Kimball Corson
12/10/2009, Neiafu, Vava'u, Tonga

Shade by the sea, a consistent Polynesian delight.
________

Someone asked what my favorite books were and also, I was called upon to list them in Facebook, so here they are, with an explanation to follow:

(* = better; ** = best)

Warpped Passages* by L. Randell (modern physics)
The Expanding Universe* by A. Guth (cosmology)
The Structure of Scientific Revolutions by T. Kuhn
A good Calculus & Analytical Geometry Text (with good problem sets)**
Selected Shakespeare**

Everything written by:

Friedrich Nietzsche, **
Elaine Pagels, *
Harold Bloom,
Norman F Cantor,
Camille Paglia,
Douglas R. Hofstadter, **
Octavo Paz,*
J. von Goethe,
Plutarch,*
Jose Saramago,
T.S. Eliot,*
The authors of the Bible and the apocryphal books, **
David Hume,
Jacques Derrida,
Niccolò Machiavelli,
Emily Dickinson, **
All the Seth books (Jane Roberts), **
Dante Alighieri,
e.e. cummings,
Henry James,
Alfred Marshall,
A.C. Pigou, *
John Maynard Keynes,*
Milton Friedman,
Willa Cather,
Franz Kafka,
Martin Heidegger,
Leo Tolstoy,
Hart Crane
and Virgil, in no particular order.
(I don't like Homer, Milton, Whitman much or especially Emerson)

(N.Y. Times Fictional and Non-Fictional Best Sellers,
typically only as one-a-day, take-a-break pap)

Etc., etc. etc.

Comment "Favorite" is hard to pin down here. I would say instead these are the books that affected my own thinking and personal development the most. Into them, I went as a naive romantic, and from them I emerged as a wizened, romantically inclined skeptic. Too, I would add that the study of higher mathematics, starting with calculus, seriously develops the mind for thinking about virtually everything.

Comments [0]

Kimball Corson
12/04/2009, Neiafu, Vava'u, Tonga

In near mid-day sun.
______

A couple of people have written asking about my background in light of all of these articles on economics. Here it is, from Facebook:

University of Chicago '71
J.D., Law

University Chicago '68
M.A. in Ph.D. program, economics, Completed Ph.D course work and core prelims, encountered diminishing marginal returns and went to law school; was a Woodrow Wilson National Scholar in economics.

Wayne State University '65
Math and Economics majors; Literature minor, (finished college in 2 years)

High Schools:
McDonogh School, graduated '60
Alliance Academy International, '56 -- '59

U. S. Army (enlisted)
Position: Launch Coordination Systems Specialist
August 1960 - August 1963;
Detroit region, MI;
I was trained and employed as fixed-base missle electronics systems technician (I also had a Level IIIA Top Secret Security Clearance)

Lewis and Roca; Partner; September 1971 - April 1990; Phoenix, AZ; did larger trials and appeals

Horne, Kaplan & Bistrow; Partner; April 1990 - June 2000, Phoenix, AZ; did larger trials and appeals

Wound down my practice 2001 to 2002 and retired ca 2003

Comments [0]

Kimball Corson
12/04/2009, Neiafu, Vva'u, Tonga

Messin' around with bright light to wash out backgrounds.
________

A Look at the Fed's Track Record

In a few words, it is not good. Here are the facts and why. In short, the dollar has been seriously compromised over the years by excessive deficits which then get monetized by the Fed. The purchasing power of the dollar is thereby compromised.

The typical problem with the Keynesian type of general deficit spending programs â€" as opposed to deficit spending on public capital goods where hard, visible returns and savings are obtained â€" is when the spending is over and the stimulus effects fade, we have nothing, but have usually only compromised the purchasing power of our dollar by monetizing those deficits. Look at what has happened.

In 1776, a dollar bought a dollar's worth of goods and services. On average, the dollar held about 95% of its purchasing power from 1776 up to 1913, that is up to the passage of the Federal Reserve Act. Since then, the dollar has lost about 90% of its purchasing power, measured by the goods and services it can buy. What have we gained for this loss?

We have had the Great Depression, the Dot Com Bubble and Bust, the Housing Bubble and Bust, and now the Great Recession. Before that, from 1913 to 2001, excluding the Great Depression, the National Bureau of Economic Research has identified 13 recessions.

Further, a 1999 study, before more recent events, by Christina Romer found that "real macroeconomic indicators have not become significantly more stable as between the pre-World War I ear and the post-World War II era". She also found that while recessions have become only slightly less severe in the latter period, they have also become longer: 11.3 months instead of 10.3 months in the earlier period. But that does not consider the record since 1999.

What these data show is that the performance record of the Fed and our government has been very poor, to say the least. Worse, than previously, without the Fed, if we consider the data after 1999.

Notwithstanding this abysmal record, I quickly concede that back-from-the-brink government intervention in the economy was necessary in 2009 and should have occurred during the Great Depression as well. To that effort we owe a great thank you to Ben Bernanke, who almost single handedly engineered the monetary portion of that effort. But still, what a terrible record this is for the dollar, the Fed and our government over the longer view.

Much of the time the deficit of our government is monetized. Whenever the Fed increases the money supply by purchasing Treasuries from the New York Open Market Window and the government is concurrently running a deficit by selling Treasuries, the deficit in effect gets monetized to the extent of the purchases. The government may as well have sold those Treasuries to the Fed in exchange for newly printed money. This is a common and on-going pattern. By and large, it accounts for the decline in the value of the dollar by more than 90% since the Fed was formed and set up to do business. It is the Fed that has destroyed the value of the dollar, together with a government that runs far too many deficits.

Of course, the reason the dollar has not collapsed against other currencies is that the governments for those other currencies have likewise depreciated them as well, so it is simply a question of relative depreciation, as far as dollar exchange rates go. This suggests a poor global track record, as far as maintaining the value of the various currencies goes.

The decline in the purchasing power of the dollar and other currencies is of course simply inflation created by those governments as a sub rosa form of tax on their citizens and others who hold their respective currencies. This is not good, above-board government.

In light of what is being done to the value of our currency, we should stop and seriously think twice about ineffective deficit spending to stimulate the economy, especially when we monetize those deficits and do not get anything permanent in return for the expenditures involved. I think the American people intuitively realize this and that is one reason they are digging their heels in on much additional deficit spending.

Keynes never recommended on-going deficit spending programs for just "fluff" employment gains or to expand government per se. We were to run surpluses during good times and deficits during bad times in the hope they would roughly balance out. What has happened to the dollar since 1913 is strong evidence we have not followed Keynes' advice here, but rather that the Fed and our government have engaged in significant and monetized deficit spending even during good times, while at the same time generating great economic instability and devaluing the dollar.

This is seriously irresponsible government.

Posted to seekingalpha.com and published as an article. Ho hum. I'm still on an economics break. This was just in the pipeline.

Comments [1]

Kimball Corson
11/27/2009, Neiafu, Vava'u, Tonga

Complete with covers to keep the deceased warm at night.
_______

Aphorisms (always my own here)

In broad brush, what is will be.

Art requires the human.

The one thing constant about real life is change.

No quote is worth remembering.

