Scattershot

It's been a while since anyone other than trusty ol' Dave has posted on the blog, but in my defense, aside from keeping myself relatively busy and off a computer the last few weeks, lately nothing has really been jumping out at me as something that warrants a comment--or at the very least my comment. Bank failures and unemployment statistics and our brand new President and his brand new era of hope just seem so last winter.

And while I still don't have much to say, I do have very little to say about a few things. Hopefully one of these few things will spark a new round of discussion. Or if not, at the very least, I'll feel a bit better about finally posting something again.

Issue 1: Goldman Got to Get Paid

And you thought we were in a recession. The news is now officially out that the investment bank Goldman Sachs is reporting a $1.8 billion profit for the first quarter of the year. Perhaps all the hedge fund managers that frequent this blog, having had their standards and expectations goosed during the hey-day of the mid-oughts, wish to snicker at such a paltry sum. But compared to the reports of that same firm throughout last year and compared to the state of the rest of the economy (yeah, there's a "rest of the economy"), this is surprisingly good news.

Particularly if you're upper-management at Goldman Sachs. If not, maybe not so much. Because if you're like me, you might be wondering in a world of parched credit and sequential downgrades and a degree of so-called "animal spirits" befitting only roadkill, where does that kind of money come from? According to Barry Ritholz, quite a bit of it probably comes from Uncle Sam.

Remember when AIG got a whole chunk of cash from the U.S. Department of Treasury? The reason that was such an important and necessary thing to do was because, according to that Department, AIG had so many liabilities reaching out like oily tentacles across the financial globe, that chain of defaults (or only the perception of a chain of defaults) would cause the entire financial system of the world to seize (like Lehman, but worse). Luckily for Goldman Sachs, it happened to be at the other side of a disproportionate number of AIG's tentacles (namely CDSs as far as I understand, but maybe I don't fully). Luckier still for Goldman Sachs, is that when the United States Government saw fit to ensure AIG's liabilities, it failed to act as any lender of last resort would and protect its investment by renegotiating the terms of its (that is, AIG's debt). So Goldman Sachs got 100 cents on every dollar invested with AIG.

And perhaps even luckier still that Goldman Sachs' former CEO was the Treasury Departments former number-one man who, according to Ritholtz

oversaw the greatest transfer of wealth in the planets history — several trillion dollars from taxpayers to the management and shareholders of inept, incompetant, wildly irresponsible companies.(Source: Big Picture)

But those are his words, not mine.

Issue 2: China Makes Some More Noise

This story has already been beaten to death on this blog, but just to provide a quick reminder, China has a lot of U.S. dollars in the bank and should it ever decide to swap some of those dollars for another currency, the U.S. dollar would likely take a big hit. And now the slow down is continuing.

Is this an enormous deal? Does Hu Jintao's statement a few weeks ago auger the imminent implosion of the U.S.'s international position? I seriously doubt it. The key phrase here is "slow down." China is still a net purchaser of U.S. government debt as far as I understand it. Perhaps their demand isn't keeping up with our supply (we're spending more than their lending), but given the fact that fear is still the international currency of choice, their are plenty of eager lenders out their looking for a safe place to stuff their cash.

In any event, China wouldn't benefit from a plummeting dollar anymore than the U.S. would. Though it may try to diversify its trade position and though it may try to diversify the balance sheet of its Central Bank, the U.S. still holds primary positions in both. In short, this is a marriage that neither country can afford to break-off.

Issue 3: Re-Regulating

This story is at least two weeks old, but last month, the Treasury Department released its vague notion of its unique approach to financial regulation--presumably the first of a series. The press statement can be found here, but let me pick out the tasty bits.

First, Treasury proposes a single regulator of the entire financial system. I suppose this centralizes the functions of the chairman of the Fed, the head of the SEC, the head of the CFTC, the head of the FDIC and a litany of other mysterious-sounding acronymed institutions. In what way the duties of this new regulator would be distinct and or separated from said institutions, I do not know. It is encouraging however that this regulator in chief will be charged with evaluating "what companies do, not the form they take"--which is to say, rather than solely looking at depository banks and allowing the various other permutations of this hallmark financial institution to inhabit various other levels of regulatory purgatory, if you are a company, for instance, that happens to be selling insurance on bonds, even if the insurance on the bond isn't called insurance and even if the letters that grace the front of your granite building do not read "insurance company," you will be regulated as such. Which, as I said, is encouraging.

