The 99 Week Dilemma

With the recent passage by the United States Congress to extend the availability of 99 weeks of unemployment insurance for an additional 18 months a unique question arises, "Does longer term unemployment benefits affect migration flows?"

From a humanitarian aspect I am a supporter of unemployment insurance. For intervals of somewhere between ninety days and six months, unemployment insurance is an important facet of civilized society. Unemployment insurance reduces the inflammation of societal unrest and generally provides a much needed safety net for not only the unemployed individual and his or her direct creditors, but his or her community as well. That said, is long term unemployment insurance creating distortions in the labor market?

Here is the rub: Joe loses his job in California where he lives with his family. His children are in school, his mother works in town and all his brothers and sisters are nearby. It is a perfect situation, well at least until the factory closed last week. Now, Joe really needs, and in fact wants, to get back to work. The problem is that the town has been hard hit and jobs like his just aren't available. What does Joe do?

Well, assuming unemployment benefits are a "necessary" safety net, meaning Joe doesn't have adequate savings to wait for employment, Joe would certainly be forced to move if no benefits were available. As a national average, despite recent trends indicating the savings rate of Americans is on the rise (over 7% at last reporting), Americans are ninety days from being broke. This means that if our Joe is in fact an "average Joe," he has ninety days to replace his paycheck or face a dire circumstance.

With the extension of unemployment benefits, workers are given a longer period to replace employment. With ninety-nine weeks of benefits and ninety days of savings, the unemployed are given the option to "wait and see." The drastic, life altering, option of uprooting oneself and leaving family behind, becomes a more distant last resort. While quite understandable, is this behavior causing market distortions in the National labor market?

Currently the Midwest, meaning Nebraska, Iowa, South Dakota, North Dakota, Kansas, Oklahoma all have unemployment ranges far below the National Average. That said, California, Nevada, Arizona, Florida are well above the National Average. Also, these relative levels have remained since the first of signs of the Great Recession in 2008 three years prior. With the current era's speed of travel and the ability of job seekers to connect with prospective employers in an instant through the Internet, why is it taking so long for people to move to more favorable job markets?

Desirability ? Inability to sell one's house? Familial roots? Perceived standard of living? Regardless of the validity of one or all of these reasons- all of them are luxuries. Starvation, homelessness and inability to provide the basic necessities certainly would trump them. During the Reconstruction Era Depression or the Dust Bowl Americans migrated far and wide to search out opportunities for work. Even in more recent recessions such as the energy crisis of the 1970's, I had the personal experience of watching my father move away to find work leaving my working mother behind to care for me while he settled into a more prosperous region. Labor moved to meet capital. The rebuilding process inert in capitalism's cycle of life thus began again.

While I am not selling one that capitalism is the paramount economic system, nor am I suggesting that providing those without isn't noble- I am merely asking whether in a capitalistic system prolonged benefits are distorting the natural reallocation of labor and capital? If the answer is yes, the more important question is: Whether the prolonged benefits will in fact work in putting Americans to work in their hometowns or whether in the end the invisible hand will force these individuals to move regardless?

Exchange Rate Roulette

The world is engaged in a game of "tug of war" that is as unprecedented as it is unpredictable. In the past, the quest to be a net exporter was often managed by import taxes, supply restraints and trade agreements. In the new world of "free" trade countries now are using indirect means to achieve the desirable end of being the world's supplier.

While this concept of currency manipulation is not new, the United States attempts to answer through quantitative easing is in fact new. The real question is what took so long for the United States to answer? Leverage certainly masked the problem for quite some time as corporations created multinational identities with no allegiance to any given population. As Americans saw their wages flat lining due to deflationary wage pressures from overseas and technology advances, Profits soared due to the lower input costs. These profits unfortunately were unsustainable because the American worker no longer fashioned the same sense of purchasing power.

In other words, instead of paying the cost to build it at home so we could afford to consume it, corporations built their goods elsewhere. Through a favorable credit corporations could enjoy these maximized profits by selling their goods to the debased American workforce over time. The problem of course is that one can only lend to a certain threshold and still expect repayment. The second problem is that because of the insufficiency of wages paid to workers in foreign manufacturing countries those workers were not viable as consumers for the goods produced.

