Friday, April 30, 2010

Reciprocating Risk...

Interesting article that echoes some of the themes discussed on this blog:

NEW YORK (Dow Jones)--Some money managers are preparing for the next stage of the global financial crisis--a world where the traditional perception of risk has been turned on its head.

Sovereign debt from the industrialized countries, particularly the U.S., the euro zone and Japan, was once perceived as the safest of investments and the benchmark by which to measure all other assets.

But massive debt loads as a result of the global banking crisis eroded sovereign debt creditworthiness, meaning investors have to rethink long-held beliefs and investment strategies. Assets that were once perceived as risky--such as emerging markets or corporate debt--are now viewed as less risky than debt sold by large developed economies such as Spain.

Greece's downgrade by Standard & Poor's into junk territory this week is merely the tipping point in what is likely to be a fundamental adjustment process that will last much longer than most realize.

"You need to think about the unthinkable," such as sovereign default and a world without AAA-rated nations, said Scott Mather, Pimco's head of global portfolio management, overseeing $41 billion in global bonds.

Greece is just the beginning: Portugal, Spain, Italy, the U.K. and even the ultimate safe-haven, the U.S., are being re-evaluated by wary fund managers looking to avoid exposure to assets that could suddenly lose sharply in value because of their government's poor fiscal management.

"We are seeing a broader repricing of G-7 credits versus the rest of the world," said Lena Komileva, economist at Tullett Prebon in London. "The most fundamental transformation in recent developments is to rethink investment grade sovereign credit."

The upshot could be "a huge systemic shock," she said, not unlike the collapse in financial markets after Lehman Brothers was allowed to fail, also due to a mispricing of risk.

For sure, the view that the world of investing has fundamentally changed has yet to be widely shared. Stocks in the U.S. just had their best quarter in decades, high-yield issuance is setting records and premiums on risky assets have tightened to historically low levels. Goldman Sachs, for example, recommends investors cut back on their exposure to risky assets, but remains positive on growth-sensitive assets in the medium term.

But those who expect a drawn-out period of adjustment--which also spells low growth and low inflation--urge investors to consider the impact of sovereign risk for every country across all asset classes. They advise investing in the assets of countries with healthier fiscal accounts, such as Australia, Canada, Germany, Mexico and Brazil, and in companies operating in these nations.

Investors should brace for lower gains than they are used to, and more volatility. They should also avoid switching from pressured bonds into stocks, especially since bonds usually outperform during periods of depressed growth and muted price pressures.

Within the fixed income universe, asset classes are less important than regional vulnerabilities--a trend that Chris Diaz, a global bond portfolio manager at ING Investment Management, expects to gather pace. "You're starting to see this convergence around the world," he said.

His portfolio, once stocked with sovereign debt, is now focused on U.S.6 credit and mortgage-backed bonds, "and other things that would usually be considered riskier than sovereign debt," he said.

The elephant in the room is the U.S.'s own debt burden. The focus of recent fears has been on the euro zone, because of the massive debt held by some of the members--Italy alone has EUR1.7 trillion in debt outstanding--the immediacy of debt payment deadlines and the fact that member countries have no control over the exchange rate.

The dollar, on the other hand, is the world's reserve currency and capital markets are deep and liquid. But the government's debt burden, already massive, will continue to grow as deficits remain high: Barclays Capital forecasts a budget deficit of $1.7 trillion in 2019, with interest payments accounting for nearly a quarter of the budget.

As this week's record debt-raising proved, Treasurys continue to enjoy solid demand as the ultimate safe haven in times of trouble. But the clock is ticking for the U.S. and other heavily indebted developed nations.

The North Dakota Bank model

A friend forwarded this to me recently inquiring about the viability of such a model. Yes, socializing banks sounds beneficial in some respects.

However, there are major (in my opinion insurmountable) problems.

1. The inevitability of politicization of the bank capital, disintermediation, and loan approval. We see ample evidence of this in China, and while this system may be working in a state with less than 650,000 residents and relative homogeneity. (it must be mentioned that culturally and demographically, North Dakota is Scandinavian, with obvious affinity to socialist policies and imbued with a special cultural affinity towards egalitarian society. A notable 30% percent of the population is of Norwegian descent.) Transplanting this system into the larger economy would be would take a nanosecond before it became completely compromised by local, state, and Federal politicians.

2. The Bank itself benefits from higher commodity prices. To say it is flourishing because it is socialist ignores this. It is flourishing because it is heavily exposed to a certain market segment and asset classes that have done very well in recent years. To its credit, it refrained from the siren call of "diversify your real estate holdings by purchasing MBS in other states" that it must have heard multiple times from multiple investment banks. But this is not to say the socialist model in it of itself is the cause of the balance sheet success of the Bank.

3. It is not scalable. From the 2009 financial report, the Bank has about 4 Billion in assets. Putting those assets to work is relatively easy. If you hold 500 Billion in assets, you must venture outside of your comfort zone in order to avoid distorting multiple markets.

4. It benefits from flows of Federal Subsidies. Agricultural prices are still subject to Federal Subsidies and North Dakota receives over $400 million dollars per year. There is a recursive element to this socialist perfection.

To conclude: unique cultural factors, a small balance sheet, government assistance, and high commodity prices have combined to make this a success story...but certainly not "because" it is a state-owned bank.

As Washington tries to regulate Wall Street's newfangled derivatives, government officials in at least a dozen states are mulling a more old-school response to the financial crisis: 100 percent state-run banks. Since 1919, North Dakota has operated the nation's only depository of this kind, a genuinely socialist enterprise that spins tax revenues into loans for in-state farmers, students, and small-business owners. Unlike other banks, the Bank of North Dakota (BND) plows about half its profits into the state budget and takes cues from the governor, who acts as chairman, and a seven-member advisory board that the governor appoints.
SUBSCRIBE Click Here to subscribe to NEWSWEEK and save up to 88% >>

In normal times, such a bank might not be politically palatable. Now, however, it's emerging as an attractive model for lawmakers—in large part because North -Dakota flourished during the recession, with the nation's lowest unemployment rate (about 4 percent) and one of the largest budget surpluses (more than$1 billion). Some of the state's well-being is attributable to its agriculture- and energy-based economy. But the BND has helped greatly, propping up more than 100 privately held community banks and keeping credit flowing to small, local businesses even as it remains tighter nationally. The bank could be attractive for more populist reasons, too: it helps keep taxes low—BND has offset $350 million in public projects since 1997—and Main Street's money out of Wall Street's coffers.

Last month Washington state formally proposed its own version, while Hawaii recently commissioned a report. And representatives from other regions are calling Eric Hardmeyer, the CEO of the BND, for advice. His response? Despite the advantages, don't count on getting your own -socialist bank. "The idea of state ownership," he says, "doesn't resonate across the country real well."

Macroeconomic quarterly data

Can be found here.

State and local spending down, savings down, but computer spending up.

L still the letter du jour.

