Europe and Its Politicians

Europe's unemployment rate increased once more -- now at 12.2 percent.  This is the highest level since data collection on European unemployment began in 1995.  Expect new records ahead.

Too bad if you are young and live in Europe.  The unemployment rate is above 25 percent for those under age 25 almost everywhere in Europe and is well above 40 percent in places like Spain and Italy (lets not talk about Greece...their data, at this point, is probably suspect).

Meanwhile, the IMF has noticed that taxpayer bailouts mainly enrich hedge funds.  Why?  Because after sovereign debt collapses in price, hedge funds come in and buy it for 20 cents on the dollar and then sit back to wait for the bailout.  So, who wins.  The average taxpayer simply transfers large amounts of private wealth into the coffers of rich hedge fund tycoons.  Great policy!

It is now dawning on the IMF that restructuring sovereign debt (meaning a controlled bankruptcy) is a far better idea.  It puts the losses where the losses belong and doesn't end up using taxpayer wealth to subsidize hedge funds.  Wonder what took the IMF so long to understand what has been painfully obvious since this whole process began?

The assumption that Europe's problems were temporary and could be solved by taxpayer bailouts was an absurd assumption.   Just one look at European government spending and government revenues would convince anyone with a modicum of common sense that Europe's debts are unpayable.  There is no way out by the simple expedient of 'temporary' bailouts.  The numbers don't work and the sooner that is acknowledged the better.

Now that hundreds of billions of Euros of ordinary Europeans citizens' wealth has been siphoned off into the pockets of hedge funds by these absurd bailout policies, the IMF shows signs of waking up.  It's a bit too late, unfortunately.  Europe's problems are now far worse.  If Greece has been permitted to default on their sovereign debt four years ago, Europe would now be in a much better place.  But, politicians stepped in. 

The only way to reform Europe is to begin the process of controlled bankruptcies across the entire Eurozone.  It will be painful.  But, there is no choice.  Europe will end up with either a controlled bankruptcy or an uncontrolled bankruptcy.  That's the real choice.

The Significance of the Smithfield Acquisition

Chinese food giant Shuanhui  announced the purchase of Smithfield Foods this week.  This is a salient example of a process that has been underway for many years.

If one country has a 40 percent savings rate and another country has a zero percent savings rate, the country with the larger savings rate will, in time, buy all of the assets of the country with a zero savings rate.  That process is underway.

The US has had no net savings for several decades.  The reason for the absence of savings is twofold: 1) the private sector doesn't save because most Americans see no need; after all, the government guarantees income security and health care into old age (social security, medicare, medicaid); why bother to save (the Obama administration's recent suggestion to begin taxing IRA's provides some additional reasons for Americans to avoid saving); 2) the government sector is a big, big dissaver (that's what fiscal deficits are all about).

But America has investment spending.  Who provides the savings for this?  Foreigners.  Foreigners pay for this by buying up US assets.  Every year that passes, Americans own a smaller percentage of American stocks, American housing, American office buildings, etc.  Eventually, we will own nothing in this country.

Government policies that actively discourage savings work.  They are working now.  (Obama policies that actively discourage hiring work as well.  They are working now.  You get what you encourage and you lose what you discourage).

Anaphylaxis

My daughter Sally is at the Grand Central Academy of Art in New York. This is one of her still lives (yes, it's a painting). See if you can figure out what it means. Then click on the figure for an explanation. Don't miss "ceci n’est pas une molécule d’histamine." 

Yes, this has nothing to do with economics. It's just cool.

The Fed and Shadow Banking

The WSJ has a fascinating Op-Ed by Andy Kessler, "The Fed Squeezes the Shadow-Banking System" Andy thinks that Quantiative Easing has the opposite, contractionary effect.

QE is just a huge open market operation. The Fed buys Treasury securities and issues bank reserves instead. Why does this do anything? Why isn't this like trading some red M&Ms for some green M&Ms and expecting it to affect your weight?  (M&M of course stands for "Modigliani Miller" if you didn't get the joke.)

