Enlightened Economics

Economics for an Enlightened Age

Posts Tagged ‘central banks’

• New Bank Regulations Likely to Fail

Posted by Ron Robins on December 22, 2010

By Ron Robins. First published December 15, 2010, in his weekly economics and finance column at alrroya.com

New banking and financial industry regulations in the US and the Basle III rules for banks globally—might fail on key issues. The newly enacted US Dodd-Frank Wall Street Reform and Consumer Protection Act, despite its noble purpose to prevent further financial chaos, is unlikely to do that. And the Basle III requirements for higher and better quality bank reserves are good on paper, but full implementation is improbable amidst likely future hefty bank losses.

At the heart of the financial crises were derivatives, and as Warren Buffett the famed investor has warned, “derivatives are financial weapons of mass destruction.” Yet, after about two years of Congressional wrangling, the Dodd-Frank bill incorporates a rough future structure for derivatives but authorizes yet another committee to report back in the spring of 2011 with detailed regulations governing them. And the old expression, ‘the devil is in the details,’ is never more apt than in this instance.

Already, US Banks are calling for derivatives called ‘foreign exchange swaps’—a $42 trillion market—to be exempt from the rules.

Derivatives are major profit centres for the too-big-to-fail US banks. These banks have repeatedly told US lawmakers—who receive considerable campaign funding from them—not to restrict those profits. Because of the influence of Wall Street on the Obama Administration and the US Congress, it is difficult to be hopeful that when it comes to the detailed regulations, and especially their enforcement, that much will really change concerning US banks’ derivatives’ activities.

Two particular varieties of derivatives are at the centre of our financial debacle. They are mortgage backed securities (MBS) and credit default swaps (CDS). The latter, though originally considered ‘insurance policies’ against debt default, are now frequently gambling vehicles that incentivize the taking-down of struggling companies (AIG)—and now, governments (Ireland?).

The size of the derivative problem for US banks cannot be overstated. As Alasdair Macleod, a British banker and economist remarked on October 28, “according to the FDIC [the US Federal Deposit Insurance Corporation], outstanding derivatives held by US banks increased from $155 trn to $225 trn between mid-2007 and mid-2010. In other words, since the credit-crunch the derivative bubble in the US has grown a further 45 per cent and is now fifteen times total US GDP, literally dwarfing the banks’ total equity, which is only $1.35 trn. Consider this fact: derivative exposure is 189 times total bank equity.”

Aside from the derivatives issue, and also not addressed in the Dodd-Frank bill, are the two massive US mortgage progenitors now on US government life-support, Fannie Mae and Freddie Mac.

Fannie Mae and Freddie Mac were formerly somewhat private institutions and own or guarantee about half of all US residential mortgages. But as the real estate crises exploded and due to their potential for vast losses that could paralyse the housing markets, the US government commandeered them in September 2008.

The principle offering in the Dodd-Frank bill concerning Fannie Mae and Freddie Mac is that by January 2011 President Obama offers a proposal to Congress to bring them out of government receivership.

Thus, on the two vital issues of derivatives and real estate, the Dodd-Frank bill seems queasy and deficient. These inadequacies allow for a re-ignition of the financial meltdown at almost any time.

Acknowledging the severe problems in the banking industry, banking regulators have introduced new global banking rules. In September, the Bank for International Settlements (BIS) in Geneva, Switzerland—which sets the regulations that banks everywhere generally adhere to—issued its Basel III regulations, which are due to come into effect for all banks between 2013 and 2019.

Basel III’s most important requirement will be that banks hold higher and better quality reserves.

But the BIS may be too optimistic about the ability of many banks, particularly the too-big-to-fail banks, to reach the new reserve requirements. For instance, a Reuters report on November 21 said, “the new Basel III banking rules will leave the biggest US banks short of between $100 billion and $150bn in equity capital, with 90 per cent of the shortfall concentrated in the top six banks, the Financial Times said, citing research from Barclays Capital.”

