Credit and Demand

Last week was supposed to be a big showdown at the Harvard Law School on whether Steve Keen is double counting  when he aggregates demand from income and the change in debt.  To look at the absurdly close correlations between the change in debt, the second derivative -- the so-called credit accelerator -- and employment, you have to conclude No.  This is massively explanatory

One participant in a session with Keen at the Fields Institute last year opined that the dispute was a matter of ex-ante and ex-post observations, and that the issue would be settled if Keen simply changed terminology from aggregate demand to effective demand.  It was the ex ante force that John Maynard Keynes had meant in his discussions of demand.

I'm personally not certain anything is explained by aggregate demand if all we are aggregating is income.  In combining the change in debt with income, we are aggregating one side.  And as I say, it is hugely explanatory regarding employment.

We might aggregate consumption and investment spending, but that will be ex-post as well, and in fact, the dividing line between consumption and investment is not particularly dark  Cars are investment for a household, and even stocks of tuna fish or the contents of a freezer.  Investment goods when manufactured by a business get a big bright bow and all kinds of tax favors.  Investment goods built by the local sanitary sewer district or the state's department of transportation get no such bow.  They might be eligible for bonds, but normally it's just spending with no positive product.

And in aggregate demand we are in one sense simply trying to close the spending gap, so we have adequate demand to employ everybody.  It doesn't really matter whether it's consumption or investment.

Except when it comes to the debt load and debt financing.

That is, if we borrow to spend, we ought to want that borrowing to produce a tool or educated person or piece of infrastructure or plant that will generate the revenue to pay back the loan out of increased goods or services.  A "productive" investment.  If we borrow to consume, we have set ourselves a problem.  And if we borrow to speculate, we have set the whole economy a problem.

Nonsense economics claims that all government can do is spend. Quite the opposite is the case.  There is very little government does, aside from the much rumored rampant corruption and the occasional sports arena that is not some sort of public good, social or physical infrastructure.  Give me an example, if you will, of blatant government spending.

The public pension program of social security?  No.  It is a transfer program, a self-contained public pension program.  Government spends nothing, it is all done by the recipients, less a tiny overhead charge.  You might say that welfare is simple spending. Subsidizing the poor and indigent up to subsistence.  But if that is as close to wasteful spending as you can get, that's pretty sad.  And if everyone had a job, the ragbag of public programs could be put away by reason of income.

A footnote:  Full employment is the law.  Bank profitability is not the law.  In the full Employment Act of 1946 Congress made full employment the target of government activity.  In the Full Employment and Balanced Growth Act of 1978, they updated and reinforced it.  But what's a law these days, eh?  Can you hear me now?

Let's return to the idea that we want to borrow money mostly to invest in productive activities, not so much to consume, and never to speculate.

And I get it that the government doesn't need to borrow in order to spend. The whole exercise with the Fed buying Treasuries illustrates if nothing else that the public doesn't need to cough up any cash for the government to spend.  So I get that.  We are printing plenty of money, it is not causing inflation, but the reason for that is that the money is not being spent, so it is not entering the money supply.  Another recent Steve Keen paper displayed how QE can migrate from the Fed to the banks and never stir up the real economy.  Its only plumage is when the banks buy shares, as Keen calls them, stocks.  Money might trickle out there.  But it could also simply be absorbed in the stock prices.

One analyst suggested, in fact, that 85% of the S&P's performance was correlated with QE.

The idea that we want productive assets for our borrowed money does have some firm roots.

One, it is much easier to sell the public on, "Let's buy infrastructure, education, or relief from the climate chaos," than it is, "Let's spend out of thin air."  Even though this is what they support with the Great and Marvelous Bernanke.

Two, if we are expanding the number of productive loans, we are expanding the hedge financing in Minsky's financing structures.  That is, as Minsky described the progression, from hedge, or productive financing, through speculative, or rollover financing, into Ponzi financing.  The reach for yield leads investors into ever more risky ventures.  But were they leaving productive investments on the table because the yield was too low?  Certainly this is one reading of Keynes and Minsky.  But what if thousands of productive investments were passed over because the markets had no access to public goods?  What if seawalls or levees costing hundreds of millions were left unbuilt and storm damage incurred in the billions that might have been avoided.  (I guess we should eliminate the double negative:  If a project costing one hundred million saved two or three billion, THERE is a productive investment.)  The fact that this prudent investment is invisible, or the benefits of good education, or even the efficiency of good transportation infrastructure, is a matter of politics, not economics ... cost and benefit  It is not the rate of return on these projects, but the fact that they are in the public realm that prevents their being undertaken.  These are high return-low risk operations when the natural payment mechanism for public goods is operable -- that would be taxes.  But we know from our political study that taxes are not really just the way we pay for public goods, taxes are instead the fangs of a vampire government.  Or to be less hysterical, I guess I should just say that the natural financing mechanism for these high return investments is clogged by petty minds.

Let's take an example.  The president of CSX, the big Eastern rail company, says in this clip that railroads have plenty of cash flow for buybacks and dividends, but not so much for investment.  Why?  They are too busy making money shipping bulk coal and oil on present track, squeezing the little guys and pushing low profit freight onto the highways, not to mention passenger.  The other hand is busy thumbing their noses at the public interest.  Well.  He doesn't say it quite like that.  You listen.

Charts .... or is it Graphs?

Money and Banking

Transcript, presentation 1.20.13, London, Positive Money Conference
Victoria Chick
Professor emeritus, University College London
author of Macroeconomics After Keynes

Money and Banking

I’ve chosen to look at this from the standpoint of academic economists, because I am one and that’s what I know, and there’s some interesting things, I think, to say about that. The rest of academics would look to us for answers, claiming this was our area of expertise and we ought to be able to enlighten them. It is a very strange fact of Fate that I’ve been in this business long enough for the kind of understanding that you’ve been exposed to through “Where Money Comes From” and this new book constitute a return to what I was taught as an undergraduate.

Dennis Robertson, a Cambridge economist, used to say, “Highbrow opinion is like a hunted hare. If you stand in the same place long enough, it will come around again.” Well, it has come around again. The shocking thing to me is the amount of energy that people in Positive Money and places like that have to expend to get a point of view across that was taught tome as an undergraduate and then forgotten. So there has been a deliberate regression. Well, deliberate? There has been a regression from the understanding which pertained in the late Fifties and early Sixties, and now we’re fighting to restore that understanding. That is a very peculiar state of affairs, and I hope to give you a few ideas, nothing more, as to how it might have come about.

The question has to be treated in two parts. According to a very strange split in the way that money is talked about in academic economics. First of all, it has a role to play in what we call “macroeconomics.” And I think most of you have a fairly good idea of what that is. It is the theory of the economy as a whole and the policies that you might use to change the economy in some way from time to time. Then, quite separate from Macroeconomics, there are always courses in Money and Banking. Macroeconomics is sort of thought of as a core part of economics, and money and banking a kind of optional, slightly frivolous thing that some people spend a little time thinking about.

So what I have to say will fall into those two parts. But they are, it turns out, connected. In macroeconomics, money in the mainstream of economics has a very limited sphere of influence. And it doesn’t connect at all well even with the kind of money and banking which is taught as this frivolous option that I spoke of. Keynes – John Maynard Keynes – in his famous letter to George Bernard Shaw said, when he was writing the General Theory, that he thought what he was writing would revolutionize the way the world thought about economic problems.

