Someone with a background in economics, business, philosophy, and watching the world. I want it to be less Krazy!
My view point is reality, not the make believe world of made up money and the use of force against the innocent. I argue from the economic view point of Austrian economics and the position of individual rights, freedom, reason, and rational self-interest as defined by Ayn Rand.
In the criticism directed at ObamaCare and socialized medicine in general, there were many consequences seen that would be detrimental to the health of men and women. One consequence that wasn’t predicted (as I recall) is occurring now. From what I have seen in various reports recently (listed below), when socialized medicine collides with high levels of government debt, which it must eventually, the results are decidedly unhealthy.
In Greece and Spain, and also in Italy, even in the United States, we are seeing disruptions in the supply of pharmaceuticals. The disruptions are being caused by two related government actions. Especially in Greece and Spain, the governments are not paying their bills. Surprisingly, the companies making the drugs are beginning to refuse to send additional supplies. I say surprisingly because I would bet that there has been some attempt to get the companies to ship regardless of the status of payment for past shipments.
The other cause of shortages, which is already happening in the U.S. and is probably happening in Europe, is that certain drugs aren’t being produced because the prevailing price, i.e., the price that the government is willing to pay, is too low to justify making the drugs. In the U.S., we are seeing pharmaceutical companies selectively choose to not make certain generic drugs because there is little or no profit in the price at which they can sell the drugs. These companies have limited production facilities and they choose to use them to produce the most profitable product. Duh!
There is another factor that is spreading the problem wider. In Europe, many countries have laws that require the government to pay the lowest price being paid by any European government. So, say Greece unilaterally decides, as it has, that to “save” money they will lower the price of some or all drugs. It doesn’t really matter what price they choose, the price is way below what the drug companies would charge if free to do so, so whatever price the Greek government chooses will be a disincentive. Then other countries’ low price law kicks in. If the drug is going to be available to patients, the drug company has to ship at the new, lower price. The moral and health consequences are very obvious. The drug companies no longer have any say in the revenue for which they are working. That is unadulterated authoritarianism. It isn’t that different from how doctors are treated by Medicare in the US.
As far as I know or have seen, there is no law saying that the drug companies have to ship, have to continue to make the medication. Slavery has not progressed to that point. If not today, then soon, the drug companies will not be able to continue shipping product on which they constantly loose money. Supplies will become smaller. Shortages rampant, not just in Europe, but worldwide. Companies may go bankrupt. Drug formula may be lost.
Some of the European drug companies are now saying that their ability to do research and create new drugs is being threatened. I expect that they are being a little timid in making known their concerns. I expect that the drug companies are not in a strong political position. Someone is probably keeping a close eye on drug company research numbers. Too bad the mainstream press isn’t interested in actually reporting news like that.
Since the widespread government debt and fiscal deficit problems is going to be a major problem for some time, one should expect the problems in Europe to get worse. The governments will have more difficulty in paying for medical care. The problem will be spreading beyond drugs and supplies to include doctors, support staff, and hospitals. I wonder if someone is paying the electric bills? A private company would be constrained from cutting off power to a hospital. A government electricity monopoly may not be so constrained.
No doubt the problem of non-payment extends to other sectors of the economy as well. Someone said that Spain in particular had determined that keeping cash and not paying bills made the government look much closer to solvency.
What bill is or is not paid is a function of the decisions by bureaucrats. These people have not learned the lesson that 70 years of Soviet economics taught: there is no substitute for a market. What drug or service is available or not will depend upon accidents, pull, and ignorance. Actual health issues and medical need will not be ignored so much as it will be unknown and unimportant. I mean the mere fact that there could be medical need will be unknown. It is government money and it will be paid to the concerns the bureaucrats choose. The fact that there is a reality is overlooked in the regulations. Good luck to us all.
Keep your eyes open. This news, that has come to us in a trickle, leaking into the mainstream in little droplets. So far the press has not be recognized the debt issue as impacting people’s health. Even if they do, there isn’t anything that can be done about it, however. Many of the European governments do not have the money to pay those bills, even if they wanted to do so. How much longer will their citizens have drugs? How long until we are in the same situation? How much will the loss of several European markets affect drug availability in the U.S.? Who knows?
Having gone to the pharmacy regularly, it would seem almost unimaginable that the drugs we rely on could cease to be there when we need them. Those of us who do depend upon them daily, for example, the millions who keep their blood pressure low or those who survive diabetes with medication, could see those meds disappear in the next few years.
Greek crisis takes heavy toll on health
Spain health service chokes in crisis
Drug shortage in US
BO to take executive action on drug shortages
More pain for Euro drug makers (includes information about lowest price laws and the threat to research)
UK pharmacists sound alarm about shortages
HIV gains ground in Greek crisis
US employer health insurance offerings reach new recent low
R&D proposed in Europe over superbugs
Cancer cost becoming unsustainable
Recently there have been several articles dealing with claims made by some Republicans that regulation hampers job growth. Mostly, these articles (for example) attempt to reject that claim. To me, and I suspect many of my readers, it seems almost obvious that when you restrict someone’s business activities, their ability to create jobs would be hampered. On the other hand, I don’t know of any book or study that documents that connection. Doing so would be a good thing. Hence, let me draw your attention to a planned book I just read about.
I receive a weekly email newsletter from John Mauldin about the economy and its impact on investing. If you keep in mind that his frame of reference is basically mainstream, with a dash of the reality of trying to deal with real businesses and their futures, then his stuff isn’t bad. I have used some of the information that he has found in this blog. He published a book last year called “Endgame” in which he discusses the world build up of debt and its impact. I don’t really recommend it, as his analysis is severely limited and warped by his basic poor understanding of economics and his conventional morality. Its redeeming feature is that he is emphatic in that the debt will be a disaster.
Now he is going to write a book about job creation. It could be decent because he seems to understand that only business can create “meaningful lasting” jobs. This is the wrong focus, of course, (it should be on how business can freely create wealth) but jobs are a consequence and if businesses can create jobs, they will be creating wealth. (I know that this wrong focus could backfire. However, it is also true that people need to know how jobs are created. If that is explained properly, i.e., as a result of creating wealth, then it will point people in the right direction.) Anyway, he is calling for examples and ideas, so why shouldn’t he get some good ones. If you want, send him an email.
“You can't read any serious economic analysis of late that does not talk about jobs, whether in Europe or the US or Asia. And not a lot of it is pretty. Politicians offer "plans" for jobs, most of which go to great lengths to illustrate the sympathy they have for people out of work, but without offering any real ideas on how to create meaningful, lasting jobs. Some are actually destructive of jobs, far from creating any (these are of the "I'm from the government and I'm here to help" variety).
I have been having a rather lively email conversation with several serious thought-leaders about what we should do to get us out of the current job malaise. The ideas we are discussing are worth a wider audience, so Bill Dunkelberg, who is the Chief Economist for the National Federation of Independent Businesses and I have decided to write what we hope will be a short book on employment (I know, I have never done a short book yet). How are jobs created? What policies should governments adopt to help create jobs? How do we get back to full employment in the US in a Muddle Through economy that needs at least 125,000 jobs a month just to keep up with population growth? (Today we learned that in October new employment was just 80,000.)
Stupid Government Tricks
The book will be US-centric in its focus, but the policies we will be talking about can be adapted to almost any country. I should note that Dunk and I will be getting a little help from our friends, and we want your help in some very specific ways.
First, I know my readers are among the smartest on the net. If you have an idea about how to increase employment, send it to us. Put "jobs" in the subject line.
Also, most of America is familiar with David Letterman's occasional skit called "Stupid Animal Tricks." We want to do a section on government policies that hurt job creation. At all levels, from local to national. Send us your anecdotes and notes on odd rules and laws that destroy jobs and opportunity, rather than create them. Almost everyone has a story about how government is hurting their business. Tell us yours.
And at the same time, what do you see that is working? Why do some states seem to attract businesses and others lose them? Again, send your comments with the subject line "jobs." And, you'll get a footnote if we use your suggestion. (Hey, I love being footnoted!)”
I am writing this for several reasons but one important one is to further establish the importance of paying attention to the real world when attempting to make policy recommendations like some recent suggestions as to how to deal with the entitlement mess.
To begin, let’s review the current situation:
1. The current ideal is to retire at age 65 and live in blissful non-productivity for 20 to 30 years.
2. Up until the 90s, it was expected that a worker would accumulate pensions from his employers over the years and when he retired he would receive a fixed income to support him. These pensions have been disappearing steadily for decades and there only a few left for new hires. The health of company savings to support existing pensions is in question. There is a federal agency that would supposedly put funds into a failing pension fund, but it is underfunded itself and could not rescue an economy wide problem (such an agency shouldn’t exist, either). (For example, see)
3. Self-funded retirement plans, such as the 401(k), have been shown by repeated surveys to be insufficiently funded by employees to provide for their retirement. The gap is very large. Employees also have the tendency to remove the funds from retirement accounts at various times for various reasons.
