2013

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Australia just scrapped its debt ceiling. America should, too.

Debt ceiling fights, it seems, have become a permanent fixture in American politics. Twice in the last couple of years, the United States has been days away from potentially irrevocable economic damage because Congress refused to raise the debt ceiling and let the Treasury issue more debt. The next debt ceiling fight is slated for March 2014.

But isn’t there a better way to increase a borrowing limit — and one that doesn’t freak out markets, investors, and, well, just about everyone every few months?

Read More At TheWeek.com

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Why I Was Wrong About Inflation

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Back in 2007, I was much more interested in finance and trading than I was in macroeconomics. When the crisis — and the government’s macroeconomic response to the crisis — began in 2008 what was really needed to get a strong grasp of the situation was an understanding of macroeconomics, which I did not have as it was a topic I only really began studying in depth at that time. This led to some misconceptions, particularly about inflation. I mistakenly assumed — as did many at the time, and as do many today — that the huge expansion of the monetary base would lead to stronger inflation than the timid and low inflation we have seen in years since the programs began. While I strongly doubted the claims of individuals like Peter Schiff that hyperinflation might be nigh — as I understood that most historical hyperinflations occurred due to a collapse in production, not solely due to money printing — I thought a strong inflationary snapback was likely, Why? A mixture of real effects and expectations. If central banks are printing money at a higher rate, people will fear that money is becoming less scarce. If having more money in circulation does not begin to bid prices upward, producers will soon begin to raise prices to anticipate any such rise. Simply, I thought that central banks couldn’t print their way out of disaster without some iatrogenic side-effects. I assumed the oncoming pain was unavoidable, and that the onset of inflation was the price that would be paid. As Ludwig von Mises put it: “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

So why did that not occur? After all, plenty of internet goldbugs — and very serious people following the advice of people like John Taylor, Eugene Fama, and Niall Ferguson — were talking about the potential for a strong inflationary shock. The gold price was soaring — hitting a peak above $1900 an ounce in September 2011 — as people anticipating inflation sought to buy insurance against it. Well, for a start it seems like the public did not really buy into the notion of an oncoming inflationary shock. Expected inflation as measured by the University of Michigan has remained very close to the post-1980 norm since the crisis:

MICH_Max_630_378

But above and beyond this, the real monetary effects were not the ones I first assumed them to be. The total money supply — most of which is generated not by the Fed but in the private sector through lending — has been stagnant, even while the Federal Reserve is expanding the monetary base. So while the financial sector is flush with cash and has bid the stock market up above its pre-recession nominal peak, other goods in other sectors just have not had enough of a bid behind them to send inflation strongly upward because other areas of the economy (for instance housing, consumer electronics and real wages) have continued to deflate in the context of continued deleveraging, accelerating offshoring driving down wages and the receding effects of the 2008 oil shock.

Yet even more importantly the supply of goods in the West — flowing as it does from East to West, from the factories of the Orient to the consumers of the West — has remained strong and stable. There has been no destabilising, chaotic Chinese crash or revolution, even though many wished there would be in the wake of the Arab spring. And for all the talk by the Chinese and Russians of bond vigilantism, starting a new global reserve currency and dumping the dollar, that has not happened either. And why would it? Certainly, the Asian bond-buyers might have suffered a few years of negative real interest rates. This might have pissed them off. But undermining the Western recoveries further (which have been quite pathetic thus far) when such a high proportion of their assets — dollars and treasuries and increasingly real assets like land and industrials — are related to the economic performance of the West would be to cut off their nose to spite their face, while simultaneously risking conflict with the American military, whose capabilities remain unmatched. The Chinese and Russian talk of de-Americanisation and a post-American world is all bluff and bluster, all sound and fury signifying very little. In the long run, America will have to accept a world where it is no longer the sole global superpower, but there is no incentive for America’s competitors to hasten that way with the kind of aggressive economic warfare that might cause an economic shock.

On the other hand, it is certainly true that much of the new money entering the system is sitting as excess reserves. Is that a symptom of the inflation simply being delayed? Until the middle of last year I thought so. Now I very strongly doubt it. The existence of excess reserves in the system is not a symptom of stored-up future inflation, but a symptom of the weakness of the transmission mechanism for quantitative easing. Simply, the system is in a depression. The banking system is infected with a deep paranoia, and would prefer to sit on risk-free cash instead of lending money to businesses. If the money was lent out, there would be an increased level of economic and business activity. Therefore there is no guarantee of any additional inflation as the money is loaned out.

