Free Markets? Sure, Because Bernanke and the Federal Reserve Can Afford One

Who ever said there's no such thing as a free market? Or, wait. Who ever said there's such a thing as a free market?

The rhetorical play is supposed to be confusing because the economic havoc unfolding these days unearths the conventional wisdom -- a phrase made popular by John Kenneth Galbraith, a Harvard economist who made a career of elucidating the realities underpinning such myths -- that the domestic economy in the US and the ever-emerging markets of the developing world are, to employ that big idea, free.

A brilliant essay in the business section of Sunday's paper by Gretchen Morgenson zeros in on the consequences of regulators gone wild. At the heart of 'free market' thinking is the understanding that economic actors -- buyers, sellers, institutions -- will undoubtedly make bad choices, but bad choices garner no profit, or penalize with a loss, so actors rationally learn from their mistakes, adjust for the next go around, and in a broader sense the market leans toward efficiency and growth.

As much as is free today, as much seems to be rational.

Morgenson aptly points out that the Fed's bailout of investment bank Bear Stearns had to be reluctant; Bear has played the role of renegade shop for a long time. Yet, it seems that the Fed didn't have much choice. It was either bailout the bad guy, or worse.

“As we got through the day, we recognized that at the pace things were going, there could be continued liquidity demands that would outstrip our resources,” Bear chief Alan Schwartz said in a conference call before the weekend. The bank was going to fold.

From Morgenson's reporting, "The Fed has now crossed the line in a very clear way on 'moral hazard,' because they have opened the door to the view that they are required to save almost any institution through non-recourse loans -- except the government doesn't have the money and it destroys the US's reputation as the broadest, deepest, most transparent and properly regulated capital market in the world," so says analyst Josh Rosner of Graham Fisher & Company.

Why is the Fed so reluctantly eager, then? (Reluctant because they know all too well that they are crossing a line, yet eager because they're getting in this dirty game regardless.) All signs point to a precipice toward which nobody wants to take even a single step closer. Practical principles of the free market? Let a bank fall and the rest of Wall Street (and the rest of us, too) will learn our lesson? Anything but.

The bailout reveals that the financial scheme in which so many are mired on the Street can't survive the market realities they have created. Were the Fed not frightened, it would let the system work out the kinks. But these aren't kinks, this is a crisis of confidence, what seems to be the only valuable asset on Wall Street anymore.

Long ago, Karl Polanyi, in his lasting book, "The Great Transformation," crushed the myth that the free-market economy somehow naturally emerged over time. To the contrary, industrialization in Great Britian gave way to a government that very calculatingly created the liberal market. From the beginning, it's never been free.

The rearview mirror is full of the guilty: predatory lenders, overzealous banks, and lest they be forgotten, American citizens who, in a lulled sense of false hope, continued to live beyond their means. The question is: will taxpayers bail out the economy? Likely. In the future, will anything change?

What would a more centrally-planned economy look like in the US, one in which short-term profit motives aren't the central driving force? With so much of the country's future uncertain, it's a discussion worth having.

This market isn't free. Let's start by conceding that. And as long as it's not, perhaps more controls and planning are reforms worth considering. The only problem is that change requires catastrophe.

Gisele, Jian, and the Dropping Dollar

Open up your wallet, pull out a dollar bill, look at it closely, and things get weird. So weird that last week both supermodel Gisele Bündchen and Chinese Bank official Xu Jian became the strangest of bedfellows. I would wager that the two have never before been mentioned in the same breath. However, as the value of U.S. currency hits record lows around the world, they both threatened to dump the dollar. Today, whether you are a made-up mannequin or a bumbling bureaucrat, American cash in your pocket is a problem.

Bündchen, a Brazilian bombshell, works all over the globe, flaunting her scantily clad curves for companies like Dolce & Gabbana and Christian Dior. She is reportedly worth hundreds of millions of dollars, the richest supermodel on the face of the planet. Only, as Bloomberg reported last week, Bündchen — like many major hedge funds — has decided to be paid for a recent American shampoo deal in Euros rather than dollars. Her manager (who is also her twin sister) said in September that “we don’t know what will happen to the dollar.” Last week she denied ever saying it, perhaps trying to save face in front of the American public. But can anyone blame her?

Switch gears to Jian, the Chinese central banker. Last Wednesday he said the dollar is “losing its status as the world currency . . . We will favor stronger currencies over weaker ones and will readjust accordingly.” China, second only to Japan in terms of U.S. currency reserves, holds $400 billion in U.S. dollars, the U.S. Treasury says. And should China “readjust,” that is, decide the dollar is a weak investment and sell off their chunk of change, there could be hell to pay.

Even Alan Greenspan, former chair of the Federal Reserve, recently told “60 Minutes” that it didn’t matter how he was paid because he would immediately diversify.

When the dollar drops abroad, inflation rises at home. Current Fed chair Ben Bernanke said as much last Thursday. Why is this all happening?

