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More to worry about … the US downturn looks to be getting worse when it should be getting better

by Brad Setser
February 6, 2009

Paul Swartz, my colleague at the Council’s Center for Geoecononomic Studies, continues to track how the current recession compares to past recessions. The United States fiscal deficit is now rising faster than in past cases. The biggest previous change was in 2000-2001 recession, when W’s tax cuts combined with a big cyclical fall in tax revenue to produce a large swing in the United State fiscal position. A modest surplus quickly turned into a large deficit. The swing in the United States fiscal position this time around is likely to be even larger. Counter-cyclical fiscal policy is back.

As Dr. Krugman notes, though, the case for a large policy response is simple: the economy is declining at a rapid pace. The US actually started to slow back in 2006, when residential investment tailed off. The recession formally started in late 2007 or early 2008. For a while it was possible to hope that the recession might prove to be fairly shallow. Exports were doing well, and the contribution of growth from net exports helped offset the fall in residential investment. And the American consumer seemed quite willing to keep spending.

But, well, things have changed. Rather than getting better, things are still getting worse. Exports are poised to fall sharply, as the world not just the US has slowed. And the fall in US industrial production has accelerated. The following graph comes from Paul’s chart book. The fall in industrial production in the current cycle is already worse than the fall in an average post World War 2 recession.

To help put this fall in context, Paul compared the current fall not just to the average but to the best and worst trajectories in the past data.

Unfortunately, the fall in US industrial production is approaching the worst falls in the post-World War 2 data set. Some recessions in the past produced a sharper initial fall. But in an average post-World War 2 recession, the economy would be recovering by now — not getting worse. If things don’t improve, the current fall may match the biggest fall in the post war data. And remember, industrial production wasn’t exactly booming during the boom years of this cycle; it took an awful long time for industrial production to top its 2000 levels

That is why — despite the risks — I support a large stimulus. The United States debt levels suggest that it still has room to use the public sector’s balance sheet to try smooth the economic cycle. And there is nothing moderate about the current cycle.

It would certainly be nice though if other countries joined in, especially those with large current account surpluses. Low oil prices are bringing the US external deficit — and the United States need for external financing — down even as the US government borrows more. This combination won’t last forever. The US government can help support US and global demand, but it would be best if it didn’t do so alone. The more countries like China do to help put their legions of newly unemployed to work at home, the better.

173 Comments

  • Posted by Indian Investor

    Brad: Rather than getting better, things are still getting worse.
    You’re right about falling US exports, and falling industrial production.
    The US housing market is showing signs of a trend reversal, as reported on Calculated Risk’s blog earlier. This is justified by lower levels of inventory and a stabilizing trend in sales volume, though prices continue to fall.
    In 2005, Calculated Risk predicted the housing fall from data showing increasing inventory levels.
    Studying some of the trade activities between the erstwhile England, Scotland and Wales geography and Her Majesty’s subjects in the colonies illustrates the nature of trans-Pacific trade relations in the modern world. While cotton farming was done in India, textiles mills manufactured clothing in British industrial era slums. While iron ore was mined and exported from India, Her Majesty’s British factories manufactured Hercules bicycles to be sold to the colonial subjects.
    Industrial production in the modern world is like cotton farming in the early part of the previous century … a low margin hard labor activity more fit for colonial subjects.
    Austrian Economics appear to have failed to update Ludwig von Mises writings from the “goods trade” and “gold currency” world to the current day.

  • Posted by Off the boil

    Investor : What would happen to the massive factories built in India and China ?

    Is there any hope for them ?

  • Posted by Indian Investor

    Sorry some of my comments got mixed up with Brad’s earlier comment by mistake while Ctrl C Ctrl V

  • Posted by Obey

    You don’t really say much to counter the arguments Buiter puts forward concerning the risks of a buyer strike in the treasury market (though you have said the Chinese will likely keep buying).

    It seems to me that the market’s reaction to the massive new supply in treasuries will depend on the structure of the stimulus plan envisaged. The way it looks now, the US is just randomly trying to prop up the debt-driven bubble in consumer spending. That is, it is doing little or nothing to recognize and ease the necessary adjustment to an economy with some other driver for growth; there is little in the way of targeted tax-cuts and investment. (This contrasts with the structure of China’s stimulus directed at education, health and infrastructure).

    If I were the treasury market, my faith in the US’s ability and will to handle the new debt load, without inflating it away, would be eroding fast. Any thoughts?

  • Posted by DJC

    A Trillion Dollars here and a Trillion Dollars there wasted on Stupid Wars in the Middle East ……..

    From Asia Times,

    After all, more than a trillion dollars later, with essentially nothing to show except an unbroken record of destruction, corruption, and an inability to build anything of value, the US is only slowly drawing down its 140,000-plus troops in Iraq to a “mere” 40,000 or so, while surging yet more troops into Afghanistan to fight a counter-insurgency war, possibly for years to come. At the same time, the US continues to expand its armed forces and to garrison the globe, even as it attempts to bail out an economy and banking system evidently at the edge of collapse. This is a sure-fire formula for further disaster – unless the new administration took the unlikely decision to downsize the US global mission in a major way.

    Right now, Washington is whistling past the graveyard. In Afghanistan and Pakistan the question is no longer whether the US is in command, but whether it can get out in time. If not, when the moment for a bailout comes, don’t expect the other pressed powers of the planet to do for Washington what it has been willing to do for the John Thains of our world. The Europeans are already itching to get out of town. The Russians, the Chinese, the Iranians, the Indians … who exactly will ride to our rescue?

    Perhaps it would be more prudent to stop hanging out in graveyards. They are, after all, meant for burials, not resurrections.

  • Posted by RebelEconomist

    Obey,

    I agree. I suspect that the bond market would have more faith in the ability of the US to repay its debt if the fiscal measures were addressing key economic weaknesses and bottlenecks to give America enhanced capacity to repay. Michael Porter made this point well speaking on the BBC World Service Business Daily programme this week. If the likes of Krugman and Cochrane cannot agree on how much stimulus fiscal measures can provide, perhaps they can at least agree that there are public projects that are worth spending on anyway.

  • Posted by DJC

    Economist Marc Faber on the United States “Banana Republic” Economy ……….

    The US risks being hit by Zimbabwe-style hyperinflation and there are signs that the world’s biggest economy risks turning into a banana republic, Marc Faber, author of the Gloom, Doom & Boom report, told CNBC’s “Asia Squawk Box.”

    “In the US, we have a totally new school, and it’s called the Zimbabwe school,” Faber said. “And it’s founded by one of the great leaders of this world, Mr Robert Mugabe, that has managed to totally impoverish his own country. And that is the monetary policy the US is pursuing.”

    Asked whether the US risked being faced with 200 percent inflation, Faber answered: “Well, not yet. Not yet. But I think eventually. If I look at government debt in the US, and debt in general, I think the only way they will not default physically on their debt is to inflate.”

    The Federal Reserve’s policy of printing unlimited money undermines the US’s economic and political clout, Faber warned. The US government should be junk,” Faber said, adding: “I don’t pay much attention to rating agencies. The rating agencies have totally failed over the last 3-4 years to identify sick companies.”

  • Posted by DJC

    CNBC Jim Cramer,

    The very industries President Obama’s spending plan was designed to help all rallied Thursday: oil, minerals, agriculture, the rails. But the White House deserves none of the credit, Cramer told viewers, because China led that charge, and not the U.S.

    Cramer went so far as to call Obama’s stewardship of our much-needed stimulus package “a complete and utter disappointment.” He’s letting congressional Democratic leaders Nancy Pelosi and Harry Reid fill the bill with pork instead of the $300 billion to $400 billion in infrastructure spending we expected. No, for building bridges and roads, we got just $30 billion instead. The jobs that were supposed to be created and the business that was supposed to be “stimulated” – all of the above-mentioned sectors and more – aren’t happening here at home. At least not yet. So there had to be another reason for today’s gains.

    Chinese leaders have taken a “kitchen sink” approach to rejuvenating its ailing economy. And in addition to that “by any means necessary” mentality is an open wallet. China’s spending more on updating just its telecommunications infrastructure than the U.S. is on its entire infra build-out.

  • Posted by Arun

    (This contrasts with the structure of China’s stimulus directed at education, health and infrastructure).

    Yet the education and health funds in the stimulus bill are being denounced as non-stimulus (if you’ve been watching the cable channels, you’d see that). The Republicans also pay lip-service to infrastructure, but seem opposed to mass transit projects.

  • Posted by Indian Investor

    Brad: The more countries like China do to help put their legions of newly unemployed to work at home, the better.

    I agree with this recommendation. It’s possible to see that consumption is being encouraged in emerging markets, and the infrastrucuture bottlenecks are being addressed, so that a larger section of the population can be integrated into a modern world with consumption patterns similar to developed economies.

    It isn’t easy to see how current account imbalances are going to be adjusted. I’d like to know if current accounts can be re adjusted if American companies use their technological expertise to run companies in emerging markets. For instance if a US firm is able to use its patented technology to set up a genetically modified seed sale in India, will the profits from those sales get accounted in the US balance of payments? Similarly, do the sales of Pepsi and Coca-Cola in India help reduce the US current account deficit?

  • Posted by Arun

    CNBC’s Jim Cramer needs a personal economic trainer.

    http://www.washingtonpost.com/wp-dyn/content/article/2009/02/05/AR2009020503413.html

  • Posted by Indian Investor

    Brad: I support a large stimulus

    Me: I think a lot of attention has to be paid to the aid for State Governments from the perspective of future technological innovations. A number of nanotechnology labs are funded by State Governments. This area of tech requires much more funding than the old .com firms, and it relies quite heavily on State funding. Typically states like New York and California compete with one another to fund these labs because of the employment stimulus they provide in the relevant area.

    So far there hasn’t been much commercial success either in nanotechnology or in pharmaceutical biotechnology.

  • Posted by Steve

    The China recovery story seems to be getting swallowed hook, line, and sinker. A couple of thoughts:

    1. It’s far too early to judge on the basis of the few fragmented pieces of data coming out of China whether or not the economy there has turned. There certainly has been plenty of spin from the leadership; I wonder whether the folks paid to produce the figures are feeling any heat?
    2. Sooner or later the stimulus probably will gain traction. How many of the new bulls in China’s shop (sorry, old pun) have focused on the fact that they are relying on a communist central government which does not have full control of decisions at the provincial level to make efficient economic decisions. (Of course, many of today’s newly minted keynesians seem to think the very act of spending money is good enough in itself, without any thought to purpose or efficiency.) I sense some disbelief being suspended here in the pursuit of good news from wherever it can be found.
    3. China’s economy is a fraction of the size of the US economy and cannot lead the world out of its near-depression. I’m afraid the deep restructuring of the global economy necessary to make sure that any eventual recovery is sustainable rather than ‘W’-shaped will take a long, long time. Wall Street wants our money, and China is the bait-du-jour.

  • Posted by Bob_in_MA

    I don’t see how that makes the case for a kitchen-sink stimulus that the Krugman curve alleges to justify.

    Yes, spending must be maintained for things like unemployment, the entitlement programs, welfare, food stamps, aid to states is reasonable.

    But debt to build frisbee courses and bridges to nowhere, or to support Bill Gross’s portfolio, are obviously going to be counterproductive.

    What the graph above seems to illustrate is how for the first nine months of this recession we papered-over the problems with all sorts of dubious bailouts and obtuse Fed lending facilities, and a pointless tax-cut.

    The jig is up. We are facing a severe downturn and the sooner we accept it, the sooner we can recover.

    The Japan route, which Krugman, et al., favor, is unlikely to be open to a nation of spenders.

  • Posted by wally

    “the case for a large policy response is simple: the economy is declining at a rapid pace”

    Perhaps. But very plainly that is no argument for any particular TYPE of policy.

  • Posted by bsetser

    The arguments against Buiter:

    a) The fiscal deficit is helping the US transition from a no private savings economy to a high private savings economy. if that is right, it won’t be linked to a large rise in external borrowing/ a major current account deficit but rather a fall in the current account deficit. the risk of a dollar crisis was always tied (in my view) to the trade deficit not the fiscal deficit and the trade deficit is coming down. i would worry more if that were to change going forward, i.e. if the us stimulus emerged as the global locomotive rather than as a cushion for a transition from a 0% to 10% household savings rate.

    b) a 40% public debt to GDP ratio isn’t that high for a major industrial country; there is scope for it to rise. The pace of the rise this time may be impressive, but if the debt to GDP ratio levels off and then comes back down, that seems doable to me. and i have more confidence than Buiter does in the ability of the us government to avoid large sustained fiscal deficits. The balance sheets that are in terrible shape in the US are found in the private sector not the public sector.

    c) right now the problem with the dollar is its strength not weakness. and treasury yields while they have come up remain low — far lower than before the US started borrowing huge sums. buiter forecasts a big swing in the future — but for now there isn’t strong evidence of a large fall in demand for dollar denominated debt.

    i.e. i see more evidence of a shortfall in demand for goods than bonds, so think that there is a case for the government issuing more bonds to help private actors in the economy buy more goods (or more accurately, keep private actors from cutting back on their goods purchases by as much as they otherwise would … )

    c)

  • Posted by DJC.

    Aron,

    The “real” problem is the US government is trying to perpetuate a “phony consumption economy” based on consumer borrowing and spending. The US Economic model based on Finance, Insurance, and Real Estate (FIRE) is bankrupt. A significant amount of the maladjusted US economy that was built up to serve the consumer-debt bubble driven economy won’t ever be solvent. Despite the Federal Reserve’s bailouts of politically-connected Wall Street banksters, it is impossible to reinflate a collapsed financial bubble. With the absence of consumer spending that constitutes 70% of GDP, there won’t be any escape for the US Economy imploding into a depressionary black hole.

  • Posted by Twofish

    DJC: With the absence of consumer spending that constitutes 70% of GDP, there won’t be any escape for the US Economy imploding into a depressionary black hole.

    And a depression in the US economy will pull down the rest of the world.

    Do you have any suggestions on what to do to either stop or mitigate the situation? One thing is that you think we are all doomed, then this means that we can try anything at all that anyone else suggests.

  • Posted by DJC.

    Write Mish Shedlock,

    “Peak credit has been reached. That final wave of consumer recklessness created the exact conditions required for its own destruction. The housing bubble orgy was the last hurrah. It is not coming back and there will be no bigger bubble to replace it. Consumers and banks have both been burnt, and attitudes have changed.”

    Writes David Rosenberg,

    “This is an epic event; we’re talking about the end of a 20-year secular credit expansion that went absolutely parabolic from 2001-2007.Before the US economy can truly begin to expand again, the savings rate must rise to pre-bubble levels of 8%, the US housing stock must fall to below eight-months’ supply, and the household interest coverage ratio must fall from 14% to 10.5%. It’s important to note what sort of surgery that is going to require. We will probably have to eliminate $5 trillion of household debt to get there, this will happen either through debt being written off, as major financial institutions continue to do, or for consumers themselves to shrink their own balance sheets.”

  • Posted by Twofish

    Bob_in_MA: But debt to build frisbee courses and bridges to nowhere, or to support Bill Gross’s portfolio, are obviously going to be counterproductive.

    Not obvious. The counterargument is that we end up in 1930 again.

    Also, it’s been suggested that the big, big mistake was to let Lehman go under, and that if Lehman hadn’t gone under, we could have continued the situation that existed in early 2008. Maybe. Maybe not. One annoying thing about economics is that you can’t rerun reality to see what happens.

    Bob_In_MA: The Japan route, which Krugman, et al., favor, is unlikely to be open to a nation of spenders.

    The counterargument was that Japan failed because 1) it didn’t fix the banks 2) it directed at the wrong things and 3) it wasn’t enough stimulus.

    In economics, nothing is obvious, so you need to keep your eyes and ears open. The reason I support massive stimulus is that its opponents really don’t have an alternative. If we are totally doomed anyway, then why not try something desperate?

    The only argument against stimulus is that it will make things worse, but given that its opponents are predicting total doom and gloom if we do nothing anyway, then I don’t see how it can hurt.

  • Posted by DJC.

    Twofish: Do you have any suggestions on what to do to either stop or mitigate the situation?

    DJC: We both can agree that the impact of a retrenching US consumer will be felt far and wide, from New York to Shanghai. If the Chinese are very lucky, they maybe able to save themselves from the depressionary global implosion with massive state driven spending on rural infrastructure. An economic renaissance of China begins with enhancing the worker productivity and living standards of the seven hundred million rural Chinese. China remains a nation of two separate societies: a well developed industrial cities especially along coastal regions, and a large backward interior. Vast interior regions of China still lack adequate electrical power, paved roads, telecommunications, railway transportation, adequate water and sewage systems, etc. But China only retains the financial resources to save itself, the Chinese cannot possibly save the US Economy or the rest of the world.

  • Posted by Twofish

    Also the immediate problem is no one is investing in anything other than Treasuries. If people decide that the US government is insane and pull their money out of Treasuries and into private investment, this is a very good thing. We’re trying to create a Treasury buyer’s strike.

    The problem is that there is a relative risk issue. If the US government goes totally insane and destroys the world economy, then you *still* want to buy Treasuries, because if Treasuries go crazy then everything else will be even worse.

    You need to remember that people are buying large amounts of Treasuries precisely *because* the US economy is imploding.

  • Posted by Twofish

    You didn’t answer the question….

    DJC: But China only retains the financial resources to save itself, the Chinese cannot possibly save the US Economy or the rest of the world.

    But if the US economy completely implodes then it’s going to destroy the Chinese economy. If the US economy merely remains stagnant, say Japan 1990, then China can survive, but if it gets worse, i.e. US-1930′s, the China is going to get pulled down with it.

    The first priority is to prevent a major depression. The second priority is to stabilize things. They may stabilize at a bad level, but we need to stabilize things so that we can figure out what happens next.

  • Posted by tega

    DJC:

    I don’t think China has enough savings to do the transformation you are talking about. They will need trillions of dollars to bring the rural areas to the standards of the coastal regions, and without the help of the bankrupt US consumer they wont have the money in a very long time.

    China also does not have any social safety networks for the its workers, that is why workers save so much. The real wages of workers have been stagnant for a long time, a long spell of unemployment will decimate any savings they have built up.

  • Posted by Indian Investor

    Brad: … and treasury yields while they have come up remain low — far lower than before the US started borrowing huge sums.

    I expect high prices for Treasuries and successful auctions. For obvious reasons. The cash from Treasury auctions is going to be used for further credit extensions to the banking system, and for capital injections as well. There’s a debate on the process of stabilizing the banking system. Either a new good bank or a new bad bank will be created, and in the worst case there will be nationalization. Irrespective of which route is chosen, there’s going to be a stable set of institutions to extend credit for regular business transactions in the US, and that’s a big change and relief for the market.
    While the China and India stock markets have bottomed out, the US and other major equity markets are in the bottoming out process.
    But the Treasury bonds are a ticking time bomb, a disaster waiting to happen. Perhaps the next major credit crisis will get triggered in 2014, on the back of the Treasury bubble burst.

  • Posted by DJC.

    Twofish: But if the US economy completely implodes then it’s going to destroy the Chinese economy. If the US economy merely remains stagnant, say Japan 1990, then China can survive, but if it gets worse, i.e. US-1930’s, the China is going to get pulled down with it.

    DJC: Given the interlocking financial and trade ties around the world, I fully concur that China will get pulled down with the US Economy imploding into a depressionary black hole. One can never prepare enough for the future, but at least the $2 trillion foreign reserves of dollars, euros, yen, and gold provide some economic cushion. But the Chinese are also the longest continuing civilization in the world today. Across the tides of world history, the Chinese have experienced much worse including Opium wars, military invasions, colonialism, neo-liberalism, famines killing tens of millions. Yet the central core of Chinese civilization has always survived intact.

  • Posted by Twofish

    tega: China also does not have any social safety networks for the its workers, that is why workers save so much.

    It depends which workers. Urban workers in state owned enterprises have reasonably good safety nets. The other thing is that most urban workers own their own housing.

    tega: The real wages of workers have been stagnant for a long time.

    This isn’t true. Wages for most people have been rising rapidly. It’s only when you use bogus measures like wages/GDP that you can argue that there are problems.

    tega: A long spell of unemployment will decimate any savings they have built up.

