naked capitalism

By Anonymous (not, I think, that Anonymous). Originally published at Global Economic Intersections.

Warren Mosler (visit Warren’s blog) applies simple arithmetic to numerical relations that have a $ sign (or € sign), and explains clearly how a money economy works.

Everybody else stares mystified, as if placing a $ or € in the equation propels us into some alternate universe where ordinary arithmetic does not apply; where suddenly everybody is offering “moral” solutions (Live within our means!) to grade school arithmetic questions, as if “being good” exempts us from the rules of adding and subtracting money numbers.

“If Timmy brings 100 marbles to school and lends them to his classmates at 5% interest for the day, and the classmates diligently work to trade and earn and win enough marbles to pay their debts, how many marbles will Timmy collect at the end of the day?”

Follow up:

Most of the pupils are of the linear thinking neoclassical persuasion steeped from the cradle in “banker arithmetic”, so they sharpen their pencils and calculate that Timmy will receive 105 marbles in total principal + interest. “Profit drives the marble economy”, Teacher correctly explains, “which is why the classmates were all so busily engaged working for marbles.” And the pupils agreed it would be great fun participating in a marble economy where you could exercise your talents to get out more than you put in.

But little Warren had failed to cram his head into the neoclassical pencil sharpening box where you learn banker arithmetic and he exclaims, “But there ARE only 100 marbles, so unless Teacher adds marbles into the room, Timmy can only get back as many marbles as he put in. So the correct answer is Timmy will get back 100 marbles and some of his classmates will default on their debts and suffer a life of stupid unemployed poverty because Teacher says “We must live within our means.” and she refuses to add the needed marbles even though she owns the marble factory that produces unlimited marbles at virtually no cost.”

Teacher, by virtue of her “solid moral character”, is hired to run the Bundesbank, from whence she engineers a German export juggernaut that trades Mercedes for marbles so that Germans always earn enough marbles as profits to pay their debts. So now the “classmates” in Europe are rich in Mercedes but are destitute for marbles, because Germany got all the marbles in exchange for the Mercedes, and after the classmates ran out of domestic marbles Teacher “loaned” them more Bundesbank marbles so they could keep buying more Mercedes to keep the export juggernaut going. But finally it turns out the classmates cannot keep borrowing and spending German marbles to buy German exports and they start defaulting on their debts.

Teacher thinks, “Default? Which of my pupils used that word before?” And she remembers the little immoral heretic Warren who couldn’t understand moral arithmetic and insisted on applying “regular” arithmetic to problems about marbles. So she calls him up from his tropical tax haven and asks him to repeat what he once explained about “not enough marbles”.

Warren explains monetary arithmetic, which turns out to be the same as “regular” arithmetic except you confuse people with the mesmerizing $ € signs that wizards like to use to show how arcane and inscrutable they are. Then Teacher’s eyes are opened to the reality that morality and arithmetic inhabit non-intersecting Venn sets, where morality does not alter arithmetic. And with her newfound numerical clarity Teacher is appointed dictator of the ECB to save Greece and Germany and euroland from their mystifying problems with money numbers.

From her commanding heights at the ECB Teacher promptly begins distributing per capita grants of euros to all the classmates in the eurozone, and soon everybody has enough marbles to pay their debts and keep their game of “money economy” happening, to the delight of all parties. Greeks are smiling in their new Mercedes and Germans are revelling in their fat bank accounts as they soak up the Greek sun on vacation. And all’s right with the world.

Except for some Austrians, who confront Teacher, “So where are you getting all the marbles you’re distributing willy nilly throughout euroland? That seems pretty immoral to us! Unsustainable, too. Vigilantes will come an’ git you. And you won’t like that, nosiree!”

And Teacher patiently explains that numbers and morals do not mix, and that she simply made up the marbles because that’s all “money” really is, equations of numbers. And you don’t “get” numbers from some secret hidden pile of numbers somewhere. You simply add numbers when your economies are short of ‘money’: when people and resources are languishing unemployed and people can’t pay their debts; and you withdraw numbers (tax) once the economy is working near full capacity and price inflation gets too hot. She explains that euroland appointed her grand wizard dictator of the ECB because she alone was not mesmerized by the € sign, and she was not afraid of invoking wrathful plagues of ‘hyperinflation’ for daring to add and take away numbers that have a € on them.

The Austrians slouched away muttering about heresies against sound money, and they tried to stir up moral outrage in euroland against this blasphemous Teacher woman. But euroland was so happy with their restored economic prosperity that few even heard the Austrians let alone heeded them.

Until the truly fearsome monstrosity from the depths of the Earth began to raise his dread voice, the inexpiable “peak resources”, the beast who will not be appeased by numbers. But that’s a fable for another day. Today’s story was about “money numbers”, and how to use this knowledge to solve the present crisis, which is a confusion of arithmetic problem, not a real resources problem.

A related fable by J.D. Alt involving a variation of the game Monopoly can be read at New Economic Perspectives.

James K. Galbraith is an economics professor at the University of Texas at Austin, where he holds the Lloyd M. Bentsen Jr. Chair in Government/Business Relations. He writes about economics for numerous publications. His latest book, “Inequality and Instability: A Study of the World Economy Just Before the Great Crisis” (Oxford University Press, 2012), is available here.

