Things Related and Not

About My Master's Thesis

2010-04-26T21:40:00.011+03:00

This post might well be the first that has any connection at all to my everyday life.

I haven't written anything here for a very long time. I have been busy enough with other things. On my spare time I have been finishing my long overdue master's thesis at the Helsinki University of Technology, which is nowadays a part of the Aalto University in Helsinki, Finland.

My thesis concerns digital texturing of solid objects, and in it I describe how texture mapping, as it is understood in computer graphics, can be used for designing objects with custom low-level surface details. The work is based on an old project in which we produced highly accurate laser-machined details into the surfaces of plastic injection molds, based on ordinary bump map images and 3D models of the mold cavities. The point of my thesis is that digital texture mapping is a viable tool for the design and manufacturing of (embossed) surface details, as long as the right tools are made available.

As one part of the work I developed a new method for adaptive displacement mapping of triangular meshes that is specifically aimed at well-specified tolerances at an optimal number of output primitives. It can be readily used to produce textured geometries for rapid prototyping or laser machining.

It's applicability is not necessarily limited to manufacturing, but could be used for visualization as well. At least it easily beats the adaptive displacement in 3dsMax.

Here is a flat shaded rendering of a sample model from the algorithm, along with the tileable displacement texture. (It's an old concept design, not any actual phone model.)

If anyone is interested in asking more, please feel free to email me at vtt.fi (firstname.lastname).

Speculation vs. Actual Investments - The Carrot and the Stick

2009-11-29T22:50:00.005+02:00

Paul Krugman takes a stand in support of taxing financial transactions. He mentions activities in the financial sector that Adair Turner referred to as "socially useless", meaning especially speculation. I'm all any means of reducing excessive speculation, if a workable solution can be found.

On the other hand, there could be more talk about encouraging more socially useful activities. Investment must be directed away from speculative secondary markets and into primary markets that create new real assets.

There was a failed attempt at getting tax relief for "angel investors" in Finland. The idea was quite sensibly dropped, because an "angel investor" is not a concept that anybody is able to define in a watertight manner in a legal sense.

So I thought: Why not give a tax relief to all capital gains income from first resales of stock that was bought in an issue. Thus, the original holder of any newly issued equity would have a favorable treatment. This would both create an incentive for participating in stock issues and a disincentive for giving up the original ownership.

This would encourage people to invest in newly started or growing businesses. It would also encourage companies to acquire new capital, thus acting as a disincentive for excessive leverage.

As a bonus, there would be no need to define any ambiguous terms like "angel investor".

John Hussman - Zen and the Art of Market Analysis

2009-10-14T03:42:00.007+03:00

Fund manager John Hussman makes some interesting, if a bit gimmicky, connections between the zen Buddhist teachings of Thich Nhat Hanh and financial decision making in his latest newsletter:

“The best way of preparing for the future is to take good care of the present, because we know that if the present is made up of the past, then the future will be made up of the present. All we need to be responsible for is the present moment. Only the present is within our reach. To care for the present is to care for the future.”

Thich Nhat Hanh

This week's comment is dedicated to my dear friend Thich Nhat Hanh, a Vietnamese Buddhist monk who was born on October 11, 1926, having been born previously in January of that same year, and twice again about 25 years earlier, not to mention countless other times through his ancestors, teachers, and other non-Thich Nhat Hanh elements. Thay (the Vietnamese word for “teacher”) would simplify this by saying that today is his eighty-third “continuation day,” because to say it is his birthday is not very accurate.

[...]

So here's another koan – “If a share of stock is sold in a forest, and nobody is around to buy it, does it still generate a fill?”

The immediate implication of interbeing is that we are forced to think about “general equilibrium” rather than imagining that one side of a trade can exist without the other. This immediately clarifies all sorts of misconceptions that we could fall victim to if we aren't careful.

For example, it immediately tells us that “cash on the sidelines” is not a useful concept, except as a measure of issuance. See, whatever “cash” is there on the sidelines exists because government has created paper money, or the Treasury has issued bills, or because companies have issued commercial paper. Until those securities are actually physically retired, they will and must remain “on the sidelines” because somebody will have to hold them.

If Mickey wants to sell his money market fund to buy stocks, the money market fund has to sell commercial paper to Nicky, whose cash goes to Mickey, who uses it to buy stocks from Ricky. In the end, the commercial paper Mickey used to have is now held by Nicky. The cash that Nicky used to have is now held by Ricky, and the stock that Ricky used to have is now held by Mickey. There is exactly the same amount of “cash on the sidelines” after this transaction as there was before it.

[...]

Here's another koan:

A novice monk approaches his teacher and asks “What is the price movement of one share being bought?”

The teacher holds out a cypress leaf in his palm and asks, “Did I catch the leaf as it fell from the tree, or did I raise it from the ground?”

We are used to thinking that the act of buying necessarily implies rising prices. But think about this for a second. In either case, the teacher gets the cypress leaf. What makes the difference so far as direction is concerned is where the pressure is coming from. If the cypress leaf is being offered down by gravity, it is caught on a decline. If the leaf is being lifted by the teacher, it is caught on an advance. Remember that. It is easy to get trapped in wrong thinking by people who talk about “cash on the sidelines” or talk about “investors” buying or selling in aggregate.

There was no excess of stock that was “sold” in March that has to be “bought” back now. Investors didn't “get out” of the market last year, and we shouldn't think that they have to “come into” the market now. Every share that was sold was bought. That has been true for every minute of every trading day since the beginning of the financial markets.

These insights, though perfectly understandable without esoteric zen Buddhist thinking, are spot on. There is no such thing as "cash on the sidelines".

Instead, one could try to evaluate the amount of potentially untapped credit. Reductions in credit lines all around have been taking this measure down lately. Both businesses and households have been shrinking their debt loads in the US somewhat. Unfortunately unemployment, lack of demand and shrinking collateral are eating the other side of the equation.

Thich Nhat Hanh writes well about zen in terms that are easily understandable by the average layperson. I liked his book "Peace is Every Step". He has lots of interesting advice for practicing zen in everyday situations, like driving a car or washing dishes. Unfortunately I have great problems in adhering to the principle of mindfulness. Absent-mindedness is my second nature. (Or is it the first?)

Financial Analyst Bias and Client Pressure

2009-10-14T00:39:00.006+03:00

Bloomberg has published an interesting article by Edward Robinson about the influence that sales representatives of investment banks have had on the financial analysts working at the companies (hat tip to C K Michaelson of Some Assembly Required):

When Credit Suisse Group analyst Ivy Zelman refused to turn bullish on homebuilding stocks during a rally in the fourth quarter of 2006, the blowback was intense.

She says investors told her that some housing industry executives were ridiculing her analysis as a “jihad,” and several of the bank’s sales representatives pressed her to upgrade “hold” ratings to “buys” on companies to appease bullish institutional-investor clients. One sales manager even sent her an e-mail warning that analysts who stayed bearish too long often lost their jobs.

The article goes on to explain how very biased analysts in general are against handing out "sell" recommendations for stocks.

The pressure that is applied on analysts that make "sell" recommendations has been documented before. Start analyst Meredith Whitney even got death threats for giving out a pessimistic but accurate analysis of Citigroup in late 2007.

The reference to "appeasing insitutional-investor clients" is a dead giveaway of the cause of this pressure. These clients are not after sound advice. They have already made their minds. What they are after is a blanket of security in the form of advice that just happens to agree with their prior decisions.

If things go wrong, these institutional investors (read retirement fund managers) can just explain that they relied on the investment bank analyst's analysis. This partly relieves them from the responsibility for the bad investments.

Maybe it would not be a bad idea to prevent companies that handle client money or have proprietary trading desks from publishing any analysis or advice at all. At least fund managers shouldn't be able to hide behind advice from parties that are completely dependent on them as clients.

Bubbles, Unemployment and Fiscal Stimulus

2009-10-05T22:15:00.004+03:00

Paul Krugman, is trying to fight for the usefulness of fiscal stimulus in mitigating unemployment.

Ryan Avent has some fairly harsh words for Arnold Kling’s recalculation theory of business cycles. Tyler Cowen, predictably, thinks Ryan is too snide.

But what none of the participants in the debate seem to realize is that Arnold is basically reinventing 1934 macroeconomics.

[...]

It’s all there: mass unemployment is necessary, because you have to shift resources away from sectors that got too big, stimulus is a bad thing because it slows the necessary adjustment. And now as then, the whole notion falls apart when you ask why, say, a housing boom — which requires shifting resources into housing — doesn’t produce the same kind of unemployment as a housing bust that shifts resources out of housing.

Both booms and busts involve shifting of resources between sectors. This much is self evident. It would be stupid to try to deny that. This doesn't mean that the unemployment should not be alleviated at all.

Krugman unfortunately makes a complete fool of himself in the last paragraph. Of course booms don't involve unemployment. In a boom, the driving force of inter-sectoral adjustment is a surge in demand. In a bust, the cause is a collapse of demand.

In a boom, the workforce moves behind the pull of opportunity. This was clearly visible in the flow of newly minted real estate brokers who were encouraged to leave their prior jobs in search of bubble-induced income. In a bust, the realignment is caused by a push-type phenomenon. (Or is it a kick?)

This is such an elementary thing that I can only wonder what Mr. Krugman has been smoking while writing that last paragraph.

To clarify, my own view is that increasing unemployment can hardly be completely avoided in a major bust of a bubble, but that government projects can (and should) be brought forward to mitigate it, if only to make use of the suddenly cheap labor and raw materials. Busts clearly have effects on people who were not directly involved in the bubble and an uncontrolled collapse is bad for everybody.

Equally, I believe that fiscal measures might even be appropriate in controlling the growth of a bubble. Additional small taxes on house-flippers (say for houses bought and sold within 12 months) could have helped slow down the development of the housing bubble. Additionally, it could have provided a larger cushion for the inevitable fiscal collapse.

In both ends of the boom-bust cycle, monetary policy should be the primary means ahead of fiscal measures. In this sense, the QE policies should go even further, as there is a lot of credit that is (and should be) paid down.

This collapsing credit can be replaced with base money even if the money multiplier has collapsed to unity. Instead of "mopping up the liquiduidity", central banks should bring back meaningful cash reserve requirements (to all bank-like entities) after the economy has recovered from the excess of credit. This would naturally will be fought against tooth and nail by the financial sector.

Must There Be a Safe Haven for Savings?

2009-09-28T22:59:00.005+03:00

Tyler Durden wrote a post at Zero hedge on Friday that points out the massive move from long term bonds to shorter term bills in foreign purchases of US government securities. The surge in the short-term market, even at the face of extremely low interest rates, is a clear sign of a run to safety.

An overall stampede to safety is somewhat detrimental to overall wellbeing, because of excessive liquidation of productive assets. It should be resisted by governments. Savers should be encouraged to either put their savings into proper investment or cease saving in the first place.

I wonder what would happen, if the US government would simply refuse to sell additional short term securities. As the interest rates for the existing securities have nowhere to fall to, the possible set of outcomes is:

Buyers would move into longer term government securities. This would be good for the government, as it would get a better control of the long term cost of the debt. It would also lower the overall price level of longer term debt.
Buyers would move into the private sector market for short term securities or bank deposits. This would be a positive thing, as there is a real shortage of short term funding for the private sector.
Buyers would stop buying any securities at all. Instead they would make real investments. This would be good for overall employment and economic development.
Buyers would reduce savings and start to consume more. As previous, this would be helpful to employment. It would not be a bad outcome for the Chinese, for example.
Buyers would move their savings into commodities and other speculative plays. This scenario would probably have some adverse effects.
Buyers would keep their money in cash. This would be a bad outcome, but highly improbable, as the savings would be threatened by inflation.

All but the first outcome could result in an overall increase in the interest rates that would be paid by the US Treasury.

The question is, would a denial of such an absolute safe haven for savers be an overall improvement, or would it cause even more disruption? What adverse effects would such a move present?

Pricing and Utilization of Pharmaceuticals - Nonsense from Greg Mankiw

2009-09-25T03:47:00.004+03:00

Greg Mankiw shared his wisdom with us in an editorial in the New York Times last week:

Imagine that someone invented a pill even better than the one I take. Let’s call it the Dorian Gray pill, after the Oscar Wilde character. Every day that you take the Dorian Gray, you will not die, get sick, or even age. Absolutely guaranteed. The catch? A year’s supply costs $150,000.

Anyone who is able to afford this new treatment can live forever. Certainly, Bill Gates can afford it. Most likely, thousands of upper-income Americans would gladly shell out $150,000 a year for immortality.

The true costs of pharmaceuticals are mostly incurred at the development phase. The actual cost of production is insignificant. No medication costs anything like $150,000 per year to produce.

So, if thousands of people are willing to pay $150,000 per year, then quite possibly tens of millions of people are willing to pay $150 per year, which would most probably bring many times the income to the drug company. Modern pharmaceuticals are simply not the hand-crafted luxury items that Mankiw is trying to portray them as. (Some of the more egregious items used in older traditions are a bit different.)

When it comes to the cost of the actual medication, any expansion of health care coverage only needs to increase the aggregate cost of medication by the price of the additional production, which really isn't very much at all. Wider utilization of a drug actually decreases the burden on individual users, as the cost of development is borne by more people.

Rational Expectations in a Recession

2009-09-22T07:05:00.009+03:00

Paul Krugman wrote a (bit self-serving) post about the differences of viewpoints between the "saltwater" and "freshwater" economists in the US.

In this article there is one bit of economic orthodoxy that I don't quite get:

Think about the story of unemployment I’ve just described. It’s a story in which a contraction in the money supply can produce a recession – but only as long as people don’t know that there’s a recession! You see, if people do know that there’s a recession, they know that the low prices they’re being offered reflect low overall demand, not specifically low demand for their products.

I'd say that en expectation of a smooth change in the overall price level in a recession is certainly not what anybody would expect in a recession.

When the general population hears the word "recession" they think of an economic disturbance. This disturbance manifests itself as a shock-wave. In this wave, most of the people quite rationally anticipate a possible loss of income, which can be passed on to expenses only with a considerable delay.

This anticipation causes people to cut down on spending, which just reinforces the initial drop in demand. It's the prisoner's dilemma with millions of participants. Betting against the shock-wave would not be too rational.

This phenomenon is not that different from a "traffic wave" that can bring a whole highway to a complete standstill even if there is no apparent reason whatsoever. However, it is quite rational to expect congestion in dense traffic, because it happens.

These kinds of issues make the economic models that assume perfection for human beings quite dangerous. As can be seen in the video of traffic waves below, even small human errors accumulate to drastic disturbances in a tightly coupled system.

To mitigate these problems, "shock-absorbers" should be built into the economy. These absorbers would eat some of the efficiency of the system. On the other hand, so do shock absorbers in vehicle suspension, if the focus is on the short term. (Shock absorbers actually do increase the initial impact of a pothole.) We really have to reach a better trade-off between efficiency and reliability in the financial system.

These economic shock absorbers could take the form of increased transaction costs, or possibly taxation of capital gains that would discourage short-term gains.

The Estonian Laboratory of "Free" Market Economics

2009-09-22T02:12:00.006+03:00

Ambrose Evans-Pritchard of Telegraph.co.uk writes an opinion piece about the "debt deflation laboratory" of the Baltics. His writing is thoroughly one-sided, as usual, but he has some valid points.

Professor Ülo Ennuste from Tallinn University says the private net wealth of Estonia's people has fallen below zero. I know of no other country in the world where this has occurred, though Latvia may be deeper in hock. Estonia's foreign debt is 116pc of GDP, second highest in Eastern Europe.

It is not a good moment for the poster-child of the flat-tax revolution, but those crowing the end of "Margaret Thatcher's Baltic Model" neglect half the story. Estonia's euro peg is anything but free-market. It makes Tallinn dance, awkwardly, to Frankfurt's distant tune. It stoked the boom by enticing people to borrow cheap at eurozone rates: it is now prolonging the bust.

[...]

The government could spend more. The national debt is just 5pc of GDP. It chooses not to do so. Such ultra-orthodoxy shows admirable discipline. Estonians will be a shining example to us all if they pull it off – and hold their society together.

Prof. Ennuste has some dubious figures. It's hard to believe that Estonian private assets would be worth less than 116% of GDP. There are other inaccuracies in the article as well.

However, the criticism against the Baltic currency peg policies is perfectly reasonable. Deflation (or "internal devaluation", as the euphemism goes) brings undeserved short term gains to those who are in cash assets. It will also encourage liquidation of real capital in a scramble to cash.

Keeping the currency pegged while maintaining completely disparate interest rates made absolutely no sense from the start. It was a source of "free money" to anyone who borrowed in Euros and invested in local currencies. Unfortunately, there's no such thing as a free lunch and never will. This "free money" virtually guaranteed a foreign currency denominated credit bubble.

The Euro is the wrong point of fixation. After all, the Euro has no inherent value of its own at all. The only meaningful measure of the value of a currency is against real goods and assets.

It might be absolutely impossible to avoid a degree of deflation after a humongous credit-fueled asset bubble, but at least one shouldn't be aggravating it, unless the objective is a massive overshoot in the downside.

A commenter "John" strongly disagrees with the opinions of Evans-Pritchard:

Estonia won't benefit from a devaluation, it will merely create instantaneous inflation, because the country is so small and so intertwined with neighboring economies.

Inflationary policy is exactly what Estonia needs right now, as it is headed for a deflationary spiral that will not stop before a serious overshoot. If currency reserves are not exhausted, the deflation will eventually come to a stop when foreign money comes in for hunting bargains. At that point the Estonian people might truly have lost their net wealth. They will be forced to sell their crown jewels just to survive.

"John" continues:

Instead a devaluation would destroy the last beacon of stability, the protection of value that the currency offers.

Currency is of no inherent value whatsoever, only real investments are. In the short term, the currency may look like a means to preserving wealth. However, this doesn't mean that people in aggregate are maintaining their wealth.

Even though the "value" of the currency is steady, or even grows in comparison to real goods, the quantity of currency shrinks through deleveraging. The grand total is actually shrinking. This reflects the real value that is destroyed through liquidation.

To all those who like comparisons to Zimbabwe: The Baltic policy is the mirror image of the Zimbabwean policy. In both cases the central bank and government is aggravating an already adverse trend. Hyper-deflation is not much nicer than hyper-inflation.

The Baltic states truly are a laboratory for the Chicago school of economics, with flat taxes, efficient market theories and all. I feel sorry for the human guinea pigs of the Baltic states.

Financial Engineering, Gambling and Deflation

2009-07-13T17:58:00.007+03:00

TomDispatch.com has a nice summary of the gambling associated with structured finance, written by Barbara Garson. She has been searching for unemployed people that were handling those structured financial products, especially credit default swaps, that seemingly brought the whole world down. She was absolutely unable to find such people, even from Lehman Brothers or AIG. (Note to Garson: These people like to call themselves financial engineers.)

At the last paragraph Ms. Garson reviews the situation from the point of view of the real economy, where productive people are kicked out of jobs, while financial engineers keep on pushing their wares.

In other words, people are speculating on derivatives and derivatives of derivatives because there's no action in the real world. You can't invest in new real businesses or lend money to old real businesses for expansion unless people can afford to buy the products they'll produce. That brings me back to where I started: our real world. You know, the one where just about everyone's unemployed except those swap guys.

In a deflationary environment, real assets, like factories, start to look like huge risks. To keep investors from withdrawing from the real economy, financial assests need to be equally scary to investors. Governmental bailouts of financial assets simply encourage people to withdraw their capital from the real economy to plunk it into government-guaranteed gambling.

Safe financial assets, like cash and government securities, that have no backing in the real world, need to be scary as well. To achieve this, some inflation expectations are required. The Federal Reserve has been quite aggressive on this front, and clearly quite successful. Unfortunately, the European Central Bank does not seem to take this thankless task quite seriously.

Even if holding cash could be turned into a scary proposition, there are ways to store value that, even though physical, are equally as useless to the real economy. With this I naturally mean precious metals. Naturally some of the "real" economic activity has not much value either. Activity with negative value is quite possible. (Let's call it the salad shooter economy, in honor of James Howard Kunstler.)

All this trouble was brought to us by a financial market that grew to be bigger than the real economy. The solution to our problems should not necessarily proceed by making the real economy even smaller. That route will only result in a self-reinforcing deflationary spiral. Instead, the real economy should be functioning, while the financial economy should deleverage and shrink. A complete government bailout of the speculative financial system will achieve the exact opposite.

Let gamblers take their losses. That alone will give a boost to the attractiveness of the real economy. There's a problem with that proposition: all of us with savings at financial institutions are part of the gamblers through our funding of it. But as we have all gambled, we must all bear the losses.

Even though deflation is the immediate issue, as credit is collapsing, ultimately existing savings that are invested in credit will lose some value, because of the eroding base of credit worthy debtors on which its value was based. This loss of value can happen through a process of default, through being diluted by new savings, or through a devastation of the real economy.

