jmkeynes

Perhaps It's Time to Think of a New Currency Regime?

Here's something from Soros that appears in the FT.

America must lead a rescue of emerging economies

George Soros

Published: October 28 2008 22:05 | Last updated: October 28 2008 22:05

The global financial system as it is currently constituted is characterised by a pernicious asymmetry. The financial authorities of the developed countries are in charge and they will do whatever it takes to prevent the system from collapsing. They are, however, less concerned with the fate of countries at the periphery. As a result, the system provides less stability and protection for those countries than for the countries at the centre. This asymmetry – which is enshrined in the veto rights the US enjoys in the International Monetary Fund, explains why the US has been able to run up an ever-increasing current account deficit over the past quarter of a century. The so-called Washington consensus imposed strict market discipline on other countries but the US was exempt from it.

The emerging market crisis of 1997 devastated the periphery such as Indonesia, Brazil, Korea and Russia but left America unscathed. Subsequently, many peripheral countries followed sound macroeconomic policies, once again attracting large capital inflows, and in recent years have enjoyed fast economic growth. Then came the financial crisis, which originated in the US. Until recently peripheral countries such as Brazil remained largely unaffected; indeed, they benefited from the commodity boom. But after the bankruptcy of Lehman Brothers, the financial system suffered a temporary cardiac arrest and the authorities in the US and Europe resorted to desperate measures to resuscitate it. In effect, they resolved that no other big financial institution would be allowed to default and also they guaranteed depositors against losses. This had unintended adverse consequences for the peripheral countries and the authorities have been caught unawares. In recent days there has been a general flight for safety from the periphery back to the centre. Currencies have dropped against the dollar and the yen, some precipitously. Interest rates and credit default premiums have soared and stock markets crashed. Margin calls have proliferated and spread to stock markets in the US and Europe, raising the spectre of renewed panic.

The IMF is discussing a new credit facility for countries at the periphery, in contrast to the conditional credit lines that were never used because the conditions attached to them were too onerous. The new facility would carry no conditions and no stigma for countries following sound macroeconomic policies. In addition, the IMF stands ready to extend conditional credit to countries that are less well qualified. Iceland and Ukraine have already signed and Hungary is next.

The approach is right but it will be too little, too late. The maximum that could be drawn under this facility would be five times a country’s quota. In the case of Brazil, for example, this would amount to $15bn, a pittance when compared with Brazil’s own foreign currency reserves of more than $200bn. A much larger and more flexible package is needed to reassure markets. The central banks at the centre should open large swap lines with the central banks of qualifying countries at the periphery and countries with large foreign currency reserves, notably China, Japan, Abu Dhabi and Saudi Arabia, ought to put up a supplemental fund that could be dispersed more flexibly. There is also an urgent need for short-term and longer-term credit to enable countries with sound fiscal positions to engage in Keynesian counter-cyclical policies. Only by stimulating domestic demand can the spectre of a world-wide depression be removed.

Unfortunately the authorities are always lagging behind events; that is why the financial crisis is spinning out of control. Already it has enveloped the Gulf countries, and Saudi Arabia and Abu Dhabi may be too concerned with their own region to contribute to a global fund. It is time to start thinking about creating special drawing rights or some other form of international reserves on a large scale, but that is subject to American veto.

President George W. Bush has convened a G20 summit for November 15 but there is not much point in holding such a meeting unless the US is serious about supporting a global rescue effort. The US must show the way in protecting the peripheral countries against a storm that has originated in the US, if it does not want to forfeit its claim to the leadership position. Even if Mr Bush does not share this point of view, it is to be hoped the next president will – but by then the damage will be much greater.

The writer is chairman of Soros Fund Management and author of The New Paradigm for Financial Markets

Emerging Markets Ready to Re-emerge - Barron's

Countries that have trade surpluses, high savings rates, and high GNP growth figures are in good shape.

If their trade surplus starts to go down (due to recession in developed countries, for example) they can stimulate their economies with fiscal policy. In some countries, the high savings rate is due to government policy, so they can reduce the savings rate and increase consumption by changing government policy.

