Daily Business Report

David Stockman's Non-Recovery Part 1: Post-2009 Faux Prosperity

2013-06-18T06:19:00.004-04:00

Few others are better equipped to comprehend both the insider's and outsider's perspective on what the government, the Fed, and the banks are doing in this so-called 'recovery' we are experiencing than David Stockman. Nowhere does he detail this better than Chapter 31 of his new book 'The Great Deformation'. In this first part (of a four-part series), he explains just what happened after the US economy liquidated excess inventory and labor and hit its natural bottom in June 2009. Embarking upon a halting but wholly unnatural "recovery," doing nothing but igniting yet another round of rampant speculation in the risk asset classes. The precarious foundation of the Bernanke Bubble is starkly evident in the internal composition of the jobs numbers.

Via David Stockman's book The Great Deformation,

After the US economy liquidated excess inventory and labor and hit its natural bottom in June 2009, it embarked upon a halting but wholly unnatural “recovery.” The artificial prolongation of the Bush tax cuts, the 2 percent payroll tax abatement and the spend-out of the Obama stimulus pilfered several trillions from future taxpayers in order to gift America’s present day “consumption units” with the wherewithal to buy more shoes and soda pop.

But there has been no recovery of the Main Street economy where it counts; that is, no revival of breadwinner jobs and earned incomes on the free market. What we have once again is faux prosperity. In fact, the current Bernanke Bubble is an even sketchier version of the last one and consists essentially of the deliberate and relentless reflation of financial asset prices.

In practice, this amounts to a monetary version of “trickle down” economics. By September 2012, personal consumption expenditure (PCE) was up by $1.2 trillion from the prior peak, representing a modest 2.2 percent per year (0.6 percent after inflation) gain from the level of late 2007. Yet half of this gain—more than $600 billion—reflected the massive growth of government transfer payments, and much of the rebound which did occur in private consumption spending was concentrated in the top 10–20 percent of households. In short, the Fed’s financial repression policies enabled Uncle Sam to fund transfer payments for the bottom rungs of society at virtually no carry cost on the debt, while they juiced the top rungs with a wealth effects tonic that boosted spending at Nordstrom’s and Coach.

The Fed’s post-Lehman money printing spree has thus failed to revive Main Street, but it has ignited yet another round of rampant speculation in the risk asset classes. Accordingly, the net worth of the 1 percent is temporarily back to the pre-crisis status quo ante. Needless to say, successful speculation in the fast money complex is not a sign of honest economic recovery: it merely marks the prelude to another spectacular meltdown in the canyons of Wall Street next time the music stops.

DEFORMATION OF THE JOBS MARKET: THE ECLIPSE OF BREADWINNERS

The precarious foundation of the Bernanke Bubble is starkly evident in the internal composition of the jobs numbers. At the time the US economy peaked in December 2007, there were 71.8 million “breadwinner” jobs in construction, manufacturing, white-collar professions, government, and full-time private services. These jobs accounted for more than half of the nation’s 138 million total payroll and on average paid about $50,000 per year—just enough to support a family.

Breadwinner jobs also generated more than 65 percent of earned wage and salary income and are thus the foundation of the Main Street economy. Yet after a brutal 5.6 million loss of breadwinner jobs during the Great Recession, a startling fact stands out: less than 4 percent of that loss had been recovered after 40 months of so-called recovery.

The 3 million jobs recovered since the recession ended in June 2009, in fact, have been entirely concentrated in the two far more marginal categories that comprise the balance of the national payroll. More than half of the recovery (1.6 million jobs) occurred in what is essentially the “part-time economy.” It presently includes 36.4 million jobs in retail, hotels, restaurants, shoe-shine stands, and temporary help agencies where average annualized compensation was only $19,000. This vast swath of the jobs economy—27 percent of the total—is thus comprised of entry level, second earner, and episodic jobs that enable their holders to barely scrape by.

The balance of the pick-up (1.1 million jobs) was in the HES Complex, which consists of 30.7 million jobs in health, education, and social services. Average compensation is slightly better at about $35,000 annually and this category has grown steadily for years. Its increasingly salient disability, however, is that it is almost entirely dependent on government spending and tax subsidies, and thus faces the headwind of the nation’s growing fiscal insolvency.

When viewed in this three category framework, the nation’s job picture reveals a lopsided aspect that thoroughly belies the headline claims of recovery. A healthy Main Street economy self-evidently depends upon growth in breadwinner jobs, but there has been none, even during the bubble years before the financial crisis. The Bureau of Labor Statistics (BLS) reported 71.8 million breadwinner jobs in January 2000, yet seven years later in December 2007—after the huge boom in housing, real estate, household consumption, and the stock market—the number was still exactly 71.8 million.

The faux prosperity of the Fed’s bubble finance is thus starkly evident. This is the single most important metric of Main Street economic health, and not only had there been zero new breadwinner jobs on a peak-to-peak basis, but that alarming fact had been completely ignored by the smugly confident monetary politburo.

Alas, the latter was blithely tracking a feedback loop of its own making. Flooding Wall Street with easy money, it saw the stock averages soar and pronounced itself pleased with the resulting “wealth effects.” Turning the nation’s homes into debt-dispensing ATMs, it witnessed a household consumption spree and marveled that the “incoming” macroeconomic data was better than expected. That these deformations were mistaken for prosperity and sustainable economic growth gives witness to the everlasting folly of the monetary doctrines now in vogue in the Eccles Building.

To be sure, nominal GDP did grow by 40 percent, or about $4 trillion, between 2000 and 2007. Yet there should be no mystery as to how it happened. As has been noted, total debt outstanding grew by $20 trillion during that same period. The American economy was thus being pushed forward by a bow wave of debt, not pulled higher by rising productivity and earned income.

Indeed, the modest gain of 7.5 million jobs during those seven years reflected exactly this debt-driven dynamic and explains why none of these job gains were in the breadwinner categories. Instead, about 2.5 million were accounted for by the part-time economy jobs described above. On an income-equivalent basis these were actually “40 percent jobs” because they represented an average of twenty-five hours per week and paid $14 per hour, compared to a standard forty-hour work week and a national average wage rate of $22 per hour. Thus, spending their trillions of MEW windfalls at malls, bars, restaurants, vacation spots, and athletic clubs, homeowners and the prosperous classes, in effect, temporarily hired the renters and the increasing legions of marginal workers left behind.

Likewise, another 5 million jobs were generated in the HES (health, education, and social services) complex. Here the job count grew by 20 percent, but it was mainly due to the fact that the sector’s paymasters - government budgets and tax-preferred employer health plans - were temporarily flush.

As discussed in part 2 of this series, however, these, too, were “debt-push” jobs that paid modest wages. While the steady 2.6 percent annual growth of HES jobs during the second Greenspan Bubble did flatter the monthly employment “print,” it was possible only so long as government and health plans could keep spending at rates far higher than the growth rate of the national economy.

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Why You Should Stop Worrying About Central Bank Losses

2013-06-17T05:32:00.003-04:00

Yves here. I guarantee this post will make some readers’ heads explode. It also explains why Germany would benefit from OMT.

By Paul De Grauwe, Professor of international economics, London School of Economics, and former member of the Belgian parliament, and Yuemei Ji, Economist, LICOS, University of Leuven. Cross posted from VoxEU

The monetary-fiscal policy connection is under scrutiny by the German Constitutional Court in the context of the ECB’s OMT bond-buying programme. This column argues that most analyses are deeply flawed by the misapplication of private-company default principles to the central bank. ECB bond-buying transforms public bonds into monetary base, and sovereign-default risk into inflation risk. The real question is: What is the non-inflationary limit to money-base expansion? This depends upon the economic situation and is much higher in the current liquidity-trap setting.

There is a lot of confusion about the fiscal implications of the government bond-buying programme – the OMT, or Outright Monetary Transactions – that the ECB announced last year.

This confusion arises mainly because the principles that guide the solvency of private companies (including banks) are applied to central banks.

• The level of confusion is so high that the president of the Bundesbank turned to the German Constitutional Court arguing that the OMT programme of the ECB would make German citizens liable for paying taxes to cover potential losses made by the ECB.
• In this column we argue that the fears that German taxpayers may have to cover losses made by the ECB are misplaced. They are based on a misunderstanding of solvency issues that central banks face.

Indeed, German taxpayers are the main beneficiaries of such a bond-buying programme.

Solvency Central Banks Versus Private Agents: The Key Difference

Private companies are said to be solvent when their equity is positive, i.e. when the value of their assets exceeds the value of their outstanding debt. The solvency of a private company can also be formulated in terms of the maximum amount of losses that a company can bear at any given time. Thus, a private company is said to be solvent when its losses do not exceed the value of its equity. Since in efficient markets the latter is equal to the present value of future profits, we arrive at the solvency constraint that says that the losses today cannot exceed the present value of expected future profits.

The problem arises when these solvency constraints are applied to central banks.

• This misapplication of private principles has led some to conclude that the loss the ECB (or any central bank) can bear should not exceed the present value of future expected seigniorage gains (see Corsetti and Delado 2013).
• Similarly, it is sometimes concluded that a central bank needs positive equity to remain solvent (Stella, 1997, Bindseil et al. 2004).

These solvency constraints should not be applied to the central bank; central banks cannot default.
A central bank can issue any amount of money that will allow it to ‘repay its creditors’, i.e. the money holders.1 Such a ‘repayment’ would just amount in converting old money into new money.
Contrary to private companies, the liabilities of the central bank do not constitute a claim on the assets of the central bank. The latter was the case during gold standard when the central bank promised to convert its liabilities into gold at a fixed price. Similarly in a fixed exchange-rate system, the central banks promise to convert their liabilities into foreign exchange at a fixed price.

The ECB and other modern central banks that are on a floating exchange-rate system make no such promise. As a result, the value of the central bank’s assets has no bearing for its solvency. The only promise made by the central bank in a floating exchange-rate regime is that the money will be convertible into a basket of goods and services at a (more or less) fixed price. In other words the central bank makes a promise of price stability. That’s all.

Seigniorage is not a Limit

Thus it makes no sense to state that the limit to the losses a central bank can make at any point in time is given by the present value of future profits (seigniorage). There is no such limit. The central bank can make any loss provided the loss does not endanger its promise to maintain price stability.
Also it is not correct to claim that the central bank needs to hold positive equity ‘to remain solvent’. A central bank needs no equity. As a result the claim that is sometimes made that a central bank with negative equity needs to be recapitalised by the treasury is senseless. To be clear:

• The central bank (that cannot default) needs no fiscal backing from the government (who can default).
• The only backing the central bank needs from the government is that it can keep its monopoly power to issue money in the territory over which the sovereign has jurisdiction.

With that power granted by the sovereign the central bank is freed from any solvency constraint.
Let us now apply these first principles to the issue of how a bond-buying programme can have fiscal implications. We first discuss the situation of the central bank that faces only one sovereign. Then we discuss the problem of the central bank in a monetary union facing many sovereigns.

The Central Bank of a Stand-Alone Country

We will consider the case of a central bank that buys government bonds in the secondary market.2 By buying government bonds the central bank transforms the nature of the public-sector debt.
When the central bank buys its government’s debt, the debt is transformed:

• Government debt that carries an interest rate and a default risk becomes debt that is a monetary liability of the central bank (money base) that is default-free but subject to inflation-risk.

To understand the fiscal implications of this transformation, it is important to consolidate the central bank and the government (after all they are separate branches of the public sector).

After the transformation the government debt held by the central bank cancels out. It is an asset of one branch (the central bank) and a liability of another branch (the government). As a result, it disappears. The central bank may still keep it on its books, but it has no economic value anymore. In fact the central bank may do away with this fiction and eliminate it from its balance sheet and the government could then eliminate it from its debt figures. It has become worthless because it was replaced by a new type of debt, namely money, which carries an inflation risk instead of a default risk.

This is why It makes no sense to say central banks lose when the market price of the government bonds drops. If there were a loss for the central bank it would be matched by an equal gain of the government (whose market value of the debt has dropped in the same proportion). There is no loss for the public sector.

Public Debt Held by the Public Sector is Different

We arrive at an important conclusion:

• When the central bank has acquired government bonds, a decline in the market value of these bonds has no fiscal implications.

The loss in one branch of the public sector (the central bank) is offset by an equal gain in another part of the public sector (the government), leaving nothing to be paid by the taxpayer.

Another way to see this is to look at the interest-rate flows underlying bond holdings. Let’s take an example and suppose the central bank has bought €1 billion of government bonds. These have a coupon of, say, 4%. Thus the central bank that keeps these bonds on its balance sheet receives €40 million from the government every year. The bookkeeping practice is to count this as profits of the central bank. At the end of the year the same central bank will have to hand over its profits to the government. Assuming that the marginal cost of managing this bond portfolio is zero, the central bank will hand over €40 million to the government. This is the left hand paying the right hand, so to speak.

This bookkeeping practice has led to the perception that the interest revenue is to be considered as seignorage. It is not. There is no profit for the public sector. The profit of the central bank is exactly offset by a loss of the government. Both could do away with this bookkeeping convention because there is no economic substance to these losses and profits.

• It is literally true that the central bank could put the government bonds ‘into the shredding machine’; nothing would be lost.

In our example, the central bank would stop receiving €40 million a year, and would stop paying out €40 million to the government every year.
What happens if the government defaults on its outstanding bonds?

• Default leads to losses for private holders of these bonds.
• But it is immaterial for central bank-held bonds.

These are now valued at zero, but they were also already worthless before the default. This is the right hand taking it back from the left hand.

Think about it in terms of the interest flows. After the default, the central bank stops receiving interest payments from the government, but by the same token it stops paying these back to the government. Nothing has happened in the public sector. Thus the loss that the central bank is making as a result of the default has no fiscal implications.

Price Stability and Public-Sector Default

There is an issue when it comes to price stability and its link to a government default. If the central bank keeps its liabilities (money base) under control, the default by itself will not lead to more inflation. The latter will arise only if the government were to force the central bank to issue more of these monetary liabilities, e.g. to finance current budget deficits that after the default the government cannot finance by issuing bonds anymore.

It is sometimes argued that if the central bank has no assets (because of a default by the government), then it no longer has instruments to reduce the money stock. This may sometimes be necessary to reduce inflationary pressures. This argument does not hold water. There are two ways a central bank that lacks assets can reduce the money stock.

• First, the central bank can issue interest-bearing bonds and sell them in the market.

This has the effect of reducing liquidity (money base).

• Second, the central bank can raise minimum reserve requirements.

As a result, the existing stock of liquidity is ‘deactivated’, which has the same effect of a decline in the money base.

The Central Bank of a Monetary Union

Things are more complicated in a monetary union that is not also a fiscal union. Here the fiscal implication of central-bank bond buying is more complicated. The crux is the presences of ‘n’ sovereigns. In the Eurozone, n = 17 (soon to be 18 with Latvia).

• If we could consolidate the ECB and the 17 sovereigns into one public sector, the analysis would carry through unchanged.
• But we cannot; the Eurozone is not a fiscal union.

As a result a bond-buying programme will lead to transfers among participating member countries.
To clarify thinking about this problem, assume that the ECB buys €1 billion of Spanish bonds with a 4% coupon. The fiscal implications are now as follows.

• The ECB receives €40 million interest annually from the Spanish Treasury.
• The ECB returns this €40 million every year to the EZ national central banks.

The distribution is pro rata with national equity shares in the ECB (see ECB 2012).

• The national central banks transfer this to their national treasuries.

For example, the ECB will transfer back 11.9% of the €40 million to the Banco de España. The rest goes to the other member central banks. The largest receiver is the German Bundesbank; with its equity share of 27.1%, it would get €10.8 million.
Thus in a monetary union (and in the absence of a fiscal union) a bond-buying programme leads to fiscal transfers among countries – but not the one common in the public perception, especially in Germany.

• An ECB bond-buying programme leads to a yearly transfer from the country whose bonds are bought to the countries whose bond are not bought.

It should be noted that the ECB could implement a bond-buying programme that avoids fiscal transfers by buying national government bonds in the same proportions to the equity shares of the participating NCBs. This has in fact been proposed sometimes. But this would not eliminate all transfers because the interest rates on the outstanding government bonds are not the same. In fact the countries with the highest interest rates would in this weighted bond-buying programme be net payers of interest to the countries with the lowest interest rates. Thus even a bond-buying programme weighted by the equity shares would involve fiscal transfers from the weaker (debtor) countries to the stronger (creditor) countries.

What Happens Under a Public-Sector Default?

One often hears in the creditor countries that these would be the losers if one of the governments whose bonds are on the balance sheet of the ECB were to default. This is an erroneous conclusion.
Returning to our example of an ECB purchase of €1 billion of Spanish government bonds, consider a Spanish defaults on these bonds.

• The Spanish government would stop paying €40 million to the ECB.
• The ECB would stop transferring this interest revenue back to the member central banks pro rata.
• The German taxpayer, for example, would no longer receive the yearly windfall of €10.8 million.

In no way can one conclude that German taxpayers, or any EZ taxpayer, would pay the bill of the Spanish default – except in the narrow sense that they would no longer be able to count on the yearly interest revenues.

• There is of course the possibility of an inflation tax.

We have noted before that at the moment of the bond buying programme interest bearing debt is transformed into monetary liabilities of the ECB (money base). This by itself could lead to inflation, and thus to an inflation tax that would be borne by all holders of euros. This leads to the issue of how large the ECB bond-buying programme can be without generating additional inflation.
From Explicit Taxation to Inflation Tax

Every open-market operation involving the purchase of government bonds creates the potential of inflation because it increases the money base. The key question we have to ask ourselves is how the increase in the money base is transmitted to the money stock. After all, it is the money stock not the money base per se that determines inflation.

In Figure 1 we show the evolution of money base and money stock (M3) in the Eurozone since 2004. We find a striking difference between the period before and after the banking crisis of October 2008.

• Prior to the Global Crisis, the two monetary aggregates move in unison suggesting that the money multiplier (the ratio of money stock to money base) is constant.

A 1% increase in the money stock led to an increase of the money stock of approximately 1%. Things are very different during the crisis period.

Figure 1. Money base, money stock (M3) in Eurozone (2007 December=100)

Source: European Central Bank, Statistical Warehouse.

Over the period 2008 (Oct) to 2013 (April), the relation between the money base and the money stock breaks down. The money base increased by more than 50%; the money stock increased by only 7%. This suggests that the money multiplier has dropped dramatically.

This dramatic decline in the money multiplier has everything to do with the liquidity trap (Krugman 2010). Banks, which accumulate reserves as a result of the liquidity injections by the ECB, hoard these reserves. Their degree of risk aversion is such that they do not use their cash reserves to expand bank credit. As a result, the money stock (M3) does not increase.

Figure 2 is also instructive. It shows the average yearly inflation rate and the average yearly growth rates of money base and money stock before and after the banking crisis of 2008.

• Prior to 2008 both monetary aggregates increased at practically the same rates; the yearly inflation was 2.3%.
• Since 2008 the growth rate of the monetary aggregates diverges dramatically.

The money base grows at a yearly rate of 11% while the growth rate of the money stock collapses to less that 2% and inflation drops below 2%.

• Our interpretation is that the strong increase in the money base helped to reduce the deflationary forces in the economy, rather than being a source of inflation.3

Figure 2. Inflation, growth MB and M3 (average yearly growth rates)

Source: European Central Bank, Statistical Warehouse.

Conclusions

The previous analysis suggests the following:

• Limits to a bond-buying programme depend on the nature of the economic and financial situation, i.e. the existence of a liquidity trap.
• In normal times when an increase of the money base leads to proportional increases in the money stock the limit to a bond-buying programme is tight.

If the target for the increase in the money stock is 4.5% (as is the case in the Eurozone where a 4.5% target is assumed to lead to at most 2% inflation) this also means that the money base should not increase by more than 4.5% per year. But then during normal times there is very little need for a bond-buying programme.

• The situation has changed dramatically since the start of the banking crisis.

During the crisis period the limits to the amount of money base that can be created without triggering inflationary pressures is much higher because of the existence of a liquidity trap.

How much higher depends on the money multiplier. In De Grauwe and Ji (2013) we estimate the size of the multiplier during the crisis period and we conclude that it has collapsed to zero. As a result, there is no limit to the size of the bond-buying programme, i.e. the ECB can buy any amount of government bonds without endangering price stability, as long as the crisis lasts.
______
1 We assume here that the central bank does not hold foreign currency liabilities. In that case the central bank can be pushed into defaulting on these foreign currency liabilities because it can only issue domestic currency liabilities (Buiter 2008).
2 Thus we do not discuss direct monetary financing of government budget deficits.
3 See Friedman and Schwartz(1961) for an analyis of the Great Depression in the US. These authors argued that the US Fed at the time failed to increase the money base sufficiently to counter the delflationary forces. As a result, the US money stock actually declined, reinforcing deflation.