The third option initially involves massive deflation, which might make it attractive to those that hold cash assets. However, it will ultimately result in people with cash assets facing empty store-shelves, at which point the deflation will suddenly turn into massive inflation, quite similar to the receding shoreline before a tsunami.

We have to remember that inflation has both a numerator and a denominator. In this situation, increasing the numerator (in the dilution scenario) is much preferable to a collapse of the denominator. Unfortunately, this might already be somewhat too late. If the collapse advances from industrial production to food production, there will be real trouble.

Paradox of Thrift, Savings and Investment

2009-07-08T03:35:00.006+03:00

There was such a great comment by reader "es" on a post about the paradox of thrift at Paul Krugman's blog that I just have to copy it here verbatim.

Krugman:

The story behind the paradox of thrift goes like this. Suppose a large group of people decides to save more. You might think that this would necessarily mean a rise in national savings. But if falling consumption causes the economy to fall into a recession, incomes will fall, and so will savings, other things equal. This induced fall in savings can largely or completely offset the initial rise.
Which way it goes depends on what happens to investment, since savings are always equal to investment. If the central bank can cut interest rates, investment and hence savings may rise. But if the central bank can’t cut rates — say, because they’re already zero — investment is likely to fall, not rise, because of lower capacity utilization. And this means that GDP and hence incomes have to fall so much that when people try to save more, the nation actually ends up saving less.

"es":

Okay, I admit I don’t really understand this. I always seem to get hung up on S = I (Savings equals Investment). What would happen if you worked from the hypothesis that S = I + W, with W standing for Waste? Sure it muddies things, because it’s hard to weight whatever you are measuring as to its true productivity. But this is reality. When the old paradigm doesn’t work, or leads to paradox, you have to question your basic assumptions. Not all savings lead to purposeful investment. Witness the proverbial gold under the mattress. Witness wheat put by for a bad harvest and then mouldering in a badly maintained storage facility. Check out the over-elaborate plastic toys that over-stimulate and maybe poison our already hyper-active children. Especially pertinent, witness a population underfed and under educated and inadequately protected from disease to guard against the future possibility of debt.

Already in your columns I see you speaking of saving and investment as different entities, and then when you get “wonkish” (I guess you mean mathematical) you fall back to S = I.
I recommend that you assign a graduate student to work on the need to incorporate more variables into the S=I axiom. It might get him a Nobel prize, or save the world, or something.

I just love the snark in that last paragraph.

Of course, the identity of savings and investment doesn't make any common sense, but since when such a thing has been expected of economic theory?

I'm not sure either if it makes any sense to think of this identity in terms of any units of currency, but in addition to the waste term on the right, there should at least be a term for credit expansion on the left. I would also amend the equation to

S + C = I + W,

where C is the net amount of credit creation. Of course this equation is not a real equation. There are severe time lags in all the processes that are part of it. It can only be discussed in a statistical sense:

E[S + C] = E[I + W],

where E denotes the expected value. In addition to a temporal sense for this statistical dependence, one must also think about the ensemble statistics to account for people with different concepts for value, etc.

Credit has the ability to create investment without any net savings. Somebody gets into debt, which is equivalent to negative saving. Somebody else gets the loaned sum of money, and decides to save it. The net savings are zero.

However, there would have possibly been an investment that was made with the borrowed money. All is well, as long as the debtor pays the money back. Credit is a form of delayed savings. Investment is made first, then come the savings, little by little.

Problems occur when too much credit is extended. What if there is no income from which to save? People default on their loans. Oops... Now (nominal) investment has been much higher that the "savings" from which it was supposedly made. Savings are actually smaller than investment.

This is where the identity asserts itself with a lag. The value of savings increases while the value of investment decreases. Result: deflation.

More on the TED AR Embarrasment

2009-06-23T23:34:00.003+03:00

Chris Anderson of ted.com in Twitter about the Chris Hughes augmented reality talk scandal:

@UnitZeroOne Chris Hughes agrees we shd take down the current version of his talk. See my comment: http://tr.im/puT5 & thanks.
about 1 hour ago from web in reply to UnitZeroOne

At 1:59, this might be the shortest ever #TED talk. Augmented reality in a browser. It's a wow. http://on.ted.com/1A
about 6 hours ago from web

From "wow" to take-down in 5 hours. Amazing.

Ugly AR Ripoff at TED.com

2009-06-23T22:47:00.006+03:00

I am completely dumbfounded. Hacker Chris Hughes made a very short presentation of Flash-based augmented reality in TED2009 without mentioning the open source projects (FLARToolkit and Papervision3D) that his very basic demo is almost completely based upon. In addition, he made remarks that let the audience understand that he had a major role in the development. Read more of the issue at UNITZEROONE.

Could it really have been true that the moderators of TED were so completely unaware of the state of the art in augmented reality? This presentation was a big failure on the part of the TED2009 organizers.

I don't think Chris's response quite cuts it. He should really apologize instead of making lame excuses about the "fear and frenzy" of speaking at a TED conference. On the other hand, I kind of feel sorry for the guy. Having made his appearance at TED practically an obsession, it surely does not feel good for him to come out of it looking so awfully bad.

Anti-Keynesian Insanity in Latvia

2009-06-19T15:03:00.005+03:00

Has the Latvian government gone mad? Sacrificing the whole economy of the country to maintain a currency peg is insane. It will most probably result in a devaluation later anyway, with much less results than an earlier devaluation.

It is a question of fairness. The only party that gains an advantage from the currency peg are those with Lat-denominated paper assets. It doesn't make much sense either, because the kind of deflation that is required for keeping up the peg will result in the paper assets being defaulted upon anyway, except for the government paper.

Devaluation will not prevent the problems that were created by excess credit, but it is an important tool in preventing a deflationary spiral.

Robert Anderson and Stefan Wagstyl wrote in the Financial Times about Latvia's conundrum:

With the backing of the International Monetary Fund and the European Union, Riga is hoping that if it can impose enough pain on the domestic economy, it will be able to maintain its exchange rate peg to the euro. That would allow it entry into the single currency zone within the next four years.
After months of dithering, the government last week put together a package of measures that will mean Ms Blumberga – who earns just 280 lats ($552, £337, €398) a month – along with hundreds of thousands of other public sector workers will suffer a 20 per cent pay cut. Even pensioners will see reductions of 10 per cent.

This is just insane. A crash in domestic demand is the only thing that is sure to follow from such moves. There is a very high risk of starting a deflationary spiral.

Landmark property developments such as the twin Panorama Plaza towers on the road between Riga and the airport stand all but empty and shopping malls look forlorn. House prices fell by one-third last year, insolvencies are up and banks are repossessing more mortgaged properties and leased cars. “Business is in hibernation,” says Gunnar Ljungdahl, who chairs the Swedish chamber of commerce in Riga.

How exactly is intentional deflation going to help in this situation? When wages are drastically cut, we can safely wait for even more insolvencies and repossessions. Shopping malls are a dead investment when the purchasing power of the population rapidly shrinks.

In these circumstances, many governments devalue to spread some of the costs to foreign creditors and to boost the economy by making exports – which include wood products – more competitive. IMF officials have indicated that the organisation was divided over the wisdom of defending the lat’s peg but was finally persuaded by pressure from Riga’s EU partners as well as the Latvian government’s own refusal to contemplate devaluation.

So it's actually other EU countries that Latvians can thank for this disastrous policy. I thought the EU was supposed to be a project of peace. Killing a member country to "protect" irresponsible creditors at other member countries is a recipe for serious conflict.

Latvia sees the currency peg as the linchpin of its economic policies. It helped drive down inflation and is the route to euro entry. Latvia’s governments have often been weak but have always defended the peg and supported the powerful central bank, where both the prime minister and finance minister used to serve. “For Latvia the peg is the last pillar of trust,” says Henrik Hololei, an Estonian cabinet head at the European Commission.

All hail The Peg!

Also, Latvian officials argue that in a small economy, where 60 per cent of export value is in imported content, devaluation will not do much except encourage inflation. With some 90 per cent of all loans in euros, they add, it could bankrupt tens of thousands of companies and individuals. But the price of avoiding devaluation will be huge economic, social and political strains. Valdis Dombrovskis, prime minister, admits his main challenge now is “to preserve the social peace”.

"Encouraging inflation" (or discouraging deflation) is exactly what is needed at the threat of a deflationary spiral. Instead, Latvian officials are ready to give the economy a good kick to the backside. The foreign loans that turn out to be unaffordable will be defaulted upon one way or the other. If the income of debtors shrinks the effect is exactly the same. And a defaulted loan in euros is no bigger loss to the creditors, whatever the exchange rate.

So, as there is a wave of defaults anyway, why should there be a wave of deflation as an insult added to the injury. Deflation is an unjust reward of those who hold paper assets, and a punishment for those who hold actual assets.

Cantarell Depletion Rate Reaches 35 Percent per Year

2009-06-19T00:56:00.003+03:00

Robert Campbell reports at Reuters about the amazing rate of decline at the giant Cantarell oil field in Mexico.

Cantarell produced more than 2 million barrels per day as recently as 2004, but yield has plunged as the aging field enters its natural decline phase, sending Mexican oil production tumbling to its lowest level since the mid-1990s.

The giant offshore Akal field and several nearby deposits that Pemex groups as Cantarell produced only 713,000 bpd in April, below Pemex's forecast of 756,000 bpd for 2009. Yields from the area have fallen at annualized rates of more than 35 percent in recent months.

Amazing. 35 percent per year. That is some serious cliff diving. If the end of Ghawar will be equally drastic, the world is going to be in a heap of trouble.

Max Boot Shows Sympathy for Fellow Militant Conservatives in Iran

2009-06-15T18:38:00.009+03:00

Andrew Sullivan is attentive to neoconservative attitudes to the Iranian election fraud issue:

Max Boot seems pleased. The neocon hope that Ahmadinejad keeps himself in power - barely disguised any more - seems to me premature. The US would be wise to wait and see how this develops before making any policy decisions. We have learned two things we knew already but now know with fierce urgency - that the Iranian people want more freedom and better relations with the outside world, and that the regime itself has a desperate, dangerous core that cannot be trusted. But how we engage these two facts remains a prudential decision best left until this revolution takes its course. What I find a little gob-smacking is that this outbreak of democracy in Iran seems to have left the neocons saddened. Interesting, no?

Max Boot has now made it official: the radical conservatives in US and Iran have a mutually cherished love/hate relationship. Max Boot on June 14 at Commentary:

On the principle of “the worse the better” for our enemies–and, make no mistake, Iran is our enemy–it is possible to take some small degree of satisfaction from the outcome of Iran’s elections.

If the mullahs were really canny, they would have let Mousavi win. He would have presented a more reasonable face to the world without changing the grim underlying realities of Iran’s regime–the oppression, the support for terrorism, the nuclear weapons and ballistic missile programs. He is the kind of “moderate” with whom the Obama administration could happily engage in endless negotiations which probably would not accomplish anything except to buy time for Iran to weaponize its fissile material.

If would be so sad if more reasonable people would come to power in Iran, wouldn't it? Without the Iranian threat there would be no distraction from the pressure for resolution of other issues in the region. This attitude is completely understandable. Peace is such an awful state of affairs.

Insights in to the Financial Crisis

2009-05-23T20:58:00.005+03:00

There was a good collection of (US-centric) insights to the credit crisis in a symposium arranged by the New York Review of Books and PEN World Voices on April 30. The symposium was attended by a good number of people who gave copious warnings prior to the onset of the actual crisis.

Yet all these insights seem to be somehow a bit disconnected. A bigger picture is clearly being formed as all these great minds get to put their thoughts together. Too bad that it has to be in hindsight.

Paul Krugman makes a pointed statement about social safety nets:

The other thing not to miss is the importance of a strong social safety net. By most accounts, most projections say that the European Union is going to have a somewhat deeper recession this year than the United States. So in terms of macromanagement, they're actually doing a poor job, and there are various reasons for that: the European Central Bank is too conservative, Europeans have been too slow to do fiscal stimulus. But the human suffering is going to be much greater on this side of the Atlantic because Europeans don't lose their health care when they lose their jobs. They don't find themselves with essentially no support once their trivial unemployment check has fallen off. We have nothing underneath. When Americans lose their jobs, they fall into the abyss. That does not happen in other advanced countries, it does not happen, I want to say, in civilized countries.

Niall Ferguson tries to make a case for the incompatibility of monetary and fiscal remedies to economic downturns.

There is a clear contradiction between these two policies, and we're trying to have it both ways. You can't be a monetarist and a Keynesian simultaneously—at least I can't see how you can, because if the aim of the monetarist policy is to keep interest rates down, to keep liquidity high, the effect of the Keynesian policy must be to drive interest rates up.

This view is completely bogus, as explained by the other participants. The point of monetary stimulus is not primarily to drive interest rates down. Its point is to drive up the money supply. When the interest rates are solidly against the zero lower bound, fiscal stimulus is actually helpful in increasing the total amount of credit. Additionally, a downturn is a great time to bring forward public investments that would have to be made later anyway. They can now be financed cheaper that ever.

Ferguson is right in worrying about the solvency of the US government. The other panelists claim to be worried as well, but their overall attitude to the deficits tend to have a somewhat worrying level of cavalier indifference.

There is one quite difficult point in this whole dislocation. Because indebted nations have been living beyond their means, there is no escape from the fact that despite any "solution" to these problems, there will be some attrition in overall standards of living.

These changes will not affect all strata of society equally. It is a very bad thing to bail out the most guilty and undeserving parties at the expense of the whole society. Some losses that, as said, are unavoidable, should be shared equally between all holders of imaginary financial "wealth".

Because huge amounts of eventual losses are unavoidable, the governments of debtor nations should not attempt a return to the "old normal". That would be a self-defeating exercise. The focus should instead be on controlled assignment of losses where they belong. And no, the losses do not all belong to the end-user speculators. Those who lend to speculators are making an equally speculative bet on the creditworthiness of the debtors, as well as any collateral that was willingly accepted.

The issue is completely different in creditor nations with low domestic levels of consumption, like China. These governments should apply fiscal measures with abandon.

Then there is the case of Japan, which has already spent its ammunition in trying in vain to uphold its previous bubble economy. This just goes to show the dangers of trying to sustain the unsustainable. In hindsight, Japan should have let financial assets go down. This would have improved the relative value of real assets and given the government more ammunition against unemployment. Unfortunately it would have hurt pension savings, which are highly dependent on financial assets.

Existing financial assets, level of employment and future debt load form a trifecta, of which any one can be improved only at the expense of the other two.

There is a danger in the US that the financial assets (partially earned through an unsustainable debt-powered boost to GDP) of aging baby-boomers will be overzealously protected at the expense of either real economic activity or future debt loads.

If losses are to be metered to financial assets as they deserve, there should be a combination of monetary expansion (effective sovereign default) and limits to bailing out creditors (of either banks or industry). Inflation actually lifts the prices of real assets, including commodities and equity in solid corporations. It hurts non-speculative creditors of solid corporations and households, so it should only be used with extreme caution. Some losses are, however, in order for all creditors, who should take their share of the overall responsibility for the creation of excess credit.

Paul Krugman tries to pin the roots of this crisis on the tired old explanation of a "savings glut".

One way to think about the global crisis is a vast excess of desired savings over willing investment. We have a global savings glut. Another way to say it is we have a global shortage of demand. Those are equivalent ways of saying the same thing. So we have this global savings glut, which is why there is, in fact, no upward pressure on interest rates. There are more savings than we know what to do with. If we ask the question "Where will the savings come from to finance the large US government deficits?," the answer is "From ourselves." The Chinese are not contributing at all.

Krugman is right in a limited sense. Bad investments have been made because there has been too much money chasing too few investment opportunities. He doesn't shed much light on the root sources of this "savings glut". The glut exists, all right, but it is not individual savers who have created it with their saving decisions.

As surprising as it is, savings are not created by savers. Savings are created by issuance of money and credit. All the money that is in existence is always held by someone. If one person decides not to hold it, it is passed on to the next one, but it is nevertheless always there, until the original debt is paid back, or the money withdrawn by a monetary authority. Society as a whole can not choose not to save if financial institutions just keep on churning out new money.

On the other hand, the "savings glut" is imaginary in a certain sense. Because net savings can not exceed the rate of creation of new base money, every unit of money "saved" beyond that is actually balanced by equal creation of new debt, which is a form of dissaving. Problems are caused when credit and debt are socially or geographically highly separated. This is the cause of the so called "global imbalances". We have seen the world divided between western debt and eastern savings. The problem is also manifested internally in almost all economies in the form of middle and lower class debt "canceling" out saving by the affluent.

George Soros has a good point on the lack of regulation:

About regulation, we have to start by recognizing that the prevailing view is false, that markets actually are bubble-prone. They create bubbles. Therefore, they have to be regulated. The authorities have to accept responsibility for preventing asset bubbles from growing too big. They've expressly rejected that, saying that if the markets don't know, how can the regulators know? And, of course, they can't. They're bound to be wrong, but they get feedback from the market, and then they can make adjustments. Now, it is not enough to regulate the money supply. You have to regulate credit. And that means using tools that have largely fallen into disuse. Of course you have margin requirements, minimum capital requirements; but you actually have to vary them to counteract the prevailing mood of the market, because markets do have moods. It should be recognized that exuberance actually is quite rational. When I see a bubble beginning, forming, I jump on it because that's how I make money. So it's perfectly rational.

It's the job of the regulators to regulate. However, we should try not to go overboard. While markets are imperfect, regulators are even more imperfect: not only are they human, they're also bureaucratic and subject to political influences. So we want to keep regulation to a minimum, but we have to recognize that markets are inherently unstable.

Regulators are human. This is true. And this is the reason that we should strive toward regulations based on fairly stable rules that are equally applied to everyone. We should minimize the role of regulators in making decisions and see them instead as enforcers of regulations. The regulations should thus be clear, transparent and fairly rigid, maybe even a lot more rigid than is optimal in the sense of efficiency. The separation of powers to legislative, executive and judiciary branches has to be enhanced in financial regulation to avoid cognitive capture and arbitrary decisions.

For some reason Soros doesn't mention the one regulatory issue that I somehow feel is the most important of all: reserve requirements. With reasonable reserve requirements there would be a hard limit on the creation of credit, and thus a hard limit on the level of associated imbalances.

One challenge is posed by the shadow banking system (money market accounts, etc.) that has not been operating under the same rules that apply to normal banks. Regulations should be based on the roles that are performed by entities, instead of their legal status.

Paul Krugman puts the issue of regulation in his usually pointed and prosaic style:

As I've written, we need a boring banking sector again. All of this high finance has turned out to be just destructive, and that's partly a matter of regulation. But in the political economy there was also a vicious circle. Because as the financial sector got increasingly bloated its political clout also grew. So, in fact, deregulation bred bloated finance, which bred more deregulation, which bred this monster that ate the world economy.

One thing that was conspicuously missing from the discussion was the unsustainable demand of permanent exponential growth that is required for steady operation of the financial markets. There was no discussion of the limits to growth that are presented by resource exhaustion and climate constraints. In order to have a sustainable financial system, we have to take these limits into account.

The whole structure of the economy has to change away from using credit as a permanent store of value. In a few decades, we will probably have to think about a financial system that can cope with an economy that is actually shrinking steadily. A system where credit is used as a store of value will not be able to cope with such circumstances without significant inflation.

A general move away from the use of money itself as a store of value would be a good idea. Money should be primarily used as a means of exchange, while real assets should take the role of accumulating long term savings. This would be of help in remedying the paradox of thrift that Krugman has repeatedly written about.

Of course, these ideas are not new.

The whole discussion was also centered around the ordinary economic phenomena of savings and investment. I would have expected more discussion of the "paradox of risk" (as so dubbed by Charles Hugh Smith) that is so aggressively manifesting itself at the derivatives market.

Central Bank Profligacy and Massive Malinvestment

2009-05-17T22:41:00.006+03:00

I stumbled upon a newly interesting paragraph in an article about IMF fiscal advice from 1990 by Alan Tait:

Central banks are not expected to make losses. In industrialized economies, central bank profligacy is rare. In the last few years, however, significant central bank deficits have become not uncommon in developing countries (central bank losses in Costa Rica were 5.6 percent of GDP in 1982; in the Philippines, 5.2 percent in 1984; in Uruguay, 7.6 percent in 1983; and, in Argentina, 2.5 percent in 1984). This largely occurs when a central bank undertakes quasi-fiscal activities (e.g., net lending or guaranteeing foreign exchange losses) that show up, initially, as a change in the composition of central bank's assets.

The US Federal Reserve has been working overtime to achieve an exception to the first sentence. Sure puts them in an interesting new group of peers.

