One mystery of the Dubai debt crisis is the extremely limited information about derivatives contracts for Dubai debt. Credit default swaps protecting debt holders were rising rapidly in price last week as the crisis reached a head. That's hardly surprising, nor is it terribly significant from a systemic question.
The key question is whether we have another AIG--i.e., a financial institution that wrote a large portion of the credit default swaps, or insurance, for Dubai debt protecting debt holders in the event of a default. AIG made a concentrated bet on the value of the real estate market, without any government agencies knowing until it was too late. U.S. taxpayers paid the price. Although the AIG situation should serve as the impetus for meaningful reform of the derivatives market, Wall Street banks have been lobbying vigorously to limit change. Efforts at reform in Europe haven't made much progress, either.
Thus, there is no easy way for regulators anywhere in the world to figure out whether the derivatives risks stemming from the Dubai debt crisis are under control or not. It appears that the banking system of the United Arab Emirates, of which Dubai is a member, is at significant risk. The UAE central bank has already announced a new credit facility to support its banking system. This is what central banks typically do--protect the banking system but not the debtors. Investors holding Dubai debt, especially those in Europe and the U.S., might not benefit much from stabilization of the UAE banking system.
Abu Dhabi, Dubai's oil-rich neighbor, has announced that it will support select Dubai companies, but will not provide blanket protection for Dubai debt holders. In addition, Abu Dhabi may not pay out debt holders 100 cents on the dollar. One suspects that Abu Dhabi will select those companies whose defaults would seriously injure Abu Dhabi's banks and citizens. Holders of other Dubai debt will likely be left looking for any port in the storm.
The problems aren't necessarily limited to Dubai. These crises always have secondary and tertiary effects. Some market participants are getting nervous about debt of other UAE members, and also the debt of certain nations in Eastern Europe and elsewhere. What if credit default swaps for the debt of these other nations were written by a major financial institution that also wrote a lot of Dubai credit default swaps? A major Western financial company could be in serious trouble, but there's no straightforward way to find out if this is the case.
The Dubai crisis is a reminder that the financial crisis of 2007-08 has continued into 2009, as the global economic slowdown takes its toll wherever leverage was used in abundance. And that would include lots of places. Banks worldwide continue to sit on substantial potential losses from residential and commercial real estate. And consumer loan losses have grown along with rising unemployment levels. We're still in the woods, even if some green shoots are visible.
European and U.S. banks have said little or nothing about their Dubai/UAE exposure. Their regulators have said even less. Very possibly, everyone's still scrambling trying to figure out where the problems are. The possibility of another AIG cannot be ignored. After all, the number of financial institutions that are large and well-capitalized enough to be credible issuers of credit default swaps would be quite limited, especially after the AIG mess. If there is a financial institution with concentrated Dubai/UAE/whatever risk, it will probably be a large and well-known one in Europe or the U.S.
Since Abu Dhabi and the UAE won't fully protect holders of Dubai debt, it goes without saying that they won't protect any Western financial institution that's hurting from writing too many Dubai credit default swaps. Perhaps large financial institutions have learned from the AIG experience not to concentrate too much risk in credit default swaps. Then again, movement up the learning curve cannot be assumed. Would it not be possible that Dubai debtholders were willing to buy credit default swaps from a single large dealer because they would anticipate another AIG-style 100 cents on the dollar bailout if bad things happened? Would the Fed hold the line and make them take losses? Or do we think that its still vivid memories of Lehman's collapse would lead it, once again, to speed up the printing presses and churn out more dollars?
As we write this blog, Asian shares are up 2% or more in the belief that the Dubai crisis has been overblown. Maybe so. But remember that it took 15 months or more for the impact on AIG of the real estate and credit crises to become publicly known. And even if there is no AIG, Part Deux looming in the future, the sudden shakiness of a lot of developing world debt will probably lead major banks to pull back even further on lending, contracting the money supply all the more so, and creating more drag on economic activity.
The Dubai crisis illustrates how the government interventions of the last year have slowed, but not prevented, the deleveraging process. Market forces will have their way sooner or later, one way or another. A lot of potential bad debt remains extant, which means that deleveraging will persist for years and demand for credit default swaps will continue to be strong. The risk of another AIG is real, and substantial reform of the derivatives market should be undertaken now, before the Fed and Treasury Department fail in their quest to prevent a second Great Depression.
Sunday, November 29, 2009
Tuesday, November 24, 2009
Let's Be Thankful
That:
Congress is looking closely at the Fed. In the last few years, the Fed has done a terrible job, and then a good (but risky) job dealing with the consequences of its terrible job. Some close scrutiny and double guessing would be healthy for the Fed. Congress may moderate the Fed's responsibilities and power, which could turn out for the better. Making the Fed into an uber-regulator, as proposed by the administration, would be a very risky move. Virtually all of the government's power to deal with a financial crisis would be vested in a single agency that too vigorously resists oversight. The potential for narrow focus, an oversupply of certitude in its own wisdom, and increased traffic through the revolving door make such a concentration of regulatory power a bad idea. Even though Congress is proceeding with a maximum of soundbite histrionics that obscure the substantive importance of the issues, it's making the Fed take a hard and careful look at itself. That's Congress' role in the Constitutional structure of the government, and the Fed will be a better agency after enduring the cacophony of democracy.
Retail investors have sat out the stock market rally. An objective look at the evidence strongly suggests that, for the next year or so, the market has quite a bit more downside risk than upside. Maybe stocks will drift a bit higher. But only those that believe assets only rise in value and never fall would think that 2010 will be a banner year for stocks. The good thing about retail investors sidelining themselves is that if and when the market falls, the impact on consumption will probably be less than 2008's nosedive. If your portfolio hasn't been hammered, you'll have less gut level fear of $4 lattes.
Health insurance reform is progressing. It seems like just about every alternative is criticized for involving increased costs. But the question is compared to what? Health care costs have risen faster than inflation for decades. Health care now absorbs about 16% of GDP and is expected to rise to about 20% in ten years. If a reformed health insurance system provides more comprehensive and fairer coverage, isn't that a worthwhile result? Costs are going to rise anyway if we leave our current incomplete and unfair system in place. Costs are a very important issue, but not reforming health insurance coverage isn't going to keep costs under control. We should work to achieve comprehensive and fair coverage now. Costs will be debated and dealt with as far as one can see into the future, because they'll always be an issue.
U.S. troop levels in Iraq are falling. Iraq wasn't and isn't of strategic consequence to the United States. That's why W and Dick, with their juvenile, tunnel-vision machismo, recklessly weakened the U.S. military by fighting an unnecessary war at a time of rising worldwide commitments for America. The real problems--the growing quagmire in Afghanistan, a soon-to-be nuclear armed Iran, the security of Pakistan's nuclear arsenal, safe havens for terrorists in Pakistan, Yemen and elsewhere, and the twilight zone quality of North Korea's bipolar Kabuki theatrics over missiles and nuclear weapons--will absorb all the resources the U.S. can muster.
Jon and Kate are going off the air. We like the 8. But, toward the end, Jon and Kate were mostly enriching TLC and the tabloids while sounding, shall we say, a bit tiresome.
We're reading less about Lindsay, Paris and Britney. After you've read 100 train wreck stories, the 101st really isn't all that interesting. But fear not for the tabloids. They've always got Brad, Angie and Jennifer.
Congress is looking closely at the Fed. In the last few years, the Fed has done a terrible job, and then a good (but risky) job dealing with the consequences of its terrible job. Some close scrutiny and double guessing would be healthy for the Fed. Congress may moderate the Fed's responsibilities and power, which could turn out for the better. Making the Fed into an uber-regulator, as proposed by the administration, would be a very risky move. Virtually all of the government's power to deal with a financial crisis would be vested in a single agency that too vigorously resists oversight. The potential for narrow focus, an oversupply of certitude in its own wisdom, and increased traffic through the revolving door make such a concentration of regulatory power a bad idea. Even though Congress is proceeding with a maximum of soundbite histrionics that obscure the substantive importance of the issues, it's making the Fed take a hard and careful look at itself. That's Congress' role in the Constitutional structure of the government, and the Fed will be a better agency after enduring the cacophony of democracy.
Retail investors have sat out the stock market rally. An objective look at the evidence strongly suggests that, for the next year or so, the market has quite a bit more downside risk than upside. Maybe stocks will drift a bit higher. But only those that believe assets only rise in value and never fall would think that 2010 will be a banner year for stocks. The good thing about retail investors sidelining themselves is that if and when the market falls, the impact on consumption will probably be less than 2008's nosedive. If your portfolio hasn't been hammered, you'll have less gut level fear of $4 lattes.
Health insurance reform is progressing. It seems like just about every alternative is criticized for involving increased costs. But the question is compared to what? Health care costs have risen faster than inflation for decades. Health care now absorbs about 16% of GDP and is expected to rise to about 20% in ten years. If a reformed health insurance system provides more comprehensive and fairer coverage, isn't that a worthwhile result? Costs are going to rise anyway if we leave our current incomplete and unfair system in place. Costs are a very important issue, but not reforming health insurance coverage isn't going to keep costs under control. We should work to achieve comprehensive and fair coverage now. Costs will be debated and dealt with as far as one can see into the future, because they'll always be an issue.
U.S. troop levels in Iraq are falling. Iraq wasn't and isn't of strategic consequence to the United States. That's why W and Dick, with their juvenile, tunnel-vision machismo, recklessly weakened the U.S. military by fighting an unnecessary war at a time of rising worldwide commitments for America. The real problems--the growing quagmire in Afghanistan, a soon-to-be nuclear armed Iran, the security of Pakistan's nuclear arsenal, safe havens for terrorists in Pakistan, Yemen and elsewhere, and the twilight zone quality of North Korea's bipolar Kabuki theatrics over missiles and nuclear weapons--will absorb all the resources the U.S. can muster.
Jon and Kate are going off the air. We like the 8. But, toward the end, Jon and Kate were mostly enriching TLC and the tabloids while sounding, shall we say, a bit tiresome.
We're reading less about Lindsay, Paris and Britney. After you've read 100 train wreck stories, the 101st really isn't all that interesting. But fear not for the tabloids. They've always got Brad, Angie and Jennifer.
