Wall Street + Washington

The intersection of global politics and economics

Category: General

A Note on the U.S. Economy

The biggest debate in financial markets at the moment is over the need for further government stimulus in the global economy, especially in the United States.  Here are the major arguments:

  • More Government Stimulus: Championing the case for more government spending to stimulate the global economy is Paul Krugman, winner of the 2008 Nobel Prize in Economics.  In a recent article titled The Third Depression, Krugman argues that “while long-term fiscal responsibility is important, slashing [government] spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating.”
  • Less Government Spending: Although not a direct response to Krugman, one of the more interesting arguments that I found against government stimulus was from the editorial team at the Wall Street Journal: “For going on three years, the developed world’s economic policy has been dominated by the revival of the old idea that vast amounts of public spending could prevent deflation, cure a recession, and ignite a new era of government-led prosperity.  It hasn’t turned out that way.”
  • Video (5 mins): Nouriel Roubini debates Nassim Nicholas Taleb on the role of government in an economy

My take: A quick examination of the components of the U.S. economy/GDP:

Personal consumption

  • Most important component of U.S. GDP (over 60% of all economic activity)
  • High unemployment rate: According to data from the Bureau of Labor Statistics, the average unemployment rate between 1985 and 2005 was 5.7%.  Today, it is about 9.5%
  • Deleveraging (debt reduction) by U.S. households: Earlier today, the Federal Reserve announced that consumer credit declined by $9.1 billion in May and by $14.1 billion in April.  Less borrowing implies weaker consumer spending
  • Based on the above, the current status of personal consumption: WEAK

Private investment

  • According to the Wall Street Journal, “nonfinancial companies [have] socked away $1.84 trillion in cash and other liquid assets as of the end of March, up 26% from a year earlier and the largest-ever increase in records going back to 1952.  Cash made up about 7% of all company assets, including factories and financial investments, the highest level since 1963.”
  • In addition to the hoarding of cash by U.S. companies, the current capacity utilization rate remains below 75%.  Thus, given that U.S. companies have room to increase production, capital expenditures – a major part of private investments-  might remain weak.  As a result, companies are more likely to use their cash holdings to engage in financial transactions, such as stock buybacks and strategic acquisitions, rather than on capex
  • Greg Mankiw, professor of economics at Harvard, tries to explain why companies might be holding on to so much cash: “[B]usinesses may be reluctant to invest in an economy that they expect to be distorted by historically unprecedented levels of taxation in the future.  The more the government borrows, the higher taxes will need to go, the more distorted the future economy will be, and the less attractive is investment today.”
  • Based on the above, the current status of private investment: WEAK

Net exports

  • Not much is happening here to stimulate the U.S. economy
  • U.S. exports declined from $149.8 billion in March to $148.8 billion in April, the most recent period for which data is available
  • A recent quote (06/29/2010) from New York University professor Nouriel Roubini: “A double-dip recession looks likely in the euro zone, it looks like Japan right now is falling off the cliff … and now there is evidence of a slowdown in economic growth also in China.”  Given that these are major trading partners of the U.S., net exports probably won’t spur growth in the U.S. economy anytime soon
  • Based on the above, the current status of net exports: WEAK

Government expenditures

  • This is the final component of GDP that the current debate is revolving around because it is one that policy makers can directly influence in the short-term
  • Informative PowerPoint on U.S. government expenditures (Short & Long Term Budget Trends)
  • In Government to the Economic Rescue, Alan S. Blinder, professor of economics at Princeton, argues that government intervention (TARP, stimulus package, etc) has been good for the economy
  • 2009 Stimulus bill ($787 billion): Tax cuts represented one-third of the total package, fiscal relief to state governments and other social benefits also accounted for one-third, and public investment spending, the “centerpiece” of the bill, ended up being only a third of the final package with the actual outflows spread over multiple years.  Compared to the U.S.’ annual GDP of $14 trillion or the $50 trillion decline in global financial assets in 2008 alone, it is no surprise that some prominent economists  have argued that the stimulus package was too small.  That said, it appears the stimulus has been a great success as it has helped to create almost 2.7 million jobs in the U.S.

