One of the fascinating aspects of my new American life is seeing how loud the volume of dissent is from the American
Bill Moyers
people about the shenanigans on Wall Street and the Too Big To Fail banks. There is an intensity and passion that I can’t see happening on the other side of the Pond. Maybe this is the cultural legacy of a people that just a short time ago, relatively speaking, were opening up this giant country seeking a better way of life than the ‘old countries’.
This intensity and passion is why, in the end, I believe that the solution to the huge crisis that still awaits us will start from this side of the Atlantic. But it will get a whole lot worse before it gets better, such is the complexity and depth of the fraud that is being visited on decent, ordinary folks in this and many other fine countries.
Bill Moyers of the Bill Moyers Journal on PBS is retiring. He’s approaching 76 and that’s a grand age to be dealing with the workload and stress of a weekly television presentation. His last Journal was broadcast on the 23rd April, a week ago today airing two really important topics. My only regret is that I haven’t been here sufficiently long to view many more of his Journals.
William K Black
In that last broadcast on the 23rd, Bill had two key interviews. In this Post, I want to bring to your attention his first report, which was an interview with William K Black, now an academic but, just as importantly, a former bank regulator. William Black really understands what is going on in banking.
The interview is both fascinating and captivating because, well to me anyway, it explains in terms that us laymen can understand, exactly what is going on and why it is so terribly important that legislation and regulations are brought into force to stop this fraud ever happening again.
This interview has not yet made it’s way onto YouTube so I can only post the link to the Bill Moyers website.
But, please, if you care about what is happening to us in whatever country you live in, click on this link and watch the interview.
And if you want to watch the earlier interview that Bill Moyers had with William Black then here it is.
This is the concluding part four of a multipart series on the factors that drive U.S. and foreign bond prices and yields.
[Part One is here, Part Two here, Part Three here Ed.]
Bond’s in a weak or faltering economy will generate a lower return to lenders than bonds in a strong economy, absent inflation or any other material changes in the purchasing power of the currency. Weak demand for goods and services means weak demand for financial capital which means low rates of return on financial capital.
The policies of the government can increase the borrowing costs of private industry. Fiscal policy that increases taxes reduces the profitability of projects and undermines the ability of companies to pay coupons and repay principal. Monetary policy that increases the money supply may lead to inflation, which also increases the cost of borrowing and reduces economic activity.
Lastly, and of the greatest concern of late, is the level of borrowing by the U.S. government. Debt levels are at record highs, with no relief in sight. The AAA rating of U.S. debt is reportedly in jeopardy (Chicago Tribune editorial).
Moody's Corporate Logo
Both existing and new lenders worry about the ability of the U.S. government to repay. Yes, the can simply roll over existing debt by raising taxes or creating money to retire old debt and replace it with new, but the interest rate required by new lenders goes up as the ability of the private economy to sustain tax revenues falls and the risk of inflation rises (Moody’s explains U.S. bond ratings).
Both factors are in play now: an anemic economy with little hope that this administration will undertake policies that support business, and a ballooning money supply and weak dollar that undermine the purchasing power of the returns to lenders. The returns to U.S. debt may still be healthy relative to those one can earn in other countries, but the spread is shrinking. The private economy remains fundamentally strong, thanks to the work ethic of the American people and the profit motive of the capitalistic system, but the policies of the U.S. government are straining those resources.
The yield on a bond is made up of several components. Some think of the return on a bond as the sum of the risk-free rate of interest (how impatient we are to get our money back, or how much we need to be compensated to delay consumption) and a risk premium (the additional return we require to compensate us for the risk of default, the risk the bond will be called, the risk of inflation reducing the purchase power of the repaid dollars, and many other sources of risk as outlined in the most recent article in this series).
Another useful way of thinking of the return on a bond is as the sum of the real rate of interest and the expected rate of inflation. But what is the real rate of interest? We never actually observe that rate, unless of course the inflation rate is zero and then the real rate is just the nominal rate set in the market.
It is useful, however, to think about what drives the ability of a company to generate a real rate of return to lenders, for this is essence of capitalism and risk-taking and creating economic value and growth.