So I was wrong to worry that inflation could become an imminent problem. But I was wronger than this. The entire paradigm that I was basing these fears upon was flawed. Simply, I was ignoring real and present economic problems to worry about something that could theoretically become a problem in the future. Specifically, I was ignoring the real and present problem of involuntary unemployment to worry about non-existent inflation and non-existent Asian bond vigilantes. The involuntariness of unemployment is a very simple fact — there are not enough jobs for the number of jobseekers that exist, and there hasn’t been enough jobs since the crisis began. Currently there are just over three job seekers for every job. So unemployment and underemployment are not simply things that can be dismissed as a matter of workers becoming lazy, or preferring leisure to work. Mass unemployment has insidious and damaging social effects for individuals and communities — people who are out of work for a long time lose skills. For communities, crime rises, and health problems emerge. And there are 25 million Americans today who are either unemployed or underemployed as a practical matter it is not simply a case of sitting back and allowing the structure of production to adjust to the new economy. And worse, with unemployment high, spending and confidence remain depressed as the effects of high unemployment create a social malaise. This is a mass sickness — and in the past it has led to the rise of warmongering political figures like Hitler. So while it may be preferable for the private sector to be the leading job creator under ordinary conditions, while the private sector is engaging in heavy deleveraging this is impractical. Under such an eventuality the state is the only institution that can break the depressionary trend by creating paying jobs and fighting back against the depressionary tendency toward mass unemployment. Certainly, centralised bureaucracy can be a troublesome and distortionary thing. But there are many things — like mass unemployment and underemployment, and the social problems that that can bring — worse than centralised bureaucracy. And no — this kind of Keynesianism was not the problem in the 1970s.

By worrying over the potential for future inflation or future bond vigilantism due to monetary and fiscal stimulus, I was contributing to the problem of mass unemployment, first of all by not acknowledging the problem, and second by encouraging governments and individuals to worry about potential future problems instead of real-world problems today. As it happened, a tidal wave of evidence has washed these worries away. It is clear from the economic data that inflation is not a concern in a depressionary economy, just as Keynesian-Hicksians heuristics like IS/LM suggested.

Of course, if the depression ends of its own accord then inflation could become a problem again.  If the United States were to experience a strong unexpected spurt of growth sustained over a year or so, pushing unemployment significantly down and growth significantly up, inflation could rise appreciably. The Federal Reserve would have to quickly taper both its unconventional policies and probably begin to raise rates. Of course, that is rather unlikely in the present depressionary environment. But certainly, it is a small possibility. That would be the time for the Federal Reserve to start to worry about inflation. A strong negative energy shock — like the one experienced by the UK in 2010 and 2011 — could push inflation higher too, yet that would be a transitory factor in the context of the wider depressionary environment, and would most likely fall back of its own accord.

If the Fed was engaging in actual helicopter drops — the most direct transmission mechanism possible — there would likely be a stronger inflationary response than that which we have seen thus far. Yet ultimately, this might prove desirable. After all, if the private sectors of the entire Western world have a very large nominal debt load which they are struggling to deleverage, some stronger inflation would certainly begin to minimise that. Yes, that is redistribution from lender to borrower. No, creditors will not be happy about this. But in the end, creditors may find it easier to take an inflationary haircut than face twenty years of depressionary deleveraging as Japan has done. Although the West certainly does not have the same demographic troubles as Japan, such an outcome is possible unless people — governments, entrepreneurs, individuals, society — decide that unemployment and a lack of demand in the economy must be tackled, and do something about it. Then can we confidently expect to climb out of the lip of the deleveraging trap.

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Explaining The WTI-Brent Spread Divergence

Something totally bizarre has happened in the last three years. Oil in America has become much, much cheaper than oil in Europe. Oil in America is now almost $30 cheaper than oil in Europe.

This graph is the elephant in the room:

3 year brent spread

And this graph shows how truly historic a move this has been:

brent-WTI-spread

Why?

The ostensible reason for this is oversupply in America. That’s right — American oil companies have supposedly been producing much, much more than they can sell:

This is hilarious if prices weren`t so damn high, but despite a robust export market for finished products, crude oil is backing up all the way to Cushing, Oklahoma, and is only going to get worse in 2013.

