GREAT DEPRESSION- 2: The Austrian Cure for Economic
Austrian economics explains and predicted the last depression and also the one unfolding now...
Measured by military and civilian deaths, World War II was four times worse than World War I. Likewise, the unfolding Great
Depression-2 has the potential to become much worse and more protracted than the 19301946 Great Depression. In GD-1, the U.S.
was a creditor nation. There were no subprime mortgages (and no property taxes), no credit cards (and thus no credit card
debt), and no financial derivatives (there are $600 Trillion of them today). The country had a trade surplus. The U.S. now
has a trade deficit (the gap between the nations imports and exports), ranging between $612 and $759 Billion a year since
2004. Nine months into Great Depression-2, U.S. federal debt is $11.3 Trillion ($37,000 per capita). The government also has
$62.9 Trillion in unfunded liabilities. Part of that amount is for Social Security, a legacy of the New Deal. Tax receipts
are plummeting. In the first six months of fiscal year 2009, which began in October 2008, income tax receipts fell 31 percent
and corporate tax receipts, 64 percent. The budget deficit this April was $20.9 Billion, the first deficit in this tax-paying
month in 26 years. April 2009 tax receipts dropped 44 percent compared with those in April 2008. Money collected by taxes
is only going to cover half of the fiscal 2009 federal budget, requiring the government to borrow and print more than $1.8
Trillion to fund it. Equal-sized deficits loom for fiscal year 2010 onward. Tax receipts fell 50 percent in GD-1. Now eight
months old, GD-2 is already rivaling that drop. In the 1930s the country had a strong manufacturing base and was self-sufficient
in oil. Only 12.2 million people in a total civilian labor force of 154.7 million (8 percent) are now employed manufacturing
goods, while the government employs nearly twice that number, 22.6 million people (15 percent of the labor force). The official
government-reported "U3" unemployment rate was 8.9 percent in May. Using the older "U6" method it is 15.8 percent (this includes
workers who have given up looking for a job and those working part-time who cannot find full-time work). The true rate of
unemployment is closer to 20 percent, as John Williams shows in his Shadow Government Statistics Newsletter. For the last
six months more than 500,000 people each month have lost their jobs. In March, 633,000 people lost their jobs; in April, 568,000
149,000 in manufacturing, 110,000 in construction, 269,000 in the service sector, and 40,000 lost jobs in the financial sector.
One in every 10 Americans 32.5 million people now receive food stamps. Fourteen million homes in America stand empty, one
out of every nine. And the United States now imports 62 percent of its oil. The U.S. economy today is in a much more precarious
state than it was at the onset of GD-1. Americans trusted their currency in the 1930s, even after Roosevelt (in his April
5, 1933 Presidential Executive Order 6102) no longer allowed people to redeem their Dollars in gold only central banks could
still do this. President Richard Nixon closed the central-bank "Gold Window" in 1971, taking the Dollar completely off the
gold standard. During GD-1 the U.S. Dollar was worth a fixed weight of gold. Now it is a fiat currency. The Latin word fiat
means "let it be done," and Nixon did it. The Dollar now is simply a piece of paper with printing on it, or it exists as electronic
digits in a computer. It is not backed by any tangible assets. Nevertheless, the government declares the U.S. Dollar to be
legal tender "for all debts public and private." It is the only form of currency that people can use as a medium of exchange
in the U.S. economy...(Click here to read full extensive analysis).
A BANKING SYSTEM WE CAN TRUST
we need is Limited Purpose Banking (LPB), which would transform all financial corporations, including insurance companies
and hedge funds, into mutual funds. They would, henceforth, be called banks.
Under this system, banks would never fail for a simple reason. They'd never hold any
financial assets and they'd never borrow except to finance their mutual fund operations. Instead, they'd be limited to their
legitimate purpose--financial intermediation. Under LPB, people, not companies, bear risk as their mutual funds do well or
A new Federal Financial Authority (FFA)--would rate, verify, supervise custody, disclose
and clear all securities purchased, held and sold by LPB mutual funds. Private rating companies could stay in business, but
no one would need to trust them ever again.
Banks would initiate personal and business loans (including mortgages), send them to
the FFA for processing and then sell them to mutual funds, including their own. Loans would activate when sold, so no bank
would ever have an open position.
All mutual funds would break the buck with one exception: cash mutual funds. These funds
would strictly hold cash and be valued at $1 per share. Owners of these funds would write checks against their balances and
never have to worry about a bank run. Fractional reserve banking and the FDIC would be history.
