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mises
Joined: 05 Nov 2007
Location: retired
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 Posted: Sun Sep 28, 2008 7:39 pm Post subject: Saving America |
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This is the absolute best article I've found on the current crises. It is by Andy Xie, who is an independent economist (the only kind you can trust) out of Hong Kong (PhD MIT). He was Morgan's man in Singapore for about a decade before being fired for being too honest.
Ok. He lays it down.
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The U.S. financial system could go under without swift action from the global community.
By Andy Xie, board member of Rosetta Stone Advisors Limited
Banning short selling, establishing a government entity for warehousing bad assets, and guaranteeing money market funds have brought relief to financial markets. But this may be temporary. The U.S. still needs to find money to pay the losses from disposing of bad assets, decreasing leverage in the real economy and financial sector, and finding a non-debt-driven method to make the economy grow. The road ahead will be long and hard. The global community may have to work together for a solution.
Market pressure has forced the U.S. government to adopt the barrage of new measures. The origin of the crisis is excessive leverage, especially at Wall Street brokerages. Short sellers have learned to bring them down. They short their shares to create a panic that sends their trading counterparts fleeing. The resulting loss of liquidity bleeds the highly leveraged brokers to death. Obviously, banning short selling allows them to live longer. Ironically, Wall Street created the short sellers or hedge fund industry after the hi-tech bubble burst to juice up its businesses. Like a modern day Oedipus tragedy, they have come home to slay their parents and take their homes.
However, technical changes don't alter the fundamentals. Businesses that live solely on increasing leverage are no longer viable. Deleveraging is inevitable, which could lead to a gut-wrenching recession. Every sector in America is overleveraged. Where can they find the money to recapitalise the economy?
The solution to America's crisis must involve the countries that own US$ 10 trillion in foreign exchange reserves. The U.S. economy is undercapitalised. An internal solution is usually one form of debt replaced with another. The current proposals fall into this category. When the shell game runs out of options, printing money is the only way out. That will eventually lead to the U.S. dollar collapsing and hyperinflation in the U.S. economy.
The world should come together to prevent such a tragic ending. Countries with big foreign exchange reserves like China, Japan, Kuwait, Saudi Arabia and the United Arab Emirates, for example, should sit down with the U.S. government to find a way to recapitalise its economy. They should swap their U.S. dollar assets in debt instruments like treasuries for equity assets like stocks.
The world has a vested interest in ensuring an orderly resolution to the U.S. crisis. If America prints money to solve its problems, it will lead to the destruction of other nations' wealth in U.S. dollar assets and a global depression of unimaginable proportions. Rising leverage in the U.S. has driven the demand growth in the global economy in the past decade. The high foreign-exchange reserves of its trading partners and the excessive leverage of the U.S. economy are two sides of the same coin. It seems that both sides need to participate in a solution.
The U.S. needs to change its policy towards foreign investments. Its xenophobia about investments from non-western nations is a major barrier.
The magnitude of the debt-equity swap needed is massive. The U.S.'s non-financial sector debt rose to 226 percent of gross domestic product (GDP) last year, up from 183 percent of GDP 10 years before. The financial sector debt surged to 114 percent of GDP, from 64 percent during the same period. The real economy may need 40 percent of GDP in extra equity, or US$ 5.5 trillion, equivalent to one-third of America's stock market capitalisation. Foreign capital should be sought for at least half the amount needed.
The capital requirement for the financial sector depends on how much it deleverages. The required deleveraging is probably between US$ 5 trillion and US$ 8 trillion. A significant portion of that is bad assets. As the total losses could be similar to the total amount of capital in the U.S. financial system before the crisis began, it may be necessary to let foreigners become majority owners of its big financial institutions. During the past year, U.S. financial institutions have sold minority stakes to sovereign wealth funds around the world. With no control over these institutions, other nations are of course resentful of the terrible losses they have suffered. In future fund-raising, U.S. financial institutions may have to sell controlling stakes to foreigners.
While the above proposal is a win-win for the world, the odds of it being implemented are quite low. The U.S. still has an unrealistic view of itself. Its domestic politics are too insular and xenophobic. Even though the U.S. is the largest debtor in the world, it behaves like the largest creditor. Americans may need much more hardship to change their attitude.
