on physics and money

Correct me if I'm wrong Sandy, but if I kill all the golfers, they're gonna lock me up and throw away the key.
-- Carl Spackler

For simplicity, but also quite accurately, you could define the Modern Era with Newton's Second Law: F=MxA. Though more accurately for this piece, we can use the derivative Acceleration = Force divided by Mass. Simply, this is one equation that defines the movement and shaping of physical things. At it's foundation, the Modern Era has been the human use of fossil fuel energy, coal, oil, and more recently natural gas, to shape and move physical things. Using these energy supplies, these forces, has allowed humanity in the past two-centuries, to reshape and move about this planet in ways unprecedented from the rest of human history. Now there's been plenty of good in this, but also, and much less debated, plenty bad. Whether good or bad, this reshaping and movement allowed the transformation of locality, the ability to transcend defining by the local, leading paradoxically to ever increasing homogeneity.

The Modern Era's latest and last phase is corporate globalization. While it has been forged by coal and to a lesser extent natural gas, it has been the movement provided by oil, and most importantly cheap oil, that allowed this brief, dead-end mutation we've seen the last few decades. Before the great global contraction of the last two years, the essential question of remaining global oil supplies was beginning to enter the popular mind, helped in America by plus $4 a gallon gasoline. Despite the contraction, the price of oil has remained stubbornly high and threatens to move much higher at every sign of renewed economic vigor. This is a problem for corporate globalization. The LA Times has a nice piece on how the increased price of oil is literally slowing the acceleration of corporate globalization, in this case, the great container ships plying the seven seas:

Eager to cut fuel costs, ocean shipping lines have ordered their sea captains to throttle back the engines for what is quaintly known in the industry as "slow steaming." In some cases, freighters are taking as many as 15 days to make a Pacific crossing that used to take 11 days.

There is no relief in sight, however. Ocean shippers lost an estimated $22 billion in 2009, analysts say, largely because of the global economic downturn. Saving on fuel is one way to cut losses.

This is a small but important development as it portends the end of an era, not simply the relatively recent corporate globalization era, but the Modern Era itself. Before they end, eras always gestate inside themselves the new. And as we watch the end of the Modern Era, the fossil fuel era, we see all about us the birth of the new. In place of Newton's law, we have Einstein's E=MC2, or even much more radical, the equations of the Quantum era. We see in our electronic media and more menacingly our atomic weapons, the power of these new forces, which have only begun shaping the planet, though at a rate even faster than fossil fuels and industrialization. Just as their predecessors radically changed institutions, culture, and life, so too will these forces, and maybe in the short-term, nothing more radically and necessarily than money itself.

An interesting thing occurred as energy transformed the Modern Era, money became further detached. In many ways, strangely enough, money has never been very reflective of the real economy. In its specie form, it always sat above, while in its current fiat form, money, at best, has some indeterminate relations to the real economy, any of which torn asunder over the last two decades. Reflecting this tearing has been the growing question in the financial press, "Are bonds in a bubble?" To which the answer is yes. Bonds are debt and debt is money, and we've watched the Fed, other central banks, and governments across the globe, in reaction to popping of the great private finance bubble of the past two decades, transfer the bubble into the currencies themselves.

Tom Petruno has a piece in the LA Times comparing the bond bubble to the dot.com bubble. He wants to conclude it's not as bad, but in fact it's much worse. Now Mr. Petruno concludes the bond market bubble ends in three relatively mild outcomes, but leaves out the dirty word of the bond world -- default. The greater the bubble grows, the more defaults there are going to be. Mr. Petruno alludes to, but doesn't quite bring out the even great problem with the bond bubble, it undermines the value of money itself. He states:

Others, like Ken Naehu of Bel Air Investment Advisors, are taking the opportunity to clear out lower-quality bonds in favor of higher-quality issues. "We're selling everything you won't be able to sell in the near future" should the bond market suddenly turn on investors, he said.

In other words, there will begin to be an ever increasing run, not simply to bonds, but "good" bonds, or to put it another way from bad money to good money. Begging the question, what is good money? Now, I've pointed out before, PIMCO has been ahead of the game on this topic, and well, you expect that from the world's biggest bondhouse. Several months ago, PIMCO's El-Erian came out saying we needed to start writing off some of the bad debt, destroying the bad money. I applauded this, but also pointed out that in so doing, PIMCO was trying to protect the money they held, trying to make sure it remained good by destroying other money. Mr. Petruno's article states,

The world's biggest bond fund, the $234-billion Pimco Total Return fund, by itself is taking in about $1 billion in fresh cash every week.

To which I can only plead, "Please don't give PIMCO anymore money." You're only making them more powerful and giving them an increasing ability to decide what's good and bad money, and if its based on Mr. Gross' cockamamie reasoning that future wealth depends on future population growth, and he's no way alone in his inanity, they really shouldn't be making decisions about the future on much of anything.

As we leave the Modern Era, we're going to redefine money. We might follow two simple rules of thumb, let those who know most about money today have the least to say about its future. And, if you want a good foundation for money, start with energy, and if you ever read any quantum physics, that's much much weirder than it sounds.

Greider

Mama always told me not to look into the sights of the sun
Oh but mama, that's where the fun is
-- Blinded by the Light

So, in 2010, the trajectory of an American life is you grow up a Republican in Cincinnati, attend Princeton, and eventually become a big-shot editor at the Washington Post, and finally end up giving speeches to the Democratic Socialists of America, to which the only immediate response is, "Are they still around?" The next question, how does one get there? Well that's easy, you quit the Post write the seminal book on the Fed, Secrets of the Temple, follow that up five years later with Who Will Tell the People, a documenting of the corporate take over of Washington DC, and then just to make sure you're never invited to another bigwig dinner party, you write One World Ready or Not, a scathing indictment of corporate globalization in the middle of the "high" Clinton years, where the Democratic party became a wholly owned subsidiary of Global INC and Wall Street. Such is the American life of Bill Greider.

