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Democracy at Risk?

Posted on Thursday, October 20, 2016 No comments

Thursday, October 20, 2016

If our democracy is at risk, it is because drivel which would never be permitted by a professor teaching first year critical thinking now passes for competent commentary from the Washington Post.

Our local paper, the San Diego Union-Tribune, carried Catherine Rampell's column this morning.  Apparently she thinks a "particular subset of Americans [read: 'deplorables'] have had enough of experts, facts, math, data. They distrust them all."

She is apparently appalled that "more than 4 in 10 Americans somewhat or completely distrust the economic data reported by the federal government."  And if we only count the 'deplorables', 68 percent do not trust the data "at all."  She calls roll on the usual suspects: unemployment, inflation, household spending, health insurance coverage rates, gross domestic products, etc.

If she had followed up with at least an attempt at substantive discussion of how these numbers are calculated and - even more importantly - how they are used, she could have at least avoided making her college professors look bad.  But there was nothing but red herrings and ad hominem - to the point I am left wondering if she even knows what those two terms mean in the world of critical thinking.

So let's do a little of the substantive analysis she couldn't provide in no fewer than 28 Union-Tribune column inches.

Inflation is easily the most important, and least understood, of the economic series reported by the government.  It is the most important because it provides the foundation for the 'deflator' which is used to calculate Gross Domestic Product.  The most important result of that relationship is this: If you understate inflation, you necessarily overstate economic growth.  Inflation is also what determines interest rates.  Here when you realize that the U.S. Government does not take in enough revenue month-to-month to even pay the interest on its debt, you also realize that keeping interest rates low is 1) a way of staving off the inevitable fiscal - and therefore political - reckoning; and 2) that this reckoning is, in fact, mathematically inevitable.  To understand why, just try to find someone who has refinanced their mortgage at a higher rate.

Rampell derisively refers to "shadow stats."  This can only mean one of two things: 1) She is aware of John Williams' and has thus failed to offer anything even approaching substantive interaction with his work; or 2) she has 'heard' about his work and is just parroting a second-hand narrative of 'conspiracy theories'.  Either way, she and her college profs (and we'll add her editors to the list) don't come out looking very good for her effort.

But leaving Shadow Stats aside, let's look at actual 2015 data from the Bureau of Labor Statistics.  The weighting of various prices in the Consumer Price Index is shown in complete detail.  The most glaring anomaly is rent.  The 'housing' component is 42 percent, which seems about right.  But within that component, only a little under eight percent is 'rent of primary residence' while a category called 'owners equivalent of rent of residences' is no less than 24 percent.  Let's explore that one for a moment: The 'owners equivalent' figure is notional.  This is not what owners are getting in rent; it is what the BLS guesses they could get in rent on their primary residence were they to rent it out.  But 'rent of primary residence' is an actual number - the rent being paid by the average renter of an apartment.  Can Rampell take a crack at explaining why someone would weight a notional number far more heavily than an actual number?

Another example is education.  CNBC writer John W. Schoen shows how tuition inflation has dramatically outpaced broader inflation measurements.  The BLS data shows us that college tuition is weighted at 1.8 percent.  And books and supplies at 0.16 percent (!!!).  Parents of college age students like me and my wife are painfully aware that the BLS formula ought to be labeled as the BLS formula - just remove the 'L'.

I'll round out the examples with health care.  The BLS data shows a weighting of 8.4 percent.  But when looking at various estimates of the percentage of income Americans devote to health care, 9.6 percent is the lowest number out there.  For those making $35-47K, the percentage is 14.5.  And with massive premium increases on the horizon, this picture is only going to get worse.

The long and short? The BLS data significantly under-weights the prices ordinary people (as opposed to the 'experts') know are the main drivers of price inflation.

Inflation - if we go by the 'textbook' - is the difference between the growth of the money supply and the growth of the economy.  Some will differentiate between this definition (monetary inflation) and the growth or decline in consumer prices (price inflation).  If, for example, the money supply has grown by 20 percent, but the economy only by two percent, the rate of monetary inflation is 18 percent.  One would expect - by the textbook theory - that price inflation will follow monetary inflation.  The claim is, of course, that price inflation is about two percent, so those who have been ringing the inflation fire alarm are ridiculed by writers like Rampell.

