Bonjour Tristesse

The Economic and Political Decline of France

By Mathieu von Rohr

France is in the grip of a crisis. As both its economy and European influence weaken, scandal has hobbled its political elite. The country needs drastic overhaul, but President Hollande does nothing but waver and hesitate.

Judging by the imperial magnificence of the Elysee Palace, France has never ceased to be a world power. Rooms with five-meter (16-foot) ceilings, gilded chandeliers, candelabras and elaborate stucco work are guarded by members of the Republican Guard, who parade in front of the palace gates with their plumes of feathers and bayonets.

The man in charge, on the other hand, seems lonely and small in his palace. He is surrounded by court ushers who make sure that glasses and writing sets are perfectly arranged, and when he enters a conference room, they call out grandly "Monsieur le Président de la République!", to give his attendants time to stand up for him.

François Hollande never intended to become a king, but rather a "normal president," as he put it, and now he has to play one nonetheless. He occasionally seems like an actor who has somehow ended up in the wrong play.

Outside, throughout the country, unemployment reaches new highs each month, factories are shut down daily, hundreds of thousands take to the streets to protest gay marriage, and the French are increasingly outraged over a barrage of new political scandals as the country hovers on the cusp of waning global relevance. Yet this roar of dissatisfaction doesn't permeate the walls of Hollande's world. Here, it is quiet, very quiet.

Shortly after moving into his new official residence, Hollande warned his staff that in a palace it is easy to feel protected, and he insisted that he did not want to be "locked in." But that is precisely what is happening, as evidenced by the documentary film "Le Pouvoir" (The Power), which recently debuted in French theaters and whose creators accompanied Hollande during the brutal first eight months of his presidency.

Elite in a Bubble

They paint an image of a likeable man who seems to spend a lot of time rewriting speeches prepared by his staff. As you watch him in the movie, you start to wonder: Does he do all the important things when no one's watching or does he really spends most of his time on the unimportant? However, the main subject of the film is not the president, but rather the reality bubble in the country's top echelons. Not just Hollande, but also most of his cabinet ministers, still reside in Parisian city palaces that predate the French Revolution, and perhaps that's a problem.

Are central bankers losing control?

In the meantime the debasement of paper money continues

by DETLEV SCHLICHTER

The last couple of weeks have been very interesting. Remember that, certain regional differences aside, Japan has, for the past two-plus decades, been the global trendsetter in terms of macroeconomic deterioration and monetary policy. It was the first to have a major housing and banking bubble, the first to see that bubble burst, to respond with years of 1 percent interest rates, then zero rates, then various rounds of quantitative easing. The West has been following Japan each step on the way – usually with a lag of about ten years or so, although it seems to be catching up of late. Now Japan is the first developed nation to go ‘all-in’, to implement a no-holds-barred money-printing regime to (supposedly) ‘stimulate’ the economy. This is called Abenomics, after Japan’s new prime minister, Shinzo Abe, the new poster-boy of policy hyper-activism. I expect the West to follow soon. In fact, the UK is my prime candidate. Wait for Mr. Carney to start his new job and embrace ‘monetary activism’. Carnenomics anybody?

But here is what is so interesting about recent events in Japan. At first, markets did exactly what the central bankers wanted them to do. They went up. But in May things took a remarkable and abrupt turn for the worse. In just eight trading days the Nikkei stock market index collapsed by 15%. And, importantly, all of this started with bonds selling off.

Are markets beginning to realize that all these bubbles have to pop sometime and that sometime may as well be now? Are markets beginning to refuse to dance to the tune of the central bankers and their printing presses? Are central bankers losing control?

 ‘Sell in May and go away’

Let’s turn back the clock for a moment, if only just a bit. Let’s revisit April 2013 for a moment. At the time I spoke of central bankers enjoying a kind of ‘policy sweet spot’: they were either pumping a lot of liquidity into markets or promising to do so if needed, and all of them were keeping rates near zero and promising to keep them there. Some started to consider ‘negative policy rates’. Yet, despite all this policy accommodation, official inflation readings remained remarkably tame – indeed, inflation marginally declined in some countries – while all asset markets were on fire: government bonds, junk bonds, equities, almost all traded at or near all-time highs, undeniably helped in large part by super-easy money everywhere. Even real estate in the US was coming back with a vengeance. And then, in early April, central bankers got an extra bonus: Their nemesis, the gold market, was going into a tailspin. I am sure Mr. Bernanke was sleeping well at the time: financial assets were roaring, happily playing to the tune of the monetary bureaucracy, seemingly falling in line with his plan to save the world with new bubbles, while the cynics and heretics in the gold market, the obnoxious nutters who question today’s enlightened policy pragmatism, were cut off at the knees.

