The Fabled Greek Mega-Bailout

May 16, 2012

Aziz Economic History, Economics, Fixed Income, Inflation, International Relations, Musings, Philosophy, Politics , , , , , , , , , , , , , , 42 Comments

In a truly eyebrow-raising CNBC interview, Matthew Lynn alleges that Europe shall be saved! (As if by the grace of God!).

With Europe on the brink yet again Germany will act.

The Greeks can’t carry on with the austerity being imposed on them. No country can be expected to endure annualized falls in GDP  of 7 percent or more,” he said, “and 50 percent youth unemployment for years on end.

On Tuesday we learned that the Greek economy shrank by another 6.2 percent in the latest quarter. It simply isn’t acceptable” Lynn said.

But Germany and the rest of the EU could come up with a Marshall Aid-style package for Greece. Very little of the bail-out money so far has gone to the Greeks. It has all gone to the bankers.

Forget talk of a ‘Grexit’. There will be a mega-bail-out—a ‘Grashall Plan’—instead.

And when it happens, the markets will rally on the news.

Who else would publish this? (That’s a redundant question — who else, besides J.P. Morgan and maybe a few government agencies, wouldn’t have fired Jim Cramer after what he said about Bear Stearns?)

At various stages in the last two years everyone from China, to Germany, to the Fed to the IMF, to Martians, to the Imperial Death Star has been fingered as the latest saviour of the status quo. And so far — in spite of a few multi-billion-dollar half-hearted efforts like the €440 billion EFSF —  nobody has really shown up.

Perhaps that’s because nobody thus far fancies funnelling the money down a black hole. After Greece comes Portugal, and Spain and Ireland and Italy, all of whom together have on the face of things at least €780 billion outstanding (which of course has been securitised and hypothecated up throughout the European financial system into a far larger amount of shadow liabilities, for a critical figure of at least €3 trillion) and no real viable route (other than perhaps fire sales of state property? Sell the Parthenon to Goldman Sachs?) to paying this back (austerity has just led to falling tax revenues, meaning even more money has had to be borrowed), not to mention the trillions owed by the now-jobless citizens of these countries, which is now also imperilled. What’s the incentive in throwing more time, effort, energy and resources into a solution that will likely ultimately prove as futile as the EFSF?

The trouble is that this is playing chicken with an eighteen-wheeler. While Draghi might be making noises about “continuing to comply with the mandate of keeping price stability over the medium term in line with treaty provisions and preserving the integrity of our balance sheet” (in other words, not proceeding with the fabled “mega-bailout” even if it fractures the Euro),  we may well see a full-blown financial meltdown (and of course, the ramifications of that on anyone who is exposed to the European banking system) unless someone — whether it is the ECB, or the Fed, or the IMF — prints the money to keep the banks going.

There are really two layers to bailing out the insolvent nations: the real bailout is of the banks who bought the debt, and the insolvent nations are just an intermediary. Should the insolvent nations become highly uncooperative, it seems more likely that the insolvent nations will just be cut out of the loop (throwing their citizens into experiencing a forced currency redenomination, bank runs, and even more chaos) while policymakers continue to channel money into “stabilising” the totally broken global financial system — because we know for sure that a big disorderly default will likely cause some kind of default cascade, and that is something I am sure that (based on past form) policymakers will seek to avoid.

How close to the collapse we will come before the money gets printed is another matter.

Given that it is predominantly Germans who are in charge of Europe for the moment — with their unusual (at least in the West) post-Weimar distaste for Keynesianism —  it seems to me like we will see quite a lot of chaos (read: Euro exits) before the money printing begins in earnest. And the money printing may be far more ad hoc and decentralised than 2008 (read: The Fed may be on the hook for American exposure). Just as we have seen so far, the money will come at the last minute, and will just keep things ticking over rather than actually solving anything.

And ultimately, I think it is the social conditions — particularly unemployment levels — that matter more than whether or not the financial system survives. If the attendant cost of ad hoc bailouts (in the name of pretending to stick to the ECB mandate) is a continued depression, and continued massive unemployment and youth unemployment then politicians are focusing on the wrong thing.

The problem is that as conditions continue to fester and as solutions seem distant and improbable that Europe’s problems may become increasingly political. As the established (dis)order in Europe continues to leave huge swathes of people jobless and angry, their rage and discomfort will be channelled toward dislodging the establishment. As we have seen in Greece and France, that has already produced big lifts for both the Far Left and Far Right.

We already know, I think, that in Greece’s upcoming election the outsider parties will crush the establishment, with SYRIZA most likely emerging on top. A key metric for me in the next few weeks will be Golden Dawn‘s proportion of the vote.

Let’s not forget history:

Double or Nothing: How Wall Street is Destroying Itself

May 12, 2012

Aziz Economic History, Economics, Finance, Fixed Income, Inflation, Philosophy , , , , , , , , , , , , , , , 30 Comments

There’s nothing controversial about the claim— reported on by Slate, Bloomberg and Harvard Magazine — that in the last 20 years Wall Street has moved away from an investment-led model, to a gambling-led model.

This was exemplified by the failure of LTCM which blew up unsuccessfully making huge interest rate bets for tiny profits, or “picking up nickels in front of a streamroller”, and by Jon Corzine’s MF Global doing practically the same thing with European debt (while at the same time stealing from clients).

As Nassim Taleb described in The Black Swan this strategy — betting large amounts for small frequent profits — is extremely fragile because eventually (and probably sooner in the real world than in a model) losses will happen (and, of course, if you are betting big, losses will be big). If you are running your business on the basis of leverage, this is especially dangerous, because facing a margin call or a downgrade you may be left in a fire sale to raise collateral.

