Tag: economics

Krugman dabbles in Austrian theory

Needless to say, he doesn’t do so consciously nor does he show any signs of having learned the relevant empirical lessons. But in this particular situation, he is correct in placing the blame for the present Irish debacle on a credit bubble and in recommending the right economic policy:

The Irish story began with a genuine economic miracle. But eventually this gave way to a speculative frenzy driven by runaway banks and real estate developers, all in a cozy relationship with leading politicians. The frenzy was financed with huge borrowing on the part of Irish banks, largely from banks in other European nations.

Then the bubble burst, and those banks faced huge losses. You might have expected those who lent money to the banks to share in the losses. After all, they were consenting adults, and if they failed to understand the risks they were taking that was nobody’s fault but their own. But, no, the Irish government stepped in to guarantee the banks’ debt, turning private losses into public obligations….

In early 2009, a joke was making the rounds: “What’s the difference between Iceland and Ireland? Answer: One letter and about six months.” This was supposed to be gallows humor. No matter how bad the Irish situation, it couldn’t be compared with the utter disaster that was Iceland.

But at this point Iceland seems, if anything, to be doing better than its near-namesake. Its economic slump was no deeper than Ireland’s, its job losses were less severe and it seems better positioned for recovery. In fact, investors now appear to consider Iceland’s debt safer than Ireland’s. How is that possible?

Part of the answer is that Iceland let foreign lenders to its runaway banks pay the price of their poor judgment, rather than putting its own taxpayers on the line to guarantee bad private debts. As the International Monetary Fund notes — approvingly! — “private sector bankruptcies have led to a marked decline in external debt.”

Where Krugman goes awry is in stating that the Irish are “bearing a burden much larger than the debt — because those spending cuts have caused a severe recession so that in addition to taking on the banks’ debts, the Irish are suffering from plunging incomes and high unemployment.”

It’s not the spending cuts that have caused the severe recession, it is the debt-deflation that inevitably followed the end of the credit bubble that caused it. And while Krugman is correct to note that the Keynesian solution to “restore confidence” is not working, he doesn’t realize that is because it is irrelevant and cannot work. He does, however, recognize that his usual recommendation of currency devaluation (printing away the debt) is not an option due to the financial straightjacket imposed by the Euro, which leaves the correct option of the Irish government defaulting on the bank debts, which is exactly what Austrian theory dictates should have been done in the first place.

Mailvox: the currency circus

DMM queries my forex views:

You wrote on Oct 19th the following: “This should also mark a surge in USD strength contra nearly everyone’s expectations.” I am curious if you still feel that there will be a strengthening of the dollar? With the latest actions of the FED many are claiming we will see a 20% loss in value. You have also stated that the debt deflation is overwhelming the attempted inflation of the dollar but does the FED’s actions yesterday make you think differently or are you still of the same opinion?

Given that the Euro has fallen from 1.39 to 1.34 against the dollar in the last month despite the brief spike courtesy of the Fed’s quantitative easing announcement, I think my contrarian position has been generally supported by events so far. I see no reason to change my opinion. I find it remarkable that so few see that the way in which these massive money pumps are not driving the dollar down anywhere near the depths it was in 2008 indicate that the USA is in a deflationary environment, not the inflationary one that almost everyone presently believes is the situation.

At $80, oil is much less expensive than it was in 2007. Housing prices continue to fall. And while the Federal Reserve is frantically pumping as much money through the US Treasury as it can, it’s going to run up against the debt limit soon and it cannot hope to create enough debt to make up for the $2.8 trillion in nonexistent assets presently held by the four largest U.S. banks alone. They have run extend-and-pretend longer than I’d imagined they could, but they’ve had to run it longer than they’d thought they’d have to and they cannot run it indefinitely. Either the economy turns around or something gives, and I see little sign of the former.

The important thing to remember is that the massive amounts of money being created by the central banks to bail out loans made to Greek and Irish debtors are only meant to replace money (debt) that has already gone up in smoke with the defaulted loans.

The Dread Ilk, causing trouble

Okay, this made me laugh. A lot. Scooter posted this comment at National Review in response to a call on The Corner for the Wall Street Journal to feature an economics writer to counter Paul Krugman’s influence:

He’s a bit outside the mainstream for the Wall Street Journal, but Vox Day is an excellent voice for the Austrian school and regularly rebuts Krugman and Keynesian theory in general on his blog, Vox Popoli.

Spacebunny asked what I was laughing at. When I told her, she laughed and wanted to know if Vox Day appearing regularly in the Wall Street Journal was the 5th or the 6th sign that the Apocalypse was nigh.