Bond traders
A firm’s asset cash flows support the real returns to its lenders – all kinds of lenders (debt, equity, hybrid, and derivative security holders). A firm will want to borrow more, and is willing to pay a higher interest rate for those funds, the more profitable are the projects they want to undertake, or the greater the number of profitable projects. Profitability, in turn, is determined by the relationship between demand and supply: how much does society value a good or service, and how many resources does the business use in producing the good or service. As the marginal productivity or efficiency of a business goes up, it can afford to profitably fund more projects. So the core driver of the real return on bonds is the strength of the underlying economic activity of the private economy.
Or, when viewed from the investor’s side, note that an investor will purchase a bond, or lend money to a company, if they expect to earn a return sufficient to compensate them, first, for delaying consumption and, second, for bearing the various sources of risk or uncertainty associated with the bond’s cash flows or return.
Well, it is a Chinese saying, “May you live in interesting times”!
A couple of weeks ago on Learning from Dogs, there was an article reminding readers that the web has been around for 20 years and Sir ‘Tim’ Berners-Lee is still hard at it in terms of Internet innovations. And to support this, today accompanying this Post is one on what the BBC is doing to commemorate the event.
The Internet has completely reformed the way that ordinary people get access to information. Stratfor is a great example.
From their web site:
STRATFOR’s global team of intelligence professionals provides an audience of decision-makers and sophisticated news consumers in the U.S. and around the world with unique insights into political, economic, and military developments. The company uses human intelligence and other sources combined with powerful analysis based on geopolitics to produce penetrating explanations of world events. This independent, non-ideological content enables users not only to better understand international events, but also to reduce risks and identify opportunities in every region of the globe.
One can subscribe to a range of free reports and it came to pass that a Stratfor report on China came into my in-box.
Stratfor generously allow free distribution of this report and because the relationship between China and the USA has so many global implications, the report is published in full, as follows:
A very far-sighted view of European collaboration from 12 years ago!
Once again, Learning from Dogs welcomes a guest post from Per Kurowski.
Per Kurowski
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I was intrigued by a recent Post on Learning from Dogs entitled Poor Old Europe. It included two commentaries from elsewhere about the state of Europe and how the feeling of trying to force, politically, very disparate countries together was still ever so dominant. It reminded me of an article that I wrote for my own Blog nearly 12 years ago just before the Euro came into effect. Reading it today is interesting, to say the least.
In just a few weeks, on the 1st of January 1999, eleven European countries will forsake the right to issue their own currency and accept the circulation within their boundaries of a common currency, the Euro. Monetary policy related to the Euro will be set by a European Central Bank. One fact that struck me as curious is that in all the abundant legislation that regulates this process, there is no mention whatsoever of how to manage the withdrawal or future regret of any of the union’s members.
The absence of alternatives in this case evidently represents a burning of the bridges, but this may be necessary to achieve credibility. There is no turning back and there is no doubt that this is a truly historical moment. As participants in a globalized world in which Europe has an important role, we must naturally wish all members luck, no matter what worries we might secretly harbor.
Until 1971, all money used throughout the history of humanity was backed in one way or another by something physical to which a real value was attributed. Sometimes the backing was direct, pearls for example, while in other cases it was indirect such as the right to exchange bills for a certain quantity of gold.
This physical backing in itself did not necessarily mean it consisted of something of fixed value. The value of a pearl, for example, is in itself subjective. The promise to exchange bills for gold did not guarantee anything either, since this promise could easily be voided by fraud. Whatever the backing was, however, it did at least offer the holder of the money the illusion that it was supported by something concrete.
In 1971, the United States formally abandoned the gold standard and the direct backing, however imaginary, disappeared. Since the Dollar is a legal currency, it could always be used to repay Dollar denominated debt. Today, however, in spite of the fact that the Dollars may have lost some of their purchasing power, a holder of excess Dollars can only hope that the Government of the United States will exchange his old bills for new ones of the same tenor.
This apparently precarious situation must be the raison d’etre of the motto printed clearly on the bills which states “In God We Trust”.
