Archive for September, 2011

Why we cannot “save our way to prosperity”

Sunday, September 25th, 2011

I just found an article by London Banker on Marriner Eccles’ testimony in 1933 to a Senate committee that actually and seriously investigated the nation’s economic problems.  (Back then, we had a government that managed to get useful things done!)

London Banker is one of the most thoughtful economics bloggers, and I’m glad to see he’s back, after evidently taking a break from blogging to work on the U.K. banking system!

There is a quote that Eccles gave in 1933, from W.T. Foster, which resonates today:

It is utterly impossible, as this country has demonstrated again and again, for the rich to save as much as they have been trying to save, and save anything that is worth saving. They can save idle factories and useless railroad coaches; they can save empty office buildings and closed banks; they can save paper evidences of foreign loans; but as a class they can not save anything that is worth saving, above and beyond the amount that is made profitable by the increase of consumer buying. It is for the interests of the well to do – to protect them from the results of their own folly – that we should take from them a sufficient amount of their surplus to enable consumers to consume and business to operate at a profit. This is not “soaking the rich”; it is saving the rich. Incidentally, it is the only way to assure them the serenity and security which they do not have at the present moment.

Now, this message is not real popular with my family, who believe everyone ought to earn what they get, and be able to keep what they earn. And in the current U.S. political climate, there are grave reasons to fear that in “saving the rich” from themselves, we will squander our last chance to rescue the economy through another round of waste, corruption, nonfeasance and injustice.

But there’s an abundance of evidence that the economic structure has made it too easy for too many to keep too much — and on top of that, the amount which “can” be “saved” is simply not enough for everyone who faces retirement and wants to save!

Here is a quick quantification of why the quote matters today:

In the U.S., it’s simply mathematically impossible for 76 million Baby Boomers, representing 1/4 of the population, to save 16-25 times their accustomed (final, peak) annual income and retire on “savings” by drawing out 4-6%/year. Such “savings” would have to amount to well over 4 to 5 times U.S. GDP… well over 60 to 75 TRILLION dollars. This value, 60,000,000,000,000 exceeds by at least $20 trillion the total wealth of the country! And that would leave no room for either older or younger generations to own anything!

Retirement in any civilized form simply cannot be funded by any credible “stock” of real “savings”… it must be a “flow” of goods and services provided by the increasingly productive young to the increasingly numerous elderly.

The same issue applies to China, Japan, and Europe, all of which are now facing similar demographics.

This issue is exacerbated by our credit-based approach to everything, in which very few people stockpile years worth of food, gasoline, etc. in advance in order to survive old age. In a purely tangible sense, the retired, unemployed and wealthy cannot consume more than the surplus produced by the workers.

The economically-dependent can, however, politically squeeze the workers’ share of consumption, in order to have more for themselves!

Interestingly, if one imagines persistent zero interest rates and negative real yields, the financial incentive to stockpile goods should start to impact behavior. Hopefully this will provide the stimulus to restore full production, because otherwise it must result in yet another squeeze on current consumption.

So in the end I’m forced to agree with the quotation.  The economic playing field must be leveled, to restore prosperity for all, and to bring the machinery of production back into full use.  We must not squander what we spend, any further.  But if we can pull this off, the growth in total national wealth should make the sacrifice of the rich a worthwhile investment.

Market Perspective (in metaphors)

Sunday, September 18th, 2011

In response to Mark Thoma’s repost of Shiller’s “beauty contest” article in the NYT two weeks ago:

Shiller’s two-week old “frantic beauty contest” argument wasn’t worth the paper it wasn’t printed on.

The market crash was led by and dominated by problems in Europe and had very little to do with the S&P downgrade, other than as an illustration that the U.S. government also hasn’t got a clue, much less a plan, for returning to solvency… The S&P news might have been the proverbial “wings of the butterfly” driving the chaotic “market-weather” system wild, but it WAS “hurricane season” and if not S&P, something else would’ve started the storm.

