Wednesday, October 21, 2009

How to Fix Our Economic Mess

It is not as hard as it seems. You don’t have to go to Harvard or Columbia to figure it out. You don’t have to spend hours and days campaigning for your candidate to create a change you can believe in. No, you don’t have to do any of those things. In fact, the answer is so obvious even the average Cuban businessman can tell you what to do. I am not kidding. This is really the case. To prove my point, let me introduce you to Evelio and Carlos, businessmen living in the island of Cuba—notorious for its economic follies. They were interviewed as part of a report by the Financial Times on said country.

What does Evelio think about Cuba’s central economic planning? Let’s see.
"Farmers have never wanted the state to give them anything,” one farmer,
Evelio, aged 60-plus, said in a telephone interview from the provinces. “What we
want is that they sell us what we need to produce and then not waste it through
poor planning, transport and other problems.”

What about Carlos, who is an industrial worker? Maybe he can enlighten us. What did he say?
“Our work does not depend on us but on orientations from the ministry. I can’t
plan anything because they decide the factory’s work and supplies and that’s
where the problems are and continue.”

See, this is the problem with government intervention: it ends up causing a bigger mess than what it intended to solve. It hurts the very people the system is claiming to help. It is as if you are going to cure your headache by banging your head in a wall. You will reach a point when the headache will be gone. In fact, if you continue doing this you will reach a point that you’ll have no more headaches, but at a high cost: your life. It is the same with central economic planning.

It is rather amazing that policies of state intervention are being hailed as the next best thing since sliced bread in the Western world these days. Always and everywhere government intrusion in the free-market economy fails and causes poverty. The recent state guarantees in various sectors of the U.S. economy contradict this logic. A large majority of our leaders truly believe they have done a great deed by promoting de facto communism/socialism. Politicians can put a different spin and/or play on words, but the essence in the same. Don’t listen to what is said, look at the action. You don’t take my word for it, simply listen to Evelio and Carlos. They know more than I do, and as well as most tenured economists, political leaders, and Wall St. CEOs.

Thursday, October 15, 2009

Why The U.S. Dollar Will Loose Its Eminence

Professional economists are a funny bunch. Most resemble a person who looks himself in the mirror and after walking away from it immediately forgets his appearance. Similarly, economists inspect their economic trade tool with diligence, but seem to forget them when it is of utmost important; that is, when abandoning them may lead to tenured positions or a high profiled political job. The issue of the U.S. Dollar’s eminence in international markets is no different. There are elaborate theories and abstruse statistical methods supporting this or that view of how the currency is supposed to behave. But there is an even simpler approach, a model which a scientist would say has parsimonious characteristics: it is called logic.

Since 1945 the U.S. Dollar has reigned supreme in world affairs. Many international prices and other market mechanisms are set in terms of the value of the greenback. Yet, this distinction comes with a (hidden) string attached. Simply, the Dollar status maintains a unique advantage vis-à-vis other currencies because, as long as foreigners allow it, the currency does not have to follow the standards which others are held to. In other words, the fact that the U.S. Treasury can merely print Dollars to pay its foreign claims, unlike other nations, provide America with special privileges. This is referred to as asymmetrical position. The reserve-emitting country (i.e. U.S.A) can fund many of its activities, and as long as the majority of foreign do not economically rebel, it will not suffer the consequences that another country would.

For example, a country with non-reserve currency can fund its day-to-day operations above it collects in taxes, but at a high cost: inflation and subsequent political upheaval. Inflation because the excess money printed exceeds currency demand. These excess funds chase a fixed amount of goods, or at least it is far more than the level of production. Prices will rise in this environment. High price inflation distorts prices and business decision plans.

