July 31, 2013

Why Are The Chinese Gobbling Up Real Estate And Businesses In Detroit?

Something very strange is happening to Detroit.  Once upon a time, it was the center of American manufacturing and it had the highest per capita income in the United States.  But now the city is dying and the Chinese are moving in to pick up the pieces.  Lured by news stories that proclaim that you can buy homes in Detroit for as little as one dollar, Chinese investors are eagerly gobbling up properties.  In some cases, this is happening dozens of properties at a time.  Not only that, according to the New York Times “dozes of companies from China” are investing in businesses and establishing a presence in the Detroit area.  If this continues, will Detroit eventually become a city that is heavily dominated by China?

At this point, not too many others appear interested in saving Detroit.  Right now, there are approximately 78,000 abandoned buildings in Detroit and about one-third of the entire city is either vacant or derelict.  People have been moving out in droves and there are only about 700,000 residents left.

For many Americans, Detroit is about the last place that they would want to live.  But to many Chinese, this sounds like a perfect buying opportunity.  According to a recent Fox News report, real estate agents in Detroit are being overwhelmed with inquiries from China…
Downtown Detroit is home to one of the worst housing markets in the country, as prices of homes have collapsed and foreclosures have soared in the city’s depressed economy.
But some Chinese investors hungry for real estate are hoping Detroit’s losses will be their gain. After Detroit filed for bankruptcy July 18, Motor City property has been a hot topic on China’s social media platform, Weibo, according to a Quartz.com report.
News of the bankruptcy, coupled with a Chinese TV report in March that claimed you could buy two houses in Detroit for the same price as a pair of leather shoes, has piqued investors’ interest.
And these buyers appear to be quite serious.  One buyer reportedly bought 30 properties recently, and other buyers say that they want to purchase even more homes than that…
And it appears to be translating into real interest; Caroline Chen, a real estate broker in Troy, Michigan, says she’s received “tons of calls” from people in mainland China.
“I have people calling and saying, ‘I’m serious—I wanna buy 100, 200 properties,’” she tells Quartz, noting that one of her colleagues recently sold 30 properties to a Chinese buyer. “They say ‘We don’t need to see them. Just pick the good ones.’”
Meanwhile, according to the New York Times, dozens of Chinese companies are moving into the city…
Dozens of companies from China are putting down roots in Detroit, part of the country’s steady push into the American auto industry. 
Chinese-owned companies are investing in American businesses and new vehicle technology, selling everything from seat belts to shock absorbers in retail stores, and hiring experienced engineers and designers in an effort to soak up the talent and expertise of domestic automakers and their suppliers. 
While starting with batteries and auto parts, the spread of Chinese business is expected to result eventually in the sale of Chinese cars in the United States.
Of course this is not just happening in Detroit.  The truth is that the Chinese are buying up real estate, businesses and natural resources all over the country.

But they seem to have a particular interest in Detroit.

Perhaps someone should tell them that Detroit is not actually a very safe place these days.  The violent crime rate is five times higher than the national average, and the murder rate in Detroit is 11 times higher than it is in New York City.

If you call the police, it takes them an average of 58 minutes to respond.  And sometimes the people that are committing the crimes are actually Detroit police officers.  In fact, one Detroit police officer was involved in robbing a gas station just last week
A Good Samaritan snapped photos of what appeared to be two men impersonating police officers involved in a pistol-whipping and robbery outside a Citgo gas station on Detroit’s east side on July 21. 
Once Fox 2 aired those photos, an even more disturbing picture developed.
“Several unidentified police officers were working this particular robbery case, recognized one of the suspects in the photographs as being a member of the Detroit Police Department,” Chief James Craig said Monday. 
Now under arrest are two police sergeants, a 47-year-old officer and 20-year veteran of the Detroit Police Department and his 42-year-old buddy from the police academy, who is a former DPD cop and 17-year veteran of the St. Clair Shores Police Department. The later recently received a distinguished service award. 
“In fact, they were police officers, just not working on-duty at the time,” Craig said.
Detroit is a dying, bankrupt city.  There does not seem to be much hope of a turnaround for Detroit any time soon.

So why are the Chinese gobbling up so much real estate and so many businesses in Detroit?

That is a very good question.


July 30, 2013

New York Times Slams Larry Summers, And Comes Out Hard In Favor Of Janet Yellen For Fed Chair

The "race" between Larry Summers and Janet Yellen to succeed Ben Bernanke is becoming more and more like a political battle every day.

The latest example: A STRONG endorsement of Janet Yellen in the New York Times, that reads a lot like a paper endorsing a politician.

Not only is it a strong endorsement of Yellen, it's pretty brutal towards Larry Summers, whom the paper ties to bad economic decisions, bad regulatory decisions, and even sexism.

First on the differences in their economic pasts:

A Yale educated economist and professor emeritus at the University of California, Berkeley, she was first nominated and confirmed to the Fed board in the 1990s; from 2004 to 2010, she served as the president of the Federal Reserve Bank of San Francisco. She has been vice chairwoman since 2010, a trying time in which the Fed’s largely successful efforts to steer the economy have been made all the more difficult by poor fiscal policy decisions, including the White House’s premature pivot from stimulus to deficit reduction, which happened while Mr. Summers was a top adviser to Mr. Obama.
And on the matter of gender:

...she is reminiscent of other accomplished women with whom Mr. Summers, or his supporters, or both have tangled in the past.
In 1998, Mr. Rubin and Mr. Summers opposed Brooksley Born, then the chairwoman of the Commodity Futures Trading Commission, for correctly calling for the regulation of derivatives; in 2009, Mr. Summers squelched the sound recommendation of Christina Romer, then an economic adviser to Mr. Obama, for a larger stimulus. In the first Obama term, Mr. Geithner clashed unhelpfully with Sheila Bair, then the chairwoman of the Federal Deposit Insurance Corporation, and with Elizabeth Warren, then the chairwoman of the Congressional panel overseeing the bailouts.
The final line:

In the end, the choice rests with Mr. Obama. The facts are entirely on Ms. Yellen’s side. Is the president?


July 29, 2013

Announcing a Project to Modify or Replace the US Monetary System

The US Dollar (USD) has been the world’s primary reserve currency (used for most international transactions, even when the US is not a party, and for bank reserves in all nations) since 1920, which has helped support its value due to high demand. The use of the USD for most oil sales since 1973 (the ‘Petrodollar’) has also brought helpful demand, but that is fading.

Due to excessive creation of new money (‘traditional’ monetary inflation, plus the Bernanke ‘spike’ in 2008 and recent QE activity), the USD has lost over 95% of its purchasing power (PP) since the Federal Reserve System (the ‘Fed’, our central bank) was created in 1913.

The rate of decline worsened with the end of gold ‘backing’ in 1971. To prevent losses, many nations now avoid owning or using the USD (or other assets denominated in USD), and instead trade with each other using their own currencies (led by the BRICS – Brazil, Russia, India, China, and S. Africa, plus Japan and Australia). This could lead to a major reduction in the USD role as a world reserve currency, and cause a 50% to 90% crash in value (PP) due to reduced demand. Such a crash could happen soon, and would cause; 1) Large losses for all holders (persons, firms, governments) of dollar-denominated assets (cash, CDs, bonds, annuities, life insurance, equities, real estate, etc.), and 2) A major increase in interest rates, which would blow-up the US budget and business loan rates! Thus, we must consider changes that will prevent the crash.

I hereby volunteer to be the collector of ideas, and use this input to write a draft plan, seek approval from contributors, then publish a comprehensive final plan for a modification of the current US Monetary System. The system includes the Fed and its ‘Fed Notes’, Treasury Dept. bonds and policies, legal tender laws, the FDIC, mints, banks and various banking laws and regulations.

The Initial Plan
Subject to modification, and with further definition below, the initial plan is; 1) Terminate the Federal Reserve System, 2) Make existing ‘Fed Notes’, deposits and bonds (M3) immediately redeemable for gold by any bearer on demand (100% backing will deter a ‘run’ to redeem for gold), 3) Require that all ‘Fed Note’ denominated cash and instruments be converted to the new ‘gold money’ (see plan below) by a certain date, 4) Terminate legal tender and many banking laws to allow private mints and ‘free banking’ without licenses (but with full disclosure of mint gold reserves, bank loans, etc. required by law), 5) Create a new system of gold coins, and redeemable notes and token coins, to replace the current ‘Fed Note’ currency, with ‘weight of 24 carat gold’ (or more weight for lesser carats) as the unit of account (no ‘Dollar’ or ‘price’ of gold), and 6) Design and implement the plan without formal agreements with other nations (this would just dilute and delay the new plan), but seek their ideas and keep them informed of the US plan and schedule so they can make compatible plans (or be left out!). This plan is documented in detail in Chapter 4 of my book Monetary Revolution USA, and posted at part 2 in the left margin of Forward-USA.org.

History and logic tell us that the above approach will stabilize purchasing power and bring more peace and prosperity to nations who use it, and all will convert to gold or no Seller will accept their trash fiat ‘money’.

Details of the Plan and Implementation

As a starting point, I recommend the Five-Step Plan shown below. While other private gold standards include ‘parallel government currency’ and other remnants of the monopoly and Fed system, this version has zero mandatory (but some optional) control by the government, and banks. The Fed will be gone! Notice that under this plan money is produced by private firms in the free market where customers (users of money) decide which source and type of money is best, and mints compete for customers by supplying a good product. Government mints, if any, are optional, and have no control or privilege over the private mints. The free market is allowed to work!

Step 1. Repeal: a. All legal tender laws so private mints can issue new money, b. Laws that tax increase in market value (then to be known as ‘purchasing power’) of precious-metal coins (formerly considered numismatic), and c. Any other laws that prevent, inhibit, or tax the new money. The only government role would be to prevent fraud (including counterfeiting), and to verify by physical inspection that reserves are as advertised (but with no reserve ‘requirements’). I recommend that ‘demand deposits’ (checking) have 100% reserves, and ‘time deposits’ have reserve ratios based on prudence of bankers and approval of their customers (or they will withdraw their funds or sell the stock). The Federal Reserve will be abolished three to five years after private money becomes legal (or if Congress refuses abolishment, let it atrophy to death from lack of customers and income). Its useful functions will be done by private firms.

Step 2. Private mints are allowed, with government licensing optional. Banks could also provide mint services. Silver, semi-precious metals, and foreign coins could be used (based on market demand), but for simplicity, only use of gold will be discussed here. The mints would introduce new gold money labeled by law as to the weight and purity (fineness; carats) of gold a coin contains, or that redeemable tokens or paper certificates represent (thus ‘weight’ is the unit of account). Some might offer ‘Digital Gold Currency’ (see bitcoin.org). All mints would be required by law to; 1. Publicize the weight and purity of gold they have as a reserve for redeeming paper or digital money, and the value of money issued, 2. Allow unscheduled physical inspections to confirm that the gold is in their possession, and free of encumbrances such as liens, leases, etc. The same would apply to base-metal coins. The ‘unscheduled’ requirement will prevent relocating the same gold to be put on display at different mints, or their branches, ‘just in time’ for an inspection! The results of these inspections would be published by the mint’s Internet web site, newspaper, poster in the mint, etc., and available from a government web site. The inspections would be justified as a routine function of the government to prevent fraud, but could be done by a private org. Mints with strong reserves will advertise their strength to attract customers. Customers will ‘wake up’ and pay attention to reserve status, rather than assuming the government is protecting them with regulations. The free market at work!

Step 3. Require the Federal Reserve banks, the U.S. Treasury (Ft. Knox), the Exchange Stabilization Fund, and any other part of the United States government that has gold, to promptly submit to a private audit of the amount and purity of gold they own and its title status (leased?, loaned?), reveal the results to the public, and then give it all to a ‘Redemption Trust’ owned by the U.S. Treasury, to be used to redeem existing coin or paper currency, ‘digital deposits’, and bonds (such as M3) on demand, based on a certain weight per ‘Fed Note’ Dollar, in accordance with the plan below. The Fed would not be involved in such conversions. Some may argue that the Fed is a private firm and owns the gold it has, but this ignores the fact that it got it from the US citizens illegally in the first place by issuing fake Fed Notes, and perhaps some from FDR’s confiscation of gold in 1933. If the Fed manages to win a court fight on this point, the Treasury could buy it with US bonds.