However, these equity shortfalls may well err on the low side. In the next few years, US and European banks especially, are likely to be hit with big waves of new losses related to real-estate, derivatives, and sovereign debt.

Real estate losses because US and European banks have still not written-off their full potential losses concerning toxic MBS that they may have to buy back due to newfound paperwork improprieties related to the emerging foreclosure fraud, as well as mortgage losses generally, on foreclosed and other properties.

Additionally, banks may suffer further huge derivative losses as they are eventually forced to price certain derivative and other asset classes at more realistic appraisal values instead of the ‘mark to fantasy’ that often now exists.

And recently, an even greater potential hit to banks’ capital has arisen: the possibility of gargantuan losses on bad sovereign debt in the EU and elsewhere.

On September 13, The Economist magazine had this to say on the MBS and derivatives issue relating to Basle III. “The most serious failure in Basel III is that it doesn’t address the principal contribution of Basel II to the last financial crisis, namely, the calculation of risk-weights [for instance, risks associated with MBS]… What brought banks like Citigroup and Bank of America to their knees wasn’t direct exposure to sub-prime loans, but exposure to triple-A-rated debt backed by pools of such loans, debt which turned out not to be risk-free at all.”

The US Dodd-Frank bill either passes the buck or overlooks the very problems that led to the financial meltdown, and the Basel III regulations may be rendered impotent due to massive future bank losses. Thus, these new bank regulations are likely to fail.

As Henry Ford, the founder of the Ford car company once said about banking, “it is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”

Copyright alrroya.com


Posted in Banking, Economics | Tagged: , , , , , , , , , , , , , , , , , , , , , , | 1 Comment »

• Why Most Economists Get It Wrong

Posted by Ron Robins on August 23, 2010

By Ron Robins. First published June 3, 2010, in his weekly economics and finance column at alrroya.com

While visiting the London School of Economics in the autumn of 2008, Her Majesty Queen Elizabeth asked Professor Luis Garicano a straightforward question. Quoting the Financial Times, from November 4, 2008, “if these things [causing the financial meltdown] were so large, how come everyone missed them? Prof Garicano apparently replied, ’someone was relying on somebody else and everyone thought they were doing the right thing.’”

I have some other views. Economics as practiced is still the ‘dismal science.’ Most economists rely on economic modelling for forecasting. It rarely works. Economists ignore key relevant data. Fearing for their jobs they stick with the comfortable view. Massaged government statistics also lead them astray. Furthermore, complicit media rarely question prevailing economic orthodoxies or the ‘adjusted’ government data, adding to delusional thinking. Economists’ reliance on Keynesian economic theory is likely to lead them off course and to miss the next, potentially more disastrous, downturn. Now let me flesh out the details of these points.

Reliance on faulty models and statistics
No economic model can account for sudden changes in consciousness, individual preferences, or exogenous factors. As Alan Greenspan, former head of the U.S. Federal Reserve said in March 2008, “the essential problem is that our models – both risk models and econometric models – as complex as they have become, are still too simple to capture the full array of governing variables that drive global economic reality.”

Before the meltdown, economists completely ignored voluminous data pertaining to excessive debt growth and leverage. In the U.S. and similarly in other developed countries, between the early 1980s and until the financial meltdown, annual consumer and private debt growth often greatly exceeded income and GDP gains by 100 to 200 per cent. U.S. data showed that in “2006 it took $6.32 of new debt to produce one dollar of national income.” Yet mainstream economists either did not know, or totally ignored this rapid accumulation of excessive debt and negative debt productivity with their potential for creating a devastating negative economic shock.

Even if most economists glimpsed the possibility of a forthcoming meltdown, many preferred to say nothing about it. What bank economist would want to tell his management to halt lending while every other bank is massively expanding it? A fall in the bank’s stock price could follow such an announcement and the economist would either have to retract his words or possibly be asked to leave.

