Wednesday Night #1445

Hug a Central Banker
This time last year capitalism died for 48 hours

The central bankers of the G20 stepped up to the plate
and they put things back in place.

Niall Ferguson started off the evening (on the monitors) declaring that “the technical recession may be over, but the engine of growth is clearly not the United States.” He was followed by his colleague, Professor Ken Rogoff in an equally gloomy vein. However, the economy does seem to be moving forward despite the perceived problem that Americans are consuming less and saving more. The alarming statistics for the U.S. are the unemployment figures; there is a huge disconnect between published U.S. unemployment figures, the highest since the Great Depression, not including the number of people that are underemployed, or those so discouraged as to have given up the search for employment.  It may well take from three to five years to once again achieve a normal level of employment.   
Wednesday Nighters differ in their explanation of the precipitous roller-coaster drop in the stock market following the impressive steady rally, reaching a crescendo last week.  Forecasting should bear no relationship to fortune telling but to risk assessment made on a continuous basis, an assessment that can easily be swayed by the manner in which one views the graphs and stars.
On the negative side, Americans are not saving sufficiently; Canadian banks still have on their books, an impressive volume of bad loans, invisible in their financial statements, that will take a number of years to work through the system. As discouraging as these figures appear, there is a greater probability that this week’s precipitous drop in the market is merely a glitch following the recent impressive eight month rally which will most probably continue well into the New Year.  The truth of the matter is that we have had a financial crisis that will continue until it  is completely over.  The recovery programs special programs are merely designed to slowly wean us off it and have proven successful in doing so.

Derivatives and regulation
Derivatives are extraordinarily useful – as well as complex, dangerous if misused and implicitly subsidized. No wonder regulators are taking a close look. In Canada the call for a national regulator has resulted in the creation of The Canadian Derivatives Clearing Corporation which is responsible for managing all OTC derivatives markets to minimize the systemic risk or the risk to the system because of inability to manage risk appropriately. The Clearing House becomes everyone’s counter-party – “the buyer to every seller and the seller to every buyer”. The cost of money will go up as free credit disappears. However, the need for risk taking is recognized – without it there is no venture capital, no junior mining….
In an unheard-of coordinated effort, the G20 is developing policies, principles and transparent mechanisms to prevent the type of failure we have just experienced from happening again. This will take a long time – and there is a danger of overshooting the mark, but the end result – a principle-based system that allows everyone to adapt to innovation – should be a well regulated and transparent OTC derivative market. Nonetheless, this represents a massive change in how the economy operates
The Warning
, a cautionary tale recently broadcast on PBS, highlighted the travails of the then-Chairman of the Commodities Futures Trading Commission regulator who warned against the dangers of derivatives’ trading. It should be remembered however, that the derivatives themselves were not the underlying problem – the free money available through the carry trade led to bad lending processes and ultimately, some very ‘stupid derivatives’. Compounding the problem was very poor record keeping, which, as swaps increased and trust eroded, became a huge liability.
A. Great question, and one of the biggest debates between the various regulators. In essence, most commercial enterprises use their banking relationships to manage the credit risk associated with derivatives; with clearing houses they have to pledge cash against these positions. This can constrain their business; and the derivatives they use legitimately help them manage their risks.
Not resolved yet, but best guess would be that non-financial commercials will have a clearing exemption for non-standardized activity; all activity will have to be reported to a central repository for transparency. Again – a best guess.
Q. Re our discussion on the derivative clearing house We never clarified who is required to put transactions through the clearing-house, and who is exempt.

World economy  
To this point, the availability of virtually interest-free money has helped fuel the recovery but continues to serve as a temptation to borrow and invest in the ever risky derivative markets.  The key to control is oversight, a role which the G-20 is taking seriously.  However, considering the makeup of the G-20, it is not evident to all that the expectation of the emergence of an effective workable solution is realistic. The answer is that those members of the G-20 that have neither a sophisticated banking or legal system, nor a derivative market, will not have an equal voice in the planning of safety measures for the global economy.

