The Ripples Are Getting VERY Big

The ripples in the financial crisis pond keep getting bigger and bigger. IndyMac was just taken over by the Feds and now the behemoths Fannie and Freddie are, too. Obviously, this is very bad news: hundreds of billions of taxpayer money will be needed. Like I said in the previous post, this is orders of magnitude bigger than all previous bailouts. These are no longer ripples but waves..

And what if it doesn't work out? What if, after an initial positive knee-jerk reaction, the market prudently decides to "give" (sell to) the Treasury as much stock in Fannie and Freddie as it has , while there is big buyer? What will the government do then? Double up and buy even more? Trying to put an artificial floor under stock prices is a fool's game and always ends up creating a bigger mess.

And the size of the two GSEs is so large that a BIG mess is all but guaranteed. The real danger here is that these actions ultimately lead to a cross-infection of the Treasury bond market. If this happens the wave will be a tsunami that will wipe the US off the global financial map.

I have reason to fear, too. This is the same band of incompetents that "managed" New Orleans into near oblivion.

Insolvency Dominoes

If Fannie and Freddie are at, or near, technical insolvency (combined assets worth less than debt) as ex-Fed member William Poole said yesterday, what are we to think of every other bank in the US?

Those two GSE's alone own or guarantee nearly $6 trillion in mortgages and have another $1.45 trillion of their own bonds outstanding, so ownership of their (nominally AAA) mortgage pools and other securities is definitely widespread amongst the US and global financial institutions. And let's not forget that central banks accept such AAA repo collateral willy-nilly, to finance banks and investment banks.

This being summer (numerous alternatives to writing and reading blogs) I have but a single question:

Can everyone see the dominoes?
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Addendum, July 11

The NY Times has a story about the government considering a takeover of the two GSE's in the form of conservatorship. Well worth a read, it clearly spells out the serious problems facing such an undertaking. For example, such a move would not really solve anything because the market already assumes that Fannie and Freddie have the implied backing of the government.

There are no easy solutions here. Time has come to look for the hard ones, and take the bitter medicine as soon as possible. There is no way to sugar coat this pill - it's simply too big, orders of magnitude bigger than Bear Stearns/JP Morgan.

My opinion is to let those two behemoths wind down their business in a controlled fashion and to revert to a mortgage market backed by regular banks. Mortgage issuers would then not be able to pass the paper to Fannie and Freddie and would have to hold on to it themselves.

In my view this would be a blessing and go a long way in eventually normalizing the real estate and mortgage markets.

First Rule Of Banking - Broken

"Only lend money to those who do not need it".

This seemingly senseless maxim has been banking's cardinal rule since time immemorial. Another way to put it is this: borrowing should only be undertaken to improve returns, not to cover basic needs. Optimally, then, borrowing should be a choice, not a necessity and bankers should act accordingly.

However, lending to those who do not need the money is a ho-hum business and not very profitable. Witness the sleepy, two-martini lunch era of banking that lasted until the late 1970's. A comfortable living to be sure, but nothing to set the world on fire - or to buy mega yachts with.

But look at what happened during the last decade: banks increasingly lent to those who really needed it. Households needed to borrow heavily to buy homes and/or to supplement their dwindling income. Portfolio managers were forced to expose themselves to ever increasing leverage via exotic structures (e.g. SIV's) in order to enhance their dwindling returns from conventional securities. Investors, even conservative ones like pension and endowment funds, were forced into hedge and private equity funds because politicians left them few alternatives in a world of rapidly deteriorating demographic and labor conditions.

Well, we know what happens when bankers get greedy, break the cardinal rule and lend money to those who need it - don't we? Just ask Shylock...

The pound of flesh, which I demand of him,
Is dearly bought; 'tis mine and I will have it.
If you deny me, fie upon your law!
There is no force in the decrees of Venice.
I stand for judgment: answer; shall I have it?

May I remind all readers (bankers included) that Shylock does not get his "pound of flesh" in the end..

Pinocchio-nomics

On this Fourth of July let's pause to ponder a most basic foundation of democracy: Truth.

Unfortunately, these days economic truth is hidden behind a constellation of asterisks and footnotes, making it nearly impossible to distinguish fact from fiction. Perhaps data releases should be sung to the tune of "When You Wish Upon A Star" - complete with a picture of Pinocchio's growing nose..

Consider "core" CPI inflation for May: it came in at the astonishingly low level of 1.8% annualized. I don't know about your own level of product substitution as assumed by the Bureau of Labor Statistics, but I haven't switched from wearing shoes to wrapping my feet in old newspapers yet.

And how does one account for the discrepancy between CPI and PPI, which came in at 11% for finished goods? Not easy to do hedonic pricing on a ton of copper, eh?

Ah, well.. we can at least use the releases for starting today's barbecue. Enjoy the holiday.

Hand-basket, Stage Two

Well, I'm back from sailing and, as a reader said in a comment, all "Hell" broke loose while I was away. Putting it another way, things kinda went to hell in a hand-basket, as the saying goes...

Is this a climactic event that signifies a major bottom? No, I don't think so. It looks to me that we are in the early stages of a long, drawn-out process of reshaping the economy to a more rational model, one where corporatism, finance and markets play a smaller role. The clearest sign can be seen in politics, where Sen. Obama is successfully articulating a common sense theme: America's economy should benefit the vast majority of the people instead of a few mega-rich.

Corollary: all wealth-concentration processes will be running on reverse for years, including the biggest and most notorious of them all, i.e. speculative finance (high leverage, senseless M&A activity, etc.).

The old model is still very popular abroad, particularly in China and Russia. Despite their communist background (what a sad joke), the most extravagant excess is now happening right there. During my trip I heard a yacht broker boasting of chartering a sailing yacht for $450,000 for just one week to Russians - a big yacht (over 120 ft.), but still...

