Bloomberg put up a headline this morning that I found eye-catching: “Stock Market ‘Bubble’ to End, Morgan Stanley Says”, http://www.bloomberg.com/apps/news?pid=20601110&sid=a.YErMIwMYKA. Ruchir Sharma, who oversees $25 billion in emerging-market stocks at Morgan Stanley, is quoted as saying “the (global stock market) rally will end as the effects of the (government) stimulus begins to fade and the credit bubble caused by easy money disappears.”
We are still learning about asset bubbles and credit bubbles so it is interesting to examine what market participants are seeing and what they are saying about the existence of bubbles and the subsequent collapse of bubbles. In this reported interview we get some insight as to how one person sees the current situation in the stock market.
“Some markets may be hurt by the diversion of government stimulus away from the economy and into stocks and other investments,” Sharma states. “Central banks globally were hoping the funds would result in an increase in credit growth, driving the economy. That remains weak in most countries.”
“Liquidity has found its way to the wrong assets,” he said. “You can take a horse to water but can’t force it to drink.”
According to Sharma, what many have been talking about with respect to the United States economy is being seen around the world. Governments have spent large amounts of money attempting to stimulate their economies and the central banks in those countries have poured liquidity into their country’s financial system in order to get credit flowing again.
Rather than the funds going directly into the spending flow, increasing economic activity, the funds have circuitously found their way into “stocks and other investments.” The diversion of these funds into “stocks and other investments” have resulted in a substantial rise in asset prices in these areas, stock markets and commodities markets, and have left productive outlets wanting for resources.
How could this situation have evolved having just gone through three recent experiences of asset or credit bubbles, the stock market bubble of the 1990s, the “bull run,” according to Sharma, “between 2003 and 2007” and the housing bubble? Don’t the policymakers have any idea of the damage they can do to a financial system and economy?
In this respect, another person, Arthur Smithers, with a “deep understanding of economics and a lifetime’s experience of financial markets” (See Martin Wolf”s “How Mistaken Ideas Helped to Bring the Economy Down” in the Financial Times: http://www.ft.com/cms/s/0/38164e12-c330-11de-8eca-00144feab49a.html.) has also questioned current values in stock markets.
Smithers has used “two fundamental measures of value” to determine the “fair value” of markets. These two measures are the “Q” valuation ratio that was developed by the economist James Tobin and the CAPE measure, the Cyclically Adjusted Price Earnings” ratio developed by the economist Robert Shiller. (The “Q” data are available from Smithers own company, Smithers & Co, http://www.smithers.co.uk/, and the CAPE data are available through Shiller’s web site relating to his book “Irrational Exuberance”, http://www.irrationalexuberance.com/index.htm.)
Both measures relating to the stock market give off very similar signals. Each measure is indicating that, currently, the stock market in the United States is 30% to 35% overvalued.
According to Smithers, and as discussed by Wolf, being overvalued, even by this amount, does not mean that the market will immediately revert back to a more reasonable price. The market may not revert back to its more fundamental value for a year or more. But, it does return to more “justified” levels. Sharma also indicates that the markets he is talking about may not return to more reasonable levels for some time.
A reason why the value of the stock market may deviate from its fair value for an extended period of time? Government policy, especially monetary policy, may “inflate credit growth and asset prices.” And, errors in monetary policy can extend on for several years. (For more on this see the book “Wall Street Revalued” just published by Smithers. Also, you can read my review of this book on Seeking Alpha: http://seekingalpha.com/article/163499-imperfect-markets-inept-central-bankers-wall-street-revalued-by-andrew-smithers.)
Wolf summarizes the work produced by Smithers: “Imperfectly efficient markets rotate around fair value. Bandwagon effects may push them a long way away from fair value. But, in the end, powerful forces will bring them back.” In other words, bubbles always burst and the balloon always comes back to earth.
Another problem associated with bubbles like this is that resources are pushed back into the same old economic sectors that had been the focus of investors in the past. That is, physical resources are going back into industries that are less productive and less robust than what they should be going into. As Sharma is quoted as saying, “A new rally globally needs to be driven by new industry groups,” not the same sectors that led “the bull market that ended in 2007.”
This is exactly the problem that I presented in my posts of October 26, http://seekingalpha.com/article/168852-the-state-of-the-economy-the-good-news-and-the-not-so-good-news, and October 27, http://seekingalpha.com/article/169130-is-it-time-for-more-economic-stimulus. The trouble with trying to “force” the economy to grow and to achieve certain objectives that are important to the politicians, the economy does not grow and develop organically.
Thus, the sluggishness of old industries is re-enforced while the opportunities connected to new, more dynamic industries are retarded. The consequences are only seen later in slower economic growth and reduced increases in productivity. But, these problems are for another time, and the politicians don’t have to focus on yet.
Thursday, October 29, 2009
Tuesday, October 27, 2009
Ecomonic Stimulus: Do We Need More?
When the history of the recent financial crisis and Great Recession is written, the basic conclusion that will be presented is that a financial crisis can be ended and a major recession turned around if the government throws massive amounts of money at the economy.
And, even after all this money is thrown at the economy, the calls for more and more stimulus remain. The lead editorial in the New York Times this morning calls for additional stimulus: see “The Case for More Stimulus”, http://www.nytimes.com/2009/10/27/opinion/27tue1.html. The Times struggles to come up with legitimate proposals for additional spending and comes up with only two: extending unemployment benefits and a program to “ease the dire financial condition of the states.” The newspaper bails out with the claim that “To be highly effective as stimulus, cash aid must be targeted to needy populations.” But, the Times can’t do any better than that.
Spending is addictive. Once you start, it is hard to stop.
Another problem, however, is that it takes time for economic systems to work things out. Sure, a “cash for clunkers” program can goose up spending in August, but September turns into a bust.
Real programs take time because the programs not only have to be designed, resources have to be assembled, and the projects have to actually get started. Then the effects of the program must work their way through the economy. “Shovel ready” programs that have an immediate economic impact on a city or a region are really few and far between, as we have seen from the initial Obama stimulus package.
So, what time frame are we looking at for government stimulus to work its way through an economy? Maybe three to five years?
And, how do you measure the effectiveness of the government stimulus? The Wall Street Journal today attempts to provide some idea of how this question might be answered: see “The Challenge in Counting Stimulus Returns”, http://online.wsj.com/article/SB125659862304009151.html#mod=todays_us_page_one. The conclusion of the author of the article is not encouraging.
Then there is the question about whether or not these programs replace or reduce other programs that would have been undertaken at this time. This is the question of the multiplier effect of government expenditures: is it above one or below one. Some of us believe that the multiplier for government spending is below 0.5. Not a very good bang for your buck!