FINAL WORDS:

  • On monetary stimulus: In their 1963 book, “A Monetary History of the United States, 1867-1960,” Nobel Laureate Milton Friedman and Anna Schwartz argue that a contraction in U.S. money supply contributed to the Great Depression.  Given that the Federal Reserve acted promptly at the height of the recent financial crisis by embarking on expansionary monetary policies, i.e., slashing of interest rates and opening of the discount window to more financial institutions, government intervention here seems justified.  As a matter of fact, the Fed has been transferring record profits to the U.S. Treasury for the benefit of taxpayers.  That said, going forward, the Fed’s ability to successfully exit these expansionary policies remains an open question
  • On fiscal stimulus: Keynesianism lives on, and the debate continues

Abraham Tiamiyu

Education reform in the U.S.

The American education system is undergoing some pretty dramatic changes at the moment. If you are interested in learning about them, here is an article that recently appeared in the New York Times Magazine titled “The Teachers’ Unions’ Last Stand.” Although quite lengthy, I enjoyed it and I would certainly encourage you to check it out. Cheers!

Abraham Tiamiyu

Financial reform legislation

On May 20, 2010, the United States Senate passed the most important regulatory reform of the financial system since the Banking Act of 1933. Here are some of the critical components of the legislation:

  • The bill explicitly prohibits future government bailouts of financial institutions and it requires that the financial industry be responsible for the cost of unwinding failing banks
  • Resolution Authority: According to Bloomberg, “the Senate bill would give the Federal Deposit Insurance Corp., which already has authority to liquidate failed commercial banks, power to unwind large failing financial firms whose collapse would roil the economy.”
  • Creation of a Consumer Financial Protection Agency at the Federal Reserve to protect consumers from abusive credit-card and mortgage lenders
  • Establishment of a Financial Stability Oversight Council to monitor major financial institutions so that the failure of one large bank does not pose a systemic risk to the entire financial system
  • U.S. banks are now banned from engaging in proprietary trading as well as from owning hedge funds and private-equity funds (The “Volcker rule,” named after the former Fed Chairman Paul Volcker)
  • Greater transparency in the $615 trillion derivatives market as most trades will now have to be conducted on regulated exchanges, where trades are made public, instead of the current over-the-counter system (In addition, banks with access to the Federal Reserve discount window would be required to spin off  their swaps trading operations)
  • Creation of a credit ratings board that would randomly assign ratings agencies for securities to reduce conflict of interest (Currently, banks are responsible for choosing and paying the agencies that rate their securities)
  • Hedge funds with $100 million or more in assets would be required to register with the Securities and Exchange Commission and those deemed too risky will be supervised by the Federal Reserve

Note that the Senate bill needs to be reconciled in conference with the version passed by the House last December.

Sources: Bloomberg, CNN

Abraham Tiamiyu

Seeking a safe haven

Thanks to the resurgence in the United States’ economy (consecutive quarters of positive GDP growth + the surge in equity markets since March 2009 lows), coupled with the current fiscal crisis engulfing the European Union, global investors – governments and organizations – are increasingly flocking to U.S. financial assets as a safe haven. Here are some stats from a recent Bloomberg article:

  • Total foreign purchases of U.S. treasury notes and bonds were $108.5 billion in March 2010, up from $48.1 billion in February
  • China increased its holdings of U.S. debt (treasuries), by 2 percent, to $895.2 billion in March
  • Japan, the second-largest investor in U.S. debt, increased its holdings by $16.4 billion to $784.9 billion in March
  • The U.K. increased its holdings by $45.5 billion to $279 billion
  • The Organization of Petroleum Exporting Countries (OPEC)’s holdings rose to $229.5 billion, an increase of $10.7 billion
  • Russia increased the amount of dollars in its currency reserves to 44.5 percent, up from 41.5 percent
  • Finally, foreign demand for U.S. agency debt, those issued by organizations such as Fannie Mae and Freddie Mac, resulted in net purchases of $22 billion in March, the biggest gain since June 2008

All data are as of March 2010

Sources: U.S. TreasuryBloomberg, BusinessWeek

Abraham Tiamiyu

Back in the game

UBS AG, the global financial services firm, recently released its 2010 first quarter financial results :

  • Highest quarterly profit in almost three years: net earnings was 2.2 billion Swiss francs ($2 billion) in the first quarter of 2010, up from a loss of 1.98 billion francs a year earlier
  • Strong performance driven by UBS’s investment bank, especially its fixed income, currencies and commodities (FICC) business
  • Revenue of 752 million francs from credit trading, a business built from scratch over the past year
  • At the end of Q1 2010, core tier 1 capital ratio increased to 12.5%, up  from 11.9% as at Q4 2009
  • Balance sheet with total assets of 1.4 trillion Swiss francs ($1.3 trillion)
  • All business divisions reported a pre-tax profit

