The Economic Interest

2008-12-13T14:59:00.001+09:00

2008-12-13T14:27:00.013+09:00

Why America Will Avoid an Extended Period of Debt Deflation

First a primer on Deflation. Central banks seek to maintain demand at a level that matches economic output by managing the money supply. Keeping the cost of capital low stimulates investment. Meanwhile commercial banks lend their client's deposits out to other clients while only keeping a fraction in reserve thereby stimulating demand and increasing the money supply. This tends to create a mildly inflationary environment which ideally tracks at 2-3% and is deemed by most economists to be a favorable alternative to deflation given the impossibility of holding supply and demand in perfect equilibrium.

Deflation occurs when a significant decrease in demand causes prices across a broad index to fall over an extended period and has several negative impacts on the economy. Critical in the process is a reduction in the money supply which tends to be self perpetuating as seen in the United States during the Great Depression and Japan during the 1990's.

As demand initially decreases and prices fall consumers develop the expectation that prices will fall further thereby encouraging a delay on capital expenditure which further lessens demand. Meanwhile the real cost of servicing existing debt goes up. As asset prices and income levels fall the real value of existing commercial loans and mortgages increase contributing to a rise loan impairment and further price declines - debt deflation. Banks holding bad loans and devalued collateral lend less further diminishing demand.

In this crisis accommodating monetary policy and loose credit combined with ineffective regulation and poor risk management among regulated institutions can be blamed for creating the debt inflated bubble. Several trends support this analysis.

Since passage of the Monetary Control Act of 1980 in the US reserve requirements for banks on transactional deposits have fallen from 12% to 10%. Savings have also increasingly flowed into money market mutual funds which in term lend to business but are not required to maintain reserves. The Federal Funds effective rate has also been lower in absolute terms than its historical average. Meanwhile accounting standards have facilitated the creation of new debt and fueled expansion of credit ultimately leading to a loss of confidence in securitized loans.

With the developed world mainly in recession the question becomes the shape of the recovery. On December 9th the yield on 3 month treasuries tuned negative for the first time since they began trading in 1929 confirming a deflationary environment. Policy makers are now confronted with stabilizing prices (stimulating the economy) in a deflationary environment where nominal interest rates are already low and effective rates are near zero or negative already.

Yet despite the dire outlook there are reasons to believe that an extended period of debt deflation as seen globally in the 30's and again in Japan in the 90's may be avoided.

Confidence in leadership. President elect Obama has openly stated that the economy will be his administration's top priority when he takes office and has promised targeted fiscal stimulus on a level with Roosevelt's New Deal.

A better understanding. During the period leading up to The Great Depression the prevailing view was that government should avoid intervening in markets and that deflation would abate when prices became low enough to encourage consumer spending. Similarly in Japan the initial policy response was limited by a number of factors but included an existing high level of government debt exceeding the existing level in the US which is still only 60% of GDP.

Today's Fed is committed to expanding the money supply and those funds are beginning to be seen in official figures. In data released on December 11 by the St Louis Fed, the money at zero maturity (a commonly used measure of the money supply) compounded annual rate of change for the four weeks ending October 6th grew to 11.7% versus 5.8% in September and 3.7% the month prior.

The view here is recession yes, depression no (ex unexpected rare events). There may be a trade available accumulating select US equities given a desire for exposure to risky assets but use a currency overlay. Or maybe try a trade on Dollar depreciation - selling USD/CHF currently bid at 1.1777.

**Please note markets are inherently risky. This paper amounts to a work in progress and is not an offer or recommendation to buy or sell securities.**

2007-03-03T17:34:00.000+09:00

2006-03-27T08:36:00.000+08:00

'Post-war' means nothing.
What fools called 'peace' simply meant moving away from the front.
Fools defended peace by supporting the armed wing of money.
Beyond the next dune the clashes continued.
The fangs of chimerical beasts sinking into flesh, the heavens full of steel and smoke, whole cultures uprooted from the earth.
Fools fought the enemies of today by bankrolling those of tomorrow.
Fools swelled their chests, talked of 'freedom', 'democracy', 'in our country', as they devoured the fruits of riots and looting.
They were defending civilisation against Chinese shadows of dinosaurs.
They were defending the planet against fake images of asteroids.
They were defending the Chinese shadow of a civilisation.
They were defending the fake image of a planet.

