Archive for June, 2010

Austerity: Dumb, but Not Dumb Enough

June 30, 2010 Leave a comment

Some say we aren’t spending enough globally to fight off a renewed recession…or, (gasp) a new depression!

Baloney. Any austerity enacted today pales in comparison to the vast monetary and fiscal stimulus conducted globally over the last ~1.5 years, and much of it continues today. On the fiscal side, a fair amount of the stimulus was probably fake anyway. (Said differently, much of the stimulus took so long to disburse and/or reach the economy it didn’t play much of a role in stabilization or recovery anyway). But monetary policy and liquidity provisions, on the other hand, have been excellent stabilizers and boosts to capital markets and the broader economic recovery. That continues in a very big way and will at least through this year and probably next.

But there’s another tailwind feature for those who worry austerity will strangle us all: Many politicians probably won’t have the gumption to do all the cutting they’re promising. An example: Germany’s Merkel has seen her power weaken significantly since entering the fray of austerity and EMU backstopping. My guess is leaders stationed in relatively highly socialized societies (Zapatero, Sarkozy, etc.) will feel similar heat. Specifically since a lot of these cuts happen over many years. By then, we’ll have a much stronger global economy…in which case the cuts won’t seem so vitally important any longer.

It’s true that raising taxes and cutting certain types of spending (like infrastructure or stuff that gives folks a job) is bad economic policy amidst a budding recovery, but the smaller magnitude of the austerity relative to the larger stimulus of recent years makes this dumb, but not quite dumb enough to derail things significantly.

Small Business Lending—Far From DOA

June 25, 2010 Leave a comment

I commonly hear that small businesses do not have access to credit and that’s hurting the economy. It’s true that credit is still somewhat impaired today, but the below chart demonstrates improvement—we’re much higher today than we were in 2008 and early 2009. (Source: Small Business Association)

Actually, with all the programs in place to facilitate small business loans, I’d bet that this says as much about improving access to credit as it does about improving demand for credit.

Source: SBA, May 2010

Deficit Reduction; Higher Taxes?

June 23, 2010 Leave a comment

Why is it that reaction to high deficits generally leads to more confiscation of private property? In this case, cash money in the form of taxes. It’s never been clear to me why more taxation would get a country out of debt woes (assuming there are truly sovereign debt woes. There are, to be sure, but it’s taken as given far too often these days to my view).

After all, if you tax an economy you effectively limit—or create a disincentive for—potential for economic growth. Well, economic growth is the name of the game when it comes to digging out of deficit trouble. Headlines will be dominated with “austerity measures”, and “painful” or “unavoidable” measures. But through history, the best way to solve budget/deficit problems is to fuel a dynamic, diverse economic engine to serve as a growing tax base to service said debt. (Don’t get me wrong, for the Greece ’s of the world austerity probably can’t be avoided—they’re just too small and their economies too narrow.)

What’s “painful” is cutting benefits. Painful, that is, for politicians. The last thing they want to do (as they value their political lives) is hugely cut programs and entitlements. It leads to unrest and protests and weakens their power (just ask Germany ’s Angela Merkel). So they limit that (I’d bet that that most economies, at best, will end up cutting a few percent off their budget when it’s all said and done), but they’ll gladly raise taxes the first opening they get.

For now, these measures seem small enough not to knock the global economic recovery. But this is a topic to keep a close eye on.

The Law of Unintended Consequences

June 17, 2010 Leave a comment

“…banks are preparing new fees on basic banking services as they try to replace revenue lost to regulatory rules…” (From today’s Wall Street Journal, End Is Seen to Free Checking)

I think it was Princess Leia in Star Wars who said, “The more you tighten your grip, the more banks will slip through your fingers.” Or something like that. At any rate, this is a classic instance of regulation causing consequences that end up hurting the folks who were—ostensibly—being “helped”.

Instead, what we get is tantamount to a new regressive tax. I’m willing to guess rich folks with big deposits will continue to get free checking while lesser account sizes will pay fees. Not sure that’s exactly what they set out to accomplish.

In the meantime, don’t hold your breath on an apology from Barney Frank.

Could Headlines

June 15, 2010 Leave a comment

This isn’t news:

Fed Weighs Growth RisksOfficials Keep Fresh Eye on Slowing Inflation, Europe Even as the U.S. Recovers

It’s a kind of anti-news, what-if news, not-really news, speculative news. There’s no story here. It’s what I call a “could” headline in my book, 20/20 Money. There’s the possibility of a story, but not really a story. Nothing about the Fed keeping an eye on global growth and weighing options for what it might do in the future is different than any other day of financial existence. Some will say, “But the stakes are higher today and the Fed’s moves are more important than ever.” I’ve been hearing that for as long as I’ve been in this business. What the Fed does is always important, as is what the economy, inflation, and unemployment are doing. That will never not be true.

Investors would do well to completely skip headlines like these, which waste time and offer nothing but obfuscation.

