns up appreciably before these cyclical agents lose steam, you have the makings of a multi-year recovery. This is how every economic cycle develops. This one is no different in this regard.

Now, I have turned slightly more dour of late and see a double dip as more likely in the medium-term. Longer-term, things depend on government because we are in a balance sheet recession. Ray Dalio and David Rosenberg make this case well in the previous quotes I supplied, but it was a post about Richard Koo from Prieur du Plessis which originally got me to write this post. His post, “Koo: Government fulfilling necessary function” reads as follows:

According to Koo, American consumers are suffering from a balance sheet problem and will not increase consumption until their personal finances are back in order. The banks are not lending mainly because nobody wants to borrow and, furthermore, the banks want to build their own balance sheets (raise cash) and get rid of toxic garbage…

Again, when asked what would happen if the government cuts back on its fiscal stimulus, Koo replies: “Until the private sector is finished repairing its balance sheets, if the government tries to cut its spending, we’re going to fall into the same trap Franklin Roosevelt fell into in 1937 (a crushing bear market) and Prime Minister Hashimoto fell into in 1997, exactly 70 years later.

“The economy will collapse again and the second collapse is usually far worse than the first. And the reason is that, after the first collapse, people tend to blame themselves. They say, ‘I shouldn’t have played the bubble. I shouldn’t have borrowed money to invest – to speculate on these things.’

I wrote last November that if government stops the support, recession is going to happen.

The U.S. economy cannot possibly work itself out of the greatest financial crisis in some 70-odd years in a mere 4 years and then expect to raise taxes on the middle class without a major recessionary relapse.

So, when you hear policy makers talking about reducing the deficit as soon as possible, what you should think is 1938 and continued depression.

Right now, if you listen to what President Obama is likely to do, you know that the government prop for the economy is going to be taken away. Get ready because the second dip will occur. It will be nasty: unemployment will be higher and stocks will go lower than in 2009. I The question now is one of timing: when will the government stop propping up the economy? The more robust the recovery, the quicker the prop ends and the sooner we get a second leg down.

So to recap:

A depression was borne out of high levels of private sector debt, the unsustainability of which became apparent after a financial crisis.
The effects of this depression have been lessened by economic stimulus and government support.
Government intervention led to a reduction in asset price declines, which led to stock market increases, which led to asset price stabilization and more stock market increases and eventually to asset price increases. This has led to a false sense that green shoots are leading to a sustainable recovery.
In reality, the problems of high debt levels in the private sector and an undercapitalized financial system are still lurking, waiting for the government to withdraw its economic support to become realized
Because large scale government deficit spending is politically unpalatable and unsustainable over the long-term, expect a second economic dip within three to four years at the latest.
Why is government spending key?

The government plays a crucial role here because of the huge private sector indebtedness. In the U.S. and the U.K., the public sector is not nearly as indebted. So while, the private sector rebuilds its savings and reduces debt, the public sector can pick up the slack. Marshall Auerback says it best in a recent post:

We’ve said it before and we’ll say it again. As a matter of national accounting, the domestic private sector cannot increase savings unless and until foreign or government sectors increase deficits. Call this the tyranny of double entry bookkeeping: the government’s deficit equals by identity the non-government’s surplus.

So, if the US private sector is to rebuild its balance sheet by spending less than its income, the government will have to spend more than its tax revenue. The only other possibility is that the rest of the world stops saving on a massive scale — letting the US run a current account surplus. But that is highly implausible and socially undesirable, since it means we export our economic output, rather than consume it domestically. And if the government deficit does not grow fast enough to meet the saving needs of the private domestic sector, national income will decline, which, given the size of the private sector’s debt problem, will generate a huge debt deflation.

This is the foundation of modern monetary theory. Would that the IMF and the G20 understood these basic facts.

If the private sector is a net saver, the public sector must run a deficit. The only other way to prevent the government from running a deficit when the private sector is net saving is to run huge current account surpluses by exporting your way out of recession – what Germany and Japan tried in the 1990s and in this decade.

However, I must admit to having a preternatural disaffection for large deficits and big government which is what Koo and Minsky advise respectively. It is this knee-jerk aversion to what is viewed as fiscal profligacy which makes it likely that the government prop will be taken away inducing another downturn.

So, what does this mean for the American and global economy?

The private sector (particularly households) is overly indebted. The level of debt households now carry cannot be supported by income at the present levels of consumption. The natural tendency, therefore, is toward more saving and less spending in the private sector (although asset price appreciation can attenuate this through the Wealth Effect). That necessarily means the public sector must run a deficit or the import-export sector must run a surplus.
Most countries are in a state of economic weakness. That means consumption demand is constrained globally. There is no chance that the U.S. can export its way out of recession without a collapse in the value of the U.S. dollar. That leaves the government as the sole way to pick up the slack.
Since state and local governments are constrained by falling tax revenue (see WSJ article) and the inability to print money, only the Federal Government can run large deficits.
Deficit spending on this scale is politically unacceptable and will come to an end as soon as the economy shows any signs of life (say 2 to 3% growth for one year). Therefore, at the first sign of economic strength, the Federal Government will raise taxes and/or cut spending. The result will be a deep recession with higher unemployment and lower stock prices.
Meanwhile, all countries which issue the vast majority of debt in their own currency (U.S, Eurozone, U.K., Switzerland, Japan) will inflate. They will print as much money as they can reasonably get away with. While the economy is in an upswing, this will create a false boom, predicated on asset price increases. This will be a huge bonus for hard assets like gold, platinum or silver. However, when the prop of government spending is taken away, the global economy will relapse into recession.
I believe this dynamic will induce a Scylla and Charybdis of inflationary and deflationary forces, forcing central bankers to add and withdraw liquidity in a manic way. The likely volatility in government spending and taxation gives you the makings of a depression shaped like a series of W’s consisting of short and uneven business cycles. The secular force is the D-process and the deleveraging, so I expect deflation to be the resulting secular trend more than inflation.
Needless to say, this kind of volatility will induce a wave of populist sentiment, leading to an unpredictable and violent geopolitical climate and the likelihood of more muscular forms of government.
From an investing standpoint, consider this a secular bear market for stocks then. Play the rallies, but be cognizant that the secular trend for the time being is down. The Japanese example which we are now tracking is a best case scenario.
That’s my thesis. What’s your view?

Sunday, November 22, 2009

Cascading Theft … Compounding Misery...

Cascading theft … compounding misery
by Peter Souleles
A few thoughts about the limitations of government, By Edward Harrison of Credit Writedowns.

I used to think that "civilized society" was defined as people collaborating and in the process of doing so, providing each other with goods and services, mostly for reward but at times – either through taxation or volunteerism – for free to those less fortunate. In the process of this collaborative exchange, man was supposed to become more enlightened, thus ensuring optimum outcomes could be secured with fewer natural resources and less labor, abetted by invention, cooperation and innovation. Each generation was to leave behind a legacy of capital formation (roads, bridges, schools, etc.) as well as an intellectual legacy in the arts and technology.

Over time, a compounding of these positive developments would endow each successive generation with a higher standard of living, without the good earth being gutted and polluted beyond recognition.

But something, unfortunately, has gone wrong, and it may possibly become far worse than we can imagine. What has been the source of this failure to compound progress?

The answer is theft. Earthquakes, tsunamis and other such natural phenomena, as well as diseases, are of miniscule consequence compared to theft. Theft throughout history has manifested itself in the same forms again and again and each time it has resulted in resources either being destroyed or re-distributed in the process.

It is my thesis, in this brief essay, that theft is supplanting value in both the medium of exchange as well as in the exchange itself. Theft has become the manifestation of greed and moves in when the conscience moves out. As a result, we are faced with the phenomenon of cascading theft – that is, theft that leads to more theft. In the end, the concept of "value added" is transformed increasingly into "value lost."

