More Tells

I am kind of shooting from the hip with this post, having not fully thought through potential causes, but...

In the last book that I read by Richard Koo, and really totally consistent with all the well-known Keynesians out there, there is a belief that a balance sheet recession prevents huge amounts of QE from causing inflation.  And, according to most "experts", Europe is in the midst of a balance sheet recession.  So, why then are inflation rates spiking up from Germany to Belgium to Spain?  Add to that, bond rates for weaker issuers (and I am throwing French OATs in there) are starting to flash out relative to Bunds.

I'm suspecting that what everyone thinks they know is about to be thrown on its head.

The Revolt Against the Masses

The subtitle is How Liberalism Has Undermined the Middle Class and the author is Fred Siegel (2013).

There are times when I read books to challenge my beliefs. This time is not one of them. Given the current political environment, and my sense that liberal outrage is an exercise in hypocrisy, I sought out a well-regarded argument that might confirm my understanding. Such is this book, as it takes us back in time to the roots of today’s liberal progressive agenda, and elucidates how it has always sought to impose the will of the elite on the perceived philistines and hoi polloi.

The progenitors are people like H.G. Wells, H.L. Mencken, Sinclair Lewis, Randolph Bourne, and Herbert Croly. Let’s start out by noting that all were believers in eugenics, which wasn’t deemed a bad thing until it became integral to Nazism. Moreover, all were big believers in the disinterested technocrat guiding the morally unsophisticated and unintelligent masses. They also all admired the Bolsheviks and frowned upon the economic motive. To wit: “We were all sworn foes of capitalism, not because we knew it would not work, but because we judged it, even in success, to be lethal to the human spirit.” This strand of ideology was very much at the heart of the New Deal and influenced its creation, as it drew on the same circle of professionals and professors who thought so much of Moscow. As such, it was a manifestation of the perceived solution to class conflict, more than just an answer to the Great Depression – not surprisingly, it was the genesis of so many social welfare programs that still exist today.

As a general observation, liberalism was an expression of “European Socialist parties rewritten in the language of rights”. Whether the New Deal programs earlier on, or the legal changes that came out of the ‘60s, it was an attempt to have the central power administer how humans should interact. Don’t get me wrong, as I have no objection to civil rights and personal liberties, but when all too often such decisions come out of the Supreme Court rather than majoritarian-ism, there is a disconnect between what the Democratic process is supposed to be and how morals and ideals are actually being implemented.

So, if I were to take anything away from this book, it is that good intentions matter more than outcomes in looking at the progression of this movement. Proving the point that not every problem can have a solution.

As an interesting tangent, the response to the 1980 presidential election might be useful. Over the course of that campaign, Democrats sought to turn the Republicans into populists, as Reagan was the outsider candidate trying to bring morning back to America after the turbulent 1970s of stagflation and high unemployment. While claiming the moral high ground, unfortunately for liberals their policy regime had left a country that was teetering – and in winning, Reagan engendered unexpected support from white working class Democrats (sound familiar?). The response from the losing side was vitriol (sigh) and nothing that resembled a re-think on ideas. The social programs were failures, as poverty continued to rise, but were now re-imagined as rights and racial justice (did they march the day after the inauguration also?). I would remind everyone that this book was written years before the Trump phenomena. And maybe what we are seeing yet again from the resistance – actually what I believe is going on in earnest – is the easy pivot that liberals make between acceptance and rejection depending upon who is in power.

Counter Factuals

I am reading another book right now by economist Richard Koo, innovator of the balance sheet recession concept.  If you remember what his idea entails, it's that when you have a big bust in asset prices when folks are highly levered, causing technical insolvency as values tumble, the introduction of monetary stimulus is of limited usefulness.  Ultimately, you need fiscal policy from the government to help mend the economy.  He notes that the big examples of a balance sheet recession include the Great Depression, Japan's bust in the late 1980's, and most of the large western economies post-2008.  What Koo emphasizes is that fiscal stimulus, in those cases, was the ultimate antidote.  But, look a little deeper, and there is probably cause for concern even beyond the misallocations that are allowed to linger.  In the case of Japan for the past 25 years, and the U.S. since 2008, the fiscal stimulus implemented prevented a Great Depression type event, but still did no better than only tepid growth.  Now, looking at the Great Depression, Koo would argue that there were initially mistakes under Hoover that exacerbated the initial bust, and later under FDR when he tried to cut budget deficits and triggered the double-dip in 1937.  So, what was it, by Koo's account (and others, like Paul Krugman who calls for a space invasion), that did the trick?  Massive, massive stimulus -- and the only thing that ever gets you there is war.