Now that Enterprise Products Partners LLP has let the cat out of the bag that less than a month after expanding the Seaway pipeline capacity to 400,000 barrels per day, The Jones Creek terminal has storage capacity of 2.6 million barrels, and it is basically maxed out in available storage.

But there’s something fishy about this explanation. I don’t know for sure about the underlying causality — and it is not impossible that the oil companies are acting incompetently — but are we really supposed to believe that today’s oil conglomerates in America are so bad at managing their supply chain that they will oversupply the market to such an extent that oil sells at a 25% discount on the price in Europe? Even at an expanded capacity, is it really so hard for oil producers to shut down the pipeline, and clear inventories until the price rises so that they are at least not haemorrhaging such a huge chunk of potential profit on every barrel of oil they are selling? I mean, that’s what corporations do (or at least, what they’re supposed to do) — they manage the supply chain to maximise profit.

To me, this huge disparity seems like funny business. What could possibly be making US oil producers behave so ridiculously, massively non-competitively?

The answer could be government intervention. Let’s not forget that the National Resource Defence Preparedness Order gives the President and the Department of Homeland Security the authority to:

(c)  be prepared, in the event of a potential threat to the security of the United States, to take actions necessary to ensure the availability of adequate resources and production capability, including services and critical technology, for national defense requirements;

(d)  improve the efficiency and responsiveness of the domestic industrial base to support national defense requirements; and

(e)  foster cooperation between the defense and commercial sectors for research and development and for acquisition of materials, services, components, and equipment to enhance industrial base efficiency and responsiveness.

And the ability to:

(e)  The Secretary of each resource department, when necessary, shall make the finding required under section 101(b) of the Act, 50 U.S.C. App. 2071(b).  This finding shall be submitted for the President’s approval through the Assistant to the President and National Security Advisor and the Assistant to the President for Homeland Security and Counterterrorism.  Upon such approval, the Secretary of the resource department that made the finding may use the authority of section 101(a) of the Act, 50 U.S.C. App. 2071(a), to control the general distribution of any material (including applicable services) in the civilian market.

My intuition is that it is possible that oil companies may have been advised (or ordered) under the NDRP (or under the 1950 Defense Production Act) to keep some slack in the supply chain in case of a war, or other national or global emergency. This would provide a capacity buffer in addition to the Strategic Petroleum Reserve.

If that’s the case, the question we need to ask is what does the US government know that other governments don’t? Is this just a prudent measure to reduce the danger of a resource or energy shock, or does the US government have some specific information of a specific threat?

The other possible explanation, of course, is ridiculous incompetence on the part of US oil producers. Which, I suppose, is almost believable in the wake of Deepwater Horizon…

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America Loves Drone Strikes

This graph shows everything we need to know about the geopolitical reality of Predator Drones (coming soon to the skies of America to hunt down fugitives?).

The American public loves drone strikes:

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The American public does not approve of the extrajudicial killing of American citizens. But for everyone else, it’s open season.

But everyone else — most particularly and significantly, the countries in the Muslim world — largely hates and resents drone strikes.

And it is the Muslim world that produces the radicalised extremists who commit acts like 9/11, 7/7, the Madrid bombings, and the Bali bombings.  With this outpouring of contempt for America’s drone strikes, many analysts are coming to believe that Obama’s drone policy is now effectively a recruitment tool for al-Qaeda, the Taliban and similar groups:

2_Hands

Indeed, evidence is beginning to coalesce to suggest exactly this. PressTV recently noted:

The expanding drone war in Yemen, which often kills civilians, does in fact cause blowback and help al-Qaeda recruitment – as attested to by numerous Yemen experts, investigative reporting on the ground, polling, testimony from Yemen activists, and the actual fact that recent bungled terrorist attacks aimed at the U.S. have cited such drone attacks as motivating factors.

After another September drone strike that killed 13 civilians, a local Yemeni activist told CNN, “I would not be surprised if a hundred tribesmen joined the lines of al-Qaeda as a result of the latest drone mistake. This part of Yemen takes revenge very seriously.”

“Our entire village is angry at the government and the Americans,” a Yemeni villager named Mohammed told the Post. “If the Americans are responsible, I would have no choice but to sympathize with al-Qaeda because al-Qaeda is fighting America.”

