Libertarian Democrat Point Of View: An Eccentricity

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Showing posts with label Allowing US to Default. Show all posts

Wednesday, May 27, 2009

U.S. has the “enormous privilege of controlling the world’s most important reserve currency,” allowing it “to borrow almost without limit

TO BE NOTED: From Alphaville:

“Why the USA will not get downgraded” Posted by Stacy-Marie Ishmael on May 27 15:55.

Gluskin Sheff’s David Rosenberg weighed in on Wednesday on the likelihood of a sovereign downgrade for the US of A (emphasis FT Alphaville’s):
I realize this it is borderline heresy to say anything positive about the U.S. economy so I will just say something that is less positive. It is highly unlikely that the U.S. government will ever default. Why? Well, it can always print dollars — and all its liabilities are in dollars.

Not only that, but it was comical to see the markets focus on the U.S. dollar and the Treasury market following the downgrade to the U.K.’s credit outlook. There is no use comparing the diversified economic base between the two countries.

Not only that, but the taxing capacity in the United States is much larger — government revenues absorb 42% of national income in the U.K. versus 33% in the U.S.A. Those comparable figures are 43% in Germany, 46% in Italy, and 49% in France. In Canada, it is 40%. But here is the grim reality for American workers, especially those in the upper income echelons. The President ran on a campaign to redistribute income, and at the same time he has beefed up what was already a near-intolerable deficit, and as we saw in the 1930s as the top marginal tax rate climbed to nearly 80%, Uncle Sam is going to be increasing its revenue take for a long, long time. The era of the word ‘tax’ being a dirty three-letter words in the United States is about to come to a close, if it hasn’t already in areas like New York, where the top rate has already risen to 46%. Shades of Ontario during the Rae years of the early 1990s.

Which is somewhat more optimistic than he said last Thursday, after S&P revised its outlook on the UK to negative from stable:

Don’t think for a second that the same cannot happen to the USA at some point judging by the massive runup in government debt and debt guarantees.

In fairness, last week he was responding specifically to the possibility of an outlook revision, which is much more likely than an outright downgrade of the US credit rating.

Moreover, S&P seems to want to allay concerns that it is even considering any such thing. Here’s Bloomberg on the matter:

Standard & Poor’s decision to cut its outlook on Britain’s top credit rating doesn’t signal a similar move for the U.S. will follow, said Moritz Kraemer, S&P’s head of sovereign ratings for Europe, Middle East and Africa. “I want to make it very clear that the negative outlook on the U.K. is not a secret message to Washington,” Kraemer told reporters at a media briefing in Johannesburg today. If we wanted to talk about the U.S. then we’d talk about the U.S.”

And, echoing Rosenberg:

The U.S. has the “enormous privilege of controlling the world’s most important reserve currency,” allowing it “to borrow almost without limit,” Kraemer said. U.S. debt has a “top notch credit rating” and is “very safe,” he said.

S&P estimates that 48 percent of all U.S. Treasuries are held abroad, “mostly by central banks,” Kraemer said. The percentage of U.K. gilts held by foreign central banks “is in the lower thirties” and less than that for Germany, he said. There is no “serious contender” to threaten the dollar’s status as a global reserve currency, Kraemer added. The euro is the “only credible alternative” to the dollar, though it’s “not mature enough,” he said.

Everyone calm down, then (and here’s looking at you, Bill Gr0ss).

UPDATE at 16:45 - Moody’s is now weighing in, with a press release titled “US government’s Aaa stable despite increased debt burden” (emphasis ours):

New York, May 27, 2009 — Even with a significant deterioration in the US government’s debt position, its rating has a stable outlook and demonstrates the attributes of a Aaa sovereign, says Moody’s Investors Service in its annual report on the United States. These attributes include a diverse and resilient economy, strong government institutions, high per capita income, and a central position in the global economy.

“Moody’s expects that, because of these factors, US economic strength will emerge after the crisis without major impairment,” said Moody’s Vice President Steven Hess, author of the report. “The global role of the US currency also contributes to the ability of the economy and government finances to rebound.”

He said the government balance sheet has been weakened by the combination of efforts to stabilize the financial system, the effects of the sharp economic recession on federal finance, and the $787 billion federal stimulus package passed earlier this year. The result has been much higher debt ratios that may persist for some years to come. While these ratios are deteriorating in the US, they are also doing so in most other advanced economies due to the global recession.

Furthermore, the level of debt is less important than the government’s balance sheet flexibility, which Moody’s believes is still high in the case of the US. Despite a worsening government balance sheet, Moody’s cites other factors in support of the Aaa rating. “The current economic downturn has only temporarily altered America’s productivity dynamic, and productivity has risen in the recession period, as is typical,” said Hess. “US labor market flexibility has been a key factor in this trend.”

A higher rate of US population growth through 2025 relative to other advanced economies will also contribute to continued economic growth — and government revenues.

“While our outlook for the US rating is stable, a reassessment of the long-term growth prospects of the economy and the ability of the government to return to a sustainable debt trajectory could put negative pressure on the rating in the future. How the economy and fiscal policy fare after the recession will be key,” said Hess. He added that, over the longer term, contingent liabilities related to Social Security and Medicare programs could also pressure the rating.

Related links:
Exploding debt threatens America - FT
Marc Faber: Hyperinflation coming to the USA - FT Alphaville
On the not-unlimited appetite for government bonds - FT Alphaville

This entry was posted by Stacy-Marie Ishmael on Wednesday, May 27th, 2009 at 15:55 and is filed under Capital markets. Tagged with Debt, sovereign ratings, usa."

Moi ( Me, in French ):

The question of default by the US is not an economic issue, but a political issue. The question is really about whether or not US politicians would favor a default at some point. The clear answer to that is that they would, under the right circumstances, such as needing the issue to win an election. I would look to whether or not politicians start blaming China and the giant foreign pool of money for US problems. That is a good default indicator.

Likely. No. But aren't we all a bit dubious now of our ability to predict the future?

Thursday, May 21, 2009

Even a doom-monger like John Hussman says that Treasury bonds are “default-free securities”

From Reuters:

"Felix Salmon

is summer arriving?

« Previous Post

May 21st, 2009

Can America’s debt get too big to pay?

Wednesday, April 8, 2009

But to say that these were justifiable sovereign defaults does not mean that they were not sovereign defaults. Similar circumstances could arise agai

TO BE NOTED: BUITER:

"The green shoots are weeds growing through the rubble in the ruins of the global economy

April 8, 2009 3:20am

The Great Contraction will last a while longer

This financial crisis will end. The Great Contraction of the Noughties also will come to an end. But neither the financial crisis nor the contraction of the global real economy are over yet. As regards the financial sector, we are not too far - probably less than a year - from the beginning of the end. The impact of the collapse of real economic activity and of the associated dramatic increase in defaults and insolvencies by non-financial enterprises and households on the loan book of what is left of the banking sector will begin to show up in the banks’ financial reports at the end of the summer and in the autumn. By the end of the year - early 2010 at the latest - we will know which banks will survive and which ones are headed for the scrap heap. With the resolution of the current pervasive uncertainty about the true state of the banks’ balance sheets and about their off-balance-sheet exposures, normal financial intermediation will be able to resume later in 2010.

Governments everywhere are doing the best they can to delay or prevent the lifting of the veil of uncertainty and disinformation that most banks have cast over their battered balance sheets. The banking establishment and the financial establishment representing the beneficial owners of the institutions exposed to the banks as unsecured creditors - pension funds, insurance companies, other banks, foreign investors including sovereign wealth funds - have captured the key governments, their central banks, their regulators, supervisors and accounting standard setters to a degree never seen before.

I used to believe this state capture took the form of cognitive capture, rather than financial capture. I still believe this to be the case for many, perhaps even most of the policy makers and officials involved, but it is becoming increasingly hard to deny the possibility that the extraordinary reluctance of our governments to force the unsecured creditors (and any remaining non-government shareholders) of the zombie banks to absorb the losses made by these banks, may be due to rather more primal forms of state capture.

History teaches us that systemic financial crises are protracted affairs. A most interesting paper by Carmen M. Reinhart and Kenneth S. Rogoff, “The Aftermath of Financial Crises”, using data on 10 systemic banking crises (the “big five” developed economy crises (Spain 1977, Norway 1987, Finland, 1991, Sweden, 1991, and Japan, 1992), three famous emerging market crises (the 1997–1998 Asian crisis (Hong Kong, Indonesia, Malaysia, the Philippines, and Thailand); Colombia, 1998; and Argentina 2001)), and two earlier crises (Norway 1899 and the United States 1929) reaches the following conclusions (the next paragraph paraphrases Reinhart and Rogoff).

First, asset market collapses are deep and prolonged. Real housing price declines average 35 percent over six years; real equity price declines average 55 percent over a downturn of about 3.5 years. Second, the aftermath of banking crises is associated with large declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, but the duration of the downturn averages around 2 years.

Nothing more can be expected as regards a global fiscal stimulus. Indeed, the G20 delivered nothing in this regard. It would have been preferable to maintain the overall size of the planned (or rather, expected) global fiscal stimulus but to redistribute the aggregate (about $5 trillion over 2 years, as measured by the aggregated changes in the national fiscal deficits) in accordance with national fiscal spare capacity (I believe the World Bank calls this ‘fiscal space’). This would mean a smaller fiscal stimulus for countries with weak fiscal fundamentals, including the US, Japan and the UK, and a larger fiscal stimulus for countries with strong fiscal fundamentals, including China, Germany, Brazil and, to a lesser degree, France.

The effect of the Great Contraction on potential output growth

Furthermore, a likely consequence of the fiscal stimuli we have already seen or are about to experience is a negative impact on the medium- and long-term growth potential of the global economy. The reason is that, if fiscal solvency is to be maintained, there will have to be some combination of an increase in the tax burden and a reduction in non-interest public spending in most countries when this contraction is over. The inevitable effect of the crisis and the contraction is a higher public debt burden and therefore a larger future required primary government surplus (as a share of GDP). Almost any increase in the tax burden will hurt potential output - just the level of the path of potential output if you are a classical growth groupie, both the level and the growth rate of the path of potential output if you are an adept of the endogenous growth school.

In the study of Reinhart and Rogoff cited earlier, the authors conclude that the real value of government debt tends to explode following a systemic financial crisis, rising an average of 86 percent in major post–World War II episodes. The principal cause of these public debt explosions is not the costs of “bailing out” and recapitalizing banking system. The big drivers of these public debt burden increases are rather the collapse in tax revenues that comes with deep and prolonged output contractions (the operation of the automatic stabilisers) and discretionary counter-cyclical fiscal policies.

For political expediency reasons, cuts in public spending are likely to fall first on maintenance, public sector capital formation and other forms of productive public expenditure, including spending on education, health and research. Welfare spending in cash or in kind is likely to be the last to be cut. The result is again likely to be a lower level (or level and growth rate) of the path of potential output.

