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Financial Skeptic Bulletin, July 2008
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Situation continued to deteriorate from
June. Bonds dropped considerably, essentially in sync with stocks
on inflation fears.
For 401K investors one of the problems is
extremly poor performance of some Vanguard fonds during the downturn . Especially dismal
performance of Windsor II probably can be explained by the fact that
James P. Barrow has lost his touch. In February, 2008 Vanguard
dropped
Grantham's Firm as Co-Manager of Funds (Bloomberg.com)
which has a bear bias. If a value dropped more then
S&P 500 during the downturn this is not a value fund. With Windsor II
this happened probably due to overexposure to finance. Vanguard
Windsor II holding in Bear Stears at end of 2007 was $694,324,525! The
"golden days" of this fund are probably over due to the amount of assets
under management.
See
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Growth for growth’s sake is the ideology of the cancer cell.
Edward Abbey
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| "Any fool can buy a company. You should be congratulated
when you sell." Henry Kravis
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| “Financial
operations do not lend themselves to innovation. What is recurrently
so described and celebrated is, without exception, a small variation
on an established design . . . The world of finance hails the
invention of the wheel over and over again, often in a slightly
more unstable version.”
John
Kenneth Galbraith, A Short History of Financial Euphoria
|
Milton
Friedman’s misfortune is that his economic policies
have been tried.”
- John Kenneth Galbraith
Comments
It looks like each class experience its own level of inflation. So there are
different inflation levels for low income, middle-class and rich. In no way
this is one nation under God.
Government statistics, particularly the CPI, have been in the news (e.g.,
[0]). Following
up on my previous posts
[1],
[2],
I want to take a stab at the question posed in the title.
This post focuses on issue separate from the mathematics of the index forumulation,
and has to do with what the typical weights at any given instant in time
should pertain to. Should one use the expenditure weights that pertain to
all the households aggregated in the economy? Or should one use the expenditure
weights that pertain to the "typical" household?
Kokoski (2003) summarizes
the distinction thus:
In the democratic index, the expenditure pattern of each household counts
in equal measure in determining the population index; in essence, it is
a case of "one household--one vote". In the plutocratic case, the contribution
of each household's expenditure pattern is positively related to the total
expenditure of that household relative to other households--in essence,
"one dollar, one vote".
Clearly, there's no "right" answer to this question. Just like when
asking for the average household income, does one take the income earned
in a year, and divide by all the households in the US? Or does one identify
all the households in the US, rank them by income from top to bottom,
and pick the one in the middle. The former yields the mean, the latter
yields the median. Both are measures of central tendency.
Understanding
that distinction can be helpful in understanding why any given observer
does not feel the CPI represents his or her experiences. Literally,
unless the income distribution is concentrated at one level, or
all households have the same expenditure patterns regardless of income
levels, then almost nobody will feel the CPI is representative of the
changing prices facing them. The more unequally income is distributed,
or the more expenditure shares vary by income level, the more strongly
this perception will held.
The gap between the CPI weighted by expenditures (so that higher
income households will naturally get a greater weight) and the CPI weighted
by the average over households, irrespective of each household's total
expenditures, is sometimes termed the "plutocratic gap". From Eduardo
Ley in a 2005 Oxford Economic Papers article. From the abstract:
Prais (1958) showed that the standard CPI computed by most statistical
agencies can be interpreted as a weighted average of household price
indexes, where the weight of each household is determined by its
total expenditures. In this paper, we decompose the CPI plutocratic
gap -- i.e. the difference between the standard CPI and a democratically-weighted
index, where each household has the same weight -- as the product
of expenditure inequality and the sample covariance between the
elementary individual price indexes and a term which is a function
of the expenditure elasticity of each good. This decomposition allows
us to interpret variations in the size and sign of the plutocratic
gap, and to discuss issues pertaining to group indexes.
Note that despite the tendency to associate "democratic" with good,
and "plutocratic" with bad (the terminology originates with Prais, I
believe), economic theory does not provide a basis for strongly preferring
the democratic over the plutocratic, in the absence of some strong conditions.
And indeed, it's not clear that either index can be justified under
general conditions.
Now, in the commentary on my two previous government statistics posts,
a recurring theme is that the CPI is not representative of the particular
writers' experiences. And it is true that if one's consumption bundle
does not match that of the average consumption bundle, then one will
either feel that the CPI understates or overstates the price level.
Another way of tackling this question is to ask what kind of household
has a consumption pattern that matches the CPI? The answer is as follows:
It is natural to ask then what is the household better represented
by the plutocratic CPI. Muellbauer (1974) searched for the household
whose budget shares were closest to the ... aggregate weights in
the UK CPI, and found it to be at the 71st percentile in the household
expenditures distribution. For the US in 1990, Deaton (1998) estimates
that this consumer occupies the 75th percentile. Thus, the 'representative'
consumer embedded ... is inclined towards upper-expenditure households.
Ley cites a 1987 study by Kokoski that estimates the plutocratic
gap at -0.1 to -0.3 percentage points per year over the 1972-80 period.
In words, this means that CPI using democratic weights experienced between
0.1 to 0.3 percentage points greater inflation than the reported CPI
inflation rate.
More recently,
Kokoski (2003) has updated her analysis (a related version published
in Monthly Labor Review in 2000, see
here).
She summarizes her paper thus:
This paper provides an empirical analysis of the differences
between the plutocratic and democratic price indices, using data
from the Consumer Expenditure Survey and the CPI for the periods
1987-1997, and for simulated price change scenarios. The results
show that there is very little difference between the two types
of index, and that one index need not always exceed the other. In
the simulated scenarios, even the extreme cases where prices changed
only for expenditure-inelastic goods and services, the difference
between the democratic and plutocratic indices was only about one
point for every ten percent increase in the relative prices of these
goods.
Can we extend these results to the present time? It's not clear.
There is the conjecture that, with lower income households having a
basket skewed toward food and gasoline, the plutocratic gap would be
wide, particularly over the last couple years. While that conjecture
makes sense to me, I'd say that answer is actually not clear. The reason
I say that is because of a recent paper by Broda and Romalis, who note
that because of Chinese imports, lower income households have actually
benefitted from globalization to a much greater degree than typically
thought exactly because they have consumption patters skewed toward
goods that have decreased in price over the past decade. From
Broda and Romalis's paper:
… we find that inflation for households in the lowest tenth
percentile of income has been 6 percentage points smaller than inflation
for the upper tenth percentile over this period. The lower inflation
at low income levels can be explained by three factors: 1) The poor
consume a higher share of non-durable goods -- whose prices have
fallen relative to services over this period; 2) the prices of the
set of non-durable goods consumed by the poor has fallen relative
to that of the rich; and 3) a higher proportion of the new goods
are purchased by the poor. We examine the role played by Chinese
exports in explaining the lower inflation of the poor. Since Chinese
exports are concentrated in low-quality non-durable products that
are heavily purchased by poorer Americans, we find that about one
third of the relative price drops faced by the poor are associated
with rising Chinese imports.
Still, the Broda-Romalis paper does not directly address what has
happened in the very recent past (say the last two and half years),
as prices of goods imported from China have started to rise, and oil
and food prices have risen relative to other prices. Some ideas can
be gleaned from the data provided in Kokoski (2003), who provides 1987
expenditure shares for the various income quintiles. I present for illustration
the distributions for the bottom first and top fifth quintiles.
Figure 1: 1987 expenditure shares for bottom income quintile,
according to Consumer Expenditure Survey. Source: Kokoski (2003), Table
5.
Figure 2: 1987 expenditure shares for top income quintile,
according to Consumer Expenditure Survey. Source: Kokoski (2003), Table
5.
With this information, one can make a back of the envelope calculation
(and I stress this is only a back of the envelope calculation),
based upon these shares and the indices reported for the components.
This yields the following figure:
Figure 3: Year-on-year inflation calculated using
annual CPI (not seasonally adjusted), (black), and guesstimated
CPI for first quantile (blue) and fifth quantile (red). Inflation calculated
as first log difference of annual CPI. Guesstimated CPIs calculated
as geometric averages of component indices. Source: BLS, and author's
calculations based on weights in Kokoski (2003), Table 5.
Here are several caveats. First, these are calculations that take
into account differential expenditures at a very high level of aggregation,
so they ignore differential shares at much finer levels of disaggregation.
Second, relative prices may have moved even more dramatically in 2008,
and the impact of that effect will be missed in this calculation. Third,
these are a calculation based upon annual data; calculation
of year to year changes will then allow for minimal influence of what
has happened to food prices in the last half of 2007.
Those caveats in mind, these guesstimates imply that the differential
between the actual CPI inflation and the inflation rate for the first
quintile is only about 0.3 ppts in 2007.