That's it for today, the employment numbers will be coming out soon and will update afterwards.

Employment numbers update.

The new positive spin mantra following economic releases is "only slightly worse than expected". That's how today's bad employment figures were labelled by the mainstream press, used to support the view that the economy is "resilient". Notice the erosion in the MoT dialectic: we have gone from "better than expected" and "in line with expectations", to "only slightly worse". I bet "one-time negative adjustment" is next.

General Observations (Plus Vacation Notice)

The share price of General Motors is plumbing lows not seen since 1982 - a sad commentary on America's once mighty automobile industry.

Is it indicative of more widespread economic trouble? With auto and parts dealers making up 22% of all retail sales - the largest sector by far - you be the judge. Remember that retail sales, even excluding restaurants and bars, account for 30% of GDP.

Data: Commerce Dept.

...and the vacation notice.

Ahoy, mates: for the next 10-12 days I shall be weighing anchor and sailing the wide blue - no computer, no Internet, no land lines, no posting. Bliss, if it weren't for the darn cell phone. Maybe it will accidentally become an offering to Poseidon after the first day..

The Trouble With Money

In broad terms money has two characteristics:

• It is a means of exchange between goods, services and labor and,
• It stores wealth.

I believe that events during the last several years are leading to money's emasculation as a storehouse of wealth. The reason, in my opinion, is that a wide variety of other, traditionally non-monetary instruments like real estate, equities, derivatives and commodities are becoming monetized.

The link between real estate and money is today quite obvious and direct: the wide securitization of mortgages created trillions in new marketable debt instruments, i.e. money, by the classical definition of credit expansion. But what about the others?

Share markets have become very liquid and deep, helped along by a dizzying variety of index and exchange traded funds, SPDRs, etc. What's the practical difference between "stocks" and "money", if the former can be transformed into the latter at a moment's notice with minimal fuss and transaction costs? And the same can credibly be said about commodities that are traded on major futures exchanges.

Other active derivatives, for example credit default swaps (CDS), can also behave like near-money. Indeed, by their very nature CDSs create money out of thin air, since they are a series of payments against stripped credit risk, i.e. a bond sheep in wolf's clothing.

What does it all mean for "traditional" monetary aggregates as published by central banks? It means they are becoming practically meaningless - there's too much of the "other" money around. That's my definition of the shadow banking system, by the way.

It also means that if/when financial markets move significantly lower there will be a lot less money around than before, with unforeseeable consequences for the economy. Simply put, we have all gotten used to lots and lots of money sloshing about.

P.S. From our "other economic indicators" dept. (the same that looks at food stamp participation, for example) comes this news bit: Delta is cutting more flights. Orlando is getting hit hard. Since this is the one-company town that Mickey built, it does not take much guesswork to deduce why Delta is cutting service there.

German - American Sentiment

Economic confidence is plunging to multi-year lows. The latest reading for the University of Michigan/Reuters index of consumer sentiment dropped to the lowest level in 27 years (see chart below, click to enlarge).

Data: St. Louis Fed/Bloomberg

Things are no better in Germany, the world's third largest economy (or fourth, depending on who's counting). The ZEW indicator of German economic sentiment just hit the lowest level in 16 years at -52.4, versus an average reading of +29.2 since 1991 (red line in the chart below).

Data: ZEW

What is interesting about both low readings is that they are occurring not because of some transient negative event (e.g. war, natural catastrophe, etc.) but are due to real, fundamental economic reasons (credit and real estate crisis, high and rising food and fuel prices). They are thus unlikely to reverse in a meaningful way any time soon.

So far, the negative sentiment has not spilled over to consumer spending in a major way. But how long can this relatively benign situation last, on both sides of the Atlantic, if sentiment continues to remain so negative?

Upcoming Flight Conditions

Reeling from zooming fuel prices, more airlines have just announced they will charge $15 for the first piece of checked luggage. Some are even starting to charge $2 for water and soft drinks. But why stop there? Here are some alternatives for the post-peak world.

1. Waste-The-Waist fares. Anyone over 100 lbs. gets charged $1/lb extra.
2. Deals-For-Meals. Planes will only carry one quarter of the meals and drinks required to serve all passengers. Attendants will then proceed to auction them off to the highest bidders. Should work particularly well on long international flights.
   
3. No Fee, No Wee. Equip all lavatories with coin-operated doors.
4. Gone With The Wind service. In a throwback to the proud clipper-ship era, airplanes won't take off for their destinations until winds are favorable. Prompt service also available at triple the price.
5. Lucky Lindy staffing levels at the flight deck. All planes flown by a single pilot.
6. Haste Makes Waste code-share flights. Actually performed by Amtrak trains.
7. No Demo, No Problemo. Planes will fly without those "life jackets are located under your seats". No heavy life-rafts and door-slides, either.
8. Slaver Layer load factors. See picture below.
   

Real GDP - Part V: Goose Eggs

The series concludes in present day America, the most global and powerful empire in the history of man. It is also the largest debtor nation by a wide margin, a curious development for a superpower. But then again, no other empire had the benefit of a worldwide fiat currency regime to help it flood the Earth with its own IOUs.

________________________________

United States, 2008 A.D.

Calculus has been dead two thousand years but his spirit lives on famously. His "financial reforms" at the orders of Debitus and Fat Flavius gave Old Rome an inch and New Rome is taking a mile. Immortality, after a fashion, for the cunning Greek...

But let us, at long last, dispense with allegory and dive into hard facts. First, the data in chart form.

Since the early 1990's debt has been rising much faster than GDP (see charts below). During 2007 nominal GDP grew by 647 billion dollars while debt of the non-financial sector increased by 2.37 trillion dollars. Total debt, i.e. including the financial sector, rose even faster by 3.96 trillion dollars. These are frightfully large numbers - where is all the extra money created by this debt going?

