Tuesday, February 28, 2006

President Bush loves the new media???

I find it interesting that the old way of gathering the news is slowly but surely losing market share.... It’s interesting to watch these media conglomerates try to deal with the realities of a new kind of world. President Bush

It seems to me, after reading the above quote from President Bush, that he is either quite the visionary or incredibly myopic in his thinking.

New media of communication are rarely beneficial to those in power, more often than not leading to radical cultural changes as forms of thought which had previously been localized begin, by virtue of the new media, to spread from mind to mind.

To cite one example from the past, Gutenberg's perfection (he didn't invent it) of the printing press, broke the Catholic Church's control of the written word and eventually their control over interpretation of the Bible. Ironically, the Vatican made Gutenberg a very rich man for printing the very indulgences that, in part, led Martin Luther to rebel against their authority. Moreover, Luther's ideas, unlike those of Jan Hus or John Wycliffe more than a century prior, could be transmitted through the new media.

As the Bible was printed in local languages and many other books, such as Dante's Divine Comedy, found a wider audience people's views of the Church and the Monarchies of the time changed dramatically.

The internet has and will, I believe, lead to profound changes in society. Indeed, I think the more profound changes are still to come. It usually takes a few generations for a culture to adapt to changes in modes of communication as the older generations tend to cling to old habits.

We will see if President Bush is as sanguine about the new media in a few decades.

Monday, February 27, 2006

Bribery not so absurdum

Convicted Rep. Randall "Duke" Cunningham actually priced the illegal services he provided....Prices came in the form of a "bribe menu" that detailed how much it would cost contractors to essentially order multimillion-dollar government contracts, according to documents submitted by federal prosecutors for Cunningham's sentencing hearing this Friday. ABC News

and I thought I was pushing the envelope with my satire....when Duke was pushing the envelope in reality

Why do I own Gold

You have to choose between trusting to the natural stability of gold and the natural stability of the honesty and intelligence of the members of the government. And, with due respect to these gentlemen, I advise you, as long as the capitalist system lasts, to vote for gold. George Bernard Shaw

While I usually agree with Austrian School of Economics, one bone of contention between that view and my own lies in the anti-government fetish. The same guys who wax apoplectic over governmental corporation transgressions will justify as righteous any commercial corporation transgression. To me, any corporation which insulates its officers, where the buck is supposed to stop, from the normal rules of human interaction and thus the effects of competition assumed by the Austrian School to purify commercial corporations' actions, creates conditions for abuse. The corporation of state, in my view, has no monopoly on evil.

Here's a local story:

Regulators in three states are investigating whether companies in London and Miami sold a fraudulent insurance policy to the owner of a tour boat that capsized on a New York lake and killed 20 elderly tourists, a Detroit newspaper reported.

The 40-foot Ethan Allen capsized Oct. 2 on Lake George with 48 people on board. Nineteen of the 20 victims were from Michigan.

The investigations in Texas, New York and Florida are trying to determine if the owner of the Ethan Allen was duped, the Detroit Free Press reported.

Texas regulators say associates of the companies that sold Quirk the policy are suspected of peddling millions of dollars in nonexistent insurance, the newspaper said.

Here's a Hedge Fund that would make even Carlo Ponzi blush:

Only about $150,000 of the allegedly $150 million in assets of an Atlanta-based hedge fund has been found by investigators probing allegations of fraud there, according to a published report.

I don't know who decided financial companies deserved to be treated like "endangered species" but this trend, much of which occurred during Greenspan's tenure as Fed Chair, of insulating them from the normal rules of human interaction has had the expected effect. Fraud, fraud and more fraud.

Why do I own gold, because I don't trust anyone who hides behind a corporation and the world is, by and large, run from behind a corporate veil.

Someday they'll give a war...

Someday they'll give a war and nobody will come. Carl Sandburg

Wars used to be good for Gold, by which I mean, the price of Gold expressed in terms of national currencies rose during war time. Inflationary finance, which used to be offensive to political sensibilities, was allowable during war time, as were other, usually undesired activities, to wit, Lincoln's suspension of habeus corpus during the War between the States.

Lately though, as inflationary finance has become acceptable at all times, it is in the aftermath of War that the financial effects manifest. I wonder, in the event war with Iran is avoided, if the price of Gold will rise. That is, opposite to the old behavior, perhaps the lack of war might be good for Gold.

I'm not much of a believer in the single cause explanation for war. There might be one or two hoped for effects many of those in power agree upon but there will also be diversity of opinion on other hoped for effects. Control of oil is most likely one of the hoped for by many effects of military expansion in the Middle East but there are, I imagine, other reasons.

I would bet that some of those in power welcomed the war, in part, because it would allow them to change the way the state dealt with the people, with other states, and with other elements within the state.

The need to put the US financial house in order, which was part of President Bush's election platform in 2000, wasn't considered necessary once the War on Terror began. Just as a resolution to the problems of the original Bretton Woods system was put off for years by the Vietnam War, so too, it seems, has a resolution to the
(much more significant) problems of Bretton Woods II been put off by the War on Terror.

Imagine if the War on Terror started winding down. Imagine if Iran managed to avoid a clash with the Security Council. Imagine if US military involvement in Iraq was reduced. Imagine if the commercial corporations of the world, as opposed to the governmental corporations of the world, began to complain they could not finance an expanded war.

This would, admittedly, be a novel choice given the history of the 20th century. However, the rush to war sometimes follows the same form as financial bubbles. It begins as an idea that captivates a growing number of other minds for a while only to burn itself out.

Given that the US cannot self-finance the current wars, much less a new one, the financial bubble analogy might be more apt than would seem given recent history. The guys paying the bills either live in the Middle East (the War zone) or need their oil (China, Japan) Perhaps the Dubai Ports deal is a sign the need for Middle Eastern finance is beginning to trump the wish to democratize the region.

If the current nuclear stand off with Iran is handled diplomatically perhaps the financial resolution to the current problems will come sooner rather than later. Perhaps years from now Sandburg's quote will be recast, someday they'll give a war and nobody will pay.

Friday, February 24, 2006

In the long run...the end game

In the long run we are all dead, said J.M. Keynes
No, Maynard, in the long run each of us is dead, replied his fellow Cambridge economist, Joan Robinson.

Inheritance in Public Policy: Change Without Choice in Britain
Richard Rose, Phillip L. Davies

There are times I think the main impetus driving modern society is evasion of long run effects- the ultimate Sisyphusian task. Increasing debt loads, obesity and family disintegration are just a few examples of behaviors which will have inevitably nasty effects in the long run. Perhaps though I shouldn't be surprised when truthiness is chosen word of the year. The currency markets are not immune to this habit of mind. With respect to the Iraq War, the writing is, in some respects, already on the wall. Yet, the US$ continues to hang in there.

Each time I recall Keynes view of the long run, I think to myself, you might be dead, Mr. Keynes, but we are still here. I wonder if later in life - he was 40 when he wrote A Tract on Monetary Reform, which contained that line - when his health was failing, he realized how silly it was. The long run comes to us all, individually and in certain respects, collectively. The period of bi-metallism ended, as did that of the Gold standard, the Bretton Woods Accords were broken and even the British Empire has receded.

My point being my belief that preparation for the future should include a clear view of the end game. This might manifest in a decision to treat one's children well as they will care for you when you are older, or financially in the choice of holding a portion of one's wealth in Gold, for all currencies collapse eventually.

Looking at Iraq, once the military option was chosen and initiated and long term bases began to be built, there seemed to me to be two options.

One, after a long, protracted, and importantly for our purposes, expensive war was fought, certain US corporations would gain control over Iraqi oil reserves. Bringing these reserves to market would require a not insubstantial amount of additional investment and military costs.

The second option,
after a long, protracted, and importantly for our purposes, expensive war was fought, the US would not gain control over Iraqi oil reserves, potentially leaving the region actively hostile to US interests.