But then came May and everything sold off.

The Microeconomics of Inflation

... or how I know this ends in tears

By Martin Sibileau

A week later and everyone is a bit more nervous, with the speculation that US sovereign debt purchases by the Federal Reserve will wind down and with the Bank of Japan completely cornered.

In anticipation to the debate on the Fed’s bond purchase tapering, on April 28th (see here) I wrote why the Federal Reserve cannot exit Quantitative Easing: Any tightening must be preceded by a change in policy that addresses fiscal deficits. It has absolutely nothing to do with unemployment or activity levels. Furthermore, it will require international coordination. This is also not possible. The Bank of Japan is helplessly facing the collapse of the country’s sovereign debt, the European Monetary Union is anything but what its name indicates, with one of its members under capital controls, and China is improvising as its credit bubble bursts.

In light of this, we are now beginning to see research that incorporates the problem of future higher inflation to the valuation of different asset classes. One example of this, in the corporate credit space was Morgan Stanley’s “Credit Continuum: Debt Cost and the Real Deal” published on May 17^th, 2013. Upon reading it, I was uncomfortable with the notion that inflation is the simple reflection of the change in a price index, which implies the thesis of the neutrality of money. For instance, the said research note discusses how standard financial metrics compare vis-à-vis a rate of inflation.

Why is this relevant? The gap between current valuations in the capital markets (both debt and credit) and the weak activity data releases could mistakenly be interpreted as a reflection of the collective expectation of an imminent recovery. The question therefore is: Can inflation bring a recovery? Can inflation positively affect valuations?

I am not going to comment on others’ views or recommendations, but on the underlying method. A price index is a mental tool that has no relation to reality. In the real world, we trade driven by relative prices. To infer economic behaviour off changes in a price index is a mistake. The impact of inflation is more complex. For this reason and in anticipation of future debates on this topic, I offer you today a microeconomic analysis of such impact, on value.

Framework

I suggest that a good way (but certainly not the only one) to assess the impact of inflation on the valuation of a firm is to think of the same within the typical free-cash flow approach. After all, what matters is not how inflation can affect a certain component of its capital structure, but how the entire value of a firm is impacted, before the same can be shared among the different contributors to the said capital structure (i.e. equity, debt holders, etc.)

Simplifying, as far as I can recall from the times when I worked in the area of Private Equity,  the way to calculate the free cash flow of a firm for a determined period is to obtain its operating margin, add to it depreciation & amortization costs and subtract capital expenditures, changes in net working capital and taxes. I show the formula below:

The old demons are not ancient history

How to Confront Chinese Power Peacefully

By PATRICK J. BUCHANAN

As America grew in the 1800s from a republic of a few millions, whose frontier stopped at the Mississippi, into a world power, there were constant collisions with the world’s greatest empire.

In 1812, we declared war on Britain, tried to invade Canada, and got our Capitol burned. In 1818, Andrew Jackson, on an expedition into Spanish Florida to put down renegade Indians harassing Georgia, hanged two British subjects he had captured, creating a firestorm in Britain.

In 1838, we came close to war over Canada’s border with Maine; in 1846, over Canada’s border with the Oregon Territory.

After the Civil War, Fenians conducted forays into Canada to start a U.S.-British battle that might bring Ireland’s independence.

In 1895, we clashed over the border between Venezuela and British Guiana.

War was avoided on each occasion, save 1812. Yet all carried the possibility of military conflict between the world’s rising power and its reigning power. Observing the pugnacity of 21st-century China, there appear to be parallels with the aggressiveness of 19th-century America.

China is now quarreling with India over borders. Beijing claims as her national territory the entire South and East China seas and all the islands, reefs and resources therein, dismissing the claims of half a dozen neighbors.

Beijing has bullied Japan and the Philippines and told the U.S. Navy to stay out of the Yellow Sea and Taiwan Strait.

In dealing with America, China has begun to exhibit an attitude that is at times contemptuous.