LPB would include insurance mutual funds. These funds would pay off based on the losses
experienced by contributors. If losses are larger than expected, less is paid out per loss. Hence, LPB prevents insurance
companies from insuring the uninsurable, e.g., claiming they'll pay the same life insurance claims even if there's a
All risk allocation arrangements can be run through mutual funds, including credit default
swaps. Take a bank that markets the GE-Defaults-On-Its-Bonds-In-2010 fund. Under this closed-end fund, shareholders specify
in advance if they want to get paid off if GE does default on its bonds in 2010 or paid off if GE doesn't default. All money
put into the fund, less the mutual fund's fee, would be held in one-year Treasuries and paid out at the end of the year to
the winning shareholders in proportion to their holdings.
Hence, Limited Purpose Banking can accommodate credit default swaps (CDS) as well as
any other risk product. But what Limited Purpose Banking won't do is leave any bank exposed to CDS risk since people, not
banks, would own the CDS mutual funds.
If such mutual funds sound revolutionary, they're not. Funds of this kind have been
around for centuries. They go by the name "tontines," or systems of "pari-mutuel betting."
Limited Purpose Banking would enhance liquidity, since all funds would trade in the
market even if their underlying assets are illiquid. It would permit the extension of as much credit as the public--which
is the ultimate source of credit--wishes to provide by buying mutual funds that purchase household and business loans. And
it would force banks to charge fees and pay their employees based on their mutual fund performances as determined by the market.
What LPB will eliminate is insider rating, freeriding on FDIC insurance, self-custody
arrangements, no-doc loans, institutionalized gambling, me-now compensation plans, financial malfeasance and the possibility
of future financial collapse. In other words, it would be a system we can trust...Extracted from Forbes
by Laurence J. Kotlikoff and Edward Leamer, professors of economics at Boston University and UCLA.
A Soros Solution for the Global Meltdown
Mar. 16, 2009 Caijing Magazine
"It's the end of an era, as far as the United States is concerned, because the prosperity
was built on a false foundation." – George Soros
reporter Ye Weiqiang
(Caijing Magazine) What are the economic realities behind and possible solutions for the crisis gripping U.S. banks, emerging markets and the entire financial world?
Caijing finance editor Ye Weiqiang traveled to New York to pose this and other questions
to U.S. billionaire investor George Soros.
Their discussion follows:
CJ: How do you identify economic cycles?
I have developed a theory about the financial market -- it’s really a philosophy -- which is at variance with the general
theory, and it has given me perhaps a certain ability to identify bubbles when they develop. The prevailing theory, which
is called efficient market hypothesis, holds that the market always reflects adequately or accurately all available information.
I think this is false. I have a different hypothesis, which consists of two principles. One is that the market always distorts
the available information. First of all, the market has to deal with the future, and the future is not predictable, and it
always has a biased view, in some way a distorted view from the reality -- that’s the first principle. The second principle
is reflexibility, as I call it. It says that mispricing of financial prices can have a way of affecting or changing the fundamentals
of prices they are supposed to reflect.
two-way connection between the markets and the underlying reality is that the markets not only passively reflect, but also
affect reality, and I call it the principle of reflexibility. This crisis now, I think, has proven that the effective market
hypothesis is wrong. I think my interpretation provides a better understanding of what is happening.
on this general of reflexibility, I have in particular talked about what is happening now. The theory of bubbles is that to
have a bubble, you have to have some trend that actually prevails over the reality, and there has to be a misconception about
the trend, and the reflective interaction between those two can give rise to these bubbles that both the trend and the misconception
mutually reinforce, and then eventually it becomes unsustainable, and it bursts. That’s the character of a bubble. It’s
not the only form of reflexibility, but it’s very dramatic form because bubbles can be very powerful.
a special theory hypothesis with regard to what’s happening now. I say that the housing bubble in the U.S. was a regular small bubble but it acted like an atomic
bomb -- a super-bubble which has been growing since the 1980s. So that’s why this crisis is not like other crises.
CJ: Is it good to change the game?
It’s not something you can control. It’s out of control. This is the situation now. The global financial structure
has collapsed, so private sector credit has collapsed, and the financial system is actually broken. There is now artificial
life support from the authorities.
CJ: Is faith in the authorities failing?
Yes. It’s more than confidence because, in reality, the international banking system has become largely insolvent. So
it’s not just the problem of liquidity but also solvency; bank assets are falling in value, and so their liability exceeds
their assets, and that means they are effectively insolvent.
