The reason why the big boys don't want a clearinghouse is because they are able to profit on information asymmetry. A good portion of profits on derivatives is made off of buying CDS, taking a cut, and then selling the CDS to someone else with a lower "premium" payout. So I sell a CDS to Bank A and receive $40,000 per year for every $10M insured. If I can purchase a CDS on the same company for under $40,000, I've just made money risk free. No not really risk free in reality, but it is to these guys. A clearinghouse would stop these transactions because everyone would know that the market price is $40,000.
The reason why there are so many CDS outstanding is because everyone plays the, pass it along and take a cut, game. I can purchase a CDS for $50,000 a year, then I write out a CDS for $60,000 a year, giving me a $10,000 a year profit that is hedged away for risk. My buyer can take my $60,000 CDS and sell his own for $65,000 a year, and get $5,000 in "risk-free" profits per year. And on and on this goes until you get a guy who wants to hold on to the CDS because he actually has the bonds to insure, or you find the biggest sucker who can't sell for a higher markup and is stuck with the CDS.
These type of profits provide no value and are born of inefficiencies that can be eliminated by way of a clearinghouse or exchange that posts the prices of the last trade
Saturday, May 22, 2010
Financial Regulation and Credit Default Swaps
CDS isn't involved in just insurance, it's used in CDOs to make synthetic bonds. If I write a CDS on GM bonds, I get paid the "premium" as long as GM doesn't default. If they do default, I must pay the contract amount and I receive the defaulted bonds in return (or I receive the liquidation value of the defaulted bonds back). I also have to put up collateral that pays the risk-free Treasury yield. Add it all together and you have something very much like a GM bond where I would receive interest payments as long as GM doesn't default and if they do, I lose my initial purchase (contract amount) minus whatever I can receive for the defaulted bonds (liquidation value).
The theory is to separate risk from investment. What if I just want to take on the risk of GM bonds without having to actually lend GM money, thus tying up my precious capital? With a traditional bond, I need to loan GM X money for a period of years and I will get X money back at the end assuming there is no default. What if I don't want to tie up that capital but still want to take on that risk? Well let someone else lend GM the money, I'll write a CDS on it and sell it to them. There, they just transferred the risk to me and I didn't have to lend GM any money (though I still have to put up collateral usually). Now that the other guy has a risk-free asset, he can then purchase more bonds up to the risk limit set by the risk management team. That's how it's supposed to work in theory. Of course, in reality his insured GM bond isn't risk free, if I go under, his insurance is worthless.
I think the problem lies with leverage and leverage ratios. CDS can help firms manage their risk without making big capital intensive moves. Selling GM bonds from your portfolio means that you have to find a buyer with the money, and then you're left with the problem of what to do with the money you just got. Where to put it? Why not just buy a CDS contract instead? That way, you get rid of the risk and don't have the problem of what to do with the excess cash.
When risk is being pawned off in an endless cycle, it can become hard to tell exactly how much systemic risk is left. I think I have sold my risk thanks to my CDS purchase, but so does the guy who sold me the CDS because he purchased another CDS to get rid of his risk. Risk keeps on getting transferred, we know that the total risk to the market as a whole cannot be eliminated or reduced merely by transferring, but each person thinks he's OK because he's sold his risk to some other guy who has sold his risk and on and on. It's hard to tell if the guy I purchased CDS from has too much CDS exposure (too overleveraged) because I don't know how many CDS he's sold or purchased since the time I originally purchased CDS from him.
Some limit has to be set for the amount of CDS exposure a firm has given his capital base. That amounts to a limit on leverage. A clearinghouse would make the market more transparent so I can see that there is way too many CDS out there for the CDS I just purchased to be considered safe. Right now there is no way for the individual actor to see the entire whole and the entire whole has a great impact on the individual actor. That is part of the problem. We need to think about the issues and come up with good solutions, I don't think banning CDS is even remotely close to the best solution.
The theory is to separate risk from investment. What if I just want to take on the risk of GM bonds without having to actually lend GM money, thus tying up my precious capital? With a traditional bond, I need to loan GM X money for a period of years and I will get X money back at the end assuming there is no default. What if I don't want to tie up that capital but still want to take on that risk? Well let someone else lend GM the money, I'll write a CDS on it and sell it to them. There, they just transferred the risk to me and I didn't have to lend GM any money (though I still have to put up collateral usually). Now that the other guy has a risk-free asset, he can then purchase more bonds up to the risk limit set by the risk management team. That's how it's supposed to work in theory. Of course, in reality his insured GM bond isn't risk free, if I go under, his insurance is worthless.
I think the problem lies with leverage and leverage ratios. CDS can help firms manage their risk without making big capital intensive moves. Selling GM bonds from your portfolio means that you have to find a buyer with the money, and then you're left with the problem of what to do with the money you just got. Where to put it? Why not just buy a CDS contract instead? That way, you get rid of the risk and don't have the problem of what to do with the excess cash.
When risk is being pawned off in an endless cycle, it can become hard to tell exactly how much systemic risk is left. I think I have sold my risk thanks to my CDS purchase, but so does the guy who sold me the CDS because he purchased another CDS to get rid of his risk. Risk keeps on getting transferred, we know that the total risk to the market as a whole cannot be eliminated or reduced merely by transferring, but each person thinks he's OK because he's sold his risk to some other guy who has sold his risk and on and on. It's hard to tell if the guy I purchased CDS from has too much CDS exposure (too overleveraged) because I don't know how many CDS he's sold or purchased since the time I originally purchased CDS from him.
