Thursday, October 15, 2009

It's a Bad Time for Bad Money

What a bunch of wussies the current generation of uber-Capitalists have become. In search of capital to bet they bought the assets of commercial banking, in effect turning those deposits into a "trust" of yesteryear. Then, with a copy of Atlas Shrugged on their bookshelves they run to the government for a bail-out when their investments don't pan out, hiding behind the recently purchased, socially vital commercial banking departments they wouldn't have deigned to join when job hunting.

Come January in upstate NY, when the snow flies and temperatures drop below 0F, it's a bad time to drive without a shovel. Likewise, when the financial system of an economy misprices assets and liabilities, it's a bad time for bad money.

To the extent one believes, as I do, that men, from time to time, as Charles Mackay wrote, think and go mad in herds, especially with regard to money, it seems a wise idea to have some sort of monetary standard to attenuate the degree of inevitable error. The more out of whack the mispricing the more difficult the path of recovery will prove to be, and the more likely will the anti-money crowd find open ears. A few more years like the last one here in the US and the Marxists will start coming out of the woodwork. The greater the disconnect between the real and financial sectors of the economy, the louder will the anti-money/anti-finance crowd scream- with even those usually in favor of Capitalism crying foul.

To wit; Naked Capitalism recently ran a piece entitled, Does Banking Contribute to the Good of Society, which opens with:

Quelle horreur, some smart people are starting to question whether banking serves a redeeming social function.

Of course, in the abstract, it does. Banking (or more accurately, extending credit) is essential for commerce. But any essential support function, if it overpriced in relationship to its true value, becomes a drag on the productive economy. And our modern system is extracting a very large toll relative to its actual worth.

That article was sourced from one similarly titled in UK's Telegraph. It argues:

The whole of economic life is a mixture of creative and distributive activities. Some of what we "earn" derives from what is created out of nothing and adds to the total available for all to enjoy; but some of it merely takes what would otherwise be available to others and therefore comes at their expense.......

Much of what goes on in financial markets belongs right at the purely distributive end. The gains to one party reflect the losses to another, and the vast fees and charges racked up in the process end up being paid by Joe Public, since even if he is not directly involved in the deals, he is indirectly through the costs and charges that he pays for goods and services.

Even what the great investors do belongs at the distributive end of the spectrum.

On the same theme I found How the Servant Became a Predator: Finance’s Five Fatal Flaws, which begins:

The financial sector is a tool to help those that make real tools, not an end in itself. But five fatal flaws in the financial sector’s current structure have created a monster that drains the real economy, promotes fraud and corruption, threatens democracy, and causes recurrent, intensifying crises.

While I agree, in part, with many of the underlying views behind the articles, and, from time to time, have used radical rhetoric myself, it's during crisis phases that proper articulation is key. Radical anarchic/revolutionary rhetoric in the late 19th Century inflamed populations sufficiently to inspire a rash of assassinations, including William McKinley here in the US. I've personally witnessed successful and attempted revolutions in Indonesia and Jamaica respectively, and they're no picnic.  During crisis phases, the risk of throwing the baby out with the bathwater rises sharply.

Back to the articles. Finance doesn't have a socially redeeming function in the abstract, it puts savings to real use, when well functioning the investments provide wonderful benefits for many. That there are more people living on the planet than, according to my understanding of history and anthropology, at any other time, speaks to these benefits.

Finance, in my view, is not necessarily a "distributive" activity. George Westinghouse's investment in Tesla's alternating current generation powers the computer on which you read this essay, and the pump that brings water in to your house, and allows sewage removal- a key point now that winter sets in as outhouses are quite cold places.

Yet, these financial polemics have a point. Big Finance, currently, is a large drag on the public sector, and by extension, the public, due to, I believe, a conflation.

Sadly, it was the titans of finance who fomented the current confusion over the virtues of finance when restrictions separating investment from commercial banking were dropped. As I recently argued, echoing Paul Volcker: Instead of designating certain financial institutions as "too big to fail" the US, he [Volcker] argued, needs to separate the aspects of finance which are too important to fail- broadly, commercial banking functions- from the more speculative practices- hedge and private equity funds and, more generally, proprietary trading. finance (intentional small "f"), i.e. commercial banking is key. Finance, i.e. investment banking, has its benefits as well, but only, I believe, when it is willing to accept the rules of Capitalism full bore- survival of the fittest.

