Commodities Bust depends on the beholder
Posted in Uncategorized by demandside on April 1st, 2009 Plus News and James K. Galbraith on the Geithner Plan Today Idiot of the week and the history note are combined on the subject of the commodities bust of 2008. And we let James K. Galbraith speak to the point regarding the Geithner plan.
But first the News.
Are T bonds a bubble?
http://www.nytimes.com/2009/03/22/magazine/22wwln-lede-t.html?ref=business
Answer: No. Essential to a bubble is easy credit. This is, as we’ve noted, the reason it is so inane for the Fed to say it cannot see bubbles until after they have occurred. Bubbles do not occur without active Fed participation.
Similarly inane is a grade of “F” the WSJ gave to the economic policies of Obama and Geithner. The Wall Street Journal and the economists it polls deserve an “F.” Obama deserves a passing grade, even a B, pending the outcome of the fracas with the financial sector, which I have to suggest is not going well.
We’ve said for more than a year that it is the function of the financial sector that must be preserved and enabled, not the institutions themselves.
I’m sorry to say it, but your 401(k) and all the stocks and bonds and derivatives in the whole casino could disappear taking that money wealth down with it and so long as we could transfer value from the future to the present by way of credit, the economy would do just fine.
In fact, it is the multi-colored chips on the financial tables that are the problem. They are somebody’s idea of how to get rich that didn’t work out and now they are expecting the federal government to make good on them, because after all, we need a functioning financial sector.
It appears to me that the Fed is gradually taking over all the functions of the banks themselves, because the zombies cannot motivate in the proper direction, but must continue to eat their young. The AIG bailout, for example, was a backdoor bailout to banks. CDS’s needed their collateral call.
We could rebuild America by rebuilding America, rather than trying to resuscitate these consumer pandering failures. One statistic last week that caught everybody but Demand Side off guard was the rise in machinery and equipment purchases. We’ve said from the start that the infrastructure spending would generate economic activity long before dollars were paid out on contracts because contractors need to gear up to do the work, investing and buying ahead of time. It is our sincere hope that these contractors are not constrained by credit market problems.
http://economistsview.typepad.com/economistsview/2009/03/grading-obama-on-the-economy.html
David Goldman March 26 http://blog.atimes.net/?p=812
From the Financial Times via David Goldman:
While US private wages and salaries fell for the fifth consecutive month in January, so-called “transfer payments” - such as old-age and unemployment benefits - surged 3.5 per cent. That helped consumer expenditure but also contributed to a jump in the savings rate to 5 per cent of disposable income, from 3.9 per cent in December and from close to zero a year ago. That’s zero to 5 per cent in under a year.
…US net flows into savings have gone into only two places — bank savings and US Treasuries, according to Charles Biderman, chief executive of TrimTabs, a research group. Both asset classes, he noted, offer extremely low yields with a high degree of safety. “During an economy where equity prices are down about 50 per cent and home prices down about 30 per cent or so, is there any question as to why money is flowing only into the safest bets?”, he told the FT.
Interestingly, adds Biderman, the previous record year for a rise in US bank deposits was 2002, following the dotcom boom, when deposits rose by $465bn. “During hard times people worry about return of principal, not return on principal”, he concluded.
For example, recently he illustrated the fact that Keynes dealt in mathematical models by illustration of a simple relationship expressed in mathematics. Would we say Keynes dealt in Portuguese if he could be translated into that language.
He continued with a short note on the gold standard in the Great Depression. But later he illustrated why math can get you stuck if you step in it too deeply with his reflection on the automatic stabilizers which are much more a part of Europe’s economy than that of the U.S.
Quoting
March 27, 2009, 12:58 pm
European stability
http://krugman.blogs.nytimes.com/2009/03/27/european-stability/
On the social front, there’s a quantum difference. For given depth of recession, the human suffering in America — where losing your job means losing your family’s health insurance, and unemployment benefits are minimal at best — is vastly greater than in Europe.
On the macroeconomic front, however, the strength of Europe’s “automatic stabilizers” has been exaggerated. Yes, government is about 12 percentage points of GDP larger; so each 1 percent fall of GDP automatically increases deficits by more than in the US. But unless the slump is much deeper than even pessimists expect, that won’t be enough to offset the stronger US discretionary action.
The IMF has tried to incorporate the automatic stabilizer effect; by their estimates, it still comes up short.
So yes, the European response is better than it might seem at first sight; but it’s still pretty bad.
