Wednesday, June 17, 2009

June 17 2009: 40 ways to lose your future

Samuel H. Gottscho When yesterday had a future November 28, 1933
Looking down South Street, New York City

Stoneleigh: People have been asking how we see the future unfold. In case you wonder what we stand for, much of our view of what's to come can be found in the primers on the right-hand side bar. Here is an additional brief summary (in no particular order and not meant to be exhaustive) of the ground we have consistently covered here at TAE over the last year and a half, and before that elsewhere.

  1. Deflation is inevitable due to Ponzi dynamics (see From the Top of the Great Pyramid)
  2. The collapse of credit will crash the money supply as credit is the vast majority of the effective money supply
  3. Cash will be king for a long time
  4. Printing one's way out of deflation is impossible as printing cannot keep pace with credit destruction (the net effect is contraction)
  5. Debt will become a millstone around people's necks and bankruptcy will no longer be possible at some point
  6. In the future the consequences of unpayable debt could include indentured servitude, debtor's prison or being drummed into the military
  7. Early withdrawls from pension plans will be prevented and almost all pension plans will eventually default
  8. We will see a systemic banking crisis that will result in bank runs and the loss of savings
  9. Prices will fall across the board as purchasing power collapses
  10. Real estate prices are likely to fall by at least 90% on average (with local variation)
  11. The essentials will see relative price support as a much larger percentage of a much smaller money supply chases them
  12. We are headed eventually for a bond market dislocation where nominal interest rates will shoot up into the double digits
  13. Real interest rates will be even higher (the nominal rate minus negative inflation)
  14. This will cause a tsunami of debt default which is highly deflationary
  15. Government spending (all levels) will be slashed, with loss of entitlements and inability to maintain infrastructure
  16. Finance rules will be changed at will and changes applied retroactively (eg short selling will be banned, loans will be called in at some point)
  17. Centralized services (water, electricity, gas, education, garbage pick-up, snow-removal etc) will become unreliable and of much lower quality, or may be eliminated entirely
  18. Suburbia is a trap due to its dependence on these services and cheap energy for transport
  19. People with essentially no purchasing power will be living in a pay-as-you-go world
  20. Modern healthcare will be largely unavailable and informal care will generally be very basic
  21. Universities will go out of business as no one will be able to afford to attend
  22. Cash hoarding will continue to reduce the velocity of money, amplifying the effect of deflation
  23. The US dollar will continue to rise for quite a while on a flight to safety and as dollar-denominated debt deflates
  24. Eventually the dollar will collapse, but that time is not now (and a falling dollar does not mean an expanding money supply, ie inflation)
  25. Deflation and depression are mutually reinforcing in a positive feedback spiral, so both are likely to be protracted
  26. There should be no lasting market bottom until at least the middle of the next decade, and even then the depression won't be over
  27. Much capital will be revealed as having been converted to waste during the cheap energy/cheap credit years
  28. Export markets will collapse with global trade and exporting countries will be hit very hard
  29. Herding behaviour is the foundation of markets
  30. The flip side of the manic optimism we saw in the bubble years will be persistent pessimism, risk aversion, anger, scapegoating, recrimination, violence and the election of dangerous populist extremists
  31. A sense of common humanity will be lost as foreigners and those who are different are demonized
  32. There will be war in the labour markets as unempoyment skyrockets and wages and benefits are slashed
  33. We are headed for resource wars, which will result in much resource and infrastructure destruction
  34. Energy prices are first affected by demand collapse, then supply collapse, so that prices first fall and then rise enormously
  35. Ordinary people are unlikely to be able to afford oil products AT ALL within 5 years
  36. Hard limits to capital and energy will greatly reduce socioeconomic complexity (see Tainter)
  37. Political structures exist to concentrate wealth at the centre at the expense of the periphery, and this happens at all scales simultaneously
  38. Taxation will rise substantially as the domestic population is squeezed in order for the elite to partially make up for the loss of the ability to pick the pockets of the whole world through globalization
  39. Repressive political structures will arise, with much greater use of police state methods and a drastic reduction of freedom
  40. The rule of law will replaced by the politics of the personal and an economy of favours (ie endemic corruption)

U.S. Cost of Living Decreases by Most in Six Decades
The cost of living in the U.S. fell over the last 12 months by the most in six decades, easing concern that government efforts to revive the economy will lead to an immediate outbreak of inflation.
The consumer price index dropped 1.3 percent in the year ended in May, the most since 1950, the Labor Department said today in Washington. Prices increased just 0.1 percent last month, less than anticipated, after no change in April. The lack of sustained gains in sales is one reason companies are finding it difficult to pass increases in fuel costs on to customers.