Tick Tock...

I sounded "sad" in yesterday's post, but really I am pretty sanguine about the election.  Change is going to come even if the status quo candidate wins today -- and it's going to happen because we can't escape the debt problem in this country.  So, to explore the issue a bit, I put together a table of annual U.S. fiscal deficits and the cumulative changes in total outstanding public federal debt since 1960.  I think it brings home the point.  Enjoy.

Year	Deficit	Public Debt Fed
1960	4.8	290.5
1961	10.5	292.7
1962	7.2	302.9
1963	4.8	310.3
1964	5.9	316.1
1965	1.4	322.3
1966	3.7	328.5
1967	8.6	340.5
1968	25.2	368.7
1969	(3.2)	365.8
1970	2.8	380.9
1971	23.0	408.2	Bye-bye gold standard…notice anything about deficits afterwards?
1972	23.4	435.9
1973	14.9	466.3
1974	6.1	483.9
1975	53.2	541.9
1976	73.7	629.0
1977	53.7	706.4
1978	59.2	776.6
1979	40.7	829.5
1980	73.8	909.0
1981	79.0	994.8
1982	128.0	1,137.3
1983	207.8	1,371.7
1984	185.4	1,564.6
1985	212.3	1,817.4
1986	221.2	2,120.5
1987	149.7	2,346.0
1988	155.2	2,601.1
1989	152.6	2,867.8
1990	221.0	3,206.3
1991	269.2	3,598.2
1992	290.3	4,001.8
1993	255.1	4,351.0
1994	203.2	4,643.3
1995	164.0	4,920.6
1996	107.4	5,181.5
1997	21.9	5,369.2
1998	(69.3)	5,478.2	Clinton "Surpluses", but federal debt grows $400Bn…hmmm
1999	(125.6)	5,605.5
2000	(236.2)	5,628.7
2001	(128.2)	5,769.9
2002	157.8	6,198.4
2003	377.6	6,760.0
2004	412.7	7,354.7
2005	318.4	7,905.3
2006	248.2	8,451.4
2007	160.7	8,950.8
2008	458.6	9,986.1
2009	1,412.7	11,875.9
2010	1,294.4	13,528.8
2011	1,299.6	14,764.2
2012	1,087.0	16,050.9
2013	679.6	16,719.4
2014	484.6	17,794.5
2015	438.4	18,120.1	Federal Debt grows $1.4Tn…hmmm
2016	587.4	19,537.4

Insanity

H/t Grant Williams & Real Vision TV:

-Since September 2008, central global banks have instituted 650 rate cuts, or one every three trading days

-Currently, 27% of total global outstanding sovereign debt trades with negative interest rates

-Currently, 65% of total global outstanding sovereign debt trades with rates of 1% or lower

This can only end well...

The Pile

With a little time off recently, I paid a visit to my old friend, reading.

(1) St. Marks is Dead by Ada Calhoun (2016). The subtitle is The Many Lives of America’s Hippest Street. A fun and interesting read, particularly for someone who holds New York City dear. In fact, the City’s entire history is played out from colonial times by focusing on one of its most eccentric streets and neighborhoods. As a bonus, I also discovered that the term “Knickerbocker” derives from a Washington Irving book, and came to mean someone who had been in New York City since colonial times – and as those times belonged to the Dutch, no wonder the orange and blue.

(2) The Forgotten Depression by James Grant (2014). The subtitle is 1921: The Crash That Cured Itself. The author attempts to demonstrate how the depression of 1920-21 undermines the Keynesian and Monetarist prescriptions that have been at work since the New Deal.