And, what happens when people don’t see any results, or, at best, minor improvements? They start clamoring for more and more stimulus as the New York Times does today. Frustration sets in and people over-react to the situation. They want results and they want them now!
Yes, people and families are hurting. Yes, communities and states and regions are hurting. We don’t like to see the pain and would like to do something about it.
However, sometimes you can only do so much to improve the situation. The abuse that got the economy into this condition leaves no good choices for us to choose from in attempting to get out of the situation.
Was this crisis due to a failure of modern economics? I agree with the economist John Taylor who has written that this crisis actually vindicates the theory developed by modern economics. The problem was that the crisis was created by “a deviation of policy from the type of policy recommended by modern economics.” He goes on to write, “In other words, we have convincing evidence that interventionist government policies have done harm. The crisis did not occur because economic theory went wrong. It occurred because policy went wrong, because policy makers stopped paying attention to the economics.”
The conclusion one can therefore draw from this is that continuing “interventionist government policies” may not resolve the current problems but only exacerbate them. For example, if part of the problem is that families and businesses used too much debt and this helped to create the financial bust, then increasing the amount of debt outstanding in the economy is not going to resolve the problem, but may actually make it worse.
Well, throwing everything including the kitchen sink at the problem may bring the financial collapse to an end and help the economy to bottom out. But, what happens next? What happens after this massive amount of money is thrown at the economy?
For this we don’t have an answer although the New York Times does. “Ongoing economic problems are a sign that stimulus needs to be bolstered. Deficits are a serious issue, but the immediate need for stimulus trumps the longer-term need for deficit reduction. A self-reinforcing stretch of economic weakness would be far costlier than additional stimulus.”
More! That’s the answer!
And, people actually say that the talk about all the deficits is harmful to the situation. We are creating massive amounts of debt, but we can’t talk about them? Come on!!!
But, what if all the discussion about future deficits is causing people to spend less? What if the discussion about future deficits is causing people to fear that the Federal Reserve will not be able to reduce the size of its balance sheet and keep money and credit from soaring? What if the discussion about future deficits continues to result in a decline in the value of the dollar? What if the discussion about future deficits weakens American bargaining power among the rising nations in the world, China, Brazil, India, Russia, and continental Europe?
Should we stop talking about the deficit?
Or should be consider that maybe, just maybe, more is not the answer.
And, even after all this money is thrown at the economy, the calls for more and more stimulus remain. The lead editorial in the New York Times this morning calls for additional stimulus: see “The Case for More Stimulus”, http://www.nytimes.com/2009/10/27/opinion/27tue1.html. The Times struggles to come up with legitimate proposals for additional spending and comes up with only two: extending unemployment benefits and a program to “ease the dire financial condition of the states.” The newspaper bails out with the claim that “To be highly effective as stimulus, cash aid must be targeted to needy populations.” But, the Times can’t do any better than that.
Spending is addictive. Once you start, it is hard to stop.
Another problem, however, is that it takes time for economic systems to work things out. Sure, a “cash for clunkers” program can goose up spending in August, but September turns into a bust.
Real programs take time because the programs not only have to be designed, resources have to be assembled, and the projects have to actually get started. Then the effects of the program must work their way through the economy. “Shovel ready” programs that have an immediate economic impact on a city or a region are really few and far between, as we have seen from the initial Obama stimulus package.
So, what time frame are we looking at for government stimulus to work its way through an economy? Maybe three to five years?
And, how do you measure the effectiveness of the government stimulus? The Wall Street Journal today attempts to provide some idea of how this question might be answered: see “The Challenge in Counting Stimulus Returns”, http://online.wsj.com/article/SB125659862304009151.html#mod=todays_us_page_one. The conclusion of the author of the article is not encouraging.
Then there is the question about whether or not these programs replace or reduce other programs that would have been undertaken at this time. This is the question of the multiplier effect of government expenditures: is it above one or below one. Some of us believe that the multiplier for government spending is below 0.5. Not a very good bang for your buck!
And, what happens when people don’t see any results, or, at best, minor improvements? They start clamoring for more and more stimulus as the New York Times does today. Frustration sets in and people over-react to the situation. They want results and they want them now!
Yes, people and families are hurting. Yes, communities and states and regions are hurting. We don’t like to see the pain and would like to do something about it.
However, sometimes you can only do so much to improve the situation. The abuse that got the economy into this condition leaves no good choices for us to choose from in attempting to get out of the situation.
Was this crisis due to a failure of modern economics? I agree with the economist John Taylor who has written that this crisis actually vindicates the theory developed by modern economics. The problem was that the crisis was created by “a deviation of policy from the type of policy recommended by modern economics.” He goes on to write, “In other words, we have convincing evidence that interventionist government policies have done harm. The crisis did not occur because economic theory went wrong. It occurred because policy went wrong, because policy makers stopped paying attention to the economics.”
The conclusion one can therefore draw from this is that continuing “interventionist government policies” may not resolve the current problems but only exacerbate them. For example, if part of the problem is that families and businesses used too much debt and this helped to create the financial bust, then increasing the amount of debt outstanding in the economy is not going to resolve the problem, but may actually make it worse.
Well, throwing everything including the kitchen sink at the problem may bring the financial collapse to an end and help the economy to bottom out. But, what happens next? What happens after this massive amount of money is thrown at the economy?
For this we don’t have an answer although the New York Times does. “Ongoing economic problems are a sign that stimulus needs to be bolstered. Deficits are a serious issue, but the immediate need for stimulus trumps the longer-term need for deficit reduction. A self-reinforcing stretch of economic weakness would be far costlier than additional stimulus.”
More! That’s the answer!
And, people actually say that the talk about all the deficits is harmful to the situation. We are creating massive amounts of debt, but we can’t talk about them? Come on!!!
But, what if all the discussion about future deficits is causing people to spend less? What if the discussion about future deficits is causing people to fear that the Federal Reserve will not be able to reduce the size of its balance sheet and keep money and credit from soaring? What if the discussion about future deficits continues to result in a decline in the value of the dollar? What if the discussion about future deficits weakens American bargaining power among the rising nations in the world, China, Brazil, India, Russia, and continental Europe?
Should we stop talking about the deficit?
Or should be consider that maybe, just maybe, more is not the answer.
Monday, October 26, 2009
The State of the Economy and Supply Side Concerns
Several of the aggregate economic indicators are indicating that the economy has bottomed out. Industrial Production seems to have hit a bottom in June 2009 as the year-over-year rate of decline on a seasonally adjusted basis was -13.3%. Since then the negative rates of growth have fallen: in August the rate of decline was -10.4% and in September this rate dropped to -6.1%. The index has actually increased, month-over-month, beginning in July.
