Keynes

The Fruits of Neoliberal Economic Thought.

Over the weekend, when I was not playing poker, I read this long piece on neoliberal economics. It’s a very long, exhaustive and thick read and it took me a while to absorb all the major points. I wanted to distill this excellent critique of neoliberalism into a few distinct points, mostly for myself, but also for those interested who don’t have the luxury of 2-3 hours of undisturbed time.

  1. Recent economic order seems to reward paper speculation and penalize work.
  2. Governing elite’s response to the recent crises is to double down on old dogmas: reduced government spending, low taxation, worship of markets to cure social ills.
  3. Our public life is thus a hostage to neoliberal market idolatry.
  4. This ideology, however, never holds any of the elites responsible or accountable for the system failures.
  5. Originally, neoliberal thinkers positioned themselves as observers and thinkers above the fray, intellectuals who looked for refuge from the New Deal liberalism. Their early association served as a basis for founding of the Mont Pelerin Society. A few decades later it coalesced around the Austrian anti-Keynesian economic thought, with F.A. Hayek at the helm.
  6. Hayek and his contemporary and intellectual comrade Ludwig von Mises, both haunted by the terrors of totalitarianism and exiles from Nazi regime shared their sense that free-market liberalism was the only answer to fascism and communism.
  7. However, Hayek drew his inspiration from Karl Popper, another economic philosopher, known for his “open society” ideas, who understood that individual liberty doesn’t have to be antithetical to economic democracy. Such philosophy permitted the adoption of egalitarian, even redistributionist policies.
  8. But Hayek chose intellectualism over practicality. He reasoned that an “intellectual adventure” even if it’s utopian in nature is what’s needed, rather than “practical compromises”, which should be left to politicians.
  9. The biggest irony is that Hayek’s utopian longings were fully realized, in Reagan’s America and in Thatcher’s Britain, but failed to bring the results he envisioned.
  10. Enter Milton Friedman, the monetarist from University of Chicago, who popularized the purely intellectual strain of Hayek’s neoliberalism. He advised Reagan, Thatcher, and Augusto Pinochet, had a regular column at Newsweek, a hit series on PBS, not to mention his association with Cato Institute, Heritage Foundation and American Enterprise Institute.
  11. With such an advocate, the free-market gospel has multiplied all over the globe. Along the way, the gospel managed to mutate from simply worshipping the markets to demonizing all public sphere. It is at that point, the 1980-90s, that the suspicion of government, or of anything “public” first took shape. Friedman believed and made others accept it as an axiom that a government, by its very nature, can’t serve the public interest.
  12. Regulations and any government involvement is thus to be resisted, or to be rid of, which is what’s been happening since the 1980s, culminating in 2008 crisis. But it’s not the lack of regulations that is the culprit in neoliberal thought. Conveniently, neoliberals are now focusing on a problem of regulatory capture: you see, the regulators rotate between the government and the industry, thus confirming the neoliberal idea of the evils of government.
  13. Because government itself is full of “defects”, according to Friedman, it therefore cannot be the one to regulate whatever flaws happen to appear in the markets. Neat logical trick, isn’t it? And that’s where we are today.
  14. The neoliberal thought that has enthralled most of today’s politicians, stymies any attempts to stimulate economy through government spending. The entire focus of the elites, nowadays, seems to be revolving around placating the “job creators,” and any suggestions to raise taxes on the rich or to help the poor are to be nipped at the bud.
  15. The author gives an example of the destructive force of such an uninhibited capitalism: the factory collapse in Bangladesh that killed more than a thousand workers. What the disaster like this should have demonstrated, is that regulations are “a largely cosmetic watchdog effort funded overwhelmingly by private-sector concerns, far from delivering oversight and accountability.” What aggressive free market delivers is “race-to-the-bottom competitive forces…that ritually sanctify all of this routine dishonesty. In their malignant neglect of worker safety measures, local factory managers are able to cite the same market pressures to maximize production and profit that have prevented the ornamental Western groups conducting audits of workplace safety practices from releasing their findings to the workers at risk of being killed by the neoliberal regime of global manufacturing.”
  16. But Chicago and Austrian scholars are unfazed by such misfortunes. It’s just a cost of doing business. Their response was a predictable call to resist the passage of any new laws to improve worker-safety standards or to allow “workers to veer into unionism or other non-market-approved modes of worker self-determination.”
  17. The grip of neoliberalism is still strong today, even among liberals. Everyone feels like they have to at least pay lip service to the wisdom of markets, if they still want to be admitted to the discussion.

