Told You So …

We are still living with the consequences of the financial crisis. The reaction of the central banks – with their balance sheet expansions and low interest rate policy – has brought too much liquidity into the financial system. What made sense at the time is a burden today. A further phenomenon is the design of the rescue which has saved the banks but was paid by the taxpayer.

In the following we present some voices which pointed out early the weaknesses in the system.

Early Warning

Sir John Templeton (1912 – 2008) [1] warned in a memo (June 15, 2005) as follows: Financial Chaos – probably in many nations in the next five years. The word chaos is chosen to express likelihood of reduced profit margin at the same time as acceleration in cost of living. … Also, the present surpluses of cash and liquid assets have pushed yields on bonds and mortgages almost to zero when adjusted for higher cost of living. Clearly, major corrections are likely in the next few years.

Most of the methods of universities and other schools which require residence have become hopelessly obsolete. Probably over half of the universities in the world will disappear quickly over the next thirty years. Research and discoveries and efficiency are likely to continue to accelerate. Probably, as quickly as fifty years, as much as ninety percent of education will be done by electronics.

Over tenfold more persons hopelessly indebted leads to multiplying bankruptcies not only for them but for many businesses that extend credit without collateral. Voters are likely to enact rescue subsidies, which transfer the debts to governments, such as Fannie May and Freddie Mac.

The top one percent of people are likely to progress more rapidly than the others. Such top one percent may consist of those who are multi-millionaires and also, those who are innovators and also, those with top intellectual abilities. Comparisons show that prosperity flows toward those nations having most freedom of competition. [2]  

Lessons Learned?

Anna Jacobson Schwartz (1915 – 2012) [3] In October 2008, she gave an interview on the measures that Ben Bernanke had taken against the financial crisis in the USA. In this, she opposed the view that there was a liquidity crisis. In contrast to the depression after 1929, this time enough money liquidity would be present. Nor would the reduction of the interest rate be the appropriate measure.

In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. They should not be recapitalizing firms that should be shut down. Rather, firms that made wrong decisions should fail, she says bluntly. You shouldn’t rescue them. And once that’s established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich. The trouble is, that’s not the way the world has been going in recent years.

But when the authorities finally got around to letting Lehman Brothers fail, it had saved so many others already that the markets didn’t know how to react. Instead of looking principled, the authorities looked erratic and inconstant.

Today’s crisis isn’t a replay of the problem in the 1930s, but our central bankers have responded by using the tools they should have used then. They are fighting the last war. The result, she argues, has been failure. “I don’t see that they’ve achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job.

Her advise: First, Do not engage in monetary expansion out of concern for depressed asset prices. Second, Do not direct monetary policy to deflate asset price booms. Let the market correct itself when asset price booms appear to be bubbles. The Federal Reserve is not the arbiter of the correct level of asset prices. [4]

Temporary Nationalization of Banks?

At the beginning of 2009, several authors, including two Nobel laureates – criticizing that the US bank rescue happened in favor of the banks and their managements and at the expense of the taxpayer – demanded the temporary nationalization of the affected banks. [5]  [6]

But bank stocks are worth so little these days — Citigroup and Bank of America have a combined market value of only $52 billion — that the ownership wouldn’t be partial: pumping in enough taxpayer money to make the banks sound would, in effect, turn them into publicly owned enterprises. My response to this prospect is: so? If taxpayers are footing the bill for rescuing the banks, why shouldn’t they get ownership, at least until private buyers can be found? But the Obama administration appears to be tying itself in knots to avoid this outcome.  [7]

2% Inflation?

Again and again it is said that inflation is driving the economy forward. As if inflation had ever done so. The reason for this claim is rather that the states are highly indebted and in a deflation / disinflation environment the debt would soon be intolerable. Today, central banks announce an inflation target of 2% as measured by consumer prices. However, if prices for imported goods remain stable or decline and raw material prices go down as today, the goal cannot be achieved. To react with a further easing is wrong, because the central banks have no influence on these forces.