Sources: UBS, Bloomberg, Wall Street Journal

Abraham Tiamiyu

Paul Krugman on Healthcare

Paul Krugman, winner of the 2008 Nobel Prize in Economics, has written quite a few articles on the topic of healthcare reform in the United States.  Over the last 12 months, I have read most, if not all, of his articles in the New York Times and here are my top six (in chronological order):

1.) Why markets can’t cure healthcare (July 25, 2009)

2.) Health Care Realities (July 30, 2009)

3.) Numerical notes on health care reform (December 26, 2009)

4.) Health Reform Myths (March 11, 2010)

5.) Why We Reform (March 18, 2010)

6.) Fear Strikes Out (March 21, 2010)

Abraham Tiamiyu

Top 10 predictions for 2010

At the beginning of each of the last 25 years, Byron Wien, the renowned investment strategist, has prepared a list of his top ten political and economic predictions for the year. Last year, he correctly predicted rallies in the S&P 500, gold and oil. Take a look at his 2009 predictions and you will be amazed at how many calls he got right! In January 2008, Wien also predicted Barack Obama’s victory in the U.S. presidential election as well as the Democratic Party’s majority in both houses of Congress. His most famous call: the interest rate cuts and recession of 2001.

Last month, Wien released his top ten surprises for 2010 (01/04/2010). Two months into the year, some of his predictions are already coming true. In number 7 of this year’s list, he predicts Washington’s funding of the first nuclear power plants in the U.S.  since 1979. Earlier today, President Obama pledged $8 billion in loan guarantees to help build the first U.S. nuclear reactors in nearly three decades. See this article.

For those interested, here are Wien’s Top 10 predictions for 2010:

The Surprises of 2010

1.       The United States economy grows at a stronger than expected 5% real rate during the year and the unemployment level drops below 9%.  Exports, inventory building and technology spending lead the way.  Standard and Poor’s 500 operating earnings come in above $80

2.       The Federal Reserve decides the economy is strong enough for them to move away from zero interest rate policy.  In a series of successive hikes beginning in the second quarter the Federal funds rate reaches 2% by year-end

3.       Heavy borrowing by the U.S. Treasury and some reluctance by foreign central banks to keep buying notes and bonds drives the yield on the 10-year Treasury above 5.5%.  Banks loan more to corporations and individuals and pull away from the carry trade, thereby reducing demand for Treasuries.  Obama says, “The suits are finally listening”

4.       In a roller coaster year the Standard and Poor’s 500 rallies to 1300 in the first half and then runs out of steam and declines to 1000, ending where it started at 1115.10.  Even though the economy is strong and earnings exceed expectations, rising interest rates and full valuations present a problem.  Concern about longer term growth and obligations to reduce leverage at both the public and private level unsettle investors

5.       Because it is significantly undervalued on a purchasing power parity basis, the dollar rallies against the yen and the euro.  It exceeds 100 on the yen and the euro drops below $1.30 as the long slide of the greenback is interrupted.  Longer term prospects remain uncertain

6.       Japan stands out as the best performing major industrialized market in the world as its currency weakens and its exports improve.  Investors focus on the attractive valuations of dozens of medium sized companies in a market selling at one quarter of its 1989 high.  The Nikkei 225 rises above 12,000

7.       Believing he must be a leader in climate control initiatives, President Obama endorses legislation favorable for nuclear power development.  Arguing that going nuclear is essential for the environment, will create jobs and reduce costs, Congress passes bills providing loans and subsidies for new plants, the first since 1979.  Coal accounts for about 50% of electrical power generation, and Obama wants to reduce that to 25% by 2020

8.       The improvement in the U.S. economy energizes the Obama administration.  The White House undergoes some reorganization and regains its momentum.  In the November Congressional election the Democrats only lose 20 seats, much less than expected

9.       When it finally passes, financial service legislation, like the health care bill, proves to be softer on the industry than originally feared.  There is greater consumer protection, more transparency, tighter restriction of leverage and increased scrutiny of derivatives, but the regulatory changes for investment bankers and hedge funds are not onerous.  Trading volume and merger activity increases; financial service stocks become exceptional performers in the U.S. market