The US is in bad shape because we've been running a huge trade deficit and borrowing money from abroad to invest in housing. Unfortunately, we can't use our houses to make goods and services to sell goods and services to foreigners.

To work off the US trade deficit, we need to invest in something (e.g. windmills) that will allow us to work off our trade deficit (e.g. reduce energy imports by reducing our dependence on oil).

So, developing counties will do fine if they are in a position to stimulate domestic consumer spending, and many are in this position.

Developed countries (the US in particular) will do better as soon as we come up with a viable industrial policy (e.g. we kick the housing habit and switch to building out our alternative energy infrastructure).

Time Not for a Bailout, But for Nationalization

Excellent article

So, lets take a poll of Seeking Alpha journalists to see where they stand:

a) Corporate Socialist (Socialism for the Rich),

b) Free Fall Market Nihilist (the End is Near, Short Everything),

c) Plain old Democratic Socialist (we need a Swedish style bailout),

d) Other/confused

Brad is clearly in the democratic socialist camp, which is my favorite too.

I assume that everyone if familiar with Socialism for the Rich already. The Free Fall Market Nihilist position is described below.



The Rise of Free Fall Market Nihilism

The latest financial crisis in the US is forcing old economic ideologies to reinvent themselves. We're long past the old socialism versus capitalism dichotomy.

Many on both the left and the right will object that the $700 billion dollar bailout plan really amounts to Socialism for the Rich.

The left favors a traditional, democratic form of socialism. So, they tend to support the approach the Swedes took when their banks needed bailouts (i.e. give taxpayers an equity stake in the banks being bailed out).

Libertarians, however, are having a harder time of it these days.

Just as there are no atheists in fox holes, we're starting to find that there are no die hard Libertarians in times of financial crisis - unless, of course, you count those who are short the market.

True believers in libertarian dogma always want the government to stand aside regardless of the consequences.

But, there are also those "pragmatists" who can espouse either a Libertarian dogma or a Corporate Socialist dogma depending on their financial position.

If you and the corporation you manage would benefit from a government bailout, then opt for corporate socialism.

But, if you don't manage a company in need of a bailout then short the market and opt for Free Fall Market Nihilism.

Whereas market bubbles are fueled by self-fulfilling optimistic prophecies, market crashes are fueled both by self-fulfilling pessimistic prophecies and naive free market ideology.

So, during times of financial crisis, Free Fall Market Nihilists short the market and then also cynically espouse a naive libertarian ideology that firms, markets, and even entire economic systems should always be allowed to fail.

The Free Fall Market Nihilist's mantra goes as follows:

"Government intervention is always wrong. In the long run, free markets will always correct. So, bring on those waves of creative destruction: The greater the financial destruction the better. The world is coming to an end, I've shorted the market, and so should you!"

So, lets take a poll of journalists at the Economist to see where they stand:

a) Corporate Socialist (Socialism for the Rich),

b) Free Fall Market Nihilist (the End is Near, Short Everything),

c) Plain old Democratic Socialist (we need a Swedish style bailout),

d) Other/confused

In Defense of Capitalism

The Rise of Free Fall Market Nihilism

The latest financial crisis in the US is forcing old economic ideologies to reinvent themselves. We're long past the old socialism versus capitalism dichotomy.

Many on both the left and the right will object that the $700 billion dollar bailout plan really amounts to Socialism for the Rich.

The left favors a traditional, democratic form of socialism. So, they tend to support the approach the Swedes took when their banks needed bailouts (i.e. give taxpayers an equity stake in the banks being bailed out).

Libertarians, however, are having a harder time of it these days.

Just as there are no atheists in fox holes, we're starting to find that there are no die hard Libertarians in times of financial crisis - unless, of course, you count those who are short the market.

True believers in libertarian dogma always want the government to stand aside regardless of the consequences.

But, there are also those "pragmatists" who can espouse either a Libertarian dogma or a Corporate Socialist dogma depending on their financial position.

If you and the corporation you manage would benefit from a government bailout, then opt for corporate socialism.

But, if you don't manage a company in in need of a bailout then short the market and opt for Free Fall Market Nihilism.

