Pimco Says ‘Fear Not,’ Weak Dollar Will Spur Growth

Wednesday, December 9, 2009

Via Bloomberg:

Pacific Investment Management Co., which runs the world’s biggest bond fund, said the dollar is poised to fall and the decline may help spur the U.S. economy.

“Fear not the falling dollar,” Scott Mather, head of global portfolio management at Pimco, wrote in an article on the company’s Web site. “A gradually weakening dollar may help heal the U.S. economy” by encouraging demand for the nation’s exports, he wrote.

“There are few viable alternatives,” Mather wrote. “No other currency offers the size and liquidity — not to mention the political and legal stability — necessary to match the dollar as reserve currency of choice.”

“Deflation is a bigger near-term threat than inflation…”

Read the full article here

Martin Wolf: Why China’s Exchange Rate Policy Concerns Us

Via FT:

We can make four obvious replies to Mr Wen. First, whatever the Chinese may feel, the degree of protectionism directed at their exports has been astonishingly small, given the depth of the recession. Second, the policy of keeping the exchange rate down is equivalent to an export subsidy and tariff, at a uniform rate – in other words, to protectionism. Third, having accumulated $2,273bn in foreign currency reserves by September, China has kept its exchange rate down, to a degree unmatched in world economic history. Finally, China has, as a result, distorted its own economy and that of the rest of the world. Its real exchange rate is, for example, no higher than in early 1998 and has depreciated by 12 per cent over the past seven months, even though China has the world’s fastest-growing economy and largest current account surplus.

Do these policies matter for China and the world? Yes, is the answer. Mark Carney, governor of the Bank of Canada, notes in a recent speech, that “large and unsustainable current account imbalances across major economic areas were integral to the build-up of vulnerabilities in many asset markets. In recent years, the international monetary system failed to promote timely and orderly economic adjustments.” He is right.

Read the full article here

Barron’s Red Flags: Do They Actually Work?

Wednesday, December 2, 2009


Investors are often concerned that managers might hide negative information in the maze of mandated SEC filings. With advances in textual analysis and the availability of documents on EDGAR, individuals can quite easily search for phrases that might be red flags indicating aggressive accounting practices or poorly monitored management. We examine the impact of 13 suspicious corporate phrases identified by a recent Barron’s article in a sample of 50,115 10-Ks during 1994-2008. There is evidence that red flag phrases like related party and unbilled receivables signal a firm may subsequently be accused of fraud. At the 10-K filing date, phrases like substantial doubt are linked with significantly lower filing date excess stock returns, higher stock return volatility, and greater analyst earnings forecast dispersion.

High-Frequency Trading Round-up

Reuters has three interesting articles on high-frequency trading:

High-frequency trading surges across the globe

Geeks trump alpha males as algos dominate Wall St

Who’s afraid of high-frequency trading?

The Economics of Credit Card Debt

Tuesday, December 1, 2009

Via Felix Salmon:

You’re a bank, and one of your customers owes you $2,000 on her credit card. You have two choices:

(a) You cut off her credit, convert the $2,000 to a loan, and she pays it off with 6% interest over four years.

(b) You keep the credit card open, she struggles to pay back the balance at 30%, and eventually declares bankruptcy with a principal balance of $1,205 outstanding, which you never collect a penny on.

Which of the two options do you choose? Mike Konczal has run the numbers, and it turns out that option (b) — driving the poor customer into bankruptcy — is actually more the more profitable of the two.

What’s more, the option value of option (b) is enormous: if she doesn’t declare bankruptcy you can make more money still, and of course if she keeps on spending on her credit card, that’s even more debt on which you can make predatory and usurious profits.

This is a prime example of what Ronald Mann calls the “sweat box” of credit card debt:

Debt-based issuers focus on debt servicing revenues… the most profitable customers are sometimes the least likely to ever repay their debts in full…

As the credit card borrower spirals downward, with the monthly balances growing to amounts that equal, or even surpass, the borrower’s annual income, the issuer begins to earn large monthly profits on the relationship.

This syndrome, Konczal explains, is the reason why Jackie Ramos was encouraged by Bank of America to deny people the ability to convert their credit-card debt into an easier-to-repay loan. Just don’t expect the banks to ever admit as much.