Some limit has to be set for the amount of CDS exposure a firm has given his capital base. That amounts to a limit on leverage. A clearinghouse would make the market more transparent so I can see that there is way too many CDS out there for the CDS I just purchased to be considered safe. Right now there is no way for the individual actor to see the entire whole and the entire whole has a great impact on the individual actor. That is part of the problem. We need to think about the issues and come up with good solutions, I don't think banning CDS is even remotely close to the best solution.
Argument Against Modern Monetary Theory and the New Keynesians
Can the FED can print all the money it wants to? Not without bad consequences, the ultimate being a Zimbabwe-like collapse of the monetary system.
What is missing from the discussion that of confidence. For the dollar to be an unit of account and store of value, society needs to have confidence that the numbers aren't being fudged, that whatever savings I've built up, my delayed consumption, isn't being manipulated.
Proponents of MMT and New Keynesian economics have pointed out that the government doesn't even need to issue bonds, it could just give itself dollars and spend up to the point where it can purchase 100% of the goods and services offered in the economy. Actually it can't, the monetary system would collapse well before the 100% and people would stop accepting dollars as money because they would have lost confidence in it as a fair and accurate unit of measurement. If even a dictatorship like Zimbabwe isn't able to compel its citizens to accept and use their worthless unit of account, I doubt the US Govt. would be able to.
The reason the government issues bonds at all (that is borrow) is to provide an open and transparent account and to assure the public that the dollar remains a good and fair measurement of the future consumption that they have saved. People want to know that, if they have saved $5 and that can purchase a sandwich at a fast food chain, they will wake up tomorrow and still have a sandwich "due to them" whenever they want it in the future. If they wake up and the $5 in their bank account can't buy them a sandwich anymore, then they know they've been had. Add expected inflation into the mix if you want a more accurate explanation.
When the government borrows money, the public knows that either future government spending will have to decrease, allowing the public to consume more (purchasing bonds is a way to delay consumption to the future), or the public will give up that future consumption in the form of higher taxes. Taxes are very visible and politicians are reluctant to raise taxes without implied consent from the public.
The FED printing money on the other hand, is a stealth tax that is not transparent and is not accounted for. At least with open market operations we can see how much the FED has printed, but as an independent agency that is not directly elected, the people have limited means to control the actions of the FED. No taxation without representation! That's a notion fundamental to our ethos. There are many reasons why FED printing of money and uncontrolled government money creation should be avoided.
Only under a communist dictatorship with an iron grip over society tighter than even Stalin was able to achieve, could government create money like the MMT/New Keynesians advocate. If I have $30000 in my bank account and the government all of a sudden types in $1,000,000,000,000 and posts it to their own account, I know all I've worked for my entire life amounts to nothing. Perhaps this gives a clue as to why people are so pissed off right now and are electing "extremists" like Rand Paul, who seem to understand better than the MMT folks.
What is missing from the discussion that of confidence. For the dollar to be an unit of account and store of value, society needs to have confidence that the numbers aren't being fudged, that whatever savings I've built up, my delayed consumption, isn't being manipulated.
Proponents of MMT and New Keynesian economics have pointed out that the government doesn't even need to issue bonds, it could just give itself dollars and spend up to the point where it can purchase 100% of the goods and services offered in the economy. Actually it can't, the monetary system would collapse well before the 100% and people would stop accepting dollars as money because they would have lost confidence in it as a fair and accurate unit of measurement. If even a dictatorship like Zimbabwe isn't able to compel its citizens to accept and use their worthless unit of account, I doubt the US Govt. would be able to.
The reason the government issues bonds at all (that is borrow) is to provide an open and transparent account and to assure the public that the dollar remains a good and fair measurement of the future consumption that they have saved. People want to know that, if they have saved $5 and that can purchase a sandwich at a fast food chain, they will wake up tomorrow and still have a sandwich "due to them" whenever they want it in the future. If they wake up and the $5 in their bank account can't buy them a sandwich anymore, then they know they've been had. Add expected inflation into the mix if you want a more accurate explanation.
When the government borrows money, the public knows that either future government spending will have to decrease, allowing the public to consume more (purchasing bonds is a way to delay consumption to the future), or the public will give up that future consumption in the form of higher taxes. Taxes are very visible and politicians are reluctant to raise taxes without implied consent from the public.
The FED printing money on the other hand, is a stealth tax that is not transparent and is not accounted for. At least with open market operations we can see how much the FED has printed, but as an independent agency that is not directly elected, the people have limited means to control the actions of the FED. No taxation without representation! That's a notion fundamental to our ethos. There are many reasons why FED printing of money and uncontrolled government money creation should be avoided.
Only under a communist dictatorship with an iron grip over society tighter than even Stalin was able to achieve, could government create money like the MMT/New Keynesians advocate. If I have $30000 in my bank account and the government all of a sudden types in $1,000,000,000,000 and posts it to their own account, I know all I've worked for my entire life amounts to nothing. Perhaps this gives a clue as to why people are so pissed off right now and are electing "extremists" like Rand Paul, who seem to understand better than the MMT folks.
Japan's Lost Decade, Glimpse of Our Future?
Below is a post by Michael Gordon, "The Buggy Professor", taken from here. It's well worth reading so I've posted it below.
Why Comparisons between the US and Japanese economies --- the latter locked in stagnation for two decades --- Are Misleading and Wrongheaded.