This fragile business model is in fact descended from the Martingale roulette betting system. Martingale is the perfect example of the failure of theory, because in theory, Martingale is a system of guaranteed profit, which I think is probably what makes these kinds of practices so attractive to the arbitrageurs of Wall Street (and of course Wall Street often selects for this by recruiting and promoting the most wild-eyed and risk-hungry). Martingale works by betting, and then doubling your bet until you win. This — in theory, and given enough capital — delivers a profit of your initial stake every time. Historically, the problem has been that bettors run out of capital eventually, simply because they don’t have an infinite stock (of course, thanks to Ben Bernanke, that is no longer a problem). The key feature of this system— and the attribute which many institutions have copied — is that it delivers frequent small-to-moderate profits, and occasional huge losses (when the bettor runs out of money).

The key difference between modern business models, and the traditional roulette betting system is that today the focus is on betting multiple times on a single outcome. By this method (and given enough capital) it is in theory possible to win whichever way an event goes. If things are going your way, it is possible to insure your position by betting against your initial bet, and so produce a position that profits no matter what the eventual outcome. If things are not going your way, it is possible to throw larger and larger chunks of capital into a position or counter-position again and again and again —mirroring the Martingale strategy — to try to compensate for earlier bets that have gone awry (this, of course, is so often the downfall of rogue traders like Nick Leeson and Kweku Adoboli).

This brings up a key issue: there is a second problem with the Martingale strategy in the real world beyond the obvious problem of running out of capital. You can have all the capital in the world (and thanks to the Fed, the TBTF banks now have a printing-press backstop) but if you do not have a counter-party to take your bets  (and as your bets and counter-bets get bigger and bigger it by definition becomes harder and harder to find suitable counter-parties) then you are Corzined, and you will be left sitting on top of a very large load of pain (sound familiar, Bruno Iksil?)

The obvious real world example takes us back to the casino table — if you are trying to execute a Martingale strategy starting at $100, and have lost 10 times in a row, your 11th bet would have to be for $204,800 to win back your initial stake of $100. That might well exceed the casino table limits — in other words you have lost your counter-party, and are left facing a loss far huger than any expected gains.

Similarly (as Jamie Dimon and Bruno Iksil have now learned to their discredit) if you have built up a whale-sized market-dominating gross position of bets and counter-bets on the CDX IG9 index (or any such market) which turns heavily negative, it is exceedingly difficult to find a counter-party to continue increasing your bets against, and your Martingale game will probably be over, and you will be forced to face up to the (now exceedingly huge) loss. (And this recklessness is what Dimon refers to as “hedging portfolio risk“?)

The really sickening thing is that I know that these kinds of activities are going on far more than is widely recognised; every time a Wall Street bank announces a perfect trading quarter it sets off an alarm bell ringing in my head, because it means that the arbitrageurs are chasing losses and picking up nickels in front of streamrollers again, and emboldened by confidence will eventually will get crushed under the wheel, and our hyper-connected hyper-leveraged system will be thrown into shock once again by downgrades, margin calls and fire sales.

The obvious conclusion is that if the loss-chasing Martingale traders cannot resist blowing up even with the zero-interest rate policy and an unfettered fiat liquidity backstop, then perhaps this system is fundamentally weak. Alas, no. I think that the conclusion that the clueless schmucks at the Fed have reached is that poor Wall Street needs not only a lender-of-last-resort, but a counter-party-of-last-resort. If you broke your trading book doubling or quadrupling down on horseshit and are sitting on top of a colossal mark-to-market loss, why not have the Fed step in and take it off your hands at a price floor in exchange for newly “printed” digital currency? That’s what the 2008 bailouts did.

Only one problem: eventually, this approach will destroy the currency. Would you want your wealth stored in dollars that Bernanke can just duplicate and pony up to the latest TBTF Martingale catastrophe artist? I thought not: that’s one reason why Eurasian creditor nations are all quickly and purposefully going about ditching the dollar for bilateral trade.

The bottom line for Wall Street is that either the bailouts will stop and anyone practising this crazy behaviour will end up bust — ending the moral hazard of adrenaline junkie coke-and-hookers traders and 21-year-old PhD-wielding quants playing the Martingale game risk free thanks to the Fed — or the Fed will destroy the currency. I don’t know how long that will take, but the fact that the dollar is effectively no longer the global reserve currency says everything I need to know about where we are going.

The bigger point here is whatever happened to banking as banking, instead of banking as a game of roulette? You know, where investment banks make the majority of their profits and spend the majority of their efforts lending to people who need the money to create products and make ideas reality?

Is China a Currency Manipulator?

May 9, 2012

Aziz Current Affairs, Economic History, Economics, Federal Reserve, International Relations, Philosophy, Politics, Technology , , , , , , , , , , , , , , , , 57 Comments

Mitt Romney thinks so:

China has an interest in trade. China wants to, as they have 20 million people coming out of the farms and coming into the cities every year, they want to be able to put them to work. They want to have access to global markets. And so we have right now something they need very badly, which is access to our market and our friends around the world, have that same– power over China. To make sure that we let them understand that in order for them to continue to have free and open access to the thing they want so badly, our markets, they have to play by the rules.

They’re a currency manipulator. And on that basis, we go before the W.T.O. and bring an action against them as a currency manipulator. And that allows us to apply tariffs where we believe they are stealing our intellectual property, hacking into our computers, or artificially lowering their prices and killing American jobs. We can’t just sit back and let China run all over us. People say, “Well, you’ll start a trade war.” There’s one going on right now, folks. They’re stealing our jobs. And we’re gonna stand up to China.”

The theory goes that by buying U.S. currency (so far they have accumulated around $3 trillion) and treasuries (around $1 trillion) on the open market, China keeps demand for the US dollar high.  They can afford to buy and hold so much US currency due to their huge trade surplus with America, and they buy US currency roughly equal to this surplus.  To keep this pile of dollars from increasing the Chinese money supply, China sterilises the dollar purchases by selling a proportionate amount of bonds to Chinese investors.  Supposedly by boosting the dollar, yuan-denominated Chinese goods look cheap to the American (and global) consumer.

