The war in Afghanistan will wind down for NATO troops. That's clear from today's news. Leon Panetta will take over the Defense Department from Robert Gates. Gen. David Petraeus will get Panetta's job running the CIA. Adm. Mike Mullen, Chairman of the Joint Chiefs of Staff, isn't eligible to be renominated. The chain of command that presided over last year's surge in Afghanistan is being dismantled. That's one of the easiest ways in Washington to change policy. Top officials don't have to change their minds; they just change jobs.
By drawing down forces in Afghanistan, President Obama would keep a campaign promise, and satisfy the wishes of the majority of Americans who recent polls indicate want the U.S. out of the war. Besides, there's more than one way to skin this cat. Today's Wall Street Journal reports on P. 1 that the Pakistani government has urged the Afghan government to join in an alliance with Pakistan and China. The Pakistanis, who may be worse enemies of America than the Afghans, are now more aggressively undermining America than ever before. America's relations with India are improving, and we may be better off easing out of Afghanistan and Pakistan, and exercising influence in South Asia by strengthening ties with New Dehli.
Meanwhile, back at the Fed, Chairman Bernanke did a fairly decent imitation of Alan Greenspan at the Fed's first ever press conference. Bernanke said . . . well, try to figure out what he said. The reaction of most listeners was to parse, then parse some more, and then parse some more. Greenspan was famous for lengthy vocalizations that meant little except, "I'm keeping my options open." Looks like Bernanke prepared for today by watching old game films from the Greenspan era.
The Fed itself released a statement earlier today, following its April meeting, in which it said it would stay the course. So the sum total of this month's Fed meeting and today's press conference is we know pretty much what we knew before. The stock market took it all positively, assuming that the Fed will keep the monetary printing presses rolling 24/7. Maybe. But Bernanke did keep all options open. His remarks that could mean QE3 is coming could also mean that the Fed will drain liquidity, depending on circumstances.
And that's the problem with today's Fed. Even though Ben Bernanke has said he wants to provide greater transparency, the tendency of the markets to pop or swoon over a lifted eyebrow or a hint of a frown has forced him to be measured, and then cautious, and today, simply ambiguous. He ends up telling us very little, which lets the markets interpret his remarks as they wish and force the Fed to follow their lead. Today's positive market reaction highlights the financial system's dependence on subsidies from the Fed, and increases the cost to the Fed of changing its policies. A fall in the stock market is virtually guaranteed whenever the Fed changes policies, and that puts enormous political pressure on the Fed to keep printing money indefinitely. By purporting to provide transparency, but not actually doing so, the Fed is losing control over monetary policy. All this is fine if no amount of money printing leads to significant inflation. If only we lived in Wonderland, where one can believe as many as six impossible things before breakfast.
Wednesday, April 27, 2011
Monday, April 25, 2011
A Question for the Chairman: Is the Fed Doing Its Part to Reduce the Federal Deficit?
This week, Chairman Ben Bernanke of the Federal Reserve holds the first ever press conference by a Fed Chairman. The wisdom of opening himself up to volleys of dumb, loaded, and unfair questions isn't crystal clear. Since, however, he's voluntarily decided to position the seat of his pants in the middle of a firing range, here's a question that should be posed to him.
It's Econ 101 that the lower the price of something, the more of it people will consume. Isn't the Fed making it easy for the federal government to run massive deficits by keeping interest rates ultra low?
The stated purpose of low interest rates is to stimulate the economy. But they also stimulate government borrowing. Look at Japan. Its public debt is something like 200% of its GDP (America's is around 70%). But interest rates in Japan are so low that the government's annual bill for borrowing all this moola isn't terribly painful. Most Japanese government debt is held by Japanese citizens, who seem perfectly willing to refinance the government every time its debt falls due, asking for scarcely any interest income at all. From an economic standpoint, it makes sense for the Japanese government to keep borrowing. Since it can roll over maturing debt at will for ultra low rates, it never really needs to control its deficits and can keep borrowing more at minimal interest expense. The U.S. Treasury, too, can easily roll over its debt at historically low prices. So its need to reduce deficits isn't pressing.
The Fed's low interest rate policy is inflating commodities and equities, but its impact beyond that is unclear. Big banks aren't increasing the net amounts of their loan portfolios and small businesses still limp along with working capital from their owners' credit cards. Real estate remains moribund, with more of the same expected for the future. Raising interest rates will make financial markets speculators unhappy. But let's remember that central bank manipulation of asset prices doesn't produce lasting prosperity, but indeed the opposite (for further reading, see 2007-08 financial crisis).
For all the political hoopla over deficits, reality is that money talks and bullsh . . . uh, political dialogue walks. What's forced Greece, Ireland, Portugal and other Euro bloc nations to rein in their spending? Not frowning bureaucrats in Brussels, but rising interest rates demanded by their creditors. Chairman Bernanke recently scolded Congress and the administration for not doing enough to reduce the deficit. Well, remember, Mr. Chairman, money talks and bu . . . well, you know. If you want the government to reduce the deficit, make it pay for borrowing.
It's Econ 101 that the lower the price of something, the more of it people will consume. Isn't the Fed making it easy for the federal government to run massive deficits by keeping interest rates ultra low?
The stated purpose of low interest rates is to stimulate the economy. But they also stimulate government borrowing. Look at Japan. Its public debt is something like 200% of its GDP (America's is around 70%). But interest rates in Japan are so low that the government's annual bill for borrowing all this moola isn't terribly painful. Most Japanese government debt is held by Japanese citizens, who seem perfectly willing to refinance the government every time its debt falls due, asking for scarcely any interest income at all. From an economic standpoint, it makes sense for the Japanese government to keep borrowing. Since it can roll over maturing debt at will for ultra low rates, it never really needs to control its deficits and can keep borrowing more at minimal interest expense. The U.S. Treasury, too, can easily roll over its debt at historically low prices. So its need to reduce deficits isn't pressing.
The Fed's low interest rate policy is inflating commodities and equities, but its impact beyond that is unclear. Big banks aren't increasing the net amounts of their loan portfolios and small businesses still limp along with working capital from their owners' credit cards. Real estate remains moribund, with more of the same expected for the future. Raising interest rates will make financial markets speculators unhappy. But let's remember that central bank manipulation of asset prices doesn't produce lasting prosperity, but indeed the opposite (for further reading, see 2007-08 financial crisis).
For all the political hoopla over deficits, reality is that money talks and bullsh . . . uh, political dialogue walks. What's forced Greece, Ireland, Portugal and other Euro bloc nations to rein in their spending? Not frowning bureaucrats in Brussels, but rising interest rates demanded by their creditors. Chairman Bernanke recently scolded Congress and the administration for not doing enough to reduce the deficit. Well, remember, Mr. Chairman, money talks and bu . . . well, you know. If you want the government to reduce the deficit, make it pay for borrowing.
Monday, April 18, 2011
Did the Fed Add to the Fall in Stocks?