The next step seems to be to shift private-sector debt to the public sector. The proposed government body to take over bad assets provides such an instrument. In theory, it unwinds by selling bad assets along the way. But who would the buyers be, and who would be responsible for the losses? Everyone in the U.S. has too much debt already. Only foreigners can provide the equity capital required for the final debt-equity swap. However, the unwillingness to accept capital from non-western countries may push the U.S. to print money. The Federal Reserve can purchase whatever papers the federal government issues to cover the losses in the bad-asset disposal. That will lead to high inflation. When foreigners dump their U.S. dollar assets, the dollar will crash, and the U.S. may experience hyperinflation and economic chaos.
To protect themselves against such a scenario, foreign governments should switch their treasury holdings into stocks. These preserve their value better during inflationary times. U.S. stocks are valued fairly. They may decline in the coming months, but they are better value than treasuries now. Central banks should put wealth preservation ahead of all else.
Ironically, if foreigners switch from treasuries to stocks, it will ease the equity-capital shortage in the U.S. economy and discourage the Fed from printing money by pushing up treasury yields. Perhaps foreigners can save America.
First published in Southern Morning Post on September 23, 2008. |
There you have it. America needs huge, massive inflows of money from the creditor world to keep it afloat. If this does not happen, the result is depression and the writer thinks it unlikely to happen.
Who thinks America would swap her debt for stocks? Will America choose hyperinflation over selling the DOW to Saudi? |
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mises
Joined: 05 Nov 2007
Location: retired
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| Posted: Sun Sep 28, 2008 7:56 pm Post subject: |
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In a separate article he goes on to further elaborate the risks to the global economy. I think the dude is 100% bang on, as usual. Xie is always balanced and fair.
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Global Hard Landing
09-22 18:53 Caijing Magazine comments( 6 )
While the financial crisis is far from over, the economic crisis is just around the corner, and the U.S. may be headed for a hard landing.
By Andy Xie, board member of Rosetta Stone Advisors Limited
The US government is setting up an RTC-like organization to purchase bad assets from financial institutions for warehousing and disposing overtime. This is a step in the right direction. Market may feel good for a couple of weeks, which is how long this bounce would last, in my view. Details of the rescue may unsettle investors. The government may purchase the bad assets at very low prices. Many financial institutions still wouldn't be viable after the forced write-downs. The government may seek deals with them like with AIG, which would be hugely dilutive for existing investors. This is a bounce to sell into.
Apart from the short-lived bounce, there is little upside to stay in the market. While the financial crisis is far from over, the economic crisis is already around the corner. The U.S. is heading for a hard landing. A significant part of the US consumption is kept afloat by the credit bubble. As the bubble collapses, the credit for consumption dries up, the US's economy will likely contract by 2-5 percent. 1997 for Asia is 2008 for America, 1998 for Asia 2009 for America.
Europe and Japan are already contracting. Their recession will likely last through 2009. They have little domestic demand strength and have always been export-driven. Their weakness will feed back into the US. It has benefited from strong exports in 1H08. The export support vanishes just as its credit crisis hits its consumers. The downward spiral is just beginning.
The risk for a hard landing in China is rising and fast. China's exports, 40 percent of GDP in nominal value and probably 25 percent of GDP in value added, may decline in 2009 for the first time in three decades. China was small enough and cheap enough to grow its exports regardless of global demand through market share gains. But, China is now the largest exporter in the world. Market share gain couldn't offset downward trend anymore.
China's property bubble is bursting. The fuel for the bubble was the export income and hot money inflow. Both sources are contracting. The property market is probably heading for a hard landing. The property burst will have a large effect on industry. Demand for auto and white goods won't grow much, may even decline.
Retail sales would do ok. Wages are rising at good speed due to better balance between demand and supply in labor market. But, China's consumption is only 40 percent of GDP. Even if it grows 10 percent, it contributes four percentage points to GDP growth. But, the income effect from slowdown or contraction in exports and property should have a meaningful effect on household income. 10 percent growth is clearly optimistic.