See here for references

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Is the Fed Going to Dial Down Its QE Taper Talk?

2013-06-14T05:54:00.001-04:00

We’ve suggested that the Fed has drunken a bit too much of its own confidence Kool-Aid to be talking about tapering QE. The problem now, as we’ve stressed, is that the effect of QE may prove to be asymmetrical, that the flattening the yield curve exercise when short rates were already in ZIRP land haven’t done much to stimulate the real economy (where was the Fed in calling for more fiscal stimulus, or in arguing against deficit scare-mongering?). But perversely, taking it away could be more of an economic downer than the central bank anticipates. Mere talk of ending QE is tantamount to urging on a rate hike for the longer end of the yield curve. And higher rates there will not only prove to be a damper, but with economic growth slowing all over the world, has the potential to have knock-on effects.

Three front page stories at the Wall Street Journal tonight all highlight reasons why the Fed might dial down taper expectations.

The first is that mortgage refinancings have fallen, which we predicted would happen. Even though there is some whistling-in-the-dark talk about how some consumers might refinance with rates going in the wrong direction, the most you are likely to see is people who’ve been distracted and haven’t gotten around to doing the paperwork. Anyone who is remotely attentive to rates has likely refied multiple times already. Refis are a weak but real source of stimulus, since lower mortgage payments means more money in consumers’ pockets to spend on other stuff. So a big drop in rates takes that source of incremental spending away.

The second is on how the Fed-induced interest rate increases have led to worrisome interest rate increases in Eurozone periphery countries. Suddenly the belief that the Eurozone crisis was over is coming into question> From the Journal:

Government bonds have recently taken a hit around the world, now that investors are preparing for the possible end of central banks’ boundless economic stimulus. And those bonds of the weakest euro-zone countries have shown some of the biggest drops…

Yields on the 10-year Greek bond, which had strengthened remarkably since last summer, ended Thursday at 10.03%. That is two percentage points higher than where they stood on May 22, when the U.S. Federal Reserve signaled its giant bond-buying program might slow this year. At 6.47%, the Portuguese 10-year is more than one percentage point above its May low. Bond yields rise when their prices fall.

The 10-year Spanish bond, which was near 4% in early May, closed Thursday at 4.61%, flat on the day. The Italian 10-year, a hair stronger Thursday at 4.35%, also is off over the month. The spread—or the amount of additional yield investors demand, above that paid by benchmark Germany—also has risen for both countries over the period.

And the piece points out how putting these countries on the austerity rack is not going to improve their ability to make good on their obligations:

But a larger problem may be looming: In order to restore their economic viability, weaker countries must improve their industries’ competitiveness by pushing down wages and other costs, relative to Germany and other northern countries. But the German economy appears to have settled into a pattern of low growth and low inflation.

That means Italy, Spain and the others need more of this so-called internal devaluation. And devaluation makes it harder to pay down debt.

Some economist have question whether wages are even the source of the periphery countries’ woes. One line of thought is the simple, “you can’t starve labor and expect to have anyone to buy.” A second is that the periphery countries have the wrong industrial mix, and cutting wages won’t make enough of a dent in their competitiveness. They need to be in more value-added products (which is basically the approach taken by Mondragon, and the Basque region has much lower unemployment than the rest of Spain as a result).

The third article in the Journal addresses another topic near and dear to our heart, that inflation rates and inflation expectation are falling. The Fed has been taking the view that this is an aberration but if current patterns hold or intensify, it will have to rethink its assumptions. From the article:

The Fed has a 2% inflation goal and doesn’t want consumer prices to veer too much above or too much below that number over time. Some recent inflation measures have dropped below that level this year, but Fed officials haven’t been too worried because expectations of future inflation were stable….

“It is no longer clear that inflation expectations are so stable,” Jan Hatzius, chief economist at Goldman Sachs Group Inc., said in an interview. Market-based measures of inflation expectations are now on “the low side of comfortable.” In a note to clients June 10, he predicted that expectations of lower inflation are likely to make Fed officials less willing to pull back on the bond-buying programs out of fear it could destabilize those expectations about future inflation….

In that context, the Fed launched its bond-buying program to bolster economic growth by pushing down long-term interest rates and pushing up asset prices, hoping that would spur spending, hiring and investment. If officials believe the economy is on track to gain strength in coming months, they might start to reduce the size of the bond purchases. But if they thought low inflation and falling expectations signaled new weakness in the economy, they might want to continue the program at its current level for longer.

The Fed’s next pronouncement is late next week. It’s too bad no one is capable of Greenspanian obfuscation. I’m not much good as a Fedwatcher since I’m not good at identifying with their point of view. Logically, given the above, you’d expect the Fed to walk back the taper talk a bit. But they may believe more “we’re staying with the program” messaging is better for the confidence fairy.

Source

Western Workers Lose Faith in Retirement?

2013-06-13T06:00:00.004-04:00

Saving for retirement? We wish we hadn't bothered, say one in 10 ... More than 10pc of people who are saving for retirement wish they hadn't bothered and one in five fears that it's a waste of money, research suggests. The past five years of economic and financial turmoil have left almost three quarters of retirement savers less confident in the ability of stock market investing to deliver their ambitions for retirement income. – UK Telegraph

Dominant Social Theme: The stock market will provide ...

Free-Market Analysis: Modern stock markets can provide profits, even tremendous profits, but they surely should not be seen as a panacea for a larger commitment to self-sufficiency and monetary diversification.

Those who trusted government propaganda over the efficacy of equity and its inevitable, endless rise have long been disappointed – certainly in the US and now in Britain, as this study shows.

It is a major dominant social theme that people ought to simply stick their money in stocks and ... wait.

Sure, equity does move up a good deal, especially certain stocks but those same stocks can move down, too.

In fact, the stock market is far more influenced by business cycles than any other factor. Central banks print money, forcing a boom that eventually turns into a bust. Stocks plunge, people lose wealth and then are counseled not to remove their funds, which may have been halved.

It is almost impossible for someone to lose half of their invested income and keep still. Most people don't have that much money. Frightened by the prospect that stocks might unravel further, they remove their life savings and who can blame them?

Then the stock market goes back up, thanks to monetary stimulation in large part, and those who lost money have no possibility of gaining it back, as they have been scared out of investing further.

This has long been our conclusion and now there are studies – see above – to back it up. Here's more:

In research among retirement savers aged 45 or more, Metlife, the insurer, found that 12pc wished they hadn't bothered saving for retirement and nearly one in five were unhappy with their pension savings or feared they had wasted money. Six per cent were unhappy with their retirement savings despite the recent stock market revival, the survey found.

The past five years of economic and financial turmoil have left almost three quarters of retirement savers less confident in the ability of stock market investing to deliver their ambitions for retirement income ...

Dominic Grinstead, the managing director of MetLife UK, said: "It's clear that the events of the past five years have hit confidence and undermined faith in pension saving."

But he added: "The Government has worked hard to make retirement saving pay, with plans for a universal state pension, automatic enrolment into company pensions and changes to the rules on taking retirement income that allow greater flexibility."

It is, of course, government that is the problem to begin with, however. The modern mechanism of monopoly monetary stimulation causes great booms and busts via endless currency inflation. People know intuitively at this point that stock markets aren't going to provide reliable riches while the money in their pockets loses value regularly.

For this reason, it is occurring to people that saving for retirement may not be a reasonable course of action. If one loses a chunk of money every five to ten years and if the rest of one's wealth is dissipated via price inflation, then what is the scrimping and saving really worth?

This is, of course, an extremely dangerous conclusion from the standpoint of the larger civil society. When middle classes lose faith that they can create and sustain their own futures within their various societies, then a bedrock certainty has been breached.

There are few in middle classes, historically, who wish to turn their futures entirely over governmental technocrats. The hallmark of a healthy culture traditionally is one that allows individual families to make their own way within the larger environment that safeguards their ambitions and their savings.

But now all that is becoming reversed as monopoly monetary stimulation grinds on relentlessly and the 21st century reveals itself as a replica of the 20th century ... only worse.

The difference is, of course, that people know more now and understand the impoverishment of their financial conditions more clearly. For millions, even tens of millions, the central banking mechanism has been revealed ... and people naturally are surprised by what they discover.

The idea that only a privileged few control the money spigots and that the vast majority inherit its inflations and destructive business cycles is increasingly prevalent and no doubt contributing to the disenchantment with modern retirement.

Conclusion: The viewpoints revealed by this survey are not merely surprising; they ought to be profoundly disturbing to those who have concocted the present system and seem determined to continue its inflictions no matter the cost.

Source

Nouriel Roubini Seriously Misguided on Gold, on Equities, on Economic Growth, on Money

2013-06-12T05:38:00.001-04:00

I just finished reading Nouriel Roubini's seven point analysis on the Bursting of the Gold Bubble in which Roubini's asks and answer the question "Gold skyrocketed to over $1,900 per ounce in the fall of 2011 from $800 in early 2009, but has since collapsed by around 27%. Why?"

I offer a point-by-point rebuttal.

Roubini: First, tail risks are lower. Gold tends to spike when the global economy faces severe economic, financial and geopolitical threats; but, thanks to a variety of policy actions, the tail-risks argument for holding gold is less compelling today than at any time since the start of the financial crisis in 2007.

Mish: Japan is flirting with a Yen crisis thanks to Abenomics. Nothing has been fixed in regards to structural problems in the eurozone. A US recession is at hand. A China slowdown is baked in the cake. Trade wars loom between China and Europe. A full scale housing bust is underway in Australia. The UK threatens to leave the EU. The eurozone is unlikely to survive in its current state. Tail risks are enormous (and growing). I would have thought tail risks were so obvious that any serious economist would notice them. I was mistaken.

Roubini: Second, inflation is low and falling. Gold does best when there is a risk of high inflation, as it is a traditional store of value against inflation. But, despite the very aggressive monetary and quantitative easing from many central banks, global inflation is actually low and still falling as growth in most of the global economy remains below trend.

Mish: Gold actually does well in periods of deflation, in periods of credit risk, in periods of stagflation, and in periods of hyperinflation (the latter is obvious). Price inflation fell from 2000 to 2013 and gold rose from $250 to $1900. When was there risk of high inflation in that time-frame?

To be fair, one also needs to look at the disinflationary period between 1980 and 2000 when the price of gold collapsed from $850 to $250. Yet, in disinflationary periods in the last decade, gold soared. The difference? Credit risk and global distrust of fiat currencies. It's easy to cherry pick a timeframe and say gold does this or that, when other timeframes and other factors disprove the thesis.

Roubini: Third, other assets provide better returns. Now that the global economy is recovering, other assets, such as equities or even real estate, are performing much better than gold.

Mish: Lovely! The same sort of argument regarding housing could have been presented in 2002, in 2003, in 2004, and in 2005. Yes, other assets are performing better, for now. But for how long? Is the current trend supposed to last forever? Has Roubini suddenly become a momentum trader in what is performing best?

Roubini: Fourth, exit from ZIRP will be bearish for gold. Real interest rates and gold prices are highly inversely correlated. Although real rates are still negative, the more positive outlook for the U.S. and global economy implies that the Fed and other central banks will gradually exit from QE and ZIRP. Real rates will rise over time rather than fall.

Mish: Precisely when is the Fed supposed to end ZIRP? Tomorrow? Next Month? Next year? A decade? If "real rates rise" won't that be a sign of increasing inflation? Is increasing inflation good for gold or not? Roubini attempts to make a case that rising inflation and falling inflation are both bad for gold and both are about to happen simultaneously. Let me also point out that Roubini thinks 'QE' won't end for another two years! He can't have it both ways.

Roubini: Fifth, highly indebted countries are planning to sell their gold. Some argued that a world full of highly indebted sovereigns would push investors into gold as government bonds would become more risky. Instead, these countries are likely to dump their gold reserves to reduce their debts, or at least are considering doing so.

Mish: Roubini's thesis has gone from circular silliness to the point of complete absurdity. Other than Cyprus (and Cyprus was forced at gunpoint) what central banks are dumping gold? And what central banks are buying gold? ZeroHedge reports Russia, Greece, Turkey, Other Central Banks Buy Gold

Russia, Greece, Turkey, Kazakhstan and Azerbaijan expanded their gold reserves for a seventh straight month in April, buying bullion to diversify foreign exchange reserves due to concerns about the dollar and the euro.

Russia’s steady increase in its gold reserves saw its holdings, the seventh-largest by country, climb another 8.4 metric tons to 990 tons, taking gains this year to 3.4% after expanding by 8.5% in 2012, International Monetary Fund data show.

Kazakhstan’s reserves grew 2.6 tons to 125.5 tons, taking the increase to 8.9% this year after a 41% expansion in 2012, data on the website showed.

Turkey’s holdings rose 18.2 tons to 427.1 tons in April, increasing for a 10th month as it accepted gold in its reserve requirements from commercial banks.

Belarus’s holdings expanded for a seventh month as did Azerbaijan’s.

Interestingly, Greece’s gold holdings climbed for a fourth month, according to the IMF data. Cyrus has about 14 tons of gold. If Cyprus sold all of it, the addition by Turkey alone would cover all of it.

Roubini: Sixth, U.S. dollar appreciation is bearish for gold. There is usually an inverse relationship between the value of the U.S. dollar and the dollar price of commodities, including precious metals like gold. Looking ahead, the relative strength of the U.S. economy and of U.S. asset prices compared with those of other DMs suggests that the dollar may appreciate—as it has done recently—against a basket of DM currencies.

Mish: The biggest gold rally of all time (1979) occurred while the dollar was going sideways with a slight upward bias. The dollar and gold both rose in 2005 as well. If the dollar were all-important for gold, it would never rise in terms of foreign currencies, but it definitely does do that.

Roubini: Seventh, gold has been hyped for irrational political reasons. Some extreme politically conservative gold bugs think that all government is evil, that there is a government conspiracy to expropriate most private wealth and that gold is the only hedge against this risk. This group also believes that we will return to the gold standard as central banks “debase” paper money and as hyperinflation ensues. However, inflation is falling globally and gold is not in any way a currency.

Mish: Yes gold has been hyped by many hyperinflationists. The same was true two years ago, five years ago, and 10 or more years ago.

That makes Roubini's own hype all the more laughable. Roubini ends his hype with this statement: "The price of gold may temporarily go higher in the next few years, but it will be very volatile and trend lower over time as the global economy slowly mends itself. RGE expects gold to go to $1,300 by end-2013 and $1,000 by 2015. For the most part, it is time to offload and underweight Keynes’s barbarous relic."

People ask me all the time where the price of gold is headed. I do not pretend to know, especially in the short-term.

However, I understand the fundamentals and Roubini clearly doesn't.

Nor does Roubini have a clue about money or what causes economic growth. His statement "It is time to offload and underweight Keynes’s barbarous relic" is quite telling.

Can Printing Money Create Wealth?

Clearly Roubini believes that printing money creates wealth. The average 7th-grader (not yet influenced by Keynesian and Monetarist clown teachers) can easily figure out the fallacies of such ridiculous economic theories.

Who benefits from printing? The answer is those with first access to money (the banks, the already wealthy, and the government). Printing money does nothing but exacerbate the trend of income inequality. This is so obvious that Roubini cannot see it.

Buying gold is a perfectly rational reaction to the crazy central bank and governmental policies that Roubini advocates.

Precious Metal Fundamentals

Those interested in a primer on precious metal fundamentals can find it in Precious Metals – An Update by Pater Tenebrarum on the Acting Man Blog.

Those who think Fed asset levitation can and will last forever need to consider John Hussman's June 3, 2013 article Following the Fed to 50% Flops.

Finally, those who wish to see a brilliant takedown of Roubini's recent bullishness might enjoy “Dr. Doom” Becomes “Dr. Boom” – 1,000 SPX Points Too Late, also on the Acting Man Blog.

Things Roubini is Wrong About

Gold
Tail Risk
Benefits of monetary printing
Benefits of fiscal stimulus
On what causes economic growth
Inflation
Stock market risk
That is one heck of a lot of things to be wrong about!

Source

From 9/11 To PRISMgate - How The Carlyle Group LBO'd The World's Secrets

2013-06-11T05:23:00.001-04:00

The short but profitable tale of how 483,000 private individual have "top secret" access to the nation's most non-public information begins in 2001. "After 9/11, intelligence budgets were increased, new people needed to be hired, it was a lot easier to go to the private sector and get people off the shelf," and sure enough firms like Booz Allen Hamilton - still two-thirds owned by the deeply-tied-to-international-governments investment firm The Carlyle Group - took full advantage of Congress' desire to shrink federal agencies and their budgets by enabling outside consultants (already primed with their $4,000 cost 'security clearances') to fulfill the needs of an ever-more-encroaching-on-privacy administration.

Booz Allen (and other security consultant providing firms) trade publicly with a cloak of admitted opacity due to the secrecy of their government contracts ("you may not have important information concerning our business, which will limit your insight into a substantial portion of our business") but the actions of Diane Feinstein who promptly denounced "treasonous" Edward Snowden, "have muddied the waters," for the stunning 1.1 million (or 21% of the total) private consultants with access to "confidential and secret" government information.

Perhaps the situation of gross government over-spend and under-oversight is summed up best, "it's very difficult to know what contractors are doing and what they are billing for the work — or even whether they should be performing the work at all."

First, Diane Feinstein's take on it all...

“I don't look at this as being a whistleblower. I think it's an act of treason,” the chairwoman of the Senate Intelligence Committee told reporters. The California lawmaker went on to say that Snowden had violated his oath to defend the Constitution. “He violated the oath, he violated the law. It's treason.”

So how did all this get started?... (via AP)

The reliance on contractors for intelligence work ballooned after the 9/11 attacks. The government scrambled to improve and expand its ability to monitor the communication and movement of people who might threaten another attack.

"After 9/11, intelligence budgets were increased, new people needed to be hired," Augustyn said. "It was a lot easier to go to the private sector and get people off the shelf."

The reliance on the private sector has grown since then, in part because of Congress' efforts to limit the size of federal agencies and shrink the budget.

Which has led to what appears to be major problems.

But critics say reliance on contractors hasn't reduced the amount the government spends on defense, intelligence or other programs.

Rather, they say it's just shifted work to private employers and reduced transparency. It becomes harder to track the work of those employees and determine whether they should all have access to government secrets.

"It's very difficult to know what contractors are doing and what they are billing for the work — or even whether they should be performing the work at all,"

... And to the current PRISMgate whistleblowing situation:

Of the 4.9 million people with clearance to access "confidential and secret" government information, 1.1 million, or 21 percent, work for outside contractors, according to a report from Clapper's office.

Of the 1.4 million who have the higher "top secret" access, 483,000, or 34 percent, work for contractors.
...

Because clearances can take months or even years to acquire, government contractors often recruit workers who already have them.

Why not - it's lucrative!!

Snowden says he accessed and downloaded the last of the documents that detailed the NSA surveillance program while working in an NSA office in Hawaii for Booz Allen, where he says he was earning $200,000 a year.

Analysts caution that any of the 1.4 million people with access to the nation's top secrets could have leaked information about the program - whether they worked for a contractor or the government.

For individuals and firms alike.

Booz Allen has long navigated those waters well.

The firm was founded in 1914 and began serving the U.S. government in 1940, helping the Navy prepare for World War II. In 2008, it spun off the part of the firm that worked with private companies and abroad. That firm, called Booz & Co., is held privately.

Booz Allen was then acquired by the Carlyle Group, an investment firm with its own deep ties to the government. In November 2010, Booz Allen went public. The Carlyle Group still owns two-thirds of the company's shares.

Or, a full-majority stake.

Curiously once public, The Booz Allens of the world still operate like a psuedo-private company, with extensive confidential cloaks preventing the full disclosure of financial data. But don't worry - we should just trust them. Via Bloomberg's Jonathan Weil.

Psst, here's a stock tip for you. There's a company near Washington with strong ties to the U.S. intelligence community that has been around for almost a century and has secret ways of making money -- so secret that the company can't tell you what they are. Investors who buy just need to have faith.

To skeptics, this might seem like a pitch for an investment scam. But as anyone who has been paying attention to the news might have guessed, the company is Booz Allen Hamilton Holding Corp.
...

"Because we are limited in our ability to provide information about these contracts and services," the company said in its latest annual report, "you may not have important information concerning our business, which will limit your insight into a substantial portion of our business, and therefore may be less able to fully evaluate the risks related to that portion of our business."

