Is the Stock Market Working?

The heading of this post may seem like a strange question, but I think at times like these we need to ask ourselves more fundamental questions. The American people are deeply invested in the stock market in a myriad of ways, and now that stocks have lost almost half of their value, I think it’s time to re-evaluate the very model of our economy, and in particular, the role of the stock market. A majority of Americans are to a great extent dependent on the stock market doing well for their fundamental well-being. What I’m asking is: should that really be so?


The stock market is supposed to fill an essential function in an advanced society: to provide money for ventures that otherwise would have been far too expensive to embark on. The invention of the stock corporation was an ingenious one, in that it allowed many people, not just kings and despots, to invest in large and expensive projects such as factories, mines, and much more. This adds a whole new layer to society and enables immense progress, innovation and price reductions.


To determine whether or not the stock market is “working” from the perspective of society at large, one must try to determine the reason why investors buy stocks of different companies. If investors truly believe that a company has a good plan and structure for growth and profit, and invest in that company as a result, then that is a good example of how the stock market can help society progress and prosper. If, however, an investor invests in a company for other reasons, the role of the stock market in society becomes much more questionable.


The way you can tell whether or not investors are buying stock because they believe in companies or for other reasons is by looking at how the stock market moves. If the whole stock market as one, regardless of the industry that the companies are in, then something is up. Of course there will always be a connection to the economy as a whole, but different industries will always be affected differently. When the stock market moves up and down as one, as the American stock market has for a long time, then there is unquestionably something that is not working.


What is causing this is speculation without a motive. Investors buy stocks not because they think that the companies are going to do well, but because they think that other people will buy the stocks too, so that the price will go up. When they do that with borrowed money, a huge bubble is created, which will eventually pop and create a recession or a depression. This creates an outcome that is completely contrary to what the stock market is meant to do, in that companies that do well can get punished, and companies that do poorly can get a hugely inflated stock price. This sort of behavior removes the good dynamics of capitalism.


U.S. politicians have over the last 30 years allowed the stock market to become almost a state within the state. If the stock market does not get what it wants in terms of de-regulation and bailouts, it brings stock indexes down until politicians cave in. This is what happened when the first TARP-plan was voted down. Remember, stock brokers don’t get paid a percentage of the profit they make for their clients, they get paid based on the volume of what they trade. Hence, it does not matter to them if they win or lose, they just have to play. They need people to believe that the stock market is a good place to invest money in, and that is why you hear endless optimism everywhere in the media with regard to the stock market. When it seems like the whole financial world is coming to an end, stock brokers will try to tell people that it’s a great time to buy stocks based on some economic report that says that the situation isn’t quite as bad as everyone thought. It’s simply absurd.


Because almost all Americans own stocks in one form or another, Wall Street can hold everyone’s money hostage at the same time. This situation is undemocratic, inefficient and immoral.


The American people and the American economy must de-couple itself from the stock market. The stock market has become a place of pure gambling and blackmailing, without regard to what a stock market is actually supposed to do.






Moreover, I advise that the winner-takes-all voting system should be destroyed.

Good Versus Bad Protectionism

For the longest time, The United States had a firm commitment to protectionism. Protectionism is a policy under which a country limits imports by different means so that the country consumes primarily its own goods. In the early 20th century, America’s commitment to protectionism was ended, and a commitment to free trade was started instead. Of course, protectionism has its clear advantages. It is clearly better for the U.S. economy on the whole if Americans buy Fords instead of Toyotas, because the money would stay in the U.S. instead of being transferred to Japan. The story, however, is much more complicated than that.


During times of a severe crisis when job losses mount and industries shut their doors, calls for protectionism usually grow louder. That happened during the Great Depression, and it is happening now. Much of Barack Obama’s campaign rhetoric was centered on domestic industry and a return to consumption of domestic goods, and more recently, Timothy Geithner has repeatedly alluded to the fact that China is manipulating its currency to stimulate exports. What Geithner is effectively saying is that China should raise the value of its currency, so that Chinese goods will become more expensive in the U.S., so that Americans will buy American goods instead. So, what are the benefits of free trade, and is there such a thing as “good protectionism”?


Free trade has many advantages. Most importantly, it lowers the price of goods dramatically, and makes goods available everywhere. 20 years ago, the prices of food, furniture, clothes, electronics, appliances and much more were considerably higher than they are today. The globalization of free trade have made these goods much cheaper in the West and provided jobs in the Third World. Today, most types of trade is global, and many countries even import the same goods that they export (this is also called “counter trade”). Globalization has, in short, put millions of people to work, and brought cheaper goods and greater prosperity to everyone.


During a crisis, globalization and free trade do little good. The enormous forces of the global economy cannot be controlled or steered towards a certain goal, such as job creation in the U.S.. Protectionism can do that, but at a cost to the global economy, and global growth. An increased amount of protectionism would likely cause some problems in trade relations around the world, but those problems may not be as large as those that would occur if the unemployment rate were to go up to 15-20%. There are definitely some excesses in global trade that could be addressed, while local goals could be achieved.


Not every country can produce everything, and it would make little sense for advanced, industrialized countries to start producing basic goods again just to create jobs. For the government to sponsor a pencil factory next to a bio-tech lab would be stupid. That would be an example of bad protectionism. We need trade to a large extent, but we don’t need trade for everything, and in some cases, trade can be a liability.


There are certain goods that are not suited for global trade, for various reasons. I’m thinking primarily of food, defense and government contracts. If a country does not have its own food production, it becomes very vulnerable to political insecurity in the world. If a food exporting country has a choice between feeding its starving citizens, or breaking a deal with a food importing country, the former will obviously be chosen.