In Fed We Trust

Tuesday, November 17, 2009

Via Robert A. Eisenbeis and Ellis Tallman of Cumberland Advisors:

David Wessel’s book, In Fed We Trust: Ben Bernanke’s War on the Great Panic, is the definitive chronicle of the 2007-2009 financial crisis, but it is much more.  The book gives us an inside view of how policy making took place in response to the striking events. Wessel provides insights into the key players and decision makers, and conveys a very real sense of what they were thinking as those events unfolded.  In doing so, however, his account triggers serious questions about the Treasury/Federal Reserve decision-making process.  Here, we emphasize three serious flaws in the policy-making process that Wessel describes: the consistent lack of a plan and short-time horizon of the decisions, the insularity of the decision makers, and the apparent disregard for FOMC information-security rules governing meetings and associated documents.  We conclude by noting some oversights in Wessel’s account of the Great Depression and the Panic of 1907.

Lack of a Plan

The insider’s view of the policy making is the unabashed strength of this book, and Wessel provides an extensive chronology of how the crisis unfolded.  It is not a pretty picture.  His most telling observation is that the principals seem to have lurched from event to event without a plan, even after it should have been apparent that one was needed.

The discussions among key participants – namely Chairman Bernanke, Secretary Paulson, then-president Geithner, and Governors Kohn and Warsh – seem rushed, from Wessel’s descriptions of them.  The policy discussions tended to focus on short-term problems, pushing off potential longer-run consequences of the policy responses as a matter of expediency.  The sense is that the participants expected each decision to be sufficient to return markets to normalcy; but of course, they were not.  The ad hoc, short-term nature of policy process, as described in the book, carried with it the risk that not all decisions would be good and would carry with them unintended consequences.  For example, the problems of exiting from many of the policies are now significant and have yet to be addressed.

Wessel alleges that the policy makers continually underestimated the crisis and that there was no long-range planning undertaken from the time that the crisis initially erupted.  This should come as no surprise to anyone reading closely the financial press throughout the crisis, and yet it remains disappointing.  It is important to note that not all the decisions had the time constraints that surrounded the issue of the Lehman failure in the fall of 2008.  That event was preceded by almost a year of financial turmoil, serial reports of losses, failures or mortgage related institutions, and market disruptions that should have signaled to policy makers that something serious was at hand and that they weren’t simply facing a short-term liquidity problem.

By now, it is apparent that the crisis was misdiagnosed as a liquidity problem when in fact it was a solvency crisis.  Funds didn’t suddenly dry up and markets did not stop functioning because there were no funds available.  Rather, because of the trail of losses and preceding events, financial markets finally became wary of the solvency of key counterparties, as the Bear Stearns episode clearly demonstrated.  This was long before the problems in Lehman Brothers emerged.  Market participants’ concerns, as subsequent events proved, were well-founded.  It took policy makers too long to recognize the capital deficiencies relative to the risk exposures of major primary dealers, which then left them with insufficient time to design resolution plans.  Most of the largest financial institutions – both domestic and international – proved to have inadequate capital.  Some failed, and many were bailed out by their respective governments.

Wessel’s description of the decision-making process reminds one of a perpetual Chinese fire drill rather than a considered, analytic approach to the problems as they unfolded over time.  The latter implies a systematic plan, and the former implies a sequence of ad hoc responses to unrelated shocks. Even if an initial plan proved inadequate, the experience would have permitted corrections as events evolved.  And lacking a plan, it is harder to see if and when a decision was wrong.

Delegated and Concentrated Decision Making

The second issue that emerges from Wessel’s account is the insular and concentrated nature of the decision-making process, which excluded many members of the Board of Governors and FOMC.  Three governors and the president of the NY Fed apparently took on the decision-making responsibility for the central bank in the midst of the crisis. From the narrative, it seems as if this core group effectively froze out the remaining two members of the Board and FOMC members from both decision making and access to key real-time information.