But if we look at all of the various paths money takes in the economy, and look at three in particular: the stock market; the bond market; and real estate, the answer is right in front of us.  And, no, Ms. Rampell, we don't need 'experts' to see it.

Stocks, bonds, and real estate are 'inflation sinks'.  Just like a 'heat sink' dissipates heat, these three markets are dissipating the inflation of the money supply.  But the only way to hide this effect in real estate, for example, is to underweight actual rents (which are soaring) and overweight notional rents - like what I might get were I to rent the house I live in.  It's as if we are to believe that notional rents have greater influence on consumer spending choices than actual rents.

And by not counting the stock or bond markets (they are not 'consumer prices', after all), we are hiding the real threat to our democracy: wealth inequality.  If Ms. Rampell was actually familiar with the writing of 'deplorables' like myself and others who challenge the 'data', she would see that between us and the Left, we agree that income inequality is a problem.  Where we disagree is on the origins of - and therefore the solutions to - the problem.

Income inequality is a function of public debt; here is how the cycle works: Each time the U.S. Treasury issues a 'bond', it is bought by a 'primary dealer'.  It then gets sold on the 'secondary market'.  When the Federal Reserve was engaging in Quantitative Easing (QE), they were literally creating money out of thin air (digitally) to buy these bonds on the secondary market. Each time a bond changes hands, fees and commissions are booked.  These bonds are issued, of course, to pay for deficit spending. Wall Street loves the arrangement - they are the ones booking the fees and commissions, after all.  And so just as the public debt soars, so does political spending.  Where does political campaign cash come from?  Primarily Wall Street - from the fees and commissions they book trading in government debt.

It is essential, then, both for the political and the financial halves of the 'political/financial' complex that this borrowing continue.  What threatens it?  Rising interest rates... again, who refinances a mortgage at a higher rate?  How do you keep interest rates artificially low?  By keeping the rate of inflation artificially low.

When we look at the multiplier between the salary of an average worker and that of a CEO, the 'norm' used to be about 20 (the CEO would make 20X the salary of the average worker.  When we look at the multiplier in companies 'closest' to all the new money that has been created (the 'political/financial' complex) the multiplier runs as high as 300.  If increases in income can be tied to increases in productivity and other forms of wealth creation, people should be free to make as much money as they please.  But when these increases are derived from proximity to banks and government, and funded by the banks lending to government, something is very wrong. And campaign finance reform will not fix it. And end to borrow-and-spend government will.

Inflation, then, works it way into so many other numbers.  With an honest reporting of inflation - by accounting for actual rather than notional prices for things like rent, properly weighting education and health care, and by taking into account stocks, bonds, and real estate - inflation would be significantly higher. And that would mean GDP would be significantly lower.  That, then, would expose the Big Lie - that we have been 'recovering' since the last financial crisis.  The fact that we have likely been in recession throughout the entirety of Obama's two terms is a very inconvenient truth.  But even worse - for both political parties - a true accounting of inflation would cause interest rates to surge, putting an immediate end to the debate over the debt ceiling.  That debate would be over because when no one is willing to lend us money at a rate we can afford, it will not make one whit of difference what the 'debt ceiling' is.

The cooperation and compromise everyone says they want will not happen until we start doing something very simple: Tell the truth about the economy.

Memo to the Fed: "Not Spending" and "Saving" are not the same!

Posted on Friday, October 14, 2016 No comments

Friday, October 14, 2016

Janet Yellen today:
We need to know more about the manner in which inflation expectations are formed and how monetary policy influences them.
OK, good start because it suggests they might be aware that there are things out there they don't know.  Her whole speech today actually hints that this is beginning to dawn on them.

Good news. So, let me offer a little help:

By 'inflation expectations', Yellen means ordinary people start believing that prices will go up soon.  The idea is that if you think that box of something is going to be more expensive tomorrow, you'll buy it today.

Now, as to how they are formed, and how monetary policy influences them: 'Saving' and 'not spending' are NOT THE SAME.  If I am 'not spending' it may be because I think prices are going to drop.  This is the opposite of the observation above: If that box of something is going to be cheaper tomorrow than today, why would I buy today?