In accomplishing that feat, Grant must first demonstrate that the downturn could be qualified as a depression on par with other notable periods. It all starts with World War I, and the common phenomenon where the government creates buying power by printing money and borrowing where taxes could not cover the costs. The result is a great and crushing inflation that knocks the economy over after the war ends. To put the decline in context, Grant offers the following:

“According to Historical Statistics of the United States, gross national product, before adjustment for changes in prices, plunged to $69.6 billion in 1921 from $91.5 billion in 1920, a loss of 24 percent. Even after making allowances for falling prices, the decline in national output amounted to 9 percent. For perspective, the Great Recession of 2007-09 delivered a drop in nominal domestic product of 2.4 percent, a price-adjusted fall of 4.3 percent. From 1920 to 1921, the Federal Reserve’s index of industrial production fell by 31.6 percent; in 2007-09, it declined by 16.9 percent.”

And from a first-hand commentary standpoint, Grant found the following from none other than Irving Fisher: “It seems manifest that thus far the difference between the present comparatively mild business recession and the severe depression of 1920-21 is like that between a thunder shower and tornado.” What makes that quote extra special is that Fisher was looking at the landscape in 1930 and praising Hoover and the Federal Reserve for being very reactive to the circumstances and stepping in with fiscal and monetary measures to boost the economy. How ironical, no?

In any event, having set the stage, what we see the government do in response in 1920-21 is to raise interest rates, run budget surpluses, and actually act to see wages go lower in tandem with prices. An overall deflation was permitted and encouraged as the appropriate remedy to the excesses that had gone in the other direction. As a result, as American investments became more “value-laden” and exports more attractive, within 18 months, the bottom was in and the roaring ‘20s were set to start. The interesting contrast is Great Britain, which went through its own economic downturn after the War, but where folks like Keynes had already gained more influence over policy. Accordingly, political forces intervened and a floor was set in wages where unions had a stronger foothold. Their recovery was certainly weaker and more tepid and unemployment higher. In the U.S., standing down from action was apparently the right tact.

What shouldn’t be lost, however, is that this approach did lead to human suffering with jobs lost, companies bankrupted and wealth destroyed. But, the depth and length of that suffering was shortened because natural market processes were allowed to play out. There should be a lesson in that, particularly when viewed through recent downturns. The recession that followed the tech boom of the ‘90s was difficult, and the so the Fed went to work and we ended up with a housing crash that nearly upended the entire financial system. And so here we are, witnesses to monetary policy that is simply beyond anything that we have seen before. Is it reasonable to believe that the next time will be even worse?

Anyway, to finish the story, despite a seeming understanding of the causes of the 1921 downturn, over the course of the years to follow, the political tides changed and the forces in Europe that took a more Keynesian turn found their way to these shores as well. And, to make matters worse, the inflation which should’ve put everyone on notice, as it did in 1919-20, was much more subtle and dangerous. The ‘20s was a period of innovation, but unlike the second half of the nineteenth century where a healthy deflation ensued, prices largely went sideways because of the offsetting activist Federal Reserve and loosened credit standards; so the obvious symptom of the past simply looked like price stability. Moreover, where the inflation lived was where people weren’t looking – stocks, real estate and other capital investments. And when the bust came, there weren’t any adults left to offer the remedies that worked before.

(3) The Ministry of Guidance Invites You To Not Stay by Hooman Majd (2013). The subtitle is An American Family in Iran. I have read a couple of his books before. As a reminder, he is Iranian born, Western educated, and currently lives in Brooklyn. In 2011, he decided that he should move to Tehran for a year with his American wife and infant child. During that time, he observes how the government really is not working for its people in the way that it should, and that many citizens understand the problems and would like to see change. As such, the section that resonated most was where he tried to rationalize the disconnect between word and deed:

“A number of different groups of Iranians are opposed to the current political system or the government, and certainly object to the continuing human rights abuses, but the ones looking to overthrow the regime through revolution still seem to be in the minority. Perhaps the memory of the 1979 Islamic Revolution is too strong, if not in their own young minds, then in the minds of their parents and grandparents who took part in it; for it was a revolution hijacked, a revolution that broke promises, a revolution that, even with its authoritarian and sometimes fascist impulses, has yet to provide economic security, or any other kind, for a large portion of its population. In 1979, eliminating the 2,500-year-old monarchy was supposed to usher in a democratic era, albeit with an Islamic hue; now the disappointment many Iranians feel, even pious Iranians who once believed in the revolution, is tangible and observable. Many of them seem reluctant to repeat what they believe will be another disappointment.”

