Sunday, May 24, 2009

The Future of the American Economy

I've been reading lately about the "future of the financial industry" and I must say I'm both amused and alarmed. The Wall St. Journal had some sort of forum on this topic, but all the noted financiers and economists could think to talk about was regulation. The gist of it was that we had to regulate the industry in a meaningful manner -- but if we did, then the industry would no longer be in a position to make any real money. Which got me to thinking: how on Earth are any businesses of any size and scope in the USA going to make any sort of money in the coming months -- and years?

The backbone of our financial industry for the last 25 years has been all the uncontrolled trading. Money has been made, gobs of it, specifically because highly risky, highly questionable, but also high profitable (because the risk could be deferred almost endlessly) trades were not only permitted but encouraged. All the Wall St. "talent" the banks are now afraid of losing (unless obscene bonuses can continue to be awarded) were seen as talented only because they had mastered this highly dubious -- and dangerous -- system. If the system is going to be sensibly regulated from now on, that game will be over. So what are they going to be doing with themselves from now on? No wonder the bankers are lobbying like crazy against meaningful reform. With no possibility of gaming the market, there will be no "interesting" money to be made, the traders will get bored and the entire financial industry will be cut down to size. WAY down. Nevertheless, without such reform, the same gamers will be back in business and we'll soon be forced into yet another round of bluster cum bailouts. That can NOT be allowed to happen.

So forget the bankers for a minute and let's concentrate on some other businesses and where they might be after the eagerly awaited recovery? What businesses, exactly? you well may ask. The major US production industry has been the auto industry, which will never be the same and will for a very long time operate on a very limited basis. The computer industry? That's been outsourced for years. Other service industries? Also for the most part outsourced. The health industry? That's due for a very large haircut in the near future if our President has anything to say about it -- and he has.

Let's face it, the real engine of growth in this country over the last 25 years -- or more -- has been the financial industry, which has accounted for a whopping percentage of the GNP. And if it gets cut down to size, as MUST happen, then what will become the basis for the American economy during the "recovery"? Where will the jobs be? Any thoughts? Anyone at all?

I have an answer in mind, by the way. I always do. But I'm wondering if anyone else has any ideas on this topic.

Wednesday, May 20, 2009

The Guantanamo Flap

Guantanamo should be returned to Cuba. The base there serves no purpose and never did serve a purpose -- other than military intimidation, bullying and posturing. But the prison at Guantanamo does serve a purpose. Obama's decision to close it is one of the dumbest things he's ever done. Return the base and make a deal with Cuba to lease the prison.

Back in January, I kept this issue within parenthesis, planning to return to it at some later date: "President Obama has already decided to eliminate the prison. (Whether this is a wise decision is open to debate, but I'll leave that issue for a future post.)" Well, the time has come to discuss it here -- I should have discussed it sooner. I never thought closing the terrorist prison at Guantanamo was a wise decision. And the matter is no longer open to debate. Even the Democrats now see that. Obama is due to give a speech tomorrow and hopefully he'll back down. If he doesn't he's a fool. (This is a Democrat talking, by the way, in case you're new to this blog.)

The problem Obama and the Democrats rightfully seek to address has nothing to do with the facility at Guantanamo, which is simply a prison, neither more nor less. It also happens to be a very convenient prison, because it's located many miles off the shores of the USA, an ideal spot for the incarceration of those who might want to do us harm. The Senators who expressed skepticism regarding the closing of this facility were absolutely right, and the Democrats among them should be commended, because this country should never be run on the basis of empty ideology, but on the basis of sound, critical thinking. In opposing Obama, they are making an all too rare show of responsibility and guts.

If there is a problem with the legal status of the prisoners, that has nothing to do with Guantanamo. Their status is a completely different issue from the issue of where they are to be held. Guantanamo has a purely symbolic significance, of course. Certain highly questionable practices took place there. So end those practices, fine. As far as I'm concerned, water boarding definitely looks like torture. Sleep deprivation doesn't. (Been there done that -- insomnia can be pretty awful, but it's something millions of people endure and if innocent people can endure it, terrorists can endure it.) But the larger point is that these practices have been examined and meaningful decisions are being made regarding them. Fine.

As far as the question of whether or not they are to be treated as prisoners of war, as I see it they are most certainly not prisoners of war. Nor are they common criminals. We need to face the fact that their status is unique and we need to treat them in a unique manner. War in the 21st Century is going to be very different from the way it was in the 20th, just as war in the 20th Century was very different from the 19th. The role of terrorism is going to be increasingly important, which means that protecting our borders is going to be increasingly important -- along with many other things, such as the growing importance of intelligence -- both kinds of intelligence, the spying kind but also the intelligent kind, aka simply being smarter, better informed, and also, when necessary, even more deceptive than your enemy.