Thursday, April 29, 2010


His Op-Ed tomorrow is called "The Euro Trap" and warns against the possibility of a Euro collapse and EU re-alignment.

He states "what the crisis really the danger of putting yourself in a policy straightjacket".

Very good, so it is only a lack of flexibility and an unfortunate lack of foresight that caused the crisis. In other words, more power should be assigned to a central authority in order to avoid crisis. What could possibly go wrong?

Treasury bond sales...

...coming in strong in both maturities offered today.

One of the (many) problem with the EOT'ers analysis regarding a meltdown in U.S. Treasury securities and corresponding/contemporaneous massive dollar inflation is when debt destruction occurs, incredibly deflationary forces come to bear by reducing outstanding dollar denominated debt.

When your assumptions are incorrect, the resultant analysis is hopelessly flawed. Unfortunately, it appears as if the FED and other CBs do not consider flawed assumptions a weakness as their reaction function to interest rates rests more on the ability to persuade than to predict.

At the moment, I am studying various eunuch/preisthood classes, their function in historical society, and their similarity to our own FED. It is illuminating.

The Euroskpetic...

...chimes in on the Greek Tragicomedy.

“Europe risks the biggest coordination failure in modern history,” said David Simmonds, research chief at RBS. The Berlin talks are as vague as ever. “We believe that markets will remain very sceptical.”

UBS said it was disturbed by signs of counterparty fears among European banks that replicate events in credit derivatives before the financial crisis in late 2008. “Investors will need to be on their guard,” it said.

The Greek debt market came close to disintegration yesterday. Yields on two-year bonds rose briefly to 38pc. “This no longer has anything to do with interest rates: it is a forward contract on the return of the Greek Drachma,” said Charles Dumas, head of Lombard Street Research.

Markets are already looking beyond Greece to Portugal where spreads on 10-year bonds rose to 330 points -- higher than the level that first prompted Athens to invoke aid -- before falling back on pledges of further austerity.

Premier Jose Socrates is to bring welfare cuts planned for 2011 and 2012, accepting that the markets will not give Portugal another year to tackle its deficit of 9.4pc of GDP.

S&P cut Spanish debt one notch to AA with a negative outlook, warning that the fall-out from the housing bust will keep the country trapped in near slump until 2016. It said private sector debt of 178pc of GDP was a major concern.

Daniel Cohn-Bendit, leader of the European Greens, said Europe’s handling of the crisis had been “catastrophic” and rebuked Germany for resorting the “discipline of the whip”.

But Mrs Merkel is treading on eggshells. She faces a crucial election in North Rhine-Westphalia on May 9 that will decide control of the Bundesrat, and risks a court challenge if any rescue breaches the EU’s no `bail-out clause’. David Marsh, author of `The Euro: The Politics of the New Global Currency` said the moment of truth has come when Germany must decide whether to accept the burden of propping up Europe’s southern ring or let Greece fail and endanger its strategic investment in Europe’s post-War order.

“There are some senior figures who would like so see the gangrenous leg of Greece chopped off, to set an example. But they want to avoid leaving any German fingerprints on the blood-stained knife,” he said.

It is far from clear whether Athens will agree to further austerity as strikes hit the country day after day. Andreas Loverdos, Greece’s labour minister, said the EU-IMF team wants further wages cuts. “We cannot accept that.”

Wednesday, April 28, 2010


The English have a saying: "PGO", an acronym for "Penetrating Glimpse of the Obvious".


Tuesday, April 27, 2010

The orginators of the Drama...

...opening new chapters by the hour...

April 28 (Bloomberg) -- Holders of Greek bonds may lose as
much as 200 billion euros ($265 billion) should the government
default, according to Standard & Poor’s.

The ratings firm cut Greece three steps yesterday to BB+,
or below investment grade, and said bondholders may recover only
30 percent and 50 percent for their investments if the nation
fails to make debt payments. Europe’s most-indebted country
relative to the size of its economy has about 296 billion euros
of bonds outstanding, data compiled by Bloomberg show.

The downgrade to junk status led investors to dump Greece’s
bonds, driving yields on two-year notes to as high as 19 percent
from 4.6 percent a month ago as concern deepened the nation may
delay or reduce debt payments. Prime Minister George Papandreou
is grappling with a budget deficit of almost 14 percent of gross
domestic product.

“It’s now not just market sentiment, but a top rating
agency sees Greek paper as junk,” said Padhraic Garvey, head of
investment-grade strategy at ING Groep NV in Amsterdam.

Before yesterday, Greece’s bonds had lost about 17 percent
this year, according to Bloomberg/EFFAS indexes. The 4.3 percent
security due March 2012 fell 6.54, or 65.4 euros per 1,000-euro
face amount, to 78.32.


Round-up of affected players regarding PIGS debt and contagion risk.

All for one and one for all?

Nails, nails everywhere...

"When your only tool is a hammer, everything in the world starts to resemble a nail"

Variations on this rule of thumb vary, but it does seem to capture analytical ossification that clouds all technical fields, economics and finance included. The below article is interesting (more so because as you readers know I agree with its tenor), but fails to understand that dollar's strength derives primarily from two sources: The ability of the United States to tax its citizens, and the ability of the United States to provide security services for the world.

But alas, only economic arguments are proferred in the article. This is most unfortunate becuase currencies, being political inventions, are subject to the same socio-political sources of power and conflict that effects individual society and, indeed, the globe.

Beware the consequences of a resurgent greenback

By Mansoor Mohi-uddin

Published: April 20 2010 03:00 | Last updated: April 20 2010 03:00

This year the currency markets have been torn between fears over budget deficits in the eurozone and hopes that the global economic recovery is gathering pace. Amid all the noise and angst, however, a more profound change seems to be taking place, with the dollar starting to behave as a growth currency, appreciating at the same time as investors seek more risk in equities, commodities and emerging markets. In short, the exchange rate markets seem to be undergoing one of their periodic "regime shifts".

The picture was very different over the past decade. Following the bursting of the internet bubble in 2000, the dollar tended to benefit when investors turned risk-averse, and weaken when confidence returned to financial markets. As equities rallied from 2003 to 2008, the greenback fell to a record low of 1.60 against the euro. But when financial markets were gripped by risk aversion after the demise of Lehman, the dollar soared as investors uniformly dumped assets elsewhere and sought refuge in US Treasuries. As a result, the greenback became identified as a safe haven currency, along with the Japanese yen and the Swiss franc. The dollar's safe haven reputation has been enhanced this year by concerns that the eurozone may start to break up. The renewed decline of the yen as Japan only slowly emerges from recession and the frailty of Britain's economy have also supported sentiment towards the dollar.

Meanwhile, in Iberia...

News that S&P downgrades Greece, once again confirming its role as ratings equivalent of a the police in so many Hollywood movies that "just" get to the scene after a massive 10 minuite long gunfight between protagonist(s) and antagonist(s).

More troubling (although not surprising) is the downgrade of the 5 largest Portuguese banks.