( A Wu Ming creation -- Wu Ming is an outgrowth of an international collective of "artists, activists, and pranksters" that previously published under the pen name of Luther Blissett. Members of Wu Ming, including a group of four based in Bologna, are largely responsible for the novels Q and 54. 54 speaks of political self determination, a sensitive young idealist who, "isn't happy with what he has..." as well as Stalin, McCarthy, Tito, Hoover, Lucky Luciano, Steve Cement, and Cary Grant on LSD among others. 54 can be downloaded in its entirety from the official WU MING website http://www.wumingfoundation.com/ )

2006-01-13T07:33:00.000+08:00

A 2000 report by the International Physicians for the Prevention of Nuclear War describes the likely effects of a single 1 megaton weapon - dozens of which are contained in the Russian and U.S. inventories. At ground zero, the explosion creates a crater 300 feet deep and 1,200 feet in diameter. Within one second, the atmosphere itself ignites into a fireball more than a half-mile in diameter. The surface of the fireball radiates nearly three times the light and heat of a comparable area of the surface of the sun, extinguishing in seconds all life below and radiating outwards at the speed of light, causing instantaneous burns to people within one to three miles. A blast wave of compressed air reaches a distance of three miles in about 12 seconds, flattening factories and commercial buildings. Debris carried by winds of 250 mph inflicts lethal injuries throughout the area. At least 50 percent of people in the area die immediately, prior to any injuries from radiation or the developing firestorm.

On Nov, 7th 1995 the mayor of Nagasaki recalled his memory of the attack in testimony to the International Court of Justice, "Nagasaki became a city of death where not even the sound of insects could be heard. After a while, countless men, women and children began to gather for a drink of water at the banks of nearby Urakami River, their hair and clothing scorched and their burnt skin hanging off in sheets like rags. Begging for help they died one after another in the water or in heaps on the banks.... Four months after the atomic bombing, 74,000 people were dead, and 75,000 had suffered injuries, that is, two-thirds of the city population had fallen victim to this calamity that came upon Nagasaki like a preview of the Apocalypse."

It has been widely reported that Sultan Bashiruddin Mahmood, former director of Pakistan's nuclear reactor complex, met with bin Laden several times. Were al Qaeda to acquire fissile materials, especially enriched uranium, its ability to produce nuclear weapons would be great. The knowledge of how to construct a simple gun-type nuclear device, like the one dropped on Nagasaki, is now widespread. At a recent meeting of the National Academy of Sciences, former Secretary of Defense William J. Perry said, "I have never been more fearful of a nuclear detonation than now.... There is a greater than 50 percent probability of a nuclear strike on U.S. targets within a decade."

(Taken from Apocalypse Soon by Robert McNamara, 2005)

2006-01-10T11:37:00.000+08:00

Studies related to global warming conducted at the University of Manitoba now suggest that melting ice in the Arctic could make the Northwest Passage viable for commercial shipping in as little as 10-15 years. The issue of sovereignty in the region has once again gathered political significance.

An Artic passage would provide tankers and container ships a new route between Europe and Asia and reduce reliance on the Panama Canal.

It would also open the way for the next generation of cargo ships (cargo ships are currently built to the width of the canal) and offer an alternative for existing vessels like supertankers which are currently too wide. A passage through the north also has military significance for aircraft carriers, such as those in the Nimitz class, which are also too wide to make use of the canal.

Shipping routes have long been an area of great strategic importance. When Manuel Noriega became uncooperative as leader of Panama in the 1980’s he was duly charged with drugs and forcefully removed by then president George Bush. The canal has since been nominally returned to Panama. Control now rests with the Panama Canal Authority (PCA) insofar as the canal operates, “in a safe, continuous, efficient, and profitable manner.” Some 14,000 ships made passage through the Panama Canal in 2005 each paying an average toll of $54,000.