Since wealth is not created by income, but rather sustainability of one's standard of living- the American practice of being a net importer was doomed to fail. This failure was systematic and without reprieve. Eventually lending had to slow due to ability of the borrowers to pay. Without lending deflation was almost certain. So it is certain the American worker in mass must produce as much or more than they consume to create sustainability. Americans cannot continue to consume and not produce, because production creates the wages with which they are able to consume. Conversely, wealth is assured if the Americans can produce more than they consume because that surplus is savings. Of course this is the benefit of being a net exporter.

That said, with countries such as Brazil and North Korea limiting and taxing capital inflows that would cause their currencies to naturally appreciate, how does this game end? With Japan and China dedicated to purchasing US dollars to diffuse currency appreciation and undermine the Fed's efforts to devalue the currency, is the end a net wash? Perhaps its a game of chicken that dares the other to veer off of collision course first. If we keep printing money simply for them to buy it up to maintain status quo can capital flows ever reach equilibrium?

In sum, the end game will have to be accomplished through direct means such as treaty or taxes since no one seems to be willing to say "uncle." Of equal importance America will have to deregulate the workplace requirements and union strongholds on issues of workplace standards if America is to compete for the world's jobs in the future.

The Mirror and the Window

"ANYONE CONTINUALLY KNITTING HIS LIFE INTO CONTEXTS OF INTENTION,IMPORT AND CLARIFICATIONS OF MEANING WILL IN THE END FIND THAT HE HAS LOST THE SENSE OF EXPERIENCING LIFE,"

- JOSEPH CAMPBELL

A Carney, of sorts, travels the continent with his magical house of mirrors. His mirrors are magical because they represent all the ways in which man could judge him or herself. Each mirror- a standard for which purpose is usually derived.

There is a mirror of Morality, Society, Capability, Purpose, Strength and many more. The traveling man sets the mirrors along the edges of the room surrounding an empty center. Standing alone in the middle of the room is a four sided mirror that reflects Success.

Visitors are encouraged to look in each mirror individually and then use each mirror to angle its reflection into the Success mirror so that both reflections are revealed in one frame of vision. At the end of a trip through the perimeter mirrors, guests are directed to walk slowly around the four sided mirror of success in the center of the room and "re-read" the reflection of the numerous perimeter mirrors in the reflection of the the Success mirror.

Some hover in the Success mirror with it reflected against Morality. Others read the reflection of Success against the mirror of Capability. As people vary in taste, they also tend to value the amount of time spent in each mirror differently.

Some cry when they view the mirrors, some cheer, some are awestruck and some get angry at what they see. The Carney does his best to be a good host to his guests and always offers to adjust the lighting and change the angles of the mirrors to best suit his customers' preferences. Should a woman feel wronged by the Societal mirror, for instance, years of experience allow the Carney to adjust the lights and add props, such as clothing and lenses, to satisfy her. As a disclaimer to those who may be offended by the mirrors the Carney proclaims, "My mirrors are not calibrated for every height and proportion so please ask for assistance should the mirrors not accurately reflect the requisite standard to your satisfaction and I will be happy to make the necessary adjustments."

Over the years, the Carney is engulfed with observing his guests encounter the mirrors. He rarely takes a break from his work. The Carney actually rarely even goes into the outdoors. Rather, he keeps a detailed journal of all of that happens and every unbelievable encounter that occurs in his house of mirrors. There aren't many days that the Carney doesn't feel like the luckiest person in the world for being the possessor of such important and fulfilling items.

Queens, socialites, Wall Street billionaires, mystics, artists, musicians and clergy come and go. The responses of these people seldom disappoint the ever watching Carney. In fact, as time passes there are two fairly predictable occurrences: 1. When in the house of mirrors people tend to distance themselves from other guests, whether acquainted, related, in love, best friends or strangers, and 2. People spend disproportionate amounts of time at each mirror. That said, a line always forms at the coup De teat- the Success mirror.

One day a very simple and normal looking man pays his admittance and enters the mirrors. The simple and normal man acts peculiarly once inside the the room. He first weeps and then proceeds to scream. The Carney finds this simple and normal man's behavior to be extremely odd as the man had yet to even reach the first mirror. The simple and normal man walked towards the participants and began to plead with them. He proclaimed:

"Leave this place. It is not you in and of yourself, by yourself and thinking of yourself, that determines your relevance."