    I don’t think that this is likely because people will riot before savings runs outs.

  • Posted by Albion

    Twofish« You need to remember that people are buying large amounts of Treasuries precisely *because* the US economy is imploding »

    They are quiet reservation as to who is buying. Anyway the « homo economicus » is not often as governments and associates, would wish an « homo asinus » « donkey »
    As shown before the banks reserves have not flooded the credit market.

    They are several issues militating for prudence if not a real buyer strike
    Financial markets manipulations have been excessive during these ten years
    Legislative safe guards have not been operative
    Court cases hare much smaller than in 2001/ 2002
    Banks known for their activism in financial prices exasperation are far from being sanctioned but rescued
    The banking structure has not been addressed and if implosion by fission occurs it will be through « fusion »
    The debt flow may be decreasing but the debt stock is increasing

    I see no progress made on debts issues and the next cycle will be insovencies

    « German bond sale’s fate signals trouble ahead
    By David Oakley in London
    Published: January 7 2009 13:30 | Last updated: January 7 2009 20:45
    A German sovereign bond auction failed on Wednesday as investors shunned one of the most liquid and safe assets in the world in a warning for governments seeking to raise record amounts of debt to stimulate slowing economies.
    The fate of the first eurozone bond auction of 2009 signals trouble ahead as governments around the world hope to issue an estimated $3,000bn in debt this year, three times more than in 2008. »

  • Posted by DJC.

    Twofish,

    A depths of an economic bust, correspond to the gross excesses of a credit bubble driven economic boom. Unfortunately, there isn’t any magical cure for a depressionary credit bubble bust, except for to have never let a credit bubble inflate in the first place. The negative interest rate policies of the Federal Reserve massively misallocated capital across the entire US Economy resulting in the appalling phenomena of America’s landscape littered with McMansion housing from coast to coast. A depressionary black hole is you might say, baked into the cake already.

  • Posted by Twofish

    DJC: But at least the $2 trillion foreign reserves of dollars, euros, yen, and gold provide some economic cushion.

    No it won’t. If the US economy self destructs, the dollars will be worthless.

    DJC: But the Chinese are also the longest continuing civilization in the world today.

    No thanks to the type of thinking that you support, which I think is highly destructive to China’s continued survival.

    China survived because it had political leaders that made good decisions along with a bit of luck. If Chinese leaders had made different decisions, then China today would like like the Middle East, and China would be a memory like the Ottomans or the Habsburgs.

    The fact that China managed to survive the 19th century means *NOTHING* if you have idiotic leaders and ideologies in the 21st. The second you start living in past glories and think that you are special, that’s the moment you are doomed. Thinking that China has some sort of historical destiny is garbage and seriously destructive garbage.

    DJC: Yet the central core of Chinese civilization has always survived intact.

    Which says *NOTHING* about its continued survival in the future.

    The central core of Chinese civilization is that there is no central core. China has survived because it has managed to adapt and change. China has one big advantage over Japan and that is that China had take whatever works and make it Chinese.

    Also China isn’t particularly unique. Kurds and Armenians have very long histories.

  • Posted by tega

    twofish:

    The number of urban workers in state owned companies are small compared to the other sectors. the value of housing has been in a free fall the last couple of months, so workers are not worth as much.

    Inflation in China has been horrible the last couple of years (the past quarter has been the exception). wages have not increased a lot to counter the persistent high inflation levels.

    I am hoping that the government can come up with tangible solutions before workers riot.

  • Posted by Indian Investor

    DJC: China remains a nation of two separate societies: a well developed industrial cities especially along coastal regions, and a large backward interior. Vast interior regions of China still lack adequate electrical power, paved roads, telecommunications, railway transportation, adequate water and sewage systems, etc.

    In India we have what we call “two Indias”. Sometimes you can see both the Indias at opposite ends of the same city,and you can even see new Indians with old Indians together in the same place in some situations.
    South Bangalore, with Electronics City & International Technology Parks Ltd. enclosures for software development firms, can be thought of largely as part of the new India, whereas North Bangalore, with the Peenya Industrial Area, symbolizes part of the old India.
    If you drive a few hundred miles outside Bangalore, you arrive in villages where nothing much has changed for centuries in terms of technology and economic development.
    A successful new Indian, driving an imported BMW, stops at a traffic signal in Dollars Colony,and a small kid from old India in tattered clothes knocks on the car window, trying to sell plastic Indian flags for Republic Day for a few rupees.

  • Posted by Albion

    United China or before the middle kingdom is a young story as it has been united for 500 years only

  • Posted by Twofish

    DJC: A depths of an economic bust, correspond to the gross excesses of a credit
    bubble driven economic boom.

    That’s what the Austrian think. I think they are talking non-sense here.

    DJC: Unfortunately, there isn’t any magical cure for a depressionary credit bubble bust, except for to have never let a credit bubble inflate in the first place.

    Yes there is. Massive Keynesian stimulus worked in the 1940′s and in the 1980′s. You can’t do massive Keynesian stimulus if you already have huge debts or have idiot IMF restrictions on your economy, but none of those restrictions are in place for the US.

    And in any case, the question then has to be how you do mitigate the damage. What do you do to make sure that the rough patch lasts for 20 months rather than 20 years.

    DJC: The negative interest rate policies of the Federal Reserve massively misallocated capital across the entire US Economy resulting in the appalling phenomena of America’s landscape littered with McMansion housing from coast to coast. A depressionary black hole is you might say, baked into the cake already.

    The trouble with that argument is that even with massively mis-allocated capital you didn’t have mass unemployment until the last two months. The US economy was running in reasonable shape with massively misallocated capital until about September last year.

    What I don’t understand is that you keep talking about the tremendous damage that IMF policies have done in the developing world, yet you insist on supporting the theories that led to those bad policies. Haven’t we had enough with “structural adjustment?”

    The negative interest rate policies of the Federal Reserve massively misallocated capital across the entire US Economy resulting in the appalling phenomena of America’s landscape littered with McMansion housing from coast to coast. A depressionary black hole is you might say, baked into the cake already.

  • Posted by Twofish

    tega: The number of urban workers in state owned companies are small compared to the other sectors.

    It’s small compared to people in agriculture. It’s larger than the export manufacturing sector.

    tega: The value of housing has been in a free fall the last couple of months, so workers are not worth as much.

    But this doesn’t matter much since workers have 100% ownership of their house which means that they don’t have to pay mortgages or rent. That gives them a huge amount of disposible income.

  • Posted by DJC.

    Twofish: If the US economy self destructs, the dollars will be worthless.

    DJC: The composition of Chinese foreign reserves is a state secret, but even Brad Setser doesn’t say it’s all in US Dollars. It is estimated that 60-70 percent of foreign reserves are US Dollars. The Chinese PBoC has spoken about diversify into Euros, yen, Malay Ringit, Japan yen, Gold, and even Russian Rubles. It can be assumed that the remainder of China’s forex reserves are invested in a diversified currency basket along with 2-4 percent Gold reserves.

    Twofish: No thanks to the type of thinking that you support, which I think is highly destructive to China’s continued survival.

    DJC: Around 50% of the US Strategic Nuclear arsenal is targeted at the destruction of Chinese cities. Both current US Defense Secretary Robert Gates and former Donald Rumsfeld in sworn statements have designated China as a “strategic threat to the United States”. Probably the China PLA arsenal of around 50 nuclear warheads would not survive a US Nuclear attack of over 1000 strategic missiles currently targeted at Beijing. Except for the possibility of Nuclear extermination, Chinese civilization will survive. The biggest threat to global security is the Washington Consensus agenda for absolute US global hegemony across both the military and political spheres that has already bankrupted the American economy.

  • Posted by Twofish

    DJC: Except for the possibility of Nuclear extermination, Chinese civilization will survive.

    Read up on the Ottomans and the Austrian-Hungarians or for that matter Arab history or the history of Yugoslavia. The United States cannot destroy China, but China can destroy China. Look at what happened to the Soviets. They were defeated not in battle but by internal economic collapse.

    DJC: The biggest threat to global security is the Washington Consensus agenda for absolute US global hegemony across both the military and political spheres that has already bankrupted the American economy.

    It actually hasn’t. If you look at the numbers, the United States is nowhere near bankrupt. US banks are bankrupt, but not the US as a whole.

    Also, as long as the United States does not interfere in Chinese vital national interests, then there is no reason for China to challenge US global hegemony or worse yet try to become a hegemony itself, and we’ve reached the point where the United States is not in a position to challenge Chinese vital interests.

  • Posted by Twofish

    DJC: The Chinese PBoC has spoken about diversify into Euros, yen, Malay Ringit, Japan yen, Gold, and even Russian Rubles.

    But it really can’t. If it moves out of dollars then it makes the rest of its reserves less valuable. Also there aren’t enough yen, ringit, gold or Rubles to support Chinese currency reserves. The only two currencies that are usable as reserves are dollars and euros.

  • Posted by Indian Investor

    Brad: a 40% public debt to GDP ratio isn’t that high for a major industrial country; there is scope for it to rise.

    According to the Bureau of Public Debt, the latest total public debt outstanding is $ 10.67 trillion, of which $6.36 trillion is held by the public and $ 4.31 trillion is intra-governmental holdings.
    The 2008 estimated US GDP at official exchange rates is $ 14.58 trillion according to the CIA world factbook.
    So the total public debt/GDP ratio is 73.18% and if you look only at the debt held by the public you get 43.62%.

    Is it possible to explain the exclusion of intra governmental debt holdings; I’m assuming you’re approximating from public holdings of debt to get 40%.Does intragovernmental holdings include or exclude the Fed’s holdings of Treasuries?

  • Posted by DJC.

    Twofish: The trouble with that argument is that even with massively mis-allocated capital you didn’t have mass unemployment until the last two months. The US economy was running in reasonable shape with massively misallocated capital until about September last year.

    DJC: That is why economic bubbles are called just that, bubbles. Credit bubbles provide the appearance of prosperity, then they just pop. Except for the fact that dimwit US Neo-liberal Economists never learn anything from history, Financial Bubbles have imploded and created massive dislocation from the beginning of mankind’s recorded history. For instance, Europe’s Dark Age era that lasted for a couple of centuries was a result of a credit bubble collapse centered around Italian City State of Genoa.

  • Posted by DJC.

    DJC: The Chinese PBoC has spoken about diversify into Euros, yen, Malay Ringit, Japan yen, Gold, and even Russian Rubles.

    But it really can’t. If it moves out of dollars then it makes the rest of its reserves less valuable. Also there aren’t enough yen, ringit, gold or Rubles to support Chinese currency reserves. The only two currencies that are usable as reserves are dollars and euros.

    DJC: Oh please, the China PBoC already has reached an agreement with the ASEAN+3 countries for the equilvalent of a $150 billion curency swap. Futhermore, the China PBoC is allocating billions into filling a Chinese strategic oil reserve. Frankly, it’s a self-serving myth by US policymakers that the only global asset class for China PBoC forex reserves are US Treasury bonds that yield approximately zero interest. However, since China is prohibited from high-tech US imports and investments in the US natural resource sector, it is only true that the only asset class available for sale to the Chinese in the United States are US Treasury bonds or AAA-rated Subprime CDO garbage bonds.

  • Posted by DJC.

    Twofish: Also, as long as the United States does not interfere in Chinese vital national interests, then there is no reason for China to challenge US global hegemony

    DJC: The breakaway province of Taiwan remains a core National Security issue for the China PLA. Due to Pentagon interference, formal and informal relations between the Pentagon and China PLA have recently completely collapsed. Presently, the Chinese and American governments aren’t in any communications across the global security and geo-political spheres.

  • Posted by Indian Investor

    Twofish: Look at what happened to the Soviets. They were defeated not in battle but by internal economic collapse.

    I think it would be wise for investors not to bet against the Treasury Secy prices in the near future. Also it might be wise not to subscribe to US Govt. securities if you’re just a small private investor.
    It looks to me that the US Govt. is headed inexorably for a sovereign default, as commentators like Peter Schiff, Marc Faber, etc are always indicating.
    Given my above comment on the level of public debt, and the relatively much lower amount of currency in circulation right now, it’s not possible to inflate this level of debt away.
    Since I’m not an expert on this issue I’d like to know if I’m missing something really important.

  • Posted by Albion

    It may be a repeat,Asia should revisit the project of issuing debts in Asia currency (that would comprise a basket of Asian currencies) as it could provide an immunity to interest whipsaws elsewhere.

  • Posted by jjm

    Brad,

    I disagree that our public debt to GDP ratio has room to grow. We have a large bolus of baby boomers about to enter the Medicare system. This unfunded liability is not entered into your public debt calculations, but it should be.

    JJM

  • Posted by Indian Investor

    Though not an expert I think the US public debt is an issue that can cause more serious problems a few years ahead, rather than right now. Perhaps push will come to shove by 2014 or so. Though the debt is at $10 trillion, my impression is that USG retains the ability to service the debt. Rather than print dollars to repay, they might have a strategic plan to print dollars to pay interest on the public debt.
    Also, a large percentage of forex reserves are still held in US dollars, and that is starting to shift slowly now.
    USG needs to avoid being in a situation called as a “debt trap” i.e. inability to service the debt. USG might be able to improve public income with taxes in future. And meanwhile some inflation perhaps doesn’t do harm in a deflationary crisis.
    For my part I’m hopeful for a market and economic recovery for now. But I do think there might be a really major crisis by around 2014 or so, because of the public debt problems.
    If one sovereign defaults, especially one like the US, that would have implications for other sovereigns who’re holding the US Treasury securities as well. China is holding around $ 900 billion in Teasuries, according to Brad’s last estimates. China would therefore do well not to fund the US Govt. any more, and gradually shift the composition of its forex reserves away from USD.
    Any further analysis or information would be quite useful.

  • Posted by Will

    “This unfunded liability is not entered into your public debt calculations, but it should be.”

    You mean the small matter of 90 trillion in unfunded SS and Medicare liabilities ?

  • Posted by Indian Investor

    @Djc: I don’t think the US is aiming missiles at China. They’re actually setting up a new direct telephone hotline between the US and China military commands.
    Also China’s views on US military bases such as the earlier Uzbek base were because of the US military support for Islamic separatist militants there.
    China doesn’t have any agenda to throw the US out of Central Asia, and the US doesn’t have any agenda to militarily attack China.
    But there’re serious problems between Russia and the US. Russia wants to dominate its “near abroad” while the US is trying to get Central Asian countries like Ukraine and Georgia into NATO.

  • Posted by purple

    I agree on the need for counter-cylical spending simply on a human level. But the root problem is the inability of the American economy to support a reserve currency. It’s not the fault of Americans really, no one else can do it either. This isn’t 1955, and our manufacturing – the lifeblood of an economy – has declined dramatically, relative to world, over the last 10 years. (world manufacturing is also declining relative to GDP, but ours more)

    The ending of a reserve currency is actually not a good thing, and that’s why it’s being resisted by most parties for now. It puts the world into a pre-WW 2 or WW 1 type of situation. Without a dominant currency as a glue, capitalism rapidly becomes a battle over spheres of influence and markets.

  • Posted by Obey

    Brad- thanks for the detailed answers against Buiter.

    Like Indian Investor, I was a bit confused by this

    “a 40% public debt to GDP ratio”.

    This ignores the Social Security Fund holdings I take it. And then there is the little matter of the 2-3 trillion in eventual liabilities tied to the bank bailout, and the structural deficit adding 500 bn+ per year. So I have 100% public debt/GDP ratio on a 3-4 year horizon. And that is PIGS territory.

    Also this

    “The balance sheets that are in terrible shape in the US are found in the private sector not the public sector.”

    was not convincing. This assumes that the government will stop subsidizing the big banks and backstopping losses. Are your friends Geithner and Summers telling you something they are not telling the markets?

    This:

    http://www.marketwatch.com/news/story/moodys-says-us-financial-position/story.aspx?guid={7DB52440-A28B-4834-A050-F844ECB90014}&dist=msr_4

    also suggests some rumblings in the market.

  • Posted by Will

    “Similarly, do the sales of Pepsi and Coca-Cola in India help reduce the US current account deficit?”

    Why should they ? That would be inconsistent with beggar thy neighbor policy.

  • Posted by jonathan

    I have to add – to hear myself talk – that I don’t understand the Chicago et al objections to the stimulus plan. (That is, I understand them on one level but not on another.)

    To be brief, Chicago is not only the bastion of free market thinking but also the place where rational behavior won the Nobel Prize. So using that side of Chicago thinking, my phrasing is simple: if you have a 1 in 6 to 1 in 10 chance of a catastrophic event – such as losing your legs, enduring a true Depression – then how do you rationally respond to that? If doing nothing is that 1 in 6 to 10 chance, my guess is that most people would do a lot to avoid that outcome. So if stimulus has a 1 in 4 chance of you keeping your legs or the world avoiding depression, I’d bet almost everyone would take that choice. If you believe stimulus has a 1 in 50 chance, your answer might well be different, but even then the behaviorists (economists and sociologists) would say that if you phrased the question to focus on the risk of loss you’d still have people taking the chance to avoid loss.

  • Posted by ReformerRay

    If we are headed for an economic collapse, as many assume, let it begin with the financial sector, the guys that created the problem.

    NO MORE CASH GOING FROM THE PUBLIC SECTOR TO PRIVATE BANKS.

    The first step to recovery is to allow the banks with toxic assets to survive if they can on their own.

    An alternative is to force them, by law, to sequestor these toxic assets in a new private bank they will establish, that will own all the toxic assets. This law will also prohibit anyone from suing them to force them to pay any debts, retire any bonds, etc. for an unspecified interval, until they have the time to recover as much value from these toxic assests as can be derived.

  • Posted by Beans

    Twofish, it is true that a US collapse will temporarily hurt China, especially if China’s holdings of dollars become worthless. However, unlike you I doubt that China will totally crash.

    China is not Japan. China is a huge country with lots of natural resources, more than enough to sustain internal growth for a long time. The major exception to this is oil. And since a US collapse will mean that US hegemony over the Middle East will end, China’s access to fossil fuels will actually improve in that scenario. I just don’t see an implosion in China.

    So even if the US completely dies there will be a lot of reason for optimism from China’s point of view.

  • Posted by DJC.

    For the record, Chinese President Hu Jintao doesn’t particularly like US geo-political policies. Perhaps Hu Jintal can peel a few fingers of US hegemony over the Gulf Arab energy states?

    LOL :-)

    China’s Hu to visit Saudi Arabia, Africa
    http://www.msnbc.msn.com/id/28989838/

    BEIJING – Chinese President Hu Jintao will visit key oil supplier Saudi Arabia and four African countries later this month.

    China has boosted its ties with Africa in recent years as it seeks resources to power its expanding economy.

    More than half of China’s oil exports come from the Persian Gulf region, mainly from Saudi Arabia.

  • Posted by DJC.

    Indian Investor,

    From the New York Times,

    Kazakhstan-China oil pipeline from Central Asia is supplied from the Aktobe region’s fields and from the Kumkol field. The pipeline is used also for the transportation of oil from Russia’s western Siberia by connection with the Omsk (Russia). In future, another supply source will be Kashagan field.

    In 2005, the China National Petroleum Corporation bought Petrokazakhstan, a Canadian-run company that was the former Soviet Union’s largest independent oil company, for $4.18 billion and spent another $700 million on a pipeline that will take the oil to the Chinese border.

    “China is being increasingly dependent on Middle East oil and it wants a supply that would be blockade-proof in case of a conflict over Taiwan,” said Thierry Kellner, a specialist in China’s relations with Central Asia at the Free University of Brussels.

    China’s leadership has viewed with alarm the creation after Sept. 11, 2001, of American military bases in Central Asia — which China considers its backyard — and has tried to woo Kazakhstan’s longtime president, Nursultan Nazarbayev, away from closer relations with the United States, he said.

  • Posted by Twofish

    Obey: was not convincing. This assumes that the government will stop subsidizing the big banks and backstopping losses. Are your friends Geithner and Summers telling you something they are not telling the markets?

    The government will stop subsidizing the big banks when the big banks stop losing money, and for how to structure that, you can take a look at what the Chinese government did with its big banks.

    DJC: For the record, Chinese President Hu Jintao doesn’t particularly like US geo-political policies. Perhaps Hu Jintao can peel a few fingers of US hegemony over the Gulf Arab energy states?