The U.S. government claims to have 8,134 metric tonnes of gold in its reserves (an audit is needed). At 32,150 troy oz. per metric tonne, the US has 260.415 million troy ounces. Others say the US currently holds 261.5 mill. troy ounces, or 265 mill., but these figures are all close enough for this analysis. There is also a question as to the purity (fineness; 24 carat is 0.9999 pure) of the US gold (debased or fake bars in storage, or gone on lease or loaned?). Only a proper audit will tell.

The Fed stopped publishing M3 in 2006 (claiming high expenses; I say to hide its growth!), but private sources put it at about $15 trillion worldwide in Feb-2012. If 100% of the M3 Fed Note dollars and bonds were made redeemable with our 260.415 million troy ounces of gold there would be 0.0000186 oz. per dollar (about 2 ‘100 thousandths’; or less if the Fed is lying about how much gold we have!). This means 53,763 ‘gold-backed’ Fed Note dollars would be redeemable for one troy ounce of gold. This implies a 96% drop in the dollar's current value versus the July 26, 2013 spot price of $1,330 per oz.; a ‘gold value’ ratio of about 25:1, to be known as the ‘Conversion Factor’. Some suggest we repudiate all federal debt, but this would be immoral Of course, other nations  -- Russia, Argentina, etc. -- have done it without legal backlash). The dreaded day of reckoning! But this issue fades as all nations convert to gold money (they must or no sellers will take their trash fiat 'money' once the US dollar is redeemable) and there is no ‘price’ for gold, just its weight, because gold IS money (example; what is the ‘price’ of a Dollar?).

We need to audit and inspect U.S. gold reserves in the Ft. Knox and the New York Fed vaults, and determine whether some has been secretly removed, leased, loaned, or some bars replaced by gold-plated base metal. This concern was heightened when in Jan-2013 the Fed told Germany it would take seven years to return the 300 tonnes gold they were storing for them!.

Once the legal tender laws are repealed;

a. No additional units (physical or electronic, including new credit) of the old ‘Fed Note’ money will be issued. The free market will provide new money as needed; if the Fed isn’t required to stop creating new money at first – due to politics, etc.- the new private money should proceed in parallel; let the best money win!,

b. Holders of old ‘Fed Note’ physical money would be required to convert it to new private money within two years of private money becoming legal,

c. The government must accept payments by ‘new private money’ if the issuing firm’s reserves are at least forty percent, and have been verified to the public and gov’t, and

d. Federal and State governments can issue new gold money, but it would have no privileges over private issues.

Step 4. To implement the new monetary system, I propose that Congress create the ‘Currency Act of 2013’. No government ‘commission’ is needed to ponder whether a gold standard is needed (unless forced for political reasons!). The Act should:

a) Incorporate the ideas and requirements in ‘Redick’s Four Monetary Rules’ (in Chapter 4 of book Monetary Revolution USA, and posted at part 2 in the left margin of Forward-USA.org) and this ‘Five Step Plan’,

b) Set the weight and fineness of gold that the existing Fed Notes and coins (physical, bond, or digital) will represent. This will involve debate as to % reserves and how many USD - M1, M3? - are covered, and the effective date. I suggest 100% of M3 and activation of the new system within 3 to 6 mo. after the Act is passed. Using M1 (or repudiating all debt) would have a lower inflationary impact on the dollar’s value (more gold per dollar), but leave savings accounts, and domestic and foreign bond owners, with worthless paper, which amounts to default, repudiation, and theft! Reserves of 40% might be enough (to avoid redemption ‘runs’ that would destroy the new system), but it is better to be on the safe side. A ‘run’ could ruin the system, just as occurred in the 1960s, ending in Nixon ‘closing the gold window’ in Aug-1971.

c) Require that new money issued by the U.S. Treasury (no Fed issues) be labeled only by weight and purity of gold (no ‘name’ or religious content) and made available on the day the new system is effective. All government transactions (fees, payments, taxes, Soc. Sec., bond principal, etc.) would be denominated by weight of gold. This will foster public use of gold weight as the unit of account for pricing.

d) Include lessons from how other nations changed money,

e) Publicize the discussions leading to the definition of the Act so US citizens and firms, and other nations, are aware and can submit their ideas and make their conversion plans. I oppose multi-nation planning conferences; they would just cause delays and dilution of terms.

f) The Act should include a ‘Conversion Factor’ (about equal to the ratio of gold price between the new and old systems; ‘25’ per Step 3 above) to adjust values in existing agreements (bonds, wages, loans, mortgages, pensions, insurance, etc.), and set new values by weight of gold. Using lower reserves, or M1, would reduce this factor but increase risk of a ‘redemption run’. Pricing for new transactions or agreements would be set in the free market, and using ‘weight of gold’ as pricing (no ‘Dollars’) would be encouraged.

Step 5. Terminate Useless and Harmful Organizations:

A. Domestic: Abolish the unconstitutional GSEs such as Fannie, Freddie, Ginnie, and Sallie Mae, FHA, Pension Benefit Guaranty Corp (PBGC), FDIC, all TARP-Like projects, the Exchange Stabilization Fund (ESF), Export-Import Bank, USAID, NSA, CIA, NED, etc., etc. All of these are part of the government’s counter-productive intervention in, and manipulation of, money, private business, banking, and the affairs of other nations. While at it, end all unconstitutional departments and agencies!

B. International: Terminate US membership in the IMF (and get our gold back), World Bank, CBGA, BIS,

G-20, G-8, NATO, United Nations, NAFTA, CAFTA, GATT, WTO, and others. Free trade and embassies are adequate for contact with other nations.


Once launched, in my above version of the Private Gold Standard, gold value (purchasing power) is self-controlled by supply and demand, with no ‘parities’ to maintain. Gold and money ‘values’ are the same (gold IS money, and there is no ‘price’ for gold). No ‘management’ is needed!

Ending on a key point, notice that there will always be ‘enough’ gold, because as demand goes up, with a near-fixed supply, Econ-101 says that gold’s value (PP) will APPRECIATE to be in equilibrium (without government ‘management’ !). We are so accustomed to monetary inflation and depreciation of the dollar’s PP, it is easy to forget that the PP of commodity money reacts both ways as demand varies. Another great reason to USE GOLD AS MONEY!

Implementation of the Project
This announcement has been sent to over 100 authors of books, financial firms, and more to publishers of Internet web sites that include analysis of money, and to media, academic, and government persons (US and foreign) who have shown interest in our monetary system, seeking their suggestions. A list (names and web sites) is available on request.

Please send your comments and suggestions to me at Dave@SaferInvesting.org. All will be published on www.SaferInvesting.org. Thank you.

I look forward to submitting the draft plan to you for your comments.


July 26, 2013

Detroit's Fallout: Muni Illiquidity And Full-Faith-And-Credit Failure

Municipal finance is in sharp focus after Detroit filed the largest municipal bankruptcy in history. Detroit’s filing is arguably an isolated case and its fiscal problems are not indicative of the broader municipal credit landscape; but, the outcome of the bankruptcy process will dictate whether the value of the full faith and credit pledge backing GO bonds will be diminished going forward. The global hunt for yield has probably chased new investors into the Muni market who may not fully understand that in recent years it has become an ‘ownership not rental’ market.  In other words, it is unlikely holders of Munis can sell what they own, as liquidity in the secondary
market is almost non-existent

Via Guy Haselmann (ScotiaBank),
Municipal finance is in sharp focus after Detroit filed the largest municipal bankruptcy in history and with analyst Whitney warning of more to come.  At the moment, Detroit’s (relatively small) $18 billion in GO (general obligation) bonds have had few ripple effects on the $3.7 trillion US municipal market, or on the $100 trillion of global fixed income securities.  However, this bankruptcy could eventually lead to significant reappraisals of credit risk, higher funding costs, and legal precedents pertaining to debt creditors and pension ‘guarantees’.

Many fiscal stresses have roots originating from the duplicitous incentive system of elected officials who over the past several decades promised future perks to state and local public employees, but who leave the fulfillment of those promises to successor governors or mayors.  In New Jersey for instance, Governor Chris Christie inherited an underfunded pension, mostly caused by 22 years in a row of preceding Governors not paying into the pension system the full amount allocated in the State’s annual budget.  Part of Christie’s high popularity in NJ and across the US is due to his plan to save the pension system – a plan that passed the state legislature with bi-partisan support.

Most US cities and states have not made much progress in addressing the legacies of those future promises.  Making matters worse is the fact that municipal finances (in recent years) have run deficits despite constitutions that require balanced budgets.  Reduced federal subsidies and low economic growth rates after the 2008 financial crisis have further impaired budgets.  To bridge the gap, spending cuts are often made to basic social services such as education, road and park maintenance, infrastructure projects, or police and fire.  Cuts to pensions or bond creditors are typically skirted due to legal protections.

Michigan’s governor appointed an emergency manager who proposes paying Detroit’s GO bondholders less than 20 cents on the dollar.  As for the pensioners, the state constitution refers to accrued pension benefits as “contractual obligations which shall not be diminished or impaired”; yet, with a $9 billion underfunded gap, pensioners expect cuts.  At some point, a judge is likely to make a ruling on the legality of cuts to creditors or pensions which could have an impact on market premiums and other public pensions. (The PEW Research Center estimates US pension underfunding as high as $3 trillion).

GO bonds are viewed as relatively safe securities because they are seen as being in the first lean position and ‘guaranteed’ by the taxing authority of the municipality.  When problems develop, cuts in services happen, even as taxes rise.  The combination drives out residents and businesses.  The erosion to basic social services often leads to drops in home values and rising crime, further setting off a negative feedback loop.  Therefore, the ability to tax or cut service has its limitations and should not be seen as a solution to ‘guarantee’ creditors, because they destructively undermine the sustainability of the city or state.

The global hunt for yield has probably chased new investors into the Muni market who may not fully understand that in recent years it has become an ‘ownership not rental’ market.  In other words, it is unlikely holders of Munis can sell what they own, as liquidity in the secondary market is almost non-existent.
Via George Friedlander (Citi),
The Detroit bankruptcy filing is no surprise, given that its financial distress can be traced as far back as 1992, when Moody’s downgraded the City’s debt to junk. While ratings did bounce back to IG levels for brief periods, the City has essentially faced worsening budget deficits and liquidity challenges over the last decade.

The Detroit Emergency Manager’s proposal for creditors was unprecedented, at least as far as municipals are concerned, as it essentially tried to flatten the debt priority structure by attempting to impose the same treatment for GO bonds as other forms of debt which are deemed unsecured, including pension obligations, OPEBs, leases and COPs.

The Emergency Manager’s restructuring plan was unlikely to succeed via bilateral agreements and just on the face of it, the Chapter 9 filing could be viewed as mild positive for GO bond holders (especially unlimited GO bondholders) as now more control rests with the bankruptcy judge and standard Chapter 9 rules could apply.

However, the Emergency Manager retains the exclusive rights to file an adjustment plan (unlike Chapter 11, there is no provision in Chapter 9 for creditors to end this exclusivity or propose a competing plan). Thus, the original restructuring plan could serve a baseline for the ultimate settlement and recovery process.

It is still early in the process to predict recovery rates but the unlimited tax GO bond structure provides creditors with a stronger lien on the issuer’s resources and thus recovery rates on this class of debt could be somewhat higher vs. limited tax GOs and other forms of debt which are deemed unsecured. Again, it’s early in the process and there is no precedent for a large city with this level of financial distress.

Detroit’s filing is an isolated case and its fiscal problems are not indicative of the broader municipal credit landscape, in our view. But, the outcome of the bankruptcy process will dictate whether the value of the full faith and credit pledge backing GO bonds will be diminished going forward.