War, which has often been described as organized theft, most probably occupies equal top spot in the rankings. History has repeatedly cast conquerors as liberators who bring some form of democracy/freedom to the downtrodden, when in fact a closer examination shows that the conqueror either carts off the spoils and/or leaves behind a corrupt and compliant democracy or dictator that allocates favorable concessions to the bankers and capitalists of the conqueror.

War not only vanquishes the loser, but also has the effect of weakening the ally. A study of how a financially cash-strapped Great Britain was made redundant as an Empire is fascinating as it is telling about who your friends are. According to a recent article by economist and historian Zachary Karabell, Great Britain in 1946 asked for a loan of $5 billion at zero percent interest for 50 years. What she got was a $3.7 billion loan and a set of conditions which effectively installed the United States and the U.S. dollar as the linchpins of power and finance. As someone once cleverly quipped, "I want to thank the U.S.A. for coming to our assistance in 1941 when we really needed them in 1939."

To maintain its Empire, the U.S.A. has installed bases all over the world. According to Hugh Gusterson, professor of Anthropology at George Mason University, the United States has over 1,000 bases worldwide which constitute 95% of all foreign bases in the world. So we have the U.S. citizenry largely footing the bill for human and material resources so that major corporations can extract "profit" which is often not even taxed in the U.S.A. Can anyone estimate what those resources would have yielded the American people had they been deployed in the U.S.A? Moreover, has there ever been an instance in history where a nation has spent so much to make so many enemies? Perhaps it was only a coincidence that the United States invaded Iraq a few months after it announced that it would refuse U.S. dollars for the sale of its oil. It is clear here that business must be protected against "unreasonable" foreigners.

Unfortunately, the matter does not stop there and as part of the cascading effect, additional theft is warranted through the implementation of the Department of Homeland Security and other such measures.

The Banking System
The banking system, which is war's grotesque Siamese twin, is the greenhouse, factory and laboratory of every paper alchemy known and unknown to man. Is there any wonder that this is the case? A recent Wall Street Journal report stated that Wall Street firms would be paying out $140 billion in bonuses this year as opposed to $130 billion a year before the meltdown. Amounts of this size are neither payment nor reward; they are bribes to buy the intellect of America's best without the inhibition of conscience. At least New York might be saved by the infusion of these bonuses.

The credit creation system, which is the heart of banking, is by all accounts nothing more than a debt pyramid that, in combination with opportunistic mortgage brokers, accommodating government-sponsored enterprises (GSEs), clever bankers and gullible investors, gave rise to an unprecedented orgy of buying, speculation and manipulation. Manufactured income details and low upfront interest rates gave the perpetrators of this theft the means to initially create dreams for the clueless home buyers – and to subsequently substitute those dreams with nightmares.

The cascading effect of this theft has led not only to loss of homes, but also bankruptcy, loss of jobs, breakdown of families and the gutting of so many industries that sprung up in the wake of a building boom struggling to keep up with demand. The game was good while it lasted, but the day arrived when even the banks were brought to the brink as a result of losses being generated by the subprime fiasco. This was no doubt greatly complicated by derivatives, which still remain more deadly than the unaccounted for nuclear-bomb briefcases of the USSR.

It is no secret that the Federal Reserve has more or less provided astronomical amounts at a virtually zero rate of interest to a raft of top banks in an attempt to counter horrendous losses, and to therefore save them from annihilation. Has the Fed's largesse flowed to the struggling home owner? According to a recent Bloomberg News report, a total of 937,840 homes received a default or auction notice or were repossessed by banks, which represented a 23% increase from a year earlier. So there is your answer.

Fear not, as not all is lost. Goldman Sachs reported a $3 billion profit in three months just days ago. Is this a sign of recovery or massaging the truth? I am afraid to say the latter after reading various commentators and in particular the piece by Dylan Ratigan in the Huffington Post. Some $64 billion received through the Trouble Asset Relief Program (TRAP), AIG, the Fed and the FDIC was exponentially leveraged to buy distressed assets, which has led to their reflation.

The taxpayers, of course, have received precious little in return but the politicians did better. According to the Center for Responsive Politics, major banks and financial institutions in receipt of $295 billion in TARP money reciprocated with $114 million to Washington for lobbying and campaign contributions. As Andrew Cockburn puts it, "at 258,449 percent, it has been called the single best investment in history."

The mutually parasitic relationship goes further, in that the major banks are also keen buyers of U.S. Treasurys sold at auction. And what they cannot lend out, they deposit with the Fed at interest. Generations of future economists, analysts and commentators will scratch their heads in disbelief at this fiasco which is so brazen that it defies any modicum of common sense.

Whether the assistance afforded by the Fed to banks can outrun the pace of foreclosures and rising unemployment remains to be seen, although the signs are not encouraging. Either the unfolding internal collapse or the external refusal to continue funding the United States while its dollar slides will inevitably bring on a resolution unlikely to be palatable to anyone. In the meantime, depositors are subjected to laughable rates of interest on their savings as well as the ignominy and insult of potentially having their bank closed by the FDIC on a Friday afternoon.

If war and banking are the terrible Siamese twins then surely government is the mother of these two creatures. Whilst I do not consider myself to be a member of some lunatic fringe advocating the dismantling of government, I nevertheless consider most of its activities to be wasteful and many without purpose and therefore a form of theft. (Here the astute reader will correctly point out that war is their doing also).

Do I need to remind readers that Social Security contributions disappear into the unified budget and replaced with increasingly worthless IOU's in the forms of government securities? Through inflation, their value diminishes until retirement resembles imprisonment. Government will either tax or borrow in increasingly larger vicious circles to both placate the masses but also to cement its position and authority. As the vicious circle grows, so does the amount "skimmed" by corporate America which provides the bulk of the services. Where otherwise would the Halliburtons of this world be without Uncle Sam's generosity?

The final member in the quadriga of theft belongs to consumption. No doubt the Renaissance and the Industrial Revolution transformed the world of consumption, but it has been in the last couple of decades that consumption took on a hideous conspicuousness that has in its own right threatened the viability and stability of the system. Whereas only the rich in previous generations could flaunt their "toys," in the world of today, anyone armed with a credit card could create a veneer of affluence. As Warren Buffet once exclaimed, "price is what you pay, value is what you get." It is clear that whilst price and value are rarely identical, nevertheless the hiatus between the two has never been so disturbingly wide.

Housing values up to the time of the bust were the major but not the only example of this rift. No doubt the siren call of easy credit and the interest-ree loans of retailers also proved extremely powerful and effective. The reality is that the real wages of Americans had not increased since the 1970s, and in an effort to keep the lid on their wage demands and propensity to strike, credit became a common currency. The ability to borrow not only gave the masses the ability to buy, but also blurred the distinction between needs and wants. Consumption was fast-tracked well beyond the normal trajectory of the economy to the point that it now constitutes some 70% of U.S. Gross Domestic Product (GDP).

To repeat an earlier point in a different manner, the price of a need more closely tracks value than what the price of a want does. When wants are satisfied in increasing measures, another cascading sequence of "thefts" occurs. A simple example would be the consumption of high-sugar carbonated drinks and fatty foods, which are simply wants. The effects are well documented and the results highly visible when one looks at the youth of America as it claims close to top spot (if not top spot) on the obesity charts. The effects of such over consumption on their health and by extension on the health system cannot be overestimated. Nor can the effect on their education, employment, income earning capacity, relationships and mental well being be discounted.

Possible Solutions
Between wars, the banking system, government and consumption, one can safely say that the four have combined to bring a great nation to its knee. Should the United States go down on both knees, the ramifications for world prosperity and peace will be greatly jeopardized. The United States has but little time and very few options to counter the present descent in its economy. Creative destruction has largely been thwarted by the interference of government in banking and the car industry, as well as by providing stimulus checks. It may well be that the White House has a chaotic solution in mind should it be faced with doomsday economic scenarios. The reasoning may be that if you cannot get back on top of your affairs, then at least cause as much chaos to your rivals as is possible, to even out the net result. No doubt the U.S. dollar could become a refuge by default.

