Sunday, May 31, 2009

May Recap

Bailout news is fewer and farther between lately. I don't think that it has lightened up, only that the DJIA has crashed twice now after the initiation of major bailout packages—the TARP and the Obama Stimulus—so they've learned to be more discrete.

The dollar continues to be under persistent and heavy fire with bouts of quantitative easing, which in essence blows a new treasury bubble after the internet, housing, and commodities bubbles crashed. Quantitative easing is the lender of last resort—the printing press—however just like any debt-driven "prosperity" it will eventually reach its limits and make the crash that follows all the more worse rather than letting equilibrium forces restore our economy to its natural state in the fastest and most painless way.

The dollar hasn't lost all of its gains since it March 2008 lows, but its heading in that direction. How far it will go before the treasuries bubble collapses I don't think anyone can know for sure but I don't think it will retrace all the way before quantitative easing reaches its natural endpoint.

Keep in mind, there has been quantitative easing in Japan for years, and the yen is one of the stronger currencies.

I've heard no word as of yet about the beginning of the Public-Private Investment Program, the last piece of bailout malfeasance, which in essence will unload toxic securities held by banks on to the tax base. I wouldn't be surprised if that has begun, I just haven't seen anything specific about it. It is terrible for the tax base and takes money away from more needed and socially beneficial bailouts, but this would have no effect on money supply or inventory and so no direct effect on the dollar, unlike quantitative easing which amounts to a temporary increase in cash supply.

Tuesday, May 19, 2009

1F-passes; 1A-1E fails

In one of those rare moments where I agree fully with the California electorate, propositions 1A-1E—which offer diffuse tax increase to cover California's budget shortfall—have been defeated; and 1F—which blocks pay raises of elected officials during deficit years—has passed.

The voters, what few of them showed up, have spoken. Hopefully this generalizes to the rest of the country regarding voter attitudes toward uncontrolled government spending.

Sunday, May 17, 2009

On the Origin of Currency

Today, we will have a speculative history lesion.

Our prehistoric ancestors lived in small communities. Specialized communities prevailed over generalized ones, since specialization exists in all human groups today, but we don’t see it in other primates, so specialization ruled. Such groups require trade among members—potters need to be able to pay the bakers, and everyone needs to contribute for the soldiers—and to do this human society requires a tool of exchange.

In small communities a “moral economy” forms—people share, but individuals who give more things of greater value to others are regarded by the group more highly than those who gave less. People gave what they had, and took what they needed—and people who gave more were remembered more fondly, and prospered.

As small villages grew into cities, moral economies became impractical. Trading had to be done through barter if the group was too big for everyone to know everybody else. Trust could not be relied upon. An economic exchange had to be sealed at the moment, which meant if one wanted or needed the possessions of another, they had to offer something immediately in exchange.

Currency is an extension of barter. The coin of the kingdom would be a tradable good, desired by many, that ideally would have been convenient in the sense of being (1) easily portable and (2) divisible. For example, if you want a haircut and you have a goat, then exchange is problematic, because the goat is worth more than the haircut, and you cannot cut off a piece of the goat for the haircut. Ideally, currency would be (3) long lasting and not degrade over time, and also it had to be (4) precious to some degree—it could not be too easy to procure. The bartered good that best displayed these properties would be widely accepted as the natural currency.

In World War II, for example, when cash was scarce, cigarettes were used as currency among GIs, and are probably still used that way in prison today. In ancient times, salt was used to pay roman soldiers, which likewise has many of the properties of a natural currency. But it was mostly gold that would prove to be ideal, and coin was preferable to crown or ring, being standardized and more divisible. Over the centuries, gold came to be replaced by bank notes, which were more convenient still, being even more portable than gold. However, trading bank notes was still essentially trading gold, since bank notes could be redeemed for gold.

With the development of fractional reserves, things began to change. Usually you could redeem banknotes for gold, but if the bank ran in to trouble, and there was a run on it, there were more banknotes than actual gold. Notes required faith in a stable economic system. They were riskier, and required there be no economic surprises.

The final stage of the evolution of currency has been a disconnection of bank notes from gold. Bank notes are not longer redeemable for gold, or anything. Cash is not a “natural currency,” and it is not based on faith either; its use is legally enforced. It is legal tender. Whether anybody has any faith in the dollar or not, bond holders must accept it as a means of payment. The law cannot say what its value is though—that is determined by their supply (which is regulated), and individual judgments about the desirability of the goods dollars can buy.

Modern cash has the advantage and disadvantage of manipulability by federal regulators. During times of wealth expansion, the fiat currency system can be easily increased to accommodate growth while preventing constriction of prices due to scarce cash. But regulators can also get it wrong, and expand the currency when the economy isn’t really expanding, except in the form of a speculative bubble. When people think they are in a new economic paradigm, they are really just greater fools getting in a lot of debt to pay excessive prices on speculative assets or commodities.

So that’s the good and the bad of where we find ourselves in regard to cash. It is the central lynchpin of a demand-driven economy.

Saturday, May 9, 2009

A False Assumption

I’d like to comment on a statement one routinely sees in nearly every critique of the dollar or fiat currency—the fallacy that it is "backed by nothing." This sentiment is all over the blogs, even otherwise good ones supporting free market principles.