The customers began to work their way away from the simple and normal man attempting to create space from him and still find the answers they sought with their admission ticket. The simple and normal man continued his mission by walking in front of many of the guests and blocking the mirrors. He said:

"Your worth, your answers, your self, is not found this way. It is not the reflection of light that is reality, it is the light itself."

Having disturbed the client base substantially, the Carney came out of his perch high in the rafters and demanded the simple and normal man to leave. After restoring order, the guests once again began to gaze and pose, smile and frown, turn and shift in the mirrors as they always had. The magic of the mirrors was restored and all was calm as the Carney liked it.

After that strange day many more years passed in the manner they had always passed in the Carney's world. The Carney had grown quite wealthy through providing his service of magic mirrors. Then one night at closing time the simple and normal man from many years ago appeared at the door. The Carney greeted him cordially but cautiosly by saying, "I want no trouble please let us be."

The simple and normal man looked deep into the Carney's eyes, something the Carney hadn't experienced since he was a child, and gently said:

"Walk with me through the mirrors. You and I will come to an understanding."

The two entered the room as the simple and normal man took the Carney's hand. He looked at the Carney as they walked the perimeter in a forced, but even, pace. As they walked, the Carney's eyes filled with tears. His skin prickled with anxiety and sweat began to surface on his back and coat his skin beneath his clothes. The Carney felt the tears come on even stronger and his throat close down as the simple and normal man made no reflection in any mirror. The two reached the Success mirror, one in blithering tatters comprised of red wet eyes and shuttering- the other calm and compassionately resolved to finish the gauntlet. The Success mirror bore no reflection of the two men, one supporting the other as a soldier carries the wounded to safety on the battlefield, the mirror only reflected the lights of the room. With this the simple and normal man, while staring forward into the mirror bearing no image and essentially holding the Carney up, said:

"Our Journey is to comprehend and find happiness in the light, not it's reproduction."

Crying and chilled to the bone the Carny finally broke the simple man's grasp and fell to his knees. The simple and normal man knelt directly in front of him and stared into the top of the Carney's bowed head as if speaking into his soul directly and whispered:

"One must let go of self to find bliss. In the world it is impossible to truly see one's self if it is isolated from its place.... the web that connects all."

The simple and normal man then left the room never to return and the Carney followed him into the wilderness.

Why the US struggles with a Budget

Americans in general seem to be concerned about the Federal Budget Deficit and the level of the National debt. While valid, do these same Americans know how to create a surplus? Is this simply partisanship and saber rattling or are they serious? As an independent voice in the era of politically owned media- this blog will explain the necessities to create a budget surplus and then reduce the National Debt. Be warned, budget discussions are always uncomfortable and often take sacrifices. Since I am not a partisan- this discussion is sure to upset all who are.

Let us start with the latter, reducing the National Debt. This is simple, once we have a budget surplus we must dedicate no less than 50% of that surplus to paying down our debt. So how do we create a budget surplus?

1. National Defense. The most expensive portion of our expenditures is National Defense. From a budget perspective it was pure insanity to enact the tax cuts of 2000 and then start a war in 2001. Even dumber was the choice to start two. Even worse is our continued choice to fight them both.

Since the beginning of time, war constituted assessments on that country's citizens to pay for them. War is extremely expensive and not an attractive behavior for fiscal responsibility. War bonds have been floated, taxes raised, and rationing instituted in the past to help bear the costs of going to war. None of these measures have been instituted in these two current wars that have lasted twice as long as World War II.

Solution: End the wars immediately, we can't afford them. This may cause future danger to some Americans, but safety is never a guarantee. There will always be violence, always. The point is to minimize it in a cost effective manner. In addition, TSA, defense spending, military spending, CIA, FBI, DEA and all other public safety must be cut. Seventy percent of the US Government's budget goes to the military and public safety. Cuts in this arena is the fastest track to fiscal discipline. The balancing act is not what does it take to keep every American safe, but what can we afford to spend to keep the most amount of Americans safe.

Second, to help fill the hole created in our budget, the United States must ensure payment of reparations from the defeated countries of Afghanistan and Iraq. Should currency be insufficient, natural resources that can be easily exchanged for currency would suffice. This second part is very difficult to enforce because the United States was the aggressor in both wars and thereby not truly eligible for reparations. That said, the victor in war has traditionally had reparations paid in exchange for relinquishment of control and/or peace.

