Monday, December 27, 2010

Is raising inflation expectations a good idea, and will it work?

There have been several discussions about the viability of monetary policy right now, just when the economic authorities need to create demand while at the same time rates are at the zero bound*

Focusing on interest rates had always been what monetary authorities focused on. And for a long time, it seemed the effective and fiscally prudent policy choice. For as long as tweaking rates could increase or decrease economic activity, there was no sense in putting focus on extensive fiscal action. Fiscal policy determination is a politically-charged process, and very often ends up being directed at wasteful projects, and cutting the most fruitful activities in the worst possible way.

But for as long as the challenge is to simply reduce demand, increasing rates will do. If the challenge were to increase demand, as it is in the US right now, you also have to address several factors. I could list a few things other than rate/price that could influence, or put a limit on demand at the individual level.

Level of current income, level of current expenses, current level of indebtedness, capacity to service existing debt, capacity to borrow more-to financing more spending, confidence in stability of future income, expectations about future increases in fixed expenses, confidence in future value of purchasing power of current savings (if you have any), non-existence of any lender calling on their debt, confidence in future positive value of existing savings/investments/net worth, ease of liquidating current savings –to finance current spending, tax implications of using current income/net worth to spend now vs. later, confidence about over-all economy, and how it is being run… the list goes on further.

These can be addressed either directly, via fiscal policy action, or indirectly, via monetary policy action. When you are at the zero rate bound, the monetary policy tools to use (QE, etc) have the objective of increasing inflation expectations. If people expect heightened inflation, monetary authorities intend them to do several rational acts: buy stuff now that they would have postponed ‘til the future, and make investments in businesses, stocks, and others that rise in tandem with inflation.

Examples were made of buying a canoe now, buying a farm, buying oil and gas shares, as well as buying a restaurant meal now. The point was also made that rising inflation will spur people to borrow money, since the rising inflation will increase the value of physical assets, while inflating away the real cost of borrowing.

But rising inflation expectations cuts both ways. If a lender is going to lend to a borrower to buy his canoes now, it's now going to lend him at the rate that incorporates the higher inflation expectations for next year. So the higher borrowing rate effectively offsets the value of buying canoes now rather than buying it at a higher price next year and just borrowing less (or not at all). There's no way to get ahead if the other side also knows what one side knows.

And if Farm sellers and oil and gas shares owners know that inflation will be higher next year, they won't sell their farm now. Or they will sell their shares at a price that reflects the higher inflation. Intentional buyers may end up not wanting to buy anymore.

Having the restaurant meal now will likely be the best bet to get ahead, since the restaurant will likely still be selling at the price level that he already bought his cost inputs. But then, if one is worried about looming inflation, he may be less likely to eat out, too. For if people can be influenced that inflation can and will be increased by monetary authorities, they can also, and might be, influenced that inflation will get out of control (maybe because the currency is depreciating and higher imported input costs are wreaking havoc on the economy). In this sense, increasing inflation expectations may backfire, and cause demand destruction, the opposite of the intended effect. He may now be thinking that he needs to preserve his soon to be diminished purchasing power for basic necessities. He will trade down to less costly substitutes. He will ration his supplies. He will repair stuff rather than buy new ones. These are rational actions to make during runaway inflation.

It would be better yet, if the challenge were to increase demand, to just directly address the following: level of current income, level of current expenses, current level of indebtedness, capacity to service existing debt, capacity to borrow more-to financing more spending, confidence in stability of future income, expectations about future increases in fixed expenses, confidence in future value of purchasing power of current savings (if have any), non-existence of any lender calling on their debt, confidence in future positive value of existing savings/investments/net worth, ease of liquidating current savings –to finance current spending, tax implications of using current income/net worth to spend now vs. later, confidence about over-all economy, and how it is being run…..via fiscal policy action instead.

*This post flows from two unrelated comments I made in discussions elsewhere. It doesn't particularly react to the original post where those discussions arose.

Tuesday, December 14, 2010

Flaws in the belief in effectiveness of Fed monetary easing

QE2 is hailed by some economists as the tool needed to jumpstart the laggard US economy. The mechanism here is - The build-up of the monetary base eventually leads to rising inflation expectations. This is supposed to then encourage people to start buying things now, in anticipation of rising future prices, which then leads to a positive multiplier effect for the economy. There are several flaws in this belief. Here are reasons that I could think off the top of my head:

Debt among economic agents is ignored/inflation expectations is over-estimated. Debt does make a difference. Inflationary measures can be hindered in a recession economy with a lot of debt, because the indebted that are undergoing deflation, i.e. balance sheet recession, will not be induced to make more purchases if paying off the debt is already eating up much of their income. They will hope that the non-indebted ones will come to the rescue, and be induced to consume more via increased inflation expectations. But then, the non-indebted have to be convinced that the ongoing balance sheet recession among the indebted will not counteract any of the inflationary measures.

This was effective on the way up to becoming a debt society. Now no longer.

Transmission to the larger economy will be via even more debt. QE2 puts more reserves on the banks, but no money goes directly to people who will spend it on consumption. For this to get to the end-consumers, those remaining non-indebted will have to take one for the team, get into debt, and spend it in the local economy.

On the way towards becoming a debt-centered society, people managed to continue their consumption activities by getting into more debt. They were able to secure debt because they were able to borrow against the increasing values of homes and investments. This increasing value was only possible for as long as more people were chasing into appreciating assets, but had to stop when many people can no longer realistically afford the increasing prices. The debt deleveraging that follows results in depreciating assets, and which leads to more insolvencies, leading to even more deleveraging.

Getting into new debt will be the last thing on the minds of those currently deleveraging.

It floods the banking system with trillions in reserves but zero new capital. Banks do not need reserves to do their lending activities. If a bank is to grant more loans, it needs adequate capital, in order to buy risk-weight assets, and needs to have credit-worthy borrowers. If it has both of these, it can always raise any deficiency in its reserves, i.e. deposit base, by borrowing in the interbank market, or from the Fed’s discount window. If it doesn’t have adequate capital, or a compelling borrower, no loans will be extended.

The continuing deleveraging doesn’t help in building up bank equity, or confidence to lend.

It assumes that in deciding to borrow, companies care more about cost of funds than improving sales and profit. QE2 is supposed to decrease long-term interest rates. That’s meant to elicit more company borrowing for long-term capex. But without improvement in aggregate demand, sales prospects and profits do not improve. Also, to the extent that QE2 results in more funds being diverted towards asset bubbles, it’s going to make cost of funds more expensive.

These arguments doesn’t necessarily mean that I believe monetary policy/quantitative easing will have no effect on sentiment whatsoever. I think the effect will not be evident while having a long build-up. In the end, there will be a big snap. This comes when people lose confidence in the debased currency (which is toxic when not matched by a growing economy), and people begin to trash it.

Wednesday, December 8, 2010

Computing for the Bail-Staff jobs save factor

My last post expressed surprise that McD’s was involved in the massive Fed emergency program. But then, I got to thinking, if one of the purposes of the bailout had been to save jobs, then McD’s should be right up there with the rest of them, right? After all, McD’s employs lots of entry level staff positions, contributing significantly to aggregate demand. So I wondered further, why don’t we try to evaluate the effectiveness of the Fed bailouts in terms of saving jobs? What if we were to use a new metric, something like the Bailout dollar amount to number of staff jobs saved, or more simply, a Bailout to Staff multiple. To be short, let’s simply call it the “BS factor”. Here then is a table, evaluating the Fed emergency loans in terms of its BS factor among a sampling of recipients (click for full view):
From the list, it is evident that McD’s actually registers the lowest multiple on our newly-minted “BS factor” scale. The highest BS factor belongs, far and away, to Bear, followed distantly by a close tie between Merrill and Morgan.

Citi and BofA register much lower BS factors because of their higher staffing numbers (Taking into consideration, of course, that much of this staffing number is actually outside the U.S. putting them outside the Fed’s purview. But then, every nation that hosts a Citi or a BofA branch likely has sizeable dollar holdings. While the dollar is the US currency, if the Fed debases, it is everybody else’s problem).

Now I don’t know if looking at emergency loans provides a comprehensive picture of the overall assistance back in ’08. After all, the Fed also took on derivative positions and bought toxic assets, so this table may actually be discounting a large multiple of BS factor .

