Washington, D.C., Food Administration: Making sauerkraut
Ilargi: Recent observations by readers about empty malls and parking lots in the US point to a bleakening picture of the holidays as seen from the real economy. When the numbers come out in early 2009, retail stores and airlines, just to name a few, will be forced to cut back dramatically. Corporate bankruptcies will soar, and millions of jobs will vanish, all just in the first quarter. 2008 was used across the economic board to survive simply by spending whatever excess or surplus still could be found in wallets, books and ledgers. There will be no more excess come January. The cream on top is gone, we’ll have to consume the principal, the coffee itself, just to stay alive. It’s much easier, as I've said before, to cope with the first loss than with what comes after. We're about to find out how true that is. And no, our economic systems, whether you look at individuals or corporations or governments, were not designed with optimum resilience in mind. That's another issue we're about to find out. The hard way.
1 million US jobs were lost in the first 10 months of 2008. In November, the number was over 200.000, for an annualized loss of 2.5 million. This accelerating trend will continue, and do so exponentially. Whether automakers get their federal billions or not, they won’t be able to avoid downsizing their operations in a spectacular fashion. Detroit needs to cut its production by more than 50%, or all rescue plans are useless. That cut, in turn, will result in about 2.5 million pink slips, and Obama needs to come with a plan soon to prevent all pensions and health benefits from breaking into unrecognizably small fragments. If he doesn't, he’ll have one or another form of urban guerilla warfare on his hands. Losses of that caliber will stretch the Detroit region beyond its limits.
I've been thinking about the impossible conundrum that the autoworkers union, the UAW, finds itself in, and I’m happy not to be in the shoes of its leaders. Their mission is to protect the jobs and perks of their members. Well, they've already offered to cut many of the perks, and one of these days they will have to look a few million workers in the eye and tell them their jobs will have to be cut, in order to save their neighbors' jobs. And even that comes with a BIG Maybe. Not a nice tale to tell. Some homes in Detroit were already cheaper than cars, and in 2009 you'll probably get a home free if you buy an automobile.
A new contract recently negotiated between the Big 3 and the UAW brings down the total cost of hourly wages from $71 to $53. But even that doesn't really help anyone: as UAW President Ron Gettelfinger said this week: "To be honest with you, right now if the UAW members went in these facilities and worked for nothing...it would not help the companies that much.". Of course the reality is that the unions, along with the companies, have been living in the clouds for years, and they'll all come crashing down together. It's up to Obama to soften the blow. However, so far all the Democrats have pushed for is capital injections into the Big 3, which is the worst of all possible options.
Detroit is not an exception: French President Sarkozy today announced €26 billion in government support for the economy, including 0% loans for first-time homebuyers and ultra-low-cost loans for vehicle purchases. 10% of all jobs in France are linked to the auto industry, and many plants have been temporarily shut down: car sales are not just down, there’s downright rare these days. Why? because people can't get credit to buy cars.
The idea then is to push credit down people's throats, a brilliant notion we see all around the western world. It's the only way governments and central banks can conceive of to jumpstart the dead horse. But the poor thing has been flogged to death. In other words, since people realize quite well that getting credit, getting a loan, to buy homes and cars, in the end simply means getting yourself deeper into debt. Which for many, who are finally waking up to their real situations, looks like a bad idea. Real bad. A car you bought a few years ago can last for a few years more, so why buy another one? Home prices are falling, and there's nothing in sight that would seem to be able to stop that process, so why buy now? Sure, there are places in the US where home sales are up, because people think prices can fall no more, but they are dead wrong, and their necks are now ripe for strangulation.
Besides, money is handed out to banks so deep in debt that they can’t possibly use it to lend. Banks have no equity. The famous Fed graphs show that all they have left is what they themselves have borrowed, while what is on their books as assets is to a large extent of, to put it mildly, questionable value. Whatever number of billions in taxpayer money they receive will be used to stem losses, not to give loans to destitute clients. There are hundreds of billion of dollars in writedowns coming up in the next quarter, Q1-’09, and banks need, and will use, every penny to pay off their existing obligations. Whoever claims that banks should use the cash to help customers doesn't understand how bad their positions are.
All the rate cuts we've seen today, and all the stimulus packages, are aimed at the wrong target: restoring a system, including banks and large corporations, that are beyond restoring, that are insolvent, bankrupt and should be left to die with dignity. Still today we see "leaders" talking about the need for their economies to grow, economies that have been shrinking for a long time, a truth disguised only by cooked books and phantom statistics.
Please heed my advice: get out of debt, don't sign up for any new loans, move your money where you can control it, and never ever think that your job or your salary is guaranteed. We have entered a depression. I’ll talk more about that later this week, and especially about the Fed’s denial of it. Don't get me started.
Citi reaps fantastic deal in Fed bailout
Vikram Pandit isn't known for his deal-making. The Citigroup chief executive famously got beaten by a nose by Wells Fargo in the battle for Wachovia two months ago. However, Pandit has seemingly pulled off one fantastic deal: Citi's own bailout. Some details of the deal haven't been disclosed - and some haven't even been nailed down. So piecing together what is going on is a bit like solving a Rubik's cube with some of the squares missing. But, from what is public, Pandit has shuffled off to Uncle Sam much of the risk in his $306 billion bad bank for what looks like a low insurance premium.
One key number, which Pandit let slip in an interview on the Charlie Rose television show last week, is that the original value of this bundle of assets was between $340bn and $350bn. Given that they are now valued on Citi's books at $306bn, the assets have so far suffered a "haircut" of about 11pc. That looks pretty modest. It is impossible to be sure whether this is adequate without knowing exactly what assets are in the portfolio. Yet history suggests that banks' valuations of mortgage-related assets have been like the throws of a drunken darts player whose every flight hits the ceiling - consistently off target and far too high.
Citi will absorb the next $29bn of losses. But even after adding that, there is only a buffer of about 20pc between the original value of the assets and the value to which they would have to fall before the state started to get hit. What's more, the government isn't just insuring Citi against losses. The Federal Reserve is providing the bank with a backstop loan to fund the portfolio net of all these losses, if they happen. That funding line means Citi isn't under pressure to dump assets at fire-sale prices. Without the loan, the bank could have been in the position of many other financial institutions such as Merrill Lynch and UBS which had to crystallise big losses when they were forced to sell assets quickly.
In return for giving Citi so many goodies, the government receives $7bn in preference shares plus some warrants to buy ordinary shares. That doesn't look much. One pointer is the deal the government was prepared to give Citi when it was trying to buy Wachovia. In that case - which was the model for this bailout - the state was to receive $12bn of preferred shares and warrants. What's more, with the Wachovia deal, Citi would have had to absorb the first $42bn hit. This time the "first loss" is only $29bn although Citi would also get hit with 10% of any subsequent losses. Given that the size of Wachovia's portfolio was $312bn - almost exactly the same size as Citi's own bad bank - Pandit looks to have got a better and cheaper insurance policy.
Of course, Citi may not have got a better deal overall in that, with Wachovia, it was also going to get a large deposit base at a knock-down price. What's more, the story isn't entirely over because the $306bn valuation of Citi's bad bank hasn't yet been agreed by the government. If the Treasury concludes that a lower value should be used, that would give the taxpayer a bigger buffer against losses while shifting more of the pain to Citi. Taxpayers should hope that Hank Paulson, the Treasury secretary, negotiates sensibly on their behalf. As for Pandit, he should wait before cracking open the champagne. He knows too well how easily deals can slip through his grasp.
Bernanke Says U.S. Must Step Up Foreclosure Efforts
Federal Reserve Chairman Ben S. Bernanke urged using more taxpayer funds for new efforts to prevent home foreclosures, saying the private sector is incapable of coping with the crisis on its own. The Fed chief outlined four possible options, including buying delinquent mortgages and providing bigger incentives for refinancing loans. He called for addressing the “apparent market failure” where lenders aren’t modifying mortgages even in cases where it’s in their own economic interest to do so.
Each option would require “some commitment of public funds,” Bernanke said, underscoring his position that the central bank alone can’t revive the economy through its interest-rate cuts and emergency lending programs. The Republican’s stance may also put him in line with President-elect Barack Obama, who said yesterday that “we’ve got to start helping homeowners in a serious way.”
“More needs to be done,” Bernanke said in a speech to a Fed research conference on housing and mortgage markets in Washington today. “Policy initiatives to reduce the number of preventable foreclosures should be high on the agenda.” The government could buy “delinquent or at-risk mortgages in bulk,” then refinance them through the federal Hope for Homeowners program, Bernanke said. Congress could also help reduce loan rates and lender insurance premiums, he said.
Foreclosures may begin on 2.25 million homes this year, more than double the pace before the financial crisis, he said. Estimates show as many as 20 percent of borrowers may now be “under water,” where their mortgage is bigger than the price of their home, Bernanke said. “Despite good-faith efforts by both the private and public sectors, the foreclosure rate remains too high, with adverse consequences for both those directly involved and for the broader economy,” Bernanke said.
Some foreclosures are happening “even in cases in which the narrow economic interests of the lender would appear to be better served through modification of the mortgage,” Bernanke said. That is partly the result of packaging loans as securities for sale to investors, where there’s the risk of lawsuits and a lack of “clear guidance,” he said.
Bernanke said a loan-guarantee proposal by the Federal Deposit Insurance Corp. has “strengths,” including that the government is involved only if a borrower defaults again. FDIC Chairman Sheila Bair is pressing the Treasury Department to use authority in the $700 billion financial-rescue package to implement the program to spur mortgage modifications.
Another option is to have the government share costs when a loan servicer reduces a borrower’s monthly payment, Bernanke said. While this would put a “greater operational burden on the government” than the FDIC plan, it would “build on, rather than crowd out, private-sector initiatives,” he said. The Hope for Homeowners program, run by the Federal Housing Administration, has signed up few lenders since it started in October because banks must write off a large portion of the loan and pay high fees. The Fed sits on a board that oversees the program.
Bernanke’s proposed changes would go beyond those announced last month by Housing and Urban Development Secretary Steve Preston, who oversees the FHA. The agency will lower the amount of the loan a lender must forgive, allow banks to extend mortgage terms to 40 years from 30 years and give subordinate holders immediate payment for releasing their liens. Congress could make the program more attractive by reducing the up-front insurance premium paid by the lender, which is now 3 percent of principal, and the borrower’s 1.5 percent annual premium, Bernanke said.
Lawmakers should also consider reducing borrowers’ interest rate, which may be near a “quite high” 8 percent, he said. That could be accomplished by having the Treasury buy Ginnie Mae securities, or having Congress directly subsidize the rate, Bernanke said. Last week, the Fed announced a new program aimed at lowering borrowing costs for homebuyers, committing to buy as much as $600 billion of debt issued or backed by government-chartered housing- finance companies Fannie Mae and Freddie Mac.
Separately, Treasury Secretary Henry Paulson is considering a new plan to reduce borrowing rates involving the purchase of mortgage-backed securities issued by Fannie and Freddie, a government official said yesterday. The Treasury, which already has a program to buy the securities, could step up those purchases to drive down interest rates on some loans to 4.5 percent, the official said on condition of anonymity. The plan is preliminary and could change.
The Bush administration has been faulted by Democrats and consumer advocates for failing to take sufficient steps to stem record home-loan foreclosures this year. Federal Housing Finance Agency Director James Lockhart has been prodding private mortgage servicers and bond investors to cooperate with government efforts to modify or refinance loans for troubled borrowers.
Yesterday, the Fed’s Beige Book regional-business survey said residential real estate was running at a “slow pace” across the country, with sales down in most districts.
New-home sales in the U.S. fell in October to the lowest level in 17 years, the Commerce Department said last week, as the credit crunch deprived potential buyers of needed financing. Sales of new homes were down 40 percent from a year ago. “Residential construction is likely to remain soft in the near term” given high inventories of unsold new homes, Bernanke said today.
Europe’s Central Banks Lower Rates to Fight Recession
Europe’s central banks cut interest rates as policy makers stepped up their response to the credit crisis that has pushed the region into a recession. The European Central Bank delivered a 75 basis-point reduction in its main refinancing rate, the most in its 10-year history, while the Bank of England cut its benchmark rate to 2 percent, the lowest level since 1951. The Swedish and Danish central banks also lowered their key rates.
Central banks are battling to contain the economic damage as the 17-month credit drought weighs on companies and consumers around the world. The biggest advanced economies are already set for their first simultaneous recession since the Second World War, the International Monetary Fund forecasts. “Policy makers are moving toward historically low levels of interest rates and they probably won’t stop there,” said Paul Dales, an economist at Capital Economics Ltd. in London. “We are going to see all central banks bring rates down as close to zero as they can get.”
Bank of England Governor Mervyn King discussed the possibility of lowering the U.K. rate to zero for the first time on Nov. 25 and said the biggest challenge he faces is renewing the flow of credit in the economy. The U.K. economy may contract by 1.1 percent next year, the most since 1991, the Organization for Economic Cooperation and Development said Nov. 25. Gross domestic product fell by 0.5 percent in the third quarter, the first drop in 16 years.
Today’s moves in Europe are part of a global pattern. The U.S. Federal Reserve cut its key rate to 1 percent last month. New Zealand’s central bank cut its rate by a record 1.5 percentage points to 5 percent, and Bank Indonesia reduced its rate to 9.25 percent from 9.5 percent. The Polish zloty dropped to a five-week low against the euro today, falling more than any other currency worldwide, after central-bank Governor Slawomir Skrzypek said policy makers may lower his country’s rates this month.