The risk of ’sudden stops’ in the overdeveloped world

In a number of systemically important countries, notably the US and the UK, there is a material risk of a ’sudden stop’ - an emerging-market style interruption of capital inflows to both the public and private sectors - prompted by financial market concerns about the sustainability of the fiscal-financial-monetary programmes proposed and implemented by the fiscal and monetary authorities in these countries. For both countries there is a material risk that the mind-boggling general government deficits (14% of GDP or over for the US and 12 % of GDP or over for the UK for the coming year) will either have to be monetised permanently, implying high inflation as soon as the real economy recovers, the output gap closes and the extraordinary fear-induced liquidity preference of the past year subsides, or lead to sovereign default.

Pointing to a non-negligible risk of sovereign default in the US and the UK does not, I fear, qualify me as a madman. The last time things got serious, during the Great Depression of the 1930s, both the US and the UK defaulted de facto, and possibly even de jure, on their sovereign debt.

In the case of the US, the sovereign default took the form of the abrogation of the gold clause when the US went off the gold standard (except for foreign exchange) in 1933. In 1933, Congress passed a joint resolution canceling all gold clauses in public and private contracts (including existing contracts). The Gold Reserve Act of 1934 abrogated the gold clause in government and private contracts and changed the value of the dollar in gold from $20.67 to $35 per ounce. These actions were upheld (by a 5 to 4 majority) by the Supreme Court in 1935.

In the case of the UK, the de facto sovereign default took the form of the conversion in 1932 of Britain’s 5% War Loan Bonds (callable 1929-1947) into new 3½ % bonds (callable from 1952) on terms that were unambiguously unfavourable to the bond holders. Out of a total of £2,086,000,000 outstanding, £1,500,000,000, or something over 70%, was converted voluntarily by the end of 1932, thanks both to the government’s ability to appeal to patriotism and joint burden sharing in the face of economic adversity and to ferocious arm-twisting and ‘moral suasion’.

I believe both defaults were eminently justified. There is no case for letting the interests of the holders of sovereign debt override the interests of the rest of the community, regardless of the financial, economic, social and political costs involved. But to say that these were justifiable sovereign defaults does not mean that they were not sovereign defaults. Similar circumstances could arise again.

While I consider an inflationary solution to the public debt overhang problem (and indeed to the private debt overhang problem) to be more likely in the US and even in the UK than a sovereign default (or ‘restructuring’, ‘conversion’ or ‘consolidation’, as it would undoubtedly be referred to by the defaulting government), neither can be dismissed as out of the question, or even as extremely unlikely.

Central banks: a mixed bag

Central banks, with the notable exception of the procrastinating ECB, are doing as much as they can through quantitative easing and credit easing to deal with the immediate crisis. Unfortunately, some of them, notably the Fed, are providing these short-term financial stimuli in the worst possible way from the point of view of medium- and longer-term economic performance, by surrendering central bank independence to the fiscal authorities.

When the Fed lends on a non-recourse basis to the private sector with only a $100 bn Treasury guarantee for a possible $1 trillion dollar Fed exposure (as with the TALF), when the Fed purchases private securities outright with just a similar 10-cents-on-the-dollar Treasury guarantee or when the Fed is party to an arrangement that transfers tens of billions of dollars to AIG counterparties - money that is likely to be extracted ultimately from the beneficiaries of other public spending programmes or from the tax payer, either through explicit taxes or through the inflation tax - the Fed is acting like an off-balance sheet and off-budget special purpose vehicle of the US Treasury.

When the Chairman of the Fed stands shoulder-to-shoulder or sits side-by-side with the US Treasury Secretary to urge the passing of various budgetary proposals - involving matters both beyond the Fed’s mandate and remit and beyond its competence - the Fed is politicised irretrievably. It becomes a partisan political player. This is likely to impair its ability to pursue its monetary policy mandate in the medium and long term.

The G20 wind egg

The global stimulus associated with the increase in IMF resources agreed at the G20 meeting earlier this month will be negligible unless and until these resources actually materialise. The statements, declarations and communiqués of the G20, including the most recent ones highlight the gaps between dreams and deeds.

Even the promise of an immediate increase in bilateral financing from members of $250 bn is not funded yet. Only $200 have been promised firmly - $100 bn by Japan and $100 bn by the EU. Prime Minister Brown announced that the PRC had committed another $40 bn, but apparently he had forgotten to clear this with the Chinese.

As regards the plan to incorporate in the near term, the immediate financing from members into an expanded and more flexible New Arrangements to Borrow would be increased by up to $500 billion (that is by another $250 bn). Unfortunately, nobody has volunteered any money yet. It therefore has no more substance than past commitments by the international community to fund the achievement of the Millenium Development Goals.

Then there is the promise that the G20 will consider market borrowing by the IMF to be used if necessary in conjunction with other sources of financing, to raise resources to the level needed to meet demands. That is classic official prittle-prattle - suggesting the IMF borrow without providing it with the resources (capital) to engage in such borrowing.

There is also $6 bn for the poorest countries, to be paid for by IMF gold sales and profits. Nice, but chicken feed.

Finally there is the decision to support a general allocation of SDRs equivalent to $250 billion to increase global liquidity, $100 billion of which will go directly to emerging market and developing countries. The problem is that this requires the approval of the US Congress, which is deeply hostile to any additional money for any of the Bretton Woods institutions. A special allocation of SDRs is also out of the question, because the US has not yet ratified the fourth amendment to the IMF’s articles (approved by the IMF’s Board of Governors in 1997!).

So apart from the $240 bn (or perhaps only $200 bn) already flagged well before the G20 meeting, the only hard commitment to additional resources (or to resources that have any chance of being available for lending and spending during the current contraction) is the $6 bn worth of alms for the poor from the sale of IMF gold. That’s what I call a bold approach!

The Multilateral Development Banks may well be able to increase their lending by $100 bn as announced by the G20, even with existing capital resources.

The increase in trade credit support announced at the G20 meeting is very modest indeed - $250 bn could be supported (mainly through guarantees, I suppose) over the next two years.

As regards protectionism, we must be grateful for the vast difference between today’s relatively mild manifestations and the virulent protectionism of the 1930s. But again, the last few G20 meetings have yielded not a single concrete protectionism-reducing measure.

Conclusion

There are signs that the rate of contraction of real global economic activity may be slowing down. Straws in the wind in China, the UK and the US hint that things may be getting worse at a slower rate. An inflection point for real activity (the second derivative turns positive) is not the same as a turning point (the first derivative turns positive), however. And even if decline were to end, there is no guarantee that whatever growth we get will be enough to keep up with the growth of potential. We could have a growing economy with rising unemployment and growing excess capacity for quite a while.

The reason to fear a U-shaped recovery with a long, flat segment is that the financial system was effectively destroyed even before the Great Contraction started. By the time the negative feedback loops from declining activity to the balance sheet strenght of what’s left of the financial sector will have made themselves felt in full, financial intermediation is likely to be severely impaired.

All contractions and recoveries are primarily investment-driven. High-frequency inventory decumulation causes activity to collapse rapidly. Since inventories cannot become negative, there is a strong self-correcting mechanism in an inventory disinvestment cycle. We may be getting to the stage in the UK and the US (possibly also in Japan) that inventories stop falling an begin to build up again.

An end to inventory decumulation is a necessary but not a sufficient condition for sustained economic recovery. That requires fixed investment to pick up. This includes household fixed investment - residential construction, spending on home improvement and purchases of new automobiles and other consumer durables. It also includes public sector capital formation. Given the likely duration of the contraction and the subsequent period of excess capacity, even public sector infrastructure spending subject to long implementation lags is likely to come in handy. A healthy, sustained recovery also requires business fixed investment to pick up.

At the moment, I can see not a single country where business fixed investment is likely to rise anytime soon. When the inventory investment accelerator goes into reverse and starts contributing to demand growth, and when the fiscal stimuli kick in, businesses wanting to invest will need access to external financing, since retained profits are, after a couple of years of declining output, likely to be few and far between. But with the banking system on its uppers and many key financial markets still disfunctional and out of commission, external financing will be scarce and costly. This is why sorting out the banks, or rather sorting out the substantive economic activities of new bank lending and funding, that is, sorting out banking , must be a top priority and a top claimant on scarce public resources.

Until the authorities are ready to draw a clear line between the existing banks in western Europe and the USA, - many or even most of which are surplus to requirements and have become parasitic entities feeding off the tax payer - and the substantive economic activity of bank lending to non-financial enterprises and households, there will not be a robust, sustained recovery."

Tuesday, March 24, 2009

“We’re in a government-dependent financial system; I never thought I would live to see the day… We’ve got to fight to get away from that.”

TO BE NOTED: From Real Time Economics:

"By Phil Izzo

When talk at the Journal’s Future of Finance Initiative turned to inflation, participants turned the resident expert: Paul Volcker. He had a lot to say.

The former Federal Reserve chairman touched on a number of subjects ranging from the Fed’s communication strategy to China’s concerns about the U.S. debt load. The latter sparked questions over whether the U.S. could default on its debt — it effectively had done that at least once, Yale professor Robert Shiller noted. When President Roosevelt took the U.S. off the gold standard and unilaterally devalued the dollar, the move wiped out some 75% of dollar-denominated debt. “Maybe I shouldn’t even mention this,” Shiller joked.

Volcker, who as head of the White House’s Economic Recovery Advisory Board is a key adviser to President Obama, expressed concerns about inflation as a way of dealing with mounting debt. “One historic way of getting yourself out of this situation — or trying to — is to inflate. Either you do it deliberately or you allow it to happen,” he said. “And if we permit that to happen then I think all these dollars will come tumbling down on us.” He said the U.S.’s greatest strength is its history and reputation, and suggested that shouldn’t be put at risk.

He also critiqued the Fed. “I get a little nervous when I see the Federal Reserve announcements that they want have the amount of inflation that’s conducive to recovery,” Volcker said. “I don’t know what ‘the amount of inflation that’s conducive to recovery’ would be appropriate. I’d much rather they say that they want to maintain stability in the currency, which is conducive to confidence and recovery.”

As for China’s criticism of the U.S., Volcker was unsympathetic. “I think the Chinese are a little disingenuous to say, ‘Now isn’t it so bad that we hold all these dollars.’ They hold all these dollars because they chose to buy the dollars, and they didn’t want to sell the dollars because they didn’t want to depreciate their currency. It was a very simple calculation on their part, so they shouldn’t come around blaming it all on us.”

The 81-year-old elder statesman commented on the current state of the U.S. economy: “We’re in a government-dependent financial system; I never thought I would live to see the day… We’ve got to fight to get away from that.”

Tuesday, February 24, 2009

the inevitability of debt repudiation in the U.S.

From Paul Kedrosky:

"The Inevitability of U.S. Debt Repudiation

Thoughtful and important post from my friend Gregor Macdonald on the inevitability of debt repudiation in the U.S. It can be de facto or explicit -- through inflation or a declining tax base -- but Gregor's point that U.S. debt repudiation is "already in the pipeline" is one that anyone interested in the future of U.S. economic growth must reckon with.

We also know that flagrant monetization will not be allowed to go on forever. That too is in the pipeline, as the FED has expanded outright non-sterilized purchases of financial assets. They have backed-stopped trillions in assets already with Treasury lending, but have since moved on to outright purchases. It’s likely that any month now they will start classical monetization of Treasuries. The FED has told us so. Thus, the second path to repudiation will come via quantitative easing, and inflation.

