Tag: Finance

In or out of recession?

A friend on another site just posed this question.

Why is it that a recession is described as two or more successive quarters of “negative growth”, but being out of recession is just one quarter of (estimated) growth?

I felt emboldened to pen an answer as follows ….

In Britain, the definition of recession-emergence is from the same school of economics as growth predictions for next year (any year), which are always about 5 zillion% more than actually turns out to  be the case.

Recession in Britain

The cunning  idea is that future growth will be vast enough to cover the even vaster existing debts and commitments. And, of course, by the time we KNOW what the growth actually turned out to be, most people will have forgotten the predictions on growth from the financial and economic wizards running the country. That’s also one of the great things about a new mess or crisis; it always takes the mind off previous crises, which are likely to be ongoing but less in the media and therefore not to be bothered about too much.

This is, of course, in addition to the fact that growth in itself is incompatible with reducing global warming, but here we are getting a bit too technical.

Well, that’s how we do it in Britain anyway. How do you manage it over there?

by Chris Snuggs

A reply from a U.S. economist.

Hello there Chris!

Recession in the U.S. is also defined as two successive quarters of negative GDP growth.  At least, that’s how its officially defined.  And to add my answer to your friend’s question — either the economy is either in a recession — i.e., two or more consecutive quarters of negative GDP growth — or it isn’t, which means that the string of negative GDP growth rates is broken.  And that only takes one quarter of positive growth.

Most of the economists I know personally tend to look at a bigger picture than the stated GDP figures, however.   I focus on capital and labor utilization rates as I believe that they are more important measures of a well-functioning economy.  The final GDP figures in both of our countries are national income accounting figures, and have all the weaknesses of any income statement variable.   They are flow variables, which ignore the stock of economic wealth.   For example, if you invest $100 this year in the stock market, and it grows in value by $20, only the $100 is counted. The increase in wealth is never captured in measures of GDP.

Another problem with current measures of GDP and GDP growth is that government spending is considered on par with private spending, which brings into question the sustainability of growth measures based on GDP, although President Obama and perhaps Prime Minister Brown are both fine with growth rates being fueled by large increases in government spending.  Finally, a significant fraction of economic activity, like the value of work in the home — is not measured.

So, yes, the official measurement of GDP is all wrapped up in technicalities.  But most economists I know pay little attention to it.  They are more concerned with how well the economy is functioning, whether the growth is sustainable, and whether people who want to work can find work.  If you are unemployed, the economy is in a recession, regardless of what the GDP figures say!

by Sherry Jarrell

Fed Funds Rate and Consumer/Business Costs

Looking more closely at the implications of changes in the Fed rate

Fed funds rate chart_img
Fed Funds rate influences consumer and business interest costs

Does the Fed Funds Rate, the rate charged by the Federal Reserve to make short-term loans to banks, directly influence the interest rate consumers and businesses pay on credit cards, mortgages, and consumer and business loans?  If you took the word of the average business news commentator, you would think not.  But the answer, of course, is yes.

One way to view the market rate of interest, although certainly not the only correct or useful way, is to think of it as a base rate that represents the risk-free rate, a rate that compensates the population for its impatience to consume the goods it would have consumed had it not lent the funds out in the first place. This risk-free rate is also influenced by the efficiency and functioning of the capital markets that bring borrowers and lenders together.

A risk premium is then added to this base rate of risk-free interest, one that varies depending on the degree of uncertainty of the lender getting repaid.  The risk of default, the risk of prepayment, the risk of political uprising, exchange rate risk, and many other sources of uncertainty — including the risk of inflation — raise the level of the risk premium commanded by lenders in the market.  As an example, over the last 100 years or so, the average annual risk-free rate in the U.S. has been about 4%, and the average annual risk premium for equity securities has been about 8%, bringing the average annual observed interest rate or rate of return to about 12% on these securities.

So what happens to the interest rate charged to consumers and businesses when the Fed raises the fed funds rate?  Basically, the level of the risk-free rate in the economy rises and, as debt contracts expire or new lending takes place, this higher base rate gets factored into the market rate of interest charged.