Economists agree there’s nothing radical or controversial here: For far too long, the U.S. has been living beyond its means. And there’s no quick fix. The bankers who botched the housing market are going to have to pay. But for the rest of us, our hard-earned cash is worth less and less. Maybe we should all pull a Gisele and demand to be paid in Euros.

(Also published in Metro. Image from flickr.)

ETA of China's Rise? Delayed, 100 Years.

Playing catchup is a tough game, especially when you're talking superpowers. And according to a piece in the Times by MIT Professor Lester Thurow, while many believe China will, in effect, catch the US this century, for a range of reasons--which include the Chinese government exaggerating the reporting on their economy--Thurow argues that China's century will not be this one, but the next.

Thurow ticks off a list of "implausibilities" put forth by official Chinese statistics. For instance, if the Chinese economy is growing at 10% or more annually, and 70% of the economy in rural areas were not growing, then (according to his math), cities would be growing at 33% a year. Thurow dismisses this as inflated.

Next, he matches economic growth rates to electricity consumption, and he finds provinces where GDP is outpacing energy use. And after a little more math, he decides that the Chinese economy is growing at 4.5 to 6% annually.

These seem worthwhile points for discussion, yet, where is the incentive for the Chinese to inflate their own numbers. With global markets so interconnected, and more, emerging markets taking so much money in from institutional investors, any gains reaped by exaggerated numbers would surely be paid for by the penalties incurred once push comes to shove, no?

Wal-Mart Below the Border Goes South

Equations from the housing fallout in the States continue to add up to bad numbers. Take the following, for instance:

(Subprime mortgages go bust) + (New home construction slows) + (1 in four housing construction workers is Hispanic) = (Money transfers home to Mexico drop)

And in turn, Wal-Mart takes a  hit, on both sides of the border.

Interestingly, to accommodate exactly such a population, Wal-Mart had setup its own wire transfer service. Only today, with less cash being sent home from workers in the states, their Mexican retail outlets are suffering also. WalMax, with $18 billion in annual sales, makes up a quarter of the company's international sales.

It's another case of shoddy loans in the States rippling throughout the global economy. From the Journal:

The money-transfer slowdown is but one of several factors hampering the Mexican economy. Most importantly, U.S. demand for goods manufactured in Mexico -- cars, auto parts and consumer electronics, among others -- has eased. "Definitely, the slowdown in the U.S. economy in the first quarter triggered a slowdown in Mexican growth," said Rafael Amiel, a managing director in Philadelphia for Global Insight.

Free Global Financial Markets, More Transparent for Your Pleasure

Ramifications of the subprime mortgage market fallout continue to sprout up. As we've watched the ripples shut down deals around the world and shake a prominent Middle Eastern real estate company, there are now calls for international oversight of the US financial markets.

The International Herald Tribune reports from New Delhi that "politicians, regulators and financial specialists outside the US" want regulation on the financial products that the States are shipping overseas. Such proposals have been made in the past, when the US held a more commanding financial position around the globe. However, as the IHT puts it, "Washington might have to yield if it wants to succeed in imposing bilateral regulations on state-owned investment funds from other emerging economies."

The IHT quotes a German economic  official, "'America depends on the rest of the world to finance its debt," Bofinger said. "If our institutions stopped buying their financial products, it would hurt.'"

The cry is for transparency, but would transparency have satiated, or quelled, the appetite investors around the globe had for the medium- and high-risk collateralized debt obligations packed with subprime loans that they all bought up?

How would regulation temper the extreme, say, the blind fervor of the market?

Subprime Market Fallout Shakes Middle East

Earlier, the Inquirer pointed to tightened purse strings around the world because of the shoddy home loan market going bust in the US. Deals from Argentina to Japan have been put on hold, because financing has finally begun to discriminate.

In there a sour deal was listed in the United Arab Emirates. London-based Barclays bank had put the brakes on a $937 million loan to DAE Aviation, the Washington, DC subsidiary of Dubai Aerospace Enterprises Ltd. The company had wanted to buy some airplane maintenance companies from investment behemoth, the Carlyle Group.

And now it seems that the ripples of the subprime fallout are rolling deeper into Dubai.

Oil-rich investors in the Middle East have been making the best of depressed markets. For instance, Dubai World has just taken a $5 billion stake in MGM Mirage. At the same time, however, the Journal points to Emaar Properties, the maverick real estate company, which is taking a bit hit.

Emaar is one of the jewels in the crown of the Middle East economy. In a project for the UAE, Emaar is partway finished with the $20 billion Burj Dubai project, which will include the world's tallest building, the Dubai mall (Emaar says it will be the biggest in the world), and a serious of housing developments.

Emaar also has operations in the US, and in a conference call yesterday, Chief Financial Officer Amit Jain said that those operations were taking a hit on Emaar's bottom line.

According to the Journal, shares hit their lowest price in two years yesterday at about 9.75 dirhams, or $2.65. Emaar shares pulled on the Dubai bourse, which dropped 2.4%.

Lehman Brothers, other banks, and plenty of subprime lenders have already began firing staff. Could the subprime mortgage fallout prove to be more a kick in the shins than a full-on topple for the world economy?

