January 23, 2009

A Pound of Manufacturing Base, Please

Dean Baker writes about the strength of the pound as the cause of a weak manufacturing base in Britain:
The British Pound, like the U.S. dollar, had been seriously over-valued in recent years. That is why it had been running a large trade deficit.


In most contexts reporters are able to understand the relationship between higher prices and demand, but for some reason in the context of trade, they discuss the topic as though there is no relationship. Hence in an article on the falling British pound, the NYT tells readers that Britain's prosperity over the last decade "camouflaged a steadily weakening manufacturing base."

Of course, the prosperity did not just "camouflage" a weakening manufacturing base, to a large extent, the prosperity was directly related to the weakening manufacturing base (except for the laid-off manufacturing workers).

The over-valued pound allowed the British to buy imported goods at lower prices than their own industry could produce them. However, this led to a large current account deficit which could not be sustained indefinitely.
I both agree and disagree with this view. It is stupid of NYT to speak of Britain's “prosperity”.

In the case of “prosperity” (= access to liquidity) being directly related to a weakening manufacturing base, I would go even further. In a limited sense, the temporary “prosperity” is both directly and indirectly caused by diminishing assets, including the manufacturing base.

Liquidation of capital, like industrial machinery, is an easy and short-sighted way of getting hold of currency to spend on imported consumer goods. It's a simple case of eating your seed crop. You can get fat for a short while on such consumption. Until you run out.

This temporary “prosperity” is just a loan from the future. Most of these inter-temporal fund transfers are actual loans, but a liquidation of productive capital for the purposes of consumption is a loan from the future in an equally real sense. One might also ultimately need to liquidate assets to pay off a loan in the end, with identical results.

That's the way trade deficits go and ever will. You get more than you give at one time. Later you have to reciprocate. And you just might have some regrets when the time comes. (Just ask Icelanders.)

No current account deficit can ever be sustainable (in the sense of having less than infinite zero crossings in infinite time). Unfortunately there is no upper bound on the time span and the magnitude of a single era of imbalance. For the purposes of fairness, we should strive to keep them at less than a generation. (OK, I'm guessing. I don't have the mathematical proof for these claims.)

In what comes to the expensive pound as a cause for manufacturing weakness, I seriously object. I do agree that the pound has been too expensive, and that it does encourage eating into capital.

But how could the value of the pound be the ultimate cause of anything? Prices are like weightless particles, always at the mercy of external pressures. One has to search for the real cause from the factors that affect supply and demand, of which the price is merely a shadow.

When a price is “wrong” it is most certainly caused by a lack of information.

Overly high flexibility of credit is the key here. Loss of income and wealth due to eating into assets is too easily “camouflaged” by excess credit. Inefficiencies in the foreign exchange, like the pound being too expensive, are merely a symptom of such blindness.

Without credit, all overconsumption would be immediately reflected as a loss of assets. Credit has a way of complicating the process, but the fundamental effect is still there. More consumptions results in less assets later on. This can not be escaped.

These price distortions, which do exist, have an unfortunate reinforcing effect on the original cause by further encouraging people to eat into their assets. A high price encourages activity that decreases the underlying value, like over-construction. With credit as a disguise, this decrease in real value is not necessarily recognized by the market participants. The relative price is thus further increased. This is especially true in a mental environment where the “market is always right,” which encourages price-inelasticity.

In a sense it is even rational, to a degree, to eat into assets when the price is good. But the human mind is too biased for the near term and against the long term to ever make these kinds of trade-offs rationally. People do get greedy and they definitely do get regrets. (I know from personal experience.) Humans are not adapted to easy credit. It's an unnatural state of affairs.

“The over-valued pound allowed...” sounds quite too much like the pound has a will of its own. It is much more honest to just say that somebody overpaid. The British sold (or pledged) too much of what they had (or will earn) and used the proceeds for consumption. Now they have little left. The buyers (of the pound and ultimately British assets) probably overpaid because of a false sense of value generated by a seemingly insatiable demand from the very same Brits who are now impoverished.