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1) FIRST SOME DATA ABOUT JAPAN, COMPARATIVELY VIEWED: per capita income
All translated into $US at purchasing power parity for 2009, estimated (CIA World Factbook)
USA: …….$46,400
Ireland….$42,700
Swiss……..$41,700
Austria…..$39,400
Holland….$39,200
Aussies…..$38,800
Canada…..$38,400
Belgium….$36,400
Denmark…$36,000
Britain…….$35,200
Finland……$34,900
Germany…$34.100
Spain………$33,700
France……$32,800
Japan……$.32,600
EU-27 Aver,,,,,,,,,$32,600
Greece …..$32,200
Italy………$30,300
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2) WHAT HAPPENED TO THE JAPANESE MIRACLE?
As you can see from the per capita income comparisons, Japan --- once touted by statist admirers like Robert Reich (the salvation from the USA depended on our copying Japanese industrial policies) --- Japan has ended up at just about the level of Greece in 2009.
How did this happen? Consider by way of response the growth rates of GDP from 1960 until 2009.
……………...Growth Rate of GDP
1960-1969: 10%
1970-1979: 5%
1980-1989…..4%
1990-1999…..1.5%
2000-2009…..0.8%
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In effect, Japan’s fast growth rate in the 1960s and 1970s reflected standard neo-classical Solow growth theory, and especially convergence catch-up: the further behind a country is from the lead country or countries in productivity and per capita income when it is launched into sustained economic growth, the faster it will grow compared to the lead countries, only to slow down as it approaches the technological frontier.
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3) Japan’s Government Debt Servicing and Rollover Needs for Government bonds
The two sources for the data in this section need to be set out here: http://ftalphaville.ft.com/blog/2010/03/08/167701/japans-brewing-fiasco/
http://www.economist.com/business-finance/displaystory.cfm?story_id=15663864
• Government debt in Japan already absorbs 35% of government revenues . . . a result of constant fiscal stimuli that failed to kickstart sustained good growth since the early 1990s.
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• Gross Government Debt equaled 192% of GDP in 2009. That is the 2nd highest in the world behind Zimbabwe at 304% of GDP. By comparison, Italy’s gross public debt is 115% of GDP and Greece’s 108%.
…….Japanese official spokesmen, plus some financial institutions, argue that gross total government debt in Japan overstates the problem. The government, it’s said, has lots of assets it could sell like its railway system to private businesses. Maybe. It depends on the estimated value of those assets.
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• In 2010, $2.4 trillion dollars worth of government Yen-denominated bonds are scheduled to be roll over. This astonishing figure equals about 45% of total Japanese GDP!
The big question here?
Will Japanese businesses, financial institutions, and householders be willing to recycle their matured bonds, never mind buy new bonds? Household savings --- which were once about 16% of GDP in earlier decades --- have plunged to around 3.0% of GDP last year. What’s more, as the population ages swiftly --- the Japanese already the oldest people among rich industrial countries ---more and more Japanese households will stop saving and begin to dissave for their retirement.
Up to recently, Japanese investment groups and big businesses have bought the government’s bonds, despite extraordinarily low interest rates --- two year bonds, for instance, returning 0.15% interest. Right now, it’s not clear, but some international financial observers note that the largest government pension funds’ agency,
GPIF, in charge of government pensions, has acknowledged that it won’t be capable of rolling over maturing bonds to meet its pension commitments and is instead going to open credit lines. (GPIF’s portfolio happens to be larger than India’s total GDP)
Note finally here that Japan’s short-term debt-maturity is only 6 years compared to the UK’s average 14 years.
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• Will foreign investment groups buy Japanese bonds if Japanese households and businesses and investment groups can’t cover all the new or rolled-over bonds?
Possibly. Japan’s financial flexibility has noticeably improved in the last decade or so. Still, it’s hard to believe that foreign investors would be happy with the very low rate of return on government bonds that the Japanese themselves have accepted. Imagine what Greece’s official national debt would dwindle to as a problem the Greek government could borrow at 3.0% or lower long-term rates for their bonds.
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4) UNSOUND AND MISLEADING COMPARISONS.
All of which brings us to the soundness or not of comparing the US economy today with a slide into a Japan-like future. The comparison, to put it bluntly, seems extravagantly unsound. And for several reasons, to wit:
• Overall, Japan’s economic structures and policies are very different from ours. Which means very different business and financial institutions; and public-private sectors interaction (far more government regulations); and culture (which emphasizes stability); and swiftly aging population; and hostility to immigration and (less now than before) openness to market-oriented reforms.
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• On top of that, Japan’s growth model for decades --- back to the end of WWII --- has stressed export-led growth --- national consumption kept to levels since the 1960s to somewhere between 55-58% (as opposed to the US’s 65-73%). Only Germany has a similar record of restraining domestic consumption (for whatever reasons) among the rich big countries in the world.
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• And until last year, the Liberal Democratic Party --- which united big giant corporations, giant financial institutions (the banks owning the corporations’ equity in large part, and the corporations in turn owning the banks’ lion share of equity), small businesses, and farmers ---ruled as the majority party since the early 1950s except for a 9-month coalition at the start of the 1990s. In the process, political and bureaucratic ties to special interests --- not least to those that cling to the status-quo --- have piled up and fence in the room for maneuver open to policy reforms.
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• Except for impressive technological innovation in the past --- by means of importing American and West European technologies or building around their patents, then improving on their quality incrementally while reducing prices for the finished goods in Europe, the USA, Asia, and elsewhere --- the Japanese have not been creative innovators on their own. As a result, despite noteworthy manufacturing in autos and consumer electronics (and to an extent in some ICT products and optics), the Japanese economy hasn’t experienced any big breakthrough changes in its industrial structures since the 1970s. By contrast, a good 75% of the Fortune 500 Biggest Firms in the USA in the late 1990s hadn’t even existed 25-30 years earlier.