Granted, the only use of paper money I can think of other than spending is to patch side wall tears in bicycle tires: due to its durability you can stick paper money between the torn tire and the inner tube and get home that way. Otherwise it is already printed on so you can't use it as notepaper, and due to paper money’s poor absorbent qualities it wouldn’t even be good for the usual uses of throwaway paper.

Okay, there isn’t much intrinsic value in the bill itself, unlike gold coins which could be melted down to make jewelry, arthritis medication, or a handful of other industrial uses.

But fiat currency is backed by the law. It’s legal tender. So legally, it is backed by all things for sale in the American economy; in a 10% fractional reserve system, credit accounts for around 90% of the money supply, so it is not something a merchant could easily turn away. In practice dollars can be conveniently and easily exchanged for goods and services. For anyone who holds the dollar, it is backed by any and all things for sale in America.

In this light, let us compare paper money to a stock certificate. Those who would disparage the dollar would tend not to say that a stock certificate is backed by nothing. But practically speaking, it is not like you can exchange some certificates for machinery from a factory, even if you are supposedly a part owner of it. The stock certificates gives one power over the management, supposedly, and the potential for dividends. But beyond that, company stocks can only be exchanged for dollars. So really a stock certificate is backed only by that which many consider to be backed by nothing, or fiat currency.

So paper money has all kinds of backing. Any criticism built on the premise that fiat currency is backed by nothing is illogical, dead wrong, and can be safely dismissed.

Friday, May 8, 2009


It feels like we are in a "mini-2006" right now, which was a bubblicious jubilee in a credit-intoxicated delirium as prices hovered in orbit well beyond any stones throw of fundamentals. Generally, in jobs and the stock market there seems to be an optimism out of proportion and disconnected from the gravity of the facts.

Since mid-March the stock market has made a robust comeback from its 6000-range lows, back into the mid-8000 range. Among job-seekers I know there doesn't seem to be the weight of economic pessimism beating down as it has been at least since the holiday season.

Still though, this mini-correction of the economy is a far cry from its speculative highs and is following the pattern of a dead cat bounce found in the midst of any crash. To the degree that quantitative easing is contributing, and it may be, even though one would still anticipate this faux-recovery without it, quantitative easing will still be an economic burden in the long run weighing on us later either through a restriction of economic activity through tight credit and reduced government spending; or a devaluation of cash and debt—in other words inflation.

As always, since those whose wealth is stored as debt are the same ones who pull the cranks and turn the levers on the money machine, I think we'll see trends toward deflation in the long run.

It's still cheaper to rent than to buy, and P/E ratios still stink. The job market continues to contract, and for each job lost, that is a further decline in economic velocity which builds as it cycles.

But for those who remember fondly 2003-2006, current events should arouse a pleasant sense of deja vu, while it lasts.

Thursday, May 7, 2009

ECB Rate Cut and more Easing out of England

Today, the European Central Bank continues toward ZIRP with dropping overnight lending rates to 1%. The Bank of England has announced another 50B GBPs of quantitative easing (in addition to 75B GBPs before), and maintained thier overnight rate at 0.5%.

Both of these would be favorable developments for the value of the U.S. dollar on world markets, but tempered by the fact of our own quantitative easing underway. There was a mild spike in the value of the euro vs. the dollar today, probably from those investors who regard this sort of intervention as a favorable development, and no changes of significance with the pound.


The results of the Fed's stress test of major banks are finally in, projecting how much loan losses banks might face under adverse financial circumstances.

Between credit extended for businesses, mortgages, and consumer loans, under the worst case scenario they considered (basically a mild economic contraction over the next two years—not the worst case scenario possible), banks stand to lose upward of $600B; $186B from mortgages alone. Ten of the 19 banks looked at are undercapitalized, needing raise close to $75B total by this November. Bank of America is the worst offender, needing to raise $34B, Followed by Well Fargo at $14B, GMAC at $12B, Citigroup at $5.5B, and the rest under $3B or not needing to raise any capital. Bank of America and Wells Fargo are no doubt dragged down by their accumulation of Countrywide/Merril Lynch and Wachovia (who before that had acquired Golden West), respectively.

So, the test results today confirm the presence of severe undercapitalization in the system, and major losses as the credit contraction moves forward. The tests seem to have been conducted responsibly; perhaps skewed a little too optimistically, but not sugarcoating the problem either. I'm going to hazard a guess now that the economic contraction will exceed their worst case scenario, and another stress test will be needed before all is said and done.

Tuesday, May 5, 2009

Chrysler Bankrupt

We are in the midst now of an arranged bankruptcy of Chrysler, where it would be purchased by Fiat, all coordinated by the federal government at a suppressed price. We've seen this before, where banks were seized by the FDIC and then sold to other banks, whereupon shareholders lost everything, and unless special deals were made then bondholders lost everything too.

With Chrysler, the federal government does not have seizure power, but the Treasury Department can twist the arms of TARP lenders with exposure to Chrysler to comply with the plan. Non-TARP lenders to Crysler, and stock and bondholders of any sort, are compromised by the deal and their only recourse is to file legal action, which surely will happen.

Unlike bank seizures, this is going to be messy, I suspect worse even that Wells Fargo's purchase of Wachovia, which was bad enough.

Having owned a Dodge pickup—and not that I didn't like the truck but I was distinctly unimpressed the way the company operates and treats its customers—I'm left thinking the government shouldn't lift a finger for Chrysler.