I believe that the government will initiate a fiscal stimulus package. The third plenum of the 17th Party Congress will convene next month. It could bring a consensus on the need for stimulus. The content is unpredictable. I want the package to address liquidity problem at local governments, redistribute income to farmers by raising prices for food products, and accelerate infrastructure projects. I would be surprised that the package can add more than 2 percentage points to growth. It could only be a cushion on the way down, not sustain high growth rate.
No matter how we look at production, demand, or income angles, China's growth rate next year would be significantly lower than in 2008. In 1998, electricity consumption contracted for two quarters. I wouldn't be surprised that the same happens next year.
With Europe and Japan contracting, the US is heading for a hard landing, and China possibly heading for a hard landing, market can hardly perform in the foreseeable future. If global recovery, probably a mild one, is possible in 2010, markets may perform only by mid-2009.
I remain bullish on energy and gold in the current environment. A cartel of rich men works. The OPEC is that now. It didn't work in the 1990s because they were poor and everyone cheated to gain income. They have no incentives to produce more in an environment of declining price. They can't even spend the money they have earned and don't need new money. Gold is a play on easy monetary policy. All major economies have negative real interest rates. The situation would only worse in 2009. Gold is a currency substitute. When currency supplies surge like now, it should appreciate too.
We live in interesting times. This is the end of the Greenspan bubble. Finance has led the global economy in the past two decades, because Greenspan's liquidity made Wall Street very big relative to real economy. It was a debt bubble in the derivative dress. The future will be very different. In 1989, socialism was discredited. In 2008, financial capitalism is discredited. The world would be different in future. In what form we don't yet know. |
http://english.caijing.com.cn/2008-09-22/110014905.html |
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mithridates
Joined: 03 Mar 2003
Location: President's office, Korean Space Agency
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| Posted: Sun Sep 28, 2008 9:40 pm Post subject: |
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The world should come together to prevent such a tragic ending. Countries with big foreign exchange reserves like China, Japan, Kuwait, Saudi Arabia and the United Arab Emirates, for example, should sit down with the U.S. government to find a way to recapitalise its economy. They should swap their U.S. dollar assets in debt instruments like treasuries for equity assets like stocks.
The world has a vested interest in ensuring an orderly resolution to the U.S. crisis. If America prints money to solve its problems, it will lead to the destruction of other nations' wealth in U.S. dollar assets and a global depression of unimaginable proportions. |
Good article. This is exactly why I said on the other thread that no other country has the desire to take the US' place as the world's superpower. It's a nice dream for the future perhaps, but at the moment they all have a vested interest in keeping the US where it is at the top.
That book by that guy on the Daily Show about two years ago (I think it was called the friendly giant or the beneficial giant or something like that) said pretty much the same thing, that the US also provides a lot of free services to other nations in areas such as trade in how it patrols the seas and keeps things safe for those that need the ocean to make a profit, and that without the US somebody else would have to step in to do that and nobody has that ability. |
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mises
Joined: 05 Nov 2007
Location: retired
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| Posted: Sun Sep 28, 2008 9:49 pm Post subject: |
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I agree. But I worry that there is a very strong lack of goodwill towards the US that could pollute this process and also that American pride might not permit it as well.
On balance, I'd say a coordinated international bail-out is extremely unlikely. |
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Jandar
Joined: 11 Jun 2008
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| Posted: Sun Sep 28, 2008 10:50 pm Post subject: |
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The real question is how to absorb the "Default Swaps" invented by the Morgan Mafia and abused by AIG.
Was AIG the only institute that abused these vehicles?
Are all the symptoms the well spring of AIGs abuses or are there more abuses out there?
How healthy are the Citibank "Default Swap" vehicles, how much real capital is behind those "Default Swaps" or are they as "Leveraged" as every other financial vehicle out there?
Can someone tell me where these "Default Swaps" are in the monetary cycle? M7 or M9 maybe or M2 to the nth? |
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ontheway
Joined: 24 Aug 2005
Location: Somewhere under the rainbow...
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| Posted: Mon Sep 29, 2008 9:17 am Post subject: |
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| If America prints money to solve its problems, it will lead to the destruction of other nations' wealth in U.S. dollar assets and a global depression of unimaginable proportions. Rising leverage in the U.S. has driven the demand growth in the global economy in the past decade. The high foreign-exchange reserves of its trading partners and the excessive leverage of the U.S. economy are two sides of the same coin. |
Quoting the author, everyone, including the author should take note of this.
