Ask a banker, and listen to what they say!

Nice post on Planet Money which actually gets many of the facts right! Unfortunately, they do not see how these facts actually pull together, and so do not quite capture the core insight into bank operations. But overall, it's a nice piece.

So, on some simplistic assumptions, capital is just the result of some arithmetic:
Capital is how much money would be left in the bank if you sold all the bank's stuff and paid off all its debts.
If you actually did that - and you wouldn't, it wouldn't really work out this way, but pretend - if you actually did that then that leftover money would go to JPMorgan's shareholders. They're what's called the "residual claimants," which just means that they get what's left after everyone else has been paid off.**** So the capital is sometimes called "shareholders' capital," because it belongs to them.

Yes, not bad! They've shown a balance sheet, and highlighted how capital is, in some sense, the stub value between assets and liabilities.

Those arithmetic definitions of capital should make clear an important fact: if a bank loses money, its capital is reduced before any of its debts are. The capital is the "first-loss position"; sometimes people say it "absorbs" losses. If JPMorgan just misplaces $100 billion of cash, then its assets will go from $2.4 trillion to $2.3 trillion, but its debts won't change by a penny: it'll still owe various bondholders, depositors, etc. a total of about $2.3 trillion. This means that its capital will now be $107 billion, say, instead of $207 billion: the entire $100 billion loss will go directly to the people who own stock in JPMorgan — the people with a claim on JPMorgan's capital. If JPMorgan misplaces $300 billion of cash, then its capital will be zero, and the stock in JPMorgan will be worth zero. On top of that, some of the people who loaned money to JPMorgan won't be paid back.

Yes, this is core fact. Capital is money in first loss position. If you want banks to make more responsible credit decisions, you need to put the folks who own the bank (shareholders) in more of a first loss position for when those decisions turn out to be wrong. That, by itself, is a strong argument for higher capital levels.

But there's another issue, which is that banks - and their shareholders - tend to like leverage, which is the superpower that borrowed money creates. Borrowing money - especially when you can borrow it really cheaply, like you can today - allows you to magnify your profits and losses. Magnifying your profits is good for shareholders (they get the profits!). Magnifying your losses isn't great, but since the shareholders don't necessarily suffer all of the losses (their shares can't go below zero), they might still prefer to take the risk. "Capital," remember, just refers to money that the bank hasn't borrowed: the more capital a bank has, by definition, the less leverage it has.

Great point. When you have an asymmetric payout structure (heads I win, tails I get bailed out) then increasing risk is the rational strategy. Lower capital, combined with the structural reasons we have had and will continue to have tax payer bailouts, increase this risk and so help banks make more money.

The article then gets lost in the maze of liquidity, not understand regulatory capital requirements, the forbearance thereof, and not looking at the very strange role the overnight interbank market and Fed discount window plays in all of this. Oh well. However, at the end it just becomes wrong.

But sometimes that's a good secret to keep. Ultimately banks get their money from people. People for putting money into banks in "safe" forms (deposits, etc.), rather than "risky" forms (shares of stock). If regulation shifts the mix into more "risky" forms of bank financing - if it makes people face up to the risks of their banks - then they will have a harder time satisfying that preference for safe assets. Then what happens?

Deposits are not substitutes for equity investments. Banks do not get their money to make loans from deposits. On the contrary, bank make loans out of thin air which then create deposits.

Fundamental error in banking

Megan McArdle, who I am fond of, is smart and understands economics and data well. And she illustrates the pervasive misunderstanding of how banking works in a throwaway line about Obamacare:

A bank account with $500 in it costs just as much to services as a bank account with $50,000 in it, in terms of ATMs and teller time and account statements mailed.  But the bank account with $50,000 turns a lot more profit for the bank when it's loaned out. 

Emphasis mine.

Banks do not loan out deposits, whether they are $500 or $50,000. Banks create loans out of thin air, expanding the asset and liability side of their balance sheets simultaneously, constrained by the amount of capital they hold and the capital requirements enforced by the regulatory regime. Loans create deposits.

Woolwich Machete Attack Ignored in US

Yesterday, two black Muslims cut down a British Soldier in Woolwich with a machete. But you would not have known looking at the front pages of the US's Paper of Record, or the Capitol's favorite rag. British papers did focus on the incident, however.

