Monday, April 21, 2008

Bad Markets!

Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability. We continue to monitor exchange markets closely, and cooperate as appropriate. G7 Statement Apr. 11, 2008

I don't have the impression that financial markets and other actors have correctly and entirely understood the message of the G7 meeting. Jean-Claude Juncker: Chairman of the Eurozone Finance Ministers' Group Apr. 17, 2008

As a parent, I sometimes find myself, when speaking to my son, starting sentences with, "Didn't I just tell you..." I get the sense Mr. Euro, Jean-Claude Juncker, is just itching to say, "Bad markets, bad, bad markets- we told you what we wanted you to do and you didn't do it."

Of course, financial market participants are not the children of the G-7 governments, although the more they feed at the trough of the states, the more likely will the states feel justified in the age old parent-child argument, "so long as you live under my roof, you will follow my rules."

Liquidity, apparently, comes with strings attached.

In defense of those recalcitrant financial market participants, perhaps, as children are wont to do, they focused on different aspects of the statement.

To wit: 1) We reaffirmed our strong commitment to continue working closely together to restore sustained growth, maintain price stability, and ensure the smooth and orderly functioning of our financial systems. We welcome the coordination by major central banks to address liquidity pressures in funding markets and recognize the importance of their coordinated actions to address disruptions in global financial markets. In particular, the recent steps taken by some central banks to expand access to central bank lending facilities and expand the range of collateral that they will accept is providing liquidity to financial institutions and helping to support improved market functioning. In addition, we welcome other measures that have been taken including monetary and fiscal policy that aim to give support to underlying economic activity and ensure price stability. Each of us remains committed to taking action, individually and collectively as appropriate, consistent with our respective domestic circumstances.

2) The turmoil in global financial markets remains challenging and more protracted than we had anticipated.

So, the children think, Mommy and Daddy are mad, but they'll let us keep playing and not send us to our rooms, and didn't they just admit they got it wrong?

Few things fortify institutional credibility more than identifying and riding the prevailing trend- think Greenspan's Fed and the Tech and Housing Booms- while few things destroy that credibility than fighting the prevailing trend.

And the trends prevailing today are the unwinding of those booms that fortified faith among both financial market participants and the general public in the wisdom and potency of the financial market managers.

Mr. Juncker, et. alios, can cry foul all they want but the discovery of faith misplaced almost inevitably leads to volatile behavior as the warning signs, so long ignored when faith was strong, now seem much more ominous. Teddy Roosevelt may have thought a big stick was sufficient, but no stick is big enough when you get things wrong.

And hey, what's wrong with volatility?

Aren't the markets price discovery mechanisms? If the G-7 can't figure things out, perhaps some markets are very mispriced? If so, isn't it better to find the right price(s) sooner rather than later?

But "better" is a relative term. It might be better, over the longer run, for the general public if radical mis-pricing was corrected quickly. It won't, however, be better for those who built their reputations, and continued occupations, on maintaining previous trends.

And that's the rub, ain't it?

Monday, April 14, 2008

Let them eat $s

Mr. Strauss-Kahn said he had heard from many financial officials this weekend that the West’s focus on fuel, at the expense of food, was a "crime against humanity." Though he noted that the I.M.F. is primarily a monetary and financial agency, he said it would try to "review its tools" to help countries pay for food imports.

I'm in the middle of a longer essay inspired, in part, by George Soros' new book, The New Paradigm for Financial Markets: The Credit Crisis of 2008 and what it means. Here's a few thoughts while I wait for my muse to finish singing that score.

The financial powers that be have noticed a disturbance in the force that binds society together- rapidly rising food prices.

According to the NYTimes: Dominique Strauss-Kahn, the managing director of the International Monetary Fund, said the food crisis posed questions about the survivability of democracy and political regimes.

"As we know in the past, sometimes those questions lead to war," he said. "We now need to devote 100 percent of our time to these questions."

There was a time in the not-so-distant past when financiers financed entrepreneurs. Now, in part as a result of Greenspan's et alios deification of that economic sector, financiers are often considered entrepreneurs. Thus, it seems to me, financiers feel justified in financing themselves- as if such will alleviate the problems of the world.

