Ben Bernanke: 100% Wrong.

December 6, 2010 Leave a comment

Bernanke made an appearance on “60 Minutes” the other night (Part 1, Part 2). This is a soft interview for Bernanke. There are no tough questions because the interviewer does not understand economic science or finance.

First, I would like to remark on what is apparently Bernanke’s profound nervousness — at least that is how I interpret his trembling voice and his quivering lips. I’ve seen a lot of Bernanke footage, albeit not often so close up on his bearded mug. He often sounds shaky, even back in 2006-2007 when his forecasts were all rosy, but not this shaky. This is not the look of a man who is 100% sure of his actions. But enough of my pop psychology, and on to a few matters of substance.

“This fear of inflation is overstated,” he says. Is it really? It looks like Bernanke did create lots of money, but has not yet translated into a rise in M1 — instead, it is stockpiled as excess reserves of commercial banks. The monetary base has been basically flat the last several months.

Yet, when the banks do start to lend and the magic of fractional reserve banking kicks in, prices will be bid up to epic proportions. Export economies such as Canada will in turn have to inflate so they can push up the US dollar and push down their own currencies. That is why QE2 is a big concern to many people. What Bernanke says in defense of QE2 is important:

“We are not printing money,”

This comment drew a few snickers from my peers, but I think this might be a rare case of Bernanke speaking the truth. The “QE2” announcement did not actually mention quantitative easing at all, it merely said the Fed would buy long-term Treasuries. Since then, it has increased its holdings of Treasuries but sold other assets. Net effect – no real change in the base. I suspect this will continue into the near future.

The purpose of the Fed is to protect the big banks. Bernanke can handle 10% unemployment so long as the big banks are happy. When the banks get in trouble, then he will be forced expand. I think this arises from his complete failure to understand the business cycle. His ideas about the Great Depression are not reassuring.

The mainstream likes to make Bernanke out to be a great sage on the subject of the Great Depression, and that is the case here. I guess the logic is something along the lines of: if Bernanke believes something about the Great Depression, it must be true. It’s Bernanke, he’s smart and he studied the Great Depression, how could he be wrong? (hmm…) Well, I have a big chip on my shoulder about this. This is one of the most baleful ideas in the realm of economic inquiry. Bernanke is totally wrong on this issue.

Bernanke’s thesis is that the Great Depression was caused by the Fed’s contraction of the money supply and the failure to inflate. The Fed did not reduce the monetary base after the crash. After a period of keeping it flat, they expanded the monetary base slightly in 1932 then dramatically from 1933 onward.

The money supply did collapse, but only because so many banks went bankrupt. This came to an end in 1934 when the FDIC was created. From here on the money supply rose. The Great Depression did not end until after World War II. Bernanke’s theory is not supported by evidence.

(This chart was taken from here.)

With Bernanke running things, we are probably doomed. I believe his policies will eventually cause mass inflation, and nations where the economy is structured towards servicing American consumption will be forced to inflate as well. Canada sells the Americans $350 billion dollars worth of goods each year. Mark Carney thinks a strong Canadian dollar is bad for Canada’s economy.

Filed under Banking and Finance, CMR, Economics, Intervention Tagged with ,

Canadian banks, bailed out by the Fed.

December 1, 2010 Leave a comment

Documents released by the Federal Reserve show that Canadian banks used the Fed’s special loan programs to strengthen themselves when the economy started to go sour.

I find this very enlightening. First of all, there is stubborn myth that circulates our country, averring that Canadian institutions did not need a bailout. This is simply untrue. Canada’s bank bailout was a little more sophisticated, a little less blatant, than, say, the US bank bailouts, but it amounted to a bailout nonetheless. The Canadian government buffered its big financial institutions with a whopping $75 billion dollars used to buy bad assets.

Second, the Fed’s loan programs are bailouts too.

Canadian banks said the moves to seek loans from the Fed were dictated by strategy and not by necessity.

RBC accessed funding from the Fed “purely for business reasons – better pricing and collateral rules – and because they were the best deal for our shareholders at the time,” said Gillian McArdle, a bank spokesperson. “Our access to funding remained very strong through the entire crisis.”

This is an interesting thing to say. Let us think about this a bit.

Remember that the Federal Reserve has a monopoly on the creation of US dollars. It can buy any asset it wants with digital dollars created out of nothing. Other institutions cannot do anything like this.

If an institution like Royal Bank cannot raise capital on the market and turns to a central bank for help, this is a bailout. This allows it to strengthen its balance sheet in a way that would not be possible without the central bank’s intervention. Saying this does not amount to a bailout is incoherent.

Central banks exist to bail out big financial institutions and governments when markets go bad. In 2008, the Fed bought a trillion dollars or so in garbage assets that the market would not touch at face value. The Bank of Canada helped bailout banks too.

