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New round of financial crisis hit rather suddenly and bonds join stocks in decline.
The Mess That Greenspan MadeThe hits keep-a-comin' for former Fed Chairman Alan Greenspan. In today's installment at Bloomberg (hat tip CB), Jonathan Weil turns back the clock to 1963 when the Ayn Rand devotee was formulating his view of the world.
Ironically, this view of things might have described the current condition much better had he not been head of the world's most important central bank for 18 years.Greenspan's '63 Essay Foretold Subprime Inaction: Jonathan WeilOnce again, had he not been Fed Chairman for almost two decades, helping to transform the world's greatest economy into a country full of leveraged speculators, willing to take risks with borrowed money that they wouldn't have dreamed of years earlier, his 1963 views might be a lot more relevant today.
Why did Alan Greenspan fail to act while the roots of the subprime-mortgage crisis spread? Here's one possible explanation: The Ayn Rand disciple held fast to his unwavering laissez-faire beliefs.
Yesterday's New York Times carried a front-page article chronicling the many warnings the former Federal Reserve chairman received about aggressive subprime lenders luring unsuspecting customers into crazy mortgages they never could afford. "Where was Washington?" the newspaper asked. And where was Alan?
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I believe the best answer can be found in an August 1963 article called "The Assault on Integrity" that Greenspan, then 37, wrote for Rand's monthly journal, "The Objectivist." Judging by how he rebuffed Gramlich and others, it looks like he followed his old instincts as the subprime mess festered.
Agent of Consumers
"Protection of the consumer against 'dishonest and unscrupulous business practices' has become a cardinal ingredient of welfare statism," Greenspan began his essay, which Rand included in her 1967 book, "Capitalism: The Unknown Ideal."
"Left to their own devices, it is alleged, businessmen would attempt to sell unsafe food and drugs, fraudulent securities, and shoddy buildings. Thus, it is argued, the Pure Food and Drug Administration, the Securities and Exchange Commission, and the numerous building regulatory agencies are indispensible if the consumer is to be protected from the 'greed' of the businessman.
"But it is precisely the 'greed' of the businessman or, more appropriately, his profit-seeking, which is the unexcelled protector of the consumer.
"What collectivists refuse to recognize is that it is in the self-interest of every businessman to have a reputation for honest dealings and a quality product."
...
"Protection of the consumer by regulation is thus illusory," he said. "Rather than isolating the consumer from the dishonest businessman, it is gradually destroying the only reliable protection the consumer has: competition for reputation.
"While the consumer is thus endangered, the major victim of 'protective' regulation is the producer: the businessman."
The largely unregulated subprime-lending industry, of course, didn't turn out this way. Countless mortgage brokers and lenders didn't care about their reputations. Wall Street banks, which packaged and pitched the loans as AAA securities, didn't care about theirs either. There were quick killings to be had.
Four decades later, Greenspan's argument seems almost childlike in its idealism. Yet, judging by his inaction, it looks like he never stopped believing.
"The reality is that after years of reckless consumption and dollar debasement, Americans are now being priced out of the very markets over which they formerly held unchallenged title."
It’s unfortunate that the U.S. Supreme Court, in its ruling last week that U.S. currency is unfair to the blind, did not make the next logical step and declare it unfair to everyone who buys gasoline.
In their search for explanations as to why oil has surged past $130 per barrel, Washington, Wall Street and the financial media are as clueless as cavemen after a freak summer snowstorm. Despite the head-scratching, the blame game is nevertheless in full force.
Speculators and big oil companies are being trotted out as scapegoats, and increased margin requirements and taxes on windfall profits and futures trading have been mentioned as appropriate sanctions. It should be clear that this is pure farce, and that no one understands what is actually happening.
The reality is that after years of reckless consumption and dollar debasement, Americans are now being priced out of the very markets over which they formerly held unchallenged title. As more affluent foreigners consume more of the resources and products they previously exported to us, Americans are being forced to cut back. The rising dollar-based price of gasoline is simply an illustration of this global trend.
Poorly concealed behind contrived government statistics, the signs of America’s falling standard of living are everywhere; all one has to do is look. We are unloading our SUVs for less-desirable compacts, and are paying more to fly on crowded planes (where we pay to check luggage and dine only on what we bring onboard). We now buy our lattes from McDonald’s Corp. (MCD) or not at all, and we increasingly forego dining out, trips to the mall and vacations - just so we can scrape together enough to fill our gas tanks and kitchen pantries, pay taxes and insurance, or make credit card, mortgage or car payments.
The collective belt tightening is simply the down payment on the U.S. government’s massive bailout of Wall Street investment banks and mortgage lenders. As the U.S. Federal Reserve creates money to buy bad mortgages and other shaky securities held by banks and brokerage firms, the value of the savings and wages of everyone on Main Street will continue to fall. As a result, the costs of products previously taken for granted have begun to bite.
The various housing bills and stimulus packages now passing through Congress will add significantly to the staggering final price tag. In the end, the "free lunch" currently being dished out by Washington will be the most expensive meal ever served. The cost will be borne by ordinary Americans citizens every time they open their wallets. And $4 gasoline is just the beginning.
For all the talk of increased global demand, few seem to understand from where it actually comes. The surge in global demand is both a function of the increased purchasing power of foreign currencies and the fact that foreigners are choosing to spend more of their incomes themselves.
In other words, former Fed Chairman Alan Greenspan’s famous "global savings glut" is turning into a global consumption binge, with Americans unable to crash the party. This trend will only get worse as the dollar-denominated price of just about everything that is either imported, or capable of being exported, goes through the roof.
We can look for scapegoats all we want, but the simple fact is Americans are going to have to get used to a much lower standard of living. Those who have been putting all the food on our tables are finally pulling up chairs and are serving themselves.
Vladimir Masch has offered some radical solutions to the problems of globalization. In terms of the U.S., here is how he describes the problem:The US is currently in a precarious position, one of the most dangerous in its history. In addition to geopolitical threats, we face a severe economic shock. The enormous wealth of this country is transferred abroad at a high and accelerating rate. To finance our voracious consumption, we borrow from potential adversaries. We lose important industries and millions of middle-class jobs. With the industrial base being destroyed, our security is compromised. The country has lost every important economic weapon that can be used in thorny geopolitical situations, which will prevail in this century.At the heart of the problem is the problem of trade, a problem that few economists have addressed. Instead, we have a "relentless propaganda" machine, headed by economists on both the right and on the left--Krugman and Mankiw are examples--that globalization as practiced will bring benefits to all. Free Trade is the mantra. And here are the results.In 2006, its current account deficit will probably reach about $900B, or almost 7% of GDP, with its rise accelerating. In just one year, the deficit exceeded more than twice our expense on the Iraq war for four years. The notorious "bridge to nowhere" costs $222 million; in foreign trade, we lose that amount every two and a half hours. In 6 to 8 years, just our return payments on foreign holdings on US securities may reach half a trillion dollars a year. A large part of that debt is borrowed from China, our potential adversary; it holds now more than one trillion dollars of currency reserves, predominantly in the US debt securities, and expects to double that amount in four years. This is an ever-growing mortgage on our country, and the situation is unsustainable. Even President Bush, a religious devotee of free trade, says so.The just completed draft of the Horizon Project, which is intended to be a Marshall type Plan for America and has been authored by eleven eminent CEOs and policy
innovators, comes to basically the same conclusions. The Horizon Project talks about "a hollowing out of American productive and services capacity," about "the US international trade position … being in free fall," about "many U.S. multinational corporations which … seem tempted to off shore almost everything but consumption." Consequently, "The traditional U.S. trade surplus in agricultural products is nearing zero, in high-technology products it has turned negative, and in trade services it is small and declining as a proportion of total trade." Moreover, it considers emigration of such industries as chip manufacturing to China, Taiwan and South Korea as "very unwise," as these areas are threatened by potential geopolitical disturbance in the region that might "greatly diminish U.S. armed forces operations and effectiveness."The present relatively low rates of inflation and unemployment and satisfactory rates of growth were bought at an enormous price of transferring our wealth and labor force abroad.Vladimir addresses the so-called law of "comparative advantage", which assumes that every country will specialize in what it does best. While theoretically, the law seems elegant and incontrovertible, it ignores important externalities such as adjustment costs--re-training, etc.
Outsource everything--full speed ahead. Damn the costs. And, if the money has flowed abroad or into CEO and corporate coffers, who is to pick up the tab? How are we to adjust? How do we pay for re-training? And in what?
We are not talking here about a few people; we are talking about millions of people and uncountable industries. And then, of course, we have to wait--painfully--while wages equalize...if they ever do. And what has been the result: Enormous polarity in the distribution of wealth. So many problems; so little thought has been given to them.
No economist gave any thought to wage disparity; it simply became tucked into the law of comparative advantage.
No economist ever gave thought to labor rights as essential for sound trade. Again, labor rights became a mere externality--an uncomfortable side issue that deflates the bottom line.
Should the WTO have insisted that China protect labor rights prior to WTO entry? Of course it should have.
Right wingers love to tell us how much better off the poor peasant is in his sweat shop. Does the right winger care about sweatshop labor conditions? Of course not. Meanwhile, the rich get richer. And meanwhile, the U.S. is headed down the tubes.