Sigh

Courtesy of Jesse:

"The main thing is that the debt is in dollars. So we can't run out of cash--we print the stuff. Suppose that foreigners decide we're not reliable.   How does that drive up interest rates?   The Fed controls short-term interest rates, and long-term interest rates reflect expected short rates. How's that supposed to happen?"

-Paul Krugman

I take exception to the notion that the Fed, or any other central bank, is bigger than the market.  If that were really true, then why do we see so many results/recessions/busts that run counter to their agendas and policy plans?

But, more than that, if we look at the broader implications of his comment, do the problems end simply with where rates are?  In fact, if the Fed has to print endless amounts of money to battle bond sellers, foreign and domestic, what happens to the dollar?  There are so many possible knock-on effects that are troubling, that the sheer academic arrogance in his comment is astounding.

The Death of Money

The subtitle is The Coming Collapse of the International Monetary System and the author is James Rickards (2014).

From the same writer as Currency Wars, the subtitle should give it away – he looks at the dynamics at play that will undermine the existing structure, specifically dollar supremacy. All of it presages financial war, a state where efficient markets theory and rational behavior can be thrown out the window. Unfortunately, politicians, central bankers and the like rely on theories and models that in no way reflect the complexity theory that governs the real world – in part, because a complex world can seem noncritical up until the moment that all hell breaks loose. Hence the reason that so many “experts” struggle to see crises in advance. And this sense of confidence in their understanding of the world is what encourages these central planners to take a top-down approach of managing and fine-tuning all elements of the economy. All leading to their eventual downfall. Beyond these larger ideas, though, Rickards provides interesting analysis on a few specific topics.

The first is an explanation of why so many “Euroskeptics”, expecting the currency to combust any day now, have been wrong. First, in a world where the U.S. has been forcing a weak dollar policy, it should not come as a shock that the Euro would gain relative strength. Second, the currency’s strength is more related to capital flows and central bank policy, and is not at the mercy of a particular bond default – so the issues with Greek and Spanish bonds does not predict with any certainty what might happen to the Euro. Third, even as export competitiveness went down in Europe, the U.S. and China were involved in swaps with the ECB and sending money into Europe in the form of FDI, thereby supporting the currency. Fourth, there exists a belief in Keynesian theory, specifically in the notion of sticky wages and that inflation is needed to lower real unit labor costs and to avoid a liquidity trap. Well, Europe has seen wages go down, and the result has been a lack of need or desire to break free from the Euro and return to national currencies that encouraged inflation and corruption. Finally, as the Euro is a political project, the will to stick with it is much greater than many analysts realize. I don’t necessarily subscribe to all these points, but feel they are worth highlighting.

The second subject is the way to think about Debt-to-GDP ratios. In the end, what is most critical is not the absolute level of that ratio, but its trend towards sustainability. Which is to say that the use of debt must be for productive ends, thereby creating economic output (net of interest expense) that is measurably in excess of the primary deficit. For countries like the U.S. and Japan, the trend is not their friend – especially as the use of debt by government in the QE and Abenomics programs is for non-productive ends.

As a corollary of that discussion, Rickards brings up a topic that has intrigued me for a while and generated thoughts in other posts on this site – namely, about a true understanding of the period referred to as the “Golden Age of Keynesianism” following WW2 until 1971. I have said that a Minsky analysis of that time would reveal, simply, that the trend towards reckless and speculative behavior was slowed only because the Depression and war had led to a very high level of savings in this country that took a longer time to burn through – the Keynesians simply try to take credit where no credit is due. Rickards’ view is similar – that financial repression was allowed to go on for a longer period of time before inflation took off because so many were living with recent memories of the Depression and wartime controls and rationing, thus keeping a very large portion of their money in banks.