The decline in real Gross Domestic Product (GDP) lessened in the third quarter this year on a seasonally adjusted year-over-year basis. The greatest year-over-year decline came in the second quarter of 2009 when real GDP fell at a 3.8% annual rate over the second quarter of 2008. The first look at the third quarter number is to be released on Thursday. According to the Wall Street Journal, estimates for the third quarter over the second quarter annual rate of increase stand at a positive 3.1%. If this quarter-over-quarter rise takes place, the year-over-year rate of decline for the third quarter of 2009 will be -2.4%.
On the surface, it does look at this time as if the third quarter of 2009 will be declared the beginning of the economic recovery in the United States.
That is the good news.
The not-so-good news, to me, is the extent of the recovery. There are some areas we need to keep our eyes on in order to help us understand what is going on in the economy. These are the “supply side” conditions that indicate something else is happening in the economy other than just an economic recovery. They are conditions that tell us that some economic dislocations exist that will have to be resolved in the future if the United States economy is going to become robust once more.
The first of these areas has to do with our manufacturing capacity. Capacity utilization in September of this year stands at 70.5%, up from the trough of about 68% in June. So, capacity utilization has begun to increase.
The problem is that this capacity utilization is at a post-World War II low! But, even more important is that the previous peak in capacity utilization came in the 2005-2006 period but was just over 80% at that time. And, this peak was down from the 85% capacity utilization of the 1995-1997 period and the 1988 period. And, these peaks were down from the 87% capacity utilization of the 1978 period, which was down from the 89% rate of the 1974 period and the 90+% of the middle 1960s.
The United States has seen over the past forty years or so a deterioration of its industrial base. There is a lot of idle capacity that is in place but, for various and sundry reasons, is not being used. We can address some of these reasons in forthcoming posts. The important concern to me is that in the economic recovery we will not even us get back to the 80% range of capacity utilization. The implication of this is that unemployment will not fall as much as we would like and that business investment spending would not be very robust because firms won’t need manufacturing capacity, they already have it.
This would lead one to the conclusion that business spending will not be too strong in the recovery. But, it is a supply side problem, not a demand side problem.
And, speaking of employment, there is an unused capacity problem as far as the labor market is concerned. The official unemployment rate, the total unemployed as a percent of the civilian labor force, stood at 9.8% in September 2009. The rise over the last year is from 6.0% in September 2008.
The total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all marginally attached workers is 17.0% in September 2009 up from 10.6% in September 2008. That is, there has been a substantial increase in persons who are neither working, nor looking for work but indicate that they want a job and are available, discouraged workers and people working part time who would like to work full time.
There is a lot of unused capacity in the population as a whole. From everything we are hearing, the marginally attached and the discouraged do not have too much to hope for in the upcoming economic recovery and this doesn’t even consider the expected rise in the official unemployment rate.
The conclusion one can reach from these data is that whatever has been going on in the United States for the past 40 or 50 years has not been totally healthy for the supply side of the economy. Basically, the past 40 or 50 years has seen a lot of inflation. Since January 1961, Consumer Prices in the United States have risen by 625%, or, in other words, the real value of a dollar has decline by 86% since then.
One could easily make the argument that whatever went on in the United States over this period, it was a period of extended inflation and that such an environment was not the most productive one for economic resources. This environment resulted in a lot of unused productive capacity, in terms of physical resources but also in terms of human resources.
Current policy is doing what has been done consistently in this period, emphasized a demand side bias. An inflationary policy, created using fiscal and monetary policy to stimulate aggregate demand, has been the response to the economic slowdown. And, the policy attempts to achieve higher rates of employment by putting resources back to work at their old functions. Of course, this cannot be fully achieved as technology and other efficiencies allow new jobs to be created that do not use the old skills, or old jobs to be eliminated and excess capacity to grow. Thus, capacity utilization continues to drop and those in the workforce that are discouraged from seeking a job remain unfulfilled.
The decline in real Gross Domestic Product (GDP) lessened in the third quarter this year on a seasonally adjusted year-over-year basis. The greatest year-over-year decline came in the second quarter of 2009 when real GDP fell at a 3.8% annual rate over the second quarter of 2008. The first look at the third quarter number is to be released on Thursday. According to the Wall Street Journal, estimates for the third quarter over the second quarter annual rate of increase stand at a positive 3.1%. If this quarter-over-quarter rise takes place, the year-over-year rate of decline for the third quarter of 2009 will be -2.4%.
On the surface, it does look at this time as if the third quarter of 2009 will be declared the beginning of the economic recovery in the United States.
That is the good news.
The not-so-good news, to me, is the extent of the recovery. There are some areas we need to keep our eyes on in order to help us understand what is going on in the economy. These are the “supply side” conditions that indicate something else is happening in the economy other than just an economic recovery. They are conditions that tell us that some economic dislocations exist that will have to be resolved in the future if the United States economy is going to become robust once more.
The first of these areas has to do with our manufacturing capacity. Capacity utilization in September of this year stands at 70.5%, up from the trough of about 68% in June. So, capacity utilization has begun to increase.
The problem is that this capacity utilization is at a post-World War II low! But, even more important is that the previous peak in capacity utilization came in the 2005-2006 period but was just over 80% at that time. And, this peak was down from the 85% capacity utilization of the 1995-1997 period and the 1988 period. And, these peaks were down from the 87% capacity utilization of the 1978 period, which was down from the 89% rate of the 1974 period and the 90+% of the middle 1960s.
The United States has seen over the past forty years or so a deterioration of its industrial base. There is a lot of idle capacity that is in place but, for various and sundry reasons, is not being used. We can address some of these reasons in forthcoming posts. The important concern to me is that in the economic recovery we will not even us get back to the 80% range of capacity utilization. The implication of this is that unemployment will not fall as much as we would like and that business investment spending would not be very robust because firms won’t need manufacturing capacity, they already have it.
This would lead one to the conclusion that business spending will not be too strong in the recovery. But, it is a supply side problem, not a demand side problem.
And, speaking of employment, there is an unused capacity problem as far as the labor market is concerned. The official unemployment rate, the total unemployed as a percent of the civilian labor force, stood at 9.8% in September 2009. The rise over the last year is from 6.0% in September 2008.
The total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all marginally attached workers is 17.0% in September 2009 up from 10.6% in September 2008. That is, there has been a substantial increase in persons who are neither working, nor looking for work but indicate that they want a job and are available, discouraged workers and people working part time who would like to work full time.
There is a lot of unused capacity in the population as a whole. From everything we are hearing, the marginally attached and the discouraged do not have too much to hope for in the upcoming economic recovery and this doesn’t even consider the expected rise in the official unemployment rate.
The conclusion one can reach from these data is that whatever has been going on in the United States for the past 40 or 50 years has not been totally healthy for the supply side of the economy. Basically, the past 40 or 50 years has seen a lot of inflation. Since January 1961, Consumer Prices in the United States have risen by 625%, or, in other words, the real value of a dollar has decline by 86% since then.