The ECB’s decision to accelerate the pace of rate cuts signals the governing council may be prepared to breach the 2 percent level it last reached in 2005, said Erik Nielsen, chief European economist at Goldman Sachs Inc. in London. The ECB lowered borrowing costs by 50 basis points in October and November. “This probably undermines this idea that they have given us that 2 percent would be a longer-run floor,” Nielsen said in a Bloomberg Television interview. “By early next year, they might go through 2 percent.”
Europe’s economy fell into its first recession in 15 years in the third quarter after the U.S. subprime mortgage crisis led to bankruptcies on Wall Street and pushed up lending costs worldwide, eroding the confidence of investors and consumers. With oil prices collapsing, the euro-area inflation rate fell the most in almost 20 years, to 2.1 percent from 3.2 percent, giving policy makers more room to act on interest rates.
A bolder move from the ECB was “sorely needed,” said Holger Schmieding, chief European economist at Bank of America in London. The global economic downturn has caused an “unprecedented collapse in sentiment,” he added. Sweden’s Riksbank lowered its key rate by 1.75 percentage points, the biggest reduction in 16 years. The Danish central bank matched the ECB, cutting by 75 basis points.
The U.K. interest rate now matches the lowest in the central bank’s history. It was last at 2 percent when Winston Churchill’s victory in a general election made him prime minister for the second time. “If this goes wrong we are just going to go sideways for the next decade,” Graeme Leach, chief economist at the Institute of Directors in London, said in a television interview. Once interest rates reach zero, central bankers have to resort to other measures to stimulate the economy. Such steps may include expanding money supply and using it to finance government deficits or buying securities such as bonds or stocks, former policy maker Willem Buiter said this week.
ECB’s Trichet Says Euro-Region Economy Will Contract
European Central Bank President Jean- Claude Trichet said the euro region’s economy will shrink next year for the first time since 1993 after the bank delivered the biggest interest rate cut in its 10-year history. “Global and euro-area demand are likely to be dampened for a protracted period of time,” Trichet said at a press conference in Brussels today. The ECB lowered its benchmark by three quarters of a percentage point to 2.5 percent. Trichet declined to give clues on further moves, saying only that the ECB shouldn’t get “trapped” by cutting rates too low.
The ECB’s decision came after the Bank of England today cut its key rate by one percentage point to 2 percent and Sweden’s central bank lowered borrowing costs by the most since 1992. The Federal Reserve’s benchmark rate now matches a five-decade low as central banks rush to respond to the global recession. “The level of uncertainty remains exceptionally high,” Trichet said. The euro rose after his comments and traded at $1.2681 at 3:50 p.m. in Brussels.
As well as cutting rates, the ECB has flooded money markets with cash and widened its collateral rules to unfreeze credit markets. Trichet said today it may be possible for the bank to purchase financial assets outright to reflate the economy, although he declined to say if it would. Trichet said the euro region’s gross domestic product will shrink around 0.5 percent next year as the financial turmoil takes its toll, the first time the ECB has ever predicted a contraction. In September, the bank forecast a 1.2 percent expansion next year.
“The ECB is moving towards an acceptance of reality but the growth projections are still not low enough,” said Ken Wattret, euro area chief economist at BNP Paribas in London. Trichet refused to be drawn on further moves, saying only that policy makers must avoid getting “trapped at nominal levels that would be too low.” The ECB’s benchmark compares with the Fed’s rate of 1 percent. On inflation, Trichet said it will slow to about 1.4 percent in 2009 from 3.3 percent this year.
“Overall, since our last meeting, evidence that inflation pressures are diminishing has increased,” Trichet said. “Inflation rates are expected to be in line with price stability over the relevant policy horizon.” Until today, the ECB had restricted itself to two 50-point cuts since October, with Trichet stressing its role as an “anchor of stability.” Some ECB policy makers have advocated a steady-hand approach to tackling the recession. Executive Board member Lorenzo Bini Smaghi said on Nov. 25 that “sharp” rate reductions “may contribute to, rather than obviate, a worsening of market sentiment,” prompting speculation the bank would limit itself to a half-point cut today.
Trichet said today’s decision was made by consensus and declined to divulge if there were calls for smaller or bigger cuts. “This suggests to us that the decision might have been more difficult to reach than at the last meeting with possibly some members favoring a smaller cut,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland Plc in London. Manufacturing and service industries contracted at the fastest pace on record in November and economic confidence plunged to a 15-year low. With oil prices collapsing, the inflation rate fell the most in almost 20 years last month, to 2.1 percent from 3.2 percent in October.
The International Monetary Fund predicts the euro-region economy will contract 0.5 percent in 2009. Trichet declined to follow Fed Chairman Ben S. Bernanke in outlining what his strategy would be should the ECB’s key interest rate fall close to zero or whether he’d pursue so-called “quantitative easing.” He noted the bank had already cut rates at the fastest pace in its history and offered unlimited cash to the region’s banks. “If new decisions are needed we will take new decisions, but I can’t say anything else at this stage” he said. “We continue to look very carefully at the situation of the market and the situation of the economy.”
November Job Losses Could Be Worst in 28 Years
New figures may show 300,000 layoffs for the month, and possibly 400,000. The U.S. economy is bleeding jobs faster than it has since the early 1980s, and perhaps since the mid-'70s. Economic forecasters are now projecting that on Dec. 5, the government will announce the loss of more than 300,000 jobs in November—possibly more than 400,000. December is shaping up to be a bad month as well. The rate of layoffs should slow next year as economic stimulus begins to kick in, but modest monthly declines could continue well into 2010. "Let's get real. These numbers are horrible," says Ellen Zentner, senior U.S. economist for Bank of Tokyo-Mitsubishi UFJ in New York.
A burst of negative statistics from purchasing managers and other sources has caused economists to darken their outlooks in the past few days. The median forecast in a Bloomberg survey as of Dec. 3 was a decline of 330,000 in nonfarm payrolls in November, but that included many forecasts that had not been updated to reflect the latest spate of bad news. The most recent projections are among the gloomiest, ranging as high as 470,000 in job losses. These statistics are far worse than anything felt in the past two recessions, in 1990-91 and 2001. For comparison, the U.S. economy lost 431,000 jobs in May 1980, which was the worst month of the back-to-back recessions of 1980-82. If it's any comfort, November is highly unlikely to be worse than the recession month of December 1974, when the economy lost a staggering 602,000 jobs, according to the Bureau of Labor Statistics.
One factor that will most likely account for a big share of the job loss is the tepid shopping season. The government's seasonal adjustment attempts to filter out ups and downs in employment caused by seasonal factors like holiday shopping. So when retailers ramp up employment less than they have in the past, it shows up as an outright employment decline in the seasonally adjusted data, notes Bank of Tokyo's Zentner. Zentner has one of the most bearish outlooks among Wall Street economists, predicting a decline of 470,000 jobs in November. Some others aren't far behind. Deutsche Bank Securities (DB) predicts a decline of 425,000 jobs, while National City (NCC) is at 418,000 and ING Financial Markets (ING) is at 400,000. "Things in this quarter look downright ugly," says Torsten Slok, a Deutsche economist in New York.
Economists marked down their forecasts after getting two key reports from the Institute for Supply Management, a group of purchasing managers. Their employment index for the service sector issued on Dec. 3 was the lowest since its 1997 inception, while its manufacturing employment index issued on Dec. 1 was back to the levels of the 1990-91 recession. Another bearish signal was a report on initial claims for unemployment insurance, which hit 543,000 the week of Nov. 14, which is the week the survey of November employment is conducted. That claims figure is consistent with a monthly job loss of well over 300,000.
While December is a lost cause, 2009 could start to look better as interest rate cuts and other government pump-priming measures start to work. Zentner says the measures "could go very far in pulling the economy out of its current slump." But she notes that employment is a lagging indicator, meaning that even if economic output starts growing again, job rolls could continue to shrink. Case in point: Even though the last recession technically ended in November 2001, the economy was still losing jobs as late as August 2003. The interval between the November Presidential election and the inauguration in January is particularly dangerous, says Deutsche's Slok, because the economy isn't getting as much stimulus as it needs in the power vacuum. Says Slok: "A policy response is becoming more and more urgent."
Jobless Claims Fall Unexpectedly
New claims for jobless benefits fell unexpectedly last week but the number of people continuing to claim benefits reached a 26-year high. The Labor Department reported Thursday that initial claims for unemployment insurance dropped to a seasonally adjusted 509,000, from an upwardly revised figure of 530,000 for the previous week. That was significantly below analysts' estimates of 537,000, according to a survey by Thomson Reuters. But other figures showed the labor market remains weak due to the recessionary economy. The National Bureau of Economic Research said Monday that the economy fell into a recession in December 2007.
The number of people continuing to claim unemployment benefits last week reached 4.09 million, the highest level since December 1982, when the economy was in a steep recession. More workers continuing to claim benefits is an indication that unemployed workers are having a harder time finding new jobs. The four-week average of initial claims, which smoothes out fluctuations, increased to 524,500, also the highest level since December 1982, the department said. The work force is roughly 50 percent larger than it was in the early 1980s.
The department said the proportion of workers continuing to receive jobless benefits has reached its highest level since September 1992, when the economy was slowly recovering from recession. Jobless claims have soared in recent months as the housing slump and financial crisis caused consumers and businesses to cut back their spending. Initial claims last month reached a 16-year high of 543,000. A year ago, initial claims stood at 340,000. Employers have eliminated jobs every month this year, shedding 1.2 million positions through October. That has sent the unemployment rate to a 14-year high of 6.5 percent.
Economists expect the Labor Department will report Friday that the rate increased to 6.8 percent in November and that companies cut another 320,000 jobs. Large layoffs are occurring across many sectors of the economy. JPMorgan Chase & Company said this week it would eliminate 9,200 positions at failed thrift Washington Mutual , which it acquired in September. Jet engine maker Pratt & Whitney , a subsidiary of United Technologies Corporations; the financial services firm State Street Corporation and the mining company Freeport-McMoRan Copper & Gold also announced layoffs this week.
Factory orders drop more than expected in October
Orders to U.S. factories plunged in October by the sharpest amount in over eight years as a deepening recession caused big cutbacks in demand for steel, autos, computers and heavy machinery. Analysts expect the weakness will continue for some time. The Commerce Department reported Thursday that factory orders dropped 5.1 percent in October, the largest decrease since an 8.5 percent fall in July 2000.
It was larger than the 4 percent drop that economists had been expecting. They believe manufacturing will continue to be under pressure for many more months, reflecting a deepening recession that already is the longest slump in a quarter-century. The drop in orders marked the third consecutive decline with demand for both durable goods and nondurable goods falling.
Demand for non-defense capital goods, considered a good proxy for business investment plans, fell by 5 percent in October, the biggest decline since January and the fourth straight monthly decrease. With the economy weakening, businesses are cutting back on their plans to expand and modernize, adding another drag to overall growth. Orders for durable goods, items expected to last at least three years, fell by 6.9 percent, even bigger than the 6.2 percent initial estimate the department made last week.
Orders for nondurable goods, such as food, clothing, paper goods and petroleum products, dropped by 3.4 percent, partially reflecting the big declines occurring in energy prices.
The weakness was led by a big 11.2 percent fall in demand for transportation equipment. Demand for autos fell by 2.8 percent and commercial aircraft orders were down by 4.8 percent. The auto companies have been in a prolonged slide, reflecting not only the weak economy but the huge jump in gasoline prices earlier in the year. Even though gas prices have retreated from their highs above $4 per gallon this summer, car sales have remained depressed, reflecting rising unemployment and the severe credit crisis which hit in September, making it harder to get auto loans.
U.S. auto sales plunged by 37 percent in November to their worst level in more than 26 years, adding more ammunition to Detroit automakers' case for a congressional lifeline that they are pressing again for Thursday on Capitol Hill. Every major automaker reported a year-over-year sales decline of more than 30 percent on Tuesday with the Detroit carmakers among the worst hit. Sales at General Motors Corp. fell by 41 percent, Chrysler LLC's sales dropped by 47 percent and Ford Motor Co. saw a 31 percent drop.
Excluding transportation, factory orders would have been down by 4.2 percent in October, indicating that the weakness in manufacturing is widespread. Orders for primary metals such as iron and steel plunged by 23.1 percent in October while demand for machinery was down by 9 percent. Construction machinery was off 25.6 percent, reflecting the hard times in the building industry which is suffering through the biggest slump in home construction in decades.
Demand for computers and other electronic products fell 3.4 percent in October, while furniture makers reported a 5 percent drop in demand. All of the weakness is causing a rising number of layoffs. Dallas-based AT&T Inc. said Thursday it is cutting 12,000 jobs, or about 4 percent of its work force, because of the economic downturn, while Wilmington, Del.-based chemical giant DuPont said it would cut 2,500 jobs.
Black Friday Boost Fails to Stem U.S. Retail-Sales Drop as Confidence Ebbs
“Consumers were bargain-hunting and therefore if you had better bargains, you had more customers,” Amy Wilcox Noblin, a retail analyst at Pali Capital Inc. in Larkspur, California, said in a Dec. 2 interview. The National Bureau of Economic Research said earlier this week that the U.S. economy entered a recession in December 2007. The jobless rate probably increased to 6.8 percent last month, the highest level since 1993, the median estimate in a Bloomberg News survey showed.
