STRANGE 2006 REPORT TO GEITHNER, ‘BORROWING WITHOUT DEBT’

I was digging around the NY Federal Reserve archives because of Geithner.  Found a really awful report that was given to him.  It said, basically, who gives a hoot about the rising trade and budget deficits?  Our ‘dark matter assets’ would balance our grossly out of balance budget and trade deficits!  I wonder what these mysterious ‘dark matter assets’ were!  I wonder if this is the Derivatives Beast.  They don’t make it very clear, what these things are.   Many things are brewing this week, it is a total witches’ brew of eyes of toads and toes of baboons.

http://www.newyorkfed.org/research/staff_reports/sr271.pdf

Borrowing without Debt? 

Understanding the U.S. International Investment Position 

Matthew Higgins 

Thomas Klitgaard 

Cédric Tille 

Staff Report no. 271 

December 2006 

Abstract

Sustained large U.S. current account deficits have led some economists and policymakers to worry that future current account adjustment could occur through a sudden and disruptive depreciation of the dollar and a sharp drop in U.S. consumption.

No kidding! Back when this report was issued by Geithner’s crew, I was busy at Culture of Life News, yelling about budget and trade deficits! Click here for my oldest issues: Culture of Life News II: March 2005.

 

Today, a lot of the same guys who didn’t see the obvious back in 2005 are all around the neighborhood, shouting, ‘No one could have foreseen this!’ Well, that is a lie. This report is a fine example of how our top experts deliberately refused to understand simple, basic economic realities. And they lied about things, too.

Two factors that, to date, have cast doubt on such concerns are the stability of U.S. net external liabilities and the minimal net income payments made by the United States on these liabilities.

OMG. HAHAHA. This happens to be the Derivatives Beast. Yes, there were very minimum net income on these liabilities! This is why the system collapsed.

We show that the stability of the external position reflects sizable capital gains stemming from strong foreign equity markets and a weaker dollar—conditions that could be reversed in the future.

This was actually the Japanese carry trade at work. The Japanese didn’t do this with yen. They did this with dollars.

We also show that while minimal U.S. net income payments reflect a much higher measured rate of return on U.S. foreign direct investment (FDI) assets than on U.S. FDI liabilities, ongoing borrowing is likely to overwhelm this favorable rate of return, pushing the U.S. net income balance more deeply into deficit.

When this report was drawn up, the mega-trade and budget deficits were just beginning. IN 1990, the US was worried if the trade deficit was over $5 billion a month. By 2005, it began running at well over $50 billion a month! This was utterly ridiculous.

In addition, we review the argument that the United States holds large amounts of intangible assets not captured in the data—assets that would bring the true U.S. net investment position close to balance.

And pray tell, what were these considerable ‘intangible assets’?  Shall we all take exactly one guess?  SAY HELLO TO THE DERIVATIVES BEAST!   These hideous bets were considered to be assets!  Assets!  Isn’t that utterly hilarious?  And now, these stupid assets are rapidly destroying the entire financial systems of the world.

We argue that intangible capital, while a relevant dimension of economic analysis, is unlikely to be substantial enough to alter the U.S. net liability position.

Are they talking about ‘intellectual property’?  That can’t fix anything since it is worth whatever we can squeeze from people which is very little if they are poor and are pirating music, for example.  One of the few good things about ‘free trade’ is the fact that many humans can literally take things for free.  This irritates all the rich people who need to collect ‘rent’ for as long as humanly possible.

 

Also, I note the problem here where the writers talk about ‘assets’ and then, switch to talking about ‘capital’.  They are not one and the same.  At least, not in Marxian analysis.  Capitalization of a system via ‘intangible assets’ is just not possible.  Ever since we chose the floating currency system, we live in this strange upside down world that is all mirrors. Are ‘intangible assets’ the air we breath?  Or is this our education systems?  I wish the writers spent a paragraph, listing these mysterious intangibles.