Fisher Investments Analyst’s Book Review: Getting Off Track

June 10, 2010 Leave a comment

I had every intention of winding down my reading on the crisis, but it just seems to keep going—books from worthy authors are still arriving weekly on the topic. So, let us press forward, then, with John Taylor’s Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis. This dainty 92 page book is not light reading, nor will it appear on any bestseller lists. But actually, these scant few pages are as cogent and clear as any I’ve encountered in describing the mechanics of the financial problems that caused the panic.

John Taylor is a noted economist of this era in his own right, but is most often referred to as a friend of Milton Friedman (provocative because he’s critical of Uncle Alan in this book). Taylor’s pedigree includes stints (as either a student or professor) at Princeton, Stanford, and Columbia. In the early 90s he coined the Taylor Rule (more on this momentarily), and he’s been a part of many prestigious economic counsels (as economists with sterling pedigrees are wont), including multiple presidential administrations.

Taylor’s book makes a very clear and pointed proposition: The government caused the financial and market ills of 2008, and played a key role in exacerbating those problems. He is right to blame the government for worsening the panic, but wrong to point such a strong finger for causing it. Or, rather, when he blames the government for causing it, he tends to blame the wrong parts. Let me explain.

Taylor Rule for Everyone!

The Taylor Rule is a “guide” to central banks on how to determine interest rates. It tracks inflation, output, and employment, recommending a higher interest rate when inflation is above comfortable levels and/or when full employment and capacity is reached. When inflation and/or output are low, the rule argues for a low interest rate. (There’s plenty of mathematics to this, which we’ll abstain from here.)

Much of this book is a case study articulation of the theory. Specifically, that the rule was ignored for much of the last decade (Greenspan kept interest rates too low for too long). This inaction was a principal cause of the overheated boom and bust in housing, which eventually caused the panic and recession. Taylor might be a little bit right in this, but it’s far too bombastic a claim. It’s much more reasonable to say perhaps monetary looseness exacerbated some of the frothiness. Taylor is more right in pointing a finger at the moral hazard atrocities that are (and continue to be) Freddie and Fannie.

Still, amazingly, there’s no mention of FAS 157 and the dubious features of Sarbanes-Oxley. These two causes alone so obviously account for so much of Financials’ problems that it boggles the mind we don’t hear about them more often. If we are to successfully assign government blame for the origins of the downturn, we must go there, and prominently. Taylor doesn’t.

More importantly, such hard and fast economic equations as Taylor’s often fail in practice, and blind adherence to them is a recipe for chaos. Taylor readily cops to the fact that we cannot put our faith in a theory, and that we must be versatile and aware of the peculiarity of each circumstance. But this is the problem with all rigid quantitative economics—in practice it works until it doesn’t, at which point there you are, stuck with an equation that’s somewhat mercurial in its forecasting power, and ultimately still requires a qualitative decision. Whether such equations help those decisions or obfuscate them is debatable.

Risk versus Liquidity

Although Taylor sometimes mis-assigns blame for the origins of Financials’ problems, he gets as close to correctly assigning causality for the latter stages of the panic as anything I’ve so far read. He makes an important distinction about the crisis, one that few have drilled down to: The problem wasn’t liquidity in the beginning—first it was risk and then liquidity.

What does this mean? Differentiating between risk and liquidity might seem like hair-splitting. Certainly, in the marketplace risk and liquidity can be siblings, and at times seem nearly interchangeable. We’re better off calling late 2008 a period of “uncertainty” instead of risk.

Why? Economist Frank Knight illuminated this issue brilliantly. He said that risk and uncertainty are two different things. Risk is what happens when you know the odds. If you flip a coin, there’s a 1 in 2 chance of coming up heads. That’s risk—you know the probabilities and can make a bet on it. But uncertainty is totally incalculable: these are situations where there is no way to know the odds—the probability of an outcome is just a wild guess.

Indeed, the Fed and its cohorts innovated tremendously to provide liquidity to banks, but never actually took uncertainty off the table until way late in the game. In fact, they probably increased uncertainty by acting so haphazardly—each inconsistent reaction creating mounting uncertainty over the latter half of 2008. Who would they save? Who would they watch fail? What tactics would they use? Each reaction was different (from Bear Stearns to AIG and all in between) and thus, by the time we got to September ‘08, uncertainty about what happens next was at all-time highs. This is deadly poison for markets, which always look ahead. When even the next few hours are opaque, liquidity dries up. No one is willing to put money on the line when the government seems to be making the rules up as they go. And there you have your panic.

As with any event in a hugely complex global economy, there are multiple reasons for the cause of everything—the best we can do is figure out how much each factor mattered. Of course, that will always be a matter of opinion, hence the never-ending debate on such issues. With this book, Taylor does better than most at sluffing off the inane tendency to blame “greed” and stupidity for the panic. In an era when we seem to keep looking to the government for answers, this is an important perspective about its ills. But if this book proves anything, it’s that the very causes of this era in financial history are still very debatable and in doubt in the public forum, and will be for decades to come.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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