What a bunch of wussies the current generation of uber-Capitalists have become. In search of capital to bet they bought the assets of commercial banking, in effect turning those deposits into a "trust" of yesteryear. Then, with a copy of Atlas Shrugged on their bookshelves they run to the government for a bail-out when their investments don't pan out, hiding behind the recently purchased, socially vital commercial banking departments they wouldn't have deigned to join when job hunting.

I wonder if the currently in production sequel to Wall Street will have Gordon Gekko almost losing it all in derivatives and then getting bailed out by the Feds to retire in comfort.

But where, you might be wondering, do the monetary standards you noted come into play?

Thanks for the reboot, I sometimes go off on a rant.

I opened with the idea that monetary standards act sometimes as a policy tool itself but minimally as a measuring tool of sorts. If a specie standard is chosen the drain (or excessive gain) thereof sends a sign that policy needs to change. If some monetarist standard is chosen there will be limits on the amount of liquidity prudently considered available to "buy time." There are other standards one can use but all act as a limiting factor- an anchor to some sense of reality, or measure of the divergence between the real and imaginary.

French Philosopher Baudrillard (about whose views I've opined here) reflected on the NYC Billboard depicting the growth of the public debt: The disappearance of the referential universe is a brand new phenomenon. When one looks at the billboard on Broadway, with its flying figures, one has the impression that the debt takes off to reach the stratosphere.

In other words, by bad money I mean unreal money, anchorless money. There is, apparently, no accepted measure by which one might judge a currency as failed- Baudrillard's hyperreallity. In plain language our money has been so bad for so long many assume it to be normal.

Consider. The British Pound was the currency of choice for a good portion of international trade in the latter half of the 19th and early 20th Centuries. It cost a bit more than 4 Pounds to buy an ounce of Gold. Over time it lost its utility as both a medium of international trade and standard of value from WWI through the eventual loss of most of its colonies in the 60s. During this time the value of the Pound declined from that 4+ Pounds per oz. of Gold to 14.5 Pounds per oz.- roughly 72 pence off each pound.

Few in the 40s, 50s, and 60s would have argued that such a devaluation was not a disaster. The US$ has lost a similar amount vs. Gold in the past nine years and yet there is heated debate to the effect that the demise of the US$ is exaggerated.

Some, like the FT's Martin Wolf, in rather stark contrast to his usual astute views, argues that Gold's price is a dubious indicator of inflation risks: its previous peak [just north of $800] was in January 1980, just before inflation was crushed.

This argument strikes me as silly. Yes, Gold did fall from $800, settling during the almost 2 decades of relatively stable commodity prices from 1980 to 1999 at $350. But that $350 was a 10-fold increase from the Gold Standard rate of $35. In my view, Gold was a wonderful inflation barometer during the 70s, and, barring the overshoot inspired by the Iranian Revolution and Russian invasion of Afghanistan, inter alia, remained a good barometer during the 2 decades of price stability- and obviously since (or perhaps not so obviously).

If you prefer a monetarist perspective; the Greenspan Fed's decision, followed more vigorously by Bernanke's Fed, to allow the monetary base to expand by leaps and bounds every time investment banking got in trouble seems ominous, the warning signs are clear.

Pick a standard and the message is the same, the US$ as international medium of exchange and on the margin choice of international store of value, is not just dying, it is dead. But as John McCain once quipped about Greenspan, the authorities are simply doing a Weekend at Bernie's- propping up the corpse of the US$ and declaring everything fine.

If we had some monetary standard I believe the monetary authorities would long ago have decided that investment banking needs to be cut loose to sink or swim on its merits, which are not small, if the manager is competent (I don't see George Soros begging for hand-outs) instead of dragging the US medium of exchange into the toilet and risking social discord on a scale not seen in many decades.  Instead the disconnect between the real and financial economies will simply be allowed to widen further.

Imagine how angry the common man will be if the DJIA hits 15K with gas at $5 and unemployment at 20% (as so accurately measured by the BLS).  It seems to me time to choose between letting the big investment banks go bust or (if you happen to have some assets left) living in walled off communities, hoping a revolutionary spark won't ignite.  I wonder if some have forgotten that there are other reasons besides gaining wealth that economists began tracking economic growth, income equality and other such statistics- societies are not inherently stable, reason and wisdom do not always prevail. 

Do you know where the tipping point is?   

Russia and China are just now recovering from a few decades of the effects of throwing the baby out with the bathwater.  These things happen.

Yes, it's a bad time to have bad money.

Full Disclosure: I'm long Gold and Silver