Negativity

To clarify - quantitative easing (QE) is buying commercial paper of banks, which is equivalent to depositing money at the bank, which is equivalent to giving the bank a loan. CP matures very quickly (1-4 weeks).

If QE doesn't cause banks to lend more, and if banks have to resort to negative interest rates to discourage the risk-averse practice of depositing excess funds at the central bank (see Japan, Dennmark), then the following are happening:

• Banks don't want to lend because:
• They are artificially constrained by government-imposed capital reserve requirements
• They are constrained by increasing % of bad loans, which are increasing their capital reserve requirements 
• They are so administratively inefficient that none of them can do their core business
• They are afraid due to uncertainty about future government requirements or actions
• They see no viable loan applications
• They think inflation will devalue the future repayments they receive
• Companies don't want to borrow because:
• People aren't buying their stuff for a profitable price
• They are afraid due to uncertainty about future government requirements or actions
• They think their company will not grow in the future and/or is already shrinking
• They think deflation will make their debt painfully expensive to pay back

If QE broadens to include equities or real assets, this is exactly equivalent to government manipulation of markets or nationalization at the extreme. This is not the behavior that made the US the world's largest and strongest economy. This is not the behavior that makes other governments want to sell their own currency and hold their money in USD. This is not the behavior that makes the USD the currency of reference on the vast majority of financial tranactions worldwide, including most oil and other commodity transactions.

Rather, this is the behavior of a failing state - Post-coup Thailand; Argentina; Ecuador; 1980s Mexico; 1970s Iran; Stallinist Russia, Mao's China.

But ... isn't the core issue really about lagging demand? If so, that is driven by:

• Consumers who overspent in the past and are paying down debt (including student debt?) instead of consuming
• Consumers who are broke and/or don't have a reliable income and/or are delaying consumption because they are still acquiring skills to build a career 
• Consumers who are afraid for the future and are saving everything they can
• Consumers who are delaying purchases because they think deflation (aka industry-wide discounting) will mean cheaper prices in the future
• Fewer consumers (ahem, one-child-China?) 

While I'm not going to take a position on which of the above are the primary drivers, I will say that we all keep hearing how expensive it is to have kids. Betcha didn't think that's where this was going. No debate about the cost of kids, but it's interesting to break that into component pieces:

• The "we don't want to give up our current level of consumption/lifestyle" aspect
• and the "the cost of having kids is high and increasing rapidly" aspect
• and the "we are saving for our own retirement and thus don't need a gaggle of kids to support us when we're old" aspect, which may sound silly until you look at how we took care of the elderly 150 years ago. (Hint: it wasn't an assisted living facility covered by a supplemental insurance policy).

All of the above decrease the motivation to have more than 1-2 kids, if at all. The planet is crowded, and emerging economies continue to make it more so, but they don't consume at the same levels we do (yet). Coastal China, Mexico, Philippines, and urban India all demonstrate that consumption patterns can swing from subsistence to luxury good quickly (in way less than a generation). So, despair on this front may be temporary. Or maybe not.

What will tomorrow bring? Trump baseball

This week is inning 8 in the meltdown story. The 9th inning may be ugly.

Nik's Laws: Don't Arm your Future Enemy

Hey world (and Barack and the useless heap of Congress) are you listening?

Finally.

Yes, finally.

Motown Lowdown

As far as I'm concerned, city bankruptcies are good with one possible exception.

The exception is pension funds. If the city changes the pension payments they promised to retirees, that strikes me as pretty evil. People plan their whole life for retirement based on the assumption that they will get certain pension benefits. These should be preserved. If Detroit had been smart, they would have insured or offloaded this liability long ago. It's simple math and stochastics. Let the experts in the financial world make it work.

Bondholders should be aware of the risks of lending money to cities with large deficits, so it shouldn't be any surprise that they'll get a "haircut" meaning less than 100% of their value back. In the mean time, they got interest on the bonds.

Aside from that, city bankruptcies allow cities to renegotiate every contract - suppliers, vendors, unions in a public way (as opposed to back-room deals). I guarantee you that there's plenty of fat to be cut here.

What is sadly missing from most municipal bankruptcies is austerity. Bondholders should really pressure Detroit to not only pay less for what they buy (my prior point) but also to buy less, cut services or at least make them cheaper, privatize or close inefficient departments, etc. These are tough decisions, of course, and can create a negative-reinforcement cycle where the city gets worse and more people move out. Ideally, they offset this by improving the economy and thus increasing revenues.