'Saving' is different.  If I am 'saving' it could be because I am 'buying' peace of mind in case of a rainy day.  And if my savings earn me less and less (by way of interest rates), it only means that 'peace of mind' becomes more expensive.  I have to save more to 'buy' the same peace of mind I could have gotten for less if my savings earned a decent rate of interest.

I could also be saving for a couple similar reasons: If I want to save to help a child pay for college, again, I am 'buying' the ability to discharge what I might think is a parental responsibility.  The less I get on my savings, the more 'expensive' that ability becomes - because I have to make up for what I am not getting in interest by adding to my savings.  And in a sector of the economy without any 'normal' price discovery (for tuition and books), that 'ability' is outrageously more expensive than it should be.

I could be saving for retirement.  Here I'll let you in on the somewhat colorful sense of humor between me and my oldest son, who is 18.  We were talking about why paying off our mortgage is so important to me and his mom.  I buried my parents in 2010, so I have seen the care needed for a dying parent.  I was starting to explain why I wanted the house paid off as early as possible and said: "So you and your brother..."

My oldest interrupted. "...don't have to change your diaper instead of the other way around!"

We got a very good laugh out of that. (The way he actually put it was a bit more colorful.) And he was spot on the money!

So by paying off our mortgage, I am saving for my old age. I am 'buying' the peace of mind that I will not end up relying on my boys to 'change my diaper' as my time on this earth draws to a close.

This is all entirely different than 'not spending' and therefore has nothing to do with inflation expectations (save perhaps the matter of saving for college).  And it is appalling that I find myself - a charter member of the Basket of Deplorables - having to explain these things to the Chair of the Federal Reserve, for Pete's sake!

But it isn't really that surprising after all.  I look at money and see a way of measuring the output of my time and skills.  I then see it as a means by which I discharge what I believe to be responsibilities to my children.  Ms. Yellen, the Federal Open Market Committee (FOMC), and their coterie of academic economists apparently do not see money this way, but rather as a tool of the State to be used to dictate the social order.

Of course we have seen this before in King Charles I, before he triggered the English Civil Wars with his monetary impunity.  It has a lot to do with why do not have a Monarch in this country...

Or do we?

To Big to Fail, v2.0 - Deutsche Bank

Posted on Wednesday, October 5, 2016 No comments

Wednesday, October 5, 2016

Yup, here we go again...

Recently the Department of Justice levied a $14B fine against Germany's Deutsche Bank (DB) for its role in the last financial crisis - which was mainly a matter of selling securities based on mortgages they knew were bad.

DB, however, is on the brink of becoming the next "Lehman Brothers" (LB).  If that name isn't familiar, LB was the "systemically important" bank which went bankrupt, triggering the last financial crisis.  The way LB triggered the crisis was actually best explained in "The Big Short" - by Selena Gomez of all people! (Seriously, folks, please watch the video - you may well be about to see a re-run in DB.)

After you've watch this clip, read here.  This is the Reuters story on the quiet talks going on between German and U.S. officials about the fine.  There are so many angles to this, it is hard to know which ones to pursue and in which order.  I'll pick a few, to wit:

1) This is going to blow up the 'myth' that is the European Union and the fraud that is its money (the Euro) in a way that the Brexiteers couldn't have dreamed of;

2) This is going to prove that Central Bank intervention not only did nothing to end 'too big to fail', but actually made it exponentially worse; and;

3) This is going to demonstrate, once and for all, that we were lied to the first time around (the last financial crisis).

Taking these three up in reverse order: We are about to hear the term "under-capitzalized" again.  This was the reason we were given for the bailouts in the last financial crisis.  If we pay attention this time, we will discover there is actually another way of describing the same situation: Too much bad debt.

The difference is between looking at bank through the 'lens' of the asset side of the accounts instead of through the 'liabilities' side.  All we have to do - and no, you do not need a degree in anything to understand this - is ask ourselves how banks are supposed to be doing business.  Its actually pretty simple: they lend out money against collateral.  If you own a home, you understand this.  The bank lent you money to buy the home, and home itself is the collateral.  If you stop making payments, they take it from you and sell it to offset the loss.  A debt that is backed by good collateral - like your house - is considered a 'good' debt even if the borrower stops paying, because there is recourse.  Debts, however, that are not being paid back and have no such recourse are given all kinds of wonderful names like "non-performing loans" (NPLs), or "impaired" loans.  Its all euphemisms for 'bad debts.'