The run is on, and multi-lateral rescue efforts including Neo-Brady bonds must rush in as stop gap. So reminiscent of the ERM crisis, which is the event that caused yours truly to begin to take interest in the financial markets (prior to picking up Soros's Alchemy, law was my calling).


Arizona illustrates a dangerous new trend regarding Mexico. In addition to its U.S. dollar funding needs, competition with China for U.S. market share, and its failing government, it now faces a rise in protectionism from neighboring U.S. jurisdictions.

This could not come at a worse time for a country which is gradually being phased out by China, who has realized very quickly that Mexico is an easy mark from which to gain export market share and has most likely "suggested" that U.S. policy be balanced to a more malevolent bent south of the border. This will be obvious to me if China surprises and revalues the Yuan. If China faces decreasing profits by revaluing the Yuan, they WILL attempt to make it up on VOLUME by increasing market share. There is a large volume of business literature on the subject of market share capture, and this activity is not for the faint of heart or weak of stomach. China has no choice but to engage as its entire model of social cohesion is based on export-driven mercantilism. Of the top five U.S. trading partners, Mexico is the weakest hand and China must sense this.

So Mexico is now being squeezed economically and geographically. It is losing connectivity while internal strife erodes the ability to govern. This is not good.

Mexico's exports to China are comprised mostly of building materials and services related to the construction industry. The level of export in this area will subside with the popping of the construction bubble.

More ominously, China has taken great pains to build its own construction materials enterprises and is now directly competing with Mexico. Businesses who supply China suddenly find themselves in direct competition for market share in the U.S.

And now, logistic concerns and risks will increase costs and uncertainty with the import of Mexican goods. A container from China and a container from Mexico will receive very different treatment from customs officials (on average). This unfortunately is a socialized cost to Mexico and the U.S. from the disaster of drug prohibition.

The Peso, Bonds, and select equities will see precipitous declines in the coming months.

MEXICO CITY, Apr 14, 2010 (IPS) - China has replaced Mexico as the top supplier of goods to the United States, and experts say that a specific trade strategy is needed for this Latin American country to compete successfully with Beijing in the U.S. market, the world's largest.

"What is lacking is an active trade policy to try to cut down imports of many inessential articles, and a policy to boost national exports," Arturo Ortiz, of the Institute of Economic Research at the state National Autonomous University of Mexico, told IPS.

Since 2003, China rather than Mexico has been the chief source of U.S. imports, a situation maintained by the artificially low value of China's currency, the yuan, which drives that country's exports, according to local and international analysts.

The U.S. Department of Commerce reported Tuesday that China had a trade surplus of 16.5 billion dollars with the United States in February, having sold 23.4 billion dollars' worth of goods and purchased 6.9 billion dollars' worth.

Mexico also had a positive trade balance with the United States, of 4.8 billion dollars in February, with exports worth 16.4 billion dollars and imports worth 11.6 billion dollars from its northern neighbour, according to the report.

"Mexico can regard China as a partner, and not necessarily as a competitor," Chilean economist Osvaldo Rosales, head of the Division of International Trade and Integration at the Economic Commission for Latin America and the Caribbean (ECLAC), told IPS. "There is room to sell any category of goods, but the relationship must be approached with a forward-looking vision, for the medium term."

Also on Tuesday, ECLAC published its report, "La República Popular de China y América Latina y el Caribe: hacia una relación estratégica" (The People's Republic of China and Latin America and the Caribbean: Towards a Strategic Relationship), just ahead of Chinese President Hu Jintao's trip to Brazil, Venezuela and Chile, this Wednesday to Sunday Apr. 18.

Hu visited Mexico in 2005 and Mexican President Felipe Calderón travelled to Beijing in 2008.

The report says that over the present decade, Latin America and the Caribbean have recorded an overall trade deficit with China, mainly due to the increasingly negative trade balances of Mexico and Central America with the Asian giant.

Monday, April 26, 2010


Greek spreads "widening" (most people say "blowing out" or "exploding" or some equally pyrotechnical term).

Institutional integrity will cede to pragmatic alms giving in the short term. This will come at significant cost as the modern manifestation of a Brady Bond (using the IMF as proxy) is the only port in the storm.

Sunday, April 25, 2010

Those who make the rules...

...have the gold.

U.S. presence is the 800lb. gorilla in all international rule-setting summits.

(from an FT article)

By Tom Braithwaite

Published: April 25 2010

The US is preparing to pivot from domestic regulatory reform to a push
for a tough new international capital regime after the weekend’s G20
and International Monetary Fund meetings glossed over differences
between leading economies.

Tim Geithner, US Treasury secretary, met Mario Draghi, chairman of the
Financial Stability Board, on Sunday to discuss the contours of a
system that would decide the safety and profitability of banks for
decades to come and could eclipse the arguments over bank taxes and

Capital Flows...

...the instruments for re-balancing are not very elegant. I italicize "re-balancing" because this assumes that there is some equilibrium that serves as a panacea for global instability and poverty. There is no such thing in reality. We see in the graph I attached above the natural state of balance of payment accounts where the developed world consumes while investing in developing and emerging markets while at the same time providing order. (both militarily and by establishing rule-sets that act as treaties)

Yes, saving rates will increase in the developing world, but let us hope that a temporary re-balancing will not upset the established order. Because if it does, much more conflict and instability will ensue. A project for the reader here would be to look up current account data from earliest inception dates for all countries. You will notice that "equilibrium" is optimal only in the minds of myopic economists. Who, with serendipitous timing, have commissioned a report stating that capital controls are warranted in this situation.

(Bloomberg) -- Capital controls are a “legitimate” tool in some cases for governments facing surges in investment that threaten to destabilize their economies, an International Monetary Fund study said.

The IMF’s study comes as some Asian countries have said they’re studying capital controls to protect against asset bubbles and currency appreciation. Brazil introduced taxes on overseas investors in its stocks and fixed-income assets in October after the real rallied almost 33 percent.

“Even when flows are fundamentally sound, it is recognized that they may contribute to collateral damage, including bubbles and asset booms and busts,” the IMF research department said in a report released today. “Capital controls on certain types of inflows might usefully complement prudential regulations to limit financial fragility and can be part of the toolkit.”

The IMF and the World Bank are warning that asset bubbles may be forming in some emerging economies, particularly in Asia. China’s central bank last week took the second step in a month to restrain inflation and damp asset prices, ordering lenders to set aside larger reserves.

Saturday, April 24, 2010

G20 back-slapping

Giving the "mission accomplished" signal. Let us hope the outcome does not parallel Mr. Bush's experience when he uttered the same words in 2003. The press release displays the typical hubris of international institutions taking credit for a recovery caused by their prudent use of "concerted policy effort". No mention of the risk of regulatory and jurisdictional arbitrage and competition that will inevitably follow.

Simple Public Relations.