Why people don't like deficits

I think Robert Vienneau is being disingenuous when he asks claims "our rulers don't know why they don't like deficits". Furthermore, I think his arguments about conspiracies by evil capitalists hoping to keep down the common man reflect his (and Krugman's) politics more than anything real. Not that politics isn't real.

People don't like deficits because they've 1) been told that deficits are bad, and 2) it's easy to make an analogy between an overly indebted family and an overly indebted nation. I think we need to address these matter-of-fact concerns first -- going straight to conspiracy explanations are political, and that's a shame because this core misunderstanding is causing real economic hardship right now.

I think anyone reading this would see the obvious partisanship dissmiss Vienneau:

They report views on many areas of public policy. Generally, our rulers are reactionary and the opposite of benevolent. Business backgrounds in finance or industry, inherited wealth or "earned" wealth, were not correlated with differences in views. The sample size might be too small to provide enough power to distinguish, among the wealthy, effects of where they sit on where they stand. Professionals, mainly lawyers and doctors, tended to be slightly less reactionary. 

Really? Our current President does not have a background in finance or industry, nor did he inherit much wealth (you can decide whether he's "earned" the wealth that he has). Looking through most of Congress, by and large their members are professional politicians. And let us not overstate their power, given how independent most Government agencies are in their operations. Finally, the antonym of "benevolent" is "cruel". Enough said.

Professional Economists are generally poorly versed in accounting, and so do not understand how the balance sheet of a currency issuer operates and is different from the balance sheet of a currency user. Accounting entries like "negative capital" are rare birds, but important in understanding sovereign monetary operation. But since this is a blind spot, they too are guided by their familiarity with household finance and we are told deficits are bad.

Keynesians, are slightly more nuanced and say that deficits aren't bad now, but will be bad in the future, so therefore we should let the Government spend more immediately. However, there is a second way to generate deficits which is to cut taxes, and Keynesians do not put this option on the table. As such, their prescription is partisan in nature and observed as such. Much like Vienneau.

More on the XBox One

Yesterday, I posted my initial reactions on the Xbox One. Some additional thoughts.

1. While the instant response makes it easier to switch from TV to the game, it's not clear to what degree this XBox One is really a gaming machine at all. Tadhg Kelly asks what the whole thing is for, anyway.

2. It wasn't just me, there seems to be no DVR support in the Xbox. Not so good for TV then.

3. While elements of the XBox One were iOS like, it does not have an independent app store where indie developers can self publish. I think this is most likely a temporary state of affairs, perhaps to support the major 3rd party game developers to support the console and invest in some launch, post-launch titles.

4. The fact that MSFT will simply consolidate all games together suggests that yes, we will be seeing indie next to free-to-play next to AAA titles in the same library. Just like iOS with the market pressures that will bring.

5. Sony's PS4 is the more gamer-centric gaming console. From a pure core-Gamer perspective, that is the one to buy. The question is, will the more casual player be tempted to get an XBox instead because of the "life style" features packed into the Xbox? Or will they continue to just play games on their iPad and stream Netflix via Airplay, like they do now?

Xbox ONE

Not as anticipated as an Apple event, but Microsoft's XBox One launch was interesting, both for what they emphasized about their new console, and also what they did not mention.

If Microsoft was not in the console market today, I don't think they would choose to enter it. Windows, and the PC, is being assailed by Linux, iOS, Android, tablets, smart phones, etc. and Microsoft has not been able to defend it's home turf, or leverage Windows into these new worlds. These are they key existential threats to Microsoft, and they should take up all of the company's attention.

XBox One, therefore, should sort of be a B-team effort, with the A-players managing phones and tablets. But the presentation did not give that impression. We saw interaction experiences built from iOS deeply embedded into the console, in particular, voice command, gestural interface, instant task switching, and always-on service delivery. The whole thing feels like a bunch of apps.

In the last console cycle, HD graphics were the clear reason to get a console, and nothing like that exists today. I think some of MSFT's technology might generate legitimately better experiences, like good player matching, but overall there isn't any "must buy" feature for the hardcore gamer.

Actually, I think the ability to instantly task switch between TV's and games might end up being the most important feature for the marginal customer, because it makes it convenient to play console games more casually. Look for an XBox App store, with Free-to-play titles available for download and instant play soon. We'll know in February.

Yahoo! + Tumblr

In light of the $1B Tumblr acquisition by Yahoo!, I'd rather not comment on whether it was a good move by Yahoo! or not. From what I've heard, Tumblr was not making much money and was coming close to its fume date. Also, I've heard that growth of the platform was slowing.