Also, looking at the “beneficial” effects of the bailout simply on the number of staff positions saved is an incomplete analysis. After all, many of the bailoutees were highly interconnected entities whose failure may have caused even more staff positions lost in the economy, whether directly employed by the bailoutees, or not. (A failure by one of these guys has a negative effect on the viability of companies like McD’s, whose business operations are facilitated by the financial system). So the table may also be overestimating “BS factor”.

If there's anything to learn in this exercise, it’s nigh impossible to calculate the effectiveness multiple when we are talking about bailouts – you get lost in all the layers of BS.

Wednesday, December 1, 2010

The Fed's beneficiaries list

We ’ ve been getting big interesting news today. The Fed finally made public its list of the biggest beneficiaries of its emergency program during the 2008 financial crisis. In case you didn’t know, this is the long-held secret list that Ben Bernanke and the rest of the Fed had wanted to take with them to their grave. But due to some astute legal maneouvers by media, this is now seeing the light of day.

And according to the list, among the biggest beneficiaries were, no surprise here, European banks. But surprise, surprise, we also see that non-bank non-financial firms Mcdonald’s and Harley Davidson are on the list. So it seems Mcdonald’s has found a rich new revenue source - satisfying the Fed’s Super-sized hunger for toxic assets. From Huffington Post. HT: CW

The data revealed that the Fed's aid was scattered much more widely than previously understood. Two European megabanks -- Deutsche Bank and Credit Suisse -- were the largest beneficiaries of the Fed's purchase of mortgage-backed securities. The Fed's dollars also flowed to major American companies that are not financial players, including McDonald's and Harley-Davidson, through unsecured short-term loans.

Wow. That’s $billions$ worth of two all-beef patties, subprime sauce, lettuce, cheese, pickles, onions on a CDO bun. I guess I now have to ask the question that’s probably on a lot of people’s minds right now… did that amount come with a large side of fries and coke?

UPDATE: McD's issues a correction statement: The Fed determined that McDonald’s, while not listed as a borrower under the CPFF, benefited from the program as a “parent/sponsor” of Golden Funding Corp., which sold a total of $203.5 million in commercial paper.

The designation is incorrect, McDonald’s spokeswoman Heidi Barker Sa Shekhem said in a statement. “McDonald’s Corp. was erroneously listed by the Federal Reserve Bank as a recipient of federal funds during the financial crisis of 2008,” she said. So it's not McD's, it's a subsidiary (you see a difference?), and I should clarify that the Fed assistance is in buying their paper, not mortgage bonds that they own.

Friday, November 26, 2010

Does QE enable more fiscal policy action by government?

Is the Fed’s QE2 program a monetization of sovereign debt? And hence, does it enable more fiscal policy action?

Looking at it from its effectiveness as an enabler of private bank lending, it falls short. QE 2 operationally is the purchase of long-term government bonds by the Fed. The largest holders of this security are commercial banks, who will essentially get cash, or in bank parlance, additional reserves, in exchange for their government securities.

Scott Fulwiller has given a convincing explanation for how banks do not lend their reserves. Put another way, banks do not need reserves to do their lending activities. If a bank is to grant more loans, it needs adequate capital, in order to buy risk-weight assets, and it needs to have credit-worthy borrowers. If it has both of these, it can always raise any deficiency in its reserves, i.e. deposit base, by borrowing in the interbank market, or from the Fed’s discount window. If it doesn’t have adequate capital, or a compelling borrower, no loans will be extended.

So QE2’s flood of new reserves into the banking system will not necessarily result in a flood of new loans. So what can this be useful for? Well, you could look at it this way. Excess reserves may not fund more loans, but any excess will be put into more liquid marketable securities. If the natural buyers of government bonds suddenly have more cash, and lesser of the bonds, will they be more susceptible to buy bonds in the next auction? Yes.

The Fed , by its charter, is not allowed to buy government securities in auctions, it can only buy them in the secondary market, via open market activities (or QE) . Treasury, on the other hand, is not allowed to fund its deficits by printing money, it needs to float bonds to finance the deficit. The Fed, by buying the older issues of treasury via QE2, has given the banks, the natural buyers in Treasury auctions, a clean slate, so they can again be buyers in the government’s next auction. Because they have a clean slate, they will be ready to fund a higher government deficit, without raising borrowing costs for the government. So they can enable the government to undertake more pump-priming activities.

This can be tricky, though. The Fed should clearly show the market that its interventions in the bonds market will not make owning government bonds too penalizing (by causing zero to negative returns), or the banks will just stick to their cash, and not participate as actively in the next auction (thereby increasing government borrowing costs again).

Now, is QE2 necessary to ensure that funds are available for the next government bond auctions? No. Government deficits, or government spending, by their nature, create private sector income. It is this private sector income which can then be used for consumption in more private sector goods, and eventually result in private sector savings, which go into commercial banks as deposits, which causes bank reserves to increase, which makes banks buy more government securities.

No Fed easing required. QE2 only increases reserves, most of which will likely be kept within the banking system, and nowhere near the real economy, and it only increases the Fed’s balance sheet. It may result in some banks using the new reserves to speculate in risk assets other than loans (if they do have adequate capital, but still not enough credit-worthy borrowers). Some of it may be deployed into risk assets by credit-worthy borrowers who are not building businesses, but are building portfolio assets on margin. But that’s another story.

Our point here is, does the Fed’s QE2 program enable further fiscal policy? You could say yes, but it is not necessary. Government deficits, which put money into the people’s pockets, who will then spend it in the economy, enables its funding by itself.

Monday, November 15, 2010

Super-freakin' CDO P.I.M.P.

I don't know what you heard about me
But a bitch can't get a dollar out of me
No Cadillac, no perms, you can't see
That I'm a motherfucking P-I-M-P

Whenever I sell U my CDO’s
I’m gonna fuck U like common ho’s
‘Cos I’m a bonus-driven banksta
Comin’ to push subprime at’ ya

Pushing toxic is my specialty
Whenever my clients ask for their sexy
AAA debt with yield that make ‘ya come
I slice ‘n dice ‘em ‘til the risk seems gone

You won’t know it when I’m short
It’s yo’ goddam fault if yo’ get hurt
Securitizing shit is the thing in my ‘hood
Ripping clients’ face off whenever we could

Yo, I’m a super-freakin’ banksta
At the right basis points, I securitize yo’ grandma
When I get in trouble, you’ll save me ‘cos I’m so fly
I’m 2big2fail, I can blow tha system sky-high

Don’t get mad at me ‘cos I’m rich
I’m just doing God’s work, bitch!
No Cadillac, no perms, you can't see
That I'm a motherfucking P-I-M-P
snoop or white shoe banker?

Friday, November 5, 2010

Silver lining to quantitative easing?

Could there be a silver lining to quantitative easing/currency depreciation of the US dollar? Previous posts here, and much of elsewhere, have focused on the destructive effects of the easing. But my question now is, could it actually have a positive effect?

In my thinking, it all depends on whether it succeeds in effecting one of the lesser talked about objectives that the global economy right now – realigning and revaluing of currency values, commensurate to the growth rates of their respective economies.

Right now, global imbalances persist because certain countries choose to peg their currencies to the US dollar. So if an overvalued US dollar results in a trade deficit to the US, the self-correcting mechanism of an appreciating currency does not result. The continuous peg of exporting countries on the dollar keeps it from doing so. So the US continues incurring a trade deficit while the pegged countries continue having their surplus.

What quantitative easing would do, more than causing the hoped for but largely improbable reflation in the US economy, is to cause this inflation elsewhere, mainly due to shifts in hot money flows and the carry trade, particularly to the countries that peg themselves to the US dollar.

It is inescapable. If they choose to keep the peg, the more inflation they cause on themselves, because their trade surplus results in a continuous influx of currency into their economy, but also because their peg forces them to allow in more of the US dollars being printed. The more the Fed eases, the more dollars these pegged currencies have to sterilize, and hence, the more they too, end up loosening monetarily. A loose monetary policy is the last thing a surplus country with a booming economy should be doing.

A silver lining that might result is an overall increase in salaries of the surplus nation’s local workers, to compensate for the increasing costs of goods domestically. This would lead to more equalization of living standards globally. Done the right way, and in the right areas, and it would no longer matter which country you go to, to hire a mechanic, a barber, or have your taxes done. They will all congregate to one global standard price.