A final caveat to keep in mind (from Kokoski (2003)):
...For most a priori definitions of demographic groups, there
is generally more variation across households within each group
than there is across groups. Since the statistical significance
of any differences observed here between quintile indices is unknown,
one should not draw quantitative conclusions from these results.
So one's experience should deviate from that represented by
the CPI, even if one were at the 75 th quintile, exactly because of
the highly individual nature of consumption bundles. But it is not clear
that the income distributional aspects are driving people's differential
experiences.
[Update, 2pm Tue 22 July]: Reader Andrew asks why I used geometric
averages. Upon inspecting BLS documentation, I learn that I should aggregate
the high level components (as opposed to the elementary prices) using
the arithmetic average. I’ve recalculated the indices using the arithmetic
averages, and present them in Figure 4. There is little visible difference
in the pattern of results.
Figure 4: Year-on-year inflation calculated using
annual CPI (not seasonally adjusted) , (black), and guesstimated
CPI for first quintile (blue) and fifth quintile (red). Inflation calculated
as first log difference of annual CPI. Guesstimated CPIs calculated
as arithmetic averages of component indices. Source: BLS, and
author’s calculations based on weights in Kokoski (2003), Table 5.
Posted by Menzie Chinn at July 21, 2008 08:15 AM
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Another great post!It is important to note that the issues considered here
are separate from the issues about substitution (Laspeyres vs. Paacshe indexes
and so on) discussed in the last post. And they are also separate from the many
other issues such as those in the Boskin report (such as quality changes, new
goods, price variation among retailers, how to treat housing, etc.)
Before people jump to criticize the CPI, I hope they take time to understand
these issues, and how inherently complicated calculating
a useful price index can be.
Posted by: ed at July
21, 2008 09:08 AM
Very nice post. Even though you show that everyone experiences inflation
differently, it doesn't explain widespread beliefs that inflation is understated
by 3 percentage points or more. I think the
explanation for that perception is more psychological in that people experience
inflation in their marginal spending. They really notice
paying an extra $30 a week at the gas pump, but don't consider that amount
in the context of their entire spending.
Posted by: Joseph at July
21, 2008 10:22 AM
As an interesting side note, what I found surprising from your figures 1
and 2 is that the affluent have so much more
discretionary spending available beyond basic food, housing and utilities
and they seem to squander it all on cars (private trans.)
It seems to imply that in our society, when someone gets more money,
the first thing they do is buy more expensive cars.
Posted by: Joseph at July
21, 2008 10:24 AM
As an upper middle class parent hoping to buy a home, to pay college tuition,
and eventually to retire, the computed CPR is almost completely irrelevant.
Housing purchase price (which isn't even in
the CPR), tuition and medical costs together account for over 90% of my
take-home income.
Once I have a house purchased and tuition paid for, it will again be
irrelevant, but in some other direction.
Posted by: fg at July 21,
2008 10:57 AM
As mentioned by fg, above, ignoring the issue
of the difference between Owner's Equivalent Rent, and actual housing prices,
will mean that numbers for both your high and low quintiles don't really
match actual experience.If you instead took the "housing"
component, and instead replaced it with rents for low income people (rents
have increased by 10% per annum for the the last five years where I live),
and housing prices (which have tripled in the last five years where I live),
I suspect you'll see a rather different picture.
Garbage in, garbage out, and OER is garbage, in terms of computing real
inflation.
===
Posted by:
odograph at July 21, 2008 05:55 PM
I guess my take-away is that we should de-emphasize "the" CPI. As Menzie
chronicles, there are many CPIs.
I don't see the word "core" in this page.
There is one particularly poor CPI, beloved by glib politicians.
I think the (glib) claims that "inflation is low because the (glib) CPI
is low" should be viewed with real suspicion.
As to what's better, we probably need to tailor it to our audience. A
welfare recipient should have a CPI tailored to real rent. Perhaps retiree
CPI should be rent-based as well.
Those of us concerned with retirements decades off might need another
CPI to gauge our how well our savings are, or aren't, pacing buying power
in geriatric drugs and fishing cabins.
====
Posted by: Andrew
at July 21, 2008 07:29 PM
To people talking about owner's equivalent rent. If you want to track the
prices that people experience you need to track the payments that people
typically make. Housing is often paid for via a loan, so you need to use
housing loan repayments as a major part of the housing cost rather than
the raw cost of the house. The same for cars. This is how it is done in
many places. So housing costs are made up of loan repayments, real actual
rent, and a smaller portion for direct house prices since some housing is
purchased that way.
In the US, tax laws treat a house that you live in as an investment rather
than as a consumer item, so owner's equivalent rent is consistent with that
treatment - you buy your house as an investment and rent it to yourself.
In other places, your primary residence is treated for tax purposes as a
consumer item (no tax deduction, but also no capital gains tax on it). It's
a matter of classification. The house you live in is both an investment
and a consumed item. You might try to work out what portion of it is investment
and what portion consumed, and weight the loan repayments and owners equivalent
rent by those weights.
Posted by: Andrew
at July 21, 2008 07:49 PM
Anecdotal evidence suggests that people do not generally perceive
the official CPI to be characteristic of their own inflation experience.
Yale University professor Eduardo Engel reports that a popular newspaper
in Chile ran a series of interviews with two dozen celebrities who
were asked the same battery of questions, one of which was: "Do
you trust the official CPI?" It was the only question to which all
the respondents answered in agreement: "No." Government statistical
agencies, therefore, have a difficult task: How best to summarize
thousands of price movements in a single index.
(1) Why the CPI
may be inappropriate: escalating transfer payments by the usual
plutocratic CPI may result in over- or under-compensation relative
to a democratic index during different times. Although these deviations
may prove unimportant when averaged over time, there is an important
perversity, however, that should be emphasized. The plutocratic
gap in the CPI often accentuates the change in household welfare
rather than smooth it. In effect, lower-income households suffer
under-adjustments when inflation is more harmful to them (ie, when
they can least afford it). During periods in which the plutocratic
gap is negative, when prices behave in an anti-poor way, social
programs, which primarily benefit the poor, are revised less than
what would be the case with a democratic group index. Similarly,
when price movements ar (ie, when the plutocratic gap is positive)
indexed social transfers grow faster than proper cost-of-living
adjustments would dictate. Thus, plutocratic-CPI adjustments display
harmful procyclical features.
(2) On the other hand, plutocratic
weights would arise if we were to draw prices at random in
such a way that each dollar of expenditure had an equal chance of
being selected (Theil, 1967; Economics and Information
Theory p.136). So the standard CPI is quite useful as a macro indicator.
(3) Bottomline: different indexes could be easily computed for
different purposes.
Posted by:
Eduardo Ley at July 21, 2008 08:12 PM
Thank you very much for putting together such a picture of a discussion.
There are a number of things that come to mind including why governments
collect this data (cost of living indexed expenditures and stuff).
I wonder if something could be learned by not worrying too much
about the whole, or the individual or the average. Instead, use
the IRS data on household income by size and source (a series produced
with a delay)to develop a distribution curve for household income
by size, using a five-fold division, (too low, under, adequate,
comfortable, more than enough)by comparing with the BLS household
expenditure data by household income.
This approach would permit one to estimate the different effects
of food, energy, transport and debt service on lower income households,
the effects of health, energy, transport and education type expenditures
on the better off.
It could provide a corrective to "core" CPI which probably eliminates
the bottom half of households from the CPI estimates altogether
while providing a basis for working towards a representative household
defined in terms of the income which would support consumption expenditures
which would be a norm to aim for rather than a description of what
might appear to be.
The approach would also provide interesting critical insights
into the three-key government data series, employment, income and
consumption while offering the potential for an implied view of
investment.
July 31, 2008
Of Misnomers, Fallacies, and Lies
by Brady Willett
The Misnomer
The top misnomer being perpetuated by personalities like Jim Cramer and
policy makers like Henry Paulson today is that financial problems are lingering
because there is a 'crisis of confidence' in the marketplace. This misnomer
continues that confidence can only be restored via radical bailout actions
by policy makers. To note: we are not being told that Bear Stearns, the
GSEs, and others necessarily deserve to exist, only that they must be bailed
out because there existence is essential to the system (how confident are
you in the 'system' after hearing this?)
To begin with, the contention that unprecedented bailout efforts are
required to restore investor confidence is patently wrong. If a company
is reliant upon the credit markets for its day-to-day survival and/or can
not function if its reckless trading book no longer fetches top dollar,
investors were wrong to have confidence in this enterprise in the first
place. In this regard confidence restoration in the U.S. is akin to trying
to bring back the grainy luster of a table made press board.
