Protectionism: G-20's Elephant In The Room
Vidya RamA Latvian farmer explains why it's destroying his business.
Uldis Krievars has had to make big changes to keep his 400-cow dairy farm in Latvia alive. He's cut back on feed, canceled construction plans and got some of his tractor drivers to sell milk on the streets. Other Latvian farmers are worse off, pulling children out of school to help out in the field and giving up equipment to the bank. Though there have been just a handful of failures, Krievars says it's only a matter of time before more farmers have to give up the business.
Latvia's dairy industry dominates the central and eastern regions of country, but falling milk prices, crushing foreign-currency debts and now "explicit" protectionism is devastating the sector, says Krievars, also chairman of the board of Latvian dairy cooperative Trikata.
Latvia sells between 55.0% and 60.0% of its milk and milk-based products abroad, but exclusive agreements between distributors and manufacturers within individual members of the European Union and protectionist measures by some non-E.U. states like Russia, which recently raised import duties on milk products, has left farmers like Krievars hard-pressed to sell their products abroad. He now has no choice but to sell his milk on the streets at heavily subsidized prices.
Ahead of the G-20 Summit on Thursday, much attention has focused on the need to offer more stimulus spending, greater funding for the International Monetary Fund and financial regulation. But for Eastern Europe, a key issue of concern is protectionism. In a report published last month, the World Bank said it had identified 47 measures "that restrict trade at the expense of other countries," since a November agreement by the G-20 and is now urging countries to take more concrete steps to thwart it.
Protectionism has been noticeable in developing countries, with India banning Chinese toys and China eschewing Italian brandy and some Belgium chocolates, but it's been devastating for Eastern European, already suffering from a deep lending freeze. One example: French carmakers like Renault who have received bailouts from the government are already leaning towards cost-cutting outside of France, and in the Czech Republic. (See "Renault Keeps France In Work") "It's key that we get a clear commitment to avoid protectionism, which would be catastrophic for a lot of export-orientated economies in Eastern Europe," said Lars Christensen, head of emerging market research at Danske Bank.
The real danger is that protectionism will spiral out of control as countries introduce tit-for-tat measures. In the past couple of months, Latvia has been hit by a wave of protests by farmers demanding subsidies, costing the agriculture minister his job in February.
Latvia's problem has been its openness, says Krievars: the country has amongst the lowest subsidies for the agricultural sector within the European Union, which has made the farmers less able to face up to more heavily-subsidized and better-protected foreign competitors in the local Latvian market too. "What we need is an agreement on fair trade and against protectionism," he said. "But it takes two to tango."
JOHN BOEHNER: We Must Rein In a Government Gone Wild
JOHN BOEHNER: We Must Rein In a Government Gone Wild
By John Boehner
House Minority Leader
Congratulations to FOX on the launch of the new “FOX Nation.”
With Democrats now firmly in charge of Congress and the White House, Washington is increasingly out of control. From a Treasury Department that refuses to cooperate with independent oversight to a Democratic budget that causes the national debt to explode to the President’s firing of a private-sector CEO, Americans on a daily basis are seeing their government cross lines they never thought they would see their government cross.
As Americans become more incensed with government run amok in Washington, they are becoming more eager for a credible, energized alternative. This is why my House Republican colleagues and I have placed a strong emphasis on identifying better solutions and communicating them to the American people through the new media. Blogs, social networks, and the use of “next step” news and opinion websites like FOX Nation will play a big role in how House Republicans regain ground in the effort for a responsible government.
Democrats have controlled the White House, the Senate, and the House of Representatives for three months now, and from their actions, a discomforting narrative has emerged. It’s a pattern of fiscal recklessness that is piling debt on our children and grandchildren—a pattern of flagrant indifference to waste and abuse of taxpayers’ money at a time when every penny counts.
And this week’s ratification of President Obama’s budget by the Democrat-run Congress serves notice to Americans that never-before dreamed of levels of spending, taxation, and red ink are on their way. Republicans countered their complete lack of fiscal discipline with an alternative budget that curbs spending, creates jobs, cuts taxes, and controls the debt.
The majority’s fiscal arrogance has sparked an insurgency not just among Republicans in Congress, but in communities and neighborhoods across America. “Taxpayer tea party” protests are erupting in city after city. In my hometown of Cincinnati, thousands of citizens recently gathered on Fountain Square to protest government policies that are forcing responsible Americans to subsidize irresponsibility. Similar protests are flaring up in cities and towns nationwide.
Americans are growing increasingly outraged, and for many reasons. Here are a few:
Energy Taxes. President Obama and Democrats want to enact a new national energy tax to pay for more government spending – a new tax that will cost each American family as much as $3,100 a year.
Bailout Chaos. Instead of outlining an exit strategy to get government out of the bailout business, Democrats want to expand the TARP program. Even worse, the Government Accounting Office says TARP has actually paid out $100 billion more than what Treasury Secretary Geithner claims.
Waste & Abuse. Democrats are already conceding that the pork-laden trillion-dollar “stimulus” spending bill that became law in February will not achieve its goals of job creation. And days after enacting the “stimulus,” Democrats passed an “omnibus” government funding bill loaded with approximately 9,000 earmarks that were inserted without scrutiny.
