When is a Non-Default a Default?

'When I use a word,' Humpty Dumpty said, in rather a scornful tone, 'it means just what I choose it to mean — neither more nor less.'

'The question is,' said Alice, 'whether you can make words mean so many different things.'

'The question is,' said Humpty Dumpty, 'which is to be master — that's all.'

The US Government, according to most press reports, has, by virtue of a last minute- a self-designated limit, it seems worth noting- deal, avoided default.  Amazingly, both the process and situation are even more confusingly convoluted than my opening sentence. 

Imagine a world in which the debtor determines whether or not he is in default.  In that world defaults would be rare events indeed.  Alas for the debtors, but fortunately for the solvent, our world doesn't work that way, no matter how things might appear. 

In our world, debtors don't determine default, creditors do. 

Here's what some important US Government creditors have recently been saying:

1) China: (Xinhua News) With its debt already almost equaling its gross domestic product, the United States, as a major anchor of the increasingly globalized world economy and the issuer of the dominant international reserve currency, needs to roll out more responsible and effective measures to balance its budget and restore the economic health of itself and the world.

2) Russia: (Reuters) They are living beyond their means and shifting a part of the weight of their problems to the world economy...They are living like parasites off the global economy and their monopoly of the dollar. - Russian Prime Minister Vladimir Putin

3) China: (RawStory) China's foreign exchange reserves will continue following the principle of diversified investment, enhancing risk management and minimising the negative impact of volatility in global financial markets," People's Bank of China governor Zhou Xiaochuan said in a statement.

"Large fluctuations and uncertainty in the US treasury bond market will affect the stability of international monetary and financial systems, which will hurt the global economic recovery."

Also on Wednesday, the Chinese ratings agency Dagong downgraded the United States for the second time since November, with a continuing negative outlook.

Meanwhile my preferred measure of US credit worthiness (and market in which nations of less military prowess might express their views more safely), the value of Gold in US$s continues to set new records.

With combined holdings on some $1.28T of US Treasuries, China and Russia are, unlike the US, in a position to declare the US in default, which brings us back to the big egg.  Humpty Dumpty's great fall might prove prophetic (and hopefully, beneficially cathartic) but it's his words that haunt me.

The question is, which is to be the master- that's all. 

Once words (like default, creditworthy, war, ally, etc.) lose their agreed upon, dictionary meanings, might is eventually used to make right.  The US Kabuki Play that was the debt ceiling debate has apparently failed to convince our militarily armed creditors we have jumped back from the abyss.  They seem to think our non-default still looks like a near default, and are taking action.  Will we continue our dance, putting off hard (but oh-so-necessary) decisions hoping to distract our creditors with drama, or will we make honest strides towards resolving our debt issues, which, first and foremost, must include growth policies (of the non-rent-seeking kind)? 

As an aside, the notion that our debt problems can be solved simply through broad spending cuts or tax increases is absurd to me (and likely to our creditors).  If the US economy does not resume growing fast the Washington crowd can crow about avoiding default all they want, but the rest of the world will know otherwise and act accordingly. 

If the Washington crowd chooses the former "more of the same" option, we might have to have a contest (a.k.a. War) to answer Humpty Dumpty's question- which is the master?

In hindsight, it might have been better to self-declare default and immediately start picking up the pieces instead of watching and waiting while the big egg teeters on the precipice.  After all, we know how the rhyme ends.

Luckily, capitalism doesn't require putting the pieces back together again.  Indeed, capitalism works best when the broken pieces are used to make newer, better things than a silly egg on a wall, destined to fall.

Full Disclosure: Long Gold

The Kins(l)ey Report (on Inflation)

One could, in a debate of US inflation prospects, discuss the virtues of issuing the currency in which your debt is denominated, and the ability of US political leadership to enact tough change counter-balanced, I think, by the magnitude of the debt in question relative to world GDP, and the actual history of US political leadership to enact tough change. But my aim is not (in this essay) a reasoned debate but a notice of the lack thereof.


If, like me, you're an official member of the pajama wearing blogger corps, you might be familiar with the recent debate over US inflation prospects between Michael Kinsley and Paul Krugman, et. al. If not, here's Kinsley's initial article, Krugman's rebuttal, Kinsley's retort, and Krugman's rebuttal of the retort.

Krugman's second rebuttal dripped with condescension, or so it seemed to me, recalling memories of school yard bullies. Those memories tempted me to begin this article with a quip about Krugman needing to pick on someone his own size......, but I'll use a different metaphor.

"Ouch!," you might be thinking, "that's a bit cruel."

True.

So's this line from Krugman to Kinsley: "I’m tempted to get into an argument about whether it’s “bullying” to suggest that if you’re going to write about an economic issue, you might want to study it first. But what I really want to do is..."

Don't you love the artful use of the non-statement statement?

Aside from my belief that future events are more likely to follow some variation of Kinsley's nightmare scenario than Krugman's Japan model (about which, more here), the element of the exchange that inspired this post was Krugman's nasty dismissal of an apparently serious inquiry from one who apparently admires his views.