Today, Standard and Poor's lowered its outlook on long term U.S. Treasury debt from "stable" to "negative". What happened? U.S. Treasuries went up in value.
Huh?
Market forces would have dictated that Treasuries should have fallen. In fact, they did drop immediately after the announcement. But then they rose, even while stocks fell. If anything, one would have expected stocks to do comparatively well. Investors might logically ditch Treasuries and buy stocks.
So what happened? One serious possibility is that the Fed was buying in the Treasury market big time today, as part of its quantitative easing program and perhaps as part of its open market operations as well. The last thing the Fed wants to see is a rise in interest rates. If a downdraft hits the Treasury market, the Fed would move quickly to counteract it.
All that's understandable, given the Fed's statutory mandate to maximize employment. But it's possible that the fast traders on Wall Street--which would be most of the market today-- saw an arbitrage opportunity. If you know the Fed will be a heavy buyer of Treasuries, then you'd think about ditching stocks to raise cash, buying Treasuries quickly when they first drop, and reselling them at a profit to the Fed as it revs up its buying. The smart traders on the Street like to take advantage of large buyers and sellers, who often provide such arbitrage opportunities. The really cynical smart money would, indeed, short sell stocks to profit from the expected downdraft. That, if it occurred, would have added to the downward spiral of stocks.
The Fed also doesn't want stocks to drop. That might cool the consumption of the well-to-do and hamper the economic recovery. But the Fed is a lumbering cow in a market full of wolves, and today's weird market action indicates the wolf packs were probably voracious.
Huh?
Market forces would have dictated that Treasuries should have fallen. In fact, they did drop immediately after the announcement. But then they rose, even while stocks fell. If anything, one would have expected stocks to do comparatively well. Investors might logically ditch Treasuries and buy stocks.
So what happened? One serious possibility is that the Fed was buying in the Treasury market big time today, as part of its quantitative easing program and perhaps as part of its open market operations as well. The last thing the Fed wants to see is a rise in interest rates. If a downdraft hits the Treasury market, the Fed would move quickly to counteract it.
All that's understandable, given the Fed's statutory mandate to maximize employment. But it's possible that the fast traders on Wall Street--which would be most of the market today-- saw an arbitrage opportunity. If you know the Fed will be a heavy buyer of Treasuries, then you'd think about ditching stocks to raise cash, buying Treasuries quickly when they first drop, and reselling them at a profit to the Fed as it revs up its buying. The smart traders on the Street like to take advantage of large buyers and sellers, who often provide such arbitrage opportunities. The really cynical smart money would, indeed, short sell stocks to profit from the expected downdraft. That, if it occurred, would have added to the downward spiral of stocks.
The Fed also doesn't want stocks to drop. That might cool the consumption of the well-to-do and hamper the economic recovery. But the Fed is a lumbering cow in a market full of wolves, and today's weird market action indicates the wolf packs were probably voracious.
Thursday, April 14, 2011
The Point Missed in the Budget Debate
It's become all the rage in Washington to froth over the federal deficit and produce sound bite-driven proposals on how to reduce it. In the relentless quest for media coverage, everyone involved in the budget debate has something accusatory to say about someone else. As in sports, trash talking and cheap shots get more attention than real accomplishments.
The lack of attention to real accomplishments allows an important point about the budget deficit to go unnoticed. When we talk about splitting up a pie, the size of the pie is crucial. A large, fast growing pie is much easier to divide than a smaller, slowly growing pie. A stagnant or shrinking pie can be poisonous to the debate. Right now, we have a slowly growing pie that may go stagnant or shrink soon given the rising costs of energy and food. And the debate is indeed poisonous.
We need to focus more on expanding the pie, not in the Federal Reserve short term-next quarter, money printing, inflation-risky way, but for the long term. We also can't look to the federal government to solve all our problems. At the risk of asking Americans to behave like adults, it would be better if we looked for some non-federal ways to boost long term economic growth. There is a limit to the effectiveness of federal policies, which are mostly subsidies and handouts, and we pretty much surpassed that limit a while ago. What should be done?
Embrace Innovation. Innovation was the key to America's spectacular growth in the past two centuries. Railroads, the telegraph, the telephone, the airplane, automation of farming, new energy technologies, electronics and computers were essential factors in making America an economic powerhouse. We celebrate the concept of innovation today, but don't encourage it enough. Immigration rules for the highly educated should be relaxed--we'll never recapture manufacturing from Asia, but we can try to bring more of their brainpower to America. Many of Asia's smartest people want to live here, at least for a while and maybe for the rest of their lives. Brains produce innovation; tariffs don't. America's economic future will be in the production of high value added goods and services. (And not, contrary to what the Fed thinks, a revival of housing, which can't be revived by the government because it remains buried under a crushing load of bad debt, and only politically unacceptable levels of taxpayer subsidies will revive housing.) Innovation was the key to America's past prosperity and will be the key to its future.
Hug nerds. America's educational system is roundly criticized for failing to teach many students the basics. That's a valid point, but we're too focused on making America's schools training facilities for corporate employers. Schools should also be a place for exploration and creative thinking. They're not. Today's elite universities' admissions standards place enormous emphasis on being well-rounded, having not only fantastic grades, but athletic achievement, public service, experience in the arts, internships left and right, and international travel. The people admitted will make good corporate executives, management consultants, corporate lawyers, accountants, and doctors. Those with good math skills may become Wall Streeters. Most likely, none will create innovative technologies or establish major businesses. It's not an accident that Bill Gates, Steve Jobs, and Larry Ellison were all college dropouts. (So was Mark Zuckerberg, although it's not yet clear if Facebook is a transformational company or a fad-and-fade like Yahoo.) America's leading universities don't embrace original thinkers; they favor compliant kids who know how to manipulate and please their elders. Today's elite schools don't encourage or even tolerate the wacked out thinking that transformational economic change requires. Gates, Jobs and Ellison had to swim upstream to accomplish what they did. One can only wonder how many dozens, hundreds and maybe thousands of other free thinking, but slightly less determined kids have been discouraged from fostering innovative change. We need to think outside the box to make America grow again, and one way would be to encourage, and indeed embrace, kids who think outside the box.
Improve transportation and communications. America is a big country. Look on a globe, and you'll find very few other countries as large. We need really good transportation systems, because ultimately goods and many services need to be physically delivered. One can't live off Internet access alone. State and federal governments in the 19th Century did a much better job in this respect than their counterparts today. The Erie Canal was sponsored by New York state. The railroads were subsidized by the federal government. In the 20th Century, air transportation and the interstate highway system were creations of federal policy, and local governments took on much of the burden of building suburban infrastructure. America became wealthy from the massive markets permitted by these government supported transportation systems. Today, highways need to be maintained, bridges repaired, and subway systems renovated and expanded. Suburban roads need maintenance and improvement--remember that most economic growth is in suburban areas, in spite of renewal in a few urban areas. Roads and other transportation systems don't have powerful lobbyists, so they are easily ignored. That is a serious mistake.