Whereas market bubbles are fueled by self-fulfilling optimistic prophecies, market crashes are fueled both by self-fulfilling pessimistic prophecies and naive free market ideology.

So, during times of financial crisis, Free Fall Market Nihilists short the market and then also cynically espouse a naive libertarian ideology that firms, markets, and even entire economic systems should always be allowed to fail.

The Free Fall Market Nihilist's mantra goes as follows:

"Government intervention is always wrong. In the long run, free markets will always correct. So, bring on those waves of creative destruction: The greater the financial destruction the better. The world is coming to an end, I've shorted the market, and so should you!"

So, lets take a poll of journalists at the Seeking Alpha to see where they stand:

a) Corporate Socialist (Socialism for the Rich),

b) Free Fall Market Nihilist (the End is Near, Short Everything),

c) Plain old Democratic Socialist (we need a Swedish style bailout),

d) Other/confused

5 Things the Treasury Should Clarify Now

Free Fall Market Nihilism

Economic philosophy of libertarians who short the market during a financial crisis.

Summary of a free market nihilist's philosophy:

"Bring on those waves of creative destruction: The bigger the financial collapse the better, I'm short the market!"

Barney Frank's Money Quote

Free Market Nihilism

Economic philosophy of libertarians who short the market during a financial crisis.

Summary of a free market nihilist's philosophy:

"Bring on those waves of creative destruction: The bigger the financial collapse the better, I'm short the market!"

Canadian Financials Missing from the Short-Selling Ban List

Naked short sellers of the world unite! You have nothing to lose but your tan lines.

It is doubtful that all the contradictions in the SEC's temporary ban on short sales will be worked out before the ban is lifted.

However, the existing rules against naked short selling will be enforced and they're not going away.

So, if you want to make money as a naked short seller, you may have to go elsewhere.

Speaking of which, I hear that Brazil is now promoting a few secluded beaches where naked short sellers will be allowed to congregate. However, I don't think they'll be allowed to buy or sell anything. :-)

The Artificial Inflation of Stock Prices, Due to the Short Selling Ban

Naked short sellers of the world unite! You have nothing to lose but your tan lines.

It is doubtful that all the contradictions in the SEC's temporary ban on short sales will be worked out before the ban is lifted.

However, the existing rules against naked short selling will be enforced and they're not going away.

So, if you want to make money as a naked short seller, you may have to go elsewhere.

Speaking of which, I hear that Brazil is now promoting a few secluded beaches where naked short sellers will be allowed to congregate. However, I don't think they'll be allowed to buy or sell anything. :-)

SEC Bans Shorting Financials

It is doubtful that all the contradictions in the SEC's temporary ban on short sales will be worked out before the ban is lifted.

However, the existing rules against naked short selling will be enforced and they're not going away.

So, if you want to make money as a naked short seller, you may have to go elsewhere.

Speaking of which, I hear that Brazil is now promoting a few secluded beaches where naked short sellers will be allowed to congregate. However, I don't think they'll be allowed to buy or sell anything. :-)

Short Selling: The Free Speech of Wall Street

It is doubtful that all the contradictions in the SEC's temporary ban on short sales will be worked out before the ban is lifted.

However, the existing rules against naked short selling will be enforced and they're not going away.

So, if you want to make money as a naked short seller, you may have to go elsewhere.

Speaking of which, I hear that Brazil is now promoting a few secluded beaches where naked short sellers will be allowed to congregate. However, I don't think they'll be allowed to buy or sell anything. :-)

It's Only the End of the Beginning

The main economic problems Americans need to are address are: the current banking crisis, the energy/environment crisis, and the trade deficit.

As for the banking crisis, as I see it there are three options for dealing with institutions that are thought to be too big to fail:

1) a free market approach that lets failing banks fail,

2) a socialism for the rich approach that bails banks out but then lets them go back to their high risk behavior, which leads to future bailouts, and

3) a plain old socialism approach that nationalizes institutions that are deemed to be too big to fail and turns them into highly regulated government agencies.

The Resolution Trust Approach is a variant on option (2).

Most business journalists argue about whether option (1) or (2) is better, but they don’t give option (3) any coverage.

