Last year, we put America on Banana Republic watch, and sadly, things appear to be playing out as we feared:
I'm certain you're familiar with the expression "death wish." I am beginning to wonder whether America has a banana republic wish. The country has been taking steps towards being a small-minded, elite-dominated, sham democracy.

Mind you, I am pointing to a tendency, not an established fact. The US isn't Haiti, or even Argentina. But we are moving in that direction on a variety of fronts, and the devolution seems so concerted that I wonder if there is some unconscious mass desire to give up on the messiness and ambiguity of an open society and surrender to the certainty of one with institutionalized inequality, more authoritarianism, but more predictability, and perhaps an illusion of greater security.

What triggered this line of thought? Something surprisingly minor: the April employment report,...But even this disappointing figure may have been the product of manipulation, as we will discuss in due course. And we've now had so many instances of what charitably may be called artful reporting that it's beginning to undermine my faith in government statistics. Unreliable government statistics are a Banana Republic Indicator..... the integrity of that data is becoming compromised on enough fronts so as to render them suspect. And inaccurate data leads to bad business and bad policy decisions. Bad policy decisions are particularly likely since the information is massaged so as to minimize unpleasant news.
What is remarkable is that today's 2Q GDP revision. from a 1.9% that most observers regard as likely to be revised downward (and initial releases are often revised by significant increments), has now been revised to a simply not credible 3.3%. We'll discuss in a bit how this artwork was achieved.
...Barry in a later post, with the help of a chart provided by Michael Panzner, found the real smoking gun: a laughable assumption for inflation. The lower the inflation assumption, the higher the GDP figure. Not only was the 1.2% chosen lower than CPI, which has been adjusted over time to underreport inflation so to reduce payouts on CPI-indexed programs, most notably Social Security, but as a commentor on Econompics noted, constituted the biggest gap between the GDP deflator and CPI since 1980 (squinting at the chart, that seems to be accurate)...

...Mind you, this massaging is taking place on top of long-running adjustments that make both GDP and inflation stats questionable. Is it time to revive the 1960s expression "credibility gap"?

Refreshingly, some in the MSM are coming close to doing so. This story in Bloomberg, "Lagging Incomes Signal U.S. Economy Weaker Than GDP Suggests," which came out within hours of the release, discusses the disparity between incomes data and GDP without taking on the GDP report frontally. That's a step in the right direction.

===

Anonymous said...

Some don't seem to understand what the GDP covers or what the GDP deflator measures. GDP covers more than the US consumer - GDP and its growth include the contribution of net exports. And exports have been undergoing disinflation due to the cheaper dollar. This brings down the deflator.

In other words, the proper inflation measure of GDP includes the effect of prices on foreign buyers as well as American consumers.

It's an open economy after all.

One of the bloggers you quote is also famous for promoting the idea that the measurement of savings is wrong because it doesn't include marked to market changes for assets.

Similar errors - the problem lies in not understanding (or being unwilling to understand) what the scope of the measurement is intended to be.

Yves Smith said...

Anon of 10:07 PM.

With all due respect, with an export sector of roughly 15% of GDP, it is well nigh impossible to reconcile a 2Q GDP deflator of 1.2% with a CPI-U running at 4.3% over the last year (and stronger appreciation in 2Q) and a PPI rising at 8.9% in the last year (and again, faster in 2Q).

Nor is there any reason to expect that exports are decreasing their prices in dollar terms. A weak dollar in fact permits them to increase prices in $; that's an oft-cited worry, that manufacturers become fat and lazy with a weak currency, either increasing prices and fattening their margins, or simply failing to innovate since the price advantage lessens the pressure to improve features or quality.

Further, as we noted in a recent post, policymakers are worried that much of our export gains are skewed towards commodities, not finished goods. You'd need to look at a US basket of commodity exports to come up with the right number to determine how their prices changed over the quarter.

Nevertheless, I imagine most readers of this blog would be delighted to bet $100 against you that US commodity export prices overall fell in dollar terms from the end of 1Q to the end of 2Q. The dollar rally did not occur until July.

The fact that Barry Ritholtz is off the mark upon occasion does not refute any of the arguments of his cited above.

And that marvelous tidbit from Genesis, that the deflator for non-financials was negative, says how dubious this entire exercise is.

David said...

Tell me it ain't so. I heard the wildly optimistic 'growth' figure and wondered what country I am in.

Political manipulation?

However, perhaps the overwhelming profits in commodities (oil especially_) and estimated profits from future uncollected loans are skewing the figures. One gal making a million an hour makes 10,000 guys look like they're doing well even if they are losing individual income while they are included in the same quantity averaged with the million an hour person. That's the law of averages. Just a few wild successes make the whole pie look good. We know how a few Mobile Exxons are doing. Of course 10,000 small businesses are failing at the same time but that's statistic not parsed in the overall "growth".

Growth like this reminds me of cancer.

Anonymous said...

menzie chinn i thought had a nice, balanced take, while merrill lynch's david rosenberg was quite critical if you can get a hold of the report; here it is in a nutshell:

So let’s get the picture straight:

To believe in today’s revised GDP data, we have to believe that...

1. We are seeing near-record deflation in the nonfarm nonfinancial corporate sector.

2. We are seeing double-digit earnings growth in the financial arena.

3. Productivity growth is running at a near-3.5% pace and as such, “potential” GDP growth is close to 5% (we’d like to believe that, but it can’t be true).

4. Unit labor costs in the nonfarm nonfinancial sector were actually declining at a 2.2% annual rate in the second quarter (again, being bond bulls, nothing would make us happier if this were all true),

5. Somehow, in a quarter which saw the CPI rise at a 5% annual rate and PPI up by more than a 10% annual rate – both accelerating over the 1Q runup – the GDP price deflator managed to decelerate from a 2.6% annual rate in 1Q to a 1.2% annual rate in 2Q, the softest economy-wide inflation print in a decade (and recall, the 2Q ends in June when the commodity bubble was just about to reach its climax).

We are non-believers...

www.nakedcapitalism.com

"[Freddie] had to pay hefty interest rates [in an auction of its debt yesterday]….Five-year notes were priced to yield 4.172%, or 1.13 percentage points above yields on safe Treasury notes, the highest “spread” Freddie has ever paid on such debt."

So the momentary backing off of Japanese investors in and of itself may not be as big a cause for concern as it appears to be. But there is a second-order question: if the populace of a country comes to regard US credits, public and private, as less than desirable, continuing large central bank purchases will become increasingly controversial.

Now China may seem immune to that sort of pressure, but recall even they have taken a lot of heat for the Blackstone investment and actually seem (as best I can judge at this remove) more than a tad embarrassed.

Skeptical CPA points to a similar line of thinking: the return on offer for US bonds is inadequate. quoting Steve Hanke at Forbes (August 11, no online source):

In short, the dollar rules, to the great benefit of the U.S. Could it lose its dominion? It could. ... For real rates, compare the nominal return on short-term Trasury bills (less than 1.5%) with the rise in the consumer price index over the last year (5%). Someone sitting on cash in the form of T bills is seeing his wealth shrink (and this is before income tax is subtracted). Neither U.S. savers nor foreign central banks are willing to undertake this sacrifice forever. ... Foreign central banks purchase roughly 80% of all the new debt issued by the U.S. government. ... By my calculation, approximately 55% of the increase in corn since 2001 can be accounted for by the dollar's decline. ... By denying a direct link between the dollar and commodity prices, the Fed is signalling that it wants room to move interest rates and the dollar down

Now to the story on Japan from Bloomberg:

Japanese investors made the biggest weekly net sales of overseas bonds since at least 2001 on currency swings and concern the U.S. housing slump will worsen.

===

Anonymous said...

According to U.S. Dept of State, United States 2006 GDP component makeup was:

67.8% Service
12.4% Government
12.1% Manufacturing
4.9% Construction
1.9% Mining
0.9% Agriculture, Forestry, and Fishing

Source: http://usinfo.state.gov/products/pubs/economy-in-brief/page3.html

Banks Need Fistfuls of Dough Through End of 2009, Thanks to Refis

Many investors might have decided to sit with their 2 year paper; others may have gotten in opportunistically, finding what looked to be an attractive trade. But anyone looking at these credits now is going to be worried about the risk of further downgrades. That, plus the sheer amount of paper on offer is going to mean these deals will need to carry healthy spreads to get done.

Of course, as the article notes, financial firms could simply shrink their balance sheets. And even though that is what ultimately needs to happen (the US is overleveraged), its the last thing the Fed or Congress wants to see, since deleveraging is deflationary.

From the Wall Street Journal (hat tip reader Steve A):

At issue are so-called floating-rate notes -- securities used heavily by banks in 2006 to borrow money. A big chunk of those notes, which typically mature in two years, will come due over the next year or so, at a time when banks are struggling to raise fresh funds. That's forcing banks to sell assets, compete heavily for deposits and issue expensive new debt.

The crunch will begin next month, when some $95 billion in floating-rate notes mature. J.P. Morgan Chase & Co. analyst Alex Roever estimates that financial institutions will have to pay off at least $787 billion in floating-rate notes and other medium-term obligations before the end of 2009. That's about 43% more than they had to redeem in the previous 16 months....

As banks scramble to pay the floating-rate notes, they could see profit margins shrink as wary investors demand higher interest rates for new borrowings. They're also likely to become less willing to make new loans to consumers and companies, aggravating economic downturns in both the U.S. and Europe.

