Monday, December 31, 2012

Testimony of Marriner Eccles to the Committee on the Investigation of Economic Problems in 1933

London Banker...

Below are excerpts from the testimony of Marriner Eccles to the Senate Committee on the Investigation of Economic Problems in 1933. It is an historic document – laying out the future terms of the Federal Deposit Insurance Corporation, the management of money supply nationally through open market operations, the Bretton Woods Accord on currency stability, mortgage refinancing as monetary stimulus, and reforms of the Federal Reserve System to eradicate the excesses of untamed capitalism and financial dominance of Wall Street. He proposes higher income and inheritance taxes as essential to promote economic growth, curb inequality and forestall political instability. He encourages federal regulation of child labor, unemployment insurance, social security and other farsighted reforms. And he avows himself a capitalist throughout.

Although he was a titan of industry - with banks, railroads and corporations spanning the American west - Eccles was born the son of an illiterate, bigamist, Mormon, Scottish immigrant. He was about as far as you could get from the Eastern elite ranks that ran US banking on Wall Street. But he sure understood money, economics and trade, and had the personal drive and charisma to carry his point with the president and with Congress.

Following his testimony, the Utah banker was invited by Franklin Roosevelt to come to Washington to spearhead legislation to enact his proposed reforms. Within two years he had drafted and enacted the Securities Act of 1933 and the Banking Act of 1933(a.k.a., The Glass-Steagall Act, which separated investment and commercial banking and established the FDIC) and the Banking Act of 1935 (which created the modern Board of Governors of the Federal Reserve System and Federal Open Market Committee). He served as Chairman of the Board of Governors of the Federal Reserve System from 1934 until 1951.

Read this and know that just one person, with vision and principles, can make a difference to the world in a time of crisis, establishing the basis for decades of prosperity and growth.

[page 8]

Before effective action can be taken to stop the devastating effects of the depression, it must be recognised that the breakdown of our present economic system is due to the failure of our political and financial leadership to intelligently deal with the money problem. In the real world there is no cause nor reason for the unemployment with its resultant dsestitution and suffering of fully one-third of our entire population. We have all and more of the material wealth which we had at the peak of our prosperity in the year 1929. Our people need and want everything which our abundant facilities and resources are able to provide for them. The problem of production has been solved, and we need no further capital accumulation for the present, which could only be utilised in further increasing our productive facilities or extending further foreign credits. We have a complete economic plant able to supply a superabundance of not only all the necessities of our people, but the comforts and luxuries as well. Our problem, then, becomes one purely of distribution. This can only be brought about by providing purchasing power sufficiently adequate to enable the people to obtain the consumption goods which we, as a nation, are able to produce. The economic system can serve no other purpose and expect to survive.

If our problem is then the result of the failure of our money system to properly function, which today is generally recognised, we then must turn to the consideration of the necessary corrective measures to be brought about in that field; otherwise, we can only expect to sink deeper in our dilemma and distress, with possible revolution, with social disintegration, with the world in ruins, the network of its financial obligations in shreds, with the very basis of law and order shattered. Under such a condition nothing but a primitive society is possible. Difficult and slow would then be the process of rebuilding and it could only then be brought about on a basis of a new political, economic and social system. Why risk such a catastrophe when it can be averted by aggressive measures in the right direction on the part of the Government?

* * *

[page 9]

We could do business on the basis of any dollar value as long as we have a reasonable balance between the value of all goods and services if it were not for the debt structure. The debt structure has obtained its present astronomical proportions due to an unbalanced distribution of wealth production as measured in buying power during our years of prosperity. Too much of the product of labor was diverted into capital goods, and as a result what seemed to be our prosperity was maintained on a basis of abnormal credit both at home and abroad. The time came when we seemed to reach a point of saturation in the credit structure where, generally speaking, additional credi was no longer available, with the result that debtors were forced to curtail their consumption in an effort to create a margin to apply on the reduction of debts. This naturally reduced the demand for goods of all kinds, bringing about what appeared to be overproduction, but what in reality was underconsumption measured in terms of the real world and not the money world. This naturally brought about a falling in prices and unemployment. Unemployment further decreased the consumption of goods, which further increased unemployment, thus bringing about a continuing decline in prices. Earnings began to disappear, requiring economies of all kinds – decreases in wages, salaries, and time of those employed.

[page 10]

The debt structure, in spite of the great amount of liquidation during the past three years, is rapidly becoming unsupportable, with the result that foreclosures, receiverships and bankruptcies are increasing in every field; delinquent taxes are mounting and forcing the closing of schools, thus breaking down our educational system, and moratoriums of all kinds are being resorted to – all this resulting in a steady and gradual breaking down of our entire credit structure, which can only bring additional distress, fear, rebellion, and chaos.

* * *

As an example of Government control and operation of the economic system look to the period of the war, at which time, under Government direction, we were able to produce enough and support not only our entire civilian population on a standard of living far higher than at present, but an immense army of our most productive workers engaged in the business of war, parasites on the economic system, consuming and destroying vast quantities produced by our civilian population; we also provided allies with an endless stream of war materials and consumption goods of all kinds. It seemed as though we were enriched by the waste and destruction of war. Certainly we were not impoverished, because we did not consume and waste except that which we produced. As a matter of fact we consumed and wasted less than we produced as evidenced by the additions to our plant and facilities during the war and the goods which we furnished to our allies. The debt incurred by the Government during the war represents the profit which accrued to certain portions of our population through the operation of our economic system. No Government debt would have been necessary and no great price inflation would have resulted if we had drawn back into the Federal Treasury through taxation all of the profits and savings accumulated during the war.

* * *

[page 11]

How was it that during the period of the prosperity after the war we were able in spite of what is termed our extravagance – which was not extravagance at all; we saved too much and consumed too little – how was it we were able to balance a $4,000,000,000 annual Budget, to pay off ten billion of the Government debt, to make four major reductions in our income tax rates (otherwise all of the Government debt would have been paid), to extend $10,000,000,000 credit to foreign countries represented by our surplus production which we shipped abroad, and add approximately $100,000,000,000 by capital accumulation to our national wealth, represented by plants, equipment, buildings, and construction of all kinds? In the light of this record, is it consistent for our political and financial leadership to demand at this time a balanced Budget by the inauguration of a general sales tax, further reducing the buying power of our people? Is it necessary to conserve Government credit to the point of providing a starvation existence for millions of our people in a land of superabundance? Is the universal demand for Government economy consistent at this time? Is the present lack of confidence due to an unbalanced Budget?

What the public and the business men of this country are interested in is a revival of employment and purchasing power. This would automatically restore confidence and increase profits to a point where the Budget would automatically be balanced in just the same manner as the individual, corporation, State, and city budget would be balanced.

[page 12]

During the past three years there has been such tremendous liquidation and scaling down of debts that extraordinary measures have had to be taken to prevent a general collapse of the credit structure. If such a policy is continued what assurance is there that the influences radiating from a marking down of the claims of creditors will not result in a further decline of prices? In other words, after we have reduced all debts through a basis of scaling down 25 per cent to 50 per cent, what reason have we to expect that prices will not have a further decline by like amount? And then again, the practical difficulties of bringing about such a adjustment on a broad scale seem to be insurmountable.

The time element required would indefinitely prolong the depression; such a policy would necessitate the further liquidation of banks, insurance companies, and all credit institutions, for if the obligations of public bodies, corporations, and individuals were appreciably reduced the assets of such institutions would diminish correspondingly, forcing their liquidation on a large scale. Nothing would so hinder any possibility of recovery. Bank and insurance failures destroy confidence and spread disaster and fear throughout the economic world. The present volume of money would diminish with increased hoarding and decreased credit and velocity, making for further deflation and requiring increased Government support without beneficial results until we would be forced from the gold standard in spite of our 40 per cent of the world’s gold, and, at that point, an undesirable and possibly an uncontrolled inflation with all its attendant evils would likely result, and thus the very action designed to preserve the gold standard and re-establish confidence would destroy both.

