Posts Tagged: zero interest rate policy

American Society / Oil / Political — 0 Comments
30
Jun 11

The Law of Opposites

In management settings, the law of opposites applies far more often than many executives would admit.   On its face, the law is counterintuitive.  One concentrates much energy and time on setting and achieving a certain goal and despite best efforts the exact opposite occurs.   This paradoxical construct is closely allied to another behavioral law: that of unintended consequences.   Writing about politics and government, Ron Paul gives us some insight and some examples:

Everyone is aware of the Law of Unintended Consequences. Most members of Congress understand that government actions can have unintended consequences, yet few quit voting for government “solutions” – always hoping there won’t be any particular unintended consequences this time. They keep hoping there will be less harmful complications from the “solution” that they currently support. Economics teaches that for every government action to solve an economic problem, others are created. The same unwanted results occur with foreign policy meddling.

The Law of Opposites is just a variation of the Law of Unintended Consequences. When we attempt to achieve a certain goal – like, “make the world safe for democracy,” a grandiose scheme of World War I – one can be sure the world will become less safe and less democratic regardless of the motivation.  See The Law of Opposites

Opposites and Consequences in the Workplace

In the business world, both laws frequently apply.   Oftentimes employees complain that they are not appreciated or promoted.  Worse, they observe less qualified employees who are.  My advice on promotion to any employee was:  forget about it.  Go back, do an outstanding job, and hope that excellence will be recognized and promotion will follow.   Most of the time, the complaining individuals spent much of their time not doing excellent work because they spent way too much of their time complaining.  These were the schemers, not the doers.  Inevitably, the job performance of these employees suffered.  These employees did not want to hear:  “relax, go back, work hard and do a good job.”  They felt there was some secret formula that I, the supervisor, was hiding from them.   While it is naïve to think that everyone who does a good job gets promoted, it is a sure bet that needless complaining won’t get an employee there.

Similarly, friends and colleagues in conversation would often say how they wanted to be rich.   Rarely does a person become quickly and safely rich.    The fantasy goal in these conversations was usually some high risk, short term investment which would provide that mythical short cut to riches.  Alas, the only short cut to riches isn’t that at all:  it is hard work, thrift, consistency, perseverance, and perhaps a little luck.   My best advice to these friends and colleagues is similar to the directives to my “underappreciated” employees:   relax, save some money, invest wisely and grow rich over time.

Paradoxically, the more one focuses on a goal, the less the chances of success.  It is much like the philosophy of  Inner Tennis: Playing the Game:  the more one focuses on the score and winning the game the less likely one will succeed.  Relax, see the ball, hit the ball, success will follow.

Solving Economic Problems

This personal rumination brings me, once again, to the actions of the current administration.  Somehow bailing out the banks and car companies, setting interest rates at zero, and printing money was going to solve our economic problems?  What did we get by doing this?  A slumping economy (euphemistically called a “soft patch”); falling house prices; 45 million Americans on food stamps, and soaring food and energy prices.   While the goal of the Administration was not to destroy the economy, look at what has occurred.   Speculators in stocks and commodities have thrived at the expense of taxpayers and millions of our citizens.

The latest Administration skirmish with the law of opposites was tinkering with the strategic petroleum reserve (SPR).  On June 23, the International Energy Agency (IEA), with full support of the Obama Administration, released 60 million barrels of oil from its reserves.  Fully half of these reserves came from the US.  Republicans and others claim that this effort was done for political reasons to lower pump prices for beleaguered consumers before the 2012 election.   See Global Oil Reserves Tapped in Effort to Cut Cost at Pump.  The Huffington Post applauded this maneuver.  While conceding 60 million barrels represents only 16 hours of worldwide oil consumption, prices dropped 6% and speculators were chastened.  See Strategic Petroleum Reserve Release under Fire – For Being Effective.

But the strategy was transitory, ephemeral, and ineffective.  By Tuesday, June 28th, both crude and gasoline prices surged past the price they had been at immediately before the June 23rd IEA release, a reprieve from higher oil prices of just five days.

Kevin Kerr, of Money and Markets predicts that the release will completely back fire, and will result in a dramatic spike in prices:

It’s another foolish rob-Peter-to-pay-Paul action by the imploding U.S. government.

The careless action taken by the IEA and President Obama, has now underscored how worried they actually are about global economic growth and tight supplies. So in essence this move could actually stoke the fire to drive prices much higher, much more quickly.