"It's going to be a bigger problem now than it was in the first half of this year, but it's going to continue on for probably at least a nine-month period," said Guy Stear, credit strategist at Société Générale SA in Paris.

By the end of this year, big banks and investment banks such as Goldman Sachs Group Inc., Merrill Lynch & Co, Morgan Stanley, Wachovia Corp., and U.K. lender HBOS PLC must each redeem more than $5 billion in floating-rate notes, according to a recent report from J.P. Morgan. Other big lenders such as General Electric Co., Wells Fargo & Co. and Italy's UniCredit Group also face big bills in coming months, the report says.

As we and the Journal noted earlier, the GSEs have over $225 billion to refinance by the end of September.

"Too Big to Fail- We'll See about That,"

"We are approaching a solvency crisis that we think is about to result in an avalanche of asset sales"

The mess in the U.S. financial system is making me nostalgic for the dot-com collapse of 2000-2002.

The U.S. credit crunch turned 1 year old this month, and the situation clearly isn't improving. Major financial companies continue to reel from huge losses on defaulted home loans. Barring a dramatic turnaround in the economy, commercial real estate loans could become the next black hole -- although the banks will say, as they did initially with home loans, that commercial losses should be "manageable."

The unwinding of any market mania takes time, of course, and produces many casualties. That's the ugly side of capitalism at work.

...But the list of potential victims now includes too many of the biggest institutions, which in turn have financial ties to countless other players in the business. Every huge tree that falls can take down a lot of other trees.

... if regulators are ready to play tougher with other financial companies in jeopardy, they are likely to have plenty of opportunities to demonstrate their resolve.

That's because the banking and brokerage businesses have entered a second phase of the bad-asset workout, according to one large hedge fund manager whose views circulate on Wall Street but who doesn't seek or want publicity.

The first phase, the manager says, involved attempts by loss-ridden financial companies to raise fresh capital from investors. Some were successful, some were not.

The second phase, now underway, involves fire sales of assets by banks and brokerages that have no choice but to shrink themselves because there isn't enough willing and able capital out there to buttress every damaged balance sheet that needs it.

And as assets are dumped at fire-sale prices, that will trigger markdowns of similar assets, further weakening the finances of banks and brokerages across the board.

"We are approaching a solvency crisis that we think is about to result in an avalanche of asset sales," the hedge fund manager says.

Good luck, Chairman Bernanke.

[Aug 25, 2008] IMF cuts forecasts for world growth ahead of G20 meeting - Times Online

In a note prepared for a meeting of the Group of 20 (G20) nations next week, the IMF predicts world growth this year of 3.9 per cent, down from the 4.1 per cent estimated in its World Economic Outlook last month, a G20 finance official told Reuters. It expects growth of 3.7 per cent in 2009, down from 3.9 per cent.

The IMF's forecast for growth in the US this year remains unchanged at 1.3 per cent, but it trimmed its outlook for 2009 from 0.8 per cent to 0.7 per cent, Reuters reports.

It also revised expectations for growth in the eurozone: down to 1.4 per cent for the rest of 2008 from 1.7 per cent in July, and down to 0.9 per cent for 2009, from its earlier forecast of 1.2 per cent.

[Aug 25, 2008] Hamilton on Recession Indicators

From Professor Hamilton at Econbrowser: Recession indicators

Many people may not care whether our current situation meets the formal definition of a recession, but as I've explained previously, you should. ...

I do think there's a pretty strong case, based on the employment and unemployment numbers, that we are currently in a recession. ... the whole reason I'm interested in this question of whether our current difficulties should be classified as a recession, is that if we are in a true recession, the process is going to feed on itself, and more bad things are ahead of us. If it's a real recession, it should be evident in the 2008:H2 GDP numbers.
See Jim Hamilton's graphs.

I believe the economy is in recession and the negative feedback loops have started to kick-in. Good examples are less business investment and less local government spending - both impacting employment. These will be classic symptoms of a recession.

[Aug 25, 2008] LA Times: FBI Saw Mortgage Fraud Threat in 2004

by CalculatedRisk

From the LA Times: FBI saw threat of mortgage crisis

Long before the mortgage crisis began rocking Main Street and Wall Street, a top FBI official made a chilling, if little-noticed, prediction: The booming mortgage business, fueled by low interest rates and soaring home values, was starting to attract shady operators and billions in losses were possible.

"It has the potential to be an epidemic," Chris Swecker, the FBI official in charge of criminal investigations, told reporters in September 2004. But, he added reassuringly, the FBI was on the case. "We think we can prevent a problem that could have as much impact as the S&L crisis," he said.
As the article notes, the FBI had other priorities, and they didn't really have the resources to investigate the growing epidemic of mortgage fraud, and most of the mortgage lenders didn't seem to care:
Officials said they began approaching mortgage companies and others in an attempt to raise awareness about the growing fraud problem. But the lenders had little incentive to cooperate because they were continuing to make money.
More warnings that were ignored.

[Aug 24, 208] Home Sales Probably Held Near Decade Low: U.S. Economy Preview by Shobhana Chandra

Looks like we were present on the opening ceremony. The real game might start only in the 4th quarter or beginning of 2009. We might realize that freedom to shop is actually it's opposite

Bloomberg.com
The real-estate recession will persist into next year as stricter lending rules and higher borrowing costs shackle demand. At the same time, equity is disappearing as home prices fall, and wages aren't keeping up with inflation, depriving Americans of the means to maintain spending, the biggest part of the economy.

``The economy is going down a shaky path,'' said Maxwell Clarke, chief U.S. economist at IDEAGlobal Inc. in New York. ``We're not going to see a rebound in housing anytime soon. Consumers are living hand to mouth, and the outlook for spending is very weak.''

...Consumers, after getting a temporary lift from the government's tax rebates earlier this year, are focusing on buying necessities and hunting for bargains to stretch their paychecks following the jump in food and fuel costs.
...Commerce Department figures on Aug. 29 will underscore the dimming outlook for consumer spending, according to the Bloomberg survey.
The report is also projected to reinforce concern over inflation ...probably rose 4.5 percent in the year ended July, the biggest 12-month gain since 1991.

...The one bright spot for the economy remains the narrowing of the trade deficit. A surge in exports caused the economy to grow even faster in the second quarter than previously projected. Revised figures from the Commerce Department, due Aug. 28, may show the economy expanded at a 2.7 percent annual rate from April through June, up from an advance estimate of 1.9 percent issued last month, according to the survey median.

``The data releases this week should illustrate the stark contrast between how well the economy performed in the second quarter and how bad the outlook for the second half of the year is,'' said Paul Ashworth, international economist at Capital Economics Ltd. in London.

Other reports this week may show orders for durables goods stalled in July and confidence among American consumers was little-changed this month from multiyear lows reached earlier this year, even as gasoline prices retreated.

[Aug 22, 2008] If Only Central Bankers Would Hit Bottom

I'm told that alcoholics and addicts have to hit bottom before they are able to renounce their self destructive ways. Ironically, their personal collapse makes them more capable of change than scientists, who, according to Thomas Kuhn in his landmark, The Structure of Scientific Revolutions, were so incapable of abandoning core beliefs that it would take an entire generation for significant advances to become widely accepted. The old guard literally had to die off before the new paradigm could take hold.

Bear with me in delving deeper into this comparison. The Wikipedia entry on Kuhn's work gives a sense of the power and durability of existing frameworks:

There is a prevalent belief that all hitherto-unexplained phenomena will in due course be accounted for in terms of this established framework. Kuhn states that scientists spend most (if not all) of their careers in a process of puzzle-solving. Their puzzle-solving is pursued with great tenacity, because the previous successes of the established paradigm tend to generate great confidence that the approach being taken guarantees that a solution to the puzzle exists, even though it may be very hard to find. Kuhn calls this process normal science.
As a paradigm is stretched to its limits, anomalies — failures of the current paradigm to take into account observed phenomena — accumulate. Their significance is judged by the practitioners of the discipline. Some anomalies may be dismissed as errors in observation, others as merely requiring small adjustments to the current paradigm that will be clarified in due course. Some anomalies resolve themselves spontaneously, having increased the available depth of insight along the way. But no matter how great or numerous the anomalies that persist, Kuhn observes, the practicing scientists will not lose faith in the established paradigm for as long as no credible alternative is available; to lose faith in the solubility of the problems would in effect mean ceasing to be a scientist.

In any community of scientists, Kuhn states, there are some individuals who are bolder than most. These scientists, judging that a crisis exists, embark on what Thomas Kuhn calls revolutionary science, exploring alternatives to long-held, obvious-seeming assumptions. Occasionally this generates a rival to the established framework of thought. The new candidate paradigm will appear to be accompanied by numerous anomalies, partly because it is still so new and incomplete. The majority of the scientific community will oppose any conceptual change, and, Kuhn emphasizes, so they should. In order to fulfill its potential, a scientific community needs to contain both individuals who are bold and individuals who are conservative.

We are desperately in need of radical new thinking among the financial elite. We may not simply be at the end of an era, we may be on the verge of a reformulation of capitalism itself. However, the signs are that there are few iconoclasts among the policy elite. Central bankers in particular seem hopelessly stuck in their world views, starting with their conception of their role.
Bloomberg's story, "Central Bankers at Retreat May See Few Options to Fix Economy," would normally get me riled up, but I am suffering from central banker fatigue. Railing at them is an exercise in futility, so I'll just hit the high points and encourage readers to jump into the fray.