    Doubtful. It doesn’t matter because Arab oil is useless to China in case the US Navy blocks it. Also oil from Central Asia is useless to China if Russia blocks it. China really should stay out of Central Asia because that is Russia’s turf.

    China’s best geopolitical approach is to try to be nice to everyone, and to make sure that it doesn’t get into a situation in which everyone hates it, and to avoid any permanent alliances.

    Trying to go for global power, is an easy way of getting everyone to hate you.

  • Posted by Twofish

    DJC: That is why economic bubbles are called just that, bubbles. Credit bubbles provide the appearance of prosperity, then they just pop.

    At which point things over-correct and you get huge economic disruptions which are not warranted.

    DJC: Except for the fact that dimwit US Neo-liberal Economists never learn anything from history.

    Contracting the economy in response to a credit bubble burst is classic neoliberal policy. Neo-liberals don’t believe in government intervention and are very much against Keynesian interventions, and believe that its best to just let things fall apart like they did in East Asia during the Asian crisis.

    You are advocating that the US follow neo-liberal policies, and it’s amazing to me that you don’t realize that.

    DJC: Financial Bubbles have imploded and created massive dislocation from the beginning of mankind’s recorded history.

    But without bad governmental policies they create minimal long term damage that can be resolved within a year or two. China had a classic credit and financial bubble over the last few years, but the government has been able to cool the bubble, and now that things are swinging too far, they are reheating things.

    The thing that neo-liberals get wrong is that they don’t see that governments have an essential role to play in fixing the problem.

  • Posted by Twofish

    Investor: Control over petroleum and petroleum gas resources in Central Asia is a key US strategy to counter the effects of burgeoning public debt and contain the consequences of a sovereign debt default.

    I think that’s total nonsense. Petroleum is not going to help you if you have a dysfunctional economy. Ask Nigeria.

  • Posted by ole_captain

    Brad-

    Buiters remarks should be noted. He’s a good chap over in London with a very good feel for flows. No doubt that the measure of this bill will have huge global impact and that’s why we need more time on it. Let’s be honest, this is likely the last stimulus plan the U.S. and the world can afford to support. Fair enough? It’ll near one trillion so must be adequate. Let’s get a little more breaks for investment vs. driving consumer sentiment. Get the Asians to run out to malls! i’d like to save although my wife sure doesnt: (who said life was easy?)

    my notes are the current Stimulus plan (with current measures in tact) will fail this weekend when the senate votes….Monday will be a “Big Day”.

    It maybe bad for the market, but let’s get it right!

  • Posted by DJC.

    Twofish: It doesn’t matter because Arab oil is useless to China in case the US Navy blocks it. Also oil from Central Asia is useless to China if Russia blocks it. China really should stay out of Central Asia because that is Russia’s turf.

    DJC: Oh please, the Russians could care less about Taiwan’s political status and won’t block energy shipments to China over a conflict across the Taiwan Straits. In fact, Russian government official policy recognizes the Beijing government’s legal authority over Taiwan and Tibet provinces. Both Russia and China share common geo-political concern about breakaway revolts sponsored by the US intervention. Furthermore, most of the China PLA weapon systems including its integrated Air Defense network are derivatives of licensed Russian weapon technologies.

  • Posted by Twofish

    Investor: From this analysis you can see that it would have been easy for China to provide funding to Zardari, but their refusal helped the us case by making Pak dependent on US aid.

    And that’s fine for Beijing. Beijing would much rather have Pakistan dependent on US aid than be dependent on Chinese aid. China is very selfish in this regard. If you can provide a reason why and how Chinese aid to Pakistan would help China’s economic (which are domestic) or political interests (which are very limited), then it would have been considered, but there really wasn’t.

    Investor: Though not an expert I think the US public debt is an issue that can cause more serious problems a few years ahead, rather than right now.

    Sure, but how does crashing the economy help matters? People are so worried about water damage that they are forgetting the fire in the living room. Yes, spending several hundred billion dollars is going to cause a big mess, but nowhere near the mess that you get if you don’t spend the money.

    China went through this in 1993, when it choose to create this huge NPL problem because a huge NPL problem being dealt with over several years was better than the alternatives. Same thing happened in the 1980′s when Reagan got the economy out of the slump by massive deficit spending.

    I’m not that worried about the debt since if Obama is successful at getting us out of the slump, then he is going to have enough political capital to have massive increases in taxation, and personally I support big, big taxes for the rich. If I ever make $1 million a year, I’ll gladly pay 50% marginal taxes.

    The trouble is that there are no alternative proposals other than let the economy crash and burn, and that is unacceptable.

  • Posted by DJC.

    Twofish: You are advocating that the US follow neo-liberal policies, and it’s amazing to me that you don’t realize that.

    DJC: You are advocating statist policies under the US Treasury Department that legalize “privatizing the profits and socializing the losses” to the US taxpayer. Billions of US taxpayer dollars in corporate welfare handout have been provided to the same Wall Street who created the financial fiasco. It borders on ludicrous that the Wall Street banksters that bankrupted their shareholder corporations are demanding taxpayer dollars pay for bonuses payments and resort vacations. Not a penny from the Federal Reserve to pay for state unemployment insurance payment but billions paid to Goldman Sachs and Hank Paulson to cover AIG derivative losses. LOL.

  • Posted by Twofish

    DJC: Oh please, the Russians could care less about Taiwan’s political status and won’t block energy shipments to China over a conflict across the Taiwan Straits.

    Not now, but if China has too much influence over Central Asia or Russia thinks that China is growing too powerful then things may change.

    Also, if the US and China ever a permanent split, then China is going to be dependent on Russia for oil. If this happens then Russia is going to make China pay and pay dearly.

    DJC: Both Russia and China share common geo-political concern about breakaway revolts sponsored by the US intervention.

    Sure, and China has geo-political concerns over breakaway revolts sponsored with Russia invention. In Russia’s intervention in Georgia, China is very much on the side of the United States against international recognition of Abkhazia and South Ossetia, because that would set some really, really bad precedents.

    China should have neither friend nor enemies, allies or adversaries, merely interests. Sometimes it means siding with Russia, sometimes it means siding with the US.

    DJC: Furthermore, most of the China PLA weapon systems including its integrated Air Defense network are derivatives of licensed Russian weapon technologies.

    Sure, but Russia (for obvious reasons) isn’t giving China it’s latest technology. China really needs to get it’s own defense industry going, and that means learning US project management techniques. Sure the US isn’t going to try to teach the China how to build a better fighter, but you have lots of Chinese in the US learning how to build a better laptop and refrigerators, and that technology rubs off.

  • Posted by Indian Investor

    Twofish: Sure, but how does crashing the economy help matters?

    Me: I support a big stimulus spending with lots more borrowing to douse the credit crisis issues right now. And as I wrote, the Treasury prices are going to be high and the auctions will be a good success.

    But I wouldn’t advocate blind long term faith in holding dollars. The USG will default by 2014 or so. If they win in Afghanistan, it can help them to contain the effects by issuing blue dollars; and forcing all the foreign central banks to hold blue dollars instead of green dollars.

    If they lose in Afghanistan then nobody will hold the blue dollars; that will be like a fresh start for the US; and everybody in the US has to think like their grandparents, who just arrived on a ship in front of the Statue of Liberty with nothing but their clothes on them.

  • Posted by Twofish

    DJC: You are advocating statist policies under the US Treasury Department that legalize “privatizing the profits and socializing the losses” to the US taxpayer.

    Absolutely, because it is less bad than the alternative of letting the banks go under. Now how you handle “too big to fail” is tricky, and this is where the Chinese experience comes in.

    I’m a statist. Statist. Statist. Statist. Call me a statist. A collectivist statist. A *liberal* collectivist statist. A liberal collectivist communist-sympathetizing colllectivist pinko statist.

    Whatever….

    Actually, I’m open to free market, anti-statist ideas for getting out of this mess. What I do oppose is this “boo, hoo, we can’t do anything nonsense.”

    DJC: Billions of US taxpayer dollars in corporate welfare handout have been provided to the same Wall Street who created the financial fiasco.

    Ironic. Isn’t it? If you have a better solution then I’d like to hear it.

    DJC: It borders on ludicrous that the Wall Street banksters that bankrupted their shareholder corporations are demanding taxpayer dollars pay for bonuses payments and resort vacations.

    But if the alternative is destroying the economy, then I don’t think it matters. If you think you can save the economy without making these payments, then they should be made (and I have some ideas). But since the only thing that you’ve suggested is “destroy the economy”…..

    Burning the house down will punish the guilty. It will also punish the innocent. Most of the people losing their jobs right now have nothing to do with the financial crisis.

    DJC: Not a penny from the Federal Reserve to pay for state unemployment insurance payment but billions paid to Goldman Sachs and Hank Paulson to cover AIG derivative losses.

    OK, Wall Street types are evil nasty money grubbing bastards. Now what?

    This is actually why I very strongly support payments to state unemployment insurance taxes, and heavy taxes on the rich. If middle class people seeing rich people paying huge taxes, then they won’t mind people get megamillion bonuses.

    (There is precedent for this. One reason Sweden ended up with a huge socialist state was so that the wealthy families could keep their money. You see the same dynamic in India.)

    People mainly get upset at corruption when they aren’t getting any of it. So spread the wealth.

  • Posted by DJC.

    Twofish: Also, if the US and China ever a permanent split, then China is going to be dependent on Russia for oil. If this happens then Russia is going to make China pay and pay dearly.

    DJC: Oh please, assuming peacetime conditions even during a Cold War, oil is still a tradeable commodity with a market price. Venezuela, Sudan, Syria, Angola, Nigeria, Brazil and Iran export plenty of oil to China currently. China CNPC and Sinopec are equity partners in all of the above mentioned nations and Russia.

    Twofish: Sure, and China has geo-political concerns over breakaway revolts sponsored with Russia invention.

    DJC: China didn’t support the Russian intervention nor did they vote for a UN resolution condemning the intervention.

    Twofish: Sure, but Russia (for obvious reasons) isn’t giving China it’s latest technology.

    DJC: Without Russian technology, the balance of military power across the Taiwan Straits wouldn’t have shifted to China. With the latest S-300PMU2 Air Defense Missiles, the powerful radar networks on land and sea almost completely control Taiwan Airspace. Even the US Airforce admits that only the stealth F-22 is capable of pentrating Chinese Air Defense. Under the ocean, a dozen Russian supplied Kilo attack submarines and new Type-40 Submarines with Air Independent Propulsion will keep any US Aircraft Carrier battlegroup tied down hundreds of miles from the Taiwan Straits.

  • Posted by DJC.

    Twofish: because it is less bad than the alternative of letting the banks go under. Now how you handle “too big to fail” is tricky, and this is where the Chinese experience comes in.

    DJC: In China, a government bailout of state-owned banks merely represents an intergovernment transfer of funds. In the United States, it’s not the same when private Citicorp and AIG management receive a US taxpayer bailout and still demand that corporate executive receive bonuses. After bankrupting their shareholder corporations, they get to keep their jobs and bonuses? Citicorp even ordered a $50 million corporate jet with taxpayer TARP funds. It represented a terrible conflict of interest for Hank Paulson with $600 million of Goldman Sachs stock assets to authorize a US taxpayer bailout of AIG Corporation in order to protect Goldman Sachs derivative positions. Greed is Good at US taxpayer expense has unfortunately become the name of the game.

  • Posted by Indian Investor

    Twofish: But if the alternative is destroying the economy, then I don’t think it matters.

    Well, Twofish, nobody will talk about this but the real culprit isn’t the US private sector banking corporations. It’s the Fed. The Fed isn’t accountable to anyone other than themselves. So they don’t care when these kinds of busts happen and a lot of people lose their jobs. Plus, they can show a lot of favoritism when a bust happens and probably get bribes for that.
    The US needs to nationalize the Fed and set up a few state owned banks, so that they can hold somebody to account for not regulating things. A free market can still be there through loosely regulated non banking finance companies. Somebody who wants to make out a risky loan or is willing to make a risky deposit for a higher interest rate can deal through the NBFCs, so you can still have a free market there.
    If the state owned bank goes bust, you can catch the culprits and you can re capitalize them more easily. You can just allow the nationalized Fed to order the state owned banks to lend to certain priority sectors with fixed norms and interest rates.Private sector banks need not follow those orders. But the priority sectors will still get credit at a controlled interest rate.
    Emerging markets have this kind of regulated banking system, and conceptually it’s a better system than having the economy dependent on a completely independent central bank and a cartel of large private sector banks.

  • Posted by Jian Feng

    Twofish,

    US treasuries are popped up because it is deemed the “safest”. That reminded me of black tulips in the old days. The price of black tulips were popped into stratesphere because they were deemed the best investment. There is really no economic basis for US treasury to go up. It is purely psychological and will thus be reined back by the gravity of economic laws. perhaps quite soon. It is unthinkable, but nevertheless must be thought through if we want to keep our money. In gold, oil, commodity, RMB? Any suggestions.

  • Posted by Twofish

    DJC: In the United States, it’s not the same when private Citicorp and AIG management receive a US taxpayer bailout and still demand that corporate executive receive bonuses.

    Well then, just say no. Personally, I think it was a great thing that Obama did by ordering that banks that get bailouts cap executive salaries, since that removes that issue from the table. Also you do have the same dynamics in Chinese state corporations. You want the shareholders and managers of state owned enterprises to be from different parts of the government.

    Investor: So they don’t care when these kinds of busts happen and a lot of people lose their jobs.

    They do care, because the Fed gets a lot of political pressure from elected officials to get the economy working. The problem with getting the Fed too close to elected officials is that you then run into the problem that elected official start effectively raiding the central bank.

    Investor: If the state owned bank goes bust, you can catch the culprits and you can re capitalize them more easily.

    It’s actually a lot harder than it sounds, because if you structure things the wrong way, the heads of the state owned banks are going to be too close to the politicians to touch. Also, catching people after something bad happens is a very inefficient way of running an economy.

    Investor: But the priority sectors will still get credit at a controlled interest rate.

    This is a big problem.

    Investor: Emerging markets have this kind of regulated banking system, and conceptually it’s a better system than having the economy dependent on a completely independent central bank and a cartel of large private sector banks.

    But in the actual implementation, it can work very badly (Mexico is a good case study). The thing that you want to avoid is too much or too little collusion between the owners and the officials, and this requires some extremely tricky balances.

    My observation is that tearing a system to the ground and starting up back up from scratch rarely improves things. Complex systems tend to evolve rather than be designed. Also, you can have a working state system of banks, you can have a non-working state system. You can have working and non-working private systems. You can also have systems that stop working or act in bad ways in response to different stresses (see Japan’s main banking system).

    Investor: Along with siphoning out most of the Lehman money, the GSEs were also looted and allowed to go under with no full guarantee, just to make sure that the rest of the world will experience a major credit crisis, so more profits can be made by the big four cartel.

    I’ve been trying to be patient with you, but I’m rapidly losing it. No one engineering this damn credit crisis. If you go around Wall Street, you will see people with 25-50% pay cuts and that’s assuming that you get to keep your job, since there have been 20-30% layoffs. What really stinks is if you work for a firm that did everything right, since you are still getting pay cuts and layoffs.

    This non-sense conspiracy theory of yours is total garbage, and suggesting that people around here engineered the crash on purpose is getting offensive considering how depressed and angry people are in finance right now.

    People are *NOT* making profits. People are *NOT* getting rich. The big bonuses you hear about work out to 25% pay cuts from last year and 50% pay cuts from the boom years. Most people in finance are *NOT* multi-millionaires or anything close to it.

    The only way that people in finance are going to make big money again is if the economy gets back on track.

  • Posted by DJC.

    Statistics indicate the US Economy is imploding into a Depression …

    From BBC News,

    Spending on durable goods, such as cars, furniture and domestic appliances, plunged 22.4% during the quarter, the biggest drop in this figure since 1987.

    The amount spent on food and clothing dropped 7.1%, the steepest quarterly decline since 1950.

    Overall U.S. exports fell by 19.7%.

    Meanwhile, business equipment and software spending was down 27.8%, with spending by homebuilders down by 23.65%.

  • Posted by DJC.

    Twofish: Personally, I think it was a great thing that Obama did by ordering that banks that get bailouts cap executive salaries, since that removes that issue from the table.

    DJC: It’s not enough that Citicorp and AIG executives only receive a reduced 500K bonus at US taxpayer expense, why aren’t the corporate executives that bankrupted their shareholder corporations fired from their jobs?

    Surprise, Robert Rubin is still on Citicorp’s payroll until he retires next September screwing the US taxpayer out of every last dollar.

  • Posted by Indian Investor

    @ Twofish: Here’s an example of how they’re making money:
    Outstanding mortgage loan $300,000. Outstanding MBS $300,000. Only $300,000 of cash was lent, though there are two securities outstanding.
    Market value of house crashes to $240,000. The banks show one loss of $60,000 on the direct “real loan”. The MBS is now trading at a “mark to market loss” of ANOTHER $60,000.
    The Fed gives them a loan to cover the “cash loss” of $60,000. Plus they get another NEW CREDIT, say $200,000, or whatever be the ‘fair value’ when the Fed takes the MBS and gives them some money.
    Now there’s actually $200,000 MORE credit in the system than before. Plus, the bank is going to get CAPITAL injection, as well.
    Everybody’s rolling in more money, all round. And where did the Fed get that *new money* from, to give credit? They got it from the US Treasury issuance. Treasury borrows from taxpayers, and gives the cash to the Fed, which lends it to the banks. Or directly, the Treasury buys some equity in the bank.
    While home prices fell around 20-30%, causing a lower cash loss to the banks; Fed gave them Extra credit of $2 trillion, plus a Treasury bailout of totally $700 billion, and there’s more coming along in the pipeline.
    Of course this money goes into the bank’s books and benefits the owners of the banks, and not downstream employees.

  • Posted by Indian Investor

    @ Twofish: Think of it this way. Suppose you lend me $300,000; then you issue a securitized bond to DJC for $300,000; so DJC has given you $300,000 from his side. Because of the mortgage crisis I default and you only get back $240,000 from selling the house. Now how much money is lost, actually?
    Only $60,000 is lost. But the banks used accounting tricks to claim tremendous losses. What the IMF estimation models, and the Bank of England financial stability reports, and the various Fed and US Treasury reports have done with the above situation is this:
    They’re saying, apart from $60,000 which was lost on the direct loan, ANOTHER $60,000 ‘mark to market loss’ was there on the securitized bond that you gave to DJC. So apart from you getting new credit, new capital etc to cover that $60,000; a second thing has happened.
    The Fed takes DJC’s bond (which you gave him) and tries to value it at ‘fair value’, say $200,000. The Fed takes money borrowed from taxpayers and gives $200,000 to DJC, and the Fed keeps the bond with them. Now, since you gave the bond to DJC, you owe the Fed $200,000. You earlier got $300,000 from DJc when you gave him the bond. You got back $240,000 from selling the house. DJC got $200,000 from the Fed in new credit.
    You or DJC might even get a new capital injection of ANOTHER $100,000.

    :-)

    Do you see now? There’s much more credit available now. Through elaborate accounting tricks a few trillions more have been given to the banks than they ever had before the crisis, or they ever actually lost due to it.

  • Posted by Indian Investor

    Twofish:I’ve been trying to be patient with you

    Either patience can give a big reward, or it can go as a waste. I think it’s a reward, in this case.

    I can assure you what I’m saying here is just a result of a great deal of independent thinking and reasoning by me. I’m saying there’s actually much more credit available with the remaining DIs now, than they ever had before the crisis started.

    And much of that credit is going to be lent to China. Perhaps some to India as well. Those exchanges have bottomed out. The remaining indices will bottom out very soon.

    As for the arrival of a great bull rally, that will take a further detailed study of geopolitics than I’ve managed to do so far.

  • Posted by stimulus?

    Pass or Fail?

    Why don’t the public get a preview of the highlights before a senate vote?

    Don’t the taxpayers have an opinion? I’m in the midwest and although the picture ain’t pretty i just wish Gov’t would stay out of the market.

    Friends in NY say it’s over. Where they going? Asia….

  • Posted by Twofish

    Investor: Of course this money goes into the bank’s books and benefits the owners of the banks, and not downstream employees.