Now comes the populist response to the financial crisis. This is the third pressure that will come to bear on both tax revenues to Washington, and Washington financial policy. One face of the populist response is Liquidationist. The other face is Keynesian and Interventionist. The Liquidationist movement, to the extent its successful, will promote default in the private sector. (It will also be associated with Tax Revolts). The Interventionist movement will seek to move default into the public sector. In the end, it doesn’t really matter which pipeline is the conduit for default.

Read the whole thing."

Me:

The only default plan that will work is default to foreign investors. Just as raising taxes or cutting costs, the natural solutions, won't work politically,and are ruled out, so inflating the home economy or some such variant won't work, and for the same reasons.

On the other hand, blaming foreigners might work, especially if you can say that they caused this crisis by loaning us the money in the first place. Expect them to be compared to drug dealers before long, thus introducing crime and terrorism into the mix.

Of course, we could try dealing with these problems ourselves by making hard choices.

Friday, February 20, 2009

Inflating away debts is a time honored tradition, but hasn't its time passed in the developed world?

From Kevin Drum:

"Inflating Your Troubles Away

— By Kevin Drum | Fri February 20, 2009 10:43 AM PST

Michael Kinsley is understandably skeptical that once we've stimulated our way out of the recession we'll all suddenly see the light and begin saving more and consuming less. So what will happen instead?

There is another way. If it's not the actual, secret plan, it will be an overwhelming temptation: Don't pay the money back. So far, even as one piggy bank after another astounds us with its emptiness, there have been only the faintest whispers about the possibility of an actual default by the U.S. government. Somewhat louder whispers can be heard, though, about the gradual default known as inflation. Just three or four years of currency erosion at, say, 10 percent a year would slice the real value of our debt — public and private, U.S. bonds and jumbo mortgages — in half.

Inflating away debts is a time honored tradition, but hasn't its time passed in the developed world? Most domestic debts (adjustable mortgages, credit card rates, etc.) are tied to LIBOR or the prime rate, which generally follow the inflation rate. So if inflation goes up, so do your payments. No help there. As for foreign debt, inflation would weaken the dollar — assuming arguendo that other countries all kept their inflation in check at the same time — but that would cause interest rates to rise in response. A weaker dollar would help exports and reduce domestic consumption, which is good, but higher interest rates on treasury bonds would make our fiscal situation worse, not better. So there's no help there either.

Do I have this right? Or is Kinsley right to be concerned? Isn't inflation hedging too built in to our current economic system to offer the kind of benefit he suggests?"

Me:

US Default

Submitted by Don the libertarian Democrat (not verified) on February 20, 2009 - 11:44am.

Since the problem is partly political, in that we can't seem to raise taxes and lower spending when times get better, you need to ask yourself which option would be easier to sell here, inflation or default. It seems to me that inflation will have a lot of easily seen negative side effects on our citizens, while defaulting on debts, especially to foreign countries, could be quite popular. One way to do this would be to blame our troubles on the countries that funded our debt, say, China. That could make it much easier to default on them.

Now, some people say that we can only use inflation, but I came across this:

http://www.rgemonitor.com/us-monitor/255267/was_there_ever_a_default_on_us_treasury_debt

And there's this possibility:

http://www.bloomberg.com/apps/news?pid=20601080&sid=aFgHlh.Dn4Lc&refer=news

By Stanley White and Shigeki Nozawa

Dec. 24 (Bloomberg) -- Japan should write-off its holdings of Treasuries because the U.S. government will struggle to finance increasing debt levels needed to dig the economy out of recession, said Akio Mikuni, president of credit ratings agency Mikuni & Co.

The dollar may lose as much as 40 percent of its value to 50 yen or 60 yen from the current spot rate of 90.40 today in Tokyo unless Japan takes “drastic measures” to help bail out the U.S. economy, Mikuni said. Treasury yields, which are near record lows, may fall further without debt relief, making it difficult for the U.S. to borrow elsewhere, Mikuni said.

“It’s difficult for the U.S. to borrow its way out of this problem,” Mikuni, 69, said in an interview with Bloomberg Television broadcast today. “Japan can help by extending debt cancellations.”

Perhaps President Obama can mention this possibility to PM Aso on the 24th.

Thursday, February 12, 2009

But could it be the case that American default is simply inevitable?

From Free Exchange:

"Will America default?

Posted by:: Economist.com | NEW YORK

Categories:: Financial markets; Fiscal policy; Government spending

OUR own Grep Ip had a very interesting op-ed recently on the possibility that America might default on its debt. He noted that the credit derivatives market (American sovereign CDS traded at 82 basis points last Friday), now peg the probability of default at about 6%. That's amazing—last summer I found it incredible that CDS traded at 24 basis points. The rising CDS spreads are the result of speculation that spreads will rise even further, rather than the belief America will actually default. But even still, it suggests that markets are at the very least considering the possibility of a debt downgrade.

Mr Ip believes the government will sooner try and inflate down the debt than default, which is probably true. But he reckons that in the unlikely event America must choose between hyperinflation and default, the unthinkable could occur. In November, I imagined a scenario in which default could happen for political reasons, but that currently seems equally far fetched.

But could it be the case that American default is simply inevitable? As Mr Ip points out, the government must address its looming entitlement crisis. A solution there will involve either increased taxes or reduced benefits (and will probably some combination of the two), which is really just another form of default. Social Security is a pay-as-you-go system which means that there exists a social contract that current contributors will receive a particular annuity (based on wage and price inflation). Altering the benefit formula violates that contract, because the government will no longer pay what it promised cohorts when they paid into the system.

Still, a Social Security “default” or restructuring is probably the best alternative. Markets do not like surprises and most American put the probability of a change to entitlements near unity."

Me:

Don the libertarian Democrat wrote:

My understanding is that the Supreme Court held that:

http://www.rgemonitor.com/globalmacro-monitor/255267/was_there_ever_a_default_on_us_treasury_debt

"The clearest summation of the judicial outcome was in the concurring opinion of Justice Stone, as a member of the majority: • "While the government's refusal to make the stipulated payment is a measure taken in the exercise of that power, this does not disguise the fact that its action is to that extent a repudiation." • "As much as I deplore this refusal to fulfill the solemn promise of bonds of the United States, I cannot escape the conclusion, announced for the Court, that the government, through exercise of its sovereign power, has rendered itself immune from liability." So five of the nine justices explicitly stated that the obligations of the United States had been repudiated. There can be no doubt that the candid conclusion of this highly interesting chapter of our national financial history is that, under sufficient threat, crisis and pressure, a clear default on Treasury bonds did occur."

So the US can default, contrary to some opinions. I'd like to find out more actually. Although inflation is more or less a default, it has more negative consequences for the electorate than default, doesn't it? And, since the problem with raising taxes or cutting spending is political, just reneging on the debt seems politically more palatable.

Then there's this:

http://www.bloomberg.com/apps/news?pid=20601080&sid=aFgHlh.Dn4Lc&refer=news

By Stanley White and Shigeki Nozawa

Dec. 24 (Bloomberg) -- Japan should write-off its holdings of Treasuries because the U.S. government will struggle to finance increasing debt levels needed to dig the economy out of recession, said Akio Mikuni, president of credit ratings agency Mikuni & Co.

The dollar may lose as much as 40 percent of its value to 50 yen or 60 yen from the current spot rate of 90.40 today in Tokyo unless Japan takes “drastic measures” to help bail out the U.S. economy, Mikuni said. Treasury yields, which are near record lows, may fall further without debt relief, making it difficult for the U.S. to borrow elsewhere, Mikuni said.

“It’s difficult for the U.S. to borrow its way out of this problem,” Mikuni, 69, said in an interview with Bloomberg Television broadcast today. “Japan can help by extending debt cancellations.”

Surely the easiest way for us to deal with the unwinding of the Saver: Export Country / Spender Country Symbiosis is for the Saver Countries to cancel some of the debt. This allows everybody to continue doing what comes naturally and doesn't demand preposterous ideas like people having to radically alter their behavior. Since markets don't like surprises, it will hardly come as a surprise that it's often easier to walk away from a debt than repay it, especially when it involves personal sacrifice. What could come as less of a surprise?

Sunday, February 8, 2009

a clear default on Treasury bonds did occur

From RGE Monitor:

"Was There Ever a Default on U.S. Treasury Debt?

Delicious Digg Facebook reddit Technorati

Alex Pollock | Jan 23, 2009

As the bailouts in the current bust inexorably mount, financed in rapidly increasing U.S. government debt, one might wonder whether a default on Treasury debt is imaginable. In the course of history, did the U.S. ever default on its debt?

"How will the rest of the world restructure in the face of a United States hell-bent on replenishing its bank accounts?"

Paul Kedrosky on a Savings Spree:

"PAUL KEDROSKY

From Friday's Globe and Mail

January 16, 2009 at 7:23 AM EST

In one of the biggest and most misunderstood changes in modern economic history, citizens of the largest economy in the world are suddenly doing something they haven't done in years: They're saving money. It is having myriad consequences, including a tsunami of money in one part of the world, and an air pocket in demand in other parts of the world, especially China.

Americans are suddenly spending less than they earn. While that might not sound heretical or surprising - how long can you go on spending more money than you earn? - it is an epochal moment for the free-spending United States. After saving an average of more than 7 per cent of disposable income until almost 1990, the United States went into a savings tailspin. Savings rates fell, in fits and starts, from 8 per cent, through 6 per cent in the early 1990s, to 2 per cent around 2000, to the ignominy of a negative savings rate by mid-2005.

Now, however, that is changing rapidly. November economic data showed U.S. savings spiked to 2.8 per cent of disposable income, up from zero at the beginning of 2008. Is it that Americans have suddenly figured out that saving is a good thing, or are they taking some sort of moral stand against profligate spending?

Be serious. Americans remain the wild-eyed spenders of the world, and that was never likely to change without external pressure. They have, however, been forced into this, with their equity investments and real estate investments all sliding into nothingness, and with the economy in a deep recession. They must repair their broken personal balance sheets, and so, as painful as it might be, they are saving money. ( I AGREE )

Great. Good for Americans, right? Savings über alles! Well yes, but there is much more to it than that. For starters, the U.S. savings rate won't stop at 2.8 per cent. My guess is it will rapidly rise to 4 per cent by the end of the year, and will likely hit 7 per cent by late 2010.( I SAY 5% )

But in the end, fixating on those numbers misses everything that matters because that money has to come from somewhere. Your savings, in some sense, represent my lost income. Increased consumer savings is like extending a dam further into a river of money - call it personal income - and diverting some of the flow into a different river. Instead of going into the river called "consumer spending," more of it is going into the river called "savings."( BUT THAT CAN END UP AS INVESTMENT MONEY )

To put it in context, a U.S. savings rate of minus 1 per cent meant roughly $2-million a minute was flowing out of U.S. consumer savings into other things, mostly consumption, like TVs and home renovations, and so on. Or, on an annual basis, that worked out to almost $1.3-trillion exiting the U.S. banking system for other places.

Turn that around, however, and things get very different, very quickly. At a 3-per-cent savings rate, the United States will see $3.8-trillion showing up next year in the banking system just from domestic savers. At 7 per cent, almost $9-trillion will come rushing in as part of the savings tsunami( SPREE ). It is a fire hose of money pointed at the banks, and it's just beginning.