The final topic is around why deflation is so problematic – from the point of view of politicians and central bankers. First, under deflation, the government debt burden becomes greater in real terms, making it more difficult to repay. Second, as an off-shoot of the first, the Debt-to-GDP ratio would move against governments in such times (since debts would go up, but economic growth would go down), thereby leading to higher interest rates and even larger deficits. Third, as deflation causes the real burden of debt to go up, it stands to benefit creditors – until defaults go up as a result, and bank failures follow. Fourth, real wages go up even as nominal wages stay constant – and from a tax collection standpoint, the government is not able to monetize that benefit. Inflation is the easy way, even if it just delays the day of reckoning. All worth keeping in mind, I think , any time you hear an economist or politician prattle on.

As a last anecdote, the author speculates that $9,000 per ounce for gold is closer to fair value given the global money supply.

Setting Sun

I pay close attention to Japan, so this Bloomberg article about the widening trade deficit is interesting. I liked this quote from economist Junko Nishioka at RBS: “In spite of the continued weaker yen, the performance of Japanese exporters is quite weak compared to competitors like Korea or Taiwan.”

This next one from Bloomberg highlights how inflation in Japan has picked up, but consumer confidence has dropped, because there has been no rise in wages to offset the inflation. So much for inflationary “benefits”.

Things don’t look so good for Shinzo.

Also, thought the chart below from the New York Sun tells a worthwhile story. It looks at income inequality in the U.S. – interesting what coincides with the spike up that starts in 1971…

The Taper

A few thoughts:

-Even after a $10Bn monthly decrease, the Fed is still on pace to grow its balance sheet by $900Bn per year

-My view is that this move was really a token gesture, so that Bernanke could exit office having done something that resembles prudence

-The reaction of the stock market, to shoot upwards, is only emblematic of the goldilocks crowd, detached from the realities of hard data. Rates went down but then crept back to 2.89%. That trend continues to be up and the disconnect between equities and fixed income will not last indefinitely

-People like to say that QE has not been inflationary, and that all those newly-created reserves just sit at the Federal Reserve doing nothing. If that’s really the case, then why not start to unwind, since they have no impact. But, obviously, their existence has some significance. Clearly, not only can no unwind occur, but it continues to be important to grow the volume of those idle dollars

-Eventually what has been done today will be undone, and in magnitude greater than $10Bn

And, no, I’m not in denial about where things are. I’m just convinced that the majority is.

Ruh Roh

I thought this Bloomberg article on Japan was pretty interesting. Basically they are getting inflation without wage growth – cost push, not demand pull, the very issue that we were concerned about months ago. So much for those wonderful theories by Keynesians and Monetarists.

(Sigh)

It’s 10 days old and continues to receive attention, so now it’s my turn.

Mr. Krugman is at it again, commenting on a recent presentation by Larry Summers at the IMF Research Conference. Summer’s attention-grabbing and provocative conclusion is that the U.S. has basically been in a secular stagnation since the 1980s. The source of stagnation could be demographics, a decline in innovation or something else – but the key point is that bubbles have become necessary in order for the economy to grow.

Krugman, as usual, is careful to talk with caveats and in measured language, but it’s clear that he finds much merit in the position, ultimately concluding “What Larry did at the IMF wasn’t just give an interesting speech. He laid down what amounts to a very radical manifesto. And I very much fear that he may be right.”

But let’s dig in to some of the commentary before we get there. For starters, Krugman the Statist implies that government spending is better than private spending. Specifically, he notes that the Keynes' hypothetical of burying currency in holes for the private sector to dig up, or Krugman’s notion of preparing for a fake alien invasion, are both the types of massive government spending that the economy needs right now – because spending is the priority and “unproductive spending is still better than nothing”. And the same logic applies to the private sector as well, at least sort of: ”Private spending that is wholly or partially wasteful is also a good thing, unless it somehow stores up trouble for the future. That last bit is an important qualification.” Huh? Is he really suggesting that the risk only lies with the private sector when the mandate is just to spend?  I don't really think the facts support that, but it sure does tell us a lot about the mindset behind the Krugman schtick, and why he often supports programs that take control away from individuals and centralizes it in Washington.