Monday, November 23, 2009
Congress, the Administration, and the Fed: Ships Passing in the NIght
The soundbite du jour on Capitol Hill is outrage over the Federal Reserve Board. The Fed, according to outspoken members of Congress, encouraged profligacy with low interest rates, missed the boat on the financial crisis, failed to protect retail borrowers, coddled and protected Wall Street firms, and now wants even more power, as proposed by the Obama administration. The Fed, particularly Chairman Ben Bernanke, is trying to reach out to the legislature and make nice. However, there is scant indication that it admits a whole lot of error, or that it would settle for less than the administration's proposal to increase its jurisdiction and power.
Meanwhile, in the next ring of this circus, Congressional criticism of Treasury Secretary Timothy Geithner is increasing in volume and stridency. Some have called for his resignation. Geithner, who doesn't have the professorial detachment that may be Bernanke's best PR weapon, forgot to smile.
In the third ring of the federal circus, swing votes in Congress dig in their heels in opposition to a public health plan for the uninsured, even as a majority of the public supports one. The administration seems to be ducking for cover behind both sides of this fence.
The level of federal dysfunction has risen along with the Dow. When the markets were plunging a year ago, there was near unanimity in Washington. The one time Congress got fussy, initially voting down TARP, stocks nosedived. An overnight plunge in 401(k) accounts concentrated legislators' minds wonderfully, forcing Congress to get right with its constituents. TARP lived.
Now that investors are feeling a little better about their portfolios, Congress is feeling its oats again and becoming, well, democratic. Cacophony is in the nature of democracies, and Washington is very natural these days. Wall Street compensation is leaping and bounding again, as is unemployment on Main Street. So there's lots of grist for the condemnation mill.
One hundred schools of populism have bloomed and now contend. We have tea parties, Sarah Palin book parties, increasingly unpredictable independent voters, Lou Dobbs resigning from CNN with an indication that he might enter politics (Sarah, watch your right flank--this guy is your real competition), and more. Militia movements awaken from hibernation. Guns and ammo sales boom amidst rising prices (the firearms industry loves Democratic presidents). The bi-coastal elites that control the Democratic Party misunderstand just about all of this. The guns and ammo sales, and reawakened militias, aren't an indication of increasingly violent tendencies so much as an expression of uncertainty and fear, a way to feel like you're protecting yourself because you don't think you can count on the government. Tea parties, Palin, Dobbs, Glenn Beck and the like find support because citizens feel that no one in Washington speaks for them.
The federal government's ability to function could be critical to economic recovery. The economy last year stepped back from the abyss because of massive governmental intervention. Even today, the economy and stock market are all government, all the time. As long as the Fed promises to keep interest rates at zero, the dollar remains weak and the stock market moves up (a somewhat dysfunctional correlation since a weak dollar will ultimately undermine America's way to borrow its way out of recession). But if the Fed's policy were to change, the market and perhaps the economy would do a 180 muy pronto.
The next 11 months, leading up to the fall 2010 elections, will be a crucial test for the federal government. Health care reform is essential. Federal financial regulation must be altered to prevent, well, a helluva lot of things. No more too big to fail banks. No more runaway, unregulated derivatives markets. No more stupid mortgage loans to people who have no demonstrated ability to pay. No more easing back on bank capital requirements as assets are bubbling and leverage is booming.
People in Washington are talking past each other; indeed, sailing past in the dead of night. And that's just the Democrats. The Republicans don't even look at the Democrats when they speak, but instead the TV cameras and their potential campaign donors. We know at this point that there won't be any bipartisan marshmellow roasts where Kumbaya tops the charts. But we have an economy and financial system that are all government, all the time. If the government doesn't function, at least minimally, the economic recovery, ever so fragile, will become evanescent.
Meanwhile, in the next ring of this circus, Congressional criticism of Treasury Secretary Timothy Geithner is increasing in volume and stridency. Some have called for his resignation. Geithner, who doesn't have the professorial detachment that may be Bernanke's best PR weapon, forgot to smile.
In the third ring of the federal circus, swing votes in Congress dig in their heels in opposition to a public health plan for the uninsured, even as a majority of the public supports one. The administration seems to be ducking for cover behind both sides of this fence.
The level of federal dysfunction has risen along with the Dow. When the markets were plunging a year ago, there was near unanimity in Washington. The one time Congress got fussy, initially voting down TARP, stocks nosedived. An overnight plunge in 401(k) accounts concentrated legislators' minds wonderfully, forcing Congress to get right with its constituents. TARP lived.
Now that investors are feeling a little better about their portfolios, Congress is feeling its oats again and becoming, well, democratic. Cacophony is in the nature of democracies, and Washington is very natural these days. Wall Street compensation is leaping and bounding again, as is unemployment on Main Street. So there's lots of grist for the condemnation mill.
One hundred schools of populism have bloomed and now contend. We have tea parties, Sarah Palin book parties, increasingly unpredictable independent voters, Lou Dobbs resigning from CNN with an indication that he might enter politics (Sarah, watch your right flank--this guy is your real competition), and more. Militia movements awaken from hibernation. Guns and ammo sales boom amidst rising prices (the firearms industry loves Democratic presidents). The bi-coastal elites that control the Democratic Party misunderstand just about all of this. The guns and ammo sales, and reawakened militias, aren't an indication of increasingly violent tendencies so much as an expression of uncertainty and fear, a way to feel like you're protecting yourself because you don't think you can count on the government. Tea parties, Palin, Dobbs, Glenn Beck and the like find support because citizens feel that no one in Washington speaks for them.
The federal government's ability to function could be critical to economic recovery. The economy last year stepped back from the abyss because of massive governmental intervention. Even today, the economy and stock market are all government, all the time. As long as the Fed promises to keep interest rates at zero, the dollar remains weak and the stock market moves up (a somewhat dysfunctional correlation since a weak dollar will ultimately undermine America's way to borrow its way out of recession). But if the Fed's policy were to change, the market and perhaps the economy would do a 180 muy pronto.
The next 11 months, leading up to the fall 2010 elections, will be a crucial test for the federal government. Health care reform is essential. Federal financial regulation must be altered to prevent, well, a helluva lot of things. No more too big to fail banks. No more runaway, unregulated derivatives markets. No more stupid mortgage loans to people who have no demonstrated ability to pay. No more easing back on bank capital requirements as assets are bubbling and leverage is booming.
People in Washington are talking past each other; indeed, sailing past in the dead of night. And that's just the Democrats. The Republicans don't even look at the Democrats when they speak, but instead the TV cameras and their potential campaign donors. We know at this point that there won't be any bipartisan marshmellow roasts where Kumbaya tops the charts. But we have an economy and financial system that are all government, all the time. If the government doesn't function, at least minimally, the economic recovery, ever so fragile, will become evanescent.
Thursday, November 19, 2009
The Strange Pricing of Money
Strangely enough, the economies of the United States and all other major countries rest on prices set by the government. Market forces establish most prices. Governments--specifically, central banks--set the price of money.
The price of money is usually seen as the interest rate paid for loans. In general, central banks set short term interest rates for loans they make to banks, and for interbank loans (i.e., loans between banks). The Federal Reserve in the United States does this primarily through its discount rate, and the fed funds target rate. In addition, the Federal Reserve has gone farther than usual during the current economic crisis by purchasing large quantities of Treasury securities and mortgage-backed securities in order to hold down long term interest rates.
Federally prescribed interest rates are tools for combating economic problems. As the economy nosedives, the Fed lowers interest rates in order to soften the impact of the plunge and foster recovery. When inflation flares, the Fed raises interest rates in order to dampen pricing pressures.
It goes without saying that political considerations affect the government's pricing of money. In order to stave off a depression, the Fed last year reduced its fed funds target to a range of 0 to 0.25%, about as low as you can go. The European Central Bank, created against the backdrop of the German hyperinflation of the 1920s and the political extremism it fueled, focuses primarily on keeping prices stable, and was less aggressive on cutting rates.
Market forces seem to have little to do with government pricing of money. Commercial and consumer loan markets set the price of individual and corporate creditworthiness, with recognition (most of the time) that not everyone will repay a loan. But the price of money itself is set by governments to advance governmental goals.
How does the government know what price for money is right? Without the interaction of supply and demand to settle upon an equilibrium, can the government establish a price level that allocates resources efficiently? Or will it set a price that is politically expedient but not economically sound?
The pure time value of money, without considering credit risk, inflation or other factors, is believed to be somewhere around 3%. At the beginning of 2001, the fed funds rate was targeted by the Federal Reserve at 6%. Inflation in 2000 was 3.4% (as measured by the CPI-U), so a 6% fed funds target rate pretty much squared with the natural time value of money. But as the tech stock bubble collapsed, and then the 9/11/01 bombings took place, the Fed went whole hog for stimulus, lowering the fed funds target to 1.75% by the end of 2001. It didn't stop there, reducing the fed funds rate to 1.25% late in 2002 and to 1% in June 2003. Inflation averaged just under 2% per year from 2001 to 2003. When inflation is added to the 3% pure time value of money, one would have expected a free market to offer interest rates of around 5%. So the government's pricing of money was, in effect, negative. It shouldn't be surprising that everyone in the country with a pulse and a signature wanted a mortgage loan, regardless of their ability to pay. Giveaways attract interest. And this giveaway pumped up a big bubble in the housing and credit markets. We know the rest of the story.
Today, inflation in the last year is just barely negative, and the fed funds target rate is just barely positive. So another government sponsored giveaway is in progress. The Fed's purpose--revival of the economy--is salutory. But market forces, even when ignored or disrupted, have a way of coming back at you. A shipload of stimulus/accommodation/bailout money is funneling overseas via the carry trade to revive commodities prices and the economies of other nations. Fed governors seem to believe asset bubbles to be theoretical and not to be found in the wild. Foreign officials have already expressed concern over ongoing dollar-driven asset bubbles. Add to this continuing questions about how mere green shoots could support a 60% stock market rally in the last eight months, and the specter of asset bubbles grows.
Other cheap federal money sits on bank balance sheets, waiting to offset likely writedowns for yet more real estate lending losses. Scant portions of federal money have reached the real economy.
