Friday, March 19, 2010

KRIS SAYCE: How Will Heads of Government Departments Cut Regulatory Costs?

More wisdom from`Kris Sayce at Money Morning Australia.

* * * * *

_Kris_Sayce We couldn’t help but laugh at the front page of yesterday’s Australian Financial Review (AFR):

“Tanner takes razor to red tape”

Apparently, “The Rudd government will increase the powers of its red-tape regulator in a bid to prevent any unnecessary rules from stifling economic growth…”

Red-tape regulator!

Anyway, it goes on,

    “Finance Minister Lindsay Tanner will subject new legislation and regulation to greater scrutiny while also forcing the heads of government departments to take greater personal responsibility for finding ways to cut regulatory costs.”

Sounds good doesn’t it? Heads of government departments cutting regulatory costs. Hmm, how will they do that we wonder?

But that’s the trouble, they can’t. It’s impossible. There’s no market mechanism for them to benchmark against. It’s not as though federal government departments can send spies out to see what that other Australian federal government is doing, because there isn’t one.

And even the idea that it can benchmark against other departments’ costs is false. Without a motivation to make a profit, and fully knowing that any shortfall can be covered by increased taxes or public borrowing, governments can’t know whether it is saving money.

Besides, hapless public servants will inevitably fall for the old, “costs have increased due to inflation” trick.

They’ll see any cost increase in-line with price inflation or just below price inflation as a ’saving.’ Their other trick will be to claim the rate of cost increases is lower than in previous years.

Either way, there won’t be any savings.

But back to the AFR. The bit that really tickled us was this:

    “Mr Tanner has finalized orders that would empower an independent agency to decide whether a department needed to report on the economic cost of a new regulation, taking the decision out of the hands of the department itself. The change gives the Office of Best Practice Regulation (OBPR) greater authority to scrutinize laws and rules proposed by departments…”

Ah, only in government. You can imagine the conversation when this OBPR department was set up:

Pen-pusher 1: I’ve had a great idea of how we can cut red tape.

Pen-pusher 2: Really, how?

Pen-pusher 1: It’s simple, we’ll set up a brand new department, staffed by tens, even hundreds of people to handle all the red tape and then it can make the cuts.

Pen-pusher 2: You’re a genius.

Pen-pusher 1: I know.

Only a chump would think that creating a whole new government bureaucracy in some way reduces bureaucracy. One step forward, two steps back.

However, that wasn’t the most ridiculous thing we read yesterday. That honour goes to Nobel prize winning economist Paul Krugman for his column in the New York Times.

As we’ve written before, not only is it sad that a supposedly well-educated man like Krugman could get so much wrong, but it’s even sadder that so many people read and truly believe what he has to say.

And even sadderer is that the chumps in government largely follow his advice.

Take this bit of babble:

    “Most of the world’s large economies are stuck in a liquidity trap – deeply depressed, but unable to generate a recovery by cutting interest rates because the relevant rates are already near zero.”

Doesn’t something seem terribly wrong with that argument? If low interest rates was the solution to excessive debt then surely interest rates near zero would already have solved the problem.

Wouldn’t the fact that it hasn’t solved the problem not make you think that perhaps, just perhaps, low interest rates aren’t the solution at all?

Perhaps when you keep doing the same thing – cutting rates – and it keeps causing the same problems – excessive credit – the answer is to do something else. Such as not letting the ‘excessive credit genie’ out of the bottle in the first place.

Not according to Krugman. With interest rates near zero, he and his Keynesian mates are in a bind. They’ve got no more ideas apart from closing their eyes and wishing really hard that it will all go away.

Actually, that’s not strictly true because –- wait for it -– Krugman does have a cunning plan.

But before I reveal his dastardly deed to solve the world’s woes, there is a point he makes about what would happen if China started to dump US dollars. Something we covered in yesterday’s Money Morning.

Krugman asks:

    “What you have to ask is, What would happen if China tried to sell a large share of its US assets? Would interest rates soar?”