About Those Rising Interest Rates

I’m in a bit of a wonkish mood today. Last week bond yields have risen to the highest levels in about a year, thus making market participants nervous, thinking “is this it?”. Some in the “inflation is bad and imminent” camp are probably ready to pop Champaign bottles open to celebrate the long (very long indeed) awaited arrival of inflation and a vindication of their self-imposed black-and-white view of the world. But let’s examine two obvious questions: 1. Is inflation indeed already here? and 2. Is it as bad as they say?

First, the whole purpose of the much-derided Bernanke’s QE exercise is to spur growth: that’s what the Fed does when the economy is slow – cuts and keeps the interests rate as low as possible for as long as the economy is weak. The widely used indicator that the growth is back is inflation: if we begin to spot rising prices it means the economy is recovering (people find employment, consumers back in the stores, driving prices up). This is a far cry from Zimbabwe or Weimar Republic hyperinflation which is what alarmists have in mind when they say “inflation”.

Second, and this is an extension of the previous point – inflation is not always bad, precisely because it indicates a growing economy. It’s all about the range: 2% inflation is too low, Bernanke and his Fed colleagues would probably like to see it in the 4-5% range, 7-8% would probably warrant a tightening action from the Fed (rising rates, this is what Paul Volcker famously did in the early 80s). Yes, the Fed wants to see real, consumer-driven inflation rising, which of course doesn’t mean it wants to see it rising forever. Fed’s actions at keeping interest rates low are intended for a pick-up in business activity (making it cheap to borrow and consume or start a business), thus inflation is not seen as a negative side-effect that everyone should fear, but instead an intended and positive consequence of QE.

This is where many people get confused: Bernanke is pushing down rates in order to see them rise? In a sense, yes. Here’s a good summary:

“In a nutshell, that’s the QE conundrum. Central banks argue that their bond purchases are meant to push down yields in order to make long term finance cheaper. But, at the same time, a sign that QE’s working is rising yields.”

10-year Treasury yields have risen to 2.25% recently, highest in a year, which many say is some kind of dangerous threshold. Bond traders are especially jittery and here’s why (now I’ll get really wonkish, but if you do read on I promise to make it exciting if you remember one thing: when bond prices rise, interest rates decrease; and vice versa, if bond prices fall the interest rates rise): Many of the bond portfolio managers are holding huge portfolios of agency mortgages. Those mortgages are primarily fixed-rate – they pay a fixed coupon. If interest rates rise, like they did in the past few weeks, it means that homeowners holding those mortgages suddenly pay a lesser (in relative terms) interest rates than the market and thus are less likely to refinance. Because those people are less likely to refinance, our bond managers are stuck with their portfolios of mortgages that pay less than they could get in the market today. On top of that, because people are not refinancing, it forces bond managers to hold those losing bonds longer (it’s what they call duration risk), and because the average maturities of those bonds are further into the future it also increases those bonds’ risks and volatility (one would much prefer to hold a 5-year bond as opposed to 10-year bond all other things being equal – you get your money back faster). So now, our bond managers who thought they were holding a 5-year bond find themselves holding a much “longer” bond that is risker and thus requires additional hedging. Now we come to this concept that they call “convexity vortex”. In order to hedge their exposure to rising interest rates the bond managers’ most widely used tool is to sell US Treasuries: because they’re losing money on their portfolios of mortgages due to rising rates, they want to at least make money on the other side of the trade – be short Treasuries and thus benefit from rising rates on this hedge. So as interest rates increase they begin to sell more and more US Treasuries to hedge their portfolios. This brings a self-perpetuating vicious circle: rates rise and makes them put on hedges by selling Treasuries that, in turn, make Treasury rates rise even higher.

