Saturday, April 20, 2013

Rogoff, Reinhart, and minding your "D'oh"s and "Duh"s

"D'oh!" according to the Oxford English Dictionary (really!) is self--and-past-referential (think "eureka" with a self-deprecating slant) while "duh" refers, insultingly, to others without any sense of time.  In the words of Matt Groening, "so, you might say 'D'oh!' when you've been stupid, and 'Duh!' when you think someone else is being stupid, but then duh!, everyone knows that, right?"

Timing, as the saying goes, is everything.  In Carmen Reinhart's and Kenneth Rogoff's experience timing is the difference between enjoying bestselling author status and wearing a (metaphoric) dunce cap.  Examining centuries of history and most major trading nations of earth, This Time Is Different, their impressively researched, financial perspective on financial crises won them great fame, credibility and, I assume, money.    Based on the same data and premise- too much debt is bad- their paper,  "Growth in a Time of Debt", merely narrowed its focus to the public sector.   Their timing, and tone, with the benefit of hindsight, couldn't have been worse. 


Why?    


It's as simple as the difference between "D'oh" and "duh" and an interesting mental habit known as confirmation bias.


As evidenced by the wild who, how and why speculations following the Boston Marathon bombing, people's search for meaning in the face of disaster often leads inside rather than out.  Upset when the unthinkable becomes real, the threatened mind redoubles its efforts confirming other assumed aspects of "reality."  Those fearful of radical Islam before the bombing weren't surprised when first a Saudi National, and then Chechen immigrants were labelled suspects.  Their bias confirmed, no further questions needed to be asked.


This mental habit has its virtues. Imagine feeling the need to thoroughly examine a table's stability before putting a coffee mug down?  or a road's stability before driving?  A quick biased glance usually suffices for most.  Expertise in a field depends, in part, on informed bias.  An experienced auto mechanic (at least back when human diagnostics were the norm) usually narrowed down problems after a few questions, glances and a listen (whether they used this information to save you money is another matter entirely).


Sometimes, however, even well-informed bias misses warning signs hindsight, informed by consequence, can't ignore.  Homer Simpson's famous "D'oh!" got laughs because we've all been there.


For Reinhart and Rogoff, however, the crisis of 2008 wasn't a "D'oh" but a "duh" event.  Their bias wasn't a revelation occasioned by the crisis, its roots, as I'll soon explain, are much older than that.  The revelation was that others, influential others, didn't share their bias and maybe they could change that.


Years before This Time is Different was conceived Mr. Rogoff revealed his bias in a letter to Joseph Stiglitz just dripping with "duh": You seem to believe that if a distressed government issues more currency, its citizens will suddenly think it more valuable. You seem to believe that when investors are no longer willing to hold a government's debt, all that needs to be done is to increase the supply and it will sell like hot cakes. We at the IMF—no, make that we on the Planet Earth—have considerable experience suggesting otherwise. We earthlings have found that when a country in fiscal distress tries to escape by printing more money, inflation rises, often uncontrollably. Uncontrolled inflation strangles growth, hurting the entire populace but, especially the indigent. The laws of economics may be different in your part of the gamma quadrant, but around here we find that when an almost bankrupt government fails to credibly constrain the time profile of its fiscal deficits, things generally get worse instead of better.
 

Ouch!

In book form, their bias won them fame and fortune by eliciting "Doh"s.  Unlike the letter excerpt above with its reference to different laws in your part of the gamma quadrant, their book modestly hoped to give future policy makers and investors a bit more pause. 

That same bias, in the follow-up paper more closely resembled the letter in tone than the book.  In Congressional testimony, Carmen Reinhart wasn't sharing their bias to give pause, but to form policy.  Stripped of some nuance, and thus more actionable (politicians dream of such one-handed economists) correlation became dissent quashing causation. 


A unilateral causal pattern from growth to debt, however, does not accord with the evidence. Public debt surges are associated with a higher incidence of debt crises. In the current context, even a cursory reading of the recent turmoil in Greece and other European countries can be importantly traced to the adverse impacts of high levels of government debt (or potentially guaranteed debt) on county risk and economic outcomes.

There is scant evidence to suggest that high debt has little impact on growth.


Duh (ok, she didn't say that)

Another thing she didn't say was: In most instances, with enough pain and suffering, a determined debtor country can usually repay foreign creditors. The question most leaders face is where to draw the line. The decision is not always a completely rational one. Romanian dictator Nikolai Ceau┼čescu single-mindedly insisted on repaying, in the span of a few years, the debt of $ 9 billion owed by his poor nation to foreign banks during the 1980s debt crisis. Romanians were forced to live through cold winters with little or no heat, and factories were forced to cut back because of limited electricity.  
Reinhart, Carmen M.; Rogoff, Kenneth (2009-09-11). This Time Is Different


I copied the above from their book and am not surprised Reinhart didn't share it with Congress.  The story didn't fit what she was trying to sell.  In the event, Ceausecu's policy of austerity led not only to revolution, but his own execution.  That tale would have made for bad "optics" as they say in Washington.