First, I don’t really think we can conclusively say that the yuan is necessarily undervalued. That is like assuming that there is some natural rate of exchange beyond prices in the real world. For every dollar that China takes out of the open market, America could print one more — something which, lest we forget — Bernanke has been very busily doing; the American monetary base has tripled since 2008. Actions have consequences; if China’s currency peg was so unsustainable, the status quo would have collapsed long ago. Until it does, we cannot conclusively say to what extent the yuan is undervalued.

What Romney is forgetting is that every nation with a fiat currency is to some degree or other a currency manipulator. That’s what fiat is all about: the ability of the state to manipulate markets through monetary policy. When Ben Bernanke engages in quantitative easing, or twisting, or any kind of monetary policy or open market operation, the Federal Reserve is engaging in currency manipulation. Every new dollar that is printed devalues every dollar out in the wild, and just as importantly all dollar-denominated debt. So just as Romney can look China in the face and accuse them of being a currency manipulator for trying to peg the yuan to the dollar, China can look at past U.S. administrations and level exactly the same claim — currency manipulation in the national interest.

While China’s currency policy in the past 40 years has been to attract manufacturing, technology, resources and investment into China (and build up a manufacturing base to provide employment to its low-skilled population) by keeping its produce cheap, America’s currency policy has sought to enjoy a free lunch made up of everyone else’s labour and resources. This has been allowed to develop because of America’s reserve currency status — everyone has needed dollars to access global markets, and so America has rested on her laurels and allowed her productive industries to decline. Why manufacture the bulk of your consumption when China can do it cheaper, and Wal Mart has no problem with slave labour? Why manufacture your military hardware when China can do it cheaper? Why produce your own energy when you can instead consume Arab and Latin American oil?

Former U.S. ambassador Jon Huntsman raised this issue in an article from China Business News in a cable that was eventually leaked via Wikileaks:

The U.S. has almost used all deterring means, besides military means, against China.  China must be clear on discovering what the U.S. goals are behind its tough stances against China. In fact, a fierce competition between the currencies of big countries has just started.  A crucial move for the U.S. is to shift its crisis to other countries – by coercing China to buy U.S. treasury bonds with foreign exchange reserves and doing everything possible to prevent China’s foreign reserve from buying gold.

If we use all of our foreign exchange reserves to buy U.S. Treasury bonds, then when someday the U.S. Federal Reserve suddenly announces that the original ten old U.S. dollars are now worth only one new U.S. dollar, and the new U.S. dollar is pegged to the gold – we will be dumbfounded.

Today when the United States is determined to beggar thy neighbor, shifting its crisis to China, the Chinese must be very clear what the key to victory is.  It is by no means to use new foreign exchange reserves to buy U.S. Treasury bonds.  The issues of Taiwan, Tibet, Xinjiang, trade and so on are all false tricks, while forcing China to buy U.S. bonds is the U.S.’s real intention.”

Romney and others of his ilk might brush this off, believing that China’s $3 trillion dollar reserve hoard was gained through unfair means — slave labour, cutting corners in quality, the aforementioned “currency manipulation”, etc, and that that somehow gives America the right to inflate away its debts and screw its creditors. To some degree, they have a point. If China had a problem with America inflating away its debts, it should never have put itself so deep into dollar-denominated paper. If China recognised that America’s debt position was unsustainable, it should never have put so much into something so unsustainable, irrespective of supposed American pressure.

In the short term, though, I think escalating the trade war through the imposition of tariffs is a very bad idea. America is a consumption-led economy, and with middle class incomes already squeezed, a constriction of the supply of cheap and readily available goods is likely to put a lot of downward pressure on consumption. And it’s not just consumption — in today’s hyper-globalised world, a huge proportion of manufacturing — including military hardware — at some stage flows through China.

As Vincent Fernando noted:

Most of America’s key military technologies require rare earth elements, whose production China holds a near-monopoly over.

It’s thus perhaps no surprise that China has made the threat of rare earth export restrictions a new political bargaining chip.

American corporations could gradually pull out of China and shift to manufacturing and extracting resources elsewhere including America (which has large rare earth deposits), but it would be a challenging process. Rebuilding an industrial base is hard: skilled and experienced labour takes time to develop (American labour is rusty and increasingly unemployed and disabled), and supply chains and webs have all agglomerated in China. Building up domestic supply chains takes time, expertise and entrepreneurial zeal. And any destabilisation could spook global markets.

So let’s make no mistake: in the short term America needs China far, far, far more than China needs America. The notion that China needs America as a consumer is totally false; anyone can consume given the dollars or gold, and China holds $3 trillion, and continues to increase its imports of gold.

Peter Schiff summarises:

The big problem for countries like China and India is that they still subsidize the U.S. They buy our Treasury bonds and lend us all this money so we can keep consuming. That’s a big subsidy and a heavy burden.

They can use their money to develop their own economy, produce better and more abundant products for their own citizens. It’s a farce to think that the only thing China can do with its output and savings is lend it to the U.S. government, especially when we can’t pay it back.

Mitt Romney seems intent on destabilising this fragile relationship. American policy that incentivised globalisation and the service economy has very foolishly drawn America into this fragile position where its economy is increasingly fuelled not only by energy coming out of the politically and economically unstable middle east, but also by goods coming from a hostile and increasingly politically and economically unstable power.

And make no mistake — although China has done well to successfully transform itself into the world’s pre-eminent industrial base and biggest creditor, it has a lot of bubbles waiting to burst (particularly housing), stemming from the misallocation of resources under its semi-planned regime. Which makes this entire scenario doubly dangerous. Any shock in China would surely be transmitted to America, simply because it is becoming increasingly pointless for China to continue subsidising American consumption (through buying treasuries) when they could instead spend the money raising the Chinese standard of living. That could mean a painful rate-spike.