Another area where his position just glosses over the facts is in arguing that with all the bubbles since the S&L crisis, there really has been no inflation. And to agree you basically have to ignore financial assets and the size of government or the persistent instability in the face of a “Great Moderation”. CPI doesn’t capture any of those things, of course – and it also ignores food and energy prices as well. But, by all means, continue with your hedonics and substitution, forget about wage stagnation, and pretend that people can afford just as much, and you still end up with a CPI (bogus as it may be) that is more than 2.5 times higher than it was in the late 80s.

Krugman also says the problem is not loose money and low rates.  If anything, if Summers is right, the economy has been trying to get into a liquidity trap for a long time, and but-for high household spending and increasing debt, things would probably look much worse.  I find it a bit misleading then to ignore the shift from a gold standard to an unbacked currency, and the resulting spike in debt levels since then, with an attending decrease in the bang that you get from each incremental dollar of debt, and still to conclude that monetary policy is not related here.

Anyway, to wrap this up, Krugman offers some ideas for how to handle this new reality. Like paying negative interest rates on deposits, pushing inflation much higher, and worrying less about financial regulation since we really need to encourage bubbles. Some of which we’ve heard before, maybe once or twice. And which I’m sure will all turn out wonderfully. After all, Nassim Nicholas Taleb is banking on it.

More Links

In this week’s note from Doug Noland, I think he does a good job of explaining how QE leads to speculation in financial assets – in this instance, U.S. equities:

“As an illustration, follow the trail of outflows from a somewhat less popular “Total Return Bond Fund” (TRBF). To fund outflows, TRBF sells Treasuries to the Federal Reserve. TRBF then transfers Fed liquidity to exiting investors that then use this “money” for investment in the now extremely popular “Total Stock Market Index Fund”. This fund then takes this “money” that originated with the Fed and bids up stock prices.

Or, how about an example where a hedge fund moves to exit an underperforming emerging bond market. Here the fund is unwinding a leveraged “carry trade” that involves selling the EM bond and liquidating the EM currency position. With the EM bonds and currency under intense (“hot money” outflow) pressure, the local EM central bank intervenes with currency purchases (sells dollars to buy the local currency). To fund these purchases, the EM central bank sells Treasuries to the Federal Reserve. The central bank then uses Fed liquidity for purchasing currency from the hedge fund, and the hedge fund then has “money” to rotate into 2013’s speculative vehicle of choice - US equities.”

Then in the latest Hussman piece, he covers a lot of interesting ground related to this overvalued stock market. For example, part of the problem is that many look at the market and think that there is nothing remarkable from a multiples perspective – until one considers that corporate profit margins are 70% above historical norms. All of which means, one, expect some mean reversion, and two, it is not practical to extrapolate from the present on what the discounted value for stocks should be prospectively. That’s why the Schiller P/E is a better multiple to focus on since it measures price to 10-year historical, inflation-adjusted earnings. And it currently stands at a robust 25x.

The other noteworthy point is more of a rebuttal to anyone who tries to tie employment and inflation – essentially the logic behind the Phillips Curve. Here’s Mr. Hussman: “This isn’t to say that A.W. Phillips was incorrect. Rather, his “Phillips Curve” was actually a relationship between the unemployment rate and wage inflation, in a century of British data when Britain was on the gold standard and general prices were stable. What Phillips said, in effect, is that unemployment is inversely related to real wage inflation. That proposition holds true in U.S. data as it does internationally. But it is hardly the basis for any strong belief that we can buy a few more jobs by targeting a higher inflation rate in the general price level.”

Notable Comments

A recent addition to my regular reads is the weekly note from Ben Hunt at Epsilon Theory. In this week’s issue, he tackles how politics have corrupted economic theory. And in getting there, he has a couple of observations worth repeating:

“Suffice it to say that it’s not a coincidence that Social Security is a child of the Great Depression in the same way that both QE and Obamacare are children of the Great Recession. The institutionalization and expansion of centralized economic policy is what always happens after an economic crisis, but the scale and scope of QE and Obamacare, particularly when considered together as two sides of the same illiberal coin, are unprecedented in US history.”

and…

“In exactly the same way that French kings in the 13th century used ecclesiastical arguments and Papal bulls to justify their conquest of what we now know as southern France in the Albigensian Crusades, so do American Presidents in the 21st century use macroeconomic arguments and Nobel prize winner op-eds to justify their expansionist aims. Economists play the same role in the court of George W. Bush or Barack Obama as clerics played in the court of Louis VIII or Louis IX. They intentionally write and speak in a “higher” language that lay people do not understand, they are assigned to senior positions in every bureaucratic institution of importance, and they are treated as the conduits of a received Truth that is – at least in terms of its relationship to politics – purely a social construction.”

