Majorityrights Central > Category: Economics & Finance

By Martin Hutchinson

The first quarter Gross Domestic Product rise of 0.6% was greeted with considerable relief by most Wall Street commentators; they had expected the chaos in the housing market and the banking system to have pushed the US economy into recession. This was unreasonable; the huge monetary stimulus currently being hurled at the economy was always likely to prevent immediate recession, while the fiscal stimulus of the $110bn rebate package is likely to prop it up through July or so. Beyond that, the future becomes less clear: at some stage the monetary and fiscal stimulus must run out.

As I have frequently written, monetary conditions have been pretty lax since 1995. It had been becoming difficult to determine how lax since March 2006, when the Federal Reserve stopped reporting M3 money supply, the measure used by the European Central Bank and other monetarist organizations. However the St. Louis Fed, which for the decade until April was run by the monetarist William Poole, has constructed its own measure of broad money, Money of Zero Maturity, which is a reasonable proxy for M3; it consists of M2 plus institutional money market funds minus small time deposits. Like M3, MZM began to expand excessively in early 1995; in the 13 years to March 2008 it grew at an average annual rate of 8.88%, compared with growth in nominal GDP during that period of 5.25%.

Thus monetary policy, however measured, has been excessively expansionary since 1995, in the sense of expanding the money supply faster than output. As I have written previously, the inflation-creating effect of this excessive monetary expansion has been suppressed for a decade by the Internet, which has had a similar deflationary effect through enabling outsourcing to cheap labor countries that the railroads and refrigeration did in the 1880s through allowing cheap agricultural produce from the Midwest, Canada, Australia and Argentina to be shipped worldwide.

From the beginning of 2008, however, monetary expansion has sharply accelerated. In the three months to April 21, the latest data available, MZM expanded at an annual rate of no less than 28.7%. This extra-rapid expansion is not surprising – the Fed has been terrified that the US financial system was about to collapse, and has been making funding available in large quantities in a variety of ways. Indeed on May 2 the Fed, concerned about the credit card financing market, allowed banks to use credit-card-backed AAA bonds as security for Fed loans – needless to say this involves yet more monetary expansion and further risk to the taxpayer. Monetary stimulus of this extraordinary magnitude will have an effect, it has to.

READ MORE...

Max Keiser, the engaging and extremely well-travelled financial journo at Al Jazeera, on the clear implications of central bank support for dumb and busted speculators:-

The money quote - sorry for the pun - comes right at the end.  “In this globalised financial world the profits have been privatised and the risks have been socialised”.  In other words, the bankers can’t feel the effects of their crazier speculations because government simply shifts the losses to the taxpayer.  In effect, the more crazy the speculation and the more spectacular the losses, the more certain it is that government will insulate the errant banker from the pain he causes.  Government actually condones his most irresponsible speculation.

How sustainable this nonsense is, we are now engaged in discovering.  Economic common sense dictates that it isn’t sustainable at all, and the longer it takes for the cost to return to source, the more likely the financial system will not be able to accomodate it, and will collapse.

Another very good financial dissection by Keiser, this time on what the yen carry trade is doing to Iceland, is available here.

Recently on an MR thread the question arose as to whether Latinos and blacks were really at the root of the sub-prime crisis.  Here’s Stan Liebowitz, who is the Ashbel Smith professor of Economics in the Business School at the University of Texas at Dallas, with a definitive “yes”.  Thanks to “The Fellist” for the link.

THE REAL SCANDAL

How feds invited the mortgage mess

PERHAPS the greatest scandal of the mortgage crisis is that it is a direct result of an intentional loosening of underwriting standards - done in the name of ending discrimination, despite warnings that it could lead to wide-scale defaults.

At the crisis’ core are loans that were made with virtually nonexistent underwriting standards - no verification of income or assets; little consideration of the applicant’s ability to make payments; no down payment.

