Tag: economics

Greece junked

Another Black Swan spotting!

Greece’s credit rating was cut three steps to junk by Standard and Poor’s, the first time a euro member has lost its investment grade since the currency’s 1999 debut. The euro weakened and stock markets throughout the region plunged.

Greece was lowered to BB+ from BBB+ by S&P, which also warned that bondholders could recover as little as 30 percent of their initial investment if the country restructures its debt. The move, which puts Greek debt on a par with bonds issued by Azerbaijan and Egypt, came minutes after the rating company reduced Portugal by two steps to A- from A+.

Wait a minute, hasn’t the financial media reported that Greece was saved, bailed out, etc about 20 times in the last month? Anyhow, you may recall that I suggested going long dollar a few months ago, back when the Euro was around $1.45. Needless to say, the few people who noticed at the time said I was crazy. Again.

On a tangential note, don’t you enjoy the way the ratings services always helpfully let you know that a bond is worthless well after it becomes completely freaking obvious? I don’t often agree with Paul Krugman, but I thought it was impressive that 93% of the AAA-rated mortgage securities are now downgraded to junk. Ex post facto, of course. It would appear that an AAA rating doesn’t mean what so many investors thought it meant.

The calm before the storm

In response to Dr. Helen’s question, the answer is an unequivocal “yes”.

Glenn just got Vox Day’s new book in the mail, The Return of the Great Depression, so I picked it up and started reading. It is not for the faint of heart or the economically hopeful…. I have noticed that house sales (at least in the lower prices) in our area seem to be picking up and people seem to be out buying again–or at least, they are in the stores. I wonder if this is just the calm before the storm or whether things are improving?

This graph on debt outstanding by sector should explain why things look superficially as if they are improving, while they are actually doing absolutely nothing of the kind. Keep in mind that Q2 2010 – in other words, now – marks the beginning of the end of the massive federal stimulus plan that has allowed the substitution of G for C over the last six quarters. But as the first graph shows, that substitution cannot continue indefinitely. It would require deficits that are multiples of Obama’s record-setting 2009 and 2010 deficits and it wouldn’t ultimately work any better than either the Bush or Obama stimuli did.

And this is an amusing aside from Dr. Helen’s husband:

SORRY, WE’RE STILL SCREWED: Reihan Salam says we’re heading into a decade-long economic buzz saw. “We are propping up the most rotten sectors of the economy and diverting talent that would otherwise shift into the new interrelated systems that are slowly emerging—and this emergence will prove very slow indeed once the inevitable tax burden required to prop up aging yet politically powerful sectors hits.” Let’s hope this is wrong, but it’s basically an explanation of why a powerful federal government, unconstrained by traditional limits, is a bad idea. Oh, well, at least I’ve got Vox Day’s book to cheer me up . . . .

The Ark-B economy

Greece exemplifies the inherent unreliability of government economic statistics:

Financially-stricken Greece had an even bigger budget deficit for 2009 than previously thought, official figures showed Thursday — at a time the country is considering whether to tap a bailout facility from its 15 partners in the eurozone and the International Monetary Fund.

The European Union’s statistics office Eurostat said that Greece’s budget deficit in 2009 as a percentage of economic output was 13.6 percent — that’s up from the previous estimate of 12.9 percent and nearly double the 7.7 percent recorded in 2008.

Fictional numbers informing the deployment of fictional money by fraudulent financiers. I have a sneaking suspicion that the people of the far future are going to look back on our time as the Idiot Ages. We are the telephone sanitizers.

An end to extend and pretend?

This doesn’t appear to harmonize well with the economic recovery tune:

A record number of U.S. homes were lost to foreclosure in the first three months of this year, a sign banks are starting to wade through the backlog of troubled home loans at a faster pace, according to a new report. RealtyTrac Inc. said Thursday that the number of U.S. homes taken over by banks jumped 35 percent in the first quarter from a year ago. In addition, households facing foreclosure grew 16 percent in the same period and 7 percent from the last three months of 2009. More homes were taken over by banks and scheduled for a foreclosure sale than in any quarter going back to at least January 2005, when RealtyTrac began reporting the data, the firm said.