CJ: Is nationalization necessary at this point?
Nationalization is a false label. Since the banks lost a lot of capital, and the private sector is not willing to replace
the capital, the government has to do it. And one case when they decided not to do it, Lehman Brothers, set in motion this
have determined not to let any other institutions that could endanger this system fail, so they are keeping them artificially
alive. But it’s not enough to keep them alive; you also have to recapitalize them, and has to be done by the government.
is a big problem in emerging markets on the periphery of the system, where governments are not strong enough to provide guarantees
for the banking system. The capital is moving out, creating a worse crisis than in the United States.
CJ: What is the current debate?
It looks like the government is not willing or able to recapitalize the banks in a way that will give them adequate capital
to lend; all they do is prevent the banks from collapsing.
CJ: What is the current political barrier?
Unfortunately, the previous administration spent US$ 700 billion in an ineffective way, and it’s now politically difficult
to secure additional funds needed for proper recapitalization.
CJ: What’s the government’s best course?
I advocate separating the existing assets of the banks and leaving the existing capital to be responsible… to suffer
first loss, if the value of the assets decline, and put new capital into the future business of the bank. So separate past
businesses from future businesses, and create a clean bank within the bank, which is not weighed down by these toxic assets
that are losing value. And then put the new capital either from the private sector and the government into this new bank.
Then this new bank would have adequate capital and would be eager to lend. That would restart the economy.
CJ: What’s the government’s approach, in reality?
The government is examining the balance sheets of banks, and that’ll take until the end of April. Then the decision
will have to be made what to do in the case of individual banks. So the government is on the way, but for the time being it
takes time to prepare and decide.
CJ: What should we consider when banks privatize?
You now have conditional collapsing credit; that’s very far from normal. You can’t get back to normal in a simple
way; you have to first replace the credit with government credit, which means effectively creating money, increasing the balance
sheet of the Federal Reserve Bank. But that’s too technical; it really means creating money. But when credit is restarted,
and you put this very big base of money, suddenly the danger of deflation would be replaced by the danger of inflation, and
then you have to shrink the money supply as far as credit is increased. So you have two steps: First you have to increase
the money supply to replace shrinking credit, and then you have to reduce the money supply to offset the growth of credit.
CJ: After recapitalization, should the government control bank system decision-making?
No. The governments should regulate, but government is not suited to make economic decisions. It should regulate the amount
of credit available, but how the credit is used should be determined by economic actors. Of course, the government is an economic
actor itself responsible for a very large part of economic activity. But it’s not the only actor; it needs counterparties
CJ: How do you value toxic assets?
You don’t value it; you avoid the valuation problem. If you separate and auction it, then you will have to value it.
But if you just keep it in the bank, and you keep the capital of the bank, the equity, and the subordinated debt to cover
those assets, then you can wait and allow assets to be gradually liquidated. Then you will determine whether there is anything
left for shareholders. What are values? It depends on the asset. Probably the asset will recover some value, especially over
a long period.
CJ: How about the Obama administration’s stimulus plan?
It’s certain to help moderate the decline. It’ll be a counter-cyclical force. It’s just starting now. You
need to recapitalize the banks, and you have to stabilizing the housing industry. By reducing foreclosures, and modifying
the mortgages so that people can pay them to stay their houses, you reduce forced selling.
you have to, most important, do something about the rest of the world because the emerging market is more severely affected
than the United States. Here, the government
has credibility and government credit is accepted. But in other countries, the governments don’t have the means to guarantee,
so you have to provide them with the means, somehow, lend them the money or make money available enabling them to protect
their banking industry in a way we protect ours. A lot of their banks are actually owned by multinational American or European
banks. Those American or European banks are taking money back. And loans are maturing without measures enabling those countries
to roll over the debt. If they are not able to pay, the crisis will get worse. So we really place a serious problem on the
rest of the world. And that can only be solved by international cooperation. It is very important that the United States and China,
as the most important countries now, work together.
CJ: Our readers are interested in how the financial crisis will evolve.
I think China is much better situated than the United States to come out of the crisis. I expect China
to be growing by the end of the year, because the crisis hit China
hard and suddenly, and exports came to a standstill. That also affected production for domestic demand, so domestic demand
also declined. It takes time for the government to respond, but it did put together a stimulus package that’s quite
significant. And if it’s not enough, they will, I think, increase it. They are in a position to do it and they know
what is expected. So they are determined to bring about growth. Now you can’t make exports grow, because the demand
is not there. But you can stimulate domestic demand, and especially you can engage in infrastructure projects. The main push
will come from the infrastructure. And that will stimulate domestic consumer demand as well.