With so little federal money reaching the real economy, the question arises whether today the Fed's pricing of money allocates resources efficiently and spurs productive economic activity. GDP is growing again. But that's to a large degree because the federal government portion of GDP is growing. Take away this statistical effect, and the picture is less rosy. The government can always pump up GDP statistics by borrowing or printing more money. But with unemployment rising, there is a serious question how much good it's actually doing.
It would seem that for the second time this decade, the Fed has mispriced money. The first time, it produced gross distortions in the real estate and credit markets. There are signs it's producing more distortions now. Realistically, no modern industrialized economy can exist without fiat money (i.e., government issued currency). Complex economies require enormous amounts of exchange to circulate, and there isn't enough gold, silver and copper in the world to accommodate the need. But when the government misprices its currency, bad things will happen. Market forces, one way or another, will clear. It took them a while during the recent real estate and credit boom to bust, but bust they did and how. The Fed's stated intention of keeping short term interest rates at zero for the foreseeable, extended future is coming dangerously close to violating the law of unintended consequences.
The price of money is usually seen as the interest rate paid for loans. In general, central banks set short term interest rates for loans they make to banks, and for interbank loans (i.e., loans between banks). The Federal Reserve in the United States does this primarily through its discount rate, and the fed funds target rate. In addition, the Federal Reserve has gone farther than usual during the current economic crisis by purchasing large quantities of Treasury securities and mortgage-backed securities in order to hold down long term interest rates.
Federally prescribed interest rates are tools for combating economic problems. As the economy nosedives, the Fed lowers interest rates in order to soften the impact of the plunge and foster recovery. When inflation flares, the Fed raises interest rates in order to dampen pricing pressures.
It goes without saying that political considerations affect the government's pricing of money. In order to stave off a depression, the Fed last year reduced its fed funds target to a range of 0 to 0.25%, about as low as you can go. The European Central Bank, created against the backdrop of the German hyperinflation of the 1920s and the political extremism it fueled, focuses primarily on keeping prices stable, and was less aggressive on cutting rates.
Market forces seem to have little to do with government pricing of money. Commercial and consumer loan markets set the price of individual and corporate creditworthiness, with recognition (most of the time) that not everyone will repay a loan. But the price of money itself is set by governments to advance governmental goals.
How does the government know what price for money is right? Without the interaction of supply and demand to settle upon an equilibrium, can the government establish a price level that allocates resources efficiently? Or will it set a price that is politically expedient but not economically sound?
The pure time value of money, without considering credit risk, inflation or other factors, is believed to be somewhere around 3%. At the beginning of 2001, the fed funds rate was targeted by the Federal Reserve at 6%. Inflation in 2000 was 3.4% (as measured by the CPI-U), so a 6% fed funds target rate pretty much squared with the natural time value of money. But as the tech stock bubble collapsed, and then the 9/11/01 bombings took place, the Fed went whole hog for stimulus, lowering the fed funds target to 1.75% by the end of 2001. It didn't stop there, reducing the fed funds rate to 1.25% late in 2002 and to 1% in June 2003. Inflation averaged just under 2% per year from 2001 to 2003. When inflation is added to the 3% pure time value of money, one would have expected a free market to offer interest rates of around 5%. So the government's pricing of money was, in effect, negative. It shouldn't be surprising that everyone in the country with a pulse and a signature wanted a mortgage loan, regardless of their ability to pay. Giveaways attract interest. And this giveaway pumped up a big bubble in the housing and credit markets. We know the rest of the story.
Today, inflation in the last year is just barely negative, and the fed funds target rate is just barely positive. So another government sponsored giveaway is in progress. The Fed's purpose--revival of the economy--is salutory. But market forces, even when ignored or disrupted, have a way of coming back at you. A shipload of stimulus/accommodation/bailout money is funneling overseas via the carry trade to revive commodities prices and the economies of other nations. Fed governors seem to believe asset bubbles to be theoretical and not to be found in the wild. Foreign officials have already expressed concern over ongoing dollar-driven asset bubbles. Add to this continuing questions about how mere green shoots could support a 60% stock market rally in the last eight months, and the specter of asset bubbles grows.
Other cheap federal money sits on bank balance sheets, waiting to offset likely writedowns for yet more real estate lending losses. Scant portions of federal money have reached the real economy.
With so little federal money reaching the real economy, the question arises whether today the Fed's pricing of money allocates resources efficiently and spurs productive economic activity. GDP is growing again. But that's to a large degree because the federal government portion of GDP is growing. Take away this statistical effect, and the picture is less rosy. The government can always pump up GDP statistics by borrowing or printing more money. But with unemployment rising, there is a serious question how much good it's actually doing.
It would seem that for the second time this decade, the Fed has mispriced money. The first time, it produced gross distortions in the real estate and credit markets. There are signs it's producing more distortions now. Realistically, no modern industrialized economy can exist without fiat money (i.e., government issued currency). Complex economies require enormous amounts of exchange to circulate, and there isn't enough gold, silver and copper in the world to accommodate the need. But when the government misprices its currency, bad things will happen. Market forces, one way or another, will clear. It took them a while during the recent real estate and credit boom to bust, but bust they did and how. The Fed's stated intention of keeping short term interest rates at zero for the foreseeable, extended future is coming dangerously close to violating the law of unintended consequences.
Tuesday, November 17, 2009
Bernie Madoff's Ponzi Scheme is Cleaned Up While the Federal Scheme Keeps on Rolling
How much would you pay for Jesse James' revolver? He was highly felonious, robbing numerous banks and taking a role in many murders. But his revolver, if it ever were auctioned, would probably sell in the millions. Crime, as long as it's notorious, confers value. We saw this last weekend.
The federal marshalls' auction of Bernie and Ruth's paraphernalia produced some surprisingly large bids. A pair of diamond earrings thought to be worth $21,400 went for $70,000. Bernie's Mets jacket went for $14,500. A wooden duck decoy thought to be worth $60 went for $4,750. A pair of boogie boards estimated at $90 went for $1,000. Someone even paid $500 for a table made from a tree trunk, saying he hoped Bernie had stashed some money inside it. (This is a long shot; Bernie didn't have to salt away money since he could always rip off another investor if he needed more cash.) All told, the auction yielded over $900,000, well over the $500,000 or so that was expected.
Some of the aggressive bidding could come from the eBay effect--put "Madoff" into the Search function on eBay and you'll see a few of the auctioned items already for sale. Since you can't flip houses today, try Bernie's and Ruth's belongings. Other buyers may be biding their time, as the continuing Madoff saga leads to more prosecutions, further revelations and enhanced value for his erstwhile possessions. Still other buyers may hold onto their acquisitions, feeling good about owning something that once belonged to someone who was seriously bad.
Meanwhile, back at the ranch, the U.S. government continues to operate the biggest Ponzi scheme of all. The official federal debt will probably end the year over $12 trillion, around 90% of the U.S. Gross Domestic Product. Ten years ago, it was under 60% of GDP. By 2011, it will probably exceed 100% of GDP. And we're not counting unbooked liabilities from Social Security, Medicare, Medicaid, Fannie Mae, Freddie Mac, FHA and continued bank bailouts. Let's not even go there because the RAM in most personal computers can't handle numbers that large.
America's government debt will never be repaid. It's gotten too big. The government pays debt coming due by finding new lenders or convincing holders of old debt to roll their investments over. The government is lucky that the dollar is the world's reserve currency, or it would be up a poorly lit creek. (For more on this point, see http://blogger.uncleleosden.com/2009/11/is-federal-government-tempted-by-moral.html.)
Using new loans to pay off old loans isn't by itself illegal. Many corporations do that with their bonds and commercial paper. All banks fund daily operations that way. A Ponzi scheme differs from legitimate enterprise because the bad guys don't use the money they take in to operate bona fide businesses. They pocket it and use it to buy cars, jewelry, houses, clothing, vacations, expensive meals and so on. In short, it's used for consumption.
What does the U.S. government do with all its borrowed money? Stuff that looks suspiciously like consumption. Most government operations aren't meant to generate profits. Law enforcement and regulation protect lives and property. The courts are there to resolve disputes. The President is supposed to manage the Executive branch departments and provide leadership. The legislative process is supposed to do something useful, although what that might be seems to have been lost in the mists of time. These operations are not intended to yield dividends or create wealth. They are forms of consumption. So, too, is most of the federal stimulus spending. And the federal bailouts and accommodations that are never repaid (which could total to a large amount) will end up as consumption.
Granted, not personal consumption. But that simply means that the federal government isn't operating an illegal Ponzi scheme. Since the government survives mainly by wheedling money out of Peter to pay Paul, its finances sure look like some kind of Ponzi scheme. To make things worse, nowadays when Peter doesn't have enough cash to cover all the government's spending, the Federal Reserve simply prints money. Indeed, trillions of dollars worth. Paul gets . . . paper spun out of thin air.
Recent comments by Chairman Bernanke and other governors indicate that the Fed isn't about to pull back those printed dollars. The Fed's balance sheet will apparently stay its Brobdingnagian size as far into the future as one can foresee. The latest thinking at the Fed about "withdrawing" liquidity seems to be that it would pay higher interest rates on member bank deposits at Federal Reserve banks. That would put a floor under fed fund rates, and arguably reduce interbank lending (and thereby constrain overall lending). But the target for fed fund rates these days is zero to 0.25%, so even if the Fed pays 0.2% and effectively prevents fed fund rates from going below 0.2%, how much will lending be constrained? The hot, new thing in the financial markets is the carry trade, where speculators borrow dollars, convert them into foreign currencies, and invest overseas for returns expected to be a shipload larger than 0.25%. A 0.2% interest rate on member bank deposits won't constrain an unemployed novice day trader let alone a multi-billion dollar hedge fund. We hesitate to delve into anathema, but the Fed needs to raise its fed funds target rate before it will constrain much of anything.
So we have a government ponzi scheme, which gives itself a boost by printing money whenever it can't find new lenders. What a racket. No wonder the Chinese and other foreign creditors of America are nervous.
There is a way out of the federal Ponzi scheme--a marked increase in federal tax revenues, which is devoted to debt repayment. That could come from a brisk resumption of economic growth or by increasing taxes. The former seems as likely as Godot's arrival. The latter may happen, although the additional tax dollars don't seem destined for debt reduction.