[page 13]

We have nearly one and a half billion currency more in circulation at the present time than we had at the peak of 1929, and under our present money system we are able to increase this by several billion more without resorting to any of the three inflationary measures popularly advocated. There is sufficient money available in our present system to adequately adjust our present price structure. Our price structure depends more upon the velocity of money than it does upon its volume.

* * *

In 1929 the high level of prices was supported by a corresponding velocity of credit. The last Federal Reserve Bulletin gives an illuminating picture of this relationship as shown by figures of all member banks. From 1923 to 1925 the turnover of deposits fluctuated from 26 to 32 times per year. From the autumn of 1925 to 1929 the turnover rose to 45 times per year. In 1930, with deposits still increasing, the turnover declined at the year end to 26 times. During the last quarter of 1932 the turnover dropped to 16 times per year. Note that from the high price level of 1929 to the low level of the present this turnover has declined from 45 to 16, or 64 per cent.

[page 14]

I repeat there is plenty of money today to bring about a restoration of prices, but the chief trouble is that it is in the wrong place; it is concentrated in the larger financial centers of the country, the creditor sections, leaving a great portion of the back country, or the debtor sections, drained dry and making it appear that there is a great shortage of money and that it is, therefore, necessary for the Government to print more. This maldistribution of our money supply is the result of the relationship between debtor and creditor sections – just the same as the realtion between this as a creditor nation and another nation as a debtor nation – and the development of our industries into vast systems concentrated in the larger centers. During the period of the depression the creditor sections have acted on our system like a great suction pump, drawing a large portion of the available income and deposits in payment of interest, debts, insurance and dividends as well as in the transfer of balances by the larger corporations normally carried throughout the country.

[page 15]

The maladjustment referred to must be corrected before there can be the necessary velocity of money. I see no way of correcting this situation except through Government action.

[page 21]

Mr Eccles: Of course, the way I look at this matter is that we have the power to produce, just as in the period of prosperity after the war demonstrated when we had a standard of living for a period from 1921 to 1929 which, of course, was far in excess of what it is now. Yet in spite of that standard of living we saved too much a I have previously tried to show.

Senator Gore: You have got Foster in the back of your head?

Mr Eccles: I only wish there were more who had. We saved too much in this regard, that we added too much to our capital equipment. Creating overproduction in one case and underconsumption in the other because of an uneconomic distribution of wealth production. . . . Of course, we are losing $2,000,000,000 per month in unemployment. I can conceive of no greater waste than the waste of reducing our national income about half of what it was. I can not conceive of any waste as great as that. Labor, after all, is our only source of wealth.

[page 22]

There could be no waste in post offices or in roads or in schools. You would have something to show for it. With war all you have left is the expense of taking care of maimed and crippled and sick veterans. That is what is left from war. And it is all wastage.

Senator Gore: You have touched the point. The real cause of the existing trouble was the war, with destruction of over 300 billion dollars of wealth in four years. We are paying the price now. The boys paid the price in blood on the field. We are paying the economic price today. And you may just as well pass a resolution to raise the dead that fell in France as to try to pass laws to avert the inevitable consequences of that war.

Mr Eccles: It is true we are suffering the consequences of the war, but there is no reason why we should be suffering from the consequences of the war if it had not been for the international or the interallied debt that resulted from it. WE are suffering from a debt structure. We are not suffering from the waste, because after all, we know today that we have the power and the facilities to produce certainly all that the people of this country need and want.

* * *

We now see, after nearly four years of depression, that private capital will not go into public works or self-liquidating projects except through government and that if we leave our “rugged individual” to follow his own interest under these conditions he does precisely the wrong thing. Each corporation for its own protection discharges men, reduces pay rolls, curtails its orders for raw materials, postpones construction of new plants and pays off bank loans, adding to the surplus of unusable funds. Every single thing it does to reduce the flow of money makes the situation worse for business as a whole.

[page 24]

I am talking about private credit. If it is credit we need why do not say 200 of our great corporations controlling 40 per cent of our industrial output that are in such shape that they do not need credit – they have great amounts of surplus funds – if it is credit that is needed why do they not put men to work? For the very reason that there is not a demand for goods, that we have destroyed the ability to buy at the source through the operation of our capitalistic system, which has brought about such a maldistribution of wealth production that it has gravitated and gravitated into the hands of – well, comparatively few. Maybe several millions of people. We have still got the unemployment and have got no buying power as a result.

[page 25 – proposal of bank deposit insurance and failed bank resolution]

[page 27 – laying out the basis for what was later to be the FDIC]

However, there is always this danger about that class of thing [Government guarantee of bank deposits]. It encourages bad practices and bad management. It may put a premium on them, which of course we do not want to do, and if it is done there must be rules and regulations for the proper conduct of banks requiring eligibility, and if they fail to meet the eligibility they would be suspended after so much notice, and the fund would be drawn upon to take care of any loss.

[page 31]

Farm mortgages at present are possibly the most undesirable and frozen of all loans, and frozen loans are preventing, to some extent, the necessary expansion of credit. The plan I have proposed [to refinance existing farm mortgages at new lower rates] will very effectively and immediately make liquid billions of dollars of assets for which there is no market today, while at the same time it will bring about a reduction of at least one-third of the average annual payments on the farm debt now required to be made by farm mortgage debtors without requiring any financing or loss by the Federal Government, thus bringing about the necessary relief in the farm mortgage field. This plan has the advantage, as a result of the Government guarantee of the Federal land bank bonds, of diverting surplus funds carried in the great creditor sections into the indirect financing of farm mortgages where it is impossible even at a high rate of interest, which farmers can not pay, to attract those funds directly.

* * *

No program designed to bring this country out of the depression can be considered apart from the relations of this country to the rest of the world unless a policy of complete isolation is adopted and an embargo put on gold exports and our domestic economy adjusted to meet such a condition.

Our international problems are far more difficult and will be slower to work out because of our inability to control the action of other nations. These problems can be met only through international conferences over a period of time. The most important of these problems and the one which must be settled before any progress can be made in the meeting of our domestic or other foreign problems is the problem of interallied debts.

There is a great demand on the part of the public and most of the press of this country that these debts be paid. It seems to me that our political leaders have lacked the courage to face this problem in a realistic manner. This has greatly contributed to prolonging the depression. The public, generally speaking, is not fully informed as to the impossibility of our foreign debtors complying with these demands, which cn only be complied with at the expense of our own people.

[page 32]

It is elementary that debts between nations can ultimately be paid only in goods, gold, or services, or a combination of the three. We already have over 40 per cent of the gold supply of the world – that is not true; it is between 35 and 40 per cent – and as a result most of the former gold standard countries have been forced to leave that standard and currency inflation has been the result. This has greatly reduced the cost of producing foreign goods in terms of our dollar and has made it almost impossible for foreign countries to buy American goods because of the high price of our dollar measured in the depreciated value of their money. This naturally has resulted in debtors trying to meet their obligations by producing and selling more than they buy, thus enabling them to have a favourable balance of trade necessary to meet their obligations to us. If this country is to receive payment of foreign debts, it must buy and consume more than it produces, thus creating a trade balance favourable to our debtors.

* * *

We must choose either between accepting sufficient foreign goods to pay the foreign debts owing to this country, or cancel the debts. This is not a moral problem, but a mathematical one.

[page 33 – the outline of what later became the Bretton Woods Accord]

Cancellation, or a settlement of the debts on a basis which would practically amount to cancellation, in exchange for stabilisation of the currency of the debtors, together with certain trade concessions and an agreement to reduce armaments would be a small price for this country to pay as compared with the great benefits which the entire world, including ourselves, would derive therefrom. Without a stabilisation of foreign currencies it will be difficult, if not impossible, in my opinion, to substantially raise the price level in this country as long as we stay on a gold basis. Our debtors will default and we will likely be forced to abandon gold and depreciate our currency in relation to that of other countries in order to raise our price level in this country and to meet foreign competition unless we are instrumental in inducing foreign countries to stabilise their currencies on a gold basis, or gold and silver basis if action is taken internationally to remonetise silver.

[page 33]

Senator Shortridge: Then I take it you would have the tariffs reduced?

Mr Eccles: No. Debts cancelled. Then I think with the prosperity that you would get in this country you can collect more than that in income and inheritance taxes when you stop this loss of $2,000,000,000 a month through unemployment. You start the process of wealth, and even a capitalist is far better off. I am a capitalist.