In a recent Bloomberg report, Caroline Bain, of the Economist Intelligence Unit, was quoted as saying:

“Although the immediate impact of the IEA’s reserve release will be to depress prices, in the more medium term, it could actually be bullish for prices. Reserves are finite and cannot be released forever.”

Unlike Uncle Ben’s printing press that never seems to run out of ink, oil supplies are not something the U.S. government can simply print more of.

To put the gravity of the situation in perspective, this is only the third time in the past 50 years that IEA has released strategic reserves. And in order to tap the SPR, President Obama had to authorize it.

Frighteningly, the prior two times resulted in super-spikes. And I think we can expect that record to hit 3-0 very shortly.  See Why Obama’s Desperate Move Could Send Oil Prices Soaring

Once again, the Administration undertook a policy shortcut for political reasons  and it backfired.  Further, we have renewed speculation in a key commodity.   Wouldn’t a more functional way to deal with high oil prices be to encourage supply increases through responsible exploration, and reduce demand through conservation?

Gimmickry

Unfortunately we live in the age of gimmicks.   If we could only find the right interest rate, the most robust stimulus package, the most flexible accounting rules, a way to get the stock market to boom, or the right oil price our economy would be healed and we would again be prosperous.   The law of opposites mandates that the longer we focus on the problem and tinker, the more those nasty, unintended, negative consequences will occur and move us further away from our goal.   Only hard work, thrift and political integrity solve these intractable problems, yet the Administration and the Federal Reserve keep searching for the quick fix.   As long as that is the case, we are doomed to more unintended consequences, shaky financial markets and a weak economy.

 

 

 

 

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American Society / Economics / Journalism / Technology — 0 Comments
13
Jun 11

The New York Times Finally Discovers Structural Unemployment

We have visited the issue of structural unemployment several times.  See, e.g. Unemployment and the Fall of Labor, Why this May be Worse than the Great Depression and The New Reality: Permanent Job Loss.   Let’s define it again:

Joblessness caused not by lack of demand but by changes in demand patterns or obsolescence of technology, and requiring retraining of workers and large investment in new capital equipment. Source:  Business Dictionary

How incredulous that it took until June 9th, more than three years into the current recession, for The New York Times to finally discover this “new” reality. Companies Spend on Equipment, Not Workers.

What Did the Times Discover?

Workers are getting more expensive while equipment is getting cheaper, and the combination is encouraging companies to spend on machines rather than people. See Companies Spend on Equipment Not Workers

The article at issue focuses on a Minnesota plastic products manufacturer which hired only two workers, but spent almost three times more on new labor saving machinery. The Times attempts to draw from this example some larger societal and economic points:

  • American workers just can’t compete with Chinese and other low cost foreign workers.
  • Since the recovery began, equipment prices have declined 2.4% while labor costs are increasing about 6.7%.
  • The four newly purchased machines mentioned in the article all come from foreign suppliers.
  • Much of the labor cost increase arises from increasing health care costs and other benefits.
  • Hiring has hidden costs:  including days spent culling the resumes of unqualified applicants.
  • Many applicants lack basic writing, mathematical, technical or computer skills.
  • New employees must go through a federally required safety program, be drug tested at a cost of $150 and require ongoing training, which diverts management from other work.
  • “You don’t have to train [or drug test] machines.”  Generous depreciation allowances and tax credits favor investment in machinery rather than people.

I would argue that The Times article misses one key point, zero interest rates.  Holding interest rates at artificially low levels further encourages equipment purchase rather than new employment.

Complete Lack of Journalistic Insight?

The Times has an amazing lack of self awareness.  Perhaps reporters and editors forget their own editorial stance on key issues:

  • Free Trade – We were implored by The Times to support free trade and open our borders to foreign goods.  These goods are often produced by workers earning less than a dollar a day without employment, safety or environmental protections. How could American business hope to complete with this?
  • Economic Stimulus – Among other incentives, The Times has advocated liberal tax breaks for equipment purchases.  Is it surprising that employers indeed invest in labor saving equipment?
  • Zero Interest Rates – Krugman and other Times editorial and op-ed writers have favored Bernanke’s zero interest rate policy.  With ultra low borrowing rates, of course employers purchase equipment rather than higher cost labor.
  • Obamacare – Once again, The Times has supported a government initiative that effectively has put a stranglehold on employer benefit costs.
  • Other Pro-Worker Legislation – The Times has long promoted employment and labor law reforms which make hiring expensive: The Family and Medical Leave Act, The Americans with Disabilities Act, The Older Workers Benefit Protect Act all have hidden costs which make hiring unattractive.  Couple that with attempts to expand union involvement, and employers are compelled to favor machines over people.

