the election of 1960, which Kennedy barely won, there was a cartoon
of a scowling Nixon, with this caption:
you buy a used car from this man?"
was made into a mimeographed poster and posted everywhere. Because
the race was so close, any single factor could be blamed for Nixon’s
loss. That cartoon had its share of analysts who said it provided
Kennedy with his margin of victory. That was as good a guess as
any, and it had the advantage of being tied to a grass-roots phenomenon
that seemed to come out of nowhere. It was democracy at work.
since, we have heard the phrase popping up: "Would
you buy a used car from . . . ?” It has become
part of the rhetorical landscape. I am doing my best to keep this
President is the man from whom the world buys Federal debt. He is
the nation’s representative agent. It is his policies that are assumed
to be capable of maintaining "the full faith and credit of
the United States."
unto that President who sits in the Oval Office on the day that
this faith is tested by the capital markets. Woe also to his party.
don’t watch any TV drama except The
West Wing. I think it’s in its final season. It is steadily
losing ratings to American Idol. I shall not berate American
Idol because all I know about that cultural phenomenon is that
a stupendously untalented Asian singer got a recording contract
after he was booted off the show. I say, good for him. He is in
the tradition of Florence Foster Jenkins, whose extraordinary voice
is remembered by few. This is only true of people who never heard
famous record. Once you have heard it, you will never forget
it, short of Alzheimer’s — maybe.
The West Wing lets me see which political issues are filtering
down to the script writers, who in turn serve as funnels to the
sorts of people who watch the show — not the people who watch
American Idol. The issues that appear as main plots on the
show are like early warning indicators of what the literate viewing
public may pick up next. There was a show this year tied to the
falling water level of the Colorado River. Another show was titled
Hubbert’s Peak, referring to the consumption of oil and the
possibility that energy prices will soar, breaking the economy,
most recent show had President Bartlett, a Nobel Prize winner in
economics, come face-to-face with his old nemesis, who shared the
prize with him. Bartlett is about as mature about this as a junior
high school student who tied for valedictorian.
West Wing always has at least two subplots going on, sometimes
three. They get wrapped up, but the main story line rarely gets
settled definitively. It is just dropped — rather like the
show’s Nielsen ratings.
the main plot, if it was the main plot, Bartlett reluctantly sits
down to speak with his old rival, whom he describes as someone who
makes Milton Friedman look like a middle-of-the-roader. The economist
is Japanese. He brings the President a friendly warning. The deficit
is too large. He is speaking of the Federal deficit, not the trade
deficit. He says that Japan may not continue to buy U.S. Treasury
debt. Other Asian nations may also cease to buy.
counters with a standard argument: they do not want their assets
to decline. Refusing to buy T-bonds would lower the international
value of the dollar, and hence lower the value of existing portfolios
of Treasury debt.
never get around to discussing central bank policy, but they do
speak about government policy. Bartlett admits that his greatest
regret about his two terms as President is the deficit: $300 billion
a year since 2001.
reality, of course, is much worse. The script writers actually low-balled
the problem. Bartlett argues that the deficit would have been high,
no matter who was President. His rival presses the point: there
will come a day when Asians will no longer buy Treasury debt. There
will be a day of reckoning.
terms of the size of the show’s audience, this exchange of opinions
on international credit is probably the most sophisticated one that
most of these viewers have been exposed to. It did lay out the central
issue: Asians are buying Treasury debt and thereby keeping U.S.
interest rates lower than would be the case if they stopped buying.
At some point, they will stop buying: private investors, central
banks, and commercial banks. At that point, the Treasury will have
to find replacement buyers. It is unlikely that the Treasury will
be able to persuade new buyers of its debt to do so at the low rates
that prevailed before Asians politely bowed out.
have been reading about all this for years. You may not be aware
of the fact that the vast majority of Americans know nothing about
this. They are not aware of the relationship between U.S. government
debt, mortgage interest rates, the economy, and Asian central banks.
They do not spend time thinking about possible scenarios that might
result if Asian central banks cease buying dollar-denominated debt,
including Treasury debt. They assume that someone is taking care
of this. But nobody is.
IN CHARGE HERE?
every level of discussion, something is confusing for the experts
on the next level down. Recently, Alan Greenspan testified that
he doesn’t understand why long-term rates have fallen.
international economy is complex, the product of competing bids
and competing dreams of billions of people. Reality is more complex
than our minds can comprehend, but we do our best to make sense
reality of credit/debt is that the numbers are enormous, the systems
are decreasingly understood, there is no final regulator, but there
are multiple national regulators who are unable to determine the
direction of the whole.
Greenspan can do is to influence the direction of the world’s largest
economy. Right now, the push is toward rising short-term interest
rates. This "push" is in fact a reaction against the absence
of monetary push. The Federal Reserve has been inflating the adjusted
monetary base, year to year, at a 5% rate. In the last three months,
there has been a lot of gyrating up and down. The recent push is
up, but not at anything approaching double-digit rates.
is more than Treasury debt. Credit is way, way more than Federal
Reserve credit. The free market is replacing central banking as
the primary determiner of money and credit. It’s not how much is
produced by central bank policy that counts. It’s what is done with
it that counts. The capital markets determine this. The day-to-day
decisions of traders, coordinated only by the price system, determine
the flow of funds. Nobody is in charge.
assume that the free market will produce better results than a tenured
committee of agents for a government-protected cartel of commercial
banks. But the cartel and its agents can create illusionary interest
rates and thereby produce booms and busts. They cannot prevent busts,
but they always try.
