The Thought of Chairman Liu

Central Banks Have Become Market Destroyers 10-28-2008

2008-10-29T18:57:00.000-07:00

The market was more honest than most paid pundits and special interest policymakers. Market participants knew the crisis was not merely a passing liquidity crunch, but a widespread insolvency created by excessive asset value unsupported by compensatory revenue. Insolvency will translate into sharp declines in asset price. The government can destroy the market in the name of saving it but the laws of market cannot be negated by government intervention.

The recent opening of the Federal Reserve discount window to borrowings by commercial banks, collateralized by illiquid assets, and the extension of discount window access to investment banks have pushed the central bank across the line of being a lender of last resort to being a market destroyer. It is no wonder that its liquidity injection moves have failed to moderate seizure of global credit markets. This is because the central bank, not constrained by the supply and market value of money, can set the price of illiquid asset by fiat, thus destroy the very function of the market in setting meaningful prices that can defuse market seizure. Central bank intervention into credit markets to artificially support asset prices above market levels carries no fundamental market implication, save the impact of future inflation. The market knows that asset prices assigned by the central bank are not real and will be adjusted downward as soon as central bank intervention ends. And until central bank intervention ends, the market remains in suspension.

Leverage and Deleverage 10302008

2008-10-29T12:26:00.000-07:00

The Impact of Leverage and De-leverage on Asset Price

The net capital rule created by the SEC in 1975 required broker-dealers to limit their debt-to-net-capital ratio to 12-to-1, and they must issue early warnings if they began approaching this limit, and were forced to stop trading if they exceeded it, so broker-dealers often kept their debt-to-net capital ratios much lower than 12-1. The rule allowed the SEC to oversee broker-dealers, and required firms to value all of their tradable assets at market prices. The rule applied a haircut, or a discount, to account for the assets’ market risk. Equities, for example, had a haircut of 15%, while a 30-year Treasury bill, because it is less risky, had a 6% haircut. But a 2004 SEC exemption -- given only to five big firms -- allowed them to lever up 30 and even 40 to 1.

The five big firms wanted for their brokerage units an exemption from the 1975 regulation that limited the amount of debt they could take on to $12 for every dollar of equity. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those equity funds could then flow up to the parent company, enabling it to invest in the fast growing but opaque world of mortgage-backed securities, credit derivatives, credit default swaps - a form of insurance for bond holders - and other exotic structured finance instruments

In 2004, the European Union passed a rule allowing the SEC’s European counterpart to manage the risk both of broker dealers and their investment banking holding companies. In response, the SEC instituted a similar, voluntary program for broker-dealers with capital of at least $5 billion, enabling the agency to oversee both the broker-dealers and the holding companies. Ever since the Great Depression, the government has tried to limit the leverage available to the public in the US stock market by maintain margin requirements. But regulators, led by former chairman of the Federal Reserve Alan Greenspan, thought financial innovation would be hampered, and financial activity driven to unregulated market overseas, if there were any attempts to impose limits on leverage in the unregulated credit and capital markets. After all, innovation was viewed as the driving force in US prosperity. The global financial system embarked on a race to assume more risk under a mentality of “if I don’t smoke, somebody else will.”

This brave new approach, which all five qualifying broker-dealers - Bear Stearns, Lehman Brothers, Merrill Lynch, Goldman Sachs, and Morgan Stanley - voluntarily adopted, altered the way the SEC measured their capital. The five big firms led the charge for the net capital rule change to promote financial innovation, spearheaded by Goldman Sachs, then headed by Henry Paulson, who two years later, would leave Goldman to become the Treasury Secretary, who now has to deal with the global mess created by high leverage.

Using computerized models provided by the five big firms, the SEC, under its new Consolidated Supervised Entities (CSE) program, allowed the broker-dealers to increase their debt-to-net-capital ratios, sometimes, as in the case of Merrill Lynch, to as high as 40-to-1. It also removed the method for applying haircuts, relying instead on another math-based computerized model for calculating risk that led to a much smaller discount.

The SEC justified the less stringent capital requirements by arguing it was now able to manage the consolidated entity of the broker-dealer and the holding company, which would ensure better management of risk. “The Commission’s 2004 rules strengthened oversight of the securities markets, because prior to their adoption there was no formal regulatory oversight, no liquidity requirements, and no capital requirements for investment bank holding companies,” a spokesman for the agency rationalized.

In loosening the capital rule, which was supposed to provide a buffer in turbulent times, the SEC also decided to rely on the five big firms’ own computer risk models, essentially outsourcing the job of monitoring risk to the banks it was supposed to supervise. Over subsequent years, all would take advantage of the looser capital rule to increase leverage.

It is now clear that the SEC leverage modification in 2004 is a primary reason for the massive losses that have occurred in 2008.

On Sept. 26, 2008, Chairman Cox announced a decision by the SEC Division of Trading and Markets to end the Consolidated Supervised Entities (CSE) program, created in 2004 as a way for global investment bank conglomerates that lack a supervisor under law to voluntarily submit to regulation. Chairman Cox also described the agency’s plans for enhancing SEC oversight of the broker-dealer subsidiaries of bank holding companies regulated by the Federal Reserve, based on the recent Memorandum of Understanding (MOU) between the SEC and the Fed.

Chairman Cox made the following statement along with the SEC announcement on ending the CSE:
The last six months have made it abundantly clear that voluntary regulation does not work. When Congress passed the Gramm-Leach-Bliley Act [on November 12, 1999 to repeal the Glass-Steagall Act of 1933 which had prohibited a bank from offering investment banking and insurance services], it created a significant regulatory gap by failing to give to the SEC or any agency the authority to regulate large investment bank holding companies, like Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, and Bear Stearns.

Government Backing of Bank-issued debt will make all other forms of debt riskier and more expensive.

The government’s intervention has created a relative advantage for companies to raising funds through guaranteed bank paper versus the asset-backed markets. The ability of banks and other financial groups to raise money via government guarantees means funding through more traditional routes like asset-backed securities will be much more expensive. In the short-term, the government moves is having an effect. There has not been any issuance in credit cards because all the major banks now have another, cheaper option. In addition to offering banks cheaper sources of funding, the explicit government guarantees on many bank securities has led to a sell-off in bonds issued by mortgage financiers like Fannie Mae and Freddie Mac, as well as asset-backed securities. As a result, the cost of borrowing in asset-backed markets has soared, with the premiums over US government bonds at record highs. This makes private sector funding even less attractive.

Systemic Insolvency mistaken for liquidity crisis - Oct 22 2008

2008-10-22T18:58:00.000-07:00

The diagnosis misjudged the current credit crisis as only a temporary liquidity quandary instead of recognizing it as a systemic insolvency.

The misdiagnosis led to a flawed prognosis that the liquidity crunch could be uncorked by serial injections of more government funds into intractable credit and capital market seizure. This faulty rationale was based on the fantasy that distressed financial institutions holding assets that had become illiquid could be relieved by wholesale monetization of such illiquid asset with government loans, even if such government loans are collateralized by the very same illiquid assets that private investors have continued to shun in the open market. Its not that government officials knows more than market participants about the true value of these illiquid assets; it is only that government officials with access to taxpayer money have decided to ignore market forces to artificially support asset overvaluation, the original root cause of the problem. Instead of being the solution, the government with flawed responses backed by the people’s money has become part of the problem.