Annual Changes in GDP and Debt (Data: FRB Z.1 Release)

Ratios of Debt Growth to GDP Growth

Excess debt is frequently (and highly deceptively) labeled as "liquidity", giving the unaware a sense of financial comfort. Nothing is further from the truth for, in reality, it works towards the debasement of our fiat currency's purchasing power. Like Milton Friedman said, "inflation is always and everywhere a monetary phenomenon". The more dollars in circulation, above and beyond the real economy's incremental requirements, must by definition raise prices.

Let's use a simple example: if there are only one dollar and one egg in existence, the price of one egg cannot exceed $1. If, however, next year there are two eggs and three dollars around, the price of each egg may rise to $1.50.

Since the excess debt generated in the US is obviously not going into productive economic use (debt is rising much faster than GDP), this "liquidity" results in higher prices for assets like stocks, real estate, ships and even paintings or Bordeaux wine futures. And now the flood is spilling over into consumables, i.e. commodities like fuel and food.

It's a simple balance sheet: if the liability side (debt/fiat money) expands, then the asset side must expand to match it. Let this expansion go on unchecked and pretty soon you have a rapidly ballooning balance sheet, also known as a bubble.

We can call this process any manner of names, but my favorite is "goosing", as in force-feeding debt to the economy to induce unnatural growth. Turning to pictures again:

This is natural growth...

...and this is growth, American-style.

What's worse, such a debt-spinning machine eventually gets out of control and self-destructs. For 2007, I estimate that interest alone on the $43 trillion in total debt outstanding came to $3 trillion out of the $3.96 trillion in new debt that was created during the same year. In other words, three quarters of all new debt went into paying interest on the old debt - and remember that GDP rose only by $647 billion.

Putting it in dollars and eggs, nearly 4 trillion more dollars went into circulation while only 647 billion new goose eggs were hatched. No wonder then that the price of geese is rising. Furthermore, for as long as this "goosing" goes on, national accounting becomes a messy omelette. Using a fiat currency to keep accounts in such circumstances makes it impossible to distinguish between real growth and mere bubble-blowing. At a minimum we should realize that reported GDP growth bears little resemblance to thermodynamic activity which, in my opinion, is the only unfailing yardstick.

I believe that traditional macro-economic measurements like GDP, debt, etc., will soon have to be retooled or replaced entirely with new ones based on real activity (e.g. see my Greenback suggestion).

In closing this "blast from the past" series, I thank you for your kind words left in the comment section. I had lots of fun with Debitus, Flavius and Calculus and it seems you liked them, too, by Jove.

Oil In The Brain, Pie In The Sky

Looks like some people have so many dollars that it's burning a hole in their pockets. Dubai is planning to build the world's largest airport: big enough to handle 120 million passengers per year, its size will roughly equal Chicago's O'Hare and London's Heathrow put together. Putting it another way, that's 19,200 football fields. And they're planning to do it fast - it's supposed to open in 2009.

For comparison, the world's three busiest airports in 2007 were Atlanta with 90 million passengers, O'Hare with 76 million and Heathrow with 68 million. Dubai came in at number 27 with 34 million.

Question: why will 120 million people be going or passing through Dubai (pop. 1.4 million) any time soon?

Hmmm... someone(s) is getting mighty cocky down there (a.k.a. oil = $135/bbl). They better check out the meaning of the word "hubris".

Real GDP - Part IV: Tempus Fugit

Rome 72 AD

Three years after Debitus ordered Calculus to cook the books, he is no longer emperor of Rome. He was immediately overthrown by one Titus Flavius Sabinus Vespasianus [Ed. In December 69 AD]. The new emperor is known to modern historians as Vespasian.

Wikipedia has this to say about him: "Little factual information survives about Vespasian's government during the ten years he was emperor. His reign is best known for financial reforms following the demise of the Julio-Claudian dynasty, the successful campaign against Judaea, and several ambitious construction projects such as the Colosseum."

What historians don't know - but readers of this apocryphal story can quickly surmise - is that Vespasian was the younger brother of none other than our Fat Flavius, the greedy merchant and financier. Obviously, once the ball got rolling on those "financial reforms" the Flavian gang had no more use for the slow-witted Debitus, so they simply got rid of him. Rumor has it that instead of being assassinated by his own Praetorian guard - the usual method of imperial succession - he was allowed to retire in a large estate located in North Africa. He died there a few years later from excessive drinking, forgotten by everyone - history included.

On the other hand, Calculus is still head of accounts down at the Treasury, though only nominally. All day-to-day affairs are handled by Ursatalus, the young and ambitious bearded official who has risen fast under the Greek's tutelage and is now his deputy. This leaves Calculus plenty of time for other activities, for he is - curiously - still a very busy man.

Various businessmen come and go to his office all day long: timber and stone merchants, lime and cement providers, agents for sculptors and painters. He tells everyone that in this way he keeps a sharp eye on the economy, and controls building costs for the Flavian Amphitheater, which in now rising smartly. Interestingly, he never meets with bankers leaving them instead to deal with Ursatalus. No one can prove it, but those in the know say that Calculus' sudden interest in commodities is because he owns a couple of small quarries or gravel pits that provide a bit of material to the building contractors.

They are wide of the mark. The foxy Greek owns a great many businesses that supply everything from sand, stone, timber and rope, to fine marble and sculptures. He bought them on the cheap exactly three years ago and was smart going about it: knowing that Fat Flavius would seek to profit outrageously from building the amphitheater, he only purchased small, obscure businesses that no one was interested in. Everything was done quickly and quietly through nominee and dummy owners set up in Alexandria, Naples, Marseilles and Syracuse [Ed.: old Greek colonies] - none in Rome itself. Calculus' name appears nowhere, not even in the accounts he opened with two merchant bankers in Rhodes.