On the US side, this means a return of a lot of manufacturing capacity, as their local manufacturing wages become more competitive vis-à-vis the rest of the world. As for the rest of the world, i.e. the emerging markets, their populace’s rising income should make their local economies more readier to accommodate higher value-added services and businesses that currently are only viable in the US.

Could we see the rise of an equal to Wall Street in Shanghai or Melbourne? Or an equal to Silicon Valley and Hollywood in Mumbai? What about an automotive design center considered a peer to Detroit situated in Bangkok? Or a garment design center similar to New York, but located in Jakarta. Could this actually happen, or can this be nothing more than a pipe dream for the emerging economies?

My guess is that as things currently stand, a fast-rising inflation will crush these economies. Inflation will end up killing the people’s real income, and hence, their purchasing power, and lead to over-all depression in the economy. Which is why they are taking steps to prevent this from happening. They would rather have capital controls, and likely, would rather give up the peg than allow hyperinflation to kill their economies.

But what should be done, such that the alternative scenario could happen? What is needed, so that emerging economies can take this opportunity to grow and nurture viable higher value-added service economies that could be considered equal level alternatives to those in the US? Previous posts here would provide some ideas.

Not all emerging economies are as big as the BRIC nations, hence not everyone has the requisite economies of scale to nurture high end service-intensive industries that can compete side by side with the US. So they need to set aside any local rivalries, and start thinking about creating regional trading blocs.

Higher end service industries need a lot of higher-end personnel. Hence, they need to open up and allow unfettered migration of experts into their local economies. As repeatedly recommended, like a broken record, on this site and elsewhere, they need to develop a healthy thriving local consumer base. Do so, and perhaps, even higher-end personnel they have already lost to the developed economies will start coming back to help jumpstart the transition to higher end. They need to put special focus on and promote small business, the largest employer in the aggregate of the economy. Since a thriving and healthy local consumer populace will start eating more and demanding more, they need to reinvest in agriculture.

I speculated as much once before.

Addendum: I add more in comments section here.

Friday, October 29, 2010

Will Social Security ever be bankrupted?

Just the other day I again heard the claim that Social Security (in this context, the U.S. Social Security fund) was due to become bankrupt, and is expected to be extinct by 2030. I used to have this notion, too, until I came across this paper. It’s a paper by Dimitri Papadimitriou and L. Randall Wray, written in 1999. I ran across it in my previous research on Chartalism, and disabused me of any notion that Social Security, and for that matter, Medicare (or Social Insurance, as its Canadian counterpart is known) will ever be bankrupted out of existence. At least not until we first encounter either extreme inflation or deflation economy-wide.

The paper writes: “According to intermediate-cost assumptions, total income (of the fund) will begin to fall short of expenditures by 2020” and outlines several statistics for why this would be so, which is basically largely due to the retiring baby boomers.

The paper acknowledges that “the real burden will be faced by future workers who will have to produce the goods and services required by future retirees”. But the paper also states that “this issue is separate from the supposed financial crisis of the fund. The future problem will be one of distributive issues rather than financial”.

“Taxes paid by today’s workers are used to pay today’s retirees. If money is left over, it finances other government spending.” In other words, the fund surplus we see today merely enables government to incur more spending (After all, all the fund’s investments in government securities in effect funds government spending (and deficits).

“When the benefits due exceeds the proceeds from payroll taxes, the difference will be financed by raising taxes, borrowing, creating money or reducing government spending.” In other words, there will come a time when government spending will largely be made towards funding the pensions and healthcare of more retirees. What this also means is less spending on other items (defense, war, pork barrel projects). But the government will still have to undertake that spending, even if it means going into bigger deficits. After all, all that future government deficit will then be financed by the investments of the nation’s future workers who expect to be retirees themselves one day. For as long as somebody needs to set aside some savings, and is looking for an investment outlet, there will be a market for government securities.

In other words, when current taxes no longer match fund payouts, we can expect more government deficits to make up for the gap, in effect, perpetuating the fund. I know that in concept and practice, the fund seems like a Ponzi scheme (and it is), but then isn’t the whole business of older generations spending for the raising and caring of a new generation also one giant Ponzi scheme?

To finance fund deficits that would definitely come by 2020, the fund will also have to start selling assets. “Selling of assets will only work smoothly in funding the needs of retirees if those who obtained income from work in 2020 reduced their consumption in order to buy the assets being sold by the fund” (in effect replace the retirees on the savings side). “Otherwise, asset sales would merely depress asset prices, and the competition for consumption by workers and retirees would drive up the prices of goods and services.”

The authors write: “Future burdens (on the fund) can be reduced by increasing the growth of the labor force, by increasing employment opportunities, and by attracting new workers. ….In short, productivity gains plus labor force growth will together determine growth of real output.…..Unless we enhance society’s ability to produce goods and services by 2020, the amount to be distributed will be exactly the same whether the fund is larger, smaller”

The authors advocate a “pay as you go” system, and that taxes be reduced now so that fund revenues and costs are more easily aligned. The fund need not increase taxes now to accumulate more investments to prepare for the time in 2020 when program benefits are expected to surpass taxes. “Higher taxes (now) might reduce consumption (now), and might also depress (private) incentive to invest, generating unemployed resources, and further deteriorating consumption patterns.

“Simply trying to encourage investment by itself will not work in a demand constrained system because it just leads to excess capacity. It would be better to stimulate other spending that then creates the private incentive to invest …Government spending will raise demand and thus stimulate investment.”

In short, we have been doing everything possible to exacerbate the future situation of the fund. We advocate all sorts of austerity programs that destroy current demand, which destroys economic growth, and hence, diminishes the future economic pie that would be distributed for the time when there are more retirees on fixed income.

What we should be doing is focusing on improving productivity now, so that the economy produces enough goods to satisfy the needs of everyone by 2020 and onwards, whether they can still come to work, or can barely get out of bed. But a larger tax base now will depress consumption NOW.

A larger tax base will probably be necessary in the future if are to have a fund that can finance the needs of more retirees without relying too much just on deficits. (And in a future where the retirees are the majority, it doesn’t take much imagination whose interests future politicians will favour on most cases).

But a larger tax base when the time comes will be more palatable if there is enough income left over to satisfy the needs of those who'll be paying them by then, for their own consumption and savings. That income will only be sufficient if the economy is producing enough, so that nobody is priced out of basic necessities.

If productivity in basic necessities does not increase between now and 2020, then future competition for consumption will result in inflation down the line, and this will help no one. In that case, the fund being bankrupted out of existence will be the least of our worries. Extreme inflation (due to consumption competition) or deflation (due to excess saving without investment) will be.

Friday, October 22, 2010

Is there really a bank overcapacity, and have we reached the tipping point of bank privatization

It has been repeatedly said that there is a big overcapacity in the US financial industry. But is there really an overcapacity? So how come we see instances of this, of banks using robosigners to mindlessly sign foreclosure papers, and not employing adequate staff to check for proper documentation?

This overcapacity depends, to a significant degree, on what part of the bank you are looking at. Look at the trading and securitization side, and yes, there would seem to be a major overcapacity. Look however at the traditional banking operation side, and well, everywhere you look you’re bound to you see the work of an army being done by a platoon, on some cases, by a squad, and even, more frequently than is supposed to, by a lone person.

So why do we see this dichotomy? At a time when banks are supposed to be the biggest profitmakers in the economy, a time when it seems that they can extract a spread out of every deal, fart, or twitch a market makes, why do we see staffing in crucial and oftentimes franchise-breaking operations severely constrained?

Blame it on the same cost-cutting mentality found on every other industry. Operations is a cost center, not a profit center. In any business, the profit centers are where the deals get done, where the sales are made, and where the trades are decided. Never mind that any of these activities cannot be done without adequate operational backup. If you are not in a client-facing role, you may as well not exist. If you do not bring any transactions, you are eating off the pie of the hardworking rainmakers.

Let’s pause a minute to consider the economics of banking. Being intermediaries, they act essentially as middlemen. The more a particular banking service becomes crowded, the less profitable that service becomes. Any form of banking service is non-patentable. Hence, any and all new innovation is easily copied and competed away by its peers. The less profit, the greater the need to cut costs.

