03 August 2012

May You Live in Interesting Times

Yesterday went according to plan, sort of. Pick up a dead trees NY Times, and head for a pre-prandial pastry at Panera. This time, and not for the first, the mind wander off to ponder long term interest rates. As a professor of mine said, "whether you get paid or not, you'll always do economics." Turns out he was right.

The Right Wingnuts in the choir have been singing the Fed is Evil and Ben is Bad songs for some time, arguing that "historically low" interest rates are just bad, bad, bad. They deny the truth, which is that this interest rate level was started by Greenspan, in the hopes of averting a Depression until Dubya was out of office. Almost got there, but not quite.

Among the problems with the Wingnut accusation is that Fed interest rates very short term; the principle one being the overnight Fed Funds rate. Long term rates for Treasuries are set by auction; they have been tracking with Fed rates, but don't have to. This site has some very interesting material. I haven't gone through all of it, and what I've seen only goes back to 1900, not the Golden Age of American Exceptionalism of Right Wingnuts. The reality is that long term interest isn't just a matter of saver/lender time preference, but mostly about real return on physical investment. Fiduciary gambles ultimately depend on physical production growth to make the money to pay the vig.

So, the first question is whether or not low Fed rates have a bad effect on an economy? In general, no. The losers, if that be possible, is the Coupon Clipper Class, who seek to live off income from fiduciary instruments. When interest rates are low, then the income they receive is lower. On the other hand, these fat cats also have the opportunity to sell off sufficient numbers of bond units at the "inflated" prices brought on by declining interest. In other words, they can't lose. Further, TARP and the like were driven to protect bondholders, for some reason. As stated here numerous times: interest is just a monetization of increased productivity. This is why there must always be some real physical investment at the foundation of any fiduciary instrument.

The basic reason for The Great Recession was that there was no such foundation. Much as I find .com investing pointless, the first time through and now, there is really no such thing as residential (there may be for commercial, it depends) housing investment. Housing creates no physical product, only what some economists call "psychic returns" (if images of Patrick Jane dance in your head, you're watching too much of the TeeVee). They provide no additional money stream to pay the vig. Plant and equipment do. Some argue that intellectual property does, but on the whole I disagree with that notion. But that's another episode.

So, then, what should the long term interest rate be? Who wins, and who loses, when it rises or falls? What causes it to move? Inflation, or deflation, are believed to be the most significant determiner (but follow the above link, to be disabused). But I disagree there, too. In a post from some time ago (I've lost the link), there was a quote from a business person to the effect that no productive use could be found for a pile of money, so the company decided to buy back its shares. Economists, more so than MBAs, have long criticized this. The demand for investment, ultimately, is determined by the quality of physical investment. Lose vision for how to allocate capital, and the economy falls back on fiduciary fiddling.

Not to put too fine a point on the issue, these are *risk free* interest rates. Corporate bonds, where capital has a least a chance of being used to improve output, pay more.

Which brings us to some pieces from yesterday. Let's start with this front pager. The saltwater faction of economists spend a good deal of typing pointing to object lessons in real life for guidance on what decisions should be made here in the USofA. Japan has been such a lesson for some decades, the country has been in the shitter for that long. This piece lays out the history, and implications, of Japan's dance with Dee Flation. The story casts itself as an inter-generational conflict; old folks living on pensions and bonds versus everybody else.

By speeding the flood of cheaper imported products into Japan, the strong yen is contributing to deflation, a broader drop in the prices of goods and services that has helped retirees stretch their pensions and savings. The resulting inaction on the yen, according to a growing number of economists and politicians, reflects a new political reality, with already indecisive leaders loath to upset retirees from the baby boom who make up more than a quarter of the population and tend to vote in high numbers.

Now, whether most of the money being made off of bond yields and deflation is pensioners is an assertion I certainly question. But it is part of the issue.

Back to Japan. It seems to have its share of narrow minded wingnuts, too.
Shigeru Ono, a retired oil company manager who won a small following blogging on deflation's virtues ...

The piece goes on the chronical the de-industrialization of Japan, not a feel good story. It ends with this:
One way to spur such awareness, critics say, would be to allow national pension payments to drop with falling consumer prices, as the law demands. But the government ignored the law for years rather than upset elderly voters.

Last year, it finally took a baby step, slightly trimming pension payments. The loss of just a couple of dollars a month, though, was enough to start Mr. Ono, the blogger, rethinking. "Now I am starting to realize that deflation can be bad, too," he said.

Which was just the front page. Get to the Business Section, and a piece from a Pro Publica on the virtues of being an unpunished bankster. Sandy Weill gapes out at you; at least in the dead trees version, it's a dull B&W photo, on-line is far more disgusting. Ooh. Regular reader will know that when Weill floated the break them up balloon a few days ago, I asserted that he's got a bunch of stock that's worth more in pieces than the companies whole. IOW, he's advocating to make himself yet richer. Such a public servant.
His institution had also served as a (unheeded) harbinger of the banking rot to come. Throughout the 2000s, Citigroup was riddled with scandal. It settled with the Federal Trade Commission over deceptive practices. Its CitiFinancial unit was embroiled in predatory lending controversies before it was fashionable. The bank was an entwined backer of both Enron and WorldCom. Citigroup employed Jack Grubman, who was at the heart of the research conflict-of-interest scandals of the early 2000s. Even back in his less reflective days, Mr. Weill had to apologize for that.

I'll close with a snip from the piece, which echoes writing here, over the years:
In 1936, Roosevelt gave his famous speech listing reckless banking and speculation among the "enemies of peace." These enemies hated him and he asserted, "I welcome their hatred."

Obambi would do well to sail with that wind.

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