Greasy Thinking

I love to hate Krugman's one-size-fits-all big-government answers to every problem but today through clenched teeth I have to agree with his op-ed yesterday (partially). Europe and the Euro need to put their big boy pants on and learn some bladder control. Fast. Diapers just aren't appropriate anymore. As he said in the NY Times today:

For the past two-and-a-half years, European leaders have responded to crisis with half-measures that buy time, yet they have made no use of that time.

Not sure how that jives with this first sentence, but anyway I agree with him: The Greece problem is not new. The Economist summarizes well this week:

Greece really has suffered: between 2007 and 2012 its economy is expected to have shrunk by almost a fifth. The economy is being strangled by a severe credit and liquidity crunch, with more budget cuts and tax rises to come. Even if all goes well, Greece’s debt will be 161% of GDP next year.

The Spanish, Portuguese, Italian and Irisih problems are not new either.

The facts about Europe (and especially these retarded countries) which have created the current situation are not new. The EC, the EU, the EMU, the European Parliament, the European Presidency - all impotent, except for farm policy (huh?). National governments, all ineffective, focused on pandering, philandering, scandal (either chasing or running away from). Citizens feel emasculated (at best), despondent and dependent (especially those just out of school), and generally pessimistic. Employers are hamstrung on everything from employment/firing to compensation to innovation to outsourcing. Consequently, employees are lazy (not dumb) and inefficient. The governments have pissed away more than enough livelihoods. They need to get busy.

As Reagan put it,

There are no easy answers but there are simple answers. We must have the courage to do what we know is morally right.

The answer to Europe's issues is simple. It may seem odd to use the phrase "morally right" in this case, but it IS a moral issue for Europeans. It should be if they care about their children, their nation, their place in the world. 

Krugman's focus yesterday was on inflation, but the price level is not the core problem, nor is inflating your way out of debt a silver bullet. Happily, it will make European products less expensive. Here's to more Bordeaux and aged Gouda and European vacations! This, however, just corrects an existing price misalignment. A croissant and coffee shouldn't cost the equivalent of $20. That's just nuts. The reason Krugman is wrong is simple:  prices go up, but productivity per worker doesn't change. Every European becomes poorer. Fewer car/house/consumer loans/credit cards are available. House prices go down. Companies can't as easily justify borrowing to invest or launch new products. Which means less innovation and growth.

And that's exactly what Europe needs, particularly in the south: GROWTH. Even Krugman will agree with that usually. 

The only ways to get there are through INNOVATION, PRODUCTIVITY, and/or DEBT.

The last one is Europe's current favorite: beg, borrow, and steal. From the rich. From the companies. From each other. From the future. Money flows from northern countries through the EU/ECB to southern countries without compensation or realistic ability to earn enough to pay it back. Money flows out of companies' profits and employees' income through high taxes but is not set aside for their own social welfare. Instead, it is used to buy votes from those without jobs and/or those with political power. Quoting Krugman again:

Europe’s central bank is, in effect, financing this bank run by lending Greece the necessary euros; if and (probably) when the central bank decides it can lend no more, Greece will be forced to abandon the euro and issue its own currency again ... This demonstration that the euro is, in fact, reversible would lead, in turn, to runs on Spanish and Italian banks

It's just not sustainable. History is littered with examples of failed currencies and governments who thought they could just borrow their way to success. 

Instead, the core issues of low productivity, low innovation, and perverse incentives need to be addressed. Europe needs to start acting like a single community rather than a bunch of clans of grumpy neighbors. Europe needs to recognize the limits of socialism in the face of globalization. Europe needs to acknowledge global realpolitik. Protectionism and nationalism are luxuries they can no longer afford. The Euro cannot be a fiat currency - it needs backing based on the power of taxation and reserves.