4. Survey after survey has documented that Americans have a very poor grasp of how to manage their savings and investment, including retirement accounts. The primary element driving most decisions is fear of loss. The sources of their fear are stories about the Great Depression, reading newspaper headlines, incomprehensible discussions of investment options, stories of thief and greed, and the economic chaos around them.
5. Retirees are becoming increasingly dependent upon Social Security and Medicare after retirement (see below).
6. The government dominated economy has resulted in two major recessions in the last ten years resulting in the current period that is described by the government and press as a recovery but feels very much like a bad, senseless downward spiral.
Consider the situation of a reasonable, hardworking, educated baby-boomer who has been successful from the standpoint of the quality of jobs and his level of income. Let’s call him Max. Max is 62 and all his life he has accepted the idea that age 65 he will retire. As a responsible person, he has saved and tried to make sound investments his entire life. He has not hired professional help other than talking to various stockbrokers. He began working as adult in 1972 but didn’t begin paying attention to the issue of savings for several years. His initial experience in the 70s was with high inflation and then the recession that ended in 1982.
But Max has now entered what will surely be remembered as the golden years of investing for the baby-boomers. From 1982 until December 1999, the market rose nearly continuously (for example, 1987, which is remembered as the year of a crash, was actually up slightly for the calendar year.) The later 90s were somewhat skewed by the inflation fueled tech boom, but overall, the period was the best of the Twentieth Century.
Since 1999, the investment markets have flattened or worse. Consider that the inflated high of the Dow Jones Industrial Average of December 1999 was 11497. As I write the Dow is 11471 (and in my opinion, it is over priced). After nearly twelve years, the Dow sits at the same place, nominally. I say nominally because the dollar today is not the dollar of 1999. If we accept the government Consumer Price Index as a real measure of consumer prices over time (I am not advocating using the CPI, but I don’t know of a good alternative.), since 1999 the dollar has fallen over two percent a year. According to the Department of Labor’s online inflation calculator, it takes $1.36 today to buy the same stuff as one dollar in 1999, or today’s dollar is worth $0.73. (The same calculator gives the today’s figure of $234.76 in relation to 1982.) That means that if you correct for inflation today’s Dow is 73% of what it was, or 8434, not 11471. Even if you add in dividends and subtract taxes (capital gains taxes as well), you have a result that a general investment in American productive assets for the last twelve years has been a very large loss. Max has suffered a major blow to the prospect of a comfortable retirement. Maybe Max may not be able to retire at all, even with Social Security, although I am not sure that there would a job for Max when he needs it.
How could Americans prepare for retirement in such an economy?
Most prescriptions offered for investing for retirement assume an economy that is growing. Those recommendations didn’t work in the decade ending in 1982 and they aren’t working now. There are recommendations for periods of crashes and depressions. If these ideas work at all, they generally don’t work for prolonged periods of time. There are other approaches that do work to a certain extent and are good. However, they tend to be complex and assume knowledge that few have. They also wouldn’t work if widely practiced (which is to say that I am here concerned with the general situation and not how an individual could protect himself). For the vast majority of people, there is no good investment option today that will help them through to their last years.
Another little known fact is that those people who have saved some assets for retirement have often not actually planned. Their accumulation was based on what they could save and invested in what made sense at the time. Many, when they retired, accepted the conventional wisdom that retirement income needed to be “income without undue risk” and placed significant amounts in bonds. These people will tend to run out of money even faster during retirement. They don’t have enough to support their rate of spending for very long. Nor do they or their advisors have the tools to recognize the threat and make changes early enough to make a difference. They have not made provision for consumer price inflation or the rapidly rising cost of medical care. They aren’t prepared for 20 years or more of idleness. They just don’t know how to plan financially and don’t know they should.
For the many people who keep whatever they have managed to save in “safety of principle” accounts (fixed annuities, savings accounts and CDs) or fixed income accounts (bonds and pensions), they have seen their assets and income slowly decline as the Fed has kept interest rates low, inflation continues, and the what small income they receive is taxed. People with bonds have seen their principle increase as interest rates and their income have declined. But, if they are paying attention, they know that the future probably holds higher interest rates (see Greece, Spain, and Italy today), and their principle will drop like a rock if they still hold those bonds.
Beyond that it should not be surprising that very few people have any idea of how to invest. They do not know how the economy works. Where would they get that knowledge? It isn’t taught in schools at any level nor do the academics actually know anything about the real economy. They don’t know how retail businesses work. They don’t know how manufacturing works. They don’t know how businesses make profits. They don’t know how international commodity or currency markets work. They really don’t know why stocks have the prices they have or why they change, short term or long term. The ignorance about economics or our economy is more than widespread. It is terminal. Who suggests that it is important to know? People learn about their own professions, but often not much beyond that. Business schools are not good sources, either. Most businesses have to retrain business school grads, even MBAs. It is no wonder that few people are able to save and invest in a manner that will successfully support them into their 90s, especially if they retire later than normal. The number of people who do adequately save and invest has to be less than five percent.
A realistic look at today’s economy would suggest that the foreseeable future does not hold the promise of better results. There is no indication that anyone in authority has a clue as to what makes an economy grow and contract. They do not even understand that only productive, profitable jobs are worth creating. Government debt will continue to pile up. The Fed will continue to add stimulus, achieving nothing but a huge financial overhang that may fall and crush us. Don’t forget that the regulations required by all of the reform bills after the Meltdown in 2007-8 have yet to be released and implemented.
It seems to me that any criticism of people for not being prepared for retirement is not based upon a recognition of the facts of the real economy. Only a very few are going to have found a method to invest their savings in such a way to be able to support themselves if they retire.
To sum up, it is very difficult for salaried or wage paid individuals to save and invest successfully for their retirement, standard pension plans have suffered significantly due to the economic conditions, and from other sources we know that Social Security and Medicare can not continue for very long. So, what can we conclude? My conclusion is that the mixed economy, the welfare state in the United States, cannot support the coming old age of the baby boomers, with or without Social Security.
These problems that people have with their savings and investment, the nature of our economic situation, and the poor future prospects are not the fault or the responsibility of individuals. The responsibility lies with the people who control the dominate actor in our economy, the Federal government in its many aspects: the President, the Congress, the Fed (and the intellectual leaders who guided them).
What else did you expect from 100 years of constant legislative attacks on capitalism and the businesses in the United States. That the problem has not been big until now is a testament to American perseverance. It couldn’t last forever.
For the future to achieve the promise of a happy old age, not to mention prosperity for everyone, in the US, a couple things have to happen:
1. The economy has to be freed up to become productive and prosperous. In other words, our country needs to become a capitalist nation. The process of transforming ourselves from a welfare state to a nation that recognizes right must do so in a manner that does not further victimize the present day population, as I discuss elsewhere.
2. People need to revise their thinking about retirement and work. Work is not the onerous thing most people make of it. Retirement for 20 or 30 years, after working for 40, is not generally feasible in good situations, let alone the one we are in today.
This Post is one of three that deal with the issues connected with the entitlement mess and how to resolve it. All three should be read in order to fully understand the issues. The other two Posts are:
It is important that I first am clear that I am against the use of government, i.e., the use of force, against the inhabitants of our nation, to provide for benefits of the retired, the sick, the unemployed, business, anyone. Such action by the government is wrong morally, wrong politically, and very bad economics. It should be stopped. It must be stopped. Okay? Is there any question about my position on this (for the justification see Ayn Rand’s “The Nature of Government”).
What I am concerned with in this post is that I have seen people, good, solid, rational people, suggesting solutions to the entitlement problem that I think are not good choices. It is possible that they are not completely setting out their solutions, but what has been offered are insufficient to change the situation.
I want to begin my comments with a question: What do we want to achieve? My answer to this question is that, ultimately, what we want to achieve is a productive, rational society in which we are free to pursue our own goals based upon our own judgment. We want to achieve freedom, capitalism.
Further, we want to achieve this result with the least chaos and human suffering as is possible. We see that if capitalism isn’t achieved we and our fellow man will be in for a lot of suffering, and possibly worse. We may completely lose our freedoms. We may completely lose our stand of living. In an interview on The Dailer Ticker, Yaron Brook emphasized these very points. Stop gap measures will not work. There needs to be a change in philosophy.
Our goal is capitalism, not merely lower government debt or fewer people depending upon the government. Anything but actual capitalism would not be safe or permanent, but would merely delay reinstatement of the government activities that we had managed to reduce. In an interview on The Dailer Ticker, Yaron Brook emphasized these very points. Stop gap measures will not work. There needs to be a change in philosophy.