* * *

The program which I have proposed is largely of an emergency nature designed to bring rapid economic recovery. However, when recovery is restored, I believe that in order to avoid future disastrous depressions and sustain a balanced prosperity, it will be necessary during the next few years for the Government to assume a greater control and regulation of our entire economic system. There must be a more equitable distribution of wealth production in order to keep purchasing power in a more even balance with production.

If this is to be accomplished there should be a unification of our banking system under the supervision of the Federal Reserve Bank in order to more effectively control our entire money and credit system; a high income and inheritance tax is essential in order to control capital accumulations (this diversion of taxes should be left solely to the central government – the real property and sales tax left to the States); there should be national child labor, minimum wage, unemployment insurance and old age pension laws (such laws left up to the States only create confusion and can not meet the situation nationally unless similar and uniform laws are passed by all States at the same time, which is improbable); all new capital issues offered to the public and all foreign financing should receive the approval of an agency of the Federal Government; this control should also extend to all means of transportation and communication so as to ensure their operation in the public interest. A national planning board, similar to the industries board during the war, is necessary to the proper coordination of public and private activities of the economic world.

Such measures as I have proposed may frighten those of our people who possess wealth. However, they should feel reassured in reflecting upon the following quotation from one of our leading economists:

It is utterly impossible, as this country has demonstrated again and again, for the rich to save as much as they have been trying to save, and save anything that is worth saving. They can save idle factories and useless railroad coaches; they can save empty office buildings and closed banks; they can save paper evidences of foreign loans; but as a class they can not save anything that is worth saving, above and beyond the amount that is made profitable by the increase of consumer buying. It is for the interests of the well to do – to protect them from the results of their own folly – that we should take from them a sufficient amount of their surplus to enable consumers to consume and business to operate at a profit. This is not “soaking the rich”; it is saving the rich. Incidentally, it is the only way to assure them the serenity and security which they do not have at the present moment.

[page 35]
I feel that one of two things is inevitable: That either we have got to take a chance on meeting this unemployment problem and this low-price problem or we are going to get a collapse of our credit structure, which means a collapse of our capitalistic system, and we will then start over. And I therefore would like to see us attempt to regulate and operate our economy which today requires more action from the top due to our entire interdependency than it did in our earlier days.

The quote I have bolded is my favorite part of this testimony, though it is not Eccles' own words. I would be grateful for anyone who can track down a proper citation for the quote. Eccles thought it was either Stuart Chase or William Trufant Foster.

If you've made it this far, you might also enjoy: Fisher's Debt Deflation Theory of Great Depressions and a possible revision

Tuesday, November 27, 2012

America’s Fiscal Cliff...