Neither option would fix the hole in US external accounts although option one would be less onerous than option two.

on the FX markets, the US$ still holds its own despite a potential 2006 C/A deficit approaching US$1T or roughly 8% of GDP. We await congressional approval for a debt limit hike when the federal debt to GDP ratio is already 65%, a ratio that has doubled in the past few years. Meanwhile we seem to live in a financial world where corporations are reluctant to pass on higher input prices, which is cheered by Bernanke et. al. as a sign of flexibility, as if the US$'s loss of purchasing power is temporary.

In the long run, which will come eventually, the US$ will fall. It might be slow, as in the seventies. Or it might be quick, as in the Asian or Latam crises. Regardless, it will fall and fall far.

I received a few emails after my argument of a potential deflation scare in the offing to the effect that I sounded (metaphorically I imagine) like the average gold bug investment letter writer. I was a bit confused at that. I never wrote I was selling Gold, or any other of my inflation related investments.

Rather, I wrote I was mentally prepared to deal with potential portfolio losses and would be looking to add on any decline. My short term guess was based on a temporary halt in US federal debt monetization and a few other seasonal factors which, via Soros' reflexivity, and the black box crowd, might feed on themselves for a while.

More to the point, I wrote, if the pro inflation trades are not further unwound under the conditions noted, stronger forces would apparently be at work. Those stronger forces might include investors being forced by current events to begin to consider the end game in Iraq and its effect of the US$.

The long run comes for us all.

You wound 'em up

O, what a tangled web we weave,
When first we practice to deceive! Sir Walter Scott

As a father to a 5 year old boy I go to my share of birthday parties. Almost invariably cake, ice cream and soda are served and the children are running about madly, sometimes yelling at the top of their lungs, having fun as only little kids can.

On occasion, the host will comment, in a surprised tone, how strange it is that the children are so animated. My normal retort to this is something along the lines of, "they're just having fun," but inside I'm thinking, "you wound 'em up, what did you expect?" Put a group of kids together in a confined space, load them up with sugar and this is what you get.

This isn't a rant against little kid parties, I love to see the smiles on their faces while they're rampaging around. Rather it is a rant along the lines of Bastiat's unforeseen negative effects, when you wind up a group of kids with sugar or more broadly a population using demagoguery, there are certain longer lasting effects.

There are two main approaches in politics, demagoguery and calm rationality. Of these, the latter takes far longer, while the former is quicker, which tends to be why that path is chosen more often. However, once you opt for demagoguery, that is, evoking emotions like fear, instead of rationality, you risk ending up with a population not unlike a group of young kids at a birthday party. If you ever wish for calm rational debate, and in this instance that seem to me to be desirable, don't be a demogogue. Once that Pandora's Box is opened, it is very tough to shut.

When I read about the brouhaha over the Dubai Ports deal I remember the President's Feb 9 speech, among other such communications with the public, detailing the allegedly foiled al-Qaeda plot to blow up LA's US Bank Tower, the coverage of which on FOX included footage of the tower blowing up from the film, Independence Day.

You wound 'em up, what did you expect?

p.s. once the population is wound up, anybody with a microphone, metaphorically writing, in or out of the country can play them

Thursday, February 23, 2006

Bribery ad absurdum

With thoughts of Jack Ambramoff, Tom DeLay, Duke Cunningham and other assorted characters in my head, a thought experiment occurred to me. How potentially enlightening it would be, I thought, to invent an imaginary world where the covert became both overt and not just accepted but mandated and then ask people what they thought. I can think of few better days than today, when reports of Bob Dole of Viagra fame lobbying for Dubai Ports hit the wires, to unveil my thought experiment, Bribery ad absurdum.

Imagine a nation whose citizens believed in the sanctity of the auction process, by which I mean, any decision could be purchased, whether made by the lowest or the highest in society. Nobody thought it odd that Presidents, Senators, Congressmen, Judges, Corporate Heads and even baggage handlers all had websites with E-Bay like auction software selling each and any decision they might make during the day.

Want to meet the President?, no problem, simply go to the web site and out bid anyone else who wants to meet with him at your chosen date. Want to block some legislation?, no sweat, just hop on some of the Congressional Committee members' web sites and outbid those who want the legislation passed. Want to get something through customs?, pull up the appropriate baggage handler's web site and place your bid. It would be a Central Bankers dream, the emergence of the great god Money. The cause of humanity, at least in that nation, would be money.

This nation, again in your imagination, for nothing so absurd could ever really exist, would find itself in a world of other nations who did not share this desire for money. The citizens of those other nations would be concerned about various other things.

What do you, my 4 readers of this blog, think would happen in a nation run on that principle in a world where, outside of that nation, money was not the first and ultimate cause?

If you think a nation run out that principle would not fare well, consider which principles might be more helpful.

Perhaps it would be better to live in a nation run on principles other than to the highest bidder go the spoils. Oh well, I can dream, can't I?

Wednesday, February 22, 2006

Summation of Forces

After re-reading my deflation scare post I see I've left out an important part of my thinking, which is an occupational hazard of losing one's mind. In Physics, summation (addition) of forces is used to, you guessed it, add up all the forces acting on an object along a vector, or direction, such as one of the x,y,z, coordinates of 3 dimensional space. I find it a useful heuristic, or thought model, in contemplating the financial markets as there are always multiple forces, if you will, acting on the minds of market participants.

I my earlier post I alluded to one force, the Federal Government's deficit in an environment of Central Bank accommodation, by which I mean, the government spends money it does not have by diluting the stock of money already in existence. Friedman, I believe, refers to this force when he argues that inflation is always and everywhere a monetary phenomenon.

There are, however, other forces acting on the minds of market participants. These can be grouped into expectations, which can flow from both fundamental and technical analysis. For instance, in our example, if market participants expect that the current pause in money dilution is just that, they might just keep piling into gold, oil, equities, etc. Alternatively, if a price level is broken, say $535 support in Gold, expectations for further declines by the black box crowd might come into play.

The spice of playing the markets in the short term is never knowing which of the forces you deem to be causal is in play at the moment.

Deflation scares and the debt limit

The U.S. Senate might wait until mid-March to raise the U.S. borrowing limit. Sen. Grassley

To the extent the main impetus behind the inflationary bent to the US economy is the accommodation of government deficits, that the debt has hit its Congressionally mandated limit has and will likely cool some of the pro-inflation trade flows. Prices of some commodities may fall, the curve may invert a bit further and the US$ might rally further in FX markets. As I don't expect the trend, if it does manifest further, to last, I will both be preparing myself for further albeit temporary declines in my main precious metals holdings, and looking for opportunities to add to the inflation trade in the next month.

Market participants, as my friend Stephen Plant often reminds me, have a tendency to create their own reality- generating a mythology to justify the most recent price changes. Don't be surprised, given the unseen as of yet but expected effects of past tightening of the short end particularly with respect to the mortgage market, to hear and read fears of coming deflation. January's warm weather boosted strength might give way to February's snapback to weakness in economic data. Who knows, maybe the stock market will take a bit of a dive if the deflation fears get some traction in equity index prices. Japanese fiscal year end is another factor which tends to tighten credit markets at that time.

The key to remember, at least for me, is that there is always ebb and flow. The Fed has suggested it will be "data driven", perhaps knowing that the next string of data will be weak, justifying a pause in its tightening. A bit of a stock market swoon, and weak February economic data released in March, might be just the ticket for the next burst of inflationary finance. Once the black box and hedge fund crowd starts piling into the deflation trade, Congress can raise the debt limit and the Fed will be more able to accommodate those deficits without complaint.

To the extent further declines are not seen in commodity prices, equity markets remain bouyant and the quantification of economic activity remains robust the next manifestation of inflation related speculation might be quite strong.

Tuesday, February 21, 2006

When did the executive branch become the government?

"After careful review by our government, I believe the transaction ought to go forward," Bush said. He added that if the U.S. Congress passed a law to stop the deal, "I'll deal with it with a veto." Reuters

What is Roach smoking?