These are ear-popping figures. Three per cent, for example, produces almost five times as much in one-year U.S. capital inflows as the entirety of China's current Treasury holdings. It is four times as much as the proposed Obama stimulus plan. In short, at even relatively small changes, at least in percentage terms, the United States will rapidly transform its banking system and its capital markets.

All that money has to come from somewhere, however, and among the main sources will be the United States' largest trading partners, chief among them China. The U.S. economy is more than three times the size of China, and if you match the U.S. trade deficit against the Chinese trade surplus you'll see that China accounts for, on average, about 60 per cent of the U.S. deficit. As a result, China is going to need to find a way to replace more than 10 per cent of its gross domestic product if the U.S. savings rate returns to its historical norm( THEY REALLY DON'T WANT TO ). Making matters worse is that Chinese consumers are a smaller percentage of GDP than their U.S. counterparts, so to make the math work, Chinese consumers would have to up their buying by something like 25 per cent. Will it happen? No way.( I AGREE )

To be fair, China is not the only country faced with the problem. Similar situations exist in most countries with which the United States has deficits, all of whom are going to see massive export declines as U.S. consumers turn spending into savings. It will be the biggest story of 2009: How will the rest of the world restructure in the face of a United States hell-bent on replenishing its bank accounts( ALLOW US TO DEFAULT OR CONSUME LIKE HELL ) )? In the short run, it can't, which is, in part, why we're seeing the global trade tailspin that we are.

Paul Kedrosky is Senior Fellow at the Kauffman Foundation, and editor of Infectious Greed, a popular financial blog"

Since I see the Savings Spree as a reaction to this crisis, I don't see it lasting. However, I wish it would. We need to save more.

Tuesday, January 6, 2009

"the demons of our past – above all, nationalism – will return. Achievements of decades may collapse almost overnight."

Martin Wolf in the FT:

"Welcome to 2009. This is a year in which the fate of the world economy will be determined, maybe for generations. Some entertain hopes( THE SAVER/EXPORT COUNTRIES ) that we can restore the globally unbalanced economic growth of the middle years of this decade. They are wrong. Our choice is only over what will replace it. It is between a better balanced world economy and disintegration. That choice cannot be postponed. It must be made this year.

We are in the grip of the most significant global financial crisis for seven decades. As a result, the world has run out of creditworthy, large-scale, willing private borrowers. The alternative of relying on vast US fiscal deficits and expansion of central bank credit is a temporary – albeit necessary – expedient( I AGREE ). But it will not deliver a durable return to growth. Fundamental changes are needed.( SUCH AS? )

Already it must be clear even to the most obtuse and complacent that this crisis matches the most serious to have affected advanced countries in the postwar era. In a recent update of a seminal paper, released a year ago, Carmen Reinhart of Maryland University and Kenneth Rogoff of Harvard spell out what this means.* They note the similarities among big financial crises in advanced and emerging countries and, by combining a number of severe cases, reach disturbing conclusions.

Banking crises are protracted, they note, with output declining, on average, for two years. Asset market collapses are deep, with real house prices falling, again on average, by 35 per cent over six years and equity prices declining by 55 per cent over 3½ years. The rate of unemployment rises, on average, by 7 percentage points over four years, while output falls by 9 per cent.

Not least, the real value of government debt jumps, on average, by 86 per cent (see chart). This is only in small part because of the cost of recapitalising banks. It is far more because of collapses in tax revenues.( THESE STUDIES HAVE LIMITED USE )

How far will the present crisis match the worst of the past? The continuing willingness of the world to finance at least the US – though not necessarily the smaller and more peripheral deficit countries, such as the UK – is a reason for optimism. It does allow the US government to mount a vast fiscal and monetary rescue programme.

Cumulative increase in real public debt in the three years following a bank crisis

Yet, as Profs Reinhart and Rogoff note in another paper, this is a global crisis, not a regional one (see chart).** It has reminded us that the US is still, for good or ill, the core of the world economy( TRUE. IT'S GLOBAL BECAUSE IT STARTED IN THE US ). In the big crises of recent decades, US demand has rescued the world. This was true during the 1990s, after the Asian crisis, and again after the stock market crash of 2000. But who, apart from its government, will rescue the US? And on what scale must it act?( VERY LARGE )

This issue is addressed in another seminal paper, the latest in the series co-written by Wynne Godley and two others for the Levy Economics Institute of Bard College.*** The underlying argument is one with which readers of this column should, by now, be all too familiar.

What makes rescue so difficult is the force that drove the crisis: the interplay between persistent external and internal imbalances in the US and the rest of the world. The US and a number of other chronic deficit countries have, at present, structurally deficient capacity to produce tradable goods and services. The rest of the world or, more precisely, a limited number of big surplus countries – particularly China – have the opposite. So demand consistently leaks from the deficit countries to surplus ones.

In times of buoyant demand, this is no problem. In times of collapsing private spending, as now, it is a huge one. It means that US rescue efforts need to be big enough not only to raise demand for US output but also to raise demand for the surplus output of much of the rest of the world. This was a burden that crisis-hit Japan did not have to bear.

What has happened to US private spending follows from the collapse in borrowing: between the third quarter of 2007 and the third quarter of 2008 net lending to the US private sector fell by about 13 per cent of gross domestic product – by far the steepest fall in the history of the series (see chart). With borrowing out of the picture, private net saving – the difference between income and expenditure – is likely to remain positive for years, as households pay down debt, willingly or not.

Given the persistent structural current account deficit, how large does the fiscal deficit need to be to balance the economy at something close to full employment? Assuming, for the moment, that the private sector runs a financial surplus of 6 per cent of GDP and the structural current account deficit is 4 per cent of GDP, the fiscal deficit must be 10 per cent of GDP, indefinitely.

And to get to this point the fiscal boost must be huge. A discretionary boost of $760bn (€570bn, £520bn) or 5.3 per cent of GDP is not enough. The authors argue that “even with the application of almost unbelievably large fiscal stimuli, output will not increase enough to prevent unemployment from continuing to rise through the next two years”.

Now think what will happen if, after two or more years of monstrous fiscal deficits, the US is still mired in unemployment and slow growth. People will ask why the country is exporting so much of its demand to sustain jobs abroad. They will want their demand back( OR THEY WILL ALLOW US TO DEFAULT ). The last time this sort of thing happened – in the 1930s – the outcome was a devastating round of beggar-my-neighbour devaluations, plus protectionism( WE HAVE SOME OF THAT ALREADY. ). Can we be confident we can avoid such dangers? On the contrary, the danger is extreme. Once the integration of the world economy starts to reverse and unemployment soars, the demons of our past – above all, nationalism – will return( I THINK THAT HE'S THE FIRST PERSON I'VE READ WHO AGREES WITH ME ON THIS. ). Achievements of decades may collapse almost overnight.

Yet we have a golden opportunity to turn away from such a course. We know better now. The US has, in Barack Obama, a president with vast political capital. His administration is determined to do whatever it can. But the US is not strong enough to rescue the world economy on its own. It needs helpers, particularly in the surplus countries( SAVER COUNTRIES ). The US and a few other advanced countries can no longer absorb the world’s surpluses of savings and goods. This crisis is the proof. The world has changed and so must policy. It must do so now.( IT'S GOING TO BE TOUGH FOR THE SAVER/EXPORT COUNTRIES. )

* The Aftermath of Financial Crises, December 2008; www.economics. harvard.edu/faculty/rogoff/files/ Aftermath.pdf; ** Banking Crises, December 2008, National Bureau of Economic Research Working Paper 14587, December 2008, www.nber.org; *** Prospects for the US and the World, December 2008, www.levy.org"

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Don's Hermeneutics: Like Rabbi Yishmael's Rules, Only Not

"Searle's Sagacity":

"If a person can't explain something simply, then they don't know what they're talking about. The only exception being Kant."

"Corollary to Searle's Sagacity":

"questions should be simple and comprehensible, and meant to elicit a simple explanation."

"Samuel Johnson's Dictum":

One thing about passing fifty years of age is that I now feel old enough to invoke what I call Samuel Johnson's Dictum. It is thus: If I invoke a view based on an author that I read in the past, and that view is not actually held by that author, I'm more than willing to claim the view as originating with me. The beauty of this Dictum is that it is self-referential. It is based upon my reading of Johnson and on Boswell, but I can't remember the actual references that led me to believe that Johnson believed something like this. In any case, I do.

"Burke's Principle":

Another of my motley list of nostrums is what I call Burke's Principle. Burke's Principle holds that there is a distinction between:
1) Political Theory: A theory of the perfect society, the good life, etc. Your general political philosophy.
2) Politics: The rather messy art of governing which involves dealing with what is possible on earth and compromising as the need arises.

"Burke's Rule":

"All government, indeed every human benefit and enjoyment, every virtue, and every prudent act, is founded on compromise and barter. "

"Burke's Paradox":

"Mere parsimony is not economy. Expense, and great expense, may be an essential part in true economy."

"Burke's Prescience":

"You can never plan the future by the past.

Letter to a Member of the National Assembly (1791)"

"Burke's Wisdom":

"A very great part of the mischiefs that vex the world arises from words.

Letter to Richard Burke"

"Bagehot's Principles":

1) If the Fed exists, it will be the Lender Of Last resort, and that has to be taken in to account in real world Political Economy. It should lend freely in a crisis to solvent banks.

2) The rules for LOLR( from here on down this includes any government guarantee ) intervention should be clear, public, and followed, otherwise Moral Hazard is ineffective. All guarantees must be explicit.

3) The terms must be onerous.

4) The LOLR should get something valuable in return.

Here are a few others:

5) The taxpayer's interests should come first.

6) Moral Hazard needs to be constantly applied by quickly liquidating problem banks in normal times.

7) Any entity receiving a guarantee will have to be supervised or regulated effectively, and violations should be quickly and severely punished.

8) There is no doubt that any entity receiving a LOLR guarantee will need to be more conservative in its practices in order to limit the liability of the taxpayer.

9) There should be a class of financial concerns that can act more freely, but they should not receive LOLR guarantees. They will be strictly supervised or regulated though, and are subject to laws against fraud, etc."

Sources which back up my view of Bagehot:

http://www.pittsburghlive.com/x/pittsburghtrib/opinion/columnists/guests/s_593875.html

"Who can forget the end of "Planet of the Apes" when Charlton Heston, kneeling before the half-buried remains of the Statue of Liberty, slams his fists into the sand and cries, "You maniacs! You blew it up! Ah, damn you ... damn you all to hell!"

Now imagine the same scene, but with a half-buried Morgan Stanley building standing in for Miss Liberty and a time-traveling Walter Bagehot playing the lead and you've got the perfect Hollywood dramatization of the real-life tragedy that, with luck, is having its denouement on Wall Street.

Bagehot? The great Victorian man of letters, best remembered today as the second and most celebrated editor of the British magazine The Economist, wasn't exactly a hunk. But he certainly could have delivered those futile last lines with real conviction, for he was among the first to recognize the vast destructive potential of that newfangled weapon of Victorian finance: the modern central bank.

Bagehot first alerted readers to this potential and offered his suggestions for containing it in an article that appeared in The Economist after the great panic and credit crisis of 1866. That panic witnessed the spectacular collapse of Overend, Gurney & Co., which had long been Great Britain's premier investment house.