July 25, 2013

Who Controls The Global Economy? Do Not Underestimate The Power Of The Big Banks

Are the big banks really as powerful as some people say that they are?  Do they really control the global economy?  If y0u asked most people, they would tell you that governments control the global economy.  But the campaigns of our politicians are funded by the ultra-wealthy, the big banks and the large corporations that they control.  Others would tell you that the Federal Reserve and the rest of the central banks around the world control the global economy.  But the truth is that the Federal Reserve was established by the bankers and for the benefit of the bankers.  As you will see below, at the very core of the global economy there exists a "super-entity" of financial institutions that control an almost unimaginable amount of wealth and power.  These financial institutions and the ultra-wealthy individuals behind them are really the ones that are pulling all the strings.  In this world money equals power, and the borrower is the servant of the lender.  When you follow the pyramid all the way to the top, it begins to become very clear who really is in control.

In business schools all over America today, instead of dreaming of starting new businesses and contributing something positive to society, most business students are dreaming of going to Wall Street and getting rich.  But Wall Street doesn't actually create or build anything of value for society.  Instead, the bankers make most of their profits by essentially pushing money and paper around.  In a recent article, Chris Martenson commented on this...
Today, some of the most celebrated individuals and institutions are ensconced within the financial industry; in banks, hedge funds, and private equity firms. Which is odd because none of these firms or individuals actually make anything, which society might point to as additive to our living standards. Instead, these financial magicians harvest value from the rest of society that has to work hard to produce real things of real value.
While the work they do is quite sophisticated and takes a lot of skill, very few of these firms direct capital to new efforts, new products, and new innovations. Instead they either trade in the secondary markets for equities, bonds, derivatives, and the like, which perform the 'service' of moving paper from one location to another while generating 'profits.' Or, in the case of banks, they create money out of thin air and lend it out at interest of course.
But just because they aren't adding much value to society does not mean that these big banks are not extremely powerful.  In fact, anyone that underestimates that power of these monolithic financial institutions is being quite foolish.

A team of researchers at the Swiss Federal Institute of Technology in Zurich studied the relationships between 37 million companies and investors worldwide, and what they found was absolutely stunning.

What they discovered is that there is a "super-entity" of just 147 very tightly knit companies that controls 40 percent of the entire network...
When the team further untangled the web of ownership, it found much of it tracked back to a "super-entity" of 147 even more tightly knit companies - all of their ownership was held by other members of the super-entity - that controlled 40 per cent of the total wealth in the network. "In effect, less than 1 per cent of the companies were able to control 40 per cent of the entire network," says Glattfelder. Most were financial institutions. The top 20 included Barclays Bank, JPMorgan Chase & Co, and The Goldman Sachs Group.
So exactly who are the companies that are at the core of this "super-entity"?

Well, almost all of them are banks or financial institutions.  The following is a list of the 50 "most connected" companies from the study, and the notes in parentheses are from Chris Martenson...

1. Barclays plc
2. Capital Group Companies Inc (Investment Management)
3. FMR Corporation (Financial Services)
4. AXA (Investments & Life Insurance)
5. State Street Corporation (Investment Management)
6. JP Morgan Chase & Co (Bank)
7. Legal & General Group plc (Investments & Life Insurance)
8. Vanguard Group Inc (Investment Management)
9. UBS AG (Bank)
10. Merrill Lynch & Co Inc (Bank)
11. Wellington Management Co LLP (Investment Management)
12. Deutsche Bank AG (Bank)
13. Franklin Resources Inc (Investment Management)
14. Credit Suisse Group (Bank)
15. Walton Enterprises LLC
16. Bank of New York Mellon Corp (Bank)
17. Natixis (Investment Management)
18. Goldman Sachs Group Inc (Bank)
19. T Rowe Price Group Inc (Investment Management)
20. Legg Mason Inc (Investment Management)
21. Morgan Stanley (Bank)
22. Mitsubishi UFJ Financial Group Inc (Bank)
23. Northern Trust Corporation (Investment Management)
24. Société Générale (Bank)
25. Bank of America Corporation (Bank)
26. Lloyds TSB Group plc (Bank)
27. Invesco plc (Investment mgmt) 28. Allianz SE 29. TIAA (Investments & Insurance)
30. Old Mutual Public Limited Company (Investments & Insurance)
31. Aviva plc (Insurance)
32. Schroders plc (Investment Management)
33. Dodge & Cox (Investment Management)
34. Lehman Brothers Holdings Inc* (Bank)
35. Sun Life Financial Inc (Investments & Insurance)
36. Standard Life plc (Investments & Insurance)
37. CNCE
38. Nomura Holdings Inc (Investments and Financial Services)
39. The Depository Trust Company (Securities Depository)
40. Massachusetts Mutual Life Insurance
41. ING Groep NV (Bank, Investments & Insurance)
42. Brandes Investment Partners LP (Financial Services)
43. Unicredito Italiano SPA (Bank)
44. Deposit Insurance Corporation of Japan (Owns a lot of banks' shares in Japan)
45. Vereniging Aegon (Investments & Insurance)
46. BNP Paribas (Bank)
47. Affiliated Managers Group Inc (Owns stakes in 27 money management firms)
48. Resona Holdings Inc (Banking Group in Japan)
49. Capital Group International Inc (Investments and Financial Services)
50. China Petrochemical Group Company

Are you starting to get the idea?

The global economy truly is completely dominated by banks and other financial institutions.
In the United States, the big banks are not just content to own other companies anymore.  Now, some of our largest banks are actually starting to directly get into businesses such as "electric power production, oil refining and distribution, owning and operating of public assets such as ports and airports, and even uranium mining".  The following is an excerpt from a letter that several members of the U.S. Congress recently sent to Federal Reserve Chairman Ben Bernanke...
We write in regards to the expansion of large banks into what had traditionally been non-financial commercial spheres. Specifically, we are concerned about how large banks have recently expanded their businesses into such fields as electric power production, oil refining and distribution, owning and operating of public assets such as ports and airports, and even uranium mining. 
Here are a few examples. Morgan Stanley imported 4 million barrels of oil and petroleum products into the United States in June, 2012. Goldman Sachs stores aluminum in vast warehouses in Detroit as well as serving as a commodities derivatives dealer. This “bank” is also expanding into the ownership and operation of airports, toll roads, and ports. JP Morgan markets electricity in California. 
In other words, Goldman Sachs, JP Morgan, and Morgan Stanley are no longer just banks – they have effectively become oil companies, port and airport operators, commodities dealers, and electric utilities as well. This is causing unforeseen problems for the industrial sector of the economy. For example, Coca Cola has filed a complaint with the London Metal Exchange that Goldman Sachs was hoarding aluminum. JP Morgan is currently being probed by regulators for manipulating power prices in California, where the “bank” was marketing electricity from power plants it controlled. We don’t know what other price manipulation could be occurring due to potential informational advantages accruing to derivatives dealers who also market and sell commodities. The long shadow of Enron could loom in these activities.
You can read the rest of their letter right here.

This week, Goldman Sachs has been facing allegations that it has cost American consumers billions of dollars by manipulating the price of aluminum.  The following is from an article that was posted on CNBC...
Hundreds of millions of times a day, thirsty Americans open a can of soda, beer or juice. And every time they do it, they pay a fraction of a penny more because of a shrewd maneuver by Goldman Sachs and other financial players that ultimately costs consumers billions of dollars. 
The story of how this works begins in 27 industrial warehouses in the Detroit area where Goldman stores customers' aluminum. Each day, a fleet of trucks shuffles 1,500-pound bars of the metal among the warehouses. Two or three times a day, sometimes more, the drivers make the same circuits. They load in one warehouse. They unload in another. And then they do it again. 
This industrial dance has been choreographed by Goldman to exploit pricing regulations set up by an overseas commodities exchange, an investigation by The New York Times has found. The back–and-forth lengthens the storage time. And that adds many millions a year to the coffers of Goldman, which owns the warehouses and charges rent to store the metal. It also increases prices paid by manufacturers and consumers across the country.
If that sounds shady to you, that is because it is shady.

But as the big banks continue to gain even more power in our society, this kind of thing will become even more common.

So what can we do about it?

Not much.

Do you think that the media will tell us the truth about all of this?  I wouldn't count on it.  At this point, there are just six giant media corporations that control more than 90 percent of the news and entertainment that you see on your television.  And those six giant media corporations are very hesitant to do anything that will damage their corporate owners or their corporate advertisers.

Do you think that our politicians will do anything about all of this?  I wouldn't count on it.  In national elections, the candidate that raises more money wins more than 80 percent of the time

Our politicians know where their bread is buttered, and as history has shown most of them are very good to the guys with the big checkbooks.

As I said at the top of this article, money is power, and according to a report that was released last summer, the global elite have up to 32 TRILLION dollars stashed in offshore banks around the globe.

The global economy belongs to them.  We are just living in it.

But hopefully if enough people start waking up, someday we will see some significant changes.
One of my favorite musical artists of all-time, Michael W. Smith, once wrote a song that contained the following lyrics...
Tell me, how long will we grovel at the feet of wealth and power?
Tell me, how long will we bow down to that golden calf, now?
(How long will be too long)
Will the people of the world ever get sick and tired of the overwhelming power of the big banks and start demanding changes?

That is a very good question.  Please feel free to share what you think by posting a comment below...


July 24, 2013

Does Free Money Exist?

Three trends that will create demand for an Unconditional Basic Income ... The digitization of our economy will bring with it a new generation of radical economic ideologies, of which Bitcoin is arguably the ?rst. For those with assets, technological savvy, and a sense of adventure, the state is the enemy and a cryptographic currency is the solution. But for those more focused on the decline of the middle classes, the collapse of the entry-level jobs market, and the rise of free culture, the state is an ally, and the solution might look something like an unconditional basic income. Before I explain why this concept is going to be creeping into the political debate across the developed world, let me spell out how a system like this would look: Every single adult member receives a weekly payment from the state, which is enough to live comfortably on. The only condition is citizenship and/or residency. You get the basic income whether or not you're employed, any wages you earn are additional. – Simulacrum

Dominant Social Theme: The state will take care of us all, just wait.

Free-Market Analysis: Are there any words to describe this evil? We've written dozens of articles on this over the past few years, observing the growth of this meme.

Everything repeats in this century of directed history. The social credit crackpottery of the 1930s has returned, wrapped in the robes of Neo-Nazi statism. Those boosting it wrap their rhetoric in anti-banker sentiments, but make no mistake: A meme of this magnitude is a Tavistock-like promotion.

These people use the rhetoric of libertarianism to arrive at terrifyingly statist conclusions. The state wiped out some 150 million people in the 20th century, and we would actually think it's a lot more. The idea that the state will provide for its citizens is a mythological sleight-of-hand.

Give the state the power to provide and ultimately it will provide only for the strongest. The weakest will perish and free-market enterprise will wither.

These are not idle prognostications. The upshot of social credit is a fascist society in which only the biggest corporations survive, in league with the government itself. And these ideas are gaining traction. From New Zealand to the European Union, we see mysterious groups springing up to demand a "living wage."

There is nothing Money Power would like more than to organize societies around full-employment welfare. Think of the power that would give to governments. And therefore, to those who CONTROL government.

We are told "the people" ought to control government. But in reality the people never control government. Over time, special interests take over. And these special interests are beholden to the wealthiest among us ... the same groups that dominate the money structure via central banking.

One needs to do everything possible to SHRINK government. This is not how it is presented, of course. We are told it will be different this time. The meek shall finally receive their portion of the monetary pie. The humble among us shall influence Leviathan alongside the mightiest.
Here's more from the article:

The welfare bureaucracy is largely dismantled. No means testing, no signing on, no bullying young people into stacking shelves for free, no separate state pension. Employment law is liberalised, as workers no longer need to fear dismissal.

People work for jobs that are available in order to increase their disposable income. Large swathes of the economy are replaced by volunteerism, a continuation of the current trend. The system would be harder to cheat when there's only a single category of claimant, with no extraordinary allowances. This may sound o?-the-charts radical, but here's why you're going to be hearing a lot more about it:

1 – The Middle Classes Are In Freefall

2 – Demand For Human Labour Is In Long Term Decline

3 – Cultural Production Is Detaching From The Market

This is a mish-mosh, a jumble of economically illiterate ideas presented as fact. We are to believe it is simply coincidence that Western middle classes are declining? Funny, we would tend to believe that a combination of inflationary money printing, high taxes and draconian regulation puts the squeeze on middle incomes and makes social mobility increasingly difficult.

