10 May 2010

Evil Taking Root in Europe -- The Next Day

How will the eurozone survive crushing debt?
Yesterday's announcement of a €750 Billion bailout of eurozone sovereign debt was cause for some celebration in the world's bond markets.  That celebration appears to have been short lived, as by the end of the trading day today bank swaps and the LIBOR inter-bank interest rates showed pessimism over the viability of the bailout, while the Japanese yen rose against the euro.

The market place assessment of the bailout has been simply this: "That's fine for today, now what about tomorrow and the day after next year?"  The bailout may have arrested the free-fall of eurozone sovereign debt in the marketplace, but it does nothing to eliminate the burden that debt places on the economies of Europe.
“Markets realized quickly that this crisis won’t be cured by adding liquidity, no matter how big it is,” said Toshihiko Sakai, head of trading for currencies and financial products at Mitsubishi UFJ Trust & Banking Corp. in Tokyo. “The structural problems of the euro zone will persist. I’m not surprised at all the euro is losing strength again.”
Still unanswered are the lingering questions about how successful efforts to trim deficit spending in the eurozone will be--even fiscally prudent Germany's deficit will be in excess of 5% this year, well in excess of the 3% allowed under euro rules.  Nations such as Greece and even the UK are faced with the daunting challenge of growing their economies while drastically slashing government spending, a task that yesterday's bailout mechanism does not even begin to address.

The eurozone is spending the equivalent of $1 Trillion, not to solve their sovereign debt crisis, but to buy (on credit) a little time before they must resolve their sovereign debt crisis.  That does not seem a wise use of increasingly scarce financial resources.  €750 Billion of new debt will not make the existing debt any less troublesome; it will most likely make that debt more troublesome.

The evil taking root in Europe is simply this: to defend a particular bit of money--the euro currency--Europe is prepared to lay waste to its nations' finances and economies.  The marketplace realizes this, and so the euro's downward spiral against other currencies continues despite Europe's spending their very last euro to reverse that course.

09 May 2010

Evil Taking Root in Europe

The Euro is under duress from a slew of unforced errors.
Recently, I speculated on the practical wisdom contained in the Bible verse "For the love of money is a root of all kinds of evil....." Since then, events in Europe have illuminated the Biblical warnings about an inordinate focus upon money, as the $146 Billion bailout of Greece announced on 3 May 2010 failed to soothe global bond markets, resulting in a pan-European debt crisis:
Yields on German two-year debt reached a record low, falling to 0.71pc on safe-haven demand in echoes of credit stress at the height of the financial crisis. This is below the European Central Bank's short-term rate of 1pc. "This is very unusual and indicates concern about systemic risk from sovereign debt," said Stephen Lewis from Monument Securities.
The response of European finance ministers has been to blame the bond markets themselves, laying the need for a fresh bailout of the Euro currency itself squarely on the bond markets:
“In the night, when the markets are opening, we cannot afford a disappointment,” said Finance Minister Anders Borg of Sweden, one of 11 EU nations not in the euro. “We now see herd behavior in the markets that are really pack behavior, wolfpack behavior.”
The solution to the Euro crisis?  Pile on still more money--this time on a scale to rival the US Treasury's TARP program in 2008:
European policy makers unveiled an unprecedented loan package worth nearly $1 trillion and a program of securities purchases as they spearheaded a drive to stop a sovereign-debt crisis that threatened to shatter confidence in the euro.  Jolted into action by last week’s slide in the currency to a 14-month low and soaring bond yields in Portugal and Spain, governments of the 16 euro nations agreed to make loans of as much as 750 billion euros ($962 billion) available to countries under attack from speculators.
Is that really a solution, when every nation in Europe has external debt in excess of one hundred percent of GDP?
  • Greece' external debt is 170% of GDP
  • Italy's external debt is 147% of GDP
  • Germany's external debt is 182% of GDP
European nations are all highly leveraged--far more so than the United States is (external debt is 96% of GDP)--which begs the question of from where do the EU countries presume to get these billions of euros?