On the opening day of this Congress I vowed Republicans would not just be the party of “opposition,” but the party of better solutions to the serious challenges facing our country. And in response to a challenge from President Obama, House Republicans put forward a stimulus plan that created twice as many jobs at half the cost.
Since then, dozens of House Republicans have volunteered for duty on solutions groups to develop ideas and to challenge the Democratic majority where they fail or refuse to lead. These include:
The Economic Recovery Solutions Group, led by Whip Eric Cantor (R-VA), to develop ideas on housing, financial recovery, and to lead a “stimulus watch” with Senate Republicans.
The Health Care Solutions Group, led by Rep. Roy Blunt (R-MO), to solicit input from all Americans in crafting proposals to increase access to quality, affordable health care.
The Savings Solutions Group, which I lead, addresses Americans’ number-one economic concern: restoring the savings lost during the present economic crisis and preventing Washington from causing more damage.
The American Energy Solutions Group, led by House GOP Conference Chairman Mike Pence (R-IN) to help America achieve energy independence through an “all of the above” energy strategy.
In the coming days, we will also launch the GOP State Solutions project led by with Reps. Devin Nunes (R-CA) and Mike Rogers (MI). House Republicans will work with reform-minded GOP governors and state legislators to fight Washington bureaucracy and inefficiency.
This is a time of great challenge for the American people. But there has never been a challenge Americans could not overcome. Our potential as a nation is unlimited because we are a people dedicated to freedom and liberty. Republicans know we can’t spend our way back to prosperity, and we certainly can’t achieve prosperity by saddling our children and grandchildren with debt. Join us as we fight to restore fiscal sanity and rein in a government gone wild.
A Global Free-For-All?
A Global Free-For-All?
By Robert SamuelsonWASHINGTON -- We are in a race between economic recovery and economic nationalism. At last week's G-20 summit, leading nations agreed to roughly $1 trillion of additional lending, mostly through the International Monetary Fund, to help end the worldwide slump. But beneath the veil of consensus, countries are maneuvering to protect their economies and blame someone else for the crisis. Will the world economic order overcome these stresses or give way to a global free-for-all, characterized by rampant protectionism, nationalistic subsidies and preferences?
Emblematic of the tension is a recent proposal by Zhou Xiaochuan, governor of the People's Bank of China (PBOC), to replace the dollar as the world's major international currency. In a paper, Zhou argued that today's crisis reflects "the inherent vulnerabilities and systemic risks" of the dollar-based global economy. The PBOC is China's Federal Reserve; Zhou is no obscure bureaucrat.
It may surprise Americans that, up to a point, his analysis is correct. The dollarized world economy developed huge instabilities -- vast trade imbalances (American deficits, Asian surpluses) and massive, offsetting international money flows. But Zhou's omissions are equally revealing. To wit: China is heavily implicated in the dollar system's failings. By keeping its currency artificially depressed -- as an aid to exports -- China abetted the very imbalances that it now criticizes.
The Chinese denounce American profligacy after promoting it and profiting from it. Low prices of imported goods (shoes, computers, TVs) encouraged overconsumption. From 2000 to 2008, the U.S. trade deficit with China ballooned from $84 billion to $266 billion. China's foreign exchange reserves are now an astounding $2 trillion.
It's not just that exchange rates were (and are) misaligned. American economists have argued that a flood tide of Chinese money, earned from those bulging trade surpluses, depressed interest rates on U.S. Treasury securities and sent investors searching for higher yields elsewhere. That expanded the demand for riskier securities, including subprime mortgages, and pumped up the housing bubble. So China's policies contributed to the original financial crisis, though they were not the only cause.
For decades, dollars have lubricated global prosperity. They're used to price major commodities -- oil, wheat, copper -- and to conduct most trade. Countries such as Thailand and South Korea use dollars for more than 80 percent of their exports. The dollar also serves as the major currency for cross-border investments by governments and the private sector. Indeed, governments hold almost two-thirds of their $6.7 trillion in foreign exchange reserves in dollars.
But overreliance on the dollar can also backfire, as it now has. Not only have countries suffered declines in exports to a slumping U.S. economy. They've also lost dollar loans needed to finance trade with third countries. "When the crisis hit, U.S. banks cut back on dollar credit lines to foreign borrowers," says David Hu of the International Investment Group. The extra loans endorsed at last week's summit aim to offset these losses.
Given the dollar's drawbacks, why not switch to something else, as Zhou suggests? The trouble, as even he concedes, is that there's no obvious replacement. The attraction of an international currency depends on its presumed stability, what it will buy and how easy it is to invest. The euro (27 percent of government reserves) and the yen (3 percent) don't yet rival the dollar. As for China, it hasn't made its own currency (the renminbi, or RMB) automatically convertible for Chinese investments.
We're stuck with the dollar standard for a while. To work, it requires that countries with huge trade surpluses reduce the export-led growth that fed the system's instabilities. The Chinese increasingly recognize this. "They're very aware of the need to promote consumer spending," says economist Pieter Bottelier of Johns Hopkins University. In November, China announced a 4 trillion RMB ($586 billion) "stimulus." In addition, says Bottelier, the government is improving health and pension benefits to dampen households' need for high savings.