Nor is demand for human labor declining. Were society freer, people would find their own entrepreneurial niches as they have throughout human history. The article also asks, "How would we pay for it?" And answers, "Don't dismiss this as socialism, it involves a complete rejection of the Stakhanovite work ethic and a full-throttle embrace of consumer culture."

Really? What else is necessary? ...

We could start by getting corporations to pay their taxes. Money will circulate far faster if it's placed in the hands of consumers. For salaried workers a basic income would likely be a repackaging of tax free allowances, although they would likely need a net gain to buy into it. The scheme would also yield savings elsewhere in the public sector, from a reduction in the size of the bureaucracy, to an increasing role for volunteers and charities.

The authoritarian mindset is busily at work here. The idea of the corporation is accepted as a fait accompli. The regnant state is supposed to tame these behemoths on behalf of the people to ensure they pay "their fair share" of taxes.

The issue of central banking is avoided altogether, though surely modern central banking is fully able to print enough money to compensate for taxes – were taxes not to be collected.

Imagine that the state paid for everybody's sustenance. Imagine the power that such a bureaucracy would hold over the population. And imagine the power that would give to those who controlled the state.

Were this simply the uncoordinated ramblings of a radical fringe, it wouldn't be worrisome. But in our view, there is ample evidence it is a highly coordinated campaign.

That these individuals, whoever they are, have adopted the language of libertarianism while making free-market economics the number one enemy is only more evidence of a malicious and sinister coordination.

Conclusion: Beware of those who come along offering gifts of free money.


July 23, 2013

The Detroit Syndrome

When the city of Detroit filed for bankruptcy last week, it became the largest such filing in United States history. Detroit’s population has dropped from 1.8 million in 1950, when it was America’s fifth-largest city, to less than 700,000 today. Its industrial base lies shattered.
And yet we live in a world where cities have never had it so good. More than half of the world’s population is urban, for the first time in history, and urban hubs generate an estimated 80% of global GDP. These proportions will rise even higher as emerging-market countries urbanize rapidly. So, what can the world learn from Detroit’s plight?
As recently as the 1990’s, many experts were suggesting that technology would make cities irrelevant. It was believed that the Internet and mobile communications, then infant technologies, would make it unnecessary for people to live in crowded and expensive urban hubs. Instead, cities like New York and London have experienced sharp increases in population since 1990, after decades of decline.
One factor that has helped cities is the nature of twenty-first century life. Previously, life in developed countries was based on daily routines: people went to work in offices and factories, returned home to eat dinner with their families, watched their favorite television programs, went to sleep, and repeated the cycle when they awoke.
Such regular cycles no longer apply to most peoples’ lives. In the course of a work day, people mix and match many activities – they may work at a desk, but they may also meet a friend for lunch, go to the gym, do chores, travel on business, shop online, and so on.
Similarly, time at home is no longer clearly demarcated, with people working online or participating in conference calls even as they manage their family life. We have discovered that this multi-tasking life is best done in cities, which concentrate a multiplicity of hard amenities – airports, shops, schools, parks, and sports facilities – as well as soft amenities like clubs, bars, and restaurants.
Another factor is that cities have increased in importance as hubs for innovation and creativity. Until the nineteenth century, innovation was carried out mostly by generalists and tinkerers, which meant that the accumulation of new knowledge was slow, but that its diffusion across different fields was rapid. In the twentieth century, knowledge creation became the job of specialists, which accelerated knowledge creation but retarded inter-disciplinary application.
But recent studies have shown that this source of innovation is rapidly decelerating (the productivity of an American research worker may now be less than 15% of a similar researcher in 1950). Instead, innovation is increasingly based on mixing and matching knowledge from different specializations. Certain cities are ideally suited for this, because they concentrate different kinds of human capital and encourage random interactions between people with different knowledge and skills.
The problem with this post-industrial urban model is that it strongly favors generalist cities that can cluster different kinds of soft and hard amenities and human capital. Indeed, the growth dynamic can be so strong for some successful cities that they can hollow out smaller rivals (for example, London vis-à-vis the cities of northern England).
Some specialist cities could also do well in this world. But, as Detroit, with its long dependence on the automotive industry, demonstrates, cities that are dependent on a single industry or on a temporary location advantage may fare extremely poorly.
All of this has important implications for emerging economies. As it transformed itself into the “factory of the world,” the share of China’s urban population jumped from 26.4% in 1990 to around 53% today. The big, cosmopolitan cities of Beijing and Shanghai have grown dramatically, but the bulk of the urban migration has been to cookie-cutter small and medium-size industrial towns that have mushroomed over the last decade. By clustering industrial infrastructure and using the hukou system of city-specific residency permits, the authorities have been able to control the process surprisingly well.
This process of urban growth, however, is about to unravel. As China shifts its economic model away from heavy infrastructure investment and bulk manufacturing, many of these small industrial cities will lose their core industry. This will happen at a time when the country’s skewed demographics causes the workforce to shrink and the flow of migration from rural areas to cities to slow (the rural population now disproportionately comprises the elderly).
Meanwhile, the post-industrial attractions of cities like Shanghai and Beijing will attract the more talented and better-educated children of today’s industrial workers. Unlike rural migrants heading for industrial jobs, it will be much more difficult to guide educated and creative professionals using the hukou system. The boom in the successful cities, therefore, will hollow out human capital from less attractive industrial hubs, which will then fall into a vicious cycle of decay and falling productivity.
Stories like Detroit’s have played out several times in developed countries during the last half-century. And, as the fate of Mexico’s northern towns suggests, emerging economies are not immune from this process.
That is why China needs to prepare for this moment. Rather than building ever more cookie-cutter industrial towns, China needs to refit and upgrade its existing cities. As its population begins to shrink, it may even be worthwhile to shut down unviable cities and consolidate. Detroit’s fate should serve as a warning, not only for China, but for the next generation of urbanizing countries (for example, India) as well.


July 22, 2013

How Goldman Made $5 Billion By Manipulating Aluminum Inventories (and Copper is Up Next)

What sexual favors were exchanged so that the New York Times blunted the impact of an important, detailed investigative story on Goldman profiteering, this time in the aluminum market, by releasing it on a heat-addled summer Saturday?

On a high level, the story sets forth a simple and damning case. Not all that long ago, banks were prohibited from being in operating businesses. But the Federal Reserve and Congress have loosened those rules and big financial players have gone full bore backward integrating from commodities trading into owning major components of the delivery and inventorying systems. This doesn’t just give them a big information advantage by having better access to underlying buying and selling activity. It allows them to manipulate inventories, and thus, prices. And Goldman’s aluminum henanigans increased prices all across the market, not just for the customers who chose to use them for warehousing and delivery.

The article A Shuffle of Aluminum, but to Banks, Pure Gold by David Kocieniewski, tells us that the newly-permissive rules allowed Goldman to buy Metro International Trade Services, a concern in Detroit with 27 warehouses that handles a bit over 25% of the aluminum available for delivery. And here’s where the fun and games begin:
Each day, a fleet of trucks shuffles 1,500-pound bars of the metal among the warehouses. Two or three times a day, sometimes more, the drivers make the same circuits. They load in one warehouse. They unload in another. And then they do it again. 
This industrial dance has been choreographed by Goldman to exploit pricing regulations set up by an overseas commodities exchange, an investigation by The New York Times has found. The back–and-forth lengthens the storage time. And that adds many millions a year to the coffers of Goldman, which owns the warehouses and charges rent to store the metal. It also increases prices paid by manufacturers and consumers across the country…
Before Goldman bought Metro International three years ago, warehouse customers used to wait an average of six weeks for their purchases to be located, retrieved by forklift and delivered to factories. But now that Goldman owns the company, the wait has grown more than 20-fold — to more than 16 months, according to industry records. 
Longer waits might be written off as an aggravation, but they also make aluminum more expensive nearly everywhere in the country because of the arcane formula used to determine the cost of the metal on the spot market. The delays are so acute that Coca-Cola and many other manufacturers avoid buying aluminum stored here. Nonetheless, they still pay the higher price.
The Times’s sources estimate the price impact across the market at 6 cents per pound, which adds $12 to the price of a typical car. Goldman piously claims it obey all the rules, but obeying the rules is far from operating in a fair or pro-customer manner. Metro’s inventories ballooned from 50,000 tons in 2008 to 850,000 tons in 2010. By 2011, Coca Cola complained to the London Metals Exchange, which attempted to address the situation by increasing the amount that warehouses must ship daily from 1,500 tons to 3,000 tons. But all that appears to have taken place is that Goldman simply shuffles more inventory among the 27 Metro warehouses while thumbing its nose at the LME (its inventories have almost doubled again from the 2010 levels, standing at 1.5 million tons).

The article goes into considerable detail as to how Goldman and its speculator allies manipulate prices (remember that holding inventories off the market results in higher prices, this is supply-demand 101):
Industry analysts and company insiders say that the vast majority of the aluminum being moved around Metro’s warehouses is owned not by manufacturers or wholesalers, but by banks, hedge funds and traders. They buy caches of aluminum in financing deals. Once those deals end and their metal makes it through the queue, the owners can choose to renew them, a process known as rewarranting. 
To encourage aluminum speculators to renew their leases, Metro offers some clients incentives of up to $230 a ton, and usually moves their metal from one warehouse to another, according to industry analysts and current and former company employees.
To metal owners, the incentives mean cash upfront and the chance to make more profit if the premiums increase…metal analysts, like Mr. Vazquez at Harbor Aluminum Intelligence, estimate that 90 percent or more of the metal moved at Metro each day goes to another warehouse to play the same game. That figure was confirmed by current and former employees familiar with Metro’s books, who spoke on condition of anonymity because of company policy… 
Despite the persistent backlogs, many Metro warehouses operate only one shift and usually sit idle 12 or more hours a day. In a town like Detroit, where factories routinely operate round the clock when necessary, warehouse workers say that low-key pace is uncommon. 
When they do work, forklift drivers say, there is much more urgency moving aluminum into, and among, the warehouses than shipping it out. Mr. Clay, the forklift driver, who worked at the Mount Clemens warehouse until February, said that while aluminum was delivered in huge loads by rail car, it left in a relative trickle by truck. 
“They’d keep loading up the warehouses and every now and then, when one was totally full they’d shut it down and send the drivers over here to try and fill another one up,” said Mr. Clay, 23. 
Because much of the aluminum is simply moved from one Metro facility to another, warehouse workers said they routinely saw the same truck drivers making three or more round trips each day.
There is plenty more damning material in this excellent and important piece, which I strongly urge you to read in full. This is simply another form of looting. And the Times highlights, as we warned, that JP Morgan is running the same trick in copper, and Goldman will join the party:
In 2010, JPMorgan quietly embarked on a huge buying spree in the copper market. Within weeks — by the time it had been identified as the mystery buyer — the bank had amassed $1.5 billion in copper, more than half of the available amount held in all of the warehouses on the exchange. Copper prices spiked in response. 
At the same time, JPMorgan began seeking approval of a plan that would ultimately allow it, Goldman Sachs and BlackRock, a large money management firm, to buy 80 percent of the copper available on the market on behalf of investors and hold it in warehouses. The firms assert that these stockpiles, which would be used to back new copper exchange-traded funds, will not affect copper prices. But manufacturers and copper wholesalers warned that the arrangement would squeeze the market and send prices soaring. They asked the S.E.C. to reject the proposal. 
After an intensive lobbying campaign by the banks, Mary L. Schapiro, the S.E.C.’s chairwoman, approved the new copper funds last December, during her final days in office. S.E.C. officials said they believed the funds would track the price of copper, not propel it, and concurred with the firms’ contention — disputed by some economists — that reducing the amount of copper on the market would not drive up prices. 
Others now fear that Goldman and JPMorgan, which also controls metals warehouses, will repeat the tactics that have run up prices in the aluminum market. Such an outcome, they caution, would ripple through the economy. Consumers would end up paying more for goods as varied as home plumbing equipment, autos, cellphones and flat-screen televisions.
There is a long-shot hope:
All of this could come to an end if the Federal Reserve Board declines to extend the exemptions that allowed Goldman and Morgan Stanley to make major investments in nonfinancial businesses — although there are indications in Washington that the Fed will let the arrangement stand.
The Fed chairmanship is up as of January. The nomination and approval process provides an opportunity for Fed policies to be subjected to scrutiny and debate. Contact your Senators, as well as Elizabeth Warren, and tell them the Fed needs to stop allowing Wall Street to manipulate the prices of critical commodities by getting into the shipping and storage game. And circulate it to friends and colleagues who will would understand the cost and damage done by inflating metals and other commodity prices. The more noise, the better.