Greider's speech is excellent, it is a shot against way too much pessimism and despair currently gripping this republic. It is a reminder, that this country is a very wealthy place and we need to embrace our history and more importantly embrace the opportunities to meet the challenges of this era. We need to change, we can change, and it can be better. We can have, as Greider puts it, "larger lives." But we need to rethink many many things and simultaneously we need to begin to act. Let us first and foremost embrace our heritage of self-government -- the democratic idea -- as a reconstructed foundation. What is the democratic idea, "Every person has the ability to participate in the decision makings that affect their lives." Reforming our political economy to the realities of the 21st century based on this fundamental principle will get us a very long way.

on money and the fed

Switch on your electric light
Then we can get down to what's really wrong
-- Caravan

John Hussman has a nice piece on the recent testimony of Ben Bernanke and the Fed's moves over the last couple years. It's important to understand what's happened here. Just as important, we need to understand most of the mortgage drek wasn't put on the Fed's books, but transferred to Fannie and Freddie. There's too much garbage money out there and it needs to be dealt with, bondholders of garbage need to take a haircut. How much? Well let's start with what the administration did with GM workers -- 50%.

The nut of Hussman's piece:

Last week, Ben Bernanke appeared before Congress for his regular Humphrey-Hawkins testimony. For most of that testimony, it fascinated me that every time the Bernanke said that the Fed has taken no losses on its operations, there was absolutely no remark that the reason the Fed has not lost money is that the Treasury, directly (Fannie, Freddie) or indirectly (AIG) has made the liabilities held by the Fed whole.

From that perspective, the critical part of Bernanke's testimony was the following exchange with New Jersey Congressman Scott Garrett of the House Financial Services Committee. Importantly, Bernanke concedes that by placing two-thirds of its balance sheet into the liabilities of insolvent agencies (Fannie Mae and Freddie Mac), now under conservatorship, the Fed is essentially relying on Congress to make these institutions whole at taxpayer expense. The Fed has put the public on the hook to bail out the GSEs.

SCOTT GARRETT: You bought over a trillion dollars of GSE debt, and to that point, under normal circumstances, on the Fed's balance sheet what you have on there are Treasuries, or if you had anything else on there, I assume you would have a repurchase agreement for those securities on your balance sheet. Now of course around two-thirds of that are in GSE debt.

BEN BERNANKE: Correct.

GARRETT: So right now, those are guaranteed - whether they're sovereign debt or not, we don't know - but they're guaranteed by the U.S. government. But they're only guaranteed to when? 2012, right? After that, Congress may in its wisdom make another decision, and at that point in time, you may be holding on your balance sheet - two thirds of your balance sheet - something that is not guaranteed by the Federal government. First of all, you don't have a ... do you have a repurchase agreement on those with anyone? No.

BERNANKE: I don't know what you mean by a repurchase agreement. We own those securities.

GARRETT: You own those securities. Right. So there is no repurchase agreement outside to buy them back. You own them.

BERNANKE: Right.

GARRETT: So after 2012, if they're no longer guaranteed, is it fair to say that you may at that point in time actually engage in fiscal policy, because you basically are creating money at that time? And I know that you'd agree that it would be an unconstitutional role for the Fed to engage in fiscal policy - so where will you be at 2012 if they had to take a haircut on those because they're no longer guaranteed?

BERNANKE: Well, first from the government's perspective, I, uh, such an act would, uh, there would, the Federal Reserve would lose money which the Treasury would gain. There would be no overall change to the position of the U.S. government. Secondly, the Federal Reserve act explicitly gives..

GARRETT: How would we be gaining? How is the Treasury gaining?

BERNANKE: Well, if there's a bad mortgage and the Treasury.. it requires $10 to make it good, if the Treasury refuses to do that then the Fed loses $10, so one way or another the government's going to lose $10. But I would just say two things, one is that I think, uh...

GARRETT: But if you didn't purchase them in the first place, it would just be a total - then what would have occurred? There would not have been the creation of that $10. Now that you've purchased them, and in essence if we don't back them up, then you will have created that additional $10.

BERNANKE: Well, I hope that doesn't happen, because I think it's very important for financial stability and confidence that we, that we guarantee...

GARRETT: Let's play out that hypothetical that it does happen.

BERNANKE: Well, then the Fed would lose money there. But let me just point out that the Federal Reserve Act, that we did not invoke any emergency or unusual powers to buy those agencies. It is explicitly in the Federal Reserve Act that we can buy Treasuries or agency securities and so we did not do anything unusual there.

GARRETT: In what status were they when you bought them? Were they in conservatorship at that point?

BERNANKE: Um, yes.

GARRETT: Is it normal practice for the Fed to buy agency securities when they're in conservatorship? Was that ever done before?

BERNANKE: It's never been in conservatorship before.

GARRETT: Well, there you go. So the normal practice is not what was followed here. It just seems to me that we may have gone down a different road than we've ever gone down in U.S. history, where the Federal Reserve has engaged in buying a security, it's not Treasury, it's not guaranteed by the full faith and credit of the United States for its lifetime, nor is there any repurchase agreement from any other entity that you purchased - that you have a trade with an agreement with - and that the Fed in essence could have created money if the government does not guarantee them. At least, that could be the situation we could find ourselves in 2012.