China will cooperate with the rest of
the world, will provide enough credit to the rest of the world. Then they can also engage in domestic stimulus and re-open
the market for Chinese exports. By the end of the year, they may probably still decline, and then they may begin to recover.
I think China is situated relatively above the United States. It will take longer for the United
States and Europe to get out of the crisis.
CJ: Maybe next year?
I also don’t think we’ll ever get back to where we came from. In other words, it’s the end of an era, as
far as the United States is concerned,
because the prosperity was built on a false foundation. It has now collapsed, and you cannot rebuild it. So we have to be
major changes in the United States and
the global financial system. And I hope we will be able to reconstruct the financial system on sounder grounds than they were
until now. So it’ll be a different situation.
not back to normal because what was considered normal was actually not sustainable. So I hope that we can reconstruct a better
CJ: So it’s not just a simple economic cycle.
stimulus plan, do you think it’s good?
Probably you’ll need to do more, and it’ll be relatively easier to stimulate GDP than provide employment. Because
exports are very labor intensive, and infrastructure projects are more material intensive, and so they provide less employment.
A big problem is to generate employment and whether to find work for people in the countryside.
task of all is for China is to fit in
to the global economic system and to play a constructive role in shaping the new financial system. China
cannot live in isolation, just as the United States
cannot. I think China
has to play a more important role in reconstructing the financial system than in the past.
CJ: What’s your view on regulation?
If you want to have a global financial system, you have to have global regulation, which we don’t have now. All the
regulators are national. So you will need to strengthen them, the international financial institutions. That is a big task
By Ricardo J. Caballero
Suppose it was possible to rewind the clock to the first time we had a strong urge to rewrite economic history.
A favourite stopping date would be the days before theLehman-AIG debacle last year. Until then, we were dealing with localised inefficiencies and predatory behaviour
among the main financial institutions. There was plenty to fix but it seemed manageable, mostly a matter of accelerating the
medicine and aggressively dealing with problems on a case-by-case basis.
All of this changed for the worse after the Lehman-AIG event. The problem ceased to be firm-and market-localised,
and turned into a severe systemic panic attack. This change in the nature of the problem has strong policy implications, since it requires a systemic,
not a case-by-case, remedy. Of course the systemic problem first appears in relatively weaker institutions, but one
should not confuse causes and consequences. Surely some financial institutions will appear insolvent in the strict accounting
sense; this is what mark-to-market accounting will do to almost any leveraged institution in the midst of a severe systemic
However, simply destroying the intangible capital of a financial institution, or forcing a significant dilution
of a stakeholder as a means of dealing with a systemic symptom of fear, is a highly inefficient and counterproductive policy
response. It is the economic equivalent of putting out a fire with gasoline.
Fortunately, both the US Treasury and the Federal Reserve have the right diagnosis. They understand that the need
is to restore systemic confidence
with a limited amount of financial and political capital. They are on the right track, although not at the speed we all feel
To remedy the latter, we should help, rather than obstruct them. We all have our favourite plans, but at this
point we are of little help to anyone when we keep changing the entire policy paradigm. We should take what we know of their
current plan as given, and restrict our recommendations to operate within their framework. This is important not only to accelerate
the process, but also to eliminate the enormous policy uncertainty that is destroying the stock market, private wealth, and
In this spirit, I would propose that any new recommendation should satisfy three constraints:
- Only good (policy) news is allowed. Any amendment
to their plan must do more, not less, for the financial institutions and their stakeholders. This principle should be advertised
broadly right away
- It must have a reasonable cost. The amendment
cannot be significantly more expensive for the US government than the current plan, and
- It must be wealth enhancing. It cannot go
against, and it hopefully should reinforce, the fiscal stimulus package.
The following plan satisfies these constraints:
- Raising private capital. Announce today that
banks in need of more capital if aggregate conditions worsen (the stress test), will be given an option between the previously
announced programme and one in which new private capital raised receives a government guarantee for a price five years from
now set at the February 2009 price used for the preferred shares. Alternatively, the government may invest in common shares
but give the right to new investors to repurchase the government shares within five years at that price plus an interest rate
charge. This guarantee holds regardless of whether the financial institution survives the crisis. Any difference between the
expected costs of these two options is paid as a premium by shareholders (and possibly debt-holders).
