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John M. Mason
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John M. Mason writes on current monetary and financial events. He is an entrepreneur and a writer. Current projects include a new banking institution, an Internet company, a private equity fund, two depository institutions and a community redevelopment fund. He formerly was on the faculty of the... More
  • What is Needed to Reduce the Federal Deficit
    My major point in “The Bear and the U S Dollar” (http://seekingalpha.com/article/255989-the-bear-and-the-u-s-dollar) is that the United States government has actively pursued a policy of “credit inflation” for the past fifty years and shows no signs of altering this policy stance in the future. 
    The federal government is projecting a budget deficit of $1.5 trillion for the current fiscal year and my estimate is that cumulative budget deficits for the next ten years will be at least $15 trillion. This is the foundation for the continuation of a governmental economic policy stance that is no different from what existed during the last fifty years. 
    Many in Washington are now saying that the budget deficit needs to be brought under control and there is a substantial amount of discussion about how much needs to be cut from expenditures.
    How credible is this ranting and raving?
    Not very says the foreign exchange market! The value of the United States dollar is under pressure and continues to decline and traders in this market seem to be ignoring all the “fuss and bother” going on.
    Why focus on the value of the United States dollar?
    To me, “a nation’s exchange rate is the single most important price in (the) economy; it will influence the entire range of individual prices, imports and exports, and even the level of economic activity. So it is hard for any government to ignore large swings in its exchange rate.” This quote is from Paul Volcker (“Changing Fortunes: the World’s Money and the Threat to American Leadership,” by Paul Volcker and Toyoo Gyohten, Times Books, 1992, page 232.)
    The problem is that the United States government has given vocal support to “a strong dollar” over the past fifty years and then inflated the economy and been surprised that the value of the dollar has declined and has continued to decline. 
    The question should be: “Why should anyone think that the United States government has any credibility when it comes to attempting to control the federal deficit?” 
    And, the gross federal debt has risen at a compound rate in excess of 7% from 1961 to 2009. The currency that could buy $1.00 worth of goods and services in 1960 can only buy $0.15 worth of goods and services now. The purchasing power of the dollar has declined by about 85% in this time period! 
    The United States government believes in a strong dollar? Have I got a bridge to sell you!
    The reason for this abysmal performance? The United States government has an objective, written into law, that says that it should focus on achieving high levels of employment, low levels of unemployment, in crafting its economic policy.
    And, has the United States achieved this objective? Not unless you believe that having roughly one in five working age adults under-employed as meeting this objective. Oh, and by-the-way, this policy has resulted in the income distribution in the United States being the most skewed toward higher incomes ever. Good work, government!
    The problem with this economic philosophy is that it was constructed in the 1930s and 1940s when “things” were different. There are three basic assumptions that lie behind the philosophy that are not applicable in today’s environment. The first had to do with the lurking fear of a Bolshevik revolution resulting high levels of unemployment in England and on the European continent.  The second had to do with the international flow of capital: there was little or no flow of financial capital in the world. The third assumed fixed exchange rates. (See http://seekingalpha.com/article/167893-john-maynard-keynes-and-international-relations-economic-paths-to-war-and-peace-by-donald-markwell.)
    The presence of the second and third assumption allowed a government to construct an economic policy that was independent of every other nation in the world. And, this economic policy could be designed to achieve high levels of employment thereby thwarting the possibility that there would be a successful revolution. The economic philosophy relied on the creation of governmental budget deficits and the underwriting of the credit inflation that was needed to achieve the government’s employment goals.
    What happened? Well, by the time the 1960s got going, the new policy of fiscal deficits and credit inflation was in place while, at the same time, international capital flows became quite fluid. For example, by the end of the 1960s, Eurodollar deposits, dollar deposits at London banks, became a major factor in international money markets and a real problem for the conduct of the Fed’s monetary policy. So, one assumption “bit the dust.”
    On August 15, 1971, President Nixon took the United States off of the gold standard and allowed the price of the United States dollar to float in foreign exchange markets. The flow of capital throughout the world was so fluid that the United States could not continue to “fix” the value of the dollar and continue to conduct an inflationary economic policy that was independent of other nations.  
    Now, politicians could focus on getting re-elected by promising high levels of employment for everyone!
    However, conducting an “independent” economic policy based on credit inflation when your currency floats and capital flows are relatively fluid internationally can result in a falling value for your currency and a weakening of your economic and political power. As Volcker suggested, that is exactly what happened.
    There were two periods in which the policy of the government counter-acted this policy of credit inflation. The first came when Paul Volcker was the Chairman of the Board of Governors of the Federal Reserve System (1979-1987) and the second came when Robert Rubin was the Secretary of the Treasury (1995-1999). Volcker, in an effort to fight a robust spurt in inflation, oversaw a massive tightening of monetary policy. As a consequence, the value of the dollar soared when he was chairman by 55% from early in 1980 to the middle of 1985. Rubin oversaw the efforts to balance the federal budget. During this effort the value of the dollar rose by almost 30% from the middle of 1995 to the end of 1998.
    So, if the foreign exchange markets believe that you are serious about establishing some discipline over your economic policy, you can achieve a rise in the value of your currency. And, this policy stance can accompany economic growth: after the double-dip recessions which ended in November 1982, the Reagan expansion continued through the rest of the decade; and the Clinton expansion continued into 2000 without the balancing of the budge affecting economic growth. 
    Thus, it would seem as if the first task of the current government would be to honestly commit to achieving a strong dollar and assign a lesser priority to achieving low levels of unemployment. Then the Congress needs to construct a budget that will earn a positive response from the foreign exchange markets. People in the foreign exchange markets realize that the deficit gap is not going to be closed immediately. But, the government must earn its credibility with respect to its support for a strong dollar. And, the government must continue to prove this commitment every day, from the President on down.
    Mar 03 12:31 PM | Link | Comment!
  • Is the Future of Finance "Post-Human"?
    Thursday, February 17, I put up a post titled “The Future of Finance is Getting Closer” (http://seekingalpha.com/article/253645-the-future-of-finance-is-getting-closer). In this post I discussed the changing world of finance and how it is being impacted by changes in information processing and the spread of information. I write on this subject fairly frequently because I believe that the continued improvement in information processing and the continued spread of information are going to dominate the future of finance…and everything else. 
    A reader of this post expressed concern over this assessment: derryl, stated that “John seems to be describing, not a post-industrial world, but a post-human world. Disembodied minds trading in information.”
    I don’t believe that I am describing a “post-human world.” Information processing and the spread of information has been going on for a long, long time. Let me put this in context. Freeman Dyson, Physics Professor Emeritus at the Institute for Advanced Study in Princeton wrote in review (New York Review of Books, March 10. 2011) of the new book by James Gleick, “The Information: A History, A Theory, A Flood” that “Everywhere around us, wherever we look, we see increasing order and increasing information.”   This is true both in the living world as well as the non-living world.
    Dyson goes on to qualify this statement. This “unending supply of information is a glorious vision for scientists. Scientists find the vision attractive, since it gives them a purpose for their existence and an unending supply of jobs.” Scientists work with the increasing amount of information to identify and work with the increasing amount of order.
    The concern by derryl only becomes real if the amount of information that exists is finite. Then the advancements of information technology can conceivably capture and model all that is and we evolve into “post-human world”. 
    The world being described by Dyson is a world in which the questions never end because the amount of information in this world is growing and will continue to grow. Thus, there will always need to be humans because there will always be questions to ask and inferences to be made. This world Dyson sees is continually requires humans to be around to gather the new information being produced and incorporate into new concepts and models.
    This is even more true of “human” activities like finance and investing. All the studies of complexity theory argue that the behavior of humans is much more “complex” than the behavior of non-living things. The reason for this is that modeling humans requires more information and more sophisticated models than is required to model non-living things. Thus, building models relating to investment behavior in a world where the total amount of information is increasing is something that cannot become “post-human.”
    Dyson captures this reality by writing that “The vision is less attractive to artists and writers and ordinary people…Ordinary people may not welcome a future spent swimming in an unending flood of information.”
    We see the problems in modeling human behavior in the book “The Quants” (See review: http://seekingalpha.com/article/188342-model-misbehavior-the-quants-how-a-new-breed-of-math-whizzes-conquered-wall-street-and-nearly-destroyed-it-by-scott-patterson.) In this book, the author describes what has been called a quant-led collapse: specifically the August 2007 market meltdown. “This meltdown came in what is known as the “shadow banking system” and not the true banking system (for) the Federal Reserve really didn’t seem to know what was going on. The first catastrophe came when the Bear Stearns hedge funds were instructed to file for bankruptcy on July 30, 2007. The melt-down started in earnest on Monday August 6.” Quant firms suffered large losses on “toxic” assets. 

