Monday, June 25, 2007

BIS Goes Austrian

Just a link for this one, to a great article at the Wall Street Journal, which I found at this site

Finally!!!!! Austrians may yet get the respect they deserve.

As to what the Fed should do, I have expressed my unsolicited opinion here and my fears here.

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Another Behind-the-Scenes Wall Street Bailout

Most people don't know it, but the financial world almost stopped turning in 1998 when a huge hedge fund called LTCM (Long-Term Capital Management) "lost $4.6 billion in less than four months and became the most prominent example of the risk potential in the hedge fund industry," according to Wikipedia. ($4.6 billion in 1998 is the equivalent of $5.79 billion in today's dollars. Source)

Fearing devastating repercussions at the time, the Central Bank of New York got involved, and a "bail out" arrangement ensued whereby several large financial houses agreed to back the bad loans.

Where have I heard before that history always repeats itself? We now have a similar situation happening today, only the present-day LTCM is Bear Stearns. This time, we're talking about $3.2 billion at risk, guaranteed by Bear Stearns itself. The quasi-authoritarian intermediary this time is Blackstone, whose two principals are a former classmate of Bush at Yale and a former US secretary of commerce, the same Blackstone in which China just invested mucho dollars. (Aside: Has anyone investigated the potential conflict of interest with this kind of mixed-bedfellow deal? But I digress.)

So far, this is well within Bear Stearn's means, so panic hasn't started yet. But the jitters have begun in earnest, as players watch the other hedge funds that have highly leveraged portfolios as well. There may be a steady flow of money coming into the country even as the big players unwind their unbalanced dollar portfolios, but panic is a funny thing: it doesn't always listen to reason and won't always wait for a level-headed solution to an immediate sticky problem.

sticky situation
[Thanks to for the image.]

The problem irking everyone is that the global financial markets now flow so easily from one country to another, and from one sector to another, and the sums are so huge, that any sign of instability could create a panic environment. The US deficit is supported by billions of investment from foreigners, and these investors have already begun to diversify away from the US dollar as it loses value on the international market. (It has gone from $1 = euro 1.20 to $1.00 = euro 0.74 over the last 6.5 years.)

Whether or not this situation is actually going to threaten America's financial stability is not a sure bet. There are those who deny that the LTCM matter was life-threatening, ironically among them the former chief of Bear Stearns himself. But there is a consensus that there exists an unsavory level of leveraged risk-taking at the present time.

I'm all for risk taking, assuming that it will be the risk-takers who pay the piper, and not the rest of us. Unfortunately, as I have explained in previous posts like this one, I believe the central banks are responsible for this situation and that we are all paying for it through diversion of real wealth to such lottery games, due to the uncertainty of the financial times we live in.

For more on these events, read this article at The Economist, this one by Michael Panzner at, and this one by Jody Shenn and Bradley Keoun at Bloomberg.

This is definitely something we all should be following closely.

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Thursday, June 21, 2007

Hedge Fund Woes Finally Hitting the Fan?

Peter Viles, blogger at the LA Times, writes today about the saber rattling going on among a few of the big bullies on Wall Street, most recently Bear Stearns, JP Morgan, Deutsche Bank, and Merrill Lynch. It seems that those risky subprime mortgage financing vehicles that were all the rage until 2006 are coming back to haunt the current owners.

This touches on a domain that central bankers have been jawboning about for months now, the credit derivative and securitization market imbalances that are becoming dangerously out of whack. They know--and Wall Street bankers must know (even if they don't act like it)--that there are factors at work in the global economy that have created huge waves of what the financial world calls "liquidity," or large holdings of spending and investing money, if you will.

You have only to follow the recent buzz around the newer Basel II accord to see that the international banking community is aware of the problem; however, just like hyper-gifted children, they sometimes have a hard time disciplining themselves. This lack of self-discipline is creating much central banker angst, because the central bankers are supposed to be supervising banking activity. If they fail to do so, their respective governments will either have to mop up the mess (i.e. bail somebody out) or take blame for the devastating consequences that are potentially very bad for the dollar (not that anyone seems to care anymore) and horrible for the US economy.