Now everybody has regrets: The British, for having to pay for their past consumption from diminished income, and their trading partners, for receiving less from the British than they expected in return for the consumer goods provided earlier.

I think I have written this before but its worth repeating: Oversized credit facilities are to the economy like pulling a heavy trailer with a bungee cord.

In what comes to a reform of the existing credit system, a downturn is not the time to start making radical restrictions. These things have to be taken carefully, in a regulatory, a monetary and a fiscal sense. It's like fishing. Give it some slack when it's kicking, reel it in when the coming is good.

Unfortunately, in the US, the EMU, the UK and Japan, all three means, the monetary, the regulatory and the fiscal, are pretty much exhausted, due to giving up too much line in easy times. Deregulation has been taken to the limit, monetary policy is at the zero bound, and government deficits are already huge. The spool is approaching empty, and the line is in danger of snapping.

Whatever slack is given now, the most important thing is to start reeling in as soon as the situation improves. People really have to be dragged into austerity kicking and screaming. Otherwise the spool will get empty and the line will snap. (OK, enough bad fishing analogies. Anybody know if Keynes was a sports-fisher?)

January 21, 2009

A Crude Contango. What? Why?

Crude oil prices in the futures markets are currently so much higher than spot prices that big investment houses are hiring oil tankers just to keep crude oil in storage for a few months and cashing in the price difference.

Bloomberg reports of Morgan Stanley, among others, hiring more vessels.

Morgan Stanley hired a supertanker to store crude oil in the Gulf of Mexico, joining Citigroup Inc. and Royal Dutch Shell Plc in trying to profit from higher prices later in the year, two shipbrokers said.


Frontline Ltd., the world’s biggest owner of supertankers, said Jan. 14 about 80 million barrels of crude oil are being stored in tankers, the most in 20 years. A purchaser could buy oil now, keep it for months at sea and fetch better prices by selling futures that are higher than the spot price.


Phibro LLC, Citigroup’s commodities trading unit, has the 1 million-barrel carrier Ice Transporter stationed off north Scotland and also hired the supertanker Ashna to store. Shell, Europe’s largest oil company, booked two supertankers.

“From a tanker owner’s perspective, this is a little gift from heaven,” Finn Engelsen, managing director of Lorentzen & Stemoco AS, an Oslo-based shipbroker and consultant, said by phone from Oslo today.

For the shipbrokers and shipping companies this is clearly a perfect deal. But what is the status of the tanker crews? I guess they have it easy being harbour-bound.

But seriously, who on earth are the counterparties that are buying these expensive futures? Can't they see that there is a huge build-up of crude in storarge that is going to push the spot price even lower in the future? Has price discovery completely broken down in such an intensely followed market? How about that. We really do live in interesting times.

US Official: Suspect in a Guantánamo Trial Case Was Tortured

Finally an outspoken Bush administration official has said it straight. In an interview with Bob Woodward in the Washington Post, Susan J. Crawford, who is in charge of the military commissions for trying terrorism suspects, says that US has tortured a detainee in Guantánamo Bay. (Thanks to Andy Worthington for the link.)
The top Bush administration official in charge of deciding whether to bring Guantanamo Bay detainees to trial has concluded that the U.S. military tortured a Saudi national who allegedly planned to participate in the Sept. 11, 2001, attacks, interrogating him with techniques that included sustained isolation, sleep deprivation, nudity and prolonged exposure to cold, leaving him in a "life-threatening condition."


The interrogation, portions of which have been previously described by other news organizations, including The Washington Post, was so intense that Qahtani had to be hospitalized twice at Guantanamo with bradycardia, a condition in which the heart rate falls below 60 beats a minute and which in extreme cases can lead to heart failure and death. At one point Qahtani's heart rate dropped to 35 beats per minute, the record shows.
Sleep deprivation alone is a very serious method of torture, as any person with experience of severe insomnia knows very well. Sleep deprivation over several days is enough to drive a person insane. Added to other forms of mental and physical hardship it is simply devastating.

