Thursday, August 27, 2015

Reveal, Restore and Resurrect: The Truth About Racial Disparities in the Arkansas Criminal Justice System

On August 28-29th, 2015, the University of Arkansas at Little Rock William H. Bowen School of Law will host a critically important conference "Reveal, Restore and Resurrect: The Truth About Racial Disparities in the Arkansas Criminal Justice System."  This conference, based on the newly completed report  generated by the Racial Disparities in the Arkansas Criminal Justice System Research Project which found fairly stark racial disparities in Arkansas's policing and prison outcomes, will seek to uncover the reasons that racial disparities exist in Arkansas's criminal justice system and develop strategies to overcome and equalize criminal punishment in The Natural State.

The slate includes several keynote speakers, panels that include activists, scholars, judges, and formerly incarcerated persons, and scheduled time to brainstorm on strategies and proposals to end criminal justice racial disparities in Arkansas and across the nation.

Saturday, August 22, 2015

One Ugly Week in Global Finance (Deflation 2015 Update)

Nevertheless, that was probably not the worst news of the week. In fact, the US stock market is late to the real horror show--which is a deflationary vortex that is rapidly spreading throughout the global economy, particularly in Asia and emerging markets. Consider the following news from last week:

1) On Monday morning the WSJ reported: "Japan’s economy contracted in the second quarter as overseas demand for Japanese goods slumped and households spent less, raising the possibility the government will act to bolster an anemic recovery. Japan’s gross domestic product shrank 1.6% on an annualized basis in the April-June quarter, according to data released Monday by the Cabinet Office." Japan teeters toward recession.

2) On Monday the FT reported that: "Russia, Turkey, Malaysia and Taiwan headed a lengthening list of emerging market countries seeing their currencies pummelled by markets’ continued fixation with China’s slowdown and an imminent US rate rise." Emerging market currency devaluations means more exported deflation worldwide.

3) On Tuesday USA Today reported that China's main stock index "plunged more than 6% . . . and other Asian markets also declined as investors appeared to show a delayed reaction to news that China's market regulator would allow market forces to play a greater role in determining stock prices.The mainland China stock benchmark's 6.2% drop to 3,748.16 was its biggest decline in three weeks. The index fell 8.5% in late July as worries about China's ability to maintain high economic growth levels undermined investor confidence." China's stock market crash now mirrors the Crash of 1929.

4) On Wednesday USA Today reported that: "The stock market closed lower Wednesday after minutes from the Federal Reserve's last policy meeting showed the central bank was 'approaching' its first rate hike in nearly a decade. . . .The Dow Jones industrial average ended down 162 points" and "[t]he energy sector was the hardest hit as oil prices tumbled about 4% after a government report showed that U.S. crude stockpiles rose. U.S. benchmark crude fell $1.82 to $40.80 a barrel." Oil prices now stand at a six year low threatening a huge part of the global economy with an oil depression.

5) On Thursday CNBC reported that "China, which is at the heart of the region's deflation challenge, has seen 41 consecutive months of falling producer - or wholesale - prices. In July, the country's producer prices index (PPI) fell 5.4 percent from a year earlier, the worst reading since late 2009, during the aftermath of the global financial crisis. Over the past nine months, PPI deflation pressures have reached nine out of ten economies in the region." Virtually all of Asia is now in a "deflationary funk."

6) Yesterday Bloomberg reported that: "The Bloomberg Commodity Index of 22 raw materials dropped Wednesday to its lowest since 2002, paced this year by declines in nickel, sugar, and crude oil" and that "[s]lumping prices for raw materials have wiped out $2.05 trillion from the shares of mining and oil companies since the middle of last year." Emerging markets now face a "death spiral" of falling commodity prices and falling currencies.

7) Yesterday the WSJ reported that: "[t]he Caixin China Manufacturing Purchasing Managers' Index . . . fell to a 77-month low in August." This private survey contradicts official sources and proves China is in much worse shape than previously thought.

All of this highlights that serious deflation haunts the global economy with China, Japan and other emerging markets suffering serious economic slowdowns accompanied by severe crashes in the market price of almost all commodities. Now, these nations are exporting deflation through falling currencies which effectively slash prices on everything they produce. This constitutes a serious threat to the global economy.  On top of those problems, Greece and the Eurozone are still a mess.