This seems like it would be a dream arrangement for some corporations: Not only is Booz Allen allowed to keep investors uninformed, it's required to. I suppose we should give the company credit for being transparent about how opaque it is.

And while the media and popular attention is currently focused on who, if anyone else, may be the next Snowden struck by a sudden pang of conscience, perhaps a better question is what PE behemoth Carlyle, with a gargantuan $170 billion in AUM, knows, and why it rushed to purchase Booz Allen in the months after the Bear Stearns collapse, just when everyone else was batting down the hatches ahead of the biggest financial crash in modern history.

From Bloomberg, May 2008:

Carlyle Group, the private-equity firm run by David Rubenstein, agreed to acquire Booz Allen Hamilton Inc.'s U.S. government-consulting business for $2.54 billion, its biggest buyout since the credit markets collapsed in July.

The purchase would be Carlyle's biggest since it agreed to buy nursing-home operator Manor Care Inc. last July for $6.3 billion. Deal-making may be rebounding from a 68 percent decline in the first quarter as investment banks begin writing new commitments for private-equity transactions. Buyouts ground to a halt last year because of a global credit freeze triggered by record U.S. subprime-mortgage defaults.

The Booz Allen government-consulting unit has more than 18,000 employees and annual sales of more than $2.7 billion. Its clients include branches of the U.S. military, the Department of Homeland Security and the World Bank.

Carlyle, based in Washington, manages $81.1 billion in assets [ZH: that was 5 years ago - the firm now boasts $170 billion in AUM]. Rubenstein founded the firm in 1987 with William Conway and Daniel D'Aniello. The trio initially focused on deals tied to government and defense.

Carlyle and closely held Booz Allen have attracted high-level officials from the government. Carlyle's senior advisers have included former President George H.W. Bush, former British Prime Minister John Major, and Arthur Levitt, the ex-chairman of the U.S. Securities and Exchange Commission.

R. James Woolsey, who led the U.S. Central Intelligence Agency from 1993 to 1995, is a Booz Allen executive. Mike McConnell, the U.S. director of national intelligence, is a former senior vice president with the company.
...

Carlyle last year sold a minority interest in itself to Mubadala Development Co., an investment fund affiliated with the government of Abu Dhabi, capital of the United Arab Emirates.

And in addition to the UAE, who can possibly forget Carlyle's Saudi connection. From the WSJ circa 2001:

If the U.S. boosts defense spending in its quest to stop Osama bin Laden's alleged terrorist activities, there may be one unexpected beneficiary: Mr. bin Laden's family.

Among its far-flung business interests, the well-heeled Saudi Arabian clan -- which says it is estranged from Osama -- is an investor in a fund established by Carlyle Group, a well-connected Washington merchant bank specializing in buyouts of defense and aerospace companies.

Through this investment and its ties to Saudi royalty, the bin Laden family has become acquainted with some of the biggest names in the Republican Party. In recent years, former President Bush, ex-Secretary of State James Baker and ex-Secretary of Defense Frank Carlucci have made the pilgrimage to the bin Laden family's headquarters in Jeddah, Saudi Arabia. Mr. Bush makes speeches on behalf of Carlyle Group and is senior adviser to its Asian Partners fund, while Mr. Baker is its senior counselor. Mr. Carlucci is the group's chairman.

Osama is one of more than 50 children of Mohammed bin Laden, who built the family's $5 billion business, Saudi Binladin Group, largely with construction contracts from the Saudi government. Osama worked briefly in the business and is believed to have inherited as much as $50 million from his father in cash and stock, although he doesn't have access to the shares, a family spokesman says. Because his Saudi citizenship was revoked in 1994, Mr. bin Laden is ineligible to own assets in the kingdom, the spokesman added.
...
People familiar with the family's finances say the bin Ladens do much of their banking with National Commercial Bank in Saudi Arabia and with the London branch of Deutsche Bank AG. They also use Citigroup Inc. and ABN Amro, the people said.

"If there were ever any company closely connected to the U.S. and its presence in Saudi Arabia, it's the Saudi Binladin Group," says Charles Freeman, president of the Middle East Policy Council, a Washington nonprofit concern that receives tens of thousands of dollars a year from the bin Laden family. "They're the establishment that Osama's trying to overthrow."
...
A Carlyle executive said the bin Laden family committed $2 million through a London investment arm in 1995 in Carlyle Partners II Fund, which raised $1.3 billion overall. The fund has purchased several aerospace companies among 29 deals. So far, the family has received $1.3 million back in completed investments and should ultimately realize a 40% annualized rate of return, the Carlyle executive said. But a foreign financier with ties to the bin Laden family says the family's overall investment with Carlyle is considerably larger. He called the $2 million merely an initial contribution. "It's like plowing a field," this person said. "You seed it once. You plow it, and then you reseed it again."

The Carlyle executive added that he would think twice before accepting any future investments by the bin Ladens. "The situation's changed now," he said. "I don't want to spend my life talking to reporters."

We can clearly see why. We can also clearly see why nobody has mentioned Carlyle so far into the Booz Allen fiasco.

A U.S. inquiry into bin Laden family business dealings could brush against some big names associated with the U.S. government. Former President Bush said through his chief of staff, Jean Becker, that he recalled only one meeting with the bin Laden family, which took place in November1998. Ms. Becker confirmed that there was a second meeting in January 2000, after being read the ex-president's subsequent thank-you note. "President Bush does not have a relationship with the bin Laden family," says Ms. Becker. "He's met them twice."

Mr. Baker visited the bin Laden family in both 1998 and 1999, according to people close to the family. In the second trip, he traveled on a family plane. Mr. Baker declined comment, as did Mr. Carlucci, a past chairman of Nortel Networks Corp., which has partnered with Saudi Binladin Group on telecommunications ventures.

As one can imagine the rabbit hole just gets deeper and deeper the more one digs. For now, we will let readers do their own diligence. We promise the results are fascinating.

Going back to the topic at hand, we will however ask just how much and what kind of confidential, classified, and or Top Secret information is shared "behind Chinese walls" between a Carlyle still majority-owned company and the private equity behemoth's employees and advisors, among which are some of the most prominent political and business luminaries currently alive. The following is a list of both current and former employees and advisors. We have used Wiki but anyone wishing to comb through the firm's full blown roster of over 1,000 employees and advisors, is welcome to do so at the firm's website.

Business

G. Allen Andreas - Chairman of the Archer Daniels Midland Company, Carlyle European Advisory Board
Daniel Akerson -CEO of General Motors, Board member at 7 companies, Managing director at Carlyle
Joaquin Avila - former managing director at Lehman Brothers, Managing director at Carlyle
Laurent Beaudoin - CEO of Bombardier (1979-), former member of Carlyle’s Canadian Advisory board
Peter Cornelius - Managing Director of Nielsen Australia.
Paul Desmarais - Chairman of the Power Corporation of Canada, former member of Carlyle’s Canadian Advisory board
David M. Moffett - CEO of Freddie Mac, Former Senior advisor to the Carlyle
Karl Otto Pöhl - former President of the Bundesbank, Former Senior advisor to the Carlyle Group
Olivier Sarkozy (half-brother of Nicolas Sarkozy, former President of France) - co-head and managing director of its recently launched global financial services division, since March 2008.

Political figures

North America

James Baker III, former United States Secretary of State under George H. W. Bush, Staff member under Ronald Reagan and George W. Bush, Carlyle Senior Counselor, served in this capacity from 1993 to 2005.
George H. W. Bush, former U.S. President, Senior Advisor to the Carlyle Asia Advisory Board from April 1998 to October 2003.
Frank C. Carlucci, former United States Secretary of Defense from 1987 to 1989; Carlyle Chairman and Chairman Emeritus from 1989 to 2005.
Richard G. Darman, Director of the Office of Management and Budget in the Bush Administration; Managing director from 1993, later Senior Advisor
William E. Kennard, chairman of the Federal Communications Commission from 1997-2001 and United States Ambassador to the European Union; Carlyle managing director from 2001-2009
Arthur Levitt, Chairman of the U.S. Securities and Exchange Commission (SEC) under President Bill Clinton, Carlyle Senior Advisor from 2001 to the present
Luis Téllez Kuenzler, Mexican economist, former Secretary of Communications and Transportation under the Felipe Calderón administration and former Secretary of Energy under the Zedillo administration.
Frank McKenna, former Premier of New Brunswick, Canadian Ambassador to the United States between 2005 and 2006 and current Deputy Chairman of Toronto-Dominion Bank; served on Carlyle's Canadian advisory board.
Mack McLarty, Carlyle Group Senior Advisor (from 2003), White House Chief of Staff to President Bill Clinton from 1993 to 1994.
Randal K. Quarles, former Under Secretary of the U.S. Treasury under President George W. Bush, now a Carlyle managing director

Europe

John Major, former British Prime Minister, Chairman, Carlyle Europe from 2001–2004

Asia

Anand Panyarachun, former Prime Minister of Thailand (twice), former member of the Carlyle Asia Advisory Board until the board was disbanded in 2004
Fidel V. Ramos, former president of the Philippines, Carlyle Asia Advisor Board Member until the board was disbanded in 2004
Peter Chung, former associate at Carlyle Group Korea, who resigned in 2001 after 2 weeks on the job after an inappropriate e-mail to friends was circulated around the world
Thaksin Shinawatra, former Prime Minister of Thailand (twice), former member of the Carlyle Asia Advisory Board until 2001 when he resigned upon being elected Prime Minister.

Media

Norman Pearlstine - editor-in-chief of Time magazine from (1995–2005), senior advisor telecommunications and media group 2006-

and across the entire globe?

Source

Sheila Bair: Everything the IMF Wanted to Know About Financial Regulation and Wasn’t Afraid to Ask

2013-06-10T04:40:00.004-04:00

I was honoured when the IMF asked me to moderate the Financial Regulation panel at this year’s Rethinking Macro II conference. And while naturally, I delivered one of the more enlightening and thought-provoking policy discussions of the conference, I did fail in my duties as moderator to make sure my panellists covered all the excellent questions our sponsors submitted to us. Of course, this was to be expected, as panellists at these types of events almost never address the topics requested of them (I certainly never do), but rather, like Presidential candidates, answer the questions they want to answer. However, being the conscientious person I am, who accepts responsibility for my mismanagement (unlike some bank CEOs we know), I will now step up and answer those questions myself.

1) Does anybody have a clear vision of the desirable financial system of the future?

Yes, me. It should be smaller, simpler, less leveraged and more focused on meeting the credit needs of the real economy. And oh yes, we should ban speculative use of credit default swaps from the face of the planet.

2) Is the ATM the only useful financial innovation of the last thirty years?

No. IF bankers approach the business of banking as a way to provide greater value at less cost to their customers, (I know – for a few bankers, that might be big ‘if’) technology provides a virtual gold mine for product innovations. For instance, I am currently testing out a pre-paid, stored value card which lets me do virtually all my banking on my I-phone. It tracks expenses, tells me when I’ve blown my budget, and lets me temporarily block usage of the card when my daughter, unbeknownst to me, has pulled it out of my wallet to buy the latest jeans from Aeropostale. The card, aptly called Simple, was engineered by two techies in Portland, Oregon. (Note to mega-banks: ditch the pin stripes for dockers and flip flops. The techies are coming for you next.)

3) Does the idea of a safe, regulated, core set of activities, and a less safe, less regulated, non-core make sense?

No.

The idea of a safe, regulated, core set of activities with access to the safety net (deposit insurance, central bank lending) and a less safe, MORE regulated, noncore set of activities which DO NOT UNDER ANY CIRCUMSTANCES have access to the safety net – that makes sense.

4) How do the different proposals (Volcker rule, Liikanen, Vickers) score in that respect?

Put them all together and you are two-thirds of the way there. The Volcker Rule acknowledges the need for tough restrictions on speculative trading throughout the banking organisation, including securities and derivatives trading in the so-called “casino bank”. Liikanen and Vickers acknowledge the need to firewall insured deposits around traditional commercial banking and force market funding of higher risk “casino” banking activities. Combining them would give us a much safer financial system.

But none of these proposals fully address the problem of excessive risk taking by non-bank financial institutions like AIG. Title I of Dodd-Frank empowers the Financial Stability Oversight Council to bring these kinds of “shadow banks” under prudential supervision by the Fed. Of course, that law was enacted three years ago and for nearly two years now, the regulators have promised that they will be designating shadow banks for supervisory oversight “very soon”. This was repeated most recently by Treasury Secretary Jack Lew on 22 May 2013, before the Senate Banking Committee (but this time he REALLY meant it). For some reason, the Fed and Treasury Department were able to figure out that AIG and GE Capital were systemic in a nano-second in 2008 when bailout money was at stake, but when it comes to subjecting them to more regulation now, well, hey we need to be careful here.

5) How much do higher capital ratios actually affect the efficiency and the profitability of banks?

You don’t have to be very efficient to make money by using a lot of leverage to juice profits then dump the losses on the government when things go bad. In my experience, the banks with the stronger capital ratios are the ones that are better managed, do a better job of lending, and have more sustainable profits over the long term, with the added benefit that they don’t put taxpayers at risk and keep lending during economic downturns.

6) Should we go for very high capital ratios?

Yep. I’ve argued for a minimum leverage ratio of 8%, but I like John Vickers 10% even better (and yes, he put out that news-making number during my panel…)

7) Is there virtue in simplicity, for example, simple leverage rather than capital ratios, or will simplicity only increase regulatory arbitrage?

The late Pat Moynihan once said that there are some things only a PhD can screw up. The Basel Committee’s rules for risk weighting assets are Exhibit A.

These rules are hopelessly overcomplicated. They were subject to rampant gaming and arbitrage prior to the crisis and still are. (If you don’t believe me, read Senator Levin’s report on the London Whale.) A simple leverage ratio should be the binding constraint, supplemented with a standardised system of risk weightings to force higher capital levels at banks taking undue risks. It is laughable to think that the leverage ratio is more susceptible to arbitrage than the current system of risk weightings given the way risk weights were gamed prior to the crisis, e.g. moving assets to the trading book, securitising loans to get lower capital charges, wrapping high risk CDOs in CDS protection to get near-zero risk charges, blindly investing in triple A securities, loading up on high-risk sovereign debt, repo financing … need I go on?

8) Can we realistically solve the “too big to fail” problem?

We have to solve it. If we can’t, then nationalise these behemoths and pay the people who run them the same wages as everyone else who work for the government.

9) Where do we stand on resolution processes, both at the national level and cross border?

Good progress, but not enough. Resolution authority in the US could be operationalised now, if necessary, but it would be messy and unduly expensive for creditors. We need thicker cushions of equity at the mega-banks, minimum standards for both equity and long-term debt issuances at the holding company level to facilitate the FDIC’s “single point of entry” strategy, and most importantly, we need regulators who make clear that they have the guts to put a mega-bank into receivership. The industry says they want to end “too big to fail” but they aren’t doing everything they can to make sure resolution authority works smoothly. For instance, industry groups like ISDA could greatly facilitate international resolutions by revising global standards for swap documentation to recognise the government’s authority to require continued performance on derivatives contracts in a Dodd-Frank resolution.

10) Can we hope to ever measure ‘systemic risk’?

Yes. It’s all about inter-connectedness which mega-banks and regulators should be able to measure. Ironically, inter-connectedness is encouraged by those %$#@& Basel capital rules for risk weighting assets. Lending to IBM is viewed 5 times riskier as lending to Morgan Stanley. Repos among financial institutions are treated as extremely low risk, even though excessive reliance on repo funding almost brought our system down. How dumb is that?

We need to fix the capital rules. Regulators also need to focus more attention on the credit exposure reports that are required under Dodd-Frank. These reports require mega-banks to identify and quantify for regulators how exposed they are to each other. Mega-bank failure scenarios should be factored into stress testing as well.

[Since these questions relate to financial regulation, I will not opine on measuring systemic risks building as a result of loose monetary policy.]

10) Are banks in effect driving the reform process?

Sure seems that way.

11) Can regulators ever be as nimble as the regulatees?

Yes. Read Roger Martin’s Fixing the Game. Financial regulators should look to the NFL for inspiration.

12) Given the cat and mouse game between regulators and regulatees, do we have to live with regulatory uncertainty?

Simple regulations which focus on market discipline and skin-in-the-game requirements are harder to game and more adaptable to changing conditions than rules which try to dictate behaviour. For instance, thick capital cushions will help ensure that whatever dumb mistakes banks may make in the future (and they will), there will be significant capacity to absorb the resulting losses. Unfortunately, the trend has been toward complex, prescriptive rules which smart banking lawyers love to exploit. Industry generally likes the prescriptive rules because they always find a way around them, and the regulators don’t keep up.

You can see that dynamic playing out now, where the securitisation industry is seeking to undermine a Dodd-Frank requirement that securitisers take 5 cents of every dollar of loss on mortgages they securitise. They say risk retention is no longer required because the Consumer Bureau has promulgated mortgage lending standards. But these rules are pretty permissive (no down payment requirement, and a whopping 43% debt-to-income ratio) and I’m sure that the Mortgage Bankers Association is already trying to figure out ways to skirt them.

Rules dictating behaviour can sometime be helpful, but forcing market participants to take the losses from their risk-taking can be much more effective. One approach tells them what kinds of loans they can make. The other says that whatever kind of loans they make, they will take losses if those loans default.

Source

Lies the IMF Tells?

2013-06-07T02:06:00.005-04:00

IMF: Our Greek bailout was full of 'notable failures'... The International Monetary Fund has published a scathing internal self-assessment of its bailout of Greece three years ago. It isn't pretty. The IMF underestimated the damage that fiscal austerity would do to the Greek economy in its earliest rescue of the nation in 2010. It was too slow to promote a write-down of the nation's debts to more sustainable levels. And it was compromised by a sometimes unwieldy partnership with major European institutions in what became known as the "troika." The IMF could have handled its 2010 bailout of Greece quite a bit better, a staff review found. – Washington Post

Dominant Social Theme: Wow, we just realized we made some mistakes.

Free-Market Analysis: Who believes this stuff anymore? The point of the IMF's attack on Greece, so far as we can tell, was to show the rest of Europe that the arm of Brussels was long and strong.
The unbreakable will of the Eurocrats was to be on full display and those who were to challenge the IMF were to think again. But a funny thing happened on the way to a more perfect union.

In both Greece and Spain, and other countries as well, the unemployment figures kept going up, the markets kept going down and even the mainstream media seemed to notice that things weren't working out.

Could it be that a climb-down has commenced?

That's how it seems to us, anyway. The implacable rigor has subsided. The blow back from a fracturing

Europe seems to have tamed German bankers and cowed Eurocrats. And now the IMF, too. Here's more.

The result of these "notable failures," enumerated in an "Ex-post evaluation" that the IMF published Wednesday, is the depression-stricken nation that is Greece today. The nation's unemployment rate is 27 percent and economic activity remains well below its levels of half a decade ago. "Market confidence was not restored, the banking system lost 30 percent of its deposits, and the economy encountered a much-deeper-than-expected recession with exceptionally high unemployment."
Public debt remained too high, Greece waited too long to restructure its debt, and "structural reforms stalled and productivity gains proved elusive." The newly released document is an after-action report of sorts, an attempt by IMF staff to grapple with the lessons from Greece.

It focuses in the initial Greek rescue package, approved in May 2010, which has since been reworked multiple times. The staff review argues that there was no avoiding a steep economic contraction, given the excesses of Greek government borrowing and spending in the years before the crisis. "A deep recession was unavoidable," the report concludes. But it also holds that a series of decisions by the IMF and the other members of the troika made it worse than it otherwise might have been.

If the Eurocrats behind this climb-down want to cure Europe of its many problems, all they have to do is scuttle the euro. But this they will never do.

The IMF apparently doesn't even consider it and Eurocrats are on the record in the past as saying that a financial crisis was necessary to deepen a political union.

Everyone who studies these issues honestly and with an open mind must come to the conclusion that the EU has been built with an empire rather than a trade union in mind and that from the very beginning, EU officials and those who stood behind them were not honest about the true goals of the union.

This IMF self-critique must be seen within this context. Little ever takes place when it comes to the EU that is either transparent or honest.

There is no reason to believe this IMF document is any more honest than what has gone before or what is yet to come. If top officials with the EU are engaging in self-flagellation, it is only because they are afraid of losing control of the EU project and of further alienating the support of Europeans generally.

Conclusion: It may be too late?