Many in the U.S. intelligence community also believe the drone war is contributing to the al-Qaeda presence in Yemen. Robert Grenier, who headed the CIA’s counter-terrorism center and was previously a CIA station chief in Pakistan, told The Guardian in June that he is “very concerned about the creation of a larger terrorist safe haven in Yemen.”

“We have gone a long way down the road of creating a situation where we are creating more enemies than we are removing from the battlefield,” he said regarding drones in Yemen.

Iona Craig reports that civilian casualties from drone strikes “have emboldened al-Qaeda” and cites the reaction to the 2009 U.S. cruise missile attack on the village of al-Majala in Yemen that killed more than 40 civilians (including 21 children):

That one bombing radicalized the entire area,” Abdul Gh ani al-Iryani, a Yemeni political analyst, said. “All the men and boys from those families and tribes will have joined [al-Qaeda] to fight.

And al-Qaeda’s presence and support in Yemen has grown, not shrunk since the start of the targeted killing program:

Meanwhile Yemen Central Security Force commander Brig. Gen. Yahya Saleh, nephew of ousted president Ali Abdullah Saleh, told Abdul-Ahad that al-Qaeda has more followers, money, guns and territory then they did a year and a half ago.

All at a time when Yemen is facing a “catastrophic” food crisis, with at least 267,000 children facing life-threatening levels of malnutrition. Hunger has doubled since 2009, and the number of displaced civilians is about 500,000 and rising.

As U.S. drones drop bombs on south Yemen villages and AQAP provides displaced civilians with “free electricity, food and water,” tribes in the area are becoming increasingly sympathetic to AQAP.

Let’s be intellectually honest. If a country engages in a military program that carries out strikes that kill hundreds of civilians — many of whom having no connection whatever with terrorism or radicalism — that country is going to become increasingly hated. People in the countries targeted — those who may have lost friends, or family members — are going to plot revenge, and take revenge. That’s just how war works. It infuriates. It radicalises. It instils hatred.

The reality of Obama’s drone program is to create new generations of America-hating radicalised individuals, who may well go on to be the next Osama bin Laden, the next Ayman al-Zawahiri, the next Abu Musab al-Zarqawi. The reality for Obama’s drone program is that it is sowing the seeds for the next 9/11 — just as American intervention in the middle east sowed the seeds for the last, as Osama bin Laden readily admitted.

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Securitisation and Risk

João Santos of the New York Fed notes what forward-thinking financial writers have been thinking for a long, long time:

There’s ample evidence that securitization led mortgage lenders to take more risk, thereby contributing to a large increase in mortgage delinquencies during the financial crisis. In this post, I discuss evidence from a recent research study I undertook with Vitaly Bord suggesting that securitization also led to riskier corporate lending. We show that during the boom years of securitization, corporate loans that banks securitized at loan origination underperformed similar, unsecuritized loans originated by the same banks. Additionally, we report evidence suggesting that the performance gap reflects looser underwriting standards applied by banks to loans they securitize.

Historically, banks kept on their books the loans they originated. However, over time they increasingly replaced this originate-to-hold model with the originate-to-distribute model, by syndicating the loans they originated or by selling them in the secondary loan market. The growth of securitization provided banks with yet another opportunity to expand the originate-to-distribute model of lending. The securitization of corporate loans grew spectacularly in the years leading up to the financial crisis. Prior to 2003, the annual volume of new collateralized loan obligations (CLOs) issued in the United States rarely surpassed $20 billion. Since then, this activity grew rapidly, eclipsing $180 billion in 2007. 

Corporate loan securitization appealed to banks because it gave them an opportunity to sell loans off their balance sheets—particularly riskier loans, which have been traditionally more difficult to syndicate. By securitizing loans, banks could lower the risk on their balance sheets and free up capital for other business while continuing to earn origination fees. As with the securitization of other securities, the securitization of corporate loans, however, may lead to looser underwriting standards. For example, if banks anticipate that they won’t retain in their balance sheets the loans they originate, their incentives to screen loan applicants at origination will be reduced. Further, once a bank securitizes a loan, its incentives to monitor the borrower during the life of the loan will also be reduced.

