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