Further, how does the creation of still more debt by nations already drowning in debt lend strength and credibility to the euro?  This latest rescue package is still little more than a series of preferential loans to distressed nations--cheaper than what those nations could borrow on the open market, but borrowing nevertheless.  This past week's currency crisis is a debt crisis on steroids, and the European Union's solution is to just borrow more, albeit at more "friendly" rates.  Given that the debt crisis is predicated upon the grave doubt that Greece and other nations will be able to pay off their external debts, further borrowing does not deliver any new assurance that the new debt will be easier to repay than the old debt.

Finally, the bailout mechanism is laden with its own potential instabilities, for it empowers the European Union to reach deeper into the governance of member states than any ratified treaty envisions:
"It is an absolute general mobilization: we have decided to give the eurozone a veritable economic government," said French president Nicolas Sarkozy, once again basking as Europe's action man. "Today we have an attack on the whole of the eurozone. This is a systemic crisis: the response must be systemic. When the markets open on Monday morning we will be ready to defend the euro." 
In the space of a weekend, the EU has determined to arrogate to itself powers well in excess of those contained within the Lisbon Treaty:
But if the early reports are near true, the accord profoundly alters the character of the European Union. The walls of fiscal and economic sovereignty are being breached. The creation of an EU rescue mechanism with powers to issue bonds with Europe's AAA rating to help eurozone states in trouble -- apparently €60bn, with a separate facility that may be able to lever up to €600bn -- is to go far beyond the Lisbon Treaty. This new agency is an EU Treasury in all but name, managing an EU fiscal union where liabilities become shared. A European state is being created before our eyes.
Perhaps this is an inevitable evolution, but it is worth noting that the United States Constitution was hammered out over a summer in 1787, and that the Constitutional Convention was only called after some years of ineffective central government under the Articles of Confederation; similarly, the Treaty of Lisbon--analogous in many ways to the US Constitution--took the better part of a year to craft.  Is zealous defense of a particular currency sufficient impetus to accomplish in a weekend what otherwise would (and, arguably, should) take far longer?

Very likely, the answer will turn out to be "No."  Already, there are consequences to the bailout strategy which reach beyond Athens and Brussels, and even Berlin.  Regional elections in Germany have produced a rejection of German Chancellor Angela Merkel's acceptance of a Euro-centric response to the ongoing financial crisis and with it her control of the Bundesrat, the upper house of the German parliament.
According to a poll on Saturday, 21 % of voters said their decision would be influenced by the bailout.

And the next day they voted the regional coalition of Mrs Merkel's Christian-Democrats (CDU) and their liberal Free Democrat allies (FDP) out of office.
Such are the "sorrows" generated by making currency--money--the center of everyone's attention.  Such are the "sorrows" cautioned against by the Apostle Paul in his letter to Timothy.

The nations of Europe have lived beyond their means for many years--Greece in particular although not exclusively.  For years they have consoled themselves with a conceit that a common currency meant money would always be in abundance.  For years they have ignored the fundamental economic nature of money:
It's time to get back to basic economics. Money--both the paper and electronic varieties--is, in and of itself, worth nothing; it has no intrinsic value. It is a means--and a profoundly important one--of enabling people to more easily conduct transactions without having to go through the clumsy and utterly inefficient barter process.
What the governments of Europe refuse to acknowledge is that the current debt crisis within the Eurozone is not "wolfpack behavior" but a vote of no-confidence by bond markets in those governments' fiscal policies.  There is no denying that is the fiscal policies of European nations that have brought them to this point--the decision to run a deficit is a fiscal decision, after all--and therefore it will be within the realm of fiscal policy that ultimate resolution to the debt crisis will be found.  