Credit contagion

Well, three of five isn’t bad as the Eurozone is on the verge of melting down again:

The EU authorities have begun to vent their fury against Ireland over its refusal to accept a financial rescue, fearing that the crisis will engulf Portugal and Spain unless confidence is restored immediately to eurozone bond markets…. A simultaneous bail-out for both Ireland and Portugal might run to €200bn, depleting much of the EU rescue line. The European Financial Stability Facility (EFSF) can raise up to €440bn on the bond markets but only two thirds of this would be available. The IMF is expected to loan a further €3 for every €8 from the EU under the bail-out formula.

The great concern is that the crisis could spread to Spain, which has a far bigger economy that Greece, Portugal, and Ireland combined. Foreign banks have €850bn of exposure to Spanish debt.

In RGD, I correctly identified Ireland and Spain as the likely culprits for the modern version of 1931’s Creditanstalt collapse. But I have to admit, I did not see Greece or Portugal being a probable issue; Estonia doesn’t count because it is not part of the Eurozone until 2011, assuming that there is still is Eurozone in 2011. But Greece was faking its economic statistics – they released yet another and increasingly bad debt/GDP report yesterday and I only looked at Portugal’s real estate sector, so presumably their excessive debt was concentrated elsewhere.

“According to Austrian theory, the effects of the housing bust on the overall economy should be much greater in countries like Estonia, Spain, and Ireland than in Austria, Germany, and Poland, and to the extent that inexpensive debt was made available to that and other sectors of the economy, we would expect to see that signs of the resulting economic contraction are similarly greater as well. Therefore we should see unemployment rising faster, prices falling further, GDP contracting more, and government deficits growing larger in the three housing boom countries than in the three non-boom ones. Due to the Austrian doubts about the reliability of macroeconomic data, greater credence should be given to historical statistics that are less easily manipulated, such as government deficits and interest rates, rather than GDP, unemployment, and inflation.”

Ireland is right to refuse the EU-IMF bailout. Notice that the bailout is not, as it is improperly characterized, a bailout of Ireland per se. It is actually a bailout of the banks that invested in Irish government debt and it is intended to put the people of Ireland on the hook for it in much the same way that Americans were put on the hook for the cost of the TARP bailouts.

Although it isn’t mentioned in the article, I noticed that Australia’s bond spreads have risen even higher than Portugal’s in the two-year. Australia has had a serious housing bubble too, one that continued into 2010, so don’t be surprised if there is news of a Australian crisis in the near future.

A shot across the bow

And the much-expected monetary war begins… the Market Ticker reports that China has downgraded US debt:

Chinese rating agency Dagong Global Credit downgrades US credit rating due to QE program

– Cut long term US sovereign rating one notch to A+ from AA, with a negative outlook.

– “The serious defects in the U.S. economy will lead to long-term recession and fundamentally lower the national solvency. The credit crisis is far from over in the United States and the U.S. economy will be in a long-term recession. In essence, the U.S. government’s move to devalue the dollar indicates its solvency is on the brink of collapse”

The status of the U.S. dollar as the dominant international reserve currency determines that its depreciation gives an inevitable impact to the interests of all creditors. In addition to the shrinking of creditors’ assets, the utter chaos in the international currency system triggered by the depreciation of the U.S. dollar will definitely damage the interests of all the creditors in the world at various levels. Together with the possibility of inflation in the future, the wealth of creditors will be plundered once again by the malicious act of currency devaluation conducted by the U.S. government after it suffered the losses during the financial crisis since 2007.

The value fluctuation of the world’s major currencies caused by the continuous devaluation of the U.S. dollar will push the adjustment in world interest pattern through the value comparison of the monetary system. The essence is to transfer the interests of the creditors to the debtor free of charge, and that will fundamentally destroy the international credit system and global economic system comprised of the creditor system and debtor system, resulting in an overall crisis around the world.

Translation: you’re not going to rescue the big banks on our dime, Ben. By the way, notice that USD has been moving higher since the initial dive following the QE2 announcement. It’s not always as obvious as it looks. Anyhow, this could end up marking a historic moment in the struggle for 21st century supremacy. And if the pattern of history holds true, the real winner will be a third party that doesn’t get involved until throwing its weight in will close the deal.

In other words, bet on India.

WND column

Too Soon to Tell

It was just over one year ago that WND Books published “The Return of the Great Depression.” In that book, I articulated six possible scenarios and explained which scenario I considered to be most likely. I also made a number of predictions, some of which can now be profitably analyzed to see how accurate they were. Keep in mind that at the time the book was published, the end of October 2009, the scenario which most of the mainstream economists were declaring to be in effect was the Green Shoots scenario.

Time preferences

This should serve as a cautionary tale to those who still believe that giving money to the impoverished is a rational solution to poverty. And yet, we can be confident that it won’t.