Late to the Party Again

Once again, the pre-eminent New York Times is not reporting the news, but rather restating the obvious. Why have they missed another major economic trend?  Their reporters are smart but ideological.  They are ideologically and emotionally wedded to Keynesian nostrums of economic stimulus and ultra loose monetary policy.  If instead they took a holistic view of what is happening in the real economy, following real business people making real hiring and investment decisions, they would be forced to reassess their adherence to old and dubious politics and theory.

If The Times is about all the news that’s fit to print, it should be least be subjected to  intellectual rigor, and critical and honest thinking.  And let’s not forget timeliness; do we really need to clutter Page One with what we already know?

 

 

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American Society / Banking / Business / Corporate Behavior / Financial / Political / The Federal Reserve — 0 Comments
30
May 11

Wildfires and the Economy

Sometimes very wise things are also very simple: like a story for children.  I am a mentor volunteer for local disadvantaged fourth graders. This week’s reading assignment was to read and discuss Wildfires, a short children’s book written by Seymour Simon.

The author’s theme seemed contradictory:  wildfires are not always harmful.  Rather, they are part of the natural cycle of forest life.   They occurred well before man populated North America.  Extended droughts provided the necessary environment so that when lightning storms arose, wildfires ensued.   No firefighters or park rangers impeded the natural order of things.   Eventually, enough rain fell to extinguish a fire, or a fire would run out of fuel.

In elegant language understandable to fourth graders, Mr. Simon advocates a controversial and grown up point. The US Forest Service actually did a disservice to the long term health of our forests.   Our ecosystem needs fires to allow light to reach the forest floor, to remove kindling which could cause even larger conflagrations, to permit certain animal species to reproduce, and to allow tree seeds to travel and reproduce.  New and natural growth cannot occur without the cleansing effect of a wildfire.   We now understand that aggressive firefighting was poor governmental policy that actually damaged the environment.

An Economy Managed Like a Wildfire?

The economic analogy is obvious.  When the 2008 great financial crisis occurred the Treasury and the government overreacted.   Treasury pleaded with Congress to create bailouts: TARP, TALF and an alphabet soup of other programs.  The Federal Reserve aggressively lowered interest rates to zero and made bank purchases of distressed mortgage-backed securities and other poorly-rated assets.   Finally, the Administration went on a policy and public relations campaign to save GM, Chrysler, GE, AIG and other large private companies.   Government chose to aggressively fight the financial wildfire.

Policy makers forgot that, like a healthy forest, capitalism requires “creative destruction.”   Coined by Joseph Schumpeter in his work entitled “Capitalism, Socialism and Democracy” (1942), this term denotes a “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.”

In a properly functioning capitalist economy, old or dysfunctional businesses must be discarded and  replaced by more dynamic enterprises.    If not, we would still be powering computers with vacuum tubes instead of advanced generations of semiconductors.

Killing the Business Cycle

On Friday, David Goldman’s blog Inner Workings pointed out the fallacy of aggressive governmental steps to arrest the financial crisis.  His prediction:  we will be mired in a little or no growth mode for years.

I’ve been on Larry Kudlow’s CNBC show arguing that the US will have 2% growth indefinitely–no real recovery, no double dip, no banking crisis, but no bank stock rally. Today’s depressing numbers are in line with my depressing expectations. We’ve got a creative-destruction economy, without the creation: the startups, the venture capital, the entrepreneurship. MySpace and LinkedIn don’t count: they are a faddish extension of old technology, a means by which Americans who bowl alone can pretend to have lots of friends.  The People’s Republic of America Reports 1.8% GDP Growth (or: Why this is NOT a Business Cycle)

Lending to create new businesses has evaporated.  In fact, credit creation is moribund.  Banks are happy to borrow at low interest rates and reinvest at higher interest rate government securities without undertaking the riskier business of lending.  New business formation is harmed.  Multinational corporations are satisfied with earning profits outside the United States, which means we have anemic job growth.  We are mired in a non-recovery recovery.

Let the Light In

In our wildfire analogy, the largest trees are the ones that most need to be eliminated.  These are the ones that block growth on the forest floor.   Government may have temporarily arrested financial decline, but at what cost?   I grant you that it will be painful to permit the creative destruction of our “tallest trees”: poor performing banks and industrial companies.   The pain would be sharp but not prolonged.  Using another analogy, we needed to rip the economic band aid off quickly to minimize prolonged pain.http://www.prophetwithoutprofit.com/wp-admin/post-new.php

Mr. Simon in Wildfires pointed out another flaw in aggressive fire fighting:  putting out smaller fires too early.  Dangerous residual undergrowth became tinder for more destructive, larger, out of control wildfires.   Similarly, our government did not fix the financial problems of 2008; they only postponed our date with a larger financial conflagration.

