Jamie

Warren Buffett wants to give Jamie Dimon a job:

On the Charlie Rose show [last month], Buffett was asked what kind of message it would send if President Obama picked Jamie Dimon or another Wall Street banker to succeed Timothy Geithner, who has expressed a desire to leave the post after Obama’s first term.

“I think he’d be terrific,” said Buffett, chairman of Berkshire Hathaway, about Dimon. “If we did run into problems in markets, I think he’d actually be the best person you could have in the job.”

Buffett added that Dimon would have the confidence of world leaders if he were appointed to the Treasury post.

Warren Buffett is one of America’s biggest bailout beneficiaries, having profited hugely from buying into firms whose assets were subsequently bailed out. Shortly after the crisis began in 2008, Warren Buffett loaned money to, and bought options from, Goldman Sachs, seemingly with the knowledge the bailout of AIG — a counterparty to which Goldman had massive, massive exposure — would take place.

Dimon as Treasury Secretary would intend more of the same. Dimon and Buffett and others like them believe in having their cake and eating it. They seem to believe that the U.S. taxpayer should provide a liquidity lifeline to their fragile and risky too-big-to-fail businesses, but without at the same time demanding any regulatory oversight to prevent too-big-to-fail banks from acting irresponsibly.

The Financial Times noted in 2011:

Jamie Dimon, chief executive of JPMorgan Chase, launched a broadside against financial regulation on Wednesday, warning that new capital rules could be “the nail in our coffin for big American banks”.

Regulators are negotiating international capital standards for the biggest banks but Mr Dimon said setting the new requirements too high, or allowing overseas banks to calculate their asset base differently, could disadvantage US banks and was already stifling economic growth.

If you want to set it so high that no big bank ever goes bankrupt … I think that would greatly diminish growth,” he told a US Chamber of Commerce conference. Too large a disparity in capital requirements between Europe and the US would mean “you’re pretty much putting the nail in our coffin for big American banks,” he said.

What this really amounts to is a lack of skin in the game. Big banks can gamble and speculate without remorse and without risk — if they win they keep the proceeds, and if they lose the taxpayer will pick up the pieces. This destroys the market mechanism, and any hope of self-regulation. Were lessons learned from 2008? If the antics of Corzine, Kweku Adoboli and the London Whale — just three big financial blowups in the last year — are any guide, big finance is acting just as irresponsibly and self-destructively as before the crisis.

Buffett and Dimon surely have in mind more cronyism, bailouts and free lunches, but the reality of the next four years and beyond may be very different indeed.

While it is impossible to predict exactly when the next crisis will emerge, the current slump in capital goods orders, the intractable debt overhangand the general trend of ditching the dollar as a reserve currency do not look good. As one of the architects (both practically and ideologically) of the current mess, Dimon as Treasury Secretary would at least get all the blowback and blame when the bubblecovery finally implodes into a currency or supply chain crisis that cannot be bailed out through liquidity injections.

JamieCoyote

About these ads

Krugman, Newton & Zombie Banks

Paul Krugman:

Mitt Romney – supposedly advised by Mankiw among others – is outraged:

[T]he American economy doesn’t need more artificial and ineffective measures. We should be creating wealth, not printing dollars.

That word “artificial” caught my eye, because it’s the same word liquidationists used to denounce any efforts to fight the Great Depression with monetary policy. Schumpeter declared that

Any revival which is merely due to artificial stimulus leaves part of the work of depressions undone

Hayek similarly decried any recovery led by the “creation of artificial demand”.

Milton Friedman – who thought he had liberated conservatism from this kind of nonsense –must be spinning in his grave.

The Romney/liquidationist view only makes sense if you believe that the problem with our economy lies on the supply side – that workers lack the incentive to work, or are stuck with the wrong skills, or something.

Perhaps Krugman ought to consider more seriously the reality that since both Japan and now America have gone down the path of continually bailing out a corrupt, dysfunctional and parasitic financial system that neither nation has truly recovered.