Fostering high-speed Internet access for all should be a priority. This would include hard wired access and wireless access. The easier it is to communicate, the more innovation we'll have. And, let's face it, the more consumption we'll have since we're approaching the point where you can buy almost anything over the Internet. Way too many people share way too much about themselves in the Internet. But speed of communication speeds up economic activity. Even if some people are tacky and tasteless, others will increase their productivity--and, along with it, our prosperity.
The lack of attention to real accomplishments allows an important point about the budget deficit to go unnoticed. When we talk about splitting up a pie, the size of the pie is crucial. A large, fast growing pie is much easier to divide than a smaller, slowly growing pie. A stagnant or shrinking pie can be poisonous to the debate. Right now, we have a slowly growing pie that may go stagnant or shrink soon given the rising costs of energy and food. And the debate is indeed poisonous.
We need to focus more on expanding the pie, not in the Federal Reserve short term-next quarter, money printing, inflation-risky way, but for the long term. We also can't look to the federal government to solve all our problems. At the risk of asking Americans to behave like adults, it would be better if we looked for some non-federal ways to boost long term economic growth. There is a limit to the effectiveness of federal policies, which are mostly subsidies and handouts, and we pretty much surpassed that limit a while ago. What should be done?
Embrace Innovation. Innovation was the key to America's spectacular growth in the past two centuries. Railroads, the telegraph, the telephone, the airplane, automation of farming, new energy technologies, electronics and computers were essential factors in making America an economic powerhouse. We celebrate the concept of innovation today, but don't encourage it enough. Immigration rules for the highly educated should be relaxed--we'll never recapture manufacturing from Asia, but we can try to bring more of their brainpower to America. Many of Asia's smartest people want to live here, at least for a while and maybe for the rest of their lives. Brains produce innovation; tariffs don't. America's economic future will be in the production of high value added goods and services. (And not, contrary to what the Fed thinks, a revival of housing, which can't be revived by the government because it remains buried under a crushing load of bad debt, and only politically unacceptable levels of taxpayer subsidies will revive housing.) Innovation was the key to America's past prosperity and will be the key to its future.
Hug nerds. America's educational system is roundly criticized for failing to teach many students the basics. That's a valid point, but we're too focused on making America's schools training facilities for corporate employers. Schools should also be a place for exploration and creative thinking. They're not. Today's elite universities' admissions standards place enormous emphasis on being well-rounded, having not only fantastic grades, but athletic achievement, public service, experience in the arts, internships left and right, and international travel. The people admitted will make good corporate executives, management consultants, corporate lawyers, accountants, and doctors. Those with good math skills may become Wall Streeters. Most likely, none will create innovative technologies or establish major businesses. It's not an accident that Bill Gates, Steve Jobs, and Larry Ellison were all college dropouts. (So was Mark Zuckerberg, although it's not yet clear if Facebook is a transformational company or a fad-and-fade like Yahoo.) America's leading universities don't embrace original thinkers; they favor compliant kids who know how to manipulate and please their elders. Today's elite schools don't encourage or even tolerate the wacked out thinking that transformational economic change requires. Gates, Jobs and Ellison had to swim upstream to accomplish what they did. One can only wonder how many dozens, hundreds and maybe thousands of other free thinking, but slightly less determined kids have been discouraged from fostering innovative change. We need to think outside the box to make America grow again, and one way would be to encourage, and indeed embrace, kids who think outside the box.
Improve transportation and communications. America is a big country. Look on a globe, and you'll find very few other countries as large. We need really good transportation systems, because ultimately goods and many services need to be physically delivered. One can't live off Internet access alone. State and federal governments in the 19th Century did a much better job in this respect than their counterparts today. The Erie Canal was sponsored by New York state. The railroads were subsidized by the federal government. In the 20th Century, air transportation and the interstate highway system were creations of federal policy, and local governments took on much of the burden of building suburban infrastructure. America became wealthy from the massive markets permitted by these government supported transportation systems. Today, highways need to be maintained, bridges repaired, and subway systems renovated and expanded. Suburban roads need maintenance and improvement--remember that most economic growth is in suburban areas, in spite of renewal in a few urban areas. Roads and other transportation systems don't have powerful lobbyists, so they are easily ignored. That is a serious mistake.
Fostering high-speed Internet access for all should be a priority. This would include hard wired access and wireless access. The easier it is to communicate, the more innovation we'll have. And, let's face it, the more consumption we'll have since we're approaching the point where you can buy almost anything over the Internet. Way too many people share way too much about themselves in the Internet. But speed of communication speeds up economic activity. Even if some people are tacky and tasteless, others will increase their productivity--and, along with it, our prosperity.
Monday, April 11, 2011
Corporate Earnings Will Be the Ball Game For Stocks
The headwinds in the stock market are rising. Government accommodation in major parts of the world is being dialed back. China is raising interest rates to cool growing inflation and a runaway economy. The Euro bloc is raising interest rates to combat inflation, in spite of a slow growing economy. Brazil is growing, but will have to battle serious inflation. Oil prices keep rising; $4 a gallon gas is a reality in most of the U.S., even if statistical averages haven't quite gotten there.
Black swans fill the air. Arab unrest has a whack-a-mole quality to it. No matter what is done to calm things down, eruptions get bigger and more widespread. Libya has stalemated, putting pressure on Western nations to join the ground war. Japan just elevated its nuclear crisis to Chernobyl status. And that's just the part the Japanese government has told us about. Considering that it hasn't been a paragon of transparency, one can only wonder what we don't know. Japan keeps having aftershocks that would qualify as big earthquakes anywhere else. Things aren't settling down there.
Portugal has just gone to the EU, hat in hand, to ask for a loan in the range of 80 billion Euros plus, following the path paved by Greece and Ireland. The Euro crisis is sliding downhill more or less as predicted. (Watercooler gossip has it that Spain will be next in line for a bailout.) As France takes the lead to spend Germany's money bailing out weaker EU nations, the markets snooze in the belief that creditors will be paid 100 cents on the Euro. Some day that won't be true. If you look at the Euro bloc as a whole, it's awash in debt. We have the lesson from the U.S. and other real estate markets that too much mortgage debt leads to bad things. That will also be true for sovereign debt.
The U.S. Federal Reserve is keeping its monetary printing press going 24/7. A majority of governors say they don't see any inflation, but would welcome it if it happened. That way, they can keep paying the print shop staff overtime no matter what. Meanwhile, back at the ranch, the poor consumer, whose wages aren't rising now or any time soon, is cutting back on driving while trying really hard to believe that beans and franks make a fine meal. Walmart just announced a return to every day low prices. That, as much as anything, tells you the consumer is under pressure. Since the U.S. economy is two-thirds consumption, the economy will soon be under pressure, too.
Stocks have more than doubled since their 2009 lows. Just about the only thing that can keep the bull running would be glowing corporate earnings. Alcoa was at the top of the order today, and whiffed. It reported greater earnings but disappointing revenues. Its stock is off about 3% in afterhours trading. Not a good beginning to the earnings season. If other companies follow Alcoa's lead, well . . . just tell yourself that beans and franks make a fine meal.