It's important to understand that historically, the Fed has never actually "created money" out of thin air. What it has always done is purchase Treasury debt, paying for that debt by creating "Federal Reserve Notes" (see the top of your dollar bill). When it has purchased other types of securities, it has historically done so using "repurchase agreements." These enable the Fed to sell those securities back at a known price, even if the security itself was to default. By restricting the vast majority of its purchases to U.S. Treasury securities, the Fed has always operated under a budget constraint: Congress has always had the sole, Constitutionally enumerated power to authorize the spending that creates government liabilities, and the Fed has merely affected whether those liabilities were held by the public in the form of Treasury debt or in the form of Federal Reserve Notes (money).

For example, if Congress votes on a billion dollars of spending, and the Treasury issues debt to finance this spending, the Fed might buy that billion dollars of Treasury debt and create a billion dollars of currency to pay for it. But notice that from the standpoint of the public, the end result is still a billion dollars of government liabilities, that was explicitly authorized by Congress. The Fed was never involved in spending decisions, which is fiscal policy.

Contrast this with what the Fed has done in this instance. It has taken its balance sheet up from about $800 billion two years ago (almost exclusively in Treasury securities) to over $2 trillion today, mostly in Fannie Mae and Freddie Mac liabilities. The government's backing of Fannie and Freddie debt was always implicit - they do not have the full faith and credit of the U.S. for their full maturity. If Congress chooses to restructure that debt after 2012, the Federal Reserve will have created money without an offsetting asset of equal value on its balance sheet. It will have spent money out of thin air to pay off the holders of Fannie and Freddie securities. This would constitute a fiscal policy decision that was not actually voted on by elected representatives in Congress

A Tale of Three Cities

Waste forces within him, and a desert all around, this man stood still on his way across a silent terrace, and saw for a moment, lying in the wilderness before him, a mirage of honorable ambition, self-denial, and perseverance. In the fair city of this vision, there were airy galleries from which the loves and graces looked upon him, gardens in which the fruits of life hung ripening, waters of Hope that sparkled in his sight. A moment, and it was gone. -- Charles Dickens

Here is a tale of three cities best illustrating our times. The first city is New York. Gretchen Morgenson has a piece digging further into the back door bailout of the banks accomplished with Washington DC's, our second city, funneling billions through AIG. Morgenson shows despite Wall Street denials, some of the largest banks were saved from great losses, if not insolvency, by our government's backdoor largess. Continuing in Washington, our so-called pay czar, Kenneth Feinberg, announced that using tax-payer bailouts, the banks lavished themselves with bonuses, claiming $1.6 billion in bonuses the most egregious, but also stating the government would do nothing about it, as, it was "not contrary to the public interest." Some Czar. Some public interest.

But these are old stories and the machinations of New York and DC really come to full flower in our third city Detroit. The Post has an excellent must read story about the results of the GM bailout concocted by our two other cities. Most interesting is the fact wages for new hires were cut 50% under the deal, making a two-tier labor system, with half making $28 an hour and the other $14. No bonuses for GM workers, instead pay is cut by half. The story reveals DC doing New York's dirty work:

The administration proposal also called for all new production employees to be paid the $14 rate, expanding a 2007 labor agreement that set up the lower rate, though only for some "non-core" jobs. In doing so, the administration went well beyond the pay cuts the automakers had envisioned, sources said.... The government didn't say $28 an hour was overpaying people," the source said. "But they saw the $14 rate as a way to lower overall labor costs to be competitive."

In the middle of the collapse of corporate global finance and all it represented, the Democratic administration, the so-called socialists, argued the same tripe used for the last three decades to decimate the American middle class. Most unpalatable is agreement of the UAW to whole mess, though at the very least there was some dissent,

The two-tier agreement "effectively ends many of the principles established 70 years ago in the UAW's birth," Bill Parker, a negotiating committee leader, wrote in an unusual dissent. "For years, the UAW embodied industrial unionism and the gains of the New Deal. So goes the UAW, so goes the American middle class."

This pretty much states it all. The UAW just another crumbling component of the New Deal, and understand, one of the most important elements of the New Deal, and its greatest small "d" democratic element, was the establishment of a strong labor movement. But that as they say is history, organized labor is a dead force in economic matters in this country, and with its decline the American middle class has become subjugated to the looting of New York and DC. This story has been running for over three decades now, and it will continue until the American people say enough. "Which side are you on?" was a rallying cry for working people in the 1930s, it would do us well to re-ask the question. You can start in November. Dylan Ratigan has done a service by giving us a voters guide, reminding us of all the people who voted for the bank bailouts, begin rewriting the story, vote them out.

on restructuring

Credit Writedowns has some extremely important comments by financier Jeremy Grantham on the financailization of the American economy. Restructuring the American economy begins with shrinking the financial sector by half at least. Mr. Grantham:

My previous argument in the Economist debate was that the 3% of GDP that was made up of financial services in 1965 was clearly sufficient to the task, the proof being that the decade was a strong candidate for the greatest economic decade of the 20th century. We should be suspicious, therefore, of the benefits derived from the extra 4.5% of the pie that went to pay for financial services by 2007, as the financial services share of GDP expanded to a remarkable 7.5%. This extra 4.5% would seem to be without material value except to the recipients. Yet it is a form of tax on the remaining real economy and should reduce by 4.5% a year its ability to save and invest, both of which did slow down. This, in turn, should eventually reduce the growth rate of the non-financial sector, which it indeed did: from 3.5% a year before 1965, this growth rate slowed to 2.4% between 1980 and 2007, even before the crisis.

on banks and bubbles

The Wall Street Journal has a good piece on the growing reliance of European banks on the European Central Bank:

As such, ECB lending to the banking systems of Portugal, Ireland, Greece and Spain rose by €126 billion ($162.45 billion) in the first half of the year, accounting for almost all of an overall increase of €141 billion. Overall ECB lending volumes have fallen since June, with the repayment of €442 billion in 12-month funds. But by the end of June, these four countries accounted for 42% of the ECB's total lending of €870 billion, up from 33% at the start of the year. By contrast, those countries contribute only 13% of the ECB's capital.