And while we are at it, let me suggest another difficulty: Specialization has its own difficulties, as I pointed out in this piece: Local or Global .
Specialization puts any country at risk, especially in key commodities. And if big players with deep pockets can quickly shift money to exploit the problems, what then? According to one wag, 60% of the cost of oil is a result of one such shift. (While I do not agree with this figure, many here apparently do. And if they do, what say they then about free trade?)
Vladimir has described the problem, at least for the U.S. And what is his answer: Trade balances must be controlled. He suggests the following:Interesting, but I think unworkable.
- Congress sets annual limits (upper bounds) on the overall U.S. trade deficit in consumer goods and undesirable capital goods (oil and gas excluded)
- The President of the U.S. allocates the allowed deficit for each of our trading counterparts—countries or groups of countries
- A country may exceed the limit if its government pays the U.S. Treasury a stipulated percentage (up to the full amount) of the excess deficit, also approved for each country by the President of the U.S. These payments may be capped
- To raise the money for excess deficit payments, our trading counterparts may either use export taxes and export certificate auctions or pay from their currency reserves
Imagine telling China that it must compensate us for its trade surplus! And what do we say to poor Mexico? Or to Canada? Send us our monthly check, please.
My own solution is three-fold and it is based on the following--over 60% of China's exports are from foreign companies inside of China. Unless we address that uncomfortable fact--almost 80% in IT--, our goose is cooked.
- Insist that all countries protect labor rights. No more fast track trade deals that are merely grease for our companies to find cheap labor.
- Reform the WTO or withdraw from it. The WTO should immediately start a process whereby all WTO countries move towards an acceptable standard for the protection of labor. Better late then never.
- Tax goods that U.S. companies make with cheap overseas labor. Put a price on outsourcing and offshoring. Hey, Intel and Apple, no more free rides. Hey, Walmart, your prices are going up. Time to compete fairly.
As someone who in not an economist, but who has to make investment decisions based in part on understanding what is going with oil, I have been devoting some effort to this issue. Particularly after Krugmann's essay claiming supply and demand is the only possible explanation, I tried hard to understand if he was right because my bias is to think he isn't.
Since I don't have the theoretical expertise, after a while, due to my science training perhaps, it occured to me to use the data. smart huh?
So... if the price of oil is purely reflective of supply and demand, then it necessarily follows that when the price of oil dropped precipitously immediately prior to the 2006 election, a drop that was a bigger delta than across the entire 2001 recession period, (in a matter of weeks, not years), it follows that this must have been entirely due to supply and demand. uh, no. No way, sorry not buying it. The idea that supply in 2001 was tighter than in 2006, or that demand in 2006 with the economy booming, was less than than demand at the bottom of a recession, and that moreove this change happened in a couple of weeks, instead of a couple of years is... absurd.
It is in fact, beyond absurd, it is manipulative to even propose it. That price drop in 2006 clearly demonstrated that oil prices are affected by things other than supply and demand. You may choose to believe that it was a nefarious manipulation of price or that it was a surprise consequence of Goldman Sachs for some reason choosing to make a change, but you cannot argue that supply and demand together swung by that amount in that short of a period of time with little or no macro cause, or consequence interestingly enough.
The whole thing is absurd, and for any economist to devote more than one word of theorizing about why it isn't a consequence of the financial market structure, is for them to be engaged in foolish sophistry, at best or outright duplicity at worst
A reader pointed me to a great post at Institutional Risk Analytics, which consists of an interview with Richard Alford, an economist in the Federal Reserve Bank of New York's foreign department during the heady years of the Plaza Accord and active FX intervention by the Group of Seven who now works as an expert in macroeconomic trends.
I'm particularly keen about Alford's views because he picks up on themes that are important yet sorely neglected. One is that the US formulates its monetary (indeed its broader economic policies) as if the nation was an independent actor. The role of the trade sector and our dependence on boatloads of foreign inflows to fund our trade deficits is missing from the official calculus (note this is also one of my pet peeves in most analyses of the Great Depression: the role of the breakdown of the financial flows among Germany, which had to pay reparations to England, which had to repay war loans from the US, which in turn was lending money to Germany to pay its reparations, is generally omitted). Alford says the Fed in fighting deflation has misread the US situation. He also warns our trading partners don't believe we will drive the dollar to the level required to get US consumption back in line (he has an intriguing view of why other countries won't be so keen to step into the reserve currency role).
Alford, with his focus on the trade/international funds flows component, highlights another aspect too often neglected: our unsustainable level of consumption and what bringing it down might entail. He is blunt in saying that the Fed did damage by defining the problem incorrectly and implementing wrongheaded measures. It's a compelling, sobering analysis.
From Institutional Risk Analytics:The IRA: Dick, in your latest missive you say that the Fed has misread inflation for deflation, and that former Fed Chairman Alan Greenspan and now Ben Bernanke are fighting the wrong battles. There is clearly a lot of new inflation in the system due to energy prices, but you rarely hear anyone talking about monetary policy as a secular source of inflation.
Alford: One of the interesting aspects of economic policy in the US is a belief that we exist independent of the rest of the world. In the minds of many policy makers, the US is the focus and the rest of world economy is just a stable background. To open the model up to external factors, market imperfections, and quasi-floating exchange rates would increase the complexity of the model and limit the number of policy prescriptions that could be made, so most US economists pretend that the rest of the world does not exist, is stable, or that the dollar will quickly adjust so as to maintain US external balances. It has only been in the past few years that the trade deficit has moved to a level that is clearly unsustainable. The US economic model is yet to catch up with reality.
The IRA: But don't you argue that because no other nation wants to be a reserve currency this allows the US to play this game without limit?
Alford: A lot of people thought that the game would end when foreign investors no longer wanted to hold dollars. All of a sudden China and Japan or OPEC would just say "no mas." But the problem with that view is that in most cases the reason to accumulate dollar reserves still exists. China, among others, still wants to grow through exports. They'll let the exchange rate appreciate until it really affects their growth, but no more. In addition, it is useful to remember that for a currency to function as a reserve currency, non-residents must hold large net claims denominated in that currency. This can only happen if the country of issue runs a large current deficit. I do not see any policymaker in the EU or Japan permitting large current account deficits. The dollar still may be the only game in town. But the other part of the equation, what people often forget, is that Americans must also be willing to hold more debt. At some point - and I think we are here now - Americans are not going to want their debt to income ratio to go up any more. They will stop borrowing and this whole game is going to come to an end. If Americans can't or won't borrow, they can't spend and the US economy goes into recession.
The IRA: Not only a recession, but a lowering of overall expectations, don't you think?
Alford: The primary effect is going to be that aggregate demand growth, especially consumption, is going to fall. We'll be at a point where the Fed can lean on monetary policy, but like Japan, these policy moves will do absolutely nothing. I can see a rather long period where the US underperforms trend growth by a significant amount.
The IRA: But going back to the point about the insular US mentality, isn't it obvious that once debt and other sources of new "bubble" financing are exhausted that we must see a downward adjustment in consumption?
Alford: If you look at the difference between gross domestic purchases and potential output, by US consumers, businesses, and government -- all are above potential output. The only time in recent memory when the difference between these two measures started to narrow was in 2001 when we were in a recession. One of the things we need to consider is that that US may need to see consumption drop significantly before we can achieve a sustainable position, for example vis a vis the dollar. That is going to be painful. I think private consumption must drop because a fall in investment will further limit income and job growth. I do not believe government expenditures are about to contract nor do I believe that the US has "decoupled" from the rest of the world. If we slow our growth rate and our consumption falls, then the rest of the world will slow as well.
The IRA: Correct. So if, for example, you take the worst case scenario of our friend Nouriel Roubini for US consumption, such a retreat by American consumers could ripple throughout the global economy, possibly causing an absolute decline in trade and financial flows.
Alford: Part of the issue is that where the US does have exchange rate flexibility, it is where we least need it. We certainly are competitive with the EU, but there are parts of the world where we are not competitive, where the exchange rate is not moving or not moving quickly enough. But we've past the point where prices alone- namely exchange rates - could adjust the system. Now we see income starting to adjust.
The IRA: Americans certainly are feeling the adjustment, especially in view of energy prices. Given what you see on the trade and economic front, how would you characterize Fed monetary policy?
Alford: Fed policy has been inappropriate to say the least. If you listen to Chairman Bernanke, he and the members of the Board of Governors are responding to the prospect of deflation in the US - a deflation which he describes as the result of a shortfall in aggregate demand.
The IRA: Thus the Bush stimulus package.
Alford: Yes. My view is that the demand side is fine. Remember, US domestic purchases are still running around 105-106% of potential domestic output. The problem is not the level of demand but rather the composition of demand. Americans are buying too many imported goods and the world is not buying enough of our exports. So we have a growing wedge growing between gross domestic purchases, which is what the Fed really controls, and net aggregate demand, which is defined as gross domestic purchases less the trade deficit. Given the inability or unwillingness of the US to correct the trade imbalance, the Fed has run expansionary monetary policy almost continuously, generating higher levels of domestic purchases so as to keep net aggregate demand near potential output. The Fed did this using low interest rates, which generated asset bubbles, large increases in consumer debt and sharp declines in savings, and also a larger trade deficit. What has been totally missing is any policy aimed correcting the external imbalance. We are relying on the tools of counter-cyclical domestic demand management to address problems caused by a structural external supply shift.