Bear Stearns and the failure of the repo market debt

For example, the trigger point behind Bear Stearns’s near failure came from the repo market where banks and securities firms routinely extend and receive short-term loans, typically made overnight and backed by top grade securities. Hours before 7:30 am on March 14, 2008, Bear Stearns was faced with the problem of not being able to roll over its huge repo debt because its high-rated collaterals had fallen in market value. If the firm did not repay the maturing debt on time with new funds from new repo contracts, its creditors could start selling the collateral Bear had pledged to them at fire sale prices to cause substantial loss to Bear Stearns. The implications would go far beyond losses for Bear Stearns. The sale receipts might not repay all investors and cause losses to conservative institutional investors such as pension funds and money market funds. If investors begin to question the safety of loans collateralized by triple-A securities they make in the repo market that are now worth less than their face value, they could start to withhold funds from the credit market when other investment banks and companies need to roll over their maturing short-term debts. Hundred of firms would default and fail from a seizure of the $4.5 trillion repo market, bringing down banks which have issued standby credit to them in a financial chain reaction.

the Logic of Repo Failures

As with other financial markets, repo markets are subject to credit risk, operational risk and liquidity risk. However, what distinguishes the credit risk on repos from that associated with uncollateralized instruments is that repo credit exposures arise from volatility (or market risk) in the value of collateral. For example, a decline in the price of securities serving as collateral can result in an under-collateralization of the repo. Liquidity risk arises from the possibility that a loss of liquidity in collateral markets will force liquidation of collateral at a discount in the event of a counterparty default, or even a fire sale in the event of systemic panic. Leverage that is built up using repos can exponentially increase these risks when the market turns. While leverage facilitates the efficient operation of financial markets, rigorous risk management by market participants using leverage is important to maintain these risks at prudent levels.

The Basic Principle of Structured Finance

Companies involved in structured financing arrangements often consult with credit rating agencies to determine how to structure individual tranches of debt so that each receives a desired credit rating to certify its risk exposure. For example, a firm may wish to borrow a large sum of money by issuing debt securities. However, the amount is so large that the return investors may demand on a single issuance would be prohibitive. Instead, it decides to issue three separate bonds, with three separate credit ratings -- A (medium low risk), BBB (medium risk), and BB (speculative), using Standard & Poor’s rating system. The firm expects that the effective interest rate it pays on the BB-rated bonds will be more than the rate it must pay on the A-rated bonds, but that, overall, the amount it must pay for the total capital it raises will be less than it would pay if the entire amount were raised from a single bond offering. This is the basic principle of structured finance: the squeezing of financial value out of unbundling of debt.

The Fed Supports Money Market Mutual Funds

The US Federal Reserve on October 21 announced it would create a Money Market Investor Funding Facility (MMIFF) to support a private-sector initiative designed to provide liquidity to U.S. money market investors. MMIFF will finance up to $540 billion in purchases of short-term debt from money market mutual funds to shore up a key pillar of the US financial system. It will provide senior secured funding to a series of special purpose vehicles to facilitate an industry-supported private-sector initiative to finance the purchase of eligible assets from eligible investors. Eligible assets will include US dollar-denominated certificates of deposit and commercial paper issued by highly rated financial institutions and having remaining maturities of 90 days or less. Eligible investors will include US money market mutual funds and over time may include other US money market investors.

Money market funds are facing severe redemption pressures since the financial crisis deepened last month, forcing them to raise cash by scaling back their short-term lending to banks and selling their holdings of commercial paper. This retreat has contributed both to a freeze in the interbank market and a steep decline in activity in the commercial paper market, which has made it difficult for banks and companies to raise short-term funds.

Government Strategy Ignores Fundamental Problem of Asset Overvaluation

Although each step by the government in reaction to the credit crisis was a logical, targeted response to new systemic financial upheavals, the result was to prop up select distressed firms deemed too big to fail and support failing markets as they occurred, hoping in vain that it would be the last move needed to resolve the systemic crisis to put the economy on a path of recovery. The Fed and the Treasury appeared to be rushing from emergency to emergency without a strategic plan to deal with the fundamental problem of a debt bubble collapse.

The disjointed interventions appeared designed to keep a collapsing debt bubble from collapsing, a hopeless task that even Alan Greenspan, the bubble wizard par excellence, was not naive enough to try. Greenspan merely replaced a burst bubble with a new bigger bubble, never tried to keep stop a collapsing bubble in mid course. Greenspan’s approach was that of a post disaster cleanup crew, not rushing into a collapsing structure as the current bailout team appears to be trying to do. Throwing good money after bad merely makes good money into bad. Spending good money after the collapse would infinitely buy more in the cleanup task

Global Bank Bailout by Central Banks

Prompted by the US, governments across Europe took action to bail out their respective banks and protect their separate banking systems after the G7 meeting in Washington during the weekend of October 11.

France extended state guarantee to $435 billion of senior bank debt to help jumpstart French credit markets. It created a state company with up to $54 billion in capital to recapitalize distressed French banks. The UK guaranteed $434 billion of bank debts and injected $64 billion into Royal Bank of Scotland Group, HBOS, a banking/insurance group in the UK, and Lloyds TSB Group, as part of its already announced £400 billion bail-out plan. Germany guaranteed up to $544 billion inter-bank debts, setting aside $27 billion for potential losses and injected up to $109 billion equity in German banks. Italy announced it will recapitalize Italian banks and guarantee bonds on a case-by-case basis. Spain will guarantee $136 billion in Spanish bank debts, set up preventive facility to inject new capital into distressed Spanish banks until 2009 and established up to $68 billion to buy Spanish bank assets. The Netherlands is injecting €10 billion ($13.4 billion) into ING Group, the banking and insurance gaint who just weeks earlier was the white knight to bail out troubled Fortis NV. Austria, Portugal and Norway joined the effort, committing a total of €501 billion in guarantees and capital for banks in their respective jurisdiction.

commercial paper - Henry Liu - Nov 2007

2008-10-17T18:56:00.000-07:00

Commercial paper has become an important debt market because of the advantages of commercial paper for both investors and issuers. Commercial paper outstanding grew at an annual rate of 14% from 1970 to 1991, totaling $528 billion at the end of 1991. Until the recent market seizure, the commercial paper market was a $3 trillion market with half of the market consisting of bank-financed “conduits” of asset backed commercial paper (ABCP). The ABCP market shrank 13% in August 2007 as US companies struggled unsuccessfully to raise short-term funds to roll over maturing outstanding debts

Characteristics of Commercial Paper

Securities offered to the public must be registered with the Securities and Exchange Commission according to the Securities Act of 1933. Registration requires extensive public disclosure, including issuing a prospectus on the offering. It is a time-consuming and expensive process. Most commercial paper is issued under Section 3(a)(3) of the 1933 Act which exempts from registration requirements short-term securities with certain characteristics. The exemption requirements have been a factor shaping the characteristics of the commercial paper market. The key requirement for exemption is that the maturity of commercial paper must be less than 270 days. In practice, most commercial paper has a maturity of between 5 and 45 days, with 30-35 days being the average maturity. Many issuers continuously roll over their commercial paper, financing a more-or-less constant amount of their assets using commercial paper. The nine-month maturity limit is not violated by the continuous rollover of notes, as long as the rollover is not automatic but is at the discretion of the issuer and the dealer. Many issuers will adjust the maturity of commercial paper to suit the requirements of an investor.
Notes must be of a type not ordinarily purchased by the general public. In practice, the denomination of commercial paper is large: minimum denominations are usually $100,000, although face amounts as low as $10,000 are available from some issuers. Typical face amounts are in multiples of $1 million, because most investors are institutions. Issuers will usually sell an investor the specific amount of commercial paper needed.

