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by Tom Burghardt
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A truism perhaps, but before resorting to brute force and open repression to halt the “barbarians at the gates,” that would be us, the masters of declining empires (and the chattering classes who polish their boots) regale us with tales of “democracy on the march,” “hope” and other banalities before the mailed fist comes crashing down. Putting it another way, as the late, great Situationist malcontent, Guy Debord did decades ago in his relentless call for revolt, The Society of the Spectacle: “The reigning economic system is a vicious circle of isolation. Its technologies are based on isolation, and they contribute to that same isolation. From automobiles to television, the goods that the spectacular system chooses to produce also serve it as weapons for constantly reinforcing the conditions that engender ‘lonely crowds.’ With ever-increasing concreteness the spectacle recreates its own presuppositions.” And when those “presuppositions” reproduce ever-more wretched clichés promulgated by true believers or rank opportunists, take your pick, market “democracy,” the “freedom to choose” (the length of one’s chains), or even quaint notions of national “sovereignty” (a sure fire way to get, and keep, the masses at each others’ throats!) we’re left with a fraud, a gigantic swindle, a “postmodern” refinement of tried and true methods that would do Orwell proud! Ponder Debord’s rigorous theorem and substitute “cell phone” and “GPS” for “automobile,” and “Internet” for “television” and you’re soon left with the nauseating sense that the old “infobahn” isn’t all its cracked up to be. As a seamless means for effecting control on the other hand, of our thoughts, our actions, even our whereabouts; well, that’s another story entirely! In this light, a new report published by Cryptohippie, The Electronic Police State: 2010 National Rankings, delivers the goods and rips away the veil from the smirking visage of well-heeled corporate crooks and media apologists of America’s burgeoning police state. “When we produced our first Electronic Police State report” Cryptohippie’s analysts write, “the top ten nations were of two types:
But as they reveal in new national rankings, “This is changing: The able have become willing and their traditional restraints have failed.” The key developments driving the global panopticon forward are the following:
In France, the German newsmagazine Spiegel reported that a new law passed by the lower house of Parliament in February “conjures up the specter of Big Brother and the surveillance state.” Similar to legislation signed into law by German president Horst Köhler last month, police and security forces in France would be granted authority to surreptitiously install malware known as a “Trojan horse” to spy on private computers. Remote access to a user’s personal data would be made possible under a judge’s supervision. While French parliamentarians aligned with right-wing President Nicolas Sarkozy insist the measure is intended to filter and block web sites with criminal content or to halt allegedly “illegal” file sharing, civil libertarians have denounced the legislation. Sandrine Béllier, a member of the European Parliament for the Green Party, said that “when it comes to restrictions, this text is preparing us for hell.” Additionally, the new law will include measures that will further integrate police files and private data kept by banks and other financial institutions. French securocrats cynically insist this is a wholly innocent move to “maintain the level and quality of service provided by domestic security forces,” Interior Minister Brice Hortefeux told Spiegel. Generalized political measures such as these that hinder free speech and expression, whilst enhancing the surveillance capabilities of the state, also indicate that so-called “Western democracies” are not far behind beacons of freedom such as China, North Korea, Belarus and Russia when it comes to repressive police measures. Indeed, Cryptohippie’s rankings place the United States a mere 2/100ths of a point behind Russia when it comes to Internet and other forms of electronic spying. The top ten scofflaws in 2010 are: 1. North Korea; 2. China; 3. Belarus; 4. Russia; 5. United States; 6. United Kingdom; 7. France; 8. Israel; 9. Singapore and, 10. Germany. A Profit-Driven Panopticon In a capitalist “democracy” such as ours where the business of government is always business and individual liberties be damned, grifting North American and European telecommunications and security firms, with much encouragement and great fanfare from their national security establishments and a lap-dog media blaze the path for Western versions of the sinister “Golden Shield.” Recently in the United States, whistleblowing web sites such as Cryptome and Slight Paranoia have come under attack. Both sites have been hit by take down notices under the onerous Digital Millennium Copyright Act for posting documents and files that exposed the close, and very profitable arrangements, made by giant telecommunications firms and ISPs with the American secret state. In Cryptome’s case, administrator John Young had his site shuttered for a day when the giant software firm, Microsoft, demanded that its so-called “lawful spying guide” be removed by Young. All five files are currently back on-line as Zipped files at Cryptome and make for a very enlightening read. But the harassment didn’t stop there. When Young published PayPal’s “lawful spying guide,” the firm froze Cryptome’s account, in all likelihood at the behest of America’s spy agencies, allegedly for “illegal activities,” i.e., offering Cryptome’s entire archive for sale on two DVDs! Why would the secret state’s corporate partners target Young? Perhaps because since 1996, “Cryptome welcomes documents for publication that are prohibited by governments worldwide, in particular material on freedom of expression, privacy, cryptology, dual-use technologies, national security, intelligence, and secret governance–open, secret and classified documents–but not limited to those. Documents are removed from this site only by order served directly by a US court having jurisdiction. No court order has ever been served; any order served will be published here–or elsewhere if gagged by order. Bluffs will be published if comical but otherwise ignored.” In previous reports, Cryptohippie characterized an electronic police state thusly:
Silent and seamless, our political minders have every intention of deploying such formidable technological resources as a preeminent–and preemptive–means for effecting social control. Indeed, what has been characterized by corporate and media elites as an “acceptable,” i.e. managed political discourse, respect neither national boundaries, the laws and customs of nations, nor a population’s right to abolish institutions, indeed entire social systems when the governed are reduced to the level of a pauperized herd ripe for plunder. How then, does this repressive metasystem work? What are the essential characteristics that differentiate an Electronic Police State from previous forms of oppressive governance? Cryptohippie avers: “In an Electronic Police State, every surveillance camera recording, every email sent, every Internet site surfed, every post made, every check written, every credit card swipe, every cell phone ping… are all criminal evidence, and all are held in searchable databases. The individual can be prosecuted whenever the government wishes.” “Long term” Cryptohippie writes, the secret state (definitionally expanded here to encompass “private” matters such as workplace surveillance, union busting, persecution of whistleblowers, corporate political blacklisting, etc.), “the Electronic Police State destroys free speech, the right to petition the government for redress of grievances, and other liberties. Worse, it does so in a way that is difficult to identify.” As Antifascist Calling and others have pointed out, beside the usual ruses deployed by ruling class elites to suppress general knowledge of driftnet spying and wholesale database indexing of entire populations, e.g., “national security” exemptions to the Freedom of Information Act, outright subversion of the rule of law through the expansion of “state secrets” exceptions that prohibit Courts from examining a state’s specious claims, one can add the opaque, bureaucratic violence of corporations who guard, by any means necessary, what have euphemistically been christened “proprietary business information.” In a state such as ours characterized by wholesale corruption, e.g., generalized financial swindles, insider trading, sweetheart deals brokered with suborned politicians, dangerous pharmaceuticals or other commodities “tested” and then certified “safe” by the marketeers themselves, the protection of trade secrets, formulas, production processes and marketing plans are jealously guarded by judicial pit bulls. Those who spill the beans and have the temerity to reveal that various products are harmful to the public health or have deleterious effects on the environment (off-loaded onto the public who foot the bill as so-called “external” costs of production) are hounded, slandered or otherwise persecuted, if not imprisoned, by the legal lackeys who serve the corporatist state. How does this play out in the real world? According to Cryptohippie, the objective signs that an electronic net has closed in to ensure working class compliance with our wretched order of things, are the following: Daily Documents: Requirement of state-issued identity documents and registration. Border Issues: Inspections at borders, searching computers, demanding decryption of data. Financial Tracking: State’s ability to search and record all financial transactions: Checks, credit card use, wires, etc. Gag Orders: Criminal penalties if you tell someone the state is searching their records. Anti-Crypto Laws: Outlawing or restricting cryptography. Constitutional Protection: A lack of constitutional protections for the individual, or the overriding of such protections. Data Storage Ability: The ability of the state to store the data they gather. Data Search Ability: The ability to search the data they gather. ISP Data Retention: States forcing Internet Service Providers to save detailed records of all their customers’ Internet usage. Telephone Data Retention: States forcing telephone companies to record and save records of all their customers’ telephone usage. Cell Phone Records: States forcing cellular telephone companies to record and save records of all their customers’ usage, including location. Medical records: States demanding records from all medical service providers and retaining the same. Enforcement Ability: The state’s ability to use overwhelming force (exemplified by SWAT Teams) to seize anyone they want, whenever they want. Habeas Corpus: Lack of habeas corpus, which is the right not to be held in jail without prompt due process. Or, the overriding of such protections. Police-Intel Barrier: The lack of a barrier between police organizations and intelligence organizations. Or, the overriding of such barriers. Covert Hacking: State operatives copying digital evidence from private computers covertly. Covert hacking can make anyone appear as any kind of criminal desired, if combined with the removing and/or adding of digital evidence. Loose Warrants: Warrants issued without careful examination of police statements and other justifications by a truly independent judge. Sound familiar? It should, since this is the warped reality manufactured for us, or, as Debord would have it: “The spectacle cannot be understood as a mere visual excess produced by mass-media technologies. It is a worldview that has actually been materialized, a view of a world that has become objective.” That such a state of affairs is monstrous is of course, an understatement. Yet despite America’s preeminent position as a militarist “hyperpower,” the realization that it is a collapsing Empire is a cliché only for those who ignore history’s episodic convulsions. If, as bourgeois historian Niall Ferguson suggests in the March/April 2010 issue of Foreign Affairs, the American Empire may “quite abruptly … collapse,” and that this “complex adaptive system is in big trouble when its component parts lose faith in its viability,” what does this say about the efficacy of an Electronic Police State to keep the lid on? Despite the state’s overwhelming firepower, at the level of ideology as much as on the social battlefield where truncheons meet flesh and bullets fly, Marx’s “old mole” is returning with a vengeance, the “specter” once again haunting “rich men dwelling at peace within their habitations,” as Churchill described the West’s system of organized plunder. Against this loss of “faith” in the system’s “viability,” Debord points out, although the working class “has lost its ability to assert its own independent perspective,” in a more fundamental sense “it has also lost its illusions.” In this regard, “no quantitative amelioration of its impoverishment, no illusory participation in a hierarchized system, can provide a lasting cure for its dissatisfaction.” Forty years on from Debord, sooner rather later, an historical settling of accounts with the system of global piracy called capitalism will confront the working class with the prospect of “righting the absolute wrong of being excluded from any real life.” As that process accelerates and deepens, it will then be the “watchers” who tremble… |
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Archive for March, 2010
Beyond Orwell: The Electronic Police State, 2010
Posted in Blogroll on March 17, 2010 by MinimuxWhat Caused the Financial Crisis, Delusion or Crime? Critique of Michael Lewis
Posted in Blogroll on March 17, 2010 by MinimuxPolitics / Credit Crisis 2008 Mar 16, 2010 – 08:34 AM
By: Danny_Schechter
The Big Short Is A Bit Short In Missing The Reasons for The Crisis: Michael Lewis’s Delusion Thesis vs Senator Kaufman’s Case for Crime
It’s the number one book in the county. Every day, Michael Lewis’s the Big Short is getting B I G G E R, no doubt because he is so mediagenic, conversational and likes to laugh with the hosts who interview him about his findings.
On Sunday, he laughed with Steve Kroft on 60 Minutes when the two bantered on about how about stupid it all was and why so many smart people drank the Kool Aid. The story he tells has no hard edges really…it’s about “delusion,” Wall Street deluding us all and then each other.
The idea of delusions feeds a psychological and cultural analysis of bankers cut off from the world, focused on their own pocket books and believing their own hype. It is in this sense Shakespearian—the stuff of drama, not calculation. What a web we weave when first we practice to deceive, to quote Sir Walter Scott.
At one point in the 60 Minutes two part interview purporting to explain the collapse, Lewis drifts off message and calls it all, an “elegant theft.”
Theft is a word we associate with crime, not personal greed or human failings. But that point was left unexplored by 60 Minutes, of course, because if the story is about crime, than we have to move into the arena of facts, not just opinions, insights, hyperbole and personalities.
Ironically, many of the facts that Lewis himself cites comes from an undergraduate college thesis according to the Deal Journal of the Wall Street Journal which calls his book a “yam.” They note that his book credited ““A.K. Barnett-Hart, a Harvard undergraduate who had just written a thesis about the market for sub prime mortgage-backed CDOs that remains more interesting than any single piece of Wall Street research on the subject.”
Perhaps even more interesting than his book?‘
Earlier, Lewis told the Atlantic what his main sources of information is: “Actually, if you were to draw a pie chart of where I get news from, I bet I get a third from whatever people in Berkeley—specifically the parents’ at my kids’ school—are outraged about. I’m surrounded by people who are alive to what’s going on in the world and who are quick to be outraged by it.”
So there he goes again, with emotion and attitude apparently meaning more to him than fact finding.
Lewis has criticized those who criticize Goldman Sachs, according to Bloomberg, writing earlier, “bashing Goldman Sachs is Simply a Game for Fools.”
Which side is he on I would guess, his side? On 60 Minutes, TV’s top newsmagazine, he was described as a former trader. Not according to Janet Takakoli who runs her own financial firm:
“Imagine my surprise to see him billed as a trader on 60 Minutes, since he was actually a junior salesman, she writes on Huffington Post, “Well-heeled male peacocks strutted the trading floor, and junior salesmen were girlie-men, mere eunuchs serving their pashas.”
She also notes that he was among the “experts” who downplayed the warnings about the very financial crisis that he has suddenly, thanks to validation from CBS and MSNBC, become THE expert on, charging, “he ridiculed their concern of a pending crisis due to the surge in derivatives demand and called it “this year’s case in point.” Then Michael showed how dangerous it is to be a brilliant writer with a poor command of facts and their true meaning”
Financial analysis is not what the media is well equipped to communicate. As a media dissector and editor of Mediachannel, I have followed the reporting of this story closely with many detailed articles and in two books since, even before it became a story back to 2005 when I made my film IN DEBT WE TRUST only to be dismissed by some as a doom and gloomer for exposing the subprime mortgage fraud.
I was hoping that Rachel Maddow would challenge his mass delusion theory but she bought right into it also, in her interview. At one point Lewis opined that there was DECEPTION (i.e., lying by the investment world) but that too was not examined as Lewis himself counterpoised two explanations for the disaster, asking, “was it mass delusion or crime?
And then he “answered” his own question or appeared to, by asserting that when you ask the people involved, they say it was delusion.
Duh, Michael? What do you think they would say? Do think they would cop to their own criminality? For them, it was all one big miscalculation, never mind who got hurt, which neither 60 Minutes nor Maddow explored.
Sorry to say, Jon Stewart did no better with his part of Lewis’ all star media mystery tour. He did introduce him as one of the people making big money on the crisis but then jokingly let him ramble on, praising the sometimes weird people who made small fortunes betting against Wall Street. They were his heroes. Again no concern was expressed for the people they cheated—only the idiots who lost money in the” kingdom where the blind man was king.”
Lewis like many non-fiction novelists prefers character-based story telling or “yarns” to more objective analytical investigation. It makes for better narratives, and bigger best sellers. It also gets e interviewers laughing instead of crying. Why? Because there are only smart men doing things that turn out to be stupid, it makes us all feel superior to them even if they had the last laugh on the way to the bank.
Sorry, the Big Short seems short—short of a serious consideration of what really drove the financial crisis and the reason that 82% of the American people recently said they want a crack down on Wall Street, not a chance to feel sorry for the “delusions” of its masters of the universe. They want a jail out—not a bailout.
On the very day of Rachel’s fawning, but well intentioned interview, United States Senator Ed Kaufman of Delaware, the state that provides a sanctuary for most US corporations and credit card companies, made a speech which got at the heart of the matter.
Senator Kaufman did not get lost in the vague clouds of “delusion.” He was more down to earth arguing.
“Fraud and potential criminal conduct were at the heart of the financial crisis”
Let me repeat and capitalize this brave Senatorial assertion: “FRAUD AND POTENTIAL CRIMINAL CONDUCT WEERE AT THE HEART OF THE FINANICAL CRISIS/”
The Senator goes on: “Americans could draw at least three lessons from the (Lehman) report: that we must “undo the damage caused by decades of deregulation;” that the United States must “concentrate law enforcement and regulatory resources on restoring the rule of law to Wall Street;” and that Congress must help regulators and other gatekeepers “by providing clear, enforceable ‘rules of the road’ wherever possible.”
Unfortunately, says Kaufman, “I’m concerned that the revelations about Lehman Brothers are just the tip of the iceberg. We have no reason to believe that the conduct detailed last week is somehow isolated or unique. Indeed, this sort of behavior is hardly novel.”