That said, they could not have been in such difficult straights if they were able to negotiate a $1.1B all cash exit.

Acquisitions are hard. Turning popular (dare I say it, faddish) consumer platforms into real businesses is hard, and I wish everyone the best of luck.

I think it is worth looking at something Mark Suster wrote a few days ago which jives with my experience, and that is the downside of acquisitions for the existing team:

For the past 5 years or so Google, Facebook and a handful of tech industry giants have been quietly buying scores of early-stage startups for their talent. And to keep up with the Jones’s it seems that Yahoo! has now employed the same strategy.

And who cares, right?

How about if we look at it from the “rest of company” perspective.

You have been at Google, Salesforce.com, Yahoo! for years. You have worked faithfully. Evenings. Weekends. Year in, year out. You have shipped to hard deadlines. You’ve done the death-march projects. In the trenches. You got the t-shirt. And maybe got called out for valor at a big company gathering. They gave you an extra 2 days of vacation for your hard work.

And that prick sitting in the desk next to you who joined only last week now has $1 million because he built some fancy newsreader that got a lot of press but is going to be shut down anyways.

What kind of message does that send to the party faithful who slave away loyally to hit targets for BigCo?

The Tumblr faithful are in arms about the purchase, they are worried that Yahoo! will change Tumblr, and it will (it must) because while the service seems to be generating plenty of value, it is not capturing enough of what it has created, and it isn't creating enough new value any more to get a pass.

I will also add, that just when something seems like it cannot be made any simpler, it can (and does). Anyone else remember the early days of Dave Winer's blogging software, or Joel Spolsky's downloadable blogging solution? Then came Blogger, and it was simpler and better. Then Twitter. Then Tumblr. Twitter is technically simpler than Tumblr, but Tumblr is cognitively easier to get your head around.

Are we in a stock market bubble?

The S&P just breached 1600, an all time high. Are we in a stock market bubble?

(Please indulge me in a brief aside. This image of the S&P from the 1970s is depressing). Basically, the stock market has gone sideways from the internet boom of the mid-90s to today. In the last decade, there have been two brutal downturns, and the extreme volatility you see in the charts, against a backdrop of sideways drift, should make anyone wonder whether investors, as opposed to speculators, really have any business being in this HFT driven market. But I digress. Let me segue back to the point of this post and talk about whether we are currently in a bubble or not).

James Surowieki tackles this in his latest New Yorker post:

With the stock market setting new highs on a nearly daily basis, even as the real economy just slogs along, there seems to be one question on everyone’s mind: are we in the middle of yet another market bubble? ...

The bubble believers make their case with a blizzard of charts and historical analogies, all illustrating the same point: the future will look much like the past, and that means we’re headed for trouble... The bears admit that corporate profits are high, which makes the market’s price-to-earnings ratio look quite normal, but they insist that this isn’t sustainable... Today, after-tax corporate profits are more than ten per cent of G.D.P., while their historical average is closer to six per cent. That’s a vast gap, and it’s why bears believe that the market is, in the words of the high-profile money manager John Hussman, “overvalued, overbought, overbullish.”

All good points. Corporate profits are high, and labors share of income, which has been historically very stable in the US at about 70%, has fallen to just 60%. This is a big deal. Check out this chart, it begins in 1947. So a ratio which has been fairly stable in the US for over 50 years, has fallen off a cliff.


This is the source of rising corporate profits -- there is enough consumer demand to support flat or rising top lines, but a glutted labor market which means that companies can keep compensation costs in-line and increase their overall share of profit. Surowieki cycles through other explanations: corporations pay less in taxes, labor unions are weaker, S&P 500 earnings include overseas operations which are looking to grow, but I think the Labors Share of Income Chart from the Cleveland Fed tells the real story -- a dramatic and recent decrease in labor market strength is flowing through to the corporate bottom line.

So, why? James is coy:

The underlying issue is that in recent decades there’s been a shift in the U.S. economy: it’s become far more congenial to businesses and investors. The fundamental trends that have driven the profit boom are unlikely to be reversed. That doesn’t mean that companies are going to be able to keep slashing their way to profit growth. As Doug Ramsey, the chief investment officer for Leuthold Weeden Capital Management, told me, “It’s hard to see how companies can get profit margins much higher, unless they want to see massive labor strikes across the country.” But keeping profits where they are doesn’t look all that difficult, which makes stocks today quite reasonably priced. It’s still possible that investor hysteria could eventually inflate stock prices, or that investor panic could send them crashing, but there is no profit bubble and, for now, no stock-market bubble, either.

