(An interesting piece of analysis via TBP about rising gas prices crowding out retail and industrial consumption. The premise is sound but fails to acknowledge the already stimulative effect of a $2.50 decline in prices from their 2008 peak…)
As if the US consumer didn’t have enough to worry about, following the DOE data, the front gasoline contract is rallying to the highest level since Oct 15th ‘08. This morning, AAA said the national average for unleaded gasoline rose to $2.63, the most since Oct 28th ‘08, up from the recent low of $1.62 at the end of Dec. To quantify, the US uses about 9mm barrels of gasoline per day with 42 gallons in each barrel, thus 378mm gallons per day and almost 140b per year. Therefore, for every $1 move in the price of gasoline, it’s an extra $140b more in consumer spending at the pump. If gasoline prices stay elevated, it will dramatically dilute the tax cut portion of the Obama stimulus plan. On Feb 17th, Pres Obama signed the $787b stimulus plan that included $237b of ‘tax relief’ for individuals, $116b of which was a temporary payroll tax credit for income earners under a certain level.
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(Noted financial blogger Barry Ritholtz comments on macroeconomic housekeeping, the unexplored links between shrinking demand and credit-starved supply, and support for commodities and commodity-linked markets/currencies once institutional capital resumes its existential search for yield…)
The Eternal Optimism of Opening Day
As we are one week removed from Opening Day, the eternal optimism this time of the year is always apparent. The weather gets nice and the forever belief of a fan is always ‘this is the year.’ Cub fans can relate, with no disrespect to them as I am the Cubs of my baseball fantasy rotisserie league, aka never won. There is also the hope now that 2009 will be the bear killer as we are just a few months away from matching the length of the longest post WWII recession, that of the early 1980’s. There are also fingers crossed that the extraordinary steps taken by our Fed, Treasury, Congress and President can engender a recovery.
Before I give my opinion on this, let me first give my quick background review on what brought us to today. Alan Greenspan, an Ayn Rand disciple who ironically became head of the Kingdom of Market Manipulation and industrial policy, the Federal Reserve, sowed the seeds for the credit bubble as artificially low interest rates created a mad scramble for yield that resulted in a massive misallocation of capital and huge leverage. Many go drunk at the credit party, such as consumers, bankers, other lenders and politicians, but Greenie, Mr. Bernanke and their cohorts brought the booze, the kegs, shot glasses and funnels.
The broken damn that flooded us with easy credit coincident with too much spending at all levels has brought us a total debt level to GDP of 350% and a household debt to disposable income ratio of 123%, from below 90% in 1995, both higher than in the great depression. If only the Fed let the 2000-2002 cap ex led recession run its course, I wouldn’t be here talking about monetary policy and political science. I’d be talking about P/E ratio’s, returns on equity and earnings growth instead. But, we’re here and our future right now is beholden to those who live and work in our nations capital instead of to the industriousness of our private sector.
(In the midst of a global financial pandemic, private enterprise finds itself under the public microscope yet again — as it did during the 1930s after a century of unbridled growth and later in the 1970s after decades of stifling regulatory oversight. With this 21st century changing of the guard, the theoretical bases for free market capitalism are now under academic and legislative review. At the heart of the debate is the accuracy of the neoclassical economic models taught to college students around the planet as though they were immutable physical laws. Having some basis for estimating the future is clearly a useful if not interesting intellectual exercise, but building models and ultimately the entire financial system around half-baked calculus and thermodynamics seems like a dangerous over-simplification of modern commercial behavior.
In this eulogy to Homo economicus, the author explores the roots of political economy among thinkers like Smith, Ricardo, and Keynes, then describes how their keen sociological observations would never stand up to the quantitative rigors of modern economics. To be sure, there is certainly a place for analytical modeling and econometric analysis in framing our understanding of the world. But after a century of increased commercial, psychological, and informational complexity, maintaining a naive confidence in neoclassical methodology seems almost as “short-sighted” as the political economy it was originally designed to replace…)
Goodbye, Homo Economicus
by Anatole Kaletsky in Prospect
Was Adam Smith an economist? Was Keynes, Ricardo or Schumpeter? By the standards of today’s academic economists, the answer is no. Smith, Ricardo and Keynes produced no mathematical models. Their work lacked the “analytical rigour” and precise deductive logic demanded by modern economics. And none of them ever produced an econometric forecast (although Keynes and Schumpeter were able mathematicians). If any of these giants of economics applied for a university job today, they would be rejected. As for their written work, it would not have a chance of acceptance in the Economic Journal or American Economic Review. The editors, if they felt charitable, might advise Smith and Keynes to try a journal of history or sociology.