To act well is to lie convincingly.
_______

A Step Toward Better Government

The Daily Beast reports --

"Happy Thanksgiving, lobbyists! Now get out. The White House is
instituting new rules for lobbyists that could eject as many as thousands of
lobbyists from positions on federal advisory panels. 'Some folks have
developed a comfortable Beltway perch sitting on these boards while at
the same time working as lobbyists to influence the government,' White
House ethics counsel Norm Eisen told the Washington Post. 'That is just
the kind of special interest access that the president objects to.' The
move is by far the strongest effort yet from the Obama administration to
curb their influence, affecting the approximately 1,000 advisory
committees that advise federal officials on a number of policy
questions."

"Lobbyists and some businesses warn that the government may lose
valuable technical expertise from panel members ejected under the
new rule."

Um hum.

Disclosures: none beyond jubilation

Posted on seekingalpha.com. Rejected as an article. I won't fight it. I should have worked, expanded and added to the story, but I am tired of thinking and writing about economics just now. I think I'll take a nice long break and go get some exercise, take some photographs and prep my boat for cyclone season.

Comments [5]

Kimball Corson
11/27/2009, Neiafu, Vava'u, Tonga

Near the waterfront.
____________

On the New "Lower Normal"

Mortality is fatal -
Gentility is fine,
Rascality, heroic,
Insolvency, sublime!

Emily Dickinson
____________

Why Our Economy Will Not Fully Recover

In a nutshell, the reasons are (1) our large trade deficit and (2) our maldistribution of income. Both permanently lower aggregate demand as long as they exist and that permanently lowers our new level of equilibrium relative to the higher level where the economy would otherwise be. Until they are fixed, our recovery can only go up so high, to the new "lower normal." This will likely leave us with higher employment than we would like and less economic activity than we would prefer

Because the Fed and government refuse to recognize these facts and continue to extrapolate off old higher normal levels, we will probably see them adopt detrimental expansionary policies that will try to push us beyond our new "lower normal" level into bubbles which will burst, just like housing bubble did. It felt good going up, but was a disaster coming down. However, the housing bubble was in the making for a long, long time because of tax rules and other laws that favored housing purchases over other goods and thereby misallocated resources.

The permanent relative drops in aggregate demand from the trade deficit and from the maldistribution of income are easy to understand. On the former, to the extent we spend a large percentage of our income to buy goods from abroad instead of domestically, domestic aggregate demand will drop and stay down. If we suddenly were to export enough to balance the trade deficit, for example, then we would then have the income or money from our exports to buy more and replace our lost domestic aggregate demand. This is why Keynes said countries with continuing large trade deficits will stay relatively depressed.

On the maldistribution of income problem (60% get 21% of the income), aggregate demand is permanently reduced because lower income households use most of their income to create the aggregate demand for consumer goods and services, but now they have much less income, whereas high income households with more income spend only a small fraction of it on those goods and services and invest the rest in secondary financial markets, driving financial asset prices up.

Redistributing income more fairly would increase aggregate demand significantly, but like fixing the trade deficit, it is not going to happen any time soon. Both of these problems are largely off the radar screens of policy makers.

We also need to consider the context of these two problems. We have a huge backlog of unemployment generated over the last twenty years or so from our manufacturing sector, which is a separate problem. We have been exporting jobs for years. The service sector can only absorb so many new employees.

This is one reason the new lower level equilibrium will entail higher unemployment than we would like, except perhaps during cyclical boom times around that lower level. It will bother policy makers and politicians immensely and induce them to adopt mistaken expansionary policies that are counterproductive.

Until these two problems - the large trade deficit and the maldistribution of income -- are fixed, we can only hope for a new "higher normal" level of equilibrium; we can't get there . . . except perhaps temporarily on the crest of some new bubble policy makers will generate. Unfortunately, the likelihood that policy makers or politicians will understand or admit the new lower level equilibrium is not good. That is why we had the housing bubble, engineered deliberately by Greenspan and the Fed with the support of many others, including Paul Krugman. They still thought then that they could get back to the old higher normal equilibrium, with further expansionary policies. What will happen when we push the economy beyond our new natural "lower level" equilibrium is that we will get booms and busts that damage us and the economy.

These problems are going to be with us for a good while, I am afraid.

Posted and published as an article on seekingalpha.com

Comments [1]

Kimball Corson
11/27/2009, Neiafu, Vava'u, Tonga

The major competition for the Catholics.
______

The Troubled Role of Governement in Our Economy -- An Overview

Several readers have asked an interesting question, in one form or the other -- Inasmuch as our government has grown so hugely over the last 50 years, are there instances of government growth and intervention which are harmful to the economy and the people who do not benefit directly?

The Roles of Government in the Economy

To address this question we need to consider the types of government growth and intervention. Basically, they are:
(1) Financial intervention by the Fed, Treasury or both to address economic slumps;
(2) Direct ownership or leveraged intervention in specific, troubled companies;
(3) Intervention to support and correct markets which do not function properly, e.g., health care;
(4) Intervention to assure fair play and non-abuse in markets
(5) Intervention to expand the role of government in the economy; and
(6) Congressional intervention on behalf of lobbied for special interests.

The Mixed Record of the Fed and Treasury

Most wouldn't or shouldn't dispute (1), at least in emergencies. Recent financial intervention by the Fed and Treasury, in fact saved us from a major depression. In the present instance, while many don't like the debt we have incurred, the truth is we needed drastic action. The stimulus program of tax relief and infrastructure repair, and the zero interest rate and quantitative easy policies have saved the day. We were sinking much faster than in 1929. These programs stopped that.

In other instances, intervention by the Fed has simply created bubbles, e.g., housing, because the Fed and Treasury do not recognize that our equilibrium level now, from the trade deficit and our maldistribution of income, is a new "lower normal." They targeting on the old higher equilibrium level extrapolated from the good old days.

In truth, the debt numbers on the books now are staggering. But they are clearly dwarfed in magnitude by what our losses and the transactional costs from dislocations would have been from the major and fast hitting depression we just avoided. We are clearly better off now than we would have been, the Austrian School and the dooms day guys notwithstanding. It is hard to even imagine the costs of a major, hard hitting depression, fully and completely considered, down to health consequences for the population. What debt we have on the books presently is chump change by comparison.

Item (2), on corporate intervention, is dicey. TARP I and II entailed both good points and bad ones. Taking stock warrants for cash helped the major banks a lot and was good and very profitable for the government, on balance. Simply giving away TARP funds, without serious consideration or concessions in return, was clearly a mistake. More operational concessions and salary and bonus limitations should have been extracted from the banks. That is clear. As to what to do, the answer is fix what problems we can and move on.

The government made big mistakes on TARP and all that can really said in its defense is it was rushed, bankers have a lot of political power and the government used intermediates who were too close to the banks to begin with. A fair criticism, too, is the money was not well spread among the banks. Smaller ones got too little or nothing. Spreading the funds too far, however, risked ineffectiveness. The truth is the TARP programs avoided a large collapse on Wall Street. We learned the hard way from the collapse of Lehman Bros, which created massive damage. Aside from AIG, GM is much more problematic. It is clear, however, the government wants out of these interventions as soon as practicable. That is good.

Other Interventions by Government

As for (3), intervention to support and correct markets which do not function properly, health care is the major example, as Kenneth Arrow has shown. We are working on a fix, but for the new health care system we are getting to be effective, we are going to have to learn to get health care costs down. Presently, they are silly. I am sure we will attack that problem in due course. It just takes time and smaller steps. We will build and use a consensus on costs.

