Month: November 2010

Ireland: Slammed by the Global Economy

Ireland has been persuaded by the European Union to accept a $114 billion bailout to save the Irish government from defaulting on its government debt. Of course the gift comes with strings attached: an austerity program that includes steep tax increases and major cutbacks in social service programs.

Ireland didn’t have to accept the bailout; it could have gone a different route. It could have defaulted on a portion of its debt, thereby forcing investors to take the loss, instead of imposing hardships on its poor, disabled, and elderly citizens. But just the whiff of a default, just the barest hint that Ireland was considering default as a possible alternative, sent the interest rate on Ireland’s bonds shooting up over 8%, making a bailout necessary immediately.

Therein lies a lesson on the pitfalls of an international financial system. The Bush Sr./Clinton/Bush Jr. administrations all trumpeted the beauty of the World Trade Organization, the “liberalization” of the world economy, the dissolution of trade barriers and the deregulation of the financial industry worldwide. A “global economy” was supposed to make us all richer. In fact, it’s made a few financial industry executives and securities traders astoundingly wealthy, while the rest of us are struggling to get by on less than ever, many of us buried in piles of debt.

Thirty years ago, Ireland’s bonds would have been held by its national banks and its own public, and default might have been a workable possibility. Investors would be forced to take the brunt of the loss (which is the way the system is supposed to work) and they wouldn’t be able to easily move their money to another country at the push of a button. Today, Ireland’s bonds are sold to investors all over the world, from Japan to the U.S. to Brazil, sold to pension funds, to hedge funds, to major international banks—all of whom are quick to dump a security when it looks a little risky. The speed at which these rats desert a sinking ship can precipitate financial disaster within hours or even minutes.

And so, we get emergency bailouts. It’s quick and it’s easy to dump the problem on the taxpayers; but once you go down the road of bailouts, it’s nearly impossible to turn back. The bailout of Ireland comes hot on the heels of Greece’s bailout. Now Portugal is teetering on the brink, next in line for an IMF-style bailout/austerity package. Unfortunately, that won’t be the end: Spain is also suffering under an investor retreat, and Spain’s economy is twice the size of Greece’s, Ireland’s, and Portugal’s put together.

The European Economic Union could eventually collapse under a financial version of the domino effect. Yet investors and big banks are protected at all costs. Without regulations, restrictions, boundaries, and borders, they can always take their money and go elsewhere.

Maybe what we need is a new set of laws to regulate the flow of money in the global economy. Forget about migrant workers: migrant money is what’s hurting us the most.

Shoot-out at the Wall Street Corral

Mini flash crashes are proving that the US stock markets are an ungovernable mess.

On May 6, 2010, the US stock markets went into a wild plummet. Over the course of a few seconds, the stock price of several Fortune 500 companies dropped to only pennies a share while the stock of relatively unknown companies shot up to nearly a thousand dollars per share. After several minutes of chaos, human intervention finally stopped all trading on the markets. When trading resumed, prices went back to normal.

What happened? Market analysts dubbed it a “flash crash,” and the SEC spent several months studying the trades that led up to the meltdown to try and figure out what caused it. As a result, most of the major stock markets in the US (there are over a dozen now) instituted automatic circuit breakers to stop all trading in any single stock that experiences a steep and unexplained drop in price. The heads of the New York Stock Exchange and the NASDAQ reassured investors that the new circuit breakers would work and prevent another flash crash from ever happening.

Last week, the New York Times reported that, since May 6, there have been at least a dozen more mini flash crashes that have triggered the market circuit breakers. The mini crashes have involved the stock of relatively unknown companies like Progress Energy (an old-style, stable, profitable utility company) in addition to well-known mega-corporations like Citigroup, Washington Post Co., and Nucor.

A dozen mini crashes since early May means that these events are happening at the pace of at least two per month, which puts the lie to any claim that a major flash crash over the entire system couldn’t happen again. Eventually it will, if nothing is done to address the causes of market chaos.

Critics point the finger at three main causes: 1) electronic trading, 2) high frequency traders, and 3) poorly written computer algorithms. Electronic trading means that anyone, anywhere in the world can have access to the market and, with the use of a computer can set up an automatic trade. Trades occur at the speed of light, taking only microseconds to be executed. High frequency traders take advantage of the parameters of electronic trading by making a profit off the pennies or fractions of a cent that they can make on millions of lightning fast trades in any given day. Most high frequency traders enter the market every morning with their cash and completely exit the market at the end of the day owning no stock, but having amassed a tidy cash profit by gaming the system. Most of them use computer algorithms to help them buy and sell multiple stocks quickly. Poorly written computer algorithms like the one that triggered the flash crash on May 6 can lead to a crash in a single stock price, which can be magnified by the actions of other high frequency trades.