Next, if 'confidence' in the marketplace can only be generated by making
the populace share the financial burden of bad financial choices it would
be socialism, not capitalism, which engenders the greatest confidence in
financial markets. How many bailout efforts does it take before the supposed
confidence generating payoff from socialistic activities no longer outweighs
the growing burden on the U.S. government and its citizens? Current trends
suggest that we will eventually find out.
In short, the real story is not of investors being more or less 'confident',
but of investors no longer behaving stupidly.
The Fallacy
The top fallacy making the rounds today is that inflation is the
serious threat. What few seem willing to acknowledge is that the rising
inflationary trend in 2008 has not been hurting the U.S. on a relative
basis. Rather, and after ending a multiyear stretch of sever underperformance
in 2007 (compared to other world markets), U.S. markets are holding up exceptionally
well in 2008. Moreover, spiking inflation rates have helped take the once
ominous threat of emerging market dominance off the radar.
Another positive (?) inflation story is seen in the debasing of the U.S.
dollar (or the primary cause of today's 'inflation'). With trillions in
U.S. assets being destroyed, bank stocks crashing, and policy makers reacting
frantically to this deflation, dollar debasement is not only generating
inflation but also helping smooth an otherwise rocky path for the financial
markets. Given that this statement may seem controversial, consider the
following: take away the debasing of the dollar and the bailouts still to
come do not get enacted, future stimulus checks do not get printed, and
wars do not get funded. In other words, it is a massive contradiction to
extol the benefits of a strong dollar to combat inflation in one breath
while calling for more unprecedented bailout efforts with the next.
To make a potentially long story short, a weakening dollar has and can
be in the best interests of America if this weakness does not spark a 'crisis
of confidence' in the dollar, or (remembering the above misnomer) so long
as investors continue to behave stupidly.
The Lie
The biggest lie is that the Fed can always save the day. The reality
is that post-Volcker the Fed has done everything possible to avert periods
of creative destruction in the marketplace while at the same time doing
little to promote the longer-term health of the U.S. financial markets through
regulatory prudence. At the risk of sounding like a broken record, this
deadly dynamic is largely the result of Alan Greenspan, a man who eulogized
the supposed benefits of self-regulation at every opportunity. Today's crisis
is suggesting that the self-regulated beast requires larger and larger bailouts
in order to survive and a super-regulator to tame it - thanks for nothing
Sir Alan!
As the Fed slashes interest rates, accepts junk for treasuries, and applies
for the job of regulatory ringmaster, the recurring gravity of the situation
should be obvious: the Fed can only save the day by postponing necessary
periods of adjustment (i.e. today's 'deleveraging' is moving at a snails
pace largely because of Fed meddling!) It goes without saying that when
the adjustment obstacles become too large for even the Fed to handle the
U.S. dollar and financial system crumbles. Perhaps only then will the 'lie'
in question be fully exposed.
MF&Ls Unite!
If the deflationary monsters can remain veiled behind advantageous amounts
of inflation, perhaps the U.S. bailouts can be effective over the short-term.
Perhaps also if the world feels that it has no choice but to continue along
the USD-hegemony-trail a little while longer, the system can avoid Armageddon.
Nevertheless, few trends tell us that longer-term a crisis of confidence
in the U.S. dollar can be avoided, and this suggests that one of the few
safe options for the investor remains gold.
But before arguing that gold is about to return to its safe haven throne,
remember that global policy makers, regulators, and money managers desperately
want to avoid this outcome. As for the average investor, so long as he or
she remains hooked on the misnomers, fallacies, and lies, they will continue
running down a paper dream while walking right by gold. To wit, amidst today's
financial blow-ups, foreclosures, and bank runs how many investors have
been hoarding gold because they fear holding fiat money? Not many.
In short, while gold is the answer if the explosion occurs, there
is reason to be optimistic that the paper chase can continue. Confidence
in paper money may indeed be shrinking as the inflation rate increases and
the Fed tries to throw its soothing cocoon over the financial world, but
this confidence - unlike the trillions in OTC derivatives and off-balance
sheet schemes - is nonetheless still observable.
Safe Haven
Are we in a recession or are we not? The debate goes on. Take a look at the
year-over-year change in operating profits of the S&P 500 corporations (see
Chart 1). Profits have declined for three consecutive quarters through
the first quarter of this year. Given reports of second-quarter profits
to date and estimates of those corporate profits to be reported,
it is a good bet that year-over-year profits will
be down for four consecutive quarters.
... the current behavior of corporate profits is signaling a recession.
... ... ...
Now, the nice thing about corporate profit data
is that they do not get revised as do a lot of other data that go into the recession
decision. (I suppose that there might be an exception to this
when it comes to the profit data associated with Fannie and Freddie!) With the
S&P 500 profits data there is no debate as to whether the Commerce Department
is using a correct measure of prices to deflate nominal data.
If Ben Stein wants to continue arguing that the U.S. economy has not yet
slipped into a recession, as he did in Sunday's New York Times, so be it. In
the meantime, those who are paying attention to
the behavior of corporate profits continue to win Ben Stein's money.
The following is an excerpt from commentary that originally appeared
at
Treasure Chests
for the benefit of subscribers on Tuesday, July 8th, 2008.
As discussed in previous commentary, despite the
dire realities affecting the global economy, it appears investors are not
heeding the warnings. Sure, some people are paralyzed like a deer in the headlights,
where you can't blame them if they are just waking up to the reality of what
lies before us. However, these still appear to be the few, with most still in
denial concerning future prospects for the economy and markets. This is evidenced
in gold and silver's sluggish performance of late. It should be doing far better
as an alternative, but again, the public does not see the need to buy it yet.
Can you blame them however, with the incessant cheerleading and gaming that
the media (CNBC in particular) pawns off as analysis? Exposed long enough to
this kind of thing it's bound to have an effect - that's just common sense.
What effect is this having on investors? The effect this is having is to
make the greater investing population, who get most of their analysis from television
believe it or not, complacent, where the conditioned response 'everything is
just fine' is predicated on the belief that as with all the other times it appeared
the sky was falling - it didn't. What's more, if you don't capitalize on other
people's weakness and buy every dip in the stock market, bubble-vision commentators
endeavor to make it appear you are an idiot, and will be left behind in the
dust. Combine this with the belief the bureaucracy would never let anything
happen to the economy / markets in an election year, and you have a recipe for
disaster in terms of sentiment, which is the primary reason(s) stocks are falling
- and could fall a great deal more.
Why would stocks fall a great deal more? On the surface, which is where most
minds operate on a perceptual basis, if the stock market were to 'crash', it
would be attributed to a disintegrating economy, which as you know from our
last meeting is the case with respect to
corporate earnings. The economy is falling off the preverbal cliff hypothecated
by so many for years now (which again, is why the public thinks it doesn't matter),
and the
quality minds in the bureaucracy appear powerless to stop it this time because
they can't keep the stock market from falling. Of course the reason they can't
keep stocks from falling is not because of pessimism, but again, complacency.
Market participants are not
buying enough puts to keep the perpetual short squeeze alive - so the stock
market naturally falls.
Of course the real bad news is the stock market is an important source of
asset-derived income
for many (the most important next to the housing market), as was the case with
home equity withdrawals. So, if this source of income
is lost, an unstoppable negative spiral could ensue, possibly ushering in the
unthinkable - a
Depression.
The bureaucracy knows this of course, which is where the inflation thingy
comes into the picture. Here, as the economy gets progressively worse, central
monetary authorities find the justification to print ever-increasing quantities
of fiat currency to
combat the slowdown, with the end result being rising prices as this
inflation works its way
through the (global) system to the consumer.
With all this said, it's not difficult to understand why
stagflation appears to
be the word right now then, because macro-conditions are undoubtedly gripped
in a period of rising prices that appears to be having a visible impact on the
economy. Unlike the last time we had a prolonged stagflation episode back in
the 70's however, with
high consumer
debt rates set against low
savings rates,
the ultimate outcome will likely be quite different this time around. This time,
with the US tapped on both a
domestic and international
basis, along with
demographic
considerations, regenerating the credit cycle will not be quite so easy,
if not impossible. This is of course what is not being talked about in the mainstream
media; the dire prospects
that lay ahead for the larger economy.
This is because that's what it's all about you know, keeping the credit cycle
growing. And this is how all economies mature through time. In the case of the
US, being the centerpiece of the current global boom, the bureaucracy decided
to export it's manufacturing sector(s) in favor of ever-increasing
deficits and debts to extend
the credit cycle, where since Nixon closed the gold window in 1971, the party
has been nonstop basically. Here, manufactured imports could be had on an increasing
basis in exchange for fiat currency so long as this inflation was not felt on
a wholesale basis by exporting nations. As with all things however, the global
nexus is maturing too now, where process has led to increasing input costs /
commodity prices as an enriched labor pool in these exporting nations adds to
demand.