The IRA: All in the name of maintaining the nominal appearance of growth. So what measure does the Fed use to gauge its policy actions? Is the Fed's measure the dollar or what Americans have come to expect in terms of income levels?
Alford: The Fed is living in a Taylor rule world. Given the Taylor rule framework and the deflationary impact of globalization, the policy goal has been to generate sufficient levels of demand to support full employment. It is important to note that the Taylor rule framework implicitly attaches zero cost to growing external imbalances or financial instability. They are trying to get net aggregate demand to equal potential economic output. That would be fine if we did not have a net trade sector or at least had a stable net trade sector. But globalization has occurred and we've had a flood of imports which have depressed prices in tradable goods. Fed Governor Don Kohn gave a speech recently that said imported deflation knocked 50-100 basis points off measured per annum inflation. At the same time, rising imports have hurt American workers. From the US is an island, Taylor rule perspective, such a result is consistent with a shortfall in aggregate demand and requires expansionary policy. But today the underlying problem is not deficient US demand, but a structural external increase in supply (globalization). Given the inability of the dollar to serve as an adjustment mechanism, we are consuming too many imports, but instead of US policmakers addressing this global development, we created a number of unsustainable domestic imbalances to keep employment at politically acceptable levels. Higher levels of debt and asset bubbles have been the result of policy responses to external imbalances.
The IRA: Your description of the macro economic situation makes us think of the deteriorating credit quality of the American consumer. The higher debt levels and reliance upon speculative binges to manufacture the appearance of economic vitality at the national level ultimately manifest as higher default rates for individual consumers. Your scenario for the US adjustment process makes us feel even more bearish about US bank asset quality, if that is possible.
Alford: It seems that while the regulators and the Congress abhor (some might say abet -- editor) leverage and dodgy financial structures, they are also addicted to the asset prices only reached because of leverage and financial engineering. So now it seems that that the authorities will want better capitalized banks to support inflated asset prices previously reached through excessive leverage! We'll see how the great deleveraging plays out.
The IRA: Right, but this is not a particularly credible policy for a central bank to take over the medium to longer term. In the meantime, something had to move - namely the savings rate?
Alford: Yes, something had to move. You had to have net demand rise relative to income, which means that savings had to fall. Since 2000, the demand increases relative to GDP in the US mostly came from the consumer and housing sectors. Now with domestic demand waning, the attention has turned to stimulating foreign demand via a weaker dollar.
The IRA: OK, so what happens when the US consumer reaches the natural limit in the deterioration in their credit quality? When consumer have to become net savers, how much of US aggregate demand disappears from GDP?
Alford: That is a very complex question and one that is best addressed in pieces rather than via a point in time forecast. If the US consumer were to go back to savings rates of the 1996 period, then you are talking about savings going from essentially zero today to approximately 8% of disposable income. Since US GDP is about 70% consumption, that implies a decline in demand of about 5 to 5.5%. That would be a very dramatic effect. I don't think that this type of shift will happen all at once. It would occur over time. A shift back to a higher level of savings by the US consumer implies that the actual growth rate of the US economy will trail potential growth and will not support full employment-unless the trade deficit collapses.
The IRA: Well that's precisely the point, is it not? The US has an aging population that is intent upon drawing down savings in the later years of their lives. This means that the relatively smaller population of younger workers must be saving like crazy to offset the continued dis-saving by the Greatest Ever Generation.
Alford: Young people will have to save like crazy and the public sector will also have to save as well, though recent history is not encouraging in that regard. The Clinton deficit drawdown of the 1990s was a transitory event driven by tax policy and bubble induced stock market capital gains, not the underlying dynamics of the US economy.
The IRA: So how does the Fed's moves to re-liquefy Wall Street and bailout Bear, Stearns (NYSE:BSC), JPMorgan (NYSE:JPM) and the rest of the dealer community figure in the monetary policy equation?
Alford: Lots of people in a position to know have told me that they could not say no to a BSC rescue, that it was OK for the Fed to intervene. We'll it's not OK. This intervention may have been necessary, but it is also very troubling. To say it is OK or doesn't free policymakers from responsibility for their role in promoting the financial excesses that lead to the current dislocations in the world's financial markets. The policies that we followed since 1996 explain how we got to the present juncture, including keeping Fed Funds at 1% for almost a year and then the Fed taking its sweet time raising rates, and doing so in quarter point increments! The Fed's actions provided an incentive for economic agents to lever up and run maturity mismatches. Even households went out and got ARMs while the Fed was keeping rates artificially low! Banks (SIVs) and municipalities (auction rate securities) and corporate were all funding long-term obligations with short-term debt, so it's no big surprise that the economy takes a hit when rates finally rise back to normal. Short-term interest rates were clearly too low for financial stability in the early part of the decade and everyone in the US economy was running grotesque maturity mismatches that have now collapsed.
The IRA: So it was Fed monetary policy that has in fact created a safety and soundness problem in the US?
Alford: Yes. The policy stance was sufficient to generate asset bubbles and misallocations of resources. The regulatory system helped shape the crisis, but isn't a sufficient explanation for the crisis arising. That is a far easier explanation than to say that the regulatory system somehow simultaneously failed in the mortgage industry, the banking industry, municipal finance, etc and that we now require new layers of regulation in every corner of the financial system to correct the imbalances in the system. The Fed's monetary policy, in fact, was a necessary component of the systemic instability. No amount of regulation could prevent market participants from taking advantage of the incentives created by the Fed from 2001 through 2005 via extreme easy money policy. The incentive to run maturity mismatches would still be there and people would find a way to take advantage of it. This is not say that all regulation is futile, but rather that incentives are also important.
The IRA: So Milton Friedman was right when he said that keeping money policy relatively stable helps to avoid other evils.
Alford: The Fed has taken an approach that focuses on apparent price stability to the exclusion of other policy goals. The problem is that while price stability is necessary for long run economic and financial stability, it is not sufficient. When the Fed decided to focus on relative price stability, the US did not have a functional policy regarding the dollar. We did not and still do not have a functional trade policy. We have deficient regulatory policy. So by pursuing this one policy goal, which would be admirable if there other areas were being addressed, the Fed actually contributed to vast problems elsewhere.
The IRA: In fairness to the Fed, aren't they simply trying to make up for a government that is completely dysfunctional in areas like trade and the dollar? The Bush Administration's approach to things like economic policy is to simply have no policy.
Alford: It is incumbent on the Fed to go to the Congress and even the American people and say "we do not have the tools to address globalization." The Fed can clearly ease the transition, but adjusting the Fed funds rate is not an adequate response to the changes that the globalization of trade and investment flows are having on the US economy.
The IRA: Agreed. Why is it that the Fed cannot tell the White House and the Congress that these issues fall outside the realm of monetary policy?
Alford: Under Greenspan, there was this aura at the Fed that said "let's take credit for everything that's good" regarding the economy. The trouble with that position is that politicians and markets then expect the Fed to keep the party going. Fed policy, monetary policy has been vastly oversold. By focusing on short-term inflation and employment, the Fed misses a lot of other factors - like global trade and investment flows, like the decline in household savings as percentage of income, like leverage in the financial markets - which we can now see are rather important. Going back to the early part of the decade, economists within the Fed system apparently saw a world where US prices and incomes were made at home. Now we see that is not the case. In the EU and around the world, currency movements are seen as a constraint on monetary policy, but in the US economists have grown up thinking that the dollar would never be a constraint on policy. I think that the FOMC was probably a little surprised recently when they found that the dollar and commodity markets impinged on their ability to ease.
The IRA: Fine, so let's assume that you are a Fed governor - which we think is a good idea, by the way - what would you do differently?
Alford: Asking what should have been done in 1996 or 2000 is a tough enough question because the imbalances were all smaller, but today by comparison we have serious problems. Politically and economically, there is no painless solution to the imbalances in the US. For US policymakers, it seems that even short-term pain is intolerable. Nobody in Washington wants to bite the bullet and explain the full dimension of the required change to the US electorate, so we muddle. Going back to the early 1990s, US politicians have bought support from the voters by keeping consumption on an ever rising trajectory. For at least 12 years, we've had debt induced increases in consumption and the political class optimized their behavior to maintaining that illusion of rising consumption even as the economic fundamentals worsened.
The IRA: Members of Congress actually believe that endlessly rising home prices are now part of the American Dream.
Alford: Precisely. The US population is not ready to hear that their real levels of income, assets prices and other indicia of national well being may be falling or relatively stagnant for the foreseeable future. This is just politically not acceptable. So our politicians will attempt to maintain the appearance of growth, but not address the underlying causes. Devaluing the dollar alone is not going to correct the issue. World financial markets would destabilize if they perceived that the dollar was about to depreciation enough to restore the US to external balance. They still believe that it will never happen.
The IRA: Never say never. Thanks Dick.
May 29 2008
Some say the credit crisis is over. Not Tom Attwood, managing director of Intermediate Capital Group (ICG), a firm which makes few waves outside financial circles. Its business is mezzanine finance, specialist high-risk lending to private equity firms. That puts it at the frontline of the financial turmoil and Attwood's bleak assessment of conditions yesterday is worth quoting.