A country that is dependent on imports for its defense is also very vulnerable to insecurity. Again, if a weapons exporting country is faced with a choice of defending itself or breaking a deal with another country that wants to buy weapons, the former will be chosen.


With respect to government spending in general, it makes little sense not to buy domestically when buying police cars, fire trucks, steel for bridges, energy, and so on. To directly take taxpayer money and transfer it to foreign taxpayers through government imports results in a dramatic hemorrhaging of money for the country’s finances.


The conclusion one can draw from these examples is that there is such a thing as “good protectionism”. If the American government wants to create jobs at home, it should primarily focus on supporting domestic production in food, defense and whatever goods the government purchases. Good protectionism is protectionism that makes economic and philosophical sense.


No country can be legitimately blamed for implementing such policies, so the impact on global trade is minimized using this approach. Focusing on good protectionism can also lower the trade imbalance and strengthen the dollar. When it comes to free trade, the story is very similar to that of public goods and public utilities: there are times when the free market is unmatched in providing what is needed, but there are other times when the free market is completely unsuited to the task at hand.

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The Good Bank Solution

One solution to the financial crisis that is currently being discussed is the so-called “bad bank solution”. What this means is that the government would set up an entity, and gather all the toxic assets that the banks have, so that the bank system can be freed of the bad stuff and move on. Sounds good, but where do the losses go? The answer is: to the American people.


This solution is no different from the original TARP plan, in that the American taxpayer simply gives banks money to cover all the mistakes those banks made, with no strings attached. I believe that the losses in the banking system are too great for a bailout like this one to have the potential to work, regardless of the moral implications. That is why we need a different solution.


First, a reality check to illustrate my point. Bank of America and Citigroup are the two large banks that are in the worst shape. Consider their market value in 2007 compared to today:


Bank of America’s market value in the second quarter of 2007: $228 Billion


Bank of America’s market value in January 2009: $33 Billion


Citigroup’s market value in the second quarter of 2007: $255 Billion


Citigroup’s market value in January 2009: $15 Billion


In addition to this, these banks have several times their market value in toxic assets, which means that they are effectively insolvent already. Consider also what Bank of America did after it received bailout money: it went and bought MORE mortgage-backed securities, creating even greater losses. When the bank found out that it was going to get a bailout, it started paying huge bonuses to its executives, in reality using TARP money for that. It’s definitely time to stop betting on the losing horses. It doesn’t matter how much money we spend on these banks, they’re not going to be able to continue in their current forms. The bad bank solution is nothing more than a bad solution.


I am instead proposing a Good Bank Solution, under which the government sponsors entirely new banks, completely untainted by the crisis and the toxic assets. Instead of trying to repair a complete wreck of a bank, a new one is constructed from scratch. The public could then safely put its money into those banks, investors could invest money in them, and the banks could immediately start lending with prudent standards. More specifically, the plan would consist of the following steps:


1. The government drafts a bank charter (the rules for the bank), and includes very stringent standards on lending, how much capital the bank must have, how the bank can invest, how much money the bank must lend, and so on.


2. The government puts money into the bank. We’re talking about billions of dollars, not billions in losses, but in investments in a new banking system with a clear potential for profit. The government owns 100% of the bank.


3. The bank opens for business, takes customer deposits and starts lending immediately. Investors will be able to buy 49% of the stock, but the government must remain the majority shareholder for a few years until the financial crisis has been resolved. By selling stock, the government may already have recouped half of the investment at this stage, potentially at a profit.


The government can create many of these banks, and in one fell swoop bring confidence and lending back. It is important to note that this is just a temporary solution. Once the crisis has passed, these entities can be sold completely, so that the government does not have to act as a banker.


Before that happens, the government will also have been given time to legislate the new financial regulation that is so direly needed. The “good banks” don’t need regulation, because they will have that written into their charters. This would be a big operation for sure, but it must be done, because the current system is broken.






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The Six Stages of the Credit Crisis

Recently, the idea of the nationalization of major banks has been gaining ground in the U.K. and the U.S.. I am against the idea, simply because I think it will cost too much in the end. It was the right thing to do in the 1980:s in the U.S., it was the right thing to do in Sweden in the 1990:s, but this time the scale of the problem is so different that nationalization could be very dangerous.


I’d like to talk about the current crisis on a larger scale, because there are some definite patterns that have shown up in recent years in several countries that now seem to be imploding. I’m thinking of the U.S., the U.K., Ireland and Iceland. The common denominator for the last 20 years of financial history is crystal clear:


All four countries decided about 20 years ago that they would promote and expand the financial industry through deregulation, tax incentives and lower interest rates.


Of course, the U.S. was already the financial hub of the world, but it nevertheless embarked on the same strategy as the other three countries. In all four countries, the financial industry’s share of GDP grew steadily and even explosively as a result of the respective governments’ efforts. This was a very attractive development for politicians, because only by de-regulating, they could hold off on raising taxes, grow GDP and increase the standard of living. It seemed to be a win-win situation, if it hadn’t been for the familiar problem of credit.


Debt fueled both speculation and consumption, so that debt levels have now risen to astronomical levels in all four countries. Private debt is now several times larger than the GDP in each of these countries. By borrowing money to speculate and consume, companies and individuals have set in motion a huge credit expansion and created the enormous credit bubble that we have today. As I wrote here ,whenever such a system is shaken, everything falls apart, because real debts stemming from fantasy money must be paid back with real money.