Key excerpts:

The world's top central bankers gather at their annual U.S. mountainside symposium today with a sense there's not much more they can do to repair credit markets and rescue the global economy.
Reports in the last week showing a surge in inflation reinforce expectations that Federal Reserve Chairman Ben S. Bernanke will have to keep U.S. interest rates on hold. Similar conditions in Europe are paralyzing his counterparts at the Bank of England and the European Central Bank.

``All the central banks can provide now is time for the banking system to heal,'' Myron Scholes, chairman of Rye Brook, New York-based Platinum Grove Asset Management LP and a Nobel laureate in economics, said in an interview. ``What more they have to offer is now very limited.''....

``There isn't a lot they can do'' now, said former Fed Governor Lyle Gramley, senior economic adviser at Stanford Group Co. in Washington. ``The Fed really has to hope and pray that credit markets begin to heal by themselves.''...

The Fed, while leaving the benchmark interest rate unchanged for its last two meetings, says financial markets ``remain under considerable stress.'' One gauge watched by the Fed, the premium for banks to borrow for three months over a measure of the future overnight lending rate, averaged 0.77 percentage point last week, the highest since April.

The Fed's rate cuts also have failed to pass through to the housing market. The average rate on a 30-year fixed mortgage was 6.47 percent last week, about where it was a year ago....

Apart from lowering rates, Bernanke has pushed the limits of the Fed's powers to ease the crisis in credit markets. In December, he started auctioning 28-day loans to commercial banks. He followed that in March with a $200 billion program to auction Treasuries to investment banks in exchange for mortgage-backed securities and other debt. Bernanke also offered cash loans to other bond dealers that trade with the Fed.

With all these programs in place, Fed officials may be reluctant to do more without assurance that it will ease the credit crisis and not do more harm.

``They have done a lot, and at some point they simply have to give the markets the time needed to heal,'' said former Fed researcher Brian Sack, senior economist at Macroeconomic Advisers...

Some, such as former Bank of England policy maker Willem Buiter, who will address the meeting tomorrow, argue that the Fed's actions to date store up trouble for the future.

``There will have to be a lot of soul searching about whether central banks, in their rush to forestall a financial disaster, have created moral hazard and perverse incentives on an unprecedented scale,'' Buiter said.

The repeated use of the word "heal" says that the Fed has done a great job of pre-selling its message and the words of realists with Buiter will fall on deaf ears.

So what's wrong with this picture? Here is a starter list. Readers are encouraged to add to it.

1. There is a remarkable lack of introspection. The Fed (and by extension other central banks) seem to think they performed ably and are victims of circumstance. They seem to see themselves as agents that act on the system, and implicitly deny their role in creating the current circumstances.
2. Part of the lack of introspection is how mission creep worked to their disadvantage. The Fed in the old days understood its job: take the punchbowl away before the party got good. But Congress gave the Fed the dual mandate of price stability and creating full employment. The Fed was effectively given responsibility without having authority, yet over time seemed to develop unwarranted belief in its ability to deliver on these objectives (as opposed to the more modest aim of doing what it could around the margin to help). We recall hearing paeans to the financial authorities almost like clockwork before crises (well, maybe not 1997-1998): "Gee, they have things so well under control, we won't have a recession."

That false confidence got worse under Greenspan, who loves scouring data and took an inordinate interest in the stock market, indeed, seemed to regard rises in the averages as validation of his policies (see here for a longer discussion). And this misguided thinking conditioned Bernanke's reflexes when the crisis hit, His priority became validating asset prices, when the experience of Japan showed what a misguided course of action that was. Indeed, the most successful example of coping with a housing/banking crisis was Sweden in the early 1990s, when the markets were permitted to fall but the authorities moved quickly to recapitalize the banking system. Funny that we never hear anyone in the officialdom mention that model.

The Fed even considers itself to be in charge of the stability of the financial system , even though Congress has not added that to its job description. Moreover, the Fed has direct oversight over only a relatively small subset of market participants. For instance, only 15% of non-agricultural debt in the US falls under its purview.

Now the US central bank could kid itself that it, along with its peers, was doing a good job based on the so-called "Great Moderation," a twenty-year period that featured more stable growth (although it also came with more frequent financial crises). However, economist Thomas Palley disputes the conventional account of the success of this period and the contribution of central bankers to it:

It is often said that the winners get to write history, which matters because the way we tell history frames our understandings. What is true for general history also holds for economic history...
The last twenty-five years have witnessed a boom in the reputation of central bankers...based on an account of recent economic history that reflects the views of the winners...

The raised standing of central bankers rests on a phenomenon that economists have termed the “Great Moderation.”... the smoothing of the business cycle over the last two decades....

Many economists attribute this smoothing to improved monetary policy by central banks....This explanation is popular with economists since it implicitly applauds the economics profession by attributing improved policy to advances in economics and increased influence of economists within central banks....

That said, there are other less celebratory accounts of the Great Moderation that view it as a transitional phenomenon, and one that has also come at a high cost. One reason for the changed business cycle is retreat from policy commitment to full employment. The great Polish economist Michal Kalecki observed that full employment would likely cause inflation because job security would prompt workers to demand higher wages...rather than solving this political problem, economic policy retreated from full employment and assisted in the evisceration of unions. That lowered inflation, but it came at the high cost of two decades of wage stagnation and a rupturing of the link between wage and productivity growth....

With regard to lengthened economic expansions, the great moderation has been driven by asset price inflation and financial innovation, which have financed consumer spending...

The important implication is that the Great Moderation is the result of a retreat from full employment combined with the transitional factors of disinflation, asset price inflation, and increased consumer borrowing. Those factors now appear exhausted. Further disinflation will produce disruptive deflation. Asset prices (particularly real estate) seem above levels warranted by fundamentals, making for the danger of asset price deflation. And many consumers have exhausted their access to credit and now pose significant default risks.

3. Focus on monetary policy and liquidity and lack of attention to regulatory and structural reform. The credit crisis has been a massive indictment of financial deregulation. Yet the Fed remains a hostage of free market ideology and what Willlem Buiter calls "cognitive regulatory capture." The Fed is too close to banks and industry, and almost seems to lack belief in the importance of oversight.
A full year ago, a vocal minority recognized the role of structural failings and called for the Fed and other regulators to investigate and develop new approaches. The proponents included Henry Kaufman, Australia's former Reserve Bank Governor Ian Macfarlane, Steven Roach, and Jim Hamilton. Kaufman in particular has offered some sound analysis and proposals that have languished on op-ed pages (one example here); others over the past year have pondered the need for reform and made recommendations.

But what do we see instead? The Treasury launching a plan to make the Fed into an uber-regulator, with the Fed having no particular idea of what it would do with its new powers. This is the worst of all possible worlds. The current fragmented system allows an ambitious or progressive regulator to take ground, which forces the other to react to protect their turf (Eugene Ludwig, head of the Office of the Comptroller of the Currency in the Clinton Administration end ran the Fed more than once).

Now one can correctly argue the central bank lacks formal authority to do much in the way of regulatory reform. Yet first, Bernanke has been extraordinarily aggressive in going to the limits of, even beyond, the Fed's charter (it most assuredly did not have the authority to stick taxpayers with the losses that eventually result from the Bear bailout, but Congress failed even to slap the central bank on the wrist for overstepping its bounds). Second, there has been an intellectual vacuum about what to do about the mess. The Fed and other central banks could readily have framed the debate and taken the lead in proposing reforms. But that role instead seems to have been seized by the Treasury, which seems more interested in quick fixes and the appearance of being in charge rather than the harder job of trying to achieve lasting progress.

I'm sure there is plenty to add to the Fed's rap sheet, and I hope readers will provide input.

[Aug 22, 208] It's Not Just Food and Energy

Financial Armageddon
Over the past year or so, much has been said about the impact that rising food and energy prices have had on poor and working-class families. Yet one household expense that has been a constant source of worry for a growing number of Americans over a much longer period of time is health care.

Not only are people struggling to pay medical bills that have long risen at a faster pace than reported inflation, the numbers of those who are uninsured have also jumped to record highs. Is it any surprise that with the economy heading into the tank, we are seeing stories like the following, "79 Million Americans Struggle to Pay Medical Bills," from HealthDay News?

Working-age Americans are facing mounting problems when it comes to affording health care, a result of what analysts are calling a "perfect storm" of economic woes.

In 2007, 41 percent of working-age Americans -- 72 million people -- reported having medical bill problems or trouble paying off medical debts, up from 34 percent in 2005.

Another 7 million adults over 65 had similar problems, bringing the total to 79 million adults struggling to pay health-care bills, according to a new study from The Commonwealth Fund, Losing Ground: How the Loss of Adequate Health Insurance Is Burdening Working Families.

"These findings provide further evidence that the health system is falling short of where it needs to be to ensure health and economic security," Karen Davis, president of The Commonwealth Fund, said at a Tuesday teleconference. "We need a new administration to make universal and affordable health insurance available," she said.

Also unsettling is the fact that adults in more income groups are being affected.

"What is notable is how this is spreading up the income scale," said Commonwealth Fund assistant vice president Sara Collins.

The survey, based on telephone interviews conducted between June 6 and Oct. 24, 2007 with 3,501 adults aged 19 and older in the continental U.S, found problems across multiple fronts:

In 2007, nearly two-thirds of U.S. adults under 65 (116 million people) reported having problems with medical bills or debt, having put off needed care due to cost, or being uninsured or underinsured and consequently having high out-of-pocket medical costs relative to their income.