Like many Americans, I was doing everything I could to help elect Barack Obama. It wasn’t all that much—but as an economist in Texas, I had some authority on the thinking of former Senator Phil Gramm, John McCain’s chief economic adviser. I’d made the front page of the Washington Post describing Gramm as a “sorcerer’s apprentice of financial instability and disaster.” (Gramm, with a certain sense of humor, denied it.) For that, and for my experience drafting policy papers, I was in contact every few days with Obama’s economists.

To economists in my own circle, it had long been clear that the financial crisis then unfolding was an epic event. We had watched the subprime mortgage disaster build up. In August 2007 we knew the meltdown had begun. Bear Stearns had failed. But for reasons that have to do with the pace and rhythm of politics, these issues remained on the back burner, the campaign being dominated by health care and the Iraq war. For those of us on the outside, it was hard to know whether the insiders understood what was coming.

And so it seemed a good idea to raise an alarm. But here you confront the Cassandra paradox: if you predict disaster, no one believes you. Economics is rife with alarmists; if the wolf really is at the door, it’s better to have a whole chorus saying so.

For this I had the help of the Charles Leopold Mayer Foundation for Human Progress, which convened a meeting in Paris. When you invite twenty friends to spend a few days in Paris in June, it’s rarely hard to persuade them to come. Among the Americans in the group were the editors of two important journals, a former United Nations financial expert, and the former federal regulator who had blown the whistle on the savings and loan fraud. There were also senior specialists from France, Britain, India, China, and Brazil.

The meeting had no political connection, but one result was a long memorandum, which I sent in early July to the Obama team. I do not know whether, or by whom, my memo was read. Not the slightest word came back.

Yet the memo disproves the notion that nobody knew. To the group in Paris, three months before Lehman, what I wrote was obvious. It was our consensus view. What follows is an excerpt.

* * *The most important common ground was over the depth and severity of the financial crisis. We placed it in a different league from all other financial events since the early thirties, including the debt crises of the eighties and the Asian and Russian crises of the late nineties. One of us called it “epochal” and “history-making.” And so it has turned out. What distinguishes this crisis from the others are three facts taken together: (a) it emerges from the United States, that is, from the center, and not the periphery, of the global system; (b) it reflects the collapse of a bubble in an economy driven by repetitive bubbles; and (c) the bubble has been vectored into the financial structure in a uniquely complex and intractable way, via securitization.

Bubbles are endemic to capitalism, but in most of history they are not the major story. In the nineteenth century, agricultural price deflation was a larger problem. In the twentieth, industrialization and technology set the direction. It was only in the information technology bubble of the late nineties that financial considerations including the rise of venture capital and the influx of capital to the United States following the Asian and Russian crises—came to dominate the direction of the economy as a whole. The result was capricious and unstable—vast investments in (for instance) dark broadband, followed by a financial collapse—but it was not without redeeming social merits. The economy prospered, achieving full employment without inflation. And much of the broadband survived for later use.

The same will not be said for the sequential bubbles of the Bush years, in housing and now commodities. The housing bubble—deliberately fostered by the authorities that should have been regulating it, including Alan Greenspan and Ben Bernanke—pushed the long-standing American model of support for homeownership beyond its breaking point. It involved a vast victimization of a vulnerable population. The unraveling will have social effects extending far beyond that population, to the large class of Americans with good credit and standard mortgages, whose home values are nevertheless being wiped out. Meanwhile, abandoned houses quickly become uninhabitable, so that, unlike broadband, the capital created in the bubble is actually destroyed, to a considerable degree, in the slump.

Securitization is a long-standing practice but the question is, at what point does it go too far? It should be clear by now that nonconforming home loans cannot be safely securitized, because the credit quality and therefore the value of the asset cannot be reliably assessed. Further, in the regulatory climate of recent years (where as William K. Black pointed out, political appointees brought chainsaws to press conferences), ordinary prudential lending practices broke down completely. The housing crisis was infected by appraisal fraud, a fact overlooked and therefore abetted by the ratings agencies. “No one looked at the loan package.” Now the integrity of every part of the system, from loan origination to underwriting to ratings, is under a cloud.

Fraud is deceit, a betrayal of trust. And it is trust that underlies valuation in a market full of specialized debt instruments, off-books financial entities and over-the-counter transactions. That trust has, as of now, collapsed. The result, as John Eatwell phrased it, is that financial crisis takes the form of market gridlock—a systematic unwillingness of institutions to accept the creditworthiness of their counterparties. This is, of course, especially grave where a counterparty has no direct resort to a lender of last resort—and so the crisis naturally erupts in parts of the system that are outside the direct purview of central banks. Deregulation is, in other words, a vector of financial crisis.

The message of all this for the Obama presidency is fairly clear. No one in the group expects the financial crisis to have disappeared, or even to be under stable control, by January of 2009. At that time there will no doubt be immediate priorities: more fiscal expansion, fast action against the wave of home losses to foreclosures, plus fast action against financial speculation in commodities would seem as of now to head the “to-do” list. But the financial problems will not go away. And that means that a seemingly benign credit expansion, such as got underway for Clinton in 1994 and carried him through his presidency, is not in the cards for Barack Obama.

Given the fact that vacated and unsold houses (unless destroyed outright) stay in inventory for a long time, there is little prospect of a housing recovery, or that a new expansion of loans to the broad population will be collateralized by home values any time soon. Recovery from this source should indeed not be expected within the policy horizon of the next presidential term. Something could happen, for reasons largely unforeseen, as it eventually did in the 1990s. But to bank on such a happy development would be an act of faith. More likely, there won’t be good news on the growth front in 2009, 2010, or 2011. Achieving economic growth in some other way will therefore be an overriding policy preoccupation.