Item (4), intervention to assure fair play and non-abuse in markets, is problematic. Too often regulators become the captives of the regulated. Personnel are swapped back and forth too much. This is a long standing problem without a clear solution. Perhaps a policing agency to watch those who regulate and also to keep politicians from direct interference would help. No fast solution here.

Item (5), intervention to expand the role of government in the economy is a growing problem. Many times it is implicitly done to pad the government payroll with supporters and friends, if not relatives. Other times it is done as the behest of Congress or one or more of its members, to expand their own power base of influence. Other times it is done to convey favors to special interests or to protect them against the public interest. A strong eye��"perhaps, the same policing agency -- needs to keep watch here. The role of government should be curtailed where it reasonably can be, not expanded. The correct dictum is the government that governs least governs best. We are getting that backwards.

Congress is the Core Problem of the Economy

Item (6), Congressional intervention on behalf of lobbied for special interests is THE major problem. It has proved that trickle up economics does not work.

(a) It has created and allowed our maldistribution of income, where the lower 60% get 21% of the income;
(b) It ignores our large trade deficit and its implications;
(c) It has funded our wars to keep the defense industry politically placated;
(d) It revels in pork and ignores the public interest;
(e) It looks to enlarge its power base at the expense of society and the economy;
(f) It takes good care of the wealthy and in turn, members of Congress get taken care of well; sooner or later by those whom they support; and
(g) It regulates and supervises poorly and ineptly, doing very little well.

By these means, it has jeopardized our entrepreneurial society and is destroying the middle class and small business at the same time.This amounts to the destruction of our economy in no small measure. This should be the focal point of everyone's attack.

To answer the question, regrettably, there are too many instances of government growth and intervention which are harmful to the economy and to the people who do not benefit directly. Government is moving from being an asset of the people to a liability, and I do not mean just financially.

Posted and published as an article on seekingalpha.com.

Comments [0]

Kimball Corson
11/25/2009, Neiafu, Vava'u, Tonga

Dark mask by doorway and dolphin carving outside.
______

Two Unfortunate, Possible Consequences of Our Deficit Hysteria

There is much silly hysteria regarding the federal deficit right now.

While large, the deficit is not exceedingly so, considering the economic problems we have faced and those we now confront. In fact, the stimulus program in retrospect was probably too small, all things considered, including the attending deficit.

The deficit hysteria is being fed by right-wing talk show hosts, most of whom never finished college, and by commentators who have virtually no real expertise in these matters, but struggle hard to sound knowledgeable and significant. Right wing senators have chimed in to make it a chorus. Regrettably, so too have some others, who are usually more sensible, largely because of the hue and cry over the matter. Also, everyone accurately recognizes that the health care legislation is going to have a serious price tag and that we will run deficits on that program, too, at least until we figure out how to effectively control costs. (Doctors [and nurses] salaries are too high because of restraints on producing more doctors adopted by the AMA years ago. A governmentally protected restraint of trade, if you will.)

How the hysteria is born

The hue and cry over the deficit is a serious problem, but not the deficit itself. I will explain, but first look at the type of thought process behind the hysteria. It is the way things work in our political arena these days. By simplified analogy, it goes something like this. If one person states the deficit is an insurmountable problem, people take note. If two say so, they develop interest. If three repeat the developing hysteria, people become intrigued. If four say so, it must be true. If a fifth chimes in, the hysteria reaches full bloom and suddenly becomes gospel, that is, it is something to be taken on faith, regardless of the facts that were never investigated or well understood. This is how Americans publicly and politically think. We have a problem here and a big one. It is what is happening in the U.S. right now regarding much economic thinking.

The consequences

Consider two possible consequences of this mistaken hysteria, both serious.

First, it is clear that, while the Administration does not believe the deficit is so large that it should not do more for the economy, it is becoming concerned about the hysterical outcry. Most regrettably, the Administration is starting to cave into the hysteria and by doing so it will necessarily be backing away from secondary efforts to aid our unemployment problem and the economy. Understandably, some demoralization will be setting in. These developments jeopardized our recovery in ways we cannot yet even begin to imagine. It is as though some people in the U.S. want our economic system to collapse, even if for no other reason than to support their own economic viewpoints.

The recovery -- while not strong -- is real and it needs help. It is not so bad off, as the permabears and the crying dooms day fanatics make it out to be. It is, to be sure, in a bad fix, but the last quarterly GDP real growth figure was positive and that is certainly much better than the -6.4% figure for the first quarter. We have in fact turned the corner on the recession. Too many ignore this basic fact or attempt to rationalize it away because it does not square with their own preconceived notions about the economy. In truth, we are moving forward, but with difficulties. Difficulties, unfortunately, that are being made worse by the deficit hysteria, I contend. Here are but two important ways how, the first I have already suggested.

What if, instead of fixing, streamlining and expanding the infrastructure rebuilding program to better address unemployment, and what if, instead of providing additional tax relief to the middle and lower income classes as a further needed stimulus, Obama and his advisors decide -- as a political matter - that they need to capitulate to the hysteria? Not only is that bad itself, politically, but it is a major problem for another reason. It causes Obama and the Administration to retreat from the Administration's efforts on the economy and also to withdraw somewhat from the public. In truth, the very opposite reaction is needed.

Obama should explain himself

I contend Obama needs to stand up and explain to the American people, where we are and why, what the programs have contributed, what mistakes have been made, what is being done to fix them, why the infrastructure rebuilding program needs to be expanded, streamlined, legally facilitated and made more labor intensive and how we need now to address our banking system in light of its current problems and our past mistakes. He needs to promise and deliver more transparency on all the programs. People want to understand where we are and how we got there. Much money has been spent and there needs to be direct public accountability for it.

The truth is -- Obama should go on to explain -- we have never dodged a depression like we did this time and in some measure we had to proceed quickly and to some extent by trial and error. The fact is we have headed off a depression. We forget too quickly almost a year ago when the credit crisis threatened to almost immediately to put us in one. We beat it back. We pull the economy back from the abyss. We are historically on an economic frontier. Monetary policy has had to be made up as we go along, because we are in a liquidity trap. The last one we had produced a depression very fast. But not this time. Obama should explain these matters with charts and graphs in a series of TV fireside chats with the American people. He could ask for their patience and support and very likely get both.

Good things in truth have been done, but it is all being threatened now by the foolish deficit and dooms day hysteria. Defensive inaction can still sink our ship at this point. We are not out of the woods, by any means.

Dollar expectations

Consider another possible problem the hysteria and foolishness might generate.

Economics is all about expectations. Here is an example. As we know there is a large carry trade exporting borrowed dollars out of the country to invest in risk-adjusted higher return areas. Dollars directly owned by others are migrating to those areas in a similar fashion for the same reasons. To invest in those foreign countries, investors trade their dollars for local currencies and the central banks get those dollars, lots of them. Those banks would normally use those dollars to mostly buy U.S. Treasuries for their portfolios. Better to earn some interest on near cash than hold cash itself.

What if they hear and come to believe the hysteria, the forecasts of the permabears and what the doom and gloom guys are preaching and praying for? Worse, what if they learn Obama is listening and has impliedly conceded the deficit fight and is now backing away from helping the economy and the unemployed further? What if they think Obama is starting to act too defensively? Perhaps, they just might think they should be buying a lot more Eurobonds and far fewer Treasuries . . . just to be prudent.

This development would increase our economic problems seriously. It could limit our government's options to deal with the economy. It could create problems for debt management. It would put substantial downward pressure on the dollar as well. Clearly, these are all bad consequences for us in the here and now. They could arise simply because of loose and thoughtless talk that too many have mistakenly come to believe in.