Now, it so happens that I have been making a similar argument in my own book THE CRIME OF OUR TIME, and a film PLUNDER THE CRIME OF OUR TIME.” But I am not a former Wall Streeter or best selling author or a US Senator. So my work and the work of many other “outsiders” are still unknown.
The media prefers to seek the truth from the very people who either caused the crisis or who were in media perches that ignored it.
The point is that many people, many very qualified who have arguing the crime thesis—some in my film—have not so far had the benefit of the prime time exposure even though the American people believe it even was the media downplays it.
Will that change? Only if the people don’t believe the hype and demand the truth!
New Baghdad and the Collapse of Capitalism
Posted in Blogroll on March 17, 2010 by Minimux
Doug Hornig, Casey Research writes: Forty years ago, it was a small town on the Persian Gulf, merely one of seven sheikdoms joined in federation in 1971 to create the United Arab Emirates. Basically, there was nothing there but sand. Yes, oil had been discovered under that sand, and the city/state was enjoying its first economic boomlet. From about 60,000 in 1968, population tripled by 1975, doubled in the next ten years, and nearly doubled again by 1995.
Problem is, especially compared with many of its Gulf neighbors, it didn’t have all that much oil to begin with, and its reserves were falling fast. What it did have was Sheikh Mohammed bin Rashid Al Maktoum, the most influential member of the family that had ruled for more than a century and a half. And the sheikh had a vision.
Sheikh Mohammed believed that the Muslim world needed a New Baghdad, a center of commerce and learning and culture that would shine like the hub of the old caliphate, which had dominated the civilized world a thousand years earlier. He was determined to erect a dazzling, ultra-modern new metropolis, starting from scratch.
On the sands of Dubai.
The rest of the story is pretty well known. The crown prince, and later ruler, of Dubai had his way. His emirate became one of the richest and gaudiest places on the planet. Population shot to almost 1½ million, about 90% of them immigrants – from unskilled Bangladeshi laborers to software engineers from the U.S. – all lured by the promise of better-paying jobs than they could find at home.
Even more striking was the explosion of construction projects. Up went mansions, office skyscrapers, artificial islands, stadiums, a speedy Metro, a busy international airport, and the world’s only 7-star hotel, among other things. And the capstone was, of course, the Burj Khalifa, formally opened on January 4.
The Burj Khalifa is the tallest manmade structure on earth. Not by a little, mind you; halfway is not a word in Sheikh Mohammed’s vocabulary. Tallest by so much that it boggles the mind. It’s 2,717 feet high. That’s more than half a mile. For comparison purposes, take New York’s late Twin Towers. Stack them one atop the other. Now you’ve got the Burj Khalifa.
Begun in late 2004, the building was originally budgeted at US$869 million. Final tally as we entered 2010 was something north of a billion and a half. That bought the first luxury hotel to bear the Armani name, four swimming pools, a 158th-floor mosque, 57 elevators, and an observation deck at 1,450 feet, along with 52,490 square meters of office space and 288,000 square meters divided among 900 apartments.
Its coming-out party, with 10,000 fireworks and synchronized fountains shooting jets of water 150 feet into the air, was a spectacular light show, worth watching if you haven’t yet seen it. Hard to believe that you’re looking at a bone-dry desert
You may also be looking at a gargantuan white elephant. Although every unit in the Burj Khalifa has supposedly been sold, some unknown percentage of buyers (likely very large) was speculators who opted in during the height of the world real estate boom. Properties were flipped like it was Southern California. At the market peak, modest flats were fetching more than $2,700/sq. ft. No wonder Emaar Properties, developer of the project, claims it has already recouped its capital outlay from these suck–, er, investors.
Those prices have now plummeted by up to 50%. Of the folks left holding the bag, how many of the 25,000 slated to live in the building will actually do so? We don’t know, and no one who does will talk vacancy rates. In terms of transparency, Dubai makes the Bush administration look like an ad for Window World.
What we do know is that at the moment the structure is the Big Empty. Western critics have limbered up their keyboard fingers in order to pound out expressions of disdain, everything from “The Final Monument to Excess” to “Bling City Is Dead” to “The End of Capitalism.” The first may be apt, as we’ll probably not see the likes of the Burj Khalifa again, but the last? That’s something we want to look at more closely. There is a lesson to be learned.
The truth of the matter is that there were two key, and contradictory, elements to the Dubai miracle, and when the world recession hit in 2007, one overrode the other and the whole thing came tumbling down.
First: As noted, Sheikh Mohammed didn’t have a river of oil money to rely on. So how did he manage to build his gleaming city by the sea? On the surface, it was simple. Turn Dubai into one of the world’s premier places to do business. Make it essentially tax free. Create investment incentives. Attract entrepreneurs from all over. Enlarge and capitalize on the city’s status as a deep water port. Replace traditional smuggling with legit import/export operations. Become a world financial center.
In short, install the best aspects of free-market capitalism, then send an Open for Business letter to the world.
It worked. Capital, resources, and personnel flooded in. By 2005, oil and gas were responsible for only 6% of the emirate’s GDP. Property and construction was the biggest contributor at 22.6%, followed by trade at 16%, entrepôt (duty-free import/export business) at 15%, and financial services at 11%.
No one, apparently, thought it ominous that nearly a quarter of GDP was generated by the construction and trading of properties, nor paused to consider what would happen when the music stopped and supply exceeded demand. Dubai was riding high, a model for other resource-poor, developing nations, showing them how to get rich.
Today, the hot desert wind blows through half-buildings that will never be finished. Immigrants, their work visas rescinded, are rounded up and sent home. Mercedes Benzes and Jaguars have For Sale signs taped to their windows or are just abandoned at the airport. Real estate prices tanked by 50% in 2009 and are projected to suffer another 30% haircut this year. The stock market has plunged 70%. Unmaintained, the artificial islands designed as millionaires’ playpens have begun to sink beneath the sea.
The glorious ride is over. But just in case there was any doubt, the point was hammered home last November, when Dubai World – one of the country’s leading development conglomerates – told creditors it was declaring a six-month moratorium on repayments it could no longer make.
That sent shock waves through financial markets the world over. Everyone, it seems, had invested in Dubai during the boom times. Now they’re staring at a very unfavorable restructuring at best and flat-out default at worst.
Dubai’s debt, or at least as much of it as its rulers will reveal, is about US$80 billion, or 140% of GDP. Bad enough, but it may well be significantly understated. One local investment banker puts the real number in the $120-150 billion range; with no balance sheets to pore over, we can’t know. Dubai will ask oil-rich fellow emirate Abu Dhabi for help, but there are no guarantees help will be forthcoming. Abu Dhabi has always cast a disapproving eye on Dubai’s helter skelter expansionism, and if it does step in, it will probably demand a whole lot of collateral.
Critics of a certain bent have pounced. History’s grandest experiment in unfettered free-market capitalism ran aground, they cry. Therefore the system doesn’t really work.
Which brings us to the second element in the Dubai miracle. It was built on a mountain of debt that couldn’t survive an economic downturn. And who supported that debt? The government. All of those go-go corporations, like Dubai World, are essentially government owned. Sheikh Mohammed wanted his New Baghdad, no matter the cost.
Granted, private enterprise businesses are imperfect. When in trouble, they will lie and cheat like anyone else. But in the end, they have a bottom line that they have to reveal at some point. Accounting tricks are eventually exposed. Capitalism, like a computer, is strictly binary. A company with sound finances prospers; a company that fails in the marketplace simply disappears.
Government-sponsored entities have no such limitations. They’re actively encouraged to overreach, to take risks that no sane CFO would approve. Because if they bleed red ink, the government is there to step in and prop them up. All of Dubai’s corporations were “too big to fail.” But fail they did, and in the process pushed the government into insolvency as well.
The takeaway from this story is simple. Dubai was no more free-market capitalist than Soviet Russia. Or the U.S., for that matter. If the government is the guarantor of last resort or just perceived as the ultimate reliable source of bailout money, a business has no incentive to be well run. When government (with taxpayer funding) takes a stake in even that most American of corporations, GM, capitalism truly has collapsed. Not, however, because of its shortcomings. Because government has not allowed it to function properly.
Though we lack a symbolic last gasp like the Burj Khalifa, make no mistake about it: we’re all fellow travelers with Dubai now. Washington would do well to study what happened there and hopefully learn a thing or two. Because we’re speeding toward the same crack-up.
The U.S. economy is like an out-of-control sports car in search of a tree, and the government is not “here to help you.” Take matters in your own hands and prepare as best as you can for the crash that will come. To find out what to expect in 2010 and how to bullet-proof your assets, read our FREE special report “The Good, the Bad, and the Ugly.”
The Work of Art in the Age of Globalisation: Social Realist Art and Global Solidarity
Posted in Blogroll on March 17, 2010 by Minimux| by Caoimhghin Ó Croidheáin | |||||
| Making Cents: Life Below the Bottom RungA series of oil paintings examining the daily existence of people making a living in the worst working and living conditions in the global economy.
DIAMOND PANNING
AERIAL BOMBARDMENT Protocol Additional to the Geneva Conventions of 12 August 1949, and relating to the Protection of Victims of International Armed Conflicts (Protocol I), 8 June 1977 http://www.icrc.org/ihl.nsf/WebART/470-750065?OpenDocument
INTERROGATION United Nations Convention Against Torture defines torture as: http://www.hrweb.org/legal/cat.html
AFTERMATH OF SUICIDE BOMBER, A man looking for relatives at a morgue in Rawalpindi in Pakistan after a suicide bombing in which at least 35 people were killed and dozens more wounded in November 2009. Soldiers and civilians had gathered outside a branch of the National Bank of Pakistan to collect their monthly salaries and pension payments when the bomb exploded.
KIBERA, NAIROBI, Kibera is the second largest urban slum in Africa (after Soweto in South Africa) with a population estimated at between 600,000 and 1.2 million inhabitants. It is located in southwest Nairobi, about 5 kilometers from the city centre. Improving the situation for the people who live there has been beset by problems such as petty and serious crime, difficult vehicle access, and the lack of building foundations as much of the ground is composed of refuse and rubbish.
FAVELA, RIO DE JANEIRO Many favelas in Rio de Janeiro are shanty towns built up the side of hills with access only by stairs and narrow pathways. They are affected by landslides in heavy rain and their inhabitants regularly have to face the problems of drug wars and petty crime. Many were constructed in the 1970s when a construction boom attracted rural workers from poorer states in Brazil. It is estimated that about 19 per cent of Rio de Janeiro’s population is living in one of 600 favelas around the city.
DHARAVI SLUM, MUMBAI While Dharavi has been featured in films such as Danny Boyle’s 2008 film Slumdog Millionaire, the difficulties such as sanitation issues, an inadequate water supply, overcrowding and poverty faced by people who live there are some of the worst in the world. It is estimated that around 1 million people live in Dharavi making it one of the largest slums in Asia.
SOLDERING CIRCUIT BOARDS Factory conditions in China have come under much criticism for issues such as subsistence wages, long working days, seven day weeks and illegal overtime hours. In some cases workers need permission to leave the factory grounds and live in cramped conditions sharing large dorms. Foreign investors, who have a huge presence in China, often violate the most fundamental human and worker rights. Opposition to such conditions can lead to being fired, or even arrest and imprisonment.
PHONE RECYCLING In many slums around Mumbai people worked in traditional industries such as pottery and textiles. Now there is a growing recycling industry processing waste from other parts of Mumbai. Many of these industries are carried out in one-roomed factories manufacturing products that are distributed globally. While there have been some projects set up to improve living conditions, Dharavi remains a source of cheap labor for local and foreign investors.
RUBBISH DUMP RECYCLING It is believed that over 3000 scavengers live and work around the Stung Meanchey municipal rubbish dump situated on the outskirts of Cambodia’s capital city Phnom Penh. Many of the scavengers are children who have to leave school to earn money for their families. They work up to 14 hours a day looking for glass, plastic, metal and any other materials which can be recycled. Fumes from burning rubbish, dirty needles, flies and truck accidents pose huge threats to the safety and health of the workers there.