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• As for industrial targeting, the best studies showed that it might have speeded up Japanese economic growth in the 1960s and 1970s by a tad. After that, it was used to prop up the most backward domestic industries and shelter them from international competition.
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• Enter demographics. Japan’s 128 million population is aging rapidly, making its average the oldest among the rich industrial countries. Aging populations are, like aging individuals, less and less willing to undertake risky changes in their lives. At the same time, as people enter into retirement, they begin to dissave. In the upshot, the Japanese face a problem of financially supporting more and more retirees with fewer and fewer active workers. The US native-born population, by contrast, is just about at replacement levels in births, not to overlook the benefits of our openness to legal immigration.
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• Finally, for complex reasons, Japanese culture --- forced under pressure to open up to epochal changes by the intrusions of the US navy and other industrial countries after the 1850s and 1860s and modernize rapidly --- has emphasized stability and aversion to change for decades now . . . the whole massive assemblage around the status-quo well-nigh impregnable.
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5) WHAT EMERGES HERE?
Just all this that follows:
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(I.) A DUALISTIC ECONOMY in Japan
Japan’s economy emerged even in its fast-growth period before WWII and into the next three decades as a dual-system: a small number of giant cartel-like advanced firms like Toyota, Panasonic, Sony, and so on --- increasingly internationalized under pressure of globalization --- and a huge set of backward, low-productive industries that have been protected from change by a combination of political pork-barrel, politically inspired governmental policies, bureaucratic regulations and intrusions into the private sectors of the economy, and fears and worries about disruptive changes that have pervaded the outlook of average Japanese.
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(II.) THE OUTCOME?
Sooner or later, despite all the misleading hullabaloo about Japan’s miracle --- never mind that Japan (like Germany) had won the cold war by 1991 and was about to become the world’s dominant economic and financial superpower --- these anti-change, anti-free market aversions and rigidities were bound to slow down the country’s growth.
--- Since 1991, that landmark year, Japan has vied with Germany to rack up the worst growth-performance of any industrialized or post-industrialized country since the 1930s’ Great Depression. And unlike Germany, whose governments starting in the Socialist-Green era earlier in the last decade – and accelerated in the Merkel era --- carried out a series of major labor-market reforms along free-market lines, the German economy looks capable of sustained solid, if relatively low growth in the future . . . at any rate, once the global economy recovers and the eurozone’s crisis-laden problems are solved one way or another.
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(III.) THE CAUSES OF STAGNATION.
As for the problems of Japan’s failure to recover from its huge financial and economic crash of the early 1990s, it’s not because of what Krugman and a few others have claimed have been the basic causes ---- timid policymaking in fiscal and monetary policies, which to boot now hover over the US economy.
Instead of that, it’s erratic, politicized policymaking that, as one cause, further disrupted a rigid dualistic economy resistant to change once the earlier growth-path and growth-model of a large statist-guided market-system crashed all around them. It’s the combination of these interacting clusters of structural rigidities, politicized catering to public fears of change, bureaucratic pathologies, a small mountain of anti-market rigidities, and a status quo of a dualistic economy marked by low-productive industries for most of the economy that underlies Japan’s two-decade stagnation.
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Examples:
• Japan’s regulators didn’t seek to overhaul the banking system for a good 8 to 9 years into the crisis of the 1990s. That included more effective regulations as well as seeking with government assistance to make the banks liquid and solvent. In the US, these measures were taken almost immediately. And that includes, let us hope, new and effective regulations to prevent a financial meltdown in the future. Here, despite all the fretful worries about our political system, it has generally performed with unusual speed and flexibility since the fall of 2008.
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• The claim that Japan’s governments haven’t fought the stagnant economy and deflationary tendencies with aggressive fiscal policies is simply wrong. If that were the case, how did the Japanese public sector end up with national debt almost 200% of its GDP (vs., to take one well-known calculation, about 80% here, much of which is intra-governmental transfers between programs and agencies). What is accurate is the haphazard ways fiscal stimuli have been applied: large amounts for a while, then the spigot shut tight for fear of inflation or excessive governmental debt.
--- Even now, Japanese and foreign specialists haven’t reached a consensus on whether the fiscal policies helped or hurt the Japanese economy’s short- and mid-term revival.
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• Monetary policymaking has also been erratic. At times it supported the fiscal expansion. Most of the time, it proved timid and often worked against fiscal stimuli. At times too, it engaged in outright quantitative expansion (along Krugman-urged lines), with dubious results
As for monetary policymaking, the fears of change pervading the shared mentality of a rapidly aging population --- where the ratio of active workers to retirees living for decades is declining too --- would have stymied even more effective monetary expansion had it been implemented.
Traditionally, you see, like all the Asian Pacific countries, the Japanese have been big savers for a combination of cultural reasons reinforced by the kinds of export-oriented policymaking of intrusive state-led policies.
One of the curious results?
When interest rates are low, Japanese households – like those in China or South Korea --- don’t interpret those low rates the way Americans (and Europeans) do: as signs that asset prices in the bond and stock-markets or in owned residences have risen in value and start consuming more. Americans in such a context feel wealthier. Not so the Japanese and other Asians. They have, apparently, set ambitions to save such-and-such a percentage of their annual income no matter whether their incomes have risen or fallen under pressure of boom-times or recessions or, in the Japanese case, prolonged stagnation. And so they try to save more.
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• Note though the contrary trend in the last 12-15 years among households.