Nevertheless, let's accentuate the positive. With all these freshly minted dollars floating around, it's understandable why the bids at the Madoff auction were higher than expected. Bernie's victims, at least, can be grateful for federal profligacy.
The federal marshalls' auction of Bernie and Ruth's paraphernalia produced some surprisingly large bids. A pair of diamond earrings thought to be worth $21,400 went for $70,000. Bernie's Mets jacket went for $14,500. A wooden duck decoy thought to be worth $60 went for $4,750. A pair of boogie boards estimated at $90 went for $1,000. Someone even paid $500 for a table made from a tree trunk, saying he hoped Bernie had stashed some money inside it. (This is a long shot; Bernie didn't have to salt away money since he could always rip off another investor if he needed more cash.) All told, the auction yielded over $900,000, well over the $500,000 or so that was expected.
Some of the aggressive bidding could come from the eBay effect--put "Madoff" into the Search function on eBay and you'll see a few of the auctioned items already for sale. Since you can't flip houses today, try Bernie's and Ruth's belongings. Other buyers may be biding their time, as the continuing Madoff saga leads to more prosecutions, further revelations and enhanced value for his erstwhile possessions. Still other buyers may hold onto their acquisitions, feeling good about owning something that once belonged to someone who was seriously bad.
Meanwhile, back at the ranch, the U.S. government continues to operate the biggest Ponzi scheme of all. The official federal debt will probably end the year over $12 trillion, around 90% of the U.S. Gross Domestic Product. Ten years ago, it was under 60% of GDP. By 2011, it will probably exceed 100% of GDP. And we're not counting unbooked liabilities from Social Security, Medicare, Medicaid, Fannie Mae, Freddie Mac, FHA and continued bank bailouts. Let's not even go there because the RAM in most personal computers can't handle numbers that large.
America's government debt will never be repaid. It's gotten too big. The government pays debt coming due by finding new lenders or convincing holders of old debt to roll their investments over. The government is lucky that the dollar is the world's reserve currency, or it would be up a poorly lit creek. (For more on this point, see http://blogger.uncleleosden.com/2009/11/is-federal-government-tempted-by-moral.html.)
Using new loans to pay off old loans isn't by itself illegal. Many corporations do that with their bonds and commercial paper. All banks fund daily operations that way. A Ponzi scheme differs from legitimate enterprise because the bad guys don't use the money they take in to operate bona fide businesses. They pocket it and use it to buy cars, jewelry, houses, clothing, vacations, expensive meals and so on. In short, it's used for consumption.
What does the U.S. government do with all its borrowed money? Stuff that looks suspiciously like consumption. Most government operations aren't meant to generate profits. Law enforcement and regulation protect lives and property. The courts are there to resolve disputes. The President is supposed to manage the Executive branch departments and provide leadership. The legislative process is supposed to do something useful, although what that might be seems to have been lost in the mists of time. These operations are not intended to yield dividends or create wealth. They are forms of consumption. So, too, is most of the federal stimulus spending. And the federal bailouts and accommodations that are never repaid (which could total to a large amount) will end up as consumption.
Granted, not personal consumption. But that simply means that the federal government isn't operating an illegal Ponzi scheme. Since the government survives mainly by wheedling money out of Peter to pay Paul, its finances sure look like some kind of Ponzi scheme. To make things worse, nowadays when Peter doesn't have enough cash to cover all the government's spending, the Federal Reserve simply prints money. Indeed, trillions of dollars worth. Paul gets . . . paper spun out of thin air.
Recent comments by Chairman Bernanke and other governors indicate that the Fed isn't about to pull back those printed dollars. The Fed's balance sheet will apparently stay its Brobdingnagian size as far into the future as one can foresee. The latest thinking at the Fed about "withdrawing" liquidity seems to be that it would pay higher interest rates on member bank deposits at Federal Reserve banks. That would put a floor under fed fund rates, and arguably reduce interbank lending (and thereby constrain overall lending). But the target for fed fund rates these days is zero to 0.25%, so even if the Fed pays 0.2% and effectively prevents fed fund rates from going below 0.2%, how much will lending be constrained? The hot, new thing in the financial markets is the carry trade, where speculators borrow dollars, convert them into foreign currencies, and invest overseas for returns expected to be a shipload larger than 0.25%. A 0.2% interest rate on member bank deposits won't constrain an unemployed novice day trader let alone a multi-billion dollar hedge fund. We hesitate to delve into anathema, but the Fed needs to raise its fed funds target rate before it will constrain much of anything.
So we have a government ponzi scheme, which gives itself a boost by printing money whenever it can't find new lenders. What a racket. No wonder the Chinese and other foreign creditors of America are nervous.
There is a way out of the federal Ponzi scheme--a marked increase in federal tax revenues, which is devoted to debt repayment. That could come from a brisk resumption of economic growth or by increasing taxes. The former seems as likely as Godot's arrival. The latter may happen, although the additional tax dollars don't seem destined for debt reduction.
Nevertheless, let's accentuate the positive. With all these freshly minted dollars floating around, it's understandable why the bids at the Madoff auction were higher than expected. Bernie's victims, at least, can be grateful for federal profligacy.
Sunday, November 15, 2009
Currency Exchange Rates: Playing Musical Chairs with Fire
Currency exchange rates have been much in the news as President Obama makes his first visit to China. The dollar is sinking, and China has ensured that its yuan falls in tandem with the dollar. Other nations, disadvantaged by the drop in two of the most important currencies in the world, complain vociferously. The U.S. government proclaims a strong dollar policy, and then looks away as the dollar continues to fall. The Chinese government scolds the U.S. government, which lectures back.
The currency markets are different from other markets. They don't just consist of private buyers and sellers. Governments also get involved, and generally do so for political and macro-economic reasons. Since nothing is as unpredictable as politics, currency exchange rates can move in ways that seem seriously out of whack.
To make things worse, currency exchange fluctuations are, at best, a zero-sum game. One currency's gain comes at the expense of other currencies, and resulting trade imbalances have a similar effect on the nations issuing the currencies. Only today, it's worse than that. Two powerful nations--America and China--rely on policies that may produce near term gains for them but potential longer term losses for everyone. The currency markets may now be a negative sum game.
For decades, China has linked the yuan to the dollar. Thirty years ago, the rate was about 8 yuan to the dollar. Today, it's around 6.8 yuan to the dollar. By contrast, the Japanese yen has tripled in value against the dollar during the same time period. The yuan has never been fully convertible into other currencies, as China has sought to prevent the rapid inflows and outflows of foreign capital that have bedeviled the development of other Third World nations. Considering the devastation wreaked in Asia by the 1997-98 financial crisis, one would have to concede that the Chinese have a point. They aren't unvarnished capitalists, and won't allow markets to operate freely simply as a matter of principle. They utilize market forces pragmatically, mixing in government dictat whenever they believe Adam Smith's invisible hand may be a little shaky. By holding the the yuan relatively steady against the dollar, they ensure pricing stability for their exports to dollar bloc nations (i.e., nations that use the dollar or maintain currency stability against the dollar, including the U.S. and, at times, various nations in Latin America). Chinese manufacturers could largely ignore the complexities and costs of currency fluctuations and commit to low, fixed prices to buyers abroad.
China's fixed exchange rate did much to make China a dominant exporter. But it had to take a lot of dollars in exchange--ultimately trillions of dollars. These were mostly invested in U.S. Treasury securities and American mortgage-backed securities (on which the Chinese have already taken nasty losses resulting from the mortgage crisis). Now, as the dollar falls in value, China loses more money on these assets. Hence, China's scoldings to the U.S. government to get its house in order and prop up the greenback.
The U.S. government in turn has countered that China is itself responsible for this dilemma, having created the trade imbalance that resulted in its enormous dollar holdings. The U.S. government would have China restructure its economy to focus on domestic consumption, and reduce exports to take pressure off the dollar.
However, neither government is doing much to change the status quo. China's government has launched a major stimulus program to forestall economic slowdown, with much of its spending directed at building infrastructure. These are wise expenditures for a developing nation, but they do little to promote domestic consumption. The Chinese are among the world's most frugal people, because they have no other choice. China has no Social Security system. Most Chinese have no pensions; the pensions that exist are meager. The health insurance that was part of Communist China's iron rice bowl has disappeared along with sales of Chairman Mao's little red book. The Chinese save because it's the only way they can have health care and a half-way decent retirement. The Chinese government has done nothing to alter this dynamic. Since China needs about 8% economic growth every year simply to keep up with population growth, it has no choice except to keep exporting. And to do that, it has to keep its currency stable against the dollar.
The U.S. government has responded to America's economic crisis primarily by borrowing and printing dollars--shiploads of dollars. Pushed by the forces of a lot of supply and not so much demand, the dollar has not surprisingly fallen in value. Euro bloc nations have grumbled about the rise of the Euro, especially export-dependent Germany. Several smaller Asian exporting nations have recently been buying dollars in order to defend their currencies. Oil exporters, like Russia and the OPEC nations, have complained of losses in their holdings of dollar-denominated assets and hinted at pricing oil in a basket of currencies to free themselves of dollar risk. In short, the U.S. government's primary response to the economic crisis has imposed losses on the rest of the world.
The flood of the cheap money being pumped out by the Fed has fueled the "carry trade," in which speculators borrow dollars at extremely low interest rates, convert them into currencies where interest rates are higher (such as in much of Asia) and invest overseas for those higher returns. This outflow of dollars is stimulating economic activity in other nations, and appears to be creating asset bubbles in Asia. While other nations don't mind a touch of stimulus courtesy of the Fed, many in Asia have vivid and disturbing memories of the Asian financial crisis of 1997-98, when asset bubbles fueled by inflows of foreign capital burst painfully and caused severe recessions.
There is little sign that the U.S. government intends to pull its stimulus back. The Fed has made clear its intention to maintain zero interest rates as far into the future as one can foresee. The carry trade will expand and perhaps even explode--in a time of slow economic recovery, it's one of the very few ways to make fast money. China will complain and lecture, but won't change the exchange rate of the yuan by much, because it needs continued access to American markets. Other exporting nations will grumble and defend their currencies with little likelihood of long term success. Oil exporters and other holders of dollars (including China and Japan) will take more losses on their dollar reserves, as there is no other currency or asset into which they can easily transfer their wealth.