The only other known way is fiscal policy, and this raises two questions: how much fiscal expansion will be needed, and over what time horizon?

Calls are now being heard for a “second stimulus package”; these reflect the fact that the first stimulus package [the Bush package of Spring 2008], while effective, was necessarily short-lived. But the same will be true of the second stimulus package. And once the election is over, will the coalition presently supporting short-term stimulus stay in place? If not, what then?

If the above analysis is correct, the political capital of the new presidency risks being exhausted, quite quickly, in a series of short-term stimulus efforts that will do little more than buoy the economy for a few months each. Since they will not lead to a revival of private credit, every one of those efforts will ultimately be seen as “too little, too late” and therefore as ending in failure. Meanwhile a policy of repetitive tax rebates can only undermine the larger reputation of the country; it is unlikely that the rest of the world will happily continue to finance a country whose economic policy consists solely of writing checks to consumers.

What is the alternative? It is to embark, from the beginning, on a directed, long-term strategy, based initially on public investment, aimed at the reconstruction of the physical infrastructure of the United States, at reform in our patterns of energy use, and at developing new technologies to deal with climate change and other pressing issues. It is to support those displaced by the unavoidable shrinkage of Bush-era bubbles but to do so efficiently—with unemployment insurance, revenue sharing to support state and local government public services, job training, adjustment assistance, and jobs programs. It is to foster, over a time frame stretching from five years out through the next generation, a shift of private investment toward activities complementary to the major public purposes just stated. It is to persuade the rest of the world that this is an activity worthy of financial support.

As noted, this strategy will have to be developed in a hostile environment of unstable oil and food prices. However, it would be a grave mistake to interpret that unstable price environment as “inflationary,” as leading toward a sustained or inertial inflation. In particular, money wages have not changed or caught up; real wages are therefore falling—and quite sharply—in view of the commodity price jumps. As Ben Bernanke acknowledged in a recent speech, nothing in the present movement of price indices can be attributed to wages. In Bernanke’s choice phrase, “the empirical evidence for this linkage is less definitive than we would like.”

It is Democratic Party mantra that Presidents do not comment on the actions of the Federal Reserve. But in this situation, comment is needed. An appropriate comment on the larger role of monetary policy does not amount to interference in routine decision-making, e.g., of the Federal Open Market Committee. Rather, it should reflect the core reality: the Federal Reserve and other financial regulatory agencies failed in their responsibilities in the past decade and now they must take up those responsibilities again.

The entire point of a regulatory system is to regulate. It is to subordinate the activities of an intrinsically unstable and predatory sector to larger social purposes, and thus to prevent a situation in which financial interests dictate policy to governments. That is, however, exactly the situation we have allowed to develop. The job of the Federal Reserve and of the other competent agencies in the next administration must be, in part, to reestablish who is boss. Specifically, there needs to be a very thoroughgoing revamping of the financial rules of the road, to dampen financial instability, deflate the commodity bubble, reduce the enormous monopoly rents in the financial sector, set new terms for credit management, and generate productive capital investment where it is most required. This is in large part the Federal Reserve’s job, though it has strong inter-agency and international dimensions.

These measures cannot be viewed, or undertaken, in isolation from the international financial position of the United States. Obviously, a successful speculative attack on the dollar would severely disrupt the orderly implementation of this or any other strategy. Equally obviously, a unilateral defense of the dollar via a campaign of high interest rates would severely aggravate the problems of the real economy.

The way out of this dilemma—the only way out—lies in multilateral coordination and collaboration: a joint effort by the United States and its creditors. And this means that the next administration must return, rapidly and with a credible commitment, to the world of collective security and shared decision-making that the Bush administration has been at pains to abandon. An orderly disengagement from Iraq would send a major signal of the intent of the U.S. government to play, in the future, by a different set of rules.

Collective security, in short, is not merely a slogan. It is the lynchpin of our future financial and economic security—security that cannot be assured by any unilateral means. Only a collective effort will keep America’s creditors committed to the stability of the dollar-reserve system for long enough to effect the next round of economic transformation in the United States. Conversely, continued failure to appreciate the financial and economic dimensions of unilateral militarism is one certain route toward the failure of the next administration’s economic and financial strategies. The two largest issues we face—how to maintain American economic leadership in much of the world and how to manage American military power—cannot be separated from each other.

Collective security is, however, also more than simply a way of reducing risks and instabilities. It is the foundation stone for many physical transformations of the economy to come. It is obvious, in particular, that the military basis of international power on which the United States continues to rely is completely out of date, and has been for decades. As Iraq has demonstrated to everyone including the professional military, military power alone cannot deliver stability and security at all—let alone at an acceptable human and social cost. Yet parts of the military establishment continue to develop, and to harbor, the technological talent and capacity for problem solving which every aspect of our energy problem now needs. Shifting the basis of our security system away from one based on military equipment is a key step toward making those resources available.

And the same is true for other countries. China, for example, has long made energy choices favoring coal partly because the resulting power plants are diffuse and militarily expendable. In a secure world, that country would be far more willing to develop its vast hydroelectric potential, as the then-invulnerable United States did in the 1930s. Hydropower is carbon-clean, but militarily exposed. A stable reduction of military fears is a key step toward opening up markets that can potentially permit resolution of collective problems on the grand scale.