If you think I exaggerate, ask yourself what role academic economists have played in the present crisis. Granted, a few mainstream economists with practical backgrounds—like Paul Krugman and Larry Summers in the US—have been helpful explaining the crisis to the public and shaping some of the response. But in general how many academic economists have had something useful to say about the greatest upheaval in 70 years? The truth is even worse than this rhetorical question suggests: not only have economists, as a profession, failed to guide the world out of the crisis, they were also primarily responsible for leading us into it.
By “economists” in this context I do not mean the talking heads and commentators (myself included) employed by the media and financial institutions to explain the credit crunch or the collapse of house prices or the rise of unemployment or the movements of currencies and stock markets—usually well after the event. Neither do I mean the forecasters whose computer models churn out scientific-looking numbers on future growth or inflation, numbers that have to be revised so drastically whenever something “unexpected” happens (as it always does) that they are not really forecasts at all but descriptions of recent events. An IMF study of 72 recessions in 63 countries found, for example, that in only four of these cases had economic forecasters predicted a recession three months or more before the event. Economic forecasters and pundits cannot predict the future for the same reason that weather forecasters cannot predict the weather—the world economy is too complex and too susceptible to random shocks for precise numerical forecasts to have any real meaning.
This doesn’t mean that economics is useless, any more than unreliable weather forecasts should lead us to ignore Newton’s laws of motion, on which they rely. But economics should recognise that, as a discipline, it cannot be about predicting, but is instead about explaining and describing.
(While many observers are still consumed by the economic complexities of the financial crisis, historians have been busy making predictions about the ominous geopolitical implications of a destabilized global economy, rising unemployment, falling incomes, and swelling ethnic tensions. Much like its individual citizens, countries in the aggregate tend to retrench in the face of uncertainty about the future, and that could lead to some dangerously myopic decision-making in the months and years ahead…)
The Axis of Upheaval
By Niall Ferguson in Foreign Policy
March/April 2009
Forget Iran, Iraq, and North Korea—Bush’s “Axis of Evil.” As economic calamity meets political and social turmoil, the world’s worst problems may come from countries like Somalia, Russia, and Mexico. And they’re just the beginning.
Seven years ago, in his State of the Union address on Jan. 29, 2002, U.S. President George W. Bush warned of an “axis of evil” that was engaged in assisting terrorists, acquiring weapons of mass destruction, and “arming to threaten the peace of the world.” In Bush’s telling, this exclusive new club had three members: Iran, Iraq, and North Korea. Bush’s policy prescription for dealing with the axis of evil was preemption, and just over a year later he put this doctrine into action by invading Iraq.
The bad news for Bush’s successor, Barack Obama, is that he now faces a much larger and potentially more troubling axis—an axis of upheaval. This axis has at least nine members, and quite possibly more. What unites them is not so much their wicked intentions as their instability, which the global financial crisis only makes worse every day. Unfortunately, that same crisis is making it far from easy for the United States to respond to this new “grave and growing danger.”
When Bush’s speechwriters coined the phrase “axis of evil” (originally “axis of hatred”), they were drawing a parallel with the World War II alliance between Germany, Italy, and Japan, formalized in the Tripartite Pact of September 1940. The axis of upheaval, by contrast, is more reminiscent of the decade before the outbreak of World War II, when the Great Depression unleashed a wave of global political crises.
