A Posthumous Nobel Award for Dr. Suess in Economics?
A Posthumous Nobel Award for Dr. Suess in Economics?
By J.M. Hamilton
One can imagine the tykes Blankfein and Diamon reading “The Sneetches,” hungrily…
On one level Dr. Suess’ children’s books have always been a bit of a Technicolor trip, providing an alternate universe with fantastic creatures, and always hugely entertaining. Then there’s the deeper meaning behind the stories, quite often providing social or political commentary. One of the many great things about being an uncle is you get to go back and read some of these fine stories, and in the process, one can pick up on a whole different set of meaning.
The good doctor, apparently, was quite the economist, among his many varied gifts and talents. In one particular story he presaged our own economic crisis by nearly fifty years, and Japan’s economic problems by nearly thirty years; and in the same book also wrote of financial hedging more than a decade before Black & Scholes offered up "The Pricing of Options and Corporate Liabilities,” a cornerstone of modern day derivatives trading.
Within this mini-novella, Mr. Suess writes of an economic meltdown, and an asset bubble in stars. It’s all here: greed, avarice, social-climbing, wild mania and speculation. And at the center of the story is a unique figure, who appealing to the vanity of the masses, sells them exactly what they want, stars. But what makes Mr. McBean so unique is that he foresees the inevitable crash in stars, and hedges his bet by offering star removal (in essence a financial move against his own product), which only fuels the extraordinary delusion even further. Hence, Mr. McBean makes money coming and going, while leaving the multitude penniless, deeply depressed, and in a state of economic collapse.
One can imagine the tykes Blankfein and Diamon reading The Sneetches, hungrily, with wide-eyed amazement and wonder. Could that story, published in 1961, have lodged in many a future banker’s subconscious, and what did it do to their young and malleable minds? Either way, clearly Mr. Suess was quite cutting edge in matters concerning banking and commerce, and perhaps should be awarded a Nobel Prize in Economics, posthumously?
Derivatives Trading
Today, Mr. McBean is best exemplified by the Wall Street banks, which make money coming and going, and quite often bet against their own product offerings. And the vehicle of choice for Wall Street banks to bet against the public, their own clients, and hedge their own bets, is the derivative or credit default swaps (C.D.S.), the very same financial instrument that played a hugely important role in our present economic collapse. The derivative is what the esteemed Mr. Buffet referred to as “financial weapons of mass destruction,” that is to say, when one of his many storied companies isn’t buying and selling derivative products, themselves.
For despite the best efforts of Dodd-Frank, this product worth hundreds of trillions in notional value remains largely hidden from public view, opaque, and under the absolute control of the Wall Street Banking cartel. As such, the world is primed, yet again, for another financial Armageddon. Louise Story, in a New York Times piece, “A Secretive Banking Elite Rules Trading in Derivatives,” writes of how the major Wall Street Banks collude to fight full disclosure, an options board/clearing house, and additional entrants into the swaps markets place, at every turn.
Why? Answer: Per the banks to protect the public, but also to secure their own profits.
The implications for the public, business, and governments are staggering. A clearing house would make the C.D.S./derivatives market transparent to all, the pricing of this commodity would become far more competitive for businesses and investors, and the capital or equity backing these bets would, presumably, be held by the exchange or clearing house, and not left in the hands of the banks. Society, and the consumers of such products, would benefit immensely from the proposed controls, since the pricing of the product is there for all the world to see, capital is put up to secure these bets (helping to avoid future bank bailouts), and wild swings in the market (including those initiated by short sellers, hedge funds and banks) may be observed in advance by watching the trade in C.D.S. All of which would serve to limit some of the speculation in these products, and cut into bank profits.
Hence, the fight, if you can call it that. For despite the role these instruments played in the crash we are all living through today, and that basically insured the wild speculative fever in stars, I mean real estate in Europe and the U.S., the banks remain in control.
What’s even more frightening is that these same products serve, primarily, to insure banking, business, and government debt issuance. And as predicted by this blog, and by others, our next source of economic crisis is likely to be from sovereign debt.
Haircut Time for the E.U. Bond Holders… NOT Yet!
The McBeans of the world, and an opaque derivates market, play a key and crucial role in why the problems of international finance are placed upon the taxpayers of the E.U. and the United States, instead by the perpetrators of our present economic crisis, the banks themselves.
