Monday, December 22, 2008

Is China an Emerging Superpower? What is a "Superpower"?

People have been predicting China’s emergence as a superpower since the days of Napoleon.  He appreciated China’s potential as a world power and cautioned against waking the sleeping dragon. China’s subordination into the Western international system in the 1839-1842 Opium War and its decline as the “sick man” of East Asia for the rest of the nineteenth and for the first half of the twentieth centuries dulled, but never extinguished, the expectation that, sooner or later, China would again dominate the world.

The term “superpower” is often used loosely in popular discourse to describe anything that achieves unmatched dominance from the status achieved in international affairs by the United States since World War II.  The discussion here will be better served by a somewhat more precise definition: a “superpower” is a country that has the capacity to project dominating power and influence anywhere in the world, and sometimes, in more than one region of the globe at a time, and so may plausibly attain the status of global hegemon.  The basic components of superpower stature may be measured along four axes of power: military, economic, political, and cultural (or what political scientist Joseph Nye has termed “soft”).

China is not now a superpower, nor is it likely to emerge as one soon. It is establishing itself as a great power, on par with Great Britain, Russia, Japan, and, perhaps, India. China is today a serious player in the regional politics of Asia, but also is just one of several. At a broader level, in global affairs, its stature and power are growing, but in most respects it remains a regional power, complementing the cast of other great powers under the overarching dominance, however momentary, of the United States. [1]

Will dumping the dollar make a difference?  Not likely!

Thursday, December 18, 2008

Bailouts / Ponzi Scheme

As the U.S. government is looking for something or someone to blame for the housing and banking debacle,  finally it seems that they have chosen Bernard Madoff as one of the many scape goat's in a supposed Ponzi like scheme.  

Today's schemes are often considerably more sophisticated than Ponzi's, although the underlying formula is quite similar and the principle behind every Ponzi scheme is to exploit investor naïveté. 

Back in May, four months before it collapsed, American International Group Inc. increased its dividend at the same time it unveiled plans to raise $12.5 billion in capital. Later, when its cash ran out, AIG got a government bailout, the size of which has expanded to about $150 billion.
It might not have been such a bad thing for those shareholders that invested in the last round of $12.5 billion in capital.  It has been shown that entering a Ponzi scheme can be rational even at the last round of the scheme if a government will likely bail out those participating in the Ponzi scheme.  

Fannie Mae, Freddie Mac and Citigroup are just a few firms that have required taxpayer bailouts to the tune of hundreds of billions of dollars.  They were not running a traditional Ponzi scheme but their scheme collapsed under its own weight, as investment slows and the promoters start having problems paying out the promised returns. 

It seems that many companies have a business model that resembled  a Ponzi scheme.  Ponzi hired a publicity agent, James McMasters.  The so called legit companies did too. However, Ponzi's publicity agent quickly became suspicious of Ponzi's endless talk of postal reply coupons, as well as the ongoing investigation against him. He went to the Post, calling Ponzi a "financial idiot." The paper offered him five thousand dollars for his story, and ran a headline on August 2 declaring Ponzi hopelessly insolvent.  We have all heard the world insolvent recently in the news.

When a Ponzi like scheme is exposed, legal authorities begin examining accounting records of the so-called enterprise and they find that many of the "assets" that should exist do not. 

In Michigan a company and A.J. Obie, two firms with the same managers, Sixteen hundred investors lost approximately $50 million.  In what was described as the largest reported 'Ponzi' scheme in the history of the state.  The scheme led to the passage in 1987 of the MBLSA (Mortgage Brokers, Lenders, and Servicers Act)."

Another Ponzi like scheme, Lou Pearlman's scam involved bilking investors out of their savings with a fraudulent savings and loans program claiming it to be FDIC insured though it was not. 

Fast forward today Ponzi’s schemes are very much alive.  Wall Street and its bankers, mortgage lenders, and soon to be automakers were all caught running Ponzi like schemes.  