Globalization has forever changed the way the world works....A new macro is needed that replaces antiquated closed models with the open models of globalization.

The evidence is too overwhelming to dismiss as happenstance. Here we are in the midst of the strongest four-year spurt of global growth since the early 1970s and there has been no meaningful acceleration of inflation. Stephen Roach

Joseph Goebbels argued, if you tell a lie big enough and keep repeating it, people will eventually come to believe it. It appears this adage holds true in US financial circles for virtually everyone with a voice on the public stage hews to the party line of low inflation. Both the old and new Fed Chairman see inflation, perhaps more accurately stated as the effects thereof, as low as does Mr. Roach of MSDW.

Gold in $ terms is at a 25 year high. Oil and Natural Gas, although having eased down from record levels still trade at many multiples of their old 1983-1999 averages. Other commodities from steel to coal to copper are also far above what used to be considered normal prices. Yet, the "low inflation" propaganda holds sway.

Contra, Mr. Roach, I don't think globalization has changed the way the world works. To me what has changed is the meaning of the words, at least in some minds, used to describe the way the world works. I imagine if Physicists changed the definition of force to refer to something other than what it now refers to, they too would become confused. This would not mean that Newton was wrong or that new models needed to be invented.

After reading Mr. Roach's latest, I think he must have found some potent stuff. This is one batch of Kool-Aid even the Dude wants no part of.

External debt, the Suez Canal and US ports

New York Gov. George Pataki and Maryland Gov. Robert Ehrlich on Monday voiced doubts about the acquisition of a British company that has been running six U.S. ports by Dubai Ports World, a state-owned business in the United Arab Emirates.

The British company, Peninsular and Oriental Steam Navigation Co., runs major commercial operations at ports in Baltimore, Miami, New Jersey, New Orleans, New York and Philadelphia.
Associated Press

Muhammad Ali’s son Muhammad Said (1854-63), and his successor, Khedive Ismail (1863-79) came under the influence of European bankers. Partly under their influence, Ismail embarked on a series of expensive projects, which pushed the country deeper and deeper into an external debt trap. The Suez canal linking the Red Sea and the Mediterranean was dug during the period of his rule. But its control passed almost at once into the hands of the British who had managed to acquire most of the shares of the canal company, including those which had been originally allotted to Khedive Ismail.Egypt effectively passed into the control of European financial advisers because of the inability of the Khedive to repay his debt. The Other side of Foreign Investment

Frédéric Bastiat's Selected Essays on Political Economy explored, inter alia, the unforeseen future negative effects of policies which had initial temporary benefits. As I read the debate over the potential sales of commercial operations at 6 major US ports I have yet to see reference to the causal impulse, rising external debt in the US. If the US was running a surplus this debate would most likely be moot as US corporations would be more likely to be scrambling around to find investments, rather than Middle Eastern or Asian investors. I'll let Bastiat have the metaphoric floor for a moment.

In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.

Yet this difference is tremendous; for it almost always happens that when the immediate consequence is favorable, the later consequences are disastrous, and vice versa. Whence it follows that the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil.

The Ottoman Empire was destroyed, in large part, not by war, but by debt, which forced the sale of crucial operations and increased tax predation on its citizens. The opening of the Suez Canal reduced overland trade fees and Egypt's loss of the Suez Canal to Britain due to external debt further reduced income.

Next time you hear or read someone proclaim the wisdom of US economic policy, remember Bastiat, the Suez Canal, these 6 ports and other sales of US businesses that lead the nation ever closer to Buffett's sharecropper society.

Friday, February 17, 2006

The data driven Fed

The wind is howling outside as a cold front descends on upstate NY. My power is flickering in and out so I'll keep this short today.

Although the outlook contains significant uncertainties, it is clear that substantial progress has been made in removing monetary policy accommodation. As a consequence, in coming quarters the FOMC will have to make ongoing, provisional judgments about the risks to both inflation and growth, and monetary policy actions will be increasingly dependent on incoming data. Ben Bernanke

I find this "data dependent" guide to policy somewhat curious given Bernanke's Q&A comment that monetary policy actions work with a lag of up to 18 months. If the Fed is currently making policy based upon incoming data and the full effects of past policy actions have not been made, how does the Fed know that the next set of data might not paint a different economic picture? Paul Kasriel Director of Economics Northern Trust

Yesterday's post on Mr. Bernanke's quest for credibility explained my sense of his focus on appearance instead of reality. Mr. Kasriel raises a point which I believe comports with that focus. The Fed is apparently concerned with being seen to be responsive. Actually responding in a manner consistent with any monetary theory is of less import.

That monetary policy acts on an economy with a lag is part of economic dogma at this time. Estimates of that lag vary, ranging from 3 months to as much as 18. Thus the point Mr. Kasriel raises seem valid, if policy actions act with a lag, and policy has been changing how does the Fed know that the next set of data might not paint a different economic picture? Perhaps, their focus is not on real sector effects?

Public and investor opinion responds much more quickly to Fed policy changes than the real sector. Given Mr. Bernanake's quest for "credibility" distinct from his actual record, pandering to public and investor opinion, that is, being seen to react to data as they do, might be the way he hopes to acheive his goal. He will achieve credibility in their minds by being one of them.

This seems to me to be one of the worst ways of running a Central Bank. It is, however, entirely consistent with the Greenspan approach as Mr. Bernanake promised Congress.

Thursday, February 16, 2006

Central Banker Credibility

To be or to seem to be
That is the question

Sometimes I get a bit too clever with my choice of words to the point where even I lose track of the meaning. The desire to make something sound brilliant gets in the way of actually being so, if such is possible for a hacker like myself. When I read
What have we learned since October 1979 by Fed Chairman Bernanke, I chuckled a bit, remembering times I had confused myself. Perhaps I'm still confused but discussions of Central Banker credibility as something distinct from their actual record seems silly to me.

Here's an excerpt:

Central bankers have long recognized at some level that the credibility of their pronouncements matters. I think it is fair to say, however, that in the late 1960s and 1970s, as the U.S. inflation crisis was building, economists and policymakers did not fully understand or appreciate the determinants of credibility and its link to policy outcomes. Specifically, Kydland and Prescott demonstrated why, in many situations, economic outcomes will be better if policymakers are able to make credible commitments, or promises, about certain aspects of the policies they will follow in the future. "Credible" in this context means that the public believes that the policymakers will keep their promises, even if they face incentives to renege.

Note that credible doesn't mean that they actually stuck to their promise but that the public believes they will. It seems to me inflation didn't fall in the early 80s because the public believed Volcker would follow through on his promise to tighten but because be actually tightened, substantially. It also seems to me that inflation rose in the late 60s and early 70s not because Martin or Burns
did not fully understand or appreciate the determinants of credibility but because they provided too much monetary accommodation, as they both admit.

Bernanke goes on:

If the policymakers' statements are believed (that is, if they are credible), then the public will expect inflation to be low, and demands for wage and price increases should accordingly be moderate. In a virtuous circle, this cooperative behavior by the public makes the central bank's commitment to low inflation easier to fulfill. In contrast, if the public is skeptical of the central bank's commitment to low inflation (for example, if it believes that the central bank may give in to the temptation to overstimulate the economy for the sake of short-term employment gains), then the public's inflation expectations will be higher than they otherwise would be.

Is he arguing that economics or monetary policy is all a con game?

To me the study of credibility distinct from the sense derived from true fulfillment of obligation is a study in the art of deception. Let me use small words so I don't get confused. They want to know how long lies last.


Sympathy for the Devil

But what’s puzzling you
Is the nature of my game Mick Jagger

Q And you -- and I take it, you missed the bird.

THE VICE PRESIDENT: I have no idea. I mean, you focused on the bird, but as soon as I fired and saw Harry there, everything else went out of my mind. I don't know whether the bird went down, or didn't. Interview

I feel for the Veep. I really do. Let me tell you why.