So, let's take stock here. We have stagflation in Western (mature) economies,
who in turn export their inflation to a developing world that needs to print
money at break-neck speeds in order to cope with demand in their now booming
economies courtesy of globalization. What's more, these countries, with the
most notable example being China of course, are running huge foreign currency
reserves as a result off all this, meaning too much money is chasing too few
goods, which is why commodities are going through the roof. More recently however,
wage gains in these economies that are necessary to keep the global credit cycle
expanding have caused prices to rise too quickly - to the extent bureaucracies
are having to attempt walking the fine line of slowing their own booming economies
while not tipping mature economies into irreversible credit contractions. One
could hypothesize we have already arrived at the station in this regard, which
could permanently disrupt the entire global boom.
Politics
of Foreign Debt - Part I Why the government had to bail out the GSEs - iTulip.com
Forums
Most Americans do not question the existence of giant government sponsored
corporations that subsidize the real estate industry with discounted loans.
When I was interviewed by German Public Radio (See
Recorded at Wall Street) my interviewer, besides expressing surprise at
absurdly low prices in New York City where the interview took place, wondered
why Americans tolerated US government subsidies of the US real estate industry
via institutions and tax policies that the German constitution, as most European
constitutions including the French, forbid. Good question. In August 2007, French
President Nicolas Sarkozy proposed the mortgage interest deduction,
a cornerstone of US FIRE Economy policy passed as
part of the 1986 Tax Relief Act. The Constitutional Council,
the highest court in France, struck it down as unconstitutionally creating a
tax advantage for property owners. The development of a system of rent extraction
by one class of society over another worried the framers of the US constitution,
but in the end loopholes remained that left us open to the crisis of systemic
corruption that we face today.
FIRE
In August 2007, French President Nicolas Sarkozy proposed the mortgage interest
deduction, a cornerstone of US FIRE Economy policy
passed as part of the 1986 Tax Relief Act. The Constitutional
Council, the highest court in France, struck it down as unconstitutionally creating
a tax advantage for property owners. The development of a system of rent
extraction by one class of society over another worried the framers of the US
constitution, but in the end loopholes remained that left us open to the crisis
of systemic corruption that we face today.
Home
mortgage interest deduction - Wikipedia, the free encyclopedia
Tax Break - Who Needs the Mortgage-Interest Deduction - NYTimes.com
President Reagan was not. Addressing the National Association of Realtors
in 1984, he said, "I want you to know that we will preserve the part of the
American dream which the home-mortgage-interest deduction symbolizes." He didn't
mention that it also symbolized the American love affair with debt; after all,
it encourages people to pay for their homes with a mortgage instead of with
equity. Two years later, in the tax-reform act of 1986, Congress ended the deductibility
of interest on credit-card and other consumer loans; it left the mortgage deduction
in place.
But Congress did set a cap. Today, a taxpayer
can deduct the interest on mortgages worth up to a total of $1 million on his
or her first or second homes. Also, you can deduct up to $100,000
on a home-equity loan. (And what prevents you from using a home-equity line
to buy a flat-screen TV and then deducting the interest? Absolutely nothing;
go for it.)
At the beginning of 2005, flush from his election victory, President Bush
envisioned another major tax reform, somewhat similar to that of 1986. Simplifying
the tax code was a major goal, as was winnowing out the tax breaks that were
again eating a hole through the Treasury. Bush appointed a nine-member, bipartisan
panel to drum up a proposal. The president ordered the panel to "recognize the
importance of homeownership." People figured the interest deduction was off
limits.
But the panel, with former Senator Connie Mack III as chairman, asked the
taboo question of whether homeownership and the interest deduction were related.
It decided that they weren't.
The Liberty Papers »Blog Archive » Eliminate The Home Mortgage Interest Deduction
I agree that the mortgage interest rate deduction should be eliminated. What
folks don’t understand is that it benefits banks. To avoid taxes people are
willing to pay a bank $1000 to save $700. How whacked it that?
Banking expert Martin Mayer, author of
The Bankers: The Next Generation The New Worlds Money Credit Banking Electronic
Age and a dozen other books on banking and frequent writer for Barron’s
Magazine, Institutional Investor, and others explains:
Exporters to America who keep the dollars and use them for American purchases
and investments create what economists call an autonomous flow of funds
back to the United States, financing the American trade deficit with an
American investment surplus.
This produces the argument most closely associated with the new Federal
Reserve chairman, Ben Bernanke (though Alan Greenspan believed it, too),
that our trade deficit is caused by a surplus of savings that can't be profitably
invested in the home countries of our trading partners. Financing for our
trade deficit comes before — and actually causes — the deficit itself.
If instead of investing their dollars in the United States, foreign exporters
want to take the proceeds of their sales in their own currency, their central
banks will in effect sell them that currency for their dollars. Back in
the late 1960's, when Great Society deficits and the Vietnam War prompted
the first serious sell-off of dollars (and forced the United States to abandon
the gold standard because too many holders of dollars, led by President
Charles de Gaulle of France, wanted gold), those central banks lent those
dollars into the new Eurodollar market, where they traded somewhat separately
from domestic dollars.
This created a nightmarish prospect of the United States losing control
of its own currency, and in 1971 the Fed chairman, Arthur Burns, negotiated
a deal with the European and Japanese central banks. The deal was that they
would return to America the dollars they acquired in their own economies,
and the Fed would invest the money on their behalf, in absolutely safe government
securities, without charge and at the best rates.
Today, the Fed continues as custodian of the "foreign official holdings"
of such government obligations. During the Clinton administration, the Fed
agreed to invest in federally guaranteed housing securities for those foreign
central banks that wanted a better yield on their dollar reserves than they
would get from government bonds, and now half a trillion dollars* of the
total official holdings are invested in agency paper.
Foreign official holdings of government paper is a miner's canary number.
It tells you if there is big trouble ahead. The most common worry is that
the number will shrink suddenly, with foreign governments dumping their
dollar holdings, driving down the dollar's value and driving up American
interest rates, but that's not a real danger. If the price of our government
securities dived, the foreign central banks would have to bear the loss.
This would be a budget item for their governments, whose leaders would not
like it at all.
- Federal Reserve System: The Mark of the Bust,
Martin Mayer, June 14, 2006
* Half a trillion two years ago, almost a trillion today.
... ... ...
This marked the beginning of a period of political
versus economic investment by foreign governments in the US. One
government does not support another without purpose; compensation is
expected in return, which compensation may not accord with US domestic
interests. The bailout of Fannie and Freddie is the first example of a
domestic economic policy decision made to satisfy short term foreign and US
interests to the detriment of long term US interests. As we circle the
whirlpool created by foreign debt and the folly of the FIRE Economy that the
debt has enabled, you can be certain it will not be the last. To make
matters worse, the maintenance of the FIRE Economy depends on foreign
lending from non-market oriented, unelected often repressive governments.
More on that and the implications later.
"In the U.S., the Standard & Poor's 500 Index will tumble another 10
percent to 15 percent by 2010 as global growth slows and inflation accelerates,
he said. Until then, the outlook for commodities and equities in developed
and emerging markets looks poor, he said."
July 31 (Bloomberg)
Jeremy Grantham, chairman of Grantham, Mayo, Van Otterloo & Co.,
told investors to cut holdings of
emerging-market stocks, reversing his recommendation earlier this
year.
``Our advice until now was very simple: take as little risk as possible
except for emerging markets,'' Grantham, 69, whose Boston-based firm
oversees $126 billion, wrote in his
quarterly letter to investors. ``Now
it is even simpler: take as little risk as possible.''
Grantham said he favors holding cash
instead of owning stocks
because ``there are likely to be much better investment opportunities
in a year or two (or three) than we have seen for 20 years.''
Dubbed a ``perma-bear'' for his dour view on U.S. stocks
for more than a decade, Grantham correctly predicted a crash in
technology shares two months before the bubble burst in March 2000.
The money manager cut his weighting on
emerging-market
stocks to ``neutral
or just below.'' In the U.S.,
the Standard & Poor's 500 Index will tumble another 10 percent
to 15 percent by 2010 as global growth slows and inflation accelerates,
he said. Until then, the outlook for commodities and equities in developed
and emerging markets looks poor, he said.
``I underestimated in almost every way how badly economic and financial
fundamentals would turn out,'' Grantham wrote in the letter. ``Events
must now be disturbing to everyone, and I for one am officially scared!''
Professor Roubini notes, there are a number of key countries now
either in, or flirting with, recession. If the global economy slows
enough - causing U.S. exports to decline - we might start to see significant
job losses in manufacturing, and then the current recession could be
more severe than I currently expect.
Comments:
As I noted in a prior thread - Japan mfg output is down 2% in the
last Q. Most found the speed/abrupt adjustment surprising.