The real problem is that Romney is trying to address a problem that is very much in the past. If Romney was elected as President on this platform in 2000, things might be different. But China got what it wanted: by keeping its currency cheap and its labour force impoverished it became the world’s pre-eminent industrial base, the spider at the heart of the web of global trade, and a monopoly on important industrial components and resources. China used American demand, technology and investment during the 00s to develop. Now the imperative is not to grab a bigger share of global manufacturing, or a bigger hoard of dollars, it’s to leverage that position toward the ultimate aim of returning China to its multi-millennial superpower status. The promise of Chinese primacy is quite simply the strongest tool for the CPC to retain its (increasingly shaky) grip on China.

However we should not discount the possibility that bursting economic bubbles may stoke up some kind of popular rebellion against the Communist authorities in some kind of Chinese Spring. A new more pro-Western regime is surely America’s best hope of containing China, while gradually manoeuvring itself out of dependency on Arab oil and Chinese goods. But that may just be wishful thinking; it is possible that a new Chinese regime may be vehemently anti-Western; the Opium War and China’s 20th century humiliation still ring deeply in the Chinese psyche.

So it is unclear what is next for China, and the relationship between China and America. But having the world’s biggest manufacturing base and a monopoly over rare earths is a strong position to be in if your ultimate aim is to manufacture huge quantities of armaments in the pursuit of an aggressive, expansionist foreign policy…

Paul vs Paul: Round #2

May 4, 2012

Aziz Current Affairs, Economic History, Economics, Federal Reserve, Fixed Income, Inflation, Philosophy, Politics, Wall Street , , , , , , , , , , , , , , , , 19 Comments

Bloomberg viewers estimate that Ron Paul was the winner of the clash of the Pauls. But that is very much beside the point. This wasn’t really a debate. Other than the fascinating moment where Krugman denied defending the economic policies of Diocletian, very little new was said, and the two combatants mainly talked past each other.

The real debate happened early last decade.

To wit:

Readers are free to make up their own minds who won that one.

And so, round two. Krugman wants more inflation; Paul is scared of the prospect. From Paul’s FT editorial yesterday:

Control of the world’s economy has been placed in the hands of a banking cartel, which holds great danger for all of us. True prosperity requires sound money, increased productivity, and increased savings and investment. The world is awash in US dollars, and a currency crisis involving the world’s reserve currency would be an unprecedented catastrophe. No amount of monetary expansion can solve our current financial problems, but it can make those problems much worse.

Or, as Professor Krugman sees it:

Would a rise in inflation to 3 percent or even 4 percent be a terrible thing? On the contrary, it would almost surely help the economy.

How so? For one thing, large parts of the private sector continue to be crippled by the overhang of debt accumulated during the bubble years; this debt burden is arguably the main thing holding private spending back and perpetuating the slump. Modest inflation would, however, reduce that overhang — by eroding the real value of that debt — and help promote the private-sector recovery we need. Meanwhile, other parts of the private sector (like much of corporate America) are sitting on large hoards of cash; the prospect of moderate inflation would make letting the cash just sit there less attractive, acting as a spur to investment — again, helping to promote overall recover.

Ron Paul believes that inflationary interventions into the dollar economy will have unpredictable and dangerous ramifications. Paul Krugman believes that a little more inflation (although he forgets that by the old measure of CPI inflation is already running at 9%, far higher than his supposed target) will spur economic activity and decrease residual debt overhang. Krugman seems to give no credence to the prospect of inflation spiralling out of hand, or of such policies triggering other deleterious side-effects, like a currency crisis.

The prospect of a currency crisis is a topic I have covered in depth lately: as more Eurasian nations ditch the dollar as reserve currency, more dollars (there are $5 trillion floating around Asia, in comparison to a domestic monetary base of just $1.8 trillion — the dollar is an absurdly internationalised currency) will be making their way back into the domestic American economy, and that this may have a steep inflationary impact. Additionally, many of the deflationary pressures that existed in 2008 or 2009 (e.g. shadow bank deleveraging) aren’t there anymore.

I don’t really know how much of this is to do with the Fed’s inflationary policies, and how much is to do with the United States’ role as global hegemon coming to an end. I tend to think that the dollar hegemony has always been backed by American military force, and with the American military overstretched and its funding increasingly debt-fuelled, the dollar’s role is naturally threatened. If America can’t play the global policeman for global trade, why would the dollar be the currency on global trade?

However it must be noted that America’s creditors do believe that their assets are threatened by the Fed’s inflationism.

As the Telegraph noted last year:

There has been a hostile reaction by China, Brazil and Germany, among others, to the Federal Reserve’s decision to resume quantitative easing.

Or as a Xinhua editorial put it:

China, the largest creditor of the world’s sole superpower, has every right now to demand the United States to address its structural debt problems and ensure the safety of China’s dollar assets.

Probably, the egg of American imperial decline came before the chicken of the recent inflationism, but that inflationism certainly has the capacity to worsen the problems rather than lessen them. After all, if America’s consumption-based economy is dependent on China’s continued exportation, and Krugman is advocating slamming creditors (i.e. China) by inflating away their debt-denominated financial assets, then surely Krugman’s suggestions imperil the already-fragile trans-Pacific consumer-producer relationship?

And this is a crucial matter — there is nothing, I think, more crucial than the free availability of goods and resources through the trade infrastructure, which is something that Krugman’s policies seem to endanger.

As commenter Thomas P. Seager noted yesterday:

[The situation today] is directly analogous to the first Oil Shock in 1973. In the decades prior, the US had been a major oil producer. However, efficiency gains and discoveries overseas resulting in an incrementally increasing dependence of foreign petroleum. Price signals failed to materialize that would caution policy makers and industrialists of the risks.

Then, the disruption of oil supplies from the Middle East caused tremendous economic dislocations.

Manufacturing is undergoing the same process. The supply chain disruption from the Japanese earthquake and Tsunami was merely a warning shot. Imagine if S Korean manufacturing were taken off-line for any length of time (a plausible scenario). The disruption to US industry would be catastrophic.

In the name of increased efficiency, we have introduced brittleness.

Time will tell which Paul is right. But I know where I stand.