Social Security and Medicare. The second largest portion of the Government's budget is Social Security and Medicare. This is the time old political trap because folks eligible for Social Security and Medicare tend to vote at a higher percentage than those not receiving these subsidies. That said, cutting defense spending is not exactly politically popular either. Remember the point of this article is not the political double speak one finds in the Republican and Democratic controlled news stations- this is the straight stuff.

Solution: Social Security and Medicare must be made smaller. Privatization does not work, because whenever the market gets involved the trademarks of markets, greed and fear, take hold. Those trademarks create volatility not suitable for people of age. Since we live longer, the programs need to reflect our ability as a people to work for more years. Remember the intent of these programs is to provide for those who CANNOT provide for themselves. Social Security was never created to be a retirement program. Clearly, there is an age when we as citizens no longer can gainfully be employed, but at the current age limits we see seniors engaged in massive fraud to make sure they qualify for these social programs when it is not yet necessary. Manipulating income and assets is rampant in the United States to ensure qualification. In fact, many financial planners encourage and assist in such crimes. Simple fix, increase the age by ten years retroactively. Remember, this is not about being fair or proper, this is serious budget talk.

Unemployment, AFDC, and Disability. These programs need to be budgeted per the revenue of the Country as a whole and pegged to that revenue as a fixed percentage. Businesses may plan for the future, 5, 10, 20, 50 years, but they do not budget by the year because they cannot forecast sales that far in advance. Businesses budget by the hour by fixing expenses to a percentage of sales. The government must adopt this practice when it comes to entitlement spending.

Solution. Entitlement spending must be tied to revenue in the given quarter. Currently these programs encompass approximately 18 percent of the Federal Budget. So, the Government must ensure that these programs never exceed there intended level of impact. In other words, if the Government chooses entitlement spending is appropriate for 15% of the total budget, then benefits shall be reduced pro rata by any declines in Federal tax receipts and also increased by the same measure. This is simple budgeting. If the Federal Receipts are trending lower by 3 percent per the oodles of payroll and earnings reports generated on a weekly basis, then benefits shall be three percent less in that quarter (notice the cut comes in the current quarter when a businessman budgets, because the preceding quarter is irrelevant and the future is never certain). If those reports show an increase of 6%, then everyone receiving aid gets a raise.

One more important thing about this system is that it is mathematical and cannot quantitatively be abused. If too many people are using the benefits, payouts will be too low because the receipts generated by taxes will be lower and benefits will not create enough money to live well. Subsequently, those that can work and do better will. Once the marginal recipients return to work, those who truly cannot work will get a raise because of increased revenue in the system. From a budget standpoint the equilibrium of entitlements (where people will enter and leave the entitlement programs based on individual payout amounts) described in the preceding sentence doesn't matter because the payments shall never exceed the designated percentage.

Natural Disasters. Simply stated, we cannot budget for something that would happen by surprise. As a result, localities must be responsible for their own natural disasters. Volunteerism, charity and local authorities must right these occurrences.

Environmental Agencies. Simply stated, Environmental Agencies such as the EPA must be self funding without any dedication of tax payer monies.

TARP, FDIC and Redevelopment. The government should always take chances such as these when available as a lender or contractor of last resort because they are necessary to ensure tax receipts for the future and are generally revenue positive. TARP, for example, was a massive success of the Bush Administration. Currently with many loans yet paid back the program is already ahead in sum without those repayments. Should the outstanding debts be paid back without default, the program will yield over a 14% per annum return on investment. That's revenue positive and budget friendly.

Solution: When feasible, and sufficient collateral or equity available, the Government should act in its best interest fiscally. No business could budget itself with flat lining or declining revenue streams. As a staunch believer that raising taxes beyond its optimum level actually reduces revenue, the Government should always tax at its maximum level of efficiency (which is most likely lower than current levels). To supplement income, the Government should make business ventures that provide adequate return on investment. After all, there is little risk since the Government is immune to bankruptcy laws making its investments always collectible.

