Hot Money and Capital controls

[....lybob]

[Magox]

It is an extremely complicated dilemma. If you are an EM economy that is showing promising growth while the rest of the world is floundering, it is only natural that money will find its way over to these economies. That can be a good and bad thing, sure it provides money to these economies to help them expand and develop new technologies and etc. But of course if too much money flows into these countries then bubbles can be created.

 

To make things much much worse, the developed world is trying to combat "deflationary" fears through cheap money. It's not even just cheap money, it's money created out of thin air, which of course filters its way into other areas. Once again, a natural option is to park your money in parts of the world that offer growth, which creates an even larger headache for these economies.

 

If you are one of these countries, you can't blame them for having capital controls. It just makes sense, you don't want to overheat your economy. For these countries that are flushed with cash, inflation is a bigger problem than deflation. Inflation effects every single person in a much more meaningful way in these economies than in the developing economies, simply because the essentials (food,clothing and energy) make up a much larger portion of their disposable income than it does over here.

 

However, what was not mentioned in this interview were the unintended consequences of capital controls. In order for this to work more effectively for the global economy, there needs to be a coordinated global effort. Unfortunately this won't happen, the world is fighting with one another, and I am pretty certain that this won't be resolved in the next few years.

 

Here are some of the unintended consequences of capital controls in todays world:

 

DISLOCATIONS in the market place:

 

1)There is a tremendous amount of cash looking for places to park. The purpose of Capital controls is to limit the inflows of capital into some of these EM economies. So some of that money that was going to be moving into these economies will find other places to invest. In todays world, developed nation economies don't offer tremendous growth, which is what money likes. So as a result of these capital controls some of that money will just shift to another EM economy without capital controls, which of course will fuel bubbles in this economy. This is why there will have to be a global coordinated effort, specially in the EM economies.

 

2)Even if there is a global EM coordinated effort (which will be difficult considering the trade agreements that currently exist), money still has to find a place to park. So if some of those funds don't go into these areas, it is very likely some of that money will go into commodities. Commodities make sense, the value of paper is getting debased, people would rather hold onto a hard assets as opposed to paper money.

 

3)This creates further risktaking in investments with less than stellar fundamentals. Once again it is another dislocation of funds, some of that money that was moving into these EM economies will find its way into developed nation equities and investments. You may see money pouring into certain equities and investments that don't warrant the price movement.

 

4)Bubbles will become Mega bubbles. To put it simply; If the world is creating more money out of thin air, and there are less places to park that money, then the value of those investments that appear to be logical will most likely grow into a humongous bubble.

 

This is not their fault. The lion's share of the blame has to be placed with those central banks (mainly the federal reserve) that practice cheap money policies.

 

Haven't they learned? Cheap money helps fuel tech bubble, tech bubble bursts, then we create cheap money again, then this fuels housing market, housing market forms a bubble then it busts, so when the housing bubble busts, we create more cheap money and now we are beginning to see other bubbles forming. Rinse and Repeat.

 

Also, I don't know about you guys, but I thought it was highly unusual and improper for our president to endorse Ben Bernankes QE policies. The president shouldn't in my view, interject and endorse policies from the Federal Reserve. There has to be or maybe I should say there should be more of a level of independence of the president from the Federal Reserve. It almost implies that there is some level of coordination between the two (which I don't believe is the case) but none the less it definitely lends to this perception. I was going to mention something about this a couple days ago, I thought it was yet another poor moment for the president and I don't believe I am the only other person who thought that this was highly improper.

Edited November 13, 2010 by Magox

[TPS]

It is an extremely complicated dilemma. If you are an EM economy that is showing promising growth while the rest of the world is floundering, it is only natural that money will find its way over to these economies. That can be a good and bad thing, sure it provides money to these economies to help them expand and develop new technologies and etc. But of course if too much money flows into these countries then bubbles can be created.