One could easily make the argument that whatever went on in the United States over this period, it was a period of extended inflation and that such an environment was not the most productive one for economic resources. This environment resulted in a lot of unused productive capacity, in terms of physical resources but also in terms of human resources.
Current policy is doing what has been done consistently in this period, emphasized a demand side bias. An inflationary policy, created using fiscal and monetary policy to stimulate aggregate demand, has been the response to the economic slowdown. And, the policy attempts to achieve higher rates of employment by putting resources back to work at their old functions. Of course, this cannot be fully achieved as technology and other efficiencies allow new jobs to be created that do not use the old skills, or old jobs to be eliminated and excess capacity to grow. Thus, capacity utilization continues to drop and those in the workforce that are discouraged from seeking a job remain unfulfilled.
Friday, October 23, 2009
Wall Street Smarts
After I posted my comment on “Do we Really Need to Break up the Banks?” yesterday (http://seekingalpha.com/article/168514-do-we-really-need-to-break-up-the-banks), I remembered an anecdote from my time in the Finance Department at the Wharton School, University of Pennsylvania. It relates to commercial banks moving from “utilities” to “casinos” in the words of Mervyn King, Governor of the Bank of England.
What brought this incident back to my mind was the recent op-ed piece by Calvin Trillin in the New York Times with the title “Wall Street Smarts.” (See http://www.nytimes.com/2009/10/14/opinion/14trillin.html?scp=2&sq=calvin%20trilin&st=cse.) In this piece Trillin runs into a person who reflects on something a speaker who had just been to a college reunion had shared with him.
“One of the speakers at my 25th reunion said that, according to a survey he had done of those attending, income was now precisely in inverse proportion to academic standing in the class, and that was partly because everyone in the lower third of the class had become a Wall Street millionaire.”
He goes on, “Don’t get me wrong: the guys from the lower third of the class who went to Wall Street had a lot of nice qualities. Most of them were pleasant enough. They made a good impression. And now we realize that by the standards that came later, they weren’t really greedy. They just wanted a nice house in Greenwich and maybe a sailboat. A lot of them were from families that had always been on Wall Street, so they were accustomed to nice houses in Greenwich. They didn’t feel the need to leverage the entire business so they could make the sort of money that easily supports the second oceangoing yacht.”
I joined the Finance Department at the Wharton School in the fall of 1972. At the time they had one course related to commercial banking, but the course was structured to discuss banking structure and regulation.
I was interested in running banks so I made the suggestion that we offer a course in bank management that was similar to the courses in the financial management of corporations, only make it specifically related to the issues and concerns of the banking industry.
The response I received from some of the administration was that they were unsure that a course like that would attract many students, particularly at the MBA level. The reason being, that except for hiring several people that were interested in running bond portfolios, the large money center banks did not recruit from the Finance Department at Wharton.
Well, I knew that there were a lot of people from the University of Pennsylvania that worked at the large money center banks so I asked a stupid question: “Where did these banks recruit Penn grads?”
The response: “Oh, they recruit from the History Department, or the English Department or areas like that. What the banks really want are people that get along with others, enjoy social drinking, playing golf or playing tennis, who belong to social clubs and things like that. They don’t want someone that is mathematically trained or otherwise quantitatively orientated. They want someone to help establish or build relationships.”
Well, not that there weren’t smart people that graduated from History, or English, or areas other than math, statistics, physics, and finance. It’s just that, at the time, banks didn’t consider that these were the people they wanted working with their customers. I guess there is a bit of truth to Trillin’s op-ed piece.
Anyway, we did create the course in the financial management of commercial banks. In my last semester at Wharton the graduate class was held in a large auditorium and was completely filled. The textbook written for the course, The Financial Management of Commercial Banks can still be found on Amazon.com. (See http://www.amazon.com/Financial-management-commercial-banks-Mason/dp/0882623095/ref=sr_1_1?ie=UTF8&s=books&qid=1256315167&sr=1-1.)
What brought this incident back to my mind was the recent op-ed piece by Calvin Trillin in the New York Times with the title “Wall Street Smarts.” (See http://www.nytimes.com/2009/10/14/opinion/14trillin.html?scp=2&sq=calvin%20trilin&st=cse.) In this piece Trillin runs into a person who reflects on something a speaker who had just been to a college reunion had shared with him.
“One of the speakers at my 25th reunion said that, according to a survey he had done of those attending, income was now precisely in inverse proportion to academic standing in the class, and that was partly because everyone in the lower third of the class had become a Wall Street millionaire.”
He goes on, “Don’t get me wrong: the guys from the lower third of the class who went to Wall Street had a lot of nice qualities. Most of them were pleasant enough. They made a good impression. And now we realize that by the standards that came later, they weren’t really greedy. They just wanted a nice house in Greenwich and maybe a sailboat. A lot of them were from families that had always been on Wall Street, so they were accustomed to nice houses in Greenwich. They didn’t feel the need to leverage the entire business so they could make the sort of money that easily supports the second oceangoing yacht.”
I joined the Finance Department at the Wharton School in the fall of 1972. At the time they had one course related to commercial banking, but the course was structured to discuss banking structure and regulation.
I was interested in running banks so I made the suggestion that we offer a course in bank management that was similar to the courses in the financial management of corporations, only make it specifically related to the issues and concerns of the banking industry.
The response I received from some of the administration was that they were unsure that a course like that would attract many students, particularly at the MBA level. The reason being, that except for hiring several people that were interested in running bond portfolios, the large money center banks did not recruit from the Finance Department at Wharton.
Well, I knew that there were a lot of people from the University of Pennsylvania that worked at the large money center banks so I asked a stupid question: “Where did these banks recruit Penn grads?”
The response: “Oh, they recruit from the History Department, or the English Department or areas like that. What the banks really want are people that get along with others, enjoy social drinking, playing golf or playing tennis, who belong to social clubs and things like that. They don’t want someone that is mathematically trained or otherwise quantitatively orientated. They want someone to help establish or build relationships.”
Well, not that there weren’t smart people that graduated from History, or English, or areas other than math, statistics, physics, and finance. It’s just that, at the time, banks didn’t consider that these were the people they wanted working with their customers. I guess there is a bit of truth to Trillin’s op-ed piece.
Anyway, we did create the course in the financial management of commercial banks. In my last semester at Wharton the graduate class was held in a large auditorium and was completely filled. The textbook written for the course, The Financial Management of Commercial Banks can still be found on Amazon.com. (See http://www.amazon.com/Financial-management-commercial-banks-Mason/dp/0882623095/ref=sr_1_1?ie=UTF8&s=books&qid=1256315167&sr=1-1.)