Planes, ships, missiles, high tech weaponry, etc. are going to be increasingly unimportant. The ability to outsmart your opponent is going to be increasingly important. Torture is reprehensible for many reasons, and it is also ineffective. So why bother with it? If you have someone in custody who might have important information don't bother torturing him, first because it's wrong, but also because it won't do you any good. Lie to him! Manipulate him. Fool him. Hire a magician to make him think he's in the presence of Allah almighty. Be smart, not dumb.

Closing Guantanamo purely because it's taken on some sort of symbolic significance that makes it politically incorrect, is not smart. Transferring possibly dangerous individuals to the US mainland because it makes you feel better about yourself is not smart. I hate to say it but imo the ACLU has outlived its usefulness. Listening to anyone from this organization is a waste of time, i.e., also not smart. The facility at Guantanamo has never been the problem. Our failure to get beyond the political correctness thing, our failure to think more critically, deeply, logically and dispassionately about the world we now live in -- that's the problem. I like my fellow Democrats, I'm proud to be one of them. I admire my president. However: can we drop all the kid stuff and finally: GROW UP??????????

Friday, May 15, 2009

Climate Change -- Some Inconvenient Truths

One of my favorite columnists, Paul Krugman, has a piece in today's New York Times, entitled Empire of Carbon, that I have some serious problems with. Focussing on China, a favorite target of NY Times China-bashers for a great many years, he writes:

The scientific consensus on prospects for global warming has become much more pessimistic over the last few years. Indeed, the latest projections from reputable climate scientists border on the apocalyptic. Why? Because the rate at which greenhouse gas emissions are rising is matching or exceeding the worst-case scenarios.

And the growth of emissions from China — already the world’s largest producer of carbon dioxide — is one main reason for this new pessimism.
I felt impelled to respond with the following comment:
I am alarmed and disheartened by the persistent manifestations of naivete, hysteria, and yes, neo-colonialist arrogance, on the part of intelligent, well meaning individuals, many of whom, as is certainly the case with Dr. Krugman, should know better. Yes, global warming is undoubtedly a reality. Yes, in all likelihood it is caused, or at least hastened, by human activity. And yes, it is likely to present the human race with some serious challenges over the next 50 to 100 years. Nevertheless, there are some other truths, no less apparent, compelling and “inconvenient,” that must also be taken into consideration when evaluating this situation.
For examples of what I am talking about, I directed his readers to this blog. Here are some of the "inconvenient truths" I have in mind:

1. The Earth has undergone many cycles of climate change in the 150 to 200 thousand years we Homo Sapiens have roamed the planet. In every case, humans have found ways to adapt.

2. While persistent droughts in parts of Africa have been attributed to global warming, “a new study of lake sediments in Ghana suggests that severe droughts lasting several decades, even centuries, were the norm in West Africa over the past 3,000 years. The earlier dry spells dwarfed the well-documented drought that plagued West Africa in the late-20th century . . .” While drought is naturally of great concern in Africa, as elsewhere, global warming due to industrial activity is clearly only one, relatively small, part of the problem.

3. Many sources of greenhouse gas have nothing to do with industrial activity: “By burping, belching and excreting copious amounts of methane — a greenhouse gas that traps 20 times more heat than carbon dioxide — India's livestock of roughly 485 million (including sheep and goats) contributes more to global warming than the vehicles the animals obstruct”; recent studies of “black carbon” emissions (aka “soot”) from the inefficient stoves of hundreds of millions of third world households have shown that they, too, have a significant role to play in global warming: “ ‘It’s hard to believe that this is what’s melting the glaciers,’ said Dr. Veerabhadran Ramanathan, one of the world’s leading climate scientists, as he weaved through a warren of mud brick huts, each containing a mud cookstove pouring soot into the atmosphere.”

4. Any attempt to slow global warming by imposing economic restrictions is sure to have devastating effects, not only on the economies of emerging industrial nations such as China and India, but the poorest of the poor in every part of the world. And in the face of the worst economic downturn since the Great Depression, the effects on many working and middle class families may also be dire. If global warming can be characterized as a man-made disaster, ill informed and panicky attempts to reverse it can be seen as part of the same depressing trend, founded in human arrogance, hubris and sheer pig-headed ignorance. If nothing else, the recent ethanol farce should give us pause before we embark on yet another, possibly far more costly, folly.