 

To make things much much worse, the developed world is trying to combat "deflationary" fears through cheap money. It's not even just cheap money, it's money created out of thin air, which of course filters its way into other areas. Once again, a natural option is to park your money in parts of the world that offer growth, which creates an even larger headache for these economies.

 

If you are one of these countries, you can't blame them for having capital controls. It just makes sense, you don't want to overheat your economy. For these countries that are flushed with cash, inflation is a bigger problem than deflation. Inflation effects every single person in a much more meaningful way in these economies than in the developing economies, simply because the essentials (food,clothing and energy) make up a much larger portion of their disposable income than it does over here.

 

However, what was not mentioned in this interview were the unintended consequences of capital controls. In order for this to work more effectively for the global economy, there needs to be a coordinated global effort. Unfortunately this won't happen, the world is fighting with one another, and I am pretty certain that this won't be resolved in the next few years.

 

Here are some of the unintended consequences of capital controls in todays world:

 

DISLOCATIONS in the market place:

 

1)There is a tremendous amount of cash looking for places to park. The purpose of Capital controls is to limit the inflows of capital into some of these EM economies. So some of that money that was going to be moving into these economies will find other places to invest. In todays world, developed nation economies don't offer tremendous growth, which is what money likes. So as a result of these capital controls some of that money will just shift to another EM economy without capital controls, which of course will fuel bubbles in this economy. This is why there will have to be a global coordinated effort, specially in the EM economies.

 

2)Even if there is a global EM coordinated effort (which will be difficult considering the trade agreements that currently exist), money still has to find a place to park. So if some of those funds don't go into these areas, it is very likely some of that money will go into commodities. Commodities make sense, the value of paper is getting debased, people would rather hold onto a hard assets as opposed to paper money.

 

3)This creates further risktaking in investments with less than stellar fundamentals. Once again it is another dislocation of funds, some of that money that was moving into these EM economies will find its way into developed nation equities and investments. You may see money pouring into certain equities and investments that don't warrant the price movement.

 

4)Bubbles will become Mega bubbles. To put it simply; If the world is creating more money out of thin air, and there are less places to park that money, then the value of those investments that appear to be logical will most likely grow into a humongous bubble.

 

This is not their fault. The lion's share of the blame has to be placed with those central banks (mainly the federal reserve) that practice cheap money policies.

 

Haven't they learned? Cheap money helps fuel tech bubble, tech bubble bursts, then we create cheap money again, then this fuels housing market, housing market forms a bubble then it busts, so when the housing bubble busts, we create more cheap money and now we are beginning to see other bubbles forming. Rinse and Repeat.

 

Also, I don't know about you guys, but I thought it was highly unusual and improper for our president to endorse Ben Bernankes QE policies. The president shouldn't in my view, interject and endorse policies from the Federal Reserve. There has to be or maybe I should say there should be more of a level of independence of the president from the Federal Reserve. It almost implies that there is some level of coordination between the two (which I don't believe is the case) but none the less it definitely lends to this perception. I was going to mention something about this a couple days ago, I thought it was yet another poor moment for the president and I don't believe I am the only other person who thought that this was highly improper.

Somewhat related to what I am currently writing about, which is a topic we debated previously. You say cheap money policies, I'd say look at changes over the past 30 years that have lead to too much money chasing too few assets. Several major related changes have taken place which have led to the taming of goods inflation, but that has been replaced by rampant asset inflation.

 

Increasing globalization has helped seriously weaken labor's ability to bargain. Globalization has tamed wage inflation and increased the inequality of income. Goods inflation has been conquered through cheap imports and the destruction of the unionized industrial base (good or bad depending on your politics). The other side of this coin is that most of the benefits from these changes have accrued to the top 5% of the population. From 1980 to 2009, the share of income going to the top 20% has increased from 44.1% to 50.3%, but most has gone to the top 5%, as their share increased from 16.5% to 21.7%. In current $s that means an extra $200 billion per year going to the top 5%. Combine this with the trend to lower tax rates at the top (while increasing taxes for everyone else via the Social Security tax increase), and you get a massive flow of savings looking for financial returns. It is no coincidence that asset inflations--bubbles--have become more frequent and more intense.