What is this shift which began when the internet bubble popped in ~2000, never recovered, and then took another dogleg down when the debt bubble popped in 2008? Quite simply, I'd say it's a weak labor market because the economy, as a whole lacks aggregate demand. This is not structural, and its congeniality to businesses and investors is accidental, I believe, not calculated. I think that the US Govt has been unwilling to take the necessary fiscal actions, through tax cuts or increased spending depending on your politics, to step in and restore the demand which never really recovered from the internet boom ending.

Whatever happened to Cyprus?

It seems that a few months ago, Cyprus was on the verge of imploding. What happened -- did it implode? Did the Germans relent and let the ECB write a big cheque?

I have no idea. A quick google search revealed these two articles, both of which are interesting, neither of which really catch me up.

Athanasios Orphanides blames it all on the Communists.

What was the role of decisions by Cyprus, decisions by Europe, and other factors in producing the crisis we see now?

A number of factors played a role. The global financial crisis and exposure to Greece made Cyprus vulnerable. But the outcome was determined by decisions taken by the previous government in Cyprus as well as the broader malfunction of the euro area over the past three years.

Two months after Cyprus joined the euro area [in January, 2008], there were presidential elections and the Cypriot public elected as president a communist, Demetris Christofias. The public was convinced he could solve the political problem we had with Turkey and reunify the island. The issue was not economic.

If one thing has become clear over the last five years in Cyprus, it is that the euro area, which is not just a market economy but a currency union with strict rules, is not compatible with a communist government. Why is this important? This government took a country with excellent fiscal finances, a surplus in fiscal accounts, and a banking system that was in excellent health. They started overspending, not only for unproductive government expenditures but also they raised implicit liabilities by raising pension promises, and so forth.

Well, never a bad move to blame communists (except maybe out loud) but you will note Orphanides never mentions the structural problems that an archipelago of currency users has when there is no issuer to back claims between them.

And on the latest plan?

Why, in your view, was the March 16 plan flawed?

The Cyprus parliament had passed a number of laws that influenced the current and future spending and pensions. And they were also in the process of finalizing how they would do privatizations of the semi public companies. So all the standard elements you'd expect in other programmes had been done or were being done.

Why did they attack retail deposits in this manner? This had never before been a requirement of any other programme. And why did the German government insist in the last three days that there should be a bail-in? The only logical explanation I could see is that Angela Merkel's government faces re-election in September of 2013 and the SPD [the Social Democratic party, the principal opposition to Ms Merkel's Christian Democratic Union] has made it an issue: it does not want to support a loan by the German government to Cyprus because, they claim, that would be like bailing out the Russian oligarchs. This is how Cyprus got caught up in the German election...

What will the implications be for Europe and the stabilization of the euro zone?
This is similar to the blunder in Deauville with PSI that injected credit risk into sovereign government debt. The governments have created risk in what before last week were considered perfectly safe deposits. This is going to have a chilling effect on deposits in any bank in a country perceived to be weak. This will mean the cost of funding will increase in the periphery of Europe and as a result, the cost of financing for businesses and households will increase. That will add to the divergences we already have and make the recession in the periphery of Europe deeper than it already is. This is really a disaster for European economic management as a whole.

OK, so it's not all the communists' fault, the Germans are also to blame. History rhyming.

I, however, still do not know, structurally, what happened in Cyprus. This second feed does not help, although it does have pictures of angry Spaniards.

So, did some debt deal go through? Was there any material outcome besides a worsening of living standards in Cyprus, and I assume Greece? International stock markets seem to have been fine, so maybe the ECB wrote a cheque after all?


If anyone can clue me in, I would be obliged.

The True Cost of (Equity) Capital

I know it's nice to discount any complaint or warning issues by bankers that some new regulation will negatively impact the economy, but I think when it comes to concerns around increasing (equity) capital requirements, they are correct. We should increase capital requirements anyway.

Kwak discounts the bankers' concerns with a number of assertions which are, factually, not true:

Some of the arguments against higher capital requirements are simply incoherent, like the idea that banks would be forced to set aside capital instead of lending it...