The nature of the factors behind this liquidity has provoked much speculation, but as yet there is no consensus. The US banking-overseer head honcho, Ben Bernanke, blames it on what he has called a "global savings glut" (as though there could exist an excess of savings). Personally, I suspect that the central bankers themselves are at least partially responsible, but I'm not so sure they would agree. (See this previous post in rebuttal to a couple of Fed researchers who tried to pass the buck.)

But whatever the cause, the fact is that trillions of dollars are currently roving the earth looking for a roost, and everywhere they have chosen to alight they have caused bubbles, to wit the 2000 event and more recently the 2002-2006 housing boom. Other more sustained and recent bubbles can be found in the current securitizations and derivatives markets, where high-rollers bet on the odds of certain financial events happening. (See my article at for a discussion of the process.) Until recently, much of this activity centered around the subprime mortgage market, which as we all know is now turning very sour.

bubble gum
[Thanks to for the photo.]

Now, if these particular bubbles burst, they will smack the face of some pretty embarrassed Wall Street fellows who, up until now, have been riding pretty high, making trillions of high-roller subprime risk-taking profits. Who are these gamblers? The same hedge fund managers about whom Peter Viles blogs.

But it goes beyond a mere squabble among bankers. If these bubbles burst, the amount of money involved is so large that the mess could be substantial. This situation must have every central banker on the edge of his seat, wondering whether he will be able to juggle this new event, on top of the rest of the problems of the economy that they are supposed to manage. (See my earlier post for more.)

I wouldn't want to be in their shoes--and I certainly won't be buying hedge fund stock any time soon. (Yes, they're trying to pass the buck, too.)

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Thursday, June 14, 2007

Credit Squeeze on the Horizon, With or Without the Fed

Looks like the infamous "conundrum" (former Federal Reserve chairman Alan Greenspan's way of describing seemingly counter-cyclical low market interest rates that stayed low in spite of the Board's supposed efforts to raise them) are now becoming a "reverse-conundrum." The Fed hasn't moved a muscle yet to raise rates further, but that hasn't prevented the interest rate market from increasing on its own.

Yes, rates are beginning to increase again, as you may know if you have an adjustable mortgage. At the same time, wholesale prices are on the rise, forecasting a lift in consumer prices down the line, which prediction I have confirmed anecdotally. My business friends have described to me in detail the doubling of the rent for commercial space in Los Angeles, the increasing financing costs, and the rising costs of raw materials and labor, all of which put pressure on them to increase their own prices.

On the other hand, they all have also told me that their turnover has dropped some three to five percent. This creates what economists like to call a "squeeze," or pressure from two sides. The squeezed entrepreneur should raise prices three to five percent to cover his increased costs, but he doesn't out of fear of of losing market share. And let me remind you that this squeeze comes right off the top, i.e. out of net profit.

[Thanks to for the photo.]

[NB: About my use of anecdotal information: For all you economic "scientists" out there (and you know who you are), let me remind you that this is my blog, and that therefore I can allow myself to be as informal and personal as I wish. Some blogs (like this one), are written mainly for entertainment; but common sense can still peek through, couched inside a little humor. Although I appreciate the rigors of the scientific method in more formal pieces, I enjoy the license afforded to me by this more flexible and entertaining medium, to get basic points across while having a little fun. Just because the intent is to entertain does not mean that the writer and readers cannot also be sharing something useful.]

Restaurants in Los Angeles are not the only business people feeling the squeeze. Wall Street financiers are, too. In this article by Yalman Onaran at Bloomberg, we read that Bear Stearns's profits are also down. They are suffering from another kind of squeeze, this time from the repressed subprime mortgage market and from rising interest rates. We also read here in an article by Kathleen M. Howley at Bloomberg that the number of late mortgage payments has reached a record high.