No need to bother yourself by thinking of an answer, Krugman’s got that sorted:

    “Short-term US interest rates wouldn’t change: they’re being kept near zero by the Fed, which won’t raise rates until the unemployment rate comes down.”

Is that possible? Let’s think about it. Let’s look at the transaction from the both sides.

If the Chinese did dump US dollars then they’re doing so because they believe something else represents better value. Either they’re selling US dollars to buy another currency to hold, or they’re selling US dollars to buy a physical commodity or some other asset.

Either way, the seller is selling because it values the US dollar less than the currency or item it’s buying.

But what about the buyer of the US dollars? If the buyer is a firm that’s sold a commodity or other good to the Chinese then the buyer of the US dollars will either keep the dollars to invest or it too will trade them in for something else –- another currency maybe, or more supplies for the business.

Again, the business makes a decision about which is more valuable or useful to it –- the US dollars or what can be bought using US dollars.

So, to avoid lengthening this example, let’s assume the firm intends on saving whatever proceeds it has. Its first choice is to keep the money in US dollars and earn only a fraction of a percent in interest.

That’s not much of a return. But the firm must really believe that’s the best investment for them when all things are considered. If it wasn’t it wouldn’t make the investment.

But that’s a firm buying and selling stuff. Let’s also consider a big global investing firm. In both instances the investors that need to get a return for their clients. Is holding US dollars such a great idea?

It certainly isn’t a good idea if you’re concerned that a big holder of US dollars –- China –- plans on selling lots and lots of the little Greenbacks.

The reason it’s not a good idea for the investor is this: when any asset is sold down, the price tends to fall. It’s the same for shares, property, bonds, and even currencies.

If that happens then, relative to other currencies, those investors that continue to hold US dollars would see the value of their US dollar assets fall. The knock-on effect is that investors would anticipate a further sell-off and therefore look to sell their US dollar positions first. It would be the proverbial rush for the exit. Unless…

What’s the one thing that could discourage an investor from selling a depreciating asset? One thing would be an increase in the income flow from retaining the currency. In other words, a higher rate of interest.

If as an investor you’re offered a higher rate of interest, you may view this as an acceptable trade-off to counteract the falling value of the dollar. This could make you less likely to sell your US dollars.

But if there is no interest rate incentive it’s only natural an investor would look to sell out before other sellers pushed the price down.

With no comparable increase in the interest rate, the investor isn’t getting paid for holding on to the currency.

And furthermore, if the investors knew in advance that interest rates would not rise then why hang around waiting for something that’s not going to happen. And investors must be pretty certain interest rates won’t go up because the US Federal Reserve tells them so:

“…warrant exceptionally low levels of the federal funds rate for an extended period.”

OK, “low” doesn’t necessarily mean zero, but it clearly doesn’t mean 2% or 3%.

But the typical response to that is, won’t the ‘free market’ automatically adjust interest rates higher? Correct, a ‘free market’ would do that. But don’t forget, whenever there is a central bank a free market in the truest form doesn’t exist.

Besides, as Krugman ingeniously points out:

    “Long-term rates might rise slightly, but they’re mainly determined by market expectations of future short-term rates. Also, the Fed could offset any interest-rate impact of a Chinese pullback by expanding its own purchases of long-term bonds.”

That’s right, the Fed will keep interest rates low by just buying up all the bonds. Bond sellers will get a bail-out and receive top dollar rather than suffer losses from falling bond prices. And buyers who may have bought bonds at a lower price (when bond prices fall interest rates rise) won’t get a chance to benefit from a lower bond price and higher interest rate because the Fed will just print money to try and support the bond price at a higher level and therefore maintain low interest rates.

That means investors who may have been tempted to keep hold of their US dollars in order to invest in lower priced bonds with a higher yielding interest rate will now have no incentive to do so.

I mean, seriously, can it really be true that a Nobel Prize winning economist thinks it’s a good idea for the Fed to create money from thin air to pay off debts? It’s just not logical.

Think about it, if it was such a good idea why don’t all governments do it? Then there would be no government debt at all and we could all start from scratch. Better still, why not let all private individuals do the same thing?