Friday, December 12, 2008

GM out of options

The UAW's refusal to agree to wage concessions by a specific date in 2009 killed the senate version of H.R. 7321. [1] According to GM's annual report, it paid the UAW workers $73.26 per hour in wages and benefits. [2]  The Senate Majority leader Harry Reid of Nevada spoke shortly after Republicans left a closed-door meeting.  He said that Republicans balked at giving the automakers federal aid unless their powerful union agreed to slash wages next year to bring them into line with those of Japanese carmakers. [3]   

GM has sought to reduce production costs to about $48 per hour, about the average hourly cost incurred by Toyota, Honda and Nissan Motor Co., company officials have said.[4] If wages were reduced the vehicle assembly cost would have saved GM about $1,000 per vehicle.  General Motors had offered buyouts to all of its 74,000 U.S. hourly employees. [5]  Those workers could have elected to take a lump-sum payment of $45,000 or $62,500, depending on their job description, and retire with full benefits. [6]

Republican Sen. George V. Voinovich of Ohio, a strong bailout supporter, said the UAW was willing to make the cuts - but not until 2011.  GM built 9,286,000 vehicles last year [7] , if it could have brought wages down to that which the Japanese auto makers pay their hourly workers it would have saved GM $9,286,000,000 last year.  In stead GM's share holders lost $68,450,000 last year.

For now my question on my post, “Who killed GM? Will it rise again?”, looks like it was true when I stated that if anything has killed GM it is its managements lack of vision and the UAW's not looking out for the best interest of its members. 

Thursday, December 11, 2008

The BIG 3’s auto bail out is a joke.

As of now.

The house bill H.R. 7321 loans $14 billion at the rate of 5% for each of the first five years, after that the rate will be 9%.  The President shall designate one or more from the Executive branch.  The  designate shall have private expertise in such areas as economic stabilization, financial aid to commerce and industry and financial restructuring, energy efficiency, and environmental protection. Where in the h#$% will the White House find this person? 

Those that take part in the bridge financing will give warrants to the government, these warrants shall give the President’s designee the right to receive nonvoting common stock or preferred stock.  Warrants that are common stock will have value that is equaled to 20 percent of the aggregate amount of all loans provided.  The common stock warrant price of each company shall be the 15 day moving average of the company that is requesting assistance as of December 2, 2008.  Preferred stock Warrants may also be issued.
The Secretary of Energy will make $7.1 billion available to the President’s designee.   The Secretary of Energy will also reserve $500 billion.

Wednesday, December 10, 2008

Congressional Oversight - Troubled Asset Relief Program TARP - Emergency Economic Stabilization Act of 2008

The White House, spokesman Tony Fratto said that, “The Treasury Secretary Henry Paulson said he's working to continue to design and develop programs, and when it's the right time to use them Treasury will announce it. And if it then makes sense to go to Congress, he'll recommend we request to drawdown the second $350 billion,”  Last week the Treasury secretary announced he was abandoning his plan to free up the nation’s credit system by buying up toxic assets from troubled financial institutions.  Paulson wants to take a more direct action on the consumer credit front.  So far, the Treasury Department has pledged $335 billion mostly for banks in return for partial ownership, a measure designed to encourage the institutions to boost lending and stabilize credit markets. 

The Oklahoma U.S. Senator Jim Inhofe told the Tulsa World that, “It is just outrageous that the American people don’t know that Congress doesn’t know how much money the Treasury Secretary Henry Paulson has given away to anyone,”  Later he learned of the initial $250 billion being allocated, the Treasury has sent out more than $161 billion in checks to 52 banks in exchange for preferred shares and a high dividend.
When the bill was enacted a Congressional Oversight Panel was created to review the state of the markets, current regulatory system, and the Treasury Department's management of the Troubled Asset Relief Program. The panel is required to report their findings to Congress every 30 days, counting from the first asset purchase made under the program. The panel must also submit a special report to Congress about regulatory reform on or before January 20, 2009.
The panel consists of five outside experts appointed as follows, one member chosen by the Speaker of the House, Richard H. Neiman, one member chosen by the minority leader of the House, Judd Gregg quit the panel citing his congressional duties, one member chosen by the majority leader of the Senate, Elizabeth Warren, one member chosen by the minority leader of the Senate, Jeb Hensarling, and one member chosen by the Speaker of the House  and the majority leader of the Senate, Damon Silvers, following consultation with the minority leaders of Congress. 
The Comptroller General (director of the Government Accountability Office) is required to monitor the performance of the program, and report findings to Congress every 60 days. The Comptroller General is also required to audit the program annually. The bill grants the Comptroller General access to all information, records, reports, data, etc. belonging to or in use by the program.