Kinsley's initial article contains statements like: "am I crazy?", "Every economist I admire, from Paul Krugman and Larry Summers on down, is convinced that inflation will remain low for as long as we can predict", "I can’t help feeling that the gold bugs are right", and "My fear is not the result of economic analysis. It’s more from the realm of psychology."

These are the words of a humble student searching for wisdom to quell his fears.

The wise Professor Krugman begins his rebuttal with: "Mike Kinsley has an odd piece in the Atlantic in which he confesses himself terrified about future inflation, even though there’s no hint of that problem in the real world."

You can almost see the sneering Professor holding up the student's paper in front of the class as you read the words (at least I could).

Using the tried and true nasty Professor trick of tossing about a bit of relevant jargon and a counter-example, Krugman expects Kinsley to slink back into his seat.

To his credit, Kinsley doesn't flinch.... much. He almost falls for the Professorial misdirection (debating whether a sudden 100% inflation shock is better than a Weimar hyper-inflation is like debating whether losing both legs is better than getting killed- I see your point, but I'll take none of the above) but then gets back on point, telling the Prof (in effect), "you didn't answer my question."

Why not inflation?

As Kinsley argued, the 70s demonstrated the US is not immune to inflation and Gold has risen from $275 to over $1000 during the past decade. Perhaps Kinsley's main confusion lies in his focus on the future tense, instead of seeing it as an ongoing issue.

Kinsley's search for the truth on inflation reminds me of Alfred Kinsey's search for truth on human sexual habits, which led to the publication of two books on human sexuality known collectively as the Kinsey Reports. Like Kinsley (or so it seems to me) Kinsey's search for truth battled with popular conceptions of what should (in some views) be, but wasn't.

In a sense Kinsey reported on what everyone (collectively) knew, but was afraid to say. The fear (perhaps, with the benefit of hindsight, somewhat justified) among then current opinion shapers was, in part, that open discussion would release the genie from the bottle. Hugh Hefner, of Playboy fame, credits Kinsey with opening his eyes to human sexual experience.

Krugman, in my view, is too smart an economist to dismiss outright the possibility of another significant inflation episode in the US, which may or may not be followed by hyper-inflation.

To use his phrasing, for those dismissing prediction of substantial US inflation, what is it about the US now that looks different to you from Thailand, Korea and Indonesia in say, 1997 (or Russia in 1998, or Iceland just recently)? Substantial public and private sector debt? Check. Huge expansion in the monetary base? Check. Large external debts and ongoing external deficits? Check. Increasing difficulties rolling over ever shorter term debt? Check. And yet each of those countries suffered, not multi-year hyperinflation, admittedly, but a sudden substantial (50-100% or more) inflation shock.

There are, admittedly, differences. As I wrote, I was using his phrasing and argument form. One could debate the virtues of issuing the currency in which your debt is denominated, and the ability of US political leadership to enact tough change counter-balanced, I think, by the magnitude of the debt in question relative to world GDP, and the actual history of US political leadership to enact tough change. But my aim is not a reasoned debate but a notice of the lack thereof.

Mr. Krugman might snidely respond to my snidely put question that the issue was hyper-inflation. I lived in Asia during their crisis and such shocks are worth worrying about even if hyper-inflation is avoided (besides, his use of Japan- a nation which self-finances, which seems to me a critical distinction- as counter-point suggests even moderate inflation is unlikely). Moreover, as Kinsley notes, who knows what policy makers will opt to do when the next crisis erupts. The history of the Bernanke Fed is not one of monetary restraint in a time of crisis.

I suspect that Krugman, not the economist, but the opinion shaper is, like those Kinsey battled, trying to keep the genie in the bottle- thus the Professorial dismissal instead of reasoned discussion of the issue. Inflation has both psychological and real world causes- when the two unite, the fireworks begin.

Perhaps, in a limited fashion, the Kinsley Report on Inflation will have a similar effect as Kinsey's, (then again maybe both should be seen as catalyst instead of cause) by bringing the debate into the open.

I wonder who the Hugh Hefner of Inflation will prove to be- perhaps Bill Murphy of GATA?

My advice to Kinsley is to have the courage of his convictions and buy some Gold, the price of which may have been as suppressed as reasoned open debate on US inflation prospects appears to be- both actions aim at the same effect.  I did (at $275 for Krugman's information) and I'm still holding.

Big Finance as Napoleon: Heading to its Waterloo

I cannot accept your canon that we are to judge Pope and King unlike other men, with a favourable presumption that they did no wrong. If there is any presumption it is the other way against holders of power, increasing as the power increases. Historic responsibility has to make up for the want of legal responsibility. Power tends to corrupt and absolute power corrupts absolutely. Great men are almost always bad men, even when they exercise influence and not authority: still more when you superadd the tendency or the certainty of corruption by authority. There is no worse heresy than that the office sanctifies the holder of it. Letter from Lord Acton to Bishop Creighton

To everything there is a season, and a time for every purpose under heaven, begins Turn, Turn, Turn by the Byrds. Within that perspective men play the parts assigned to them (sometimes poorly and sometimes exceptionally) towards some goal which may not, as Hegel, inter alios, assumed, by easy to divine.