There is a third squeeze that will be forthcoming, I predict (unscientifically). The Federal Reserve will find that they are squeezed between two clauses of their own mandate. The first requires them to make every effort to control US inflation. To measure this, they read many statistics including the CPI, the Producer Price Index or PPI, various production figures, inventory figures, and lots of others. These are showing earnest signs of rising.

The second mandate on the other side of the Fed squeeze will be the clause pertaining to GDP and unemployment. The Fed also watches many figures pertaining to these two gauges. What happens if they start to read signs of inflation on one hand, and signs of stagnating GDP, and/or even rising unemployment, on the other? You guessed it: S-Q-U-E-E-Z-E. Or as the Fed would call it, stagflation.

What will they do? This is anyone's guess. I've had fun trying to imagine at this previous post and this one. The truth of the matter is that no matter what they do, there is a good chance it will be counterproductive--as usual--unless they can actually persuade themselves to do nothing. Historically, that would be rare.

Bear Stearns et al., well, they are juggling their portfolios to cover their behinds, and I guess if worse comes to worse, they can always ask their upper management to return all those bonuses to buck up the bottom line. (Good luck.)

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Wednesday, June 13, 2007

Is Tom Potter Nuts?

He is the mayor of Portland, OR., and he has said this:

"I am angered by this morning's arrest by federal officers of approximately 150 Portland residents who were working at a local produce company. I certainly understand why federal officials executed criminal warrants against three individuals who stole and sold Social Security numbers. But to go after local workers who are here to support their families while filling the demands of local businesses for their labor is bad policy." (Source, through Drudge.)

So, if I understand him properly, if a band of robbers attacks a bank and there are three ringleaders who are US citizens while the collaborators are illegals, the police should catch and punish only the top three and let the illegals go.

What is becoming of our politicians' common sense?

illegals signpost
[Thanks to for the photo.]

On a parallel front, I understand the economic argument for the guest worker program, but I am against it in its present form for the following reasons:

1. Granting illegals a path to citizenship, no matter how arduous, is rewarding lawbreakers and affording an economic incentive for others to sneak into the country.

2. Just because legislation establishes a large fine to become legal does not change the fact that the present legislation is a form of amnesty. The word means "a pardon, esp. for political offenses against a government." Even if the pardon has a price tag, it is still a pardon--worse, it becomes a kind of post-delictum (don't bother looking up the word, I invented it) licensing fee that will not discourage future illegals one little bit. They'll just save up for it along with the coyote fee.

3. Foreign cheap labor seems to be an international phenomenon, but that doesn't mean it is healthy. It has its pros and cons. Pro: It lowers the cost of labor and the price of the products that this labor produces (and that we all buy). Con: It puts downward pressure on wages and therefore on the standard of living of the next-higher-up wage earners, and so on at least part way up the ladder. At the very least, if we have a guest worker program, foreign workers should be required to leave the country, period. If they want to immigrate at some point, they should get in line behind other legal immigrants for the path to citizenship. Having said that, I see no reason why legal immigration cannot open its doors to unskilled workers, on one essential condition: that all applicants go through a rigorous testing procedure that will eliminate all those who do not understand and endorse the US Constitution--e.g. those applicants who would repress women, such as, say, hard-line muslims; or who do not believe in the separation of church and state (hmm, orthodox muslims again.) Without such a careful screening process, the US will find itself in the same bind as Great Britain, France and Germany, who must now fight their own constituents in order to preserve their long-standing equivalent of the Bill of Rights. And the danger in a democratic society is that politicians tend by nature to want to please a majority of voters no matter what they believe--or conversely, the only representative who will be elected is one who represents that majority no matter what they believe.

4. Foreigners who come to this country are more valuable in their country of origin as a source of pressure on their own government to reform. The fact that Mexico, for example, can send its young, adventurous, risk-taking, able-bodied workers and their immediate families to the US must take a huge thorn out of the side of all those in government who prefer their little privileged comforts in the corrupt status quo. We would all benefit from these reforms.