That proceeds from commercial paper issues can be used to finance “current transactions”, which include the funding of operating expenses and the funding of current assets such as receivables and inventories. Proceeds cannot be used to finance fixed assets, such as plant and equipment, on a permanent basis. The SEC has generally interpreted the current transaction requirement broadly, approving a variety of short-term uses for commercial paper proceeds as proceeds are not traced directly from issue to use. Firms are required to show only that they have a sufficient "current transaction" capacity to justify the size of the commercial paper program. For example, a particular level of receivables or inventory. Firms are allowed to finance construction as long as the commercial paper financing is temporary and to be paid off shortly after completion of construction with long-term funding through a bond issue, bank loan, or internally generated cash flow.

Liu excerpted from http://www.eagletraders.com/neg_financial_instruments/commercial_paper_o.htm

AIG, Lehman, RTC 2? - Too big to fail - Sep 19 2008

2008-09-20T19:10:00.000-07:00

The way the Fed has been trying to stabilize the financial market in this horrendous credit crisis since it burst open in August 2007 is looking like punching new gaping holes in the throat of the patient to deliver more air to his lungs. One of these days, it may accidentally puncture a jugular vein to end the game. The lender of last resort has become a predator of last resort, nationalizing all dying enterprises. But it seems to be racing headlong onto the road of nationalization not so much as to help the common people as to keep dying financial dinosaurs alive.

The Fed continues to pretend that firms likes AIG are merely going through a liquidity crunch. The fact is that undercapitalization is by definition a solvency problem. The problem is not that good assets are temporarily hit with prices below their real worth and that new capital is needed to maintain debt to equity ratio. The problem is that all these debts were not worth their face value to begin with. The high inflated market values of these assets were held up by circular trading of debt by assuming that they could always be sold at still higher prices way beyond their true worth. Now that the market is finally adjusting the price bubble downward and a lot of firm who were incredibly profitable on the way up are falling like leave in autumn in a bear market. The Fed is merely trying to inject money to keep prices not supported by fundamentals from falling. It is a prescription for hyperinflation. The only way to keep price of worthless assets high is to lower the value of money. And that appears to be the Fed unspoken strategy.

AIG is faced with $441 billion of exposure to credit-default swaps and other derivatives. Losses on these contracts have driven AIG into a vicious downwards spiral in which it needs ever more cash to remain a top-rated counterparty. JPMorgan Chase and Goldman Sachs had been charged by the government with finding $75 billion from private sources to rescue failing firm. They both failed. The shares of Morgan Stanley and Goldman Sachs themselves were down sharply one day after the Fed issue an $85 billion bridge loan to keep AIG from defaulting.

Milton Friedman - Business vs Economy Sep 5 2008

2008-09-06T18:29:00.000-07:00

The market is merely the transactional record of the economy. Students of the market economy tend to confuse business, which is transacted in the market, as the whole economy itself. That is the problem with Business School economists who really should be called “busi-nomists” rather than eco-nomists because by definition and by design they are not concerned with eco, a Greek word “oikos” meaning house. The word describes the complex symbiotic relationships of all living organisms in relation to their environment in the eco-system. Business is ony a subsystem of the socio-economic ecosystem. The goal of busi-nomists is to keep the business cycle from recurring crashes even if it means destroying the economy in the process. To achieve this goal, central banking was invented.

This is not to denigrate business experts. All experts, however narrow, perform useful functions and brilliant experts deserve admiration. It is just that they should refrain from fantasizing that they are generalists dealing with the economy. Business exists to make profit for the businessman and there is nothing wrong with that as long as ethical rules are observed. Unlike business, the economy exists to enhance progress in civilization. The former is artificial, the latter is actual. The key problem of the recent decades of Friedman monetarism has not been that money matters but that it matters too much.

Labor-theory of Value turned upside down

2008-07-29T11:02:00.000-07:00

World trade is now a game in which the US produces fiat dollars of uncertain exchange value and zero intrinsic value, and the rest of the world produces goods and services that fiat dollars can buy at “market prices” quoted in dollars. Such market prices are no longer based on mark-ups over production costs set by socio-economic conditions in the producing countries. They are kept artificially low to compensate for the effect of overcapacity in the global economy created by a combination of overinvestment and weak demand due to low wages in every economy. Such low market prices in turn push further down already low wages to further cut cost in an unending race to the bottom. The higher the production volume above market demand, the lower the unit market price of a product must go in order to increase sales volume to keep revenue from falling. Lower market prices require lower production costs which in turn push wages lower. Lower wages in turn further reduces demand. To prevent loss of revenue from falling prices, producers must produce at still higher volume, thus lowering still market prices and wages in a downward spiral. Export economies are forced to compete for market share in the global market by lowering both domestic wages and the exchange rate of their currencies. Lower exchange rates push up the market price of commodities which must be compensated by even lower wages. The adverse effects of dollar hegemony on wages apply not only to the emerging export economies, but also to the importing US economy. Workers all over the world are oppressed victims of dollar hegemony which turns the labor theory of value up-side-down..

In a global market operating under dollar hegemony, the world’s interlinked economies no longer trade to capture Ricardian comparative advantage. The theory of comparative advantage as espoused by British economist David Ricardo (1772-1823) asserts that trade can benefit all participating nations, even those who command no absolute advantage, because such nations can still benefit from specializing in producing products with the lowest opportunity cost, which is measured by how much production of another good needs to be reduced to increase production by one additional unit of that good. This theory reflected British national opinion at the 19th century when free trade benefited Britain more than its trade partners. However, in today’s globalized trade when factors of production such as capital, credit, technology, management, information, branding, distribution and sales are mobile across national borders and can generate profit much greater than manufacturing, the theory of comparative advantage has a hard time holding up against measurable data.

Holy Dollar Empire

Echoing the Holy Roman Empire, the global economy has been operating as a global Holy Dollar Empire with the Federal Reserve as the Holy Dollar Emperor. Similar to the Holy Roman Empire which disintegrated from the rise of Lutheran nationalism, this Holy Dollar Empire will eventually disintegrate from progressive centrifugal forces of a new populist economic nationalism. This new populist economic nationalism is not to be confused with regressive trade protectionism. The formation of the new Group of Five (G5 - China, Brazil, India, Mexico and South Africa) in the 2008 Group of Eight Summit in Tokyo (G8 – US, UK, Germany, France, Italy, Japan, Russia and the European Union) is a sign of this new trend of progressive new economic nationalism. The 2008 US presidential election may herald in a new populism in US history to reform the structure of US debt capitalism. In his speech to the G5 leaders, President Hu Jintao said: “It is necessary to take into full account the issue of food security in tackling the challenges in energy, climate change and other fields.” Apart from calling for the setting up of an UN-led international co-operation mechanism and a global food-security safeguard system, Hu said all countries should strengthen co-operation in grain reserves, a process of proven success in China but not recommended by the UN Food and Agriculture Organization which views such scheme as a distortion of trade. Liberation from this Holy Dollar Empire of dollar hegemony can only come from sovereign nations withdrawing from the global central banking regime to return to a national banking regime within a world order of sovereign nation states to put monetary policy back in its proper role of supporting national development goals, rather than sacrificing national development to support global dollar hegemony through wage-suppressing export-led growth. In a world order of sovereign nation states, the supranational nature of central banking will render it inoperative, as it can be and has been used as an all-controlling device for the world’s rich nation to neutralize the sovereign rights of financially weak nations. In a democratic world order, central banking is also inoperative within national borders, as it can be used by a nation’s rich as a device to deny the working poor of their economic rights. Central banking, in its support of dollar hegemony, operates internationally in opposition to the economic interests of sovereign nation states and domestically in opposition to the economic rights of the working poor by discrediting enlightened economic nationalism as undesirable protectionism.

