The funny thing about the times we live in, and the institutions that, ahem, serve "us" is that when a stock market turn-around like the one on Wednesday is put down to rumors of a surprise rate cut, it's accepted without the bat of an eyelid. Never mind the train cars full of traders having heard how Europe was trading that day heading to the city early to face an anticipated tidal wave of sell orders. Never mind the tenuous nature of current v-shaped earnings expectations with "back to normal for '08" (as if the last 12 quarters have been anything but normal) looking more and more, well, nuts really. Never mind the chart picture that has PPT conspiracy watchers in a lather.
What should be no surprise is that the housing bubble continues to unwind. What also should be no surprise is that every dip in the market with just a hint of panic (and that's most of them now - since valuation was tossed aside for the greater fools of private equity, followed by shots of rate cut tequila) will be met with calls for more cuts. Soon enough m* thinks, even the existence of the PPT and its "interventions" will simply become accepted as fact, so cynical and so desperate for a bail out has the Street become. Public calls for the necessity of interventions will soon follow.
m* remembers well that Japan actually had a PPT during the unwind of that great bubble which served no one but the politicians who could claim to be "doing something" while owners of real estate and equities saw nominal prices decline 75% over the 90's. There are scant reasons to expect different this time.
But the Rolling Thunder in the title of todays post refers to something even more ominous and was sparked by todays utter meltdown (with tree in the forest effect) of the fantasy that the credit crisis of July and August ended with a 50bp freebie from the Fed and new equity highs.
On the surface, today's rumors of sub-prime write downs at AIG, the further erosion in Merrill Lynch (also on rumors of further writedowns - yes even with yesterdays announced $8bn writedowns), and the long overdue implosions of the "cya" facilitators who previously insured municipal debt and more recently took their thoroughly dubious business model into the structured credit space, are just echoes of the summer's difficulties, nothing much to worry about now that the Fed is on our side and earnings from the global boom will most certainly hold up . Except that developments in the credit space are continuing to unravel. FT: Mortgage bond index declines 30%.
To those former CDO manufacturers and buyers now picketing Moodys and clamoring for more Fed assistance m* asks, if the insurer of your structured CDO deal is levered 100x, is that really insurance? Forget the rating agencies, insuring structured credit deals is (was?) the ultimate "cya" business.
What's important about this, coinciding with the failure of the delaying action formerly known as MLEC - the SIV PPT, is the realisation on the street that while Merrill took an $8bn writedown, it's very likely they, like everyone else, are still holding the stuff. Moreover, to the extent they did sell some, its more likely they sold what they could (the higher quality paper with perhaps some transparency) and are left with a portfolio even heavier (on a relative basis) in the toxic unsellable stuff than before.
The July-August asset backed market crisis was actually very orderly - the market simply closed. The panic was real, the paper markdowns painful, but there was relatively little selling. It was obvious to everyone that selling would only hurt one's own remaining positions more. It was better to wait it out if possible rather than force the issue with prices in a market with no buyers.
However that situation was always going to be temporary, hence the proposed master SIV as a vehicle to delay the day of reckoning indefinitely. That moratorium is now over. Over the last few days, m* has heard of several deals that would "never never" be unwound before maturity now being shut down, their assets liquidated. The lenders need the cash. Debt is finding its way back to banks balance sheets. Asset backed commercial paper is coming due. Not much of it will be re-extended and the forced selling that the market successfully avoided in July-August is quietly spreading.
Thursday, October 25, 2007
Monday, October 8, 2007
Ricardo Revisited
After last week's bleeding heart post about the downside to our absolute acceptance of the concept of free trade, m* finally got around to opening up the October issue of The Atlantic, a magazine recently suffering from a summer-long bout of irrelevance, and worse - has anyone else had about enough of Robert D. Kaplan's context-free sycophantic martial worship?