Update: And before you think the call for action at the end is quixotic, the lead article at Bloomberg is Fed Reviews Rule on Big Banks’ Commodity Trades After Complaints by Bob Ivry. Some key bits:
When the Federal Reserve gave JPMorgan (JPM) Chase & Co. approval in 2005 for hands-on involvement in commodity markets, it prohibited the bank from expanding into the storage business because of the risk. 
While the Fed has never explained why it let that happen, the central bank announced July 19 that it’s reviewing a 2003 precedent that let deposit-taking banks trade physical commodities. Reversing that policy would mark the Fed’s biggest ejection of banks from a market since Congress lifted the Depression-era law against them running securities firms in 1999… 
On June 27, four Democratic members of Congress wrote a letter asking Fed Chairman Ben S. Bernanke, among other things, how Fed examiners would account for possible bank runs caused by a bank-owned tanker spilling oil, and how the Fed would resolve a systemically important financial institution’s commodities activities if it were to collapse.
The Senate has hearings on this topic scheduled for July 23, so this media attention is timely.


July 19, 2013

The U.S. Government Will Borrow Close To 4 Trillion Dollars This Year

When you add maturing debt to the new debt that the federal government is accumulating, the total is quite eye catching.  You see, the truth is that the U.S. government must not only borrow enough money to fund government spending for this year, it must also "roll over" existing debt that has reached maturity.  Of course the government never actually pays any of that debt off.  Instead, it essentially takes out new debts to cover the old ones.  So the U.S. government is actually borrowing far more money each year than most Americans realize.  For fiscal year 2013, the U.S. budget deficit will be about $845 billion, but on top of that the government will also have to borrow about 3 trillion dollars to pay off old debt that is maturing.  Overall, the U.S. government will borrow close to 4 trillion dollars this year, and that number will likely be even higher next year.  That is not going to cause a crisis as long as interest rates stay super low, but if interest rates begin to rise substantially, the game will change dramatically.

When the government borrows money, it has to pay it back someday.  Back in the old days, the federal government used to issue lots of debt that would not mature for a very long time.  But in recent years things have been very different...
In order to fund the government, the Treasury Department periodically auctions Treasury securities with various maturities ranging from 30-day Treasury bills to 30-year Treasury bonds, with 2-3-5-7-year and 10-year Treasury notes in between. It used to be that the bulk of Treasury borrowing was done in the longer-term instruments with maturities of at least 10 years. 
In more recent years, however, this trend has shifted more toward shorter-term Treasury securities. There are pros and cons to both strategies. Generally speaking, the shorter maturities are considered more risky since short-term interest rates can vary frequently. Shorter-term maturities obviously have to be rolled over much more often. That raises the risk that there might not be enough buyers when the government needs them.
At this point, the average maturity of outstanding government debt is only 65 months, and only about 10 percent of all Treasury debt matures outside of a decade.

So what does that mean?

It means that the federal government must constantly roll over massive amounts of debt.  Once again, this is not too much of a problem as long as interest rates stay super low, but as John Cochrane pointed out, if rates start rising back to "normal" levels things could get quite hairy very quickly...
Here’s the nightmare scenario: Suppose that four years from now, interest rates rise 5 percent, i.e. back to normal, and the US has $20 trillion outstanding. Interest costs alone will rise $1 trillion (5% of $20 trillion) – doubling already unsustainable deficits! This is what happened to Italy, Spain, and Portugal. Don’t think it can’t happen to us. It’s even more likely, because fear of inflation – which did not hit them, since they are on the Euro – can hit us.
Sadly, those running things appears to be quite clueless.  For example, retiring U.S. Representative Michele Bachmann recently asked Federal Reserve Chairman Ben Bernanke why the national debt has remained frozen in place for 56 straight days even though we have been borrowing lots of money.  Bernanke seemed to have no idea how to answer that question...
As Federal Reserve Chairman Ben Bernanke testified before the House Financial Services Committee Wednesday, Bachmann asked how there could be no increase reported in the total debt when the government is racking up about $4 billion a day in new debt. 
“After nearly 10 years as the head of the Federal Reserve, Chairman Bernanke could not answer my question today in Financial Services Committee,” Bachmann told WND.
She wondered if there’s a political motive. 
“I asked whether the Treasury Department was cooking the federal government’s books as it was reported that the Feds debt balance sheet remained at $16,699,396,000,000 for 56 days straight, presumably so the Treasury Department wouldn’t officially register that once again the Congress had exceeded its legal borrowing limits.”
For the moment, the federal government is able to recklessly borrow and spend money and investors are rewarding this behavior with super low interest rates.

Unfortunately, this state of affairs is completely and totally unsustainable.  At some point global financial markets will begin to behave rationally, and when that happens it is going to mean a tremendous amount of pain for the United States.

Over the past decade, the U.S. government has added more than 11 trillion dollars to the national debt at a time when the U.S. economy has been steadily declining.  Anyone that thinks that we can continue to pile up more debt like this indefinitely does not know what they are talking about.
The following are some more statistics about the U.S. national debt for you to consider...
-Back in 1980, the U.S. national debt was less than one trillion dollars.  Today, it is rapidly approaching 17 trillion dollars.

-During Obama's first term, the federal government accumulated more debt than it did under the first 42 U.S presidents combined.

-The U.S. national debt is now more than 23 times larger than it was when Jimmy Carter became president.

-If you started paying off just the new debt that the U.S. has accumulated during the Obama administration at the rate of one dollar per second, it would take more than 184,000 years to pay it off.

-If right this moment you went out and started spending one dollar every single second, it would take you more than 31,000 years to spend one trillion dollars.

-If you were alive when Jesus Christ was born and you spent one million dollars every single day since that point, you still would not have spent one trillion dollars by now.

-Some suggest that "taxing the rich" is the answer.  Well, if Bill Gates gave every single penny of his entire fortune to the U.S. government, it would only cover the U.S. budget deficit for 15 days.

-If the federal government used GAAP accounting standards like publicly traded corporations do, the real federal budget deficit for 2011 would have been 5 trillion dollars instead of 1.3 trillion dollars.

-The United States already has more government debt per capita than Greece, Portugal, Italy, Ireland or Spain does.

-At this point, the United States government is responsible for more than a third of all the government debt in the entire world.

-The amount of U.S. government debt held by foreigners is about 5 times larger than it was just a decade ago.

-The U.S. national debt is now more than 37 times larger than it was when Richard Nixon took us off the gold standard.

-The U.S. national debt is now more than 5000 times larger than it was when the Federal Reserve was first created.

-Boston University economist Laurence Kotlikoff is warning that the U.S. government is facing a gigantic tsunami of unfunded liabilities in the coming years that we are counting on our children and our grandchildren to pay.  Kotlikoff speaks of a "fiscal gap" which he defines as "the present value difference between projected future spending and revenue".  His calculations have led him to the conclusion that the federal government is facing a fiscal gap of 222 trillion dollars in the years ahead.

For the moment everything is fine because interest rates are incredibly low and the mockers in the "deficits don't matter" fan club are having a field day.

But what is going to happen when interest rates return to rational levels?

How will the U.S. government be able to borrow the trillions of dollars that it needs to borrow every single year?

That is why it is so important to watch interest rates.  When they start skyrocketing, big trouble is ahead.


July 18, 2013

TransPacific Partnership to Let Foreign Investors Gut Regulations, Keep Big Ag Subsidies

The nature and effects of free trade agreements has become a topic of public discussion, especially with the round of talks of the Trans-Pacific Partnership Agreement (TPPA) about to take place in Malaysia.

Not much is known about the TPPA drafts. But with some of its chapters leaked and available on the internet, and since much of the TPPA is likely to be similar to bilateral FTAs that the United States has already signed, we can have a good idea of its main points.

As can be expected, there are many contentious issues to consider, especially for developing countries like Malaysia.

Actually, only a small part of the TPPA is about trade as such. Most chapters are on other issues, like services, investment, government procurement, disciplines on state-owned enterprises and intellectual property.

Joining the TPPA or similar FTAs will mean the country having to make often drastic changes to existing policies, laws and regulations, which will in turn affect the domestic economy and society.
On trade itself, the TPPA countries will have to remove tariffs on almost all products coming from one another. Perhaps only one or two products can still be protected.

The main implication is that local producers and farmers would have to compete with tariff-free imports from other TPP countries. This may lead to loss of market share or closure of some sectors.
Ironically, agricultural subsidies, which is the main trade-distorting practice of developed countries like the US, have been kept out of the agenda of the TPPA or other FTAs involving Europe.

The developed countries are clever not to include what would be damaging to them. Thus the developing countries are deprived from what would have been the major trade gain for them.

On services and investments, we can expect that TPP countries will have to open all their services and investment sectors to the entry and establishment of companies, in manufacturing as well as services including finance, commerce, telecoms, utilities, professional and business services.

If a country wants to exclude any sector, it will have to list this in a table of exceptions, and this will also be subject to negotiations. Future new services cannot be excluded as they are not even known yet today.

In the investment chapter, the country will have to commit not only to liberalise the entry of foreign companies, but also to protect the foreign investors’ rights in an extreme way that goes far beyond what is recognised in national laws and courts.

For example, the foreign investor includes any person or company who has an asset (factory, land, shares, contract, franchise, intellectual property, etc). “Fair and equitable treatment” to be given to them has been interpreted in past cases to include a standstill on (no changes in) regulation.

Thus, any new laws or changes in laws and regulations that the foreign investor claims will affect its future revenues can be challenged in an international tribunal for monetary compensation.

The regulations could be economic (for example, terms in contracts, type of or ratios on foreign ownership, financial regulation including in a crisis), health-related (food safety, tobacco control, provision of cheaper medicines), environment-related (ban on chemicals, policies on rivers, forest, climate change) and social (for example, affirmative action for disadvantaged groups or communities).

TPP countries have agreed to allow foreign companies to sue governments in an international court (usually ICSID, based in Washington) for compensation for expropriation, or for not giving them fair treatment.

Expropriation is defined not only as confiscation of property or breaking of contracts, but also as reduction of revenues due to a change in policies and regulations.

These investor-to-state disputes can cost countries a lot. A court awarded an American oil company US$ 2.3 billion against Ecuador’s government in 2012. Indonesia is being sued US$2 billion for withdrawing a contract that a state government made with a UK-based company.

The TPP will also open up government procurement, with foreigners allowed to bid on similar terms as locals for goods, services and projects of the federal government (and possibly also state and municipal governments) above a threshold value.

Existing preferences in government procurement for local companies will be affected, as will be the ability of government to use its spending and procurement policy to boost the domestic economy and as a major social and economic policy instrument.

Since government procurement contracts are considered investments, the foreign supplier can sue the government at an international tribunal by claiming unfair treatment including a renegotiation of contract.

There is also a sub-chapter on state-owned enterprises (SOEs). The USA and Australia are proposing disciplines on the operations of SOEs, including commercial companies in which the government has a share.

This would restrict the state’ ability to govern or manage government-linked companies, or provide them with incentives and preferences. This would have serious implications for many a developing country whose success is based on the role of the state in the economy, and on public-private sector partnerships.

The chapter on intellectual property has generated public debate because it obliges the TPP countries to have IP laws far beyond the WTO rules.

Longer patent terms and restrictions on the state’s policy freedom to promote generic medicines are expected to raise the prices of medicines. Tighter copyright rules would also affect access to knowledge, including books, journals and digital information.

Local producers in industry may also find it more difficult to upgrade their technologies and local farmers could have less access to agricultural inputs including seeds.

These are the specific issues that are or should be in the centre of the negotiations. There are many benefits to the foreign investors or companies, as contrasted to the local, as can be seen from the above. Local companies would lose a lot of their present advantages or preferences, they cannot stake a claim to “fair and equitable treatment” nor sue the government in a foreign court, unlike the foreign.