 

This is a consequence of the belief that increased savings leads to productive investment; it does not. Business expands because of the expectation of higher sales, not because there is an increased pool of savings--in fact, that tends to dampen demand for products.

 

There is too much money chasing too few assets. Tax cuts for the top combined with a massive shift in the distribution of income IS a major cause of the bubble economy.

[Magox]

Somewhat related to what I am currently writing about, which is a topic we debated previously. You say cheap money policies, I'd say look at changes over the past 30 years that have lead to too much money chasing too few assets. Several major related changes have taken place which have led to the taming of goods inflation, but that has been replaced by rampant asset inflation.

 

Increasing globalization has helped seriously weaken labor's ability to bargain. Globalization has tamed wage inflation and increased the inequality of income. Goods inflation has been conquered through cheap imports and the destruction of the unionized industrial base (good or bad depending on your politics). The other side of this coin is that most of the benefits from these changes have accrued to the top 5% of the population. From 1980 to 2009, the share of income going to the top 20% has increased from 44.1% to 50.3%, but most has gone to the top 5%, as their share increased from 16.5% to 21.7%. In current $s that means an extra $200 billion per year going to the top 5%. Combine this with the trend to lower tax rates at the top (while increasing taxes for everyone else via the Social Security tax increase), and you get a massive flow of savings looking for financial returns. It is no coincidence that asset inflations--bubbles--have become more frequent and more intense.

 

This is a consequence of the belief that increased savings leads to productive investment; it does not. Business expands because of the expectation of higher sales, not because there is an increased pool of savings--in fact, that tends to dampen demand for products.

 

There is too much money chasing too few assets. Tax cuts for the top combined with a massive shift in the distribution of income IS a major cause of the bubble economy.

 

Globalization was inevitable. So it is just a matter of adjusting.

 

To your second point, you basically are inferring that the tax code only benefits the rich, and it appears to me that this is a class warfare sort of argument. This simply isn't true. You can't blame the tax code for the facts that you provided. As a matter of fact, you could make a strong argument that because of globalization that it did keep manufacturing wages lower, which did what to profit margins? Would that make CEO compensations higher or lower? Also as a result of cheap money policies TPS, this benefits the rich more than anyone. This is not that difficult to understand.

 

The tax code argument that you are making doesn't hold water.

 

You cannot make a credible argument about the middle classes taxes going higher when a large portion of them after tax deductions don't pay income taxes. So what that S.S went up a LITTLE BIT!

 

Tax cuts for the top combined with a massive shift in the distribution of income IS a major cause of the bubble economy.

 

Sorry, this had a very very negligible effect on asset bubbles.

 

The main reason why asset bubbles are created is simply a monetary phenomena.

Edited November 13, 2010 by Magox

[....lybob]

The nation state vs the religion of business

 

 

http://www.youtube.com/watch?v=v3vbCxj2ifs

[Magox]

Not able to see it Lybob. What is the gist of the video? That the world is a business?

[....lybob]

linky

 

 

nation state vs the religion of business

Edited November 13, 2010 by ....lybob

[Alaska Darin]

There is too much money chasing too few assets. Tax cuts for the top combined with a massive shift in the distribution of income IS a major cause of the bubble economy.

Holy oversimplification.

[TPS]

Holy oversimplification.

How else are you going to understand it?

[Magox]

On a related note:

China renewed an attack on quantitative easing, citing the risk of increased prices in emerging economies, a day after the Group of 20 nations said the markets can adopt regulatory steps to cope.