A pattern seems to be emerging with respect to how a country develops after the huge credit bubble is popped. The smaller you are, the sooner you will go down. The more debt you have, the less likely rescue attempts are to work. There seems to be six stages to the further development of this crisis, and the following scenario may play out in all four of these debt-laden countries:


1. Real estate prices go down


2. The stock market collapses


3. Bailout attempts fail


4. The currency gets attacked and loses much of its value (which greatly increases the country’s foreign debt)


5. The banking system becomes nationalized


6. The country becomes insolvent


Iceland has already gone through all the stages. The U.K. is in stage number 4. Ireland is in stage number 3, where the U.S. also currently finds itself. Will all the four countries go through the six stages? That doesn’t have to happen if you do the right thing. We must stop throwing good money after bad, and only invest minimal amounts in the current financial system, while we build a new one at the same time. I believe we must move very quickly with a new plan, the creation of completely new banks, which I will elaborate further on in my next post.


P.S.
To those who say that nationalization is “socialism”, I’d like to say that it actually amounts to the opposite of socialism: it is meant to save the capitalist system. If the system is not saved, you may very well experience actual socialism.






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Crowd Them Out!

President Obama and his administration is currently working on a new stimulus package that includes large amounts of spending on public goods, such as infrastructure, health care and the environment. Traditionally, a public good is something that is available to all citizens of a country at little or no cost, to the benefit of everyone. However, in The United States, goods that are considered “public” in most other countries, are considered “private”. For example, health care is considered a right (by extension a public good) in the EU, whereas it is considered a privilege (a private good) in The United States. Such thinking is the reason why a lot of commentators are voicing opposition to Obama’s stimulus package at the moment.


The free market philosophy is deeply ingrained in American culture, and stretches back hundreds of years. A lot of Republicans and other free market proponents are now criticizing Obama’s plan, saying that it would “crowd out” the private sector from the provision of certain goods and services. “Crowding out” is a phrase that is used to describe a situation where the government provides a service that could have been provided by the private sector. For instance: if the government were to provide free health care for U.S. citizens that was as good as private health care, why would anyone pay for health care? As a result, private health care companies would be “crowded out”.


It is important to remember that Obama’s stimulus plan is concerned almost exclusively with public goods, or at least what the administration considers to be public goods. Obama is not suggesting that the government should start producing toaster ovens to sell for a profit. He is proposing to use public money for public goods. Very few people would argue that the government would be better at producing toaster ovens than the private sector. They tried this in the Soviet Union, but wound up with toaster ovens that could barely toast one piece of bread, as well as a mountain of them that was never sold. As I eluded to earlier, the Republicans don’t consider health care to be a right. The current debate is hence a highly ideological one. The real question here is: can the private sector provide the goods in Obama’s plan 1. affordably and 2. reliably?


Let’s go through a few examples. The most important sectors that this plan is concerned with are electricity, roads and health care.


Electricity - does anyone remember the Enron scandal? If not, this company pioneered a new approach to the provision of electricity and natural gas. Before Enron, electricity was considered as something that should be provided to citizens at the lowest cost possible. There was literally a direct link between the government’s not-for-profit production and distribution of electricity and the citizen’s outlet. Unbeknownst to citizens, Enron convinced politicians that that should no longer be so.


By introducing itself as an intermediary between the energy source and the electrical outlet, Enron was able to charge customers vast sums of money, while making electricity much more expensive. Enron bought up power grids (which were built up with taxpayer money) and charged more. It bought power plants, and charged more. It intentionally choked the supply of energy, and charged more. In the ground zero of free market philosophy, Texas, electricity prices rose by 800%, and are still at that level today even though Enron is gone. California experienced countless blackouts when Enron was in charge of electricity provision in that state. These blackouts were partly intentional to choke the supply, and partly due to incompetence. So, the result was blackouts and price increases of 800%... - guilty on both counts.


Roads - Americans are always screaming about high gas prices, but I never hear anyone screaming about road tolls. In the New York area, a trip to the shopping mall can easily wind up costing $40 in tolls. It’s important to remember that almost all roads in the country have been built with taxpayer money at some point in the past. As such, they are the property of taxpayers, as much as the White House itself is. Local governments all over the country have been selling roads to private companies since the 1980:s, in the same way that electricity grids were sold to Enron. Road tolls inhibit citizens from driving on roads that they themselves paid for, and in many cases, the money goes to private companies. These private companies have no incentive to make the roads as good as possible, their only incentive is, and should be as a corporation, profit. Hence, it makes no sense to sell a road to a private company to run it for profit, when the government can run it without a profit motive. It’s a question of good governance.


The very reason that the country’s roads are crumbling is the outsourcing of roads to private companies. By doing this, The United States now has a more expensive, and lower quality transportation system. Guilty on both counts.


Health care - need I even mention the 50 million Americans who do not have access to health care? That number is growing as the economic crisis gets worse. The United States ranks very low on measures of population health, far behind all other Western countries, and even behind Cuba. Also, I never understood why employers should be saddled with health care costs. The duty of an employer is first and foremost to pay a salary and adhere to labor laws.


A little known fact is that The United States spends around twice as much tax money per capita on health care compared to the countries in the EU that provide the most comprehensive free health coverage, such as Germany, France and Sweden. In The U.S. you are covered for nothing, and in the EU you are covered for everything, at half the cost! What does that tell you about the efficiency of the market in the provision of health care for citizens?


So, what we have is truly second-rate health of the population and non-existent coverage at astronomical prices. Guilty on both counts.