    No it doesn’t. It benefits the creditors of the bank who would be out of money if the banks went under. It’s only after the banks creditors get paid that the owners make anything.

    Now who are these bank creditors?

    You got a checking account?

    Investor: Suppose you lend me $300,000; then you issue a securitized bond to DJC for $300,000; so DJC has given you $300,000 from his side. Because of the mortgage crisis I default and you only get back $240,000 from selling the house. Now how much money is lost, actually?

    In your example US$120,000 and probably more. I lose $60,000, DJC loses $60,000. You’ve just illustrated how in a leveraged system that a loss in one place gets transmitted throughout the system. You can reduce losses by having capital reserves.

    Investor: The Fed takes DJC’s bond (which you gave him) and tries to value it at ‘fair value’, say $200,000. The Fed takes money borrowed from taxpayers and gives $200,000 to DJC, and the Fed keeps the bond with them. Now, since you gave the bond to DJC, you owe the Fed $200,000.

    No. I still owe the Fed $300,000, unless the Fed makes a deal to write down the bond.

    Investor: You earlier got $300,000 from DJc when you gave him the bond.

    Which I’ve paid the home owner.

    Investor: You got back $240,000 from selling the house.

    Which I immediately have to give to the Fed.

    Investor: DJC got $200,000 from the Fed in new credit.

    Which is bad since he paid me $300,000 to begin with.

    Investor: Do you see now? There’s much more credit available now.

    No there isn’t. I’m out $60,000. DJC is out $100,000. If we have reserves to cover that, then fine. If we don’t then our creditors get hosed, which means you….

    Investor: Through elaborate accounting tricks a few trillions more have been given to the banks than they ever had before the crisis, or they ever actually lost due to it.

    Nope. The basic problem is that people were paying for things with houses which weren’t worth as much as people thought they were. When housing prices collapse, the chain fell apart.

    I just have to say this over and over again until you get it. No one is benefiting from this. The only people that got something were people who cashed out last year before the crisis happened, and even they have lost much of the value of their holdings becomes of the crash.

  • Posted by bsetser

    I am a little disappointed by how far off topic the discussion went; this was a US economy based post — not a China or a geopolitical based post. The discussion spun off topic rather rapidly this afternoon (I was tied up, so i couldn’t immediately respond). I took down some off topic posts. i don’t like doing this but i will as a deterrent …

    On substance, intergovernmental holdings are debts that aren’t settled in the market. so if you are worried about the treasury’s ability to finance itself in the market, they aren’t relevant (there is a small sense in which this isn’t true, namely one way the government might meet its obligations to the trust fund is by selling debt to the public as the trust fund’s obligations come true, so the size of the trust fund could be an indicator of future market debt). But in a macro sense, social security payroll taxes are gonna be used to fund the government no matter what the interest rate is …

    there also isn’t much evidence that unfunded entitlement promises have much impact on market rates. the best evidence is that the prescription drug benefit had no measurable impact.

    the cost of the bailout of the banks could push the debt stock up, and large fiscal deficits compound. On the other hand, a constant nominal debt stock and a deflating economy can also quickly generate a big rise in debt to GDP, especially if there is an underlying structural deficit (which there is, at least until the bush tax cuts expire and probably thereafter). that also is a context that generates a very large bank bailout bill incidentally, so debt to GDP rises then too.

    I would prefer to take my chances with a bit of spending now to get the economy growing in nominal terms (indirectly reducting the bill for the bank bailout) and hope that the economy’s nominal expansion helps bring down the debt to GDP ratio after an initial rise. That is especially the case in a context where the current account deficit is falling. I would be much more worried if I thought the CAD was going to be 6-7% of GDP in 09 rather than 3-4% of GDP …

  • Posted by Twofish

    Investor: I’m saying there’s actually much more credit available with the remaining DIs now, than they ever had before the crisis started.

    And I’m saying that you are just plain totally wrong about this. Your example only makes sense if people forgive loans, which they won’t do lightly, and can’t do if they owe people money.

    If a $300,000 note gets give to the Fed, I still owe the Fed $300,000. I still owe them that even if the Fed bought the note for $1, and even if I don’t have $300,000. If the Fed forgives the loan then fine, but the Fed has to then make up for the loss.

  • Posted by Glen M

    Of course US industrial production is going down. With or without the current crisis it was bound to happen. Even without China’s manipulated currency, US industries cannot overcome the other mercantilist practices.

    Since its acceptance into the WTO in 2001, China has been guilty of a number of impermissible trade practices, including the deliberate downward manipulation of its currency contrary to both WTO and IMF rules. But in the steel and iron sectors, its practices, however superficially shrewd, are clearly illegal.

    China accomplishes preferential treatment for those industries through outlawed export restrictions. These restrictions have a negative impact not only on steel produced in the U.S. and other countries, including presumably Canada, but on a wide range of products, such as chemicals, ceramics, semiconductor chips, aircraft, petroleum products and fibre-optic cables, to name but a few. This is all documented in the December 2008 U.S. trade representatives (USTR) report to Congress on China’s WTO behaviour.

    One of steel’s principal raw materials is coking coal, of which China is the world’s major supplier. China currently limits exports of coke to 12 million tons per year and additionally imposes 40 per cent duties on coke exports. In 2007, China produced 350 million tons of coke, all but 12 million of which was sold in its domestic market. As the USTR reports:

    “The effects of these export restrictions on pricing have been dramatic. In 2008, the world price for coke reached as high as $750 per ton at the same time that China’s domestic price was $350 per ton. A $400 per ton price difference creates a huge competitive advantage for China’s downstream steel producers over their foreign counterparts, as coke represents about one-third of the input costs for integrated steel producers.”

    http://www.thestar.com/comment/article/583158

  • Posted by Twofish

    bsetser: . But in a macro sense, social security payroll taxes are gonna be used to fund the government no matter what the interest rate is.

    The other thing is that eye popping numbers about future liabilities in social security and medicare assume that taxes won’t be raised and benefits won’t be cut. If you make modest tax increases and benefit cuts, then the numbers work out.

    The problem is that no politician can come out and say taxes will be raised and benefits cut so when you have politicians present numbers, they have to use numbers that are based on these assumptions, whereas the bond market assumes that there will be tax increases and benefit cuts.

    bsetser: The cost of the bailout of the banks could push the debt stock up, and large fiscal deficits compound.

    The problem is what are the other options. If the government just let the banks fail, then it is on the hook for massive amounts of depositor insurance and other debts incurred to keep the system from failing.

    The other alternative is “close your eyes and pretend there is no problem.” This means that you keep the bad assets on the books at unrealistic valuations and rollover bad loans. As long as people pay interest, there is no immediate problem. The trouble with this approach is that you then starve the economy of new lending, which is what happened with Japan.

    bsetser: I would prefer to take my chances with a bit of spending now to get the economy growing in nominal terms (indirectly reducting the bill for the bank bailout) and hope that the economy’s nominal expansion helps bring down the debt to GDP ratio after an initial rise.

    My concern is unemployment (mine really). If may turn out that this stimulus package won’t work, but if I end up sleeping on park benches under newspapers, and selling apples on street corners next to the soup kitchen, I can at least be comforted by the thought that we tried everything and it really was hopeless.

    As far as finance goes, I do understand the public’s anger at investment bankers, but people have to understand that no one in Wall Street is smoking cigars with $100 bills and there is a lot of anger and depression here as people here wait for layoff notices just like everywhere else in America.

    It is very possible that there are and were too many people working in finance and that the layoffs and pay cuts are necessary to shrink the industry. You really have to ask if Wall Street is the best place for a physics Ph.D. to end up, but I ended up here for lack of any decent jobs involving physics skills elsewhere. Sad really.

    I’d be in much less bad mood, if they people that think that finance is evil and parasitic could point out what I should do instead. The basic problem is that in order to restructure an economy you need large amounts of money and credit, and to deal with money and credit, that involves creating finance jobs.

    I’m also pretty shock at how few people know what a bank does. This wouldn’t bother me as much, except for the fact that people end up supporting plans and proposals that seem to me to be wildly self-destructive, and that wouldn’t bother me as much as the fact that in being self-destructive, it’s dragging me down with them.

  • Posted by Cedric Regula

    Welcome back Brad

    I was doing other stuff today too, and when I finally checked into the blog I was also shocked at the posts here. When the cat’s away, the mice will play.

    But I did come across one thing in the US economy today that I’d like to report. I bought 85% hamburger in a family pack for $1.59/lb. It was a sale price and the sale ends Wednesday, so maybe we will be out of the deflationary woods by then. Lets keep our fingers crossed.

    Other news is the quarterly refunding of treasuries is coming up next week. You mentioned that you would like to see the US spend a bit of money (2 Trillion, how droll). So next week is when we get to see for real how we start getting a bit of funding. Just suggesting that as maybe a blog subject for maybe late next week.

    Also came across a short, recent Roubini post on if we can monetize and stimulate ourselves from becoming another Japan. He lists the obvious reservations as well. I think if we can re-employ bankers as construction workers, or cattle ranchers and have them short input commodities, it may make some sense, but otherwise it’s just GDP manipulation.

    http://www.rgemonitor.com/blog/roubini/255398/is_the_us_a_japan_2_the_return_of_japans_free_fallin_stag-deflation_and_the_risks_of_a_us_l-shaped_near_depression

  • Posted by jim

    stimulus passed! thoughts?

    lots of credits for consumption. i wonder if Obama believes america can consume itself out of a crisis?

    -30 B infostructure spending?
    -Limited investment in Alternative energy vs. China’s latest plan…
    -credits for auto purchase? more money going to japan.
    -stimulus to buy home? don’t americans have debts?

    interesting plan Obama has lined up. I just wonder how he’s going to come back and ask for another 800B in 6-12 months.

    hmmmmmmmmmm….

    and Geithner on banking plan?

    Mr. Geithner please get on a call and speak with the guys who invented/sold and packaged CDO’s, MBS, and CDS. Please realize that you will need much much more than 1 Trillion to re-capitalize the banks.

    I would post contacts for Mr. Geithner if thats what it takes for him to realize how deeply or perhaps insolvent the banks balance sheets are. Mr. Geither, please realize we’re looking at a hole between 3-8 Trillion dollars.

    The 350B remainder of TARP is…well… chump change for what we need. 350B will cover holes for a month maybe two…

    feel free to add thoughts.

  • Posted by jim

    also a quick note that Protectionism is still out-lined and clear (although a play on words) in the current/revised bill:

    BUY AMERICAN
    6 SEC. 1604. USE OF AMERICAN IRON, STEEL, AND
    7 MANUFACTURED GOODS. (a) None of the funds appro8
    priated or otherwise made available by this Act may be
    9 used for a project for the construction, alteration, mainte10
    nance, or repair of a public building or public work unless
    11 all of the iron, steel, and manufactured goods used in the
    12 project are produced in the United States.
    13 (b) Subsection (a) shall not apply in any case in
    14 which the head of the Federal department or agency in15
    volved finds that—
    16 (1) applying subsection (a) would be incon17
    sistent with the public interest;
    18 (2) iron, steel, and the relevant manufactured
    19 goods are not produced in the United States if suffi20
    cient and reasonably available quantities and of a
    21 satisfactory quality; or
    22 (3) inclusion of iron, steel, and manufactured
    23 goods produced in the United States will increase
    24 the cost of the overall project by more than 25 per25
    cent.
    VerDate Nov 24 2008 02:17 Jan 31, 2009 Jkt 079200 PO 00000 Frm 00429 Fmt 6654 Sfmt 6201 E:\BILLS\H1.AS H1 smartinez on PROD1PC64 with BILLS
    430
    AMDT. NO. 98
    1 (c) If the head of a Federal department or agency
    2 determines that it is necessary to waive the application
    3 of subsection (a) based on a finding under subsection (b),
    4 the head of the department or agency shall publish in the
    5 Federal Register a detailed written jurisdiction as to why
    6 the provision is being waived.
    7 (d) In this section, the terms ‘‘public building’’ and
    8 ‘‘public work’’ have the meanings given such terms in sec9
    tion 1 of the Buy American Act (41 U.S.C. 10c) and in10
    clude airports, bridges, canals, dams, dikes, pipelines, rail11
    roads, multiline mass transit systems, roads, tunnels, har12
    bors, and piers.
    13 CERTIFICATION

  • Posted by Indian Investor

    Jim: I would post contacts for Mr. Geithner if thats what it takes for him to realize how deeply or perhaps insolvent the banks balance sheets are. Mr. Geither, please realize we’re looking at a hole between 3-8 Trillion dollars.

    All these are just accounting entries and not real cash. You can’t buy Treasuries without real cash. The Treasury and Fed are taking real cash from the public and giving the public real Treasury bonds. Then they’re lending or buying stocks in these banks with that real cash.

    For the same mortgage loan, the banks have set up a series of derived securities and put all those derived securities on their balance sheet.

    While people never defaulted on loans for trillions, the banks are claiming artificial losses of trillions in “mark to market” losses.

    Once the TARP series is up, the banks will have much more money, this time real cash, on their books that was borrowed by the taxpayers. They’re going to lend that money wherever it’s most profitable to lend, viz. in China.

    US entrepreneurs and soon going to see a big influx of equity investments; hang on till the TARP series gets executed.

  • Posted by Indian Investor

    The banks can’t hope to be bailed out for all the “holes” worth trillions in all the “mark to market” losses which they’ve constructed up with just electronic accounting entries. After the TARP series is over, the rules will be changed and the mark to market losses will just disappear in thin air.
    The money given from the Treasury borrowing to fill the holes in the bank balance sheets will be lent out to fill potholes in Indian roads, and earn real interest on that.

  • Posted by Indian Investor

    Re Buy American: The US isn’t a land of milk and honey in the vicinity of Pittsburgh, PA and Birmingham, Alabama. In Pittsburgh you get people manufacturing *steel*, as if they were in a third world country.
    The US Steel Corporation is the main player in the Steel industry in the United States.
    JP Morgan founded the US Steel Corporation in 1901 and it was the largest ever business enterprise at the time of its founding.

  • Posted by Off the boil

    I think Twofish is confused with the whole securitization process like Ken Lewis.

    Also for someone to think that there is no conspiracy in this crisis is very naive.. (if there is no conspiracy, why would BoFA buy Merill ? For the retail RIA business ? lol)

  • Posted by Off the boil

    If there is no crisis why is BAILOUTS and TARPS so stupidly designed and executed.

    I believe its a calculated ploy to cut the rates to Zero …to make foreign holdings of US assets (MBS,ABS, TBills) worthless ..i.e make your debt worthless .

    There could also be a conspiracy to make USD worthless. For a country running massive deficts..its a nice incentive to devalue their currencies. USD will be next shoe to drop (may be triggered by an aution failure or something of that sort).

    I really love this game. I pity all those who have investments other than CASH at HOME (under the mattress).

  • Posted by Twofish

    jim: also a quick note that Protectionism is still out-lined and clear (although a play on words) in the current/revised bill

    No, it really doesn’t. All that section does create an extra sheet of paper that someone has to sign in order to buy non-American steel. I expect that there will be a form that says “I, agency head, waive the requirements of this section because to do otherwise would violate treaty commitments under WTO and GATT and hence would be against the public interest.”

    I should point out that this is why lawyers and lobbyists get highly paid. The entire result of this section would be different if someone changed line 21 from “or” to “and” and I’m pretty sure that there was a draft of the bill that at one point had “and”.

    Going through multiple drafts of an 800 page bill and fighting over a single word is why there are so many people in Washington. It’s like going over a 150 page response to committee questions and looking for the one sentence that will cause a diplomatic incident, or going over someone’s tax returns for the last ten years making sure that they didn’t miss something.

  • Posted by Twofish

    jim: Mr. Geithner please get on a call and speak with the guys who invented/sold and packaged CDO’s, MBS, and CDS.

    You do realize that some of them happen to post online in blogs like this one.

    It’s actually really simple. What do we talk about when we talk about a “price” of an MBS. There are two different numbers a) the price you can get if you sell it now and b) the money that you will eventually get from the note. The problem with b) is that it depends on what fraction of people will be able to pay their mortgages. Normally a) is something close to b), but right now people are assuming that the world is going to explode, and so the market price for most MBS is extremely low, because people are thinking about the worst case scenarios.

    If it turns out that we are entering a second great depression, then most of the notes are going to be worthless.

    If it turns out that we have a deep and nasty recession, then most of the notes are going to be good, and someone is going to make several billion dollars buying up cheap MBS’s now and then reselling them when the world doesn’t end. All you have to do to make a huge amount of money in mortgage securities is a) have cash now and b) have the world not end.

    The problem with predicting the future is that the future depends on human action and your choices change the future. The fact that human beings have something called “free will” means that there are limits to which you can value securities.

    jim: Please realize that you will need much much more than 1 Trillion to re-capitalize the banks.

    No. You may not. It really depends on how the economy goes. If the economy starts picking up again, then people will pay their mortgages, credit cards, and car loans, and the amount of money you will need to recapitalize the banks is tiny. If you can get unemployment down to 5%, you may not need any money at all.

    If we have 20% unemployment, then the banks are toast and we are all in deep trouble. The danger is that things feed on themselves. Bad banks -> no lending -> bad economy -> bad banks.

    All the stuff about derivatives at this point is just a side show. The big question on which the fate of the US economy depends on is whether or not people will be able to pay their mortgages and credit cards this year. The problem with subprimes is manageable. It’s the spark that set off the forest fire, but now the forest is burning, the spark doesn’t matter much.

    The problem now is that all of these prime borrowers are losing their jobs, and if you get into a situation where people stop paying their loans because they don’t have jobs, and than people have no jobs because banks are busted because they have all these bad loans.

  • Posted by Twofish

    Investor: All these are just accounting entries and not real cash. You can’t buy Treasuries without real cash.

    All cash is an accounting entry. At some level, there is nothing “real” about cash. The only reason that money has any value is that people are under this mass delusion that money has any value.

    Investor: While people never defaulted on loans for trillions, the banks are claiming artificial losses of trillions in “mark to market” losses.

    That’s because people *could* be defaulting by the trillions. If you look at the market prices for mortgage securities right now, people are assuming that the world is going to end, and that we are going to have a second great depression. The reason people are assuming this is that it is *possible* that they are right. One thing that is important is to make it clear to everyone that the world is not going to end.

    One other reason people assume this is that there are people that have lost tens of billions in cash money assuming “things can’t get any worse” when they did. This makes the situation worse because when people see people losing money betting “things can’t get worse” it makes people less likely to invest.

    Also the difference between amateurs and professionals is that amateur investors assume that you can predict the future, whereas professionals deal with the fact that you can’t.

  • Posted by Ian R. Campbell

    That U.S. industrial production is falling is hardly a surprise given recent manufacturing job losses. Given the way the charts in the article are configured I don’t think they include January 2009 numbers. If true, given yesterday’s reported U.S. manufacturing job losses were 207,000 (of approximately 600,000 total job losses – click here – U.S. industrial production almost certainly dropped further in January.

    I summarized this article in my blog, http://www.stockresearchportalblog.com, this morning. You might want to visit the blog for a compendium of economic, mining and oil & gas news. Each day I summarize what and link articles I think are the ‘best of the best’ – and Brad Setser certainly qualifies.

  • Posted by Indian Investor

    Twofish:There are two different numbers a) the price you can get if you sell it now and b) the money that you will eventually get from the note.

    ME: Only b) matters. If somebody is paying a price a) to buy now, they have a view as to what b) is ultimately going to be.

    Losses in a) are counted in reduced recoveries as result of defaults. The IMF/Fed/BOE methodology adds up reductions in b) as “mark to market loss” and counts that amount as well in ‘total losses and write downs due to the global economic crisis’.

    b) is just an artificial number representing a market assessment of a). a) is what is owed in real cash. Counting reductions in market value of b) and adding up a) as well cleverly creates an impression of tremendous losses, justifying equally breathtaking, staggering, humongous bailouts.

    The new credit from the bailouts thus means that there’s much *more* credit available in the system than before the crisis started.

  • Posted by Twofish

    Off the boil: I think Twofish is confused with the whole securitization process like Ken Lewis.

    I defer to your greater expertise then. My only claim to expertise in investment banking and securitization is to have actually had at one point in my life worked in one next to people that do it.