Bagehot understood that, during such panics, the Bank of England alone commanded the confidence needed to serve other financial firms as a "lender of last resort." But as Bagehot put it later in his book "Lombard Street: A Description of the Money Market" (1873), the bank's "faltering way" -- its arbitrary and inconsistent use of its unique lending powers -- tended only to make things worse.

"The public," Bagehot wrote, "is never sure what policy will be adopted at the most important moment: it is not sure what amount of advance will be made. ... And until we have on this point a clear understanding with the Bank of England, both our ability to avoid crises and our terror at crises will always be greater than they would otherwise be."

The ultimate source of trouble, Bagehot believed, was the very existence of the Bank of England and the special privileges it enjoyed. But because nothing save a revolution seemed likely to do away with the "Old Lady of Threadneedle Street," as it was called, Bagehot's preferred, practical solution was for the bank expressly to commit itself to lending freely during crises, though on good collateral only, and at "penalty" rates.

The restrictive provisions were supposed to limit aid to otherwise solvent firms panic had rendered illiquid.

Bagehot's recommendation has since become a sort of master precept of central banking -- albeit one that's mainly honored in the breach by central bankers.

To be fair to today's central bankers, there's never been much agreement on how to apply Bagehot's rule in practice. Just what do "good collateral" and "penalty rates" mean in times like these?

While no one might precisely be able to define good collateral -- and one can debate whether the rate at which banks offer to lend unsecured funds to other banks, known as the London Interbank Offered Rate, or LIBOR rate, plus 8 percent constitutes a "penalty" rate -- who even pretends that recent central bank lending has been based on good collateral?

But rescuing insolvent firms is the least of it. The real damage comes from the Treasury's utter lack of any consistent last-resort lending rule. The recently enacted financial institutions bailout bill does little to clarify this.

That's just the sort of thing that troubled Bagehot almost a century and a half ago, when central banks were still in their swaddling clothes. Yet central bankers and governments still don't get it, despite the lip service they pay to this great thinker from our past."

http://www.theweeklystandard.com/Content/Public/Articles/000/000/015/921taekw.asp?pg=1

"The Unwisdom of Crowds
Financial panics still require what Walter Bagehot prescribed--that practical men violate their own principles.
by Christopher Caldwell
12/22/2008, Volume 014, Issue 14

Neither Barack Obama nor John McCain had much of value to say about the financial crisis as it raged through the headlines this fall. Rather than shred their campaign strategies, they played it safe, as most politicians would have. But in the name of justice we ought to recall that there was one candidate who did foresee our predicament with considerable accuracy when it still lay far in the future. Ron Paul, in almost every speech he made during the Republican primaries, spoke of bubbles, reckless credit growth, and the "unsustainability" of present policy. So why isn't there more demand for the common-sense solutions he put forward? Because common sense is not much use in a financial panic.

This was the great discovery of Walter Bagehot, the prolific 19th-century essayist and journalist, who was editor of the Economist from 1860 to 1877. (His name rhymes with gadget.) Ninety-nine percent of the time, common sense is a synonym for practicality. But in a serious banking crisis, doing the commonsensical thing--hunkering down and counting your pennies--has proved to be not practical at all. Bagehot's Lombard Street is an insider's look at the Bank of England, and at the principles on which political and financial leaders act when advanced economies come under pressure. Those principles are depressing in the extreme for anyone with an uncomplicated idea of how a democracy works. But they are effective. That is why, in the so-called Anglo-Saxon world, Bagehot's book still provides the bedrock of policy thinking during financial emergencies, including our present one.

Lombard Street was published in 1873, seven years after the sudden collapse of Overend, Gurney & Co., a bank that lost £11 million, spread panic among investors, sparked a run, and became "the model instance of all evil in business." The crisis made such a deep impression on British finance and government that the country did not have another bank run for 141 years--not until Northern Rock collapsed in the summer of 2007. (English investors must have longer memories than American ones. Most of our own noxious subprime mortgages were contracted, and the securities built on them concocted, after Enron became our own model instance of evil in 2001.) It was the Bank of England that took charge of averting panic, during the Overend, Gurney crisis and thereafter. It did so by injecting credit into the economy, by bailing people out. Bagehot approved of this. Many ordinary retailers could not pay their suppliers until they got the money for the things they sold. Without credit, they would be ruined, and the ruin would spread to those to whom they owed money. This was not a question of moral failing, it was just the way a modern economy worked.

But the modern economic system interacts with the modern political system--democracy--in a rather uncomfortable way. Indeed, at more than one juncture in Lombard Street, Bagehot framed the problem of booms and busts as part of the "increasingly democratic structure of English commerce." People in a democracy are most comfortable when their institutions do the same things that they would do as individuals. In a crisis, banks--like everyone else--reflexively hoard their money. But a central bank must do the opposite. It must lend freely.

This was the most basic affront to common sense that the Bank of England presented, but it was not the worst. The worst was that the bank could carry out its necessary duties as a lender of last resort only by breaking the law. The basis of the bank's operating procedure--and of its soundness--was the Bank Act of 1844. We would call it a regime of sound money. It included stringent caps on the ratio of notes issued to reserves held. These caps were hewed to when the economy was running smoothly. Yet at the time Bagehot was writing, a quarter century later, the law had already been suspended three times. Not just that. "No similar occasion has ever yet occurred," Bagehot wrote, "in which it has not been suspended." So the law on which the solvency of the British nation rested was ironclad, except when someone felt a need to break it.

Stranger still, never did the Bank of England acknowledge its duty as the lender of last resort. Some of its governors even denied that any such duty existed. Bagehot thought the bank should come clean about what it really was:

There should be a clear understanding between the Bank and the public that, since the Bank hold our ultimate banking reserve, they will recognise and act on the obligations which this implies--that they will replenish [the reserve] in time of foreign demand as fully, and lend it in times of internal panic as freely and readily, as plain principles of banking require.

But there was a reason for the central bankers' dissembling. If the bank ever acknowledged a duty to rescue banks by generous extensions of credit, it would create a form of moral hazard. Thomson Hankey, a Bank of England director whom Bagehot much admired (and to whom the financial writer James Grant devotes an admiring essay in his new book Mr. Market Miscalculates), called Bagehot's lender-of-last-resort views "the most mischievous doctrine ever broached in the monetary or banking world in this country."

In practice, Bagehot was right and Hankey was wrong. The bank was beyond question the lender of last resort. In principle, Hankey was right and Bagehot was wrong. Unless there was a real, credible threat that a bank would be allowed to fail, the guarantee of rescue would simply get priced into any financial bubble that developed, making things worse when the bubble popped. The situation required what we would now call "strategic ambiguity"--both Hankey's doctrine and Bagehot's practice, which contradicts it.

The situation today requires the same mix. Central banking is thus often a high-stakes game of chicken. And sometimes, when banks enter the game insufficiently scared, it will be played out to the end. It certainly was in September when the U.S. Treasury terrified the financial world by not coming to the rescue of Lehman Brothers. This was a catastrophe in terms of Bagehot's practice, but it will produce benefits in terms of Hankey's principle. It will discourage people from paying more than is reasonable for assets on the belief that they come equipped with an insurance policy (the promise of a central bank rescue) that has been underwritten by taxpayers. The Republicans who nearly derailed the Treasury's Troubled Assets Relief Program in September played a similar role.

A final problem is that there are limits to how accountable a central bank can be. Everyone is always hollering for clear rules and transparency. But a dirty secret of regulation is that it frequently influences conduct most effectively when it is capricious and opaque. Any regulatory system will reveal its vulnerabilities over long use. If it addresses economic problems in a predictable way, savvy investors will find a way to "game" that predictability. You can draw an analogy with antidepressant drugs. There is no permanent right match of medication for a depressive. Antidepressants work only until the mind (or is it the brain?) finds a way around them, at which point a new, unfamiliar drug must be substituted. In the same way, no matter how good the content of a regulatory regime, it must change periodically if big market players are to be kept from profiting off it.

As Bagehot outlined his system, he was conscious that the practical realities of banking required him to heap paradox upon paradox. There is a hint of both Andrew Jackson and Thomas Aquinas in the way he referred to central banking as an "unnatural" thing in its very conception. "The business of banking ought to be simple," he wrote. "If it is hard it is wrong." If it is hard, the banker is either delegating poorly or has entangled his institution in complex transactions where it has no business. According to Bagehot, "Adventure is the life of commerce, but caution, I had almost said timidity, is the life of banking."

Centralizing a society's cash reserves is complicated, reckless, and artificial:

A republic with many competitors of a size or sizes suitable to the business, is the constitution of every trade if left to itself, and of banking as much as any other. A monarchy in any trade is a sign of some anomalous advantage, and of some intervention from without. . . . The natural system of banking is that of many banks keeping their own cash reserve, with the penalty of failure before them if they neglect it.

In his ideas of company size, Bagehot harkened back to the 18th century rather than ahead to our own. To modern eyes, Bagehot is, as a factual matter, simply wrong. The natural tendency under free-market conditions is towards consolidation, and even monopoly. If you want small firms, you must protect them through government--whether this means Teddy Roosevelt-ian trust-busting, French-style subsidies to tobacconists, the EU's hounding of Microsoft, or the NIMBY anti-Wal-Mart campaigns aimed at preserving Mom-and-Pop stores. Bagehot sometimes contradicted himself on this point, noting also that "a large bank always tends to become larger, and a small one tends to become smaller," but his application of the word unnatural to a large central bank was frequent and must be taken as his settled view. It is curious that Bagehot, a contemporary of Marx, came to the opposite (and false) conclusion about how firms evolve.

Where Bagehot would agree with Marx is in his belief that there is something predictably destabilizing about modern economies. You don't need banks to have a precarious economy, or one liable to speculation--Bagehot noted that there were no banks, as we would understand them, in 1720, at the time of the South Sea Bubble and the Mississippi Scheme. But modern banking is precarious by design. "In exact proportion to the power of this system is its delicacy," he wrote. "I should hardly say too much if I said its danger." The power, delicacy, and danger all have the same source. In fact they are just different names for the same thing: leverage.

At the very opening of the book, Bagehot illustrates with exquisite simplicity how, at least in a boom economy, traders on margin can "harass and press upon, if they do not eradicate, the old capitalist." The old capitalist in question is the poor sap who believes all this stuff about neither-a-borrower-nor-a-lender-be and is foolish enough to be using his own cash:

If a merchant have £50,000 all his own, to gain 10 per cent on it he must make £5,000 a year, and must charge for his goods accordingly; but if another has only £10,000, and borrows £40,000 by discounts (no extreme instance in our modern trade), he has the same capital of £50,000 to use, and can sell much cheaper. If the rate at which he borrows be 5 per cent, he will have to pay £2,000 a year; and if, like the old trader, he make £5,000 a year, he will still, after paying his interest, obtain £3,000 a year, or 30 per cent, on his own £10,000. As most merchants are content with much less than 30 per cent, he will be able, if he wishes, to forego some of that profit, lower the price of the commodity, and drive the old-fashioned trader--the man who trades on his own capital--out of the market.