This, of course, is the crux of the problem, for no nation wants to take on the hard choices necessary to bring their debts under control.  As Bill Fleckenstein observed in his "Contrarian Chronicles" column:
The ending is not clear, but here's something that is: There's virtually no chance that the Greeks (who have defaulted on debt often in the past) will be willing to adhere to austerity measures just so they can use a colored piece of paper -- the euro. Especially since government workers, the folks who would probably have to give up the most, are the most entrenched.
 Nor is a nation such as Great Britain any more amenable to such policies:
Mervyn King is warning that the victor in next week's election will be forced into austerity measures that will keep the party out of power for a generation, according to the US economist David Hale.
Instead of tackling these issues head-on, the nations of Europe have opted to merely shovel more money on top of the pile, digging themselves deeper into a financial hole, in hope that stabilizing the euro will make all these distasteful duties disappear.

When at last the money runs out, Europe may find itself so deep in a financial hole that not a single one of the institutions it has built up since WWII will survive intact.  Such is the destruction that comes when the evil that is a love of money and currency takes root on a national scale.

04 May 2010

Arizona's Immigration Law -- Affirming Federal Law, Challenging Federal Supremacy

The State of Arizona accomplished something remarkable last week, when, on 24 April 2010, Governor Jan Brewer signed Arizona Senate Bill 1070 into law.  Widely described as "the nation’s toughest bill on illegal immigration", SB1070 empowers local and state law enforcement officers to investigate a person's immigration status in conjunction with the normal investigations carried out during routine stops such as for speeding or other traffic violation.

The reaction of the Obama Administration has been one of condemnation:
Speaking at a naturalization ceremony for 24 active-duty service members in the Rose Garden, he called for a federal overhaul of immigration laws, which Congressional leaders signaled they were preparing to take up soon, to avoid “irresponsibility by others.”
The Arizona law, he added, threatened “to undermine basic notions of fairness that we cherish as Americans, as well as the trust between police and our communities that is so crucial to keeping us safe.”
How does SB1070 "undermine basic notions of fairness"?  By strict enforcement of Federal immigration statutes, as stated plainly in Section 1 of the bill:
The legislature finds that there is a compelling interest in the cooperative enforcement of federal immigration laws throughout all of Arizona. The legislature declares that the intent of this act is to make attrition through enforcement the public policy of all state and local government agencies in Arizona. The provisions of this act are intended to work together to discourage and deter the unlawful entry and presence of aliens and economic activity by persons unlawfully present in the United States.
It is certain that a number of mis-statements have been reported about the bill.  The New York Times, for example, incorrectly stated that the bill criminalizes a failure by immigrants to carry their immigration documents with them at all times:
The law, which proponents and critics alike said was the broadest and strictest immigration measure in generations, would make the failure to carry immigration documents a crime and give the police broad power to detain anyone suspected of being in the country illegally. Opponents have called it an open invitation for harassment and discrimination against Hispanics regardless of their citizenship status.
In fact, such failure has been a misdemeanor under Federal law since 1952, and may be found at 8 USC §1304(e):
(e) Personal possession of registration or receipt card; penalties
Every alien, eighteen years of age and over, shall at all times carry with him and have in his personal possession any certificate of alien registration or alien registration receipt card issued to him pursuant to subsection (d) of this section. Any alien who fails to comply with the provisions of this subsection shall be guilty of a misdemeanor and shall upon conviction for each offense be fined not to exceed $100 or be imprisoned not more than thirty days, or both.
8 USC §1306(a) enhances the penalties for willful non-compliance with this requirement:
(a) Willful failure to register
Any alien required to apply for registration and to be fingerprinted in the United States who willfully fails or refuses to make such application or to be fingerprinted, and any parent or legal guardian required to apply for the registration of any alien who willfully fails or refuses to file application for the registration of such alien shall be guilty of a misdemeanor and shall, upon conviction thereof, be fined not to exceed $1,000 or be imprisoned not more than six months, or both.
What SB1070 does do is add to the federal misdemeanor offense a state offense of trespass, according to Section 3 of the bill:
Additionally, SB1070 explicitly defers to Federal authority in determining a person's immigration status:
However, SB1070 does not, in fact, enhance the criminality of being in the United States illegally.  The Arizona Criminal Code already defines trespass in sections 13-1502 and 13-1503, in both sections establishing the criteria of "Knowingly entering or remaining unlawfully" at a particular property.  Arguably, then, even without the provisions of SB1070, an illegal immigrant is guilty of trespass wherever he or she goes, within the jurisdiction of Arizona law.