Our ancestors who correctly judged the climate, soil and rainfall and planted crops that flourished were rewarded with a bumper harvest. Those who planted the wrong crops did not get a bailout — they got a lean harvest, and were forced to either learn from their mistakes, or perish. While some surely perished from misfortune, and some surely survived from luck, this basic antifragile mechanism ensured the survival of the fittest agriculturalists and the transmission of their methods, ideas and genes to further generations. In the financial sector today the Darwinian mechanism has been turned on its head; in both Japan and the West, financiers have not been forced by failure to learn from their mistakes, because governments and regulators protected them from failure with injections of liquidity. Markets have become hypnotised and junkified, trading the possibility of the next injection of central banking liquidity instead of market fundamentals.

So it should be no surprise that financial institutions have continued making exactly the same mistakes that created the crisis in 2008. That crisis was caused by excessive financial debt. Many Wall Street banks in 2008 had forty or fifty times as much leverage as they had equity. The problem with leverage is that while successful bets can very quickly lead to massive profits, bad bets can very quickly lead to insolvency, liquidity panics and default cascades.

Following 2008, many on Wall Street promised they had learned their lesson, and that the days of excessive leverage and risk-taking with borrowed money were over. But, in October 2011, another Wall Street bank was taken down by bad bets financed by excessive leverage: MF Global. Their leverage ratio? 40:1.

So why was the banking system bailed out in the first place? Defenders of the bailouts have correctly pointed out that not bailing out certain banks would have caused the entire system to collapse. This is because the global financial system is an interconnected web. If a particularly interconnected bank disappears from the system, and cannot repay its creditors, the creditors themselves become threatened with insolvency. Without state intervention, a single massive bankruptcy can quickly snowball into systemic destruction. The system itself is fundamentally unsound, fundamentally fragile, and prone to collapse.

Government life-support has given Wall Street failures the resources to continue their dangerous and risky business practices which caused the last crisis. Effectively, Wall Street and the international financial system has become a government-funded zombie — unable to sustain itself in times of crisis through its own means, dependent on suckling the taxpayer’s teat, alive but yet failing to invest in small business and entrepreneurs.

My theory is this: our depression is not a problem of insufficient demand. It is systemic; most prominently and immediately financial fragility, financial zombification, moral hazard, and excessive private debt, alongside a huge number of other long-term systemic problems.

The new policy of unlimited quantitative easing is an experiment. If those theorists of insufficient aggregate demand are right, then the problem will soon be solved, and we will return to strong long-term organic growth, low unemployment and prosperity. I would be overjoyed at such a prospect, and would gladly admit that I was wrong in my claim that depressed aggregate demand has merely been a symptom and not a cause. On the other hand, if economies remain depressed, or quickly return to elevated unemployment and weak growth, or if the new policy has severe adverse side effects, it is a signal that those who proposed this experiment were wrong.

Certainty is something that economists in particular should be particularly guarded against, even as a public relations strategy. Isaac Newton famously noted in the aftermath of the South Sea bubble that “I can calculate the motion of heavenly bodies but not the madness of people.” In the sphere of human action, there are no clear and definitive mathematical principles as there are in astronomy or thermodynamics; there have always been oddities, exceptions and quirks. There has always been wildness, even if it is at times hidden.

So we shall see who is right. I lean toward the idea— as Schumpeter did — that the work of depressions and crises is clearing out unsustainable debt, unsustainable business models, unsustainable companies, unsustainable banks and — as much as anything else — unsustainable economic theories.

Penis Length, LIBOR & Soviet Growth

Healthy markets require solid data based on reality.

It is hard enough to determine what, when and how to invest even with solid data. We live in an unpredictable and chaotic world, and the last thing that investors need is misinformation and distortions. That is why the LIBOR manipulation scandal is so infuriating; as banks skewed the figures, they skewed entire marketplaces. The level of economic distortion is incalculable — as LIBOR is used to price hundreds of trillions of assets, the effects cascaded across the entire financial system and the wider world. An unquantifiable number of good trades were made bad, and vice verse. Yet in truth we should not expect anything else from a self-reported system like LIBOR. Without real checks and balances to make sure that the data is sturdy, data should be treated as completely unreliable.