A banking service niche can easily be stolen by a competitor, by poaching key salesmen, technical staff, or traders. After the competition has bid away these key people, what you have left are the support people. Without the volume generated by, or any key people to support, these operations become too unwieldy and costly to maintain. After all, it is mainly the fees, trading gains, and commissions that subsidize them.

So what does a typical bank CEO do? Driven by the profit motive, and egged on by insistent board of directors, and shifty shareholders, he will focus his efforts on keeping the rainmakers, and on curtailing the operations side. The focus then becomes doing as many deals as possible, and taking on as many risky trading bets as can be found. This is what affords the heightened costs of keeping the rainmakers as well as maintaining the operations side.

So we see the proliferation of endless origination, packaging, and selling off of deals, even after the market for viable clients has long been saturated. For as long as the bank’s value at risk seems maintained at a reasonable level, and in a market where every asset is pushed up to ever-higher levels it will be, the success of previous deals and bets sets off a continuous pipeline of further deals and bets.

In the first stage, the bank’s goal is to achieve economies of scale, for this is what justifies having the infrastructure that executing these deals and bets successfully needs. In the second stage, the bank’s goal is now to achieve growth for growth’s sake, profit for profit’s sake. If you do not take that last piece of the market, you competitor will, and before you know it, it’s also taking away the piece you already have. If you do not take that last piece of profit, you competitor will, and before you know it, that profit is enabling him to under-price you, and is now taking away the piece you already have.

So what do we have here? A bank which engages in a lot of utility banking, the kind that you and I use in our everyday needs (checking, credit cards, wiring and payment remittances, etc) also engaging in a lot of risky and directional bets (casino banking) to compensate itself for the “God’s work” that it does for society.

In this current American foreclosure crisis, we’ve seen that banks, in their race to the bottom to cut costs, have found themselves inadequately staffed to undertake a process whose proper execution is to their own interest. How much less do you think are they adequately staffed to undertake a task whose proper execution is to the client’s (you and I’s) interest?

I ’m taking this up because what becomes industry standard in the US becomes industry standard elsewhere in the world. If the onset of globalization had not suddenly and violently been shaken by the crisis, how much more of crucial operations ( crucial to yours and mine, the general public) would have been subject to the axe and chainsaw? How long before this unsustainable standard is the standard in your local bank?

Banks do a lot of utility banking, the kind that are so crucial, that the government needs to step in at times to maintain them in functioning order at all times. But they also do a lot of casino banking, both to maintain the utility side, as well as to satisfy their leaders’ and their shareholders’ need for more wealth. And more often than not, the government has had to step in to save the bank from its casino deals than to ensure the continuation of utility banking.

How much easier it would be if we were to find a way to completely separate the utility and the casino sides of banking, and to extend the government blanket on just the utility side of banking. And perhaps, freed from the (seemingly) excruciating burden of having to maintain an adequate operations side for utility banking, the private investors and shareholders of pure casino banking would be satisfied with much lower profit expectations. The knowledge that the government umbrella has been divorced from their casino activities should further dampen their need for greater risk and yield.

But we do not live in an ideal world, nor has anyone found the ideal way of separation. We live in a world where the government needs to constantly monitor banks, and regulate them like a hawk. It needs to constantly see whether bank competition is getting out of hand, because the banks’ goal is now to achieve growth for growth’s sake, profit for profit’s sake.

In this way, it ensures both that the traditional utility banking that you and I have come to depends on keeps running, as well as ensures that the need for further government bailouts of casino bets gone made and bad are avoided. Perhaps the ideal is for the biggest utility banks to be state-owned banks.

Have we finally reached the tipping point of the move for bank privatization?

Thursday, October 14, 2010


It’s late in the game, and the beleaguered coach of the recovery team gathers his clutch players together to come up with crucial new plays and team substitutions. He huddles with his key clutch players: Central Bank (CB), Finance Minister (FM), and Commerce Minister (CM).

COACH: Okay team, looks like we’re getting clobbered really bad in here. We’re down 30 points, and everyone in our team on the court is not doing his job. They’re just standing there while our score gets deeper into deficit. We need a play, and I’m putting in key substitutes.

Coach looks over to FM and CM: you guys are going to go out there and rouse everyone into better play. You need to come in big, and you need to do it quickly.

CM and FM: Yes coach!

COACH: FM, you need to take the ball and start passing it around. We need to get the other players into key positions to make a score. You know the drill. You can always get the ball when nobody else can. You do your job. CM, you need to make some key defense maneouvers. The other team is really good, and our players and getting creamed. You need to protect each one of them so they can get into the scoring position that we want them to get into.

Suddenly, CB starts shouting at the coach.

CB: But coach, why are you sending in these two guys? I’m way better at getting the team back into play. You know this, I’ve done it many times before!

COACH: I know. I’ve been sending you out every time we were behind previously. But we need a different play this time. It seems that every time you get in the game, everybody else gets too complacent and expect you to do everything. You grab the ball, you run with the ball, and then you’re supposed to shoot. It just makes it worse because it gets everybody else out of the game. We need everyone working their positions, CB. I don’t want your play dominating our team. It’s not sustainable.

CB: But coach, I can sustain it. I have many more tools up my sleeve. You have yet to see them!

COACH: No, no. you’ve done enough. The team already anticipates your moves, and are automatically adjust themselves to you. They no longer have their eye on the ball whenever you’re out there. They don’t focus on the other team or the game. They just focus on you. I want this to stop. I want our new play to consist of FM passing on the ball and setting up our other players to key scoring positions. But CM needs to do his job of defense as well. The other team has been playing it dirty.

CB protests: But coach, FM has this tendency to pass the ball to his favourites. They’re not always the best ones to make the score. We only end up wasting scoring positions. And every wasted score by FM only makes our team more tired! When I do my play, nobody gets tired. I do the heavy lifting for everyone! You have to see….

FM protests this time: Now wait a minute, CB. That’s a big accusation. I don’t play favourites here. I just pass to whoever has the position. You may not like my methods much, but I’m effective, because I can see the entire court. I just happen to want everyone to be happy, so I have to give everyone a chance to get the ball.

CB: See, that’s the problem! You don’t really see the entire court! You never see the opposing team coming up behind your back. How many times have you lost the ball that way? And this business about giving the ball to everyone who asks for it….

FM: Hey! I resent that! I at least have better teamplay and accountability than you! The other players understand when I tell them to move this way or that way. They know what I’m trying to do. Whereas you, you march to your own drum. Everybody just ends up wasting effort trying to read what you’re going to do. You end up making everyone pile into the same position they think you’re going to. That creates a dangerous crowding of the players, and just creates a large offensive opening for the opponent.

CB: Hey, that’s been effective in confusing the opponent too. You see them also crowding into the same positions too. I can manipulate them, so as to create an opening for the others. Your endless passing around of the ball is the one that’s confusing, and, as I said, tiring for the players.

CM: You too should just really chill, okay. The players are well able to score by themselves, okay. They don’t want either of you manipulating anything. Just let me help set up their defense. I’m also going to organize a stronger clustering play. You’ll see. We’ll start making points as soon as I set them up to double team the opposing team.

FM: You and your harebrained plays! The team is outclassed this time. They need my help. I run faster and see farther than any of them. I’ll run over to where they can’t run, and start passing. That’ll revive their spirits. That’s what we need right now. A rekindling of the fighting spirit. They’ve lost it, because of the disorganized play that resulted from your constant insisting that we leave them alone.

CM: You can’t run forever. You’ll eventually tire.

FM: No I won’t. I’m not subject to the same constraints as the others. I can keep producing a new ball to pass. The more balls going around, the better our chances of scoring.

CB: I can also produce balls myself. Let me do it. And I can immediately replace the balls that the other team stole, either because you passed it to the wrong person, or he misplayed it. That way, no player is ever left without a ball.

CM: What! This is madness! What utter madness! Do you know what it will do to the other players and their games if you keep giving them a ball for every one that they lose?

COACH: Enough, all of you! Look at the other team. Their own CB player is doing exactly the play that CB is contemplating. Constantly replacing all the lost balls of their team. FM, CM, sit down. CB, get into the game! You’re the only one who can defend us against this vile play. FM, you’re gonna have to cool it first. Your play is pointless if the other team keeps producing a ball for every one you steal. You too, CM. There’s no better defense against a constantly ball-replenished team than having team that’s also constantly ball-replenished.

