Tuesday, March 31, 2009

Manning the Barricades

A special report (pdf) from the Economist Intelligence Unit examines the increased possibility for unrest due to the global economic crisis. Manning the Barricades lists three main risk scenarios, with rough probabilities of occurrence:

1. Central Forecast - 60%

Government stimulus stabilises the global financial system and restores economic growth in leading developed markets during 2010, albeit at lower levels than in recent years. This scenario underpins our regular analysis and is
not the subject of this report.
2. Main Risk - 30%
Stimulus fails, leading to continued asset price deflation and sustained contraction in the leading economies-a depression persisting for some years. The stubborn decline in global economic activity is punctuated by occasional rallies that are taken as signs of recovery, but these quickly fade as the underlying downward trend reasserts itself. The prominent role of governments in propping up banks and reviving domestic demand leads to strong political pressure for protectionism, effectively putting the process of globalisation into reverse.
3. Alternative Risk - 10%
Failing confidence in the dollar leads to its collapse, and the search for alternative safe-havens proves fruitless. Economic upheaval sharply raises the risk of social unrest and violent protest.
Luckily, the most probable outcome is the one where everything turns out for the best, but the two negative outcomes still make up a 40% share. In Hold'em parlance, that's like A10 vs. KQ - not exactly a match up on which you'd like to stake your tournament life.

Social unrest has already begun to increase in some parts of the world and the economic conditions that are driving it seem to show little sign of relenting. This unrest can lead to calls for protectionist economic moves, civil disobedience, or outright regime change.

While one might think of such problems being relegated to the third world, there certainly exists the possibility for upheaval in our neighborhood. Certainly the potential for Mexico to collapse under the weight of narco-violence is a sobering prospect, especially for border states. We don't even have to look beyond our borders, however, to be faced with the possibility for trouble.

According to their rankings, the US falls in the "moderate" category, placing 110th out of 165. Very concerning to me is the fact that we are tied with Iceland. While social discontent may not have reached a fever pitch yet, it does not take too much imagination to envision a scenario that would result in violent mass protests if the economy worsens. Any more miscues with executive bonuses and financial bailouts while millions are out of work and hungry could quickly spread into dangerous populist anger. And beyond social discontent, the report lists three other forms of political risks:
  • threats to democracy over and above outbreaks of political unrest;
  • a negative impact on economic policies and longer-term potential growth rates—in particular, there is a risk of a descent into protectionism;
  • a host of geopolitical risks, including ultimately the outbreak of large-scale international conflicts
It can be argued that several of these risks have already started to be realized. While the final wording was softened, "Buy American" provisions in the stimulus package brought calls of protectionism from around the world. A spat over Mexican truck driver privileges brought retaliation tariffs on American goods.

As for threats to democracy, dire financial situations have the possibility to allow government to take unprecedented steps many times at odds with the Constitution. The ramifications of historic levels of government control into private businesses have yet to be fully understood. In the name of expediency, due process can become a casualty.

And perhaps most frightening of all, geopolitical conflict is always a possibility when you owe certain (sometimes unfriendly) nations trillions of dollars and - for one reason or another - decide you cannot or will not pay up. Or perhaps you decide to repay them in currency that has been purposefully devalued after being asked several times nicely to not do such a thing. War can also be a handy way for politicians to divert the attention of an angry populace looking for a scapegoat and an outlet for aggression. They have certainly been started for less.


Friday, March 27, 2009

Ten Trillion and Counting

The latest Frontline examines the massive US National Debt, focusing mostly on its political history. This is a story that must be absorbed by the American public. We must allow our politicians the political leeway to make the hard choices, and hold them accountable if they do not. We are literally mortgaging our country in order to live beyond our collective means. It certainly will not last forever, the question is: Will we stop before irreparable damage is done?

See also:
I.O.U.S.A. Part I and II
Squanderville vs Thriftsville


Wednesday, March 25, 2009

Triffin's Dilemma

Triffin's Dilemma, identified by economist Robert Triffin, highlights a fundamental imbalance caused by a national currency acting simultaneously as a global reserve currency. Specifically it refers to the US dollar's role under the Bretton Woods agreement.