After reading his interview and considering all that I've read about the incident, I think the Veep had one too many beers at lunch, lost a bit of control and shot his friend. How many is too many? Too many is the amount that leads you to lose control and shoot your friend. Perhaps at his age, and with his medical history and current medications, one beer is too many to maintain the control necessary to handle a gun. What clues led me to conclude he had lost control? He didn't see his friend before he shot and he doesn't know if he shot the bird. If you've hunted before you will know what I mean.

To me, this is between him and his friend. If his friend is alive and cool with it, and he appears to be, then case closed. Who knows, maybe a few years back, Dick and Harry went fishing, Harry had a few too many and caught Dick in the face with a lure, thus the perpetual sneer. These things happen. I've had a few too many beers and put my friends in danger before and my friends have had a few too many beers and put me in danger before. It's between us. We don't see any reason to get the state involved.

I'm not arguing I'd hunt quail with the Veep, or that I think it wise to drink beer and shoot guns. I wouldn't and I don't. It just seems to me that one aspect of freedom is the freedom to be stupid without getting thrown in jail, assuming you can reconcile with those hurt by your stupidity. Just because I disagree with the man is no reason, in my view, to throw away my principles.

To err is human.

Wednesday, February 15, 2006

Peak Oil and Political Economy

According to Ken Deffeyes of Princeton, the world just passed the peak of oil production on December 16, 2005. It will likely be some time before this assertion can be verified, although judging by increased US military attention to the Middle East, it would seem at least some policy makers are acting consistently with elements of this view. This however, doesn't make it true. The denizens of Washington DC have no monopoly on the truth, however much some of them might like that to be the case. Regardless, this argument assumes the main thrust of peak oil theory is true, by which I mean, the age of cheaply produced oil is, or is near to being, over, although petroleum will still be used for decades to come. Under the assumption of peak oil, what should an oil importing country like the United States do?

Sweden, for example, has formed a committee of industrialists, academics, car manufacturers, farmers and others. which aims to replace all fossil fuels with renewables before climate change damages economies and growing oil scarcity leads to price rises. According to the Guardian newspaper, a Swedish minister said oil dependency could be broken by 2020. In other words, the Swedish won't wait until rising prices force them to change their way of doing business, they will get to it now.

This, however, is not the way the United States is supposed to do business. In the illusion fostered, but certainly not created by Greenspan et. al. of a "flexible" US economy which exemplifies free market ideals and embraces creative destruction, the policy response is clear. Let the market process work its magic on the minds of entrepreneurs with as little intrusion as possible.

To me this would include keeping a tight rein on credit to make prices more responsive to changes in the real sector. The goal of monetary policy when faced with radical change in a classically liberal view of political economy should be price reality not price stability.

That price stability rather than price reality is the buzz word of Central Bankers the world over is evidence enough to me, not that I needed more, that classic liberalism as functioning philosophy among policy makers is dead. When Ben Bernanke proudly proclaims the flexibility of the US economy has kept petroleum inflation from manifesting through the rest of the economy, all I see are signs of a lack of flexibility. The word does imply change, does it not.

Am I advocating the Swedish response for the United States? Only in the sense that they practice their expressed philosophy of political economy. While some Swedes I've met have complained about the intrusiveness of the state in the economy, that it intrudes is accepted. In other words, there aren't many Swedes who believe they live in a free market economy.

There are, however, many US citizens who believe they live in a free market, or for our purposes, real price, economy. Yet, this has not been the case for decades. Thus the dilemma brought to us by the Fabians and other groups who operate in secret manifests. The Fabian method of weaning a culture from classical liberalism to state control was incremental and clandestine rather than revolutionary and overt. Over time though the gap between rhetoric and reality grows. In individuals this is sometimes called psychosis, a loss of contact with reality.

Perhaps the economic stress of peak oil on the US economy will act as a slap in the face, forcing the nation to admit it is much more centrally planned than the rhetoric would suggest. Perhaps I should use the present tense. The economic stress of peak oil on the US economy is in the process of exposing the central planning element of our current system. I'm not the first to note the Imperial Presidency.

Of course, not all psychotics reintegrate with reality. If the dream is more attractive or the reality too scary some psychotics simply shut down, rather than reintegrate. This to me will be the true test of American flexibility.

More troubling to me is the functionality of central planning in this case. The age of oil has been the age of centralization. Just as Roman roads created conditions where a much larger area could be centrally governed than was previously possible so too has oil fueled transport. It isn't just the information superhighway that makes this country work but the more mundane highways where goods and people are moved. If the age of cheap oil is over, less centralization and more local autonomy might be the best, albeit in most cases, least likely to be chosen, policy option. It seems to me in this case, the benefits of classical liberalism are especially clear.

For now though, it looks as if the psychotic game of claiming to be a free market economy while trying to clandestinely solve the problems in some central committee is still official, but secret, policy. I wish the current crop of policy makers well in their difficult task. The Soviet Union had oil, wasn't trying to hide the fact of central planning and yet they couldn't hold up the weight of their empire.

Freedom, why not, we've tried everything else.

What happened to Bernanke the inflation targeter?

Have you ever seen a TV or film rendition of a paranoid man? The depth of paranoia is usually unveiled in a comment, as the paranoid guy turns to someone he used to trust and says, so they got to you too. Remember inflation targeting Ben Bernanke? It looks like they go to him too.

Here's an excerpt from the old Ben Bernanke of three years ago:

The second major element of best-practice inflation targeting (in my view) is the communications strategy, the central bank's regular procedures for communicating with the political authorities, the financial markets, and the general public. In general, a central bank's communications strategy, closely linked to the idea of transparency, has many aspects and many motivations.8 Aspects of communication that have been particularly emphasized by inflation-targeting central banks are the public announcement of policy objectives (notably, the objective for inflation), open discussion of the bank's policy framework (including in some cases, but not all, a timeframe for achieving the inflation objective), and public release of the central bank's forecast or evaluation of the economy.

His views adjusted slowly but inexorably away from what old timers might have called a "liberal" stance on political economy, by which is meant consitent with the view that government needed to be responsive to its citizens, to an elitist view, by which is meant consistent with the view that the government is already peopled by the best and brightest so why consult with the masses.

To wit, in today's testimony to Congress:

As always, however, translating the Federal Reserve's general economic objectives into operational decisions about the stance of monetary policy poses many challenges. Over the past few decades, policymakers have learned that no single economic or financial indicator, or even a small set of such indicators, can provide reliable guidance for the setting of monetary policy.

Rather, the Federal Reserve, together with all modern central banks, has found that the successful conduct of monetary policy requires painstaking examination of a broad range of economic and financial data, careful consideration of the implications of those data for the likely path of the economy and inflation, and prudent judgment regarding the effects of alternative courses of policy action on prospects for achieving our macroeconomic objectives. In that process, economic models can provide valuable guidance to policymakers, and over the years substantial progress has been made in developing formal models and forecasting techniques. But any model is by necessity a simplification of the real world, and sufficient data are seldom available to measure even the basic relationships with precision. Monetary policymakers must therefore strike a difficult balance--conducting rigorous analysis informed by sound economic theory and empirical methods [ note: which theories, there are many, and which empirical methods...like Greenspan his speech is so general it is uninformative ] while keeping an open mind about the many factors, including myriad global influences, at play in a dynamic modern economy like that of the United States. Amid significant uncertainty, we must formulate a view of the most likely course of the economy under a given policy approach while giving due weight to the potential risks and associated costs to the economy should those judgments turn out to be wrong.

During the nearly three years that I previously spent as a member of the Board of Governors and of the Federal Open Market Committee, the approach to policy that I have just outlined was standard operating procedure under the highly successful leadership of Chairman Greenspan. As I indicated to the Congress during my confirmation hearing, my intention is to maintain continuity with this and the other practices of the Federal Reserve in the Greenspan era. I believe that, with this approach, the Federal Reserve will continue to contribute to the sound performance of the U.S. economy in the years to come.

So Ben "transparent communications" Bernanke has decided to adopt Alan "inscrutable" Greenspan's approach to policy which can be summed up in a few words, we won't tell you exactly what we're doing or why we're doing it, just trust us.