CB shouts, as he runs towards the court to play: Don’t worry coach. I won’t let you down. I’m going to keep at my play until we run down the clock. No way the other team is going to win with that play while I’m in the game.

COACH: God help us!

Friday, October 8, 2010


Alright. This has been called an outright war, gentlemen. There is no more sense being coy about it, so let’s recognize the battlefield tactics for what they are. For it is clear that this currency war is not just a mere act of policy (you wish!), but a true global trade statement – a continuation of trade policy by other means (sorry Col. Clausewitz).

Developed country with trade deficit

- Engage in massive and multi-tranche Quantitative easing/currency printing, currency depreciation.
- Buy everybody’s bad debt for cash, cash, cash, baby!
- Encourage your local fund managers to send all this new cash to asset markets all over the world.

Emerging market country with surplus trade

- Buy up all securities issued by the global reserve currency issuer/your major trading partner/the biggest moron without a clue.
- Use the forex reserves you build up to buy new colonies in Africa and/or basic commodities
- Blow asset bubbles everywhere

Developed country with surplus trade

- Group up with less productive economies.
- Adopt a common currency
- Reap the benefits as your partner countries’ debt problems cause a falling currency
- Constantly blame their idiocy, but keep bailing out their debt. Keep the gravy train rolling for your local exporters.

Emerging market country with balanced trade

- Set up capital controls/massive forex sterilization campaigns, to manage ill-effects of all the hot money coming in.
- Use the forex reserves this build up to pay down forex-denominated country debt, and/or swap medium-term sovereign loans into longer term. Exchanging 10 year tenors into 1000 years at rates that end up taking a pound of flesh from your investors is considered the equivalent of taking the hill.
- Blow asset bubbles everywhere

Developed country with balanced trade

- Keep policy rates at zero bound/quasi zero bound.
- Engage in wasteful government projects, to keep yield-chasing global speculators turned off/away
- Build multimillion dollar artificial lakes right next to the real thing. Just because.

The first and most important rule to to use our entire central bank powers with the utmost energy. The second rule is to concentrate our bank power as much as possible against that section where the chances of debauching the currency is most effective, so that our chances of success may increase at the decisive point. The third rule is never to waste time. Unless important advantages are to be gained from hesitation, it is necessary to debase at once. By this speed a hundred enemy central banker measures are nipped in the bud, and global speculator opinion is turned off most rapidly. Finally, the fourth rule is to follow up our successes with the utmost energy. Only pursuit of the race to the bottom gives the fruits of victory. (sorry again, Colonel).

Now listen up. Each one of you, soljuhs, owes me a thousand of your enemy's jobs, and I want my thousand jobs. Sdat clear?

Friday, May 14, 2010

Analogies between the state and the businessman

This post is encouraged by Edward Harrison’s post, which tries to make sense of some MMT principles. I’m also new to MMT’s idea of monetary value originally arising from the state’s accepting it as payment for tax, but in general, I think MMT principles are sound, and reflective of reality.

Think of a businessman and his business. The business is either generating positive net cash flow or negative. If positive, then it adds to the business’ existing stock of cash, and it is able to pay dividends to the businessman, thereby boosting his personal net worth. But if business expenses are greater than sales, then the negative cash flow depletes the business’ existing stock of cash. If the loss is that big, or persists for a long time, the businessman will have to boost its cash by injecting new shareholder funds. If he doesn’t, the business could eventually become insolvent, and the businessman loses his business.

Sometimes the business’ sales is going well, such that the businessman runs out of inventory. So he boosts inventory by buying more raw materials for production. But sometimes, the business needs more shareholder funds, so that it can pay for a sudden boost in business expenses, like rent, wages, or the utilities. (I’d also add that growing sales usually earns the business funds necessary to fund new raw material purchases, so the businessman more often than not ends up infusing new funds only when unplanned expenses crop up).

In the absence of new sales, adding raw materials only builds up more inventory. The company’s balance sheet may be getting bigger, but without new sales, this only leads to misallocated capital. It is important for the businessman to know whether a business issue can be solved by injecting new raw materials to increase inventory; or by infusing new funds, and to put those funds in exactly the place where he needs to put them. If they are continually misallocated, then the business will still end up needing more shareholder funds, and this could eventually bankrupt the businessman.

But the source of value should be clear. The businessman provides the initial value to the business, by seeding it with capital (without which there is no business). But if the correct conditions are present, i.e., right business plan, right market, right business resources, are in place, eventually the business creates its own value, by generating a positive return to the businessman.

Now think of the government and the economy. The economy is either positively growing, or undergoing a recession. If it's growing, then it's adding to its citizens’ existing stock of wealth, so they are able to pay their taxes to the government, thereby boosting state coffers. But if the economy is in a recession, then it is destroying existing businesses, and it needs to reallocate its resources to new opportunities. If the slowdown is that big, or could persist for a long time, the government will have to boost the economy by injecting new stimulus funds. If it doesn’t, the economic disruption could lead to a major depression/stagnation, as loss of animal spirits leads to more business destruction and greater debt deflation, thereby leading to a positive feedback of even more business destruction and greater debt deflation.

Sometimes the economy is going well, and demand is growing, so the economy needs more currency in circulation to settle transactions, otherwise some demand could be destroyed (discouraged). So government boosts the currency by loosening monetary policy. But sometimes, what the economy needs is more fiscal stimulus, like when private demand is stalled, so that its citizen’s businesses could continue generating sales, so they in turn can pay their basic expenses, like rent, wages, so that the situation does not lead to even more stalling of private demand. (I’d add that a growing economy by itself generates the credit necessary to settle growing transactions, so the government more often than not ends up needing only fiscal policy- if and only when private aggregate demand suddenly drops).

In the absence of sufficient aggregate demand, adding currency only builds up to more asset bubbles. Without new demand, this only leads to misallocated capital. It is important for the government to know whether an economic problem can be solved by injecting new currency, to facilitate more business settlements; or by infusing new stimulus funds, and to put those funds in exactly the place where the economy needs to put them. If they are continually misallocated, then the economy will still end up needing more stimulus funds, and this could eventually take its toll on the value of currency, or result in hyperinflation.

But the source of value should be clear. The state/government provides the initial value to the economy, by injecting money to the economy via various government expenditures (without which there is no circulating fiat that can be used by its citizens to settle transactions in a growing economy). But if the correct conditions are present, i.e., the right businessmen are starting the right businesses, a stable business environment is engendered, people are employed and adequately earning, eventually the economy creates its own value, by generating a healthy growing demand for goods and services.

That’s the analogy as I see it. This analogy, however, in no way indicates that I support the idea that government should micromanage the economy. What I am merely saying is that I see that government has a role to play - by providing the substitute demand when private demand is lacking. But it shouldn’t be telling its citizen businessmen what businesses to enter, or what rates of return particular businesses should have. Any more than a businessman can dictate what line of business will profit, what business plan will work, or how much money his business should earn him. In both the government and the businessman’s cases, the market decides these things for them.

Related posts
Questions about Chartalism
Responses to my questions
On currencies, global trade imbalances,and the GDR
How to think of what's happening with the Euro
and the tongue-in-cheek US Banks are not capital-constrained

Friday, April 23, 2010

IMF wants to be the new bank sugar daddy

So the IMF wants all developed countries to contribute to this new bailout fund, eh?* I got so excited about the implications of this proposal that I practically spilled my Kool-Aid all over my brand new Brooks shirt. Imagine, a global fund that will bailout insolvent banks all over the world. This is the mother lode, and it really levels the playing field.

For decades, American bankers ate everybody else’s lunch, just because they were able to lever themselves and take on more risk. Bank funders everywhere else would not tolerate such cowboy acts. Neither would regulators and risk managers. The risks just outweighed the gains. Now no longer. This global fund is such a godsend!

In fact, now that everyone is going to be required to contribute to this fund, if you didn’t take on more risk, you’re being a chump. Everybody else will be growing faster with their heightened risktaking, and should their positions fail, the bailout fund will be there. This is simply the only way you can recoup some of the benefits from the costs you are contributing towards this global bailout fund. My bank funders and regulators will know and understand this. They are no longer on the hook for failure - everybody else will. There simply will be no more rationale for them to hold back and thwart my plans. And let me tell you, innovation is my middle name, baby.