God bless you, Ms. Crawford, but why didn't you speak out before the last week of the outgoing administration? You have, after all, been in charge of the military commissions since February 2007. Were there any specific threats made against speaking out?

This is a clear signal for the incoming US authorities to start examining possible war crimes by administration officials during the 7 past years of war against terror.

Unfortunately the interview also contains some serious bullshit.
The Qahtani case underscores the challenges facing the incoming Obama administration as it seeks to close the controversial detention facility at Guantanamo Bay, Cuba, including the dilemmas posed by individuals considered too dangerous to release but whose legal status is uncertain.


"There's no doubt in my mind he would've been on one of those planes had he gained access to the country in August 2001," Crawford said of Qahtani, who remains detained at Guantanamo. "He's a muscle hijacker. . . . He's a very dangerous man. What do you do with him now if you don't charge him and try him? I would be hesitant to say, 'Let him go.' "
If someone's legal status is uncertain, he should be released. Nobody is "too dangerous to release". That is just hyperbole. If there is reasonable suspicion of malicious intent, the person can be subjected to intensified surveillance after release. Other persons with similar intent outside of the radar screens of US intelligence—and they do exist—are much, much more dangerous. Already identified suspects, even if released because of a lack of evidence, are the least of the problems. (I've heard of hijacking planes or cars or other vehicles, but a muscle hijacker? Is that like jumping to somebody's back and saying, "to Havana, pronto!"?)

Anyway, the war on terror(ism)—an inane euphemism though it is—was supposed to be a struggle between ideas. Ms. Crawford and other US authorities are clearly missing the forest for the trees by focusing so heavily on specific individuals. There is a very fitting Finnish proverb ("ei sota yhtä miestä kaipaa"), which roughly means that no single man is needed in a war. (Everybody is needed, but nobody is irreplaceable.)

It is quite simple really. All detainees should be either tried or released. If some doubt remains of the guilt a suspect, one should keep an eye out after release. One might even find his way to some co-conspirators.

January 17, 2009

Nicholas Kristof Is Dreaming of Sweatshops

New York Times columnist Nicholas Kristof has just discovered that a sweatshop employment is not the bottom of the scale of poverty:
Talk to these families in the dump, and a job in a sweatshop is a cherished dream, an escalator out of poverty, the kind of gauzy if probably unrealistic ambition that parents everywhere often have for their children.


I’m glad that many Americans are repulsed by the idea of importing products made by barely paid, barely legal workers in dangerous factories. Yet sweatshops are only a symptom of poverty, not a cause, and banning them closes off one route out of poverty. At a time of tremendous economic distress and protectionist pressures, there’s a special danger that tighter labor standards will be used as an excuse to curb trade.
What Mr. Kristof forgets is that there will always be relative differences in income. If the Cambodian sweatshop workers would get a proper paycheck, they would be able to employ the people now living in garbage dumps at better service sector jobs, like restaurants etc.

There will always be a part of the population that will be left outside of the employment in factories. The level of poverty of the people who live in the margins of society is more a reflection of the level of disposable income of the population in general.

If the people who work in sweatshops were not offered a very small but safe income from abroad, they would most probably engage in riskier, but potentially more rewarding activities, like farming. They would trade with each other, and everybody would have a chance for accumulation of capital. Instead, they merely subsist on food imported from countries with heavy export subsidies, while the rest of the economy gains nothing.

Whole populations of poor people can be kept in sweatshop conditions by paying them just enough to keep them away from the risks associated with independent economic action, but still not quite enough for any meaningful accumulation of capital.

Mr. Kristof is correct in his notion that absolute limits on minimum wages can result in activities moving to relatively more advanced locations. The focus should be on increasing the overall level of pay in underpaid industries, like garments. Thus, any criteria in labour standards should be defined on a relative local basis, to determine a level of pay that provides enough disposable income for the development of the local economy.