American and Chinese expediency have created dangerous dynamics in the world economy. America can win only if other nations continue to fund its gigantic deficits and tolerate its uncontrolled printing of dollars by taking losses as the dollar falls. China can win only if it continues to export to America and hope that other nations will help it fund America's deficits while they become more vulnerable to Chinese exports themselves. The rest of the world is scrambling to figure out how to limit its losses and avoid being blown up by carry trade asset bubbles. Everyone, one way or another, is trying to shift their economic problems to other nations, a process that won't have a happy ending. This is starting to look like a game of musical chairs where the limited number of chairs is diminishing and all could end up net losers. If, somehow, the people running these nations would stop playing a children's game.
The currency markets are different from other markets. They don't just consist of private buyers and sellers. Governments also get involved, and generally do so for political and macro-economic reasons. Since nothing is as unpredictable as politics, currency exchange rates can move in ways that seem seriously out of whack.
To make things worse, currency exchange fluctuations are, at best, a zero-sum game. One currency's gain comes at the expense of other currencies, and resulting trade imbalances have a similar effect on the nations issuing the currencies. Only today, it's worse than that. Two powerful nations--America and China--rely on policies that may produce near term gains for them but potential longer term losses for everyone. The currency markets may now be a negative sum game.
For decades, China has linked the yuan to the dollar. Thirty years ago, the rate was about 8 yuan to the dollar. Today, it's around 6.8 yuan to the dollar. By contrast, the Japanese yen has tripled in value against the dollar during the same time period. The yuan has never been fully convertible into other currencies, as China has sought to prevent the rapid inflows and outflows of foreign capital that have bedeviled the development of other Third World nations. Considering the devastation wreaked in Asia by the 1997-98 financial crisis, one would have to concede that the Chinese have a point. They aren't unvarnished capitalists, and won't allow markets to operate freely simply as a matter of principle. They utilize market forces pragmatically, mixing in government dictat whenever they believe Adam Smith's invisible hand may be a little shaky. By holding the the yuan relatively steady against the dollar, they ensure pricing stability for their exports to dollar bloc nations (i.e., nations that use the dollar or maintain currency stability against the dollar, including the U.S. and, at times, various nations in Latin America). Chinese manufacturers could largely ignore the complexities and costs of currency fluctuations and commit to low, fixed prices to buyers abroad.
China's fixed exchange rate did much to make China a dominant exporter. But it had to take a lot of dollars in exchange--ultimately trillions of dollars. These were mostly invested in U.S. Treasury securities and American mortgage-backed securities (on which the Chinese have already taken nasty losses resulting from the mortgage crisis). Now, as the dollar falls in value, China loses more money on these assets. Hence, China's scoldings to the U.S. government to get its house in order and prop up the greenback.
The U.S. government in turn has countered that China is itself responsible for this dilemma, having created the trade imbalance that resulted in its enormous dollar holdings. The U.S. government would have China restructure its economy to focus on domestic consumption, and reduce exports to take pressure off the dollar.
However, neither government is doing much to change the status quo. China's government has launched a major stimulus program to forestall economic slowdown, with much of its spending directed at building infrastructure. These are wise expenditures for a developing nation, but they do little to promote domestic consumption. The Chinese are among the world's most frugal people, because they have no other choice. China has no Social Security system. Most Chinese have no pensions; the pensions that exist are meager. The health insurance that was part of Communist China's iron rice bowl has disappeared along with sales of Chairman Mao's little red book. The Chinese save because it's the only way they can have health care and a half-way decent retirement. The Chinese government has done nothing to alter this dynamic. Since China needs about 8% economic growth every year simply to keep up with population growth, it has no choice except to keep exporting. And to do that, it has to keep its currency stable against the dollar.
The U.S. government has responded to America's economic crisis primarily by borrowing and printing dollars--shiploads of dollars. Pushed by the forces of a lot of supply and not so much demand, the dollar has not surprisingly fallen in value. Euro bloc nations have grumbled about the rise of the Euro, especially export-dependent Germany. Several smaller Asian exporting nations have recently been buying dollars in order to defend their currencies. Oil exporters, like Russia and the OPEC nations, have complained of losses in their holdings of dollar-denominated assets and hinted at pricing oil in a basket of currencies to free themselves of dollar risk. In short, the U.S. government's primary response to the economic crisis has imposed losses on the rest of the world.
The flood of the cheap money being pumped out by the Fed has fueled the "carry trade," in which speculators borrow dollars at extremely low interest rates, convert them into currencies where interest rates are higher (such as in much of Asia) and invest overseas for those higher returns. This outflow of dollars is stimulating economic activity in other nations, and appears to be creating asset bubbles in Asia. While other nations don't mind a touch of stimulus courtesy of the Fed, many in Asia have vivid and disturbing memories of the Asian financial crisis of 1997-98, when asset bubbles fueled by inflows of foreign capital burst painfully and caused severe recessions.
There is little sign that the U.S. government intends to pull its stimulus back. The Fed has made clear its intention to maintain zero interest rates as far into the future as one can foresee. The carry trade will expand and perhaps even explode--in a time of slow economic recovery, it's one of the very few ways to make fast money. China will complain and lecture, but won't change the exchange rate of the yuan by much, because it needs continued access to American markets. Other exporting nations will grumble and defend their currencies with little likelihood of long term success. Oil exporters and other holders of dollars (including China and Japan) will take more losses on their dollar reserves, as there is no other currency or asset into which they can easily transfer their wealth.
American and Chinese expediency have created dangerous dynamics in the world economy. America can win only if other nations continue to fund its gigantic deficits and tolerate its uncontrolled printing of dollars by taking losses as the dollar falls. China can win only if it continues to export to America and hope that other nations will help it fund America's deficits while they become more vulnerable to Chinese exports themselves. The rest of the world is scrambling to figure out how to limit its losses and avoid being blown up by carry trade asset bubbles. Everyone, one way or another, is trying to shift their economic problems to other nations, a process that won't have a happy ending. This is starting to look like a game of musical chairs where the limited number of chairs is diminishing and all could end up net losers. If, somehow, the people running these nations would stop playing a children's game.
Wednesday, November 11, 2009
Techniques for Retirement Saving
Technique matters a lot in tennis, golf, basketball and a host of other sports and activities. It also matters to investors. If a middle income American approaches investing--especially long term retirement saving--the right way, he or she can be hundreds of thousands of dollars better off when receiving the retirement watch, than someone's whose technique is poor. Here are a few basic pointers that can take you a long way.
Calculate your net worth regularly. Keeping score is essential. You have to know if you're making progress. You'll need to know when you're not making progress or losing ground, so you can take action to turn the tide. Knowledge can be painful in times of market downturns, but avoiding reality won't improve your retirement finances. You may or may not have a fixed saving goal. Having a goal is good, but not essential. See http://blogger.uncleleosden.com/2007/04/goals-for-retirement-saving-and-why.html. But it's essential to know where you stand. That knowledge alone will keep you focused on building wealth for the future. Calculate your net worth at least every three months. See http://blogger.uncleleosden.com/2007/04/secret-to-building-wealth.html.
Automate the saving process and use retirement accounts. Participate in any 401(k) or equivalent retirement plan your employer may offer. Maximize the amount you contribute. Some people think you might want to contribute only enough to get an employer match and then contribute to a Roth IRA; this isn't a bad idea but you have to be conscientious about the Roth contributions because they aren't necessarily automatic (read on for the solution to this problem). If you don't have access to an employer sponsored plan, open an IRA--or a Roth IRA if you think your future tax rates will be higher than today's--and arrange with your bank to have funds transferred every month (or every two weeks if you are paid on a biweekly basis) to the IRA. It's a good idea to use retirement accounts like 401(k)s and IRAs because they are separate from your regular bank and securities accounts, and the money in them is harder to spend before retirement. For more information, see http://blogger.uncleleosden.com/2007/04/automate-to-accumulate.html.
Average returns take you to Lake Wobegon. Money managers (such as those at actively managed mutual funds) usually don't perform as well as market averages like the S&P 500. There are a number of reasons for this, including their higher trading costs and their compensation. But the bottom line is you are likely to end up with less. Focus on long term gains. Stick with index funds and other low cost investments. If you aim to get the market average for a return, you'll probably end up doing better than average. For more, see http://blogger.uncleleosden.com/2007/06/why-average-investor-does-well.html.
Keep it simple. Investing is, among other things, a sales transaction. A financial firm is the seller and you're the buyer. Complexity favors sellers and places you at a disadvantage. The seller will naturally know more about the product than you will. The law requires that sellers of financial products make a variety of disclosures to buyers. But even if those disclosures are made, the seller will probably still have a better understanding of the product than you will. So you may have trouble figuring out if the product is truly to your advantage. The complexity of some annuities and other insurance products, and some leveraged ETFs, is so great as to make them virtually opaque. Investing in opacity isn't a good idea. Complex products also tend to have higher costs, which negatively impact investor returns. Stick to index funds, and maybe some individual stocks and bonds. Plain old bank CDs aren't bad when the markets seem turbulent. If you don't understand a financial product, avoid it.
The easiest budget of all--save a good percentage of your income (especially if you're self-employed). Budgeting sucks and it seems like every month something comes up that you didn't anticipate. Then, there are the "discussions" with your significant other about how much should be allocated to what expenses, and also last week's rampage off the budget. If you want a simple way to budget, don't focus on how much you spend, but instead on how much you save. Target a good-sized percentage of your monthly income (10% is good, 15% is much better, and 20% is a home run), and make sure that come hell or high water you save at least that much. If replacing your car's exhaust system one month prevents you from hitting your goal, then add enough more the next month or two so that you backfill the deficit. The percentage-of-income-saved method allows you to avoid a lot of handwringing over lattes or not, and inter-spousal sniping, while meeting retirement goals. If you can consistently save 15% to 20% of your earnings over the course of a 30 to 40 year career, you could end up with enough to pretty much maintain your pre-retirement lifestyle during your golden years. If you're self-employed and have an uneven income, it's particularly important to save a good-sized percentage of your income because you can't easily automate the saving process. For more, see http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html.