More broadly, capitalism is the only system in which anyone who puts forth effort can and will find a way to maintain themselves, and to achieve the success they are capable of. Those who do not or cannot put forth the effort will be dependent upon the voluntary support of someone who does. There is prosperity. Capitalism does not support suffering. Contrary to criticism, capitalism does not support poverty, hunger, hopelessness.
The problems with entitlements, in addition to the moral issue, is that in the present situation, entitlements and other government wealth transfers, such as unemployment insurance, are necessarily resulting in massive government borrowing and are moving us inextricably to bankruptcy (in one form or another) and depression. Depression for an advanced country like the United States will be an unprecedented event.
It is obvious to anyone who is honest enough to look that the current situation will result in disaster. The entitlements and wealth transfer payments have to be eliminated. The rapid, dramatic growth in the government debt has to be stopped and brought down. There is no choice. Not doing so will result, as I indicated above, in disaster.
It is at this point that people are then offering some suggestions as to how the entitlement programs could be stopped. However, solutions that focus on the entitlement programs as the main issue are making an error. Stopping these programs at this point will not achieve anything but chaos and massive poverty and illness.
Consider the numbers of people who are dependent upon government programs today. The number of unemployed, (very) underemployed, and that have given up looking for work is close to thirty million people. If you add in their dependents you probably have forty to fifty million. The number of people receiving Social Security is currently sixty million (over forty million aged 65 and older). The number on Medicare is nearly forty million. Those receiving food stamps is nearly forty million. Some of these numbers overlap. Some are gaming the system and fraudulent. But the totals are overwhelming.
Another group of people dependent upon government transfer payments are government employees, federal, state, and local. A fairly recent figure for this group (excluding the military) is nearly twenty million. If you also add in the employees in the private sector who’s responsibility is keeping up with government regulations, you have another large group who are not engaged in productive work and whose indirect reliance on government money has to come to an end. (The government figure does include some who are rationally required, but it is a small percentage, I think.)
In a country of over 313 million people, over thirty to thirty-five percent are wholly dependent upon government funds and are immorally living off the productiveness of others and are an enormous drag on the economy.
The bad news is that if they all, or just the most obvious. were turned loose from their dependency and the government money were turned off, their desperate situation would become a major, immediate cause of riots and distress.
You might say a couple things, for example, that the money freed up will enable the economy to do better, or that the change will happen more slowly. The current problems in the economy is not a question of money, employment, or actually resources but government controls and interference. The constant stream of new government orders, crises, and attacks is finally, after nearly a century, dragging down the possibility of growth in the economy. Merely stopping some government transfers would not be sufficient. It would only possibly delay the result. Nor would the speed of change matter. The economy still couldn’t handle it. That is to say that these people would not be put to productive use. New, productive jobs would not appear in the numbers needed. There would be constant pressure to reinstate the programs or for something worse.
For those people who are retired, the suggested methods of replacing Social Security and Medicare, that is, putting money into their hands based upon some calculation relating to what was taxed in the past would not be sufficient to support them over the remainder of their lives, even if there were no additional general consumer price increases. Nor would they know what to do with the money, since few ever acquired the necessary knowledge.
But besides those points, very important consideration is that the economy would not be productive enough to support the massive number of people who are expected to retire.
All of the problems are interconnected. It is one economy. No freedom, no productive economy, no support in any fashion for the large number of retired people that are in the baby-boomer generation. The issue of the debt hides the fundamental problem of the welfare state. It saps the productive ability of the economy to the point that it can no longer support itself. The build up of government debt is the easiest way for today’s welfare state to finance its programs, but it could use other ways such as massive taxation and high levels of inflation, which would also lead to failure. The problems are the result of the welfare state: its morality and its economics combined.
Let me say this again. The point needs to be emphasized. Our economic structure today and into the foreseeable future will not support the expected number of people retiring over the next decade or two. That is so with or without the entitlement program. Something more has to be done than just ending the programs.
But, more important, the focus is wrong, confused, and misleads us into forgetting our goal. The entitlement programs are a symptom of the wrong philosophy supporting today’s trends in government and the economy. Do not focus on the symptoms. Focus on the philosophy and our goal.
Focusing only on the entitlement programs is also terrifying to those immediately affected and their families. It would terrify anyone who does not want to see wide spread poverty and illness. I am certain that we don’t wish to see that either.
Taking the steps to achieve the establishment of capitalism will also allow us to easily, cheaply, and happily eliminate the negatives (which we should expect would be the result of the achievement of productive values).
The initial steps of establishing capitalism would be the freeing of the productive, creative businessmen. When asked what should be done first to change the economy, Ayn Rand answered, “Start decontrolling the economy as fast as rational economic considerations permit. I speak of “rational economic considerations” because today, every part of the population is dependent on government controls. Most professions have to function under controls, and their activities are calculated on that basis. So if anyone were to repeal all controls overnight, by legislative fiat, that would be a disastrous, arbitrary, dictatorial action. What a free country needs to give all the people concerned sufficient notice to readjust and reorganize their economic activities. Therefore, after working out with economists the kind of program necessary to decontrol the country, and what controls should be repealed first, I would then advise passing legislation announcing that certain controls will be abolished within three years, say – the period calculated to allow people the opportunity to readjust their activities. In a free economy, no change happens out of the blue and overnight. Every economic change, every development, is gradual. Therefore, in a free society, there are no immediate and disastrous changes. But given our present situation, any sudden changes could create disastrous dislocations, and so we should decontrol gradually.” (Ayn Rand Answers, p. 49) She goes on to suggest that the anti-trust laws can be gotten rid of immediately, especially laws that jail businessmen. She points out that the decontrol of the economy will then pretty much eliminate our economic problems. That means, today, that the debt issues and the economic aspects of the entitlement programs will be come easier to solve. Decontrol would also result in the creation of lots of new, productive jobs.
This prospect, the resulting productivity, prosperity, and creation of wealth, will be the foundation, along with the morality of self-interest, for convincing people that ending the entitlements is going to cause, at worst, only a brief period of difficulty and the long-run result will be significantly better than Social Security and Medicare. (I have written about how these programs can be funded for those unable to rejoin the job market.)
Within a few years the older population will be the majority of voters. Many of the arguments for changing the system have to be aimed at them. They have to be shown that they will not be abandoned, that they will do okay. Merely coming up with a nice sounding set of steps will not work. It shouldn’t. Do you expect the average American retired person to accept an idea that requires him to live in abject poverty for the remainder of his life? If you want the support of intelligent people you need to show precisely how it will work. You say that they can’t expect that things will go wonderfully. No. And if you do your job right and make clear that if they don’t allow the change to happen, if they do not clamor for the change to capitalism to happen, they necessarily will live in abject poverty for the rest of their lives, then they will be able to put up with some discomfort.
Let me say this again: People have to learn that the current situation is going to result in misery. It can not survive. Depression is our future. That is their choice: depression or capitalism.
Winning the war to put man on a rational course requires both the moral and the economic argument, with full knowledge of the consequences for everyone of each step. We have to communicate and justify the idea that capitalism will be a real road to prosperity and that there is no other road. The argument is not just the moral. It is about all of reality, with a major focus on the economics. People do not know the economics of capitalism (or the world they live in now) any more than they know the morality. Neither will be a strong enough argument by itself. Combined, they are intellectually overpowering. All it takes is finding people who are willing to look at reality and showing it to them.
In the week of August 8th to the 12th, the world saw the equity markets swing very wildly from up to down and around again. It was, I am sure, very disconcerting, probably frightening. And people are confused because after a lot of reforms, laws, regulations, planning, stimulation, and quantitative easing, which was suppose to make things better, we are having big, dangerous, damaging swings.
In recent days I have seen several suggestions in the media that volatility would continue, at least for a while, because of the uncertainty as to what direction the stock market would take. These comments have a very narrow focus and fail to recognize wider causes and implications. They do not recognize that it is not just the stock market that has volatility. Currently, well, in fact I am not aware of any international market that isn’t suffering higher levels of volatility. Currency markets, commodity markets, bond markets (except very short term, which are basically pegged by Fed policy), you name it, are all experiencing significant volatility.
The biggest reason is “uncertainty”. What is meant by uncertainty is much more than an understanding that the future is not known. The future is unknowable, but, in many circumstances, it is predictable and can be expected to behave in a comprehensible manner when unexpected changes do occur. If you are a competent investor or businessman, you have confidence in your ability to respond to change. No, this uncertainty goes way beyond the basic unknowable future.
Nor is it just that the international community faces problems. There are always problems, issues that need to be addressed and dealt with. Again, competence leads to confidence.