 

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Economics / Financial / Political / The Federal Reserve — 0 Comments
1
May 11

Business as Usual?

In Economics and the Welfare State: Oil and Water we discussed the flaws of current economic policy.  The Federal Reserve continues zero interest rates and quantitative easing in hopes of controlling interest rates, the stock market and re-igniting inflation.  The Administration and Congress are locked in a meaningless battle over the debt ceiling and budget cuts.  We are in a morass.  Where did we go wrong?

The Failure of the Two Party System

The current budget and debt ceiling debate demonstrate the intellectual bankruptcy of the two party system.   We are saddled with an annual federal budget deficit of $1.6t.  We can only expect this number to increase.  Congress and the Administration have agreed on a deficit reduction of $38 billion which in reality may be a reduction of an even more paltry $353m.  See $38 Billion in Cuts? Make that $353 Million.

While Americans believe there are major differences between the parties, is there really a large ideological divide on economic matters between Democrats and Republicans, liberals and conservatives?   A close analysis reveals little difference.  And they both close ranks in support of the Central Welfare State.  Wittingly or not, both parties have weakened regulatory oversight.  Both parties participate in bureaucratic fiefdoms immune from budget cuts.

Thus, we see support for:

  • Dysfunctional health care
  • Medicare
  • Defense spending
  • Foreign military adventures
  • A tax code laced with corporate loopholes
  • Social security
  • Crony capitalism where losses from the financial system are transferred to the public

See Paradoxes at the Heart of the Conservative Project, Paradoxes at the Heart of the Progressive Project.

The Pernicious Federal Reserve

For almost three years, Fed policies have had a deleterious effect on the economy.  Every few weeks a Fed spokesperson announces while there are signs of economic growth, it is too soon to raise interest rates or end quantitative easing.  See, e.g., Bernanke Sees Economic Growth Through 2013, Fed’s Yellen Says Economy’s Improvements Don’t Warrant Exit from Stimulus.

Perhaps the Federal Reserve’s continuous support for the economy through its easy money policy is the cause, not a consequence, of the economy’s weakness.  The Fed has created a dangerous co-dependency.  Analogizing the Federal Reserve’s pathological support of the economy to patients on a ventilator, Brian Pretti found:

…the fact is that the longer a patient remained on a ventilator, the greater the chances they would not be able to be weaned off of the machine.  The body “learns” not to breathe on its own after a period of time.  Essentially a patient would pass a critical window of recovery weaning period opportunity.

Pretti uses the example of the Japanese economy:

…this analogy is incredibly apt in terms of describing the reality of the sovereign debt fiscal trap.  The longer Japan has been on the artificial zero interest rate “breathing machine” over the last decade plus, the harder it has become to wean itself off.  Although I could spend an entire discussion on Japan alone, I personally believe Japan has already passed the critical “weaning period” demarcation line for zero bound interest rate/monetary policy.  We’re Just Gonna Inflate Our Way Out of It?…Oh Really?

Current Federal Reserve policy is mirroring the actions of the Japanese central bank.

We Need New Policies

We cannot sustain the current economic path. David Stockman, in a CNN interview with Elliott Spitzer, laid out simple, workable solutions.   We must enact budget cuts and increase tax revenues.   We must significantly cut the defense budget and civilian entitlement programs.  The Bush era tax cuts need to end.

http://money.cnn.com/video/news/2011/04/12/n_stockman_0412.cnnmoney/

Stockman is advocating what I have advocated before: shared sacrifice.  In his words, the “wolf is at the door.”

Failure of Business as Usual

Continuing business as usual will result in a financial crisis many times the magnitude of 2008.  We need to cut deficits, raise taxes, end Federal Reserve intervention and end profligate Congressional and Administration spending.  We need to give this sick patient, the economy, a chance to breathe… before it suffocates.

 

 

 

 

 

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Banking / Corporate Behavior / Executive Compensatio / Justice System / Political / The Federal Reserve — 0 Comments
22
Apr 11

Over Compensating

Executive compensation is a “hot button” issue.  Corporate executives argue the need for a free hand in setting compensation:  we must attract and retain high performing executives.  They further argue that correctly tailored compensation creates appropriate incentives to increase shareholder value.  According to this thinking, this aligns management and shareholder interests.