Most people instinctively understand that such loans are likely to be unsound. But how did the heavily-regulated banking industry end up able to engage in such foolishness?

From the current hand-wringing, you’d think that the banks came up with the idea of looser underwriting standards on their own, with regulators just asleep on the job. In fact, it was the regulators who relaxed these standards - at the behest of community groups and “progressive” political forces.

READ MORE...

The papers have done their share of economic forecasting today.  In particular, The Telegraph ran a bloodcurdling take on the liquidity crisis, filled with lurid fears of downward spirals, super-depressions and the financial system tipping into the abyss.  The sub-prime loans crisis - pretty much a black and Hispanic thing - has “hit a vital nerve of the international financial system”, according to one Swiss central banker.  The article, however, plainly says, “severed a major artery.”

Meanwhile, Martin Hutchinson at Prudent Bear has produced a less hysterical and more technical forecast for 2008.

Observers of the credit crunch that has been bedeviling financial markets since August were mostly highly relieved this week when the European Central Bank injected some $500 billion into the world’s banking system via low cost funding and the Fed followed up with $40 billion of its own. This sharply lowered the premium that interbank deposit rates have commanded for the last four months over Treasury bill rates. However in the general rejoicing that the international financial markets were not about to ruin everybody’s Christmas, one question has so far been ignored: How in hell are the ECB and the Fed ever going to get their money back? The financial fate of the world’s taxpayers, as well as the future of the markets themselves, rests on the answer to this question.

READ MORE...

Martin has sent me his latest Prudent Bear piece, which deserves the posting here.

GW

Close observers of the US housing finance disaster in recent months will have noted a curious phenomenon. Companies such as Countrywide that were in late August regarded as rock solid have recently passed clearly into the danger zone while those like Fannie Mae and Freddie Mac that were regarded as potential market saviors have come under a cloud. In Britain Northern Rock, whose September bailout was said to be modest, involving little risk to the taxpayer has now turned into an immense 25 billion pound ($51 billion) potential black hole – real money even in the US economy let alone in the much smaller British one. This illustrates a deeply troubling quality of the largest downturns: the tendency for the free market to turn into a death spiral, in which even sound well-run institutions are engulfed.

Death spirals are fairly rare in financial history. The Wall Street Crash of 1929 was perhaps the most virulent example. After the first downturn, the market recovered for several months. Then the collapse of the Bank of the United States in December 1930, together with the further economic damage from the Smoot-Hawley Tariff caused a further collapse in confidence and activity that was concentrated in the banking sector, as relatively solid institutions followed the Bank of the United States into bankruptcy. The Federal Reserve failed to correct for the money supply contraction caused by the bank bankruptcies, leading the US economy further into the pit. The additional shove given by President Herbert Hoover’s 1932 tax increase was almost unnecessary; only the confidence brought by a new president (albeit with equally counterproductive economic policies) brought recovery from 1933. By the time the spiral was over, more than one fourth of the banks in the United States had gone bankrupt and the stock market had bottomed out at one tenth of its peak.

READ MORE...

A not-so-wealthy West, foreseen by Martin Hutchinson at the mainstream financial bulletin, Prudent Bear.  The piece is a follow-on from his - to mainstream financial minds - sobering prognostications on the matters of outsourcing and migration.

GW

Negative earnings surprises by Pfizer and Caterpillar at the end of last week may indicate a new reality: the income premium for being a Westerner and having access to the centuries of Western intellectual property and business acumen may be sharply diminishing. We can all rejoice as poor and middle income countries are brought up to Western levels of affluence, but our rejoicing will presumably be sharply diminished if we come to realize that much of their gains may be at the expense of our children’s living standards.

The vision of the world of 2050 or 2100, in which the great majority of Third World peoples enjoy more or less Western living standards, has always been a but fuzzy. Thirty years ago, if you had asked people to imagine the world of 2050, all but the most manically environmentalist would have envisaged Third World residents enjoying living standards comparable to those of current Westerners, while the affluent West had reached living standards that could currently be dreamed of only by an affluent few.