So in addition to getting bailed out by the the BoC and the Canadian government, Canadian banks were bailed out by the Federal Reserve as well!

Why is this important? In the business cycle, when the boom period reaches its apex and market forces begin initiating vengeful corrections, bad debts must be liquidated for the economy to become rebalanced. This is value of the recession — it restores soundness to the economic system by clearing out the malinvestments perpetuated by expansionary monetary policies that create the bubble. Of course, in 2008 governments and central bankers around the world stepped in to ensure that would not happen.

The fact that Canadian institutions availed themselves of the Fed’s interventionary loan programs (to say nothing of the $75 billion bailout from Canada) reveals that Canadian banks are not as strong as people claim. Like all commercial banks operating on fractional reserve banking systems, Canadian banks are inherently on the verge of bankruptcy at all times. Our system ought not be the envy of the world — instead, it is just another facet of the nightmarish system that Bank of England Governor Mervyn King candidly called “the worst banking system conceivable.”

Filed under Banking and Finance, CMR, Intervention Tagged with , , , , , , ,

Jim Rogers, Andrew Schiff, and some economic ignoramus named Doug Henwood talk about TBTF and taxes.

November 30, 2010 4 Comments

Listening to this Doug Henwood fellow on taxes is truly unbearable. Have fun.

This is an entertaining discussion but it is pretty boisterous and a lot of cogent points get lost. The group talks about the Too Big To Fail policy as “socialism for the rich,” which is a legitimate given the policy of bailing out big, insolvent financial institutions. There is no dispute with any of this.

Socialism for the rich should be rejected, but Schiff makes a valid point that, insofar as bailing out financial institutions was intended to keep credit flowing liberally to borrowers whose credit-worthiness was otherwise inadequate, the TBTF policy was “socialism for the poor” as well. American consumers are addicted to debt and low interest rates.

Rogers and Schiff are apparently opposed to socialism in principle, but Henwood is only against “socialism for the rich.” He likes other forms of economic interference, such as that which distorts interest rates, or that which taxes the rich.

Henwood thinks it is perfectly justified to say that higher taxes can possibly help economic growth. This is untrue, and the economic case against it is probably irrefutable. I will summarize:

If economic actors exchange property voluntarily, then it is implied that both actors are better off than they would be in absence of this trade. If both did not expect to benefit from the trade, they would not take part. The matter is quite different in the case of taxation. With taxation, the producer’s supply of goods is reduced against his will to a level below what it would be absent the taxation. In addition to this reduction of present goods, the supply of future goods is reduced as well. For taxation is not unsystematic and random, but systematic and expected to continue in one form or another. Therefore, it implies a reduced rate of return on investment and produces an added incentive to engage in fewer acts of production in the future than one otherwise would. Overall incentive to be a taxpayer decreases, and incentive to become a tax-consumer increases.

This is always true. But Mr. Henwood would disregard economic science and make his inferences based on a shallow analysis of empirical data. Of the US, he says the Clinton years saw a period of great economic growth, and tax rates were higher than they are now. So, he infers, higher tax rates contribute to economic growth.

This doesn’t make any sense. If Henwood were an economist, I would call him a crank. But he is not an economist, he is an English major. He does not have a background in economics, but he likes to write about it. There is no evidence that he is capable of applying formal theory to reality and interpreting it.

In addition to being completely fallacious, the above argument for higher taxes is only credible on the most superficial analysis. If Austrian business cycle theory is correct, then one could easily argue that the much-heralded ‘growth’ of the Clinton years was just phony wealth created by economic bubbles brought about by artificially low interest rates.

When Reagan was elected in 1980, short-term rates were 11.4 percent. When Bush I lost to Clinton in 1992, the rate was 3.4 percent. Rates moves upwards over the course of the Clinton years, and in 2000 the average Treasury bill rate was 5.8. The manipulation of interest rates created economic dislocations — the dot-com bubble, among other things — and the inevitable crash.

Doug Henwood doesn’t know what he is talking about.

Filed under Banking and Finance, CMR, Economics, Intervention Tagged with , , , , , , , , , , ,

Bank of America: WikiLeaks next target?

November 30, 2010 Leave a comment

While the US government does damage control on recently leaked State Department cables, rumors are flying that Wikileaks next target is Bank of America. Wikileaks’ founder, Julian Assange, recently told Forbes that their next target is “a major American bank.”

In 2009, Assange told Computer World:

At the moment, for example, we are sitting on 5GB from Bank of America, one of the executive’s hard drives,” he said. “Now how do we present that? It’s a difficult problem. We could just dump it all into one giant Zip file, but we know for a fact that has limited impact. To have impact, it needs to be easy for people to dive in and search it and get something out of it.”

