Archive for September, 2011

Wray on the Commodities Bubble and the Coming Crash

Michael Stephens | September 30, 2011

“The problem is that we have way too much money chasing way too few good assets. The total amount of financial bets out there is way over $600 trillion around the world. There just aren’t enough good investments to absorb that amount of money. So, what happens is they blow up–one asset after another. Then, those inevitably crash.”  Jumping off from his latest post, Randall Wray was interviewed at Benzinga regarding his arguments about a commodities bubble and the potential for a new crash.

Wray suggests in this interview that, in the face of another crisis, Washington may be constrained in its ability to come to the rescue as it did in 2008:

The Dodd-Frank legislation makes it very difficult to repeat that performance. I’m not saying that they won’t find a way around the rules, or they won’t find a way to do it again. They might, but it’s going to be very politically unpopular. I’m not sure they are going to be able to do it again.

Once prices start tumbling, all of the asset markets are actually linked. Even though it’s not obvious, they really are. It will tumble across all of them. And it’s not clear that we will be able to stop it this time. At least, not as easily as last time.


Hudson on Privatized Credit Creation

Michael Stephens | September 29, 2011

Michael Hudson on the ECB and eurozone national central banks’ restricted abilities to purchase government debt:

Their banks have perpetuated the “road to serfdom” myth that a central bank runs the danger of fueling inflation if it creates money – in contrast to commercial banks, which supposedly run no such danger if they create money on their own computer keyboards. It is not considered inflationary for them to charge interest to the government, which then needs to pay by taxing the economy at large.

When you find this kind of distortion being popularized and even written into law, there always is a special interest at work. The supposed contrast between “bad” central banks and “good” commercial banks is a lobbying effort seeking to monopolize credit creation in the hands of commercial banks, by promoting a travesty of how central banks are supposed to act.

The reality is that commercial banks have fueled an enormous asset-price inflation in recent years. The debt they have created imposes an interest burden that deflates the economy – even while adding to the cost of living and doing business. Meanwhile, central banks monetize government deficits that are supposed to spur recovery, not simply be giveaways to financial institutions and other vested interests. …

Whether a bank is private or public, money and credit are created electronically on computer keyboards. So it is a myth that government money is more inflationary. But this myth has a political function reflecting private self-interest: it blocks the “public option” of creating money without paying interest to banks which have obtained the privilege of creating credit freely. They are not lending out peoples’ savings deposits, but are creating deposits much like they used to print bank notes. They then look for customers willing to pay interest.

Hudson, a Research Associate here at the Institute, was interviewed for the “Guns and Butter” radio program on the topic of debt deflation in the eurozone and the US.  (Transcript posted over at Naked Capitalism).


Euro Toast, Anyone?

L. Randall Wray |

(Cross posted from EconoMonitor)

Greece’s Finance Minister reportedly said that his nation cannot continue to service its debt and hinted that a fifty percent write-down is likely. Greece’s sovereign debt is 350 billion euros—so losses to holders would be 175 billion euros. That would just be the beginning, however.

Nouriel Roubini has argued that the crisis will spread from Greece and increase the possibility that both Italy and Spain could be forced out unless European leaders greatly increase the funds available for bail-outs. The Sunday Telegraph has suggested that as much as 1.75 trillion sterling could be required. To put that in perspective, the US bailout of its financial system after 2008 came to $29 trillion. The 1.75 trillion figure will almost certainly prove to be wishful thinking if sovereign debt goes bad, because that will make the US subprime crisis look like a nursery school dispute. All the major European banks will go down—and so will the $3 trillion US money market mutual funds. (That probably explains why the US has suddenly taken a keen interest in Euroland, with the Fed ramping up lending to what Americans had formerly seen as “Eurotrash” financial institutions.)

It is becoming increasingly clear that authorities are merely trying to buy time to figure out how they can save the core French and German banks against a cascade of likely sovereign defaults. Meanwhile, they keep a stiff upper lip and demand more blood in the form of periphery austerity. They know this will do no good at all–indeed, it will increase the eventual costs of the bail-out while stoking North-South hostility. Presumably leaders like Chancellor Merkel are throwing red meat to their base for purely domestic political reasons.  If the EMU is eventually saved, however, the rancor will make it very difficult to mend fences.

There is no alternative to debt relief for Greek and other periphery nations.  But, they are not likely to get it, at least on the scale needed. Certainly not before a lot more pain is inflicted, and a lot more grovelling shown to Europe’s masters.

Indeed, the picture of the debtors that the Germans, especially, want to paint is one of profligate consumption fueled by runaway government spending by Mediterraneans. The only solution is to tighten the screws. As Finance Minister Wolfgang Schäuble put it: “The main reason for the lack of demand is the lack of confidence; the main reason for the lack of confidence is the deficits and public debts which are seen as unsustainable…We won’t come to grips with economies deleveraging by having governments and central banks throwing – literally – even more money at the problem. You simply cannot fight fire with fire.” You’ve got to fight the headwinds with more glacial ice.