Time to look at trasports and shipping. I suspect a huge adjustment
in this area. CA truck transport (commercial miles driven w/ paid loads)
down 18% for June, on a y/o/y basis. JIT deliveries means JIT adjustments.
Bob Dobbs writes:"I take Roubini with
a huge grain of salt. He's been crying recession since late 2006.
I think he has overestimated the time span over which the events of
late will play out."
I suspect that Roubini, and those like him, underestimated the degree
to which the economy could could be hotwired to produce good numbers,
long after the fundamentals themselves went south.
Bob Dobbs |
Homepage | 07.30.08 - 7:11 pm |
#
rich writes:
He was a little early on his call, I agree. He underestimated
stupidity. That was just about the only thing he's got wrong.
He underestimated panicky short-sighted fixes that
ramped up the federal deficit, devalued the dollar, and fueled commodities
inflation.
Tell the truckers, airline employees, hotel owners, car dealers, resort
workers, etc. that Roubini was wrong. They're all in a deep recession
right now...and for years to come.
aleister perdurabo
writes:
Michael Hudson:
MH: I assume that by doom you mean that the dollar will continue
to sink against foreign currencies, while price inflation eats
away at what wages will buy. The idea that a worse economy will
be self-curing is IMF anti-labor ideology and Chicago School
propaganda. This is indeed what Nobel Economic Prizes are given
for, I grant you. But it’s Junk Economics. A falling dollar
threatens to become self-reinforcing. For starters, dollar-denominated
stocks, bonds and real estate are worth less and less in terms
of euros, sterling or other harder and foreign currencies. This
doesn’t provide much incentive for foreigners to invest here.
And if we go into a recession (not to speak of depression),
there will be even fewer profitable opportunities to invest.
Meanwhile, U.S. import dependency will continue to rise as the
economy de-industrializes that is, as it is further financialized.
U.S. overseas military spending will throw yet more dollars
onto the world’s foreign exchange markets. So a weak economy
here does NOT mean that the dollar will strengthen; it means
we have a bad investment climate! Austerity will make us more
dependent on foreign countries. For a foretaste, just look at
what has happened when the IMF has imposed austerity plans on
Third World debtors. And remember, last time when Robert Rubin
was given a free hand, in reforming Russia under Clinton, the
result was industrial collapse and bankruptcy.
http://www.dissidentvoice.org/20...michael-hudson/
aleister perdurabo | 07.30.08 - 7:19 pm |
#
|
Americans today spend almost as much on bandwidth — the capacity
to move information — as we do on energy. A family of four likely spends
several hundred dollars a month on cellphones, cable television and
Internet connections, which is about what we spend on gas and heating
oil.
Just as the industrial revolution depended on oil and other energy
sources, the information revolution is fueled by bandwidth. If we aren’t
careful, we’re going to repeat the history of the oil industry by creating
a bandwidth cartel.
From the Centex Investor Materials (from
8-K filed with SEC):
Market conditions worsened in the quarter
Foreclosures are rising
Employment is weakening
Consumer confidence is waning
Mortgage qualification standards are tightening
Traffic and sales have diminished
Expect to see more stories like
Macon Mall Faces Foreclosure.
Restaurants chains start feeling pain. "More empty space available.
More bad debt. More consumer ripples." Will Applebee's or TGI Friday's be
next?
From the WSJ:
Bennigan's, Steak &Ale Close Doors, File for Bankruptcy Protection (hat
tip Michael)
Long-time, national restaurant chains Bennigan's and Steak & Ale have
closed their doors and filed for Chapter 7 bankruptcy protection, shuttering
more than 300 sites and letting go of thousand of employees.
It is one of the country's largest restaurant bankruptcies ... The chains
will liquidate and are not likely to re-open.
More empty space available. More bad debt. More consumer ripples.
Era of ‘buy now and pay later, and later’ is over
New York is the second state in five days to declare a fiscal emergency.
See
Schwarzenegger Announced Intention To Slash State Workers' Pay Till
Budget Passes for more on the crisis in California.
The most stunning thing about Paterson's announcement is how rational
it is. He is not begging Washington for handouts, asking for higher
taxes, or praying for miracles.
This is pretty stunning too: In June 2007, the 16 banks that pay the
most on their business profits remitted $173 million to the state treasury.
“This June, just a month ago, they sent us $5 million — a 97 percent
decrease.”
Unlike Schwarzenegger who has for years resorted to floating bond or
proposing various lottery schemes to "fix" the budget, Paterson has
the correct solution.
Comments
Peter Schiff is not only brilliant, but brave and has the courage
of his convictions. I admire him.
===
Not only is Assmuss a patronizing fart... he was and IS an ASS! Peter's
been right for so long that in certain circles he is now hated. As Peter
told us, the bail out of Freddie and Fanny, Bear Sterns (via Fed/J.P.
Morgan scam), and the collapse of big banks and investment brokers will
eventually send inflation sky-high and our GREAT grandchildren will
be left to pay for it all. The USA was once loved. We are now HATED
by many around the world for our GREED and Military stance (for oil).
===
I would like to see that pompous ignorant asshole with the Ph.D Mr.
Asmus, speak at another one of these with Schiff. Shows you the true
value of a Ph.D, or being a part of a conservative think tank - reminds
me of jumbo shrimp, an oxymoron.
===
Survival is a matter of teamwork. If people start to learn lessons
from these financial mistakes...if we use our brains... we can overcome
a disaster. Survival is your preparation NOW. But don't store food as
if it is the end of the world. As a good christian you KNOW that the
LORD GOD will "bail you out" ;) I enjoyed this Las Vegas conference
on YouTube and I posted it on my personal website, which will have a
lot of "airplay" in the village that I leave, because I will write a
goodbye letter.
When CNBC or Fox needs a guest who can be counted on to deliver a
thoroughly gloomy outlook for the U.S. economy, they call on "Dr. Doom."
To say Peter Schiff is bearish is like saying Tiger Woods is an okay
golfer, or China has a small problem with air quality. The president
of Connecticut-based Euro Pacific Capital Inc. is so pessimistic about
the U.S. economy that he lives in a rented house and keeps the vast
majority of his and his clients' money outside the country, a healthy
chunk of it in gold and energy stocks.
"America is finished. We are going to destroy this country. Our economy
is just going to unravel," he told me yesterday. "The question is how
much money is the world going to lose before it writes us off?"
Apocalyptic forecasts are a dime a dozen these days, so why should
anyone pay attention to Mr. Schiff? Because his past predictions have
proved uncannily accurate.
When dot-com stocks with no earnings were shooting skyward in the
late nineties, he was advising clients to stay away and instead putting
money into the unloved energy sector, just in time for the great oil
bull market.
A few years later, when the housing bubble was inflating, he was
warning about the dangers of reckless mortgage lending and the precarious
state of Fannie Mae and Freddie Mac. "If it looks like a bubble, walks
like a bubble and quacks like a bubble, it's a bubble," he wrote. That
was in 2004, when speculators were still lining up to buy investment
properties in Las Vegas.
Ever the contrarian, Mr. Schiff made a bundle shorting the subprime
mortgage sector.
So, one year into the credit crunch and with more than $400-billion
(U.S.) of mortgage losses piling up on company books, where does Dr.
Doom see the U.S. economy heading now?
Unfortunately, into an even deeper hole, one from which it could
take years to emerge.
Far from rescuing the economy from the housing debacle, the government's
efforts to prop up Fannie and Freddie - which own or guarantee nearly
half of the $12-trillion in outstanding U.S. mortgage debt - will only
compound the problem by delaying the inevitable day of reckoning. The
same goes for plans to help hundreds of thousands of homeowners refinance
into more affordable mortgages.
Apart from encouraging the very moral hazard that got the U.S. into
this mess in the first place, the government bailout will come with
an enormous price tag in the form of soaring inflation, Mr. Schiff argues.
He believes government figures vastly understate the true rate of inflation,
which he estimates is now running at 10 to 12 per cent. Before long,
it could be north of 20 per cent.
"The government doesn't have the balls to raise taxes. It's going
to print the money. It's going to destroy the currency," he says.
During the Depression of the 1930s, at least people who held cash
made out okay. Because prices were falling, their money actually bought
more. But if Mr. Schiff is right and the U.S. is heading into a period
of hyperinflation, then even the most prudent savers will see their
wealth eviscerated.
With the walls closing in on the U.S. economy, where is an investor
to turn? Apart from gold and energy producers, which benefit from a
plunging U.S. dollar, Mr. Schiff likes conservative, dividend-paying
stocks such as pipelines and utilities. He's especially fond of Europe,
Asia, Australia and Canada, where his holdings include Barrick Gold
Corp., Goldcorp Inc., Crescent Point Energy Trust, Baytex Energy Trust
and Pembina Pipeline Income Fund.