In my view, the United States can reclaim the high ground in five ways. Whilst its capitalist system has been abused beyond comprehension, it is nevertheless a far better foundation than any communist or socialist system that relies on squeezing and restricting its citizens. In brief the five approaches are as follows:

The components of GDP must be given differential weighting. Buying take-out food cannot be accorded the same value as buying fresh fruit. Visiting the doctor cannot be the same as visiting a gym, and buying a solar panel cannot equate to buying an electric hot water heater. Building a house with full bricks must surely rate more highly than a house built of a simple timber frame with some form of cheap cladding. Unless GDP becomes a qualitative measure instead of just a quantitative measure, then the ability of the United States to remodel itself will be hampered.

The adoption of such changes to GDP calculation may also provide the impetus for a tax system that is more skewed to taxing consumption rather than investment. Hamburgers and soft drinks can incur a value-added tax (VAT) of 20%, whereas the VAT on a solar panel can be zero. I acknowledge that such a proposal is not without difficulties and has a number of objective and subjective limitations. It should be noted, however, that some nations are already studying the proposal of taxing "unhealthy" foods favored by children.

The introduction, or rather the reintroduction, of honest money is an imperative. Gold, if nothing else, has retained value far better than almost anything else. The dollar's value since 1913 is now not much more than a noon shadow, whilst the Dow Jones Industrial Average is nothing more than a name when one considers that most of the companies in the original index are now history. Unless money regains its "store of value" characteristic, the retirement plan of every American will be become nothing more than a poor quality stamp collection.

Needless to say, the Social Security contributions of Americans must be extricated from the general budget and accounted for separately. No longer can Social Security contributions be taken in exchange for Treasury bonds, unless they are used in building income producing infrastructure. The printing of dollars by the United States over the last half century has enabled the United States to lay claim to a disproportionate amount of the world's resources. Unfortunately, this misappropriation (another theft) has very little to show as it has been wasted on foreign adventures and very little investment at home.

Additionally, the U.S. government must put a limit on the cost of health care for each person depending on age and the condition. This will prove to be a veritable minefield as there will always be cases that defy the criteria and which will give rise to many a cause celebre. This is the most unsustainable aspect of the U.S. budget going forward into the future owing to demographic developments, but failure to deal with this will render any other budgetary initiatives almost useless. Shrinkage in government in general is imperative.

Finally, the gap between rich and poor, as well as the increasing concentration of wealth among the top few percent of the population, is a dangerous development that will destabilize democracy and its workings. The recent figures indicating that gambling is most prevalent among lower socioeconomic groups, is not only a measure of poor education but also an indication of the level of exasperation and helplessness among low-income groups. Perhaps the "rich" can be required to set up or provide certain services through private foundations for the less well-off in the community. This will have the two-fold effect of not enlarging government as well as ensuring best management practices, as it will be in the interests of the "rich" as well as a matter of pride to ensure effective use of their "tax" dollars. Such a proposal is not without precedent as it was common practice in Ancient Athens.
In conclusion, it should be noted that entrenched structures, force of habit, vested interests and a population that has led the high life on debt for too long, make any changes highly difficult. All hope, however, must be kept alive through strategies that can be followed step by step and brick by brick. Failure is not an option, because if compounding misery gets the upper hand, the nation will break apart. Value must be reinstated in transactions if value added is to return to the system. Progress is predicated on value added rather than value lost, and no amount of alchemy, printing, legislation or oratory will ever be able to reverse or supplant that truth.

Peter Souleles, an economics and law graduate, ran a private accounting practice in Sydney, Australia, until retiring in 2000.

Tuesday, November 10, 2009

Law & True Emotional/Intellectual Maturity of…

The Inverse Theorem of Value__Iff Capitalist System Incentive Mechanics’ Value Is Transferred From Commodities, Goods, Services, Prices, Wages and Profits, to Fiat Money System Law, Real Wealth Can Be Created for All World Citizens…

Dan McGrew
Florian Cajori...
BIS, Derivatives $605 Trillion

Friday, November 06, 2009

Mother of all Carry Trades Faces an Inevitable Bust...

Mother of all Carry Trades Faces an Inevitable Bust
Nouriel Roubini | Nov 1, 2009

Since March there has been a massive rally in all sorts of risky assets – equities, oil, energy and commodity prices – a narrowing of high-yield and high-grade credit spreads, and an even bigger rally in emerging market asset classes (their stocks, bonds and currencies). At the same time, the dollar has weakened sharply, while government bond yields have gently increased but stayed low and stable.

This recovery in risky assets is in part driven by better economic fundamentals. We avoided a near depression and financial sector meltdown with a massive monetary, fiscal stimulus and bank bail-outs. Whether the recovery is V-shaped, as consensus believes, or U-shaped and anaemic as I have argued, asset prices should be moving gradually higher.
But while the US and global economy have begun a modest recovery, asset prices have gone through the roof since March in a major and synchronised rally. While asset prices were falling sharply in 2008, when the dollar was rallying, they have recovered sharply since March while the dollar is tanking. Risky asset prices have risen too much, too soon and too fast compared with macroeconomic fundamentals.

So what is behind this massive rally? Certainly it has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fuelling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions.

Let us sum up: traders are borrowing at negative 20 per cent rates to invest on a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade. Every investor who plays this risky game looks like a genius – even if they are just riding a huge bubble financed by a large negative cost of borrowing – as the total returns have been in the 50-70 per cent range since March.

People’s sense of the value at risk (VAR) of their aggregate portfolios ought, instead, to have been increasing due to a rising correlation of the risks between different asset classes, all of which are driven by this common monetary policy and the carry trade. In effect, it has become one big common trade – you short the dollar to buy any global risky assets.

Yet, at the same time, the perceived riskiness of individual asset classes is declining as volatility is diminished due to the Fed’s policy of buying everything in sight – witness its proposed $1,800bn (£1,000bn, €1,200bn) purchase of Treasuries, mortgage- backed securities (bonds guaranteed by a government-sponsored enterprise such as Fannie Mae) and agency debt. By effectively reducing the volatility of individual asset classes, making them behave the same way, there is now little diversification across markets – the VAR again looks low.

So the combined effect of the Fed policy of a zero Fed funds rate, quantitative easing and massive purchase of long-term debt instruments is seemingly making the world safe – for now – for the mother of all carry trades and mother of all highly leveraged global asset bubbles.

While this policy feeds the global asset bubble it is also feeding a new US asset bubble. Easy money, quantitative easing, credit easing and massive inflows of capital into the US via an accumulation of forex reserves by foreign central banks makes US fiscal deficits easier to fund and feeds the US equity and credit bubble. Finally, a weak dollar is good for US equities as it may lead to higher growth and makes the foreign currency profits of US corporations abroad greater in dollar terms.

The reckless US policy that is feeding these carry trades is forcing other countries to follow its easy monetary policy. Near-zero policy rates and quantitative easing were already in place in the UK, eurozone, Japan, Sweden and other advanced economies, but the dollar weakness is making this global monetary easing worse. Central banks in Asia and Latin America are worried about dollar weakness and are aggressively intervening to stop excessive currency appreciation. This is keeping short-term rates lower than is desirable. Central banks may also be forced to lower interest rates through domestic open market operations. Some central banks, concerned about the hot money driving up their currencies, as in Brazil, are imposing controls on capital inflows. Either way, the carry trade bubble will get worse: if there is no forex intervention and foreign currencies appreciate, the negative borrowing cost of the carry trade becomes more negative. If intervention or open market operations control currency appreciation, the ensuing domestic monetary easing feeds an asset bubble in these economies. So the perfectly correlated bubble across all global asset classes gets bigger by the day.