The global recovery has progressed better than previously anticipated largely due to the G20's unprecedented and concerted policy effort. However, it is proceeding at different speeds within and across regions, and unemployment is still high in many economies. We recognize that in such circumstances different policy responses are required. In economies where growth is still highly dependent on policy support and consistent with sustainable public finances, it should be maintained until the recovery is firmly driven by the private sector and becomes more entrenched.
Some countries are already exiting. We should all elaborate credible exit strategies from extraordinary macroeconomic and financial support measures that are tailored to individual country circumstances while taking into account any spillovers. We emphasized the necessity to pursue well coordinated economic policies that are consistent with sound public finances; price stability; stable, efficient and resilient financial systems; employment creation; and poverty reduction.
Countries who have the capacity should expand domestic sources of growth. This would help cushion a decline in demand from countries that should boost savings and reduce fiscal deficits.

Friday, April 23, 2010

A great example...

...of a Risk that nearly qualifies as unknown unknown status. Full paper can be downloaded here. With new systems (electronic data as "money") comes new vulnerabilities, new risks, and new implications therefrom.

...This potentially hazardous power of the sun comes in the form of super solar storms. Super solar storms hitting earth could possibly wipe out significant parts of electricity grids around the world.

Furthermore, our current electronic money system is particularly vulnerable. Most of today’s money is purely electronic money, depending on electricity and on fine electronics. In addition to this existence in the virtual world, since the exit from the Gold Standard in the early 1970s, there is no longer anything physical behind our money, like gold. Most of today’s money is merely numbers in computers; it is simply a large machine-operated accounting system. But yes a very important accounting system indeed. According to the Federal Reserve about 69% of all money (USD) were electronic in 1991.2 The rest of the assets were in the form of paper bills and coins. That is nearly 20 years ago, and due to enormous growth in use of computers and electronic money since then, there are reasons to believe that electronic money now is a much bigger percentage of the total money supply, if I am guessing more than 90% of the total money supply, I am probably not that far off. With electronic money we normally think of bank deposits, prepaid cards, debit cards and credit cards. This could be broadened to also include electronic securities. Today almost all financial assets like stocks and bonds are just electronic numbers in computers. In its broadest sense electronic money is any transaction or potential transaction that dose not involve physical cash (coins and bills). A very large coronal mass ejection from the sun that could cause a super solar storm if it should hit the earth might wipe out the global money system within minutes from impact. Stock exchanges would not operate, banking systems would not function, and both credit cards and ATM machines would stop working. We could find ourselves without the use of our modern electronic forms of money for months and possibly years. And yet, even in a catastrophic scenario where water pumps, power plants, public transportation, and other infrastructural assets that are essential to contemporary life had failed, some type of functioning money system would be required to keep the basic necessities, such as food and medical supplies flowing without too much friction.

The U.S. as rule-maker

And yet there are still those who see imminent demise for America, in full view of a world completely dependent on its rule-setting, security, and economic (via the IMF, which is basically an arm of the State Department) strength.

WASHINGTON (Reuters) - The IMF sought to maintain unity within the Group of 20 economic powers on Thursday, urging countries not to go separate ways in reforming the financial sector, as frictions emerged over a controversial plan to tax banks.

At the start of four days of meetings in Washington, International Monetary Fund chief Dominique Strauss-Kahn said countries need to ensure they are moving in the same direction on regulatory reform if they are to curb the risky practices blamed for the global financial crisis.

"Our main concern is to have everyone working together and to maintain the cooperation momentum," he said.

Finance ministers and central bankers will assess progress toward repairing recession-torn economies and building a more stable platform for growth, there were signs of divisions, particularly between countries hard hit by the banking troubles and those that largely escaped the pain.

The IMF this week proposed two new taxes on banks to help prevent a repeat of the kind of risk-taking that contributed to the global credit crisis. Britain and other countries welcomed the idea, but Canada is firmly opposed to such a tax.

Thursday, April 22, 2010

Open systems, financial data, and algorithmic trading

Economic data suffers from a peculiar conundrum. Most of this data is collected in the form of asset prices at different points in time. Unfortunately, since time is embedded, the points of data cannot be described as neat fungible packets such as what we find in physics or chemistry...these fields have data that operates independently of historical human events and meddling.

This is a somewhat convoluted way of saying that it is difficult to distill historical social data without reference to the unique period of time from which that data is derived. This is why finance and investing is more art than science.

Unless, of course, you are an algorithmic trader. These quants scalp spreads and collect exchange rebates with efficiency that would alarm most casual observers. The art of parsing history and data is irrelevant to these traders, which makes them extremely attractive as investments given the expectation their returns would be uncorrelated with market fluctuations.

However, the profits that were there for easy taking in my opinion are eroding fast in this field. A flood of competition, trade secret expropriation (read: some guy steals your code and uses it against you) is producing the usual effects, and the "asset class" that is algorithmic trading is experiencing its own bubble which will end (through the abruptness of the guillotine via government regulation or by more mundane natural causes) soon.


Spreads clearly indicate the total lack of a credible plan going forward. There is a real risk the EU disintegrates because of this (and Portugal, and Italy, and Spain, and Ireland, and Eastern Europe, and even France).

This is good. The markets (in some degree containing the will of the people) and local constituents are putting pressure on the myopic class of central planners who constructed this silly experiments (or at least perpetuated the "grand sweeping vision" of Jean Omer Marie Gabriel Monnet.

This is quickly going to boiling point with resulting phase transition back to nation states and Realpolitik.

The Downward spiral continues...(continued)

Mugabe meets another upstanding member of the Failed State Club.

The Associated Press
Thursday, April 22, 2010; 9:19 AM

HARARE, Zimbabwe -- President Robert Mugabe welcomed Iranian President Mahmoud Ahmadinejad to Zimbabwe Thursday, a meeting of two leaders united in fierce opposition to the West.

Mugabe met Ahmadinejad at the Harare airport Thursday afternoon. The Zimbabwe Iran Joint Commission had said ahead of Ahmadinejad's state visit that the two nations were committed to "the promotion of peace and stability in their respective regions" and welcomed Iran's proposals to host an international nuclear disarmament conference.

Iran has been under harsh criticism from Western nations for pressing ahead with uranium enrichment programs it says are to produce nuclear energy amid fears the militant Islamic state could develop nuclear weapons.

Iran is the biggest exhibitor at a trade exposition Ahmadinejad is scheduled to open in the second city of Bulawayo on Friday. Ahmadinejad is the first leader from outside the African continent to open the exposition since independence from British colonial era rule in 1980.

In Zimbabwe's ailing economy - along with white-owned and foreign companies being forced under a new law to hand over 51 percent control to black Zimbabweans - many traditional Western exhibitors and local industries have stayed away from the annual trade fair, once a showcase of regional goods and products.

The purpose of taxation...a continuing series...

As Keynes said, many of us are slaves to some defunct economist.

(This is not to say I am a Keynsian as I am strictly agnostic regarding the silly polemical devices economists fabricate in order to increase the amount of internicine argument for the express purpose of increasing controversy, leading to increased student interest, leading to increased professor appointments, leading to increased prestige, influence, and, of course, Power.)

