Enlightened Economics

Economics for an Enlightened Age

Posts Tagged ‘hyperinflation’

• New Bank Regulations Likely to Fail

Posted by Ron Robins on December 22, 2010

By Ron Robins. First published December 15, 2010, in his weekly economics and finance column at alrroya.com

New banking and financial industry regulations in the US and the Basle III rules for banks globally—might fail on key issues. The newly enacted US Dodd-Frank Wall Street Reform and Consumer Protection Act, despite its noble purpose to prevent further financial chaos, is unlikely to do that. And the Basle III requirements for higher and better quality bank reserves are good on paper, but full implementation is improbable amidst likely future hefty bank losses.

At the heart of the financial crises were derivatives, and as Warren Buffett the famed investor has warned, “derivatives are financial weapons of mass destruction.” Yet, after about two years of Congressional wrangling, the Dodd-Frank bill incorporates a rough future structure for derivatives but authorizes yet another committee to report back in the spring of 2011 with detailed regulations governing them. And the old expression, ‘the devil is in the details,’ is never more apt than in this instance.

Already, US Banks are calling for derivatives called ‘foreign exchange swaps’—a $42 trillion market—to be exempt from the rules.

Derivatives are major profit centres for the too-big-to-fail US banks. These banks have repeatedly told US lawmakers—who receive considerable campaign funding from them—not to restrict those profits. Because of the influence of Wall Street on the Obama Administration and the US Congress, it is difficult to be hopeful that when it comes to the detailed regulations, and especially their enforcement, that much will really change concerning US banks’ derivatives’ activities.

Two particular varieties of derivatives are at the centre of our financial debacle. They are mortgage backed securities (MBS) and credit default swaps (CDS). The latter, though originally considered ‘insurance policies’ against debt default, are now frequently gambling vehicles that incentivize the taking-down of struggling companies (AIG)—and now, governments (Ireland?).

The size of the derivative problem for US banks cannot be overstated. As Alasdair Macleod, a British banker and economist remarked on October 28, “according to the FDIC [the US Federal Deposit Insurance Corporation], outstanding derivatives held by US banks increased from $155 trn to $225 trn between mid-2007 and mid-2010. In other words, since the credit-crunch the derivative bubble in the US has grown a further 45 per cent and is now fifteen times total US GDP, literally dwarfing the banks’ total equity, which is only $1.35 trn. Consider this fact: derivative exposure is 189 times total bank equity.”

Aside from the derivatives issue, and also not addressed in the Dodd-Frank bill, are the two massive US mortgage progenitors now on US government life-support, Fannie Mae and Freddie Mac.

Fannie Mae and Freddie Mac were formerly somewhat private institutions and own or guarantee about half of all US residential mortgages. But as the real estate crises exploded and due to their potential for vast losses that could paralyse the housing markets, the US government commandeered them in September 2008.

The principle offering in the Dodd-Frank bill concerning Fannie Mae and Freddie Mac is that by January 2011 President Obama offers a proposal to Congress to bring them out of government receivership.

Thus, on the two vital issues of derivatives and real estate, the Dodd-Frank bill seems queasy and deficient. These inadequacies allow for a re-ignition of the financial meltdown at almost any time.

Acknowledging the severe problems in the banking industry, banking regulators have introduced new global banking rules. In September, the Bank for International Settlements (BIS) in Geneva, Switzerland—which sets the regulations that banks everywhere generally adhere to—issued its Basel III regulations, which are due to come into effect for all banks between 2013 and 2019.

Basel III’s most important requirement will be that banks hold higher and better quality reserves.

But the BIS may be too optimistic about the ability of many banks, particularly the too-big-to-fail banks, to reach the new reserve requirements. For instance, a Reuters report on November 21 said, “the new Basel III banking rules will leave the biggest US banks short of between $100 billion and $150bn in equity capital, with 90 per cent of the shortfall concentrated in the top six banks, the Financial Times said, citing research from Barclays Capital.”