In short conclusion: from the beginning, the Obama presidency will face acute situations requiring immediate action, especially in oil and housing. It should aim for early victories in these areas as the foundation stone for intermediate- and long-term programs. For the medium term, institution building and the restoration of competent and effective regulatory power over the financial system—both national and international—will be key.

For the long term, the goal should be nothing less than the transformation of our energy base and the solution of our environmental challenges—the rebuilding of America. And that can be done only in an international financial climate made possible by a return to multilateral decision-making and a commitment to collective security. The American people are ready for this. President Obama should be prepared to explain that leadership in a world community—leadership of collective action on the grand scale—is America’s true destiny. It is not in futile warfare, but in great endeavors, that a great nation finds its future, its purpose, its place in history, and prosperity, as well as security, for its people.

* * *This piece first appeared in Issue 19 of The Baffler — available now! — and is reprinted with permission. Image from Fey Ilyas (CC BY-SA 2.0)

By Philip Pilkington, a writer and journalist based in Dublin, Ireland. You can follow him on Twitter at @pilkingtonphil

Well, there’s been a lot of talk recently about a potential Greek exit from the Eurozone. Some, like Marshall Auerback , have been calling this a lot of hot air and in seems that, in light of recent events taking place from deep within the bowels of the Eurozone banking system they may indeed be correct.

Yesterday, Gavyn Davies over at the Financial Times blog ran an excellent piece on the silent bank run that has been taking place across Europe since the sovereign debt crisis began. It would seem that the bank run has sped up somewhat, as many will likely be dimly aware of from recent articles about bank deposits moving out of Greece. The extent to which it has accelerated, however, is quite interesting and can be seen in the following chart which tracks the Target2 interbank lending system in the Eurozone:

As the reader can see the flight out of the ‘dodgy banks’ in the periphery has increased quite a bit.

The reason for this, as Davies points out, is not the type of reason classically associated with a bank run. In a typical bank run depositors get nervous that the bank will not be able to fork over their cash should they want it. Many may remember the Simpsons scene where the hapless bank clerk tells panicking customers that their money is “at Bill’s house… and at Fred’s house”. Well, that’s basically your classical bank run. So, all the central bank has to do to counteract it is to step in and provide the liquidity. Then depositors will come to see that their money is guaranteed to be safe because the central bank — which prints money — is standing behind their bank ready to meet their desire for hard cash. The ECB, for whatever else it has done wrong, has performed this role perfectly throughout the recent crisis.

However, the bank runs nevertheless continue. Why? Because this is not, as Davies points out, a typical bank run. The reason that people are moving their deposits from peripheral banks to core banks is not because they are concerned about the peripheral banks’ ability to repay. Instead they are concerned that their government might exit the euro and reissue its own currency. In that case there is a good chance that if their deposits were sitting in a bank in their own country they would be converted into the new currency and, hence, automatically devalued vis-a-vis the euro (or neo-Deutschmark if the whole thing fell apart). If the depositor moves their money to a German bank, however, this shouldn’t be a problem — and given that there are no capital controls in Free Europa, moving your money is pretty easy.

The real problem — for the Germans, that is — is that, as Davies points out, in preventing a bank run the ECB is loading up on some pretty serious risk:

“As deposits are withdrawn from Greek banks, the ECB replaces these deposits with liquidity operations. If these are standard repo operations, such as those undertaken in the LTROs in December and February, then the ECB is directly assuming risks which the Greek private deposit holder is no longer willing to hold. If the liquidity is injected via Emergency Lending Assistance, then the Bank of Greece is theoretically assuming the risk, rather than the ECB as a whole. But in the event of a euro break-up, these losses would ultimately fall on the ECB itself.”

See the dilemma here — at least from a German point-of-view? This silent bank run is seriously stacking risk upon risk onto the ECB balance sheet. Now, as long as the currency union stays together this isn’t really a problem. But if one of the links in the chain snaps, the ECB balance sheet takes a hit — a big hit.

Now, since the ECB issues its own currency this is not really a problem from an operational point-of-view. Central banks, after all, can never really go bankrupt. However, the Germans hate the idea that the ECB might allow its balance sheet to take significant losses.

So, what does all this mean? Well, it looks like the Greeks have just got a rather massive bargaining chip handed to them by the citizens of the periphery voting against the Germans by removing their deposits from peripheral banks. A classic case of subversive European democracy in action, it would seem!

Given this set of circumstances, if the Greeks are to exit it will be a major headache for the Germans and the ECB. And so it looks like Mr. Tsipras, who has recently come out talking eminent sense about what is going on in the Eurozone at the moment, is holding far more cards than many in Germany and Europe are likely to be comfortable with. And so the only people that are looking ring-fenced these days are Merkel and her political allies. Schadenfreude, much?

By lambert (Yves being on vacation).

‘Rare’ Genetic Variants Are Surprisingly Common, Life Scientists Report Science Daily

Kansas town to auction first flush of giant public toilet on eBay McClatchy

“The anatomy of the eurozone bank run” FT

Merkel Resists G-8 Spending Pressure as Soccer Breaks the Ice Business Week.

Austerity-only cure for crisis out of fashion, but growth rhetoric covers difficult realities Pravda. I thought that Bsns W article was mush.

Germany resists sense  Macrobusiness

“Supply Lines Cast Shadow at NATO Meeting on Afghan War” Times

Nato talks security and peace, Chicago has neither Guardian

Citizen Journalists Detained at Gunpoint by CPD NBC Chicago. Tim Pool. 

Rising US recession risk poses the real threat to Europe Ambrose Evans-Pritchard

“China buyers defer raw material cargos” FT

Wen changes his tune Macrobusiness

Vietnam Economic Slowdown Seen in Cobweb-Covered Crates Bloomberg

The Current Post-Recession Labor Market in Historical Perspective Brad DeLong. Awww. Just when I was buying into the happy talk!

Riot in privatized AL prison Chicago Tribune

“Factories begin to shift back to US” FT

“Seeing Bailouts Through Rose-Colored Glasses” Gretchen Morgensen (Dean Baker comments).

JP Morgan executive to walk away with millions following trading loss Telegraph ($32m)

JPMorgan CIO Risk Overseer Said to Have Record of Trading Losses Bloomberg

Zombie Preparedness Week: Are you ready? From the British Columbia government.

The end of fish, in one chart Brad Plumer for Ezra Klein™

Gazprom Hopes to Build Second Baltic Sea Pipeline Der Spiegel

U.S. Government Authorizes Killing of Endangered Bighorns in Path of Wind Project East County Magazine (KH)

How did James Hansen’s 1981 global warming predictions work out?  (America Blog)

What Makes Countries Rich or Poor? Jared Diamond

Does “culture” require microfoundations? Understanding Society

“Philip K. Dick, Sci-Fi Philosopher, Part 1″ Times

What Trayvon Martin and George Zimmerman Heard New Yorker

House approves East Coast missile shield site in $643 billion defense bill The Hill. Missed this one.

Joe Strummer: The angry young man who grew up. [Harvard Square Theatre, February 16, 1979.]

And in Montreal band wars, I’ll see the good professor’s Arcade Fire and raise him one Me Mom and Morgentaler.

World cosplay summit Bangkok Post

* * *

D – 110 and counting*

I got elected, Sweetscent, but the drats knocked me right out of office in a no-confidence recall thing they cooked up. Having to do with the Pact of Peace. They were right, of course; I shouldn’t have gotten involved in it. But who wants to make a deal with four-armed shiny bugs who can’t even talk, who have to go around carrying a translation box like an indoor potty?’ –Philip K. Dick, Now Wait for Last Year

These links are lighter than usual. Sorry! Tomorrow I’ll do much more extensive work on both Chicago and Montreal. For now, it’s quite late….

Occupy Montreal: “The camera loves you, baby!” Good, detailed, vivid blog of today’s march. Not getting a clear picture of what the march is achieving other than, well, occupying the streets. (Not “unfiltered” because the reporter’s sensibility is clear, but better than the official Gazette story.) Oakland: Portraits from the Occupation. Representatives of the Oakland Police Department, and the police union, declined our invitations to participate, as did the editors of Adbusters magazine.

NATO summit Bobbleheads translate MTP: “GREGORY: wow look at these crazy violent NATO protestors! Audience: ooh white people.” The summit actually opened: “The global leaders met over a large round table” (around, surely). Bernard Harcourt: “Welcome, Nato, to Chicago’s police state”. And a hearty thank you to President Obama, his BFF, Rahm Emmanuel, and D operatives and enablers everywhere for making it all possible! RNN video of march (DCBlogger). “In the age of camera phones, the message is that protesters are watching police too.” Miscellaneous Chicago NATO Links (Bob).

CO (Swing state). Moms battle fracking.

FL (Swing State) “Most of Bern’s Steak House produce is not organic or locally grown on its own farm.” Another revered institution #FAIL! (Ha ha ha ha!)

OH (Swing state) Shalersville speaks out against fracking.

NC (Swing state) - “The Romney and Obama campaigns also seem to be behaving as though their internal polling is showing at least a very close race.”

WI (swing state) Journal-Sentinel endorses Walker (again): “It’s time to end the bickering and get back to the business of the state. We’ve had our differences with the governor, but he deserves a chance to complete his term. We recommended him in 2010. We see no reason to change that recommendation.”

Inside Baseball HCR in classic NYRB letters exchange. Martha Angell: “So the mandate that requires uninsured people to buy private insurance, which is at the heart of the Supreme Court challenge, would cover only 16 million people, a mere 5 percent of the population.” So (to my mind) it really is the mandate — forcing citizens to purchase a defective product, private health insurance — that’s the goal. Not the care. Think of the possibilities! How the Senate “avoids unpredictable democratic floor action, and the accountability of public debate. Picking the speakers for the RNC in Tampa. Whenever you read “delicate balancing act,” stop and do something else. The phrase is a tell for insiderese. (And if you’re attending the RNC, check the FL listening above). The issue nobody mentions: “Can Washington govern?” No, but I bet a man on a white horse could!

Ron Paul MN GOP convention: “They took over, basically. Nobody else was organizing.”

Greens Jill Stein interviewed in the Sun Times: “The politics of fear has brought us everything we were afraid of.” (OK, a Sun Times blog. But still.)

Romney Romney’s new ad introducing himself: Squee! Gary Wills: “Everyone has noticed by now the non-laugh laugh of Mitt Romney, a kind of half-stifled barking.” (I’m trying to remember what Obama’s laugh sounds like. But I can’t.) Bain gives more campaign money to Democrats than it does to Republicans.

Obama Obama 2.0 is the Wanker of the Day. (Leading one to ask the obvious question…) Of course, Axelrod used ____ for a fundraising pitch (____, in this case, being the Ricketts/Wright flap).

Feeding frenzies. None.

* 110 days ’til the Democratic National Convention ends with bottomless steins in a giant beer garden specially constructed by Walt Disney and the Department of Homeland Security in a public/private partnership on the floor of Bank of America Stadium, Charlotte, NC. The Sears Tower in Chicago has 110 stories.

* * *

Antidote du jour:

By Greg McKenna, aka Deus Forex Machina. He is the CEO of Lighthouse Securities and has spent past two decades in financial markets in a number of senior roles including Head of Currency Strategy at the NAB and Westpac. Cross posted from MacroBusiness

Lambert here. This article skilfully integrates several recent threads related to JippyMo’s latest but surely not last debacle, and ties them to a 4-point proposal from one-time BoA President Sallie Krawcheck in HBR for addressing governance problems at big banks “to better align management’s incentives with those of the long term interests of the business.” I can’t help but feel that a fifth point should be added, viz: 5. Investigate big banks for accounting control fraud, and prosecute criminals where called for. A few C*Os in orange jump suits doing the perp walk on national television would do wonders pour encourager les autres, and would “reconstruct” banking’s “top echelons,” as well. And aren’t proposals that don’t restore the rule of law to our famously free markets just tinkering around the edges?

* * *

Over the weekend, there was a convergence of very good articles arising from JPMorgan’s illustration that not much has changed in banking. These articles showed that there are better ways to align management with outcomes that balance the needs of national and global economies beyond the current privitised gains and socialised losses approach.

The first of these articles was by Sell On News at MacroBusiness. Titled “Derivatives need a Priest” SoN posed the question about markets and what are they for:

…we can ask how it was that a system created for people ended being blind to people, especially weaker people in places like Greece? In this anthrosphere we have created, the one thing we seem most averse to is putting human beings at the centre. Much better to see it as a machine, and to spend our time poking it to see how it works.

Indeed. In abstracting people from the equation and viewing not only the system but the individual banks and finance institutions as machines we create a distance between ourselves and those machines in a manner that allows some to claim observer status not ownership. At the more complex financial institutions, this abstraction can separate individual departments and traders from their own organisations.

Which brings me to a piece by Barry Ritholtz published in the Washington Post on the weekend, about the similarities between AIG and the recent JP Morgan experience. The nub of what Ritholtz says is:

Finance has become a low-margin, high-leverage business. This is not surprising in an environment in which trading volumes are exceedingly low and interest rates even lower. In any other industry, a slowdown in economic activity sends management scurrying to cut costs, develop new products, become more productive. In short, to innovate. Companies can throw money at new products, marketing campaigns or discounted pricing, but a slowing economy brings down demand. What we have today is a deleveraging economy, and that is even more challenging — limiting the options that CEOs can take to increase their company revenue.

The world of finance refuses to accept that reality. Whenever Wall Street is confronted with a decrease in profits, we see the same response: Increase leverage. We usually don’t hear about it until some market wobble causes the excessive leverage to blow up in someone’s face. This time, the novelty cigar was smoked by Dimon, and the damage was inflicted on his reputation. The losses, we learned, were a “mere” $2 billion, described as manageable.

Consider any major finance disaster of the past 30 years, and what you will invariably see is the result of trying to spin dross into gold. The magic of finance is that this can work for a while. The reality of finance is simple mathematics. Eventually, the probabilities play themselves out and the dice come up snake eyes.

He is dead right – the world of finance does appear to be unable to accept reality – the bigger financial institutions, the SIFI’s, almost feel like they are trading to their heart’s content in the knowledge that they are simply too big to fail and someone else will pick up the tab if they get it wrong.

All of Ritholtz conclusions are on the money but here are a few that are pertinent for this discussion today:

Regardless, the error at JPMorgan unwittingly reveals much about the present state of finance:

● Bankers remain imperfect, overreaching and bonus-driven participants;

● When using other people’s money, the promise of enormous bonuses is still weighed heavily toward excess risk-taking;

●No major U.S. money center bank has demonstrated an ability to manage proprietary trading risks. None.

●If traders have forgotten the lessons of the financial crisis less than four years later, what sort of reckless speculative risks will mis-incentivized persons be doing after 10 years?

Which brings me to the article in the Harvard Business Review from the June Magazine, Sally Krawcheck’s  Four ways to fix the banks. While it is based on the situation in the United States it has broad application for other markets. Echoing what Ritholtz has alluded to Krawcheck says:

It is tempting to view the financial downturn as a closed chapter whose primary causes have been resolved—perhaps not perfectly, but fairly comprehensively—by the Dodd-Frank Act’s reregulation of the financial services industry. But big banks continue to have a governance problem, which poses significant risks not just to them but potentially to the entire economy during the next downturn.

She concludes:

1. Pay Executives with Bonds as well as stocks
2. Pay Dividends as a percentage of earnings
3. Don’t judge Managers (just) by earnings
4. Give Board scrutiny to booming businesses too

I encourage you to read this article. Krawcheck is saying that there is a way to better align management’s incentives with those of the long term interests of the business. If the leverage ratio at a bank increases then so does the percentage in executive compensation that is paid in bonds, not cash or equities. This will increase the incentive to worry about the return of money as well as the return on the money. This should become a self-limiting constraint on overall financial leverage. I’d extend this idea down to the divisional head level so that there is an alignment of incentives vertically throughout the organisations.

Banking at the top echelon remains unreconstructed after almost 5 years of the GFC but there is no reason why policy makers should not push harder to incentivise the boards and management of SIFI’s to better serve the needs of the economy and to rebalance the asymmetry of benefits and costs away from privatised profits and socialised losses.

Lambert Strether (Yves being on vacation).

Rapid Climate Changes Turn North Woods into Moose Graveyard Scientific American

Supervolcano Drilling Plan Gets Go-Ahead Science. What could go wrong?

“Is Insider Trading Part of the Fabric?” Gretchen Morgenson

Sell-side research isn’t inside information Felix Salmon

“Discord at Key JPMorgan Unit Is Faulted in Loss” Times

The Need For An Independent Investigation Into JP Morgan Chase Simon Johnson

BBC Interview with Nassim Taleb on JPMorgan Jesse: “The more I look into this and think about it, the more that Barack Obama’s ‘favorite banker’ looks like Enron in their heyday.”

Obama: “Unless you run a financial institution whose business model is built on cheating consumers or making risky bets that could damage the whole economy, you have nothing to fear from Wall Street reform.” I swear I’m not making this up!

Waters Challenges Khuzami on Securitization Fraud Task Force, Gets Revealing Answers David Dayen

Syndicate: If You Can Get It, Run The Other Way Big Picture. FaceBorg post mortem.

Chicago protests on eve of NATO summit raucous, peaceful Reuters

CPD: Terror suspects had planned firebomb attacks Local ABC. Helpful undercover policeman: “Hey, I just happen to have a source of jellied gasoline! And jelly jars, too!” Timothy McVeigh these guys ain’t.

NATO Summit: 3 Protesters Arrested, Charged with Conspiracy to Commit Terrorism National ABC. Nuance: Local says arrestees to attend black bloc demo; national says arrestees “proclaimed themselves to be” black block. Going with local, sensing oncoming and ugly moral panic. Honestly, it’s like watching an elephant panic at the sight of a mouse. Man up, global oligarchs!

“Student Strike” main page Montreal Gazette

Quebec student protesters find creative ways around controversial new law Toronto Star

“PLQ + Mafia = QC” (pictures); “Monsieur Trois Pour Cent”. Ouille!

The Trade Agreement You Never Heard About – TPP (Trans-Pacific Partnership) Economic Populist

So Warren Buffett likes newspapers again? Jack Shafer

“A Little Secret Denmark Shares with Canada about Social Mobility that Americans and Brits Should Know” Economist’s View. Moral is at the end.

Housing Analysis Biased Toward Removing People From Homes By Any Means Necessary David Dayen

Inflation, Credibility, and Expectations: Again Some More Angry Bear

The Pirate Party fits the political gap Guardian

Italy deploys 20,000 to protect sensitive targets AP

Ending NATO’s double standard Reuters

A Victory for All of Us Chris Hedges

Drone filmmaker denied visa to accept his film festival award Greenwald. The Obama administration is mind-bogglingly petty and thin-skinned.

Channels and channels and channels.

It’s safer to poke fun at airlines than take on a whole country FT.  Tyler Brûlé.

Psychiatrist who championed ‘gay cure’ admits he was wrong Guardian

* * *

I’m not covering the horse-race today so I can get up early and watch the Sunday morning talk shows. Not. –lambert

* * *

Antidote du jour (hat tip SV):

By J. D. Alt. The post is a continuation of ideas first developed in Alt’s novel, The Architect Who Couldn’t Sing, available at Amazon.com or iBooks. Originally posted at New Economic Perspectives.

Why does it seem like there isn’t enough money to pay for the things we really need? The headlines are filled with stories about our nation’s “debt problem” and dire warnings about our impending “bankruptcy.” As an architect who fills his waking hours thinking up all kinds of wonderful things we could be building, I’m alarmed by the idea there isn’t enough money to pay for any of them. Before wasting more time dreaming, I had to find out: Is it really true? Are we really too poor to put America back to work making and building the things we need to maintain a prosperous nation?

Searching for an answer, I discovered a small (but growing) group of economists (see here, here, here, here, here, here) who represent an emerging school of thought known as “modern monetary theory” (MMT). These men and women are valiantly trying to make us all understand a paradigm shift that occurred some forty years ago, when the world abandoned the gold standard. Their key insight shocked me: A sovereign government is never revenue constrained when it is the Monopoly issuer of its own pure fiat currency; it has all the money that’s needed to put its citizens to work building anything—and providing any service—that is desired by the public (provided the real resources are available). Even more remarkable, sovereign “deficits” in the fiat currency are just the accounting record of the surpluses that have been injected into the private economy. Eliminating the sovereign currency deficit by imposing austerity will not make the economy healthier; it will, in effect, bankrupt the citizens!

If this seems to defy logic, stay with me for just a few minutes. I’m going to propose a simple exercise that will help you “see” this reality for yourself. The exercise is simply that everyone join me in a familiar game of Monopoly. By the end of the game, I hope to convince you that MMT is correct and that we could be doing better, much better – for ourselves and future generations—if we just understood and took ad vantage of our modern monetary system.

Let’s begin.

Playing Monopolis Monopoly

We’ll play by the normal rules (I’ll suggest some added features as we go along) except this time we’ll pay special attention to certain things that are happening. For example, you’ll recall that before the game can begin, one player has to agree to be the “banker” (a tedious task, but someonehas to do it.) But now choosing this person has a special importance: it must be done democratically, with the players voting to determine who will manage the game’s money. We’ll do this little exercise because we want to pay special attention to the fact that the Monopoly “bank” is an entity created by the players themselves for their mutual benefit. In fact, we won’t refer to it as the “bank” anymore, but instead will call it our “currency issuing government” (CIG). In a real sense, we all “own” CIG together, and taking a minute to democratically choose who will manage it heightens our awareness of this key fact.

To reinforce this awareness, the next thing we’ll think about, as we set up the Monopoly board, organize the Deed Cards, shuffle the Chance Cards and choose our tokens, is that what we are really doing is setting up, and getting ready to operate, a miniature nation-state. Let’s even give it a name: Monopolis. We, the players, are the new citizens of Monopolis. We have just established, through democratic consensus, our currency issuing government, and we are now getting ready to operate our economy. That’s what the game is about.

Issuing the Currency

As we get ready to play, we immediately discover an odd dilemma: CIG has all the money! We, the players, are ready to go but we can’t start the game until we have some of CIG’s money. This is an awkward moment, which is dispensed with so quickly in regular Monopoly we hardly notice it. (The “banker” is instructed to make initial cash distributions in the amount of $1500 to each player). If we pay attention, we can see that this moment raises some interesting and crucial questions.

The first question is: are we not playing the game backwards? Isn’t it us, after all, who have to give our money to government before it has any money to spend on anything? Politicians are telling us this all the time: “Your tax dollars are going to pay for this or that.” And, as will become clear, at the state and local level, this is certainly true. But at the federal level—at the level of the sovereign state—the game of Monopoly provides us with our first clue that something is fundamentally different now from what we habitually imagine it to be.

The CIG we’ve created for our nation of Monopolis, in fact, has exactly the same purpose, and exactly the same unique and special power as any government that issues its own sovereign currency: Its purpose is to issue and manage the money we are going to play our game with, and the special power we’ve granted it is the ability to create as much money as necessary for our game to go on as long as we want it to.

Indeed, the rules of Monopoly specifically state that while players can run out of money (in which case they are bankrupt and out of the game) the Monopoly “bank” itself can NEVER run out. In the event the game unfolds in such a way that all the pink and green and blue and gold bills that come in the box are absorbed by the players, the Monopoly rule book instructs the banker to get out a pencil, paper and scissors and create new money as needed. (This is the definition of “fiat money”—money that gains its acceptance simply by decree.)

So it appears we aren’t playing the game backwards after all. The currency does flow from CIG to the players, and when we give some of that money back—in the form of taxes, or fees, or fines— by logic it cannot be because CIG needs that money. In fact, the CIG could take all the money it receives (in taxes, fees or fines) and simply shred it and throw it away: it has no need for it, because when it needs money it simply “issues” the currency. The first time I tried to wrap my thinking around this set of ideas my primordial brain-stem resonated with knee-jerk objections. (I’m not alone. See here)

Indignant as I might get, however, Monopoly forces me to realize that if I want to play the game, I have to accept the fact that the CIG gets to create the money, and I have to use the money it creates. I could insist otherwise, demanding that each player bring to the table his own private stash of gold and silver. In fact, it was just forty years ago that the real world played the game in exactly this way, and the long history associated with that experience is what implanted our brain-stems with Neanderthal beliefs about what money is and how it works. But as will become evident (if we can ever get started) the game proceeds with much greater efficiency and potential for economic growth (prosperity for more and more people) if we use our CIG’s fiat currency, which has an unlimited supply, as opposed to the player’s “gold and silver” which has a limited quantity.

Monopolis Players have Jobs

As I mentioned, “plain-game” Monopoly glosses over all these issues by directing the “banker” to simply make initial cash disbursements of $1500 to each player. In our game of Monopolis Monopoly, however, we want to emphasize that people work for a living. So we begin our game by having our government buy something it needs from each of the players.

For example, I’m a writer-architect, and the government pays me $1500 to write the Monopolis rules. You are a builder, and the government pays you $2500 to build a network of roads that will allow lumber and materials to be transported to the Monopoly board properties. Sister Sue is an administrator, and the government pays her $2000 to create the Balance Sheet we’ll use to keep track of the game’s transactions. So now we’ve each done a bit of work, have modest cash positions, and we’re ready to begin the game. Before we do, however, let’s look at the Balance Sheet sister Sue has created. Keeping this Balance Sheet up to date, and paying attention to it from time to time, is going to be important.

Finally! We’re ready to roll the dice to see who goes first. As we play, we should begin to notice the fact that there are two different kinds of transactions occurring. One set of transactions takes place among the players themselves: I land on your property and have to pay you rent. Let’s say I land on Vermont Avenue and I have to pay you $50; then you land on Baltic Avenue and have to pay Sister Sue $75; then Sister Sue lands on Charles Street and has to pay me $150. Let’s think of these transactions as happening within something we can call the “private sector”, and update our Balance Sheet to look like this:

 

Horizontal and Vertical Transactions