The Financial Markets Week in Review
Stock-Markets / Financial Markets 2010 Sep 03, 2010 - 04:36 AM GMTBy: Nick_Hubble
• Wirtschaftswunder – It’s the lack of leverage, stupid
• Promigration
• How to lose a 50/50 bet
• & more
Wirtschaftswunder - It’s the lack of leverage, stupid
At least for now, it looks like the Germans are doing well for themselves. It is worth noting, for disclosure reasons, that your editor is among them by birthright. But let’s not get too smug. Instead, we’ll examine vat ze Tshermans are sinking.
Most commentators point to the combination of a weak Euro and an export oriented industry. Makes intuitive sense. That, dear Daily Reckoning reader, should have you immediately suspicious.
The Economist’s guests' comments on the matter included the following from Beatrice Weder:
“Some 40% of Germany’s trade is in Europe where (nominal) exchange rates play no role. Trade outside the euro area will be positively affected by the depreciation of the euro but this is never an immediate effect. The recovery of exports in spring coincides with the pressure on the euro but is caused by stronger foreign demand for German-type products. If you doubt this, look at Switzerland, which exports similar products and saw its exports jump in spring—at the same time as the exchange rate appreciated massively.”
So it’s the nature of the exports, regardless of the Euro, that are driving German GDP. But surely there is more to the story than the warm fuzzy feeling you get when you see “Made in Germany”.
Reader hint: Germany didn’t have a housing boom.
Carmen Reinhart, who was our latest favourite economist until we found out she was the chief economist at Bear Stearns, has the explanation:
“Germany was a notable outlier in the now-notorious credit and debt boom of the decade prior to the onset of the subprime crisis. Credit relative to nominal GDP fell about 11 percentage points during 1997-2007; during the same period, credit/GDP rose 80 percentage points for most of the advanced economies.”
To be fair to Carmen, this was just one of the factors she and another Reinhart drew attention to in their paper After the Fall, which was presented at the recent Fed shindig in Jackson Hole. (Probably to no avail.)
But the point is that a leveraging up (caused by excessively low interest rates), leads to a boom. And a boom leads to a bust. If you avoid the leveraging, you avoid the boom, and the bust.
Well, that’s not entirely true. Germany still had a rough time during the GFC. And this is where Austrian Economic theory comes in. A credit boom misallocates capital to malinvestments. In most countries that was housing. Germany, as mentioned above, and as mentioned by the Reinharts, didn’t have a housing boom. Their capital structure wasn’t misallocated as badly. This means the period of adjustment isn’t as difficult for the Germans. To take an overly simplistic view, the Germans just have to ramp up their machines, while the Americans have to deal with the death of their economic model – mortgage, securitise, sell, build new house, mortage, securitise, sell, build new house, ....
Promigration
A massive revelation has come from the Federal Reserve of San Francisco. Apparently, “immigration boosts wages, employment and productivity”. Wow, didn’t see that one coming. It’s not like open borders aren’t a long standing libertarian idea.
But instead of reverting to logic, the Fed used its usual bean counting methods. The same that were discredited during the GFC, let alone before. That is why we have an issue with the following:
“States that have had a large influx of immigrants tended to produce more, hire more and pay workers more than states that have few new foreign-born workers, the study shows.
Now, how can you be sure that this isn’t confusing cause and effect? Perhaps people migrate to states that have high levels of production, jobs and wages...
How 60% became 100%
This statistical anomaly doesn’t create much faith in the whole maths process either. The article is entitled “Fed policy on right course, economists say”. The content reveals that only 60% of economists would agree with that. And that’s economists who are members of The National Association for Business Economics. By definition, the very mainstream who can’t even predict a financial crisis once it has begun. How about we poll economists who predicted the crisis for their opinion on the Fed? Think the result would be different?
Related to the rant above is the most damning news for climate change enthusiasts ... ever. It’s not a recent discovery, but it’s one that we only just came across. The IPCC Chairman Dr Rajendra Pachauri, is in fact not a climate change scientist by qualification. Nope, he is an Economist!
Now we don’t put much value into qualifications. In most cases they are time wasted while useful things could have been learned. But in this case, the idea of having a railway engineer turned economist in charge of a climate change panel really does seem a bit ridiculous.
How to lose a 50/50 bet
Addison Wiggin, the Executive Publisher of Agora, and 5 Minute Forecast contributor, has pointed out the following gem. But first, let’s elegantly prep it for you.
What sort of margin of error do you think should get someone fired? Say your employee, who manages the risk of your company’s financial position, was right 50% of the time. Would you be better off without him?
“Last month, a long-running Senate study determined that over 91% of the AAA mortgage-backed securities issued from 2006-2007 have since been downgraded to "junk" - BB or lower. Surely, a screw-up this gigantic can only be attributed to some extremely smart people. A man off the street would have better odds just flipping a coin. Only geniuses can be so, so wrong.”
But the beratings agencies weren’t just stupid, according to a Bloomberg article. They were a combination of very stupid and corrupt:
“A Moody’s Investors Service committee in Europe violated the company’s procedures in declining to correct errors in ratings on constant proportion debt obligations “because of concern that doing so would negatively impact” the firm, the Securities and Exchange Commission said in a report today.”