Debt capitalism self-destructs

2008-07-21T11:55:00.000-07:00

The once-dynamic US economy has turned itself into a system in which it is difficult to find any institution, company or individual not over their head in speculative debt. Undercapitalized capitalism, also known as debt capitalism, has been the engine of growth for the US debt bubble in the last two decades. This debt capitalism cancer is caused by a failure of central banking

The backing of the GSEs enabled securitization of "ninja" mortgages (no income, no job or assets), loans that no one would buy if they were not guaranteed by the government. Thus the fault did not lie with mortgage originators, for they would not be able to issue shaky mortgages unless there was a market for them. GSEs' abuse of their alleged government guarantee had rendered market discipline inoperative, allowing the system to go on a wide joyride that was bound to crash of a cliff. Because of their complexity and broad distribution, when securitized debts default, restructuring is almost impossible. There is no effective fire break once the fire begins and quickly engulfs the whole market

In 1968, then president Lyndon Johnson, as part of his Great Society program, turned Fannie into a shareholder-owned company as part of a national housing policy to make finance capitalism finance the nationalization of housing. It was the beginning of corporate market socialism in the name of populist economic democracy. The public could only benefit if corporate and financial institutional interests could profit first. And the public must pay if market capitalism fails systemically, absolving the losses of wayward corporations and financial institutions.

In 1970, the savings and loan industry, envying the huge profit made by commercial and investment banks from Fannie Mae, called for and received congressional approval for a GSE of their own and Congress created Freddie Mac. Like the Urban Renewal program of the 1950s, the GSEs served a coalition of interest that included liberals who wanted to help low-income households, real state developers that wanted guaranteed demand, home builders that wanted a guaranteed market, local politicians who wanted tax revenue from redevelopment, banks that wanted lucrative risk-free loan proceeds and congressmen who wanted campaign contributions from mortgage lenders.

The GSEs have been financially successful because they combine private sector appetite for profit with access to government-backed credit at below market rates. It was a way to nationalize housing through the free market capitalism. The problem was that financial manipulation cannot replace the need for adequate income growth. The mismatch of income with asset price is the definition of a financial bubble. People were buying homes with cheap credit at prices that their income could not afford. The more home prices rose due to cheap credit, the more homeowners fell into the debt trap. Yet in all the current talk about finding ways to deal with the crisis, not one single voice is heard from official circles about the need to increase worker income. Instead, false hopes on one-time stimulant tax rebates are hailed as the magic bullet.

A monetary history

2008-01-28T16:40:00.000-08:00

The theology of monetary economics (from Critique of Central Banking 2002)