Incomes have stagnated for two decades now in Japan. In the early and mid-1990s, Japanese household savings remained fairly high as a percentage of GDP, only --- as the stagnation persisted and people entered retirement --- for the households that are rapidly aging to be forced to dissave. That did help to offset the culturally inherited tendencies of younger households to save, but not nearly enough to interact with fiscal and monetary expansionary policies to kick-start the Japanese economy into any sustained growth from domestic stimuli.
Instead, the only sustained growth --- about four to five years in the middle part of the last decade --- came from export-surges prodded by the huge expansion of the global economy. Domestic consumption remained low (55-57% of GDP), and the solid if mediocre growth (about 2.0% a year) ensued. When the global economy tanked into a financial and economic crisis in 2008 and 2009, the Japanese export-dependent economy tanked too.
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(iv.) THE MISLEADING COMPARISONS WITH THE USA?
By now, hopefully, they’re self-evident.
As it happens, Cassandras abound in certain economic and journalistic circles in this country, among which doomster-warnings are those of Krugman who has been sounding them since the fall of 2008.
At times, he’s been a good soundboard for those in the Obama administration who were planning a fiscal stimulus anyway. At other times, his dire warnings seem to reflect excessive pessimism compounded, perhaps, by his pique at not being where Larry Summers happens to be.
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The fact is, the US economy – the most flexible and innovative among the rich industrial countries --- has recovered faster from its financial and economic crash than Japan or any of the EU countries, the whole Continent there stagnating since the official end of the recession in August 2009. There has been virtually no growth in GDP anywhere in the EU. The eurozone crisis has further inhibited a recovery by creating huge uncertainty in the business and financial worlds (with some limited spillovers here in our stock markets)
By contrast, the US economy has grown not just more quickly but by a long-shot compared to Germany, Japan, and all other industrial countries except Australia and Canada . . . both countries admirably undertaking noticeable economic and financial reforms, with Canada’s recovery closely tied to the American recovery, what with 80% of its strong export-performance slated for our country.
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As for the unusual high unemployment, it’s worth remembering here: job-creation is always a lagging indicator in the recovery from a recession. Even after the shallow recession of 2001 ended in the start of the fourth quarter, it took nearly two years before the rise in unemployment topped and then began to fall fairly quickly.
Is 10% unemployment a bad thing?
Sure, no two ways about it. But, for the Cassandras in this thread, note 10.5% or so was the normal level of unemployment in France from the mid-1980s until the boom period (with some labor market reforms) in the middle part of the last decade. In Germany, the unemployment rate since 1990’s unification was even higher until the boom and even more impressive reforms.
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A flexible innovative economy requires continual sector-reallocation of capital, skilled workers, entrepreneurial innovation, and constant technological change and adjustments before it can absorb the changes and the new surges in productivity. What government can do is limited: for those workers displaced from jobs owing to trade competition, accelerate trade-adjustment assistance. For other unemployed workers, seek to encourage better information about job-growth in other communities or economic sectors, all the while giving tax breaks to firms that hire new workers beyond a certain percentage of their existing employee staff.
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Michael Gordon, AKA the buggy professor
Why Comparisons between the US and Japanese economies --- the latter locked in stagnation for two decades --- Are Misleading and Wrongheaded.
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1) FIRST SOME DATA ABOUT JAPAN, COMPARATIVELY VIEWED: per capita income
All translated into $US at purchasing power parity for 2009, estimated (CIA World Factbook)
USA: …….$46,400
Ireland….$42,700
Swiss……..$41,700
Austria…..$39,400
Holland….$39,200
Aussies…..$38,800
Canada…..$38,400
Belgium….$36,400
Denmark…$36,000
Britain…….$35,200
Finland……$34,900
Germany…$34.100
Spain………$33,700
France……$32,800
Japan……$.32,600
EU-27 Aver,,,,,,,,,$32,600
Greece …..$32,200
Italy………$30,300
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2) WHAT HAPPENED TO THE JAPANESE MIRACLE?
As you can see from the per capita income comparisons, Japan --- once touted by statist admirers like Robert Reich (the salvation from the USA depended on our copying Japanese industrial policies) --- Japan has ended up at just about the level of Greece in 2009.
How did this happen? Consider by way of response the growth rates of GDP from 1960 until 2009.
……………...Growth Rate of GDP
1960-1969: 10%
1970-1979: 5%
1980-1989…..4%
1990-1999…..1.5%
2000-2009…..0.8%
.
In effect, Japan’s fast growth rate in the 1960s and 1970s reflected standard neo-classical Solow growth theory, and especially convergence catch-up: the further behind a country is from the lead country or countries in productivity and per capita income when it is launched into sustained economic growth, the faster it will grow compared to the lead countries, only to slow down as it approaches the technological frontier.
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3) Japan’s Government Debt Servicing and Rollover Needs for Government bonds
The two sources for the data in this section need to be set out here: http://ftalphaville.ft.com/blog/2010/03/08/167701/japans-brewing-fiasco/
http://www.economist.com/business-finance/displaystory.cfm?story_id=15663864
• Government debt in Japan already absorbs 35% of government revenues . . . a result of constant fiscal stimuli that failed to kickstart sustained good growth since the early 1990s.
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• Gross Government Debt equaled 192% of GDP in 2009. That is the 2nd highest in the world behind Zimbabwe at 304% of GDP. By comparison, Italy’s gross public debt is 115% of GDP and Greece’s 108%.
…….Japanese official spokesmen, plus some financial institutions, argue that gross total government debt in Japan overstates the problem. The government, it’s said, has lots of assets it could sell like its railway system to private businesses. Maybe. It depends on the estimated value of those assets.