 

China “doesn’t support” the monetary easing that causes “imported” inflation in developing countries, Commerce Minister Chen Deming told a forum today in Macau, a Chinese special autonomous region. The capital inflows increase the risk of “asset bubbles,” Jin Zhongxia, deputy director general of the international department at the People’s Bank of China, said at the same forum.

 

The Group of 20 offered emerging economies cover to limit currency swings and stem asset bubbles. The U.S. Federal Reserve fueled concern in emerging economies last week when it announced plans to buy $600 billion of long-term government bonds to reduce borrowing costs and spur growth in a second round of so- called quantitative easing.

 

“Major reserve-currency issuing countries excessively print money to get out of their own economic difficulties, posing a policy dilemma for emerging economies,” Jin said in Macau today, without naming any countries. “That will impose greater pressure on capital inflows, bigger bubbles in asset markets and inflationary pressure.”

 

Capital flows into emerging markets are running at $575 billion a year, 20 percent higher than before the world financial crisis, Goldman Sachs Group Inc. said in September. The U.S. dollar has weakened over the past three months against all 16 major market currencies tracked by Bloomberg.

 

Yikes

[TPS]

Globalization was inevitable. So it is just a matter of adjusting.

 

To your second point, you basically are inferring that the tax code only benefits the rich, and it appears to me that this is a class warfare sort of argument. This simply isn't true. You can't blame the tax code for the facts that you provided. As a matter of fact, you could make a strong argument that because of globalization that it did keep manufacturing wages lower, which did what to profit margins? Would that make CEO compensations higher or lower? Also as a result of cheap money policies TPS, this benefits the rich more than anyone. This is not that difficult to understand.

 

The tax code argument that you are making doesn't hold water.

 

You cannot make a credible argument about the middle classes taxes going higher when a large portion of them after tax deductions don't pay income taxes. So what that S.S went up a LITTLE BIT!

 

 

 

Sorry, this had a very very negligible effect on asset bubbles.

 

The main reason why asset bubbles are created is simply a monetary phenomena.

Do the math dude.

Here's a simple example, so I hope AD can follow it...

 

2009 personal income = $8 tril; income share of top 20% = 50%; average tax rate approximately 25%; savings rate = 25%. So we can estimate the flow of savings from the top 20% as:

Income share of the top = 50% x $8 tril = $4 tril; after-tax income = 75% x $4 tril = $3 tril; savings = 25% x $3 tril = $750 billion.

Now assume the income share and tax rates were the same as they were in 1980: income share=44% and tax rate =50%. Income share= 44% x $8 tril = $3.52 tril; after-tax income = 50% x $3.52 tril = $1.76 tril; savings = 25% x $1.76 tril=$440 billion. That's an increase in the savings flow of $31 billion for the year! That is not a trivial amount.

Is it any wonder Hedge Funds took off? While we can debate the underlying politics of the changes, these are essentially the correct data. It's pretty straight-forward: cutting taxes at the top combined with rising inequality has increased the amount of money chasing assets.

[Magox]

Do the math dude.

Here's a simple example, so I hope AD can follow it...

 

2009 personal income = $8 tril; income share of top 20% = 50%; average tax rate approximately 25%; savings rate = 25%. So we can estimate the flow of savings from the top 20% as:

Income share of the top = 50% x $8 tril = $4 tril; after-tax income = 75% x $4 tril = $3 tril; savings = 25% x $3 tril = $750 billion.

Now assume the income share and tax rates were the same as they were in 1980: income share=44% and tax rate =50%. Income share= 44% x $8 tril = $3.52 tril; after-tax income = 50% x $3.52 tril = $1.76 tril; savings = 25% x $1.76 tril=$440 billion. That's an increase in the savings flow of $31 billion for the year! That is not a trivial amount.

Is it any wonder Hedge Funds took off? While we can debate the underlying politics of the changes, these are essentially the correct data. It's pretty straight-forward: cutting taxes at the top combined with rising inequality has increased the amount of money chasing assets.