What is causing the foundation of today’s uncertainty is the lack, one could say the nonexistence, of ideas, solutions, intelligence, willingness, leadership of governments around the world. It is as if there was a contagious disease that has afflicted every ranking member of most of the major governments of the world. They fight, they seek their own political advantage, they evade, they do nearly anything except face the reality of the problems facing them. For months we have been waiting for the leaders of the governments of the eurozone to solve the sovereign debt problem facing several of their members. Several times they have announced triumphantly that they had solved the problem only to see that the market regarded those steps as insufficient. Now a few countries are in extreme recessions. As their economies shrink, their bond problems become worse. No one in Europe (or in most countries) seems to understand how an economy grows, with or without heavy debt. The stimulus steps are not working (as they aren’t in the US, as we shall see shortly). Data released this last week showed that the German economy was not growing as fast as thought. Germany is generally regarded as the backbone, best source, the money source of last resort of the euro system. If it isn’t strong, the eurozone will have much more difficulty in solving the problem of sovereign debt, let alone actually experiencing growth.
It also appears that the US has not grown much at all in the first half of 2011. Nearly everyone was expecting that because of QE2 the economy would be on its way to a normal recovery with growth powering along toward 6%. Now many people are talking about a recession this year. The government policy has failed. People don’t know what to make of that. They are confused, and uncertain.
It is being recognized, slowly, that the Fed has run out of options. In the last couple weeks in announced that it would not raise interest rates above effectively zero for at least two years. Obviously, the charge of uncertainty was heard. But this is recognized as a dumb move. The stock market tried to rally, went up wildly, and then continued downward, just as wildly. There are some at the Fed who understand some of the problems facing banks and businesses in America. For example, read this speech (not saying it is perfect, but he recognizes some important points.)
In addition, and as important, in most of the developed world, laws passed over the last few years have unleashed massive new regulations and restrictions on banks and businesses. Most of these new regulations have yet to be formulated and announced. Bankers and businessmen have little idea as to what to expect, except that it will not be supportive of normal, intelligent, profitable banking and business practices. Everyone is waiting for the shoe to drop – on their heads.
So we have uncertainty hounding us from two angles, the failure of the government policies that were suppose to save us and the impact of new, arbitrary regulatons.
With the Fed’s hands tied from all but the most crazy ideas (The Fed is run by helicopter Ben, after all.) and the Administration and Congress tied up over the astonishingly large deficit already on the books, one wonders what the government could think that it could do if we go into another recession. Will they try to enforce wage and price controls? Will they try to force a command economy? Will they watch in wonder?
Let’s say that they find that they can do nothing. Let’s say that Geither in the Treasury doesn’t go off into nether-nether land as he did in 2007-9 and write lots of checks he can’t pay. Let’s say the economy is on its own (I expect that even the Republicans will try to do something.). Is the economy strong enough and free enough to recover? If it doesn’t, will that give the anti-capitalism crowd more leverage? Is our time to fight shorter than any of us figured?
Many are thinking that foreign currencies and businesses are safe havens from the problems in the US. Actually, these safe havens are more in Asia or the BRICs. But, this is the era of globalism, of international markets and money movement. When the US and Europe are in recession Asia and the BRICs do not have markets to sell to and their economies also decline. Some of the stronger currencies may still be relatively stronger (Japan is a disaster waiting to happen.), but you need to be very careful. If and when recession comes to China, for example, and the real estate market crumbles, it will be interesting to see what the Communist government does, that is unless you live there, they it could be frightening. Remember too, that the government leaders and central bankers all went to the same schools, read the same books, heard the same speakers, and hold the same ideas as those in Washington. There is no country that is a financial and intellectual island. Differences are relative, in degrees, not fundamentals.
So the volatility we see is the result of the confusion and dismay. People see the failure of the promises of the political, economic, and intellectual leaders and do not know what to think. Even the more experienced traders are suffering whiplash by news and promises. People rush from hope to fear, back and forth. They have no foundation for understanding what is happening. The mainstream media is just as ignorant.
The hole that Keynesian policies have dug for us is very deep. The process of fighting over who will be heard and who will lead will cause constant turmoil. The inept attempts at solutions will add to the problems. Lost time in actually solving the problems will result in the problem becoming larger and exerting more strain on the international economy. Volatility will continue, sometimes becoming wilder, sometimes hitting a lull, but as the confusion and fear will not be reduced and the problems will reemerge, the volatility will return, probably in greater, wilder swings.
There will competitors offering answers and solutions. The Christian right, fascists of Christ, will offer answers. There could be an even more extreme, pro-government Democrat emerge who would rival BO in his willingness to use force to achieve the ends of destruction promised by altruism. Competition for the minds of Americans could become fierce.
People are looking for answers. This is an opportunity. Objectivism and capitalism have answers, good ones, ones based on reality. The books and ideas of Ayn Rand need to be spread further. People might be willing to listen.
There is in fact something to report. Get it here, few others are going to have this news. It might mean something, it might not, but it at least is a change.
In a recent blog about the money supply I talked about how to read the graphs we get from the Fed, that to understand the meaning of the information, you needed to keep the steepness of the curve and the relative amounts in mind. Now we have a example of what I meant. It is a nice example for illustration purposes; it is a bad example if it foreshadows things to come.
The US money supply, as controlled by the Fed, is generally fed by way of bank loans. Generally, the level of bank loans is the best place to look first to get a good idea of what is happening.
Surprise, a graph! Well, you can see that the recent activity, after several months of steep decline, there has been some rebound, but that seems to leveled off, at least briefly. I put no importance on such brief changes, even though it is a little unusual. But, here is the important part, while BO has been railing at banks to loan money (regardless of his criticism that the financial meltdown was because banks loaned money – to the poor), the regulatory agencies, The Comptroller of the Currency and the FDIC, for example, have been engaged in very heavy handed tactics to force banks to adhere to what the regulators consider, sound banking practices. They insist the banks have lots of collateral and keep minute, intrusive records about the borrowers. Further, banks are still trying to replace the capital and loan loss reserves that disappeared in the meltdown. Those who carry on about bank profits just are not taking the responsibility to find out what they are talking about.
After looking at bank loans, lets see what the money supply is doing. Ee have a choice where we look, since there are a few different indicators. What the hell, lets look a several.
First is M1, which is the basic money supply category and includes all physical money such as coins and currency; it also includes demand deposits, which are checking accounts, and Negotiable Order of Withdrawal (NOW) Accounts. So, this is the money you use to buy stuff with.
M2 is a little broader, it includes M1 plus all time-related deposits, savings deposits, and non-institutional money-market funds. This is money that is one small step from the availability to be spent.
Then we have the one I consider most useful, MZM, which is all money in M2 less the time deposits, plus all money market funds. It measures the supply of financial assets redeemable at par on demand, or all the money that can be realily spent.
Also available from private sources (because the government stopped publishing it) is M3, which is M2 as well as all large time deposits, institutional money-market funds, short-term repurchase agreements, along with other larger liquid assets. The “other larger liquid assets” includes Eurodollars, which means here we can see the overhang that could drop on us. Eurodollars are dollars held in foreign, private accounts. Thus, this measure does not include dollars held by foreign central banks as reserves (if the money has been invested somewhere, and not just held as cash, it will show up in one of the Ms).
I showed you M3 for the sake of completeness, but for our purposes, in this post, let’s use the other three, focusing on domestic dollars.
I am sure that you can readily see that each seems to currently be heading straight up. Up until now, the graphs had been moving more or less on a trend line that was fairly consistent from the 1980s. These are linear graphs, meaning that a change of $100B at the bottom of the graph was the same size on the vertical axis as a $100B at the top. That means, from a practical perspective, that a recent $100B change in the money supply was not as significant as one 30 years ago. Today, $1000B is small potatoes. So if the graph was sloping the same angle, the rise in the money supply was having less and less effect.
Now, the slope has definitely increased. If it continues, the impact of the growth in the money supply will be greater. The question is, will it continue to grow at that rate or faster?
You might ask, well if the banks are not loaning more money and that is how the Fed pumps money into the system, how is the money supply expanding?
The answer to the question is that there three other sources of growth in the money supply (that have played little or no role hitherto): 1) In QE2, the Fed was playing a little with its processes and managing to get some money directly into the hands of the Treasury (see the several comments under “Making Claims About the Money Supply), and that expanded the money supply. Whether that explains this jump is unclear, at least to me. 2) Money that was in other instruments, and not available for immediate spending may have been moved. It would take a large and noticeable move to result in this jump, but this change could explain part of it. 3) Dollars kept overseas could have been moved back to the US. This is my choice. In the recent turmoil in Europe people and businesses have been fleeing the euro and the eurozone. We could easily see billions of dollars moved, not just into dollars, which has made the dollar “stronger”, but move to be deposits within the US.