And later on in a small article he spelled out what was different about the kind of economics he was creating from what had gone before. He said, “I want to talk about a money production economics. And the kind of economics we have been doing is about a real, exchange economy.” That was his basic contrast. That was what he thought would be his big revolution. His was the theory in which money permeated the entire economy. Labor bargains for money wages. Saving and investment were analyzed by him in money terms. The rate of interest was a monetary phenomenon and it was determined by exchanges of money assets. All these aspects are missing from today’s mainstream economics, as they were from the economics that surrounded Keynes when he was writing. We have gone back in mainstream economics to talking about a real, exchange economy, which has an extremely limited role for money.

Classical economics, or pre-Keynesian economics, models everything in real terms. It’s “real” wages, that is, the amount of goods money can buy, and so on down the line. Money is only brought in at the very last minute to determine prices. So the role of money is separate from this whole analysis of the real economy. It has this little role to play in determining the price level. The term “pure” economics, as used by Alfred Marshall and Walras, meant the economics of this real economy, this barter economy. So by implication money is profoundly “impure,” I suppose.

And the idea was that money was neutral. It didn’t really affect these real relationships. All it did was determine price. Prices could be anything, it didn’t really matter. The real relationships were set up by the system elsewhere, without money, the pure economy, the barter economy, the exchange economy.

This kind of system – dividing the economy between the real and the monetary – was known as the “Classical Dichotomy.” On the monetary side, you had the Quantity Theory of Money. The quantity of money determined prices. Full stop. End of story. Not very interesting, actually, for a role for money.

Now, Keynes showed that the Quantity Theory of Money was based on enormously restrictive assumptions which were very unlikely to pertain in practice. But Milton Friedman – whose name I’m sure you know, too – was able to use the QT as the foundation of his Monetarist revolution in the late Sixties, early Seventies. And as I am sure you know, the Monetarist revolution touched the heart of Margaret Thatcher and found its way into monetary policy.

Monetarism – you may not know, but you ought to – is also the basis for the construction of the euro (Can’t be very good, then, can it?) and determines the way the ECB is doomed to function, and is responsible for inflation targeting more generally in the Western World. And it could be said to be the foundation also of Quantitative Easing, though that interpretation is open to some dispute.

Monetarism and the Quantity Theory of Money and the Classical Dichotomy are all over Western economies like a kind of skin disease. Quite extraordinary. And the Keynesian story, in which money influences everything that happens, has been forgotten, which I think is a tragedy.

Now this simple, sequestered role of money in an analysis which uses the Classical Dichotomy gives rise to some wonderful supporting rhetoric. After all, it must be more interesting to study the “real” economy than the monetary economy. And the “real” economy is a “pure” economy. Money is imagined to be only a veil thinly drawn across the real economy, not affecting anything. And anybody which thinks it does affect anything is subject to “money illusion,” which is a terrible mental illness.

Now, How does this happen? What is the appeal of this way of analyzing the economy? We know, if we keep our common sense about us that money does affect everything. One reason pertains to academic economics and not to common sense people like yourselves: Economics does not really understand its discipline to be historically situated. It thinks of itself as uncovering universal truths. And it therefore fails to recognize the institutional basis of its theories.

The Quantity Theory of Money was devised in the days of circulating gold coin, not in the days when the banks were overwhelmingly the suppliers of money. And yet the Quantity Theory of Money has been carried forward, and as I have told you, has influenced major institutions to this day. The idea that money should have something do with the determination of prices has a certain intuitive appeal. And of course, it DOES have something to do with the determination of prices. But the Quantity Theory of Money says that its ONLY function is to determine prices, and prices are determined solely by the quantity of money. And that is going far too far.

Another possibility of money of explaining how Macroeconomics has come to this pass is sheer laziness. Hayek, an unlikely source for what I am going to read to you, put it like this.

The task of monetary theory is much wider than is commonly assumed. Its task is nothing less than to cover a second time the whole field which is treated by pure theory [“pure” theory, real theory, yes?] under the assumption of barter, and to investigate what changes in the conclusions of pure theory are made necessary.

So if you want to take money seriously, you have to do the whole thing again.

Now I think Keynes DID do the whole thing again, and he has been wiped off the face of mainstream economics. He’s not taught. Nobody knows what he said. Nobody reads his book. We’ve regressed to pre-Keynesian economics.

Let me turn to this separation between Macroeconomics and Money and Banking that is enshrined in the academic curriculum. As I said, when I was a student in the late Fifties and early Sixties, it was widely understood, absolutely taken for granted, that the causality went from loans to deposits. Loans create deposits. Now students are all taught that banks lend on deposits, that deposits create the ability to lend, and banks respond to that. This is a regression, which people like Ben are trying to redress or reverse.

And again, I tried to think of reasons why this idea of deposits pre-existing and determining the volume of loans has such a tremendous appeal, and why the idea that loans create deposits is so difficult for people to grasp.

One factor is that there is a great fault in the language that we use, or a great bias in the language that we use in relation to banking. The word “deposit” is a hangover from the days of the goldsmiths who took bags of gold for safekeeping. And you’ll find if you look closely that much of the Neoclassical theory of banking still regards banks as kinds of glorified safes, which they clearly are not.

Add to this the failure to understand banks as a system, as an interrelated system. You heard much in the breaking of the crisis about the lack of systemic understanding, of the risks that the banks were running. If one DID think systemically, one would realize easily the check you deposit in your bank came from somebody else’s deposit. It’s not new money at all. It’s just moving around. Then if you think systemically, or macroeconomically, about banks, there are very few sources of new money to the system, EXCEPT when banks are all expanding their balance sheets together. So the language is bad.

And we also speak of “lending money.” Banks do not lend money. It may feel like that when you get a loan. But that’s not what they’re doing. They don’t have a pot of money which they are passing on. What they’re doing is accepting your IOU and agreeing to pay your outgoings while you don’t have any money in your account in an overdraft system. In a loan system, they simply write up your account.

This leads us to another point, which is very powerful, which illustrates that it is in the banker’s interest not to let you know what they are doing, because you really wouldn’t like it. That they have too much power. And others, including academic economists, might not like the power of bankers to be recognized either. They know that if they expose the bankers, they will be in deep trouble, and their funding will be cut, and all kinds of terrible things will happen to them. So they go along with it. You’ve all seen “Inside Job,” I take it. It is a kind of Inside Job problem.

Furthermore, there is a long history of wanting to believe that money is something real. The idea that bankers can manufacture money with the flick of a pen is just too unpalatable. And that leads to rejecting it. The idea that should depend for its money-ness only on the fact that we all accept it, is just too freaky for words. So it doesn’t come into the textbooks. It would also make it very clear that money is very fragile. Once that trust is breached, the whole thing could collapse.

But then, finally, there is a connection between that macroeconomic separation of money from the rest of the economy and the difficulty of making people understand that banks create money out of nothing, that loans are the engine of the creation of money. A deep-seated and long-standing idea in macroeconomics is that saving is necessary before you can have investment. Read the reports of the World Bank, and they all talk about insufficient saving for development. It’s absolute nonsense if the banks can create money.

And it was the ability of banks to create money out of nothing that led Keynes to say, “No, Savings is not the engine of growth in the economy. Investment is. Investment comes BEFORE savings.” And it’s the banks that permit that to happen.

So that brings me full circle. To tie those two strands together. They are related. If macroeconomics is going to regress to a pre-Keynesian form, so also did the understanding of banking have to regress. And that is what is happened.

Corporate Control

Institutionalism.  The way we use it at Demand Side, this is the "political" in political economy.  For our purposes today, it is the skewing of the economy toward the interests of the corporate elite, the corporate oligarchy.  This has been done in three significant ways: capturing the bureaucracy of government, capturing the political parties, and controlling the media.