On Productivity and Innovations:

• Ya just gotta free up the labor market, folks, or productivity is never going to get better. People/roles/trades/companies/industries/countries (including those abroad) which are more productive than others should be allowed to crowd out the less-productive. Languages can be a barrier, but to the extent that, for example, a smart and/or ambitious Pole can speak enough Italian or German to work abroad, this should be enabled, not discouraged. Even in "protected" industries. Spanish companies should be able to put callcenters and operations in, for example, Guatemala.
• Extending that point, you also need to accept that people/trades/industries/countries which are less productive are going to be less wealthy. Socialism hates inequality, but if a Finn can produce 4 cars a day while an Italian can only produce 3, the Finn should make more than the Italian. Similarly, if a Greek or Bulgarian (gasp!) is willing to earn EUR10 an hour to grow grapes while an Austrian insists on EUR25, the Greek and Bulgarian grapes should be trucked to Austria, crowding the Austrian farmers out of the business or forcing them to take a pay cut. 
• Extending the above: Learn from the US (both what to do and what NOT to do) about immigration and foreign workers. Let 'em in! Create a controlled and net-positive process (as explained in my prior blog post) and then open the gates. For one thing, allowing younger immigrants into the workforce is the only way you will be able to pay for your pensions and healthcare systems going forward. There should be no prohibitive barriers against Uruguayans moving to and working in Spain, for example. Just make sure you charge them for it.
• Aside from the ability to hire/fire the people they want and the ability to pay a market-clearing wage, companies need the ability to offer both contract and full-time work. They also need to be able to offer various tiers of benefits for interns, new-to-the-workforce, tradespeople, professionals, executives, etc. It can't be just the one-size-fits-all government-dictated (tarnishing) gold-plated package. A hundred years ago, Hayek correctly described where that road leads.
• Moreover, you can't have your cake (of national champion companies in every industry) and eat it too (expecting them to be globally competitive and profitable without being able to scale). Accept that you are a common market and allow Euro-wide champions to arise in whatever Euro country they may. No longer can the Portuguese government spend money it doesn't have to promote and protect their own national paper, airline, or cell phone companies. It's ridiculous for richly-paid Italians, French, and Germans to produce nearly 10% of the world's steel ... at a loss when all governmental supports are factored in. Buy Turkish or even Indian steel!

On Perverse Incentives:

• Government borrowing needs a revamp. Existing sovereign bond markets need to be priced based on country risk, not currency risk. Separately, the ECB should introduce Eurobonds which are guaranteed by all countries in the monetary union. Individual countries would buy SDR-like rights by either depositing collateral at the ECB or by legislating pledges of future tax receipts. They would then be allowed to request that the ECB issue bonds on their behalf, most of the proceeds going to the national government, but with an adequate reserve withheld by the ECB as collateral against future payment. Overall Eurobond issuance would be capped by the ECB based on market conditions and European Parliament votes.
• More radically, impose, by irrevocable treaty, a 5% Eurozone value-added tax. Simultaneously reduce national VATs by the same amount such that there is no impact to consumers or businesses. These funds go to the ECB and are distributed according to agreed rules. In other words, taxes collected in Spain are sent to the ECB but might get sent right back to Spain if all's well. However, if one country is circling the fiscal drain, this provides a cash buffer to protect the ECB and the other Eurozone countries from getting sucked into the vortex. Most importantly, this creates a "lever" of power by the ECB over individual countries. If you don't live up to your commitments, you don't get your 5% back. The bank NEEDS this power to protect and defend the currency. It also needs it to enforce compliance with treaties and commitments.
• Enforcement of the monetary union's and European Parliament's targets (ex. Growth and Stability) must be strict. Greece has NEVER met the very friendly targets they negotiated. Never intended to, I'm sure. They should be fined. They should not get their 5% back. Their voting rights in the European Parliament should be suspended. ECB transfers should be suspended. International remittances and account balances should be frozen.
• While you're at it - fix the banking system's capital adequacy rules. Sovereign debt is NOT risk free.  

All graphics from Economist.com. 

Yeah! What HE Said: Fareed Z on the 9-9-9 Plan

You have to understand: complexity equals corruption. Americas corruption is institutionalized and legal. The US tax system is not just corrupt. It is corrupt in a deceptive manner that has degraded the entire system of American government. Congress is able to funnel vast sums of money in perpetuity to its favored founders through the tax code without anyone realizing it. The simplest way to get the corruption out of Washington is to remove the prize that members of Congress give away. A flatter tax code with almost no exemptions does that The simplest fix to our tax code would be to lower the income tax dramatically, lower the corporate tax, and instead tie revenues through a national sales tax or value added tax. The US is the only rich country in the world without a national sales tax What is the appeal of a consumption tax? First, it's efficient. Lower fraud. More stable. Reduces consumption and borrowing at the household level.