Some contradict basic principles of corporate finance, like the idea that adding more equity capital increases banks’ cost of funding.* Yes, equity is usually more expensive than debt (meaning that investors demand a higher expected rate of return) because it is riskier (the range of possible outcomes is greater). But as you add equity, both the debt and the equity become less risky (since the firm is less leveraged), which reduces the cost of debt and the cost of equity...

In the real world, debt has a tax advantage (interest on debt is tax-deductible, while cash that is paid to shareholders or reinvested in operations is not), so increasing debt can reduce the overall cost of financing. But that’s a government subsidy...

I'll be gentle and not cite the part where he brings up Modigliani-Miller. Kwak is likely familiar with some corp fin, but is not well versed in bank operations or regulation. A banks ability to lend is primarily constrained by capital requirements (not reserve requirements as many thing) which means there is a limit to how many loans it can extend, and the riskiness of those loans, based on how much equity it has. All else equal, the more a bank lends, and the higher an interest rate in can charge on those loans, the more money it makes.

Therefore, higher capital requirements limit how much a bank can lend, which impacts its ability to make money, and also causes economic harm to the extent that less bank lending is harmful to the non-bank economy.

Some important additional elements: We want bank lending to be prudent, which means putting private capital in first loss position against bad loans. The equity that investors put into banks is exactly the capital which should be in first loss position, so having more of it is not a bad idea as it will be able to absorb more loan writeoffs before the bank needs to go to the Government for a hand out.

Beyond that, the system can still be gamed by mispricing risk on the asset side -- if you can classify a risk asset as a safe one (as the banking system did with mortgages) you can end up undercapitalized on a risk adjust basis even with larger capital requirements. Higher thresholds deal with this in a crude way, but I'm not sure what better tools there are to model risk more accurately and make sure that this sort of covert leveraging is not allowed. Better to accept it's a black box and forbid securitization -- keep loans on the books of the originator and make those who invest in the originator have their necks on the line for performance.

The Problem with 401(k)s

A really nice post on the Vanguard corporate blog (really) about the problems with 401(k)s:

The film started with two misconceptions. The first is that most Americans aren’t prepared for retirement. That’s an over-exaggeration (see my previous post on this issue)..

The second misconception was about the old defined benefit (DB) pension system. The program suggested most workers had a generous DB pension, and that there were no risks to worry about. By comparison, 401(k) plans are a poor substitute—they’re too complex, too costly, and too risky for the average person.

All of this is equally untrue. About 4 in 10 private sector workers had pensions in their heyday, and the typical pension was modest. The system was full of risks. For example, you could spend your career at a company and find out at age 65 that the pension you were entitled to was inadequate. Or, if you changed jobs frequently, whether by choice or necessity, you often got little or nothing from the pension system. And few workers were aware of these risks.

I think that it is important to note how available defined benefit pensions really were, and that they were poorly suited for job mobility. But I think it is certainly true that the individuals who run those plans are far more able to make wise decisions than individuals. The 401(k) system really does force individuals to make decisions that they are poorly equipped to make.

That said, this point is critical:

- Savings. Strikingly, the documentary said nothing about savings habits and the culture of consumption in America. If only it had! The fundamental challenge facing all retirement investors, 401(k) or not, is saving adequately. Yes, low fees, better portfolios, and good legal regulation matter. But they are second-order concerns to the first-order problem of Americans consuming less today so they can have more tomorrow. We seem to have cultural amnesia about saving—and no one really wants to talk about it.

A friend of mine in the industry made the same point years ago. Picking the right stocks (or funds), taking care that fees are as low as possible, managing taxes well is all good, but the main thing you need to do is save enough, and people don't.

It may be better to lower taxes, make social security more generous, and abolish 401(ks) altogether. In fact, the tax advantaged nature of 401(k)s means you need to lower taxes (or increase spending) anyway to handle the demand drain that comes from the increased savings that those vehicles generate. Finally have social security without automatic COLA adjustments -- this should be another inflation control lever that is counter cyclical to the business cycle, not pro-cyclical the way COLA sets is up to be.

Commodity Entrepreneurship

One thing about Y Combinator plus its imitators is that it takes a truly commodity view of the entrepreneur, at least the entrepreneurial founder. After all, what does it really ask that the founder have? Not deep technical expertise in a horizontal discipline, nor in a vertical industry, just energy and the willingness to take a risk. And energy and a willingness to take risks are the commodity of youthful labor, which puts not-so-youthful capital in the position of price maker.

Unsurprising then that financial returns accrue to the capital:

If you add up the I.P.O. figures and the sale figures, this means about 33 percent of venture capital exits are in a position for the founders to earn a dime.