He has two words for Canadian investors thinking now is a good time
to shop for bargain-priced U.S. stocks: "Stay away."
Wednesday, July 9, 2008
We have long warned that stagflation, or economic contraction accompanied
by inflation, would become so evident that even the most optimistic
observers could not deny its virulence.
Last week, Warren Buffet was the latest to describe his encounter with
the beast. The world’s most famous investor pronounced that the current
economy is in the middle stages of a stagflation episode. Although Mr.
Buffet is not typically associated with either bullish or bearish sentiment,
he asserted that both the “stag’” and “flation” aspects of the condition
would intensify before they relent. So if we can all recognize the wolf
at the door, can we agree on the best course of action?
Unfortunately for policy makers, different weaponry is called for to
vanquish the two heads of the stagflation dragon. Recession can be held
at bay by lowering interest rates, while inflation is usually tamed
by raising interest rates. Given the impossibility pursuing both courses
of action simultaneously, priorities come into play. Historically, inflation
has been considered the greater long term economic menace, and has therefore
been dealt with first.
This was the plan of attack successfully mapped out by President Reagan
and Fed Chairman Paul Volcker in the 1980s. With the President’s political
backing, Volcker was able to kill stagflation with a short but heavy
dose of double-digit interest rates. With the stable currency and low
inflation that resulted, the stage was then set for a sustained and
robust economic expansion.
By Daniel Pfaendler
Published: July 29 2008 15:06 | Last updated: July 29 2008 15:06
Developed market bond yields should move
markedly higher through the rest of this summer, but then fall sharply
going into 2009, says Daniel Pfaendler, head of G10 economics
& strategy at Dresdner Kleinwort.
He believes the oil price shock and the unwinding of asset bubbles,
over-leverage and economic imbalances in general
should keep growth significantly below trend
and real yields depressed for a protracted period of time.
[Jul 29, 2008] Quote of the Day: Michael Belkin
Permalink
Posted by Barry Ritholtz on Tuesday, | 01:15 PM
“Most global stock indexes have decisively broken
below their 200 week moving averages, which is a major trend reversal.
The intermediate term (3 month) and long term (12 month) model forecasts
point down. We recommend taking advantage of every minor rally to close
long positions, go short and shift out of tech and cyclicals into defensive
groups. Stock indexes haven’t yet had the big surge in volatility (5%
daily NASDAQ moves down and up amidst a declining market). That is probably
approaching. Bear market trading is typically more productive selling
into those big percentage bounces, rather than selling into big declines
and then watching the market bounce back in your face.
Potential downside targets after a 200 week average
breakdown are 1) the 200 month average and 2) The previous 2002-2003
lows. Those levels are 25%-47% below current levels for most stock indexes.
U.S. financial indexes are already there (BKX, XLF). So don’t think
it can’t happen for the broader market and other currently elevated
indexes, stocks and groups.”
Michael Belkin
The Belkin Report
July 6, 2008
To say it's disconcerting to find
that your bank has been shut down by authorities is probably an understatement.
We asked David Barr, spokesman for the Federal Deposit Insurance Corp.,
or FDIC, about the procedure. The FDIC is an independent agency of the
federal government. It is charged with insuring deposits in banks and
thrift institutions up to $100,000 per depositor in individual accounts
and $250,000 in retirement accounts. Deposits held in different
categories of ownership may be insured separately.
-
White House outlook turns dark grey. The sluggish economy
and expensive stimulus package will swell the U.S. budget deficit to
$482B in 2009 - $75B more than previous White House estimates. GDP is
seen growing just 1.6% in 2008, down from a previous projection of 2.7%.
In 2009 it expects 2.2% growth, down from 3%. (.pdf)
The projection
complicates the upcoming presidential skirmish: the ballooning could
play havoc with McCain's planned tax cuts, and Obama's promised health-care
expansion.
-
IMF pessimistic on U.S. The IMF riled markets Monday after
it said there's no end to housing slump in sight. The fallout will continue
to leak outside of just housing: "With delinquencies and foreclosures...
rising sharply, and house prices continuing to fall, loan deterioration
is becoming more widespread."
-
Mishkin's hard line. The Fed's Frederic Mishkin said once
again that regulators should set concrete inflation goals, instead of
their current use of comfort zones (or
shmumfort zones as he calls them). He also wants the Fed increase
its outlook to five years. Apparently, he's not too fond of their use
of so-called core inflation, which factors out volatile food and energy
prices. "It should be an inflation rate that actually affects people
- people
care a hell of a lot about what they are paying for gas."
Even though the Fannie and Freddie near crisis, which produced a
few days of panic in the credit markets, now seems to have abated, money
market investors are still on edge. The Financial Times warns that various
risk measures remain at elevated levels:
Libor, the measure of inter-bank interest
rates that is a key barometer of the health of the credit markets,
continues to signal problems a year into the credit crunch and raises
doubts about whether the financials’ share prices are close to a
bottom....There is a growing realisation that
the all-clear signal for the banking sector will not sound until
the difference between Libor and the overnight rates set by central
banks narrows from its current elevated levels.
There have been quite a few anecdotes about a new tough-mindedness among
banks, and it is finally showing up in the data. From the
New York Times:
Two vital forms of credit used by companies — commercial and industrial
loans from banks, and short-term “commercial paper” not backed by
collateral — collectively dropped almost 3 percent over the last
year, to $3.27 trillion from $3.36 trillion, according to Federal
Reserve data. That is the largest annual decline since the credit
tightening that began with the last recession, in 2001....
“The second half of the year is shot,” said Michael T. Darda, chief
economist at the trading firm MKM Partners in Greenwich, Conn.,
who was until recently optimistic that the economy would continue
expanding. “Access to capital and credit
is essential to growth. If that access is restrained or blocked,
the economic system takes a hit.”...... ... ...
Some suggest that the banks, spooked by enormous losses,
have replaced a disastrously indiscriminate
willingness to hand out money with an equally arbitrary aversion
to lend — even on industries that continue to grow.
Stumbling and
Mumbling
But there’s a nastier possibility. As Justin
says,
this is about stigmatizing the unemployed, by lumping them in with criminals
doing community service.
In this respect, for all the New Labour drivel about “modernization”
what’s going on here is something centuries old - treating poverty as
moral failure. Here’s C.B.Macpherson describing 17th century attitudes
to poverty relief:
The Puritan doctrine of the poor, treating poverty as a mark
of moral shortcoming, added moral obloquy to the political disregard
in which the poor had always been held. The poor might deserve to
be helped, but it must be done from a superior moral footing. Objects
of solicitude or pity or scorn, and sometimes of fear, the poor
were not full members of a moral community. (The political theory
of possessive individualism, p226-7)
Nothing much has changed in the last 350 years.
Low transaction costs are definitely fueling speculation.
As Alex Tolley stated incomments: "The idea
that that there is "good" and "bad" speculation depending on how prices
move is silly and, I suspect, unfounded."
Economist's View
Ah, good - I've been meaning to do something like this myself, but
never got around to it. Jeff Frankel sorts speculation into three types
and notes that only one of the three types, "bandwagon behavior," is
worrisome. However, there's little evidence that this type of speculation
is present in commodities markets:
Commodity Prices, Again: Are Speculators to Blame, by Jeff Frankel:
...Many currently are trying to blame speculators for the high prices
of oil and other mineral and agricultural products. Is it their
fault?
Sure, speculators are important in the commodities markets, more
so than they used to be. The spot prices of oil and other mineral
and agricultural products — especially on a day-to-day basis — are
determined in markets where participants typically base their supply
and demand in part on their expectations of future increases or
decreases in the price. That is speculation. But it need not imply
bubbles or destabilizing behavior.
The evidence does not support the claim that speculation has
been the source of, or has exacerbated, the price increases. Indeed,
expectations of future prices on the part of typical speculators,
if anything, lagged behind contemporaneous spot prices in this episode.
Speculators have often been “net short” (sellers) on commodities
rather than “long” (buyers). In other words they may have delayed
or moderated the price increases, rather than initiating or adding
to them. One revealing piece of evidence is that commodities that
feature no futures markets have experienced as much volatility as
those that have them. Clearly speculators are the conspicuous scapegoat
every time commodity prices go high. But, historically, efforts
to ban speculative futures markets have failed to reduce volatility.
One can distinguish three kinds of speculation in the face of
rising prices. First, there is the “bearer of bad tidings”... The
news that, in the future, increased demand will drive prices up
is delivered by the speculator. Not only would it be a miscarriage
of justice to shoot the messenger, but the speculator is
actually performing a social service, by delivering the right price
signal that is needed to get real resources better in line with
the future balance between supply and demand. Without him, the subsequent
price rise would be even greater, because supply would be less.