Breaking up the Banks?
Mervyn King, Governor of the Bank of England, gave a speech the other night and set off somewhat of a storm…at least across the pond. It is a discussion that needs to be heard here in America. (For a full text of the speech: http://www.bankofengland.co.uk/publications/speeches/2009/speech406.pdf.)
Not only did it get a lot of play in the press, but it elicited an immediate response from Prime Minister Gordon Brown and Alistair Darling, his Chancellor of the Exchequer. Here is an example that appeared in the Financial Times, “King Calls for Break-up of Banks,” see http://www.ft.com/cms/s/0/7056b56a-bda8-11de-9f6a-00144feab49a.html.
Let me point up an excellent commentary, written by Martin Wolf, in this morning’s Financial Times, “Why Curbing Finance is Hard to Do” (see http://www.ft.com/cms/s/0/0a8a6362-bf3d-11de-a696-00144feab49a.html). Wolf emphasizes the “artificial” division in financial institutions between “utilities” and “casinos.” He then goes on to discuss how difficult it is—or would be—to distinguish between these two types of organizations so as to set up a regulatory framework that would work.
I would like to add a little more to the discussion so as to second the points that Mr. Wolf makes. Going into the 1960s here in America, the distinction between financial institutions that were considered to be “utilities” which dealt in “debt” and those that dealt in “equities” and, hence, were a lot riskier, was very clear.
In fact, there were many jokes over the next few decades that commercial bankers were “debt” people and could not mix with investment bankers because investment bankers were “equity” people. People laughed at commercial banks going into the venture capital business when they put a “debt” guy in to run an “equity” business. Many suggested that my success in bank turnarounds (I did three of them) was because I was an “equity” guy and understood what it meant to focus on shareholder value whereas bank “guys”—ugh, “debt guys”--didn’t have the foggiest idea.
The first of two common points of understanding about commercial banking early in the 1960s was that commercial banks needed to be a monopoly—or, at least, a part of an oligopoly—within a limited geographic area. (Monopoly is “local” in either a geographic sense or a “product space” sense: for more on this see “Competition Demystified” by Bruce Greenwald and Judd Kahn, (Portfolio: 2005).) The reason for this was that they needed to have market power to exist. (In more technical terms, the banks could not operate in markets where they were price takers.) Monopoly power allowed the banks to earn an interest rate spread between what they earned on the funds they loaned out and what they paid out to depositors.
In many areas of the United States, geographic limitations on banks were very important and a part of the local culture. So we had states that allowed a bank only one office. (My grandfather was a Missouri banker and Missouri only allowed one office per bank. I really didn’t understand this, but it was like a religious truth to the people in the region.) Other states allowed limited branching. (My first banking job was in Michigan—if you don’t include the work I did in my grandfather’s bank—and Michigan allowed limited branching.) Then other states allowed statewide branching—but, you could not branch over state lines.
The second common point was that commercial bankers could not be trusted to operate in a “safe and sound” fashion and therefore had to be closely regulated. That is, commercial bankers always pushed the edge in terms of trying to earn a little more money and would push themselves into riskier and riskier loans. In other words, commercial bankers had to be protected from themselves.
Commercial banks were public utilities: they provided social capital to a society, they were very needed, yet they were potentially very dangerous—not unlike nuclear energy plants.
What changed?
Commercial banks were highly constrained institutions. Their ability to grow was severely limited to the deposit base that could be generated within their “local” area. But, like all human beings, commercial bankers were problem solvers. (Yes, commercial bankers are human beings although a not very advanced subset of the species.) The bankers found a way to escape the constraints on branching, both within a state and between states. They developed a class of liabilities that they could use to fund their banks that was not limited to the geographic area in which they resided: liabilities that could be purchased or sold in the open market.
This asset class included Negotiable Certificates of Deposit, Eurodollar deposits, and Commercial Paper issued by a bank holding company, the funds of which could be distributed to the commercial bank it owned. Liability management at commercial banks came into existence. Now a commercial bank could not only manage its cash position with the use of these instruments, it could expand its balance sheet beyond the scope of “local” branching restrictions. Limits on branching across state lines were doomed!
Now, however, commercial banks became price takers. They could buy or sell all the funds they wanted to at the going market interest rate. Commercial banking changed in the late 1960s and the early 1970s.
Commercial bankers and regulators still gave voice to the idea that the commercial banks were utilities, but, this was only lip service. It was no longer true.
Commercial bankers became “traders” and lived more and more off of arbitrage transactions. They still had markets they operated within in which they were not price takers, but, as the 20th century progressed, the number of these markets declined as a proportion of the whole. You look at bank balance sheets now and the vast majority of assets and liabilities come from markets in which the banks are price takers.
As financial innovation progressed and bank spreads narrowed, commercial banks spent more and more effort trying to generate “fees” on services that did not depend on spreads, increased financial leverage (achieved as a price taker), and greater mis-matching the maturities of assets and liabilities. The second common point mentioned above still applied: bankers always pushed the edge to earn a little more.
The “Age of Financial Innovation” changed everything. Financial innovators discovered that cash flows were just bits of information and information can be divided up in any way you like. Thus, financial instruments could be tailored to meet the specific needs of a particular investor. And, you could perform this service for a fee, meaning that you didn’t need to absorb the risk of the transaction and you didn’t need to finance it! Ain’t modern finance wonderful!
Two final points. First, financial innovation is going to continue to take place. The idea that finance is information is spreading to other markets (Information Markets) that deal with physical products, not just cash flows. As computer technology continues to advance and the idea that information can be traded spreads it becomes quite obvious that regulation cannot be put into the boxes or categories we used in the past. It just isn’t going to happen. Second, we are moving into a world in which the idea of regulation may become silly. We used to regulate, somewhat, pornography. With the Internet, control of the availability of pornography is ludicrous. Possible solutions for bank regulation: that is for another post.
Not only did it get a lot of play in the press, but it elicited an immediate response from Prime Minister Gordon Brown and Alistair Darling, his Chancellor of the Exchequer. Here is an example that appeared in the Financial Times, “King Calls for Break-up of Banks,” see http://www.ft.com/cms/s/0/7056b56a-bda8-11de-9f6a-00144feab49a.html.
Let me point up an excellent commentary, written by Martin Wolf, in this morning’s Financial Times, “Why Curbing Finance is Hard to Do” (see http://www.ft.com/cms/s/0/0a8a6362-bf3d-11de-a696-00144feab49a.html). Wolf emphasizes the “artificial” division in financial institutions between “utilities” and “casinos.” He then goes on to discuss how difficult it is—or would be—to distinguish between these two types of organizations so as to set up a regulatory framework that would work.