But one day this bubble will burst, leading to the biggest co-ordinated asset bust ever: if factors lead the dollar to reverse and suddenly appreciate – as was seen in previous reversals, such as the yen-funded carry trade – the leveraged carry trade will have to be suddenly closed as investors cover their dollar shorts. A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a co-ordinated collapse of all those risky assets – equities, commodities, emerging market asset classes and credit instruments.

Why will these carry trades unravel? First, the dollar cannot fall to zero and at some point it will stabilise; when that happens the cost of borrowing in dollars will suddenly become zero, rather than highly negative, and the riskiness of a reversal of dollar movements would induce many to cover their shorts. Second, the Fed cannot suppress volatility forever – its $1,800bn purchase plan will be over by next spring. Third, if US growth surprises on the upside in the third and fourth quarters, markets may start to expect a Fed tightening to come sooner, not later. Fourth, there could be a flight from risk prompted by fear of a double dip recession or geopolitical risks, such as a military confrontation between the US/Israel and Iran. As in 2008, when such a rise in risk aversion was associated with a sharp appreciation of the dollar, as investors sought the safety of US Treasuries, this renewed risk aversion would trigger a dollar rally at a time when huge short dollar positions will have to be closed.

This unraveling may not occur for a while, as easy money and excessive global liquidity can push asset prices higher for a while. But the longer and bigger the carry trades and the larger the asset bubble, the bigger will be the ensuing asset bubble crash. The Fed and other policymakers seem unaware of the monster bubble they are creating. The longer they remain blind, the harder the markets will fall.

The writer is a professor at New York University’s Stern School of Business and chairman of Roubini Global Economics

Friday, October 23, 2009

The Snowball of Derivatives: The Specter of a Second Black Swan...

The Snowball of Derivatives: The Specter of a Second Black Swan
by Ricardo Lago | Oct 21, 2009

Banking sector consolidation (via acquisition of failed banks) and the generalized bailout of bondholders, actions both promoted by governments, have aggravated the problems of “too big to fail” and “moral hazard”. Hence incentives for reckless behavior have actually heightened.

So far there has been lots of talk within the G-20 and other forums but little action to tackle the problem at national and especially at transnational levels. As Nouriel Roubini and others have pointed out, one could argue that systemic risks have in fact increased relative to the pre-crisis period. A follow-up financial meltdown would be devastating. Governments should not only hope for the best but act swiftly to forestall the worst .The arrival of a Taleb’s second black swan on stage would mean complete chaos.

Governments should urgently agree on binding disclosure, oversight and enforcement of tighter rules on derivatives at the national and supra-national level. If only for the simple reason that now their fiscal and monetary leeway for future financial rescues is much diminished. After the first round of bail outs, debt to GDP levels of developed countries already exceed 100% of GDP and nobody really knows what the ratios would be if all guarantees and unfunded liabilities were to be brought above the line.

Derivatives were the invisible 800-pound gorilla in the room. After accounting for them - even abstracting from counterparty risks - leverage ratios were a multiple of those reported in the books .It was the failure of Lehman Bros that drew the attention to the ultimate implications of this huge snowball rolling down the hill .In the eve of the bankruptcy of Lehman, the International Swap and Derivatives Association (ISDA)[1][2], had to improvise an unprecedented trading session on Sunday, September 14th 2008 to enable market participants to carry out trades and offsets of derivatives; further, the effectiveness of the transactions was contingent on Lehman filing for bankruptcy by midnight.

This was the first large-scale real life “Walrasian auctioneer” - a fictional textbook Deus ex Machina who does not allow actual trades to take place until all contracts of market players are mutually consistent. And it was precisely this exercise of contingent trading that shed light on the magnitude of AIG financial troubles. The largest supermarket of default insurance was carrying in its books Credit Default Swaps marked at up to twice the values used by Lehman. All the ingredients for the perfect storm were in place. In order to forestall collapse, AIG’s creditors (including not only all major banks but also life insurance and retirement policy holders) had to be bailed out under the disguise of a de facto nationalization of AIG.

One of the problems is that the snowball of swaps and derivatives has not shrunk much. The notional value of swaps and derivatives surveyed by the ISDA - by no means the real total which is unknown to us - amounts today to US$ 454 trillion or eight times the World’s GDP (just marginally lower than the value at the trigger of the crisis). This figure involves a gross credit exposure of US$ 26 billion or close to twice the GDP of the USA and a, more relevant, net credit exposure of US$ 4 trillion, a figure twice the total equity position of all US banks. All these figures are lower bounds; part of the problem is that we do not know what the real magnitude is.

The central question is: will the G-20 (within BIS, IMF or any other) reach binding agreements on switching the lights on and enforcing an orderly unwinding and gradual shrinkage of the snowball of derivatives? Or will they procrastinate and let the snowball continue to roll downhill in the dark?

The “Achilles heel” of the international financial system continues to be the ocean of derivates, particularly those negotiated over-the counter (OTC), including but not limited to Credit Default Swaps (CDS). If the economic recovery holds there may not be any major hassle with orderly settlements. By contrast, if a double –dip hits us and its second leg is deep enough – however small the probability - then cash-strapped governments will have to choose between a second round of massive financial subsidies or else have creditors assume the losses and let banks fail. The first would likely lead to hyperinflation and the second to a collapse of the “house of cards” of the payments system and financial chaos, a 1930s style depression.

In my view, the G-20 needs to move quickly on inter alia four specific reforms:

Dealing with the flow. First, all new swaps and derivative contracts should, at a minimum, be traded and even issued through “clearing houses” and, preferably, to the extent feasible traded on stock exchanges. This will deal with the “flow problem”. Tight constraints need be imposed on OTC “consenting adults" dealing in the dark, for at the end of the day “tax-payers” end up being a party to the deal and thus should not be taken for granted (i.e. no taxation without representation.)

Dealing with the stock. Second, as to the “stock problem”, central banks should establish compulsory daily reporting of all derivative positions (counterparty, exposure, credit risk, collateral, etc) of their supervised institutions, including those carried out by their subsidiaries abroad. Central banks should be required to report weekly this information to the BIS, IMF, or any other suitable institution.

Risk taking. Third, off-balance sheet operation should be tightened and swaps and derivative positions restricted as close as possible to risk management and hedging. The open positions of pure intermediaries in swaps and derivatives should be subject strict ceilings (i.e. no more glut of AIG –type naked Credit Default Swaps). One case of success in limiting off-balance sheet operations was the restrictions to securitization introduced by the Bank of Spain years ago.

Special resolution regime. Forth, the establishment of an automatic, special resolution regime affecting unsecured lenders of banks and other intermediaries .As Willem Buiter has put it, if the market value of a bank’s equity shrinks below a trigger then unsecured creditors should automatically receive a letter saying “ congratulations as of today you have become a shareholder of Bank XYZ.“

Warren Buffet was surely right on mark years ago when he said, “derivatives were financial weapons of mass destruction.”But even Buffet’s own holding company, Berkshire Hathaway, carries a fair amount of derivatives, including the sale of long term puts on the US stock market index.

The most naïve and really incredible development of international public policy over the last ten years or so has been the Basel II guidelines for regulatory reform. It is hard to understand how on earth regulators could embark on a trip to outsource credit and market risk management to the supervised banks themselves. The so-called Advanced Internal Rating –based Approach allowed banks to develop in-house risk management models to quantify their own capital adequacy requirements. And this proposal came after we all had the benefit of witnessing how in 1998, the very inventors of the options pricing formula - Nobel prize winners R. Merton and M. Schools - blew up with their own models the hedge-fund Long Term Capital Management.