However there were two very timely items directly connected with the free-trade (or not) discussion that m* heartily recommends. (A nominal subscription to read the articles is required). First up was a lively debate in the letters section on James Fallows' partly good, partly just bizarre, July/August essay on the terms of trade with China, "China Makes, the World Takes." Peter Navarro, author of the book "The Coming China Wars" counters Fallows' rosy piece by highlighting the darkside of the industrialization and globalization picture:
"China’s competitive advantage in world manufacturing markets is largely due to a web of illegal export subsidies, rampant counterfeiting and piracy, a grossly undervalued currency, and lax environmental and health and safety regulations. While they have benefited the American firms and other multinational companies that are offshoring to China, these mercantilist practices have put tens of millions of people out of work around the world—from the American Rust Belt to Mexican maquiladoras to the markets of Lesotho."
This may be a good place to also direct readers to an astonishing piece on the PIMCO website entitled "Renegade Economics: The Bretton Woods ll Fiction" where the authors take to task both the US and China for practicing "renegade economics" but in particular lay serious criticism on China for playing the competitive devaluation card (and getting away with it) for the better part of fifteen years. In their minds, much of the seeds of the current "savings glut/credit bubble" were sown in Chinese - as opposed to Japanese or US - monetary (and political) policy. Considering the relative importance of the China bid for the $700 billion of bonds in the Pimco portfolio, m* finds this an interesting position to advocate.
Back to the Atlantic, senior editor Clive Crook writes about the current backpedaling among prominent mainstream (well, orthodox anyway) economists on the benefits of free trade and that one true idea in all of economics, Ricardo's comparative advantage, in "Beyond Belief."
He writes, "For nearly 200 years, the principle of comparative advantage, and the ideas that flowed from it, divided the world into two camps: those with basic economic literacy; and the rest." Um, Clive? m* would like to mention that it's a pretty big world out there. He goes on to note that while challenges to the thesis on technical grounds have thus far been vanquished, notable members of the profession seem to have a problem reconciling it's conclusion with their own observation of the times.
How ironic, for that is essentially the problem with economics in a nutshell. The key that Crook misses in his glib recounting of contemporary research is not that theory is necessarily wrong, but that it often has little if anything to say about the "adjustment path" to being right. In other words, those economists whose shift is "both momentous and disturbing" are taking notice of an heretofore under-appreciated intermediate term, where the frictions of adjustment between equilibria occur. Since "in the long run we are all dead," this time-frame is therefore of importance to many people, likely even a few noted economists and senior editors.
For a serious exposition (with a humorous image) of "adjustment path" see Krugman's recent paper on the dollar and the potential for what he calls a "Wile E. Coyote moment."
However there were two very timely items directly connected with the free-trade (or not) discussion that m* heartily recommends. (A nominal subscription to read the articles is required). First up was a lively debate in the letters section on James Fallows' partly good, partly just bizarre, July/August essay on the terms of trade with China, "China Makes, the World Takes." Peter Navarro, author of the book "The Coming China Wars" counters Fallows' rosy piece by highlighting the darkside of the industrialization and globalization picture:
"China’s competitive advantage in world manufacturing markets is largely due to a web of illegal export subsidies, rampant counterfeiting and piracy, a grossly undervalued currency, and lax environmental and health and safety regulations. While they have benefited the American firms and other multinational companies that are offshoring to China, these mercantilist practices have put tens of millions of people out of work around the world—from the American Rust Belt to Mexican maquiladoras to the markets of Lesotho."
This may be a good place to also direct readers to an astonishing piece on the PIMCO website entitled "Renegade Economics: The Bretton Woods ll Fiction" where the authors take to task both the US and China for practicing "renegade economics" but in particular lay serious criticism on China for playing the competitive devaluation card (and getting away with it) for the better part of fifteen years. In their minds, much of the seeds of the current "savings glut/credit bubble" were sown in Chinese - as opposed to Japanese or US - monetary (and political) policy. Considering the relative importance of the China bid for the $700 billion of bonds in the Pimco portfolio, m* finds this an interesting position to advocate.