The private sector absolutely cannot provide these things affordably or reliably. In an economy, there are certain things that are suited to be provided by the market, and others that are definitely not. The motive of a health care organization should be to keep citizens healthy at the lowest cost possible. Anything other than that reflects a medieval state of mind. Profit cannot be a part of the equation, because dead patients are more profitable than surviving ones. The motive of an electricity infrastructure is to keep citizens warm and able to feed themselves. Anything other than that severely threatens the security of citizens. The motive behind a national infrastructure is for citizens to be able to move around and for goods to be able to travel. Anything other than that amounts to a country giving up sovereignty over its land.


Selling out public goods to private companies is highly detrimental to a country, and indeed immoral. Obama’s plan would crowd these companies out. The plan will not bring the short-term boost that Wall Street is praying for, and will actually do the opposite of what Wall Street wants in terms of the policy on public goods. However, people on Wall Street are too stupid to figure that out.


The selling of America’s resources must be stopped and reversed. Therefore I say: crowd them out!

The Hope For A New Financial Order

On this day that Barack Obama is inaugurated, I would like to talk about the need for big ideas for the world’s financial future. As the U.S. and the world is in a state of hope for a better future, now is the time to think big, and to think fundamentally about how we can move forward. What we need is a truly global effort to change our financial system for a sustainable future.


The financial crisis is getting worse every day, and there are some very good reasons for this. As a result of the developments of the last 20-30 years, the world’s financial state is worse than most people realize. I usually don’t list a heap of numbers on this blog, but this time, a bit of a reality check is called for. The current crisis actually has a pretty straight-forward cause, which is a rather simple question of plus and minus. Consider the following facts:


The GDP for the entire world in 2007 was around $54 Trillion.


The outstanding value of financial derivatives is currently over $200 Trillion


At least $100 Trillion of these financial derivatives are estimated to be so-called toxic assets, by several independent estimates. In essence, these assets are worthless, but someone has to take the hit…


So there is a slightly delicate question of $50 Trillion that needs to be resolved. I recently had a conversation with a plumber about the economic crisis. He was, understandably, confused about the crisis. He couldn’t understand how there could be more debts than there was money in the world. Though he was more familiar with plumbing than the world of high finance, his reasoning about the economy was positively more profound than that of any Wall Street trader.


The answer to the plumber’s question has to do with what is known as credit expansion. In essence, when speculators borrow money to bet on all sorts of different things, a bubble is created that will make it seem as if there is more money than there actually is. A speculator can hence own lots of “fantasy money”. However, the catch is that, if things go bad as they have now, the speculator cannot pay his debts back with fantasy money; he has to pay them back with real money (because the fantasy money is now worthless). Since there is considerably less real money than there is fantasy money, something’s got to give. That is why Lehman Brothers, Bear Sterns and all the other institutional speculators no longer exist, and that is why we are in a global financial crisis right now.


So, how do we deal with this problem? In society there are many rules. If rules were gotten rid of, does anyone really believe that everyone would behave responsibly anyway? If we took down all the road signs and got rid of all the traffic rules, would everyone drive safely down the road at an appropriate speed? I don’t think so, and the same is true for high finance.


Commerce is truly global again today, which it was not 30 years ago, and hence the same regulations as those that were gotten rid of in the 1980:s (which led to the crisis) cannot be applied today. The new legislation doesn’t necessarily need to be more draconian, but it needs to be comprehensive, simple, uniform as well as prohibitive.


I think it’s time for the U.N. to get involved in financial regulation. We need an International Treaty of World Commerce. We need clear and well thought out rules that will prevent a global meltdown like the one that we are seeing today. Here are some suggestions of what should be included in an International Treaty on World Commerce:


Prohibition on overly leveraged speculation - in other words, a prohibition on borrowing 20-30 times more than you own, in order to make financial bets. Leveraged speculation is what leads to credit expansion and asset bubbles, the cause of this crisis. In many countries, it is illegal to buy lottery tickets or place bets with a credit card (borrowed money). This law would be in the same spirit.


Tax on stock market investments - this would discourage small-scale investing by vulnerable individuals and also breed prudent investment strategies among institutions. Less volatility and less vulnerability would be the outcome. The tax money could go to a reserve fund of the IMF to fight economic crises wherever they occur.


Uniform accounting standards - these standards would be constructed so that hiding assets away from, or within a corporation’s balance sheet, would be next to impossible. The tactic of hiding bad assets or large liabilities, pioneered by Enron and perfected on Wall Street, is also an important cause of the crisis.


Prohibition on complicated derivatives - most financial derivatives were intentionally constructed in such a complicated way that the buyers were not meant to be able to understand what was in them or how they worked. The food industry could serve as inspiration for more transparency, and any financial product would have to have a strict declaration of its “ingredients” as well as the exact plan for growth and how that makes sense.


There are many more things that could be added. Readers are encouraged to add their own suggestions in the comment section.

Oligocracy

OK, Oligocracy isn’t really a word, but I hope it will become one as time goes by. Oligarchy (which is a real word) means the rule by the few, or a sustained political elite. Oligarchy tends to develop over time, as certain segments of the population, such as powerful families, accumulate more wealth and influence and become oligarchs. My version of the word, Oligocracy, is meant to describe a system that is intentionally set up from the beginning to be the rule of the few.


It comes without saying that a rule of the few, as opposed to the rule of the many, is inherently less democratic, and, indeed, undemocratic. The phrase, “the rule of the many” is not primarily meant to refer to a government that has, for instance, a lot of politicians, or a lot of public referenda. Instead, it is meant to refer to the inclusion of as many of the citizens as possible in the shaping and outcome of the political process. An oligocracy is meant to do the opposite.