Source

Slamming The Money Market “Gates” – Capital Controls Coming To $2.6 Trillion Industry

2013-06-06T06:21:00.001-04:00

The first time we wrote about the Volcker-led Group of 30 recommendation to crush Money Markets in January 2010 by effectively imposing capital controls and fund "gates", whose purpose was simply to scare investors out of the $2.6 trillion liquidity pool and force said capital to reallocate into a much more "reflation friendly" asset classes such as stocks, many were concerned but few took it seriously. After all, such a coercive push into a "free" market at the time seemed incomprehensible (if, in reality, turned out to be just a few years ahead of its time).

Fast forward two years to July 2012 when the same proposal of "risk-mitigation" by allocating a portion of the balance to a "loss-absorption fund", which would "create a disincentive to redeem if the fund is likely to have losses" was not only re-espoused by Tim Geithner, and the NY Fed but the SEC put it to a vote and the proposal would have almost passed had it no been for a nay vote by Commissioner Luis Aguilar opposing Mary Schapiro in the last minute. Still, once more many largely unconcerned about the implications behind this urgent push to intervene and establish pseudo-capital controls in this major source of potential stock buying "dry powder."

A few months later, following the coercive bail-in of Cypriot deposits, and the new "blueprint" for Europe bank rescues, whereby the authorities have strongly hinted that no more than the insured limit should be kept as as a deposit at a bank and it is preferred that the balance is invested in stocks or some other ponzi-enabling instrument, many have finally started to wonder if indeed there isn't some overarching strategy to "tax" financial assets in a world slowly but surely going insolvent and where the much desired debt inflation is so slow to materialize (just as we predicted would happen in September of 2011 in The "Muddle Through" Has Failed: BCG Says "There May Be Only Painful Ways Out Of The Crisis").

Today, with a brand new leader, Mary Jo White, now that the clueless and co-opted Mary Schapiro is long gone, the $2.6 trillion Money Market Fund industry is one step closer to finally being gated. But don't it call it that - the SEC prefers the term "protecting investors"

From Reuters:

A portion of the $2.6 trillion money market fund industry would be required to fundamentally change how it prices its shares in an effort to reduce the risk of abrupt withdrawals, under a proposal released by U.S. regulators on Wednesday.

Funds could also charge withdrawal fees and delay return of funds to customers in times of financial distress, under the Securities and Exchange Commission's proposal.

The SEC plan comes after a long debate over whether changes made in 2010 were enough to avoid a repeat of a run on money market funds seen at the height of the financial crisis.

Naturally, those who see the writing on the wall - the MMF industry - is not happy:

The fund industry has warned that further major reforms could kill investor interest in money market funds.

Well, of course. After all this is the whole point. Recall what we said in July of 2012:

In a nutshell, money market funds (much more on this below), have always been one of the most hated liquidity intermediaries by the central planners: they don't go into stocks, they don't go into bonds, they just sit there, collecting no interest, but more importantly, are inert, and can not be incorporated into the rehypothecation architecture of shadow banking.

And perhaps that is precisely why the Fed is pulling the scab off an old sore. Recall that for the past year, our primary contention has been that the core reason for all developed world problems is the gradual disappearance of good collateral and money good assets.

Even if the MMF cash were to shift, preemptively, into bonds, or any other "safe" investments, the assets backing the cash can them enter the traditional-shadow liquidity system and buy time: the only real goal at this point. In the process, the cash itself would be "securitized" and provide at least a year or so in additional breathing room for a system that has essentially run out of good liquidity, and in Europe, out of any collateral.

Expect more and more efforts to disgorge the $2.7 trillion in money market funds as the world gets closer and closer to D-Day. And what happens with MMF, will then progress to all other real asset classes as the government truly spreads out its capital controls wings.

Funny: we said this 9 months before a capital control "disgorgement" struck in Cyprus. Fear not: it is coming to every other "taxable" financial asset. But whereas we thought the money market forced capital expropriation would be first, some places like Europe were so desperate they couldn't afford to wait that long.

So what proposals is the SEC planning on applying in order to enforce the capital reallocation pardon avoid investor losses? There are two, both perfect strawmen, and have been well-known since the first time we approached this topic three and a half years ago.

In a compromise move, the SEC's plan mostly focuses on prime funds for institutional investors, which are seen as more prone to runs because those investors are more sophisticated and more likely to pull large blocks of money first if there is a panic.

The SEC estimated that institutional funds represent 37 percent of the market with $1 trillion in assets.

The SEC's plan calls for two alternative proposals that it said could be adopted alone or in combination.

The first piece would require prime funds used by institutional investors to transition from a stable, $1 per share, to a floating net asset value (NAV) - a move designed to reduce the risk of runs like those during the financial crisis.

The SEC said that retail and government funds, which are not considered to be at the same risk for runs, would not have to move to a floating NAV. Retail funds are defined as those that limit shareholder redemptions to $1 million per day.

The industry has long fought against moving away from a stable share price, which it says is appealing to investors looking for a safe product.

The second proposal, meanwhile, would give fund boards for institutional and retail funds the authority to impose so-called "liquidity fees and redemption gates" during times of stress.

That would give funds the power to stop an outflow of investor money, an idea that the SEC's two Republican commissioners last year said they might be able to support.

We are not sure what is more amusing: that the SEC is so naive it thinks someone will actually believe it can prevent a capital run in a financial panic, or that its transparent attempt to spook money market investors away from their holdings now that the threat of imminent lock ups and gates looms over their heads is not what this is all about. We anticipate that the SEC will drop numerous analogies to Cyprus as a reminder that if something can be gated, it will be gated.

What is more important, is that unlike Schapiro's plan the current SEC proposal should have no difficulty in passing.

The initial industry reaction on Wednesday indicated the SEC's plan may not generate the same degree of opposition that the SEC faced last summer when then-SEC Chair Mary Schapiro called for what some consider stricter reforms.

Schapiro, who stepped down as SEC head last December, had advocated for a series of possible reforms, including capital buffers and redemption holdbacks, or a broader switch to a floating NAV - two ideas vehemently opposed by the industry.

She was unable to muster the votes needed to issue a proposal for comment after three of her fellow commissioners said they could not support her plan without additional study.

Schapiro's proposal was starkly different from what the SEC unveiled on Wednesday. This time, the SEC's plan contains some proposals that a few fund sponsors have previously said they could live with.

"It has been a journey to get to this point," said SEC Chair Mary Jo White, who took over the agency earlier this spring.

And if the industry is onboard, all the token SEC votes needed to enforce the plan will be in place.

At that point money markets will merely be the latest experiment in behavioral control: how to spook those with money in the multi-trillion industry enough to where they pull their cash and either spend it on trinkets, boosting inflation - a very welcome outcome for the Chairman - or merely investing it in the "stock market." Perhaps instead of a lock up, at times of crisis MMF investors will be given the opion of allocating funds to the Solyndra du jour (a la the Cyprus bank bailout) or lose all the money.

We are confident the central planners will find a way,

Source

What the BIS Is REALLY Worried About

2013-06-05T05:57:00.003-04:00

'Tuned Out' Investors Under Spell of QE: BIS ... Equity markets shrugged off weak economic data and uncertainty in recent weeks and continued to extend their "relentless" gains fueled by the prospect of further stimulus, leaving them more vulnerable to shocks, the Bank of International Settlements (BIS) said on Monday. – CNBC

Dominant Social Theme: The BIS is very worried about the average investor.

Free-Market Analysis: Actually, the BIS is doing what central bank executives do all the time, which is meet to create the problem its representatives then publicly identify from the podium.

In other words, say you are a central banking boss. You meet and decide how much money to print and where to set rates. Then you walk outside, address the multitudes and worry publicly that price inflation is creeping up. Under this scenario, central banks have "hawks" and "doves" – as if we are to gather from this divide that the reality of price fixing is negated by diverse opinions about how much ought to take place.

Compare such currency price fixing to ... hmm ... murder! (Well, it DOES murder the economy.) You end up with a fairly apt, if possibly exaggerated metaphor, in our humble view. You see, it is only the style and speed of the execution that is being debated, not its necessity.

And so it is with the BIS. Having set the current market bubble in motion with the connivance of the central bankers that meet regularly in its august halls, those who run the BIS are now publicly fretting about a market bubble. A little too late, eh?

Here's more:

The bank, which acts as a hub for the world's central banks, said markets are "under the spell of monetary easing" and warned that increasingly accommodative monetary easing has helped market participants to "tune out" signs of a global growth slowdown.

Indices were lifted to fresh highs off the back of further policy easing, despite a "spate of negative economic news," but such rapid gains have made equity markets increasingly vulnerable, the BIS said. The BIS also said this "new phase" of monetary easing has helped create an environment that favors risk taking.

"This new phase of monetary policy accommodation in the major currency areas spilled over to financial markets around the world. With yields in core bond markets at record lows, investors turned to lower-rated European bonds, emerging market paper and corporate debt to obtain yield," the report said.

So markets are "under the spell of monetary easing." Who cast the spell in the first place? We've pointed this out a number of times in the recent past. Monetary easing does little for the larger economy, at least not right away, but it does evidently and obviously lift equity markets if it is applied long enough and hard enough.

What the top men at the BIS are really fretting about is that they have set another bubble in motion. When you print enough money (and debase the currency enough) to virtually double stock market averages, people are apt to sit up and take notice.

That's why we've pointed out that stocks, certain stocks and stock averages anyway, are perhaps a good short-term investment – assuming you have the skills and facility to time the market – given the amount of "easing" that is taking place.

In the long term, these markets are bound to collapse ... for nothing grows to the sky. Those who run the BIS are probably well aware that – like the ChiComs in China – they may be running out of time and excuses. Another serious crash would likely jeopardize not just people's savings but also perhaps the system itself.

Possibly ... somewhere ... there is a plan of this sort. Induce further crashes and then introduce a more globalized currency regime. But this is truly a dangerous game, if it is being played in this Internet era. Too many understand the manipulations taking place and no doubt this is one reason the BIS made the obligatory statement of concern.

Conclusion: If those at the BIS are indeed concerned, it is likely they are worried about their own job security and fiefdoms, not the fate of the average investors.

Source

Washington & Wall Street: Bernanke's Housing Bubble is Unsustainable

2013-06-04T05:26:00.002-04:00

Home prices rose last month by an average of 10.9%, according to the Case-Shiller index. The good news is that home prices continue to recover from the lows seen in 2009. The bad news is that increasingly frothy conditions in the housing market are neither normal nor sustainable.

“Home prices are still down by 28% from their 2006 peak and have returned to levels last seen in late 2003,” writes Nick Timiraos in the Wall Street Journal. “One year ago, home prices were 35% below the 2006 peak.” Timiraos notes that the largest gains in average home prices have occurred in the West, “including many markets hit hardest by the foreclosure crisis. In March, prices were up by 22.5% in Phoenix from one year earlier, and by 22.2% in San Francisco.” Markets such as New Jersey, New York and Connecticut, on the other hand, have barely moved or are actually down.

The rally in the US housing market is largely an illusion. If you take sales of distressed properties out of the Case Shiller data, for example, average home prices are up about 5% over the past year. And much of the upward move in home prices is due to short supply rather than a groundswell of real consumer demand for homes.

Almost half of all home owners with mortgages owe more than their properties are worth or had less than 20 percent equity in the first quarter, according to Zillow. Those people probably are locked in to their residences. Listing a house and purchasing a new one generally requires equity of at least 20 percent to meet costs, Zillow said.

“The effective negative equity rate nationally —where the loan-to-value ratio is more than 80%, making it difficult for a homeowner to afford the down payment on another home — is 43.6% of homeowners with a mortgage,” says Zillow. “While not all of these homeowners are underwater, they have relatively little equity in their homes, and therefore selling and buying a new home while covering all of the associated costs would be difficult.”

Since the largest percentage moves in average home prices is in CA and other western states, the supply constraint in these markets will likely continue to push home prices higher, but this is not good news. Home prices in CA are moving five times faster than the underlying growth in the job market. Indeed, there is already evidence of manic behavior in many of the hottest western housing markets.

Homes in desirable areas of CA, for example, are going in a matter of days and at 120% of the “broker price opinion” or BPO. Some of the buying interest comes from investors, who are creating a feeding frenzy in some markets not seen since the bad old days of 2006-2007. Multiple bidders for homes in the $300k, $400k and $500k range and higher are not unusual.

Part of the reason that measures such as Case-Shiller are showing such strong increases in prices is due to the disappearance of any discount for bank-owned, distressed real estate, also known as “REO.” A report just put out by the Federal Housing Finance Administration notes that REO sales have significantly increased the apparent rebound in average home prices nationally.

The agency notes that "distress-free" home price indices for 12 large metropolitan areas generally report lower quarterly appreciation than do the purchase-only indices. In 11 of the 12 areas the new indices, which remove the direct effect of short sales and bank owned or REO properties, shows lower appreciation than traditional series such as Case Shiller.

For example, in Atlanta the purchase-only four quarter index appreciation was 17.62 percent vs. just 10.3 percent excluding distressed sales. For Chicago the numbers were 4.26 percent versus 2.9 percent, respectively.

Bottom line is that the Fed’s efforts to boost home prices are working, but not for the reasons most people want to believe. Instead of a steady flow of newly formed households and first time home buyers, what we see is a speculative frenzy driven by the Fed’s zero interest rate policies. A limited number of American families are competing with highly leveraged institutional investors for an even more limited supply of properties. And mortgage rates, no surprise, are rising.

When the music stops, look for some of the same big investors who are now paying 120% of BPO to come under pressure to sell homes into a declining market. Indeed, smart managers at institutional funds and commercial banks are selling right now into Bernanke’s housing bubble. So when your stock broker calls to talk about investment opportunities in single family homes, just put down the phone.

Source

"Markets Under The Spell Of Monetary Easing" Bank Of International Settlements Finds... Same As "Then"

2013-06-03T05:45:00.004-04:00

Then....

Ben Bernanke 7/1/2005, CNBC interview:

INTERVIEWER: Tell me, what is the worst-case scenario? We have so many economists coming on our air saying ‘Oh, this is a bubble, and it’s going to burst, and this is going to be a real issue for the economy.’ Some say it could even cause a recession at some point. What is the worst-case scenario if in fact we were to see prices come down substantially across the country?

BERNANKE: Well, I guess I don’t buy your premise. It’s a pretty unlikely possibility. We’ve never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it’s gonna drive the economy too far from its full employment path, though.

Ben Bernanke 10/20/05 – Testimony before the Joint Economic Committee, Congress

House prices have risen by nearly 25 percent over the past two years. Although speculative activity has increased in some areas, at a national level these price increases largely reflect strong economic fundamentals.

Ben Bernanke 3/28/07 – Testimony before the Joint Economic Committee, Congress

Although the turmoil in the subprime mortgage market has created severe financial problems for many individuals and families, the implications of these developments for the housing market as a whole are less clear…At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.

Ben Bernanke 5/17/07 – Remarks before the Federal Reserve Board of Chicago

...we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system. The vast majority of mortgages, including even subprime mortgages, continue to perform well.

Ben Bernanke 1/10/08 – Response to a Question after Speech in Washington, D.C.

The Federal Reserve is not currently forecasting a recession.

Ben Bernanke 2/27/08 – Testimony before the Senate Banking Committee

I expect there will be some failures [among smaller regional banks]… Among the largest banks, the capital ratios remain good and I don’t anticipate any serious problems of that sort among the large, internationally active banks that make up a very substantial part of our banking system.

Ben Bernanke 4/2/08 – New York Times article after the collapse of Bear Stearns

“In separate comments, Mr. Bernanke went further than he had in the past, suggesting that the Fed would remain aggressive and vigilant to prevent a repetition of a collapse like that of Bear Stearns, though he said he saw no such problems on the horizon.”

Ben Bernanke 6/10/08 – Remarks before a bankers’ conference in Chatham, Massachusetts

The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.

Ben Bernanke 7/16/08 – Testimony before House Financial Services Committee

[Fannie Mae and Freddie Mac are] adequately capitalized. They are in no danger of failing… [However,] the weakness in market confidence is having real effects as their stock prices fall, and it’s difficult for them to raise capital.

Two months later: 9/24/08 – Response to a question after JEC testimony… during the TARP debate, two weeks before the Fed initiates its liquidity facility for commercial paper markets

I see the financial markets as already quite fragile. The credit markets aren’t working. Corporations aren’t able to finance themselves through commercial paper. Even if the situation stayed as it did today, that would be a significant drag on the economy.

* * *
... And Now

Jeremy Stein, February 7, 2013 speech "Overheating in Credit Markets: Origins, Measurement, and Policy Responses"

"[M]y reading of the evidence is that we are seeing a fairly significant pattern of reaching-for-yield behavior emerging in corporate credit....Even if we stipulate that low interest rates are part of the reason for, say, a worrisome boom in one segment of credit markets, they are unlikely to be the whole story....One of the most difficult jobs that central banks face is in dealing with episodes of credit market overheating that pose a potential threat to financial stability/"

Minutes of May 1, 2013 FOMC Meeting

"a few participants expressed concern that conditions in certain U.S. financial markets were becoming too buoyant, pointing to the elevated issuance of bonds by lower-credit-quality firms or of bonds with fewer restrictions on collateral and payment terms (socalled covenant-lite bonds). One participant cautioned that the emergence of financial imbalances could prove difficult for regulators to identify and address, and that it would be appropriate to adjust monetary policy to help guard against risks to financial stability."

May 17, Record of Meeting of the Federal Advisory Council and the Board of Governors, unleased after FOIA requests were submitted

There are potential risks associated with current policy. The Fed’s securities purchases have reduced mortgage yields and, to a lesser extent, Treasury yields. Current low bond yields are disruptive to management of fixed-income portfolios, retirement funds, consumer savings, and retirement planning. They may encourage unsophisticated investors to take on undue risk to achieve better returns. MBS purchases account for over 70% of gross issuance, causing price distortion and volatility in the MBS market. Fixed-income investors worry that attractive mortgage-backed securities are in very tight supply. Higher premium coupons carry too much exposure to prepayments, potentially led by new government support programs for housing. Many are concerned about the Fed’s significant presence in the market. They have underweighted MBS in favor of corporate, municipal, and emerging-market bonds. There is also concern about the possibility of a breakout of inflation, although current inflation risk is not considered unmanageable, and of an unsustainable bubble in equity and fixed-income markets given current prices.

Further, current policy has created systemic financial risks and potential structural problems for banks. Net interest margins are very compressed, making favorable earnings trends difficult and encouraging banks to take on more risk. The Fed’s aggressive purchases of 15-year and 30-year MBS have depressed yields for the “bread and butter” investment in most bank portfolios; banks seeking additional yield have had to turn to investment options with longer durations, lower liquidity, and/or higher credit risk. Finally, the regressive nature of the artificially compressed savings yields creates pent-up demand within bank deposit portfolios; these deposits may be at risk once yields begin to rise and competitive pressures increase.

Uncertainty exists about how markets will reestablish normal valuations when the Fed withdraws from the market. It will likely be difficult to unwind policy accommodation, and the end of monetary easing may be painful for consumers and businesses. Given the Fed’s balance sheet increase of approximately $2.5 trillion since 2008, the Fed may now be perceived as integral to the housing finance system.

BIS Quarterly Review June 2013

Markets under the spell of monetary easing

Risk assets extended their rally as further monetary easing helped market participants tune out signs of a global growth slowdown. The spate of negative economic news between mid-March and mid-April did little to interrupt the rise of equity prices in advanced economies. The growth jitters left more of a dent on commodity prices while emerging market equities continued to underperform.

This new phase of monetary policy accommodation in the major currency areas spilled over to financial markets around the world. The prospect of low yields in core bond markets contributed to investors searching for yield in lower-rated European bonds and emerging market paper as well as in corporate debt. This drove spreads even lower while issuance in riskier credit market segments strengthened. Abundant liquidity and low volatility fostered an environment favouring risk-taking and carry trade activity.

... equity markets were quick to shrug off the uncertainty and extended their gains as investors expected poor fundamentals to be followed by further policy easing.

The S&P 500 posted several all-time highs in rapid succession, first on 11 April and again throughout May. Similarly, European bourses held up well in the face of negative economic news and political uncertainty. Throughout this period, the Japanese equity market continued its relentless ascent, fuelled by the prospect of massive monetary stimulus. The rapid gains left equity valuations vulnerable to changes in market sentiment...