And there simply is no more reason to shirk from a trading position simply because the risk amount is too great, and may bring down your entire institution. So if a hotshot wannabe hedge fund guy comes to you, asking if you could go long to his short? Bring it on! And if a bunch of dipshit scaredycat babe in the woods fund managers want you to insure their portfolio? May I have some more pls?

If my longhsot bets work out, I’ll make a fortune. But if the market suddenly turns Judas on my position….well, bailout city. But by the time my insolvent bank takes the fall, all insiders will have scuttled it of any value. That's the benefit of having insurance, you can get all the gains from destroying something, while somebody else is always left holding the liabilities. Just make sure you go get your bailout before the fund itself eventually runs out of money. That’s what happens when everybody expects to hit the jackpot right? Only a few get to cash their chips before the house closes the till.

Imposing a bank tax on all countries, regardless of their history of bailouts is akin to imposing on everyone the requirement to have healthcare insurance. This socialization lowers the penalty for those who are most likely to use it, and imposes a cost on those who would otherwise have maintained healthy lifestyles. And extending this healthcare analogy, preventive monitoring and health maintenance always trumps having a comprehensive insurance coverage, at least in as far as ensuring people are not being careless about their health, and for sure, the same is true with banks. Extensive risk monitoring will always beat having a bailout fund. But how much fun is it to always be living a healthy lifestyle, right?

This global bank tax is going to standardize bank behaviour at the lowest common denominator – Wild West here we come. Everybody start thinking like American bankers.


Sunday, April 4, 2010

The EU gets its groove back

GERMANY: This is good. If we all have one currency, you’ll all have to look like me, act like me, be like me.
GREECE: Ok, so will you now get your car salesmen off me, and start sending them more to the Far East? And good luck with that. It’s hard enough for me selling goat cheese to those cheap bastards.
SPAIN: Ay Dios mio. Now I look like all you señores.
IRELAND: Seeing as I now look and act like all you grandpas, perhaps I can move in and take over your old jobs?
PORTUGAL: Great! I look like Señ
or Germany.

Thursday, April 1, 2010

April Fools for greater fools

I think I’m going to have to lay off blogging for awhile since mostly satire has been rolling off my brain these last two months. It’s either make parody, or just keep repeating myself over and over. In the meantime, you could check out recent posts in the blogroll to your right. I highly recommend checking Rortybomb’s regular posts on specific reform recommendations, Billy Blog’s daily takedowns of constraining macro thinking (though I think we would need to develop a strong countervailing check and balance for the time when government leaders of developed economies understand they now have the power of fiat), and Mark Thoma, the economist I tend to agree with the most (I think he gets it right because he forms his views after surveying all competing points of view). I will be joining discussions every now and then at WCI.

But this being April Fools, I leave you with some parodies from this site’s archives two years ago.

A crazy M&A growth strategy
A health care company’s crazy secret plan of funding itself
Paulson, Bush, and a crazy China strategy (or so I presume)

Tuesday, March 30, 2010

Diary entries of a consummate dollar pegger

2001 - I am now a member of the WTO. Now the whole world will be my oyster. But the US is my favourite market, and I want to sell everything over there. Good thing I am pegged to the US dollar.

2003 – Whee! I’m so flush with dollars! This peg is the best thing in the world. I continue to sell more wares to the US consumer, who doesn’t seem to know when to stop buying. And despite my accumulation of dollars, my wares continue to drop in price, because I keep the peg. I don’t care about my local consumer, I just want him to find work. I will sterilize all these US dollars so they don’t find their way into funding the locals’ taste for foreign goods.

2005 – Okay, I play along because everybody’s getting worried about the rising US deficits. I change my fixed peg to a managed peg. Everybody feels a bit better, though what was the big diff? I manage my peg so its stays fixed to the exchange level I want.

2007 – Uh, oh, my economy’s overheating. Too many people speculating on growth. After all, I’ve managed to grow double digits for more than a decade straight. Money continues to roll in, and more jobs are moving here from that consuming monster, the US, and from all over the world. I now want to move up the production scale. Hmmm, I think I want technical jobs to move over here too. Why not? My peasant workers work cheap, they don’t complain, and I’m still pegged to the dollar!

2009 – The US is printing money like mad! They continue to prop up their false economy, and look what it’s doing to my precious hoard! They’re losing their value! And what am I going to do with all this fixed income government bonds, whose yield is being destroyed by this madness? I better move my investment towards other things…like commodities, and perhaps, I’ll start buying companies abroad. That will help prop up other countries' wretched currencies, and perhaps…… this will benefit my long-term plan of bringing all global jobs here at home.

2011 – What am I going to do with all these commodities? There’s no more demand for my finished goods, and I fear that I may have wasted all that money I put into this junk. And my investment in foreign companies! These foreigners have no respect for the shareholder. They’re just burning through the capital I invested in them. They keep telling me they can’t make money if they don’t get access to my home market. As if!

2013 – The US is still printing like there’s no tomorrow. And they’re using this funny money to pay me the interest and principal on their bonds. They have no shame! I’ll yet show them who’s the boss. But I can’t just dump my US holdings without hurting myself in the process. After all, I’m now their biggest creditor, because of all my accumulated dollars. Oh what an idiot I’ve been! What am I gonna do?

2015 – I’ve been buying real assets in the US, mainly real estate, mines, and all that stuff. After all, they don’t make more of these anymore. I’m hoping this gives me a good hedge to the falling dollar value.

2017 – Shit! There’s another US market collapse! My real estate holdings, gone down the drain. My mining investments, they’re worthless now that nobody can afford to buy anything anymore. This lost decade is turning out to be a real bummer. I’m still trying to figure out how to get a positive yield on my dollar holdings. My local economy is now in shambles. With foreign demand having disappeared more and more these past few years, it would now take a miracle for me to keep pumping out goods. Even if I sell them at 10% of what it cost me to produce, nobody buys. I don’t know what will happen now that more of my own local population is out of work. Not much local demand has been created here, because if I try too hard to stimulate local demand, it won’t be long before these irritating foreigners start selling more to my locals, and God forbid that I start buying more abroad than I sell to them.

2019 – US lawmakers are pressuring me for the umpteenth time to abandon my peg. What do they want to happen? Don’t they realize that if I abandon my peg, their currency will have a meltdown? They won’t be able to rollover their debts. These Americans are so foolhardy, they don’t know what they want.

2021 – Yikes! The US just demonetized the dollar. It’s now issuing an entirely new currency, at a fraction of the exchange for the old one. And they're rationing it just to locals. My whole stash is now worthless! I should have given up the peg years ago, and just given the money to my local people to spend abroad. Now they don’t have jobs, I don’t my US dollars, and the world is now moving on without me. Where has this world gone to? Waaaaaaahh!!

update: Confessions of a consummate dollar hoarder

Thursday, March 25, 2010

100 year plan for unceasing hypergrowth

This lays down our 100-year long term growth plan for the propagation of Corporates USA, Inc. In this plan, we shall lay down the main principles and thrusts that the company shall undertake over the next 10 decades to ensure the continual forward movement of this illustrious company. This being the year 1950, we will endeavour to visualize the necessary steps that will take us into 10 years into this glorious future.

1950-1070 – THE MARKET SHARE PHASE. During this period, we shall endeavour to increase our profits via organic growth. We shall introduce new products and technologies, and internationalize our operations with beachheads all over the world. During the phase, we shall achieve rapid growth by becoming a world-beating multinational organization.

1971-1990 – THE COSTCUTTING PHASE. The previous phase will end when we reach eventual market saturation. Hence, the next phase of our explosive profit growth will come be via cutting excess fat off our organization. We shall streamline and automate any and all processes that we can, to cut off labour costs, which will have become expensive by this time. We shall also outsource whatever work we cannot automate to much cheaper locales.