The usual thinking is that bank reserves are "special." They are connected to GDP in a way that Treasuries are not.  In the conventional monetary view, MV = PY.  Bank reserves, through a multiplier, control M. The bank or credit channel view says that bank reserves control lending and lending affects PY. The red M&Ms, though superficially identical, have more calories.

In Andy's view (my interpretation), that is turned around now. Now, Treasuries supply more "liquidity" needs than bank reserves, and (more importantly) the supply of treasuries is more connected to nominal GDP than is the supply of bank reserves.

Part of this inversion of roles is supply. In place of the usual $50 billion, we have $3 trillion or so bank reserves. Bank reserves can only be used by banks, so they don't do much good for the rest of us. Now, they just sit as bank assets in place of mortgages or treasuries and don't make a difference to anything. More treasuries, according to Andy, we can do something with.

More deeply, constraints only go one way. Normally, the banking system is up against a constraint. Reserves pay less interest than other assets, so banks use as little as possible. Now, they are awash in liquidity. You can't push on a string, as the saying goes. Much "constraint" economics forgets that once the constraint is off, the relationship doesn't hold any more.

Andy describes the repo market and the sense in which Treasuries are "special" in providing low-haircut collateral. Lots of academic research is now viewing Treasuries as special or liquidity-providing in the shadow banking system.

So, this is at least a gorgeous possibility: In a frictionless world, open-market operations, buying one kind of government debt (Treasuries) and issuing another (reserves)  have zero effect on anything, by the M&M theorem. Monetary economics thinks the M&M theorem is violated, because one kind of government debt (M) is connected to nominal GDP and the other is not.

But financial systems change. When the textbooks were written, banks mattered a lot, so bank reserves, leveraged to loans and checking accounts, were the "special" asset. In today's market, and given today's glut of reserves, Treasuries, leveraged to mortgage backed securities and money market funds through the repo market and "shadow banking system,"  might be the "special" asset connected to nominal GDP. In that case, the effects of open market operations might have the opposite sign. As Andy says,

... the Federal Reserve's policy—to stimulate lending and the economy by buying Treasurys..—is creating a shortage of safe collateral, the very thing needed to create credit in the shadow banking system for the private economy. The quantitative easing policy appears self-defeating, perversely keeping economic growth slower and jobs scarcer.

I'm not totally convinced, though this story and the alleged enormous demand for Treasuries is being bandied around as established fact. I'm also not convinced that this is all a good idea. Maybe the Fed should starve the shadow banking system.

You repo a security so that you can borrow against it. For example, you might buy a mortgage-backed security, then leave (repo, really) that security as collateral for a loan, which you used to buy the security in the first place. But what sense does it make to repo-finance a Treasury? You can't borrow at lower interest rate to make money on a Treasury! You could, possibly, if it's a long term Treasury and you're borrowing short, betting that interest rates don't rise. But I would think an interest rate swap or future would be a cheaper way to make that bet, and anyway betting on the slope of Treasury yield curve doesn't add up to the necessary GDP-linked lending that Andy has in mind.

In short, if you have money to buy a Treasury, why do you need to borrow? For any of this to get off the ground, you have to have some other, not totally rational,  reason for buying the Treasury, and then you want to borrow against the Treasury  so you can buy the risky asset that you really wanted all along. Who is that? Why is this such a necessary part of our financial system? Can't we fix things so they just buy the MBS with their initial cash?

Andy points out that repos are re-hypothecated. You use your Treasury as collateral against a loan, then the guy you gave it to uses it again as collateral to get the money to give to you. So one Treasury is used as collateral against two or three loans. Hmm. As the money multiplier creates run-prone structures, so using the same thing as collateral two or three times is a lot of what makes banks "too big to fail." If we all go down, who has the collateral?

A system awash in all kinds of liquidity, following the Freidman optimal quantity of money, seems a lot safer to me. I'd rather we expand the "bank reserve" concept -- fixed-value, floating-rate, electronically-transferable Treasury debt, and lots of it, washing the shadow banking system in liquidity and putting the run-prone structures out of business. Of course, open market operations would then have no effect in my world either, as I have removed the liquidity constraint in the shadow banking system just as Mr. Bernanke has removed it in the conventional banking system. But violations of M&M always mean the system can be made better.