A passage through the Canadian Archipelago has been sought after since England and Spain began sending explorers to the region in the 1500’s. The Northwest Passage has claimed many lives over its long history. In 1848 two ships from a well financed English expedition became locked in ice near King William Island. The crew of 129 sailors, provisioned largely with tins sealed with lead that would later prove to be mildly poisonous, were lost to scurvy and starvation.

A team of scientists made the first successful single-season passage in 1944 using a purpose built craft. The route was deemed unsafe for other vessels at that time.

In 1985 the U.S. sent the icebreaker Polar Sea through without first asking the permission of the Canadian authorities and initiating a dispute over sovereignty. Under international law a country may claim sovereignty over the waters surrounding them provided they are able to enforce their authority. Canada maintains a minimal permanent military presence in the Arctic and their submarines are unable to operate under the ice. The Canadian government reacted by issuing a declaration in 1986 reaffirming Canadian rights to the waters. The USA, EU, and Japan, among other countries, have yet to recognize the Canadian claim.

The current Prime Minister of Canada Paul Martin, who has been outspoken against the United States on a number of issues, received a warning from American Ambassador Wilkins who said that U.S. bashing was a “slippery slope”. Now, it seems, Martin is paying the price.

Only weeks in advance of Canadian general elections on January 23rd the USS Charlotte was reported in the media to have visited the North Pole, after having passed through Canadian waters, without receiving permission.

Martin is now receiving criticism from the Conservative Party in Canada for being weak on defense and unable to defend its coastline. Meanwhile, the conservative candidate Stephen Harper, who was recently described by the Washington Times as being, “pro-Iraq war, anti-Kyoto, and socially conservative ... the most pro-American leader in the western world” and who once said that Canada was becoming a, “second tier socialist country” is using the issue to gather support.

The United States and Canada have the world's largest bilateral trading relationship. In 2004, total merchandise trade between the two countries (census basis) was $445 billion, translating into over $1 billion in goods crossing the border every day. The two-way trade that crosses the Ambassador Bridge between Michigan and Ontario equals all U.S. exports to Japan.

-- The opinion represented by the UN through the Intergovernmental Panel on Climate Change (IPCC) supports the theory of anthropogenic global warming and predicts that temperatures will increase by between 1.4 to 5.8 ºC between 1990 and 2100. Research conducted by the National Oceanic and Atmospheric Administration (NOAA), using an IPCC projection scenario for greenhouse gases, estimates that over half of the volume of sea ice above 67 degrees North latitude will be lost by 2050. --

-- Note: The Suez Canal on the border of Egypt and the Sinai Peninsula facilitates transport between Europe and Asia. The canal averages about 8% of the world's shipping traffic. Biblically significant, Mount Sinai is the site where Moses is meant to have received the Ten Commandments. The Sinai is now under the supervision of one Multinational Observer Force which mostly consists of American military personnel ( http://www.mfo.org ). This force is not part of United Nations guidance.

2005-12-08T14:21:00.000+08:00

Government Agency Urges Pension Reform

The Pension Benefit Guarantee Corporation, the government affiliated entity charged with guaranteeing pension benefits for some 44 million working Americans, recently reported a serious shortfall in its ability to cover existing liabilities. According to the agency's annual Performance and Accountability Report submitted to Congress in November the single employer program has assets of only $56.5 billion versus liabilities $79.2 billion. "Unfortunately, the financial health of the PBGC is not improving," says Bradley Belt, the organization's executive director. "The money available to pay benefits is eventually going to run out unless Congress enacts comprehensive pension reform to get plans better funded and provide the insurance program with additional resources."

Established as part of the Employee Retirement and Income Security Act in 1974 the PBGC is charged with insuring defined benefit pension plans. Unlike defined contribution plans like the 401(k), defined benefit plans are employer managed. They promise employees a lifetime retirement benefit based on tenure and salary. Unfortunately, many corporate participants have left their plans under funded and used cash to hit earnings estimates and reach other near term hurdles. When companies do go bankrupt it is the PBGC that is required to step in and guarantee under funded plans.

US Airways recently emerged from a restructuring in which the PBGC assumed responsibility for the plans of some 51,000 workers and a combined liability of $3 billion. Now it appears that Northwest Airlines and Delta may be attempting to follow suit.