What we should learn

What we observe from these two examples is this. While there has been no immediate change in our real economic circumstances, except for improvement, we will have -- by the deficit hysteria and foolish talk alone --placed ourselves in serious economic jeopardy and created real threats to our own economy. Stupid is not the word for it. It is worse that shooting ourselves in the foot. It is more like shooting ourselves in the head.

And it is all because we didn't think and consider before we collectively opened our mouths, joined the chorus, and took up foolish with a vengeance. Some would argue, we will deserve what we might get.

Posted and published as an article on seekingalpha.com.

Comments [2]

Kimball Corson
11/20/2009, Neiafu, Vava'u, Tonga

The setting for a late lunch of spicey Thai fish cakes and salad; all part of the rough life I lead.
_____
Twenty Five Reasons We Will Not Have a Depression

One particularly vitriolic reader of my last article on The Distorted Shape of the Recovering Economy seemed to think I was predicting a dooms day scenario. I was not at all. Richard Duncan's tentatively predicted Fall of Rome scenario is a true dooms day scenario, not mine.

My focus of late has been much more on the need for transparency and candor from our government on TARP I and II and the stimulus program results, as well as, more importantly, on getting the stimulus infrastructure program facilitated, expanded and working much better. The Administration needs to confess errors, fix them and get on with things.

Meanwhile, there are some signs of life in our economy and they should not be overlooked or ignored. I am not arguing we will have a robust recovery. I am arguing we will not have a depression and things will pick up, just more slowly than we would like and in the face of more risk, such as much higher oil prices, than we would like. Also, with more unemployment than we would prefer.

Consider these improvements:

-- The Baltic Dry Index is up
-- Multinationals and related companies are improving fast
-- The U.S. share of world GDP is staying about constant
-- With exceptions, the world economy is improving well
-- UPS and FedEx are seeing and expecting increased traffic
-- The rate of new jobless claims is dropping steadily
-- The housing market is tending to bottom
-- New housing construction is up in many areas
-- The U.S. private sector is slowly getting deleveraged
-- Oil prices could be a lot worse
-- Leading economic indicators are on the rise (LEI)
-- Cramer is still jumping up and down
-- Soros and Buffett are buying, e.g., Wal-Mart
-- U.S. exports are picking up
-- Big TARP banks are doing better
-- The velocity of money is improving
-- Inflation and deflation are under decent control
-- GDP growth, while small last quarter, was not negative
-- The dollar is not in freefall
-- Price earnings ratios of large cap stocks are at a discount
-- We are economically better off than we were a year ago
-- Credit availabilty, while not good, is not frozen as it was
-- The retail sector is doing better, according to the NBER
-- Government will have paid back TARP moneys to use soon
-- Most economists do not now believe a depression is at all likely

Without dwelling on or developing these points, but by simply listing them, I want to make clear that, in my view, we are not heading for a depression and we are not heading for a doom's day scenario. To be sure, we have buckets of trouble, but it is all in the framework of a slow, troubled recovery with excessive unemployment tenaciously hanging on.

With a good, cleaned-up and expanded infrastructure rebuilding program that is legally facilitated, made more labor intensive and well administered we can attack the unemployment program directly and help improve our infrastructure for the future recovery at the same time.

We need to take heart, fix things and get busy.

Posted and published on seekingalpha.com. This article turned out to be amazingly popular and much commented upon.

Comments [0]

Kimball Corson
11/19/2009, Neiafu, Vava'u, Tonga

At waters edge by day's end.
_______

The Distorted Shape of the Economic Recovery

Hints are emerging. The Baltic Dry Index is up, UPS sees a bit more traffic and multinational corporations are starting to do much better, especially from their foreign operations. My take looking forward is that, domestically, unemployment is likely to rise, income will grow too slowly and dissention will at some point break out in Washington. The economists and policy makers that have been running the show are already beginning to lose credibility. It is happening slowing, but it is happening. Why is interesting.

Too many economists, either expressly or impliedly, operate off of a macro economic model to predict what is going to happen. As Milton Friedman said many times that is a bad idea because models are only a shabby shadow of the true economy, they ignore too much that is going on, their chronological view is too narrow and they don't take politics into account. A savvy economist who studies the numbers, such as Nouriel Roubini and others, has a better sense of what is going to happen, than almost all the economists using models do. That is why Paul Krugman, a model man himself, wrote his introspective piece in the N.Y. Times on how was it so many economist got it wrong and did not foresee the financial crisis and seriousness of the recession that was coming. He missed the mark there, too. Roubini and several others didn't, but who was listening?

Considering how much such models leave out or ignore, it is not surprising at all. Consider what they ignore. They don't consider - and the policy makers using them tend not to consider -- (1) the mega trade deficit and, more specifically, what we should actually be doing about it; (2) the horribly skewed distribution of income which has sucked the life out of the middle class (60% get 21% of the income) and which has sent excess income from the rich into worldwide financial asset markets to drive up prices, exacerbated by our low interest rate environment; (3) what is happening to the stimulus program and the monies we allocated for it -- another poor result and a disaster; (4) why TARP I and II were so expensive and have not worked to fix the banks; (5) the off-shoring of jobs, factories, tax base, etc by multinationals, globalizing their operations to avoid taxes and regulations, basically gutting too much of America's industrial structure and killing much employment in the U.S.; (6) the mess with our banks and what to do about them as financial moving targets, etc, etc., etc,. Models are not equipped to deal with these most essential concerns because they don't factor them in.

The importance of these issues and their implications for our economic welfare is why the present economists serving as our policy makers, who believe in models, along with Paul Krugman and others, are eventually going to lose favor and be replaced by people with more practical economic savvy who understand the issues that do matter and have some ideas on how to fix them. Unfortunately, it will be a late end game of catch-up, with a public that has largely lost confidence, not only in those people, but substantially in the present Administration and government as well.

The rest of the world, England and others excepted, will largely and more quickly recover than we will. For that reason, our big multinational corporations will do much better. They have off-shored jobs, factories and other overhead to avoid taxes, regulations and higher costs and they have also too much hopped off U.S. tax rolls as well. They will be sitting pretty, compared to most. Much of their revenue will come increasingly from the rest of the world and not as much as before from the U.S. The mess they have left behind of lost revenues, unemployment and empty factories will saddle the domestic recovery quite badly so that, with our large unaddressed trade deficit, the U.S. domestic economy will remain largely sitting in a hole. The problems of TARP I and II and the maldistribution of income push us into that same hole. All of these pieces are not in the economic models being used or on the radar screens of too many policy makers. They are coming back to bite us.

Larger companies, and some smaller ones as well, that do considerable business with the large U.S. and other multinational companies should also fare well in the distorted recovery coming and will provide much of the economic lift we will see in the U.S. Unemployment will hang like a shroud over our heads though, as we struggle to fix, expand and streamline the stimulus program and also to repair the banking system. Job sharing should emerge forcefully. Public patience with our efforts will become thin. Obama will become less and less popular. Republicans will smell blood. Wild suggestions about what to do will fill the air and print media. Talking heads on TV will have a field day. The demand for neckties should increase.

With larger declines in tax revenues, governments at all levels will have a tough time. Much government debt will be floated, along with substantial cutbacks in personnel. That will increase unemployment. Unemployment will also rise because too many people with jobs now are hanging on to them by a mere thread. If there is not a robust recovery in the U.S., even more will become unemployed. A second major wave of unemployment will accompany the realization that the U.S. economy is not recovering very well.