Sub-prime, he says, was merely a catalyst to the bursting of the credit bubble. It was going to happen anyway. "Credit disciplines across almost all markets were bypassed in favour of loan book growth at almost any cost."
So far, so uncontroversial, and Attwood has been singing a similar tune for a while. The key point is that he can't spot the break in the clouds that many bankers claim to see. "What was a liquidity crisis is likely to lead to a credit crisis," he says.
A year or two? Well, yes. ICG assumes there will be a recession in the US, the UK, Spain - the markets most pumped up with credit - and a slowdown elsewhere.
His bottom line is: "There is no sign of a return to liquidity in debt markets as a whole. Raising new funds will become increasingly difficult across the board."
The Fed announced that Frederic Mishkin will be leaving the central bank effective August 31. The governor's term extended through 2014, but he chose to leave early to return to the Columbia faculty, where he teaches at the business school.
Personally, I think this is a good thing. Mishkin was on the FOMC and a vocal proponent of rate cuts (I'm in complete agreement with Richard Alford that the Fed is looking at the situation incorrectly and pushing the gas pedal too hard). My sense was, both due to his friendship with Bernanke and his forceful style, that his influence was far greater than his single vote.Comments
Mishkin has been to Bernanke as Bernanke was to Greenspan: he's provided the academic, intellectual justification for the Fed's deflation-fighting experiments.
It will be interesting to see whether the senate will replace Mishkin any time soon. Bernanke all of a sudden looks isolated: even Yellen, a long-time dove, doesn't necessarily buy into the Mishkin academic hocus pocus. The Chairman relies on Kohn like never before, but Kohn is only a recent convert to his line of thinking. One wonders how long the Vice-Chairman will continue to serve as an apologist for rising inflation.
financialarmageddon.com
I've often noted that the financial industry is rife with pathological optimists and clueless wishful thinkers. However, there are a few exceptions. The realists include individuals like Albert Edwards and James Montier, the highly-rated co-heads of strategy at France's Societe Generale, and Merrill Lynch's North American economist, David Rosenberg.Another individual who is not usually found in the bear camp, but who is nevertheless willing to call it like he sees it when he sees trouble on the horizon, is the billionaire chairman of Berkshire Hathaway. In "Buffett Sees 'Long, Deep' U.S. Recession," Reuters reports that the "sage of Omaha" has a less-than-sanguine outlook nowadays.
The United States is already in a recession and it will be longer as well as deeper than many people expect, U.S. investor Warren Buffett said in an interview published in German magazine Der Spiegel on Saturday.
He said the United States was "already in recession" and added: "Perhaps not in the sense that economists would define it" with two consecutive quarters of negative growth.
"But the people are already feeling the effects," said Buffett, the world's richest man. "It will be deeper and last longer than many think."
But he said that won't stop him from investing in selected companies and said he remained interested in well-managed German family-owned companies.
"If the world were falling apart I'd still invest in companies," he said.
Buffett also renewed his criticism of derivatives trading.
"It's not right that hundreds of thousands of jobs are being eliminated, that entire industrial sectors in the real economy are being wiped out by financial bets even though the sectors are actually in good health."
Buffett complained about the lack of effective controls.
"That's the problem," he said. "You can't steer it, you can't regulate it anymore. You can't get the genie back in the bottle."
When it comes to the world of business and finance, it sometimes takes tens of thousands of words to explain what is going on. Other times, it might only require a few carefully chosen sentences. In a post entitled "A Bear’s Moan" at his New York Times blog, Floyd Norris: Notions on High and Low Finance, the newspaper's chief financial correspondent highlights some brief, though very informative thoughts from a strategist who actually knows what he is talking about.
This has been a frustrating time for bears, who see disaster all around them — except in stock prices.
James Montier, an analyst with Societe Generale in London, has published what may be the ultimate scream of frustration. Entitled “Road to Revulsion,” it argues that bubbles end in total investor despair.
Here is the opening paragraph of the report:
“We have seen the heads of virtually all financial institutions stand up over the last few months and claim the worst is behind us. Who would anyone listen to those people? They didn’t see the disaster coming, and yet somehow they are qualified to tell us it is alright!
Perhaps I am just unduly skeptical, but this reeks of a conspiracy of optimism. The recession has barely started, let alone reached its nadir. The market moves of late have all the hallmarks of a classic sucker’s rally. This isn’t discounting the recovery, this is denial! Far from being behind us, the worst may still lie ahead.”
I somehow missed this piece by Robert Nadeau in Scientific American when it came out earlier this year, and I thought it made for good Sunday/holiday reading.
Nadeau's criticisms are admittedly pretty broad and similar observations have been made elsewhere (although Nadeau does add some useful historical detail), and a short piece by a non-expert is always vulnerable to criticism. But that doesn't mean that Nadeau isn't on to something. The propensity of economics to start from abstraction is limiting, yet once certain constructs become codified via textbooks, they become part of the discipline's world view.
For instance, around the time of the release of the IPCC report and the Stern report (which endeavored to assess the economic cost of climate change), there was considerable discussion of how to properly characterize the costs and risks of inaction, and the failure of market-based approaches (Brad De Long had a fine post). There have been some debates within the profession about the neoclassical orthodoxy and heterodox economics (see here and here for examples).
Now if you want to read a fair minded yet in some ways devastating critique, and a well-written, entertaining and informative one at that, you must go immediately to Deidre McCloskey's essay, The Secret Sins of Economics.
...To achieve energy independence, the U.S. needs to cut consumption of petroleum from 21 million barrels a day down to 10-11 million barrels a day (MBD), and quickly. The ignorant cheerleaders (many of whom seem to have gained elected office) are always yammering about "endless new sources of energy" but under close examination with basic high-school science, every single "miracle source" turns out to have real-world limitations.
I have covered some of these limitations in the past few months, and will mention just two (again) of the most popular "miracle cures to our need for more energy:" shale oil and coal gasification. Canada and the U.S. have hundreds of years of shale oil, tar-sand oil and King Coal, we are constantly told, yet in a peculiar oversight, nobody seems to mention that turning these hydrocarbons into liquid fuels is horrendously energy-intensive, complex and limited by physical constraints.
The best estimates by those who actually know about moving entire mountains of shale and tar sand, heating it up with vast quantities of natural gas, etc., is that total top production will reach about 2 million barrels a day--about 10% of the oil the U.S. consumes (not to mention Canada's consumption).
Gasifying coal sounds like a neato-peachy-keen "solution to our energy shortage" until you go to a vast Western strip mine and take a look at the infrastructure needed to make a paltry 2 million barrels a day. The notion that we can turn billions of tons of coal (yes, we already burn a billion tons of coal a year, and China burns 2 billion tons) into 20 million barrels of liquid fuels per day is simply absurd.
Like many of you, I think nuclear power technology has advanced (like all other technologies) since the 1960s designs which are in operation today; to dismiss nuclear power out of hand is another form of ignorance, especially when you consider the alternatives, like $300/barrel oil going to $1,000/barrel. (Yes, it could.)
But it will take years to build 100 more nuclear power plants, and they do, after all, only generate electricity, not liquid fuels. And yes, we can move to hybrid vehicles and electric tractors but those lithium-ion batteries are costly to make and replace; as the saying goes, there is no free lunch.
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Drum roll please: here are a few obvious ways to encourage conservation and making the U.S. far more energy-efficient. I know, I know, none of these are politically viable; we'll just have to watch oil go to $300/barrel before Americans will get off their duffs and start dealing with reality. But hey, it's fun to dream:
1. start supporting basic research on efficiency and alternative energy on a much larger scale. Take a look at this chart of Federally-funded research:
Here is the source article in the San Francisco Chronicle: Dan Kammen: Clean energy and America's future.
Yes, the "marketplace" is responding with its own investments but the "low cost" of oil is driving pernicious "incentives" to rely on "cheap" coal and oil. The problem is that when these "cheap" sources of energy become expensive, they will do so very quickly, and the vaunted "marketplace" won't have time to catch up.
Let's also not forget that the vast majority of technological advances can be traced back to government-funded research, work often done in University settings (like, say, nuclear technologies, the Internet, etc.), not "market-based" investment. Even most of the miracle drugs can be traced back to government research, not the pharmaceutical industry.
2. require all electronic/electrical devices to shut off rather than remain in power wasting "standby mode." Something like 5% of the entire U.S. electrical consumption is wasted by millions of transformers and inefficient circuitry in tens of millions of TVs, stereos, computers, etc.
3. mandate another round of serious efficiency improvements in all appliances. The supposedly efficient "market" did absolutely nothing about energy efficiency until the government (yes, the "evil, can't do anything right" government) imposed efficiency standards in the wake of the 1973 and 1979 oil shocks.
4. raise the mileage standards of all vehicles to 40 miles per gallon effective next year. Please don't tell me it's impossible unless you're an engineer with Honda Motor Company, in which case I would ask you to look at your own company's vehicles from 1972.
The ICE (internal combustion engine) I know best, the basic Honda CVCC, has risen from about 85 horsepower to about 120 HP in the past two decades, with a comcomitant decline in mileage (yes, some of that increase in HP is due to technology, but there are still trade-offs) . The current crop of Honda 1800CC engines could be scaled back to 1300CC with a reduction in unnecessary horsepower and a substantial increase in mileage.