But it does not appear that speculators played this role in the
commodity boom that started earlier this decade: as already mentioned
they, if anything, lagged behind the spot price.
Second, when the price is topping out, stabilizing speculators
can sell short in anticipation of a future decline to a lower equilibrium
price. This type of speculator again adds to the efficiency of the
market, and dampens natural volatility, rather than adding to it.
Third, in some case, when an upward trend has been going on for
a few years, speculators sometimes jump on the bandwagon.
Market participants begin simply to
extrapolate past trends and self-confirming expectations create
a speculative bubble, which carries the price well above its equilibrium.
Examples of previous bubble peaks include the dollar
in 1985, the Japanese stock and real estate markets in 1990, the
yen in 1995, the NASDAQ in 2000, and the housing market in 2005.
It is the third kind of speculation, the destabilizing kind (also
called bandwagon behavior or speculative bubbles) about which politicians,
pundits, and the public tends to worry. There is little evidence
that this has played a role in the run-up of commodity prices. So
far, that is. Just because the boom originated in fundamentals does
not rule out that we could still go into a speculative bubble phase.
The aforementioned bubbles each followed on trends that had originated
in fundamentals (respectively: rising US real interest rates, 1980-84;
easy money and rapid growth in Japan, 1987-89; US recession, 1990-91,
and Japanese trade surpluses; the ICT boom in the late 1990s; and
easy US monetary policy after 2001). It could happen yet in commodity
markets.
Comments
Alex Tolley says...
"Speculators have often been “net short” (sellers) on commodities
rather than “long” (buyers). In other words they may have delayed
or moderated the price increases, rather than initiating or adding
to them. "
No chance this is the physical owners hedging then?
The idea that that there is "good"
and "bad" speculation depending on how prices move is silly and,
I suspect, unfounded. Far better to recognize that
speculative instruments like futures can represent volume many times
the underlying physical or money instrument and thus can take on
a life of its own, un-anchored. Currency markets have been chronically
like this for over 30 years at least, creating wild gyrations in
forex rates. Low transaction costs lubricate these markets.
I don't know if one can mitigate this trading without either
incurring regulations that limit the # of transactions or increasing
transaction costs. Alternatively we could go back to the bad old
days of fixing prices by fiat. None of these choices seem desirable
to me.
Bridgewater Associates estimates in a recent report that marked to market,
US banking industry losses would constitute over $560 billion versus
the $116 billion they have raised today. I guarantee that if banks were
to mark their books in accordance with the levels indicated by Bridgewater,
investors would collectively have a heart attack, liquidity would evaporate,
credit spreads of all kinds would widen massively and the stock market
would head south, pronto.
While a "good bank/bad bank" structure may be part of the eventual resolution
of this mess, pray tell how does a non-failed bank go about creating
this sort of vehicle? A restructuring of this sort would presumably
require shareholder approval, and an admission that a bank was in bad
enough share to go this route would not merely tank the stock price,
but almost certainly make any kind of debt funding, including routine
money market operations, difficult to impossible. An effort to implement
this sort of program would likely lead to a bank failure (if I were
a depositor in excess of FDIC limits, I'd head for the hills). Thus
in the absence of a Federal program, I am at a loss to see how this
could work (even if the bank had a "pre-pack" negotiated with private
equity investors, you'd still need shareholder approval, and you'd be
subject to adverse reactions from funding sources).
Reader Steve e-mailed some observations about recent FDIC actions that
bear on this discussion. One of his lines of thought is how analogies
to the S&L crisis (which was considerably smaller than our current mess)
can be misleading. I've highlighted some key points:
Simple comparisons--the number of bank failures, or the total assets
of failed institutions--can be misleading. A more important measure
is the percentage of assets that remain under FDIC control vs. the
percentage sold either at the time of failure or immediately after.
For example, in the FNB/Nevada and First Heritage transactions,
FDIC is keeping 94% of the assets. FDIC has so far been unable to
sell Indymac's servicing arm, and hasn't announced any portfolio
sales. FDIC holds 100% of the assets of the second largest bank
failure in US history.
Fewer banks
are failing (so far), but the number of healthy institutions able
to absorb their performing assets has shrunk as well.
There is also a significant difference in type of troubled assets
between the 80's and today. Construction and development financing
caused the majority of failures twenty years ago. Losses on household
mortgages were not a big factor, because underwriting standards
were higher. Today the problem assets are C&D, CRE and huge numbers
of first and second home mortgages.
The law governing FDIC has changed since the last crisis. The FDICIA
of 1991 makes it impossible for FDIC to create bridge banks at will.
Twenty years ago, Indymac would have been bridged, meaning that
uninsured deposits would have been covered. Today, the `too big
to fail' test for creating a bridge bank is codified, and very few
institutions qualify.
The huge losses embedded in household mortgage portfolios make the
current banking crisis different, and the regulatory response is
different as well. The reason for the concern over foreclosures
has more to do with bank accounting than with bleeding heart concerns
for mortgagors. When a property is foreclosed, a bank must write
off the difference between the loan balance and the appraised value
of the property (with a further downward adjustment for disposition
costs). A write-off is a reduction in capital, so the bank's capital
primary capital ratio is affected. Banks are prohibited from writing
owned real estate back up. On the other hand, if the bank only recognizes
an impairment on the loan, there is a reserve against capital but
no write-off. So the loss can be strung out over time, and regulators
can allow banks a fair amount of leeway in forming `opinions' about
loss severities. In other words, an insolvent bank can appear to
be adequately or even well capitalized.
I believe an
argument could be made that many institutions would be stone insolvent
if foreclosures and write-offs were being done in accordance with
traditional banking and regulatory practices. In particular,
I suspect that the vast majority of foreclosed mortgages are investor
owned rather than bank owned, and that regulators have adopted `go-slow'
oversight in anticipation of legislative action on foreclosures.
I agree 100% with Steve's assessment. A lot of banks are no doubt
insolvent now. Critics can argue that Bridgewater's mark-to-market calculation
doesn't necessarily reflect true economics, since some markets are arguably
short of buyers, and hence the low prices reflect illiquidity as well
as impairment of the assets. But the flip side is that we are at best
only halfway through the housing price decline. Case Shiller has the
housing market currently at a 19% decline from peak. A number of metrics
(mean reversion, traditional relationship of housing prices to income
and rentals, plus the likelihood of overshoot on the downside) suggest
the bottom will be at least 35% below peak, and 40% or even lower is
not out of the question. Bridgewater's $560ish billion measure against
roughly $1.3 trillion in banking system equity (if memory serves me
right) and the $116 billion in new equity raised so far.
Even if you use the current Bridgewater
figures as a proxy for ultimate losses (and that is likely to be light),
there is a very big hole in the balance sheet of the banking system.
And the reason for trying to fudge things is to prevent panic.
It's clear the Bush II 2008 tax stimulus was poorly though over. It
would be much better move to stimulate switch to more energy efficient cars
in some way or form -- it would help auto-industry and environment.
Alan Blinder in today's New York Times, argues for an
ostensible stimulus package (hey, since more stimulus packages are
probably in the offing, better register your preferences early) that
will help the environment. But what I like about it is that it would
cost so little that it barely rates in the "let's goose the economy"
category.
The idea is that the government buys old cars of types that are just
about certain to be heavy polluters. This is the dirty secret of auto
emissions: the vast majority of the damage is done by a comparatively
small percentage of cars. The program is means tested, so only those
of middle and lower incomes can participate.
Although this initiative would do nothing to remedy America's dependence
on the internal combustion, it's an interim measure that yields tangible
benefits at a comparatively low price.
From the New York Times:
Cash for Clunkers is a generic name for a variety of programs under
which the government buys up some of the oldest, most polluting
vehicles and scraps them. If done successfully, it holds the promise
of performing a remarkable public policy trifecta — stimulating
the economy, improving the environment and reducing income inequality
all at the same time. Here’s how.
A CLEANER ENVIRONMENT The oldest cars, especially those in poor
condition, pollute far more per mile driven than newer cars with
better emission controls. A California study estimated that cars
13 years old and older accounted for 25 percent of the miles driven
but 75 percent of all pollution from cars....
MORE EQUAL INCOME DISTRIBUTION It won’t surprise you to learn that
the well-to-do own relatively few clunkers...
AN EFFECTIVE ECONOMIC STIMULUS With almost all the income tax rebates
paid out, and the economy weakening, Cash for Clunkers would be
a timely stimulus in 2009...
Here’s an example of how a Cash for Clunkers program might work.
The government would post buying prices, perhaps set at a 20 percent
premium over something like Kelley Blue Book prices, for cars and
trucks above a certain age (say, 15 years) and below a certain maximum
value (perhaps $5,000). A special premium might even be offered
for the worst gas guzzlers and the worst polluters. An income ceiling
for sellers might also be imposed...