Higher gasoline prices will probably restrain Americans’ discretionary spending at a time when the economy is showing signs of stabilizing. "Inflation is not an issue," said Michael Moran, chief economist at Daiwa Securities America Inc. in New York. "There are huge amounts of slack in the economy and demand is quite soft, so it’s difficult to see how inflation can pick up for the balance of the year." Another report showed the U.S. deficit in its current account narrowed in the first quarter to the lowest level since 2001. The gap, the broadest measure of international flows because it includes trade, investment income and government transfers, fell to $101.5 billion from $154.9 billion in the last three months of 2008, the Commerce Department reported.

Treasury securities rose, erasing earlier losses, after the price report showed inflation wasn’t accelerating. The yield on the benchmark 10-year note fell to 3.61 percent at 11:44 a.m. in New York from 3.66 percent yesterday. Concern over the amount of money the Federal Reserve has pumped into financial markets and the size of government auctions to pay for stimulus efforts caused interest rates on Treasuries to shoot higher in recent weeks. Ten-year note yields reached as high as 3.95 percent at the close on June 10. Central bankers meet to discuss policy next week. Officials are considering whether to use their statement to suppress any speculation they’re prepared to raise interest rates as soon as this year.

Economists forecast consumer prices would rise 0.3 percent, according to the median of 75 projections in a Bloomberg News survey. Estimates ranged from a 0.1 percent decrease to a gain of 0.6 percent.
Excluding food and fuel, costs also climbed 0.1 percent, matching the median forecast. Compared with a year earlier, the so-called core rate increased 1.8 percent, down from a 1.9 percent 12-month gain in April. Energy costs increased 0.2 percent in May, as a 3.1 percent rise in the price of gasoline was partly offset by declines in fuel oil and natural gas. These prices may continue to rise in coming months. The average price of a gallon of regular gasoline at the pump is up 65 percent this year, reaching an almost eight-month high of $2.68 yesterday, according to data from AAA.

Should retail gasoline prices peak at $2.75 a gallon, the increase since the start of the year will deduct $50 billion at an annual rate from household cash flows, according to a forecast by Richard Berner, co-head of global economics at Morgan Stanley in New York. The loss would offset almost all the benefit of the tax cuts from the Obama administration’s stimulus plan, he said in a June 8 report. "There’s not pricing power in this otherwise very weak economy," said Richard DeKaser, chief economist at Woodley Park Research in Washington. "Inflation is going to remain very weak and over the next year will continue to weaken given the tremendous amount of slack in the economy."

Food prices, which account for about a seventh of the CPI, decreased 0.2 percent in April, reflecting lower costs for all major categories including fruits and vegetables, meats and dairy products. The core index was constrained by falling prices for public transportation, apparel and tobacco. Rents, which make up almost 40 percent of the core CPI, were also subdued. A category designed to track rental prices rose 0.1 percent. New vehicle prices climbed 0.5 percent. Car costs may decline in coming months as automobile makers slash prices or increase incentives to revive demand and lighten bloated inventories.

Chrysler LLC, seeking to restructure under bankruptcy, began offering five-year, no-interest loans on some models this month. The financing, announced June 3, runs through July 1 and is an alternative to rebates of as much as $6,000 for consumers who buy through certain credit unions and already own a Chrysler vehicle. The cash option was put in place last month. Macy’s Inc. was among retailers cutting prices to clear stockpiles. Aeropostale Inc. earlier this month was offering 20 percent off women’s dresses. American Eagle Outfitters Inc. was giving 50 percent off the purchase of a second graphic t-shirt.