Control of the courts was accomplished by the Reagan and Bush administrations' appointments of justices with little to recommend them except ideology and willingness to actively dismantle government, epitomized by Clarence Thomas.  The court has recently elected presidents, subverted elections and pushed corporate power to the top.

Control of the regulatory bureaucracy is a natural consequence of the revolving door, with management desks and lobbyist desks revolving as the pro-corporate stuffed suit simply sits and collects.  Bureaucracy is further corrupted by armies of lobbyists controlling the process simply by their sophisticated participation as others are locked out.

As to Congress.  We have the best Congress money can  buy.  It turns out money can't buy a very good Congress.  The Republicans have two factions: business interests that are anti-government market fundamentalists and a quasi-libertarian zealot wing that is just anti-government, but is funded by anti-government corporate interests, possibly just in a cynical move to screw up government.  The past thirty years have been a series of experiments in testing the philosophy of less government and lower taxes.  Results are in.  The approach is a failure.  But they are not deterred, and they are well-funded and in power, so we have to continue the experiments until the patient dies.

The Democrats have two factions:  The progressives and the pro-business centrists, who have been neutered by big money and the necessity of campaign finance.

The functional government of pragmatists is gone.  The progressives are the pragmatists, of course. Not exclusively for their understanding of climate change, but because policies that are equitable are economically efficient, public goods as the province of the government, as in health care, is economically efficient, and it is economically efficient to regulate when no regulation means markets are structured to the specifications of the strong, not to the ideals of the invisible hand.

An essential aid to the direct control of government by the corporate institutions is the control of the media.  The concept of "liberal media" is laughable today, though you still here it.  While there may be pockets, the media has an unmistakable corporate bias.  Why not  corporate advertisers are paying the bills.  You have also the phenomenon of FoxNews and FoxNews facts.  My car is going to have a bumper sticker one day that says, "Global warming is real, FoxNews is a hoax." You can borrow that.

But more insidious is Bubblegum news.  This is not news, but accounts of violence and sex and celebrity.  Bubblegum news dovetails nicely with the sports culture and the celebrity culture.  Everything gets turned into a contest between two teams, the Republicans and Democrats, the Americans and the fill in the blanks, this side and that side.  Who will win?  Who are the big players?  Did the last zinger hit home?  Choose your side and it comes complete with ideology and convenient facts, no critical thinking necessary.

The Internet may have the potential of leveling the playing field, or it may be just another distraction, reducing attention spans to bubblegum card length, or balkanizing information and opinion and exacerbating the conflict.

I mentioned I was reading Shiela Bair's book, "Bull by the Horns."  Bair was the Republican head of the FDIC through the Great Financial Crisis. But she was close enough to see what was going on.

page 358

"The thing I hate hearing most when people talk about the crisis is the bailouts "saved the system" or ended up "making money." Participating in bailout measures was the most distasteful thing I have ever had to do, and those ex post facto rationalizations make my skin crawl.  Why system were we trying to save, anyway?  A system in which well-connected big financial institutions get government handouts while smaller institutions and homeowners are left to fend for themselves?  A system that allows government agencies unfettered discretion to pick winners and losers with taxpayer money?  A system that has created cynicism and despair among honest, average working people who take responsibility for their own actions and would never in a million years ask for a government bailout?  A system that has spawned two angry political movements on the left side and the right side that are united in their desire to end the crony capitalism characterized by too-big-to-fail policies?  That is not a system I want to save.

"With the millions of lost jobs and lost homes and the trillions of dollars of lost tax revenue, how can anyone try to rationalize what happened by saying that the bailouts "made money?" In point of fact, they did not make money.

"When the Treasury Department states that the bailouts "made money," they are referring to the dollar amounts that were invested in the financial sector offset by the amounts that were paid back.  Thus, the department does not count as a "cost" the very generous subsidies taxpayers provided financial institutions.  As one distinguished group of academic experts has pointed out, this cash flow method of measuring bailout costs is inconsistent with government accounting rules. ....If those funds and guarantees had been priced at or near their true market value, taxpayers would have been entitled to substantially higher rates of return."

Or as Joseph Stiglitz is fond of saying, "We got cheated."

but down here.

"The bailouts, while stabilizing the financial system in the short term, have created a long-term drag on our economy.  Because we propped up the mismanaged institutions, our financial sector remains bloated. The well-managed institutions have to compete with the boneheads. We did not force financial institutions to shed their bad assets and recognize their losses.  Lingering uncertainty about the true extent of those losses made previously profligate management more risk averse when prudent risk taking and lending were most needed, particularly by small businesses.  Only in 2012 are we finally seeing some meaningful pickup in lending by the big financial institutions. Economic growth is sluggish, unemployment remains high. The housing market still struggles.  I hope that our economy continues to improve.  But it will do so despite the bailouts, not because of them."

"In my farewell remarks to the FDIC, I expressed amazement at the conduct we tolerated in the years leading up to the crisis.  I said:

Looking back, How could we rationalize letting big firms take on leverage at 30 or 40 to 1, giving millions of people mortgages they couldn't afford, a mortgage refinance system which divorced the decision to make the mortgage from the responsibility if the loan went sour, the trading of hundreds of trillions of dollars' worth of derivatives without any ability of the government to police it."...

And on here, to end the chapter with,

It would be hard to find anyone on Main Street who was not in one way or another hurt by the horrible debacle. Government fundamentally failed in its role of protecting us."

Shiela Bair,


And I have to include some mention of the forecast.  The consensus is now complete, or nearly so, that we are in the great spring of recovery.  The zero interest rates and massive purchases of securities by the Fed have done their work.  Ooops.  We're actually not supposed to notice that part.  It is some kind of natural rebound.  As you know, Demand Side and Laksman Achuthan of ECRI are in the same small boat , with maybe a few others.

From the Demand Side there can be no recovery without an increase in incomes, and there is no increase in incomes, so any recovery is really a debt-fueled bubble.

This past week, we had noted regional forecaster Dick Conway in to the Seattle Economics Council.  Dick talked most about tax reform, but he did present us with a provocative chart under the title "The Great Depression and the Great Recession, Two Peas in a Pod."  We thought at first he was going to point to the debt bubble or the massive disparities in incomes and wealth that marked the decade prior to the great recession.  But the chart was in fact, GDP between 1929 and 1940 and a similar eleven-year period between 2000 and 2011.  Turns out the level of GDP in index terms was the same.  In fact, in 1940, the level was actually further above 1929, very slightly, than 2011 was above 2000.  How is that possible.  Because of the stagnation of the 2000's.  Yes, the enormous collapse of the economy between 1929 and 1933 was followed by a very strong recovery, excepting 1938.  The dot com crash was followed by seven years of a jobless recovery and then the Great Financial Crisis and Great Recession, followed by the non-recovery to date.

Dick's chart is online.

companies

Banking, Credit, Money

The precedent for the Great Financial Crisis was set only three decades ago in the 1980s with the Savings & Loan Debacle. In the early 1980s, the S&L’s or “thrifts” saw their business model undermined by high interest rates. The thrifts borrowed short, chiefly by taking deposits, and lent long, chiefly for mortgages. When interest rates ballooned from the Fed’s war on inflation under Paul Volcker, the thrift’s borrowing rate ran up well above the rate of its lending.

The answer under Ronald Reagan was not to admit insolvency and deal with the crisis in its infancy, but instead was to deregulate the thrifts in an effort to let them “grow” out of their problems. Instead it was the problem that would grow. Deregulated thrifts offered high rates and attracted massive amounts of capital, which they were then compelled to lend at even higher rates to make their profits. With the lax regulation they enjoyed, the environment was set for fraud and irrational, or at least rash, lending, and within a few years the spectacular collapse of the industry.

