Posted in Economics, Financial Markets, General Musings, Politics and Policy at 8:49 am

Barring some miraculous breakthrough over the next 24-48 hours, it would seem that time is running out for a pre-July 20 agreement and there are really only two choices left:

1) Negotiate a short term deal – bridge financing to clear the IMF arrears and make the July 20 ECB payment, and another month or two to allow time for a real agreement to be negotiated. The problem here is that all parties are sick of kicking the can further and a short term deal only makes sense if there is consensus on the broad outlines of a program and it’s just a matter of more time being needed to finalize the details. This is clearly not the case here.

2) Begin planning for an orderly Grexit. No one wants to go down this path, but if the only choices are to start planning for an orderly Grexit now or have an unplanned, disorderly Grexit in two weeks……..


Iceland and Sovereign Money

Posted in Economics, Financial Markets, Politics and Policy at 5:00 pm


Surprised this isn’t getting more press. It will be an interesting experiment to say the least.


The misguided war against shareholder value management

Posted in Economics, Financial Markets, General Musings, Politics and Policy at 8:53 am

Lots of criticism against shareholder value management and stock-based compensation for executives has appeared in the press recently.



There’s nothing wrong with shareholder value management, which simply states that when evaluating corporate investment decisions, a company’s management should A) ignore accounting fictions that have no bearing on cash flow and B) take into account their overall cost of capital, which includes both debt and equity.

Likewise, there’s nothing wrong with aligning management’s incentives with those of the owner’s of the firm via the issue of stock options or restricted shares.

As is often the case, the problem is with the execution of the above. The root cause is short-termism itself. Stock buybacks, one time dividends, and other financial engineering practices may drive the stock price higher in the short run but it does not lead to long run value creation, which was the whole point of shareholder value management. Likewise, the way we have structured stock grants to executives is not aligning their long term interests with shareholders, it’s incentivizing them to extract as much in the way of economic rents from the companies they run in as short a time as possible. The combination of these two factors is leading to disaster. The solution is to fix the implementation, not to scrap the fundamental ideas themselves.


If you were wondering why you haven’t heard anything about the deficit in awhile…..

Posted in Economics, Politics and Policy at 12:40 pm

It’s because it has fallen so far so fast, and the concern that it is likely falling too far just doesn’t make for a good fear-inducing headline.

The numbers are in for FY2014, which ended on Sept 30.

$483 billion. 2.9% of GDP.

That’s down from last years (2013) $679.5 billion and 4.1% of GDP.

It’s down from the peak 2009 figure of $1.4 trillion and 9.8% of GDP.

This is the lowest deficit in dollars since 2008 and the lowest as a % of GDP since 2007. As a % of GDP, it’s just slightly lower than the average of the past 30 years.

To put it in graphical terms:

Budget Deficit

The current CBO forecast for the current fiscal year (2015) is $469 billion and 2.6% of GDP. It’s worth noting however, that as late as this past August the CBO was forecasting a $683 billion deficit for 2014, so it’s likely their 2015 forecast will be revised a lot lower in the near future.


The acrimonious debate over inequality

Posted in Economics, General Musings, Politics and Policy at 10:37 am

A big part of the problem is that the terminology – “inequality” – is terrible.

Literally no one, including the most strident leftist, believes that everyone, from the brain surgeon to the floor sweeper to the unemployed person unwilling to work should receive the same exact income and possess the same exact wealth. A much better term would be “increasing concentration” rather than increasing inequality. Framing the problem as an increasing concentration of wealth and income would resonate much better with the American public and do a much better job of conveying the intended idea.



Posted in Economics at 12:45 pm

It’s amazing how many bloggers on both the left and right (including actual economists) are butchering Piketty’s actual argument.

Piketty’s argument comes down to 3 pretty simple points.

1) β = s/g

β is the ratio of total capital in the economy to national income or GDP (K/Y). s is the savings rate in the economy. g is the growth rate of the economy.

It’s pretty easy to see how this works. Assume a capital stock of 500, national income of 100, economic growth of 2 percent, and a savings rate of 10 percent. 500/100 = 10/2. The following year, 510/102 = 10/2. Etc. Technically this is not an equation, but rather an equilibrium condition. If you plug in a different value for one of the variables you can get an inequality, but the result will be unstable and will tend back toward equality as you iterate through it several times.

2) α = r*β

α represents capital’s share of the national income. r is the rate of return on capital.