I , as the below remarks illustrate am apparently no exception. I have written here many times regarding the misconception that sovereign currency issuers need to "borrow" in order to "finance" deficits.

From an article entitled "Taxes for Revenue are Obsolete" by Fed Chair Ruml in 1946:

The United States is a national state which has a central banking system, the Federal Reserve System, and whose currency, for domestic purposes, is not convertible into any commodity. It follows that our Federal Government has final freedom from the money market in meeting its financial requirements. Accordingly, the inevitable social and economic consequences of any and all taxes have now become the prime consideration in the imposition of taxes. In general, it may be said that since all taxes have consequences of a social and economic character, the government should look to these consequences in formulating its tax policy. All federal taxes must meet the test of public policy and practical effect. The public purpose which is served should never be obscured in a tax program under the mask of raising revenue.

What Taxes Are Really For

Federal taxes can be made to serve four principal purposes of a social and economic character. These purposes are:

1. As an instrument of fiscal policy to help stabilize the purchasing power of the dollar;

2. To express public policy in the distribution of wealth and of income, as in the case of the progressive income and estate taxes;

3. To express public policy in subsidizing or in penalizing various industries and economic groups;

4. To isolate and assess directly the costs of certain national benefits, such as highways and social security.

Wednesday, April 21, 2010

Test market for the Yuan...

...testing out Brand China just as the U.S. unveils the new $100 in a friendly (read: neo-communist) jurisdiction. Link.

BEIJING – The Chinese government confirmed Tuesday the granting of two loans worth more than $20 billion and the signing of oil and energy agreements with the government of Venezuelan President Hugo Chavez.

“We expect China and Venezuela to carry out combined efforts to implement these accords and in that way take bilateral relations to a new level,” Foreign Ministry spokesperson Jiang Yu said in Beijing.

Last Saturday a delegation of Chinese senior officials and business executives signed seven bilateral cooperation accords with Venezuela, Jiang said, including “an outline agreement by means of which the China Development Bank will lend $10 billion and another 70 billion yuan ($10.2 billion) in financing” to the oil-rich Andean nation.

The Chinese press said that the accords were signed in the presence of Chavez and a delegation led by energy czar Zhang Guobao, since Chinese President Hu Jintao canceled his trip to Caracas because of the Qinghai earthquake.

The yuan fund will be a pilot test for internationalizing the yuan, since given Venezuela’s oil potential the agreement could raise the status of the Chinese currency in the oil sector.

The Downward spiral continues... Zimbabwe. Mass starvation and capital flight due to expropriation risk is caused by economic "imbalances" from its "colonial past". The counter-factual being if Zimbabwe were to miraculously recover tomorrow, would the blessed event also be caused by its colonial past?

The companies will capitulate of course, and patiently await the coup and/or uprising. There is simply no governor switch to Mugabe's engine of holding power by any and all means.

Link is here.

Zimbabwe's mining sector will be the first target of the country's drive to force foreign firms to cede a majority stake to locals, the indigenisation minister said on Tuesday.

"I am happy to announce that government has unanimously decided that implementation of our indigenisation policy [will] start with the mining sector," Indigenisation and Empowerment Minister Saviour Kasukuwere told journalists.

Under the indigenisation law, which came into force on March 1, foreign-owned firms valued at $500 000 or more must cede at least a 50% stake to local owners.

Firms had been given 45 days to report their efforts at complying, but Kasukuwere said the deadline has been extended to May 15.

Funds 'badly needed' in Zim
The biggest targets include local subsidiaries of British banks Barclays and Standard Chartered, as well as mining companies such as Impala Platinum, Anglo Platinum and Rio Tinto.

Kasukuwere said some mining houses had prejudiced the state by sending money abroad without authorisation.

"They were externalising as much as $280-million. These funds are badly needed here," he said.

"We have so far received more than 400 submissions from various companies and as government we are happy with such an overwhelming response," he was quoted as saying by the Herald newspaper.

President Robert Mugabe has defended the regulations as a measure to correct the economic imbalances created by Zimbabwe's colonial past.

Mobius strip...

Self explanatory.

April 20 (Bloomberg) -- American International Group Inc., the financial firm rescued by the U.S., is the lead insurer of Goldman Sachs Group Inc.’s board against shareholder lawsuits, said a person with knowledge of the policy.

AIG is among firms that sold so-called Side A directors and officers’ coverage to the New York-based bank, said the person, who declined to be identified because details of the policy are private. Goldman Sachs was sued last week by the Securities and Exchange Commission, which claimed it misled investors in 2007.

AIG, along with insurers including Chubb Corp. and XL Capital Ltd., sell so-called Side A policies. The coverage kicks in when shareholders accuse directors of wasting a company’s money through failing to perform oversight duties or if the company becomes insolvent. Goldman Sachs, the most profitable bank in Wall Street history, said today that first-quarter earnings almost doubled to $3.46 billion from a year earlier.

The new $100

Theatrical unveiling of the new $100 bill. The Brand of America is still very strong and name another country that releases a currency with "features". A very important tangible item that will represent a very small amount of transactions. The visceral feel and the knowledge that numbers in your bank account represent "dollars" is a vital part of the competitive advantage this country enjoys over every other sovereign in the world.

On Youtube.

The official government site.

Monday, April 19, 2010

Historical causation...

From an article here. I have been studying the effects of Icelandic volcanoes, and I am amazed yet again the way Risk manifests itself in ways that are completely surprising, and yet have such historical "regularity". This is just one volcano of a triumvirate in Iceland that has a history of simultaneous (in geological terms) eruptions.

Just over 200 years ago an Icelandic volcano erupted with catastrophic consequences for weather, agriculture and transport across the northern hemisphere – and helped trigger the French revolution.

The Laki volcanic fissure in southern Iceland erupted over an eight-month period from 8 June 1783 to February 1784, spewing lava and poisonous gases that devastated the island's agriculture, killing much of the livestock. It is estimated that perhapsa quarter of Iceland's population died through the ensuing famine.

Then, as now, there were more wide-ranging impacts. In Norway, the Netherlands, the British Isles, France, Germany, Italy, Spain, in North America and even Egypt, the Laki eruption had its consequences, as the haze of dust and sulphur particles thrown up by the volcano was carried over much of the northern hemisphere.

Ships moored up in many ports, effectively fogbound. Crops were affected as the fall-out from the continuing eruption coincided with an abnormally hot summer. A clergyman, the Rev Sir John Cullum, wrote to the Royal Society that barley crops "became brown and withered … as did the leaves of the oats; the rye had the appearance of being mildewed".

The British naturalist Gilbert White described that summer in his classic Natural History of Selborne as "an amazing and portentous one … the peculiar haze, or smokey fog, that prevailed for many weeks in this island, and in every part of Europe, and even beyond its limits, was a most extraordinary appearance, unlike anything known within the memory of man.

