Imagine a country where the average household routinely spends half its $100 income on buying in 4,000 calories a day of flour and half on all the other necessities, as well as the little luxuries, of life.
Next, picture the response if the subjectively perceived degree of scarcity of flour suddenly rises, pushing its price up 20% as it does. To keep matters as simple as possible, let us not delve too deeply into the whys and wherefores of this impetus, but simply let us insist it is not because of any actual shortage of physical supply on the cash market.
Assuming that demand for this staple of its members’ diet is close to an irreducible minimum, and that, in its anxiety to maintain its basic nutritional needs, the family will henceforth have to spend $60 on flour instead of $50 and so will be left with a mere $40 to devote to its purchases of everything else in place of the previous $50.
Supposing, too, that money in this benighted land is no longer an emergent construct of mutual intercourse and free exchange – and therefore, in some sense, ‘hard’ – but is rather issued without restraint, at the whim of a central collective of Platonic Guardians.
Let us further insist that Hoi Phylakes see it as their calling to ensure that the averaged prices of all things other than flour can never decline and, subject to some very woolly and ill-defined limits on how much politically insupportable harm they cause in the attempt, that no-one shall lack employment for reasons which a loose-thinker might attribute to a simple lack of money, no matter how sub-marginal or even blatantly unremunerative his labours might be.
Now, given that the jump in the price of flour has – at least as a first-round effect – led to only $4 being offered for a basket of goods which used to attract an offer of $5, the combined effect (differentiated among them as it will be in practice) is that they will fall in price by something of the order of 20%. Barring some miracle of instantaneous cost cutting, the total wage bill at the firms in that line of business will need to be reduced proportionately, meaning steep wage cuts or heavy job losses – each of them anathema to the Keynesian creed of orthodox economics.
Enter the central bank, stage right. If the lack of a post-flour disposable $10 (per household) has seen ‘deflation’ of such a hideous magnitude set in among the arbitrarily flour-excluding array of goods which it monitors, the instant addition of another $10 pro rata to the money supply should, it feels, set matters straight at once.
Alas for the conceit of the planner, for, as our original premise made clear, consumer preferences have decisively shifted in favour of buying flour not other goods, to settle at a new ratio of 60/40. Thus, the new exchangeable total of $110 (assuming the extra money to have been placed into the hands of the same family and not diverted off into some other passing fad or siphoned craftily into the pockets of the politically well-connected) is likely to have $66 of it used for flour and only $44 laid out on the rest, so ‘core deflation’ (in reality nothing of the sort, of course) will only have been ameliorated to -12% and not banished entirely, as was the naïve intention.
Chasing on through this battle of wills between the state and the individual – and still ignoring second order effects – an equilibrium might only be looked for when the supply of money has been artificially swollen by no less than a quarter – to $125 per household – whereat each family can spend three-fifths ($75) of this, as they desire to do, on flour and two-fifths – or the original $50 – on everything else and so finally eliminate ‘core consumer price deflation’ if only at the cost of magnifying the original, steep 20% rise in the price of flour to a vertiginous, final 50%.
Of course, that would not be an end of it, for none of this has masked a major alteration in the terms of trade between people in their (often simultaneous) roles as flour producers and consumers, nor between them in their non-flour equivalents. Ultimately, one set has benefited from the shift and one has lost out.
Granted, to the extent that flour producers and flour consumers are not entirely one and the same body of people and, hence, may express a varying menu of preferences, the former may seek to enjoy their relatively higher incomes by buying things other than flour for themselves and so partially mitigate the real effects on others.
Moreover, the change in relative pricing (something which would have taken its natural course even if there had there been no Ivory Tower full of academic meddlers and shallow special-pleaders) will have sent signals to people everywhere that they need to further adjust to a change of circumstances largely of their own creation. Thus, they might more closely review their use of the newly-expensive flour, making sure they maximise its utility and minimise any inefficiencies or identifiable excesses in its use.
They might devote care and attention to improving grain yields, bringing more land into cultivation, automating the milling process, easing the logistics of delivery to the point of sale, and even to developing alternative sources of sustenance.
Meanwhile, the producers of non-flour goods – who nonetheless also require their daily bread if they are to have the energy to man their own offices and factories – will seek to change the ratio between the necessary flour input (and, indeed, of any other inputs) and both the physical output – and, more importantly, the value entrained therein – of what they sell in order to earn that same bread, whether for personal consumption or productive uptake.
All in all, the initial shift in relative prices – however painful to those caught unawares by it and however threatening to those improvident enough to be conducting their business without an adequate reserve against this or any similarly unforeseen vicissitude – will incentivise savers to direct funds to those entrepreneurs whose own success will depend upon serving the currently expressed preferences of their customers better than their competitors and who, along the way, will slowly but surely lessen any constraints imposed by the original re-ordering of wants.
It cannot be too strongly emphasised that this would have happened whether or not the central bank had embarked upon its Canute-like programme of futile – or, rather, actively counter-productive – monetary infusions. These will only have multiplied the confusions over both the nature and the degree of the shift which was taking place and so delayed the implementation of the necessary schedule of adaptations, something which could have been most swiftly and least wastefully realised on an entirely unhampered market.
However, given the all-but inevitable fact of the Bank’s visitations, let us pause a moment to reckon the true achievements of our pecuniary Politburo in its vainglorious attempt to frustrate the workings of economic law.
Above all, it has thrown obstacles in the paths of both the consumers and the entrepreneurs who seek to direct the productive methods by which those same consumers’ efforts aim to satisfy their own needs – whether through offering their current labour or the savings which represent the unharvested fruits of their earlier labour.