It states that the use of a national currency as global reserve currency leads to a tension between national monetary policy and global monetary policy. Triffin noticed that the US had two competing and incompatible goals while maintaining the Bretton Woods system:

If the United States stopped running balance of payments deficits, the international community would lose its largest source of additions to reserves. The resulting shortage of liquidity could pull the world economy into a contractionary spiral, leading to instability.

If U.S. deficits continued, a steady stream of dollars would continue to fuel world economic growth. However, excessive U.S. deficits (dollar glut) would erode confidence in the value of the U.S. dollar. Without confidence in the dollar, it would no longer be accepted as the world's reserve currency. The fixed exchange rate system could break down, leading to instability.

Obviously, the US was faced with a dilemma because it is not possible to run a balance of payments current account deficit and surplus at the same time.


Tuesday, March 24, 2009

Key Concept - Quantitative Easing

Quantitative easing is basically a term for "printing money". It refers to a central bank essentially creating new money and using it to reduce interest rates and thus encourage lending. It can accomplish this "easing" by: buying debt in the form of government bonds, buying assets from banks, directly lending to deposit-taking institutions, or any combination thereof.

Central banks normally use interest rate cuts to stimulate lending. Quantitative easing can be used when this strategy is not working or interest rates have already been cut to 0%. It can be used to combat deflation, but if the money supply is increased too much, it can create inflationary pressures. The ultimate risk is hyperinflation.


Monday, March 23, 2009

Bailouts In Brief

As the headlines continue to herald one multi-billion government payout after another, I thought it would be interesting to total them up. Luckily for me, CNNMoney already took care of it - listing the program, amount promised, and amount allocated thus far. The results are quite staggering.


Tuesday, March 17, 2009

Word of the Day

[hahr-uh-keer-ee, har-uh-, har-ee-]

1. ceremonial suicide by ripping open the abdomen with a dagger or knife: formerly practiced in Japan by members of the warrior class when disgraced or sentenced to death.
2. suicide or any suicidal action; a self-destructive act: political hara-kiri.
3. advice for AIG executives from a distinguished gentleman from Iowa.

Also see: seppuku


Monday, March 16, 2009





So it's been awhile...

Law school takes up a majority of my time; job and bar stuff has been taking up the rest. I had not posted in an extended period of time, so I decided to give you Winston's "Get fit for the new year" plan, appropriately three months late.

World Strongest Man - Winston addition -

First up - how to make an atlas stone


Don't forget to add sand to your cement mix for extra gripping!



Thursday, March 12, 2009

You Can't Inflate a Burst Bubble

on the state of the economy:

Perhaps some of these steps were necessary. But taken as a whole, these extraordinary measures point to a bipartisan Washington culture that's unwilling to let go of the past.

Peter Schiff of Euro Pacific Capital put it well last Friday: "Jobs must be lost in the service sector so that labor can be reallocated towards goods production. Asset prices, for both stocks and real estate, must decline to levels appropriate for current circumstances ... By postponing these adjustments we merely assure an even more painful transition in the future."

Now that the housing bubble, stock market bubble and commodities bubble have popped, the market is trying to adjust to non-bubbly conditions. Laws and regulations that interfere with that process can delay that adjustment and prolong the recession. (If a failing business is artificially propped up, valuable resources are being wasted rather than being used for productive purposes.)

Plus, the money for these bailouts has to come from somewhere. Last month Bloomberg News put the tab so far at $9.7 trillion, enough to hand each U.S. household a check for around $92,000, or pay off 90 percent of home mortgages in the country.

That money, of course, will come from taxes. We'll borrow some from China, the largest foreign holder of Treasury debt, with the promise of paying it back with interest. Some will come from the Federal Reserve printing it, a move that devalues the greenback and leads to taxation through inflation.

At some point, though, the bailout costs will simply become too immense. George Mason University economics professor Russ Roberts wrote this week: "We can't keep GM and AIG and Fannie and Freddie and every insolvent bank and every mortgage afloat. It can't be done. It's not a strategy. It's just desperation to avoid pain. We're going to have to start letting them fail. Sooner is better than later. Otherwise, we continue to throw good money after bad."