Source

Central Bankers: Debase to Create

2013-05-31T05:08:00.005-04:00

Central Banks Act With a New Boldness ... When James Bullard, president of the Federal Reserve Bank of St. Louis, arrived in Frankfurt last week, he issued an unusual public warning to the European Central Bank: Be bolder. Central bankers, anywhere in the world, are a cautious lot. They prefer slow and steady over the dramatic gesture. And they rarely go public with criticisms of other central banks. But the economic stagnation of the major developed nations has driven central banks in the United States, Japan, Britain and the European Union to take increasingly aggressive action. – New York Times

Dominant Social Theme: The good, gray men have their collective hand on the tiller and can steer us to safety.

Free-Market Analysis: This article is a companion piece to our lead story this issue (see above) and provides more evidence that one needs to look at patterns and promotions rather than taking pronouncements at face value when it comes to world affairs.

Of course, the article (excerpted above) does seem logical in that we know central bankers are concerned about lagging economies and believe they can debase currency (print money) to stimulate "growth."

But if one utilizes the correct terminology (debase) and tracks the manifestations of debasement around the world, one can come to several conclusions.

First, an uneasy balance is being sought between "revolution and recovery" – that is, those in charge of central banking policies around the world are trying to push the entire financial system toward more centralization and, at the same time, avoid outright rebellion in Europe, the US and elsewhere where these policies are taking hold with perhaps unexpected viciousness.

There is nothing especially controversial, in our view, about postulating that there is a new global economic system in the making because the same powers now in charge previously created the building blocks for this system after the Second World War.

The UN, the IMF, the World Bank and various international trade organizations still exist today and have more power than ever. Now they are being employed in the service perhaps of the evolution of the post-war environment, which was quasi-globalist but had a long way to go.

Today, it seems, we are observing the glimmers of a new paradigm, though unlike Bretton Woods, we are not yet being informed of its fullness. That is perhaps because those supporting these changes do not have a full-fledged crisis to justify what's taking place. Thus a need for secrecy.

Nonetheless, we can see a process unfolding and would be foolish, in the scheme of things, simply to discount it. Rather than war, it is the global downturn itself that is providing the beginnings of a justification for some of the moves being made, specifically the worldwide effort to reinflate (debase). Here's more from the article:

Because governments are not taking steps to revive economies, like increasing spending or cutting taxes, the traditional concern of central bankers that economic growth will cause too much inflation has been supplanted by the fear that growth is not fast enough to prevent deflation, or falling prices.
The Fed has announced plans to keep borrowing costs at historic lows until unemployment declines. The staid Bank of England has bought more than a half-trillion dollars' worth of bonds to ignite British business activity. Last month, Haruhiko Kuroda, the new chairman of the Bank of Japan, steered the central bank toward an audacious new policy of reinflating the Japanese economy by doubling the money supply. It is considered the boldest step so far by a central bank.

So far, the results of these activist central banks have fallen short of expectations. "I'm not sure why we're not getting more response," said Donald L. Kohn, a former Federal Reserve vice chairman who is now at the Brookings Institution. "Maybe we've made some progress in identifying some of the causes, but it's not fully satisfying why we have negative real interest rates everywhere in the industrial world and so little growth."

... The Federal Reserve in the United States has been significantly more aggressive since December 2008, when the Fed reduced its benchmark short-term interest rate nearly to zero. Ever since, it has pursued a pair of experiments aimed at dragging other interest rates closer to zero, too. The Fed has tried to bolster confidence that rates will stay low by talking more about the future.

The article's ultimate point is that throughout the West, central bankers are getting more aggressive about printing money and are doing it in bolder ways. Actually, we'd argue that these good, gray men have been doing pretty much what they've wanted for a century, only they have never admitted to the fullness of their manipulations in the past.

Unlike Mr. Kohn, we are not surprised at the failure of these manipulations to perform as advertised. Monetary debasement funneled through financial vehicles and into various stock markets is an incredibly tedious and complex way to "stimulate." But it is necessary if one wants to 1) draw out the pain and 2) control the process.

It sounds rash, perhaps, to accuse central bankers of wanting to prolong the current economic crisis but to us it seems inescapable. The monetary debasement probably will only end when economies finally roar back to life in all their distorted and maniacal glory.

By not allowing economies to purge themselves of failed business and corporations, top central bankers have guaranteed that whatever "recovery" actually occurs will be one that includes manifold bubbles and distortions.

Such recoveries will also boost interest rates, inevitably, giving rise to further crises. These crises will, in our view, be critical and unavoidable. As the world's financial economy threatens to collapse, cries will be raised for a new "Bretton Woods" and a new and more comprehensively global monetary pact. One guess, anyway.

You may disagree with this scenario, dear reader, but can you discount it outright? Accept it may have a correlation to reality and one then must harbor a suspicion that articles like the one we are commenting on are not properly explaining reality.

In fact, the ultimate aim here may be to CREATE a further crisis in order to resolve it.
This is certainly a cynical analysis but can we say with certainty it has never been tried before?

Conclusion: Don't believe everything you read, even in the New York Times.

Source

Volcker On Bernanke's Grand Monetary Experiment: "Good Luck In That"

2013-05-30T06:56:00.003-04:00

A week ago, in a very comic interlude, the hawkish head of the only G-7 country to have experienced hyperinflation in the recent past - Bundesbank's Jens Weidmann - had some sobering words of encouragement for his Japanese colleague Kuroda: "I wish them luck in their experiments."

Now, another former central bank head, the most famous one of the 1980s, and the man thanks to whom America did not implode in a depressionary puff of runaway inflation, Greenspan's predecessor Paul Volcker, has taken the podium and made a mockery of the entire fallback premise on which Bernanke's house of manipulated, centrally-planned cards is built: his assumption that no matter how much deferred inflation is injected, that Bernanke needs just "15 minutes" to take it away. Better yet, and as Japan has recently seen: the fact that central bank credibility is slowly but surely starting to slip away - first visible in rapid rises in bond yields, then in a surge in bond volatility, and finally: an all out inflationary conflagration.
Quote Volcker:

“The Federal Reserve, any central bank, should not be asked to do too much to undertake responsibilities that it cannot responsibly meet with its appropriately limited powers,” Volcker said. He said a central bank’s basic responsibility is for a “stable currency.”

“Credibility is an enormous asset,” Volcker said. “Once earned, it must not be frittered away by yielding to the notion that a little inflation right now is a good a thing, a good thing to release animal spirits and to pep up investment.”

“The implicit assumption behind that siren call must be that the inflation rate can be manipulated to reach economic objectives,” according to Volcker. “Up today, maybe a little more tomorrow and then pulled back on command. Good luck in that. All experience demonstrates that inflation, when fairly and deliberately started, is hard to control and reverse.”

Hopefully Volcker can be cryogenically frozen because when the Chairsatan eventually - and it is only a matter of time - loses control and all hell breaks lose, none of the muppets in the Marriner Eccles building, no click-baiting Nobel-winning trolling Op-Ed writer with socialist delusions of grandure, will have any idea what to do, and it will be someone like Paul who will be needed to unleash his magic once more. Sadly, we have the sinking suspiction that not even thawed out of carbonite, will Volcker have any success when faced with the Frankenstein monster that the MIT central-banking braintrust have managed to unleash.

Source

Is EVERY Market Rigged?

2013-05-29T04:38:00.001-04:00

European Union Launches Investigation Into Manipulation of Oil Prices Since 2002

CNN reports:

The European Commission raided the offices of Shell, BP and Norway’s Statoil this week as part of an investigation into suspected attempts to manipulate global oil prices spanning more than a decade.

None of the companies have been accused of wrongdoing, but the controversy has brought back memories of the Libor rate-rigging scandal that rocked the financial world last year.
***
A review ordered by the British government last year in the wake of the Libor revelations cited “clear” parallels between the work of the oil-price-reporting agencies and Libor.

“[T]hey are both widely used benchmarks that are compiled by private organizations and that are subject to minimal regulation and oversight by regulatory authorities,” the review, led by former financial regulator Martin Wheatley, said in August . “To that extent they are also likely to be vulnerable to similar issues with regards to the motivation and opportunity for manipulation and distortion.”

***
In a report issued in October, the International Organization of Securities Commissions — an association of regulators — said the ability “to selectively report data on a voluntary basis creates an opportunity for manipulating the commodity market data” submitted to Platts and its competitors.

Responding to questions from IOSCO last year, French oil giant Total said the price-reporting agencies, or PRAs, sometimes “do not assure an accurate representation of the market and consequently deform the real price levels paid at every level of the price chain, including by the consumer.” But Total called Platts and its competitors “generally… conscientious and professional.”

***
“Even small distortions of assessed prices may have a huge impact on the prices of crude oil, refined oil products and biofuels purchases and sales, potentially harming final consumers,” the European Commission said this week.

USA Today notes:

The Commission … said, however, that its probe covers a wide range of oil products — crude oil, biofuels, and refined oil products, which include gasoline, heating oil, petrochemicals and others.

***
The EU said it has concerns that some companies may have tried to manipulate the pricing process by colluding to report distorted prices and by preventing other companies from submitting their own prices.

***
Unlike oil futures, which set prices for contracts, the data used in the MOC process is based on the physical sale and purchase of actual shipments of oil and oil products.

***
According to Statoil, the EU investigation stretches back to 2002, which is when Platts launched its MOC price system in Europe. The suspicion is that some companies may have provided inaccurate information to Platts to affect the oil products’ pricing, presumably for financial gain.

Fox points out:

At issue is whether there was collusion to distort prices of crude, refined oil products and ethanol traded during Platts’ market-on-close (MOC) system – a daily half-hour “window” in which it sets prices.

But the European Commission also is examining whether companies were prevented from taking part in the price assessment process.

The Guardian writes:

The commission said the alleged price collusion, which may have been going on since 2002, could have had a “huge impact” on the price of petrol at the pumps “potentially harming final consumers”.

Lord Oakeshott, former Liberal Democrat Treasury spokesman, said the alleged rigging of oil prices was “as serious as rigging Libor” – which led to banks being fined hundreds of millions of pounds.

He demanded to know why the UK authorities had not taken action earlier and said he would ask questions of the British regulator in Parliament. “Why have we had to wait for Brussels to find out if British oil giants are ripping off British consumers?” he said. “The price of energy ripples right through our economy and really matters to every business and families.”

***
Shadow energy and climate change secretary Caroline Flint said: “These are very concerning reports, which if true, suggest shocking behaviour in the oil market that should be dealt with strongly.

“When the allegations of price fixing in the gas market were made, Labour warned that opaque over-the-counter deals and relying on price reporting agencies left the market vulnerable to abuse.

“These latest allegations of price fixing in the oil market raise very similar questions. Consumers need to know that the prices they pay for their energy or petrol are fair, transparent and not being manipulated by traders.”

Shadow financial secretary to the Treasury Chris Leslie said: “If oil price fixing has taken place it would be a shocking scandal for our financial markets.

The Telegraph reports:

“97 per cent of all we eat, drink, wear or build has spent some time in a diesel lorry,” said a spokesman for FairFuel UK, the lobbyists. “If it is proved, they have been gambling with the very oxygen of our economy.”

***
Platts – to determine the benchmark price – examines just trades in the final 30 minutes of the trading day. A group of half a dozen analysts gather round a trading screen and decide on the final price. As with much that goes on in the City, it is a surprisingly old-fashioned method, reliant on gentlemanly conduct. Critics say it leaves the market open to abuse, and the price can suddenly spike or fall in the final minutes of the day.

The New York Times notes of agencies like Platt and Argus Media:

Their influence is extensive. Total, the French oil giant, estimated last year that 75 to 80 percent of crude oil and refined product transactions were linked to the prices published by such agencies.

The Observer writes that manipulation of the oil markets has long been an open secret:

Robert Campbell, a former price reporter at another PRA, Argus – he is now a staffer at Thomson Reuters, which also competes with Platts and others on providing energy news and data – said this a few days ago in a little-noticed commentary: “The vulnerability of physical crude price assessments to manipulation is an open secret within the oil industry. The surprise is that it took regulators so long to open a formal probe.”

Reuters points out that the probe may be expanding to the U.S.:

In Washington, the chairman of the Senate energy committee asked the Justice Department to investigate whether alleged price manipulation has boosted fuel prices for U.S. consumers.

“Efforts to manipulate the European oil indices, if proven, may have already impacted U.S. consumers and businesses, because of the interrelationships among world oil markets and hedging practices,” Sen. Ron Wyden (D-Ore.), chairman of the Senate Energy and Natural Resources Committee, wrote in a letter to Attorney General Eric H. Holder Jr.

Wyden also asked Justice to investigate whether oil market manipulation was taking place in the United States.

Not only are petroleum products a multi-trillion dollar market on their own, but manipulation of petroleum prices would effect virtually every market in the world.
For example, the Cato Institute notes how many industries use oil:

U.S. industries use petroleum to produce the synthetic fiber used in textile mills making carpeting and fabric from polyester and nylon. U.S. tire plants use petroleum to make synthetic rubber. Other U.S. industries use petroleum to produce plastic, drugs, detergent, deodorant, fertilizer, pesticides, paint, eyeglasses, heart valves, crayons, bubble gum and Vaseline.

The India Times explains that:

The price variation in crude oil impacts the sentiments and hence the volatility in stock markets all over the world. The rise in crude oil prices is not good for the global economy. Price rise in crude oil virtually impacts industries and businesses across the board. Higher crude oil prices mean higher energy prices, which can cause a ripple effect on virtually all business aspects that are dependent on energy (directly or indirectly).

The Federal Reserve Bank of San Francisco points out:

When gasoline prices increase, a larger share of households’ budgets is likely to be spent on it, which leaves less to spend on other goods and services. The same goes for businesses whose goods must be shipped from place to place or that use fuel as a major input (such as the airline industry). Higher oil prices tend to make production more expensive for businesses, just as they make it more expensive for households to do the things they normally do.

***
Oil price increases are generally thought to increase inflation and reduce economic growth.

***
Oil prices indirectly affect costs such as transportation, manufacturing, and heating. The increase in these costs can in turn affect the prices of a variety of goods and services, as producers may pass production costs on to consumers.

***
Oil price increases can also stifle the growth of the economy through their effect on the supply and demand for goods other than oil. Increases in oil prices can depress the supply of other goods because they increase the costs of producing them. In economics terminology, high oil prices can shift up the supply curve for the goods and services for which oil is an input.

High oil prices also can reduce demand for other goods because they reduce wealth, as well as induce uncertainty about the future (Sill 2007). One way to analyze the effects of higher oil prices is to think about the higher prices as a tax on consumers (Fernald and Trehan 2005).

The Post Carbon Institute notes (via OilPrice.com) that high oil prices raise food prices as well:

The connection between food and oil is systemic, and the prices of both food and fuel have risen and fallen more or less in tandem in recent years (figure 1). Modern agriculture uses oil products to fuel farm machinery, to transport other inputs to the farm, and to transport farm output to the ultimate consumer. Oil is often also used as input in agricultural chemicals. Oil price increases therefore put pressure on all these aspects of commercial food systems.

Figure 1: Evolution of food and fuel prices, 2000 to 2009
Sources: US Energy Information Administration and FAO.

Economists Nouriel Roubini and Setser note that all recessions after 1973 were associated with oil shocks.

Interest Rates Are Manipulated

Unless you live under a rock, you know about the Libor scandal.
For those just now emerging from a coma, here’s a recap:

The big banks have conspired for years to rig interest rates … upon which $800 trillion in assets are pegged

This was the largest insider trading scandal ever … and the largest financial scam in world history

Local governments got ripped off bigtime by the Libor manipulation

Libor is still being manipulated

Derivatives Are Manipulated

The big banks have long manipulated derivatives … a $1,200 Trillion Dollar market.
Indeed, many trillions of dollars of derivatives are being manipulated in the exact same same way that interest rates are fixed: through gamed self-reporting.

Gold and Silver Are Manipulated

The Guardian and Telegraph report that gold and silver prices are “fixed” in the same way as interest rates and derivatives – in daily conference calls by the powers-that-be.

Everything Can Be Manipulated through High-Frequency Trading

Traders with high-tech computers can manipulate stocks, bonds, options, currencies and commodities. And see this.

Manipulating Numerous Markets In Myriad Ways

The big banks and other giants manipulate numerous markets in myriad ways, for example:

Engaging in mafia-style big-rigging fraud against local governments. See this, this and this

Shaving money off of virtually every pension transaction they handled over the course of decades, stealing collectively billions of dollars from pensions worldwide. Details here, here, here, here, here, here, here, here, here, here, here and here

Charging “storage fees” to store gold bullion … without even buying or storing any gold . And raiding allocated gold accounts

Committing massive and pervasive fraud both when they initiated mortgage loans and when they foreclosed on them (and see this)

Pledging the same mortgage multiple times to different buyers. See this, this, this, this and this. This would be like selling your car, and collecting money from 10 different buyers for the same car

Cheating homeowners by gaming laws meant to protect people from unfair foreclosure

Pushing investments which they knew were terrible, and then betting against the same investments to make money for themselves. See this, this, this, this and this

Engaging in unlawful “frontrunning” to manipulate markets. See this, this, this, this, this and this

Engaging in unlawful “Wash Trades” to manipulate asset prices. See this, this and this

Otherwise manipulating markets. And see this

Participating in various Ponzi schemes. See this, this and this

Charging veterans unlawful mortgage fees

Cooking their books (and see this)

Bribing and bullying ratings agencies to inflate ratings on their risky investments

Source

The Japanese Financial System Is Beginning To Spin Wildly Out Of Control

2013-05-28T04:32:00.006-04:00

The financial system of the third largest economy on the planet is starting to come apart at the seams, and the ripple effects are going to be felt all over the globe. Nobody knew exactly when the Japanese financial system was going to begin to implode, but pretty much everyone knew that a day of reckoning for Japan was coming eventually. After all, the Japanese economy has been in a slump for over a decade, Japan has a debt to GDP ratio of well over 200 percent and they are spending about 50 percent of all tax revenue on debt service. In a desperate attempt to revitalize the economy and reduce the debt burden, the Bank of Japan decided a few months ago to start pumping massive amounts of money into the economy. At first, it seemed to be working. Economic activity perked up and the Japanese stock market went on a tremendous run. Unfortunately, there is also a very significant downside to pumping your economy full of money. Investors start demanding higher returns on their money and interest rates go up. But the Japanese government cannot afford higher interest rates. Without super low interest rates, Japanese government finances would totally collapse. In addition, higher interest rates in the private sector would make it much more difficult for the Japanese economy to expand. In essence, pretty much the last thing that Japan needs right now is significantly higher interest rates, but that is exactly what the policies of the Bank of Japan are going to produce.

There is a lot of fear in Japan right now. On Thursday, the Nikkei plunged 7.3 percent. That was the largest single day decline in more than two years. Then on Monday the index fell by another 3.2 percent.

And according to Business Insider, things are not looking good for Tuesday at this point...

In post-close futures trading, the Nikkei has dropped by another couple hundred points, and has dropped below 14,000.

Are we witnessing the beginning of a colossal financial meltdown by the third largest economy on the planet? The Bank of Japan is starting to lose control, and if Japan goes down hard the crisis could spread to Europe and North America very rapidly. The following is from a recent article by Graham Summers...

As Japan has indicated, when bonds start to plunge, it’s not good for stocks. Today the Japanese Bond market fell and the Nikkei plunged 7%. The entire market down 7%… despite the Bank of Japan funneling $19 billion into it to hold things together.

This is what it looks like when a Central Bank begins to lose control. And what’s happening in Japan today will be coming to the US in the not so distant future.
If you think the Fed is not terrified of this, think again. The Fed has pumped over $1 trillion into foreign banks, hoping to stop the mess from getting to the US. As Japan is showing us, the Fed will fail.

Investors, take note… the financial system is sending us major warnings…
If you are not already preparing for a potential market collapse, now is the time to be doing so.

And all of this money printing is absolutely crushing the Japanese yen. Since the start of 2013, the yen has declined 16 percent against the U.S. dollar, even though the U.S. dollar is also being rapidly debased. Just check out this chart of the yen vs. the U.S. dollar. It is absolutely stunning...

The term "currency war" is something that you are going to hear a lot more over the next few years, and what you can see in the chart above is only the beginning.

What the Bank of Japan is doing right now is absolutely unprecedented. It has announced that it plans to inject the equivalent of approximately $1.4 trillion into the Japanese economy in less than two years.

As Kyle Bass recently discussed, that dwarfs the quantitative easing that the Federal Reserve has been doing...

"What they're doing represents 70% of what the Fed is doing here with an economy 1/3 the size of ours"

The big problem for Japan will come when government bond yields really start to rise. The yield on 10 year government bonds has been creeping up over the past few months, and if they hit the 1.0% mark that will set off some major red flags.