To some degree, that development reflects a fear of country risk, rather than bank-specific risks. The public-debt dynamics of Greece and Portugal in particular have convinced many that a default or restructuring will be necessary before long. But it also reflects the fear that even sovereigns themselves won't be strong enough to save and recapitalize national banking systems that have suffered massive losses as real-estate bubbles exploded in their countries.

The European response to the financial mess has been entirely made in America, and our response was borrowed from the Japanese. Remember as the Greek problem hit critical mass, Mr. Geithner flew over to Europe to get them to release "stress tests" to show all was fine. Now the "stress tests" conducted in the Spring of 09 in the US were a charade, as has been pointed out repeatedly by Yves Smith and others. They were the foundation to the Fed/Treasury's "extend and pretend" policy which allowed the banks to not account the massive loses still on their books, in the hope of some fine day values would once again rise to their bubble heights. From repeatedly leaks, it seems the Europeans are having a problem with "extend and pretend", as several banks are rumored to not having passed the "stress test", meaning, Mr. Geithner must be on the phone late at night explaining if they don't pass that test, give them another one they can pass.

We're a year and half into our "extend and pretend" policy, the Japanese tried it for seven years until realizing they needed to do something else, that is, make the banks take the losses. There's many problems with "extend and pretend", I'll give two. First, it doesn't matter how much the banks make trading, see Morgan Stanley's latest results, the problem is the banks don't want to do what's necessary for the real economy, because they're sitting on piles of garbage. We can all pretend the banks aren't insolvent, however, the banks understand they very well are.

Secondly, bubbles cause tremendous malinvestment in the economy, and this bubble was a duzy. Keeping the bad loans on the books, focuses the banks on trying to make them good, it encourages the wrong-headed idea that the bubble can be re-inflated, thus keeping the economy itself in check. Further, keeping alive the bad loans creates bad money, gradually undermining currencies themselves. Simply throwing more and more good money at bad debt, increasingly devalues money itself.

The first step we need to take is write-off the bad loans, a massive restructuring of global debt. It is a first step, and really a small first step to begin the restructuring of the economy necessary for future economic health.

on republics

Sky
Uncanny
The bushes are in disagreement with the heat
L-L-L-L A-A-A-A
This is my happening and it freaks me out

L.A., The Fall -- surf rock by post-industrial Mancunians, c'mon and swim this fine summer's day with Mr. and Mrs. Smith

I'm just about finished with a tremendous book recently recommended(tx tom g), Count-Duke Olivares: The Statesman in an Age of Decline. I'm going to write a longer review, early 17th century Spain has plenty of lessons for 21st century America. Most importantly, necessary reform calls for pissing off established power, there is no alternative. Secondly, when you have a system atrophying under centralization, the underlying mean to all reform is breaking up the centralization, which is even more relevant for a republic than a monarchy. The value of a republic is in dispersed power allowing for healthy change. In the US, we continue toward increased centralization, thus stagnation.

The Post has an excellent piece today showing the dire situation created since 9/11 by increasing centralization and privatization of DC intelligence services in the name of reform:

The Post's estimate of 265,000 contractors doing top-secret work was vetted by several high-ranking intelligence officials who approved of The Post's methodology. The newspaper's Top Secret America database includes 1,931 companies that perform work at the top-secret level. More than a quarter of them - 533 - came into being after 2001, and others that already existed have expanded greatly. Most are thriving even as the rest of the United States struggles with bankruptcies, unemployment and foreclosures.

Nothing better illustrates the bankruptcy of American politics, where bipartisan insolvency combine into what can only be described as fatal incompetency, looting, and ever encroaching militarism. Here you have the unaccountable National Security state feasting on New Deal democratic philosophy of centralized government, combined with the neo-Republican love to privatize activities that are by definition of the government. In this case, you create a system not only making us less safe, but so riled with corruption and waste it helps drain the rest of the economy. Nothing better illustrates the insolvency of contemporary politics.

The silly season fast approaches, and I have little to say, and really, no one should talk about elections in this country if you're not being paid. The two parties only advantages are each other, it looks like the Reps understand this, while the Dems are still struggling with the idea that the only thing they have going for them in November is the Republicans. Few tears will be shed if the Dems lose the Congress, but the thought of the Rep side of our political class taking power, and Im not talking about the "Tea party," but the criminal element that's lurked in DC for the past couple decades, is distressing, but that's where we are until we create an alternative.

I've told a couple Dems, and I'll repeat as there's no chance of them taking the advise, they need to adopt the Themosticles defense. Themosticles was an Athenian citizen at the height of ancient Athen's glory. He fought at Marathon, one of history's great battles, where the Greeks first defeated the Persians. He went back to Athens telling his fellow Athenians the Persians would be back and for years advocated they needed to build a navy and be prepared to abandon Athens and take to the sea for battle. You can imagine how popular that idea was, nonetheless, after years of cajoling, Athenians followed Themosticles, built a navy, abandoning Athens, and defeated the Persians. So, the Dems should abandon their marginal incumbents and go after the Rep incumbents, not likely, for as one Democrat said, "The party is nothing more than incumbent elected officials."