Clearly, Albert Einstein was not kidding when he said that: “Two things are infinite: the universe and human stupidity; and I am not sure about the universe”.

Monday, October 12, 2009

The Global Financial Crises' Placebo Effects...

The Global Financial Crises' Placebo Effects
by Satyajit Das

(Also see: When Money Becomes Worthless by Martin Hutchinson)

Mixed metaphors
Botanical commentators are finding "green shoots." The astronomically minded have seen "glimmers." The meteorologically minded have spoken about the storms "abating." Strong rallies in equity and debt markets have confirmed the recovery for the "true believers." The Global Financial Crisis (GFC) crisis is over!

It is useful to remember Winston Churchill's observation after the British expeditionary force's escape from Dunkirk: "[Britain] must be very careful not to assign to this deliverance the attributes of a victory.'' There may be confusion between "stabilization'' and "recovery.''

The green-shoots theory is based on a slowdown in the rate of decline in key economic indicators, improvements in the financial system, unprecedented government support for the banking system, near-zero interest rates and large fiscal stimulus packages. The recovery of emerging markets, especially China, also underpins hopes of a swift return to growth.

Receiving the messengers
The puzzling thing is that real economy indicators continue to be poor.

GDP forecasts for 2009 have steadily deteriorated, with world growth expected to be negative 2% to 3%, with especially poor prospects for Japan and the euro zone. Industrial output, employment, consumption, investment and global trade continue to be weak. Even China, which expected to grow between 6% and 8% in 2009, experienced a fall in exports of over 20% over the last year.

The wealth effects of the GFC on economic activity are unclear. In the United States alone, $30 trillion of value has been destroyed. Pension funds have lost anywhere between 20% and 50% of their value. Combined with declines in housing prices and reduced dividends and investment income, the sharp decline in wealth may not be yet to fully flow through into consumption.

The financial system has stabilized but not returned to the "rude good health" that current executive compensation demands within banks would suggest.

Good results for Goldman Sachs and J.P.Morgan are offset by less impressive performances by Bank of America, CitiGroup and Morgan Stanley. Profitability is patchy and reliant on risky trading income and large underwriting revenues from capital raisings by financial institutions and companies who are de-leveraging aggressively. Asset quality remains vulnerable to more bad debts from the normal recessionary credit cycle that is working through the economy.

Bank risk levels have increased to and in some cases beyond pre-crisis levels. Goldman Sachs second-quarter earnings showed an increase in risk levels as measured by Value-at-Risk (VAR). The increase in risk is probably understated as it takes into account diversification benefits that may be overstated under conditions of market stress. It is probably also understated because of assumption of trading liquidity that may be optimistic given recent experience. The higher levels of risk-taking reflect increasing comfort in central bank support of financial institutions' liquidity and their ability and willingness to intervene to limit price risks. Leverage and lending against risky assets has resumed at a rate not seen since 2007.

Capital remains scarce and bank balance sheets are at best not growing and at worst shrinking. Some estimates suggest that the bank capital shortfall could be in range of $1 trillion to $2 trillion, equivalent to a credit contraction of around 20% to 30% from previous levels. Proposed bank regulations, primarily the increased levels of capital and lower permitted leverage, will also affect the ability of the financial system to extend credit.

The link between debt and economic growth is well established. The global economy probably needs around $4 to $5 of debt to create $1 of GDP growth.

International Monetary Fund researchers Tamin Bayoumi and Ola Melander, in a study of the economic impacts of an adverse shock to bank capital ("Credit Matters: Empirical Evidence on U.S. Macro-Financial Linkages," IMF Working Paper 08/169) found that in the United States, a one percentage point fall in Tier 1 risk-weighted capital ratios reduces real GDP by 1.5%. This means that global bank capital shortage may restrain credit creation thereby reducing economic activity and sustainable growth levels.

The impact of fiscal stimulus packages has been variable. In some jurisdictions, the payments have been saved or applied towards debt reduction rather than consumption. Targeted measures, such as the cash-for-clunkers' deals (cleverly packaged as ‘green' environmental initiatives) have boosted immediate demand for cars, but the long-term demand effects are unclear.

The multiplier effect of the fiscal initiatives is likely to be low. Major infrastructure initiatives will take time to implement. Few projects are "shovel ready." The rate of return on government spending programs, some of which are politically motivated, is unclear. Government spending increasing capacity is likely to create problems in a world where many industries are operating with surplus capacity. Government bailout packages for various industries, such as the auto and housing industries, however well intentioned, are delaying much needed capacity adjustments and risk prolonging the problems.

The phoenix-like recovery in emerging markets is primarily driven by panicked government spending and loose monetary policies increasing available credit. Estimates suggest that around 6% of China's growth of around 8% is attributable to government spending and increased bank lending.

The extraordinary increase in lending in China is fueling unsustainable growth. In the first half of 2009, new loans totaled more than $1 trillion. This compares to total loans for all of 2008 of around $600 billion. Current lending is running at around three times 2008 levels and at a staggering 25% of China's GDP. The combination of government spending and bank loans has resulted in sharp increases in fixed asset investments (up 30% from 2008). Government incentives, in the form of rebates for purchases of high value durables such as cars and white goods, have also increased consumption (up 15% from 2008). Even Chinese government officials have admitted that the recovery is "unbalanced."

The increase in industrial production in the absence of real end demand for products could result in a rapid inventory buildup. The availability of credit is also fueling rampant speculation in stocks, property and commodities. Estimates suggest that around 20% to 30% of new bank lending is finding it way into the stock market, in part driving up values.

The price rise in emerging market shares, debt and currencies also reflects a blind belief that anywhere must be safer and more promising than the U.S., Japan or Europe. This misses the point that these markets have a strong trading and export orientation or are external capital dependent. While some have bright long-term futures, they will need to make difficult and slow adjustments to their growth models to return to trend growth.

The recovery in emerging markets has, in turn, underpinned the recovery in commodity prices and economies dependent on natural resources. A significant part of this is inventory restocking but there is a speculative element. Availability of abundant and low-cost bank financing, combined with a deep-seated fear of the long-term prospects of U.S. Treasury bonds and the dollar, has encouraged speculative stockpiling of certain commodities, artificially boosting demand.

In reality, the global economy has, in all probability, entered a period of stability after a fairly big decline. Market sentiment seems to be shaped less by facts than the Doors' song: "I've been down for so long, it feels like up to me."

Government largesse
A key risk remains the ability of governments to finance their burgeoning government deficits. A wretched combination of declining tax revenues, increased government spending to cushion the economy from recession and bailout packages for banks and other "worthies" means that many countries face large and continuing budget deficits.

In August, the U.S. Congressional Budget Office released forecast that project the 10-year deficit to reach over $9 trillion, some $2 trillion more than it had estimated as recently as March 2009. Even countries with relatively healthy balance sheets such as Australia do not anticipate balancing their books for many years. If the problems of an aging population and unfunded liabilities such as public sector pensions, health-care and social security arrangements are included, then the budgetary position looks considerably worse.

In 2009, total sovereign debt issues are expected to total more than $5 trillion, of which the United States alone will need to finance around $3 trillion. The increases in sovereign debt issuance are astonishing – U.S. around 300%, U.K. over 400%, euro zone around 50%. Government debt-to-GDP ratios for many developed countries are projected to reach and remain at levels in excess of 100%.

Overall government deficits in major economies through the recession are estimated to total around $10 trillion (around 27% of GDP of these economies). The work of economists Kenneth Rogoff and Carmen Reinhart on previous recessions suggests that the deficit estimates are conservative and the amount that will need to be financed will be between $15 trillion (40% of GDP) and $33 trillion (86% of GDP).

As a comparison, the total amount of global investment assets under management, according to one estimate, is around $120 trillion. This provides some idea of the funding task ahead.