Axel Weber [8] The original goal of the central banks was not the stability of consumer prices. The corresponding indices were not collected when many central banks were established. Central banks were introduced to secure war financing. Subsequently, their role was expanded to include the role of lender of last resort. It was only during the excessive inflation of the 1970s that the focus of central banks shifted to the importance of a stable monetary value. [9]

Short-term stable consumer prices are no guarantee for economic, financial or monetary stability. It is time for central banks to accept this fact and return to a comprehensive and long-term monetary policy approach, even if this means that the development of consumer prices differs in the short term from what is now termed “price stability”. Temporary fluctuations of a narrow and imprecisely measured consumer price index are a low price for securing the long-term stability of the money.

One word to the effect that higher inflation creates jobs. [10] This thesis has been empirically, with data refuted. Nevertheless, it is again en vogue. To this Paul Volcker:

Okay. And to get back to the central banking a little bit, given the trade-off between inflation and unemployment

PV: I don’t believe that. That’s my answer to that question. That is a scenario and a delusion, which economists have gotten Nobel Prizes twenty years ago to disprove. [11]

Back to the Future?

Milton Friedman 1997: The drive for the Euro has been motivated by politics not economics. The aim has been to link Germany and France so closely as to make a future European war impossible, and to set the stage for a federal United States of Europe. I believe that adoption of the Euro would have the opposite effect. It would exacerbate political tensions by converting divergent shocks that could have been readily accommodated by exchange rate changes into divisive political issues. Political unity can pave the way for monetary unity. Monetary unity imposed under unfavorable conditions will prove a barrier to the achievement of political unity. [12]

Martin Feldstein 1997: EMU does come into existence, as now seems increasingly likely, it will change the political character of Europe in ways that could lead to conflicts in Europe and confrontations with the United States.

Indeed, the adverse economic effects of a single currency on unemployment and inflation would outweigh any gains from facilitating trade and capital flows among the EMU members. Instead of increasing intra-European harmony and global peace, the shift to EMU and the political integration that would follow it would be more likely to lead to increased conflicts within Europe and between Europe and the United States. Since not all European nations would be part of the monetary and political union, there would be conflicts between the members and nonmembers within Europe, including the states of Eastern Europe and the former Soviet Union.

But once the disciplining example of the Bundesbank is eliminated and monetary policy is made by an ECB in which all member countries vote equally, there is a strong risk that the prevailing sentiment will be for higher inflation.

Exit? A critical feature of the EU in general and EMU in particular is that there is no legitimate way for a member to withdraw. This is a marriage made in heaven that must last forever. But if countries discover that the shift to a single currency is hurting their economies and that the new political arrangements also are not to their liking, some of them will want to leave. The majority may not look kindly on secession, either out of economic self- interest or a more general concern about the stability of the entire union. The American experience with the secession of the South may contain some lessons about the danger of a treaty or constitution that has no exits. [13]

Doubts Remain

Those responsible have not seen it coming despite various warnings from different quarters. In any case, they can be accused of having led an expansive monetary policy in the run-up to the financial crisis for too long which has made the asset bubble possible in the USA and has hidden the underlying tensions in Europe. This negligence has been punished mercilessly by the market which again has allowed those responsible to intervene ever so generously.

It will be interesting to see whether the financial crisis is finally over or the problems will resurface again. We hope for the first and fear the second.

 

Dr, Flurin von Albertini

Dec-2016

—-

John M. Templeton

Lyford Cay, Nassau, Bahamas

June 15, 2005

MEMORANDUM Financial Chaos – probably in many nations in the next five years. The word chaos is chosen to express likelihood of reduced profit margin at the same time as acceleration in cost of living.

Increasingly often, people ask my opinion on what is likely to happen financially. I am now thinking that the dangers are more numerous and larger than ever before in my lifetime. Quite likely, in the early months of 2005, the peak of prosperity is behind us.

In the past century, protection could be obtained by keeping your net worth in cash or government bonds. Now, the surplus capacities are so great that most currencies and bonds are likely to continue losing their purchasing power.

Mortgages and other forms of debts are over tenfold greater now than ever before 1970, which can cause manifold increases in bankruptcy auctions.

Surplus capacity, which leads to intense competition, has already shown devastating effects on companies who operate airlines and is now beginning to show in companies in ocean shipping and other activities. Also, the present surpluses of cash and liquid assets have pushed yields on bonds and mortgages almost to zero when adjusted for higher cost of living. Clearly, major corrections are likely in the next few years.