SHIP DISMANTLING, |
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“Any authentic work of art must start an argument between the artist and his audience.” Social Realism, also known as Socio-Realism, is an artistic movement, expressed in the visual and other realist arts, which depicts social and racial injustice, economic hardship, through unvarnished pictures of life’s struggles; often depicting working class activities as heroic. (http://en.wikipedia.org/wiki/Social_realism) Can artists use visual art to explore the process of globalization in the same way that writers write about global events? The writer has to research generally accepted facts from many different sources. So too the artist should be able to research imagery to be used as the basis for his/her art. Just as the writer often has to rely on other people’s writings, the artist often depends on other people’s images, unless, of course, the writer or artist has the time and the finance to visit the places themselves. However, the issue of authenticity can crop up, i.e., experiencing a situation oneself seems to be more important for the visual artist than the writer. Why is this? Writers and composers often make works of art based on situations outside their own direct experience. We can mention, for example, Persian Letters (Lettres persanes, written 1721), the satirical work by Montesquieu or the more modern example of Ge Gan-Ru’s String Quartet No 5 (“Fall of Bagdad”). Most artists work from photographs at some stage yet the romantic image of the artist on the street or in the fields en plein air seems to persist. Yet the photograph as a source has much in common with sources for the writer in the sense that it is based on the generally accepted facts of a situation. Of course, the source may catch out the unwary artist or writer but that does not undermine the verity of the generally known information about any given situation. So can the artist create art of a global nature and what is the role of such art? It seems to me that the art most fitted to exploring such issues is Social Realist art for reasons that will be discussed below, and its role is to help develop global solidarity. The following essay will look at the issue of authenticity in Social Realist art by looking at photography as a medium which contains ‘facts’ to the same extent, more or less, as other media. This is more complex than it first appears and will be discussed in terms of authenticity of sources, content, form, and the artwork itself. This will be followed up by an examination of Modernist and Postmodernist perspectives on authenticity and society, a brief history of Social Realism, a look at Social Realism and aesthetics from Tolstoy’s perspective on the meaning and role of art in society, and finally how all this can be related to global solidarity. Definitions – aspects of authenticity Authenticity of source: The facts of a situation may be in the form of a photograph, report, film or eyewitness account. Do the sources of the artwork conform to the facts of a situation? An actor’s voiceover of actual dialogue is authentic in the sense that its source is known but due to censorship the source is not allowed to be used. Actors could also act out an account of a torture scene. For an artwork, facts can be taken from a photograph or film, or re-enacted by models based on an eyewitness account or report. Thus the source of the facts is relevant only so far as it can be believed to be true or consistent with facts already generally agreed and accepted to be true. Authenticity of content: As above, the artwork can conform to the original by painting the essential features of a photograph or film without removing, adding or subtracting elements contained in the original thus retaining the authenticity of the content. Authenticity of form: The artwork conforms to the facts of a situation and the form used does not distort, undermine or negate the content of the facts contained therein thus producing, as far as the generally accepted facts allow, an authentic picture of a given situation. Authenticity of artwork: The artwork is known to be painted by the artist and signed by him/her and not copied directly from another artwork of the same medium. While the above examination of authenticity applies to Social Realist art, Modernist and Postmodernist art had/have a different attitude to authenticity. DIAMOND PANNING, Sierra Leone. Oil on canvas- 150cm x 150cm http://gaelart.net/
Modernist and Postmodernist perspectives on Authenticity The term Modernism is given “retrospectively to the wide range of experimental and avant-garde trends in the arts that emerged from the middle of the 19th century, as artists rebelled against traditional Historicism, and later through 20th century as the necessity of an individual rejecting previous tradition, and by creating individual, original techniques.” (http://www.huntfor.com/arthistory/c19th/modernism.htm) Modernism tended towards a break from art history in terms of a more subjective approach to authenticity, that is faithful to the artist’s self and not external reality. As Harold Rosenberg writes: Postmodernist art on the other hand, “describes tendencies perceived as relativist, counter-enlightenment or antimodern, particularly in relation to critiques of rationalism, universalism or science.” (http://en.wikipedia.org/wiki/Postmodernism) Thus, art theorists who took up the ideas of Roland Barthes and Jacques Derrida deconstructed formal values such as originality, authenticity and uniqueness in art. Modernism, Postmodernism and the Social Realist project Viewed from the perspective of Social Realist art, Modernism and Postmodernism create problems for the Social Realist project of creating “unvarnished pictures of life’s struggles” as Modernism deconstructs form and Postmodernism deconstructs content. Modernism rejected traditional forms which over time became less and less ´real´ and more abstract and conceptualised, (though not all Modernist art rejected Enlightenment thinking): “Among modernists there were disputes about the importance of the public, the relationship of art to audience, and the role of art in society. Modernism comprised a series of sometimes contradictory responses to the situation as it was understood, and the attempt to wrestle universal principles from it. In the end science and scientific rationality, often taking models from the 18th-century Enlightenment, came to be seen as the source of logic and stability, while the basic primitive sexual and unconscious drives, along with the seemingly counter-intuitive workings of the new machine age, were taken as the basic emotional substance. […]The Russian Revolution catalyzed the fusion of political radicalism and utopianism, with more expressly political stances. Bertolt Brecht, W. H. Auden, André Breton, Louis Aragon and the philosophers Antonio Gramsci and Walter Benjamin are perhaps the most famous exemplars of this modernist Marxism.”(http://en.wikipedia.org/wiki/Modernism) While traditional art forms are deconstructed in Modernism, content is deconstructed in Postmodernism: “Postmodernism describes movements which both arise from, and react against or reject, trends in modernism. Specific trends of modernism that are generally cited are formal purity, medium specificity, art for art’s sake, authenticity, universality, originality and revolutionary or reactionary tendency, i.e. the avant-garde. […] One compact definition is that postmodernism rejects modernism’s grand narratives of artistic direction, eradicating the boundaries between high and low forms of art, and disrupting genre’s conventions with collision, collage, and fragmentation. Postmodern art holds that all stances are unstable and insincere, and therefore irony, parody, and humor are the only positions that cannot be overturned by critique or revision.” (http://en.wikipedia.org/wiki/Postmodern_art) INTERROGATION. Oil on canvas- 150cm x 150cm http://gaelart.net/
History of Social Realism Social Realism arose out of a nineteenth century rejection of ‘beautiful art’. The term “dates on a broader scale to the Realist movement in French art during the mid-1800s. Social Realism in the 20th century refers back to the works of the French artist Gustave Courbet and in particular to the implications of his 19th-century paintings A Burial at Ornans and The Stone Breakers, which scandalized French Salon–goers of 1850, and is seen as an international phenomenon also traced back to European Realism and the works of Honoré Daumier and Jean-François Millet. The Social Realist style fell-out of fashion in the 1960s but is still influential in thinking and the art of today.” Social Realism in different forms Since the days of Courbet´s Social Realist paintings the desire to reproduce reality has taken many different forms. New media replace older media in their ability to re-create ‘reality’. Still photography replaces painting, film photography replaces still photography and digitization replaces analogue film photography, 3D replaces 2D. Does that make one form better than another? No, as there are advantages and disadvantages to the different forms. As Walter Benjamin writes about one of the advantages of painting in ‘The Work of Art in the Age of Mechanical Reproduction‘: “The painting invites the spectator to contemplation; before it the spectator can abandon himself to his associations. Before the movie frame he cannot do so. No sooner has his eye grasped a scene than it is already changed. It cannot be arrested. Duhamel, who detests the film and knows nothing of its significance, though something of its structure, notes this circumstance as follows: “I can no longer think what I want to think. My thoughts have been replaced by moving images.” The spectator’s process of association in view of these images is indeed interrupted by their constant, sudden change.” Different forms can lead us to think in different ways. A painting of a slum can lead us think about the poverty contained therein but a documentary, with its ability to include so much more information about the situation, can lead to confusions about whether or not they are worse off after all as our knowledge of, for example, their better sense of community could lead us think that maybe slum life is not so bad after all. So at each level of reality the rhetoric of the image increases too, both in terms of image (quality) and expense (ideology). The better the quality of the image is the more we are led to believe it is true while the more money spent on the image the more it is limited to the ideology of those financially supporting the project. Therefore the reproduction of reality in art is no more and no less legitimate than in other forms. Newer forms do not replace older forms as being superior. Each form continues with its interpretation of reality through time yet not necessarily in isolation as the different forms can influence each other in terms of ways of seeing. Social Realism and aesthetics “No longer able to believe in the Church religion, which had betrayed its own lie, and unable to adopt the true Christian teaching, which denied their entire life, these wealthy and powerful people, being left without any religious understanding of life, returned willy-nilly to that pagan world which locates the meaning of life in personal pleasure. [...] Having recognised pleasure – that is, beauty – as the standard of what is good, people of the upper classes of European society returned in their understanding of art to the crude understanding of the primitive Greeks, already condemned by Plato.” Tolstoy contrasts the life of the labouring man with the art of the wealthy classes: “And this opinion, that the life of the labouring people is poor in content, while our life, the life of idle people, is full of interesting things, is shared by a great many people of our circle. The life of the labouring man, with its infinitely diverse forms of labour and the dangers connected with it on the sea or under the ground, with his travels, dealings with proprietors, superiors, comrades, with people of other confessions and nationalities, his struggle with nature, wild animals, his relations with domestic animals, his labours in the forest, the steppe, the fields, the orchard, the kitchen garden, his relations with his wife and children, not only as close and dear people but as co-workers, helpers, replacements in his work, his relation to all economic questions, not as subjects of discussion or vanity, but as questions vital for himself and his family, with his pride in self-sufficiency and service to others, with his pleasure in time off, and all these interests pervaded by a religious attitude toward these phenomena – to us, who have no such interests and no religious understanding, this life seems monotonous compared with the small pleasures and insignificant cares of our life, not of labour and creativity, but of the use and destruction of what others have made for us. We think that the feelings experienced by people of our own time and circle are very significant and diverse, but in reality almost all the feelings of people of our circle come down to three very insignificant and uncomplicated feelings: the feelings of pride, sexual lust, and the tedium of living. And these three feelings, with their ramifications, make up almost exclusively the contents of the art of the wealthy classes.” Tolstoy puts forward his own ideas on the origins of art. He believed that: “Art begins when a man, with the purpose of communicating to other people a feeling he once experienced, calls it up again within himself and expresses it by certain external signs. Thus the simplest case: a boy, who once experienced fear on encountering a wolf, tells about this encounter and, to call up in others the feeling he experienced, describes himself, his state of mind before the encounter, the surroundings, the forest, his carelessness, and then the look of the wolf, its movements, the distance between the wolf and himself, and so on. All this – if as he tells the story the boy relives the feeling he experienced, infects his listeners, and makes them relive all that the narrator lived through – is art. Thus, Tolstoy believed that relating one’s experience or relating creatively something outside one’s own experience forms the basis of a sense of community or solidarity. He sums up his view in the following way: “Art is not, as the metaphysicians say, the manifestation of some mysterious idea of beauty or God; it is not, as the aesthetical physiologists say, a game in which man lets off his excess of stored-up energy; it is not the expression of man’s emotions by external signs; it is not the production of pleasing objects; and, above all, it is not pleasure; but it is a means of union among men, joining them together in the same feelings, and indispensable for the life and progress toward well-being of individuals and of humanity.” AERIAL BOMBARDMENT. Oil on canvas- 150cm x 150cm http://gaelart.net/ Solidarity Tolstoy’s view of art as a means of forming unity within a community is often still the driving force of Social Realism today. It creates solidarity by identifying with a group or class that is struggling against injustice and hardship. As Aurora Levins Morales writes: “Solidarity is not a matter of altruism. Solidarity comes from the inability to tolerate the affront to our own integrity of passive or active collaboration in the oppression of others, and from the deep recognition of our most expansive self-interest. From the recognition that, like it or not, our liberation is bound up with that of every other being on the planet, and that politically, spiritually, in our heart of hearts we know anything else is unaffordable.” However, solidarity has tended to come from voluntary groups interested in helping others such as Médecins Sans Frontières, The International Red Cross and Red Crescent Movement, Oxfam International, Amnesty International etc. More recently efforts have been made to put the concept of international solidarity on a more solid foundation. The United Nations Human Rights Council has assigned an independent expert to work on a report in which he is developing the concept of a human right to international solidarity: “On October 1, 2009, a majority of the members of the Human Rights Council adopted a resolution taking note of the report and requesting the independent expert to continue his work, with emphasis on developing guidelines, standards, norms and principles for promoting international solidarity and analyzing developments in international economic, social, and “climate” fields.” However, this development is not the only new development as new radical-democratic global solidarity movements begin to come together and seek alternatives to capitalist globalisation. In the realm of art, Social Realism is an art form which can also play an important role in highlighting injustice and hardship. In the words of Armstrong Williams: “In short, we cannot grow, we cannot achieve authentic discovery, and our eyes cannot be cleansed to the truly beautiful possibilities of life, if we simply live a neutral existence.” Caoimhghin Ó Croidheáin (pronounced Kee-veen O Cree-awn) is a prominent Irish artist who has exhibited widely around Ireland. |
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Wall Street’s War Against Main Street America
Posted in Blogroll on March 17, 2010 by Minimux| by Prof. Michael Hudson | |
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Former Treasury Secretary Hank Paulson wrote an op-ed in The New York Times, (Feb. 16)[1] outlining how to put the U.S. economy on rations. Not in those words, of course. Just the opposite: If the government hadn’t bailed out Wall Street’s bad loans, he claims, “unemployment could have exceeded the 25 percent level of the Great Depression.” Without wealth at the top, there would be nothing to trickle down.
The reality, of course, is that bailing out casino capitalist speculators on the winning side of A.I.G.’s debt swaps and CDO derivatives didn’t save a single job. It certainly hasn’t lowered the economy’s debt overhead. But matters will soon improve, if Congress will dispel the present cloud of “uncertainty” as to whether any agency less friendly than the Federal Reserve might regulate the banks. Mr. Paulson spelled out in step-by-step detail the strategy of “doing God’s work,” as his Goldman Sachs colleague Larry Blankfein sanctimoniously explained Adam Smith’s invisible hand. Now that pro-financial free-market doctrine is achieving the status of religion, I wonder whether this proposal violates the separation of church and state. Neoliberal economics may be a travesty of religion, but it is the closest thing to a Church that Americans have these days, replete with its Inquisition operating out of the universities of Chicago, Harvard and Columbia. If the salvation is to give Wall Street a free hand, anathema is the proposed Consumer Financial Protection Agency intended to deter predatory behavior by mortgage lenders and credit-card issuers. The same day that Mr. Paulson’s op-ed appeared, the Financial Times published a report explaining that “Republicans say they are unconvinced that any regulator can even define systemic risk. … the whole concept is too vague for an immediate introduction of sweeping powers. …” Republican Senator Bob Corker from Tennessee was willing to join with the Democrats “to ensure ‘there is not some new roaming regulator out there … putting companies unbeknownst to them under its regime.’”[2] Mr. Paulson uses the same argument: Because the instability extends not just to the banks but also to Fannie Mae and Freddie Mac, Lehman Brothers, A.I.G. and Wall Street underwriters, it would be folly to try to regulate the banks alone! And because the financial sector is so far-flung and complex, it is best to leave everything deregulated. Indeed, there simply is no time to discuss what kind of regulation is appropriate, except for the Fed’s familiar protective hand: “delays are creating uncertainty, undermining the ability of financial institutions to increase lending to businesses of all sizes that want to invest and fuel our recovery.” So Mr. Paulson’s crocodile tears are all for the people. (Except that the banks are not lending at home, but are shoveling money out of the U.S. economy as fast as they can.) As Mr. Obama’s chief of staff Emanuel Rahm put it, a crisis is too good a thing to waste. It’s a con man’s old trick to pressure the victim to make a decision fast. Having created the crisis, Wall Street wants to use its momentum to knock out any potential checks to its power. “No systemic risk regulator, no matter how powerful, can be relied on to see everything and prevent future problems,” Mr. Paulson explained. “That’s why our regulatory system must reinforce the responsibility of lenders, investors, borrowers and all market participants to analyze risk and make informed decisions,” In other words, blame the victims! The way to protect victims of predatory bank lending (and crooked sales of junk securities) is not new regulations but just the opposite: “to simplify the patchwork quilt of regulatory agencies and improve transparency so that consumers and investors can punish excesses through their own informed investing decisions.” Simplification means the Fed, not a Consumer Financial Protection Agency. Moving in for the kill, Mr. Paulson explains that the Treasury is bare, having used $13 trillion to bail out high finance in 2008-09. So he warns the government not to run a Keynesian-type budget deficit. The federal budget should move into balance or even surplus, even if this accelerates the rise in unemployment and decline in wage levels as the economy moves deeper into recession and debt deflation. “We must also tackle what is by far our greatest economic challenge — the reduction of budget deficits — a big part of which will involve reforming our major entitlement programs: Medicare, Medicaid and Social Security.” The economy thus is to be sacrificed to Wall Street rather than reforming finance so that it serves the economy more productively. It is simple mathematics to see that if the government cannot raise taxes, it must scale back Social Security, other social welfare spending and infrastructure spending. What is remarkably left out of account is that today’s financial crisis centered on public debts is largely fiscal crisis. It is caused by replacing progressive taxation with regressive taxes, and above all by untaxing finance and real estate. Take the case of California, where tears are being shed over the dismantling of the once elite University of California system. Since American independence, education has been financed by the property tax. But Proposition 13 has “freed” property from taxation – so that its rental value can be borrowed against and turned into interest payments to banks. California’s real estate costs are just as high with its property taxes frozen, but the rising rental value of land has been paid to the banks – forcing the state to slash its fiscal budget or else raise taxes on labor and consumers. The link between financial and fiscal crisis – and hence the need for a symbiotic fiscal-financial reform – is just as clear in Europe. The Greek government has pre-sold its tax revenues from roads and other infrastructure to Wall Street, leaving less future revenue to pay its public debt. To cap matters, paying income tax is almost voluntary for wealthy Greeks. Tax evasion is hardly necessary in the post-Soviet states, where property is hardly taxed at all. (The flat tax falls almost entirely on labor.) Throughout the world, scaling back the 20th century’s legacy of progressive taxation and untaxing real estate and finance has led to a public debt crisis. Property income hitherto paid to governments is now paid to the banks. And although Wall Street has extracted $13 trillion in bailouts just since October 2008, the thought of raising taxes on wealth to pay just $1 trillion over an entire decade for Social Security or health insurance is deemed a crisis that would lead Wall Street to shut down the economy. It is telling governments to shift to a regressive tax system to make up the fiscal shortfall by raising taxes on labor and cutting back public spending on the economy at large. This is what is plunging economies from California to Greece and the Baltics into fiscal and financial crisis. Wall Street’s solution – to balance the budget by cutting back the government’s social contract and deregulating finance all the more – will shrink the economy and make the budget deficits even more severe. Financial speculators no doubt will clean up on the turmoil. Notes [1] Henry M. Paulson Jr., “How to Watch the Banks,” New York Times op-ed., February 16, 2010 [2] Tom Braithwaite, “Senators oppose ‘systemic risk’ curbs,” Financial Times, February 16, 2010. |