1991-2010 – THE LEVERAGING PHASE. The previous phase shall have ended, despite the untold influx of riches that accrues to our organization, with the hollowing of the economy, and the decrease in the purchasing power of our end consumers. Hence, the next important evolution in our growth shall be to circumvent the inconvenience this scenario brings by leveraging ourselves, and that of our consumers, and focus on asset trading. The leveraging shall facilitate the continual movement of our products, and the illusion of wealth from shifting assets around shall make everybody continue to patronize our products, which by this time, shall involve a lot of obtuse financial innovations. Everybody who lost jobs in the previous cycle shall be encouraged to become amateur traders, and thereby become self-reinforcing cogs in this well-oiled machine that we shall endeavour to create. Everyone’s leveraged bets in our machinations will lift all markets and hence, the mark to market gains shall be our main source of profits during this phase.

2011-2030 – THE FIAT PRINTING PHASE. The previous phase shall have ended when our machinations have encouraged enough asset bubbles, and greater than serviceable leveraging in the economy. This asset bubble will end in serious financial crises, and have long-term repercussions for the next phase in our growth cycle, particularly when it results in much painful asset and credit writedowns. This will otherwise result in a devastating deflation to out organization, and a general and sustained fall in aggregate demand, which is why our main thrust during this phase will entail the active participation of government, which shall ensure the continual sustenance of our asset bubbles via the printing of fiat money. This printing shall take place via myriad forms of government guarantees, quantitative easing activities, and monetary policy loosening. During this phase, our growth initiatives will be the selling of products, both real and financial, that will facilitate people’s beliefs that they are outracing the continual upward motion of nominal prices.

2031-2050 – THE REBIRTH PHASE. The previous phase shall then end with a general breakdown of the currency, which is why the last phase in this 100-year plan shall involve our initiatives during that period when government eventually scraps the previous fiat currency with a new improved one. Our opportunities during this phase shall come from the undoubtedly myriad activities that will have to be done to rebuild lost livelihoods and broken economies, resulting from there being more currency than productive capacity. This shall henceforth be the new golden age for our company, because this is where we shall repeat all our previous processes right from the very beginning. Big opportunities will come from the need for our country to take over less developed economies (the ones who didn’t profit from our previous imaginative machinations), to take advantage of their oceans of unutilized productive capabilities A.K.A. PEOPLE.

RISKS. These long-term initiatives do not come without risks, primarily during the fiat printing stage, because this is the stage where the forward motion of the economy is outside our organization’s control, and more so in the hands of government. We shall therefore endeavour to ensure that by the time 2010 rolls around, we have sufficient government capture, so that our initiatives encounter less friction. We shall also undertake that by 2010, general consciousness is more open to the idea of monetary easing and government guarantees. It is imperative that we make everybody understand during this stage that propping up asset prices is what it takes to sustain deficient aggregate demand.


Friday, March 19, 2010

The growth of 2B2F banks, and what to expect when they grow much larger

Karl Marx thought that capitalism sowed the seeds of its own destruction. He thought that capitalism destroys itself because of its endless search for surplus value. This surplus value gets reinvested in more capital-intensive means of production, which substitutes for labor. This action decreases the returns on capital, until eventually capitalism turns in on itself.

That is one way to look at it. But Karl Marx’s analysis was incomplete, and therefore erroneous in his inevitable conclusion.

He did not anticipate the cleverness of many capitalists, particularly American financial institutions. He did not anticipate the value of debt, using other people’s money, to increase the returns on capital, when equity capital alone could no longer do the job. He did not anticipate the values of doubling down to win over the market place. After all, when everybody else is shrugging and thinking, “enough leverage already!”, who ultimately grows and eats everybody else’s lunch? That’s right, the one who’s not afraid to grow the most, regardless of the risk.

Many fall by the wayside because of the risks of leverage. But not if you know the tricks of the trade. Wall Street knows the tricks, which mainly involve accounting deception, using various derivative and off-balance sheet transactions.

Accounting gimmicks may actually just be a symptom rather than a cause of financial instability. It is a symptom of an economy where everybody is looking for yield, for investment return, where everybody thinks firms should either grow at a constant 10%, 20%, or 30%, otherwise, investors will flock in droves to the next hot entity.

How silly is it to expect a perpetual 10% increase in return? A one million dollar profit today, growing by 10% annually, will be a $2.4 million profit expectation in ten years. In twenty years, it’s $6.1 million. And if the growth expectation is 20% annually? $1 million today will grow to $5.2 million profit expectation in ten years, and $32 million in twenty years. What if it's 30% growth?

Before long, those little companies that met your 20% annual growth expectations could already make up 40% of the entire economy. Now is that realistic?

But if through the use of leverage, a firm is able to grow - much, much bigger than its competitors, it is now in a position to either: beat them down, eat them up, or take them to the cleaners.

There is another secret power that leveraging up provides the firm, particularly a capital intermediary, whose market positions affect the over-all valuation of the entire capital system. It gives them the power to realign the system. Eventually, if they grow overly big, overly leveraged, and overly connected to the system – they become too big to fail.

Too big to fail firms know this. Their failure can never be as clean as any other firm’s, because they are a pipeline of capital to the economy. Financials can take the entire economy hostage if they fail. So the goal is to become overly big, overly leveraged, and overly connected to the system.

The rules of capitalism are the rules of the jungle. The simple over-arching rule is: the biggest, strongest, fastest , will survive and thrive. But we are not animals. And not everyone can be the biggest, strongest, or fastest. If the competitors in the capitalist jungle are all thinking, scheming humans, who eventually thrives?

That’s right. The one who can credibly convince everybody else that his demise will result in the demise of the jungle itself. This is where the forward motion of capitalism will end. Not with the end of surplus value. Humans proved too clever to be stuck with a dreadful law such as that. It will end when the only remaining key players all have the ability to blow up the capitalist jungle all by themselves.

Financials can take the entire economy hostage if they fail. Remember that the next time you expect your investment in financial firms to perennially grow by double digit rates. Remember that in the next leg up in the growth of already too big financial firms.

Tuesday, March 16, 2010

Lehman in Wonderland

Now I don’t know about you, but I think the Valukas report will make for adventurous reading. For now it can be told - Lehman Brothers’ balance sheet is FULL of fascinating mysteries.

Let’s look at the liability side. Now we know that unicorns* exist on Lehman’s liability side. They disappear when you start looking for them, but they irritatingly reappear at the most inconvenient of times. Now we know what happened to Lehman’s equity – the unicorns ate it!

Now how about Lehman’s asset side? Now we know that Valkyries** exist on Lehman’s asset side. The more we look, the more beautiful they are. But watch out. They‘ll take the life out of you.

And I’m pretty sure that if you look hard enough, you’ll also find Gorgons on their asset side. If you look straight into their eyes, it turns them into capitalized gain.

Now, I haven’t actually read the report, but how come there seems to be no mention of the possibly numerous Elvis sightings*** on the income statement?

* Liabilities that disappear via the magic of Repo 105 and total return swaps.
** Assets whose risks are obscured, via the magic of mysterious valuation techniques.
*** Items which are not exactly what you think they are. These sightings were also numerous in a previously famous company.

Friday, March 12, 2010

Just how important is it really to the world financial system to prop Citigroup up?

This is a question I’ve always wondered to myself, ever since the US financial system first teetered on the brink of mass bankruptcy in the fall of 2008. We know that the US Federal Reserve was ready to bail out some banks (not all banks), but many banks. We don’t know what the real criteria was for choosing which bank to save, but we do know some banks were too systemic to let fail.

Citibank is my first candidate for a bank too systemic to fail. Not just for the US system, but for many other countries as well. Unlike UBS or Credit Suisse, which source much of their deposits via their Switzerland operations, or BNP and Soc Gen, which source most of their deposits in France, Citigroup sources its deposits from all six continents.

It is the most transnational of all banks as far as setting up branches is concerned. So how does a systemic failure of a bank of this magnitude (and this geographical breadth) affect the world financial system? Very seriously, I would believe.

So if ever its US operations will have to face the music for all the dancing it’s done all these past years, will Citi’s foreign branches have to dance along?

US branches notwithstanding, Citibank branches the world over are among the most profitable of all banks. They tend to serve the biggest multinationals. In whatever pat of the world there is a Citibank, they serve the local elite, both on the deposit side, and on the borrowing side. And Citi branches usually have the most repertoire of profitable services of all banks in any jurisdiction. Most local banks are usually just playing catch up each time Citibank comes up with a new product offering.