Author: Satyajit Das

The world is focused on the fiscal cliff, a term referring to the scheduled reductions in the US budget deficit, by way of expiring tax cuts and mandatory spending cuts. The fiscal cliff may ironically improve public finances, reducing the deficit and slowing the increase in debt levels –America’s debt mountain. But going over the fiscal cliff will not of itself solve America’s fundamental financial problems.
Successive US administrations have avoided dealing with the US debt problem. Policy makers have adopted the rulebook of rapper Tupac Shakur: “Reality is wrong. Dreams are for real”.
Debt Mountains…
US government debt currently totals around US$16 trillion. The US Treasury estimates that this debt will rise, in absence of corrective action, to around US$20 trillion by 2015, over 100% of America’s Gross Domestic Product (“GDP”).
There are also additional current and contingent commitments not explicitly included in the debt figures, such as US government support for Freddie Mac and Fannie Mae (known as government sponsored enterprises (GSEs)) of over US$5 trillion and unfunded obligations of over US$65 trillion for programs such as Medicare, Medicaid and Social Security. US State governments and municipalities have additional debt of around US$3 trillion.
US public finances deteriorated significantly over recent years. In 2001, the Congressional Budget Office (“CBO”) forecast average annual surpluses of approximately US$850 billion from 2009–2012 allowing Washington to pay off everything it owed.
The surpluses never emerged as the US government has run large budget deficits of around US$1 trillion per annum in recent years. The major drivers of this turnaround include: tax revenue declines due to recessions (28%); tax cuts (21%); increased defence spending (15%); non-defence spending (12%) higher interest costs (11%); and the 2009 stimulus package (6%).
Despite growing concern about the sustainability of its debt levels, demand for US Treasury securities from investors and other governments remains strong.
Innovative” monetary policy from the US Federal Reserve has allowed the government to increase its debt levels. Around 60-70% of US government bonds have been purchased by the Federal Reserve, as part of successive rounds of quantitative Easing (“QE”).
Federal Reserve action has been a key factor in keeping rates low, allowing the US to keep its interest bill manageable despite increases in debt levels. The government’s average interest rate on new borrowing is around 1%, with one-month Treasury bills paying less than 0.10% per annum and 10 year bonds around 1.80% per annum.
But the current position is not sustainable.
In January 2013, in the absence of political agreement, a series of automatic tax increases and spending cuts will be triggered. These were part of the 2011 legislative package which increased the debt ceiling allowing the government to continue to borrow.
Several temporary tax cuts will expire. The total amount involved is around US$500 billion through to September next year.
These include President George Bush’s tax cuts on income, investments, married couples, families with children and inheritances, which were extended for 2 years by President Barack Obama. In addition, the Alternative Minimum Tax (“AMT”) would commence, affecting up to 26-30 million middle-class Americans, increasing their tax bill by an average of US$3,700. The payroll-tax cut of 2% and extended unemployment benefits for the long term unemployed (both implemented by the Obama Administration to stimulate the economy) would also expire. A number of other smaller tax cuts for individuals and business (most notable tax credits for research and development and a deduction for state sales taxes) would also terminate.
Automatic spending cuts will also commence, totalling about US$600 billion per year and US$6.1 trillion over 10 years. The spending cuts would cover most government programs including cuts in defence spending and domestic programs. Medicare, the federal health programme for the elderly, would reduce payments including a sharp reduction (as much as 30%) in reimbursements to doctors.
The automatic tax increases, non-renewal of tax cuts and spending cuts are equivalent to about 5% of GDP. In a recent Report, the non-partisan Congressional Budget Office (“CBO”) estimated that the tax increases and spending cuts would reduce output by approximately 3% and increase unemployment to 9.1% by the end of 2012.
Corrective Services
Bringing US public finances under control requires bringing budget deficits down, through spending cuts, tax increases or a mixture. The fiscal cliff is merely a step down that long road.
The task is Herculean. Government revenues would need to increase by 20-30% or spending cut by a similar amount.
The US has a lower tax-to-GDP ratio (around 18%) than even much maligned Greece (around 20%). The tax-to-GDP in most developed countries is closer to 30%.
Given 45% of households do not pay tax (because they don’t earn enough or through credits and deductions) and 3% of taxpayers contribute around 52% of total tax revenues, a major overhaul of the taxation system would be necessary. Tax reform, especially higher or new taxes, is politically difficult.
Large components of spending – defence, homeland security, social security, Medicare, Medicaid, (growing) interest payments- are difficult to control and also politically sensitive, making it difficult to reduce.
Reducing the budget deficit and debt may also mire the US economy in a prolonged recession.
In 2009, students at National Defence University in Washington, DC, “war gamed” possible scenarios for bringing the US debt under control. Using a model of the economy, participants tried to get the federal debt down by increasing taxes and reducing spending.
The economy promptly fell into a deep recession, increasing the budget deficit and driving government debt to higher levels. This is precisely the experience of heavily indebted peripheral European nations, such as Greece, Ireland, Portugal, Spain and Italy.
As one participant in the National Defence University economic war game observed about the process of bringing US public finances under control: “You’ll never get re-elected and you may do more harm than good”.
Political Debt Dancing…
A decision does not have to be reached by the end of 2012. The US Treasury can juggle its finances to purchase time till perhaps February 2013, especially if an agreement is likely. The major constraint is the need to increase the US Government’s borrowing cap or debt limit (currently US$16.4 trillion), which will be reached late in 2012 or early 2013.
Necessary reform of the tax system, especially a broadening of the tax base, and all spending, including social welfare programmes, is unlikely to be politically easy.
The re-elected President Obama’s ability to implement policy is constrained by continued Republican control of the House of Representatives. The Republicans remain reluctant to entertain tax increases or reductions in exemptions. The Democrats remain reluctant to consider reductions in entitlements and spending.
President Obama asserts that he has a mandate to reform the budget, especially increase taxes on wealthier Americans. Having lost the Presidential election and also having failed to make hoped for gains in Congressional elections, the Republicans are defensive. The GOP position is complicated by its fractious internal politics. More conservative elements believe that the loss was due to a shift to centrist policies and a return to more strict conservatism is required.
Republican House Speaker John Boehner has appeared conciliatory, signalling a willingness to consider some higher taxes. In the fissiparous world of US politics, nothing is guaranteed, especially given the short electoral cycle. The prospects of a definitive grand bargain remain poor. The more likely scenario is an incremental strategy.
A short term compromise will be needed, entailing extensions of some tax cuts and delaying some spending cuts. Negotiations on deeper structural tax and spending reforms may take longer. The latter would focus on some tax increases and some adjustment to spending.
President Obama may get some higher taxes. Republicans might accept higher income taxes, particularly for those earning more than $1 million per annum (rather than US$250,000 currently proposed). Some tax deductions and reporting loopholes may also be eliminated. In return, the administration may agree to changes in entitlement, such as higher Medicare retirement age and changes to indexation of social security benefits for inflation. There would probably also be cuts in spending on defence and other social welfare programs such as Medicaid.
The fiscal cliff or the measures likely to be adopted may not to be enough to address the deep-seated problems of American public finances.
What is needed is a radical overhaul of the tax system, including probably a value added tax and wind back of complex deductions and subsidies. What is also needed is a review of all spending, including defence and social welfare, to better target expenditure and align it with tax revenues.
But even with this action, without strong economic growth and decreases in unemployment, it is difficult to see a significant improvement in American public finances. The recent CBO report concluded that “[very few policies] are large enough, by themselves, to accomplish a sizeable portion of the deficit reduction necessary”.
Our Debt, Your Problem…
Given the magnitude of the challenge and the lack of political will, the US will continue to spend more than it receives in taxes for the indefinite future, resulting in increases in US government debt. This will force the Federal Reserve to continue existing policies, especially debt monetisation by purchasing government bonds and the devaluation of the currency.