It is then posited that the Treasury Department will work to ensure that so-called "over the counter" derivatives are brought, if not off of the counter and into some formal exchange, than onto a new semi-official counter which will be watched by some watchdog. But, as you might expected from my wording, the details are fairly slim here.

Next, the press release discussed how "capital requirements" for all relevant financial institutions will be increased. Capital requirements, generally assumed to be around 8%, is that proportion of money a bank must own its very own self for every asset that graces its balance sheet. For example, if I loan out $100 to company x, regulation may stipulate that I have to hold at least $8 in cash or stock as a safeguard against default on my loan. Unfortunately, as it stands now, capital requirements differ based on the portfolio of a particular institution. For example, if the $100 loan I make is rated very well by an esteemed rating agency, I may have to hold much less than $8, whereas if Company X turns out to be run out of someone's basement, I may have to hold much more than $8. Unfortunately, as we've seen, the rating agencies are slightly less reliable--optimism on their part go up and down with the market (or to put it in the unnecessary parlance of economics, their ratings tend to fluctuate pro-cyclically). This aspect is not addressed at all by the Treasury brief.

Lastly (at least for me), the Treasury recommends that both large Hedge Funds and the entire Money Market be regulated.

I don't have much to say about that.

Fin

Anyway, thanks for reading this far. This has been a fairly disorganized post, but I felt like I ought to write about something or other. Perhaps one of these three topics will spark someone's interest in writing another post (or just a comment).

Or maybe we can just talk about the Obama DOJ following the lead of its predecessor on both Guantanamo and state secrecy and domestic wiretapping . This kind of analysis (that is, angry and/or political) isn't something I'm particularly good, but I'd love to hear what it is that I must be missing so that this can in any way seem justified.

Also, if anyone is up for more reading, this is really entertaining, low on financial lingo and telling as all hell.

They Made Us Do It

I promise to keep this one shorter.

This afternoon, Dave and I were discussing something his professor had said in class about the sources of the financial crisis. To summarize a summary (I wasn't in the class, so Dave is invited to correct my presumptuous ass), the unnamed professor pointed out that a great deal of blame for this whole mess should be placed at the bounded feet of the Chinese. By pegging their currency at an artificially low level through massive purchases of U.S. treasury bonds, the United States was drowned in an ocean of cheap money which allowed too much investment and too much spending to occur too quickly with too little oversight or forethought.

I've seen this argument before. In a New Yorker article on Ben Bernanke, John Cassidy portrays the chairman as a soft-spoken, gee-is-he-a-nice-guy but a bizarrely dogmatic chamption of, among other theories populur within the administration, the notion of a so-called "global savings glut." As I paraphrased before, this is basically the idea that the Chinese (with a devalued currency) were saving "too" much, which allowed the U.S. to spend "too" much. Without knowing too much about it, I was struck while reading the article at the convenience of the argument. Perhaps oversight was lax in the U.S., yes, and perhaps interest rates were held too low by the Fed, and mabye in retrospect it wasn't quite such a good idea to deregulate such a vast segment of the financial and banking industry, but it isn't our fault or that of any of our ideological predecessors. It was the Chinese. If you leave bacon on the living room floor, you can't blame the dog for eating it.

But this seems like a bit of a cop-out. Yes, the Chinese government allowed interest rates in the U.S. to fall (which not only exacerbated silly lending in the real economy, but also drove many of the poorer financial choices as investment banks sought out higher yields and finding them in riskier bonds and instruments), but U.S. montetary authorities slurped up that liquidity with the eagerness of a paid professional. And given the hatchet that has been tearing into the aeorta of the financial regulations and taxcodes of America since the late 1990s, as the blog post which provided the imputus for this one writes,

"Maybe it's time to revisit the "saving glut" hypothesis, and say that perhaps capital [was] "sucked" into America, rather than "pushed""(Source: Econbrowser)

I didn't write this post as a "fuck you" to a professor whom I've never met. I just meant to take his point, summarized by Dave and taken out of context by myself, and add to it: while China (and any other implausably wealthy "developing" countries you might wish to blame) have perhaps* been the pushers in the international trade narrative of the financial crisis, the U.S. has consistantly and unapologetically played the role of the ichy-skinned, lice-ridden, toothless adict. In international economics it takes two to make frottage cheese.