America should also look to its fiscal health
by Kenneth Rogoff

America desperately needs a better framework for providing healthcare and Barack ?Obama’s administration is right to press on for change, even as the economy remains frail in (it is to be hoped) the aftermath of the financial crisis. Yet given the explosion of the federal debt, it is extremely important to craft a plan that will not excessively risk the government’s own fiscal health. The risks cannot easily be overstated. The US government is already entering a prolonged period where it is extremely vulnerable to a loss in investor confidence from the Chinese and other main holders of its Treasury securities. Foreign investors are rightly concerned about the deeply ingrained reluctance of Americans to tax themselves.

The last thing the US needs is to be viewed as one giant California, rich but unwilling to pay enough taxes to fund the services its citizens demand. A sharp rise in taxes to pay for healthcare initiatives could potentially weaken the credibility of the government’s promise to raise taxes as needed to pay off debtors. It is true many people are claiming that a new healthcare package can be a big part of the cure for US budget problems. They argue that standard measures of national debt are far too narrow and do not take into account a country’s huge commitment to future expenditures such as old age pensions and, especially, healthcare programmes.

Given generous benefits, increasing life expectancy and adverse demographics, old age benefit programmes have actuarial debts that are many times the conventionally measured national debt, even as conventional measures rise to levels last seen after the second world war. According to this logic, finding a way to contain rising healthcare costs would help more than almost anything to reduce the broadly defined government budget debt. Lower healthcare costs would also help the private sector, presumably raising investment, growth and, of course, future tax revenues. It would also be helpful, of course, to have a healthier and happier workforce.

Thus, in principle, fixing the imbalances in the Social Security and, especially, the Medicare programmes could provide a powerful offset to the huge increase in debt burdens visited by the financial crisis. Unfortunately, the idea that healthcare reform will alleviate debt problems rather than exacerbate them is far-fetched. As the US Congressional Budget Office warned this week, many proposed healthcare reforms are more likely to worsen the government’s budgetary health than to improve it. This should hardly be surprising, given that a main purpose of reform is to help provide better care for Americans who cannot afford insurance. Higher taxes to pay for healthcare are also likely to reduce US growth, making it far more difficult to escape the debt trap.

This comes at a time when other policy initiatives, such as tackling environmental degradation and income inequality, are also likely to imply higher tax burdens (the taxes are implicit in the case of cap and trade legislation to protect the environment). In addition, the continuing weakness of the financial sector weighs on growth, and it is by no means clear yet when and how some semblance of normality will be restored. This is particularly the case as the government struggles to reform regulation of the financial sector, with many political and economic puzzles to solve, not least the international dimensions of the problem.

All of these considerations appear to underscore the importance of finding ways to keep the new health plan from being overly burdensome, and to avoid unduly optimistic projections on efficiency savings. Healthcare reform is no substitute for finding a credible path to fiscal sustainability. If badly handled, it could prove the straw that breaks the camel’s back. Make no mistake, the US and much of the developed world is in a frighteningly precarious fiscal state. Exploding debt levels have remained manageable in no small part thanks to the extraordinarily low level of global real interest rates.

Should the general level of global interest rates rise substantially, perhaps owing to a pick-up in emerging market growth over the next few years, a number of developed countries, including the US, may have to tighten their belts sharply in order to maintain stable debt ratios. Countries that fail to do so will suffer severe consequences, including spiralling interest rates and, ultimately, default by direct means or through high inflation. It is a disgrace that the world’s richest country cannot provide reliable basic care for its poorest citizens. But if the politics of reform produces too extravagant a plan when the nation’s fiscal health is already so weak, the US may experience a form of financial crisis even more virulent than the one it is recovering from. Any healthcare plan would then be dead on arrival.

California's Economy: Too Big to Fail?
Despite a $24 billion budget deficit and a legislature in stalemate, California lawmakers haven't persuaded the Obama Administration to bail out the state. California's economy is in deep distress. Political gridlock is preventing tax increases and spending cuts, and the recession has pushed its deficit over the edge. Governor Arnold Schwarzenegger's proposals to fix the mess have been rejected by California voters, most recently on May 19. On June 16, Standard & Poor's put California's credit rating—already the lowest among states—on watch for a downgrade. Golden State residents are all too aware of the cuts in essential services that may result, or that some businesses or taxpayers may have to accept IOUs as payment from the state.