Although such problems were seen across the board, they were particularly pronounced among low- and moderate-income families. More than half of adults earning less than $40,000 annually reported problems paying medical bills or being in debt as a result of health care expenses.

Thirty-nine percent of people with mounting bills or debts said they had depleted their savings to pay off bills; 29 percent were having problems paying for food, heat, rent and other basic necessities; and 30 percent had accumulated credit card debt.

Many are also foregoing medical care, including medications: 45 percent of adults reported problems getting care because of rising costs (up from 29 percent in 2001).

One-third of respondents reported spending 10 percent or more of their income on medical costs, including premiums, in 2007, up from 21 percent in 2001.

About one-quarter of working-age adults with medical debt owe $4,000 or more while 12 percent owe $8,000 or more in medical expenses.

Twenty-eight percent of working-age U.S. adults (about 50 million people) were uninsured for at least part of 2007, up from 24 percent in 2001.

Fourteen percent of working-age adults (25 million people) were underinsured, up from 9 percent in 2003.

Sixty-one percent of those with medical bill problems or accumulated medical debt were insured at the time care was provided. "Even adults with insurance reported problems in getting needed care," Collins noted.

Americans were experiencing the burdens outlined in the survey during a time of relative economic levity, the researchers pointed out. "Even in 2007, when the economic slow-down hadn't really taken hold, you found that 29 percent of those with medical bill problems or accrued medical debt reported being unable to pay for basic necessities like food, heat, rent," Davis said.

For more on the findings, head to The Commonwealth Fund.

[Aug 20, 208] Sunrise, Sunset by Jon Chait

The problems with economics were structural but remedies were monetary (excessive credit) which like steroids created additional problem we are experiencing now.

Economist's View

Jon Chait says the so-called Bush Boom didn't do much for most people:

George W. Bush's Economy: The Invisible Hand Slaps Conservatives Again, by Jonathan Chait, TNR: ...Ah,... the Bush Boom. It's a bygone era, ... cut short--by ... the Bush recession. Actually, the second Bush recession, to be precise.

Now, I don't really think it's fair to blame a president for having the ecome that any subsequent improvement was the result of his policies. Of course,... the economy ... goes through cycles. ... Bush was claiming his miracle fertilizer succeeded because his plants were taller at the end of the summer than at the beginning of spring.

So the justification for Bush's economic policies was that the economy was no longer in recession. Now they can't even claim that any more. It's as if Bush's plants suddenly wilted in August.

[Aug 19, 2008] More Evidence of Sharp Contraction in Money Supply (Not for the Fainthearted)

"Monetarists insist that shifts in M3 are a lead indicator of asset prices moves, typically six months or so ahead. If so, the latest collapse points to a grim autumn for Wall Street and for the American property market."

The Telegraph story that highlighted this development provided additional detail:

Paul Kasriel, chief economist at Northern Trust, says lending by US commercial banks contracted at an annual rate of 9.14pc in the 13 weeks to June 18, the most violent reversal since the data series began in 1973. M2 money fell at a rate of 0.37pc...
Leigh Skene from Lombard Street Research said the lending conderve gave up being interested in money supply in the early 1980s, when new banking products made the data behave differently. But that hardly seemed a reason to abandon a useful tool, at least not without trying to understand how the new instruments affected monetary aggregates. Instead, the Fed sets target interest rates in a not-terribly-scientific fashion.

Note that while the Fed still published M1 (narrow money, currency plus demand deposits) and M2 (M1 plus time deposits, savings accounts, and non-institutional money market funds), it stopped reporting M3 (M2 plus large time deposits, institutional money market accounts, and short-term repos) in March 2006. However, some economists and services provide estimates,

The Telegraph tells us today that those private calculations of M3, like the publicly available monetary aggregates, show a sudden contraction, a deflationary signal. From the Telegraph:

Data compiled by Lombard Street Research shows that the M3 ''broad money" aggregates fell by almost $50bn (£26.8bn) in July, the biggest one-month fall since modern records began in 1959.
"Monthly data for July show that the broad money growth has almost collapsed," said Gabriel Stein, the group's leading monetary economist.

On a three-month basis, the M3 growth rate has fallen from almost 19pc earlier this year to just 2.1pc (annualised) for the period from May to July. This is below the rate of inflation, implying a shrinkage in real terms.

The growth in bank loans has turned negative to a halt since March.

"It's obviously worrying. People either can't borrow, or don't want to borrow even if they can," said Mr Stein.

Monetarists say it is the sharpness of the drop that is most disturbing, rather than the absolute level. Moves of this speed are extremely rare....

Monetarists insist that shifts in M3 are a lead indicator of asset prices moves, typically six months or so ahead. If so, the latest collapse points to a grim autumn for Wall Street and for the American property market. As a rule of thumb, the data gives a one-year advance signal on economic growth, and a two-year signal on future inflation.

"There are always short-term blips but over the long run M3 has repeatedly shown itself good leading indicator," said Mr Stein...

M3 surged after the onset of the credit crunch, but this was chiefly a distortion caused by the near total paralysis in parts of the American commercial paper market. Borrowers were forced to take out bank loans instead. The commercial paper market has yet to recover

[Aug 19, 2008] Economist's View Paul Krugman It’s the Economy Stupor

In his speech accepting the Democratic nomination in 1992, a year in which economic conditions somewhat resembled those today, Bill Clinton denounced his opponent as someone “caught in the grip of a failed economic theory.” Where Mr. Obama spoke cryptically in St. Petersburg about a “reckless few” who “game the system, as we’ve seen in this housing crisis” — I know what he meant, I think, but how many voters got it? — Mr. Clinton declared that “those who play by the rules and keep the faith have gotten the shaft, and those who cut corners and cut deals have been rewarded.” That’s the kind of hard-hitting populism that’s been absent from the Obama campaign...

Of course, Mr. Obama hasn’t given his own acceptance speech yet. Al Gore found a new populist fervor in August 2000, and surged in the polls. A comparable surge by Mr. Obama would give him a landslide victory...
Bruce Wilder says...
Krugman on politics is tiresome, indeed. If he has some evidence for his thesis that the American People long for a populist vision, he should bring it forward; otherwise, he should shut up. He doesn't know what would cause Obama to surge ahead in the polls, and should not be mind-reading the whole electorate, while pretending that he does.

Obama has managed to draw a clear contrast on income taxes, and is fighting to keep it from being completely obscured by our incompetent Media. Larry Bartels is pretty clear that Obama's tax plan, as simple as it might seem to this blog's readers, is just the kind of thing American voters get confused about, and the Media proves incapable of reporting on accurately. Populism is not as easy a campaign theme as Krugman imagines.

On a number of other populist themes -- the mortgage crisis, gas taxes, off-shore drilling -- Obama would run some serious risks of committing himself to bad policy, if he tries to out-demagogue McCain on these issues. Does Krugman have any ideas about how to stop "Drill Here, Drill Now"? I didn't think so.

Obama is ahead in the polls, which indicate -- surprise! -- that about a third of the electorate has not paid any attention, yet. A majority of voters in 2004 elected George W. Bush; those people and their bad judgment haven't gone away, and their numbers, though diminished, put a floor under McCain's support, and a ceiling on Obama's.

Clinton's economic populism may have been a lovely thing, but not nearly as lovely in terms of his electoral chances, as Ross Perot. Clinton never achieved an actual majority, but he didn't need to. Obama will have to have an actual majority to beat McCain, but he's well on track to achieve that.
NLS says...
Bruce Wilder is on point once again. Most folks still haven't begun to pay attention and haven't even entered the stadium. (For example, note the traction Jackass Corsi's slash and bash book grabs.) PK is no doubt a brilliant economist, but doesn't he understand that injecting doubt and offering hesitation only steepens the hill?

The object of the game is to beat McCain.

Cyrille says...

Bruce Wilder on Obamania is tiresome. Anyone who speaks his mind for anything but singing the praise of Obama is immediately rebuked.

Krugman asks to state demonstrable facts, Bruce Wilder calls that asking to out-demagogue McCain. Uh?

Obama's lead in the polls is considerably smaller than his party's, so surely he must be doing everything perfectly. Still, Krugman notes that Obama has not had his acceptance speech yet, and that it could create a surge, but that won't make him less tiresome since he's a miscreant, he does not blindly worship.

Republican economics should these days be called names that will get you censored if children might be watching (they should have for the past 30 years, but now the conclusions are so obvious and immediate as to be plain to all, even those who reckon that "in 3 years time" is too far to ever happen). Failure to do so is yet another worrying sign that Democrats have turned into Republican light.

They have stolen, looted, lied and ruined a country the size of a continent for the sole benefit of them and their cronies. It's not demagogue to hold them accountable. And it's crazy to not attack them on that when the horrible consequences of their acts are the main thing on everyone's mind (OK, Iraq should be as well, but now all the media reports are sterilised and very few people in the US will get first hand experience).
Bruce Wilder says...
str: "Did a dysfunctional primary system give us two mediocre candidates?"

The primary systems of the two parties are quite different, and they produced contrasting candidates. Obama is a an excellent, historic candidate, leading an extraordinarily capable campaign organization, and an enthusiastic, motivated Party.