As I've argued in the past, finance, or intermediation, if you prefer, has proven to be a powerful catalyst which can accelerate material goods production. But it is not a thing unto itself. Its utility should not be measured in the $s it creates, as we do now with GDP, but in the increased flow of goods.

Put another way, while a nation of farmers might want for many of the niceties of life, they will at least have food- a nation of financiers will soon go hungry.

Thus I find Mr. Strauss-Kahn's comment above about reviewing its tools a bit funny. Unless those tools include planting, irrigation, distribution and harvesting equipment, the IMF may well prove impotent to the task.

When you're hungry, you don't go to the bank. You go to a farm.

Wednesday, April 09, 2008

Good leaders build things

Marmoream relinquo, quam latericiam accepi (I found Rome a city of bricks and left it a city of marble.) - Augustus Caesar

As the election of 2008 nears I can't muster much enthusiasm for any of the remaining candidate's platforms. Their issue statements are, alternatively, polemic or apologetic, but there seems to me to be no vision for the future. Our leaders are more like caretaker CEOs, enjoying the fruits of prior labor. To the extent one can infer that these candidates collectively speak for a broad swath of at least corporate America, these United States seem like a heavily armed battleship drifting nowhere.

Consider the debates over the Wars in Iraq and Afghanistan. The focus is on whether we can win or if we should be over there, in the abstract. Reminiscent of the Vietnam War, there seems to be no plan for victory, no desired end. Instead, we seem to be fighting to stop others from taking the prize. This lack of vision in all three wars explains, in part, our failure to attract and maintain local support.

It almost seems as if the purpose of these wars is war itself- as a display of strength, a warning, and a punishment- with the added kicker of great profits to the military industrial complex of which Eisenhower warned.

In short, it seems we are fighting to maintain our place in the world, not make that world a better place. Our aggression is defensive.

Foreign policy may not be the only example of such defensiveness.

For many years now we have embraced speculation as an economic driving force, forgetting that speculation per se has no aim. Making money these days is more important than doing something with it. Wealth, like war, has become an end, not a means to an end.

Capital flows are directed to maintain financial intermediaries who have financed precious few constructive endeavors of late. Besides fast computers, connectivity and Viagra what will these ailing financial intermediaries leave to posterity? A few grand mansions in Greenwich Ct. and thousands of foreclosed mcmansions?

Increasingly I find Bernanke's "global savings glut" argument of a few years back a useful heuristic. As Warren Buffet is well aware, there's a lot of money to invest but few compelling investments, in part, I suspect, because, on balance, rent seeking is preferable to risk these days. Heck, even the supposed supreme risk takers on Wall St. have quickly morphed into rent seekers feeding at the public trough under the banner of "too big to fail." But rent seeking carries its own risks. We are the King Midas of paper about to choke on our $s.

Ominously, while we are engaged in defensive foreign and economic policies, impotently trying to hold back the march of time, that which we are defending seems to be falling down around our ears. As my friend James Howard Kunstler will tell you, our 50 year experiment in suburbia is a bust- built on a vision of cheap petroleum in perpetuity.

Our leaders over the past few decades seem to have forgotten that good leaders build things- they leave the world, to the extent one favors civilization, a better place than they found it (admittedly not without breaking a few eggs in the process).

Alexander the Great didn't make his mark in history solely due to his military conquests. He was no Atilla or Genghis Khan. Alexander left the world with many new cities- Alexandria, a center of commerce and education, first and foremost.

The great Emperors of Rome didn't just conquer territory, they improved it. They rebuilt what was decaying, as Augustus did Rome, while living in a fairly modest home himself. Nero, by contrast, took advantage of the Great Fire of Rome to build himself a grand palace, and has been derided by history. His error was corrected by the Flavian Emperors, notably Vespasian and Titus.

Charles Martel hammered the invading Muslims at Tours (rightfully earning the nickname "The Hammer" in contrast to our current Treasury Secretary) and unified the Franks but his grandson, Charlemagne, is rightly, in my view, known as the Father of Europe. His belief in the virtues of scholarship engendered the Carolingian Renaissance, reversing a centuries long trend towards ever greater illiteracy.