But it is probably lower than that. According to Sand Hill, 7.5 percent of the venture capital I.P.O.’s had exit values that were below the total venture capital investment. As for sales, the venture capital investors still need to be paid back their 8 percent accrued dividend. This probably puts the number of deals where the founder receives anything in the 20 percentile range. These numbers also do not take into account management or other fees paid to the venture capital firms.

The notion that entrepreneurs are the new labor is explored in more detail here.

"Ample theoretical reasons to worry about debt..."

Rogoff and Reinhart seem to be debunked, at least somewhat, but fear not -- the result is still true!

9.  There are still ample theoretical and empirical reasons to worry about debt.  To name just a few:

a.  "Crowding out": the logic of Clintonomics.  If the government borrows too much, the private sector doesn't have money to invest.  Pretty certain that this doesn't apply in America or Europe right now, but it certainly has and could in other times and places.

Government deficits are what gives the private sector money to invest. If the government taxed back all the money it ever printed, I would have no money for anything.

b. Debt crisis: these are ugly, and often accompanied by other ugly, destructive things,like hyperinflation.  Of course causality runs both ways; countries in trouble are more likely to get into a debt crisis.  But the more debt you have on the books, the higher the risk that a downturn tips you into crisis.  Sudden fiscal contractions are much worse for the economy and other living things than gradual winddowns.  

Hyperinflation is definitely a problem, and the reason to worry about running too high debt/deficits. Good thing we have no sign of it here, and Japan has had no sign of it for a generation and counting.

 c. Debt dynamics driving fiscal contraction:  Well short of an all-out crisis, if your interest rates start rising faster than inflation, you start having to either raise taxes or cut spending; usually both.  That slows your GDP, at least in the near term.  

 

Interest rates are set by the Government, up and down the yield curve depending on how they choose to manage their QE. If you see rates go up, you don't actually need to do anything unless you want the rates to be different.

d. Income redistribution: worth noting that repaying a big debt load usually involves cutting spending or raising taxes on middle class folks who have to cut their own spending, and giving that money to capital owners.  Some of those owners are outside your country, so you don't even get derivative benefits.

Repaying debt involves changing numbers in a spreadsheet. Paying down debt involves running surpluses, but you would only do this if there was a problem with inflation. How you would run surpluses through taxes and spending, and where that incidence falls, depends on implementation.

Our Internet Surveillance State

Just a great post from Bruce Schneier:

So, we're done. Welcome to a world where Google knows exactly what sort of porn you all like, and more about your interests than your spouse does. Welcome to a world where your cell phone company knows exactly where you are all the time. Welcome to the end of private conversations, because increasingly your conversations are conducted by e-mail, text, or social networking sites.

And welcome to a world where all of this, and everything else that you do or is done on a computer, is saved, correlated, studied, passed around from company to company without your knowledge or consent; and where the government accesses it at will without a warrant.

Welcome to an Internet without privacy, and we've ended up here with hardly a fight.

His examples are particularly good. Sort of like Elementary.

What is Bitcoin?

Might as well wander into the fray.

I won't say whether Bitcoin is "money" or not, because that depends on your definition of "money". It is certainly not a "fiat currency" because fiat currencies are manifestations of a Sovereign's power to set and enforce taxes. If the US$ can tax you, you will need US$ to extinguish that tax obligations, which mean you will need US$. The Schelling Point, or Nash equilibrium (pick your model) is not spontaneous -- it is an outcome of demand creation generated by power.

Now, there may be users who do wish to use it as a store of value, and to that extent it may be money in some true Schelling or Nash sense, but this will only be true if it actually wins. Which it won't. Bitcoin is not a good alternative to your sovereign's scrip, nor is it a better mechanism to hold wealth than land or other real assets.

It is also not a Ponzi scheme because it does not rely on new investors to fund payouts to old investors.

It is certainly a vehicle for financial speculation, much like a penny stock except there are no real assets at all behind it. Making it, perhaps, a perfect, purely speculative instrument. It's ironic that it's championed by gold bugs who tend to be suspicious of flimsy specie.

Ron Johnson, Apple, JC Penny

Ron Johnson, after 18 months where he saw same-store sales fall by 30%, and the share price half, is out of JC Penny. I feel sorry for the guy.

