QE vs. Velocity

Most of us have heard about QE2 more that we would like over the past few weeks.

Today -- a "liquidity trap" is sited as a reason for QE2.

It is hard for me to understand why the Fed is focusing upon the amount of money available vs. velocity of money.

Let's give people (hopefully private sector) incentives (and the laws/regulations and confidence) to spend. Let's get money into productive assets (rather than money for the treasury and for offering leverage to companies like Microsoft).

I suppose the Fed could use some help from legislators to better achieve this though.

US Pension Fund - $20 Trillion?

There seems to be some new push for privatizing portions of social security -- perhaps even allowing people to keep their own accounts.

On the other hand:

- We are spending tremendous amounts subsidizing housing (guess we are nationalizing Fannie and Freddie) and other political priorities, so as to distort the economy and create bubbles.

- We have interest rates below real inflation, we have the fed buying treasuries and MBS, trying to use monetary policy to "broadly" stimulate the economy, again creating massive distortions.

- We are hiding the true nature of our deficit spending by using social security proceeds, likely spending more than if people really new how much financing is required for the deficit spending.

- We are overall crowding out private investments, and market-based capital allocation with these distortions and deficit spending.

A solutions? The creation of the US Pension Fund.

We can begin with new social security payments and some contribution from the Fed (that would like to stimulate the economy). Later, the US government can begin to fund it (like the states fund their pension liabilities). This would become a fund of $trillions very soon - and eventually tens of trillions!

This fund would need to recruit the best managers and allocate some funds to private fund managers around the world. It would have to balance short-term cash needs (to pay social security benefits) with its ability to make very long-term investments.

The benefits:

- Much better returns than investing in the US government (with scale, less political investment decisions).

- Much better capital allocation (than the US government spending).

- Likely reduced government spending.

- Tremendous stimulus by increasing the money supply by $20 trillion?(as the government and Fed wants to achieve -- but does not have the capability to target spending).

- Big boost to asset management in the US (by supporting US fund managers).

- Source of capital for true long-term investments and R&D.

- Overall, less crowding out of private sector investment.

- Tremendous extension of US financial power around the world.

There must be some lobby that can push this through congress.

Fiscal Responsibility Can Work

As Greece and Spain to Germany are moving toward some fiscal responsibility - U.S. is pushing them to continue with expansionary policies. And many do not seem to dig much further.

The monetary easing during the financial crisis has focused on: (a) reducing the short-term cost of the immense sovereign debts, (b) subsidizing financial institutions to bring them back to health, and (c) replace some of the money eliminated by reduced velocity (Focus on wealth effects on monetary supply seem secondary).

I would also suspect that some inflation fueled by negative interest rates (held too long) -- would be designed to further aid debtors.

With a bit of confidence restored in the financial system, this Great Recession was ended via neo-Keynesian fiscal stimulus.

But this stimulus has focused on short-term expenditures (albeit with some thought as to potential long-term investment benefits -- e.g., build-out of infrastructure).

We must now consider the longer-term impact of deficit spending -- in the U.S., Europe and others.

Asset Prices (particularly real estate related) and currency imbalances have been at the crux of the financial crisis.

The future will be determined by how well we are able to: (1) wean ourselves from the current, extreme expansionary policies, (2) reinstate adequate capital formation with manageable private and public sector LONG-TERM capital costs, and (3) truly begin to make inroads into addressing the real costs of fossil fuels, over-population, and political, social, and resource inequities.

For the first two, I would argue that there are COMBINATION policies that can: (a) restore short-term interest rates to some normal real rate, (b) mitigate inflation momentum, (c) preserve quantitative easing measures, (d) make large improvements in deficit spending, and (e) increase certain fiscal spending to mitigate economic tightening effects.

(a) to (c) are relatively straightforward policy measures. For (d) and (e), governments should consider that:

- Increasing the retirement age will only have a secondary effect on reducing consumption (and will have a significant positive productivity effect).

- Reducing vacation and retirement benefits, in many cases for public sector employees, will also increase productivity and not immediately reduce consumption.

- In fairness, countries like Greece really needs to improve its collection of taxes from the upper class in order to make all of this not so regressive. They can go further by addressing the entitlements amongst the private-sector unions.

- For other belt-tightening measures that do have a negative consumption effect, governments can expand certain fiscal stimulus measures in the short-term. Those measures with a MULTIPLIER effect should be emphasized -- including programs for first-time home buyers, cash for clunkers, etc.

It is very easy, particularly for liberal governments, to use the financial crisis as an excuse to spend and put off hard-decisions on entitlement programs.

But governments must have the resolve and creativity in revitalizing the economy while aiding long-term investments with reduced long-term capital costs. We are already seeing dramatic currency fluctuations and capital flows -- with imbalances that we have not even begun to identify.

Hopefully we will do the right thing . . . soon.

As for energy, population and inequities, it would seem:

- The BP oil spill would seem to be an additional catalyst in a move toward renewable energy and energy efficiency.

- Gates/Buffet and others seem to have initiated a new era of philanthropy.

- Americans voting for an African-American President with a Muslim name has far reaching impact within and outside the U.S. Just today, the U.S. and Russia efficiently resolved the spy issue rather than make a drawn-out Cold War affair. And the Israeli Prime Minister looked unusually nervous to meet the President this week - not that I think he should. This is just a few of this weeks events, of course -- and not because of BO in particular, but because the people and king makers decided that 2008 was the right year.

- The population thing seems to have taken a back seat. Countries like Japan and Korea with low birth rates are trying to increase baby production and immigration (at least in Korea and seemingly the U.S.). It would seem that most of the farmers in China have already migrated to the cities -- but the idea that China and India and Indonesia and Nigeria will add multiples to the current middle class of over consumers . . . is pretty scary.