The stock market tail is being wagged by the huge bond market dogs. We are reaching the end of a 30-year bull market in bonds.  Interest rates have been falling consistently from 1982-present, but now have almost no room to fall further.  The much smaller stock market is being wagged violently because a whole bunch of bondholders at the Emperor’s dinner party have finally conceded that he really doesn’t look good with no clothes on, and they now fear losing the shirts off their backs to cover his new wardrobe bill.

As a result of this belated realization that the Eurozone financial sector is once more deeply insolvent… that our 21st-century Titanic really is going to sink despite all the hubristic “financial engineering”… credit seized up when everyone jumped into the non-Euro lifeboats. Mountains of money (literally, if you think of it in terms of printed $1 bills or 1-Euro coins!) are jumping all over the world.  Some are seeking safe-haven shelters, others need to cover rampaging liquidity problems.  Totally “unexpected” (yet obvious in hindsight) events are catching huge numbers of traders and hedge funds off guard, causing margin-call collateral damage across a number of markets.

And that’s just the most immediate list of crisis issues!  We live in interesting times…

Even the bondholders who emerge with their principal intact can expect only minimal interest, and also only minimal capital gains over the next decade. Particularly relative to the gains typical during the 1982-2010 period, the near future looks very grim.  And those receiving their principal back from their “certificates of confiscation” will be the lucky ones!  The market desperately needs a cleansing wave of defaults to dissuade lenders from taking even more foolish risks in the future.  Some folks, who have made themselves examples of how not to lend, will have to be exposed for the frauds that they are, so that others will learn.

MEANWHILE, back in Shiller’s home country, there’s the emerging data that the U.S. economy recently slid back into recession.  Businesses can feel it and astute traders can see it in the emerging data, but America’s economists and political leaders haven’t got a clue, much less a politically viable plan.  So now we face huge new series of crises, at a time when we haven’t even seriously started to address the fundamental, structural economic problems that were exposed 3-5 years ago.  One can only hope that this time, sensible voters get educated and demand real reforms, rather than letting the financial elites squander another crisis.

Amidst all of this, the S&P downgrade had nothing to do with anything, except in the minds of some politicians and economists.  The T-bond markets totally ignored the news, except for TIPS pricing in an inflationary recession rather than a deflationary one.
The wonder is not whether there’s a volatile beauty contest going on in the absence of news.  The wonder is that this market is as stable as it has been!

Had even one of these issues been on the radar in, say, 2004-2005, it alone would’ve dominated the news cycle and the markets would have swooned as much as they have so far.

As things stand, the two most obvious solutions facing policymakers are, on the one hand, to let bonds default and deflate the government-credit bubble directly at the direct expense of mismanaged capital, or on the other hand to print money and inflate everything away primarily at the expense of labor.  The implications of those two choice result in starkly different valuations for corporate stocks, and the market can be expected to veer up and down wildly until the political outcome becomes more certain.  It could be years yet.

So methinks Shiller should stop grasping at explanatory straws and get ready for the deluge…

Why are TIPS bid-only today? (Out to 10 years!)

Monday, September 12th, 2011

Both the Vanguard and Fidelity bond sites show no TIPS available for sale with maturities under 10 years.  Why?  (Is it impossible to offer bonds for sale with negative effective yields for some reason?)

Can the bond market’s “implied inflation expectations” be accurate if the TIPS market is totally broken?

One might infer that if sellers were able to raise their prices, there would be a price at which someone would make offers.  In that case TIPS are currently underpriced (yields too high) and the implied inflation expectations are too low (spread to Treasury yields too small).

Another way of saying it is that the supply of 5 and 10-year TIPS is inadequate and the government is, in effect, manipulating perceived inflation expectations to the downside. One would be tempted to consider this a policy choice, but it could just be that no one remembers that supply matters.

Hope to update this later after learning more.

Update 9/13:  Same situation again today. It wasn’t a one-off thing.  It would be interesting to know whether the situation changes after the upcoming 10-year TIPS auction later this month, and again with the 5-year in October…  But with the market this jittery, it seems a lot could happen between now and then!