More Fraud

So, as was always feared, the SEC investigation into Goldman turned out to be just another element of the great fraud against the American people perpetrated by Wall Street and their government supplicants. In another alarmingly frequent reaction to corporate and white collar crime, a settlement was reached acknowledging no criminal activity. The consent reads like a bad joke. In the third paragraph Goldman agrees it will uphold the law, "permanently restrains and enjoins Defendant from violation of Section 17(a) of the Securities Act of 1933 [15 U.S.c. §77q(a)];," which is funny, if you have the stomach. Better, a couple paragraphs later Goldman admits it was not committing active fraud, but it was simply a "mistake." This is the kind of treatment you get when you buy the American political class and own the regulators.

Of course, the biggest joke is the $500 million hush-money Goldman pays out, so the SEC can close the case and further investigations. The Wall Street Journal reports the settlement, "is equivalent to just 14 days of profits at Goldman in the first quarter." So, along with no justice, we don't even get a healthy dose of blood-lust revenge. Understand, this one case was simply illustrative of the massive fraud conducted and still being conducted by Wall Street. And the crime wasn't the individual case, or all the cases combined, the real crime was and is the destruction of the American and global economy. Jesse sums it up nicely:

And it was all unnecessary, attributable to the dishonesty and greed of a remarkably small number of men in New York and Washington who managed to rig the markets and the political process, with the acquiescence and support of a public grown complacent and in far too many cases, soft headed and corrupt.

At this point, I've been warning for far longer than I care to think, the corruption of the political process, the whole scale buying and selling of elected officials would gradually undermine the government itself. Each year, the political process has become increasingly illegitimate in the eyes of an increasing number of Americans. In the last couple years, this "crisis of legitimacy" spread, as was bound to happen, to the government itself. Make no mistake, this settlement only adds to it.

Gombe 50 Years

Fifty years ago today, Jane Goodall walked into the forest of Tanzania and changed our understanding of chimps and ourselves forever. It is quite a story, and I recommend all of Goodall's books if you've never read one. In reforming our global political economy, the insights and understandings of Jane Goodall will be necessary and essential components. She's a beautiful earthling.

It's not the 1930s

Keynes was a brilliant mind. For a self-proclaimed economist, Keynes understood a lot about money and the financial system, which is rare in the breed. However in reading Keynes, his thoughts on financial bubbles are not very satisfying. In fact, in reading Keynes you'd be hard pressed to think they existed. In fact of the bubble of recent years, the best comment from Keynes would be in his 1930 Treatise on Money where he wrote:

But the same arguments apply, mutatis mutandis, when a Credit Cycle has been initiated by a drop in saving uncompensated by decreased investment. This is not very likely to occur in practice on an important scale, because the influences which determine the volume of saving are such a kind that they are not so likely to change suddenly as those which determine the volume of investment.

This is exactly what happened over the past two decades, a drop in saving uncompensated by decreased investment, or tremendous malinvestment on not simply an important scale, but a massive economy wide scale.

Understand this is very different than what Keynes thought about the financial crisis and early Depression of the 1930s. Steve Waldman(tx yves) has a nice piece explaining further how this is not the 1930s. He quotes from Keynes about the early 1930s:

Doubtless, as was inevitable in a period of such rapid changes, the rate of growth of some individual commodities could not always be in just the appropriate relation to that of others. But, on the whole, I see little sign of any serious want of balance such as is alleged by some authorities. The rates of growth [of different sectors]… seem to me, looking back, to have been in as good a balance as one could have expected them to be. A few more quinquennia of equal activity might, indeed, have brought us near to the economic Eldorado where all our reasonable economic needs would be satisfied….

Keynes was an industrial economist, he had tremendous respect for the hundred years that had preceded him and the massive creation of industrial wealth, and particularly the great growth rates of the 1920s. The base of his economic thinking were these very real physical processes. In the early 1930s, Keynes looked around the planet and saw a great ability and need for this real physical growth process to continue, though not as he pointed out on many occasions ad infinitum. He also thought it completely ridiculous that the very unreal financial system and money should at any point greatly impede this process, that simply made no sense.

However, in the last couple decades, particularly in the US, Europe, and Japan, the need for industrial growth is not the need of the past, and a financial system, which Keynes would agree, at the best of times one step away from fraudulent, became riddled with fraud, and tremendous malinvestment, greatly distorting the real economy -- a real economy that isn't, nor does it need to grow at the rates of past decades.

Now if you wanted a real Keynesian program to meet the present challenge, it would be to stop the foreclosures, keep people in their houses, and write down the value of the loans, but that would show the banks are insolvent. Yves Smith has an excellent piece on the banks and the continuing foreclosure fiasco. Very much related is the FT's Satyajit Das piece on the "three card monte" operation now being carried out in the name of saving Europe's banking system.

As long as we continue extend and pretend, as long as we continue avoiding a fundamental restructuring of the financial system, and as long as we refuse to rethink our economy, we will be at best in economic stagnation and increased political volatility.

well, now I can't resist

I was going to write this earlier today, and then I couldn't bring myself up, or more accurately, down to it. More Krugman bashing? Look, there's just no sport in it. Then Chris Whalen's piece came out, so I'll blame him. You know, the old adage of choosing your enemies wisely, it really is sound advise. And over the last several decades, it's been difficult to have any real good enemies in American politics without lowering oneself considerably. "Oh, but you hate the Clintons!" No, they disgust me, that's a big difference, and, they just will not go away. The same with Mr. Krugman, who really is just a not very good polemicist, a large voice in a publication that defines the bad thinking of our rotted political class. Today's NYT was just a good example of the insolvency of our political economy.