Krugman’s error here is assuming that the social security, if I may use that term, of the European system does not affect the multiplier and hence the value of the automatic stabilizers. Remember the multiplier is composed of the consumption function and the amount of — here — deficit spending. The problem in the U.S. is that the consumption function is shrinking. This means a given amount of stimulus has less bang.
Consumers in the U.S. must try to hoard against want because the safety net is so low to the ground. If you fall into it, you still take a heck of a shot.
We can see by the savings rate, which is the inverse of the consumption function that things are slowing down.
And simultaneously, while the stimulus did give states a bit of a cushion, there is still the problem that states and localities are shrinking even as the federal spending is going up. The multiplier works in reverse, too.
As for the IMF. These folks are desperately intense, but only so because they are always trying to catch up.
In fact, it would be better to be in Europe right now, even though monetized activity is slowing, the true measure of economic health — employment — is not doing so bad.
IDIOT
Idiot of the Week and the commodities bubble.
Perhaps the greatest story never told is that of the commodities bubble and bust of 2007-08. Not to say nobody noticed the tripling of oil prices and the abrupt collapse in July 2008. Many people noticed, but it was treated like a summer storm, violent and in some places devastating, but entirely natural and now it’s over. In fact, it was a financial bubble exactly on the order of the dot.com boom and the housing boom, only shorter and sharper. AND MORE GLOBAL. Commodities producers around the world are still reeling
But let’s jump right in. Here is — from Inside Business with Jeff Colvin, managing editor of Fortune Magazine. This episode is dated July 28, 2008, three weeks after the peak of oil prices and the Demand Side call that the bubble had burst.
COLVIN
Now here is Steven Hanke of Cato from a more recent interview on Bloomberg, peddling the preposterous claim that it was the relative strength of the dollar that drove oil and commodity prices. These Monetarists are like cultists who see magical properties in the currency. It’s a medium of exchange, for God’s sake. The only thing supernatural about it is your fetish and the fever of adherence to theories that repeatedly do not work.
Currency and commodities prices are, of course, related. But the causal arrow runs in the opposite direction to Hanke’s claims here. You need the local currency to buy commodities, so the dollar trades down when the price of commodities goes up. The reverse happens when you don’t need so much of the local currency.
This guy is an example of the economics that does not work that is marbled through the Fed and the capitalism that is failing.
HANKE
So, there you have it, a two-fer. Jeff Colvin and Steve Hanke. Idiots of the Week!
But to continue with the history note, here are a couple of voices speaking on the same subject. First Fed-Ex Founder and CEO Fred Smith, certainly not my favorite person, but here:
SMITH
Smith puts his finger on the tremendous shock to the consumer that the boom in commodity prices was. Note the shock was much greater because at the time it did not look like commodity prices were ever going to fall. This uncertainty caused a great deal of stress.
Now to somebody who does know what he is talking about, from a fundamentals point of view.
SCHORK
That is Stephen Schork, president of the Schork Group. Also concerned, like Colvin of Fortune, with what doesn’t make sense.
Now to save our voice without sacrificing utility, we reproduce some comments from James K. Galbraith to Democracy Now! earlier in the week.
GALBRAITH:
Transcript from Democracy Now! follows:
JAMES GALBRAITH: … The difficulty I have with that is that I think that plan is based upon an excessively optimistic assessment of the prospects for those assets.
And what Secretary Geithner said yesterday, that these assets were issued to consumers that in many cases did not understand what they were getting into and that they were magnets for fraud, both of those remarks are absolutely true. But once one, I think, takes that into account, effectively, you realize that the prospects for capital losses on those assets are really very, very high, the recovery rates are likely to be quite poor, and that we’ve already seen that with banks that the FDIC has taken over, specifically with IndyMac in California.
And so, that suggests to me that this is a—this plan would have the effect of transferring the losses to the taxpayers without exacting any serious consequences for the banks that essentially created the fiasco. And since the financial system has to shrink one way or another, if you protect the largest banks, as I think the Treasury plan does, then the consequences will fall on other financial institutions, which are relatively well managed and which did not take part in the—to the same degree in the subprime debacle. And those would tend to be smaller banks. And I think it’s really—it’s likely to be—promote an unmanageable banking structure, if we go that route.
And secondly, it’s not going to solve the problem which everybody would like to see solved, which is the complete breakdown of the credit system. It’s not going to bring the economy back to life by the vehicle of new bank spending.