Naturally, there are pros and cons to any agreement. Any potential gain for a country in exports or investments should be weighed against potential losses to domestic producers and consumers, and especially the loss to the government in policy space and potential pay-outs to companies claiming compensation.


July 17, 2013

The Fed Is The Problem, Not The Solution: The Complete Walk-Through

It may be ironic that one of the best and most comprehensive critiques of central bank policy comes from none other than Raghuram Rajan: a visiting professor for the World Bank, Federal Reserve Board, and Swedish Parliamentary Commission, he is the former chief economist of the International Monetary Fund, and currently the chief economic adviser to the government of India. Then again it should not be ironic: Rajan, as the ultimate insider in the dark corridors of the centrally planned New Normal, really gets it, unlike the vast majority of his ivory tower economist peers.

Already a recognized authority on these pages as one of the very few people who understands how shadow banking operates, we were happy to read his recent BIS speech "A step in the dark: unconventional monetary policy after the crisis", which is must read for all Congressmen (and for everyone else) ahead of tomorrow's appearance by Bernanke on the Hill for the first round of hiw Humphrey Hawkins presentation: it is a walk through for everything that central banks may (and are) wrong about although being part of the system, Rajan's diplomatic finesse lays it out in far more politically correct terms.

Consider this brilliant argument for why not only has Bernanke rendered Congress and the entire democratic apparatus meaningless, and hence why tomorrow's presentation is merely a travesty, but why it is central banks, controlled not by the people but by a syndicate of private banks, that truly run the show:
Perhaps the success that central bankers had in preventing the collapse of the financial system after the crisis secured them the public's trust to go further into the deeper waters of quantitative easing. Could success at rescuing the banks have also mislead some central bankers into thinking they had the Midas touch? So a combination of public confidence, tinged with central-banker hubris could explain the foray into quantitative easing. Yet this too seems only a partial explanation. For few amongst the lay public were happy that the bankers were rescued, and many on Main Street did not understand why the financial system had to be saved when their own employers were laying off workers or closing down.
If nothing else, after reading Rajan's thought below at least it will allow for some more intelligent questions if not answers.

A step in the dark: unconventional monetary policy after the crisis

by Raghuram Rajan, via BIS

I am honored to be invited to give the first Andrew Crockett Memorial Lecture at the Bank for International Settlements (BIS). Sir Andrew Crockett was the General Manager of the BIS from 1 January 1994 until 31 March 2003. During this time, he led the Bank through a period of considerable change. In particular, he strongly encouraged the expansion of BIS membership beyond its traditional, mostly European, base. Earlier than most, he saw that multilateral organizations needed to change to stay relevant. But perhaps his most prescient act was the speech he gave on February 13, 2001 entitled "Monetary Policy and Financial Stability".

In it he argued

"the combination of a liberalised financial system and a fiat standard with monetary rules based exclusively in terms of inflation is not sufficient to secure financial stability. This is not to deny that inflation is often a source of financial instability. It certainly is... ...Yet the converse is not necessarily true. There are numerous examples of periods in which the restoration of price stability has provided fertile ground for excessive optimism. ..."

He went on

"If an absence of inflation is not, by itself, sufficient to ensure financial stability...to what can we look to contain their build-up? The answer is, of course, prudential regulation. However, the tools of prudential regulation are themselves based on perceptions of risk which are not independent of the credit and asset price cycle. If prudential regulation depends on assessments of collateral, capital adequacy and so on, and if the valuation of assets is distorted, the bulwark against the build-up of financial imbalances will be weakened."

In these few paragraphs, Andrew Crockett summed up what has taken many of us an entire global financial crisis and years of research to learn. The paper is only 7 pages long but contains many gems that have guided the very active research program at the BIS and formed the basis of numerous papers that have been written since the crisis. The superb research team at the BIS, including Claudio Borio, Bill White, and many others, carried on the research program laid out in Andrew Crockett's speech. It is too bad that the policy establishment paid little attention to them before the global financial crisis of 2007-2012. We must ensure we do not neglect the wisdom of Andrew Crockett and his team once again.

Central bankers today have given us many reasons to go back to Andrew Crockett's speech. In the talk today, I want to go over their new tools, which come under the rubric "Unconventional Monetary Policies". Much of the time, I will be exploring the contours of what we don't know, asking questions rather than providing answers. But let us start at the beginning, to the deeper underlying causes of the recent financial and sovereign crisis in the United States and Europe. By its very nature, this has to be speculative.

The Roots of the Crisis

Two competing narratives of the sources of the crisis, and attendant remedies, are emerging. The first, and the better known diagnosis, is that demand has collapsed because of the high debt build up prior to the crisis. The households (and countries) that were most prone to spend cannot borrow any more. To revive growth, others must be encouraged to spend - surplus countries should trim surpluses, governments that can still borrow should run larger deficits, while thrifty households should be dissuaded from saving through rock bottom interest rates. Under these circumstances, budgetary recklessness is a virtue, at least in the short term. In the medium term, once growth revives, debt can be paid down and the financial sector curbed so that it does not inflict another crisis on the world.

But there is another narrative. And that is that the fundamental growth capacity in industrial countries has been shifting down for decades now, masked for a while by debt-fuelled demand. More such demand, or asking for reckless spending from emerging markets, will not put us back on a sustainable path to growth. Instead, industrial democracies need to improve the environment for growth.

The first narrative is the standard Keynesian one, modified for a debt crisis. It is the one most government officials and central bankers, as well as Wall Street economists, subscribe to, and needs little elaboration. The second narrative, in my view, offers a deeper and more persuasive view of the blight that afflicts our times. Let me flesh it out a bit. 2

The 1950s and 1960s were a time of strong growth in the West and Japan. A number of factors, including rebuilding from wartime destruction, the resurgence of trade after the protectionist 1930s, the rolling out of new technologies in power, transport, and communications across countries, and the expansion in educational attainments, all helped industrial countries grow. But as Tyler Cowan has argued in his book, The Great Stagnation, when these "low hanging fruit" were plucked, it became much harder to propel growth from the 1970s onward.

In the meantime, though, as Wolfgang Streeck writes persuasively in the New Left Review, when it seemed like an eternity of innovation and growth stretched ahead in the 1960s, democratic governments were quick to promise away future growth to their citizens in the form of an expanded welfare state. As growth faltered though, this meant government spending expanded, even while government resources shrank. For a while, central banks accommodated that spending. The resulting high levels of inflation created widespread discontent, especially because little growth resulted. Faith in Keynesian stimulus diminished, though the high inflation did reduce public debt levels.

Central banks started focusing on low and stable inflation as their primary objective, and increasingly became more independent from their political masters. Government deficit spending, however, continued apace, and public debt as a share of GDP in industrial countries climbed steadily from the late 1970s, this time without the benefit of unexpected inflation to reduce its real value.

Recognizing the need to find new sources of growth, the United States towards the end of Jimmy Carter's term, and then under Ronald Reagan, deregulated industry and the financial sector, as did Margaret Thatcher's United Kingdom. Competition and innovation increased substantially in these countries. Greater competition, freer trade, and the adoption of new technologies, increased the demand for, and incomes of, highly skilled, talented, and educated workers doing non-routine jobs like consulting. More routine, once well-paying, jobs done by the unskilled or the moderately educated were automated or outsourced. So income inequality emerged, not primarily because of policies favoring the rich, but because the liberalized economy favored those equipped to take advantage of it.

The short-sighted political response to the anxieties of those falling behind was to ease their access to credit. Faced with little regulatory and supervisory restraint, sometimes based on the faith that private incentives worked best in this best of all worlds, the financial system overdosed on risky loans to lower middle class borrowers, aided and abetted by very low policy interest rates.

Continental Europe did not deregulate as much, and preferred to seek growth in greater economic integration. But the price for protecting workers and firms was slower growth and higher unemployment. And, while inequality did not increase as much as in the US, job prospects were terrible in the Euro periphery for the young and unemployed, who were left out of the protected system.

The advent of the euro was a seeming boon, because it reduced borrowing costs and allowed countries to create jobs through debt-financed spending. The crisis ended that spending, whether by national governments (Greece), local governments (Spain), the construction sector (Ireland and Spain), or the financial sector (Ireland). Unfortunately, spending pushed up wages, especially but not exclusively in the non-traded sectors like government and construction. Without a commensurate increase in productivity, the heavy spenders became increasingly uncompetitive and indebted and started running large trade deficits.

Of course, it did not seem at that time that countries like Spain, with its low public debt and deficits, were overspending. But as Andrew Crockett foresaw, the boom masks lending problems. Spanish government revenues were high on the back of the added activity and the additional taxes, and so spending seemed moderate. However, if spending was adjusted for the stage of the cycle, it was excessive. 3

The important exception to this pattern was Germany, which was accustomed to low borrowing costs even before it entered the Eurozone. Germany had to contend with historically high unemployment, stemming from reunification with a sick East Germany. In the euro's initial years, Germany had no option but to reduce worker protections, limit wage increases, and reduce pensions as it tried to increase employment. Germany's labor costs fell relative to the rest of the Eurozone, and its exports and GDP growth exploded. Germany's exports, at least in part, were taken up by the spending Euro-periphery.

Eventually, the financial crisis starting in 2007 brought debt-fueled growth to an end. The United States and Europe fell into recession, in part because debt-fueled demand disappeared, but also because it had a multiplier effect on other sources of demand.

The Case for Unconventional Monetary Policies

The crisis was devastating in its impact. Entire markets collapsed, depositors lost confidence in even the soundest banks, and over time, started losing faith in the debt of weak sovereigns. For the financial economist, perhaps the most vivid demonstration of the depth of the problems in the financial sector was that standard arbitrage relationships such as covered interest rate parity started breaking down. 4 There was money to be had without risk - provided one could borrow! And few could. The real economy was equally devastated. For a while, as economist Barry Eichengreen has pointed out, the downturn in economic activity tracked developments during the onset of the Great Depression.

Hindsight is 20-20. It now seems obvious that central banks should have done what they did then, but in many ways, the central banks were making it up as they went. Fortunately for the world, much of what they did was exactly right. They eased access to liquidity through innovative programs such as TALF, TAF, TARP, SMP, and LTRO. By lending long term without asking too many questions of the collateral they received, by buying assets beyond usual limits, and by focusing on repairing markets, they restored liquidity to a world financial system that would otherwise have been insolvent based on prevailing market asset prices. In this matter, central bankers are deservedly heroes in a world that has precious few of them.

If they are to be faulted at all on the rescue, perhaps it is that the repair the central bankers effected was too subtle for some. Conditional on the illiquid conditions, the financial system received an enormous fiscal subsidy - if central bank actions such as guarantees and purchases had not worked out, the tax payer would have been hit with an enormous loss if matters did not improve. But conditional on repairing the system, the subsidy seemed small. Not surprisingly, rescued bankers (and rescued countries) felt somewhat aggrieved when the rescuers expected them to change their behavior. Instead, the public saw large banker bonuses return, and banker attitudes that implied the rescue was a great investment opportunity conferred on the rescuers. No wonder bankers today, and unfortunately, have a social status somewhere between that of a pimp and a conman. I say unfortunately, because more than ever, the world needs good banking to promote growth.

Be that as it may, the second stage of the rescue was to stimulate growth with ultra-low interest rates. And thus far, the central banks have been far less successful. Let us try and understand why.

The Keynesian Explanation and an Alternative

According to the most influential Keynesian view, the root cause of continued high unemployment and a slow recovery is excessively high real interest rates. The logic is simple. 5 Before the financial crisis erupted in 2008, consumers buoyed US demand by borrowing heavily against their rising house prices. As the crisis hit, these heavily indebted households could not borrow and spend any more.

An important source of aggregate demand evaporated. As indebted consumers stopped buying, real (inflation-adjusted) interest rates should have fallen to encourage hitherto thrifty debt-free households to spend. But real interest rates did not fall enough, because nominal interest rates cannot be reduced below zero - the so-called zero lower bound became a constraint on growth. 6

The Keynesian explanation suggests that the full-employment equilibrium real interest rate in the post-crisis over-leveraged world - the so-called neutral rate -- should be strongly negative. This has been the justification for central banks to employ innovative policies to try and achieve ultra-low real interest rates. That the low rates do not seem to have enhanced growth rates quickly has only made central bankers even more innovative.