Follow Up 2: Less is More

The lead story in the August 6, 2011 Economist minces no words in their opinion of US politicians' "current uselessness" which the paper fears will be responsible for a double-dip recession. They specifically highlight the negative impact of the growing US governmental unpredictability:

Any hard decisionshave been given to a commission--a cop-out that condemns workers and firms to more crippling uncertainty about how the country's fiscal mess will be tackled. Would you build a factory today if you knew that taxes had to rise eventually, but had no idea which ones?

Worse, the poisonous politics of the past few weeks have created new sorts of uncertainty.

This was precisely my message in a January 2010, blog post:

Risk is equivalent to unpredictability. The more able one is to predict the future, the lower the risk and the more confidently one can make moves today which create a nice return tomorrow. Conversely, when the rules of the game may significantly change tomorrow or next year, risk is dramatically increased. This raises the risk-vs-reward bar such that fewer investment options are viable.

Its no wonder that corporations and banks are choosing to sit on "piles of cash" instead of launching big, strategic, long-term investments which would support long-term and largely high-skilled job creation ... and hopefully long-term profitability for the investors.

No, US federal policy currently discourages that type of thing. More precisely, it forces such investment offshore. When US businesses choose to NOT use their cash for investment in their own commercial projects, they must find something else to do with the cash. People say that Apple has umpteen-hundred-billion dollars "in the bank" but more accurately, Apple has this cash invested in non-apple projects in that Apple owns shares, CDs, bonds, and IOUs from other banks and companies who are not subject to the unpredictability and caprice of the US government.

As my blog post continued:

Governments can increase or decrease this risk. Those with the discipline to stick to a stable, sensible, transparent industrial policy over a long period build tremendous "trust equity" with investors ... Ideas become businesses become economic value ...Unfortunately, being based entirely on intangibles (consensus expectations), this trust equity is a very fragile thing. Governments can quickly sabotage themselves, their economies, and thus their citizens by giving off even the whiff of erratic or ill-advised behavior.

 The current lot in Washington reek of it. Like Renaissance French nobility, they slather themselves in ever-increasing amounts of perfume to cover it up, but the flies still swarm. Here's David Brooks:

"If you ask people, 'why aren't you investing? Why aren't you lending?' it all comes down to uncertainty ... If bankers and entrepreneurs don't have any sense of certainty, they're just not going to invest ... We've not only got this economic problem, but its compounded by a psychological problem, magnified by the fact that distrust of institutions is at its highest level in history." - David Brooks, Meet the Press 1/31/2010

The answer? Of course, it's complicated but a good start is in the title of this blog. The Economist is concerned that immediate fiscal austerity would thrust the economy deeper into trouble. They suggest that we wait a bit. They're half right. I'd listen to Greenspan, who has been a long proponent of using the economic power of "signalling." Without changing a single regulation or appropriation today, the government can clearly communicate what changes are coming when. If the message is credible, people will respond as though the change had happened today. Markets will rapidly price in the new information, and the trajectory of the whole economy will shift.

IF the government's message is credible. This is the rub, given the extent to which Washington has squandered that intangible "trust equity." Given this situation, I'd suggest Obama and Congress see a psychologist ... to better understand how to psychologically build trust in a population.

I'd suggest follow-though is key.

Nik's Laws: Mortgage Interest Deductability

Eliminating the mortgage interest deductability on income taxes will have the effect of instantly reducing all house prices by 10-30%. Such an attempt to increase federal tax receipts would have the inverse effect, as it would push the economy soundly into a double-dip recession, would degrade the capital stock of most US financial institutions at a time of increased capital requirements, would push a new tier of homeowners underwater, and would trigger a new round of bankruptcies for those on the margin.

Staged.

Does the White House really think that all it takes to control public opinion is having the US people watch Congress clap for the President for 3 minutes straight? Last time I checked, the only people less liked than the President were the Congressmen.

Yeah, What HE Said: Limited Government

Quote shamelessly borrowed from the Cato Institute's blog today:

"Limited government is one of the greatest accomplishments of humanity.
It is imperfectly enjoyed by only a portion of the human race, and, where
it is enjoyed, its tenure is ever precarious. The experience of the last
century is surely witness to the insecurity of constitutional government
and to the need for courage in achieving it and vigilance in maintaining it."
- Tom G. Palmer, Cato Institute Fellow and Humanitarian

Nik's Laws: Profit

If profit is outlawed, only outlaws will profit.