 
Switching tone from "D'oh" to "duh" has its perils as explained hereDuh is more derisive than doh. Perhaps because the word is associated with Homer Simpson, doh has a humorous quality about it. Duh is sometimes deployed with humorous intent, but more often for the purpose of mocking oneself or another. Put another way, saying duh in the wrong place at the wrong time could ignite a bar brawl. To my knowledge, no physical violence has ever been sparked by the word doh.

Dissenting economists, who'd previously been civil, dropped the gloves. Preferring to brawl in words and numbers rather than fists, the growing number of dissenters increased their scrutiny of the data.  Hell, it seems, hath no fury like an economist duh-ed.  Like Joe Wilson  fighting "stove-piped" data and the 16 words the dissenters' charges of cherry picked data, un-reproducible results, and excel coding errors started flying.  The damage, however, had been done.  Austerity in policy circles became a "duh".  I hope the bias doesn't lead to self-fulfillment.


In the event the US might have muddled through but for this, don't assume I'm laying the blame entirely on their, no doubt, well meaning shoulders.  To me, their bias was a catalyst which ignited another more commonly held bias.

Money not only matters, it matters a lot.

Hoping to give pause to austerity cheerleaders I'll offer a dissenting opinion (most likely to a chorus of "duhs" from the dissenting economists noted above).  It's not so much the size of the debt, it's what you do with it that matters.  Duration, source and relation of debt to current growth shouldn't be ignored but, in my view, the use of debt generated funds and the context of time and place are at least as important considerations.  While nothing is guaranteed in such matters, debt incurred to build hoped to be productive capital shouldn't incite as much worry as debt incurred to buy sports cars and vacation homes (or debt incurred to pay banks to hide the true level of debt).


What we in the US have been doing with debt sourced funds is a study for another time.  What we will do with it in the future is still unwritten.

Thursday, April 18, 2013

Goldenfreude? how about Bankenfreude

Cheer if you will Goldbug bashers, but I suspect if Gold starts another swan dive, it won't be alone.  There may even come a time when you wish Gold would rise.

"Triumphalism," Paul Krugman opined in a 1997 New Republic article, "presents its own problems." Under the, dare I suggest, ironic headline, Superiority Complex, Mr. Krugman completed his thought: " though the "American model" has scored some important successes, it continues to fail in other respects, above all in generating an ever-increasing level of inequality. And we won't begin to address those failures if the national mood remains dominated by self-congratulation." He closed the article with sage advice for his readers: "The truth is that nothing in the experience of the last few years contradicts the idea that we could have a kinder, gentler economy that preserves the main virtue of the American system--high employment. All it would take is compassion. And a little less gloating."

Compassion, and a little less gloating might also help Mr. Krugman understand, rather than mock, Goldbugs- a label which, contra Krugman's caricature thereof, denotes a group exhibiting a very wide range of economic/investment views- while they are nursing their recently suffered monetary wounds. I imagine for every gold hoardin', gun totin', doomsday preppin' angry white male proclaiming the end of the world (they annoy me too),there's at least one confused, upset and perhaps unemployed person who's fed up with Wall Street's "head's I win, tails you lose" investment strategy, (or one, like myself, who believes structural reform-blocking rigidities in the developed world won't be overcome easily leaving only 2 eventual paths for excess liquidity, inflation or default). Those confused and unsettled Goldbugs, having witnessed a succession of bursting investment bubbles at home and more recently read about bank runs abroad might, not without justification, have decided to save in Gold, rather than a bank, or his mattress.

Mr. Krugman, alas, is not gloating alone over Goldbug's recent misfortunes. One clever soul coined the term Goldenfreude to describe his state of mind. Joe Weisenthal proclaims, EVERYONE Should Be Thrilled By The Gold Crash- a view echoed by Felix Salmon. Barry Ritholtz leavened his disdain for Goldbuggery with a sliver of compassion, I do not want to engage in Goldenfreude — the delight in gold bugs’ collective pain — but I am compelled to point out how basic flaws in their belief system has led them to this place where they are today. Gold, he avers, has no fundamentals and those who buy are engaging in the ultimate greater fool trade.

While living in SE Asia during their late 90s crisis I witnessed first hand one of Gold's great virtues- when a nation's banking system, and almost always coincidentally, currency, comes under pressure Gold holds its value. The haircut recently forced on Cypriot savers was far less than that inflicted on Gold by the market. In other words, despite recent declines I'd rather be holding Gold in Cyprus than waiting in an ATM line to withdraw my daily allotment of currency.