And for everyone who whines that their SUV or truck needs 200 HP, recall that a Volkswagen bus (the original hippie SUV, van and truck combined) operated quite well (albeit slowly when ascending steep grades) with a 45 HP engine that was terribly inefficient.
A standard Honda-type engine of 1300CC would very easily generate enough horsepower (when properly geared) to power non-bloated pickups. Larger vehicles would work just fine with "larger" 1800CC engines producing 125+ HP.
The only real trade-off is a loss of acceleration. Autos and trucks have gotten bigger, heavier and faster, all at the expense of efficiency and mileage. Reverse those trends and you will see immediate reductions in transportation consumption, which accounts for 2/3 of U.S. oil consumption.
... ... ...
5. lower speed limits to 65 MPH and enforce the limit. This is the easiest, most obvious way to boost mileage by 10-20%--lower speeds from 75+ MPH to 65 MPH. We'll all still get there, believe me. Just as an experiment, the last time I drove home from Los Angeles (380 miles) I drove about 65-67 MPH most of the way. I wasn't in a big hurry, thiugh it certainly seemed like everyone else was; most of the vehicles whizzing past were traveling in excess of 80 MPH. (This was at night, by the way.)
The slower pace added about 20 minutes to a 7-hour drive, but is this really the end of the world? Meanwhile, because we keep our 1998 Honda Civic properly tuned and the tires properly inflated--not exactly brain surgery--I got about 42 miles per gallon in a standard ICE production engine with 10-year old technology--more than most hybrid cars which cost much more and require hideously costly batteries.
If Honda cut the engine size and HP down a bit, I could probably get 50 MPG without any reduction in driving pleasure or convenience. And so could everyone else. And I'm 6 foot 2 inches tall, so please don't tell me you need a huge vehicle. (The guy in the video link above is 6 foot 5 inches tall.)
6. close entire streets to vehicles, creating safe, convenient bikelanes. My brother-in-law and I took a pleasant bike ride recently, in honor of his visiting us, and our 40-mile roundtrip (70 KM) ride on marked bike lanes eventually took us onto the shoulder of I-580--a freeway. I am not kidding--the bike lane merged onto the shoulder of a freeway for quite some distance. A single sign marked "share the road" with a bike logo on it denoted that the drivers whizzing past should not think the two bicyclists were insane and should be arrested. Was that part of the ride enjoyable? Do you reckon?
This is in "astoundingly environmental" California.
We all know Americans are too fat for their own good, and riding a bike is, for at least much of the year in most of the country, a convenient way to get about. (You can always put on a rain slicker like people do in other countries.) But it's only pleasant and convenient if roads are closed to cars and trucks. Yes, such closures would impose a burden on vehicles, but the time for wimpy half-measures like bike lanes on freeways and busy 4-lane roads is long past.
7. subsidize bus, train ans subway rides with a $1/gallon tax on gasoline, diesel and jet fuel. To repeat: the time for wimpy half-measures like subways and trains which cost a bloody fortune to ride is long past. If we want to modify behavior to conserve energy, then we have to make it nearly free to ride a bus, train or subway and very dear to drive a car.
Yes, you can argue about commutes and how big the West is and fairness and exurbs and all the rest, but it's really very simple: if it's nearly free to take public transport or carpool, people will do so and find some way to get to the station or pickup point. Ditto for carpools and other huge, practical, behavioral (not technological) efficiency-boosts. Even a 15 MPG SUV becomes efficient when there's six people being transported in it.
8. make building in the distant suburbs/exurbs either impossible or extremely expensive, and make building more low-rise housing in the city and inner ring essentially quick and cost-free to developers, non-profit and for-profit alike. I happen to live in a college town with population densities rivaling Hong Kong (in the south of campus area), yet there are very few buildings over three stories in height. You don't need highrises to increase density, you simply need mid-height buildings (see Paris or equivalent European cities for examples; six-story buildings create a very liveable scale.)
It's a simple idea, encouraging people to live closer to their jobs, and yet we as a nation have created all the wrong incentives: it's been dirt-cheap to build 50 miles from the city but costly and tiresome to obtain permission to tear down an obsolete structure and build a liveable moderate-density building in or near the city.
You can probably add another 8 or 16 or 24 other obvious, non-fancy ideas which would require little real sacrifice. You want sacrifice? How about no light at night? How about cold water baths? How about walking 10 miles to and from school/water/work/market? This is normal life in much of the world; just how awful will it be to have a street without cars? Is that really so unbearable? How about a car which doesn't accelerate like a race car? Is that really such an immense burden that we can't bear to give it up?
Funny, nobody thought life was miserable and awful and wretched and they had to cry themselves to sleep in 1957; have you ever driven an old American pickup truck from that era, a truck with a simple engine and wood slats in the bed? They didn't exactly accelerate like greased lightning, yet somehow (breathlessly, we ask, how? How? It's impossible!) the farmwork and building got done despite a horrible, soul-draining lack of horsepower and acceleration.
Then fine, the world will take it away from us in it's own time--which will be sooner than most of us can possibly imagine.
Extra-special bonus idea: convert all large U.S. Navy ships to nuclear power plants. The U.S. Military uses as much oil as the entire nation of Sweden; surely there are some efficiencies which could lower this stupendous consumption (along with curtailing U.S. involvement in Iraq.)
Companies are now facing a squeeze. Figures from Britain this week showed that firms had pushed up their output prices by 7.5% over the previous year but this rise, while startling enough, was nowhere near sufficient to compensate them for a 23.3% gain in raw-materials prices, the biggest since 1980.
It will be even more difficult to maintain profit margins when consumers are under pressure. Again, higher oil prices are part of the problem. Goldman Sachs reckons that some $3 trillion of wealth was transferred from oil consumers to oil producers between 2001 and 2007 and the pace of transfer is running at $1.8 trillion a year. In general, producing countries save more, and spend less, than consuming nations. At the same time, of course, falling house prices in America, Britain, Spain and Ireland threaten to make consumers feel the pinch.
Moreover, central banks may be unable to give consumers much help. With British inflation rising faster than expected, the Bank of England may join the European Central Bank, the Bank of Japan and the Federal Reserve in keeping interest rates on hold for the foreseeable future. So far oil has been the “dog that did not bark”; but it may yet give the global economy a nasty bite.
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gwalduck wrote:May 16, 2008 07:53... For my part, I am concerned that central bankers think they are in control. It's all very well to dampen demand by raising interest rates, but when price rises are caused by fundamental changes in the balance of economic power - in this case from "western" consumers to commodity producers - the only thing that can happen is a fall in the "western" standard of living. Not a bad thing, really, if it reduces waste and economic arrogance along the way. We can't inflate ourselves out of this situation, even if the bankers would let us.
I keep hearing on CNBC and reading at some blogs that if cars get better mileage that people will drive more by enough to offset the improved mileage.
I can see that people could drive more because of the savings. But to argue that reducing mileage by 20%, for example will lead to people increasing their driving by more then 20% seems like a very questionable conclusion. I'm willing to listen to an argument that increasing gas mileage would be partially offset by increased driving, but not that the responses would be more than 100%.
Does anyone have any idea of the original source or research of this belief by so many Republicans, Conservatives and Libertarians?
Is it just another Wall Street Journal editorial page finding that is too good to be true?Comments
Libertarians want to say that, given increased fuel efficiency, to say 400 miles per tank, people will choose to live further out from city centers, their jobs, and services. If that's true, then it's a wash.
Constraints on the consumption of time make this type of response nonlinear, perhaps highly so. Doubling the efficiency may make it possible to double the driving distance at the same price; but it doesn't address the problem of greatly increased driving time.===
The effect is real but small -- it's called the 'rebound effect' in fuel economy rulemaking speak. The current CAFE notice of proposed rulemaking assumes an elasticity of vehicle-miles traveled with respect to per-mile fuel cost of -0.15. So reducing fuel consumption per mile by 20% would (holding price constant) be expected to increase VMT by about 3%.
My visceral reaction (no hard data) is that these WSJ people are idiots who live in an intellectual vacuum, well apart from the real world. Here in the real world, people are trying to reduce their fuel *expenses*, not be able to drive more for the same cost. Morons.
I'm not sure that mileage has improved 20%, if that is the figure mentioned. The EPA released a report on "real world" estimates which flat-lines fuel economy (or worse) from the mid-eighties. A chart and link to that report is on my blog thedailychart.blogspot.com
Furthermore, for the past 4 months or so traffic volumes have been decreasing, a link to the February Federal Highway Admin Report is also on my blog.
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The level of ignorance required to believe this effect dominates is astounding. The largest single contributor to consumption of gas is incomes. Since incomes have risen in real terms, consumption of energy has grown. Period.
Most of the other effects are swamped by income growth. To try to look at consumption without considering income growth is absurd.
Greg | 05.24.08 - 4:29 am | #
The Twelve Steps:1. Stop deluding ourselves. The era of cheap, readily-available oil has ended. Prices may fluctuate, but the underlying trend is up, up, up. We have to get used to using less.
2. Demand that politicians take the issue seriously. Make it an election issue. Don’t take ‘we’ve got everything under control’ as an answer.