Shareholder activist groups strenuously disagree.  Management over compensates itself, and awards senior executives hundreds of times the average worker salary.  Equity compensation (options, restricted stock grants) richly rewards management at the expense of diluted shareholders.   Even more egregious are executive compensation increases even when the corporation has a bad year or underperforms its industry peers.  Boards of Directors, who should be guardians of shareholder interests, are often too aligned with ineffective management. True confession: executive compensation issues comprised much of my career.  Generally, I agree with keeping the government out of the executive compensation process.  In my view, management knows its own business and knows the market for top talent. With Board of Directors’ review, advice and consent, let management set compensation and let the chips fall where they may.  Internal safeguards and shareholder activist groups inevitably punish bad or greedy managements.

However, there is one industry where the government needs to take an active role in setting executive compensation.

Is Goldman Sachs Allowed To Fail?

Simon Johnson, former IMF chief economist, asks the question:  if another financial crisis appears would Goldman Sachs be permitted to fail and follow the Lehman Brothers bankruptcy route?  See Could Goldman Sachs Fail? Johnson polled leading experts who unambiguously stated that Goldman would be bailed out again.  Goldman’s balance sheet at $900b would be just too big to permit bankruptcy.  Dodd-Frank legislation which has resolution authority to handle a large bankruptcy would be ineffective because of the international scope of Goldman’s operations.

While Goldman is one case study, Mr. Johnson could ask the same question about JP Morgan, Citibank, Wells Fargo or a number of other large American financial institutions. I believe he would get the same answer: they are too big to fail. Thus, the experts agree that these institutions have a favored position in the market place: they borrow at below market costs, and benefit from the full faith and credit guarantee of the US government.

A Modest Proposal or a Proposal for Modesty

Mr. Johnson posits that the only solution is to “press hard for higher capital requirements for Goldman and all other big banks.”  More capital would permit absorption of more losses in the event of a financial crisis.  Allow me to propose an alternative.

Goldman and other large banks pay out nearly half their revenue in compensation:  amazing that this practice has not received more government scrutiny.   As we know from Untimely News That’s Unfit to Print, the government is afraid to prosecute these banks for their financial misdeeds.  How about severely limiting executive compensation?

I can hear the howls from Wall Street now.  How can we attract the best talent?  This is antithetical to the principles of the free market!  Our work would not be properly valued!

When a bank accepts bailouts from the government (TARP), when it enlists the government to make good on derivative bets (AIG and Goldman), when it is subsidized by American savers through a zero interest policy, and when it receives a full faith and credit guarantee of the US government,  that bank is no longer a free market enterprise.  That bank is a ward of the state.  As such, its compensation should look more like the federal civil service pay scale.

Controlling and changing bank top management pay scales in this way would be hugely beneficial:

  • Banks would be able to retain more earnings, and immediately improve their capital base.
  • Shareholders would benefit as more cash would be available for dividend payments.
  • The productive economy could successfully compete for the best university graduates.
  • Wall Street firms would shrink.
  • Systemic risk of too big to fail institutions would diminish as would rent seeking behavior.
  • The real economy would flourish.

Perhaps we should start a new campaign:  Government Service Levels (GS) for Goldman Sachs (GS). Put more simply:  GS for GS.

 

 

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Banking / Financial / Municipal Finance / Pensions / State Finance — 0 Comments
22
Oct 10

Elements of an Unstable Financial System

We are currently caught up in the day to day gyrations of the stock, bond or foreign exchange markets.   Politicians tell us that we are recovering, but we just need more stimulus packages and investment tax credits.   The Federal Reserve proudly takes credit for “the recovery.”  They maintain we have avoided a depression, but at the same time report monthly that we need interest rates at zero indefinitely.  Members of the Federal Reserve and the financial press strongly hint that we need a second round of quantitative easing (the monetizing of debt), even though this program ended in March 2010.