America, the gloaters might retort, is not Cyprus. No, it isn't, and I (casting off one aspect of Krugman's Goldbug caricature) sincerely hope we don't find ourselves in their financial straits. My bet is that such can only be avoided by further monetization AND, in the absence of rapid real sector productivity gains which don't exacerbate income inequality induced domestic tensions (unlikely given right wing intransigence on welfare state expansion or a domestic Modest Proposal a la Swift), wage and price inflation.

"A ha," Krugman, beating his gloating compatriots to the punch, would likely argue, "you Goldbugs are always talking about runaway inflation. Didn't you read my recent article mocking your inflation worries thusly: "But the runaway inflation that was supposed to follow reckless money-printing — inflation that the usual suspects have been declaring imminent for four years and more — keeps not happening."

I agree, and the absence of broad based inflation given the stimulus in an environment of limited structural reform outside the developing world is my concern. I suspect if Mr. Krugman would stop gloating, it might be his too (more on this below).  If the recent decline in Gold signals, as many gleefully hope, a decline in inflation expectations, might the US, and, I suspect, other mature industrial economies (Europe and Japan) be drawing ever nearer to a stall in growth followed by a liquidity crunch?

Consider this potential catalyst for the Gold crash. "Macroeconomic stimulus," said a US Treasury FX Report chiding Japan for the recent, now reversed, Yen slide, "...cannot be a substitute for structural reform that raises productivity and trend growth." We'll return to structural reform momentarily after a look at market reaction. The Yen's rapid recovery following this report's release was coincident with the Gold crash- perhaps both price adjustments represent market belief that inflation games (currency debasement either externally or internally) won't be tolerated.  With austerity the rage in European policy circles (we aren't far behind in that regard, thanks to the Republicans), competitive devaluation verboten and Gold signalling, to the cheers of many, declining inflation expectations, I'd be surprised if yet another liquidity crunch isn't around the corner.

Factors Behind the Forecast:  Structural Rigidities and Over-Leveraged Finance

Despite recent record profits, the US financial system, still dependent on a few highly leveraged (how else to achieve such profits in a low interest rate environment) TBTF banks, is far from stable. Many mortgaged home-owners are still looking up at the zero-equity line. Those cheering the absence of inflation simply, it seems to me, because such makes Goldbugs look stupid, might want to consider that in a highly leveraged economy, the cascading defaults of deflation- the "it" Bernanke assured us wouldn't happen here- always loom in the background.

Cheer if you will Goldbug bashers, but I suspect if Gold takes another swan dive, it won't be alone. As we've seen over the past few days, Gold price declines are mirrored to various degrees by oil, other commodities, and equities. Declining prices, if such becomes the trend, will lead to higher unemployment and, amplified by the former, declining house prices and rising foreclosures. In the teeth of such an event, some might be yearning for the days when Gold was rising and inflation was assumed. I'll admit, such a scenario favors the dollars-saved-in-a-mattress strategy rather than Gold ownership but both tactics are anti-investments ridiculed by Goldbug bashers.

The elephant in the room for the Goldenfreuders is the lack of structural reform in the developed world- an omission perhaps due to a focus on high frequency and exclusion of low frequency economic factors. Structural reform, for those unfamiliar, refers to changes in the capital structure (factories, transport systems, education programs, agricultural methods, etc.) that hope to produce more for less. China's rapid economic growth over recent decades is, in large part, an effect of these reforms such as the shift, in 1978, from communal to industrial farming.

Significant structural reforms are often resisted.  Consider the resistance some individuals display when asked to eat less, drink and smoke less, and exercise more.  Note, "when asked."  Change is much easier (but not guaranteed) when it's wanted.  Consider, for example, the rapid adoption of computers and cell phones.  I doubt even severe coercion could have done half as much in twice the time.  Fortunately the benefits of these new technologies were readily apparent and despite some resistance by, e.g., book store owners to Amazon, those individual losses were smaller than the aggregate productivity gain.  Those productivity gains created an environment where jobs were plentiful, further easing stress caused by the destruction economic creation usually entails- agriculturalists rarely coexist harmoniously with hunter gatherers but they produce more food per acre meaning, if the latter adapt to the new system, both groups can survive.

In cases when reform calls for the destruction of wealthy industries with government ties, substantial legal changes, or labor downtime and re-education for a significant portion of the work-force (especially in the absence of a decently funded welfare state), resistance can effectively block what would likely be widespread productivity gains.  Pre WWII rail transport in continental Europe seems a case on point.  International disagreements over railway standards and routes (an example of structural reform-blocking rigidities) kept the continent from reaping the productivity gains a fully connected rail system promised- and delivered, after a devastating war cleared away both dissent and, sadly, large chunks of the old rail system.  Expanding on von Clausewitz for the modern world (which finds the more apt term, political-economy, too archaic) war is not just politics by other means but economics by other means- the worst means, in my view.