By 1995, half the thrifts had gone out of business. The Federal Savings & Loan Insurance Corporation (FSLIC) was abolished and replaced by the Office of Thrift Supervision (OTS). A massive takeover and rationalization of the industry took place, with the determination, “This will never happen again.” Twenty years later the OTS was abolished in the wake of a second and far greater financial sector collapse. Deregulation had returned within a decade, in even more complete form, with the repeal of New Deal banking laws (Glass-Steagal) and the rise of the anti-regulators of the George W. Bush administration.

The housing boom of the 2000’s depended on mortgage originators and mortgage lenders who were virtually unregulated, but it also depended on the banks and Wall Street. Originators found takers for fraudulent, onerous and undocumented mortgages and sold them to mortgage lenders. The banks provided the short-term “warehouse” loans to bridge the deal on into the Wall Street securitization market. Here the individual mortgages were combined to form securities that were sold as solid investments around the world. At the same time, banks themselves originated their own somewhat better, but still suspect, subprime and non-traditional mortgages to turn into securities.

When the inherent weakness of the mortgages came to the top and the securities found their true value, the Great Financial Crisis was triggered.

In the S&L debacle it was high interest rates instigated by the Fed’s war on inflation that led to a Wild West of fraud and excess. In the Great Financial Crisis, it was low interest rates forced by the Fed in fear of deflation that created another Wild West, as massive amounts of capital searching for yield flooded into the “safe” mortgage market.

Regulators who saw each crisis forming and who advocated strong action at the outset or strict rules governing lending activities were muted and frustrated by other, “captured” regulators and pressured directly by elected politicians acting on behalf of big donors. The “Keating Five” was a memorable example from the S&L debacle. Five Senators were censured for their efforts to protect Charles Keating, an S&L billionaire. When the S&aL debacle was over, more than 3,000 bankers and thrift officers went to jail.

That number is about 3,000 more than the Great Financial Crisis. Many banks have failed, but a certain class is still with us – the too big to fail. (These now include JP Morgan Chase, Wells Fargo, Bank of America, Goldman Sachs, Morgan Stanley, and Citigroup.) These institutions continue to receive special concessions, but more than anything else, it is the too big to fail insurance they enjoy that gives these enormous companies lower cost capital and an advantage over their smaller rivals. (Banking is not an industry with economies of scale.)

That favoritism arises in part from the efforts of Fed Chairman Ben Bernanke, one of the economists who has failed. Bernanke himself, or the Fed itself, took over the original mandate of TARP, or one of them, and bought one and quarter trillion dollars of mortgage backed securities. This year the Fed is ready to take another trillion dollars on to its balance sheet. Thus we see incredible efforts to expand credit to the private sector at the same time we are determined that the public sector do nothing of the sort.

The recent turn in the housing market, in terms of price and volume, is thought of as a recovery. Indeed, it is. As in going up. The upturn is a blip with respect to the long term, and the foregoing shows that every effort has been made to do this without recognizing it in the lives of the underwater homeowners. What that means is that as prices recover, at each step, shadow inventory will come back on line.

So credit and banking, success or failure?

Political Frame, Whither Balanced Growth?

"The federal budget is the main single instrument of national economic policy. Its use is fundamental, toward promoting economic performance in accord with our needs and capabilities. Nobody denies this in principle..."

Said Leon Keyserling 35 years ago as he looked in frustration at the onset of the largest post-war recession prior to our 2008 Great Recession, the Reagan-Volcker Double Dip recession of 1979-1982. The Full Employment and Balanced Growth Act of 1978 had been passed by large majorities in both houses of Congress to deal with the problem. The Act was promptly and nearly completely ignored by first Jimmy Carter and then Ronald Reagan.

It was in this context that Keyserling produced one of his best works, "Liberal" and "Conservative" National Economic Policies and their Consequences, 1919-1979, subtitled: "A Study to Help Implement Promptly the Humphrey-Hawkins Act."

Leon Keyserling was one of the most successful economists in American history in terms of getting significant legislation passed, influencing public policy over a long term, and seeing results in the performance of GDP, inflation, employment, growth and national well-being. He had a hand in the Wagner Act of the New Deal (1935), also known as the National Labor Relations Act. He claimed to have modeled the Full Employment Act of 1946, which was probably the single most important piece of economics legislation in the country's history. And he participated in and influenced greatly the Humphrey-Hawkins Act. Keyserling was a member of the Council of Economic Advisers, then chair, under Harry Truman, and helped immensely in the transition from war to peace and managing the economy into a period of prosperity.

"Balanced growth" was Keyserling's vision of how successful economics and public policy operated, as a partnership between labor (consumers), business (and investors), and the government (public sector). The problem Keyserling saw in 1979 was overcapacity, resulting in a reduction in investment and recession. The condition of overcapacity was a function not only of overbuilding, but of under-consumption and a deficiency in government outlays. "Balanced" growth was a coordinated expansion in each of these three components. Investment was necessary, but could not run ahead of consumption, or the profits would not ratify the investment, prompting cut-backs and recession. Sufficient federal outlays were necessary to provide the foundation for investment and consumption and to address the nation's overarching priorities.

Keyserling saw over-investment as a problem virtually throughout the "conservative" period beginning with Richard Nixon in 1969. The federal budget, both its spending and its taxing sides, promoted ever more investment, more capacity. "Belt-tightening" was prescribed for spending -- wonderful if you're a household, but seriously negligent and lazy if you're a family farm or a government with responsibilities. There was no aggressive effort to expand employment or incomes, quite the opposite. National priorities, such as energy independence, were left to half-hearted measures. Not surprisingly, this was the era that spawned the great divergence of incomes, the inequality that has now become corrosive and destabilizing to the society.

We listen to Keyserling in 1979 and we think, "We would be lucky to have these problems."

Compared with the attainable goals under appropriate changes in national economic policies and programs, the likely and very disturbing results of the projection of current national policies ... are: An average annual real economic growth rate of only 3.0 percent from 1979 to 1980, and the same average from 1979 to 1983; a productivity growth rate averaging only 1.8 percent throughout; an inflation rate of 9.0 percent in 1980 and 7.5 percent in 1983; real growth in federal outlays of only 2.5 percent during the first year and averaging only 2.2 percent during the period as a whole; and an unemployment rate of 6.8 percent for 1979 and averaging 6.5 percent for the whole period.
...

GDP 1979-1983

The President's [Carter's] goal for real economic growth is 3.3 percent from 1978 to 1979, and this has already turned out to be unrealistic on the high side. The goal is only 2.2 percent for 1980. Both of these goals are egregiously below our needs and capabilities at almost any time. Viewing the goals for these two years, the President's 3.8 percent average annual growth rate for 1978-1983 is utterly unattainable. It would require a real economic growth rate during 1980-1983 which is pie in the sky in terms of the programs and policies which he sets forth. And it is pure pie in the sky, under these goals, to expect to come anywhere near the goal of 4.0 percent unemployment in 1983, which the president also sets. The President projects a productivity growth rate averaging only 1.5 percent annually for the period as a whole. This is a surrender to the declining growth rate which has resulted from repeated economic stagnations and recessions, and it is not at all consistent with our revealed capabilities during good economic performance years, nor with the requirements for full production.