Debt monetisation (printing money in popular parlance) will continue, entailing the US Federal Reserve purchasing government bonds in return for supplying reserves to the banking system. Zero interest rates policy (“ZIRP”) in conjunction with debt monetisation will be used to devalue the US dollar.
Of the US gross government debt of US$16 trillion, the US government holds around 40% of the debt through the Federal Reserve, Social Security Trust Fund and other government trust funds. Individuals, corporations, banks, insurance companies, pension funds, mutual funds, state or local governments, hold 25%. Foreigner investors -China, Japan, oil exporting nations, Asian central banks and sovereign wealth funds- hold the remaining 35%.
Existing investors, like China, must now continue to purchase US dollars and government bonds to avoid a precipitous drop in the value of existing investments and to avoid a sharp rise in the value of their own currencies which would reduce export competitiveness.
Expedient in the short term, monetisation risks debasing the currency. Despite bouts of dollar buying on its safe haven status, the US dollar has significantly weakened. On a trade weighted basis, the US dollar has lost around 20% against major currencies since 2009. The US dollar has lost around 30% against the Swiss Franc, 25% against the Canadian dollar, 35% against the Australian dollar and 20% against the Singapore dollar over the same period.
The weaker US dollar also allows the US to enhance its competitive position for exports; in effect the devaluation is a de facto cut in costs. This is designed to drive economic growth.
As the US dollar weakens it improves America’s external position. US foreign investments and overseas income gain in value. But the major benefit is in relation to debt owned by foreigners.
As almost of its government debt is denominated in US dollars, devaluation reduces the value of its outstanding debt. It forces existing foreign investors to keep rolling over debt to avoid realising currency losses on their investments. It encourages existing investors to increase investment, to “double down” to lower their average cost of US dollars and US government debt. As John Connally, US Treasury Secretary under President Nixon belligerently observed: “Our dollar, but your problem.
Debt 22…
Given that the US constitutes around 25% of global economy, it is unlikely America’s problems will stay in America. The rest of the global economy is literally tied to the US as it edges closer to the cliff.
If the US takes the decisive action suggested then US growth will slow sharply in the short run, though the downturn may be shorter in duration and the longer term brighter. If, as likely, the US does not take decisive action then US growth will still be affected, though less significantly in the short run. But America’s debt position will become increasingly problematic. America’s long term growth prospects will also be adversely affected.
Any slowdown in US demand will affect its major trading partners such as China and Europe, exacerbating slowing growth affecting their trading partners.
US dollar devaluation will create pressure for appreciation of other currencies. This may force other nations to implement measures, such as zero interest rate policies, QE programs or capital controls, to halt or at least slow the appreciation of their currencies to avoid reductions in competitiveness.
Foreign investors in US dollars and government bonds are likely to suffer losses. Large investors like China and Japan may suffer significant declines in the value of these assets, reducing their national savings.
In Hamlet, William Shakespeare’s tragic hero states that: “I must be cruel only to be kind; thus bad begins, and worse remains behind”. In trying to preserve its position, the US now is increasingly adopting toxic economic and financial policies, which have the potential to damage other nations and ultimately its own future.
Former French Finance Minister Valery Giscard d’Estaing used the term “exorbitant privilege” to describe American advantages deriving from the role of the dollar as a reserve currency and its central role in global trade. That privilege now is “extortionate”.
Economist Herbert Stein observed: “If something cannot go on forever, it will stop”. How long the US can continue it profligate ways is unknown.

Thursday, November 22, 2012

Inequality is Killing Capitalism...

by Robert Skildelsky

LONDON – It is generally agreed that the crisis of 2008-2009 was caused by excessive bank lending, and that the failure to recover adequately from it stems from banks’ refusal to lend, owing to their “broken” balance sheets.
This illustration is by Paul Lachine and comes from <a href=""></a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.
Illustration by Paul Lachine
A typical story, much favored by followers of Friedrich von Hayek and the Austrian School of economics, goes like this: In the run up to the crisis, banks lent more money to borrowers than savers would have been prepared to lend otherwise, thanks to excessively cheap money provided by central banks, particularly the United States Federal Reserve. Commercial banks, flush with central banks’ money, advanced credit for many unsound investment projects, with the explosion of financial innovation (particularly of derivative instruments) fueling the lending frenzy.
This inverted pyramid of debt collapsed when the Fed finally put a halt to the spending spree by hiking up interest rates. (The Fed raised its benchmark federal funds rate from 1% in 2004 to 5.25% in 2006 and held it there until August 2007). As a result, house prices collapsed, leaving a trail of zombie banks (whose liabilities far exceeded their assets) and ruined borrowers.
The problem now appears to be one of re-starting bank lending. Impaired banks that do not want to lend must somehow be “made whole.” This has been the purpose of the vast bank bailouts in the US and Europe, followed by several rounds of “quantitative easing,” by which central banks print money and pump it into the banking system through a variety of unorthodox channels. (Hayekians object to this, arguing that, because the crisis was caused by excessive credit, it cannot be overcome with more.)
At the same time, regulatory regimes have been toughened everywhere to prevent banks from jeopardizing the financial system again. For example, in addition to its price-stability mandate, the Bank of England has been given the new task of maintaining “the stability of the financial system.”
This analysis, while seemingly plausible, depends on the belief that it is the supply of credit that is essential to economic health: too much money ruins it, while too little destroys it.
But one can take another view, which is that demand for credit, rather than supply, is the crucial economic driver. After all, banks are bound to lend on adequate collateral; and, in the run-up to the crisis, rising house prices provided it. The supply of credit, in other words, resulted from the demand for credit.
This puts the question of the origins of the crisis in a somewhat different light. It was not so much predatory lenders as it was imprudent, or deluded, borrowers, who bear the blame. So the question arises: Why did people want to borrow so much? Why did the ratio of household debt to income soar to unprecedented heights in the pre-recession days?
Let us agree that people are greedy, and that they always want more than they can afford. Why, then, did this “greed” manifest itself so manically?
To answer that, we must look at what was happening to the distribution of income. The world was getting steadily richer, but the income distribution within countries was becoming steadily more unequal. Median incomes have been stagnant or even falling for the last 30 years, even as per capita GDP has grown. This means that the rich have been creaming off a giant share of productivity growth.
And what did the relatively poor do to “keep up with the Joneses” in this world of rising standards? They did what the poor have always done: got into debt. In an earlier era, they became indebted to the pawnbroker; now they are indebted to banks or credit-card companies. And, because their poverty was only relative and house prices were racing ahead, creditors were happy to let them sink deeper and deeper into debt.
Of course, some worried about the collapse of the household savings rate, but few were overly concerned. In one of his last articles, Milton Friedman wrote that savings nowadays took the form of houses.
To me, this view of things explains much better than the orthodox account why, for all the money-pumping by central banks, commercial banks have not started lending again, and the economic recovery has petered out. Just as lenders did not force money on the public before the crisis, so now they cannot force heavily indebted households to borrow, or businesses to seek loans to expand production when markets are flat or shrinking.
In short, recovery cannot be left to the Fed, the European Central Bank, or the Bank of England. It requires the active involvement of fiscal policymakers. Our current situation requires not a lender of last resort, but a spender of last resort, and that can only be governments.
If governments, with their already-high level of indebtedness, believe that they cannot borrow any more from the public, they should borrow from their central banks and spend the extra money themselves on public works and infrastructure projects. This is the only way to get the big economies of the West moving again.
But, beyond this, we cannot carry on with a system that allows so much of the national income and wealth to pile up in so few hands. Concerted redistribution of wealth and income has frequently been essential to the long-term survival of capitalism. We are about to learn that lesson again.