Because Japan has a debt to GDP ratio of more than 200 percent, the only way that it can avoid a total meltdown of government finances is to have super low interest rates. The video posted below does a great job of elaborating on this point...

It really is very simple. If interest rates rise substantially, Japan will be done.
Investor Kyle Bass is one of those that have been warning about this for a long time...

There's a fatalism, he says, in everyone he talks to in Japan. Their thinking is changing, and the way they talk to him about debt is changing. They already spend 50% of tax revenue on debt service.
"If rates go up, it's game over."

The financial problems in Cyprus and Greece are just tiny blips compared to what a major financial crisis in Japan would potentially be like. The Japanese economy is larger than the economies of Germany and Italy combined. If the house of cards in Japan comes tumbling down, trillions of dollars of investments all over the globe are going to be affected.

And what is happening right now in Japan should serve as a sober warning to the United States. Like Japan, the money printing that the Federal Reserve has been doing has caused economic activity to perk up a bit and it has sent the stock market on an unprecedented run.

Unfortunately, no bubble that the Federal Reserve has ever created has been able to last forever. At some point, we will pay a very great price for all of the debt that the U.S. government has been accumulating and all of the reckless money printing that the Fed has been engaged in.

So enjoy the calm before the storm while you still can.

It won't last for long.

Source

IMF Rethinks Sovereign Defaults, Again

2013-05-27T05:46:00.004-04:00

I noted back in January that the IMF had started to do its own “lessons learned” on its European financial crisis response and had begun to admit it had made some fairly terrible mistakes in its assessment of the debt sustainability of a number of nations, including Greece, under its current programs.

Late last week the IMF released another discussion paper (available below) that covers recent developments in sovereign debt restructures and their effect on IMF policy. The paper concludes that:

First, debt restructurings have often been too little and too late, thus failing to re-establish debt sustainability and market access in a durable way. Overcoming these problems likely requires action on several fronts, including

(i) increased rigor and transparency of debt sustainability and market access assessments,
(ii) exploring ways to prevent the use of Fund resources to simply bail out private creditors, and
(iii) measures to alleviate the costs associated with restructurings
Second, while creditor participation has been adequate in recent restructurings, the current contractual, market-based approach to debt restructuring is becoming less potent in overcoming collective action problems, especially in pre-default cases. In response, consideration could be given to making the contractual framework more effective, including through the introduction of more robust aggregation clauses into international sovereign bonds bearing in mind the inter-creditor equity issues that such an approach may raise. The Fund may also consider ways to condition use of its financing more tightly to the resolution of collective action problems;

Third, the growing role and changing composition of official lending call for a clearer framework for official sector involvement, especially with regard to non-Paris Club creditors, for which the modality for securing program financing commitments could be tightened; and

Fourth, although the collaborative, good-faith approach to resolving external private arrears embedded in the lending into arrears (LIA) policy remains the most promising way to regain market access post-default, a review of the effectiveness of the LIA policy is in order in light of recent experience and the increased complexity of the creditor base. Consideration could also be given to extending the LIA policy to official arrears.

In short, the assessments of debt sustainability have been woeful, there aren’t strong enough binding terms (read CACS) in sovereign securities, the official sector, but not the IMF itself, need to play a part in defaults and the IMF should investigate the optimal debt resolution mechanisms available for negotiating between creditors and debtors.

The paper discusses the implication of the ongoing litigation against Argentina as well as the experience of the fund in the recent case of Greece. Of note is the admission by the fund that it was forced to lower its assessment of the country due to contagion worries from the official sector in Europe:

Accordingly, when a member’s sovereign debt is unsustainable and there are concerns regarding the contagion effects of a restructuring, providing large-scale financing without debt relief would only postpone the need to address the debt problem.
Instead, the appropriate response would be to deal with the contagion effects of restructuring head-on by, for example, requiring that currency union authorities establish adequate safeguards promptly and decisively to cushion the effect of spillovers to other countries (via, e.g., proactive recapitalization of creditor banks, establishment of firewalls, and provision of liquidity support). In the context of the first Greece program, financial assistance was delayed until Greece had lost market access. In response to concerns about possible spillovers from debt restructuring, the Fund lowered the bar for exceptional access (second criterion) by creating an exception to the requirement for achieving debt sustainability with a high probability in the presence of systemic inter national spillover effects. In light of these issues, the modification of the exceptional access policy could usefully be reviewed

In other words, Europe, and its banks, weren’t prepared for a Greek default so the IMF was forced to pretend that the country’s position was better than it actually was. That was obviously a mistake and the country, like many before it, was forced to take a second bailout followed by a re-structure that should have occurred up front. As noted by the paper:

A review of the recent experience suggests that unsustainable debt situations often fester before they are resolved and, when restructurings do occur, they do not always restore sustainability and market access in a durable manner, leading to repeated restructurings. While the costs of delaying a restructuring are well recognized, pressures to delay can still arise due to the authorities’ concerns about financial stability and contagion. Delays were also sometimes facilitated by parallel incentives on the part of official creditors, who accordingly may have an interest in accepting, and pressuring the Fund to accept, sanguine assessments of debt sustainability and market reaccess.

And:

In hindsight, the Fund’s assessments of debt sustainability and market access may sometimes have been too sanguine.

The existing DSA framework does not specify the period over which debt sustainability or market access is supposed to be achieved (although it is generally understood that debt would be sustainable within a five-year horizon) or how maximum sustainable debt ranges should be derived, leaving this mostly to Fund staff judgment. Sustainability was generally assessed on the basis of an eventual decline in the debt-to-GDP ratio—Argentina, Seychelles and St. Kitts and Nevis were the only three cases that provided for a quick and sizable reduction in the debt-to-GDP levels post-restructuring. St. Kitts and Nevis also targeted an explicit debt threshold, i.e., the ECCU debt target of 60 percent of GDP by 2020. Most other cases allowed more than five years for the debt level to fall significantly below safe levels.

For example, in Greece the debt-to-GDP ratio in the most recent program projections is not expected to be reduced substantially below 110 percent before 2022, while in the forthcoming Fund-supported program with Jamaica, debt is still projected to remain close to 120 percent of GDP in five years’ time. In Grenada, the debt ratio at the end of the five-year horizon actually turned out much higher than staff projections at the time of the restructuring. Also, in Greece, Jamaica (2010) and Seychelles, staff medium-term debt projections have been revised upward substantially within only a few years compared to projections made at the time of the restructurings.

Also of note is the emphasis on the broader guidelines of the IMF programs , supporting countries sustainable return to private capital markets in a specific time-frame , and what that means in terms of the types of restructures that should be used and how, and when, the IMF can support them:
There may be a case for exploring additional ways to limit the risk that Fund resources will simply be used to bail out private creditors.

For example, a presumption could be established that some form of a creditor bail-in measure would be implemented as a condition for Fund lending in cases where, although no clear-cut determination has been made that the debt is unsustainable, the member has lost market access and prospects for regaining market access are uncertain.

In such cases, the primary objective of creditor bail-in would be designed to ensure that creditors would not exit during the period while the Fund is providing financial assistance. This would also give more time for the Fund to determine whether the problem is one of liquidity or solvency. Accordingly, the measures would typically involve a rescheduling of debt, rather than the type of debt stock reduction that is normally required in circumstances where the debt is judged to be unsustainable.

Providing the member with a more comfortable debt profile would also have the additional benefit of enhancing market confidence in the feasibility of the member’s adjustment efforts, thereby reducing the risk that the debt will, in fact, become unsustainable. While bail-in measures would be voluntary (ranging from rescheduling of loans to bond exchanges that result in long maturities), creditors would understand that the success of such measures would be a condition for continued Fund support for the adjustment measures. Such a strategy—debt rescheduling instead of debt reduction—would not be appropriate when it is clear that the problem is one of solvency in which case reducing debt upfront to address debt overhang and restore sustainability would be the preferred course of action.
In light of the ongoing litigation against Argentina the paper also appears to be pushing for two things, firstly the introduction of a standard across-the-board mechanism to support collective action clauses, and resolution, within the sovereign debt markets:

Recent experience indicates that the contractual, market-based approach has worked reasonably well in securing creditor participation and avoiding protracted negotiations. But these episodes have also foreshadowed potential collective action problems that could hamper future restructurings. These problems are most acute when a default has not yet occurred, large haircuts are needed to reestablish sustainability, and sovereign bond contracts do not include CACs. The ongoing Argentina litigation has exacerbated the collective action problem, by increasing leverage of holdout creditors. Assuming there continues to be lack of sufficient support within the membership for the type of statutory framework envisaged under the SDRM, avenues could be considered to strengthen the existing contractual framework.
—
These aspects of the Greek legislation resemble the aggregation features of the SDRM. The key differences between the framework envisaged under the SDRM and the Greek legislation is that the SDRM would be established through a universal treaty (rather than through domestic law),

apply to all debt instruments (and not just to bonds governed by domestic law), and be subject to the jurisdiction of an international forum (rather than the domestic courts of the member whose debt is being restructured). At this stage, there does not appear to be sufficient support within the membership to amend the Articles of Agreement to establish such a universal treaty.
—-
Complementing efforts to revamp CACs, the Fund may consider conditioning the availability of its financing more tightly to the resolution of collective action problems.
For instance, the use of high minimum participation thresholds could be required in debt exchange operations launched under Fund-supported programs to ensure broad creditor participation. Fund policy encourages members to avoid default to the extent possible, even after restructuring. An expectation of eventually being paid out in full may encourage holdouts. The use of high minimum participation thresholds would help reduce such incentives. The Fund could also routinely issue statements alerting creditors that securing a critical participation mass in the debt exchange would be required for the restoration of external stability—the implication being that failure to meet the
established minimum participation threshold would block future program financing, leaving no other option but default and protracted arrears.

Also, in pre-default restructurings, where collective action problems are most acute, the Fund could consider setting a clearer expectation (already allowed under existing policy) that non-negotiated offers by the debtor—following informal consultations with creditors—rather than negotiated deals, would be the norm, as in these cases speed is of the essence to avoid a default. These ideas could be explored in future staff work.

And the second area, that is also “to be explored in future staff work”, is what to do about the risks caused by asymmetry in the treatment of private and official sector creditors, something that was very apparent in the recent Greek restructure:

… arrears to private and official creditors are currently treated asymmetrically under Fund policy.

Private external arrears are tolerated but arrears to official bilateral lenders are not. This subjects the Fund to the risk that it could not assist a member in need due to one or more holdout official bilateral creditors who seek favorable treatment of their claims.

Consideration could be given to extend the LIA policy to official bilateral arrears and in that context clarify the modality through which assurances of debt relief are provided by (non-Paris Club) official lenders. Another possibility would be for the Paris Club to extend its membership to all major lenders, so as to allow the Fund to rely on the Paris Club conventions with respect to financing assurances and arrears.

However, it is uncertain whether the Club could achieve such an expansion.

All up it’s an interesting paper and well worth the read if you are interested in this type of thing. The paper also has some discussion on the European crisis-resolution mechanism ( discussed in more detail here ) , although given recent back-steps from Europe on the banking union this looks to still be something of a distant dream at this point.

It will be interesting to see if this paper has any effect on future programs, but it does appear, if only very slowly, that the IMF is learning from past mistakes and attempting to shift policy in a direction to address that issue. It would appear, at least from this paper, that the IMF will be demanding a more realistic assessment of the debt sustainability of target nations and a greater use of up-front restructuring as a per-requisite for program engagement. We’ll have to watch the next steps in Europe to determine if this is simply a talking point or something the IMF board will action.
Full paper below.

IMF_SDR

Source

Why the Stock Market Is Going Higher, According to Goldman

2013-05-24T05:43:00.003-04:00

Goldman: Four Reasons Why the Market is Going Much Higher ... Last night's much-buzzed about research report from Goldman Sachs, in which the firm lays out its new S&P targets, contains an interesting rationale for higher stock prices. Rather than making the bull case based on earnings growth, Goldman believes that the 2% dividend yield on the S&P 500 will serve as a rising floor of sorts. This, along with an expanding PE multiple, augur well for US equities. – The Reformed Broker
Dominant Social Theme: Stocks are on a tear, despite the recent Nikkei setback.

Free-Market Analysis: Goldman Sachs has released a research report with four reasons why stocks are poised to go higher, as related in this short article posted over at The Reformed Broker.

The reasons reduce to some simple observations. First, the economy is getting better, meaning that good economic news will buoy stocks; second, stocks will continue to outperform bonds, which means stocks will attract a good flow of investment cash; third, companies will raise dividends, making stocks more attractive for those interested in an income stream; fourth, interest rates may remain low, benefiting stocks.

From our point of view, of course, it is simpler than that. Central bankers have decided that even the current rates of monetary debasement are not enough. They are determined to print even more money, thus swelling the prospects of equity even further.

In retrospect, the Japanese decisions to print money seems part of a larger promotion to make clear to a worldwide audience that economies are only being run one way these days, via Keynesian stimulation.

The BRICS, the EU and, of course, the US are all embarked on various forms of monetary stimulation and much of the talk in the financial press is about doing more of it rather than less.
Yesterday, Ben Bernanke gave congressional testimony warning against any significant diminution of "quantitative easing." At the same time, over in Europe, a senior Fed banker was purveying much the same message to the European Central Bank. Here's how the New York Times put it:

James Bullard, president of the Federal Reserve Bank of St. Louis and a voting member of the Fed's policy-setting open markets committee, said Europe's central bank should consider quantitative easing similar to that undertaken by the Fed — large bond purchases meant to drive down market interest rates.

The public comments were highly unusual. While central bankers from different countries frequently confer in private and offer advice and criticism to their peers behind closed doors, it is rare for any official to go public with even the mildest criticism of another central bank.

But with official interest rates in almost every advanced economy already close to zero, Mr. Bullard said, central bankers must reach for stronger tools to avoid getting trapped in economic doldrums.
This seems to us to have elements of a planned campaign. Japan's easing has received wide publicity of late and the ECB's determination to ease has proven both controversial and newsworthy.

Even Ben Bernanke's massive money printing schemes are attracting more attention than previously. Now, such a seemingly deliberate program will doubtless buy some more time for beleaguered central bankers. But the ultimate result is sure to be more ruined economies, countries and companies before this latest bout of trillion-dollar-plus stimulation has run its course.

In the meantime, as we've written, those with strong constitutions and an appetite for risk may wish to position themselves in various equity markets, counting on the strong central banking bias toward continued money printing.

Rightly or wrongly, what matters these days is monetary policy. The Goldman Sachs stock report, just released, is a kind of window dressing. For the most part, with some exceptions, the performance of a stock does not matter nearly so much as the commitment to a steady production of currency.

Conclusion: The Fed and central bankers generally are going out of their way to indicate that such an easing will continue. And despite recent market volatility, those who choose to ride the trend rather than oppose it may book at least short-term profits.

Source

Billion-Trillion Derivatives Market! ... Reform or a Blowup?

2013-05-23T04:53:00.005-04:00

Derivatives Reform on the Ropes ... New rules to regulate derivatives, adopted last week by the Commodity Futures Trading Commission, are a victory for Wall Street and a setback for financial reform. They may also signal worse things to come ... The regulations, required under the Dodd-Frank reform law, are intended to impose transparency and competition on the notoriously opaque multitrillion-dollar market for derivatives, which is dominated by five banks: JPMorgan Chase, Goldman Sachs, Bank of America, Citigroup and Morgan Stanley. – New York Times

Dominant Social Theme: We have this billion trillion market under control. Don't worry.

Free-Market Analysis: Derivatives reform? We hardly think so ...

First of all, nobody knows how big the derivatives market is and no one knows how many dollars are at risk. Those involved in making the regulations are also the largest players in the market. Whatever "reform" is being worked out will benefit those who are part of the industry.

Here's how Wikipedia describes a derivative:

A derivative is a financial instrument which derives its value from the value of underlying entities such as an asset, index, or interest rate--it has no intrinsic value in itself. Derivative transactions include a variety of financial contracts, including structured debt obligations and deposits, swaps, futures, options, caps, floors, collars, forwards, and various combinations of these.

To give an idea of the size of the derivative market, The Economist magazine has reported that as of June 2011, the over-the-counter (OTC) derivatives market amounted to approximately $700 trillion, and the size of the market traded on exchanges totaled an additional $83 trillion. However, these are "notional" values, and some economists say that this value greatly exaggerates the market value and the true credit risk faced by the parties involved. For example, in 2010, while the aggregate of OTC derivatives exceeded $600 trillion, the value of the market was estimated much lower at $21 trillion. The credit risk equivalent of the derivative contracts was estimated at $3.3 trillion.

Still, even these scaled down figures represent huge amounts of money. For perspective, the budget for total expenditure of the United States Government during 2012 was $3.5 trillion, and the total current value of the US stock market is an estimated $23 trillion.

The world annual Gross Domestic Product is about $65 trillion. And for one type of derivative at least, Credit Default Swaps (CDS), for which the inherent risk is considered high, the higher, notional value, remains relevant. It was this type of derivative that investment magnate Warren Buffet referred to in his famous 2002 speech in which warned against "weapons of financial mass destruction." CDS notional value in early 2012 amounted to $25.5 trillion, down from $55 trillion in 2008.

Perhaps the most important part of this Wikipedia article (and admittedly Wikipedia is not definitive and often inaccurate) is this statement:

Proportion Used for Hedging and Speculation ... Unfortunately, the true proportion of derivatives contracts used for legitimate hedging purposes is unknown (and perhaps unknowable), but it appears to be relatively small. Also, derivatives contracts account for only 3–6% of the median firms' total currency and interest rate exposure. Nonetheless, we know that many firms' derivatives activities have at least some speculative component for a variety of reasons.

Not knowing how much of a billion trillion dollar market is unsecured and speculative would seem to be a problem. It is a problem because the derivatives market is not a normal market as the securities industry is abnormal, constrained by regulation and fattened by incredible amounts of fiat money.
Nothing like the modern money industry would exist without big government support and central bank monetary stimulation.

Because Wall Street and the City in particular are abnormal industry enterprises, the derivatives market itself is artificial and sooner or later apt to deflate unless one believes that trees can grow to the sky, eternally. But nothing goes up forever.

In the 1980s, portfolio insurance was supposed to insure that counterparty risk was a thing of the past. The Crash of 1987 put that incorrect assumption to rest and those who had depended on those instruments lost billions. There is no such thing as a "sure thing," and no regulatory oversight will adequately supervise or diminish the risk posed by a billion trillion dollar market. Even the New York Times recognizes this:

In the run-up to the financial crisis − and since − the lack of transparency and competition has fostered recklessness and instability. But banks like opacity, because their outsized profits depend on keeping clients in the dark about what other clients pay in similar deals. Under the Dodd-Frank law, derivatives are supposed to be traded on "swap execution facilities," which are to operate much like the exchanges that exist for equities and futures ...

The initial proposal ... called for derivatives trading to take place on open electronic platforms. The final rules will allow much of the negotiation over derivative prices to take place over the phone, a practice that is difficult to monitor and prone to abuse.

By themselves, these new rules are not fatal to the overall reform effort. And they are the best that the commission's reform-minded chairman, Gary Gensler, could achieve at this time because of resistance to tougher standards by the agency's two Republican commissioners and by one of its Democratic commissioners, Mark Wetjen.

The problem now is that Mr. Gensler's term has officially ended, and he is expected to leave the agency at the end of the year. Given Wall Street's incessant lobbying and powerful presence in Washington, it is assumed that he will be replaced by a chairman who is friendlier to Wall Street. That bodes ill for rules that have started out weak and need to be shored up later. To lose a reformer would also reflect poorly on President Obama, but he has not yet shown interest in keeping Mr. Gensler in the government.

This last paragraph refers to something called "regulatory capture." It is one reason why consumers should not count on regulation to protect them. Inevitably in modern governance those who are begin regulated end up in control of the regulations.

The CFTC is a notoriously weak regulator in any case and to further complicate matters US derivatives regulations are not being applied overseas. A lack of transparency, regulatory capture and a regime that ends at the water's edge means that the regs now being put in place for derivatives would seem to be virtually useless. In any event, regulations cannot stabilize a market in advance of a destabilizing event. They are price fixes that transfer risk and wealth from one place to another.

So what is the average investor to do? Given the amount of money pouring into stock markets, it is evident and obvious that averages will continue to move up in the long or short term. Eventually markets around the world will move back down – and no one actually knows when – but it is likely that time is not now.

For those who want to participate in the "only game in town," given that central banks control money printing, US stock markets in particular must present a tempting target. They will likely inflate further.