Black swans fill the air. Arab unrest has a whack-a-mole quality to it. No matter what is done to calm things down, eruptions get bigger and more widespread. Libya has stalemated, putting pressure on Western nations to join the ground war. Japan just elevated its nuclear crisis to Chernobyl status. And that's just the part the Japanese government has told us about. Considering that it hasn't been a paragon of transparency, one can only wonder what we don't know. Japan keeps having aftershocks that would qualify as big earthquakes anywhere else. Things aren't settling down there.
Portugal has just gone to the EU, hat in hand, to ask for a loan in the range of 80 billion Euros plus, following the path paved by Greece and Ireland. The Euro crisis is sliding downhill more or less as predicted. (Watercooler gossip has it that Spain will be next in line for a bailout.) As France takes the lead to spend Germany's money bailing out weaker EU nations, the markets snooze in the belief that creditors will be paid 100 cents on the Euro. Some day that won't be true. If you look at the Euro bloc as a whole, it's awash in debt. We have the lesson from the U.S. and other real estate markets that too much mortgage debt leads to bad things. That will also be true for sovereign debt.
The U.S. Federal Reserve is keeping its monetary printing press going 24/7. A majority of governors say they don't see any inflation, but would welcome it if it happened. That way, they can keep paying the print shop staff overtime no matter what. Meanwhile, back at the ranch, the poor consumer, whose wages aren't rising now or any time soon, is cutting back on driving while trying really hard to believe that beans and franks make a fine meal. Walmart just announced a return to every day low prices. That, as much as anything, tells you the consumer is under pressure. Since the U.S. economy is two-thirds consumption, the economy will soon be under pressure, too.
Stocks have more than doubled since their 2009 lows. Just about the only thing that can keep the bull running would be glowing corporate earnings. Alcoa was at the top of the order today, and whiffed. It reported greater earnings but disappointing revenues. Its stock is off about 3% in afterhours trading. Not a good beginning to the earnings season. If other companies follow Alcoa's lead, well . . . just tell yourself that beans and franks make a fine meal.
Tuesday, April 5, 2011
Roth IRA versus Traditional IRA: a Snapshot of Our Tax Dilemma
Should you have a Roth IRA or a traditional IRA? That's the question for many of today's savers. The answer illustrates a basic problem in America's system of taxation, one that doesn't appear likely to be fixed any time soon.
Traditional IRA. The more or less standard reasons for choosing a traditional IRA is that you can deduct the contributions now, and defer taxation until you begin withdrawals. Generally, speaking, you must wait until you're 59 and 1/2 before you can take withdrawals. You can defer withdrawals, though, and let your savings continue to grow on a tax-deferred basis until age 70 and 1/2. Then, you must begin to withdraw a minimum amount each year or face tax penalties.
You can contribute up to $5,000 a year in 2011 (or $6,000 if you're 50 or older), or the amount of your earned income, if less. You can deduct the contribution if you and your spouse (if you have one) aren't covered by an employer retirement plan. If either of you is covered by an employer retirement plan, the amount of your deduction in 2011 begins to shrink if your adjusted gross income is $56,000 or more (if single), or $89,000 or more (if married and filing jointly). To get a headache reading about the mindlessly complex rules concerning deductibility, go to IRS Publication 590 at http://www.irs.gov/publications/p590/ch01.html#en_US_2010_publink1000230433. Keep reading for a while, because the rules really do go on at some length.
The conventional wisdom is that a traditional IRA is good for people who can deduct all or most of their contributions, and are likely to fall into a lower tax bracket in retirement. In essence, the traditional IRA lets you "borrow" the taxes that would otherwise be due on the income contributed and use them for a while to generate investment returns. You'll pay taxes eventually, but eventually could be decades away. This is one of the few loans you can take that might actually make sense.
Roth IRA. The Roth IRA is funded with aftertax dollars, up to $5,000 a year (or $6,000 if you're 50 or over), or the amount of your earned income, if less. You get no deduction from your current tax bill. Note that the $5,000/$6,000 limit is a combined annual limit for all contributions to whatever traditional and Roth IRAs you might have. For example, if you have both types of accounts and contribute $2,000 to a Roth, you can't contribute more in the same year than $3,000 to the traditional IRA.
If you maintain the Roth for at least five years, you will be able to withdraw the earnings tax free beginning at age 59 and 1/2. However, you don't ever need to make withdrawals and can keep the money in the Roth accumulating tax free investment returns until the end of your life. In such circumstances, the beneficiaries you designate will be required to gradually withdraw the funds over their lives, but they won't need to pay income taxes on those withdrawals. The Roth account will be included in your estate for federal estate tax purposes, so it may be taxed in that way if you're well-off enough. But consider yourself fortunate if you have this problem. For those with a very long term perspective, the Roth is a good estate planning device.
The conventional wisdom is that a Roth IRA is good for people who expect to be in a tax bracket equal to or higher than the one they're in currently. That would mean that Roths are basically good for relatively high earners who expect to retire relatively well off. Another consideration is that Roths are administratively easier than traditional IRAs. You don't need to fuss with calculations of minimum annual withdrawals when you get older. You can take withdrawals as and when you choose, and they aren't taxed. Or you can pass the money along to your designated beneficiaries and they aren't taxed.
The Tax Dilemma. All this is well and good if you can reasonably predict what future tax rates will be. But the current modus operandi in Washington is to jury rig ad hoc short term tax provisions, where rates, deductions and other important aspects of the tax code have very limited half-lives. Most recently, the 2010 tax compromise between President Obama and the House Republicans resulted in a two-year tax cut program that will increase, rather than decrease, the federal deficit. So you can now plan as far as two years ahead. After that, it's anyone's guess where tax brackets will be. Realistically speaking, taxes will have to rise in order to bring deficits under control. But politically speaking, the likelihood of tax increases is low, but may be more likely for moderate and low income Americans than the well-off. (If you think I'm kidding, take a look at the 2010 tax compromise: the progressive $400 Making Work Pay credit was eliminated and a less progressive 2% point cut in Social Security taxes was substituted.)
When it comes to a choice between a traditional IRA or a Roth IRA, the bottom line is no one knows for sure what's best, and most likely you won't know in the future, either. Much of life involves operating on limited information in foggy conditions. One approach would be to split your contributions between a traditional and a Roth, thereby hedging your bets. Another approach is to use only a Roth. While it's more expensive to fund, a Roth is easier administratively on the back end--when you're 83 and juggling a half a dozen prescription medications, you won't want to fool around with the IRS formula for minimum required distributions from your IRA. And a Roth may be a beneficial estate planning tool if you want to leave money to someone else.
Note to the truly frugal. If you have a moderate or low income, you may actually be able to get a tax credit of up to $1,000 for contributions to a traditional or Roth IRA. The credit is available in 2011 only if your income is $55,500 if married and filing jointly, $41,625 if you file as a Head of Household, or $27,750 if single, married filing separately or a qualifying widow(er). This credit offers a dollar-for-dollar reduction of your tax liabilities, so it's worth claiming if you can (in essence, the government funds your IRA up to $1,000). It isn't easy to save at these income levels, but the 7 or 8 Americans who manage to do so can get a nice tax credit.