Mr. Krugman's column, the self-proclaimed liberal Keynesian, is a serving of monetarist's tripe. The same gruel fed to us for the last three decades, which we were asked to believe was five star cuisine. The Fed will come to our rescue advocates Mr. Krugman, yes, the very institution singularly most responsible for the dire financial situation we find ourselves is now going to save us. It's one nasty habit of a lot of economists, whatever they've advocated that isn't working, the reason is always you didn't do enough -- not enough tax cuts, not enough debt, not enough free money, not enough fiscal stimulus....

Now, what is most amazing of today's NYT, in its constant defining of American politics in the vacuous dichotomies of left/right, conservative/liberal, or Democratic/Republican, is their Liberal Keynesian advocating more money for the banks and Wall Street, while another piece by its "conservative" columnist Ross Douhat proclaims the need for a class war, "a need to recognize that the most pernicious sort of redistribution isn’t from the successful to the poor. It’s from savers to speculators, from outsiders to insiders, and from the industrious middle class to the reckless, unproductive rich." The only proper reaction to the two pieces is "Which side are you on?"

Chris Whalen has more shredding of Krugman, including the remembrance of both Krugman and Summers working in the early 80s Reagan administration under William Poole and Martin Feldstein, obviously picking up many bad habits. But Whalen's piece goes much deeper in understanding where we are as a nation:

A political position, like one's view of the economy or the orbiting planets, is very much a matter of perspective. One of the things that troubles us about where the U.S. economy is headed is that opinion leaders such as Krugman cannot seem to accept, much less articulate, the fact that the global economic equation has changed and that U.S. economic assumptions must also be adjusted in response.

We talk about a double dip in the economy, for instance, as though we all are going to miraculously return to "normal" after the latest economic slowdown is past. But these promises of a return to normalcy seem out of line with the economic reality that every American can see before them. As the COO of one of the largest hedge funds in the world asked recently: "Are we in a typical business cycle or does the crisis of 2008 represent a reset for the global economy?" We believe it is the latter.

He adds:

Instead of talking about ways to boost national income and create real employment, Krugman and his ilk simply call upon the Fed to print more money to boost short-term demand for goods, many of which are imported. By encouraging consumption without regard to the source of the goods, Krugman and his peers in the world's second oldest profession remain locked into the same mental framework and vocabulary that has governed the mainstream of American fiscal and monetary policy since WWII. This is unacceptable.

Economists such as Krugman do not seem to appreciate that all of the Fed's extraordinary efforts over the past two years to inject liquidity into the U.S. economy have had little impact outside of the financial sector. The suggestion by Krugman that the Fed do more of the same really is quite irrelevant to our current national predicament....

Americans need to build a new economic narrative, one that is based upon creating real jobs in the real economy and not upon subsidies for foreign exporters and mismanaged Wall Street banks. We need new economic thinkers who are not hobbled by devotion to the failed economic structures of the post-WWII world. Regaining control of the U.S. economy must start with a frank discussion with our trading partners and foreign creditors about jobs, the value of the dollar and what it will take to bring America's economy back into balance.

On Money

The madman -- Have you not heard of that madman who lit a lantern in the bright morning hours, ran to the market place, and cried incessantly: “I seek God! I seek God!”–As many of those who did not believe in God were standing around just then, he provoked much laughter...The madman jumped into their midst and pierced them with his eyes. “Whither is God?” he cried; “I will tell you. We have killed him–you and I. All of us are his murderers. But how have we done this?" -- The Gay Science

A century later, it would be much more appropriate to place the madman running down Wall Street shouting, "We have killed money-you and I." Or maybe more appropriately through the halls of the Fed crying, "We have killed the dollar. How were we able to drink up the sea? Who gave us the sponge to wipe away the entire horizon? What did we do when we unchained this earth from its sun?" Good questions for our monetary priesthood as global currencies continue to roil in existential anguish. Greider's seminal book, "Secrets of the Temple", on the Fed and money, wasn't named by accident. Money is a faith based system, a social construct, and times where that faith is shaken, the priests questioned, and the Temple quakes, when the previous intrinsic value of money comes into question, these are always times of great change.

It is one of the great paradoxes of civilization that money, that most unreal of constructs, is at the same time, one of the great pillars of power and stability for most cultures. One can be assured when the accepted value/role of money in any given culture comes under question, much more than the value of money is at stake, but much of the established power structure, cultural norms, and the practices and institutions of political economy. Chris Whalen has a good thought provoking interview concerning the dollar with James Rickards of Omnis Inc. The interview is excellent because it ties together the role of the dollar, our military Pax Americana, and great questions facing the corporate globalization experiment of the last half-century. What happens as all established components weaken together? As Mr. Rickards states:

We have been operating in a dollar world for decades. Notwithstanding the demise of Bretton Woods in 1971, it's still a dollar system. All of the world's expectations, all of its productive capacity, all of its allocations of capital are built around that system. When the caretakers of that system allow weeds in the garden and for the system to disintegrate and fall apart, which is what I see happening in the U.S., the immediate reaction is first confusion, then panic and then self help. This gets to the heart of the national security implications of the financial crisis. Initially other nations were content to wait for the U.S. response, but now I see nations like China, Russia and Germany increasingly willing to act on their own.

What happens in world where the dollar is no longer king? I don't agree with some of Mr. Rickards analysis on where things are going or should go, but he's definitely asking necessary questions. Most alarming is the thought that the US Treasury is pushing to strengthen the position of the IMF, particularly by having the IMF pseudo-currency the SDR(Special Drawing Rights) play a greater role in global currency affairs. This calls for a long discussion, but I'll make two short comments. The idea of some sort of currency standard devised from a basket of currencies, such as the SDR, and possibly including some commodities, for example I would think energy an essential component, is not necessarily bad. How it's done is a another matter, particularly if this standard comes attached to some powerful centralized institution, and most alarmingly if that institution is the IMF.

