Friday, October 29, 2010

An Excellent Idea

According to Bloomberg: "President Barack Obama will make the case that his proposal to let companies take immediate tax deductions for the full cost of new equipment will help the economy grow and create jobs by encouraging about $50 billion in new investments through 2011."

I think that's an excellent idea.  It should be expanded and embraced by other countries, as well.

In my opinion, if the developed world (US, Europe and Japan) is to transform its bankrupt consumer spending economic model (which ultimately involved unsustainable borrowing) it must undertake and sustain very large capital investment, preferably in energy and transportation infrastructure.  For example, investing in upgraded electricity grids, instead of shopping malls and ski chalets.

By definition, such an economy involves more knowledge, more technology, more highly skilled workers and more value added per hour worked.  That's exactly what "developed" is all about - or should be, anyway.  And that's exactly what our resource-stretched, environmentally-challenged world needs, right now.

It would also rather quickly reduce pernicious trade imbalances which are spilling over into the foreign exchange battleground (that's code for US-China relations and the yuan peg).

Congress should move immediately.

Friday, October 15, 2010

Making Real Things For Real People (tm)

Three years into the crisis we can say that the world did not come to an end, the economy did not fly off the cliff and markets are operating in "safe" mode.  Not to mention that Wall Street is smugly preparing to pay huge bonuses once again.  Credit must go to the Fed and Mr. Bernanke personally for making so much, well, credit available to everyone who asked for it and even to some who didn't.  

But is it, in fact, credit that we must give the Fed? 

During the past three years the Federal Reserve has assumed a role never envisaged by its founders or anyone who ever worked there - Mr. Greenspan included, I'm sure.  Despite his "heli-Ben" moniker, I even doubt if Mr. Bernanke himself ever truly believed that the Fed would have to go as far as it has under his guidance. 

Because it's one thing for the Fed to respond to challenging economic conditions by lowering interest rates down to ZIRP.  But it's quite another, a quantum leap (of faith?), to become the major shaping force of the economy by inundating it with so much money as to reverse the natural ebb and flow of capitalism, to forestall what Joseph Schumpeter called creative destruction.

They say that the road to hell is paved with good intentions, and I am afraid that we have all of us allowed Mr. Bernanke to lead us a merry journey that may end in a very hot place, indeed.  He has good intentions, undoubtedly: to "save us" from a financial meltdown which could have resulted in another Great Depression.  He has used monetary policy to an incredible extent, encouraged, it must be admitted, by an executive branch that was so intertwined with Wall Street as to be practically indistinguishable.

So, monetary and fiscal policy both opened up fire on the Great Recession using the only big guns they could bring to bear: money and government borrowing /spending.  They fired so many rounds of such heavy gauge that the "enemy" was stunned and is - at the moment - still dizzy from all the noise and smoke.

But the enemy is definitely not dead, because money-for-nothing and government spending are to him as effective as flash-bang grenades.  Lots of smoke, lots of noise - but no damage.

  • Point: The real enemy is widening income inequality.  The vast majority of people have seen their real income remain stagnant for 40 years and had to burden themselves with ever-increasing debt to make ends meet.  
Massive debt is, therefore, but the proximate cause of the crisis.  It's actually a resulting effect of the ultimate cause, which is high income disparity (see chart below).

Chart: FRB Survey of Consumer Finances

Obviously, easier credit (more debt) and government deficit spending (even more debt) do nothing to solve the income inequality problem, which can be summarized thus: lower and middle income people spend a far greater percentage of their income than the rich, who amass wealth instead. Therefore, it is imperative for the former to have growing income to maintain their spending out of earnings and keep the economy healthy.

The obvious solution, most will say, is as as old as Robin Hood: take from the rich and give to the poor.  Really?  While the egregious favoritism shown to the rich in previous tax laws must definitely be rolled back, taxation alone cannot do the job of repairing decades of yawning income inequalities.  Instead, we should pay great attention to the most fundamental economic concept of all: adding value through peoples' work.

What I am trying to say is that real incremental wealth, and the social "fairness" that results from its more equitable distribution, cannot come about from re-distribution, but only from the creation of new useful real assets that generate added value for society at large.  For example, an upgraded electric grid that reduces losses and permits two-way power flow;  such an "asset" can be put to work immediately and will generate profits (added value) for all, i.e. it's useful to the vast majority of people.  Its design, construction and maintenance will create tens, even hundreds of thousands of new, skilled jobs that will command high wages, precisely because of the grid's profitability.  That's how income gaps get smaller (think Ford, Model T, etc.).

Contrast this with trading CDS's.  While there is a small theoretical benefit to society at large from such an activity (I could argue that it's actually a cost, but that's another discussion), the benefits that accrue are not real but purely actuarial or monetary, i.e. virtual.  Furthermore, because of the nature of the financial industry itself, those benefits end up in the hands of a tiny part of the population which is already super-rich.

In conclusion: we have reached, nay surpassed, the limits of monetary and fiscal policy in dealing with this Great Recession.  What we urgently need now is -gasp- an Industrial Policy.  Yes, that's making real things for real people (tm).

P.S.  There is at least one guy who "gets it".  Robert Reich was Labor Secretary under Bill Clinton and has just come out with a book about exactly this matter.  Aftershock: The Next Economy and America's Future is well written, well argued, brief and to the point.  It also includes several workable ideas on how to close the income gap.

Sunday, October 10, 2010

The Peoples' Slice Of The Pie

Economists are forever trying to come up with theories to explain unemployment and wages.  It is always a "hot" topic, and the Bureau of Labor Statistics (BLS) monthly release on the employment situation is arguably the one statistic which can - and does - move markets most.