Structural reform-blocking rigidities are, in a sense, other words for productivity sapping rent seeking- e.g. from a bottom up perspective, Luddites breaking machinery or US autoworkers striking to avoid being replaced thereby, and from a top down perspective, trade barriers (tariffs) or de jure monopolies (Britain's BBC prior to 1955).  Profits and Investments in rent seeking industries, particularly when higher productivity methods are known and feasible, tend to be misdirected from entrepreneurial activity (why make a better or cheaper widget when it's cheaper to bribe a competition stifling official?).  Bribery doesn't seem to me a very economically productive activity although it obviously benefits some while irking others.

For an example of a structural rigidity overcome consider recent changes in US law which reduced regulations on where and how (think fracking) petroleum products can be extracted.  Fracking has changed N. Dakota from a deficit to a surplus state and driven unemployment to near zero.  Before you send me a nasty-gram, I'm not arguing such is an unalloyed good- insufficient profits are likely flowing to those who have been and certainly will be negatively affected (this is no environmentally neutral practice).  I'm merely pointing out the positive economic benefits thereof.

To digress for a moment, first with an apology to the economically literate for the rudimentary and likely (to some) unsatisfactory treatment of these issues and second with further explanation thereof: the ideological (and physical) battle between communism and capitalism over the past two centuries is the battle between productivity and people.  In my view, productivity is most effectively and durably enhanced at an imaginary "sweet spot" between radical laissez faire (think Ayn Rand) and communal ownership (Marx).  Transfer payments, whether private (charity) or public (government welfare) are, in my view, necessary to ensure social cooperation within the capitalist framework.  Domestic dissent is a sign that transfer payments are, whether as a result of insufficient funds or inefficient distribution, not performing their function.  Labor dissent in many developed economies (Occupy and austerity protests in America and Europe respectively) suggest to me a hopefully solvable but currently intractable transfer payment crisis.  The pendulum has swung too far right which isn't meant to obviate calls therefrom for greater transfer payment efficiency.

Cheers for the Gold crash sound to my ears like cheers for austerity in Europe and further dismantling of the welfare state in the US. If Japan needs inflation now, don't we as well? Perhaps we too should join the Euro? and give up our right to buy time with inflation?

I'll close with a look at another structural reform-blocking rigidity whose removal might justify a moment of schadenfreude. The phrase "Too Big To Fail" speaks to a de jure monopoly of sorts for those protected banks.  Potential competitors were blocked from taking over business which would have looked elsewhere for financial services absent government support.  Competition was stifled and the public debt increased.  I believe, but for delusional faith in the virtues of these institutions (more below), a less costly, competition enhancing solution could have emerged from the crisis of 2008 and resolving that rigidity would have eased tensions between labor and capital. 

Consider: Would current budget negotiations in the US be so contentious in the absence of the recent bail-out and additional debt incurred?

Returning to the delusion, TBTF banks remind me of Alchemists wasting labor and resources trying to turn lead into gold, or, more accurately, trying to squeeze more profit out of trade than trade generates.  Finance, at best, facilitates trade. In practice it records, analyses, calculates and communicates. What Amazon did to the local book merchant a similar company (or 5 or 20) can do even more effectively to finance.  Surely networked computing should decrease the cost of finance for the rest of the economy. 

On the bright side, the presence of rigidities suggests greater future productivity upon their resolution, although it would be tragic if such resolution comes via violence rather than diplomacy.  I believe a new cooperation enhancing agreement between labor and capital is possible.  Given the European example, I believe American energy efficiency can be increased.   As noted above, I believe American financial efficiency can be greatly enhanced through the dissolution of TBTF. 

When that happens I'll suggest a new word- Bankenfreude- and might even indulge in some myself.  I'll swap my Gold for currency and put it back in the game.  Until then, I'll remain a Goldbug.

Full disclosure (if it wasn't obvious) I own gold.

Thursday, September 27, 2012

On NFL Referees and Owner Lock-Outs I'd Like to See

From a Capitalist perspective, even CEOs are workers

It's a sign of the times that labor disputes often collapse not into strikes but owner lock-outs.  Capitalists have surely taken the upper hand. 

Or have they?

Regardless of whether workers walk off or owners lock them out, consumers still have a decisive say in these matters.  If, for instance, NFL replacement refs had performed their function without too much fan (i.e. consumer) complaint, locked-out refs would have lost their bargaining power (and perhaps their jobs) while owners would have increased profits.


Alas for the owners, NFL consumers were none too pleased with "scab" refs who seemed at times baffled by the speed of the game and subtleties of the rules.  Score one for the workers, and I'll add, Capitalism itself where the market is supposed to rule.

Sadly, it seems to me, hard-nosed Capitalist battles tend to be fought in these most trivial of pursuits- sports (don't get me wrong, I love sports, still play men's league ice hockey and really want my NHL).  By trivial I refer to the product sold, which doesn't directly add anything to national goods supply (yes there are indirect, likely not insubstantial, effects).  Consider the NHL or early season NBA.  Consumers of these products weren't starving for anything other than entertainment.