5. A recent study suggests that global warming has already reached a point of no return, where the worst of its effects may well be irreversible, no matter what we do: “The damage will persist even when, and if, emissions are brought under control, says study author Susan Solomon, who is among the world's top climate scientists."

6. Global warming is a potentially disastrous, but also slowly developing, trend that we will have ample time to prepare for. The key to dealing with it clearly does not lie in desperate, hasty, attempts to reverse the irreversible, but in the sort of long-term planning that would help us adapt. Not emission control, but population control, thus emerges as a key factor in facing the coming challenge. Since China has been a leader in dealing, however clumsily, with this absolutely fundamental problem, the many criticisms that have been directed at this country with regard to climate change are both ironic and disturbing in the extreme.

Thursday, May 14, 2009

Sign of the Times, from The Times

Hot off the presses, here's the headline, and subscript, from today's NY Times:
Jump in Food Costs Drives Up Prices -- "Wholesale prices rose slightly in the U.S. in April, the government reported, blunting fears of deflation."
Wholesale prices in the United States rose slightly in April, the government reported on Thursday, as falling oil and gasoline prices leveled off and food prices rose the most in a year. The Labor Department reported that prices received by producers of finished goods rose 0.3 percent last month, further discounting the prospect that the economy was veering into a vicious cycle of lower prices and lower wages known as deflation.
So rising food prices, at a time of high unemployment and low wages, is good news. Well Halleluyah! That should make you feel a whole lot better as you decide what you can afford to feed your kids tonight. In the interests of journalistic balance, the Times does present another viewpoint, though it seems a bit half-hearted:
But for some economists, the prospect of rising energy and food prices at a time of deep unemployment and shrinking wages raised concerns that strapped consumers could see their cost of living rise even as the job market continued to get worse. . . “There’s this squeeze going on,” John E. Silvia, chief economist at Wachovia Corporation, said. “We still have job losses. We still have a lot of pressure. And now you’re going to tell me that a lot of these basic commodities are rising? People’s real income is going to get squeezed.”
Exactly! The "squeeze" referred to is part and parcel of the more fundamental aporia I've alluded to in some earlier posts. At every level of the economy we literally do not know which way to go. Do we allow the banks to fail, which could destroy the world economy, or do we prop them up with trillions in bailouts, which could destroy the world monetary system? Do we nationalize the banks, which could lead to socialism, or do we try to restore the status quo, which could re-inflate the old bubble, leading to an even greater disaster? Do we encourage prices to rise, which would lead to serious hardship, not to mention the very real possibility of runaway inflation, or do we allow them to fall, which could lead to that dreaded "deflationary spiral" so many economists are now so worried about.

I looks very much as there is no way out, one way or another we are going down the tubes. There is another alternative, however, a very logical and sensible alternative, which I've been writing about here, a fresh approach to the economy that could certainly work. But it would require a major paradigm shift that few in this country are in a position to accept. Until we do, be prepared for a continual roil of the economy, as it lurches from one extreme to the other, from recapitalization to nationalization, from endless bank failures to endless bailouts, from price increases to price decreases, from runaway deflation to runaway inflation and back. If you really like roller coasters you might enjoy the future, but be careful, because too much of this sort of thing could make you very, very sick.

Tuesday, May 12, 2009

Stress Tests, Regulatory Capture, and the Fatal Flaw of Capitalism

Let's deal with the last-named item first. The fatal flaw of capitalism is that it is fundamentally beyond regulation. Advocates of laissez faire have always recognized this, arguing that in order for capitalism to work it must be allowed to proceed free from external constraints. The theory has always been that "the market," driven by "enlightened self-interest" (aka "greed is good"), will naturally regulate itself, because self-regulation is in the interest of all market players. External regulation, so the argument goes, will only introduce distortions that interfere with the natural balance of an inherently self-regulating system. As has long been known, however, laissez faire capitalism works only for the benefit of the few, with maybe some degree of trickle-down to the rest of us, if we're really lucky. And as we've only recently learned, laissez faire capitalism, when carried to an extreme, can be so self-destructive as to put everyone at risk.

So if capitalism cannot be relied on to regulate itself, then government needs to step in and regulate it, right? Wrong. The "free market liberals" were in fact correct in arguing that external regulation won't work -- though probably for the wrong reasons. Which brings me to the second topic in my title: regulatory capture.

Regulatory capture refers to a situation in which a regulator becomes so entangled in the mechanisms he is attempting to regulate that he can no longer perform his duties effectively. The assumption is that such a person can become co-opted in one way or another, to the point that he develops a conflict of interest. This is what happened to the institutions, such as Standard & Poor, Moody's, etc. that gave so many of our failing banks triple A ratings. In this instance the evaluators became dependent on the good-will of the bankers, who were, after all, paying their salaries.