The Medici of Florence, inter alios of the time, were certainly power hungry and greedy, but with a purpose. They supported men like: Leonardo da Vinci, Brunelleschi, whose architectural genius- notably, the dome of Santa Maria del Fiore- finally delivered Europeans from the shadows of antiquity, Michelangelo, Botticelli and Raphael, to name a few. They invested in education, assisted by the diaspora following the loss of Constantinople, building the Laurentian Library and supporting scientists like Galileo. As this wonderful documentary puts it, the Medici were the Godfathers of the Renaissance.

More recently, and closer to home, American entrepreneurs, mirroring the success of their European counterparts, with and without the help of the state, dug canals, built railroads and carved millions of miles of roads out of the wilderness. While they lined their pockets as avariciously as many of today's CEOs, at least they gave something in return.

Incomes during the Gilded Age were as polarized as today, but the accomplishments of men like Alexander Graham Bell, Thomas Edison, George Westinghouse and John Rockefeller, to name a few, are, in my view, far more visionary than today's CEOs. They, and those of the preceding generation, found America a nation of farms and made it a nation of industry- a vision men like Jarred Diamond might decry but at least it was a vision.

Within the past century, Presidents like Herbert Hoover championed the construction of the Hoover Dam (at the time the largest electricity generating plant and concrete structure) and Franklin Roosevelt surpassed him with the Grand Coulee Dam (still the largest electricity generating plant and concrete structure in the US). While many, including myself, wish he had chosen different means to achieve his ends, his shift left was much less pronounced than that seen in most of Europe at the time. FDR's Rural Electrification Act brought the technological benefits of electricity and phones from the cities into the country. Modern Internet connectivity hangs, in a sense, from the poles FDR put up.

Eisenhower, impressed by Germany's Autobahn, championed the Interstate Highway System and Nixon (who had more than his share of faults) signed the Trans-Alaskan Pipeline Authorization Act and opened diplomatic relations with China.

Since then, although the trends had begun earlier, we have, it seems to me, been treading water. We seem more like squatters than owners.

The birth of the Nuclear Age, which, recalling President Eisenhower's Atoms for Peace speech of 1953, seemed so promising, was aborted in the US when a partial core meltdown occurred at Three Mile Island in 1979. While French Nuclear Power Plants generate 78% of their total production (89% of consumption as they export electricity), US Nuclear Plants produce only 20% of our electricity production (fossil fuels generate 71%).

To be fair to the current President, Mr. Bush has spoken of the need to expand our nuclear power generating capacity and invest in alternatives, but seems less inclined to spend political capital in pursuit of those goals. Instead, he spent his capital on the War in Iraq and on resistance to Nuclear Power in Iran.

The oil shock of 1973, which inspired Japan and especially (as noted above) France to invest heavily in Nuclear Power, also drove a world-wide shift towards greater automobile efficiency (the hatchback) and raised interest in other alternatives. While this inspiration lost some of its effect everywhere as real oil prices fell from their peaks during the 80s and 90s, the US took the lead in jumping back into the "cheap energy pool." Millions of SUVs in suburban garages offer testimony of our desire to retain the status quo.

But time, as they say, stands still for no man, or nation.

We are, it seems to me, in dire need of a new vision for the future.

And I'm all ears.

One good thing about the onrushing economic crisis, rent seeking will no longer be as profitable as entrepreneurism.

Wednesday, April 02, 2008

What is the value-added?

What is the value-added produced in this city? Alan Greenspan asked his wife during a visit to Venice

What a wonderful question Alan Greenspan asked his wife. It's a pity he didn't honestly ask that question of the institution he led. What is the value-added of the Federal Reserve?

According to the Fed's web site, the Fed's primary responsibility is the formulation (an interesting choice of words, given that, at least during Greenspan's tenure, there was no formula that anyone other than himself could divine, see Alan Blinder) of monetary policy.

One key aspect of correctly setting monetary policy, it seems to me, is the ability to understand the economic forces acting on the US economy, and the effects and intents of those policies- not in some idealized sense but in the real world. On that front I give the Fed an "F" and cite two recent issues: 1) the fear of deflation which led the Fed to lower and maintain rates at levels not seen since the US was the creditor to the world 2) faith in the view that a soft landing had the same cleansing effect as a recession.

