Monday, May 10, 2010

Thoughts on the Greek So-called Crisis

What they call a crisis in Greece really has three aspects:

1) The Greek government is unable to make full repayment of loans

2) The impaired ability to repay current loans inhibits the government's ability to access new credit.

3) The governments inability to pay salaries in full makes employees mad, thus there are protests and riots.

What is clear from this is that the Greek government cannot support it's spending habits. They were able to get away with massive overspending in the short run because, for some reason, lenders were willing to lend. The risks associated with lending to the Greek government were apparent. Like al governments that maintain perpetual deficits, the Greek government was running a Ponzi scheme. They had no intention to ever pay down the outstanding principal of their loans. They instead use new borrowers to pay off old debts and hope that system can be maintained forever. Keep in mind, folks, that the new government of Greece came in to power a few months ago promising INCREASED spending.

But this Ponzi scheme has one key difference from the ones operated by Bernie Madoff and others. It's victims are fully aware of the scam.

So today we get news of a giant bailout, nominally of the Greek government. But the bailout will only increase the suffering of the Greek people. It is really the bondholders who are being bailed out. And though I have not the stomach to look at a list of these creditors, you can bet they have names like Goldman Sachs, Citigroup, Bank of America, Banco Santander, etc.

Through all the bullshit talk of contagion, the only people who would truly suffer from a Greek default are those who accepted the risk of a Greek default. And yes that includes a few grandmas and retired teachers, but mostly we are talking about wealthy, wealthy people. Again, we see a massive wealth transfer from the middle class to the rich.

So what about contagion? A Greek default would have little effect on the real economy. What the powers worry about is subsequent defaults of Spain, Ireland, Portugal, California, etc. But those governments need to default. The losses have already occurred. All that remains is to demand who bears those losses. Should it be the people who made the bad decisions? I think so.

So what about the civil servants who will surely be getting paycuts and pink slips? The first think everyone needs to recognize is that these people have been severely overpaid for a long time. The Greek tax base simply cannot support this level of services, nor the salaries given to those service providers. But, right now these people are being asked to shoulder the bulk of the burden of "fiscal responsibility," and that is just plain wrong. The people of Greece and the employees of the Greek government must accept the fact that their lifestyles have exceeded their productivity, and they must retrench, but those who underwrote the excesses must bear their share (in fact, rightfully the largest share) of the loss.

The Greeks were running a deficit of about 14% of GDP, in violation of their commitment to keep the deficit under 3%. I have 2 comments here. First, the Greek government has no right to the promised support from its Euro-neighbors. The Greeks reneged, and the German taxpayers and others should let them default.

But contrary to this, the rest of Euroland is coming to the rescue, and in exchange they are demanding austerity measures. Basically, they want Greece to reduce and limit the size of its deficit. This action obscures the true problem and completely fails to address its root cause. The Greeks do not need to reduce their deficit; they need to eliminate it. And this needs to happen not over the course of a few years; it needs to happen now.

So what should happen? The Greeks should say no-thanks to any bailout. They should negotiate a default with their creditors. This would give them the credibility to level with their citizens and reduce the scope of government action, and relieve them of the burden of paying off debts that have already soured.

This would make it difficult for Greece to access credit markets in the short-run, and there are people who say that a government must be able to borrow. I say that is ridiculous. Greece needs to learn how to operate a balanced budget. If they can prove to lenders that they are responsible, they should be able to borrow. Right now the opposite is true.

Friday, March 19, 2010

This Myth Makes No Sense

Have you ever walked into your boss's office and demanded a decrease in salary? If so, you probably left work that day, smiling from your successful negotiation, and stopped off at the steakhouse where you insisted they accept $60 for a $40 steak... More on that later.

At least since the days of John Snow, American power brokers have been publicly lambasting the Chinese government for currency manipulation. Specifically, the Chinese maintain an artificially low exchange rate by buying dollars and dollar-denominated bonds in the currency and bond markets. In other words, if the exchange rate of yuan-to -dollars (the number of Chinese yuan one can purchase with 1 U.S. dollar) were allowed to float freely, it would naturally decrease.

So, are the Chinese manipulating the market? Absolutely

Is this manipulation bad for the American people? That is another matter.