Perhaps now we know why Ben got the nod. I wonder when the Queeen will Knight him?

Tuesday, February 14, 2006

Flotsam and Jetsam

Upon hearing of Vice President Cheney's shooting skills, and Mary Matalin's assertion that the Veep "didn't do anything he wasn't supposed to do", George Washington jumped out of his grave to assert, "I cannot tell a lie. The Cherry Tree jump'd in the path of my axe whilst I was chopping wood."

I wonder what might have happened had the Veep been shot by Mr. Whittington.


Are bankruptcies or perhaps more accurately mortgage defaults deflationary? As fears of an impending housing crash rise, this seems a useful question to ponder.

The history of the Great Depression and the experience of the late 80s early 90s real estate market decline informs common sense that bankruptcies are deflationary. Yet, I am not so sure, perhaps "it depends" is my best response to the question.

If my neighbor goes bankrupt and defaults on his mortgage the total level of credit declines and one additional house for sale enters the market. If someone else borrows an equal or greater amount than the defaulted mortgage to buy the house, total credit is constant or rises.

Thus I could imagine a dramatic rise in mortgage defaults which did not lead to deflation of the housing market in terms of either price or credit. The Department of Housing and Urban Development which cut its teeth, in a sense, during the S&L bailout, might be one of the means by which the housing market could be stabilized.

Obviously, the proof of the pudding is in the eating, but don't be surprised if a rise in mortgage delinquencies and defaults doesn't lead to large price declines.


Money, according to this survey, is positively correlated with happiness. Perhaps Thomas Jefferson had no need to alter John Locke's "life, liberty and estate" when listing the rights of man in the Declaration of Independence. The pursuit of property, measured in terms of income, at least in the minds of those surveyed, is synonymous with the pursuit of happiness.

One, by which is meant me, wonders how those surveyed might define happiness. This reminds me of those surveys which ask if people believe in God, to which most Americans reportedly reply, "yes." I'd love to ask the follow up, how would you distinguish believing from not believing in God, besides the simple assertion?

Running with this meme, what is happiness? Is it a state of mind we call "feeling good?" Is it that mental state characterized by greater than normal levels of serotonin? If so, happiness comes in a bottle.

I think though that Jefferson was leaning more on Aristotle than Locke when he made the change. Perhaps constrained by the English language, he couldn't use the word he meant, eudaemonia. To the ancient Greek philosophers eudaemonia wasn't a state but a process, perhaps better expressed by "flourishing" than "happiness" as Carolyn Ray argues here.

I've known quite a few people (and been one myself) who are money happy but hardly flourishing.

Monday, February 13, 2006

Ben, all hat and no cattle, Bernanke

Open market operations affect the supply of Federal Reserve balances to depository institutions. Purchases of securities increase the quantity of Federal Reserve balances because the Federal Reserve creates the balances to pay the seller by crediting the account of the seller’s depository institution at the Federal Reserve. Conversely, sales of securities decrease the quantity of Federal Reserve balances because the Federal Reserve extinguishes balances when it debits the account of the purchaser’s depository institution at the Federal Reserve. In contrast, when financial institutions, business firms, or individuals conduct transactions among themselves, they simply redistribute existing balances held at the Federal Reserve without changing the aggregate level of those balances. Federal Reserve Bulletin

Remember when monetary policy used to work both ways? While the Fed, as famously noted by current Chairman Ben Bernanke, is more than able to create reserves and then let the multipliers do their thing, putting a lid on the money supply by withdrawing reserves seems harder. Perhaps the fact that foreign holdings of US Treasury Securities, the means by which the Fed implements monetary policy, dwarf the Fed's has something to do with the problem.

As the opening excerpt from the Fed relates,
sales of securities decrease the quantity of Federal Reserve balances because the Federal Reserve extinguishes balances when it debits the account of the purchaser’s depository institution at the Federal Reserve. This only works in a closed system with the Fed as swing factor in the market.

In that closed system, Fed sales of securities not only drive the prices of those securities lower, the reduction in reserves had a multiplicative effect on credit. Thus the old adage, don't fight the Fed. So long as the Fed and its member banks had the Treasury Security market cornered, they called the shots.

But those days are gone. Now the Fed can sell those same securities into the market only to find an ever willing foreign buyer. And with the annual Trade Gap roughly equal to Federal Reserve holdings of US Treasury Securities, I don't think the Fed is in any position to bring this market back under control.

When Ben Bernanke testifies to Congress later this week, he may well, as this article from Bloomberg suggests, try to "establish his anti-inflation credibility" with his rhetoric. This will be good practice as that will be about his only tool in reality. Barring the breakdown of the current Bretton Woods II system, which could come at any time, I think the big surprise in 2006 will be the continued ability of the out of Fed control US credit system to sustain itself.

In a sense the US credit system reminds me of the Gordian Knot awaiting its Alexander.

Saturday, February 11, 2006

On Church and wiretappping

If you don't do anything wrong you have nothing to worry about.

Oh really.

Jeff, talking to his cousin, Bill, on the phone Saturday morning: Remember that piece of land behind my house I told you I wanted to buy?
Bill: Yes. Quite a nice lot, what's up?
Jeff: I just saw a For Sale sign on it. I'm going to give the agent an offer on Monday.
Bill: Wow, good for you. Are you going to try to get a deal?
Jeff: No I really want the piece, I think it's a steal at their selling price so I'm just going to take it.

On Monday, Jeff calls the agent to give them his offer and finds that someone else already signed a contract with the seller on Sunday. The agent mentions that the purchaser just might be willing to sell, at a higher price, of course.

I think the Bush Administration may finally have gone too far with the wiretapping. My argument is not "moral" in the sense that wiretapping is believed to be (or not as the case may be) inherently "wrong." Rather, given the nature of our economy, wiretapping is one of the few unpardonable sins not from the perspective of the political left, but from the right. Predator capitalism, inter alia, becomes very difficult in an environment where anyone can be wiretapped.

Was it just 30 years ago that this report on Domestic Spying was front page news. Here's a few excerpts:

The number of Americans and domestic groups caught in the domestic intelligence net is further illustrated by the following statistics:

-- Nearly a quarter of a million first class letters were opened and photographed in the United States by the CIA between 1953-1973, producing a CIA computerized index of nearly one and one-half million names. 13

-- At least 130,000 first class letters were opened and photographed by the FBI between 1940-1966 in eight U.S. cities. 14

-- Some 300,000 individuals were indexed in a CIA computer system and separate files were created on approximately 7,200 Americans and over 100 domestic groups during the course of CIA's Operation CHAOS (1967-1973). 15

-- Millions of private telegrams sent from, to, or through the United States were obtained by the National Security Agency from 1947 to 1975 under a secret arrangement with three United States telegraph companies. 16

-- An estimated 100,000 Americans were the subjects of United States Army intelligence files created between the mid 1960's and 1971. 17

-- Intelligence files on more than 11,000 individuals and groups were created by the Internal Revenue Service between 1969 and 1973 and tax investigations were started on the basis of political rather than tax criteria. 18

-- At least 26,000 individuals were at one point catalogued on an FBI list of persons to be rounded up in the event of a "national emergency". 19



Intelligence techniques which previously had been concentrated upon foreign threats and domestic groups said to be under Communist influence were applied with increasing intensity to a wide range of domestic activity by American citizens. These techniques were utilized against peaceful civil rights and antiwar protest activity, and thereafter in reaction to civil unrest, often without regard for the consequences to American liberties. The intelligence agencies of the United States -- sometimes abetted by public opinion and often in response to pressure from administration officials or the Congress -- frequently disregarded the law in their conduct of massive surveillance and aggressive counterintelligence operations against American citizens. In the past few years, some of these activities were curtailed, partly in response to the moderation of the domestic crisis; but all too often improper programs were terminated only in response to exposure, the threat of exposure, or a change in the climate of public opinion, such as that triggered by the Watergate affair.

