Category: Economy

Analysis of the global economy

Posted on

Europe’s Dying Bank Model – Gene Frieda – Project Syndicate

In general, the eurozone has outsized banks (assets equivalent to 325% of GDP) that are highly leveraged (the 15 largest banks’ leverage is 28.9 times their equity capital). They are also dependent on large quantities of wholesale debt – totaling €4.9 trillion (27% of total eurozone loans), with €660 billion maturing in the next two years – to fund low-yielding assets. According to Barclays Capital, the 15 largest banks increased their returns on equity by 58% between 1998 and 2007, with 90% of the gain coming from higher leverage. Returns have since collapsed.

This model’s viability depends on large amounts of cheap leverage, supported by implicit government backing.

via Europe’s Dying Bank Model – Gene Frieda – Project Syndicate.

Posted on

Basic definitions

I use basic economic terms quite frequently and it may be useful to set out their definitions:

  • Consumption ~ is any purchase/sale that is not between entrepreneurs. That is, purchases from entrepreneurs by consumers.
  • Savings ~ the excess of income over expenditure on consumption. Savings can include debt repayment and money lost or hidden in your mattress — they do not have to be deposited with a bank.
  • Investment ~ an addition to the real capital stock of the economy. Alternatively, any purchase between entrepreneurs that is not part of user cost.
  • Income ~ the value in excess of user cost which the producer obtains for the output he has sold.
  • User cost ~ the measure of what has been sacrificed to produce finished output.

Keynes:

“Income is created by the value in excess of user cost which the producer obtains for the output he has sold; but the whole of this output must obviously have been sold either to a consumer or to another entrepreneur; and each entrepreneur’s current investment is equal to the excess of the equipment which he has purchased from other entrepreneurs over his own user cost. Hence, in the aggregate the excess of income over consumption, which we call saving, cannot differ from the addition to capital equipment which we call investment. Saving, in fact, is a mere residual.”

Richard Koo (The Holy Grail of Macro Economics) points out the flaw in this argument: when savers are forced to repay debt, savings no longer equal investment.

Steve Keen also highlights this:

“However when one thinks in truly dynamic terms, income is not all there is to aggregate demand. In a dynamic setting, aggregate demand is not merely equal to income, but to income plus the change in debt.”

Posted on

Quantitative Easing!!! – Andy Lees, UBS | Credit Writedowns

The BoJ announced today that it will expand its asset purchase programme by JPY5trn (USD66bn), with all the purchases being directed at JGB’s. Add that to the GBP75bn (USD120bn) by the BoE, CHF50bn (USD57bn) by the SNB and the EUR341bn (USD477bn) expansion of the ECB balance sheet since the end of June, and it collectively adds up to USD720bn. Clearly this explains the market rally from the low.

via Quantitative Easing!!! | Credit Writedowns.

Posted on

Wall Street is Still Out of Control, and Why Obama Should Call for Glass-Steagall and a Breakup of Big Banks

In the wake of the bailout, the biggest banks are bigger than ever. Twenty years ago the ten largest banks on the Street held 10 percent of America’s total bank assets. Now they hold over 70 percent.

….I doubt the President will be condemning the Street’s antics, or calling for a resurrection of Glass-Steagall and a breakup of the biggest banks. Democrats are still too dependent on the Street’s campaign money.

That’s too bad. You don’t have to be an occupier of Wall Street to conclude the Street is still out of control. And that’s bad for all of us.

via Robert Reich: Wall Street is Still Out of Control, and Why Obama Should Call for Glass-Steagall and a Breakup of Big Banks.

Posted on

E-Commerce Shipments to Drive Record FedEx Holiday Volume | FedEx Global Newsroom

MEMPHIS, Tenn., Oct. 24, 2011 – FedEx Corp. (NYSE: FDX) expects to move more than 17 million shipments – almost double its daily average volume – through its global networks on December 12, the projected busiest day in company history. The 10 percent year-over-year increase will be driven by FedEx SmartPost, a residential shipping service designed for online and catalog retailers, as well as expected increased volume at FedEx Ground and FedEx Home Delivery.

via E-Commerce Shipments to Drive Record FedEx Holiday Volume | FedEx Global Newsroom.

Posted on

The Paradox of Thrift — debunked

Ever since John Maynard Keynes popularized the Paradox of Thrift, economists, central bankers and politicians have labored under the misapprehension that high levels of savings are bad for the economy and inhibit growth. The Paradox of Thrift:

  • Increased savings means there are less buyers for goods produced, so the nation as a whole will tend to produce less.
  • If an individual saves they increase their wealth;
  • But if an entire nation saves, this causes a shortfall in consumption; and
  • The shortfall in consumption will cause national income to fall.

Keynes was correct in his observation that high level of savings caused a shortfall in national income, but we need to remember that he was writing in the 1930s — in the middle of the Great Depression. His General Theory was published in 1936. What Keynes observed was an anomaly caused by the financial crisis. Falling asset prices threatened the solvency of both individuals and corporations, forcing them to increase their level of savings and — most importantly — use their savings to repay debt.

Not only will national income fall when savings are used to repay debt, but it falls rapidly. The shortfall between saving and new investment (or spending and income) may be small but, like a punctured car tire, the result is disastrous. At each point in the supply chain the leakage is repeated: A receives an income of $1.00 and use 5 cents to repay debt, only spending $0.95. B will receive $0.95 from A, where previously they received $1.00, and will use 5% to repay debt, only spending $0.9025. C will only receive $0.9025 from B but still uses 5% to repay debt, only spending $0.857……… The pattern continues until incomes shrink to the point that parties are forced to consume all of their income and can no longer afford to repay debt. The impact on national income — as evident from the 1930s — can be devastating.