Comments
Anonymous said...
The US had much higher growth rates when taxes were more progressive
2. The "rebates" were rebates in name only. The idea of an economic
stimulus is to increase spending. The rebate proposal was widely derided
as providing something like 70% of the proceeds to middle income consumers
who do not have as high a propensity to spend as lower income people.
Economists argued that the best bang for the buck, stimulus wise, would
be to increase food stamps and extend unemployment coverage.
3. The rich have a hugely favorable tax regime thanks to low capital
gains taxes and no taxes on corporate dividends. And since stock issuance
is a trivial source of funding for businesses (less than 2%; retained
earnings and debt are the big sources) the idea that the stock market
is vital to the funding of American businesses is way overplayed. Big
companies, the kind that fund in the stock market, have if anything
been saving (which means getting smaller) as opposed to growing, in
balance sheet terms, thanks to outsourcing and cost cutting.
This is the key idea behind
Keynesianism.
(see also
Keynesian
Economics, by Alan S. Blinder).. Government should play an active role.
Keynesians believe the short run lasts long enough to matter. They often
quote Keynes's famous statement "In the long run, we are all dead" to make
the point.
[M]acroeconomics is not just the summation of microeconomic outcomes,
but rather the interaction of microeconomic outcomes. For me, a simple
concept brought this realization: the paradox of thrift... if we all
individually cut our spending in an attempt to increase individual savings,
then our collective savings will paradoxically fall because one person’s
spending is another’s income... what holds for the individual doesn’t
necessarily hold for the community of individuals. Understanding this
paradox is absolutely vital to understanding macroeconomics and even
more so to understanding what is presently unfolding in global financial
markets. Once the double bubbles in housing valuation and
housing debt burst a little over a year ago, everybody, and in particular,
every levered financial institution – banks and shadow banks alike –
decided individually that it was time to delever their balance sheets.
At the individual level, that made perfect sense. At the collective
level... when we all try to do it at the same time, we actually do less
of it, because we collectively create deflation in the assets from which
leverage is being removed....
[M]onetary easing is of limited value in breaking the paradox of
deleveraging if levered lenders are collectively destroying their collective
net worth. What is needed instead is for somebody to lever up and take
on the assets being shed by those deleveraging. It really is that simple....
[T]hat somebody is the same somebody that needs to step up spending
to break the paradox of thrift: the federal government...
By definition, levering Uncle Sam’s balance sheet to buy or guarantee
assets to temper asset deflation will put the taxpayer at risk – but
will do so for their own collective good! This was de facto what the
Federal Reserve did when it put up $29 billion on nonrecourse terms
to buy assets so as to facilitate the merger of Bear Stearns into JPMorgan...
this was a fiscal policy operation.... At the end of the day, there
are $29 billion more Treasuries on the open market than otherwise would
be the case, and the Treasury is, one small step removed, on the hook
for any losses the Fed experiences on the $29 billion of non-Treasury
assets it now de facto owns....
Which brings us to Mr. Paulson’s request to Congress to give him
– and his successor – the power to spend unlimited amounts of taxpayers’
funds to buy the debt or equity of Fannie Mae and Freddie Mac. I confidently
predict that he’s not going to get unlimited authority; it will most
likely be checked by counting any such deficit-financed injections into
Fannie and Freddie against the Treasury’s statutory borrowing limit,
which can be lifted only by Congress. But Mr. Paulson is going to get
most of what he wants, if only because legislators are too fearful of
the consequences if they stiff arm him.... This is the way it should
be: bailouts and backstops with taxpayer funds should be legislated
by Congress and placed on the Treasury’s, not the Fed’s, balance sheet....
Conventional wisdom holds that when an economy faces a paradox of
private thrift, it is appropriate for the sovereign to go the other
way, borrowing money to spend directly or to cut taxes, taking up the
aggregate demand slack.... [C]onventional wisdom is struggling mightily
with the notion that when the financial system is suffering from a paradox
of deleveraging, the sovereign should lever up to buy or backstop deflating
assets. But analytically, there is no difference: both the paradox of
thrift and the paradox of deleveraging can be broken only by the sovereign
going the other way. Fortunately, Congress is finally grappling
with this reality, as it moves towards passage of Mr. Paulson’s plan
for backstopping Fannie and Freddie with taxpayer funds. It’s not a
fun thing to do, particularly following the use of $29 billion of taxpayer
funds to facilitate the merger of Bear Stearns into JPMorgan. But it
is the right thing to do. And it is further the right thing that Congress
is doing it, not the Fed under Section 13(3), except as a possible bridge
to Treasury authority.
Comments from Brad Delong Blog
-
Maynard Handley |
July 26, 2008 at 08:33 PM
- "At the individual level, that made perfect sense. At the collective
level... "
Or to put it more simply,
the whole Invisible Hand concept is a crock.
Or, more specifically, it is a crock
to claim that at all times, in all places, it will solve all problems.
Why is it that even your smarter libertarians like Richard Epstein,
the ones who will admit that there might, in theory, be such a thing
as externalities, even though they'll never actually admit to one
in practice, can't seem to get this?
And why is it that econ 101, at the same time that it is going
on about the wonders of free trade, and the importance of not setting
the minimum wage too high, is not flogging this type of example
with the same enthusiasm? The primary reason that the country is
populated by a large number of gullible fools who believe everything
the GOP feeds them about the importance of removing regulation is
because of what is taught in AP Economics and Econ 101. This sort
of pattern is enough to make one a Chomskyan.
Now, with respect to the details of this plan. Once again we
have a situation where, sure it's for the taxpayers' benefit, but,
once again, it turns out that it will be the super-rich who benefit
most. Once again, I have to ask: if it's so essential that this
sort of bill get passed, why not pass it in tandem with legislation
that lays the bill where it is due; for example a surtax on incomes
above a certain level, or on financial industries, or a very small
financial transactions tax (like the stamp tax of many countries)
that won't dissuade transactions of genuine financial merit but
will dissuade vast amounts of the meaningless sloshing of money
back and forth that we see these days?
- MattY |
July 26, 2008 at 11:31 PM
- By the way, the author makes the common economic mistake. The
backstopping done by the legislature only occurs when it is too
late. Like the New Deal, the legislature only hires labor when labor
has already gotten very cheap.
In this case, the legislature is
investing in mortgages because they are very cheap right now.
PIMCO basically is going to want this government backstop so
it can re-enter the business. PIMCO had been very careful about
not getting caught, now, like wealthy do, this company wants the
federal backstop, then PIMCO can be the second investor and do well.
I would not be surprised if much of the gains possible in this
backstop will end up, not in taxpayer hands, but in PIMCO hands
and their followers.
The real test here is to raise progressive
taxes by a few points, then see how the legislature handles this.
I think PIMCO would change their tune once they find their investors
will have to pay for the bulk of their government guaranteed winnings
some two years down the line.
-
Publication of such papers suggests that situation is closer to "light
at the end of tunnel" then one might think... Passing of Foreclosure
Prevention Act of 2008 points to the same direction.
naked capitalism
Research by an IMF economist concludes that US residential real estate
was overvalued by 14% as of the first quarter of 2008. The paper seeks
to define an equilibrium price and also anticipates that the housing
market will fall markedly below that level.
Comments
Milton Freedman was really disingenuous promoter of 'free markets" (IMHO
"Capitalism and Freedom" was written really of CNBC level ;-). But people
do a lot of stupid things for good money and professors, especially former
"undernourished" professors, are no exception...
Chicago School Unwelcome at Chicago
University of Chicago academics
oppose naming a new research centre after Milton Friedman:
In a letter to U. of C. President Robert Zimmer, 101 professors—about
8 percent of the university’s full-time faculty—said they feared
that having a center named after the conservative, free-market economist
could “reinforce among the public a perception that the university’s
faculty lacks intellectual and ideological diversity.”
“It is a right-wing think tank being put in place,” said Bruce
Lincoln, a professor of the history of religions and one of the
faculty members who met with the administration Tuesday. “The long-term
consequences will be very severe. This will be a flagship entity
and it will attract a lot of money and a lot of attention, and I
think work at the university and the university’s reputation will
take a serious rightward turn to the detriment of all.”
...faculty critics are concerned that it will be one-sided, attracting
scholars and donors who share a point of view.
The opposition probably tells us more about the lack of diversity
and the ideological biases at the rest of the university than at the
new research centre.
Most commentary on the
2006q4 current
account balance release focused on the improvement in the overall
balance. Little noted is the fact that 2006 is the first year in which
the net income category has registered negative. From
Haver:
... The 2006Q4 current account deficit shrank sharply to $195.8bln
from $2
But I concur that there is a certain “detrimental reliance” argument against summarily revoking it (i.e., “I was counting on it when I bought my home in the first place…”).