Saturday, November 15, 2008

The TARP Fund? and Empire

A few weeks back I almost felt hopeful.

The Fed and Treasury had decided to take some of the more toxic "assets" off US banks, and gotten funding therefore. The Fed had substantially expanded its balance sheet. A new President who had been listening to Buffett and Volcker, and seemed keen to rebuild American infrastructure, was elected.

"Maybe," I thought, "inflation, even if it meant the end of US$ hegemony, would finally be embraced."

By embracing inflation I mean accepting that US imbalances are so large that a deflationary resolution would ignite a depression that would make the Great one of the 30s seem minor. It would be a sign of submission to economic reality- the US$ as currently constituted is doomed. Let's stop fighting it. Let it find its level. Let's devise a new international financial architecture within which all particiapting nations are expected to play by the rules instead of one nation dictating to the others.

Alas, my hopes have faded. President-elect Obama, in my view and as of this moment, is not the radical, right-wing talk radio claims. Ex-Clintonite men like Rahm Emanuel and (horror of horrors) Larry Summers were on the short list of his Cabinet (or already there). These men are not radical "new ideas" men. They are status quo perpetuators.

Perhaps, like Winston Churchill, who famously quipped, "I have not become the King's First Minister in order to preside over the liquidation of the British Empire," but was clever enough to realize his error and begin liquidation, President Obama will see that our Empire too begs liquidation. America as a nation, even now, seems to me without peer. The American Empire, however, seems a fast fading pipe dream.

Or it would if certain people would stop filling the pipe.

Was life in America so horrible before we opted for Empire- before we decided (inter alia) to issue the world's reserve currency? Has our quality of life, in all senses of that phrase, actually improved since we started walking this path? We were a Nation that used to believe in a better tomorrow and have become an Empire that requires it- for we have already borrowed against it.
One of the key features of a stable and enduring Empire is a strong currency that facilitates rather than hampers commerce throughout the Empire. That strength, however, should flow from wise economic policies- whether that wisdom is gleaned, as in the ideal of capitalism, from the action of free markets discovering prices and allocating investment accordingly, or elsewhere. Like the stock price of a well managed company, the value of the US$ (the currency of our Empire) should rise in a sense, of its own accord. Just as a well managed company's stock price should not require stock buy-backs to rise, so too should our US$ not need intervention.

Yet, it seems to me that is just what is happening. The vehicle by which this is financed, I speculate, is TARP.

Reflective pause: My view is not that those at Treasury and the Fed are operating under some grand plan but rather that they are fumbling, partially in the dark, trying to maintain US$ supremacy between the two ever narrowing, by virtue of the ever increasing imbalances, constraints of a crippling depression and a hyper-inflation that makes international use of the US$ as reserve undesirable.

After Bear Stearns collapsed, the chosen policy seemed to me to be $ depreciation, but this soon led the international community, Europe in particular, to complain about "beggaring thy neighbor." The inflationary constraint of loss of US$ supremacy had been reached. Accepting loss of US$ supremacy is part of what I mean by embracing inflation in the same way a chemo patient in embracing his treatment must accept the loss of hair and otherwise ill health.

What happened in the middle of September that drove Hank Paulson to Congress for funds? Why did he wish to keep the disposition thereof a secret? Why, even though the legislation requires transparency, is that disposition still a secret?

Few things inspire true confidence more than transparency.

Perhaps there are good reasons for the opacity about TARP, not the least of which is the sense that there is not now nor was there ever a clear plan but rather a fear of being exposed as fumblers in the dark. My speculation is but one of many theories that fit the facts.

Yet the government's embrace of Goldman Sachs, and its predatory (as in market forcing) Hedge Fund mentality makes me suspicious. These folk believe the financial cart pulls the real sector horse with or without consent. Recent history demonstrates their tendency to bump into constraints rather than anticipate them. Thus the wisdom, to those in charge, of recapitalizing a banking sector without requiring change in the way it does business. If the dead horse won't run, flog it harder.

But, back to my earlier question. What happened in the middle of September? What drove the Republican Executive Branch to the Democratic Congress hat in hand, destroying their (admittedly small) chance of retaining control of that office? What difference would a few weeks have made?

In a word, disintermediation. In a short span of time, the US$, which had been rallying, suddenly began to fall. LIBOR jumped. Oil prices rose, and for one day exploded. Gold prices jumped $100. Background complaints about the need to move away from the US$ as anchor of world trade came to the foreground with a bang.

Again, the inflationary constraint of fear of loss of US$ supremacy had been reached.

Since then, $100s of billions have been allocated, but for what? Credit conditions for trade, housing and other real sector investment remain tight. Yet reserves for Federal Reserve System banks have increased by a factor of 10 (check it out). Money is flowing, but not to the real sector.

Imagine the boom (albeit of a sufficiently inflationary type that would likely have put paid to the US$'s days as major global reserve) that would result from those billions flowing into infrastructure rebuilding. The absence of a boom tells me that money is staying in the financial sector enforcing prices (like a strong US$ on FX markets, weaker Gold and strong US Treasuries) which quiet calls for a shift away from the US$.

Enron, a corporation that turned its back on organic growth and opted for increasingly short term (and opaquely financed) leverage to finance stock buy-backs to keep its "currency" (i.e. stock price) strong collapsed in the first year of the Bush Administration. It would be ironic if our currency collapsed just the same way in the last year of that administration.

Regardless of the timing, it seems to me the stage is set. Barring a swift turn in the real sector, the TARP fund, whose financing is on the shortest terms, will, in a sense, go bust as well. Prices that justify the US$'s status as major global reserve are, in my view, inconsistent with those which will improve the real sector, both domestically and internationally. A strong $ is no longer in US interests.

The financial cart has long been leading the real sector horse, fortunately, horses are (usually) smart enough to not follow off a cliff.


Muzungu said...

So, I'm not sure I get all of your thoughts. The money flowing to banks, largely in the form of equity investments from this TARP Fund, you think, is largely supporting the US $. Or is supporting asset prices (of US$ denominated assets), as opposed to if the money flooded into the real economy where it would increase the prices of goods and services. I guess I agree with that...but eventually all of this financing is really tantamount to printing currency (this currency just has a ten year period where it earns interest.) It eventually leads to inflation. Another thing I'm not sure I get, is the deflationary stance after Bear Stearns? Was that a gov't position...or it was an omission -- a refusal for the Fed Gov't to act which would lead to deflationary pressures. Deflationary pressures inspired by a depression...thats no good. It's a fine line to walk and one I'm not comfortable the US gov't managing. Though personally I'll take inflation over deflation any day. Luckily deflation has an easy cure.

Manish Jain said...

transparency should be at the heart of anything to install confidence when dealing with taxpayer money.