Many in Congress will get their walking papers in the next elections. Lobbying will come under more scrutiny. Taxes may need to be raised which would further slow a domestic recovery. There will be threats to the independence of the Fed. The core arguments will be that the Fed undermines economic stability, the Fed has failed to fix the banking system and the Fed has been financially imprudent with its policies. The Taylor rule stands a good chance of being adopted.

Whether we will seriously address our trade deficit problem remains to be seen. So far, we have kept our head in the sand. What or who might cause us to pull it out and seriously look at and fix the problem by whatever means necessary is not at all clear now. Tough measures are called for and presently we are not up to it.

Ultimately, the infrastructure stimulus program will be expanded, cleaned up and streamlined and the laws surrounding it made faciliatory. It will be most effective in reducing unemployment in the interim. Americans will take heart from the improvements they see. But the problem of how to create longer term jobs will remain with us for some time.

Recovery of the world economy outside the U.S. and England, will certainly help, but until then, the infrastructure repair and maintenance work is America's best intermediate hope. What the longer term solution is for unemployment in the U.S. is unclear, but it will certainly have to include making life much easier for small businesses in America. That has not even occurred to governments yet, but it is absolutely crucial.

Bubbles in one or another asset class will expand and contract. Crises of one type or another will come and go. If the Fed raises interest rates, financial asset prices will fall generally and there will be much consternation. If the Fed doesn't raise rates, financial asset prices will continue to bubble up. The Fed is not likely to face that problem very soon or the problem of how to mop up excess liquidity in the banking system.

If and when the Fed does try to mop up, it will likely get it wrong, unless it is done in the context of FDIC-like reorganizations of the big money center banks. However, if the economy does not really pick up and unemployment increases, more bad loans will surface and banks will still need yet more help that the public will be reluctant to give them. Fixing the banks will be like shooting at a moving target. The situation is a vicious circle. Increasingly, it seems, banks will have to live off of their trading operations, Fed interest on their excess reserves and nickel and diming their customer bases.

We are in for some prolonged trouble, I'm afraid. Let's hope I am wrong and we are able to find our way blindly out of this mess. It is possible, but it is just not very likely.

Posted and published by the editors of seekingalpha.com

Comments [2]

Kimball Corson
11/17/2009, Neiafu, Vava'u, Tonga

You have to talk a lot to get a girl in Tonga.
________

Why the Opposition to Deficit Spending is Growing Rapidly

Policy makers are wringing their hands and lamenting the growing opposition to more deficits. There is, to be sure, a problem developing with Congress and the people on more deficits for the economy. Deficit hawks are on the rise. Why, you ask? Consider the situation.

The Fed and policy makers have wasted a lot of political capital by not obtaining better results with the bailout and stimulus programs by now. Serious money has been spent and look at the results. Too many are left wondering. What this means is we may not have enough political capital left to do what needs to be done, assuming, of course, we can agree on what that is.

TARP and Fed policies have been very expensive and most Americans do not understand what they have accomplished or where the monies have gone. These are serious issues. Even those wanting to be informed cannot readily get the information they would like on what and how the programs have done. The Fed has had two Freedom of Information Act lawsuits pending against it for hiding data and where are clear income statements for TARP I and II? For most Americans, these areas are entirely too murky for comfort. They worry -- rightly, many would say -- that the wealthy on Wall Street and elsewhere have managed to line their pockets from these programs and that cuts seriously into the goodwill that government has left and the willingness of the people to support further deficits.

I do not mind running larger deficits in these kinds of times, but we need more understanding of what is happening and why the results we have gotten so far are not better. Too, I think we need better programs as well. I explain.

The original stimulus program, aside from some of the tax relief afforded, is a disaster; most projects either have not been started or are too far from complete. I think we have maladministration here and it has prevented some of the improvement in the economy we would like to have seen by now. Also, a lot of the projects in the stimulus program turned out to be obvious Democratic pork or for private interests. All of this injures the political capital needed to get things done, and alienates many. The goodwill of the stimulus program with the public is damaged.

However, it is absolutely crazy to have so very many unemployed and our public goods infrastructure needing some $3 trillion plus in repairs, according to the American Society of Civil Engineers, at the same time. We cannot seem to get the two together effectively. It is patently ridiculous and unfair to us all.

We need to streamline the laws governing such projects, simplify the projects to be more easily labor intensive and get on with the repairs and the maintenance needed. The program should be treated like one for the mobilization and preparation for a war. Then, deficits in this quarter would be fine for most people, but regrettably too much of the original stimulus program is behind and then there is the pork, so people are upset. Too, they do not see enough results and grow suspicious, and that injures the goodwill associated with the program.

We need to retroactively cut the funding for the pork and special interests, add many more new, simplified and honest public goods projects and then get on with it. Where has America's "can do" spirit gone here? Have we checked and balanced ourselves into paralysis?

Meanwhile, the cost of repairing the sagging infrastructure continues to rise daily. Governments at all levels over the years have spent the maintenance and repair monies on new hires, expanding the roles of government and on similar endeavors instead -- thereby making a mess of the infrastructure. Again, this inspires public ill-will and a lack of confidence in government which is needed now.

Presently, we still might have a chance to pull it all together, take care of a lot of the unemployment problem and fix the infrastructure in significant measure, but we are blowing it big time and destroying, instead of building political capital with the American people. It is hugely stupid. Looking at the progress and the pork involved, many Americans feel, like me, that we were sold a bill of goods.

What we need is a serious, new public information campaign by the federal government to set out the details of the programs, admit its mistakes, explain how it is fixing them and what people should expect from the programs and their costs in the future.

And to think policy makers are anxious about why so many have become deficit hawks, and they do not understand why. The rise of the hawks is in truth largely a vote of no confidence in the solutions and programs that have been adopted, in light of their costs, where the monies have gone and where those programs and the economy are now.

We just might have blown our chances here. The problem needs to be aggressively and quickly addressed by the Administration, but I don´t really see that happening any time soon.

Posted for publication as article on seekingalpha.com; selected to be an article and, further, designated as an "Editors Pick" article.

Comments [1]

Kimball Corson
11/14/2009, Neiafu, Vava'u, Tonga

Harold Bloom, America's premier literary critic and a professor at Yale, has said that, for sheer cognitive power only Emily Dickinson can rival Shakespeare at his best. Emily is truly powerful, mentally. Bloom has said that after teaching a class on her poetry to graduate students, he is always exhausted. She is an original American genius who stood in no one's intellectual shadow, which is extremely hard to do. Most great literary figures reflect in their work the subtle or not so subtle influences of other literary masters. They suffer from what Bloom has called, the anxiety of influence. Not Emily. She was a true original, which is so hard to be.

Unlike Shakespeare, who had no college or university training, Emily attended Mount Holyoke for a year. In studies requiring verbal skills, she was most advanced. In math and the sciences, she solved problems correctly and quickly, but in most unorthodox ways. Her father, a successful lawyer, was one of the original founders of Amherst College.

In all of literature, I most enjoy Emily Dickinson, but she is hard to get a handle on because she uses the language in her own more powerful and unique way. It is really dazzling.

While she lived, only her brother, who predeceased her, could comprehend and really understand her. The rest were left behind. I personally believe she had an incestuous relationship one summer with her brother. Emily clearly knew no boundaries.