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Evidence of a Financial Coup in America The devastating Lehman Brothers bankruptcy report
Posted in Blogroll on March 17, 2010 by Minimux| by David DeGraw | |||||
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| “The ideas of economists… are more powerful than is commonly understood. Indeed, the world is ruled by little else.” — John Maynard KeynesHow much more evidence of a financial coup and the THEFT of TRILLIONS of DOLLARS do we need before the media and our politicians do something, anything, to restore a rule of law in this nation? What is it going to take? About four months ago, I reached a breaking point and wrote an angry post calling out the media, even Independent online media, for their lack of intensive coverage on the THEFT of TRILLIONS of OUR DOLLARS. I just can’t understand how this has not been the number one story every second of every day? And now comes the devastating Lehman Brothers bankruptcy report/indictment, which, once again, proves the all-out fraudulent activities that led to the THEFT of TRILLIONS of OUR DOLLARS. Over the past few days, I have skimmed through the over 2000 page report/indictment of Lehman Brothers, Ernst & Young, the Wall Street elite, Federal Reserve and US government. You would think, just maybe, that this report would finally set off major alarm bells within the mainstream media and Washington. Finally, we will get the wall-to-wall coverage this deserves, right? . . . Ah . . . nope! Some coverage, yes, but not nearly enough. It has been only a few days since the report was released and the coverage is already dropping off into the cesspool of “reporting” that masquerades as modern “journalism.” The only thing keeping me sane these days is when I go into my office, close the door and start yelling out loud, to myself: “Are you (politicians and mainstream media) f#@king kidding me! What in the name of God is it going to take?!” Or, as I, a little more calmly, put it on Max Keiser’s TV show recently: “Free market capitalism is done! This is a rigged market!… This is straight up criminal activity! This is what the American people really need to understand that they’re not getting through their television set: TRILLIONS of DOLLARS in STOLEN MONEY! CRIMINAL ACTIVITY! This is STRAIGHT UP MAFIA RULE!” I wanted to write an analysis on this revealing Lehman bankruptcy report, but just don’t have the time right now. So, here’s a roundup of the far too little coverage thus far: First up, Dylan Ratigan, the one person on US television that actually reports on this. I couldn’t agree with him more, as he puts it: “The bottom line: While many Americans and many in our government would love for you to believe that the financial crisis and the transfer of wealth in this country was an accident, this report comes just short of suggesting this is by no means an accident, but instead one of the greatest crimes ever perpetrated against a group of people. This crime: an accounting fraud perpetrated by bank CEOs against the American taxpayer and enabled by the US government.” Lehman bankruptcy report exposes Wall Street criminality The Lehman report demonstrates that workers’ jobs, homes, wages and life savings, as well as their access to health care, education and even such rudimentary necessities as light and heat, are being sacrificed to pay for the criminality of the financial elite, which has further enriched itself from the catastrophe of its own making. In the wake of the report’s release, major Wall Street firms such as Goldman Sachs and JPMorgan Chase have expressed shock over the Lehman revelations and averred that they never employed the accounting dodges used by their former competitor. One is reminded of the film Casablanca, in which Captain Renault declares his “shock” at discovering gambling in Rick’s casino. All of the major banks employed intricate schemes, such as “structured investment vehicles,” to shift their losses off of their balance sheets, and made billions by repackaging what they knew to be dubious sub-prime loans and selling them as “collateralized debt obligations.” Lehman’s practices have been exposed only because it was the weakest of the big Wall Street firms and was forced into bankruptcy, in large part because its bigger rivals, smelling blood, took aggressive actions to push their struggling rival over the edge…. The examiner’s report further details the role of the Federal Reserve Bank of New York in allowing Lehman to exchange worthless securities for public funds from March of 2008, when Bear Stearns collapsed and was taken over by JPMorgan Chase in a deal subsidized by the Fed, to September of that year, when Lehman filed for bankruptcy protection. The president of the New York Fed at the time was Timothy Geithner. Obama rewarded Geithner for his services as chief bagman for Wall Street by making him his treasury secretary. Neither Fuld, whose compensation for 2007 totaled $22 million, nor any other Lehman executive has been prosecuted for their crimes. Nor has any other top executive on Wall Street. In response to the greatest social catastrophe since the Great Depression, the Obama administration and the Democratic-led Congress have rejected any serious reform of the financial system. They have held no one accountable for plunging the US and the world into an economic disaster. Instead, they have devoted their efforts to covering the bad debts of the financial oligarchs and enabling them to expand their swindling and increase their wealth. The Lehman story is not an aberration. Corruption, fraud, criminality are not simply the results of a few “bad apples,” or merely the expression of the subjectively determined depravity of certain executives. The collusion of all official institutions―the White House, Congress, the regulatory agencies, the media―testifies to the systemic character of financial gangsterism. [read more] Max Keiser and Stacey Herbert: The Truth About Rigged Market Capitalism We talk about so called free market capitalism in reality is rigged market capitalism; Hank Paulson and Dick Fuld, Lehmans and Barclays. [Listen Here] How Lehman, With The Fed’s Complicity, Created Another Illegal Precedent In Abusing The Primary Dealer Credit Facility Five months ago, Zero Hedge observed the nuances of the Federal Reserve’s Primary Dealer Credit Facility (PDCF) and concluded that this artificial liquidity boosting construct was nothing more than yet another scam to allow banks to extract ever more money from taxpayers, with the complicit blessing of the Federal Reserve Board Of New York (as the original piece also provided an in-depth discussion of the triparty repo market which is now a parallel to the buzzword of the day in the form of Lehman’s “Repo 105″ off balance sheet contraption, it should serve as a useful refresher course to anyone who wishes to understand why while Repo 105 with its $50 billion in liability contingency may have been an issue, the true Repo market, with over $3 trillion of likely just as toxic assets, is where the real pain in the future will come from). The PDCF would allow assets of declining and even inexistent value to be pledged as collateral, thus making sure that taxpayer cash was funneled into sham institutions holding predominantly toxic assets, and whose viability was and is limited, yet still is backed by the Fed, which to this day continues to pour our money into them. Today, with a tip from the NYT’s Eric Dash, we demonstrate just how grossly negligent the Federal Reserve was when it came to Lehman’s abuse of the PDCF, and how the trail of slime of Lehman’s increasingly obvious manipulation of its books goes to the very top of the Federal Reserve Bank of New York, and its then governor – a very much complicit Tim Geithner. [read more] Frank Partnoy: Lehman Examiner Punted on Valuation The buzz on the Lehman bankruptcy examiner’s report has focused on Repo 105, for good reason. That scheme is one powerful example of how the balance sheets of major Wall Street banks are fiction. It also shows why Congress must include real accounting reform in its financial legislation, or risk another collapse. But an even more troubling section of the Lehman report is not Volume 3 on Repo 105. It is Volume 2, on Valuation. The Valuation section is 500 pages of utterly terrifying reading. It shows that, even eighteen months after Lehman’s collapse, no one – not the bankruptcy examiner, not Lehman’s internal valuation experts, not Ernst and Young, and certainly not the regulators – could figure out what many of Lehman’s assets and liabilities were worth. It shows Lehman was too complex to do anything but fail. The report cites extensive evidence of valuation problems. Check out page 577, where the report concludes that Lehman’s high credit default swap valuations were reasonable because Citigroup’s marks were ONLY 8% lower than Lehman’s. 8%? And since when are Citigroup’s valuations the objective benchmark? [read more] NY Fed Under Geithner Implicated in Lehman Accounting Fraud Allegation Hank Paulson’s recent book mentions repeatedly that Lehman’s valuations were phony as if it were no big deal. Well, it is folks, as a newly-released examiner’s report by Anton Valukas in connection with the Lehman bankruptcy makes clear. The unraveling isn’t merely implicating Fuld and his recent succession of CFOs, or its accounting firm, Ernst & Young, as might be expected. It also emerges that the NY Fed, and thus Timothy Geithner, were at a minimum massively derelict in the performance of their duties, and may well be culpable in aiding and abetting Lehman in accounting fraud and Sarbox violations. We need to demand an immediate release of the e-mails, phone records, and meeting notes from the NY Fed and key Lehman principals regarding the NY Fed’s review of Lehman’s solvency. If, as things appear now, Lehman was allowed by the Fed’s inaction to remain in business, when the Fed should have insisted on a wind-down (and the failed Barclay’s said this was not infeasible: even an orderly bankruptcy would have been preferrable, as Harvey Miller, who handled the Lehman BK filing has made clear; a good bank/bad bank structure, with a Fed backstop of the bad bank, would have been an option if the Fed’s justification for inaction was systemic risk), the NY Fed at a minimum helped perpetuate a fraud on investors and counterparties. [read more] Lehman Brothers, Fraud and the New York Fed · This Calls for a Wider Investigation, writes Tyler Durden at Zero Hedge: “There should be an immediate investigation into how many other banks are currently taking advantage of this artificial scheme to manipulate and misrepresent their cap ratio, and just why the New York Fed can claim it had no idea of this very critical component of the Shadow Economy.” · It’s Time to Wake Up, writes Matthew Yglesias at Think Progress: “There’s a theory out there about why the free market ought to produce sound accounting and ratings agencies, but the empirical evidence says otherwise. And it’s ultimately going to be important to address these issues. It’s more polite to talk about an impersonal crisis, but it’s clear that on both the micro scale (getting individuals to take out mortgages) and the macro scale (distorting the real quantities of leverage banks were carrying) that a lot of fraud and deception was in the room when this all went down.” · Geithner Must Resign, insists Yves Smith at Naked Capitalism: “Lehman was allowed by the Fed’s inaction to remain in business, when the Fed should have insisted on a wind-down…The Fed, which by its charter is tasked to promote the safety and soundness of the banking system, instead, via its collusion with Lehman management, operated to protect particular actors to the detriment of the public at large… The NY Fed, and likely Geithner himself, undermined, perhaps even violated, laws designed to protect investors and markets. It is time for Geithner to go. He is not fit to serve as Treasury secretary.” [read more] Repo 105: Lehman’s ‘Accounting Gimmick’ Explained The big Lehman post-mortem released yesterday spills a lot of ink on a complicated accounting trick with an awesome name: Repo 105. Here’s the story. As the financial crisis grew in 2007 and 2008, Lehman knew it needed to reduce its reliance on borrowed money. But it was a bad time to sell stuff off and pay back debts. So Lehman made special use of something called the repo market. Investment banks use the repo market all the time. It’s basically a way for banks to borrow money from big companies that have extra cash sitting around. To make the loan safer for the big company, the bank “sells” the company some asset — like a bond. That way, if the bank goes bankrupt before it repays the loan, the big company can sell the bond and get its money back. As part of the deal, the bank agrees to buy back the bond at the end of the loan, minus some small amount that the company gets to keep as interest. (”Repo is short for “repurchase.”) [read more] What killed Lehman is alive and kicking The most alarming element of the report may not be what it says about Lehman, but what it reveals about the rottenness and risks that still endanger the financial services industry and the global economy. Lehman couldn’t have been the only one borrowing from Peter to show Paul that its debts were manageable. According to Gary Gorton, a professor at Yale School of Management, $12 trillion in loans was circulating in the repo market on any given day before the financial crisis. From 2001, no American accounting firm or legal practice would certify Lehman’s quarterly reports so long as they relied so heavily on the repo market, but auditors in London welcomed their business. This unevenness in accounting standards still provides incentive for banks to seek the weakest regulatory link. There remains little oversight of repurchase markets, whether in the US, Europe or elsewhere. What’s worse, the spirit of co-operation that emerged at the height of the financial crisis is unravelling. On developing uniform regulations for executive compensation, derivatives markets and hedge funds, the EU and the United States are farther apart than at any time since Lehman collapsed. [read more] JPMorgan, Citigroup helped trigger Lehman collapse, report argues Among Mr Valukas’s findings – which are designed to help the court and the bank’s trustees establish where there may be legal grounds for future claims – he asserts that the evidence “may support the existence of a . . .[valid] claim that JP Morgan breached the implied covenant of good faith and fair dealing by making excessive collateral requests” to Lehman. “The demands for collateral by Lehman’s lenders had direct impact on Lehman’s liquidity pool,” he says. [read more] CSI Lehman-Barclays: Who Really Killed the September 2008 Deal? The U.S. bankruptcy-court examiner’s report into the collapse of Lehman Brothers Holdings may have kicked off a Transatlantic kerfuffle over whether an attempt to buy Lehman Brothers by Britain’s Barclays was torpedoed by U.K. regulators. Buried within the report is a submission from the Financial Services Authority that contradicts the account of the September weekend when Lehman went down given in former Treasury Secretary Hank Paulson’s new book, “On the Brink: Inside the Race to Stop the Collapse of the Global Financial System.” [read more] Lehman as Enron 2.0 If you have a society where it becomes foolish not to steal, then only fools don’t steal, and that society has not much of a future. The bankruptcy examiner’s report on Lehman reveals the fraud behind too much that goes for business on Wall Street. The fact is nothing really is new, many of the transactions were exactly what Enron “innovated”, validated by a major accounting firm with the active collusion of Tim Geithner’s NY Fed. The only question, when is someone going to jail? Begging the question, when is our government going to do something? Of course, when you have a Congress that has been bought and sold five times over, one shouldn’t hold their breath. Talk of financial reform out of the Congress makes health care reform look like Public Citizen good government. How can you have any take on financial reform when you have no idea about what occurred, well if you’re in Congress you let Wall Street write the laws, then you don’t have to know. [read more] Further Lehmans revelations blocked by Barclays Further damaging revelations about the collapse of Lehman Brothers are being held up in the US courts by Barclays… Legal sources say there is more to come with the publication of the millions of pages of Lehman e-mails, internal company files and documentary evidence from third parties that formed the basis of the report. A court hearing will take place soon, possibly as soon as April 1, in which the examiner’s team is expected to argue for the release of these “underlying documents”. “All of the parties have agreed to allow those documents given to [the examiner] under confidentiality agreements to be made public, with two limited exceptions that we are working out,” a person familiar with the matter said. The objectors include Barclays, which is concerned that some of the information on Lehman extracted from its databanks by Mr Valukas’ team of 70 lawyers may also contain commercially sensitive proprietary data that the bank does not want released because it involves clients. [read more] Lehman Report: BNN speaks to Yves Smith, Editor of Naked Capitalism [video] |
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| David DeGraw is a frequent contributor to Global Research. | |||||
SULTANS OF SWAP: Smoking Guns & the Sting!
Posted in Blogroll on March 17, 2010 by MinimuxStock-Markets / Market Manipulation Mar 12, 2010 – 12:06 PM
By: Gordon_T_Long
There are 7 stages to executing a successful sting operation. Whether this is the modus operandi behind the Sultans of Swap operating in the $605 Trillion OTC Derivatives market or just simple coincidence, I will leave it to you shrewd reader to determine. The seven stages do however offer us an instructive theater guide to better understanding these murky instruments called Interest Rate Swaps.
For our younger readers The Sting is a 1973 American movie set in September 1936 (an era not too dissimilar economically to present day) that involves a complicated plot by two professional grifters (Paul Newman and Robert Redford) to con a mob boss Robert Shaw. The story was inspired by real-life con games documented in “The Big Con: The Story of the Confidence Man”. (Not to be confused with “The Confidence Game” by Stephen Solomon documenting today’s Global Central Banking structure and our own Federal Reserve).
The title phrase refers to the moment when a con artist finishes the “play” and takes the mark’s money. If a con game is successful, the mark does not realize he has been “taken” (cheated), at least not until the con men are long gone (1)
The 7 steps of a successful Sting normally occur in 3 stages which we will distinguish as Acts in today’s modern ‘play’. Now that you understand the plot line, sit back, tightly hold onto your wallet and enjoy the ‘play’.
ACT I - SMOKING GUNS
Usually a caper or heist film will contain a three-act plot. The first act usually consists of the preparations for the heist: gathering conspirators, learning about the layout of the location to be robbed, learning about the alarm system, revealing innovative technologies to be used, and, most importantly, setting up the plot twists in the final act. (Wikipedia)
1 -THE PLAYERS
Like any play we first need to introduce the actors. Who exactly are the Sultans of Swap who play the $437 Trillion global Interest Rate Swap game? There are many actors involved, all with their own motivations and sub plots. We should pay close attention because like any good mystery the answers are unravelled in the multitude of sub plots all happening concurrently.
- THE PATSY: The Counterparties A & B (shown to the right in a simple interest rate swap structure) actually hold the OTC (Over-the-Counter) contracts. We will refer to them as the “PATSY” or “PATSIES”. Like all PATSIES they have an angle and think they are smarter than most. They have just enough knowledge to be dangerous.
- THE ACCOUNTANTS: These are the third parties that administer the ongoing interest payment stream exchanges. We include here also the major global law firms making daunting fees for contract writing and consultation. We will refer to them as a group called “THE ACCOUNTANTS”.
- THE SPECULATORS: These are the issuers and holders of CDS’s that protect against or speculate on counterparty failure of the interest rate swap contract OR the PATSY specifically. We will refer to them as “SPECULATORS”. It needs to be fully understood that our SPECULATORS engage in naked shorting of CDS’s in an unregulated OTC where no DTCC exists that acts as a matching inventory custodian. Our SPECULATORS appear as sinister looking characters in our fictional play.
THE PRODUCERS: These are the magicians that put the OTC contract together, take a quick fee and rapidly leave the scene in Act I as an apparent supporting actor. We could call them the “magicians” but we will call them the PRODUCERS after the Broadway play by the same name and possibly with similar motivations. You may recall that the 2005 movie “The Producers” was about two producers pulling a sting where they intentionally produced a play expecting and planning for its failure. The TAKE was in the failure. Broadway is only uptown from Wall Street and in the center of the mid town Investment Banking crowd. Like a chicken & egg it is hard to tell which was devised first – the evening theater entertainment or their daily enterprising activities. (Note: We need to carefully watch the sub plot of the PRODUCERS unfolding or we won’t see the sting coming).
- THE CON MEN: These are the “Confidence Men” or “CONS” for short. Their role is make our PATSIES feel confident. These are the Credit Rating Agencies who have starred in previous plays (i.e. the Toxic Asset ratings associated with the financial crisis) once again doing their mysterious and well disclaimed ratings. In our play they are rating both the credit worthiness of either PATSY and even the SPC (Structured Private Company) involved in certain Sovereign Interest Rate Swaps (more on that later). Their role allows either PATSY to feel comfortable that the other PATSY can pay (we need to immediately recognize the difference between operative words: can and will).
THE DIRECTORS: These are the SEC, CFTC & corresponding international regulatory authorities. This group additionally includes Legislative authorities such as the US House Financial Services Committee and the US Senate Banking Committee that somehow are always overlooked but are senior DIRECTORS in this play. All the DIRECTORS in our fictional play are dressed as sleepy eyed police officers with little to no interest in the shenanigans of the other actors throughout all three acts. The DIRECTORS are seen to react to telephone calls that occur throughout our play where there is a brief flurry of disorganized and short lived attention. They are then seen to supervise the fallout of some exploding financial event, before just as quickly returning to their ongoing siesta.