I'd love to see these hard-nosed Capitalist battles taking place in less trivial pursuits.  I'd love to see Roger Goodell named as Commissionner of the new National Banking League (NBL).  His take no prisoners and let the market sort it out approach seems to me just the sort of thing a true Capitalist (and these bankers sure love to talk about being epitomes thereof) would appreciate.

C'mon bank owners, hire someone who would really fight for YOU for you are indeed on the endangered species list.

Mr. Goodell would likely find the recent shrinkage of the NBL distressing (remember those two great teams of yore, Bear Stearns and Lehman Brothers) and would be seeking expansion, rather than contraction.  Given the harsh penalties given to New Orleans Saints' management over Bountygate, I'd love to let him sink his teeth into say, the LIBOR scandal.  Further, in the same way that Mr. Goodell has locked out players and refs, he could lock out senior bankers/traders who warn of economic collapse if their bonuses and salaries aren't paid. Heck, we could have a salary cap for bankers!

Let the market sort things out!

Goodell for NBL Commissionner!

Funny thing is, I'm pretty sure the replacement bankers would do a far better job than the replacement refs.  After all, the current bankers have botched things up far worse than the Seattle-Green Bay game, don't you think?

Oh, well, a man can dream.

Kidding aside, US financial problems are not an effect of too much capitalism, but too little- active owners seeking to maximize profits are necessary.

Wednesday, September 19, 2012

Romney, America's Churchill?

I have not become the King's First Minister in order to preside over the liquidation of the British Empire. Winston Churchill

I can imagine President Romney repeating some version of Churchill's view at his first State of the Union address.  "I did not get elected President to act as liquidator of the American Empire."

In Churchill's case, he likely meant what he said without realizing that liquidation was the most likely outcome following their military losses (which destroyed any sense of British superiority among the colonized) especially given Americans' anti-imperial sentiment at the time. 

A President Romney, if such proves to be the case, might not not mean what I imagine him saying and might even desire just such an outcome.  After all, Bain Capital did evidence some expertise in profiting from liquidations.  This is, of course, a serious allegation- disingenuously seeking the office of President of the United States merely to profit from empire liquidation.

Yet, judging from the now infamous (or laudatory, depending on perspective) video of Mr. Romney's unvarnished views, he seems well aware of America's precarious fiscal situation and even used the term "bankruptcy" in reference thereto as if such was a perhaps preferable certainty. It might also explain Romney's apparent inability to capitalize on the poor economy.  Like John Paulson, Romney might be betting on a crisis. 

Audience member:
The debates are gonna be coming, and I hope at the right moment you can turn to President Obama, look at the American people, and say, "If you vote to reelect President Obama, you're voting to bankrupt the United States." I hope you keep that in your quiver because that's what gonna happen. And I think it's going to be very effective. Just wanted to give you that. 

Romney: Yeah, it's interesting…the former head of Goldman Sachs, John Whitehead, was also the former head of the New York Federal Reserve. And I met with him, and he said as soon as the Fed stops buying all the debt that we're issuing—which they've been doing, the Fed's buying like three-quarters of the debt that America issues. He said, once that's over, he said we're going to have a failed Treasury auction, interest rates are going to have to go up. We're living in this borrowed fantasy world, where the government keeps on borrowing money. You know, we borrow this extra trillion a year, we wonder who's loaning us the trillion? The Chinese aren't loaning us anymore. The Russians aren't loaning it to us anymore. So who's giving us the trillion? And the answer is we're just making it up. The Federal Reserve is just taking it and saying, "Here, we're giving it.' It's just made up money, and this does not augur well for our economic future.

You know, some of these things are complex enough it's not easy for people to understand, but your point of saying, bankruptcy usually concentrates the mind. Yeah, George.


Yet such an outcome is not a fait accompli (although we might well be seeing, as Churchill put it, the end of the beginning of that process).

As Alicia Munnell of the Boston Fed noted in reference to the use of the SS "Trust Fund:"

The conventional argument, and the one just alluded to, is that whether or not government saving actually occurs will depend on how the assets in the Social Security trust funds are used. If the reserves are used to finance current consumption - for example, to pay for current outlays in the rest of the budget - no real saving will occur. On the other hand, if the government alters its spending and taxing patterns to produce surpluses at the federal level - not just in the Social Security trust funds - the nation will enjoy higher saving and investment. 

That argument is basically correct. The only difficulty is that it characterizes all government spending as consumption. Clearly, the building of roads, bridges and other types of physical infrastructure is just as much an investment as the construction of any factory in the private sector. Equally important, however, is investment in human beings, because future output will depend upon having a healthy and educated work force. In other words, money spent on nutrition programs for pregnant women, on health care for poor children, and on Head Start programs will contribute just as much as physical investment to ensuring that we produce lots of income in the future.