Overall, the demand for loanable funds falls, the aggregate demand curve for the economy falls, and equilibrium output and employment fall, RELATIVE to where they would have been without the rate increase. The bright side is that a reduction in the money supply that accompanies an increase in the fed funds rate is absolutely essential to curtailing inflation, which drives the risk premium, and represents a much greater cost to the economy.

By Sherry Jarrell

Why the Fed Raised the Interest Rate

Contractionary Fed policy in a recession?

What does it mean when the Fed raises the interest rate? It helps to first understand how the Fed raises the rate, which may surprise some people.  The Fed does not “set” the interest rate as it might, for example, by declaration or edict or by fixing prices.  No, it targets a higher interest rate by contracting the money supply until that money supply intersects the market demand for money at a higher market-clearing rate of interest.

Ben Bernanke, recently reconfirmed Fed Chairman

How does the Fed reduce the money supply? Typically by conducting open market operations, which is the purchase or sale of government securities by the Fed.  To raise the money supply, it purchases new government securities, paying for them by creating — out of thin air — reserves for the commercial banking system. To reduce the money supply, it sells securities which shrinks the amount of deposits in circulation in the economy. In other words, it reduces the liquidity or amount of credit in the system.  This is equivalent to reducing aggregate demand for the goods and services in the economy. (Yes, you heard right — a reduction in the money supply decreases the aggregate demand for goods and services by businesses and consumers.)

Raising interest rates is a contractionary policy decision.  It is designed to “slow down” the economy, reducing output and employment, and raising the equilibrium prices of goods and services in the economy.  Why would the Fed choose to contract an already anemic economy?  To head off inflation, which has it own set of insidious costs and distortions that significantly hurt the economy.

The Fed has always had to tread a very fine line between increasing the money supply enough in the short run to pump up demand and minimize the depth and length of a recession, but not increasing the money supply so much that the increase in demand outstrips the ability of the economy to produce, which creates inflation in the longer run.   Excessive money growth is what causes inflation.  And over the last two years, the U.S. has witnessed a record-shattering increase in the money supply as policymakers struggled to deal with an unprecedented financial crisis.

I have been saying for months that this behemoth money supply would inevitably lead to significant inflation unless steps were taken to shrink it.  I believe the Fed has now begun to take those steps.

By Sherry Jarrell

Oh, Irony! The Markets and Obama’s Policies

Where are capital markets heading?

In a recent article, Moody’s announced that it may have to reduce the AAA rating of U.S bonds because of excess spending and historic debt levels of the U.S. government under President Obama.

Moody’s Investors Service Inc. said the U.S. government’s AAA bond rating will come under pressure in the future unless additional measures are taken to reduce budget deficits projected for the next decade.

The U.S. retains its top rating for now because of a “high degree of economic and institutional strength,” the New York- based rating company said in a statement today. The ratios of government debt to the U.S. gross domestic product and revenue have increased “sharply” during the credit crisis and recession. Moody’s expects the ratios to remain higher compared with other AAA-rated countries after the crisis.

What this means in practical terms is that the cost of borrowing by the U.S. government will rise, which will increase spending via more borrowing or higher taxes or more money creation to pay for the higher interest costs.  Sound like a vicious cycle to you?

Has anyone noticed the absolute irony of the world capital market having a seat at the table that assesses the viability of Obama’s policies? Obama, who has spent the last year denigrating free markets and capitalism, and has laid the blame for the credit crisis squarely at the feet of those greedy capitalists, now has to deal with a rating agency, which plays a pivotal role in the functioning of those very capital markets, evaluating the creditworthiness of his policies and those of his budget director, Peter Orszag, pictured here.

Peter Orszag, Obama's Budget Director

How wonderfully ironic!

The U.S. would not be the first.   Ireland was recently downgraded, and Japan lost its AAA rating from Moodys in November of 1998; both faced higher borrowing costs as a result.