If you want to comment and explain shadow banking, please use little words that the rest of us can understand.

Epstein on the IRS and more

Richard Epstein has a lovely essay, "The Real Lesson of the IRS Scandal" As lots of commentators left and right are realizing, this kind of outcome is baked in to our regulatory system. A small excerpt:

The dismal performance of the IRS is but a symptom of a much larger disease which has taken root in the charters of many of the major administrative agencies in the United States today: the permit power. Private individuals are not allowed to engage in certain activities or to claim certain benefits without the approval of some major government agency. The standards for approval are nebulous at best, which makes it hard for any outside reviewer to overturn the agency’s decision on a particular application.


That power also gives the agency discretion to drag out its review, since few individuals or groups are foolhardy enough to jump the gun and set up shop without obtaining the necessary approvals first. It takes literally a few minutes for a skilled government administrator to demand information that costs millions of dollars to collect and that can tie up a project for years. That delay becomes even longer for projects that need approval from multiple agencies at the federal or state level, or both.

The beauty of all of this (for the government) is that there is no effective legal remedy. Any lawsuit that protests the improper government delay only delays the matter more. Worse still, it also invites that agency (and other agencies with which it has good relations) to slow down the clock on any other applications that the same party brings to the table. Faced with this unappetizing scenario, most sophisticated applicants prefer quiet diplomacy to frontal assault, especially if their solid connections or campaign contributions might expedite the application process. Every eager applicant may also be stymied by astute competitors intent on slowing the approval process down, in order to protect their own financial profits. So more quiet diplomacy leads to further social waste.

Richard goes on to skewer the FCC, the EPA, and the FDA. The fight over approval of liquid natural gas exports, which Richard doesn't mention is a perfect example.

I think the point is larger still. The ACA (Obamacare) under Health and Human Services and financial regulation under the Dodd-Frank act are even more stark instances of the phenomenon.  The regulations are immense, vague, contradictory, and demand discretionary approval by regulators.  For a company to speak out against those acts is very dangerous.

India's sclerosis was once described as the "permit raj." That describes our future well.

But at least Americans are still outraged at this sort of thing. At least, unlike most other over-regulated countries, regulatory discretion is still traded for political support, not suitcases full of cash. However, what Epstein makes clear is, a witch-hunt at the IRS won't solve the problem.

The larger answer here seems pretty clear to me too. Why do we have tax-exempt status for any political groups? Actually, why do we have tax-exempt status for any groups at all? It's easy to be a non-profit -- just don't make any money.  When you look at what a lot of "non-profits" do, how efficiently their money is used, the idea that we should be subsidizing most of them seems pretty silly. If we chucked out the whole tax-exempt business entirely, and allowed people to give money to any group they feel like giving it to without tax preference one way or another, the whole temptation for the IRS to hand out this subsidy in nefarious ways would vanish.

Local Austerity

The Wall Street Journal had a really heart-warming article, Europe's Recession Sparks Grass-Roots Political Push  about groups taking over local governments in southern Europe, and cleaning out years of mismanagement. An excerpt

At her inauguration Ms. Biurrun [the new mayor of Torroledones, Spain] choked up before a jubilant crowd.

Then she began slashing away. She lowered the mayor's salary by 21%, to €49,500 a year, trimmed council members' salaries and eliminated four paid advisory positions.

She got rid of the police escort and the leased car, and gave the chauffeur a different job. She returned a carpet, emblazoned with the town seal, that had cost nearly €300 a month to clean. She ordered council members to pay for their own meals at work events instead of billing the town.

"I was so indignant seeing what these people had been doing with everyone's money as if it were their own," Ms. Biurrun said.

Those cuts, combined with savings achieved by renegotiating contracts for garbage pickup and other services, helped give a million-euro boost to the city treasury in her first year in office.

Great, no?

But wait, isn't this all "austerity?" Isn't cutting spending  exactly the kind of thing that Keynesian macroeconomists, as well as the reigning IMF-style policy consensus decries, saying we need stimulus now, austerity later?