    Off the boil: Also for someone to think that there is no conspiracy in this crisis is very naive.. (if there is no conspiracy, why would BoFA buy Merill ? For the retail RIA business ? lol)

    I see no conspiracy. Breathtakingly large amounts of stupidity and miscalculation, yes, but no conspiracy.

  • Posted by Twofish

    Investor: Only b) matters. If somebody is paying a price a) to buy now, they have a view as to what b) is ultimately going to be.

    And that view is likely to be wrong. When times are good, people vastly underestimate the probability of defaults. When times are bad, people vastly overestimate them. Also, risk aversion plays a big factor. Personally, I think that mortgage securities are vastly undervalued. Does that mean I’m going to out money to buy them? HAAA!!!!

    Investor: b) is just an artificial number representing a market assessment of a). a) is what is owed in real cash. Counting reductions in market value of b) and adding up a) as well cleverly creates an impression of tremendous losses, justifying equally breathtaking, staggering, humongous bailouts.

    But there is a good reason for this. Suppose you have a million depositors outside your bank wanting their money *NOW*. The fact that you are likely to get a large amount of money for your loans in the future is completely irrelevant. You have to sell your loans and securities *NOW* to give cash to the angry mob at the teller window, and that means getting whatever price you can get. If everyone else is selling, you have a really big problem. If you can’t get enough cash to satisfy the angry mob at the teller window, then you have a really, really, really big problem.

    Banks are hoarding cash right now, because no one knows what the situation is going to be like in a year, and people want to be able to deal with the angry mob outside the teller window. Everyone realizes that this is a bad thing for everyone to do, because if no one loans money, this is going to cause a bad economy which makes everyone’s situation worse.

    Investor: The new credit from the bailouts thus means that there’s much *more* credit available in the system than before the crisis started.

    No there isn’t. People are taking money, and putting it into mattresses and bank vaults. If consumers are hoarding cash and stuffing mattresses, why is it unreasonable to expect banks to do the same thing for the same reasons?

    People have been pumping money into the system, but that money isn’t being loaned out, and if you have money just sitting in a vault, then there is no credit expansion. And the initial bailout wasn’t to expand credit, it was to calm the angry mob outside the teller window.

    When people look in a bank, and see piles of cash in the bank vault, and makes them much less likely to go into the bank and demand all of their money, which is the situation we were in in October. We got past that, and we now have a different problem.

  • Posted by Indian Investor

    @Twofish: Perhaps you’re so mired in stochastic calculus that you’ve forgotten more basic things. This is the same as Brad Setser being mired in current account deficits that he doesn’t realize that the US Govt. just borrows wagonloads of money from around the world and splurges it on Lockheed Martin.etc deadly weapons contracts.
    First of all, if you deposit $1100 in a bank, they can’t lend out $1100 *10 = $11,000 in the market. They have to keep $100 real cash in your account and lend out $1000 in the market.
    The leverage level improves when multiple banks/IBanks lend and borrow amongst one another and follow the same reserve ratio.
    How securitization works is that when Bank A lends out $300,000 to somebody, they can issue a bond against that and get back $300,000 from someone else. So whoever borrowed from Bank A, when they pay back to Bank A, Bank A in turn pays to the bondholder. The borrower defaults and Bank A loses a certain amount.Ordinarily Bank A would have taken that lost amount from the borrower and given it to the bondholder. \
    In the accounting entries you’re counting the same amount as a loss for Bank A. And again you’re counting the same amount as a loss for the bondholder as well. Essentially this is double counting of losses.
    In the real world you have a long series of derived securities and bonds. They’ve come together to multiple-count these losses and give bailouts against them.
    Which is why the question of the world ending, etc doesn’t arise. The banks now have more money than they ever started with before the crisis.
    If I’m missing something please let me know.

  • Posted by Indian Investor

    Twofish: When times are good, people vastly underestimate the probability of defaults. When times are bad, people vastly overestimate them. Also, risk aversion plays a big factor.

    Let’s do the example correctly again. Suppose you lend me $300,000 against a home. Then you issue a bond to DJC. DJC gives you $300,000 for the bond. When I pay you every month, you give the payment to DJC for the bond he’s holding. I’m the borrower, you’re the bank and DJC is the whole fixed income securities market.

    Suppose I default and you only get back $240,000; my point is that the total loss here is only $60,000. Nothing more than that. Think about this carefully.

    Suppose I had paid you back properly, you would have taken that $60,000 and given it to DJC. Now you didn’t get it, so you won’t pay DJC either.

    In the accounting you see that you’ve lost $60,000, and DJC also lost $60,000 which he would have got from your securitized bond. This is incorrect totaling of the losses.

    If you’ve made a write down of $60,000 in your mortgage loan receivable; you also have to write down your liability to DJC on the derived mortgage backed bond. Suppose you’re not writing down your liability to DJC. This means that DJC has a good balance sheet. He doesn’t have a loss because you’re still owing that $60,000 to him.

    What the banks have done in practice is that they’ve written down the mortgage loan receivable as a loss. But they’ve kept their liability on the securitized mortgage bonds intact. So their balance sheet shows lower assets than liabilities, and they’re saying “we’re insolvent, give us a TARP.”

    Now look at what the bondholders have done in practice. They’re still holding the receivables from their mortgage backed bonds.But they’ve marked their bond value to market. They’re saying we’re supposed to get that whole $300,000 back, but we’re not getting $60,000 because of the bank’s problems. This means the market value of the bond is either $240,000 or less and we have a mark to market loss of $60,000 or more. So the bond holders have written down their assets based on mark to market while they’re showing their liabilities and capital as before. This means the bondholders can also say “look at our balance sheet, we’re insolvent, give us some TARP.”

    The whole bailout sequence involved the Fed giving out more than $2 trillion in new loans, and another $700 billion in new capital injections, in response to the above accounting tricks. That much money was never lost; so now there much more credit in the system than there ever was before.

  • Posted by Twofish

    Investor: How securitization works is that when Bank A lends out $300,000 to somebody, they can issue a bond against that and get back $300,000 from someone else. So whoever borrowed from Bank A, when they pay back to Bank A, Bank A in turn pays to the bondholder.

    No. That’s not how it works at all. When a bank securitizes a mortgage, the bank is now out of the loop. The money goes directly from the borrower to the bond holder, and doesn’t pass through the bank that made the initial loan.

    If the bank kept the cash, and put it into a vault, then if the homeowner defaults, it’s not the bank’s problem. However, banks can get into problems by….

    1) the bank doesn’t keep the cash in a vault but rather loans out the cash to another home owner. This is what got WaMu and mortgage brokers in trouble…. or

    2) the bank offers the bondholder a guarantee to pay the bond in case of default by the home owner. This is what got Citigroup in trouble….. or

    3) instead of selling the bond to a third party, the bank keeps the security. What would a bank hold securities rather than loans? Because 1) securities can be counted as required capital and 2) securities can be sold quickly. This is what got Lehman and lots of German banks in trouble…..

    Investor: The borrower defaults and Bank A loses a certain amount.

    If the bank sells the loan to a third party and gets cash, then the bank loses nothing if the borrower defaults. The trouble is that the bank is not going to just keep the cash, they are going to make another loan with it. It’s a game of musical chairs that collapses when the music stops.

    Investor: Which is why the question of the world ending, etc doesn’t arise. The banks now have more money than they ever started with before the crisis.

    No they don’t. They just don’t.

  • Posted by Kafka

    Mr. Setser, I love your math on funds flow and wish someone like you would explain with math how the stimulus is supposed to work and assign probabilities to the potential outcomes. Otherwise, I am just left to think the whole thing is some sort of ponzi scheme to benefit the Politicos and their friends. Especially when I hear things like, this is your last chance. If you don’t get in now you are gonna miss out. Not everyone has this opportunity but if you act now, much money is gonna be made. I am not going to tell you my secret formula but it works, I promise. Is this Madoff or Obama talking? Is this Paulson talking about TARP 1 or Obama talking about Stimulus? Does anyone actually understand what Obama is selling? Has anyone done any math? How can people support something they don’t understand based on the words of Politicos or their Shills? Does anyone understand the multiplier effect, how it is actually computed, where the numbers come from, which derivative of some estimated number is being used to bolster the hypothesis? What about the Lucas Critique, has it been factored into the analysis and if so how? All the people purveying the stimulus have been dead wrong so far yet they are the ones being relied upon to fix everything? Now Rush is in the act with some ill defined unquantifiable analysis which is becoming the mantra of the conservatives, is everyone just an idiot? Why anyone listens to Rush the junkie is beyond me especially since like most conservatives that which he rails against most, he is a purveyor of. If most Americans were honest they would admit their stupidity, admit they are sheep, admit they are relying on people who have not only been wrong the whole time about his mess but now are hoping for the best. Of course, Freud or Einstein would describe this behavior as fantasy or lunacy. My point, how can Americans be so passionate about something they don’t understand and which is being purveyed by those who have been wrong every step of the way (not to mention the purveyors been have lying to them their entire lives)? Madoff truly had the psyche of man figured out which is incredible as the scams have been going on for centuries. Most Americans are truly rats in a maze.

  • Posted by Twofish

    Investor: Let’s do the example correctly again. Suppose you lend me $300,000 against a home. Then you issue a bond to DJC. DJC gives you $300,000 for the bond. When I pay you every month, you give the payment to DJC for the bond he’s holding. I’m the borrower, you’re the bank and DJC is the whole fixed income securities market.

    No. There are two different roles for banks. Mortgage originators and mortgage servicers. Once the originator sells the loan, they are out of the loop. When you mail a mortgage payment to a bank chances are that you are mailing it to a mortgage servicer who just forwards the payments to the bondholders.

    Investor: In the accounting you see that you’ve lost $60,000, and DJC also lost $60,000 which he would have got from your securitized bond. This is incorrect totaling of the losses.

    In the example, you gave, I lost nothing, because I’m just forwarding the payments to bond holders, but the example is not an accurate explanation for what is going on. What usually happens is that I take the money that I get from securitizing the loan and make another loan.

    Investor: If you’ve made a write down of $60,000 in your mortgage loan receivable; you also have to write down your liability to DJC on the derived mortgage backed bond.

    It depends. If I’m Wells-Fargo, and I just sold the mortgages to someone else, then I don’t write down anything. It’s not my problem, because I’m out of the loop. If I’m Lehman or Freddie, then I have a big problem because I promised DJC $300,000, and if my assets are only $240,000, then I’m dead.

    This is why Wells-Fargo is still in business whereas Lehman is not.

    There are lots of ways to lose money, but lets just focus on one……

    Investor: What the banks have done in practice is that they’ve written down the mortgage loan receivable as a loss. But they’ve kept their liability on the securitized mortgage bonds intact.

    If you have an investment bank or GSE that takes loans and issues a new bond, then yes this is correct accounting, because they still owe $300,000 even though they can get $240,000.

    Investor: Now look at what the bondholders have done in practice. They’re still holding the receivables from their mortgage backed bonds.But they’ve marked their bond value to market. They’re saying we’re supposed to get that whole $300,000 back, but we’re not getting $60,000 because of the bank’s problems.

    Which is also correct accounting. Even though you are owed $300,000, you can only report $240,000 because that is how much money you can get if you sell the bond.

    In practice the situation is worse because the mark to market values on a lot these bonds are worse than the housing losses. For example, it is common now to have a $300,000 bond on a $240,000 house that now has a market value of $150,000. In that situation, MTM account requires you to mark your bond at $150,000.

    Investor: The whole bailout sequence involved the Fed giving out more than $2 trillion in new loans, and another $700 billion in new capital injections, in response to the above accounting tricks.

    There’s no trick, since these are all real losses.

    The investment bank has to report a loss because they are still on the hook for $300,000 even if their assets are impaired. The bond holders have to report a loss because even though they are owed $300,000 on a $240,000 house, they can only sell the bond for $150,000.

    What’s happened in the end is that you have a massive contraction in the financial system that is larger than the initial losses. You also have an interesting problem here, because it’s not clear at all what the Fed should pay for the mortgage bonds. $300,000? $240,000? $150,000?

    Investor: That much money was never lost; so now there much more credit in the system than there ever was before.

    This is false. What has happened is that you have this cascading effect in which initial losses causes massive losses in credit which brings the entire economy to its knees. The fact that the Fed has pumped in the amount of money that it has before has just stabilized the system and prevented everything from breaking down completely.

    The basic misconception that you have (which a lot of people have) is the idea that money is something other than account entries, and that when the accounting entries change, there something “real” that doesn’t.

  • Posted by Indian Investor

    @ Twofish:
    Ok, I’ll accept your mechanics and re do the example:
    $300,000 is owed from me on the home loan. You’re saying that as I pay EMIs, the servicer directly sends the money to DJC, who’s the bondholder. Twofish, as the lender bank is out of this loop since the bond has been sold to DJC for cash. (I think this is your understanding of Wells Fargo model in your post above).

    Now I default and the home is foreclosed and re sold for $240,000. Even in this mechanics, the total loss is only $60,000 for the system. This is because now DJC won’t be getting the $60,000 so his bond is worth $240,000, or less. Twofish has no loss in this scenario.

    What you pointed out is that Twofish might have taken the $300,000 from DJC and lent it out once again to another borrower. As long as Twofish has been following the model of re selling the mortgage loan as a securitized bond, there is no loss to Twofish.

    The other model you point out is that the bank(the Lehman example in your post) has made out a guarantee to pay $300,000 to DJC in case of my default. In this situation The bank has a loss of $60,000 because of the guarantee. DJC shouldn’t have a loss, because DJC has to get the money from the bank.

    Now you see why the mysterious Lehman collapse is so important. The total loss to the system, irrespective of how the actual mechanics of securitization work, is the same as the reduced value of the recovery from borrowers at the retail end. But if an important institution collapses, it creates additional losses, and those losses spread out around the world due to the interconnections. This was used to trigger the 2008 Credit Pandemonium. If money could be siphoned out from even one systemically important institution, and then it goes and files bankruptcy, you have created a global crunch due to the ripple effects.

  • Posted by Kafka

    Don’t forget the CDS dudes also should be taking a hit not withstanding the Fed artificial manipulation of rates to avoid the hits. Are you listening Jamie, I know u b cooking the books and I hope JPM goes over 30 again on the news of the Geithner’s latest theft plan on Monday because we will be shorting you again, thanks for all the dough so far dude, Jamie you can’t hide all your bad credit card receivables or $100 Trillion CDS exposure forever (even though you got a good deal on the Bear, AIG and LEH fiasco from the Feds).

  • Posted by Twofish

    Investor: The bank has a loss of $60,000 because of the guarantee. DJC shouldn’t have a loss, because DJC has to get the money from the bank.

    But he does, because people don’t trust the guarantee. Now if it was the Federal government giving the guarantee, then we have a different situation…..

    You are assuming the bank stays alive, but people are looking at the fact that the bank has lost $60,000, and are wondering about that….. Also, the bank has lost $60,000 now. The note isn’t paid off for another 15 years. Maybe next year, the bank will have lost $100,000 and be out of business.

    Investor: The total loss to the system, irrespective of how the actual mechanics of securitization work, is the same as the reduced value of the recovery from borrowers at the retail end.

    No it’s not, it’s much larger. Once people stop trusting each other, you end up with huge losses.

    Investor: But if an important institution collapses, it creates additional losses, and those losses spread out around the world due to the interconnections.

    Maybe. But if you really want find someone to blame for the Lehman collapse, don’t blame the “evil conspiracy.” Blame the people on this board. Suppose, the Fed spend $50 billion to bail out Lehman, and suppose it worked and nothing bad happened. Everyone would hail Bernake and Paulson as heros that saved the financial system, right? HA!!!

    People would be screaming at them for having a totally unnecessary bailout and wasting taxpayers money for rich corporate fat cats. I don’t think politically Lehman was salvageable.

  • Posted by Indian Investor

    @ Kafka:
    I would sincerely advice you not to bet against Jamie. You’ll lose heavily if you go short on any big banking stock now; post the Monday Geithner announcement the banking stocks will rally much more.
    You might want to avoid subscribing to US Govt. bonds, but don’t make any bets against the success of the US Treasury auctions. There isn’t going to be any repeat of the German auction failure in the US.
    How the stimulus works overall is less important. As far as multipliers are concerned plenty of Nobel prize winners are debating multipliers and they aren’t agreed on multiplier effects of tax cuts versus govt. public goods spending, etc. which looks like a basic issue to the non economist. If you ask a political question about multipliers you’ll get a political answer depending on who you ask.
    The most important part is how the banking bailouts work. The Treasury issuance provides dollars. The dollars go onto the bank’s books as either new credit from the Fed, or as a Treasury capital injection.
    Some part of the Fed credit is against collateral from the banks. Let’s not discuss too much on the accounting entries for this to happen.
    If you bet either against Treasury issuance, or against the Geithner bank bailouts, you’re going to lose heavily, for sure.

  • Posted by Twofish

    But the thing it consider is that we pretty much know what is going to happen if we *don’t* do anything, which is that the bad cycle will continue until there is nothing left.

    Kafka: Otherwise, I am just left to think the whole thing is some sort of ponzi scheme to benefit the Politicos and their friends.

    The main goal of people with money and power is to keep and extend their money and power. However, in this situation, those interests are roughly aligned with the general public. Not totally aligned, but roughly aligned. If the ship sinks, everyone is going to get soaked, and the ship is sinking.

    I’m won’t be too surprised once I get off the lifeboat to find my wallet missing, but if I make it to dry land, I really won’t care.

    Kafka: Does anyone actually understand what Obama is selling?

    I don’t think that Obama, Bernanke, Geithner, or any human being fully understands what is going on. But there are some basics that people are operating against.

    What is happening is that people are looking at US 1930-1932 and Japan 1990, and saying my God, we don’t want this to happen again. So a lot of what people are doing is saying well, in 1930 they went up, so we need to go down, they went left so we need to go right.

    Whether this will work or not? I don’t know. I hope for my sake that it does, and I’m open to any alternative ideas. The problem with the Republicans right now is that they are pointing to all of the flaws in the package, and there are some huge flaws. But I don’t hear any alternatives. We we don’t pass this then what do we do? Nothing? Looking around me, I have a pretty clear idea of what will happen if nothing is done, and it’s not pretty.

    Kafka: How can people support something they don’t understand based on the words of Politicos or their Shills?

    Take a good look at what is happening around you, and see if it makes sense. Also, one thing that works for me is that I tend to trust people more if they start saying that they don’t understand or if they say something that they know I don’t want to hear.

    Look at what you are doing and why. What are you afraid of? If you are like me you are afraid of losing your job. What are you doing? If you are like me, you’ve stopped spending. What happens if you stop spending? Well, I used to spend money eating at an Indian buffet that I no longer go to. Those waiters are now no longer getting tips, and it’s likely that they have stopped spending.

    Part of the reason that I don’t think that tax cuts are a good idea is looking at my own reaction. Suppose I got a $2000 tax cut, am I going to spend that money? Hell no. Now suppose I look around and I see my friends getting government jobs and contracts, and I figure I can do the same thing. At that point, I might start eating at that Indian buffet again.

    Kafka: Does anyone understand the multiplier effect, how it is actually computed, where the numbers come from, which derivative of some estimated number is being used to bolster the hypothesis? What about the Lucas Critique, has it been factored into the analysis and if so how?

    No, we all are just guessing. It may be guesses with fancy math, but it’s just guessing.

    I think you are making things too complicated. Sometimes it’s best to say “I just don’t know” and work from that.

    No one knows whether any of what we are doing will work. Maybe it’s completely wrong. However, we do know what people did in the past and right now we are trying to do something different.

    Kafka: All the people purveying the stimulus have been dead wrong so far yet they are the ones being relied upon to fix everything?

    We are dealing with falliable, mistake prone, often stupid human beings. People can be dead wrong. I’m sure that there are a dozen things about what we are doing that are just plain wrong. I’m just hoping that they are “we can laugh at ourselves later” wrong rather than fatally wrong.

    Also people have gotten some things right. The fact that unemployment is at 7% rather than at 15% right now is something of a miracle.

    I should point out that one reason banks tend to hire physicists and mathematicians is that physicists and mathematicians know when *NOT* to use math.

