Monday, May 31, 2010

No Soup For You!

They wait nervously in line curling behind them outside the shopfront. A straight and orderly queue. No pushing. No standing too close to the counter, or unnecessarily entering the kiosk before one's moment. Eyes wandering everywhere but the server. Whatever you do: Don't stare. No smelly perfumes or wisecracks. And no idle chat or loud laughter while in line. "What's on today?", the young Greek -looking girl discreetly whispers into her Italian-looking friend's ear, careful not to offend the Soup Nazi's sensibilities, the wrath of which has the most dire consequences for the soup-needy and soup-desperate alike. "Mediterranean Bean...I think...", comes the reply out of the corner of his mouth, making like a ventriloquist. The customer in front takes his bag, shuffles left to the cash-register as if mid-waltz, and politely hands the server his crisp ten-dollar bill. "NEXT!" She steps forward. His gaze focuses upon her, she hesitates, "One large soup, please..." she blurts out finally....and errrr ummm do you accept Travelers Cheques..?!?!" He stops ladling. Nostrils flare. Eyes narrow. "WHAT??? Travelers Checques...Where do you think you are....GREECE?!?! NO SOUP FOR YOU!!" "NEXT!". Her friend follows behind as they depart empty handed. Now, the American steps forward: "One extra-large soup please....."


Anonymous said...

wait but i was told by comrades Krugman and Stiglitz that deficits saved the world from a depression??

"Cassandra" said...

oh, they may well be correct, i cannot rule on this (and perhaps are marginally sympathetic). perhaps it is not a problem if the Fed is required to monetize only the marginal difference between the market's CURRENT aggregate funding preference. But the problem is of course, IF the market's preference changes, then the monetization requirement does become rather large and admittedly frightening. My analogy is not novel: the evil eye will eventually turn to/on the US. And we. too, will be forced into austerity mode of higher taxes, lower expenditure, and offsetting lax monetary policy (only partially) offset the contractionary pull. These two, as Rogoff has suggested will produce the third needed/demanded adjustment of forced debt restructuring amongst at least of some debts, yielding simultaneously the three adjustments of tighter fiscal policy (both fronts) some real loss of purchasing power, and some restructuring. Thus, the Austrians, may get their way in the end...and return to their errrr ummm whatever it is they do when not Austrianizing

Anonymous said...

well given the political will on the part of both parties in Washington to make the just, right, and tough decisions, then I don't have much confidence in austerity and restructuring. more likely a silent default via inflation, -ve real rates, and/or currency depreciation. the only thing that makes me somewhat sanguine is that evil eye will prolly get to France, Japan, or the UK before the US and therefore wake up the idiots in DC before it's too late like Greece.

Anonymous said...

how can you expect austerity and restructuring in the US when the Sarbox criminals in DC haven't accounted for Fannie and Freddie on the national balance sheet? These companies are now 140bln in the hole and yet the bondholders haven't been restructured, swapped for equity, or had a haircut. i suppose the market may force it at some point but Bernanke and Geithner will fight it head-on with the printing press.

joe said...

once again, Cassandra lacks much imagination in thinking about policy responses for the government to get the financing it needs. Print, baby, print, is not the only option.

During prior periods when the US government needed financing, it used additional strategies. It had a financial securities tax during WWI and WWII, which pushed people from trading stocks to investing in US government debt. The government can also modify capital requirement rules for banks and insurance companies, by requiring investments in treasuries, or just by reducing or even eliminating reserve requirements for investments in treasuries. The government can also change rules for investments in IRAs, 401(k)s, keoghs, and other retirement accounts to require investments in treasuries. The government's accounting standards are already encouraging insurance companies and pension funds to invest in treasuries in order to avoid P&L volatility by matching the maturities of assets and liabilities. The switch to IFRS will increase the pressure. And all this doesn't even take into account, the fact that, by historic standards, households, banks, and insurance companies are underinvested in government securities.

You can't talk about treasuries by only looking at the supply, you have to look at both the demand and supply. And you have to look at the full panoply of policy tools available to the government. There are far more than print, baby, print.

Anonymous said...

joe - I believe in the scenario C and Anon are discussing, the US government will not have these options, eg a currency crisis or 1970s style inflation. Are you really suggesting that the government could increase financial transactions taxes in a globalized world, or a forced allocation to government bonds for already underfunded or even bankrupt pension and endowment funds, or forced retail allocation to Treasuries when Joe Retail already spent the proceeds from the treasury auctions?? In that scenario, the government has ZERO options or negotiating leverage, just like the position the PIGS find themselves in now. I don't doubt that leaders will flail and fight and take desperate actions, but they will fail because when the crisis hits, they will only exacerbate the capital flight. Similarly, the austerity programs in Greece will hit nominal GDP, tax revenues, and economic slack which will ultimately make the situation worse. Greece needs 5 years of this, and if they can get through it then maybe they can stay in the same currency union as Germany and Finland and Holland. the US needs about 5-10 years of faster nominal GDP growth than total credit market debt growth, otherwise WHEN the crisis hits there will be no other options but to print or default or most likely a combination of both.

joe said...

anon 1145 - I believe in the scenario C and Anon are discussing, the US government will not have these options, eg a currency crisis or 1970s style inflation.... the US needs about 5-10 years of faster nominal GDP growth than total credit market debt growth, otherwise WHEN the crisis hits there will be no other options but to print or default or most likely a combination of both.