Later, Bagehot showed that this need for leverage is no different for those selling money than it is for those selling dry goods. The banker can no more choose not to lend than the merchant can choose not to borrow:

The bill-broker has, in one shape or other, to pay interest on every sixpence left with him, and that constant habit of giving interest has this grave consequence: the bill-broker cannot afford to keep much money unemployed. He has become a banker owing large sums which he may be called on to repay, but he cannot hold as much as an ordinary banker, or nearly as much, of such sums in cash, because the loss of interest would ruin him.

In finance, once you can have leverage, you must have leverage. Once you have some leverage, getting more of it than your competitors is a matter of survival. And when governments and central banks debate whether to loosen or tighten up money, they face a constant clamor from the financial world to permit more leverage still. That is why, even in democracies, the instruments of monetary policy tend to be kept far from the influence of voters, and even hidden from view. Otherwise, credit tends to spiral. Bubbles result.

Nothing could be more foolish than to assume that this process of spiraling speculation is unleashed by "greed," unless by greed you mean human nature. Credit spirals are a darker aspect of the world Adam Smith described in The Wealth of Nations and Bernard de Mandeville did in the Fable of the Bees. Just as society can be improved by the uncoordinated action of the selfishly motivated, an economy can collapse for reasons having nothing to do with anybody's cupidity.

We should be moral in the way we think about money, but a credit system tends to make a mess of moral accounting. Bagehot described London's financial district as "a sort of standing broker between quiet saving districts of the country and the active employing districts." Decent, puritanical Suffolk farmers want to put their money in a safe place; Lancashire entrepreneurs want money to put to work. Thanks to London bankers, both can follow their wishes and make a profit in the process. We have an idea that the Suffolk dairyman is the "moral" party here (he's saving) and the Lancashire speculator the "immoral" one (he's gambling). But, once a banking system intervenes, they are both gambling and they are both saving. In good times you are welcome to mouth the folkloric cliché that holds farmers to be better people than financiers. When depression looms, you had better realize that the rain falls on the just and the unjust.

Many Americans who have wound up underwater on their houses and maxed out on their credit cards are greedy, climbing, brand-intoxicated, materialistic shopaholics who thought the world owed them a living. But just as many of them are not. They are trapped, as surely as financial institutions are, in a system based on wild borrowing. Participation in this system is not exactly required, but it is not exactly optional, either. One's quality of life is determined not just by one's purchasing power but also by one's relative economic standing. Chagrin at seeing one's neighbors get richer faster may be a sign of bad character, but do not for a minute assume there is nothing to feel chagrin about! When it comes to the very goods people deem most essential--the proper mate; the schooling of one's children; the size, location, elegance, and comfort of one's house--relative standing is more important than absolute wealth.

Those who kept their money in savings banks in the 1990s lost out to those who did things we are supposed to disapprove of, like "spending money they didn't have," borrowing profligately to invest in stocks and even bonds, which appreciated at an average of 15 percent a year over the decade. Among rich people, how one entered the present decade had more to do with how one had done in the stock market than with how one had done in the labor market. Is that just? Of course it's not! It's easy to see now. But while the boom was going on there was all sorts of rationalizing about why it was okay that the social hierarchy should be reordered through stock and housing speculation. One line of argument was that people who did not have a ton of money in stocks, as well as those who rented rather than bought the houses they lived in, were foolish. This line of argument peaked at the turn of the decade, when Americans elected a president who had argued that the public was foolish for not launching its retirement savings onto the open seas of the stock market.

Bagehot saw that a speculative mania eventually sweeps up everyone in its path. "Every great crisis reveals the excessive speculations of many houses which no one before suspected," he wrote, "and which commonly indeed had not begun or had not carried very far those speculations, till they were tempted by the daily rise of price and the surrounding fever." Avaricious people get hurt, but it is in the nature of crashes that they are not the ones who get hurt most. A tragic figure present in almost every historic account of speculation and collapse in history is the person who believed, year after year, that the boom was an illusion, and held himself aloof until, at the very last minute, whether out of self-doubt or deference to the opinions of his fellow man, he entered the fray and was (having bought at the top, rather than the bottom, of the market) wiped out. What a wicked irony! His punishment is as much for his long and wise forbearance as for his momentary weakness.

So the "cultural contradictions of capitalism" run deeper than we thought. The classic idea, as laid out in their different ways by the economist Joseph Schumpeter and the sociologist Daniel Bell, is that capitalism rewards diligence; diligence produces wealth; wealth begets idleness; and idleness undermines capitalism. But when, as now, push comes to shove, we can ask whether there is really anything particularly capitalist about the virtues of diligence and self-restraint. The real capitalist virtues appear to be optimism and luck. From a central-banking perspective, the cultural contradictions are not results of capitalism but elements of it.

The problem with central banking is that it reacts to a system that has been mismanaged by rewarding the managers. That is why objections to central banking, although they can come from the right (Ron Paul, Jim Bunning) or the left (Barney Frank, William Greider), tend to be populist. Bagehot was no populist. He was comfortable with the idea that what some people think should be more important than what other people think:

Almost all directors who bring special information labor under a suspicion of interest; they can only have acquired that information in present business, and such business may very possibly be affected for good or evil by the policy of the Bank. But you must not on this account seal up the Bank hermetically against living information.

Although he would surely fault Treasury Secretary Hank Paulson for many things, the criticism most often heard at present--that Paulson is too close to former colleagues on Wall Street, where he worked for years as CEO of Goldman Sachs--would strike Bagehot as misplaced.

Because it is on Wall Street, alas, that "the state of credit" is to be determined:

The state of credit at any particular time is a matter of fact only to be ascertained like other matters of fact; it can only be known by trial and inquiry. And in the same way, nothing but experience can tell us what amount of "reserve" will create a diffused confidence.

To be blunt, credit is successfully reestablished when financial elites say, "When." Credit is close to a synonym for the mood of the ruling class. To say an economy is based on credit is to say it is based on animal mysteries. Glamour, prestige, élan, sprezzatura, cutting a figure . . . that is what the economy is made of. It is a rather terrifying thought. Viewed as Bagehot viewed it, from the perspective of a central bank in a crisis, an advanced economy looks an awful lot like a primitive economy."

http://blogs.iht.com/tribtalk/business/globalization/?p=680

"Loyal readers, please take a moment to check out Gretchen Morgenson’s column this week. She’s taken a close look at the buyout of Bear Stearns organized by the Federal Reserve, and she has come to an intriguing conclusion: that the Fed not only wanted to prevent financial havoc - it also wanted to deter speculators who were betting on big banks to fail.

Adherents of the Walter Bagehot school of central banking - and I have been among them at times - have cried foul at the sight of big bailouts and the granting of emergency credit at low interest rates. The Bagehot argument is that emergencies that arise from the risks that banks have chosen to take should not be treated with overwhelming sympathy. Emergency credit should be offered, yes, but at rates that will make banks think twice about using the safety net again. That’s not the case this time around (neither in the United States nor in Britain, and probably not in Europe either by the time the folks in Brussels are finished), so the central banks may be telling financial institutions that they can take silly risks without fear of disaster.

But if Morgenson is right, there is a long-term purpose here, too: to reduce the winnings of those who bet on failure, and thus to reduce the incentives to bring that failure to pass. And let’s face it, the speculators aren’t operating in a vacuum; their bets can start to snowball with market sentiment, as they did against Lehman Brothers last week. Still, the Bagehot argument (often called moral hazard) is also a powerful one - which one do you agree with?"

http://blogs.wsj.com/economics/2007/08/20/from-bagehot-to-bernanke/

"In his 1873 book “Lombard Street,” the closest thing to a user’s guide to central banking, Walter Bagehot criticized the Bank of England’s handling of earlier panics by responding “hesitatingly, reluctantly, and with misgiving.”

Federal Reserve Chairman Ben Bernanke, who has read his Bagehot and kept a copy in his Princeton office when he was a professor, responded to recent developments first by pumping money into the markets through the New York Fed’s open-market operations and then last week by easing the terms on loans to banks from the Fed’s discount window.

Bagehot (pictured at right) still makes for good reading at times like this.

“What is wanted and what is necessary to stop a panic is to diffuse the impression, that though money may be dear, still money is to be had. If people could be really convinced that they could have money if they wait a day or two, and that utter ruin is not coming, most likely they would cease to run in such a mad way for money. Either shut the Bank at once, and say it will not lend more than it commonly lends, or lend freely, boldly, and so that the public may feel you mean to go on lending. To lend a great deal, and yet not give the public confidence that you will lend sufficiently and effectually, is the worst of all policies; but it is the policy now pursued.”

Robert Feldman, Morgan Stanley’s chief economist for Japan, writes in a note today that it’s key to distinguish between internal discredit — private domestic lenders retreating — and external discredit, which Bagehot defined as a foreign drain on a bank’s money. (Bagehot’s solution to the problem of external discredit is to still lend freely but “at very high rates.”) That doesn’t apply in today’s floating rate system, Feldman says, and exchange rates don’t provide a good substitute, with the dollar’s drop against the yen suggesting we have external discredit while the strengthening against the euro saying we don’t.

Feldman writes: “My view is that the modern counterpart of ‘external discredit’ is moral hazard. The credit of the U.S. IS a problem, since no one knows how big the subprime and related housing market problems really are. Given how poorly banks know their clients, the ‘high rates’ part should come into play. There is no way to re-establish confidence unless those who have made loans to questionable borrowers pay a price for rash lending. Only then will markets regain confidence that risk is under control.

“The next stage of the credit problem — and whether it affects the real economy seriously — depend on eliminating the moral hazard,” Feldman says. “The faster the moral hazard in eliminated, the less impact on the real economy.”

Fed officials are acutely aware of the moral hazard, having resisted action for weeks to not be seen as bailing out risky investments. But they also don’t want a crisis to feed on itself. The Fed stressed its statement, in lowering the discount rate for banks, that it would accept “a broad range of collateral…including home mortgages and related assets.” The central bank sought to reassure a market that had been roiled by risky investments in subprime mortgages.

That’s how the Bank of England halted a panic in 1825, as Bagehot recounts: “A panic, in a word, is a species of neuralgia, and according to the rules of science you must not starve it. The holders of the cash reserve must be ready not only to keep it for their own liabilities, but to advance it most freely for the liabilities of others. They must lend to merchants, to minor bankers, to ‘this man and that man,’ whenever the security is good. In wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them. The way in which the panic of 1825 was stopped by advancing money has been described in so broad and graphic a way that the passage has become classical. ‘We lent it,’ said Mr. Harman, on behalf of the Bank of England, ‘by every possible means and in modes we had never adopted before; we took in stock on security, we purchased Exchequer bills, we made advances on Exchequer bills, we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the Bank, and we were not on some occasions over-nice. Seeing the dreadful state in which the public were, we rendered every assistance in our power.’ After a day or two of this treatment, the entire panic subsided, and the ‘City’ was quite calm.”

http://www.realclearmarkets.com/articles/2008/03/bagehot_central_banking_and_th.html

"Bagehot advocated in 1873 that a Lender of Last Resort in a crisis should lend at a penalty rate to solvent but illiquid banks that have adequate collateral. The doctrine has been criticised as having no place in our modern interbank market, but this is wrong. Bagehot’s prescription aims to eliminate the coordination problem of investors at the base of the crisis. It is still a useful guide for action when the interbank market stalls.1 It makes clear that discount-window lending to entities in need may be necessary in a crisis.

