FM newswire for 13 February, articles for your morning reading

Today’s links to interesting news and analysis.  If you find this useful, pass it to a friend or colleague.

  1. Why Not the Gold Standard? – Talking Points on the Likely Consequences of Re-Establishment of a Gold Standard“, Brad DeLong (Prof Economics, Berkeley), 10 August 1996
  2. Watch your liberties slip away while you doze:  “Student air passenger handcuffed to echoes of 9/11 fears“, Philadelphia Daily News, 11 September 2009
  3. From global warming sceptics, effective propaganda for morons:  “From Their Own Mouths: Global Warming is a Fraud“, Information Liberation, 10 November 2009 — It has 1.6 million Google hits, but no a shred of evidence.   When we no longer accept this sort of trash, America will be back on track for success.  See below for a specific example.
  4. More fruit from the liberation of the CRU emails.  We owe a medal to whoever did it.  “Science chief John Beddington calls for honesty on climate change“, The Times, 27 January 2010 — Suddenly the things sceptics have recommended for years become respectable, but they remain outcasts.
  5. You’re Rich. Get Over It.“, Daniel Gross, Slate, 3 February 2010 — “People who make $250,000 or more a year can afford a tax hike.”
  6. One key to China’s success:  reverse-engineering — “How Manufacturing’s Mockingbird Sings“, Caixin, 10 February 2010 — “From batteries to cars, BYD engineers have found that successful product manufacturing begins by copying others.”
  7. The dream of a political alliance of all right-thinking folk:  “Fantasy-League Politics“, Mark Schmitt, American Prospect, 11 February 2010 — After all, don’t all good and wise people agree with me?
  8. Speech by New Jersey Governor Chris Christie:  New Jersey is in a state of financial crisis, 11 February 2010
  9. Valuable analysis of liabilities of western governments:  “Government hedonism and the next policy mistake“, Dylan Grice, Société Générale, 11 February 2010 — Excellent graphics.  His forecasts have not been so accurate, however.
  10. Poll: Tea Party Shows Prospects; Less So for Sarah Palin“, ABC News, 11 February 2010
  11. Looking at Palin’s ratings over time:  “National Favorable Rating: Sarah Palin“, Pollster

Today’s special feature, with powerful implications for both the EU and us

An overvalued “hard currency” can be a horrible drag on a nation:   “Latvia’s Recession: The Cost of Adjustment With An ‘Internal Devaluation’”, Mark Weisbrot and Rebecca Ray, Center for Economic and Policy Research, February 2010 — Excerpt:

The Latvian recession, which is now more than 2 years old, has seen a world-historical drop in GDP of more than 25% . The IMF projects another 4% drop this year, and predicts that the total loss of output from peak to bottom will reach 30%. This would make Latvia’s loss more than that of the U.S. Great Depression downturn of 1929-1933.

This paper argues that the depth of the recession and the difficulty of recovery are attributable in large part to the decision to maintain the country’s overvalued fixed exchange rate. With the nominal exchange rate fixed, the adjustment in the real exchange rate takes place through pushing down prices and wages.

… In addition, as a result of the recession, the Latvian government is rapidly accumulating debt. From just 7.9% of GDP in 2007, Latvia’s debt is projected at 74% of GDP for this year, stabilizing at 89% of GDP in 2014. This would put Latvia far outside the Maastricht debt/GDP limit of 60% of GDP for adopting the euro. The goal of adopting the euro has been one of the main arguments for making the sacrifices necessary to keep the peg.

Latvia’s experience has been similar to that of Argentina from 1999-2002, which also suffered a deep recession as it tried unsuccessfully to adjust its economy under a fixed exchange rate regime. The government tried to maintain confidence in the peg through contractionary fiscal and monetary policies, and borrowing for interventions to support the currency. But with rising interest rates and a rising public debt burden, this proved impossible. At the end of 2001, the government defaulted on its debt and by January 2002 it abandoned the peg. It is worth noting that, despite widespread consensus that the Argentine economy would experience prolonged economic problems after its default and devaluation, and the collapse of its banking system, the economy contracted for just one quarter before beginning a robust recovery in which it grew by 66% over 6 years.

In comparison, the IMF’s projected recovery for the Latvian economy is weak, just 13.9% for the four years 2010-2014.

Note:  this is about Latvia, the Baltic nation.  Not Latveria, the nation ruled by Dr. Doom (see Wikipedia).