The implication is that if we were doing a careful and serious job of assessing whether trust fund surpluses were adding to national saving, we would have to do more than look at whether the non-Social Security portion of the budget were in deficit or surplus. If the Social Security trust fund surpluses were used to finance new health or educational programs, they would be adding to future income just as surely as if they had been invested in General Motors stock.


In other words, and applying her views more broadly (including a wider range of investment options), it seems to me Americans need to choose (and soon).  Either we liquidate or we invest in making the nation much more efficient at producing and distributing the goods to whom they have been promised- in effect, making real the money "made up" by the Fed.  Neither choice will be pleasant and the latter may not be feasible given the divisive politics of today, although I have faith, should the political will be found the technology would be possible.  "Kicking the can down the road" makes the former option an eventual certainty.


Whether President Obama is the man for the latter job remains to be seen.

Thursday, November 17, 2011

Let's Fold Vegas

If US cities were poker hands, America's invisible hand would have folded Las Vegas long ago for there is nothing capitalist about gambling.  Aside from being an anti-capitalist theme park (about which, more later), Vegas, as it is affectionately known, competes with Southern California, wherein a large portion of US fruits and vegetables are grown, for Lake Mead's water.  Me, I'd take food over black jack any day.

If I were a talk radio host I might authoritatively assert, "we should just shut Vegas down, move the people elsewhere in the country and be done with it- simple, really."  Fortunately (for both you and me) I'm not a talk radio host and thus, on occasion, take a moment to reflect on the practical difficulties of policy proposals. 

Can you imagine the hue and cry from the media (jealous, no doubt, at the attention I'd be receiving), the various governments (rightly fearing a loss of tax revenue), the banks (who'd have to increase the pace of debt write-offs with no hope of return) and, last but not least, the people forced to relocate.  Yep, it's an absurd idea.

Except it isn't. 

Vegas was a bad bet.  Yet not only have we (i.e. us Americans, to greater or lesser degrees) continued to play it, we've bet heavily on what is a sure loser.  Consider.  It is a city which produces nothing economic, yet requires not only a large volume of water (precious stuff in the desert), but electricity as well.  Imagine the boon to other users of Colorado River hydro-power and water if Vegas was allowed to return to the desert it was.  Imagine the economic benefits accruing from reallocation of Vegas labor into more economic pursuits than income redistribution.

What's that, you say, gambling isn't economic?  Nope.  Gambling is as un-economic as theft.  Income changes hands but nothing comes from the exchange.  In a sense, Vegas is like Wall St.- a place where economics eats its own arm.

Nonsense, you say, Wall St. is about investing, not gambling.

Not so much these days, I counter.

Consider a few definitions before hyper-ventilating.

Gambling: a zero-sum game in which money changes hands leaving the world in exactly the same state

Investment: a non-zero-sum game in which money is exchanged for capital which is put to use in the pursuit of profit, thereby changing the world (admittedly sometimes not for the better) in the process

How much of Wall St. engages in the former instead of the latter?

But I digress.

As a practical matter folding Vegas would be difficult for us.  The US has proven its skills breaking virgin territory, and its impotence in reforming already existing territories (see also nation building).  China, by contrast, would have little difficulty evacuating Vegas, just ask the millions of former residents of the Three Gorges Dam area. 

On the topic of evacuations, Michael Bloomberg is probably scratching his head wondering why it was so easy to evacuate much of lower Manhattan in August and now so difficult to evacuate Zuccotti Park but a few months hence.  Note to Mike, it wasn't the police, but the shared sense of dire consequence if they didn't evacuate in August, and, I suspect, if they do evacuate now- the fear of being swamped by Irene or Wall St. respectively.

In a sense, Occupy Wall St. wants to fold Vegas too- the Vegas that is Wall St.

I can't say I blame 'em.  Let's fold Vegas, stop gambling and start investing (which, as an added benefit, might give some of the protesters something better, i.e. working, to do- just saying).  Why are we taking lessons (or, as seems more the case, not taking the lessons) on Capitalism from China?

ps As a closing note, I sometimes chuckle to recall the vigor with which men like Morgan and Rockefeller fought to avoid exchanging their businesses for money- they much preferred the latter than the former.  These days many can hardly wait to sell out.  There might be a lesson in that.

pps As I recently received notice of a (now-deleted) comment on this post which assumed my view was more literal than metaphoric let me set the record straight. I'd much rather get Vegas out of Wall St. than Nevada (although the latter has its merits).

Tuesday, September 06, 2011

The Price of Bank Immortality?

ZURICH, Sept 6 (Reuters) - Switzerland is set to partially meet a U.S. ultimatum and deliver an estimate of the amount of assets held by U.S. residents in secret accounts at Swiss banks, possibly up to $30 billion, a newspaper reported on Tuesday.