Build your benefits. Even though private sector employers are abandoning pensions faster than New York high society abandoned Bernie and Ruth Madoff, just about everyone has the equivalent of a pension through the Social Security system. Although much maligned and stereotyped, Social Security is the port in the storm for tens of millions of Americans. The longer you work, the greater your benefits will be. Even though the level of Social Security benefits is subject to the whim and caprice of Congress, the tenure of members of Congress is subject to the whim and caprice of voters (including most of the tens of millions of Social Securities recipients). Whatever Congress may do in the future about Social Security benefits, it won't destroy the system and you'll be better off by working longer. If you're fortunate enough to have access to a pension, work as long as you can to boost your benefits. You'll sleep better, without having to buy a new mattress, if you can count on the automatic deposit of a monthly check. For more, see http://blogger.uncleleosden.com/2007/05/how-to-retire-without-saving.html.
Attitude. Perhaps the most important factor, but the hardest one to control, is how you view money and saving. If you look at them the right way, you'll do fine. Understand that you have a finite stream of income during your life. If you spend your money, you can't save it. It's gone forever, and you're left with the now diminished remainder of your finite stream of lifetime income. Saving is a choice, not a sacrifice. Money saved now builds security for the future. Because your lifetime income is finite, you can economize now or economize later. Consider that eating dog food in your old age probably won't be a high point of your life. Remember that savings generate returns that can be compounded, so they may increase your finite lifetime income. Save enough, and you'll hit a financial home run by compounding. (See http://blogger.uncleleosden.com/2009/09/if-you-love-compounding-compounding.html.) This isn't about being greedy in an unseemly way or living like a pauper during your working years. It's about common sense and living within your means. If you adopt the right attitude, you'll establish control over your finances, and that will give you a very good feeling.
Calculate your net worth regularly. Keeping score is essential. You have to know if you're making progress. You'll need to know when you're not making progress or losing ground, so you can take action to turn the tide. Knowledge can be painful in times of market downturns, but avoiding reality won't improve your retirement finances. You may or may not have a fixed saving goal. Having a goal is good, but not essential. See http://blogger.uncleleosden.com/2007/04/goals-for-retirement-saving-and-why.html. But it's essential to know where you stand. That knowledge alone will keep you focused on building wealth for the future. Calculate your net worth at least every three months. See http://blogger.uncleleosden.com/2007/04/secret-to-building-wealth.html.
Automate the saving process and use retirement accounts. Participate in any 401(k) or equivalent retirement plan your employer may offer. Maximize the amount you contribute. Some people think you might want to contribute only enough to get an employer match and then contribute to a Roth IRA; this isn't a bad idea but you have to be conscientious about the Roth contributions because they aren't necessarily automatic (read on for the solution to this problem). If you don't have access to an employer sponsored plan, open an IRA--or a Roth IRA if you think your future tax rates will be higher than today's--and arrange with your bank to have funds transferred every month (or every two weeks if you are paid on a biweekly basis) to the IRA. It's a good idea to use retirement accounts like 401(k)s and IRAs because they are separate from your regular bank and securities accounts, and the money in them is harder to spend before retirement. For more information, see http://blogger.uncleleosden.com/2007/04/automate-to-accumulate.html.
Average returns take you to Lake Wobegon. Money managers (such as those at actively managed mutual funds) usually don't perform as well as market averages like the S&P 500. There are a number of reasons for this, including their higher trading costs and their compensation. But the bottom line is you are likely to end up with less. Focus on long term gains. Stick with index funds and other low cost investments. If you aim to get the market average for a return, you'll probably end up doing better than average. For more, see http://blogger.uncleleosden.com/2007/06/why-average-investor-does-well.html.
Keep it simple. Investing is, among other things, a sales transaction. A financial firm is the seller and you're the buyer. Complexity favors sellers and places you at a disadvantage. The seller will naturally know more about the product than you will. The law requires that sellers of financial products make a variety of disclosures to buyers. But even if those disclosures are made, the seller will probably still have a better understanding of the product than you will. So you may have trouble figuring out if the product is truly to your advantage. The complexity of some annuities and other insurance products, and some leveraged ETFs, is so great as to make them virtually opaque. Investing in opacity isn't a good idea. Complex products also tend to have higher costs, which negatively impact investor returns. Stick to index funds, and maybe some individual stocks and bonds. Plain old bank CDs aren't bad when the markets seem turbulent. If you don't understand a financial product, avoid it.
The easiest budget of all--save a good percentage of your income (especially if you're self-employed). Budgeting sucks and it seems like every month something comes up that you didn't anticipate. Then, there are the "discussions" with your significant other about how much should be allocated to what expenses, and also last week's rampage off the budget. If you want a simple way to budget, don't focus on how much you spend, but instead on how much you save. Target a good-sized percentage of your monthly income (10% is good, 15% is much better, and 20% is a home run), and make sure that come hell or high water you save at least that much. If replacing your car's exhaust system one month prevents you from hitting your goal, then add enough more the next month or two so that you backfill the deficit. The percentage-of-income-saved method allows you to avoid a lot of handwringing over lattes or not, and inter-spousal sniping, while meeting retirement goals. If you can consistently save 15% to 20% of your earnings over the course of a 30 to 40 year career, you could end up with enough to pretty much maintain your pre-retirement lifestyle during your golden years. If you're self-employed and have an uneven income, it's particularly important to save a good-sized percentage of your income because you can't easily automate the saving process. For more, see http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html.
Build your benefits. Even though private sector employers are abandoning pensions faster than New York high society abandoned Bernie and Ruth Madoff, just about everyone has the equivalent of a pension through the Social Security system. Although much maligned and stereotyped, Social Security is the port in the storm for tens of millions of Americans. The longer you work, the greater your benefits will be. Even though the level of Social Security benefits is subject to the whim and caprice of Congress, the tenure of members of Congress is subject to the whim and caprice of voters (including most of the tens of millions of Social Securities recipients). Whatever Congress may do in the future about Social Security benefits, it won't destroy the system and you'll be better off by working longer. If you're fortunate enough to have access to a pension, work as long as you can to boost your benefits. You'll sleep better, without having to buy a new mattress, if you can count on the automatic deposit of a monthly check. For more, see http://blogger.uncleleosden.com/2007/05/how-to-retire-without-saving.html.
Attitude. Perhaps the most important factor, but the hardest one to control, is how you view money and saving. If you look at them the right way, you'll do fine. Understand that you have a finite stream of income during your life. If you spend your money, you can't save it. It's gone forever, and you're left with the now diminished remainder of your finite stream of lifetime income. Saving is a choice, not a sacrifice. Money saved now builds security for the future. Because your lifetime income is finite, you can economize now or economize later. Consider that eating dog food in your old age probably won't be a high point of your life. Remember that savings generate returns that can be compounded, so they may increase your finite lifetime income. Save enough, and you'll hit a financial home run by compounding. (See http://blogger.uncleleosden.com/2009/09/if-you-love-compounding-compounding.html.) This isn't about being greedy in an unseemly way or living like a pauper during your working years. It's about common sense and living within your means. If you adopt the right attitude, you'll establish control over your finances, and that will give you a very good feeling.
Tuesday, November 10, 2009
Car Savings
If you're thinking of buying a car, don't just look at the price, mileage and cost of a loan. Some of the biggest expenses of car ownership come after you drive it off the lot, and they aren't well advertised. Here are some of the unpleasant surprises that await buyers of both new and used cars who don't carefully research their purchases.
Tires. Car manufacturers are increasingly using high performance tires to boost the driving experience of their products. The designs of high performance tires are taken from racing tires, and use softer rubber compounds to keep a grip on the road. This means the tires wear out faster and cost more to replace. Some high performance tires cost $500 each, meaning you have to spend $2,000 for 4 tires. This expense may come as soon as 20,000 miles and isn't covered by any warranty. Standard, black high wall tires, by contrast, cost around $100 to $150 each to replace, and can last 50,000 miles or more (depending on how you drive and how well you take care of the tires). You probably shouldn't replace high performance tires with standard tires, since each car's suspension is designed to be complemented by tires like the original equipment. So a car with high-performance tires can become a money pit.
Maintenance and repair costs. Many higher end cars, especially luxury nameplates like Mercedes Benz and BMW, are amazingly expensive to maintain and repair. Lexus and Volvo aren't cheap, either. Repairs on American cars that might cost hundreds can cost thousands for some high end cars. Part of the reason is that the parts are imported, and cost more because of the weak dollar. Also, the technology and design embodied in these cars can be more complex than in other cars. We also suspect that some of the cost is simply because the dealerships think they can get away with it because people expect high end cars to be expensive. Whatever the reasons, research maintenance and repair costs before buying.
Insurance. Insurance costs catch a lot of buyers by surprise. Small, inexpensive, fuel efficient cars like the Toyota Corolla, Honda Civic and so on can be more expensive to insure than a big old sedan like a Ford Crown Victoria or a mid-size SUV. A lot of the reason is smaller cars provide less protection in a collision. Also, because they are popular, they are stolen pretty often (for parts). Of course, your individual cost of insurance depends on your driving record, the state in which you live, the insurance company you use (shop around) and how large your deductibles are. But keep in mind the additional insurance expense of an "economy" model.
Depreciation. Models with established reputations for reliability and longevity depreciate more slowly than other cars. Toyotas and Hondas generally depreciate more slowly than Chryslers, Chevrolets and Fords. As American manufacturers improve quality, the depreciation rates on their models should improve. Research depreciation. It's a hidden cost that doesn't seem to matter while you own the car. But when you decide to trade it in, you'll find out that depreciation can be important.
Remember to use competition in your favor. When buying a new car, trying e-mailing the Internet departments of several dealerships for a price. You can easily get a quote lower than the showroom floor price. See http://blogger.uncleleosden.com/2007/05/buy-new-car-without-haggling-and-save.html.
Tires. Car manufacturers are increasingly using high performance tires to boost the driving experience of their products. The designs of high performance tires are taken from racing tires, and use softer rubber compounds to keep a grip on the road. This means the tires wear out faster and cost more to replace. Some high performance tires cost $500 each, meaning you have to spend $2,000 for 4 tires. This expense may come as soon as 20,000 miles and isn't covered by any warranty. Standard, black high wall tires, by contrast, cost around $100 to $150 each to replace, and can last 50,000 miles or more (depending on how you drive and how well you take care of the tires). You probably shouldn't replace high performance tires with standard tires, since each car's suspension is designed to be complemented by tires like the original equipment. So a car with high-performance tires can become a money pit.