The President's goals for major components of GNP also do violence to the requirements for economic balance or for an acceptable rate of real economic growth. By way of example, at the start of 1979, the President projected for that year real economic growth rates of only 1.7 - 2.25 percent for consumer expenditures, and only 0.75 - 1.25 percent for Federal purchases of goods and services. His projection of 4.0 - 4.5 percent for nonresidential fixed investment is far out of balance with the other projections, and unattainable in terms of them. The President also projected for 1979 a real rate of increase in Federal purchases of 0.75 - 1.25 percent. This is also very low, and out of balance w9ith an non-supportive of some of the other goals.

The President commits himself to a "lean and austere" Federal Budget, with outlays rising at an average annual rate of 1.4 percent during fiscal 1979 - 1983, and generally declining from year to year. In ratio to GNP, this would represent a decline from 21.55 percent in fiscal 1979 to 20 percent or lower in fiscal 1983. That might be acceptable in a rapidly expanding economy; it would be intolerable in a repressed and slowly growing economy. Such Federal Budget trends in actuality would portend great losses for the economy and great hardship for large portions of the people.

All in all, to put it mildly the President has committed himself to the contrived development of the recession which is now under way, although in early 1979 his Economic Advisers denied that a recession was just around the corner."

...

In any event, the goals are dismal in terms of our needs and capabilities, or in terms of fulfilling the mandate of the Humphrey-Hawkins Act.

Indeed, the experience of the economy was substantially worse than Keyserling envisioned in 1979. GDP shrank by 0.3 percent in 1980, recovered to 2.8 percent in 1981 and shrank again, this time by 1.9 percent in 1982. The average for the period 1979 to 1983 was 1.3 percent. Unemployment skyrocketed under Reagan, 10.4 in 1981, 11.7 percent in 1982 and still growing at 12.2 percent in 1983. Meanwhile the deficits of $28 billion in Carter's austere year of 1979 ballooned to $60 billion in 1980 and then ever higher, being $195.4 billion in 1983.

Keyserling's book "Liberal" and "Conservative" National Economic Policies and their Consequences, 1919-1979 draws the end of the "liberal" regime in 1969, with the last four years of this period 1966-69 being decidedly more mixed than the period up to 1966. In 1979, he had not yet experienced Reagan, Supply Side, the Laffer Curve, triple digit budget deficits, massive budget deficits, double digit unemployment (except for two years under Nixon and Ford), the stagnation of wages, and the rest. Nor had he experienced the rise of the financial sector and the Ponzi finance that was to mark the 1990's and 2000's.

In Keyserling's world the overcapacity and under-consumption of private and public goods would certainly lead to serious economic consequences. Others looked at the correspondence of investment and growth and determined that stimulating investment would bring the economy out by itself.  Keyserling saw the only road as balanced growth, beginning with consumption, jobs and government outlays.  Debt was incurred to finance investment in productive physical assets: factories, machinery, housing. His recessions were imbalances of overcapacity and inadequate consumer or government demand.

Although Hyman Minsky had already teased out the principles of the Financial Instability Hypothesis and the structures of hedge, speculative and Ponzi financing, the role debt could play in extending demand while it destabilized the economy was not obvious in the 1970s. The growth of debt over the next thirty years, public and private, sponsored much of the demand that has kept the economy afloat. And when debt and debt service became too large, the economy stopped. That is where we are now.

The Fed and others believe the answer is more debt and more and riskier investment, but Keyserling would have objected in flamboyant terms. there is plenty of investment, far too much, promoted by years of tax concessions to business and inadequate support to labor and government outlays.

Demand Side sees government outlays and debt restructuring in the private sector as being the two pillars of any recovery. The government spending needs to come in the form of needed infrastructure investment, physical and social, and green jobs. The debt restructuring needs to be substantial, not only to revive consumer spending, but to return some form of market discipline to the financial sector.

Human and Social Capital, plus the "Retirement Co-op" proposal

This week's folder is labeled Human and Social Capital. We're going to get into some forecasting problems, and then to a specific scheme to solve a looming problem for many people, the boomers, in retirement financing, but first some notes.

It's funny how people get more respect when you consider them alongside machines or land or natural resources, and that is what happens when we put capital alongside "human" or "social." We begin to see that the society does better when people are better educated and in better health, irrespective of the increase in well-being to those people themselves.

There is an educational level -- skill level, if you must -- and a level of health that creates an intrinsic value that can be tapped. When we allow our educational systems to deteriorate -- often as a result of misguided schemes to hold teachers "accountable" -- or our health systems to run to high cost and low benefit -- often for the benefit of mega-corporations wearing free market costumes -- we are letting our infrastructure and capital decay just as surely as when we let the roadways turn to potholes or the sewer systems break.

Notice the difference between human capital and social capital. The educational and health care systems are parallel to physical capital, as well, and when we allow these, or police, or courts, or parks and libraries, or any of the rest of the utilities-type social services ... transportation ... to deteriorate, it is no different than a company allowing its production facilities to fall apart. Yet, corporations who would never let their machines rust or their roofs leak demand that the public sector do just that in the name of fiscal responsibility.

So when we consider the forecast for the medium and long-term futures, we need to take account of the crumbling human and social capital. But there are other issues.

One of them is the tendency to place more emphasis on the read-outs on the economic indicator dials -- GDP, investment, inflation, the rest -- than on the obvious condition of the infrastructure and what that portends for the future. Or for that matter, on the obvious condition of the population, its finances, health, security, and so on. One of the issues in this metrics vs. real condition that has gotten good attention recently is income disparity.

Which society is healthier, the one where the average income is $40,000 or the one where it is $50,000? Not enough information. In a society of 25 people, if 24 are getting $10,000 per year and one is getting a million, it is not clear that this is better than when all 25 are getting $40,000.

So, combine the two problems, the ignorance of social and human capital in the assessment of national well-being and the problem that the metrics often miss the mark, and you have a recipe for bad policy. Here we come again to health care, but also to retirement. One side says, cut the funding for social insurance, increase the contributions, raise the retirement age. But this doesn't fix the problems of growing older or being sick, it just shuffles the accounts and pushes people into private insurance. This is a more costly alternative, not as efficient, but it is good for GDP, or at least that part of GDP associated with the providers. In fact, as a public good, we need to universalize health care to drive the costs down. Doesn't do a thing for GDP. But we also need to make retirement efficient.

That brings us to today's special post, delivered partly for a want of time, since this is in the can from another project, but partly to offer a way out of the current and prospective dead-end for many baby boomers entering retirement. The investments many have made, the 401(k)s and individual retirement plans, have shrunk sadly under the Fed's easy money for the banks and corporations policy. A million dollars which returned $70,000 per year now returns half that. The house we were going to sell for a fat profit is now not worth enough for the down payment on the next one.

So, we've put up the Retirement Co-op Scheme. You can find the whole post below. But if you want to comment, please go to Retirement Co-op (http://retirementco-op.blogspot.com/) It is the first cut at this. Hopefully the concept comes through. There are a lot of details and aspects not directly addressed.

It offers retirees a way of securing their future in a very insurance-like way, entering a community before they need to join one physically, converting their energy, talent and property into the services they need while retaining equity and maximum estate value.


Basics

Issue:

People are entering retirement without adequate resources to fund traditional schemes. Drastic drops in the returns on savings and investment over recent years make the individual retirement scheme less and less viable. The process of retirement, from early, active stages to later, more restricted and dependent stages is clouded by uncertainty. Many retirees are capable, talented and interested in community. Many are determined to remain in their homes, in "independence" that may become simply isolation.

Question:

Is there a way to organize resources, particularly the property and energy and talents of retiring people in an efficient way that will provide adequacy and certainty to their physical and financial futures?