Traditional IRA. The more or less standard reasons for choosing a traditional IRA is that you can deduct the contributions now, and defer taxation until you begin withdrawals. Generally, speaking, you must wait until you're 59 and 1/2 before you can take withdrawals. You can defer withdrawals, though, and let your savings continue to grow on a tax-deferred basis until age 70 and 1/2. Then, you must begin to withdraw a minimum amount each year or face tax penalties.
You can contribute up to $5,000 a year in 2011 (or $6,000 if you're 50 or older), or the amount of your earned income, if less. You can deduct the contribution if you and your spouse (if you have one) aren't covered by an employer retirement plan. If either of you is covered by an employer retirement plan, the amount of your deduction in 2011 begins to shrink if your adjusted gross income is $56,000 or more (if single), or $89,000 or more (if married and filing jointly). To get a headache reading about the mindlessly complex rules concerning deductibility, go to IRS Publication 590 at http://www.irs.gov/publications/p590/ch01.html#en_US_2010_publink1000230433. Keep reading for a while, because the rules really do go on at some length.
The conventional wisdom is that a traditional IRA is good for people who can deduct all or most of their contributions, and are likely to fall into a lower tax bracket in retirement. In essence, the traditional IRA lets you "borrow" the taxes that would otherwise be due on the income contributed and use them for a while to generate investment returns. You'll pay taxes eventually, but eventually could be decades away. This is one of the few loans you can take that might actually make sense.
Roth IRA. The Roth IRA is funded with aftertax dollars, up to $5,000 a year (or $6,000 if you're 50 or over), or the amount of your earned income, if less. You get no deduction from your current tax bill. Note that the $5,000/$6,000 limit is a combined annual limit for all contributions to whatever traditional and Roth IRAs you might have. For example, if you have both types of accounts and contribute $2,000 to a Roth, you can't contribute more in the same year than $3,000 to the traditional IRA.
If you maintain the Roth for at least five years, you will be able to withdraw the earnings tax free beginning at age 59 and 1/2. However, you don't ever need to make withdrawals and can keep the money in the Roth accumulating tax free investment returns until the end of your life. In such circumstances, the beneficiaries you designate will be required to gradually withdraw the funds over their lives, but they won't need to pay income taxes on those withdrawals. The Roth account will be included in your estate for federal estate tax purposes, so it may be taxed in that way if you're well-off enough. But consider yourself fortunate if you have this problem. For those with a very long term perspective, the Roth is a good estate planning device.
The conventional wisdom is that a Roth IRA is good for people who expect to be in a tax bracket equal to or higher than the one they're in currently. That would mean that Roths are basically good for relatively high earners who expect to retire relatively well off. Another consideration is that Roths are administratively easier than traditional IRAs. You don't need to fuss with calculations of minimum annual withdrawals when you get older. You can take withdrawals as and when you choose, and they aren't taxed. Or you can pass the money along to your designated beneficiaries and they aren't taxed.
The Tax Dilemma. All this is well and good if you can reasonably predict what future tax rates will be. But the current modus operandi in Washington is to jury rig ad hoc short term tax provisions, where rates, deductions and other important aspects of the tax code have very limited half-lives. Most recently, the 2010 tax compromise between President Obama and the House Republicans resulted in a two-year tax cut program that will increase, rather than decrease, the federal deficit. So you can now plan as far as two years ahead. After that, it's anyone's guess where tax brackets will be. Realistically speaking, taxes will have to rise in order to bring deficits under control. But politically speaking, the likelihood of tax increases is low, but may be more likely for moderate and low income Americans than the well-off. (If you think I'm kidding, take a look at the 2010 tax compromise: the progressive $400 Making Work Pay credit was eliminated and a less progressive 2% point cut in Social Security taxes was substituted.)
When it comes to a choice between a traditional IRA or a Roth IRA, the bottom line is no one knows for sure what's best, and most likely you won't know in the future, either. Much of life involves operating on limited information in foggy conditions. One approach would be to split your contributions between a traditional and a Roth, thereby hedging your bets. Another approach is to use only a Roth. While it's more expensive to fund, a Roth is easier administratively on the back end--when you're 83 and juggling a half a dozen prescription medications, you won't want to fool around with the IRS formula for minimum required distributions from your IRA. And a Roth may be a beneficial estate planning tool if you want to leave money to someone else.
Note to the truly frugal. If you have a moderate or low income, you may actually be able to get a tax credit of up to $1,000 for contributions to a traditional or Roth IRA. The credit is available in 2011 only if your income is $55,500 if married and filing jointly, $41,625 if you file as a Head of Household, or $27,750 if single, married filing separately or a qualifying widow(er). This credit offers a dollar-for-dollar reduction of your tax liabilities, so it's worth claiming if you can (in essence, the government funds your IRA up to $1,000). It isn't easy to save at these income levels, but the 7 or 8 Americans who manage to do so can get a nice tax credit.
Thursday, March 24, 2011
Derivatives Dealers Grumpy Over Deutsche Bank Ruling
Derivatives dealers worldwide are grumpy because of a ruling by the highest civil court in Germany finding that Deutsche Bank AG was responsible for disclosing the risks of a derivatives transaction to a company that bought an interest rate swap. The German court was concerned by the bank's conflict of interest from the risks in the transaction being stacked in its favor, at the customer's expense. The court especially didn't like the bank's failure to disclose that the customer's starting value in the transaction was an unrealized loss of -80,000 Euros, or over -$100,000. The court noted that although Deutsche Bank had warned the client that the risk of loss was theoretically infinite, it also predicted that the transaction would be profitable for the customer. The court thought the bank should have made loud and clear that the customer's losses could really be costly, and not just theoretically so. (See Wall Street Journal, Dec. 23, 2011, P. C3).
From a derivatives dealer's standpoint, disclosure obligations like those required by the German court seriously erode the dealer's informational advantage. In the financial markets, an informational advantage is more valuable than gold. That's why, as illustrated by the U.S. government's investigation into trading by hedge fund manager Galleon Group and others, there is so much apparent insider trading. Having the informational advantage really pays. If derivatives dealers now have to make disclosures as contemplated by the German ruling, bank profits might suffer. And nothing, as we all know, could be more horrifying than that.