Maintenance and repair costs. Many higher end cars, especially luxury nameplates like Mercedes Benz and BMW, are amazingly expensive to maintain and repair. Lexus and Volvo aren't cheap, either. Repairs on American cars that might cost hundreds can cost thousands for some high end cars. Part of the reason is that the parts are imported, and cost more because of the weak dollar. Also, the technology and design embodied in these cars can be more complex than in other cars. We also suspect that some of the cost is simply because the dealerships think they can get away with it because people expect high end cars to be expensive. Whatever the reasons, research maintenance and repair costs before buying.
Insurance. Insurance costs catch a lot of buyers by surprise. Small, inexpensive, fuel efficient cars like the Toyota Corolla, Honda Civic and so on can be more expensive to insure than a big old sedan like a Ford Crown Victoria or a mid-size SUV. A lot of the reason is smaller cars provide less protection in a collision. Also, because they are popular, they are stolen pretty often (for parts). Of course, your individual cost of insurance depends on your driving record, the state in which you live, the insurance company you use (shop around) and how large your deductibles are. But keep in mind the additional insurance expense of an "economy" model.
Depreciation. Models with established reputations for reliability and longevity depreciate more slowly than other cars. Toyotas and Hondas generally depreciate more slowly than Chryslers, Chevrolets and Fords. As American manufacturers improve quality, the depreciation rates on their models should improve. Research depreciation. It's a hidden cost that doesn't seem to matter while you own the car. But when you decide to trade it in, you'll find out that depreciation can be important.
Remember to use competition in your favor. When buying a new car, trying e-mailing the Internet departments of several dealerships for a price. You can easily get a quote lower than the showroom floor price. See http://blogger.uncleleosden.com/2007/05/buy-new-car-without-haggling-and-save.html.
Sunday, November 8, 2009
Big Ticket Savings
If you've just been downsized, or have had your hours or pay cut, or you just want to stop the flood of money out of your wallet, saving is on your mind. Cutting out the $4 lattes helps, and over time can really add up. But economizing on small items takes years to have a big impact. If you've suddenly gone from being well-ensconced in the middle class to thinking about food stamps, you need big savings fast. Housing is the largest monthly expense for most households, but one that's very difficult to change. Here are some ideas for more immediate ways to save.
Cars. Keep your old car longer. Other than housing, few things cost a typical household more than the expense and depreciation of a new car. If you're part of a multi-car household, think about getting rid of one car. Drive less. Public transportation and/or carpooling are usually cheaper than driving your own car.
Home Cooking. Cut back on restaurant meals--and especially the bar tabs. Home cooking is generally less expensive, and you have much more control over the ingredients. Some restaurants dump salt, sugar and fat by the truckload on their dishes, for a variety of nefarious reasons. A home cooked meal can be quite tasty and satisfying without half the bad stuff. If you don't know how to cook, stay out of restaurants, buy a week's worth of frozen pizzas and TV dinners at the supermarket, and by the end of the week, you'll be avidly learning to cook.
Clothes. When you get down to it, most clothes purchases are discretionary, not essential. Cut back, and look for sales and discounts. You need a work wardrobe. But you don't have to dress like royalty at home or at the supermarket.
Entertainment. Entertainment is ultimately something that happens between your ears. You have control over what you find entertaining, and it doesn't need to involve a lot of money. When you were 18 and broke just about all the time, you probably had quite a few good times. You still can, even if you're broke today.
Shop for less. If you're a shopaholic, stop going to the mall. Shop at thrift shops, Goodwill and garage sales. Go to places where you can buy interesting stuff for less than $5 or even $2. That way, you can buy lots but not spend much.
Reduce your income. If you're still employed with a good income, arrange for some of your paycheck to be automatically transferred from your checking account into another account. It can be a savings account, a money market account, a mutual fund account or wherever else you might like. That way, you'll automatically save something without having to consciously decide what you have to do without. You'll have less spending money, and the thing of it is that you'll adjust to spending less.
Cars. Keep your old car longer. Other than housing, few things cost a typical household more than the expense and depreciation of a new car. If you're part of a multi-car household, think about getting rid of one car. Drive less. Public transportation and/or carpooling are usually cheaper than driving your own car.
Home Cooking. Cut back on restaurant meals--and especially the bar tabs. Home cooking is generally less expensive, and you have much more control over the ingredients. Some restaurants dump salt, sugar and fat by the truckload on their dishes, for a variety of nefarious reasons. A home cooked meal can be quite tasty and satisfying without half the bad stuff. If you don't know how to cook, stay out of restaurants, buy a week's worth of frozen pizzas and TV dinners at the supermarket, and by the end of the week, you'll be avidly learning to cook.
Clothes. When you get down to it, most clothes purchases are discretionary, not essential. Cut back, and look for sales and discounts. You need a work wardrobe. But you don't have to dress like royalty at home or at the supermarket.
Entertainment. Entertainment is ultimately something that happens between your ears. You have control over what you find entertaining, and it doesn't need to involve a lot of money. When you were 18 and broke just about all the time, you probably had quite a few good times. You still can, even if you're broke today.
Shop for less. If you're a shopaholic, stop going to the mall. Shop at thrift shops, Goodwill and garage sales. Go to places where you can buy interesting stuff for less than $5 or even $2. That way, you can buy lots but not spend much.
Reduce your income. If you're still employed with a good income, arrange for some of your paycheck to be automatically transferred from your checking account into another account. It can be a savings account, a money market account, a mutual fund account or wherever else you might like. That way, you'll automatically save something without having to consciously decide what you have to do without. You'll have less spending money, and the thing of it is that you'll adjust to spending less.
Thursday, November 5, 2009
Is the Federal Government Tempted by Moral Hazard?
The British government recently announced that it is thinking of breaking up the big British banks in order to avoid having institutions that are too big to fail. The U.S. government, by contrast, contemplates maintaining its de facto too-big-to-fail policy and building regulatory reform around it.
The British approach has the beauty of simplicity and the sensibility of placing limits. Smaller institutions, with effective controls over the amount of leverage and derivatives exposure they can take on, would be less likely to blow up counterparties. They would probably be less complex, engaging in fewer types of activities, and would therefore be easier to regulate. The system as a whole would be healthier. British taxpayers would sleep better.
In America, however, size and complexity remain. Regulators mostly believe that they can effectively oversee the behemoths they in part helped to create through mergers they strongly encouraged of failing firms with stronger ones. Perhaps they've also been subtly influenced by the industry's belief that size confers competitive advantages.
But the size advantage of America's big banks is meaningful only because the federal government backs them up. If there were no too-big-to-fail doctrine, the size of these institutions might frighten counterparties concerned about unseen exposures. The sheer complexity of the big banks on an operational level, something that not all their chief executives could master, would heighten counterparty fears of another AIG, where risks of its credit default swap operations weren't apparent to most market participants (and perhaps its executive management) until too late.
The U.S. government is able to back up America's big banks to a large degree because of the dollar's unique position among currencies as the world's reserve currency. Much and perhaps most of the world sees the dollar as a reservoir of value, and it's still used in international transactions far more than any other currency. In order to support the banking system, the U.S. government (primarily the Federal Reserve) has driven short term interest rates to zero while printing trillions of dollars. If any other country had taken these steps, its currency would have collapsed. But the dollar is special and the U.S. government can pull sh . . . stuff that no other government can pull.
That's a concern. On Halloween, when children have unusually easy access to candy, it's hardly surprising that they go on sugar binges. Wall Street banks were no different when they thought they could make money underwriting mortgage-backed securities based on loans to borrowers who had no verified income, employment, or assets, because they supposedly could pass the credit default risk onto investors. The banks, too, went on a binge--and we've all got a hangover from that one.
Federal officials are human, and it wouldn't be surprising if they've been tempted by the dollar's reserve status to push the edge of the envelope. The idea behind monetary and fiscal stimulus is that it triggers consumption and investment, which in turn spur more economic activity, which then pushes the virtuous circle farther along with new rounds of consumption and investment, etc. But the fiscal stimulus has been slow and spotty, and the monetary intervention seems to have put a lot of money in the big banks' reserves instead of being loaned out, or to have been sent overseas via the carry trade to stimulate the economies (or at least the investment assets) of foreign nations. The credit crunch hasn't gone away; it's simply shifted from Wall Street to Main Street.
Sugar binges ultimately have bad consequences, as do binges of poor mortgage underwriting. A federal monetary and fiscal binge isn't likely to be any different. If things fall apart, it's likely to have really, really bad consequences, because the U.S. government may have taken advantage of the dollar's reserve currency status to binge more merrily than a government that knew its limits.
The British learned prudence after World War II, when the United States deliberately displaced the pound sterling as the world's reserve currency with the dollar. The British government's 1992 attempt to intervene against hedge fund speculation in the pound was a dismal failure, reinforcing the lesson that currencies, like all other things economic, are subject to the laws of supply and demand. The U.S. government, triumphant after victories in World War II and the Cold War, acts as if the sun will never set on the all mighty greenback. The Fed, in its statement yesterday, continued to forecast zero interest rates over an extended period of time, in effect promising its print shop employees oodles of overtime pay for the foreseeable future. This enthusiastic wallowing in moral hazard is reminiscent of the British government's eagerness to borrow from America to pay for World War II. The Lend Lease Program, which gave the Brits multiple dollars for each dollar they actually repaid, was perhaps the biggest "wink and nod" ever in government-to-government lending. But that only ensured British insolvency at the end of the war, and when Britain asked for yet another loan after Japan's surrender, America's terms, in essence, probably accelerated the dissolution of the British empire. Britain had no choice but to agree (and repay this loan in full as well, with payment completed in 2006).
America's foreign creditors--China, Japan, oil producing nations and others--can do little in the near term about the federal government's profligacy other than preach and make subtle threats. They, indeed, have an interest in America's prosperity. But the more chits they hold, the more leverage they will have. At some point, they'll pull the plug on America, just as America pulled the plug on Britain. Not because of animosity--even today, Britain remains America's closest ally--but simply because it's in their interests to do so. America's system of national accounting doesn't very clearly balance assets against liabilities--indeed, it mostly focuses on national income (as measured by GDP) without much consideration of the costs, risks and liabilities connected with producing that income. There are no federal reserves to tide us over hard times (like many states' rainy day funds). We are in deep yogurt, but there is scant federal data revealing that problem.