But will the rest of the U.S. have to share California's pain? In May, State Treasurer Bill Lockyer sent a letter to U.S. Treasury Secretary Tim Geithner urging him to consider helping cash-strapped municipalities. The pitch by Lockyer and other California Democrats is a play on the "too big to fail" argument made on behalf of bank bailouts: If you don't save this bank (or in this case, state), the financial markets and the national economy will be thrown into turmoil. "This matters for the U.S., not just for California," Representative Zoe Lofgren (D-Calif.), who chairs the state's Democratic congressional delegation, told The Washington Post. "I can't speak for the President, but when you've got the eighth biggest economy in the world sitting as one of your 50 states, it's hard to see how the country recovers if that state does not."

The Obama Administration is now seeking to answer that question. So far the Administration has declined to bail out California. At a June 16 press briefing, White House spokesman Robert Gibbs underscored that stance, saying California's budgetary problem "unfortunately is one that [the state is] going to have to solve." Later, in the evening, Republican Governor Schwarzenegger issued a statement denying he was seeking any such help. "We are in complete agreement with the White House that California should be solving its budgetary problems on its own without a bailout from the federal government," said the statement issued by Communications Director Matt David. But there remains concern that the deeper California's woes get, the more it will delay the potential U.S. recovery.

A report released by the University of California at Los Angeles on Tuesday projects the $24 billion annual state budget deficit will translate into 60,000 job losses by the middle of 2010. At the same time, the state could institute massive cuts in public services such as its welfare program, which serves 1.3 million people. The worry is that these efforts to balance California's state budget would work in a direct cross-purpose with the $787 billion U.S. stimulus package Obama signed in February. Though few experts think California will default on its debt—following the example New York City set in 1975 and Cleveland in 1978—the mere possibility is troubling for the credit markets. "If California truly defaults, I am sure it will shake the faith of bondholders and noteholders in the overall municipal finance system," says Dan Boyd, senior fellow at the Rockefeller Institute of Government. "That would undoubtedly lead to higher issuance costs to additional state and local government loans."

Investors in the municipal bond industry are monitoring the situation. "California is one of the largest states in the municipal bond market, so we have to follow it and make sure we get the call right as an investor," says Hugh McGuirk, head of municipal bond investments for T. Rowe Price (TROW), an investment firm. California is not alone in its fiscal misery. All but three U.S. states face budget gaps in the 2010 and 2011 fiscal years, with a collective shortfall of $350 billion, according to the Center on Budget & Policy Priorities, a Washington-based nonprofit. Michigan, whose economy was among the country's weakest even before the bankruptcies of General Motors and Chrysler, has also asked Washington for help.

Treasury officials are considering helping the state's auto suppliers stay afloat to prevent mass layoffs. While California is a huge state, some economists believe the harshest shocks from its distress may be confined to its borders. A hit to the technology or entertainment industry would be worse, economically speaking, for the rest of the U.S. than losses of state jobs for California services such as schools, universities, and hospitals, they say. "Losing private-sector jobs in export industries that drive the state's economy has more of a contagion effect," says Richard Ciccarone, managing director of McDonnell Investment Management in Chicago. "[Loss of] government workers have an impact, but the multiplier effect is not as big as in other industries."

Nearby states also would undoubtedly feel some pain. "The [economic] connection is not that strong unless you're talking about neighboring states with a trade connection like Nevada and Arizona," says Rajeev Dhawan, director of Georgia State University's Robinson College of Business. For example, Las Vegas would suffer if Los Angelinos make fewer trips to the city. "The further from California the state is, the less directly affected it will likely be." Still, Boyd says that a default by California or any other state—or even severe spending cuts to balance their budgets—would take considerable stimulus out of the U.S. economy when it can least afford it.

He says that state and local economies are pro-cyclical, meaning they are exacerbating the downturn even as the federal government pumps money into the economy. "States are raising taxes and cutting spending, while the feds are trying to achieve exactly the opposite." Says Dhawan: "The fiscal landscape at the state and local level is more brutal than at the federal level, where you hear talk of 'green shoots' emerging. The exterior paint may look O.K., but the inside of the house is crumbling."