The reason why there have been asset bubbles over the past couple decades is mainly because of cheap money. Your hypothesis is a reach to say the least, an EXTREME reach.

 

We aren't going to agree on this, just the same I didn't agree with your theory of Fed QE isn't "money printing" or that it won't lead to inflation unless the banks began to lend and of course I argued this point with a passion. I think we are now seeing that what you argued won't come to fruition. For the sake of not hijacking Lybob's thread maybe we should just stick to Capital Controls. Maybe we'll find something to disagree with there.

Edited November 13, 2010 by Magox

[TPS]

The reason why there have been asset bubbles over the past couple decades is mainly because of cheap money. Your hypothesis is a reach to say the least, an EXTREME reach.

 

We aren't going to agree on this, just the same I didn't agree with your theory of Fed QE isn't "money printing" or that it won't lead to inflation unless the banks began to lend and of course I argued this point with a passion. I think we are now seeing that what you argued won't come to fruition. For the sake of not hijacking Lybob's thread maybe we should just stick to Capital Controls. Maybe we'll find something to disagree with there.

So you believe that an increase in money can cause inflation but an increase in the flow of savings can't affect asset price inflation? Ok, have it your way.

As for my other point, I guess you have a problem with facts. I provided you with a link from the Fed with the excess reserve data. It is a fact that banks are sitting on $1 trillion in reserves. If you can refute that, please do so. Just as it is a fact that tax rates have been cut and the share of income to the top is the highest it's ever been. Facts seem to make you uncomfortable, and want to return to other issues...

[Magox]

So you believe that an increase in money can cause inflation but an increase in the flow of savings can't affect asset price inflation? Ok, have it your way.

As for my other point, I guess you have a problem with facts. I provided you with a link from the Fed with the excess reserve data. It is a fact that banks are sitting on $1 trillion in reserves. If you can refute that, please do so. Just as it is a fact that tax rates have been cut and the share of income to the top is the highest it's ever been. Facts seem to make you uncomfortable, and want to return to other issues...

Okey dokey mr. there will be no inflation unless banks lend.

[Alaska Darin]

Do the math dude.

Here's a simple example, so I hope AD can follow it...

 

2009 personal income = $8 tril; income share of top 20% = 50%; average tax rate approximately 25%; savings rate = 25%. So we can estimate the flow of savings from the top 20% as:

Income share of the top = 50% x $8 tril = $4 tril; after-tax income = 75% x $4 tril = $3 tril; savings = 25% x $3 tril = $750 billion.

Now assume the income share and tax rates were the same as they were in 1980: income share=44% and tax rate =50%. Income share= 44% x $8 tril = $3.52 tril; after-tax income = 50% x $3.52 tril = $1.76 tril; savings = 25% x $1.76 tril=$440 billion. That's an increase in the savings flow of $31 billion for the year! That is not a trivial amount.

Is it any wonder Hedge Funds took off? While we can debate the underlying politics of the changes, these are essentially the correct data. It's pretty straight-forward: cutting taxes at the top combined with rising inequality has increased the amount of money chasing assets.

You're not helping yourself. Quite the opposite. Your "examples" make you trying to talk down to someone else even more laughable.

[....lybob]

Magox I don't mind you and TPS hijacking my thread I find the back and forth pretty interesting.

 

But my real interest is does anyone see Capital controls as a small reemergence of the national perspective as opposed to the global perspective.

 

I will state here that I see many of America's problems as a acceleratingly unequal yoking between the American nation state and the American corporate governance multinationals.

 

I think that many of the heads of the multinationals have an almost religious view of their purpose as portrayed by this scene from Network

 

When Lloyd Blankfein says he's doing God's work I don't think he's being disingenuous I think he believes that Goldman Sachs and the financial industry as a whole is a force of nature like the weather, and if they cause a flood here and a drought there it is insignificant when compared to how they make the flowers,trees and crops to grow.