A Mexican Standoff

Or, more appropriately, a Chinese American standoff. Here, in a nutshell is the situation:

1. The Chinese are nervous about holding large dollar denominated foreign reserves, but are also nervous about allowing their currency to appreciate. The only way to keep the currency to appreciate is to buy dollar denominated assets in sufficient amounts to keep that from happening.

2. The Americans want the Chinese to allow the Chinese currency to appreciate, but need the Chinese to continue buying U.S. government securities to finance the American deficits (fiscal and trade). If the Chinese were to stop increasing, much less begin liquidating, their dollar holdings there would be a serious problem.

So, the Chinese cannot achieve their currency objective without continuing to finance the American deficit. The Americans may lecture on currency manipulation (lecturers fallen silent recently) but urgently need the Chinese purchasing presence.

What makes this situation unusual, from an American perspective, is that the outcome is dependent more on how the Chinese assess the situation than on any American initiative.

The United States is in the unfamiliar position of responding to the policies of others, rather than framing an initiating its own. This is Un-American, and a situation ripe for miscalculation.

Neo-Marxist Caveats, Part 2

The first step towards assessing the current American situation employing a neo-Marxist analysis is to assess the Marxist approach itself in little of current circumstances. In particular, the continuing conceptual viability of several of the key building blocks of the approach is questionable.

The first of these is the notion of defining class in terms of relationship with the means of production. Forest of trees have died, and oceans of ink have been spilled in an effort to define class, which is a slippery concept indeed. A bit less attention has been devoted to defining the idea of 'means of production', mostly, because doing so actually requires some understanding of how things work, how work is done and all sorts of grubby details about all sorts of odd little backwaters in which the vast majority of humankind labors.

Suffice it to say that a mid-19th century focus on the industrial wastelands and imperial steamship routes of the dominant European nationstates of the era are about as relevant to the beginning of the third millenium as exegesis of Sharepeare's bare ruined choirs of 16th century Catholicism would have been to understanding the 18th century Enlightenment on England.

I would be inclined to acknowledge from the get go that class is defined in political and social as well as economic terms, and that the 'means of production' has to be understood to mean something radically different in a service dominated economy with an significant public sector than it did a century and a half ago. That said, focusing on what makes fmembers of the population productive (or economically autonomous) rather than blathering on about the "American consumer" or the "consumer society" or looking to renewed credit flows to stimulate consumer spending as a way out of the economic malaise is probably a step in the right direction.

A second major caveat to a neo-Marxist analysis is what I'll call the Freudian problem. Like Freudian analysis, Marxism was a product of a time and place, and it's not at all clear how well either travels through time and space so as to be usefully applied elsewhere (even assuming that they served explicatory purposes where they originated). There can be perfectly valid, local belief systems that organize human activity and regulate human conduct that do not serve the came purpose once exported. Voodoo and witchcraft may have local power in Haiti, but in New Orleans, they are merely camp. Clearly, the Freudian approach to understanding the human mind was premised on a set of bourgeoisie family relationships that were simply not to be found in, say, the Japanese imperial court or an Amerindian tribe.

A fair amount of the Marxist tradition falls prey to the same tendencies. There is a progressively more complex self-referential conceptual trend of increasing refinement that is progressively less-intelligible to outsiders and, indeed, less and less concerned with the external world and more and more focused on the internal balance of philosophical construct.

This criticism is not, however, confined to Marxist philosophical developments. No fair minded legally trained American can help but look on the development of First Amendment jurisprudence and not marvel at how we have tied ourselves in knots in a similar fashion. The ancient criticism of the Scholastics debating how many angels can dance on the head of a pin shows similar theological tendencies. So, while the Freudian analogy is cautionary, it is not a grounds for discarding the approach.

Basically, this is boiling down to a question of whether one can identify groups of actors sufficiently well defined by their roles to be deemed classes, and whether those actors have a reified class consciousness that determines (in some sense) their actions.

Neo-Marxist Approach, Part 1

It's time to put the politics back into political economics.

The Financial Times is taking a first tiny step by introducing ideas of behavioral economics into the discourse. But that is a timid, trivial and bourgeois approach to a bigger problem.

Let's begin by accepting that the current analytical framework is roughly as bankrupt as the financial services sector that crucified the general economy on its own contradictions. So, folks are casting about for something a bit more, er, operative.

There are some serious problems with attempting a neo-Marxist construct to explain the current mess. And that's leaving aside the delicate American queasiness at being labelled a socialist, a commie, a pinko, or anything of that sort. Forget, for the moment, that queasiness, or at least enjoy the outre opportunity to leave respectability behind.