This highly unstable financial system threatens to wreck the economy, deplete retirement savings and imperil democracy.  This is not hyperbole.  Let’s examine the indicia of instability:

  • A Failing Banking System – So far this year, 120 banks have failed.  This is well ahead of last year’s failure rate.  As of August, 829 of a total of 7800 FDIC supervised banks were on a watch list.  A watch list indicates a high probability of bank failure.  The prior year 416 banks were on this list.   See FDIC Finds 829 U.S. Banks at Risk
  • Foreclosure-Gate – Poor documentation during the foreclosure process, ranging from false affidavits to improper notarizations to suspected forgeries, looms as the next big scandal.    All this will lead to the real issue of violation or representations of representations and warranties during the securitization process.  It has already led to financial participants attempting to return mortgage backed securities to their originating banks. See Pimco, Blackrock and New York Fed  Seek Bank of America Mortgage Putbacks. Other money center banks face similar demands.  For just Bank of America, Goldman Sachs analysts predict the put back liability could be as much as $25b.  Foreclosure-gate and the “put back wars” will tie banks up in expensive litigation for years with the prospect of large losses.  See Goldman on Total BofA Putback Losses:$25 Billion Which Apparently is a Good Thing
  • High Frequency Trading – Lightening fast computer trading now dominates daily stock exchange activity.  Trades are based on small pricing differentials rather than stock fundamentals.  On May 7th, the Dow Jones Industrial Average plunged 700 points in 5 minutes.   The SEC investigation attributed the crash to high frequency trading.  See Speed-Addicted Traders Dominate Today’s Stock Market
  • QE2 and Government Manipulation of Asset Prices – Brian Sack of the New York Federal Reserve has openly stated that the goal of the Federal Reserve is to put a floor under asset prices.  Thus, the government is deliberately targeting and manipulating stock prices. Moreover QE2, which is the Federal Reserve openly buying government debt, has inflationary and even hyperinflationary potential. See Managing the Federal Reserve’s Balance Sheet
  • Exodus of Retail Investors – Government manipulation, high frequency trading, wild market gyrations and economic circumstances have driven the retail investor from the stock market.  The Investment Company Institute reports the 24th consecutive weekly retail outflow from equity mutual funds.  This year to date $81b has been withdrawn. See 24th Consecutive Outflow from Domestic Stock Mutual Funds is in the Books
  • Currency Wars – Despite denials from Secretary Geithner, the Administration and the Federal Reserve have engineered a 10% decline in the dollar since June 2010.  Import prices have skyrocketed for resources such as oil.    This has triggered currency wars between nations.  Foreign governments have responded with attempts to depreciate their own currencies and impose capital controls. See As Currency Declines, Currency Conflicts Arise
  • OTC Derivatives – Various forms of derivatives (credit default, interest rate and foreign exchange instruments) were one of the culprits for the 2008 financial crisis.  The Bank for International Settlements estimates that $600T of these instruments are currently outstanding.  One expert estimates that losses could run from $12.5T to $20.5T in the next crisis, with many institutions defaulting higher losses.
  • Zero Interest Rate Policy – This is a two-edged source of instability.  Banks can borrow at zero percent and use the funds to speculate, confident that the government will cover their losses.  Earning little in safe investments, prudent savers are encouraged to spend or speculate with their dwindling savings. See Why is Charles Schwab the Only One Concerned About Zero Interest Rates?
  • Leverage – The Basel III agreements were intended to impose more stringent capital requirements.  The agreement permits banks to leverage their deposits 20 times.  In the past 12 times leverage was considered prudent. Said another way, a mere 5 percent decline in an investment position under Basel III would result in the entire position being negative. See Basel III Summary, and the Fed’s Endorsement of 20x+ Leverage
  • Sovereign Default – Ireland is only the latest victim of an unstable international financial system. Initially forced to adopt austerity measures, the government recently had to bail out an Anglo-Irish bank that had just passed the EU stress test.  See An Angry Ireland Calls Out Europe.  The specter of sovereign default still remains in Europe and experts have questioned the soundness of US debt.
  • Looming Bailouts – Underfunded pension plans and state and local governments’ running huge budget deficits are the next potential candidates for massive federal bailouts. See, e.g., Is a $1 Trillion Bailout Ahead of State Pension Funds?

Strange Brew

Lack of government regulation, poorly thought out government interventions,   mercantilist government policies, greed, and a myriad of other factors have created a strange brew.  Every day we witness violent swings in the fixed income, stock market and foreign exchange markets.  These gyrations have consequences in the real world as markets soar and crash.  Savers are also consumers and their incomes have been destroyed.  Consumers are threatened with higher food and energy prices.  There is no safe place to invest funds.  The success of the domestic economy depends on the whim of one man, Ben Bernanke.  It is no surprise that investors are fleeing financial markets, and that gold soars.

We are running headlong into Stein’s Law (named for Herbert Stein, Nixon and Ford’s chief economic adviser): “if something cannot go on forever, it will stop.”  But when these gyrations stop, probably sooner rather than later, we will be headlong into the next great financial crisis.

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