Monday, February 02, 2009
stimulus bill hits roadblock
the journal isn't wrong -- the bill is something of a boondoggle and won't do much for job creation. but the point isn't necessarily job creation.
the hard truth is that the world is currently suffering from a massive overcapacity problem, created by more than two decades of america and a few other western trade surplus nations calling forward incredible amounts of future income via debt instruments made available through vendor finance and the shadow banking system that was its conduit.
no realistic government stimulus can resolve this problem of overcapacity short of not only replacing the entire shadow banking construct but also convincing american households to use that system to resume going into even more egregious indebtedness than they have got into during the housing boom. bill gross may plead for it, but this is functionally impossible. even if government spending did fill the gap and sustain economic activity for a time, the stimulus would eventually end -- leaving a very similar excess capacity problem to be resolved.
so the inevitable result will be a resolution of excess capacity -- that is, businesses shuttering, economic activity declining and people losing jobs -- until global capacity begins to match much more closely the new, lower scale of global demand unsupplemented by massive growth in consumer and corporate debt.
all government stimulus can do in the final analysis is help to grease the gears of that transition, most hopefully by helping to avoid a massive debt-deflation cycle that depresses demand inordinately. demand will and must fall -- unemployment has consequences -- but the hope would be to provide enough transitional government-derived spending during the systemic delevering that demand retracement to a prudential net savings income doesn't become a demand collapse that drives the cycle.
but the real vehicles of resolving the crisis, both financial and economic, remain outside the realm of keynesian economic stimulus.
- nationalize and resolve the banks -- not some banks but all of them. henry blodget is basically right when he says that the half-measures have not worked to fix the banks and won't. and if you think the stimulus bill is a flawed giveaway to the politically connected and undeserving, get a load of the "aggregator bank" scam (calculated risk with more). paul krugman is again dead straight correct -- this is the most expensive and morally unsound way conceivable to attempt to fix the financial system -- so inefficient that indeed almost any realistic level of funding thrown at it won't, given the scale of the problem, be enough to actually fix the banks short of hazarding a dollar collapse and a run on the debt of the united states treasury.
If news reports are right, the [latest but surely not last -- gm] bank rescue plan will contain two main elements: government purchases of some troubled bank assets and guarantees against losses on other assets. The guarantees would represent a big gift to bank stockholders; the purchases might not, if the price was fair — but prices would, The Financial Times reports, probably be based on “valuation models” rather than market prices, suggesting that the government would be making a big gift here, too.
And in return for what is likely to be a huge subsidy to stockholders, taxpayers will get, well, nothing.
Will there at least be limits on executive compensation, to prevent more of the rip-offs that have enraged the public? President Obama denounced Wall Street bonuses in his latest weekly address — but according to The Washington Post, “the administration is likely to refrain from imposing tougher restrictions on executive compensation at most firms receiving government aid” because “harsh limits could discourage some firms from asking for aid.” This suggests that Mr. Obama’s tough talk is just for show.
Meanwhile, Wall Street’s culture of excess seems to have been barely dented by the crisis. “Say I’m a banker and I created $30 million. I should get a part of that,” one banker told The New York Times. And if you’re a banker and you destroyed $30 billion? Uncle Sam to the rescue!
There’s more at stake here than fairness, although that matters too. Saving the economy is going to be very expensive: that $800 billion stimulus plan is probably just a down payment, and rescuing the financial system, even if it’s done right, is going to cost hundreds of billions more. We can’t afford to squander money giving huge windfalls to banks and their executives, merely to preserve the illusion of private ownership.
current plans are a horrifyingly immense and unnecessary sop granted the banks' stakeholders by an obama administration and democratic party whose election campaigns were generously funded by the recipients. it is well past time to inflict due losses the bondholders of bank holding companies through forced debt-to-equity conversions. the alternative is gifting what will finally be several trillions of dollars to the stupid, complacent and greedy which will be paid out by our children and grandchildren in diminished incomes and reduced quality of life. no thanks -- i prefer my generation to be responsible and take its pain for itself.
- because sending banks to resolution means triggering their credit default swaps, government must freeze and nullify the CDS market to prevent a cascading unwind of collateral calls of a $30tn+ market. this may well mean nullifying as well the syntheitc CDO, whose value as an asset is predicated on the value of the underlying swaps. there may be a CDS market when all is said and done; but the one we have is infernal.
- the shadow banking system of highly leveraged hedge funds and special purpose vehicles which facilitated vendor finance must be reintermediated, brought on balance sheet and largely unwound in a regulated fashion, with the implicit deflationary consequences for credit accepted if mitigated by government safety nets.
the preceding have nothing to do with remediating the economy except insofaras the financial system must be first stabilized and then significantly downsized to provide a platform for some kind of recovery. for the economy:
- vendor finance must be stopped, as this disaster has largely proceeded from it. therefore, to the extent that china can be peaceably induced to gradually revalue the renminbi higher, reducing its current account surplus concomitantly, and accept the resultant burden of disassembling excess capacity through reduced export competitiveness, it should be.
- to the extent that it cannot -- which is likely a considerable extent -- the united states should deliberately pursue a trade war in order to force the adjustment. this will -- as willem buiter notes today, and krugman basically assents -- significantly increase the global pain of working off excess capacity. but i don't see a workable alternative that facilitates the closing of the american current account deficit, and the pain will probably be felt disproportionately in the trade surplus nations as their domestic economies alone become saddled with their previously-exporting excess capacity. western governments and societies, in positions of deep indebtedness and having largely gutted their manufacturing capacity during the boom, are in a position to provide neither the kind of demand support nor capacity winddown required without causing terrible global damage.
mitch mcconnell is leading an effort in the senate to reverse some of the damage done to international trade relations as highlighted by buiter with respect to the stimulus bill, not to mention treasury secretary tim geithner's attack on china as a currency "manipulator". this is, i think, wrongheaded. as trade collapses, the united states will be forced to build manufacturing capacity to meet domestic demand rather than importing capacity from china. this will in turn facilitate a transition away from our service-dependent domestic economy -- one in which whole sectors serve basically as a distribution network for east asian goods -- to something more balanced and sustainable.
- a very watchful eye must be kept on the dollar and, especially now, the pound. buiter's point of the limited draw of fiscal credibility in these two profligate states particularly must be taken to heart; sparking an iceland-like capital flight and triple collapse (of banks, government debt and currency) in either or both the US and UK would present a sure avenue to the global worst case scenario.
a difficult truth here, however, is that the surplus nations -- as holders of vast amounts of british and american government debt -- have the ammunition to attack these nations' currencies. while any massive sale of treasuries from china would likely be quickly offset by american central bank monetization of same, the effect on the dollar could be something more than the devaluation that is necessary and desirable to close the current account deficit.