It has effected an inequitable transfer of real wealth from creditors to debtors as a result of the sharp reduction in the value of the money in which the contracts between the two are written. It has probably done something similar to relations between counterparts at home and abroad through the effect on the currency exchange rate – something in which it will take a truly perverse degree of pride. In each case it will have made people more distrustful of acting according to that very division of labour, both across space and through time, which is what so enriches us all.
It has protracted and exacerbated the first, spontaneous rise in the price of flour with no better aim than to give everyone else the illusion that their stabilized nominal receipts have in some way compensated for their sharply fallen real ones – a cruel enough illusion if it succeeds: a fertile seed of social discontent if it does not.
It is also likely to have involved the heavy-handed intervention of the other organs of state power. These will probably stir up animosity towards the flour producers (especially if they live abroad) even to the point of penalising them retrospectively (an affront to natural justice) and so stripping them of both the motivation and the means to increase supply.
In their inept, après moi le déluge populism, they may well stoop to subsidising the consumption of that very flour which the public interest insists should be the subject of a much closer economy of use. They will probably invoke an aggressive policy of autarky, banning exports and paying tax- or inflation-dollars to homegrown Ersatz boondogglers while spreading the discord across the nations’ borders to the detriment of all concerned.
Never wasting a ‘good crisis’, all this will inevitably enhance the office-holders’ power of patronage and increase the rents paid to their cronies at the expense of the well-being of all other members of the commonwealth at large.
Finally, the central bank will have helped fuel an increasingly feverish round of financial market speculation – not just in flour but, as the all-too fungible money pours into the system and the itch to play with it becomes undeniable, in all manner of other things as well. ‘Speculators’ – the most active of them ironically housed within or financed by the central authority’s very own, cherished recipients of corporatist largesse and protection – will then provide a convenient scapegoat upon whom to deflect all criticism about the economic pain being suffered as the result of its own criminally misguided actions.
I hardly need to say that to substitute ‘oil’ for ‘flour’ or to specify one central bank in particular is to turn our little Gedanken economy into a passably close representative of the situation in which we all find ourselves today, one from which there seem to be all too few pathways not strewn with thorns, their paving of good intentions long-since broken up into a wearisome thoroughfare of jagged rocks and ankle-twisting potholes.
In fact, in command of the Federal Reserve is a coterie which is at once seeking to rationalise away its implication in rising commodity prices—the infamous argument about the cheaper, hedonised iPad2 being enough to mitigate the strain on household budgets imposed by the soaring price of necessities—and simultaneously relying upon a future deceleration in their rise to make subsequent year-on-year changes less contentious, simply by dint of the arithmetical ’basis effect.’
As well as being a decidedly obvious attempt at having things both ways, what we really have here is a hidden policy of rehashed, New Deal, price leveltargeting—i.e., price rises are not only not to be fought, but actively encouraged, so long as these erode both real debt levels and real wages, although it is also to be hoped that they do not increase for too long at the current rapid rate, lest that conditions an economic response which is only likely to see them spiral upward in a disastrously quickening fashion as echoes of Mises’ famous ‘crack-up boom’ begin to be heard.
Against this, the market has become somewhat fixated on what happens at the end of June when the current monetization of the misconduct of a derelict fiscal authority is due to end—an obsession which has some justification given that it has arguably been the single most important factor in a 32-week run which has led to the fastest, like-period gains in commodity prices since the first oil shock and to a rise in the S&P which, before being dampened by events in the Middle East and the Miyagi prefecture, had touched a rapidity only lately exceeded during the initial rebound from the GFC, the Tech Bubble, and the run-up to the Crash of ‘87.
Even if the winds are blowing against any immediate extension of this insanity, there seems little doubt that the Bernanke Fed is concreted into a position of chronic over-laxity and that if both asset prices and the macroeconomic aggregates subsequently start to suffer a bout of cold turkey, it will not be too long before the political calculus once again begins to coincide with the prejudicial leaning of the Chairman and his acolytes on the FOMC and some other, equally ill-advised measures are taken in response.
Two further market reactions may well prove conducive to such an early resumption of the game.
Firstly, much hinges on the fate of Treasury yields which will only have the support from any emergent ‘Risk Off’ move to help them and not the rather more tangible backstop of a near-100% central bank bid for net new debt. By seemingly ‘overtightening’ asset markets—and by dint of its possible repercussions for stock prices — this would see a widespread chorus of complaints—emanating from Wall St. as well as the Beltway—in favour of a prompt resumption of the policy of the printing press.
Secondly, any liquidation-led drop in key commodity prices—most notably oil – will strengthen the Fed’s hand in arguing, however speciously, that it was right all along not to compound the economically disruptive effects of a rapid rise in the stuff with a succession of higher interest rates, as was typically its response in the past.
Beyond the influence exerted by the Fed (and the policy paralysis evident at the BOE), we have seen the ECB make good on its threat to act just a little more responsibly when it raised its rates by 25bps and then backing this up with some reasonably forthright rhetoric which implies that the market is right to fear that there might be more in store where that came from.
In truth, we should not be as harsh about the bankers in Frankfurt as we are about their transatlantic peers, since the ECB has been reasonably successful in ring-fencing its emergency, quasi-fiscal role as financier of bust PIGS from its more typical function of providing liquidity to the system at large. So much so, in fact, that real Eurozone M1 is barely growing at all, having undergone its sharpest deceleration in at least thirty years—a grand aggregate phenomenon which presumably masks sharply divergent behaviour in a Germany where industrial production is rising at a trend 10% a year pace to within a whisker of its pre-Crash highs and the blighted, over-built periphery where the weeds are metaphorically springing up in the half-completed streets.
As for China, despite a swathe of surprisingly forthright local commentary underlining the inflationary horror which was unleashed by last year’s vast stimulus efforts, its central bank’s latest incremental tightening has been greeted with a yawn by a market both increasingly conditioned to such measures and wilfully optimistic that each such move simply hastens the great day when the series will end and we are off to the races again, trading everything frantically up on the wings of a newly invigorated Dragon.