Why did it happen?  Under what authority did this happen?  One plausible answer is that the core group felt that the existing structure was too cumbersome to effectively coordinate policy among so many principals, and so they simply exploited a loophole in the law governing open and closed meetings of government agencies.  Let us explain.  Normally, there are seven members of the Board of Governors, so that a gathering of four would constitute a majority and could officially make decisions.  According to the 1976 Government in the Sunshine Act, which sets out the rules meetings of  federal governmental agencies, official Federal Reserve Board meetings in which policies are considered must be announced in advance and,  at a minimum, an agenda must be provided,.  For this reason, only three governors can get together in the same room without it constituting a “meeting”  and invoking the provisions of the Sunshine Act.   But during the entire crisis there have only been five governors on the Board, with two vacancies.  (David Kotok has written extensively on this issue in previous commentaries.)  Thus, the gathering of the three governors in the meetings that Wessel describes meant that while not technically meeting the legal requirement for a meeting, the three de facto constituted a majority of the sitting governors and could actually make decisions.  Coordinating policy with the entire FOMC would have been more cumbersome and likely would have also required that a written transcript be prepared.  It could be that the core principals felt that a smaller group would make decisions more quickly, and the sense of such a desire for quick decisions comes across in the narrative.  Nevertheless, one can’t help but feel that it might have been beneficial to have been able to tap the broader experience and expertise of the Federal Reserve Bank presidents, especially since so many of the key principals making the crucial decisions were relatively new to their jobs.

Read more »

Origins of the Federal Reserve

Saturday, November 14, 2009

Via Mises.org:

The Federal Reserve Act of December 23, 1913, was part and parcel of the wave of Progressive legislation on local, state, and federal levels of government that began about 1900. Progressivism was a bipartisan movement that, in the course of the first two decades of the 20th century, transformed the American economy and society from one of roughly laissez-faire to one of centralized statism.

Until the 1960s, historians had established the myth that Progressivism was a virtual uprising of workers and farmers who, guided by a new generation of altruistic experts and intellectuals, surmounted fierce big business opposition in order to curb, regulate, and control what had been a system of accelerating monopoly in the late 19th century. A generation of research and scholarship, however, has now exploded that myth for all parts of the American polity, and it has become all too clear that the truth is the reverse of this well-worn fable.

In contrast, what actually happened was that business became increasingly competitive during the late 19th century, and that various big-business interests, led by the powerful financial house of J. P. Morgan and Company, tried desperately to establish successful cartels on the free market. The first wave of such cartels was in the first large-scale business — railroads. In every case, the attempt to increase profits — by cutting sales with a quota system — and thereby to raise prices or rates, collapsed quickly from internal competition within the cartel and from external competition by new competitors eager to undercut the cartel.

During the 1890s, in the new field of large-scale industrial corporations, big-business interests tried to establish high prices and reduced production via mergers, and again, in every case, the merger collapsed from the winds of new competition. In both sets of cartel attempts, J. P. Morgan and Company had taken the lead, and in both sets of cases, the market, hampered though it was by high protective, tariff walls, managed to nullify these attempts at voluntary cartelization.

It then became clear to these big-business interests that the only way to establish a cartelized economy, an economy that would ensure their continued economic dominance and high profits, would be to use the powers of government to establish and maintain cartels by coercion, in other words, to transform the economy from roughly laissez-faire to centralized, coordinated statism. But how could the American people, steeped in a long tradition of fierce opposition to government-imposed monopoly, go along with this program? How could the public’s consent to the New Order be engineered?

Fortunately for the cartelists, a solution to this vexing problem lay at hand. Monopoly could be put over in the name of opposition to monopoly! In that way, using the rhetoric beloved by Americans, the form of the political economy could be maintained, while the content could be totally reversed.

Monopoly had always been defined, in the popular parlance and among economists, as “grants of exclusive privilege” by the government. It was now simply redefined as “big business” or business competitive practices, such as price-cutting, so that regulatory commissions, from the Interstate Commerce Commission (ICC) to the Federal Trade Commission (FTC) to state insurance commissions, were lobbied for and staffed with big-business men from the regulated industry, all done in the name of curbing “big-business monopoly” on the free market.

In that way, the regulatory commissions could subsidize, restrict, and cartelize in the name of “opposing monopoly,” as well as promoting the general welfare and national security. Once again, it was railroad monopoly that paved the way.

For this intellectual shell game, the cartelists needed the support of the nation’s intellectuals, the class of professional opinion molders in society. The Morgans needed a smokescreen of ideology, setting forth the rationale and the apologetics for the New Order. Again, fortunately for them, the intellectuals were ready and eager for the new alliance.