This blog first discussed this "perfect storm" of financial threats on December 12, 2014 and again on December 14, 2014. At that time I bemoaned the lack of any effective mechanism for sound fiscal and monetary stimulus for the global economy. I have made the same point with respect to the Eurozone. I wrote a law review article (a book review of Globalization and its Discontents by Joseph Stiglitz) on this point in 2003, and I addressed this flaw in global financial architecture in Lawless Capitalism. I have also blogged on pro-growth reforms that would help lift the global economy out of its structural deflationary malaise, such as empowering people to move freely to their highest and best use or banking currency reserves.

The other major problem with all these extreme market moves relates to the world's unregulated and opaque derivatives markets. Here, the question of the day relates to the exposure of the megabanks to the oil patch, the emerging market sector and China. My bet is that the megabanks booked big profits on all that soon-to-be distressed debt and now face the losses from those derivatives deals. If so, this meltdowm in Asia and the energy sector is about to hit home on Wall Street and our dysfunctional financial sector. Think MF Global or the London Whale.

Right now, the US economy does not face any Doomsday threat; but, that can change quickly if it turns out our oil sector collapses or the megabanks must book huge losses on derivatives transactions involving commodities, Asia or emerging markets.

Wednesday, August 19, 2015

High Inequality and Deflation 2015: Rigged Globalization

The above chart shows the massive cash hoarding undertaken in order to influence the price of exports from developing countries. While the crash of 2008 momentarily slowed the growth of world currency reserves, they promptly soared after mid-2009 as nations desperately sought to grow through exports at the expense of the price-competitiveness of other nations.

Of course, the best nation for consumption and imports is by far the USA so it is only natural that exporting nations seek to accumulate dollars to make their manufacturing sector more price competitive in dollar terms, as depicted above, showing about 2/3 of all reserves are held in dollar denominated instruments.

Today currency reserves amount to about $12 trillion--and thus represent a substantial use of the world's total capital. Essentially, developing nations face incentives to buy dollars in order to weaken their currency and strengthen the dollar because reserves subsidize the export sector of their economies. The US dollar is the ideal reserve currency because the market for dollar assets is deep and liquid.

In theory, and to some degree in practice, currency reserves serve a legitimate purpose for developing countries. Countries accumulating foreign currency reserves can use them to defend the value of their currency in the event their currency is subject to speculative attack or any financial crisis causes currency disruptions. By selling foreign currency reserves, such as dollars, they can restrict the supply of their own national currency and cause it increase in value relative to the dollar. It can be very important to defend the value of a national currency because the vast majority of international debt is denominated in dollars. This means that if a currency dives in value relative to the dollar debt burdens can increase often dramatically. As a result nations cannot allow the value of their currency to dive or public and private debt burdens can spiral out of control and a financial crisis may ensue.

Fine. But, economists have shown again and again that the degree of reserve accumulation cannot be explained by the need to defend  a currency's value in time of crisis. Instead, they have identified 20 nations that clearly accumulate currency reserves to lower the cost of their exports to the US and other developed nations. This currency manipulation through constant accumulation of dollar reserves is highly costly to the global economy.

According to Maurice Obstfeld and Kenneth Rogoff the accumulation of currency reserves was "intimately connected" to the financial crisis because it allowed the US "to borrow cheaply abroad and thereby finance its unsustainable housing bubble." The stronger dollar meant lower cost exports, lower inflation and thus lower interest rates. The constant purchase of dollar denominated assets (no country holds actual currency as currency reserves opting instead for the safest and most liquid dollar-denominated assets) also lower interest rates in the US as well as the developed world. I explained this dynamic in detail in chapter 4 of Lawless Capitalism.

Today, this festering problem with our global economy appears to be spawning global deflation throughout emerging markets and even into China and Japan. Basically, by accumulating reserves central banks in exporting countries divert investment from their own economies in order to purchase low-yielding debt of developing countries. Over the long term this suppressed investments hobbles their growth.

Meanwhile, in the developed world, currency reserves mean more debt and fewer jobs as is evident (see chart above demonstrating the role of the Euro in reserves). In the US and the Eurozone, economists estimate that the entire output gap experienced since the financial crisis can be attributed to currency reserves. Experts estimate that the US alone has lost up to 5.8 million jobs.

Thus growing currency reserves are a powerful deflationary force.

