Wednesday, July 26, 2006

The Bretton Woods trip

It wasn't until I was googling for golf courses around North Conway, NH that it hit me- I was going to visit Bretton Woods. Yes. That Bretton Woods.
oops, my invite arrived 62 years too late

When I finally arrived at the place I was suitably impressed by the scenery.
While much of the world was engulfed in war 62 years ago, hundreds of delegates from around the world met at this wonderful place to devise a new monetary system, with one aim of avoiding some of the causes of the then current war. Jung might have argued that the scenery evoked notions of Olympians looking down on the rest of the world planning the path ahead and in the bright sun light of my first visit, I wouldn't disagree.

Although much of the world's finances still flow through its remains, the essential elements of the system put in place by these delegates has long since been abandoned. Just as the financiers of the world removed the domestic check and balance of the classical gold standard, which gave the citizenry the right to withdraw real money (specie) from any bank to which they had lent, so too have they removed the international check and balance of the gold exchange standard, which gave sovereign nations the right to withdraw real money (specie) from any national banking system to which they had lent.

With the notion of the removal of the check and balance of specie redemption in mind, consider the recent exchange between William Greider, of Secrets of the Temple fame and Robert, strong $, Rubin.

In response to a question from Greider about rising external imbalances Rubin argues:

Rubin: But I don't think people thought--I'll speak for myself--I surely never thought, if you have the kinds of imbalances you have today, you'd have the kinds of exchange rates we have today, that exchange rates would have substantial adjustments. To put it differently, I never thought in the face of very substantial trade imbalances, you would have inflexible exchange rates. I don't think that was part of anybody's anticipation.

Greider: Does that suggest something else should have happened in the design running up to the current situation?

Rubin: I don't think that's a design issue. I don't think that's actually a trade issue. I think it's a foreign exchange issue.... If you had had fully flexible exchange rates. Though I'm not advocating, by the way, that China go to that immediately because I think it might create a lot of chaos.... But I don't think it's anything in the design in the system. Maybe I'm missing something, but I don't think there's anything in the design of the system we would have done differently....

"So," your author mused to himself while admiring the view at Bretton Woods, "even though the lack of FX adjustment in the face of rising imbalances is a surprise to Rubin, he doesn't think this suggests a design flaw."

Yet, 62 years ago, when the then economic solons of the world designed the system whose remains we currently use, they foresaw the need to have a check and balance to forestall the growth of just such imbalances, in the form of gold redemption. Having removed that check and balance, by changing the system's design, the imbalances, surprisingly to some, grow unchecked and it isn't a design flaw?

On my Bretton Woods trip I began to wonder if the view of humanity that informed the crafters of the system 62 years ago or more to my liking, the view of humanity that informed the founders of this country more than 2 centuries ago, was just that, a trip, a delusion.

Expanding my scope I begin to wonder if it was all just a trip.

Is the US Constitution just a piece of paper? Can unchecked finance produce better results than a regulated (and the rule of specie is one such regulation) system? Should humanity try to adhere to the Geneva Conventions? Is coercion a better method than persuasion coupled with patience while "the penny drops" as the Brits put it? Are systems of morality just the means by which the elite milk their charges?

Or is there something to it? Are there better and worse ways to maintain and further civilization? Civilization, after all, is the goal we seek, not wealth or power which does not exist outside of that context.

I, for one, don't believe it was all just a trip. I believe in the virtue of checks and balances. Power unchecked runs amok, as we see today in many aspects of human relations.

The United States has, correctly in my view, been called an experiment in self-government. Hopefully the experiment can continue before the civilization train leaves the station.

Tuesday, July 11, 2006

Who's paying for the War on Terror?

Late last week I came across the first of what is now a collection of articles proclaiming an improvement in the US fiscal deficit. Being a skeptical sort I did a bit of cross checking, using government figures, mind you, and discovered there is both more and less to this tale than meets the eye.

On the "less" side of the tale I find the "improvement" in the deficit. The term "deficit", at least as I understand it, is a flow figure. It refers to a shortfall of income relative to expenditure over the course of a period of time, usually a year. The sum of these deficits is a "stock" figure, the debt. I bore you with this remedial accounting as preamble to my rather curious discovery. If, as the President, inter alios, avers, the deficit is shrinking, why is the debt still rising at a rapid pace?

The graph below depicts the annual change of the public debt for the past few years. As you can see, the public debt has risen just under $500B ($478B to be precise) thus far this year and the final quarter of the fiscal year (which ends 9/30) usually results in further increases in the debt on the order of $60-100B. I think it is quite possible that the public debt could increase the same this year as it did last.

So, is the Prez just pulling another Mission Accomplished or is the deficit really shrinking? It depends on how one defines deficit.

If, as many Presidents before him, particularly Bill Clinton, have done, President Bush includes the Social Security (and other government administered "trust" funds) surplus in the general government accounts, the deficit appears smaller than it is in the sense that the Social Security funds are not tax revenues but funds held in trust to be repaid. This trick of hiding general government deficits behind trust fund surplusses, an artifact of the post WWII baby boom, has about run its course.

Within a decade, the Social Security surplus will be too small to hide much of anything. A few years after that, assuming extrapolations from current data hold, Social Security will be competing with Treasury to sell bonds into the open market. Of course, this assumes the government intends to pay out Social Security benefits, instead of pulling an Enron, looting the funds by placing them at risk in a Texas Hedge which goes awry, and then claiming innocence.

This brings us to the "more" side of the tale. While looking through the debt data, I realized that "intragovernmental holdings" of public debt had risen much faster than debt held by the public for the past decade. While much has been made of Asian and more recently OPEC holdings of US debt notably rising the much less heralded rise in intragovernmental holdings beats that hands down.

Since 1997, debt held by the public has risen about $1Tln ($1,000B) while over the same period, intragovernmental holdings have risen about $2Tln ($2,000B). Since the War on Terror began, debt held by the public has risen $1.4Tln (yes, it is higher than the increase since 1997 as Clinton paid down a chunk of debt held by the public) while intragovernmental holdings have risen about $1.2Tln.

In other words, the single largest financier of recent deficits, including those associated with the War on Terror, are not the Chinese, Japanese or Saudis but the US government administered trust funds for the people of the United States. That means the people taking the biggest risk are those betting on returns from those funds, and those betting on the social harmony which, it is hoped, such programs were designed to promote.

Tragically, in my view, very few people are aware of this bet, made with their money...or its implications.

Of course, I don't think the War would have been such an easy sell if people had been informed that their Social Security funds were at risk.

p.s. Worse, it isn't as if these funds are buying an equity share in any winnings, given the recent low Treasury rates, the best people can expect is 5% annually. In the event of default....let's not think about that.