The enormous growth of intellectuals, academics, social scientists, technocrats, engineers, social workers, physicians, and occupational “guilds” of all types in the late 19th century led most of these groups to organize for a far greater share of the pie than they could possibly achieve on the free market. These intellectuals needed the State to license, restrict, and cartelize their occupations, so as to raise the incomes for the fortunate people already in these fields.

In return for their serving as apologists for the new statism, the State was prepared to offer not only cartelized occupations, but also ever-increasing and cushier jobs in the bureaucracy to plan and propagandize for the newly statized society. And the intellectuals were ready for it, having learned in graduate schools in Germany the glories of statism and organicist socialism, of a harmonious “middle way” between dog-eat-dog laissez-faire on the one hand and proletarian Marxism on the other. Big government, staffed by intellectuals and technocrats, steered by big business, and aided by unions organizing a subservient labor force, would impose a cooperative commonwealth for the alleged benefit of all.

Continue reading the article here

Augmented Reality Goes Mobile

Via BusinessWeek:

It was the shake heard ’round the world. On Aug. 27, 2009, überblogger Robert Scoble uncovered a hidden software feature buried within an iPhone application that provides access to Yelp.com reviews.

The secret, it turns out, was that users needed to shake the phone to activate the capability, known as Monocle. In the wake of Scoble’s discovery, shared publicly via FriendFeed, iPhone users far and wide could be seen shaking their iPhones to get access to the new feature. Yet the frenzy was about more than the novelty of how to open it, or even the trove of Yelp.com reviews.

The bigger prize was in how that information shows up on the phone. Once Monocle is activated, users looking through the iPhone camera can see reviews and other information about restaurants, stores, and other businesses in the direction the camera is pointing. Monocle was one of the first smartphone applications in the U.S. to use a technology known as augmented reality, which meshes digital information with actual images of the subject of that data. For many, augmented reality evokes images of what the Terminator sees as he homes in on a potential target, or the real time data seen by Luke Skywalker as he scans the barren Tatooine desertscape through a pair of field goggles.

Read the full story here

Rosenberg: U.S. Unemployment Rate Headed For 12-13%

Wednesday, November 11, 2009

Rosie (of Gluskin Sheff) shares his insights on unemployment:

There are serious structural issues undermining the U.S. labour market as companies continue to adjust their order books, production schedules and staffing requirements to a semi-permanently impaired credit backdrop. The bottom line is that the level of credit per unit of GDP is going to be much, much lower in the future than has been the case in the last two decades. While we may be getting close to a bottom in terms of employment, the jobless rate is very likely going to be climbing much further in the future due to the secular dynamics within the labour market that need to be discussed:

  • For the first time in at least six decades, private sector employment is negative on a 10-year basis (first turned negative in August). Hence, the changes are not merely cyclical or short-term in nature. Many of the jobs created between the 2001 and 2008 recessions were related either directly or indirectly to the parabolic extension of credit.
  • During this two-year recession, employment has declined a record 8 million. Even in percent terms, this is a record in the post-WWII experience.
  • Looking at the split, there were 11 million full-time jobs lost (usually we see three million in a garden-variety recession), of which three million were shifted into part-time work.
  • There are now a record 9.3 million Americans working part-time because they have no choice. In past recessions, that number rarely got much above six million.
  • The workweek was sliced this cycle from 33.8 hours to a record low 33.0 hours — the labour input equivalent is another 2.4 million jobs lost. So when you count in hours, it’s as if we lost over 10 million jobs this cycle. Remarkable.
  • The number of permanent job losses this cycle (unemployed but not for temporary purposes) increased by a record 6.2 million. In fact, well over half of the total unemployment pool of 15.7 million was generated just in this past recession alone. A record 5.6 million people have been unemployed for at least six months (this number rarely gets above two million in a normal downturn) which is nearly a 36% share of the jobless ranks (again, this rarely gets above 20%). Both the median (18.7 weeks) and average (26.9 weeks) duration of unemployment have risen to all-time highs.
  • The longer it takes for these folks to find employment (and now they can go on the government benefit list for up to two years) the more difficult it is going to be to retrain them in the future when labour demand does begin to pick up. Not only that, but we have a youth unemployment rate now approaching a record 20%. Again, this is going to prove to be very problematic for employers in the future who are going to be looking for skills and experience when the boomers finally do begin to retire.