When put together, however, his collection of modest companies is currently supplying at least 10% of everything that is going into the Colosseum - for this is what Romans are already calling it. Calculus is quietly and slowly becoming a very rich man on this small portion of the pie, letting the big dogs fight it out over the larger part. By design, then, his commercial activities are too small to provoke any interest. In addition, he is still going about his life exactly as before, down to frequently getting his bread from the plebes' dole.

The same cannot be said of Ursatalus. After being appointed as Calculus' deputy, he started putting on airs. First, he moved to a small but sumptuous villa on Palatine Hill bought by borrowing heavily from Flavius, who was more than happy to provide a low-interest loan and have him under his thumb. He also keeps a chariot and a team of four beautiful stallions which he frequently enters -and bets heavily on - at the races held in Circus Maximus. Not being familiar with racehorses he mostly loses and Flavius covers him there, too.

Racing in the Circus Maximus

Understandably, Ursatalus more than compensates by letting the merchants and bankers run wild with their demands on the Imperial Treasury. Their most outrageous ruse is to present the Treasury with heavily shaved gold coins and to receive whole ones in exchange. Ursatalus has the deficient aurei melted down and mints new, full-weight ones, adding the missing gold from the Treasury's reserves. But the most common trick is for the Treasury to borrow money at 6% per annum, while at the same time lending out funds at 3%, usually to the very same bankers who lend it the money in the first place. The Flavian Gang is making a mint, literally.

Calculus is well aware of what is going on but is wise enough to keep quiet. The Flavians, from the Emperor on down, are entirely ruthless and amoral. Slicing his throat would be no different from casually wringing a chicken's neck for dinner. The once proud and powerful Senate has long ceased to function as a counterweight to balance the Emperors' absolute powers and, though all edicts still bear the vaunted SPQR* signature, everyone knows it's just for show.

Calculus is also silent about the Imperial accounts, as maintained by Ursatalus. They keep showing constant and robust economic activity for the empire. Every time the Treasury borrows heavily to pay for the Colosseum and associated projects, "growth" is shown to be taking place. Added with all other frauds perpetrated by the Flavian Gang, it has gotten to the point where every year total debt - public and private - is increasing four or five times faster than the economy. Where is all the extra money going? In the Gang's pockets, of course.

This lucrative smoke and mirrors was Calculus' greatest "financial reform", three years ago. He changed the rules so that Treasury bookkeepers no longer had to subtract new debt from gross Imperial income to arrive at a net figure. Instead, he devised a system of accounting such that liabilities and assets (usually entirely fictional) appear in separate columns, as do debits and credits [Ed. Double-entry accounting was "re-discovered" over 1,400 years later by one Luca Pacioli, an Italian mathematician]. In that way, accounts can be swollen and fudged at will, never having to touch base with reality.

In a wicked way, Calculus is very proud of his creation and does not much care for what happens to Rome anymore. He has decided it is time to retire - to Rhodes, as we already know. He has notified Ursatalus that he will recommend him as his successor to Emperor Vespasian - a joke, of course, since the Flavians would have no one else, anyway. Ursatalus is salivating at the extra income, fool that he is.

At his last audition with the emperor, Calculus bows and scrapes a bit more than usual, feints a bit of gout and rheumatism and laments his old age. He politely expresses his fervent wish to see his homeland once again before Death takes him - soon now, he tells the emperor.

"Tempus fugit, my lord" he shakes his head, "and for us mortals Atropos*** always cuts our thread of life with her shears much sooner than we wish. I beg of you to allow me to retire in peace in the island of Rhodes, away from my duties in Rome. Young Ursatalus is doing famously, as you know, so what few talents I still possess won't be missed."

It's not necessary to recount the entire conversation here - one can easily imagine it. Fast, perfunctory and totally without emotion. Calculus is out of the Palace in less than fifteen minutes: a shamefully short time for a lifetime of devoted work. Yet the Greek is elated. Freed at last from his daily grind, which had only gotten worse in the last three years, he does not even await for the Senate's official bestowal of his recognition as Creativus. His few belongings already packed, within the hour he is on the Via Ostiensis leading to the Port of Ostia and a waiting ship.

There is another minor detail: upon his arrival in Rhodes his ship passed under The Colossus, the giant statue of Apollo that straddled the entrance of the harbor. A faint smile crossed Calculus' face as he looked up.


A few days later he secretly paid one hundred aurei - a very considerable sum - to have the following graffito chiseled upon Colossus, the deed covered by darkness of night. It was placed directly under the god's groin and in small letters it said:

Timeo Danaos Nunc Dona Ferentes

Calculus made sure that "nunc" was in italics. Like most educated foreigners, the Greek's knowledge of Latin was perfect - more than nearly every native speaker's.

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*SPQR- Senatus Populusque Romanus: (In the name of) The Senate and People of Rome.
**Tempus Fugit: Time flies.
***Atropos: The third and oldest of the Fates.

Note: Real GDP will conclude with a follow-up technical post, based on my idea that we should subtract debt increases from nominal GDP growth. Sorry, no toga party.

Real GDP - Part III: Let The Games Begin

After receiving his marching orders from Emperor Debitus, Calculus walked slowly down Palatine Hill, heading towards the Forum and his official chambers at the Treasury basilica. He was in deep, troubled thought.

On the one hand he felt professional rage at being ordered to manipulate the Imperial books to accommodate Flavius' boondogle. Up to now he was always scrupulous in his accounting, down to the last copper as that crossed his books. Given its size and nature, the overhaul required by Debitus would entail smoke and mirrors on a grand scale, with a similar-sized reduction in his own integrity as a public servant. Old, stammering Emperor Claudius would be horrified. But then again, he was long dead and safely ensconced in Elysium, along with the rest of his god-like kin. What care had gods of earthly matters?