The critical long term issue is whether you want the CEO’s (and other high ranking executives) of these firms to be high paid, high rollers who earn their eight digit paychecks by taking big risks.

If so, then the taxpayers will rebel when they’re left holding the bag on bad investments.

Alternatively, do you want bank managers to be competent (but rather boring) functionaries who simply follow the script set forth in regulation. If this is what you want, then the taxpayers should be more willing to fund bank bailouts. But, don’t expect much innovative behavior from banks if this is the way we want them to operate.

You can’t really have it both ways.

So, if a majority of Americans really want an innovative, high risk banking system, then we need to be willing to let banks fail and suffer the consequences.

On the other hand, if the majority of Americans want a safe, reliable, but unexciting banking system, if we think banks are inherently too to fail, then I say we move banking to the public sector.

In any event, if we look at the current crisis as "merely" a problem of socializing a few hundred billion dollars worth of bad debts, then we’re missing the forest for the trees.

Those who obsess over the credit crisis generally make three faulty assumptions:

(1) they assume that since US economy is consumer driven it has to be that way going forward,

(2) they think the only way to prop up consumer demand is to re-inflate the housing bubble, and

(3) they conclude from (1) and (2) that to avoid another Great Depression the US has to bail out the banks.

We need to examine how these three faulty assumptions are part of a larger story.

To see the larger picture one needs to understand the link between America’s energy policy, its chronic trade deficit, and asset bubbles induced both by the Fed’s easy money policy and America’s need to borrow from abroad to finance its trade deficit.

America’s energy policy has been entangled with our military policy for many years. Even Alan Greenspan admits that the war in Iraq was and is largely about oil.

Unfortunately, those opposed to the war have not insisted that Americans must at least pay for the war by imposing a tax on oil consumption. Since the cost of the war is not included in the price of oil, America is subsidizing its consumption of oil.

Taxing oil would help bring down the trade deficit and it would encourage investments in alternative energy. But, instead, America borrows money from abroad to pay for the war.

The Chinese, Japanese, Germans, Saudis, and others have been all too willing to loan American money to help stimulate their own trade surpluses. In fact, their surpluses are so large, and America’s deficit is so big, that America is allowed to borrow still more to pay for “investments” in housing - hence the housing bubble.

If America could redirect investment spending away from housing and toward alternative energy we might be able to make a dent in our trade deficit.

According to T. Boone Pickens, America needs to invest around one trillion dollars in windmills and another 200 billion dollars in an expanded electricity grid to bring power to the coastal states.

In short, we need to make massive investments in alternative energy. Given the need for massive investment spending, a slowdown in consumer demand may actually be a blessing in disguise.

But politicians cannot get elected by telling voters the country needs to take some bad tasting medicine to regain its economic health.

Instead, politicians tell voters what they want to hear. Both the Republicans and Democrats push for cutting oil taxes and income tax rebates to encourage consumption spending even though both policies will exacerbate the trade deficit.

Of course, in an economic downturn it does make sense to borrow money (from abroad if need be) to stimulate aggregate demand. But, the government can and should stimulate demand by investing in alternative energy infrastructure.

Windmills help bring down the trade deficit, but more consumer spending simply drives up imports.

Finally, to top it all off, politicians seek to capture the home owner vote by insisting that their party has the best plan to re-inflate the housing bubble.

Unfortunately, politicians, voters, and some economic journalists have come to believe that the US economy must continue to depend on consumer spending.

What is worse, “free market” economists argue that government shouldn’t make (or even try to promote) investments in alternative energy because this would be industrial policy. And, according to free market buffs, industrial policy is yet another futile attempt by government to “pick winners.”

Oddly, these same “free market” economists don’t see the war in Iraq (a war Greenspan admits is largely about oil) as energy policy or industrial policy. They see war as “military policy” so therefore picking winners in this instance is OK according to the Ayn Rand and Milton Friedman guidebook on what governments should and should not do.

So, America borrows money from abroad and lets the Fed run the printing presses to send out tax rebates, bailout banks, and jack up home prices.

These policies may be “good tasting” but they’re not good medicine, they’re poison.