In a nutshell, to be calling for a 12.0-13.0% unemployment rate is meaningless except that it is very likely going to be a headline grabber. The most inclusive definition of them all, the U6 measure of the unemployment rate, which includes all forms of unemployed and underemployed, is already at 17.5%. The posted U3 jobless rate that everyone focuses on is at 10.2% (though if it weren’t for the drop in the labour force participation rate, to 65.1% from 66.0% a year ago, the unemployment rate would be testing the post-WWII high of 10.8% right now). The gap between the U6 and the official U3 rate is at a record 7.3 percentage points. Normally this spread is between 3-4 percentage points and ultimately we will see a reversion to the mean, to some unhappy middle where the U6 may be closer to 15.0-16.0% and the posted jobless rate closer to 12%. This will undoubtedly be a major political issue, especially in the context of a mid-term elections and the GOP starting to gain some electoral ground.

Think about it. We haven’t yet hit bottom on employment but that will happen at some point. Employment is not going to zero, of that we can assure you. But when we do start to see the economic clouds part in a more decisive fashion, what are employers likely to do first? Well, naturally they will begin to boost the workweek and just getting back to pre-recession levels would be the same as hiring more than two million people. Then there are the record number of people who got furloughed into part-time work and again, they total over nine million, and these folks are not counted as unemployed even if they are working considerably fewer days than they were before the credit crunch began.

So the business sector has a vast pool of resources to draw from before they start tapping into the ranks of the unemployed or the typical 100,000-125,000 new entrants into the labour force when the economy turns the corner. Hence the unemployment rate is going to very likely be making new highs long after the recession is over — perhaps even years.

After all, the recession ended in November 2001 with an unemployment rate at 5.5% and yet the unemployment rate did not peak until June 2003, at 6.3%. The recession ended in March 1991 when the jobless rate was 6.8% and it did not peak until June 1992, at 7.8%. In both cases, the unemployment rate peaked well more than a year after the recession technically ended. The 2001 cycle was a tech capital stock deflation; the 1991 cycle was the Savings & Loan debacle; this past cycle was an asset deflation and credit collapse of epic proportions. And economists think that the unemployment rate is in the process of cresting now? Just remember it is the same consensus community that predicted at the beginning of 2008 that the jobless rate would peak out below 6% this cycle. Thanks for coming out.

Dollar’s Days as the World’s Reserve Currency Are Far From Over

Via The Economist:

Worries about the dollar’s dominance of the global monetary system are not new. But debate about replacing the beleaguered dollar, whose trade-weighted value has dropped by 11.5% since its peak in March 2009, has resurfaced in the wake of a global financial and economic crisis that began in America. China and Russia, which have huge reserves that are mainly dollar denominated, have talked about shifting away from the greenback. India changed the composition of its reserves by buying 200 tonnes of gold from the IMF.

None of this threatens the dominance of the dollar yet, particularly as a dramatic shift out of the currency would be damaging to the countries (such as China) that hold a huge amount of dollar-denominated assets. But a new paper by economists at the IMF, released on Wednesday November 11th, acknowledges that the global crisis has reignited the debate about anchoring the world’s monetary system on one country’s currency.

Some say that America’s role as the principal issuer of the global reserve currency gives it an unfair advantage. America has a unique ability to borrow from foreigners in its own currency, and wins when the dollar depreciates, since its assets are mainly in foreign currency and its liabilities in dollars. By one estimate America enjoyed a net capital gain of around $1 trillion from the gradual depreciation of the dollar in the years before the crisis.

In a sense the world is hostage to America’s ability to maintain the value of the dollar. But as the IMF points out, the currency’s primacy arises at least partly because China and other emerging countries have chosen to accumulate dollar reserves. The depth of America’s financial markets and the country’s open capital account have made the dollar attractive. So some of the advantage has been earned.

But large and persistent surpluses in countries like China mean continued demand for American assets, reducing the need for fiscal adjustment by either country. This, in turn, has contributed to the build-up of the macroeconomic imbalances that many blame for the financial crisis.

Read the full article here

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