Another new member to the roster is Michael Pettis, who writes a blog about China from a financial perspective. In a piece from last month, he addresses the interesting topic of the PBoC’s huge foreign reserves and why they are not really a safeguard in the event that Chinese banks need to recapitalize. To wit:

“A much more important objection is the idea that reserves can be used to clean up the banks (or anything else, for that matter) is based on a misunderstanding about how the reserves were accumulated in the first place. There seems to be a still-widespread perception that PBoC reserves represent a hoard of unencumbered savings that the PBoC has somehow managed to collect.

But of course they are not. The PBoC has been forced to buy the reserves as a function of its intervention to manage the value of the RMB. And as they were forced to buy the reserves, the PBoC had to fund the purchases, which it did by borrowing RMB in the domestic market.

This means that the foreign currency reserves are simply the asset side of a balance sheet against which there are liabilities. What is more, remember that the RMB has appreciated by more than 30% since July, 2005, so that the value of the assets has dropped in RMB terms even as the value of the liabilities has remained the same, and this has been exacerbated by the lower interest rate the PBoC currently earns on its assets than the interest rate it pays on much of its liabilities.

In fact there have been rumors for years that the PBoC would be insolvent if its assets and liabilities were correctly marked, but whether or not this is true, any transfer of foreign currency reserves to bail out Chinese banks would simply represent a reduction of PBoC assets with no corresponding reduction in liabilities. The net liabilities of the PBoC, in other words, would rise by exactly the amount of the transfer. Because the liabilities of the PBoC are presumed to be the liabilities of the central government, the net effect of using the reserves to recapitalize the banks is identical to having the central government borrow money to recapitalize the banks.”

Mr. Pettis has another recent post about Abenomics in Japan and why if it succeeds, it still might fail. Here’s the punchline:

“Japan’s enormous debt burden was manageable as long as GDP growth rates were close to zero because this allowed both for the country to rebalance its economy and for Tokyo to make the negligible debt servicing payments even as it was effectively capitalizing part of its debt servicing cost. If Japan starts to grow, however, it can no longer do so. Unless it is willing to privatize assets and pay down the debt, or to impose very heavy taxes of the business sector, one way or the other it will either face serious debt constraints or it will begin to rebalance the economy once again away from consumption.

As this happens Japan’s saving rate will inexorably creep up, and unless investment can grow just as consistently, Japan will require ever larger current account surpluses in order to resolve the excess of its production over its domestic demand. If it has trouble running large current account surpluses, as I expect in a world struggling with too much capacity and too little demand, Abenomics is likely to fail in the medium term.

Perhaps all I am saying with this analysis is that debt matters, even if it is possible to pretend for many years that it doesn’t (and this pretense was made possible by the implicit capitalization of debt-servicing costs). Japan never really wrote down all or even most of its investment misallocation of the 1980s and simply rolled it forward in the form of rising government debt. For a long time it was able to service this growing debt burden by keeping interest rates very low as a response to very slow growth and by effectively capitalizing interest payments, but if Abenomics is “successful”, ironically, it will no longer be able to play this game. Unless Japan moves quickly to pay down debt, perhaps by privatizing government assets, Abenomics, in that case, will be derailed by its own success.”

Courtesy of Stratfor, I found this feature of Chilean governance to be incredibly interesting:

“Economically, Chile has an institutionalized monetary and fiscal policy, which means that politicians are limited in their ability to tamper with macroeconomic fundamentals. Of particular note is the countercyclical fiscal rule, which essentially dictates that politicians are required by law to save copper proceeds in sovereign wealth funds during booms but are allowed to use deficit spending during downturns.”

And, finally, here is the Zero Hedge article that examines the recent revelation of manipulation of the jobs reports by the Census Bureau, including the one just before Obama got re-elected in 2012 when the unemployment rate dropped meaningfully under 8.0%.