Friday, February 10, 2006

The invisible fence of monetary policy

Every time the government moved to enlarge the flow of benefits to the population at large, or to this or that group, the assumption was implicit that monetary policy would somehow accommodate the action. A similar tacit assumption was embodied in every pricing decision or wage bargain arranged by private parties or the Government. The fact that such actions could in combination be wholly incompatible with moderate rates of monetary expansion was seldom considered by those who initiated them, despite frequent warnings by the Federal Reserve that new fires of inflation were being ignited.

Facing these political realities, the Federal Reserve was still willing to step hard on the monetary brake at times-as in 1966, 1969, and 1974-but its restrictive stance was not maintained long enough to end inflation. By and large, monetary policy came to be governed by the principle of undernourishing the inflation process while still accommodating a good part of the pressures in the marketplace. Arthur Burns

Government policy acts on the population at large in two main ways. Many citizens, at least in a well functioning society, go along with policy either out of fear of sanctions, or simply because they are law abiding citizens. A hopefully smaller set of citizens will not go along with policy and thus become object lessons. Government policy enforcement then determines which set grows or shrinks over time. This is not to argue the law is the only means by which cultural behaviors are shaped, which I don't believe. Rather, to the extent the law has an effect, i
n general, harsh, equally applied sanctions will lead more to stay within the law while loosely applied, less harsh sanctions will lead to the opposite.

While monetary policy is, at least currently due to the worship thereof, not thought of as a form of government policy sanctions, I think this is a useful heuristic when tightening comes into play. Just as the state may choose to criminally sanction fraud, insider trading, or drug dealing to change people's behavior so too does the Central Bank monetarily sanction indebtedness.

If the criminal sanctions for
fraud, insider trading, or drug dealing were only enforced say every three years, and even then not harshly, over time I would expect to see those behaviors become more entrenched in the population at large. Equally if the monetary sanctions for indebtedness were (are) only enforced sporadically and rarely for long or with harsh penalties, indebtedness will (has) become more entrenched in the population at large.

Are you familiar with the "invisible fence?" It's a wire buried in a perimeter around your yard which, when operating, will first cause a whistle in a special dog collar to sound and then, assuming your dog doesn't move away from the wire, send a shock of variable voltage into your dog. Dogs deal with this behavior modification tool much as humans deal with sanctions. Some learn very quickly, while some take longer and higher voltages.

Once the dogs learn the new boundaries some people turn the shock voltage down or off altogether, not wanting to hurt their dog. They then hope that the whistle alone will do the trick. Sometimes it does, but over time, the whistle alone is rarely enough. Once the whistle alone fails to do the trick, then owners face a dilemma. They can try to recreate the association of whistle and pain but this usually requires much higher voltage. Worse, once a dog learns that the shock only hits it when it crosses the wire, it is much more likely to "jump the fence" regardless of the voltage. On rare occasions, the dog gets tired of being shocked altogether and bites the owner.

The practice of monetary policy described by Arthur Burns and practiced by the Greenspan Fed seems to me like the kind hearted invisible fence approach. There is this hope that people will remember the pain of restrictive monetary policy or persistent market intervention and change behavior at the hint thereof. Some Central Bankers, like dog owners would prefer not to hurt their charges.

Yet, just as a properly administered invisible fence keeps dogs from being run over by cars, inter alia, properly administered monetary policy help the nation avoid inflation, and other manifestations of overextension, such as external account deficits which can lead to wars, inter alia. The dog owner, hopefully being aware of the possible dire consequences will restrict the dog's ability to roam, while the Central Banker, hopefully being fully aware of the possible dire consequences, will, to borrow a well worn cliché, take away the punchbowl, before the party gets out of hand.

It is, as Arthur Burns describes, a difficult task and beyond the ability of the Central Bank to enforce alone if other segments of society refuse to admit the possible dire consequences. A few months of an inverted curve that is quickly aborted at the first real signs of economic pressure is not, in my view, sufficient to dampen inflation pressures over the medium term. As one of the current major culprits behind rising national indebtedness is government itself, one of the slowest responders to monetary policy, particularly when external finance is available, the Central Bank may find its invisible fence quite ineffective.

To wit, judging from the most recent auction result reports and bond market action, the US federal government continues to have little trouble financing its deficits. This means behavior changes will be forced on the private sector. Within the private sector, the household and corporate financial sectors seem to me the possible swing factors. Of these the latter is a protected industry which leaves the household sector.

Within the household sector, mortgage related finance is the key. Will the Fed be able to squeeze real estate debtors sufficiently to bring about a radical shift in economic behavior? Using our dog analogy, will policy makers be able to enforce sanctions without being bitten?

I doubt the household sector can do the heavy lifting on its own without a substantial, long lasting credit restriction. I also don't think the executive branch is willing to risk such a squeeze given low approval ratings. Given that the seven voting members of the current Fed have now all been appointed by President Bush, his administration might have some say in the implementation of policy. Unpopular wars and coincident credit restriction induced recessions are rarely good for the party in power.

Over the short term, I'm interested to see if the invisible fence is working at all. That is, are higher short term rates slowing the mortgage finance machine? If, for instance, foreign demand for mortgage debt grows, higher rates may have much less of an effect than expected. This, it seems to me, would surprise the markets. Secondly, how long will the Fed keep the curve inverted or more generally restrict credit to the household sector?

My guess is that policy makers and big players in the financial markets feel confident the invisible fence works. I think they will be surprised both by its lack of efficacy and the swiftness with which the dogs begin to snarl and bite even at low voltage.

Thursday, February 09, 2006

A window on Wall St. deals

Less than a week into my new job as FX trader at Chase Manhattan Bank I found myself accepting a beer from one of my brokers in a South St. Seaport Bar on a Thursday afternoon. "Thanks," I told this man I had just met face to face. He told the bartender to get me whatever I wanted on his tab and then told me, "no problem." I proceeded to have a very fun night.

The next morning I crept quietly into the dealing room on the 35th floor, nursing a hangover. I hadn't even taken my suit jacket off when I heard the voice of my new friend through one of the little speakers or "broker boxes" on my desk, "can I get some help with a switch?"

I didn't then know what a switch was so he informed me that his desk had done a deal with two clients who didn't have credit lines with each other. As Chase had large credit lines with everyone, I could help him complete the deal by acting as intermediary and as a side benefit to him, double his brokerage as 1 ticket became 2.

So began my career on the Wall St. favor circuit. Beers at a bar became dinners at expensive restaurants with cocktails at a club after and limo rides in between. Good seats to virtually any sporting event or concert were mine for the asking, especially as I started to trade in larger volumes. The amounts they spent to keep me happy were small in comparison to the brokerage fees they earned from Chase through me. It was good to be a parasite.

When I moved to the buy side of the market at a major Hedge Fund I didn't have any more brokers as I now dealt through the banks (the sell side). But the deal was the same and the amounts were larger.

At times when we traded aggressively, driving the market sufficiently such that our bank counter parties made losses, meetings would be set up to discuss this "unfair" arrangement. Almost invariably we would do a few "open fill" orders, instructing the banks to buy or sell $100M of whatever currency at their discretion, which meant that we would allow them to make a few "pips" on the order. A pip on $100M $/DEM is roughly $10,000.

The point I'm trying to make here is that the amounts being traded were so big, (this was more than a decade ago) and the profits to be earned so large that the money spent generating the "good will" was almost always very well spent. Of course, from the perspective of the end user, those who provided the funds to be intermediated, or needed the funds to put to use, this was a tax, or vig, if you will.

So when you read that Lehman paid Mr. Greenspan $250K to speak at a dinner of hedge fund guys don't worry about them. I'm sure as the NYPost relates, It is very safe to say that [Lehman] will have its strongest week of the year based on this meeting. Equally, don't worry about the Hedge Funds giving up a few pips, I imagine the managers thereof made their trades and waited for "news" of the dinner to leak.