But those who want to expose some funds to stocks ought to keep in mind that what goes up can come down. Rigorous diversification is surely called for. Cash and precious metals ought to compete with any equity exposure. And it is possible that one ought to consider taking the initial investment out of the market over time, while leaving in the appreciation. This way the risk – and there is a billion trillion dollar risk to be concerned about – will be lessened.

Conclusion: Central banks are apparently determined to lift markets higher with money printing, at least in the short term. Those tempted to play the game – and it can be a profitable one – will remember the risks as the mainstream press is not apt to present many reminders.

Source

Banks Win Big as Regulators Refuse to Rein in $700 Trillion Derivatives Market

2013-05-22T04:53:00.003-04:00

Here are Black’s policy recommendations:

JAY: Okay. So you can’t get even measly regulation through. You can’t tame the scorpion. And the scorpion ain’t changing its nature. I guess most people know this little story by now. So you’re talking about let’s get rid of the scorpions. What does that mean?

BLACK: Yeah. So my thing is we’ve got to do three things. And the good news is economically it would make a better economy. The first of the three things is stop the entities that are systemically dangerous from growing. And many of them are growing very substantially.

The second thing is to order them to shrink over the next five years below $50 billion in assets, a point where they’ll no longer pose a systemic risk. And let them figure out how they’re going to do that.

And the third thing that we need to do–admittedly it assumes to some extent the answer–is to have hyperintensive regulation during that time period. Now, I do recognize that I just told you a story about how the Commodity Futures Trading Commission couldn’t even get fairly weak regulation, but that’s why I’m saying where our effort should be as progressives during that period is to be hypervigilant about the regulation.

JAY: So to get to what you’re talking about means a political transformation of the country, ’cause right now the scorpions control the politics.

BLACK: And that’s really my point is that the systemically dangerous institutions, first, they are so large that they are horribly inefficient and risky.

Second, they have this massive implicit federal subsidy that means that any of these, you know, odes you hear to free markets are completely fictional. And conservative scholars agree that there’s absolutely nothing free about the financial markets.

Then you have the fact that they do create these periodic crises that are getting worse. We simply cannot afford to have the next crisis.

And the final thing is the point you were raising. It is impossible to have a real democracy with these kind of systemically dangerous institutions. What you have instead is crony capitalism, and crony capitalism is the death of democracy.

OK. But how?

Source

The Coming Collapse Of The Petrodollar System

2013-05-21T04:39:00.005-04:00

PETRODOLLAR WAR

The theory of Petrodollar Warfare can be attributed to US analyst and author William R Clarke, and his 2005 book of that title which interpreted the US-UK decision to invade Iraq in 2003. He called this an "oil currency war", but the concept of the petrodollar system and petrodollar recyling dates back to the eve of the first Oil Shock in 1973-1974. The role of the petrodollar system as a driving force of US foreign policy is explained by analysts and historians as basic to maintaining the dollar's status as the world's dominant reserve currency - and the currency in which oil is priced.

The term "petrodollar warfare" as used by William R. Clark says that major international war, legal or not, was seen as justified to protect the petrodollar system. Over and above the loss of human life, the combined costs of the Afghan and Iraq wars for the US are controversial like the interpretation of these wars as "oil wars", but analysts like Joseph Stiglitz and Linda Bilmes put the total combined war cost at above $4 trillion. This can be compared with - and totally dwarfs - the annual cost of US oil imports, which are now sharply declining on a year-in year-out basis as domestic shale oil output ramps up, and US oil demand stagnates.

Clarke's theory, like the explanation of the role and power of the "petrodollar system" depends on two basic drivers. Most major developed countries rely on oil imports, which are purchased using dollars, so they are forced to hold large stockpiles of dollars in order to continue importing oil. In turn this also creates consistent demand for dollars, and prevents the dollar from losing its relative international monetary value, regardless of what happens to the US economy.

Variants of the Petrodollar War concept include the role of oil currency conflicts and rivalry, notably concerning US relations with Iran, Venezuela and Russia, and possibly with Europe concerning the gradual replacement of US dollars with the euro, for oil transactions. More important, the entire petromoney system and the potential for Petrodollar War hinges on global oil import demand and the oil price. Both of these have to hold up. When or if they do not, foreign oil importer nations who formerly found it beneficial to hold dollars to pay for oil, would have to find some other (unexplained) reason for huge holdings of dollars, when their oil imports decline and-or oil prices also decline.

The "currency war" variant of the petrodollar system theory, holding that a shift to notably euros or gold for oil payments would undermine the system, is unrealistic when given any serious analysis, because all world moneys are interchangeable or convertible, and gold is priced in US dollars.

THE THREE PHASES OF THE SYSTEM

These are easy to define.

1974-1986 The first phase. The 1972 start of "petrodollar recycling" initiated by Nixon and Kissinger just before the fivefold rise in oil prices of 1973-74, set the process of US-Saudi Arabian cooperation for the near-exclusive benefit of these two players. The US dollar was "backstopped" by the transfer of Saudi liquidities to the US Federal Reserve system banks, especially the Federal Reserve Bank of New York. A small number of other chosen central banks, especially the Bank of England, and the central banks of Germany, France, Italy and Japan also benefitted.

1986-1999 The second phase. This also featured US and Saudi control, but under Clinton's two mandates the focus radically changed to the controlled deflation or reduction of both oil prices and the world value of the US dollar. While the US continued to benefit from "petrodollar recycling", Saudi Arabia was the major loser, undoubtedly changing its perceptions of the system's utility to KSA.

2000-2013 The third and last phase. This period featured a major longterm rise in oil prices and the entry not in force, but progressively of the euro currency into the now enlarged "petromoney recycling" process. Euros now cover about 25% of global oil transactions, for an annual value of around €700 billion, with about the same amount of back-to-back additional lquidities. The massive growth of QE and central bank "easing", from 2008, has heavily reduced the role of "petromoney recycling".

Among the major changes of the petromoney system during these 3 phases, the first phase set the basic political concept among US deciders that "petrodollar recycling" could at one and the same time enable the US to run huge trade and budget deficits, low or very low interest rates, and prevent the collapse of the dollar's value due to the forced need of all world buyers of oil to hold US dollars to make purchases of oil. By the second phase, this underlying concept shaded to including non-oil assets as the focus of value manipulation, controlled inflation and controlled deflation of value. In the third phase, massive increases of the oil price to 2008 played a major role in enabling the continued depreciation of the dollar's world value as US sovereign debt also massively increased, but since 2008 and the start of central bank QE the need for, and role of the petrodollar system have heavily contracted.

THE SYSTEM IS NOW MENACED

Estimates of the exact size and role of petrodollars and petroeuros in the international money system, finance system, and economic system are varied. Many analysts however say the minimum role of the petrodollar system is to create, back-to-back, liquidities at least equivalent to the transaction value of the world oil trade, which for crude and products is about $3.4 trillion-a-year. Combined, the approximate minimum total $6.8 trillion annual value of oil trade plus the petromoney system is about 10% of world annual GNP, equivalent to about 45% of US annual GDP. This may appear as still large and important but has to be compared with, for example, the exposure of national private banks only in Europe in relation to national GDPs, which is often 300% - 400%.

Only QE can "plaster over" these liabilities.

Petromoney recycling is still treated by "the elites" as a critical prop to monetary system integrity, and explains why the USA is far from the only country depending on the system holding up. All oil producers, even smaller-sized, are beneficiaries the same way as all major developed nations' central banks, but the US is still the prime beneficiary. However, the basic supports for the system's operation - continuing high oil demand, high oil prices, and oil priced in dollars - have all weakened or are threatened, today. In particular when global oil demand declines or stagnates, and when oil prices decline, the dollars that will no longer be needed for global purchases of oil will return in massive amounts back to their country of origin, the USA. The consequences can only be dramatic, and threaten the start of a process completely unlike the Clinton-era controlled devaluation of the dollar's value along with the decline of oil prices consented by Saudi Arabia.

The now-menaced "petrodollar system" is also weakened because of worldwide change in the perception of oil and oil energy. From the dawn of the petroleum age to its accelerating twilight, today, geopolitical strategies concocted by developed nations featured the maintenance of secured access to world oil supplies. This was believed to be a win-win strategy for developed nation policy makers, and especially for US policy makers. From the 1970s and the first Oil Shock of 1973-1974, the only "morph' in this policy and strategy was to substitute expensive oil, for cheap oil.

For the USA's ability to run deficits and the petrodollar system, much higher oil prices were a major gain, not a loss, and this is almost surely still the perception of the Obama administration today.

In its first phase and last phase, the economic and political incentives for ensuring national access to oil supplies, and the existence of the petrodollar system as a monetary and finance tool - unrelated to the economy - worked better with higher oil prices. Today however, with the major and massive changes of oil resource availability revealed by the shale energy revolution, rising global oil production capabilities, stagnating oil demand, and rising renewable energy supplies in all major developed countries, and the constantly declining role of oil in the economy, the Petrodollar System's days are surely numbered, like the notion that $100-oil prices are "normal".

The impact of this will be massive.

Source

Helicopter money as a policy option

2013-05-20T05:07:00.003-04:00

Since the crisis central banks have implemented a variety of non-standard monetary policies aiming at stabilising nominal demand in the presence of major disruptions in financial markets. These policies had different intermediate objectives: market making, controlling long term interest rates or asset prices, support of credit via subsidies. They had a role in stabilising financial markets after the collapse of Lehman Brothers and the banking crisis which followed. Their effects on the real economy, however, are uncertain.¹

Notwithstanding this uncertainty the Bank of Japan has recently engaged in bold action, announcing that it will double the monetary base and its holding of government bonds in the next two years.

Some think that quantitative easing will fuel the next financial bubble and that exiting will create financial instability (see Stein 2013).
Others think that more should be done to sustain the real economy.

Adair Turner has recently put a different option on the table (Turner 2013): “helicopter money” or permanent money creation. This is an idea that was discussed in the thirties in the US as a response to the great recession (see Friedman 1948 and Simon 1936) and more recently by Bernanke in relation to the zero lower bound problem in Japan (Bernanke 2003). As Bernanke has suggested it can be implemented via transfers to households and businesses via a tax cut coupled with incremental purchases of government debt, so that the tax cut is in effect financed by money creation.

Although the idea has been around a long time it is a taboo today. Non-standard monetary policies in response to the recent crisis have all led to an increase in the size of central banks’ balance sheets but in the recent experience no central bank, including the Bank of Japan, has purposefully increased the monetary base and committed to keep this additional money in circulation permanently. The idea, however, gets some support from academia.

In his 2012 Jackson Hole speech Michael Woodford suggested a version of flexible inflation targeting whereby the central bank commits future monetary policy to a permanently higher nominal target (such as the path of nominal GDP) and discussed various tools within that framework, including permanent increases in the monetary base via fiscal transfers (Woodford 2012).
In a situation of persistently weak economic conditions it makes sense to consider all options including tools that have stayed long in the closet.

The following is a summary of the questions posed by Reichlin and the answers by Turner and Woodford.

Question one : Adair, can you explain why, in your view, helicopter money is an option for monetary policy that is relevant to today?

‘Helicopter money’ – by which we mean overt money finance of increased fiscal deficits – may in some circumstances be the only certain way to stimulate nominal demand, and may carry with it less risk to future financial stability than the unconventional monetary policies currently being deployed.
The crucial first question is: do we want more nominal demand? The answer should be yes if (i) we are confident that some of the increase will take the form of increased real output or (ii) if some increase in the inflation rate is in itself desirable. These conditions seem likely to apply in some developed economies today, with nominal GDP growth rates very low, depressed by private sector deleveraging in the aftermath of the financial crisis. And if these conditions do not pertain, we should not be trying to stimulate nominal GDP by any means.

So let’s assume that increased nominal GDP growth is desirable. The problem is that other levers may be ineffective or have adverse side effects. Monetary policy, in both its conventional and unconventional forms, may be ‘pushing on a string’. Reducing policy interest rates to the zero bound fails to stimulate credit supply and demand in a ‘balance sheet recession’ in which the private sector is deleveraging. Cutting long-term interest rates by quantitative easing may be equally ineffective. And very low interest rates, sustained for many years, will encourage a search for yield, hence financial innovation and carry trades, which create risks to financial stability.

Fiscal stimulus, in its conventional funded form, financed by bond issues, may be more effective. Fiscal multipliers may be high when central banks are committed to keeping interest rates low for the foreseeable future. But with public debt levels already high and rising, concerns about future debt sustainability may create ‘Ricardian equivalence’ effects with households and companies aware that tax cuts today will have to be offset by tax rises later.

In this specific environment – ‘helicopter money’ – should be regarded as an available option. Ben Bernanke proposed this for Japan in 2003. If Japan had used it then, it would now have some mix of a higher real GDP level, a higher price level, and lower public debt to GDP.

Question 2: Mike, what in your view are the potential effects of this policy on the economy as compared to traditional quantitative easing and how do you relate it to your framework of targeting the path of nominal GDP?

It is possible for exactly the same equilibrium to be supported by a policy of either sort. On the one hand (traditional quantitative easing), one might increase the monetary base through a purchase of government bonds by the central bank, and commit to maintain the monetary base permanently at the higher level. On the other (‘helicopter money’), one might print new base money to finance a transfer to the public, and commit never to retire the newly issued money. Suppose that in either case, the path of government purchases is the same, and taxes are raised to the extent necessary to finance those purchases and to service the outstanding government debt, after transfers of the central bank’s seignorage income to the Treasury. Assuming the same size of permanent increase in the monetary base, the perfect foresight equilibrium is the same in both cases. Note that the fiscal consequences of the two policies are actually the same. Under the quantitative easing policy, the central bank acquires assets, but it rebates the interest paid on the government bonds back to the Treasury, so that the budgets of all parties are the same as if no government bonds were actually acquired, as is explicitly the case with helicopter money.

The effects could be different if, in practice, the consequences for future policy were not perceived the same way by the public. Under quantitative easing, people might not expect the increase in the monetary base to be permanent – after all, it was not in the case of Japan’s quantitative easing policy in the period 2001-2006, and US and UK policymakers insist that the expansions of those central banks’ balance sheets won’t be permanent, either – and in that case, there is no reason for demand to increase. Perhaps in the case of helicopter money, it would be more likely that the intention to maintain a permanently higher monetary base would be believed. Also, in this case, the fact people get an immediate transfer should lead them to believe that they can afford to spend more, even if they don’t think about or understand the consequences of the change for future conditions, which is not true in the case of quantitative easing.

But while I grant this advantage of Adair’s proposal, I believe that one could achieve a similar effect, with equally little need to rely upon people having sophisticated expectations, through a bond-financed fiscal transfer, combined with a commitment by the central bank to a nominal GDP target path (the one that would involve the same long-run path for base money as the other two policies). The perfect foresight equilibrium would be exactly the same in this case as well; and as in the case of helicopter money, the fact that people get an immediate transfer would make the policy simulative even if many households fail to understand the consequences of the policy for future conditions, or are financially constrained. Yet this alternative would not involve the central bank in making transfers to private parties, and so would preserve the traditional separation between monetary and fiscal policy.

Question three: Adair, do you agree with Mike that a bond financed fiscal transfer, combined with central bank action in pursuit of a nominal GDP level target would be desirable and better than pure helicopter money?

Well as Michael quite rightly says, if there is perfect foresight, the equilibrium resulting from the two strategies is exactly the same. But perfect foresight may not naturally arise. It may need to be created by the transparency of overt money finance.

Michael’s proposal is essentially that (i) the government increases its fiscal deficit, directly putting money into people’s pockets (whether by tax cuts or public spending increases); and (ii) the central bank commits to maintaining a nominal GDP growth path, buying government bonds as necessary to achieve this even if, as is highly likely, achieving and maintaining that path of GDP level is likely to entail a permanent increase in the monetary base.

And if individuals and companies perceive that the increase in the monetary base will in fact be permanent, they will not rationally worry about any Ricardian equivalence cost of the future increase in government debt burden. They will understand that the fiscal stimulus is effectively going to be paid for with permanent central bank money.

Clearly therefore, Michael’s proposal is substantially very close to open monetary financing. But it isn’t quite overt. And that creates a danger that perfect foresight will not pertain and that individuals and companies will still worry unnecessarily about future government debt burdens. As a result, we might have to do even more quantitative easing type bond purchases to achieve Michael’s nominal GDP level target, creating the financial stability risks I referred to earlier.

The crucial question to me therefore is whether the more overt form of the strategy can be made consistent with central bank independence and with appropriate discipline against overuse of money finance. I believe it can.

Question 4: Helicopter money is a form of fiscal policy. The question arises of whether it is the central bank, the Treasury or both in coordination that should implement it. This has the potential to threaten the principle of central bank independence or at least it may force us to reconsider the rules that govern the relation between Treasury and central banks today. Mike, what is your view on how we can deal with the problem of moral hazard possibly caused by an unclear separation between them?

I think this would indeed be a problem with outright ‘helicopter money’, and it is why I prefer the alternative sketched above. The policy that I proposed would require coordination of monetary and fiscal policy actions, but it could be carried out while preserving a traditional separation of roles. The fiscal authority would make the transfers, issue debt to pay for them, and later tax people to service its debt; the monetary authority would conduct open-market operations in the amounts needed to keep nominal GDP on the target path (or to keep nominal interest rates at zero, if undershooting of nominal GDP is unavoidable), hold assets against the liabilities that it issues, and distribute its earnings to the Treasury. The fact of such coordination on joint efforts to achieve a desirable equilibrium would in no way imply that the Treasury gets to dictate monetary policy, and so I don’t see it as raising moral hazard concerns. Indeed, it could be implemented by a central bank that commits itself to its policy (namely, use of monetary policy to achieve the nominal GDP target) regardless of what the fiscal authority does. I believe that the policy would be more certain of success (assuming an economy initially at the zero lower bound) if the fiscal authority were to cooperate, because success would not depend purely on the expectation channel; but it would be a sensible one for the central bank regardless.

Question five: Adair, how do you respond to the concern that your proposal dangerously undermines central-bank independence?

I absolutely agree that there are dangers in breaking a taboo by recognising that Outright Monetary Financing is possible: but I think there are ways to guard against that danger. And conversely, I think we should recognise that Michael’s proposal might also undermine appropriate fiscal discipline.
Michael and I both agree that optimal policy today requires closer coordination of monetary- and fiscal-policy actions. In his option the fiscal authority can increase the fiscal deficit, directly stimulating the economy, confident that there will be no crowding out offset, since it knows that the central bank, committed to a nominal-GDP target, will purchase and in all likelihood permanently keep much of that debt. But that in itself might endanger fiscal indiscipline; the fiscal authority might run increased fiscal deficits to a greater extent than reasonably justified by the nominal GDP target and by the likely permanent increase in the monetary base.

Under the Outright Monetary Financing approach that I propose, by contrast, the scale of money financed fiscal deficits would be clearly determined in advance by an independent central bank. The fiscal authority would decide how to spend the money (the balance between tax cuts and public expenditure): but the central bank would determine the amount of permanent money finance, consistent with an appropriate inflation or money GDP target. And it would do so as an independent central bank, and through the same decision making processes which govern the use of other monetary-policy tools.

Read the entire article

The Empire's Next Effort To Extract Your Wealth

2013-05-17T05:02:00.002-04:00

Since before the tech bust, we’ve been suggesting that while Americans “think” they’re getting richer... they’re actually heading in the other direction. They’re getting poorer.

This proposition has been easier for folks to entertain since housing busted and the financial crisis reversed the “wealth effect” in 2008. With that in mind, let’s take a look at the logic of the American Empire and what you can expect in the year(s) ahead.

“Great empires, such as the Roman and British, were extractive,” economist Paul Craig Roberts observed recently. “The empires succeeded because the value of the resources and wealth extracted from conquered lands exceeded the value of conquest and governance.”

We explored a similar theme in our 2006 book, Empire of Debt. But unlike empires of the past, the American Empire has a logic all its own.

“America’s wars are very expensive,” says Roberts, stating the obvious. “Bush and Obama have doubled the national debt, and the American people have no benefits from it. No riches, no bread and circuses flow to Americans from Washington’s wars.”

In the big Iraqi oil auction of 2009, for example, even as U.S. helicopters droned overhead, the oil minister gave out zero contracts to American firms. Not one. And we spent at least $3 trillion on war — $2.9 trillion more than Team Bush’s original budget. So much for paying for war with “oil profits.”

Russia was actually the big winner here. So what gives? The American Empire has perverted the Roman mantra “Veni, vidi, vici” (I came, I saw, I conquered) into the odd imperial slogan, “We came, we saw… we borrowed!”