"The sun, at noon, looked as blank as a clouded moon, and shed a rust-coloured ferruginous light on the ground, and floors of rooms; but was particularly lurid and blood-coloured at rising and setting. At the same time the heat was so intense that butchers' meat could hardly be eaten on the day after it was killed; and the flies swarmed so in the lanes and hedges that they rendered the horses half frantic … the country people began to look with a superstitious awe, at the red, louring aspect of the sun."

Across the Atlantic, Benjamin Franklin wrote of "a constant fog over all Europe, and a great part of North America".

The disruption to weather patterns meant the ensuing winter was unusually harsh, with consequent spring flooding claiming more lives. In America the Mississippi reportedly froze at New Orleans.

Sunday, April 18, 2010

Et tu Gordon?

This will be an interesting test to discover just how much influence Goldman has. These are very non linear times for them in the sense that international pressure and multiple (both civil and criminal) lawsuits can paralyze any firm, especially one that relies on connectivity to global capital flows as its primary business model.

So this is no time to be circumspect, as the vultures are circling. It would be interesting to determine the total UK tax levy Goldman has paid. All the benefits Goldman gave to the UK exchequer are now moot. It will remain to be seen whether or not this is an exercise in political cover or if something is structurally changing with respect to governmental emotional orientation towards investment banks. I say this because the false ignorance demonstrated in the below quote from Mr. Brown regarding bank business practices betrays a more sinister and populistic motive...coincidentally on the heels of a terrible debate performance against mssrs. Clegg and Cameron.

Prime Minister Gordon Brown today called for the Financial Services Authority to start an investigation, saying he was “shocked” at the “moral bankruptcy” indicated in the suit. Germany’s financial regulator, Bafin, asked the SEC for details on the suit, a spokesman for Chancellor Angela Merkel said.

Saturday, April 17, 2010

The Saga of Eyjafjallajokull

(800 years from now a parchment is discovered by locals in Iceland which reveal the real reasons surrounding the events, financial and geophysical, of 2008-2010. Another Saga to add to the proud history of Icelandic culture.)

There were freebooters named Landsbanki and Glitnir, wealthy and strong they were. They were friends and had common purpose.

Landsbanki and Glitnir roamed the seas, and offered booty to the Island nations of the East in gestures of good faith and friendship. The Isle people and the Place Where We Go To Raid And Pillage (translator note: from the Icelandic "KeFubarskinoord", which is roughly today's "Europe") They composed love songs for one another and midgard was at peace.

But the Elf Masters Of Taking Stuff and Giving Less Back (translator note: from the Icelandic "BaweekGukaaKinyyrk" or "Central Bank") were jealous of Landsbanki and Glitnir, and conspired to destroy them by waiting until they slept in The Glenn Of No-one Knows What Is Going On (translators note: "overnight interbank market") and choking Landsbanki and Glitnir.

The people of the Eastern Isles fled like cowards from this news that their friends were dead, and Landsbanki and Glitnir were buried in the earth, eternally betrayed by The Elf Masters Of Taking Stuff and Giving Less Back.

Landsbanki and Glitnir were ashamed, and when a Valkyrie asked them what had befallen them, she was resolved to seek address from the Gods for this betrayal. She told Heimdall on the rainbow bridge to Asgard the tale.

This story angered Heimdall, and he ushered them into Asgard. Heimdall then told Thor, who was eating 100 Elk. Landsbanki and Glitnir were trying to pillage and were betrayed by the Elfs who know nothing of pillaging and war and fun.

Thor was enraged by this betrayal. Thor donned his belt, quaffed a barrel of mead, and threw Mjollnir with such force that it cracked the sky of Asgard and entered into Midgard. Mjollnir then pierced the heart of the sleeping Fire Giant Eyjafjallajokull.

So terrible was the wound that Eyjafjallajokull awoke, coughing in his death throws, and covered the Eastern Isle people and KeFubarskinoord in his blood and entrails. This caused great discomfort for the Elfs had to give back more than they took, and great inconvenience to the cowardly people who could no longer flee anywhere. Thor was pleased.

Friday, April 16, 2010

When the risk free rate is not risk free, CAPM musings

Much of modern finance and pricing theory rests upon the firm bedrock of a "risk free" asset from which all other prices and returns derive.

This has to do with the ramifications of the CAPM pricing model. The risk free asset or rate has zero volatility and zero covariance with market returns or the systemic risk associated with market returns.

But the CAPM (and its extensions by Tobin, et al.) also has the unfortunate property of not working in reality. How can this be?

Let's look at "Beta", defined as the covariance of an asset and a portfolio in terms of the variance of the market portfolio (all assets, but typically for stocks this is taken to be the S&P 500). This is a nice and tidy way to say an asset is less risky if it tracks market returns, since the market is broad and efficient.

But there are problems.

Over what period of time are we measuring? The beta of an asset with the market can vary between time periods (would a measurement including only the returns from 2006-2009 be an accurate indication of an assets "Beta"?) Since time is a non-fungible item (every second that passes this world is unique given the activity of all matter at that time), assigning a discrete value to a continuous series of events is not helpful.

Saying "this asset has a Beta of x, and thus, its behavior with respect to the market at future point T1 will be Y" is fallacious. Post hoc ergo propter hoc.

As for the "risk free" rate. This should in theory always be zero (risk=return). But since we rarely see this, all assets contain some risk. Treasuries contain a massive number of risks (most of them collapse into results like "inflation" and "devaluation" or "ceasing to exist").

Thus, the two major assumptions of the CAPM, the risk free rate and Beta, are not very helpful when attempting to assess the relationship between risk and return. It is no surprise then that prices according to CAPM formations have simply not conformed to its rules. It is a dead theory and we should all move on instead of creating epicycles explaining "anomalies".

Wednesday, April 14, 2010


Appears to be the shape of this recovery, given Treasury data.

Tuesday, April 13, 2010

The experiments of intellectuals...

...can be rightly cited as one of the major forces for poverty, despair, and political unrest.

Throughout history, we find examples of intellectuals who provide positivistic counsel to policymakers, officials, monarchs, and executives. The dogmatic nature of this top-down, autocratic governance takes different forms, but the mechanism remains the same.

An intellectual "bubble" forms, and, regardless of where this "new" concept originates on the political spectrum, it is suddenly discovered that concentration of power in a few individuals and institutions who are trusted to make the "correct" decisions as advocates of the public good (as opposed to their private gain) has disastrous effects for the majority of people who comprise the electorate/proletariat/worker class/etc.

Again, the mechanism remains the same. Concentration of power and the overconfidence that comes with it are the main culprits for the collective misery of Billions of people. This concentration can originate in ideas (which are relatively inexpensive to reproduce), physical coercion (much more expensive, but physical threats are extremely effective), or a combination of the two (the Orwellian approach).

Capitalism is the best system, producing the greatest wealth and the "most fair" distribution of assets. But no economic system can exist in a vacuum. This is what libertarians cannot understand; the self interested pursuit of power by those who are in governance positions (and ALL human societies REQUIRE governance or power structures to exist) are unavoidable.