Citing unnamed sources, the TagesAnzeiger reported that Switzerland would hand over on Tuesday details that the FINMA financial markets regulator has gathered from banks in recent months on accounts held by Americans with more than $50,000. Thomson/Reuters

If you happen to be one of the reported tens of thousands of US citizens with a hidden account in Switzerland, now might be a good time to contact a tax attorney and take advantage of the IRS' Offshore Voluntary Disclosure Initiative (OVDI) which expires on 9/9/2011.  If UBS' previous disclosure of a few hundred US account holders back in 2008 didn't faze you, and the above news excerpt doesn't scare you, indulge me a few more minutes of your time.  The days of bank secrecy, at least for big banks which have needed bail-outs, may be ending.  In the not too distant future UBS' acronym might better be translated as Used to Be Secret, and they might not be alone.

Modern Technology, goes the cliche, has transformed the world.  Within the last century armies lost the ability to be formed and moved in secret as satellites peer down on the world.  Untold millions of cameras record our every move in both urban and suburban areas augmented by camera equipped police cars on the roads.  Computers listen in on our phone conversations and eavesdrop on email, searching for key words or phrases begging, and receiving, deeper human scrutiny.

The practice of Finance has also been transformed.  When I worked at Chase Manhattan in the late 80s deal tickets were hand written and confirmed either by phone or Telex.  Auditing bank trading and accounts required hundreds of accountants and many trees worth of paper.  Bank secrets were easier to keep if only because of the manpower required to unearth them.  Now the same technologies which allowed banks to cut thousands of back office employees from payrolls are being used to scrutinize account holders and their transactions.  Automated Database searches can do in a millisecond what used to take millions of man hours.

Clever minds at the IRS (and, I suspect,  the Treasury and Military) were no doubt quite pleased to see banks adopting the new technology.  As satellites made it extremely difficult to hide an army, networked computer bank records will make it extremely difficult to hide a financial transaction.

How long (if such isn't already being implemented covertly) before governments around the world have real time access to all account data?  Imagine a world in which you no longer file your taxes, the IRS simply sends you a bill or return.  Worse, there may be no tax bills or returns as withdrawals are made directly by the IRS, in real time.

Forget about the declining separation of church and state (and aspirations of the union thereof by US right-wing zealots), a more pressing concern might well be the declining separation of money and state.

Of course, as bastions of Capitalism, at least according to their press releases, the Big Banks would, you'd think, surely object to any such union.  Alas, these institutions have, it seems to me, chosen immortality, granted by the state, in return for much greater scrutiny.  UBS (Used to Be Secret) tried to fight a July 2008 John Doe summons of US account holders, but they quickly folded, not long after US government support of AIG gave them a back-door bailout (how causal the coincidence I leave to you to decide).  One wonders how many clever bureaucrats watched banks increase their credit market leverage hoping the inevitable collapse would leave them with real leverage over the banks.

Of course, the battle over this issue is far from over.  Banks will fight to maintain what they can of client secrecy.  Yet, if they keep lining up at the bailout line, they can hardly be expected to bite the hand feeding them.  Lack of solvency will equal lack of secrecy.

It would be ironic if big banks and their clients lost their autonomy, and potentially their wealth and freedom (penalties are most severe) by forgetting one of Capitalism's maxims, there's no such thing as a free lunch (or bailout).

Thursday, August 11, 2011

Why is the Invisible Hand in My Pocket While China Grows Unchecked?


Devotees of Rapture Theory are likely wondering why they got left behind during the Tribulation.  More worldly, modern persons, who eschew eschatology might nonetheless be worrying about TEOTWAWKI (which is, ironically enough, the same thing).  Devotees of Cyclical Theories of History (Kondratiev, Strauss and Howe, Hinduism) are likely seeing the end of a K-wave, the Fourth Turning, or the coming of Shiva, respectively.

Was it just a little over a decade ago that the New American Century was dawning?  History itself, according to some, was ending.  With free markets across the globe open 24 hours a day the invisible hand was sure to make our future bright.

Then the invisible hand started picking pockets, crashing the Tech market in which many had invested, and foreclosing on houses in which even more had not only invested but lived.

What happened to the invisible hand?  Was it always just a scam- a means to shift income to an increasingly select few?

Back when Francis Fukuyama was proclaiming the End of History, faith in the free-market inspired invisible hand's virtue was hard to challenge publicly.  A few years ago, echoes of that faith still resonated, as was evident when the presumed bastions of free markets, the banks, were saved from the effects of their own unwise speculations and lending.  Today, the natives seem a bit (in London, a lot) more restless.  It might, given current conditions seem a bit odd to resurrect that rapidly fading totem so let me try to explain.