Erdogan's Grip on Power Is Rapidly Weakening

The prime minister is doing all he can to portray the protests as an attack on Turkey

By Özlem Gezer, Maximilian Popp and Oliver Trenkamp

For a decade, Prime Minister Recep Tayyip Erdogan has had a tight grip on power. But it suddenly looks to be weakening. Thousands have taken to the streets across the country and the threats to Erdogan's rule are many. His reaction has revealed him to be hopelessly disconnected.

The rooftops of Istanbul can be seen in the background and next to them is a gigantic image of Recep Tayyip Erdogan. Turkey's powerful prime minister is watching over the city -- and is also monitoring the work of the political party he controls. At least that seems to be the message of the image, which can be found in a conference room at the headquarters of Erdogan's Justice and Development Party (AKP).

These days, though, Istanbul is producing images that carry a distinctly different meaning -- images of violent protests against the vagaries of Erdogan's rule. And it is beginning to look as though the prime minister, the most powerful leader Turkey has seen since the days of modern Turkey's founder Mustafa Kemal Atatürk, might be losing control.

As recently as mid-May, Erdogan boasted during an appearance at the Brookings Institute in Washington D.C. of the $29 billion airport his government was planning to build in Istanbul. "Turkey no longer talks about the world," he said. "The world talks about Turkey."

Just two weeks later, he appears to have been right -- just not quite in the way he had anticipated. The world is looking at Turkey and speaking of the violence with which Turkish police are assaulting demonstrators at dozens of marches across the country. Increasingly, Erdogan is looking like an autocratic ruler whose people are no longer willing to tolerate him.

Gold, money and everything else

More Than Meets the Eye

by Aristotle

Part 1 --- Stormclouds Gather...

The estimable economist Milton Friedman stated his forgettable opinion in 1974 that OPEC would collapse and oil would never get up to $10 per barrel. In all fairness to Professor Friedman, we must recognize his position as coming from a staunch monetarist, emphasizing money supply as the "true religion" for the Federal Reserve to keep the US Dollar as good as Gold. At times, he half-seriously argued for the abolition of the Federal Reserve in light of the simple monetary policy guidelines that could serve in its stead, with the economy returning to a state of self-regulation. (In the past sound-money days, economic hardships were far from unnatural, and they were not necessarily attributable to acts of government. However, modern attempts to centrally manage the economy ensures that any blame for systemic difficulties today may be clearly laid at government's feet.)

Milton's mistake was two-fold. First was his knowledge that Arabian oil could be produced for one dime of real money, and that inevitable competition among OPEC members would surely keep the price close to cost of production. Second, and most importantly, Milton failed to account for the possibility that the government would abandon such reasonable monetary management to keep the dollar nearly as good as Gold. This fact was NOT lost, however, on the oil producing countries. Ask yourself, what would YOU do if your business or trading partners suddenly started offering you payment with Monopoly money instead of "real" money? Would you shun real money as though it were the plague, and embrace Monopoly money as the greatest thing since sliced bread? If you would, then I have got a job for you!! Bring your shovel and some work-clothes, you have been hired for life...

Upon the 1971 declaration by the United States that redemption of dollars for Gold would be terminated, the entities in receipt of dollars for balance of trade settlements had no difficulty recognizing this as an outright default on payment contracts. The scramble was on to make sense of this new payment system in which the dollar was no longer a THING of value (a small amount of Gold), but was now reduced to a CONCEPT of value; an undefined unit with which the world would denominate the amount of value in contracts for goods and services. The problem ever since has been in coming to terms with the meaning of value for this shifting and undefined unit, and its vulnerability for mismanagement and abuse.

Jelle Zijlstra, who became head of the Bank for International Settlements, said while with the Bank of the Netherlands in regard to the 1971 severing of Gold from the dollar, "When we left the pound, we could go to the dollar. But where could we go from the dollar? To the moon?"

As I continue this tale, I hope it becomes clear that not only have we gone to the moon, but that Gold is going there also.

Part 2 --- A Transition: Things Are what they Are...

Do you see the world as it is? Or, do you see the world as you are? A tough obstacle, to be sure, as our experiences weigh heavily on our perceptions, and many people have no practical earthly experience with real money. There is hope..."the Truth is out there!" as a popular show is quick to proclaim. Albert Einstein puts an interesting slant on this theme: "My religion consists of a humble admiration of the illimitable superior spirit who reveals himself in the slight details we are able to perceive with our frail and feeble mind."