Back to the Atlantic, senior editor Clive Crook writes about the current backpedaling among prominent mainstream (well, orthodox anyway) economists on the benefits of free trade and that one true idea in all of economics, Ricardo's comparative advantage, in "Beyond Belief."
He writes, "For nearly 200 years, the principle of comparative advantage, and the ideas that flowed from it, divided the world into two camps: those with basic economic literacy; and the rest." Um, Clive? m* would like to mention that it's a pretty big world out there. He goes on to note that while challenges to the thesis on technical grounds have thus far been vanquished, notable members of the profession seem to have a problem reconciling it's conclusion with their own observation of the times.
How ironic, for that is essentially the problem with economics in a nutshell. The key that Crook misses in his glib recounting of contemporary research is not that theory is necessarily wrong, but that it often has little if anything to say about the "adjustment path" to being right. In other words, those economists whose shift is "both momentous and disturbing" are taking notice of an heretofore under-appreciated intermediate term, where the frictions of adjustment between equilibria occur. Since "in the long run we are all dead," this time-frame is therefore of importance to many people, likely even a few noted economists and senior editors.
For a serious exposition (with a humorous image) of "adjustment path" see Krugman's recent paper on the dollar and the potential for what he calls a "Wile E. Coyote moment."
Thursday, October 4, 2007
Globalization's Red Skeptics
For the dollar-crash pundits, one of the key drivers of the doomsday scenario where the US is suddenly cut off from the torrent of foreign capital necessary to fund it's negative savings economy (and a trillion dollar war habit) is a rather nebulously specified "rise in protectionism."
As every student of orthodox economics is taught, and the public debate on trade has accepted as fait accompli since what feels like the Reagan era, the goodness of free trade is as pure a thing as there is to be explained in economics. As the story goes, the principle of comparative advantage enlarges the economic pie for everybody. Furthermore the reduction of frictions and barriers to trade are touchstones of a modern, efficient, and open society.
However, a lot of economics is about the frictions, the sand in the gears, of theoretical purity. Ronald Coase, one of m*'s favorite old time economists, won the Noble prize for examining some of those frictions, transaction costs to be specific, and theorizing that enterprises organize themselves into corporations in order to minimize those transaction costs.
When it comes to the sacred cow of free trade however, the frictions created by globalization - the very real and serious impact on the economic well being of ordinary people, are the inconvenient truths rarely discussed openly by serious members of the profession, with some exceptions. As long as the pie is expanding, it is impolitic to ask whether and for whom the pie is shifting as well. Inequality is not a subject economics handles well, and this ideal, utterly inimicable to the economic well being of the US middle class, has somehow become the law of the land in economic thought.
Yet a strong case can be made that for adherence to an economic ideal, the manufacturing base in the US and a sense of purpose and security for a large mid-section of the population has been sacrificed. No doubt a young Chinese factory worker's life in an industrial complex resembling a city is better in many respects than the deep rural poverty that would have preceded it. And m* can well appreciate the benefits of "everyday low prices" in poor rural sections of the US as well. But those kinds of benefits do absolutely nothing to create investment or better long run prospects for our people, and our democracy.
What is surprising to m* is how little complaint there has been from the manufacturing regions of the country, as one industry after another has been packed up and shipped off overseas. Distracted by fighting the war on terror, and fooled about their prospects by the (now departed) housing bubble, the US's losers in globalization have been mostly silent. Now they are waking up.
The extraordinary article on the WSJ's front page today, Republicans Grow Skeptical on Free Trade , signals a dramatic shift in opinion that brings the Red State voter in close alignment with many Blue State voters, and portends significant pressure on the unfettered free trade the owners of capital have enjoyed (with extraordinary sized profits as a share of GDP to show for it) while real wages for the average US worker have steadily declined. While pockets of dissatisfaction have surfaced before, a two to one margin of Republican voters now believe free trade is bad for the economy.