Long-term interest rates have risen sharply, reflecting supply pressures. The 30-year U.S. Treasury yield has increased by around 1.50 percentage points since the start of 2009. Maturities also have shortened, increasing the refinancing challenges ahead. Participation of central banks in the U.S. and U.K. bond markets, under their quantitative-easing mandates, has hold down interest-rate increases, creating a somewhat artificial market.

A key issue over the coming months is the continued demand for increased sovereign debt issues. China, Japan and Europe historically have been major buyers of U.S. Treasury bonds. As their own fiscal position changes and their current account surplus shrinks, the ability of these investors to absorb the increased supply is unclear. China's foreign exchange reserves are growing more slowly than before. China has continued to purchase U.S. Treasury bonds, but some purchases represent a switch from U.S. agency paper. As the United States has increased its issuance program, China's purchases are now a smaller portion of the total.

In the best case, the government debt issuance is accommodated but squeezes out other borrowers. In the worst case, governments find themselves unable to finance their deficits setting off a new stage of the GFC.

Withdrawal method
Given the size of the intervention, a key question is the timing of withdrawal of government support for the economy.

The current apparent health of the financial system owes everything to wide-ranging government support. The ability of the banks to raise equity and debt is substantially underwritten by the "too-big-to-fail" doctrine. Profitability is supported by low and, in some cases, zero cost of deposits and a sharply upward sloping yield curve that creates significant earnings from borrowing short and lending long. Withdrawal of support may expose deep-seated and unresolved problems in the financial system.

Substantial quantities of structured securities are now held by central banks either as collateral for funding arrangements or through other innovative market support mechanisms. This has substantially increased the size of central bank balance sheets in the U.S., U.K and Europe.

It is not clear how and when these "temporary" positions will be unwound. Attempts to create structures for repackaging these securities, such as the frequently touted but still to be implemented Public Private Investment Partnership (PPIP) program, have enjoyed limited success. Untimely attempts by governments to liquidate these portfolios may be disruptive to fragile markets.

These securities may have to be held to maturity (sometimes over 10 years in the case of some Asset Backed Securities (ABS) and allowed to self liquidate from the underlying cash flows. The bloated central bank balance sheets may restrict policy flexibility significantly.

Government spending has been substituted for private consumption and investment. The deficits will ultimately necessitate a combination of increased taxation and reduced spending to correct this position.

Assume a country has government debt equal to 100% of its GDP. Assuming an annual interest rate of 5% and a GDP growth rate of 4%, a 1% budget surplus is required to maintain debt at current levels. If the gap between interest rates and growth is greater, then the size of the required surplus is commensurately larger. In effect, it is unlikely that the present expansionary fiscal position can be sustained over a long period. The fiscal position of major economies may restrain growth.

Fundamental truths
Belief in the recovery story and sharp financial market rallies fail to recognize that little has actually changed since the GFC began. Fundamental failures have not been fully addressed.

The required reduction in debt levels has not been completed. Increases in government debt have substantially offset reductions in private sector debt.

Instead of dealing with the problem of leverage, the debt has also merely been rolled forward through a variety of clever warehousing structures and the manipulation of accounting rules.

In a system that has excessive leverage, there are only two adjustment mechanisms. The value of assets supporting the debt and income available to service the borrowing can be increased, usually by inflation. The value of the debt can be reduced through writing it down to the real value of the assets.

Governments and central banks have gambled on inflation despite its social and economic costs. In reality, inflationary pressures in the global economy are not apparent. The rebound in energy and food costs has prevented deflation. The absence of demand, excess capacity, reduced credit creation and low velocity of money circulation may mean that it is disinflation or deflation that is the problem going forward.

There is now faith-based reliance on governments' ability to rescue the economy. Intervention has helped stabilize economic activity and the financial system but it improbable that government actions alone can prevent the necessary adjustment in debt levels and growth rates.

Government's share of most developed economies is around 25% to 40% of GDP. Its role in liberal democracies is limited by the fact that is fundamentally an intermediary, not dissimilar to a bank. It derives its resources through taxation from certain sectors of the economy and redirects it to other sectors. This means that its ability to control an economy has limits in the absence of nationalization of all productive activity.

In the short run, governments can borrow or print money to augment its resources. Like all debt, it borrows from tomorrow to pay for today. Quantitative easing (the now respectable name for printing money) also has limits, unless governments are willing to risk hyper-inflation and the social dissolution of the Weimar Republic or Zimbabwe. While governments can influence an economy, they cannot completely reverse inevitable adjustments dictated by market forces.

Governments may also be impeding necessary adjustments. Rising government investment is increasing capacity in a world with stagnant demand and over-capacity in many sectors.

China's current growth is being driven by government investment that is increasing capacity, which in the absence of sufficient domestic demand may be directed to exports increasing the global supply glut. Politically and socially motivated bailouts of national champions and strategic industries mean the necessary reductions in capacity through bankruptcy and corporate failure have not been allowed to happen.

There are even signs that the financial sector is rediscovering old habits. The government and taxpayer paid for return to profitability of major financial institutions, and the return of remuneration levels to pre-crisis levels raises fundamental questions about whether any change has occurred. After the strong second-quarter earnings report for Goldman Sachs, Chief Financial Officer David Viniar told Bloomberg News that, "Our model really never changed, we've said very consistently that our business model remained the same." Despite the egregious excesses, governments seem collectively to lack the will to reform the financial system to avoid the problems of the past.

In 2007, when the U.S. housing bubble collapsed, the satirical magazine The Onion demanded that the American people be given another bubble to speculate in. Their wish now appears to have granted. Actions to stabilize the global economy seem only to have created new bubbles – in government debt and emerging markets. Government actions seem to be primarily designed to ensuring continuation of the Ponzi scheme. The only lesson learned is that no Ponzi scheme can ever be allowed to stop.

As states one familiar but anonymous saying: "Never in the history of the world has there been a situation so bad that the government can't make it worse."

Global questions
There is broad agreement that a key component of the GFC was the problem of global capital imbalances. A central feature was debt-funded consumption in the United States that allowed 5% of the global population to constitute 25% of its GDP, 15% of consumption and 48% of global current account deficit. Japan, China, Germany and the other savers funded the consumption. At its peak, the United States was absorbing about 85% of total global capital flows to fund its government and private debt.

Any lasting solution to the GFC requires this imbalance to be dealt with. The glib solution requires the United States to save more and consume less, and the savers to save less and consume more. The problems in implementing the solution are considerable.

Timothy Geithner's recent discussion with Chinese officials, to assure his hosts of the safety of their investments in dollars and U.S. Treasury bonds, reveals the dilemma. On the one hand, America needs the Chinese to continue and increase their purchase of U.S. government debt to finance its fiscal stimulus and bailouts. On the other hand, America needs China to cut the size of its current account surplus, boost government spending, encourage personal consumption and reduce savings. All this should also occur ideally without any major decline in the value of the dollar or U.S.
Treasury bonds or the need for China to liberalize it currency and open its capital account, allowing internationalization of the Renminbi!

A cursory look at the respective economies highlights the magnitude of the task. Consumption's contribution to U.S. GDP is 71%, while in China, it is 37%. Given that the GDP of China is around $4 trillion to $5 trillion, vs. $15 trillion for the United States, and average income in China is around 10% to 15% of U.S. earnings, the difficulty of using Chinese consumption to drive the global economy becomes apparent.

Additionally, over the last 25 years, Chinese consumption has declined from around 50% to current levels of 37%. During that same period, Chinese savings have risen and exports have been the engine for growth. Given that a significant portion of exports is driven ultimately by American buyer, lower U.S. growth and declining consumption creates significant challenges for China.

Dealing with these global imbalances has not been a high priority in the various summits, symposiums and talk-fests that global leaders have shuttled to and from. The focus has been ‘NATO' – no action talk only. Half-hearted and unworkable proposals, such as the use of the synthetic Special Drawing Rights as reserve currency, have emerged.