The essential, unstated premise of federal economic policy today seems to be that by using the relatively painless process of printing money, we can get something for . . . well . . . basically, nothing. With the indulgence in moral hazard that the dollar's role as reserve currency allows, it's easy for the federal government, almost unconsciously, to reach this conclusion. The big banks on Wall Street now understand that they have to beware of the risks of moral hazard. If only this understanding extended to the government . . . because not every day can be Halloween.
The British approach has the beauty of simplicity and the sensibility of placing limits. Smaller institutions, with effective controls over the amount of leverage and derivatives exposure they can take on, would be less likely to blow up counterparties. They would probably be less complex, engaging in fewer types of activities, and would therefore be easier to regulate. The system as a whole would be healthier. British taxpayers would sleep better.
In America, however, size and complexity remain. Regulators mostly believe that they can effectively oversee the behemoths they in part helped to create through mergers they strongly encouraged of failing firms with stronger ones. Perhaps they've also been subtly influenced by the industry's belief that size confers competitive advantages.
But the size advantage of America's big banks is meaningful only because the federal government backs them up. If there were no too-big-to-fail doctrine, the size of these institutions might frighten counterparties concerned about unseen exposures. The sheer complexity of the big banks on an operational level, something that not all their chief executives could master, would heighten counterparty fears of another AIG, where risks of its credit default swap operations weren't apparent to most market participants (and perhaps its executive management) until too late.
The U.S. government is able to back up America's big banks to a large degree because of the dollar's unique position among currencies as the world's reserve currency. Much and perhaps most of the world sees the dollar as a reservoir of value, and it's still used in international transactions far more than any other currency. In order to support the banking system, the U.S. government (primarily the Federal Reserve) has driven short term interest rates to zero while printing trillions of dollars. If any other country had taken these steps, its currency would have collapsed. But the dollar is special and the U.S. government can pull sh . . . stuff that no other government can pull.
That's a concern. On Halloween, when children have unusually easy access to candy, it's hardly surprising that they go on sugar binges. Wall Street banks were no different when they thought they could make money underwriting mortgage-backed securities based on loans to borrowers who had no verified income, employment, or assets, because they supposedly could pass the credit default risk onto investors. The banks, too, went on a binge--and we've all got a hangover from that one.
Federal officials are human, and it wouldn't be surprising if they've been tempted by the dollar's reserve status to push the edge of the envelope. The idea behind monetary and fiscal stimulus is that it triggers consumption and investment, which in turn spur more economic activity, which then pushes the virtuous circle farther along with new rounds of consumption and investment, etc. But the fiscal stimulus has been slow and spotty, and the monetary intervention seems to have put a lot of money in the big banks' reserves instead of being loaned out, or to have been sent overseas via the carry trade to stimulate the economies (or at least the investment assets) of foreign nations. The credit crunch hasn't gone away; it's simply shifted from Wall Street to Main Street.
Sugar binges ultimately have bad consequences, as do binges of poor mortgage underwriting. A federal monetary and fiscal binge isn't likely to be any different. If things fall apart, it's likely to have really, really bad consequences, because the U.S. government may have taken advantage of the dollar's reserve currency status to binge more merrily than a government that knew its limits.
The British learned prudence after World War II, when the United States deliberately displaced the pound sterling as the world's reserve currency with the dollar. The British government's 1992 attempt to intervene against hedge fund speculation in the pound was a dismal failure, reinforcing the lesson that currencies, like all other things economic, are subject to the laws of supply and demand. The U.S. government, triumphant after victories in World War II and the Cold War, acts as if the sun will never set on the all mighty greenback. The Fed, in its statement yesterday, continued to forecast zero interest rates over an extended period of time, in effect promising its print shop employees oodles of overtime pay for the foreseeable future. This enthusiastic wallowing in moral hazard is reminiscent of the British government's eagerness to borrow from America to pay for World War II. The Lend Lease Program, which gave the Brits multiple dollars for each dollar they actually repaid, was perhaps the biggest "wink and nod" ever in government-to-government lending. But that only ensured British insolvency at the end of the war, and when Britain asked for yet another loan after Japan's surrender, America's terms, in essence, probably accelerated the dissolution of the British empire. Britain had no choice but to agree (and repay this loan in full as well, with payment completed in 2006).
America's foreign creditors--China, Japan, oil producing nations and others--can do little in the near term about the federal government's profligacy other than preach and make subtle threats. They, indeed, have an interest in America's prosperity. But the more chits they hold, the more leverage they will have. At some point, they'll pull the plug on America, just as America pulled the plug on Britain. Not because of animosity--even today, Britain remains America's closest ally--but simply because it's in their interests to do so. America's system of national accounting doesn't very clearly balance assets against liabilities--indeed, it mostly focuses on national income (as measured by GDP) without much consideration of the costs, risks and liabilities connected with producing that income. There are no federal reserves to tide us over hard times (like many states' rainy day funds). We are in deep yogurt, but there is scant federal data revealing that problem.
The essential, unstated premise of federal economic policy today seems to be that by using the relatively painless process of printing money, we can get something for . . . well . . . basically, nothing. With the indulgence in moral hazard that the dollar's role as reserve currency allows, it's easy for the federal government, almost unconsciously, to reach this conclusion. The big banks on Wall Street now understand that they have to beware of the risks of moral hazard. If only this understanding extended to the government . . . because not every day can be Halloween.
Tuesday, November 3, 2009
Investing Hint: Sometimes, Just Say No
So where do you put your money now? Stocks are uneasy, Treasuries are slipping back, gold and oil are dicey, and real estate is unpredictable. Corporate and muni bonds may be okay, but you have to be careful and selective. Simply buying a corporate or muni bond fund may get you a lot of garbage as well as gems. Asia, especially China, has enjoyed good economic growth, so perhaps you think Asian stocks might be a good bet. But one wonders whether the carry trade, now consisting of borrowing U.S. dollars at dirt cheap interest rates and converting them into another currency for investment overseas, isn't responsible for a lot of the pop in Asia. If so, it would be nice that the Federal Reserve is financing much of the resurgence in Asia. But the Fed may gradually withdraw its accommodation. And Asia remains export driven; it will be dependent on a strong U.S. recovery for long term growth, and few are expecting the U.S. to be the consumption wonder it was earlier this decade.
Sometimes, there are few or even no good investments. The fall of 2008 was one such time, when numerous investors came to understand why their grandfathers of the Depression era liked so much to carry a roll of $200 or $300 in their pockets. Cash felt good.
We may be entering such a time period now. There's nothing on the investment horizon that looks like a screaming buy. There isn't much that looks more than tepid. There's no law of investing that says you have be fully invested. Holding some or even a lot of cash is perfectly okay. Mutual fund and hedge fund managers often feel they need to be fully invested. But that's because they compete against other professionals. They don't want to run the risk of missing a rally and doing less well than other professionals. If a professional money manager stays fully invested and crashes into a bear market instead, that's usually not as bad because numerous other money managers suffered the same losses from also being fully invested. Just remember that most professional money managers don't even manage to beat broad market indexes like the S&P 500. So if you want to pretty much ensure that you won't keep up with the market as a whole, stay fully invested like the other losers.
If you have some uninvested cash, this may be a time to just say no to new investments. Take your time and wait for a good opportunity. If you hold cash for a year and miss out of turbulent markets, you may be better off. Even with this year's rally, the stock market is where it was in 1999, without adjusting for inflation. That's ten years of no gains (and indeed losses if you factor in inflation). If you had taken all your available capital in 1999 and put it in a money market fund, you'd be ahead today by a nontrivial amount. In the last ten years, the nervous Nellie turtles have beaten the hare.
Holding cash isn't a long term investing strategy, and it's advisable to go back into stocks, bonds and perhaps other investments eventually. This, of course, involves some market timing. But, notwithstanding all the expert advice against market timing, large swaths of the investing public do it. So do highly successful investors like Warren Buffet, and more recently John Paulson. There's no guarantee that holding cash now and for the next six, twelve or however many months will be more profitable than diving into something or other. But trying too hard can lead to mistakes. If you aren't sure that the goose you're looking at will lay golden eggs, keep your cards close to your vest and play them when the odds look better.
Sometimes, there are few or even no good investments. The fall of 2008 was one such time, when numerous investors came to understand why their grandfathers of the Depression era liked so much to carry a roll of $200 or $300 in their pockets. Cash felt good.
We may be entering such a time period now. There's nothing on the investment horizon that looks like a screaming buy. There isn't much that looks more than tepid. There's no law of investing that says you have be fully invested. Holding some or even a lot of cash is perfectly okay. Mutual fund and hedge fund managers often feel they need to be fully invested. But that's because they compete against other professionals. They don't want to run the risk of missing a rally and doing less well than other professionals. If a professional money manager stays fully invested and crashes into a bear market instead, that's usually not as bad because numerous other money managers suffered the same losses from also being fully invested. Just remember that most professional money managers don't even manage to beat broad market indexes like the S&P 500. So if you want to pretty much ensure that you won't keep up with the market as a whole, stay fully invested like the other losers.
If you have some uninvested cash, this may be a time to just say no to new investments. Take your time and wait for a good opportunity. If you hold cash for a year and miss out of turbulent markets, you may be better off. Even with this year's rally, the stock market is where it was in 1999, without adjusting for inflation. That's ten years of no gains (and indeed losses if you factor in inflation). If you had taken all your available capital in 1999 and put it in a money market fund, you'd be ahead today by a nontrivial amount. In the last ten years, the nervous Nellie turtles have beaten the hare.
Holding cash isn't a long term investing strategy, and it's advisable to go back into stocks, bonds and perhaps other investments eventually. This, of course, involves some market timing. But, notwithstanding all the expert advice against market timing, large swaths of the investing public do it. So do highly successful investors like Warren Buffet, and more recently John Paulson. There's no guarantee that holding cash now and for the next six, twelve or however many months will be more profitable than diving into something or other. But trying too hard can lead to mistakes. If you aren't sure that the goose you're looking at will lay golden eggs, keep your cards close to your vest and play them when the odds look better.
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