Krugman, Diocletian & Neofeudalism

May 1, 2012

Aziz Economic History, Economics, Economics for the Jilted Generation, Federal Reserve, Inflation, Philosophy, Politics, Wall Street, War, What is Money? , , , , , , , , , , , , , , , , , , , , , 63 Comments

The entire economics world is abuzz about the intriguing smackdown between Paul Krugman and Ron Paul on Bloomberg. The Guardian summarises:

  • Ron Paul said it’s pretentious for anyone to think they know what inflation should be and what the ideal level for the money supply is.
  • Paul Krugman replied that it’s not pretentious, it’s necessary. He accused Paul of living in a fantasy world, of wanting to turn back the clock 150 years. He said the advent of modern currencies and nation-states made an unmanaged economy an impracticable idea.
  • Paul accused the Fed of perpetrating “fraud,” in part by screwing with the value of the dollar, so people who save get hurt. He stopped short of calling for an immediate end to the Fed, saying that for now, competition of currencies – and banking structures – should be allowed in the US.
  • Krugman brought up Milton Friedman, who traversed the ideological spectrum to criticize the Fed for not doing enough during the Great Depression. It’s the same criticism Krugman is leveling at the Fed now. “It’s really telling that in America right now, Milton Friedman would count as being on the far left in monetary policy,” Krugman said.
  • Paul’s central point, that the Fed hurts Main Street by focusing on the welfare of Wall Street, is well taken. Krugman’s point that the Fed is needed to steer the economy and has done a better job overall than Congress, in any case, is also well taken.

I find it quite disappointing that there has not been more discussion in the media of the idea — something Ron Paul alluded to — that most of the problems we face today are extensions of the market’s failure to liquidate in 2008. Bailouts and interventionism has left the system (and many of the companies within it) a zombified wreck. Why are we talking about residual debt overhang? Most of it would have been razed in 2008 had the market been allowed to liquidate. Worse, when you bail out economic failures — and as far as I’m concerned, everyone who would have been wiped out by the shadow banking collapse is an economic failure — you obliterate the market mechanism. Should it really be any surprise that money isn’t flowing to where it’s needed?

A whole host of previously illiquid zombie banks, corporations and shadow banks are holding onto trillions of dollars as a liquidity buffer. So instead of being used to finance useful and productive endeavours, the money is just sitting there. This is reflected in the levels of excess reserves banks are holding (presently at an all-time high), as well as the velocity of money, which is at a postwar low:

Krugman’s view that introducing more money into the economy and scaring hoarders into spending more is not guaranteed to achieve any boost in productivity.

As I wrote last month:

The fundamental problem at the heart of this is that the Fed is trying to encourage risk taking by making it difficult to allow small-scale market participants from amassing the capital necessary to take risk. That’s why we’re seeing domestic equity outflows. And so the only people with the apparatus to invest and create jobs are large institutions, banks and corporations, which they are patently not doing.

Would more easing convince them to do that? Probably not. If you’re a multinational corporation with access to foreign markets where input costs are significantly cheaper, why would you invest in the expensive, over-regulated American market other than to offload the products you’ve manufactured abroad?

So will (even deeper) negative real rates cause money to start flowing? Probably — but probably mostly abroad — so probably without the benefits of domestic investment and job creation.

Nor is it guaranteed to achieve any great boost in debt relief.

As Dan Kervick wrote for Naked Capitalism last month:

Inflation only reduces debt overhang in a significant way for households who are fortunate enough to see their nominal wages rise along with the general rise in prices. In today’s economy, workers are frequently not so fortunate.

Again, I have to bring this back to why we are even talking about debt relief. The 2008 crash was a natural form of debt-relief; the 2008 bailouts, and ongoing QE and Twist programs (which contrary to Professor Krugman’s apologetics really do transfer wealth from the middle classes to Wall Street) crystallised the debt burden born from a bubble created by Greenspan’s easy money policies. There would be no need for a debt jubilee (either an absolute one, or a Krugmanite (hyper)inflationary one) if we had simply let the market do its work. A legitimate function for government would have at most been to bail out account holders, provide a welfare net for poor people (never poor corporations) and let bankruptcy courts and markets do the rest. Instead, the central planners in Washington decided they knew best.

The key moment in the debate?

I am not a defender of the economic policies of the emperor Diocletian. So let’s just make that clear.

Paul Krugman

Actually you are.

Ron Paul

Ron Paul is dead right. Krugman and the bailout-happy regime for which he stands are absolutely following in the spirit of Diocletian.

From Dennis Gartman:

Rome had its socialist interlude under Diocletian. Faced with increasing poverty and restlessness among the masses, and with the imminent danger of barbarian invasion, he issued in A.D. 301 an edictum de pretiis, which denounced monopolists for keeping goods from the market to raise prices, and set maximum prices and wages for all important articles and services. Extensive public works were undertaken to put the unemployed to work, and food was distributed gratis, or at reduced prices, to the poor. The government – which already owned most mines, quarries, and salt deposits – brought nearly all major industries and guilds under detailed control.

Diocletian explained that the barbarians were at the gate, and that individual liberty had to be shelved until collective liberty could be made secure. The socialism of Diocletian was a war economy, made possible by fear of foreign attack. Other factors equal, internal liberty varies inversely with external danger.

While Krugman does not by any means endorse the level of centralism that Diocletian introduced, his defence of bailouts, his insistence on the planning of interest rates and inflation, and (most frighteningly) his insistence that war can be an economic stimulus (in reality, war is a capital destroyer) all put him firmly in Diocletian’s economic planning camp.

So how did Diocletian’s economic program work out?

Well, I think it is fair to say even without modern data that — just as Krugman desires — Diocletian’s measures boosted aggregate demand through public works and — just as Krugman desires — it introduced inflation.

Diocletian’s mass minting of coins of low metallic value continued to increase inflation, and the maximum prices in the Edict were apparently too low.

Merchants either stopped producing goods, sold their goods illegally, or used barter. The Edict tended to disrupt trade and commerce, especially among merchants. It is safe to assume that a gray market economy evolved out of the edict at least between merchants.