Keynesian, and especially new-Keynesian economics wants more government spending, even if completely wasted. Those trimmed salaries, fired "advisers," cleaning bills, restaurant spending, overpaid contracts are, in the standard mindset, all crucial for "demand" and goosing GDP.  If stimulus advocates were at all honest, they would be writing blog posts decrying Ms. Birrun and her kind.

Of course they don't. Abstract "spending" sounds good, and touting abstract "topsy-turvy" model predictions sounds fine.  But when it is concrete, it's so patently absurd that you don't hear it.

The Greek city of Thessaloniki cut costs after Yannis Boutaris, a businessman-turned-politician, took office in late 2010 and ended City Hall's relationship with a few selected providers. Competitive bidding has saved the city 80% of its previous spending on accounting, 25% on waste disposal trucks and 20% on printer paper. The savings have allowed Mr. Boutaris to spend more on social services, even while cutting taxes and paying down City Hall's debt to suppliers.

How sad. So much "demand"-destroying "austerity."

(Of course, the main point of the articles is about a political realignment, in which local governments are becoming responsive to local voters, transparent, and efficient, rather than being cronyist machines of national political parties. I can't imagine anyone not feeling warm about that!)

Update: Courtesy Marginal Revolution, I found this nice story about the new Spanish $680 million submarine that will sink if put in water.  MR snarkily asks "did this help Spain or hurt Spain." $680 million of government spending raises Spanish GDP by nearly $1 billion, so this is great, right?

Hitchhiking across America: embracing optionality and risk

Have you ever wanted to spend a month hitchhiking your way across country, or see the American landscape pass by from the inside of a freight train boxcar? 

In the Vice documentary series, How to Hitchhike Across America: Thumbs Up, artist David Choe and his friend/nephew Harry Kim show us how to do just that. 

 

Note: You can watch the full series by clicking through to the next episode link at the end of each clip.

I started watching this series on YouTube without any real expectations and was sucked in. The two start off hopping a freight train out of Los Angeles. As they make their way, slowly, to Las Vegas, we hear a bit of back story on David's life and their immediate plans for the trip. 

While I won't give away all the details of their trip, I will say this: only in America can you hop out of a freight train boxcar and walk right over to your comped room at the Venetian.

Now, what I didn't know until after I started watching is that David Choe is a rather well-known graffiti artist and painter. In fact, back in 2005 Choe was hired by Sean Parker to paint some "graphic" murals on the walls of Facebook's first Silicon Valley office. David took company stock in lieu of cash for his efforts. Those shares were worth $200 million at the time of Facebook's IPO (about 5 years after this series aired).

As you watch David and Harry make their way across country, you begin to notice a theme. Aside from their most immediate concerns - finding a place to sleep, hitching a ride to the next town - there is no preplanned structure to their days. If the guys see an opportunity to have some fun or meet someone new, they take it. 

Sure, there's a great deal of risk in this style of travel. When they're not avoiding cops or railway security guards, the guys discuss their fears of being mugged or raped, while also acknowledging the fear most drivers have of them. It's not easy hitching a ride from strangers in a time when, as one of their new pals offers, "the media has us scared of each others' shadows". 

David and Harry and their fellow travelers have embraced these risks and try to meet them as best they can, while opening their lives to a sense of freedom and optionality. They go where they want and they can take the odd detour on their way if they so choose. In this, they might find approval from Antifragile author, Nassim Taleb, who argues for an anti-fragile world of "many highway exits and options" (more on that here). 

While I watched their (well-edited) adventure unfold, I wondered about the benefits of such of a lifestyle. Although these two can probably choose to dip in and out of the hobo life at will, maybe they're gaining an insight into America, and life, that some of us may never have. Is it possible their serendipitous travels and approach to life might open up opportunities that may never have come if they were shackled to their work desk or stuck inside a corporate office? 

While we ponder that, I'll leave you with this quote (thanks Wikipedia!): 

"It has often been said that Choe's greatest artwork is his own life. As his friend Jason Jaworski explained, "For me, there is no artwork Dave or anyone can create that is capable of completely equalling the vast canvas of Dave's life, which he paints daily while simply living." 

Your life is your own unique canvas. Try to paint something you'd want to see.