Now each Citibank branch, having its own complete banking operations (including deposits) in many countries, definitely is accountable to its own set of regulators. The US parent cannot just transfer capital from its far flung branches, if ever the US arm starts experiencing hyperventilating bouts of insolvency (or could they?) Alert Central bankers the world over will probably sit up in attention if they notice their local Citibank repatriating large sums towards the parent. Capital controls (if they did not already exist in that jurisdiction) will surely dam the outflow before you can say ‘bank run’.

Is it possible that if the US parent becomes insolvent, it becomes insolvent by itself?

Now of course, the US parent retains majority equity ownership of its foreign branches. Even though these foreign branches may not be allowed by their respective central bankers to close, they will surely be tapped by Citibank as possible sources of funding to pay off any creditors in any theoretical insolvency.

And as sources of funding, these branches (I haven’t run any numbers) will surely prove rich pickings. I’m pretty sure, in many jurisdictions, local banks will salivate at the prospect of buying their local Citibank competitor, and subsuming it into their own operation. They will probably be willing to pay an arm and a leg in some cases (I am making a bold assumption here). After all, Citibank has a client list of the wealthiest retail clients (Citigold), the biggest companies, and the most multinational organizations. This beachhead should be worth a lot, and even more so, for a newby wannabe transnational bank. (You can list the banks I mentioned above in this group, plus JP Morgan, Deutsche, BofA, Barclays, etc.) The only other bank I know that has Citi’s retail footprint world-wide is HSBC. Because of the possible synergies that can be realized here, these branches have got to be bigger gems than what AIG’s foreign subsidiaries proved to be.

You might say that Citi’s huge global footprint serves as its insurance in a possible insolvency. Bundled altogether, or as separate regional bundles, they gotta be worth at least what Citibank currently seems to owe anyone (again a heroic assumption here). And I could see their value in more ways than one. Because, if your little boys are all systemically important in their respective bases, wouldn’t you think all central bankers the world over will stand at attention in case you, the parent, will ever need help? They’ll probably be forming into ad hoc action committees faster than you can say ‘moral hazard’.

In short, a Citi problem is a global problem. If Citi needs help, we may probably finally see that a global coordinated action is not entirely impossible. You’ll probably see reserves flowing from all central banks concerned (!) to help Citi out. (maybe they’ll even form a Citi global reserve fund) After all, if Citi closes in their jurisdiction, it probably will affect other parts of their system, rather than just Citi’s own retail clients there. Maybe in their jurisdiction, Citi acts as a central clearing authority of some sort, or maybe it’s the chief market maker in some vital sovereign issue. Maybe it’s not even hard to fathom that its local branch could be the main depositary bank of members of the central bank board of governors (Now wouldn’t that get them into code red alert at the first sign of Citi trouble).

Now I don’t claim to know much about the internal workings of Citibank, or have crunched a realistic recreation of its real and actual financials (who knows how they really look like). But as I have been a detached observer of Citi in several places, I could say that Citi is a close enough proxy for the global financial system.

If we ever let Citi fall down to its knees, we may very well have to figure out how to remake a new financial order from scratch. Now that’s a Citicatch22.

Friday, March 5, 2010

Why do bank regulators seem toothless?

Felix makes a valid observation: The problem of non-bank lenders is a huge one: most existing regulatory institutions were created to protect depositors, rather than borrowers, and as a result just about anybody can lend however much they like to whomever they like on whatever terms they like sans any real regulatory oversight at all.

The reason for this I think is that Central bank regulators have yet to catch on to the idea that banks can victimize more than just the depositor. Historically, it’s always been the depositor who was fleeced whenever a bank misbehaved. It was his money that the bank played with, and that the bank lost. The borrower , on the other hand, was someone that everyone thought could take care of himself.

When a bank provided a no-doc, no down payment loan to anyone who did not exhibit the ability to repay it at some point in time, the automatic assumption has been that that borrower must be the bank owner, one of his affiliates, or one of his cronies. He was never thought to be the ‘victim’ but a parasite instead.

We all know that the US experience shows that this is not always going to be the case. Their experience, in a society where there are more net borrowers than there are net savers, a ‘corrupt’ banker’s attentions can in fact turn towards the borrower. The pickings are just more abundant on that side of the business. And now that the we understand that the bank need not be lending its deposits when it makes loans (there are numerous ways banks can raise their loanable funds), there need not even be sufficient deposits for mass gouging of the consumer to occur.

That in turn creates a disastrous race to the bottom as banks try to compete with unregulated lenders, and in the end everybody — banks, consumers, non-bank lenders, the lot — finds themselves heaped up, broken and crumpled, in the corner (solution).

I have always wondered why the move in the US towards universal banking (allowing banks to operate both as commercial and investment banks) did not result instead, in stifling risk-taking at the investment banking arms of the unibanks. After all, if you have all these units under the same roof, they all automatically fall under the regulatory umbrella of the central bank?

So if a certain type of investment is not allowed for a commercial bank, it should automatically be disallowed for the investment banking unit. After all, it’s not hard to imagine that the ultimate backstop for any investment banking loss resulting from excessive risk-taking is always going to be the depositor. Hence, any i-bank coming under the roof of a commercial banking parent ought to have been effectively neutered of its risk-taking impulses. And any self-respecting bank examiner doesn’t even have to fully understand what it is that the i-bank is doing, because that fact of complexity alone would have raised flags immediately. He could have easily just either disallowed it, or simply counted the whole position 100% against the capital of the commercial bank (which would have immediately led to the parent disallowing the position itself).

So if you understood how unibanks are supposed to be regulated, their mere formation should have suggested to you that it leads to more investment banks competing on the same playing field, and same level, as the commercial banks.

…while non-bank lenders can act more or less with predatory impunity unless and until they grow above $10 billion in size, stealing customers from banks and gouging them freely. As for non-banks (including check cashers, payday lenders and title insurers in Felix’s argument) some central banks even put all these entities under their supervision, merely because they engage in a bank-like activity with the general public. Any sign of misbehaviour and they lose their intermediary license.

My guess is that this is easier to say than do, especially in a large capital market such as the US. But then…

And this from Joseph Stiglitz may simply be the most logical reason for the seeming toothlessness of regulation in the US. "It's time for us to reflect on our own structure today, and to say there are parts that can be improved." The core issue is that regional Fed banks, such as the New York Fed, have clear conflicts of interest -- a result of the banks being partly governed by a board of directors that includes officers of the very banks they're supposed to be overseeing.

Monday, March 1, 2010

Private loans and government guarantees

Felix Salmon adds more voice to the ‘loans growth is not affected by the size of deposits’ meme: The size of a bank’s deposit base is not a meaningful constraint on the amount of lending it does. And what’s more, if you have an adequately-capitalized bank, like say JP Morgan Chase, then throwing money at it either through fiscal policy (Troubled Asset Relief Program) or through monetary policy (cutting interest rates) is by no means guaranteed to change the amount of lending that the bank engages in.

If you want to get banks lending again, governments can try a bit of moral suasion, but ultimately it’s a decision that any bank is going to have to make on its own economic merits….When the government guarantees loans, for instance through the Small Business Administration, that might do more to help increase lending — but only by transferring credit risk out of the banking sector and onto the taxpayer.

If a bank is long on loans but deposits short, it has alternative funding channels, so it can go ahead and make the loan. But if it’s deposits long but loans short, there is nowhere it can go to get that creditworthy alternative (except in the government bonds market, or yes, loans guaranteed by government)

So if government wants lending to be more robust, focusing accommodating policies just on the banking side is not going to be very enough. More focus on supporting private industry and the consumers is needed (But yes, government guarantees will likely be a necessary component in this, to boost the economic merits of lending to these sectors.)

There is currently a large pent up opportunity globally just waiting to unrestrained (if the proper supports are in place). I said it before, I’ll say it here again: Global rebalancing will be the greatest source of growth, as well as the greatest challenge, for capitalism in the coming decade. The developed world needs to rebuild its manufacturing base, while the developing nations need to develop a thriving consumer economy. Much capital investment for production needs to be rebuilt in the developed countries, while much more advanced distribution chains and financial networks need to be established in the developing nations. The best guarantee is a government commitment to this rebalancing. Government has to support the profitable growth of manufacturing in previously hollowed out economies, and to support consumer social safety nets in previously export surplus countries.