Keynes pointed out that government can break the cycle and make up the shortfall, by spending more than it collects by way of taxes — so that the aggregate level of spending is unchanged. But fiscal stimulus is fraught with dangers, not least of which is the massive public debt hangover faced by the US, Japan and many European economies. I will cover these dangers in more depth in a later post.

Under normal conditions, however, the paradox of thrift does not apply:

  • If an individual saves they will increase their wealth;
  • If the entire nation saves, there is no effect on national income provided savings are channeled through the financial system into new capital investment.
  • All that then happens is less consumer goods are produced but more capital goods — spending as a whole does not fall.
  • Production, as a result, will also not fall.

National income is, in fact, likely to rise. New capital investment will boost productivity and accelerate growth.

Consider the simple example of a farmer who saves and buys a tractor. His overall spending is unaffected. He merely consumes less and spends the proceeds on something else — in this case a tractor. The income of the store that supplies him with consumer goods will decrease, but the income of the dealer that sells him the tractor will rise; the net effect on national income is so far zero. But the farmer now produces more food with his new tractor; so his income — and the national income — increases.

This misconception that the paradox of thrift applies in normal markets has done immense harm to the economy and eroded the savings of the middle-class and retirees. For three generations, central bankers attacked savers by artificially reducing interest rates — in the belief that lower savings would boost demand and stimulate the economy. Low interest rates simply forced savers to assume more risk, in order to earn a return on their investment, and encouraged speculation. The traditional work hard and save ethic that is the backbone of the capitalist system has been supplanted by the consume, borrow and speculate profligacy that got us into such a mess. High levels of public and private debt, inflation, volatile investment returns and rising income inequality are all consequences of the low-interest policy pursued by the Fed. Today’s giant casino is a far cry from the cautious, prudent investment outlook of our grandparents’ generation.

I will conclude by reminding you that savings channeled into new capital investment actually boost growth.

  • Savings are only harmful when used to repay debt or for other non-productive purposes.
  • Low interest rates encourage speculation and the formation of bubbles;
  • Bubbles cause financial crises; and
  • Financial crises force consumers to repay debt.

….the never-ending circle of life.

Posted on

Ron Paul: “Blame The Fed For The Financial Crisis” | ZeroHedge

The Fed fails to grasp that an interest rate is a price—the price of time—and that attempting to manipulate that price is as destructive as any other government price control. It fails to see that the price of housing was artificially inflated through the Fed’s monetary pumping during the early 2000s, and that the only way to restore soundness to the housing sector is to allow prices to return to sustainable market levels. Instead, the Fed’s actions have had one aim—to keep prices elevated at bubble levels—thus ensuring that bad debt remains on the books and failing firms remain in business, albatrosses around the market’s neck.

The Fed’s quantitative easing programs increased the national debt by trillions of dollars. The debt is now so large that if the central bank begins to move away from its zero interest-rate policy, the rise in interest rates will result in the U.S. government having to pay hundreds of billions of dollars in additional interest on the national debt each year. Thus there is significant political pressure being placed on the Fed to keep interest rates low. The Fed has painted itself so far into a corner now that even if it wanted to raise interest rates, as a practical matter it might not be able to do so.

via Ron Paul: “Blame The Fed For The Financial Crisis” | ZeroHedge.

I agree that the Fed should not interfere with interest rates. It causes market imbalances that later lead to recessions and bubbles in stocks and housing and threaten the very survival of the banking system the Fed is trying to protect.

QE achieved the opposite of its stated objectives, raising long-term interest rates with lowering unemployment, but did not really increase the national debt by a dollar. Sales of  bonds by the Federal Treasury to the Federal Reserve is like the US government selling to itself. The Fed is just an off-balance sheet, special-purpose entity (think Enron, bank CDOs and other bad smells) created by  the government and banks in 1913 to  bypass restrictions in the Constitution on the issue of bank notes. In all but name it is a division of the US Treasury. The majority of the “independent” board of directors are political appointments. Ever seen a dissenting vote coming from one of the political appointees? Regional board members, where most dissenting votes come from, are a minority appointed by regional banks. They can dissent, but when it comes to counting the votes they’re outnumbered.

Posted on

The Bankers’ Capital War – Howard Davies – Project Syndicate

Basel 3, the Basel Committee’s new global regulatory standard on banks’ capital adequacy and liquidity, will more or less double the equity requirements, and will impose extra costs on banks deemed “too big to fail.” The Committee’s analysis of the economic consequences found that the impact on growth would be modest, perhaps reducing GDP by 0.33% after five years – easily within the margin of forecast error. The OECD took a different view, putting the growth impact at about twice that level, and rather higher in Europe, where companies rely far more on bank financing than they do in the US.

In sharp contrast, the Institute of International Finance, the leading trade association for the world’s top banks, believes that the impact of higher capital requirements could be far stronger. The IIF believes that GDP could be fully 5% lower after five years, with unemployment more than 7% higher.

The IIF’s forecast may seem alarmist, but the competing estimates are based on some intriguing analytical differences. Regulators take the view that the impact of higher capital requirements on the cost of credit to borrowers will be modest, as the overall cost of funds to banks will not rise much. They rest their case on the famous Modigliani-Miller theorem, which implies that a company cannot alter its capital cost by changing the balance between equity and debt on its balance sheet. If there is more equity, then logically debt should be cheaper, as the company (or bank) is better insulated from default.

Bankers accept that, in the long run, the theorem might hold, but argue that it will take time, especially given recent events, to persuade investors that banks are genuinely safer….

via The Bankers’ Capital War – Howard Davies – Project Syndicate.

Powered by WordPress / WordPress Maintenance Service By Website Helper