If the last of my three options is the reason for the rapid increase in the money supply, I don’t think that it is sustainable and then not a threat for our consumer prices. The reason being that there is only so many dollars that can be moved quickly. There are many financial and business obligations overseas that are paid in dollars. If too many dollars come here, they will just have to go back. It would take time for those obligations to be unwound and the dollars freed up so that they could remain here. If that begins to happen, then we will see a significant influx over time and a consequent increase in dollars for asset investment and spending. We will either have another asset boom, a general consumer price inflation, or both.
But, in order for the role of dollars to begin declining in international trade and finance, there would have to be a replacement. People overseas would have to find a currency that they were willing to trust as much as they trust dollars today. It would have to be a currency that is as available as dollars are (a large quantity). There isn’t one. Nor is there one on the horizon. (I mean in terms of the recognition of the people overseas, not as a potential.) Therefore, if I am correct in my suggestion as to the source of the increase in the money supply, we need not worry about that problem right now. But we do need to keep our eyes on it.
But, we have to keep an eye on what the money supply is doing anyway. It isn’t optional, because it foretells what we will have to face.
Manias, Panics, and Crashes: A History of Financial Crises; 5th ed.
By Charles P. Kindleberger and Robert Aliber
This Time is Different By Carman M. Reinhart & Kenneth S. Rogoff
Objective Economics is the triumphant entry of man, the rational, thinking man, into the study of economics. For the first time, man is the focus. This is in contrast to the “blind market forces”, “invisible hand” and disembodied supply and demand that has populated economics previously. Here, man makes choices by the use of his reasoning power based upon the facts of reality. Certainly, irrationality is recognized, but so are the consequences (i.e., failure). The book also presents a method of objective science, focusing on the facts of reality, and notes specifically where more information is needed. It does continue in the tradition of the best economists in that it is exhaustive, discussing the various important issues in detail and making note of the differences in this book vs. its predecessors. In this regard, Dr. Buechner’s consistent references to the three classifications of philosophy, i.e., the intrinsic, subjective, and objective, are important and helpful.
Good to Great has much to offer. It clearly presents what is actually a very objective (in the proper sense) look at the reasons why certain companies met a very high standard of greatness as businesses. The conclusions are very interesting and useful. The method and the clearness of the thinking are enjoyable and instructive. What is also interesting is that, clearly, the author and his research staff do not have the knowledge to understand and elucidate the character of the great businessmen they discuss (neither do the businessmen). People familiar with Objectivism will understand.
A facebook “friend”, someone who is considered an Objectivist by himself and others that I respect, referred to Charles Kindleberger as a good source to understand economics. I hadn’t really heard of Kindleberger, being as I left school before he began writing. So I looked around and the only book that I could easily access was Manias, Panics, and Crashes: A History of Financial Crises by Charles P. Kindleberger and Robert Aliber (Aliber does not seem to figure much in this, somehow). I was greatly surprised to see a glowing recommendation for the book on the cover by Paul Samuelson, the Keynesian author of one of the worst college texts ever forced on the innocent. Samuelson’s recommendation was well deserved. I haven’t discussed this book with the facebook friend, yet. But this indicates that he is sadly wrong. Kindleberger is strongly for government control of the economy, has no ability to distinguish between different economic events, is unable to understand the concept of causality in economics, and writes in a style designed to bore and obfuscate. I found one, accidental, modest idea in the book that might suggest some further thinking. One.
On the other hand, This Time is Different, although written by two economists who do not seem to have found anything in mainstream economic theory to question, do have some respect for facts, and wondrously, actually go and search for them. The detail and organization of the facts sometimes are a little difficult to get through, and much of what the two authors have to say is superficial. Yet, on some important points, they are very good and do provide some understanding that is important. The point of the book is that excesses in credit and money creation in every instance leads to disaster. This time is never different. I am not recommending this book to anyone who is not serious in their studying of economics and history. It certainly does have major significance to today, both here, in Europe, Japan, China, and most of the world.
Number one on my list of fantasies is the US Treasury Bond. (Just for the record, in this context I mean nightmares. I do have good fantasies!) People feel US Treasury Bonds are safe. Are they?
The usual reason given for the safety of US Treasurys is that they are backed by the ability of the US government to dip into the pocket of the most-wealthy nation on earth to meet interest payments and redeem the bond upon maturity. Well, yes, that is true, still true. But that proposition does have limits, limits that have not been stated or acknowledged before, but need to be seriously considered, soon. (Notice that the wakeup call of the S&P downgrade of US Treasury Bonds has not resulted in honest reconsideration of the path of the Obama administration, but has caused several loud calls for destroying the remaining limited independence of the credit rating companies.)
There is also another issue that isn’t addressed in the basic reasons for the safety of the US Treasury Bond, prices. You see (and I am sure that many of you do see) the price of the bond is related to the interest rate that it pays, which in turn is related to the interest rates paid on other bonds around the world. If interest rates begin to climb, and the secondary market for Treasury Bonds (where bonds purchased from the Treasury are resold), even the Treasury itself, need to compete for funds, the interest rates for the bonds will climb. The consequence will be that the price of the bonds will fall. So Treasury Bond prices do change. If interest rates move, say, a whole percentage point upward what happens to the price? The current benchmark 10 year Treasury Bond has a yield (interest rate) of about 2.4% (the date of my first draft being somewhat different from my publishing date). So I am suggesting that it went from 2.4% over time, however long you want, to 3.4%. The latter interest rate is still very low. Historically, this bond has been much closer to 5%. Even at 3.4%, with taxes at roughly 25% and inflation around 2%, the bond isn’t making you any money (at 2.4% you are taking a loss). (Of course, foreign governments aren’t paying taxes!) But, a bond purchased originally at 2.4% will not yield the new market rate and can’t be sold for the original purchase price (nominally $10,000). Instead it must be sold for the amount that will bring the current market rate of 3.4%. (or $240 – the actual dollars paid in interest – divided by the new interest rate) which is close to $7058 ( there are issues of time to maturity, when you receive back your $10,000 that will adjust the actual sell price). You have lost roughly 29% of your principal. You see, relatively small moves in interest rates will have significant effects on the market value of your bond.
This example demonstrates that bonds are no safer in terms of maintaining your principal than any other asset, unless you hold to maturity. How safe is that? Depends upon the inflation rate doesn’t it. When thinking of long-term monetary values, don’t think in terms of currency, that is, fiat currency. Think in terms of some real, basic thing that you use in daily life, like a loaf of bread, or a pound of ground beef, or a latte in Paris, whatever. You will connect the rate of inflation to your currency denominated assets and be able to better realize what is happening to your capital. The bottom line is that US Treasury Bonds are very risky. (I won’t even go into the fact that you have put your savings into the hands of people like Obama, Bernanke, and Geithner.)
Many, if not most investors know these facts, so why are they still running to US Treasuries? Context. Or, a perhaps better way of putting it, where else are they going to put their money? There are a couple currencies that are considered strong, i.e., the Yen and the Swiss Franc. Both of these have been bid up sky high (much to the dismay and panic of the authorities and business people in those countries). There isn’t any real room there for more money. Other currencies are not considered safe by the populations of those countries. The best current example of that is the eurozone. This group of “developed countries” have people making decisions who are more concerned about voters than solvency. People who wish to protect the value of their liquid assets are scared of what these politicians will do (not to mention the so-called economists who do not think stability or production as important to economic health). The person holding liquid assets wants to put his property somewhere that the whims of the politicians can’t destroy it.
The bond markets for stronger countries, such as German and Austrailia, are small, very small in comparison to that of the US, and can realistically take only a small portion of the available funds. So for anyone wanting to get out of their home market, out of their currency, out away from their authorities, the US is still a better place. It just gives you a good idea of how bad it is elsewhere that the US dollar and the US Treasury Bond are about as good as it gets.
The result is that Obama, Bernanke, and Geithner feel pretty strong and confident, in spite of the downgrade of US government bonds by S&P. Again, isn’t it amazing that the politicians in other countries scare their populations more than the US trio of idiots.
The above discussion also gives you some idea of what could be the future for the cost of gold in fiat currencies. The gold market is smaller than the market for the Yen or even the Swiss Franc.
At this point I should explain how the bid/asked market functions: it is the margin that moves a market, especially a auction market like stocks, bonds, currencies, commodities. It is not the total demand or ownership. It is the most recent orders, their size, their volume, and which side of the transaction they are on, buy or sell, that moves the market. The traders do what they can to meet the reqirements of the open orders, moving the price as required to elicit corresponding orders (a buy order to match the existing sell order) to clear the market. Higher volumes of demand for a item, like gold, will send the price up. The higher the volume, the faster and larger the price movement.
So if people really begin to consider gold as safe and a real alternative to fiat currencies, the current price will be considered very low. Any kind of movement into gold from these other markets will send the gold price to astounding heights and will really scare a lot of people.