There are several reasons why the founder or founders of a political system would want to limit the influence of citizens in the country when drafting a constitution. The United States constitution is by far the oldest constitution that is still in use in the world. Many other industrialized countries have had to write new constitutions because of wars, or chosen to significantly re-write them as they have become seen as obsolete. The older and less amended a constitution is, the more likely it is that values that are unfamiliar to us today will appear in it. Values tend to go through an evolution as societies evolve. For instance, we would be very unlikely to see a new constitution in an industrialized country that would prohibit black people from voting.


When The United States Constitution was drafted and consequently adopted, a few important values that are unfamiliar, and even reprehensible, to us today, were commonplace and seen as normal. A few of these values, which were expressed in law in The Constitution, were:


- the belief that black people should not be allowed to vote


- the belief that women should not be allowed to vote


- the belief that people who do not own property should not be allowed to vote


These beliefs express clearly, more than anything else, the belief that only a small segment of the population should be allowed to have an influence in the political system. Although all three of the abovementioned rules have been gotten rid of, the spirit of them most certainly remains in the constitution, because that constitution is so old and relatively unchanged. The U.S. Constitution, as well as other federal and state-level law, retains a very large number of provisions that are meant to limit the influence of currently disenfranchised citizens and political actors. The United States is a clear example of an Oligocracy.


In the current U.S. system, there are mainly three factors that perpetuate the U.S. oligocracy:


1. Winner-takes-all voting system. In this system, the party that gets the most votes in a given district gets all the seats in that district. The U.S. and British systems are examples of this, and this system invariably creates a two-party system. Only two parties have actual influence on national politics, and all other parties are, in practice, excluded. The alternative, which is used in a majority of advanced democracies, is proportional representation. Proportional representation awards seats in proportion to how many votes a party received. Hence: 25% of votes = 25% of seats.


2. Bipartisanship. In a two-party system, the two parties will benefit from working together, so that no other party can be successful in elections. This creates a type of political cartel, much like an economic cartel, where supposedly competing companies agree to set high prices for the customer instead of competing with each other. The voter will inevitably be short-changed in a system of bipartisanship.


3. Limiting voting rights and voting access. The U.S. still legally restricts voters who have been convicted of crimes, and to some extent, university students who study in a state other than their home state. In The U.S., voting is a much more complex affair than anywhere else, where complicated registration and voting procedures are clear and intentional deterrents to voting. Illegal voter suppression is also more common than anywhere else.


An oligocratic system is an undemocratic system that excludes large segments of the population. It comes as no surprise that The United States has, by far, the lowest voter participation in the entire industrialized world.

Why Didn't They Listen?

It has been announced today that Obama, by way of President Bush, has asked for Congress to release the second half of the TARP fund. The institution of this requirement may have been the only sensible thing to come out of the TARP plan. If it had not been instituted, all the 700 billion would have already been given away to Wall Street institutions and banks, never to be seen by taxpayers again.

The Democrats now say that they have a plan to use this money to help Main Street instead of Wall Street because the original TARP plan produced so much “unhappiness”, according to Barney Frank (who, by the way, has received millions in donations from Wall Street firms over the years). The question then becomes, in light of the hundreds of thousands of emails, letters and phone calls from voters telling politicians not to vote for the TARP plan: why didn’t they listen?


Economics is not as difficult an issue as some make it seem. Most of what it’s about is pluses and minuses. The public rightly understood that the original TARP plan was a huge cry for help by Wall Street firms that were about to go under. Simply giving them money without strings attached would not achieve anything. The public understood this too. What the public did not understand was the concept of “Voodoo economics”, where money magically appears if you leave financial markets alone. The reason that the public didn’t understand this was that it makes no sense. It makes no sense because it doesn’t work. End of story.


Politicians, however, strongly believed that they had mastered the art of Voodoo economics. They listened to who they referred to as “the smartest people in the room” (Wall Street executives), in addition to taking millions in donations from those same people. “The smartest people in the room” had for years told them that the free market can provide all the security Americans need, so taxes could be kept low and the government would not have to take responsibility for the well-being of Americans. It’s a pretty sweet deal if you think about it: in your job you get to:


1. have less responsibility (by not insuring pensions, wages, affordable education and more)


2. get millions in donations


3. not have to take any tough decisions that will anger and disappoint people (raising taxes)


The politicians were able to outsource their own jobs, while also keeping them and receiving millions of dollars in donations from the ones they outsourced to. Sweet deal! That is why they didn’t listen.

Question: what possible upside could there be to allowing large-scale campaign donations, for instance by Wall Street firms? The argument that it is essential for freedom of speech is a pretty weak one...

Protecting Your Investments With Foreign Securities

Let’s say that the economic crisis really does turn in to a full-blown depression, currency crisis, inflation or deflation spiral and obviously further deterioration in the stock market. What can you do to protect your investments? Not a whole lot, but there are a few alternatives that should be considered. What I’m about to suggest is not an easy thing to do, because it requires knowledge far beyond traditional investing and hedging in The United States.


The premise on which this analysis is based is that the U.S. economy as a whole, including the financial economy, the government, the local governments and U.S. corporations are all in very bad shape, and hence cannot be trusted as investment vehicles. Furthermore, if the U.S. government is in bad economic shape, that fact has word-wide implications on most investments.


The real core of any investment is what’s actually behind it. In the end it comes down to what someone else is willing to pay for that investment, and that in turn has everything to do with the environment in which the investment is situated. If the U.S. economy is sinking, then U.S. corporations will suffer, and U.S. stocks will sink too. (also, in case someone forgot, the U.S. stock market was and is a house of cards…)


If the U.S. government is doing poorly, and is at the same time drastically lowering interest rates, not only does one not get a good return on U.S. Treasuries, the government may actually default on the Treasuries, or inflation will make the principal worth much less. In the end, all this has to do with the way a country is run in the long term. Keeping your money inside a country that is poorly run will deteriorate all your assets domestically and internationally. The key to protecting yourself during a catastrophic crisis could then be to find a different, well-run country, from which to buy Treasuries.