- Insuring aggregate risk. The return on hard
to value assets, whether they remain on the books of the financial institutions or are sold into the PPIF (public-private
investment fund), should be guaranteed by the government at the insurance prices prevailing before the Lehman-AIG crisis. These
assets can be subject to a “representations and warranties” clause where the financial institution pays a penalty
if the performance of its insured assets is worse than the average of the corresponding category, five years hence.
The first item is clearly a positive development for shareholders since it adds an option which has no additional
value over the current programme if the financial institution’s post-crisis future is poor, but is very valuable otherwise.
Interestingly, whenever the option has value, it also helps the government since now the private sector injects
the capital in exchange for a guarantee that is not likely to be executed in such a scenario. Moreover, by bringing some sense
of a floor, this policy also would trigger a stock market boom and hence reinforce the aggregate demand effects of the fiscal
package. The second item has similar virtues, and it deals directly with one of the key adverse selection problems complicating
asset valuations at this time (that banks will sell and insure their worst assets).
Will these policies be enough? Surely not, but if we are all rowing the same boat in the same direction, and
keep a cool head, we will get out of this mess sooner rather than later...FT
Ricardo J. Caballero is head of the department of economics at Massachusetts Institute of Technology
Extract of Editorial
It’s the Regulations, Not the
It has become a truism of the financial crisis that
the system was prone to collapse because there
was no single regulator who had the legal tools and
authority to prevent a systemwide meltdown. That
belief has led to calls from some lawmakers and
major banks, among others, for a new “systemic
risk regulator” — one regulator to monitor
entire financial landscape for problems that could
lead to cascading failures...
There’s just one problem with all that. The
is false. The financial crisis, including what went
wrong at A.I.G., is not just the result of a missing
regulator, a gaping structural gap in the regulatory
Rather, it is rooted in the refusal of regulators,
lawmakers and executive-branch officials to heed
warnings about risks in the system and to use their
powers to head them off. It is the result of
antiregulatory bias and deregulatory zeal —
ascendant over the last three decades, but
especially prevalent in the last 10 years — that
eclipsed not only rules and regulations, but the very
will to regulate...
In the late 1990s, a drive to fully regulate swaps
was squashed by Congress, with the support of
then-President Bill Clinton’s Treasury Department.
Instead of regulation, which could have prevented
the A.I.G. fiasco, a law was passed in 2000 that
deregulated swaps. By then, the Treasury secretary
was Lawrence Summers, who is now Mr. Obama’s
chief economic adviser.
There are many other examples where rules were
blocked, eliminated or ignored. They all make
painfully clear that what is needed is a
comprehensive response — to restore rules,
develop new ones as needed and enforce them
day to day; to reassert the government’s
regulatory mission; and to reaffirm the centrality of
solvency, safety and soundness of financial firms,
and of investor and consumer protection.
A new systemic-risk regulator could play a role in
that, coordinating the efforts and identifying
emerging risks. A systemic-risk regulator could also
assume the important function, currently lacking, of
a sort of F.D.I.C. for nonbank financial firms, with
authority to seize and restructure critically impaired
firms before they threaten the broader system...
Processes to Restore Sustainable U.S. Economic Growth
There are actually three processes that need to complete to a sufficient, if not ideal, degree to restore
an attractive basis for long term U.S. economic growth. They are: righting the financial system, systemic de-leveraging and
re-balancing the global trade and currency systems.
1. Righting the Financial System
– This has clearly been the focus of Bernanke and
Geithner, and evidence suggests that progress if not perfection has been made. However, a key element of correcting the banking
industry that requires more effort on their part is getting the shadow banking system out into the light and neutralizing
the derivative bomb. Because the amount of derivative exposure is so huge ($ hundreds of trillions notional and $ tens of
trillions net) and because it is unclear who, besides AIG, is holding the old maids, extension of credit will remain restricted
until the practical creditworthiness of institutions can be comfortably asssessed. It is not clear that Geithner's toxic asset
plan includes derivatives. Part of this is a disclosure issue, which will be ongoing. Another part is a one time clean-up
of the current situation.
are other measures, besides dealing with toxic assets and liabilities that should be implemented as well. First, any institution
too big to fail should be broken up or if it presents some other risk to the system, that risk should be regulated out of
the firm. Second, leverage must be regulated in business lines that on a pooled basis present a systemic risk. Even if no
one institution poses a problem, a large group of institutions that collectively over levers can also pose a problem. Three,
incentive structures need to be changed to discourage looting behavior. It is perfectly rational for individual executives
to originate or underwrite overly risky and poor investments when bonuses big enough to retire on are paid near the time of
origination and long before the risks and hazards play out. 30 years ago, when most Wall Street firms were partnerships, a
comfortable retirement depended on executives not putting their firms into jeopardy. Four, the captive relationship between
Wall Street and Washington should be broken.