 

Now, I am always curious about comparing various time frames to see if things change.  And with the US International Reserve position, this can be a weary but amusing pastime.  The Treasury just issued our monthly report.  

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http://www.treasury.gov/press/releases/200932414194221296.htm

 

March 24, 2009
2009-3-24-14-19-42-21296

U.S. International Reserve Position

The Treasury Department today released U.S. reserve assets data for the latest week. As indicated in this table, U.S.reserve assets totaled $76,353 million as of the end of that week, compared to $74,132 million as of the end of the prior week.

I. Official reserve assets and other foreign currency assets (approximate market value, in US millions) March, 2008 data in red   December, 1990 in green   LS-1101: U.S. International Reserve Position

	March 20, 2009
A. Official reserve assets (in US millions unless otherwise specified) 1	Euro	Yen		Total
(1) Foreign currency reserves (in convertible foreign currencies)				76,353 75,840 66,064
(a) Securities	9,462 15,732 5,265	13,452 12,289 10,333		22,914 28,021 15,588
of which: issuer headquartered in reporting country but located abroad				0
(b) total currency and deposits with:
(i) other national central banks, BIS and IMF	10,828 15,622 8,900	6,578 6,881 6,424		17,406 22,503 15,323
ii) banks headquartered in the reporting country				0
of which: located abroad				0
(iii) banks headquartered outside the reporting country				0
of which: located in the reporting country				0
(2) IMF reserve position 2	7,843 4,374 13,635
(3) SDRs 2	9,179 9,901 10,472
(4) gold (including gold deposits and, if appropriate, gold swapped) 3	11,041 11,041 11,046
–volume in millions of fine troy ounces  Anyone have any idea, what is going on here?  Look at the numbers, they are totally different from each year!	635261.499 261.499
(5) other reserve assets (specify) Why is this number exactly the same as the ‘other’ three lines below?  Is this the same thing?  A ‘reversal’?  We didn’t do this in 2000 or 2008.	7,970 0 0
–financial derivatives
–loans to nonbank nonresidents
–other (foreign currency assets invested through reverse repurchase agreements)	7,970 0 0

II. Predetermined short-term net drains on foreign currency assets (nominal value)

			Maturity breakdown (residual maturity)
		Total	Up to 1 month	More than 1 and up to 3 months	More than 3 months and up to 1 year
1. Foreign currency loans, securities, and deposits
–outflows (-)	Principal
	Interest
–inflows (+)	Principal
	Interest
2. Aggregate short and long positions in forwards and futures in foreign currencies vis-à-vis the domestic currency (including the forward leg of currency swaps)
(a) Short positions ( – )   IN NO OTHER US RESERVE REPORTS, ARE THERE ANY SHORT POSITIONS AT ALL!		minus    327,728	minus    184,946	minus -142,782
(b) Long positions (+)
3. Other (specify)
–outflows related to repos (-)
–inflows related to reverse repos (+)
–trade credit (-)
–trade credit (+)
–other accounts payable (-)
–other accounts receivable (+)

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Before we return to the NY Fed Bank report, let’s also look at some charts:

 

St. Louis Fed: Series: BOPOIMF, U.S. Reserve Position in the IMF

The US reserve position isn’t stable, is it?  In fact, like many of our charts, this one shows how buried beneath the surface of seemingly stable inflation data, lurks some pretty active monsters.  This shows clearly how we had a small spike right when Nixon was forced to dump our gold standard, a very sharp spike in the hyper-inflation era and then, we slid into a deep freeze after 1980, which was a bad recession.  Then, we see a series that looks like a bouncing ball that bounces higher and drops lower, very rapidly, very suddenly, there are no gentle curves like the first half of the chart.  No, the bounces are increasingly violent.  This is a classic sign of instability leading to a collapse.