A later paragraph states:

Frequently, the public sector has undertaken massive investment programs, often with an eye on the symbolic need to "think big." But some of this investment may prove unproductive if the initial capital commitment is not followed up by maintenance. Donors will give capital but are reluctant to fund maintenance costs. Fund and Bank advice may well be to forego some large new projects for the sake of maintaining and operating efficiently the existing capital stock.

Massive investment programs? Yes, sir! Unproductive? You bet.

IMF's Anti-Stimulus Rules

2009-05-17T18:35:00.004+03:00

Mark Weisbrot writes in the Guardian of how the IMF is hurting poor countries by imposing tough rules on government deficits and interest rates at the face of a severe economic downturn. He refers to the anti-stimulative and deflationary conditions that are associated with IMF loans as "punishment". This seems to be quite justified at the face of the fact that even a 40 % budget cut in Latvia is not enough for the IMF.

Mr. Weisbrot points to the severe additional tension that IMF's diktats might potentially cause in already volatile Pakistan: "Slowing Pakistan's economy at a time when the global economic crisis is already doing that may not be the best policy from the point of view of political stability."

Getting away from government deficits is without doubt necessary in the long run, but the severity of the measures are and should be up for debate. Application of such measures should be postponed until the end of the economic downturn. They should also be associated with at least some concessions from creditors.

It also seems that American and European economists are not quite so ready to apply their "scientific" doctrines at home. This creates the inevitable appearance of high hypocrisy. Forcing some nations to tighter their belts 'till they pass out, while others freely splurge on trillion-dollar government deficits is very ugly to look at.

Western economists are quite easily throwing about the notion that these measures are for the good of the target nations, and that they must "swallow the bitter pill". What is easily forgotten is that some people's lives will be permanently ruined by such measures. When your children are about to die for the lack of medical services, the "long run" can be surprisingly short.

How the IMF works can only be described with the term "predatory lending". The whole point seems to be the creation of a permanent debt relationship, with all of the resources of a nation directed at paying the interest on the debt.

IMF strongly opposes progressive taxation as a way of escaping government debt. The regressive cuts to the most productive parts of the target governments' budgets, like education and health care, keep the debtor nations at the status of quasi-colonized sources of free labour and raw materials.

Individual Advantages as a Cause of Systemic Weakness, a Parallel in Biodiversity

2009-05-03T19:59:00.007+03:00

BBC News reports of a study that comes to a conclusion that increased nutrients decrease biodiversity by letting the fastest growing plants grab all the sunlight, while slower growing species suffocate. In a more nutrient-constrained environment, plants that use nutrients efficiently succeed alongside plants that make effective use of light. (Hat tip to Yves Smith)

I think this is a more general game-theoretic phenomenon: the higher the number of binding constraints there are in a system, the higher the number of successful strategies. The individual constraints can be seen as objectives for a multi-objective optimization problem, thus controlling the degrees of freedom in the world of Pareto-optimal solutions.

I have been thinking of the role that this phenomenon has had on the financial world. Before 1980's, the financial world was comfortably resting on limits of liquidity, in the form of binding reserve requirements, and leverage, in the form of binding limits of bank capital.

After removing the important constraint of reserve requirements, especially after 1994, when retail sweep programs were allowed, leverage has been the only major remaining limit, and was thus taken to the maximum.

After the weakening of even that limit, by changes in rules and active avoidance of regulations, actual solvency is now the only remaining factor to limit the growth of financial institutions. This is not a good limiting factor for a system built mostly of institutions that are “too big to fail”.

Naomi Klein on Wall Street Cronyism and “Free Market” Fundamentalism

2009-05-01T12:57:00.009+03:00

There is a really great, long interview of Naomi Klein at wowowow.com by Joan Juliet Buck:

JOAN: And can Obama provide the real deal?

NAOMI: What gave me hope was that when the economic crisis hit, Obama got serious and his analysis became more concrete. It’s really worth remembering that he started winning the election when Lehman collapsed and he started putting the ideology of Reaganism on trial. He started saying, “This economic crisis is the result of the policies of deregulation and trickle-down economics that have dominated this country.” But he said, “for the last eight years.” That was wrong. And that was part of the problem.

JOAN: Because it’s the last 30.

NAOMI: It’s the last 30 and, you know, that was a piece of intellectual dishonesty that I think has cost us dearly. That was a good electoral line because we all wanted to be able to blame it all on Republicans, because that was a much more sellable election slogan. “Everything was fine in the ‘90s when you had Clinton and we just need to get back to that.” And what that did was gloss over the absolutely central role that Robert Rubin and Larry Summers played in creating this crisis. And lo and behold, they’re back with their protégés in tow. There’s really a shared responsibility, and it’s an argument for more intellectual honesty, more principled stands and fewer strategic calculations. What worries me so much is that it’s fine for politicians to be strategic. But social movements should be principled. They shouldn’t always be thinking about what’s the right strategy, what’s the sellable message, what’s the talking point, because then you end up in a situation like this. Larry Summers is back. Larry Summers was given a pass during the entire election.

Ms. Klein makes some very deep observations on the dynamics of politicized mass movements:

JOAN: Just start with the Icelandic protests. Why are there no protests in the streets in America?

NAOMI: This comes back to the problems of hero worship. It’s hard to protest your hero. But it’s more than that. It’s also that the virulence of the Right in the United States is so frightening and the problem is that it is the merger of the extreme far right and large corporations, in the form of media conglomerates. So Glenn Beck on Fox or Lou Dobbs on CNN have these unbelievable megaphones to attack Obama, and to spread fear, which makes reasonable people feel that their main political role is to defend the Obama administration against this very frightening right-wing onslaught. It’s understandable but it’s also hard to do that while being in the streets protesting that administration’s bailout – which is what’s happening in Britain, which is what’s happening in France, what’s happening in Italy. I think the problem in the U.S. is that many people who were part of the campaign to get Obama into power now see their role as being kind of an unofficial arm of the administration, with some groups even taking talking points from the White House. It’s a recipe for political failure, because what actually makes space for Obama to do more of what we want him to do is to make him look less radical, by being more radical ourselves.

This is a very acute problem in two-party systems like the one in the US. It’s very hard to critique one party without the fear of playing into the hands of the other one.

I am totally dumbfounded at the lack of campaigning for a true multi-party political system in the US. What makes the idea such a non-starter? Are Americans just so used to the system that they have that they don’t even consider any alternatives?

It is natural that neither of the two power parties are going to embrace a multi-party system. Maybe this crisis could act as a lightning rod for a new multi-party revolution, as it becomes ever more clear that both parties are in the pockets of moneyed interests: employers for Republicans and Wall Street for Democrats.

Naomi presents some of the issues as a gender bias.

NAOMI: Brooksley Born [chairwoman of the Commodity Futures Trading Commission], who, during the Clinton administration, blew the whistle on the unregulated derivative industry and wanted to regulate it like any other banking sector. For her prescience she was bullied by Rubin and Greenspan and Summers, who’s actually the enforcer of the three. He was the one who called her. They argued that just by talking about the need to regulate derivatives, she was going to create market panic. So not only wouldn’t they consider it, they wouldn’t even let her talk about it. She saw this whole crisis coming. You often hear this: “Well, no one saw this coming.” And that is such a reflection on who these men believe is someone. But there are so many people who saw this coming, and they’re considered nobodies. The only way you get to be a somebody is if you agree with them. Brooksley Born saw it coming. Elizabeth Warren has been an incredible watchdog. Sheila Bair, chair of the FDIC, also had a much more principled and ethical vision of what the bailout should be, in arguing that they should be offering direct aid to homeowners, as opposed to this top-down bailout. I feel like this gender split is not coincidental. There’s a need for more of a feminist analysis in understanding how we got here.

I think Ms. Klein exaggerates the issue a bit. There were a lot of men who saw this coming. But in some cases the men were not tossed aside as easily as the women.

I do think that it is a lot easier for men to leverage their positions. It is not as easy for women to get the benefit of the doubt. It is usually men who are treated with “for his position, he has to know what he’s talking about”. Just look at the deification of Alan Greenspan. If he had been a woman, his speeches would have received a whole lot more criticism.

Somehow, I also think that women are more readily accepted as having rigidly ideological views, even when they make great and reasonable analysis based on facts and research. It is also a lot more easy to brush aside pessimistic analysis from a woman as just instinctive worrying, which is seen as a feminine trait and a weakness of mind in the irrational macho culture that is still dominant, especially in the financial world.

The dominance of macho culture and euphoric over-optimism is quite understandable in modern finance. People with normal attitudes to risk simply can not function in an industry so clearly based on an unsustainable bubble. It’s pretty much a case of self-enhancing adverse selection. At the start of an irrational boom, people who see it as such are pushed aside or drop out voluntarily, which just makes the boom stronger.

Ms. Klein presents some unfounded opposition to market-based solutions to climate change:

And at this point, I think there’s a lot of rightful cynicism about the Kyoto protocol because the whole question of "How are we going to respond to climate change?" was entirely infected by market fundamentalism. Bringing it back full circle to where we started, the ideas that have dominated for the past 30 years have utterly shaped the environmental debate during the Kyoto era. So the idea was to always find “market-based solutions” to climate change, which meant that we couldn’t really legislate, and everything had to be creating market incentives for the private sector to solve the problem for us. And I think that’s a much harder sell today in the context of people rightfully losing faith in the ability of the market to solve our most pressing problems. So I think you’re going to see a lot of very different, non-market-based solutions being proposed ahead of the Copenhagen Summit, which is in December 2009.

There is nothing wrong in principle in market-based solutions, but markets have to have clear, fair and binding rules to work properly. Solutions that would be based on unregulated markets obviously don’t work, but a well-thought-out, competitive, non-oligopolistic market solution would not be against the goals of social development.

It is truly unfortunate that people are losing their faith in the market. What they really should be losing their faith in, is the concept of “free market” as practised on Wall Street. Really free markets have strong and fair rules in effect that everybody is bound to. The modern “free market” is a mix of the law of the jungle, with a firm and unfair control from above by a semi-private block of financial interests, represented by central banks.

Principled opposition to markets is like opposition to the rule of law, because of bad laws. Anarchy is not a solution. The progressive movement is badly hurt by people who propose price controls as a way to social goals. There is really no alternative to the market in some aspects of human behaviour. We should instead be focused on the rules that govern the market.

The “free market” fundamentalism as teached by the Chicago school of economics is a perversion of the ideas of Adam Smith. David Korten wrote in his book When Corporations Rule the World:

These practices were strongly condemned by Adam Smith in The Weath of Nations. Smith saw corporations, much as he saw governments, as instruments for suppressing the beneficial competitive forces of the market. His condemnation of corporations was uncompromising. He specifically mentioned them twelve times in his classic thesis, and not once did he attribute any favorable quality to them. Typical is his observation that: “It is to prevent this reduction of price, and consequently of wages and profit, by restraingin that free competition which would most certainly occcasion it, that all corporations, and the greater part of corporation law, have been established.”

It is easy to forget, that the world of Adam Smith was very much different from ours. Back then, it was the government that had actively granted very profitable monopolies to favored corporations. Now, corporations mostly gain monopoly positions by utilizing the lack of willingness to enforce regulations that would limit their growth in size.

Smith was against monopolization, not all government action. He was not an anarchist. He was all for sensible regulation of finance, for example. In the current business atmosphere, Adam Smith would have strongly supported anti-trust legislation, which has not been properly enforced in a long time.

Economist Dean Baker recently made a good point about incorporation being a privilege:

Finally, the article asserts that: "certain very large companies must organize as separate entities that are taxed twice -- on profits and shareholder dividends." Actually, it is not true that any business "must" organize as a separate entity. Certain very large businesses choose to incorporate because they find that the benefits that the government gives them by granting corporate status are so great as to make it worthwhile to pay the corporate income tax.

Market regulation is not inherently antithetical to freedom, as long as the same rules apply equally to everybody, and no special favous are provided. The rules of the markets should be arranged so that there is a price to be paid for all actions that have adverse effects on others. Incorporation is itself an act by the government, extracting a cost from other market participants in the form of reduced competition.

But markets are ultimately made of people. Markets do not have a soul of their own, even if it sometimes seems like that. And people can not be truly free without a fair set of rules to protect their freedom. The modern “free market” fundamentalists are actually nothing but market anarchists.

The Bubbles Are Piling Up

2009-04-27T23:05:00.000+03:00

It seems that a Kazakh bank might be the first one to collapse from losses that originated in the commodity bubble.

New York Times: The largest bank in the Central Asian nation of Kazakhstan, whose economy soared when oil prices were high, announced on Friday that it could no longer repay $11 billion in foreign debt.

The bank, BTA, said it would pay only interest to foreign creditors, who lavished the country with loans during the commodity boom. The move underscored the growing financial instability in countries all across the former Soviet Union.

[...]

BTA had been wobbly for some time. The Kazakh government partly nationalized the bank in February. That was taken as a sign that the bank’s debt might be covered by a sovereign guarantee, though even at the time government-appointed executives said they were studying ways to restructure foreign debt.

I have long been suspecting that the dangers of letting large banks fail have been much exaggerated, especially compared to the burden that is caused by governments picking up the tab. Hopefully the economy of Kazakhstan will not completely collapse.

The losses from the housing market and structured credit bubbles haven't been cleared. Yet we are already witnessing huge losses from the commodity bubble.

Since the 60's the US has seen an ever more rapid sequence of bubbles: conglomerates, junk bonds, real estate, tech stocks, housing, structured credit, commodities, and finally, government bonds. When the accumulation of foreign dollar reserves reverses itself, the government bond bubble will come to an end. That might actually be pretty close now.

It seems that the era of serial bubbles is ending in bubbles that are ever more short in duration, until they can no longer be “fixed” by creating a new one.

When looking at the whole trend, I can't help but to think that the biggest bubble of all has been of the standards of living in the developed world. Western standards of living were raised to unsustainable levels by relying on undercompensated use of colonial resources, until the 1960's. After the colonial period, a massive accumulation of debt has been used to delay the inevitable balancing of global consumption patterns. All the other bubbles are just minor manifestations of this all-enclosing bubble of debt.

Pain in the Fertilizer Supply Chain

2009-04-27T22:22:00.005+03:00

Bad news on global agricultural output:

The Globe and Mail (Canada): Farmers across Canada, the United States and elsewhere are ... holding off on fertilizer purchases in the hope prices will fall. Their collective action has sent fertilizer sales into an unprecedented nosedive and pummelled the bottom lines of agriculture giants like Potash Corp. of Saskatchewan Inc., [POT-T]Viterra Inc., Bunge Ltd. and Terra Industries Inc.

[...]

Fertilizer dealers have been hit even harder and a few small stores in Canada have gone out of business.

"It's not good," said Bob McNaughton, who runs Sylvite Agri-Services Inc. in Putnam, Ont., which has six locations. He knows several stores that are facing financial trouble. "They're gone, or will be."

Many stores bought potash last year at close to $1,000 a tonne, he said. The price has fallen to around $800, which many still believe is too high. Even if a retailer can make a sale, Mr. McNaughton said the owners have to eat the loss.

"Everybody was expecting a mind-blowing, record fall season and it was a bust," said David MacKay, executive director of the Winnipeg-based Canadian Association of Agri-Retailers, which represents about 1,000 fertilizer dealers.

It seems that retailers will rather let their stockpiles lay still than sell at a heavy loss. I have a radical suggestion: If the producers want to see potash move in the market, they should accept that the super high prices of last fall were a mistake. They should make temporary offers of retrospective rebates to retailers, payable against retail sales, to encourage reductions in stockpiles.

Potash chief executive officer Bill Doyle said farmers are playing a "dangerous game" that will have consequences.
"This level of reduction has never been seen before," he told analysts on a conference call. "No one can state precisely what the impact will be on the world's food supply, immediately or over the longer term. But we know with scientific certainty that nutrient underapplication damages both crop yields and quality."

Mr. Doyle said farmers in Brazil and Argentina are already witnessing the fallout. They used far less fertilizer on their crops and are now seeing production yields fall by as much as 20 per cent.

He said fertilizer sales to North American farmers have dropped as much as 86 per cent but farmers still plan to plant the same amount of corn, canola and other crops as last year. If farmers around the world follow the same path, global food supplies will be affected. "After two record world crops in 2007 and 2008, the year 2009 could be a completely different story," he said.

No, it’s the potash producers who are playing a dangerous game by trying to leverage their oligopolistic market status to extract excessive profits at the expense of the whole population of the earth. Farmers don't have the money.

These kinds of “pile-ups” in the supply chain are an unfortunate side effect of unregulated speculation on essential commodities.

Tom Toles on Waterboarding Iraq–al Qaida “Links”

2009-04-27T08:44:00.005+03:00

Tom Toles just got it:

False confessions flow naturally from torture. I think Tom just summed it up perfectly. It's a feature.

The Seducing Simplicity of Gaussian Models

2009-04-25T01:00:00.003+03:00

This is a great illustration from Paul De Grauwe, Leonardo Iania and Pablo Rovira Kaltwasser of the dangers of using the wrong probability distributions in a statistical model. In eurointelligence.com (ht Yves Smith, emphasis is mine):

October 2008 was certainly a spectacular month in the stock markets. Large daily changes occurred that surprised most investors. Yet, although many investors had not seen such wild gyrations of stock prices for a long time, there was a general sense that this had happened before.

Those of us who studied modern finance theory, however, were truly astonished by the sheer improbability of the events occurring in the stock markets during that fateful month. One of the basic assumptions used in almost all our finance models is that returns are normally distributed. These models are widely used to price derivatives and other complex financial products. What do these models tell us about the probabilities of the events that occurred in October?
The following table gives an answer. We selected the six largest daily percentage changes in the Dow Jones Industrial Average during October, and asked the question of how frequent these changes occur assuming that, as is commonly done in finance models, these events are normally distributed. The results are truly astonishing. There were two daily changes of more than 10% during the month. With a standard deviation of daily changes of 1.032% (computed over the period 1971-2008) movements of such a magnitude can occur only once every 73 to 603 trillion billion years. Since our universe, according to most physicists, exists a mere 20 billion years we, finance theorists, would have had to wait for another trillion universes before one such change could be observed. Yet it happened twice during the same month. A truly miraculous event. The other four changes during the same month of October have a somewhat higher frequency, but surely we did not expect these to happen in our lifetimes.

Trying to explain these deviations as just a few outliers in an otherwise well-behaving Gaussian process just doesn't cut it. A simple visual comparison of these time series is enough:

Figure 1: Dow Jones Industrial Average 1928-2008

Figure 2: Random Normal Process

The “Tortuous” Search for Iraq-al Qaida Links

2009-04-24T09:34:00.005+03:00

Jonathan S. Landay of McClatchy Newspapers drops a bomb:

The Bush administration applied relentless pressure on interrogators to use harsh methods on detainees in part to find evidence of cooperation between al Qaida and the late Iraqi dictator Saddam Hussein's regime, according to a former senior U.S. intelligence official and a former Army psychiatrist.
Such information would've provided a foundation for one of former President George W. Bush's main arguments for invading Iraq in 2003. In fact, no evidence has ever been found of operational ties between Osama bin Laden's terrorist network and Saddam's regime.

So detainees were tortured while trying to make them speak of a non-existing issue. So much for the ticking time bomb scenario. This gives whole new meaning to the original source for the title phrase of this blog. “Go massive” indeed.

Collateral Damage and Force Protection

2009-04-23T19:09:00.005+03:00

Tom Engelhardt writes thoroughly in TomDispatch.com about the deaths of civilians in US operations in Afghanistan and the various approaches for handling the cases by the military brass.

Admittedly, there's been a change in the assertion/repeated denial/investigation pattern instituted by American forces. Now, assertion and denial are sometimes followed relatively quickly by acknowledgement, apology, and payment. Now, when the irrefutable meets the unchallengeable, American spokespeople tend to own up to it. Yep, we killed them. Yep, they were women and kids. Nope, they had, as far as we know, nothing to do with terrorism. Yep, it was our fault and we'll pony up for our mistake.

This new tactic is a response to rising Afghan outrage over the repeated killing of civilians in U.S. raids and air strikes. But like the denials and the investigations, this, too, is intended to make everything go away, while our war itself -- those missiles loosed, those doors kicked down in the middle of the night -- just goes on.

[...]
But let's consider here just one recent incident that went almost uncovered in the U.S. media. According to an Agence France Presse account, in a raid in the eastern Afghan province of Khost, the U.S. military first reported a small success: four "armed militants" killed.

