"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008

Wednesday, April 21, 2010

Really great links - Aggregate demand failure - Goldman - Goldman II - USA vs. China

Bill Woolsey - Aggregate demand failure - "How do you know that aggregate demand is deficient? If cash expenditures have fallen below their trend growth path, and the levels of prices and wages have not fallen in proportion, then the presumption should be that aggregate demand is too low, that there is an excess demand for money, and that the market interest rate is above the natural interest rate.
        Never, never, never look at market interest rates and the quantity of money and compare them with historically "normal" levels.
        If some aggregate measure of production has fallen, and in the particular markets where it has fallen, there are shortages and higher prices, then deficient aggregate demand is probably not the problem.
        If aggregate production has fallen and in the markets where output fell there were surpluses (that is, production was cut because it couldn't be sold,) but that there are other markets where demand, production, prices, employment are all rising. Further, the rate of expansion in production is being limited by bottlenecks of various sorts. Complains about finding workers with specific skills, prices of key materials rising and the like, then there is a difficult judgement call. How significant are these expanding industries relative to the contraction ones. Is the unobservable excess demand in these markets greater than the reduction in output?
        If there are no such markets with increased demand, and every market is in surplus, then it is clear. There is obviously an excess demand for money generating the problem."

Brad DeLong - Goldman - "But in general acts of market exchange are win-win, for people trade off things they don't value very much for the things they value a great deal. I give the barista behind the coffee machine money--generalized purchasing power. She gives me coffee. Beforehand, she had too much coffee and not enough money. Beforehand, I had too much money and not enough coffee. Afterwards we are both happier and both better off.
        Now let's move to finance. The problem with finance is that we are not treating coffee for food, or CD players for clothes, but that we are instead trading money for money. The win-win benefits from exchanges of goods for goods are obviously there. The win-win benefits of trading money for money--where are they? It turns out that they are there. There are, actually, four:
        Trading money now for money later: people who want to save now and spend later can make win-win trades with people who want to spend now and save later.
        Risk: people who are unusually averse to risk in general can make win-win trades by trading off some of the risks that they are bearing to people who are unusually tolerant of risk in general.
        Insurance: people who are holding a lot of one big risk can reduce the risk of catastrophic loss by paying a great many others to each take a small piece of that risk.
        Information: people who have information that prices are going to rise can make win-win deals with people who have information that prices are going to fall--although here the win-win is not for the participants in the trade: for them it is zero-sum, and the winners are those others who observe the market price at which the trades occur.
        And here we come to the crux of the SEC's Goldman Sachs case. The SEC alleges that Goldman Sachs claimed to the buyers of the ABACUS 2007-AC1: $2 Billion Synthetic CDO Referencing a static RMBS Portfolio security that it was a deal of type (3) constructed primarily by ACA Management, LLC when it was in fact a deal of type (4) constructed primarily by investor John Paulson, and that this claim by Goldman Sachs was a misstatement of a material fact--an active attempt by sellers to mislead buyers, and thus to erase the win-win character of the deal."

Goldman II - A Wall Street participant who wishes to remain anonymous says - Naive version of the story - "Perhaps the reason that Goldman Sachs is so outraged at being accused of playing the investors in Abacus by concealing from them material information--that John Paulson played a big role in selecting the portfolio--is that they are totally innocent. Perhaps they were not trying to play the investors in Abacus by handing them a sub-standard produc. Perhaps, instead, they were trying to play John Paulson--a man who showed up with irrational expectations, eager to make bad bets, and who would have lost heavily had not he struck it freakishly lucky.
        The overwhelming probability, GS thought, is that Paulson will be the loser--but because his expectations are irrational he's willing to take the short side. So the important thing is to keep this big fish who promises to give us lots of money on the hook. Let him pick the underlying securities--it really doesn't matter, and it gives him the illusion of an edge. Don't bother telling Paulson's role to IBX and company--it really doesn't matter, and it might spook them off and then we might lose the real pigeon while we hunt for more counterparties to take the long side.
        And, the GS people probably still think: It should have worked. Only a truly freakishly freakish mischance produced not only a crash but a freakishly hard and fast crash so that Paulson looks like a genius. But he isn't--he's a gambler who got lucky. And the idea that we weren't doing our duty to our long-side clients while we tried to land this particular fish--well, perhaps the people at GS think, that's simply insulting. We were injured when bad luck not only let this fish get away but get away with some of the money that is rightfully ours. And now we are being insulted by the SEC to boot. This is intolerable..."

Michael Pettis - Chinese savings and the wealth effect - "Declining interest rates in the US usually (but not always) mean that Americans feel richer because the market value of their homes, stocks and bonds has risen. Declining deposit rates in China usually mean that Chinese feel poorer because the return on their savings relative to their implicit discount rate has declined."

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