Inflation, the all-consuming target of central banking, is popularly thought of as too much money chasing too few goods, which economists refer to as the Quantity Theory of Money (QTM). QTM is one of the oldest surviving economic doctrines. Simply stated, it asserts that changes in the general level of commodity prices are determined primarily by changes in the quantity of money in circulation. But the theology of monetary economics has a long and complex history, an understanding of which is necessary for forming any informed opinion on the validity and purpose of central banking. Below is a brief summary of the stuff dinner conversation is made of among the gods of monetary theory. Jean Bodin (1530-96), a French social/political philosopher, attributed the price inflation then raging in Western Europe to the abundance of monetary metals imported from the newly opened gold and silver mines in the Spanish colonies in South America. Though he held many aspects of mercantilist views, Bodin asserted that the rise of prices was a function not merely of the debasement of the coinage, but also of the amount of currency in circulation. Bodin's religious tolerance in a period of fanatical religious wars drew upon him the accusation of being a "freethinker", a label as damaging as being called a communist sympathizer in the United States in modern times. In his Les Six Livrers de la republic (1576), Bodin replaced the concept of a past golden age with the concept of progress. He foreshadowed Thomas Hobbes (1588-1679: The Leviathan, 1651) by stating the political necessity of absolute sovereignty, subject only to the laws of God (morality) and nature (reality). Bodin also anticipated Baron Montesquieu (1689-1755: De l'esprit des lois, 1748) by highlighting environment as a determinant of laws, customs, beliefs and the interpretation of events, a view that influenced the US constitution, a view since rejected by current US moral imperialism. John Locke (1632-1704) and David Hume (1711-76) provided considerable refinement, elaboration and extension to the QTM, allowing it to be integrated into the mainstream of orthodox monetarist tradition. Locke developed the right of private property based on the labor theory of value and the mechanics of political checks and balances that were incorporated in the US constitution. Locke, in 1661, asserted the proportionality postulate: that a doubling of the quantity of money (M) will double the level of prices (P) and half the value of the monetary unit. Hume, in 1752, introduced the notion of causation by stating that variation in M (money quantity) will cause proportionate changes in P (price level). Concurrently with Irish banker Richard Cantillon (1680-1734), Hume applied to the QTM two crucial distinctions: 1) between static (long-run stationary equilibrium) and dynamic (short-run movement toward equilibrium); and 2) between the long-run neutrality and the short-run non-neutrality of money. Hume and Cantillon provided the first dynamic process analysis of how the impact of a monetary change spread from one sector of the economy to another, altering relative price and quantity in the process. They pointed out that most monetary injection would involve non-neutral distribution effects. New money would not be distributed among individuals in proportion to their pre-existing share of money holdings. Those who receive more will benefit at the expense of those receiving less than their proportionate share, and they will exert more influence in determining the composition of new output. Initial distribution effects temporarily alter the pattern of expenditure and thus the structure of production and the allocation of resources. Thus it is understandable that conservatives would be sympathetic to the QTM to maintain the wealth distribution status quo, or if the QTM is skirted, to ensure that the maldistribution tilts toward those who are more likely to engage in capital formation, namely the rich. Thus developing economies in need of capital formation would find logic in first enriching the financial elite while advanced economies with production overcapacity would need to increase aggregate demand by restricting income disparity. Hume describes how different degrees of money illusion among income recipients, coupled with time delays in the adjustment process, could cause costs to lag behind prices, thus creating abnormal profits and stimulating optimistic profit expectations that would spur business expansion and employment during the transition period. These non-neutral effects are not denied by the adherents of QTM, who nevertheless assert that they are bound to dissipate in the long run, often with great damage if the optimism was unjustified. The latest evidence of the non-neutral effects of money is observable in expansion of the so-called New Economy from easy money in the past decade and the recent collapse of its bubble. The QTM formed the central core of 19th-century classical monetary analysis, provided the dominant conceptual framework for interpreting contemporary financial events and formed the intellectual foundation of orthodox policy prescription designed to preserve the gold standard. The economic structure in 19th-century Europe led analysts to acknowledge additional non-neutral effects, such as the lag of money wages behind prices, which temporarily reduces real wages; the stimulus to output occasioned by inflation-induced reduction in real debt burdens, which shifts real income from unproductive creditor-rentiers to productive debtor-entrepreneurs; the so-called "forced saving" effect occasioned by price-induced redistribution of income among socio-economic classes having structurally different propensity to save and invest; and the stimulus to investment imparted by a temporary reduction in the rate of interest below the anticipated rate of return on new capital. Yet classical quantity theorists tended persistently to minimize the importance of non-neutral effects as merely transitional. Whereas Hume tended to stress lengthy dynamic disequilibrium periods in which money matters much, classical analysts focused on long-run equilibrium in which money is merely a veil. David Ricardo (1772-1823), the most influential of the classical economists, thought such disequilibrium effects ephemeral and unimportant in long-run equilibrium analysis. Gods, of course, enjoy longer perspectives than most mortals, as do the rich over the poor. As John Maynard Keynes famously said: "In the long run, we will all be dead." As leader of the Bullionists, Ricardo charged that inflation in Britain was solely the result of the Bank of England's irresponsible overissue of money, when in 1797, under the stress of the Napoleonic Wars, Britain left the gold standard for inconvertible paper. At that time, the Bank of England was still operating as a national bank, not a central bank in the modern sense of the term. In other words, it operated to improve the English economy rather than to strengthen the sanctity of international finance. Ricardo, by focusing on long term-equilibrium, discouraged discussions on the possible beneficial output and employment effects of monetary injection on the national level. Like modern-day monetarists, Bullionists laid the source of inflation, a decidedly evil force in international finance, squarely at the door of the national bank. As Milton Friedman declared some two centuries after Richardo: inflation is everywhere a monetary phenomenon. Friedman's concept of "money matters" is the diametrical opposite of Hume's. The historical evolution in 18th-century Europe from a predominantly full-metal money to a mixed metal-paper money forced advances in the understanding of the monetary transmission mechanism. After gold coins had given way to banknotes, Hume's direct mechanism of price adjustment was found lacking in explaining how banknotes are injected into the system. Henry Thornton (1760-1815), in his classic The Paper Credit of Great Britain (1802), provided the first description of the indirect mechanism by observing that new money created by banks enters the financial markets initially via an expansion of bank loans, through increasing the supply of lendable funds, temporarily reducing the loan rate of interest below the rate of return on new capital, thus stimulating additional investment and loan demand. This in turn pushes prices up, including capital good prices, drives up loan demands and eventually interest rates, bringing the system back into equilibrium indirectly. The central issue of the doctrines of the British classical school that dominated the first half of the 19th century was focused around the application of the QTM to government policy, which manifested itself in the maintenance of external equilibrium and the restoration and defense of the gold standard. Consequently, the QTM tended to be directed toward the analysis of international price levels, gold flow, exchange-rate fluctuations and trade deficits. It formed the foundation of mercantilism, which underpinned the economic structure of the British Empire via colonialism, which reached institutional maturity in the same period. Bullionists developed the idea that the stock of money, or its currency component, could be effectively regulated by controlling a narrowly defined monetary base, that the control of "high-power money" (bank reserves) in a fractional reserve banking regime implies virtual control of the money supply. High-power money is the totality of bank reserves that would be multiplied many times through the money-creation power of commercial bank lending, depending on the velocity of circulation. In the 1987 crash when the Dow Jones Industrial Average (DJIA) dropped 22.6 percent in one day (October 19) on volume of 608 million shares, six times the normal volume then (current normal daily volume is about 1.6 billion shares), the US Federal Reserve under its newly installed chairman, Alan Greenspan, created US$12 billion of new bank reserves by buying up government securities. The $12 billion injection of high-power money in one day caused the Fed Funds rate to fall by three-quarters of a point and halted the financial panic. If the government had been running a balanced budget and there were no government securities to be bought, the economy would have seized up. This shows that government deficits and debt are part and parcel of the modern financial architecture. In the three decades after Britain returned to the gold standard in 1821, the policy objective focused on the maintenance of fixed exchange rates and the automatic gold convertibility of the pound. But the Currency School (CS) versus Banking School (BS) controversy broke out over whether the "Currency Principle" of making existing mixed gold-paper currency expand and contract in direct proportion to gold reserves was sufficient to safeguard against note overissuance, or whether additional regulation was necessary. This controversy grew out of the expansion pressure put on the supply of pound sterling by the rapid expansion of the British empire. Members of the CS argued that even a fully, legally convertible currency could be issued in excess with undesirable consequences, such as rising domestic prices relative to foreign prices, balance-of-payment deficits, falling foreign-exchange rates, gold outflow resulting in depletion of gold reserves and ultimately forced suspension of convertibility. The rate of reserves drain often accelerated when the external gold drain coincided with internal domestic-panic conversion of paper into gold in fear of pending depreciation. Thus the CS promoted full convertibility plus strict regulation of the volume of banknotes to prevent the recurrence of gold drains, exchange depreciation and domestic liquidity crises. The apprehension of the CS was fully justified by past actions of the Bank of England, which had been perverse and destabilizing by international finance standards. The destabilizing argument stressed the time lag on the Bank's policy response to gold outflow and to exchange-rate movements. The inevitably too little, too late measures taken by the national bank, instead of protecting gold reserves, merely exacerbated financial panics and liquidity crises that inevitably followed periods of currency-credit excess. The famous Bank Charter Act of 1844, in modern parlance, imposed a 100 percent reserve requirement, with an unabashed bias toward wealth preservation over wealth creation. The CS also asserts that money substitutes cannot impair the effectiveness of monetary regulation. Thus if banknotes could be controlled, there would be no need to control deposits explicitly, on the ground that money substitutes have low velocity and are of declining substitutional value in times of crisis. Keynesians argue that the QTM is invalid because it assumes an automatic tendency to full employment. If resource under-ultilization and excess capacity exist, a monetary expansion may produce a rise in output rather than a rise in prices, as in the case of the 1930s Depression. Money is not a mere veil. Monetary changes may have a permanent effect on output, interest rates, and other real variables, contrary to the neutrality postulate of the QTM. Post-Keynesians also contend that the QTM erroneously assumes the stability of velocity and its counterpart, the demand for money. Velocity is a volatile, unpredictable variable (technically known as exogenous - due to external causes), influenced by meta-rationality and by changes in the volume of money substitutes, not to mention hedges in the form of derivatives. The erratic behavior of velocity makes it impossible to predict the effect of a given monetary change on prices. John Law (1671-1729), a contemporary of Bodin, elaborated in 1705 on the distinction drawn by Bernardo Davanzati (1529-1606) between "value in exchange" and "value in use", which led Law to introduce his famous "water-diamond" paradox: that water, which has great use-value, has no exchange-value, while diamonds, which have great exchange-value, have no use-value. Contrary to Adam Smith, who used the same example but explained it on the basis of water and diamonds having different labor costs of production, Law regarded the relative scarcity of goods in demand as the generator of exchange value. Davanzati showed how "barter is a necessary complement of division of labor amongst men and amongst nations"; and how there is easily a "want of coincidence in barter", which calls for a "medium of exchange"; and this medium must be capable of "subdivision" and be a "store of value". He remarked "that one single egg was more worth to Count Ugolino in his tower [prison] than all the gold of the world", but that on the other hand, "ten thousand grains of corn are only worth one of gold in the market", and that "water, however necessary for life, is worth nothing, because superabundant". That was of course before International Monetary Fund (IMF) conditionality requiring the poor in the indebted Third World to pay for water through privatization of basic utilities to service foreign debt. Davanzati observed that in the siege of Casilino, "a rat was sold for 200 florins, and the price could not be called exaggerated, because next day the man who sold it was starved and the man who bought it was still alive". Of course, modern economists would call that a market failure. Davanzati viewed all the money in a country as worth all the goods, because the one exchanges for the other and nobody wants money for its own sake. Davanzati did not know anything about the velocity of money, and only recognized that every country needs a different quantity of money, as different human frames need different quantities of blood. The mint ought to coin money gratuitously for everybody; and the fear that, if the coins are too good, they should be exported is simply illusory, because they must have been paid for by the exporter. Law's "Real Bills Doctrine" of money applied the "reflux principle" to the money supply. Money, Law argued, was credit and credit was determined by the "needs of trade". Consequently, the amount of money in existence is determined not by the imports of gold or trade balances (as the Mercantilists argued), but rather on the supply of credit in the economy. And money supply (in opposition to the Quantity Theory) is endogenous (growing from within), determined by the "needs of trade". Post-Keynesians have drawn on the Real Bills Doctrine, which asserts that the money supply is an endogenous variable that responds passively to shifts in the demand for it. Thus monetary changes cannot affect prices. Being demand-determined, the stock of money cannot exceed or fall short of the quantity of money demanded. In short, there is no transmission mechanism running from money to prices. Analysts should look instead for the source of economic dislocations in real rather than monetary causes. Inflation creates a corresponding increase in the money supply, not the other way around. Yet QTM theorists exposed the Achilles' heel of the Real Bills Doctrine by demonstrating that as long as the loan rate of interest is below the expected yield on new capital projects, the demand for loans will be insatiable. Thus the "real bills" criterion as an automatic regulator of the money supply is inoperative unless central banks intervene to raise interest rates in concert with expected return on capital.