A short drive away, Hamon Matipe, the septuagenarian chief of Kili, confirmed that he had received that sum [$120,000] four months earlier. In details corroborated by the local authorities, Mr. Matipe explained that the provincial government had paid him for village land alongside the Southern Highlands’ one major road, where the government planned to build a police barracks.

His face adorned with red and white paint, a pair of industrial safety glasses perched incongruously on a head ornament from which large leaves stuck out, Mr. Matipe said he had given most of the money to his 10 wives. But he had used about $20,000 to buy 48 pigs, which he used as a dowry to obtain a 15-year-old bride from a faraway village, paying well above the going rate of 30 pigs. He and some 30 village men then celebrated by buying 15 cases of beer, costing about $800.

“All the money is now gone,” Mr. Matipe said. “But I’m very happy about the company, ExxonMobil. Before, I had nothing. But because of the money, I was able to buy pigs and get married again.”

Now, not everyone is capable of blowing $120,000 in only four months and winding up with nothing but another notch on the old bedpost. But this sort of behavior is seen all the time, from professional athletes to lottery winners. So long as an individual’s time preference is limited to the short term, he will never amass any wealth because he will immediately spend any amount of money that is given to him or earned by him.

This is why societies that insist on transferring wealth from those with long-term time preferences to short-term preferences are ultimately doomed. One can always eat a heartier meal if one does not save the pigs for breeding and the grain for planting, but there won’t be anything left to eat come the winter. And unfortunately, one cannot instill time preferences though education due to the human talent for rationalization.

Stay on target

Remember this January 1st prediction for December 2010? “The national median existing-home price will not rise 4% from $172,600 to $179,500 as predicted by NAR’s lead economist Lawrence Yun, but will fall below 165k instead.”

From yesterday’s September NAR report: “The national median existing-home price for all housing types was $171,700 in September, which is 2.4 percent below a year ago.”

Considering that the impact from the Great Mortgage Fraud hasn’t begun to appear yet in the housing statistics, I’m not the least bit concerned about this one panning out. And on that note, MSNBC’s Dylan Ratigan is doing an excellent job covering what the so-called conservative media won’t. The Bill Black segment starting at 6:20 is particularly informative, although the nurse that precedes him is fantastic in her observation that virtually none of the politicians, including the Tea Party all-stars, are talking about holding the bankers responsible for their crimes. Black draws a very clear picture pointing directly at the mortgage banks as being the sole causal factor of the fraud, with the Federal Reserve becoming subsequently complicit in the coverup through its purchase of $1.5 trillion in fraudulent loans. He also explains how the “deadbeat” borrowers cannot have been responsible for committing any fraud due to their ignorance of the loan ratios and various formulas involved in framing their “liars loans” to allow their categorization as AAA-rated loans.

Black is entirely correct to say that the Federal Reserve cannot be trusted in its belated “investigation” that Bernanke announced yesterday. And it is obvious that the Treasury cannot be trusted either.

“The United States Treasury concealed $40 billion in likely taxpayer losses on the bailout of the American International Group earlier this month, when it abandoned its usual method for valuing investments, according to a report by the special inspector general for the Troubled Asset Relief Program.”

In which Heimdall takes a deep breath

This news may help explain why the pension funds are so desperate to force the mortgage security push-backs though sooner rather than later… as if the thought of being able to legitimately reclaim billions of dollars in investment losses wasn’t enough incentive in its own right.

On Nov. 1, the Financial Accounting Standards Board (FASB) ceases to take public comment on a new rule requiring that companies more accurately report liabilities they have from participation in multiemployer pension plans. Unless FASB is persuaded otherwise, the rule takes effect Dec. 15.

There are some 1,500 multiemployer pension plans in the United States, which are unique to unions. In these plans, multiple companies pay into the pension plan, but each company assumes the total liability. Under “last man standing” accounting rules, if five companies are in a plan and four go bankrupt, the fifth company is responsible for meeting the pension obligations for the employees of the other four companies….

FASB’s new rule could effectively wipe out the paper worth of many companies, especially in the trucking and construction industries. Once banks and creditors are aware of these staggering pension liabilities, it will make it nearly impossible for union businesses to get loans, credit lines or bonding.

Now, obviously I didn’t know that the mortgage fraud would run as deep and wide as it does, nor did I know anything about the way in which this FASB rule is likely to put so much pressure on the pension plans. But I did know that the accounts of every bank, pension, and public corporation were fictitious to some level and would likely be exposed once the pressure of debt-deflation and economic contraction set in. This is why I have resolutely ignored all of the frantic cheerleading of the desperate economists and financial analysts; being cognizant of the true nature of Keynesianism, I recognized it as nothing more than a futile attempt to revive the animal spirits that they, like neolithic cavemen dancing around a bear skull, worship without comprehension.

Moreover, you can be certain there will be more unhappy revelations and “surprises to the downside” ahead.