What this means is that we have a bubble, caused by the Federal Reserve. They did it again: a socialist, fiat money inflation bubble, has burst.
The proposed solution is to reinflate the bubble. This will bring temporary relief followed by a complete meltdown sometime in the future. It could come in 2 months or 12 years, but it will come and unless we go back on the gold standard, it is now inevitable. The $700 billion to $1.5 trillion bailout, which will no doubt grow and expand until it bursts, makes it inevitable.
We should have let the contraction come and the prices fall, and then gone back on the gold standard. Very quick and painful recession followed by a fast rebound and record growth in a free market. But, the government is afraid to let the people see the socialist system fail, (Since the people expect socialism to cure all.)
Or...
We could go on the gold standard at the current price levels, and let the market adjust from here. Less effective and we'll have to suffer for a while, but workable. Of course, having gone off gold in steps at $20, then $32, then $35 and going back on probably at $2000 to $5000 per ounce would show just how badly the Federal Reserve and Federal Government socialist fiat money system was. So, they won't do this ...
Which leaves the US Government ...
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| " [printing] ... money to solve its problems, it will lead to the destruction of other nations' wealth in U.S. dollar assets and a global depression of unimaginable proportions." |
It's the death of socialism in the US. The US government and federal reserve will fall for exactly the same reasons that the USSR fell - the failure of socialism. |
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mises
Joined: 05 Nov 2007
Location: retired
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| Posted: Mon Sep 29, 2008 9:25 am Post subject: |
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Yes dude. The Fed is responsible but all this "socialism" stuff is annoying. The Fed is a poor institution but it isn't socialist. Feudal, more like.
I like Xie's ideas. I want the United States to be a normal country, and not because I dislike it. I want the US to be on stable financial footing precisely because I like it - or the idea of it - so much. It can't afford empire anymore and frankly American ideas about her role in the world need to change. |
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Juregen
Joined: 30 May 2006
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| Posted: Mon Sep 29, 2008 10:09 am Post subject: |
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I can't see either where he gets this "socialist" idea from.
Giving people loans based on bad fundamentals has nothing to do with socialism. It's crony capitalism.
Then leveraging those loans on stock markets and derivatives ... with people badly informed about the actual risks involved ....
Again I see no socialism there. Just some people who got rich on the back of others. |
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ontheway
Joined: 24 Aug 2005
Location: Somewhere under the rainbow...
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| Posted: Mon Sep 29, 2008 10:13 am Post subject: |
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The Federal Reserve is a government created institution. It is therefore socialist by definition. All government is socialism.
In a free market we would have sound money based on commotities, and in most cases on gold. Some issuers would use silver or platinum or a basket of such commodities, perhaps.
Under such a free market money system, a bubble like we are witnessing would be impossible.
It is only possible with socialist fiat money. |
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mises
Joined: 05 Nov 2007
Location: retired
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| Posted: Mon Sep 29, 2008 10:17 am Post subject: |
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You're working on a very broad definition of socialism. Not every political/economic arrangement directed by a state is socialism.
Anyways, it is a pointless discussion. The Xie pieces are what ought to be discussed here as they are the very best on the subject thus far. |
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ontheway
Joined: 24 Aug 2005
Location: Somewhere under the rainbow...
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| Posted: Mon Sep 29, 2008 10:20 am Post subject: |
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Today we are witnessing a market crash, Dow down 700 points, based on the possibility of the bailout not happening. This sudden decline is based on market participants watching what is happening in Washington.
Now, because of the bubble, we need to have a crash.
But, this shows how the market anticipates the future. If the bubble does not get reinflated, then we will have to have a major correction and shake the malinvestment out of the system. We will shake some of the inflation out of the system. This is a good thing. But it means that stock prices will have to fall drastically. Actually, the market is NOT yet fully anticipating that the Congress will do nothing.
This also shows what happened with the famous Stock Market Crash in October 1929.
As the market participants watched congress, and it became apparent that the market would pass and the President would sign the Smoot-Hawley tariff, and knowing the detrimental effects that bill would have on future trade and buisness profits, the market crashed.