The road to hyper inflation Jan 23 2008

2008-01-23T20:01:00.000-08:00

The Myth of Global Over Saving By the Working Poor

Both former Fed chairman Greenspan and his current successor Ben Bernanke have tried to explain the latest US debt bubble as having been created by global over-saving, particularly in Asia, rather than by Fed policy of easy credit in recent years. Yet the so-called global savings glut is merely a nebulous euphemism for overseas workers in exporting economies being forced to save to cope with stagnant low wages and meager worker benefits that fuel high profits for US transnational corporations. This forced saving comes from the workers’ rational response to insecurity rising from the lack of an adequate social safety net. Anyone making around $1,000 a year and faced with meager pension and inadequate health insurance would be suicidal to save less than half of his/her income. And that’s for urban workers in China. Chinese rural workers make about $300 in annual income. For China to be an economic superpower, Chinese wages would have to increase by a hundred folds in current dollars. Yet these underpaid and under-protected workers in the developing economies are forced to lend excessive portions of their meager income to US consumers addicted to debt. This is because of dollar hegemony under which Chinese exports earn dollars that cannot be spent domestically without unmanageable monetary penalties. Not only do Chinese and other emerging market workers lose by being denied living wages and the financial means to consume even the very products they themselves produce for export, they also lose by receiving low returns on the hard-earned money they lend to US consumers at effectively negative interest rates when measured against the price inflation of commodities that their economies must import to fuel the export sector. And that’s for the trade surplus economies in the developing world, such as China. For the trade deficit economies, which are the majority in the emerging economies, neoliberal global trade makes old-fashion 19th-century imperialism look benign.

Greenspan - wizard of bubbleland pts 1-4 2005

2008-01-08T19:24:00.000-08:00

monetary diarrhea that manifests itself in run-away asset price inflation mistaken for growth

In plain language, central banking sees as its prime function the management of the money supply to fit the transactional needs of the economy, instead of fixing the amount of money in circulation by the amount of gold held by the money-issuing authority. Thus central bankers believe in sound money, but not too sound please, lest the economy should falter. Their mantra is borrowed from the Confessions of St Augustine: “God, give me chastity and continence - but not just now.”

Greenspan’s formula of reducing market regulation by substituting it with post-crisis intervention is merely buying borrowed extensions of the boom with amplified severity of the inevitable bust down the road.

Greenspan’s monetary approach has been when in doubt, ease. This means injecting more money into the banking system whenever the economy shows signs of faltering, even if caused by structural imbalances rather than monetary tightness.

Greenspan’s measured-paced interest rate policy is a reversal back to the Fed’s tradition of gradualism

All economists agree that when money growth slows, market interest rates go up. Yet the emergence of unregulated credit markets has cast doubt of the reverse causal effect. Rising interest rates no longer necessarily slow money growth. Often it merely makes money growth more costly to accelerate asset price appreciation, curiously defined by economists as growth, not inflation.

The long boom fueled by securitization
The growth of capital markets was responsible for the long boom that began with the Greenspan era in 1987, rather than bank lending. Banks’ share of net credit markets, according Fed data on flow of funds, dropped from a peak of over 62% in 1975 to 27.5% in 2004 while securitization’s share rose from negligible in 1975 to over 60% in 2004. Securitization now stands at over $3 trillion up from $375 billion in 1985

Systemic problem of asset bubble mania
Consumer spending has been holding up the US economy in recent years, while most of the supply-side investment has gone overseas. This has caused a separation between the dollar economy and the US economy. The dollar economy expands from global dollar hegemony while the US economy is hollowed out of manufacturing. Dollar hegemony has deprived the US economy of real productivity from manufacturing and forced it into virtual productivity from finance manipulation

The Repo time bomb

A repurchase agreement (repo) is a loan, often for as short as overnight, typically backed by top-rated US Treasury, agency, or mortgage-backed securities. Repos are contracts for the sale and future repurchase of a top-rated financial asset. On termination date, the seller must repurchase the asset at the same price at which he sold it, pay interest for the use of the funds, and if the asset was borrowed, the borrowed assets will be returned to the lending owner who also receives a fee for lending. If the repoed security pays a dividend, coupon or partial redemptions during the repo, this is returned to the original owner. Institutions with excess assets routinely avoid holding unproductive idle assets by lending them for a fee to institutions in need of more assets. A well defined legal framework has developed to facilitate repo transactions

A key distinguishing feature of repos is that they can be used either to obtain funds or to obtain securities. The former feature is useful to market participant who wish to acquire other assets that provide arbitrage opportunities against the collateralized assets. The latter feature is useful to market participants because it allows them to obtain the securities they need to meet other contractual obligations, such as to make delivery for a futures contract. In addition, repos can be used for leverage, to fund long positions in securities and to fund short positions for hedging interest rate risks. As repos are short-maturity collateralized instruments, repo markets have strong linkages with securities markets, derivatives markets and other short-term markets such as interbank and money markets. Securities dealers use repos to finance their securities inventories. Counterparties may be institutions, such as money market funds which have funds to invest short-term. Or they may be parties who wish to briefly obtain the use of a particular security by doing a reverse repo. For example, a party may want to sell the security short, or they may need to deliver the security to settle a trade with a third party. Accordingly, there are two possible motives for entering into a reverse repo:1) short-term investment of funds, or GC (general collateral) repos; and2) to obtain temporary use of a particular security, or special repos.

Because repos are essentially secured loans, their interest rates do not depend upon the respective counterparties’ credit ratings. For GC repos, the same rates apply for all counterparties. Accordingly, GC repo rates, or simply repo rates, are benchmark short-term interest rates that are widely quoted in the marketplace. They differ from LIBOR (London Interbank offered rate) in that repo rates are for secured loans whereas LIBOR are for unsecured loans based on the credit worthiness of the borrower.