When Senator Inhofe said, “It is just outrageous that the American people don’t know that Congress doesn’t know how much money the Treasury Secretary Henry Paulson has given away to anyone.”  Is he not reading the reports from the Comptroller General the director of the Government Accountability Office or the reports of the Congressional Oversight Panel that was created as part of the legislation?  Did they get lost in the mail?  For God’s sake he is a member of the Senate if he is not getting the reports he should do something about it.

Tuesday, December 9, 2008

The dangers of deflation can be scary not to mention Inflation

The Federal Reserve Chairman Ben Bernanke seems to have his hands full lately.
When asked about  General Motors Corp., Ford Motor Co. and Chrysler LLC Bernanke said that Congress should consider a “range of possible policy actions” besides direct aid, including a government-assisted “orderly bankruptcy reorganization” or company mergers. 

General Motors Corp., Ford Motor Co. and Chrysler LLC have asked U.S. lawmakers for as much as $34 billion in aid. Congress is discussing a $15 billion rescue proposal where the Treasury would get warrants for stock equivalent to 20 percent of any government loans.  Stock warrants are issued so that the warrant holder has the option to buy stock at a particular price.

 “Even if the companies have sufficient collateral, lending to an auto manufacturing company would represent a marked departure from that policy, and would take us into distinctly new realms of policymaking,” Bernanke said.  He also said that, “the Federal Reserve would be extremely reluctant to extend credit where Congress has actively considered providing assistance but, after due consideration, has decided not to act.” [1]

As default rates get high enough, banks will simply be unwilling to lend which will severely limit money and credit creation.  Whitney, an analyst and managing director at Oppenheimer & Co. who predicted the current financial-services industry meltdown, now says credit-card issuers will eliminate more than $2 trillion in available credit over the next 18 months. [2]

Pumping up the money supply should melt a credit freeze. The Fed chairman faces huge obstacles in trying to restart the credit engine and get maxed out consumers spending again.  Given the scale of the Fed's interventions, it should be weakening the value of the dollar and setting us on a course toward inflation.  Inflation happens when prices rise. Deflation happens when they fall. In this December's dark economy, falling prices for gasoline, cars, and clothes and just about anything would seem like a silver lining.

Federal Reserve Chairman Ben Bernanke and his colleagues are clearly more concerned with the risk of a deflationary spiral than with inflation right now.  But deflation can be scary. Buyers assume everything will be cheaper in the future, so they wait for bargains. If no one is buying, factories curb production. Workers lose their jobs and shops close.

“The federal funds rate is trading persistently below target,” said Poole, who is a contributor to Bloomberg News. “That can’t be an accident. I personally do not believe the Fed should tie asset purchases to any specific fiscal programs, whatever their merits,” Jeffrey M. Lacker President of the Federal Reserve Bank of Richmond said after a speech in Charlotte, North Carolina, Dec. 3. At the same time, he said he was open to purchasing U.S. government debt for the purpose of fighting the danger of deflation.  

Friday, December 5, 2008

How does the Federal Reserve spend so much?

The Federal Reserve Banks earned $6.9 billion in 1977. How are the Federal Reserve Banks able to “earn” this amount of income? One popular misconception is that the Federal Reserve Banks earn income by investing member bank reserves. In fact, earnings of the Federal Reserve Banks are not the result of the volume of member bank reserves, but that bank reserves and earnings of the Federal Reserve Banks are both by-products of the way a central bank operates. [1]

Assume that there were no legal restrictions that required banks to hold deposits at Federal Reserve Banks.  Would the ability of the Federal Reserve Banks to generate their own earnings be affected? The answer is no.  To implement its monetary policy objectives, the Federal Reserve would still buy and sell Government securities.  Its holdings of Government securities would still represent the primary source of the “base” under bank deposits.  The Federal Reserve would pay for the securities just as it does now, with a check written on itself.  Commercial banks would then be “paid.” [2]

In 2005 the Federal Reserve System had holdings of $753,748,000,000, in 2006 it had $787,872,000,000 and in 2008 it had holdings of $816,115,000,000.[3]

As of September 2008 the holdings of the Federal Reserve System was $476,600,000,000. [4

Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the change in excess reserves of $90 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000), e.g.$100/0.10=$1,000. 