Yeah! What HE Said: Smart is as Smart Says ... Hopefully History Repeats

Allow me to quote myself quoting someone who has every right to give Uncle Sam a big ole "told ya so" right now.

"Experience hath shewn, that even under the best forms of government those entrusted with power have, in time, and by slow operations, perverted it into tyranny." - Thomas Jefferson

"And to preserve their independence, we must not let our rulers load us with perpetual debt. We must make our election between economy and liberty, or profusion and servitude." - Thomas Jefferson

"That government is best which governs least." - Thomas Jefferson

Time for Timmy to Take a Page from the Dick Nixon Book

Three months ago, on April 19, Timmy G flashed that charming nose-flair and scowl as he proclaimed "no risk" of credit rating downgrade. With a Treasury Secretary like that, who needs enemies?




That incredible foresight has created quite a bank of political capital and immense credibility for Timmy. Knowing that his fatherly tone alone can instill confidence in the most dubious heart, he decided today to leverage a bit of his capital, saying, in effect, 'trust me - China will continue to support borrowing habit.' No need to get our fiscal houses in order. That's just too hard. Too confusing. Too complicated for the average dumb voter. Better to just distract everyone by attacking the ratings agencies ... for ... um ... our fiscal mess?


Also based on his incredible Volcker-like, Lula-like track record of securing our country's fiscal future, he shared some friendly advice with his colleagues in Europe, admonishing those pre-pubescent countries to make sure they don't spend more than they make. If only they were as fiscally responsible as we are. If only they were lead by such world-class minds as we.


Investors are expressing their immense appreciation for Timmy's FDR fireside chat moment by voting with their feet ... from equities, debt, swaps, and even energy straight into gold.

Risk Free?

S&P's downgrade of US debt is not the first domino, nor will it be the last.

Traders and Brokers: wear rubber underwear Monday.

Thousands of funds are contractually required to hold a specified percentage of AAA debt. They ALL have a significant position in US Treasuries. Monday they will have to decide whether they go to their investors hat in hand requesting permission to hold non-AAA US debt or whether to dump their holdings. Furthermore, risk algorithms and valuation models used by nearly all financial institutions and investors are based on the US treasuries as the "risk free" rate of return. These models will have to be re-assessed ... and the consequence will be a shift in investments.

The charters of many countries and sovereign wealth funds require their central banks to hold AAA notes (or the currencies of those countries) for their national reserves. Thus, the US's reserve currency status may also be reviewed next week. FX markets, interest rate markets, swap markets ... wow - hold your hats, kiddos.

(update) Don't take my word for it. Mohammed el-Elrian echoed my comments in the Financial Times over the weekend.

The fact that yields on US debt have fallen all week speaks more to our ability to manipulate markets (in the short and medium term) than it does to confidence level. So don't go there.

This could have been avoided. Go ahead and fiddle, Congress. Washington is burning.

Stupid is as Stupid Does

Switzerland has spent over a century building a safe, predictable, stable currency. Sadly, as one of the last bastions of sovereign stability, the nation is now feeling the unintended consequences of their scotch ways. It is teetering on the verge of recession because their currency is too expensive. As a consequence, Europeans are cancelling trips to the Swiss Alps because everything is too expensive there. Swiss are driving across the (0pen) border to buy TVs and food in Italy where their francs go much further.

Thus, the central bank intervened in currency markets today to knock down the franc. Tonight, the franc is trading above where it started the day.

Ditto Japan.

Consequently, the Swiss and Japanese central banks' wallets are a few billion dollars lighter tonight ... and currency traders' wallets are a few billion dollars heavier.

When will central banks learn??

Nik's Laws: Croaking Canaries

The states are the canaries in the mine of our economy.

Talk Amongst Yourselves: US Government Spending as a Percentage of GDP

The Zeitgeist of the BearDogs

Sometimes Simple IS the best way to communicate. Here's to the simpletons.

The Word about The Fed and The Plan for the Change

The Fed is powerful. I'm a fan of a good Fed. We currently do not have a good Fed. I'm horrified.

Be horrified.