Interested observers, including those at the PBGC, are increasingly concerned by the growing number of firms that are using Chapter 11 as a means of offloading their pension liabilities only to emerge and continue to do business. Companies that do avoid bankruptcy feel as though they are punished for not taking advantage of the system. Director Belt made the following comments, "The financial challenges facing the airline industry are significant, but nothing in the bankruptcy code requires companies to skip their pension funding payments. Indeed, these companies will continue to pay for fuel, wages, health care, utilities and aircraft leases. As long as companies remain in operation with ongoing pension plans, they have a legal obligation to meet their funding requirements."

Pension liabilities are also putting serious pressure on many businesses. Companies in the automotive and airline industries are among those most affected. The PBGC estimates that exposure to losses from pension plans from employers “that have a reasonable likelihood of defaulting” rose to $108 billion from $96 billion from the previous year. Because the PBGC does not disclose the names of companies it sees as at risk it is unclear if General Motors is included in the recently released figures. Industry experts estimate that GM's unfunded pension liability alone could be anywhere between $12-31 billion. Although unwilling to disclose actual figures GM, with 600,000 covered employees, did release the following announcement through company spokesman Jerry Dubrowski, “We don’t think it is appropriate to view the pension plan on a termination basis because GM has no plan to end it.”

The PBGC currently estimates total liabilities resulting from under funded pensions in the United States to be approximately $450 billion.

- Companies with pension plans that are expected to be under funded by at least 25% of their market capitalization -

Changes have been proposed that would increase annual premiums paid by companies to $30 per employee per year from the current requirement of $19. There is also talk of penalizing companies whose credit ratings slide and of requiring additional financial oversight. The Financial Accounting Standards Board has formed a team to look into the possibility of requiring companies to report their over or under funded plans on the balance sheet instead of in the footnotes as they are currently.

Lawmakers seem to agree that action is necessary however actual legislation has been slow to arrive. Complicating the need for reform are concerns that higher premiums and increased scrutiny might force a growing number of businesses into bankruptcy - a blow the economy might not withstand. It is unlikely to think that the United States government will allow pension liabilities to cause the downfall of companies such as Maytag or Lockheed Martin. With pension shortfall continuing to grow many suggest that it will ultimately be tax payer dollars that are used to rescue corporate America.

2005-12-07T17:36:00.000+08:00

Japan Is The Friendly Alternative For Investment In Asia

Despite being the second largest economy in the world Japan is largely overlooked in the media and is most closely associated with underperformance and financial mismanagement. Japan now appears to represent an attractive alternative for foreign investors after the BoJ released estimates calling for an end to deflation and modest growth in 2006 led by consumer demand and corporate profits. This is a welcome development for Japan and provides an opportunity to re-evaluate East Asia and investment opportunities in the region.

Despite being lost in recession for almost a generation Japan’s substantial base of capital is still intact. Post war reconstruction in Japan saw an early emphasis on industrial products and rapid expansion. Later, oil shocks and other factors affecting international prices in the 1970's shifted the emphasis towards technology intensive industries that had larger margins and were less dependent on raw materials. The robust expansion leading up to the "asset bubble" crisis in 1991 has left Japan with substantial physical infrastructure to include a modern system of highways, railroads, airports, and harbors.

Its people are industrious and well educated – each contributing approximately $33,000 to GDP. There is also a strong emphasis on innovation with science and technology degrees representing 25% of those awarded. According to a recent study released by the OECD Japan has the highest number of scientific researchers relative to total employment in the world and is second only to the United States in annual R&D expenditures at $114 billion. Japan’s top firms include some of the most expertly managed companies in the world.

Though faced with high levels of public debt evidence suggests that efforts at fiscal consolidation are underway. The administration stands ready to buy back $100 billion of government bonds and Prime Minister Koizumi appears to have the consensus necessary to push forward important reforms including reduced issuance of debt, continued deregulation, and further corporate restructuring. With the Yen approaching 32 month lows versus the Dollar officials at the Ministry of Finance seem content citing "fundamentals" and emphasizing exports and corporate reinvestment. Similarly foreign exchange reserves have increased indicating that recent intervention has not been necessary. Analysts reason that another factor contributing to the Yen’s recent descent is that Christmas bonuses are being spent or invested overseas. This also underlines consumer confidence. Bonuses this year are the largest on record in many sectors.