Wal-Mart’s increase beat the average analyst estimate of 2 percent, according to Swampscott, Massachusetts-based Retail Metrics. Costco, the largest U.S. warehouse-club chain, trailed projections of a 1.3 percent drop. Comparable-store sales are considered by some investors to be the best measure of retail health because they exclude the effect of location openings and closings in the past year.
Gap, the largest U.S. apparel retailer, posted a 10 percent comparable-store sales decline, exceeding analysts’ estimates for a 17.6 percent drop. The owner of the Banana Republic and Old Navy chains said it had “more aggressive offers” to attract customers, hurting profit margins. Abercrombie & Fitch Co.’s same-store sales plunged 28 percent. The teen apparel retailer, known for its shirtless male models, said last month it won’t use promotions to lure shoppers to protect its brand image. Analysts projected a 26 percent drop.
American Eagle Outfitters Inc. posted an 11 percent decline as the retailer discounted clothes. Fourth-quarter profit will be 30 cents to 36 cents a share, it said. Analysts surveyed by Bloomberg estimated an average of 39 cents. Sears Holding Corp., the largest U.S. department-store chain, said Dec. 2 that November comparable-store sales declined 8.7 percent. Macy’s, the second-biggest, said today that same-store sales fell 13 percent.
J.C. Penney’s sales dropped 12 percent, within its forecast and better than analysts predicted. Kohl’s Corp. dropped 18 percent. Target Corp., the second-largest U.S. discount retailer, lost 10 percent, worse than it had forecast. “Results from post-Thanksgiving holiday sales, particularly Friday, were stronger than the rest of the month, but were insufficient to offset earlier weakness,” Target Chief Executive Officer Gregg Steinhafel said in a statement. “Consumers remain very cautious and event-driven in their purchasing behavior.” Neiman Marcus Group Inc. sales fell 12 percent, while Saks had a 5.2 percent drop, better than the 20 percent fall estimated by analysts. Nordstrom Inc. sales retreated 16 percent. Analysts projected a deceleration of 19 percent.
Victoria’s Secret Chief Executive Officer Sharen Jester Turney said in a Dec. 2 interview that the retailer was a little more promotional on Black Friday this year than in the past. The company may take additional steps, marking down some beauty gift sets 40 percent, for example, she said. “The remaining three weeks are incredibly important,” Bill Dreher, director and senior retail analyst at Deutsche Bank Securities Inc. in New York, said in a Dec. 2 interview. “The last week before Christmas is perhaps more important than it’s been in years. Will it pay off? It’s unlikely.”
Deflation: Bargains abound, which could be a problem
Everything is on sale. And that's not a good thing. Consumer prices in October fell at the fastest pace in more than 60 years, sucked down by the rapidly deteriorating economy. The prices of oil, food, cars, clothing and electronics have all plunged. Home prices continue to swoon and so do stock prices.
As the early reports from the holiday shopping season suggest, the nationwide fire sale might seem like a boon for consumers. But it's increasing the risk that the economy could become mired in a dangerous deflationary spiral — a widespread, sustained reduction in prices. That's something that hasn't happened here since the Great Depression.
Economists say it's too early to tell whether deflation has set in — and many say the government's aggressive responses to the credit crunch likely will prevent sustained deflation. Others aren't so sure. Nouriel Roubini of New York University predicts that what he calls "stag-deflation" — a recession combined with deflationary forces — will be a big concern in the coming months, here and abroad. A deflationary spiral can have several causes, such as a widespread glut of goods that forces manufacturers to slash prices. In the current crisis, the bursting of the housing bubble has forced home prices down, pulling down the prices of raw materials, cars and even stocks.
As prices fall, consumers eventually stop spending, either because they are worried about their jobs, or because they figure they can get lower prices later. Companies start laying off workers because lower prices have pushed down — or eliminated — their profits. That, in turn, means even less demand. Ultimately, higher unemployment and lower demand create a self-reinforcing cycle that further depresses profits, growth, wages and prices. President-elect Barack Obama cited the danger of deflation last month in calling for a massive stimulus bill to put millions to work in the next two years and boost economic activity.
Already, prices are cracking nationwide:
•Oil is down about 70% from its 2008 high to $46.96 a barrel.
•Wheat is down about 60% from its 2008 high.
•Home prices are down 21% from 2006 highs.
It's not just houses and raw materials. Nancy Wurtzel, owner of All About Baby, a Thousand Oaks, Calif.-based Internet retailer that sells baby gifts, is offering 20%-off coupons to try to lure customers to the company's website. Even with the discount, sales since August have slowed considerably. The discount "has not given us the big boost that I hoped it would," Wurtzel says. "But maybe it would be worse" without the discount.
Like Wurtzel, Faith Freeman, owner of Primal Elements, a specialty soap and candle company in Huntington Beach, Calif., is planning to sell a new kind of soap early next year that will be more basic than the regular fare and sell for about $24 a loaf, which you cut yourself, rather than the $35 the company usually fetches. "I'm not really thrilled that I have to do this, but I'm trying to do what I can," Freeman says. She says her company's sales were likely to be higher in November compared with a year ago because of some large orders from bigger retailers.
Costco Wholesale sold 20% more TVs in October than it did a year ago. But because prices were lower, the dollar amount from all TVs sold was below the year-earlier total. Consumer spending fell 1% in October, the biggest decline since September 2001 and the fourth-consecutive monthly drop, the Commerce Department says.
Bargain shopper Loralisa Gainsborough, a hospice social worker in San Diego, says record-high gasoline prices earlier this year and the plummeting stock market led her to be even more careful with her money. She has kept up the practice even though prices at the pump have fallen."I do a lot more comparison shopping," says Gainsborough, 36. "I know what is a good price for pretty much everything I buy." Jeremy Melnick, a partner at Gordon's Ace Hardware, a string of six hardware stores in downtown Chicago, says people have gone from "replace to repair" and are spending less per shopping trip.
He expects to mark down Christmas-related goods earlier than usual this year and is still waiting to see how much his suppliers cut their prices, if at all, on other items. "I haven't seen too much come down yet," he says. "It's obviously scary times for everybody." Deflation hits investors, too. Falling prices are devastating to nearly every type of investment — except for Treasury securities. When prices fall steadily, companies repeatedly chop prices until only the strongest are left standing.
During the 19th century, for example, when deflation was more common than inflation, railroad barons would routinely engage in price wars, slashing fares until only one or two railroads were left standing. The victor would then buy the bankrupt companies for pennies on the dollar. In a deflationary period, the best investment is a bond backed by a very strong issuer — say, the U.S. government or a top-quality corporate borrower. Bonds are long-term IOUs that pay regular interest. When prices fall, each new interest payment can buy more goods and services.
Sam Stovall, chief stock strategist for Standard & Poor's, notes that one of the greatest bull markets of all time was from 1932 to 1937, when the Dow Jones industrial average soared to 192 from 42. But stocks in the 1930s — aside from being extremely cheap, relative to earnings — were prized mainly for dividends. Roubini, whose gloomy predictions have mainly come true, thinks that the collapse of the debt markets will lead to increased defaults — and that, in turn, will feed deflation as companies frantically sell assets at any price to try to remain afloat.
Others also fret about deflation. "The global economy gives a good impression of having run at top speed into a brick wall," says Jeremy Grantham, chairman at Grantham Mayo Van Otterloo, an institutional money manager. "I defy anyone to find anyone who isn't cutting back. They are all deep into ways to be frugal." Grantham thinks that "we could have something reminiscent, in some respects, to the Japanese situation" that began in the early 1990s and continued well into this decade — a long, low-grade deflationary recession.
One reason: U.S. investors in stocks and bonds may have to write off $20 trillion, he says. "When you write off that much of your net worth," Grantham says, "it changes your world." At least in the short term, deflation is inevitable, says Mihir Worah, portfolio manager of the Pimco Real Return fund. "Part of it is already baked in the cake, given the fall in commodity prices," Worah says. By mid-July, Worah expects the inflation rate to drop to -2%. In the longer term, Worah is more optimistic. "Policymakers clearly get the scope of the problem," he says.
Philadelphia Federal Reserve Bank President Charles Plosser Tuesday said the nation is "not close to a sustained deflation," calling recent price declines simply the mirror image of the price increases earlier in the year. But Plosser said that just as the Fed acts to tamp down inflation, it must send a clear message that it won't let deflation take hold. The Fed and the Treasury have been pumping money into the economy, hoping to keep borrowers afloat and forestall a chain reaction of bankruptcies and liquidations.
The Fed, for example, has pushed its key federal funds rate — the overnight lending rate between banks — to 1%. Fed Chairman Ben Bernanke said Monday that it could push rates down further. Some economists say the Fed could even drop the rate to zero. But that, too, brings a further worry: Will pushing rates to zero have an effect? Does it make a difference if interest rates are 1% or 0.5% or zero? After all, low rates didn't save the Japanese from their punishing brush with deflation.
And cutting rates to near zero has practical problems. Money market mutual funds, for example, may find it impossible to operate if short-term rates fall to 0.5%. Many funds have expenses higher than 0.5%, meaning investors would get nothing — or even a negative return. And if rates fall to zero, banks and companies would have no reason to make short-term loans to each other. Bernanke tried to reassure consumers and investors, saying the Fed still has plenty of ammunition, even if rates hit zero.
The Fed can turn to "quantitative" strategies such as buying Treasury bonds to push down longer-term rates, injecting money into banks or promising to keep rates low for a long time to change market expectations. But the Fed has used some of those strategies aggressively for months, to limited effect. The central bank's balance sheet has soared from about $800 billion a year ago to about $3 trillion now, for example, as it has lent to banks and financial firms.
Nevertheless, some economists say there's only an outside chance that disinflation, a decrease in the inflation rate, will turn into more serious deflation. They point out that costs in the nation's huge services sector continue rising. Overall consumer prices have declined at a 4.4% annual rate since August, but they are still up 3.7% in the past year. "It's natural that the discussion of deflation has started," says Marvin Goodfriend, a Carnegie Mellon professor and former Federal Reserve economist, noting falling commodity prices. "On the other hand, the broader measures of consumer inflation … haven't fallen as much at this point. It's a little premature to be worried."
Jeremy Siegel, professor of finance at the Wharton School of the University of Pennsylvania, says he thinks the country will avoid deflation, primarily because of all the money the Federal Reserve and the Treasury have been pumping into the market. "I don't think we're going to get deflation, and absolutely nothing like the 1930s," Siegel says. Stovall, the S&P market strategist, also thinks full-blown deflation is unlikely. "It's a threat that's out there, but the Treasury and central bankers have learned a lesson from the 1930s and from Japan in the 1990s," Stovall says. "They will do whatever they have to (do) to avoid that."
AT&T Plans to Cut 12,000 Jobs
AT&T, the telecommunications company, said Thursday that it was cutting 12,000 jobs, or about 4 percent of its work force, because of the economic downturn. The company, based in Dallas, said the job cuts would take place in December and throughout 2009. The company also cited a changing business mix and a more streamlined structure as other reasons for the layoffs. It was not immediately clear what departments and cities would suffer the cuts. However, like most telecom companies, AT&T has been seeing many customers defect from landline phones to wireless services, and the company noted that it would still be hiring in 2009 in parts of the business that offer cell phone service and broadband Internet access.
The company also said it planned to reduce capital spending next year. AT&T plans to take a charge of about $600 million in the fourth quarter to pay for severance costs. The company noted that many of its non-management employees have guaranteed jobs because of union contracts. All affected workers will receive severance a "in accordance with management policies or union agreements," the company said.
GM, Ford, Chrysler Chiefs Urge Congress to Approve $34 Billion Rescue Plan
The Big Three automakers renewed their plea for an emergency federal bailout, as the head of General Motors Corp. told a deadlocked Congress the industry has made mistakes and economic forces have pushed it “to the brink.” GM Chief Executive Rick Wagoner said time is running short and his company could be out of funds by the end of the year. “We’re here today because we made mistakes,” he said in written testimony to the Senate Banking Committee in Washington. “And we’re here because forces beyond our control have pushed us to the brink.”
Wagoner, Chrysler LLC Chief Executive Robert Nardelli and Ford Motor Co.’s Alan Mulally are asking for as much as $34 billion in federal aid. The three men demonstrated contrition by pledging to work for $1 a year and traveling to Washington by car. They were ridiculed at a hearing last month for taking separate private jets and left empty-handed after pleading for $25 billion.
Democrat Senator Carl Levin, from the carmakers’ home state of Michigan, said “it’s essential” that President George W. Bush and President-elect Barack Obama “become more active” in talks to rescue the carmakers. Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, praised the chief executives for coming up with new plans. They have done “far more than the financial companies to show they deserve taxpayer support,” he said. The senior Republican on the panel, Senator Richard Shelby of Alabama, said he still opposes a bailout.
As today’s hearing began, White House spokeswoman Dana Perino said it is up to the automakers to show that their plans for revamping their companies will work. “It’s too early to give these plans a grade,” Perino said. “The linchpin of our support has been that we would not provide taxpayer dollars unless they could prove viability.” GM and Chrysler say they need the first installments on a rescue package this month to avoid running out of cash. Ford has requested a $9 billion credit line it said it may not need to tap.
“I recognize this is a significant amount of public money,” Nardelli said in written testimony. “We believe this is the least costly alternative considering the depth of the economic crisis and the options we face.” U.S. lawmakers have said they may schedule votes next week to aid automakers after hearings today and tomorrow. Leaders haven’t resolved a deadlock over how to provide aid, with Republicans backing use of Energy Department loans that were intended to help retool the industry and Democrats preferring to tap a $700 billion rescue package targeted for financial institutions.