Unsurprisingly, it is emerging that many more self-reported figures may have been skewed by self-reporting bullshittery.

The Telegraph noted:

The Libor scandal could be repeated in a number of other “self-certifying” markets where prices are determined, he said

“Self-certification is clearly open to abuse, so this could occur elsewhere,” he said.

A Financial Services Authority inquiry into Libor should be extended to other self-certifying markets, he said. The Treasury said last night that the review, led by Martin Wheatley, was free to examine markets other than Libor.

An expansion of the FSA review could take in a number of other interest-rate-related data as well as some complex financial instruments measuring the difference between banks’ borrowing costs and that of the US government.[i.e. the Ted spread]. Some markets in gold and oil are also based on self-certification.

This all reminds me of this:

When humans have an incentive to exaggerate or lie — either to bolster their ego by lying about penis size, or to cream an easy profit by rigging rates — it seems they have a propensity to do so.

Hopefully there will be one beneficial side-effect of the LIBOR rigging — self-reporting will die. It seems inevitable that market participants will pay a premium for solid, independent data. But sadly, any auditor can be bribed. And in a generation’s time, the LIBOR-rigging scandal of 2008 (and probably much earlier) may just be an antique detail known to only a savvy few. Scepticism, caution and portfolio robustification will always remain essential tools for savvy investors who don’t want to lose their shirt and shoes.

It was scepticism that was the difference between economists who refused to buy into the notion of Soviet prosperity in spite of impressive (and entirely self-reported) figures emerging from the Soviet Union, and those Western economists like Paul Samuelson (perhaps spurred on by ideological fervour) who predicted again and again in textbooks spanning thirty years that the USSR would overtake the USA in GDP:

Alex Tabarrok notes:

In the 1961 edition of his famous textbook of economic principles, Paul Samuelson wrote that GNP in the Soviet Union was about half that in the United States but the Soviet Union was growing faster.  As a result, one could comfortably forecast that Soviet GNP would exceed that of the United States by as early as 1984 or perhaps by as late as 1997 and in any event Soviet GNP would greatly catch-up to U.S. GNP.  A poor forecast — but it gets worse because in subsequent editions Samuelson presented the same analysis again and again except the overtaking time was always pushed further into the future so by 1980 the dates were 2002 to 2012.  In subsequent editions, Samuelson provided no acknowledgment of his past failure to predict and little commentary beyond remarks about “bad weather” in the Soviet Union.

The reason for his prediction? Apparently, bad data.

“No incentive to amend data to show strong Russian proletarian outperforms weak American capitalist, Comrade!”

Matthew Ashton writes:

To his credit Samuelson was always fairly open about it when his predictions failed to come true, stating that he was using the best data available at the time and he changed his mind as the evidence changed. I’d argue that in some cases, especially concerning evidence coming out of the Soviet Union, he possibly should have been a bit more sceptical as to its accuracy, however almost everyone in economics is guilty of that.

One can only wonder how bad the state of misreporting, fraud and delusion is in the various economies where central planning plays an even larger role than here in the West.

Is China Really Liquidating Treasuries?

The news that China has become the first sovereign to establish a direct sales relationship with the U.S. Treasury (therefore cutting out the middleman and bypassing Wall Street ) raises a few interesting questions.

From Reuters:

China can now bypass Wall Street when buying U.S. government debt and go straight to the U.S. Treasury, in what is the Treasury’s first-ever direct relationship with a foreign government, according to documents viewed by Reuters.

The relationship means the People’s Bank of China buys U.S. debt using a different method than any other central bank in the world.

The other central banks, including the Bank of Japan, which has a large appetite for Treasuries, place orders for U.S. debt with major Wall Street banks designated by the government as primary dealers. Those dealers then bid on their behalf at Treasury auctions.

China, which holds $1.17 trillion in U.S. Treasuries, still buys some Treasuries through primary dealers, but since June 2011, that route hasn’t been necessary.

The documents viewed by Reuters show the U.S. Treasury Department has given the People’s Bank of China a direct computer link to its auction system, which the Chinese first used to buy two-year notes in late June 2011.