“The human mind cannot grasp the causes of phenomena in the aggregate. But the need to find these causes is inherent in man’s soul. And the human intellect, without investigating the multiplicity and complexity of the conditions of phenomena, any one of which taken separately may seem to be the cause, snatches at the first, the most intelligible approximation to a cause, and says: ‘This is the cause!’ ”
— Leo Tolstoy, War and Peace, Book IV, Part 2, Chapter 1, first paragraph
(Contagion could be used to describe much of the activity in the capital markets over the last 40 years, as global financial flows have accelerated, trade and capital barriers have disappeared, regulatory oversight has diminished, and financial innovation has made the packaging and sale of securities as easy as ordering a Big Mac combo. From defaults on recycled petrodollars in the early 1980s, to the Mexican peso crisis in 1994, to the “Asian Contagion” in 1997-98, and most recently the Great Collapse of 2008, what began as sanity checks on asset values and risk metrics quickly evolved into stampedes of herding capital feeling to higher ground. In this look at the nature and understanding systemic collapse, Kotok explores whether anything is too big to fail and at what point intervention / evolution might be necessary to prevent future dislocations…)
“Systemic risk is the risk imposed by inter-linkages and interdependencies in a system or market, which could potentially bankrupt or bring down the entire system or market if one player is eliminated, or a cluster of failures occurs at once.
Systemic financial risk occurs when contingency plans that are developed individually to address selected risks are collectively incompatible. It is the quintessential “knee bone is connected to the thigh bone…” where every element that once appeared independent is connected with every other element.”
- Source: AIG draft document dated Feb. 26, 2009, ABC News and Barry Ritholtz
We are almost two years into this developing financial mess. Yes, it has been two years since Fed Chairman Bernanke stopped using the word contained in his public remarks when he described the state of things in the money world. Much of the current activity focuses on the structure of the massive and unprecedented federal bailout of the financial firms and financial system. The bailout is a response to the elevated and intensified level of systemic risk now widely accepted as prevalent and sufficient to justify these unprecedented federal financial actions. The label “systemic risk” is the latest in prominent titling of the state of affairs. Fed Chairman Bernanke’s recent speech elevated the term to “best seller” status.
There are many definitions of systemic risk. In fact it is one of the least precise terms in the current lexicon. It seems to be defined like pornography: “you know it when you see it.” AIG’s self-serving definition is sufficient for this commentary.
(”In 1969, a 14-year-old Beatle fanatic named Jerry Levitan, armed with a reel-to-reel tape deck, snuck into John Lennon’s hotel room in Toronto and convinced John to do an interview about peace. 38 years later, Jerry has produced a film about it. Using the original interview recording as the soundtrack, director Josh Raskin has woven a visual narrative which tenderly romances Lennon’s every word in a cascading flood of multipronged animation. Raskin marries the terrifyingly genius pen work of James Braithwaite with masterful digital illustration by Alex Kurina, resulting in a spell-binding vessel for Lennon’s boundless wit, and timeless message...”)
(Few economists now doubt that private household spending and corporate investment will rescue the economy on their own. The debate now lies in the scale and scope of the government’s intervention, as the only institution with the access to capital, macroeconomic scope, and investment horizon needed to jump-start the labor market, keep production cycles from seizing up, and create the necessary conditions for manageable lending and spending to resume.
In the following commentary, David Kotok of Cumberland Advisors suggests that any stimulus of this size shouldn’t be rushed or it risks not achieving the plan’s most basic objectives: immediate job creation and demand stabilization. While fiscal conservatives and liberals argue over the relative effects of tax breaks versus direct spending, the debate ought to focus on the nature of the spending itself. Infrastructure investments are a great way to support demand for key goods and services that have been disproportionately affected by the economic downturn, but if these projects take months and even years to plan and carry out, there may be better ways of borrowing $3,000 a head for every American and putting that capital to more immediate and productive use…)
Washington seems in disarray
February 13, 2009
Imagine! There is a Congressman who actually wants to delay the vote on the stimulus bill so he can read it and make sure it says what he was told it says. Kudos for him. There is still hope for our country.
This 575 page piece of legislation is being rammed through Congress without any hearings, without any detailed examination, without any vetting. It is loaded with pieces of spending that are not going to trigger job creating activity for months or even years or maybe never. It is larger than all the money spent on the Iraq war. Its size rivals the Defense Department appropriations. It will be funded through federal borrowing. And there has not been any comprehensive vetting of the component parts.