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• In 2010, $2.4 trillion dollars worth of government Yen-denominated bonds are scheduled to be roll over. This astonishing figure equals about 45% of total Japanese GDP!
The big question here?
Will Japanese businesses, financial institutions, and householders be willing to recycle their matured bonds, never mind buy new bonds? Household savings --- which were once about 16% of GDP in earlier decades --- have plunged to around 3.0% of GDP last year. What’s more, as the population ages swiftly --- the Japanese already the oldest people among rich industrial countries ---more and more Japanese households will stop saving and begin to dissave for their retirement.
Up to recently, Japanese investment groups and big businesses have bought the government’s bonds, despite extraordinarily low interest rates --- two year bonds, for instance, returning 0.15% interest. Right now, it’s not clear, but some international financial observers note that the largest government pension funds’ agency,
GPIF, in charge of government pensions, has acknowledged that it won’t be capable of rolling over maturing bonds to meet its pension commitments and is instead going to open credit lines. (GPIF’s portfolio happens to be larger than India’s total GDP)
Note finally here that Japan’s short-term debt-maturity is only 6 years compared to the UK’s average 14 years.
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• Will foreign investment groups buy Japanese bonds if Japanese households and businesses and investment groups can’t cover all the new or rolled-over bonds?
Possibly. Japan’s financial flexibility has noticeably improved in the last decade or so. Still, it’s hard to believe that foreign investors would be happy with the very low rate of return on government bonds that the Japanese themselves have accepted. Imagine what Greece’s official national debt would dwindle to as a problem the Greek government could borrow at 3.0% or lower long-term rates for their bonds.
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4) UNSOUND AND MISLEADING COMPARISONS.
All of which brings us to the soundness or not of comparing the US economy today with a slide into a Japan-like future. The comparison, to put it bluntly, seems extravagantly unsound. And for several reasons, to wit:
• Overall, Japan’s economic structures and policies are very different from ours. Which means very different business and financial institutions; and public-private sectors interaction (far more government regulations); and culture (which emphasizes stability); and swiftly aging population; and hostility to immigration and (less now than before) openness to market-oriented reforms.
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• On top of that, Japan’s growth model for decades --- back to the end of WWII --- has stressed export-led growth --- national consumption kept to levels since the 1960s to somewhere between 55-58% (as opposed to the US’s 65-73%). Only Germany has a similar record of restraining domestic consumption (for whatever reasons) among the rich big countries in the world.
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• And until last year, the Liberal Democratic Party --- which united big giant corporations, giant financial institutions (the banks owning the corporations’ equity in large part, and the corporations in turn owning the banks’ lion share of equity), small businesses, and farmers ---ruled as the majority party since the early 1950s except for a 9-month coalition at the start of the 1990s. In the process, political and bureaucratic ties to special interests --- not least to those that cling to the status-quo --- have piled up and fence in the room for maneuver open to policy reforms.
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• Except for impressive technological innovation in the past --- by means of importing American and West European technologies or building around their patents, then improving on their quality incrementally while reducing prices for the finished goods in Europe, the USA, Asia, and elsewhere --- the Japanese have not been creative innovators on their own. As a result, despite noteworthy manufacturing in autos and consumer electronics (and to an extent in some ICT products and optics), the Japanese economy hasn’t experienced any big breakthrough changes in its industrial structures since the 1970s. By contrast, a good 75% of the Fortune 500 Biggest Firms in the USA in the late 1990s hadn’t even existed 25-30 years earlier.
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• As for industrial targeting, the best studies showed that it might have speeded up Japanese economic growth in the 1960s and 1970s by a tad. After that, it was used to prop up the most backward domestic industries and shelter them from international competition.
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• Enter demographics. Japan’s 128 million population is aging rapidly, making its average the oldest among the rich industrial countries. Aging populations are, like aging individuals, less and less willing to undertake risky changes in their lives. At the same time, as people enter into retirement, they begin to dissave. In the upshot, the Japanese face a problem of financially supporting more and more retirees with fewer and fewer active workers. The US native-born population, by contrast, is just about at replacement levels in births, not to overlook the benefits of our openness to legal immigration.
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• Finally, for complex reasons, Japanese culture --- forced under pressure to open up to epochal changes by the intrusions of the US navy and other industrial countries after the 1850s and 1860s and modernize rapidly --- has emphasized stability and aversion to change for decades now . . . the whole massive assemblage around the status-quo well-nigh impregnable.
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5) WHAT EMERGES HERE?
Just all this that follows:
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(I.) A DUALISTIC ECONOMY in Japan
Japan’s economy emerged even in its fast-growth period before WWII and into the next three decades as a dual-system: a small number of giant cartel-like advanced firms like Toyota, Panasonic, Sony, and so on --- increasingly internationalized under pressure of globalization --- and a huge set of backward, low-productive industries that have been protected from change by a combination of political pork-barrel, politically inspired governmental policies, bureaucratic regulations and intrusions into the private sectors of the economy, and fears and worries about disruptive changes that have pervaded the outlook of average Japanese.
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(II.) THE OUTCOME?
Sooner or later, despite all the misleading hullabaloo about Japan’s miracle --- never mind that Japan (like Germany) had won the cold war by 1991 and was about to become the world’s dominant economic and financial superpower --- these anti-change, anti-free market aversions and rigidities were bound to slow down the country’s growth.
