Friday, December 31, 2010

The Global Imbalance

Sure there are lots of imbalances in the global economy. But one is more pervasive and persistent than any other. Let me ask you: are emerging markets net exporters? The U.S.? We know the answers. So why? Here's the answers we've heard ad naseum: the U.S. has lost its drive, it's become bloated or slowed by entitlements, taxes, bureaucracy, demographics, over regulation and under regulation.

OK sure. But why would emerging countries, the have-nots endlessly give developed countries more goods than they receive? Not for just for any money. For dollars of course. Perhaps, in focusing on net export imbalances we are analyzing the symptoms and not the disease.

Said another way, one could view the situation not an under production in the US but an over investment. That's right those proletariat types are at it again. Now they are forcing us to into deficit-financing! But why? Law and order. Institutions and property and contract rights. Emerging markets are importing the security of the U.S. system (and military might) when they bring in dollars.

Looking at investments from within the U.S. or a highly developed country, emerging market investments are a no brainer. Look at the growth potential! But consider the inverse. Looking at the U.S. and developed nations from the outside, surrounded by unstable governments, heirarchical non-pluralist bureaucracies, rampant inflation, large criminal organizations, and otherwise lacking and untested law, order, and institutions, well from that point of view, I'ld like a helping of dollars please... and seconds if nobody minds. This is the type of logic that leads me to view capital flows as the tail ever so slightly wagging the net exports dog.

Well all I do here is post diatribes of varying length, but now its time for something really tangential. Both pre- and post- world wars rounds of globalization have been marked by a convergence of institutions. As a communist Deng Xiaoping would have said, we are all just trying to catch mice. In so doing, we seek the best mouse trap (or cat). When the best is found, who wouldn't want to use it? I'ld like the best whether it's black or white, capitalist or communist, 12% risk-adjusted total capital ratios or 9% tier-1 common ratios. Hence, convergence.

Now pretend that I've convinced you that capital flows have an under appreciated responsibility for the persistent net export imbalance. The security of the dollar (and investments in the U.S.) from the perspective of the emerging market based investor is a way of attaining the benefits of the best institutions. Governments that collect dollars attain those benefits as well. Of course, the effect of having a mountain of dollars doesn't replace the need for a proper political-economic systems. Just look at what has happened to Argentina since WWII. Dollars are more of a compliment and only a very slight substitute for institutions. When things get ugly, a country can to a certain extent buy its way out of a problem that might have also been cured by better institutions.

China for example could deal with a currency troubles by preemptively taking 'institutional' actions such as allowing for partial market adjustments and limiting public and private sector borrowing in foreign currency and taking dollar actions in accumulating trillions in reserves.

So far this post has nothing to do with financial guarantee. I can change that with a violent turn. Our institutions are strong. One could argue that U.S. contract laws are its most predictable. For that reason, JP Morgan, Barclay's and myself think their is no reason to even consider the viability of challenges to the MBIA/Nat'l PFG split given the clarity of Article 78. So lets briefly consider the weight of the topic on repurchase litigation. Let's start by way of analogy:

You bought a house with a large basement. You want to flip it. I am a prospective buyer but have worry about termites. I ask you if the house has termites. You say you won't answer, but refer me to various inspectors. You pay the inspectors. When the inspectors come to the house, you tell them it has no basement. The locked door you falsely claim leads only to a broom closet. They find no termites and they tell me the house has no termites. I buy the house. I find termites in the basement, they destroy the house. I sue you. We discover that you hired another, better equipped inspection company three months earlier before you bought the house and they found a massive termite infestation. You used that to negotiate a lower price on the house. You are guilty of fraudulent conveyance. You owe me restitution.

Strong property laws determine that the results of the above example will not change easily. They will not change if we switch the roles of you and me or you and Bank of America and me and MBIA. They will not change due to incorporation. They will not change if it is a house and termites or mortgages and bad credit, inspectors or rating agencies and Clayton, or a basement or underlying loans. And they certainly will not change if you promised to recompense me for termite damage or repurchase non-qualifying loans as the case might be. (B of A argued that fraud claims against them should be dropped because the claims against them were for failure to perform contractual agreements. Their motion was dismissed.)

If I were a defendant in such a case and realized that I was going to lose, then I would come to the table with private investors who could probably only actually cooperate in a suit if they saw huge payoffs. I would show I was willing to talk by dropping other loosely related and weak suits. Defendants have recently done these things.

The value of strong contract law supersedes the financial health of any individual, natural or corporate. Even in a closed economy, predictable property rights and contract laws encourage investment, entrepreneurship and thus growth in prosperity. Yes, somehow I just argued that that the same factors that drive persistent net exports are going to lead to a windfall for financial guarantors. I hope you found it titillating. Perhaps we can flush out the latter part of the post a bit more in future. Tata.

No comments:

Post a Comment