Santos’ study found that the dual phenomena of lax lending standards and securitisation existed as much for corporate debt as it did for housing debt:

To investigate whether securitization affected the riskiness of banks’ corporate lending, my paper with Bord compared the performance of corporate loans originated between 2004 and 2008 and securitized at the time of loan origination with other loans that banks originated but didn’t securitize. We found that the loans banks securitize are more than twice as likely to default or become nonaccrual in the three years after origination. While only 6 percent of the syndicated loans that banks don’t securitize default or become nonaccrual in those three years, 13 percent of the loans they do securitize wind up in default or nonaccrual. This difference in performance persists, even when we compared loans originated by the same bank and even when we compared loans that are “similar” and we controlled for loan- and borrower-specific variables that proxy for loan risk.

This is an important study, because it emphasises that this is a universal financial phenomenon, and not one merely confined to mortgage lenders that were encouraged by the Federal government into lending to risky mortgagees. The ability to securitise lending and so move the risk off your balance sheet leads to riskier lending, period.

This exemplifies the problem with shadow finance. Without the incentive of failure for lenders who lend to those who cannot repay, standards become laxer, and the system begins to accrue junk loans that are shipped off the lenders’ balance sheets and onto someone else’s. This seems like no problem to the originating lender, who can amass profits quickly by throwing liquidity at dubious debtors who may not be able to repay without having to worry about whether the loan will be repaid. The trouble is that as the junk debt amasses, the entire system becomes endangered, as more and more counterparties’ balance sheets become clogged up with toxic junk lent by lenders with lax standards and rubber-stamped as Triple-A by corrupt or incompetent ratings agencies. As more laxly-vetted debtors default on their obligations, financial firms — and the wider financial system, including those issuers who first issued the junk debt and sold it to other counterparties  — come under pressure. If enough debtors default, financial firms may become bankrupt, defaulting on their own obligations, and throwing the entire system into mass bankruptcy and meltdown. This “risk management” — that lowers lending standards, and spreads toxic debt throughout the system — actually concentrates and systematises risk. Daron Acemoglu produced a mathematical model consistent with this phenomenon.

In a bailout-free environment, these kinds of practices would become severely discouraged by the fact that firms that practiced them and firms that engaged with those firms as counterparties would be bankrupted. The practice of making lax loans, and shipping the risk onto someone else’s balance sheet would be ended, either by severely tightened lending standards, or by the fact that the market for securitisation would be killed off. However, the Federal Reserve has stepped into the shadow securities market, acting as a buyer-of-last-resort. While this has certainly stabilised a financial system that post-2008 was undergoing the severest liquidity panic the world has probably ever seen, it has also created a huge moral hazard, backstopping a fundamentally perverse and unsustainable practice.

Shadow finance is still deleveraging (although not as fast as it once was):

But so long as the Federal Reserve continues to act as a buyer-of-last-resort for toxic junk securities produced by lax lending, the fundamentally risk-magnifying practices of lax lending and securitisation won’t go away. Having the Federal Reserve absorb the losses created by moral hazard is no cure for moral hazard, because it creates more moral hazard. This issue soon enough will rise to the surface again with predictably awful consequences, whether in another jurisdiction (China?), or another market (securitised corporate debt? securitised student loan debt?).

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2008 Again?

The so-called recovery is built on sand, and as stock markets climb and climb, and more traders and investors turn bullish, we come ever-closer to a new 2008-style collapse.

Markets have already gone far, far higher than many expected on a drift of reinflationary central bank liquidity. Yesterday the DJIA hit a new post-2007 high:

fredgraph (14)

The same day, it was revealed that the big Wall Street banks are gambling again with billions and billions of dollars of clients’ funds. Goldman Sachs are back to pre-crisis-style profits. Again and again — from the LIBOR scandal, to MF Global, to the London Whale, to Kweku Adoboli — the financial sector has illustrated that it has learned very little from 2008, and is still practising many of the same hyper-fragile ponzi finance practices that led to the subprime bubble and the 2008 collapse.

Soaring markets, and soaring speculation. Big finance using loopholes to speculate bigger and harder. Mainstream financial journalists becoming more and more complacent about the “recovery”.

We’ve been here before. Isn’t repeating the same behaviour and hoping for different results the very definition of insanity? 

I don’t know exactly how the next crash will occur — although there are many potential ignition spots including a severe trade or energy shock, or a Chinese real estate and subprime meltdown, or a natural disaster, or a new Western financial crisis.  I don’t know when the next crash will occur, or how high the markets will climb before it does (DJIA 36,000 maybe? That would be hilarious).