And certainly Rome lived for almost 150 years after Diocletian. However the long term effects of Diocletian’s economic program were dire:

Thousands of Romans, to escape the tax gatherer, fled over the frontiers to seek refuge among the barbarians. Seeking to check this elusive mobility and to facilitate regulation and taxation, the government issued decrees binding the peasant to his field and the worker to his shop until all their debts and taxes had been paid. In this and other ways medieval serfdom began.

Have the 2008 bailouts done the same thing, cementing a new feudal aristocracy of bankers, financiers and too-big-to-fail zombies, alongside a serf class that exists to fund the excesses of the financial and corporate elite?

Only time will tell.

Anything the Government Gives You, the Government Can Take Away

April 29, 2012

Aziz Current Affairs, Musings, Philosophy, Politics , , , , , , , , , , 82 Comments

From the Guardian:

A majority of doctors support measures to deny treatment to smokers and the obese, according to a survey that has sparked a row over the NHS‘s growing use of “lifestyle rationing”.

Some 54% of doctors who took part said the NHS should have the right to withhold non-emergency treatment from patients who do not lose weight or stop smoking. Some medics believe unhealthy behaviour can make procedures less likely to work, and that the service is not obliged to devote scarce resources to them.

And that’s the trouble with services and institutions run from the taxpayer’s purse, administered by centralists and bureaucrats. It becomes a carrot or a stick for interventionists to intervene in your life. Its delivery depends on your compliance with the diktats and whims of the democracy, or of bureaucrats. Your standard of living becomes a bargaining chip. Don’t conform? You might be deemed unworthy of hospital treatment.

It seems innocuous to promise all manner of services in exchange for taxes. Citizens may welcome the convenience, the lower overheads, the economies of scale. They may welcome a freebie, and the chance to enjoy the fruits of someone else’s labour. They may feel entitled to it.

Many words have been spent on the problems of dependency; that rather than working for an honest living, the poor may be sucked into a vortex of entitlement, to such an extent that they lose the desire to produce. A tax-sucking multi-generational underclass can develop. Individuals can live entirely workless lives, enjoying a semi-comfortable existence on the teat of the taxpayer, enjoying the fruits — financial handouts, free education, free healthcare, a free home — of social engineers who believe that every problem under the sun can be remedied by government largesse and throwing money at problems. And who can blame them? Humans have sought out free lunches for as long as there have been humans.

Welfare dependency is generally assumed to be viewed negatively in the corridors of power. After all, broad welfare programs mean greater spending, and that very often means great debt. And why would a government want to be in debt? Surely governments would prefer it if more of the population was working and productive and paying taxes?

But it is easier to promote behaviour desired by the state when a population lives on state handouts. And for states that might want to influence the behaviour of their citizens — their resource consumption, their carbon footprint, their moral and ethical beliefs, or their attitude toward the state — this could be an attractive proposition. It might cost a lot to run a welfare system, but it brings a lot of power to influence citizens.

And increasingly throughout the Western world, citizens are becoming dependent on the state for their standard of living. In the UK, 92% of people are dependent on the socialist NHS for healthcare. 46 million Americans receive food stamps. That gives states a lot of leverage to influence behaviour. First it may be used in a (relatively sensible) attempt to curtail smoking and obesity. Beyond that, the sky is the limit. Perhaps doctors or bureaucrats may someday suggest withholding treatment or dole money from those who exceed their personal carbon or meat consumption quota? A tyrant could even withhold welfare from those who do not pledge their undying allegiance or military service to a regime or ideology (it happened many times last century). An underclass of rough and hungry welfare recipients is a fertile recruiting ground for military and paramilitary organisations (like the TSA).

With the wide expansion of welfare comes a lot of power, and the potential for the abuse of power. Citizens looking for a free lunch or an easier world should be careful what they wish for. Welfare recipients take note: you depend on government for your standard of living, you open yourself up to losing your liberty.

Mining the Skies

April 22, 2012

Aziz Environment, Musings, Philosophy, Technology , , , 40 Comments

In August last year I wrote:

Concerned about resource scarcity? There’s plenty more up there. Last year, scientists confirmed that there was water on the moon. And there are metals and hydrocarbons abundant in asteroids. Metallic asteroids  possess copper, silver, gold, and all other such elements as well, though not in abundances anywhere near as large as those of their primary constituents.

It’s an age old trope, going back to John S. Lewis’ book on the subject, and one of my greater interests.

I know that Earth is finite. I know that in some limited sense Malthus — my great intellectual nemesis, albeit one who has been proven wrong and wrong again and again — could be proven right. Earth’s resources are limited simply by the fact that Earth is a limited space. If we don’t leave Earth behind, and we continue to expand we will hit Earth’s limits, if not by the end of the century (unlikely, in my view) then by the end of the millennium.

But my key message on this subject is this: Malthus will only ever be proven right if we screw up. It’s a big expansive universe, and we are smart, flexible, ingenious creatures. We don’t know how big, but the amount of resources out there seem far, far beyond the scope of the human imagination. Malthus will always be there with us, a shackle around our necks, forewarning us not to be too gluttonous, or to expand too far too fast, and to maintain an awareness of our access to resources, particularly water and sustenance. Forewarning us, I might add, of the dangers of our own arrogance. But resource pressures are something we can always conquer without resorting to the kind of nasty authoritarianism that so often passes for “environmentalism” today.

For just as I expected — and not a moment too soon — a cohort of the wealthy are putting their economic weight behind the idea of going out and getting more resources.

From the Telegraph:

Power players including Eric Schmidt, the Google chairman, and James Cameron, the film director, are planning to mine the final frontier: space.

They are among the backers of a new venture that will reach for the riches lying elsewhere in the solar system. Planetary Resources will be a “space exploration company to expand Earth’s resource base” according to scant information released ahead of the start-up’s launch in Seattle on Tuesday.