In theory, a completely independent regulator ought not be vulnerable to co-option and ought not, therefore, develop conflicts of interest. A government regulator would be paid by the government, not the banks or investment houses, and would thus, in theory, be in a position to offer a completely independent, unbiased and honest assessment. The setting up of such an independent regulatory system is, of course, an essential part of the Obama-Geithner-Bernanke-Summers plan.

Which brings me to the first element in my title: the stress tests (forgive me folks, I seem to be going bass-ackwards here). Here's what one of our most knowledgeable and widely quoted bloggers, Yves Smith, had to say, in a piece pointedly invoking one of my favorite heroes, The Banks and Orwell:

I'd prefer an open sales effort to this mingling of hucksterism with supposed regulatory policy. And they have clearly been intermingled. Note how the prime objective of the stress tests has been above all to restore confidence. Huh? The most important aim should be to assess their condition so as to determine what if anything needs to be done. To subordinate proper regulatory action to reassuring "the markets" is backwards. If the public had faith in the integrity of the process, the need for a confidence exercise would vanish.
Herein lies the crux of the problem, because the stress tests have two contradictory goals: first, to objectively assess the condition of the banks; but second, as Obama and Geithner have repeatedly insisted, to restore public confidence in the banking system. As everyone knows, most if not all of these banks would have failed had there been no bailout. What would have been expected from an honest stress test would, therefore, have been a dire assessment indeed. But that would hardly have restored confidence in the system. Consequently, the stress tests were compromised, serious problems were papered over, and a truly Orwellian process of doublethink came into play. Think two contrary thoughts at the same time, first the unpalatable truth that our financial system has been ruined; second the necessary lie that everything is really OK, that with a little tweaking the system is going to recover quite nicely. Because the primary goal of the exercise was not proper regulation of the banking industry, but the restoration of confidence.

While so many economists are expressing irritation and disdain, few seem to realize that the fundamental flaw at the heart of the tests cuts also to the heart of any hope for regulatory reform. Over and over again the pattern repeats itself. Some institution becomes hopelessly overextended, for whatever reason, legal or illegal, by choice or by chance. Everyone at the top sees what is going on, knows very well exactly how terrible things are -- and yet, the whistle never gets blown. I'm thinking, for example, of that famous speech by Enron CEO Ken Lay, declaring Enron was doing great at a moment when he knew full well it was on the rocks, that all was lost. Why would he make such a speech at such a time? Well, what other choice did he have? If he had told the truth, the company would have tanked then and there. And he'd have been blamed. Lay was in a classic lose-lose situation. If he told the truth, his words would have precipitated a run for the exits and he'd have been blamed for Enron's fall; by forcing a smile and insisting all was well (as he did), he bought himself some time -- knowing in his heart that it was just a matter of time before his lies would be exposed.

I think it highly significant that no one with any real influence blew the whistle on Bernie Madoff, despite all the many alarm signals going off for so many years. It's hard to believe that no one, none of the experienced traders he did business with, none of his alleged victims, not even anyone at the SEC, was aware that he was perpetrating an outrageous scam. Regardless, he was simply too hot to handle, the consequences of exposing him would have been too disastrous, not only for his associates and those invested with him, but even the functionairies at the SEC, who would certainly have been blamed for the billions in losses.

Something similar must have been at work with the agencies rating the banks, as they began to realize how serious a situation their clients were in. When things reach a certain pass it's not so much a feeling of loyalty or obligation to the guys who write your checks, as a feeling of responsibility for the entire financial edifice, which could collapse to the ground if you said the wrong thing at the wrong time. What sort of courage would it have taken for some functionary at Moodys or S&P to get up one fine morning and announce to the world that Lehman Brothers must be downgraded from AAA to ZZZ? If that had happened and Lehman had gone bust, guess who would have been blamed? When one gets into a situation of this sort, ones mind must definitely incline toward magical thinking. Because being realistic and hard nosed is going to get you exactly nowhere. Let someone else take the hit when all goes bust.

Obama, Geithner and Bernanke are in essentially the same untenable situation. And in fact any regulator or regulatory agency would inevitably be placed in the same untenable situation. So long as all goes well and there is nothing to regulate, then you can do your job of regulation really well. As soon as something goes wrong, however, then, simply by exercising your regulatory responsibilities, you run the horrible risk of precipitating the calamity you were hired to avert.

And hence: the fatal flaw of capitalism is that it is fundamentally beyond regulation. QED.

(Of course, for some, that is its supreme strength.)
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