It has been proven.
Now, we can see a similar effect happening right before our eyes. |
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mises
Joined: 05 Nov 2007
Location: retired
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| Posted: Tue Oct 07, 2008 10:22 am Post subject: |
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http://blogs.cfr.org/setser/2008/10/07/russia-global-lender-of-last-resort-will-russia-bail-out-the-hedge-fund-of-the-north/
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Russia, global lender of last resort? Will Russia bail out the hedge fund of the North �
Posted on Tuesday, October 7th, 2008 by bsetser
A few years ago, analysts looking at the same data that Dr. Krugman highlighted started to call the US a hedge fund. It borrowed short-term in dollars, providing the world wit a safe liquid asset (or it was said) and used the proceeds to buy risky assets abroad � collecting a risk premium in the process.
That kind of hedge fund is has had a bad run recently. The US � viewed as a hedge fund � is structurally �short� the dollar and �long� global equities, as it borrows in dollars to buy assets abroad. It consequently did well when the dollar fell and global equity markets rose, and correspondingly did poorly when the dollar rises and global equities fall. Unless something changes, the United States net international investment position will deteriorate quite sharply this year.
The US as hedge fund metaphor actually never quite worked for the US � as the US was borrowing as much to finance a current account deficit (current consumption) as to finance the purchases of assets abroad. It actually was a better description of Europe (which also is having a bad week) in general and the Eurozone in particular. The Eurozone attracted large inflows and used the resulting inflows to finance equally large outflows, not a large current account deficit.
But no national resembled a high-living hedge fund quite as much as Iceland. Its big banks and big firms had enormous international liabilities and enormous international assets � at least in relation to Iceland�s small economy. And for a while, Iceland used the profits from its intermediation to live very well, running a large current account deficit. In that sense, it also resembled the US.
Suffice to say it is a very troubled hedge fund.
And it has apparently turned to Russia � yep, Russia � for emergency financial support. Iceland�s prime minister claimed to have no choice. Iceland�s friends, he claimed, all turned Iceland down (maybe they were too busy rescuing their own banks). The FT reports
It is a strange deal though, assuming there is actually a deal. Iceland is a member of NATO. The US had an airbase there for a long-time � in large part to keep an eye out for Russia. During the cold war there is no way the US would ever have allowed Russia to bailout a military ally. Russia hasn�t traditionally thought of Iceland as part of its near-abroad. And Russia is lending to support a Iceland�s new peg � a peg that I assume will be too a euro-heavy rather an ruble-heavy basket.
One of the strategic changes that I discussed in my Council Special Report was the possibility that countries with large reserves might displace the US, the G-7 and institutions like the IMF from their traditional role as the world�s financial crisis managers. I am though still surprised by Russia�s move, largely because I assumed that Russia�s current financial troubles would keep it from financial adventures abroad. Russia�s reserves fell by $40b between the end of July and the end of September, though part of that comes from the fall in the dollar value of Russia�s euros and pounds.It almost certainly isn�t pegging to the ruble. And finally, Russia�s central bank has had its hands full � or so it seemed � managing Russia�s own crisis. Russia�s government recently indicated it would give long-term (not just short-term) financing to Russia�s big state banks. I guess Russia wanted to show it has enough reserves to play offense as well as defense.
I consequently wouldn�t characterize this move as �stabilizing.� It may help Iceland � but it also destablizes the world�s existing architecture for crisis management. The IMF has plenty of cash. It could have been at the center of an international effort to support Iceland, though the Fund�s rules and Iceland�s small size likely would have implied that the other Nordic countries and perhaps all of Europe would have needed to lend along side the Fund.
Or, I guess, Norway could have used its sovereign fund to bailout Iceland�s government and its banks �
Certainly lots of countries (Russia, Kuwait, Australia) have been using their sovereign funds to support their domestic banks recently.
Nor is Iceland the only small country with lots of external debt. Dubai looks rather like a real-estate heavy hedge fund � with lots of short-term liabilities and long-term, rather illiquid assets. I would bet though that it will turn to Abu Dhabi rather than Russia for help.
Suffice to say the world is changing rapidly � |
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