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?