Since 1971, the real value of the Dollar as an element of exchange, has lost some of its value due to inflation. Today, we would need many more Dollars to buy the same houses, cars, movie tickets and gold than we would have needed in 1971. In spite of the above, with few exceptions such as the end of the ‘70s during which inflation increased dramatically, few would dare qualify the United States’ elimination of the gold standard as a failure.
The world’s economies have managed to increase international commerce drastically and with it, sustain a healthy growth rate. Many analysts would explain this phenomenon by saying that the discipline exacted by the gold standard represented a brake on international commerce. The growth rate registered in commerce after 1971 was the result of the release of this brake. Other more critical analysts sustain the thesis that, due to the fact that we have abandoned the discipline required by the gold standard, the world has accumulated gigantic accounts payable, which we may be coming due very soon.
I personally swing back and forth between amazement of the fact that the world has accepted such a fragile system and satisfaction that it actually has done so.
The Euro has one characteristic that differentiates it from the Dollar. This characteristic makes me feel less optimistic as to its chances of success. The Dollar is backed by a solidly unified political entity, i.e. the United States of America. The Euro, on the other hand, seems to be aimed at creating unity and cohesion. It is not the result of these.
The possibility that the European countries will subordinate their political desires to the whims of a common Central Bank that may be theirs but really isn’t, is not a certainty. Exchange rates, while not perfect, are escape valves. By eliminating this valve, European countries must make their economic adjustments in real terms. This makes these adjustments much more explosive. High unemployment will not be confronted with a devaluation of the currency which reduces the real value of salaries in an indirect manner, but rather with a direct and open reduction of salaries or with an increase of emigration to areas offering better possibilities.
What worries me most is the timing. The world is facing the possibility of a global recession. This will require very flexible economic and monetary policies. The fact that the search for initial credibility for the Euro is based on trying to assure markets around the world that the new currency will be guided by a philosophy closer to that of Bonn than that of Rome, probably goes against the best interests of the world.
Published in Daily Journal, Caracas, November 19, 1998
Why has it seemed like pushing water uphill for so long?
I’m in my mid-60s, having been born six months before the end of WWII. From the earliest days that I can remember, my parents loved to holiday in France and Spain. In those days if one was to motor into Europe then it was a case of the car being craned aboard the ferry from England to France. How things change!
Modern cross-channel ferry
Much later on in life, I did business extensively in many European countries and, for a while, taught sales and marketing at the international school, ISUGA, in Quimper, NW France. (Indeed, fellow Blog author Chris Snuggs was my Director of Studies at ISUGA – that’s how we came to meet.) I like to think that I have a reasonable understanding of the variety of cultures that is Europe.
So while acknowledging the convenience of a common currency (sort of) and ease of border transits, the one thing that has remained in my mind is that each country in Europe is very, very different to the other. These core differences have always struck me as so strong and deep-rooted that any form of real union was a ridiculous concept. The present deep problems with Greece seem to be the tip of this fundamental issue. Thus a couple of recently published articles, on Baseline Scenario and The Financial Times seem worthy of being aired on Learning from Dogs.
Learning from Dogs has been publishing on a daily basis since July 15th, 2009. That’s over 460 posts and is a great tribute to the commitment of all the authors of this Blog. We are grateful that our regular readership is also measured in the hundreds and is growing steadily.
Elliot Engstrom
It seemed time to make a small change. We have decided to include articles from Guest Authors on a regular basis. Our first guest is Elliot Engstrom.
Elliot Engstrom is a senior French major at Wake Forest University, and aside from his schoolwork blogs for Young Americans for Liberty and writes at his own Web site, Rethinking the State
Elliot first post for Learning from Dogs is about the US Federal Government and Poverty. This also appeared in The Daily Caller.
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The federal government, which claims to be the greatest supporter of those in need, is anything but a friend of the impoverished.