…
We hear this expression that credit flows are blocked and that there is a need to get credit flowing again. And it really is—it’s a metaphor. And I think it’s a revealing metaphor, if it in fact reflects the way in which high officials of the government are thinking about the problem. The idea of a flow, of course, is something that comes from on high and goes down below. A blockage is a kind of plumbing problem.
The difficulty is credit isn’t like that. Credit is a bilateral contract. It’s a relationship between a lender and a borrower. And the problem is not that the lenders don’t have money to lend. The problem is, in very large part, that there are no prospects or very few prospects for profit in the economy, and therefore, borrowers, business borrowers aren’t coming in to ask for loans for economic expansion. And secondly, on the residential and household side, households are strapped. They’re desperate to hang onto the cash that they have. They’re trying to pay down their debts, not to get into new debts. For that reason, they’ve stopped buying cars and stopped buying houses for the time being. And then, even if they did want to come in, in many cases, they don’t have the collateral that they had last year or the year before, because the value of their houses has fallen. So those are the problems of the underlying economy, the consequences, to be sure, of the collapse of the housing—of the subprime housing bubble.
But they’re not problems that can be solved by simply adding new reserves, new capital, to the banks. And, in fact, we’ve seen that the banks are flush with cash. They’re largely sitting on it. And to the extent that they’re not sitting on it, they may be using it for things like acquisitions, acquisitions of other banks, for instance. So the effect of the program is actually to expand the market share and the market power of the largest institutions. And again, to me, that is deeply problematic, because we’ve got banking institutions that are so large at this point, they’re so complicated, so opaque, so deeply involved in offshore tax havens, shell corporations and complicated derivatives, that they can’t be managed, let alone regulated.
The top executive officers didn’t know, to a very large extent, or at least by their own testimony, they didn’t know, the risk exposure of their own institutions. And they made catastrophic mistakes on the scale of tens and scores of billions of dollars, because they didn’t have effective internal controls. And if you don’t have the internal controls, there’s just no way that an outside regulator can get a grip on the systemic risk that the institution may be causing. So my view is, if you want to have a system that has appropriate checks and balances, the institutions in that system have to be of a scale such that the regulators, which Secretary Geithner properly said yesterday must be strengthened, but they also have to have the basic capacity to deal with the institutions that they’re regulating.
…
It is not the case that the securitization of subprime mortgages is a long-term phenomenon. It is something which has been a practice, prevalent practice, for about eight years at the maximum. Before that, the markets would not have contemplated the massive securitization of loans which are subprime.
What does the subprime mean? Subprime means loans that do not meet the standards for a normal mortgage loan that could be taken up by the secondary markets, by Fannie Mae and Freddie Mac. And so, those loans are characteristically loans that don’t have documentation, that don’t have proper credit histories on the borrowers, and where the appraisals seem a little funny. And in the case of the subprime loans in the middle of the decade, there was systematic fraud in the appraisals, systematic overstatement of what the houses were worth, because the bigger the loan that you gave, the bigger fee you could book. And so, these are markets that should never—historically didn’t exist and should not have been allowed to develop. They’re intrinsically unsafe. And so, from that point of view, Paul, of course, is exactly right, that the—trying to restore these markets, trying to go back to the normal of two years ago, is really trying to go back to a situation that is historically abnormal and intrinsically unstable.
And in some ways, you can say what the Treasury plan actually is is a way of creating a new derivative, a new bond, if you like, which the Treasury has half the capital and provides 85 percent of the value of the purchase in the form of a low-interest, non-recourse loan that’s designed to make the purchase of these so-called assets from the banks a highly profitable proposition for hedge funds and private equity investors and others who are in a position to risk their capital without having to face fiduciary consequences.
And so, you know, it’s something which—I suppose there may be investors out there who think that they could make money off of this, but I’ll tell you who it would be particularly attractive to, if they could get away with it, and that is the banks themselves or people acting on their behalf, because what it would mean is that, in effect, the banks can transfer—someone acting on behalf of a bank could arrange for the transfer of a dollar’s worth of these bad securities at face value for seven-and-a-half cents of risk. And that means that you’re really, in effect, creating a conduit, which would just take these losses off of the books of the banks, put them on the books of the Federal Deposit Insurance Corporation. And I would say that would solve the problem for the banks, but it wouldn’t solve the problem for anybody else.
James Galbraith, courtesy of Democracy Now!
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