depend on well heeled bankers to fund increasingly expensive election campaigns and bureaucrats look to the street for well
paying jobs when they have done their time working for peanuts at an agency. The inevitable quid pro quo from this dependency
has resulted in de-regulatory favors, looking the other way (even at times for criminal behavior) and outright payments from
taxpayers (call them bailouts or toxic asset purchases if you will). Government cannot serve the general interest of the populace
when it is captive to the players of the securities industry. One tell-tale on this issue is a lack of indictments emerging
from the present crisis. When the internet bubble broke a few years ago, several executives went to jail. The current mess,
which has arguably been created by even more egregious behavior, has generated a rescue response rather than a draw-and-quarter
response, complaints about bonuses notwithstanding.
2. Systemic De-Leveraging – Not only does the financial system need to be righted from over-leverage and other
ills, but also the consumer sector, which is the major driver of the economy, needs to de-lever. Hedge fund manager Ray Dalio's
notion of a D-process seems right on the mark here. Years of easy credit for mortgages, auto loans, credit cards (under the
guise of financial innovation) fueled purchases beyond what was possible with household cash flow (i.e. take-home pay). False
perceptions that increases in wealth due to rising home and equity prices were permanent lured people to spend more than they
had earned, reducing the national savings rate to 0%. To a lesser extent, the industrial sector needs to de-lever as well.
A surge of cheap credit fueled a buyout boom, and there are several good businesses bought by private equity firms that are
carrying too much debt...
Asset values and the debts monetizing those assets have to return to a sustainable balance that is supportable
with cash flow (ideally also recognizing requirements for future off balance sheet liabilities such as retirement). As Dalio
has noted, this is a process not an event. Over the years, through the money multiplier effect, increasing leverage has been
a significant driver of economic growth and thus systemic cash flow. With the tide going out, we are now in the difficult
part of the cycle where the money multiplier works in reverse. That is falling asset values require reduced debt which reduces
cash flow which further reduces credit which hurts asset values more and so on.
interesting aspect of this process is the role of government. In order to reduce the pain of this process and perhaps to slow
it down to a pace that can be managed (as an alternative to a collapse), the U.S. government has embarked on a process of
transferring debt from the private sector (the banking system and consumers) to the public sector. Thus through bailouts,
which allow financial institutions to settle debts, and outright purchases of mortgage backed securities by the Fed, Government
has been assuming a portion (a sizeable one actually) of the declining leverage elsewhere in the economy. Furthermore, through
transfer payments such as welfare to the unemployed, the government is braking the cashflow effect of the deleveraging process.
It is clear though, that this is ballooning government debt (by some estimates currently on the order of $750,000 for a family
of four) and that limits may be reached. If the federal government needs to go through a D-Process of its own, the implications
will be significant. Rising treasury rates, a falling dollar either to other currencies and/or precious metals and surging
tax rates may all be fallout from this in the future.
3. Rebalancing the global trade
and currency systems – While the two processes
above appear to be underway in varying degrees… and with varying competence… the process of reforming the trade
and currency system appears yet to begin. While the globalization of trade over the last 20 years has clearly been beneficial
to the parties involved (particularly those countries who have raised unprecedented numbers of citizens out of poverty), it
has taken place in a less than perfect system. In the ideal of a free and fair trade system, markets and prices (including
currency exchange rates) function so that economic forces (a la Adam Smith's invisible hand) allocate resources to their most
productive uses in a fashion that leads to long run balances of trade between participating countries. While there are degrees
of freedom in the current system, there are also a host of structural restrictions that inhibit free market processes in ways
that provide certain significant favors to various parties. There is a reason World Trade Organization rules and other “free
trade” agreements are tens of thousands of pages long. They are actually not “free trade” agreements but
“negotiated trade” agreements. Consequently, economic laws that naturally regulate supply, demand, pricing and
other variables to achieve balance are constrained and influenced by the arbitrary rules built into the system.