S&P warns California's credit rating is at risk of another cut
California's credit rating, already the lowest among the 50 states, may be hacked again, Standard & Poor's warned today. As the debate over budget cuts drags on in Sacramento, S&P put its "A" grade on the state's $59 billion in general obligation bonds on "negative credit watch," meaning the rating is at risk of a downgrade. Using language that could further spook bond investors, S&P said, "Although we continue to believe the state retains a fundamental capacity to meet its debt service, insufficient or untimely adoption of budget reforms serve to increase the risk of missed payments in our view."

The Legislature and Gov. Arnold Schwarzenegger are facing a $24-billion budget shortfall, and Controller John Chiang has warned that the state could run short of cash beginning July 28, just one month into fiscal 2010. Noting that time is running out, S&P warned:
Both the timing and magnitude of the state's impending liquidity shortfall raise significant credit concerns, in our view, particularly if the state were to begin fiscal 2010 without having meaningful budget revisions in place. We believe that without budget revisions, the state may need to defer (or issue registered warrants in lieu of making) cash payments for certain lower-priority obligations (such as vendors, student aid, and tax refunds) in order to preserve cash for required payments for education and debt service.

Were the state to do this, or if it were to adopt a budget package that relied on assumptions that we regard as too optimistic or that relied on mechanisms for bridging the projected shortfall through at least fiscal 2010 that we regard as unreliable, we may consider lower ratings.

Any downgrade could spur investors to force the state to pay even higher interest rates when it borrows. Market yields on California's general obligation bonds already have surged in recent weeks as the prices of the bonds have fallen, reflecting investor jitters. California and Louisiana had been tied for last place, at "A-plus," on S&P’s state ratings list, until February, when S&P cut the Golden State to "A." Most states are rated either "AA" or "AAA." S&P's latest downgrade warning also applies to its "A-minus" rating on the state's $8.1 billion of appropriation-backed lease revenue bonds.

S&P Says US To Keep AAA Ratings In Near Term
Standard & Poor's Ratings Services said its AAA ratings on the U.S. are safe for the near term, despite significant weakening in the economic outlook, projected fiscal deficits and the high costs of government support of the U.S. financial sector. The ratings firm said the key credit strengths of the U.S. include its high-income, diversified economy, the advantage of the U.S. dollar's role as the world's most used currency, the country's openness to trade and its stable political system.

S&P credit analyst Nikola Swann said those credit strengths continue to outweigh any weaknesses. Including the U.S., S&P has AAA ratings and stable outlooks on 17 of the 124 countries it rates. That includes Canada, France and Germany. Last month the ratings agency revised its outlook on the U.K. to negative. Since the financial crisis intensified in September, the U.S. has spent billions of dollars propping up what were once the nation's strongest financial and automotive firms in an effort to protect jobs and stem a steep drop in consumer confidence.

S&P Downgrades Wells Fargo, U.S. Bancorp, 20 Other Banks
The ratings agency lowered its ratings and revised its outlooks on 22 banks, as stress tests signal the potential for more pain ahead. Standard & Poor's Ratings Services lowered its ratings and revised its outlooks on 22 rated U.S. banks on June 17. The actions reflect S&P Ratings' belief that operating conditions for the industry will become less favorable than they were in the past, characterized by greater volatility in financial markets during credit cycles, and tighter regulatory supervision. The changes also reflect S&P Ratings' ongoing broad-ranging reassessment of industry risk for U.S. financial institutions. S&P Ratings' overall assessment of the U.S. banking industry incorporates the following key points:
  • The industry is now in a transition and will likely undergo material structural changes;
  • The loss content of loan portfolios should increase, but recent capital rebuilding should help banks defray these losses;
  • Stress tests point to more pain in the future;
  • S&P Ratings doesn't view regional banks as being highly systemically important; and
  • Potential losses could increase beyond S&P Ratings' current expectations.

"We believe the banking industry is undergoing a structural transformation that may include radical changes with permanent repercussions," says S&P credit analyst Rodrigo Quintanilla. "Financial institutions are now shedding balance-sheet risk and altering funding profiles and strategies for the marketplace's new reality. Such a transition period justifies lower ratings as industry players implement changes." Possible changes include increased regulatory oversight and lower profitability. In addition, S&P Ratings reassessed the relative creditworthiness of many institutions based on their abilities to deal with the increased risks during this transition period. "We believe some firms may be better able to weather the risks ahead than others," Quintanilla adds.