So after this brief common sense budgeting exercise are you truly concerned about the budget? I can assure you that many cannot honestly answer yes. Most say yes to some of these basic budget principles, but no to others. Many only want to budget when it is convenient. Tea Party constituents are generally not willing to cut defense, even though its the biggest and most over spent portion of our budget. Many others want to end the war, but won't stand for poverty. If one truly claims to be pro balanced budget or budget surplus, there can be no emotion and no gray area. After all, its all just simple addition and subtraction with a few fractions. The numbers are neither good nor evil, they are just numbers. Right?

The Truth about Inflation

My senior year thesis in Economics was Brazilian hyperinflation. After creating oodles of econometric models based on numerous commonly held truths about inflation, the only factor that was significantly correlated to hyperinflation was inflation expectations.

The news, the financial analysts and even the Wall Streeters love to talk about inflation and its roots being firmly grounded in money supply. The truth is that while money supply is a factor, the issue of inflation is psychological. A government can theoretically print money until kingdom come, so long as the population values those dollars the same.

This reality of people not realizing increased money supply as inflationary is often explained by financial spinsters as the theory of the velocity of money. In other words, whether money is actually being circulated or whether it is parked in places where it isn't creating new capital or purchasing goods and services. In other words, under this theory the printing money without that money being used is a canceling of sorts of inflation.

While I believe from a strict construction stand-point these two theories may amply define the causes of inflation- the real question still comes down to people's perception of money's value. With record deficits and the printing presses hard at work, the dollar just hit a one year high today against all major currencies. Why? How?

First, in a globalized world the dollar is either strong or weak based on what it is compared against, another currency. The dollar no longer can be evaluated in a vacuum. Every day dollars are evaluated based not only on the demand of individuals and entities for dollars to use for purchases, dollar value is also based on institutional investment preferences to hold dollars instead of another currency or asset. This preference influence in the short run is more relevant than fundamental needs.

Ask yourself this, "If Europe just approved a one trillion dollar Euro infusion on May 20, 2010, why did the Euro increase in value to a value of $1.26/Euro from $1.23/Euro one day prior to the infusion commitment?" If there is more Euros to be circulated wouldn't that increase in supply devalue its value? Yes, maybe but no, is the answer currency investors have given. Some maintain increased money supply in Euros is less inflationary than allowing the credit woes of Greece, Portugal and Italy spread across the region because that would make goods and services far more expensive due to borrowing costs to procure them in a currency under fire.

But wouldn't a debt crisis be deflationary? Well, it should, but the investors preference to hold Euros now that an orderly support has been set in place has counteracted that premise. Sound confusing, it sure ought to.

The simple truth is that no one, including myself, can tell you why inflation and moreover hyperinflation occurs. It's a psychological and sociological phenomena. If inflation can be correctly determined to be a vote of confidence in prices and the economy, hyperinflation is the loss of confidence in paper as a proper valuation of goods and services. In sum, the two are very different causes of a devaluation of currency. One is based in beliefs based in strength of the underlying assets, while the other is based in beliefs of the weakness of purchasing power of money. The most important takeaway is both are created by beliefs and neither are based directly in the concepts of supply and demand.

Regardless of our current deficits, money supply, or central bank subsidies, if people are unable to see wage appreciation (mostly because of excess supply in labor and global pressure on wages) the US will not experience inflation. A simple look at the producer price index from April demonstrates this reality (0% price inflation). The reader can come to this same conclusion through common sense. If you were a business owner would you favor raising your prices to consumers today? If the answer is "No, the economy won't sustain increased prices," the disconnect becomes clear. Inflation is a vote of confidence that assets will appreciate versus the currency. Hyperinflation is the ability of a public to rapidly increase prices on fears the currency isn't worth the assets. The US cannot raise prices on either account because the average citizen doesn't have the currency in the first place.

What About the Silent Majority in Housing?

Could it be that current housing prices are not real? Are houses undervalued? Are current prices as artificially low as they were artificially high in 2006?

Something to consider for many market watchers and analysts is that the majority of homeowners are current on their mortgages and fifty percent of home owners have title to their house. These individuals are not participating in the current market. These home owners wouldn't even consider selling at 140% of current appraised values. Most crucially these are the true sellers.

Right now housing prices are determined by transactions between willing buyers and unwilling sellers (i.e. banks, unemployed workers, and forced sellers). This is not a traditional market. It is certainly not an efficient equilibrium- it is a slaughter.