By Sherry Jarrell

Tax, Law, Crime and Morality in Banking

More holes than in a Swiss Cheese!

There is currently a merry old ding-dong spat going on between the German and Swiss governments. Basically, someone has got hold of information about German citizens with bank accounts in Switzerland where they are hiding large sums on which they should pay German taxes.

This or these enterprising whistleblower(s) are offering to sell this data to the German government for a hefty fee. The German government is on the point of accepting to buy this “illegally-obtained” information from the (from the Swiss point of view) criminals who have stolen their secret bank data.

This story raises a large number of fascinating questions. It has long been common knowledge that Switzerland offers banking facilities with few questions asked. Any self-respecting criminal or tax evader has or had a secret, numbered Swiss account.

What has always amazed me is how they have got away with this for so long, stuck as they are in the centre of Europe. How is it possible that other countries have allowed Switzerland to become a haven for money obtained illegally in other countries?

For it is clearly immoral to profit from the illegal activities of foreign nationals, isn’t it? What exactly is the difference between this behaviour and “receiving stolen goods”? Worse, we have to remember that the largest sums come from drugs. Anyone willing to look after (or launder) drug  money is complicit in the misery and deaths of millions of drug addicts worldwide. Yet the Swiss have pulled off this trick for decades. The Swiss banking (and government) fraternity has never shied away from shady dealings, being until the end of WWII covert supporters of the Nazis.

Well, Angela Merkel is going to do a deal with presumably Swiss “criminals” (according to the Swiss government) in order to recoup money it is owed by German criminals (according to Germany). What a merry old moral maze we have here. But in truth, the world is now too small and inter-connected to allow either tax evasion on a vast scale  or the safeguarding of criminal funds.

Switzerland has to decide whether to remain as a supporter of tax evaders and gangsters (including of course African Presidents who have ripped their countries off in a big way) OR to join the real, civil, honest and inter-connected world.

The rest of us should stop tolerating this connivance with crime. “Client secrecy” is no excuse for condoning and profiting from crime.

More on the whole  Nazi gold in Switzerland story is here.

By Chris Snuggs

Bankers’ Bonuses

Scoop information – direct from the Board Room

Given the plethora of comments on banking bonuses recently our intrepid reporter has managed to get access to a bankers’ board meeting to establish exactly how targets and bonuses are planned. His transcript is highly revealing of a complex system tightly geared to the bank’s activities and designed to give maximum incentive to those at the highest level.

So here you have it …..

Board Meeting at FatGreedyBankers, Limited (extremely)

Hello chaps. We’re here to set the targets for this year’s bonuses.

Jolly good, Sir Tosser. What did you have in mind?

Well, if the bank doesn’t actually go bankrupt we all get £1,000,000 quid. This is our baseline. Got to have a baseline ….. Then we get an extra £1,000,000 bonus for every £10 profit we make. What do you think?

I must say these are pretty stiff targets, Sir. As you know, the chances of going bankrupt are very high.

Yes, but then we get bailout money so we don’t have to worry about that.

No Sir. Well, I’m sure we all relish a challenge, don’t we chaps? Let’s go for it!

By Chris Snuggs

The Mystery of the Disappearing Ethics

The Dubai debt crisis raises fundamental questions.


UK banks account for half the £60billion of global loans to the debt-laden emirate, new statistics show.

Well done British banks ….. loads of loans built on sand … I suppose the words “conservative” and “prudent” didn’t get printed in the Banking Terminology dictionary?

So Britain, that Global Giant of the banking world, has half the dodgy loans? British banks are therefore as daft as the rest of the world put together? (Can someone check my maths!)

Oh, and why exactly were the banks lending money to SORDID DICTATORSHIPS? Would we have lent billions to Hitler’s Germany in 1937? What on earth happened to ETHICS in the financial world? I suppose lending to POOR countries who need it rather than the nasty, venal, corrupt dictatorships of the Middle East was right off the radar?