For if you are a U.S. consumer, understanding that your sneakers and plasticware are coming from China, you might ask for something else from your elected representatives.

Yet, apparently, about 130 members of Congress have sent a letter to King Bush the 3rd requesting that he take punitive action on the Chinese.

Leaving aside the fact that if the Congress feels this is necessary, they should levy tariffs on Chinese goods, like the Constitution says is THEIR job, let's examine this policy.

It is really quite simple. Our government wants the Chinese to allow their currency to appreciate against ours. In other words, they want the Chinese to make the dollars you and I buy things with, LESS valuable. This is exactly equivalent to demanding that the Chinese raise prices on everything we buy from them AND telling them to pay us lower prices for everything they buy from us.

Now, if you've had any experience living in the world, you know that lower prices are better for consumers and higher prices are better for sellers. So why would our government advocate a policy that is bad for almost all Americans?

Well, the short answer is that they don't understand economics. Yes, a few select US exporters would benefit, but let's look at the big picture. The Chinese are allowing us to buy their products at below-market prices. They are effectively giving us stuff for free. If they choose to do this, why would we want to stop them?

Now in my opinion, it is the Chinese that are making a mistake. They are foregoing the benefits of their own productivity. Of course, they feel like there are sufficient benefits to maintaining this policy, and they may be right. But the day will come when that ceases to be true. The best thing we can do is take advantage of the policy while it lasts and prepare ourselves for the day when it stops.

It is certain that the day will come, with or without U.S. pressure, when the Chinese will allow their currency to float. And when that day comes, look out, we will feel it. Be careful what you wish for; be even more careful what you allow your elected representatives to demand.

Saturday, February 20, 2010

The Audacity Of Running For President Without Knowing Any Economics

Barack Obama said last week, in reference to the large bonuses paid to Jaime Dimon of JP Morgan Chase and Lloyd Blankfein of Goldman Sachs that:

“I know both those guys; they are very savvy businessmen... I, like most of the American people, don’t begrudge people success or wealth. That is part of the free-market system.”

He also said:

“There are some baseball players who are making more than that and don’t get to the World Series either, so I’m shocked by that as well.”

Well, our president obviously does not know what a free-market system is, but he ought to know at least this: We don't have one. Not in banking anyway - the market for banking services in the U.S. is just about the least free of all markets that we have. There are no bailouts in a free market.

These two men, far from being successful businessmen, are among the primary beneficiaries of anti-free market policies. They have not earned their money by being good bankers, but by effective lobbying. They are good at convincing powerful people that they deserve wealth that other people have earned. In fact, they have destroyed wealth and, in a free-market system, would earn no more than a subsistence wage.

Economic activity is all about production and trade. What we produce can be consumed or saved. What we save can sit idle or be used to produce things for future consumption. When we use savings for the latter it is called investment. Savings (also called wealth) is really just an uncertain claim on future consumption. It is uncertain because an investment may or may not work out well. For example, building a house that no one wants to live in is an investment with a negative return; making a small machine that can store and play thousands of songs that is consumed by millions of people has a positive return.

The role of bankers is an important one in any economy, but it is often performed quite poorly. Actually, the role of a banker is simple - he is the middleman between savers and investors. Savers are not necessarily good at producing things that can be consumed in the future, so they take their money to a banker. In theory, the banker knows people who are good at producing. They make a deal that gives the investors access to the savers' resources and all three share the proceeds in some way that they agree to among themselves.

Now, some of these investments fail and some succeed, but in a free market, we can expect that, on average, they will have a positive return. This is true, not because the group of bankers and investors are inherently skilled, but because those who are not skilled will fail and move into other professions. An investor who consistently has negative returns will eventually lose the trust of the bankers and lose access to the resources of savers; a banker who consistently funnels money to failed enterprises will lose savers as customers.

But this process of weeding out incompetent bankers only happens if the bankers must rely on their own success to make a living. If an outside entity, like the government, gives bankers an opportunity to continue banking after they have failed, the system falls apart.

Bailouts accomplish exactly that, and Goldman Sachs and JP Morgan Chase were among those at the front of the bailout line.