- THE BANKSTERS: These are the international banks making obscene fees and trading charges. We are talking $35B in 2009 trading fees alone (6) for brokering these swaps from parties desperate to re-align contract bets since the financial tsunami arrived. We will call them the “BANKSTERS”.
As in any mystery thriller the sub plots can make a simple story appear more complex than it really is. We need to remember what the old carnival ‘3 shells & a pea’ game teaches – it is a sleight of hand & deception that allows the trick to work.
Enter stage left our PRODUCERS and PATSIES.
2- THE SET-UP
The Set-Up must achieve two objectives: Establish the NEED and create CONFIDENCE.
THE NEED – Debt Addiction
The ideal need is one that is addictive. Drugs, Alcohol and Tobacco are three of the clearer examples. Like pushers conning children into using drugs for the first time, the PRODUCERS must convince the PATSIES there is no danger. Everyone is doing it and it will make life better.
Our addiction of choice in this sting is Debt. Whether Consumer, Corporate or Sovereign Debt, western economies have become addicts over the last 30 years – there can be little disputing this fact. It did not happen by chance. To those trafficking in debt the Holy Grail is Sovereign debt. This is due to both its size and its ability to guarantee debt payments based on a legal authority to tax. It has the law and enforcement powers behind it.
John Perkins has authored a series of books from “Confessions of an Economic Hit Man” in 2004 to “Hoodwinked” in 2009, laying out his personal involvement in intentionally establishing false economic justifications for large sovereign infrastructure projects around the globe. Whether you believe his assertions that it was at the behest of elements within the US government, we can clearly see is he was up front and involved in perpetrating the plans & justifications upon which governments in third world countries could secure massive levels of debt based on fraudulent economic justifications. Even those who weren’t addicted because they didn’t have the ability to borrow were drawn into the game by agents that would free foreign leaders from debt constraint. Debt obligations through the hands of these pushers quickly flowed like drugs to an addict and liquor to an alcoholic.
In more developed countries with legacy social entitlement programs we are seeing massive social entitlements continuing to only get larger, more generous and more underfunded. None is more obvious than in Greece, Portugal, Italy, Greece, Spain (PIGS) and across Western & Eastern Europe where the unquenchable thirst for more debt has reached the terminal stage that all substance abusers will eventually find them if all restrictions to drugs (lending) are removed.
Enter stage right the CON MEN to join the others on the stage.
CREATING CONFIDENCE – The “AAA”
In “The Swaps that Swallowed Your Town”, the New York Times on 03-05-10 illustrated how Interest Rate Swaps were shrewdly peddled to US municipalities, school districts, sewer systems and other tax-exempt debt issuers. In this world of the intersection of Derivatives and Municipal debt financing, the sales pitch they report “(the peddlers) accentuated the positives in them. “Derivative products are unique in the history of financial innovation,” gushed a pitch from Citigroup in November 2007 about a deal entered into by the Florida Keys Aqueduct Authority. Another selling point: “Swaps have become widely accepted by the rating agencies as an appropriate financial tool.” And, the presentation said, “they can be easily unwound” (1).
The ratings agencies were at the center of the collapse in the mortgage securitization collapse because of the perceptions that the rating agencies rated CDO (Collateralized Debt Obligations) and all the other toxic waste as AAA. In the interest rate swap play the credit rating agencies rate the sovereign debt based on what the balance sheet shows them. They would likely argue that even if they are fully aware of off balance sheet activities their duties are to appraise only what is before them, what the accounting standards of a particular sovereign outlines and specifically how those standards interpret ‘contingent liabilities’. (More on this subject as our play unfolds). Armed with the newly arrived CON MAN’s credit rating on both PATSIES, with the assurances of the PRODUCERS, and with the help of the now present ACCOUNTANTS, our PATSIES feel confident that risks are manageable based on everything they have heard from the experts present on stage.
3- THE HOOK
The hook is about the Timing and Rationalization of the Sting.
The BANKSTERS join the large crowd of actors now performing complex magical acts before the PATSIES on stage.
Like any addiction it takes an event to initiate the addiction. The event delivers both Timing & Rationalization.
Whether it is a third world leader clinging to power by offering expensive populist solutions, declining revenue bases due to failing industrial policy, geo-political defense requirements, a natural disaster, economic strategies like Dubai’s opulent extravagances or membership in the European Union with its Maastricht Agreement requirements etc, etc., these are the justifications, excuses or motivations for the loan and expanding debt.
This list and endlessly more justifications have always existed. Getting the money historically has been the constraining element. No more constraints thanks to our Sultans of Swap.
4- THE TALE
The Tale is the presentation of the OFFER.
With all our actors seated at the table in the center of the stage we hear the quiet whispers as the plan is secretly divulged.
From the endless list of timing & rationalizations we will select just one to overhear in our fictional play which is garnering a lot of investor & media attention – The European Union Experiment.
According to the Maastricht Agreement and the EU Stability & Growth Pact (SGP) a condition of entry and ongoing membership is the adherence to fiscal deficits of no more than 3% of GDP and total debt of no more than 60% of GDP. It is now emerging that members were creative in their accounting to facilitate membership, and then even more creative to allow for existing debt compounding and the increases due to additional populist programs.
The audience tentatively listens as the whispered plans are unveiled:
GREECE
We form a PPP (Public Private Partnership) under the direction of a PPI (Public Private Initiative). We form a SPC (Special Purpose Company). Through the contractual use of a legal opus magnum called a Novation Agreement the Greek government exchanges fixed interest streams for floating interest rate streams and in so doing receives cash up front with a bubble payment at the termination of the Interest Swap Agreement. Presto, we have an off balance sheet debt without any impact to Greece’s sovereign debt rating. It is much more involved than this and I therefore refer you to: SULTANS OF SWAP: Explaining $605 Trillion in Derivatives! and SULTANS OF SWAP: Fearing the Gearing! which outlines this structure as specifically applied at Kitlos PLC (SPC) in Greece.
Reggie Middleton at the BoomBustBlog.com has done some truly tenacious digging and has unearthed the following further smoking guns:
“According to people familiar with the matter interviewed by China Securities Journal, Goldman Sachs Group Inc. did as many as 12 swaps for Greece from 1998 to 2001, while Credit Suisse was also involved with Athens, crafting a currency swap for Greece in the same time frame. Under its “off-market” swap in 2001, Goldman agreed to convert yen and dollars into euros at an artificially favorable rate in the future. This helped Greece to use that “low favorable rate” when it recorded its debt in the European accounts-pushing down the country’s reported debt load.
Moreover, in exchange for the good deal on rates, Greece had to pay Goldman (the amount wasn’t revealed). And since the payment would count against Greece’s deficit, Goldman and Greece came up with another twist: Goldman effectively loaned Greece the money for the payment, and Greece repaid that loan over time. And the two sides structured the loan as another kind of swap. So, the deal didn’t add to Greece’s debt under EU rules. Consequently, Greece’s total debt as a percentage of GDP fell from 105.3% to 103.7%, and its 2001 deficit was reduced by a tenth of a percentage point in GDP terms, according to people close to Goldman”. (3)
ITALY
“As discussed in a recent ZeroHedge article, a 1996 Italian currency swap, arranged by J.P. Morgan, allowed Italy to receive large payments upfront that helped keep its deficit in line, with the downside of greater payments later. In addition, to curbing their current deficits, countries are now using these swap agreements to push off their loan liabilities (related to swap agreements) to a later date through securitization, and Greece is one such example.
Under the 2001 deal brokered by Goldman, Greece swapped dollar and yen-denominated debt for Euros at below-market exchange rates. The result was that the country got paid €1 billion ($1.35 billion) upfront on the swap in exchange for an obligation to buy the swaps back later. In 2005, this obligation was in turn securitized as part of a 20-year debt issue, further pushing off the day of reckoning.
Moreover, one of the key reasons why such manipulations continued is the apparent ignorance of the EU’s Eurostat, which knew enough about these deals to tighten the rules governing their accounting-albeit only after they had served their purpose – the Ponzi! When Italy’s then-Prime Minister Romano Prodi miraculously achieved a four-percentage-point improvement in Italy’s budget deficit in time to usher the country into the common currency, Italy’s use of accounting gimmicks was widely discussed, and then promptly ignored. As at that time, everyone was only too eager to look the other way in the drive to get the single currency up and running.
It wasn’t until 2008, a decade after the deals became popular, that Eurostat was able to revise its rules to push countries to include swaps in their debt and deficit calculations. Still, todate too little is known about countries’ continued exposure to the deals that are already out there.
Overall, though there is less evidence to support that there are more such swap deals that happened during the late 90′s until early part of this decade, the data to the right showing a sharp decline in interest payments as a percentage of GDP particularly for Belgium (apart from Greece and Italy), hints that there are considerably more of these deals to be discovered. The question is, will they be discovered before or after the respective sovereign issues record debt to the suckers sovereign fixed income investors.
Notice the extremely supercalifragilisticexpealidocious reductions Belgium, Greece and Italy have made in their interest payments from 1993 to 2000 in this graphic made pre-2000. If one didn’t know better, one would have thought these countries actually used magic to make such reductions. Italy practically cut their debt service (projected, of course) in half. It really makes one wonder. I’m just saying…
According to DERIVATIVES AND PUBLIC DEBT MANAGEMENT by Gustavo Piga, “The political stakes of the 1997 budget package were enormous. Therefore, it was no surprise that many countries were accused of ‘creative window-dressing’ in their budget through the use of accounting tricks to reach the desired goal. One contentious item was interest expenditure, which is the interest expense that governments sustain to finance their deficit and roll over their debt. Interest expenditure represents a high percentage of public spending and GDP in the European Union. It is highly variable over time, especially when compared to other components of the budget. Because of its relevance and because it is subject only to minimal scrutiny during budget law discussions (and many times even after its realization during the fiscal year), interest expenditure is an ideal target for reaching fiscal stabilization goals without incurring excessive political protest or opposition”. (3)
Reuters leaves little to speculation when it reported on March 11, 2010:
Forget Greece: Italy derivatives bomb also ticking
Many local governments eager to cut financing costs for years rushed to sign up for complex derivatives contracts, even when the terms were in English. But some cities, facing big losses when interest rates go up, are now trying to pull out of derivatives and suing the international and local banks that arranged the deals.
In a test case, a judge in Milan will decide in coming weeks whether to try 13 people and four banks — UBS (UBSN.VX), Deutsche Bank (DBKGn.DE), Germany’s Depfa and JPMorgan Chase & Co (JPM.N) — on aggravated fraud charges. The case stems from a derivatives swap over a 1.68 billion euro ($2.28 billion) 30-year bond, the biggest issued by an Italian city.
Milan, Italy’s financial capital, is facing a 100 million euro loss on the deal, city officials say. Milan is also suing the banks for 239 million euros in overall liabilities.
In the southern region of Puglia, prosecutors are seeking to bar Merrill Lynch, a unit of Bank of America Corp (BAC.N), from government contracts for two years. The move stems from derivatives losses from 870 million euros in regional bonds.
JPMorgan, UBS and Deutsche have denied wrongdoing, and Depfa has declined comment. Merrill has not commented.
MAKE THE SWITCH
Almost 500 small and large Italian cities are facing mark-to-market losses of 2.5 billion euros on the contracts, according to the Bank of Italy. Analysts say that figure will balloon when interest rates go up.
Most of the contracts involved switching fixed rates on loans to variable ones with banks.
“With the economic crisis, the problem has been lessened a bit (with lower rates) … But in fact with a rate rise it becomes an even worse problem,” said Fabio Amatucci, an expert on local government finances at Milan’s Bocconi University.
The European Central Bank is expected to start hiking rates at the end of this year or early next year.
U.S. and European officials are looking into how U.S. investment bank Goldman Sachs Group Inc (GS.N) may have helped Greece disguise the size of its budget deficit through the use of cross-currency derivatives in 2001.
The Italian deals differ somewhat from the Greek case since the instruments were usually for switching rates on loans, but Italy stands out because of the vast number of cities, regions and public entities — even a theater association — that turned to them from 2001 to 2008.
The Bank of Italy put the notional value of derivatives contracts at 24.1 billion euros in June 2009. However, Il Sole 24 Ore business newspaper on Thursday cited Treasury data to put the overall figure at 35.5 billion euros — a third of local governments’ debt — when wider criteria were used.
Although central bank figures show 467 local governments had derivatives contracts at the end of September, Amatucci believes the real number could be around 3,000 as more deals emerge.
The government banned new contracts in 2008 pending new rules. Economy Minister Giulio Tremonti has said there is “no effect” from derivatives held by local governments.
LOOSEN UP
Local governments rushed into derivatives in part because they helped ease the rigidity of a 2001 law that bars taking on new debt except to finance investment.
But another big draw was the upfront payment many cities got in advance for signing revamped agreements, usually done without a bidding process, analysts said.
Renegotiated deals shoved back payment and costs in a “political manipulation” of signings, said Giampaolo Gialazzo with the Tiche consultancy in Treviso.
Revised deals also carried increasingly restrictive terms and higher costs for municipalities and other local governments.
“Greece did nothing more than get itself money right away and then pay it back slowly. Local administrations in Italy did the same thing,” said Massimiliano Palumbaro with CFI Advisors in Pescara.
Pescara, a southern Italian city, itself took out a total of 108 million euros in interest rate swaps and is suing UniCredit SpA (CRDI.MI) and BNL, a unit of France’s BNP Paribas (BNPP.PA), over them. UniCredit had no comment, while BNL had no immediate comment.
When rates are low, as they were when many contracts were agreed, local authorities using a variable rate could find their costs shrinking. However, when rates rose, officials would find themselves owing more money.
Milan has argued, as have many other local administrations, that the contracts were murky, carried hidden costs and banks had failed to explain them.
However, a source close to the issue said Milan could not argue that it was ignorant about derivatives since the 2005 swap replaced a contract that had been renegotiated repeatedly.
The city also has wide securities markets experience given its joint control of listed utility A2A (A2.MI), the source said.
With banks putting in place a complex deal that had to be overseen for 30 years with hefty back-office costs, “the city could not expect that the banks were going to take that position for free,” said the source.
Despite the court cases, Milan is still interested in derivatives. The city council said on Wednesday it was studying a switch from a variable rate on the contract to a fixed one.
PORTUGAL
“Portugal has also been known for years to take advantage of derivatives contracts to dress up its budget numbers in the late 1990s. In a recent press article (Debt Deals Haunt Europe) Deutsche Bank’s spokesman Roland Weichert commented that the bank has executed currency swaps on behalf of Portugal between 1998 and 2003. He also said that Deutsche Bank’s business with Portugal included “completely normal currency swaps” and other business activity, which he declined to discuss in detail. He also added that the currency swaps on behalf of Portugal were within the “framework of sovereign-debt management,” and the trades weren’t intended to hide Portugal’s national debt position (yeah okay!). Though the Portuguese finance ministry declined to comment on whether Portugal has used currency swaps such as those used by Greece, They said Portugal only uses financial instruments that comply with European Union rules.” (3) The Portugal comment begs the whole issue of “Framework of Sovereign Debt Management “. What it is and how exactly it aligns with standard international accounting practices as it relates specifically to “contingent liabilities” – but we digress and will return to this briefly.
We could go from Spain to France and other EU countries operating under the Eurostat framework guidelines and see the same thing. We could discuss the Millennium Dome Project in the UK. We could discuss Dubai World and the hidden amount of debt recently discovered (and still being discovered), but let’s skip over the pond to the USA to see if this is just an isolated European “TALE” being told.
US – NY STATE MUNICIPALS
In The Swaps That Swallowed Your Town the New York Times shows that there is widespread use of Interest Rates swaps across US Municipalities with extremely negative consequences now showing up that were not understood when the PRODUCERS and BANKSTERS made their presentations. Though I failed to see clear proof in their examples of the adoption of the Novation agreement being used in Europe, this doesn’t necessarily mean it is not being used or there is derivation from being employed in the US. What I found interesting was that the CEO of an advisory firm on this subject is quoted as saying ““We need transparency where Wall Street discloses not only the risks but also calculates the potential costs associated with those risks. If you just ask issuers to disclose, even in a footnote, the maximum possible loss or gain from the swap, they probably wouldn’t do it.” (1) The audience must surely notice that the DIRECTORS in our play are now completely asleep on stage though another frustrated call is heard from Harry Markopolos over the stage loud speaker.
And here ladies and gentleman – watch closely – we have the sleight of hand mentioned earlier.
Everything is aimed at getting debt off the balance sheet. Whether through SPE (Special Purpose Entities) of various descriptions or conduits such as SIV (Structured Investment Vehicle) the shell game is all about avoiding the “d” word or Debt.
A LOAN is a debt and must be accounted as A LIABILITY.
A GUARANTEE is not a loan! It is a CONTINGENT Liability.
A Guarantee is something that accountants refer to as a “contingent liability”. The operative word here is “contingent”.