3. Stop building new roads. They’re a monumental waste of money, time and effort. They encourage, rather than ease, congestion, and besides, the growth in car travel that’s used to justify them isn’t going to happen anyway.
4. Divert that money and effort into measures that address the challenges of oil depletion and climate change.
5. Make a major investment in public transport. It needs to be better, faster, more comfortable, more regular, and more predictable. It needs to cater for everyone, not just peak-hour commuters — though they need a better service as well.
6. Make a major investment in broadband internet to allow more people to work from home, and change tax and business practices that discourage working from home. The more car trips we can avoid, the better.
7. Electrify transport where possible. New Zealand is well placed to use renewable electricity for transport. We should be electrifying commuter rail where it is not already electric, using light rail (trams) in cities, and looking at electrification of the main trunk line. On the other end of the scale, electric bikes and scooters can make a big difference in our cities. And electric cars show promise, though there’s a lot of questions to be answered yet.
8. Don’t use cars unless there’s no alternative. Take the bus. Take the train. Switch to a scooter. Walk or cycle – both your wallet and your doctor will thank you.
9. Deal with other aspects of our oil dependence. Agriculture, for example, is highly dependent on oil. We’re going to need to change the way we grow and distribute food. Let’s get to work on that now, not wait until supermarket shelves start to empty.
10. Stockpile or manufacture vital products currently imported from overseas. When oil runs short, will that still be possible? Let’s take stock now and work out what we may need to start stockpiling or making in New Zealand.
11. Think local. Ending our oil addiction isn’t just up to central government, though it can play its part. Communities can work together to make themselves more resilient. Join or start a Transition Towns group in your local area.
12. Accept reality. The age of cheap oil is over. It’s not coming back. As individuals and as a nation, we have to adapt.
The Debate Challenge
Before the debunking commences in earnest, I want to reiterate a debate challenge I made to Khosla. Following his essay at The Huffington Post entitled The Big Oil Companies Have Been Ripping Californians Off -- And Not Just at the Pump, I issued a challenge to Khosla to debate his claims. I repeat that challenge here. We can engage in a written debate (so claims can be referenced and verified) hosted at The Oil Drum, or at the venue of his choice. The focus will be on various ethanol claims that he has made. I will show that many of his claims are simply incorrect, and a lot of it is propaganda.
Debunking Selected Claims
Let’s focus on some specific claims that Khosla made in his presentation, and see if they hold up to scrutiny. If they don’t, then I want to ask why anyone takes his claims seriously, and why we are allowing him to influence energy policy. I want to ask those who encounter him to vigorously challenge him on his exuberant claims (and make sure he knows about the debate challenge). Because if he is wrong, and political leaders are betting that he is correct, we will be throwing good money away and wasting time while we could be going after real solutions.
During the video presentation, at the 3:50 mark Khosla makes the following claim:
Vinod Khosla: Brazil has replaced 40% of their petroleum use with ethanol already.So, is this true? No. As I documented in the article on ethanol that I wrote for Financial Sense:According to BP’s recently released “Statistical Review of World Energy 2006”, Brazil consumed 664 million barrels of oil in 2005. In 2005, Brazil produced 4.8 billion gallons of ethanol, or 114 million barrels. However, a barrel of ethanol contains approximately 3.5 million BTUs, and a barrel of oil contains approximately 6 million BTUs. Therefore, 114 million barrels of ethanol only displaced 67 million barrels of oil, around 10% of Brazil’s oil consumption. In other words, Brazil’s energy independence miracle was 10% ethanol and 90% domestic crude oil production.
According to BP’s recently released “Statistical Review of World Energy 2006”, Brazil consumed 664 million barrels of oil in 2005. In 2005, Brazil produced 4.8 billion gallons of ethanol, or 114 million barrels. However, a barrel of ethanol contains approximately 3.5 million BTUs, and a barrel of oil contains approximately 6 million BTUs. Therefore, 114 million barrels of ethanol only displaced 67 million barrels of oil, around 10% of Brazil’s oil consumption. In other words, Brazil’s energy independence miracle was 10% ethanol and 90% domestic crude oil production.
One of the innumerable problems with Wall Street and the City is that they never do seem to learn from their mistakes....Each generation seems obligated to re-experience the errors of its predecessors. There is little or no ‘race memory’ that might at least mean that this year’s crisis is brand new rather than a tired retread of past embarrassments.
... ... ...
What makes markets so intriguing today is that equities seem largely immune to a combination of $120+ oil, softening housing markets and a likely collapse in western consumer spending. Arguing that several trillion currently either sheltering in money market funds or rapidly accumulating thanks to petrodollar wealth in sovereign wealth funds will ride in to support stock markets (a.k.a. greater fool theory) only logically goes so far in the face of such sizeable challenges. But some confusing short-term resilience on the part of stock markets does not invalidate the need for caution, it rather reinforces the need for patience.I
... ... ...
n the face of almost insurmountable doubts (over likely economic slowdown, the impact on consumer confidence of softening residential property prices, the robustness of Asian fundamentals in the face of the ongoing commodity rally, the impact of $130+ oil, and the health of government bond markets given growing doubts over the under-reporting of inflationary pressures) it makes absolute sense to assume ongoing and substantial macro uncertainties....Unfortunately, an especially discredited Wall Street establishment now has peculiarly weak authority in either recommending appropriate strategies or taking advantage of the resultant dislocations in markets.
Tom Keene's show:Bloomberg Podcasts: DeLong Expects Dollar to Fall Versus Asian Currencies: May 20 (Bloomberg) -- Bradford DeLong, an economics professor at the University of California, Berkeley, talks with Bloomberg's Tom Keene in San Francisco about the outlook for the U.S. dollar versus Asian currencies, Federal Reserve monetary policy and the battle between Democratic U.S. presidential candidates Hillary Clinton and Barack Obama.
http://media.bloomberg.com/bb/avfile/Economics/On_Economy/vKpRex1Ueuy0.mp3
So just as Bank of America's once touted deal with Countrywide looks like it will turn out to be a slow-motion train wreck, the Bear deal has the potential to be a millstone rather than an asset to JP Morgan.
A further sign that all is not well in former Bear-land is the sudden exodus of two former executives who were given very senior roles at Morgan.
A run on central banks?When I see what commodity prices are doing, I don't think "low interest rates" or "skyrocketing demand". I think about a loss of confidence.
There is that old saw about gold, that it is the only money that is no one's liability. Wheat is no one's liability, and neither is corn. Oil is no one's liability.
It is common to invest in commodities as an "inflation hedge". If the central bank prints too much money, you need wheelbarrows to buy bread. If you have a sack of wheat, you will have your bread whatever the central bank does. But if everyone buys wheat, the price of grains will rise, even if the central bank does nothing at all.
Just as the fear of a bank's insolvency can precipitate a run that drives a bank to ruin, loss of confidence in a central bank can provoke a great inflation. The Federal Reserve, much I might criticize it, has not gone on a printing spree. It has lowered interest rates, and altered the composition of bank assets by replacing less liquid with more liquid securities. But the most these measures should do is bring us back, monetarily speaking, to the status quo ante, back to a year ago when asset-backed securities were liquid. The Fed's actions are best described as antideflationary, not inflationary.
But confidence is a funny thing. Central bankers are supposed to be dour and dependable. The current crop is not. Rather than "taking away the punchbowl", central bankers have become the life of the party. Japan's central bankers hand out Yen like free acid. China's guy will give you a microwave oven and a DVD player if you draw him a picture (and sign Henry Paulson's name to it). Our man Ben is an Amadeus-cum-Macguyver, he's brilliant, unpredictable, he'll improvise a Delaware company from paper clips and vacuum up your derivative book with a toenail clipper. Even the ECB's Trichet, who at first comes off like a sourpuss, turns out to be alright, when you've got some Spanish mortgages to pawn.
Some of us think that something's wrong, and these guys we're drinking with aren't serious enough to fix it. We know that trillions of dollars in presumed housing wealth have disappeared, but we don't know who's ultimately going to bear the loss. Americans know that as a nation, we cannot afford our clothes, furniture, or gas, unless the people who are selling it to us lend us our money back. Economists fret about "imbalance" and "adjustment", but we've yet to see a serious plan, other than let's-keep-this-party-going.
So, we lose faith. When we lost faith in Northern Rock, Bear Stearns, Citigroup, or Lehman, the central bankers stepped into the fray, and stood behind them. So, we ask, who stands behind the central bankers? We take a peek, and all we see is our own money. Which we quickly start exchanging for something else.
Although commodity prices have been increasing for years, you'll notice that the very sharp run-up began last summer, at roughly the same time as the credit crisis. Commodities soared when interest rates were still high, but predicted to fall. Commodities are soaring today, even though US interest rates are now predicted to rise. Commodities have soared in euro terms, despite the ECB's refusal to drop interest rates.
I can't tell you where the inventories are, except to wonder why anyone would put them where they would be counted. Hoarders tend to get nervous, and not advertise their hoards. (But this is pretty obvious.) Perhaps producers of storable commodities who lose faith in paper quietly hold back production. Interestingly, people who no longer trust the very core of the financial system remain comfortable with collateralized, centrally-cleared futures exchanges. These are well designed to manage credit risk, but they can default, have defaulted, and will default in extremis. I heartily endorse Cassandra's suggestion that they step up their margin requirements, ASAP.