On May 6, a trader entered a sale of a huge quantity of a single security tied to the S&P 500, but didn’t specify a minimum sale price. This made the price of the security plummet to near zero as market computers continued to try and sell the stock long after all legitimate buyers had made their purchases. Other investors, seeing a security tied to the value of the S&P 500 lose all its value, promptly panicked and sold all their holdings, which sent other stocks into a tailspin. To magnify the problem, high frequency traders, which make up the majority of trading on the markets on any given day, froze all of their trading. By withdrawing from the markets, they removed massive amounts of market liquidity; and with few buyers and no cash in the markets, the entire system crashed.

Clearly, as the subsequent mini flash crashes show, the problems still exist. The SEC has made no rules to restrict electronic trading or high frequency traders by, for example, requiring them to hold each security for a minimum amount of time. No rules exist to govern computer algorithms, either, although the SEC could and should require all traders to enter certain basic information for each trade, including minimum sales and maximum purchase prices. As the New York Times pointed out by quoting the head of the Laboratory for Financial Engineering at MIT: “The US equity markets have become the Wild, Wild West.” And the town sheriff is hiding in the saloon.

Millions of investors have pulled back or pulled out of the market since the events of May 6, and billions of dollars have been withdrawn from US mutual funds, in spite of the current stock market upturn. This begs the question: is the current stock market upturn sustainable or is it built on wild speculation?

Meanwhile, the Federal Reserve’s policy to stimulate the economy is doomed to fail. It’s based on the assumption that if the Fed lowers long-term interest rates to boost stock prices, Americans will feel wealthy enough to spend money and the increased consumer spending will stimulate the economy. But, since the economic downturn started in 2008, fewer Americans hold stock and, if they do, flash crashes have done little to reassure them that their investments are safe, stable, or reliable.

The G-20 Currency Skirmish

President Obama spent all week in Asia, posing with heads of state prior to the G-20 economic summit in Seoul, South Korea. It was all in vain.

Both Obama and Treasury Secretary Timothy Geithner were rebuffed at the summit. They came to the table arguing that the group needed to agree on ways to address trade imbalances between nations. In other words, they wanted China to raise the value of its currency.

A trade imbalance occurs when one nation’s population buys more goods from abroad than it can sell on the world market. This creates a national trade deficit, which is very similar to a person charging goods on a credit card and not paying it off every month. If the trade imbalance accumulates for too long and becomes too high, it can negatively affect the nation’s economy. No population can consume more than it produces without eventually suffering a collapse, and the US trade deficit has hovered at record highs for some time now.

China, on the other hand, has a record trade surplus. While China has a large population, most of its citizens don’t make enough money to afford expensive imports. In addition, the Chinese government holds the value of the Chinese currency tied to a peg—in other words, the government determines the value of the renminbi by averaging the value of a basket of other nations’ currencies and arbitrarily deciding how many renminbi can buy a share of that basket.

Since World War II, the US government has worked assiduously to force smaller nations to unpeg their currencies (i.e., allow them to “float”) so that the value of most currencies in the world now rise and fall according to the markets (and market speculation, but that’s another issue.) As a consequence, those nations whose currencies are strong (have a higher value) can buy more imported goods, while those countries whose currencies are weak (have a lower value) can’t afford many imports, but can sell a lot of their manufactured goods on the world market because their goods are cheap to buy. This gives developing nations like China an incentive to artificially keep the value of their currencies low—their populations don’t have much buying power, but their industries make a lot of money selling cheap goods to the rest of the world…especially to the US.

Obama and Geithner were articulating a long-term US goal that’s been on the national agenda since the Clinton era: China has a lot of cash to spend, and the US can no longer be the consumer of last resort for the entire world.

At the G-20 meeting, however, the Americans were literally laughed off the stage. The Federal Reserve’s recent announcement that it would print money in an effort to stimulate the economy has the whole rest of the world aghast. By increasing the supply of US dollars, the Fed is weakening the value of the dollar and making US exports cheaper. The rest of the world views this as outright currency manipulation very similar to what China has been doing for decades.

Recently, however, China has been slowly allowing the value of its currency to rise in an effort to control runaway growth and a worrisome asset bubble. It may not be happening fast enough for the US government, but the renminbi is already increasing in value. China doesn’t want its economy to crash, as it would if they were to suddenly let the renminbi float; instead, they’re bringing the plane in for a soft landing.

That’s a lesson we could learn from them: how government regulation can smooth over both the peaks and valleys in a national economy. In our free-for-all economy, we’ve eliminated regulations so the peaks can grow extremely high, but the ensuing plummet can be precipitous and long-lasting.