Now we are continually told that there will be a “catastrophe” or a “disaster” if this 789 billion dollar package is not passed at once. Note that there is a continuing reference that ONLY government can fix the economic problems in the United States.
Not once did anyone mention that Cisco financed a 4 billion dollar bond issue without any TARP funds and without any government guarantees. Note that Intel announced an investment of billions into an entire new facility that will be located in the United States (Arizona) and will be privately funded. Intel didn’t need TARP funds. Intel didn’t need the stimulus package. Not one official in the Obama administration has even acknowledged the Intel commitment.
All we hear is that government can fix what will otherwise be a complete disaster. And all we hear is that banks are not lending and that there is no credit available.
(The frightening this about this table isn’t lavish CEO pay after record bank losses, nor the 9-figure scale of the payouts, but just how closely the bailout money matches the total bonus pool in almost every case. Granted, base compensation in investment banking is nearly equivalent to the minimum wage, but there are a lot of people – roughly 3.6 million in America alone – that would jump at the chance to make $150,000 for 90 hour work-weeks, if only they could…)
SOURCE: The Big Picture
*Total of top five bonus packages (including stocks) received by highest-ranking officers.**Estimated as 60 percent of compensation where exact figures are not available.
(This TED talk by mathematician Steven Strogatz “shows how flocks of creatures (like birds, fireflies and fish) manage to synchronize and act as a unit — when no one’s giving orders”. The parallels to market behavior and financial panic are implicit but obvious. We often perceive of our decisions during a crisis as unique and self-preservational, but the tendency toward spontaneous order is a powerful impulse. The coordinated reaction to natural threats, be it a hungry seal or predator hawk, can often increase a group’s biological fitness and probility of survival, while a coordinated reaction to synthetic financial crises can actually amplify individual exposure – like Strogatz’s example of London’s Millenium Bridge – and actually make matters worse…)
(For nearly a quarter century, Milton Friedman’s monetarists and their acolytes at the Federal Reserve have pursued American prosperity on the assumption that the sheer quantity of money in the economy, along with the degree to which it turns over annually, are the principal levers shaping macroeconomic fundamentals. For the better part of the 20th century that assumption proved to be true as money supply was carefully managed, rising when the economy slowed down and contracting when it looked to be overheating.
The theory originally draws its roots from a flawed response by the Fed to the Great Depression, which might have been mitigated if only the Bank had started printing money, flooding inter-war markets with much needed capital to unfreeze bank lending and stimulate private demand for consumption and investment. Instead, the Fed evaporated what little capital was left by actually raising interest rates, thereby decreasing business investment and placing upward pressure on the dollar. This made the country’s exports less competitive and slowed industrial activity to a crawl, pushing unemployment at its height to nearly 25% – not including women who at the time represented only a small fraction of the paid workforce.
What follows is an examination of the monetarist school of thought as it has evolved over time, along with evidence of its recent failings and the limited options that now remain for its practitioners in dealing with the current financial crisis…)
THE GREAT EXPERIMENT
Quarterly Review and Outlook — Fourth Quarter 2008 Hoisington Investment Management Company
The late Nobel Laureate, Milton Friedman, noted in his 1963 book, Monetary History of the United States (coauthored with Anna Swartz), that the money stock decreased by a massive 31% in the Great Depression. The turnover of that money, called velocity, fell 21%. Nominal GDP equals money multiplied by velocity. Consequently, from 1929 to 1933 the breakdown of both measures resulted in a contraction in nominal GDP of approximately 50%. However, Friedman postulated that if the Fed had not let money shrink, velocity would have been steady and the Great Depression would have been averted, i.e., nominal GDP would not have collapsed. Our current Fed Chairman, Ben Bernanke, is an expert on the Great Depression, and he has, in fact, adopted Friedman’s strategy to greatly expand the money supply. Whether this prescription for economic stability will work in a period of over indebtedness, such as now exists in the U.S., is most uncertain. Indeed, this could be called the “great experiment” since this economic theory has yet to be thoroughly tested in the real world.