Japan is also an attractive store of value on a relative basis when compared with other countries in the region.

While the potential for China and its 1.3 billion inhabitants is enormous serious issues remain. There is evidence of widespread corruption and the World Bank estimates that 152 million Chinese still live on less than $1 a day. Questions about property, intellectual, and human rights violations have yet to be addressed. Publicized episodes of unrest have led to increased concerns about government control and corruption. In a recently published article Minxin Pei, director of the China program at the Carnegie Endowment for International Peace, makes the following observation, "The experience of General Suharto´s Indonesia suggests that predatory autocracies have trouble turning high rates of economic growth into political stability. There even 30 years of impressive growth wasn’t enough to save the regime."

South Korea also lacks Japan’s stability as tensions with North Korea persist. As both sides work toward reunification a violent conflict appears less likely. The role, however, of western commercial interests in the region remains unclear. Reform is also required in order to relax rigid labor regulations and add transparency to family owned and government assisted conglomerates called chaebol.

Meanwhile, unlike other countries in the region, Japan is one of the most prosperous and stable democracies in the world, with low unemployment and a history of sustained endeavor. Koizumi is a long standing and popular leader and emphasizes an outward looking foreign policy. The interests of the United States are closely aligned with those of Japan. They are key trading partners (in 2003 the U.S. purchased 24.6% of Japan's exports and supplied 15.4% of its imports) and, perhaps more importantly, close political allies. Japan has ongoing territorial and ideological disputes with its neighbors and relies on the US to maintain military equilibrium in the region. Similarly the Unites States places significant strategic importance on its military bases in Japan with some 40,000 troops on the mainland and Okinawa.

While many investors are satisfied borrowing Yen cheaply to reinvest in higher yielding Dollar denominated assets; now may also be the time to consider investing in Japanese equity as profits grow and the economy continues to expand. Japan is now more accessible to direct investment as companies, particularly in the financial sector, seek to strengthen their balance sheet with foreign capital. Similarly the Nikkei 225 has yet to approach pre-recessionary levels of the late 1980's and looks cheap relative to other asset markets around the world.

2005-12-05T11:30:00.000+08:00

REALISM
Founders: Hans Morgenthau, Kenneth Waltz
Thinkers: John Mearsheimer, Robert Pape, Stephen Walt
Doers: Otto Von Bismarck, Henry Kissinger, Brent Scowcroft

Core beliefs - Self interested states compete for power and security
Key actors in international relations - States, which behave similarly regardless of their type of governement
Main instruments - Military power and state diplomacy
Theory's intellectual blind spots - Doesn't account for progress and change in international relations or understanding that legitimacy can be a source of military power
What the theory explains about post 9/11 world - Why the United States responded aggresively to terrorist attacks; the inability of international institutions to restrain military superiority
What the theory fails to explain about post 9/11 world - The failure of smaller powers to militarily balance the United States; the importance of non-state actors such as al Qaeda; the intense U.S. focus on democratization

LIBERALISM
Founders: Adam Smith, Immanuel Kant
Thinkers: Michael Doyle, Robert Keohane, G. Johgn Ikenberry
Doers: Woodrow Wilson, Kofi Annan, Bill Clinton

Core beliefs - Spread of democracy, global ties, and international organizations will strengthen peace
Key actors in international relations - States, international institutions, and commercial interests
Main instruments - International institutions and global commerce
Theory's international blind spots - Fails to understand that democratic regimes survive only if they safeguard military power and security; some liberals forget that transitions to democracy are sometimes violent
What the theory explains about post 9/11 world - Why spreading democracy has become such an integral part of current U.S. international security strategy
What the theory fails to explain about post 9/11 world - Why the United States has failed to work with other democracies through international organizations