Repos are useful to central banks both as a monetary policy instrument and as a source of information on market expectations. Repos are attractive as a monetary policy instrument because they carry a low credit risk while serving as a flexible instrument for liquidity management. In addition, they can serve as an effective mechanism for signaling the stance of monetary policy. Repos have also been widely used as a monetary policy instrument among European central banks and with the start of EMU (European Monetary Union) in January 1999, the Eurosystem adopted repos as a key instrument. Repo markets can also provide central banks with information on very short-term interest rate expectations that is relatively accurate since the credit risk premium in repo rates is typically small. In this respect, they complement information on expectations over a longer horizon derived from securities with longer maturities

As with other financial markets, repo markets are also subject to credit risk, operational risk and liquidity risk. However, what distinguishes the credit risk on repos from that associated with uncollateralized instruments is that repo credit exposures arise from volatility (or market risk) in the value of collateral. For example, a decline in the price of securities serving as collateral can result in an under-collateralization of the repo. Liquidity risk arises from the possibility that a loss of liquidity in collateralized markets will force liquidation of collateral at a discount in the event of a counterparty default, or even a fire sale in the event of systemic panic. Leverage that is built up using repos can exponentially increase these risks when the market turns.

Bernanke and the Dollar Savings Glut Symptom of global stress

While Bernanke accurately describes the conditions, he obscures the causal dynamics. The so-called global savings glut is hardly the result of voluntary behavior on the part of foreign central banks. It is the coercive effect of dollar hegemony which has left the trading partners of the US without a choice. The US trade deficit is denominated in dollars which can only be recycled into dollar assets. Local currency debts are issued by foreign treasuries to soak up the current account surplus dollars so that foreign central banks end up holding larger dollar reserves that can hardly be viewed as national savings

US current account deficit exporting inflation

The exporting economies ship real wealth to the US in exchange for fiat dollars which cannot be spent in their own economies without first being converted into local currencies. If the local central banks exchange the trade surplus dollars with local currencies, local inflation will result from an expansion of the money supply while the wealth behind the new money has been shipped to the US. Thus when most foreign governments issue sovereign debts in local currencies to soak up the dollars and turn them over to their central banks as foreign exchange reserves, the local sovereign debt is equal to the loss of real wealth from export to the US.

Fiat money – Sep 2004 Sovereign Debt

2008-01-02T18:57:00.000-08:00

The Liu Chronicles
Fiat money – Sep 2004 Sovereign Debt

fiat money is sovereign credit created by the sale of government bonds

Monetary economists view government-issued money as a sovereign debt instrument with zero maturity, historically derived from the bill of exchange in free banking. This view is valid only for specie money, which is a debt certificate that can claim on demand a prescribed amount of gold or other specie of value. But fiat money issued by a sovereign government is not a sovereign debt but a sovereign credit instrument. Sovereign government bonds are sovereign debt while local government bonds are agency debt but not sovereign debt, because local governments, while they possess limited power to tax, cannot print money, which is the exclusive authority of the Federal government or a central government. When money buys bonds, the transaction represents sovereign credit canceling public or corporate debt. This relationship is rather straightforward but is of fundamental importance.Money issued by government fiat is now exclusive legal tender in all modern national economies. The State Theory of Money (Chartalism) holds that the general acceptance of government-issued fiat currency rests fundamentally on government's authority to tax. Government's willingness to accept the fiat currency it issues for payment of taxes gives such issuance currency within a national economy. That currency is sovereign credit for tax liabilities, which are dischargeable by credit instruments issued by government in the form of fiat money. When issuing fiat money, the government owes no one anything except to make good a promise to accept its money for tax payment. A central banking regime operates on the notion of government-issued fiat money as sovereign credit. A central bank operates essentially as a lender of last resort to a nation’s banking system, drawing on sovereign credit. Thomas Jefferson prophesied: "If the American people allow the banks to control the issuance of their currency, first by inflation, and then by deflation, the banks and corporations that will grow up around them will deprive people of all property until their children will wake up homeless on the continent their fathers occupied ... The issuing power of money should be taken from the banks and restored to Congress and the people to whom it belongs." This warning applies to other peoples in the world as well. Government levies taxes not to finance its operations, but to give value to its fiat money as sovereign credit instruments. If it chooses to, government can finance its operation entirely through user fees, as some fiscal conservatives suggest. Government needs never be indebted to the public. It creates a government debt component to anchor the private debt market, not because it needs money. Technically, a sovereign government needs never borrow. It can issue tax credit in the form of fiat money to meet all its liabilities. And only a sovereign government can issue fiat money as sovereign credit. If fiat money is not sovereign debt, then the entire conceptual structure of finance capitalism is subject to reordering, just as physics was subject to reordering when man's worldview changed with the realization that the earth is not stationary nor is it the center of the universe. The need for capital formation to finance socially-useful development will be exposed as a cruel hoax, as sovereign credit can finance all socially-useful development without problem. Private savings are not necessary to finance public socio-economic development, since private savings are not required for the supply of sovereign credit. Thus the relationship between national private savings rate and public finance is at best indirect. Sovereign credit can finance an economy in which unemployment is unknown, with wages constantly rising to provide consumer buying power to prevent production overcapacity. A vibrant economy is one in which there is persistent labor shortages that push up wages to reduce overcapacity. Private savings are needed only for private investment that has no intrinsic social purpose or value. Savings without full employment are deflationary, as savings reduces current consumption to provide investment to increase future supply, which is not needed in an economy with overcapacity created by lack of demand, which in turn has been created by low wages and unemployment. Say's Law of supply creating its own demand is a very special situation that is operative only under full employment with high wages. Say's Law ignores a critical time lag between supply and demand that can be fatally problematic to the cash-flow needs in a fast-moving modern economy. Savings require interest payments, the compounding of which will regressively make any financial scheme unsustainable. The religions forbade usury for very practical reasons.The relationship between assets and liabilities is expressed as credit and debt, with the designation determined by the flow of obligation. A flow from asset to liability is known as credit, the reverse is known as debt. A creditor is one who reduces his liability to increase his assets, which include the right of collection on the liabilities of his debtors. Sovereign debt is a pretend game to make private monetary debts denominated in fiat money tradable.The sovereign state, representing the people, owns all assets of a nation not assigned to the private sector. This is true regardless whether the state operates on socialist or capitalist principles. Thus the state's assets is the national wealth less that portion of private sector wealth after tax liabilities, plus all other claims on the private sector by sovereign right. High wages are the key determinant of national wealth. Privatization generally reduces state assets while it may increase tax revenue. As long as a sovereign state exists, its credit is limited only by the national wealth. If sovereign credit is used to increase national wealth, then sovereign credit is limitless as long as the growth of national wealth keeps pace with the growth of sovereign credit.When a sovereign state issues money as legal tender, it issues a monetary instrument backed by its sovereign rights, which includes taxation. A sovereign state never owes domestic debts except by design voluntarily. When a sovereign state borrows in order to avoid levying or raising taxes, it is a political expedience, not a financial necessity. When a sovereign state borrows, through the selling of sovereign bonds denominated in its own currency, it is withdrawing previously-issued sovereign credit from the financial system. When a sovereign state borrows foreign currency, it forfeits its sovereign credit privilege and reduces itself to an ordinary debtor because no sovereign state can issue foreign currency.Government bonds act as absorbers of sovereign credit from the private sector. US Government bonds, through dollar hegemony, enjoy the highest credit rating, topping a credit risk pyramid in international sovereign and institutional debt markets. Dollar hegemony is a geopolitical phenomenon in which the US dollar, a fiat currency, assumes the status of primary reserve currency in the international finance architecture. Architecture is an art the aesthetics of which is based on moral goodness, of which the current international finance architecture is visibly deficient. Thus dollar hegemony is objectionable not only because the dollar, as a fiat currency, usurps a role it does not deserve, but also because its effect on the world community is devoid of moral goodness, because it destroys the ability of sovereign governments beside the US to use sovereign credit to finance the development their domestic economies, and forces them to export to earn dollar reserves to maintain the exchange value of their own currencies.Money issued by sovereign government fiat is a sovereign monopoly while debt is not. Anyone with acceptable credit rating can borrow or lend, but only sovereign government can issue fiat money as legal tender. When sovereign government issues fiat money, it issues certificates of its sovereign credit good for discharging tax liabilities imposed by sovereign government on its citizens. Privately-issued money can exist only with the grace and permission of the sovereign, and is different from sovereign government-issued money in that privately issued money is an IOU from the issuer, with the issuer owing the holder the content of the money's backing. But sovereign government-issued fiat money is not a debt from the government because the money is backed by a potential debt from the holder in the form of tax liabilities. Money issued by sovereign government by fiat as legal tender is good by law for settling all debts, private and public. Anyone refusing to accept dollars in the US for payment of debt is in violation of US law. Instruments used for settling debts are credit instruments.Buying up sovereign bonds with government-issued fiat money is one of the ways government releases more sovereign credit into the economy. By logic, the money supply in an economy is not government debt because, if increasing the money supply means increasing the national debt, then monetary easing would contract credit from the economy. But empirical evidence suggests otherwise: monetary ease increases the supply of credit. Thus if fiat money creation by sovereign government increases credit, money issued by sovereign government fiat is a credit instrument.Economist Hyman Minsky rightly noted that whenever credit is issued, money is created. The issuing of credit creates debt on the part of the counterparty; but debt is not money, credit is. Debt is negative money, a form of financial antimatter. Physicists understand the relationship between matter and antimatter. Einstein theorized that matter results from concentration of energy and Paul Dirac conceptualized the by-product creation of antimatter through the creation of matter out of energy. The collision of matter and antimatter produces annihilation that returns matter and antimatter to pure energy. The same is true with credit and debt, which are related but opposite. They are created in separate forms out of financial energy to produce matter (credit) and antimatter (debt). The collision of credit and debt will produce annihilation and return the resultant union to pure financial energy un-harnessed for human benefit. The paying off of debt terminates financial interaction.Monetary debt is repayable with money. Sovereign government does not become a debtor by issuing fiat money, which, in the US, takes the form of a Federal Reserve note, not an ordinary bank note. The word "bank" does not appear on US dollars. Zero maturity money (ZMM) in the dollar economy, which grew from $550 billion in 1971 when President Nixon took the dollar off a gold standard, to $6.6 trillion as of June 2004, is not a federal debt. It amounts to about 65% of US GDP of $11.64 trillion, slightly below the national debt of $7.38 trillion at the same point in time. Sovereign credit is what gives the US economy its inherent strength.A holder of fiat money is a holder of sovereign credit. The holder of fiat money is not a creditor to the state, as some monetary economists mistakenly claim. Fiat money only entitles its holder a replacement of the same money from government, nothing more. The dollar, being a Federal Reserve note, entitles the holder to exchange the note to another identical note at a Federal Reserve Bank, and nothing else. The holder of fiat money is acting as a state agent, with the full faith and credit of the state behind the instrument, which is good for paying taxes and is legal tender for all debt public and private. Fiat money, like a passport, entitles the holder to the protection of the state in enforcing sovereign credit. It is a certificate of state financial power inherent in sovereignty