The U.S. SEC's 2010 case against Goldman Sachs for its role in a mortgage-related derivatives transaction called Abacus 2007-AC1 crimped the style of banks acting as underwriters. The German court's ruling may have a bigger day-to-day impact, since it concerns a bank acting as a dealer in the interest rate swaps market. Trillions of dollars of transactions per month take place in this market. Banks are dealers--i.e., they act as principal on one side or the other of the swap--because customers don't want the credit risk of any counterparty other than a very large (and de facto government guaranteed bank). Too-large-to-fail banks of commercially powerful nations like Germany and the U.S. have an advantage in this market, since their governments' implicit guarantees are worth much more than, say, the Greek or Dubai government's guarantee. If the laws of commercially powerful nations like Germany and the U.S. begin to tilt the derivatives playing field toward anything approaching level, the banks may seek more accommodating nations in which to ply their derivatives trade. But, as financial markets globalize, there will be fewer and fewer places for big banks to go. And increasingly savvy corporate clients may abjure from doing transactions routed through a Caribbean island or Equatorial African nation.
Progress on the regulatory reforms in the Dodd-Frank financial legislation enacted last year has, on the best of days, been confined to the slow lane. Big banks have lobbied combatively to limit and water down the changes. The SEC has long known of the informational disparity in the derivatives market, having brought an enforcement case in 1994 that illustrated the problem. See http://blogger.uncleleosden.com/2010/02/will-wall-street-get-pass-on.html. Perhaps the German court's decision will help to encourage U.S. regulators to push through the headwinds of the big bank lobbying juggernaut. Some of the big banks' corporate customers have been convinced to lobby against change. But the German case, and the SEC's 2010 and 1994 cases, reveal that corporate customers sometimes don't even know what they don't know. It's one thing to let people knowingly take risks. It's another thing to leave them unknowing and saddled with risk.
From a derivatives dealer's standpoint, disclosure obligations like those required by the German court seriously erode the dealer's informational advantage. In the financial markets, an informational advantage is more valuable than gold. That's why, as illustrated by the U.S. government's investigation into trading by hedge fund manager Galleon Group and others, there is so much apparent insider trading. Having the informational advantage really pays. If derivatives dealers now have to make disclosures as contemplated by the German ruling, bank profits might suffer. And nothing, as we all know, could be more horrifying than that.
The U.S. SEC's 2010 case against Goldman Sachs for its role in a mortgage-related derivatives transaction called Abacus 2007-AC1 crimped the style of banks acting as underwriters. The German court's ruling may have a bigger day-to-day impact, since it concerns a bank acting as a dealer in the interest rate swaps market. Trillions of dollars of transactions per month take place in this market. Banks are dealers--i.e., they act as principal on one side or the other of the swap--because customers don't want the credit risk of any counterparty other than a very large (and de facto government guaranteed bank). Too-large-to-fail banks of commercially powerful nations like Germany and the U.S. have an advantage in this market, since their governments' implicit guarantees are worth much more than, say, the Greek or Dubai government's guarantee. If the laws of commercially powerful nations like Germany and the U.S. begin to tilt the derivatives playing field toward anything approaching level, the banks may seek more accommodating nations in which to ply their derivatives trade. But, as financial markets globalize, there will be fewer and fewer places for big banks to go. And increasingly savvy corporate clients may abjure from doing transactions routed through a Caribbean island or Equatorial African nation.
Progress on the regulatory reforms in the Dodd-Frank financial legislation enacted last year has, on the best of days, been confined to the slow lane. Big banks have lobbied combatively to limit and water down the changes. The SEC has long known of the informational disparity in the derivatives market, having brought an enforcement case in 1994 that illustrated the problem. See http://blogger.uncleleosden.com/2010/02/will-wall-street-get-pass-on.html. Perhaps the German court's decision will help to encourage U.S. regulators to push through the headwinds of the big bank lobbying juggernaut. Some of the big banks' corporate customers have been convinced to lobby against change. But the German case, and the SEC's 2010 and 1994 cases, reveal that corporate customers sometimes don't even know what they don't know. It's one thing to let people knowingly take risks. It's another thing to leave them unknowing and saddled with risk.
Tuesday, March 22, 2011
Health Insurance for Pre-existing Conditions
[Updated Feb. 19, 2013]
If you're healthy, health insurance is an expensive annoyance. You know you should have it, but it seems like a waste of money. And millions of Americans go without health insurance, because they don't want to be expensively annoyed. But if they get sick or are injured while uninsured, they learn the hard way that, even more than a loan, health insurance is hard to get when you really need it. That's why you should always have health insurance, especially if you're in good health (when it's much easier to get).
Once you become sick or are injured, you have a pre-existing condition. From the perspective of a health insurer, that very possibly makes you a losing proposition. No one likes losing propositions, and certainly not insurance companies, whose business is, in essence, to bet on the health of their customers. Very few people today contract leprosy, but a lot of people who have a pre-existing condition and are uninsured learn what it feels like to be a leper.
So how can you protect yourself?
Get health insurance while you're healthy. The best way to cover pre-existing conditions is to be insured at the time they first occur. It's now illegal for insurance companies to drop coverage for customers who get sick or are injured. Axing customers who might actually make claims is prohibited by the federal health insurance reform enacted last year (derisively called Obamacare, but it really does help those who are sick or injured).
Keep your current health insurance. If you are covered by health insurance, keep it. That would mean exercising your COBRA rights if your employment is terminated. As your COBRA coverage expires (usually after 18 months), buy an individual policy to continue coverage. Avoid time gaps in coverage--continuous coverage one way or another makes it essentially impossible for insurers to stiff you on pre-existing conditions.
Be young. Last year's health insurance reform law now makes it illegal for insurers to decline coverage for children under the age of 19 due to pre-existing conditions. In addition, young adults up to age 26 may be covered under their parents' health insurance (if their parents have family coverage).
Be old. If you're 65 or older, make sure you're enrolled in Medicare (at least Parts A and B, and also Part D if you don't otherwise have prescription medication insurance). Pre-existing conditions are covered by Medicare.
State pools. Many states have insurance pools that offer coverage for their residents with pre-existing conditions. These pools can be expensive. But being uninsured with a pre-existing condition can be more expensive.
Federal High Risk Pool. A federal program created by last year's health insurance reform provides coverage to those who are uninsured with pre-existing conditions. This program isn't cheap, but is less expensive than many state pools. (A problem for those in state pools who want to switch to the lower cost federal program is that you have to be uninsured for something like six months before you can get into the federal program; that's because the federal program is meant to help the uninsured, not the expensively insured.) The federal high risk pool expires in 2014, when a permanent program for comprehensive nationwide health insurance coverage is supposed to begin. The website for the federal high risk program is at www.pcip.gov. Feb. 19, 2013 update: the federal high risk pool is closing on Feb. 22, 2013 because of funding problems. If you want to participate, get your application in by Feb. 22, 2013. If you miss this deadline, look for any available state insurance pool, find out if you're eligible for Medicaid (see below), try a community health center, and wait until 2014, when comprehensive insurance coverage under the Affordable Care Act will become available.
2014. If you live until 2014, a comprehensive nationwide program for health insurance coverage will begin, which will prohibit health insurers from excluding pre-existing conditions. Insurance for those who otherwise aren't covered can be purchased through so-called health insurance exchanges. Your home state may offer an exchange (possibly in conjunction with other states), and a federal exchange will be available if your state does not offer one.