Often times when conservatives speak of the government treating the rich differently than the poor, the discussion is framed around taxes and welfare, with the argument being made that the government forces the highest earners to pay a massive percentage of all taxes, both punishing success and stifling overall economic productivity and making it all the more difficult for anyone not in the upper echelons to accumulate wealth for themselves. I sincerely hope that I have not constructed a straw man version of this common conservative argument, as I certainly think it has a great deal of credibility. However, I also would like to draw attention to the fact that while government loots the rich through the direct means of taxation, it likewise loots the poor, albeit through a different set of means that is much more difficult to recognize, and thus much more difficult to counteract.
While looting the wealthy can often be construed as some kind of humanitarian effort to aid the poor, looting the impoverished is a much more difficult enterprise to disguise as a moral good. Thus we will find that the government’s means of taking money from the poor are much more difficult to detect, comprehend, and eliminate than the means of direct taxation that is used to extract money from the wealthier members of society.
The dollar in which the majority of Americans receive their wages or salary has no absolute, set value. We see this in the fact that the value of the dollar is constantly fluctuating when compared to gold, silver, or the currencies of other nations (which are all constantly fluctuating in value themselves). “Value” is determined by a wide range of factors, but is based in the fact that human beings are all rational maximizers who are all trying to get what they want while expending the least amount of resources possible to do so. The occurrence of this phenomenon in the mind of every single individual economic actor coordinates the price system in a free market economy.
A given worker making $10.50/hour may see himself as bringing home a constant source of income. However, this is not the case at all due to the constantly shifting value of the dollar. Even in a free and unhindered market, the value of the dollars that this worker takes home each day would fluctuate based on factors like how much liquid currency was actually in existence in the market, how many resources had been invested in banks or stocks, and what amount of resources had been converted into physical capital or products. In the end, the dollar itself has all the value of a flimsy piece of cotton paper – it derives its true value from the productive activities of economic actors who use it as a medium of exchange. In other words, the dollar is a widely accepted “I.O.U.” This would be the case even in the freest of economies. Values of commodities and currencies are always changing based on the effectual demand and effectual supply of the moment.
But, as we all know, we live in anything but a free and unhindered economy. Our supposed “free market” is criss-crossed with a Federal Reserve System that manipulates the value of the dollar at will, a corporate welfare system that socializes the losses of corporations at the expense of the rest of society, and law enforcement policies that weigh the heaviest on those who do not have the time or resources to easily deal with court and lawyer fees, jury duty, and detainments prior to trial, not to mention the fact that the War on Drugs does substantially greater damage to the lower classes of American society than it does good, particularly when speaking of poor African-Americans.
And here’s the scary part – this was all the case before the bailouts and stimulus package that George Bush began and Barack Obama continued and amplified. Not only do these bailouts threaten to massively inflate our currency, spelling disaster for those whose livelihood is based in hourly wages paid in dollars, but it also directly took from all of society, not just the rich or the poor, and gave to a few select corporate entities such as Goldman-Sachs and Wells Fargo. We know this because every new dollar created by the government in the stimulus plan detracted from the value of every dollar already existing in the pre-stimulus economy (or will do so when released into the economy).
Does this sound confusing? It should, because it is, and that’s exactly how the federal government likes it.
While the federal government would tell us that they protect the poor from the exploitation of the rich, economics would tell us that it is in fact the federal government itself that is the greatest exploiter of our nation’s impoverished, and it is this institution that in fact facilitates much of the disparity in wealth between wealthy national corporations and impoverished local communities.
Those of the small government mindset who wish to rally more people to their cause should not go about proclaiming that we should be immediately getting rid of affirmative action and welfare for the poor, but instead should be putting forth a rallying cry against corporate welfare, an inflation-minded Federal Reserve System, and a law enforcement system whose economic penalties weigh heaviest on those with the least money in their savings accounts. It does not have to be out of selfishness that we advocate for a reduction of the federal nanny-state. It can, and should, instead be out of a concern for the poverty and destruction of wealth that is directly generated by this institution’s misguided policies.
The Federal Reserve finally addresses how it plans to unwind trillions in toxic assets
Finally, we hear from the Federal Reserve about how they plan to unwind the billions of dollars of toxic assets they purchased over the last 18 months or so without creating further distortions in the U.S. and world financial markets (Fed lays out exit detail). This after the Fed barely acknowledged one of the most dramatic runups in the money supply in U.S. history.