Proposal:

A non-profit corporation which (1) assembles a group of retirees with common or complementary interests, (2) converts time, talent, energy and property resources to shares in the corporation, and (3) uses these shares as a kind of currency to maintain the facilities and provide the services for their retirement.

Discussion:

Let us illustrate with two examples:

(1) A widow who owns her home and wants to remain in it as long as possible.

This person would buy the "plan" by transferring her house to the non-profit corporation (hereafter, "the Co-op") in return for shares. [She would retain residual rights to the property and the prerogative to remain there as long as possible, as well as the option to "buy back" her house for the original payment.] She would use the shares to procure services through the Co-op for meal services, home health care, grounds maintenance, personal services, etc. The widow would never be required to move. If she wanted to exit the plan, she would need only to reimburse the Co-op in the amount of shares used. This last option would be available only to the point she stayed in the home. If she moved to a group home or other Co-op facility, the home would not be recoverable in this manner.

(2) Person or couple with no property

This person would buy the Co-op "plan" with cash or services. The payments could be lump sum or streaming, and could come in the form of cash or services provided to other Co-op members. In between these two examples lie any number of combinations.

Service providers:

Three key classes of service providers make this program work:

(1) The retirees themselves who provide services in exchange for shares in their own plans.

Cooking, grounds keeping, health care, transportation, personal services, cleaning, entertainment, education, management are all services that are needed by some which could be provided by other Co-op members. The transfer of shares between the two is a key part of keeping costs down and eligibility up.

(2) The motivated group home manager.

Absolutely essential to a successful group facility is the manager. This person needs to be well rewarded as well as well oriented in terms of personal values. He must be enrolled in the plan himself, so as to give a personal stake in success. His remuneration might well come in the form of property. That is, he might occupy Co-op owned facilities before retirement as well as after. This should be a desirable and lucrative position.

(3) Non-member providers.

People hired to provide services who are not members may also receive remuneration in one of three ways: wages, housing services (living arrangements in Co-op owned facilities), or shares.

Plans:

The plans would be lifelong insurance and provide a transition from more to less independence, and fewer to more services. Actuarial determinations would be made to determine the level of plan buy-in. Different plans might be offered depending on facilities and services provided. Everything from complete stay-in-your-home support to modest quarters in a group home. In between would be apartment-style, clustered living, or other arrangements. The transition from one living arrangement to the next would be voluntary, with limitations and restrictions known well in advance. Services available would depend on the buy-in and accumulation of shares through services provided by members.

Note here: It is not necessary for the buy-in to cover the entire projected lifespan and needs of the individual. As with private individuals, a certain wealth and income level enables Medicaid support. An individual who enrolls in the Co-op plan who exhausts his or her shares, would continue in the co-op supported by Medicaid. Similarly, health care would be coordinated with Medicare. Nobody would ever lose their access to services and facilities after being enrolled.

Management:

The co-op concept reduces costs, provides certainty and control to members, and converts retiree's resources into the services they will need. It uses shares in the nonprofit as a kind of currency to make this conversion efficient. The concept is simple, but the execution will be complicated.

The accounting for what is needed, by whom, who receives payments in what form, what types of facilities are required, will be a matter that needs close attention. It must be clear to all current and potential members that their property is safe, their shares convertible in some form and their futures not at risk. The legal structure must be air tight to assure, for example, residual rights as above to the widow, and to make sure shares are directly backed by claims on real property.

As a nonprofit, the Co-op would be run by a board of directors elected by member-shareholders. The board would hire managers who would oversee operations. managers would be required to be co-op members. A strict auditing regime would be required for both finances and operations. Members' choices would determine what facilities were obtained, what services provided, and when. These choices would be updated regularly.

Summary:

The intent is to provide an efficient mechanism to transfer property, talent and energy to a retirement program that is transparent and complete. The mechanism is the non-profit corporation, the Co-op, and the shares of the Co-op which act as a kind of currency. Co-op plans are basically retirement insurance and rely on coordination with public sector insurances, such as Medicare, Social Security and Medicaid.

Addenda:

The Co-op, again, would be a kind of insurance, as well as a retirement plan.

Property would be valued in terms of shares for its functionality to Co-op needs, not by its market value. Thus an expensive house, say in an up-scale neighborhood, may have the same value to the Co-op as a more modest or appropriately designed house elsewhere with a much lower market price. The potential member who is a homeowner may not want to covert that property to shares in line with Co-op appraisal, but rather to sell and either buy in via cash, or to buy another property that is more in line with Co-op valuations.

There is no particular need for Co-op facilities to be geographically concentrated, except as indicated to keep providers of services from having to travel too far from one home or facility to another.

Because of the complexity of execution, there is probably a critical mass of some number over 15 members and some need for grant funding to identify the legal constraints and to backstop a pilot project.

Again, coordination of social insurance benefits with Co-op services and facilities is an important element that keeps costs down and eligibility up.

A health assessment would be required upon admission, not so much to restrict access as to tailor plans. It would not be efficient, for example, to maintain somebody in their home who for severe health issues needs more intense monitoring and services.

The two simplest models that inform this proposal are: (1) the individual homeowner with a mother-in-law apartment, who "rents" the apartment to a person in exchange for services, and (2) the group home with a dedicated manager/RN.


Next Steps:

(1) Vetting by you. Your comments are very valuable. Submit them in the comments section at Retirement Co-op or e-mail us at demandside@live.com.

(2) Obtaining grant funding for a pilot project. Again suggestions are useful. We anticipate submitting this to the AARP for suggestions.

Commodities

This segment of reMacro is reserved for Commodities, Resources and the Commons. We're going to begin with a look at commodities markets, as they are a serious problem and an ignored risk.

Commodities have become an investment vehicle. Speculation has divorced the market price from the physical supply-demand price. Futures markets that were once 70 percent hedging and 30 percent speculation are now the reverse.Once the futures markets were ways to hedge price exposure. Farmers and other producers of commodities could lock in a price that made sense and operate accordingly. Users of commodities could lock in a price that made sense in their production schemes. Price surprises could be avoided.

That has changed. Commodities are no longer products or intermediate goods whose prices need to be hedged. They have become an asset class, and futures markets have become their stock markets. That is not quite accurate. With the advent of exchange traded funds -- ETFs -- commodities are now traded like stocks. Not for their intrinsic value, but for their value as chips in the casino.

It is fair to say that speculation has a long history and is needed to keep markets liquid. Speculation is by definition an attempt to profit by movements in prices. John Maynard Keynes is said to have been good at it. Farmers themselves have tried it by simply withholding sale, as in the period directly after World War II. But with the advent of cash settlement, where you no longer have to take physical delivery of your commodity if you hold the futures contract to completion, and then with the advent of the ETF, speculation has moved to a new level.

The series of charts below demonstrates the scale of the commodities distortion. Dare we call it a bubble? The pattern is evident across all classes of commodities except gold. [Gold has been called a currency, and certainly it displays the characteristic of steady appreciation against the dollar.] Supply and demand are plainly overwhelmed by the great swings in prices. (Chart Source:  Seeking Alpha.)

Major Commodities Indexes

Oil

Food

Coal

Copper

Gold

Prominent investor Jim Rogers has fingered tight supply and more importantly the easy money policy of central banks as bullish for "physical assets," as he calls commodities. We do not see the tight supply, but we do see the printing of money. Rogers' thesis is that this appreciates the value of physical assets in the same manner as with gold. We see it as providing chips in the casino, and there is no reason the bets should pay off just because they are larger.