To be clear, m* is all for fair and open trade, and abhors tariffs, subsidies, and import quotas on principle. However, the system now in place, beginning with China's accession to the WTO in 2001, has been anything but fair and open. Heavily lobbied for by corporations seeking access to a vast and dirt-cheap labor pool as well as a billion person market, the accession allowing China to maintain a closed capital account and an inconvertible currency was a grave error of short-term profit seeking behavior. The 2001 agreement focused almost exclusively on microeconomic issues, market structures, and reducing trade controls, many of which, six years later, appear to have failed. Yet the macroeconomic "global imbalances" that have resulted from an unlevel monetary playing field, including massive trade deficits, distorted risk premiums, over-investment and consumption globally, and an explosion of debt in developed nations, will have serious consequences on US standards of living as the inevitable (and thoroughly underway) inflation and debasement of the dollar gather pace.
For the moralists' case, the Red's are coming around.
As every student of orthodox economics is taught, and the public debate on trade has accepted as fait accompli since what feels like the Reagan era, the goodness of free trade is as pure a thing as there is to be explained in economics. As the story goes, the principle of comparative advantage enlarges the economic pie for everybody. Furthermore the reduction of frictions and barriers to trade are touchstones of a modern, efficient, and open society.
However, a lot of economics is about the frictions, the sand in the gears, of theoretical purity. Ronald Coase, one of m*'s favorite old time economists, won the Noble prize for examining some of those frictions, transaction costs to be specific, and theorizing that enterprises organize themselves into corporations in order to minimize those transaction costs.
When it comes to the sacred cow of free trade however, the frictions created by globalization - the very real and serious impact on the economic well being of ordinary people, are the inconvenient truths rarely discussed openly by serious members of the profession, with some exceptions. As long as the pie is expanding, it is impolitic to ask whether and for whom the pie is shifting as well. Inequality is not a subject economics handles well, and this ideal, utterly inimicable to the economic well being of the US middle class, has somehow become the law of the land in economic thought.
Yet a strong case can be made that for adherence to an economic ideal, the manufacturing base in the US and a sense of purpose and security for a large mid-section of the population has been sacrificed. No doubt a young Chinese factory worker's life in an industrial complex resembling a city is better in many respects than the deep rural poverty that would have preceded it. And m* can well appreciate the benefits of "everyday low prices" in poor rural sections of the US as well. But those kinds of benefits do absolutely nothing to create investment or better long run prospects for our people, and our democracy.
What is surprising to m* is how little complaint there has been from the manufacturing regions of the country, as one industry after another has been packed up and shipped off overseas. Distracted by fighting the war on terror, and fooled about their prospects by the (now departed) housing bubble, the US's losers in globalization have been mostly silent. Now they are waking up.
The extraordinary article on the WSJ's front page today, Republicans Grow Skeptical on Free Trade , signals a dramatic shift in opinion that brings the Red State voter in close alignment with many Blue State voters, and portends significant pressure on the unfettered free trade the owners of capital have enjoyed (with extraordinary sized profits as a share of GDP to show for it) while real wages for the average US worker have steadily declined. While pockets of dissatisfaction have surfaced before, a two to one margin of Republican voters now believe free trade is bad for the economy.
To be clear, m* is all for fair and open trade, and abhors tariffs, subsidies, and import quotas on principle. However, the system now in place, beginning with China's accession to the WTO in 2001, has been anything but fair and open. Heavily lobbied for by corporations seeking access to a vast and dirt-cheap labor pool as well as a billion person market, the accession allowing China to maintain a closed capital account and an inconvertible currency was a grave error of short-term profit seeking behavior. The 2001 agreement focused almost exclusively on microeconomic issues, market structures, and reducing trade controls, many of which, six years later, appear to have failed. Yet the macroeconomic "global imbalances" that have resulted from an unlevel monetary playing field, including massive trade deficits, distorted risk premiums, over-investment and consumption globally, and an explosion of debt in developed nations, will have serious consequences on US standards of living as the inevitable (and thoroughly underway) inflation and debasement of the dollar gather pace.
For the moralists' case, the Red's are coming around.
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