But China also has a default position: promote exports. It has increased export rebates; engaged in RMB currency "swaps" with trading partners (the latest: $10 billion with Argentina) to stimulate demand for Chinese goods; and stopped the RMB's slow appreciation. China seems comfortable advancing its economy at other countries' expense. Zhou's pronouncement provides a political rationale for predatory behavior: If we're innocent victims of U.S. economic mismanagement, then we're entitled to do whatever is necessary to insulate ourselves from the fallout. Down this path lies growing mistrust.
The world economy is suspended between the lofty rhetoric of last week's summit and the gritty realities of national politics. Protectionism is rising. A World Bank study found that 17 countries in the G-20 have recently adopted discriminatory policies. Though still modest, they "open the door for a lot of other opportunistic measures," says Gary Hufbauer of the Peterson Institute. And the deeper the recession, the greater the danger.
Obama's Double-Talk
Obama's Double-Talk
While the president talks sobriety, his policies take America on an economic bender.
Matt WelchHigh-flying presidencies tend to reveal their base character in trivial moments. In March 2002, when the nation was still massively behind George W. Bush in the wake of the September 11 attacks, he gave the first obvious signal that his administration would play cheap politics even in a time of grave global uncertainty by slapping a temporary new tariff on imported steel. If the world’s fragile economy and the putatively bedrock principles of free trade could be sold out for a couple of percentage points in contested Rust Belt states, we shouldn’t have been surprised to learn that the very “war on terror” would be subject to political manipulation, or that Bush’s skin-deep economic philosophy could not be counted on in a crisis. The costs of what this move revealed became clear soon enough, and eventually Americans withdrew their benefit of the doubt.
Barack Obama’s revelatory moment may have come in his first week as president. On his first day of work, he signed an executive order prohibiting lobbyists from holding highranking administration jobs, thereby fulfilling a campaign promise to “close the revolving door” between K Street and government via “the most sweeping ethics reform in history.” Two days later, the president granted a “waiver” from the new rules to install Raytheon lobbyist William Lynn as the No. 2 man in the Pentagon.
As offenses go, the move was trivial. But as a signal of a governing pathology, it established a pattern that Obama has repeated serially since being sworn into office: reiterate a high-sounding promise from the campaign, undermine said promise with a concrete act of governance to the contrary, then claim with a straight face that the campaign promise has been and will continue to be fulfilled.
So candidate Obama promised to usher in the “most transparent administration in history,” in part by making sure the American people were allowed to read each proposed non-emergency law for at least five days before the president signs it. Yet in his first month, President Obama signed three laws from the liberal wish list—the State Children’s Health Insurance Program (SCHIP), the Lily Ledbetter Fair Play Act, and the $787 billion “stimulus” package—in less than five days. Explained the White House: “We will be implementing this policy in full soon.…Currently we are working through implementation procedures.”
The SCHIP law, which was paid for in part by a cigarette tax hike of 61 cents a pack, also put the lie to a pledge Obama repeated after its passage in his first address before a joint session of Congress. “Let me be perfectly clear,” he said on February 24, with less than perfect clarity. “If your family earns less than $250,000 a year, you will not see your taxes increased a single dime. I repeat: not one single dime.”
But not only is the cigarette tax a “tax” (and worth six dimes at that), it’s among the most regressive kind possible, since poorer people are more likely to smoke and spend a larger share of their incomes on cigarettes than richer smokers do. And it’s hardly the only tax Obama will levy on those not yet in the quarter-million club. In that same speech, and also in the budget proposal he handed to Congress shortly thereafter, the president called for a cap-and-trade system for companies that emit carbon. That would surely translate into a price increase on every gallon of gasoline sold in the United States, a change that would have more impact on the household budgets of working-class heroes than those of modern-day plutocrats.
Spending? Candidate Obama promised “a net spending cut” in which “every dollar that I’ve proposed, I’ve proposed an additional cut so that it matches.” President Obama has proposed the largest net spending increase since World War II, even while holding summits on “fiscal responsibility” and vowing to live by the same “pay as you go” principles he’s already blown to smithereens.
Deficits? A president whose first budget will expand the deficit into uncharted territory (see Veronique de Rugy’s “When Do Deficits Matter?,” page 21) nonetheless promises to cut his shortfall in half within four years. This, he claimed in his speech to Congress, will be achieved partly through $2 trillion in “savings” that will come by “eliminat[ing] wasteful and ineffective programs.” Analysts noted within hours that around half of Obama’s “savings” actually come from letting Bush’s tax cuts expire after 2010. It takes a certain kind of mind-set to characterize Americans’ taking home their own money as a “wasteful and ineffective program,” let alone tax increases as “savings.”
Once you identify the president’s tic of celebrating the very campaign promises that he breaks, you’ll see it everywhere. So there he is, “proud that we passed the recovery plan free of earmarks,” just days after passing a recovery plan stuffed with what the investigative website Pro Publica described as “items that could arguably be called earmarks” (and in the same week that Congress handed him a new budget swollen with brand new chunks of pork). The stimulus package will “save or create 3.5 million jobs,” an elastic, impossible-to-prove projection that neatly gives him credit for either boom or bust. (For more on Obama’s stimulus, please see “Will We Be Stimulated?,” page 32. For more on the state government jobs that will be “saved” by using federal money to cover for bad fiscal management, see “Failed States,” page 24.)
The two faces of Obama reveal more than just a politician hardwired to work both sides of a room. The new president’s political goals and governing goals are in tension. The post-Bush executive needs to solve a mammoth financial and economic crisis affecting the entire country, but the pre-Clintonomics Democrat needs to blame it on fat cats and Republicans.