However, these equity shortfalls may well err on the low side. In the next few years, US and European banks especially, are likely to be hit with big waves of new losses related to real-estate, derivatives, and sovereign debt.

Real estate losses because US and European banks have still not written-off their full potential losses concerning toxic MBS that they may have to buy back due to newfound paperwork improprieties related to the emerging foreclosure fraud, as well as mortgage losses generally, on foreclosed and other properties.

Additionally, banks may suffer further huge derivative losses as they are eventually forced to price certain derivative and other asset classes at more realistic appraisal values instead of the ‘mark to fantasy’ that often now exists.

And recently, an even greater potential hit to banks’ capital has arisen: the possibility of gargantuan losses on bad sovereign debt in the EU and elsewhere.

On September 13, The Economist magazine had this to say on the MBS and derivatives issue relating to Basle III. “The most serious failure in Basel III is that it doesn’t address the principal contribution of Basel II to the last financial crisis, namely, the calculation of risk-weights [for instance, risks associated with MBS]… What brought banks like Citigroup and Bank of America to their knees wasn’t direct exposure to sub-prime loans, but exposure to triple-A-rated debt backed by pools of such loans, debt which turned out not to be risk-free at all.”

The US Dodd-Frank bill either passes the buck or overlooks the very problems that led to the financial meltdown, and the Basel III regulations may be rendered impotent due to massive future bank losses. Thus, these new bank regulations are likely to fail.

As Henry Ford, the founder of the Ford car company once said about banking, “it is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”

Copyright alrroya.com

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Posted in Banking, Economics | Tagged: , , , , , , , , , , , , , , , , , , , , , , | 1 Comment »

• Manipulated Markets Can Cause Ruin

Posted by Ron Robins on December 10, 2010

By Ron Robins. First published October 9, 2010, in his weekly economics and finance column at alrroya.com

Market manipulations eventually led to Soviet economic collapse. Though not as overt as the Soviets, it is the manipulation of currencies and interest rates by major economic powers that has mostly led to massive misalignments in investment and consumption that pose extraordinary dangers to global economic health.

Ask anyone if they believe that the Chinese currency, the renminbi, is manipulated. Almost everyone agrees that it is. Are US interest rates manipulated? Again, everyone knows they are. (Not too long ago it was only the short term rates that were controlled. Now the US Federal Reserve [the Fed] is buying longer dated US treasury bonds to bring their rates down too.) Countries all over the world are manipulating their currencies lower to gain export advantages and maintaining near zero interest rates to spur domestic demand and cheap government borrowing.

It is basic economics that where markets are manipulated, supply and demand are distorted. And one distortion creates the need for a further distortion, and so on. The longer the distortions continue the greater the possibility of total market failure. We are near that point today with currencies and interest rates.

The Chinese have scored a major mercantile advantage by pegging their currency, the renminbi, at a relatively set and undervalued rate to the U.S. dollar. Not only have US exports suffered, but the exports of many other countries have suffered as well. Under US law, the Chinese should probably have been labelled a ‘currency manipulator.’ However, by bowing to Chinese demands that they not be labelled a currency manipulator, President Obama’s administration is losing credibility everywhere.

So, Americans are waking up to find that not only does China dictate U.S foreign exchange policy, but China indirectly influences its domestic economic agenda as well. Everything from employment policies (export expansion) to government funding needs (requiring Chinese funding) are all partly defined by the present exchange rate policies.

Increasingly, Americans realize that on the foreign exchange front they have been ‘checkmated’—as in the game of chess—by China. Should difficult economic times continue, or worsen, increasing American anger is likely at this arrangement. It could pass the breaking point and encourage America to act unilaterally against China. Currency turmoil might then embrace the globe.

However, one never discussed but possible reason why the US government has been afraid to label China (and Japan previously) as currency manipulators may be because the US itself may be acting covertly to manage the dollar exchange rate.

