Thursday, January 22, 2009

What I Know and Believe

What I Know

A set of maxims.

1. There are two crisis occurring right now, one is a bank crisis and the other is a crash in future expectations.

2. The budgets/costs of the two crisis have to be differentiated and considered separately

3. The bank crisis is a classic Bagehot-Kindelberger bank crash where the inherent instability in open market financial money markets given excess growth and too rapid expansion of leverage results in sharp cusp like failure and a rush to hoard cash by banks as they cannot differentiate who might fail.

4. The academic literature on how to manage this crisis is deep and well studied, from Bagehot’s “Lombard Street” to the ex head of the Swedish Central Bank’s essays to Kindelberger to Minsky.

5. The methods to manage a bank crisis are of a very limited set but no one can find an example of a failure in policy once these remedies are applied.

6. The “cost” to repair and fix a banking crisis is really not a cost, but a certain amount the lender of last resort has to expand their balance sheet. The concentration of problematic assets of the system, apply punitive management changes of the problem banks, make creditors whole, and ruin equity holders or substantially reduce value so precedent is set.

7. Never can the lender of a last resort work on with the bank that is being rescued's executive post-rescue. They mist be removed in punitive fashion.

8. Total balance sheet expansion for our banking crisis was once about $750 billion but as contagion spread given the lack of a lender of last resort operation other assets failed such as derivatives based upon bank counterparty risk (AIG).

9. Now the required and inevitable lender of last resort operation is equivalent to the Federal Reserve balance sheet which basically has to be returned to the private sector banking system at some point – about 1 ¾ trillion.

10. This balance sheet expansion is not a net amount but by definition a gross number – net end csts will be about ¼ of whatever the required balance sheet expansion. (Based upon historical consideration of bank crisis last 50 years on global basis – literature is deep and the above isn’t debated.)

11. The NY Fed has effected the end results of a post lender of last resort operation as shown how solid and pre-crisis levels key money market relationships are – but unless we wish a command economy this has to be returned to balance sheets of private banks.

12. The other crisis, resulting from the banking crisis, is a classic Keynesian/Minsky implosion of demand which shocks capital to a large excess capacity or excess capital. The offset to this is a drop in consumption and a comparable rise in savings and drop in gross investment.

13. Profits are near impossible to maintain given the cost of the fixed capital investment and capacity cannot be liquidated – so most industry is thrown to a deficit

14. No investments are made as the expectation develop that this state will last long enough to assure negative return on investment.

15. A spiral develops in investment and drop in consumption and attempt to remove excess capacity and is characterized by deflation; no future expected return produces an excess return to the cost of capital.

16. The public sector must fill the void of the drop in consumption and investment to initially an amount equal to this drop and with utility such that a positive expected return to investment schedule – Keynes called in “rent” returns.

17. This is a real spend, a real cost, but the public sector will have the assets or investments resulting from this spend on the balance sheet and is an offset.

18. This amount is roughly equal to the increase in savings – which is going from 0% towards 7%, or at 7% about $1 trillion. However the unresolved bank crisis along with further cycles of the Fisher Debt Deflation Spiral means a meter is running and shortly will be well in excess of $1 trillion and likely is expanding at some power law and not linearly.

19. The amount of fiscal stimulus is at or over $1 trillion now but that is not to be a spot actual dollar spend, rather it has to be firmly in expectations and certitude that it will be spent has to develop. That means spend on non-abstract clear large projects assists in the speedy development of those expectations.

20. There is much truth to “only thing to fear is fear itself” as that captures the spiral of expectations in the future problem. The ability for the USA to easily produce such a fiscal stimulus is obvious and easily proven through history and experiences of other countries - mostly recent experiences

21. The bank crisis is fixed now as far as liquidity, but until a removal of toxic assets and freeing bank balance sheets so lending and then resulting multiplier effect occurs, it can only be stop-gap and maintain with by definition no growth.

22. The Federal Reserve has to conclude the Bagehot lender of last resort operation by removing problem assets and also, just as important, removing all executives of failed bank(s). Carping about executive pay is meaningless.

23. The fiscal stimulus is getting larger and larger and the political process must be able to manage the vast sum without either ending in total gridlock and stalemate or a kleptocracy (why World Bank fiscal stimulus and projects rarely produce growth in LDCs as corruption results) Also shows why FDR was so clever to realize an SEC was required. But we likely have passed the legislatures ability to implement and manage the large stimulus now required – it will be solely a executive task. Even there political capability is being swamped by the task.

24. But, fiscal stimulus will occur sooner or later – think on that why that is logical – standard Pacioli identity. Dual sided accounting. Otherwise means a organized democratic community which is well connected now will allow deflation and depression ongoing. I think not. Either enlightened political movement starts, or a demagogue/fascist captures imagination (Huey Long, LaGuardia, Hitler, Mussolini), or classic socialism seizes n behalf of the state the methods of production, or an external motive for the fiscal stimulus is found which is inevitable war which is only variable that can generate unity and the size of stimulus to “balance” the books. The right way to read WW II was it was caused by the inability f the USA to get past political hurtles and reflate in the 30s.

25. The world will discover that there is still only one power and it is the USA and since this discovery will be from their specific countries demise, extreme frustration and anger will develop. Leaders will try to divert that anger and frustration against the USA. Keep in mind this will be desperate times with unemployment leveraged to the hegemon’s experience.

26. The pressures which force the public to insist on the fiscal flow required will be urban revolution, anarchy, riots, crime waves, and intense immoral behaviour.

27. The misery in LDCs will be unfathomable

28. The concepts of green and global warming will be exposed for what they are – an attempt to make a supra-national revenue/tax flow to empower non-nation state organizations, to the demise of the hegemon. There will be an attempt to use green policies by foreign elements/leaders to divert internal pressure to the USA.

29. So so much misery and trauma and death and destruction could be averted by firm large and classic Keynesian stimulus by Obama’s administration in very short order.

30. In the age of Google so much literature and information can be acquired. There is no excuse for any civilized American adult, especially leaders, to not understand the above.

31. None of the above can be seen to be out of line with either liberal, socialistic, or conservative principles as the above are that aspects of economics that is fact and are the only remedies available and are applied by all forms of government in the end - be it Hitler, FDR, Stalin, Reagan, LBJ, or now Obama. How the government proceeds post-crisis is dependent on political philosophy. But for now, considering the risk and possible dire results, all parties and people should be united to implement the above. Later folks can have a nice long debate on the unwind.

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