So I'm against present immigration legislation as it stands. And if the authorities are feeling the pressure to get on the stick and crack down on illegal hiring, more power to them. In fact, this is the true answer to the problem. It must be done slowly so as not to create a labor vacuum and destroy millions of businesses both large and small; but nevertheless, it should be done. I can guarantee you that as soon as increasing numbers of business owners hear about raids at businesses down the street, illegals will pour out of this country like rats out of an abandoned warehouse as the wrecking ball shows up. Remember, while the complacent-government cat's away, the mice will play.

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Tuesday, June 12, 2007

The Second Wave of Subprime Victims

I've been complaining on behalf of those innocent borrowers, now foreclosed upon, whom the mortgage industry has chewed up and spit out as a result of the recent turmoil in the housing industry. My fury has always been directed at the "buck stops here" top of the line, which is the US Federal Reserve and the other central banks of this world who have been pumping damaging excess liquidity into the system, under the mistaken impression that they are "controlling" prices and employment. (More on that later when I attack Fed Governor Frederic S. Mishkin for some really stupid and conflicting statements.)

Now we have the second wave of victims: Those who bought the securities that funded the housing boom. (For a good explanation of the transactions behind the issuance of these securities, see my Prudent Bear article.)

Some of these buyers of bonds are ordinary Joes and Janes and pension managers who are now looking for a scapegoat. "It's those nasty big banks who put the bond packages together," they are yelling in unison, in the hopes that Congress will "do something about it." Everybody hates the Big Bad Banks. (See this Bloomberg article by Christine Richard.)

This crying-to-papa is a very dangerous trend. This is how Big Government pulls your heart strings and gets you to vote for more regulation of industry, which regulations actually are counterproductive. They eliminate competition by squashing the smaller players in any given industrial field and create monoliths like Bear Stearns, JP Morgan Chase, Credit Suisse and Morgan Stanley.

Jackals & Impala
[Thanks to for the image.]

That said, most of the damage done in the subprime market was done by players who are outside of the Fed's jurisdiction. Please keep in mind that the banks and mortgage companies are just the jackals of this world doing what comes naturally: eating up the weak. The Big Bad Wolf in Sheep's Clothing is the Government itself through its collaborator, the Federal Reserve. It is they who proclaim to the world that they are in control of inflation (Mishkin uses the catchy erudite-economist-sounding phrase "nominal anchor." I'll address this speech soon.) It is they who say that this is not a housing bubble caused by their own loose monetary policy. (See my post back in September of 2006 when their researchers declared just that.) It is they who deny any and all responsibility for the damages now being suffered by the little people. And it is they who stand by and watch the massacre while continuing to deny their hand in it.

A pox on 'em.

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Friday, June 08, 2007

This is One of those Fulcrum Moments for the US Dollar and Hence World Economic Stability

What I mean by this is that the US dollar, and therefore the US economy (and therefore the global economy, and also--while I'm at it--gold and real estate and stock markets all over the world), are all holding their breath to see what happens in the following days and weeks.

Market expectations had been wishful-thinking a monetary loosening over the past year (i.e. a quasi-government-controlled increase in the availability of credit due to their confidence in the Fed's success in controlling inflation). But the Fed has done its best to convince players that there would be no such thing.

Because we all are skeptical of the Fed's word, ever since Forked-Tongue Al (former Fed Chairman Alan Greenspan) taught us that our monetary regulators needed secrecy to function, we still have trouble believing them; but ever since Ben Bernanke got into Al's hot seat, they have shown themselves serious about turning over a new communicative leaf through surprising forthrightness and clarity. They have simplified their sentences and acknowledged their shortcomings--at least many of the board members have, if not all.