The biggest Chinese outflows in U.S. Treasuries occurred in the months following the establishment of this relationship:

Which begs the question for some analysts — was China really selling? Or was China stealthily buying direct from the U.S. Treasury (unrecorded) and selling back into Wall Street (recorded)?

Well, according to the Treasury, the Treasury International Capital data seeks to record foreign holdings of U.S. securities, not just the flows, and given that the Treasury was the seller in these direct transactions (and so obviously was aware of them) there’s no reason to believe that they wouldn’t include any such direct outflows in the data. That suggests very strongly that yes, China really was selling.

And maybe the real reason that the Treasury offered China direct access (thus cutting out the middleman and offering China cheaper access than ever) was precisely because China was selling, and because the Treasury was concerned about the effect on rates, and wanted to give China some incentive to keep buying. As Jon Huntsman noted in a 2010 cable leaked by Wikileaks, the PBOC has felt pressured to keep buying, and as various PBOC officials have hinted in recent months, China is actively seeking to convert out of treasuries and into gold. And that makes sense — treasuries are yielding ever deeper negative real rates. People holding treasuries are losing their purchasing power. No wonder the treasury is willing to cut Wall Street out of the deal.

And it isn’t like the Treasury would have taken this move lightly — cutting Wall Street out of the equation is a slap in the face to Wall Street.

This raises a much more interesting question — now that the PBOC has effectively been upgraded to primary dealer status, would the Fed start buying treasuries directly from the PBOC in order to manage rates downward and prevent a spike in Treasury borrowing costs should China choose to quicken the pace of a future liquidation, potentially bursting the treasury bubble?

The New Goldbuggery

In my travels across the internet, I often hear a disparaging label being thrown around to describe libertarians and adherents of Austrian economics: goldbug.

The Economist’s Free Exchange column from last July encapsulates this perfectly:

The disappointing thing about Ron Paul’s goldbuggery is the weakness of the analysis behind it. His support seems almost mystic in nature: that gold is money is a law of economics that’s held for 6,000 years! In his defence, this quasi-mystical belief in the sanctity of gold in a monetary system was shared by the world’s financial leaders for much of the industrial period. That’s not much of a defence, though. Gold worship repeatedly drove the economy into ditches and off cliffs, but for a few lucky years in which the pace of new gold discoveries fortuitously matched growth in the global economy.

I can do a pretty good job of analysing and deconstructing that (and indeed have already strongly questioned the claim that it was “gold worship” that drove the economy off a cliff in the 1930s) but in the interests of economic “progress”, I would rather outsource my analysis to China. If it’s good enough for Apple, it’s good enough for me.

More specifically, I want to outsource my analysis to Zhang Jianhua of the People’s Bank of China.

From Forbes:

Analysts believe China bought as much as 490 tons of gold in 2011, double the estimated 245 tons in 2010.  “The thing that’s caught people’s minds is the massive increase in Chinese buying,” remarked Ross Norman of Sharps Pixley, a London gold brokerage, this month.

So who in China is buying all this gold?

The People’s Bank of China, the central bank, has been hinting that it is purchasing.  “No asset is safe now,” said the PBOC’s Zhang Jianhua at the end of last month.  “The only choice to hedge risks is to hold hard currency — gold.”  He also said it was smart strategy to buy on market dips.  Analysts naturally jumped on his comment as proof that China, the world’s fifth-largest holder of the metal, is in the market for more.

Wow. This, more or less, is the argument about gold that I advanced last month:

[Gold] doesn’t do anything. It doesn’t create any return. It just sits. It’s a store of long-term purchasing power.

And most importantly it is a hedge against counter-party risk.

What is counter-party risk?

Counter-party risk is the external risk investments face. The counter-party risk to fiat currency is that the counter-party — in this case the government — will fail to deliver a system where that fiat money will be acceptable as payment for goods and services. The counter-party risk to a bond or a derivative or a swap is that the counter-party  will default on their obligations.