  • Posted by Kafka

    Indian Investor, thanks for the advice, I have been going in and out of these banks for the last six months and made a small fortune for me. I gotta keep going until I lose at least half my profits under my stupid system, I use a progressive shorting system. The accounting statements are full of lies, that I know, JPM is technically insolvent and it amazes how it has any life other than from Fed support. Jamie is good but math will always carry the day, much more bad is coming. I am already heavily short 10 year notes with a duration of more than 7 years remaining, I went all the way down to 2% . Two fish, not bad dude and fair enough (though I wish the Politicos would describe it to the public as you just did) but I don’t think in the long run Schumpter will be or has ever been disproven, sometimes it is just better to let Rome burn now as opposed to later. As for unemployment, I will quibble, I bet the real rate is over 15%. I am not complaining, I know where the lies are (or at least think I do) which makes profiting in the markets much easier, or I guess it could be dumb luck (but I would rather be lucky than good anyways).

  • Posted by Indian Investor

    @Twofish: I have a good deal to learn from you despite not being able to convince you that the China and India exchanges have bottomed out, and that the US exchanges may follow soon. My confusion over the US exchanges is that the planned recovery for the US economy isn’t yet clear to me.
    Now I have a question for you. Suppose credit flows had to be encouraged in China, in sectors like housing, railway infrastructure, white goods consumption in rural areas, telecom, electric power, etc. And suppose this had to be done with financing flows from New York banks.
    How would this happen, theoretically? And what would be the kinds of employment growth in financial sector? Will this type of flow increase financial services opps in NYC or in Shanghai,and what types?

  • Posted by Indian Investor

    @Kafka: I’m long the Nifty (Indian stock index) in futures (the futures margin is 16%) with a pile of cash on the side of that margin that covers me for a good 25% fall, the position gets marked to market everyday and I started this last week, with a long term view.
    The hot money from FIIs (mostly US-based) flew out the Nifty bets, causing a correction down from 6300 to 2500 (Jan-Oct 2008) and since then things are steady.
    The Nifty long has a lot to do with the sequence that follows the Geithner announcement – New hedge funds with a USD carry – expectations of strengthening INR and RMB – local stimulus – basically overall a reversal of the 2008 outflows from equities. This time round the rally should be better than the previous one after the September 2001 bottoming out, because of higher involvement of FIIs in this round. Worst case Nifty will languish for more than a year in a trading band, unable to test old lows, and then start a great bull rally after Afghanistan and related issues are sorted out.

  • Posted by jonathan

    Brad, if I may, I find it hard to believe a few individuals need to post so often and have long conversations with each other about their own concerns in what is your blog. You have a lot of patience.

    Truth be, if individuals wish to discuss matters at length among themselves, they can communicate by email or visit a blog or website of one of the participants. Indian Investor links directly to his site.

  • Posted by Indian Investor

    jonathan – why don’t you skip posts that you don’t find interesting?
    i find it hard to udnerstand how other people’s posts disturb you
    as far as relevance is concerned i think Brad is capable of deciding for himself which is relevant and which is not
    I can’t safely express my views on my own blog in my own name because they’re too controversial.
    If I notice too many people reading my blog I’ll have to abandon it.

  • Posted by Kafka

    Indian Investor, good luck dude, I would be nervous playing the Nifty especially the index but I get it, though I think many accounting problems exist in the Nifty companies. Of course, I thought the same about Shanghai and since the presumed bottom it is doing great, time will tell. I know the U.S. exchanges are corrupt beyond belief and where most of the lies are (god bless all the liars). Of course the psychology of the markets is undeniable but eventually the math usually carries the day, the banks are hiding massive losses, CRE is gonna crash and hosing has another 20% to bottom, no one can stop the train at this point, no matter what the multiplier effect is. The American economy is built on a house of unsustainable debt cards and like all good fantasies, eventually the sham ends.

  • Posted by Indian Investor

    @Kafka: I’m actually not so skeptical as Roubini is on the American economy. I think the debate should be whether there will be a recovery beginning in June 2009, or later, by 2010; many people, especially the Austrian school, insists that “things will get worse”.
    But I don’t have as deep an understanding of what happens on the ground in the US equity exchanges, and in any case I wouldn’t bet on that directly.
    You’re right in saying there are high debt levels. What I’m looking at is that beginning next week, you’re heading for a financial system with at least 4 large banks that have received a lot of new credit from the Fed, plus there’s going to be equity injection as well. Their focus will mainly be off shore, but there isn’t enough opportunity to lend those trillions to China, or anywhere else outside.
    Calculated Risk shows you the falling home inventory level. Though prices are falling, I see the situation as the reverse of 2005. In 2005, Calculated Risk saw the rising inventory levels signaling a mortgage bust.
    Prices continued to rise well into 2006, and the index I looked at(OFHEO) showed a peak in April 2007, rather than in 2006.
    In Dec 2008, you’re seeing falling inventory and rising volume of sales.prices may well fall further, but my sense is that there is a trend reversal in the mortgage market.
    The predictive limitations of fundamental equity analysis, and technical analysis are well known. I’ve added quite a vast repertoire to that. Macroeconomics, including global capital flows and balance of payments data. Plus geopolitics; especially geopolitics with a view to separate facts from interpretations; and to second guess the real financial motivations rather than propagandized ideological justifications.

  • Posted by socrates

    brad-
    have you thought about setting up:

    http://www.blogs.cfr.org/indianinvestor

    the guy or girl needs it….
    with the amounts of comments i wouldn’t be surprised if this individual has a a major crush on you:)

    @ indian investor. don’t be so confident that markets have bottomed. kondratieff cycles suggest we’re in for a period of stag-deflation followed by flat japan like markets (at least in the u.s.)….Also skeptical China and India will emerge with growth levels witnessed 04-7…

  • Posted by Indian Investor

    My motivations are much simpler. I’d appreciate some inputs on how I can utilize my new-found understanding in a constructive manner.
    I don’t think that as an individual I will be able to change the system, and I don’t intend to either.
    My insight is that all the modern wars are being fought for strong financial reasons, rather than ideological reasons, with no side of the conflict, according to me, holding real high moral ground.
    Starting with this I’ve evaluated various other sovereign policies and connected everything together with stock market movements. This is still not a complete picture. For instance I don’t have as much insight on the African continent conflicts as on the others.
    Now, it’s easy to see that I will end up like Kondratieff or like Karl Marx if I try to get my views publicized, perhaps even much worse.Or I could get dismissed as somebody with a wildly negative imagination, which would be better.
    But I would much rather end up like George Soros than like Kondratieff, for obvious reasons. One way I see is to think up some wildly unlikely new postulates, such as the George Soros funny reasonings on “reflexivity” or the Kondratieff cycles, or Joseph Schumpeter “Business Cycle Theory”, and make some predictions based on that.
    This will help me keep my dangerous Tintin in Afghanistan logic safely to myself and be able to make some good profits by getting other people to invest with my logic.
    A successful cycle theory has to be something that’s amenable to different interpretations by different people, and yet it should seem like a great fundamental financial economics insight.
    Think of Warren Buffett. With his buy low, sell high statement, he manages to hide a lot of real knowledge as to what’s happening.

  • Posted by Jon Pananas

    “2000-2001 recession, when W’s tax cuts combined….” Let’s see…George Bush was elected in Nov. of 2000 and didn’t take office until January of 2001. The Bush tax cuts had nothing to do with the recession of 2000-2001 and less to do with the fall in tax receipts. Remember a little event known as 9-11? Please try to avoid coloring your financial perspectives with such blatant bias.

  • Posted by Indian Investor

    Jon is referring to the little 09/11 event that happened when W’s people planned to invade Afghanistan over an oil pipeline, just as O’s people are now surging there over a gas pipeline. Unarguably, W started it.

  • Posted by predictor

    Indian investor

    would china + india not favor such a pipeline? they will need lots of oil flows to fuel growth.

  • Posted by Indian Investor

    @predictor: India and China are in this situation: You need to get a cable connection and you’ll pay for it. Cable guy 1 comes and asks you to sign a MOU that he will give you connection 1. If you refuse to sign, Cable Guy 1 will be very upset and he will punch you. So you just sign on the dotted line. Now Cable guy 2 wants to sign a similar agreement, and you sign it to avoid being punched by cable guy 2. Now the 2 cable guys go around the neighbourhood doing the same to all the neighbours and they start a fight between themselves. You can’t stop the two cable guys from fighting because if you do anything stupid you will get punched.
    Occasionally India and China do something stupid by taking sides, and usually it results in a really major punching.

  • Posted by Cedric Regula

    DANGER OFF TOPIC – AVERT YOUR EYES OR BE SORRY

    The AP went thru all the trouble of reading the stimulus bill and outlined the spending of both House and Senate versions. Not that much difference between the versions and Obama has already said that close is good enough in horseshoes, hand grenades and stimulus bills. So it looks like the Senate version here is it.

    http://biz.yahoo.com/ap/090207/congress_stimulus_highlights.html

    Now back to our regular scheduled programming: Couldn’t we have Pakistan and India nuke each other and then let China patrol Afghanistan to protect their oil or gas? Both the USSR and the US have done their tour of duty there already. Then let Israel take over Iran and solve that problem.

    Also, it was Clinton that shot cruise missiles at the Taliban in 1998, but missed bin Laden.

  • Posted by Indian Investor

    OFF-TOPIC DON’T READ
    @Cedric: I must admit that right now the Congress Sarkar is dancing to the US Department of State tune on just about everything. There was a nice little wake up alarm bell when British Foreign Secretary David Milliband wrote an essay proposing something or other about ‘the resolution of Kashmir’, where he justified the Mumbai terror attacks as a natural consequence of the genocide of Hindus in Kashmir by Pakistan trained Taliban militants there.
    But the Department of State has toned down the issue with their own statements.

  • Posted by gillies

    “No one knows whether any of what we are doing will work” (twofish)

    i do -

    it’s not going to work.

  • Posted by Indian Investor

    OFF-TOPIC DON’T READ
    @Cedric: 09/11 was actually quite a complicated affair with so many surrounding events. 2 days before, on 07/11/2001, Ahmad Shah Massoud, the Afghan President, was assasinated by the same AlQaeda group that did the 09/11 attacks.
    I wonder what led to the 09/11 attacks. Whatever the Mumbai gambit was – if it was to create an Indo-Pak warlike scenario – then that gambit has failed. I fear there might some other attacks on Western soil if the same situations that led to 09/11 are there at present.
    One of the things I wish I knew was where Russia stood in relation to the Taliban and AlQaeda just before 09/11. One of my suspicions is that the AlQaeda did something desperate because they were probably completely isolated at that point in time.

  • Posted by bsetser

    Joe Pananas — i should have said “in the period following the 00-01 recession” rather than “in the recession’ but otherwise my argument about the pace of fiscal deterioration is a statement of fact. paul can pull up the chart. the methodology we use looks at the change in the fiscal position in the 20 quarters following the official start of a recession, and during that period, W’s tax cuts took place. W himself credited the cuts with recovery –

    I have my biases, but in this case i was working off objective data. the revival of counter cyclical fiscal policy will be dated to the 43rd president …

  • Posted by bsetser

    indian investor — i think you might want to reconsider your aversion to posting your opinions on your own blog, and i confess that i have no idea how you have the time to maintain your own blog and maintain a profuse stream of comments here …

  • Posted by Twofish

    Investor: Now I have a question for you. Suppose credit flows had to be encouraged in China, in sectors like housing, railway infrastructure, white goods consumption in rural areas, telecom, electric power, etc. And suppose this had to be done with financing flows from New York banks.

    Why do you suppose that the financing has to come from NY banks? One thing that is historically the case is that any emerging economy *SHOULD NOT* depend on foreign banks for financing growth. You can and should let foreign capital in, but you need to drive an extremely hard bargain. Above all, you do not want foreigners owning key pieces of infrastructure if you can help it since they will use it to exert political and economic control, and even worse they’ll all run for the exits the second something goes wrong.

    China has been very careful about letting foreign capital in after the 19th and early 20th centuries in which foreigners ended up owning all of the railroads.

    It’s not that foreigners are evil. They aren’t. It’s that business is business, and you are negotiating with people that have interests that are different than yours. In the case of finance people, their interest is to make as much money as possible.

    With foreigners its tricky because there are limits to which a banker living in New York City will go to damage New York City because they end up hurting themselves. Whereas the NYC banker is not going to care as nearly as much about what happens in Shanghai and New Delhi.

    To keep the topic focused. This is why I’m rather optimistic about the future. In the Asian Crisis, countries such as Indonesia were hurt by the fact that the people making the decisions about Indonesia didn’t really live in Indonesia and hence didn’t care about Indonesia.

    In the current situation, it’s obvious to everyone that if the economy falls apart then the rich and powerful in the United States are going to lose their wealth and power, and hence you have a bunch of people are that are extremely motivated out of pure greed and self-interest to get the economy working again.

  • Posted by Stefan

    The world’s real economy is to 99,9% the same as two years ago.
    - People are the same
    - Resources are the same
    - Knowledge is the same
    (of course the inventory of residential real estate is marginally higher and the inventory of oil in marginally lower)

    This is a margin-game where Obama’s package(s) will turn deleveraging into leveraging. Deflation into inflation. The world’s savers are finally put in front of the choice: invest your money, or consume your money, or see your money diluted.

    67 BUSD new money (i.e treasuries with the liquidity of money) will be pumped into markets next week.

  • Posted by Michael

    Cheap global energy,labor + technological innovation -> tech bubble -> tech bust -> cheap global credit + creative-finance-exploded-capital -> financial (including housing) bubble -> financial bust -> ZIRO + $$printing + govt exploding deficits -> zombie finance + govt debt bubble -> ? Govt debt bust + deflationary depression? Stagflation? You make the call, but I suspect it’s not going to be called “The Great Moderation Part II.”

  • Posted by otto

    I just read all the comments. My brain hurts.

    Can you guys please respect Setser’s rule to stay on topic in the future?

  • Posted by Cedric Regula

    stefan:”This is a margin-game where Obama’s package(s) will turn deleveraging into leveraging. Deflation into inflation. The world’s savers are finally put in front of the choice: invest your money, or consume your money, or see your money diluted.”

    If that’s what our leaders have in mind for us, then I think we need to organize the AARP Liberation Army (AARPLA), stage a government coup, then arrest politicians and economists for Treason Against Greying Americans.

  • Posted by Cedric Regula

    OFF-TOPIC DON’T READ

    indian:”I wonder what led to the 09/11 attacks.”

    I’m not an expert on it, but from the news I would call it radical Islam. They want to kill Big Satan and Little Satan, Hindus in India, Christians in Burma, Buddhists in Thailand, whatever they are in Sudan, and other places I can’t think of off the top of my head or don’t know of yet.

    And of course they aren’t done trying yet.

  • Posted by Twofish

    I don’t think that stagflation is likely. If Keynes is right, then you can only get stagflation if the supply curve changes, and nothing has happened in the last year and a half that would greatly change that. The non-financial parts of the economy are still more or less the same as they were a year and a half ago. It’s the financial structure that is radically different, and the sense of urgency is to get some workable financial structure together before the non-financial parts change.

    The “I don’t think inflation is going to be a problem” is important, because if we do start seeing signs of inflation, that means that there are big holes in my understanding of how the economy works. At that point it’s a matter of stepping back and figuring out what went wrong.

    We are in the middle of one of the greatest financial experiments in history, and the exciting (in the sense that getting caught in a sinking ship is exciting) part of it is that we are going to know a lot more about how economies work in three months than we do now, just like we’ve learned quite a bit since September.

    One reason I’m not to much in the prediction business is that I don’t know of anyone in last September that predicted the exact sequence of events between then and now. You have lots of predictions that something bad was about to happen, but nothing detailed. So I think it is foolhardy, even dangerous to try to make detailed predictions for the next year. The best I think you can do is “If X is the situation, then I expect Y.” and if Y doesn’t happen, then you have to step back and look at X.

    Where the really big arguments will come is if we get to April or May, and there is no sign of any improvement. In which case, you’ll have bitter arguments between people that think it was too much, and people that think it was not enough.

    The thing that I’m trying to come up with are some guidelines for figuring out at what point to cut the rope and try something else.

  • Posted by Twofish

    Two comments that are relevant to the topic:

    1) I don’t think that the important comparisons are to the recessions. It’s clear that we are in something much worse than your standard recession. The relevant comparisons are to the Great Depression 1929-1932 and Japan 1990-1993.

    One of the things people don’t appreciate was that it just wasn’t the case that the stock market crashed in 10/1929 and the next day people were in soup kitchens. It took about a year for things to get bad, and then a another year for things to get really, really bad.

    This was part of the problem. Hoover gets a bad reputation from history because he didn’t seem to do very much. But in Spring 1930, the situation really didn’t look that bad.

    2) The key number is employment. If you have bad enough employment figures then the banks start cracking up.

    The bad news is that the job losses right now look as bad as those in Spring of 1930. The good news is that we haven’t seen a systemic collapse of the banking system, and there are things in place like FDIC that make this more difficult. The other thing is that unlike 1930, we know we are in a crisis.

  • Posted by Cedric Regula

    2fish:”I don’t think that stagflation is likely.”

    I’ll start out by saying that things haven’t been broken this badly since the ’30s, and in some ways could be worse, i.e. size of credit bubble(consumer+business+government), extent of globalization effects, etc…

    So making guesses is obviously difficult.

    But my thinking is we don’t get inflation anytime soon. I don’t doubt Keynes and his liquidity trap, and it’s pretty clear we are in one, whether it’s bank willing to lend or consumers able to borrow.

    Milton Friedman did extensive studies on the time lag between monetary policy changes and the effect on the economy. He put it at a two year lag, but those studies where done in a world that ran slower.

    Where we always get bite by inflation is when the velocity of money jumps up because banks and consumers feel good again about the economy. That’s when all that liquidity they pumped into the system starts moving. That is when the Fed is supposed to drain liquidity, but they always seem to have trouble pulling that off (i.e. Greenspan’s jobless recovery -> real estate is not becoming a bubble, real estate prices skyrocketing are not inflation, and other fairy tales). Then it takes a wage price spiral to keep it going. That hasn’t happened in the US in a while.

    Unless we get a ’80s Brazilian economy and the government keeps monetizing debt and “growth” and everyone goes on a COLA to keep up. Brazil also made it illegal to hold gold, foreign currency, or move your savings out of the country. Brazil finally decided this is not a good idea.

    They way the Fed drains liquidity is either by selling its stock of short term marketable treasuries, or swapping it’s IOUs with the NY Fed.

    If Ben goes forward with his QE plan to buy long term treasuries, then when it comes time to drain liquidity he has to sell them cheap (before maturity with market interest rates surely higher) and take a big loss. I don’t see how that works. Sure he can print money, but……

    So I think longer term inflation is baked in the cake.

    As far as the stimulus goes, we will get some GDP effect out of it. Some will go to repairing balance sheets, some to paying consumer and business debt, but some will get spent.

    But I wouldn’t buy any stocks just yet.

  • Posted by Kafka

    What is wrong with Fischer’s solution? The current pattern of deficit spending both private and public is unsustainable but me and my friends will keep profiting off this foolishness. Check out Roubini’s predictions, he was darn close.

  • Posted by Cedric Regula

    Kafka:

    That’s my plan, and I hope I’m up to the task.

    Just longing for a simpler retirement, however.

  • Posted by Kafka

    Crooks correctly called ahead of the curve for the strengthening of the dollar under his analysis that essentially provides in a liquidity trap flooding the markets with money does not work. I think he or his buddy Weiss at Money and Markets have called for a Treasury bubble (which has gotta happen). He ascribes the Bernanke strategy to Friedman though I doubt Milton would agree with what Bernanke is doing in these circumstances. Crooks also points out that Fischer’s plan which Fischer’s naysayers would describe as let Rome burn now because it has to before things can get better as never happening because it is not Politically expedient. For long term investments I did not follow Crooks’s advice on currencies (wish I had but I suck at market timing) as I think the dollar has got to devalue eventually but short term the profits have been wonderful in currencies if you use charts and a strong dollar trend subject to the news (except in the Yen). Of course as soon as the trend changes I will change my directional bets vis a vi the charts. As always, one should consider shorting Bear rallies until it does not work anymore, especially financials and consumer companies that use debt to clear their balance sheets and debt to fund consumer purchases, it has worked wonderfully for the last 8 months or so (but has gotta end or not much will matter anyways), should have started sooner but I am a pansy short seller only looking to take the middle (which is getting narrower and narrower and perhaps, gone).
    ………………………………………………………………………………………………
    An epic battle being waged
    by Jack Crooks………………

    At a time of major risk aversion, the world will flock to its reserve currency — the U.S. dollar.
    And once the debt is removed, monetary velocity “V” increases to more normal levels; therefore tinkering with money supply isn’t necessary.
    Sadly, I think, all governments are on the side of King Kong. And their flood-the-market monetary policies may make this global recession a whole lot worse.
    So from a currency perspective I think it means this: We will be locked in a sustained period of risk aversion (rising unemployment, deflation, and sovereign debt defaults) as this crisis plays out. And in a world of major risk aversion, that mantle rests at the feet of the world reserve currency — the U.S. dollar.