On the contrary, the reserve currency country is not readily prone to such immediate consequences. Because of it’s prestige, traders and international investors have granted the greenback a tremendous standing. When economic worries sip into various countries, immediately you will see a sell-off in the said country. These investors pursue capital preservation. The U.S. Dollar has that perception. U.S. dollar assets are purchased, consequently providing support for the currency and the economy too. Over this decade, however, the growth in money printing has exceeded the growth in currency accumulation of foreigners. Said differently, had the U.S. dollar not have its unique status, it would have depreciated below what it is now a long time ago. An overvalue currency without due adjustment through the foreign exchange market would be price inflationary. However, in the case of the U.S., demand for dollars by foreigners has increased faster during the time the currency has had eminence, thereby transferring price inflation and other economic costs to foreign markets.

This arrangement cannot continue indefinitely. At some point it will come to an end. As to how it will unravel? I leave that thought to seers and soothsayers.

Saturday, October 10, 2009

Why Will the Next Economic Crisis Be Worse

The spate of economic data revealing the supposed economic recovery is merely covering the massive capital misalignment that still plagues the U.S. Bad debt and toxic assets continue to clog the balance sheets of financial firms, many of which would have gone under had it not been for the massive intervention provided by the government. Many economists and armchair pundits hailed the apparent success of the interventionists, I suppose, like the admirers who hailed the survival miracle of Annie Taylor’s daredevil stunt at the Niagara Falls.

Government intervention and its failure to prevent the dissolution of insolvent firms have magnified the problem of asymmetric information. The reasoning of their intervention, of course, ran along the logic that these firms are “too big to fail.” In other words, these companies are deeply embedded in the economic landscape that one bankruptcy would have triggered a cascade of other failures, causing the economy to come to a grinding halt and ultimately a collapse. Of course, politicians and government bureaucrats never let a crisis of this magnitude go to waste for their own purposes. There are always votes to win for the next election.

That being said, the problem of “saving” these so-called “too big to fail” firms is that it helps foster and promote moral hazard. Moral hazard is the idea that individuals will act different than they otherwise would in the presence of insurance. For example, a person might drive more recklessly, which increases the likelihood of an accident, if he knew he has full-cover car insurance. Similarly, for many years financial firms and investors understood that should a major crisis occur, the government would bail them out. And bailed out they indeed were. Let’s take a brief look into the annals of recent bailout history: In the early 1980s, banks received help from the government which curtailed looses stemming from the emerging market debt crisis. In the late 1980s, the government stepped in to help the financial industry from the saving and loans debacle. In the late 1990s, the Federal Reserve orchestrated a bailout of a prominent hedge fund. From 2005-2009, the government has become a shareholder in industries where constitutionally they have no business to be in. Of course, this has been spun in such a manner that glorifies the behavior of the market interventionists.

Moral hazard is a hidden action in the sense that it cannot be seen publicly: that is, only those holder of toxic assets—to use an example—know with almost full assurance the type and quality of assets they hold in their balance sheets. The government and other outsiders do not. Since the firms know the government will intervene in the case of a crisis, companies will be more conducive to take on higher riskier. Given the massive amounts of unprecedented money printed during the most recent crisis, government is laying the foundation for further capital misallocation. The “money” (which really is just paper printed with green tint) is being spent on things that are not productive. The risky behavior feeds on itself to the point of speculation. When we reach this transition, it is just a matter of time before the economy collapses again.

Monday, October 5, 2009

The Deminse of The Dollar - by Robert Fisk



In the most profound financial change in recent Middle East history, Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.

Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars.

The plans, confirmed to The Independent by both Gulf Arab and Chinese banking sources in Hong Kong, may help to explain the sudden rise in gold prices, but it also augurs an extraordinary transition from dollar markets within nine years.

The Americans, who are aware the meetings have taken place – although they have not discovered the details – are sure to fight this international cabal which will include hitherto loyal allies Japan and the Gulf Arabs. Against the background to these currency meetings, Sun Bigan, China's former special envoy to the Middle East, has warned there is a risk of deepening divisions between China and the US over influence and oil in the Middle East. "Bilateral quarrels and clashes are unavoidable," he told the Asia and Africa Review. "We cannot lower vigilance against hostility in the Middle East over energy interests and security."