“The collapse of one or both of our domestic competitors would threaten Ford because we have 80 percent overlap in supplier networks and nearly 25 percent of Ford’s top dealers also own GM and Chrysler franchises,” Mulally said. In a related development, GM and Chrysler executives were said by a person familiar with their private discussions to be considering accepting a pre-arranged bankruptcy as the last- resort price of securing the bailout. The executives have said publicly that bankruptcy would lead to liquidation as customers abandoned the companies. Wagoner said today bankruptcy isn’t in his plan.
Staff for three members of Congress have asked restructuring experts if a pre-arranged bankruptcy -- negotiated with workers, creditors and lenders -- could be used to reorganize the industry without liquidation, a person familiar with that matter said.
Black suppliers at the center of auto crisis
While talks continue on Capitol Hill to find a solution to the imminent collapse of the industry, minority suppliers in Detroit are making adjustments - both financially and philosophically. Leon Richardson, CEO of Chemico-Mays, a minority supplier that provides chemical management services, said that the downturn has been significant, so a new way of thinking needs to be proffered.
“One of the things we try to do is diversify our product offering,” Richardson said. “We’ve done a really good job in that diversity effort. The automotive industry was 95 percent of our overall business (five years ago). Now it’s 60 percent. What’s really afforded us the opportunity to do that is that we’ve taken the skills, the knowledge and talent we’ve used in the automotive industry, and have applied it to other businesses and it really works well for us.” Since most minority suppliers are first or second generation, he noted, they are still relatively new businesses. “While we’re in the process of building equity and building these companies to scale, these suppliers are being caught in a situation,” Richardson added. “The credit markets are becoming very tight, and it's becoming very, very challenging. Revenues are shrinking; the cost of financing is becoming more expensive. The biggest problem is a reduction in volume. It’s having an adverse effect on those suppliers.”
The connection between minority communities, auto suppliers and the Black community is an obvious one in his opinion. “If you look at some of the largest minority companies in the country, a large portion of those are directly tied to the automotive industry,” Richardson said. “A large portion of the middle class was derived from the auto industry. If that industry was to disappear or diminish, it’s going to have a dramatic effect on the minority community. Most of the large companies that are minority-owned are tied to the auto industry.” Richardson recently met with the House and Senate to plead the case from the minority suppliers’ perspective. “We think it would be a travesty to let another manufacturing sector go away,” he said. “It’s critical we save this industry. The message is that 2009 going into 2010 is going to be very difficult. We need to understand how important manufacturing is.”
Like Richardson, Kirk Lewis, president of The Bing Group (a minority owned supplier), traveled to Washington to present the arguments in favor of a bailout. “The minority supply base, which tends to be much smaller companies, are challenged with similar issues as it relates to credit availability and volume,” Lewis said. “What we’ve been doing over the last 24 months is really focusing on how do we run our businesses at lower volumes? At certain points, you reach a level where you can’t cut expenses anymore. And that’s where we are now. The volumes have dropped so low where we can’t do many things to offset the lack of margin.”
The largest issue is that every sector is suffering, he noted. “You’re having significant industry-wide distress,” Lewis said. “Our customers are in financial distress; all our suppliers are in financial distress, which really puts the whole system in distress. I think our biggest challenge today outside of reducing the cost and process improvement is how do we deal with the lack of available credit and the negative view on the automotive industry? It’s a long process that we’re going to have to work our way through. There’s no silver bullet. There’s structural change that needs to happen, that’s a long term and very painful process.” He steadfastly believes that if the auto industry as it is today is to survive, it will have to transform itself. “The question is how do you survive so that when you come out this thing, you’ll be in a position to grow your business?” Lewis said. “That’s one of the things we’re focusing on - how to do that.” Bankruptcy, he believes, would be a mistake. “I think that if GM files bankruptcy, it would be devastating to the automotive industry, and the ripple effects would be unprecedented,” he said.
During his meetings in Washington, Lewis stressed the importance of seeing the auto industry collapse as a national, possibly even global crisis. “This isn’t a Detroit issue,” Lewis said. “This is a U.S. issue because the automotive industry directly and indirectly reaches just about every state, and it’s important that we get the right focus to get this industry back on track. That’s really been the push - internally looking at our operation and going on to talk to other folks and letting them know the impact of having a failed industry.” As for a timetable, he can’t realistically see one. “I think it’s going to be painful,” Lewis said. “Everybody’s going to have to come to the table - the car companies, labor and government, but we will eventually get it wrapped up. Is it the end of the year? January? I don’t know. It’s really going to be based on how far they can stretch their cash.”
FDIC's Bair warns investors fighting loan changes
Investors in mortgage securities who are challenging home loan modification programs aimed at avoiding foreclosures could provoke a "backlash" from Congress, the head of the FDIC said Thursday.Sheila Bair, the chairman of the Federal Deposit Insurance Corp., made the comments in response to a question following a speech to a consumer group gathering.
Two companies that invested in mortgage-backed securities recently sued Countrywide Financial Corp. over its plans to make as much as $8.4 billion in loan modifications as part of a settlement with attorneys general in 15 states. Their lawsuit maintains that Countrywide, now owned by Bank of America Corp., sold most of the loans to trusts that turned them into securities, and that Countrywide intends to pass the cost of reducing the mortgages to the trusts.
Elsewhere Thursday, two Countrywide subsidiaries agreed to repay $11.5 million to nearly 4,800 North Carolina borrowers who were overcharged on their mortgages, the state banking commission said. Countrywide Home Loans and Countrywide Mortgage Ventures will refund the money to close an investigation. For lenders and companies servicing loans held by struggling borrowers, Bair said, "There is an obligation to modify, not to foreclose. Investors should be taking a hard look at what they're advocating," she said. The harder investors push, "the more there's going to be backlash here."
Congress may step in and change the legal obligations of mortgage servicers toward investors, she suggested. Bair was the leading architect behind a loan modification program at IndyMac Bank, a big thrift that failed in July and was taken over by the FDIC, in which thousands of struggling home borrowers pay interest rates of about 3 percent for five years. Rates are reduced so that borrowers aren't paying more than 38 percent of their pretax income on housing.
Bair was asked Thursday about an industry-backed proposal being considered by the Treasury Department to lower the rate on 30-year home loans to 4.5 percent by buying mortgage-backed securities from government-controlled Fannie Mae and Freddie Mac. "Getting mortgage rates down is ... positive, but it doesn't help people that currently have unaffordable mortgages because it doesn't help them refinance," Bair said. "Low interest rates help some consumers, but the ones that really need help and can't refinance are not helped."
Bair has been pushing for the government to use $24 billion in bailout funds to help 1.5 million borrowers avoid foreclosure by guaranteeing modified mortgages -- a move opposed by Treasury Secretary Henry Paulson and the Bush administration. In her remarks to the Consumer Federation of America gathering, Bair disputed the notion that the Community Reinvestment Act -- the 1977 law requiring banks to make loans in low-income areas where they operate as a condition for opening new branches -- was a cause of the subprime mortgage debacle and ensuing financial crisis.
Critics of the law, notably conservative Republicans, recently have blamed the crisis on the lending law, saying it forced banks to make home loans to borrowers who were bad credit risks. Champions of the law, known as CRA, credit it with having boosted the renewal of inner-city areas in recent years. "I think we can agree that a complex interplay of risky behaviors by lenders, borrowers and investors led to the current financial storm," Bair said in her speech. "To be sure, there's plenty of blame to go around. However, I want to give you my verdict on CRA: Not guilty."
U.S. Comptroller of the Currency John Dugan, whose Treasury Department agency oversees national banks, made the same point as Bair about the CRA law in a speech last month. Only about one in four higher-priced home loans were made by banks subject to CRA in the subprime mortgage boom from 2004-2006, Bair said, with the rest coming from stand-alone mortgage companies and bank affiliates not covered by the law. The abusive lending practices at the root of the crisis were driven by the appetite for increased market share and revenue, Bair said.
Geithner May Seek to Push Bair Out After Clashes During Crisis
Timothy Geithner, President-elect Barack Obama's choice for U.S. Treasury Secretary, is seeking to push Federal Deposit Insurance Corp. Chairman Sheila Bair out of office. Geithner, president of the Federal Reserve Bank of New York, has argued Bair isn't a team player and is too focused on protecting her agency rather than the financial system as a whole, according to two congressional officials and a person familiar with his thinking. Bair has battled with Geithner and fellow regulators over aid to Citigroup Inc. and other emergency actions, making her enemies in the Bush administration.
“The idea of having an independent actor on the stage with you who might not be singing the same tune can make you nervous,” said Wayne Abernathy, a former Treasury official who is now executive vice president with the American Bankers Association in Washington. “They recognize that she's a very independent person.” It isn't clear that Obama would ask Bair to step down. Such a move would be fraught with political risk for the new administration, especially on Capitol Hill, where Bair's campaign to rework mortgages for struggling homeowners has won respect from top lawmakers, including Senate Banking Committee Chairman Christopher Dodd and Barney Frank, his counterpart in the House.
Bair's spokesman Andrew Gray declined to comment. Obama's transition spokeswoman Stephanie Cutter had no immediate comment. Even if Bair remains at the FDIC, the Obama economic team has decided that she won't play a central role in policy, the people said. While Bair, like Obama, has favored aid for Main Street as well as Wall Street, the new administration will have its own plan to help the millions of people facing eviction from their homes. It will also have its own team to run the government's $700 billion bailout program, they added.
Pushing out the head of the FDIC, which oversees more than 5,000 banks and savings institutions, would clash with the pledges made by Obama's own transition team. Bair has become the most prominent Republican regulator, and the incoming administration has promised to give Republicans important jobs. “You'll see Republicans again, in his administration, not just a token member in the Cabinet, but you'll see them spread throughout the administration,” transition director John Podesta said in an interview with Bloomberg Television last week.
Bair, who was appointed by President George W. Bush to a term as chairman that ends in 2011, has been lobbying behind the scenes for a stepped-up role in the Obama administration. Frank, a Massachusetts Democrat, has suggested that she be named to a special post to oversee government-wide programs to stop foreclosures. Bair “brings a lot of credibility” on crafting ideas to ease the mortgage crisis, said Kevin Petrasic, a former Office of Thrift Supervision official who now works at law firm Paul, Hastings, Janofsky & Walker in Washington.
In public comments, Bair, 54, has indicated she'd like to stay on, while she'd be prepared to depart if Obama wants someone else to take the helm at the FDIC. She said at a press conference in Washington Nov. 25 she'd work “in whatever role they want me in this institution to play.” The month before, Bair said in an interview on “Political Capital with Al Hunt” on Bloomberg Television that “I'm happy to go back to academia too. So I want to be flexible for the next president.” Geithner became increasingly wary of Bair as she worked with the other regulatory agencies on emergency bailouts of banks in recent months.
The New York fed chief has been concerned that Bair was more worried about keeping the FDIC's insurance program protected than she was about the entire financial system, one person said. Bair twice sparred with her colleagues at the Fed and Treasury over efforts involving Citigroup. In October, she acquiesced to Wachovia Corp.'s agreement to a takeover by Wells Fargo & Co. days after agreeing to back an initial deal with Citigroup. Geithner was concerned that allowing the Citigroup transaction to fail would inhibit other lenders from working with the FDIC on any subsequent rescues, the people said.
Wells Fargo offered about $15 billion for Wachovia, compared with Citigroup's $2.2 billion deal to acquire Wachovia's banking operations, and didn't need any FDIC aid. Citigroup's position weakened, with its shares losing as much as 65 percent after the failed Wachovia deal amid a collapse in investor confidence -- precipitating another rescue attempt. Again, Bair held out for concessions as the Fed and Treasury sought to shield Citigroup from losses in its holdings of toxic assets. Bair insisted on getting preferred shares for the FDIC in the New York-based bank.
She also demanded that Citigroup agree to implement mortgage modifications according to a model developed by her agency. At one point during a Nov. 23 Fed board meeting about the Citigroup rescue, Chairman Ben S. Bernanke stepped out to take a call from Treasury Secretary Henry Paulson. Returning a few moments later, Bernanke told his colleagues that the secretary was still locked in negotiations with Bair, whose demands were delaying the deal. The political peril of ousting a popular regulator who has sided with struggling homeowners and sought tougher conditions on financial firms could fuel charges that Geithner and other Obama appointees are too closely connected to Wall Street.
“I don't think you want an FDIC chairman who isn't willing to stand up,” former FDIC Chairman William Isaac, who is now head of Secura Group LLC in Falls Church, Virginia, said in an interview. On other issues, too, Bair has stepped out in front of her Bush administration colleagues. As the mortgage bust deepened, Bair repeatedly pushed Fed and Treasury officials to boost aid for homeowners. In 2007, Bair told lawmakers the Fed should use its authority over home-loan standards to tighten oversight and crack down on the practices that contributed to the subprime mortgage mess.
This year, Bair has proposed using taxpayer funds to help refinance loans for struggling homeowners. She told legislators at an Oct. 23 hearing that the Treasury could use its $700 billion financial-rescue fund to set terms for mortgage modifications and offer guarantees for loans that meet the standards. Senators pressed Neel Kashkari, the Treasury official overseeing the Troubled Asset Relief Program, on his department's reaction. “We are looking very hard” on the proposal, he said.
The White House later that month sought to scale back Bair's idea to use as much as $50 billion from the program. Yesterday, an official said Paulson instead is considering a proposal to drive down home-loan rates through purchases of mortgage-backed securities.