(Scientists and market commentators have long been aware of the susceptibility of the markets to any single investment philosophy. The rise of early program trading contributed to the historic one-day loss of nearly 23% on Black Monday in 1987, and later experiments with the seemingly innocuous yen-carry trade and more broadly the bundling of leverage into collateralized pools of assets have generated severe economic dislocations that have cost trillions of dollars to unwind and may take years to fully digest. In this piece by veteran commentator Michael Lewis, the blame is placed squarely on the flawed assumptions of the Black-Scholes model, and the degree to which its methodology spread from the arcane trading desks of the world’s biggest investment banks to the private retirement savings of the beleaguered middle class…)
For years, investors have relied on a complex formula to manage risk. But what happens if the Black-Scholes model is wrong—and we’re in bigger trouble than ever?
The striking thing about the seemingly endless collapse of the subprime-mortgage market is how egalitarian it has been. It’s nearly impossible to draw a demographic line between the victims and the perps. Millions of ordinary people ignorant of high finance have lost billions of dollars, but so have the biggest names on Wall Street, and both groups made exactly the same bet: that real estate values would never fall. Stan O’Neal, the former C.E.O. of Merrill Lynch, was fired for the same reason the lower-middle-class family in the suburban wasteland between Los Angeles and San Diego may have lost its surprisingly nice home. Both underestimated the likelihood of an unlikely event: a financial panic. In retrospect, the small army of Wall Street traders who lost tens of billions of dollars in subprime-mortgage investments looks as naive and foolish as the man on the street. But there’s another way of viewing this crisis. The man on the street, for the first time, acted on the same foolish principles that have guided the behavior of sophisticated Wall Street traders for the past few decades.
As if the US consumer didn’t have enough to worry about, following the DOE data, the front gasoline contract is rallying to the highest level since Oct 15th ‘08. This morning, AAA said the national average for unleaded gasoline rose to $2.63, the most since Oct 28th ‘08, up from the recent low of $1.62 at the end of Dec. To quantify, the US uses about 9mm barrels of gasoline per day with 42 gallons in each barrel, thus 378mm gallons per day and almost 140b per year. Therefore, for every $1 move in the price of gasoline, it’s an extra $140b more in consumer spending at the pump. If gasoline prices stay elevated, it will dramatically dilute the tax cut portion of the Obama stimulus plan. On Feb 17th, Pres Obama signed the $787b stimulus plan that included $237b of ‘tax relief’ for individuals, $116b of which was a temporary payroll tax credit for income earners under a certain level.
(Noted financial blogger 
(In the midst of a global financial pandemic, private enterprise finds itself under the public microscope yet again — as it did during the 1930s after a century of unbridled growth and later in the 1970s after decades of stifling regulatory oversight. With this 21st century changing of the guard, the theoretical bases for free market capitalism are now under academic and legislative review. At the heart of the debate is the accuracy of the neoclassical economic models taught to college students around the planet as though they were immutable physical laws. Having some basis for estimating the future is clearly a useful if not interesting intellectual exercise, but building models and ultimately the entire financial system around half-baked calculus and thermodynamics seems like a dangerous over-simplification of modern commercial behavior. 
The Axis of Upheaval
By 
Imagine! There is a Congressman who actually wants to delay the vote on the stimulus bill so he can read it and make sure it says what he was told it says. Kudos for him. There is still hope for our country.
Quarterly Review and Outlook — Fourth Quarter 2008
The striking thing about the seemingly endless collapse of the subprime-mortgage market is how egalitarian it has been. It’s nearly impossible to draw a demographic line between the victims and the perps. Millions of ordinary people ignorant of high finance have lost billions of dollars, but so have the biggest names on Wall Street, and both groups made exactly the same bet: that real estate values would never fall. Stan O’Neal, the former C.E.O. of Merrill Lynch, was fired for the same reason the lower-middle-class family in the suburban wasteland between Los Angeles and San Diego may have lost its surprisingly nice home. Both underestimated the likelihood of an unlikely event: a financial panic. In retrospect, the small army of Wall Street traders who lost tens of billions of dollars in subprime-mortgage investments looks as naive and foolish as the man on the street. But there’s another way of viewing this crisis. The man on the street, for the first time, acted on the same foolish principles that have guided the behavior of sophisticated Wall Street traders for the past few decades.