I would like to add a little more to the discussion so as to second the points that Mr. Wolf makes. Going into the 1960s here in America, the distinction between financial institutions that were considered to be “utilities” which dealt in “debt” and those that dealt in “equities” and, hence, were a lot riskier, was very clear.
In fact, there were many jokes over the next few decades that commercial bankers were “debt” people and could not mix with investment bankers because investment bankers were “equity” people. People laughed at commercial banks going into the venture capital business when they put a “debt” guy in to run an “equity” business. Many suggested that my success in bank turnarounds (I did three of them) was because I was an “equity” guy and understood what it meant to focus on shareholder value whereas bank “guys”—ugh, “debt guys”--didn’t have the foggiest idea.
The first of two common points of understanding about commercial banking early in the 1960s was that commercial banks needed to be a monopoly—or, at least, a part of an oligopoly—within a limited geographic area. (Monopoly is “local” in either a geographic sense or a “product space” sense: for more on this see “Competition Demystified” by Bruce Greenwald and Judd Kahn, (Portfolio: 2005).) The reason for this was that they needed to have market power to exist. (In more technical terms, the banks could not operate in markets where they were price takers.) Monopoly power allowed the banks to earn an interest rate spread between what they earned on the funds they loaned out and what they paid out to depositors.
In many areas of the United States, geographic limitations on banks were very important and a part of the local culture. So we had states that allowed a bank only one office. (My grandfather was a Missouri banker and Missouri only allowed one office per bank. I really didn’t understand this, but it was like a religious truth to the people in the region.) Other states allowed limited branching. (My first banking job was in Michigan—if you don’t include the work I did in my grandfather’s bank—and Michigan allowed limited branching.) Then other states allowed statewide branching—but, you could not branch over state lines.
The second common point was that commercial bankers could not be trusted to operate in a “safe and sound” fashion and therefore had to be closely regulated. That is, commercial bankers always pushed the edge in terms of trying to earn a little more money and would push themselves into riskier and riskier loans. In other words, commercial bankers had to be protected from themselves.
Commercial banks were public utilities: they provided social capital to a society, they were very needed, yet they were potentially very dangerous—not unlike nuclear energy plants.
What changed?
Commercial banks were highly constrained institutions. Their ability to grow was severely limited to the deposit base that could be generated within their “local” area. But, like all human beings, commercial bankers were problem solvers. (Yes, commercial bankers are human beings although a not very advanced subset of the species.) The bankers found a way to escape the constraints on branching, both within a state and between states. They developed a class of liabilities that they could use to fund their banks that was not limited to the geographic area in which they resided: liabilities that could be purchased or sold in the open market.
This asset class included Negotiable Certificates of Deposit, Eurodollar deposits, and Commercial Paper issued by a bank holding company, the funds of which could be distributed to the commercial bank it owned. Liability management at commercial banks came into existence. Now a commercial bank could not only manage its cash position with the use of these instruments, it could expand its balance sheet beyond the scope of “local” branching restrictions. Limits on branching across state lines were doomed!
Now, however, commercial banks became price takers. They could buy or sell all the funds they wanted to at the going market interest rate. Commercial banking changed in the late 1960s and the early 1970s.
Commercial bankers and regulators still gave voice to the idea that the commercial banks were utilities, but, this was only lip service. It was no longer true.
Commercial bankers became “traders” and lived more and more off of arbitrage transactions. They still had markets they operated within in which they were not price takers, but, as the 20th century progressed, the number of these markets declined as a proportion of the whole. You look at bank balance sheets now and the vast majority of assets and liabilities come from markets in which the banks are price takers.
As financial innovation progressed and bank spreads narrowed, commercial banks spent more and more effort trying to generate “fees” on services that did not depend on spreads, increased financial leverage (achieved as a price taker), and greater mis-matching the maturities of assets and liabilities. The second common point mentioned above still applied: bankers always pushed the edge to earn a little more.
The “Age of Financial Innovation” changed everything. Financial innovators discovered that cash flows were just bits of information and information can be divided up in any way you like. Thus, financial instruments could be tailored to meet the specific needs of a particular investor. And, you could perform this service for a fee, meaning that you didn’t need to absorb the risk of the transaction and you didn’t need to finance it! Ain’t modern finance wonderful!
Two final points. First, financial innovation is going to continue to take place. The idea that finance is information is spreading to other markets (Information Markets) that deal with physical products, not just cash flows. As computer technology continues to advance and the idea that information can be traded spreads it becomes quite obvious that regulation cannot be put into the boxes or categories we used in the past. It just isn’t going to happen. Second, we are moving into a world in which the idea of regulation may become silly. We used to regulate, somewhat, pornography. With the Internet, control of the availability of pornography is ludicrous. Possible solutions for bank regulation: that is for another post.
Thursday, October 22, 2009
A Quick Look at Profits
So far, two facts stand out to me in many of the current earnings releases. First, for many large financial firms, trading profits have provided almost all of the positive results that we have seen. Second, for many large non-financial firms, cost cutting has resulted in better-than-expected earnings.
Both of these lead me to the conclusion that the basic or fundamental businesses of the companies reporting are showing little or no life. In other words, the demand for the basic products or services they provide is listless, at best. And, results like these are not sustainable.
Yes, the results are encouraging. Profits are always better than losses. But, these profits are not connected with the core business of these companies and hence give no indication that either the financial firms or the non-financial firms have established some kind of competitive advantage that will last into an economic recovery.
In terms of the large financial firms, like Goldman Sachs and JPMorgan Chase, the trading profits have allowed them to post substantial earnings and get the government off their backs. Getting the government off their backs is important and will become more so in the future because these companies can pay to keep their top-flite executives or pay to attract other major talent to their organizations. They can buy time as their core businesses improve. However, trading profits are not sustainable and should not be counted over an extended period of time.
The large financial firms that have not produced, like Citigroup and Bank of America, will find themselves at a considerable competitive disadvantage, both in the United States and worldwide, as their competition can apply their strengths to continue to grow and increase market share. Plus, these non-producers are having to sell off assets like BOA’s sale of First Republic and Citigroup’s sale of Phibro even though both were profitable operations.
The last thing these organizations need is to have their pay the top officers receive drastically cut. Not only do troubled firms have problems hiring top talent, but to have the onus of the government hanging over the companies and controlling what top executives get paid is doubly bad. These financial institutions were too big to fail—immediately. But, they are not too big to fail a slow death. Certainly the government’s effort to impact the remuneration of the top executives at firms still receiving government help will skew the playing field to the Goldman’s and the JPMorgan’s.