So in early January, the president-elect lamented that “banks made loans without concern for whether borrowers could repay them, and some borrowers took advantage of cheap credit to take on debt they couldn’t afford.” In February his administration pushed banks to lend still more to risky homebuyers while bailing out underwater borrowers. Technocrat Obama wants to jumpstart the “flow of credit,” which he has described as “the lifeblood of our economy,” but politician Obama wants to somehow surgically remove the “speculators” from the process. “I will not spend a single penny,” he vowed to Congress, unconvincingly, “for the purpose of rewarding a single Wall Street executive, but I will do whatever it takes to help the small business that can’t pay its workers or the family that has saved and still can’t get a mortgage.” The following week his administration authorized another $30 billion in the $163-billion-and-counting bailout of the Wall Street insurance giant AIG.
There are both risks and rewards when a politician pronounces gray skies (particularly of his own making) to be blue. For now, Obama is mostly reaping the rewards. A public weary of the president’s tongue-tied predecessor is giving the eloquent new fellow the benefit of the doubt, as evidenced by an MSNBC poll in early March showing his approval rating at an all-time high of 68 percent. But that same poll pointed to Obama’s weakness: A substantially smaller number, 54 percent, thought the president’s policies were on the right track. The country seems to like the guy who talks about fiscal responsibility, less so the one who practices the opposite.
The illusion will eventually give way, and voters will see more of who Obama is than who they wish him to be. In the meantime the president has proposed a budget blueprint that would significantly alter the way Americans spend money on energy, mortgages, charities, and investments, to name just a few areas. Will they recognize the tic in time?
Matt Welch is editor in chief of reason.
Blowing Bubbles
Blowing Bubbles
As all the world economies writhe in financial pain from the cleansing of the largest bubble in financial history, the same question is being asked — how could this happen? Of course the usual answers are trotted out — human greed, animal spirits, criminal fraud, or capitalism itself. Modern financial history has been a series of booms and busts that seem to blend together making one almost indistinguishable from the next. The booms seduce even the most conservative into taking what in retrospect appear to be outlandish risks speculating on investment vehicles they know nothing about.
In response to the financial meltdown, central banks are slashing interest rates to nearly zero and growing their balance sheets exponentially. With no more room to lower rates, central bankers now speak of a "quantitative easing" policy which in plain English means "creating money out of nowhere." But no one is shocked or horrified by this government counterfeiting. All this, after the US central bank (the Federal Reserve) has already, at this writing, increased the M2 money supply by 11 times since August of 1971 when the US dollar's last faint ties to gold were severed.
While history clearly shows that it is this very government meddling in monetary affairs that leads to financial market booms and the inevitable busts that follow, mainstream economists either deny that financial bubbles can occur or that the "animal spirits" of market participants are to blame. Economists running central banks even claim that it is impossible to identify asset bubbles. Meanwhile, the Austrian school stands alone in pointing the finger at government intervention in monetary affairs as the culprit.
Austrian economists Ludwig von Mises and Friedrich A. Hayek's Austrian business-cycle theory provides the framework to explain speculative bubbles. The Austrian theory points out that it is government's increasing the supply of money that serves to lower interest rates below the natural rate or the rate that would be set by the collective time preferences of savers in the market. Entrepreneurs react to these lower interest rates by investing in "higher order" goods in the production chain, as opposed to consumer goods.
Despite these actions by government, consumer time preferences remain the same. There is no real increase in the demand for higher order goods and instead of capital flowing into what the unfettered market would dictate — it flows into malinvestment. The greater the monetary expansion, in terms of both time and enormity, the longer the boom will be sustained.
But eventually there must be a recession or depression to liquidate not only inefficient and unprofitable businesses, but malinvestments in speculation — whether it is stocks, bonds, real estate, art, or tulip bulbs.
This book was my master's thesis (with just a couple slight changes and additions) written under the direction of Murray Rothbard and examines three of the most famous boom and bust episodes in history. Government monetary intervention, although different in each case, engendered each: Tulipmania, the Mississippi Bubble, and the South Sea Bubble.
As the 17th century began, the Dutch were the driving force behind European commerce. Amsterdam was the center of this trade and it was in this vibrant economic atmosphere that tulipmania began in 1634 and climaxed in February 1637. At the height of tulipmania, single tulip bulbs were bid to extraordinary amounts with the Witte Croonen tulip bulb rising in price 26 times in a month's time. But when the market crashed: "[s]ubstantial merchants were reduced almost to beggary," wrote Charles Mackay, "and many a representative of a noble line saw the fortunes of his house ruined beyond redemption."
What made this episode unique was that the government policy did not expand the supply of money through fractional reserve banking which is the modern tool. Actually, it was quite the opposite. The Dutch provided a sound money policy that called for money to be backed one hundred percent by specie, which attracted coin and bullion from throughout the world. Free coinage laws then generated more money from this increased supply of coin and bullion than what the market demanded. This acute increase in the supply of money fostered an atmosphere that was ripe for speculation and malinvestment, manifesting itself in the intense trading of tulips.
The Bank of Amsterdam, which was at the center of tulipmania, was an inspiration for one of history's most notorious currency cranks — John Law. Gifted in math, Law learned the banking business from his father in Scotland. But after his father died, the young Law had more interest in games of chance and women. During the day he would write pamphlets on money and trade while enjoying the social life at night.