*There is also the possibility that the imbalance is fundamentally not a matter of excess supply (of savings in China), but one of excess demand (for more borrowing in the U.S.). Throughout much of the 19th century, it was generally believed that "supply creates its own demand," otherwise known as Say's Law, a theory considered by most non-loonies to be a theoretical relic, put out of its misery by John Maynard Keynes sometime during the 1930s. Is the savings glut hypothesis just an international capital market version of Say's Law. A more coherent, concise critique:

"I think that the conventional wisdom is more plausible: there is a savings scarcity in the United States, driven largely by the federal budget deficit, and it is this savings drought in the United States that has been sucking in excess savings from the rest of the world for most of the past five years. What about the low interest rates? In my view, the low interest rates are more the function of expansionary monetary policy, and corporate savings at home, rather than excess savings abroad."(Source: Econbrowser)

Currency Values: What the Christ?

In the comment section of my last post, Dave asked me to clarify a few things about how imports affect currency values. Having given it some thought, I now realize that not everyone reading this blog has spent the past few years of their lives learning about the virtuous optimality of a Dickensian distribution of income (i.e. study economics) or happen to suffer from that particular form of brain worm that leads a person to voluntarily immerse oneself in economic literature (Lion). Therefore, I'd like to take this opportunity to explain for those who are interested that whole deal with currency values. If my explanation resorts to asinine metaphor or a patronizing tone of voice, it isn't because I think anyone here is an idiot. Those who study economics are lucky enough to be a part of discipline which straddles the line between the byzantine abstraction of most academic fields and actual, real-life relevance. That is, economists get to be confusing on the news, not just in the lecture hall. I'm sure if there was a global crisis of post-modern literature, I'd be scratching my head along with everyone else.
So here we go: Exchange Rates. I apologize beforehand if this is all really boring.
Studying it myself, I find it much easier to wrap my head around exchange rates by thinking of currency as if it were any other commodity. The price of this particular commodity happens to be its exchange rate (that is, how valuable it is relative to all other currencies), and that price is determined by those ever-present crossing-swords, supply and demand.
When I talk about the "demand" and "supply" for a currency, I am talking about a few things:

a) Trade of Goods and Services: To give a tremendously oversimplified example, if I wanted to buy a Mexican-made radio, I, as an American, would be purchasing a radio imported from Mexico just as the manufacturer in Mexico is exporting that radio to the United States. When Mexico exports that radio, demand for the peso goes up. Why? I spend the money and somewhere along the supply line that money is converted into pesos. Within the foreign exchange market (not any one place, but an aggregate of thousands of different banks and financial institutions carrying out similar transactions for all trade between the U.S. and Mexico), this constitutes one additional "pull" on the Peso v.s. the American dollar; that is, one more person who wants X amount of Mexican pesos rather than the proportionate amount of Dolla-Dolla-Bills. If Mexican exports are suddenly all the rage and there are millions of stupid Americans like me buying cheap Mexican stuff, looking at trade as a factor alone, that demand for Mexican goods (and therefore pesos) will increase the "price" or "value" of the peso--the peso will "appreciate," so that it takes more American currency to buy the same amount of Mexican currency.
Likewise, during the same process, all the importation of Mexican goods to the United States increases the supply of American dollars on the foreign exchange market. This enormous supply, under these simplified conditions, should lead to a decline in the "price" of American dollars--the American dollar will "depreciate."