Ranciere's on Plato's theatrocracy

2007-03-09T20:41:00.000-08:00

New Left Review - Peter Hallward: Staging Equality: "Such confusion
inspired the multitude with contempt of musical law, and a conceit of their own competence as judges. Thus our once silent audiences have found a voice, in the persuasion that they understand what is good and bad in art; the old ‘sovereignty of the best’ in that sphere has given way to an evil ‘sovereignty of the audience’, a theatrocracy (theatrokratia)."

New Left Review - Peter Hallward: Staging Equality

2007-03-09T19:45:00.000-08:00

New Left Review - Peter Hallward: Staging Equality: "The essence of equality is not so much to unify as to declassify, to undo the supposed naturalness of orders and replace it with controversial figures of division. Equality is the power of inconsistent, disintegrative and ever-replayed division"

Asia Times Online :: China Business News - Paulson, China and the turmoil beneath

2007-01-10T18:06:00.000-08:00

Asia Times Online :: China Business News - Paulson, China and the turmoil beneath: "Actually, what is odd is US foreign debt being denominated in dollars, a fiat currency that the US and only the US can print at will. The United States is the only nation in the world whose foreign debt is denominated in its own currency. In that sense, the US has no real foreign debt as all its debts are sovereign debts payable in currency it can issue at will. The term 'foreign debt' usually means debt denominated in foreign currencies. Such debts require the backing of adequate foreign reserves because the debtor governments cannot print foreign currencies and are therefore subject to risks of default on foreign currency loans. Foreign debts for the US, as they are denominated in dollars, are only sovereign debts held by foreigners. If foreigners holding US sovereign debt want to cash them in, the US can print as many dollars as it needs to satisfy them. "

The Coming Trade Wars - Pt3

2006-02-25T18:52:00.000-08:00

Market fundamentalism is the belief that the optimum common interest is only achievable through a market equilibrium created by the effect of countless individual decisions of all market participants each seeking to maximize his own private gain, and that such market equilibrium should not be distorted by any collective measures in the name of the common good. It is summed up by Margaret Thatcher's infamous declaration that there is no such thing as society

US policymakers are beginning to realize that a capitalist China in a neo-liberal world order is by far more of a threat to US national interests as a superpower than a communist China in the Cold War.

What Toyota really wants is to keep GM manufacturing in the US, where it can never achieve cost competitiveness, and not move its manufacturing to China with a new business paradigm to compete with Japanese auto makers there.

On one level, the world economy needs to develop these populous markets to relieve global overcapacity; on another level, the rise of income necessary for such expanded consumption translates into a leveling of the power differential long enjoyed by the world's sole superpower. Suddenly, the needs of the global market to overcome global overcapacity with new consumers are turning against the traditional security and economic interests of the United States. In response, the US is turning back toward its own history of command economy. Emotional debates have emerged within US policy circles on the merits of globalized neo-liberal market fundamentalism versus the need for protectionist economic nationalism.

Policymakers in self-proclaimed market economies normally manage their policy objective through monetary and tax policies in accordance to macro-economic theories, but even then they do so with national objectives in mind. Such national objectives are known as national interests in policy nomenclature. For example, the Fed defers to the Treasury on determination of the proper exchange rate for the dollar. When market forces move against the Treasury's view, moving the dollar either too high or too low in relation to other currencies, the Fed supports the Treasury as a matter of national security in its effort to intervene in the market to bring the dollar back in line, or at least moderate the volatility. All nations employ industrial policy when it comes to defense and defense-related sectors. And as military/civilian dual-use definition expands, more and more of research and development, high-tech production, heavy manufacturing and strategic materials are removed from free trade to rely on government subsidies and procurement contracts. Dual-use restriction is one of the major factors contributing to trade imbalances between the US and China. Beyond dual-use technology, the US has very little to sell. Free trade in the US perspective is not remotely the same as freedom to trade.