Law made various proposals to governments around Europe for what we would call today a central bank and was turned down until 1716 when one of Law's partying friends, the Duke of Orléans, assumed control of the French government after Louis XIV died. The French government was on the verge of bankruptcy, and its citizens were fed up with their government's currency depreciation, recoinage schemes, and increased tax collections. The situation was ripe for Law's monetary magic.
Law sought to "lighten the burden of the King and the State in lowering the rate of interest" on France's war debts and to increase the supply of money to stimulate the French economy, with the opening of General Bank, owned 25 percent by Law and 75 percent by the King, and the formation of a series of companies that when ultimately merged together were known as the Mississippi Company. Two years into his system, the regent granted Law's request that the General Bank be made part of the state, becoming the Royal Bank, patterned after the Bank of England.
With the Royal Bank creating vast amounts of paper currency, Mississippi Company share prices took off which led Law to issue more shares, using the capital to refinance more of the government's debt. Ultimately, the scheme unraveled, despite Law demonetizing gold and silver so that only royal banknotes and Mississippi Company shares would circulate as money. An outraged French public ultimately forced the regent to place the once-revered Law under house arrest.
While John Law was struggling to keep his Mississippi bubble inflated, across the English Channel, a nearly bankrupt British government looked on with envy, believing that Law was working a financial miracle. It was anything but, however Sir John Blunt followed Law's example with his South Sea Company, which in exchange for being granted monopoly rights to trade with South America, agreed to refinance the government's debt.
As the price of South Sea Company shares rose, as in the case of Law's system, more shares were sold and more government debt refinanced. The company had no real assets, but that didn't matter as speculators bid the share price higher and higher, spawning the creation of dozens of other "bubble companies."
The South Sea Company lobbied the British government to pass a Bubble Act that would shut down these new companies that were competing for investor capital. Ironically, it was the enforcement of that act that burst the bubble with South Sea Company shares falling nearly 90 percent in price. Beloved British statesman Sir Robert Walpole reorganized the technically bankrupt South Sea Company, and it remained in business for years.
Although these episodes occurred centuries ago, readers will find the events eerily similar to today's bubbles and busts: low interest rates, easy credit terms, widespread public participation, bankrupt governments, price inflation, frantic attempts by government to keep the booms going, and government bailouts of companies after the crash.
Although we don't know what the next asset bubble will be, we can only be certain that the incessant creation of fiat money by government central banks will serve to engender more speculative booms to lure investors into financial ruin.
Greenspan's Bogus Defense
Greenspan's Bogus Defense
In his March 11 Wall Street Journal op-ed, former Federal Reserve Chairman Alan Greenspan tried to exonerate himself from the housing boom and bust. Even though more and more analysts are realizing that Greenspan's low interest rates fueled the bubble, the ex-maestro himself uses statistics to defend his record. On these pages Frank Shostak has already taken on Greenspan's spurious arguments, but in the present article I'll touch on a few more points.
Greenspan Couldn't Push Up Rates?
Greenspan's main argument is that the Fed lost control of the ability to move long-term interest rates, especially 30-year fixed mortgage rates. Since it is these longer rates that (at least in theory) ought to influence house prices much more than the overnight federal-funds rate, Greenspan can't possibly be held responsible for the housing bubble. In his words,
The Federal Reserve became acutely aware of the disconnect between monetary policy and mortgage rates when the latter failed to respond as expected to the Fed tightening in mid-2004. Moreover, the data show that home mortgage rates had become gradually decoupled from monetary policy even earlier — in the wake of the emergence, beginning around the turn of this century, of a well arbitraged global market for long-term debt instruments.
U.S. mortgage rates' linkage to short-term U.S. rates had been close for decades. Between 1971 and 2002, the fed-funds rate and the mortgage rate moved in lockstep. The correlation between them was a tight 0.85. Between 2002 and 2005, however, the correlation diminished to insignificance.
Now this is extremely misleading. Judging from Greenspan's description, the reader would think that the federal-funds rate (which the Fed directly targets with its open-market operations) and the mortgage rate moved along in sync, when all of a sudden Greenspan tried to jack up short-term rates in 2004, and yet those pesky mortgage rates refused to move up. Hence, he did what he could to slow the housing bubble, but alas, it was precisely when he tried to help that the markets rendered him impotent.
On the other hand, Greenspan says (truthfully) that the correlation between the two series broke down earlier, in 2002. Let's look at the graph and see exactly what happened:
So it's true, the red and blue lines in the chart above moved pretty much in lockstep up until 2002, as Greenspan claimed. But the disconnect occurred when Greenspan slashed short-term rates while mortgage rates held steady. Since the participants in the mortgage market wisely realized that rates wouldn't be held at 1% forever, they didn't foolishly drop their own yields down so far. Then in June 2004, when Greenspan began ratcheting the federal-funds rate back up, it is perfectly understandable that mortgage rates wouldn't rise with them.
To repeat, Greenspan's defense of his policies made it sound as if he tried to push up mortgage rates, but that they wouldn't budge. Yet, as the chart above makes clear, Greenspan didn't really push up very hard on rates. After all, he stopped short of breaking through mortgage rates (the blue line) once the federal-funds rate (the red line) plateaued in June 2006 at 5.25%. If he really had wanted to push up mortgage rates, he could have pushed up the federal-funds rate more.