Thus SB1070 becomes a most paradoxical articulation of states' rights--an affirmation of the right (and perhaps duty?) of a state to enforce and thus re-affirm Federal law.  The historical expressions of states rights generally run counter to this, as far back as the Kentucky and Virginia Resolutions of 1798 and 1799.  

Penned by Thomas Jefferson and James Madison, respectively, the Resolutions asserted the power of states to nullify Federal law on the basis of unconstitutionality, as the Kentucky Resolution of 1798 declares quite forcefully:
Resolved, That the several states composing the United States of America are not united on the principle of unlimited submission to their general government; but that, by compact, under the style and title of a Constitution for the United States, and of amendments thereto, they constituted a general government for special purposes, delegated to that government certain definite powers, reserving, each state to itself, the residuary mass of right to their own self-government; and that whensoever the general government assumes undelegated powers, its acts are unauthoritative, void, and of no force; that to this compact each state acceded as a state, and is an integral party; that this government, created by this compact, was not made the exclusive or final judge of the extent of the powers delegated to itself, since that would have made its discretion, and not the Constitution, the measure of its powers; but that, as in all other cases of compact among powers having no common judge, each party has an equal right to judge for itself, as well of infractions as of the mode and measure of redress.
South Carolina, in enacting its Ordinance of Nullification in 1832, was similarly emphatic in proclaiming the power of an individual state to invalidate Federal statute on the basis of unconstitutionality:
We, therefore, the people of the State of South Carolina, in convention assembled, do declare and ordain and it is hereby declared and ordained, that the several acts and parts of acts of the Congress of the United States, purporting to be laws for the imposing of duties and imposts on the importation of foreign commodities, and now having actual operation and effect within the United States, and, more especially, an act entitled "An act in alteration of the several acts imposing duties on imports," approved on the nineteenth day of May, one thousand eight hundred and twenty-eight and also an act entitled "An act to alter and amend the several acts imposing duties on imports," approved on the fourteenth day of July, one thousand eight hundred and thirty-two, are unauthorized by the constitution of the United States, and violate the true meaning and intent thereof and are null, void, and no law, nor binding upon this State, its officers or citizens; and all promises, contracts, and obligations, made or entered into, or to be made or entered into, with purpose to secure the duties imposed by said acts, and all judicial proceedings which shall be hereafter had in affirmance thereof, are and shall be held utterly null and void.
Far from nullifying Federal law, SB1070 declares a most unequivocal support of Federal law--specifically, the willingness of Arizona to expend state resources in its enforcement.

How is it, then, that Arizona's immigration law has earned especial opprobrium from Obama, his Administration, and a number of commentators throughout the media?

One possible answer may be that Arizona's statute, as it affirms the probity of Federal law, also affirms Arizona's power and prerogative as a state in enforcing all the laws governing its territory--including Federal law.  While such affirmation is not a direct challenge to Federal authority, it does pose a challenge to Federal supremacy.  Arizona, with passage of SB1070, has declared itself co-equal with the Federal government in enforcing immigration law.  With SB1070, Arizona need not await the pleasure of Immigration and Customs Enforcement (ICE) agents to investigate the immigration status of persons contacted in the ordinary course of law enforcement; Arizona proclaims for itself the autonomy to undertake such investigations, and to act on the results.