The results from this turn of phrase are less than desirable. Again Roberts:

“Washington’s empire extracts resources from the American people for the benefit of the few powerful interest groups that rule America. The military-security complex, Wall Street, agribusiness and the Israel lobby use the government to extract resources from Americans to serve their profits and power. The U.S. Constitution has been extracted in the interests of the Security State, and Americans’ incomes have been redirected to the pockets of the 1%.

“That is how the American Empire functions,”

We agree. To grow, the American Empire is always looking to inflate the next bubble. These serial bubbles each have the effect of “extracting” wealth from the citizens — in the form of bigger mortgages, heftier credit card statements and stuffed stock portfolios. The “extracted” money is, over time, passed from the wallets of citizens to the pockets of the well connected.

For confirmation of this assertion we need look no further than the top o’ the 1%, the Oracle of Omaha. Peter Schweizer of Reason reckoned in an exposè published last year on Warren Buffett that this folksy fellow “needed the TARP bailout more than most.”

Let’s run through the numbers. Berkshire Hathaway firms in total received $95 billion in TARP money. Berkshire, you’ll recall, held stock in Wells Fargo, Bank of America, Goldman Sachs and American Express. Not only did these companies receive TARP funds… they also dipped into the FDIC’s treasury to back their debt. Total bailout: $130 billion. TARP-enabled companies accounted for 30% of the Oracle’s publicly disclosed stock portfolio.

He’s definitely one of the top beneficiaries of the big bank bailout. And to sharpen the sting, he even got a better deal to help ailing Goldman Sachs than our own government. Buffett got a 10% preferred dividend while the Feds got all of 5%. He cleaned up with $500 million a year in dividends. Without the bailout, you can bet many of his stock holdings would have gone near-zero instead.

Contrast that with a blog post from Rosemarie Jackowski, a community activist at Dissident Voice. She’s describes her experiences working with the underclass in a small town in Vermont.

“In Bennington, there are three very distinct classes,” writes Jackowski. “First, there are the ‘fancy people.’ They are the ones who rule and control everything. They are on the boards — the hospital board, the library board, the select board, the school boards. They have the power — even the power over life and death. They, occasionally during a medical crisis in the hospital, make the decision to pull the plug or allow life to go on.”

We hear you. At first, we were prepared to dismiss the piece as another bleeding heart diatribe… but she goes on to describe a theme very familiar to our readers.

Then there is the large group of ordinary citizens. Some are blue-collar workers. Most work hard. Love their families. And have had family in Vermont for generations. They acknowledge the class system in conversation often. They call it the ol’ boys network — cronyism.

The third group consists of those who are in need. Those on the bottom of the economic pile. At the conference, some of the most-impressive comments were made by a poor mother of two disabled children. She talked about the oppressive avalanche of redundant paperwork required to get any tiny benefit. The social services system is designed by nameless, faceless, unelected bureaucrats. It is setup to assure maximum job security to the workers in the system. To a struggling family, it often feels like an attack of the “paper churners.” Being poor is a full-time job.

More and more “ordinary citizens” are faced with the challenge of joining this third group of government dependents… or choosing to join the ranks “nameless, faceless, unelected bureaucrats” just to survive.

Case in point: “In the most recent Census,” writes co-author Samantha Buker in The Little Book of the Shrinking Dollar, “48% of America qualifies as ‘low income.’ There are more Americans living under extreme poverty than have ever been recorded.

“Since 2009, we’ve added another 4 million souls to the category of low income to below the poverty line. That’s 146 million people in America who aren’t consuming much aside from ever-increasing applications for food stamps.”

In November 2008, food stamp applicants topped 30 million for the first time in history. We’re still posting “record highs,” having added over 16 million more names (and counting…) to the food stamp list.

Does this sound like a nation of ripe, robust citizens ready to be drained for the benefit of the national coffers? Au contraire. Sounds like another case in which our Empire will hand out more than it’s taking in.

Again.

In her post, Ms. Jackowski provides a list of 35 ways poverty robs you of your dignity. Here are just a few:

“Poverty means living with shame.”

“Poverty means working three jobs and still not ‘making it.’”

“Poverty means that you go to work when you are sick. Worse than that, you send your children to school when they are sick.”

“Sometimes poverty means that you skip meals so that your children can eat.”

“Poverty means that your housing is never secure…”

“Poverty means following all of the rules. Then graduating with oppressive student debt so that the president of UVM can be paid $447,000 per year.”

It’s Jackowski’s final mention of extraction - the student debt fiasco - that worries us. This bubble that has already taken flight. Now it’s flying dangerously close to a few pins.

Just like with housing, this is one hell of a bubble. And when it bursts, it’ll invite another crew of crony capitalists to the Beltway, who will soon be lining up for bailouts. I urge you to grip your wallet with both hands and prepare for the worse.

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The Problem of Central Banks With Multiple Goals and Few Tools

2013-05-16T04:34:00.003-04:00

While there are numerous definitions of economics, the most widely used is:

Economics is the study of how economic agents – households, businesses, governments – allocate limited resources across competing uses.

The definition encompasses market, command and mixed economies as the need to allocate resources transcends legal, institutional and other societal arrangements. Various sub-fields of economics have area-specific operational definitions, but the core, the fundamental economic problem, is the same: the allocation of resources. The relative scarcity of resources implies opportunity costs or tradeoffs, e.g., guns versus butter, labor versus leisure, present versus future.

However, current monetary policymakers (largely economists) have designed and employed macroeconomic models and a policy framework that allow only one goal for central banks: price stability. They did not solve the problem of how to allocate scare resources (in this case limited policy tools) in pursuit of competing ends, e.g., stable prices, full employment, sustainable growth, financial stability, external balance. They simply designed models that assumed the problem away and freed central banks from the fundamental problem of finding acceptable, if not optimal tradeoffs when setting policy.

Post the financial crisis, the great recession and in the midst of a painfully slow recovery, economists and central bankers are moving in the direction of flexible inflation targeting, i.e., allowing for the possibility that monetary policy should pursue goals other than just price stability. However, the flexibility appears to be limited to sequential shifts from inflation-only targeting to employment targeting and back. Policymakers are still talking as if they will never be faced with policy tradeoffs.
More recently, and very belatedly, monetary policymakers have acknowledged the existence of a link between monetary policy and financial stability. The existence of the link implies that the Fed faces potential tradeoffs not only between inflation and unemployment, but among inflation, unemployment and financial stability. Given that financial instability implies the possibility of increased unemployment in the future, there are also potential tradeoffs between current unemployment and future unemployment.

With financial stability as a goal in addition to its dual mandate, i.e., price stability and full employment, the Fed has three policy goals. How many resources, aka policy tools, does the Fed have? In terms of monetary policy per se, the Fed has one tool, either interest rates or the quantity of reserves. It also has a set of regulatory tools, but as Yellen has pointed out:

The Federal Reserve has been working with a number of federal agencies and international bodies since the crisis to implement a broad range of reforms to enhance our monitoring, mitigate systemic risk, and generally improve the resilience of the financial system. Significant work will be needed to implement these reforms, and vulnerabilities still remain. Thus, we are prepared to use any of our many instruments as appropriate to address any stability concerns.”

Policymakers do not have the necessary regulatory tools in place. The financial industry also has a well established record of innovating to avoid regulation. Hence, the Fed and other regulatory authorities will likely continue to lag the markets on the regulatory front. Furthermore, financial regulation and supervision will not control the behavior of financial institutions that innovate to avoid regulation, operate outside the regulatory border or across political boundaries. The remote likelihood of a lasting and sufficiently robust regulatory system raises the possibility that there will be times when it is advantageous for a central bank to alter interest rate policy to reflect financial stability concerns.

Interest rate policy also has advantages over regulatory policy in promoting financial stability. Interest rate policy has a non-discriminatory impact on regulated and non-regulated entities as well as across financial products. Furthermore, interest rate policy can alter the incentive that financial entities have to engage in regulatory arbitrage or to innovate to avoid the costs of regulation. This effect has been noted by Fed Governor Stein:

For example, if low interest rates increase the demand by agents to engage in below-the-radar forms of risk-taking, this demand may prompt innovations that facilitate this sort of risk-taking.

Consequently, interest rate and regulatory policies are not independent. The Yellen statement implies that the Fed is prepared to address financial stability concerns with interest rate policy. Plosser of the Philadelphia Fed has said that some members of the FOMC are concerned about the low interest rate policy because of increasing potential costs of financial instability. However, the Fed has not shown any inclination to do so and still asserts that interest rates were not “too low for too long” prior to the crisis. In fact, economists, central bankers and pundits continue to resist calls to acknowledge the possibility that it might be advantageous to design monetary policy with more than just one target in mind. They mustered a number of arguments. They include 1) the Tinbergen separation principle and 2) arguments based on the idea that central banks should specialize/focus on inflation as they have a comparative advantage in maintaining price stability.

Tinbergen Separation Principle

Wikipedia summarizes the Tinbergen separation principle as follows:

Tinbergen, in his work on macroeconomic modeling and economic policy making, classified some economic quantities as “targets” and others as “instruments”. Targets are those macroeconomic variables the policy maker wishes to influence, whereas instruments are the variables that the policy maker can control directly. Tinbergen emphasized that achieving the desired values of a certain number of targets requires the policy maker to control an equal number of instruments.

Tinbergen’s classification remains influential today, underlying the theory of monetary policy used by central banks. Many central banks today regard the inflation rate as their target; the policy instrument they use to control inflation is the short-term interest rate.

Ben Bernanke espoused this position in 2002 when he was a Federal Reserve Governor.

My suggested framework for Fed policy regarding asset-market instability can be summarized by the adage, “Use the right tool for the job.”

As you know, the Fed has two broad sets of responsibilities. First, the Fed has a mandate from the Congress to promote a healthy economy–specifically, maximum sustainable employment, stable prices, and moderate long-term interest rates. Second, since its founding the Fed has been entrusted with the responsibility of helping to ensure the stability of the financial system. …By using the right tool for the job, I mean that, as a general rule, the Fed will do best by focusing its monetary policy instruments on achieving its macro goals–price stability and maximum sustainable employment–while using its regulatory, supervisory, and lender-of-last resort powers to help ensure financial stability.”

Unfortunately, defense of inflation-only targeting via appeals to the Tinbergen separation principle are over simplified and misplaced. The separation principle was derived in the context of a macroeconomic model comprised of well-behaved linear equations. It is clear that real economies include dynamic non-linear relationships between variables and that behavior is at times chaotic.
Furthermore, Tinbergen’s principle was much more nuanced than one instrument for one target. In the context of his model, Tinbergen found that:

1. When the number of policy instruments exceeds the number of targets, policymakers will be able to chose from a menu of possible combinations of instruments to achieve the goals;

2. When the number of instruments equals the number of targets, all targets can be met and one instrument can be used for each goal; and

3. When the number of targets exceeds the number instruments, it will not in general be possible for policymakers to reach all the goals. Policymakers will be faced with having to make tradeoffs across goals. In general, policies will have to be designed with multiple goals in mind, if all targets are to be pursued.

The number of policy goals far exceeds the number of effective instruments.

Regulatory policy has been and is likely to remain incapable of insuring financial stability. Fiscal policy appears to be driven by concerns other than promoting the goals of economic policy, e.g., full employment. International economic policy is non-existent. Consequently, the Tinbergen separation principle should not be invoked to support inflation-only targeting, as the conditions under which it was derived are not met.

Appeals to Comparative Advantage

Central banks, including the Fed, presumably have both absolute and comparative advantages over other policy institutions in maintaining price stability. The exploitation of comparative advantages gives rise to specialization, trade, markets and increased efficiency. To many, this suggests that it is advantageous for the Fed to specialize in maintaining price stability.

However, there are limits to specialization, aka the division of labor. This was noted by Adam Smith in An Inquiry Into The Nature and Causes Wealth of Nations. Chapter III is titled “The Division of Labour is Limited by the Extent of the Market” and includes the following observations:

As it is the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market. When the market is very small, no person can have any encouragement to dedicate himself entirely to one employment, for want of the power to exchange all that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men’s labour as he has occasion for.

In simple terms, the ability of specialization to enhance efficiency and welfare depends not only on the existence of an agent with a comparative advantage, but also on the market and institutional setting.

If the Fed’s goal is to design and implement the optimal monetary policy for an otherwise perfect world, then complete specialization in the pursuit of a single target is appropriate. If the Fed’s goal is sustained stable growth with full employment in a world characterized by market and institutional failures, e.g., other policy tools are either non-existent or incapable of achieving their intermediate goals, then economics suggests that the Fed must accept the possibility that a one-target-only policy may exacerbate resource misallocation and contribute to inferior outcomes.

It is ironic that economists in pursuit of macroeconomic models with microeconomic foundations have adopted models and an operating framework that preclude the existence of the rationale for economics – the relative scarcity of resources and resulting existence of tradeoffs. In so far as inflation-only targeting contributed to the asset price bubbles, the financial crisis and recession, it was costly as well.

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10 Scenes From The Ongoing Global Economic Collapse

2013-05-15T05:14:00.004-04:00

When is the economic collapse going to happen? Just open up your eyes and take a look around the globe. The next wave of the economic collapse may not have reached Wall Street yet, but it is already deeply affecting billions of lives all over the planet. Much of Europe has already descended into a deep economic depression, very disturbing economic data is coming out of the second and third largest economies on the globe (China and Japan), and in most of the world economic inequality is growing even though 80 percent of the global population already lives on less than $10 a day. Just because the Dow has been setting brand new all-time records lately does not mean that everything is okay. Remember, a bubble is always the biggest right before it bursts. The next major wave of the economic collapse is already sweeping across Europe and Asia and it is going to devastate the United States as well. I hope that you are ready.

The following are 10 scenes from the economic collapse that is sweeping across the planet...

#1 27 Percent Unemployment/60 Percent Youth Unemployment In Greece

The economic depression in Europe just continues to get worse with each passing month. According to the Daily Mail, the unemployment rate in Greece has nearly tripled since 2009...

Greek youth unemployment rose above 60 per cent for the first time in February, reflecting the pain caused by the country's crippling recession after years of austerity under its international bailout.

Greece's jobless rate has almost tripled since the country's debt crisis emerged in 2009 and was more than twice the euro zone's average unemployment reading of 12.1 percent in March.

While the overall unemployment rate rose to 27 per cent, according to statistics service data released on Thursday, joblessness among those aged between 15 and 24 jumped to 64.2 percent in February from 59.3 percent in January.

#2 Detroit, Michigan Is Insolvent And Is Rapidly Running Out Of Cash

I love to write about Detroit because it is a perfect example of where the rest of the country is headed. They have just gotten there first. At this point, Detroit is essentially bankrupt, and the new emergency financial manager is saying that Detroit may totally run out of cash next month...

Detroit may run out of cash next month and must cut long-term debt and retiree obligations, according to emergency financial manager Kevyn Orr’s preliminary plan to save Michigan’s largest city from bankruptcy.

Orr’s report says the cost of $9.4 billion in bond, pension and other long-term liabilities is sapping the ability to provide public safety and transportation. He listed cutting debt principal, retiree benefits and jobs among his options.

“No one should underestimate the severity of the financial crisis,” Orr said yesterday in a statement. He called his report “a sobering wake-up call about the dire financial straits the city of Detroit faces.”

#3 Economic Despair In France

France is going down the same path that Greece, Spain, Portugal and Italy have gone. The following is an excerpt from a recent article in the Economist...

HELDER PEREIRA is a young man with no work and few prospects: a 21-year-old who failed to graduate from high school and lost his job on a building site four months ago. With his savings about to run out, he has come to his local employment centre in the Paris suburb of Sevran to sign on for benefits and to get help finding something to do. He’ll get the cash. Work is another matter. Youth unemployment in Sevran is over 40%.

#4 7,000 Abandoned Buildings In Dayton, Ohio

All over the upper Midwest, there are formerly great cities that are dealing with thousands of abandoned buildings. Dayton, Ohio is one example...

Like many urban cities in recent years, Dayton still finds itself knee-deep in abandoned, dilapidated properties as the result of the foreclosure crisis and economic downturn five years ago.

Boarded up buildings that appear to be on their last legs litter the city as it attempts to recover.

Kevin Powell, the city’s acting manager of housing inspection, says officials plan to use $5.2 million — half from the state’s Moving Ohio Forward program and a matching grant from the city’s general fund — to raze 475 abandoned properties by the end of September.

That will scratch the surface of an estimated 7,000 abandoned property problem that is growing.

#5 Overwhelmed By Squatters In Spain

In Spain, unemployment is rampant and people have become incredibly desperate. In fact, in some Spanish cities you can now find entire apartment buildings that are being overwhelmed by squatters...

A 285-unit apartment complex in Parla, less than half an hour’s drive from Madrid, should be an ideal target for investors seeking cheap property in Spain. Unfortunately, two thirds of the building generates zero revenue because it’s overrun by squatters.

“This is happening all over the country,” said Jose Maria Fraile, the town’s mayor, who estimates only 100 apartments in the block built for the council have rental contracts, and not all of those tenants are paying either. “People lost their jobs, they can’t pay mortgages or rent so they lost their homes and this has produced a tide of squatters.”

#6 The Collapse Of Chinese Power Consumption

Energy consumption tends to closely mirror economic activity. That is why the recent collapse of Chinese power consumption is so alarming. The following is from Zero Hedge...

According to CLSA's Chris Wood using NEA data, China's monthly power consumption (the most accurate proxy for underlying economic strength according to the current premier) growth slowed from 5.5% YoY in Jan-Feb 2013 to 1.9% YoY in March, the slowest growth rate since May 2009 (as discussed in-depth here).

#7 Horrible Economic Data Coming Out Of The Second Largest Economy On The Planet

The economic data that has been coming out of the second largest economy on the globe has been quite alarming recently...

#000000;">For starters, China’s recent economic data, as massaged as it is to the upside, is downright awful. China’s PMI numbers were the worst in two years. Staffing levels in the Chinese service sector decreased for the first time since January 2009 (remember that year).

#000000;">China’s LEI also shows no sign of recovery. If anything, it indicates China is heading towards an economic slowdown on par with that of 2008. And if you account for the rampant debt fueling China’s economy you could easily argue that China is posting 0% GDP growth today.

#8 One Out Of Every Five U.S. Households On Food Stamps

Back in the 1970s, about one out of every 50 Americans was on food stamps. Today, even though we are supposedly in the midst of an "economic recovery", food stamp enrollment continues to soar to new highs. The following is from CNS News...

The most recent Supplemental Assistance Nutrition Program (SNAP) statistics of the number of households receiving food stamps shows that 23,087,886 households participated in January 2013 - an increase of 889,154 families from January 2012 when the number of households totaled 22,188,732.

The most recent statistics from the United States Census Bureau-- from December 2012-- puts the number of households in the United States at 115,310,000. If you divide 115,310,000 by 23,087,866, that equals one out of every five households now receiving food stamps.

#9 Child Hunger In America

Those that work for the big banks on Wall Street may have no problems feeding their children, but overall there is a rapidly growing child hunger crisis in America today. Just check out the following statistics from one of my previous articles...

*For the first time ever, more than a million public school students in the United States are homeless. That number has risen by 57 percent since the 2006-2007 school year.

*In Miami, 45 percent of all children are living in poverty.

*In Cleveland, more than 50 percent of all children are living in poverty.

*According to a recently released report, 60 percent of all children in the city of Detroit are living in poverty.

#10 The Tremendous Suffering Of Hundreds Of Millions Of Desperately Poor People That We Never Hear About

There are billions of people around the globe that are deeply suffering but that do not have a voice. We usually never hear about the desperate poverty that these people are living in, but that doesn't mean that they don't exist. The following statistics that Stephen Lendman recently compiled should shock and alarm you...

At least 80% live on less than $10 a day. Over three billion people live on less than $2.50 a day. More than 80% live in countries where income disparity is increasing.

The poorest 40% of world population has 5% of global income. The bottom fifth has $1.5%. The top 20% has 75%.

According to UNICEF, 22,000 impoverished children die daily. They "die quietly in some of the poorest villages on earth, far removed from the scrutiny and the conscience of the world. Being meek and weak in life makes these dying multitudes even more invisible in death."

An estimated 28% of children in developing countries are underweight, malnourished and/or stunted.

How can so many people be living like that in a world with such wealth?

Sadly, things are going to get much worse. The economic and financial systems of the world are rapidly breaking down, and in a few years these are going to look like "the good old days".

And a growing number of people are starting to realize the direction that things are headed. For example, according to a survey that has just been released, 48 percent of all Americans believe that the best days of America are now behind us.

So what do you think?

Are our best days behind us, or are they still ahead of us?

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