Let's look at this issue a little more carefully. In the chart below, I've graphed the difference between the federal-funds and mortgage rates; i.e., I am plotting the gap between the blue and red lines from the first chart, above. In addition, I overlay the average value of this gap for the period 1971–2002:
The above chart takes a minute to digest, but if the reader masters it, he will see just how silly Greenspan's argument is. The great "divergence" between the two interest rate series that began in 2002 was nothing unusual by historical standards. And once Greenspan tried to slam on the brakes by raising short rates (in 2004), a full year went by before the gap between the two had returned to its average over the 1971–2002 period — the very period that Greenspan says the two series moved "in lockstep." In terms of the graph itself, it is not until June 2005 that the blue line crosses below the red line. Only from that point onward was the gap between the mortgage and federal-funds rates even smaller than average. (And the gap even went negative several times during the 1970s, when the federal-funds rate exceeded mortgage rates.)
Finally, just step back and look at the chart. Does it look as if something crazy and unprecedented happened from 2002–2005? Not at all: the whole housing boom period from 1998–2007 looks almost like a mirror image of 1988–1997.
So to repeat, the reason that the correlation between the federal-funds rate and the 30-year mortgage rate broke down during the housing boom was that Greenspan whipsawed short rates waaaaaay down, then waaaaaay up, in a fairly narrow window. Mortgage rates (thank goodness) didn't move around in such a volatile manner. If one series goes from 6.5% down to 1%, then back up to 5.25%, while the other series stays roughly flat, then obviously the measured correlation is going to be low.[1]
Those Pesky Asian Savers
Greenspan repeats the claim that Asian savings were the real culprit. But there are two problems with this theory: first, global savings rates continued to rise throughout the housing boom and bust. So it's very difficult to explain the peak of the housing boom with reference to Asian saving. (In contrast, Greenspan's actions with short-term rates fit the fortunes of the housing market much more closely.)
But a second major problem is that even on its own terms, the influx of blind Asian saving — to the extent it existed at all — was itself partially a product of Greenspan's monetary inflation. Remember that the Chinese central bank had maintained a rigid peg to the dollar until it was pressured to drop it — right around the time the housing boom faltered:
To put it somewhat simplistically, when Greenspan flooded the world with more dollars, the dollar fell sharply against most major currencies. But in order for the Chinese to keep the renminbi (yuan) from appreciating against the dollar as well, they had to load up on dollar-denominated assets, such as US Treasuries. Thus, Greenspan's inflation in combination with the Chinese peg, on paper might have appeared as an irrational influx of Asian investment, which stubbornly refused to subside even as US indebtedness grew.
Conclusion
It is bad enough that Alan Greenspan refuses to acknowledge what more and more people are realizing: his ultralow interest rates — which were in turn accomplished through injections of artificial credits into the banking system — fueled the housing boom. The Greenspan Fed was not a sufficient condition to cause the housing and stock bubbles, but it was almost certainly a necessary factor. If the Fed had let the post-9/11 recession run its course, there would have been no absurd boom (and now bust).
But beyond Greenspan's refusal to admit his mistakes is the ludicrous accusation that high savings rates among the world's poorest people — coupled with growing incomes made possible by technological and legal advances — was cause for misery. What a warped view of how the market economy works, to think that savings and foreign investment can cripple an economy.
Obama Wants to Control the Banks
Obama Wants to Control the Banks
There's a reason he refuses to accept repayment of TARP money.
STUART VARNEY
I must be naive. I really thought the administration would welcome the return of bank bailout money. Some $340 million in TARP cash flowed back this week from four small banks in Louisiana, New York, Indiana and California. This isn't much when we routinely talk in trillions, but clearly that money has not been wasted or otherwise sunk down Wall Street's black hole. So why no cheering as the cash comes back?
My answer: The government wants to control the banks, just as it now controls GM and Chrysler, and will surely control the health industry in the not-too-distant future. Keeping them TARP-stuffed is the key to control. And for this intensely political president, mere influence is not enough. The White House wants to tell 'em what to do. Control. Direct. Command.
It is not for nothing that rage has been turned on those wicked financiers. The banks are at the core of the administration's thrust: By managing the money, government can steer the whole economy even more firmly down the left fork in the road.
If the banks are forced to keep TARP cash -- which was often forced on them in the first place -- the Obama team can work its will on the financial system to unprecedented degree. That's what's happening right now.
Here's a true story first reported by my Fox News colleague Andrew Napolitano (with the names and some details obscured to prevent retaliation). Under the Bush team a prominent and profitable bank, under threat of a damaging public audit, was forced to accept less than $1 billion of TARP money. The government insisted on buying a new class of preferred stock which gave it a tiny, minority position. The money flowed to the bank. Arguably, back then, the Bush administration was acting for purely economic reasons. It wanted to recapitalize the banks to halt a financial panic.
Fast forward to today, and that same bank is begging to give the money back. The chairman offers to write a check, now, with interest. He's been sitting on the cash for months and has felt the dead hand of government threatening to run his business and dictate pay scales. He sees the writing on the wall and he wants out. But the Obama team says no, since unlike the smaller banks that gave their TARP money back, this bank is far more prominent. The bank has also been threatened with "adverse" consequences if its chairman persists. That's politics talking, not economics.
