Good morning Super,
I read and enjoyed the WSJ article you recommended. My summary is that their can be two generic problems within banks: A lack of liquidity and a lack of equity ( insolvency ). At this present time, I believe there is a crisis of insolvency which has cause almost all inter-bank lending to cease and thus removed the FED's ability to manipulate the credit cycle and by extension, the real economy.
Now we have to issues to deal with: 1) the FED has lost a good portion of its ability to regulate economic demand and 2) Many of the major financial institutions are insolvent.
As far as I know, the last time the banking system in America was insolvent was in the early 1980s. At this time many of the Latin America and other 3rd world loans were in default. A formal recognition of this fact would have caused write downs that would have bankrupted most of Europe's, America's and Canada's banks. The solution at that time was to allow the Banks to collectively hold these loans on their books at par value until they had built up enough equity to weather the write downs. This happened for the first time in 1986, when Citi Bank announced that they were writing down a portion of their loans; other banks followed Citi's lead.
What, in part, enabled this strategy to work was the continue profitability of each banks domestic franchise. All of the European, American and Canadian banks enjoyed robust levels of growth and profitability in their home markets and a steep yield curve.
Today, the profitability of each bank's domestic franchise, in most cases, is materially compromised in America and Europe; Canadian banks are remarkably profitable at home.
In my view, if the US and Europeans continue on their current path, the solution will be painful. When equity is injected, banks regain the ability to sustain write downs and remain technically solvent. But, the opposite side of a Bank's write down is either a consumer of commercial default. These continued defaults discourage consumers and businesses from taking any risks or additional debt; thereby removing the prospect of any economic growth outside of increased government spending. This process can be successful if enough equity is injected and all of the bad loans are written off and the assets behind them liquidated, but the cost is incredible.
The other option is to manufacture equity. This can be done through inflation. If the US and Europe were to devalue their currencies by 25% of so, then wages would rise between 20% and 33% on both continents. With hire incomes, families could begin to afford the mortgages on their homes again and businesses would see their balance sheets improve. Additionally, with fewer loans going into default, there would be less need to inject equity into the balance sheets of banks and because of this counter party risk would diminish.
Each scenario will have its own winners and losers. In the first scenario, the wealthy make out better as their prudent investments will retain their value through time. In the second scenario, we are bailing out many of the imprudent speculators; those who are the most indebted and who can avoid being liquidated will come out the best.
I don't know what will happen. But with the prospect of 1 in 5 US home ( and probably a similar number in Spain, the UK, Ireland and some parts of Italy ) worth less than their mortgage the political pressure to 'save the voter' will be substantial.
There is certainly the sense of panic in the air. Looking down from Canada, the US electorate is desperate for change. But, it also appears to have lost much of its frontier self reliance in what appears to be a jump to the left. A larger government is certainly the most prospective outcome at this time.
In my opinion, much of the economic freedom I enjoy today in Canada is the result of Canadians being forced to remain competitive with the massive US economy to the South. I suspect that this constructive pressure is about to diminish considerably.
Cheers,
Cameron
To: equismetastock@yahoogroups.com
From: no_reply@xxxxxxxxxxs.com
Date: Sat, 18 Oct 2008 19:29:15 +0000
Subject: [EquisMetaStock Group] Monetary History of the US
If you like to read clear and concise economic theory and what's wrong
with what is happening now, the Wall Street Journal had an interview
with in the Saturday Oct 18 edition with Anna Schwartz, co author
with Milton Friedman of A Monetary History of the United States.
Here's the link.
http://online.wsj.com/article/SB122428279231046053.html
The Journal allows non-subscribers to read opinions for a few days
before they take them down.
This is an exceptional look at economic theory from someone who was
alive during the depression and through all of the recessions. She
understand economic policy as well as any Fed executive.
As traders, we all need to prepare for a return to the oppressive tax
policies of the 1930's through the 1980's. Implied tax rates hit 70
plus percent in those days. If you want a read an article that
illustrates how someone with a small amount of historical knowledge
and misapplied statistics can make a case for higher taxation as a way
to grow, here's a link to an article written by such a person.
http://www.oregonlive.com/opinion/index.ssf/2008/10/bailout_instead_double_the_top.html
I also found it interesting how many comments were supportive. Wow,
does this speak to the level of education, or lack of it, in our
society. There is a huge difference between implied rates and
effective rates. In those days there were a zillion ways to tax
shelter income. Back then the IRS even allowed income averaging. Those
deductions are gone. No mention of that. No mention of the effective
tax rate back then and why rates were brought down.
In addition, America was not a global economy then, the economy was
nationalized. We bought what we consumed! so we h ad a huge post war
expansion because of the population growth. Of course the standard of
living was much lower then than it is today. In addition, credit was
hard to come by. No one was leveraged up to their teeth in credit card
debt. Opps. Was that all conveniently left out, forgotten, or maybe
the author just didn't know about those economic factors--that's
called ignorance. This is what happens when GDP is looked at as an
isolated number. Back then the government accounted for less than 10%
of the GDP. As we've moved toward socialism, the government now
accounts for 28% of the GDP. And it's going to grow in the next 8
years to something over 35%.
I also noticed that the economic history writer left out the fact that
when Europe raised taxes, particularly the UK, to those levels upto
90% business investment dropped and the wealthy left. (If that's
incorrect, the UK members my age should correct my argument.)
Anyway the point is when all these new tax policies hit, it's going to
change trading strategy. TA isn't going to help with that. When a
trader is keeping $0.40 on the dollar from successful trading rather
than $0.67 on the dollar, it changes the risk/reward ratios.
Remember the government is our partner only when we win. If we have a
net loss, the government only allows us to deduct up to $3000 a year
in losses. That's a great partnership. If you win I get 35% (moving up
to 50% or more shortly) and if you lose, my share of your losses is
limited to $3000. Sweat!
A large part of the population is yelling for change. They might want
to be careful what they wish for!
Enjoy those articles. Your trading life is going to change in the
years to come. Well, only the ones of you who survive.
Super
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