First serious problem is that state directed economic production schemes utterly failed in the 20th century. Call it communism. Call it socialism. Call it state planning. Call it Marxist-Leninist. As a way of organizing complex economic activity, the approach which had its genesis in the writings of Karl Marx and Frederich Engels in the mid-19th century failed the test of history. Their thoughts, as developed and implemented by their followers and adherents, were relatively inferior to alternative approaches to organizing collective economic activities. This approach failed in multiple cultures and different societies. So, let's not even suggest that Marxist-Leninist state planning provides a viable approach to organizing and regulating the economy of a developed or developing country. But that doesn't mean it doesn't offer a tool with which to critique the current situation.

Second serious problem is that no one, and I mean no one, has been pursuing seriously an attempt to apply this analytical framework to the current economic situation for at least a generation. Following the collapse of the Soviet Empire in Eastern Europe, I believe all the departments of Marxist-Leninist studies were shut down. In the West, the few adherents of the approach focused themselves of issues of social justice, income distribution, and the like--not so much attempting to understand the prevailing economic system as critique certain of its outcomes. And most of those guys are either dead or pensioned off. There is no expertise, and there are no experts.

Third serious problem is that there is no coherent and agreed theoretical framework that can be applied to the current crisis. There are (or were) as many flavors of Marxism as there have been flavors of ice cream in the last century or so. And they've all melted into a big puddle. On the other hand, this may be an advantage, since it would allow picking and chosing, adapting and applying what's useful, while leaving the rest of it in the intellectual recycling bin.

With those caveats, we proceed.

Stale News Remains Important

Some things to remember if you want to anticipate the future:

1. In the United States, the financial services sector is and will remain until recapitalized, insolvent. This is a solvency problem, not just a liquidity problem. 6 of 19 per the leaked stress test results, need additional capital. And that's the official story. We need to learn how to get along without those guys.

2. U.S. house prices are and will continue to decline, making it impossible to value a huge chunk of assets critical to financial services sector liquidity. The sociological consequences of unemployed company store peons trapped in real estate they don't own are interesting. And, commercial real estate is in the early stages of joining the residential stuff in a revaluation. While the trajectory is the same, the commercial stuff will be, ah, lumpy, and less suceptible to smoothing.

3. The regulatory apparatus has been captured by the financial services sector. Whatever squabbling is under way within the political classes (viz., the competitive outing of Raul Emmanuel and Larry Summers this month, and the Thain/Lewis catfight, with Paulson calling the count), has yet to metastize into a purge of the financial elite. While bullets in the head aren't called for in America, a rather less drastic purge in, ahem, called for. This is, incidentally, a global issue.

4. The epicenter of this particular crisis was in at the heart of the developed world, and that is where the pain is most likely to be felt most intently. Countries like China, India and Brazil have an opportunity to, if not displace their betters, at least join them at the high table. If that happens, look for some changes in the menu.

And that is the way it looks from here, today.

Why I Mock John Maynard Keynes

In case anyone has missed it, we are in a bit of a fix financially, on a global basis. The policy works and mandarins of assorted stripes generally responsible for keeping this sort of thing from happening are perplexed, and more than aggravated that a number of the formerly reliable levers that worked when employed now produce--when tugged--nothing. New techniques from the bottom of the toolbox are being taken out--quantitative easing--and much dark muttering of 'pushing on a string' can be heard in the distance, in the darkness.

So, if the macroeconomic tools of a lifetime and the institutional expertise of the worlds central banks and international monetary authorities has most its magic, it's time for something else. Because most of these guys were trained in the second half of the 20th century, and because John Maynard Keynes was the fellow whose approach had been most recently superceded, there is a group grope of the Keynesian canon, for something that, if not functional, at least sounds profound.

That's why I mock all the invocations of J.M. Keynes. If you actually go back and read the guy, he has some interesting observations that shed light on the current mess. For that matter, so does Ezra Pound. But the solution is no more to be found in Keynes' writings than in Pound's Cantos. And the aspects of Keynes that are being invoked are among the least interesting of his observations (to me, at least, I find his policy prescriptions pretty pedestrian, while his conjectures on how his world got in its fix quite intriguing in the application to the current fiasco).

So, my first alternative is Marxist economic analysis. Unfortunately, while the Marxists have some great one-liners, as I've tried to deploy what I remember of Marxist economics to the current situation, I find that it really doesn't work very well. It is destructively inspirational, rather than immediately applicable.

But more of that another time.

Bank Earnings

Okay, confession time.