Think about it: If Rick Wagoner can be fired and compact cars can be mandated, why can't a bank with a vault full of TARP money be told where to lend? And since politics drives this administration, why can't special loans and terms be offered to favored constituents, favored industries, or even favored regions? Our prosperity has never been based on the political allocation of credit -- until now.
Which brings me to the Pay for Performance Act, just passed by the House. This is an outstanding example of class warfare. I'm an Englishman. We invented class warfare, and I know it when I see it. This legislation allows the administration to dictate pay for anyone working in any company that takes a dime of TARP money. This is a whip with which to thrash the unpopular bankers, a tool to advance the Obama administration's goal of controlling the financial system.
After 35 years in America, I never thought I would see this. I still can't quite believe we will sit by as this crisis is used to hand control of our economy over to government. But here we are, on the brink. Clearly, I have been naive.
Mr. Varney is a host on the Fox Business Network.
Bank, Merger Worries Weaken Stocks
Bank, Merger Worries Weaken Stocks
Stocks edged lower Monday amid bearish analyst comments and reports that a blockbuster technology deal is close to collapse.
The Dow Jones Industrial Average was recently down about 106 points, or 1.3%, at 7910. The S&P 500 was off 1.7%, led by a 3% slide in its financial sector.
![[Markets Data]](http://s.wsj.net/public/resources/images/MDGpromo_D01222009151210.jpg)
Many traders came into Monday's session thinking that the financial sector might be due for a pullback after leading a market rally from bear-market lows hit in early March.
That sentiment took firmer hold after Calyon Securities analyst Mike Mayo initiated coverage of 11 big-name banks with "underperform" or "sell" ratings, saying recent government efforts to stabilize the financial system won't prevent Wall Street's loan losses from exceeding those of the Great Depression by late 2010.
"The industry is in a Catch-22," with banks destined either to remain saddled with toxic assets or to take heavy write-offs as those assets are removed from balance sheets either by the government or private buyers, Mr. Mayo wrote.
He estimated that, on average, banks have marked down their troubled loans at 98 cents on the dollar -- an unrealistically optimistic valuation.
All 11 names mentioned in Mr. Mayo's report traded lower. The hardest hit were Suntrust Banks, off nearly 9%, and BB&T, off 6%. U.S. Bancorp, Wells Fargo, and KeyCorp fell at least 5% each.
Over the weekend, Treasury Secretary Timothy Geithner said bank executives could be ousted if they require further "exceptional assistance."
Investors also reacted Monday to reports that International Business Machines' proposed $7 billion acquisition of Sun Microsystems may fall apart. Sun shares were recently down 23%, while IBM was down 1.3%. The Nasdaq fell 2.2%.
First-quarter earnings season is due to kick off this week. Many analysts warn that worse-than-expected profit reports could rattle the market.
Ian Scott, head of global and European strategy at Nomura International, said cyclical stocks across the world now trade on a 26% price-to-earnings premium to other sectors.
"Back in the early 1990s, the cyclicals ran for another 14 months after reaching a similar P/E premium to the one they enjoy today; given the velocity of this current cycle, we doubt the rotation will last as long this time, but it is still probably too early to get defensive," said Mr. Scott in a note to clients.
Gold futures slumped $14 an ounce, and the dollar rallied more than 1% versus the Japanese yen. Yields on 10-year Treasury bonds rose to 2.9%. Bond yields move in the opposite direction to prices. Oil futures added 61 cents to $53.12 a barrel.
Overseas stocks generally were stronger. In Asia, markets looked past North Korea's test-firing of a rocket, with Japan's Nikkei 225 ending up 1.2% -- its highest level since Jan. 8. Banks led the gains in Europe, with the FTSE 100 up 1.1% and the pan-European Stoxx 600 rising 1.3%.
Putin Defends Economic Record
Putin Defends Economic Record
LIDIA KELLY ANDREW LANGLEY
MOSCOW -- Russia faces a "very difficult year" that will test the economy and ordinary Russians alike, Prime Minister Vladimir Putin warned Monday.
Defending his government's management of Russia's worst crisis in a decade, Mr. Putin told the Duma, the lower house of Parliament, that the international crisis is "far from over."
![[Russian Prime Minister Vladimir Putin defended his handling of Russia's worst economic crisis in a decade in his first annual report to the Parliament.]](http://s.wsj.net/public/resources/images/OB-DL013_PUTIN0_D_20090406060554.jpg)
ReutersRussian Prime Minister Vladimir Putin defended his handling of Russia's worst economic crisis in a decade in his first annual report to the Parliament.
The chief priority for the government in the coming months is stimulating domestic demand in the Russian economy. Russia has entered its first recession since the late 1990s, with official estimates projecting a 2.2% contraction in gross domestic product in 2009 -- after years of growth of 5% or higher. The Organization for Economic Cooperation and Development forecasts Russia's economy contracting by 5.6%.
Mr. Putin spent most of the almost hour-long address listing the government's achievements in softening the outcome of the financial crisis, especially for ordinary Russians and strategically important sectors, such as energy.
"Support of the banks was needed especially and perhaps chiefly to preserve the savings of ordinary Russians, and to avoid paralysis in financial settlements between companies," Mr. Putin said. "And both of those goals have been achieved."