What will be interesting to watch (but not to live through) will be the point at which people begin to doubt that US government assets are a good idea, including the dollar. We don’t even have to worry about China or Japan for things to get ugly. If just foreign banks, businesses, and individuals begin to sour on our debt, its yield will move strongly upward and its market price downward. The budget deal and all of the carefully crafted, make-believe scenarios will be revealed as so much fantasy. These scenarios (models) are also among my favorite nightmare fantasies.
So many people are reacting to the recent bill to raise the debt ceiling as if it meant anything. It did mean something, but not what people are whining about and not what the Dems or the Republicans are suggesting.
You should have expected that the debt ceiling would be raised, and probably by the arbitrary date that had been set. If anyone in Congress had suggested that the US go into even partial default, they weren’t being taken seriously. When the government has been shut down before, the Republicans have taken the blame and felt the pain on election-day. They weren’t going to do that again. No, they were going to raise the debt ceiling.
I am a little surprised that they raised it as much as they did, although the actual number was rarely mentioned in the press. No wonder, since the increase was about the same amount as the announced reduction in spending – that is suppose to occur over ten years.
Add in the fact that actually less than a trillion dollars of spending reduction was identified in the bill that was passed and the remainder is suppose to be selected in a special legislative committee, we have a bill that doesn’t mean much. Nor are the effects to begin for the next two years, except to raise the debt ceiling by over $2T.
The “reasoning” behind not having any cuts in the next two years is strictly Keynesian economics. It is accepted by both sides that government spending is a good thing for an economy that is not growing sufficiently (if at all). No one questioned this claim. The Republicans went right along with it. If you think about it, it makes even less sense in this case. I mean they are accepting the idea that not reducing the spending that BO wants in 2012 means that the economy then will do better than if his budget was reduced. This is just amazing. It this thinking is correct, the correct thing for Republicans to do would be to push for more spending, regardless of the deficit, to have even better economic performance. Well, of course, we are now talking Ben Bernanke’s language.
Many people are claiming that the loser was BO. They say that he didn’t get the increased taxes on the wealthy that he insisted upon. Maybe. There is always tomorrow, of course, or after the next election. The way the Republicans are going, BO will look great. I am sure that he hasn’t given up on raising taxes on the most productive members of our nation, he will find another time to push this through.
The bill hasn’t made our immediate situation any worse. If you understand that the debt limit was going to be increased and the whole thing was a game (a game that was taken very seriously by all participants), then you just hoped they didn’t do anything more stupid than normal. There are no new immediate taxes, no new spending, no explicit attacks on our freedom.
There is one bright spot, I think. It is that the very issue of the debt was brought forward and made a big deal. It gained the attention of the media and many people in the country for a couple weeks. It also seems that the Republicans did latch on to this issue and maybe they will try to keep it in the forefront of their public comments. That is a good thing.
Yet, as I say that I also remind myself that they did not make clear to the American public that Social Security and Medicare are doomed, no matter what the Dems do about it. Those programs have a cost that no nation could pay, and certainly not one as encumbered and regulated as this one.
The Republicans also undercut their case when they fought for such small potatoes. Cuts of $2.7T (or whatever the final advertised number was) spread over ten years do very little to impact annual deficits of over $1T a year. It was such a big fight over so little.
But actually, it is even worse because what they were fighting over weren’t cuts at all. The Congress uses terms differently than us common folk, and the “Tea Partiers” fell right into it. The budget projection process assumes that most programs will continue to expand over the years. What Congress fought over was the rate of increase of those programs. They weren’t cutting anything at all.
The expectation that reducing the increase will make a difference assumes that the income side of the budget would grow at a certain rate, meaning that if income continues to climb, and we reduce the increase in spending, we will see a reduction in the deficit and we will borrow less. But, where is this increase of revenue coming from? Well, two options: price inflation or actual growth. Along with price inflation often means increases in income as well and thus increases in tax revenue. Historically, however, income lags, meaning that our standard of living lags, and tax revenue lags. So, price inflation would only partially support a decrease in the growth of the debt.
Really, Congress is assuming that the economy will grow. I do not know what growth rate was used to figure out that their numbers would work and the deficit would not grow as fast as it has. I expect that it had some relation to our history since WW2. The growth rate over the last ten years has been much lower, however. We may not expect our growth rate to achieve the historical average any time soon, since we really haven’t recovered from the last recession. There are lots of reasons to think that the last recession is continuing and tending downward. You can be certain that the framework of this “Deal” didn’t assume a recession in the ten-year timeframe. The entire underpinning of the “Deal” is flawed.
The bottom line is that the “Deal” that was suppose to cut spending will have little effect on what will happen in the economy over the next ten years. It is a nothing. It has many fraudulent characteristics. Worse, it may make some people relax and think that things are in better shape.
That is one reason why I don’t understand the people who were so disappointed that the “Deal” was done. The bottom line was that the Republicans were fighting for show, not for real results, and not passing the debt ceiling was just too real for them (as a group, anyway).
And now (have to write more cuz stuff is happin’), S&P has actually shown up. I think that their explanation is pretty good, except that they should have mentioned that the politicians got us into this fix in the first place. I have seen two different kinds of responses, well, three, but the third, “It’s about time!”, is a very small minority.
One response is surprise that the downgrade is occurring now since the US government can meet its obligations of paying interest and paying back bonds. This is as short-sighted a view as we see from the Congress. The issue isn’t about today’s payments, but the payments during the life of the bond, which is in doubt, really.
The other response is from the Administration and the Democratic members of Congress. They apparently believe that anyone who disagrees with their view, their very subjective view that whatever they want to do is good, is at best mistaken and probably evil. Don’t be surprised to see the FBI visit S&P headquarters. If Obama actually realizes what the meaning of the downgrade means, he will look for ways to use the power of the government to change the rating of his debt.
Many of the supposed financial experts interviewed that I have seen have been unwilling to predict what we will see tomorrow when trading restarts around the world. I certainly don’t know. We may see some pause as people try to come to grips with the revised situation. Many of the organizations that currently hold Treasuries as assets that must be AAA rated may be calling their attorneys to find out what they must do. Prudence would require that they change their assets in an orderly manner and not wildly sell. But then, we could see some panic selling. Either way, a lowering of the rating of US government bonds should see an increase in the interest rate being demanded in the market. How much is very much open to question. The Treasuries will still be a major holding by many different international and domestic organizations.
But think what the downgrade does for the “Deal”. The whole plan did assume a certain cost of borrowing. That is, paying the interest on the debt is a large portion of the federal budget. That portion has just gotten larger. I bet that the projection of future spending used in shaping the “Deal” assumed pretty much the same interest rate on bonds for the entire 10 years. It certainly assumed a continued AAA rating. Now that rating is gone at the very beginning of the 10 year timeframe, and it is unlikely that the Administration or the Democratic members of Congress will do anything that will provide reasons to change the downgrade. The supposed cuts will be off set by the higher cost of paying the interest on the debt. So much for the entire hoopla and the “Deal”.
We need to focus on the primary thing, which is the education of the American people. If a sufficient number (say 20%) understand the situation, their voice concern will cause Congress to move in the correct direction. As long as the American people believe that, for example, Social Security and Medicare can be viable over the long term, nothing will be done.
As we move into the forth year since the bust of 2008 and there is no real recovery, we do have an opportunity to point out the reality of the Keynesian policies of the government. The American people do not want to live this way. I think that even the ones receiving government payouts may be willing to listen more than their counterparts in other countries because they are still Americans. In any event, we have our opportunity. Let’s make the most of it.
I’m not giving you a blow-by-blow account of events in and around Greece. I am trying to give you some perspective on the situation, which seems hard to find. I am beginning by offering you some stuff that I have found here and there that adds to the picture. They show that the possibility of Greece growing out of its current difficulties is impossible, because real growth is impossible. Read this article from the BBC to get an idea of how the government and business get along. It makes many of our state governments look brilliant by comparison (but not Obama). I found another article about a village that had attracted major industrial investment, but is now dying and businesses that can are moving out of the country (sorry, I proceeded to lose the address of the article). There is also plenty of evidence that money is fleeing from the country. Bank deposits are declining relatively quickly. None of that is good for the survival of Greece without major disruption.
For you one note medical issue people, read this note form a recent weekly email that I receive from John Mauldin (6-24-11):
“But there are very sad things going on. It is not just banks that are losers here. Pharmaceutical companies are starting to refuse to deliver to Greek hospitals, as they are up to two years behind on their payments. It turns out that Greece owes some €6 billion to private businesses like hospitals and simply cannot pay. Those costs are rising, and much of it is to hospitals for medical care supported by the government. They are issuing bonds (shades of California) for the debt in some cases, which sell for a discount of 50%, if they can be sold. And we thought finding €12 billion was a hard thing. This is not just a Greek problem, it is a concern in many countries that are having financial difficulties.”