First, JC Penny's difficulties long predated Johnson coming on board. The mid-market department store chain has been under pressure as higher-end specialty stores pick off more affluent customers, and discounters pick off the price sensitive. And then there are online competitors putting pressure on retail on general.

These structural problems put JC Penny in a difficult position between serving it's shrinking base of existing customers--who by definition are particularly loyal to JC Penny since they haven't defected yet--or trying to find a new mass market. It's the classic position of an incumbent being disrupted, and it's a tough place to be.

I don't know to what degree Johnson was running his old Apple playbook, or to what degree he was relying on research, analytics, and calculated hunches to try and find a new market. I'm not sure who this market was (or could be). If Johnson reflexively reached for his old tool kit, then there could be hope yet for someone to come, focus on customer needs in a disciplined way, and find a market they can successfully contest. If Johnson was doing the best he could with data, then I'm not sure what options JC Penny has left.

Wet pavements don't cause rain

Megan has a good, conventional wisdom post, on the mechanics of debt and deflation in Japan. Japan is a fantastic case study because it has run up massive, truly massive, deficits, and has had extremely loose monetary policy for almost a generation now, and still remains in the post-crash funk it was in after its property bubble popped in the mid-80s. And yet, despite all of this, priors around deficits and monetary policy remain unchanged. Here's Megan:

I join most economists in thinking that deflation is bad, and it will be good if Japan can stop it.  Deflation causes money hoarding--if that dollar you have now will be worth more later, it only makes sense to spend it later.

Deflation does not cause money hoarding any more than wet pavements cause rain. Money hoarding--driven by animal spirits--causes deflation when the Government does not meet it's responsibility as the currency monopolist to print money that people desire to hoard. When you can hoard through paying lower taxes (or getting a cheque from the Government) you do not need to try and hoard by skimping on your grocery bill, and thus reducing someone else's income.

Similarly, think through the assertions here and compare them to what actually happens in real life:

Deflation is good for creditors.  But it's terrible for debtors.  Say that business is slow and your mortgage is really starting to pinch.  If inflation is 2-3%, you just need to hold on a bit; every year, the real value of your mortgage will shrink, making it easier to pay.

Really? If your nominal income stays the same and your nominal mortgage stays the same, how will a change in the real value of anything have any impact?

Debt is nominally denominated, it's just a number in a spreadsheet somewhere, just as currency is. Nominal problems need nominal solutions, otherwise they become real problems and you get high unemployment and the various social ills that come from that.

Do not make a vice out of virtue

Nice article by James Surowiecki on the "war-on-savers":

But, to his detractors, Bernanke is guilty of waging a “war on savers”—fleecing people, especially retirees, of hundreds of billions of dollars that they could have earned in interest. Among many conservatives, this notion has become mainstream. Last year, both Mitt Romney and Paul Ryan regularly attacked the Fed for keeping interest rates too low, and, when Bernanke testified before Congress in February, Senator Bob Corker, of Tennessee, upbraided him for “throwing seniors under the bus.”

Certainly, it’s not the easiest time to live off interest income. The average rate on a savings account is less than 0.25 per cent. Long-term certificates of deposit offer rates well below inflation, and even a ten-year government bond yields less than two per cent. No wonder people with lots of savings want the Fed to start tightening—to stop buying bonds, and to raise interest rates. But most Americans depend on wages and salaries for their livelihood, not on interest income, and higher interest rates would hurt the job market, which is still weak, with unemployment near eight per cent and wages barely rising. Also, most Americans have more debt than savings, which means that they benefit directly from lower interest rates

Lots of assumptions, let's see what's actually true.

First, it is true (but an oft neglected fact) that interest rates have a fiscal knock-on effect through the interest rate channel. Low rates mean low interest income, which is a fiscal contractor just as higher taxes of lower government spending is.

Second, to the extent that low interest rates are fiscally contractionary, it is not at all clear that higher rates would hurt the economy. Americans do depend on wages, but wages depend on sales, and sales depend on people having money in their pocket. Higher rates put more money in peoples' pockets.

Lastly, it is not true that most Americans have more debt than savings. On a net basis, the non-Govt sector is a net lender, not a net borrower, and we know this because the Govt sector has an outstanding multi-trillion dollar debt -- money which it has spent but not collected. That money must be somewhere. And within the non-Govt sector, horizontal lending must, by accounting, net out to zero.


I think it is fair to consider savers to be collateral damage, since they harm they are suffering is incidental to the intentions of Government officials and regulators alike. Ultimately, only higher deficits, and more fiscal transfer, will sate their savings desire and begin to generate aggregate demand again.

