notes oct 16

October 16, 2008 § Leave a comment

From asian times..

There’s no enforcement mechanism or sanction to make sure the banks lend out what they have just taken in. If the US banks, arguing that they have a greater fiduciary responsibility to their common, voting shareholders over their silent partners in the US government, continue to hoard, not lend, their new riches, or maybe just invest them in short-term US Treasury Bills (essentially the same thing), this will all be for naught, and then we’ll be seeing what bright boy or girl has the next big idea to deal with this current catastrophe…..The predicament is not a static problem, in that the banks haven’t suddenly come up $250 billion short. It’s the dynamic problem of the deleveraging monster that only gets stronger with each institution it destroys. That $250 billion is nothing to this beast; the world’s central banks have tried to provide the system with about four times that amount in recent weeks, with the money disappearing into deleveraging’s black hole to emerge out the other side as Treasury bill purchases.

If the enhanced FDIC guarantees, along with the MBS buyout and the equity buy-ins don’t work, it’s hard to see what will. Just about the only arrow left in the quiver then would be a full nationalization of the financial system, making it a public utility, like the US Post Office or European and Asian railroads.

So why was it unlikely that Fama would get the Nobel? Well, if you can provide a wholly rational reason why world stock prices would be worth about 30% less than they were just four weeks ago, I strongly suggest that you should get on the first plane to Stockholm to have a chat with the committe for the Nobel Prize in economics.
The current events in the financial markets are much better explained by the next great paradigm shift in economics, behavioral finance. Here, it is not assumed that human economic actors operate with computer-like logic and dispassion, but are subject to the same wide emotional swings from euphoria to panic, from fear to greed, that is expected in the rest of the human condition. This framework much better explains a financial system willing to lend to anything with over 40 chromosomes (“46 chromosomes? That’s so old fashioned!”) a few years ago, but unwilling to lend even to itself right now.

2:44 am

Conventional economics describes an artificial world of slight deviations from equilibrium; Brenner presents the real world, in all its danger and uncertainty. Man lives not only by the sweat of his brow, but by the fortitude of his intestines, for survival demands that we take mortal leaps of a kind that are unknown to the conventional model. Men who would prefer to be timid risk everything to leapfrog their peers before they themselves are left behind.

American asset markets did not offer returns high enough for the baby boomers to earn enough to retire. There are a number of reasons for this. One is that not only Americans, but Europeans, Japanese, and above all Middle Easterners are aging rapidly and seeking retirement assets, such that the price of all capital assets rose and their prospective rate of return fell. Capital markets, as I have argued in the past, come down to old people lending money to young people, and the declining numbers of young people in the industrial world during the past generation are reflected in shrinking investment opportunities.

With home prices rising 10% a year between 1998 and 2006, Americans found that they could use leverage to achieve triple-digit returns on their equity (if you buy a $200,000 house with $10,000 down and its price rises by 10%, or $20,000, your return on equity is 200%).

In Brenner’s model, survival means maintaining one’s social status, one’s place in the pecking order or the corporate food chain, because falling behind decreases the likelihood of survival. Rivalry is the driving force, not an abstract measure of utility. There is something profoundly Biblical in this view: “I considered all labor and all excelling in work, that it is a man’s rivalry with his neighbor. This also is vanity and a striving after wind.” – Ecclesiastes 4:4.

Rivalry between nations never was so clear cut as in the preparations for World War l. Each European nation feared being leapfrogged by the others. France feared Germany’s high population growth rate, Russia feared Germany’s intrusion into the restive western wing of its empire, Germany feared Russian industrialization, England feared the losses of its ability to control the continental balance of power, Italy felt left out, and so forth. All had excellent reasons to fight rather than be left behind, but the result was the collective ruin of all the European nations.
At the outbreak of the war in 1914, some of Europe’s best minds exulted in the “leap into uncertainty”. Thomas Mann, arguably the greatest writer of the past century, wrote a famous essay entitled “Thoughts in War” comparing the risk-taking attitude of the artist and that of the soldier. A great sense of liberation from the ordinary swept over Europe as its nations prepared to risk everything for their place at the head of the queue. The trouble is that they risked everything, and they all lost everything.