Distorted commodities prices, particularly food prices, have real and tragic consequences. Desperation and social disruption across the globe heightens when food is priced out of reach of people. The current crisis in Egypt is sharpened by this effect. (Egypt is also a laboratory of another aspect of commodity distortions, which is the preference given to U.S. industrial cotton farms in contrast to the cotton producers in Egypt, which reduces incomes and standards of living there. This will be taken up in a future Commodities-Resources-Commons segment.)


The Influence of Commodity ETFs on the Commodity Markets

By Chuck Kowalski, About.com Guide

Commodity ETFs and ETNs have become a new and easy way for investors to trade commodities and include them as part of their long-term investment portfolio. However, commodity ETFs have somewhat changed the dynamics of the markets, as some believe this wave of new funds into the markets has increased volatility, ultimately leading to exaggerated moves in commodity prices.

How Commodity ETFs Work

Commodity ETFs are funds that invest in commodities. They typically invest in futures contracts on an unleveraged basis. Money flows into and out of the ETFs similar to the way mutual funds invest in stocks. When people invest money into the funds, the fund manager has to buy a designated amount of commodities – or futures contracts. Oppositely, when a person redeems funds in the ETF, the fund manager has to sell a proportional amount of futures contracts.

There is an obvious flow of money coming into and out of these funds each day. The net result is what you want to follow. You’ll often find that investors tend to put more money into the commodity ETFs that are moving higher. They also have a tendency to avoid the markets that aren’t hot.
Overall Commodity Investments

It is important to note that commodity ETFs typically are not leveraged like futures contracts. Some funds are leveraged 2x or 3x, but not to the degree of futures contracts. In theory, this would drop the likelihood that commodity ETFs lead to over speculation and exaggerated price swings. After all, it is still a large capital outlay and it takes a great deal of money to move markets. However, there are still some underlying concerns with commodity ETFs that might eventually cause greater problems.

The commodity ETFs that invest in the actual commodity, like SPDR Gold Shares (GLD), are supposed to buy actual gold. The fund is currently worth about $72 billion. That means the fund should have bought and is currently holding $72 billion of gold in storage. In reality, that is probably not the case and some experts in the investment world believe this is cause for concern.

It is unlikely that every owner of the SPDR Gold Shares would want to redeem their investment in gold at the same time. If you could picture a stampede of people wanting their $72 billion worth of gold, that is what it would be. What would happen if the fund couldn’t make good on this redemption? Certainly they would pay in cash, but that really isn’t the point.

The issue of commodity ETFs influencing the markets might become clearer if you realize that investors can continue to buy an asset where there is really no claim on it. What if there was only $100 billion worth of a commodity in the world, yet a commodity ETF was holding $200 billion worth of claims on those commodities. Is that how things should work?

A good case could be made that the fund is oversubscribed and they should only be allowed to accept investment dollars in a commodity that they can actually attain for their investors. That sounds good on the surface, but what happens when you have too many dollars chasing too few goods? Yes, the price rises and some times substantially. You would get the same result in price with or without a commodity ETF. An argument could be made that prices would actually be higher if investors could only purchase the readily available supplies.

Commodity ETFs have opened the door to a new crowd of people to invest in commodities and there is actually more money invested in commodities today. Many investors and money managers won’t invest in futures contracts, but now they have a new mechanism to participate in commodities. Commodity ETFs aren’t necessarily to blame for the volatility in the markets. They might be the vehicle that brings extra money to the markets, but you still have the same investor mentality. The only difference now is that there are more investors and more money – that is what causes the wider swings in the market.


Are ETFs To Blame For Over-Speculation, Record-Correlations, And A Potential Crash?

Seeking Alpha
October 19, 2011
ETFs are huge enablers for soaring stock and commodity prices. And like their mutual fund predecessors, ETFs may have encouraged mass over-speculation that will ultimately result in a stock market crash.

ETF investing continues to be a top choice for diversification, targeted exposure, and specific strategies; but they have caused such mass speculation and have inflated prices to such an extent, that their intended benefits may actually be void and nullified by the tremendous risks and unintended consequences they have posed. ETFs have increased speculation, massively inflated stock and commodity prices, and may be responsible for the unprecedented and hugely-risky correlations across all stocks, sectors, and markets.

ETF Overview

Exchange Traded Funds (ETFs) are a revolutionary financial innovation, and provide many benefits for both individuals and institutions. Bought and sold much like stocks, ETFs are listed on exchanges and allow investors to trade them throughout the day. Like mutual funds, ETFs aim at providing diversification and exposure to a wider range of individual stocks or assets. Unlike mutual funds, however, ETFs can be traded all day, since their prices are instantaneously adjusted. Moreover, ETFs are cheaper and easier to invest in than mutual funds.

ETF Uses

ETFs represent a portfolio of individual stocks, and provide an enormous number of uses – from tracking broad stock indices (like the S&P 500 (SPY) or Russell 2000 (IWM), for example), to investing in specific themes or sectors (like technology (XLK), financials (XLF), housing (XHB)), to providing exposure to emerging markets and individual countries (emerging markets (EEM), China (FXI), Brazil (EWZ), etc.), to currency investment (US Dollar (UUP)), Euro (FXE)), to volatility (VXX), to commodities (Oil (OIL), Gold (GLD), Natural Gas (GAZ)), to bonds (TLT, TBT), and even to actively-managed trading strategies. In other words, ETFs are exceptional tools for individuals and institutions to invest in commodities, sectors, countries, bonds, currencies, strategies, and just about any investment theme imaginable. ETFs provide a way for the average person to invest in a wide basket of stocks which he otherwise would not be able to.

ETFs offer many uses for portfolio strategy and asset allocation:

They also provide a slew of reasons why investors should use them as part of their investment approach:

ETF Industry

With so many innovative uses and benefits, it is no surprise ETFs have grown at such a rapid and perhaps unprecedented pace. By May 2011, there were 2,747 ETFs offered by 142 ETF providers and traded on 49 exchanges – adding up to $1.446 Trillion in assets! There were also plans to launch an additional 1,022 ETFs. With such a huge number of ETFs being traded, there is no doubt that ETFs have revolutionized stock market trading – the question now, however, is “how have ETFs affected markets?”

Massive ETF Growth

Since their introduction, ETFs have grown tremendously – from $0.8 billion in 1993 to nearly $1.5 trillion by May 2011:

ETFs’ popularity has soared largely because institutions have embraced them:

ETFs have also made it much easier and more accessible for individuals and institutions to invest in commodities:

Prior to ETFs, investment in commodities such as oil, gold, grains, and others was limited to commodity traders, futures, or buying the physical commodities themselves. ETFs have provided a means for the common investor to buy these commodities from the comfort of his or her home, without any expertise or knowledge of the underlying asset. To make matters worse, the availability of these ETFs and the constant touting by the institutions that sell them, has greatly increased speculation in commodities and tremendously inflated prices. It is easy to understand why we’ve seen such massive rises in commodity prices over the past few years – investors have poured billions of dollars into commodity ETFs in order to profit from the shortage they expect, as China and emerging markets demand more and more commodities and raw materials for their growing economies. The major problem, however, is that it has become extremely hard to track exactly how much of this commodity price surge is due to real demand – as opposed to the inflated demand that ETFs have caused. In other words, commodity prices could be severely out of whack with reality and way beyond where they should be.

ETFs may have offered tremendous benefits when they were introduced, and still continue to offer investors a way to pick specific sectors, themes, individual commodities, etc; but we are at a point where ETFs may have created such investor frenzy and over-investment, that current prices for stocks and commodities may be highly overextended – and set for a sharp pullback.

