Thursday, September 18, 2008

Negative Three Month Treasury Yield

The yield on a three month treasury bill went negative this morning. That means that people are paying the government to borrow their money. The price of gold is going through the roof because people are also willing to put their money there.

The good news: this means people still have confidence in the U.S. government, at least. They could be dropping Treasury bills for gold alone, after all.

The bad news: this means that every single other security out there is so bad that people are paying the institution they believe most reliable (the government) to take their money. People now feel like their optimal choice is taking a guaranteed loss. When the optimal is a negative return, that is not good.

I've personally been worried that when this whole Chinese-financed financial free-for-all finally burst, people would run like mad from a U.S. government that couldn't pay it's debts. Thankfully that hasn't happened yet. They're running toward the government. I guess that just goes to show that even when you've been fiscally irresponsible, having a defense budget that equals the rest of the world's combined and having the most advanced civilization in the history of the species still buys you something!

The Great Rebalancing

Steven Pearlstein has a good article in the Post this morning that presents a big-picture view of the financial crisis. He presents a very stark case - that this crisis is nothing less than the rebalancing of the global imbalances that have persistently defied economic gravity for at least the last two decades.

For years we have been willing recipients of a flood of cheap cash from abroad - mostly East Asia, but elsewhere as well. We didn't get this cash by exporting - we got it by borrowing it. The government borrowed it, corporations borrowed it, and through banks and credit card corporations, families borrowed it from places like Japan, Taiwan, and now China. That flood of money pushed up prices everywhere - price increases in real estate allowed the average American family to live a life of luxury they had never known before. Tuitions sky-rocketed, but record rates of college attendance were still attained because of the availability of student loans. Our government was able to wage indefensible and unconscionable wars because it didn't have to ask the American people for any kind of sacrifice. Why would they bother asking for that kind of sacrifice? The Chinese were more than willing to finance the invasion of sovereign nations!

In other words, for the last two decades bubbles have been percolating throughout America. Bubbles in housing. Bubbles in tech stocks. Bubbles in ALL stocks. Buyers were readily available to get a piece of the pie which seemed to magically keep increasing as East Asia pumped more and more cash into our economy. Then one bubble burst - housing. And another - investment banking. Now with the precarious state of the newly nationalized AIG, banks that American families interact with on a daily basis look more unstable.

Pearlstein uses scary language:

"You know you're in a heap of trouble when the lender of last resort suddenly runs out of money."

"What we are witnessing may be the greatest destruction of financial wealth that the world has ever seen -- paper losses measured in the trillions of dollars." (when he says "paper losses" here it sounds rather trivial... but remember how many jobs were created by those "paper gains").

"But more than psychology is involved here. What is really going on, at the most fundamental level, is that the United States is in the process of being forced by its foreign creditors to begin living within its means. "

I've talked at length about the danger of "global imbalances" in the past. Everybody that's written about them has prayed for a "smooth landing". And who knows - maybe we'll get a relatively smooth landing and this is just a really bad business cycle. Maybe by 2010 or so, foreigners will still want to lend to us... just less than they did before. I hope so.

One thing is for sure - with the events of the last three days, 2008 will enter the history books next to 1981, 1929, and 1873. It will be a doozy people - and unlike '81 and more like '29 and '73, '08 is likely to completely redraw the economic and power map in the United States and the world - we will spend differently, we will have different national priorities, we will interact differently with the rest of the world, and we will look at ourselves differently afterwards.

Wednesday, September 17, 2008

McCain and Hoover

Paul Krugman's blog has been very active lately. One of the things he's posted is this article from the American Prospect on the similarities between John McCain's statements about the economy being "fundamentally strong", and Herbert Hoover's similar pronouncements before the Great Depression.

An interesting thought - and I think the parallel is worth noting. McCain does sound quite out of touch on the economy these days, even when you disregard the comments of some of his staffers and just focus on what he says (i.e., "the nation of whiners" fiasco).

But at the same time, I have to give John McCain some credit here. I think the point is that most of the fundamentals of our economy are strong. We have strong, flexible labor markets, a great education system that provides one of the highest and broadest-based levels of human capital in the world, a reliable currency, a stable government, a wide consumer market, and a mobile population. We have a LOT going for us that will allow us to weather this current financial typhoon.

But one fundamental that is not strong is the stability of the investment banking industry. Robert Samuelson, as usual, provides some great insights in to these issues in this morning's Post. He describes how freely available capital, and poor regulation of the measurement of the amount of risk involved in these new securities has allowed investment banks to take unprecedentedly risky bets. That is one fundamental that is NOT strong... and even worse - not only is it not strong, but for years it has given the impression of strength where there was none.

So overall I'd say yes - McCain is the wrong choice if you're worried about the economy. But Krugman shouldn't overplay his cards. McCain is right that most of our economy is fundamentally strong, but wrong about it in the one instance that really matters this time - and is costing us hundreds of billions of dollars.

Tuesday, September 16, 2008

Yes America, we pulled a Chavez...

So the federal government effectively nationalized the largest insurance company in the country. Oh wait, not the federal government... the federal reserve board... you know, that thing that operates independently of our elected officials, save the occassional appointment of a chairman.

I don't know if this is as scary or shocking as it sounds - but it does make me wonder. To quote the senior Senator from New York: "The administration is approaching an unprecedented step, but unfortunately we are living in unprecedented times".

I don't like unprecedented times... there's just not precedent for them!

Representative Barney Frank (D - MA) is proposing the creation of a new federal agency to buy bad debt and reorganize companies as a long-term solution to the crisis. This article notes that a similar action was taken during the S&L crisis of the 1980s, but the that goal there was much simpler - limit taxpayer liability. The government was on the hook to insure those deposits.
No such clear cut goal exists in this case - it's not clear whether Frank's agency would be charged with lowering taxpayer liability (i.e. - probably selling off our newly nationalized companies as quickly as possible so that we're not left holding the bag there), protecting large financial institutions, or protecting homeowners.
On the deposit insurance front - it looks like all this could expand beyond the investment banking industry. The same article I linked to above suggests that Washington Mutual may be in trouble - and that if the government were to bail them out (which they are obligated to do because it's a deposit institution), then it could deplete half of the FDIC fund.