This quickly gets extremely tricky to quantify in its simplest form without adding the complexity of layers of structures and parties around it. It becomes a game of assessed probabilities. The results of the probabilities determine the amount of contingent liabilities to be accrued as a debt liability. Then there is the question of timing. What event might trigger this and when should the liability treatment be reflected.
As an illustrative example, what were the chances of housing correcting 15% when we hadn’t seen housing go down in neither our lifetime or our possibly our parents? Many considered it unlikely and therefore either minimal or no contingencies were allowed.
Add to this confusion a slew of accounting standards with various interpretations and rulings (ias 37 contingent liabilities, ifrs contingent liabilities , fasb contingent liability, us gaap contingent liabilities, Government Accounting Standards Advisory Board, contingent liabilities disclosure etc.) and you end up in very murky waters – Waters not too dissimilar to those associated with toxic assets in the financial crisis where is was nearly impossible to value Level 1 bank Capital Ratios – Mark-to-Market was Mark-to-Model or more aptly Mark-to-Myth. This is the same problem with a slightly different twist. There is the same consistent concern about debt appearing on an asset / liability ledger.
5- THE WIRE
The bookie operation was a wire service in the movie ‘The Sting’ and it was central in pulling off the story’s heist. In our play we have an electronic wire service but it runs between the BANKSTERS and some of the PRODUCERS. It is called the OTC or Over-the-Counter trading. This is how all $605 Trillion Derivatives, including $437 Trillion in Interest Rate Swaps, are traded. No regulations. No standards. No supervision. No audits. They are completely private, restricted and proprietary. There is no sheriff or watch dog. It is the Wild West without a sheriff in town. The boys can shoot it up all they want. Similar to the DTC & Naked Shorting, Dark Pools, High Frequency Trading etc., it is ripe for creative enterprise. Just the kind of secrecy I believe people serving time at “Sing-Sing” like things.
If you thought the play was getting complicated when we discussed the Novation agreement and assessing Contingent Liabilities, let’s add the twist that all these private contracts are traded. The poor auditors must have their heads spinning. Which auditor in which country you astutely ask? As Johnny Depp famously drawls in the mob crime flick “Donnie Brasco” to explain handling transactions like this – “Forget about it!”
Even an old fashion Bookie wire operation in the 1930’s had more supervision than the modern day OTC.
THE SPREAD or ‘the vig’
The difference between the bid and the ask on an open exchange is the spread. According to Wikipedia the spread or Vigorish, or simply the vig, also known as juice or the take, is the amount charged by a bookmaker, or bookie, for his services. What we have on the closed non transparent OTC is no visibility to either the Bid nor Ask. Only the BANKSTERS trade on this info. Therefore the spread is more accurately called the vig. This is completely different to electronic trades today on the NYSE and Nasdaq where spreads have become negligible with many ‘spread men’ being forced out of the business. So what is the the vig or the take on the trades where the PATSIES are desperate to get out from under trades that have went bad since the financial crisis occurred? According to Bloomberg in a March 1, 2010 report:
“The five largest U.S. derivatives dealers, including JPMorgan Chase & Co., Goldman Sachs Group Inc. and Bank of America Corp., were on pace through the third quarter to record as much as $35 billion in revenue last year from trading unregulated derivatives contracts, according to company reports collected by the Federal Reserve and people familiar with banks’ income sources.” (3)
In our modern day world of Trillions being bantered around daily we need to think about this number. It borders on the completely insane! It is bigger than the GDP of a vast majority of the member countries of the United Nations. It almost makes us feel compassion for our poor desperate duped PATSIES.
“Bookmakers use this (the vig) concept to make money on their wagers regardless of the outcome. Because of the vigorish concept, bookmakers should not have an interest in either side winning in a given sporting event. They are interested, instead, in getting equal action on each side of the event. In this way, the bookmaker minimizes his risk and always collects a small commission from the vigorish. The bookmaker will normally adjust the odds, or line, to attract equal action on each side of an event. – Wkipedia
CDS’s (CREDIT DEFAULT SWAPS)
The OTC also trades CDSs (Credit Default Swaps) which allows our PATSY to feel confidence that they are protected if something should go wrong and the counterparty they are contracted with is unable to pay. CDS’s are thought as insurance but they have none of the protection of insurance where collateral is posted for potential payouts.
What insurance company would allow you to buy fire insurance on someone else’s house? Insurance companies knowing it is their money at risk on a claim would be concerned it might foster bad behavior. Since you look particularly desperate they might suspect you of being what our former Harvard MBA trained President (who stood watch during this era), so eloquently erudiated as an ‘evil doer’. You cannot have an exchange where people know (other than the regulated exchange itself) who is on the other side of a trade. It leads to deviant and unfair behavior. CDS (Credit Default Swaps) are the case in point. These instruments, which former New York Insurance Commissioner Eric Dinallo in testimony before congress, related there was a disagreement about who was the supervisory authority on these instruments when they first surfaced. Both the NY Insurance Commission and the CFTC (Commodities Futures Trading Commission) felt they were not their responsibility and agreed with the NY Gaming Commission who felt they more appropriately fell under their purview. That tells you about all you really need to know about CDSs to understand our play. But there is more – unfortunately.
It needs to be fully appreciated that our SPECULATORS in our play are engaged in naked shorting of CDS’s in this unregulated OTC where no DTCC exists that acts as a matching inventory custodian. There is no limit to the number of short transactions that can be sold. For those familiar with shorting you know you get cash upfront when you short. The cash can then be used to fund buying Option PUTs while additionally selling the PATSIES bonds short. The number of strategy permutations is limitless. In a $605 Trillion pool you can do a lot of splashing around.
It would be remiss of me not to say that CDS’ can have an important role to play, but not without a regulated exchange and capital requirements on those selling these instruments. AIG is your blatant example of what the fall out is!
What has been the reaction by our DIRECTORS? – You guessed it – they are still in the midst of their siesta on the side of our stage!
INTERMISSION
OLD SAYING:
“When you owe the bank $100,000 and can’t pay you have a problem. When you owe the bank 100M ($100,000,000) and can’t pay the bank has a problem”
TODAYS VERSION:
When the banks owe 100B ($100,000,000,000) and can’t pay the banks have a problem. When the Banks owe 1T ($1,000,000,000,000) and can’t pay the taxpayer has a problem”
INTERMISSION
Sign Up for the next release in the Sultans of Swap series: Sultans
To be continued with:
ACT II – THE STING
The second act is the heist itself. With rare exception, the heist will be successful, though some number of unexpected events will occur.
ACT III – THE GET AWAY
The third act is the unraveling of the plot. The characters involved in the heist will be turned against one another or one of the characters will have made arrangements with some outside party, who will interfere. Normally, most of or all the characters involved in the heist will end up dead, captured by the law, or without any of the loot; however, it is becoming increasingly common for the conspirators to be successful, particularly if the target is portrayed as being of low moral standing, such as casinos, corrupt organizations or individuals, or fellow criminals.
SOURCES
(1) 03-05-10 The Swaps that Swallowed Your Town the New York Times
(2) 03-03-10 Smoking Swap Guns Are Beginning to Litter EuroLand, Sovereign Debt Buyer Beware! Reggie Middleton
Reggie Middleton at the BoomBustBlog.com
(3) 03-01-10 Frank, Peterson Vow to Eliminate Provision Keeping Swaps Opaque Bloomberg
(4) 03-08-10 Default Protection Is Lowest in Six Weeks as Greece Calms BL
(5) 02-10-09 CSPAN Rep Paul Kanjorski Reviews the Bailout Situation
Wkipedia: http://en.wikipedia.org/wiki/The_Sting The Sting
Wikipedia: http://en.wikipedia.org/wiki/Heist_film A Heist Film
03-03-10 Smoking Swap Guns Are Beginning to Litter EuroLand, Sovereign Debt Buyer Beware!
Gordon T Long gtlong@comcast.net Web: Tipping Points
Mr. Long is a former executive with IBM & Motorola, a principle in a high tech start-up and founder of a private Venture Capital fund. He is presently involved in Private Equity Placements Internationally in addition to proprietary trading that involves the development & application of Chaos Theory and Mandelbrot Generator algorithms.
Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you confirm the facts on your own before making important investment commitments.
© Copyright 2010 Gordon T Long. The information herein was obtained from sources which Mr. Long believes reliable, but he does not guarantee its accuracy. None of the information, advertisements, website links, or any opinions expressed constitutes a solicitation of the purchase or sale of any securities or commodities. Please note that Mr. Long may already have invested or may from time to time invest in securities that are recommended or otherwise covered on this website. Mr. Long does not intend to disclose the extent of any current holdings or future transactions with respect to any particular security. You should consider this possibility before investing in any security based upon statements and information contained in any report, post, comment or recommendation you receive from him.
The European Union Debt Deflation Trap Economic Deflation
Posted in Blogroll on March 17, 2010 by MinimuxMar 09, 2010 – 02:45 PM
By: John_Mauldin
“The underlying principle flows from the financial balance approach: the domestic private sector and the government sector cannot both deleverage at the same time unless a trade surplus can be achieved and sustained. Yet the whole world cannot run a trade surplus. More specific to the current predicament, we remain hard pressed to identify which nations or regions of the remainder of the world are prepared to become consistently larger net importers of Europe’s tradable products. Countries currently running large trade surpluses view these as hard won and well deserved gains.
They are unlikely to give up global market shares without a fight, especially since they are running export led growth strategies. Then again, it is also said that necessity is the mother of all invention (and desperation, its father?), so perhaps current account deficit nations will find the product innovations or the labor productivity gains that can lead to growing the market for their tradable products. In the meantime, for the sake of the citizens in the peripheral eurozone nations now facing fiscal retrenchment, pray there is life on Mars that exclusively consumes olives, red wine, and Guinness beer.” – Rob Parenteau, CFA Let me state upfront that this is not the easiest to grasp Outside the Box that I have sent you. But if you can get what Rob is saying, you will understand why the problems facing the world, and especially Europe, are so difficult. Everyone cannot export their way out of this crisis.
Someone has to actually run a current account (trade) deficit. My suggestion is that you read this once through, and then read it again. If you see where Rob is going, it makes it easier to understand the second time. Warning: Rob Parenteau is an Austrian economist. In many circles, what he is saying is controversial, if not at least counter-intuitive. But it makes us think, which is the purpose of Outside the Box. If I get a response that is robust and thoughtful, I will run it in the future. The problem that Rob articulates is the center of the problems we face. There are no good or easy choices, as I have been writing for a log time. Rob Parenteau, CFA, is the sole proprietor of MacroStrategy Edge and editor of The Richebacher Letter. He also serves as a research assistant to the Levy Institute of Economics.
For those interested, you can subscribe to The Richebacher Letter at https://reports.agorafinancial.com/.. (yes, more hyper marketing copy, but that is the link if you want his letter.) Will the Earnest Quest for Fiscal Sustainability Destabilize Private Debt? By Rob Parenteau The question of fiscal sustainability looms large at the moment – not just in the peripheral nations of the eurozone, but also in the UK, the US, and Japan. More restrictive fiscal paths are being proposed in order to avoid rapidly rising government debt to GDP ratios, and the financing challenges they may entail, including the possibility of default for nations without sovereign currencies. However, most of the analysis and negotiation regarding the appropriate fiscal trajectory from here is occurring in something of a vacuum.
The financial balance approach reveals that this way of proceeding may introduce new instabilities. Intended changes to the financial balance of one sector can only be accomplished if the remaining sectors also adjust in a complementary fashion. Pursuing fiscal sustainability along currently proposed lines is likely to increase the odds of destabilizing the private sectors in the eurozone and elsewhere – unless an offsetting increase in current account balances can be accomplished in tandem. To make the interconnectedness of sector financial balances clearer, proposed fiscal trajectories need to be considered in the context of what we call the financial balances map. Only then can tradeoffs between fiscal sustainability efforts and the issue of financial stability for the economy as a whole be made visible. Absent consideration of the interrelated nature of sector financial balances, unnecessarily damaging choices may soon be made to the detriment of citizens and firms in many nations. Navigating the Financial Balances Map For the economy as a whole, in any accounting period, total income from producing final goods and services must equal total expenditures on final products. There are, after all, two sides to every transaction: a spender of money and a receiver of money income. Similarly, total saving out of income flows must equal total investment in tangible capital during any accounting period. For individual sectors of the economy, these equalities need not hold.
The financial balance of any one sector can be in surplus, in balance, or in deficit. The only requirement is, regardless of how many sectors we choose to divide the whole economy into, the sum of the sectoral financial balances must equal zero. For example, if we divide the economy into three sectors – the domestic private (households and firms), government, and foreign sectors, the following identity must hold true: Domestic Private Sector Financial Balance + Fiscal Balance + Foreign Financial Balance = 0 Note that it is impossible for all three sectors to net save – that is, to run a financial surplus – at the same time. All three sectors could run a financial balance, but they cannot all accomplish a financial surplus and accumulate financial assets at the same time – some sector has to be issuing liabilities. Since foreigners earn a surplus by selling more exports to their trading partners than they buy in imports, the last term can be replaced by the inverse of the trade or current account balance. This reveals the cunning core of the Asian neo-mercantilist strategy. If a current account surplus can be sustained, then both the private sector and the government can maintain a financial surplus as well. Domestic debt burdens, be they public or private, need not build up over time on household, business, or government balance sheets. Domestic Private Sector Financial Balance + Fiscal Balance – Current Account Balance = 0 Again, keep in mind this is an accounting identity, not a theory. If it is wrong, then five centuries of double entry book keeping must also be wrong.
To make these relationships between sectors even clearer, we can visually represent this accounting identity in the following financial balances map as displayed below. On the vertical axis we track the fiscal balance, and on the horizontal axis we track the current account balance. If we rearrange the financial balance identity as follows, we can also introduce the domestic private sector financial balance to the map: Domestic Private Sector Financial Balance = Current Account Balance – Fiscal Balance That means at every point on this map where the current account balance is equal to the fiscal balance, we know the domestic private sector financial balance must equal zero. In other words, the income of households and businesses just matches their expenditures (or alternatively, if you prefer, the saving out of income flows by the domestic private sector just matches the investment expenditures of the sector). The dotted line that passes through the origin at a 45 degree angle marks off the range of possible combinations where the domestic private sector is neither net issuing financial liabilities to other sectors, nor is it net accumulating financial assets from other sectors. Once we mark this range of combinations where the domestic private sector is in financial balance, we also have determined two distinct zones in the financial balance map. To the left of the dotted line, the current account balance is less than the fiscal balance: the domestic private sector is deficit spending.
To the right of the dotted line, the current account balance is greater than the fiscal balance, and the domestic private sector is running a financial surplus or net saving position. This follows from the recognition that a current account surplus presents a net inflow to the domestic private sector (as export income for the domestic private sector exceeds their import spending), while a fiscal surplus presents a net outflow for the domestic private sector (as tax payments by the private sector exceed the government spending they receive). Accordingly, the further we move up and to the left of the origin (toward the northwest corner of the map), the larger the deficit spending of households and firms as a share of GDP, and the faster the domestic private sector is reducing the stock of net financial assets it holds. This usually entails an increasing its private debt to income ratio, or a falling net worth to income ratio (absent an asset bubble, which would raise the valuation of assets held). Moving to the southeast corner from the origin takes us into larger domestic private surpluses, where households and firms can increase their holdings of net financial assets. The financial balance map forces us to recognize that changes in one sector’s financial balance cannot be viewed in isolation, as is the current fashion. If a nation wishes to run a persistent fiscal surplus and thereby pay down government debt, it needs to run an even larger trade surplus, or else the domestic private sector will be left stuck in a persistent deficit spending mode. When sustained over time, this negative cash flow position for the domestic private sector will eventually increase the financial fragility of the economy, if not insure the proliferation of household and business bankruptcies. Mimicking the military planner logic of “we must bomb the village in order to save the village”, the blind pursuit of fiscal sustainability may simply induce more financial instability in the private sector. Fiscal sustainability may ultimately prove destabilizing to the economy. Leading the PIIGS to an (as yet) Unrecognized Slaughter The rules of the eurozone are designed to reduce the room for policy maneuver of any one member country, and thereby force private markets to act as the primary adjustment mechanism. Each country is subject to a single monetary policy set by the European Central Bank (ECB). One policy rate must fit the needs of all the member nations in the eurozone. Each country has relinquished its own currency in favor of the euro. One exchange rate must fit the needs of all member nations in the eurozone. The fiscal balance of member countries is also, under the provisions of the Stability and Growth Path, supposed to be limited to a deficit of 3% of GDP. The principle here is one of stabilizing or reducing government debt to GDP ratios. Assuming economies in the eurozone have the potential to grow at 3% of GDP in real terms, and inflation is held to 2%, nominal GDP growth of 5% will be likely over the medium term. Starting from a 60% government debt to GDP ratio nominal terms, which is also the proposed public debt limit, a fiscal deficit of 3% of nominal GDP, when combined with a 5% nominal GDP growth tendency, will stabilize the government debt ratio at this limit (.03/.05 = .6, and the average debt ratio will migrate toward the marginal over time). In other words, to join the European Monetary Union, nations have substantially diluted their policy autonomy. Markets mechanisms must achieve more of the necessary adjustments – policy measures are circumscribed. Policy responses are constrained by design, while experience suggests relative price adjustments in the marketplace have a difficult time at best of automatically inducing private investment levels consistent with desired private saving at anything approach the level of full employment income.