This sounds like a dangerous prediction of a future economic war between the US and China over Middle East oil – yet again turning the region's conflicts into a battle for great power supremacy. China uses more oil incrementally than the US because its growth is less energy efficient. The transitional currency in the move away from dollars, according to Chinese banking sources, may well be gold. An indication of the huge amounts involved can be gained from the wealth of Abu Dhabi, Saudi Arabia, Kuwait and Qatar who together hold an estimated $2.1 trillion in dollar reserves.

The decline of American economic power linked to the current global recession was implicitly acknowledged by the World Bank president Robert Zoellick. "One of the legacies of this crisis may be a recognition of changed economic power relations," he said in Istanbul ahead of meetings this week of the IMF and World Bank. But it is China's extraordinary new financial power – along with past anger among oil-producing and oil-consuming nations at America's power to interfere in the international financial system – which has prompted the latest discussions involving the Gulf states.

Brazil has shown interest in collaborating in non-dollar oil payments, along with India. Indeed, China appears to be the most enthusiastic of all the financial powers involved, not least because of its enormous trade with the Middle East.

China imports 60 per cent of its oil, much of it from the Middle East and Russia. The Chinese have oil production concessions in Iraq – blocked by the US until this year – and since 2008 have held an $8bn agreement with Iran to develop refining capacity and gas resources. China has oil deals in Sudan (where it has substituted for US interests) and has been negotiating for oil concessions with Libya, where all such contracts are joint ventures.

Furthermore, Chinese exports to the region now account for no fewer than 10 per cent of the imports of every country in the Middle East, including a huge range of products from cars to weapon systems, food, clothes, even dolls. In a clear sign of China's growing financial muscle, the president of the European Central Bank, Jean-Claude Trichet, yesterday pleaded with Beijing to let the yuan appreciate against a sliding dollar and, by extension, loosen China's reliance on US monetary policy, to help rebalance the world economy and ease upward pressure on the euro.

Ever since the Bretton Woods agreements – the accords after the Second World War which bequeathed the architecture for the modern international financial system – America's trading partners have been left to cope with the impact of Washington's control and, in more recent years, the hegemony of the dollar as the dominant global reserve currency.

The Chinese believe, for example, that the Americans persuaded Britain to stay out of the euro in order to prevent an earlier move away from the dollar. But Chinese banking sources say their discussions have gone too far to be blocked now. "The Russians will eventually bring in the rouble to the basket of currencies," a prominent Hong Kong broker told The Independent. "The Brits are stuck in the middle and will come into the euro. They have no choice because they won't be able to use the US dollar."

Chinese financial sources believe President Barack Obama is too busy fixing the US economy to concentrate on the extraordinary implications of the transition from the dollar in nine years' time. The current deadline for the currency transition is 2018.

The US discussed the trend briefly at the G20 summit in Pittsburgh; the Chinese Central Bank governor and other officials have been worrying aloud about the dollar for years. Their problem is that much of their national wealth is tied up in dollar assets.

"These plans will change the face of international financial transactions," one Chinese banker said. "America and Britain must be very worried. You will know how worried by the thunder of denials this news will generate."

Iran announced late last month that its foreign currency reserves would henceforth be held in euros rather than dollars. Bankers remember, of course, what happened to the last Middle East oil producer to sell its oil in euros rather than dollars. A few months after Saddam Hussein trumpeted his decision, the Americans and British invaded Iraq.

S&P 500...Insanity???

S&P 500 Statistics As of September 30, 2009

Total Market Value ($ Billion) 9,337
Mean Market Value ($ Million) 18,673
Median Market Value ($ Million) 7,978
Weighted Ave. Market Value ($ Million) 74,455
Largest Cos. Market Value ($ Million) 329,725
Smallest Cos. Market Value ($ Million) 814
Median Share Price ($) 32.850
P/E Ratio* 140.76
Indicated Dividend Yield (%) 2.05NM

*Based on As Reported Earnings.