There is an obsession with the “Human Rights” of immigrants and others in Britain, but a complete and utter turning of  blind eyes to the slavery going on in the Middle East, as if it doesn’t concern us because it’s in “another far-off country of which we know little”. (Neville Chamberlain’s shameful explanation of his inaction over Hitler’s annexation of the Sudetenland in Czechoslovakia in 1936.)

Sorry, but “No Man is an Island” …. we can’t sign the UN Declaration of Human Rights on the one hand and then blithely lend money (the PEOPLE’S money) to countries that are treating people so terribly.

I hope Dubai goes bankrupt and our cretinous banks with it so that we can start again with people’s banks that have a modicum of honour and decency and are prepared to invest in democracies, not insanely greedy property developments based on dictators’ idle fantasies.

It wasn’t much different with Sadaam Hussein, whatever you think of the invasion. This was a man who – just to take one example – gassed to death 5,000 innocent men, women and children in one single village alone. Yet countries in the “free world” were secretly queuing up to do deals with him. One British government MP even went there and shook his hand, the hand that consigned hundreds of thousands of people to a horrible death.

Ecology? Apart from anything else, Dubai’s carbon emissions are pro rata 250% higher than the US, so much power goes into air-conditioning and desalination. Once again, the left hand doesn’t know or care what the right hand is doing. A British minister tells us to stop eating meat to save the world while British banks simultaneously rush to finance a humongously-profligate and obscenely-elitist project in the desert.

I sometimes wonder if we really deserve to survive Global Warming. Will it be God’s way of cleansing the Earth of an aberrant experiment in free will?

By Chris Snuggs

Paul Krugman’s Endless Ego

A small challenge to a Nobel prize winner in Economics!

In a recent New York Times op-ed, Paul Krugman continues his boundless quest to become the “it” guy in the world of economics.  I have taken issue with his command of basic economic facts in the past — a gutsy, if not insane thing to do given the man was awarded a Nobel Prize in Economics.

Krugman accepting the Nobel Prize

This post is more about ego than economics, however.

In this op-ed, Mr. Krugman says (and I kid you not),

…But after the debacle of the past two years, there’s broad agreement — I’m tempted to say, agreement on the part of almost everyone not on the financial industry’s payroll — with Mr. Turner’s assertion that a lot of what Wall Street and the City do is “socially useless.” And a transactions tax could generate substantial revenue, helping alleviate fears about government deficits. What’s not to like?

Well, I disagree with the idea that what Wall Street does is socially useless.  And I am not on the financial industry’s payroll.

Nope, I’m just a simple economist, using my head, training, and experience to consider this idea, map out the pros and cons, and analyze the logical end-game of such a tax.  I conclude that it is a really bad idea.

Why?  There are lots of reasons, but I will mention only two.

  • One, raising taxes reduces private economic activity, which will curtail growth, reduce tax revenues and increase the deficit.
  • Two, taxes distort the price signal between suppliers and demanders of goods and services, including financial capital, reducing economic efficiency.

His reasons?  Other than citing one academic study (while ignoring the many others that reach a different conclusion), he gives no economic reasons for his views.  Instead, he make claims. He claims, for example, that “socially damaging behavior … caused our current crisis.”  He says that the financial services industry is “bloated” and needs to be cut down to size.   He says that the new tax is okay because it raises revenues for the government which, he claims, should make us all feel better about the deficit and, apparently, the size and nature of government spending under Obama. And, the lamest of all, for no other reason than to hide behind their skirt, he claims the existence of some phantom majority, apparently to create the impression that anyone with a different view is clearly in the minority.   A tactic that should be beneath a Noble Prize winner, but one that runs through his work with increasing frequency over time.

But, Mr. Krugman, I so disagree with you.  And even in an op-ed piece — perhaps especially in an op-ed piece – I believe that one needs to reign in an ego that would parade claims as facts, especially when each of those claims is disputed by your fellow economists, none of whom stooped so low as to imply that you were paid for your views.

By Sherry Jarrell