And if you're broke? If your financial condition is sufficient modest, you may qualify for Medicaid (it's primarily for people with dependent children or a disability). You might also be able to get care at a community health center (which generally serve the low income). And there's always the hospital emergency room, which provides care to the indigent (although it may not be as comprehensive as the care provided to the insured).
For more information, see http://blogger.uncleleosden.com/2010/04/benefits-of-federal-health-insurance.html, and http://blogger.uncleleosden.com/2007/06/how-to-find-health-insurance.html. The U.S. Department of Health & Human Services provides a website where you can research health insurance options: http://www.healthcare.gov/.
Tuesday, March 15, 2011
Losers and Winners on the Ides of March
They weren't kidding about the Ides of March.
LOSERS. This is a day for losers.
Japan. With the 9.0 earthquake (about as big as they come) and the 30-foot tsunami that followed, Japan got walloped. Now, the rising risk of reactor fuel meltdown has the Japanese nation turning to its nuclear industry and asking, "Et tu?"
Industrialized World. Japan is deeply integrated into the world economy, as an exporter and importer. The ramifications of the soon-to-come earthquake-driven recession there affect crucial industries around the globe, including electronics, automotive, insurance (obviously), petroleum, and banking. With China slowing its economy to rein in inflation, Europe turning to austerity as it struggles with its currency crisis, and America getting by on the methadone of Federal Reserve easy, easy money, there's not a whole lot of horsepower in the international economy to pick up the slack left by Japan. The stock markets are starting to figure this out.
Nuclear Power Industry. While some Japanese nuclear power plant workers may, in effect, be committing hara kiri trying to contain meltdown risk, nuclear power projects worldwide are being curtailed and cut. When you play around with stuff that has real potential for destruction, no amount of engineering can guarantee safety. That's true of nuclear energy, and it's also true of financial derivatives.
Libyan Rebels. With the world's attention diverted to East Asia, the Libyan rebels' chances for resupply and a no-fly zone from other nations are fading rapidly. The U.S. buys little or no Libyan oil, and has no vital national interest there. Britain and France were quick to advocate a no-fly zone, but they know that only the U.S. Navy has the resources and power to actually impose one. That means America would have to bear the burdens and take the casualties. The U.S. government is clearly stalling for time--its demand for UN authorization is a transparent pretext for delay. Maybe the Obama administration knows something it can't really share with the rest of us, yet. Things in the Persian Gulf may be worse than the news services have reported. Saudi Arabian troops have rolled (in unmarked vehicles) into Bahrain, in order to help the Bahraini government stay in control. Things in the Persian Gulf could be deteriorating, and the U.S. military may have to keep its powder dry in order to retain the option to play a role there, where the U.S. has a large vested interest.
Barack Obama. The President hesitated to join up with the Libyan rebels, and they now think he has a secret pact with Gaddafi. Obama has called on Gaddafi to cede power and leave Libya, so Gaddafi knows that Obama isn't on his side. No matter who wins in Libya, America and Obama lose. The Japanese nuclear crisis has blown up Obama's nuclear power policies, and a recession in Japan could put pressure on the administration to apply more fiscal stimulus (i.e., engage in more deficit spending, which isn't exactly politically trendy these days). The perhaps not well publicized unrest in Bahrain and Saudi Arabia, along with a deteriorating situation in Yemen, put the Obama administration in the position of wanting to side with oppressive monarchs in order to protect U.S. interests. Even if these monarchs survive, America's already compromised image in the Arab world will suffer.
Republicans. International events are taking front page news coverage away from Republicans and their domestically-focused agenda. They can't easily criticize President Obama's foreign policy, which is strikingly similar to George W. Bush's. They may have to settle for appearances on Dancing With the Stars.
WINNERS. Even in ugly situations, there are winners. That's why you find the most cynical of stock market speculators swarming into select parts of the market when a crisis hits.
Natural Gas and Shale Oil. The NIMBY style controversies over fracking may seem manageable in light of massive radiation releases from Japanese nuclear power plants. Natural gas and shale oil might have to be repriced to cover the costs of reimbursing people damaged by fracking. But the stuff is found in plenitude in these United States, and will surely be a growing source of energy in the future.
Coal. It's not beloved by environmentalists and mining it leaves ugly scars on the land. But America has massive coal reserves and will surely turn more and more to them in the future. Long term, alternative/renewable energy sources may begin to play a major role in America, but for the short and medium term, coal will be definitely be a part of our lives.
Oil Producers. Oil producers, like Venezuela, Russia, Nigeria and Canada, see their fortunes rise. Too bad not all of them are friendly to America.
Iran. Iran gets a win-win here: increased revenues from rising oil prices and more opportunity from the Arab uprising to stir up Shiite co-religionists on the Arabian peninsula.
China and Taiwan. As Japan's economy struggles, Chinese and Taiwanese companies will get a chance to get into high value-added product lines the Japanese have dominated. Semiconductors and high tech automotive components are obvious targets. Look for Chinese automobile companies to try to move up their deadlines for introducing their products to America.
LOSERS. This is a day for losers.
Japan. With the 9.0 earthquake (about as big as they come) and the 30-foot tsunami that followed, Japan got walloped. Now, the rising risk of reactor fuel meltdown has the Japanese nation turning to its nuclear industry and asking, "Et tu?"
Industrialized World. Japan is deeply integrated into the world economy, as an exporter and importer. The ramifications of the soon-to-come earthquake-driven recession there affect crucial industries around the globe, including electronics, automotive, insurance (obviously), petroleum, and banking. With China slowing its economy to rein in inflation, Europe turning to austerity as it struggles with its currency crisis, and America getting by on the methadone of Federal Reserve easy, easy money, there's not a whole lot of horsepower in the international economy to pick up the slack left by Japan. The stock markets are starting to figure this out.
Nuclear Power Industry. While some Japanese nuclear power plant workers may, in effect, be committing hara kiri trying to contain meltdown risk, nuclear power projects worldwide are being curtailed and cut. When you play around with stuff that has real potential for destruction, no amount of engineering can guarantee safety. That's true of nuclear energy, and it's also true of financial derivatives.
Libyan Rebels. With the world's attention diverted to East Asia, the Libyan rebels' chances for resupply and a no-fly zone from other nations are fading rapidly. The U.S. buys little or no Libyan oil, and has no vital national interest there. Britain and France were quick to advocate a no-fly zone, but they know that only the U.S. Navy has the resources and power to actually impose one. That means America would have to bear the burdens and take the casualties. The U.S. government is clearly stalling for time--its demand for UN authorization is a transparent pretext for delay. Maybe the Obama administration knows something it can't really share with the rest of us, yet. Things in the Persian Gulf may be worse than the news services have reported. Saudi Arabian troops have rolled (in unmarked vehicles) into Bahrain, in order to help the Bahraini government stay in control. Things in the Persian Gulf could be deteriorating, and the U.S. military may have to keep its powder dry in order to retain the option to play a role there, where the U.S. has a large vested interest.