This is what happens when you teach university students that expectations and confidence are what drive markets. No mention of reality. Just avoid causing a panic.
So you would think that after this miserable failure, somebody would be getting into trouble. But no. jurisdictional issues don’t allow it.
That hasn’t stopped the SEC from expanding:
“The SEC expects to increase its budget by about 20 percent in the next fiscal year, to $1.2 billion, more than triple its size in 2000. Its staffing is expected to increase by more than 1,000 people, some 800 just to deal with the reforms, to about 4,700, a 36 percent jump from the head count in 2007, before the financial meltdown.”
Free market, huh?
That’s what happens in the world of government. The bigger the c*ck up, the more resources you get. After being told Madoff was a ponzi, after being told that the crisis was imminent, after being aware of the regulatory environment the mortgage industry was operating in, they didn’t do a thing.
Now, they get bigger.
If at first you don’t succeed, try again and again and again
In the same vein as the SEC, the Basel bunch have been busily planning their latest incursion into bank management:
“As part of the reforms, the Swiss-based Basel Committee said that banks would be asked to build up a buffer of capital when national authorities judge that there is excess credit growth together with a build-up of system-wide risk.
“The buffer will normally be set at zero, but if a credit boom starts, banks would have to begin hoarding extra cash in case the upswing turns sour and hobbles the sector.
“APRA would work with the RBA to institute the reforms and to measure when the economy was approaching a trigger point.”
Now this should have your blood boiling. Does it seem strange to you that the reform rests on the idea that government regulators can pick a bubble? I mean, these guys aren’t just stupid in the sense of being unable to predict a bubble. They aren’t just stupid in the sense of being unable to realise they are sitting on a bubble. They are even stupid in the sense of claiming they can do what they know for a fact they can’t. From a recent and painful experience. But still, they plan on basing the future capital adequacy laws on their ability to do so!
Watch this space, if you can bear to.
What caused the crisis?
The Economist has come up with a series of articles with promising titles. They are well worth a read. Not just the titles, that is. The debate between the various authors centres around the causes of the financial crisis. More specifically, on the following comment from Peter Wallison, and other ones to the same effect:
“Mortgage brokers--even predatory ones--cannot create and sell deficient mortgages unless they have willing buyers, and it turns out that their main customers were government agencies or companies and banks required by government regulations to purchase these junk loans. These government-mandated loans amount to almost two-thirds of all the junk mortgages in the system, and their delinquency rates are nine to fifteen times greater than equivalent rates on prime mortgages.”
Despite the above, the influence of the government in the crisis is hotly debated. Tempers quickly flare on this issue. The Economist’s journalists remain civil with each other, but take the occasional snipe:
“The market failed. And the market was what it was because government made it that way.”
In fact, the articles are permeated with “my colleague this” and “my colleague that”. And the same facts are interpreted in directly contradictory fashion in each article. It reminds us of the economists who spend their time trying to disprove accepted economic theory with mathematical models and observations. For example, they will collect data and conclude that minimum wages do not in fact increase unemployment. That flies in the face of accepted economic theory, let alone logic. But still, the economist stands by his conclusions. Obviously, something is wrong.
What pains the most in all this debating about the causes of the GFC is that credibility lies with one group and not the other. As a generalisation, those in favour of regulation did not predict the crisis. Those in favour of laissez faire did. And they have long standing theories that explain it.
So why argue when the debate is already won? Well, it isn’t. Those who were wrong have been bailed out, in financial and political terms. There has been no evolution.
Follow the money
We had bailouts, followed by stimulus that was borrowed for. The stimulus money came to a great extent from the banks that got the bailouts, as they had to sure up their balance sheets with “safe” treasuries. Hey, the figures even match. 800 billion dollar bailout, 800 billion dollar stimulus... Financial flows all round for those in the loop.
And now, news from the US suggests Obama is winding up for another round of stimulus:
“My economic team is hard at work in identifying additional measures that could make a difference in both promoting growth and hiring in the short term and increasing our economy’s competitiveness in the long term.”
HAHAHA! Long Term!
Here is what the US auto industry is getting post cash-for clunkers:
“The nation's top automakers reported disappointing sales Wednesday, resulting in the worst August for industrywide auto sales in 27 years.”
How about the housing market, which was subject to stimulus, tax cuts and tax credits?
“... the 27 percent plunge in existing home sales in July...”
How about the banking industry, which had funds shoved in all sorts of places they didn’t want?
“So far this year, 118 banks have failed, with 45 closings during the last quarter.”
In fact, the more government gets involved the worse things seem to go. Surprise!
What is it good for?
What do Marc Faber, Gerald Celente and Charles Nenner have in common? War. They are forecasting one that is. The concerning part of this is the accuracy of their past forecasts. Faber and Celente at least. We don’t know much about Nenner.
Nick Hubble is a writer for The Daily Reckoning Australia. Having recently escaped from academia, Nick decided to drop his tights (the required attire of a trapeze artist) and joined Port Phillip Publishing. Instead of telling everyone about the Daily Reckoning, he now spends his time writing for the weekend edition.
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