“The company will overlay two critical sectors – space exploration and natural resources – to add trillions of dollars to the global GDP,” was the bold claim. “This innovative start-up will create a new industry and a new definition of ‘natural resources’.”

Mr Schmidt and the internet giant’s co-founder Larry Page are listed alongside Mr Cameron, the director of Titanic and Avatar, among the venture’s investors and advisers.

The company was founded by Eric Anderson and Peter Diamandis. “Since my childhood I’ve wanted to do one thing, be an asteroid miner,” Mr Diamandis told Forbes earlier this year. “So stay tuned on that one.”

While the costs of space travel are high, the hope is that riches contained in asteroids would make the sums worthwhile. Studies suggest that gold and other metals in the earth’s crust originated from asteroids that collided with the planet during its early life.

This is not the end of the road, but the start.

In any new industry there will be failures, some dramatic. Solar energy is a wonderful principle, but Solyndra was a terrible company.

But it is a pleasing start. Human civilisation just took a step in the right direction. And the ghost of Malthus just took another crashing blow.

Lao Tzu on Liberty

April 15, 2012

Aziz Philosophy , , , , , , , , , , 14 Comments

Regular reader Alister Cyril Blanc reminds me of Roderick Long’s Austro-Libertarian Themes in Early Confucianism, an interesting essay that attempts to find the roots of the modern schools of libertarianism (Rothbard, Boaz, Menger) in Taoism and Confucianism.

Long concludes (as I did on Friday) that Confucianism — while certainly not being entirely the same as modern libertarianism — was built up around the (peculiarly unmodern) concept of spontaneous order, and developed the concept that interventionism can be problematic.

Mencius (also known as Mengzi, and Confucius’ student) wrote:

There was a man from Sung who pulled at his rice plants because he was worried about their failure to grow. Having done so, he went on his way home, not realising what he had done. “I am worn out today,” said he to his family. “I have been helping the rice plants to grow.” His son rushed out to take a look and there the plants were, all shrivelled up. There are few in the world who can resist the urge to help their rice plants grow.

Statue of Lao Tzu (Fujian Province)

While Confucianism has some useful concepts, so too does Taoism. Lao Tzu also developed this theme:

The more prohibitions there are, the more ritual avoidances, the poorer the people will be. The more laws are promulgated, the more thieves and bandits there will be. So long as I do nothing the people will of themselves be transformed. So long as I love quietude, the people will of themselves go straight. So long as I act only by inactivity the people will of themselves become prosperous.

Long’s essay tries to compare Taoism and Confucianism in terms of their concepts of liberty and which is closer to modern libertarianism; I have nothing to say on that matter. I am a magpie; as I have explained before I pick and choose whatever philosophy I fancy from wherever I find it. But if we have to make a real contrast, I would bunch Taoism and Confucianism together, and compare them to the various shades of collectivist imperialism, most recently manifested in China as Maoism.

Joshua Snyder elaborates:

Confucius, Lao Tzu, and Sun Tzu all lived and taught in pre-imperial China. In 221 B.C., Ch’in Shih-huang united the various Chinese states into an empire and set about to burn the Confucian classics and bury their scholars alive. The Legalism of Han Fei Tzu, which centered on the totalitarian power of the ruler, replaced the humanistic teachings of Confucianism and Taoism.

The modern Chinese regime, of course, is a strange muddle of imperialism, Maoism, and Confucianism, and I think all of these instincts are in constant conflict (sometimes within one individual) which is why the Chinese regime is such a self-contradictory creature.

On the other hand (and rather bizarrely) here in the West, imperialism is far and away the dominant establishment instinct. That’s why both sides (Romney & Obama) of the 2012 American Presidential election are running on a platform of extending and expanding authoritarian centralist legislation like the Patriot Act, and the indefinite detention provision of the 2011 NDAA.

Confucius or Lao Tzu would reject such things; the more prohibitions there are, the more ritual avoidances, the poorer the people will be. The more laws are promulgated, the more thieves and bandits there will be.

Genius is Not Educated

April 15, 2012

Aziz Philosophy , , , , , , , , , , , , 26 Comments

The WSJ published an interesting article entitled Educating the Next Steve Jobs:

Though few young people will become brilliant innovators like Steve Jobs, most can be taught the skills needed to become more innovative in whatever they do. A handful of high schools, colleges and graduate schools are teaching young people these skills.

In most high-school and college classes, failure is penalized. But without trial and error, there is no innovation. Amanda Alonzo, a 32-year-old teacher at Lynbrook High School in San Jose, Calif., who has mentored two Intel Science Prize finalists and 10 semifinalists in the last two years—more than any other public school science teacher in the U.S.—told me, “One of the most important things I have to teach my students is that when you fail, you are learning.” Students gain lasting self-confidence not by being protected from failure but by learning that they can survive it.

It’s nice to read about the value of failure, a topic that I have written a few words about.

But really, I don’t think that revolutionary thinking can be educated, and I think it’s foolish (and possibly even counter-productive) to try. School by definition inculcates systematic thinking, methodology and dogma. It inculcates competence. That’s generally a good thing; surgeons, medical researchers, lawyers, engineers, musicians and all manner of professionals need to be competent to function. Innovation is not necessarily inherent in any of those fields. But genius and revolutionary thinking is not really about competence and confidence.

Malcolm Gladwell is famous for formulating the idea that with 10,000 hours of practice, it is possible to master a skill.

The key to success in any field is, to a large extent, a matter of practicing a specific task for a total of around 10,000 hours.

So is 10,000 hours of practice all that stands between incompetence and world-changing greatness?

Gladwell grandly theorises that many famous history-changers (“outliers”) like Bill Gates, Steve Jobs, and the Beatles got to where they did with 10,000 hours of practice. But that ignores a lot of silent evidence; for every Bill Gates programming over a mainframe for 10,000 hours, there is a housewife that we have never heard of who has done 10,000 hours of parenting, and (probably much more than) 10,000 hours of housework. There is a surgeon who has done 40,000 hours of operations. There is a truck driver who has driven for 100,000 hours.