Looking back, I'm embarrassed to realize that I refused to grasp what I was doing, taking solace in numbers - "everyone's doing it." As I've reported on in the past, one of the major trends during the Greenspan Fed has been the shift of profits from manufacturing firms to financial firms. I guess easy Al has been champing at the bit to get a slice of the pie he helped bake.

In 1987, less than 19% of total domestic corporate profits were earned by financial firms, while just under 27% were earned by manufacturing firms. In 2004, 33% of total domestic corporate profits were earned by financial firms while just over 12% were earned by manufacturing firms. In 1987, the US had a slightly positive net international investment position. In 2004, the net international investment position was -$2.5T, which is to say that under Greenspan's Chairmanship, the US sold the family jewels to keep up appearances and the guys who served as middlemen in the process, the owners of the financial sector, got rich doing it. (all data: BEA)

Wednesday, February 08, 2006

Greenspan as Fed Watcher

What makes some red in the face is that he can speak about Fed policy and the economy just days after leaving the Fed when his insights are most relevant and freshest and impact markets....It's great if you were among the lucky few to attend, as the rest of the B-list money managers are only now just hearing about the meeting. David Gilmore, FX Analytics

It appears that the ex Fed Chair has ruffled a few feathers with his jump into the private sector. Some, like Mr. Gilmore above, are moaning about asymetric information release, or not being on the inside. Others are worried that Greenspan might release critical Fed information. I think they have little to fear on that front. Greenspan's skill as Fed watcher ended once he stopped making the calls.

Before Mr. Greenspan was Fed chair, he ran a consulting firm called Townsend-Greenspan which.... well I'll let Murray Rothbard have the floor:

I found particularly remarkable the recent statements in the press that Greenspan's economic consulting firm of Townsend-Greenspan might go under, because it turns out that what the firm really sells is not its econometric forecasting models, or its famous numbers, but Greenspan himself, and his gift for saying absolutely nothing at great length and in rococo syntax with no clearcut position of any kind.

As to his eminence as a forecaster, he ruefully admitted that a pension-fund managing firm he founded a few years ago just folded for lack of ability to apply the forecasting where it counted- when investment funds were on the line.

I think Mr. Greenspan's new venture, Greenspan Associates, will follow the same path, eventually. The more people see Greenspan outside of the Fed, the more they will see the man behind the mystique.

Greenspan speaks his mind

Greenspan said the high cost of gold did not reflect inflation or the strength of commodities, but rather a fear among investors of a major geopolitical conflict. There were people who believed that a nuclear weapon could be detonated within five years, the former American central bank supremo said. Greenspan says

Not infrequently over the past years I've wondered what now retired Federal Reserve Chairman Greenspan might say were he free to speak his mind. My hope was that he might echo the sentiments of his mentor, Arthur Burns, noting the constraints of the office, and the dangers of being affected by the philosophic and political trends of the time. My fear was that he had been, more or less, already speaking his mind. His first comments since retirement lead me to the latter view.

It is, of course, possible that his acceptance of an advisory role to the UK's Treasury will act as further constraint on his "free speech." On the other hand, despite Paul Volcker's continued involvement with government, he apparently feels free enough to criticize the lack of policy response. Perhaps more time needs to pass before Mr. Greenspan finds his voice. For the purposes of this essay, however, I'll proceed under the assumption that he is speaking his mind.

Clashes between internal sensibilities and the pressures of public office can manifest in many ways. Dissenters who wish to remain "inside" might pay lip service to policies for public consumption while effort is directed to exposing the perceived error. These people can sometimes stall institutional acceptance of the passions of the day. Sometimes the clash is so intense that dissenters take action, Daniel Ellsberg and Lawrence Wilkerson come to mind.

Mr. Greenspan's lack of private life, by most accounts he devoted himself to his job, further leads me to think that what you see is, by and large, what you get. Perhaps underneath the expressed sense that he has managed the economy well lies, not a family man concerned about the future state of the world, Greenspan has no children, but the belief that he has managed things well and price action to the contrary is a temporary phenomenon. His history as Objectivist, the philosophy that the world is as it seems to you, and that people who disagree don't get it, also suggests this view. Then again, should I even be surprised to find that a man who does not believe in the soul demonstrates his lack thereof?

Why, you might be wondering, would I be fearful that Greenspan was, in the main, calling it like he saw it? I feared that view because the projected Greenspan seemed quite shallow to me suggesting that policy changes would reflect that shallowness. Remember this wasn't a man who grudgingly went along with executive branch pressure to ease policy, but rather one whose embrace of "new economy" tenets led him to revise statistical definitions in support of that view. He biased institutional measures which will remain with us for some time.

He seemed to be a true believer, in himself, merely paying lip service to "on the other hand." Men of that persuasion are apt to lead people over a cliff, because they can't imagine the edge even exists, until it's too late.

To wit, it seems extraordinarily shallow to me to argue that Gold is not rising due to inflation concerns but rather due to fear of geopolitical conflict. Is conflict between nations (a phrase I much prefer to the popular sound bite "geopolitical conflict") an exogenous event, or a result of policy failures? In the event of an expanded conflict, (perhaps someone should tell Mr. Greenspan that there already is a war going on) would it not be a wise trade to expect further inflationary finance from the nation which acts as both policeman and banker to the world?

Admittedly, some time passed before Arthur Burns wrote what I read as an indictment of discretionary monetary policy:

Viewed in the abstract, the Federal Reserve System had the power to abort inflation at its incipient stage fifteen years ago or at any later point, and it has the power to end it today. At any time within that period, it could have restricted the money supply and created sufficient strains in financial and industrial markets to terminate inflation with little delay. It did not do so because the Federal Reserve was itself caught up in the philosophic and political currents that were transforming American life and culture.

Greenspan, it seems to me, was and still is caught up in those currents.

Tuesday, February 07, 2006

Eris and the cartoons of discord

Helen of Troy's beautiful face that launched a thousand ships might be traditionally cited as the cause of the Trojan War but according to Greek Mythology, the ultimate cause can be found in the tale of Eris and the Apple of Discord. Eris, the goddess of strife, was not invited to the wedding of Peleus and Thetis, apparently THE party of the century, and in a fit of pique threw a golden apple with the words "to the fairest" on it in the midst of the party, knowing that the ensuing arguments among the Goddesses would ruin the party. Eris, it seems, has been up to her old tricks again, although being hip to the 21st Century, she opted for cartoons instead of apples.

In this age of TV and movie worship, iconoclasm, the belief that images are not the proper medium through which to worship God, likely seems a dated idea. Yet, Iconoclasm has been a feature, from time to time, of most of the major faiths. Christianity has gone through quite a few iconoclastic phases. Indeed, one of the bones of contention between Protestants and Catholics was the use of images in worship. During the Reformation period, Catholic icons were destroyed in many parts of northern Europe.

A visit to a mosque will attest to the absence of religious imagery in the practice of Islam. Some might remember the Taliban's destruction of the Buddha statues at Bamiyan as evidence of this iconoclastic tendency. If you are a devout Muslim, you will look dimly (actually not at all) on images of Allah or the Prophets thereof. This might explain some of the outrage currently being vented over the cartoons of Mohammed. Certainly, that there would be outrage would be apparent to anyone with passing familiarity with the basic tenets of that faith.

As the global media machine has done its thing, these images have been republished and rebroadcast, inspiring angst among devout Muslims, acting as a general focal point for the growing sense of Muslim suppression and now ridicule by the West, and providing opportunity for the human worshippers of Eris, those who would welcome discord. Perhaps these new Eris worshipers haven't studied the legends. Even the Greek Gods suffered as a result of these disputes.

Even now the discord multiplies. Apparently, one sacred cow (even the Hindus are going to be pissed) killed deserves another. Iranian papers are now holding Holocaust cartoon contests.

I keep having thoughts of the Sorcerer's Apprentice running through my head as I watch this game unfold. This could very easily get out of hand, if it hasn't already. Last year, President Bush spoke of a fire burning in the minds of men. I hope this one burns itself out before too long.