Afterword

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10 thoughts on “FM newswire for 13 February, articles for your morning reading

  1. FM note: Before anyone reads this, be aware that much of it is false.
    * No State has “imploded into bankrutpcy” during this crisis.
    * States cannot file under Chapter 9 of the US Bankruptcy Code.
    * The 26 States that Mclaren lists are not those “that have declared bankruptcy”, but States that prohibit cities from filing under Chapter 9.
    * Even during the Great Depression no State went bankrupt. Arkansas defaulted on its bonds in 1933; they were eventualy paid in full.
    For more on this subject see “Nightmare scenarios haunt states“, Stateline, 14 December 2009

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    State after state implodes into bankruptcy — Michigan, Ohio, Oregon, California..now New Jersey and most recently, Nevada: “Governor plans emergency address on Nevada budget“, San Francisco Chronicle, 7 February 2010: “Assembly Speaker Barbara Buckley, D-Las Vegas, said balancing the budget would require 22 percent cuts across the board. She said the state could lay off every worker paid from the state general fund — and still be $300 million short. (..) Nevada’s education system could take the brunt of the blow.”

    The list of states that have declared Chapter 9 bankruptcy now runs to 26 (mysteriously, California isn’t on the list — perhaps they think the Fiscal Fairy will descend and wave away their current 24 billion dollar deficit with her magic wand): {snip}

    It’s gotten so bad that the rich parasites have started issuing stern warnings that states shouldn’t walk away from their unsustainable debts. It’s fine when billionaires abandon their bad investments and walk away, but for ordinary homeowners whose homes are now underwater and worth less than their mortgages, or states whose finances have collapsed? Oh, no, no, noooooooo, in that case, walking away from your debt is evil and irresponsible and intolerable. But of course if you’re a billionaire and one of your investments implodes, then it’s just good common sense to walk away from it.

    Bankruptcy Bloodbath May Hit Muni Owners“, Bloomberg, 10 February 2010: “Public officials shouldn’t think about filing for Chapter 9 municipal bankruptcy to solve mounting labor costs and pension liabilities. … Stiffing bondholders, even a little bit, would be unusual in the tax-exempt market, said James E. Spiotto, a partner at Chapman & Cutler in Chicago and a municipal bankruptcy specialist. That’s because most municipalities don’t go out of business in bankruptcy and need ready access to the credit market in order to borrow money. Reducing interest rates and extending repayment terms to bondholders are the usual strategies.”

    Of course the real worry here is the rich people who invest in muni bonds and make a fat living off the public dole by slurping up all those muni bond payments every month won’t get their money. As usual, the rich people who supposedly invest their capital and create more “productive” industries actually sit like giant ticks on the body politic and suck the blood of the ordinary nine-to-five worker in the form of those muni bond payments paid for by state income taxes and sales taxes and states fees. And so we learn once again that the biggest welfare queens are the rich…

  2. “Watch your liberties slip away while you doze: “Student air passenger handcuffed to echoes of 9/11 fears“”

    The kid is an idiot, and the actions of the authorities were entirely appropriate. This is an example of fine police work, the sort often spoken of as an alternative to the war. You can’t have it both ways.
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    FM reply: What did he do to justify you calling him an “idiot”? Learn Arabic? Carry flash cards? Travel overseas? These things might justify some questioning, but not being cuffed and taken to the police station.

    FYI — When you watch WWII movies, the men wearing sharp black uniforms with the spider-like insignnia are the bad guys.

  3. @ mclaren

    You seem unaware of the role of insurance in state and municipal bonds. Warren Buffet wrote about this last year in his annual letter to the Berkshire Hathaway shareholders. I am sadly unable to provide a link, or I would do so. His comments were interesting and relevant.

    Nowadays most tax free bonds are insured, which changes the incentives a bit if the issuer runs into trouble. As Buffet explains it, in 1975, whan New York City was facing possible default, the bondholders, the City, and the unions all had an incentive to come together and work something out, or face serious consequences. Nowadays the temptation is to throw the losses off onto the insurance company. Although Berskshire Hathaway underwrites a few tax free bonds, Buffet expressed doubt that ever make any money at it, given the incentives involved.

    Default by states and municipalities would, if it resulted in enough insurance losses, pose a risk to the financial system and would likely produce an eventual bailout, transferring the losses to the public sector.
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    FM reply: This is wrong on two levels.

    First, some minor errors.
    * States and muni are part of the public sector. You mean “transferring losses to the Federal government.” {correction: I musunderstood what he was saying}
    * Mclaren discusses State bonds. Few of these are insured.
    * Muni insurance assumes a few isolated defaults. The municipal insurance companies will go broke if this recession continues, a systemic event which will bankrupt many municipal entities.