b) Financial Activity: to assume that exchange rates are determined simply by the trade of actual goods is to overlook the enormous amount of currency trading that goes on in financial markets. Some estimate that 90% of currency flows result from capital market activity. This kind of activity is often speculative and generally extremely complicated, but it suffices to say that if someone in America wants to invest in Mexico (either in stocks, bonds, etc, which is called portfolio investment) or in physical goods (such as a factory or a hotel or a housing development, which is called foreign direct investment), again, he or she has to exchange American dollars for pesos. This, all other things held constant, will increase the demand for pesos and the supply for American dollars respectively, and will contribute to a relative deprecation of the American dollar against the Peso.
Bringing it all back to the China-America issue one last time:
When I wrote that one blogger was speculating that the drop off in exports would put downward pressure on the Chinese yuan, I said this because of "factor a" above. If the United States and Japan and Germany and everyone else is in a recession and can't by Chinese stuff, the demand for the Chinese RMB falls as well.
What is the significance of this? China's exchange value is not determined by the foreign exchange market. Because a lower exchange rate (for a while around 8 Yuan for every 1 American dollar, now closer to 7:1) means that Chinese goods in America are cheaper, China has for some time actively kept its exchange value low to facilitate that lop-sided trade relationship. While this certainly complicates matters if someone in China wants to buy anything not from China, such a policy is unquestionably good for those Chinese firms in the business of manufacturing. So how do the Chinese keep their currency low?
Turning to "factor b" above, the Chinese government buys (partially with the money they recieve for all their exports) American (and European) financial assets. These purchases have largely been of U.S. government bonds (basically interest-bearing IOUs from the Federal Government), but also bonds of government sponsored enterprises (Fannie Mae, etc) and the commercial paper and equity of private firms. Regardless of where the money is going, the effect is the same: by buying up American financial assets, they are increasing the demand for American dollars, while flooding the market with Chinese yuan. Tinkering in the market this way, they are able to set a "peg" on their currency; a value or band of values from which the currency is not allowed to deviate.
A drop in exports however, which would decrease the upward pressure on the Chinese currency--so wrote the blogger--would mean that the Chinese government would no longer be so hard-pressed to buy up American financial assets. The consequences of such a shift, he wrote, could be serious for the American economy, since its all that financial activity--namely the buying up of American Treasury Bills (T-Bills being, once again, IOUs to the Federal Government)--that allows the Federal government to borrow so much so cheaply. As soon as the Chinese recognize that it is no longer in their interest to lend to (buy bonds from) the Americans, the Americans either have to stop borrowing or start offering a higher interest rate. The ramifications of this are manifold and mani-fucked, but I won't get into it too much.
What I was writing, on the other hand, was based on a BBC article which pointed out that while Chinese exports are indeed dropping, their imports are dropping further. Why? Countries buy imports when the people and the firms there have money to spend. Since the Chinese economy is so heavily reliant on exports, a decline in exports leads to a decline in consumer and business expenditures, which leads to a drop in imports. The significance of this for currency values--what Dave was asking about in a comment from a post below--is that if a decline in exports leads to a decline in demand for Chinese currency, a decline in Chinese imports also leads to a decline in demand for the currencies of China's import partners relative to the RMB. The net effect, with some oversimplification, is potentially zilch. The depreciative pressure resulting from a decline in demand for Chinese exports/RMB is countered (perhaps overwhelmed, given that the net exports of China during December were at record high levels) by the decline in supply of RMB in foreign exchange (forex) markets resulting for a decline in imports into China.
I hope I've made some sense of all this for those of you who couldn't make sense of my previous article. Exchange rate determination is probably one of the more complex processes in the world of trade and finance, so I've undoubtedly left out of a few factors. I just wanted to explain the basics so that, in the future, if I or anyone else talks about why it is that the American dollar is so strong right now (for instance), everyone will know more-or-less what the hell is going on.

Beating a Dead Tibetan 2: the Remetaphorizing!

Sorry to sweat-shop-belabor this--I'm sure we're all sick of discussing just where China falls on the Economic Boogy-man Index (76 as of yesterday)--but just to go back to point I was talking about earlier...
I mentioned an article/blog I read a few days ago which claimed that the current demand for treasury bills from China will likely begin to wane as their exports drop off. As demand falls for Chinese goods (and therefore Chinese RMB), so the argument goes, there is less upward pressure on the Chinese currency and therefore less need for the Chinese government to intervene directly into American financial markets to keep the peg...well, pegged. In his own words:

China no longer needs to be as active to keep the yuan (which now appears to be back to a hard peg) where China wants it to be. A presumably smaller current account surplus and a capital exodus would seem to be prime suspects. (Link)

Tonight, the BBC is running a headline: "China's Exports in Record Decline".
Bad news for China certainly, but not necessarily a vindication of the argument above. Scroll down on the BBC article and you will eventually find that

December imports fell even more sharply, declining 21.3%, the China Daily reported.

That was a bigger decline than November's 17.9% drop.

With exports in December worth $111.2 billion, and imports worth $72.2 billion, that made December's trade surplus $39 billion.
That is the country's second highest trade surplus ever, just short of November's record $40.1 billion. (Link)