New Zealand Cuts Key Interest Rate by Record to 5%
New Zealand’s central bank cut its benchmark interest rate by a record 1.5 percentage points to 5 percent and signaled more reductions to come as it attempts to steer the economy out of it worst recession in 18 years. “Today’s decision takes monetary policy to an expansionary position,” Reserve Bank Governor Alan Bollard said in a statement in Wellington today. “Some further but significantly smaller reductions in interest rates may be warranted.”
Central banks are cutting borrowing costs worldwide to try to stimulate spending amid a global economic contraction that is crimping demand for exports and stalling investment. Bollard said his 3.25 percentage points of rate reductions since July will ensure New Zealand recovers from a recession that started in the first quarter of this year.
“Given the data over recent weeks, both domestically and globally, there will be a deep recession in New Zealand’s economy,” said Helen Kevans, economist at JPMorgan Chase & Co. in Sydney. “The Reserve Bank has a lot more work to do.” The Reserve Bank projected further declines in three-month bank-bill yields, adding to signs that Bollard will keep cutting the benchmark rate in early 2009. His next review is on Jan. 29. Economists forecast the rate will fall to 4.5 percent by the end of the first quarter.
“The current way we are looking at it, cuts may trough around the middle of next year, but this does depend on where the global economy goes and how the New Zealand economy responds,” Bollard told reporters today.
Today’s cut is the largest since the Reserve Bank began using the official cash rate in 1999 and takes the benchmark to its lowest since December 2003. Eleven of 17 economists surveyed by Bloomberg News forecast the move. Six expected a 1 percentage point reduction. New Zealand’s dollar rose to 53.31 U.S. cents at 1:35 p.m. in Wellington from 52.80 cents immediately before the statement was released. The currency paced gains in the Australian dollar as a rally in U.S. equities raised speculation investors will purchase higher yielding assets.
The spread between New Zealand’s benchmark interest rate and Japan’s narrowed to 4.7 percentage points, which may reduce demand for currency in the so-called carry trade. The economy slipped into a recession in the first quarter amid a drought, soaring energy costs and a slump in the housing market. As the world’s largest economies contract, demand for exports is falling, making the recession the most prolonged since 1990.
“The New Zealand economy went into a shallow recession in this calendar year,” Bollard said in an interview. “What we’re now seeing is a shallow recovery. We’ve actually taken our foot off the brakes and put it mildly on the accelerator.” Bollard today said the economy might grow in the fourth quarter, but could start contracting again in the first half of 2009. It will probably shrink 0.2 percent in the year ending June 30, 2009, before recovering, he said.
The International Monetary Fund predicts advanced economies including the U.S. and euro area will contract simultaneously next year for the first time since World War II. The economies of New Zealand’s 12 main trading partners may grow just 1.1 percent next year, the central bank said. Bollard, 57, is responding to a slump in consumer spending and business confidence that is likely to see the jobless rate rise as companies fire workers to arrest a slide in profits.
Last month, companies were the most pessimistic about sales and profit in more than 20 years, according to a report by ANZ National Bank Ltd. More than a fifth of companies said they are likely to fire workers and the proportion of firms expecting profit will fall was the highest in the survey’s 21-year history. Air New Zealand Ltd., the nation’s biggest airline, last month said it will fire as many as 200 full-time staff to reduce costs as global demand for travel declines.
New Zealand’s jobless rate rose to a five-year high of 4.2 percent in the third quarter. It could reach 6 percent by early 2010, the central bank said today. Employment is likely to fall in the year to March 2010, it said. Consumer spending will contract in the year to March and housing investment will shrink this year and next, the central bank said. Still, interest-rate cuts, lower taxes and a 32 percent slide in the currency the past six months will “create the conditions for some rebound in growth,” Bollard said.
ASB Bank Ltd. and Westpac Banking Corp. were among lenders to reduce their variable home loan rates after the statement. Payments on an average NZ$270,000 ($144,000) variable-rate home loan will fall by about NZ$220 a month. Still, more than 80 percent of home loans are fixed and won’t immediately benefit from today’s reduction.
Bollard, who is required to keep average price gains between 1 percent and 3 percent, expects the annual inflation rate will fall to 1.5 percent by Sept. 30, 2009, after reaching an 18-year high of 5.1 percent just a year earlier. “Given the developments in the global economy, the risks to inflation are to the downside,” he said. The reduction in borrowing costs would keep inflation from falling below the target band.
Central banks around the world are slashing interest rates in response to a global slump in demand. The Reserve Bank of Australia this week cut its cash rate target by 1 percentage point to 4.25 percent and also said borrowing costs are now “expansionary.” The Bank of England and the European Central Bank will also lower borrowing costs later today, according to economists surveyed by Bloomberg News.
1930s beggar-thy-neighbour fears as China devalues
China has begun to devalue the yuan for the first time in over a decade, raising fears that it will set off a 1930s-style race to the bottom and tip the global economy into an even deeper slump. The central bank has shifted the central peg of its dollar band twice this week in a calculated move that suggests Beijing aims to offset the precipitous slide in Chinese manufacturing by trying to gain further export share abroad. The futures markets are pricing in a 6pc devaluation over the next year. "This is clearly a big shift in policy and we are now on alert," said Simon Derrick, currency chief at the Bank of New York Mellon.
The move follows a Politburo speech by President Hu Jintao warning that China is "losing competitive edge in the world market". China has allowed a crawling 20pc revaluation over the past three years. Any reversal risks setting off conflict with the incoming team of President-Elect Barack Obama in Washington. Mr Obama called China a "currency manipulator" during the campaign, a term that carries penalties under US trade law. Outgoing US Treasury Secretary Hank Paulson is viewed as a "friend of China". He called for a stronger yuan this week before embarking on a visit to Beijing, but the plea was couched in friendly terms. This soft-peddling may soon change. Hans Redeker, currency head at BNP Paribas, said China's policy switch could set off a dangerous chain of events. "If they play this beggar-thy-neighbour game, it will cause a deflationary shock for the whole world," he said.
It makes sense for countries with current account deficits such as the UK, US or Turkey to let their currencies fall, but China has the world's biggest trade surplus. Michael Pettis, a professor at Beijing University, said it was "very worrying" that a pro-devalulation bloc seemed to be gaining the upper hand in the Communist Party. "I really do believe that we are on the brink of a very ugly period for trade relations," he said. China has relied on exports to North America and Europe as its growth engine, making it acutely vulnerable to the contraction in global demand. Mr Pettis said this recalls the role played by the US in the 1920s, a parallel fraught with danger. "In the 1930s the US foolishly tried to dump capacity abroad, but the furious reaction of trading partners caused the strategy to misfire. China already seems to be in the process of engineering its own Smoot-Hawley," he said, referring to the infamous US Tariff Act in 1930.
China showed restraint during the Asian crisis in 1998, holding the line against domino devaluations across the region. It may yet hold the line this time. However, this crisis is more serious. The manufacturing sector has seen the steepest decline since the records began, with devastation sweeping the textile, furniture and toy sectors. Civil unrest has begun to rock the Guangdong and Longnan regions. Beijing has slashed rates and unveiled a fiscal stimulus of 14pc of GDP, but most of the spending comes in the form of instructions to local governments to spend more – but without giving them the money. Does China really intend to step in to prop up global demand? The jury is out.
Is China experiencing dollar outflows?
The government was actively buying stocks today and as a result, not surprisingly, the market surged on hopes that they are serious about putting an end to the bear market. After declining yesterday by 0.3%, the SSE Composite jumped 76 points today to close the day at its high of 1965, up 4.0%. Central Huijin, a subsidiary of the CIC, increased its stake in China Construction Bank, as it said it would do last September. If this is sustained, it may help relieve a little of the gloom, but it is not clear to me that the rally has stronger legs than previous government-inspired rallies.
More interestingly, the dollar market today was acting strangely. Since late yesterday there have been no bid-offers on dollars, until the PBoC came in late in the day to sell dollars (the PBoC is normally a buyer of dollars). This suggests that capital outflows, at least for this week, have outpaced current account inflows, although we don't want to read too much into this as of yet. January's 4th Quarter PBoC numbers should prove very interesting as we wade through the increasingly difficult-to-interpret numbers to estimate hot money behavior.
As far as I can piece together today's currency-market activity from conversations with some of my former students, now trading, and my friend Logan Wright, at Stone & McCarthy, the market has been very short of dollars in recent days as corporations over the past three days have been net buyers from banks. Since banks are not allowed to be net short, there were rumors that they had reached their dollar limits yesterday and were refusing to post prices for fear of being lifted.
Why have corporations been buying dollars? Part of the reason seems to be the NDFs in Singapore are pricing in a depreciation of the RMB, and corporations who can get around the capital control rules are finding it profitable to buy dollars in China and sell them in the NDF market. This is a great arbitrage if you can do it. But part of it may simply reflect the fact that talk of currency depreciation has increased in recent weeks, and until today the RMB has been depreciating. Today the central parity appreciated by 0.0025 to 6.8501, although the RMB closed the day at the weak end of the 0.5% band.
It is not irrelevant that Secretary Paulson will be here tomorrow for two days as part of the Strategic Economic Dialogue. His call for a stronger RMB yesterday signals that the currency is still likely to be at the heart of the debate. There has been more and more talk over the past few days about the possibility of RMB depreciation, and of course President Hu's comments on Sunday about China losing its competitive edge strengthened the talk, but until there has been no real reason to think that there has been a policy shift.
Still, the possibility that pro-depreciation constituencies in China may yet gain the upper hand in the debate is very worrying. At first depreciation might seem like an obvious policy move – if export growth is slowing, and if unemployment pressures are rising, why not engineer demand expansion by increasing foreign demand for Chinese goods? After all, the outlook is increasingly grim. A "Blue Paper" by the prestigious Chinese academy of Social Science forecast GDP growth for next year at 9.3% – insanely optimistic, I think – but they did list some of the problems facing China. According to today's Xinhua:
The Blue Paper also notes that housing prices will fall dramatically in a short period of time, and subsequently enter a rather long adjustment period in 2009. Economists from CASS believe the real estate industry will be bogged down throughout 2009 as demand weakens under high prices and the global financial crisis. Homebuyers and investors will be more prudent in their activities. Suppliers will also experience a chilly season next year as some small and medium-sized enterprises with limited capital are forced to leave the market.
Risks will increase as some homebuyers become unable to pay their mortgages and some builders will not be able to pay workers to complete projects. On the country's employment front, the Paper adds that one million college graduates will be unable to find jobs by the end of 2008, a problem that will be exacerbated when more people may lose their jobs in 2009 as more than five million new graduates begin seeking employment the same year.
But remember that Chinese overcapacity is part of the global problem, and as interesting as they may seem at first, capacity-boosting measures only make the global imbalance worse. Yesterday Vice Premier Wang Qing made a speech on the subject in which he both called for consumption enhancing moves as well as export-enhancing moves. An article in Xinhua reported:
Chinese Vice Premier Wang Qishan has called for more concrete measures to tap China's domestic consumption potential to sustain economic growth. External demand for Chinese goods has fallen markedly amid the global financial crisis, while domestic consumption power also fell, Wang told recent meetings on foreign and domestic trade.
…The vice premier urged a reduction of burdens for businesses, help for them in getting finance and promotion of mergers and acquisitions. He also called for more measures to optimize the export structure and explore new markets to offset the negative impact on the export sector of the global economic slowdown
That last paragraph worries me if it indicates the direction of policy. I really do believe that we are on the brink of a very ugly period for trade relations, and anyone in China who thinks that trade conflicts will not be devastating for China does not understand China's role within the global balance of payments. This is not the time to try to strengthen exports at the expense of trading partners without a significantly larger increase in imports. On that note, the EU Observer had the following piece earlier this week:
EU-China relations usually revolve around trade, with the EU buying €231 billion worth of goods from China last year and exporting €72 billion in return. But human rights concerns came to the fore during the Beijing Olympics, when scores of EU leaders stayed away from the opening ceremony after Chinese troops shot Tibetan protestors.
China is also unhappy that the EU continues to uphold an arms export embargo dating back to the 1989 Tiananmen square massacre. The latest summit and death penalty row could play into the hands of European leaders keen to restrict the flow of Chinese imports during the EU's economic downturn, experts warn.
"Protectionist sentiment toward China in Europe has been growing for a while," Center for European Reform analyst Katinka Barysch wrote in the Wall Street Journal. "Anti-China sentiment is on the rise in Germany …Even in traditionally liberal Britain, people who see China as an economic threat outnumber those who see it as an opportunity by four to one.'
The meetings between the Dalai Lama and European leaders is once again inflaming passions both in China and in Europe, and this is not the kind of atmosphere in which trade disputes are easy to resolve. There is (yet again) a movement afoot in China to boycott French goods, but I am not sure countries running large current account surpluses should be talking about boycotting countries who are running deficits with them.
This kind of talk can easily backfire. An interruption of the trade relationship between the two countries is actually likely at the macro level to be good for France in the short term (or, in what amounts to the same thing, it is easy enough politically to make the argument), and bad for China in both the short and long term. Remember, for France any interruption of international trade means they need to increase production to meet domestic demand. That means hiring workers. For China it means reducing its ability to export overcapacity, and this usually means closing down factories. I know, I know, France is not necessarily likely to produce at home what China sells, but in this world, finding a new supplier is a lot easier than finding a new customer.