The Real Reasons the Republicans Won

After reading a lot of post-election articles, I’m stunned that most analysts have completely missed the main reasons why people voted the way they did. Most Americans are not obsessed with politics; they don’t dig deeply into the candidates’ backgrounds, and often don’t take the time to read and understand the candidates’ positions on the issues (if indeed the candidates even have any—and many don’t).

There were three important dynamics involved the current election:

1) Anti-incumbent fervor.

This election was not a massive victory for the Tea Party candidates, or even for the Republican Party, as exit polls showed. Many voters supported Republican candidates, but when asked if they supported the platforms of the Republican Party, they disagreed with most of its tenets. For example, a majority of Americans are against making changes to Social Security or cuts to Medicare—but both those issues will be major components of any Republican plan to balance the budget. Likewise, most Americans think the Bush era tax cuts shouldn’t be extended for people making more than $250,000, although the Republicans want to extend them for everyone, the rich included.

By and large, the single sentiment that most people expressed was a yearning either for less intrusive government or a desire to “throw the bums out”—possibly reflecting a desire to make politicians understand our high unemployment rate through firsthand experience.

2) Elderly voters.

Midterm elections are usually dominated by older voters (folks who are over 50 and are nearing or in retirement). What exactly is the current situation for older Americans in this lingering recession?

Well, for one thing, the value of their homes has plummeted by as much as 50% in some parts of the county, and it’s not recovering anytime soon. It can be disheartening, to say the least, to work hard most of your life, pay off your home, and then find out it’s worth a lot less than you put into it, especially if you were counting on selling it to help pay for your retirement.

Secondly, most elderly Americans live on a fixed income: Social Security plus whatever savings they’ve accumulated, which is usually invested in very safe, fixed income investments (i.e., cash accounts or bonds). But right now, the policy of The U.S. Treasury and The Federal Reserve is to keep interest rates at or near zero, which means elderly Americans are making no money on their savings during a time when they have to spend a portion of it to pay for living expenses. As a consequence, they’re seeing their retirement funds dwindle at an accelerating rate, and many are having to go back to work or delay their retirement to make ends meet at a time when there’s already a shortage of jobs. And the U.S. government is doing nothing to create jobs.

And, finally, even though inflation is near zero, healthcare costs are still increasing by double digits every year, while the new healthcare reform legislation won’t kick in for a while yet. Elderly and disabled Americans take the brunt of our broken healthcare system, and that’s played a major role in how they voted in this election.

3) Rural vs. urban.

One useful graphic I saw on TV this week was a map of the United States with the areas of the nation that elected Republicans candidates in red and the areas that elected Democrats in blue. The entire center of the country was red, with a thin blue edging on the east and west coasts and a few isolated blue dots corresponding to major Midwest cities. Nothing so clearly shows the rural vs. urban divide in the U.S. electorate.

Why do rural folks vote overwhelmingly for the party that promises a smaller government? It’s because of an enduring perception that government takes more away from them than it gives back—a perception aggravated by the biannual act of paying property taxes. A higher percentage of rural people tend to own land, and own more of it, than city dwellers (more than 50% of urban dwellers in the U.S. are renters). When rural folks open their property tax bills, it sets off strong anti-government feelings.

Yet studies have shown that rural communities benefit more from state and national government services than their local tax base could afford. In short, taxes paid by city dwellers helps to subsidize services provided to the surrounding rural areas: roads, schools, fire departments, police, hospitals and health clinics—you name it. Few of these things would exist in rural areas without state and national government funding.

In addition, many rural people take for granted the federal “entitlement programs” that the Republicans would like to dismantle: Social Security, Medicare, Medicaid, Unemployment, Disability, and Welfare. In fact, the term “entitlement program” is meant to make us think that people who receive money from these programs don’t really deserve what they’re getting. But they do, and the fact that these programs are or will be available to all of us if we need them is a form of insurance that underpins a humane, modern, and civilized society.

These programs should be called “the safety net,” because that’s what they are. Yet those of us who are not receiving any direct cash benefit from the safety net often have the suspicion that someone else is, and is taking unfair advantage of it. Why can’t those people just work hard like we do, who are also struggling to get by? This is where rural isolation comes into play. Urban dwellers routinely encounter the poor, disabled, and disadvantaged and can’t deny the need for programs to care for them.

In rural areas, the attitude is often: “give me my guns, my family, and my land, and the rest of you can go to hell!” But a nation—and its economy—can’t survive with that attitude.

Hopefully, the next two years of gridlock in Washington DC will be eye-opening for the American public. I’m hopeful that people will begin to talk more about the issues and less about personalities, and make more effort to become educated about the issues that face us as a nation. As a first step, we should acknowledge the problems I’ve listed above, and try to figure out a way to address them.

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