 

St. Louis Fed: FRED GRAPH

This graph is a reminder.  It shows the awful mess we are in.  We never, ever, not even with the 9/11 micro-burst of easy money making, did we ever get near even $30 billion.  Now, just this last 5 months, it shot upwards to nearly a trillion dollars!  THIS IS NOT NORMAL.  Nor, sustainable.  And it screams, ‘Instability!’  The NY Fed bank report is all about how things were not really all that unstable and we could go back to snoozing and ignoring reality.

 

http://www.newyorkfed.org/research/staff_reports/sr271.pdf

1. Introduction Years of large current account deficits have left the United State with the world’s largest net liability position. By the end of 2005, net foreign claims on the U.S. amounted to $2.5 trillion, more than 20 percent of U.S. GDP. We added another $3+ trillion since this report. Moreover, the U.S. current account deficit continues to climb higher, both in dollar terms and as a share of U.S. GDP. In 2006, according to the IMF, the U.S. deficit is likely to reach almost $870 billion, some 6.6 percent of GDP, and up from 4.8 percent of in 2003 and just 3.8 percent of GDP as recently as 2001.

After writing this paragraph, did the economists run from the room, screaming for Geithner? Did Geithner then rush to DC to scream at everyone? Did they see how alarming this news was? Things were rapidly getting much, much worse, thanks to the ‘free trade’ ideology. United States. In particular, asset price movements can easily move in the opposite direction and increase rather than decrease U.S. net liabilities.

This report was written right at the top of the US housing bubble.  All seemed well. Yet, this is the same year, I was yelling about this bubble and warning everyone, a real estate bubble pop is the worst one we could have.  For it takes twice as long for an economy to recover from a housing bubble popping.  This would be no mere ‘recession.’

A second development that has worked to the advantage of the United States is that it makes minimal net payments on its net liabilities HAHAHA because the United States earns a substantially higher rate of return on foreign assets than it pays out on foreign liabilities. Some analysts have cited this higher rate of return as evidence that U.S. foreign assets are higher than reported in the official data, reflecting unmeasured holdings of intangible capital in the form of specialized knowledge, management expertise, and brand name value (so called “dark matter” assets).

Ah!  These ‘intangible capital’ things are brand names?  HAHAHA.  Now, utterly worthless.  As for ‘management expertise’…who on earth will want to touch any of our crazy gnomes with a ten foot pole these days?  Our gnome’s knowledge is also not exactly in high repute anymore, either.  Then there are the ‘dark matter’ stuff: again, isn’t this referring to the ‘dark pools’ which is where the Derivatives Beast lives?

However, even generous assumptions as to the scale of intangible foreign assets would still leave the U.S. with a sizeable net foreign liability position. More important for current account adjustment, however, the scale of such intangible assets turns out to have no material implications for future net payments to the rest of the world. In particular, large ongoing current account deficits will steadily increase U.S. net payment over time. Our analysis does not settle whether U.S. current account adjustment will be gradual and benign, as the consensus now expects, or sudden and disruptive, as others argue. According to latest reports, us ‘sudden and disruptive’ people are the ones who called the shots correctly. All the Pollyannas missed this boat by a million miles. It does indicate that any eventual adjustment will be made more difficult by a growing net income deficit. No kidding! Theses trends raise worries about the sustainability of the U.S. external position. After all, continued large current account deficits should result in a growing net international liability position, and growing payments on those liabilities. It’s no surprise, then, that the clear consensus among policymakers and economists is that the U.S. current account deficit will eventually need to narrow, as a percentage of GDP if not in dollar terms. And some argue that the U.S. faces a growing risk that current account adjustment will be sudden and disruptive, with potential consequences of a sharply weaker dollar and a contraction in U.S. consumption.

They all agreed that we need to close the deficit.  But alas, anyone suggesting simple and sane [as well as very ancient] methods of closing this gap, they would be shouted down.  Trying to keep ‘free trade’ and make it even worse, seems to be the only alternative.  Indeed, there are no alternatives.  Aside from whining to our trade rivals as they cheerfully destroyed our industrial base and our financial systems, the brainiacs at the top of our system just sat on their asses.