That leaves as perhaps the most salient question to confront us as that relating to the side-effects of the BOJ’s programme of emergency liquidity injections, loan-support programmes, forex intervention, and—potentially—fiscal backstopping for another creakingly over-burdened state.
Already the Bank’s balance sheet has climbed to post-Lehman heights and the count of current account (reserve) balances has soared beyond all previous comparison, breaking the yen out against nearly every currency pairing of significance and taking risk reversals and basis swaps and other such positioning indicators with them.
The burning issue here, then, is this: in its misplaced anxiety to assist its people by showering them with money amid the rubble of their lives and homes, will the BOJ do enough to re-instate the yen as carry currency of choice and so negate any contractionary effects (however ephemeral) of the coming end of QE-II in the US?
Loose US monetary policy has had its echoes all around the world. The US dollar, once thought to be “as good as gold”, has now been shown be nothing of the kind. Gold bugs the world over have been proven right. Countries scattered all over the world have either dollarised, or run very tight pegs. In either case, this has meant largely adopting US monetary policy in countries as far flung as humble Ecuador (dollarised in 2002 following its own runaway inflationary disaster, which resulted in the emigration of 10% of the population) to the collection of Asian nations, China, Hong Kong, Malaysia, Taiwan, Indonesia, all of whom adopt some sort of peg to the US dollar. Without exception, each of these countries has experienced extreme property appreciation these last two years.
The mechanism through which expansionary policies are communicated through China appear to follow the following pattern:
Central government requires GDP growth/employment creation and so instructs the state-owned banks to lend.
State-owned banks lend principally to state-owned companies as these are good credit-risks, backed – as they are – by the state.
State-owned companies buy land from local governments for property development in accordance with a master plan for development of a new business district.
Local governments spend the proceeds on who-knows-what…here the trail goes cold. However, land sales actually account for the vast majority of local governments’ income so one can be sure that they put plenty of pressure back on the central government to keep the cash coming! Once the local government has it, this cash leaks out into the real economy somehow. Some of it presumably gets recycled into new deposits on property.
Individuals buy units using mortgages from private and state-owned banks, often using equity released from the appreciation of property bought in previous transactions. Ultra-low interest rates, fixed by the central bank, help them keep up with their repayments.
In short, this process is little different in essence from the credit-fuel property booms that have occurred the world over and it will have at its heart cronyism, corruption and waste.
The stories of the booms and busts of each country carry a different twist as the setup of institutions in each country is different, with the common flavour being that of credit growth aided by monetary expansion.
To the requisite ingredients of loose money and credit growth, China has added the explosive ingredient of it being a command economy, which has served to amplify the misallocation of capital. The results are spectacular. The most populous nation on earth does most things on an epic scale, and property boom and bust is seemingly no exception. Enjoy.
Even though the Chinese authorities made no bones about the fact that they had conveniently ‘rebased’ their latest CPI numbers in order to mitigate the rather inconvenient influence thereupon of surging food prices, so eager was the market to hew to its chosen course of Onward and Upward, that this naked manipulation was gratefully taken at full face value, all around the speculative globe.
Perhaps more germane to the preservation of the Herd’s blithe psychology, however, was the additional information that Chinese money supply seems to have decelerated alarmingly to reach its slowest real (and nominal) pace since the great, post LEH‐AIG adrenaline shot was injected directly into the heart of the economy in early 2009.
Moreover, there are numerous reports in the press that the successive increases in bank reserve ratio requirements are starting to bite and that pressure is also being felt in maintaining the prudentially‐mandated loan‐deposit ratios in a system where banks are precluded from competing for deposits by adjusting interest rates and where their customers are becoming tired of seeing the real value of their savings continually eroded.
If this is indeed the case—and, as ever with China, it is foolish to be too categorical about what does or does not make it into the English version of its press—this could truly mark the beginning of the end of the reflationary asset cycle we have all been so happily riding, for much of these past two years.
Certainly, China, is not the whole world, but it has unchallengeably become what is perhaps the nexus of current economic evolution, as well as comprising the most important marginal consumer of many key inputs, whether we consider raw materials, capital goods, or components.
Take two‐way trade flows as an instance. From a base of around 15% of those passing across US borders in the 1990s, China’s ports now deal within excess of 70% of the value handled in the world’s biggest economy and the gap is closing so rapidly that—were the present trends to remain in place for just another 3‐4 years— China would take over the undisputed, global number one spot. Just in case one is tempted to dismiss this as more a tale of secular American decline than of Chinese resurgence, note that, in the same period and in regard to this same measure, China has moved from 50% of Japan to more than 200% and from ~30% of Germany to 140%.
Another little factoid which should give one pause is that, over the past six years, China’s cumulative $920 billion trade surplus with the consumer of first resort—the US— matches, almost dollar for dollar, China’s combined trade deficit with Japan, South Korea, and Taiwan combined, a correspondence reinforced by that fact that the relevant totals for each individual year lie in a range of parity +/‐15%.
For another indication of the key role being played by China and those within its economic ambit, take the case of Germany. Between 2000 and 2010, this, the world’s other great export powerhouse, did almost no new business with the US, its growth being predicated upon sales to (and purchases from) the rest of Europe (whether inside or outside the single currency area) with between a fifth (of incremental exports) and a quarter (imports) also being accounted for by Asia.
To show just how crucial this re‐orientation has been for the German rebound of the past two years, look also at the following plot showing the progression of business revenues through Boom and Bust, and take this in cognisance of VDMA comments about its members’ unprecedented present concentration of orders in Asia, in general, and China, in particular.