I am pleading with Assange to release this information ASAP, before the US assassinates him. Do it in a big cumbersome Zip file, if you must. The impact will not be limited, I promise!

Filed under Banking and Finance, CMR Tagged with ,

Is Bank of America: confusing and confused.

November 30, 2010 Leave a comment

Bank of America is suffering bad publicity over bad foreclosures and bad finances over bad mortgages.

In a confusing PR move, they send their “Senior Economist” over to Bloomberg to discuss the economy. This video is a few weeks old now, but you should take a look. The videos from Bloomberg cannot be embedded, so you will have to visit their site.

This Senior Economist looks like she is 16 years old. Eighteen, tops. She does not speak with confidence and gives mostly what sounds like canned, rudimentary answers. She does not instill confidence that her analysis is cogent.

Consider for a moment Bloomberg’s main audience: Middle-aged men with money. I imagine such people look at this young woman like their old buddy’s daughter who has just come back from first year at university with an A+ in Economics 101, and now has the the pretense to offer genuine insight.

If I were BoA, I would have sent an old man to Bloomberg who exuded reams of wisdom with something interesting to say. BoA is the biggest bank in the United States and this makes them look silly.

Filed under Banking and Finance, CMR, Mainstream Media Tagged with , , , ,

Canadian university budgets: standing at the edge of the abyss.

November 30, 2010 Leave a comment

The Globe & Mail reports that Canadian universities face a budget nightmare brought on by pension shortfalls. Article highlights:

… Most faculty and staff have defined benefit pensions, which promise a set retirement income based on service and salary. But those funds suddenly cratered when markets crashed in 2008, most losing 15 to 30 per cent of their value. …

Two years ago, Dalhousie University’s $726-million pension plan lost 16 per cent of its value, leaving a $129-million solvency deficit – the amount that needs to be added so that if the university suddenly folded, it could honour the plan. …

The University of Toronto’s pension fund was the hardest hit, losing 29 per cent in 2008. As a result, the school expects to owe an extra $50-million a year on top of $100-million it already contributes from a $1.5-billion operating budget. Since an arbitrator recently ruled against a proposed premium hike for faculty and librarians, cuts to services are the likely solution again. …

Saskatchewan is in the midst of a three-year moratorium on solvency payments, while Manitoba and Quebec universities already enjoy permanent exemptions. So does Alberta’s UAPP, which the employers and employees run jointly, making employees “part of the problem, part of the solution,” Mr. Gupta said. But because UAPP lost 20 per cent in 2008, its employees now fork over nearly 2.4 per cent more of their salaries than they did two years ago.

Canadian universities are public institutions. The bloated pensions in the public sector are the product of the bubble mentality. When times were good, fund managers did not anticipate anything but steadily rising returns. They did not anticipate 2008. Now all the lavish promises of myriad pension plans seem unrealistic, to say the least. To keep these generous promises, universities will have to cut services for students who are already paying too much for their schools.

The article mentions about $2.06 billion pension deficits among select plans. And this is merely a snapshot of nine different institutions. In a small country like Canada, $2 billion is serious money. The final price tag will ultimately be much higher. And university pensions are just a snippet of a more general problem — unrealistically generous pensions in the public sector will become a cancer on Ottawa’s budget.

As with most western democracies, Ottawa is bound to obligations that it will be unable to meet without default, either through repudiation or Bank of Canada money printing. Ottawa is on the hook for $208 billion in public pensions, which is $65 billion more than Ottawa’s crony accounting previously suggested. This says nothing of the CPP, which will not withstand future demographic burdens, and is made up of 33% per cent fixed income, mostly government bonds, which will be decimated by the mass inflation that is sure to come. Then there are the obligations of individual provinces to various unions which are likewise unsustainable.

When the private pensions of Chrysler and GM were bust, governments intervened. University staff do not have the votes that inefficient auto workers have. But over time, as more pension funds are threatened, Ottawa’s nationalization of different retirement accounts is a very real possibility. This would be done in the name of the general welfare, of course. A government guaranteed return, say at the rate of Canada’s long-term bond, would be more reliable than the ups and downs of capital markets.

This is already reality in some parts of the world. This radical idea even gets serious consideration in the US.

Why would a government want to do this anyway? Two reasons: 1) It can help defer the bankruptcy for the CPP and federal employee pensions; 2) it confers control over Canadian capitalism because common stock carries voting rights. Think about how the US government got the president of GM to step down.

These dangers are not immediate, but they must be considered as you prepare for the future. The main lesson — whether you are a government employee sucking blood from the economy, or a productive worker whose blood is getting sucked — you cannot count on government promises for retirement.

 

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