Quothe Captain Obvious: China's economic growth has largely been driven by exports. Imports, otherwise considered exogenous (i.e. not at all related) to exports, are a function of overall demand within the economy. But for China, where overall demand is disproportionally accounted for by foreign demand through exports, a drop off in exports will necessarily lead perhaps not an equal, but proportionate decline in imports. This isn't just an issue of exports => aggregate demand => imports (if you'd like additional sophisticated diagrams, I'm available for any class or business presentations). Most of Chinese exports are "re-exports": raw materials are imported and assembled cheaply for export or sophisticated technological equipment is imported and, again, assembled cheaply for export. Therefore, imports aren't just a function of exports in an indirect sense (see elaborate illustration above), but literally make up the exports. As an aside, contrast this with the United States. If everyone were to hypothetically stop buying American stuff (see: past 10-35 years), that wouldn't stop all us good ol' boys and gals from buying everyone else's stuff because our economy is more "dynamic": the Camerro that is American economic progress also runs on domestic consumption, investment, government spending and, more recently, the tears of unicorns imprissoned in the sea by Alan Greenspan.
Back to China, as the article points out, in December the fall in imports was even larger than that of exports. I don't know if that is accounted for by an actual decline in quantity imported vs. exported or by a change in currency values between one of China trading partners. Whatever the case and whether that will continue to be the trend (or whether there will be a trend at all) is secondary to the point that, because China's very economic soul predisposes it such that a drop off in exports will entail some degree of declining imports, at least in the short-term, the global recession will not fundamentally alleviate the upward pressure on that country's currency.
I should point out however that currency values are not solely (and in many cases primarily) determined by current account fluctuations (exports and imports), but by capital markets.
And everyone knows how predictable capital markets are.

Call me Ishmair

Before all is said and done, the United States may very well play Captain Ahab to China's Moby Dick. We're both going down together:

In another sign that China's slump is serious enough to evoke crisis responses from the officialdom, banking officials there announced that they were relaxing rules on bank bad debt ratios. The objective is to encourage banks to continue to extend credit to borrowers experiencing short-term difficulties who have viable businesses. (Link)

I don't know what to say except that its always a good day when deregulating Republicans and Communist Chinese see eye-to-eye on policy.

My alternative is to encourage new lending by lowering capital requirements at the margin. Tell banks that loans issued after September 1, 2009, require half the capital of similar loans issued before September 1. (Link)

Maybe the case of China is a bit different. Digging yourself out of a standard economic slump in a country with a so-called "savings glut" by encouraging the expansion of credit may seem a bit less perverse than digging yourself out of a subprime mortgage crisis in a country with a virtual zero savings rate by encouraging the expansion of even more subprime lending. It's worth noting anyway.

Beating a Dead Tibetan

Just a few more thoughts on the relationship between the United States and China. So far the discussion of this sorta-kinda-reciprocal co-dependence between the two countries has been defined as, one side of the Pacific, a need for easy credit and cheap plastic shit and easy credit to buy that cheap plastic shit. And war and stuff. And then on the other hand, we have an economy completely reliant on exports. Why can't China just pull the plug on the comatose vegetable that is the American Dream? So far we've talked about China's need to keep its currency and wages low, both of which help to make their lead and melamine so deliciously cheap. That's the macroeconomic perspective, and its correct.
What we haven't really talked too much about (or if we have, I wasn't paying enough attention) is that China's interests in American T-bills and private equity is not just about keeping the dollar strong against the RMB; these are legitimate investments. Given the massive inflation that up until recently China was worrying about, the massive amount of money poured into the American financial system wasn't just a way to keep China's trade-relationship as static as possible (though it certainly was), it was also about keeping the money in a secure and safe place. Now that that secure and safe place has turned out to be neither, this doesn't mean that the Chinese government is going to sell off all of its American assets. If China decides to start selling off its American assets (and in doing so, take a dump all over the American dollar), we therefore just see a sharp(er) deterioration of China's trade position, we will see a massive deterioration of its financial position. An estimated 70% of Chinese reserves are held in dollar-denominated assets. In a sentence then: in my limited capacity to evaluate things, I would imagine that the flow of cash from China will not turn on a time, but instead slow down. On the other hand, as one blogger writes, China may not need to be so concerned about an imminent appreciation of its currency: right now, people aren't buying as much of their exports (i.e. its current account surplus is beginning to flatten if not fall) and people aren't investing as much in China, financially or directly. Which is to say, in the absence of the standard upward pressure on the Chinese currency, the Chinese government may not need to interene in currency markets by gobbling up T-Bills and other American assets. Which is to say, that counter to everything I've said to far, the value of Freedom is about to dive off a cliff.
On the other hand, and I'm just speculating here, the middle of a world-wide recession might be just the time for China NOT to loosen up on its currency manipulation. Any appreciation resulting from a more laissez-faire approach is only going to compound the short-term pain. And that brings me back to my initial thought: there will be no sudden apocolyptic cluster-fuck where American interest rates sour, the dollar tanks and the North American continent disappears into the ocean. This may all very well occur--but in slow motion.
Such is the fate of American prosperity: not out with a bang, but a whimper.
Oh, and a lot of unemployment.