Barack Obama. The President hesitated to join up with the Libyan rebels, and they now think he has a secret pact with Gaddafi. Obama has called on Gaddafi to cede power and leave Libya, so Gaddafi knows that Obama isn't on his side. No matter who wins in Libya, America and Obama lose. The Japanese nuclear crisis has blown up Obama's nuclear power policies, and a recession in Japan could put pressure on the administration to apply more fiscal stimulus (i.e., engage in more deficit spending, which isn't exactly politically trendy these days). The perhaps not well publicized unrest in Bahrain and Saudi Arabia, along with a deteriorating situation in Yemen, put the Obama administration in the position of wanting to side with oppressive monarchs in order to protect U.S. interests. Even if these monarchs survive, America's already compromised image in the Arab world will suffer.
Republicans. International events are taking front page news coverage away from Republicans and their domestically-focused agenda. They can't easily criticize President Obama's foreign policy, which is strikingly similar to George W. Bush's. They may have to settle for appearances on Dancing With the Stars.
WINNERS. Even in ugly situations, there are winners. That's why you find the most cynical of stock market speculators swarming into select parts of the market when a crisis hits.
Natural Gas and Shale Oil. The NIMBY style controversies over fracking may seem manageable in light of massive radiation releases from Japanese nuclear power plants. Natural gas and shale oil might have to be repriced to cover the costs of reimbursing people damaged by fracking. But the stuff is found in plenitude in these United States, and will surely be a growing source of energy in the future.
Coal. It's not beloved by environmentalists and mining it leaves ugly scars on the land. But America has massive coal reserves and will surely turn more and more to them in the future. Long term, alternative/renewable energy sources may begin to play a major role in America, but for the short and medium term, coal will be definitely be a part of our lives.
Oil Producers. Oil producers, like Venezuela, Russia, Nigeria and Canada, see their fortunes rise. Too bad not all of them are friendly to America.
Iran. Iran gets a win-win here: increased revenues from rising oil prices and more opportunity from the Arab uprising to stir up Shiite co-religionists on the Arabian peninsula.
China and Taiwan. As Japan's economy struggles, Chinese and Taiwanese companies will get a chance to get into high value-added product lines the Japanese have dominated. Semiconductors and high tech automotive components are obvious targets. Look for Chinese automobile companies to try to move up their deadlines for introducing their products to America.
Tuesday, March 8, 2011
Will the Arab Revolution Topple the Dollar?
As unrest in the Arab world has grown over the past few weeks, the dollar has fallen in value. That would seem anomalous, since the dollar has served for decades as a safe haven in times of crisis. But investors apparently have noticed that the U.S. is unbalanced: too much in the way of imports, not enough in the way of exports, and a growing federal deficit that is likely to punish holders of U.S. Treasury securities if it isn't brought under control.
Exacerbating things is the rising price of oil. Since oil is traded in dollars, the lower the value of the dollar, the cheaper oil becomes to holders of other currencies. One player to watch in particular is China, a large consumer of oil with a growing appetite. The Chinese have already been gradually diversifying their foreign currency investments away from the dollar. Rising oil prices may, more than all the political pressure that can be exerted by the U.S. and other Western governments, convince the Chinese government to truly de-link the yuan from the dollar. As the yuan rises, oil becomes cheaper for the Chinese. If China can turn its economy toward domestic consumption--a goal the Chinese government acknowledges--look for the yuan to rise markedly against the dollar.
Some in the U.S. government would contend all this is good. A cheaper dollar enhances America's exporting competitiveness. But the price of a cheaper dollar is likely to be higher inflation--in gasoline prices and also the price of our numerous imports. The Fed's ultra-easy money policies would have to end and interest rates would rise. That would throw a wrench into the economy in many ways, from slowing the still feeble real estate market to discouraging business expansion to wrecking Wall Street profitability (which rests on a zero cost of funds) to knocking down stock prices.
The Arab revolution is almost entirely out of the control of Western governments, especially the mess in Libya. And even if things in the Arab world settle down in a few months, growing demand from Asia will continue to support and maybe push up oil prices. It's in the interest of the rest of the world to weaken the dollar in order to make oil cheaper. Even serial exporters like China and Japan have to weigh the increased cost of oil against their export revenues in deciding whether or not to keep their currencies weak against the dollar. Also, it seems to be a goal of the Federal Reserve's relentless easy credit policy to weaken the dollar. As the dollar drops, OPEC and other sellers of oil may begin to demand payment in other currencies. The dollar would drop further in such a scenario. Even though America would get an exporting boost from a falling dollar, rising interest rates here would slow the economy at the same time. How this mix of countervailing forces would play out is anyone's guess.
In the financial markets, something unexpected usually causes market breaks, crashes and other singularities. After all, expected events are quickly incorporated into asset prices. The dollar market is too big for an abrupt crash. But the Arab revolution has unexpectedly highlighted the dollar's weaknesses. That won't be good for the greenback.
Exacerbating things is the rising price of oil. Since oil is traded in dollars, the lower the value of the dollar, the cheaper oil becomes to holders of other currencies. One player to watch in particular is China, a large consumer of oil with a growing appetite. The Chinese have already been gradually diversifying their foreign currency investments away from the dollar. Rising oil prices may, more than all the political pressure that can be exerted by the U.S. and other Western governments, convince the Chinese government to truly de-link the yuan from the dollar. As the yuan rises, oil becomes cheaper for the Chinese. If China can turn its economy toward domestic consumption--a goal the Chinese government acknowledges--look for the yuan to rise markedly against the dollar.
Some in the U.S. government would contend all this is good. A cheaper dollar enhances America's exporting competitiveness. But the price of a cheaper dollar is likely to be higher inflation--in gasoline prices and also the price of our numerous imports. The Fed's ultra-easy money policies would have to end and interest rates would rise. That would throw a wrench into the economy in many ways, from slowing the still feeble real estate market to discouraging business expansion to wrecking Wall Street profitability (which rests on a zero cost of funds) to knocking down stock prices.
The Arab revolution is almost entirely out of the control of Western governments, especially the mess in Libya. And even if things in the Arab world settle down in a few months, growing demand from Asia will continue to support and maybe push up oil prices. It's in the interest of the rest of the world to weaken the dollar in order to make oil cheaper. Even serial exporters like China and Japan have to weigh the increased cost of oil against their export revenues in deciding whether or not to keep their currencies weak against the dollar. Also, it seems to be a goal of the Federal Reserve's relentless easy credit policy to weaken the dollar. As the dollar drops, OPEC and other sellers of oil may begin to demand payment in other currencies. The dollar would drop further in such a scenario. Even though America would get an exporting boost from a falling dollar, rising interest rates here would slow the economy at the same time. How this mix of countervailing forces would play out is anyone's guess.
In the financial markets, something unexpected usually causes market breaks, crashes and other singularities. After all, expected events are quickly incorporated into asset prices. The dollar market is too big for an abrupt crash. But the Arab revolution has unexpectedly highlighted the dollar's weaknesses. That won't be good for the greenback.
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