As Nobel laureate Joesph Stiglitz stated in 2010: "the UN Commission of Experts on Reforms of the International Monetary and Financial System highlighted the ways in which the dollar reserve system contributed to global financial instability and a weak global economy. While many of its arguments were already well known—Triffin had noted that the reserve currency country got increasingly in debt as others’ held more of its IOU’s as part of their reserves,and Keynes had noted that the build-up of reserves by surplus countries led to weaknesses in global aggregate demand—the crisis gave them increased salience." Stiglitz also argues there is a remarkably "simple" solution to this issue--to expand the use of special drawing rights issued by the IMF. This would serve as a mechanism for broadening the burden of the reserve currency.

I extended this concept to argue in favor of a more aggressive investment approach for these reserves by creating a global development bank for currency reserves to fund infrastructure projects like schools, universities, water supplies, green energy platforms, and to actualize economic human rights.

Nevertheless, such common sense solutions have gained no traction in the wake of the financial crisis. Instead, as is evident in the chart above reserve accumulation has proceeded apace. Why?

High Inequality. When a small group controls massive wealth they can dictate law for their profit regardless of costs to society as a whole. This irrational model of globalization fattens transnational corporate profits--and by extension executive compensation. They produce cheap in China and sell cheap in the US because the dollar is the reserve currency. I formalized this basic point in American Corporate Governance Law and Globalization.

In sum, globalization has been hijacked and sabotaged by powerful interests in the US that profit from the deflationary forces unleashed by the constant accumulation of massive currency reserves.

Tuesday, August 11, 2015

High Inequality and Deflation 2015: The Problem of Too Much Savings

Today, China devalued its currency, effectively cutting the price on everything it produces. It was the largest devaluation out of China in 21 years. It is just the latest sign of spreading deflationary pressures. It will probably get much worse from here.

A potentially historic deflationary vortex threatens to engulf the world. In fact, a recent survey of financial experts found that an overwhelming majority think that deflation is a much larger worry than inflation. Worse, the Fed seems determined to raise interest rates notwithstanding the deepening slowdown behind falling prices. The Fed seems oblivious to the fact that despite massive monetary stimulus, a deflationary spiral simply cannot be discounted.

This blog has long covered the deflationary forces gripping the global economy on a step by step basis. That vortex is manifestly forming today as evidenced by the oil and commodities crash, the apparent crash in China, the increasing deflationary pressure emanating from the Eurozone and Japan, negative interest rates worldwide, collapsing emerging market exchange rates, and a world awash in debt and debt defaults. Today, it is fair to say that world economy hangs by a thread above a vortext of deflationary forces. What are the roots of this deflationary threat?

Perhaps the most deflationary force in the world today is very high economic inequality in the US. I will support and defend this proposition in a series of blog posts, starting with this one.

The first problem with high economic inequality is that the marginal propensity to consume is much higher for the middle class and lower classes than for the very wealthy. High inequality therefore leads to too much savings.

The very wealthy save much more of their income. This means that as the very wealthy control more of the nation's GDP, and today they control a historically high amount of GDP (as demonstrated in the chart at right), the more national income than diverted from growth stimulating consumption and toward savings. Too much savings leads to savings gluts and bubbles because massive income is diverted from consumption to savings but too many consumers are deprived of the ability to pursue growth-enhancing innovation. That leads to too much savings and not enough productive investment opportunities.

At the same time, more global GDP has been diverted from consumption to savings by the continuing growth of globalization and China as the world's manufacturer. The savings rate in China is about 50 percent, compared to 18 percent for the US. India saves nearly twice as much as the US. So every time jobs move from the US in search of cheaper labor it leads to higher corporate profits for the top income earners here who enjoy dividends and incentive bonus compensation as well as more savings in developing economies such as China or India. The net result is a massive transfer of global demand to less stimulative savings. This point is more fully documented in Chapter 4 of my book Lawless Capitalism, entitled "Rigged Globalization."

In a forthcoming post, I will discuss the highly dysfunctional global financial system that is supposed to channel savings to productive investment but does not. The point here is simply that massive money is drained from the economy to fund a highly sub-optimal global economic system and distribution of income, and that is highly deflationary.

ADDENDUM (AUG. 12, 2015):

“As investors realise yet another recession beckons, without any normalisation of either interest rates or fiscal imbalances in this cycle, expect a financial market rout every bit as large as 2008.” China's currency devaluation could spark "tidal wave of deflation," Guardian (quoting Société Générale economist Albert Edwards).