Using the example above, in the first year if the rate of return on capital was 4%, capital’s share of national income would be 0.04 * (500/100) or 20%. Labor’s share would then just be 1 – α or 80%.

3) Neither of the above propositions is particularly controversial or insightful. In fact, you could probably call them downright obvious. But then Piketty substitutes the first equation into the second to get:

α = r*(s/g)

Pretty simple, but what this is saying is that so long as the rate of return on capital exceeds the growth rate (r > g) then capital’s share of national income (α) will be increasing. Piketty then looks at some empirical economic data over the past couple hundred years which shows that over the long term the rate of return on capital has exceeded the rate of economic growth by a few percentage points per year (with the exception of the period 1910-1950). Thus increasing inequality is not some aberration, rather it’s a fundamental feature of capitalism.

More to come…………………..


Debt Ceiling

Posted in Economics, Politics and Policy at 12:30 pm

A week ago I was convinced that there was a zero chance of the debt ceiling being breached, but over the past few days I’ve become convinced that there is a 90% chance of it happening.

The GOP is currently engaged in a full court press to make the point that breaching the debt ceiling is not the same thing as default. Putting aside the “payment prioritization” nonsense, which has no legal basis and which could not possibly be implemented in the Treasury’s systems, there are some valid reasons why October 17 may not be the date.

Keep in mind these dates:

October 22 – The date the CBO predicts the government will actually start missing payments.

October 24 – Treasury must roll over $24 billion in T-Bills. Technically the interest should be considered an expenditure (unlike the principal) but due to the zero coupon nature of these instruments I’m unclear on the actual govt accounting.

October 31 – Treasury must roll over $115 billion in Treasury Notes and Bonds and make an accompanying $6 billion interest payment.

November 1 – $55 billion in Medicare, Social Security, and military payments are due.

My prediction: The GOP is going to refuse to raise the debt ceiling on October 17 based on the calculation that they have at least until October 22 and possibly until October 31 before an actual default takes place. The morning of October 18 they’ll issue a statement to the effect of “see, we breached the debt ceiling and nothing happened”, followed shortly by a litany of demands that must be met before they agree to a debt ceiling increase, along with a sudden willingness to negotiate over those demands over the following few days.

The wildcard in this scenario, and the one that scares the crap out of me, is how the markets and the overall financial system will react in the days leading up to October 17 not to mention the days after it. This is why I’m still leaving open a 10% chance that a deal is reached at the last minute prior to the passing of October 17. A market panic could force them to abandon this plan at the eleventh hour.


Is it worth borrowing money from China to pay for that?

Posted in Economics, Politics and Policy at 9:04 am

The question in the title is becoming the new political meme for why we should cut spending on programs which are otherwise popular amongst voters.

How true is it, however, that we’re borrowing from China for our spending? Or rather, to what extent are we borrowing from China vs elsewhere?

As always, go to the source for the data:

September 2012 US Treasury Bulletin
See Table OFS-2 on page 41 for breakdown of Treasury holdings by type of investor.

Major Foreign Holders of Treasuries

I used March 2012 data for all my calculations since it’s the most recent month for which ALL data points are available.

Here are the results:

Ownership of the National Debt
Federal Government__________ 41.05%
Foreign/International Investors__ 32.95%
Private Domestic Investors_____ 23.19%
State and Local Governments___ 2.80%

- The Federal Government holdings primarily consist of the Social Security fund, but also include federal worker and military pensions plus intra-governmental accounts.
- Foreign/International Investors includes both private investors/institutions and governments.
- Private domestic investors includes banks, insurance companies, mutual funds, pension funds, and individuals.

67.05% of the national debt is owned domestically. Right off the bat, the question should be – “is it worth borrowing money from OURSELVES to pay for that”.

China is the largest of our foreign creditors, accounting for 22.22% of the 32.95% of foreign holdings. Japan is the second largest, accounting for 21.03% of the 32.85%. Brazil is in the third spot at 5.05% of the 32.95%. After that, it drops precipitously, with a few dozen countries splitting the remaining 51.7% of the 32.95%.

So what is the total percentage of the national debt owned by China?


By way of comparison, Japan holds 6.95% of the national debt.

Also interesting is the trend. From July 2011 through July 2012, China’s holdings of the national debt dropped from $1314.9B to $1149.6B while Japan’s increased from $885.2B to $1117.1.