You also lack imagination. It is also possible the US imposes capital controls to prevent capital flight. And it is also possible that US households increase their savings rates and the percentage of their net worth in bonds enough to slurp down the additional treasury supply, directly, or indirectly through their annuities, pensions, etc. If you model it out, it's possible savings increase enough to prevent a disaster in treasuries, and we get slow growth and low inflation, or perhaps mild deflation.

Alternatively, it's also possible things get sorted in an inflationary, or currency crisis manner, if savings rates don't rise enough to slurp down the supply of treasuries.

Both narratives, and many others, are plausible. Claiming to be certain of any of them is ignorant at bet and fraudulent at worst. We aren't in the prophecy business. We're in the probabilities business of betting on whichever narrative is attractively mispriced.

"Cassandra" said...

Joe is wise and correct that the palette of plausible (and unused) tools and policy responses out there is far larger (and certainly more imaginative) than the narrow caricature depicted. Joe is further correct in regards to the business that we are in.

There is much so-called heavy lifting to do. The tighter-fiscal, loose monetary policy mix emerging seems to be the meme du jour, but alone, seems insufficient to materially alter the burden in real terms without at least some general debt restructuring - and societal renegotiation on size, scale and breadth of existing promises. These too are achievable, provided they are approached with a sense of justice and fairness (pain shared across labour, middle classes and capital alike). Tightening the fiscal dials too much (at this point) will of course hasten the determinism of the restructuring portion of adjustment, but run counter the requirements for at least modest inflation to assist in the job.

I would suggest again that the risk is not of the marginal amounts needed to sustain the new normal, but of the eye-popping king-sized amounts that would be required in the event existing holders don't roll, or "shit-happening" elsewhere causes current funding sources to evaporate. I like Joe's thinking, but there remains a large gulf between the language of WWI&II and the lack of gravity with which the current situation is approached. To mobilize resources in such a way, the gravity of the threat need to be markedly amplified. Sadly, I am resigned to having to watch the wheel will come off the wagon before such [potential] measures are mobilized - a state of neglect foreign to my conservative sense of preparedness.

Too bad the Treasury didn't (when they had the wiggle room) put gates on foreign and sovereign Treasury holdings (like hedge funds) i.e. maximum of 15% net withdrawals per year. Then we could recycle their surpluses with reduced attendant risks and a reasonable window to work out of it.

Anonymous said...

Joe - you may accuse me of lacking imagination and i will accuse you of lacking perspective. have capital controls ever worked? Are they working in China right now despite all the hot money flowing in? Did they work in Weimar Germany to stem speculation in foreign currencies? Did they work in Malaysia in the Asian crisis? Capital controls, in light of historical experience and observation, rarely have worked and are always rife with unintended consequences. Moreover, how do you propose to keep the Treasury market liquid and the US the world's reserve and trade currency if you have capital controls? You can't have all three my friend.

Re: forcing saving for Joe Public to soak up the supply is also problematic, and we won't even broach the constitutional issues associated with that policy. If, as the CBO estimates, we will be running the trillion dollar deficits for the next 10 years. new issuance plus refinancings will amount to 1.5-2 trillion in issuance (i don't have the exact numbers now), so you are likely looking at about a trillion of supply that you will meet by coercing savers into treasuries and agencies (coincidentally basically the amount the Fed bought in QE from 09-10). That's about 8% of GDP, so what happens to consumption as % GDP? What happens to nominal GDP? What happens to tax revenues? What happens to bust municipalities? What happens to pension funds' underfunding with long rates going down and other assets and GDP collapsing? Even if you conservatively propose to phase that in over years, it will be a very painful process that few politicians will countenance. And it's virtually impossible to do under duress over a short time period, like the state Greece is in now.

Not sure I'm the one lacking imagination here.

Ultimately, the easiest way to ease some of the fiscal problems we face is, like Germany did in good times, raise the retirement age and we can do so gradually. Like hiking capital requirements for the banks, it's the most direct way to do so without all the micro reforms and the unintended consequences (your forced Treasury buying is akin to the Volcker Rule IMO). Unfortunately no politician as of yet will pay the political price even though that is the just, sensible thing to do in light of increased longevity, deficits, and liabilities forced on the young and constituencies who literally cannot voice their displeasure yet.

I do agree with you we can leave the forecasting to the others because that's not our business. And the Greece or 1970's stagflation or Treasury / USD market crash are not my operative scenarios. But there is no harm in exploring scenarios and even hedging it a small bit, as I and others like Klarman, Paulson, and Leitner have with their respective inflation hedges.

joe said...

anon 406:

I never said what I beleive will happen. I have seen models by inflationists purporting to show the Treasury needs to debase the dollar by 40% to make its budgets work, and I've seen models by deflationists purporting to show that savings by US households and foreign mercantilists are likely to keep the dollar strong and treasury yields low. I don't think anyone really knows, and I hope it stays that way. The uncertainty create all kinds of opportunities.

Be careful how you think you are insuring yourself against potential debasement of the dollar. People like to talk about interest rate caps, swaptions, and steepeners. However those won't protect you against a one-off devaluation big enough to restore confidence in the ability of the US to service its commitments going forward. Likewise, precious metals only protect you if they aren't confiscated before the devaluation (or afterward at pre-devluation prices). And mining stocks only protect you if there aren't windfall profits taxes high enough to derate the stocks.

And keep an eye on the government mandarins' schemes to drive savings and spike tax revenue. They persuaded a lot of the middle class to voluntarily pay taxes to convert traditional IRAs and 401ks into Roths in hopes that the government won't screw them later on. And are now proposing to have mandatory IRAs, which have a default option of being Roths and a default option of investing in annuities. I can imagine them selling Energy Independence bonds to the public with the same deceptive marketing they used to sell war bonds.