But what if low interest rates do not enhance demand in a post-crisis world beyond a point? While low rates may encourage spending if credit were easy to obtain, it is not at all clear that corporations or traditional savers today will go out and spend. Think of the soon-to-retire office worker. She saved because she wanted enough money to retire. Given the terrible returns on savings since 2007, the prospect of continuing low interest rates might make her put even more money aside. Indeed, in simple models of the kind that the Keynesians propose, the existence of savers who have suffered a loss of savings and have end-of-working-life savings objectives can imply that lower real interest rates are contractionary - savers put more money aside as interest rates fall in order to meet the savings they think they will need when they retire. 7

The point is not that this is a strong argument that ultra-low interest rates will have a net perverse effect but that a crisis potentially creates offsetting effects even on aggregate demand (through a readjustment of savings plans) that make it difficult to argue, based on theory, that strongly negative real interest rates are the right medicine to restore demand. Years of strongly negative real interest rates might contribute only weakly to demand growth.

There are two further problems in the view that a restoration of undifferentiated aggregate demand is the right solution. First, after a debt-fueled boom, the paucity of demand is localized in certain social classes, certain regions, and certain productive sectors. Second, in the years leading up to a debt crisis, it is not only demand that is distorted through borrowing, it is also supply.

To see all this, let us focus for the moment on household borrowing. Before the crisis in the United States, when borrowing became easier, it was not the well-to-do, whose spending is not constrained by their incomes, who increased their consumption; rather, the increase came from poorer and younger families whose needs and dreams far outpaced their incomes. 8 Their needs can be different from those of the rich.

Moreover, the goods that were easiest to buy were those that were easiest to post as collateral - houses and cars, rather than perishables. And rising house prices in some regions made it easier to borrow more to spend on other daily needs such as diapers and baby food.

The point is that debt-fueled demand emanated from particular households in particular regions for particular goods. While it catalyzed a more generalized demand - the elderly plumber who worked longer hours in the boom spent more on his stamp collection - it was not unreasonable to believe that much of debt-fueled demand was more focused. So, as lending dried up, borrowing households could no longer spend, and demand for certain goods changed disproportionately, especially in areas that boomed earlier.

Of course, the effects spread through the economy - as demand for cars fell, the demand for steel also fell, and steel workers were laid off. But unemployment, household over-indebtedness, as well as the consequent fall in demand, as my colleague Amir Sufi and his co-author, Atif Mian, have shown, was localized in specific regions where house prices rose particularly rapidly (and also, I would argue, more pronounced in specific sectors such as construction and automobiles that lend themselves to debt). Hairdressers in Las Vegas lost their jobs because households there skipped on expensive hairdos when they were left with too much debt stemming from the housing bust. Even if ultra-low real interest rates coerce older debt-free savers to spend more, it is unlikely that there are enough of them in Las Vegas or that they want the hairdos that younger house buyers desired. And if these debt-free savers are in New York City, which did not experience as much of a boom and a bust, cutting real interest rates will encourage spending on haircuts in New York City, which already has plenty of demand, but not in Las Vegas, which has too little. 9

Similarly, one could argue that even healthy firms do not invest in the bust, not because they face a high cost of capital, but because there is uncertainty about where, when, and how, demand will reappear. In sum, the bust that follows years of a debt-fueled boom leaves behind an economy that supplies too much of the wrong kind of good relative to the changed demand. Unlike a normal cyclical recession, in which demand falls across the board and recovery requires merely rehiring laid-off workers to resume their old jobs, economic recovery following a lending bust typically requires workers to move across industries and to new locations because the old debt-fueled demand varied both across sectors and geographically, and cannot be revived quickly. 10

There is thus a subtle but important difference between the debt-driven demand view and the Keynesian explanation that deleveraging (saving by chastened borrowers) or debt overhang (the inability of debt-laden borrowers to spend) is responsible for slow post-crisis growth. Both views accept that the central source of weak aggregate demand is the disappearance of demand from former borrowers. But they differ on solutions.

The Keynesian wants to boost demand generally. He believes that all demand is equal. But if we believe that debt-driven demand is different, the demand stimulated by ultra-low interest rates will at best be a palliative. There is both a humanitarian as well as economic case for writing down the debt of borrowers when they have little hope of paying it back. 11 Writing down former borrowers' debt may even be effective in producing the old pattern of demand. But relying on the formerly indebted to borrow and spend so that the economy re-emerges is irresponsible. And new borrowers may want to spend on different things, so fueling a new credit boom may be an ineffective (and unsustainable) way to get full employment back. 12

If the differentiated demand that emerged in the boom is hard or irresponsible to recreate, the sustainable solution is to allow the supply side to adjust to more normal and sustainable sources of demand. Some of that adjustment is a matter of time as individuals adjust to changed circumstances. And some requires relative price adjustments and structural reforms that will generate sustainable growth - for example, allowing wages to adjust and creating ways for bankers, construction workers, and autoworkers to retrain for faster-growing industries. But relative price adjustments and structural reforms take time to produce results.

The five years since the crisis have indeed resulted in significant adjustment, which is why a number of countries appear to be recovering. How much of this recovery owes to the varieties of stimulus, we will debate for a long time to come. Much as quacks claim the self-healing powers of the body to common cold for their miracle cures, I have no doubt that some economists will claim the recovery for their favorite brand of stimulus.

What is true is that we have had plenty of stimulus. The political compulsions that abetted the boom also mandated urgency in the bust. Industrial countries that relied on borrowing to speed up growth typically wanted faster results. With the room for fiscal stimulus limited, monetary policy became the tool of choice to restore growth. And the Keynesian argument - that the equilibrium or neutral real interest rate is ultra-low - has become the justification for more and more innovation.

Unconventional Monetary Policies focused on Ultra Low Rates

I have argued that unconventional central bank policies to repair markets and fix institutions worked. Even the European Central Bank's promise to do what it takes through the OMT program to bolster sovereign debt has bought sovereigns time to undertake reforms, though a fair debate could be had on whether this implicit guarantee has a quasi-fiscal element. As we have seen earlier, it is the central bank's willingness to accept significant losses contingent on its intervention being ineffective that allows it to move the market to a new trading equilibrium where it does not make losses. Many interventions to infuse liquidity have an implicit fiscal element to them and OMT is no exception.

Let us turn now to unconventional monetary policy intended to force the real interest rate very low. 13 As I have argued above, the view that the full employment equilibrium real interest rate is strongly negative can be questioned. Once that is in doubt, the whole program of pushing rates lower as a way of moving the economy back to full employment is also questionable. But I want to move on to focus here on the zero lower bound problem. I will then turn to whether low rates are being transmitted into activity.

Which interest rate is the operative one for influencing economic activity? Clearly, the long term rate matters for discounting asset prices such as stocks and bonds, as well as long term fixed asset investment, while the short term rate affects the cost of capital for entities engaged in maturity transformation. The interest rate channel (where the central bank affects consumption, savings, and investment decisions through the interest rate), the asset price channel (where the central bank aims to alter asset prices and thus household wealth and risk tolerance through interest rates), the credit channel (where the central bank affects the valuation of firm and bank balance sheets and thereby alters the volume of credit) and the exchange rate channel (whereby the central bank affects the exchange rate) all probably work through a combination of short and long rates with varying degrees of emphasis on each part of the term structure. 14

The central bank directly controls the policy rate, and thus the short term nominal rate. The zero lower bound problem stems from its inability to push the short term nominal policy interest rate below zero. Further reductions in the short term real rate will come only if it can push up inflationary expectations.

Because long term nominal interest rates are typically above zero even when the policy rate is zero, the central bank can try to push down long term nominal rates without tampering with inflationary expectations. Of course, an immediate question is why the long term nominal rate stays above zero when the equilibrium long rate is lower. One possible answer is that arbitrage from rolling-over investment strategies using the higher-than-equilibrium expected short rate holds the long rate higher than it should be.

So two strategies of bringing down the nominal long rate present themselves; First, commit to holding the short rate at zero over time even beyond the point when normalizing it would be in order. This is what the Fed calls forward guidance. Second, buy long term bonds thus creating more appetite for the remaining ones in public hands, thus pushing down the long rate. The Fed aims to use its Large Scale Asset Purchase (LSAP) program to take long bonds out of private portfolios with the hope that as they rebalance their portfolios, the price of long bonds (and other assets) will rise and yields will fall. 15 The Bank of Japan wants to add to these strategies by raising inflationary expectations, which is not an explicit objective of the Fed. 16 Neither central bank talks about depreciating the exchange rate as a central objective, though they do not rule it out as a side effect.

One could ask whether these policies should work even theoretically. Forward guidance relies on the central bank being willing to hold down policy rates way into the future below what would otherwise be appropriate - below, for example, that suggested by the Taylor Rule. 1 7 Thus it implicitly implies a willingness to tolerate higher inflation levels in the future. But what ensures such commitment? Will the fear of breaking a prior transparent explicit promise (say to hold policy rates at zero so long as unemployment is above 6.5 percent, inflation is below 2.5 percent, and long term inflationary expectations well anchored) weigh heavily on the governors? Or will they fudge their way out when the time comes by saying that long term expectations have become less well anchored?

Some argue that the source of commitment will be the LSAP itself. The central bank may fear losing value on its bond holdings if it raises rates too early. However, one could equally well argue that it could fear a rise in inflationary expectations if it stays on hold too long, which in turn could decimate the value of its bond holdings. The bottom line is that it is not clear what makes forward guidance credible theoretically, and the matter becomes an empirical one.

And then we have the asset purchase program. If markets are not segmented, a version of the Modigliani Miller Theorem or Ricardian Equivalence suggests that the Fed cannot alter interest rates by buying bonds. Essentially, the representative agent will see through the Fed's purchases. Since the aggregate portfolio that has to be held by the economy does not change, pricing will not change. Alternatively, households will undo what the Fed does. 18 For LSAPs to work, the market must be segmented with some agents being non-participants in some markets. Alternatively, the market must not internalize the Fed's portfolio holdings. As with forward guidance, the effectiveness of LSAPs is an empirical question.

Much of the evidence on the effectiveness of asset purchase programs comes from the first Fed LSAP, which involved buying agency and mortgage backed securities in the midst of the crisis. Fed purchases restored some confidence to those markets (including by signaling that the government stood behind agency debt), and this had large effects on the yields. Event studies document the effects on yields in the following rounds of LSAPs were much smaller. 19

Regardless of the effect Fed purchases may have had on the way in, speculation in May 2013 that it would start tapering its asset purchases led to significant increases in Treasury yields and large effects on the prices of risky assets and cross-border capital flows. This is surprising given the theory, because what matters to the portfolio balance argument is the stock of long term assets in the Fed's portfolio, not the flow. So long as the Fed can be trusted to hold on to the stock, the price of risky assets should hold up. Yet the market seems to have reacted to news about the possible tapering of Fed flows into the market, which one would have thought would have small effect on the expected stock. Either the market believes that Fed implicit promises about holding on to the stock of assets it has bought are not credible, or it believed that flows would continue for much longer than seems reasonable before it was disabused, or we do not understand as much about how LSAPs work as we should!

Given that long term nominal bond yields in Japan are already low, the Bank of Japan's focus has been more directly on enhancing inflationary expectations than on pushing down nominal yields. One of the benefits of the enormous firepower that a central bank can bring to bear is the ability to unsettle entrenched expectations. The shock and awe generated by the Bank of Japan's quantitative and qualitative easing program may have been what was needed to dislodge entrenched deflationary expectations.

The BOJ hopes to reshape expectations more favorably. Direct monetary financing of the large fiscal deficit will raise inflationary expectations. A collateral effect as the currency depreciates is inflation imported through exchange rate depreciation. Nevertheless, the BOJ's task is not easy. If it is too successful in raising inflationary expectations, nominal bond yields will rise rapidly and bond prices will tank. So to avoid roiling bond investors, it has to raise inflationary expectations just enough to bring the long term real rate down to what is consistent with equilibrium without altering nominal bond yields too much. And given that we really do not know what the neutral or equilibrium real rate is, how much inflationary expectation to generate is a matter of guesswork.