Thus, if China’s tightening does continue in earnest—and if it has the same effect as those already being felt in, say, India and Brazil ‐ then we can expect some pretty significant ramifications to ensue.
For over a decade we have heard reports of China’s increasing world dominance. Yet while Beijing has amassed a large war chest of savings over the past decade – $2.5 trillion remain under its control – it has been cautious in waiting for a rainy day to put its savings to use.
The times they are a changing. One day prior to his arrival in Madrid for an official visit, Chinese Vice President Li Keqiang announced that China had the utmost confidence that Spain would recover from its economic malaise. And to put China’s money where his mouth is, Li made an open-ended pledge to “help” (read: “bail”) out Spain in the future.
Citing China’s stance as a “responsible investor” with a long-term view of European financial markets, Li assured investors that purchases of Spanish public debt would continue. Moreover, the man who is widely reckoned to become China’s next premier commented on Chinese support for Spain’s austerity measures, and confirmed the conviction that Spain would achieve a swift economic recovery.
While Spain’s austerity measures are admirable, there is still a long way to go. With a deficit of 9.3 percent of GDP for 2010, and 6 percent forecast for this new year, total debt will grow to 62 percent of Spanish GDP by the time this year becomes bygones. That is, it will be 62 percent of GDP as long as GDP does not collapse further than it already has been. While GDP contracted by over 2.5 percent in 2009, and the final tally for 2010 still to come, the future debt load of Spain is more than a little uncertain.
Meanwhile, Spain’s own Socialist Prime Minister Jose Luis Rodriguez Zapatero noted that the Chinese commitment will “play a key role” in financial stabilization. This seems to be a signal that the stabilization that Zapatero is talking about is different than that which China reckons to be “investing” in.
Real stabilization will not come from having a bailout by different words. The Eurozone economy – of which Spain is a not insubstantial part as the fifth largest economy – is in the midst of a deteriorating debt crisis. Continued bailouts are band aid solutions to the wrong problem. When faced with a crisis of insolvency the solution is not continued doses of more debt. What are needed are drastic cuts to expenditures.
Spaniards, or anyone for that matter, should not be fooled into thinking that Beijing’s generosity will solve any problems. If anything a bailout will exacerbate and prolong the pain which has already been assured by the excesses of the past. When you wake up with a hangover, drinking more does little to numb the pain. More alcohol may get rid of the morning shakes, just as this “bailout” may calm market jitters, but at the cost of a more severe eventual withdrawal.
Philipp Bagus, in his new book “The Tragedy of the Euro”, explains lucidly how the European debt crisis emerged. Southern European countries joined a currency union assumed to be unbreakable. Any eventual signs of trouble with any of the weaker countries – the PIIGS of today – would by necessity be attended to by the strong. Incidentally, with reports of Belgium and even France someday requiring external aid, the list of the strong is quickly shrinking. Adding fresh troubled economies to its scope is not helping this situation either. On January 1st Estonia became the 17th country to enter the Eurozone. While Estonia ran a budget deficit of 8 percent of GDP last year it is only a matter of time before the new addition joins the ranks of the needy.
Unfortunately for Spaniards, what commentators are commonly missing (besides the fact that this bailout will breed more painful adjustments down the road) is that the pain of this bailout will fall mainly on Spaniards.
Guaranteeing a bailout will assure the government that they can continue their spending binge for a little while longer. Necessary cutbacks will not be enacted, as they will not be deemed as necessary. While the punch is still flowing, drink up. Without meaningful budget cuts there will be no improvement in an already tenuous fiscal situation. How long can insolvent countries keep getting bailouts to keep them going?
China has deep pockets, enabling it to keep bailing out troubled Europeans for a long run. But we all know what happens in the long run. Surely such a fate for Spain is worse than some short-term pain today.
My mother told me to send thank-you notes promptly. I’ve been remiss, but you know, with my firm’s revenues up 30% and its net income up nearly threefold since the Crisis struck, I thought I’d better be careful in case anyone considered my praise was a little less than disinterested.
Just over two years ago, in September 2008, the country faced an economic meltdown. Fannie Mae and Freddie Mac, the corrupted, corporatist rent-seekers you had long encouraged to disrupt the proper allocation of scarce means in the mortgage system in the lust for venal political advantage, had been forced into ‘conservatorship’ (i.e., they were permanently battened on the teat of the long-suffering tax-payer). Several of the largest commercial banks were teetering as a result of their leaders’ blind pursuit of short-term gain in the regime of extreme moral hazard instituted by you and your central bank. One of Wall Street’s giant investment banks had gone officially bankrupt, and the remaining three were poised to follow (at least until you allowed them to practice the legal fraud of what I then called ‘mark-to-myth’ in assessing their net worth) – but, of course, the full impact of flouting the eternal capitalist imperative of loss-avoidance and profit-seeking could not be allowed to be borne by them, now could it? Fortunately, the fact that AIG, the world’s most notorious mispricer of credit risk, was at death’s door offered you a way to make those same investment banks nearly whole through the back door. I believe the gamblers-in-charge who needed such unheard of levels of assistance are largely still in place and still making out like bandits at the expense of everyone else. Way to go!
Many of our largest industrial companies, foolishly over-reliant on hot-money, short-term financing via a commercial paper market that had disappeared up the tail-pipe of the mythical ‘global saving glut’ were weeks away from exhausting their cash resources. Indeed, all – well, many – oh, alright: some of the most badly run – of corporate America’s dominoes were lined up, ready to topple at lightning speed. My own company might have been the last to fall – since I am not only a recognised investment genius, but very thick with a number of your more influential servants – but that hypothetical distinction provided little solace with even my stock price back at 1998 levels, before reckoning for inflation or the weaker dollar.