And thus, on the other hand Calculus pondered how to best accomplish the task set before him. The emperor was menacingly clear: cook the books or get ready for an immediate trip to Hades - a very unpleasant choice. Though just over 70, Calculus was still in fine health and his mind was sharper than ever. He was by no means ready to throw his life away, and despite some rumors from Judea, he had never seen anyone come back from the underworld, no matter how righteous. He would have to comply with Debitus' wishes.

As he saw it, the task involved two issues: the assumption of an enormous amount of long-term debt, and the proper accounting of the eventual activities - the games themselves - in the national accounts [Ed.: today's GDP].

The Imperial Treasury had certainly borrowed money before, but always relatively modest sums and for short periods of time. For example, if a year's harvest failed and grain had to be imported from abroad to feed the people, the Treasury contracted with wealthy grain merchants who also financed the purchase until next year's harvest. Building the Flavian amphitheater, however, would require borrowing ever increasing sums of money for at least 10 years - that's how long it would take to complete it. Perhaps a creative modification of the aqueduct construction model would suffice, thought Calculus. "Hmmm... maybe we should think of it as financial engineering" he mumbled to himself.

Dealing with the second issue, the accounting of income and expense from the games, was far more difficult. Naturally, slaughter was one of Rome's mainstays, but it was always done for a solid business purpose. Namely, the conquest of more lands to increase the productive assets of the Empire in foodstuffs, timber, metals and slaves. In other words, there was profit in waging war successfully and sensibly. But slaughter inside an arena in Rome? Now, that was senseless - indeed, it would forever show a net loss. Add depreciation of human and physical capital plus interest charges, and the whole thing was a bottomless pit of ruin. Ruin for the Imperial Purse and, by extension, ruin for the entire economy.

Obviously, those who ran the show would reap huge profits. Not only would they charge an arm and a leg to construct and finance the arena, they would also provide the gladiators and beasts at a markup, hold the food and slave concessions and control the bookies taking all the bets. It would quickly result in a vast transfer of wealth from the public at large to a select few bloodsuckers - fat Flavius and his unscrupulous gang. Calculus could easily predict that in just a few decades the lower patrician classes [Ed. today's middle class] would have to go into debt in order to survive and, once stripped of all assets, ultimately be forced into indentured slavery in lieu of their debts.

And yet, Calculus had to somehow find a way to portray this constant ruination as a net economic benefit, year after year! [Ed. in today's terms, show real annual GDP growth].

Well, it serves Romans right, he thought. These days everyone simply minded his own business. However, as a well educated Greek he knew his Thucydides by heart: "We regard him who does not get involved in public affairs not as minding his own business, but as a wholly useless man."* While a Republic demanded participation, all that a dictatorship asked for was sloth. And if the citizens of Rome wished to be useless, who was he to stop them? So be it: Let the games begin.

With these thoughts still fresh in his mind, Calculus entered the Treasury and immediately called for Ursatalus**, a newly hired official with a talent for complicated mathematical calculations. Unlike most Romans who preferred to be clean-shaved, he sported a scraggly beard. Calculus quickly laid out his plan and set him to work demolishing the Empire's financial foundation.

Bust of a bearded Roman, ca. 75-150 AD

End of Part III
(Note: This is getting longer than I thought. There will be at least one more installment).

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*Thucydides: Funerary Oration by Pericles
**ursa: bear, talus: ankle

Monster, Unemployment and Food Stamps

While our team of dedicated researchers (persons: 1, but with a vivid imagination) continues to dig and shift the archeological evidence to prepare Real GDP - Part III, current events are also unfolding.

The Monster Employment Index of online job postings is continuing to weaken on a year-to-year basis, with May down 12% from the previous year. It should be noted that this index is not seasonally adjusted, so annual comparisons are more appropriate.

Data: Monster Worldwide

Continuing claims for unemployment insurance (4-wk avg.) are rising sharply. People getting laid off are having a harder time finding new jobs and are staying on unemployment rolls longer.


Finally, participation in the Food Stamp program is also rising fast. In March (latest data available) 27.9 million Americans received food benefits, up 230,000 from February and 1.5 million more than last year. Excluding the months immediately following the hurricane Katrina disaster, this is the highest number ever.

Real GDP - Part II: Alea Jacta Est

Our story continues the day after Flavius' meeting with Emperor Debitus Subitus.

It is but a few minutes after dawn but Calculus, the Treasury official, has already arrived at the Palatine Hill villa. He has barely slept during the night. Impatiently waiting for the emperor in one of the antechambers, he is cursing and mumbling under his breath and a series of nasty scowls animates his face.

Though somewhat surprised by his early arrival, the servants don't pay him much attention. Disagreeable behavior is common for the old, latinized Greek and after being searched for hidden weapons he is left alone. He rejects an offer of sweet wine and bread to break his fast while he waits and that is surprising, for he is notoriously stingy. He frequently avails himself of the plebes' daily bread dole, even though as a public official he draws an ample salary and lives alone.

The emperor is still fast asleep. Last evening's banquet was a smashing success - in his own estimation, anyway. He had ordered the banqueting couches to be arranged in a circle at the triclinium maius* and Flavius' magnificent amphitheater model placed at the center. Every time he caught a member of the Athenian delegation glancing at it he pestered him mercilessly.

"This is going to be the greatest architectural achievement in all of the Empire, eh Theodotus?"

"And it's practical, too, don't you think Aristobulus? Not at all like the Parthenon - after all, yours is just a temple. Where's the profit in that, I ask you? Now, we Romans possess a commercial mind, above all!"

"A wonder for the ages ready to rise before your very own eyes, Dionysus! Behold a modern three-way nuptial between art, commerce and Roman martial virtue. Ictinus and Callicrates**? Pshaw!"