The bottom line is that unconventional monetary policies that move away from repairing markets or institutions to changing prices and inflationary expectations seem to be a step into the dark. Of course, central bankers could argue that their bread and butter business is to change asset prices and alter inflationary expectations. However, unconventional policies are assumed to work through different channels. We cannot be sure of their value, even leaving aside the theoretical questions I raised earlier about pushing down the real rate to ultra-low levels as a way to full employment. Let us now turn to their unintended side effects.

The Unintended Effects of Unconventional Policies

Risk Taking and Investment Distortions

If effective, the combination of the "low for long" policy for short term policy rates coupled with quantitative easing tends to depress yields across the yield curve for fixed income securities. Fixed income investors with minimum nominal return needs then migrate to riskier instruments such as junk bonds, emerging market bonds, or commodity ETFs, with some of the capital outflow coming back into government securities via foreign central banks accumulating reserves. Other investors migrate to stocks. To some extent, this reach for yield is precisely one of the intended consequences of unconventional monetary policy. The hope is that as the price of risk is reduced, corporations faced with a lower cost of capital will have greater incentive to make real investments, thereby creating jobs and enhancing growth.

There are two ways these calculations can go wrong. First, financial risk taking may stay just that, without translating into real investment. For instance, the price of junk debt or homes may be bid up unduly, increasing the risk of a crash, without new capital goods being bought or homes being built. This is especially likely if key supports to investment such as a functioning and well capitalized banking system, or policy certainty, are missing. A number of authors point out the financial risk taking incentives engendered by very accommodative or unconventional monetary policy, with Stein (2013) providing a comprehensive view of the associated economic downsides. 20 As just one example, the IMF's Global Financial Stability Report (Spring 2013) points to the re-emergence of covenant lite loans as evidence that greater risk tolerance may be morphing into risk insouciance.

Second, and probably a lesser worry, accommodative policies may reduce the cost of capital for firms so much that they prefer labor-saving capital investment to hiring labor. The falling share of labor in recent years is consistent with a low cost of capital, though there are other explanations. Excessive labor-saving capital investment may defeat the very purpose of unconventional policies, that is, greater employment. Relatedly, by changing asset prices and distorting price signals, unconventional monetary policy may cause overinvestment in areas where asset prices or credit are particularly sensitive to low interest rates and unanchored by factors such as international competition. For instance, the economy may get too many buildings and too few machines, a consequence that is all too recent to forget.

Spillovers - Capital Flows and Exchange Rate Appreciation and Credit Booms

The spillovers from easy global liquidity conditions to cross-border gross banking flows, exchange rate appreciation, stock market appreciation, and asset price and credit booms in capital receiving countries - and eventual overextension, current account deficits, and asset price busts has been documented elsewhere, both for pre-crisis Europe and post-crisis emerging markets. 21 The transmission mechanism appears to be that easy availability of borrowing increases asset prices, increases bank capitalization and reduces perceived leverage, reduces risk perceptions and measures (as indicated by the VIX index or value at risk), all of which feed back into more credit and actual leverage. When this occurs cross-border, exchange rate appreciation in the receiving country is an additional factor that makes lending appear safer. The mechanism Andrew Crockett laid out has played repeatedly. 22

For the receiving country, it is unclear whether monetary policy should tighten and attract more inflows, or be accommodative and fuel the credit boom. Tighter fiscal policy is a textbook solution to contain aggregate demand, but it is politically difficult to tighten when revenues are booming, for the boom masks weakness, and the lack of obvious problems makes countermeasures politically difficult. Put differently, as I will argue later, industrial country central bankers justify unconventional policies because politicians are not taking the necessary decisions in their own countries - unconventional policies are the only game in town. At the same time, however, they expect receiving countries to follow textbook reactions to capital inflows, without acknowledging that these too may be politically difficult. Prudential measures, including capital controls, to contain credit expansion is the new received wisdom, but their effectiveness against the "wall of capital inflows" has yet to be established. Spain's countercyclical provisioning norms may have prevented worse outcomes, but could not prevent the damage that the credit and construction boom did to Spain.

Even if the unconventional monetary policies that focus on lowering interest rates across the term structure have limited effects on interest rates in the large, liquid, sending country Treasury markets, the volume of flows they generate could swamp the more illiquid receiving country markets, thus creating large price and volume effects. The reality may be that the wall of capital dispatched by sending countries may far outweigh the puny defenses that most receiving countries have to offset its effects. What may work theoretically may not be of the right magnitude in practice to offset pro-cyclical effects, and even if it is of the right magnitude, may not be politically feasible. As leverage in the receiving country builds up, vulnerabilities mount, and these are quickly exposed when markets sense an end to the unconventional policies and reverse the flows.

The important concern during the Great Depression was competitive devaluation. While receiving countries have complained about "currency wars" in the recent past, and both China and South Korea seem affected by the sizeable Japanese depreciation after the Bank of Japan embarked on quantitative and qualitative easing (though they benefited earlier when the yen was appreciating) the more worrisome effect of unconventional monetary policies may well be competitive asset price inflation.

We have seen credit and asset price inflation circle around the globe. While industrial countries suffered from excessive credit expansion as their central banks accommodated the global savings glut after the Dot-Com bust, emerging markets have been the recipients of search-for-yield flows following the global financial crisis. This time around, because of the collapse of export markets, they have been far more willing to follow accommodative policies themselves, as a result of which they have experienced credit and asset price booms. Countries like Brazil and India that were close to external balance have started running large current account deficits. Unsustainable demand has traveled full circle, back to emerging markets, and emerging markets are being forced to adjust. Will they be able to put their house in order in time?

What should be done? How do we prevent the monetary reaction to asset price busts from becoming the genesis of asset price booms elsewhere? In a world integrated by massive capital flows, monetary policy in large countries serves as a common accelerator pedal for the globe. One's car might languish in a deep ditch even when the accelerator pedal is pressed fully down, but the rest of the world might be pushed way beyond the speed limit. If there is little way for countries across the globe to avoid the spillover effects of unconventional policies emanating from the large central banks, should the large central banks internalize these spillovers? 23 How? And will it be politically feasible?

Postponing Reform and Moral Hazard

Central bankers do get aggrieved when questioned about their uncharacteristic role as innovators. "What would you have us do when we are the only game in town", they say. But that may well be the problem. When the central banker offers himself as the only game in town, in an environment where politicians only have choices between the bad and the worse, he becomes the only game in town. Everyone cedes the stage to the central banker, who cannot admit that his tools are untried and of unknown efficacy. The central banker has to be confidant, and will constantly refer to the many bullets he still has even if he has very few. But that very public confidence traps him because the public wants to know why he is not doing more.

The dilemma for central bankers is particularly acute when the immediate prospect of a terrible economic crisis is necessary for politicians to obtain the room to do the unpleasant but right thing. For instance, repeated crises forced politicians in the Euro area to the bargaining table as they accepted what was domestically unpopular, for they could sell it to their constituents as necessary to avert the worse outcome of an immediate Euro break-up. The jury is still out on whether the OMT announced by the ECB, essentially as a fulfillment of the pledge to do what it takes to protect and preserve the Euro, bought the time necessary for politicians to undertake difficult institutional reform or whether it allowed narrow domestic concerns to take center stage again.

And finally, there is the issue of moral hazard. Clearly, when the system is about to collapse, it is hard to argue that it should be allowed to collapse to teach posterity a lesson. Not only can the loss of institutional capital be very hard for the economy to rebuild, the cost of the collapse may ensure that no future central banker ever contemplates "disciplining" the system. And clearly, few central bankers would like to be known for allowing the collapse on their watch. But equally clearly, the knowledge that the central bank will intervene in tail outcomes gives private bankers an incentive to ignore such outcomes and hold too little liquidity or move with the herd. 24 All this is well known now. Less clear is what to do about it, especially because it is still not obvious whether bankers flirt with tail risks because they expect to be bailed out or because they are ignorant of the risks. 25 Concerns about moral hazard are, of course, irrelevant if bankers are merely ignorant! Once again, we do not know.


Having experienced the side-effects of unconventional monetary policies on "entry", many now worry about exit from those policies. The problem is that while "entry" may take a long time as the central bank needs to build credibility about its future policies to have effect, "exit" may not require central bank credibility, may be anticipated, and its consequences brought forward by the market. Asset prices are unlikely to remain stable if the key intent of entry was to move asset prices from equilibrium. What is held down must bounce up.

One might think that countries that have complained about unconventional monetary policies in industrial countries should be happy with exit. The key complication is leverage. If asset prices simply went up and down, the withdrawal of unconventional policies should restore status quo ante. However, leverage built up in sectors with hitherto rising asset prices can bring down firms, financiers, and even whole economies when they fall. 26 There is no use saying that everyone should have anticipated the consequences of the end of unconventional policies. As Andrew Crockett put it in his speech, "financial intermediaries are better at assessing relative risks at a point in time, than projecting the evolution of risk over the financial cycle."

Countries around the world have to prepare themselves, especially with adequate supplies of liquidity. Exiting central bankers have to be prepared to "enter" again if the consequences of exit are too abrupt. Will exit occur smoothly, or in fits and starts, or abruptly? This is yet another aspect of unconventional monetary policies that we know little about.


Churchill could well have said on the subject of unconventional monetary policy, "Never in the field of economic policy has so much been spent, with so little evidence, by so few". Unconventional monetary policy has truly been a step in the dark. But this does raise the question of why central bankers have departed from their usual conservatism - after all, "innovative" is usually an epithet for a central banker.

A view from emerging markets is that, in the past, crises have typically occurred in countries that did not have the depth of economic thinking that the United States or Europe have. When emerging market policymakers were faced with orthodox economic advice that suggested many years of austerity and unemployment as well as widespread bank closures were needed to cleanse the economy after a crisis, they did not protest. After all, few had the training and confidence to question the orthodoxy, and the ones that nevertheless did were considered misguided cranks. Multilateral institutions, empowered by their control over funding, dictated policy from the economic scriptures.

When the crisis did hit at home, Western-based economists were much less willing to accept that pain was necessary. The Fed, led by perhaps the foremost monetary economist in the world, proposed creative solutions that few in policy circles, including the usually conservative multilateral institutions, questioned. After all, they no longer had the influence of the purse or the advantage in economic training.

This is, however, not a satisfactory explanation. After all, Nobel Laureates like Joe Stiglitz, whatever one may think about his remedies, did protest very publicly about the adjustment programs the multilateral institutions were imposing on the Asian economies.

Consider another explanation; Perhaps the success that central bankers had in preventing the collapse of the financial system after the crisis secured them the public's trust to go further into the deeper waters of quantitative easing. Could success at rescuing the banks have also mislead some central bankers into thinking they had the Midas touch? So a combination of public confidence, tinged with central-banker hubris could explain the foray into quantitative easing. Yet this too seems only a partial explanation. For few amongst the lay public were happy that the bankers were rescued, and many on Main Street did not understand why the financial system had to be saved when their own employers were laying off workers or closing down.

Let me try again. Perhaps it was the political difficulty of doing nothing after spending billions rescuing the private bankers that encouraged central bankers to act creatively. After all, how could one let a technical hitch like the ZLB (zero lower bound) come in the way of rescuing Main Street when innovative facilities such as TARP and TALF had been used to save Wall Street? Was it that once central bankers undertook the necessary rescues of banks, they were irremediably entangled in politics, and quantitative easing was an inevitable outcome?

Or perhaps it was simply common decency: being in a position of responsibility, and in a world where much had broken down, central bankers decided to do whatever they could, which included instruments like quantitative easing.

As with much about recent unconventional monetary policies, there is a lot we can only guess at. The bottom line is that if there is one myth that recent developments have exploded it is probably the one that sees central bankers as technocrats, hovering cleanly over the politics and ideologies of their time. Their feet too have touched the ground.

On a more practical note, let me end with a caution from Andrew Crockett's speech:

"The costs of uncontrolled financial cycles are sufficiently large that avenues for resisting them should at least be explored. At a minimum, it seems reasonable to suggest that, in formulating monetary policy aimed at an inflation objective, central banks should take explicit account of the impact of financial developments on the balance of risks."

Then as now, this is very good advice. Thank you very much.