At any rate this evening rumors have been swirling through the markets that November's exports have declined year on year by 7%. One of my former students, now a currency trader in Shanghai, just told me this. I have no idea if it is true, but it gives a sense of how nervous markets are.
Recession Trickles to India
After years of being blamed for job losses in America and elsewhere, India's high-tech companies and outsourcing firms are going through a downturn of their own. The global slowdown is forcing them to reduce hiring, freeze salaries, postpone new investments and lay off thousands of software programmers and call center operators. While some industry insiders insist the global crisis will actually benefit companies here, as Western businesses seek to cut costs by moving jobs overseas, right now the sector is suddenly gripped by an unfamiliar sense of uncertainty.
"It's certainly not irrational exuberance," said Nandan Nilekani, co-chairman of Infosys, one of India's best-known technology outsourcing firms. "There is a lot of introspection about what does this mean and when does it end." The downturn is exposing a deeper concern: India has become the world's front office, handling customer service calls, and its back office, helping to process payments and run accounting and other computer systems. But it has not yet become the head office — making major new products, pioneering marketing techniques or helping to shape corporate strategy.
Rather than drowning American technology firms or work forces with a vast supply of cheap engineering talent, as some had feared, India — and Bangalore, its Silicon Valley — have continued to largely serve as the information economy's version of manual labor. Historically, when it comes to innovation, Indian companies are relatively weak compared to the I.B.M.'s and Accentures of the world," said Partha Iyengar, the head of research in India for the Gartner Group, which analyzes trends in the tech sector. "It has been their chronic Achilles' heel."
Last week's coordinated terrorist attacks killed nearly 200 people and temporarily brought Mumbai, India's commercial capital, to a halt. But long before that shock, the country had been suffering the effects of the global slump, losing capital as Western investors fled to the security of American Treasuries, undermining Indian banks and company balance sheets. Infosys recently scaled back its projections for the year, telling investors that it now expects revenue to expand 13 to 15 percent, instead of the 19 to 21 percent it had forecast and far below the 30 percent annual expansion the company had been used to.
Like many of India's outsourcing companies, Infosys is heavily dependent on the financial sector, deriving a third of its revenue from banks like Citigroup and Bank of America and other financial clients. Its fate is also closely tied to the American economy: two-thirds of its business comes from the United States. Neither factor bodes well for the company's prospects. Technology Partners International, a consulting firm that publishes an index of global outsourcing deals, says its index is at a 10-year low. "People think that outsourcing is a recession-proof industry. It is not," said Siddharth Pai, a partner at the firm.
That realization has changed the boomtown atmosphere of this city. Young workers still flock to a rooftop terrace on Residency Road every Wednesday night to grind to house and hip-hop music. But lately, the crowds at NYKS, an upscale nightclub, are a little thinner. They drink a little bit less. They talk a little less loudly. "Now they are thinking twice before spending money," said Supreeth Chandrasekhar, a 25-year-old disc jockey at NYKS.
Mr. Chandrasekhar also said that he used to perform at corporate events but that this business had largely disappeared. In a country where most marriages are arranged by parents, the downturn has even taken a toll on the matrimonial prospects of those in technology outsourcing. "Because there is no job guarantees for I.T. people, for the last six months brides' families have not been accepting grooms from this background," said Jagadeesh Angadi, a matchmaker in Bangalore.
The Indian National Association of Software and Service Companies estimates that the country's technology sector will create 50,000 fewer jobs in 2008 than last year, although it predicts the sector will still have added 200,000 workers by year's end. India's technology outsourcing companies have laid off about 10,000 employees since September, according to the Union for Information Technology Enabled Services, a labor group that represents technology workers.
Among the major players that have announced cutbacks in hiring is Satyam Computer Services, which slashed its recruitment plans to fewer than 10,000 from 15,000. Infosys, by contrast, has almost $2 billion in cash on its balance sheet, a significant amount that can help it weather the downturn. It said it intended to follow through on plans to hire 25,000 workers this year. "We made offers to people, and we need to stand by them," Mr. Nilekani of Infosys said.
But some companies that have hired recruits are postponing their start dates. The deferrals allow companies, which once hired in anticipation of future business, to better manage overhead by adding staff only when they have confirmed projects. A few so-called captive outsourcing operations — those that serve only their parent company in Europe or the United States — have also cut back. American Express laid off some 200 of its 6,000 workers in India, and Goldman Sachs announced last month that it would dismiss about 10 percent of its Indian work force.
Still, for the moment, the industry has escaped large-scale job losses. Indian labor laws make it difficult for companies to drop workers, and mass firings can draw a political outcry. But outsourcing companies have begun pruning workers, citing poor job performance, a way to quietly reduce labor costs without attracting much public scrutiny.
The large outsourcing company Wipro dismissed 2.5 percent of its work force in the second quarter. Outsourcing companies are also shelving expansion plans. Wipro, for instance, announced it was postponing the opening of a major new software development center in Atlanta. But India's business leaders see opportunity in the downturn. "Once things settle down, people will start looking at their business operations and how to make them more efficient, and that is where we play," Mr. Nilekani said.
Even consolidation on Wall Street, which may eliminate some Indian companies' clients, could help Indian workers, outsourcing executives say. Mergers require technical skills to integrate disparate systems, and there is a potential for profitable outsourcing work in areas like regulatory compliance. Banks are likely to be under stricter government scrutiny given the sense that lax oversight contributed to the financial crisis.
Raman Roy, chairman of Quatrro BPO Solutions, an outsourcing firm based in New Delhi, says he has 300 employees reviewing legal documents as part of bank mergers. Copal Partners, a company that uses employees in India to help investment banks do the sort of deal-based research normally performed by the bank's junior analysts, has continued to expand even during the downturn. Critics say that will not change the local industry's basic disadvantage: a creativity gap with Western competitors. Indian technology companies are too focused on increasing the efficiency of their systems, not improving their clients' own industry-specific processes, according to Navi Radjou, an analyst with Forrester Research. "They are having trouble tailoring a technical application to a particular business need," he said.
But India's biggest tech outsourcing companies want to do as much as their European and American rivals, including expanding in Europe and the United States. And the downturn may allow them to acquire talent — and even whole businesses — on the cheap. In August, for example, Infosys acquired the British consulting firm Axon for $753 million. Wipro is said to be shopping for a similar acquisition.
The changes may come too late for workers like Vikram Hathwar. In July, Mr. Hathwar, a 22-year-old engineer, graduated from a technical college with a job offer from a software developer. But instead of starting his job — paying nearly $6,000 a year, a good starting salary in this country — Mr. Hathwar has been waiting for a letter from the company telling him when to report for work. "I called them and they said they would be calling two or three months later, but still they have not informed me anything about when I should start," Mr. Hathwar said.
In the meantime, he has begun looking for a temporary job. But he said most tech businesses are no longer hiring recent graduates. The few that are have begun asking applicants to intern for several months without pay and with no guarantee of a permanent position. "The recession has made for all these pressures on us," Mr. Hathwar said. "It is very confusing to know what to do."
Bad economic news buries hopes worst is over
Worse-than-expected US job losses, more cuts in Italy and Spain, plunging German auto sales and a "horrible" eurozone services report pointed Wednesday to a deep and painful recession ahead. After a strong stock market rally last week, investors had been hoping that massive government spending and support for the financial system would keep the economic wheels turning.
But an unrelenting flow of bad news has badly dented those hopes and they took another knock on Wednesday, especially after a report showed the US economy lost 250,000 private sector jobs in November. Analysts had been expecting survey by the ADP human resources firm to show at worst a loss of 200,000 jobs. This was "largest decrease in private sector employment since November of 2002 (and) ... offers evidence of a labor market that continues to weaken," ADP said, as it revised up its job loss count for October to 179,000 from 157,000.
The US November ISM service sector survey then showed a brutal fall to 37.3 points from 44.4 points in October, again much worse than analyst forecasts for 42 points. "It is difficult to see the rally in equities being sustained and it will not take much in the way of more bad economic news to bring a dose of reality back," warned analysts at Calyon investment bank as stocks tumbled again.
On Wall Street, the Dow Jones Industrial Average slumped more than two percent at the open, with investors worrying that the US government employment report due Friday will now make for horrific reading after the ADP survey. "It has cast a worrisome shadow over the more comprehensive employment report that comes out Friday," said Patrick O'Hare, analyst at Briefing.com.
"The latest estimate for nonfarm payrolls shows an expected decline of 325,000 positions," he noted. In October, the world's largest economy shed 240,000 jobs. In London at around 1515 GMT, the FTSE 100 index of leading shares was down 1.81 percent, in Paris the CAC 40 index was off 1.32 percent and in Frankfurt, the DAX shed 2.01 percent.
Earlier the 15-nation eurozone service sector activity index, compiled by data and research group Markit, fell to 42.5 points in November from 45.8 points in October, worse than a first estimate of 43.3 points. "This is a horrible survey across the board, showing that the eurozone service sector is being hit ever harder by the financial crisis, muted consumer spending and markedly weaker activity in key export markets," said IHS Global Insight economist Howard Archer.
The problems facing the auto industry were highlighted by German figures showing new car sales slumped 18 percent in November and appeared headed to their worst performance since national reunification in 1990. The VDA auto manufacturers federation said sales this year would be just under 3.1 million vehicles, falling further to 2.9 million in 2009. The US auto industry is likewise under severe threat, having just reported calamitous domestic sales declines in November and as its leaders plead with the US government for a bailout worth some 34 billion dollars.
Blanching at the unthinkable of bankruptcy for such a major US industry, there were signs Tuesday that help could be on the way. US House of Representatives speaker Nancy Pelosi said a short-term loan programme "is an appropriate way to go ... I think it's pretty clear that bankruptcy is not an option." French President Nicholas Sarkozy is due to unveil on Thursday a 20-billion-euro (25-billion-dollar) stimulus package targeting the vital car industry as well as housing and household spending.
There were hopes too that the European Central Bank and Bank of England would both cut interest rates sharply on Thursday to give relief to borrowers and keep consumer spending on track. "The extremely weak November service sector purchasing managers' survey exerts significant extra late pressure on the ECB to deliver a deep interest rate cut on Thursday," said Archer of IHS global Insight.
Other eurozone data showed retail sales in October down 0.8 percent from September and falling 2.1 percent from a year earlier, much worse than expected and stoking concerns about the outlook. Consumer spending typically accounts for about two thirds of all economic activity in a developed economy so any fall is taken seriously although some hoped the outcome will bolster the case for a dramatic ECB rate cut.
Even outposts which had appeared to be holding up better than others were shown Wednesday to be feeling the pain, with Australia reporting third quarter growth of just 0.1 percent, the slowest pace in eight years. China meanwhile said its sovereign wealth fund had lost faith in Western financial institutions and would no longer invest in them, ending hopes that badly damaged banks in the West could find help from this quarter. Lou Jiwei, chairman and chief executive of China Investment Corp (CIC), said the fund would now avoid investing in banks and other groups because of "uncertain" foreign government policies, the Wall Street Journal reported.
Port Authority bond offering finds no takers
The Port Authority of New York and New Jersey received no bids from investment banks seeking to underwrite a taxable note offering in another sign that the seizure in credit markets persists. The $300 million in three-year notes, backed by revenue from the bi-state agency that operates airports, river crossings and transit in the New York City area, were up for competitive sale at 11 a.m. Wednesday. The deal carried the highest short-term ratings from Moody's Investors Service, Standard & Poor's and Fitch Ratings and would have been the largest of its kind in eight months. "It's astonishing," said Fred Yosca, managing director and head of trading at BNY Mellon Capital Markets in New York. "A household name like the Port Authority not being able to get a bid is truly a sign of a market that is in distress."
States and cities have struggled to sell bonds through advertised bidding in recent months as underwriters focus on lining up individual investors in negotiated deals to avoid getting stuck with too many unsold securities. Massachusetts hired Goldman Sachs Group Inc. and Citigroup Inc. in October to negotiate the sale of $750 million of tax-exempt notes due in less than a year after scrapping two earlier advertised rounds of bidding.
Wednesday's deal was to have been the largest taxable municipal offering sold competitively since the Port Authority's own $350 million offering in March, based on data compiled by Bloomberg. Lehman Brothers Holdings Inc. was the winning bidder then, and Citigroup had the cover, or next-highest, bid. In the municipal market, competitive sales force banks to place interest-cost bids to win the right to market bonds to investors. In more-common negotiated deals, underwriters are chosen ahead of time, before borrowers talk about rates and prices with buyers. Municipal issuers have sold 81 percent of their long-term debt via negotiation this year, with competitive deals making up most of the rest, according to Bloomberg data.
The Port Authority said the lack of bids Wednesday will have "no impact" on any current capital projects because the transaction was scheduled "well in advance" of its needs, according to a news release. "We are confident that the markets will recover in the upcoming year when we plan to return with another sale," the authority said in the statement. "Our credit ratings and our financial health remain strong."
Cheap oil: short-term good, long-term dangerous
Motorists must be glad the price of fuel is one thing they do not have to worry too much about as they face the worst recession since the 1930s, but cheap fuel is not good for anyone in the long run. Global oil prices have collapsed since July, losing two thirds of their value from a peak of almost $150 a barrel and dragging fuel costs to their lowest levels for several years. But while low energy costs come as welcome short-term relief to consumers and companies struggling with the financial and economic crisis, longer term they can be bad for everyone.