Bagehot's doctrine, however, is easy to state and hard to apply. It requires the central bank to distinguish between institutions that are insolvent and those that are merely illiquid. It also requires them to assess the collateral offered. Central banks, because of information limitations, are bound to make mistakes, losing face and money in the process. This doesn’t mean they should not try.
Poor collateral versus massive liquidity

The collateral should be valued under “normal circumstances”, that is, in a situation where the coordination failure of investors does not occur. This involves a judgment call in which the central bank values the illiquid assets. A central bank that only takes high quality collateral will be safe, but will have to inject much more liquidity and/or set lower interest rates to stabilise the market. This may fuel future speculative behavior. Some of this may have happened in the Greenspan era, in the aftermath of the crisis in Russia and LTCM, and after the crash of the technological bubble. The ECB and the Federal Reserve have accepted now partially illiquid collateral that the market would not. This seems appropriate and releases pressure to lower interest rates to solve the problem, something that should be done only if there are signs of deterioration in the real economy. The problem is that central banks are extending the lender of last resort facility outside the realm of traditional banks to entities, like Bear Stearns, that they do not supervise and, therefore, over which they do not have first hand information. How does the Fed know whether Bear Stearns or other similar institutions are solvent? It seems that the Fed is not following Bagehot’s doctrine here.

Finally, if banks and investors are bailed out now, why should they be careful next time? This is the moral hazard problem: help to the market that is optimal once the crisis starts has perverse effects in the incentives of market players at the investment stage. The issue is that only when the moral hazard problem is moderate does it pay to eliminate completely the coordination failure of investors with central bank help. When the moral hazard problem is severe, a certain degree of coordination failure of investors - that is, allowing some crises - is optimal to maintain discipline when investing and, amending Bagehot, some barely solvent institutions should not be helped."

http://www.house.gov/jec/imf/blueprnt.htm

"This goal is not new. In fact, it underlay Walter Bagehot's (1873) classic policy prescriptions for domestic central banking: to lend freely at a penalty rate on good collateral. Bagehot argued an elastic and immediate supply of liquidity was essential to an effectively structured lender of last resort, and that appropriate loss sharing rules in the form of collateral requirements and penalty interest rates would discourage abuse of the safety net."

http://online.wsj.com/public/article_print/SB120908336730343529.html

"By slashing interest rates too much in 2007-2008, the Fed has accentuated the foreign drain and thus made the alleviation of the domestic drain more difficult. Yet, despite this mistake, Bagehot would approve of other actions the Fed has taken to deal with the domestic drain by unblocking specific impacted domestic markets. These include (1) swapping Treasury bonds for less safe private bonds, (2) opening its discount window to shaky borrowers, and (3) maybe even rescuing Bear Sterns. He would also approve of the relaxation of capital constraints on Fannie Mae, Freddy Mac and so on, for mortgage lending. Yet these measures will be insufficient if the foreign drain continues.

To repeat Bagehot's Rule: "very large (domestic) loans at very high rates are the best remedy for the worst malady of the money market when a foreign drain is added to a domestic drain." The Fed, and the U.S. government more generally, have so far got it only half right."

http://findarticles.com/p/articles/mi_m2751/is_56/ai_55015114/pg_6

"More than a century ago, a British economic journalist, Walter Bagehot, set out the classical principles for a central bank acting as lender of last resort: lend freely in a crisis at a penalty rate against collateral. Adapted to international lending, Bagehot's rule is the proper rule for a restructured, more effective IMF."

http://maverecon.blogspot.com/2007/08/central-banks-in-time-of-crisis.html

"In a number of recent blog contributions, we have sketched the role of a modern central bank as ‘market maker of last resort’ (MMLR). This MMLR is the analogue, in a world where intermediation is increasingly through financial markets, to Bagehot’s lender of last resort (LOLR) in a world where most intermediation took place through banks (see e.g. Willem H. Buiter and Anne C. Sibert “The Central Bank as the Market Maker of last Resort: From lender of last resort to market maker of last resort"; Willem H. Buiter “Central banks as market makers of last resort, again”; Willem H. Buiter and Anne C. Sibert “A missed opportunity for the Fed”).

The market maker of last resort function can be fulfilled in two ways. First, the central bank can make outright purchases and sales of a wider range of securities than they currently do. Second, central banks can accept a wider range of securities as collateral in repos, and in collateralised loans and advances at the discount window than they currently do. Following Bagehot’s rule, the MMLR should buy these securities outright or accept them as collateral only on terms that would imply a stiff financial penalty to the owner. The central bank of course already applies a liquidity ‘haircut’ even to liquid instruments offered as collateral in repos or at the discount window. Because the MMLR would have to establish a buying price ‘in the dark’, that is, unaided by recent relevant market prices, and would inevitably take on much more credit risk than central banks have become accustomed to, the ‘haircuts’ should be severe – a financial version of ‘short back and sides’.

http://www.independent.org/pdf/tir/tir_07_3_wood.pdf

"Further crises in 1857 and 1866 prompted the debate between Bagehot and
Thomson Hankey, a director and former governor of the Bank of England. Notwithstanding
the Bank’s undoubted responsibility, as trustee of the nation’s reserve, to
support the financial markets, Bagehot wrote:
If we ask how the Bank of England has discharged this great responsibility,
we shall be struck by three things: first, . . . the Bank has never by any
corporate act or authorised utterance acknowledged the duty, and some of
its directors deny it; second, (what is even more remarkable), no resolution
of Parliament, no report of any Committee of Parliament (as far as I know),
no remembered speech of a responsible statesman, has assigned or enforced
that duty on the Bank; third (what is more remarkable still), the distinct
teaching of our highest authorities has often been that no public duty of
any kind is imposed on the Banking Department of the Bank; that, for
banking purposes, it is only a joint stock bank like any other bank; that its
managers should look only to the interest of the proprietors and their
dividend; that they are to manage as the London and Westminster Bank or
the Union Bank manages. (1873, 153–54)
Although the Bank usually in the end supplied the market, its “faltering way”
caused needless uncertainty and more severe panics than if it communicated clearly
that it could be counted on (Bagehot 1873, 64). According to Bagehot, the rules—
to lend freely at penalty rates on sound collateral—under which assistance would be
provided should be stated also.
The public is never sure what policy will be adopted at the most important
moment: it is not sure what amount of advance will be made. The best
palliative to a panic is a confidence in the adequate amount of the Bank
reserve, and in the efficient use of that reserve. And until we have on this
point a clear understanding with the Bank of England, both our liability to
crises and our terror at crises will always be greater than they would
otherwise be. (1873, 196–97)"

One which doesn't quite:

http://www.portfolio.com/views/blogs/market-movers/2008/05/13/bernanke-on-bagehot?rss=true

"Bernanke on Bagehot

I doubt a week has gone by since last summer during which I haven't seen some pundit or other trot out Walter Bagehot's dictum that in the event of a credit crunch, the central bank should lend freely at a penalty rate. More often than not, this is contrasted with the actions of the Federal Reserve, which seems to be lending freely at very low interest rates.

Ben Bernanke, in a speech today, addressed this criticism directly:

What are the terms at which the central bank should lend freely? Bagehot argues that "these loans should only be made at a very high rate of interest". Some modern commentators have rationalized Bagehot's dictum to lend at a high or "penalty" rate as a way to mitigate moral hazard--that is, to help maintain incentives for private-sector banks to provide for adequate liquidity in advance of any crisis. I will return to the issue of moral hazard later. But it is worth pointing out briefly that, in fact, the risk of moral hazard did not appear to be Bagehot's principal motivation for recommending a high rate; rather, he saw it as a tool to dissuade unnecessary borrowing and thus to help protect the Bank of England's own finite store of liquid assets. Today, potential limitations on the central bank's lending capacity are not nearly so pressing an issue as in Bagehot's time, when the central bank's ability to provide liquidity was far more tenuous.

I'm no expert on Walter Bagehot, and in fact I admit I've never read Lombard Street. But I'll trust in Bernanke as an economic historian on this one, unless and until someone else makes a persuasive case that Bagehot's penalty rate really was designed to punish the feckless rather than just to preserve the Bank of England's limited liquidity."

"So, we have, what I will call "Grant's Graham For Investing":

1) Decent Size

2) Current Assets Exceed Liabilities By Two Times

3) 10 Continuous Years Of Profit

4) 20 Continuous Years Of Dividends

5) 10 Years Of Earnings Growth Exceeding 33%

6) Price To Earnings Ratio Less Than 15

7 ) Price To Book Ratio Less Than 1.5"

"Cake As Gift Theory":

Now, I feel similarly about government incentives. When Fannie and Freddie tempted investors, this led to the housing bubble. I think that I'm going to call this the Cake As Gift Theory. I hand you a cake assuming that you have the good sense to eat it over time, and you gorge yourself and eat it at one sitting and get sick. Clearly I'm responsible for this by handing you the cake. Give you a gift or incentive, clearly I must assume that it will cause you to be irrational.

"Spigot Theory":

One other pet theory I have about finance, besides Bagehot's Principle, is the Spigot Theory. I might rename it. It applies to the low rate of interest or the sloshing pool of money explanations for the current crisis. Turn the tap too far, then you can't stop the tub from overflowing, even if you're a human agent standing right next to the tub. I call this a mechanistic explanation as opposed to an explanation based on human agency.

"The Pragmatic Milton Friedman Principle":

The Pragmatic Milton Friedman Principle. Friedman introduced a concept called the Negative Income Tax. He proposed it saying that it was a pragmatic compromise between the Welfare State and a basic libertarian position.

"Hardy's Harangue": To Me:

"There is no scorn more profound, or on the whole more justifiable, than that of the men who make for the men who explain. Exposition, criticism, appreciation, is work for second-rate minds. "

"Titchmarsh's Two Truths":

1)"Perhaps we could regard numbers as a sort of medium of exchange, like money. Most people are really interested in the goods and services which the world offers, and to them money is only a symbol for these. But it is not a meaningless symbol. A system of barter, in which we do without money and merely exchange goods, would be very inconvenient, and practically impossible in a complicated society. So a system in which we reduce all mathematics to statements such as "I have more fingers than you have noses" would be too cumbrous to contemplate seriously. Numbers are symbols, and very useful and interesting ones. To mathematicians who work with them every day they acquire a reality at least equal to that of anything else. "

2) "The question what numbers are has been much debated by philosophers, and they do not seem to have reached any agreement about it. There is nothing particularly surprising or distressing about this. It has been said that mathematicians are happy only when they agree, and philosophers only when they disagree. Philosophic doubts about the nature of number have never prevented mathematicians from getting on with their calculations, or from agreeing when they have got the right answer. So perhaps the situation is satisfactory to all parties. "

"Thoreau's Truth":About Government:
"I heartily accept the motto, "That government is best which governs least"; and I should like to see it acted up to more rapidly and systematically. Carried out, it finally amounts to this, which also I believe--"That government is best which governs not at all"; and when men are prepared for it, that will be the kind of government which they will have. Government is at best but an expedient; but most governments are usually, and all governments are sometimes, inexpedient."

