Enlightened Economics

Economics for an Enlightened Age

Posts Tagged ‘Banks’

• The Economic Statistic US Elites Keep ‘Hush-Hush’

Posted by Ron Robins on June 14, 2011

By Ron Robins. First published June 6, 2011, in his weekly economics and finance column at alrroya.com

It is a simple statistic that continues to warn of huge economic problems ahead for the US. Some economists call it the ‘marginal productivity of debt (MPD).’ It relates the change in the level of all debt (consumer, corporate, government etc.) in a country to the change in its gross domestic product (GDP). However, due to the message it is delivering, most US economists employed in financial institutions, governments and private industry, as well as financiers and politicians, want to ignore it.

And for the US economy and government finances, the MPD (and related variants of it) is continuing to indicate extremely difficult economic times ahead.

I have vague recollections of the MPD concept from my economics classes long ago. But I was re-introduced to it around 2001 by a renowned economist who, during the following few years prior to his passing, became alarmed as to the MPD path of the US. His name was Dr. Kurt Richebächer, formerly chief economist and managing director of Germany’s Dresdner Bank. Dr. Richebächer, was so respected that former US Federal Reserve Chairman, Paul Volcker once said of him that, “sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong,” reported the online financial journal, The Daily Reckoning on May 15, 2004.

Investigating Dr. Richebächer’s concern further, I wrote an article on my Enlightened Economics blog on January 23, 2008, titled, Is the Amazing US Debt Productivity Decline Coming to a Bad End? I found that, “for decades, each dollar of new debt has created increasingly less and less national income and economic activity. With this ‘debt productivity decline,’ new evidence suggests we could be near the end-game… ”

Another way of viewing the debt productivity problem is to look at it in terms of how many dollars of debt it took to help create total national income, which is the wages, salaries, profits, rents and interest income of everyone. Again, from my above mentioned article, which quotes Michael Hodges in his Total America Debt Report, that, “in 1957 there was $1.86 in debt for each dollar of net national income, but [by] 2006 there was $4.60 of debt for each dollar of national income – up 147 per cent. It also means this extra $2.74 of debt per dollar of national income produced zilch extra national income. In 2006 alone it took $6.32 of new debt to produce one dollar of national income.”

Such data helps explain why US exponential debt growth—after reaching certain limits—collapsed in 2008 and contributed massively to the global financial crash.

However, whereas the US private sector debt has marginally ‘de-leveraged’ (retrenched) since that crash (which might now be reversing), the US government, as everyone knows, has run up mammoth deficits to purportedly keep the country’s economy from imploding. Thus, the US’s MPD is marching to another, perhaps even more frightening tune, suggesting government financial insolvency and/or debt default.

One fascinating way of looking at the declining MPD of US government debt has just been presented by Rob Arnott on May 9, 2011, in his post, Does Unreal GDP Drive Our Policy Choices? What Mr. Arnott does is to subtract out the change in debt growth from GDP, and refers to this statistic as ‘Structural GDP.’ He finds that, “the real per capita Structural GDP, after subtracting the growth in public debt, remains 10 per cent below the 2007 peak, and is down 5 per cent in the past decade. Net of deficit spending, our prosperity is nearly unchanged from 1998, 13 years ago.”

In its effort to counter the significant economic difficulties since 2008, the US government has added, or will have added, around $4 trillion in deficits (financed by new debt) in its three fiscal years 2009, 2010 and 2011. Yet, all this massive government deficit spending has failed to really ignite economic growth. Most likely this is because of the enormous dead weight of unproductive and onerous private sector debt, particularly that of consumer debt. Hence, real US GDP will have increased probably less than $1.5trn during these years. Including some further economic benefit in the years thereafter, a total GDP benefit of only about $2trn is probable.

So, $4trn borrowed for $2trn in GDP gains. Thus, in very rough round numbers, each new one dollar of US government debt might only produce $0.50 in new economic activity and probably only about $0.08 in new federal tax revenue. (Federal tax revenue as a percentage of GDP is around 15 per cent.) Therefore, the economic marginal return for each new dollar of US government debt is possibly around -50 per cent! If you loaned someone $10 million and they gave you back $5m, you would not be happy!

Hence, it might not be long before those holding or buying US government bonds perceive the reality that the US government, and US economy, are losing massively on government borrowings. This will result in much, much higher US government bond yields and interest costs. Most importantly, it may make the rollover of US debt and new debt issuance incredibly difficult unless either US taxes rise stratospherically to cover the deficits, and/or the US Federal Reserve money printing goes into hyper-drive to purchase the debt the markets will not buy. (Of course US banks, pension funds etc., could also be forced to buy them.)