McCain is a pretty typical Republican Presidential candidate: bereft of principles, callow, stupid, a serial liar, he's really old and he heads a campaign organization staffed from top-to-bottom with corrupt lobbyists. But, it wasn't a dysfunctional primary process that produced McCain, anymore than it was a dysfunctional primary process that produced Richard Nixon, Spiro Agnew, Ronald Reagan, Dan Quayle, George W. Bush or Richard Bruce Cheney. The Republican Party is designed to produce liars and fools and crooks, in service to the plutocracy.

[Aug 19, 2008] Yen Rises as Fannie Mae, Freddie Mac Concern Damps Carry Trade By Stanley White and Kosuke Goto

"Crushed by ballooning debts, the regeneration by the banks' own efforts is becoming impossible ... I bet stocks will decline further and U.S. bonds will be downgraded." said Tetsuhisa Hayashi, chief manager of foreign-exchange trading at Bank of Tokyo-Mitsubishi UFJ Ltd. in Tokyo

Bloomberg.com

``Crushed by ballooning debts, the regeneration by the banks' own efforts is becoming impossible,'' said Tetsuhisa Hayashi, chief manager of foreign-exchange trading at Bank of Tokyo-Mitsubishi UFJ Ltd. in Tokyo, a unit of Japan's largest lender by market value. ``I bet stocks will decline further and U.S. bonds will be downgraded. Risk aversion among investors will cause further yen-buying.''

The Japanese currency may rise to 100 per dollar by year- end, Hayashi said.

[Aug 18, 2008] Lehman Expected to Post Another Loss

For banks it's looking increasingly difficult to refinance their debt. Outside Fed oxygen lines are cut and for those of life support this is it.

Lehman is now expected to report a quarterly loss that analysts peg as high as $2.6 billion. Recall that last quarter's $2.8 billion loss was a stunner, nearly ten times the expected level, and a dramatic departure from the convention of preparing investors for earnings shortfalls.

Comments

S said...

Looking increasingly difficult to get oxygen. LEH reportedly having problems shopping its CMBS portfolio. You think? As the cost of debt rises (Amex 400 bps off treasury on Friday) the choke hold gets tighter. Bloomberg goes on to wonder what institutions are worth saving? Earnings season should be interesting. Clearly the companies are trying to get out in front with estimate cuts coming earlier by an inch. The upside surprise will be credit deterioration which will be accretive to earnings and help offset some of the charges (what a world!). The cruches are failing, wheelbarrows next.

[Aug 18, 2008] Commentary on questionable economic analysis

Discredited "free marketers" which got the country in the current mess try to counterattack using Wall street's "fifth column" of PPP journalists. Amity Shlaes, who is a nice example of the genre published apologetic Five Ways to Wreck a Recovery - washingtonpost.com which twists major facts about Great Depression. She does not have formal economic education (bachelor degree in English literature from Yale)

Moon of Alabama used this chart to chat about Schlaes.

GDP numbers according to the Bureau of Economic Analysis (bigger graph)
A. Smoot Hawley Tarrif Act In March 1932 the United States Senate Committee on Banking, Housing, and Urban Affairs established hearings to investigate the causes of the Wall Street Crash of 1929.
B. Democrats took over Congress in November 1932 and in early 1933 appointed Ferdinand Pecora as commission counselor. Pecora found many malpractices on Wall Street and his investigation led to the creation of the Securities and Exchange Commission. We can put these events at point B of the GDP chart

C. Hoover's tax decrease in 1929/30 was followed by four years of decreasing GDP. His "misstep" tax increase was enacted in 1932 and took effect only in 1933, point C in our graph. From there on GDP went up.

D. New Deal beginnings.

Shlaes, according to her Wikipedia entry "has no formal economic training." That certainly shows. She also seems to have zero training in history as she is unable to organize the sequence of events in a coherent way. Events and policies that obviously led to increases in GDP are attributed as having deepened the depression.

(reformatted by rdan for a quick take....the original is more detailed and much longer. I personally would not use wikipedia as an academic source, but liberties are taken and the articles linked looked reasonably accurate))

[Aug 18, 2008] FT Alphaville » Blog Archive » US banks scramble to refinance debt

Battered US financial groups will have to refinance billions of dollars in maturing debt over coming months, a move likely to push banks’ funding costs higher and curb their profitability, say bankers and analysts. The banks’ push to raise capital to offset mounting credit-related losses is forcing them to pay higher interest rates to entice investors, which is likely to put pressure on earnings and could lead to higher lending rates. Last week, groups including Citigroup, JPMorgan and AIG borrowed almost $20bn in new long-term debt, paying some of the highest rates ever in order to lock in funding. The wave of refinancing is set to continue for several months as billions of dollars in bank debt come due.
This entry was posted by Gwen Robinson on Monday, August 18th, 2008 at 5:28 and is filed under Capital markets. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

[Aug 18, 2008] Econbrowser Core inflation

Middle-class and lower definitely lost a lot of buying power during the last two years. And with 3% CD and 5% inflation they are losing their savings in all accounts: taxable, Roth and 401K.

The Bureau of Labor Statistics reported yesterday that its primary consumer price index CPI-U rose 5.6% over the last year. That's the highest inflation rate in 17 years, the newspapers all call to our attention. Just how concerned should we be about these numbers?

Comments

Posted by: sonia at August 15, 2008 06:35 PM

How shall we define stagflation? I suggest whenever unemployment is above 5% and when inflation is above 5% at the same time.

That's June and July 2008. Houston we have stagflation.

Posted by: One Salient Oversight at August 15, 2008 08:34 PM
Those expecting diminishing inflation, please contemplate CD rates of 3% (on which the holder must pay income tax) when the reported CPI is 5.6%. What person would lend his savings in such a money-losing proposition? Is this the result of a free market or of a central bank lending out money that has never been saved but created out of thin air? MZM & M2 are growing a lot faster than GDP & have been for some time.
The central banks of China, Russia, India, Saudi Arabia, et al are behaving similarly. The global credit bubble, Bernanke's savings glut, will collapse in due course. But it seems to me we aren't there yet & therefore are beset by inflation.

Posted by: Anonymous at August 17, 2008 11:57 AM

Posted by: OER at August 15, 2008 10:49 PM
sjp wrote:
Inflation is about the price level moving up.

I am bringing this up because the true mechanics of inflation must be a combination of (among other things) the extension of money/credit that algernon refers to and the raising of prices that I posited. One can't just point the finger at money supply expansion as the root of inflation. It is clearly an important part, but not the complete picture.

sjp,

I will pass on your incorrect definition of inflation as price increases to stay on topic.

Can you give me the mechanism where prices can increase with a constant money supply without reducing consumption? If you have an economy of $5 and 5 things how can the price of the each thing move to $1.10 and consumers still consume 5 things with a $5 money supply?

Posted by: DickF at August 16, 2008 02:28 PM
DickF - they'd put it on their visas!
When economists talk about wage demands being muted, they don't seem to understand how much American households have gotten into the habit of taking their future wages out as borrowed money. If I have the ability to pay 1.10 with a credit card, I can overlook that shortfall in my real income. By using behavioral patterns which were true in the 70s but are not true today to connect commodity prices to wages, economists are overlooking a central feature of the economy they have wrought. In fact, dissolving limits on credit has been the only way that the "grand moderation" could be swallowed by the American public at large. If they had to live within their real incomes, the increases in the compensation of the wealthiest group - the CEOS, the hedge funders - would simply be politically impossible. As credit is squeezed and Americans have to live within their real incomes, look for inequality to become a much hotter issue. It is the credit squeeze more than inflation that is going to jumpstart pressure to raise wages.

DickF: my definition of inflation is a rise in the price level. The only point I'm making is to dispute algernon's point; I took algernon's point to be that inflation comes solely from money supply expansion. I say that's not true.
I believe that the problem subsequently raised with my thought experiment (0 growth, 0 money supply growth, price increases) is that it is non-equilibrium. What Anonymous suggested makes sense. On the other hand, the economy might realize that the price increases weren't warranted and drop the price back down -- this might be the outcome DickF sees for his scenario. I thought a non-equilibrium thought experiment might be worth considering, though, since the jumping off point for this post is that the oil price increases we saw in the summer have been followed by price decreases: we are talking about fluctuations about the equilibrium.

I am most interested in Justin's point, that these oil price fluctuations might inordinately affect consumers' inflation expectations. It makes me wonder if certain high-profile products are weighted highly in consumers' belief formation mechanisms. Have oil price shocks been associated with shocks to consumers' inflation expectations, and is this association stronger than the association with other commodities?

Posted by: sjp at August 17, 2008 02:21 PM
DickF asks "Can you give me the mechanism where prices can increase with a constant money supply without reducing consumption?"
Simple, the rate of circulation of money can increase or decrease. Thus even if the supply of money remains the same prices can change.
And of course, there are many types of virtual money that can step into the gap, taking the place of money, debit accounts, credit accounts, loans of all descriptions etc.

Posted by: bill j at August 18, 2008 03:54 AM
Roger,
Your comment about Visas did make me laugh, but understand that credit works within an economy unless the government facilitates credit expansion with an increase in the money supply so credit in itself does not create inflation.

sjp,

Inflation is a decline in the value of money. It may lead to a rise in the price level, but a rise in the price level is not inflation. This is a huge misconception in economic circles that leads to serious misunderstandings.

If you introduce other elements into your thought experiment such as consumption preferences then yes you can create a scenario where such price increase might be accomodated, but the thought process must be deeper than a fixed money supply with rising prices. That simply is not possible without external input meaning consumption preferences, saving preferences, etc.