Nor was it just business that was in peril: 300 million Americans were in the domino line as well and it is, of course, not just a constitutional right, but a precept of natural law, that you must act as that vast, tutelary deity of whom de Tocqueville spoke when you were still little more than a lad and so spare the improvident, the indolent, and the plain unfortunate the consequences of their actions, even if it costs the thrifty, the industrious, and the innocent very dear in the process. Just days before, the jobs, income, 401(k)’s and money-market funds of these citizens had seemed secure. Then, virtually overnight, everything began to turn into pumpkins and mice – but, then again, if you take my strictures (q.v., below) about ‘bubbles’ into account, maybe they were nothing more than Bibbedy-bobbedy-boo all along (except where they held shares in MY company, of course). There was no hiding place. Thanks to your misplaced efforts in trying to keep a lid on the volcano for at least the previous decade (some would say ever since the early 1930s), instead of allowing it to depressurize in its own good time, a destructive economic force unlike any seen for generations had been unleashed.
Only one counterforce was available, and that was you, Uncle Sam. Yes, you are often clumsy, even inept (allow me a little euphemism here: I’m trying to be nice). But when businesses and people worldwide race to get liquid, you are the only party armed with the printing press and primed with an utter disregard for the long term consequences of using it and so can take the other side of the transaction. And when our citizens are losing trust by the hour in institutions they once revered – institutions which you fostered, pretended to regulate, and from which you continue to take hefty political contributions – only you can prop up a house of cards of your own construction.
When the crisis struck, I knew you would not waste the opportunity to expand the role you could play – Crisis and Leviathan, and all that. But you’ve never been known for speed, and in a meltdown minutes matter. I worried whether the barrage of shattering surprises would disorient you. Absent any guiding principles, drunk on the unbridled power of executive privilege, and utterly contemptuous of due process, you would rush (‘like a fire-engine going the wrong way down a one way street’) to improvise ill-thought out – and often conflicting – solutions on the run, violate legal boundaries and avoid constitutional inconveniences, like Congressional hearings and studies. You would also need to get turf-conscious departments to work together in mounting your counterattack. Ah, well, better luck, next time! The challenge was huge, and many people thought you were not up to it – who says you should always discount the consensus?
Well, Uncle Sam, you delivered. Oh boy did you deliver! People will second-guess your specific decisions; you can always count on that, just as you can count on the resulting uncertainty about exactly what stunt you’re gonna pull next to paralyze entrepreneurial decision-making and so prolong the slump far beyond its natural span. But just as there is a fog of war, there is a fog of panic and under its veil you certainly did a number of things which would not stand up to scrutiny in the unlikely event you ever honoured a FOIA appeal to reveal exactly who did what to (or for) whom and why. Overall, your actions were remarkably effective in taking the failure of a few egregiously over-leveraged, private-sector companies and magnifying it into a global collapse, passing the losses of the billionaire financier class onto the individual saver and the small businessman, wherever they might be found.
I don’t know precisely how you orchestrated these – certainly, the noise that came out was much more Berg than Bach. But I did have a pretty good seat as events unfolded (don’t I always?), and I would like to commend a few of your troops. In the darkest of days, Ben Bernanke, Hank Paulson, Tim Geithner and Sheila Bair finally grasped – after much prior public denial – the gravity of a situation in whose development at least the first three had been actively instrumental. As for dear ol’ Dubya, I give him great credit for leading, even as Congress postured and squabbled, for if there’s one thing that sells tickets in this Theatre of the Absurd, it’s Leadership (capitalized, naturally, just like Führerprinzip), even if too few care to check quite where they are being led until it’s far too late to do anything about it.
You have been criticized, Uncle Sam, for some of the earlier decisions that got us in this mess — most prominently for not battling the rot building up in the housing market (though to limit ourselves to this narrow field is to deny much of the discredit due you). But then, few of your critics saw matters clearly either (even though several of them now tediously hog the headlines by pretending that they did) since, they, too, are all Neo-Keynesian, macroeconomic-aggregate astrologers with no real grasp of economic theory. In truth, almost all of the country became possessed by the idea that home prices could never fall significantly – a mania which never could have taken hold if we had abolished the Fed and put in place an honest monetary system, of course. (Since you ask, my S&P put shorts and my bearish USD position are again doing quite nicely, thanks).
That was a mass delusion, reinforced by rapidly rising prices that discredited the few skeptics who warned of trouble. Delusions, whether about tulips or Internet stocks, produce bubbles. And when bubbles pop, they can generate waves of trouble that hit shores far from their origin. This bubble was a doozy and its pop was felt around the world. Thank the Lord, you’ve been trying might and main ever since to reinflate a new one on the wreckage of the old (see my comments about pumpkins and mice, above).
So, again, Uncle Sam, thanks to you and your aides. Often you are wasteful, and sometimes you are bullying. On occasion, you are downright maddening (this is meiosis, not euphemism, in case you were wondering). But in this extraordinary emergency, you came through — and the world would look far different now if you had not. What a shame we’ll be picking up the multi-trillion tab for that utterly ill-advised intervention for many a long year to come (I use the term ‘we’ loosely, of course, since I’m reaping what I did not sow as per usual).
Your grateful nephew, W
PS: Do I get my nice, shiny new medal now, please?
PPS: Please excuse the shocking punctuation, left largely unamended by the editorial staff at the nation’s premier newspaper.
Whatever encomia are being passed back and fro between the global Platonic elite, matters are a little more messy beyond the fragrant groves of the Academy.