Recently I've been reviewing the work of Mancur Olson, particularly the role of interest (or ownership, if you wish) in fostering an invisible hand effect, or in the US' case of late, the lack thereof.  In The Economics of Autocracy and Majority Rule: The Invisible Hand and the Use of Force Martin McGuire and Mancur Olson argue persuasively (in my view): that whenever a rational self-interested actor with unquestioned coercive power has an encompassing and stable interest in the domain over which this power is exercised, that actor is led to act in ways that are, to a surprising degree, consistent with the interests of society and of those subject to that power.  In other words, for the socially virtuous invisible hand to manifest some person or group has to think they own now and will in the future, their domain- that they are part of the realm. 

McGuire and Olson's argument begins with a hypothetical discussion of a bandit's transition to a benevolent dictator: Consider the interests of the leader of a group of roving bandits in an anarchic environment. In such an environment, there is little incentive to invest or produce, and therefore not much to steal. If the bandit leader can seize and hold a given territory, it will pay him to limit the rate of his theft in that domain and to provide a peaceful order and other public goods. By making it clear that he will take only a given percentage of output – that is, by becoming a settled ruler with a given rate of tax theft – he leaves his victims with an incentive to produce.

According to this view, free markets, which were apparently considered a condicio sine qua non- a necessary condition- of the virtuous invisible hand are rather simply a medium for aligning interests, which can be either those of a bandit or of a long term owner.  Multiple financial crises over a relatively short period of time are a sign that banditry, not long term ownership are the aims of large players in our free markets.  What long term owner wants multiple crises over a short period of time?

For a real world example of the difference between a bandit and an owner, consider the case of JP Morgan.  Whatever his initial designs as a young man, from his mid-50s until the creation of the Fed in 1913 Mr. Morgan had great power over (owned, some rightly argued) American finance.  As McGuire and Olson argue, the more control he gained the more he seemed to care about systemic solvency, of course, not without expecting great gains for himself.  Morgan knew that long term American financial difficulties were not at all in his interests.  A growing American economy was a condicio sine qua non for a wealthier JP Morgan.  While hardly a benevolent dictator, I hold to my view expressed here I’m confident if JP Morgan were running the Fed, credit growth would have been restrained long ago.  There is some merit to having someone "own" an issue- unlike Greenspan, Geithner, Rubin et alios, who claim no responsibility.

These days, American finance is run and regulated by people who have much less "skin in the game."  As I argued previously (here): It's apparently much better to work in a senior position at a money center bank than to own one.  For JP Morgan, risking insolvency to make Wall St. analysts happy would have been absurd.  The benefits accruing to him (higher dividend pay-outs for a few quarters- selling bank shares was considered silly then) would have been overshadowed by the potential loss in corporate stock value.  Today's money center bank CEOs, whose compensation is heavily skewed towards cash can run a bank into the ground and, in the event a bail-out isn't forthcoming, retire in luxury. 

Consider the case of Dow Kim, detailed in the aptly titled NYTimes article, On Wall Street, Bonuses, Not Profits, Were Real: For Dow Kim, 2006 was a very good year. While his salary at Merrill Lynch was $350,000, his total compensation was 100 times that — $35 million.....But Merrill’s record earnings in 2006 — $7.5 billion — turned out to be a mirage. The company has since lost three times that amount, largely because the mortgage investments that supposedly had powered some of those profits plunged in value.  Richard Fuld, ex-CEO of Lehman Brothers, earned some $45M in 2007, one year before that firm went bust.

Had Mr. Kim or Mr. Fuld held large stakes in their respective firms would they have been so reckless?  Would the real sector in the US be starved of cash, as is currently the case, if the reckless behavior of those like Mr. Kim, Mr. Fuld and others hadn't required their and other financial firms to be bailed out?  The large additions to public sector debt caused by the recent bail-outs are one of the main reasons the US debt rating was recently downgraded.

Meanwhile, over in ostensibly communist China, the invisible hand seems to be working just fine.  China's political leaders think like owners and through, at times, admittedly coercive policies, impose that view on others.  While China's middle class grows by leaps and bounds the American middle class is shrinking fast.

What can be done?  Assuming there is something to the views of McGuire and Olson, and I do so assume, the US needs leaders who think like owners instead of hit and run bandits.  Cash pay-outs and easily converted stock-option grants need to be replaced by long term equity holdings- players need to be forced to have "skin in the game".  Regulators too might perform better if their compensation was tied to disaster avoidance (imagine if FDIC regulators received bonuses if no banking crisis occurred not only during but 5 years after their tenure). 

In short, the US would be well served by reviving faith in the virtue of ownership.  Large public companies with diffuse ownership structures have been treated as disposable ATMs by senior officials.  Forcing people to have "skin in the game" before allowing them to make policy decisions seems like a good idea.  Even my local bank, of which I'm a shareholder, requires Directors to have a reasonably large stake therein.