“We’re right now on pace to see more than 1 million bank repossessions this year,” said Rick Sharga, a RealtyTrac senior vice president.

I imagine ONE MILLION repos will exert an amount of negative pressure on home prices in the near future. What most people don’t realize is the way in which being underwater tends to prevent a house from being put on the market. The recent rise in prices is the result of a temporary restriction in supply due to underwater homeowners being trapped in their worthless homes, not the rise in demand that would be a sign of recovery.

UPDATE: Forgive me if I’m skeptical that anything more than a handslap and a fine is meted out. “SEC charges Goldman Sachs with civil fraud in structuring and marketing of CDOs tied to subprime mortgages.”

The breaking of the Euro

While the Euro is still much more valuable than it was ten years ago when it was trading at .88 to the dollar, the inherent problems of both the currency and the political entity has never been more obvious. The European Union cannot survive the dissolution of the Euro. And the Euro cannot survive the intrinsic economic contradictions of the various member states. For years, Europhiles have scoffed at my prediction of a complete Eurofailure in which Britain and a few of the smaller member states would withdraw from the EU while Northern and Southern Europe break into two or more apolitical economic blocs, but I don’t see anyone scoffing at the fears of George Soros and other professional investors who follow the European economic scene.

Morgan Stanley has warned that the Greek debt crisis is setting off a chain of events that may prompt German withdrawal from the eurozone, with grim implications for investors caught off-guard. “The backstop package for Greece and the ECB’s climb-down on its collateral rules set a bad precedent for other euro area states and make it more likely that the euro area degenerates into a zone of fiscal profligacy, currency weakness, and higher inflationary pressures over time,” said Joachim Fels, head of research, in a note to clients.

As socionomics predicts, political unity is a consequence of economic growth and positive social mood. As the economy and the social mood worsens, we can expect movement away from political unity in both the USA and Europe. Since there are very strong indicators of further economic contraction, we can safely expect further trouble for the EU and the Euro.

WND column

Understanding the Numbers

“The American economy appears to be in a cyclical recovery that is gaining strength. Firms have begun to hire and consumer spending seems to be accelerating. That is what usually happens after particularly sharp recessions, so it is surprising that many commentators, whether economists or politicians, seem to doubt that such a thing could possibly be happening. … Why is good news being received with such doubt? Why is “new normal” the currently popular economic phrase, signifying that growth will be subpar for an extended period, and that the old normal is no longer something to be expected?
– “Why So Glum? Numbers Point to a Recovery,” the New York Times, April 8, 2010

There are three kinds of statistics. First, there are objective and verifiable statistics which are extremely difficult to fake due to the ease with which they can be independently measured and confirmed. These are most typically seen in sports. It would be very difficult for the Minnesota Vikings to falsely claim that Adrian Peterson ran for 3,000 yards in 2009 due to the NFL game logs and thousands of recorded videos of the 16 games in which he played. Second, there are objective and unverifiable statistics which are more easily faked due to the difficulty involved in measuring them. A movie’s box office take, for example, is not something that a third party can reasonably confirm without sending thousands of people to all of the various movie theaters and counting how many people entered the relevant screen rooms.

UPDATE: The National Bureau of Economic Research appears to be skeptical of the recovery too, considering its refusal to declare the recession over:

The Business Cycle Dating Committee of the National Bureau of Economic Research met at the organization’s headquarters in Cambridge, Massachusetts, on April 8, 2010. The committee reviewed the most recent data for all indicators relevant to the determination of a possible date of the trough in economic activity marking the end of the recession that began in December 2007. The trough date would identify the end of contraction and the beginning of expansion. Although most indicators have turned up, the committee decided that the determination of the trough date on the basis of current data would be premature.