One can understand in today’s environment that a lot of people are angry about big salaries and bonuses, especially to those that have been bailed out by the government. Certainly, the forthcoming big bonuses to be received by the executives at Goldman and JPMorgan do not help stem these populist attitudes about the pay at financial institutions. But, in this case, the response of the public is just helping the competitive position of Goldman and JPMorgan and hurting that of these other large banks because the actions on pay just makes Citi and BOA less competitive! Goldman and JPMorgan are smiling all the way to the bank!
The other banks, the regionals and the locals? They need time to continue to work out their loan and security portfolios. They need to regroup, get back to their core business and they will be fine. But, this is going to take time. Nothing substantial in profits here for a long time.
As far as the non-financial firms are concerned, their cost-cutting efforts are paying off. Their efforts to return to their core businesses are paying off. But, cost cutting alone does not produce sustainable exceptional returns. Cost cutting can be duplicated. And, as long as consumers stay on the sidelines and restructure their balance sheets and keep reducing their debt not increasing it, the final demand for goods and services will not show much bounce.
There is continued hope in one sector after another that sales will pick up. In computers. In retail sales. In food services. There is continued hope that sales will pick up during Thanksgiving, or Christmas, or at some other relevant time. But, these blips of hope seem to pass on as sales continue to disappoint. The hope is transferred to the next holiday.
Companies, for the past four or five months, have posted not-so-good earnings, but they raise their forecasts for the upcoming year.
There is nothing these companies are doing right now that produce sustainable results. Demand for their products and services must be forthcoming and, right now, there is little encouragement that this will happen any time soon.
All of these factors raise two concerns in my mind. First, what is the basis for the continued rise in stock prices. The profit results that have been achieved so far are not sustainable and point to no growth in earnings or cash flows for the time being. Furthermore, the cost cuts are great, they help companies get their focus back onto the right things. But, cost cutting does not result in a continued increase in earnings or cash flows. In addition, trading profits do not contribute to extended growth in earnings or cash flows. This is why I am concerned about the possibility that the rise in stock prices since March might just be a bubble. (See http://seekingalpha.com/article/167561-are-we-in-an-asset-bubble-or-not.)
Second, managements are refocusing their efforts and reducing inventories, labor, and other resources that they had accumulated during the go-go years. This restructuring, given past experience, will continue, even when the economy begins to recover again. These managements are not going to return to the same business practices as before. This will change the supply side of the economy and, as a consequence, full employment of resources will not be the same as it was earlier in this decade.
If this does occur, and I believe that it will, it will just be one more part of the trend that began in the 1970s. Through all the cyclical swings in the economy during the last forty years or so, the economy has never regained the height it had achieved in the previous upswing. That is, the next peak of employment, of capacity utilization, of industrial production, has never as high as it was at the previous peak.
This means that the economic policies of the last forty years or so have left more manufacturing capacity idle, more workers discouraged, and more resources wasted each cycle of the economy. The American economy is changing along with competition in the world. Artificial stimulus on the part of the United States government just tries to put people and other resources back into the jobs that they once held, like in autos and steel for example. And, such an economic policy only exacerbates the longer term trend. Furthermore, this is not helpful to the stock market.
It is easy to build a case that the rise in the stock market in the 1990s and the 2000s were asset bubbles created by easy credit. Given the performance of financial and non-financial firms at the present time could the Federal Reserve just be producing another one?
Both of these lead me to the conclusion that the basic or fundamental businesses of the companies reporting are showing little or no life. In other words, the demand for the basic products or services they provide is listless, at best. And, results like these are not sustainable.
Yes, the results are encouraging. Profits are always better than losses. But, these profits are not connected with the core business of these companies and hence give no indication that either the financial firms or the non-financial firms have established some kind of competitive advantage that will last into an economic recovery.
In terms of the large financial firms, like Goldman Sachs and JPMorgan Chase, the trading profits have allowed them to post substantial earnings and get the government off their backs. Getting the government off their backs is important and will become more so in the future because these companies can pay to keep their top-flite executives or pay to attract other major talent to their organizations. They can buy time as their core businesses improve. However, trading profits are not sustainable and should not be counted over an extended period of time.
The large financial firms that have not produced, like Citigroup and Bank of America, will find themselves at a considerable competitive disadvantage, both in the United States and worldwide, as their competition can apply their strengths to continue to grow and increase market share. Plus, these non-producers are having to sell off assets like BOA’s sale of First Republic and Citigroup’s sale of Phibro even though both were profitable operations.
The last thing these organizations need is to have their pay the top officers receive drastically cut. Not only do troubled firms have problems hiring top talent, but to have the onus of the government hanging over the companies and controlling what top executives get paid is doubly bad. These financial institutions were too big to fail—immediately. But, they are not too big to fail a slow death. Certainly the government’s effort to impact the remuneration of the top executives at firms still receiving government help will skew the playing field to the Goldman’s and the JPMorgan’s.
One can understand in today’s environment that a lot of people are angry about big salaries and bonuses, especially to those that have been bailed out by the government. Certainly, the forthcoming big bonuses to be received by the executives at Goldman and JPMorgan do not help stem these populist attitudes about the pay at financial institutions. But, in this case, the response of the public is just helping the competitive position of Goldman and JPMorgan and hurting that of these other large banks because the actions on pay just makes Citi and BOA less competitive! Goldman and JPMorgan are smiling all the way to the bank!
The other banks, the regionals and the locals? They need time to continue to work out their loan and security portfolios. They need to regroup, get back to their core business and they will be fine. But, this is going to take time. Nothing substantial in profits here for a long time.
As far as the non-financial firms are concerned, their cost-cutting efforts are paying off. Their efforts to return to their core businesses are paying off. But, cost cutting alone does not produce sustainable exceptional returns. Cost cutting can be duplicated. And, as long as consumers stay on the sidelines and restructure their balance sheets and keep reducing their debt not increasing it, the final demand for goods and services will not show much bounce.
There is continued hope in one sector after another that sales will pick up. In computers. In retail sales. In food services. There is continued hope that sales will pick up during Thanksgiving, or Christmas, or at some other relevant time. But, these blips of hope seem to pass on as sales continue to disappoint. The hope is transferred to the next holiday.
Companies, for the past four or five months, have posted not-so-good earnings, but they raise their forecasts for the upcoming year.
There is nothing these companies are doing right now that produce sustainable results. Demand for their products and services must be forthcoming and, right now, there is little encouragement that this will happen any time soon.
All of these factors raise two concerns in my mind. First, what is the basis for the continued rise in stock prices. The profit results that have been achieved so far are not sustainable and point to no growth in earnings or cash flows for the time being. Furthermore, the cost cuts are great, they help companies get their focus back onto the right things. But, cost cutting does not result in a continued increase in earnings or cash flows. In addition, trading profits do not contribute to extended growth in earnings or cash flows. This is why I am concerned about the possibility that the rise in stock prices since March might just be a bubble. (See http://seekingalpha.com/article/167561-are-we-in-an-asset-bubble-or-not.)