If you can find a “well-run” country, you can then invest in that country’s Treasuries, or government debt. The taxpayers of that country will stand behind the debt and guarantee its value. That, in turn, means that for your investment to be safe, those taxpayers must have jobs and overall security, and the government of the country must have responsible long-term policies. Otherwise you run the same risk that you run in buying U.S. Treasuries. In order to analyze what country might be a good one to invest in, one must know about mainly the political and fiscal situations in that country. A well-run country has:


- a persistent budget surplus


- a diversified economy


- a sufficiently regulated financial sector


- a long-term political commitment to fiscal responsibility regardless of ideology


- an independent national (or supra-national) bank committed only to fighting inflation


Being able to identify countries according to all these conditions is certainly not easy, and one must know a lot about international comparative politics, history, law, government studies, institutional studies, economics and much more. However, I would like to suggest two countries that fit these descriptions: The Netherlands and Sweden.


The Netherlands has for centuries been involved in trade and business in a prudent way. The commitment to sound fiscal policies is very strong, and just like Sweden, this country consistently supports the heavy spending of the EU while getting less money back in return. The country responded well to the economic crisis and took pre-emptive steps to protect its prudent, venerated banking sector.


Sweden has a more inconsistent history of financial prudence, but has more recently gone through crises that has made the commitment to sound economic dealings very strong. Sweden is most of all famous for its efficient government institutions. When the economic crisis started in the U.S., the former Swedish minister of finance, Bo Lundgren, offered to testify before Congress on how to deal with the crisis, which is very, very similar to the Swedish crisis of the early 90s. The Bank of Sweden recently had to suspend its sales of Treasuries because demand from abroad was too high. Obviously there were some investors who were thinking in a similar way to what I am describing in this post.




Addendum - What’s wrong with the traditional hedging strategies?


U.S. stocks: Traditionally, stocks are supposed to at least keep pace with inflation and pay dividends, so that they make for good investments in the long run. We now know that the stock market was a house of cards, and there is no imaginable reason why the stock market should be a good investment anytime soon.


Foreign stocks: Before the crisis, a lot of people were talking about the idea of de-coupling. that meant that it was thought that other economies were operating independently of the U.S. economy. We now know that that idea was completely misguided. Hence, foreign stocks more or less equal U.S. stocks, and as such don’t constitute good investments.


Cash: In 2008, the Federal Reserve increased the money supply enormously. That creates a huge potential for massive inflation in the future.


U.S. treasuries: Danger of default and massive inflation, in addition to non-existent returns.


Treasury Inflation Protected Securities (TIPS): Danger of default and even lower returns. Danger of deflation.


Municipal bonds: Clear danger of default. Local and state governments have not been able to sell bonds lately because confidence has already evaporated to some extent. This is because a lot of construction projects have fallen through because of the credit crisis. Many states are in a state of fiscal emergency. If all this weren’t enough, rampant fraud with respect to these assets are beginning to come to the surface. that is why Bill Richardson had to withdraw from his attempt to join the Obama administration.


Savings account: Danger that the FDIC will run out of money. In a catastrophic crisis, this is not at all a distant possibility.


Gold: Subject to much speculation and danger of loss of value. Still, by owning a commodity, you will probably be better off than with the abovementioned assets.

Obama Knows

I have recently been quite disturbed by the appointments that Obama has made, especially with respect to his economic team. Yesterday, my wife tried to console me by saying: “he has a plan”. By that she meant that the appointments don’t necessarily translate into the policy favored by the people Obama has chosen, who largely constitute a restoration of the Clinton economic team. I put a lot of blame on Clinton for the situation we are in today, and I also blame Reagan and Bush Jr., but I don’t blame Bush Sr.


In a speech at George Mason University, Obama spoke in very serious terms about the economic state, and he, I believe, correctly identified many of the upcoming challenges. What Obama realizes is that the challenges we face are not limited to the restoration of confidence in the financial markets. This is not about even about the financial markets anymore. We are unavoidably facing a paradigm shift in the way that this country functions.


To put this in perspective, we seem to be facing a budget deficit of around 2 Trillion dollars with the Obama plan. The current estimated value of “toxic” financial assets is now around 8 Trillion dollars. If it would take 8 Trillion dollars to clean up the financial markets so that those markets can again provide America with across-the-board prosperity (which they can’t), but 1 Trillion dollars to provide direct relief according to the Obama plan, then the choice seems easy. Obama suggests something pretty simple: to funnel taxpayer money directly back to the taxpayers who need it, instead of giving it away to financial institutions in the hopes that, some day, that money will trickle back to the taxpayers. The latter was the Paulson plan.


I am definitely not a fan of deficit spending, even in a crisis. Normally, I would have argued that fiscal restraint, followed by a time of a baptism of fire would be called for. However, since the people of The United States have essentially no societal protection with respect to incomes, pensions and healthcare, such a harsh experience would probably be too devastating. To set the record straight, what we really should be talking about now are things like the following:


real dangers to future American competitiveness, a deterioration of the fabric of society, hunger, poverty, crime and the like.


Obama makes the case that the only way to deal with the situation is to mortgage our economic future. I reluctantly agree.


Here’s an important quote from Obama’s speech:


“We could lose a generation of potential and promise, as more young Americans are forced to forego dreams of college or the chance to train for the jobs of the future, and our nation could lose the competitive edge that has served as a foundation for our strength and standing in the world. In short, a bad situation could become dramatically worse.”