This is important to understand because without the complicity of the monetary authorities an economy cannot experience inflation. Understand that a change in consumption preferences is not inflationary.

bill j,

A change in circulation of money does not exist in a vacuum. There must be other changes such as consumption preferences for this to happen. Dig deeper.

[Aug 16, 2008] Contrarian Indicators

So now we have magazine covers fretting over oil, pundits everywhere calling for $200 oil, and BusinessWeek articles "Bracing For Inflation" in spite of a slowing world economy. These are all contrarian indicators. And as goes oil, so goes the CPI. So unless there is a breakout of War in the Mideast, the oil bust may be deeper and longer lasting than anyone thinks.

[Aug 16, 2008] Foreign Investors Selling Freddie, Fannie Debt

While even moral hazard hawks generally agree that some sort of government intervention would be needed in the event of financial trouble at Fannie and Freddie, the most compelling reason was that the US, chronically dependent on foreign funding, would be ill advised to treat its money sources badly.

Of the GSEs' $5.2 trillion in debt (their own corporate bonds plus MBS), $1.3 trillion is in the hands of foreign investors and central banks. The speed with which the powers that be cobbled together a support program was seen in some circles as an admission of the importance of reassuring our friendly overseas credit suppliers.

If that was the motivation, it isn't working. As we and others noted, spreads on GSE debt have risen to 215 basis points over Treasuries, only a tad shy of the pre-Bear crisis level of 238 basis points. And remember, they have reached this stratospheric levels despite the Paulson rescue package, despite an alphabet soup of new Fed facilities that accept GSE paper as collateral (as the discount window did) now in place (although there were raspberries all around for the bailout bill, due to its failure to make any changes in the operation, management, or policies of the GSEs and its lack of specificity as to triggers and what mechanism would be used).

And the reason? A big factor is that foreign central banks are exiting GSE debt and have pulled back significantly from purchases of new paper. This vote of no confidence appears likely to force the Administration's hand and lead it to take more concrete measures to prop up Freddie's and Fannie's balance sheets. They are not about to risk a spike in mortgage rates and further trouble in the housing markets with elections approaching.
From Reuters:

An extraordinary Treasury capital infusion may be needed to restore faltering foreign demand for debt issued by Fannie Mae and Freddie Mac, the two top home funding sources that the government is willing to rescue to save the housing market.
The companies rely heavily on overseas investment, often up to two-thirds of each new multibillion-dollar note offering, to help pare funding costs and keep mortgage rates low.

But foreign central banks have dumped nearly $11 billion from their record holdings of this debt in four weeks, to $975 billion, and won't return in force before it's clear if -- and how -- the government will back Fannie and Freddie, some analysts say....

The bonds these companies issue in the $4.5 trillion agency MBS market are near or worse than the weakest levels, set in March before the government engineered the sale of failing Bear Stearns to JPMorgan.

... ... ...

Overseas investors took an atypical back seat in Fannie Mae's three-year note sale this week.

Central banks bought just 37 percent of the $3.5 billion issue, down from 56 percent in May's $4 billion offering of the same maturity. Asia accounts took just 22 percent of the notes, down from 42 percent in May....

Comments

Richard Kline said...

I can't think of a single reason why foreign CBs should throw their capital away buying GSE debt. Major losses on existing MBSs are locked in. Existing equity in these corps is going to get greased. Even if the Feds step in to guarantee the GSEs own paper its sure to trade at distressed levels for long to come even if it finishes in the money.
At some point it will be brought home to our public financial leadership that stiff upper lips, manful statements, and dry ice fog just do not constitute a PLAN let alone a solution. The recent hack job rush statue, the We [Heart} the GSEs Bill, does nothing to protect buyers of their debt from risk or loss. The crew in the District would love to kick this can down the road into the next Big Guy's yard, but that isn't going to happen.

August 17, 2008 6:20 AM

MrM said...

Russia, who has a large portfolio of the agency paper, not only has no reasons to buy more, but might be tempted to dump what it's got to show its displeasure with the White House around Georgia and Poland

Mara said...

If Russia, China, et al decide to stop buying GSE debt, Paulson will be auctioning off grandma's underpants, since there is precious little left of value. If foreign CBs decide to dump enough of their holdings to cause havoc just before the elections, who could stop that tide?
Anyone have an explanation as to why foreign CBs would even want this stuff? We've known that Freddie and Fannie have had financial irregs and bloated compensations most of this decade. Despite any "guarantee" it's too much money, no one could cover that bet. You don't even get good PR from, just seen as a "threatening foreigner" come to swoop in and buy America.

doc holiday said...

I think it's informative to go back and look at the compensation of the people that have done a heck of a job in contributing to this spectrum-wide systemic collusion relating to mortgage fraud:
http://www.forbes.com/lists/2006/12/Banking_Rank_1.html

These people should be in jail, but they serve as high priced reminders of how efficient The Patriot Act is, and The Pension Protection Act, The Gramm-Leach-Bliley Act, The Friends Of Angelo...

Anonymous said...

THe lesson we have learned is that it is dangerous to reach for yield.
If you are a central bank, why risk losing capital for 200 lousy basis points? If you really want to earn a higher rate of return over Treasuries, you can purchase legitimate triple AAA corporate bonds.

Why anyone would want to touch Agency debt is beyond me, other than just for pure, unadulterated GREED.

Dean said...

In response to Anonymous, the lesson we have learned is that in an environment of lower yields, we all undertook higher risks (in search of higher yields) which have backfired.

[Aug 16, 2008] Globalisation and the Costs of International Trade from 1870 to the Present

Looks like a weak article which generated interesting comments. The key question is whether peak oil will negatively influence international trade. It is clear that distance now matters more.

Will the rising price of oil reduce international trade as some have suggested? According to this research, which uses a gravity model of international trade to answer the question, thpntries trade more on international markets today than ever before – both in absolute terms and as a proportion of their national output. How can we explain this phenomenal increase in international trade over the past few decades? Will the recent rise in oil prices reverse this trend of globalisation?

History provides us with a natural comparison. Beginning in the nineteenth century, the world saw a remarkable rise in international trade that came to a grinding halt during World War I and later on in the wake of the Great Depression. This “first wave of globalisation” from about 1870 until 1913 led to a degree of international integration – measured by trade-to-output ratios – that many countries only achieved again in the mid-1990s.

Taking a comparative perspective, we juxtapose the first wave of globalisation from 1870 to 1913 and the second wave after World War II. We also study the retreat of world trade during the interwar period from 1921 to 1939. We are interested in the driving forces behind these trade booms and trade busts. Was it changes in global output or changes in trade costs that explain the evolution of international trade?

Comments

Trance says...

"for example, consumers have managed oil prices at almost five times the going price before the 70s inflation."
but this is done at the cost of diminishing discretionary income (which is worse in Europe than US). This discretionary income would otherwise go elsewhere in the economy. This money now goes into only one pocket, the oil industry.

Bruce Wilder says...

"they find that there is little systematic evidence to suggest that the maritime transport revolution was a primary driver of the late nineteenth century global trade boom. Rather, the most powerful force driving the boom was the secular rise in incomes across countries."
"the key innovations in the shipping industry were induced technological responses to the heightened trading potential of the world."

I think one would have to have a much better model of international trade, to sort this out reliably. Talking rather generically and bloodlessly about "the secular rise in incomes" seems almost a distraction.

What drives trade, international and local, are the productivity gains from specialization. These gains from specialization can rest on a variety of quite different bases. By focusing on "international" trade in particular, we are focusing on goods, where the productivity gains from specialization are extreme. In common parlance, there might be a monopoly of technical knowledge, extreme economies of scale or external economies, or a gift of nature, which can be exploited in only rare places. Not very many people will find it worthwhile to go more than a few blocks to get a haircut, even though most people will go to a professional barber or hairstylist. On the other hand, prospecting for oil in one's backyard, or refining it one's self, is rarely worthwhile. Nor do people go to a local craftsman for a television or cellphone.

The period, 1870-1913, marks the Second Industrial Revolution, a misnamed third or fourth phase of industrial revolution that began in Britain in the 18th century. Steamships were rather famously a central part of this phase -- their ability to keep to a schedule as important as their speed and capacity, and the ability to adapt them to more efficient means of carrying specialized cargoes (oil tankers, refrigerated ships, etc)

In addition, the industrial revolution was widening its geographical scope in three important respects. First, the industrial revolution was spreading out, to the Low Countries, Switzerland, France, the U.S. and Germany. After 1820, the industrial revolution was no longer occurring in one country only, and it was accelerating. Moreover, after 1870, the industrial revolution was involving more and more industries, moving from textiles and steam engines and railroads, to steel, oil, chemicals, electricity, with leadership often passing to countries other than Britain.

And, thirdly, as the industrial revolution drove economic growth, it drove demand for the fruits of the earth, sucking up everything from guano and bananas to copper and petroleum from distant places.

The ability to wrest enormous factor productivity gains from specced by the extent of the market, then we shouldn't be surprised to see the rise of national consumer markets in response to transportation and communication innovations: this is the period in which J. Walter Thompson invented magazine advertising (1877), and brandnames emerge, Nabisco (1901) and Coca-Cola (1886) and Lucky Strike (1871, 1907), Colgate toothpaste (1872) and Palmolive soap (1898).

Somehow, for me, "the secular rise in incomes" doesn't quite cover it.

If one is not going to be serious about analyzing what drives trade, I don't see how empty statements projecting that trends can continue really mean anything.