But no matter how important bond traders fancy themselves to be (Master of the Universe, Bond Vigilantes), the real danger at this moment is not rising interest rates, but the premature slowing down of the QE. The state of the economy is much more important than the hurt feelings and reduced fees that will plague bond managers. Besides, according to Krugman, it’s hard to imagine scenario where these high bond valuations don’t take some kind of a haircut. Just look at this curious matrix that he put together:

inflation_krugman2-blog480

It’s all about one’s perception of the economy: inflation hawks see inflation creeping on and will pick scenario 1; those who think Bernanke is on the verge of snatching the QE punch bowl will pick scenario 2; and those who see a recovery, but still subject to continued QE (I’m in this camp), will pick scenario 3.

I pray to monetary Gods that Bernanke is in my camp too.

The Fine Art of Being Wrong.

This is a link to Barry Ritholtz recent article on how to be wrong and move on. He applies it to trading, but the same philosophy could be used at anything. Admit your mistake, correct it and move on without dwelling on it. It helps not having a big ego – a rarity among the trading kind.

What does NOT admitting error look like? It is Apple investors, who double up all the whole way down from $700 to $400. It is the radical financial deregulators like Edward Pinto & Peter Wallison blaming the financial crisis on unrelated bank loans to poor minorities. It is the cacophony of excuses from the Gold community, blaming the 30% drop on central banks, Goldman Sachs, “paper” gold, the shorts and the dollar. My friend Albert Edward’s reiterated call for S&P500 at 450 — with the SPX kissing 1600 — smacks of a classic non-admission of error. His preference is to go down with the ship.

I would also include another category to this group: those who trade on political inclinations rather than on reality. John Paulson, one of the goldbugs (and a Romney donor) who saw his fund lose 27% last month (and 47% YTD) is one of those sophisticated guys who are no different from Glenn Beck, betting on the apocalypse. Why do they bet on the apocalypse? Because Obama is a socialist, thus the economy cannot possibly recover during his term. Although, I have to give John Paulson some credit – at least he bets his own money on entrenched personal sentiments. Glenn Beck types first scare regular folks about the upcoming Armageddon and then simultaneously peddle them gold coins. Nice, full-proof business model.

But still, I’m puzzled, and even fascinated how smart guys can be so blinded by political hatred that they allow it to envelop their thinking. John Paulson is not a stupid guy: he made billions betting against subprime in 2007-2008. How could guys like him not have put two and two together? For the last 3 years it was obvious to me that Bernanke will keep his foot on the QE gas pedal for as long as possible, and given the abject economic situation in 2009-2010, one could safely say that it’s going to be years, not months. This simple fact guided my being long stocks and withstand all the ups and downs. You don’t have to have a PhD to see what was going on. Whether QE is good or bad is secondary to this discussion: guys like Paulson don’t care about social implications when they make money; they only bring up social implications when they have lost all other arguments. Zerohedge guys, another famous goldbugs, are now annoyed to find out that without QE the market would have stayed flat. They want QE ended immediately because it was so successful and thus prevented their luddite, gold-obsessed worldview to be realized in real life! WTF?

Rupert Murdoch makes a weak case for the morality of markets.

Rupert Murdoch, chairman and CEO of News Corporation, addressed the morality of free markets in his recent editorial. The essence of Mr. Murdoch’s argument is that free market is inherently moral and that greed is not the driving force of success.

“The market succeeds because it gives people incentives to put their own wants and needs aside to address the wants and needs of others. To succeed, you have to produce something that other people are willing to pay for.” Mr. Murdoch writes.

Let’s dwell on this for a moment. Benevolence is not why people start a business. Businesses are profit driven. Some enterprises can begin as an experiment and be iconoclastic and pioneering in nature, like Apple; the rest are founded with the sole purpose of making a profit. If someone wants to put his own wants and needs aside to address the wants and needs of others he volunteers or starts a non-profit.