Banks are supposed to maintain a certain percentage of 'good' collateral against their outstanding loans to make sure they have recourse to survive when a certain percentages of those loans go bad.  The problem with DB is no one knows how to value their outstanding debts which were used for 'derivatives'. (Replay the Selena Gomez clip.  A 'derivative' is a bet on a bet on a bet on a bet on a player's Blackjack hand.)  Having good collateral is useless if you do not know what your liabilities exposure is.

We have seen this movie before.  When mortgages started going into default, no one could value the liabilities of banks like LB who had played at this Blackjack table (sub-prime mortgage backed securities).  If you cannot calculate your liabilities, you have no way of balancing the books, and therefore no way of knowing what each share of stock is worth.  When the market concludes they cannot know what a share should be priced at, everyone sells.  When everyone is selling something, and no one is buying it, that something is - by definition - worthless.  This is where DB is right now - even without the DoJ fine.  The only thing the DoJ fine may do is accelerate the day of reckoning.

We are learning that "government officials in Berlin, speaking on condition of anonymity,... hoped to facilitate a quick deal that would buy Deutsche Bank time to regain its footing."

What we are not told is how they propose DB "regain its footing."  Their "feet" are supposed to be planted on good collateral.  Either you have enough of it or you don't - and DB doesn't.  There are only two options: 1) Discharge the 'bad debt' in a bankruptcy; or 2) Raise more capital.  The raising of capital would require DB to offer more shares of stock.  There are two problems with this: First, it dilutes the value of the shares currently outstanding, making them unattractive to investors.  Second, it means investors are asked to buy shares in a company which cannot reliably state its liabilities.  You have to be smoking some choice herbs to make such an investment.

So then what?  A Central Bank - or a consortium of Central Banks - buy up the bad debt on DB's balance sheet to make it possible for DB to have a reliable print on the liabilities side of the books, so it can then raise more capital.  And in some cases, the CBs themselves buy that new stock.  When you address this problem from the 'assests' side of the sheet like this, you leave completely unaddressed the underlying cause - the excess of bad debt.

Sound vaguely familiar?  It should... again, we have seen this movie before.

On to my second point.  We have to go back to the 'dot com' bubble of 2000 to understand how we got here.  Easy money created massive speculation in 'dot com' companies because the Internet was so new and its promise so great.  When that bubble popped, 'geniuses' like Paul Krugman (single handedly responsible for the destruction of Japan's economy) called for a housing bubble to replace the dot com bubble.  We all know how that ended.

Central Bank intervention on the 'asset' side the sheet has done nothing to curb the appetite for bad debt.  In fact, by pushing interest rates ever lower, they have forced banks to 'reach for yield' in ever riskier ways.  Money and the economy is like nature and a vacuum.  The money has to go somewhere, so when all of the otherwise sound, productive uses have been funded, if money is left sloshing about the system, it will ALWAYS end up as chips on a Blackjack table.

So where are we now?  On the top of an 'everything bubble' led by junk bonds.  And a junk bond is nothing but the corporate version of a sub-prime mortgage!  DB, in particular, is the king of junk-bond-backed derivatives.  Again, replay Serena Gomez above to see what DB has been doing - only now it is in corporate bonds across the entire economy rather than mortgages.

Lastly, I have to honest about being a good German ('Horst' is actually a common German first name); I like my Schadenfreud paired with a stein of San Diego craft beer!

The entire European project has been built on a house of cards of debt denominated in Euros.  The idea is that Europe's people act in the interests of all Europeans - until they don't.  Listen to what is being said about DB:
The resolution of the crisis through a reduced settlement is crucial for Chancellor Angela Merkel, who faces a federal election next year. It could be political poison for her government to rescue a bank that got into trouble through speculating. At the same time, officials recognise that Germany's biggest bank, which employs around 100,000 people, cannot be allowed to fail.

'We are not Austria. We are the biggest economy in the European Union, one of the world's leading exporters. We need a big bank with a European and international presence but which is anchored here in Germany.' The official added that merging Deutsche with a European rival was fine in principle but only if Germans controlled the combined entity.
But wait! What happened to Europe?

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