And so we have this grand European experiment. The road to hell is paved with Good intentions, and, taking this religious tenor a bit further, the battle between "Plato's Republic" and Augustine's "City of God" grows more intense by the day. In my opinion, the narrative of the fallability of man will be revisited in Europe once again. Tying together such disparate cultures with economic strings alone, with top-down policy instead of organic measures (open travel, a common language) that take decades to accomplish was doomed to fail just as surely as Sparta.

Demographics is destiny

One version of destiny, as extrapolated by Barclays.

Of course, readers here will note I detest any form of extrapolation and would love to see what kind of variables (capacity and tradition of immigration?) are used in this model...but unfortunately readers here will also note that I human (Nietzsche would say "all too human") and love graphs like this that correspond to my Weltanschauung.

Wednesday, April 07, 2010


I agree with most of this, and would only add there will be a large security premium attached to sovereign debt issuers who can provide it. This of course leaves the U.S. in the pole position.

By Mohamed El-Erian

Published: April 7 2010 15:53

It should be apparent to all by now: despite the rhetoric out of some
European capitals, the Greek rescue package is not going according to

The triumphant Greece/European Union/International Monetary Fund
announcement of a couple of weeks ago has not calmed markets, nor has
it lowered Greek borrowing costs. In fact, market measures of risk
signal more concern today than before the announcement.

Meanwhile, worries are mounting about the health of the Greek banking
system, raising the spectre of disorderly outflows of deposits.
Society is not buying into the government’s adjustment plan. And the
EU/IMF external financing package lacks the operational clarity that
is required in these circumstances.

Veterans of past sovereign debt crises will not be particularly
surprised by this turn of events. As illustrated by Mexico in 1995 and
Korea in 1997, among many others, complicated sovereign rescue
packages often have to be re-opened. In some cases, such as Russia in
1998 and Argentina in 2001, the packages never succeed in getting
ahead of deteriorating debt dynamics.

Unfortunately, it is likely that things will get worse for Greece
before they get better. In the short run, the persistence of alarming
risk spreads will lead to even more cautious behaviour among
depositors and investors. Late movers will sell Greek assets rather
than buy, putting even greater pressure on the government’s ability to
raise sustainable funding for its forthcoming debt maturities in May.

Against this background, we should expect an intensification of the
European blame game in the weeks ahead. Greece will complain about the
lack of meaningful support from its European neighbours. They, in
turn, will point the finger right back, noting the urgent need for
Greek austerity. And the IMF will be pulled in all directions,
including by those hoping that the institution can engineer an
immaculate recovery for Greece.

Ironically, the major issues in this complex case can be summarised by
a relatively simple observation: that the solution to Greece’s
problems is undermined by the inability of the major players credibly
to commit to the required high level of co-ordination and trust.

The Greek government is having difficulty convincing its people of the
magnitude of the country’s problems and the required internal
adjustments. As a result, Greece is unable to provide sufficient
assurances to its creditors, thereby further complicating an already
tough situation. This accentuates the hesitancy of exceptional
financiers, such as Germany, who resist having to again pay the bill
after others have partied. And without exceptional financing, the
Greek government finds it even more difficult to embark on an
adjustment program that relies on only one instrument – that of fiscal

It is a classic co-ordination failure in game theory. Any first mover
will become worse off. Indeed, it is in the interest of any single
party to wait for others to move first. As a result, no meaningful
progress is made, the problems fester, and the risks of a disorderly
outcome increase.

Buoyed by a cyclical recovery, markets around the world have yet to
recognise the complexity of this situation. When they do, it will also
become apparent that Greece is part of a wider, and historically
unfamiliar phenomenon – that of a simultaneous and large disruption to
the balance sheet of many industrial countries. Tighten your seat

Sunday, April 04, 2010

Envy is good. Envy is Right. Envy Works.

Mr. Falkenstein writes a wonderful essay identifying Envy as the driving force of most human behavior (I would characterize it as something else, but the point here is that there is no such thing as utility maximizing "homo econimus" as it is not objective wealth maximization that is the goal but relative status and position. This of course begs the question of "status for what purpose?").

Many, many good observations. One particularly poignant passage for me is reproduced below.

Economists strongly prefer the idea that people are merely wealth maximizing agents because this generates tractable models, and economists are primarily modelers. Envy would invalidate many models, if not entire subdisciplines, because in that case one cannot aggregate preferences into one person, as it makes no sense to talk about the aggregate happiness of people, when their happiness depends mainly on their relative positions. Economists like to add these curiosities outside models, but clearly the objective function to maximize GDP is misleading if envy is very important. As the old can opener joke goes, economists like the assumption because it generates nice answers.

So, over the years, economists have become good at defining exactly what kind of utility allows them to generate tractable models. While some assumptions, such as assuming everyone has the same beliefs and preferences, have been attacked, they generally haven't made much of a difference. But these are rather small compared to the idea that the utility function people are maximizing has 'constant relative risk aversion'. The idea here is that while we think it fundament that people have utility increasing in wealth at a decreasing rate, the specific functional form is actually highly circumscribed.

The problem is, we know that the utility curve becomes come much flatter as one rises in wealth, implying rich people are almost indifferent to wealth, and almost indifferent to risk. It seems implausible that risk preferences for you average person have declined over the past millenium, or century, as this would be reflected in all sorts of prices like the 'risk free rate, which has not changed considerably over the past 150 years. So, economists discovere we must have 'constant relative risk aversion', so that 'risk' is relatively the same regardless of how much wealth you have: a 10% gamble always much feel the same. If risk preferences were not of this sort, one can be presented with a series of risks, each of which one finds acceptable, that lead one into any position; the other party—say, the casino management—can always make a profit, and essentially "pump" money out of players. While some people undoubtedly are like that, the population in the aggregate cannot be, or the economy would grind to a halt forever. The modern notion of risk aversion that does not lead to an absurdity is that we value wealth via a function x^(1-a)/(1-a) (where a is the risk aversion constant), because only that function would imply the consistent interest rates we have seen over the past thousand years. How plausible is it that humans have this kind of mathematically precise instinct?


...Seems like the Treasury is unaware of how much we really have.

April 5 (Bloomberg) -- Treasury Secretary Timothy F. Geithner, by delaying a report on global currency policies, is betting international diplomacy will work better than U.S. pressure to get China to strengthen the yuan.

In an April 3 statement, Geithner announced the delay of the report, scheduled for April 15, and urged China to move toward a more flexible currency. He said a series of meetings over the next three months will be “critical” to bringing policy changes that lead to a stronger, “more balanced” global economy. The decision came days after Chinese President Hu Jintao announced plans to visit Washington for a nuclear summit April 12-13.

The Treasury chief faces demands from Congress to label China a currency manipulator for keeping the value of the yuan little changed from about 6.83 to the dollar for almost two years. Geithner is instead expressing confidence that China will take steps on its own in the next several months to strengthen its currency.

The move will give China space to relax currency controls “without looking like they’re kowtowing to U.S. pressure,” said David Gilmore, a partner at Foreign Exchange Analytics in Essex, Connecticut.