The Greeks are being asked to make some very tough decisions. These decisions would be difficult for brilliant, well-trained, market oriented professionals to make, but what the Greeks are depending upon are politicians who claim to be socialists. Their entire operating mode is making promises, throwing around government money (they have no idea where the money comes from), and taking graft (It would be sort of interesting, in a pathological sort of way, to do a study on the number of “socialists” who have become rich and expect luxury since they became politicians, like the Frenchman arrested on rape charges in NYC, Straus-Khan). If the world press was able to look beyond the superficial, and report more on actual events besides government pronouncements and “protestor” activities, we would see that the Greek economy is barely functioning. To me, the problems in Greece bring into question much of the current plan. For example, the Greeks are required to raise E50B by selling off nationalized businesses. But these companies are most likely very badly managed and their assets may have been looted, many of their employees are protesting the entire program in the streets, and the prospect of profitability in the Greek economy is bleak. Who would bid on these companies? Would the Greek government get more than 10 cents on the dollar?
The entire program is based upon premises that have not been substantiated. There is very little connection with reality in the entire effort. Part of the reason is that none of the countries, including the supposed healthy countries like Germany, could comfortably face the same reality oriented scrutiny that Greece should be facing. I am sure, as a semi-reality oriented premise, i.e., the German reputation, that German nationalized companies and German government management is better than that in Greece. But I’ll also bet that it does not rise to the standard of German private enterprise, let alone American private enterprise. So the problems that the Greeks face very likely exist to some significant degree in every European country and at some point down the road, they will each face default and depression.
If Greece defaults, do not be surprised if other countries don’t follow suit. Iceland is expected to walk away from its debt at any time. As for Ireland, from all I have seen, it is a country plunging down the economic hole. Portugal is pretending that it is functioning and will not need another bailout, but it isn’t growing. Spain is seeing massive internal dissent aimed at its austerity programs. But, back to Greece.
So, in the last week the Greek parliament voted to further reduce spending and sell off government “businesses”. This is just the briefest of stop-gap measures (the popular phrase is that they are just “kicking the can down the road”) and it is not considered to be sufficient. More cutting and so on will be needed next year.
Some commentators wonder if the actual events will occur. All that has actually been passed are general bills. The legislation that will provide the details will be offered later, including the specifics of the asset sales. It is noted that the current government originally built its power base on the employees of the government and these government companies, promising them heaven on earth, regardless of the cost, productivity, or sanity of their programs or “businesses”. To sell off these enterprises would be a complete reversal, and it is wondered if these politicians can do it. Politicians of this stripe are great at making promises, but recognize the difference between policies that will get them reelected or appointed and those that no one will pay any attention to. Since these politicians are hardly connected to reality, they could easily declare that they will not act against the “interest of the Greek people”, and say to hell with the bankers, and not sell the assets. It would be a disaster and fairly soon those “businesses” would have to close down, since no money would be available to subsidize them, but the politicians would probably be reelected.
But, even if all of that goes fine, the Greeks will still need over E100B next year. I don’t know how they figured that, but if they are depending upon the Greek economy to assist in the government’s efforts to remain solvent, they will be very disappointed. I expect that the Greek economy will decline faster than they expect. Relatively speaking, it is an advanced economy, probably one of the top 20 or 25 in the world. It is more advanced than the US was in 1930. It is more corrupt and probably more productive, but in terms of interconnectedness and of business practices, it is more advanced. When even a relative small, advanced economy begins to fail, things will unravel rapidly. The politicians in charge will be like military leaders, who are said to always be ready to fight the last war. The politicians (and the economists) do not really know what is going to happen. They are basing their reasoning upon assumptions that most likely have little to do with present day economies. (Since the last depression occurred 80 years ago, we have little actual experience for rational economists to base their expectations. No one knows what will happen. But the irrational people in charge now won’t even realize things aren’t going right for some time.) So the needs of Greece next year will most likely be larger than presently expected. Larger than the current leaders in Germany and France are telling their people they are committed to cover. Politics in those countries will be rather interesting to watch.
But then, even before that point we have the French and German leaders coming up with another wrinkle, witch will cause great stress. They are saying that the “private sector” needs to participate in saving Greece. Now, considering that the “private sector” has already put itself out on a limb and bought a lot of Greek debt, it would seem the private sector has already engaged in significant participation. Why anyone in their right mind would do such a thing is beyond me. Then, much of that debt was purchased before the rating agencies really took the Greek government’s ineptitude into account and began lowering the credit rating of Greek debt, meaning that interest rates for Greek debt have gone up, a lot. Interest rates on the open market are now in the upper teens, say 16% or 18%. Say you bought Greek bonds at 8% and it is now 16%. You have lost half of your capital on the secondary market. Your only chance of getting your capital back is to keep the bond until maturity. It will probably still be a loss (due to the declining value of the currency), but perhaps not as much (figuring this out calls for some very complicated math). But now the French and Germans are telling the private sector that they will have to roll over their bonds, that is let the Greek government keep the money, with a new maturity date (I haven’t seen any indication of what duration.), but with interest rates probably lower than market. This is a clear loss for the bond-holder, and in any rational world, would be called a default, as the credit rating agencies have clearly stated.
Given a deserved black eye because of the goings on during the residential real estate boom, the credit rating agencies are trying to act like real credit raters. That is not what politicians want, actually. Welfare state politicians generally do not like letting people know the truth about things. Just in the last couple days, the leaders of Europe, especially that crazy lady in Germany, have attacked the credit rating agencies. It is an ad hominem argument, accusing the agencies of having a bias against Europe. Yes, if you don’t get your way, if someone calls your spade a spade, accuse him if bias. The best defense is a good offence. Offend every one you can.
Well, I can now get to one of my biggest reasons for writing this post. Greece is really small potatoes. I mean, Greece has a small economy, although if it does (which is to say that when it) defaults, the repercussions will be significant, because a lot of banks have significant amounts of Greek debt. But there are also two other small countries in the EU who might take the same opportunity to default on their loans, i.e., Ireland and Portugal. I’m not sure how seriously to take this, but Ireland is in dire straights and Portugal is not improving either. Then anyone who looks sees that Spain and Italy are both in situations not that much different than Greece. The “contagion” effect could go far, especially if these countries have major financial issues when Greece fails. I mean banks failing and soaring private bankruptcies will be dangerous in every country.
Then, hidden and ignored, is the plight of France and Germany (which is to actually say all of the European developed welfare states) that cannot sustain their own spending and borrowing as their populations age and shrink (and go Muslim). The problems in France and Germany are greater than that of the US in the long run, i.e., next few years.
That means that to the extent that France, Germany, and the other apparently healthier countries weaken themselves bailing out Greece, Ireland, Portugal, Spain, and Italy, they bring on their own problems that much sooner.
More broadly, the world is awash with debt. Every major economy that you can name that appears strong has got major debt, and rapidly growing debt. Japan, for example, with the reconstruction it now has to address, was beginning to feel overextended before the earthquake and tsunami. The Japanese economy is under great strain, yet the regional governments, businesses, and the population are all making new insistent demands on the national government to spend more money. The brics, Brazil, Russia, India, and China, that are growing fast depend upon the developed countries for markets, are themselves heavily controlled by their governments, are awash with government spending and debt (domestic and international), and at least three of the four (I don’t know enough about Brazil to say) are rife with corruption. In no way can we say that they are healthy economies, no matter how rapidly they are actually growing.
In spite of the international financial meltdown in 2008, there is little real difference in the way the international economy is functioning, except there is a lot more government debt worldwide and much more government interference. Consistently, they have all blamed the financial problems on the banks and, in fact, made the banks weaker.
The results from this will not be good. I am not predicting the end of the world nor utter catrosphie, I just don’t know enough to do so. But nothing good can come out of the current mix of debt, government controls, ignorance, and purposeful pursuit of policies that have never worked. It can not help but be worse than 2008.
We can avoid the meltdown here, but only by getting hold of things and making real change, to freedom, to capitalism. We will still suffer because there is no avoiding the problems of the rest of the world. But we can survive in fairly good order, if we do it.
QE2, i.e., quantitative easing two, the program by the Federal Reserve Board of buying longer-term government bonds to “support the economy” ($600B this time) is slated to come to an end June 30, 2011, today. One might ask what this round of low interest rates and easy money has done? I am sure that the governmental types will proclaim to the land that they have averted major disasters and saved civilization by their actions. Sure. Others will say that the results are a significant additional amount of inflation. Perhaps. One can definitely say that the level of reserves that the banks who are members of the Federal Reserve System (nearly all banks) have risen to new, even scarier heights. Before September 2008, the total reserves of these member banks were in the $50B range. Soon after that fateful September, the reserves rose to over $1T! Now the reserves are about $1.6T. What is good is that the “money” (which the Fed merely created out of the air) is sitting in the reserves and not roaming around the economy. Other than inflating the reserve figure, I don’t see anything beneficial that the QE2 creation of an additional $600B has done. The economy is not doing well. And much of the damage of the run up to the 2008 meltdown has not been undone, either.