--- Since 1991, that landmark year, Japan has vied with Germany to rack up the worst growth-performance of any industrialized or post-industrialized country since the 1930s’ Great Depression. And unlike Germany, whose governments starting in the Socialist-Green era earlier in the last decade – and accelerated in the Merkel era --- carried out a series of major labor-market reforms along free-market lines, the German economy looks capable of sustained solid, if relatively low growth in the future . . . at any rate, once the global economy recovers and the eurozone’s crisis-laden problems are solved one way or another.
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(III.) THE CAUSES OF STAGNATION.
As for the problems of Japan’s failure to recover from its huge financial and economic crash of the early 1990s, it’s not because of what Krugman and a few others have claimed have been the basic causes ---- timid policymaking in fiscal and monetary policies, which to boot now hover over the US economy.
Instead of that, it’s erratic, politicized policymaking that, as one cause, further disrupted a rigid dualistic economy resistant to change once the earlier growth-path and growth-model of a large statist-guided market-system crashed all around them. It’s the combination of these interacting clusters of structural rigidities, politicized catering to public fears of change, bureaucratic pathologies, a small mountain of anti-market rigidities, and a status quo of a dualistic economy marked by low-productive industries for most of the economy that underlies Japan’s two-decade stagnation.
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Examples:
• Japan’s regulators didn’t seek to overhaul the banking system for a good 8 to 9 years into the crisis of the 1990s. That included more effective regulations as well as seeking with government assistance to make the banks liquid and solvent. In the US, these measures were taken almost immediately. And that includes, let us hope, new and effective regulations to prevent a financial meltdown in the future. Here, despite all the fretful worries about our political system, it has generally performed with unusual speed and flexibility since the fall of 2008.
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• The claim that Japan’s governments haven’t fought the stagnant economy and deflationary tendencies with aggressive fiscal policies is simply wrong. If that were the case, how did the Japanese public sector end up with national debt almost 200% of its GDP (vs., to take one well-known calculation, about 80% here, much of which is intra-governmental transfers between programs and agencies). What is accurate is the haphazard ways fiscal stimuli have been applied: large amounts for a while, then the spigot shut tight for fear of inflation or excessive governmental debt.
--- Even now, Japanese and foreign specialists haven’t reached a consensus on whether the fiscal policies helped or hurt the Japanese economy’s short- and mid-term revival.
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• Monetary policymaking has also been erratic. At times it supported the fiscal expansion. Most of the time, it proved timid and often worked against fiscal stimuli. At times too, it engaged in outright quantitative expansion (along Krugman-urged lines), with dubious results
As for monetary policymaking, the fears of change pervading the shared mentality of a rapidly aging population --- where the ratio of active workers to retirees living for decades is declining too --- would have stymied even more effective monetary expansion had it been implemented.
Traditionally, you see, like all the Asian Pacific countries, the Japanese have been big savers for a combination of cultural reasons reinforced by the kinds of export-oriented policymaking of intrusive state-led policies.
One of the curious results?
When interest rates are low, Japanese households – like those in China or South Korea --- don’t interpret those low rates the way Americans (and Europeans) do: as signs that asset prices in the bond and stock-markets or in owned residences have risen in value and start consuming more. Americans in such a context feel wealthier. Not so the Japanese and other Asians. They have, apparently, set ambitions to save such-and-such a percentage of their annual income no matter whether their incomes have risen or fallen under pressure of boom-times or recessions or, in the Japanese case, prolonged stagnation. And so they try to save more.
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• Note though the contrary trend in the last 12-15 years among households.
Incomes have stagnated for two decades now in Japan. In the early and mid-1990s, Japanese household savings remained fairly high as a percentage of GDP, only --- as the stagnation persisted and people entered retirement --- for the households that are rapidly aging to be forced to dissave. That did help to offset the culturally inherited tendencies of younger households to save, but not nearly enough to interact with fiscal and monetary expansionary policies to kick-start the Japanese economy into any sustained growth from domestic stimuli.
Instead, the only sustained growth --- about four to five years in the middle part of the last decade --- came from export-surges prodded by the huge expansion of the global economy. Domestic consumption remained low (55-57% of GDP), and the solid if mediocre growth (about 2.0% a year) ensued. When the global economy tanked into a financial and economic crisis in 2008 and 2009, the Japanese export-dependent economy tanked too.
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(iv.) THE MISLEADING COMPARISONS WITH THE USA?
By now, hopefully, they’re self-evident.
As it happens, Cassandras abound in certain economic and journalistic circles in this country, among which doomster-warnings are those of Krugman who has been sounding them since the fall of 2008.
At times, he’s been a good soundboard for those in the Obama administration who were planning a fiscal stimulus anyway. At other times, his dire warnings seem to reflect excessive pessimism compounded, perhaps, by his pique at not being where Larry Summers happens to be.
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The fact is, the US economy – the most flexible and innovative among the rich industrial countries --- has recovered faster from its financial and economic crash than Japan or any of the EU countries, the whole Continent there stagnating since the official end of the recession in August 2009. There has been virtually no growth in GDP anywhere in the EU. The eurozone crisis has further inhibited a recovery by creating huge uncertainty in the business and financial worlds (with some limited spillovers here in our stock markets)
By contrast, the US economy has grown not just more quickly but by a long-shot compared to Germany, Japan, and all other industrial countries except Australia and Canada . . . both countries admirably undertaking noticeable economic and financial reforms, with Canada’s recovery closely tied to the American recovery, what with 80% of its strong export-performance slated for our country.
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As for the unusual high unemployment, it’s worth remembering here: job-creation is always a lagging indicator in the recovery from a recession. Even after the shallow recession of 2001 ended in the start of the fourth quarter, it took nearly two years before the rise in unemployment topped and then began to fall fairly quickly.