Politicians have over promised their citizens more services and largess than states can possibly provide, which leads to the issuance debt. In many instances, the sovereign debt problem has become so acute that many private and institutional investors in state, muni and E.U. bonds will not purchase government debt without the insurance protection provided by a derivative and C.D.S. contract (which provides payment in the event of a default by a sovereign). Add to this salient fact that the vast majority of C.D.S. contracts are purely speculative, as opposed to being purchased by the relevant counterparties (the debtor and debtee), by exponential ratios, and that the notional values of these instruments is worth hundreds of trillion in value, and we have yet another economic time bomb just waiting to go off.
All of which explains why governments are so eager to bailout banks, and each other, at the expense of its citizens and taxpayers. For if our elected officials attempted to hold the banks, or their own governments accountable for financial malfeasance, and went into bankruptcy, which would require a debt restructuring (i.e. a “haircut” among bond holders), the entire banking system would collapse, and possibly a global currency or two, with it. That is to say, as governments and banks went into default, it would trigger payment from these wildly speculatively, hidden, and more than likely under-collateralized instruments, known as derivatives/C.D.S.
But heh, these instruments are incredibly profitable for banks to trade.
Meanwhile instead of forcing the plutocracy to take a financial hit on their holdings of bank bonds and sovereign debt, the costs of a never ending stream of bank and sovereign bailouts are carried by debt monetization and taxpayers…. All so that the banks don’t have to close up shop. This scenario is a never ending economic fugue, headed in the wrong direction, as many sovereigns have absolutely no hope whatsoever of paying their debt, and wealthy nations, such as Germany, end up bailing out fiscally irresponsible nations, such as the PIIGS. As a result, the human suffering and hardship, created by rising taxes, reductions in social services (such as education), commodity inflation, and austerity measures, is no longer being taken with equanimity among the citizens of the world.
A House of Cards, or a Chain of Dominos, Choose your Metaphor!
Even as I write this bond vigilantes, many of them undoubtedly hedged with C.D.S. products, are testing E.U. sovereign bond issuance and interest rates spreads. The bond vigilantes know that if they can make a sovereign default they will be handsomely paid via their own speculative C.D.S. contracts, and what better way to tear a fiscally impaired sovereign budget apart than with higher interest payments, a cost that will undoubtedly be carried by the taxpayers of a target country, if not cause outright default.
The problem is that sovereign debt, and C.D.S. issuance, is so interconnected throughout the globe, that if one sovereign defaults it could set off a chain of sovereign dominos, as stronger countries continue to throw good money after bad in the hopes of staying one foot ahead of the contagion. Strong countries, in essence, becoming and joining the ranks of the weak, through successive bank and sovereign bailouts.
Fiscal policy and monetary policy, in the U.S., is well on its way to becoming impotent; as pointed out by Mr. Randall Forsythe in his column, Current Yield, in Barron’s, the recent continuation Bush era tax policies, combined with the monetary policy of QE2, was met with rising treasury yields: expansionary fiscal and monetary policy runs into reality and higher yield, a contractionary force.
Ultimately, the ability to print money to fund a never ending stream of bailouts is going implode, and politicians are grasping at straws - faced with the limits of fiscal and monetary policy; and ultimately, the only way out is going to be some sort sovereign and bank restructuring program, and in the process all those speculative holders of C.D.S. and derivatives contracts are going to have to be told that their contracts are worthless, or worth a great deal less than there notional value, as is a C.D.S. holder’s perfected interest in assets in the event of a bankruptcy.
As for our friends the Republicans(?), the party in charge when the current financial crisis erupted, well they want to delay implementation of a watered down Dodd - Frank legislation, because they believe it needs further study on its impact on bank profits; and the banks themselves, particularly the Wall Street banks, well they are fighting Basel III, international bank regulation, at every turn.
Doctor Suess hit the nail on the head at the end of his book, The Sneetches. We have the jaded view of Mr. McBean (aka Bankers) that the public won’t learn, and we have the reality that the Sneetchs (aka the Public) will eventually catch up on the scam, and not repeat the mistakes of the past:
“Then, when every last cent of their money was spent,
The Fix-It-Up Chappie packed up. And he went.
And he laughed as he drove In his car up the beach,
“They never will learn. No. You can’t Teach a Sneetch!”
But McBean was quite wrong. I’m quite happy to say.
That the Sneetches got really quite smart on that day.
The day they decided that Sneetches are Sneetches.
And no kind of Sneetch is the best on the beaches.
That day, all the Sneetches forgot about stars and whether
They had one, or not, upon thars”.
Ultimately, my bet is on the Sneetches!
http://blog.jmhamiltonpublishing.com/2010/07/05/thinking-the-unthinkable.aspx
Comments