Maybe what has happened is that the economy has floated along on the Fed cushion for the first half of this year. It is growing slightly, say less than 2%. At this point in most “recoveries” the economy has achieved much higher growth. The current economy has not gotten back to even, yet. Some prices have fallen, e.g., real estate. Residential real estate prices have probably not fallen enough and the sector is still in poor health, with foreclosures still happening at a high level. Employment as a percentage of the working population is still low. It is even lower when the actual productivity of the many of the new “jobs” is taken into account (i.e. government “jobs” that produce nothing). Moreover, for various reasons, some having to do with money creation around the world and some having to do with enforced shortages in the face of growing demand, the prices of some basic commodities are high, meaning a lower standard of living for all.
So QE2 comes to an end. Many suggest that the economy, left to its own resources does not have the strength to continue to grow, or, if at all, at a very low level. Employment, which is only doing better because of some statistical manipulation by the Labor Department, will suffer. Our standard of living will continue to fall.
The counter trend to the government’s activities is that there are millions of people in our country running businesses and working to be more productive and profitable. In spite of all the government does, some very basic elements in our economy are growing. So much of what I see from Objectivists assumes that the government is all-powerful and ignores what the non-government sector is capable of doing. Remember, the practical attack on capitalism has been going on for over 100 years (as opposed to the philosophical attack that has been going on much longer). The attack is still only partly successful because the ingenuity of the American capitalist works around and through the laws, regulations, and direct interference put in place by our politicians. The failures, when they occur, can be big, e.g., the Gulf oil spill. But on the whole, American businesses have coped pretty will with the interference. There is a limit to how much they can overcome, and we may be getting close to that limit (re. Atlas Shrugged), but American capitalists and their workers are trying, still. Whatever QE2 and its aftermath, the real economy will influence the results. This is a major reason why the consequences of government actions are so hard to predict. It is also why people do not take the predictions of doom seriously. Long-term doom just doesn’t seem to happen (as opposed to short-term doom like the sub-prime/financial meltdown). Things don’t seem to change much on the surface. We seem to still have capitalism. To the extent that capitalism has been undermined, we are in for a rough time, unless change for the good happens. (We are experiencing long-term deterioration, but we are experiencing it like a lobster in a tub of heating water, and we aren’t noticing our losses.)
To the extent that QE2 has been propping up the economy, that support will disappear. To the extent that participants in the economy thought that QE2 was providing some real support for the economy, the loss of that support will make them weary and less confident. To the extent that QE2 has been fueling the rise in the stock market and commodity prices around the world, that fuel will disappear and perhaps those prices will drop. To the extent that QE2 has been keeping longer-term interest rates low, they will now begin to rise. To the extent that QE2 has been glossing over problems in the economy those problems will reassert themselves and they will have to be addressed by the markets in a more rational manner.
The end of QE2 will be a good thing if the government and the Fed do not start tinkering again. There is another program that the Fed has ongoing, that is not changing. It has a lot of bonds and mortgage-backed securities, say about $1T. Those securities are maturing and being paid off as time goes on. The Fed has been taking that money, and buying Treasuries, about $250B a year (according to news reports). This isn’t really a good thing, since the original funds to purchase these “toxic” securities was made-up money. It would be better if the money was retired, and the member bank reserves reduced (that is actually where the money went in the first place). But at least it isn’t new made-up money.
There is a lot of talk about the reappearance of Fed “support”, say QE3 at some point within the next year if the economy begins to founder. Right now the pressure in the much of the world is for interest rates to rise. For instance, the Bank of International Settlements issued a statement that criticized developed countries for keeping interest rates so low. Other countries have raised their rates recently. Raising rates now is inconsistent with any of the Fed’s QE’s. To engage in another round of quantitative easing the Fed may have to fight a worldwide trend. Such a trend of rising interest rates would put further pressure on U.S. Treasuries since money would tend to seek higher rates of return, and Treasuries would have to have higher rates to compete for funds. This is especially true with the recent public statements from S&P and the IMF regarding the Treasuries deteriorating soundness. The U.S. government may be ignoring the negative evaluations of U.S. government debt, but the rest of the world isn’t. (On the other hand, with the problems in the Eurozone, Treasuries are viewed as very safe by comparison and there could be no significant upward interest rate pressure on them. When things are going bad, it isn’t going to be very clear what will suffer and what won’t. That kind of uncertainty is the nature of government-induced instability.)
Once interest rates begin to rise, we shall see how badly the Fed is prepared for the real world. It is suggested that to avoid significant consumer price rises the Fed will have to aggressively soak up all the liquidity that they have put into the system since 2008. That is so even if that liquidity resides only in “member’s reserves”. “Sopping up the liquidity” means doing just the exact opposite from what the Fed has been doing the last three years. It means doing just the opposite from what Ben Bernanke has built his professional life around and what he has been hailed a hero for doing. Does anyone think that the Fed is really ready to reverse course in any significant way? If there is any reason to give credence to the hyperinflationists it is the prospect of interest rates rising and the Fed allowing the policies of the last few years to run their course. It is definitely the reality that if the Fed keeps things as it is now we could see hyperinflation. Our immediate future may depend upon how the Fed reacts to rising interest rates. To that extent our future rests in the hands of a few deluded, self-proclaimed geniuses.
I am not going to forecast what will happen over the next couple years. (I have been expecting interest rates to rise for over ten years.) We just need to keep a very careful eye on events here and abroad, especially in Greece and the Eurozone. We could also see problems in China.
Let me tie my most recent Inflation Update to the end of QE2. In the inflation update I am talking about the money supply and its effect on prices. The end of QE2 will reduce the upward pressure on the money supply some. Keep in mind that QE2 was aimed at longer-term Treasuries, thinking that lower longer-term rates would spur major borrowing. The Fed is still aiming to keep short-term interest rates low, and will continue buying Treasuries where necessary to keep those interest rates in the target area of zero to 0.25%. This upward pressure on the money supply will continue.
Let us suppose that QE2 did act as Bernanke anticipated. Businesses were attracted by the lower interest rates and did invest. Then, with the end of QE2 and interest rates increase because there is less money available to loan, then we should see less borrowing, less investing, less hiring, lower growth, and perhaps less money for the equity market. And still there will be pressure on the money supply, high commodity prices, and probable upward pressure on consumer prices (from various sources).
So, the bottom line is that the next few months offer even greater uncertainty than we have been living with since the residential real estate mortgage crisis began. I think that the only thing we can be certain of is that our governmental leaders, who have nearly unlimited sway over the money taps and financial/legal gimmicks that they can produce, are going to generally make wrong decisions.
I have final note about interest rates. I have seen reports that foreign central banks, big buyers of Treasuries in the past were absent in the last Treasury auction (and the Fed stepped in and made up the difference – indirectly). As the Fed will stop buying at the end of June, if the foreign central banks do not return, the Treasury is going to have to raise rates to attract buyers, from somewhere. I don’t want to suppose at all what levels the rates are going to have to be to sell the bonds that they need to. Actually, hitting the debt limit may be helpful to the Fed’s program because the Treasury will be limited in the quantity of bonds it can offer for the next few months. The interest rate tale will begin after the debt ceiling is lifted.
It is difficult to see what the foreign central banks are doing. There just aren’t many places for them to put the excess cash they are accumulating. Probably Japan is expecting to spend a lot on its reconstruction (meaning that their money supply will expand and the Yen vs. other currencies will get stronger as the central bank buys yen). But there really isn’t another source of even decent, high grade (which is a relative term), large volume bonds besides the US government. China has told the EU that it will continue to “support” them in the face of their expanding credit crisis. I haven’t seen an exact definition of “support”. It may mean that they won’t sell out of European bonds. It may mean that the Chinese will continue buying as they had before. I doubt that it means China will increase their buying. Europe is certainly not a candidate to replace the US as a place to park hundreds of billions of dollars a year. Remember that China has a large trade surplus with the Eurozone that rivals its dollar surplus and it is already buying lots of bonds from Europe. Is China just keeping cash? We shall see.
As was pointed out in an analysis I read (an email), the funds that the Treasury can attract to replace the foreign central bank buyers would be from the US private sector, who would want higher yields. But, if the money goes to the Treasury, it won’t go into equities or other investments, and thus, for sure, the stock market’s fun days will turn into sad ones. Also, the prospects for job creation, productive jobs, will diminish further (if that is possible). Unkle Ben is expecting a rebound in the last part of the year. HA!
So what would Bernanke do then, when interest rates start going up and the true lack of recovery is obvious? What does he advocate for every instance? What has he done? Make-up more money! Watch for QE17!!