However, other features of the data don’t quite square with this disquieting view. I wonder how these three economists are dealing with being so utterly, foolishly, stupidly wrong? First, the value of U.S. net external liabilities has been rising less rapidly in recent years than the amount of net financial inflows represented by the country’s current account deficit. Indeed, from the end of 2001 to the end of 2005, U.S. net liabilities rose by little more than $200 billion, despite cumulative current account deficits of more than $2,400 billion over the period. With the U.S. economy growing, this has meant a decline in U.S. net liabilities as a percentage of GDP. Second, the U.S. now bears only a minimal servicing burden on its net liability position. Due to the Japanese carry trade. The account deficits are basically the effects of the Japanese carry trade flooding the US with funny money. Indeed, the $3.4 billion in net payments the U.S. made during the first half of 2006 implies a servicing cost of less than 0.3 percent (annualized) on net liabilities. In previous years, the net income balance was positive.

Interesting, isn’t it, the ‘servicing cost’ for this tremendous build-up of debt happens to be the same rate as the Bank of Japan’s ZIRP rates? Why have large, ongoing current account deficits recently failed to translate into a sizeable buildup in U.S. net liabilities? And how has the U.S. managed to make such small service payments on its large net debt position? Do these facts imply that the U.S. could continue to run large current accounts deficits indefinitely without facing significant economic consequences?

We now know, once the Japanese carry trade collapsed, this wonderful boon of 0.3% lending for wild US debt accumulation ended with a bang.

This report has some very dire graphs that clearly show a nation going right off a very bad cliff:

 

http://www.newyorkfed.org/research/staff_reports/sr271.pdf

Note the differential between assets and liabilities: starting in 1982, it briefly is in our favor.  But after 1990, the differential widens and from 2004-2008, it got tremendously wide.  It behooves us to keep assets and liabilities at least in balance if not, making a profit!

 

http://www.newyorkfed.org/research/staff_reports/sr271.pdf

4. Conclusion

The relative stability of the U.S. external position in recent years would seem to undermine worries about the sustainability of continued large current account deficits. The small minimal income payments on its large measured net debt position would also seem to undermine those worries.

How on earth could they be so smug, after looking at the two charts they put in their own report? This baffles me. A faux sense of stability might fool some clerk or student in school. But anyone digging in to the data could see nothing but red lights flashing and loud alarm bells ringing.

The small recent increase in U.S. net indebtedness owes to capital gains on U.S. foreign assets, both from higher equity prices abroad and the depreciation of the dollar since 2001. Addition valuation changes from a weaker dollar or increases in foreign asset prices are possible, reducing pressure on the current account deficit to narrow. The risks are that these favorable valuation changes stop or are reversed.

The pressure for current account adjustment has also been eased by minimal U.S. income payments due to a higher measure rate of return on U.S. FDI assets than FDI liabilities. On present trends, however, ongoing net borrowing will drag the U.S. net income balance steadily into significant deficit, adding to current account adjustment pressures.

We are now experimenting with hyper-debt. History is very stern about this: it never, ever works. It only destroys. But people hate the lessons History tries to teach us. I wonder why she even bothers.

Some authors have pointed to the higher rate of return on U.S. FDI assets as evidence that the U.S. holds large amounts of intangible assets not captured in the data. On this view, the U.S. net investment position close to balance, eliminating any pressing need for current account adjustment. According to our analysis, however, plausible estimates for U.S. intangible capital imply only a small reduction in U.S. net external liabilities.

Tomorrow, I am doing a video about the wizards.  The three who wrote this report are wizards.  They are as important if not more important, than the gnomes.  I learned a lot about how to use iMovie tonight.  I hope to use this information tomorrow.  We all live and learn!

 

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