It took next to no time, however, for those four militants to morph into the family of an Afghan National Army artillery commander named Awal Khan. As it happened, Khan himself was on duty in another province at the time. According to the report, the tally of the slain, some of whom may have gone to the roof of their house to defend themselves against armed men they evidently believed to be robbers or bandits, included: Awal Khan's "schoolteacher wife, a 17-year-old daughter named Nadia, a 15-year-old son, Aimal, and his brother, who worked for a government department. Another daughter was wounded. After the shooting, the pregnant wife of Khan's cousin, who lived next door, went outside her home and was shot five times in the abdomen..."
[...]
All of this was little more than a shadow play against which the ongoing war continues to be relentlessly prosecuted. In Afghanistan (and increasingly in Pakistan), civilian deaths are inseparable from this war. Though they may be referred to as "collateral damage," increasingly in all wars, and certainly in counterinsurgency campaigns involving air power, the killing of civilians lies at the heart of the matter, while the killing of soldiers might be thought of as the collateral activity.

Pretending that these "mistakes" will cease or be ameliorated as long as the war is being prosecuted is little short of folly. After all, "mistake" after "mistake" continues to be made. That first Afghan wedding party was obliterated in late December 2001 when an American air strike killed up to 110 Afghan revelers with only two survivors. The fifth one on record was blown away last year. And count on it, there will be a sixth.
[...]
Let's for a moment assume, however, that our safety really was, and remains, at stake in a war halfway across the planet. If so, let me ask you a question: What's your "safety" really worth? Are you truly willing to trade the lives of Awal Khan's family for a blanket guarantee of your safety -- and not just his family, but all those Afghan one-year olds, all those wedding parties that are -- yes, they really are -- going to be blown away in the years to come for you?

Tom correctly identifies the huge costs of trying to obtain maximum safety. Unfortunately he misses one important aspect of safety in war that plays a very important role in actually promoting the deaths of innocent civilians: force protection.

Force protection has been put into a prime position in the list of priorities for the US military, ever since the mistaken perception that the Vietnam War was lost for the loss of morale at home. Troops are trained to shoot first and ask questions later to avoid potentially hazardous situations that could be triggered by the extra few seconds or minutes that would be needed to adequately asses the threat. This is well highlighted by the case of the cousin of Awal Khan mentioned in the quote above. She most probably received five bullets in the abdomen “just in case”, simply to protect the US troops involved from even theoretical risks.

Overreliance on air power is the most awful measure of force protection. Air raids are safe for the military, but disastrous for the civilian population in anti-insurgency warfare.

This is simply wrong. Soldiers should be bearing the risks to protect the civilian population, not engaging in reckless endangerment and voluntary manslaughter on a massive scale. In this case, it is not even a case of enemy civilians, but the very civilians that the soldiers are supposed to be protecting.

Giving the safety of soldiers priority above that of the civilian population is not only wrong, but stupid as well. It unnecessarily enrages the population and enhances the popularity of the insurgency. If US soldiers are not ready to risk their lives in protecting foreign nationals, they should not engage in wars of “liberation” in the first place.

See also my post from October 2007: “Human Terrain Teams and Dehumanization of Civilians”.

About US Unemployment Non-Security

2009-03-23T00:11:00.005+02:00

Robert Eshelman writes in tomdispatch.com, under headline “The Other War on Workers”:

Under unemployment eligibility requirements, an employer must certify whether an employee committed a "fault" on the job and was therefore terminated. If an employer indicates that no fault was committed and the employee meets several other requirements, including being physically able to work, states grant an unemployment claim. In other words, Chris's former employer granted him a small concession, while otherwise turning his life upside down amid the worst job market since 1983.

Is this really the situation in the US? No wonder people are scared of their employers. Record crime rates, here we come! Americans really have to rethink about their social safety nets.

In a later paragraph:

Someone I interviewed prior to my job center visit described her reaction when she heard that her company had recently closed a plant in the Midwest: "The first thing I thought, and I felt bad for thinking it," she recalled, somewhat sheepishly, "was that means more work for us -- at least for the time being."

Her comment speaks volumes, as does her request not to be identified. Who needs union busters, patrolling shop-stewards, or legions of high-paid lawyers fighting wage and hours claims when a worker is so anxious about job security that she responds positively to the laying off of those she imagines as potential competitors? When employees police their own behavior for fear of the axe -- monitoring their time checking email or using the bathroom -- bad times distinctly have an upside for management.
...
A look at corporate opposition to the Employee Free Choice Act (EFCA), whose passage in Congress is a central demand of organized labor, offers a glimpse of how persistently companies seek to disadvantage their workers. EFCA would allow workers to form a union when a majority of them sign union cards in a given workplace. "Card check," as it is frequently called, enables them to organize unions without the need for an election. In a November column surveying the business elite's response to the Act, Wall Street Journal op-ed columnist Thomas Frank wrote: "Card check is about power. Management has it, workers don't, and business doesn't want that to change."

Trying to prevent workers from setting up a trade union should be declared illegal as a violation of the workers' freedom of assembly.

Thomas Friedman: "We Must Have Growth"

2009-03-22T19:26:00.003+02:00

Thomas Friedman states the obvious:

Let’s today step out of the normal boundaries of analysis of our economic crisis and ask a radical question: What if the crisis of 2008 represents something much more fundamental than a deep recession? What if it’s telling us that the whole growth model we created over the last 50 years is simply unsustainable economically and ecologically and that 2008 was when we hit the wall — when Mother Nature and the market both said: “No more.”

What on earth is so radical about this view? It is a perfectly acceptable possibility. It is truly sad that he feels the need to explicitly step out of the “normal boundaries” to even contemplate such an idea.

Later on he gets to his policy descriptions:

We must have growth, but we must grow in a different way. For starters, economies need to transition to the concept of net-zero, whereby buildings, cars, factories and homes are designed not only to generate as much energy as they use but to be infinitely recyclable in as many parts as possible.

Yes. Let's abolish the second law of thermodynamics. That will solve all our energy needs.

While greater efficiency is a good goal, what is it with the “we must have growth” meme? It is absolutely not true. We could very well go on with a lot less than we have, after all, our grandparents certainly did. We could produce less, we could consume less, we could travel less.

The only thing that necessitates growth (beyond population growth) is the current state of the banking system, which is built to withstand total collapse only in the presence of continuous growth. If the economy was not based on such huge amounts of debt, there would be no need for continuous growth.

US FDIC Covering Bond Holders?

2009-03-22T14:31:00.002+02:00

Something doesn't quite sound right here:

MarketWatch.com: The Federal Deposit Insurance Corp. said late Thursday that it has completed the sale of IndyMac Federal Bank FSB, the firm it took over last year, and that it took a $10.7 billion loss on the deal, far more than originally expected.

The FDIC said OneWest Bank, FSB, a newly formed Pasadena, California-based federal savings bank organized by IMB HoldCo LLC, would assume IndyMac's deposits.

"As of January 31, 2009, IndyMac Federal had total assets of $23.5 billion and total deposits of $6.4 billion. OneWest has agreed to purchase all deposits and approximately $20.7 billion in assets at a discount of $4.7 billion. The FDIC will retain the remaining assets for later disposition," the FDIC said in a press release.

How can the FDIC accumulate $10.7 billion in losses while covering $6.4 billion of deposits? Sounds like the FDIC is taking a fall for other creditors of IndyMac as well. Is this really the purpose of FDIC? I thought it was only supposed to be for deposit insurance.

Lawrence Summers is a Grand Hypocrite

2009-03-16T00:16:00.003+02:00

Lawrence Summers, former World Bank chief economics, Clinton Treasury secretary and Harvard president, has completely turn his convictions around. This would be good, if he didn't maintain that this apparent conversion is somehow 'temporary':

FT.com reports (ht to Emmanuel):

Widely seen as being among the most pro-market voices in the White House, having been Bill Clinton’s last Treasury secretary in the 1990s, Mr Summers said the view that the market was inherently self-stabilising had been “dealt a fatal blow”. At a time when the Republican critique of Washington’s aggressive response to the crisis is growing more trenchant, Mr Summers made an unapologetic case for government intervention.

“This notion that the economy is self-stabilising is usually right but it is wrong a few times a century. And this is one of those times . . . there’s a need for extraordinary public action at those times...”

What a load of crap. Summers has it almost exactly backwards. The 30 years or so that this credit bubble has been constantly growing have been the time that the market has not been self-correcting. This crisis is the much awaited self-correction.

Funny that he didn't feel this way when the Asian financial bubble burst in 1997. Then he was all for harsh austerity measures. The current global phenomenon is only different in its scope and size. There is no fundamental difference.

Not that I'm at all for letting this crisis run its course without any remedial measures. But if we are going to let the unquestionably unstable credit machine churn out bubble after freaking bubble, we should device a comprehensive safety net that covers all and every part of the world economy, not just a select set of G-7 nations.

Naturally, it would have been much more fruitful to keep the lid on the credit machine that was unleashed by the Reagan and Thatcher governments in the early 1980's. Unregulated issuance of credit has always and everywhere been the source of financial bubbles.

India's Growing Supercomputing Market

2009-03-03T22:46:00.005+02:00

Signs of the rise of India as a growing player in the world of research and development: Cray Inc. has established a presence in New Delhi. (ht insideHPC.com)

Indiaprwire.com: Global supercomputer leader Cray Inc. (NASDAQ: CRAY) has formed a new wholly-owned subsidiary in India aimed at strengthening its presence in that country's growing High Performance Computing (HPC) marketplace.
"The senior management at Cray has felt for some time that the company needed to expand its footprint in India to provide a strong, local presence for our customers," said Andrew Wyatt, vice president, Cray Asia Pacific. "The country's HPC market is of rising importance, and establishing a new subsidiary allows us to seamlessly deliver our supercomputing expertise to both new and existing Cray customers in India."

HPC utilization is an important bellwether of high-tech, high-value added research and development.

Elsewhere, SGI has announced further layoffs of 9% of its workforce, even at the face of a big order of the US DoD:

The Register: Supercomputer maker Silicon Graphics has let go 120 more employees, nine per cent of its workforce, in an effort to cut costs as its revenues decline.

These cuts come hot on the heels of a 15 per cent layoff announced in mid-December, when SGI slashed 15 per cent of its 1,500-strong workforce, eliminating 225 positions. After the latest rounds of cuts, SGI has approximately 1,155 employees. That latest round cost the company about $3m in severance and related charges, according to the 8K filing, and SGI expects the layoffs to be completed by March 27.

Ferrari's Mobile IT Needs

2009-03-02T20:37:00.002+02:00

This is not your average mobile IT solution (hat tip insideHPC):

eWeek: Something that is unique to Ferrari and about 10 other competing international companies (including Mercedes, Toyota, BMW, Renault and others) is that a number of times per year -- 18, to be exact in 2009 -- the company takes literally to the road for the Formula One Grand Prix road racing season. The season starts March 29 at the Australian Grand Prix in Melbourne.

This requires some challenging work on the part of the company's IT staff, about which most race fans have no idea.

At those 18 locations -- in places as diverse as Malaysia, Brazil, France, Japan and Australia -- the Ferrari data center team will set up a temporary data center on site that will work in real time during the race. The temporary center will hook directly into the F1 site.

The Ferrari IT team consists of about 150 crew members and seven large trucks' worth of servers, power supplies and everything else that goes with them. It is no simple chore to move this high-tech entourage from one continent to another.

Somehow this just doesn't make much sense. Why would the servers actually have to be on location at the race tracks? One would think that remote operation would be enough.

Tales of the Great Chinese Construction Boom (and the Coming Bust)

2009-02-20T23:52:00.004+02:00

Mike Shedlock of the Mish's Global Economic Trend Analysis blog passes on an amazing story about the excesses of the Great Chinese Construction Boom. The story is from an American sculptor who regularly lives long periods in China.

I have been exchanging emails with Bill Hopen, a sculptor who frequently travels to China, often for months at a time. Bill writes ....
I've been to China a lot Mish, spent many months at a time there for the last eight years. China is already in a massive overcapacity real estate bubble. They are building three apartments for everyone that is lived in. Most apartments are empty and those that are rented do not come close to paying the interest on the loan.

There are huge department stores with products loaded on the shelves and staff everywhere and no one is shopping! Staff outnumbers customers five to one. It's surreal. They are ready, waiting for a great wave of shopping to come, but no wave is coming.

Eventually this "borrow and build" economy will be a pop heard round the world. China runs on construction, build build build, but there is no reason for that many places and spaces and big mall businesses with no consumers.

[...]

My comments were about apartments in Shanghai. Middle class folks (e.g. a doctor makes about $20,000 a year) will often buy one apartment one to live in and one as "investment". Sound familiar? The extras are mostly empty, or renting for much less than 6% interest on the money to buy the unit.

We rented a luxury two floor roof top terrace apartment (20th floor) in a gated compound with gardens, sculpture, playgrounds, walkways, waterfalls, bamboo fish ponds, fountains, and underground parking for $800 a month! The apartment is fully and nicely furnished with beds HDTV, kitchen dishes...everything.

The guy we rented from said he would sell it for $650,000. This was a normal price judging from many "bargain" offers in the windows of many area Realtors.

The typical real estate secured interest rate was 6 to 6 1/2%, so that's at least $36,000 interest per year, yet we were able to negotiate a rent of $800! And there were lots of apartments available. People would approach us with incredible deals. You could tell they were hurting, had bought extra apartments and were struggling with paying the mortgages, and were desperate for any help from any rent they could get.

This is an amazingly clear description of a financial system gone seriously bad. If this is indeed an accurate description of the state of the Chinese real estate market, I would imagine that it would be much more broadly discussed in mainstream media. Are the members of the mainstream media so fearful of annoying the Chinese central government that they are keeping it all hushed up?

The Chinese upper classes have been indeed getting their hands on increasing amounts of money. But I have a strong hunch, that when their liabilities are taken into account, there hasn't been enough increase in the number of actually wealthy people to sustain the amazing rate of construction in China.

There is a large number of people with cash to command for a while. This is easy to observe. The total amount of wealth is huge. There is an assumption of a more or less even spread of the assets along a part of the population.

Widespread construction is started, for it seems that there are a lot of reasonably wealthy prospective buyers. But people's personal balance sheets are actually quite opaque. Only later is it found out, that almost all of the actual net wealth is actually concentrated in a very few and select hands, as often is the case with these Ponzi-like me too-exercises. The net wealth of the rest is zero, or even worse.

Once everybody and their best friends have taken their maximum dose of debt, there is no more cash to command. This point, it seems, can be reached very suddenly. If the wealth is in the hands of a select few, there is naturally no drive for large scale construction of expensive assets, for those few can only make use of a very limited number. A single person can only make use of a certain limited number of personal accommodations. The same goes for all kinds of financial and economic planning that has been going on on the basis of completely wrong assumptions.

Next step: Complete chaos.

Micro-Protectionism in Japan

2009-02-16T18:10:00.004+02:00

Wow. Protectionism is spreading to a whole new level in Japan, according to Times Online:

Its electronic gadgetry is gathering dust on the shelves of high street stores, nobody is buying new fridges and the mountain of unsold plasma televisions is growing by the day.
However, in desperation, Panasonic has hit on the perfect counter-attack against the consumer slump: it has ordered every member of staff to go out and buy £1,000 of Panasonic products.

Toyota and Fujitsu have announced similar campaigns. The next step must be to start paying salaries in plasma TVs. Barter economy, here we come. :-)

Hey, maybe it's not such a bad idea after all. Imagine high level management being compensated with tons of company products. What better way is there to make them concentrate on the quality of the products than having to personally sell them for cash in the market? :)

I never knew that protectionism could be a microeconomic issue.

A Covert Mea Culpa from Mankiw?

2009-02-02T01:58:00.005+02:00

Greg Mankiw writes sensibly about not judging a president for “treating a single patient”. He then goes on to reference his own record as the chief economic adviser of a president:

Now some people may be tempted to read the above commentary and call it self-serving. After all, the economy looks pretty bad right now, so maybe I am trying to excuse President Bush and, indirectly, myself as one of his economic advisers.

Not so. If you want to judge presidents and their economic advisers by outcomes, that would be all to my benefit. I arrived in Washington to head the CEA in February 2003 and left in February 2005. (Harvard has a two-year rule for faculty leave). During that time, the economy grew at a healthy annualized rate of 3.6 percent, and the unemployment rate fell half a percentage point. As judged by outcomes, I look pretty good! But I will be the first to admit that this argument is deeply silly.

Hmm. Those two years happen to coincide with the hottest period of growth for the housing/credit bubble. His policy advice led the president to adopt a position of minimal regulation. And this happened in the presence of incredibly loose monetary policy (largest sustained downward deviation from the Taylor rule in near history). This is the period that gave us the infamous 2-28 ARM.

I'm all for judging Mankiw (negatively) on his (bad) policy advice, instead of the temporary growth of a bubble. At least he seems to be a person of some intellectual honesty in pointing this out himself.

Update: The subprime teaser rate ARMs have been in existence long before 2003. However, the time period was an era of rapidly growing subprime ARM utilization and increasingly predatory lending practices.

A Pound of Manufacturing Base, Please

2009-01-23T09:04:00.007+02:00

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?)

A Crude Contango. What? Why?

2009-01-21T02:11:00.006+02:00

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

2009-01-21T00:04:00.007+02:00

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.

Nicholas Kristof Is Dreaming of Sweatshops

2009-01-17T02:43:00.005+02:00

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.

US Financial Sector Debt = Way Overboard

2009-01-15T17:03:00.003+02:00

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.

A Supervolcano for 2009?

2009-01-02T06:25:00.003+02:00

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

2009-01-02T05:56:00.003+02:00

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.

Do We Really Need More Credit?

2009-01-01T17:06:00.003+02:00

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.

Juan Cole: Top Ten Myths about Iraq

2008-12-29T23:40:00.003+02:00

Juan Cole completely thrashes a list of myths about the US invasion of Iraq at Informed Comment. Get your facts straight for a coming year of attempted revision of history by the departing neoconservatives of the Bush administration.

1. Iraqis are safer because of Bush's War. In fact, conditions of insecurity have helped created both an internal and external refugee problem. (...)
2. Large numbers of Iraqis in exile abroad have returned. In fact, no great number have returned, and more Iraqis may still be leaving to Syria than returning.

3. Iraqis are materially better off because of Bush's war. In fact, A million Iraqis are "food insecure" and another 6 million need UN food rations to survive. Oxfam estimated in summer, 2007, that 28% of Iraqi children are malnourished.

4. The Bush administration scored a major victory with its Status of Forces Agreement. In fact, The Iraqis forced on Bush an agreement that the US would withdraw combat troops from Iraqi cities by July, 2009,and would completely withdraw from the Country by the end of 2011. (...)

5. Minorities in Iraq are safer since Bush's invasion. In fact, there have in 2008 been significant attacks on and displacement of Iraqi Christians from Mosul. In early January of 2008, guerrillas bombed churches in Mosul, wounding a number of persons. More recently, some 13,000 Christians have had to flee Mosul because of violence.

6. The sole explanation for the fall in the monthly death rate for Iraqi civilians was the troop excalation or surge of 30,000 extra US troops in 2007. In fact, troop levels had been that high before without major effect. The US military did good counter-insurgency in 2007. The major reason for the fall in the death toll, however, was that the Shiites won the war for Baghdad, ethnically cleansing hundreds of thousands of Sunnis from the capital, and turning it into a city with a Shiite majority of 75 to 80 percent. (When Bush invaded, Baghdad was about 50/50 Sunni and Shiite). The high death tolls in 2006 and 2007 were a by-product of this massive ethnic cleansing campaign. Now, a Shiite militiaman in Baghdad would have to drive for a while to find a Sunni Arab to kill.

7. John McCain alleged that if the US left Iraq, it would be promptly taken over by al-Qaeda. In fact, there are few followers of Usamah Bin Laden in Iraq. The fundamentalist extremists, if that is what McCain meant, are not supported by most Sunni Arabs. They are supported by no Shiites (60% of Iraq) or Kurds (20% of Iraq), and are hated by Iran, Syria, Turkey, and Jordan, who would never allow such a takeover.

8. The Iraq War made the world safer from terrorism. In fact, Iraq has become a major training ground for extremists and is implicated in the major bombings in Madrid, London, and Glasgow.

9. Bush went to war in Iraq because he was given bad intelligence about Saddam Hussein's weapons of mass destruction capabilities. In fact, the State Department's Intelligence & Research (I & R) division cast doubt on the alarmist WMD stories that Bush/Cheney put about. The CIA refused to sign off on the inclusion of the Niger uranium lie in the State of the Union address, which made Bush source it to the British MI6 instead. The Downing Street Memo revealed that Bush fixed the intelligence around the policy. (...)

10. Douglas Feith and other Neoconservatives didn't really want a war with Iraq (!). Yeah, that was why they demanded war on Iraq with their 1996 white paper for Bibi Netanyahu and again in their 1998 Project for a New American Century letter to Clinton, where they explicitly called for military action. (...)

GDP vs. Household Income

2008-12-25T17:13:00.003+02:00

Yangshen Huan writes in the The Wall Street Journal about misguided focus on GDP and other simplistic measures of economic prosperity.