Economically marginal people in a sweatshop-based economy live in true squalor, just as Mr. Kristof has noticed. But such poverty is so complete exactly because of the lack of disposable income in the economic mainstream.

January 15, 2009

US Financial Sector Debt = Way Overboard

Financial Times columnist Martin Wolf presented a graph of US private sector debt in his column from last Tuesday:

The growth of financial sector debt is simply amazing, and reflects the absolutely out-sized growth of the financial sector compared to the real value-generating businesses. One has to note that this graph is relative to the size of the GDP and ultimately susceptible for mean-reversion.

As one can see from the figures, business and household debt has been reasonably stable, at least until the end of the techno-bubble around 2000, but the indebtedness of the financial sector has just been growing since at least 1976. It is quite incomprehensible that the financial sector has more debt than all other business sectors combined. It is quite clear that this situation has not been in any way sustainable for at least 10 years.

January 2, 2009

A Supervolcano for 2009?

According to a blog post in 60-Second Science, there has been some ominous rumbling going on in the Yellowstone caldera for the last 6 days.
Any disaster fiend will tell you that Yellowstone National Park is long overdue for a monster eruption that could leave as much as half the U.S. under a blanket of ash. And there are rumblings the big one could be imminent in the wake of a series of 30-plus mini-earthquakes in the park over the past few days—too weak to be felt by humans for the most part but picked up by the seismometers at the University of Utah.

After all, the geologic record shows that the giant caldera we affectionately call Yellowstone has blown every 600,000 years or so over the past 2 million years. The last big eruption? About 640,000 years ago when the park spit out about 240 cubic miles worth of rock, dirt, magma and other stuff.
The post mentions 30-plus earthquakes, but there have actually been almost 300 small quakes (and counting) so far, according to USGS. The tremors have been located very closely together at the northern end of the lake, which has been steadily rising for a couple of years, pushed up by a bulge of pressurized magma below. The tremors are also remarkably shallow, majority occurring 0.0–2.2 km underground.

As if a credit crisis and accelerating climate change wouldn't be enough, we could quite possibly be faced with a supervolcano eruption and a resulting centuries-long nuclear winter. Now where is that fourth rider...? But hey, at least global warming could be forgotten for a while and the seismographic images are pretty.

Yellowstone registers about 1000 quakes in a normal year, so this kind of swarming is only a bit out of the ordinary. Nothing serious is probably going to happen in another few thousand years, but whenever it happens—and it will—there is absolutely nothing we can do about it, so let's just enjoy the show.

When that eruption finally comes, it will be the media event of a few hundred thousand years. Oh, but there was no media to witness the last one, so I guess it'll be the biggest media event ever. That'll be a black swan event with some mighty consequences.

Evidence of Over-Optimization

More evidence of over-optimization—explained here by Nassim Nicholas Taleb and Benoit Mandelbrot—of the world economy: Toyota takes a step back from just-in-time production.
Toyota Motor Corp. and Honda Motor Co., Japan’s two largest carmakers, may modify their so-called “just-in-time” manufacturing system to avoid possible supplier bankruptcies disrupting production.


Plunging demand in the U.S., the world’s biggest auto market, contributed to Toyota on Dec. 22 forecasting its first operating loss since 1938. That was the same year the carmaker fully adopted the “just-in-time” model, according to its Web site. Under the system, companies avoid stocking inventories, preferring to take delivery of components as they are needed, to cut expenses.

Any emergency measure would be costly, analysts say. Increasing stockpiles would mean renting warehouse space to store parts and supplementing components from overseas would increase shipping costs.

“We’re considering many scenarios for possible outcomes” from a U.S. automaker’s collapse, said Yasuko Matsuura, a Tokyo- based spokeswoman at Honda Motor Co., Japan’s second-largest carmaker.