Here is the only photograph of her that is known to be authentic. It was taken at or about the time she attended Mount Holyoke.

Emily is a real heroine of mine. Here is a sample poem, which like all, is untitled, but numbered -- no help to be had there:

761.

From Blank to Blank -
A Threadless Way
I pushed Mechanic feet -
To stop - or perish - or advance -
Alike indifferent -

If end I gained
It ends beyond
Indefinite disclosed -
I shut my eyes - and grouped as well
'Twas lighter - to be Blind -

Even her rules of capitalization and punctuation were her own and not at all random, either.

While Emily was fully aware of where she placed prospectively in the pantheon of poetic genius, she still had the humor and margin to write:

288.

I'm nobody! Who are you?
Are you -- Nobody -- Too?
Then there's a pair of us!
Don't tell! they'd advertise -- you know!

How dreary -- to be -- Somebody!
How public -- like a Frog -
To tell one's name -- the livelong June--
To an admiring Bog!

Emily was a serious amateur botanist as well. If you have ever heard a bog with frogs in June, you know what an incredicle racket they can made. Clearly, Emily thinks many people have too high an opinion of themselves.

Emily's poems were not published during her lifetime. Shortly thereafter, interest arose and the poems were published, invariably with editors who did not understand her and changed her punctuation, capitalizations and sometimes even her wording. We know better now, but it took a while and some smart literary critics to figure it out.

Comments [7]

Kimball Corson
11/08/2009, Neiafu, Vava'u, Tonga

What is the addition here -- a wire run?
______

Why Consumption Expenditures in the U.S. Are Not Recovering Quickly

Why are consumption expenditures not recovering quickly in the U.S? In other words, what has happened to the country's consumers? This question in turn requires us to consider what has happened to the income of most American consumers? Clearly, on average, it has not risen during the recession. Absolute numbers are less meaningful here than relative numbers because they better show why national consumption has not recovered quickly. They also better reflect the results of U.S. government action and inaction, as I will explain. The relative numbers are found in the distribution of income. So our questions, as we frame them, are what has happened to the distribution of income in the U.S and with it consumption expenditures by the American consumer?

I. The Background

The truth is we don't specifically know, even though Congress has responsibility for, and absolute control over that distribution and its impact on consumption, as I explain below. The impact of the recession on income distribution has not been determined yet, amazingly enough, but we know the impact is serious and adverse and anecdotal evidence is certainly not only suggestive, but devastating: people not having enough food at the end of the month, as Walmart executives are saying. Worse, a report was released in the last day or so (Nov 16th) saying that 49 million Americans, or almost 1 in 6, are not getting enough food to eat regularly. That is how bad the situation is. A teacher in a U.S. elementary school asked a young boy what he had for breakfast that morning and he said, "Nothing. Today is not my day."

We also know that back in the good times of the 2007 housing bubble, the situation was not very good, largely due to government inaction on the matter. It looked like this:

Aggregate U.S. Household Income Distribution, 2007
Percentage of Total US Household Income by Income Groups
3.1% of income --- is less than $20k, 19% of households
8.1% of income --- is $20k to $37.5k, 19.5% of households
13.8% of income --- is $37.5k to $60k, 19.4% of households
22.3% of income --- is $60k to $90.5k, 20% of households
40.8% of income --- is $95.5k to $250k, 20.2% of households
11.9% of income --- is $250k or more, 1.9% of households
Bur. of Census See also http://en.wikipedia.org/wiki/Income_distribution

This distribution of income large reflects not the recession, but the impact of government or the lack of it on the distribution of income. As we can see here, back in 2007, the top 22% of all households walked away with 52.7% of all the income, leaving the bottom 78% of households with 47.3% of the income.

Worse, if we look at the bottom levels of households earning less than $60,000 a year, there were 58% of the households in that category in 2007 and they took home only 25% of the income. And this was in 2007, when times were booming from the housing bubble.

II. The Impact of the Recession on Income Distribution.

My best guess is most of the 17.5% to 20% of true unemployment we now have arises in this bottom almost 60% of households. Indications are that the results of the recession have been devastating in that quarter, as food retailers and other data indicate.

To try to get a fix on just how bad the current income distribution problem might be, consider this crude estimate. Assume that all the unemployment is concentrated in the 58% of households that were earning less than $60,000 a year, that the unemployed earn nothing and that the unemployed used to earn the average income for that 58% of the households. Then almost 60% of households now command 17.5% to 20% less of the income they had or about 20% and the top 42% of households now gets 80% of all income. That is down from 25% for the bottom end. My guess is that, with this recession, these results might really be pretty close to the mark, if they are not optimistic. I say optimistic because incomes have probably fallen proportionately more on average at the bottom end than the top due to other aspects of the recession.

That almost 60% of all households might be getting only 20% of the income now generated in the U.S. is flatly outrageous. The middle and lower classes should be in revolt. Nicely enough for peace and quiet, no data are available so the middle and lower classes do not know collectively how bad off they are in fact. But we are seeing anecdotal evidence of it that supports this estimate. With less income, it is not surprising that consumption expenditures are not recovering quickly, especially if many consumers are trying to increase their savings to pay down their debts or to develop a safety margin.

III. The Impact of Government on Income Distribution


But it is not just this recession that has made things harder on the lower and middle income classes. Problems were in the wind earlier, with the rise and domination of heavy lobbying of the federal and other governments, and Congresses lack of attention to the distribution of income. For the pre-2007 period, we do have data which is reliable. See the block charts at
http://en.wikipedia.org/wiki/Household_income_in_the_United_States.

The income distribution has become more badly skewed since before 1970 to the about 2007. Real income is almost flat during this period for those in and below the 60% percentile, but above that, incomes have soared, particularly in about the 90th percentile and above, where they have tripled since 1950. And these are inflation adjusted dollars, too.

This is significant. In the last 20 years or so the income distribution problem has deteriorated and with it the U.S. consumer base, which was bolstered for too long by heavy consumer borrowing, as consumers most in the lower 60% tried to keep up. Congress has done next to nothing about the distribution problem. The recession has simply compounded an already serious distribution problem.

The three major consequences for the economy of this deterioration in the distribution of income are:
1. the consumer base in the U.S. and therefore consumption expenditure has markedly deteriorated --

a. because the majority of Americans have less income to spend, that is, they have a smaller share of a shrinking income pie, and

b. because higher income households spend a much smaller percentage of their income on consumer goods and services than lower income households, that is, their average propensity to buy especially consumer goods is less,

2. much more income and dollars are now being rerouted into secondary financial markets, worldwide, by these higher income families that do not use most of their income for consumption, driving those assets prices up worldwide, and

3. government programs to stimulate and aid consumption and aggregate demand are not getting enough traction where it matters to seriously jump start the economy. It is not helping the lower 60% enough to seriously raise their consumption expenditures, given the income distribution we now have.

The economy is becoming ever more dysfunctional because of these problems, but especially the first one. The distribution of income problem is the reason the consumer base in the U.S. has become more impaired and government stimulus efforts don't have the affects we hope for on consumption. Domestic aggregate demand is seriously suffering, but financial markets are near their highs. We almost have deflation in consumer goods prices, but inflation in financial asset prices. No surprise.

A reasonable and more normal distribution of income, considering the longer historical U.S. record and how the economy has fared at various points and factoring out the excesses, should look something more like this:

bottom 20% ----------- 8% of income,
next 20% up ----------12% of income,
middle 20% ----------- 21% of income,
next 20% up ---------- 25% of income, and
top 20% ----------------34% of income.