Mr. Putin said the government has no obligations to pay corporate debts -- estimated at $135 billion this year -- but said the state is ready to take stakes in companies it deems strategic.
The prime minister also reiterated Finance Minister Alexei Kudrin's warning that the banking system will face serious tests in the coming months. "There is a serious problem of nonpayments and loan defaults (by companies and banks)," Mr. Putin said.
Government officials estimate that 10% of all outstanding debt obligations will be either delayed or not met at all this year due to a lack of refinancing and the worsening financial situation of many companies.
Mr. Putin called for a "careful" restructuring of the banking system. The government is trying to find a balance between aiding the more than 1,100 banks registered in the country and using the crisis to administer sweeping consolidation. For years the country's banking system has been criticized by economists and international financial organizations for remaining structurally weak and infested with organizations conducting shady operations.
Mr. Putin pledged to continue support of the real economy and defended the altered budget that projects an 8% deficit of GDP -- Russia's first deficit since 1999. He said the budget reflects the government's "responsible and highly realistic socioeconomic policy."
Mr. Putin said that hard times provide an opportunity to diversify the country's economy -- inextricably linked in the previous decade on oil and a small basket of other commodities -- a move that many economists were already urging when Russia's economy was buoyant. "We must not only preserve key industries, but also accelerate the progress of the economy," he said.
Sunday, April 5, 2009
Government Is Furiously Dancing the Two-Step
Government Is Furiously Dancing the Two-Step
by Robert HiggsHow do once-free people lose their liberty? The formula may be stated succinctly: crisis and leviathan. Alternatively, and somewhat more fully stated, the procedure for the government officials and their supporters who hope to gain by quashing the people’s liberties is (1) cause a serious crisis, thereby heightening the public’s fears, and (2) blame others for the crisis, pose as the people’s savior, and thereby justify the seizure of new powers allegedly necessary to remedy the crisis and to prevent the recurrence of such crises in the future. This gambit is as old as the hills, yet, given the right ideological preconditions, it works every time. Strange to say, the people never learn (in part because these experiences produce ideological change that fortifies the fiscal and institutional changes the government makes during the crisis).
Today’s news brings us a perfect illustration — one of many during the past year of financial debacle and worsening economic recession. According to an AP report, “Treasury Secretary Geithner asked Congress on Tuesday for broad new powers to regulate nonbank financial companies.” Geithner, of course, earnestly expressed the finest motives: “We must ensure that our country never faces this situation again.” Geithner’s partner in crime, Fed chief Ben Bernanke, joined him in “calling for greater governmental authority over complicated and troubled financial companies.” These rulers of the universe want the legal power “to seize control of institutions, take over their bad loans and other illiquid assets and sell good ones to competitors.” (Extra-credit question: haven’t they been taking precisely such actions for the past year or so?)
Given what a manifestly big deal this bureaucratic power-grab appears to be, why would anyone in Congress want to go along with it? Simple: failure to hand over these powers to the apparatchiks might result in the complete destruction of civilization. Speaking of the government’s having already poured more than $180 billion into AIG, Bernanke told the House Financial Services Committee that the big insurance company’s “failure could have resulted in a 1930s-style global financial and economic meltdown, with catastrophic implications for production, income and jobs.” You heard him – catastrophic implications for jobs. That’s all that members of Congress needed to hear. Faux job creation is their very lifeblood when they run for reelection.
Since the onset of the current financial troubles, government officials have made repeated use of a new mantra to justify shoveling mega-tons of the taxpayers’ money to favored firms: systemic risk. So, naturally, at today’s hearings, Geithner trotted out this new hobby-horse: “As we have seen with AIG, distress at large, interconnected, non-depository financial institutions can pose systemic risks just as distress at banks can.” But did we really see systemic risk hovering over AIG, or have we merely been told repeatedly that it was hovering? One wonders whether Bernanke and Geithner are also on record as having reported that they have definitely sighted flying saucers.
In the true spirit of neoclassical economic scientism, I say let’s stage an empirical test: let AIG or Citi or B of A or some other giant, mismanaged financial institution go down, and then let’s see whether the world comes to an end. If it does, we’ll know that these transparent power-grabbers were right about systemic risk; but if it goes right on spinning more or less as before, we’ll know that they’ve been selling us a bill of goods. I think the odds are so greatly in our favor that I’m more than willing to see the experiment carried out. After all, it’s not as though these financial geniuses have demonstrated a great deal of prowess so far, despite having tossed more than $8 trillion to the wind.
It’s possible, of course, that some people failed to see what was going on at today’s hearing, because, as usual, all parties tried to throw the bloodhounds off the scent by dragging a red herring across the trail. This time the rotten herring is the $165 million in bonuses that AIG recently attempted to pay certain employees to retain their services. Joe Sixpack got mighty hot under the collar about these bonuses, of course, goaded by the news media’s usual efforts to make their emphasis inversely proportional to an event’s actual importance. Yes, people are furious about the bonuses; these payments are the populist outrage d’jour. People seem not to have noticed, however, that the $165 million scheduled to be paid in AIG bonuses amounts to approximately 0.00002 of the total amount the government has dispensed in its recent commitments for loans, capital infusions, “stimulus” spending, loan guarantees, asset swaps, and other utter (and utterly destructive) wastes. The public might just as well have become inflamed about how Tim Geithner combs his hair.
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