Globally unbalanced
Reliance on Chinese foreign currency reserves is probably misplaced. Chinese reserves, a large proportion denominated in dollars, may have limited value. They cannot be effectively liquidated or mobilized without massive losses. Increasingly strident Chinese rhetoric about the safety of their dollar assets reflects increasing panic.

In reality, China is trying desperately to switch its reserves into real assets – commodity or resource producers where foreign countries will allow. In the meantime, China continues to purchase more dollars and U.S. Treasury bond to preserve the value of existing holdings in a surreal logic. On the other side, the U.S. continues to seek to preserve the status of the dollar as the sole reserve currency in order to enable itself to finance itself. The intractable nature of this problem is evident in the frequently contradictory statements from various Chinese spokesmen regarding the official position on the dollar.

No sustainable global recovery is likely without addressing the fundamental global imbalances that lie at the heart of the GFC.

Placebo Effects
Wolfgang Münchau, writing in the Financial Times on June 14, 2009, eloquently summed up developments. "Instead of solving the problems to generate a recovery, the political strategies have consisted of waiting for a recovery to solve the problem. The Europeans are relying on the Americans to generate growth. The Americans are relying on the Chinese, who in turn are waiting for the rest of the world."

The placebo effect is a pervasive phenomenon in medicine. A sham medical intervention may cause the patient to believe that the treatment will change his or her condition sometime causing the actual condition to improve. Conditioning, expectations and motivation all can play a role in placebo effect.

In recent times, investors, markets and governments have all come to believe in the recovery, sometimes by selective interpretation of facts to support the conclusion that they need. As T.S. Eliot observed: "Mankind cannot take too much reality."

Given reluctance or inability to deal with the real problems, it is not entirely clear whether the GFC cures are real or inert treatments. It is also not clear whether current improvements in market and economic conditions are sustainable or merely a short-term placebo effect.

Satyajit Das is a risk consultant and author of "Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives" (2006, FT-Prentice Hall).

Tuesday, September 29, 2009

A Mathematically Pragmatic Universal Constitution…

Motto of the elite: “Placate the sovereign individual with complex words' systems, to keep him docile”.

SB asked this question in his last post to me:

“Will we allow it to be ? education into the human condition if sprinkled lightly over all people can make it s(o: - any ideas on how to bypass the politicians, bankers and lawyers who don't like people talkin', getting ideas ...?"

"Politicians enriched for lawyers - words with zero information content when wielded by these dangerously erratic people."

…and yes, I do have many ideas on how to bypass the politicians, bankers and lawyers who don’t like people talkin’, getting ideas, against the wishes of politicians being enriched by/for lawyers, by words with zero information content, when wielded by these dangerously erratic people__The answer is a bit of truth, for the first time in history…

Throw away Aristotle, W.James and J.Dewey, they are fools. Pick up on all the early and late pragmatic Pythagorean Greeks, and Ibn Sina, Kant, Peirce, Veblen and J.M.Keynes, the intelligent mathematical pragmatists. Re-found all your thinking on this new principle: The Mathematical Theorem of Genericity: "Mathematical genericity is absolutely required to sensibly understand reality, simply...", and its clearer explanation: "Truth is eternally limited to genericity, due to the fact that the manifold of interpretation is infinitely extendable__X/X=1+IEE, eternally..." These general facts just make it an easier standpoint, to see the greater Universal/eclectic picture. Then maybe we’ll have a shot at enlightening the world to the fallacies of all nations’ Imperial Preference Constitutions, which are no more than Elite Documents to enhance theft by the well-off and powerful, while their handmaiden_The Academic Elites_create word systems to placate the sovereign individuals out of their natural rights, and into docility, poverty, crime and wars.

We used to have simple intelligence when we knew grounded mathematical truths could rule the massive over-inadequate word systems. Now, we have a complexity to inanity, leaving nothing and nobody in charge, but money and the evil power pinhead-elites. The sovereign individual must pick up his God-given innate talents, for recognizing new mathematical truths, and help in the great anti-intellectual battle that needs waging. It’s a simple mathematical method of truth, based on the old Greek Golden Ratios’ maths of least and most squares and powers. It quickly and easily shows everyone the two truths’ systems the Rich and powerful have erected over the millennia__The powerful one for themselves, and the weak one for the less well-off sovereign individuals.

The sovereign individual was weakened by the promise of equal rights for all, when in fact all constitutions simply guarantee rights according to the skills of theft, and you’ll all find these Imperial Preference clauses in the constitutions of all nations on Earth__These anti-innocuous laws must be changed, to laws closer satisfying the rights of all sovereign individuals, not just the wealthy few. The battle is nothing more than the sovereign individuals rights, and/verses, the corporate/government theives’ rights. It’s completely your choice to fight the intellectual battle for your own sovereign rights__Please choose correctly.

The Two Rights Systems are no more than stupid verses intelligent pragmatism. The stupid system uses complexities of all kinds, to blind all weak parties into docility. The innate intelligent system uses the sensible middle way mathematics of old, and awakens the juices of possibilities for the weak to intellectually over-throw the powerful__"Yes We Can". The faulty democracies of ‘Crooks and Criminals’ must be replaced with democracies of Total Sovereign Individual Rights of Truly and Fairly Incentivized Equality and Pure Liberty, for the first time in world history. The constitutions of pure sovereign theft must be swapped, at the nearest yard sale, for what the elite years ago threw away, as junk thought, because it slightly invaded their absolute rights of pure theft. And the greatest criminal in the long march of word-smithing was one darling lil’ ol’ Aristotle, creating the most elaborate phony logic system, the world has ever witnessed, yet most have been too ill prepared to find the simple mathematical truths of history, to over-come this madman of rhetorical solipsism. That time of sovereign individual blindness, is now ending__Good riddance to the ignorance of Aristotle and his ilk…

And, it’s time for all willing bodies to help end the World’s love affair of: “Equal Rights According and Accorded to the Skills of Theft”…

Where we are now: Link
Where we can go: Link

Wednesday, September 23, 2009

Analytic Eclecticism__A Scientific Probability Method...

"“Eclecticism” is a name given to a group of ancient philosophers who, from the existing philosophical beliefs, tried to select the doctrines that seemed to them most reasonable, and out of these constructed a new system (see Diogenes Laertius, 21). The name was first generally used in the first century BCE. Stoicism and Epicureanism had made the search for pure truth subordinate to the attainment of practical virtue and happiness. Skepticism had denied that pure truth was possible to discover. Eclecticism sought to reach by selection the highest possible degree of probability, in the despair of attaining to what is absolutely true. In Greek philosophy, the best known Eclectics were the Stoics Panaetius (150 BCE.) and Posidonius (75 BCE.). The New Academic, Carnaedes (155 BCE.), and Philo of Larissa (75 BCE.). Among the Romans, Cicero, whose cast of mind made him always doubtful and uncertain of his own attitude, was thoroughly eclectic, uniting the Peripatetic, Stoic, and New Academic doctrines, and seeking the probable (illud probabile). The same general line was followed by Varro, and in the next century the Stoic Seneca propounded a philosophical system largely based on eclecticism." Author unknown

A note just to let everybody know the method of thought, I'm most often using...

Friday, September 18, 2009

The False Utopias of Scientific Logic & God Logic, As Now Percieved…

Can any one of us truly answer the question: “How does one know the boundary line between logic and ego?” Is it even possible to discern? What is the exact criteria you use to determine whether you are using a logic faithful to your chosen field of belief? How do you even make your ideas truly clear to yourself? What are your methods? Do you even believe there are any truly value-valid methods? Is mathematics a sound method, and do you use math? Is empiricism a sound method? Is fallibility and doubt to be thoroughly investigated in developing one’s logic? Are experiments logically valid, and how does one draw conclusions from experiments? Is faith a satisfactory method for some, and what is its true ground or grounds of thought? Is science a satisfactory method for others, and what is its true ground or grounds of thought? Is logic scientifically valid, as now constructed, or as is used in a folk(natural) usage? How does ego know logic as logic, and not ego? How does logic know ego as ego, and not logic? As per all the new and extended logics, of the centuries, what makes logic sound and valid…?