UPDATE II: Did BoA, Citi, and JP Morgan/Chase just bail out Greece? Who borrowed $428 billion last week? I tend to doubt it was the American consumer.

On the Austrian analysis

In which SM asks me to respond to a post by Financial Times writer Martin Wolf:

I think we can say that conventional neo-classical equilibrium economics did a poor job in predicting the crisis and in suggesting what should be done in response. We can also say that neo-Keynesians pointed out some important precursors of the crisis, in particular, the destabilising role of huge private sector financial deficits in countries with large external deficits, such as the US, and the Keynesian view certainly played a big part in the post-crisis response, as did that of Milton Friedman.

Yet some would argue that economists working in the Austrian tradition were more nearly right than anybody else. In particular, they have argued that: inflation-targeting is inherently destabilising; that fractional reserve banking creates unmanageable credit booms; and that the resulting global “malinvestment” explains the subsequent financial crash. I have sympathy with this point of view. But Austrians also say – as their predecessors said in the 1930s – that the right response is to let everything rotten be liquidated, while continuing to balance the budget as the economy implodes. I find this unconvincing. Mass bankruptcy is extremely costly. Moreover, it is impossible to separate what is healthy from what is unhealthy during a general economic collapse triggered by an implosion of the financial system.

Anyway, what do readers think of the Austrian analysis? In particular, what does it imply about the future of the global monetary and global financial systems and about the right way to respond to financial crises when they occur?

1. Yes, Austrian economics does understand financial crises better than other schools of thought, even if one includes Hyman Minsky’s Financial Instability Hypothesis as a distinct economic school. The Austrian analysis is broadly correct because it a) provides a means of understanding one of the core components of modern economics that no other major economic school provides. None of the Neo-Classical, Marxian, Neo-Keynesian, or Monetarist theories of economics consider debt to be a primary aspect of economics and therefore their policy interpretations and prescriptions are all largely irrelevant with regards to modern economies with debt-based financial systems. Austrian school theory is also more robust and comprehensive, in my opinion, than the new empirical Post-Keynesianism which also attempts to account for debt and therefore is also vastly superior to the four major schools.

2. As I predicted both in 2002 and in my 2009 book, The Return of the Great Depression there is no future for the present global monetary and financial systems. The giant international banks are insolvent and the monetary systems are doomed to collapse. This means that in the interest of avoiding this collapse, the monetary systems will be unified, first on a regional and then eventually on a global basis when the regional moneys begin to break down. The correct response would be to let all of the “full faith and credit” moneys fail and be replaced by the gold standard or some other monetary standard less subject to the bank-driven inflate-and-collapse cycle that has been witnessed five times in the United States alone, but that is not going to happen at this point in time.

3. The right way to respond to financial crises is to let them play out. When a building is burning, it doesn’t matter how much damage is being inflicted by the fire, it is never the correct response to attempt extinguishing it by pouring something inflammable on it. Mass bankruptcy is certainly costly, but the only relevant point is that it is much less costly than the greater number of bankruptcies that will eventually follow combined with the immense costs of the futile atttempts to stave it off that will do little more than delay it for a time.

Moreover, it is ALWAYS impossible for a central authority to separate what is healthy from what is unhealthy, during a general economic collapse triggered by an implosion of the financial system or at any other time. Central economic planning does not work any more effectively or efficiently with regards to money and credit than it does with regards to goods and services.

Mailvox: take another look

HR asks an unexpected question:

I am reading your book and find it fascinating. I really appreciate your laying out the several possible scenarios and the arguments pro and con as well as identifying their supporters. The chart on your blog of “Debt Outstanding 2004-2009” I find quite convincing for your position on the key question of inflation vs deflation. However I also find that the Fed Statistics (see page 9 of this link) seem to show quite different trends and support the opposite conclusion. What is the source for your chart?