Leading to my second point, in direct contradiction to what was thought and acted upon by many after World War II, global stability will not be gained through centralized institutions. In fact just the opposite, while centralization can, maybe, provide some short-term stability, over the longer term it leads to much greater instability. We are not going to fix our current problems by creating massive centralized global bureaucracies, not only is this inherently undemocratic, it is massively unstable. We need to be much more creative in our political economy thinking. How does the world, through multitudes of connections, create a more distributed networked order? How do we take some of the ideas and practices we've learned concerning non-hierarchical natural systems, or the distributed order of the Internet and begin using these to reform our political economy? The money question offers an essential opportunity, and it's upon us whether we want it or not.

Dont Tread on Me

He has kept among us, in times of peace, Standing Armies without the Consent of our legislatures.
He has affected to render the Military independent of and superior to the Civil Power.
He has combined with others to subject us to a jurisdiction foreign to our constitution, and unacknowledged by our laws; giving his Assent to their Acts of pretended Legislation: For quartering large bodies of armed troops among us:

-- IN CONGRESS, JULY 4, 1776 The unanimous Declaration of the thirteen united States of America

CNN(tx zerohedge) has a report on the collusion of British Petroleum -- that's British Petroleum fellow citizens -- and our Coast Guard in trouncing our 1st Amendment rights in regards to the travesties of the oil disaster:

The coast guard today announced new rules keeping photographers, reporters and anyone else from coming within 65 feet of any response vessel or booms, out on the water or on beaches. In order to get closer you need to get direct permission from the coast guard captain of the Port of New Orleans. Shots of oil on beaches with booms - stay 65 feet away. Pictures of oil soaked booms useless laying in the water because they haven't been collected like they should. You can't get close enough to see that. And believe me, that is out there. But you only know that if you get close to it, and now you can't without permission. Violators could face a fine of $40,000 and class D felony charges. The coast guard tried to make the exclusion zone 300 feet before scaling it down to 65 feet.

Of course this is nothing new, our military-industrial complex, with big oil as full fledged member, learned from Vietnam the need to control the press. And how well they've succeeded with the spineless and complicit corporate media! Embedding became the practice, and a good one, to control information concerning our military misadventures.

Since, the initiation of "Morning in America", three decades ago, the military-industrial complex has been bipartisanly and scrupulously protected from criticism, in fact to the contrary, continually lavished in praise. Remember under Reagan, the little PR affairs conducted like Grenada, seeking to bring back faith in the US military after the fiasco of Vietnam? The military-industrial complex learned to keep their costs away from the American people; no draft, no death on television, and most importantly, no raising taxes. This effort led mainly by the Boomers, who did all they could to keep out of Vietnam when it was their blood on the line, yet many of the same became the greatest cheerleaders for later military misadventures when they were safely ensconced above combat age -- "fat little boys with asthma" Gore Vidal calls them.

Two centuries ago, this nation was born in revolution, in part against an out of control military, establishing in almost every original state constitution a clause against "standing armies." Fifty years ago, President(General) Dwight D. Eisenhower warned in his farewell address:

This conjunction of an immense military establishment and a large arms industry is new in the American experience. The total influence -- economic, political, even spiritual -- is felt in every city, every State house, every office of the Federal government. We recognize the imperative need for this development. Yet we must not fail to comprehend its grave implications. Our toil, resources and livelihood are all involved; so is the very structure of our society.

In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.

We must never let the weight of this combination endanger our liberties or democratic processes. We should take nothing for granted. Only an alert and knowledgeable citizenry can compel the proper meshing of the huge industrial and military machinery of defense with our peaceful methods and goals, so that security and liberty may prosper together.

Today, we find ourselves in complete subordination to the military-industrial complex, now indenturing over a trillion dollars every year. Institutions bloated and corrupt far beyond any other government institution, yet completely devoid of public criticism. Over the last decades, in what was the founding generation's greatest nightmare, the military creeps further and further into domestic affairs. Two centuries ago, a generation found this situation intolerable and on on this day:

...for the support of this Declaration, with a firm reliance on the protection of Divine Providence, we mutually pledge to each other our Lives, our Fortunes, and our sacred Honor.

The New Normal

PIMCO's Bill Gross has a good piece lamenting the fact most of the financial community still isn't getting the "new normal". With central banks plummeting interest rates across the globe, bond yields have given the debt world a head start to understanding. Mr. Gross writes:

With bonds priced not for recession but near depression, most major global bond indices now yield less than 3%, surely a forerunner of returns to come. Stocks, long the volatile vamp of investor optimism, have not yet adjusted to the New Normal.

Volatile vamp, that's funny. A little slashing quip from the old finance world, where debt once actually ruled as conservative money, while stocks were always the flashy, not quite reputable interlopers. Presently, it seems the equity seductresses are once again being dunked in the new normal river on their way to getting religion. Gross' piece has some good points on how we arrived here, but Mr. Gross himself doesn't quite understand just how radical the new normal will be -- a fundamental restructuring of the ideas and practices of economic growth and finance.

Owning a great deal of debt and no doubt deeply concerned about its return, Gross writes of what got us into our predicament:

Perhaps the enigma arises from a multi-generational acceptance of debt as common scrip, available for the asking and seemingly forever productive in boosting living standards – until, that is, liabilities became so large that the interest burden and probability of repayment overwhelmed borrower and lender alike in near unison...(helping us) understand why debt may have become a burden instead of a boon...