We cannot move forward thinking that the financial markets are going to provide prosperity and security for Americans, we must provide that among ourselves. That is the only way.

Like it or not - Burris is right

The Governor of Illinois, Rod Blagojevich, certainly seems to be a criminal. There are phone conversations in which he’s talking about selling Obama’s Senate seat, and the circumstantial evidence of Governor Rod being a crook is overwhelming. However, in the eyes of the law he is not a criminal, yet. He has not been convicted, and he has not even been indicted yet; he has only been accused of criminal activity. That means only one thing: he is still legally the Governor of Illinois, with all the powers of such a Governor.


Last week, Governor Blagojevich named Roland W. Burris as the junior Senator of Illinois to replace Obama, and Burris accepted. Today, Burris showed up in Washington for the 111th Congress, eager to get to work. However, he was shown the door by the Secretary of the Senate, Nancy Erickson because she did not accept his credentials. Burris proceeded to make the following statement to the media:


“Members of the media, my name is Roland Burris, the junior senator from the State of Illinois.”


For a replacement Senator to be named by the Governor, paperwork has to be signed by both the Governor and the Secretary of State. This is an old tradition dating back to English colonial times. In Illinois, the Secretary of State, Jesse White, has refused to sign. Theoretically, it is now argued by the Senate, this fact makes it impossible for Burris to become a Senator until White has signed. I beg to differ.


The Constitution specifically mentions that no specific tests should be required for membership in the Senate. In this case, what the Senate is actually trying to do is to:


impose a test on a would-be Senator with respect mere accusations of wrong-doing of the Governor who appointed him


It is clear that the Constitution overrules Illinois state law in this matter. The Constitution says nothing about signatures from the Secretary of State, and the Supreme Court has ruled that the Senate cannot impose any additional tests on would-be Senators. We’re not even talking about the appropriateness of the would-be Senator himself, but that of the one who appointed him. I believe that it would be very difficult to make an actual legal case that Burris should not be the Senator of Illinois. Like I said, Governor Blagojevich still has all the powers of a Governor, end of story.


This debacle certainly raises some important questions, however. The most important one, in my view is:


Who can veto a Senate appointment?


From the Burris debacle, one could deduct that the ones who can veto such an appointment is: 1. a Secretary of State, 2. a Secretary of the Senate, and 3. the Senate collectively.


Imagine if all Secretaries of State were to get together and decide to block all Senate appointments. They could then do so until people that they liked were appointed instead. These Secretaries could gain control of the Senate. Imagine if the Secretary of the Senate were to start blocking would-be Senators to achieve political goals. That would become an enormously powerful position. If the Senate started imposing all kinds of different tests on would-be Senators, the American political system would become infinitely more gridlocked than it already is.


I think the whole thing stinks, but if you want to follow the law, Burris must become Senator. The American political system fosters corruption because private donations to politicians are allowed, which makes it possible for criminals like Blagojevich to become Governors.

Fighting Off Depression

Paul Krugman writes today in The New York Times about what the new administration should do to fight off a depression. Krugman believes that large-scale Keynesian deficit spending is what is needed in a situation like the current one. He also rejects the Friedmanite theory that capital injections into banks can be a way to fight off a depression.


Krugman is certainly a decent economic thinker, but he is not known for his consistency. He used to advocate capital injections into banks, but is now apparently against those. He used to call Thomas Frank’s theories on the so-called “Southern Strategy” “erroneous” (theories having to do with poor people voting for Republicans, even though that goes against their economic self-interest), whereas he now writes about them all the time, as if he came up with them himself. Krugman, like Bernanke, lacks an ideological determination and clarity of vision.


Now, I agree that something has to be done to try to avoid a depression, but things are more complicated than Krugman make them seem. First of all, Keynesian spending is just a band-aid approach. Second, Friedmanite bank capital injections usually work, but only if they are highly controlled by the government. Third, a depression in The United States is something very different compared to a depression in every other industrialized country, because The United States does not have a social safety net.


Short-term solutions is without question the usual name of the game in terms of American politics, and also in terms of American academic economics. As I wrote in my last post, ideology is absent from American politics. If the government does not have a clear-cut ideological vision, a series of band-aid approaches tends to dominate politics. The result is the same if the ideological conviction is a conservative one, in which case (according to conservatism) band-aid approaches constitute the second-best solution, second only to doing nothing. Keynesian spending can indeed provide some short-term relief if a depression is looming. Perhaps more than anything, it can provide a “psychological stimulus”, where people see other people working, building things, and things happening in general. This can bring back confidence in the system. The question that I’m asking, however, is: should confidence in the system be quickly brought back by Keynesian spending?


I would argue that the problems we are experiencing today are much deeper than a problem of confidence. To apply a series of band-aid approaches so that we could go on as before would be a grave mistake. Like I said, there is nothing wrong with spending during a crisis per se, but you should never spend money you don’t have. Spending is good, deficit spending is bad.


I turn again to Sweden, that went through a very, very similar crisis in the early 90s. Sweden had tried the Keynesian model for 30 years, but ultimately rejected it when it became clear that it was artificially supporting a system that was not sustainable. That system came to an end in the early 80s. With these lessons in mind when the crisis came, the Parliament worked out a crisis package with broad, multi-party (yes, there are more than just two parties in Sweden…) support. The solution, thought the government, was not deficit spending, but:


1. spending reduction,


2. capital injections into banks (where the government took control of those banks, not just gave away the money like a bunch of idiots…) and,


3. Long-term commitment to budget surplus and a pay-as-you-go system for government spending


This may sound like some type of anti-government Republican credo, but keep in mind that government spending makes up over 40% of GDP in that country, whereas it makes up less than half that in The United States. Let me say this once and for all: sound fiscal policies should have nothing to do with what ideology you subscribe to.