It seems to me that the question “is it worth borrowing from China to pay for that” is highly misleading and disingenuous.


Enough with the square peg and round hole (DSGE)

Posted in Economics at 9:44 pm

Re: Krugman and his sticky wage defense:

Recessions/depressions have nothing to do with “sticky wages” and Keynes went out of his way to point this out.  That’s what makes it so disappointing to see New Keynesians make this argument, for no reason other than to rescue their DSGE modeling methodology.

Here’s why involuntary unemployment is not the result of wages being downwardly rigid.

When someone says that the price of something is too high, in real terms, we must ask “too high relative to what?”  If wages (the price of labor) are too high, relative to what?  To the price of capital?  Can’t be, since the hallmark of recessions/depressions is unemployed labor and capital (e.g., idle factories or low capacity utilization).  So then we ask whether both labor and capital are both priced too high.  Again, relative to what?  To finished goods and services?  Nope.  Two problems – 1) inventories of goods tend to swell during a recession, with unsold goods sitting in warehouses and on store shelves, so they must be overpriced according to this line of thought, and 2) wages and returns to capital represent purchasing power, so cutting wages means even less demand and greater inventory buildups.

What next?  How can labor, capital, and finished goods all be overpriced?  Perhaps the currency itself is overvalued?  Ok, now we’re getting somewhere.  An overvalued currency and slumping exports are both characteristic of recessions/depressions.  However, this is only part of the story.  Exports make up a relatively small percentage of GDP for most countries, and it’s quite common for multiple countries to enter recession/depression at the same time.  So we’re on the right track, but not nearly there yet.  The issue is that money IN GENERAL is overvalued relative to everything else.  The excess supply of everything else (goods/services and factors of production) is the result of and balanced out by the excess demand for money.  In fact, we can take it a step further and ask WHY there is an excess demand for money and the answer is that the demand for money is not a transactional demand but a precautionary one; it is not money itself that is debing demanded but rather the liquidity it provides.  So a change in “liquidity preference” is what causes the economy to remain in a depressed state.

Now we’re right back to what Keynes actually said.  We’re also right back to where many of the positions Krugman advocates do make sense.  But let’s not pretend that it has anything to do with “sticky wages”.


EU Summit Notes

Posted in Economics, Financial Markets, Politics and Policy at 8:52 am

US stock markets rallied 2-3% and crude oil jumped over 9% yesterday in reaction to the latest “plan to have a plan” and “agreement to agree on what has already been agreed” coming out of the EU.

I’m not convinced that this will amount to much more than another short term attempt to boost market confidence that rapidly deteriorates.

Everyone ought to just read the official statement (which is just slightly longer than one page in length) and ignore the speculation from the financial press.

Here are my key concerns:

  1. Debt subordination. The financial press keeps saying that the EU agreed that the Spanish bailout would be an exception that would not subordinate existing debt.  That seems to be true, but if you read the actual statement, it’s an artifact of the EU simply re-affirming that any assistance provided by the EFSF and then transferred to the ESM will not involve subordination.  This is an important point, for reasons that will become clear in a moment.
  2. ESM.  I have a number of concerns here.  First and foremost, the ESM was supposed to go into effect July 1.  That’s tomorrow.  It appears the new target date is July 9.  Is that realistic?  They need to get to a point where the countries providing 90% of capital contributions ratify it in order for it to become operational.  Progress has been quite slow.  Another concern is the size of the ESM – with approximately €500 billion in credit to be available it will not be nearly large enough.
  3. Direct injection of ESM funds into banks. This is the big one.  The question, again, is timing.  It can’t happen until the new single bank regulator is in place, currently targeted for January 1, 2013 (and we know how target dates slip in the EU).  Furthermore, each individual ESM bank bailout will require UNANIMOUS approval.  Is the thinking that no banks will get in trouble over the next 6 months, and that when they do get in trouble there will be ample time to get unanimous approval on terms?

Given the timing of the ESM itself as well as the timing of its power to provide direct assistance to banks along with the subordination issue, I think there is going to be enormous pressure over the next few months to expand both the duration and size of the EFSF while backburnering the ESM.  Alternatively, some new “medium term solution” may emerge to fill the gap between the EFSF and ESM.  It’s unlikely that matters will proceed along the lines currently proposed, with a smooth and seamless transition between the EFSF and ESM.