None of this is any good at all. Capital devoted to precautionary storage would be better employed building new enterprises, laying a foundation for tomorrow's prosperity. But claims on future money are only promises, easily broken or devalued. A run on central banks, a flight from financial assets to stored goods, sacrifices the hope of future abundance for certain present scarcity. Governments can shut futures exchanges, confiscate gold, ban "hoarding, profiteering, and price-gouging". People will hoard anyway if they don't believe in the paper. People are losing faith in financial assets for good reason. Rather than organizing productive economies, the machinery of finance has recently functioned as an anesthetic, masking the pain while resources were mismanaged and stolen. We need a solid financial system, but confidence cannot be imposed or legislated. It will have to be earned. There has to be a plan. Earnest promises to do better soon won't suffice. Nor will yet another drink from the punch bowl.
most investors are in denial about unpleasant truths:
1. Financial assets are far riskier than the press, the textbooks, and conventional methodologies indicate. The models that the pros use are based on assumptions that are fundamentally flawed. The dangers of the erroneous belief that financial assets are safe is now being revealed.
2. The people who control the markets (the intermediaries) have their own, and not the publics', best interest at heart. Due to the proliferation of OTC markets and the value of assets involved, they cannot be dispensed with. And the regulators lack the skill and will to ride herd on them. As Keynes remarked,When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.We see ample evidence of that problem, yet seem to lack a way out.
So in a way, these gnawing issues do come around to Waldman's point. In times of crisis, people look to leaders for guidance. But in our prevailing doctrine of free markets, there are no leaders, just agents interacting in ways purported to produce virtuous outcomes. And the parties who ought to step into the breach fail to understand the need for that role right now. That is why an old fashioned (and very tall) banker like Volcker is so reassuring. He handled a crisis; he's not afraid to take the reins or say things are bad and changes are needed.
We are at the end of a paradigm: large scale OTC markets, lightly regulated players and instruments, dollar as reserve currency, US as the most important global economic actors. Waldman is good here:People are losing faith in financial assets for good reason. Rather than organizing productive economies, the machinery of finance has recently functioned as an anesthetic, masking the pain while resources were mismanaged and stolen. We need a solid financial system, but confidence cannot be imposed or legislated. It will have to be earned. There has to be a plan.
But Yeats is better:Turning and turning in the widening gyre
The falcon cannot hear the falconer;
Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity
13 May 2008 HARPERS MAGAZINE, MAY, 2008Washington's harping on weapons of mass destruction was essential to buoy public support for the invasion of Iraq, the use of deceptive statistics has played its own vital role in convincing many Americans that the U.S. economy is stronger, fairer, more productive, more dominant, and richer with opportunity than it actually is.
The corruption has tainted the very measures that most shape public perception of the economy—the monthly Consumer Price Index (CPI), which serves as the chief bellwether of inflation; the quarterly Gross Domestic Product (GDP), which tracks the U.S. economy's overall growth; and the monthly unemployment figure, which for the general public is perhaps the most vivid indicator of economic health or infirmity. Not only do governments, businesses, and individuals use these yardsticks in their decision-making but minor revisions in the data can mean major changes in household circumstances—inflation measurements help determine interest rates, federal interest payments on the national debt, and cost-of-living increases for wages, pensions, and Social Security benefits. And, of course, our statistics have political consequences too. An administration is helped when it can mouth banalities about price levels being "anchored" as food and energy costs begin to soar.
The truth, though it would not exactly set Americans free, would at least open a window to wider economic and political understanding. Readers should ask themselves how much angrier the electorate might be if the media, over the past five years, had been citing 8 percent unemployment (instead of 5 percent), 5 percent inflation (instead of 2 percent), and average annual growth in the 1 percent range (instead of the 3–4 percent range). We might ponder as well who profits from a low-growth U.S. economy hidden under statistical camouflage. Might it be Washington politicos and affluent elites, anxious to mislead voters, coddle the financial markets, and tamp down expensive cost-of-living increases for wages and pensions?
Let me stipulate: the deception arose gradually, at no stage stemming from any concerted or cynical scheme. There was no grand conspiracy, just accumulating opportunisms. As we will see, the political blame for the slow, piecemeal distortion is bipartisan—both Democratic and Republican administrations had a hand in the abetting of political dishonesty, reckless debt, and a casino-like financial sector. To see how, we must revisit forty years of economic and statistical dissembling.
ARROYO GRANDE, Calif. (MarketWatch) -- Remember that big ah-ha moment in the 1939 classic "The Wizard of Oz?" Dorothy wants to see the Wizard. His voice booms: "Do not arouse the wrath of the Great and Powerful Oz! Come back tomorrow!" Afraid, Lion, Tin Man, Scarecrow shake. Dorothy's dog runs up, tugs on a curtain. She chases Toto, pulls curtain open:"Who are you?" Dr. Marvel stutters: "Well, I - I - I am the Great and Powerful, Wizard of Oz." Dorothy: "You are? I don't believe you!" He replies: "No, it's true. There's no other Wizard except me." Dorothy's miffed: "Oh, you're a very bad man!" Wizard: "Oh, no, my dear. I'm a very good man. I'm just a very bad Wizard."
2009 Sequel: Script exposes diabolical cover-up conspiracy
Flash forward: Real life, Washington, new leaders, a new Congress, old wizardry. Be forewarned: No matter who's elected president, America will soon see a massive statistical curtain pulled back, exposing a con game of historic proportions. And when that happens, you and I will suffer another ear-splitting global meltdown, bigger than today's housing-credit crisis, dragging us deep into a recession and bear market for years.
Cast: New 'leading man' from old Nixon political machine
Yes, the lead character pulling back the curtain is none other than Kevin Phillips, a former Republican strategist for Nixon, and today America's leading political historian. Phillips just published "Bad Money: Reckless Finance, Failed Politics & the Crisis of American Capitalism," everything you need to know about today's credit meltdown.
Scene 1: Numbers racket hiding behind Washington curtain
Opening shot: Phillips pulling back the curtain, exposing charlatan Wizards in a brilliant Harper's Magazine article: "Numbers Racket: Why the economy is worse than we know." Far worse. Buy it, read it -- this is essential reading if you really want to understand the depth of today's political as well as economic impending meltdown, and the harsh realities facing Washington, Wall Street, Corporate America, and Main Street in 2009 and beyond ... harsh because we cannot cover up the truth much longer.
Scene 2: Statistics, Washington's new WMDs, a time bomb
"If Washington's harping on weapons of mass destruction was essential to buoy public support for the invasion of Iraq, the use of deceptive statistics has played its own vital role in convincing many Americans that the U.S. economy is stronger, fairer, more productive, more dominant, and richer with opportunity than it really is. The corruption has tainted the very measures that most shape public perception of the economy," especially three key numbers, CPI, GDP and monthly unemployment statistics.
Scene 3: Backflash, 'It's always the cover-up, stupid!'
As I read further I couldn't help but think about similar traps politicians get themselves (and us) into. Remember nice guys like Scooter Libby and Bill Clinton: The crime wasn't their original stupidity, but their lying during the cover-up. Here, Phillips reviews endless statistical cover-ups since the 1960s and concludes there was no "grand conspiracy, just accumulating opportunisms." I call it plain old greed. And every step of the way the media went along with the con game played by politicians and economists.
Scene 4: Real numbers torture us ... like water-boarding!
How bad is it? "The real numbers ... would be a face full of cold water," says Phillips. "Based on the criteria in place a quarter century ago, today's U.S. unemployment rate is somewhere between 9% and 12%; the inflation rate is as high as 7% or even 10%; economics growth since the recession of 2001 has been mediocre, despite the surge in wealth and incomes of the superrich, and we are falling back into recession."
Scene 5: Most economists hushed, work inside conspiracy
Compare that to the phony stats Washington feeds the press and public: Unemployment 5%, inflation 2% and long-term growth at 3%-4% (actually more like 1%). For example, just last week the L.A. Times reported that while "gasoline prices are up more than 20% from a year ago and food prices have risen 5%," Washington says "inflation was fairly mild last month." A Wells Fargo economist shook his head in disbelief: That report isn't "worth the paper it was printed on." Most economists are quiet, working for the conspiracy.
Scene 6: No integrity, they cannot be trusted to tell truth!
The same can be said of any government report, every speech made by today's leaders: All hype, lies and propaganda intended to deceive us. Treasury Secretary Henry Paulson's clearly playing the game: Remember what the former Goldman Sachs CEO told Fortune last July as our credit meltdown was metastasizing into a worldwide contagion: "This is far and away the strongest global economy I've seen in my business lifetime." He has no credibility. He knew the truth. He knew the government's "numbers racket;" after all, he helped create the problems years earlier at Goldman.
Scene 7: There's enough Kool-Aid for everyone to drink
The mention of the Mortgage Lender Implode-O-Meter in the introduction of Kevin Phillips' new book Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism was a good sign of what might lie ahead. Then there was the early reference to the work of John Williams at the Shadow Stats website and liberal use of his findings later on.
In the recent article at Harpers Barry Ritholtz was mentioned, his "inflation ex-inflation" meme picked up as a central element in Numbers Racket: Why the Economy is Worse Than We Know.