Gold — at least the physical form — has negligible counter-party risk. It’s been recognised as valuable for thousands of years.

Counter-party risk is a symptom of dependency. And the global financial system is a paradigm of interdependency: inter-connected leverage, soaring gross derivatives exposure, abstract securitisations.

When everyone in the system owes shedloads of money to everyone else the failure of one can often snowball into the failure of the many.

All-denominated fiat securities are touched by counterparty risk, because of the nature of the hyper-interconnected global financial system. Physical gold will still be physical gold, even after the dust settles, even after all the unpayable debt has liquidated, and after the new global financial order has taken shape. That is what Zhang Jianhua — and presumably the PBOC — have understood. For those who possess physical gold, there will be no haircuts or write-downs on that asset. There are precisely zero historical examples of gold-denominated hyperinflation.

This is an entirely different argument to claiming that the monetary base should solely consist gold, of course. The gold standard doesn’t seem to prevent credit-driven bubbles, because it merely restricts the size of the monetary base.

But gold has retained its moneyness, its for 6,000 years for a reason. While value is subjective, I would suggest that its liquidity, its freedom from counterparty risk, its fungibility, and above all its natural scarcity have played a huge part in that.

The Only Chinese Hard Landing Will Be On America’s Head

A lot has been made of the so-called Chinese property bubble. And after 2008, when America’s subprime bubble was the straw that broke the camel’s back, who can blame those who see China as low-hanging fruit? In the hedge fund world, both Hugh Hendry and  Jim Chanos (among others) are significantly outperforming the market by shorting Chinese companies.

But the naysayers will be proven sorely wrong.

There are many differences between the Chinese situation and the American one but there is one that outsizes all the others. Over-inflated American (and by-extension, Western) property was being used as a spring-board to fund consumption. Growing home equity allowed real-estate owners to remortgage, and use their surpluses to buy boats, cars and trips around the world; i.e., living beyond their productive means. Once the property bubble burst, not only were many home-owners left underwater, but all of that excessive consumption came to a halt, with a significant negative effect on GDP. China simply doesn’t have that problem. The Chinese nation and its government are not net-borrowers but net-savers.

In addition, there is no evidence that China has the same problem with widespread securitisation that America had in 2008. The subprime bubble created huge systemic risk in the financial sector by bundling up subprime debt in mortgage-backed securities and collateralised debt obligations, and spreading it around American and European balance sheets. This made the system very fragile — as a few defaults, could lead to a global cascade of margin calls and defaults.

In fact, Chinese leverage levels are dropping.

From RBS:

Chinese firms are generally in good financial conditions. The latest data suggests that Chinese companies actually have seen their leverage ratios decline in the past three years, on the back of strong profitability and retained earnings. Most sectors have seen a decline in leverage. Property development was the only main sector that shows the opposite trend of rising leverage but it accounts for only about 6% of total loans. In fact, the average leverage ratio of Chinese companies is one of the lowest among key economies and emerging markets. At the same time, they have maintained one of the strongest profitability.

Chinese GDP (and profitability) is ballooning (and will continue to do so) because of global demand, even on the back of the recessions in Europe and America. That’s because China does everything much more cheaply, and so now controls crucial supply chains in components and products. Now that the world is flat, manufacturing such components in other places is not economically viable, so the supply chains no longer exist, and manufacturing-oriented labour markets are stagnating.

China’s good fortune is its high population levels and high population density.

From Noahpinion:

It is expensive to move products around. This means that if you have a factory, you want to locate it close to where your customers are, to avoid paying a bunch of shipping costs. Now consider two factories. The workers in the first factory will be the consumers for the second factory, and vice versa. So the two factories want to locate near each other (“agglomeration”). As for the workers/consumers, they want to go where the jobs are, so they move near the factories. Result: a city. The world becomes divided into an industrial “Core” and a much poorer agricultural “Periphery” that produces food, energy, and minerals for the Core.