I personally have been involve--not within any applicable statute of limitations, I hasten to add--in the preparation of quarterly and annual earnings reports for publicly held financial institutions. As a matter of fact, one of those institutions is, today, buried deep inside the AIG mess, and for my services to that predecessor entity I am entitled to a small pension which, a recent communication from AIG assures me, is safe. I happen to believe that communication because the pension is so small that it's guaranteed by the PGBIC so, while the dollars in which it is paid may be worth far less when I receive them than anyone would have anticipated, I would assume that when the times comes, I will receive my pittance in what script is then legal tender.

Based on personal experience, I can say that, with the most honorable of motives and the best of intentions, accurately reflecting the financial results of any financial institution in a quarterly or even annual time frame is an exercise in subjective judgement, and, to put it mildly, reasonable people can differ. Based on what I'm seeing as a member of the great unwashed, I cannot tell whether the motives are honorable and the intentions above reproach with the financial institutions currently reporting their earnings, but these are stressful times, and such times test the mettle of all involved, a certain number of whom always fall short.

So I can understand how some of the the banks are actually reporting earnings. What I can't understand is why.

Citicorp reports earnings. But those earnings are dwarfed by an item that reflects the impairment of the value of its own debt (which is only impaired because of doubts about the enterprise itself). In other words, they are making money by going broke. Or so they claim. Wells Fargo is reporting record earnings at the same time that it is adding to its loan loss reserves in amounts that are virtually certain, in hindsight, to seem laughable. Goldmans Sachs is reporting earning, but its CFO is essentially lying to the public about the benefits Goldman received from payments on AIG CDS and the firm orphaned the month of December.

Why? These guys are setting themselves up for serious trouble down the road. The phrase 'buying time' comes to mind, but buying time only makes sense if you expectd something to change. And the way the political classes and their technocrats are going to remember this will be truly ugly sometime between the World Series and Thanksgiving. The first quarter will be remembered as when the banks reported the government bailout of AIG as their own profits.

That may be simplistic. But there is enough truth to it that it will stick. Fooled me once, shame on you. Fooled me twice, shame on me.

Fiasco 2.0 The Pension Funds are Broken, too.

Just who are the victims of the current mess?

It's easy enough to say that we all are, but that really isn't true.

Are homeowners who used their houses like ATMs to finance everything from their children's college educations to trips to Disneyworld? Are we really going to try to differentiate between those who borrowed for praiseworthy ends (presumably the former) and those who didn't (presumably the latter). Are the first time home buyers who bought into the American dream at absolutely the wrong time? Are the amateur real estate speculators who loaded up on liar loans because they'd attended one of those make a million dollars in real estate using other people's money seminars that used to advertised so profusely?

I suppose the first time home buyers are more sympathetic victims than the high school principals trying to get rich after taking the early retirement package. But, so what?

It's fun to bash the perps--but to what purpose?

I mean, I see the importance of enforcing fraud laws at the local and community levels, and pursuing exemplary justice not merely in the cases of appraisers, mortgage brokers and title companies, but straw borrowers and those who took out the liar loans, as well. I see even more importance and purpose in systematically destroying the financial elite that has grown up with a parasitic financial services sector that no longer serves the needs of the general economy but rather milks the general economy insatiably for its own gaming and profit.

Here is my concern for today--pension funds, endowments and other investment pools that exist to meet non-economic social needs. These things truly are victims of the current mess. Whether a foundation is going to have to curtail its funding of the programs it was created to pursue, a university is forced to reduce its research and educational activities to conform to its resources in a new environment, or a pension fund has become unable to meet its actuarially defined future obligations, a social problem has been created that may have a financial genesis, but doesn't have an economic solution.

Focus on the pension funds. A pension fund is a pool of assets that should be matched to a pool of liabilities. Historically, pension funds have made unrealistic projections of their managers' abilities to generate financial returns from those assets and when the managers actually had good couple of innings, the sponsors used the excuse of overfunding to reduce contributions or even capture the excess. Now, hit the present. The liabilities of pension funds are relatively unaffected by the current financial crisis. But the valuation of their assets most certain is.

Even if the general economy stumbles to some kind of recovery, there will be another round of crisis. Globally, financial assets are taking a hair cut. Globally, liabilities to current and future pensioners have not. That is going to create the mother of all asset-liability mismatches.

On one level, this is the problem of the so-called Social Security Trust Fund, and it is no big deal in terms of economic policy, because it is a demographic problem (a hairy demographic problem, but a demographic problem, nonetheless). But, unlike Social Security, a program of the federal government, private pension funds are, well, private. They have sponsors with limited legal obligations to make them whole, and they have the ability to become insolvent. There is a modest federal underpinning to the whole thing, of course, the Pension Benefit Guaranty Corporation, but it will be looking to its Treasury backstop long after the FDIC has pumped that well dry.

Perhaps, once again, poverty will be the companion of age.