Most of the methods of universities and other schools which require residence have become hopelessly obsolete. Probably over half of the universities in the world will disappear quickly over the next thirty years.

Obsolescence is likely to have a devastating effect in a wide variety of human activities, especially in those where advancement is hindered by labor unions or other bureaucracies or by government regulations.

Increasing freedom of competition is likely to cause most established institutions to disappear with the next fifty years, especially in nations where there are limits on free competition.

Accelerating competition is likely to cause profit margins to continue to decrease and even become negative in various industries. Over tenfold more persons hopelessly indebted leads to multiplying bankruptcies not only for them but for many businesses that extend credit without collateral. Voters are likely to enact rescue subsidies, which transfer the debts to governments, such as Fannie May and Freddie Mac.

Research and discoveries and efficiency are likely to continue to accelerate. Probably, as quickly as fifty years, as much as ninety percent of education will be done by electronics.

Now, with almost one hundred independent nations on earth and rapid advancements in communication, the top one percent of people are likely to progress more rapidly than the others. Such top one percent may consist of those who are multi-millionaires and also, those who are innovators and also, those with top intellectual abilities. Comparisons show that prosperity flows toward those nations having most freedom of competition.

Especially, electronic computers are likely to become helpful in all human activities including even persons who have not yet learned to read.

Hopefully, many of you can help us to find published journals and websites and electronic search engines to help us benefit from accelerating research and discoveries.

Not yet have I found any better method to prosper during the future financial chaos, which is likely to last many years, than to keep your net worth in shares of those corporations that have proven to have the widest profit margins and the most rapidly increasing profits. Earning power is likely to continue to be valuable, especially if diversified among many nations.

—-

[1]    Founder (1954) Templeton Growth Fund, Inc.

[2]    http://www.huffingtonpost.com/janet-tavakoli/sir-john-templeton-financ_b_507981.html Sir John Templeton: Financial Chaos and Investing, 25.05.2005

[3]    National Bureau of Economic Research, coauthor with Milton Friedman A Monetary History of the United States, 1867–1960. http://www.nytimes.com/2009/07/26/opinion/26schwartz.html?_r=0 25.07.2009

Also: http://www.faz.net/aktuell/wirtschaft/wirtschaftswissen/die-weltverbesserer/anna-jacobson-schwartz-ist-die-herrin-des-geldes-13416012.html?printPagedArticle=true#pageIndex_2 14.02.2015

[4]    Anna J. Schwartz, Asset Price Inflation and Monetary Policy, 2002 http://www.nber.org/papers/w9321

[5]    http://www.dailykos.com/story/2009/02/09/695269/-Krugman-Stiglitz-Roubini-Taleb-Baker-Agree-Nationalize# Krugman, Stiglitz, Roubini, Taleb, Baker Agree: Nationalize, 09.02.2009

[6]    http://www.nytimes.com/2009/02/02/opinion/02krugman.html?_r=1 Bailouts for Bunglers, 01.02.2009

[7]    http://edition.cnn.com/2009/POLITICS/01/26/stiglitz.finance.crisis/index.html?iref=newssearch Joseph E. Stiglitz, Commentary: How to rescue the bank bailout, 26.01.2009

[8]    Dr. Axel Weber German Economist & Banker

[9]    http://www.handelszeitung.ch/konjunktur/ubs-praesident-weber-mehr-spielraum-fuer-notenbanker-795596

UBS-Präsident Weber: Mehr Spielraum für Notenbanker, 10.06.2015

[10]  In the 1970s then Chancellor Helmut Schmidt said: I prefer 5 percent inflation to 5 percent unemployment. Later he had to admit that the policy was wrong; he got 5% unemployment and 5% inflation.

[11]  http://dailyprincetonian.com/news/2014/05/qa-former-federal-reserve-chairman-paul-volcker-49 30.05.2014

[12]  http://www.project-syndicate.org/commentary/the-euro–monetary-unity-to-political-disunity Milton Friedman, The Euro: Monetary Unity To Political Disunity 28.08.1997

[13]  https://www.foreignaffairs.com/articles/europe/1997-11-01/emu-and-international-conflict Martin Feldstein, EMU and International Conflict, Nov/Dez 1997

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