the trade system is the world currency system, which also has some imperfections. In a more ideal world, currencies float
in value relative to each other and in doing so, they help signal important adjustments to economic activity so as to maintain
balance. The existing system, which reflects the Bretton Woods Agreement of over 60 years ago, inhibits this ideal. While
currencies do float in value, the U.S. dollar is established as the world's reserve currency, which provides it some preferences
that distort its value relative to other currencies. Furthermore, countries operating within the system, such as China , have
been allowed to peg their currency values to the dollar, which has distorted those values not only against the already distorted
value of the dollar but also against the various unpegged currencies.
consequence of structural flaws in trade agreements and the currency system have led to extraordinary imbalances in trade,
which has divided the world into surplus economies and deficit economies. The current state of affairs is unsustainable. The
question is whether the requisite changes that must be made can be achieved cooperatively or if the systems will be allowed
to break down in catastrophic fashion before a new order can emerge. If the rhetoric between China and the U.S. is any indication,
tensions are rising to a point where the stage may be set to implement change.
talks and deals can be struck productively while avoiding trade wars or, worst of all, a military war. What is at stake here
is difficult to underestimate, and the political will and craft required to achieve favorable outcomes will be extremely challenging.
It is no wonder that this process is being saved for last. While the market's exuberance of the last two weeks should be enjoyed
by all who have profited from it, eyes should be clear that more “interesting” times are in store.
By Thomas Auchincloss, Market Oracle UK
How Can We End America’s Losing
Streak? by Bob Chernow
Has America lost its confidence? Are we into a
losing streak? If so, can we turn it around?
I take my lead from Rosabeth Moss Kanter’s book,
Confidence. Kanter is a Harvard professor who has
studied long term winning and losing streaks in
business and sports. She is to the point and
practical. I have taken her observation to their
logical larger conclusion that America has a losing
Kanter says that “confidence is a sweet spot
between arrogance and despair. Overconfid
ence leads people to overshoot, to overbuild, to
become unnaturally exuberant or delusionally
optimistic and to assume they are invulnerable.
That is what induces people to become complacent
, leaders to neglect fundamental disciplines,
turn into gamblers. But under-
confidence is just as
bad, and perhaps worse. It
leads people to under-invest, to under innovate and
to assume that everything is stacked against them,
so there is no point in trying.”
Certainly this is where America stands now.
Retail spending stopped late in September, not just
for large purchases, but for modest ones. I have a
friend who owns three dry cleaner stores. He tells
me that October – usually his best month – is down
dramatically. My barber, Tom, said that his
business in mid-October was cut by 70%. Usually I
need to wait 35 minutes for a haircut. When I saw
him in mid-October at 11 a.m., I was his third
customer for the day.
My point is that Americans have pulled back. We
feel rudderless. Recently the Obama appointments
– all experienced and competent – have triggered a
Wall Street rally,
in part because it fills a void of a
leaderless country and economy. But our
problems are deeper.
For example, we are into the “blame game”. My
friend Congressmen Jim Sensenbrenner believes
that the sub-prime crisis was caused because the
poor were “given” mortgages. Support for the auto
industry is equated with helping the unions. Others
want to punish the “evil-doers” who were
responsible for the failure of our banking system.
The “blame game” turns winners into losers, in part
because the attitude is revenge, not problem
solving. Indeed when we let our ideology shape
the facts, like Mr. Sensenbrenner, we cannot
saveour problems. For my part, I want the
economy to recover. I seek financial health more
As Professor Kanter says, “if losses mount, pressure
goes up – or the perception of pressure”. “Stress
makes it easier to panic. Panic makes it easier to
lose. Losing increases neglect”.
“Signs of failure cause people to dislike or avoid one
another, hide information, and disclaim
responsibility – key elements in denial”.
As to the reason behind the sudden stopping of
shopping, it is fear and anxiety. “People can
become paralyzed by anxiety – the learned
Warren Buffett likes to say that “it’s only when the
tide goes out that you know who has been
swimming naked”. So we look at the Chrysler, GM
& Ford executives who flew down to Washington to
beg for money in their Lear jets and think silently
that “these guys are out of touch”. We see
Secretary Paulson and the now irrelevant Bernanke
fumble with their plans to shore up the system.
They are merely throwing mud against the wall to
see what sticks!
These folks are easy targets. But attacking them
does not help us solve our problems.
“Of all the pathologies that accumulate in a losing
streak, one of the most damaging to individuals,
and eventually to the places they work and live, is
passivity and learned helplessness. When people
become resigned to their fate, nothing ever
So, have we lost faith in our financial system, our
economy, our government and ourselves?