Federal Reserve lending crisis lending:
 (TAF) Term Auction Credit (allocated) $900,000
Discount Window Lending $139,256
Banks (other loans primary credit) $92,645
Investment Banks $46,611
(other loans Primary dealer and other broker-dealer credit)
Loans to buy ABCP (other loans Asset-backed $661,923
commercial paper money market mutual fund liquidity facility)
AIG (allocated minus Treasury 40B) $112,500
Bear Stearns (initial loan to JPMorgan) $295,000
(TSLF) Term Securities Lending Facility $225,000
Swap Lines (other federal reserve assets) $601,963
debt issued by government-sponsored mortgage $100,000
financers Fannie Mae (FNM, Fortune 500) and $100,000
Freddie Mac (FRE, Fortune 500).
mortgage-backed securities purchase $500,000
(these amount are in millions of dollars)

Total amount guaranteed by the Federal Reserve is $6,549,398,000,000.

When Reserve requirements are considered the potential from the banking system is $4,766,000,000,000 yet the Federal Reserve has committed spending of about $6.5 trillion.  

Hmmm, what system are they working with now to justify their spending spree?  Earlier in the week Bernanke said that the Fed may buy treasuries to aid economy. [7]  I guess they will just write a check written on themselves to buy them!

Wednesday, December 3, 2008

The BEG 3 don't forget the foolish UAW

The big day is coming up for the auto industry.  The bailout will affect the Big 3 and their 1,000 parts manufacturers.

General Motors Corp on Tuesday submitted the accelerated restructuring plan demanded by Congress, saying it needed up to $18 billion in loans and credit lines from the government.  Their position is that GM needs to receive $4 billion of that U.S. government financing this month to survive.  GM said that they would offer the government equity warrants in exchange for the financing.  [1]

GM said that it hopes to increased production of fuel-efficient vehicles and energy-saving technologies.  GM also plans rationalization of brands, models and retail outlets.  It also plans to reduce wage and benefit costs, including further reductions in executive compensation.  It plans for further and significant capital restructuring.  Finally it wants to further consolidation in manufacturing operations.[2]

GM is weighed down by heavy "legacy costs" in the pensions and health care of its retirees, while other companies have no pension plan, and its health care costs per vehicle are barely a tenth of GM's.  GM's $1.1 billion loss in the first quarter doesn't begin to tell the whole story. The carmaker is saddled with a $1,600-per-vehicle handicap in so-called legacy costs, mostly retiree health and pension benefits.  [3]

All UAW leaders and the Big 3 automakers need to show up this week together.  The leaders in Congress need to know what the UAW is willing to do to help also.  According to GM's annual report, it paid $73.26 per hour in wages and benefits to its hourly workers last year.[4]  GM will seek to reduce costs to about $48 per hour, which is about the average hourly cost incurred by Toyota, Honda and Nissan Motor Co., company officials have said.  [5]

General Motors offered buyouts to all of its 74,000 US hourly employees as the automotive giant continues to downsize operations in response to declining US market share and massive financial losses. [6]  The head of the United Automobile Workers Union said it expected 15,000 to 20,000 workers to leave General Motors during a new round of buyouts, and that G.M. would replace nearly all of them with lower-paid employees.  Including benefits and retiree health care costs, each worker who leaves under the buyout program and is replaced by someone on the lower pay scale would save G.M. about $48 an hour, or nearly $100,000 a year.

Germany has shown their faith in GM and its management since it is ready to guarantee funds for ailing carmaker Opel but any money it provides to the General Motors' unit must stay in Germany, Chancellor Angela Merkel said.    [8]

So how will the bridge loan at GM be used? Cash will support ongoing operations as we continue to restructure the business.  It plans $8.0 billion in payments to parts suppliers and another $1.2 billion for other vendors.  It also plans another $900 million in wages and another $500 million in healthcare and legacy costs.  Last but not least GM plans another $500 million in capital expenditures.[9]

Local United Auto Workers leaders from across the U.S. will hold an emergency meeting in Detroit on Wednesday to discuss concessions the union could make to help auto companies get government loans.[10]