But I know that if markets and regulators continue to repeat the mistakes that led to 2008, we will be back in a similar or worse hole soon.

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The Real 2013 Cliff

There’s a much bigger cliff than the so-called fiscal cliff. The absolute worst result of the fiscal cliff would be a moderate uniform tax increase at a bad time, resulting in a moderate contraction. It is an obvious — but ultimately rather cosmetic — stumbling block on the so-called “road to recovery”.

The much bigger cliff stems from the fact that the so-called recovery itself is built on nothing but sand. This is a result of underlying systemic fragilities that have never been allowed to break. I have spent the last year and a half writing about this graph — the total debt in the economy as a proportion of the economy’s output:

This is the bubble that won’t go away. This is the zombified mess that the Federal Reserve won’t let dissolve (as happened regularly in the 19th century and early 20th century each time there was an unsustainable debt bubble). This is the shifting sand — preserved by the massive monetary stimulus programs — that the so-called recovery is built upon. During the 1980s and 1990s and 2000s cheap money pumped up the debt level in America. In 2008, the bubble burst, and the hyper-connective fragile financial system was set to burn. Then central banks around the world stepped in to “stabilise” (or as Nassim Taleb puts it, overstabilise) the financial system. The unsustainable reality of debt vastly exceeding income was put on life support.

A high pre-existing residual debt level makes growth challenging, as consumers and producers remain focussed on paying down the pre-existing debt load, they are drained by pre-existing debt service costs, and they are wary about taking on debt or investing in a weak and depressed environment. It’s a classic Catch-22. The only true panacea for the depression is growth, but the economy cannot grow because it is depressed and zombified. That’s where a crash comes in — the junk is liquidated, clearing the field for new growth. That is what Schumpeter meant when he talked of “the work of depressions”, something that many mainstream economists still fail to grasp. (In fairness, a similar effect can probably be achieved without a depression through a very large scale debt relief program.)

Japan has been stuck in a deleveraging trap for twenty years, to no avail, all that has really occurred is that the private debt load has been transferred onto the central bank balance sheet — there has been very little net deleveraging) and while the Japanese central bank has completed round after round of quantitative easing — sustaining and preserving the past malinvestment and high debt load — the Japanese economy is still depressed.

Japan-Debt-Hoisington-27

That is the road America and most of the West are now on. And just as Japan’s bank stocks did multiple times even after the Japanese housing bubble burst, American banking stocks — even in spite of a year of fraud, abuse, mismanagement and uber-fragility — have been shooting up, up, up and away:

1220sp_data

The zombie financial sector is the real cliff — as interconnective as ever, as corrupt as ever, and most importantly, nearly as leveraged as ever:

Margin Debt November 2012

This is a reinflated bubble built on foundations of sand. I don’t know which straw will break the illusion (middle eastern war? Hostility between China and Japan? Chinese real estate and subprime meltdown? Student debt? Eurozone? Natural disasters? Who knows…) but this bubble poses a far greater threat in 2013 than the fiscal shenanigans and the Boehner-Obama “Boner-Droner” snoozefest.

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The Depressing Reality of Indefinite Detention

After all the promises from both Obama and Congressional leaders that indefinite detention for Americans would not be written into law, the 2013 National Defense Authorization Act contains exactly that.

What can we conclude from that? That both the executive branch including Barack Obama, Janet Napolitano and Eric Holder and majority elements of the legislative branch — the Senate voted 81-14, and the House voted 305-107 — want the power to detain Americans indefinitely without charge or trial. And why would they want the power if they didn’t intend to use it?

Ron Paul:

The now-infamous NDAA for fiscal year 2012, passed last year, granted the president the authority to indefinitely detain American citizens without charge, without access to an attorney, and without trial. It is difficult to imagine anything more un-American than this attack on our Constitutional protections. While we may not have yet seen the widespread use of this unspeakably evil measure, a wider application of this “authority” may only be a matter of time.

Historically these kinds of measures have been used to bolster state power at the expense of unpopular scapegoats. The Jewish citizens of 1930s Germany knew all about this reprehensible practice. Lately the scapegoats have been mostly Muslims. Hundreds, perhaps many more, even Americans, have been held by the US at Guantanamo and in other secret prisons around the world.

Rand Paul:

When you’re accused of a crime in our country you get a trial, you get a trial by a jury of your peers, no matter how heinous your crime is, no matter how awful you are, we give you a trial.