Resentment against Erdogan explodes

Mr Erdogan may well be wondering whether he is the victim of his own success

The Economist 

It all began with a grove of sycamores. For months a tight band of environmentalists had been protesting against a government-backed project to chop the trees down in order to make room for a mall and residential complex in Istanbul’s Taksim Square. Last week they organised a peaceful sit in, camping, singing and dancing by the threatened trees. 

On May 31st, in a predawn raid, riot police moved in. They set fire to the demonstrators’ tents and doused them with pressurised water and tear gas. Images depicting police brutality spread like wildfire across social media. Within hours thousands of outraged citizens began streaming towards Taksim Square. Backed by armoured personnel carriers and water cannons, police retaliated with even more brutish force. Tidal waves of pepper spray sent protestors reeling and gasping for air. Hundreds of demonstrators were arrested, and scores of others injured, in the clashes that ensued. Copycat demonstrations erupted in Ankara, the Turkish capital, and elsewhere across the country. Turkey’s “Tree Revolution” had begun. 

In fact the mass protests that are sweeping the country are not just about the trees, nor do they constitute a revolution. They are the expression of the long-stifled resentment felt by nearly half of the electorate who did not vote for the ruling Justice and Development (AK) party in the June 2011 parliamentary elections. These swept Recep Tayyip Erdogan, the prime minster, to power for a third consecutive term. 

The wave of unrest was completely unexpected. The protestors cut across ideological, religious and class lines. Many are strikingly young. But there are plenty of older Turks, many of them secular-minded, some overtly pious. There are gays, Armenians, anarchists and atheists. There are also members of Turkey’s Alevi Muslim minority. What joins them is the common sentiment that an increasingly autocratic Mr Erdogan is determined to impose his worldview. The secularists point to a raft of restrictions on booze; liberals to the number of journalists in jail (there are more journalists in prison than in any other country in the world). Thousands of activists of varying stripes (mainly Kurds), convicted under Turkey’s vaguely worded anti-terror laws, are also behind bars. Then there are those incensed by mega urban-development projects, including a third bridge over the Bosphorus, which will entail felling thousands of trees. Scenting the public mood, retailers announced that they had pulled out of the planned arcade in Taksim Square. “This is not about secularists versus Islamists—it’s about pluralism versus authoritarianism,” commented a foreign diplomat. 

Mr Erdogan wants to be elected president when the post comes free in August 2014. And he has made no secret of his desire to boost the powers of the presidency “a la Turca” as he put it, spurring accusations that what Erdogan really wants is to become a “Sultan”.

“Tayyip [Erdogan] istifa”, a call for the prime minister to resign, was the slogan most commonly chanted by the protestors. Not that most Turks would have known. Media bosses fearful of jeopardising their other business interests shunned coverage of the protests for nearly two days, opting instead to screen programmes about breast-reduction surgery and gourmet cooking. Faced with a public outcry, the main news channels began broadcasting live from Taksim Square. But pro-government papers continue to point the finger of blame at provocateurs and “foreign powers” bent on undermining Turkey. It seems an odd description of the thousands of housewives leaning over their balconies clanging their pots. 

What is economic growth?

... and why we won’t have any

As we are in the final stage of the global bubble, I realize that we often fail to ask the most obvious questions. In this case, as every central banker tells us that his policies are directed to obtain growth, the obvious question is…how do we define economic growth? What is economic growth?

by Martin Sibileau

As we are in the final stage of the global bubble, I realize that we often fail to ask the most obvious questions. In this case, as every central banker tells us that his policies are directed to obtain growth, the obvious question is... how do we define economic growth? What is economic growth? Yes, yes, I know that what they do is simply monetize deficits and enable the transfer of wealth between sectors and generations, but there is also an intellectual battlefield, which we should be aware of.

In the next sections, I will (extremely) briefly walk through the history of the idea of economic growth to this day. Obviously, I cannot be exhaustive and I encourage you to do further research on the works mentioned below. At the end, I examine what view policy makers have on economic growth, if any…

When did this all begin?

When did the idea of economic growth first appear? Up to the 18^th century, economic thinking was predominantly concerned with comparative statics, intellectual exercises designed to establish causes and consequences of policy making.