Quantitative easing programs – which is what we call printing money

Banks’ balances will repair themselves over time as poor quality loans work their way off the balance sheets (ex. The ABCP has a nine-year life -the assets eventually mature and die) and as long as the financial institutions do not add any more toxic assets. Meantime, although TARP helped a bit, as they repair their own balance sheets, banks are not lending.  The economy may be bruised but will ultimately recover only to face another crisis at a later date.
But, once damaged, pension funds have difficulty recovering if indeed, recovery is ever possible.  The solution proposed and increasingly implemented is the transformation of pension plans from defined benefit to defined contribution. This allegedly gives everyone ‘freedom’ to manage their own pensions – to the surprise of few, the participants (who may not have the same investment acumen as the managers of the funds) do not show the same enthusiasm as the managers for this solution.   The defined contribution option undoubtedly provides protection for pension plan administrators and for the integrity of the pension fund.  Objectively, defined benefit plans also place the responsibility for the maintenance of judicious investments on the plan administrators where some believe that it rightly belongs.
The intervention of the central banks appears to have worked.  In the derivative frenzy, many were caught in the trap of confusing fraud with easy money.
Will this new regulated environment stifle growth? Ideally, the financial sector will no longer be at the apex of the economy, but will have a service role- bankers will provide banking services, not driving, but servicing the economy – and our levels of growth that reflect population, productivity growth and not financial services’ growth.

A national regulator for Canada?
Our current system with some 13 regulators costs the country about $18 million – the blue ribbon panel set up to examine the system is costing us some $40 million. The Canadian system works. A national regulator might be a good idea for representing the country on the international scene, but in no way would it be a guarantee against Ponzi schemes – the problems we have have faced – Earl Jones/Madoff/Lacroix are related to bad policing, not bad regulaton. The working reality is that with the electronic systems available today, there is no problem with money moving around the country, or registration.

The global economy
Predictions on the future of the economy are perilous but interest rates are low and inflation is not a problem and is not predicted to constitute a problem for at least a year.   Asia was never really in recession and we are experiencing some growth over last year.  Japan is virtually bankrupt and has some real challenges. India, China and Indonesia are thriving. The U.S. is a long way from recovery and the situation is complicated by political instability as people realize how bad things are and that solutions are not easy. Europe has emerged relatively quickly and thanks in part to the social benefits (safeguards) that act as stabilizers. The big issue is the largest excess capacity the world has ever seen in terms of fixed physical plant (running around 67% globally – needs to run about 80-85% before it is used) and labor – the biggest unemployment and under-employment figures (which include individuals who have stopped looking for a job, those who have gone on part-time work and those who have become self-employed) since the Great Depression. This means deflation, as there is no way wages can go up – which means low interest rates. The growth vehicles of the world are in Asia – China, India, Indonesia, Malaysia, etc. and those countries supplying them.  They have the ingredients and capabilities as long as they foster their own internal growth. This bodes well for Canada and Australia.  The era of the U.S. and Europe centred world is over.   Commodities, infrastructure and transportation, notably railways, are expected to prosper.
The U.S. economy would benefit from some inflation – even a lot, which would enable the government to inflate its way out of the trillion-dollar debt and get out of the problem. Thus a weak dollar, while not politically attractive, works economically. The U.S. needs to export more and import less. Effectively, the weak dollar sets up the trade barriers.

Climate Change
As we come ever closer to the December 6-18 Copenhagen Conference of the Parties to the UN Framework Conference on Climate Change, more opinions and criticisms of the science on which the underlying assumptions of the IPCC are based are being raised. The leader of the pack is, of course, Bjorn Lomborg. Climate Change Science is suspect, – based on forecasting, probabilities and risk assessment – it is virtually impossible to build credible models. At the same time, in the face of increasing and tangible evidence of our damaged environment,  there is a genuine will to do something better, along with increasing pressure from civil society and a number of nations to reach an accord on a “Son of Kyoto'” treaty.
Unfortunately, under UN rules, the 194 Parties (nations) to the Conference must agree to all agenda items, so it is highly questionable whether any progress will be made.  Aside from the fact that politicians appear reluctant to plan beyond their term in office and other human beings beyond their lifespan, as long as energy is considered a consumable as opposed to a transformable commodity, realistic planning will be difficult.

T H E  P R O L O G U E

As we commemorate Armistice/Veterans/Remembrance Day 70 years after the outbreak of World War II, we note that there seem to be a number of milestone anniversaries that command our attention this week, including, of course, the Fall of the Berlin Wall on 9 November 1989. Less trumpeted, but surely of interest to our Hungarian and Polish friends, is the 565th anniversary of the Battle of Varna; and for the many whose ancestors emigrated to the U.S., Ellis Island closed 55 years ago; while for parents in our generation, the 40th anniversary of the first broadcast of Sesame Street on November 10 likely has even more social significance. [See Stephen Colbert segment on Sesame Street]
Finally, and most appropriate to this Wednesday’s glittering group of economists and financial gurus, on 13 November 1789, Benjamin Franklin wrote Nothing is certain but death & taxes. Two hundred and ten years later, Ronald Reagan announced his candidacy for the presidency and we all know how he felt about taxes and Big government, and can imagine what his reaction might have been to the global financial crisis. Would he have bailed out the financial institutions?
We are delighted that Maureen Farrow will be joining us this Wednesday, along with Peter Perkins, Ron Meisels and other members of what Peter Trent has termed the Wednesday Night Irregulars. Following two exceptionally interesting evenings devoted to a broad range of subjects – including religion – we plan to revert to our economic and geopolitical focus this evening, so have elected the following items to stimulate your thinking and the discussion.
Bernier still a thorn to PMO