Enough ink has been spent elsewhere on Ireland’s plight for us to avoid comment other than to point this up as a salutary warning of the perils of affording the political class too much freedom of action. In brief, under the previous easy money regime, the banks and their developer cronies were allowed to run riot because the entrained false prosperity bought votes for their buddies in the Dail. The banks were bailed out because that’s what comic-heroic ‘statesmen’ like ‘Flash’ Gordon Brown were doing to save the (Masters of the) Universe and so that’s what every Tammany Hall boss everywhere aspired to do. The banks were next fully adopted into the state to avoid losses spreading to their unthinking lenders among the Continental banks and insurers and now the problem threatens not just the livelihood of the culprits, but that of their neighbours, too, while the belated focus on hard arithmetic, rather than heady wishfulness, has threatened to unpick the shoddy fabric cloaking the naked emperors all across the European Community.
Meanwhile, China, that most-capitalist of nations, that paladin of effective government, that lodestar of future development, that world-leader-in-waiting (in the opinion of one or two prominent commentators, at least) has just fallen back on the most cack-handed, unjust, illiberal, counter-productive means of addressing its raging domestic price problem imaginable – an assault on ‘speculators’ and ‘hoarders’, coupled with the imposition of price controls and the provision of subsidies to the ‘less well-off’. The heirs of Chiang-Kai-shek might demur, since their forebears’ own, brutal attempt to suppress a paper money inflation in the 1940s was a material factor in the Generalissimo’s loss of popular support and, hence, his eventual defeat by forces loyal to Mao.
So, strangely enough, the vast monetary expansion (60% since the LEH-AIG debacle) has not only further distorted the capital structure of the country (not least – but also not only, we suspect – in real estate), but has led to a rapid escalation in the price of all manner of basic foodstuffs such as garlic and ginger (which have well nigh doubled in price) as leaders in a group of 18 such staples – including cabbage, potatoes, and cucumber – which have risen 62% in a year.
Of such matters are revolutions made, hence, Beijing’s panicky response.
What this distinctly second-best solution also shows is just how far into the quicksand the Central Planners fear their anti-bust policies have led them when they still eschew any significant use of the interest rate weapon. Trapped between the Scylla of having far too much domestic credit (and hence banking capital) at risk in the property bubble and the Charybdis of an over-developed, low-ROC horde of price-takers in the export sector at the mercy of any upward lurch in the exchange rate, our Oriental Argonauts seem to have decided to scuttle the ship midway between the two.
This time last year, we mused that the biggest single risk to the recovery and hence to commodity prices would be the roaring dragon of Chinese inflation. With its long-time diversion into the price of bricks and mortar (the one tangible form of the disease invariably viewed as a boon by most of those subject to its progression), that warning has seemed, at times, a touch premature, but the much pricier chickens may at last be coming home to roost.
Amid all the polemic it has inspired, perhaps the best summing up of current US policy was the verdict delivered by Germany’s famously irascible finance minister, Wolfgang Schaeuble, when he rather undiplomatically snorted that: ‘Bei allem Respekt, mein Endruck ist die Verienigten Staaten sind ratlos” – ‘However you look at it, my impression is that the US is in a state of desperation.’
In the heated to and fro which has ensued we have been treated to the rather singular spectacle of a lifelong, bureaucratic statist like ‘Fuzzy’ Zoeller half-admitting that even some form of suitable bastardized (i.e., neutered) gold standard would be better than the chaos which prevails today and, conversely, we have wearily had to endure the inevitable, disparaging, inflationist response from that insufferable bien pensant, the FT’s Martin Wolf.
But the polarisation of views hardly ends there, for it rages deep within the sancta of the Underconsumptionist Temple of the Marriner Eccles building itself. Blackhawk Ben himself has, of course, been defiantly unapologetic about his actions, even to the extent of telling a college audience that soaring commodity prices were not an issue since ‘final demand’ was too weak for firms to ‘pass these costs on’ – a shrug of the shoulders hardly likely to be shared by those struggling businessmen whose margins would thereby be squeezed (and whose payrolls potentially further reduced) if the Chairman’s prognosis were to break all precedent and actually come to pass.
It was also the height of either incomprehension or disingenuousness when he claimed that he had not indulged in ‘printing money’, but had simply undertaken an ‘asset swap’ of securities for deposits. Well, yes, but what else do we class as money if not bank demand liabilities and currency, these usually propped up on the basis of the claims those same banks hold against the Fed?
The fact that these reserves have not been pyramided up, post-Crisis, with the usual gay abandon is not entirely to the point for it should not go unremarked that – ‘broken multipliers’ notwithstanding – money supply proper has risen 20% in the two years since LEH went under – a percentage increase it took the previous five years to accomplish, at a compound annual growth rate all of 2 ½ times slower.
Also defending his particular brand of mindless mechanicalism, St. Louis Fed president Bullard was out touting his spurious, Fisher relation-Taylor Rule, intersecting-lines approach to why he thinks the last vestiges of common sense should be abandoned in the name of not allowing the US to turn into Japan – something which, in complete opposition to the tenor of the argument he is advancing, is only likely to happen if Bullard and his ilk maintain their insistence on treating symptoms, via a zombie-nursing ZIRP, rather than addressing causes, by liquidating the debilitating overhang of old mistakes with the aid of a sensible, freely-determined cost of financial capital .
To gauge the unworldly nature of his model-supersedes-reality thinking, consider that he exulted in the fact that TIPs yields went down after the infamous Bernanke speech, while the inflation rates implied in the gaps between these and straight bonds went up. Since, in theory, this not only reduced ‘real’ rates, but demonstrated heightened inflation expectations had arisen, to our man this was a triumph of reverse-engineering a recovery.
Unnoticed was the drawback that these two factors rather tend to cancel out when it comes to the dirty business of actually paying the interest due on a loan! We almost hesitate to bring Mr. Bullard’s attention to it, but, in fact, 10-year Treasury yields are once more above the level at which they sat when this boss cleared his throat to announce that the helicopters were being fired up, back on August 27th.