I dare to suggest that the concern on economic growth grew before the French Revolution, when the distribution of income was first examined. My suggestion contradicts Nicholas Kaldor, who finds David Ricardo pioneering the theory of distribution. Although David Ricardo explicitly says in the preface to his “Principles of Political Economy and Taxation” that: “…To determine the laws which regulate this distribution, is the principal problem in Political Economy…”, my view is that this perspective had already been adopted by Francois Quesnay, in 1759, and was the foundation of the Physiocracy. If agriculture was the basis of economic growth, a distribution of income favouring this sector was thought to be advisable. I copied below the very same Tableau Economique, probably the first economic model (designed by Quesnay):

The idea that there was an “optimal” distribution of income triggered the investigation of what determines the same. Simultaneously and brewed by Malthus, there was another idea: Full employment requires a growing income. Perhaps this idea, which we are reminded of every two months by the minutes of the Federal Open Market Committee meeting at 2:15pm, goes all the way back to Karl Marx.

It was on these two pillars (i.e. distribution of income and the relation between employment and output) that the modern theory of economic growth was born, with the additional analysis of how capital is created.

Roy F. Harrod

The first “modern” discussion on economic growth is probably that of R. F. Harrod, titled “An Essay in Dynamic Theory”, published in 1939.

IMF Board Attacks Euro Crisis Management

Call to Speed Up Creation of Banking Union

By Markus Dettmer and Christian Reiermann

The EU's bailout of Cyprus has elicited unusually frank and vehement criticism from the finance experts grouped in the IMF's Executive Board. Their damning indictment at an IMF meeting in May reflects global skepticism, especially in emerging economies, about the euro zone's crisis management. 

Paulo Nogueira Batista, 58, is a fan of classical music, a connoisseur of German literature and an advocate of straight talking. As executive director for his native Brazil and 10 smaller countries, he is a member of the Executve Board, the highest-ranking operational decision-making body of the International Monetary Fund (IMF).

His counterparts from the United States and Europe have often witnessed the combative personality of this economist with wavy, salt-and-pepper hair, who attended a high school in Bonn for two years in his youth. Batista is one of the most persistent critics of Western dominance in the IMF.

He often derides the Washington-based organization, headed by French politician Christine Lagarde, as a "North Atlantic monetary fund," because, as he argues, Americans and Europeans are primarily interested in defending their interests and preventing emerging economies like Brazil from exerting their rightful influence in the fund. He resents the Europeans for increasingly availing themselves of the fund's assets to combat their euro crisis, even though they have enough money of their own. "The euro countries abuse their power within the IMF," Batista is fond of saying.

In mid-May, the Brazilian had yet another opportunity to sharply criticize the Europeans' behavior. The bailout package for Cyprus was up for a vote in the IMF Executive Board, a package that includes €1 billion ($1.3 billion) in IMF funds. As it turned out, there were others who shared the Brazilian's critical position.

As evidenced by written position statements and the speaking notes of participants, the event turned into a critical review of Europe's bailout policy. The IMF found itself in the dock along with the European Commission and the European Central Bank (ECB), the two other members of the so-called troika, as well as the countries of the euro zone.

Anti-Primark posing helps nobody

Blaming Western shoppers for the tragic collapse of the Rana Plaza building will make life worse for Bangladeshis

by Rania Hafez 

The collapse of the Rana Plaza building in Dhaka, Bangladesh on 24 April was a terrible tragedy. Over 1,100 workers lost their lives that day – and most were making clothes for Western retailers. But, here’s the thing: despite buying clothes here in the West, I am not responsible for what happened to the Rana Plaza building.

It may sound like a strange statement, but it’s one that has to be made. Like countless others, I shop at Primark, one of the retailers which used labourers housed at the Rana Plaza. And ever since the tragic incident in Bangladesh, I have been made to feel guilty for doing so. In a cringing act of opportunism, assorted NGOs and campaign groups,  carpet-baggers of self-righteousness one and all, are using the terrible incident in Dhaka to re-assert their moral superiority and condemn us plebeian shoppers, not only as contemptible for our cheap tastes, but also as criminal for buying affordable clothes. Ordinary British consumers have been branded culpable for the death of the garment workers in Bangladesh. It is as if we have colluded in the very destruction of the Rana Plaza. The act of buying a Primark t-shirt is enough to turn us into an accessory to murder.

Yet the tragedy in Dhaka was not caused by the British predilection for cheap clothing; the garment factories involved in this incident were not sweat shops; and the workers, although poorly paid in comparison to workers in the UK, received reasonable wages relative with Bangladeshi standards. In fact, the building itself was a large complex of shops and apartments - it even housed a bank. By many accounts, it was a combination of shoddy workmanship, the flouting of building regulations and sheer corruption that led to the building’s collapse. British shoppers were not to blame.