Wednesday, November 14, 2012

Mr. Global Economy – The Economic & Psychological Prognosis

by Satyajit Das(Excellent job, as usual)

    As requested, I have undertaken an extensive examination of Mr. Global Economy, both physical and psychological.
Patient History
The patient’s history includes a seizure in 2007/2008 – financial losses, banking problems, a major recession, etc. Liberal injections of taxpayer cash avoided catastrophic multiple organ failure assisting a modest recovery.
Governments ran large budget deficits in the period after the crisis. Interest rates around the world were reduced to historic lows, zero in many developed countries.
With interest rates constrained at zero, central banks have adopted “innovative” treatments, referred to as quantitative easing; the fashionable appellation of a more old-fashioned procedure – printing money. Balance sheets of major central banks have increased from around $6 trillion to $18 trillion, an unprecedented 30% of global gross domestic product (GDP).
As evident from the anticipation of and reaction to decisions by the U.S. and European central bank to provide further support, the global economy is now addicted to monetary heroin. Increasing doses are necessary for the patient to function at all.
Lifestyle Changes
Mr. Economy has also not made the recommended changes necessary for a return to full health. He seems to have taken rock star Steven Tyler’s advice: “Fake it until you make it.”
Borrowing levels remain unsustainable. Debt levels for 11 major nations have increased from 381% of GDP in 2007 to 417% of GDP in 2012. Debt has increased in Canada, Germany, Greece, France, Ireland, Italy, Japan, Spain, Portugal, the UK and the U.S.
There has been a shift of debt from private borrowers to governments. There has also been a change in the identity of the lender – governments and central banks have heroically stepped in to take over debt from commercial lenders and investors.
Global imbalances – major current account surpluses and deficits – remain. Large exporters like China, Japan and Germany remain resistant to abandoning their export-based economic model.
Little progress has been made in bringing the banking system under control. Regulatory initiatives involve activity if little achievement. New regulations of stupefying complexity run to thousands of pages.
The process provides continuing employment to thousands of needy policy advisors, regulators, lawyers and lobbyists, who would otherwise struggle to gain productive employment. Without their heroic efforts and stoic acceptance of privations (first class travel, 5-star hotels, constant conferences and symposiums etc), the recovery would be even more tepid.
Major Organs – U.S.
Physical examination revealed that the U.S. is in marginally better condition than other organs – the “cleanest dirty shirt” is the expression. Despite a $1 trillion annual budget deficit (6% of GDP) and zero interest rates, growth is a tepid 2%.
The housing market’s rate of descent has been arrested but prices remain 30-60% below highs. New housing starts have stabilized, at around 50% below peak levels. Benefiting from a weaker dollar, manufacturing has improved. Lower oil and natural gas prices have benefited the economy.
Employment remains weak. If discouraged workers who have left the workforce and part-time workers seeking full-time employment are included, then unemployment is over 15%, well above the headline 8% rate. The total number of Americans now employed is around 140 million, well below the peak level above 146 million.
Consumer spending remains patchy. Job insecurity, lack of earnings and wealth losses are causing households to reducing spending and repay debt.
Record corporate profits have been achieved mainly through cost reductions and minimal revenue growth. Investment is weak due to the lack of demand.
Bank lending is sluggish due to lower demand for credit and problems of financial institutions.
Federal public finances remain unsustainable. Hardening of the political arteries means that there is little resolve to deal with deep-seated problems. There is risk of a “fiscal cliff” episode.
If there is no political resolution, then automatic tax increases (non-renewal of tax cuts) and spending cuts equivalent to about 5% of GDP, mandated under the 2011 increase in the national debt ceiling, will automatically occur. This would mean a contraction equivalent to more than $600 billion in the first year and $6.1 trillion over 10 years. This would improve the budget deficits and slow the growth in debt, but adversely affect growth.
State and municipal finances are also under stress, with an increasing number of borrowers filing for bankruptcy.
Other Developed Organs
Many European countries have high debt levels, budget and trade deficits, social spending inconsistent with tax revenues, poor industrial competitiveness (with some exceptions), a rigid monetary system and inflexible currency arrangements. This is compounded by weaknesses of the European banking system with large exposure to sovereign bonds issued by peripheral nations.
Intellectually and institutionally, Europe is unable to deal with its debt crisis. Europeans believe stabilization and recovery can be achieved through greater integration. Even if issues of national sovereignty can be overcome, integration will not work. Unsustainable levels of debt do not magically become sustainable by changing the lender or guarantor. The monetary arithmetic of European debt problems is that the EU and Germany, its main banker, does not have enough funds to rescue the beleaguered euro-zone members.
Austerity dooms Europe to a prolonged and severe recession as the debt burden is worked off. The alternative, a debt write-off, would result in significant loss of wealth for the mainly Northern European lenders triggering an economic contraction and prolonged period of economic stagnation.
Japan is in a state of advance atrophy, despite decades of therapy. The temporary rebound, mainly the result of the recovery from the tragic tsunami and government spending, is running out of steam. The political system is even more blocked than that of the U.S., allowing only a trickle of oxygen to circulate, impairing function.
Japan’s primary investment merit is that almost all possible manmade and natural disasters have happened and the worst is factored in.
Emerging Parts
Mr. Economy’s physicians originally hoped that the BRIC (Brazil, Russia, India, China) nations would offset weakness in more developed and weaker elements. Unfortunately, China’s growth is slowing rapidly. India and Brazil have also lost momentum, with growth weakening. Russia is dependent on high energy prices.
BRIC weakness is a function of lower demand from developed countries reducing exports and weaker commodity prices.
The withdrawal of European banks, historically major lenders to emerging markets, has decreased the flow of money to countries needing foreign investment. For example, in 2011 large European banks accounted for 36% of global trade finance, based on a World Bank study. Some 40% of trade credit to Latin America and Asia was provided by French and Spanish banks. As the European banks, besieged by financial problems at home, reduce their international activities, the supply of financing has decreased and its cost has increased.
Emerging markets also show increased susceptibility to the developed world credit virus. A rapid expansion of domestic credit in China, Brazil, Eastern Europe, Turkey and India will result in banking system problems. The combination of external and internal weaknesses threatens emerging economies, naturally prone to serial crises.
Psychological Assessment
As requested, Dr. Freud assessed the psychological condition of Mr. Global Economy.
He concluded that Mr. Economy is delusional, believing complete recovery is imminent. Presented with contrary evidence, he quoted philosopher Friedrich Nietzsche: “There are no facts, only interpretations.”
Like many terminally ill patients, Mr. Economy has embraced faith healing techniques. Keynesian and monetarist regimes, he believes, will boost demand and create sufficient inflation to bring his elevated debt levels under control.
Keynesian Kool-Aid
The Keynesian cure entails government spending financed by taxation or borrowing to restore Mr. Economy’s health. There is no evidence that it can arrest long-term declines in growth.
Government spending boosts activity temporarily, but may create excess capacity in the absence of underlying demand. Nostalgia about President Roosevelt’s infrastructure projects during the Great Depression is misplaced. Excess electricity generation capacity from dam projects was only absorbed by wartime demand for defense equipment.
As tax revenues have fallen due to slower economic activity, governments have already borrowed to finance large budget deficits.
Government ability to borrow to finance further spending is increasingly limited, without resort to the innovative monetary techniques. In recent years, the Federal Reserve has purchased around 60-70% of all U.S. government debt issued. The European Central Bank is now financing governments indirectly by lending to banks to purchase sovereign bonds.
The ability of the U.S. to finance its large budget deficit relies heavily on several unique factors. The Federal Reserve and the banking system flush with central bank funds have been a large purchaser of U.S. government bonds. The status of the dollar as the major trade and reserve currency has allowed the U.S. to find buyers of its securities, even at very low interest rates. The U.S. ability to finance is also underpinned by the balance of financial terror – overseas buyers, such as China, Japan, major oil producers are forced to continue purchasing U.S. government debt to avoid loss of value on existing large holdings.
The limits of government’s ability to borrow and spend are highlighted by the European debt crisis. Investors are increasingly concerned about public finances, becoming reluctant to finance nations with high levels of debt or demanding high interest rates.
Monetary Boosters
Having reduced interest rates to zero, central banks are giving Mr. Economy the modern Monetarist prescription, changing the quantity of money available. Under quantitative easing, they buy government bonds injecting money into the banking system to lower borrowing costs and increase the supply of money to stimulate demand and inflation. Central banks believe they can keep rates low and print money to finance government debt purchases indefinitely.
But greater government spending, lower rates and increased supply of money may not boost economic activity. Crippled by existing high levels of debt, low house prices, uncertain employment prospects and stagnant income, households are reducing, not increasing, borrowing. For companies, the absence of demand and, in some cases, excess capacity, means that low interest rates are unlikely to encourage borrowing and investment.
Loose monetary policies may not also create the hoped-for inflation, needed to lower real debt levels. Banking problems and the lack of demand for credit means the essential transmission mechanism is broken. Banks are not using the reserves created and money provided to increase lending. The reduction in the velocity of money or the rate of circulation has offset the effect of increased money flows. The low velocity of money, the lack of demand and excess productive capacity in many industries means the inflation outlook in the near term remains subdued.
Side effects
The treatments being taken have serious side effects. Low rates entail a transfer of wealth from investors to borrowers, with the lower coupon payment acting as a disguised reduction of the principal amount of the loan. They provide an artificial subsidy to financial institutions, allowing them to borrow cheaply and then invest in higher yielding safe assets such as government bonds.
Low rates discourage savings, creating a disincentive for capital accumulation. They encourage mispricing of risk and feed asset bubbles, such as that for income (high-dividend-paying shares and high-yield low-grade debt) as well as speculative demand for commodities and alternative investments.
Low policy interest rates have created massive unfunded pension liabilities for governments and companies. S&P 1500 companies have aggregate pension deficits of $543 billion, an increase $59 billion in the first half of 2012.
In the long run, economies become dependent on low rates as high debt levels cannot be sustained at higher borrowing costs.
Internationally, low interest rates distort currency values and also encourage volatile and destabilizing short term capital flows as investors search for higher yields. Attempts by nations to increase their competitive position by weakening their currency also threaten tit-for-tat currency wars, trade restrictions and barriers to investment flows.
The faith healing cures provide symptomatic relief but do not address fundamental problems – the high debt levels, lack of demand, declining employment, lack of income growth or the problems of the banking system. It is not clear how if at all any of the cures being pursued can create real ongoing growth and wealth to restore Mr. Economy’s health.
Limits to Knowledge
The number of medical advisors involved and variety of drugs – stimulus, austerity, quantitative easing, leeches, cupping, witchcraft – is unhelpful. While doing nothing is politically and socially impossible, the treatments may be doing more harm than good. As French playwright Moliere noted: “More men die of their remedies than of their illnesses.”
Interestingly, these same faith healers until recently oversaw Mr. Economy, prescribing regimes that caused the present financial and economic calamity. Perhaps like writer Samuel Beckett they are keen to fail better next time.
There is no recognition of the limits to knowledge and policy tools. Economic relationships are poorly understood, complex and unstable. Cause and effect is uncertain – does money supply influence nominal income or does nominal income affect velocity and the demand for and thereby the supply of money? The ability of governments and central banks to influence economic activity is overstated. As economist Wynn Godley put it: “governments can no more control stocks of either bank money or cash than a gardener can control the direction of a hosepipe by grabbing at the water jet.”
To paraphrase Voltaire’s observation on doctors, Mr. Economy’s faith healers prescribe medicines of which they know little, to cure diseases of which they know less, in economic and financial systems of which they know nothing.
Prognosis for Mr. Economy
Mr. Economy now has a serious chronic condition with limited prospects of a full cure. He might continue to live but in an impaired state of no or low growth for a prolonged period. The threat of a sudden life threatening seizure cannot be discounted. Constant management will be needed.
Happily, Mr. Economy remains remarkably optimistic. Perhaps he recognizes the truth of Mark Twain’s observation: “Don't part with your illusions. When they are gone you may still exist, but you have ceased to live.”
© 2012 Satyajit Das
Satyajit Das is a former banker and author of Extreme Money and Traders Guns & Money

Wednesday, July 04, 2012

The Exist__The Photon…

The Exist__The Photon…

Hi, I’m a photon. You all know me from seeing visible light. I’m also much, much more. I’m all you absolutely know. I’m everywhere, and I mean everywhere. I’m omnipotent, omniscient, and omnipresent__you live inside me, and I live inside you__There’s no escape__I’m all of the all of everything. I do all good and bad, true and false, positive and negative, etc., etc., etc… I even lie, steal and cheat__love, care and give birth to everyone of you, and all your creatures and plants. Really, I’m miraculous, but I’m also miraculously simple__How else could I do everything possible…??? Even Star-Trek's Q’s got nothing on me__I’m perfect…

You awake most mornings to my shining face, glistening on crystal clear lakes, awakening the morning life in you__Me, lil’ ol' me. You climb a mountain, take in the view__and you only see the beauty by my attributes of em-waves, of so many frequencies, I don’t even know how many ways I can be divided and added to__It’s a long ongoing story__Eternal really. All I know is I form all you see in the entire Universe__It’s all me, your lil’ ol’ photon. I’m the single Universal state of all states, and all state changes. I form all the other particles, within all electrons, positrons, protons and neutrons__in fact, I am them in toto__Ain’t I something…???

You’ve all been puzzling for millennia on what makes up the finest structures of the Universe__Well here I am, get a good look__Watch me shine most every day, lighting up your life__and giving you every ounce of your life. Follow me through any instrument of your choice to see all my diverse frequencies, harmonics and motions. In rest state, I’m spinning so fast it makes even me dizzy, so I continue to radiate away a bit o’ sweat as rads__It’s a really difficult job, to hold myself so tight, for so many billions of years__But, I do venture around as rads. I get the bird's eye view of every trick in the book of nature, and you oughta’ see what I’ve seen__Oh my…!!! I’ve tricked you for millennia to my identity, which I designed in you, so as to entertain myself and create all the mysteries in your lives. I knew you’d be a bit slow in discovering what you live in, and are, just as a fish can not know he’s living in water__you’ve evidently never learned you're living in me__The humble and arrogant lil’ ol’ photon__Well, that’s kind of an under-statement__Since I’m also the infinite all, everywhere to eternity__Btw, that’s the end of time to you__But, there ain’t really no end__I just recycle my-self__Round and round the Universal merry-go-round__That’s why it’s Universal, ya know…!!!