The more thoughtful would have recognized that there was simply not enough space for the squirearchical dream of robot servants for all, together with country houses and rolling parklands. However the 18th century customers of Capability Brown didn’t enjoy modern plumbing, found travel impossibly time-consuming and uncomfortable, and had a nasty tendency to die in childbirth at 30 or of flying gout at 50. 2100’s median Western real income of $250,000 or so would have to be spent differently, but the income itself seemed pretty assured, given the continuance of technological development.

That is no longer the case. Elite opinion remains wedded to globalization as the best of possible economic policies, and believes with fanatical devotion that David Ricardo’s Doctrine of Comparative Advantage will ensure that there will be no significant class of people, even in rich countries, who lose out because of it. However it is becoming increasingly obvious to the populace as a whole that globalization produces substantial numbers of losers, particularly among the less well educated inhabitants of Western countries. No amount of cheaper consumer goods will assuage your pain if you have been forced to exchange a $25 an hour factory job for a $8 an hour service job.

I have discussed previously the effect of outsourcing and international migration on living standards at the bottom of the scale. Here I want to examine the extent that the advantages which have traditionally kept Western countries affluent—in particular those of financial capital, intellectual capital and a near-monopoly on innovation—are all losing their power to differentiate living standards.

READ MORE...

Some grim predictions for the American, Chinese and British economies by Martin Hutchinson, in his latest piece at Prudent Bear.
GW.

The Federal Reserve, the Bank of England and the People’s Bank of China have this week all been faced with the same unpleasant reality: by their irresponsible monetary policies they have enabled gigantic asset bubbles that are redistributing wealth towards the criminal classes and in the long run will impoverish everybody else. Their reaction has been similar; to a large extent they have washed their hands of the problem.

The Bank of England’s response was most rational; it put up interest rates, though only by ¼%, far less than is required to right the foundering ship of Britain’s economy. The People’s Bank of China at least deplored the bubble, though it failed to recognize to what extent its irresponsible monetary policies and suppression of the yuan’s exchange rate had fueled it – but then after all, these people are nominally Communists; one cannot expect them to get it right every time when they are shown so many bad examples from abroad. The Fed on the other hand kept interest rates flat, as it has since last June, while easing its anti-inflationary language slightly – thus essentially acting as enabler to the Wall Street speculators, who had by Friday convinced themselves yet again that interest rates were about to drop.

READ MORE...

On a recent thread Karlmagnus invited us to post on Wolfie’s romantic difficulties, for which purpose I have been waiting for the unsavoury denouement.  However, I no longer need worry since the Bear has covered the matter in his latest offering at prudentbear.com.  The President of the World Bank may be pleased to learn that the column does not dwell too long on his love life.  He may be less pleased to learn that it details instead some of the unlovely aspects of the world he is striving so manfully to create.

GW

The decline of established institutions is supposed to be a liberating process, allowing individuals to express themselves fully and society to reach its potential through temporary structures that express its needs and values at a given time. Yet for those of us who are not 28 year old hedge fund traders, the new unstructured world seems likely to be a pretty grim place. “If you want a friend, get a dog” is in the long run an unpleasant way to live life.

The public sector in this respect is less of a problem than the private. The IMF and the World Bank have lost their useful economic role (to the extent they ever had one) but it appears unlikely that they will ever be abolished. The World Bank in particular is currently going through a bout of questioning because of its president Paul Wolfowitz’s crusade against Third World corruption. This is an entirely worthy if unpopular cause that is marred by the World Bank’s arrogance in tying it to handouts of money and by Wolfowitz’s own activity in arranging an overpaid tax-free job for his mistress. (One does not wish to be ungallant, but those wishing to make a salacious meal out of this case cannot have Googled the lady’s photo.)

READ MORE...