Go Commodities and Shipping!

Renminbi Quick Fix

It is surprising to me that we are still asking China to revalue their currency.

If everyone thinks that the Chinese currency is undervalued, then Americans, Japanese and anyone else should be exchanging their currency for Renminbi and buying up a lot of capital and real property in China (including those factories that seem to be making so much money making things for Americans).

This could certainly not be considered retaliatory. China is already one of the largest recipients of direct investments.

This might also convince the Chinese that perhaps their currency IS undervalued.

But mostly, the market forces will naturally appreciate the Renminbi. Even the Chinese government could not keep the Renminbi undervalued under such an onslaught of interest in their currency (many have tried, sometimes in reverse -- and all have failed).

So let us buy Chinese -- not just goods -- but land, buildings, factories, shares, etc.

EU Should Just Purchase on Open Market

It is confusing to me when the EU begins talking about making $600+ billion available. If they are going to lend this money to the respective governments -- then they are just transferring big profits to the speculators.

EU (and US and Asian countries) should just begin purchasing Greece (and other PIGS) notes/bonds at discounted prices -- then purchase new issues as required by the respective governments (at market interest rates -- rather than subsidized ones).

This is largely what the US Fed has been doing -- and has made money in the process.

In Europe -- this would certainly help the PIGS countries, the Euro, and the global community that provides liquidity for the PIGS countries.

Seems like a pretty simple solution to me. Would doubt that they need $600 billion -- if they went this route.

Insider Trading from Market Making

So listening to some of GS testimony yesterday -- it becomes clear where the new financial regulation should focus: Market Making.

Mr. Volcker, of course, led the idea of banning proprietary trading at banks/i-banks. But I think that he really meant market making.

The new Wall Street movie is coming out where M Douglas has gone to jail for insider trading. But I wonder if people realize the tremendous amount of "insider" information that GS and others gather from market making.

Please consider:

- GS listens to clients, and potential clients tell them how much they want to buy/sell and at what price (with particular access to larger "block" trades).

- In more complex transactions, like derivatives, clients tell them about their portfolio and how they may want to adjust the risk profile of such portfolios.

- GS gathers all this information -- and under the "guise" of internal risk management -- determines key trends, anomalies, the smart, and the stupid in the market place.

- Armed with this information, GS will broker trades and, when profitable, take one side of the trade for its own account (in the name of market making). And many would say that a "tip" from an influential GS trader can move the markets -- another convenient tool in profitable market making (If GS wants to unload a bunch of MBS, it can spread tips on how great this stuff is so that GS can get a good price).

- It seems to work well -- GS seems to represent half of the profits made on Wall Street from proprietary trading (I would guess that much of this flow through market making).

Perhaps there are issues of disclosure, very much one-sided information, insider trading?, ethics, laws?

As we all know now, this all intensified in the last 15 years when GS (and others) bought up market makers, became an exchange unto themselves, and raised capital to replace third-party counterparties to market making activities. Mr. B has said that it was a matter of survival -- well it clearly worked.

As most know -- these changes coincided with the shift in power at i-banks from the investment bankers to the traders/sales departments. It would seem that there was a shift from clients first to . . . survival.

The U.S. must have the support around the World for effective reform. Korea, in its leadership of financial reform in the G20, must consider a separation of broking and market making. Exchanges and interdealer brokers (that trade on a no-name basis) became overwhelmed by the "too big to fail" financial institutions and investors.

There seems to be grassroots/populist lobby, the banking lobby -- but where is the institutional investor lobby? Perhaps they are embarrassed that "sophisticated investors" have so long been taken advantage by their trusted advisors and trade execution providers. I would guess that real financial reform will happen when the institutional investors say -- enough.

On an Auspicious day for the Fed

So Mr. B has a second term -- it would be wise to not to be critical of one of the most power people, I suppose. But Mr. G and Mr. B reminds me of those who say: Reagan was one of our greatest Presidents -- not because he was brilliant, but because he chose and inspired good people to achieve great things.

Of course, we are also told that JFK, W Bush, and our current President have the same IQs . . .

Healthcare with the Budget, Volcker rule on a global basis, and victory in Haiti (Somalia would be good too) would be nice in 2010.

People are telling me that GS has taken a bit of a tumble. For those having difficulty getting compensated "as they deserve" at their banks/i-banks -- the opportunity of the decade will be for those that lead and own the spin-offs (hedge, prop desk, pe, etc.). In smaller spin-offs and sponsored ventures (e.g., Citi pe, Fortress, HMC spinoffs), owners have done extremely well.

Also noted that Fed e-mails indicate a bias to help GS during the AIG bailout -- like free money and putting their competitors out of business was not enough. Hope people realize that GS does not need people of brilliance -- candidates should read up on Dale Carnegie though (something about how to win friends and influence the world).

And Lazard has a new advisor -- Rohatyn (which most of us still cannot pronounce). We must all hope that we have the energy of Volcker, Rohatyn, Whitacre et. al. in our later years (and while we are at it -- guess a bit less than Edwards).

Also a bit less of Krugman's gloom and doom -- and telling the Chinese to fool with their currency. It is hard to understand Americans that ask China to do something because it might help us -- or have the hubris to think that Googleling is like eating and breathing.

Finally -- with all due deference to Mr. J -- but I wish his devices had a handle/strap -- and a detachable handset (if a bluetooth earpiece -- would, at least, recharge without carrying a separate charger). The iPad would be nice if it would fold in half, or fourths -- actually, if it was a small cube and projected a 3-d image that a person could read/interact with [that would be worthy of all this hoopla]. Thought that was the patent they just received.

Also would be great if Magicjack would finally let people keep their number -- and if they could figure out how to do business without threatening everyone else (and making money by charging for call termination).