IDEALISM
Founders: Alexander Wendt, John Ruggie
Thinkers: Kathryn Sikkink, Michael Bennet, Martha Finnemore
Doers: Mahatma Gandhi, Osama bin Laden, Antiglobalization Movement

Core beliefs - International politics is shaped by pursuasive ideas, collective values, culture, and social identities
Key actors on international relations - Promoters of new ideas, transnational activist networks, and nongovernmental organizations
Main instruments - Ideas and values
Theory's intellectual blind spots - Does not explain which power structures and social conditions allow for changes in values
What theory explains about post 9/11 world - The increasing role of polemics about values; the importance of transnational political networks (whether terrorists or human rights advocates)
What theory fails to explain about post 9/11 world - Why human rights abuses continue, despite intense activism for humanitarian norms and efforts for international justice

2005-10-14T23:26:00.000+08:00

Marxists use the term imperialism as Lenin defined it: "the highest stage of capitalism", specifically the era in which monopoly finance capital becomes dominant, forcing the empires to compete amongst themselves increasingly for control over resources and markets all over the world. This control may take the form of geopolitical machinations, military adventures, or financial maneuvers.

The essential feature of the Marxist theories of imperialism, or related theories such as dependency theory, is their exclusive focus on the economic relation between countries, rather than the explicit political relationship. Imperialism thus consists not in the direct control of one country by another, but in the economic exploitation of one region by another, or by a group from another.

Acts of militarist imperialism — in spite of humanitarian rhetoric.

>> The White Man's Burden: A phrase used to justify European imperialism in the nineteenth and early twentieth centuries. The phrase implies that imperialism was motivated by a high-minded desire of whites to uplift people of color.

>> Manifest Destiny: A popular slogan of the 1840s. It was used by people who believed that the United States was destined — by God, some said — to expand across North America to the Pacific Ocean.

2005-07-15T23:26:00.000+08:00

"Ideas..." wrote John Maynard Keynes, "when they are right and when they are wrong, are more powerful than is commonly understood.... Practical men, who believe themselves... exempt from any intellectual influences, are usually the slaves of some defunct economist....The power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas."

2005-05-25T05:29:00.000+08:00

If you are an economist you have to analyse things as would an economist. That is what gives value to your work.

Ok, ok I admit that is pretty weak. You can't just throw a statement like that out there and expect people to "really get it". What I'm saying is this:

The bias towards hedge funds right now (and maybe rightly so) is making everyone think in terms of more than one market at once, combined strategies with derivatives, single investment funds and high leverage. This continual "bi" relationship in hedge funds, this counter school mentality forces people to maintain more than one idea in mind and they can lose base in their analysis.

By considering too many factors can you lose sight of your training? Consider Eur/Usd right now to bear out an example. There are so many factors effecting the dollar right now including strength in the dollar index, Eur/Usd technical resistance brick layer, Remnimbi revaluation (positive for Dollar but is it?), Slow growth in the G-7 (?), etc. The dollar is tremendously rich in terms of that kind of information and you could revel forever in that kind of information like a dream on Saturday morning that you feel like you can almost control.

So a hedge fund director's delight right? Maybe.. but shouldn't those of us that are merely mortals stick to what we know. After all the only facts we have are what we know.

To finish with the example: There is a confluence of information right now that is suggesting that the Eur/Usd will continue to fall and test support, well in the low twenties, Remnimbi, oil, etc. The idea here is reduce the noise. Isn't this precisely what they told us in the first quarter? The dollar will not melt down directly but will instead consolidate for two quarters or so as a response to an overreaction in January and then resume its dramatic plunge?

Heh, lets all take step back and remember to stick to the facts. The US right now has trade imbalances, historical deficits, a large dependence on oil and an extremely fragile geopolitical outlook.

Its a long term sell.

Remeber: If you are an economist you must analyse things as would an economist. That is what gives value to your work.

Unless you are a trader in which case you may happily enjoy selling and buying as it glides around to your heart's content. Who ever said it was easy being beautiful.

We welcome feedback, questions, donations, loose change, and chewing gum.

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Heh, if any one really knows how to seperate fact from fiction, or identify trends before they happen can you please let me know?

2005-04-06T06:12:00.000+08:00