Perhaps! But we Americans are an optimistic
people. We see adversity as opportunity. We shine
when adversity hits us. We get up when we
Kanter suggests that we get “people to engage in
positive ways” and to “find reasons to identify with
everyone’s fate”. I’d second that suggestion.
Business and government needs to again “walk the
factory floors”. They need to understand their
customers and get useful feedback from their
employees. Some “winners” do that now. I made a
suggestion to Costco and received a call from their
CEO, who questioned me about one of their stores.
He picked up on a problem about check out lines
and corrected it. On the other hand, I wrote Fede
ral Reserve Chair Bernanke just after he was
appointed in 2006. I was predicting the sub-prime
crisis and made specific suggestions on reducing its
impact. I was answered by a PR flack who had not
read my comments. I responded to her, asking her
to pass on my letter to Bernanke. This was not
done. He and others remain isolated from the
problems we are having.
What can we as citizens do? First, be positive. Do
something positive, even if it is a small gesture. For
example, I bring up the newspapers for the office
and make the coffee when I come in early. This
starts me off positively for the day. Volunteer to
help those less fortunate.
Try to look at the glass half full, not half empty. Will
lowered gas prices stimulate the economy by
putting more money in people’s pockets? Some
conservative estimates say that most American
will“save” $1250 a year. Are there opportunities in
the bond and stock markets? Is government
helping to stabilize financial institutions and will that
lead to the freeing up of loans? Will layoffs mean
that businesses will be more efficient? Are the
Obama appointments men and women who are
competent and experienced? You get the idea.
Emblazon as your motto “Don’t address blame
solve the problem”.
Do what you can do yourself to have people look at
the world in a less defensive manner and remind
others that we have the power to change direction
, through our own efforts, through elections, and
with a plan. What was it that Horace said” Many
shall be restored that now are fallen and many
fall that are now in honor.”
is fragile should break early while it is still small. Nothing should ever become too big to fail. Evolution in economic
life helps those with the maximum amount of hidden risks – and hence the most fragile – become the biggest.
socialisation of losses and privatisation of gains. Whatever may need to be bailed out should be nationalised; whatever
does not need a bail-out should be free, small and risk-bearing. We have managed to combine the worst of capitalism and socialism.
In France in the 1980s, the socialists took over the banks. In the US in the 2000s, the banks took over the government. This
who were driving a school bus blindfolded (and crashed it) should never be given a new bus. The economics establishment
(universities, regulators, central bankers, government officials, various organisations staffed with economists) lost its
legitimacy with the failure of the system. It is irresponsible and foolish to put our trust in the ability of such experts
to get us out of this mess. Instead, find the smart people whose hands are clean.
not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks. Odds are
he would cut every corner on safety to show “profits” while claiming to be “conservative”. Bonuses
do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without
disincentives: capitalism is about rewards and punishments, not just rewards.
complexity with simplicity. Complexity from globalisation and highly networked economic life needs to be countered by
simplicity in financial products. The complex economy is already a form of leverage: the leverage of efficiency. Such systems
survive thanks to slack and redundancy; adding debt produces wild and dangerous gyrations and leaves no room for error. Capitalism
cannot avoid fads and bubbles: equity bubbles (as in 2000) have proved to be mild; debt bubbles are vicious.
not give children sticks of dynamite, even if they come with a warning .
Complex derivatives need to be banned because nobody understands them and few are rational enough to know it. Citizens must
be protected from themselves, from bankers selling them “hedging” products, and from gullible regulators who listen
to economic theorists.
Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”. Cascading
rumours are a product of complex systems. Governments cannot stop the rumours. Simply, we need to be in a position to shrug
off rumours, be robust in the face of them.
not give an addict more drugs if he has withdrawal pains. Using leverage to cure the problems of too much leverage is
not homeopathy, it is denial. The debt crisis is not a temporary problem, it is a structural one. We need rehab.
should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should
be definancialised. We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal
citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments
(which they do not control).
10. Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift repairs,
no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to rebuild the hull with new (stronger) materials;
we will have to remake the system before it does so itself. Let us move voluntarily into Capitalism 2.0 by helping what needs
to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments,
shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing
back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties.
Then we will see an economic life
closer to our biological environment: smaller companies, richer ecology, no leverage. A world in which entrepreneurs, not
bankers, take the risks and companies are born and die every day without making the news.
In other words, a place more resistant
to black swans.
The writer is a veteran trader,
a distinguished professor at New York University’s Polytechnic Institute and the author of The Black Swan: The Impact
of the Highly Improbable
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