Low energy prices squeeze investment in the oil industry, reducing future supplies. They discourage energy saving and they destabilize countries dependent on oil exports, making oil in the future more likely to be expensive and even more volatile. Perhaps most important of all, low energy prices stifle investment in alternative energy, deepening dependence on oil and other hydrocarbons and increasing greenhouse gas emissions. "In the very short term, because we are in a recession, we could all use a low oil price," said Mike Wittner, global head of oil research at French Bank Societe Generale. "It is like a tax break, putting money back into pockets for a short time."
"But in the longer term, today's oil price is too low to support much new supply and will slow the momentum toward alternative fuels, new technology and conservation." In a rare pronouncement on oil prices, Saudi King Abdullah said on Saturday that crude at $75 a barrel was "fair." Saudi Oil Minister Ali al-Naimi later explained that oil at that level would encourage new output from marginal, higher-cost sources. The comment drew criticism from some quarters, including a response from Japan's minister of economy, trade and industry.
"There are frequent comments by oil producers about $60-$75 per barrel," Toshihiro Nikai told reporters in Tokyo. "For us, the cheaper the oil price, the better." But most analysts broadly agree with the Saudi view, saying they are worried about the consequences of under investment and the need to prevent a shortage in the years ahead. They say the comments by Japan -- almost entirely dependent on energy imports and seemingly on course for its longest-ever economic contraction -- reflect a short-term strategic view.
As a key supporter of the U.N.-led Kyoto Protocol, Japan well understands the need to encourage energy efficiency, said Michael Lewis, head of commodities research at Deutsche Bank. "In a downturn, you need any type of stimulus you can get and a lower oil price can help," he said. "But you need to find a stable 'sweet spot' which balances the need for exploration and the funding of alternative energy projects." Stability in energy prices is essential for any sort of long-term planning, Lewis said, reinforcing comments by India's oil secretary, R.S. Pandey.
"As a major consuming nation we would like prices to remain stable and around this level," Pandey said on Tuesday. "What is more important is there has to be stability in prices. Volatility of the kind witnessed this year has been very bad." While the desired "sweet spot" for oil prices may be lower during a recession, when extra stimulus is needed, most oil industry economists say it is probably well above where oil prices are at the moment -- around $47 a barrel.
In real terms over the last 40 years at today's prices, Deutsche Bank estimates that oil prices have averaged around $35 a barrel, a price it says is far too low for long-term comfort. "The 'sweet spot' is between $60 and $80, probably the top of that range. That is the long-term fair value," Lewis said. Simon Wardell, director of the energy markets group at Global Insight Ltd in London, sees broad agreement between OPEC and consuming countries that around $75 is about right for oil. "That price gets you investment in new production, is high enough to encourage more efficient use of oil and is enough to maintain the budgets of the Middle Eastern countries," he said.
Washington-based consultancy PFC Energy estimates most Middle Eastern oil producers need oil prices this year between $40 and $60 to balance their external accounts. "My concern is the price going too low," said Wardell. "Closer to $70-75 is a decent equilibrium price." The International Energy Agency (IEA), which advises 28 industrialized countries on energy policy, says it wants oil prices high enough to foster sustained investment in new energy sources, including costly deep-sea drilling.
"It is very difficult to put an absolute level on what price is fair," said David Fyfe, head of the IEA's oil industry and markets division. "But there is a lot of high cost oil, be it in ultra deep-water, or Canadian oil sands or Arctic developments in northern Russia, which needs a relatively high price." "We would see a danger if prices fall a lot lower -- that would exacerbate the chances of a medium-term supply crunch."
Ireland: Tough times ahead for families as food bills increase
Families should brace themselves for an increase in food prices as the value of the pound continues to fall, according to Northern Ireland’s leading retail expert. Donald McFetridge’s comments mirror the findings of a new report, which has revealed that a basket of 12 everyday items is now dearer than last month. The bad news — which comes at a time when sterling has slid significantly against world currencies — seems to suggest that food price inflation will continue to rise in 2009. And it means that householders across the province must continue to tighten their belts as the economic downturn leaves more misery in its wake.
Speaking to the Belfast Telegraph yesterday, Mr McFetridge said that a bleak winter was likely to be on the cards. “At present, the weak pound is continuing to present problems on the world's food markets for consumers in Northern Ireland and right throughout Great Britain,” he said. “The currency fluctuation means that food prices will definitely continue to rise in this geographic region leaving consumers with no option but to tighten their belts, watch their wallets and carefully consider the use of their credit cards. “In spite of the recent VAT reduction, and in spite of the anticipated further interest rate cut this month, consumers will experience further price increases in the first part of 2009 and well beyond.”
In a study, the Grocer magazine compared the UK’s four major supermarkets — Tesco, Asda, Sainsbury’s and Morrisons (although the latter does not trade in Northern Ireland) — and found the price of rice, meat, coffee and orange juice have risen sharply. So, although prices fell for the first time in a year in September, sharp falls in the pound over the last few months appear to have minimised or reversed the effect of a drop in global food costs, pushing prices higher again on supermarket shelves. The currency fluctuation means that food prices will definitely continue to rise in this geographic region leaving consumers with no option but to further tighten their belts. The Grocer said the global economic crisis has led to a significant decrease in the price of many basic foods. However, since January the pound has fallen 25% against the dollar and 17% against the euro — with industry analysts predicting further falls if the UK cuts interest rates by more than other countries.
The report claims the drop in the value of the pound not only hikes up the cost of imported food — half of all food in the UK — but also increases the price of key agricultural commodities, priced in dollars. Among the items which have seen a considerable price increase is coffee, according to the Grocer, where the year-on-year price tag has risen 23.9%, despite being cheaper in dollar terms. Similarly, bananas are 25.2% more expensive than last year — and went up 8% in the last week alone — while orange juice has shot up in price since October (despite remaining 8.9% cheaper than last year). Other commodities are still significantly more expensive with the pound pushing prices up, including cocoa (up 47.7%), rice (41.1%), beef (30.5%) and chicken (18.4%).
Unfortunately for Ulster’s beleaguered consumers, Mr McFet-ridge, head of retail studies at the University of Ulster, predicted an upwards trend in prices. “Some economists are forecasting that this is not going to be a short recession; in fact, many anticipate it will be long, protracted and deeper than many in the industry realise,” he said. “For this reason, consumers will experience further steep price increases in the food sector, leaving them with less disposable income to spend in other sectors. This does not augur well for 2009 and I can comfortably predict that things will get much worse before we see any perceptible signs of improvement. “This is not good news for consumers and I fear that there will be more to follow. “Between now and the New Year there will be further job losses and store closures in the retail sector; it's an extremely tough time for retailers and consumers alike.
“Unfortunately, there will be further casualties on the High Street and the large/big four |supermarket groups (while unlikely to go to the wall) will continue to experience testing times in the retail marketplace, while the German deep discounters continue to see their turnover and customer growth patterns improve radically.” He added: “This will indeed herald what can only be described as a ‘bleak mid-winter' in extreme.” Martin Deboo, an analyst with Investec, said the first six months of 2009 is looking tough for food suppliers. He predicted world commodities will be 30% cheaper in 2009 compared to 2008, but due to the fall in sterling, the UK would only see half of this benefit. “While the retailers are getting aggressive, many food companies have bought stock ahead for several months, which means it will be months until they see any falls in cost prices,” he said.
Lobstermen adrift as prices sink
The cold November winds have Mike Floyd wondering if it's time to surrender to the stock-market plunges, bank collapses and credit freezes.
Someday soon, Floyd knows, the costs of steaming from home on Long Island and hauling his lobster traps will exceed the income he and his helper can earn selling their catch in a market scuttled by the global economic crisis. "What it's going to come down to is how long we're going to keep doing this at this price," he said. There are still lobsters to catch, but lobstermen up and down the Maine coast have been hauling their traps back to shore as much as two months earlier than usual. Many in southern and mid-coast Maine are now fishing for other jobs to pay the bills, while those in more isolated parts of the state are simply hunkering down for a long, lean winter. The plunge of prices since early October has lobstering families and communities closing ranks and buying time. And what worries lobstermen even more than the approaching winter, they said, is the chance that the market won't recover by next spring or summer. "We're just holding the turn," said John Drouin, repeating an old fishermen's phrase about navigating through uncertain times.
Drouin lives in Cutler, an isolated Downeast lobstering community where there are virtually no other jobs to support his wife and five children. "There is going to be a lot of guys that go out of business this winter," he said. Drouin is still fishing, even though at $2.25 a pound it's barely worthwhile. He might catch $675 worth of lobster on a good day, but spend $600 on fuel, bait and a helper, he said. Drouin plans to get through winter by cutting back on family expenses. He's more worried that he won't be able to make up for the lost income when the lobster season starts up again in April. "In reality, I don't see this getting any better next year," he said.
The rhythm of life in Maine lobstering communities is usually dictated by the tides, the weather and the size of catches. But that changed in early October, when the industry got caught up in the turmoil of global financial networks. Lobster prices plunged. Along with a drop-off in lobster consumption worldwide, the collapse of banks in Iceland froze credit to large buyers in Canada, where about 70 percent of Maine lobsters typically go to be cooked and frozen. The price paid to lobstermen dropped from $3 to $3.75 per pound to $2 to $2.75, figures not seen in more than a decade. Retail prices, meanwhile, dropped a similar percentage to as low as $3.49 per pound for soft-shell lobsters. Statewide, the October lobster catch earned Maine fishermen less than $20 million, down more than 67 percent from a high of more than $60 million in October 2005, according to state records. "This thing in October took everyone by surprise," said Floyd.
Floyd lives on Long Island, a town of about 200 year-round residents that lies six miles east of Portland in Casco Bay. The 53-year-old lobsterman is also chairman of the Board of Selectman, deputy fire chief and captain of the town's rescue boat. As in Cutler, lobstering is Long Island's primary industry. There are an estimated 24 lobster boats based on the island, and most families are connected to, if not dependent upon, the business. Long Island, however, has the advantage of being in southern Maine, where the price of lobster is about 50 cents per pound higher than in Cutler, where a struggling lobsterman is a 45-minute ferry ride from the state's largest employment center. Long Island lobstermen and their crews often find other work in winter. Floyd and Sam Whitener, a Long Island native and stern man on the Kathleen II, have been hauling lobsters at a healthy pace this fall. But while the catch has been strong, the pair has come home some afternoons with little or no profit to show for it. "If the price of fuel hadn't come down, I think we'd be in dire straights much more," Floyd said. Floyd and Whitener usually fish into January, but Floyd said they'll stop fishing as soon as the weather or the lobster price gets bad enough to make it a losing proposition. "If this price carries over to next spring and next summer, then some of these guys are going to be hurting," he said. "The first impact would be Sam would lose his job, and I'd go alone." While some lobstermen in southern Maine have already begun hauling traps alone, it's considered a difficult and potentially dangerous way to fish.
Concerned that families weren't able to put away enough earnings for the winter, officials in Long Island and other communities are trying to be prepared. Long Islanders also say the market downturn has underscored the need for affordable housing to keep more fishermen and stern men from moving to the mainland. High real estate prices, driven by the market for summer homes, has already pushed most young fishermen off the island, and a downturn in the lobster industry would likely speed up the island's demographic shift. Steve Train, a 41-year-old Long Island lobsterman with two children in the island's school, stopped fishing earlier this month, about one month earlier than usual. Soon, he'll go back to sea for his winter job as a crew member on a shrimp boat. "Right now, it's a downturn, it's not a devastation," Train said. But, he said, a prolonged trough in the lobster market could permanently change some communities. "The industry will survive. The resource will survive," Train said. "It's just the number of people in it that you worry about, and how the individual communities will survive without the same number of people in" the industry.
Businesses ranging from trap makers to general stores to pickup truck dealers in northern Maine are already feeling the effects of the industry's struggle, said John Drouin, the Cutler lobsterman. "There's 200 households in town. Fishing accounts for about 120 of those," he said. "There's a lot of concern about whether the people are going to even be able to pay their tax bills. We're just hoping that it's not a very snowy winter, because there's not going to be a lot of money to plow the roads." Some might be forced to leave town to try to find work, despite the stalled economy, because there are no other businesses nearby, he said. "It's a 40-mile round trip to get a gallon of milk."
Paul Hickey, a lobsterman in Harpswell, said it's time for the industry to get creative. Hickey, 51, is retailing some of his own catch for $4 per pound each Friday afternoon outside a store at the Tontine Mall in Brunswick until Christmas. The Wild Oats Bakery & Cafe offers a 10 percent discount to anyone who buys lobsters from Hickey. "It's to try to get a little bit better price for some of our lobsters, and just to get people to think more about eating more lobster through the holidays," he said. Hickey also is planning to get a construction job when he stops fishing around Christmastime. "I am worried about this winter, but the thing that really scares me is next year. You can tread water for a while, but I really don't see this as being sustainable," he said. "Is this going to carry forward? What's our price going to be in July?"
"In my own case, the Depression brought a strange result," writes Eddie Cantor in 1931. "Before the crash, I had a million dollars, a house, three cars and four daughters. Now all I've got left is five daughters."
Eddie Cantor (1892-1964) was a comedian, singer, songwriter and actor. "Banjo Eyes," as he was sometimes called, was also the author of two little books on the Great Depression. "People used to rob banks," he writes in Yoo-Hoo Prosperity. "Now we're lucky when it isn't vice versa." Cantor jokes about many troubles in the Great Depression, but one recurring theme is the relative lack of food. A millionaire is "one who eats three square meals a day." Things were so bad that "the pigeons are now feeding the people." They were funny lines…sort of. For many of the people living during those times, Cantor's jokes were not so far from the truth.