Why Suppressing Feedback Leads To Financial Crashes

If you eliminate feedback from the markets, you get asset bubbles and huge deficits

Central-planning manipulation "works" by closing all the safety valves of market feedback, creating a dangerous but politically appealing illusion of stability and "growth."

by Charles Hugh-Smith

If we see the economy as a system, we understand why removing or suppressing feedback inevitably leads to financial crashes. The essential feature of stable, robust systems (for example, healthy ecosystems) is their wealth of feedback loops and the low-intensity background volatility that complex feedback generates.

The essential feature of unstable, crash-prone systems is monoculture, an artificial structure imposed by a central authority that eliminates or suppresses feedback in service of a simplistic goal--for example, increasing the yield on a single crop, or pushing everyone with cash into risk assets.

Resistance seems futile, but the very act of suppressing feedback dooms the system to collapse.

Removing or suppressing feedback seems to work wonders because the systemic risks generated by this suppression are pushed out of sight. The euro is an excellent example of this dynamic.

The system of national currencies is in essence a gigantic feedback mechanism, as the relative value of a nation's currency reflects its cost structure, trade deficits or surpluses, fiscal deficits, interest rates, central bank policies and a host of other inputs.

A currency that is allowed to fluctuate acts as a "safety valve" feedback when an economy become imbalanced. If the costs of production in one nation are relatively high, its exports will decline and its imports will rise. This leads to large trade deficits, which (except in the case of the reserve currency, the U.S. dollar) lead to lower currency valuations, which feeds back into imports and exports: imports become relatively more expensive as the currency loses buying power internationally, and exports rise as the nations' goods and services become relatively less expensive to other nations.

The net result of this currency feedback loop is to lower imports and increase exports, bringing the trade deficit back into relative balance.

The euro effectively removed this complex feedback from all the economies that accepted the euro. This is the root cause of the European debt crisis: credit was allowed to reach insane levels of fragility and excess because the feedback that was once provided by national currencies and central bank/fiscal policies was removed from the system.

The Wounded Heart

Bill Gross To Ben Bernanke: "Your Policies Are Now Part Of The Problem Rather Than The Solution"

by Bill Gross

Joseph Schumpeter, the originator of the phrase “creative destruction,” authored a less well-known corollary at some point in the 1930s. “Profit,” he wrote, “is temporary by nature: It will vanish in the subsequent process of competition and adaptation.” And so it has, certainly at the micro level for which his remark was obviously intended. Once proud, seemingly indestructible capitalistic giants have seen their profits fall short of “everlasting” and exhibited a far more ephemeral character. Kodak, Sears, Barnes & Noble, AOL and countless others have been “competed” to near oblivion by advancing technology, more focused management, or evolving business models that had better ideas more “adaptable” to a new age.

Yet capitalism at a macro level must inherently be different than the micro individual businesses which comprise it. Profits in total cannot be temporary or competed away if capitalism as we know it is to survive. Granted, the profit share of annual GDP can increase or decrease over time in its ongoing battle with labor and government for market share. But capitalism without profits is like a beating heart without blood. Not only is it profit’s role to stimulate and rationally distribute new investment (blood) to the economic body, but the profit heart in turn must be fed in order to survive.

And just as profits are critical to the longevity of our capitalistic real economy so too is return or “carry” critical to our financial markets. Without the assumption of “carry,” or return over and above the fixed, if mercurial, yield on an economy’s policy rate (fed funds), then investors would be unwilling to risk financial capital and a capitalistic economy would die for lack of oxygen. The carry or return I speak to is most commonly assumed to be a credit or an equity risk “premium” involving some potential amount of gain or loss to an investor’s principal. Corporate and high yield bonds, stocks, private equity and emerging market investments are financial assets that immediately come to mind. If the “carry” or potential return on these asset classes were no more than the 25 basis points offered by today’s fed funds rate, then who would take the chance? Additionally, however, “carry” on an investor’s bond portfolio can be earned by extending duration and holding longer maturities. It can be collected by selling volatility via an asset’s optionality, or it can be earned by sacrificing liquidity and earning what is known as a liquidity premium. There are numerous ways then to earn “carry,” the combination of which for an entire market of investable assets constitutes a good portion of its “beta” or return relative to the “risk free” rate, all of which may be at risk due to artificial pricing.