I’m glad HR finds it worthwhile reading. My source for the sector debt is the Federal Reserve flow of funds account. Notice how the red line for Federal debt on the chart ends a little below the $8,000 billion line. If you look a little more carefully at the linked PDF, you’ll see that this corresponds rather neatly with the $7,805 billion reported in 2009-Q4 for the Federal Government. The reason for this is that the Federal Reserve flow of funds account is, in fact, the very Z1 report that HR cited.

In other words, you have to look at the bottom of the page, not the top, since those are the 1978 numbers. It’s a bit easier to see this in the online version, in which the years run from left to right.

RGD: a rather good review

An academic economist reviews RGD:

The book is simply a brilliant masterpiece. It is written remarkably well and gets you to read more and more. It provides a balanced mix between telling a story and zooming in on the economic fundamentals. Right from the very beginning, it becomes perfectly clear to the cognoscenti that Vox is a member of a small, ultra-elite club that has figured out the fundamental flaws of our modern-day Keynesian economic dogma, as well as the finest points of the Austrian school that only few people in the world are familiar with and understand. As an Austrian myself, it is easy to see how sophisticated Vox is in the area.

I am a professor in Economics who has been trained in and disillusioned from the mainstream economics. As an economist, I was completely reborn when I became an Austrian 7-8 years ago. Ever since, I have been teaching economics and finance mostly as an Austrian. During the Spring semester of 2008, I was teaching a course on the Financial Crisis at the American University in Bulgaria. My biggest regret is that I did not have at that time available to use Vox’s book for my course. It would have been perfect. The book may be somewhat difficult for first year Econ 101, but it is absolutely perfect for juniors and seniors – it could well be the book that will make them rethink their mainstream economics foundations. For my course, I had to use Peter Schiff’s “Crash Proof” as the very best available at the time. If I had to do it today again, I would use “The Return of the Great Depression” as my primary book. When combined with “Crash Proof”, it provides a killer combination that would open the eyes to any student willing to read. My third choice would be, without doubt, “Meltdown” by Thomas Woods.

Enough praising Vox and his book. Do not hesitate to get your copy and read it – I guarantee that you would be glad you did it.

This is without a doubt the best book review I have ever received from Bulgaria. Possibly the most interesting thing about Dr. Petrov’s review is that I happen to know he does not agree with me on the most important question of the day, inflation vs deflation. But, as I have said many times in writing about the issue, including in RGD, there are very smart and informed individuals on both sides of the issue and it is only the less sophisticated observers who think that the issue is simple enough to be critical of the other side for the way they interpret the available evidence. While I think that evidence of the last fifteen months has tended to favor the deflationary scenario, I don’t regard the matter as settled. And I certainly don’t think any less of excellent economic observers such as Marc Faber, Jim Rogers, Peter Schiff, the Mogambo Guru, or Dr. Petrov due to their expectation of a Whiskey Zulu situation.

Economics is a complex science wherein the timing remains an art. This means everyone gets something wrong sooner or later; even when you have interpreted all the evidence correctly you can still get the timing fatally wrong. I very much appreciate Dr. Petrov’s review, as it is great to see academics who have opened their minds to Austrian School economic theory. But, to return to the inflation/deflation matter, this chart on the diminishing marginal utility of debt nicely illustrates why I fall on the deflationary side and why I am confident that we are still in the early stages of the Great Depression 2.0.

The zero-reserve banking system

Unbelievable. They certainly didn’t teach this in our economics textbooks. From Ben Bernanke’s testimony to the House Committee on Financial Services:

Given the very high level of reserve balances currently in the banking system, the Federal Reserve has ample time to consider the best long-run framework for policy implementation. The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system.

Those who have RGD will note that this elimination of reserve requirements would theoretically permit the former fractional-reserve banks to make an infinite amount of loans regardless of what deposits they hold. This would also theoretically provide a rational basis for the hyperinflation scenario, but as I have pointed out many times before, even an infinite money multiple will require an infinity of borrowers.

If this does not make it clear to you that the financial authorities are getting desperate, I don’t know what will. The ironic thing is that most people still believe that the fractional-reserve system is based on a 10% minimum reserve requirement.