However, the Constitution only asserts that Federal statute is superior to state statute:
This Constitution, and the Laws of the United States which shall be made in Pursuance thereof; and all Treaties made, or which shall be made, under the Authority of the United States, shall be the supreme Law of the Land; and the Judges in every State shall be bound thereby, any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.
The Constitution is silent upon whom has the authority to enforce Federal law, and the 10th Amendment certainly opens a window for a state to assert a role in such enforcement.  The Constitution makes it clear that Federal law is fully upon a state, and the courts of every state are obligated to uphold Federal law; what state courts are obligated to uphold, state law enforcement officers might reasonably be tasked to enforce.  As the Constitution does not expressly delegate exclusive enforcement jurisdiction of Federal law to the Federal government (and in fact expressly delegates some measure of jurisdiction to state courts via the Supremacy Clause), the reservations of the 10th Amendment may reasonably allow states to declare for themselves a role in enforcing Federal statute:
The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.
Federal law enforcement is not a power prohibited by the Constitution to the states--a fact somewhat acknowledged in the 1956 Supreme Court Case Pennsylvania v Nelson:
It should be said at the outset that the decision in this case does not affect the right of States to enforce their sedition laws at times when the Federal Government has not occupied the field and is not protecting the entire country from seditious conduct.
Setting aside the particular merits and demerits of Arizona's immigration law, that Arizona would seek to enact such a statute is a challenge to reassess the relative roles and powers of state and Federal government to an extent not seen since the 1830s.  Whether the legislation is intended as a confrontational arrogation of state authority in the face of Federal inaction on immigration enforcement or as an effort to complement Federal resources with state resources, Arizona has issued a potent reminder to this nation that our system of government presents two government tracks--state and Federal--wherein neither can entirely dominate the other.

02 May 2010

The Love Of Money -- Thoughts On Finance and Financial Reform

For the love of money is a root of all kinds of evil: which some reaching after have been led astray from the faith, and have pierced themselves through with many sorrows. -- 1 Timothy 6:10

Greece is being pierced with many sorrows at the moment, facing the prospect of years of deflation induced by drastic cuts in government spending, imposed as a condition of the $146 Billion the EU and the IMF have jointly agreed to lend Greece.

What sort of sorrows?  Essentially, Greeks will be working more for less--and will do so for the foreseeable future.  Among the new government spending cuts imposed by the bailout package:
  • Scrapping bonus 13th and 14th month wages for public sector workers as well as for retired people from both the public and private sectors.
  • Raising the retirement age for women from 60 to 65, bringing it in line with that for men;
  • Raising the sales tax from 21pc to 23pc this year.
Politically, the sorrows include a passing of a measure of sovereignty from Athens to Berlin, as Germany's pivotal role in assembling the bailout package empowers them to dictate many of the conditions:
Berlin was Europe's capital last week, basking in summer heat of 26 degrees. The heads of the European Central Bank and the International Monetary Fund (IMF) – both French, oddly – arrived as supplicants, pleading with Chancellor Angela Merkel and a stern finance committee of the Bundestag to save monetary union. Nowhere else mattered. The markets have stopped listening to Paris or Brussels.
On the other side of the globe, China is struggling to avert the sorrows of a bubble economy,  raising bank reserve ratios and employing other mechanisms to stave off inflation but with no immediate impact:
China’s third increase of bank reserve ratios this year left benchmark interest rates and the yuan’s peg to the dollar unchanged, risking the need for more concerted effort to contain property prices and inflation in coming months.
The common thread in both financial events is a subordination of policy and basic economic activity to a quest for currency.  Greece's bailout is driven by their accumulation of so much sovereign debt that they are effectively excluded from capital markets, while China's manipulations are calculated to curtail a growth of the money supply without curtailing the economic expansion behind the money supply:
The latest move adds to a government crackdown on property speculation after record price increases in March and came on a holiday weekend, with Chinese markets shut today. Within an hour of the central bank announcement, Finance Minister Xie Xuren said that officials remained committed to expansionary policies to cement the nation’s recovery. 
These events make it worth reminding oneself of the fundamental nature of money, and its relevance to economics at any level.  As Steve Forbes notes:
It's time to get back to basic economics. Money--both the paper and electronic varieties--is, in and of itself, worth nothing; it has no intrinsic value. It is a means--and a profoundly important one--of enabling people to more easily conduct transactions without having to go through the clumsy and utterly inefficient barter process.
Money is important only in that it makes transactions by which we convert other resources into the things and services we desire for whatever reason--and utterly irrelevant in all other aspects.  Money is a measure of value only.