10.    Civil unrest in Iran reaches a crescendo.  Ayatollah Khomeini pushes out Mahmoud Ahmadinejad in favor of a more public relations adept leader.  Economic improvement becomes the key issue and anti-Israel rhetoric subsides.  Talks with the U.S. and Europe begin but the country remains a nuclear threat.  Pakistan becomes the hotspot in the region because of the weak government there, anti-American sentiment, active terrorist groups and concerns about the security of the country’s nuclear arsenal

Abraham Tiamiyu

The Enemy of My Enemy

Steven Strogatz, a mathematician at Cornell,  has a really interesting piece in the New York Times titled The Enemy of My Enemy (02/14/2010). In the article, he argues that the mathematical rules behind negative numbers can also be seen playing out in social and political events. For example, something most people – including myself – take for granted, i.e., the multiplication of negative numbers, could help explain the allegiances between European countries in the run-up to WWI.

Also, there is a brief mention of the philosopher Sidney Morgenbesser. For those who don’t know of Morgenbesser, check out the following:

1.) The most celebrated Morgenbesser anecdote involved visiting Oxford philosopher J. L. Austin, who noted that it was peculiar that although there are many languages in which a double negative makes a positive, no example existed where two positives expressed a negative. In a dismissive voice, Morgenbesser replied from the audience, “Yeah, yeah…” (also, “Yeah, right”)

Source: http://www.actuarialoutpost.com/actuaria…

2.) Sidney Morgenbesser walks into a restaurant, has dinner, and then asks the waitress what they have for dessert. She says apple pie and blueberry pie. Sidney Morgenbesser says he’ll have the apple pie. She comes back in a moment and says that they also have cherry pie. So Sidney Morgenbesser says “In that case, I’ll have the blueberry pie.” [Independence of irrelevant alternatives]

Source: http://itre.cis.upenn.edu/~myl/languagel…

3.) A policeman once approached Morgenbesser and told him there was no smoking on the subway. Morgenbesser responded that he was leaving the subway and hadn’t lit up yet. When the cop said, “If I let you do it, I’d have to let everyone do it,” Morgenbesser replied, “Who do you think you are — Kant?” The cop mistook the German philosopher for a vulgar epithet, and Morgenbesser had to explain it all down at a police station. [Categorical Imperative]

Source: http://www.actuarialoutpost.com/actuaria…

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Abraham Tiamiyu

How the tables have turned

I just finished Ron Chernow’s The Death of the Banker and here is one of my favorite passages from the book:
In the nineteenth century, England was one of the few nations that had attained the level of prosperity that spawns surplus capital, which spills, in turn, across national boundaries in search of the highest return. For British investors, America was a richly tempting “Third World” country, one loaded with pitfalls and a boorish habit of defaulting on debts…In the 1840s, the rogues’ gallery of sovereign deadbeats included Pennsylvania, Maryland, and other U.S. states. (The most renegade offender, Mississippi, later went so far as to pass a state constitutional amendment prohibiting repayment of its bonds.) Faced with such recalcitrance, many European investors ruled America off-limits to further investing. When Washington dispatched U.S. Treasury agents to solicit a loan from Baron James de Rothschild in Paris in 1842, the banker brusquely expelled these aliens from the office: “Tell them you have seen the man who is at the head of the finances of Europe, and that he has told you that they cannot borrow a dollar. Not a dollar.”
Source: Chernow, R. The Death of the Banker: The Decline and Fall of the Great Financial Dynasties and the Triumph of the Small Investor (New York: Vintage Books, 1997).

Abraham Tiamiyu

Nelson Mandela

  • I have always known that deep down in every human heart, there is mercy and generosity. No one is born hating another person because of the color of his skin, or his background, or his religion. People must learn to hate, and if they can learn to hate, they can be taught to love, for love comes more naturally to the human heart than its opposite (Mandela, 1994: 542).
  • I knew as well as I knew anything that the oppressor must be liberated just as surely as the oppressed. A man who takes away another man’s freedom is a prisoner of hatred; he is locked behind the bars of prejudice and narrow-mindedness. I am not truly free if I am taking away someone else’s freedom, just as surely as I am not truly free when my freedom is taken from me. The oppressed and the oppressor alike are robbed of their humanity (Mandela, 1994: 544).

Source: Mandela, N. A Long Walk to Freedom: The Autobiography of Nelson Mandela (Boston: Little, Brown & Company, 1994).

A Long Walk to Freedom

A Long Walk to Freedom

Abraham Tiamiyu