But it was something of a surprise to see the chart below show up on page 86 in this new book that is opening the eyes of many across the land (see How owners' equivalent rent duped the Fed at Seeking Alpha).
The chart looks much better in color, as shown below, which reminds me that I'm seriously delinquent in updating that series of charts that have the Case Shiller Home Price Index laid up against all kinds of other economic data with interesting results.
Yesterday brought this story in MarketWatch where Paul Farrell credits Kevin Phillips with pulling back the veil of the economic data, noting that "most economists are quiet, working for the conspiracy".
An interesting conclusion indeed - I always thought "unwitting accomplice" was a better characterization than "co-conspirator". There are about 500 comments on this story at MarketWatch with some interesting perspectives.
All it took was $4.00 gasoline for people to finally notice.
Calculated RiskFrom the WSJ: Fed Signals Rate Cuts Are Done, Lowers Growth Forecast for 2008
The Federal Reserve on Wednesday appeared to shut the door to the possibility of further interest rate cuts, saying in April meeting minutes that the last rate cut was a "close call," and that many officials think future reductions are unlikely even if the economy contracts.
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The Fed also released updated quarterly economic forecasts with the April minutes. The central tendency of officials' forecasts is for gross domestic product to rise between just 0.3% and 1.2% this year, down from the last forecast of growth between 1.3% to 2%. Officials also raised their forecasts for the unemployment rate and both headline and core inflation as measured by the price index for personal consumption expenditures.
Though our government has increasingly influenced our markets since the creation of the Federal Reserve in 1913, we have recently reached the point where it would be a glaringly obvious misnomer to call the markets "free." And while some aspects of a free market remain, those who've studied the day-to-day operations of our nation's banking system and the stock markets' performances at certain times, would likely come to the conclusion that, on occasion, the state, through the Fed and certain banks, intervenes to engineer market bottoms.Am I talking about something that is done is secret to which only the most privileged are privy? While the history of global politics and global banking has always been based on secret meetings, those who've read about the government's extensive intervention, at critical points in our markets - usually occurring at the rule-making level - are well aware of the manipulation about which I write.
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We only need to look at recent history to see the merits of our previously stated hypothesis. If I am correct, then we must set aside the tired assumptions of the market's "random walk" or "the average investor's reaction" to the latest breaking news as the impetus for large market moves. Instead, we must consider Wall Street and the Fed's actions when prices start to decline. Do they focus on facilitating exchanges between buyers and sellers, or has their focus shifted to engineering US equity market bottoms when critical price levels are met? Far from an academic discussion, this issue strikes at the very heart of confidence in our markets, which was born out of the "freedom" that has been associated with capital markets for generations.
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LAS VEGAS -- Retail construction, which surged in recent years amid easy financing and robust consumer spending, has lost momentum as retailers curtail growth plans and lenders remain stingy.
Many of the largest U.S. developers of malls and shopping centers have reacted to retailers' waning demand for space by postponing by a year or more some of their projects. Other venues will be built piecemeal as leasing progress allows. Still others have been canceled before the start of construction.
The slowdown comes as consumers rattled by the credit crisis rein in spending, causing retailers to rethink their previously aggressive expansion plans. Among the national chains that recently pared their growth plans are J.C. Penney Co., Chico's FAS Inc., Starbucks Corp. and Home Depot Inc. At least partly because of the spending lull, nearly 6,500 U.S. stores are expected to close this year, the highest tally since 2001, according to the International Council of Shopping Centers.
Standing in the way of a recovery are deep-seated problems such as depleted home equity and high personal-debt levels. "We believe it is going to be harder for consumer confidence to come back quickly until some of these issues are resolved," J.C. Penney's chairman and chief executive officer, Myron Ullman, said Monday at the shopping-center council's annual trade show here.
Mr. Practical was commenting on the variance between the crude goods PPI and the finished goods PPI. This is what Mr. P has to say:
I sent this chart of the Producer Price Index out to a few friends. I began getting calls from people I barely knew. Apparently, the chart really made the rounds and astounded people.The charts show there is virtually no ability to pass on rising input costs. This will translate into declining profits. Declining profits are never good for stock prices. There is simply no other rational way of looking at this.
click on chart for sharper image
I've talked about this before. I'm surprised people still don't get this. They look at the headline statistics the government puts out and don't bother to think about the real information embedded in the numbers.
The crush on profits is beginning to take full force as companies are having more and more difficulty passing higher input costs on to consumers, as they're getting squeezed too.
This is the most important statistical relationship to stock prices by far.
Profesor Sedacca was also talking about dilution today in Debt, Dilution, Default and Denial.
As a result of their own greed, banks and brokers have been forced, on a global scale, to write down more than $315 billion since the crisis began last summer. Most of the write-downs have been confined to the sub-prime sector to date, but I'm highly uncomfortable that the crisis, in the end, will be confined to sub-prime.
In fact, we're already beginning to see strains on other parts of the credit markets. The problems stretch all the way from credit card receivables, Alt-A loans, prime loans, auto loans and motorcycle loans. The problem is not at all contained, as many analysts, economists, TV commentators and other "hopers" would like us to believe. Unfortunately, contagion is here, perhaps for a while. To make matters worse, when we add exploding commodity prices and a rising unemployment rate to the picture, the takeaway is far from optimistic.
As a result of all the write-downs that have occurred, many financial institutions have been forced to come to market with common equity, convertible preferred and straight preferred deals. Companies on this list include the likes of Merrill Lynch (MER), Fannie Mae, Freddie Mac, National City (NCC), Regions (RF), Fifth Third Bancorp (FITB), MBIA (MBI), AMBAC (ABK), J.P. Morgan (JPM), Lehman Brothers (LEH), Citigroup (C) and so on.
Some of the companies, like National City, have diluted existing shareholders by 50% just to stay in business. The same, sadly, can be said for MBIA and AMBAC, two municipal insurers that got burned when they entered the vague world of Credit Default Swaps and CDO’s.
For what it is worth, I highly doubt that AMBAC and MBIA will survive this crisis as they now have nearly three times their shareholder equity in "deferred tax assets." Even Freddie Mac disclosed it now has deferred tax assets on its books, a potential sign of financial stress.
It is clear to me that what many of the aforementioned companies should be doing is not what they are actually doing. Take Merrill Lynch, for example. Merrill has said on several occasions that it doesn't need to raise capital, only to raise billions of capital a week later, paying as much as 8 5/8% for preferred stock.
If you owned your own company, business was slowing, your cost of capital was rising, profits disappeared, you were writing down the value of your net worth and assets, employees were leaving and you were levered up to your eyeballs, what would you do? A prudent investor would cut dividends to shareholders, reduce headcount, try to cut leverage and find a way to raise equity even if you dilute your own holdings just so you can fight to live another day.
Those companies that resist these measures will live to regret it, in my opinion, even to the extent that their stubbornness to please Wall Street and investors over the near term could result in insolvency.
Ignoring bad debt and postponing inevitable losses was one of the main reasons behind Japan's decade-long economic slump that began in the 1990s, said Boston University law professor Charles Whitehead.
Faced with new capital requirements and a weakened ability to meet them, Japanese banks deferred the recognition of their losses, aided by regulators who refrained from implementing the rules, Whitehead wrote in a 2006 paper published in the Michigan Journal of International Law.
"U.S. regulators may be tempted to go soft on banks too," said Whitehead, who teaches securities regulation, in an interview. "The new capital rules already rely significantly on self-modeling by the banks. So if anything, the risks may be greater in the U.S. today than they were in Japan in the 1990s."
The new bank-capital regime, known as Basel II, has gone into effect in some European countries and is being implemented in the U.S. and others starting this year. It allows financial institutions to use in-house risk models instead of just relying on external credit-worthiness ratings in calculating their risk- weighted capital requirements.
The largest U.S. securities firms have been under capital requirements shaped by Basel II since 2004.
Shareholders at Stake
Even if regulators are soft on banks and brokers when it comes to capital requirements, investors won't be, according to Samuel Hayes, professor emeritus at Harvard Business School in Boston.
The collapse in March of New York-based Bear Stearns Cos., once the fifth-largest U.S. securities firm, shows that fulfilling regulatory capital requirements isn't sufficient to survive, Hayes said. The SEC has said Bear Stearns was "well-capitalized" until the moment it faced bankruptcy as clients and creditors lost confidence and withdrew their money.
"They have to
High energy costs are causing draconian changes in consumer behavior. Many U.S. farmers ARE NOT planting this spring because of the extreme escalation in fertilizer and fuel prices have not been reflected yet in grain prices on the futures markets.
This dichotomy ensures a LOSS if they do plant--it costs more for fertilizer and fuel (and seed, pesticides, herbicides) , revolving credit for planting supplies is very difficult to get, so they are gonna take a year off.
This weekend, I splurged and drove almost 700 miles round trip to spend 3 days visiting my daughter. U.S. I-81 through Virginia to PA was a major portion of the route. It was absolutely EMPTY of traffic as compared to last year and 'normal times.
I estimate a drop of at least 50% in number of vehicles on the road. I was astonished at the sudden change. Gasoline costs ranged from $3.89 to $4.13, with diesel even higher. I spent some $120 on fuel. Flying was not an option, nor was mass transit. The cold,dark days of pre-oil are upon us NOW.