  • Posted by eb

    I have a couple of clarifying questions, the answers to which would help me think about whether a large stimulus makes sense:

    0) Brad’s title: “the US downturn is getting worse when it *should* be getting better…” seems a bit presumptive. Does not the use of “should” in this context assume that all recessions are the same? Do we have reason to be surprised that things are continuing to deteriorate?

    1) I understand that deflation would be very dislocating (crushing for severely indebted nations/households), but why would it be *bad* in an economic sense? It would be enormously beneficial for savers and earners. This strikes me as an OK result. Further, deflation seems like as natural of process as inflation and, indeed, it seems to me that economic systems that result in a net bias for deflation should be as stable generally speaking as those that result in a net bias for inflation.

    2) The debate over the stimulus strikes me as rather unstructured. I would love to see a tool/site in which two sides could build out a risk chart of outcomes that they believed *might* occur under varying scenarios starting from today’s initial conditions. As several sage posters have acknowledged: we can’t know the future. But if we have the discipline to develop a distribution of possible outcomes and appropriately narrowly debate the relative likelihood of alternatives subject to given conditions we might improve our collective crystal ball.

    3) I have not studied economics (yet) – I’m an engineer by trade. Are there any underlying assumptions to Keynesian stimuli? I.e. one thing that appears to be assumed is that there is productive capacity in an economy that is under utilized because of inaccess to funding. Is this correct? If so, does this assumption hold today? If so, in what industries? (I’m not convinced.)

    4) Brad, you seem particularly focused on the current account when you assess the likelihood of a treasury auction failure (and its consequences). Is there a mechanical difference between auctions offered to the US public and foreign bodies? If not, why is the CA critical to the success/failure of treasury auctions? Is it not, more generally, just the market expectation for risk free returns? (And, I suppose, any added concern about not-so-risk-free returns?)

    5) Broadly, what are the ways out of this mess? e.g. “US shifts to a non-consumer lead economy”, “India and China miraculously industrialize in 15 months”, “massive inflation to reduce the burden of current debts”, “consumer debt reduction to enable ____ to happen”. Without agreeing what success looks like, I have a hard time understanding how to evaluate the purpose of a stimulus of any kind.

    6) The current mess doesn’t look that different from the dot com bust: both were massive wealth transferences rather than wealth creation periods and resulted in the gross misallocation of capital. Can we learn anything from this?

    My guess, since I haven’t seen a cohesive problem statement -> solution map, is that no one else has either. As such the argument about whether a stimulus makes sense is not an analytical one: it’s a personal one. Savers who naturally disliked the bubble years don’t want to take on more debt to “sustain” the bubble: they want it to pop so that the rest of the world is forced to start living their way. Debtors are worried about their jobs and futures.

  • Posted by Indian Investor

    @eb: This is purely like an engineering problem which keeps occuring again and again in economics. You need to know the design document and the configuration pieces, and what has been changed, how and when. Also you need to know what solutions were tried before, and whether they worked or not.
    The problem is that nothing is personal or professional in macroeconomics … everything is political. So you will get various different theories, facts, etc from different people depending on who’s on whose side.
    There is a consensus that a stimulus is good. If you’re Republican, tax cuts for rich people and low government spending plus liberalized market and trade laws works better. If you’re a Dem, you need to think in terms of tax cuts for poor people (the majority), big highway spending and exotic healthcare benefit promises, and higher regulation of markets.
    If you’re studying economics afresh, I’d suggest not to miss out on economic history, and also go through the history of regular occuring crises in various different countries.

  • Posted by Kafka

    There is no consensus that borrowed stimulus is good just the media repeating the Politicos self serving mantras. Here is some pretty simple math and a lot of it on the link, that suggests the only way out if you can call it that is Zimbabwean style money printing or stimulus. Anything short of that can not work (of course Zimbabwean style economics has its own inherent problems and at the end of the day its effects are the same as spiraling deflation). You can’t possibly go from $20 Trillion in debt to $52 Trillion in debt in 8 years to prop up GDP (of which 20% to 30% is fake) and think more debt will solve anything, it is either serious pain now or devastating destruction later, the math is pretty simple. Of course add to that unsustainable deficit financed social and defense costs, and nothing will work unless that problem is fixed (and the answer to that problem is not pretty).
    …………………………………………………………………………………………
    Posted by Steve Keen in Debtwatch
    However, from the point of view of the empirical record, and the rival theory of endogenous money, this will fail on at least four fronts:
    1. Banks won’t create more credit money as a result of the injections of Base Money. Instead, inactive reserves will rise;
    2. Creating more credit money requires a matching increase in debt—even if the money multiplier model were correct, what would the odds be of the private sector taking on an additional US$7 trillion in debt in addition to the current US$42 trillion it already owes?;
    3. Deflation will continue because the motive force behind it will still be there—distress selling by retailers and wholesalers who are desperately trying to avoid going bankrupt; and
    4. The macroeconomic process of deleveraging will reduce real demand no matter what is done, as Microsoft CEO Steve Ballmer recently noted: “We’re certainly in the midst of a once-in-a-lifetime set of economic conditions. The perspective I would bring is not one of recession. Rather, the economy is resetting to lower level of business and consumer spending based largely on the reduced leverage in economy”.[9]
    The only way that Bernanke’s “printing press example” would work to cause inflation in our current debt-laden would be if simply Zimbabwean levels of money were printed—so that fiat money could substantially repay outstanding debt and effectively supplant credit-based money.
    http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/#_ftn6

  • Posted by Indian Investor

    @Kafka: I also think that the US Govt. is headed for a default, but that may not be an immediate consequence. Even if the US Govt. defaults, they can issue a new series of currency, such as blue dollars. If the US continues to have sufficient influence with oil exporting nations, foreign CBs will continue to hold the new blue dollars as the reserve currency.

  • Posted by bsetser

    eb — fair point that there are no normal recessions. by getting worse when it should be getting better, i meant only that 4qs into a typical downturn, the economy begins to pick up. in this downturn, the downturn gained strength.

    you can argue that the “usual” pattern came from a world where the fed engineered a slowdown to take the heat of prices, and thus it shouldn’t apply to the current slump, which was triggered not by the fed but by the collapse of the real estate/ credit bubble. the collapse of the .com bubble is arguably similar in the sense that it was driven by a collapse in asset prices, but this looks worse for four reasons:

    a) home prices didn’t fall along with equity prices in the .com crash; in fact they went up in part b/c of greenspan’s policy of cutting rates in response to a burst bubble (but not preemptively raising them). now both home and equity prices are falling; the size of the negative wealth effect is larger.
    b) the last leg of the downturn came when int. rates were already low; there isn’t any more room for conventional monetary policy (raising and lowering rates), which leaves unconventional monetary policy tools (buying and selling assets) and fiscal policy. we don’t have as much experience with those tools.
    c) the US government entered into the last recession with a surplus (clinton did run a countercyclical fiscal policy); the US enters into this downturn with a deficit. that means using one of the remaining macro tools (fiscal) implies a very large aggregate deficit.
    d) the .com boom was financed by equity, this boom was financed by debt – and as a result, the losses have fallen on the banks and key parts of the finanical system are effectively bust. this is probably the most crucial difference.

    people worry about deflation for two reasons:

    a) it is bad for debtors, as the real value of outstanding debt rises if prices are falling. if say wages fall and your mortgage payment is fixed, the mortgage takes up more or your wages … this is potentially a big problem.
    b) when prices are falling, people are often willing to hold cash as an asset — as its real value (the amount it can purchases) increases over time. that though makes monetary policy ineffective (nominal interest rates cannot go below zero, but zero nominal rates can still produce positive real rates if prices are falling), and macro managers like having monetary policy as a tool.

    there is no difference between foreign and domestic purchases at an auction (part from the fact that many foreign buyers are central banks who don’t directly bid). obviously though there is a difference when it comes to calculating the united States external debt — treasuries held in the US are debts to ourselves, treasuries held outside the US are debts to the world. it is perhaps better (though more complicated to follow the money) to think of foreign debts as claims on exports rather than as claims on tax revenues. foreigners holding treasuries don’t really want dollars per se, but us goods in the future — so they will take the dollars they get on treasuries and use them to buy goods and services, i.e. they are a claim on future exports. i have focused on the external side b/c i have long thought the risks were larger there — namely that the current account deficit was 5-6% of GDP and the US export base was 10-12% of GDP, which created a bad underlying dynamic. And i do generally think that the risks associated with fiscal deficits financed heavily by borrowing from the world are greater than the risks from fiscal deficits financed domestically. i worked on argentina in 00-01. that left an impression on me!

    maybe tho i am now overly focused on external risks, as exports have increased v GDP as a result of the weak dollar/ faster global growth (that may change in 09 … ) and the current account is likely to be in the 3-4% range. the gap between the fiscal deficit and tax revenue maybe is a bigger concern.

    it certainly would be if it becomes permanent not temporary …

    as for the long-run view, that isn’t something to cover in a comment. But i would refer back to my earlier point that the US economy is transitioning from a world of no household savings to a world of maybe 5-10% household savings. that means consumption will fall relative to GDP. that adjustment though is happening rapidly not gradually, and it as a result it would imply a large fall in output (more than most are currently forecasting for the US — a shift from 0 to 10% household savings with consumption at 70% of GDP implies a 7% fall in output, and investment would also fall … so a 10% fall in output isn’t out of the question in that scenario) if it wasn’t partially offset by more government spending/ smaller taxes (which increase income and thus spending for any given savings rate). The idea is to cushion the adjustment.

    what then emerges is an economy where consumption grows in line with income growth, and where the fiscal deficit ideally shrinks as private investment demand picks up. that is a world where the US ends up financing more domestic investment with its own savings, and thus runs a smaller current account deficit. it also is world with less US consumption, and thus the global economy needs another engine so to speak …

  • Posted by Exporter to GANT

    Indian : The Nifty long has a lot to do with the sequence that follows the Geithner announcement

    OUCH. The Geithner announcement isnt going to come soon enough. The announcement also is going to lack meat. Would you consider reversing your LONGS on NIFTY To SHORTS ?

    seriously which company in india is going to grow in a global depression. Half the companies have skins teeth margins (in india)

    Software companies already ran up well. cant expect more upside. I Think Nifty will eb stuck in 2500 forever. That is the best case scenario.

  • Posted by Indian Investor

    Exporter: seriously which company in india is going to grow in a global depression.

    What global depression?

    Telecom, Banking, Power, FMCG (Fast Moving Consumer Goods), *Agriculture* are all going to post double digit growth and in 2008 none of these sectors have disappointed.

  • Posted by Indian Investor

    Exporter: Would you consider reversing your LONGS on NIFTY To SHORTS ?

    Me: Anybody could be wrong about the market, including me. I think the Nifty has bottomed out, and currently I don’t expect it fall anywhere below 2500. If at all it falls I’ll be piling more cash next to the futures margin and go for the long wait.

  • Posted by Stefan

    -Two years ago it seemed private equity was taking over the world – people loved leverage.
    -Now it seems, bank savers are taking over the world* – people hate laverage.

    *The ultimate consequenve if banks go broke.

    INSTEAD, what will happen is that stimulus packages through us back to neutrality.

    The deeper we fall, the less (nominally) is needed in stimulus, but the more politicians will be able to do.

    We will now get more than we need.

  • Posted by Stefan

    To Cedric Regula
    It is not necessary to dilute savers, only to show that it is possible. China could buy half of the whole world at today’s prices. If they want to continue being a black whole absorbing money, the rest of the world will have to print money.

  • Posted by Stefan

    So far the Fed has FAILED to show that it is capable of printing money.

  • Posted by Cedric Regula

    I think the Jack Cooks and Steve Keen posts are exactly right as far as the economic backdrop and mechanics of a debt based economy. And if we break that, then we have a pure fiat currency based economy with all the historical examples of how that works.

    Also I think Brad’s analysis of the details in his post here are all on target. So if we topple over to the hyper-inflation side and need to form the AARP Liberation Army, I’ll recommend that we give Brad a pardon.

    But that still leaves the question of what to try in order to thread the needle between a severe deflationary outcome or hyper-inflationary outcome, which may be in fact may the same thing….collapse.

    So I think the mindset needs to be to assume the economy has to downsize to a sustainable level, and any policy actions have to be designed to achieve a controlled downsizing, and that is the best we should expect. Any thoughts of re-flating housing or GDP back to where it was in the foreseeable future should be abandoned.

    So that was a simple paragraph to type, but would make a great subject for a new book. But not today.

    Some quick suggestions:

    Start retiring baby boomers early and employ echo boomers.

    Come to the realization that the US can’t afford its global political-military footprint. England finally did fifty or so years ago.

    Pay more than lip service to energy independence. It is possible. It would make Brad very happy about the CA deficit as well.

    Keep Ben away from the printing press. Massive QE is the beginning of the end. Pay higher long term interest rates. That is financially stable. Congress has already fixed new F&F loans for real estate at 4.5%. That is enough of a stabilizer for real estate. (hope its temporary). Let long treasury rates rise so Americans want to buy them. Again, Brad says that’s more stable.

    So now I’m tired of typing, but that would be the general idea as far as I think.

  • Posted by Kafka

    I just don’t get the math especially if one believes savings will increase which necessarily will result in decreased consumption and GDP (including manufacturing). How is the stimulus supposed to work anyways? I just don’t get it. Government, Health Care (basically government) and Education (government) comprise over 50% of the economy. More government is the answer? Manufacturing comprises about 10% of the work force and as a percent of GDP is on the decline (and can only decline more rapidly as savings increases). This is a liquidity trap and more debt is never the answer in a liquidity trap. Long run borrowed stimulus will only exacerbate the problem. How much more can the government spend? In 08 the fiscal conservatives doubled government spending from 01 to $3.6 Trillion with tax revenues of $2.6 Trillion. The rich and the corps paid about 80% of the tax revenues but they aint gonna be for long and tax revenues will decline by at least $600 Billion while the bloated government spending likely increases by about $1 Trillion. This is the recipe to fix the economy? What about the $70 Trillion or so present value of unfunded social costs? In the last 8 years total U.S. debt has gone from $20 Trillion to $52 Trillion and now the answer is more debt, the consumers are tapped out and have not had a real wage increase in 10 years. Fischer knew that of which he spoke but no one listens because it is not politically expedient. Thus, we are about to witness the greatest wealth transfer in history by increased taxation to fund the deficits or inflation which of course hurts the worst those who can afford it the least.

  • Posted by Twofish

    Kafka: I just don’t get the math especially if one believes savings will increase which necessarily will result in decreased consumption and GDP (including manufacturing).

    One has to distinguish between demand and consumption. If you increase savings, those savings won’t just sit there like gold bricks. Something will be done with it, like investment in factories or restaurants.

    Kafka: I just don’t get it. Government, Health Care (basically government) and Education (government) comprise over 50% of the economy. More government is the answer?

    If it means that I get to have the same salary as physics professor rather than as an investment banker then I won’t complain.

    Kafka: Manufacturing comprises about 10% of the work force and as a percent of GDP is on the decline (and can only decline more rapidly as savings increases).

    And this is a good thing. Just imagine a world in which robots did all of the work, and the people employed in manufacturing goes to zero. You press a button and whatever you want gets made by robots. What would that world look like?

    Marx was convinced that as factories became more efficient, things would fall apart, and a lot of the 20th century was devoted to trying to figure out how to get around the paradox of overproduction. The answer of the last ten years was to have everyone be real estate brokers, and that didn’t work.

    Kafka: The rich and the corps paid about 80% of the tax revenues but they aint gonna be for long and tax revenues will decline by at least $600 Billion while the bloated government spending likely increases by about $1 Trillion.

    My proposal is that you get the economy fixed so that people are making multi million dollar bonuses creating value and then tax the hell out of this. The problem is that if you don’t get the economy out of a downward spiral, things will get worse and worse financially speaking.

    Kafka: This is the recipe to fix the economy? What about the $70 Trillion or so present value of unfunded social costs?

    Simple. Raise taxes and cut benefits. You don’t have to do it now. If Obama gets the economy working again, he’ll have enough political capital to raise taxes on the rich to whatever he wants them to be.

    Kafka: In the last 8 years total U.S. debt has gone from $20 Trillion to $52 Trillion and now the answer is more debt,

    That’s a semi-bogus number since bank deposits constitute debt. When you deposit money in a bank that increases the amount of debt in the world, since the bank owes you money.

    What matters is who owes what to whom, and the numbers don’t look bad.

    Kafka: the consumers are tapped out and have not had a real wage increase in 10 years.

    So tax the rich, and set up a health care system and good schools. One problem with the health care and school system right now is that it impedes economic flexibility. People can’t start their own businesses because of health care, and people are forced to live in high priced housing areas if they want decent schools.

    Kafka: Fischer knew that of which he spoke but no one listens because it is not politically expedient.

    And therefore what he says is useless. Telling people that they have to be unemployed for years and they are must be economically miserable is just unacceptable.

    Fischer: Thus, we are about to witness the greatest wealth transfer in history by increased taxation to fund the deficits or inflation which of course hurts the worst those who can afford it the least.

    I don’t think it will. Inflation hurts the poor. People in the US have opposed taxes on the rich, because they have believed that that taxes on the rich will hurt them. However, those arguments are dead.

    The funny thing I’ve found is that most really rich people I know, don’t mind paying higher taxes (which is why Wall Street gave more money to Obama than McCain) It’s the wannabe rich that care, and the wannabe rich don’t believe the “taxes are bad for you” arguments any more.

  • Posted by Twofish

    bseter: But i would refer back to my earlier point that the US economy is transitioning from a world of no household savings to a world of maybe 5-10% household savings. that means consumption will fall relative to GDP.

    And long term what should happen is that those savings get invested which means that you end up with the same amount of spending as before, only it will be spending on different things.

    The problem is that right now the extra savings is going into a broken financial system that has nothing better to do with the money than to put it into Treasuries. So part of the purpose of the stimulus is to “free the money” and get the money that is flooding into the government doing something useful.

  • Posted by Stefan

    When is fiscal stimulus efficient?

    1) When there are available real resources
    2) When there is low inflationary pressure
    3) When the private sector is down due to fear (i.e not real lack of demand)

  • Posted by Stefan

    …to elaborate

    A wants to buy from B and B wants to buy from A, but nobody buys because he fears the other one wont buy.

    That is the governmental kick-start opportunity.

  • Posted by Twofish

    eb: The current mess doesn’t look that different from the dot com bust: both were massive wealth transferences rather than wealth creation periods and resulted in the gross misallocation of capital. Can we learn anything from this?

    I disagree with this characterization of the dot-com period. It turns out that looking ten years out that vast amounts of real wealth was created by the dot-coms, and the new wealth created by companies that did survive far outweigh the wealth destroyed by the companies that didn’t.

    You could argue that the craziness of the dot-com era was in fact the most efficient way of allocating capital. You give vast sums of money to 1000 companies doing crazy things. 975 of the them go bust. The remaining 25 or so end up creating enough wealth to make up for the 975 that go bust.

    This is the problem that I see with the latest boom-bust cycle. I don’t see much if anything that was created long term.

    This opens up some fundamental questions about resource allocations. One fundamental question, which I don’t know the answer to, is whether I would generate more social value working as a physics researcher than I would working as a investment banker. If the answer is yes, then we have a problem if investment bankers are making three to five times the salary as physics researchers, working less, and (even with the downturn) finding it easier to get jobs.