This is a recipe for subpar growth outcomes, if not stagnation, and it presents quite a challenge if growth paths are knocked down by a global financial crisis, for instance. Now let’s layer on top of this structure three complicating developments of late. First, current account balances in a number of the peripheral nations have fallen, in part due to the prior strength in the euro. Second, fiscal shenanigans along with a very sharp global recession have led to very large fiscal deficits in a number of peripheral nations. Third, following the Dubai World debt restructuring, global investors have become increasingly alarmed about the sustainability of fiscal trajectories, and there is mounting pressure on governments to commit to tangible plans to reduce fiscal deficits over the next three years, with Ireland and Greece facing the first wave of demands for fiscal retrenchment. We can apply the financial balances approach to make the current predicament plain. If, for example, Spain is expected to reduce it’s fiscal deficit from roughly 10% of GDP to 3% of GDP in three years time, then the foreign and private domestic sectors must be together willing and able to reduce their financial balances by 7% of GDP. Spain is estimated to be running a 4.5% of GDP current account deficit this year. If Spain cannot improve its current account balance (in part because it relinquished its control over its nominal exchange rate the day it joined EMU), the arithmetic of sector financial balances is clear. Spain’s households and businesses would, accordingly, need to reduce their current net saving position by 7% of GDP over the next three years. Since they are currently estimated to be net saving 5.5% of GDP, Spain’s domestic private sector would move to a 1.5% of GDP deficit, and thereby enter a path of increasing leverage.
Spain already is running one of the higher private debt to GDP ratios in the region. In addition, Spain had one of the more dramatic housing busts in the region, which Spanish banks are still trying to dig themselves out from (mostly, it is alleged, by issuing new loans to keep the prior bad loans serviced, in what appears to be a Ponzi scheme fashion). It is highly unlikely Spanish businesses and households will wish to raise their indebtedness in an environment of 20% plus unemployment rates, combined with the prospect of rising tax rates and reduced government expenditures as fiscal retrenchment is pursued. More likely, they will try to preserve their recent net saving or financial surplus position. Alternatively, if we assume Spain’s private sector will attempt to preserve its estimated 5.5% of GDP financial balance, or perhaps even attempt to run a larger net saving or surplus position so it can reduce its private debt faster, Spain’s trade balance will need to improve by more than 7% of GDP over the next three years. Barring a major surge in tradable goods demand in the rest of the world (especially demand for Spanish tradable goods by chronic current account surplus nations in the eurozone like Germany), or a rogue wave of rapid product innovation from Spanish entrepreneurs, there is an additional way for Spain to accomplish such a significant reversal in its current account balance. Prices and wages in Spain’s tradable goods sector will need to fall precipitously, and labor productivity will have to surge dramatically, in order to create a large enough real depreciation for Spain that its tradable products gain market share (at, we should mention, the expense of the rest of the eurozone members). Arguably, the slack resulting from the fiscal retrenchment is just what the doctor might order to raise the odds of accomplishing such a large wage and price deflation in Spain. But how, we must wonder, will Spain’s private debt continue to be serviced during the transition as Spanish household wages and business revenues are falling under higher taxes or lower government spending? Spain Ensnared in the EMU Trap As evident from the financial balances map, there are a whole range of possible combinations of current account and domestic private sector financial balances which could be consistent with the 7% of GDP reduction in Spain’s fiscal deficit. But the simple yet still widely unrecognized reality is as follows: both the public sector and the domestic private sector cannot deleverage at the same time unless Spain produces a nearly unimaginable trade surplus – unimaginable especially since Spain will not be the only country in Europe trying to pull this transition off. As an admittedly rough exercise, we can assume each of the peripheral nations will be constrained to achieving a fiscal deficit that does not exceed 3% of GDP in three years time. In addition, we will assume each nation finds some way to improve its current account imbalances by 2% of GDP over the same interval. What, then, are the upper limits implied for domestic private sector financial balances as a share of GDP for each nation? Greece and Portugal appear most at risk of facing deeper private sector deficit spending under the above scenario, while Spain comes very close to joining them. But that obscures another point which is worth emphasizing. With the exception of Italy, this scenario implies declines in private sector balances as a share of GDP ranging from 3% in Portugal to nearly 9% in Ireland.
Private sectors agents only tend to voluntarily target lower financial balances in the midst of asset bubbles, when, for example home prices boom and gross personal saving rates fall. Alternatively, during profit booms, firms issue debt and reinvest well in excess of their retained earnings in order take advantage of an unusually large gap between the cost of capital and the expected return on capital. We have no compelling reasons to believe either of these conditions is immediately on the horizon. If peripheral eurozone private sectors try to maintain something close to their current financial surpluses, current account balances will not to improve more dramatically, or nominal income growth will slow, if not fall into deflation. The above conclusion regarding the need for a substantial trade balance swing in nations pursuing fiscal retrenchment flows straight from the financial balance approach, and yet it is obviously being widely ignored, because the issue of fiscal retrenchment is being discussed as if it had no influence on the other sector financial balances. This is unmitigated nonsense. It is even more retrograde than primitive tales of “twin deficits” (fiscal deficits are nearly guaranteed to produce offsetting current account deficits) or Ricardian Equivalence stories (fiscal deficits are nearly guaranteed to produce offsetting domestic private sector surpluses) mainstream economists have been force feeding us for the past three decades. Both of these stories reveal an incomplete understanding of the financial balance framework – or at best, one requiring highly restrictive (and therefore highly unrealistic) assumptions.
The EMU Triangle This observation is especially relevant in the eurozone, as the combination of the policy constraints that were designed into the EMU, plus the weak trade positions many peripheral nations have managed to achieve, have literally backed these countries into a corner. To illustrate the nature of their conundrum, consider the following application of the financial balances map. First, a constraint on fiscal deficits to 3% of GDP can be represented as a line running parallel to and below the horizontal axis. Under Stability and Growth Pact rules, we must define all combinations of sector financial balance in the region below this line as inadmissible. Second, since current account deficits as a share of GDP in the peripheral nations are running anywhere from near 2% in Ireland to over 10% in Portugal, and changes in nominal exchange rates are ruled out by virtue of the currency union, we can provisionally assume a return to current account surpluses in these nations is at best a bit of a stretch. This eliminates the financial balance combinations available in the right hand half of the map. If peripheral eurozone nations wish to avoid a return to private sector deficit spending – and realistically, for most of the peripheral countries, the question is whether private sectors can be induced to take on more debt anytime soon, and whether banks and other creditors will be willing to lend more to the private sector following a rash of burst housing bubbles, as well as a severe recession that is not quite over – then there is a very small triangle that captures the range of feasible solutions for these nations on the financial balance map. It is the height of folly to expect peripheral eurozone nations to sail their way into the EMU triangle under even the most masterful of policy efforts or price signals. More likely, since reducing trade deficits is likely to prove very challenging (Asia is still reliant on export led growth, while US consumer spending growth is still tentative, and, as mentioned earlier, most of the eurozone trade takes place within the eurozone itself), the peripheral nations in the eurozone will find themselves floating somewhere out to the northwest of the EMU triangle.
The sharper their fiscal retrenchments, the faster their private sectors will tend to run up their debt to income ratios. Alternatively, if households and businesses in the peripheral nations stubbornly defend their current net saving positions, the attempt at fiscal retrenchment will be thwarted by a deflationary drop in nominal GDP. Demands to redouble the tax hikes and public expenditure cuts to achieve a 3% of GDP fiscal deficit target will then arise. Private debt distress will also escalate as tax hikes and government expenditure cuts the net flow of income to the private sector. Call it the paradox of public thrift. As it turns out, pursuing fiscal sustainability as it is currently defined will in all likelihood just lead many nations to further destabilization of private sector debt. European economic growth will prove extremely difficult to achieve if the current fiscal “sustainability” plans are carried out over the next three years. Realistically, policy makers are courting a situation in the region that will beget higher private debt defaults in the quest to reduce the risk of public debt defaults through fiscal retrenchment. European banks, which remain some of the most leveraged banks, will experience higher loan losses, and rating downgrades for banks will substitute for (or more likely accompany) rating downgrades for government debt. A fairly myopic version of fiscal sustainability will be bought at the price of a larger financial instability involving private debt as well. Summary and Conclusions These types of tradeoffs are opaque now because the fiscal balance is being treated in isolation. Implicit choices have to be forced out into the open and coolly considered by both investors and policy makers. It is not out of the question that fiscal rectitude at this juncture could place the private sectors of a number of nations on a debt deflation path – the very outcome policy makers were frantically attempting to prevent but a year ago. There may be ways to thread the needle – Domingo Cavallo’s [Argentina] recent proposal to pursue a “fiscal devaluation” by switching the tax burden in Greece away from labor related costs like social security taxes to a higher VAT could be one way to effectively increase competitiveness without enforcing wage deflation (http://www.voxeu.org/index.php?q=node/4666).
The cost of exported goods is thereby lowered (as in a currency devaluation) without the need for domestic wage cuts and nominal income deflation, and this introduces the possibility of an improved trade balance with an unchanged fiscal balance. Cavallo’s claims to the contrary, however, it was not the IMF that tripped him up in pursuing this fiscal devaluation angle. Cavallo was, like Greece, under pressure to reduce Argentina’s fiscal deficit. Fiscal expenditure cuts and tax hikes begat lower domestic income flows, which led to subsequent tax shortfalls, missed fiscal balance targets, and another round of fiscal retrenchment, in a vicious spiral fashion (another illustration of the paradox of public thrift). Regardless, more innovative and effective solutions than the fiscal devaluation approach, need to be considered. Financial stability, not just fiscal sustainability, must be taken into account. But such solutions will not even be brought to light unless policy makers and investors begin to think coherently about how sector financial balances interact. Or to put it more bluntly, if eurozone countries try to return to 3% fiscal deficits by 2012, as many of them are now pledging, unless the euro devalues enough or some other measure produces a large current account swing, then either a) the domestic private sectors of many nations will have to adopt a deficit spending trajectory, or b) nominal private income will deflate, and Irving Fisher’s paradox will apply (as in the very attempt to pay down debt leads to more indebtedness), thwarting the ability of policy makers to achieve fiscal targets. In the case of Spain, (or adjacent to the eurozone, the UK) with large private debt/income ratios, this is an especially critical issue.
In addition, given the eurozone tended to run a minor current account surplus (until recently) as a whole, falling nominal incomes in the peripheral nations, or improved current account balances in the periphery, will tend to come at the expense of growth in the eurozone’s current account surplus nations. This introduces a possible contagion vector for Germany in particular, one that lies beyond the exposure of German banks to peripheral nation public debt or private debt. It is not obvious Germany’s policy makers have fully considered these possible feedback effects which could lead to larger. Ironically, Germany’s own fiscal balance could decline if these effects prove large enough on German income growth. The underlying principle flows from the financial balance approach: the domestic private sector and the government sector cannot both deleverage at the same time unless a trade surplus can be achieved and sustained. Yet the whole world cannot run a trade surplus. More specific to the current predicament, we remain hard pressed to identify which nations or regions of the remainder of the world are prepared to become consistently larger net importers of Europe’s tradable products.
Countries currently running large trade surpluses view these as hard won and well deserved gains. They are unlikely to give up global market shares without a fight, especially since they are running export led growth strategies. Then again, it is also said that necessity is the mother of all invention (and desperation, its father?), so perhaps current account deficit nations will find the product innovations or the labor productivity gains that can lead to growing the market for their tradable products. In the meantime, for the sake of the citizens in the peripheral eurozone nations now facing fiscal retrenchment, pray there is life on Mars that exclusively consumes olives, red wine, and Guinness beer. Rob Parenteau, CFA MacroStrategy Edge February 22, 2010 macrostratedge@yahoo.com John Mauldin, Editor Outside the Box John Mauldin Editor, Outside the Box By John Mauldin
“The Big Short” Is A Bit Short In Missing The Reasons for The Financial Crisis
Posted in Blogroll on March 17, 2010 by Minimux
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A Review of Michael Lewis’s Book
by Danny Schechter
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It’s the number one book in the county. Every day, Michael Lewis’s the Big Short is getting B I G G E R, no doubt because he is so mediagenic, conversational and likes to laugh with the hosts who interview him about his findings. On Sunday, he laughed with Steve Kroft on 60 Minutes when the two bantered on about how about stupid it all was and why so many smart people drank the Kool Aid. The story he tells has no hard edges really…it’s about “delusion,” Wall Street deluding us all and then each other. The idea of delusions feeds a psychological and cultural analysis of bankers cut off from the world, focused on their own pocket books and believing their own hype. It is in this sense Shakespearian—the stuff of drama, not calculation. What a web we weave when first we practice to deceive, to quote Sir Walter Scott. At one point in the 60 Minutes two part interview purporting to explain the collapse, Lewis drifts off message and calls it all, an “elegant theft.” Theft is a word we associate with crime, not personal greed or human failings. But that point was left unexplored by 60 Minutes, of course, because if the story is about crime, than we have to move into the arena of facts, not just opinions, insights, hyperbole and personalities. Ironically, many of the facts that Lewis himself cites comes from an undergraduate college thesis according to the Deal Journal of the Wall Street Journal which calls his book a “yam.” They note that his book credited “”A.K. Barnett-Hart, a Harvard undergraduate who had just written a thesis about the market for sub prime mortgage-backed CDOs that remains more interesting than any single piece of Wall Street research on the subject.” Perhaps even more interesting than his book?‘ Earlier, Lewis told the Atlantic what his main sources of information are: “Actually, if you were to draw a pie chart of where I get news from, I bet I get a third from whatever people in Berkeley—specifically the parents’ at my kids’ school—are outraged about. I’m surrounded by people who are alive to what’s going on in the world and who are quick to be outraged by it.” So there he goes again, with emotion and attitude apparently meaning more to him than fact finding. Lewis has criticized those who criticize Goldman Sachs, according to Bloomberg, writing earlier, “bashing Goldman Sachs is Simply a Game for Fools.” Which side is he on I would guess, his side? On 60 Minutes, TV’s top newsmagazine, he was described as a former trader. Not according to Janet Takakoli who runs her own financial firm:
She also notes that he was among the “experts” who downplayed the warnings about the very financial crisis that he has suddenly, thanks to validation from CBS and MSNBC, become THE expert on, charging, “he ridiculed their concern of a pending crisis due to the surge in derivatives demand and called it “this year’s case in point.” Then Michael showed how dangerous it is to be a brilliant writer with a poor command of facts and their true meaning” Financial analysis is not what the media is well equipped to communicate. As a media dissector and editor of Mediachannel, I have followed the reporting of this story closely with many detailed articles and in two books since, even before it became a story back to 2005 when I made my film IN DEBT WE TRUST only to be dismissed by some as a doom and gloomer for exposing the subprime mortgage fraud. I was hoping that Rachel Maddow would challenge his mass delusion theory but she bought right into it also, in her interview. At one point Lewis opined that there was DECEPTION (i.e., lying by the investment world) but that too was not examined as Lewis himself counterpoised two explanations for the disaster, asking, “was it mass delusion or crime? And then he “answered” his own question or appeared to, by asserting that when you ask the people involved, they say it was delusion. Duh, Michael? What do you think they would say? Do think they would cop to their own criminality? For them, it was all one big miscalculation, never mind who got hurt, which neither 60 Minutes nor Maddow explored. Sorry to say, Jon Stewart did no better with his part of Lewis’ all star media mystery tour. He did introduce him as one of the people making big money on the crisis but then jokingly let him ramble on, praising the sometimes weird people who made small fortunes betting against Wall Street. They were his heroes. Again no concern was expressed for the people they cheated—only the idiots who lost money in the” kingdom where the blind man was king.” Lewis like many non-fiction novelists prefers character-based story telling or “yarns” to more objective analytical investigation. It makes for better narratives, and bigger best sellers. It also gets e interviewers laughing instead of crying. Why? Because there are only smart men doing things that turn out to be stupid, it makes us all feel superior to them even if they had the last laugh on the way to the bank. Sorry, the Big Short seems short—short of a serious consideration of what really drove the financial crisis and the reason that 82% of the American people recently said they want a crack down on Wall Street, not a chance to feel sorry for the “delusions” of its masters of the universe. They want a jail out—not a bailout. On the very day of Rachel’s fawning, but well intentioned interview, United States Senator Ed Kaufman of Delaware, the state that provides a sanctuary for most US corporations and credit card companies, made a speech which got at the heart of the matter. Senator Kaufman did not get lost in the vague clouds of “delusion.” He was more down to earth arguing. “Fraud and potential criminal conduct were at the heart of the financial crisis” Let me repeat and capitalize this brave Senatorial assertion: “FRAUD AND POTENTIAL CRIMINAL CONDUCT WEERE AT THE HEART OF THE FINANICAL CRISIS/” The Senator goes on: “Americans could draw at least three lessons from the (Lehman) report: that we must “undo the damage caused by decades of deregulation;” that the United States must “concentrate law enforcement and regulatory resources on restoring the rule of law to Wall Street;” and that Congress must help regulators and other gatekeepers “by providing clear, enforceable ‘rules of the road’ wherever possible.” Unfortunately, says Kaufman, “I’m concerned that the revelations about Lehman Brothers are just the tip of the iceberg. We have no reason to believe that the conduct detailed last week is somehow isolated or unique. Indeed, this sort of behavior is hardly novel.” Now, it so happens that I have been making a similar argument in my own book THE CRIME OF OUR TIME, and a film PLUNDER THE CRIME OF OUR TIME.” But I am not a former Wall Streeter or best selling author or a US Senator. So my work and the work of many other “outsiders” are still unknown. The media prefers to seek the truth from the very people who either caused the crisis or who were in media perches that ignored it. The point is that many people, many very qualified who have arguing the crime thesis—some in my film—have not so far had the benefit of the prime time exposure even though the American people believe it even was the media downplays it. Will that change? Only if the people don’t believe the hype and demand the truth! News Dissector Danny Schechters film and book will be released in April by Disinformation. For more information, Http://www.plunderhecrimeofourtime.com. Comments to dissector@mediachannel,org |
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The Implications of Velocity of Money on the Economy
Posted in Blogroll on March 17, 2010 by MinimuxEconomics / Economic Theory Mar 13, 2010 – 02:58 PM
By: John_Mauldin
The Velocity of Money
Our Little Island World
GDP = (P) x (T)
P=MV
A Slowdown in Velocity
Dallas and Thoughts on the Economy
This week we do some review on a very important topic, the velocity of money. If we don’t understand the basics, it is hard to make sense of the hash that our world economy is in, much less understand where we are headed.