Banqueting in Rome

Eventually it got so tedious that all guests just stared at the ceiling, but the emperor didn't notice. By then he was completely drunk with the fine wine the Athenians had brought as a last-minute gift. Perhaps they were warned by the Scythians about the plonk served at the palace these days, because one of them was earlier seen at the market making hurried arrangements to buy several amphorae of an excellent red from Chios.

At least they didn't have to suffer two indignities at once. Ostentatious Roman blather plus piss to drink would have been too much, even for Stoics.

Admittedly, the entertainment got much better later at night, particularly after Debitus passed out and shut up. Say what you may about the Romans, they still knew how to throw an orgy, so the Athenians were at least well compensated for having to suffer the Caesar's indignities. In fact, they got more of their own back with the Roman matrons, who were quite partial to Greeks and always looked forward to their visits.

A Roman Party Gets Going

In the event, the emperor did not rise from his bed until well past noon. Looking up from his breakfast table (just honeyed water and bread this morning), Debitus saw through bleary eyes his approaching advisor and scoffed.

"Calculus, you look like you sucked lemons for breakfast again. What ill wind brings you to my presence so early? Does the Treasury have to start selling eggs from the sacred Capitoline geese to make a few coppers?"

Calculus was so incensed that he did not even bother with the obligatory obeisance - a protocol infraction that should have earned him a severe caning, at least - and immediately let out with a rant. It was boiling inside his head ever since Flavius had left the Treasury yesterday afternoon, so what came out was mostly steam.

"Debitus Maximus Messopotamicus, have you gone mad? What is this crook Flavius telling me? We are to borrow immense sums to build a..a.. theater and then constantly hold games? Turn Rome into a hurly-burly of gladiators, jesters and wild animals? How shall I keep my accounts in order? With what income am I supposed to balance the interest expense from the mountain of debt?"

His arms thrust out in animation, Calculus continued his tirade.

"This arena - which that snake Flavius calls an asset - will cost us a fortune to build and maintain. And for what use? To have gladiators and beasts slaughter and maul each other inside it daily. Another fortune going up in smoke - and I mean it literally, for the funeral pyres will be lit all the time. A bunch of assets depreciating inside another depreciating asset, Hermes help me."

"Flavius even suggested that we feed heretics to the animals: a win-win-win situation, he called it. A show for the people, dinner for the animals and good riddance to the troublemakers. I can see the sense in this versus crucifying - but as for the rest.. nuts! Debitus Subitus, I can't agree to this parody of proper national accounting and I shall take no part in it."

The emperor at first watched Calculus with amusement, but eventually he had to draw a line. For his impropriety this fool should be chained inside a sack with a couple of wild cats and tossed in the Tiber, but he still had his uses. Proper-looking accounts were still necessary for maintaining the empire's image.

"Listen, you stupid old Greek goat!" boomed Debitus. "My uncle Claudius may have appreciated your talents and installed you as head cicer*** counter down at the Treasury - but I am not my uncle. He may have believed that "right makes might", but let me tell you: the times, they are a-changing. In today's Rome "might makes right", so what I say, goes - understand?"

"No, don't answer. In fact, one more word out of your foul mouth and I will have my guard chop you into so many pieces that you will prove Democritus' theory^. Better yet, I will feed you to my zoo lions. Then you will discover what dinner and a show at Caesar's Palace really means. So, shut up and listen carefully."

After long years as a public servant, Calculus had survived enough imperial eruptions to know that silent discretion was always the better part of valour - and he had clearly overdone his rant today. So he quickly bowed and kept still as the emperor continued in a somewhat less threatening tone.

"I have decided to proceed with Flavius' plan. You will go back to the Treasury and do what you must to balance your books. I don't give a rat's ass if they are proper, just so long as they look proper. This is my Imperial decision and it is final: alea jacta est^^, as the Divine Julius used to say."

"Now get out of my sight and leave me in peace. The Athenian's wine is getting it's revenge on me." Debitus rested his head inside his cupped hands and moaned "Timeo Danaos et dona ferentes.@"

Calculus left and did as he was told.

Now, for the sake of historical completeness, a bit more on him before the story continues.

After three more years at the Treasury, during which he presided over one of the most sweeping overhauls of national accounting, he was given a modest pension and an honorary title by the Senate. Henceforth he was to be known as Calculus Creativus.

With his savings he was able to purchase Tiberius' old villa in Rhodes and he retired there in considerable style. This surprised everyone because, though real estate prices were quite weak by then, such villas were by no means cheap and his pension was not exactly princely. When it came to rewarding others with their own money, the Romans were incredible cheapskates. No, everyone realized that the money had to have come from elsewhere.

Suspecting foul play, the Senate ordered an audit of Imperial accounts, but could find nothing. The cunning Greek's accounts certainly looked proper. Under questioning he resolutely repeated that he always followed orders. He was eventually left alone.


Calculus lived to see the Flavian Amphitheater built and hailed as the Colosseum, though he never set a foot in it since he never returned from Rhodes. When asked if this wasn't the height of Rome's glory, he shook his head sadly and replied that no, this was the height of Rome's folly. He died quietly in his sleep, aged 104.

End of Part II

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*triclinium maius: formal dining room.
** Ictinus and Callicrates: architects of the Parthenon, 5th century BC.
*** cicer: bean
^Democritus was the father of atomic theory.
^^alea jacta est: the die is cast.
@Timeo Danaos et dona ferentes: beware Greeks bearing gifts.

Real GDP - Part I: Ave Caesar

Recently I have been thinking about a better way to measure real GDP growth, one that takes debt into account.

Lo and behold, rigorous academic research ( a weekend dozing at the beach) has uncovered a trove of heretofore unexamined historical information on the subject. It is now turned into a III-part series for your enjoyment (film rights available).

Have fun...

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Rome, 69 A.D.

The Empire is ruled fitfully by one Debitus Subitus Messopotamicus - a name frequently shortened to Dubious by his numerous enemies - an Emperor whose later reign becomes curiously shrouded in obscurity. An episode is playing out unknown to modern-day historians, because the otherwise meticulous annals of Rome were wiped clean of every mention. The eradication was not performed to protect the innocent - there were none left in Latium by then - but to perpetuate the devious conspiracy that was hatched at the time, and which is still with us to this day.

Our story begins in early summer. A pall of tenuous unease is settled over the Eternal City. It seems as if all drive and ambition have been sucked out of once mighty Rome.

It is late morning and at his villa on Palatine Hill Emperor Debitus has just finished his breakfast of fresh figs, bread and honey. As he absently gazes over the rooftops below, his guard announces the unexpected visit of Flavius, the grains merchant and financier whose immense wealth and girth are only exceeded by his greed.

"Ave Caesar, may Vesta's graces be with us today", greets Flavius at the entrance of the emperor's day-chamber, before strolling inside with an ease that belies his size. His senatorial toga bordered in crimson is spotless, though the methods by which he acquired it are far from its equal.

"I bring glad news, Sire. My fellow bankers and I have come up with a plan to resolve the plebe crisis."

"As you know, the people are no longer willing to enlist in the legions to fight for Rome's greater glory of conquest and loot. Our previous successes have made them unambitious and lazy. Trade with the eastern provinces provides cheap goods and strips them of the drive for gainful employment. Plus, we can't put them to work building more infrastructure projects. We have finished every aqueduct we need and all roads lead to Rome, anyway. Our state revenue is worsening by the day, Excellency, and we must find other ways to re-invigorate the growth of our economy."

What goes unsaid, but is perfectly understood even by Debitus, is that Flavius worries much more about his own purse - and that of his associates - than the reduced flow of gold into the Imperial Treasury.

"Yes, yes, Flavius. I know all this already" sighs Debitus impatiently.

"Yesterday, at the banquet for those barbarians visiting from Scythia, we had to serve a dreadful local Apulian instead of the fine import vintages we are used to. This economizing business has gone far enough. Come on then, out with it. What are we to do?"

"Caesar, our recommendation is that we establish a bread and spectacles economy. But first allow me to demonstrate with a model" says Flavius and claps his hands twice. At the sharp retort the doors are immediately thrown open and four slaves dressed in his family livery enter shouldering a large wooden platform. Upon it sits a detailed model of a fabulous amphitheater, complete with sunshade awnings made of coloured silk and clay figurines of gladiators, wild animals and spectators.

The Emperor's Box is rendered in rose marble and real gold, with a vague likeness of Subitus carved in ivory seated in a throne of jade. A small hydraulic mechanism allows the floor of the arena to rise and fall at the press of a toggle, revealing a maze of tunnels and corridors below populated by even more figurines. Clearly, no expense has been spared in the effort to impress the emperor, who is known to be immensely fond of clever toys.

As Debitus curiously examines the model without bothering to conceal his child-like delight, the financier explains his plan in hushed, yet excited, tones.

"We shall build an arena to host gladiatorial games, beast shows and all manner of circus-like spectacles. It will hold 50,000 spectators in comfort, plus hundreds of slaves, guards and animals at the lower levels. Building it will employ thousands of workers and artisans for years - but this is only the beginning."

"Imagine the turnover and profit once it starts operating: gladiators must be bought, trained, fed and armed, beasts imported from all over, stage managers employed to run the spectacles, food and drink provided to the spectators during the all-day shows. The economy will start growing briskly once more, with none of the risks involved in foreign wars. Riches will flow strongly to the Treasury and your fame shall glow bright to the ends of the world. "


"Wonderful, wonderful, Flavius! This amphitheater will be a great addition to the Circus Maximus where our chariot races are held. I can hear the crowds roar in delight already" exclaims Debitus.

But then a frown of worry quickly crosses his face.

"Wait a minute, Flavius. How are we going to pay for all this? My Imperial Treasury is nearly empty - though I have reason to believe that your own strongbox is in far better shape. We can't afford this idea of yours, can we?"

"Sire, I am but a humble servant of your Majesty and whatever small recompense I receive for my services pales by comparison to the benefits accruing to your august person", retorts Flavius in a slightly hurt tone.

"But I can easily comprehend your worries, Caesar. The Treasury is, indeed, in a temporary bind. But a simple lack of ready cash need not be of concern. We have arranged to borrow all the capital we need to get this great enterprise going. Once the amphitheater is ready the revenue it generates will greatly exceed the sums required to repay the loans. It has all been worked out - in great detail, I might add.

The look on Debitus' face reveals that he is still not convinced.

"Flavius, I know you are very clever with sums. For myself, I prefer the alea* to the abacus, yet even I can see that this enterprise of slaughter and gaming is not adding any real value to our economy. Where is the lasting production? And how are we going to keep proper accounts of income and wealth, if we simply destroy one day that which we created the day before? We might as well put the people to work continuously making and smashing clay chamberpots."

He pauses momentarily in thought and then snaps his fingers.

"Ha! By Jove, that's what this is! A potty idea, Flavius. What have you to say, to that, eh?" He brightens at once, bemused by his own feeble joke and proud that he has, at long last, found a fault in one of Flavius' endless schemes.

Flavius watches smiling and nodding obsequiously, though he is secretly amazed that this imbecile could so easily poke a hole at his plan. Well, he has to admit, it is not a perfect plan. And what plan is, these days, pray tell? No matter - he has to quickly draw the emperor's attention away, before everything that was so carefully put together is laid waste by this fool. For all his ineptness, Debitus is notoriously stubborn once his mind is set.