Greenspan describes his fear of deflation in The Age of Turbulence: I found it [the possibility that the US might enter a deflationary spiral a la Japan] to be a very unsettling issue. In modern economies, whose chronic headache is inflation, deflation is a rare disease. After all, the United States was no longer on a gold standard. I couldn't conceive of deflation occurring under a fiat money standard.

Sadly, for us, he didn't let his inability to conceive of deflation in a fiat money system stand in the way of acting as if such was possible.

I find the apparently generally accepted view that Japan spent a decade caught in a deflationary spiral a bit odd. According to Japan's Statistics Bureau, the CPI index in Japan fell from a peak of 104.1 in Oct. of 98 to a low of 99.7 in Feb. of 06. A 4% decline in the CPI over 8 years seems more like price stability than a deflationary spiral to me. I suspect the US population would love to have experienced such a decline over the past few years.

A classic example of a deflationary spiral, and one the current Fed Chairman studied exhaustively, is the US experience from 1929 to 1933. During that time period the CPI fell (based on annual data from the BLS) 31%- just under 8 times Japan's 4% decline. Deflationary spiral in Japan, I think not.

A bigger error, in my view, is the notion that the US operated under the same rules, or was subject to the same forces that Japan did and was.

Japan, unlike the US, is not the issuer of the world's reserve currency. Their economy operates within the US$ system. Moreover, Japan has been a chronic external surplus nation, again, unlike the US. Their decades of external surpluses should have (and did) act to strengthen their currency- perhaps one could wonder why, under those conditions, and given Japan's reluctance to allow Yen appreciation within the international system of exchange, Japan didn't really deflate. But Greenspan already answered that, there is no gold standard, therefore, and thus far, deflation remains a rare disease.

Moving from the, in my view, failure to grasp the economic forces acting on the US, let's consider the faith in the cleansing power of the soft landing, recalling William McChesney Martin's famous quote that The Federal Reserve's job is to take away the punch bowl just when the party gets going.

Note that Mr. Martin didn't say that the Fed's job was to dilute the punch in the punch bowl, or switch from punch to beer- i.e. generate a soft landing from a night of drinking- but to take the punch bowl away. Once the punch bowl is removed partiers begin to sober up and the hang-over is soon to set in. And it's the hang-over, which, assuming the punch bowl was removed at the right time, will not be too onerous, will remind partiers of the dangers of too much alcohol, or in this case, too much credit.

But Greenspan seemed to prefer the "hair of the dog that bit you" in the form of a "soft landing." As he wrote: For decades, analysts had wondered whether the dynamics of the business cycle ruled out the possibility of a "soft landing" for the economy- a cyclical slowdown without the job losses and uncertainty of a recession. Ah yes, that's what we need, a way to stop nascent alcoholics from feeling the effects of a hang-over.

Hang-overs, returning to Mr. Martin's metaphor, are like recessions. They are the entirely predictable responses to over-indulgence. But, according to Greenspan, hang-overs are nonrational. To wit: Recessions are tricky to forecast because they are driven in part by nonrational behavior.

Silly me, I thought one of the premises of the capitalist system was the view that investors acted rationally. Recessions, it seems to me, are entirely rational responses to imbalances. Expectations of permanent prosperity, which implies a lack of Schumpeter's creative destruction, are nonrational. Heck, such expectations are downright anti-capitalist.

Where's Senator McCarthy when you need him?

Venice, Greenspan writes he realized, is the antithesis of creative destruction, presumably because it looks much like it did when traders unloaded silks and spices from the Orient.

The Venetians didn't embrace creative destruction, and neither does the Fed. To be fair, the Fed is all for the creative part, but we never seem to get around to the destruction- the cleansing- the clearing away of the old when it proves to not be of use- like the bloated financial sector in the US economy, or the institutions that are supposed to regulate it.

So I ask again, what is the value-added of the Federal Reserve?

Tuesday, April 01, 2008

Giving up

The Dude has decided to shut down this website as the powers that be have finally effected a solution to the economic problems the world faces.

I will be selling my Gold today and buying long dated US Treasury bonds and US financial stocks.