Statistics that economists rely on, most especially in the U.S., have been so modified over the past three decades that comparisons with prior periods or with other countries is almost impossible. They also make the U.S. economy look better than it really is. I suggest readers go to www.shadowstats.com for an understanding of how U.S. governments’ statistics have been changed. Relying on debatably biased statistics provides cover for politicians and compliant economists to project rosier views of the world than might really be the case.

The potential of faltering consumer demand should have been obvious to economists by 2007. In the U.S., savings rates (whose statistics were again revised and look ‘better’ than they used to be) dropped to all time lows hovering in the -2 to 0 per cent range of after-tax disposable income. This was while debt service levels were at all time highs. These extremes demonstrated that consumers could retrench in their spending at any moment. Yet mainstream economists never sounded the warning!

Complicit, non-analytical media fed economic illusion
The media were at fault too. Facing deadlines and wanting ‘reputable’ quotes, they inevitably interviewed economists from major financial institutions who had a vested interest in not rocking the boat. A few years ago a top Canadian journalist, when asked why he primarily quoted bank economists on the economy, replied that they were always available, whereas economists in academia – who might give a more independent view -were not.

Keynes theory inappropriate today
Most economists follow Lord Keynes’ economic theories. A principal concern of his was what he called the ‘output gap’—the difference between an economy’s potential output versus its present performance. If the economy was underperforming, Keynes advocated the government spend and borrow more to close the gap. Of course, this is what governments are doing today, spending and borrowing anywhere from 3 to 16 per cent of their GDP as private consumer demand for goods and services has fallen precipitously.

Keynes also indicated that in good economic times governments should tax more and run surpluses to offset the deficits of bad times. However, I have not seen any large developed country government or international economic agency project surpluses in the decade ahead. Thus, Keynes’ theory relating to eliminating government deficits will not work today. His current day followers conveniently neglect this aspect of his theory. Thus, huge debt accumulation with no offsets is facing developed countries.

Debt growth to depress economic activity
Now with developed countries’ government debt expanding rapidly, a limit to their bond issuance might be reached.

In a major report last March, the Bank for International Settlements (BIS)—the ‘central bank of central banks’—studied government debt trends in twelve countries including the U.S, U.K., Germany, France and Japan. The Bank said that, “drastic measures [bold added] are necessary to check the rapid growth of current and future liabilities of governments and reduce their adverse consequences for long-term growth and monetary stability. Drastic measures means big government program cuts and higher taxes, which create slow or declining economic growth.

Highly regarded Professors Carmen M. Reinhart and Kenneth S. Rogoff confirm this prospect of slow or negative growth ahead in their seminal study, “Growth in a Time of Debt,” published January 2010. They found that when government debt/GDP ratios are, “… above 90 per cent, median growth rates fall by one per cent, and average growth falls considerably more.” BIS estimates put U.S. government debt exceeding this threshold: at 92 per cent for 2010 and 100 per cent in 2011.

Economists once again getting it wrong
Her Majesty, just like her subjects and the citizens of most developed countries, were all misled by their economists. The majority of economists today have not changed their ways, continuing to fall prey to all the concerns earlier mentioned, and again painting a rosy picture for the next few years. Quoting Christina Romer, Chair, U.S. government’s President’s Council of Economic Advisors, “the Administration forecasts [real, after inflation] growth of 3 per cent in 2010, followed by growth of 4.3 per cent in both 2011 and 2012. Our estimate of growth in 2010 is virtually identical to the consensus of private forecasters surveyed by Blue Chip Economic Indicators (Blue Chip) and is right in the middle of the central tendency of the Federal Reserve’s Federal Open Market Committee (FOMC) forecast released in November.”

Such consistent rapid growth has not been seen for many, many years—and never in periods of such overbearing private and public debt. My bet is these economists, like most of the others, get it wrong again!