The problem they still face, however, is at once simple and monstrous. According to their mandate they must control inflation, and at the same time they must not let the economy tank. This turns out to be very complicated, because they do not in fact possess tools efficient enough to exert good control over the money supply. Rather, they have only a negative, catalyst-like, clumsy, and belatedly-reactive influence on it, that tends to do more harm then good because of its unpredictability. (See my discussion in an article published at

And yet the credulous market players still want to believe in the Federal Reserve god. So here's the deal as I see it:

There are three possible outcomes for our economic equilibrium at the present conjuncture:

1. The Wishful-Thinking Scenario. The dollar rebounds (as it desperately wants to do), because the world has faith in the American "tallest dwarf" monetary management team (whether or not it deserves it). The wiser Fed continues to take a back seat, steering monetary credit on an even, transparent, and conservative course, perhaps even with the intention of phasing back their monetary role. At the same time, they step up aggressive action to defend the consumer against fraud, by curbing financial abuses like those that led to the recent subprime debacle and by pushing through and implementing BIS-originating capital-adequacy legislation. The dollar-instrument-holder stampede for the exit now taking place (mostly by trading partner central banks) proceeds calmly without overly affecting the markets, because the players somehow manage to agree to cooperate in making this a smooth transaction. Although the dollar continues its 2-5% "slow" inflationary descent to near zero, the smarter players have become accustomed to it and include this factor into their expectations. (I guess it's to hell with the little guys who don't know any better.) Gold slowly loses its luster and settles at around $400-$450 for the coming years, assuming there aren't any security scares. Oil drops back down to way below what everyone is expecting. Stagflation fears subside as housing and the rest of the economy pick themselves back up and trudge forward. All's right with the world. Well, who knows. Maybe.

[Thanks to for the image.]

2. The Out-With-A-Bang Scenario. The dollar starts to rebound (see above) as players expect the Fed to manage inflation. The Fed, in reaction to pressure from the rising core CPI stats, increases rates just a bit. This show of firm willpower spooks the over-leveraged financiers. General interest rate increases speed up, putting the more fearless risktakers in jeopardy. US government bonds continue their drop (remember, their price is a function of general interest rates). The housing market recoils; home prices drop; foreclosures multiply. Consumer sentiment drops as their own credit costs rise. They slow spending. We're on a recessionary course. The dollar does a U-turn. Gold returns to being the safest haven and speculation pushes it to well over $1,000. The FDIC will step in to save some of the larger victims of the bloodbath. Who knows what the Fed will do then.

3. The Out-With-A-Whimper Scenario. The dollar's hint at a lift is a dud. The stampede away from the dollar picks up speed. The carry trade unwinds with a snapping sound. The economy continues its descent into stagflation, with the figures telling contradictory tales and the CPI continuing to play footsie with the Fed's "comfort zone." After a year or so, when unemployment starts to set in, the Fed loosens; and the dollar drops to superseding new lows. Over a few months, the US loses its status as the leading economy of the world, and the dollar is finally recognized for what it is: an unfulfilled fiat promise, just like all the others. We lose our monopoly on seignorage. Oh, and inflation starts up in earnest as the Fed scrambles for a solution. Gold rises inexhorably. Hopefully, we take our medicine a-la-1980s and go through another Reagan revolution, this time for good.

Now, if only I knew which one it will be.

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Tuesday, June 05, 2007

Why Isn't the US Economy Vigorous?

The answer to this question is simple: It is that the cleverer entrepreneurs have turned their sights towards speculation.

This is a phenomenon of fiat money times (i.e. times like now, when the currency is not standardized, for instance by some ratio to a weight of gold. For more information on this, read my earliest posts.)

French money 1793
[French paper "livre" from the 1790s. Thanks to for the image.]

After all, how many adventurous whippersnappers can resist the carrot of gambling winnings now offered in hedge funds and take-over companies, over a nose-to-the-grindstone industrial or service sector job right now?

History is full of times like these. One was the 1920s. Another was the 1790s in revolutionary France.