Even with the enormous amounts of inventory coming on line from short-sales and foreclosures, this inventory is a mere fraction of the total houses in existence. So there are seven million foreclosures, so what? That is nothing for a growing population of 330 million strong. The United States needs substantial amounts of additional housing year after year and with home builder's sidelined with prices significantly below their costs to construct, the Country is pure and simply running in a supply deficit in the long run.

For buyers the current situation is an absolute blessing. First time home buyers, investors and people with impeccable timing have gotten a windfall. They are buying an asset for less than its input cost (the materials, land cost and permits to build the house are higher than the sale price). This cannot sustain itself in the long run. Even better for the US economy these home purchases are easily fitting into the purchaser's budget. Seriously, we are talking mortgage payments at 10-15% of the buyer's monthly income. What does that equate to? Disposable income.

Take my friend Dr. C for example. Dr C. paid $550,000 for his home and added $250,000 in cash upgrades and modifications. He also 1031 exchanged an investment into another home at $440,000 as an investment property. Both homes are currently appraised at 50% or less than his basis in these homes. However, if a buyer offered to purchase either of these properties, the offer would not be accepted for anything less than his investment. So what is his home worth? Well, we cannot answer the question because their is no willing buyer or seller to fill the transaction.

The point here is that just as buyers were artificially created by creative financing in 2002-2006 to meet seller's demands, now artificial sellers are catering to buyer's demands. I cannot tell you what the "right" price is, but I can assure you this isn't it. In our Country's more intelligent and logical past, housing prices could be derived either by median income of a given area or as a factor of market rents in an area. In an effort to be concise the reader should see Benjamin Graham and David Dodd's Securities Analysis 1934 to learn these principles. Simply stated, stock prices should be reflective of the earnings of that company in a direct analysis or current bond returns in an alternative analysis- so the same is true of housing prices by the above methods.

If all this is too complicated, simply stated this too shall pass.

What is the "Market?"

While I don't want to be purely hypothetical, I believe the use of the term "market" as a synonym for commerce creates great misunderstanding in our society. The market is not simply business or the exchange of goods. The market is society, government, and commerce wound into a single concept.

According to Wikepedia the Market (disambiguation) "is an ARRANGEMENT that allows buyers and sellers to exchange things." That's right, an arrangement! Markets are the function of a human agreement to allow the exchange, not the act of exchanging and certainly not the participants themselves (businesses, consumers, traders, brokers, etc.).

Once a population decides that it wishes to develop a market as an economic model, mind that it is a decision not as some would lead us to believe an act of nature, the choice becomes whether the market should be a market economy, a.k.a. free market economy, a mixed market economy or market socialism (like China). While there exists no true free market economy in practice, it is a useful concept to illustrate the ecomomic spectrum that ranges from free market economy to planned economy. So what are the differences? The choice by a population to allow prices to be set by market participants and the choice on how labor is to be allocated.

In its truest sense a free market would allow market participants to set prices and divide labor according to their transactions. A choice to create this type of economy can expeirence periods that are quite harsh and can result in social unrest and inefficiency in prices for extended periods of time. On the complete other side, a planned economy would set prices and labor by decision. Planned economies tend to be very harsh as output levels rarely meet necessary needs of thepopulation and labor tends to become lethargic and atrophied. As a result, the entire world attempts to address the inefficiencies of the free market model, i.e. long periods of price and societal stagnation, without the stagnation and generations without innovation that result from a planned economy.

That said, there are a number of caveats to the free market model. There is Laissez-Faire where there are no laws including property rights enforced by the government. This is the free market model on steroids as most economists believe even a free market consists of government overview with regard to settling, in whole or in part, property, contracts and general access to the market. This form of free market literally places the onus on the buyer and seller to deal with one another without appeal or recourse. This is a no holds barred, steal it if you can, John Locke State of Nature system.

Also, there is capitalism which takes a twist on the free market model and develops a coordinated system of protections that allows capital to flow to other users. Here, its no longer buyers and sellers alone, but capital investors and leverage as societally enforced instruments.

The point of all this is that before there is a market, there is a choice to have a market. The market cannot decide anything. Contrary to popular belief the market is not a decider of prices, capital flows, efficiencies, good business, stock prices, commodities, or anything else for that matter. The market participants acting within the construct of an agreed upon arrangement can decide all of those things. Markets are societal creations to create increased standards of living for its populations. In the end, the market is greater than the prices set by its participants or the efficiencies reached by its functioning.