    Second, and far more important, our answer to most financial problems is “bailout by the Federal government.” Mortgage sector bankrupt? Transfer losses to FHA, FNMA and the other GSE’s (all now owned by the Federal government). Banking sector bankruptcies? Corporate pension failures? Massive damage from floods, hurricanes? All these and more are just charges on the national charge card. At some point we’ll reach the limit, and the system will collapse. Unless we change our behavior before the crash. Anything is possible.

  4. I think Burke Sheppard was making a point that if the munis are insured, the losses would be those of the insurer, thereby remaining in the private sector. If the insurers go bankrupt, then the losses could be transferred to the public sector through bailouts.

    FM are you sure that the GSEs are “owned by the Federal Government”? The last I know they were placed in conservatorship by the Paulson Secretariat, and the conservatorship terms explicitly made it clear that Agency bonds aren’t backed byt he full faith and credit of the US Government.
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    FM reply: The take-over of the GSE’s was structured so that their debt would not be consolidated with that the US government. Under the US government’s primative accounting system, that would have looked bad. Hence the fig leaf of conservatorship, which is de facto ownership since the US government has what attorney’s call “incidence of control”:
    * As the conservator, FHFA assumed the power of the Board and management.
    * The US government is the majority holder of the GSE’s common stock (via direct purchase) and via warrants giving ownership stake of 79.9%, and the GSE’s preferred stock. Ownership of 80%+ would force ownership.
    * The US government has de facto assumed the liabilities by continued injections of capital and extention of guarantees.
    * The CBO, more interested in reality than political games, includes the GSE’s assets and liabilities in its budget estimates.

    For more information see:
    Statement of JAMES B. LOCKHART“, Direector of the Federal Housing Finance Agency, 7 September 2008
    QUESTIONS AND ANSWERS ON CONSERVATORSHIP“, issued by the Federal Housing Finance Agency
    Wikipedia entry for Federal takeover of Fannie Mae and Freddie Mac — note the links to relevant documents

    Re Sheppard’s point: Thank you for the correction. I misunderstood what he said, and have fixed my reply.

  5. FM wrote: “At some point we’ll reach the limit, and the system will collapse.

    True beyond dispute. I’m not advocating a bailout, just pointing out that the people who pay if cities and states default on their bonds won’t be mclaren’s “rich parasites”, or whatever. I expect that a bailout will occur, unfortunately.

    Yes, states and munis are part of the public sector, but the monolines (Which I believe is what they call companies that insure tax free bonds) aren’t, at least not yet. (That may change when there’s a major default, given how the Obama Administration operates.) Poor choice of words on my part, but you get the idea.
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    FM reply: I misunderstood what you wrote, and have corrected my reply. Your words were clear; it was my error.

  6. Apparently ( Wikipedia )in Butan they have given up on improving GDP and are aiming to improve GNH ( gross national happiness ) .

  7. I stand corrected about states declaring Chapter 9 bankruptcy. I should’ve read the article more closely. Of course, about half of all states are now effectively broke…so even if they can’t declare Chapter 9 bankruptcy, if it looks like a duck and it quacks like a duck and it walks like a duck…

    Burke G. Sheppard helpfully explained “You seem unaware of the role of insurance in state and municipal bonds.” Just as those stupid investors who worried about defaults on triple-A-rated mortgage tranches back in 2006 seemed unware of the role of insurance in buoying the prices of exotic financial instruments like CDOs.

    Of course, insurance proves meaningless when the whole system melts down. This is the kind of delusional fantasy-talk that money managers and Fed governors mesmerized themselves with back in the late 1990s and early 2000s. The system can’t possibly fail, they assured everyone, because those seemingly-risky CDOs and debt swaps are all collateralized with other options that are guaranteed to rise in value if the CDOs drop in value.

    That doesn’t work in the real world because when the financial system breaks down to the point where those triple-A-rated CDOs metl down and become worthless, the insuring entities have vaporized and gone broke too. The insurers have to get bailed out and that gets expensive fast.

    Burke G. Sheppard’s comment epitomize the kind of “too big to fail” thinking that got us into this predicament. The Fed quickly reaches a moral hazard situation where it has to refuse to bail states out so as not to encourage fiscal irresponsibility in the states. They’ve reached that point with California. At some point America will reach that oint with the rest of the world, which is currently financing America’s pointless lost wars and spendthrift oil-guzzling habit. At some point, the rest of the world will say, “America, if you want us to loan you some more money, you’ve got to get your act together — no more foreign invasions, no more SUVs, no more irresponsible Wall Street cowboys who run gigantic frauds and then dance away to the bank with no consequences…”

  8. The Tea Party Movement is a non-starter due to the fact that its appeal is almost exclusively limited to white people over 40. Twentieth Century relics, this demographic group is not the future of America. The ironic things is that if these people got their wish and the Federal government did fold, most would die of starvation as their income (social security) and health care (Medicare) disappeared.