Unifying and increasingly larger civilizations have been created by men like Cyrus, Alexander, Caesar, Mohammed, Charlemagne and Genghis Khan, to name a few. Whether this is for good or ill seems a matter of opinion but that these men played a large role in history is certain.

In more modern times, men like Washington and Napoleon played similar roles. The former managed to resist the temptations of power to which most men succumb, and thus helped create these United States. The latter could not resist temptation. He overplayed the given part, and ended his life in captivity.

From that perspective of purposeful history, Washington and Napoleon were asked, in a sense, to lead the effort to sweep away the Monarchical system which had run Western Civilization for centuries. Washington, perhaps due to his lack of skill as General compared to Napoleon, played his part well. His letters suggest an awareness of the role of Providence on his side and a sense that he was simply playing a role.

Napoleon, by contrast, called himself a liberator, and did free, for a time, Continental Europe from the old system and, I believe, helped plant the seed of liberation which eventually killed it. However, he, like most men who rise to positions of great power, succumbed to the temptation described by Lord Acton. He did not see that, as the Chinese might put it, the Mandate of Heaven was limited.

Big Finance, in a sense, played an important role in history as well. If you believe, as I do, that Capitalism, as classically understood, is a much better method of providing for man's material needs as compared to "rule from the top", whether by King or Committee, you might agree with the support Big Finance received from the late 70s through the end of the 20th Century. In this sense I agree, in part, with the views of Fukuyama's End of History. While I doubt the US model is an end, it seems a much better way station than the alternatives.

If the stock market crash of 1987 inspired a Mellon-esque liquidation would the Soviet Union have given way to the Russia we know today? If the Asian Crisis left those nations with the sense that their turn towards Western Capitalism was a mistake would China have continued its drive towards economic integration with the rest of the world?

Just as I can understand those who supported Napoleon early in his career, I can understand why many supported Big Finance when, from a purely economic standpoint, restraint seemed a wiser choice.

Napoleon, as we know, turned his back on the principles of the Revolution which gave him power and declared himself Emperor. Big Finance, in my view, turned its back on a key principle of Capitalism- a measure and procedure for failure- when they pushed the Financial Modernization Act of 1999 into law and used commercial deposits as assets to lever for speculation.

Since that time, Big Finance has successfully fought attempts to restrain its power. Like Napoleon in Russia, Big Finance suffered a terrible defeat in the arena of mortgage finance and credit default swaps. Also like Napoleon, Big Finance was not chastened by defeat, but rather emboldened. Like Napoleon, Big Finance pays no heed to old supporters' warnings. While Alan Greenspan doesn't strike me as a gifted economist, he has a proven knack for divining changing political winds. When he argues that banks which are too big to fail are too big, he seems to me to be sending a message that the political support Big Finance has long received is waning.

Big Finance, as I have been arguing, has as its greatest weapon the exorbitant privilege of unlimited US$ finance and presumed support of key politicians. They have bet heavily that this will continue.

Just today I find that Big Finance might have found its opponent- the counterpart to Napoleon's Wellington- in the person of the BoE's Mervyn King. Mr. King's declaration that Big Banks should be broken up sets the stage for Battle.

These words, from a recent speech by Mr. King are "fighting words": Whichever approach to the “too important to fail” problem is adopted, there is growing agreement that such financial institutions should, as I argued at the Mansion House in June, be made to plan for their own orderly wind down – to write their own will.

In support of this view he argues: To paraphrase a great wartime leader, never in the field of financial endeavour has so much money been owed by so few to so many. And, one might add, so far with little real reform.

It is hard to see how the existence of institutions that are “too important to fail” is consistent with their being in the private sector. Encouraging banks to take risks that result in large dividend and remuneration payouts when things go well, and losses for taxpayers when they don’t, distorts the allocation of resources and management of risk. That is what economists mean by “moral hazard”. The massive support extended to the banking sector around the world, while necessary to avert economic disaster, has created possibly the biggest moral hazard in history. The “too important to fail” problem is too important to ignore.......
In other industries we separate those functions that are utility in nature – and are regulated – from those that can safely be left to the discipline of the market. The second approach adapts those insights to the regulation of banking. At one end of the spectrum is the proposal for “narrow banks”, recently revived by John Kay, which would separate totally the provision of payments services from the creation of risky assets. In that way deposits are guaranteed. At the other is the proposal in the G30 report by Paul Volcker, former Chairman of the Federal Reserve, to separate proprietary trading from retail banking. The common element is the aim of restricting government guarantees to utility banking.

I wonder what carnage the upcoming battle will leave in its wake?  If Big Finance is broken up, will alternative investments like Gold become even more attractive?

Full Disclosure: Long Gold