Next, he gives a nice short explanation the role debt played in the development of industrial capitalism and pointing out what's keeping the people at PIMCO awake these dark nights before the dawn of the new normal:

We turned to the wizardry of borrowing on time to be able to purchase and then repay in full. Crucially, since debt is a handshake between at least two parties, the lender had to believe that it would be repaid, and that belief or “credere,” was based on several rather rational expectations when observed on a macro level from 30,000 feet.

This is a crucial point. People have every right to believe when they lend money it will be repaid. In fact, if this wasn't the case, the system would never work. However, when the financial system becomes a Ponzi operation, the ability to repay much of the debt goes out the window, particularly the debt that was fraudulent from inception. One thing we need to figure out on the way to the new normal is what debt is good and what debt is bad, needing to be written-off. Figuring this out isn't at all straight forward. It will take much wrangling and heavy politics to come to any resolution, but it is a necessity.

Recreating sound finance is going to be part of the new normal, begging the question, what is sound finance? The financial system that arose with industrial capitalism leaves much to be desired, but nonetheless it has served, if not benign purpose, certainly some beneficial purposes. In a great generalization, industrial finance has two foundational elements -- compound interest and growth. A financial system based on compound interest and growth, even at its most sound is only a half-step away from Ponzi finance. A good simplistic understanding of the difference between sound finance and Ponzi finance is in a sound system, capital invested sees a rate of return measured in interest, not principal. For example, the housing bubble was based not simply on fiance deriving profit from accrued interest, but also on massive returns through increased value of principal over the time of the debt. This should have set-off Ponzi alarms.

Once again generalizing to make a point, there are also two types of debt. The first is based on investment in production. In general, this production debt is healthy. After the debt is paid-off, there will be a certain quantity of new wealth added to the society. The second sort of debt is based on consumption. Money is borrowed not to increase productive capital, but purely for immediate consumption and gratification. While this isn't Ponzi finance, history shows no individual, family, or society can carry on consumption debt in perpetuity, without an equal corresponding level of increased production.

Which brings us to the increasingly problematic question of growth, the heart of all industrial finance. Mr. Gross writes:

First of all, capitalistic innovation fostered productivity, and an increasing standard of living through technology and innovation. Debts could be paid back via profits and higher wages if only because of rising prosperity itself. Secondly, the 20th century, which fathered the debt supercycle, was a time of global population growth despite its interruption by tragic world wars and periodic pandemics. Prior debts could be spread over an ever-increasing number of people, lessening the burden and making it possible to assume even more debt in a seemingly endless cycle which brought consumption forward – anticipating that future generations could do the same.

Mr. Gross wisely then splits the world into two. The developed or mature industrial economies of the US, "old" Europe, and Japan representing one part, while the other part is the industrial developing economies, represented by China, India, and the global South. However, here Mr. Gross' argument becomes less convincing. In the developed industrial world, Mr. Gross sees continued prospects for technological innovation, which from a financier perspective means growth, compound interest, and healthy sound financial returns. However, in these developed economies, he sees problems of an aging population and lack of population growth as impediments to future growth, to an extent not just resulting in fewer future returns, but endangering paying-off present debt, which again, keeps the boys at PIMCO up late at night.

Mr. Gross' take on an aging society and lack of population growth is not new, nor is it the problem he thinks, unless looking from an industrial finance perspective, and feel perpetual industrial growth is a permanent state of the human condition, and one thing our present financial crisis is telling us is it's not. The simple unavoidable fact is the developed industrial world is not going to, nor does it need to grow at the rates it did when it was industrializing. In developed industrial economies, much technological innovation will not be adding gross new wealth, so much as net wealth redistribution. Take for example the energy system, where replacement of fossil fuels with renewables and efficiency will not add to the gross amount of energy, but replace and redistribute what is already there. This need not be a problem, nor does it mean impoverishment for the industrialized world. However, we're going to have to restructure finance and much other economic thinking so it is not dependent on rabid growth. When we do this, far from being problematic, declining population growth rates will be seen as beneficial.

One of the reasons the "debt supercycle" of the 20th century became turbo-charged in the last three decades was the failure to understand growth rates of mature industrial economies are not going to be those of developing industrial economies, nor do they need to be. Instead of healthy financial investment in energy, transportation, sewage, and other infrastructure, things which unquestionably create long-term wealth, in the last several decades, debt increasingly became associated with short-term consumption, so too the entire economy. From 1975 to 2007, household debt in the US grew almost 500%! This was not investment production debt, but consumption debt. In mature industrial economies, opportunities for good industrial production debt become increasingly scarce and not as highly profitable. Our entrenched industrial finance model, searching endlessly for growth, mutated into a massive consumption debt binge, which was not healthy, sustainable or necessary. Just as importantly from an energy, particularly cheap oil perspective, but also from a host of other natural resource and environmental constraints, the established industrial models are neither long term sustainable or transferable to the non-industrial developed world. Over time, growth rates in the developing industrial world are going to be healthily higher, however, they're going to have to immediately begin making some hard turns from their present paths, developing in different ways from the US, European, and Japanese models.

So, while Mr. Gross laments industrial finance's inability to grasp the new normal, he himself isn't quite there either. He is absolutely correct the financial system developed over the past several decades is over, and some of the debt created is going to have to be written-off. However, he doesn't take it far enough. We are witnessing, particularly for the developed world, the end of industrial finance, a financial system addicted to unlimited growth. We are going to have to rethink many things as we enter the new normal, instead of relying on the brute economic force of seemingly unlimited industrial growth, we need to become a little more elegant, call it a design economy.