MP thinks single securities office unconstitutional
… He concluded that “the option of setting up a Canadian securities commission to achieve a more effective and efficient regulatory system is unconstitutional.” Our question is: If the commission were to be set up to achieve a less effective and efficient system, would it then be constitutional?
Bank Lending Down Despite Massive Bailouts and Increasing Regulations
While financial institutions including Citigroup Inc. and Bank of America Corp. have received more than $200 billion in capital from the government, they are limiting loans at a time of mounting unemployment, rising company bankruptcies and increasing regulatory oversight. Commercial and industrial lending has dropped 17 percent since October 2008, according to Federal Reserve data. (Bloomberg) Geithner Saying Be Like Buffett Can’t Make Banks Lend
And now for the G20’s next trick …
(FP) On one level, the G20 seems to be saying that the situation is still dire and interest rates will remain low for a long time. That suggests buying bonds is the smartest idea.
On the other hand, the size of the stimulus spending suggests corporate profits will be buoyed by a tidal wave of government spending. That amounts to a vote for stocks.
Yet another way to look at the situation is to wonder how countries will ever pay for the massive stimulus they’re doling out. Rather than raise taxes to pay for it, governments may inflate away the debt they’re running up. That would suggest that gold is today’s asset of choice.
And in the same vein, Terence Corcoran comments: The ability to move money and financial markets is probably something to be envied. The market-shifting accomplished by G20 finance ministers over the weekend is another matter. In the wake of their full bore commitment to “maintain support for the recovery until it is assured,” a promise that means more deficit spending and easy monetary policy around the world, markets responded by driving the price of gold up over $1,100 an ounce, sinking the U.S. dollar and rekindling stock market speculation.
Last week, JPMorgan agreed to a $722 million settlement with the SEC stemming from a risky derivatives deal that drove Alabama’s most populous county to the brink of bankruptcy. As part of the settlement, JPMorgan neither admitted nor denied wrongdoing — despite ample evidence that it had engaged in plenty of wrongdoing. This is what passes for justice on Wall Street: regulators give a company a ding to its bottom line, and are ready to quickly forget the whole thing and allow the company to move on to the next lucrative money-printing scheme. When corporate perpetrators don’t have to admit they did anything wrong, it’s as if the crime never happened. Which, of course, makes it much more likely that it will happen again. Click here to read more.
America’s most famous investor buys a railway company

WARREN BUFFETT describes his latest deal as “an all-in wager on the economic future of the United States”. On November 3rd his investment firm, Berkshire Hathaway, agreed to buy the 78% it did not already own of Burlington Northern Santa Fe, America’s second-biggest railway operator, in a deal valued at $44 billion. Saluting the flag has become an integral part of Mr Buffett’s carefully cultivated folksy image, but the deal also looks like a bet on many less stirring ideas, including ever-higher imports from China, heavier traffic through the Panama Canal, higher oil prices and the preservation of coal’s big role in power generation in America.
An earlier item that has not yet been looked at on Wednesday Night, although Tony Deutsch has commented, is Steep Losses Pose Crisis for Pensions – Two Bad Choices for Funds: Cut Benefits Or Take Greater Risks to Rebuild Assets
The financial crisis has blown a hole in the rosy forecasts of pension funds that cover teachers, police officers and other government employees, casting into doubt as never before whether these public systems will be able to keep their promises to future generations of retirees. The upheaval on Wall Street has deluged public pension systems with losses that government officials and consultants increasingly say are insurmountable unless pension managers fundamentally rethink how they pay out benefits or make money or both. Within 15 years, public systems on average will have less half the money they need to pay pension benefits, according to an analysis by Pricewaterhouse Coopers. Other analysts say funding levels could hit that low within a decade.
Of course H1N1 is always on our minds as is the forthcoming Copenhagen Conference on Climate Change – for which the prospects look increasingly dim – and we must not neglect the Auditor General’s Report (we should all give thanks for Sheila Fraser).
And a reminder to all: World premiere of John Curtin’s latest documentary film (see promo)
After Elizabeth II: Monarchy in Peril airs on CBC Thursday November 12 at 8 pm and again on Newsworld on Friday November 13, at 10 pm.
It is already stirring up controversy “Prince Charles on the throne could end monarchy in Canada: new documentary

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