Copyright alrroya.com

Posted in Economics | Tagged: , , , , , , , , | 1 Comment »

• The Allure of Gold: Now and through the Ages

Posted by Ron Robins on February 10, 2010

While respected sociologist Dr. Paul Ray reveals the rise of higher consciousness in society today, we also note the rise of something else unparalleled in our modern epoch: the declining confidence in developed countries’ paper currencies. This is clearly evidenced by that eternal barometer of currency health—gold.

Having seen gold’s U.S. dollar price rise four-fold over the past decade and with substantial gains in all currencies (while outperforming every other major asset class), gold is resuming its historical monetary role.

Why is this happening? Mainly because of our gradual realization of what I call the Really Bad Three ‘Ds’ of the developed world:

1) Debt (The Global Debt Bomb, Forbes);

2) Derivatives (… the new ‘ticking bomb,’ Marketwatch); and,

3) Demographics (The 81% Tax Increase, by Bruce Bartlett, and Global Ageing Population–Financial and Economic Crisis Brewing, by Niels Jensen.

Also supporting gold’s ascent and paralleling Dr. Ray’s thesis of a rising higher consciousness globally, is the increasing appreciation of gold’s age old and alluring spiritual, cultural, and healing qualities.

Gold through the ages
Gold has enthralled people from time immemorial. In ancient Egypt, Egyptians ingested gold for spiritual, mental, and bodily purification. In India’s Vedic tradition gold is associated with the sun, light, fire, purity, life, immortality, truth, splendour—and long revered as money and wealth. In China, traditionally gold is owned for good luck. The golden dragon, the symbol of Chinese culture, stands for happiness, procreation, and immortality.

In Europe, the Greeks, Romans, Venetians, Dutch, Spanish and British, all found gold to be the ideal currency. Gold has historically been chosen as currency due to it being “durable, divisible, consistent, convenient, and have value in and of itself.”

In our modern era New Agers call gold “the Master Healer’… Gold symbolizes the purity of spirit and they attribute the power of cell regeneration, energy conductivity, communication transmission and energy purification to the metal… In the world of spiritual healing, gold has the emotional power to ease tension, feelings of inferiority, and anger as well as encouraging the realization of one’s potential and bringing comfort.” (From: jewellerysupplier.com)

Growing practical uses of gold today
Gold also has new and rapidly growing practical applications. It is used in electronics and computers as an extraordinary natural conductor of electricity which will not rust or degrade. In medicine, it is used to treat arthritis, and gold nanoparticles are central in much of biological research. In aerospace, NASA uses gold in a film to reflect infrared radiation and as a lubricant for mechanical devices operating in space.

Gold alloys are utilized in dentistry for fillings, crowns, bridges, and orthodontic appliances. Dentists find gold easy to work with, nonallergenic, and chemically inert. (See geology.com)

Perhaps the oldest and best known use of gold is for jewellery. Analysis of GFMS Ltd.’s third quarter, 2009 report, shows gold used in jewellery represented about 59% of usage and that gold for investment purposes accounted for 28% of demand; electronics 9%; other industrial demand for 2%; and dentistry 2%.

Inflation/hyperinflation/deflation fears increase gold’s attraction
However, it seems that for 2009 as a whole, something extraordinary happened: for the first time in decades investment demand for gold exceeded that of jewellery use. Gold is being purchased as a hedge against the anticipated currency chaos resulting from the Really Bad Three D time-bombs of uncontrollable Debt, explosive Derivatives, and aging population Demographics.

The fears are that the governments and central banks of the U.S., E.U., U.K., and Japan, may of necessity create high inflation to alleviate the burden of their unsustainable debts and obligations. Unfortunately, inflation can get out of control, increase rapidly, and result in hyperinflation causing huge loss of confidence in the affected currency.

Central banks can generate inflation by printing money. Put simply, they flood the economy with almost free, ‘excess’ money, which forces a decline in value of each monetary unit, thus producing inflation. Countries (or anyone in debt) can then pay off their debts with money that buys a lot less—thus cheating their lenders. This has been common practice of indebted governments throughout time and is what ignites the lust for gold as the safe haven from the ensuing monetary and economic maelstrom.