EU bans claim that water can prevent dehydration

A New High for Brussels bureaucrats 

By Victoria Ward and Nick Collins

EU officials concluded that, following a three-year investigation, there was no evidence to prove the previously undisputed fact.

Producers of bottled water are now forbidden by law from making the claim and will face a two-year jail sentence if they defy the edict, which comes into force in the UK next month.

Last night, critics claimed the EU was at odds with both science and common sense. Conservative MEP Roger Helmer said: “This is stupidity writ large.

“The euro is burning, the EU is falling apart and yet here they are: highly-paid, highly-pensioned officials worrying about the obvious qualities of water and trying to deny us the right to say what is patently true.

“If ever there were an episode which demonstrates the folly of the great European project then this is it.”

NHS health guidelines state clearly that drinking water helps avoid dehydration, and that Britons should drink at least 1.2 litres per day.

The Department for Health disputed the wisdom of the new law. A spokesman said: “Of course water hydrates. While we support the EU in preventing false claims about products, we need to exercise common sense as far as possible."

German professors Dr Andreas Hahn and Dr Moritz Hagenmeyer, who advise food manufacturers on how to advertise their products, asked the European Commission if the claim could be made on labels.

They compiled what they assumed was an uncontroversial statement in order to test new laws which allow products to claim they can reduce the risk of disease, subject to EU approval.

There’s nothing puzzling about Britain’s stagnation Part A

Economists are perplexed to find that today, in a first in any postwar recession, productivity is not recovering

British economists are tearing their hair out over the so-called ‘productivity puzzle’ - the fact that, for the first time in any postwar recession, productivity in Britain has not recovered reasonably quickly after the initial downturn. But it isn’t a puzzle at all, and in truth points to deep structural problems in the British economy, argues Phil Mullan in this important new essay 

by Phil Mullan

The productivity puzzle

Productivity growth is the best guide to a country’s future prosperity. As a measure of economic output relative to employed labour time, productivity gives an indication of how much wealth can be created for society to live on. Productivity’s capacity to grow, therefore, underpins durably improving living standards. In Britain especially, though not uniquely within Europe, productivity growth since the financial crisis of 2008 has been extremely weak – in fact, in Britain’s case, it has remained a couple of per cent below its pre-recession peak.

This has caught many economists by surprise, prompting a significant amount of debate over why this has happened and how long it might endure. While the initial fall of productivity during the recession was in line with everyone’s expectations, there hasn’t been a subsequent recovery in productivity. Instead, productivity has remained low and pretty static. This has become known as the British productivity puzzle (1).

It is perceived as a ‘puzzle’ because normally after a recession, productivity recovers reasonably quickly. Economists traditionally attribute recovery to ‘cyclical’ reasons. Another way of viewing the ‘cyclical’ behaviour of productivity is that it is the statistical expression of two real-economy measures – output and employment. These two tend to move at different speeds during the different stages of the business cycle. Output in a recession usually declines much faster than businesses reduce their headcount, and the measure of productivity therefore falls: less output relative to workers.

Then, when the recession ends and output begins to grow again, the reverse effect is supposed to kick in: the output recovery makes better use of under-used employees before employment picks up again, creating a cyclical boost to productivity: more output relative to workers. This effect is reinforced as output often expands more quickly than employers recruit.

An important point about such ‘cyclical’ shifts is that they do not reflect the impact of the long-term driver of productivity growth: namely, productive capital investment. It is such investment that generates and spreads the innovation and the advances in technology and techniques that make people at work more productive. In contrast to ‘cyclical’ changes, we can call this type of investment ‘structural’ in its impact on productivity.

The big problem with the productivity puzzle discussion is that it assumes that what we are experiencing is primarily some form of business cycle (even if some highlight more than others its unusual and distinct origins in the West’s financial crash from 2007). But in fact, we should be looking deeper into our economic troubles rather than presuming that they are cyclical. Britain’s economic problems – and those of the rest of the Western world – are structural, and this accounts for the poor state of British productivity we see today. A long period of underinvestment in innovation, technology, capital equipment and infrastructure manifest themselves in low productivity. There is no ‘puzzle’ about the absence of a productivity recovery, because there is not a high productivity level to which the economy can recover. Structural British productivity is low. The only ‘puzzle’ is why productivity seemed to be so strong in the pre-2008 period.