The market is a population's arrangement to trade goods and services. As such, once cannot separate government from the market or the market from sociological trends. The market is politics, it is family values, it is government regulation, it is capitalism, it is socialism, it is laissez faire, it is communism, it is business, it is consumers, it is buyers, it is sellers, it is competition, it is oligolpoly, it is monopoly, it is those who participate and those who choose to protest it- it is what we as society decide it to be. Why? The market is a choice of the population. Whether or not it exists and to what form it takes has to be chosen. As I have blogged, the market is not an end, but a means to an end- prosperity.

China, We May Just Pay You Back!

Empty threats by the Chinese this week in response to United States' demands for the Chinese to cease and desist from their practice of currency manipulation are just that- empty. The Chinese love to threaten that they may stop purchasing United States Treasuries should US policy be less accomodative to their desires. The problem is that Chinese purchases of US debt are not acts of compassion or alturism towards the US, such purchases are the sustaining force of their entire economy.

Without putting US dollars back into the hands of the United States citizens, the Chinese lose their biggest market for selling their goods. Currency manipulation and unfair trade has forced American workers out of work and into debt. Due wage disparities between US workers and their Chinese counterparts, the purchasing power of the United States has been severely reduced. Without taking into consideration unsafe working conditions, no environmental obstacles, a slave-like working class, the Chinese most effectively manage labor costs by not allowing their currency to float, or trade on the free market.

When US citizens purchase a Chinese good, the dollars used are confiscated by the Chinese government and internally exchanged for Yuan. Yuan are not allowed to be taken out of the Country and strictly forbidden from being sold except to the Chinese government. As a result, it is a worthless currency that only has value to the people of China. With this control China can set the Dollar to Yuan exchange at whatever level is most beneficial to China. In other words, the Chinese government gets to stock pile green backs and pay out in paper.

To compound their control, the Chinese government does not allow foreign corporations access to their Country's markets without giving their government an equity stake. This equity stake is mostly to ensure the regulation of Yuan to ensure their competitive advantage in labor costs. It is because of this manipulation that the Chinese love to state that their exchange rates are an "internal" matter.

The rub is that China must get the dollars back into their consumers hands, the United States citizens, because their own citizens are paid in worthless Yuan (very little Yuan at that). This equates to a Chinese popultion sustain adequate demand for goods to sustain their economy. Many sources have said that if the Chinese were to allow their currency to float, the market would prove it is undervalued by up to sixty percent (Peterson Institute of International Economics states the Yuan is undervalued by 30% to currencies in general and 40% against dollar).

Allowing the Yuan to float would solve the "real" domestic demand issue; however, the Chinese luxury of being a net exporter and hoarder of natural resources would be contested as their competitive advantage in undervalued labor would be significantly reduced. Other countries would be able to compete on the global markets and jobs would return to the United States, among other countries. The necessity for the US to float debt that the Chinese must buy would thus be reduced.

Let's get back to the empty part. If the United States really wanted to call China's bluff all that has to be done is to pay them back. That's right, have the Federal Reserve buy three trillion dollars in Treasuries from the US and then cut the Chinese a check. Maybe even a big check, like the type of check one sees at a charity event. One lump sum, paid in full, check! Now I know that the dollar would be devalued into oblivion on the international markets and mayhem would ensue for the exchanges and bankers, but the sun would rise tomorrow. I would bet you 50 percent of Americans wouldn't even notice, not "real" Americans anyway. After all, many Americans think the government just prints money in the first place, so why all this nonsense accounting. Com'mon China, Wake Up! If you don't want our debt but you still want to hoard dollars by devaluing labor, the end result is we can always just pay you back and start over. We have real infrastructure, real natural resources and a capable population- I like our odds.

After all, sometimes the bank owns you, and sometimes you own the bank!

Effective Financial Regulation Means Addressing Agency Issues

The hot button on Wall Street and Washington is the proper regulation of financial markets so that the United States citizens never again have to endure a period as we currently are living within. Many ideas have been circulated regarding which institutions shall govern, capital requirements and transparency. Those concepts aside, no regulation will suffice if the agency issues of securitization and derivatives are not addressed.