The medicine America needs to take won’t taste good, but there may still be time to save the patient.

America needs to nationalized the banking system. We need to work off our trade deficit. And, we need to kick both our oil and our house-as-investment habits.

Puts Instead of Shorts? Today's Activity

It is doubtful that all the contradictions in the SEC's temporary ban on short sales will be worked out before the ban is lifted.

However, the existing rules against naked short selling will be enforced and they're not going away.

So, if you want to make money as a naked short seller, you may have to go elsewhere.

Speaking of which, I hear that Brazil is now promoting a few secluded beaches where naked short sellers will be allowed to congregate. However, I don't think they'll be allowed to buy or sell anything. :-)

Hank Paulson: Leading Us to the Next Bull, Soon

Lower oil prices will help kill off investments in alternative energy infrastructure. Why build windmills when oil is cheap, right?

Wouldn't it be much better to re-inflate the housing bubble. That way, instead of building windmills and solar energy farms, we can go back to "investing" in big houses, summer homes, etc. The bigger the better!

As long as the Chinese and Saudis are willing to lend us money, why just buy a house that fits your needs. Wouldn't it be much better to buy one with extra bedrooms, even if you never use the rooms. That way you can make more money when you sell the house. Right!

Better yet, why not buy a vacation home or two as well. Even if you don't have time to use them and they stand empty, you can make money on them with - especially with all the tax breaks congress has for home owners.

So, let's keep the American dream alive by investing more and more money on big houses (even if we never get around to visiting all the rooms) and vacation homes (even if we never take vacations).

Why invest in wind energy and solar energy when investing in housing is so much more fun an profitable! Let someone else worry about about global warming, we just want to make as much money as we can now.

So, three cheers for the Arab oil states and cheap oil. And three cheers for housing bubbles that never have to burst.

Go America. You are going to deserve what you're going to get. Unfortunately, you may just take the rest of the world with you.

Lehman's Collapse: Broader Economic Damage Unlikely

Those who obsess over the credit crisis are making three faulty assumptions:

(1) they assume US economy has to be a consumer driven economy,

(2) they assume that the only way to prop up consumer demand is to re-inflate the housing bubble, and

(3) they assume that the only way to avoid another Great Depression is to bail out any bank that would otherwise fail.

We need to examine how these three faulty assumptions are really part of a larger picture. To see the larger picture one needs to understand the link between America's energy policy, its chronic trade deficit, and asset bubbles induced both by the Fed's easy money policy and America's need to borrow from abroad to finance its trade deficit.

America's energy policy has been entangled with our military policy for many years. Even Alan Greenspan admits that the war in Iraq was and is largely about oil.

Unfortunately, those opposed to the war have not insisted that American's must at least pay for the war by imposing a tax on oil consumption. Since the cost of the war is not included in the price of oil, America is subsidizing oil imports.

Taxing oil would help bring down the trade deficit and it would encourage investments in alternative energy. But instead, America borrows money from abroad to pay for the war.

The Chinese, Japanese, Germans, Saudis, and others have been all too willing to loan American money to help stimulate their trade surpluses. In fact, their surpluses are so large and America's deficit is so big that America is allowed to borrow still more to pay for "investments" in housing - hence the housing bubble.

If America could at least stop investing in housing and start investing in windmills (something Al Gore and T Boone Pickens could agree on) we could make a dent in our trade deficit. According to Pickens, we need to spend around one trillion dollars on windmills and another 200 billion dollars on the electric energy grid to bring electricity to the coastal states. In other words, we need to make a massive investment in alternative energy. Given that need for investment spending, a slowdown in consumer demand due to house price deflation may actually be a blessing in disguise for the country (if not homeowners with bad investments).

But politicians know they can't get elected by telling voters they'll need to take some bad tasting medicine for the country to regain its economic health.

So, instead, politicians (such as McCain and Clinton) propose only what they think voters will like - cuts in oil taxes - even though their economic advisers should know this is the opposite of what America really needs to bring down the trade deficit.

To make matters worse, both the Republicans and Democrats push for tax rebates to encourage consumption spending, which further exacerbates the trade deficit.