    But, the “Quants” are still in business. And, the “Quants” are still using sophisticated mathematical models to invest. As with all human problem solving activity, the humans have learned from the 2007 experience. They have modified or re-built their models to take
    into account the new information that has been gathered and processed. And, they now have more robust models than they did before the financial collapse. 

    This is a highly quantitative world, yet it is not post-human and in my view will never be post-human. Humans are problem solvers and in playing this role they must build models, test models, modify models and use models to make decisions or explain things. Humans are information users.  And, in the world we are moving into will be even more information and information processing driven. It will be “smaller and faster.” (See http://seekingalpha.com/article/225773-the-new-world-order-smaller-and-faster-part-2.)

    This world, however, is going to be a more volatile world, it is going to be a world that
    changes faster, and it is going to be a world that requires people to adapt to the changes that they see going on around them. One cannot “lock” themselves into the world of the past. 

    History has shown that the spread of information and information technology cannot be stopped. It’s spread may be postponed for a while, but it eventually will succeed in spreading. Laws and regulations must take account of this. Congresses and regulators must take account of this. Dictators and autocrats must take account of this. Presidents and Prime Ministers must take account of this.

    A danger is that this world bifurcates…divides into two…those that can work within the new paradigm and those that adjust, for whatever reason, to the new paradigm. We are seeing some of the consequences of such division. The income distribution is being determined more and more by the amount of education a person has. Jobs are splitting more and more between service jobs and manufacturing jobs. But, even this is not all. Even clerk-like service jobs are being replaced by new technology. Jobs are more plentiful in information technology and finance than in jobs connected with “making things.” Health care is going to be an employment magnet but even there the clerk-like jobs are going to be replaced by new technology. 

    As a consequence of these developments, under-employment has grown substantially
    and will not decline much in upcoming years. Capacity utilization in the manufacturing industries will remain at historical lows. A substantial re-structuring is going to have to occur in the economies of the developed nations. 

    The point I am trying to make is that the world is going through a period of major transitions…economically, politically, and culturally. This is a once-in-a-century thing. As with major transitions in the past, the human element has not been eliminated, but the structure of human involvement in the world has changed dramatically. 

    Such change can be disturbing. I know that I am feeling the effects of this change in my life…and it is not just because I am getting older!
    Feb 25 3:39 PM | Link | Comment!
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