"In the long term, we could foresee ourselves raising ratings if lower earnings and reduced risk are accompanied by stronger risk-adjusted capital and effective governance." As a result of the most recent downgrades, as well as those since mid-2007, the counterparty ratings on U.S. banks (at the operating subsidiary level) have fallen by an average of two notches, to BBB+ today from A before the crisis began in June 2007. However, says Quintanilla, "the high number of firms with negative outlooks suggests that the ratings could still decline if the credit cycle is longer and/or deeper."

Financial Firms Repay $66.3 Billion In TARP Funds
JPMorgan Chase & Co., Goldman Sachs Group Inc. and Morgan Stanley are among nine major financial institutions that Wednesday announced they have bought back the preferred stock they issued to the Treasury Department under the Troubled Asset Relief Program. Ten banks were given $68.3 billion last fall and received approval last week to repay the funds. So far, just State Street Corp. - which ranked 9th in terms of the amount it received at $2 billion - has yet to announce its repayment. JPMorgan, U.S. Bancorp , American Express Co., Bank of New York Mellon Corp., BB&T Corp. and Northern Trust Corp. also announced plans to buy back the related warrants associated with TARP. Goldman, Morgan Stanley and Capital One Financial Corp. didn't address the warrants.

Many of the banks that accepted TARP funds starting last fall have said they want to repay the money as soon as possible in order to avoid strict government regulations, especially those on executive pay. Last week, the government cleared 10 large banks to repurchase the preferred shares they sold to the government as part of the TARP program. U.S. Bancorp and BB&T said last week they will record small second-quarter charges related to the buyback, $6.6 billion and $3.1 billion, respectively.

Bank of New York said it expects a $197 million chargefrom its $3 billion repurchase, while Northern Trust expects a $68.6 million profit hit; it received $1.58 billion. Goldman said its earnings will be cut by about 77 cents a share for paying some $425 million in dividends on its $10 billion of preferred shares. Morgan Stanley expects an $892 million profit reduction. Financials have been among a host of companies raising capital of late through stock sales, in part to raise funds in anticipation of becoming payback-eligible. JPMorgan received $25 billion in TARP funds, while Morgan Stanley got $10 billion, Capital One $3.55 billion American Express $3.39 billion.

U.S. Bancorp Chairman and Chief Executive Richard K. Davis said Wednesday the repayment of TARP funds was a "significant step forward" and returns the company to a position of independence. Separately, Standard & Poor's earlier Wednesday downgraded 18 U.S. banks, including U.S. Bancorp, Capital One and BB&T, saying the industry's future won't be as good as the past. U.S. Bancorp was lowered two notches to A+, while BB&T and Capital One were cut one notch to A and BBB, respectively.

Why Is The FDIC Ignoring Problem Banks?
USA Today had a story Tuesday that pointed out how regulators were regularly absent as the banks they were supposed to be overseeing failed under mounting debt. Bert Ely, a longtime banking consultant, has identified a data point that highlights how far behind the regulators have actually fallen. During the savings and loans crisis and its aftermath, banks that failed had a loss ratio--or a bank's total losses divided by its total deposits--of just around 13%. Since the current recession began, that same ratio for failed banks surged to more than 37%, or nearly triple S&L crisis levels.

This means that the regulator responsible for seizing failed banks, the FDIC, is waiting much longer before taking over these doomed banks, allowing their losses to mount. As a bank's loss ratio increases, it becomes costlier for the bank, and they pass the additional expenses onto their customers. Therefore, the FDIC inaction has resulted in rising costs for regular Americans, Ely said. "The big question is why is the FDIC moving so slowly? It is very evident from these numbers that there is serious ineptitude among the regulators," Ely said. "Their incompetency is costing the banking industry, but they are passing this cost on to depositors and borrows, so we end up suffering."

As for their part, the FDIC told the Huffington Post last week that the FDIC doesn't make the decision when to seize a bank. The agency said that it merely carries out the seizure, but other regulators are responsible for determining when a bank has failed. A patchwork of agencies currently make this decision. Hopefully this type of confusion can be streamlined, spurring a quicker response time among regulators, when Obama reveals to Congress tomorrow his plan to overhaul regulatory oversight of Wall Street.