Thus, the idea that US government debt continues to be ‘risk-free’ is absurd.

For this, and for many other reasons cited above, is why the US financial and political elites want to keep hush-hush about what the MPD and its variants reveal!

Copyright alrroya.com

Advertisements

Posted in Economic Measurement, Economics, Monetary Policy, Statistics | Tagged: , , , , , , , , , , , , , , , , , , , , | 5 Comments »

• Banks’ Cheap Money is Economic ‘Poison’

Posted by Ron Robins on March 13, 2011

By Ron Robins. First published March 10, 2011, in his weekly economics and finance column at alrroya.com

Developed world bankers continue to proclaim that enforced low interest rates—cheap money—will lead their countries back to economic prosperity. But didn’t the same policies a few years ago help bring us to the precipice of financial and economic collapse? Do they still not understand that cheap easy money led to many large US and European banks becoming gambling institutions, eventually failing and bailed out at taxpayers’ expense?

And above all, that cheap easy money enticed people, companies and governments, to become horribly indebted, with many individuals and companies failing. Soon, even developed country governments may go bankrupt. As proof that cheap easy money is again causing extraordinary economic problems, just look at where some of it is now going—to the commodities’ markets. There, it helps inflate food prices, thus causing starvation and food riots around the world.

Do the bankers not read history and know that artificially induced cheap easy money can be economic poison?

Of course one simple reason that many bankers advocate cheap easy money is that it makes them a lot of money. When they can—as they did for many years and still seem able to do—‘leverage-up’ their assets in relation to their equity, they can make multiples of profits compared to before. And since, often courtesy of their benevolent central bank, they can frequently borrow at nearly free rates and ‘invest’ those proceeds in bonds/securities/commodities that often offer high potential returns, it is possible for them to make ever bigger profits.

For most large US and European banks, their assets frequently exceeded their equity by 20 to 60 times before the financial crises. That is, keeping it simple, they were somehow able to leverage every $1 of equity, usually by borrowing funds, to create $20 to $60 of assets! The risk in such high leverage is that a small loss in asset values of say, just five per cent, could wipe out their equity and cause insolvency and bankruptcy.

Unfortunately, very high leverage ratios continue in many developed countries’ banking and financial institutions. (Perhaps this is the real unspoken reason for cheap money: to inflate asset markets to keep the banks semi-solvent! Though, that topic is for another post.)

Therefore, the real story is the culture of leverage and risk that numerous developed world banks now embody as a result of easily available cheap money. This is in contrast to that during much of banking history when money was regularly relatively expensive (with higher rates of interest) than today and often difficult to obtain.

The easily available cheap money encourages enormous ‘moral hazard’ among bankers and all players in the financial system. Moral hazard denotes a lack of morality and a carefree greed mentality that produces excessive speculation. It is this attitude that promotes the creation of maximum leverage and the taking of big risks—and not caring too much about any potential losses as they are covered by others. Bankers under the influence of moral hazard are like addicted gamblers who cannot stop gambling. But the gambling is not at the card table. It takes place in their boardrooms and trading desks.

And fortunately for the bankers they can enjoy their moral hazard largely at the expense of taxpayers. As we know, much of the potential and accumulated massive losses in the US and European financial and banking systems have been transferred to governments and central banks. The US and European governments and central banks make light of these burdens saying that as their economies recover these losses will be greatly reduced. However, the ‘central bank of central banks,’ the Bank for International Settlements (BIS), has issued new global bank regulations (Basel III) that—if implemented—might reign in some of the excesses associated with moral hazard.

Of course not all banks speculate or gamble to the same extent. In Islamic banking, spiritual and ethical considerations greatly restrain speculation. Also, for instance, Canadian banks adhere to more conservative principles and are better regulated and so have not suffered the same fate as that of many of their US and European rivals.

For now though, cheap easy money is seen by bankers as our economic salvation. And it inflates global markets, including those related to food and energy. As their prices rise, the unforeseen repercussions of the bankers cheap easy money ‘poison’ assists in creating starvation, food riots, and political upheaval around the globe.

Furthermore, the continuing high leverage, moral hazard, and gambling tendencies within the banking and financial system assures that some of today’s ‘good’ investments will sour and suffer large losses. Will the taxpayers again assume those losses? If not, then what? Until the cheap easy money poison is banished it continues creating conditions for even bigger economic and social catastrophes in the years ahead.

Copyright alrroya.com

Posted in Banking, Economics, Monetary Policy | Tagged: , , , , , , , , , , , , , , , , , , | Leave a Comment »

 
%d bloggers like this: