Declining Confidence in US Fiscal and Monetary Policies

A lot has happened in the last two years. When I look back onto 2008 and the first half of 2009, I see that the world is entering a paradigm shift. Structural changes have to be made to restore (my) confidence in the US market. America's leadership in the world is faltering and it still doesn't seem to understand what the underlying problems of its policies are. It is obvious that the political agenda's are too short-term and therefore a major threat to US national security and prosperity.

Following the collapse of Lehman Bros. the financial world shook on its remaining pillars. Never in modern times was systemic risk so obvious, liquidity severely constrained, banks tightening credit and loan facilities while hoarding for cash to fill up gaps in their (highly leveraged, 20-50:1) balance sheets and governments worldwide bailing out private (mostly financial) institutions to make sure the average Joe on the street received his monthly paycheck on time. When credit stops flowing, businesses can't make payments for goods and services and paychecks can't be fulfilled. In order to limit the damage that started with securitization (a treat of financial innovation) on Wall Street, banks were bailed out to avoid imminent bankruptcy, which would restrict the remaining credit facilities even further.

Under the current Obama administration the fallacy of consumer borrowing and spending is destined to continue, even considering the US national total debt per citizen is currently $38,000 and rising. When we include unfunded US liabilities the picture shows to be even more dire at $191,000 for every man, woman and child. See US National Debt Clock for real time details.

During the 2002 - 2007 timeframe, investors were overwhelmed with easy credit. Speculation and malinvestment were abundant, especially in the housing market. The policies were aligned through Washington for all American's to own a home. After 9-11 the Fed's discount window interest rate was lowered to 1%. Wall Street made use of that easy credit and some of the regulatory key figures let it happen on their watch. In short, low FED rates where the cause of excess liquidity spurring unregulated home ownership in America following 9-11 where George W. Bush told his nation to go out and spend America to prosperity in order to avoid the (much needed) recession after the NASDAQ tech-bubble collapsed.

Alan Greenspan always was a great believer in market forces. He believed that the market would always regulate itself, as he opined that employees always would deal in the interest of the company and not mainly for personal gains. Greenspan believed that bubbles are not an issue for government regulation. In May 2005 he said in a speech: "Private regulation generally has proved far better at constraining excessive risk-taking than has government regulation". Recently Greenspan came back from that statement and told the world that he made a mistake by thinking the market would regulate itself. Clearly greed is of a larger factor for long-term corporate survival.

Even more so disturbing is the fact that Greenspan reassured (first-time) homebuyers in 2004 about taking on ARM mortgages (Adjustable Rate Mortgages) when the first signs of overheating were already present in some local markets. How wrong could he be in hindsight. For me, the ordinary man on the street its hindsight but I doubt if Greenspan didn't had enough information in his circles that showed him that his economic model was early flawed. One of the indications should be the huge bonusses that drove performance. A man of his numeric intelligence should have seen the equation of low FED discount rates, high leverage, monetary expansion (M3) and the urge for high corporate earnings (PE ratios) to get investors interested in buying more of their stocks.

People now have to get their head straight and educate themselves about cause and effects of misguided monetary and fiscal policies for their own benefit and vote accordingly in the next decades to come. It is of upmost importance that American's see that their elected officials are playing partizan games in the House and Congress, putting high-ranking people in places like the FED and US Treasury that are aligned in their political will. In fact, I think that the Federal Reserve is way to aligned with the US government agenda, which currently says: expand government to save jobs and increase fiscal spending to please (better: to save) our constituencies. The FED as a private entity should do the exact opposite of what government wants in order to restore balance in the economy. To limit government and lower the deficit by raising interest rates as soon as possible. Yet they lack the courage or the right type of people to do so.

One thing is for sure though, irresponsible corporate exhuberance is (temporarily) done for and so is the American dream 1.0. The people's confidence is lost although American morale and optimism appears undented. Reality clearly indicates the need for structural sacrifice and financial regulation reform in the short term. The current spending binge from the Obama administration doesn't really help that idea come into reality. As a result, record high debt levels are frightening to look at with US national debt to GDP ratio currently at 100%. Include unfunded national liabilities like Medicare/Medicaid plus Social Security and the total US national debt to GDP reaches 400%. Thats a true debt spiral only serviceable by printing fiat dollars and thus rigorously debasing the dollar value, or simply by default.

Printing money is the only solution to fake growth and increase nominal asset prices when investors slowly increase their awareness of the coming debt spiral and retract their money out of dollar denominated assets in the coming years. In my view, its bound to happen unless government spending is cut, personal savings are increased and a renewed manufacturing base is in place.

Some people talk about avoiding the lost decades of Japan by means of loosening credit as part of the Keynesian ultimate dream (fallacy). Ironically America is walking into the same two decade trap at the very least caused by their own political ignorance and irrational spending. Time will tell.

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The Last European: Why the G-20 Was a Success

Simon Johnson, a professor of entrepreneurship at M.I.T.’s Sloan School of Management, is the former chief economist at the International Monetary Fund.

What did Thursday’s G-20 summit meeting really achieve?

On the highest-profile issues of financial regulation, fiscal stimulus and monetary policy, there was little progress. But on the International Monetary Fund, the American side engineered a breakthrough — not just in terms of how much money the fund can lend to countries, but also in terms of rebuilding its legitimacy and making it more effective as the world’s only global crisis-fighting organization.

The Europeans are claiming progress at the summit meeting in terms of promises to regulate hedge funds and create more cooperation between bank supervisors across countries. These are sensible steps in principle, but do nothing to rein in the political power of huge banks and their ability to evade regulation. No one at the meeting said anything as simple and — these days — as obvious as, “Any bank that is too big to fail is also too big to exist.”

The Obama administration pushed for more government spending as a way to provide fiscal stimulus around the world, but they were completely rebuffed by the Europeans. And not even the United States was willing to push other countries aggressively for the most important stimulus when wages and prices are entering a downward deflationary spiral — further easing of monetary policy to help borrowers around the world.

The only real news is the support shown by the G-20 for the I.M.F. The headline is obviously the extra money that the I.M.F. will have — up from $250 billion to around $1 trillion in effective lendable resources; finally, enough to begin to make a global difference. Most of the press coverage stops with this point, but all this extra money is helpful only if it gets lent out.
Lots of countries are in trouble or under pressure, yet many are reluctant to borrow from the fund because this comes with “stigma” — such loans are interpreted as a sign that you are doing badly. Many countries also feel that the conditions attached to I.M.F. loans are onerous and mostly there at the behest of the rich countries that founded the fund and still control it.

The best way to enhance the I.M.F.’s legitimacy would be to give middle- and lower-income countries a greater role in its governance (more votes or more seats on the board or both), but progress on this front remains glacial; European countries in particular are unwilling to give up their long-standing over-representation.

In this difficult context, the Obama administration produced a rabbit out of the hat.

The managing director of the I.M.F. is very powerful, with a great deal of authority and discretion, and has always been a European — in effect, appointed by European governments to represent their interests. The G-20 made it clear that this will stop — the communiqué says the selection process will be open, transparent and competitive. But really this is code for saying they will pick someone from an emerging-market country, such as India or Brazil (and there are some excellent candidates). The right person in this job could have a huge positive effect on the I.M.F.’s legitimacy.

To make things matters more interesting, the I.M.F.’s managing director is expected by insiders to resign within a year, to resume his (promising) pursuit of the French presidency. The leadership race for the next managing director effectively starts today; the stakes are high, and competition will be intense.

How did the Obama administration pull this off? In a brilliant move, they took the lead by volunteering to open up the selection process for the World Bank, the I.M.F.’s sister organization, which has always been run by an American. The next president of the World Bank is very likely to be Chinese.

By Simon Johnson

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