Second, managements are refocusing their efforts and reducing inventories, labor, and other resources that they had accumulated during the go-go years. This restructuring, given past experience, will continue, even when the economy begins to recover again. These managements are not going to return to the same business practices as before. This will change the supply side of the economy and, as a consequence, full employment of resources will not be the same as it was earlier in this decade.
If this does occur, and I believe that it will, it will just be one more part of the trend that began in the 1970s. Through all the cyclical swings in the economy during the last forty years or so, the economy has never regained the height it had achieved in the previous upswing. That is, the next peak of employment, of capacity utilization, of industrial production, has never as high as it was at the previous peak.
This means that the economic policies of the last forty years or so have left more manufacturing capacity idle, more workers discouraged, and more resources wasted each cycle of the economy. The American economy is changing along with competition in the world. Artificial stimulus on the part of the United States government just tries to put people and other resources back into the jobs that they once held, like in autos and steel for example. And, such an economic policy only exacerbates the longer term trend. Furthermore, this is not helpful to the stock market.
It is easy to build a case that the rise in the stock market in the 1990s and the 2000s were asset bubbles created by easy credit. Given the performance of financial and non-financial firms at the present time could the Federal Reserve just be producing another one?
Tuesday, October 20, 2009
Obama to Tackle Deficit--Next Year!
“This has been the year of coping with the economic mess. Next year will be the year of coping with the deficit mess that follows the economic mess.”
So says Wall Street Journal writer Gerald Seib. (See “Obama Lays Plans to Tackle Deficit,” http://online.wsj.com/article/SB125599128538995091.html#mod=todays_us_page_one.) “The timing is tricky” because next year is an election year, but Obama is going to do it! Yes we can!
The strategy is a two pronged attack with another strong initiative in the wings. The first go at it will be at the president’s State of the Union address. That’s in January.
Following right after there will be the president’s budget proposals. That will be in February.
Then, well, let’s put together a task force—say eight Democrats and eight Republicans and let them address “the nation’s long-term fiscal imbalances.”
Yes, the Obama administration has things under control.
And, the world goes on.
The value of the dollar has declined by about 13% since January 20, 2009. It is possible that it could decline another 5% to 10% over the next six months or so.
Over the last thirty-eight years, since August of 1971, participants in international financial markets have failed to trust governments that ran up huge budget deficits. The general attitude has been that governments that cause their debt to increase substantially through loose or irresponsible budgets will eventually end up having their central bank monetize large portions of their debt.
In the face of such behavior, investors have sold the currencies of these countries until some appropriate response has been forthcoming from the governments running the deficits. More than a few countries have experienced this consequence of their budgeting largesse. Concern has even been expressed about how a group of “unknown bankers” could have such an influence over sovereign nations. (See for example the book “The Vandals’ Crown: How Rebel Currency Traders Overthrew the World’s Central Banks” by Gregory Millman.)
But, the United States government ran massive deficits earlier in this decade and the Federal Reserve supported such debt with extremely low interest rates while it allowed asset bubbles to run their course. During this time period the value of the United States dollar declined by about 40%.
The situation since January 20 has several characteristics in common with this period: large deficits supported by the Federal Reserve with extremely low interest rates. And, as mentioned above the value of the United States dollar has declined by about 13% since that time.
Talk about a strong dollar is a joke at this time. Talk about getting the deficit under control is approaching the same seriousness.
Let’s face it, Obama owns the deficit now.
As is usual in economics, people and markets have a short memory. The past is the past. The current administration has been in office nine months now. It is a “full term” pregnancy! The child, the current deficit and subsequent problems, belong to Obama.
Markets will not wait for additional speeches, even a State of the Union speech. Daily, there is more and more talk about the inability of the Obama administration to make decisions, to act. It only talks and promises.
People and markets don’t want a task force to address “the nation’s long term fiscal imbalances.” How long will that take? Six months, twelve months, or longer?
The markets need some substance. As far as I can see there is no indication that any “substance” is going to be forthcoming soon. Thus, the dollar will remain weak because what reason is there to buy it?
So says Wall Street Journal writer Gerald Seib. (See “Obama Lays Plans to Tackle Deficit,” http://online.wsj.com/article/SB125599128538995091.html#mod=todays_us_page_one.) “The timing is tricky” because next year is an election year, but Obama is going to do it! Yes we can!
The strategy is a two pronged attack with another strong initiative in the wings. The first go at it will be at the president’s State of the Union address. That’s in January.
Following right after there will be the president’s budget proposals. That will be in February.
Then, well, let’s put together a task force—say eight Democrats and eight Republicans and let them address “the nation’s long-term fiscal imbalances.”
Yes, the Obama administration has things under control.
And, the world goes on.
The value of the dollar has declined by about 13% since January 20, 2009. It is possible that it could decline another 5% to 10% over the next six months or so.
Over the last thirty-eight years, since August of 1971, participants in international financial markets have failed to trust governments that ran up huge budget deficits. The general attitude has been that governments that cause their debt to increase substantially through loose or irresponsible budgets will eventually end up having their central bank monetize large portions of their debt.
In the face of such behavior, investors have sold the currencies of these countries until some appropriate response has been forthcoming from the governments running the deficits. More than a few countries have experienced this consequence of their budgeting largesse. Concern has even been expressed about how a group of “unknown bankers” could have such an influence over sovereign nations. (See for example the book “The Vandals’ Crown: How Rebel Currency Traders Overthrew the World’s Central Banks” by Gregory Millman.)
But, the United States government ran massive deficits earlier in this decade and the Federal Reserve supported such debt with extremely low interest rates while it allowed asset bubbles to run their course. During this time period the value of the United States dollar declined by about 40%.
The situation since January 20 has several characteristics in common with this period: large deficits supported by the Federal Reserve with extremely low interest rates. And, as mentioned above the value of the United States dollar has declined by about 13% since that time.
Talk about a strong dollar is a joke at this time. Talk about getting the deficit under control is approaching the same seriousness.
Let’s face it, Obama owns the deficit now.
As is usual in economics, people and markets have a short memory. The past is the past. The current administration has been in office nine months now. It is a “full term” pregnancy! The child, the current deficit and subsequent problems, belong to Obama.
Markets will not wait for additional speeches, even a State of the Union speech. Daily, there is more and more talk about the inability of the Obama administration to make decisions, to act. It only talks and promises.
People and markets don’t want a task force to address “the nation’s long term fiscal imbalances.” How long will that take? Six months, twelve months, or longer?
The markets need some substance. As far as I can see there is no indication that any “substance” is going to be forthcoming soon. Thus, the dollar will remain weak because what reason is there to buy it?
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