As the above quotation from Timothy points out, a focus on money invariably leads to trouble.  Artificial manipulations of various money metrics, such as interest rates, serves mainly to distort the value statements implicit in the prices of goods and services.  Artificially pushing prices down (as China seeks to do) implicitly declares things to be somehow less valuable, even as the desire and demand for those things is otherwise unchanged. Constant borrowing, the particular fiscal sin of Greece (and, indeed, of a great many nations including the United States), explicitly involves paying for those things without surrendering other resources--in essence curtailing one-half of every transaction.

Perhaps nowhere is the irrationality of a focus on money itself more apparent than in the contradictory efforts in Washington to "reform" America's finance industry.  While on the one hand the SEC is pursuing a fraud case against one of the largest of the Wall Street banks, Goldman Sachs, Congress is pursuing "reform" legislation that would encourage Goldman to engage in still more of the behavior for which the SEC is seeking redress:
Recall that during the financial implosion of late 2008, Goldman was not bailed out directly by taxpayers, but instead received tax dollars as a creditor of AIG. Goldman received $12.9 billion in the “backdoor bailout” of AIG because of the credit default swaps it owned that AIG had insured. Goldman and other of AIG’s counterparties were paid by the government 100 cents on the dollar in this bailout, whereas creditors in bankruptcy court often get less than 50 cents on the dollar.
Bear in mind that Goldman Sachs was, ostensibly, an "investment bank" until 21 September 2008, when Goldman and Morgan Stanley, the other major investment bank in the United States at that time, opted to become "bank holding companies" and submit themselves to regulation via the Federal Reserve. Bear in mind also the presumed purpose of an "investment bank" is to assist "...corporations and governments in raising capital by underwriting and acting as the agent in the issuance of securities."

There is no denying the value to business of intermediaries such as a Goldman Sachs in gathering together the necessary funds to build a new factory or bring a new product to market. There is also no denying that the buying and selling of derivatives that has fascinated Wall Street in recent years has little to do with the actual raising of capital. Indeed, the financial crisis of 2008 did much to prove Warren Buffet's prescient 2003 description of derivatives as "financial weapons of mass destruction"; indeed, much of Greece's present financial dilemma appears to stem from their use--and apparent mis-use--of derivatives to sustain years of deficit spending.

A love of money, it seems, has the capacity to wipe out the economies of entire nations.

Perhaps, then, the Biblical caution offers some guidance for how to reform both financial markets and public finances.  If we are to focus less on money itself, one way to do that is to focus more on the actual value of things.  If we can remember that, in the act of purchase, we are merely converting one resource into another--e.g., turning a day's labor into food for the table--and that money is never a resource but merely the medium, perhaps we can see how to order our affairs--both public and private--so as to avoid the sorrows an inordinate focus upon money brings.  If governments can absorb the grim reminder of Greece that even sovereign debts must in time be repaid, they can muster the institutional will and discipline to not borrow beyond their capacity to repay.  If banks can acknowledge their contribution to value lies solely in their capacity to facilitate non-financial business activity, perhaps they can be dissuaded from the reckless and risky gambles that derivatives transactions have proven themselves to be.

From a practical policy perspective, the Biblical caution invites governments to restrain their spending to such revenues as may reasonably be raised--that while there can and should be debates over how much government should tax, and what government should tax, there should be little debate that government should not borrow except in extraordinary circumstance.  Similarly, the Biblical caution suggests that investment banking should return to its original focus--helping businesses raise capital--and should not "invest" in synthetic means with derivative pseudo-securities whose connection to tangible assets is increasingly nebulous, and that proper government regulation of financial markets would be to maintain clear relationships between investment securities and underlying tangible assets, and that money supplies be allowed to grow--or shrink--as a rational response to the expansion or contraction of an economy's asset base--not manipulated to gain transitory advantage over other currencies in other markets.

So long as governments and financial markets focus inordinately on money, and not at all on the actual values of things, the sovereign debt crisis of Greece and the private debt crises of Wall Street are dramas that will be replayed again and again.  Any effort to "reform" financial markets should begin with moving market focus away from money itself.