According to the US government’s own legislation, it can act secretly in currency exchange markets to affect the dollar’s exchange rate using the Treasury’s Exchange Stabilization Fund (ESF). The US Treasury says that the ESF, “with the approval of the President, may deal in gold, foreign exchange, and other instruments of credit and securities.” The ESF was established by the Gold Reserve Act of 1934 and then amended in the late 1970s.

Also, the Fed engages in opaque currency ‘swaps’ with other nations, and there is significant evidence of U.S Treasury and Fed engagement in gold price suppression. Gold is the ‘anti-dollar’ and barometer of confidence in the dollar. (See my August 24 column, “The Ethics of Gold,” at http://english.alrroya.com/node/54671 and gata.org)

Another manipulation of the Fed is its control of short term rates—and now possibly long term ones as well—to smooth out the booms and busts of the economy. However, we see the falsity of this argument. After almost two years at a near zero per cent federal funds rate the US economic quagmire continues—or worsens.

Induced low rates over the past ten years or so created a massive real estate boom and bust, discouraged savings, led to inordinate financial risk taking and moral hazard, unsustainable consumer debt, and now excessive, possibly uncontrollable government deficits and debt.

In their seminal work, “Growth in a Time of Debt,” published January 2010, Professors Carmen M. Reinhart and Kenneth S. Rogoff found that when government debt/GDP ratios exceed 90 per cent, economic growth rates fall considerably. According to the BIS, U.S. government debt/GDP will be 92 per cent by the end of 2010 and 100 per cent in 2011.

Furthermore, on September 1, the International Monetary Fund said, “general government debt in the G-20 advanced economies surged from 78 per cent of GDP in 2007 to 97 per cent of GDP in 2009 and is projected to rise to 115 per cent of GDP in 2015.”

Unfortunately, the present and future private deleveraging of debt in the U.S. and some other developed countries means potentially continued high—or higher—government deficits as economic growth is retarded or declines further. The Fed has said that to counter any renewed softness in US economic activity it will significantly expand its purchases of US government bonds and possibly other assets. This has the potential for fuelling a huge expansion of the money supply and creating high or even hyperinflation.

The U.S. and some other countries are following a path whereby every manipulation begets further manipulation, and which then begets even further manipulation. With China, perhaps Japan again soon, and other countries controlling their currency values, the U.S. may be forced overtly or covertly to counter their currency manipulations. And with continuing economic difficulties, with interest rate policy having created a debt nightmare and becoming increasingly ineffective, the Fed may institute money proliferation policies that have the possibility of leading to high or even hyperinflation.

If a vicious circle of manipulations by US authorities and other countries occurs, given time, it might rival some aspects of the Soviet command economy—and with a possibly similar tragic outcome. Hopefully, Americans and others will wake up before it is too late and realise that manipulated markets can eventually cause ruin.

Copyright alrroya.com

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

• Higher US Savings Is Economic Game Changer

Posted by Ron Robins on December 10, 2010

By Ron Robins. First published September 23, 2010, in his weekly economics and finance column at alrroya.com

There is one prayer of governments and businesses around the world: that Americans forgo higher savings, banish their job and retirement income worries, and go on a spending spree. However, this is not to be. Were the prayer to be fulfilled the global trade and other economic imbalances of the past and present would be unresolved, even magnified. But fortunately, the early stages of their resolution are at hand.

To help resolve these global imbalances, US savings rates must go up while its consumption of goods and services relative to GDP goes down. And this will be a generational game-changer for the US and for the world, causing economic difficulties everywhere for the years ahead.

Depending on how fast its savings rates rise, the US economy will be mired in recessionary or depressionary conditions for some years. But America has faced many daunting economic challenges before and each time it rebirths to greater prosperity. This is likely to be true again.