"Oh, no, no Sire! As you said, accounting of sums and balances is not a subject fit for Emperors. It is best left to lowly public servants and slaves - it need not bother you one bit. I shall immediately confer with the proper officials at the Imperial Treasury and explain everything to them. It's all a matter of properly balancing debits with credits, you see. Is that Greek still the chief servant in the fiscal department? What's his name, Calculus?"

"Yes, that godforsaken Calculus is keeper of the accounts down at the Treasury. He seems to have been there since the days of Romulus, if not before", grumbles Debitus clearly upset at the mention of his chief fiscal advisor. Lately, Calculus has been making a nuisance of himself with his repeated sour warnings about the parlous state of Imperial finances.

"All right then, Flavius. Go see Calculus, by all means. Better you than me. And let me keep this lovely model until you conclude your deliberations, eh? I have another banquet tonight, this time with a delegation of Athenians - and you know how uppity they are. Always bringing up Parthenon this, Acropolis that - I would love to shove their insufferable faces into this ... this ... Wonder. A Roman Wonder is it not? Roman by Jove, not Greek! Yes, yes, that'll teach them."

"Now, run along and let me inspect this magnificent model in peace. Go!" Debitus dismisses the merchant with a flick of the wrist.

Flavius smiles and bows graciously as he takes his leave, carefully stepping backward in silence. He knows not to bother the emperor any further.

Outside, he lumbers heavily into his litter, yelling menacingly to his slaves: "To the Treasury you lazy scum, before I whip the hide off your backs. Double quick." He settles his corpulent body comfortably on the silk pillows and the six long-suffering slaves raise the litter onto their shoulders.

They quickly fall into a familiar, weary trot. The basilica housing the Treasury is not far, but the day is still young.

End of Part I
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*alea: dice

And What Are We Going To Wrap Fish With?

Circulation of American newspapers has been on the decline for nearly 20 years. Consolidation of major city newspapers took its toll back in the 1980's and the internet is now accelerating the process (see charts below, 2006 latest data).

Data: Newspaper Assn. of America

The number of daily newspapers has been declining continuously since 1980.

It's unlikely that health obsessed Americans would ever eat fish 'n chips wrapped in yesterday's newsprint soaked in vinegar, but don't news-papers have certain qualities that transcend the electronic media? Reading at the beach comes immediately to mind, but there are surely others - aren't there?

And what does all this have to do with debt, credit and markets? Nothing, except for this: the summer has officially started and I am off to the beach, where I plan to read a few research reports. Printed on paper, of course!

Have a nice weekend.

The Bernanke Put: What Next?

The Fed has so far used up almost half of its balance sheet in its bailout efforts (see chart below, click to enlarge). It has accepted all manner of securities backed by mortgages, credit card receivables and auto loans in exchange for its own US Treasurys. The Fed's holdings of Treasurys have declined from 92% of assets last May, to 57% this year*.

In essence, the Fed provided - gratis, I might add - a put option which was immediately exercised by commercial and investment banks in dire straights. What will undoubtedly become known as the Bernanke put, is currently turning schlock into lucre by the bucketful. Who said the philosopher's stone doesn't exist, eh?

Data: FRB

The Fed's unprecedented actions arrested what was shaping up as a major shake-out of the shadow banking system - but at what cost?

The immediate result is that Federal Reserve Notes (i.e. US Dollars) are now backed to a very large extent by entirely price- and quality- opaque assets, issued by private banks, brokers and special purpose securitization entities. This is certainly no small matter, but not my main concern right now.

More serious, in my opinion, is the possible effect on market psychology if there is another incident similar to Bear Stearns. This is becoming increasingly likely because the real estate market continues to weaken and consumer sentiment and behaviour remain negative. (For example, Nouriel Roubini thinks that Bank of America is now unlikely to take over Countrywide.)

In such an event, market participants will immediately think as follows:

1. Damn! Whatever the Fed did, didn't really work. Here we go again.
2. Look! They have much less wiggle room in their balance sheet.
3. So! What are they going to do now? What can they do?

At that point every investor, trader and speculator will have to make up his/her own mind how to act. Given the reduced means of the Fed's balance sheet, the chances of "shoot first, ask later" are high and this means a whole lot of pain for markets.

In other words, the extensive exercise of the Bernanke put has increased the likely damage from a second round of financial turbulence.
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* Gold, SDRs and other incidental assets have been omitted for clarity - they amount to less than $20 billion, anyway.

A Progression of Curves

Prompted by yesterday's release of the S&P - Case/Shiller home price index, here is a progression of curves. All have been indexed so that 1/1/1987 = 100.

First, the index itself.

Data: S&P

Now, let's see how home prices have fared versus inflation (CPI).

Data: S&P, St. Louis Fed

OK, that was pretty interesting. Now, how about adding per capita disposable personal income? This should give us an idea about housing affordability.

Data: S&P, St. Louis Fed

Hmm... we obviously got a ways to go before balance is restored. And with markets always prone to excess, it's quite possible that prices will undershoot.

OK, let's now add one more curve, the crucial catalyst that made this "reaction" go as fast as it did: per capita household debt.

Data: S&P, St. Louis Fed

Any questions?

Well, I have one: judging from the above, is the credit crisis over?

In Memoriam: The Age of Complacency

Today, a Memorial Day special.


When supply and demand become unbalanced in a free market, prices act to bring them back into line. But if physical supply is constrained for some reason (e.g. depletion, war or embargo) prices have to rise a lot further before balance is restored. That's because in the absence of additional supply, the only alternative is to lower demand via higher prices, i.e. prices have to do double duty. This is more so for goods that exhibit relatively inelastic demand, like crude oil.

Today, the relentless drive of crude oil to over $130 per barrel spells the end of The Age of Complacency, a quarter century during which we were lulled into smugness about the price and availability of necessities like food, energy and clean water.