Large U.S. corporate bankruptcies accelerate
Large U.S. corporate bankruptcies have accelerated in recent weeks as the U.S. economic slowdown claims more victims, according to industry data. Eight public companies with assets of more than $1 billion have filed for bankruptcy protection in the last four weeks, compared with five multibillion-dollar company bankruptcies in the prior four-week period, according to data compiled by and reviewed by Reuters. That is the largest number of multibillion-dollar public company bankruptcies in a four-week period since the year began, according to the data. tracks companies that have some form of publicly traded security such as stocks or bonds. "Corporate revenue is down in the United States and when topline revenue is down, there's less money to spread through expenses," said Brian Hamilton, co-founder and chief executive officer of financial information company Sageworks Inc. The last few weeks have brought filings from long-term lodging facility operator Extended Stay Inc, which had assets of $7.13 billion before its bankruptcy, and theme park operator Six Flags Inc, which had assets of about $3.03 billion.

The largest Chapter 11 bankruptcy case so far this year is that of General Motors Corp, which filed for creditor protection on June 1, with assets of more than $91 billion. The widespread credit crunch and economic slowdown have taken such a toll on corporations and individuals that bankruptcy courts are struggling to manage the load. Barbara Lynn, chair of the bankruptcy committee of the Judicial Conference of the United States, recommended at a congressional hearing that Congress authorize 13 new permanent bankruptcy judgeships and make 22 temporary bankruptcy judgeships permanent.

"In the 12-month period ending March 31, 2009, there were approximately 1.2 million bankruptcy petitions filed -- nearly double the number of petitions filed in 2006," Lynn said. Hamilton of Sageworks said he expects to see more bankruptcies for companies in the auto or real estate industries. "We all know the automakers are having great difficulty, but if you're producing parts for the automakers you're also having difficulties," said Hamilton, adding that "anything around real estate is probably going to have difficulty for the latter part of 2009."

Companies Signal High Anxiety With Record Share Sales Used to Retire Debts
Almost two years into the worst financial calamity since the 1930s, companies are doing everything they can to reduce their indebtedness, selling record amounts of equity to pay back bonds and loans. "Stock buybacks are a thing of the past: It’s reducing debt and bond buybacks that are in vogue," said Kathleen Gaffney, co-manager of the Loomis Sayles Bond Fund in Boston. "Stocks aren’t going to move and earnings aren’t going to move without a healthier balance sheet," said Gaffney, whose firm manages $98 billion in fixed-income assets.

More than 165 companies raised a record $87 billion in U.S. secondary share sales this quarter, and 77 percent of them used the proceeds to slash leverage, according to data compiled by Bloomberg. Ford Motor Co., the only major U.S. automaker that hasn’t filed for bankruptcy, sold $1.6 billion in equity last month to obtain cash and finance a retiree medical fund. Las Vegas-based casino owner MGM Mirage issued $1.1 billion of stock to repay debt, fueling a rally of as much as 14 cents on the dollar in its bonds.

Companies are diluting existing owners to stave off defaults during the worst economic crisis since the Great Depression. U.S. corporations have reduced the median debt-to- equity ratio for high-yield, high-risk companies by 12 percentage points since February to 54 percent and by 7 points to 32 percent for investment-grade debtors as of June 12, according to Moody’s Corp. Investment-grade corporate bonds have returned 8 percent in 2009 and speculative-grade securities are on pace for a record year, according to Merrill Lynch & Co. data, while the Standard & Poor’s index of 500 stocks recorded its steepest 67-day gain in seven decades.

Companies from Dow Chemical Co. to Hertz Global Holdings Inc. are selling shares to take advantage of a 40 percent rally in the S&P 500 between March 9 and June 12. Both were among the 54 percent of issuers since March that said they may use at least some of the money from equity offerings to repay debt, Bloomberg data show. Banks and financial companies seeking to raise capital comprised 23 percent of the sales, Bloomberg data show. JPMorgan Chase & Co. and Goldman Sachs Group Inc., both based in New York, issued stock to help return aid from the U.S. Troubled Assets Relief Program.