Now when you have different countries, the situation gets more interesting. Capital can flow relatively easily across borders (i.e. you can put your factory anywhere you like), but labor cannot. If you start with a world where everyone’s a farmer, agglomeration starts in one country, but that country gets maxed out when the costs of density (high land prices) start to cancel out the effect of agglomeration. As transport costs fall and the economy grows, the industrial Core spreads from country to country. Often this spread is quite abrupt, resulting in successive “growth miracles” that get faster and faster (as each new industrial region starts out with a bigger global customer base). The evidence strongly indicates that agglomeration is the driver behind developing-world growth.

Looking at global population density — with American taxpayers subsidising the cost of a flat global marketplace — where can we expect productivity to agglomerate?


Of course, China does have a property bubble and a scary-sounding $1.6 trillion in local government debt. But $1.6 trillion of local government debt is still significantly less than China’s dollar and treasury hoard. The bottom line is if that China’s real estate market collapses, China can bail itself out with money it has saved from the prosperity years, not through new debt acquisition. This was the lesson of John Maynard Keynes — governments should save in the boom years, to spend in the bust years and even-out the business cycle — a lesson which seems lost on Western policy-makers, who seem to believe that you should borrow massive amounts every year.

So taking the absolute worst-case-scenario, China has plenty of leeway to bail itself out. Of course, this would mean China might decide to liquidate a significant amount of its treasury holdings — especially seeing as bonds are at all-time highs.

Could such a liquidation be the event that finally bursts the Treasury bubble, sending yields soaring and making it much more difficult for America to acquire new debt?

With 10-year yields now well below 2%, that sure looks like a bubble to me.

Germany Pours Cold Water Over Europe

Just as I predicted Germany is getting restless at the idea of bailing out the bulk of Europe.

From the Telegraph:

Andreas Vosskuhle, head of the German constitutional court, said politicians do not have the legal authority to sign away the birthright of the German people without their explicit consent.”The sovereignty of the German state is inviolate and anchored in perpetuity by basic law. It may not be abandoned by the legislature (even with its powers to amend the constitution),” he said.”There is little leeway left for giving up core powers to the EU. If one wants to go beyond this limit – which might be politically legitimate and desirable – then Germany must give itself a new constitution. A referendum would be necessary. This cannot be done without the people,” he told newspaper Frankfurter Allgemeine.

Turns out that listening to Germans in the German government, and on the German street might have more bearing on reality than listening to globe-trotting, world-saving, hopium-pedling, six-pac-abs, tax-evading Timothy Geithner. For example, German finance minister Wolfgang Schauble. He might be in a position to comment (or a better one than Geithner, in any case).

From Zero Hedge:

*SCHAEUBLE SAYS `WILL NOT SPEND OUR WAY’ OUT OF CRISIS

*SCHAEUBLE SAYS `SOLIDARITY HAS LIMITS,’ REQUIRES RETURN EFFORTS

*SCHAEUBLE SAYS `IMMEDIATE FISCAL REFORMS ARE OF THE ESSENCE’

So if Germany won’t bail out Europe (until things get much worse) and China and the BRICS won’t (until things get much, much worse) then who will?

America, apparently.

From Bloomberg:

China and the U.S. finally found something to agree on: Europe is doomed and might take the world’s two biggest economies down with it.

Neither officials in Beijing nor Washington are actually using the “D word.” They don’t need to, not with Zhou Xiaochuan, China’s central bank governor, talking matter-of- factly about emerging nations bailing out the euro region and U.S. Treasury Secretary Timothy Geithner warning of “cascading default, bank runs and catastrophic risk” there.

The price tag for keeping the Greek-led turmoil from killing the euro is rising fast. Asians are so anxious about it that they’re querying Americans — like me. In my travels around the region this month, I’ve faced a harrowing question: Would U.S. President Barack Obama chip in for a giant European bailout?

It’s hard to decide what’s more disturbing: the obvious answer — over Republicans’ dead bodies — or the fact it’s being asked at all, and by whom. Among those posing it were the finance minister of one Asia’s biggest economies, the central bank governor of another and a number of major executives.

After all, the closest thing to concerted action on Europe so far has come from Bernanke.

It’s the same absurd predicament — Americans pay for global stability, everyone else benefits.