Number 1 and 2 in the list above were meant to stave off the crisis, but by no means quickly get rid of it and continue like before. The government realized that something had to give, and the recovery was painful, but real. The third action, or commitment, was actually realized, and it was meant to set the country up in such a way that the next big crisis would be easier to get through.


This is exactly what ended up happening. To be sure, Sweden is currently going through a lot of pain and job losses, but the government’s coffers are full because budget surpluses for over 10 years have created a readiness for the crisis that we see today. As a result, Sweden can use the surplus that has been built up to spend its way out of the crisis without running a deficit. That’s the beauty of the whole thing: you achieve crisis relief without setting the country up for the next crisis by means of deficits, loans, and all the rest of it.


The United States now has a chance to set the country up in the same way that Sweden did in the early 90s. By doing that, the country will be more sustainable in the future, and be able to weather the next crisis as Sweden weathers the current one now.

Without Ideology, There Is Only Anarchy

The word “ideology” has a somewhat offensive ring to most Americans. You often hear politicians on the campaign trail saying things like “Americans are not interested in ideology”, or “we will work in a non-ideological, bi-partisan manner”. All that ideology really is, is a coherent structure of ideas that are meant to appeal to voters. So how can that in itself be offensive?


When the United States was founded at the end of the 18th century, it was founded on the idea of independence from the British king. That a subordinate country broke free from a colonial power was certainly nothing new, but the great novelty in the American case was how this was done, and how the new country moved forward. If a political commentator in 1788 would have guessed what the future of America was to be, using history as a guide, he or she would most likely have guessed that the heroes of the revolution would battle it out with each other for supremacy in order to ascend the “American throne”. In other words, we could very well have had a “King George Washington”.


The founding fathers chose instead to give away power to a segment of the general population, using a model that resembles that which was used in ancient Greece, where property-owning men were made a part of the political process. Indeed, many argue that the parallels between contemporary American and ancient Greek democracy are many still today, especially with respect to Socratic ideals of the good citizen and politician who is financially and morally responsible for his household, community, as well as being a prudent policy maker in the legislature. Another important factor and parallel was the belief that politics should be primarily a local affair. This early model of democracy is hence based on the leadership of a (hopefully) benevolent elite.


When The United States was founded, all European countries were still dictatorships. This fact created a struggle for something better in Europe, which eventually created the ideologies we know today. Without question, the two most important ideologies to come out of this process are liberalism and socialism. Conservatism is not an ideology, as much as it is an absence of ideology, because it only seeks to conserve, and not to renew. Today, in the entire western world, with the exception of the United States, the political landscape in each country is basically made up of two blocks of somewhat opposing ideologies:


Right: Classic liberals along with conservatives, and


Left: Socialists along with social liberals.


The United States hence defies what seems to be the “natural order” of a Western political landscape, in that it has two blocks on the right (Republicans and Democrats), and none on the left.


Due to the fact that America was never a dictatorship governed from within, the struggle for political change with respect to economic differences between different segments of the population never quite took off. America was only a dictatorship vis-à-vis its colonial power, and not vis-à-vis a domestic dictator or domestic elite. Also, The United States was founded before a real crystallization of the ideologies occurred, so little inspiration could have come from them. At the time of its founding, The United States had the most modern form of government on earth, but because of the inherent, incredibly conservative nature of the constitution, that was eventually about to change in a big way.


Being the first one to embark on something has its pros and its cons. The early adoption must be followed by constant updating, otherwise you run the risk of lagging behind quickly. The United States was among the very first to adopt standards for electricity and TV, never to change them after that. Hence, the low Volt grid (110V as opposed to 230V in most other countries) is less efficient, and the American TV standard now has a lower resolution than that of most other countries. The United States never updated its constitution to include things like proportional representation, a unicameral legislature, a separation of the head of government from the head of state; things that most citizens of other Western countries now enjoy.


The American political system can now only be described as an 18th century dinosaur in an increasingly complex world. The recent financial crisis is the perfect example of how the individual nature of American politics is unable to deal with complex problems. Because the system is based on the perceived good personal qualities of the “benevolent elite” (meaning the individually elected Congressmen), American politics has become an awkward expression of the individual gut feelings of the elected individuals. When the financial crisis came, a motley crew of individuals who had no idea whatsoever about what they were doing or what they were dealing with, signed away trillions of dollars of taxpayer money in the biggest misguided give-away in history. The inability to act swiftly, responsibly, intelligently and successfully is, in a nutshell, the biggest problem with the American political system. In order to act swiftly, responsibly, intelligently and successfully, you don’t need a gut, you need an idea.


Negative statements about ideology from American politicians come as no surprise. Systems and institutions have a way of perpetuating themselves in their own self-interest. American politicians have been able to convince voters for centuries that ideology is bad, because that is all that voters are ever exposed to. If ideology were introduced in a big way in American politics, it would not only make it more difficult for wealthy individuals to get elected on vague policies; politicians would be able to be held accountable on a moral and philosophical level. That would in turn, by definition, take away large elements of self-interest from politicians and give that self-interest to voters. Naturally, an American politician would not want to do this.


As a direct result of this, the vagueness and lack of ability to foresee the actions of an elected politician creates a highly watered-down political process in a do-nothing government. Politicians won’t want to do anything because that goes against their self-interest. In that situation, politics inevitably moves towards a type of anarchy. Small government, less regulation, less social security, less concerted action in all things political; these are all anarchic tendencies.


Without ideology, there is only anarchy