Friday, July 25, 2008

Bailout, and government response - other view

There is an interesting post today at naked capitalism: Stiglitz; "Fannie’s and Freddie’s free lunch about justification of bailouts. US government is busy bailing out over-aggressive risk taking institutions with risk-averse sweat-and-blood money of the taxpayer who is more concerned about ways of paying his dues in a gloomy job market. This is wrong. But situation has grey areas when viewed from government side.

The institutions blame their woes on a US slowdown unashamedly pointing finger at the maxed out US consumer who has loan is past, present and future earnings to the devil himself. Let me remind you that these were the very devils who cheered on the US consumer down the valley of distress as they minted money at his/her expense. They sacrificed the consumer for the shareholder. As a reward, their shareholders lavished the boards and executives with benefits and bonuses. Today the US government is doing the exact reverse thing. It is bailing out the carefree risk-lords with shareholders’ money. At both side it is the layman at the receiving end. Yet it is not so simple.

From a government’s perch, the reality is confusing. Institutions are taxpayers themselves and hence stakeholders. They are also income sources and service providers for citizens. A large number of institutions are foreign exchange earners for their country. Governments view certain sectors as drivers of competitive advantage. US views finance and money management as its competitive advantage. A government might opine that a running system is easier to coax into order than let the system falter. Yet whatever the reason, they must be elaborated and opened to public scrutiny.

There are of course many lessons from the current crisis. Arnold Kling has thrown in his perspective here. However, that is when the sun breaks out. Right now, from within the eye of the storm, things are more difficult and often survival or preservation always gains top priority. We tend to salvage whatever we can even disregarding our lives. The roar of the catastrophy drowns the calls of prudence. I believe something similar is happening with governments globally. In their rush to do something – they may not necessarily do the right thing.

A comprehensive regulatory overhaul is definitely a take-away from this crisis. I believe, it is also important to take this regulation global. Further, taxation and social security needs to be overhauled. At the farthest “public goods” need to be defined and reworked. The most essential takeaway will be a disaster control program that tests scenarios and develops action plans to emergency alleviation. The system of academics, consultants and media (what we have currently) does not create enough accountability to identify scenarios and develop action plan. No doubt the system currently does that. But it is not treated seriously enough to become a disaster management system. Else the forecasts of lot of bloggers (including high profile ones like Dr. Roubini) would have triggered an enquiry.

Wednesday, July 23, 2008

Dollar and Yuan

We have two dramatic posts one detailing dethroning of the dollar at Vox and Yves Smith points to possible slow appreciation of Yuan here naked capitalism: China to Slow Yuan Appreciation? This is the essential dilemma that global central banks face today. The artificial currency pegs that Dr. Roubini calls Bretton Woods 2.

The first part dollar dethroning indicates that in the long term countries should not keep pegged to the dollar. The second argues that in the near term, China would refrain from un-pegging from the dollar. Now this is classic! If China sticks on to dollar too long, it will have to contend with inflation and systemic issues including devaluing reserves. On the other hand if goes for one-off devaluation it will expose its exports sector to global competition abruptly. But it will bring 300 million Chinese (the affluent ones) into the global consumer community. At the moment, that will be a big blessing.

Current exchange rate system is creating / forcing people to be global workers and local consumers. This benefits the local economy at the expense of global systemic balance. To ensure counter balancing we need global consumers and global workers supported by global capital and global regulation. By embracing the globalized system, all nations have committed to this balanced cooperative world vision. And I hope nothing we do can upset this eutopian step.

Tuesday, July 22, 2008

How did Germany avoid great inflation in 1979? � Mostly Economics

How did Germany avoid great inflation in 1979? Mostly Economics
Amol Agarwal points to interesting paper relating to German experience with inflation during the 1979 slowdown. Broadly the learning implies controlling the money supply using predictable medium term targets.

I do not believe at this stage simple controlling will help. This might result in excess money, accumulated in one part of the system (or big money), broadcasting it into the broader system. This permeation will absolutely guarantee high inflation. Conversely, less painful (for the masses) solution may be to keep excess money localized and slowly suck it out of the system.

In the US/UK today, the excess money has already permeated through the system. Increased debt burden and consumption triggered by rising house prices have already spread the excess money deep and wide. Hence a monetary tightening at this stage will have high adverse impact on US/UK population. More money in the system and alive and kicking employment alone could have been a solution if it weren't for the high household debt. Household debt burden simply inflates if value of money goes down. Hence bankruptcy laws and loop-holes therein are most critical. Prof. Elizabeth Warren realizes this and hence her strong emphasis on modification to bankruptcy laws. I understand South Korea, Australia and EU are in same situation as US/UK.

In the rest of the world, the money has not permeated as well. Sovereign funds, reserves and to some extent big money have limited the spread. In any case situation is better than US/UK. Here monetary tightening might be a useful tool. Emerging markets and other countries could do better than emulate the west in this regard.

The future is tough! Let us just hope we don't forget the lesson this time!

Tuesday, July 15, 2008

Rising commodity prices, excess money and bailouts

World is definitely in perilous situation. Expenses are rising thanks to commodity price increase. Households incomes are falling as businesses fail. Growth is slowing thanks to high cost of debt. Investments are stuck as selling assets at crazy prices is no longer possible. Only thing rising is commodity prices!

Commodity prices - what drives them?
To understand this, we need to go to first principles wherein goods and money are tradable. From here it follows that when the value of money looses its way - goods will be the lodestone, the compass. After all money is used FOR goods! We need to realise that money by itself means nothing. Money is intermediary, a common denominator amongst goods. The best mechanism to protect oneself from arbitrary manifestation of value of money is to have the goods! This has prompted the rush for commodities - the most standardized goods available to international financial community. And naturally, the prices of commodities and goods have lined themselves up in the pecking order of importance to the society. Naturally oil (presumably inelastic demand) pegs itself at the very top.

Cancerous growth of money!
Excess money is one of the root causes of the current situation. The excess money flow was further exaggerated by pegged exchange rates. Initially the increased money supply was cornered effectively by small group, mainly Central banks (reserves) and investors(wealth). The excess liquidity did not reach the masses inflation symptom was masked. The situation seemed like positive spiral. Reserves became trophies and wealth always was one. The ensuing trophy-chase, magnified by leverage, soon trounced one asset class after other. And then we hit the tipping point. Today we are bailing out the first casualties of calamity. The bailout mechanism is infusing more liquidity into the system. Like fighting cancer with cancer or fire with fire. And most likely we will be left with ashes or cancer!

Is capital destruction reasonable solution?
Capital destruction is a painful but sure-fire solution. The least we can do is to stop excess capital creation - that means bailouts will be few and far between. Further on unpegging exchange rates will help destroy some excesses. Write-offs will destroy some more. In worst case only the last person caught holding the bag will be hit. In reasonable circumstances, they will be rehabilitated. In best case - we can rewind and restart where we left off.