This would be much more sensible and much better for the economy and consumption expenditures. It shows us how far out of wack the current income distribution has become.

IV. The Mechanism of Trickle Up Economics.

What has happened is the well-to-do in Congress and government have taken care of themselves and their wealthy, solicitous and well-lobbied for friends by using government to afford the upper half of the income distribution financial and other economic benefits at the expense of the middle and lower classes. Congress adopts laws and regulations are promulgated to help special interests at the expense of everyone else. Remember the tax breaks for the rich and the virtual elimination of the estate tax? Those were only the more obvious and conspicuous efforts of lobbying. Others are less obvious, but far, far more numerous.

Significant income advantages are acquired by lobbying Congress and the top half of the income distribution does it real well and often. This has materially aided the skewedness of the income distribution in the U.S.
The distribution of income and changing it is what lobbying is all about for the most part, but it is rarely perceived that way. Congress has too largely sold the American people out, to expand its own powerbase, increase the size of government and increase the wealth of its members and supporters. Congress is somewhat of a millionaires' club taking care of its own. Those newly elected to Congress may arrive poor, but they rarely leave that way after many terms in office.

The game has been going on for years. The lobbying that has been going on so long and intensely is certainly not for nothing. You don't hire expensive lobbyists expecting not to gain, and usually , financially. Little lobbying is for the general welfare of the people. We see in substantial part the results of lobbying above in the 2007 to the extent they differ from the suggested norm. The recession has just worsened things for the bottom half in particular, but they were already in bad shape before the recession. And, of course, the gains for the upper half have come largely at the expense of the bottom half. The lower 60% of the income distribution have too little income to support substantial consumption expenditures and the upper 40% spend too low a portion of their income on consumption. Consumption expenditures have therefore dropped, worsening the recession, and creating a vicious circle.

V. What Congress Has Impaired, It Can Fix.

Congress has absolute and complete control over the distribution of income, but it lets lobbying have its way too much and we see some of the results. Under the Sixteenth Amendment to the U.S. Constitution, the federal government is charged with the power to tax and spend money, subject to the limitation that it be for the General Welfare. (See also, Sec. 8 of Article I to similar effect.) Clearly, Congress is not watching out for the general welfare of the people in regard to the distribution of income and thereby protecting America's consumer base and national consumption expenditures. It is too much pandering to special interests and has been for years.

Unfortunately, almost no one in government wants to pay attention to the income maldistribution problem, which reflects these structural difficulties. The distribution of income has the major policy implications I have described, but they are just being ignored. Of course, policy and law makers and those they pander to are the beneficiaries of this travesty, so the problem being ignored should come as no surprise. Perhaps the economic consequences I note above will force Congress to address the problem when it realizes it really has no long run alternative to permanently improving national expenditures on consumer goods and services. Another bubble, like housing, won't do. Too, Americans can no longer float a lot of personal debt to hold up their consumption expenditures as they did for a while.

By the tax system and perhaps a negative income tax, Congress could correct the problem and it effects pretty quickly, if there were a will to do so. So far, there is none.
_________________________________

Comment: I have posted this article in various forms and with many revisions, but the editors of seekingalpha.com won't publish it. It is a serious and important article, but obviously deals with very sensitive issues the upper income classes, my audience, do not wish to hear about. I have submitted it in the present form, but do not have much hope. My other articles get snapped up quickly. Update: rejected. So I submitted the following massively revised version instead, in the hope I can slip it in and by:
_____________________________________

Why the Economy Is Not Improving Much

Most economists and too many policy makers are ignoring what I think is the core reason the economy is not improving much. The real reason consumption expenditures and the economy are not doing well is found in the current distribution of income in the U.S. Let me explain. According to the Bur. of Census, in 2007, during the good times of the housing bubble, 58% of households got only 25% of the income. Bur. of Census data at http://en.wikipedia.org/wiki/Income_distribution. That was not much. Now, the situation is worse.

If we assume real unemployment of 17.5%, and assume that the unemployed have no income and came from the bottom 58% and that they used to earn the average of those in and below the 58th percentile, then we can determine now, with the recession, the bottom almost 60% are getting only about 21% of the income, instead of 25% and the upper 40% is getting 79% of it.

This is a major problem too many do not address. Here is why it is a major problem. The three major consequences for the economy of this deterioration in distribution are:

(1) the consumer base in the U.S. and therefore consumption expenditure has markedly deteriorated

(a) because the majority of Americans have less income to spend, that is, they have a smaller share of a shrinking income pie, and

(b) because higher income households spend a much smaller percentage of their income on consumer goods and services than lower income households, that is, their average propensity to buy especially consumer goods is much less,

(2) much more income and dollars are now being rerouted into secondary financial markets, worldwide, by these higher income families that do not use most of their income for consumption, driving those assets prices up worldwide, and,

(3) government programs to stimulate and aid consumption and aggregate demand are not getting enough traction where it matters to seriously jump start the economy. It is not helping the lower 60% enough to seriously raise their consumption expenditures, given the income distribution we now have.

The economy is becoming ever more dysfunctional because of these problems.

Too, the anecdotal evidence is not only suggestive and supportive, but it is devastating as well: people not having enough food at the end of the month, as Wal-mart executives and other food retailers are saying. Worse, a report was released in the last day or so saying that 49 million Americans, or almost 1 in 6, are not getting enough food to eat regularly. A teacher in a U.S. elementary school asked a young boy what he had for breakfast that morning and he said, "Nothing. Today is not my day." That is how bad the distributional problem is.

Congress has been taking care its members and the well-to-do, with their highly paid lobbyists, for so long, the income distribution has thereby become badly skewed. The tax cuts for the rich and the virtual elimination of the estate tax are only the more conspicuous and recent examples. Income is skewed so badly now it is to the point where in my opinion, the country, with the governmental regulation we have, can no longer function well as a capitalistic, entrepreuerial society.

Until we collectively address this point and our huge trade deficit I think we are going to stay largely stuck where we are or close to it. Only Congress can fix this problem by using the tax system and possibly a negative income tax to correct the maldistribution. Until then, we will just have to wait for the next bubble to feel good for a little while.

We are in a major jam that is different than most recessions we have encountered, but on the fiscal side we tend to think only of orthodox solutions and are not as inventive as we have been on the monetary side.


Comment Victory at last! This haircut version was published by the editors and is drawing favorable comments quickly.

Comments [13]

Kimball Corson
11/08/2009, Neiafu, Vava'u, Tonga

A touch of elegance; almost oriental.
_____

How the Fed Is Financing a Worldwide Financial Asset Bubble and Its Impact on the Dollar

From several comments to articles about the worldwide asset price bubble, and from some of those articles, too, I observe considerable confusion about how the asset price bubble is being financed and how it impacts the dollar. Many think that, inasmuch as virtually no one in the U.S. can borrow at reasonable rates, the carry trade and therefore the asset bubble cannot exist. Others believe that a large carry trade in dollars necessarily means there is downward pressure on the dollar. Neither is true. I explain.

As part of its quantitative easing and low interest rates policies, the Fed has targeted its purchase of $1.25 Trillion of agency mortgage-backed securities for the period from January 1, 2009, through the end of the first quarter of 2010. It is on track. Over the same time interval, the Fed is buying $175 billion of other U.S. agency debt. In roughly the first three quarter of 2009 or through October of 2009, the Fed also bought $300 billion of U.S. Treasuries, clearly increasing the money supply by at least that amount. So does the purchase of agency debt if it is backed and authorized by the federal government and new dollars are used to buy it.