In contrast to such a Half a League Onward mentality, Governor Warsh – up to now a consistent QuantEaser – did offer some verbal sops to responsible policy in trying to suggest that the ‘adjustability’ feature of the package which so enthused markets after the FOMC might not be a one-way ticket to ever more monetization.
But it was left to Dallas president Fisher to nail his 95 theses to the church door in a speech which largely echoed the observations we made in our Oct 22nd edition – ‘Of Superdollars, Spin & Summits’ – in pointing out how utterly inappropriate it was to engage in yet more massive intervention when asset and commodity markets were already on fire and in stating the truth that the real economy was languishing under burdens which were largely unrelated to the question of how low interest rates currently were ( though, of course, not unrelated to the artificially low level at which they were being held well into the previous Boom).
But if confusion reins within the Fed, just look at the parlous state of the Bank of England’s analysis, as evidenced in its latest Inflation Report. In essence, this argued that inflation will go up, then down – or down, then up – or a long way up/down or down/up, yet carries a 50:50 chance of being unchanged!!! Well, that certainly clarifies the grounds on which King & Co. twiddle the levers and knobs to jockey the nation’s economy about.
While assuring his listeners that he would not hesitate to ‘take action if necessary’ if there was appreciably more ‘up’ than ‘down’, the Governor rather spoiled the admonitory effect by then saying that rising prices were the result of a ‘sequence of shocks’ (economist speak for ‘the bad fairy did it’, or ‘the dog ate my homework’) to which it was ‘not sensible’ to respond.
Is it so hard for our Overlords to realise that it no longer serves to pass such half truths off as reasoning? That we might just work out that, agreed, the supply of money has no role to play if, say, bread prices jump as long as other prices fall to reflect the change in relative demand, but that if other things rise alongside it, it can only be because too much moolah has been stuffed in our trousers, fostering the dangerous illusion that we can have our cake and eat it, too?
In all this, the Bank is relying on that other false comfort of ‘spare capacity’ to limit the scale of future CPI increases. But this can only help if that capacity is being withheld at existing prices and can be restored to active use as they rise. If, instead, it is – or has become – largely valueless – obsolete or superabundant plant, non-versatile equipment, overbuilt, badly-located shopping centres, churlish and ill-educated welfare drones – any excess of money injected into the system will rapidly find itself enhancing the demand for the things which are still wanted and for whose production all too few of that ‘reserve army’ of un- or under-employed factors may be easily redirected.
This, in fact, may be why the UK trade gap is running at levels which exceed the Boom’s peak deficit and this despite a trade-weighted index for sterling which has declined more than a fifth to plumb its lowest levels ever. And wherein lies the source of this excess domestic appetite for goods and services? Why, that same government whose prodigality was so facilitated by the BoE’s bond-buying, of course!
It is instructive to note that in the 18 months from the great collapse of 2008, UK householders have been net lenders (or net debt repayers) of £28 bln (though they had already slipped back into their old, profligate ways in the June quarter); Private non-financial corporations squirreled away £97 bln and financial companies chipped in with £71 bln for a £196 bln, 9.3% of GDP, private ‘deleveraging’.
Alas and alack, the government managed to squander all this and more by incurring £224 bln, 10.6% of GDP, in extra net liabilities, the £28 bln difference between the two being made up by the country’s foreign suppliers, hence contributing mightily to that widening trade gap. It appears that much of Britain’s putative ‘spare capacity’ in fact lies well offshore its sceptr’d isle, beyond the BoE’s fief.
All of this may be somewhat academic if the week’s numbers trigger an intensification of the pace of China’s retreat from ‘moderately easy’ (i.e. perilously loose) money to ‘normal and prudent’ (just easy enough). Certainly there were a few straws in the wind in a trade release which attracted attention for its wider surplus, but which contained the perhaps more salient feature of a sharpish drop in imports.
Since the world’s biggest buyer of so many industrial inputs acquires them only to process and re-export later, this would be an ominous sign for global activity, were this datum not just to be an outlier.
That might just be the case if we are to take at face value the gloss being put – with unusual candour – on the Central Committee’s latest Five-Year Plan, due for implementation in 2011. According to an in-depth briefing given to Caixin magazine by Vice Minister Liu He, who was instrumental in drafting it, much emphasis was placed on the fact that the ‘external environment has changed’ in the wake of the economic crisis. In response, the avowed intent is to bring about three shifts in emphasis:-
…the transformation of the aggregate demand structure, which means shifting from economic growth that relies on exports and investment to a model of balanced consumption, exports and investment… transforming the supply structure from a model of growth driven by secondary industry to a model of balanced growth driven by primary, secondary and tertiary industries, with the service industry in particular playing a larger role… the transformation of factor inputs, from quantitative expansion to comprehensive growth relying on knowledge, technology, management, etc..
In theory, this policy will focus on better integrating the rural hinterland into the new urban centres; on encouraging SME formation; on fostering a growing, middle-income consumer class; and on downplaying the growth-at-all-costs thrust of much current policy. As Liu himself summed up:-
This proposal includes one very important sentence: Develop imports to achieve economic balance and structural adjustment, and promote fundamental balance in trade accounts. That’s a big change from the old pursuit of trade surplus and export as a means to accumulate foreign currency
But fine words butter no parsnips, so two major caveats must apply to these revelations.
Firstly, we must resist the Western impulse to deify the sage Confucian planners of China and to over-estimate their ability to effect such changes in a top-down manner, rather than providing market mechanisms and a sound legal and institutional framework within which this can flourish as entrepreneurs build wealth from the bottom up. Even absent the disadvantages of our alternating, populist vote-grubbers in the manner of planning for anything other than the incumbents’ re-election, change by diktat, if too closely specified at the centre, is hardly likely to succeed in its aims.