Measures may include increasing inventories and doubling sources to buy parts, Matsuura said. “We also have strength in having global models such as the Accord and Civic, so we can share parts from other regions for those models.”
Mandelbrot and Taleb have a solid theoretical background for speaking about over-optimization. If you have the time, you should check the whole episode of Online NewsHour. Here is a short excerpt:
PAUL SOLMAN: So, getting back to your fundamental work and insight, this is a system that can become turbulent or is inherently turbulent, that doesn't have enough of a buffer, and that's the danger?

BENOIT MANDELBROT: That is not well-understood. In fact, that is misunderstood for which tools have been developed which assume that changes are always very small.

If one of them comes, nothing bad happens. If several of them come together, very bad things have happened. And the theory does not take account of that, and the theory doesn't take account of very large and sudden changes in anything.

The theory thinks that things move slowly, gradually, and can be corrected as they change, whereas, in fact, they may change extremely brutally.

NASSIM NICHOLAS TALEB: Now you understand why I'm worried. I hope I'm wrong. I wake up every morning -- actually, I don't wake up every morning now. I start to wake up at night the last couple of weeks hoping that I'm wrong, begging to be wrong.

I think that we may be experiencing something that is vastly worse than we think it is.

PAUL SOLMAN: And we think it's pretty bad.

NASSIM NICHOLAS TALEB: It's worse. Of all the books you read on globalization, they talk about efficiency, all that stuff. They don't get the point. The network effect of that globalization, OK, means that a shock in the system can have much larger consequences.

January 1, 2009

Do We Really Need More Credit?

Eric Dash and Vikas Bajaj write in the New York Times under a headline: "In 2009, Economy Will Depend on Unlocking Credit."
How long this situation lasts will determine the immediate course of the nation’s economic life. Will the recession, already a year old, drag on through 2009 — or even longer? Will the stock market revive soon or shrivel further? What of the beleaguered housing market?

The answers to those questions will depend on the availability of credit in all its forms — home mortgages, personal and business loans and bonds sold by corporations, states and municipalities. For now, many banks are hoarding money rather than lending it. Their holdings of cash have nearly tripled to just over $1 trillion in the last three months, according to Federal Reserve data.
This is complete rubbish. There is clearly too much debt in existence. The current economic trouble is greatly magnified by the fact that each piece of actual money is lent about ten times in a ridiculous daisy chain of debt. This creates a situation pretty much analogous to a line of cars driving at a high speed on a highway with too little space in-between. Everything seems to run very smoothly until any small obstacle results in a massive pile-up.

What is now needed is some controlled creation of actual money. The problem is that the money that is created by a central bank is traditionally given to banks, which have absolutely no use for it at the moment. This is not a liquidity crisis, like the authors try to claim above. Liquidity is about trust, but insolvency is a fact. It is fully natural for the banks to keep their lending down, because of the shortage of solvent debtors.

Instead of force-feeding cash to banks, we need to have a source of money to the actual (nonfinancial) economy. Because paying back debts with existing deposits is deflationary—the deposits used for debt payment just cease to exist—money from outside the banking system will be needed for reducing the economy-wide debt load.

At the moment, people collectively owe much more money to financial institutions that they have in deposits. This is a debt trap that can not be escaped without an influx of money from outside of the financial system.

There should be a period of government spending with newly created money directly into the economy, accompanied by rising reserve requirements to prevent the banks from multiplying that cash into new debts. We should be aiming at returning reserve requirements to healthy levels around 25–50%, where each piece of actual cash could only be lent out once or twice.

The real (nonfinancial) economy would use the seignority of newly created money to escape from the clutches of the overgrown monster that the banking system has become. Paying existing debts with new money would create permanent deposits, instead of the "temporary" deposits that are borrowed into existence.

The inflationary effects of monetary printing would not necessarily be very high, if the printing is kept below the rate of credit destruction. That would not be a very difficult thing at the moment. Of course, some people that have been accumulating savings in anticipation of deflation would not get those expected gains, but the alternative of complete collapse would be even worse. Besides, those savings—even if they are stuffed into mattresses—are ultimately made of funny money like everything else.

So my point of view in short: In the long run, economy will depend on demolishing debt.