Mutual Funds vs. ETFs

ETFs have essentially made mutual funds obsolete. For decades, mutual funds were the number one way for investors to diversify and gain exposure to specific strategies and professional money managers. The introduction of the ETF, however, has made it easier, cheaper, and more effective to invest. Mutual funds have therefore seen large outflows over the past decade, as investors who were disillusioned by terrible mutual fund performance have pulled out their money. Investors simply have no good reason to keep their money in mutual funds when so many funds actually underperform and fail to beat the market while still charging high management fees. ETFs are cheaper, easier to buy and sell, and allow investors to bet on whatever they choose.

Mutual Funds, The Technology Bubble, and The Rise of ETFs

In the technology bubble era, stocks rose to extreme levels because investors were piling into technology stocks and, most importantly, mutual funds. Mutual funds were seeing huge inflows of new investors, and the money that came into these “diversified money managers” was then being invested into the stock market – sending stock prices even higher.

Eventually, after millions of investors piled their money into these mutual funds and the stock market in general, the technology bubble collapsed, and the stock market fell, and mutual funds lost their investors billions of dollars. Average investors, professionals, people with retirement accounts like 401ks or IRAs, and others lost a large chunk of their investment value.

Mutual funds are essentially an investment fund led by one or more portfolio managers. These managers accept investments, trying to invest the funds appropriately in order to make their investors profit. Most funds, however, charge a management fee just for investing. Even if the fund does not gain for the year, the manager may still get paid for managing the investors’ money. The investor is actually worse off in the mutual fund than if he owned a stock of the broader market. In other words, the fund manager did worse than the overall market, when he was actually hired by the investor to beat the market.

It is no surprise then, that mutual funds lost a lot of their appeal when the tech bubble burst and when NASDAQ and stock markets fell from 2000 to 2002. A new financial instrument was about to launch into mass popularity – the ETF. Since so many mutual fund managers couldn’t beat the market, why should investors keep their money invested there? If investors just bet on the overall market they could’ve beat the mutual fund’s returns. Yet there were few if any ways for investors to invest in the broad markets; investors would have to buy a very wide selection of stocks that represented the whole market, and track each of those positions to closely monitor the portfolio allocations. The average, and even the professional, trader simply don’t have the means to buy so many stocks and monitor them closely. Yet diversified exposure to the overall market was still available mainly through mutual funds.

The innovation of ETFs, however, largely cuts out the middle man (portfolio manager), lowers fees, and allows investors to invest in broad themes and overall stock indices that track markets. In other words, if the mutual funds were failing to beat the market, why not just bet on the market? ETFs were invented to very closely track the overall markets or sectors by buying a proportional share of stocks to mirror an index or sector. Investors now had an investment vehicle that was pretty much automated, cutting out the costly middle man and eliminating poor investment choices. Instead, investors could now just “buy the market” and expect the 8% return that the market averaged per year, going back 60 or more years.

Irrational Exuberance in ETFs?

ETFs are undoubtedly an amazing innovation in investing, but may have also helped create over-speculation and unwarranted price increases in the underlying stocks and commodities. By offering an easy, cost-effective, and highly-intriguing way of investing, ETFs have created the illusion that investing is less risky than it really is. ETFs have also massively boosted stock and commodity prices, as investors who were once not able to invest in certain stocks or commodities now bid up the prices of the underlying stocks and commodities by buying ETFs.


....

Climate Change

The fact of near term, catastrophic climate change is both illustration and proof of the dysfunction of orthodox Neoclassical economics, but also any other economics which does not have an institutional component.

Environmental Protection Agency

For forecasting, nothing is easier to read than the chart of the rise in CO2 emissions over the past quarter century. The loss of Arctic Sea ice, the growth of the average temperature, the increasing frequency of violent weather, all are charts as easy to read as they are alarming.

Wikipedia

The science behind climate change predictions is long established and solid. All major scientific organizations have asserted its validity. Its predictions have proven out over time.

Yet climate change has earned nary a whisper in the economic discussion. It is the health of the banking system, the recovery of housing, the size of the federal deficit that are presumed to be the drivers of economic well-being. This is not withstanding the enormous toll of violent weather, drought, flood we have seen so for and the potential for the effects to become hundreds of times worse. The loss of resources and natural systems are invisible to the economics as practiced in 2013. Repairing and rebuilding from damage is a positive thing in GDP, the measure used for health.

This is partly because the orthodoxy is entirely distracted with readings on the dials and how they relate to their hypothetical or replica of the economy. Federal deficits are a monetary phenomenon that has history. They can be seen in this replica. The certain collapse of the ecosystem cannot. There is no monetary trend line for it.

The other major part is not the invisibility of climate change in measurement or model, but the active denial of the science by major sectors of the existing corporate economy, and the active promotion of climate-damaging technologies by these and others. This is the institutional side: The failure to put a price on carbon, the manipulation of the political system to avoid addressing needed changes, and the simple distortion of the science for public consumption.

The challenge for the forecaster is not so much to anticipate the gradually worsening effects of climate change, but to capture these effects in numerical terms that can be tracked over time and used for policy purposes. An additional challenge is to make these numbers comparable to those of other forecasters so as to provide a base for evaluation.

These are impossible with the current tools. Efforts to create indexes which calculate the depletion of resources and the destruction of natural systems are in their infancy. Some of them are general equilibrium models. These did not work well in the Great Financial Crisis, nor do we expect them to work well in the case of unrecoverable changes to natural systems. The Stern Report made some assertions which we take seriously as the best case scenario. Noting we have already done nothing for the nearly ten of the 10-20 years mentioned.

Using the results from formal economic models, the Review estimates that if we don’t act, the overall costs and risks of climate change will be equivalent to losing at least 5% of global GDP each year, now and forever. If a wider range of risks and impacts is taken into account, the estimates of damage could rise to 20% of GDP or more.

In contrast, the costs of action – reducing greenhouse gas emissions to avoid the worst impacts of climate change – can be limited to around 1% of global GDP each year.

The investment that takes place in the next 10-20 years will have a profound effect on the climate in the second half of this century and in the next. Our actions now and over the coming decades could create risks of major disruption to economic and social activity, on a scale similar to those associated with the great wars and the economic depression of the first half of the 20th Century.

The economic modeling of climate change through Integrated Assessment Models (IAMs) is treated here in that report.


GDP, as noted, the main metric of economic health that is used to compare forecasts, actually improves with some catastrophes as rebuilding is measured well while destruction of property and wealth and productive capacity is not, at least initially. Employment and incomes may rise or fall similarly, so an economic forecast focused on the short term may miss the obvious trend entirely.

Over time we will be developing a metric for output which simply adjusts GDP for health care outcomes, public investment, and depreciation and destruction of resources and natural systems as if they were privately held capital. That project has not yet begun.

The general outline of the future, our baseline for climate change, is not a mystery. Increasing incidence of flood,wildfire, drought, violent storms, pest infestations, and the rest of the litany of outcomes are not in doubt.

Note:

Adapting to climate change can be the World War II that brings the economy back to full employment and paves the way for prosperity beyond. Investments that prolong the habitable life of the planet plainly create value that can be tapped to repay investors. If this needs to be -- as much of it certainly does -- a public investment, so much the better.

World War II entailed spending on arms and munitions and operations that created great destruction. Immense progress was made in spite of this. The technologies of aviation, communication, transportation and others were greatly enhanced by wartime research and development and deployment. After the War the U.S. grew and prospered as never before, partly because of the absence of industrial competition from Europe and Japan, and partly because of the economics of the New Deal and Keynes that put jobs first and did not fear big government.

Climate change is a looming disaster larger than World II. It is replete with tragic possibilities, determined adversaries, and those who would pacify the enemy and compromise away a livable future. It does not have to be that way.