Chrysler LLC, its monthly sales were off more than GM's, says it will need "immediate liquidity support" of $7 billion to reassure customers, encourage dealers and make it into next year.  Cerberus / Chrysler LLC says that it will work with government to provide collateral and secure taxpayer funding.  Cerberus / Chrysler LLC expect to be in a position to begin repaying government loans in 2012.   So how will the bridge loan at Chrysler be used?  Cash will support ongoing operations as they continue to restructure the business, including in the first quarter alone.  It plans $8.0 billion in payments to parts suppliers and another $1.2 billion for other vendors.  It also plans another $900 million in wages and another $500 million in healthcare and legacy costs.  Last but not least Chrysler plans another $500 million in capital expenditures.  [11

Ford Motor Co., says it's OK for now. Although it is seeking up to $9 billion in bridge financing, but says it hopes to complete turnaround without accessing the loan should Congress agree to make the funds available.  But it wants the ability to access up to $9 billion in government credit.  They also said that if GM fails it could take the entire domestic auto industry down with it. [12

All UAW leaders and the Big 3 automakers need to show up with this week too.  The leaders in Congress need to know what the UAW is willing to do to help also.  According to GM's annual report, it paid $73.26 per hour in wages and benefits to its hourly workers last year.[13

 Do you think that U.S. automakers should be allowed to fail?  I do.

I think they should file for Chapter 11 bankruptcy protection under the U.S. courts and reorganize. The reason is that the decline in competitiveness of General Motors, Ford and Chrysler is a long-term problem, going back to the 1970s and 1980s, beginning with lagging physical productivity in assembling automobiles compared to the leading Japanese companies, and then in quality and also in engineering productivity for product development.  "The Machine that Changed the World", which documents the state of the world auto industry circa 1990 and the mounting problems of the U.S. automakers. But things have gone from bad to worse.  

The only question is shall they stay or shall they go now?

Monday, December 1, 2008

Can the mess be cleaned up in time?

According to Keynes, the root cause of an economic downturns is an insufficient aggregate demand. When the total demand for goods and services declines, businesses throughout the economy see their sales fall off. Lower sales induce firms to cut back production and to lay off workers. Rising unemployment and declining profits further depress demand, leading to a feedback loop with a very unhappy ending.[1]

The economy’s output of goods and services is traditionally divided into four components: consumption, investment, net exports and government purchases. Any expansion in demand has to come from one of these four. But in each case, strong forces are working to keep spending down.[2]

Drivers in the U.S. traveled 15 billion miles less in August, or 5.6%, which is about 770 million barrels of oil in reduced consumption. [3][4]  The miles driven per month have been on a decline for many months.  

Since March, the dollar has appreciated 19 percent, a move that will put a crimp in the export boom. [5

The U.S. Treasury announced last week that is had invested $290 billion of the $350 billion that remained from the initial Tarp offering.[6

The Fed’s decision last week to start buying mortgage debt shows its willingness to act creatively.  Between the Federal Reserve’s and the U.S. Treasury department’s new investments have been promised up to $7.6 trillion.  Of the $7.6 trillion promised $3.7 trillion has been committed for spending. [7]

In normal times, a fall in consumption could be met by an increase in investment, which includes spending by businesses on plant and equipment and by households on new homes. But several factors are keeping investment spending at bay.  One problem seems to be the dropping real estate values, which typically sees people waiting for the floor to be reached.[8

In 2003, William White and a colleague, Claudio Borio, attended the annual conference in Jackson Hole, where they argued that policymakers needed to take greater account of asset prices and credit expansion in setting interest rates, and that if a bubble appeared to be developing they ought to “lean against the wind”—raise rates.  “Ben Bernanke really believes that it is impossible to lean against the wind on the way up and that it is possible to clean up the mess afterwards,” White said recently that, “Both of these propositions are unproven.”[9

Conditions are different under a credit expansion which first affects the loan market. In this case the inflationary effects are multiplied by the consequences of capital malinvestment and overconsumption.  Ludwig von Mises, warning, “There is no means of avoiding the final collapse of a boom brought about by credit expansion.”[10]

From the tools used today it is likely to be a long road before things get back on track.  For everyone’s sake we hope that Chairman Bernanke was right and that it is possible to clean up the mess afterwards.