Knight, unlike Brenner, thought that entrepreneurship did not add enough wealth to justify the disruption that it occasioned. Joseph Schumpeter, who took from Mephisto the notion of creative destruction and applied it to economics, was pessimistic about the future of capitalism. He thought communism would triumph.

3:02

This is the first all-encompassing global dislocation of contemporary finance, impacting virtually all economies, markets and asset classes. The media are now all over the “Wall Street” and “banking” crisis. I am of the view, however, that the collapse of the hedge fund industry has moved to the forefront – that it is now at the epicenter of global market upheaval.

Having watched the ballooning of the hedge fund industry over the past few years in absolute awe, I can say today that an industry collapse would entail the sale (voluntary and forced by the margin clerk) and unwind of literally trillions of positions. It has been history’s most spectacular speculative bubble and, especially over the past few years, it became very much global in nature and infiltrated virtually all asset classes. This bubble is in a full-fledged collapse – entailing unprecedented liquidations – and it’s taking global markets down with it.

3:07 am

….being political and arbitrary, Paulson and Bernanke have rejected value theory and opposed the free-market price mechanism. They have striven to reinflate high speculative housing prices and staunchly opposed a return of these prices to some long-term equilibrium. They acted intentionally to depreciate the US dollar so as to increase competitiveness of US exports and reduce the real burden of US foreign debt. They forced negative real interest rates in an environment where interest rates have to be totally freed and help in making sound economic policy.
This environment was characterized by rapidly falling real savings, outrageous food and energy price inflation, and mounting loan defaults. Recently, the Fed has become over-leveraged by injected close to one trillion dollars of liquidity into the financial system, simply by printing money out of thin air.
Had the Fed allowed free interest rates, financial markets would have never become frozen. A market freezes only when the government decrees a price far below the equilibrium price, which forces suppliers to withdraw their commodity from the market. Moreover, equilibrium interest rates would have allowed banks to strengthen their incomes, and would have called for a small amount, if any, of liquidity injection by the Fed since demand for credit would be checked and deposits and foreign savings would increase. That Paulson and Bernanke’s action is dangerously destabilizing is clear. Just ask what will happen when the Fed cannot add another trillion or decides to withdraw liquidity; most likely, the whole system will freeze again.

Had the Fed allowed free interest rates, financial markets would have never become frozen. A market freezes only when the government decrees a price far below the equilibrium price, which forces suppliers to withdraw their commodity from the market. Moreover, equilibrium interest rates would have allowed banks to strengthen their incomes, and would have called for a small amount, if any, of liquidity injection by the Fed since demand for credit would be checked and deposits and foreign savings would increase. That Paulson and Bernanke’s action is dangerously destabilizing is clear. Just ask what will happen when the Fed cannot add another trillion or decides to withdraw liquidity; most likely, the whole system will freeze again.
The destabilizing policy of Paulson and Bernanke has been rightly addressed by Professor Jonathan R Macey from Yale University in a Wall Street Journal article on October11, 2008, titled “The government is contributing to the panic: it’s time to let markets do their messy work”. He showed that Paulson and Bernanke have always acted in panic, distorted market mechanisms, rewarded speculation, punished conservative bankers, and heightened uncertainties to a point of freezing capital markets. He could have also added that the demeanor of Paulson and Bernanke was hardly the stuff to encourage trust and confidence among the public, the needed ingredient in a state of panic.

Governments have to defend the value of money, so essential for production and exchange, and should not kill the goose that lays the golden eggs. Governments can guarantee the money of depositors. But the purchase of bad mortgages and of intoxicated assets by governments will create immense fiscal and social problems, administrative burdens, and should not be acceptable

Proponents of bailouts contend that without these the economy will succumb. Their argument is not substantiated by monetary data; they only seek a golden opportunity to get rid of their losses. Economic policy should never be conducted through judgment and power struggle. It has to be based on the statistical apparatus, and evaluated carefully by policymakers.

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You are currently reading notes oct 16 at Reflections on GardenWorld Politics Douglass Carmichael.

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