But before we jump into that, I want to let my Conversations subscribers know that we have posted a recent conversation with two hedge-fund managers, Kyle Bass of Hayman Advisors [and his staff] here in Dallas and Hugh Hendry of the Eclectica Fund in London. Our discussions centered on what we all think has the potential to be the next Greece, but on a far more serious level. It was a fascinating time.
Then next Wednesday we will post a Conversation I had with George Friedman of Stratfor fame, and then the following Wednesday a Conversation that I just completed with Dr. Ken Rogoff and Dr. Carmen Reinhart, the authors of This Time Is Different.
For new readers, Conversations with John Mauldin is my one subscription service. While this letter will always be free, we have created a way for you to “listen in” on my conversations with some of my friends, many of whom you will recognize and some whom you will want to know after you hear our conversations. Basically, I will call one or two friends each month and, just as we do at dinner or at meetings, we will talk about the issues of the day, with back and forth, give and take, and friendly debate. I think you will find it very enlightening and thought-provoking and a real contribution to your education as an investor.
And as you can see, I can get some rather interesting people to come to the table. Current subscribers can renew for a deeply discounted $129, and we will extend that price to new subscribers as well. To learn more, go to http://www.johnmauldin.com/newsletters2.html. Click on the Subscribe button, and join me and my friends for some very interesting Conversations.
The Velocity of Money
The Federal Reserve and central banks in general are running a grand experiment on the economic body, without the benefit of anesthesia. They are testing the theories of Irving Fisher (representing the classical economists), John Keynes (the Keynesian school) Ludwig von Mises (the Austrian school), and Milton Friedman (the monetarist school). For the most part, the central banks are Keynesian, with a dollop of monetarist thrown in here and there.
Over the next few years, we will get to see who is right about debt and stimulus, the velocity of money, and other arcane topics, as we come to the End Game of the Debt Super Cycle, the decades-long cycle during which debt has grown. I have very smart friends who argue that the cycle is nowhere near an end, as governments are clearly increasing debt. My rejoinder is that it is nearing an end, and we need to think hard about what that end will look like. It will not be pretty for a period of time. The chart below shows the growth in debt, both public and private.
But the end of this debt cycle involves more than just debt reduction. There are a number of ideas we have to get our heads around, including the velocity of money. Basically, when we talk about the velocity of money, we are speaking of the average frequency with which a unit of money is spent. To give you a very rough understanding, let’s assume a very small economy of just you and me, which has a money supply of $100. I have the $100 and spend it to buy $100 of flowers from you. You in turn spend $100 to buy books from me. We have created $200 of our “gross domestic product” from a money supply of just $100. If we do that transaction every month, we will have $2400 of annual “GDP” from our $100 monetary base.
So, what that means is that gross domestic product is a function of not just the money supply but how fast that money moves through the economy. Stated as an equation, it is P=MV, where P is the nominal gross domestic product (not inflation-adjusted here), M is the money supply, and V is the velocity of money. You can solve for V by dividing P by M. By the way, this is known as an identity equation. It is true at all times and all places, whether in Greece or the US.
Our Little Island World
Now, let’s complicate our illustration a bit, but not too much at first. This is very basic, and for those of you who will complain that I am being too simple, wait a few pages, please. Let’s assume an island economy with 10 businesses and a money supply of $1,000,000. If each business does approximately $100,000 of business a quarter, then the gross domestic product for the island is $4,000,000 (4 times the $1,000,000 quarterly production). The velocity of money in that economy is 4.
But what if our businesses get more productive? We introduce all sorts of interesting financial instruments, banking, new production capacity, computers, etc., and now everyone is doing $100,000 per month. Now our GDP is $12,000,000 and the velocity of money is 12. But we have not increased the money supply. Again, we assume that all businesses are static. They buy and sell the same amount every month. There are no winners and losers yet.
Now let’s complicate matters. Two of the kids of the owners of the businesses decide to go into business for themselves. Having learned from their parents, they immediately become successful and start doing $100,000 a month themselves. GDP rises to $14,000,000. In order for everyone to stay at the same level of gross income, though, the velocity of money must increase to 14.
Now, this is important. If the velocity of money does not increase, that means that (in our simple island world) on average each business is now going to buy and sell less each month. Remember, nominal GDP is money supply times velocity. If velocity does not increase, GDP will stay the same. The average business (there are now 12) goes from doing $1,200,000 a year down to $1,000,000. The prices of products fall.
Each business now is doing around $80,000 per month. Overall production is the same, but divided up among more businesses. For each of the businesses, it feels like a recession. They have fewer dollars, so they buy less and prices fall. So, in that world, the local central bank recognizes that the money supply needs to grow at some rate in order to make the demand for money “neutral.”
It’s basic supply and demand. If the demand for corn increases, the price will go up. If Congress decides to remove the ethanol subsidy, the demand for corn will go down, as will the price.
If Island Central Bank increases the money supply too much, you will have too much money chasing too few goods and inflation will rear its ugly head. (Remember, this is a very simplistic example. We assume static production from each business, running at full capacity.)
Let’s say the central bank doubles the money supply to $2,000,000. If the velocity of money is still 12, then the GDP will grow to $24,000,000. That will be a good thing, won’t it?
No, because with the two new businesses only 20% more goods are produced. There is a relationship between production and price. Each business will now sell $200,000 per month, or double their previous sales, which they will spend on goods and services, which only grew by 20%. They will start to bid up the price of the goods they want, and inflation sets in. Think of the 1970s.
So, our mythical bank decides to boost the money supply by only 20%, which allows the economy to grow and prices to stay the same. Smart. And if only it were that simple.
Let’s assume 10 million businesses, from the size of Exxon down to the local dry cleaners, and a population that grows by 1% a year. Hundreds of thousands of new businesses are being started every month and another hundred thousand fail. Productivity over time increases, so that we are producing more “stuff” with fewer costly resources.
Now, there is no exact way to determine the right size of the money supply. It definitely needs to grow each year by at least the growth in the size of the economy, the population, and productivity, or deflation will appear. But if money supply grows too much then you have inflation.
And what about the velocity of money? Friedman assumed the velocity of money was constant, and therefore he stated that inflation is always and everywhere a function of the supply of money. And it was, from about 1950 until 1978 when he was doing his seminal work. But then things changed.
Note that nothing Friedman says contradicts the equation MV=PT, if you assume constant velocity. Almost by definition you get inflation if the money supply grows too fast.
Let’s look at two charts sent to me by Dr. Lacy Hunt of Hoisington Investment Management in Austin (and one of my favorite economists). First, let’s look at the velocity of money for the last 108 years.
Notice that the velocity of money fell during the Great Depression. And from 1953 to 1980 the velocity of money was almost exactly the average of the last 100 years. Also, Lacy pointed out in a conversation that helped me immensely in writing this letter, that the velocity of money is mean reverting over long periods of time. That means one would expect the velocity of money to fall over time back to the mean or average. Some would make the argument that we should use the mean from more modern times, since World War II; but even then, mean reversion would result in a slowing of the velocity of money (V), and mean reversion implies that V would go below (overcorrect) the mean. However you look at it, the clear implication is that V is going to drop. In a few paragraphs, we will see why that is the case from a practical standpoint. But let’s look at the first chart.
Now, let’s look at the same chart since 1959 but with shaded gray areas that show us the times the economy was in recession. Note that (with one exception in the 1970s) velocity drops during a recession. What is the Fed response? An offsetting increase in the money supply to try and overcome the effects of the business cycle and the recession. P=MV. If velocity falls then money supply must rise for nominal GDP to grow. The Fed attempts to jump-start the economy back into growth by increasing the money supply.
In this chart from Hoisington, the recessions are in gray. If you can’t read the print at the bottom of the chart, he assumes that GDP is $14.5 trillion, M2 is $8.2 trillion, and therefore velocity is 1.7, down from almost 1.97 just a few years ago. If velocity is to revert to or below the mean, it could easily drop 10% from here. We will explore why this could happen in a minute.
P=MV
But let’s go back to our equation, P=MV. If velocity does slow by another 10%, then money supply (M) would have to rise by 10% just to maintain a static economy. But if we assume 1% population growth, 2% (or thereabouts) productivity growth, and a target inflation of 2%, then M (money supply) actually needs to grow about 5% a year, even if V is constant. And that is not particularly stimulative, given that we are in recession.
Bottom line? Expect money-supply growth well north of 7% annually for the next few years, or at least the attempt. Is that enough? Too much? About right? We won’t know for a long time. This will allow armchair economists (and that is most of us) to sit back and Monday-morning quarterback for many years.
A Slowdown in Velocity
Now, why is the velocity of money slowing down? Notice the real rise in V from 1990 through about 1997. Growth in M2 (see the above chart) was falling during most of that period, yet the economy was growing. That means that velocity had to rise faster than normal. Why? Primarily because of the financial innovations introduced in the early ’90s, like securitizations, CDOs, etc. It is financial innovation that spurs above-trend growth in velocity.
And now we are watching the Great Unwind of financial innovations, as they were pursued to excess and caused a credit crisis. In principle, a CDO or subprime asset-backed security should be a good thing. And in the beginning they were. But then standards got loose, greed kicked in, and Wall Street began to game the system. End of game.
The financial innovation that drove velocity to new highs is no longer part of the equation. Its absence is slowing things down. If the money supply hadn’t risen significantly to offset that slowdown in velocity, the economy would have been in a much deeper recession, if not a depression. While the Fed does not have control over M2, when they lower interest rates it is supposed to make us want to take on more risk, borrow money, and boost the economy. So they have an indirect influence.
And now we come to the policy conundrum for the Fed. They have pumped a great deal of money (liquidity) into the economy. Normally, banks would take that money and multiply it by lending it out (through fractional reserve banking at a potential 9-times factor), increasing velocity and the overall money supply. In the past, the more the Fed increased the money supply, the more banks lent.
But today bank lending is still falling at an average of 15% annually, so far this year. But what if that trend stops?
Corporations in the US have more money on hand than ever in the last 54 years. They are more productive. Their debt-to-equity ratio has been dropping by about 25% for the last 3 quarters, as they repair balance sheets. Capital spending jumped 18% annually in the last quarter. If we are not at an inflection point of rising employment, we are close to it (although we do need at least 100,000 new jobs a month to make up for increased population). And thus are the stock market bulls inspired, and we hit new trend highs weekly.
While growth this quarter will not be as robust as last, it will be fairly good for an economy with 10% unemployment. If you are a Fed governor, you have to be worried that things could turn around quicker than now seems plausible. What if corporations decided to take their cash and start investing in growth?
The last chart showed a small uptick in velocity at the end of last year. What if that is for real? What if we have turned the corner? Then the Fed will have to start taking back the money they have put into the economy, unless they want to see inflation. And indeed, that is what some Fed governors are arguing. They want to raise rates now, or at least signal that they will begin to do so soon. Note there have been a number of speeches by Fed officials of late assuring the bond market that they are aware of the problem, and that they have all the tools they need to keep inflation (and higher interest rates) at bay.
But then again, while there are signs that the economy may be picking up, it is a strange type of recovery. It is what I call a statistical recovery. Let’s look at this litany from my friend David Rosenberg of Gluskin Sheff. He notes that there are measures of economic health other than the stock market and GDP. To wit:
- More than five million homeowners are behind on their mortgages.
- There are over six million Americans who have been unemployed for at least six months, a record 40% of the ranks of the jobless.
- The private capital stock is growing at its slowest rate in nearly two decades.
- Roughly 30% of manufacturing capacity is sitting idle.
- Nearly 19 million residential housing units, or about 15% of the stock, is vacant.
- One in six Americans is either unemployed or underemployed.
- Commercial real estate values are down 30% over the past year.
- The average American worker has seen his/her level of wealth plunge $100,000 over the last two years, even with the recovery in equity markets this past year.
- Bank credit is contracting at an unprecedented 15% annual rate so far this year as lenders sit on a record $1.3 trillion of cash.
- Unit labor costs are down an unprecedented 4.7% over the past year, and what has replenished household coffers has been the federal government, as transfer payments from Uncle Sam now make up a record 18% of personal income (and the Senate just passed yet another jobless benefit extension bill!).”
Wow. 18% of personal income in the US is now from the US government (also known as taxpayers, current and future).
If you take away the punchbowl too soon, you risk strangling a very shaky recovery that is significantly dependent on stimulus spending, which is going to rapidly go away the second half of this year. Further, the Fed situation is complicated by the fact that taxes are highly likely to go up in 2011 (maybe the largest tax increase ever), which will put a serious strain on the economy.
I think the Fed is on hold throughout 2010 and well into 2011, as they see what effect the tax hikes, coupled with decreased stimulus, bring. Next week we will explore the potential effects of the tax hike on the 2011 economy. Stay tuned.
Let me ask for a little bit of help. I am trying to find data on the potential tax increases, and what I am finding is all over the board. In fact, I had intended to write about that topic this week, but simply don’t trust the numbers I am reading. If you have a source or RECENT paper, I would love to see it. Thanks.
Dallas, and Thoughts on the Economy
What started me thinking about tax increases was the problems that so many people I know personally are having, including my kids. It is difficult watching your kids struggle with fewer work hours, the need to make car payments and buy diapers. For many, it’s cuts in pay, lost jobs, and more. Lack of health insurance is often a worry, too.
And knowing it could get worse is rather sobering. Trust me, I see the human side of the need for health-care reform, but also balance it with the need for some fiscal responsibility. We have $38 trillion in unfunded Medicare liabilities. How can we add more? Does anyone really believe that this bill being offered will actually cut spending? How do you cut Medicare by $500 billion when it is already so underfunded? Really? But what about kids and families with no insurance? Something better than what we are seeing is needed to get the problem solved. More on this next week.
I will be a panelist in the inaugural “America: Boom or Bankruptcy?” summit to be held in Dallas on March 26. There will be five of us, presenting problems (plenty of those!) and possible solutions. This promises to be a no-holds-barred, full-throttle event. It should be a lot of fun. Details at www.fedfriday.com.
It’s time to hit the send button. I have kids coming to the airport, and I want to be there. Spring break and all, and I look forward to it. Have a great week.
Your worried about the kids analyst,
By John Mauldin
![Frozen lake [Explored]](http://static.flickr.com/7154/6775468053_d50864e5be_t.jpg "Frozen lake [Explored]")
Minimux
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