However, renowned economics’ professors Carmen M. Reinhart and Kenneth S. Rogoff, as well as Dr. Lacy H. Hunt, and others, believe that deflation will rule. In deflationary periods, as in the 1930s, the money supply contracts, prices fall, debt deleveraging occurs, major financial system defaults occur, the economy shrinks, and government deficits and debts explode upwards. Even in deflationary episodes, investors fearing losses or government failure buy gold for protection. (See The Long Wave Analyst.)

Therefore, central banks in the developing world possessing the world’s largest reserves of developed countries’ currencies and debt are fearful of losses arising from any of the above potential conditions. So, to protect the value of their assets they do what central banks have always done—they buy that ancient metal of kings—gold. The central banks of China, India, and Russia, are among the biggest buyers of gold today.

Furthermore, as these developing nations grow they are investing increasingly in their own locales where investment returns are higher than in developed countries. Thus, their reduced buying or outright selling of developed countries’ debt and currencies is further lowering the value of those currencies and debt.

Gold’s new role
These developments are creating mounting instabilities in the world’s financial system and are encouraging discussions of a new global currency that might compete with or replace the U.S. dollar. Already, Brazil, Russia, India and China (the so-called BRIC nations) as well as developed countries such as France, are demanding the establishment of a new world currency order.

To accommodate these demands the International Monetary Fund’s (IMF) Special Drawing Rights (SDRs—a ‘basket’ of currencies used as money between central banks) may well be re-formulated to include new currencies and commodities. Theoretically, the re-formulated SDRs could even become the world currency.

Top gold analysts like Jim Sinclair see the linking of gold to both the SDRs and to the U.S. dollar money supply. By anchoring the dollar to a rising gold price the U.S. could likely stem the dollars declining value.

The downside of gold production
If proper safety and environmental rules are not followed the mining and production of gold can mean ill health for miners and mining communities, and environmental degradation. Mining and processing of gold ore usually requires the use of the highly toxic chemicals such as arsenic and mercury.

The ore after processing is left in tailings ponds, and if the ponds are not carefully designed, built, and maintained, the water from these ponds can contaminate water sheds, rivers, and farm fields. If not properly managed, there are real downside risks in the mining of gold.

However, there are two reasons why I feel more optimistic about gold mining in the future. Firstly, non-governmental organizations (NGOs) around the world are bringing to light those gold mining activities that are doing harm. In some cases NGOs have caused abusive mining operations to shut-down or to make major changes in their operations. Secondly, governments are implementing ever tighter health and environmental controls concerning mining.

These factors are slowing the amount of gold mined, as well as making the mining itself more expensive. Hence, as gold demand increases and the above factors help to restrain its supply, gold prices are likely to receive even further support. Incidentally, since the 1990s, global gold demand has substantially exceeded what is mined, while the amount of new gold found is unable to replace that mined.

To summarize, gold is re-incarnated
In the next few years the probability of currency and economic turmoil due to the Really Bad Three Ds—Debt, Derivatives, and Demographics of the developed world—will be greater than at any time since the 1930s. Similar turmoil has occurred innumerable times over countless millennia, and can be seen from the ancient civilizations of Egypt, India, China—to modern Europe. As turmoil occurs, gold becomes the store of wealth and assumes its role as the currency of choice.

However, gold is not only rising due to currency and economic instabilities. It is also rising because of its many fast growing commercial applications and particularly because of the allure of its age-old spiritual, cultural, and healing characteristics. In the era of higher consciousness where Enlightened Economics reigns, gold serves many key functions. The future is indeed golden!


© Ron Robins, 2010.

Posted in Consciousness/Psychology, Economics, Finance & Investing, Gold & Precious Metals, Personal Finance, Spiritual | Tagged: , , , , , , , , , , , , , , , , | 1 Comment »

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