Agency Issue of Securitization

Since loan originators in modern days no longer hold, service or maintain their loans, the true test of a loan's worth is how much they can sell it for on the secondary market. Such loans, once regarded by the industry as one of the safest of debt obligations for an investor to purchase (see Hildy Richelson & Stan Richelson, Bonds: The Unbeaten Path to Secure Investment Growth), now have become one of the most dangerous of debt purchases. Why?, you ask.... It's the agency issue.

Agency issues rarely immediately gain steam. There was a time when the lender was invested in the borrowers successful repayment of the debt they had extended because they had to collect it to recoup their investment. The care and attention put into these loan originations made such debt issuances very stable and quite reliable investments. The combination of a proven track record and the general appreciation of real estate values created new demand for debt as an investment. With demand growth additional sellers, or suppliers, entered the market sending origination volumes skyrocketing.

Like most agency issues, the problem begins to occur once capitalism has inflicted a significant amount of competition on an industry. At this point, survival instincts can get the best of some market participants. In this specific case, the focus becomes originate and sell the loan at any cost regardless of ability of the borrower to pay- so long as a rating agency will stamp it and someone will buy it.

The practice of only dealing with the credit worthy is no longer of paramount consideration because the market place is overrun with competition, making risk less of a concern, and profit the bottom line. Since an originator can sell loans on the secondary market "without recourse," or no downside for nonperformance of the borrower, loan originators do not weigh the dangers of extending credit so long as their investment can be sold for a profit. At this point, the loan is often sliced, diced and divided then passed like a hot potato with the final holder being the big loser (often pension funds and institutional investors who relied on the rating issued by the bond company to judge the debt).

The reality is that the second, third, fourth holder of a debt obligation has no chance to truly evaluate the issuance. The originator is the most capable entity to judge whether or not a borrower will pay. Here is an example:

Joe wants to buy a house and he has a credit score of 700 and a job in construction. When the originator calls to verify employment they are told that Joe is an independent contractor and they use him for about 60 hours a week because of the demand. Joe makes $7,000/month. Now the originator understands that Joe is working way above his capacity for the long term and that the $7,000/ month is probably not sustainable. Nonetheless, Joe looks great on paper, even with two years tax returns. He budgets even though he has a trailer payment, two quad payments and two leased cars.

If the originator knew they had to collect this debt, the loan wouldn't be made. However, the originator can send the loan packet to the rating agency and sell it before the ink dries. Here's the best news for the originator, when Joe works a year at 30 hours a week and makes half the income, they aren't responsible for a dime of the loaned principle. The hazard thus lands with whomever holds the loan when the music stops.

Serious reform, means serious regulation on how much responsibility a loan originator must hold on its own paper. Also, much like the Glass-Steagall Act, the Country must not deviate from this simply because times improve.

Agency Issue of Derivatives

This one is simple- it is bad policy for a disinterested party to buy insurance on someone else's demise. How would you as the reader feel if I was buying short term life insurance on your life? While I understand why someone would want to buy these products, and moreover why people love to sell these "instruments of mass destruction" (Warren Buffet on CNBC, 2007), profit, I don't understand why as a society we believe that this behavior is worth the risks? I, personally, would rather see these firms cheer against little league players or bet the "don't come line" in Vegas than wager and actively participate in the destruction of our system for profit.

Great economies and great societies thrive when a profit leads to greater money flows and greater profits leading to gentle and sustainable inflation of prices. Zero sum game markets such as derivatives pit market participants against one another in an unnatural way- the equivalent of every dollar made is lost somewhere else. In other words, their is not the exchange of goods for currency based on differences in subjective valuations of the parties ( A is a willing seller of a widget for x, and B is a willing buyer of a widget at x), but rather a dollar made is a dollar lost. Derivatives are even different from traditional insurance where the buyer gives currency in exchange for a risk to him or herself, hence the traditional trade off where the seller needs additional capital and the buyer needs less risk.

The liquidity and hedging benefits are far less important to the market as a whole than the costs of having to pay off these bets when the market is least able to bear the cost to do so.

Without addressing the agency issues of these two products the market is not safe from another collapse. Effective reform must make market participants accountable for the sustenance of the markets in general; as well as, their own actions.