Saturday, March 7, 2009

Key Concept - Ricardian Equivalence

Ricardian Equivalence is an economic theory that postulates debt-financed government spending will leave demand unchanged. It suggests that it does not matter whether a government finances its spending with debt or a tax increase, the effect on total level of demand in an economy will be the same.

According to the theory, the public will save any excess money received to pay for the inevitable future tax increases. In an extreme case, current generations will save the money and bequeath it to future generations to pay the bill.

The theory, developed by the 19th century political economist David Ricardo (who also was a pioneer in the description of comparative advantage), rests on several key assumptions:

1. A perfect capital market - all players can borrow or save as much as is required at a fixed rate which is the same for all persons at a given date
2. Fixed government spending path
3. Inter-generational concern - The increased taxes may not be paid by the current generation. Current individuals would need to have concern for their descendants.
4. Rational citizens

Obviously these are assumptions that are on shaky footing in our current world, which tends to cause the theory to lose some validity. Since the theory doesn't hold up completely, government stimulus plans can affect the economy, and may explain standard Keynesian theory where bond financed spending has a bigger effect than tax financed spending.

However, while perhaps not perfect, it certainly can explain some behavior that will temper the effectiveness of government stimulus programs. Many people use their stimulus checks to pay down debts, thus leaving more ability for payment of future tax increases.

It also brings up moral issues about financing current spending by writing debt to be paid by future generations that have no say in the process. Even if issuing debt does give an increase in demand for the economy, the recipient of the benefit and the payer of the debt should both be willing participants.

wikipedia, investopedia


Friday, March 6, 2009

Quote of the Day

As an energy conservation measure -
the light at the end of the tunnel has been turned off until further notice.


Wednesday, March 4, 2009

The Defense of Howard Roark

“Degrees of ability vary, but the basic principle remains the same: the degree of a man’s independence, initiative and personal love for his work determines his talent as a worker and his worth as a man. Independence is the only gauge of human virtue and value. What a man is and makes of himself; not what he has or hasn’t done for others. There is no substitute for personal dignity. There is no standard of personal dignity except independence.
“In all proper relationships there is no sacrifice of anyone to anyone. An architect needs clients, but he does not subordinate his work to their wishes. They need him, but they do not order a house just to give him a commission. Men exchange their work by free, mutual consent to mutual advantage when their personal interests agree and they both desire the exchange. If they do not desire it, they are not forced to deal with each other. They seek further. This is the only possible form of relationship between equals. Anything else is a relation of slave to master, or victim to executioner.
“No work is ever done collectively, by a majority decision. Every creative job is achieved under the guidance of a single individual thought. An architect requires a great many men to erect his building. But he does not ask them to vote on his design. They work together by free agreement and each is free in his proper function. An architect uses steel, glass, concrete, produced by others. But the materials remain just so much steel, glass and concrete until he touches them. What he does with them is his individual product and his individual property. This is the only pattern for proper co-operation among men.
“Now observe the results of a society built on the principle of individualism. This, our country. The noblest country in the history of men. The country of greatest achievement, greatest prosperity, greatest freedom. This country was not based on selfless service, sacrifice, renunciation or any precept of altruism. It was based on a man’s right to the pursuit of happiness. His own happiness. Not anyone else’s. A private, personal, selfish motive. Look at the results. Look into your own conscience.
“It is an ancient conflict. Men have come close to the truth, but it was destroyed each time and one civilization fell after another. Civilization is the progress toward a society of privacy. The savage’s whole existence is public, ruled by the laws of his tribe. Civilization is the process of setting man free from men.
“Now, in our age, collectivism, the rule of the second-hander and second-rater, the ancient monster, has broken loose and is running amuck. It has brought men to a level of intellectual indecency never equaled on earth. It has reached a scale of horror without precedent. It has poisoned every mind. It has swallowed most of Europe. It is engulfing our country.

Excerpt from The Fountainhead, by Ayn Rand