Is 10% unemployment a bad thing?
Sure, no two ways about it. But, for the Cassandras in this thread, note 10.5% or so was the normal level of unemployment in France from the mid-1980s until the boom period (with some labor market reforms) in the middle part of the last decade. In Germany, the unemployment rate since 1990’s unification was even higher until the boom and even more impressive reforms.
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A flexible innovative economy requires continual sector-reallocation of capital, skilled workers, entrepreneurial innovation, and constant technological change and adjustments before it can absorb the changes and the new surges in productivity. What government can do is limited: for those workers displaced from jobs owing to trade competition, accelerate trade-adjustment assistance. For other unemployed workers, seek to encourage better information about job-growth in other communities or economic sectors, all the while giving tax breaks to firms that hire new workers beyond a certain percentage of their existing employee staff.
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Michael Gordon, AKA the buggy professor
Our Current Low Inflation Environment
There is no inflation right now because people are deleveraging by cutting down their debt loads. Credit is still very very hard to get for the average person, I just applied for a mortgage and the fees alone are outrageous, but credit is limited and those who offer credit can charge whatever they want to. Most banks aren't interested in lending.
Americans understand that they can't spend like they used to, debt loads cannot continue to go up like they did before, the banks/credit lenders won't allow it and people don't want more debt anyway. So instead of spending and bidding up prices by demand, people are paying off debt as they can. We won't see inflation until the average American's balance sheet is repaired.
That means government fiscal policy will not be able to increase aggregate demand. As soon as government stops spending, demand will fall back to levels Americans find appropriate. However, should government continue to spend and spend, a new crisis will emerge pertaining to government debt loads. We'll be in the same position as Japan, the spending having accomplished nothing but with a huge debt weighing on our heads. Unlike what MMT proponents say, government cannot finance its debt and interest payments by itself, any attempt to do so will cause a collapse in confidence and bring about a crisis, much like the one we're witnessing in Europe.
The European crisis is one of the reasons for such low Treasury yields. Investors are pulling money out of Europe, selling their bonds, and investing in US Treasuries instead, causing a decline in yields. If there is one thing to be learned, it's that the financial landscape can change very very quickly once a tipping point is reached. Once confidence is lost and fear takes over, a stampede for the exits ensues. The collapse of the Euro from $1.50 to $1.23 was as quick as lightning. And it only took a matter of months for Greece to find out that their debt could only be sold at incredibly high interest rates, that is if it could be sold at all.
A similar tale awaits the US should it continue on with reckless spending, especially the useless pork barrel spending that the Congress is accustomed to. Once it becomes evident that the debt load is too large to finance, yields will rise very quickly and capital will flee the scene. Confidence once lost, is hard to regain. Draconian cuts to government spending will be demanded and government will have to surrender to the bond vigilantes and speculators as they have done in Greece, Spain, and even France.
We don't have to go down that road. And it bothers me that what money is being spent is not being spent well. At the very least spend money for productive projects that has some chance of paying off in the future, not on cars for clunkers or any of the crap that has so far been proposed. Tax breaks for corporations to buy equipment? No thanks. How about extending the Bush tax cuts permanently if you insist on continued stimulus? Allowing Americans to deleverage faster by taking less from them is the quickest way out of this crisis. The economy cannot heal until Americans are in better financial shape and are ready to spend again.
Americans understand that they can't spend like they used to, debt loads cannot continue to go up like they did before, the banks/credit lenders won't allow it and people don't want more debt anyway. So instead of spending and bidding up prices by demand, people are paying off debt as they can. We won't see inflation until the average American's balance sheet is repaired.
That means government fiscal policy will not be able to increase aggregate demand. As soon as government stops spending, demand will fall back to levels Americans find appropriate. However, should government continue to spend and spend, a new crisis will emerge pertaining to government debt loads. We'll be in the same position as Japan, the spending having accomplished nothing but with a huge debt weighing on our heads. Unlike what MMT proponents say, government cannot finance its debt and interest payments by itself, any attempt to do so will cause a collapse in confidence and bring about a crisis, much like the one we're witnessing in Europe.
The European crisis is one of the reasons for such low Treasury yields. Investors are pulling money out of Europe, selling their bonds, and investing in US Treasuries instead, causing a decline in yields. If there is one thing to be learned, it's that the financial landscape can change very very quickly once a tipping point is reached. Once confidence is lost and fear takes over, a stampede for the exits ensues. The collapse of the Euro from $1.50 to $1.23 was as quick as lightning. And it only took a matter of months for Greece to find out that their debt could only be sold at incredibly high interest rates, that is if it could be sold at all.
A similar tale awaits the US should it continue on with reckless spending, especially the useless pork barrel spending that the Congress is accustomed to. Once it becomes evident that the debt load is too large to finance, yields will rise very quickly and capital will flee the scene. Confidence once lost, is hard to regain. Draconian cuts to government spending will be demanded and government will have to surrender to the bond vigilantes and speculators as they have done in Greece, Spain, and even France.
We don't have to go down that road. And it bothers me that what money is being spent is not being spent well. At the very least spend money for productive projects that has some chance of paying off in the future, not on cars for clunkers or any of the crap that has so far been proposed. Tax breaks for corporations to buy equipment? No thanks. How about extending the Bush tax cuts permanently if you insist on continued stimulus? Allowing Americans to deleverage faster by taking less from them is the quickest way out of this crisis. The economy cannot heal until Americans are in better financial shape and are ready to spend again.
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