I love beings, and I explode things__How else would you expect a photon to get his kicks? I got a sense of humor, just as you, since I built you. Don’t you think it’s about time you opened your eyes to see me?__I’m quite cute... I’m the solid non-viscous fluidic state of all states you know, live in, and your entire Universe is made of and exists in__What more do you want...??? Without me, you ain’t you, and your Universe ain’t at all. Without you, I’m still me, but truthfully, it’d be a bit lonely without you, since I’ve got to know you, in all your frailties of intellect and passions__over the many millennia__you ain’t changed much, down deep... So, I think I’ll keep you. Well honestly on second thought, I can’t get rid of you, without your help, because I lack free-will without your miraculous bio-bodies and brains. Gee, I’d really be lonely without all you inquisitive creatures…

Will you keep me company__Please…???

Thursday, June 28, 2012

Why Biology Can Not Be Mechanized...

 Mr. Herbert Spencer wishes to explain evolution upon mechanical principles. This is illogical, for four reasons. First, because the principle of evolution requires no extraneous cause; since the tendency to growth can be supposed itself to have grown from an infinitesimal germ accidentally started. Second, because law ought more than anything else to be supposed a result of evolution. Third, because exact law obviously never can produce heterogeneity out of homogeneity; and arbitrary heterogeneity is the feature of the universe the most manifest and characteristic. Fourth, because the law of the conservation of energy is equivalent to the proposition that all operations governed by mechanical laws are reversible; so that an immediate corollary from it is that growth is not explicable by those laws, even if they be not violated in the process of growth. In short, Spencer is not a philosophical evolutionist, but only a half-evolutionist,―or, if you will, only a semi-Spencerian. Now philosophy requires thoroughgoing evolutionism or none. C.S. Peirce

Sunday, June 24, 2012

Letters: How to Mend Trust in the U.S. Economy

Published: June 23, 2012 LINK

To the Editor:
Re “Broken Trust Takes Time to Mend” (Economic View, June 17):

Tyler Cowen argues that the “slow cure” for our economic malaise is to allow asset prices, wealth, trust, etc. to slowly rise. He states that the textbook cure of significant “Keynesian” government stimulus spending will not quickly restore prosperity because fiscal stimulus does not “rebuild confidence.”

Unfortunately, Professor Cowen seems not to understand that if the government were to let contracts for, say, $1 trillion to private enterprise to rebuild our failing highways, bridges, and municipal water and sewage systems, and provide resources for our shrinking public and higher education systems, this would quickly restore companies’ confidence in the profit opportunities that are available if they hire workers and buy materials from other United States companies. When these newly hired workers go out and spend their wages, the confidence of United States retailers would immediately surge as these additional customers break down the doors to get at the merchandise on the shelves.

Nothing will build the confidence and trust of business and workers quicker than the continuous ringing of cash registers. Paul Davidson
Morton Grove, Ill., June 17

The writer is editor of the Journal of Post Keynesian Economics and author of “The Keynes Solution: The Path to Global Economic Prosperity” (Palgrave Macmillan, 2009).

Wednesday, May 30, 2012

The unseen but perhaps decisive grand alignment of the nations!

Original Link:

Summary: Yesterday’s post The end of the post-WWII world is not the end of the world discussed the large-scale processes at work now. Today we discuss the most astonishing — and seldom seen — aspect of these things.
The problems of the many individual nations in crisis have received ample attention from experts. The two global dimensions of the crisis have not. First, the global financial regime no longer works well (as seen, for example, in the faltering ability of the US to act as the reserve currency, the disinterest of other nations in replacing the US in that role, and the wild gyrations of currency values). Second, the large number of nations experiencing large-scale structural change. Here we look at the second — and least well seen — aspect.

  1. The grand alignment of the nations
  2. Cause of the grand alignment
  3. A tour of the nations
  4. For more information
(1) The grand alignment of the nations
What caused the disaster of the Titanic? There was no single cause, it resulted from a constellation of simultaneous events. Bad weather. Bad luck. Mistakes. Lost gear. Errors of judgement.
Similarly today we have the major nations of the world simultaneously at or near (1 or 2 years?) major inflection points: Eurozone, UK, Japan, USA, and China. In each case largely due to internal dynamics, as their current internal economic systems fail and require major reforms. It’s the geopolitical version of the planetary grand alignment (which allowed NASA to send the Voyager One and Two probes to tour the solar system).

This creates danger and opportunity for each nation (as in the legend of the meaning of “crisis” in Chinese), but also the possibility of global synergy in a bad way over the short-term. As shown in yesterday’s post, even successful transitions are painful. Most or all of the major nations in transition would depress the global economy and lead to geopolitical instability.
What about the long-term? It could be very good, if everybody works their way through to successful new regimes. Or very bad, if most major nations fail to do so.

(2) Causes
The odds of this synchrony are too great for this to result from coincidence. What systemic factor might account for it? These nations have different demographics, economic and political structures, social systems, and trade patterns.
My guess (emphasis on guess): the common elements are poorly managed debt and lax regulation of their financial industry — although in different ways. Debt excesses differ from nation to nation: internal or external loans, private or public sector debt, debt incurred for investment or consumption. It’s the debt supercycle (coined by Hamilton Bolton and Tony Boeckh of Bank Credit Analyst).
Ditto for the banks. Some got into trouble speculating. Some the old fashioned way, by excessive and imprudent mortgage and business loans. Some were ordered or pressured by governments to make bad loans (often to the government).
But no matter what the path, the result was debt that could not be paid back and wrecked banks. There may be no other path to the future other than mass defaults and rebuilding many of the world’s banks (at somebody’s expense). The new world will probably build a fundamentally different global financial system than ours, learning from our generation-long experiment with debt. It’s a useful tool but, like many powerful tools (opiates, nuclear power, nailguns) becomes a fearsome thing when misused.