Gladwell is keen to point out, of course, that people’s skills also flourish through the networks they cultivate, and the people they meet, and that (of course) it’s just a little more complicated than 10,000 hours of practice.

My view is that all 10,000 hours of practice (something which of course can be delivered within a traditional educational framework) does is lay down a bedrock of competency.

My theory is that revolutionary thinking is not simply a matter of persistence, but is instead attitudinal, and mostly comes out of people who are forced or who force themselves to take a radically different perspective to the rest of the world. They are — almost by definition — autodidacts, simply because their style of thinking has not yet been pioneered. They have to teach themselves, and iron out the kinks. Being an autodidact of course is not necessarily a matter of choice; very often it is a matter of necessity — people who don’t have access to traditional education, or who are forced to exist outside the system. This can be due to poverty, strong personalities, or a preference for self-teaching (very often expressed as a preference for doing over thinking).

The established system is often very useful for such people, because it gives them a framework from which to hang contrarianism. It gives them something to rebel against and kick out against.

On the other hand there are many examples of professional academics and those within the establishment who pioneer and innovate (although of course it should be noted that the overwhelming majority of academic papers today are masturbatory regurgitation). But such activity forces even the most staid into autodidactic learning; it forces them to make mistakes, and challenge themselves and learn their own lessons.

I suppose it is possible to try to inculcate a love of tinkering, of trial-and-error, and an understanding of the value of failure. It is certainly possible to encourage an interest in self-teaching. But it remains to be seen how many of us will really bite. It strikes me as if most of us do not really want to be innovators; I see far more who want job security, loving families, and plenty of leisure time.

I tend to believe that today’s education system is fit for its own purposes; it churns out competent thinkers, competent doers, people who can analyse to a framework and work to a deadline. True autodidacts and philosophers (in the most literal sense of the word — lovers of thinking, learning and wisdom) will find their own way.

Rome & Central Planning

April 12, 2012

Aziz Economic History, Musings, Philosophy , , , , , , , , , , 56 Comments

Central planning — like war — never changes. It has always been a powerful and effective way of achieving an explicit objective (e.g. building a bridge, or a road), but one that has has always come with detrimental side-effects. And the more central planners try to minimise the side-effects, the more side-effects appear. And so the whack-a-mole goes on.

This was true in the days of Rome, too.

From Dennis Gartman:

Rome had its socialist interlude under Diocletian. Faced with increasing poverty and restlessness among the masses, and with the imminent danger of barbarian invasion, he issued in A.D. 301 an edictum de pretiis, which denounced monopolists for keeping goods from the market to raise prices, and set maximum prices and wages for all important articles and services. Extensive public works were undertaken to put the unemployed to work, and food was distributed gratis, or at reduced prices, to the poor. The government – which already owned most mines, quarries, and salt deposits – brought nearly all major industries and guilds under detailed control. “In every large town,” we are told, “the state became a powerful employer, standing head and shoulders above the private industrialists, who were in any case crushed by taxation.” When businessmen predicted ruin, Diocletian explained that the barbarians were at the gate, and that individual liberty had to be shelved until collective liberty could be made secure. The socialism of Diocletian was a war economy, made possible by fear of foreign attack. Other factors equal, internal liberty varies inversely with external danger.

The task of controlling men in economic detail proved too much for Diocletian’s expanding, expensive, and corrupt bureaucracy. To support this officialdom – the army, the courts, public works, and the dole – taxation rose to such heights that people lost the incentive to work or earn, and an erosive contest began between lawyers finding devices to evade taxes and lawyers formulating laws to prevent evasion. Thousands of Romans, to escape the tax gatherer, fled over the frontiers to seek refuge among the barbarians. Seeking to check this elusive mobility and to facilitate regulation and taxation, the government issued decrees binding the peasant to his field and the worker to his shop until all their debts and taxes had been paid. In this and other ways medieval serfdom began.

So much for the view that increasing aggregate demand is the recipe for wider prosperity; Diocletian surely raised it a lot. But that didn’t really accomplish much, either in terms of wider prosperity, or in terms of the sustainability of the Roman civilisation. Raised aggregate demand is only useful if it contributes to creating and producing things that society needs and wants. And as Hayek brutally demonstrated, central planning is notoriously useless at determining what people actually want.

Of course, no modern centralist (e.g. Krugman) explicitly endorses price controls although, I am sure some of the more Hayekian or Paulian-minded among us will point out among other things that the minimum wage and the setting of interest rates are both kinds of price control. Diocletian however, was far more expansive.

From Wiki:

The first two-thirds of the Edict doubled the value of the copper and bronze coins, and set the death penalty for profiteers and speculators, who were blamed for the inflation and who were compared to the barbarian tribes attacking the empire. Merchants were forbidden to take their goods elsewhere and charge a higher price, and transport costs could not be used as an excuse to raise prices.

The last third of the Edict, divided into 32 sections, imposed a price ceiling - a maxima - for over a thousand products. These products included various food items (beef, grain, wine, beer, sausages, etc), clothing (shoes, cloaks, etc), freight charges for sea travel, and weekly wages. The highest limit was on one pound of purple-dyed silk, which was set at 150,000 denarii (the price of a lion was set at the same price).

And how did it work out?

The Edict did not solve all of the problems in the economy. Diocletian’s mass minting of coins of low metallic value continued to increase inflation, and the maximum prices in the Edict were apparently too low.

Merchants either stopped producing goods, sold their goods illegally, or used barter. The Edict tended to disrupt trade and commerce, especially among merchants. It is safe to assume that a gray market economy evolved out of the edict at least between merchants.

Bernanke of course is much more sophisticated; he uses the facility of the primary dealer banks to hide the currency inflation necessary to monetise government debt. Central planning wins again? No; central planning always comes with unpredictable boomerang side effects.

I suppose, though, that it is comforting that history is repeating itself. After the horrors of mediaeval feudalism, we pulled ourselves up anew from the wastes of history.

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