The fundamental problem, and a mortal bias of economists, is a fixation with simple measurements -- especially GDP data. Ask a professional economist how many provinces China has and you are likely to draw a blank stare. But ask him what the GDP growth of China has been and he'll quickly be able to tell you that China has grown at a double-digit rate for 30 years and that at this rate China will overtake the U.S. by 2035 (or some other date). GDP-centrism is endemic, and often comes at the expense of deeper analysis. Just look at the enthusiasm with which economists and analysts greeted Goldman Sachs's famed "BRIC" report forecasting dramatic booms in Brazil, Russia, India and China -- a report based on little more than fifth-grade mathematics.

This obsession with China's impressive GDP growth often ignores discussion of what's causing that growth and whether it's self-sustained. This is where the decoupling enthusiasts stumbled, and where policy makers can still go seriously wrong. Consider, for example, data about the very slow growth of household incomes in China. This is particularly apparent in rural households. For the past 20 years or so, rural household income has grown at a rate half that of GDP growth. The slow household income growth, combined with rapid GDP growth, means that China has created a huge production capacity but it has done so at the expense of its own consumption base. This fact alone should have disproved the decoupling hypothesis. All the new "excess" production had to go somewhere, i.e., to the U.S. What's more, the persistence of this gap suggests that over time, China's growth has become more, not less, a derivative of America's consumption appetite.

This is a global phenomenon, and not strictly restricted to China. Overflowing credit and growing income inequality have caused individual consumer incomes to stay way behind the overall size of the economy all over the world.

How Not to Stimulate Economy, Indeed

2008-12-24T01:12:00.006+02:00

Harvard professor Greg "Bush advisor" Mankiw posts some first class crap in his blog:

In thinking through the fiscal policy options and their implications, it might be useful to compare a few hypothetical, fanciful scenarios. Suppose that the federal government borrows some money and then...

Case A: uses the money to give a lump-sum payment (such as a tax rebate) to Joe Average, who chooses to spend his free time sitting at home watching Mork and Mindy reruns.

Case B: uses the money to hire Joe to sit at home and watch Mork and Mindy reruns.

Case C: uses the money to hire Joe to sit at home and watch Family Feud reruns, which Joe does not enjoy quite as much as Mork and Mindy.

How about:

Case D: uses the money to hire Joe to upgrade the national railway system, or

Case E: uses the money to hire Jane to give better education for 20 children, or

Case F: uses the money to fund Jack's research on new energy sources, etc.

There is no shortage of public goods that a government can take upon when the private sector absolutely refuses to make use of the available resources, preferring instead to sit on its hands and watch those Mork and Mindy reruns, or even worse, engage in blowing bubbles.

The private sector, especially the unregulated financial one, has already proven its capacity to misallocation of resources. It is high time to do something different.

Naturally, the government should take it easy on investment at times when the economy is red hot and there is scarcity of resources, but this is definitely not one of those times. Besides, those much needed public investments are soon cheaper than ever before. The situation would be much better, if the US government had gathered some surplus in the good times, instead of letting rip with massive deficits.

It's easy to make your preferred solution look good when you only compare it to even worse propositions. Why is it that some people equate government spending to burning bills? As if being paid by the government somehow makes everything worthless.

Have a Cheerful Christmas?

2008-12-21T01:34:00.005+02:00

Ed Halliwell writes in the Guardian under the headline "Reasons to be cheerful". He has a Buddhist view on the topic of happiness and makes the case that no reason is needed for being cheerful. He interprets the word "cheerful" as an attitude, unlike "happiness", which is a state of affairs.

The next week or so will bring most of us a higher-than-usual number of wishes for our "happiness". Whether it's "Happy Christmas" (which seems to have eclipsed the more traditional exhortation to be "merry"), "Happy New Year", or the religion-neutral American import "Happy holidays", so many hopes for contentment can have the unintended effect of seeming like a reproach, especially if we are not feeling as chipper as the season appears to demand.

[...]

However, there is another, much more useful phrase for describing the potential of the holiday period – "the season of good cheer". Whereas the word happiness implies an end state, the result of causes and conditions over which we may have little control, cheerfulness is volitional, a deliberate decision to be good-spirited. Indeed, it may be especially appropriate to rouse "good cheer" at times – such as midwinter – when outer circumstances seem wretched and we are more likely to feel downcast.

[...]

The acceptance part of the process is important – cheerfulness should not be confused with the sometimes-nauseating "everything's-going-to-be-alright" approach that positive thinking gurus often appear to advocate. The purpose of cheerfulness isn't to deny that life is sometimes shit, it's that we aren't dependent on the happiness that comes from circumstances in order to find ways to wonder at it – as one Buddhist elder once asked me: "Rather than just liking the smell of roses, or hating the smell of manure, perhaps you could start appreciating that you have a nose?" (Read the whole story)

I guess this is what is usually referred to as "Christmas spirit". I guess what Ed wants to wish for everybody is: take it easy. I couldn't agree more.

Debt as a Source of Short-Sightedness

2008-12-06T19:00:00.004+02:00

As an addendum to the previous post, there is a reason for the increasing short-sightedness of businesses.

Shortening of the time scale of business decisions is a direct result from the overall increase in the level of gearing. When equity decreases in size compared to the overall level of debt in a company, the time scale is inevitably compressed. This is because creditors, unlike equity investors, are not willing to wait for profits. Interest must be paid on the debt at a predetermined rate, or a default is triggered. When the overall level of debt increases, time scales shorten and risk-aversion increases.

Below is a graph of the average rate of growth of credit/debt versus GDP in various industrial nations:

Here is the same thing as a graph over time:

There is no reason to assume that this statistic would not revert to a mean over time. Such relative measures can not keep developing in one direction forever. What is noteworthy, besides the huge level of the debt, is its remarkably monotonic growth. The developed world has not seen a real reduction in debt for over 30 years. Now we are finding out how painful that actually is.

Oversized Financial Sector vs. True Innovation

2008-12-06T18:43:00.004+02:00

Micheline Maynard publishes a sharp observation by John Casesa of Casesa Shapiro Group in a New York Times article about the trouble at GM:

But G.M., despite its tradition of fostering innovation, has often been impatient for profits to emerge.
Mr. Casesa said that pattern stemmed from the fact that so many of the company’s top executives had a background in finance, not in engineering and designing cars and trucks.

This out-sized rule by financial professionals in a single company is directly related to the overall size of the financial sector in developed countries. The same short-sightedness rules today in the stock market, resulting in an oversized focus on quarterly results. A long term focus and a will to wait for profits is a requirement for successful innovation.

Hoarding - Coin "Shortage" in Buenos Aires

2008-12-06T16:16:00.005+02:00

An amazing story about the dynamics of hoarding coins in Argentina is presented by Joe Keohane in The Slate: (hat tip to Paul Kedrosky)

Welcome to the world's strangest economic crisis. Argentina in general—and Buenos Aires in particular—is presently in the grip of a moneda, or coin, shortage. Everywhere you look, there are signs reading, "NO HAY MONEDAS." As a result, vendors here are more likely to decline to sell you something than to cough up any of their increasingly precious coins in change. I've tried to buy a 2-peso candy bar with a 5-peso note only to be refused, suggesting that the 2-peso sale is worth less to the vendor than the 1-peso coin he would be forced to give me in change. When my wife went to buy a 10-trip subway pass, which retails for 9 pesos, she offered a 20-peso note and received 12 pesos in bills as change. This is commonplace—a daily, if not hourly, occurrence. It's taken for granted that the peso coin is more valuable than the 2-peso note.

No one can say what's causing this absurd situation. The government accuses Argentines of hoarding coins, which is true, at least to some extent. When even the most insignificant purchase requires the same order of planning and precision as a long-range missile strike, you can hardly blame people for keeping a jar of monedas safe at home. The people, in turn, fault the government for not minting enough coins. In fact, the nation's central bank has produced a record number of monedas this year, and the problem has gotten even worse. (Read more)

When everybody does something in anticipation of others doing the same, things can sometimes escalate out of hands in a completely uncontrolled way. If everybody would stop the adverse behaviour all at once, things would rapidly come back to normal. But how could such a coordinated action be achieved?

Hoarding is a phenomenon that is going to be a hot topic in the coming decades of resource scarcity. It is a good research subject for economists, sociologists and anthropologists. Too bad I'm an engineer myself.

What to Do with Excess Financiers?

2008-11-26T13:32:00.006+02:00

A hilarious outburst of frustration from Stormy at the Angry Bear blog:

I still think nationalizing the banking system is a clean solution. No more fancy derivatives or CDO's. Let's have an old-fashion banking system. Sideline the money boys. Send them off to China or Sudan. Let them watch ice melt in the Arctic. Count polar bears. Have them do something useful.

Borrowings of Depository Institutions from the Federal Reserve

2008-11-26T01:49:00.001+02:00

The credit crisis just keeps escalating. A picture is worth a thousand words:

New York Times: Let's Make up Charges for "Heinous Terrorists"

2008-11-25T22:57:00.004+02:00

New York Times wrote in its Sunday editorial about the "problems" of closing the Guantánamo prison camp.

Even with all those demands, there is one thing Mr. Obama must do quickly to begin to repair this nation’s image and restore its self-respect: announce a plan for closing Mr. Bush’s outlaw prison at Guantánamo Bay.

The prison is the premier example of the disdain shown by Mr. Bush and Vice President Dick Cheney for the Constitution, federal law and international treaties. Most sensible governments cannot see past Guantánamo to even recall America’s long history as a defender of human rights and democratic values.

We are under no illusions. Closing the prison will not be easy, or quick, but it can be done. It does not mean that the United States will set free heinous terrorists. But it may mean that these prisoners will have to be tried on other very serious charges than the ones supposedly for which they were sent to Guantánamo.

Hmm... So Times is proposing made-up charges? A majority of the detainees do not fit under the description of "heinous terrorists". If there's no concrete evidence, why should the US government try to squeeze out a conviction.

Does this mean that truly dangerous men will be set free, to go back to plotting more attacks against America? No. But it will require smart legal thinking by the new administration.

Oh, those very dangerous people. Time for a reality check. Releasing a few people with evil intentions is a big thing in comparison to keeping possibly innocent people detained for seven years, and tortured as well. Those "heinous terrorists", against which there just doesn't happen to be much evidence, can surely be kept under check after release, and captured, if they actually take up arms again.

Normal Level of Lending?

2008-11-19T18:05:00.005+02:00

A quote from a Bloomberg article about the ongoing discussions in the US Congress:

Federal Reserve Chairman Ben S. Bernanke told lawmakers at the hearing that using the TARP for buying stakes in banks is ``critical for restoring confidence and promoting the return of credit markets to more normal functioning.'' He warned that lending in the U.S. is ``still far from normal.''

Quite true, Chairman Bernanke. Lending is far from normal in the US. It has only just started to come down to normal levels after 30 years of excess.

An honest analysis would discuss ways of slowing down the return to norm. Even more important would be measures that would help people and businesses to adjust to smaller levels of lending and debt.

Interfluidity: If only We Had a Financial System...

2008-11-02T20:43:00.003+02:00

Steve Randy Waldman of the Interfluidity blog has posted a great piece of common sense, titled "If only we had a financial system...":

The elephant that is not in the room is a financial system. By a financial system, I don't mean the tottering cartel of banks and insurers loudly sucking newly printed cash into "collateral postings" and "deleveragings" and other meaningless nonactivities. That is no financial system at all. It is an ecology of intestines and tapeworms, tubes through which dollars flow and are skimmed en route to destinations about which the tripe-creatures have little interest or concern.

The post is a polemic for a financial system that doesn't think it can create wealth on its own, independently of the actual economy of manufacturing and trade. Read the whole thing. It's a great post.

Electronic Voting Stupidity in Finland

2008-11-02T18:55:00.002+02:00

The Electronic Frontier Finland (EFFI) organization has published a highly critical press release of the electronic voting problems in three small Finnish communities.

It seems that the system required the voter to insert a smart card to identify the voter, type in their selected candidate number, then press "ok", check the candidate details on the screen, and then press "ok" again. Some voters did not press "ok" for the second time, but instead removed their smart card from the voting terminal prematurely, causing their ballots not to be cast.

Here, the issue is one of usability. 232 votes were ignored because of the missing press on the OK button. The number might seem small, but taking into account the small scale of this trial, the number adds up to about 2 percent of the whole electoral roll in the small communities that participated in the trial.

The most amazing thing is that even though the authorities admit that there was a usability problem, there will be no repeat of the vote.

It is very strange, though, that there is no mention in the EFFI press release about voter confidentiality issues, even though administration officials have admitted that they know the exact identity of each person that left an uncounted ballot because of this issue. There is no mention of verifiability of counting either.

EFFI does make a strong statement for abandoning such stupid experiments. A purposefully simplified and transparent voting procedure is an aim in itself. Traditionally, this has meant a paper ballot, into which a number is written with a pen. The vote counting is left to teams of voluntary people from all parties in each voting location. Even with such a system, the full count is usually achieved in hours. The additional good that is supposed to be provided by a computerized ballot is a complete mystery to me.

New Targets for IMF "Bail-outs"

2008-11-01T01:33:00.005+02:00

The UK Telegraph writes under a headline: "Pakistan to receive $9bn from IMF in fight against bankruptcy".

Pakistan is to receive a $9bn (£5.5bn) bail-out loan from the International Monetary Fund as the country has three weeks to stave off bankruptcy.

Sound more like a bail-out of Pakistan's creditors. Pakistan will have just as much trouble paying to IMF as it has to its current creditors, and even more so after its public infrastructure, especially education, has been demolished by IMF demand. The same goes for Iceland and the others. Many earlier IMF clients would probably have done better by going bankrupt.

Now that the IMF is "aiding" both developed and developing countries at the same time, it will be most interesting to see it the same standards and conditions are applied for all, or if its demands for "tough medicine" are for developing countries only.

The demand for 18% interest rates for Iceland does seem to be quite ~~insane~~ tough. Expect a very hard landing indeed for the Icelandic economy. I guess the people in IMF will never learn from their experiences. What these countries need is debt relief and negotiations with creditors. Bailing out the creditors will just make sure that the same thing happens again and again and again...

Onion: Bush Calls for Panic

2008-10-26T20:17:00.006+02:00

The Onion proves once again that is truly is the [US] Nation's Finest News Source in a great piece of satire titled: "Bush Calls for Panic".

In a nationally televised address to the American people Wednesday night, President Bush called upon every man, woman, and child to spiral uncontrollably downward into complete and utter panic.

It sure has been looking like inducing panic is the Bush administration's goal. The way that they suddenly switched from "everything is all right, our banking system is save and sound" to "we are doomed, unless we get to blow the lid off the national debt, in which case we are doomed anyway" is a sure way to create a massive panic.

This is not the first time, either. After September 11th, there was an equally sudden turn to scaremongering from absolute indifference. The initial approach to the threat of terrorism in the Bush administration was highly dismissive, even though the departing Clinton officials tried to raise awareness of the situation. This dismissive attitude was then suddenly switched to claims of existential threat.

If the purpose was not to create a state of panic, it can only be explained by complete incompetence. Maybe the administration will next produce a colour-coded economic warning system, directing the citizenry to selling into coordinated panics, followed by buying at the tops.

Learning from the Great Depression

2008-10-25T22:37:00.005+03:00

N. Gregory Mankiw, the economics professor from Harvard, writes in the New York Times about the lessons learned by economists since the Great Depression. He takes issue with overconfident rhetoric from IMF's chief economist, Olivier Blanchard.

Like most economists, those at the International Monetary Fund are lowering their growth forecasts. The financial turmoil gripping Wall Street will probably spill over onto every other street in America. Most likely, current job losses are only the tip of an ugly iceberg.

But when Olivier Blanchard, the I.M.F.’s chief economist, was asked about the possibility of the world sinking into another Great Depression, he reassuringly replied that the chance was “nearly nil.” He added, “We’ve learned a few things in 80 years.

Yes, we have. But have we learned what caused the Depression of the 1930s? Most important, have we learned enough to avoid doing the same thing again?

The Depression began, to a large extent, as a garden-variety downturn. The 1920s were a boom decade, and as it came to a close the Federal Reserve tried to rein in what might have been called the irrational exuberance of the era.

So professor Mankiw clearly recognizes the significance of the prior excess. He then goes on to discuss the effects of the stock market crash.

But things took a bad turn after the crash of October 1929. Lower stock prices made households poorer and discouraged consumer spending, which then made up three-quarters of the economy. (Today it’s about two-thirds.)

Here Professor Mankiw is putting the carriage way ahead of the horse. The fact that the economy was almost completely built on consumption is clearly the primary cause of the depression, just as it is now. Such "hollowness" of the economy was the reason for the market implosion, not vice versa.

Is Professor Mankiw really trying to say that if only consumption could have been kept going, a downturn would have never come? Have we really learned so very little in those 80 years?

But such an assumption is partially correct. The consumption could have continued in a less diminished form, only not without a massive recognition of losses for those that had amassed huge savings in the form of debt receivables during the previous decade or two. Those savings were mostly imaginary. The "wealth" that was supposed to be so great in the roaring twenties was mainly a mirage. It was not backed up by actual assets, just a whole lot of credit.

But there was actual wealth, even though it was not up to the level of credit in the banking system. People can't eat credit. There was real production. Real buildings were built.

What resulted in losses to the real economy was the panicky scramble by the owners of the financial system to realize as much as possible of their inherently imaginary wealth. This resulted in factory closures, cuts to production and overall liquidations of everything in sight.

But preserving the imaginary value of the financial system in general was impossible. The value just wasn't there. Even if a few early birds might have salvaged an out-sized piece of the pie, liquidations of productive assets made the overall situation catastrophic, and actually reduced the pool of real wealth in existence.

The only way to prevent such a panic of liquidations is an abrupt and early recognition of the true base of value in the economy, combined with equitable distribution of losses to holders of imaginary wealth. This much is clearly understood by professor Mankiw.

Probably the most important source of recovery after 1933 was monetary expansion, eased by President Franklin D. Roosevelt’s decision to abandon the gold standard and devalue the dollar. From 1933 to 1937, the money supply rose, stopping the deflation. Production in the economy grew about 10 percent a year, three times its normal rate.

It is nice to see that Professor Mankiw recognizes the value of giving up on the gold standard. After all, the standard was effectively given up much earlier by letting the financial system grow so far ahead of its reserves.

Monetary stimulus can not be trusted to perform the delivery of losses in an equitable way. It hurts savers in actual assets and favours the owners of imaginary wealth in the financial system. Monetary stimulus must be accompanied by distribution of losses to all levels of the financial system, including depositors and other creditors. Professor Mankiw kind of admits this in a later paragraph.

The Fed and the Treasury Department, intent on avoiding the early policy inaction that let the Depression unfold, have been working hard to keep credit flowing. But the financial situation they face is, arguably, more difficult than that of the 1930s. Then, the problem was largely a crisis of confidence and a shortage of liquidity. Today, the problem may be more a shortage of solvency, which is harder to solve.

The comment about 1930's not being mostly about shortage of solvency is quite frankly puzzling.

It must be recognized that the free market does not much help us here. In a free market of rational people, there will be a completely rational panic in a widespread insolvency situation. This puts us in a prisoner's dilemma situation where the common good is seriously neglected by individuals acting out of rational self-preservation. If we are additionally ready to accept, as the economic theory of late has been very loath to do, that people in general are not very rational, or have no access to the necessary information for rational decision-making, we can assume that there will be complete carnage.

An equitable distribution of losses, as a necessary but inherently repulsive proposition, requires some kind of coordination. This includes taking bad banks out of business as early as possible, instead of letting them pile on the losses.

But human nature is not very well suited for early recognition of losses, even if that would be rational. Overall deposit guarantees has been the unfortunate (and very late) first reaction from governments in Europe. It just makes the situation worse and further delays the recognition of the differences in the values of the financial system and the real economy.

Instead of guaranteeing all deposits, there should be a way to rearrange all bank liabilities, including deposits, into new equity, while the old equity would be wiped out.

Deposits above a suitable threshold, which could be quite high, should be converted to new equity in a bank failure. This would directly address the solvency issues without causing a need for fire-sale disposition of the assets of the failed bank. This would also be useful for keeping bank management in a healthy state of fear: "Do your job properly, or face a mob of angry ex-depositors in the next general meeting of shareholders."

A solution to too much credit is not more credit. It is conversion of credit to equity and realizing losses from imaginary wealth.

Fannie and Freddie no Longer Run to Minimize Taxpayer Losses

2008-10-13T03:37:00.003+03:00

MarketWatch reports of Fannie Mae and Freddie Mac getting new marching orders from the US government:

Regulators initially restricted Fannie and Freddie's growth when they seized control. To "promote stability" and lower mortgage costs to borrowers, Treasury Secretary Henry Paulson said the two companies would be allowed to "modestly increase'' their mortgage portfolios to as much as $1.7 trillion through the end of next year and said they would no longer be run "to maximize shareholder returns."