  9. I would like to make one additional point. Even in cases where bonds are not insured, there may be credit default swaps that will create various kinds of counterparty risks in the event of default. Here is an example relating to California. “California Budget Crisis Spurs Trading in Credit-Default Swaps“, Bloomberg, 2 February 2010.

    Fabius is probably right that most state bonds are uninsured, but default may still pose a risk to the financial system. I do not advocate bailouts (Especially not of California), and I very much agree with Fabius that there is a hard limit to that sort of thing. But if we get a wave of state and/or municipal defaults, then we’ve got quite a problem.

    I wonder if we should consider a ban on insurance of bonds and on derivatives. It seems conducive to moral hazard, and seems to provide a way to hold the government to ransom. The irresponsible can threaten to take down part or all of the financial system if their losses are not covered.
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    FM reply: By the numbers.
    (1) While the almost unregulated growth of over-the-counter derivatives (such as CDS) probably is a ticking bomb, every major corporate bankruptcy (e.g., GM) has been preceded by forecasts of doom from CDS. While that does not mean that the next will not spark armageddon, it suggests that the odds are against it.
    (2) Everyone agrees, I suspect, that defaults on any State’s bonds would certainly pose a LARGE risk to the financial system. But history says default by a State is unlikely, if for no other reason that if the Federal government bails out auto companies, insurance companies, and banks — it will certainly bailout a State (a provider of essential social services).
    (3) If the recession has a second dip, a wave of municipal defaults is very likely.
    (4) The bond insurance business is dead (although the corpses of the monolines continue to live as zombies, as everybody now understands that no private company can insure against system risks — like we see today.

  10. Its simply not possible to go back to a gold standard, because there is not enough gold. We hit ‘peak gold’ production ages ago.

    But Keynes ‘bancor’ idea was, is, brilliant. He proposed an international currency for tranding between countries. It was not to replace internal currencies. From Wikipedia:

    “It was to be initially fixed in terms of 30 commodities, of which one would be gold. It would stabilize the average prices of commodities, and with them the international medium of exchange and a store of value. Central to Keynes’ proposal was to tax countries’ current account surpluses, encouraging domestic demand and promoting global trade balance.[2]”

    The beauty of the system was that it would:
    (1) Stabilise trade deficits/surpluses. Now small ones for a short time are neither here nor their, but large ones and/or long term ones have to corrected.
    (2) Stabilise currency prices, holding them closer to their true value. Thus ending efforts to undercut prices by subsidies, as in agriculture.
    (3) Virtually eliminate international speculation. Now you could still speculate within your own country (if your local Govt was that stupid to allow it) but not internationally. Hard to play games with another country’s currency when you can’t get any bancors.
    (4) Reduce, possibly even nearly eliminate international money laundering, for tax havens, criminals, etc.
    (5) Eliminate currency dumping, the ‘carry trade’, exported inflation, etc.
    (6) Eliminiate off shoring, except where there were clear (that is real) advantages to investment in another country. Note, the majority of off shoring is only possible because of (1) cheap transport, (2) more importantly, tax advantages.
    (7) Eliminate what we have now, wage, tax and environmental arbitrage (the race to the bottom). Heck we might even create a ‘race to the top’.

    The key is that every international transaction has to go through an international (regulated and transparent) clearing house and use stored bancors. You have to use your balance. Now if you have ran persistent deficits then there there will be nothing in the pot for you to use.

    You cant print bancors, you can’t just magically create them (through the wonders of private debt creation or the Govt printing press).

    But Keyne’s added another twist, bancor surpluses would would not be allowed to exist foever. After time they, if not used, would be passed to an international investment branch, for poor countries only. At one stroke the ‘begger my neighbour’ (more accurately ‘begger my population’) antics of Japan, China, etc would be eliminated. Nothing wrong with them building up their economies, if anything the bancor regime would have made that happen faster. But they would have to pass on the benefits to their own people quickly … or lose it.

    On the other side, the US would have had to change it’s spots a lot longer ago, basically you would not be able to buy oil or plasma televisions because you don’t have enough bancors to do it. So, after a few Govt’s were thrown out (local gas prices of, say, $10 a gallon would do that easily), the US would change and get back to making and exporting things.

    Plus it would not have enough money to fund those 1,000+ (and expanding daily) foreign bases either. Now there’s a good idea.

    He was a clever old sod Keynes. One day we might actually become as clever as he was (note the lack of breath holding as I alway go by Einstein’s dictum*).

    * “There are only 2 things that are infinite. The Universe and human stupidity … and I’m not sure about the first one”.

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