Krugman and the dopes at the Fed must surely know that monetizing debt by just creating more money to pay it off is a bad idea.

But just in case you need confirmation of why it’s a bad idea, it’s simply this. It’s an appalling inflationary tactic that harms everyone. The only short-term beneficiaries are the government as it doesn’t need to suffer the wrath of the electorate by either cutting services, raising taxes, or defaulting on debt.

Everyone else is a loser.

Naturally Krugman wraps up his sorry tale with another fallacy:

    “It’s true that if China dumped its U.S. assets the value of the dollar would fall against other major currencies, such as the euro. But that would be a good thing for the United States, since it would make our goods more competitive and reduce our trade deficit. On the other hand, it would be a bad thing for China, which would suffer large losses on its dollar holdings. In short, right now America has China over a barrel, not the other way around.”

We can only think he’s got in mind that old saying: “If you’re in debt to the bank for a million dollars and you can’t pay it back, you’re in big trouble. But if you’re in debt to the bank for a billion dollars and you can’t pay it back, the bank is in big trouble.”

It’s a nice saying. Very twee. Trouble is, it’s not true in the case of the individual, and it’s not true in the case of China. Although, granted, for different reasons.

Although it’s true that the obligations the US has to China is little more than the ‘promise to pay the bearer’ a gazillion dollars, the reality is that the US doesn’t have China over a barrel at all, far from it.

As we pointed out yesterday, China is probably already resigned to losing a big chunk of its US dollars. That’s why it’s building skyscrapers instead of building piles of Greenbacks.

According to Krugman, China has around the equivalent of USD$2.4 trillion of reserves. Of which, according to the US Treasury, USD$889 billion is held in US treasury securities.

In other words, about 37% of China’s reserves are in US dollar bonds.

So, if China did dump all of its bonds and US dollars, what would the impact be? Well, we’ll assume the bonds and dollar isn’t going to fall to zero – we’ll assume that because Krugman seems confident the Fed would backstop it by buying up these securities!

Therefore, the Chinese may take something of a hit, but unless we’re talking hyper-inflationary money printing by the Fed – which is possible – then the Chinese will still get something out of it.

But even if we are talking hyper-inflation, so what. China has 63% of its reserves that aren’t denominated in US dollars. That’s 63% of its reserves which would increase in value relative to US dollars. What it loses in US dollar terms it gains in all other terms – China has a hedged exposure.

The losers would be America not China. A terminally weakened currency and massive debt which no one would want to buy. Not until hyper-inflation had run its course anyway.

A nation that would be unable to afford to import goods and services. The only possible savior for the US is its massive holding of gold – providing it’s all accounted for! But even so, that doesn’t necessarily give it a get-out-of-jail-free card. Having a store of gold is fine, but unless the US could do a quick about-turn and reinvigorate its formerly productive economy, then the gold would slowly but surely be exported in exchange for consumer goods.

Let me put it this way. The picture Krugman paints is a world where everyone pays off their own debt by creating money out of thin air, and where the economically successful economies play second fiddle to the weak and desperate.

It’s a world that doesn’t and cannot exist. It only exists in the child-like minds of mainstream economists who fail to understand the real consequences of harmful government and central bank policies.

Don’t get us wrong, we think the whole China story is a bubble waiting to pop. But the idea that the US is playing this perfectly and holds the upper hand is completely and utterly false.

Cheers.
Kris.

NB: Meanwhile, in completely unrelated news to Australia’s announcement of a “red-tape regulator” to stimulate economic growth, here at home in New Zealand, Finance Minister Sir Double Dipton and “Regulatory Reform” Minister Rodney Hide have announced the creation of “a Productivity Commission” to help boost New Zealand’s economic performance . . .

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2 Comments:

Blogger gregster said...

Excellent article by Sayce.

3/19/2010 10:14:00 am  
Anonymous Julian said...

I agree Gregster.

His demolition of Krugman in this article is supurb. Well worth the read.

Julian

3/19/2010 10:26:00 am  

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