The right thing is to think seriously about distinguishing between the factors driving trade in commodities and fruits of the earth, and what drives trade in manufactured goods, and, finally, what drives trade in services. Underlying all of this is what drives specialization.

Peak oil implies no further gross increases in trade in raw petroleum. Similar considerations apply to many raw mineral products, like copper and zinc, and other commodities. Industrial development and rising population in the Persian Gulf will also result in more trade in petroleum products, as the expense of raw petroleum.

Peak oil also implies rising relative cost of jet fuel -- air travel is going to get more expensive, and with vacation travel to exotic places. (Recreational and business travel is a significant part of international trade.)

The kind of intense specialization, which yields enormous factor productivity enhancement, typically involves a coordination and control, which entails communication. Communication advances were important complements to the increasing speed and falling cost of transporation in 1870-1913, as well as now.

A useful analytical exercise might focus on whether falling communication costs, increasing capability imply more or less physical trade in goods. McDonald's, Toyota, IKEA, Lenovo -- are the limits to economies of scale of physical product in one place such that, say, all the corkscrews in the world should be made in one place?

Or, does falling costs of communication and control imply more widely distributed physical production of manufactured goods and less physical transport?

If we could leverage computers to design a washing machine plant, to flexibly build several different models or designs of washing machines, would we care to import washing machines from Sweden or Italy or China, and would they want to import washing machines from Benton Harbor, Michigan?

How does the financial interact with trade? If a country fails to invest in the production capacity to make and export goods and services in sectors where the gains in total factor productivity are greatest, how does that affect the terms of trade? Median incomes? If not "protectionism", what is an organizing principle for a national strategy? (Is there nothing more convincing that pieties about education, and taxcuts for plutocrats?)

robertdfeinman says...

Perhaps the analysis is backwards. The rise of highly efficient production produced an excess of manufactured goods (or at least the capacity to make them). This then led firms to seek markets elsewhere. Because of the efficiency trade costs were not enough to deter this trend.

As trade increased the efficiency of trade also improved and its costs dropped as well. The depression caused a loss of markets and trade dropped. The "protectionism" was a political attempt to fix something which was misguided effort, just like offshore drilling is the wrong fix now. The lack of markets caused a drop off in innovation so trade costs stopped dropping, then the wars intervened and destroyed productive capacity and markets.

In the latest round, the cycle has repeated, this time there has been a new set of innovations in IT and supply chain management and a corresponding rise in efficiency with containerization and high speed ships. Both these improvements have now stalled so other factors have started to become more important.

The response to this has been yet another set of political nostrums designed for their ear appeal to the public, rather than for their efficacy.

Just a conjecture...

roger says...

Huh, is this economics of numerology:
"To answer that question we set up a gravity model of international trade. This model borrows Isaac Newton’s insight that the gravitational force between two planets in space is inversely related to their physical distance. Instead of planets, we consider countries whose “gravitational force” is the amount of their bilateral exports and imports. Instead of physical distance, bilateral trade is impeded by trade costs such as transportation costs, tariffs and language barriers."

Wow, and this is considered serious economics! Why not borrow their model from, say, Revelations, where the antichrist - protectionists - put a bar code on their followers heads, with the bar code being legislation designed to discourage trade. It would make the same amount of sense.

This doesn't even achieve a low level of chicanery.

dissent says...

"overall, history gives us little reason to expect a sharp and fundamental reaction of international trade in response to changes in transportation costs."
The problem with this argument is that all prior history took place prior to peak oil. Transportation costs will be impacted by peak oil in a historically anomalous fashion.

[Aug 15, 2008 Economist's View Paul Krugman The Great Illusion

Krugnam understanding of politics is definitely limited, but the observation that there will be more intense struggle for limited natural resources might be true...

Is the "second great age of globalization" about to end?:

The Great Illusion, by Paul Krugman, Commentary, NY Times:

...as I was reading the latest bad news, I found myself wondering whether this war is an omen — a sign that the second great age of globalization may share the fate of the first

... ... ...

But then came three decades of war, revolution, political instability, depression and more war. By the end of World War II, the world was fragmented economically as well as politically. And it took a couple of generations to put it back together.

So, can things fall apart again? Yes, they can.

Consider ... the current food crisis. For years we were told that self-sufficiency was ... outmoded..., that it was safe to rely on world markets for food supplies. But when the prices of wheat, rice and corn soared, Keynes’s “projects and politics” of “restrictions and exclusion” made a comeback: many governments rushed to protect domestic consumers by banning or limiting exports, leaving food-importing countries in dire straits.

... ... ...

Angell was right to describe the belief that conquest pays as a great illusion. But the belief that economic rationality always prevents war is an equally great illusion. And today’s high degree of global economic interdependence, which can be sustained only if all major governments act sensibly, is more fragile than we imagine.

Lee A. Arnold says...
The illusion? Keynes' Londoner had no inkling that the reason he could telephone products from around the world was because of the British Empire's militarism and imperialism? This seems a bit disingenuous on JMK's part. Or maybe sarcastic? Then the very next thing: Your history quiz: Where were the first British troops sent when Archduke Ferdinand was shot? Answer: To Basra -- because the German and British navies had both just converted from coal to oil, and Germany was going to extend the Orient Express past Constantinople to take all the petroleum in the area out by rail. When Ferdinand was shot, everything went up into the air... Starting the ninety-year (so far) resource war. Now the U.S. is run by climate-denying gasoholics and the American public apparently hasn't guessed the possibility that their leaders have handed Iraq to Iran's best friends and the Shi'ites are merely standing-down and smiling until the Americans leave. So it looks like Bush and Cheney must change the regime in Iran, in order to exit Iraq. No wonder David Kilcullen, Petraeus' counterinsurgency consultant, called the invasion "fucking stupid." (Later changed to an "extremely serious strategic error.") With which the entire foreign policy community (except for the numbnuts neocons) and all the military analysts heartily agree. The U.S. could be tied-down there for generations. But but but Victory looms large, baby! So the Russians take a piece, while the right-wing howls it's totally unjustified. Well of course it is, you dumbasses. And the Russians might have done it anyway. But you throw things up in the air, all sorts of people start grabbing.

Alex Tolley says...

But the belief that economic rationality always prevents war is an equally great illusion. And today’s high degree of global economic interdependence, which can be sustained only if all major governments act sensibly, is more fragile than we imagine.

Anyone with the slightest sense of history does not have these illusions. All the knowledge gained in the last 100 years that could be used to understand how best to manage human affairs is overridden by base human nature. In our (US) own milieu, we have at least half the population that is effectively anti-science and prefers to make emotional decisions and votes for political candidates that do the same thing. The US congress routinely votes on emotional or ideological lines only. I see no evidence that the rest of the world is any less irrational.

[Aug 15, 2008] The Project Gutenberg eBook of The Economic Consequences of the Peace, by John Maynard Keynes

A very important book now available for free..

[Aug 15, 2008] Stage two of the gold bull market is just beginning Ambrose Evans-Pritchard

Yet gold crashes. It has failed to deliver on its core promises as a safe-haven and inflation hedge, at least for now. Why?

Four possible answers:

1) Nobody seriously believes that Russia will over-play its hand. The world could not care less about Georgia anyway. Ergo, this is a bogus geopolitical crisis.

2) The inflation story is vastly exaggerated in the OECD core of countries that still make up 60pc of the global economy. The price of gold is already looking beyond the oil and food spike of early to mid 2008 (a lagging indicator of loose money two to three years ago) to the much more serious matter of debt-deflation that lies ahead.

3) The seven-year slide of the dollar is over as investors at last wake up to the reality that the global economy is falling off a cliff. Indeed, the US is the only G7 country that is not yet in or on the cusp recession. (It soon will be, but by then others will be prostrate). As an anti-dollar play, gold is finished for this cycle.

4) The entire commodity boom has hit the buffers. Looming world recession (growth below 3pc on the IMF definition) trumps the supercycle for the time being.

Gold has fallen from $1030 an ounce in February to $807 today in London trading. It has collapsed through key layers of technical support, triggering automatic stop-loss sales. The Goldman Sachs short-position that I have been observing with some curiosity has paid off.

For gold bugs, the unthinkable has now happened. The metal has fallen through its 50-week moving average, the key support line that has held solid through the seven-year bull market. This week is not over yet, of course. If gold recovers enough in coming days, it could still close above the line.

Courtesy of my old colleague Peter Brimelow - whose columns on gold are a must-read - note that Australia's Privateer point and figure chart has also broken its upward line for the first time since 2002. This is serious technical damage.

So have we reached the moment when gold bugs must start questioning their deepest assumptions. Have they bought too deeply into the "dollar-collapse/M3 monetary bubble" tale, ignoring all the other moving parts in the complex global system? Nobody wants to be left holding the bag all the way down to the bottom of the slide, long after the hedge funds have sold out.

Well, my own view is that gold bugs should start looking very closely at something else: the implosion of Europe. (Japan is in recession too)

Germany's economy shrank by 1pc in Q2. Italy shrank by 0.3pc. Spain is sliding into a crisis that looks all too like the early stages of Argentina's debacle in 2001. The head of the Spanish banking federation today pleaded with the European Central Bank for rescue measures to end the credit crisis.

The slow-burn damage of the over-valued euro is becoming apparent in every corner of the eurozone. The ECB misjudged the severity of the downturn, as executive board member Lorenzo Bini-Smaghi admitted today in the Italian press. By raising interest rates into the teeth of the storm last month, Frankfurt has made it that much more likely that parts of Europe's credit system will seize up as defaults snowball next year.