Brian Sack, EVP Markets Group, Federal Reserve
The announcement came in a speech by Brian P. Sack, the executive Vice President of the Markets Group at the Fed. I am impressed by this guy. He seems to know what he’s talking about and seems to understand how markets and fed policy interact.
In earlier posts I wondered aloud how the Fed might accomplish this tricky task. It is a very delicate balance between reducing the money supply too quickly, which would spike short term rates, and too slowly, which would increase long-term rates due to worries about inflation (which occurs when money growth is higher than the economy’s real growth, even if money growth is falling).
The Fed, the article explains, apparently intends to let $200 billion of the estimated $1.25 trillion in new money supply simply “mature” by the end of 2011 without replacing it. This represents largely toxic assets. The Fed might let another $140 billion of Treasuries it purchased during normal open market operations mature at the end of 2011, but they aren’t committing to that. So that’s about $340/$1,250 or about 35% of the historic increase in money supply that may be vaporized over the next 21 months. What about the rest? It would be nice to know but….
The Fed is doing the right thing by explaining its policy intentions — ANY of its policy intentions — to the markets. Markets want, need, and deserve information from our officials, something that has been sorely lacking of late. With information, lenders and borrowers can plan, they can optimize. Without information, guessing, withdrawing from the market, and fear rule the day. Not a good environment for economic recovery.
I apologise for the rather trite sub-heading but it was a bit of attention grabbing to promote the results of a recent conference called Let Markets Be Markets. It was published by the Roosevelt Institute and had one very impressive line of speakers.
One of the speakers was Simon Johnson of Baseline Scenario fame, a Blog that Learning from Dogs has followed since our inception.
Here’s 8 minutes of Simon pulling no punches.
If you want to read and watch other presentations, then Mike Konczal’s Blog Rortybomb is the place to go.
As this Blog has repeated from time to time, this present crisis is a long way from being over.
Learning from Dogs muses the new book from Yves Smith
ECONned, by Yves Smith
In Econned, Yves Smith, founder of Naked Capitalism, argues that the economy was doing just fine in the regulated environment up to the 1970s. Then began the work of the Chicago economists who challenged Keynesian economics and touted the benefits of deregulation which eventually led to the financial crisis we have today.
Yves argument is internally consistent and well researched, but ignores some factors that I think would change the conclusions drawn from her work.
Yves Smith, author and founder of Naked Capitalism
First, Yves notes that the primary reason that economists are not useful to the real world is that economic research presumes equilibrium. Smith misses the point here, but it is understandable. It took me years of study and contemplation to fully appreciate that an equilibrium simply gives economists a point of reference, a common base, from which to study shocks and movements. In and of itself, equilibrium is not interesting or important. But movements to and from equilibrium are of real interest because they enable us to study and try to predict how individuals will react to incentives and changes in market conditions.
Second, we have to put the contributions of the Chicago economists of the 1970s into context. Up until that time, the only real school of thought in macroeconomics was based on Keynes, who presumed that markets fail and that the government must play an active and large role – primarily through government spending and taxes — for the economy to perform well. Keynes’ work was a reaction to the Great Depression.
Friedman’s monetarism also sought to explain the Great Depression, but focused on the role of monetary policy on the economy. This work showed that the missteps of the Federal Reserve was the primary cause of the depth and length of the Great Depression, and that long-term accommodative monetary policy causes inflation. This body of work did not stress deregulation, although it did lean more heavily on enabling private market solutions than on replacing them with government solutions. Neither theory is complete; Keynes focused on the short run (“In the long run, we are all dead” is a rather famous Keynes quip) and Monetarism focused on the long run.
There was a second large body of work that came out of the University of Chicago during the late 1960s and 1970s. This research documented the tremendous costs of regulation. I know this literature personally and believe that its conclusions are very sound: it shows that any effective regulation limits either the quantity or price of a good or service away from what it would have been without the regulation. In fact, in my view, it was the passage of regulations requiring certain lending behavior that set off the series of events that led to the crisis, which is the exact opposite argument from what Ms. Smith makes.
Learning from Dogs 