In an economic downturn, it does make sense to borrow money from abroad to stimulate aggregate demand. But, the government could and should do stimulate demand by spending money on alternative energy infrastructure.

Windmills help bring down the trade deficit, but increased consumer spending at WalMart only drives up imports.

Finally, to top it all off, politicians seeking to capture the home owner vote argue about who has the best plan to re-inflate the housing bubble.

Unfortunately, politicians, voters, and some economic journalists have come to believe that the US economy has to depend on consumer spending.

For some reason, they think the US has to focus on consumer demand and can't get our economy going again by making investments in projects that will reduce our trade deficit.

What's worse, some so called "free market" economists argue that the government shouldn't make or try to promote investments in alternative energy because this would be industrial policy, which they criticize as yet another futile attempt by to government to "pick winners."

Oddly, these same "free market" economists don't see the war in Iraq (a war Greenspan admits is largely about oil) as energy policy or industrial policy. They see war as "military policy" so therefore picking winners in this instance is OK according to the Ayn Rand and Milton Friedman guidebook on what governments should and should not try to do.

So, America borrows money from abroad and lets the Fed run the printing presses to send out tax rebates, bailout banks, and jack up home prices.

These policies may be "good tasting" but they're not good medicine, they're poison.

The medicine America needs to take won't taste good, but there may still be time to save the patient.

America needs to work off its trade deficit. And, to do so, we need to kick both our oil and our house-as-investment habits.

As for dealing with investment banks and other financial institutions that are thought to be too-big-to-fail - as I see it there are three options:

1) a free market approach that lets failing banks fail,

2) a socialism for the rich approach that bails banks out but eventually lets them go back to their high risk behavior that will lead to future bailouts, or

3) a plain old socialism approach that nationalizes institutions that are inherently too big to fail and turns them into highly regulated government agencies.

People keep arguing about whether option (1) or (2) above is better, but they don't give any serious thought to option (3).

The question is whether you want the CEO's and other high ranking executives of these firms to be highly paid, high rollers who earn their fat paychecks by taking big risks. If so, that's great but the taxpayers don't want to get left holding the bag.

Or, do you want the managers of these firms to be competent but rather boring bankers who are heavily regulated and are therefore obliged to follow a script. If so, that's great the taxpayers should be more willing to backup and bailout this kind of operations. But, don't expect much innovative behavior from banks if this is the way we want them to operate.

You can't really have it both ways.

So, if a majority of Americans really want an innovative, high risk banking system, then we need to be willing to let banks fail and suffer the consequences whatever they might be.

On the other hand, if the majority of Americans want a safe, reliable, but unexciting banking system, if we think banks are just too to fail, then great, I say we take banking out of the private sector and make it a function of the public sector.

Lehman Is Just the Thin Edge of the Wedge

The financial press spends 99% of its time debating whether taxpayers should or should not bail out financial institution X.

Despite all the electronic ink that has been spilled, the tax payers have become liable for Fannie & Freddie and we will, no doubt, become liable for more institutions in the future.

So, since it's a given that taxpayers will be required to bail out financial institutions that are too-big-to-fail, too-politically-well-c... or whatever, I say we turn the discussion of WHICH TAXPAYERS should be on the hook.

For example, the Fed is pleading with a number of financial institutions to get them to take over Lehman. And Lehman is just the thin edge of the wedge.

So, instead of pleading with financial institutions, the government should be considering new taxes that will make those responsible for the credit crisis pay up.

Personally, I favor a retroactive financial institution CEO tax. Let's have congress pass new tax legislation that will give the IRS the mission of leveling taxes on financial institution CEOs over the past ten years.

After we've taxed the CEO incomes, we can institute net wealth taxes on everyone who's become rich over the last ten years by running up the housing bubble.

We could start by retroactively taxing the capital gains on home sales over the past ten years. These homeowners have been the principal beneficiaries of the housing bubble, so let's let them pay their fair share for dealing with the financial crisis that has resulted from the housing bubble.

What we shouldn't do is assume that tax payers who have not gained in any way from the housing bubble should be made to pay for the mess created by the housing bubble.