(Image a rendering of the Burj Dubai.)

Peace is Bad For Business. See: Angolan Diamond Industry

Strange that a strong central system, even if it is run by warlords, may sprout the flowers of economic prosperity. Such was the case in Angola, a former Portuguese colony left in shambles when the Europeans left in 1975. Rebel commander Jonas Savimbi made good use of the chaos, armed himself and ran the country's diamond exporting industry, raking in good money from what are commonly known as blood diamonds.

Ray Fisman in Slate chronicles a case study of Savimbi's downfall, and how investors yanked capital as soon as he was killed in combat. Fisman writes:

Most people, including nearly all of my first-year MBA students, think that the key to business success is cheaply and efficiently producing something people want to buy. If this were the case, then war's end should have made Angolan miners and their shareholders richer as production costs plummeted. But the effect of peace on diamond mining in Angola shows that more important than producing something well is doing it better than the competition—and the potential competition.

The Inquirer has reported extensively on the Dirty Diamond Industry, so to go further, how emblematic is Fisman's example of the security situation in Angola of other industries thriving off of conflict?

Let My Hedge Fund Thrive, Inshallah

While today in Iraq Muqtada al-Sadr may be perhaps on of the most popular Shia political figures, if not the most powerful, his pedigree makes his leadership all the more interesting. His father in law, Muhammad Baqir al-Sadr, who was a scholar and devoted to Khomeni's Islamic Revolution in neighboring Iran, actually wrote the book on Islamic economics.

Entitled, "Iqtisaduna," or, "Our Economics," al-Sadr critiqued both capitalism and socialism, claiming that Sharia law doesn't jibe with the western liberal ideals of private property. Instead, public and private property come from Allah. He wrote extended critiques of Marxism, and his economic worldview envisioned a system that was not only in line with the teaching of the Koran, but also reconciled the inherent contradictions of capitalism.

At the same time, there are nearly a billion Muslims today across the world, and the free-market system is making attempts to appeal to would-be investors. A recent front page piece by Joanna Slater in the Wall Street Journal investigates the 'Rent-a-Sheik' issue and asks, "Could a hedge fund be Islamic-friendly?"

Sharia law prohibits interest, as it exploits the borrower. Where are Muslims to invest, then? Der Spiegel tracked a new set of "Sharia compliant" mutual funds setup by Deutsche Bank late last year. Reportedly, DB is joining UBS, HSBC and Citigroup, who all have already made the same kind of venture.

Seeing that economies across the Middle East, mainly due to increased oil revenues, have been growing at more than 10% on average, Western bankers clearly see a demand. But how severe will the shifting be from emerging Muslim societies who face an opportunity to put their money to work and, at the same time, vow to act in accordance with a religious edict?

(An advertisement for Islamic banking in Kabul, Afghanistan.)

Governments on a Shopping Spree: the Emergence of Sovereign Wealth Funds

The corporatization of government continues with the rise of what's called a sovereign wealth fund. Put briefly: governments have got money, and they're playing the market.

Ever since gold was tossed out as the international standard of value and exchange, countries have held large amounts of foreign currency, called foreign exchange reserves. For instance, as for US dollars, China holds $1.3 billion, Japan $924 million, and Europe $439 million. Only today, instead of sitting on that cash, countries are throwing that money into international investments.

The Economist, in a piece called 'Governments Go Shopping' put it this way:

Go for a walk in Chelsea, an expensive bit of London, and you may stroll by the Coldstream Guards' barracks, now the property of the government of Qatar; a branch of the venerable Barclays bank, soon to be part-owned by the People's Republic of China; and then buy a picnic at Sainsbury's, Britain's oldest supermarket, which the Anglophile Qataris are trying to buy too. What goes for Chelsea may soon be true for neighbourhoods in open economies all over the world: governments are on a shopping spree.

Earlier this summer, US officials started to grumble. Their worry is that these are immense amounts of money (sovereign wealth funds are expected to be worth $12 trillion by 2015) subject to little oversight or scrutiny. The fear of hedge funds has always been that they are too hidden. Sovereign wealth funds are much more shrouded.

A complete portrait has hardly been painted, made clear by a report from the US Treasury that states, "Because relatively little is known about most SWFs, market estimates of their size vary widely."

Emerging markets, in their rise to power, have amassed big foreign exchange reserves. They're ready to play, only, as China recently bought into the massive global bank Barclays, one has to ask: strategically, what kind of new leverage do sovereign wealth funds offer to a new crop of states playing on the global economic stage?

Subprime Fallout Starves World of Easy Going Credit

The ramifications of the subprime mortgage market fallout are now spinning quickly across the globe. While cheap loans for Americans with bad credit and Americans wanting to make a quick buck buying and selling houses seems just an American problem, it is anything but.

The way bankers sold off this shoddy debt to the rest of the world in complex arrangements of risk is now proving to be hazardous, shaking world indicies (though fundamentals of the global economy are still sound, if not outright strong) and pinching high-profile deals around the world.

The Wall Street Journal put together an informative, interactive world map with some of stalled projects. Click on the image to check it out.