A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Tuesday, September 22, 2009

Economy on the bottom, Dow on the rise, Question Mark

Plus a continuation of our look at Hyman Minsky.

In chess match analysis, whenever a move is followed by an exclamation point, it means "good move." When it is followed by a question mark, it means "blunder." The Fed's aggressiveness in taking over the bad securities of the zombie banks and keeping the money taps open for financial speculators has resulted in Dow ten thousand and strong commodity markets. Exclamation point or question mark?

Question mark. And the technical chess term "Blunder."

This is Alan Greenspan's one percent interest rates only on a grander scale. The Fed hoped that saving the banks and giving them lots of money would encourage them to restart credit flows. It is not working. It hasn't worked. It won't work. No market works from the supply side, not even the financial markets.

Where is the money going? Here are three quick perspectives off of Bloomberg, the first from Marc Faber, the well-respected investor.


We may play more of Marc Faber in an upcoming podcast, as he weighs in on Paul Krugman and economics.

But here, also from Bloomberg September 15, Liam Dalton, chief executive officer of Axiom Capital Management, saw this:


Liam Dalton

and here, George Magnus, senior economic adviser at UBS,


George Magnus

"Exit strategy" is often equated with unprinting money. As we've noted before, the Fed cannot print money fast enough to counteract the destruction of money caused by deleveraging. The real exit strategy is how to get the garbage off the Fed's balance sheet when it is not worth anything and the institutions who created it cannot repatriate it. They barely have the strength to stand even with the massive assistance they're getting.

At one point the Fed floated the idea of having the Treasury buy it, making explicit the taxpayer's responsibility for the recklessness of Wall Street. That didn't fly. Still, the implicit guarantee to anything and everything Wall Street wants to do is hardly hidden. And that guarantee, along with the wall of money, make things not better, but worse, as we go forward.

Robert Reich has another idea of why the Dow is rising.

Why the Dow is Hitting 10,000 Even When Consumers Can't Buy And Business Cries "Socialism"
by Robert Reich
September 22, 2009

So how can the Dow Jones Industrial Average be flirting with 10,000 when consumers, who make up 70 percent of the economy, have had to cut way back on buying because they have no money? Jobs continue to disappear. One out of six Americans is either unemployed or underemployed. Homes can no longer function as piggy banks because they’re worth almost a third less than they were two years ago. And for the first time in more than a decade, Americans are now having to pay down their debts and start to save.

Even more curious, how can the Dow be so far up when every business and Wall Street executive I come across tells me government is crushing the economy with its huge deficits, and its supposed “takeover” of health care, autos, housing, energy, and finance? Their anguished cries of “socialism” are almost drowning out all their cheering over the surging Dow.

The explanation is simple. The great consumer retreat from the market is being offset by government’s advance into the market. Consumer debt is way down from its peak in 2006; government debt is way up. Consumer spending is down, government spending is up. Why have new housing starts begun? Because the Fed is buying up Fannie and Freddie’s paper, and government-owned Fannie and Freddie are now just about the only mortgage games remaining in play.

Why are health care stocks booming? Because the government is about to expand coverage to tens of millions more Americans, and the White House has assured Big Pharma and health insurers that their profits will soar. Why are auto sales up? Because the cash-for-clunkers program has been subsidizing new car sales. Why is the financial sector surging? Because the Fed is keeping interest rates near zero, and the rest of the government is still guaranteeing any bank too big to fail will be bailed out. Why are federal contractors doing so well? Because the stimulus has kicked in.

In other words, the Dow is up despite the biggest consumer retreat from the market since the Great Depression because of the very thing so many executives are complaining about, which is government’s expansion. And regardless of what you call it – Keynesianism, socialism, or just pragmatism – it’s doing wonders for business, especially big business and Wall Street. Consumer spending is falling back to 60 to 65 percent of the economy, as government spending expands to fill the gap.

The problem is, our newly expanded government isn't doing much for average working Americans who continue to lose their jobs and whose belts continue to tighten, and who are getting almost nothing out of the rising Dow because they own few if any shares of stock. Despite the happy Dow and notwithstanding the upbeat corporate earnings, most corporations are still shedding workers and slashing payrolls. And the big banks still aren't lending to Main Street.

Trickle-down economics didn't work when the supply-siders were in charge. And it's not working now, at a time when -- despite all their cries of "socialism" -- big business and Wall Street are more politically potent than ever.

Robert Reich. See the complete piece in today's transcript on the blog. Demandsideblog.blogspot.com.

But Reich is wrong here.

Yes, the government is responsible for every penny of real investment now being done through its support of mortgages and its direct purchase of construction services for infrastructure. But in the stock market we are not talking about real investment, we are talking about financial investment. It is a casino. Buying a share of stock does not produce one penny of investment. They are like baseball cards, whose value depends on the willingness of others to buy. There is no demand to spur investment or produce a flow of dividends. Commodity prices are being floated by speculation in ETF's and futures markets. It is the same house of cards we just came from.


I have queued up here a very interesting short historical take from an EPI -- Economic Policy Institute -- event on too big to fail, featuring Simon Johnson, formerly chief economist at the IMF and now at MIT's Peterson Insitute.

We're not going to get to it today, but next week, look for that.


Hyman Minsky.

So very intersting.

I should make a short note here on a piece we put up on the blog this week from By Stephen Mihm and Boston Globe on Minsky under the title

Why capitalism fails

said the following.

To prevent the Minsky moment from becoming a national calamity, part of his solution (which was shared with other economists) was to have the Federal Reserve - what he liked to call the “Big Bank” - step into the breach and act as a lender of last resort to firms under siege. By throwing lines of liquidity to foundering firms, the Federal Reserve could break the cycle and stabilize the financial system. It failed to do so during the Great Depression, when it stood by and let a banking crisis spiral out of control. This time, under the leadership of Ben Bernanke - like Minsky, a scholar of the Depression - it took a very different approach, becoming a lender of last resort to everything from hedge funds to investment banks to money market funds.

Our reading of Minsky says, yes, the economy is stabilized by lender of last resort backstopping, but it continues forward at a more sluggish pace as the debts weigh on the economy, and the future is no less unstable, but more so, for the implicit guarantees to yet another class of financing instrument.

This lender of last resort function -- whether under the auspices of the FDIC or other agency -- is ultimately the Fed. When it is required, it will be will be immense, because when it is called for, the entire market will be in need. And it is backstopping of debt incurred in a speculative form. For example, as we understand it, simple borrowing for inventory is speculative financing because it is not buying and selling. There is a further speculation, however, when one borrows to set up a business which then depends on borrowing for inventory. And so on, as virtually all business depends on financing much more complex than this.

Absent the lender of last resort, an institution will be forced to sell out its position in financial and real assets to meet its short-term needs, which then leads to sharp declines in asset values. We must ask ourselves today whether the government, the Fed, is actually large enough to be the lender of last resort, or whether the markets have grown out of scale with even the central bank. Our answer, looking at the hundreds of trillions in derivatives, is unfortunately, yes. I'm sorry. It was necessary not to backstop over-the-counter derivatives and to thus drive down their prices and their uses.

You know, let's listen to the Simon Johnson piece and get back to Minsky next week. We'll take half the podcast then, and deal with his insights into the role of prices, profits and investment.

Here, Simon Johnson.


No comments:

Post a Comment