WEB OF DEBT
a March 1 posting by Eric Janszen of Trident
Capital, the author pulls together a lot of material in a short
essay. I had seen some of this material before, but there are some
new things that I think deserve consideration.
quotes from a book I have mentioned before, Peter Warburton’s Debt
and Delusion (1999). It is out of print. I have written
to Mr. Warburton to encourage him to bring it back in print in some
form. So far, it remains out of print. Janszen quotes Warburton.
This was written at least six years ago. It relates to derivatives,
which are futures contracts tied mainly to the movement of interest
rates. Companies try to hedge their portfolios against adverse movements
of interest rates. Speculators offer to bear this uncertainty if
they can make money by betting right. One party bets on rising rates;
the other party bets on falling rates. Wrote Warburton in 1999:
is an even more serious dimension to the meteoric rise in the
use of financial derivatives; the implicit credit system that
operates within it. Quite apart from the inherent gearing of futures
and options, relative to trades in the underlying securities,
it is possible to use unrealized gains in financial assets (including
derivatives contracts) as collateral for future purchases.
other words, it’s a process of pyramiding. One profitable trade
leads to more trades. The profits of one trade become the security
(margin requirement) for the next trade. The knee bone’s connected
to the thigh bone.
persistent upward trend in asset prices has amplified these unrealized
gains and has enabled and encouraged the progressive doubling
up of "long" positions, particularly in government bond
futures. It is easy to envisage how the cumulative actions of
a small minority of market participants over a number of years
can mature into a significant underlying demand for bonds. While
financial commentators are apt to attribute a falling US Treasury
bond yield to a lowering of inflation expectations or a new credibility
that the federal budget will be balanced, the true explanation
may lie in progressive gearing.
that’s who is buying the used deficit from this man! Derivatives
the government can’t spend promises to pay. It has to spend money
put up by investors or by the Federal Reserve, which isn’t putting
up much these days. So, what is happening is that those putting
up the money are hedging against interest rate moves by entering
into contracts. The derivative market provides what appears to be
insurance against bad guesses.
question is: How safe is the insurance that is provided by speculators
on the other side of these trades? Here, Janszen quotes from Martin
Mayer, a long-time FED watcher. I think this is as astute an observation
on the whole process as any I have seen. Mayer calls it Mayer’s
Third Law. I wish I knew the first two.
markets guarantee a winner for every loser, but they will over
time concentrate the losses in vulnerable sectors. Nature obeys
Mayer’s Third Law, which holds that risk-shifting instruments
will tend to shift risks onto those less able to bear them, because
them as got want to keep and hedge while them as ain’t got want
to get and speculate. The logic behind margin requirements in
stock markets and capital requirements in banking also holds in
the derivatives markets. Permitting highly leveraged institutions
to hold private parties behind closed doors is the political version
of selling volatility: the predictable likely gains will one day
be overwhelmed by an equally predictable disastrous loss.
will be the day of reckoning. That will be the day when the optimism
of the Establishment holders of debt will be sorely tested.
comments on the irrational exuberance of the 1990s and the failure
of the system to unwind in 2001. Unlike the 1920s, the banks did
not participate in the boom directly. They participated indirectly.
banks did not participate much in the 1990s stock market bubble,
thanks largely to post-Great Depression government regulations
that limit banks’ exposure to equities. Instead, to generate the
profits denied them by regulations and regulators in other markets,
today our nation’s banks carry the liability of several trillion
dollars of replacement value for the modern version of the intertwined,
non-transparent and highly leveraged bets of the 1920s, but in
the bond markets via OTC derivatives, rather than in the equity
banks are regulated. The over-the-counter market for derivatives,
heavily international, is not. So, the regulators can direct where
the money won’t go, point A to point B, but they can’t direct where
the money will go, and by what paths.
is why the regulatory system will be sorely tested when, as Mayer
so aptly puts it, them as got try to collect from them as ain’t
derivatives market is a $140 trillion (or thereabouts) unregulated
market for unsecured promises to pay. The commodity futures markets
are not far behind, though regulated.
entire modern economy is essentially a gigantic system of promises
keep thinking of those famous words, "Your check is in the
am asking you to do me a favor. My
new book, an economic commentary on the Gospel of Luke (700
pages), is now posted online for free. I know that most of you won’t
want to read a 700-page book. But I want to make sure that my books
are on hard drives all over the place. If I drop dead and the site
is taken down for any reason, I want to be sure that the book, even
though unread, is widely dispersed. You can always e-mail it as
a PDF file to someone. To download it, right-click on the address.
Right-clicking pops up a list of options. Choose "Save Target
As… " Name the file "Gary North on Luke."