And children of those indefinitely detained during World War 2 have launched a legal challenge to the status quo:

The children of Japanese-Americans whose internment during World War II was upheld by the infamous Supreme Court ruling Korematsu v. United States are stepping into a new legal battle over whether the military can indefinitely detain American citizens.

Writing that their parents “experienced first-hand the injustice resulting from a lack of searching judicial scrutiny,” the children of Fred Korematsu and other Japanese-Americans who were interned filed a brief on Monday in support of a lawsuit against the National Defense Authorization Act of 2012. Critics say the law allows the military to lock Americans away without trial merely on suspicion of support for terrorist organizations.

“During WWII, President Roosevelt essentially issued the military a ‘blank check,'” Korematsu’s children wrote in a friend-of-the-court brief. The military’s orders, “to which the Court uncritically deferred, culminated in the internment. In reviewing the NDAA’s new detention provision, the courts cannot afford to mimic the wartime Supreme Court’s failure.”

Then, America was at war with nations. Once a peace treaty was signed, the vile, racist detention ended. But for those detained under an accusation of being a part of decentralised groups like al-Qaeda, or Wikileaks, or Anonymous there are no peace treaties, no definite end to hostilities.

And while the judiciary has so far thrown out indefinite detention as unconstitutional under the Fifth Amendment, this has not stopped the legislative and executive branches of government from bulldozing on. Obama, the “constitutional scholar” defends the principle of the indefinite detention of Americans. The neocon triumvirate of Lindsey Graham, John McCain and Joe Lieberman continue to demand it.

This is terrible. If evidence exists of lawbreaking, suspects can be charged and tried. If the government has no evidence that can stand up in court, it shouldn’t be in the business of detaining anyone.

Today the detained may be those accused of being members of al-Qaeda, Wikileaks, or Anonymous. Tomorrow, who knows who might find themselves in the crosshairs of indefinite detention — journalists, whistleblowers, dissidents. As Naomi Wolf noted when Judge Katherine Forrest first struck down indefinite detention:

Forrest asked repeatedly, in a variety of different ways, for the government attorneys to give her some assurance that the wording of section 1021 could not be used to arrest and detain people like the plaintiffs. Finally she asked for assurance that it could not be used to sweep up a hypothetical peaceful best-selling nonfiction writer who had written a hypothetical book criticizing US foreign policy, along lines that the Taliban might agree with. Again and again the two lawyers said directly that they could not, or would not, give her those assurances. In other words, this back-and-forth confirmed what people such as Glenn Greenwald, the Bill of Rights Defense Committee, the ACLU and others have been shouting about since January: the section was knowingly written in order to give the president these powers; and his lawyers were sent into that courtroom precisely to defeat the effort to challenge them. Forrest concluded: ”At the hearing on this motion, the government was unwilling or unable to state that these plaintiffs would not be subject to indefinite detention under [section] 1021. Plaintiffs are therefore at risk of detention, of losing their liberty, potentially for many years.“

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When Currency Wars Become Trade Wars…

Beggaring thy neighbour has consequences. Neighbours might turn around and bite back.

China and the United States are already locked in an intractable and multilayered currency war. That has not escalated much yet beyond a little barbed rhetoric (although if China want to get a meaningful return on the trillions of dollars of American paper they are holding, one can only suspect that there will be some serious escalation as the United States continues to print, print, print, a behaviour that China and China’s allies are deeply uncomfortable with).

But Brazil are already escalating.

Brazil flag face

The Washington Post notes:

When the Brazilian economy began to stall last year, officials in Latin America’s largest country started pulling pages from the playbook of another major developing nation: China.

They hiked tariffs on dozens of industrial products, limited imports of auto parts, and capped how many automobiles could come into the country from Mexico — an indirect slap at the U.S. companies that assemble many vehicles there.

The country’s slowdown and the government’s response to it is a growing concern among U.S. officials worried that Brazil may be charting an aggressive new course — away from the globalized, open path that the United States has advocated successfully in Mexico, Colombia and some other Latin American nations, and toward the state-guided capitalism that the United States has been battling to change in China. As the world economy struggles for common policies that could bolster a still tentative recovery, the push toward protectionism by an influential developing country is seen in Washington as a step backward.