"Will's Warning": Concerning The Use Of "Socialism":
Hyperbole is not harmless; careless language bewitches the speaker's intelligence. And falsely shouting "socialism!" in a crowded theater such as Washington causes an epidemic of yawning.

"Kling's Principle":About Regulated Banks And Unregulated Financial Entities
"The banks seem to find a way to take risks, and the unregulated folks seem to find a way to get guarantees."

"Janeway's Dictum": On Political Economy
"Political economy is not a science, it's a clinical art, like medicine."

"Cowen's Creed": On Policies

"YOU CAN’T TURN BAD TO GOOD The good New Deal policies, like constructing a basic social safety net, made sense on their own terms and would have been desirable in the boom years of the 1920s as well. The bad policies made things worse. Today, that means we should restrict extraordinary measures to the financial sector as much as possible and resist the temptation to “do something” for its own sake."

"Hendry's Heartfelt":

"I antagonise people,' says Hugh Hendry. 'It's part of my skill set."

"Diebel's Dare:

"You can’t be forced out further on the yield curve than a perpetual.”

"Peston's Promise": Good Until ...

"And, as I've been pointing out for some time, we are being asked to provide life support to a swathe of the real economy, from steel makers to car manufacturers.

The Government will succumb and will lend taxpayers' money to non-financial companies.

In a way, there's no choice, because we'll be hobbled for years as an economy if our few remaining manufacturers and exporters are wiped out."

"Trader's Narrative's Due Diligence":

"The process of investigation undertaken by an party to gather material information on actual or potential risks involved in a financial transaction or relationship."

The Quotes Above

W. Bagehot, R.W. Emerson, M. Proust, W.H. Auden, W. Bagehot, P.Levine

Read J.L. Austin "A Plea For Excuses" here:

http://www.ditext.com/austin/plea.html

Read " Reflections on the Revolution in France by Edmund Burke 1790" here:

http://www.constitution.org/eb/rev_fran.htm

P. Levine reading "They Feed They Lion"

http://www.ibiblio.org/ipa/poems/levine/they_feed_they_lion.php

Read H.D. Thoreau " On Civil Disobedience " here:

http://sunsite.berkeley.edu/Literature/Thoreau/CivilDisobedience.html

Read W. Bagehot " Lombard Street" here:

http://bagehot.classicauthors.net/LOMBARDSTREET/LOMBARDSTREET9.html

Read Irving Fisher's "The Debt-Deflation Theory Of Great Depressions" here:

http://fraser.stlouisfed.org/docs/meltzer/fisdeb33.pdf

Read H.D. Thoreau "Walking" here:

http://www.ecotopia.org/ehof/thoreau/walking.html

About Rabbi Ishmael's Rules, see here:

http://en.wikipedia.org/wiki/Baraita_of_Rabbi_Ishmael

Read E.C. Titchmarsh on "Counting" here:

http://www-groups.dcs.st-and.ac.uk/~history/Extras/Titchmarsh_Counting.html

Read Granville Barker's "Voysey Ineritance" here:

http://books.google.com/books?hl=en&id=jFNFAAAAIAAJ&dq=the+voysey+inheritance&printsec=frontcover&source=web&ots=7TZP8W9Hlh&sig=yEoasq-eebAqE6H0iOnVaJhqFRs&sa=X&oi=book_result&resnum=4&ct=result#PPA6-IA3,M1

Read Henry James "The Sacred Fount" here:

http://www2.newpaltz.edu/~hathaway/sacredfount.html

Read "The Calculus Of Consent" here"

http://www.econlib.org/library/Buchanan/buchCv3Cover.html

Read "Did Reagan Rule In Vain? A Closer Look at True Expenditure Levels in the United States and Europe by Jacob Funk Kirkegaard " here:

http://petersoninstitute.org/publications/interstitial.cfm?ResearchID=1096

Read "The Postulates Of Political Economy" by Bagehot here:

http://books.google.com/books?id=ZrA-AAAAIAAJ&dq=bagehot+political+economy&printsec=frontcover&source=bl&ots=dN6OiMA8wi&sig=gV8nfKIxA1hYR9oAIxvQFdNZD0w&hl=en&ei=15uXSZf7CoKqsAPHz-mLAQ&sa=X&oi=book_result&resnum=2&ct=result#PPP1,M1

Read W.Buiter "Helicopter Money" here:

http://www.nber.org/~wbuiter/helijpe.pdf

Read Remarks by Governor Ben S. Bernanke
Before the National Economists Club, Washington, D.C.
November 21, 2002 Deflation: Making Sure "It" Doesn't Happen Here"

http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm#f8

Shema by Primo Levi

You who live secure
In your warm houses
Who return at evening to find
Hot food and friendly faces:

Consider whether this is a man,
Who labours in the mud
Who knows no peace
Who fights for a crust of bread
Who dies at a yes or a no.
Consider whether this is a woman,
Without hair or name
With no more strength to remember
Eyes empty and womb cold
As a frog in winter.

Consider that this has been:
I commend these words to you.
Engrave them on your hearts
When you are in your house, when you walk on your way,
When you go to bed, when you rise.
Repeat them to your children.
Or may your house crumble,
Disease render you powerless,
Your offspring avert their faces from you.

Translated by Ruth Feldman And Brian Swann

For me, being a Jew means feeling the tragedy of yesterday as an inner oppression. On my left forearm I bear the Auschwitz number; it reads more briefly than the Pentateuch or the Talmud and yet provides more thorough information. It is also more binding than basic formulas of Jewish existence. If to myself and the world, including the religious and nationally minded Jews, who do not regard me as one of their own, I say: I am a Jew, then I mean by that those realities and possibilities that are summed up in the Auschwitz number.

– Jean Améry, At the Mind's Limits, p. 94

J.L. Austin

'there is no simple and handy appendage of a word called "the meaning of the word (x)"'

...our common stock of words embodies all the distinctions men have found worth drawing, and the connections they have found worth marking, in the lifetime of many generations: these surely are likely to be more numerous, more sound, since they have stood up to the long test of survival of the fittest, and more subtle, at least in all ordinary and reasonable practical matters, than any that you or I are likely to think up in our armchair of an afternoon – the most favorite alternative method

L. Wittgenstein

94. But I did not get my picture of the world by satisfying myself of its correctness; nor do I have it because I am satisfied of its correctness. No: it is the inherited background against which I distinguish between true and false.

95. The propositions describing this world-picture might be part of a kind of mythology. And their role is like that of rules of a game; and the game can be learned purely practically, without learning any explicit rules.

96. It might be imagined that some propositions, of the form of empirical propositions, were hardened and functioned as channels for such empirical propositions as were not hardened but fluid; and that this relation altered with time, in that fluid propositions hardened, and hard ones became fluid.

97. The mythology may change back into a state of flux, the river-bed of thoughts may shift. But I distinguish between the movement of the waters on the river-bed and the shift of the bed itself; though there is not a sharp division of the one from the other.

98. But if someone were to say "So logic too is an empirical science" he would be wrong. Yet this is right: the same proposition may get treated at one time as something to test by experience, at another as a rule of testing.

99. And the bank of that river consists partly of hard rock, subject to no alteration or only to an imperceptible one, partly of sand, which now in one place now in another gets washed away, or deposited.

100. The truths which Moore says he knows, are such as, roughly speaking, all of us know, if he knows them.

Jackson's Rules Of The Road

I'm going to be a happy idiot
And struggle for the legal tender
Where the ads take aim and lay their claim
To the heart and the soul of the spender
And believe in whatever may lie
In those things that money can buy
Thought true love could have been a contender
Are you there?
Say a prayer for the pretender
Who started out so young and strong
Only to surrender

Gotta do what you can just to keep your love alive
Trying not to confuse it with what you do to survive

And in the end they traded their tired wings
For the resignation that living brings
And exchanged loves bright and fragile glow
For the glitter and the rouge
And in the moment they were swept before the deluge

Don't confront me with my failures
I had not forgotten them

But its a long way that I have come
Across the sand to find you here among these people in the sun
Where your children will be born
You'll watch them as they run
Oh its so far the other way my life has gone

I caught a ride into the city every chance I got
I wasn't sure there was a name for the life I sought
Now I'm a long way gone down the life I got
I don't know how I believed some of the things I thought

Rock me on the water
Sister will you soothe my fevered brow
Rock me on the water, maybe Ill remember
Maybe Ill remember how
Rock me on the water
The wind is with me now
So rock me on the water
Ill get down to the sea somehow

But you said "morocco" and you made me smile
And it hasn't been that easy for a long, long while
And looking back into your eyes I saw them really shine
Giving me a taste of something fine
Something fine

V. Frankl

"In camp too, a man might draw the attention of a comrade working next to him to a nice view of the setting sun shining through the tall trees of the Bavarian woods (as in the famous water color by Dürer), the same woods in which we had built an enormous, hidden munitions plant. One evening, when we were already resting on the floor of our hut, dead tired, soup bowls in hand, a fellow prisoner rushed in and asked us to run out to the assembly grounds and see the wonderful sunset. Standing outside we saw sinister clouds glowing in the west and the whole sky alive with clouds of ever-changing shapes and colors, from steel blue to blood red. The desolate grey mud huts provided a sharp contrast, while the puddles on the muddy ground reflected the glowing sky. Then, after minutes of moving silence, one prisoner said to another, 'How beautiful the world could be!'

Libertarian Democrat Point Of View: An Eccentricity

Wednesday, May 27, 2009

U.S. has the “enormous privilege of controlling the world’s most important reserve currency,” allowing it “to borrow almost without limit

Thursday, May 21, 2009

Even a doom-monger like John Hussman says that Treasury bonds are “default-free securities”

is summer arriving?

Can America’s debt get too big to pay?

Wednesday, April 8, 2009

But to say that these were justifiable sovereign defaults does not mean that they were not sovereign defaults. Similar circumstances could arise agai

April 8, 2009 3:20am

Tuesday, March 24, 2009

“We’re in a government-dependent financial system; I never thought I would live to see the day… We’ve got to fight to get away from that.”

Tuesday, February 24, 2009

the inevitability of debt repudiation in the U.S.

Friday, February 20, 2009

Inflating away debts is a time honored tradition, but hasn't its time passed in the developed world?

Thursday, February 12, 2009

But could it be the case that American default is simply inevitable?

Sunday, February 8, 2009

a clear default on Treasury bonds did occur

Friday, January 16, 2009

"How will the rest of the world restructure in the face of a United States hell-bent on replenishing its bank accounts?"

Tuesday, January 6, 2009

"the demons of our past – above all, nationalism – will return. Achievements of decades may collapse almost overnight."

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Wednesday, May 27, 2009

Thursday, May 21, 2009

is summer arriving?

Wednesday, April 8, 2009

April 8, 2009 3:20am

Tuesday, March 24, 2009

Tuesday, February 24, 2009

Friday, February 20, 2009

Thursday, February 12, 2009

Sunday, February 8, 2009

Friday, January 16, 2009

Tuesday, January 6, 2009

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Don's Terms Of Reference

Don's Hermeneutics: Like Rabbi Yishmael's Rules, Only Not

The Quotes Above

From "The Snowfall" by D. Justice

Jackson's Rules Of The Road

Blog Archive

V. Frankl

About Me

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