Tuesday, September 08, 2009

False & True Philosophical Utopias...

(Anyone wishing to follow these dabates as they take place: cleck here)(click image for larger view)
“Two things here are all-important to assure oneself of and to remember. The first is that a person is not absolutely an individual. His thoughts are what he is "saying to himself," that is, is saying to that other self that is just coming into life in the flow of time. When one reasons, it is that critical self that one is trying to persuade; and all thought whatsoever is a sign, and is mostly of the nature of language. The second thing to remember is that the man's circle of society (however widely or narrowly this phrase may be understood), is a sort of loosely compacted person, in some respects of higher rank than the person of an individual organism." C.S. Peirce

The above quote is the central premises of explanation of my graphic, in my first post this month. If one studies the depth of Peirce’s statements related to my graphic, the truths are represented by the three center circles, which can actually be the three conceptual/perceptual and non-perceptual selves, as one fades, one is present ‘I’/being, and the third is the self “coming into life in the flow of time”. The reason I’ve chosen conflexivity is I didn’t feel the present terms actually covered all the actions taking place in our mental processes. Others have chosen the words, ‘Abduction’, ‘Reflexivity’ and ‘Reflexive Control’, but it’s more than a mere reflexive system__The deepest mind states are a truly conflexive process. By conflexivity, I mean, as an analogy, say an epiphany, which is a split second lucid vision into the super-consciousness of one’s own mind, or as some would believe, into the super-consciousness of all minds or even a universal mind. The reason I choose ‘con-’ is it has the meaning, when added to ‘flexivity’, of being two or many processes in one, especially as relates to a small split second’s epiphany, having the massive power of vision to reveal such a large amount of information, it’s often over-whelming to retrieve at that moment. It may take years or even decades to understand the entire meaning of such epiphanies, as I’m sure many of you have experienced, and for this reason and the explanation’s complexity, I’ve chosen the word conflexivity. If one looks up ‘con’ in the online etymology dictionary at; one will quickly see the utility of the many meanings, which suits my purpose well, as I intend, over the next 6 months, to relay an entire system of philosophy, by a method I’ll later explain. For now, it’ll be from a universal standpoint of eclectic genericity. By using a general method, it allows me to take in all the breadth of universal facts and beliefs, and at the same time allows a perspective of the depths of particular facts and individual beliefs, desires, habits and ambitions…

So as not to become bogged down in constant extreme debates between others varied views and ideas, and my own, I’ll be responding with general impersonal expositions of my ideas, as loosely relates to others’ ideas. My methods have their main foundations in the early Jains, Nyaya, Heraclitus, Pythagoras, Socrates, Plato, Euclid, Eudoxus, Nicomachus, Archimedes, Apollonius, A.Biruni, Avicenna/Ibn Sina, A.Magnus, F.Bacon, Boole, De Morgan, W.Clifford, A.Schopenhauer, C.S.Peirce, T.Veblen, W.Durant and L.Kolakowski. The three I’m most impressed with are Ibn Sina, C.S.Peirce and L.Kolakowski, as all three offer eclectic universal genericity perspectives. Both Ibn Sina and C.S.Peirce offered complete philosophical systems, including all views of human thought, i.e., Logic, Physics, Metaphysics, Spiritism and complete category systems to boot. These two are the only ones who offered all of human thought in one person, and respected all aspects of these diverse mentalities of history, therefore I have a great deal of respect for them, especially as offering a great helping hand to unite the many dis-united schools of thought, mentalities and ideas of our present ‘crazy’ world.

As to the ‘False & True Philosophical Utopias’, this will be an ongoing discussion about “The Mentalities of Histories” as Kolakowski has named them. This ‘mentalities’ has far greater conceptual representational power than say, ‘The History of Ideas’, ‘The Intellectual History of Eras’ or ‘The History of Concepts’, as ‘The History of Mentalities’ can represent anything from the smallest personal individual in depth idea, to the largest universal open conceptual ideas of the planet’s evolutional mental state, as expressed by people such as P.T de Chardin, E.Schrodinger, D.Bohm and even J.Lovelock. I intend to discuss most all the false utopias of leftists and rightists, i.e., Marxism, socialism, communism, the Heinz 57 totalitarianisms, the Heinz 57 capitalisms and anything else that comes up as relates to social philosophy, social justice and a possible evolution to a true state of pure liberty, based on the complete ‘Inversity’ of present state law system understandings, through full explanations of what ‘Inverse Greed’ truly consists of. This may sound like a tall order, but I assure you I have simplified the process greatly over the last two years, by graphing, tabling and charting these processes and methods with an analogical/visual representation that’ll become obvious as we progress. I’ve named my entire philosophical system ‘Aneology’, which means ‘One Visual Logic…’

Not to make this post any longer, I’ll end here for now…

The Q, C, and X, as represented above stand for Q = quantum states(though all 3 are quantum change states), C = biological cells, and X = foreign exchange markets, as so emplaced. These letters can be replaced to represent all central actions of brain/mind states, or other states of complexity of the nations' systems and world systems, where complexities yet unsolved exist. In other words I could have the letters, M = minds, P = photons, and C = concepts, etc., etc. Just as in all algebras, the letters are interchangable as per the topics of discussions proceed. As per the drawing's box informations, they are all chiralling cycloid motions of photons, as photons are the family of bosons, which allow super-positioning/cloning, etc., as per Einstein, which allows concepts to merge from lesser states to greater vision states, then fade to emplaced memory states. Future diagrams and explanations of the mechanics will form the entire picture of a working brain/mind model and possible and necessary probable world mechanics of...

The reason foreign exchange is included is it represents one of the largest areas of incomplete complexity(and many others will be shown in future posts), similar or symmetrical, information wise, as that of deep brain/mind mechanics of hypotheses formations, and possibly a clearer method of future explanations, since any internal mind states, not completely understood, can more easily be represented by symmetrical relationships of external real world states(I'm drawing the symmetries of actions from E.Noether and her statements of physical states in relation to the symmetries of the laws of physics and nature, and the required conditions of her theorems_She's one of our most important global resources of unifying thought). Just as morality can not be agreed to internally(the epistemic dilemma of 'free will and responsibility'), other than our individual prejudices learned by age 18, as per Nietzsche, this same internal moral state can be understood through its symmetrical external relationship of the desires, ambitions and habits of entire communities' esthetic liberty actions, as represented by the real world accomplishments we see around us, which actually exists by the original moral desires and ambitions of individual choices, and this way morality is actually externally/objectively, scientifically measurable_over time. As an example, we all enjoy living in comfortable houses, as per living in cold, damp caves_that's a moral/happiness personal choice we all make. Though some may not see it as a moral choice, one only has to think about the more compassionate condition of wife and children's comfort of house compared to cave, then one sees the moral/happiness implications. This will also be given through future graphs, tables and graphics, with their related explanations, and showing how to measure not only morality, but a closing of many of philosophy's epistemic and ontological gaps...

Hope that helps...

And as per logic of, logic simply tells us the true and false condition states of our reasoning, and no more, i.e., reason asks/contemplates the questions/doubts, and logic answers the condition states of... Of course, many conflate logic states with Aristotle's syllogistic 3 laws of logic__I use Ibn Sina's, Boole's, Lobachevsky's, Grassmann's, De Morgan's, Clifford's, Peirce's and Vasiliev's much extended logics, over Aristotle's less extensive reasonings...