“These are unhelpful and concerning developments which are contrary to our mutual attempts” to strengthen the world economy, outgoing U.S. Trade Representative Ron Kirk wrote in a strongly worded letter to Brazilian officials that criticized recent tariff hikes as “clearly protectionist.”

And Brazilian officials are very, very clear about exactly why they are doing what they are doing:

Brazilian officials insist the measures are a temporary buffer to help their developing country stay on course in a world where they feel under double-barreled assault from cheap labor in China and cheap money from the U.S. Federal Reserve’s policy of quantitative easing.

“We are only defending ourselves to prevent the disorganization, the deterioration of our industry, and prevent our market, which is strong, from being taken by imported products,” Brazil’s outspoken finance minister, Guido Mantega, said in an interview. Mantega popularized use of the term “currency war” to describe the Federal Reserve’s successive rounds of easing, which he likened to a form of protectionism that forced up the relative value of Brazil’s currency and made its products more expensive relative to imports from the United States and also China.

How long until other nations join with Brazil in declaring trade measures against the United States is uncertain, but there may be few other options on the table for creditors wanting to get their pound of flesh, or nations wishing to protect domestic industries. After all, the currency wars won’t just go away; competitive devaluation is like trying to get the last word in an argument. The real question is whether the present argument will lead to a fistfight.

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George Osborne & Big Banks

The Telegraph reports that George Osborne thinks big banks are good for society:

The Chancellor warned that “aggressively” breaking up banks would do little to benefit the UK and insisted the Government’s plans to put in place a so-called “ring fence” to force banks to isolate their riskier, investment banking businesses from their retail arm was the right way to make the financial system safer.

“If we aggressively broke up all of our big banks, I am not sure that, as a society, we would benefit from it,” he said. “We don’t have a huge number of banks, sadly, large banks. I would like to see more.”

His comments came as he gave evidence to the parliamentary commission on banking standards where he was accused of attempting to pressure members into supporting his ring-fencing reforms.

“That work has been accepted, as far as I’m aware, by all the major political parties. We are now on the verge of getting on with it,” he said.

Several members of the Commission have argued in favour of breaking up large banks, including former Chancellor, Lord Lawson.

This is really disappointing.

Why would Osborne want to see more of something which requires government bailouts to subsist?

Because that is the reality of a large, interconnective banking system filled with large, powerful interconnected banks.

The 2008 crisis illustrates the problem with a large interconnective banking system. Big banks develop large, diversified and interconnected balance sheets as a sort of shock absorber. Under ordinary circumstances, if a negative shock (say, the failure of a hedge fund) happens, and the losses incurred are shared throughout the system by multiple creditors, then those smaller losses can be more easily absorbed than if the losses were absorbed by a single creditor, who then may be forced to default to other creditors. However, in the case of a very large shock (say, the failure of a megabank like Lehman Brothers or — heaven forbid! — Goldman Sachs) an interconnective network can simply amplify the shock and set the entire system on fire.

As Andrew Haldane wrote in 2009:

Interconnected networks exhibit a knife-edge, or tipping point, property. Within a certain range, connections serve as a shock-absorber. The system acts as a mutual insurance device with disturbances dispersed and dissipated. But beyond a certain range, the system can tip the wrong side of the knife-edge. Interconnections serve as shock-ampli ers, not dampeners, as losses cascade. The system acts not as a mutual insurance device but as a mutual incendiary device.

Daron Acemoglu (et al) formalised this earlier this year:

The presence of dense connections imply that large negative shocks propagate to the entire fi nancial system. In contrast, with weak connections, shocks remain con fined to where they originate.

What this means (and what Osborne seems to miss) is that large banks are a systemic risk to a dense and interconnective financial system.

Under a free market system (i.e. no bailouts) the brutal liquidation resulting from the crash of a too-big-to-fail megabank would serve as a warning sign. Large interconnective banks would be tarnished as a risky counterparty. The banking system would either have to self-regulate — prevent banks from getting too interconnected, and provide its own (non-taxpayer funded) liquidity insurance in the case of systemic risk — or accept the reality of large-scale liquidationary crashes.

In the system we have (and the system Japan has lived with for the last twenty years) bailouts prevent liquidation, there are no real disincentives (after all capitalism without failure is like religion without sin — it doesn’t work), and the bailed-out too-big-to-fail banks become liquidity sucking zombies hooked on bailouts and injections.

Wonderful, right George?