Turbulence in the Flow of Funds

What if they had a refunding and nobody came?

Quarterly Refunding weeks were almost always exciting when I was trading currencies at Chase, particularly the first auction week of the year. The whole floor was buzzing as each trader tried to siphon off his share of the billions of dollars of flows which financed the Federal Government.

I imagine the excitement these days must be even more intense as the flows, in terms of dollars, have multiplied. Yet, if the magnitude has increased the oscillation pattern in prices is somewhat similar. As I recall, the US dollar tended to trade a bit stronger on the FX market prior to and into the auction, presumably, or so I was told, because bond buyers needed dollars to settle their trades.

A similar pattern is evident in the Gold market. Over the past few years, Gold, in terms of US$ has reached a short term peak just prior to or during the February refunding.

Efficient market theorists might explain this pattern as a hedge in the event of a failed refunding. Adherents to the secret market manipulators theory might explain this pattern as intervention to make the $ market appear stronger than it is while intervention apologists might respond that such is simply to facilitate smooth market flow during a period of temporary, but normal, financial stress. Regardless, the pattern is fairly evident, albeit less prominent in some years than others.

Speculators in Gold, as opposed to investors, might be thinking, after watching today's steep slide, now you tell us, while a skeptical subset thereof might be thinking, yeah right, you want us to believe you knew it was going to fall. No, I didn't know it would fall, only that the pattern tends to recur around this time. Further, I don't try to profit from the noise as a price taker, which is not to suggest that substantial profits cannot be made that way, it was my bread and butter on the sell side.

I'm intrigued to see how prices respond in the coming weeks. For Gold, in 2003, the Q1 refunding coincided with the beginning of a 20% drop in the price of Gold from a peak which was not seen again for quite a few months. 2004 and 2005's Q1 refundings coincided with less dramatic peaks and in the case of 2005 the post refunding week low was the low for the year for Gold.

Among the $48B of securities to be sold this week will be $14B in 30 year bonds, reintroduced after a few year's absence. Perhaps a bit of new supply in the long end of the curve will steepen the curve a bit and give the Fed room to tighten further without inverting. I'm also interested to note foreign, specifically foreign official demand in the long end of the curve.

Curiously, this auction is proceeding while the US Treasury is still waiting for Congress to raise the debt ceiling. As the Treasury explains:

Securities issued during the Quarterly Refunding will not be affected due to debt limit constraints. All securities auctioned during the Refunding will settle as normal on February 15, 2006.

While Treasury is working with Congress to promptly pass legislation to raise the debt ceiling, Treasury market participants should be prepared for possible delays in the auction schedule if Congress does not enact legislation to raise the debt limit.

So the quarterly refunding will not be affected due to debt limit constraints but Treasury market participants should be prepared for possible delays in the auction schedule if Congress doesn't raise the debt limit. 'nuff said.

What an interesting confluence of events; the Federal Government of the US is in a stand-off with Iran, is in a War in Iraq that, by the way, will be partially financed by this auction, and is defending itself from charges of illegality in Congress, who by the way, need to vote soon to raise the debt ceiling. Ah to be the NSA monitoring all the horse trading going on. Alas, I don't have security clearance so I'll just have to watch the effects of the horse trading in the markets.

This should be an exciting week.

Returning the Lousiana Purchase?

France can take Treme. The king of Jordan can take the Lower Ninth Ward. - King Abdullah of Jordan

wants to be a long-term partner for Louisiana and New Orleans. - Dominique Perben, French Transport Minister

I know we had a little disappointment earlier with some signals we're getting from Washington but the international community may be able to fill the gap. - Ray Nagin, Mayor, New Orleans

Is it just me or does it seem just a tad ironic that the Federal Government is spending 100s of billions of $ trying to bring oil rich Iraq under their umbrella but may well lose the oil rich state of Southern Lousiana in the process? I exaggerate, but.....

Monday, February 06, 2006

When investment becomes consumption

Everyone knows the U.S. is well down the road to becoming a knowledge economy, one driven by ideas and innovation. What you may not realize is that the government's decades-old system of number collection and crunching captures investments in equipment, buildings, and software, but for the most part misses the growing portion of GDP that is generating the cool, game-changing ideas. Michael Mandel, Chief Economist Business Week

The siren's song of the new economy, which I had thought silenced by the partial deflation of the Tech Bubble, can still be heard while reading the pages of Business Week. According to their Chief Economist, Michael Mandel, the Economy is a lot stronger than you think, because "we're becoming a more knowledge based economy" but not accounting for the knowledge based investment. I wonder what people used to do 100 years ago, without knowledge or ideas or any of those new fangled contraptions we recently invented.

To be fair to Mr. Mandel, back before I came to believe in history, I too found new economy theories seductive. The idea that man is much smarter now than he was before is, after all, a seductive idea. The idea that I am smarter or better looking than my neighbor is equally seductive. Unfortunately, just because an idea makes one feel good does not mean it is true, indeed, these are the ideas about which, I feel, one should be most skeptical.

The primary mistake, in my view, of the new economists, is to fall into Fukayma's End of History trap - to think that man has made some great evolutionary leap forward in the current generation. This, by the way, is a very old idea. Once one takes this assumption as dogma, one can deduce all sorts of, what I believe to be, silly ideas.

Some of you might be wondering what I mean by coming to believe in history - surely everyone believes in history? Maybe I'm the exception but I don't think I did, although I could answer an assortment of questions on the topic.

There is a difference, I believe, between the ability to regurgitate "1776" when asked for the date of the signing of the Declaration of Independence and imagining the reality of a bunch of guys, quite similar to you or I in most respects, boldly signing a document of radical ideas at risk of life and liberty.

To believe in history is to come to the view that Thomas Jefferson and George Washington (and Julius Caesar and Cicero for that matter) were just as real as Tiger Woods or President Bush. I choose the two current era examples to pick people of whom many would know and yet with whom few have met, similar to the historical examples. Just like the President and Mr. Woods, Jefferson, Washington and Cicero ate, slept, loved, lost, laughed, cried and thought. They lived, just as we live, in the same material universe. They used their ideas, just as we do, to carve out a life in this world.

To believe in history is to put flesh on the bones of the historical record, if you will. To believe in history is to imagine minds capable of writing, reading and understanding Shakespeare (or Sophocles for that matter) long before you or I or our parents even walked the earth. Once you do that, I argue, the new economy arguments will be seen in a new light. Let's revisit the opening excerpt:

Everyone knows the U.S. is well down the road to becoming a knowledge economy, one driven by ideas and innovation. What you may not realize is that the government's decades-old system of number collection and crunching captures investments in equipment, buildings, and software, but for the most part misses the growing portion of GDP that is generating the cool, game-changing ideas.

Is Mr. Mandel arguing that the US was not a knowledge based economy until just recently? Is the US only now generating cool, game changing ideas? Let me throw out a few names and let's imagine they are not merely the answers to game show trivia questions but real people, Thomas Edison, Nicola Tesla, Marie Curie, and Henry Bessemer. I think light bulbs, alternating current, radium and cheap steel were pretty cool, game changing ideas, certainly the historical record describes them as such.

This brings us to the crux of the matter, the practical effects. Inadequate accounting for knowledge based, as opposed to physical capital, investment is the basis of Mr. Mandel's argument
that the economy is stronger than we think. Yet, investment per se, doesn't drive the economy over the long term, rather it is investment that produces returns.

If, instead of assuming that modern man is inherently more clever than his ancestors, Mr. Mandel had put some flesh on the bones of his own idea, he might not be so sanguine about the future. To wit, let's grant that the BEA doesn't count billions of dollars of "knowledge based" investment. The BEA does, however, count profits. To the extent profits or returns are counted with reasonable accuracy, but investment is undercounted by a large margin, then return on investment in this country is far lower than we thought. You know, he might be on to something after all.

In the end all of this spending on intangibles might end up being just that.
Investment that generates no returns is just consumption, just ask any owners of the now defunct "B to B" companies.