We have it comparatively easy in this, the crisis of 2008. We may have to make do with fewer Swatch watches and Coach handbags. We may have to pass on the latest iPod and make do with last year's winter coat. These hardships are not important, except for people selling those goods. But the credit crisis is also affecting the world's ability to produce one thing important to everyone: food. It's harder for farmers to get credit for next season's crop, especially farmers overseas. They need fertilizer, seed, fuel and more. And most farmers need to borrow money to obtain these essential items. No credit; no crops.
Therefore, the global credit squeeze might reduce plantings of key grains, even as world inventories of these grains hover near historic lows. In Russia, for example, cash-starved banks have cut off funding for the industry. The head of the Russian Grain Union says, "Many farmers probably won't be able to borrow money for the spring sowing." This is important because Russia is no lightweight in the grain division. It produces 9% of the world's wheat, for instance. No surprise that the United Nations considers Russia a critical component of the global food supply.
Ironically, Russia just had its best harvest ever. And still, global grain inventories remain low. Bloomberg reports that global inventories of corn, wheat and soybeans are the second lowest they've ever been since 1974. A number of countries already fear what might happen next year. The Washington Post Foreign Service in Shanghai reports that China adopted a number of measures to protect itself from the worsening food crisis: "Among the most extreme measures [China] took was to impose new export taxes to keep critical supplies such as grains and fertilizers from leaving the country."
These taxes are extremely high, on the order of 150%-185%. China worries that richer countries may outbid its own farmers for supplies and weaken China's own food supply. One Chinese fertilizer company, which produces 150,000 tons per year, already said that the new taxes mean exporting is no longer profitable. China was the biggest exporter of certain types of fertilizer. No longer. That's a lot of supply off the market.
Fertilizers are absolutely critical in maintaining (and improving) crop yields. Without them, we'd produce far less per acre. As a result, in parts of Africa where people depend on Chinese fertilizers, the food supply problem is now more acute. China's export taxes and bans follow those of other grain producers, including the Ukraine, India, Pakistan and Argentina.
Amazingly, despite these various maneuvers around the world to prevent grain exports, the prices for wheat, corn and soybeans are all half of their mid-summer highs. It seems the market believes a global recession will dampen demand. Maybe so, or maybe the market doesn't know anything. The severe commodity selloff during the last few weeks might be saying a lot more about the desperation of hedge fund managers to raise cash than about the prospect that grain demand will fall — in which case, we could see another surge in prices next year.
Demand for grains is still very strong. In China, each wage-earner devotes about 40 cents of every dollar earned to buying food. In India, that number is a staggering 70 cents out of every dollar earned. In other words, the food budget in these countries is hardly a discretionary item. It will remain constant, or even rise, no matter what the global economy does.
Meanwhile, the people in these countries who have a couple of extra rupees to toss around are upping their consumption of meats, which increases the per capita demand for grains. As PotashCorp chief William Doyle recently pointed out: "The average daily protein intake in China has increased by 40% over a 20-year period, with the greatest percentage of that increase coming from meat consumption." You can see it in the size of the people themselves: The average six-year-old Chinese boy is 12 pounds heavier and two inches taller than 30 years ago. These people aren't going back to the ways thing were. This is a long-term story, and these trends should continue.
Yet even if demand growth for grains slows, it's not likely that those low global grain inventories will improve. Even if grain demand fell to 2% per year, we'd still need record production to keep grain inventories from falling further. For all these reasons, I think the future is still bright for agriculture and all that it entails. In 1931, Eddie Cantor wrote that the biggest thing in years was bread. "Why, they're giving it away free! Whenever four men get together at a street corner, it used to be a merger," he writes. "Now it's a bread line!" It's funny now. Next year, it might not be, at least to some.
Economists without a clue
Prepare to observe the spectacle of the two great economic paradigms of the twentieth century crashing to the ground, locked in mortal combat. A hundred years past, markets ruled freely: fortunes were made, workers abused, bubbles blown. According to the Austrian School of economists, led by Ludwig von Mises, this was all as it should be: despite any temporary pain or inconvenience, the unfettered market always knows best how to allocate goods and organize investment and labor.
But the ensuing pain and inconvenience were just too much for the various stripes of Marxists and socialists, some of whom led a revolution in Russia to establish the first state-controlled, planned economy. The catastrophes of the Great War and the Great Depression led to the ascendancy of John Maynard Keynes, the British economist who argued that even capitalist economies needed regulation and controls in order to avoid excessive manias and subsequent implosions. Keynesianism reigned supreme throughout the middle decades of the century, as the US, Britain, and nearly every other country adopted regulations on banking, finance, and industry, in many cases going so far as to nationalize railroads and other central features of the productive economy.
Meanwhile, rival economist Friedrich von Hayek and his followers quietly plotted the Austrian School's revenge—the occasion for which was offered by the stagflation of the 1970s. Von Hayek, who had raised a generation of followers (including Milton Friedman) at the Chicago School of Economics while toiling in obscurity, was now prominently rewarded with the so-called Nobel prize in economics (there actually is no prize in economics offered by the Nobel family), and his acolytes Margaret Thatcher and Ronald Reagan promised to show the world the way back to freedom and prosperity: government was the problem, they proclaimed, and privatization the solution!
The ensuing three decades have seen economists crowding back to the "Let Markets Rule" side of the ship, as they giddily praised the wonders of globalization and free trade. Now with the Collapse of 2008, economists are rushing to announce a new era of neo-Keynesianism: lack of regulation in the finance industry has led to a cataclysm of unimaginable proportions, and only massive government intervention can put us back on track.
Sadly, this time the tracks have been moved, maybe dismantled altogether. The two great economic paradigms of our age simply took too much for granted. They assumed that economies run on money and labor, whereas real economies also need energy and natural resources. They assumed that because population, resource extraction, and available energy had grown throughout the 19th and 20th centuries, they would continue to grow in perpetuity; all that was necessary was to properly adjust the relations between money, market forces, and government regulation. No one (within the economics profession) stopped to think that limits to Earth's supplies of fossil fuels, topsoil, water, and other resources might impose ultimate limits on economic activity.
The fields of ecological economics and biophysical economics have sprung up in the past two or three decades to fill in this enormous blind spot of conventional economic thinking, but both are currently marginalized to the point of irrelevance. In the months and perhaps years ahead we will see a titanic battle to the finish between the free marketers and the state controllers over who is right about the economy, and about who is capable of restoring the beatific condition of perpetual growth.
Sadly, neither camp has the answer this time around. Humanity has reached a significant physical limit to growth—Peak Oil—that will spell ruin to all economic philosophies that fail to take such limits into account. How long will it take the theoreticians to figure this out? How much of our remaining wealth will they destroy in a futile attempt to prove one or another of their paradigms to be eternally true? How far will society unravel before someone in charge begins to question the received wisdom? Let's hope their learning curve is short.
The Global Poker Tour: An Allegory
Welcome to the cautionary tale of the Global Poker Tour.
The GPT, or Global Poker Tour, had humble beginnings. Back about 11 years ago or so, a few high-stakes Texas Hold ‘em aficionados got together in a dark room somewhere and began to hatch a plan that would change the poker world forever. Their birth child: The GPT.
It was a simple proposition really. The founders---we’ll Blithely refer to them as “the Masters” for lack of a better moniker---the founders each called a couple of their friends from Vegas and Monte Carlo and Macau and planned to meet one evening for a game of poker. They rented a room at the local Holiday Inn Express, rented a table and some chips, and they were ready to rock!
So, on this pretty starlit evening in 1997, all of the players descended upon room #1600 at the Holiday Inn and the game was on. And it was a good game, with lots of big pots and exciting show downs. And the game went on well into the wee hours of the morning. And by dawn everyone was pretty beat and hungry and in need of fresh air, and so they decided to settle up their accounts and come back tomorrow night for another game.
Now, one of the really groovy parts of the new GPT was that none of the players actually had to bring cash with them. The Masters figured that all were good for their markers, and besides, carrying a lot of cash around ain’t so safe these days.
So at the end of the inaugural game of the GPT, over 3 million dollars had changed hands. (Well you know what I mean. 3 Million chips we'll say.) The big winner this night was poker giant HP who had won over a million dollars in chips! Many others hovered around the break even point, and only AG found himself in the hole over $500,000. Of course, no debts were settled on this evening. The game would continue tomorrow, and trust among fellow gamblers runs as deep as blood.
Night 2 arrived, and 8 more players joined the game! And so the Masters went out and rented another table, and a few more poker chips, and took a bigger room at the Holiday Inn Express, and as the clock struck 8pm it was game on! And what a spectacular night it was for poker lovers!! Over 15 million dollars gambled, with BB finishing the night as the big winner with over 5 million in chips. Again, most players hovered close to even, and only 2 or 3 players had losses over 1 million $$$.
Again, as this was a small game and everyone at the tables was considered good for their debts, no actual money exchanged hands. A few IOUs were scratched out on napkins and torn pieces of dominoes pizza boxes, but that was primarily just for references sake. The GPT was off to a rousing start, and the game was just beginning!!
Well as I’m sure you can imagine, the GPT really took off. Soon games were organized all over the country, and no longer were mere rooms at the local Holiday Inn Express sufficiently large enough---now we were talking ballrooms, and even auditoriums and arenas for the really huge events. And thousands of players had joined the ranks of the GPT brethren, and tens of BILLIONS of dollars was changing hands. And so the Masters met one night and penned a few rules to keep things running smoothly.
The 1st rule of the GPT was that all members were considered absolutely good for their debts, and since the 2nd rule of the GPT was that no member could cash out and leave the tour without the permission of the other members, none of the tens of billions of dollars in debts and winnings needed to take place in cash. It was perfect! And all of the IOUs and markers and debts were recorded in a central repository run by the Masters---and all of the players trusted the Masters as they trusted their own family members. In fact, the GPT became a sort of surrogate family for the members, and loyalty ran deep.
So one day the Masters were discussing how they could grow the GPT without adding too many more actual players. You see, the games had gotten so unwieldy and massive---sometimes involving 10,000 players or more---that entire city blocks had to be rented out to accommodate not only the players but also the growing crowds of spectators.
And then it hit them! The Masters decided that they would create two new parts of the GPT: one would be a method by which spectators could wager with each other on who each thought would win the tournament, survive longer than another player, or even win a given hand. The second would be a program by which players AND side-betting spectators could purchase insurance against their bets AND debts, just in case some member of the GPT or some member of the spectator group had unexpected bills to pay or, god forbid, broke rule #2 and asked for cash instead of the usual and expected IOU.
Well this idea took off like a jet plane! Soon Trillions and trillions of dollars were being bet and "swapped" by players and spectators and insurers and side-bettors. The excitement was palpable, and the GPT became the world’s highest grossing institution. My gosh, at one point it was estimated that the Global Poker Tour was worth almost half a QUADRILLION dollars!!! And from such innocent beginnings, just 11 years prior.
But as we must remember, the 2 rules of the GPT were sacrosanct. All of the transactions were accounted for through IOUs and promissory notes and contracts and everyone in the GPT abided by these rules, and all grooved along quite swimmingly….that is, until the fateful day. The fateful day to which I refer----it makes me shudder to remember that awful day---that fateful day was the day that Bobby Lehman, one of the tours rising stars, realized that he couldn’t pay some of his bills…and he broke the 2nd rule! He went to his friend and fellow star, Franky Goldman, and told Franky that, as unfortunate as it was, he needed to cash in on Franky’s IOU to Bobby----an IOU totalling 22 billion dollars.
Franky was stunned. Franky didn’t have 22 billion dollars in cash!! The only way Franky could pay Bobby was to find his buddy Tommy Stearns and demand the 56 billion dollars that Tommy owed Franky.
Well I needn’t tell you what happened next. T’was a sad day in not only the life of the GPT, but also for the whole wide world. The avalanche of margin calls and requests for payment of debts and requests for payments of side bets and demands for payments of insurance policies exploded. And while theoretically the whole thing added up to zero---many people just figured that it wasn’t a big deal because everyone could just get together and exchange all the money and everything would work out---there were lots of flies in the ointment.
First it was discovered that the clearing house created by the Masters for all of these IOUs hadn’t really done a great job of accounting for everything. There were lots of holes in the books and strange entries and "fuzzy math" and missing pages. Second of all, the web of IOUs and debts was so tangled and so huge, that there was no way for everyone to be able to work out their debts with everyone else simultaneously and in a way that would leave everyone back at zero. Thirdly, literally MILLIONS of players and spectators and side-bettors had used their IOU "winnings" as collateral to buy stuff like houses and yachts and airplanes, and so the IOUs really didn’t represent the zero-sum dynamic that everyone said it did. And fourthly, some of the players and side-bettors and insurers were more entangled than others---just like O’Hare airport is more entangled with flights that the airport in West Lebanon, NH----and so lots the more entangled players ended up getting so overwhelmed that they----I hate to say it---took their own lives and left all of their counterparties holding IOUs that had no way of being paid.
What a disaster this was. What a mess! What had begun so innocently and had been so small at first became the engine that ended up bringing the entire world’s economic system tumbling down. And all of the leaders of the world got together and decided that they still wanted the GPT to exist, because it made them really really rich, but that they could never ever let anyone break rule #2 again! And so there would be no more Tommy Lehmans. Anytime a player was broke and needed cash for some reason, the governments of the world would give them the money and the people of the world would pay back the government through taxes. And that way the Global Poker Tour could survive and live on forever! Because the survival of the GPT, after all, is best for everyone.