Saturday, April 03, 2010

South Africa

I have many friends in SA who inform me this man did not have a terrible amount of influence among Afrikaners...however, the integration difficulties for the largest economy in Africa continue, with mass emigration certainly among the probable outcomes.

Global Warming...

...a wonderful article from Spiegel in Germany that echoes many of the themes I have discussed here from time to time. The Human Element, intellectual bubbles qui bono, etc.

It should not be lost on anyone the timing involved and that a prominent whistleblower was a laid-off finance professional. False precision in the markets and false precision in an equally complex system.,1518,686697,00.html

Thursday, April 01, 2010

Construction slows

Mixed signals today after the ISM data.

ISM looking hopeful...

...index and new orders growing.

PMI 59.6 56.5 +3.1 Growing Faster 8
New Orders 61.5 59.5 +2.0 Growing Faster 9
Production 61.1 58.4 +2.7 Growing Faster 10

(yet another) Herald of Doom...

"Superstar" Robert Gordon chimes in...this is getting tiresome. Yes, there will be many more shoes to drop, but U.S. institutional structures enjoy a special resiliency due to the cathartic effects of the populace's ability to elect officials. I suppose we should not blame them, as these kinds of forecasts, if they come to fruition, make careers. How many articles have you read with the words "Mr. Roubini, who predicted the Global Financial Crisis..."

My comments are in italics in relevant sections below.

Obama and America’s 20-year bust
Mar 31, 2010 06:51 EDT

It is an alarming, jaw-dropping conclusion. The U.S. standard of living, says superstar Northwestern University economist Robert Gordon in a new paper, is about to experience its slowest growth “over any two-decade interval recorded since the inauguration of George Washington.” That’s right, get ready for twenty years of major-league economic suckage. It is an event that would change America’s material expectations, self-identity and political landscape. Change in the worst way.

We have "superstar economist" and "suckage" in the first paragraph...this does not bode well.

Now it’s not so much that the Great Recession will morph into the Long Recession. More like ease into the Great Stagnation. As Gordon calculates it, the economy will average only 2.4 percent annual real GDP growth over that span vs. 3 percent or so during the previous 20 years. On a per capita basis, the economy will grow at just a 1.5 percent average annual rate vs. 2.17 percent between 1929 and 2007.

A 20 year prediction regarding GDP growth. The professor uses the Japanese case.

That might not seem like much of a difference, but it really is. Over time, the power of compounding would create a huge growth gap measured in the trillions of dollars. To look at it another way, assume you had an annual salary of $100,000. If you received a 1.5 percent raise each year, you would be making $134,000 after 20 years, $153,000 after 40 years. But a 2.17 annual raise would boost your income to $153,000 after 20 years and $236,000 after 40 years.

yes, the power of compounding. What about more lumpy growth? Say 3.0% in the first ten years and 0% in the following 10 years? The reverse case? Ah, but then we run into problems rolling into other packages of time, which are not very tractable when analyzed in discrete and arbitrary packages of time.

For Gordon, the culprit is weaker productivity. Productivity, economists like to say, isn’t everything — but in the long run it is almost everything. A nation’s GDP growth is little more than a derivative of how many workers the nation has and how much they produce. And if Gordon is correct, U.S. productivity is about to weaken. He forecasts that over the next two decades, the metric will grow at just a 1.7 percent annual rate. From 1996-2007, economy-wide productivity averaged just over 2 percent with GDP growing at 3.1 percent.

Productivity is presently growing, but I take the point that this is his metric.

Gordon’s argument is simple: The productivity surge starting in the 1990s was driven primarily by the Internet, though drastic corporate cost-cutting in the early 2000s helped, too. Going forward, though, Gordon thinks the IT revolution will be marked by diminishing returns. He concludes, for instance, that most of the product innovations since 2000, like flat screen TVs and iPods, have been directed at consumer enjoyment rather than business productivity. (Also not helping are a more protectionist trade policy and a tax code where the penalties on savings and investment are about to skyrocket with rates soaring 60 percent on capital gains and 200 percent on dividends.)

Most of the innovations? Quantify. Trade policies can change. Tax codes can change. These policies are not monolithic...they are dynamic. The present administration (which I am at odds with on a variety of issues) has not exactly shied away from tinkering with policy.

All this dovetails nicely with research showing financial crises are followed by negative, long-term side-effects such as slow economic growth and higher interest rates. Lots of debt, too. Indeed, researchers Carmen Reinhart and Kenneth Rogoff find advanced economies with debt-to-GDP ratios above 90 percent grow more slowly than less-indebted ones. (Japan is the classic example.) America is on track to hit that level in 2020, according to the Congressional Budget Office.

Finally he mentions Japan, but I think we are putting the effect before the cause when we say "countries grow slower with debt/GDP above 90%. Japan's is near 200%, and is not nearly as dynamic as the U.S.

But maybe Gordon is wrong. Productivity has been surprisingly robust during the downturn, helping the overall economy (though not the labor market) weather the storm better than most expected. Maybe nanotechnology or genetic engineering will be the next Internet and ignite further creative destruction. Yet even if Gordon is correct, Americans still control their own economic destiny.

Very good. The point is that from Malthus to Marx there has never been a shortage of theorists who arbitrarily choose factors that will grow or decline and conclude that, all things being equal, their pet factor will destroy society as we know it. The problem is that other factors, such as innovation, can grow exponentially as well. The U.S. has a very long history of this kind of innovation (intellectual capital). We are also tolerant of immigration (human capital). It is a mistake to assume a society that adapts as well as the United States will simply stop innovating, declilne in productivity, and gently go off into that good night.

Since the 2008 election, American economic policy has been about wealth preservation (keeping the economy from sliding into a depression) and wealth redistribution (healthcare reform.) Wealth creation? Not so much. That needs to change. Washington needs to focus on growing the economy and competing with the rest of the G20 nations, including the other member of the G2, China. Every policy — from education to trade to the tax code — needs to be seen through that lens.

This is beginning to sound like a college essay.

America faced a similar turning point a generation ago. During the Jimmy Carter years, the Malthusian, Limits to Growth crowd argued that natural-resource constraints meant Americans would have to lower their economic expectations and accept economic stagnation — or worse. Carter more or less accepted an end to American Exceptionalism, but the 1980 presidential election showed few of his countrymen did. They chose growth economics and the economy grew.

Well, Malthus shows up here.

Now they face another choice. Preserve wealth, redistribute wealth or create wealth. Hopefully, President Barack Obama will choose door #3. Investing more in basic research (not just healthcare) would be a start, as would slashing the corporate tax rate. A new consumption tax would be better for growth, but only if it replaced the current wage and investment income taxes. Real entitlement reform would help avoid the Reinhart-Rogoff scenario. The choices made during the next few years could the difference between America in Decline or the American (21st) Century.

A basic re-hash of current thinking. I am going to go ahead and publish this as it does serve as a good example of how to frame a title for garnering attention.