These are the sources of dollars for not only the carry trade, which by definition requires borrowing dollars or leveraging, but also for dollars that can simply be exported to seek higher earnings abroad by those who own them and previously held Treasuries or agency debt.

By themselves, these exports of dollars would seriously depress the dollar. However, there is a countervailing consideration. When the foreign central banks receive dollars for their sales of local currency to invest, they typically turn around and buy Treasuries with those dollars which neutralizes the downward pressure on the dollar. The net impact on the dollar from this source is essentially zero if the flow in each direction is the same. But there is the rub.

Although the U.S. is the biggest player by far, other G-20 nations also have low interest rate policies and are also using quantitative easing. For example, the E.U. is likewise financing the worldwide asset bubble and in the same way. But when Euros are transferred abroad for higher returns to buy local currencies, the foreign central banks may or may not purchase all Eurobonds. They might purchase some Treasuries as well. Or they might buy more Treasuries than Eurobonds. Factor in all the nations using some variation of low interest rates and quantitative easing and you can see there is considerable slippage regarding not only what happens to the dollar, but also to the Euro, as well as to the other currencies. Of course, other economic factors likewise affect these various exchange rates.

These currency flows can make it very hard on foreign central banks in high return countries. Brazil, for example, is using its exchange controls to block many such capital transfers seeking higher returns. It does not want asset prices to bubble up and returns drop in its country. Australia recently created a ruckus when it decided to raise its interest rates, but unlike many nations Australia has resisted quantitative easing and now faces a solid upturn in its economy.

Leveraging and the carry trade are not the only means by which the worldwide asset bubble is being financed. The impact on the dollar from that financing is likewise variable. The basic source of the moneys used to push up world asset prices and lower their returns is the governments of the world using longer term low interest rate policies and quantitative easing.

Posted and published on seekingalpha.com

Comments [0]

Kimball Corson
11/08/2009, Neiafu, Vava'u, Tonga

On a pole mounted step down transformer.
_____

Interest Rates Do Not Equalize Savings and Investment

Savings and investment are flow variables in Keynesian models that are brought into balance by the interest rate so that the quantity of dollars saved is equal to the quantity of dollars invested, at any particular level of GDP. That is the orthodoxy and it is well received. It is also flatly wrong, I submit.

Consider sample households, some in the lower half of the income distribution and the others in the upper half. Let us look at how they typically dispose of their income these days. Households in the lower half spend most of their income on consumer goods and services, saving a portion usually to help pay off their debts. How much they save has little if anything to do with any interest rate, except perhaps the onerous ones being charged on a portion of their debt, e.g., credit card debt. These rates, in turn, have little to do with anything but opportunistic usury.

At the other end of the income distribution, the richer households have a lower average propensity to consume and put a much higher proportion of their income into secondary financial markets, also with little regard for interest rates. In fact, if stock prices are high and rising, with lowering returns, they are inclined to invest more in secondary markets in order to ride the trend. The relationship between savings and interest is then turned on its head for a large portion of the GDP, given the skewed distribution of income in the country.

Obviously, income much more determines the levels of savings than interest rates and by a very wide margin at both ends of the income distribution. But worse, savings can increase more, the faster and higher secondary asset prices rise and the lower is the return on them, at least within a broad range and for a lot of the time.

Alternatively, say both sets of households decided to save more in case the recession worsens, i.e., GDP and their incomes fall. Putting a portion of their incomes into bank savings accounts almost guarantees the money will not be loaned out for original investment in bad economic times. It will likely be used directly or indirectly for bank investments in the secondary financial markets as well. Again, interest rates or returns have little to do with it and the relationship can actually be turned on its head again. High and rising prices implying lower returns with even greater secondary market investments, of course, to a point.

The notion that an interest rate has any real bearing here is largely ludicrous. Indeed, moneys that might have been used for original investment are often diverted often into the secondary financial markets in ever larger quantities the lower is the interest rate and the faster financial asset prices are rising, exactly the opposite of what the Keynesian models suggest.

At least in a poor economy, original invest is minimal and substantially interest inelastic. Savings, on the other hand tends to increase as interest rates fall and financial asset prices rise. But is it any different in good economic times?

Original investment may well be higher and more interest elastic in good times, but savings can well have the same inverse relationship to interest rates noted above. There is no reason whatsoever to believe that interest rates will equalize the amount of money originally invested with that saved. None at all.

The Keynesian model supposes people save by either direct original investment or by putting their money in institutions that immediately do so and that they save more, the higher the interest rate. Those making original investments, on the other hand, consider carefully the return on that investment compared to the interest rate they must pay for the money to invest. That is, most simply, Y = C + S and S = I, where Y is income, C is consumption and I is investment. The interest rate equalizes I and S.

Only in these incredibly naive and rarefied circumstances, where everything else is equal, does the Keynesian model have any credibility at all in regard to savings and investment. Too much is patently ignored. Given the collateral affects on the economy of secondary markets (via wealth and other affects) and the impact on those markets of Fed and governmental policies, all savings not directed into original investment cannot simply be chalked up to hoarding.

The situation is much more complicated than that, in both good times and bad. The equations above have to be opened up to the secondary financial markets. Once that occurs, trends in those markets and the manner in which they compromise those markets destroy the Keynesian models. See my articles here entitled Good Picks Can Be Clobbered by Trading Trends and How Trend Trading Compromises the Market for further background. Trends occur most of the time that secondary markets are rising or falling, that is, virtually all the time.

Just as Says Law fails in regard to equalizing production and consumption, the same type of variability destroys any presumed equality of the amount saved and the amount originally invested, interest rates notwithstanding. This is largely rendered true given the existence huge of secondary financial markets, the amount of income going into them and, indeed, the typical inverse relationship between asset returns and the demand for them in those markets much of the time.

Posted and published on seekingalpha.com

Comments [1]

Kimball Corson
11/08/2009, Neiafu, Vava'u, Tonga

All in a row.
_____

Why a New Stimulus Package is Premature

The reason is simple. We have not implemented most of the last stimulus package, yet. Very few project funds have been awarded and paid out for work in progress, excluding the $83.8 billion in tax benefits. See, http://www.recovery.gov/Pages/home.aspx.

Of the total of $787 billion authorized as the stimulus package, more formally known as the American Recovery and Reinvestment Act of 2009, only $194.5 billion has actually been paid out by all means whatsoever, that is only about 25% of the funds authorized. If we exclude tax benefits from this figure, only $110 billion of the stimulus package or about 14% has actually been paid out for projects as of the end October 30, 2009.

But this tells us nothing about how the projects are coming along. On that score, a pie chart shows us the number of stimulus projects in the program which have been completed, started but less than 50% completed, started but more than 50% completed and not started, as measured by on-going work in progress payments. The data are shocking and set out below:

4,110 Completed
25,932 Less than 50% complete
5,063 More than 50% complete
21,881 Not Started

Of the total projects slated for the stimulus program, the vast majority are either not started or less than 50% complete. Less than 8% are completed. Almost 40% are not started. And over 45% are less than 50% complete.

Surely, we don't need a new stimulus program until we have implemented and tried this one.

Posted and published on seekingalpha.com

Comments [0]