    Your typical Wall Street investment bank has a staff of about 150 or so physicists and mathematicians, and Wall Street is the only major employer of physicists to do physics work with money that isn’t (or at least wasn’t) coming from the government.

  • Posted by Stefan

    Today’s “dotcom-sector” should be the development of electric vehicles.

    The welfare gain that is about to be made is immense.

    And it will be easier for capitalists to “lock in” profits, as this industry/infrastructure will be far more capital intensive.

  • Posted by Cedric Regula

    stephan:

    There is a little room for everything. I’ll guess I’ll have to report here on my economy activity of last night.

    Went to the local nightclub. A few months ago they changed ownership and after an extensive remodel re-opened with a $10 cover charge and Guinness on tap for $4.50 a pint. I went back then and the place was nearly empty.

    Last night I was pleased to find out they lowered the cover charge to $7 and Guinness was on tap for $2 !!!!!!!!

    The place was packed and no one looked depressed at all !

    So that got me thinking of supply-demand-price curves of course. And the potential for stimulus checks is enormous here.

    But before I firm up any conclusions, I’ve decided to go back a few more times to get some more data points and make sure last night was not just a fluke.

  • Posted by Kafka

    Two fish, interesting but I don’t buy it. The only reason for the GDP increase was the faux debt increase in the last 8 years and bank deposits are a small component of the aggregate increase. Some estimate it now takes about $5 of debt to create $1 if GDP and after interest costs, that aint profitable. Equating campaign contributions by Wall Street to the rich not minding if taxes go up is a bit disingenuous since the campaign contributions are nothing more than bribes (called something else). If you think the rich don’t mind paying taxes why do they devote so much time and expense to avoiding them? Maybe you think Laffer was wrong but there is a threshold where it becomes pointless to work. Of course Buffet and Gates don’t mind paying taxes since a substantial portion of their worth and earnings have been contributed to non taxable private foundations where only a small percent has to be paid to charity each year and everything else accumulates tax free after costs (costs include salaries to your family and friends). At the end of the day what you advocate is something that sounds an awful lot like socialism, which is fine, I love Europe where most are the same, but guarantee you, me and my kind (and many more) will go to places like Monaco (I know good riddance). Fischer and Schumpter were right that is the point and if you truly want to fix the problem as opposed to going socialist, you gotta fix the problem not perpetuate it. If you wanna go full fledge socialist fine (me and mine will leave) but don’t have what exists today, social fascism (privatization of profit and losses absorbed by the public). For that matter why should I work 120 hrs per week if Uncle Sam is gonna take my dough and give to my neighbor who works 8 hrs/4 days a week (and is likely sleeping with my wife while I am hard at work). And lastly, if you think the switch to a services based economy as opposed to production based economy under a fractional reserve fiat based money financial system controlled by Politicos is the answer, name one time it has ever worked, I can name a bunch where it hasn’t?

  • Posted by bsetser

    indian exporter — you are right that central banks hold dollars to cover BoP outflows from the capital account not just because they want a claim on future us exports. but ultimately us dollars held abroad are a claim on future us production; investors only want dollars as long as they are convinced those dollars hold value. and their ultimate value is a claim on future us production.

  • Posted by david_in_ct

    stefan:
    You are going to be very very right.

    twofish:
    I have often had similar thoughts to yours about societal worth in terms of what I can earn doing quant type things in finance vs. what I might earn writing real-time operating systems, automating medical testing or working in a physics lab, all things I’ve had occasion to do. In the end I come to the conclusion that the payment schedules are not that far off. At least in what I do in the financial world I am very much paid as an entrepreneur. If things work out there is a nice payoff. If not, very little or negative. The same is definitely true in the other professions. I think the confusion comes in because the comparison is often made between the virtually risk free life of a professor and the apparently fairly large risk undertaking of a ‘trader’.
    Another thought along the same lines is why did an apparently very smart lot of people make what turned out to be horrendous capital allocations. I think the answer to that question is undoubtedly because they could and in each of their own personal calculations it made perfect sense to make the bets. Understanding it from this point of view leads one back to the idea that the system itself is fatally flawed if from a rational game playing perspective the aggregate behavior of the players can bring down the house.
    I would be interested in Brad’s or anyone else’s opinion on disentangling money creation from private banking. I believe that if the power of dollar creation was vested totally with the government and not with the private banking system then what we have witnessed could never have transpired. Bubbles would quickly run into horrendous capital costs as they sucked in more and more of a relatively fixed monetary base. Without fractional reserve banking and the fed policy of limiting the price of credit instead of its amount bubbles could never get any real traction.

  • Posted by Cedric Regula

    Regarding electric cars and CA deficit reduction.

    Here is S. Africa’s electric car they just unveiled at the Paris auto show. Detroit tells us they need $50B from the taxpayer to get started on these.

    These go best with a complement of nuclear power plants. A great public infrastructure program in my opinion. I think $50B buys something like 20 nuke plants.

    http://blog.wired.com/cars/2008/10/south-african-e.html

  • Posted by Cedric Regula

    Coal-to-Liquid(CTL) and CA deficit reduction

    CTL without greenhouse gas reduction (carbon sequestering) was price competitive with $55 oil.

    A new study was done with GHG sequestering added and that took the cost up to $86 oil. Another opportunity for a public works program.

    This does make clean diesel fuel and diesel engines are 35% efficient compared to 25% for gas engines. Electric beats all at 80%.

    So the fuel price is not as bad as it may seem.

    ==========================================
    NETL Report Concludes CTL Plus Carbon Capture Results in Fuel with 5-12% Less Lifecycle GHG Than Petroleum Diesel; Modest Biomass Additions Lower GHG Further
    7 February 2009
    Tarka1

    A new report from the US Department of Energy (DOE) National Energy Technology Laboratory (NETL) concludes that coupling a Coal to Liquids (CTL) process with carbon capture and sequestration (CCS) yields a fuel with 5-12% less lifecycle greenhouse gas (GHG) emissions compared to the average emissions profile of petroleum-derived diesel, based on the US national average in 2005. These synthetic fuels are economically competitive with petro-diesel when the crude oil price (COP) is at or above $86 per barrel (based on a 20% rate of return, in January 2008 dollars, with a carbon price of zero).

    Adding biomass to the coal in the CTL process (Coal and Biomass to Liquids, CBTL) can reduce the GHG emissions further, according to the study. A mixture of 8% (by weight) biomass and 92% coal can produce fuels which have 20% lower life cycle GHG emissions than petroleum-derived diesel and which are economically competitive when crude prices are equal to or above $93/bbl.

  • Posted by adiemuso

    we are already in a depression of somesort. call me a pessimist but i think realistically we are already one step in the sinking ship.
    China is not looking good now. Guangzhou which is one of the main industrial ‘park’ of China is slowing down to almost a stop. And freight rates from China to Europe cost you almost nothing except for some charges and bunkering fees. I do hope things get better and are what the pessimists here believe. Sadly its not.
    Be it the US or anywhere else, government stimuli plans require funding. these funding comes from borrowing, be it from citizens or foreigners, this increase in Sovereign debt amidst the current situation of massive asset deflation is worrying. Of course, by driving up domestic savings rate, the improvement in the current account balance, can hopefully offset the increase of the Government Borrowings/Spending. But, if everyone else is doing that, who then is left to spend? who then is left to buy these debts? do we revert back to the old credit boom, but this time on a larger grander national scale amongst nations in the world? if so, it will be a clash of debts, national debts. and that is very very scary.

  • Posted by locococo

    Yes, the nonsense at “the depths of an economic bust, correspond to the gross excesses of a credit bubble driven economic boom” being that they can easily overshoot on the downside also.

    In order not to perhaps (tho not excluding)
    - to follow djc s advice on making credit bubble »unissued« through
    - to address some of the albion s points there, banning the naked shorts and adding those bond and cdo holders in for the ride while keeping them out of the good bank and from their former deposits
    - diminish confusion on what constitutes a »reserve« generally and what in particular plus how did we get here in the first place. It is here where the final solution will or will not come from.
    - and for those here of keynesian views spending focus on manipulating real estate drop to a stand still preferably routed through municipal level using also the conservatorships to their…. points? Here you get PR and Gs in sufficient quants and diminish the removed from market marked part of the equation further some

    all might be advised

    Not sure about the triggering the Ponzistop tho. That may indeed require rethinking approach to the real zero interest and combining it with the newer reserve deal

    The other argument I have with Austrians is that base of the currency needs to be a sound tangible. In absence a sound reason might help also. In a time race here the hedge becomes a sound tangible regardless of exchanges supposed to be traded on and of its denominator. That enemy actually helps. I d name the long yied – the judge, don t know about you.

    By now there s a 4 months lagg behind the curve plus a total blunder of the biggest manipulation ever to add on no focus of wrong people and nonsense policy proposals. Remember Schwartz? And japan?

    It s the finest of tuning of major proportions not major tune of the two details. Anyway, don t look like you re up to it?

  • Posted by Twofish

    Kafka: The only reason for the GDP increase was the faux debt increase in the last 8 years and bank deposits are a small component of the aggregate increase.

    I don’t think so. In the last eight years, we’ve seen a explosion in technology that has generated real value and real wealth. Think of what computers were like eight years ago versus what they are like now, and the entire industries that have been created.

    The US does not have a problem with wealth creation. It has a serious problem with wealth distribution.

    Kafka: If you think the rich don’t mind paying taxes why do they devote so much time and expense to avoiding them?

    They don’t really. It’s the wannabe rich “Joe the Plumber” types that care about taxes. The really rich people have so much money that they don’t care about taxes. As long as you could convince the wannabe rich that they will become rich, you could get their support, but that era is gone.

    Kafka: At the end of the day what you advocate is something that sounds an awful lot like socialism, which is fine, I love Europe where most are the same, but guarantee you, me and my kind (and many more) will go to places like Monaco (I know good riddance).

    I don’t care what you call it. If I was running for office, I’d care not to be labelled “socialist” or “Marxist” but since I’m not, you can label me whatever you want. If you want to call me a socialist or communist, fine, then I’m a socialist and/or communist.

    Kafka: For that matter why should I work 120 hrs per week if Uncle Sam is gonna take my dough and give to my neighbor who works 8 hrs/4 days a week (and is likely sleeping with my wife while I am hard at work).

    Because you may will find yourself out on the street tomorrow, and the 120 hours per week may not be generating any real wealth or value for society.

    Kafka: . And lastly, if you think the switch to a services based economy as opposed to production based economy under a fractional reserve fiat based money financial system controlled by Politicos is the answer, name one time it has ever worked, I can name a bunch where it hasn’t?

    The US economy works quite well. There are a lot of flaws and things that can be fixed, but it fundamentally works. It’s not perfect, no system is, but it’s amazing how well it does work.

    Just to give you an example. People got fed up with the old set of officials, voted them out, and now we have a new set of officials. No riots. No blood in the streets. No coup. We even had a nice ceremony and party to celebrate. People are screaming at each other in committee rooms to figure out what to do. It looks messy, but no one is shooting each other.

    Compare that to how most countries handle economic crises, this is amazing. Absolutely amazing.

    Ultimately, I think we’ll get through this thing, because I have faith in the American economic and political systems to self-correct. I have no idea whether the stimulus plan will work. If it does, great!!! If it doesn’t, we’ll try something else. If that doesn’t work, we’ll try something else. We’ll just keep trying things until we end up with something that works.

  • Posted by Twofish

    dave_in_ct: I think the confusion comes in because the comparison is often made between the virtually risk free life of a professor and the apparently fairly large risk undertaking of a ‘trader’.

    The trouble here is that this is an apple to oranges comparison. Tenured faculty have jobs that are relatively “risk-free” but to get to that point, you have to be a slave for about a decade, and there is no assurance that you will get to that position. For the same amount of risk/effort that it takes to be a tenured physics professor, you can end up being a IB managing director.

    Kafka: I would be interested in Brad’s or anyone else’s opinion on disentangling money creation from private banking. I believe that if the power of dollar creation was vested totally with the government and not with the private banking system then what we have witnessed could never have transpired.

    How money gets created is a very interesting topic, but I don’t see how you can prevent private creation of money. If I write you an IOU and people start trusting my IOU’s, then I’ve just created money. It so happens that people trust US Government IOU’s more than they trust my IOU’s, but if you restruct government issued IOU’s then you end up with lots of private people issuing their IOU’s.

    Very little of what people think of as “money” is government created. There are only about $900 billion dollars in Federal Reserve Notes out there. Most of what we consider “cash” (i.e. checks that people write to each other) is not “government created money.”

    Kafka: Without fractional reserve banking and the fed policy of limiting the price of credit instead of its amount bubbles could never get any real traction

    I don’t see how you can have a world without fractional reserve banking. Fractional reserve banking has existed since the 16th century, and if you try to get rid of it, it just pops up in some other form. To get rid of fractional reserve banking, you basically have to get rid of all debt, because the moment someone can write an IOU, it will be very quick before it becomes a bank.

  • Posted by Twofish

    BTW, I think that hedge funds and Wall Street are going to end up making a huge amount of money off of Geithner’s plan. Probably much. much more money than they would have made under Paulson’s plan.

    What is likely to happen is that private investors are going to be buying mortgage securities at current market rates, once it becomes clear that the world isn’t going to end, the value of these securities is going to go up by a huge amount, leaving lots of hedge fund people very wealthy.

    Before anyone complains about a secret government bailout…. Let me explain why this is happening….

    1) The government has to pump money into the banks. If the US government walks away, people’s checking accounts become worthless. That’s not going to happen.

    2) Banks need cash now. They would like to hold on to the securities, but that need cash now to loan out.

    3) If the government pays any money for the mortgage securities, people are going to be screaming “bailout”. This is especially the case of the government pays more than current market rates for them.

    4) You can’t force people to sign something that they think won’t be good for them. If the government forces private investors to take losses, then you won’t find any private investors. You can try to mix the gains and losses, but after Merrill-Lynch, no one is going to do that.

    So what is going to happen is that Treasury puts money into the banking system to keep it from collapsing. It gets private investors to purchase mortgage backed securities. It will be presented (truthfully) as a way of saving taxpayer money.

    What I want people to do is to accept some responsibility for their decisions, and not to get too upset when people start making huge amounts of money from what is now worthless junk. You had the chance to have Treasury buy the assets under Paulson’s plan, passed it up, so if someone else makes huge amounts of money from it, they deserve it, and don’t complain about any back room deals, because everything here was above board.

    This also goes for people that think the US economy is doomed. If someone bets that the economy is not, and then two to three years from now they make heaping large amounts of money from that bet, you shouldn’t complain about that. Personally, I think it is a sucker bet.

    You can tax capital gains heavily to get some of the money back.

    One final thing. I could be lying or wrong. It could be that the assets that I claim will be valuable in two years are really worthless, and being the evil investment banker that I am, I’m trying to off load junk on the taxpayer. Or I could be sincere and just wrong. Maybe it is a good thing that you off load junk to private investors.

    Or maybe not…..

  • Posted by cdr

    About the fiscal policy
    1. Envelopes show that the sum, that’s currently under consideration, will in effect cause the stick for the gap jump to shorten by half (for the purpose of doing the job).
    2. The direction and timing of spending currently aims to replacing the missing C with a G (intended for winning the 2010 – buy American – election). The original preaching labels such a plan as “misdirection”.

  • Posted by david_in_ct

    Twofish: How money gets created is a very interesting topic, but I don’t see how you can prevent private creation of money. If I write you an IOU and people start trusting my IOU’s, then I’ve just created money. It so happens that people trust US Government IOU’s more than they trust my IOU’s, but if you restrict government issued IOU’s then you end up with lots of private people issuing their IOU’s.

    You could not nor would you want to prevent private creation of credit. The BIG difference would be that private parties could not create the unit of account. While there would certainly be a price and an exchange rate for private credit this is vastly different from the issuance of new legal tender. I think from an analytical standpoint (and a fair banking system) it is far cleaner to disentangle federal reserve notes from any and all calls upon them.

    The quantity of Twofish notes would be unlimited but their only conversion to legal tender would be a market based one. Now it is largely up to a bank credit officer to decide whether a checkable deposit magically appears. There are a complex web of restraints placed on the bank in the current system which attempt to manage this process but we have just witnessed their spectacular failure mainly because of the inherent conflict of interest which resided within the banking system. The more money banks lend the bigger the call option they are generating for themselves. Since they can create vastly more credit exposure for themselves than their capital base, beyond a certain tipping point it makes perfect economic sense for them to lever up to the moon. Which is exactly what happened.

    By splitting the two pieces there would be investment banks, and for lack of a better term vault banks. Vault banks would simply hold your units of account and provide checking services. Investment banks would take your federal reserve notes and invest them in other things. While they were invested you would not have access to them. No different than a hedge fund.

  • Posted by Twofish

    david_in_ct: You could not nor would you want to prevent private creation of credit. The BIG difference would be that private parties could not create the unit of account. While there would certainly be a price and an exchange rate for private credit this is vastly different from the issuance of new legal tender

    I don’t see how this would be a big difference. Except for very small transactions, people rarely use legal tender to make economic exchanges. If you show up to a buy a car with a suitcase full of cash, rather than a check, then people will look at you very strangely.

    Unless you actually using the physical green stuff, you are not using government created money or legal tender.

    david_in_ct: . Since they can create vastly more credit exposure for themselves than their capital base, beyond a certain tipping point it makes perfect economic sense for them to lever up to the moon. Which is exactly what happened.

    Which is why banks need to be heavily regulated, and bad things happen when they are not.

    david_in_ct: Vault banks would simply hold your units of account and provide checking services. Investment banks would take your federal reserve notes and invest them in other things. While they were invested you would not have access to them. No different than a hedge fund.

    What’s in the vault? One problem you have is that most checks, savings accounts and money market accounts are not backed by paper dollars, and you are going to have to massively contract the money supply if you want anything to fit inside the vault.

    The trouble with this is that pretty soon you would end up with a “shadow banking system” in which people started making direct exchanges of IOU’s. At which point you end up pretty much where we are now.

  • Posted by david_in_ct

    Twofish: I don’t see how this would be a big difference. Except for very small transactions, people rarely use legal tender to make economic exchanges. If you show up to a buy a car with a suitcase full of cash, rather than a check, then people will look at you very strangely.

    Unless you actually using the physical green stuff, you are not using government created money or legal tender.

    david: This is just not correct. When you show up to a car dealer ship to buy car even if you use a check you are using legal tender irrespective of whether the frn were created by the Fed or by the bank. Every checkable dollar in the system is exchangeable for foldable green on demand.
    The only way that checkable deposits come into being are either because the money is first printed by the fed and used to monetize some treasury debt, OR and this is the big one, the bank loans it into existence in your checking account. When a bank does this they do not remove the money from someone else’s checking account, it just gets created from nothing.

    Twofish:What’s in the vault? One problem you have is that most checks, savings accounts and money market accounts are not backed by paper dollars, and you are going to have to massively contract the money supply if you want anything to fit inside the vault.

    The trouble with this is that pretty soon you would end up with a “shadow banking system” in which people started making direct exchanges of IOU’s. At which point you end up pretty much where we are now.

    David: There is a big difference between a money market fund and a checkable deposit and there should be. One is pure cash which is convertible on demand to green the other is an investment in short term debt which needs to be sold to someone with cash. Cash should have no return but also no risk.

    It would exactly be what was needed if people made more direct exchanges of IOU’s. I suspect that you would think for more than an instant before exchanging your labor for david_in_ct redbacks. This is a good thing.

    As it stands now, once the Fed has had their bimonthly meeting, the banks then make virtually all the decisions with regards to whether or not the base money supply will grow. Again, base money (cash and checking accounts which represent cash) grows as a function of Fed printing FRN’s and monetizing treasury debt (bill passes) or loan origination at a bank. When loans are made where a bank is not a counterparty there is no change in the base money supply. This difference in crucial.

  • Posted by df

    I sure don’t see anything surprising. The global debt bubble as exploded.
    There s no demande for debt, hence money growth can not happen any more through new loans.
    Everything is happening as explained 60 years ago by K. Polanyi.
    If you let markets rule money creation, they create bubbles and bust. We are in a bust. One like 1929, but worse since Debt/GDP ratio is worse.

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