Taliban seen waltzing in Tehran

Omar’s blue-eyed boys surface above the radar

By M K Bhadrakumar

The equation between Tehran and the Taliban has always been a matter of speculation. There has been  this notion that the Taliban subscribe to the Wahhabi faith and are virulently anti-Shi’ite and, therefore, they will be on hostile terms till eternity with Iran. But this was never really the case. 

At any rate, the Taliban comprise many factions and it all depends on who one is referring to. As for Iranian intelligence, they’d sup with the devil if need be in the national security interests. 

Conceivably, below-the-radar contacts have been kept up by the Iranians with the Taliban through the past decade. Neither side publicized it, though. Therefore, what happened last week isn’t  earthshaking  – that Tehran has hosted a Taliban delegation. But the stunning part is that the Iranian side publicized it first, on Saturday (here).   

The Taliban confirmed the information earlier today. Presumably, Mullah Omar decided to come clean. It now appears that many a Taliban delegation would have visited Iran from time to time. It also transpires that  Pakistani intelligence was in the loop all along.  

What is of interest is that Iran hosted the Taliban representatives based in Qatar. They are Omar’s blue-eyed boys. This does raise some serious issues. 

After having enjoyed such lavish Qatari hospitality — according to Rod Norland of New York Times (here)  –  it is highly unlikely that the Taliban kept the Emir in Doha in the dark and simply sneaked out to catch a flight to Tehran. 

No, Sir, it doesn’t need much ingenuity to comprehend that the Qataris okayed the trip of the 4 key Taliban reps.Now comes the most intriguing part: If the Qatari Emir knew, would he have kept the matter hidden from the Big Boss in Washington? Impossible, inconceivable, implausible, improbable, incogitable, incredible. You may choose the appropriate word.

Risk and reward

Why the Fed Can't Stop Fueling The Shadow Bank Kiting Machine

by Bill Frezza

Fractional reserve banking is unlike most other businesses. It's not just because its product is money. It's because banks can manufacture their product out of thin air. Traditional commercial banks essentially create money through a well understood and time honored pyramiding of loans. Depositors who understand that their deposits are thereby placed at risk choose their banks accordingly.

Under the bygone rules of free market capitalism, only one thing kept banks from creating an infinite amount of money, and that was fear of failure. Failure occurs when depositors come to believe that their bank has lent out too much manufactured money to too many dodgy borrowers and may not be able to cover depositors’ withdrawals. When this happens, depositors rush to reclaim their money while there is still some left, leading to the bank’s collapse.

Under free market capitalism, banks compete along a spectrum of risk and reward.Conservative banks offer a higher degree of safety by maintaining larger reserves, thereby manufacturing and lending out less money. Through word and deed they let depositors know that they lend to only the most creditworthy borrowers, who generally must post valuable collateral. These banks remain profitable because they successfully attract prudent depositors willing to accept lower rates of interest.

Banks of a more speculative bent offer a lower degree of safety, maintaining smaller reserves to create and lend out more money. Seeking higher returns, they often lend to less creditworthy borrowers who may put up poor quality collateral or none at all. These banks attract risk-taking depositors looking for a higher rate of interest. They can be very profitable during periods of economic expansion but often fall into distress during economic downturns.

Periodic bank failures remind depositors of the connection between risk and reward. When caveat emptor rules, smart depositors who pay attention make money and dumb depositors who don't lose theirs.

Because the latter outcome is intolerable in a democracy, we have government-provided deposit insurance and other taxpayer-financed backstops that shield most depositors from the risk of loss. In theory banks pay premiums to fund this insurance. In practice these premiums are not risk-based. Banks are not penalized for making riskier loans, in turn often leaving the premiums too low to finance payouts. This creates a huge moral hazard, as it frees depositors to seek the highest return without regard for safety.

Worse, it removes conservative banks’ competitive advantage. Under a government-guaranteed deposit insurance regime, conservative bankers who want to stay in business must take on more risk in order to pay the higher interest rates necessary to attract depositors. This often sets off a race to the bottom, which results in periodic banking crises.

After each of these crises, politicians promise taxpayers that it will never happen again. And each time it does, the government creates a new set of labyrinthine regulations that attempt to mimic the business judgment of conservative bankers. Minimum reserve requirements are established, which normally become the maximum as there is little advantage in exceeding them. And both depositors and the bankers themselves become complacent about the banks’ investments because it is so easy to privatize gains and socialize losses.