Since no returns of any kind are to be expected in a little while, the last sentence should actually be translated to a more accurate wording: They are no longer run to minimize shareholder losses. And "shareholder" now practically means the US government. Isn't that nice and reassuring. And a good way to promote the "free market".

Moral Factors in the Free Market

2008-10-12T18:14:00.005+03:00

There is a very interesting review in Time magazine of an article, from a forthcoming Oxford University Press book, titled "The Recession of 2008: The Moral Factor — A Jewish Law Analysis.", by Aaron Levine, who is both a rabbi and an economics professor.

The article comes up with a pro-regulatory stance that has its basis on the ancient principles of Judeo-Christian ethics, including not putting a stumbling-block before the blind (economically so in this case), disclosure (of hidden flaws) and over-charging.

That economics professors start to discuss ethics is a much needed step towards creating a principled compromise between freedom and moral restrictions in the prevailing "free market" ideology.

The old adage of "no freedom without responsibility" has been greatly manifested by the current financial crisis. The free agents in a marketplace are suddenly not so free after all, when confronted with margin calls. If one does not act in a responsible way, one's freedom will we taken away, one way or another.

In our usual feelings of self-importance and entitlement, we could take a word from Abraham Lincoln: "I like to see a man proud of the place in which he lives. I like to see a man live so his place will be proud of him."

Cyclic History in Action

2008-10-07T22:45:00.005+03:00

Finance professionals have had quite a negative attitudes to talk of paralles between the current situation and that prior to the Great Depression of the 1930's. Now that such comparisons are starting to appear in many mainstream publications, Scott Reynolds Nelson, a professor of history, in a guest post in iTulip.com, makes a claim that the 1930's depression is not the correct parallel with the current situation. Instead he makes direct parallels with the Real Great Depression that started with the panic of 1873. (Hat tip to Tim of The Mess That Greenspan Made)

When commentators invoke 1929, I am dubious. According to most historians and economists, that depression had more to do with overlarge factory inventories, a stock-market crash, and Germany's inability to pay back war debts, which then led to continuing strain on British gold reserves. None of those factors is really an issue now. Contemporary industries have very sensitive controls for trimming production as consumption declines; our current stock-market dip followed bank problems that emerged more than a year ago; and there are no serious international problems with gold reserves, simply because banks no longer peg their lending to them.

In fact, the current economic woes look a lot like what my 96-year-old grandmother still calls "the real Great Depression." She pinched pennies in the 1930s, but she says that times were not nearly so bad as the depression her grandparents went through. That crash came in 1873 and lasted more than four years. It looks much more like our current crisis.

He also provides a nice lithograph from 1875 that shows the get-rich-quick attitude of the time as people chasing bubbles that are blown by a devil-looking character. I have reproduced the lithograph here in a less compressed format from the US Library of Congress.

He also draws analogies to the global imbalances caused by unequal cost factors across the global marketplace.

Wheat exporters from Russia and Central Europe faced a new international competitor who drastically undersold them. The 19th-century version of containers manufactured in China and bound for Wal-Mart consisted of produce from farmers in the American Midwest. They used grain elevators, conveyer belts, and massive steam ships to export train loads of wheat to abroad.

[...]

The echoes of the past in the current problems with residential mortgages trouble me. Loans after about 2001 were issued to first-time home buyers who signed up for adjustable rate mortgages they could likely never pay off, even in the best of times. Real-estate speculators, hoping to flip properties, overextended themselves, assuming that home prices would keep climbing. [...] As in 1873, a complex financial pyramid rested on a pinhead. Banks are hoarding cash. Banks that hoard cash do not make short-term loans. Businesses large and small now face a potential dearth of short-term credit to buy raw materials, ship their products, and keep goods on shelves.

Wow. I hope that he is not proven right in this assessment.

Blowback from Economic Black Ops?

2008-10-06T22:17:00.002+03:00

I've been reading John Perkins' book "Confessions of an Economic Hit Man". It has made me think how much the oversized financial trouble in the economies of the developed world is at least partly an instance of blowback from economic operations that were initiated in the 1970's.

Perkins claims in his book that he was approached by people from the NSA in the beginning of his career as an economist in a big energy engineering company. (Chas. T. Main, now part of The Parsons Corp.). He was encouraged by the government people and his superiors to produce overly optimistic economic forecasts to encourage foreign governments to take huge amounts of debt for oversized development projects. The aim of this was to bring nations into debtor relationships with the US and the World Bank, thus retaining significant political control.

One paragraph in a chapter that is otherwise focused on the problems of modern Ecuador lit up a lingering thought that had been floating around my head for some time:

"During those tree decades, thousands of men and women participated in bringing Ecuador to the tenuous position it found itself in at the beginning of the millennium. Some of them, like me, had been aware of what they were doing, but the vast majority had merely performed the tasks they had been taught in business, engineering, and law schools, or had followed the lead of bosses in my mold, who demonstrated the system by their own greedy example and through rewards and punishments calculated to perpetuate it. Such participants saw the parts they played as benign, at worst; in the most optimistic view, they were helping an impoverished nation." [emphasis mine]

If this "operation" was as widespread as Mr. Perkins claims, it might actually have had an influence in the behaviour of underlings that observed their bosses coming up with and encouraging the most hyper-optimistic assumptions of economic development.

Because people do not just stay at a single job, untold numbers of workers might have participated in operations that were led by people secretly but intentionally working towards creating financial hardship. These people would take this behaviour as the normal way to do business. Some of those people that had early in their careers in the 1970's unwittingly worked in such projects are now on the very top of the business world.

The stream of thought in the financial world that just like that crosses straight over into hubris has been somewhat a mystery to me. This explanation, though only partial at best, is a very tempting one.

Naturally such operations could not be single-handedly responsible for the psyche of a whole generation. But it could have produced an additional amount of cultural acceptance for seemingly short-sighted practices of financial overreach.

It is, of course, also perfectly feasible that Perkins' book is not completely honest, but an elaborate attempt at trying to clean his own image. It can be a drag on one's conscience to witness the economic ruins left behind by sloppy or self-serving economic assessments.

Perkins' writing style does have a certain bit of self-centredness. (I was a hit man, but a conscious one.) The story also project an image of a person with such a level of cognitive dissonance that makes it somewhat hard to believe. Perkins' possible exaggerations of his moral discomfort in the early years doesn't necessarily mean that he is lying about the alleged government collusion.

As an idea, especially knowing of other operations of the US intelligence apparatus, the situation described by Perkins has some credibility. If these operations did indeed happen, a part of the financial trouble today can surely be ascribed to blowback from these (hopefully foregone) misdeeds.

Are the Liquidationists Starting to Raise their Heads?

2008-08-04T16:43:00.004+03:00

Princeton economist and NY Times columnist Paul Krugman makes an excellent point in his NY Times blog:

Ken [Rogoff] tells us that
The huge spike in global commodity price inflation is prima facie evidence that the global economy is still growing too fast.
And then he calls for
a couple of years of sub-trend growth to rebalance commodity supply and demand at trend price levels
Um, why? Basically, the world is employing rapidly growing amounts of labor and capital, but faces limited supplies of oil and other resources. Naturally enough, the relative prices of those resources have risen — which is the way markets are supposed to work. Since when does economic analysis say that the way to deal with limited supplies of one resource is to reduce employment of other resources, so that the relative price of the limited resource returns to “trend”?

Ken Rogoff's point can be understood in a more limited sense. We do need an actual reduction in the relative size of the financial sector, which has grown way out of its intrinsic value. But that doesn't mean that economic activity in itself should slow down.

The transition from financial labour to more productive uses does entail some amount of higher unemployment. It does take some time for all the extra mortgage professionals to find a more productive employment. But this process of adjustment has started to happen on its own. There is no need (anymore) to help it on by excessive tightening of monetary controls.

The instinctive reaction to long dormant inflationary pressure that is suddenly fully revealed is quite similar to a person in a rocket that has been launched in a gigantic thrust and is comfortably looking at the sky (growing asset prices). Then the upward momentum runs out (we are entering a permanently high plateu...). The rocket turns towards the earth (existing stimulus moves from assets to commodities).

Now what is the appropriate response? Some people have just only come to realize that we are way too high and heading downwards. Their instincts are saying: If we keep the thrusters on, we will crash into the earth.

But this is a wrong reaction. This parable is completely bogus. The "thrusters" have not been on for a while. And we are not in a rocket in which the thrusters are always behind us. What we have is closer to a hot air balloon (pun intended). The burners were on for too long when we left the ground.

Monetary stimulus works quite like the torch in a hot air balloon. It has no immediate effect on the level of lifting force. Instead it builds up a reserve of lifting force quite like the temperature in a balloon.

And we do need some extra lift to keep us from falling straight to the ground. We can not, and should not try to keep permanently high, or we risk running out of fuel. But we do need to slow down the fall.

But fall we will. The global imbalances are too great. But we should not try to accelerate these inevitable changes. They will manifest by themselves. We should try to land as fast as we safely can without running out of fuel.

Some people have been looking to the clouds far above, and have only recently come to realize how very far we actually are from the ground below. For some of these people the immediate reaction to the sudden realization is "full speed down!". This is the liquidationist viewpoint. "Puncture the bubble!". It could have been fine in the beginning (and some have been calling it as it is), but will result in a very hard landing if rigorously applied at this "altitude".

Our current altitude is a matter of reality. We have a massively out-of-size financial sector and a global economy that is quite heavily out of whack. Some people think that this condition can be kept forever. But should we attempt that, we would surely run out of fuel. We are actually quite close to that situation. And it would result in a crash just as devastating as the liquidationist approach, only somewhat later.

What we have is a pretty tricky situation. We should not aim for a permanent bubble. And we should not aim for immediate deflation. We should aim for a steady brisk pace of continuous adjustment until the financial "industry" is the size of its actual utility, productive labour has the value that it should, and people would by paid around the globe according to their actual productivity.

In that sense Ken Rogoff is right. We do need to head down. But we do need to head down by careful administration of the torch. Not by letting the balloon completely deflate.

And Paul Krugman is exactly right. There is no sense in underutilization of labour and capital. Closing down factories and cutting down production produces nothing but poverty. Collectively we can't keep wealthy just by holding cash or government bonds.

The currently low interest rates are more a function of people wanting to hold secure government bonds than any sign of excessively "loose" monetary policy. The Federal Reserve has actually been withdrawing money in its open market operations. The overall liquidity has been stagnant, while the money has been pumped back into the system through various special lending facilities.

Unfortunately US monetary policy is now quite irrelevant. Bank accounts are primarily made of promissory notes, and cash is just a tiny fraction. When banks stop lending, the money supply shrinks on each payment that the public makes to banks, including interest and equity injections.

Money came from thin air, and to the same place it disappears. And the less there are actual deposits, the less banks have any need for cash, and the harder it is to try to slow down the collapsing bubble through monetary policy action. The zero interest limit (and running out of "fuel") awaits.

Mechanical Economists and the Gold Standard

2008-07-28T17:10:00.005+03:00

Bill Bonner writes well in the Daily Reckoning Australia about the difference between the humanistic viewpoints of classical economists and the technical viewpoints of modern day economists.

The first economists - the two Adams, Adam Smith and Adam Ferguson - called themselves "moral philosophers." They were studying the human economy as though it were an anthill -- to see how it worked. They figured it must follow rules - just like all other things under Heaven - and tended to see mistakes people made, such as spending too much money, as moral failings.

Modern economists are more like auto mechanics. They think they can control the economy with a screwdriver. And to some extent they're right. Which is why the world economy is in such a mess; they turned the wrong screws. But it's why we moral philosophers are having such a good time; finally, we get to laugh and say "I told you so."

Economic activity is inherently a human process, and economists would need a lot more understanding of psychology (especially mass psychology) and philosophy. Instead, they tend to treat economics like it was a branch of engineering. This is most strongly evident in the modern field of "financial engineering".

But Bill Bonner has a strange fixation on the gold standard, which is actually not so relevant in this issue. He writes:

Since then, the U.S. government could print almost as many dollars as it wanted. Arguably, it printed too many. For something - perhaps it was too much cash and credit in circulation - led American homeowners to think house prices would rise forever.

In this case it is mostly too much credit. Growth of cash has been relatively sluggish (except in the far east and the Euro zone). The reality is that the credit decisions of commercial banks are not tied to the amount of cash anymore. Reserve requirements have been taken to practically zero. And this has happened in a regulatory environment that has the near equivalence of cash and credit as a base assumption.

In earlier times, before the deregulatory wave of the last 30 years, banks were forced to acquire a certain amount of cash for each accepted promissory note. But this is not so anymore. The last major relaxation in the US was in 1995 when retail sweeps were taken into use. There is almost nothing in these regulations to relax anymore. Banks have been able to magic deposits from thin air by accepting huge amounts of promissory notes at a negligible opportunity cost.

This relaxation has been a main cause in the growth of speculative flows as well. When banks can accept a promissory note at zero cost to cash reserves, it is very easy for them to lend huge amounts to speculators that make leveraged short term bets on price fluctuations.

In earlier times banks had to find actual depositors for a fraction of each dollar that they lent out. But now they have almost no opportunity cost at all.

Without cash reserve requirements, the only thing that is left to limit the growth of credit is solvency, either regulatory solvency in the form of capital requirements, or actual solvency. It is only natural that any lower limits of a self-enforcing process will eventually be reached, so here we are, exactly where the deregulators put us, either willfully or unwittingly.

More importantly, the lack of reserve requirements has essentially decoupled the financial economy from any actual monetary policy. When no cash reserves are needed for the growth of credit, a gold standard would not have necessarily saved the banks from this kind of a "race to the bottom".

In a certain sense, a gold standard would have been a fear factor for the bank owners. It would have made many of the ongoing bailout efforts much more difficult, thus raising the impact of the current crisis. This would have encouraged more strident risk controls from bank equity investors, but not in any binding way.

Bill Bonner's orthodox take on the gold standard creates a strange contrast with the philosophical and practical outlook of the classical economists that he so admires. A strict attachment to a crude and inflexible tool like the gold standard is more like a mechanistic view of the economy.

After all, gold has no practical inherent value at all. It is durable and its quantity is hard to manipulate. But it has been responsible for some of the most useless undertakings in human history, like gold rushes, military adventures, occupations and wars.

Money can also retain its value too well in some situations. In a deflationary spiral, money is seen to have a rising value. But cash should only have value as a medium of exchange. It should not be infinitely storeable. Value is only in what goods or services people can provide to each other, not in some heavy and soft (if quite pretty) metal in a safe.

The purpose of monetary policy should be aimed at keeping people from excessive hoarding or excessive consumption, either of actual goods or of the medium of exchange. The only way to create actual savings is to invest in capital goods (no, commodities are not capital goods) that have a value in being able to produce goods and (increasingly) services.

Dictatorial Powers for the US President

2008-07-25T10:23:00.004+03:00

Andy Worthington (author of "The Guantánamo Files"), has written a good review of the recent US 4th Circuit Court decision against Ali Al-Marri, a Qatari national and legal resident in the US.

This decision has upheld an indefinite military detention, as an "enemy combatant", of a person that has never raised arms against the US. It gives the US president the authority to designate just about anybody as an "enemy combatant" on the basis of hearsay "evidence" of assumed intentions.

Mr. Worthington finishes with a strong quote from the verdict's minority opinion:

I leave the final words to Judge Motz, and her clear-eyed awareness of the injustice of the al-Marri verdict. “To sanction such presidential authority to order the military to seize and indefinitely detain civilians, even if the President call them ‘enemy combatants,’ would have disastrous consequences for the Constitution –- and the country,” Judge Motz wrote. “For a court to uphold a claim to such extraordinary power would do more than render lifeless the Suspension Clause, the Due Process Clause, and the rights to criminal process in the Fourth, Fifth, Sixth and Eighth Amendments; it would effectively undermine all of the freedoms guaranteed by the Constitution. It is that power — were a court to recognize it — that could lead all our laws ‘to go unexecuted, and the government itself to go to pieces.’ We refuse to recognize a claim to power that would so alter the constitutional foundations of our Republic.”

Unless Ali al-Marri is allowed a meaningful review of his status as an “enemy combatant,” Judge Motz’s fears have already come true.

The Onion: Recession-Plagued Nation Demands New Bubble To Invest In

2008-07-17T23:00:00.002+03:00

The Onion hits the nail on the head with a piece of satire on the state of the US economy.

A panel of top business leaders testified before Congress about the worsening recession Monday, demanding the government provide Americans with a new irresponsible and largely illusory economic bubble in which to invest.

"What America needs right now is not more talk and long-term strategy, but a concrete way to create more imaginary wealth in the very immediate future," said Thomas Jenkins, CFO of the Boston-area Jenkins Financial Group, a bubble-based investment firm. "We are in a crisis, and that crisis demands an unviable short-term solution."

Go ahead and read the whole piece. It would be quite hilarious if it wasn't so accurate.

Investors Worrying about Cheap Stocks?

2008-07-01T19:00:00.003+03:00

Carter Dougherty writes in the New York Times under headline "Falling Prices Grip Major Stock Markets Around the World":

As the United States markets edge toward bear territory, losing nearly 20 percent of their value from last fall’s peak, investors might wonder where they can turn for relief.

The gloomy answer: nowhere.

This is a pretty typical viewpoint in the financial world. But there are two sides in every transaction: The buyer and the seller. There are a lot of people, predominantly young, that are currently accumulating their savings. They are looking for a place to park their surplus earnings.

These are the people that fit mostly under the headline of "investors". For these people, a stock market that goes cheaper is a very positive thing. Of course the situation would be better, if the price declines would not be preceded by even higher profit declines. But a lower price level is always preferable to a higher one if one wants to make long time investments.

The same situation was clearly visible in the real estate market. One person's unearned equity was another person being priced out of the market or going into crushing debt. There are a lot of young couples that are breathing a sigh of relief in the face of plummeting house prices. But there are also a lot of young couples in serious negative equity.

Then who are the people that are losing in a bear market? Naturally most damaging it is to people who are drawing from their savings, such as the baby boomers who are at the start of retirement. But they are not "investors" any more. They are more accurately referred to as "divestors".

So why are the baby boomers losing out on their savings? Simply, they have already eaten those savings, by letting the businesses that they have invested in take on huge debts to create premature earnings, dividends and market valuations. A huge part of future income has been already paid out, just like in the housing market. Many companies, like GM, are like squeezed oranges. Completely devoid of any significant equity. And this is at a time when those savings would really be needed.

Baby boomers have also taken out a significant portion of future taxes, which will be paid by the younger generations. Now that there is a day of reckoning, many divestors that are losing out on their investments are going to cry to high heavens. But one can't eat one's cake and save it too.

End to Price Controls by Central Banks

2008-05-24T08:22:00.002+03:00

It is becoming to be quite evident that control of short term interest rates by central banks is prone to be a cause of market disturbances, including speculative manias and crashes. Financial bubbles have of course existed much before the existence of central banks. The current problem, however, is a common problem in situations where prices are set by a third party that is not fully in control of supply. Such price controls cause both rampant overproduction or overconsumption and shortages, depending on whether the prices are set too low or too high.

Central banks used to be in control of the supply of money, but since the early eighties, they have given this power away by drastically reducing reserve requirements of commercial banks. This means that commercial banks are now primarily in charge of the development of the money supply.

This divergence between the power to control prices and the power to control supply is inherently unstable, so we have to go back to the old days of strict control of bank lending, or we have to go forward to release short interest rates from the clumsy control of central monetary authorities.

Central banks seem to be aware of their loss of control, but there does not seem to be much thought about what this implies. Price controls by decree without control of supply have been found to be a bad solution to economic problems.

Discussion of the possibility of US Federal Reserve paying interest on bank reserve balances has been a hot topic earlier this month. The Fed seems to be working towards implementation of an interest rate corridor policy, which has already been adopted in Canada, UK, and New Zealand.

In this system, the central bank sets both a lower and an upper bound for the interest rates of over-night inter-bank loans. This is accomplished by paying a minimum interest on cash balances at the central bank. There is no reason for banks to offer loans to other banks on interest any lower than that. The upper limit is the discount rate, at which banks can borrow directly from the central bank.

A 2006 paper titled "Monetary Policy Implementation Without Averaging or Rate Corridors" by William Whitesell discusses a third alternative for monetary policy application, but the focus of this paper is hopelessly fixated on how the central bank could fix the inter-bank interest rates as tightly as possible. What is missing is any discussion of the sense in trying to achieve such a rigid goal in the first place.

My intuition would tell me that a fixed interest rate for short term lending is inherently a bad thing. Lending rates should accurately reflect the existing earning opportunities and costs of investment activity. A misalignment between opportunities and policy rates create bubbles of hyper-active speculation, because of seemingly risk free opportunities for arbitrage between short term borrowing and lucrative investment opportunities. On the other hand, a misalignment between costs and policy rates create unnecessary slow-downs in investment and savings.