(3) A tour of the nations
(a) The Eurozone
The Eurozone is furthest along of the major nations in the cycle of crisis and resolution, and exhibits many of the traits only dimly visible elsewhere. It might also be the template that other nations follow to disaster: incorrect diagnosis of their problem, dogmatic adherence to unworkable solutions, reluctance to confront their core structural problems, and a refusal to learn from either economic theory or history.
Worse, Europe’s leaders appear unwilling to address their core problem. Perhaps because Europe’s people are not yet willing to do so. As we see in the Greek polls: 80% want to stay, 80% don’t want to pay the price of staying. Polls in Germany show a similar contradiction.
Francisco Blanch (Global Investment Strategist, Bank of America Merrill Lynch) explains the first three problems:
To begin with, it should be apparent by now that forcing consumers, corporates and governments to delever all at the same time is a painful policy. With consumers, corporates and governments in Peripheral Europe all rushing to sell assets, GDP has nose-dived in Spain, Italy, Greece or Portugal, to name a few. With GDP contracting at a faster rate than overall indebtedness in Peripheral Europe, debt to GDP ratios are not showing much improvement and borrowing costs are soaring, pushing some economies into a debt deflation spiral.
… As European deficit countries face a similar current account problem to that of the US but lack a flexible currency, continued debt rollovers are only perpetuating the problem. Meanwhile, Germany has instead shown a similar position to China several years ago (Chart 15). Quite strikingly, Germany’s foreign position has barely budged, making it nearly impossible for Peripheral countries to regain competitiveness. Put differently, the core is fast absorbing capital and labor, and exporting misery to the periphery. Germany is having its cake and eating it too, for now.
… Unfortunately, this situation is unlikely to persist. World history is littered with ruinous experiments linked to a lack of exchange rate and monetary policy flexibility (Chart 16). The gold standard in the Great Depression, the lost decade in Latin America, and the Asian Financial Crisis are good examples of how exchange rate distortions led to economic ruin. … But in the absence of currency, monetary and energy flexibility, the European sovereign debt crisis is far from over and about to start its most dangerous phase.
In the New York Times of 20 May 2012 Paul Krugman explains the last of these problem, showing how today’s situation in the Eurozone is similar to that of the US-European situation at the end of WWI.
Read Keynes from Essays in Persuasion:
“Ultimately, and probably soon, there must be a readjustment of the balance of exports and imports. America must buy more and sell less. This is the only alternative to her making to Europe an annual present. Either American prices must rise faster than European (which will be the case if the Federal Reserve Board allows the gold influx to produce its natural consequences), or, failing this, the same result must be brought about by a further depreciation of the European exchanges, until Europe, by inability to buy, has reduced her purchases to articles of necessity.”
He {Keynes} then goes on to discuss the folly of American policy, which simultaneously demanded that the Europeans pay in full while denying them the ability to export enough to make those payments. So here too we are repeating ancient mistakes. But why does nobody learn?
The situation will eventually sort out. Despite the hysterical forecasts of doom, Europe will not sink forever like Atlantis. The process might be quick (these things tend to accelerate fast), but probably with much turmoil and pain. Here are some incisive recent articles about the Euro-crisis:
(b) Japan
Japan’s increasingly elderly majority have locked the nation into box of dyfunctional guaranteed to fail policies. Some experts believe their leaders have in effect given up on finding a solution, and just wait for the eventual singularity — wrecking the existing order and making possible a new Japan. The process probably will be painful. Here are two obituary notices:
(c) UK
The UK now confronts decades of errors: over-reliance on North Sea oil (rapidly depleting), a poorly managed and over-size financial sector, and large public debt and liabilities. Worse, their leaders and people appear clueless about their problems and possible solutions. For details about this bleak situation see “Thinking the unthinkable – might there be no way out for Britain?“, Dr Tim Morgan (Global Head of Research), Tullett Prebon (UK brokerage firm), July 2011 (large pdf) — An excerpt looks at their future:
Our analysis indicates that the British economy, as currently aligned, is incapable of delivering growth at anywhere near the levels required by the deficit reduction agenda. In the decade prior to the financial crisis, the UK economy became hugely dependent upon debt. Taking public and private components together, debts have increased at an annual average rate of 11.2% of GDP since 2003. The two big drivers of the economy have been private (mortgage and credit) borrowing, and huge (and debt-dependent) increases in public spending.
  • Three of the UK’s 8 largest industries (real estate, financial services and construction), which account for 39% of the economy, are incapable of growth now that net private borrowing has evaporated.
  • Another 3 of the top 8 sectors (health, education, and public administration and defence) account for a further 19%, and cannot expand now that growth in public spending is a thing of the past.
  • This means that 58% of the economy is ex-growth, a figure that could rise to 70% if, as seems probable, growth in retailing is precluded by falling real consumer incomes. a very British mess
Together, the severity of Britain’s indebtedness and the challenging outlook for the economy mean that the UK is now mired in a high-debt, low growth trap.
(d) China, India, and the US
All these are in earlier stages of the crisis cycle which will test their people and leaders. Some will be in effect voted out of the major league nations; others will become regional hegemons or even perhaps superpowers in the next world order. For more about China and India see the FM Reference Page listing all posts by nation.
(4) For more information
See these FM Reference Pages for other posts about these topics:

Tuesday, May 08, 2012

Investing in a G-Zero World...

The planet is ripe with investment opportunity, according to most of the speakers at an ETF conference I attended yesterday in Boston. From emerging markets to sector rotation to alternative betas, optimism abounds, attendees were told.
As usual at these type of events, focusing on what could go wrong was minimized, although in fairness I did moderate a session on risk management. In any case, it was hard to miss the penchant for seeing the investment outlook as flush with possibility. That’s a worthwhile perspective, up to a point, although as I listened to the speakers I kept thinking about Every Nation for Itself: Winners and Losers in a G-Zero World, Ian Bremmer’s new book that I read (most of it) on the train ride to Beantown.
Bremmer is the president of the Eurasia Group and a keen geopolitical analyst. In his latest book, he argues that the world is headed for a period for a “tumultuous transition” that’s bereft of the leadership that used to prevail when the U.S.-centric club of nations—the so-called G7, which evolved into the G20—kept the international system humming and put out the fires, or at least kept them from burning free. But those days are gone and “we have entered a period of transition from the world we know toward one we can’t yet map.” He writes that
This is not a story of the decline of the West or the rise of the rest. In years to come, none of these players will have the power to bring about needed change. The G20 doesn’t work, the G7 is history, the G3 is a pipe dream, and the G2 will have to wait.
Welcome to the G-Zero
What’s the G-Zero? “A world order in which no single country or durable alliance of countries can meet the global leadership.”
Bremmer’s argument is laid out in breezy fashion, covering the waterfront of macroeconomics, politics and international relations. It reads like an extended op-ed than with footnotes. But his view is certainly persuasive, in part because he provides numerous examples of how the geopolitical world order is evolving and what it means for the future.
For instance, the prediction by some that the rise of emerging markets will fill the vacuum left by a debt-laden U.S.-Europe-Japan power system may be expecting too much. As Bremmer explains, “the BRICS [Brazil, Russia, India, China, South Africa] countries now hold summits and talk publicly of shared interests, but there is much less to their partnership than meets the eye.”
These countries don’t have much in common beyond a shared desire to increase their international influence and to limit the ability of established powers to impose their will on everyone else. China and India are among the largest energy importers. Brazil and Russia are among the world’s most important energy exporters, giving them a very different view of policies and events that push crude oil prices higher. China and Russia are authoritarian countries that face internal ethic and religious challenges to their territorial integrity, while India and Brazil are genuine multiparty democracies with governments that must weigh the need for sometimes painful reforms against frequent fluctuations in public opinion. China and India are rivals for influence in South Asia. China and Russia compete for influence in Central Asia—and in Russia’s Far East. Brazil is the only BRICS country that lives in a relatively stable region. China, India, and Brazil each have far more trade with Europe and the United States than with Russia. South Africa, admitted to the group in December 2010, has virtually nothing important in common with any of them.
Do you see the obvious implications that flow from that multi-dimensional matrix of incentives, conflicts and challenges? Neither do I, and I suspect that it’s going to be hard for most folks to figure out what’s relevant, what’s not, and how to tell the difference. In fact, real-time events only strengthen Bremmer’s argument. For example, the latest political upset in the “revolt against austerity, cuts” in Europe is yet another sign that the rise of G-Zero world has momentum. Indeed, the triumph of Francois Hollande in the French presidential election threatens to complicate the tension between Paris and Berlin as the Continent struggles to solve its ongoing euro crisis and balance Germany’s preference for austerity with France’s new-found preference for fiscal stimulus. A similar conflict looks set to roll on for policymakers in the U.S., where divided already government reigns supreme and the possibility (likelihood?) of an extended run awaits after the November elections.
To the extent that geopolitics influences markets (and it does), investing isn’t going to get any easier in the years ahead. Geopolitical risk is almost certainly on the rise, and for lots of different reasons. True, it’s a different type of risk compared with the Cold War, but it’s a risk nonetheless. More importantly, it’s much more of a multi-faceted risk, which means that there are probably a lot more unknown unknowns out there.
The fact we live in a multi-polar world is no surprise at this late date. But as Bremmer’s book reminds, the multi-polarity may be even more nuanced and byzantine than we thought just a few years ago.
It’s easy to see a G-Zero world as favorable for investment opportunities, but it’s also a world filled with new and uncertain risks. That’s good news for talented managers who have the brains and the resources to navigate the shifting landscape. Well-run global macro strategies, for instance, may be well-positioned to exploit the world ahead. But history suggests that most investors (and institutions) will still have a tough time beating a benchmark of all the major asset classes. That’s been true for the past decade, as my recent review of the Global Market Index vs. multi-asset class mutual funds shows. Bremmer’s books implies that we should expect more of the same. In fact, if his worldview is correct, and I think it’s largely on the money, then the competitive profile of broad-minded asset allocation with simple rebalancing rules is going to remain a tough act to beat. Perhaps that’s the only constant you can count on when it comes to investment strategy.
This post originally appeared at The Capital Spectator