As readers know, I do not believe the eurozone is a fully workable currency union over the long run. There was a momentary "convergence" when the currencies were fixed in perpetuity, mostly in 1995. They have diverged ever since. The rift between North and South was not enough to fracture the system in the first post-EMU downturn, the dotcom bust. We have moved a long way since then. The Club Med bloc is now massively dependent on capital inflows from North Europe to plug their current account gaps: Spain (10pc), Portugal (10pc), Greece (14pc). UBS warned that these flows are no longer forthcoming.

The central banks of Asia, the Mid-East, and Russia have been parking a chunk of their $6 trillion reserves in European bonds on the assumption that the euro can serve as a twin pillar of the global monetary system alongside the dollar. But the euro is nothing like the dollar. It has no European government, tax, or social security system to back it up. Each member country is sovereign, each fiercely proud, answering to its own ancient rythms.

It lacks the mechanism of "fiscal transfers" to switch money to depressed regions. The Babel of languages keeps workers pinned down in their own country. The escape valve of labour mobility is half-blocked. We are about to find out whether EMU really has the levels of political solidarity of a nation, the kind that holds America's currency union together through storms.

My guess is that political protest will mark the next phase of this drama. Almost half a million people have lost their jobs in Spain alone over the last year. At some point, the feeling of national impotence in the face of monetary rule from Frankfurt will erupt into popular fury. The ECB will swallow its pride and opt for a weak euro policy, or face its own destruction.

What we are about to see is a race to the bottom by the world's major currencies as each tries to devalue against others in a beggar-thy-neighbour policy to shore up exports, or indeed simply because they have to cut rates frantically to stave off the consequences of debt-deleveraging and the risk of an outright Slump.

When that happens - if it is not already happening - it will become clear that the both pillars of the global monetary system are unstable, infested with the dry rot of excess debt.

The Fed has already invoked Article 13 (3) - the "unusual and exigent circumstances" clause last used in the Great Depression - to rescue Bear Stearns. The US Treasury has since had to shore up Fannie and Freddie, the world's two biggest financial institutions.

Europe's turn will come next. We will discover that Europe cannot conduct such rescues. There is no lender of last resort in the system. The ECB is prohibited by the Maastricht Treaty from carrying out direct bail-outs. There is no EU treasury. So the answer will be drift and paralysis.

When EU Single Market Commissioner Charlie McCreevy was asked at a dinner what Brussels would have done if the eurozone faced a crisis like Bear Stearns, he rolled his eyes and thanked the Heavens that so such crisis had yet happened.

It will.

Gold bugs, you ain't seen nothing yet. Gold at $800 looks like a bargain in the new world currency disorder.

[Aug 14, 2008] Making Markets Work for Everyone

This is an important post that shows how free market retoric was abused to enrich few at the expence of many...

Greg Anrig via Brad DeLong:

Greg Anrig on the GOP, by Brad DeLong: He smells a wind from out of the west:

McCain's Problem Isn't His Tactics. It's GOP Ideas.: At long last, the conservative juggernaut is cracking up. From the Reagan era until late 2005 or so, conservatives crushed progressives like me in debates as reliably as the Harlem Globetrotters owned the Washington Generals. The right would eloquently praise the virtues of free markets and the magic of the invisible hand. We would respond by stammering about the importance of regulation and a mixed economy, knowing even as the words came out that our audience was becoming bored.

Conservatives would get knowing laughs by mocking bureaucrats. We would drone on about how everyone can benefit from the experience and expertise of able civil servants. ... They offered tax cuts. We talked amorphously about taxes as the price of a civilized society. ...

But now, seemingly all of a sudden, conservatives are the ones who are tongue-tied, as demonstrated by Sen. John McCain's limping, message-free presidential campaign. McCain's ongoing difficulties in exciting voters aren't just a tactical problem; his woes stem largely from his long-standing adherence to a set of ideas that simply haven't worked in practice. The belief system and finely crafted policy pitches that enabled the right to dominate the war of ideas for the past 30 years have produced a relentless succession of governing failures, from Iraq to Katrina to the economy to the environment.

Largely as a consequence, the public's attitude toward government -- Ronald Reagan's bête noire -- has shifted. A recent Wall Street Journal/NBC News poll found that, by a 53-to-42 percent margin, Americans want government to "do more to solve problems"; a dozen years ago, respondents opposed government action by 2 to 1. Meanwhile, Republican constituency groups' long-standing determination to put aside their often significant differences and band together to support GOP candidates is fracturing: The libertarian darling Ron Paul and the evangelical Christian leader James C. Dobson are among the Republican bigwigs who haven't so far endorsed McCain. ...

As I listen to leading voices and thinkers on the right pondering the condition of their ideology, it is increasingly clear to me that they face a fundamental dilemma -- one that cannot be resolved anytime soon and that might well leave the conservative movement out to pasture for as long as we progressives have been powerlessly chewing grass. That choice is whether to stick with rhetoric and policies wedded to free markets, limited government and bellicose unilateralism, or to endorse a more robust role for the public sector at home while relying more on diplomacy and international institutions abroad. Either way, conservative Republicans seem destined to have a much harder time winning elections for the foreseeable future. Just ask McCain how much fun he's having.

The single theme that most animated the modern conservative movement was the conviction that government was the problem and market forces the solution. It was a simple, elegant, politically attractive idea, and the right applied it to virtually every major domestic challenge -- retirement security, health care, education, jobs, the environment and so on. Whatever the issue, conservatives proposed substituting market forces for government -- pushing the bureaucrats aside and letting private-sector competition work to everyone's benefit.

So they advocated creating health savings accounts, handing out school vouchers, privatizing Social Security, shifting government functions to private contractors, and curtailing regulations on public health, safety, the environment and more. And, of course, they pushed to cut taxes to further weaken the public sector by "starving the beast." President Bush has followed this playbook more closely than any previous president, including Reagan, notwithstanding today's desperate efforts by the right to distance itself from the deeply unpopular chief executive.

But in practice, those ideas have all failed to deliver...

Conservatives will contest that "President Bush has followed this playbook more closely than ... Reagan." They'll try to argue that the problem is the Bush administration, not conservative ideas. In fact, liberals make this argument too:

[T]he free-market, supply-side crowd... had behind them the authority of a vast academic establishment, ranging from Friedrich von Hayek to Milton Friedman to such contemporaries as Gary Becker and Robert Mundell... The academic economics of the 1970s lined up behind the right-wing politics of the 1980s for a reason. Reaganomics had a logic. ... Deregulation, above all, would substitute the invisible hand of the "efficient market" for the dead hand of bureaucracy.

The judicial coup of December 2000 that installed Bush and Cheney brought back some of Reagan's men and his most extreme policies - tax cuts for the wealthy, big increases in military spending, aggressive deregulation. But it didn't bring back the ideas. Instead, it became clear that Bush and Cheney had no real ideas, no larger public justification. They cut taxes to enrich their supporters. ... They were willing to have the government spend like a drunken sailor in 2003/4 to boost the economy before the election. ...

It was very interesting to me that some of the first to sense this loss of public purpose were the very conservatives who had swept in with Reagan. The nemeses of my youth, people like Bruce Bartlett, Paul Craig Roberts, the late Jude Wanniski, went over into hard opposition..., at the core they felt that Bush had no conservative convictions.

The free market rhetoric still has power even when it offers false hopes. In previous campaigns we heard how tax cuts would pay for themselves. Cut taxes and get the government out of the way, the argument goes, and output will grow so much that taxes will actually rise. That, of course, didn't happen. This campaign, it's offshore drilling. Offshore drilling won't lower oil prices, that's a false hope, yet the cry that government imposed environmental restrictions are causing higher prices has had some success. Let the market work, we hear, and it will solve the problem. There are other of signs that politicians are not yet ready to abandon the free-market message. When it comes to health care reform, the Obama campaign fears the word mandates for a reason, and prefers to push a plan that has "many private health insurance options." Talk of raising taxes and increasing the size of government is avoided, and Democrats step very lightly around free trade. The idea that the market works still has resonance.

So my instinct is different. Markets do what we expect them to do - they allocate resources efficiently - when they operate under the proper conditions. Those conditions include lack of market power among market participants, the lack of political influence, having the proper regulatory structure in place, and so on. Using anti-government ideology, conservatives have undermined rather than supported the market system, and that's the important message. Take deregulation as an example. There were certainly places where government overreached, and removing regulations in those cases was needed, but thoughtlessly stripping away any rule or regulation pertaining to business that you encounter is not the way to create a market system that functions optimally.

I want Democrats to make it clear that we aren't opposed to markets, not at all, and to say it forcefully. In fact, we like markets so much we want to fix the ones that are broken from so many years of neglect by Republican administrations. We want to make markets work for everyone, not just a few at the very top who are able to work the system to their advantage. We have a pretty good idea of what it takes for markets to function well, and it requires active government involvement to create the conditions and supporting institutions for markets to flourish. That type of government oversight has been absent under Republican administrations - see the financial meltdown - and it's up to Democrats to step up and fill the void.

The confusion here is simple, I think. Free markets - where free simply means minimal government involvement - are not necessarily the same as competitive markets. There is nothing that says what many interpret as freeing markets - lifting all government restrictions - will give us competitive markets, not at all. Government regulation (as well as laws, social norms, etc.) is often necessary to help markets approach competitive ideals. Environmental restrictions that force producers to internalize all costs of production m