An ideal would be a market-determined interest rate that would dynamically reflect changes in actual opportunities and costs. When a dislocation would suddenly create an investment opportunity, there is always a risk of a speculative bubble. Short term interest rates should react swiftly to sudden increases in demand for credit. If the opportunities are real, it is only just that the savings customers of banks get their fare share of the investment income. If the opportunities are a mirage, the sudden rise in interest rates would quickly deflate the emerging speculative bubble without letting it gather too much steam.

I have been thinking of a mechanism by which central banks could fulfill the function that they were created for, ie. liquidity support, without actually engaging in direct control of interest rates.

First let's be clear about what liquidity actually is. Liquidity is a multi-faceted concept. It has something to do with the volume of trade. It has something to do with transaction costs. Liquidity is not a synonym for lack of volatility, which is possible in perfectly liquid assets.

Liquidity can probably be best described by insensitivity of market prices to a unit volume of trade transactions. It is also related to the amount of losses incurred by simultaneous buying and selling in a single market.

In a trading system there is a certain volume of bidding and asking at different prices. In a real time system, there is a gap between these. This bid-ask spread can be used as a quite reliable measure of liquidity.

I have been thinking of a liquidity provision system through a dynamic interest rate corridor. Instead of a policy rate, set by a committee, the central rate of the corridor would be based on a market average.

In such a system, all interbank lending would pass through a transaction system that is managed by the central bank. The central bank gathers pricing information from this system, and determines an average market price. A suitable margin is then put around the central rate to determine an interest rate corridor. This corridor guarantees a maximum bid-ask spread, ie. a minimum liquidity, at with banks can directly transact with the central bank.

The central rate could be calculated by taking a significant amount, say $100 million, of both the highest asking rates and the lowest bids. By taking a weighed average of these, a neutral market rate would be determined. A meaningful bidding amount should be used for the determination to prevent market manipulation with insignificantly small bids.

Banks would be free to transact with the central bank at the corridor rates, but they could still get better rates by bidding inside the corridor. The corridor should be wide enough for everyday trading to occur between the market participants. But in times of uncertainty, when the spread would otherwise be stretched uncomfortably wide, there would still be a guarantee of minimum liquidity from the central bank.

In times of stress, such a market-based interest rate would be equally uncomfortable to both sides of the market, which is as close as one can get to neutrality. A strictly enforced policy rate, on the other hand, can create highly biased situations, in which either the lender or the borrower would benefit at the expense of the other.

I am quite completely ignorant of most issues of monetary policy, but I would hazard a guess that the level of activity in such a dynamic interest rate corridor could be used as a measure of monetary conditions. Persistent borrowing from the central bank could be a sign of the need for increasing reserves. Persistent deposits would signal a need for reduction.

Commodity Inflation and the Missing Wage/Price Spiral

2008-05-05T21:09:00.005+03:00

Why are commodity prices rising worldwide? What does that do to western inflation pressures?

Permanent inflation is not possible without a wage/price spiral (the more usual term wage/price spiral has the cause and the effect backwards). There might be such a thing in China, but not in the strength that some foodstuffs have risen lately. In the US there seems to be no such thing, except for an insignificant 1 percent of the population. This fraction might be significant enough for gold, maybe, but not for other commodities.

So clearly this price growth is at least partly a financial phenomenon. I would say that it has been probably started by a spurt of speculative growth, based on a limited underlying fundamental scarcity, a surge of short term credit from central banks and a dearth of better speculative prospects. After all, one can't do much other than speculate on short term capital.

But this speculative start was most probably amplified by sudden hoarding by actual consumers, who were frightened by the initially speculative price surge. This hoarding has generated an actual (but temporary) shortage in some basic foodstuffs, like rice and wheat.

Some people, like Paul Krugman, have proposed that inventory levels do not support the speculative hypothesis. I think he is pretty much right when it comes to the gradual price development of oil and metals. But I think that the unofficial inventories created by simple consumer hoarding, which is just as speculative as anything, is quite enough to explain the extreme price movements of basic foodstuffs.

Let's study another example: Was there a big inventory of houses as a sign of the growing speculative bubble? No, there was a perceived shortage of houses, caused by consumer hoarding, ie. the inventory was held by the house flippers. The same goes with foodstuffs, and might go on with metals as well. End users are always hoarding somewhat when there is an expectation of price increases.

Such hoarding can create a false signal of shortage, which can then be met by a surge of overproduction and a price collapse, when consumers have filled their cupboards and return to normal consumption. When prices stabilize, they start to unwind their inventories, which results in a fall in demand to even lower levels than the actual consumption. This gives the consumers incentive to draw down their inventories as low as possible in expectation of further price reduction.

So what will happen in the western world where any evidence of a wage/price spiral just isn't there. An equation of rising cost of living with stagnant wages is not sustainable in the long term. In the Western world, there are, of course, significant "buffers" until people start to go hungry. What if we add ever extending credit into this equation? Growing debt repayment makes this equation even more unsustainable, as in prone to a violent snap-back effect. Credit is no substitute for income.

As wages are not going to grow, either prices or consumption must (eventually) come down. Debt will be simply defaulted on. People haven't understood that "free money" only refers to the interest, not the principal. One can not consume something today without giving up something tomorrow. If nothing else, then your credit score.

Unless wages are going to follow prices, there is going to be an eventual price deflation, no matter how much baseless credit is extended. US monetary base has been stagnant for two years. The Chinese have probably prevented massive printing with the nuclear option of massive Treasury liquidations.

An ounce of gold is always going to be worth an ounce of gold. There is no reason why its value should change (or not change) very much against other durable if nonproductive assets, including little green pieces of paper that can be used for paying taxes. But there are precious few (0.8 trn) pieces of green paper, compared to the mass of promises to deliver those pieces of paper on a later date (25 trn).

In these circumstances, the value of those few little green papers might actually rise significantly. But wouldn't that be an intolerable atrocity, because those little green papers are just little green papers, right? They can't be used to produce anything, except that special something, which until recently used to be called "AAA". But nowadays everybody knows what those three vowels really stand for, and that ain't much. So isn't it just appropriate that those little green papers should lose their value along with the worst of IOUs written on a paper napkin with lipstick?

Don't let yourself be fooled. Good credit still exists, even though "AAA" has lost its significance. Looking at how US stores have become a bargain basement for foreigners, it seems that the US dollar does have some value after all. Dollar has been getting a lot cheaper, but has it really lost value? That of course depends entirely on what you are going to buy. ("Price is what you pay. Value is what you get.")

BTW, since GDP is a measure of added value, shouldn't US GDP statistics for the last ten years be revised downwards for the "value" that is now melting away from housing? That value was never actually created, after all. It was just a pricing mistake. Think about that.

Since the instruments of exchange (promissory notes, not to be confused with cash) that were used to create those imaginary valuations are still in circulation, they will find a home somewhere else, like basic commodities. But those are still just promissory notes. They are not little pieces of green paper. I guess the Federal Reserve could convert all kinds of promissory notes to little green pieces of paper, but that wouldn't do the US external credit very much good at all.

So first the US economy was producing value in dotcoms, then in housing, then in commodities. Then what? How much of all that added value still exists? Maybe a little more than the value of a pair of collapsed Bear Stearns hedge funds. But all is fine as long as the fund managers get their 2 and 20 from each successive bubble.

Unfair competition from Northern Rock

2008-03-12T15:55:00.002+02:00

From The Guardian:

Northern Rock offers a number of table-topping accounts, including an online account aimed at the over-50s paying 6.49% and a fixed-rate cash Isa with a rate of 6.2%. Its one and three-year fixed-rate savings bonds paying 6.45% and 6% respectively are also listed as best buys on the website of the financial data provider Moneyfacts.

Not only are the interest rates good, the state-owned Northern Rock, unlike other high street banks and building societies, can offer its customers a guarantee that any money in its accounts - whether it is £1 or £1m - is 100% secure.

The bank says its customers' cash is "completely safe ... The Bank of England and HM Treasury guarantee arrangements protect all savers in all accounts, regardless of the amount deposited, and applies to all existing and new accounts".

Ugh. "Give us your money. The UK taxpayer will be glad to give you a handsome return on you deposit."

More Shortsighted Dollar Speculation

2008-03-12T15:04:00.003+02:00

From FT.com:

EADS, the Franco-German aerospace group, is preparing to adjust to a “weaker and weaker US dollar” by demanding that its big European suppliers bid for new contracts in the US currency, according to Louis Gallois, chief executive.

Not a good idea when the US dollar is in its weakest. Euro seems more and more like a bubble against the US dollar.

When US deflation hits in force--because US financial institutions have no choice but to reduce leverage--the dollar will start to regain its value. Of course, it might take a long time for the euro-bubble to pop, but it will happen.

For EADS this might be feasible, because much of its income is in dollars as well, but there's no doubt that those suppliers will put considerable risk premiums into their bids for the currency volatility.

European Companies Are Borrowing in Dollars

2008-02-21T17:31:00.003+02:00

Financial Times reported about European companies borrowing in dollars:

European companies are increasingly being forced to turn to the dollar markets to raise funding as the credit crunch makes it almost impossible for them to launch deals in the euro-denominated market.

This is going to hurt these European debtors when the euro inevitably comes down from its overly high valuation. The draught in euro-denominated bond investment is probably a sign of disbelief in the sustainability of the euro's high exchange rate against the dollar.

European money supply growth has been much higher than its US counterpart, especially in the narrow sense, and the emerging deflationary environment is just raising the actual buying power of the US dollar.

Europe is fundamentally just as over-leveraged as the US. The possibility of a deflationary trend in Europe should not be dismissed as a possibility, at least when it comes to the property markets. The biggest differences are in the levels of consumer debt. High corporate leverage is not as prone to cause deflation as excessive consumer debt is. UK is closer to the US in this sense, but it is not a part of the European monetary union.

About the Theory of Efficient Markets

2008-01-19T13:49:00.001+02:00

I have just read a book, The Crisis of Global Capitalism, by George Soros. It was written in 1998, but oh so fit for 2008. Soros is a critic of the efficient markets hypothesis. I think he is right in saying that markets do not succeed in finding a balanced state, but act instead like a wrecking ball that swings uncontrollably around a point of stability.

In this book he describes a phenomenon, which he refers to as reflexivity. In systems that are made up of humans, like all markets obviously are, the ground truth is not independent from those that are trying to observe it. Instead, there is a constant bidirectional relationship between the observers and the observed. Similar problems are encountered in observing elementary particles, hence the Heisenberg uncertainty principle.

The book was written as a reaction to the Asian financial crisis and the Russian collapse. These events started a strong flow of capital to the established capital centers of New York and London. These flows made up the peak of the tech bubble. They were further prolonged by loose monetary policy. Now we are observing the turning point, where the wrecking ball hits the wall and turns back towards the point of stability.

If we want to actually reach the point of stability and stay there, there would have to be some kind of forces that would slow down the velocity of the ball while it speeds towards the point of stability. At the current situation, the global financial system is like a car without shock absorbers.

Every automation engineer knows that dampers are essential for stability. Why is it so hard for economists to realize that?

Credit Default Swap Counterparty Risk

2008-01-19T12:43:00.000+02:00

The enormous amount of counterparty risk that is associated with the $45 trillion market in credit default swaps seems to be finally hitting the radar screens of mainstream news outlets. Unfortunately this reporting interest is way behind the curve, as the said counterparty risk is being triggered in a big way in the problems of the ACA Financial Guaranty Corp.

The Wall Street Journal published a front-page article titled "Default Fears Unnerve Markets" by Susan Pulliam and Serena Ng. It is an excellent overview of the troubled CDS market.

Today, a struggling bond insurer, ACA Financial Guaranty Corp., will ask its trading partners for more time as it scrambles to unwind more than $60 billion of insurance contracts it sold to financial firms but can't fully pay off, according to people familiar with the matter. The contracts were intended to protect Wall Street firms from losses on mortgage securities and other debt they own.

The problem is that the insurer itself is teetering -- with repercussions across the financial world. Some of its trading partners, called counterparties, already are writing off billions of dollars because of its inability to pay.

This is the reason why some deals that looked like "free lunches" in February 2007 are not so free after all.

With many bond values falling and defaults rising, especially in the mortgage arena, some institutions involved in these trades are weakened. This has investors and regulators worried that, through such swaps, some market players could spread their own problems to the wider financial system.

"You are essentially counting on the reliability of strangers" to pay up on their contracts, notes Warren Buffett, the Omaha billionaire. In some cases, he says, market players can't determine whether their trading partners have the ability to pay in times of severe market stress.

What the article omits, though, goes even further. It doesn't mention that a very big part of these CDS contracts are written by synthetic CDOs that are by definition not prepared for major payments at all. If they were, they would not have been closed in the first place.

The current problems are all derived from the proliferation of belief in the efficient market hypothesis. This theory, which posits that market valuations carry meaningful information about the real world, is basically self-defeating.

A high proportion of credit market participants look at prices, believing that those prices actually represent expectations of future defaults, which they do, initially. Then those market participants start to make investment decisions based on the price level, resulting in even smaller risk premiums. These same investors now think that the reduction in risk premiums is a signal of lower risk, even though the price reduction was caused by their very own uninformed investment decisions.

This is just like Winnie the Pooh following his own tracks in the snow, round and round again, until a moment of truth arrives. The music stops, and some of the players are left without seats.

The Unsustainable Level of Public Debt in the US

2008-01-18T21:55:00.000+02:00

A very sobre analysis of the problematic US debt situation was published in the Houston Chronicle this week. The column, titled "Wake-up call's for us all", was written by Loren Steffy.

On Monday, Moody's Investors Service, one of the credit-rating agencies that blessed those pungent loans that now beleaguer Citi and Merrill, warned that the U.S. could lose its triple-A credit rating within a decade.

That's a wake-up call for the rest of us.

We are addicted to spending. We buy based on want rather than need or ability. The bills are a worry for later, a someday that we postpone like a dentist appointment.

When the unsustainability of the US public debt becomes increasingly mainstream, it is going to be interesting to see the diversity of proposed solutions. It is a certainty that some of the proposals will contain fascist or other authoritarian ideas. It's going to be a hard time for champions of anti-authoritarian ideals.

Nostalgic for a Crack-Up Boom

2008-01-07T17:54:00.001+02:00

An article titled "And the good news is ... hard to find" in the Observer by Ruth Sunderland discusses the developments in the financial markets.

It is hard to recapture the mood of this time last year. In January 2007, the City was still riding high, private equity was still on its buying spree, shoppers were still spending, house prices still soaring and Gordon Brown was still hailed as a paragon of economic competence. Northern Rock still seemed a decent bank; it delighted shareholders by kicking off the reporting season with a hike in its dividend, largely in anticipation of new rules that would allow it to hold less capital.

This paragraph is a perfect description of the sources of the problems at hand, which are caused by a runaway crack-up boom. Unsustainable credit expansion is initially caused by lax monetary policy, then further sustained by irresponsible dismantling of the financial safety buffers. Those buffers would have been provided by demanding reasonable levels of capital in depository institutions. Instead, the level of leverage in the system was allowed to grow like there's no end.

What leaves me wondering, is how Ms. Sunderland can write with such a longing tone for such a destructive trend. Did she really expect such financial self-destruction to go on forever? What is so wonderful about house prices soaring to levels that are out of the reach of first-time buyers?

It is indeed very hard to recapture an irrational and sentimental mood while being face-to-face with harsh reality. The humongous pile of bad debt that was created by this stretch of irrationality is now backing the savings deposits of the whole industrial world. The depositors are screwed, no matter which way the situation is defused. In the UK, it seems that the burden is going to be put on the taxpayers.

Binge Drinking and the Difficulty of Changing Course

2007-12-30T21:41:00.000+02:00

Psychiatrist Paul Steinberg wrote an interesting op-ed article in the New York Times about the permanent effects of binge drinking on the human brain. He discusses the results of experiments with lab rats that indicate that a period of heavy drinking causes difficulties in not learning, but specifically relearning.

When put into a tub of water and forced to continue swimming until they find a platform on which to stand, the sober former binge-drinking rats and the normal control rats (who had never been exposed to alcohol) learned how to find the platform equally well. But when the experimenters abruptly moved the platform, the two groups of rats had remarkably different performances. The rats without previous exposure to alcohol, after some brief circling, were able to find the new location. The former binge-drinking rats, however, were unable to find the new platform; they became confused and kept circling the site of the old platform.

The article is written as a general warning for the forthcoming new year's eve celebrations, but it also contains a choice of words that really beg for an association with a certain individual case.

The binges activate an inflammatory response in rat brains rather than a pure regrowth of normal neuronal cells. Even after longstanding sobriety this inflammatory response translates into a tendency to stay the course, a diminished capacity for relearning and maladaptive decision-making.

Maybe it's not intentional, but I could not avoid making the association to GWB.

The article has some comforting tips for recovering. Exercise has been shown to help recovery in rats. Maybe I should adjust my attitudes to exercise. I could do with some additional relearning capacity.

Nobody Knows?

2007-12-22T11:05:00.000+02:00

Here is a hilarious quote from The Economist:

Nobody yet knows whether the extreme borrowing in the credit boom was a sensible result of the powerful new machinery of debt, or the sort of excess still unwinding in Japan.

That certainly is a tough thing to decide, but I do think that a lot of people have at least a pretty strong hunch about it.

Oil Depetion in Mexico

2007-12-20T14:45:00.000+02:00

The Economist wrote about the problems that the world is facing with the rapidly depleting Mexican oil fields, especially the giant field Cantarell:

This flawed behemoth is now in “a race against time” to compensate for Cantarell, says Fabio Barbosa, an energy specialist at Mexico's National Autonomous University. It is a race that Pemex seems likely to lose. In a document released in December setting out its strategy for the next five years, the energy ministry forecast that total oil production would decline to 2.5m b/d unless policies were reformed, and would remain roughly constant even if the industry were liberalised.

This is partly the result of two wasted decades in which governments have milked Pemex of cash which it might otherwise have invested. That has begun to change: investment in exploration and production doubled between 2000 and 2006 (though much of the increase came through federal debt guarantees to private contractors). Mexico's president, Felipe Calderón, has pushed through a reform of public finances that will cut the royalty Pemex pays from 79 centavos on every peso of oil it extracts to 71.5 centavos by 2012. The company expects its capital spending to rise in 2008 by 20% in real terms.

This is correct in a certain sense. Additional investments might have kept up the trend of production levels. But think about this: Does it really make much sense to spend enormous amounts of money to accelerate the already high rate of depletion? Does it make sense for Pemex to invest heavily so that it can drain its reserves dry even faster?

Crude oil is a non-renewable resource with a finite supply. At some point there comes a time when it doesn't make any sense to keep increasing up the output, as this would have a negative effect on the return to investment. A higher flow rate from a heavily depleted resource base means a lower flow rate later on, with an ever increasing cost for keeping up the rate up.

Many oil producers are entering a phase where additional investments to uphold rates of extraction just don't make any sense. It will actually make economic sense to leave as much oil as possible to the future, where prices will be significantly higher. The producers will ultimately try to maximize the total value that they can extract from the remaining reserves, and all investments will be directed at increasing the ultimate volume of recovery instead of maximizing the rate of production.

Many economists are feverishly trying to debunk the idea of a global peak of oil production in the near term. They claim that developments in engineering and economic incentives will keep the rates of extraction on an upward slope virtually forever. This is a fallacy of demand driving the supply, which was true in the earlier years of oil production. Nowadays, the roles of supply and demand are rapidly reversing, and there is a whole new situation of increasing competition for a stagnating supply.

The truth is that it makes perfect economic sense for individual producers to let the flow steadily wind down from a peak level, which is determined by economic and geological circumstances. From that point on, the rate of extraction can be increased through political decisions that have nothing to do with economics and everything to do with geopolitics.

Buying Power Disparities and Corporate Profits

2007-12-07T14:18:00.000+02:00

The Economist wrote yesterday about the prospects for corporate profits in 2008:

The big question is not whether 2008 profit estimates will have to be revised down; they almost certainly will. It is whether this shift marks a short-term cyclical setback or something more structural as profits retreat from the 40-year-high share of economic output that they notched up in 2006.

The optimists argued that profits could stay high because the balance of power had moved in favour of capital and away from labour, thanks to the globalisation of the workforce. But perhaps profits had been boosted by accommodating monetary policy, a credit boom and the associated surge in asset prices. In other words, financial services may have dragged the rest of corporate America up. If the credit crunch has a long-lasting effect, the banks may end up dragging corporate America back down again.

This imbalance of earnings between capital and labor is going to be corrected eventually. Since the 1970's, the proportion of income that is earned by the labor force has been declining. Corporate profits are taking an ever higher chunk of the GDP in most developed countries.