What price is wrong?

Krugman tries to distinguish between Austrians vs Monetarists as two groups arguing about what is being priced incorrectly. The assumption is that something is price incorrectly because we have a market which is failing to clear (unemployment):

As I see it, the whole structural/classical/Austrian/supply-side/whatever side of this debate basically believes that the problem lies in the labor market. (I know, the Austrians will deny it — but it doesn’t matter what you say about their position, any comprehensible statement leads to angry claims that you don’t understand their depths). For some reason, they would argue, wages are too high given the demand for labor. Some of them accept the notion that it’s because of downward nominal wage rigidity; more, I think, believe that workers are being encouraged to hold out for unsustainable wages by moocher-friendly programs like food stamps, unemployment benefits, disability insurance, and whatever.

As regular readers know, I find this prima facie absurd — it’s essentially the claim that soup kitchens caused the Great Depression. But let’s stick with the economic logic for now.

So what’s the alternative view? It’s basically the notion that the interest rate is wrong — that given the overhang of debt and other factors depressing private demand, real interest rates would have to be deeply negative to match desired saving with desired investment at full employment. And real rates can’t go that negative because expected inflation is low and nominal rates can’t go below zero: we’re in a liquidity trap.

My question is, suppose what's wrong is that there are insufficient Net Financial Assets (Equity) to supply the demand for private sector savings (broadly, and precisely defined)? In this model, the extra required savings, at the sector level, aren't available for any price and so the market doesn't clear. Deflation doesn't help, because it makes real debt burdens worse, and low interest rates don't help because ameliorate and exacerbate the issue at the same time.

Marc Andreesson: Strangely self-serving?

I'm not sure what to make of this very strange post on Marc Andreesson's blog. It's not by Marc, it's by Scott Kupur who works at the fund.

The post argues three points:

1. The middle class is now missing out on hot-IPO action because all the value creation is happening in private markets, and post-IPO performance is disappointing as the company is already past its prime. Therefore, we should loosen the rules barring non-accredited investors from primary markets.

2. Kickstarter, and other crowd funding projects, actually expose these individuals to seed stage investments that are the most risky.

3. We need to roll-back decimalization, so there is a larger spread in trading small cap stocks, making it easier for financial firms to profit from their trading.

I'm not kidding about the last one:

A number of policy and market changes—all with well-intentioned goals—have created a hostile environment for new IPOs and, in particular, for small IPOs. Arguably the most significant among the changes was the 2001 move to decimalization. Much has been written about the “death star” of decimalization, a phrase first coined by David Weild, former vice chairman of Nasdaq. But simply stated, decimalization eliminated all of the profits from trading small-capitalization stocks. How did this happen? Because decimalization reduced the “tick size,” the minimum increment in which stock prices can trade, to a penny (from its previous level of 25 cents). Thus, a trader who previously might have purchased a block of small-cap shares knowing that a $0.25 tick size likely represented his minimum profit potential on a trade now found his minimum profit potential reduced to a penny. Facing this uneconomic situation, small-cap traders simply abandoned the market, killing liquidity for these stocks.

It's good to be reminded how much one's position influences which side of an argument seems reasonable. I'm sure that Kupur is quite sincere in all of his recommendations, but it's also hard to miss just how blatantly self serving they are.

First, after the internet boom of the late 90s, the technology bubble has shifted to private markets where venture capitalists, and other accredited investors, are investing at too-high valuations. What's different this time is that the public markets aren't stepping up and being the bag holder, so that's trickling down to banks, VCs, and other primary market participants. Naturally, Kupur would like public money to step in and overpay for assets, so his fund could enjoy an earlier liquidity event and not have to deal with dogs like Groupon, Facebook, and Zynga.

Second, many kickstarter projects are very different from the high-potential, high-profit businesses traditionally interesting to VCs. They are things like fancy jeans, or cool font, or an indie film. People aren't investing in these hoping for a return, it's a just a cool (and very SWPL) way to shop.

Finally, the decimalization argument assumes that there should be profit in trading small cap stocks. Why? If a small cap does well and becomes a medium or large cap, then the far sighted investor should be rewarded for that, but why is there some God given right to make money off the flow? I think the crash of 2008 is still too fresh in people's minds for "liquidity" to seem like a worthwhile end in and of itself. Liquidity is never there when you need it most.