America once had high savings rates with much lower levels of personal consumption than now. Between, 1950 and 1975, its savings rates were generally in the 8 to12 per cent range of disposable income, and personal consumption relative to GDP averaged around 64 per cent. In the years between 1975 to 2000 savings rates declined significantly to under 5 per cent and then to 1 per cent by 2005 when personal consumption rose to a high of about 72 per cent of GDP.

Since 2006, America’s savings rates have been moving up—and most especially after the 2008 financial crisis. Today, they average about 6 per cent.

Furthermore, it is probable that US savings rates will move even higher to the 10 to 15 per cent range in the next few years as Americans worry about job security, home values, and retirement income. As this happens, US consumption rates will fall back to the 60 per cent region. This will have initially deleterious effects for the global economy and countries reliant on exports for income and jobs. Thus this is another game-changing situation.

No country or countries can presently replace the American consumer. For instance, the combined annual personal consumption of China and India is about $2 trillion, compared to America’s nearly $9 tln.

The big Asian exporters, as well as Germany, will have to find other markets for their products—or stimulate internal consumption to grow. Intra-regional Asian trade is growing rapidly but “is still mainly driven by supply-chain links involving intermediate goods rather than newly surging end-market demand in Asia,” says Stephen Roach, non-executive chairman for Asia at Morgan Stanley, in a Financial Times report.

So where will increased US savings go? As of now they are going mostly into bonds, especially US government bonds. Annual funding needs for the US government over the next few years will probably be close to $2 tln if economic growth stalls or declines. That sum is equal to about 13 per cent of US GDP. It will be increasingly financed from within the US by savers, banks and especially the Federal Reserve (the Fed).

The Fed will create new money to purchase US Treasury debt and probably other assets. This ‘money-printing’ will generate huge amounts of ‘excess’ dollars. The consequences of this action will produce a litany of global economic difficulties. These will include a slumping dollar, domestic inflation—and even possibly hyperinflation.

Upset at the dollar’s fall, other countries and regions from China to Japan to Europe, will attempt to devalue their currencies, leading to probable currency and trade wars. (I have written more on these subjects in previous columns.)

Of course a lower dollar and likely new US import restrictions will mean higher US import prices, or even unavailability of some products. This will give some American manufacturers the opportunity to recoup previously lost domestic markets and the servicing of new ones as well. US industrial production could be re-ignited and even induce foreign companies and manufacturers to buy or invest in US domestic manufacturers as well.

With US imports from oil and computers to foodstuffs, as well as domestically manufactured goods costing more, Americans will find their standard of living declining.

“The need to overcome the effects of reduced [American] individual buying power will lead to the invention of a new class of product which will be a major trend of 2010 and into the future: Technology for The Poor…,” says Gerald Celente, the renowned American trends forecaster and president of the Trends Institute. Continuing, he says that, “growing with the same speed as the Internet Revolution, the trend will be recognised, explored and exploited by legions of skilled but jobless geeks, innovators and inventors who will design and launch a new class of products and services affordable by millions of newly downscaled Western consumers… ”

Mr Celente further forecasts, “a ‘not made in China’ consumer crusade that will spread among developed nations, leading to trade wars and protectionism.”

Americans have little choice but to increase personal savings rates. The Fed will ‘hyperventilate’ to derail prolonged economic malaise and promulgate vast quantities of new dollars, causing the dollar to fall—or crash! A dollar fall will produce inflation; a crash could ignite hyperinflation in the US and elsewhere. Also unleashed could be ‘buy America’ strategies and policies within the US thus further inciting the risk of global currency and trade wars.

This sounds like dire news. However, a new, free America could be born as it rids itself of the shackles of debt. Americans, renowned for their outstanding drive, creativity and innovation, may create a new generation of ingenious products and services geared to the new economic reality. ‘Made in America’ products could again fill retail shelves. And Asia’s export-reliant countries will finally focus on enhancing domestic consumer demand to purchase their wares, thereby bringing much improved living standards to their populations.

Higher US savings will be an economic game-changer for the US and the world.

Copyright alrroya.com

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