While the story of fiscal excess is a stretch even in the case of the Greeks, it certainly cannot apply to Ireland and Iceland—or even to Spain. continue reading…


Operation Twist Has a Twist

Michael Stephens | September 28, 2011

According to Alan Blinder, writing in the Wall Street Journal, the Fed’s latest operation includes a detail (“the sleeper in the package”) that is aimed at boosting the housing market:

For more than a year now, the Fed has been allowing its portfolio of agency debt (e.g., Fannie Mae and Freddie Mac) and mortgage-backed securities (MBS) to shrink naturally as mortgages are paid off and securities mature. To maintain the size of its balance sheet, the Fed has been reinvesting the proceeds in Treasurys. But starting “now” (the Fed’s word), and continuing indefinitely, those proceeds will be reinvested in agency bonds and MBS instead. The objective here is exactly what it was for the first round of quantitative easing, QE1: to reduce spreads between MBS and Treasurys (which had widened a bit), and thereby to help the ailing housing market.


How to Put More J in the AJA

Michael Stephens |

Rania Antonopoulos, director of the Gender Equality and the Economy program at the Levy Institute, has a blog post up at Direct Care Alliance making the case for adding social care investments to the American Jobs Act, citing the large employment effects of direct job creation programs in early childhood education and long-term care for the elderly and chronically ill.

A version of this idea showed up on the DC legislative radar recently, in the form of a jobs bill that includes a “Health Corps” and “Child Care Corps” among its provisions for direct job creation (see items 5 and 7).


Forbes: The Smart Money Is Insane

Michael Stephens |

Money quote from a recent Forbes article:  “with the right parenting [psychopaths] can become successful stockbrokers instead of serial killers.”

Also, a reminder that when we talk about how “the markets” are reacting to this or that, we’re talking about this guy:

(hat tip to Thorvald Grung Moe, our visiting Norwegian central banker)


Where the Action Is on Financial Reform

Michael Stephens | September 27, 2011

In the case of a major reform like the Dodd-Frank Act, the attention spans of most journalists and opinion-mongers inevitably peak around the legislative battle, pronouncements are made in the aftermath, and then everyone moves on.  But as articles like this remind us, so much of the action still remains to be played out, in the nitty-gritty of the rule-making process.  To wit, a draft proposal that fleshes out the “Volcker rule” prohibitions on proprietary trading was recently released.  The rule was intended to restrict banks’ ability to make bets with their own capital, but the draft language in question suggests those restrictions could end up being fairly weak (due in part to a broader interpretation of the sort of “hedging” that will be deemed permissible).

This is just the beginning of the beginning for Dodd-Frank.  Looking beyond these initial rule-writing stages, there is the further question of how the law and its provisions will hold up over time.  Rules are only as good as the regulatory and enforcement structures that shape and govern them.  That’s not much of a catchy slogan (worst-selling bumper sticker of all time?), but it contains some critical truth.

Jan Kregel (recently elected to the Lincean Academy) highlighted these dynamics in his investigation of the origins and eventual erosion of Glass-Steagall, the New Deal-era legislation that separated commercial and investment banking (some regard the Volcker rule as a kind of tame, second-best alternative to a return to Glass-Steagall).   In addition to tracing the history of the collapse of the 1933 law, Kregel argues that we cannot simply go back to a Glass-Steagall-style regime.  (Read the policy brief here; highlights here.)

While so much attention is paid to Gramm-Leach-Bliley (the Financial Services Modernization Act of 1999), Kregel demonstrates that the “end” of Glass-Steagall and of its restrictions on securities trading was a fait accompli well before the much-maligned 1999 law had passed.  All of the action had already taken place through a series of rulings and interpretations by the Fed, the SEC, the Supreme Court, and lesser known bodies like the Office of the Comptroller of the Currency (see Kregel, on pp. 9-11 of the brief, for a crisp summary of the key provisions that were weakened and effectively dismantled over time; particularly with reference to Section 16 of the 1933 law, the “incidental powers” clause; which Kregel refers to as the “Achilles heel” of Glass-Steagall).

At a deeper level, and of great policy relevance to current discussions (as well as post-mortems) of financial reform, Kregel goes on to argue that there are serious challenges to reinstating Glass-Steagall-type separations between banking and securitization. continue reading…


Adam Smith Doesn’t Agree with You: Regulation Edition

Michael Stephens |

It’s a time-honored tradition, and something of a mug’s game, to pick quotations from Adam Smith that clash with contemporary free market doctrine.  But uses and misuses of Smith aside, this one happens to hit the conceptual nail on the head.  Jared Bernstein, who is evidently working on a longer piece on debt, pulls this quotation from Adam Smith on the regulation of financial institutions:

Such regulations may, no doubt, be considered as in some respects a violation of natural liberty.  But these exertions of the natural liberty of a few individuals, which might endanger the security of the whole society are, and ought to be, restrained by the laws of all governments…[T]he obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty, exactly of the same kind with the regulations of the banking trade which are here proposed.


History of the Think Tank (or, Your Fish)

Michael Stephens | September 23, 2011

“A rollicking saga that involves all sorts of things not normally associated with think tanks – chickens, pirate radio, retired colonels, Jean Paul Sartre, Screaming Lord Sutch, and at its heart is a dramatic and brutal killing committed by one of the very men who helped bring about the resurgence of the free market in Britain.”  Over at the BBC, Adam Curtis provides an entertaining mini-history of think tanks in the UK — the “dealer in second-hand ideas,” as Hayek allegedly described them.

Featuring this fantastic image of an early pamphlet (easily the best title ever for a political pamphlet, or anything else for that matter):

(hat tip INET)


Commodities Bubble Reax

Michael Stephens |

Wray responds to critics of yesterday’s post, and includes an excerpt from his policy brief on the topic (for a more condensed version, highlights of the brief are here).