The sound idea of Henry Ford, that workers should be able to afford the things they are producing has been completely neglected. The fundamental unsustainability of this disparity has been masked by ever growing levels of consumer debt.

Now we are seeing the results of this unsustainable development. The average American consumer is now at the end of his ability to go any further into debt. American levels of consumption have not been truly affordable in years, which has been reflected in the huge current account deficit. Now the American current account deficit is starting to morph into a significant capital account deficit. The capital account deficit for the third quarter (published Dec 17) is probably going to be huge, in the tens of billions of dollars, due to the loss of credit since August.

A reduction of western over-consumption is probably unavoidable. It might even be considered a welcome development for ecological sustainability, but the level of compensation for workers in the developing world has to pick up quickly so that they can absorb a significant part of the existing production without too much panicky destruction of productive capacity that would be caused by a rapid deflationary wipe-out of fictitious capital.

There are two possibilities. Either the proportion of global GDP that is earned by the workforce is increased through wage negotiations, or there will be a significant deflationary trend that will take care of it.

Buying power disparities will be corrected through either wage adjustments or price adjustments, or a combination of both. Protracted abuse of under-paid workforce will eventually result in a loss of wellbeing for all of us.

Hedge Funds and Low-Frequency Volatility

2007-12-05T16:34:00.000+02:00

The Economist writes in an article titled "Crunch Time":

Perhaps this will be the pattern for markets for some time: a breathtaking switchback ride as risk-seeking investors try to take advantage of short-term trends (and by their actions, make those trends more vicious). But that does raise the question of why volatility was so low in the period 2004-2006. After all, plenty of hedge funds were in existence during that period.

Volatility was not low in 2004-2006. It was extreme. Prices were rising everywhere, especially in the housing sector. This is a form of volatility, also known as a crack up boom. Prices going up fast, later coming down just as fast or even quicker. What is that if not volatility?

This kind of volatility just happens to have a bit lower frequency. But it's the amplitude that really matters.

Hedge funds where going fast in 2004-2006. They were just all running in the same direction. Now they are acting like headless chickens until the herd finds a direction again, but they have to keep running even faster in order to make up their existing losses.

The usual hedge fund payment structures are a very strong incentive to using Martingale strategies, due to the "high water marks" in their payment structures. The managers' fees are stopped until all losses are recovered, even from unreasonably high speculative peaks.

This is of course completely reasonable. The managers have already been paid for the peak. Paying for it again would actually encourage volatility. Many hedge fund managers have instead decided to just call it quits instead of trying in vain to reach former highs, leaving the managers paid at the top and the investors paid at the bottom.

The economy reflects exactly the kind of behavior that these payment structures encourage. A long hard push to the top. What comes after that, doesn't matter. The managers have already been paid. If investors want fund managers to think about their interests, they should make the managers share the losses as well as the profits.

Providers of leverage should be extremely careful at this situation. Hedge funds will not stop after losing investor equity. They will eat right into margin debt if they are let to.

Pretty soon they will all settle into a direction opposite to that in 2004-2006. They will plow the market deep underground until they change direction again in a similarly disorderly way.

Extremist Hawks and Violent Radicalization

2007-11-28T21:20:00.000+02:00

William Fischer writes in antiwar.com about the "The Violent Radicalization and Homegrown Terrorism Prevention Act" that is being put through the US legislative process. The act contains some definitions that enable really wide interpretations.

The act defines "violent radicalization" as "the process of adopting or promoting an extremist belief system for the purpose of facilitating ideologically-based violence to advance political, religious, or social change". Thought crimes, here we come. Who is capable of determining the "purpose" of believing in something? Who can say what is and is not "extremist"?

That definition is actually quite a fitting description of some of the most radically hawkish thinking in the US. If some of the activities of the people that were pushing for the war in Iraq were not cases of "promoting an extremist belief system for the purpose of facilitating ideologically-based violence", then nothing is. The same goes for the insane calls to nuke Iran, for example.

Extremist hawks should be careful in pushing through legislation that could be used to judge their own actions as well. The whole US political process since the 9/11 terrorist strikes has been an exemplary case of "violent radicalization". Mental projection—seeing one's own traits in others instead of oneself—is a powerful force in the human psyche.

Central Bank Transparency and Speculation

2007-11-18T12:37:00.000+02:00

Comparing the levels of transparency in the US and UK central banks, Michael Shedlock, of "Mish's global economic analysis", writes:

Now that's candor and true transparency. In the UK, rate cuts are "penciled in" while the Fed disingenuously calls the risks balanced. In the UK there is talk of falling commercial real estate prices. In the U.S. the Fed knows commercial real estate is staring over the abyss but no one talks about it. While King says financial turmoil is "far from over", the Fed's Poole says "the market is healing".

I beg to differ. Even if Mervyn King is now talking straight, it does not deserve the name of candor and transparency. King has started to talk about the problems now that the problems are already self evident. He would make an ass of himself, if he was still trying to talk up the situation.

Compared with the people at the Fed, he is, of course, a paragon of virtue. The general US belief in the power of jawboning is quite ridiculous, and a fitting symbol of the insubstantial nature of the conceptual US economy. In the typical American mental state, only marketing is important, whether it is related to economic or political products.

If there was real wisdom and responsibility in the central banks, they would start talking when the problems are building up, not when a catastrophe can no longer be avoided. Mish writes:

Does anyone ever recall Bernanke, Paulson, Bush, or for that matter any Fed governor actually giving a genuine warning about possible economic malaise? Compare and contrast all of the above with the following.

Alan Greenspan had a moment of candor, when he tried to take up the issue of "irrational exuberance" in the early rising side of the dot-com bubble in December 1996. Unfortunately he was too weak to resist the shouting down by people with vested interests in blowing up the bubble.

So now Mervyn King is talking, when the damage has already been done and a catastrophe is imminent. Words of caution would have been so much more useful, if they had been uttered in the height of the hubris. But it takes a lot of courage to speak against a prevailing trend.

Central banks should be proactive in working against trends that have no cause in the underlying fundamentals. They should be actively discouraging useless speculation. It's a hard and ungratifying job, but price stability is in the interest of everybody in the long term.

Mish quotes an article from Bloomberg:

Bernanke said yesterday that Fed officials will add a third year to their forecasts and double the frequency to once a quarter. The reports will give investors and companies more details on why interest rates were adjusted and offer a map for where they are likely to go.

In promoting price stability, central banks should use their statements as a means of spreading information about fundamental aspects that have an indisputable effect on the values of assets. In this sense, the move to even longer term forecasts in central bank statements is a negative.

Central banks should discourage investment that is too heavily based on forecasting. They should have their focus on intrinsic values, and speculative trends that go against it. They should be making it clear that whenever they see excessive speculation, they will move against it. And they should back up their words with action, withdrawing the means of continuing speculation.

To make it clear, I am not promoting a tighter monetary policy at this state of affairs. The time of tightening has long gone. The credit market has already been forced to tighten itself dramatically. It is exactly this situation, where excessive looseness has resulted in a forced tightening at the worst possible time, that could have been avoided by a tighter monetary policy a few years earlier.

But the Fed should be honest about the situation. Even if it means a more rapid crash. A rapid crash might actually be better, because normal economic activity would return sooner, and the losses would be incurred by the speculators that deserve them. In fact, it would be best, if the crash in paper values would be so quick, that the real economy would not have time to react.

If the decline in paper values is prolonged, there will be a sustained deadlock of actual economic activity, and that would not be in the interest of the general public. This deadlock is currently happening the US housing market, where the gap between the buyers and the sellers has brought the market to a virtual standstill. The quicker the sellers come to terms with the situation, and capitulate on their bubbly asking prices, the quicker the market comes back to life.

Ahmad Chalabi is Back

2007-11-13T23:59:00.000+02:00

Christian Berthelsen of The Los Angeles Times writes about the new role that was given to Ahmad Chalabi, the infamous conduit of bogus intelligence that was used to justify the invasion of Iraq.

Now the 63-year-old Chalabi, ever the political chameleon, has maneuvered back into prominence and power. Prime Minister Nouri Maliki appointed him to a pivotal position last month overseeing the restoration of vital services to Baghdad residents such as electricity, potable water, healthcare and education. The U.S. and Iraqi governments say the job is crucial to cement security gains of recent months - and that failure could cause the country to backslide into chaos.

Seems that Mr Maliki is not fazed by Chalabi being a fugitive from justice, having been convicted in absentia for bank fraud in Jordan in 1992. I wouldn't trust him with a penny of public funds.

Chalabi espouses free-market doctrine as the best way to cure the area's ills, a prescription that would buoy his neoconservative benefactors if they were here to hear it.

"Everyone is looking for employment with the government," he says. "This is a dead end. It's not possible. We need to get the economy going. Construction projects are needed."

With a billoin dollars in seed money from the Iraqi government for housing projects and a loan program to help residents buy a home, he says, "we would have no unemployment."

Exactly what does a billion dollars of "seed money" from the government have to do with free-market doctrine? I guess he is not getting that seed money anytime soon.

Are housing projects and a "loan program" really the best way to alleviate the huge problems of no electricity, no drinkable water and no health care? I can't imagine that the first thing on the minds of the Baghdad residents would be plunging themselves into debt.

Ahmad Chalabi is a former banker. The old saying fits his situation pretty well: When all you have is a hammer, everything looks like a nail.

Seeing what the "free-market" doctrine--actually, a financial-political cartel--of his buddies in Washington and New York has brought about, the Iraqi government would be well advised to stay away from him. But maybe they could use him as a negative indicator and a decoy for trapping corrupt officials.

Banking Deregulation, Unlimited Creation of Credit and Asset Price Bubbles

2007-11-10T19:58:00.000+02:00

In "Why We Are Not in a Recession, Yet, and What a Recession Will Look Like" at lewrockwell.com, Robert Wallach writes about business cycles being created by the Federal Reserve's erratic creation of money, and how this causes asset bubbles.

He is correct in that it is the Fed's policies that are the culprit, but it is not the Fed that is printing the money. In the current surge of money supply growth, it is not the Federal Reserve that is creating new money, but commercial banks and other privately held financial institutions. The Federal Reserve has actually been very stable in their creation of money.

Commercial banks are creating money when they issue new credit. When a bank "gives out" a loan to a private customer, the money is not taken from anywhere. The bank just creates a new deposit, which is covered by nothing except the debtor's promise of paying it back.

Robert Wallach cites the growth of the MZM (money of zero maturity) statistic as a sign of monetary inflation. This figure is now well above $6 trillion. But only a bit more than $800 billion of this figure is actually created by the Federal Reserve. This relatively small amount of high-powered money is the Monetary Base, which Gary North has been referring to. All the rest of this money is actually credit, which is forever in danger of default, though the risk is very small for most of the deposits.

Even though commercial banks have tightened their lending standards, the MZM is growing, probably because of people moving their deposits from long term investment contracts into shorter term accounts, which is shown as a spike in the MZM measure. That the MZM is growing so fast relative to the monetary base is a worrying sign in itself, because such a growth can not go on forever. When people start shifting their money from long term investments contracts into short term deposits, it is a sign of increasing intentions of withdrawal.

When the housing market was inflating, and new credit was created quickly, people put their profits into savings accounts and other long term investments. Now that people can not go any further into debt, they have started to dig into their savings, which puts a strain on the banking system. The MZM, as well as other monetary statistics figures, is actually a liability for the banks. It is a measure of deposits. Increasing short term liabilities at a time of decreasing asset values is not a good environment for the banks.

M3, the widest available money supply statistic, which was discontinued by the Fed in 2006, has also hastened its growth in the last couple of years, now going at well above 10% per year. This means that the creation of new credit has not come to a halt. There might be new bubbles brewing in other asset classes except just houses.

This might also be a sign of financial institutions frantically searching for new sources of profits to cover up their losses in the housing market. In doing so, they are probably taking ever higher risks, with ever higher levels of leverage, because they have less and less to lose.

The wider the gap between the amount of credit and the monetary base, the bigger the eventual crash is going to be. At some point, the game will be whistled to a stop, and a counting of losses will begin. This game has been going on for over 25 years.

The Federal Reserve is duly blamed for encouraging such excess credit creation by the commercial banks. The relative explosion of credit-based money supply was started in the early 1980's, when the reserve ratios were drastically cut in the name of "deregulation". Ever since, the answer to financial troubles has been more easing of restrictions.

Even researchers at the Fed itself have figured that the banks' reserve balances are not much affected by the reserve requirements, which are so small, that the logistics of cash handling itself is a more important restriction. The final detachment from reserve requirements came in 1995, when sweep accounts were taken into use.

When this game with continuously easing rules has been going on so long, what happens when there are no more rules to be eased anymore? We have already seen the Fed giving up on enforcement of section 23A of the Federal Reserve Act, which limits the exposure of depositor insured funds to the more risky broker-dealer units of financial corporations to 20% of the bank's capital. Every time that the banking system has been at risk since the early 1980's, there has been a relaxation of rules, and everything has been fine again for a while. What happens, when there are no more rules to relax, and the system is still in trouble?

These relaxed rules mean in practice that banks can create just as much new credit as they want. The only remaining regulatory restriction is the capital ratio, which is there to protect against actual insolvency. But the capital ratio is severely infected by the mostly symbolic "paper values" of banks' assets. This restriction has also been actively avoided by using off-balance-sheet structured investment vehicles.

Even though it has been mainly discussed as a "liquidity crisis", the
current crisis is in fact a solvency crisis created by simple overextension. In a deregulated competitive environment, occasional bankruptcies all but inevitable. But the whole system is built on the supposed infallibility of major financial institutions.

The Fed's slashing of the federal funds target rate to 1% for a prolonged time created a massive encouragement for banks to increase their lending, without the Fed actually having to print that much new money at all. By extending credit, banks can create not only brand new "assets", but also a lot of new money from nothing at all. This money has in turn the ability to affect the prices of other assets.

The prices of bank assets have been inflated by excess credit. In inflating asset prices,
the banks have also inflated their own capital. Because capital ratio is one of the few remaining constraints to lending, this has allowed the banks to create ever more credit, resulting in ever higher asset price inflation, and a self-reinforcing cycle. With no reserve requirements, the amount of credit has been totally unhinged from the actual amount of money that is created by the Federal Reserve.

The banks have been left holding a mass of assets whose value depends on their own willingness to pay for those assets, either by extending credit for purchases by a customer, or by direct purchases themselves. When that willingness is taken away, these asset prices collapse. Liquidity is naturally constrained in a situation like this, because the sellers of these assets (banks) and the potential buyers (banks) are in fact the same entities. It is a simple case of herd mentality, which is found in the background of every bubble and even a minor business cycle.

So banks have huge holdings of assets, whose values are completely dependent on perpetual growth of credit. But credit can not be extended beyond the debtor's ability pay back. This very hard wall has now been hit, and the value of these loans, as well as the underlying collateral, i.e. the houses, has become questionable.

The credit market is now in a valuation crisis that puts the banks'
solvency into question. Because the reserve ratios are so small, about $300 billion of cash assets against $6600 of deposits, the banks can not survive long without liquidity. They have to be able to quickly sell their assets at a decent price or risk defaulting on their obligations.

But liquidity can only be provided by the banks themselves, because they are the principal creators of money. The Fed has lost its influence. Even a rapid flow of cash from the Fed could be overcome by an even greater withdrawal of credit by commercial banks. There is an actual risk of a complete banking system meltdown. If that risk is realized, we can forget inflation.

This scenario would bring us back to the great depression, with much bigger excesses this time. This is what the bankers, including Bernanke, are really scared about. They are willing to risk serious inflation to avoid that.

The fact that the US dollar is sinking might be a sign of expectations of actual monetary inflation. But there is a delay in the effect of monetary inflation. It takes time for the new money to end up in the pockets of the average consumer, so a severe recession and even nominal deflation can possibly not be avoided.

If an actual solvency crisis in the banking system occurs, there might be a mad dash for cash, with bank runs everywhere, and an associated spike the US dollar's foreign exchange rate.

The Credit Crisis and the Fundamentals of the Stock Market

2007-10-27T11:52:00.000+03:00

Ambose Evans-Pritchard writes in a blog entry at the Telegraph:

Even so, equities have not begun to reflect the reality that the 2006-2007 credit bubble has popped and cannot be easily reflated at a time of stubborn, lingering inflation. Spare me the mantra that the “fundamentals” are sound. Credit is the ultimate fundamental.

This is a folly. It is natural for the stock prices to edge higher when the alternative investment opportunity that is provided by the credit market is in trouble. Upward drift in the stock market is not always a reflection of belief in higher profits. In this case it is more likely to be a lack of good alternatives.

It is a mistake to report the stock market mood as "jubilant" after the Fed acknowledged the credit market troubles with the rate drop. The mood is quite probably more like: "These stocks are going to stink at these prices, but hey, look at the alternatives." Willingness to buy at a higher price without any underlying positive indicators is a sign of acceptance of lower yields. I would hesitate to call such a mood "jubilant".

The recent returns to lower stock market price levels have most probably been caused by disappointing profit reports, especially from the financial companies.

There is some correlation between the credit market and the stock market, but these markets are also ever competing against each other. A crisis in the credit market is bound to have a short term boost in the stock market. If an investor is faced with modest yields and a high risk in the credit market, he might just as well put his money into the stock market.

On the other hand, trouble in the credit market might actually be a real boost to established companies with sound cash positions. After all, tightening credit conditions cause hard times for their growth-hungry and deeply indebted smaller competitors. To the economy in general, this is not good news.

Human Terrain Teams and Dehumanization of Civilians

2007-10-26T21:22:00.000+03:00

Nick Turse wrote in TomDispatch.com about the mind-set of big game hunters being taken as a model for US Marine troop in Iraq and Afghanistan. He quite correctly recognizes this as a part of the dehumanization of the enemy.

Yet, the very first paragraph of his post brings forward the fact that in this war, the dehumanization has gone much further than seeing the enemy combatants as animals to be hunted for pleasure:

Earlier this month, news of the military's use of Human Terrain Teams -- U.S. combat units operating in Afghanistan and Iraq that contain anthropologists and other social scientists who have traded in their academic robes for body armor -- hit the New York Times. While the incorporation of academic experts into combat units has raised ire in some scholarly circles, their use as "cultural advisers" to aid the war effort has been greeted by the military as "a crucial new weapon in counterinsurgency operations" and in the media as an example of increased cultural sensitivity as well as evidence of a new Pentagon willingness to think outside the box.

"Human Terrain Team" is a perfect display of the role that is played by the Iraqi civilian population in this conflict. This term does not refer to a terrain team made up of humans. It mean a team that is focused on issues with the "human terrain".

This term, human terrain, relegates the population to the level of mere landscape features in a battlefield. They are put on the same level with rocks, buildings, trees, rivers and other parts of the overall scenery that is usually thought of as the terrain. How much lower can we go with dehumanization?

This view-point is directly related to the reckless endangerment that the civilian population has been put through in Iraq. The lives of Iraqi civilians are not only much below the safety of American troops, but they are also much below the importance of killing of capturing even low-level insurgents.

There have been numerous cases of deaths from shooting through doors without warning and calling in air-raids to properties with known civilian presence. In the early part of the invasion, we heard reports of numerous bombings of buildings that Saddam Hussein or other high-level Baath party members were rumored to be located at. There were no limits for such strikes. No matter if it was an apartment building with many families, or a restaurant where innocent people were having dinner. The importance of eliminating a single individual was, and still is, seen as a higher priority.

But now that the original "reasons" for the war have been found to be false, the only remaining concern for the American troops in Iraq is supposed to be the safety of the Iraqi people. Yet the same reckless abandon continues in force.

Some people have claimed that the US must stay in Iraq to fix the damage that they have done. But the US military, with associated private contractors, are the proverbial bull in the china shop. The longer the bull stays in the shop, the more destruction there will be. And it is some very expensive destruction at that.

The Iraqi government is finally starting to show some real frustration with this phenomenon. In two years at most there will be angry demands for a US withdrawal from the Iraqis, and no talking about any enduring bases to be left behind. US strategists should start to prepare for that if they want to save themselves from major embarrassment. They would, of course, be also saving thousands of additional Iraqi people from being hunted for sport or being shot as parts of the landscape.

Moving to Blogger from Yahoo 360°

2007-10-25T18:36:00.000+03:00

This blog is a continuation of the blog with the same title that I have been very infrequently writing at Yahoo 360°.

I have become increasingly annoyed by the Yahoo system, especially its tendency to lose entire blog entries at submission, so I finally decided to move it here. I think that this move should have been made a long time ago.

This blog is true to its title and not dedicated to any specific subject. The title is also a quote from Donald Rumsfeld, who, according to reports, showed his priorities on 11 September 2001 by saying to his aides: "Judge whether good enough hit [Saddam Hussein] at same time. ... Go massive, Sweep it all up. Things related and not."