I won't go into the various economic theories on how wages, unemployment and inflation all come together to shape (or "clear"), the labor market.  I have a more fundamental question, instead:  How important are wages in today's economy, overall?  Or, to put it more precisely, how come we have allowed gainful employment and earned income to become so unimportant?

The following chart shows that wages and salaries as a percentage of GDP have been dropping steadily for 40 years, from a high of 54% of GDP in 1970 to a low of 43.5% this year (see chart below).  Including other forms of compensation like pension and medical benefits does not alter the picture appreciably: total compensation of employees went from 60% of GDP in 1970 to 54% this year.

Simply put, then, working people are getting a smaller slice of the economic pie.

Yeah, The Pie Is Bigger But Your Slice Is Smaller

This is as major of a transformation of the economy as it gets but it is almost never discussed by academic economists, who are forever trying to figure out how to model unemployment, or interest rates, or whatever econometric datum strikes their fancy.  It's like pondering the price of candle oil while Rome burns.  And they get Nobels for it, too!

(A small aside about the Nobel Prize for economics: it was not part of Alfred Nobel's will in 1895.  It was instituted and funded much later, in 1969, by Sweden's central bank;  it is formally known as the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.  Considering its provenance in the depths of Money Central, it's highly unlikely that a more "radical" economist is ever going to be awarded one. )

Anyway, who's been eating the Peoples' Slice Of The Pie (TM) then?

Is it proprietors of small businesses or farms?  Hardly.  Their income as a share of GDP was 8% in 1970 and it's still around 7% today.

For a clue, look at the following chart of net dividends as a percentage of GDP: they have steadily climbed over the years and literally soared after 2003 to nearly triple what they were in the 70's.

If stock ownership was even somewhat evenly distributed amongst Americans I would have no real problem with this picture.  But, it isn't - not by miles and miles. The richest 10% families owned in 2007 a mean $700,000 worth of stocks, while the next 15% owned a mere $53,000.  The rest, i.e. 75% of the people, owned next to nothing at all (see chart and table below). 

The United States, indeed the entire West, has in recent times been transformed from a society defined by the constructively paired work-income relationship, to one oriented towards an asset-debt pair.  Even worse, most assets are now owned, controlled and exploited by an ever-shrinking minority of super-rich, forcing the vast majority of the people into virtual debt slaves.  That's what Virulent Capitalism is all about, in my opinion.

But does anyone really give a hoot?  Are important economists really screaming bloody murder?  Are politicians really taking notice? The short answer is no.

Notice my main recommendation on the right: Animal Spirits is an excellent book authored by George Akerloff and Robert Shiller, two economists who hardly fit the classical model.  For example, they make mincemeat of the deeply-ensconced theory that humans are constantly acting in their so-called "rational" self interest when they make economic decisions.  Akerloff ans Shiller are willing - and scientifically able - to tear down the entire foundation upon which classical economics has been resting for centuries.

And yet...

Whilst they correctly identify the causes of the current crisis and properly point accusingly to all the proper directions, what is it that they recommend as a solution?  That the Fed should target credit expansion, i.e. make as much credit available to the economy as possible.  Not a word about the huge deficit in earned income, not a peep about the enormous asset ownership gap.  Instead, more credit, more debt for the masses.   

Sorry guys, that's plain insane.

Don't get me wrong.  Animal Spirits is an otherwise excellent book, well worth reading for its spirited departure from classical metrics-based economic theory.  Buy it, read it, profit from it.  But, my point here is that even such forward-thinking economists atavistically fall back to old remedies when faced with financial crises.  It's like a modern day doctor correctly diagnosing TB and then prescribing a long stay in a Swiss mountain sanatorium as a cure.  Well, good luck with that...

(Maybe it's because Akerloff's wife is none other than Janet Yellen.  Yup, maybe he's being very rational, after all.  From a personal peace-in-the-family standpoint, of course.  Eh...)

P.S.  This post was written during the weekend, so I should seriously consider testing myself for ESP because the Nobel committee just announced its choices for the aforementioned Economics prize - and guess what?  They gave it to three economists for their work on unemployment, job vacancies and wages.  Same old, same old unfortunately. 

Tuesday, October 5, 2010

Where's The Yen Carry Trade Now?

Three years ago I was shaking my head at the yen carry trade (As The Yen Strengthens).  Today's decision by the Bank of Japan to formally ZIRP (Zero Interest Rate Policy) itself into a corner, to - as it hopes - stop the yen from strengthening further, underscores how far the yen carry has unraveled since then.

This so-called "strategy" of borrowing yen at low interest rates to speculate in financial markets all over the world was one of the major generators of hot money and, thus, a big enabler of the bubble finance that ended up as The Crisis.

In August 2007 I estimated the size of yen-carry money at around $1 trillion, based on data from the Bank of International Settlements (BIS).  The updated chart below shows what has happened since then - I call it the rise and fall of the yen carry trade and it largely confirms my initial estimate of $1 trillion.  Notice how nominal amounts of yen FX swaps and forwards spiked upwards by about $1 trillion at the top of the bubble folly, only to come down by the same amount as soon as the bubble burst.

Data: BIS

I thought the yen carry trade to be so risky as to be downright foolish, at the time.  It made no sense to assume very high currency risk (the yen was at multi-year lows) in order to place highly leveraged bets on instruments providing very small spreads over Treasuries and over borrowing costs.  One example was buying second-tier European debt (e.g. Greek government bonds) at minuscule spreads of 50 basis points over bunds.  What followed is history, and it is still unfolding.

But now is now, and if I was a betting man - which of course I am, being in this business - I would be quite interested in putting on some new yen carry trades at this juncture.  

For the record,
  • JPY borrowing costs: essentially 0% (assuming, of course, that you can borrow at all).
  • Greek 10-year bond spreads over bunds: 800 bp
  • USD/JPY: 84