In rereading Andrew Dickson White's classic, Fiat Money Inflation in France, I was struck by the following passage, and by the similarities between conditions today and those of France at the time:

"They knew too well, from that ruinous experience, seventy years before, in John Law's time, the difficulties and dangers of a currency not well based and controlled. They had then learned how easy it is to issue it; how difficult it is to check its overissue; how seductively it leads to the absorption of the means of the workingmen and men of small fortunes; how heavily it falls on all those living on fixed incomes, salaries or wages; how securely it creates on the ruins of the prosperity of all men of meagre means a class of debauched speculators, the most injurious class that a nation can harbor,—more injurious, indeed, than professional criminals whom the law recognizes and can throttle [emphasis added]; how it stimulates overproduction at first and leaves every industry flaccid afterward; how it breaks down thrift and develops political and social immorality. All this France had been thoroughly taught by experience. Many then living had felt the result of such an experiment—the issues of paper money under John Law, a man who to this day is acknowledged one of the most ingenious financiers the world has ever known; and there were then sitting in the National Assembly of France many who owed the poverty of their families to those issues of paper. Hardly a man in the country who had not heard those who issued it cursed as the authors of the most frightful catastrophe France had then experienced.

"It was no mere attempt at theatrical display, but a natural impulse, which led a thoughtful statesman, during the debate, to hold up a piece of that old paper money and to declare that it was stained with the blood and tears of their fathers."

(The whole work can be downloaded from the website.)

Do any of these words touch you? The difficulty of checking the "overissue" of fiat money? The "absorption" of the working man's purchasing power through inflation? The toll it takes on "fixed incomes," people like your grandmother? The trillions of dollars being made today in speculative finance?

The over-stimulation and then "flaccid" letdown in industry? The "breakdown" of savings? The "blood" of the unsuspecting victims of the recent sub-prime mortgage debauchery?

The outcome of the French experiment with fiat money was a catastrophe. There are those who will say that times have changed, that with today's electronic communication systems and current data, such a tragedy is impossible. I say watch out, because history has a nasty habit of repeating itself.

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Monday, June 04, 2007

China: 1.3 Billion, of whom 900 Million are Peasants

China is a huge country, and with its recent incorporation of capitalist market freedom, one would think that the only direction for their economy is up. But the path upward will be a torturous one, because 70% of the population is still living in an agrarian economy.

Just think about this. Nine hundred million peasants. This means that the other 400 million are carrying the weight of the industrial boom all by themselves -- not many more people than in the US. How is the Chinese government dealing with this dichotomy?

I have translated below an interesting review in a French website called of a book that was censured in China but that managed to circulate anyway, clandestinely, at a volume of millions of copies. The book is titled in French: Chinese Peasants Today, and the authors' names are Chen Guidi and Wu Chuntao. (See below for information about the Engliah translation.)

Here is the interesting review [my translation]:

"The Study. Today China has 900 million peasants. For Mao Tse-tung, this peasant class was supposed to be the spearhead of the revolution. It is, instead, the forgotten bystander of economic growth. After three years of research in a rural province west of Shanghai named Anhui, the two authors offer up the true portrait of hard Chinese reality: peasants who are overtaxed, victims of the corruption of local authority figures whose powers succeeded those of the old war lords. 'The sky is high and the emperor is far away,' decry the authors to describe the difficulties the peasants encounter in appealing to Beijing for help.

"Points of interest. Forbidden in China, millions of copies of this work were distributed clandestinely, before being translated into several languages. The authors use a style that is simple, sometimes almost naive, to turn their report into a cry of alarm: one day a peasant revolt could transform itself into a new revolution.

"The quote. 'The first three shovelfuls are for the government, because taxes must be paid in money and in kind; the next three are for the community leaders, the team and the production brigade, because their salaries must be paid; the next three, for the multitude of contributions, because their glasses of alcohol must be bought. And the last tenth is for me,' according to an old saying from the 1970s."

You can buy the American version of this work at Amazon at this page. The title is Will the Boat Sink the Water?: The Life of China's Peasants.

[Thanks to for the image.]

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