Secondly, we have to worry about whether the centre has either the resolve or the means to push through meaningful reform in the face of the entrenched local power structures and the SOE oligopolies with whom they often collude in order to feather their own in nests in frustration of Beijing’s will. After all, it has taken the best part of a year to stop these two from end-running measures aimed at cooling the property bubble, with questionable success thus far.
If – and the conditional is a large one –there really is a palpable change of focus in this manner, the ramifications could be significant. At the very least it suggests there will be no more use of cheap money and underpriced resources to re-export pre-imported goods with scant value added to them (indeed, with value subtracted from them were the accounts rendered fully and accurately).
It also suggests less blind duplication of investment and construction projects domestically in the name of Output for Output’s sake and hence with the principal aim of securing a gold star in the career record of the officiating apparatchik.
If this meant that China was to become a lesser sink of expensive commodities and a concomitantly lesser source of cheap manufactured goods; less, too, an accumulator of – and an embarrassed disposer of – others’ depreciating paper promises to pay, the world could be a very different place in the next five years from the one built into the monetary hallucinations of Occidental policy makers and global financial market speculators, both.
The Chinese will have to “come back to the party again pretty soon” and raise interest rates in the face of rising prices, Sean Corrigan, chief investment strategist at Diapason Commodities Management told CNBC Monday. He said Chinese money supply has been decelerating, but not as rapidly as authorities may have anticipated.
Ben Davies, of Hinde Capital, has written an excellent article about all of the fiat currency devaluations that have been going on recently around the globe. He spoke about this piece with Eric King, in the 10-minute interview below:
The thrust of the argument is that a ‘Bretton Woods II’ arrangement has arisen in the last few decades based upon the Renminbi-Dollar peg and the three-legged tripod of the Chinese and the Americans, with the Japanese trapped between them. This crystalline financial peg, held in place by the tripod, has supported the creation of a hugely imbalanced global financial structure rising above it into the clouds.
The subsequent and necessary unwinding of this peg in the last few years — as spoken about at length by men like Jim Rogers — has then become the internal engine of the world’s external financial problems, as this complex structure of pegged falsity twists painfully into a simpler more truthful shape.
The theory of money is like a Japanese garden: simple on the surface, but filled with subtleties that emerge after prolonged contemplation.
Davies argues that we may reach the point soon where this Hector-like crystalline fiat currency system will fracture and shatter completely, under the unrelenting stress of the Achilles-like unwinding peg, to be replaced by an honest metals-backed monetary system.
Until that shatter-point is reached, the current wave of currency devaluations will continue as the torque force of $3 trillion dollars of US assets in China and the $1 trillion dollars of US assets in Japan spins outwards, while the world’s governments constantly try to evade and escape this splattering deluge by devaluing their currencies. (These devaluers include the Swiss National Bank, the one former reliable home of ‘solid’ fiat currency, hence the rush to gold rather than to the Swiss Franc).
Paper money systems have always wound up with collapse and economic chaos.
Howard Buffett, former four-term US Congressman from Nebraska and father of Warren Buffett
Calling into question the entire Fractional Reserve Banking system, Davies declares that “the world is one big version of Zimbabwe”, and that “the pied-piper is a’calling”, because the whole world cannot export at the same time, which is the usual aim of one country engaging in a currency devaluation.
In a race to the bottom, all of the fiat currencies will eventually have nowhere to go but into the incinerator, along with all other historical fiat currencies.
The universe of fiat currency that we currently live in really will have become a burnt-out cinder.
I warn you that politicians of both parties [the Republicans and the Democrats] will oppose the restoration of gold, although they may outwardly seemingly favour it. Also, those elements here and abroad who are getting rich from the continued American inflation will oppose a return to sound money. You must be prepared to meet their opposition intelligently and vigourously. They have had 15 years of unbroken victory.
But, unless you are willing to surrender your children and your country to galloping inflation, war and slavery, then this cause demands your support. For if human liberty is to survive in America, we must win the battle to restore honest money.
[The Scribd document below contains the original 1948 article written by Howard Buffett, which is referred to several times in the recorded interview above.]
In the latest Peter Schiff videoblog (July 12th), Mr Schiff thinks we are entering the economic lull before the storm and that the Dollar has finished its recent bear market rally, with the world now re-focusing its attention on the US economy and its failed stimulus, after the travails in Europe.
With stimulated US car and home sales both now slumping, following this failed stimulus, the US people may now be finally losing their faith in Keynesian stimulus policies.
Schiff then moves on to discuss a Chinese bond rating agency which has recently put the US government’s debt at number 13 in the world (unlucky for some). Of course, US ratings agencies usually place the US government at the top of the tree with a triple-AAA rating, though all of the licensed US ratings agencies have a government-tranted monopoly privilege, so Schiff thinks they may be under some pressure to keep US government high in their bond rating charts.
As the same ratings agencies which triple-AAA rated most of the world’s collateralised debt obligations (CDOs), Schiff wonders how can they rate China four notches below the US when the US is the world’s biggest debtor and China is a global net creditor with $2.5 trillion Dollars in reserves?
After pondering this intriguing question, Schiff notes that the Bank of International Settlements (BIS, the central bankers’ bank) have noted that global maturity of debt is the shortest it has been for many years, because lenders do not want long-term interest rate risk and want borrowers to hold this risk. When all these borrowing governments and banks want to roll over this debt in a couple of years, then there will be an almighty competition for funds (i.e. interest rates must go up or the printing presses must roll into overdrive, to produce the required funds).
Schiff leaves us with the thought that the economy will either grow, according to the Krugman stimulus model, so interest rates must go up to keep pace with this growth, or economies will collapse, thus causing governments to try to borrow more money to fund more stimulus packages.