One can’t mindlessly marvel at the virtue of the free markets without considering the following: people are not always rational; markets do not always self-correct; there are informational asymmetries between transaction parties; there’s an agency problem (that is when a hired representative, in business or in public life, represents his own interests rather than the client’s). If we lived in an idealistic world of artisanal mom and pop shops, Mr. Murdoch would have a case for the morality of market participants. But when those small shops run out of natural customers the troubles begin. Embarking on the quest of permanent growth, those businesses tend to enter the realm of creative finance, consolidation, dubious products and political favors. Business models for many big firms have long ceased to resemble the innocuous model that some laissez faire idealists subscribe to. We’re not living in the world of mom and pop cupcake stores and community banks anymore. Consumers’ interests and corresponding profits are not aligned anymore: customers and their interests are secondary to the interests of shareholders and investors. Because everything is put at the altar of “growth” there’s a point where a business begins to invent useless or harmful products (addictive prescription drugs, subprime mortgages, leveraged buyouts, entertainment disguised as “news”).

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Ben Bernanke is vindicated.

On the pages of WSJ, no less.

I have been one of the biggest supporters of Bernanke (here, here and here) in terms of both the remedies he used in the aftermath of the crisis and, as an extention, being long stocks for the last 3-4 years. Inflation is non-existent, QE helped asset prices rise and keep yields low, banks are flush with cash. Bernanke is becoming a legend.

Now, many say that he can’t dispose of those assets purchased without doing damage to the economy and driving the inflation up. But why is he’s receiving so little credit? Do they just expect him to dump the entire porfolio on the market in the matter of days? And secondly, if it drives inflation up a bit – it will only indicate a growing economy, or in simpler terms, more money chasing fewer goods – a scenario that we all should welcome. Wild-eyed inflation hawks, of course, envision Zimbabwe-like scenario where we push wheelbarrows of cash going grocery shopping. My only answer to them is: put your money where you fear is. Put the freaking inflationary position, like PIMCO did many times, and show us all how it’s done! Make some money on  your sentiment.

Some conflicted professor has advice for Keynesians.

A confused professor thinks we, Keynesians, don’t understand Keynes at all. He thinks we think Keynes advocated for planned economy and proceeds to demonstrate that Keynes was at times a supporter of free markets. As such, Keynesians and progressives in general, in his view, lionize him for some ideas that he did not have. He doesn’t think we can support Keynes for the ideas that he actually professed, because in a conservative two-dimension world there are only two choices: free markets and communism and we must be for the latter.

 “Assumption is a mother of fuck up” – is one of my favorite expressions. The author of this article assumes a lot. For example right after he quotes Keynes: “the political problem of mankind is to combine three things: economic efficiency, social justice and individual liberty” he proceeds to assume that Keynes was looking to force social justice at the cost of economic liberty and efficiency.  Why doesn’t he assume that Keynes was looking to force economic liberty at the cost of social justice and efficiency, or efficiency at the cost of social justice and economic liberty? Or why does he think that Keynes was looking to force anything at all, by merely stating a problem? Why such a conclusion?

I was getting more and more confused with the point the author was trying to make as I read a long. If, according to the author, Keynes was such a heavy-handed Commie, then how I can take the later argument that Keynes, after all, was for free markets, seriously?

“In addition, he believed in cutting taxes in recessionary times to stimulate economic activity and raising taxes during times of prosperity. This is contrary to the modern liberal philosophy of raising taxes and spending ad infinitum.”  WTF? Didn’t Obama just kept tax cuts for 98% of Americans, not to mention his tax cuts a few years ago that everyone forgot about?

Dean Kalahar claims to know what we, Keynes supporters, supposedly don’t know. He thinks we don’t know that Keynes wasn’t adamant about rejecting free markets when he delivers Keynes quote: “The engine which drives enterprise is not thrift, but profit” as some kind of revelation that will prompt us, Keynes supporters, to renounce him. He probably thinks that if we support government planned economy (a mistaken belief in itself), why would we waste our time with lukewarm and conflicted Keynes instead of aligning directly with the grandfather Marx himself?

“Whichever the case, if Keynes is the darling of the progressive left, they ought to have the guts and intellectual integrity to accurately portray the man they are canonizing and actually align their actions to his words.”  But we do! We do see the world like he did, in gray, not in black and white as Milton Friedman acolytes. We do believe in applying appropriate remedies as a certain situation requires, not a one-size-fits all laissez-faire free for all, all the time. We acknowledge that there are times to cut taxes and there are times to raise taxes. For conservatives, there are no circumstances under which taxes should be raised.