The benefits of selling more shares outweigh the disadvantages of dilution, said Thomas Sowanick, chief investment officer of Princeton, New Jersey-based Clearbrook Financial LLC, which manages $30 billion. "The overall cost to rebalancing the balance sheet is worthy of the dilution," said Sowanick, the former head of wealth-management strategy at Merrill Lynch. "You’re saving your interest payments and you are showing strength by being able to raise capital." With speculative-grade securities gaining about 30.4 percent through June 16, borrowers are also refinancing maturing debt in the bond market.

Companies have sold a record $682 billion of offerings in the U.S. this year, according to Bloomberg data. By focusing on credit quality, companies are putting bondholders ahead of share owners for the first time since 2003, said Christopher Garman, chief executive officer of debt research firm Garman Research LLC in Orinda, California. "When corporations are taking debt off the table, it does signify that companies are being run for the benefit of bondholders," Garman said. "Many companies were not rewarded for refusing to lever up in 2003 to 2007," he said. "There was a lot of pressure for almost a good five years there to retire equity and add debt."

Companies piled on debt in 2006 and 2007 to repurchase stock and boost shareholder returns when borrowing costs were at all-time lows. Private equity firms such as KKR & Co. and Apollo Management LP led a record $1.29 trillion leveraged buyout boom that collapsed in August 2007 along with the subprime mortgage market. The borrowing binge contributed to the almost $1.5 trillion of writedowns and losses at financial institutions worldwide. The high-yield default rate has jumped to 8.3 percent, its highest since November 2002, according to S&P. The extra yield, or spread, investors demand to own such bonds instead of similar-maturity Treasuries has ballooned to 10.5 percentage points from a record low of 2.41 percentage points in June 2007, Merrill Lynch index data show.

"Given the choice between dilution and default, they’ll opt for dilution," said John Lonski, chief economist at Moody’s Capital Markets Group in New York. "Whenever you have a rising default rate amid relatively tight credit conditions, companies have an extra incentive to repay debt with funds raised in the common equity market," Lonski said. The ratio of credit rating upgrades to downgrades climbed to 26 percent in the second quarter from 8 percent in the first three months of 2009, when increases accounted for the lowest percentage of rating changes since at least 1998, according to Bloomberg data based on S&P actions. Debt-to-equity ratios remain above their five-year averages of about 39 percent for high-yield companies and 26 percent for investment grade, Moody’s data show.

MGM sold stock to help repay debt maturing this year, remove the threat that banks would force the company into default and buy time to wait out Las Vegas’s worst gambling slump. The company, 36.99 percent-owned by billionaire Kirk Kerkorian, faced a June 30 deadline to restructure after auditors in March questioned its ability to stay in business. MGM also sold $1.5 billion in secured notes and amended its loan facility. By selling 164 million shares, MGM diluted its existing stockholders by 59 percent, according to regulatory filings.

The company’s debt-to-equity ratio has tumbled to 77 percent from 114 percent in March, according to Moody’s. S&P raised MGM’s credit rating one grade to CCC+, while Fitch lifted it two steps to CCC.
"The dilution was more than accepted by our shareholders," MGM Chief Executive Officer Jim Murren said in a telephone interview. "The reaction was that MGM dodged a major bullet, that they were able to navigate through a very tough time and had they not done that equity raise, the shareholders would be in far worse condition today."

MGM’s $298 million of 9.375 percent notes due in 2010 have climbed 14 cents to 96 cents on the dollar since May 12, the day before the offerings were announced, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Its shares have fallen 46 percent during the same period in New York Stock Exchange composite trading. After earnings fell for seven straight quarters, companies are trying to reduce indebtedness in preparation for what Pacific Investment Management Co. Chief Executive Officer Mohamed El-Erian calls a "new normal" for the U.S. economy. El-Erian said in a Bloomberg Radio interview last month that the potential growth for the U.S. is "no longer 3 percent, but is 2 percent or under." Pimco, in Newport Beach, California, manages the world’s biggest bond fund.

The S&P 500’s rally since March left the index at a seven- month high at the end of last week and valued it at 14.9 times its companies’ earnings, near the highest since October. Last week, the Dow average became the last major U.S. stock gauge to turn positive in 2009 amid optimism that government efforts to revive the economy are working. "With a very modest economic recovery, survival is being able to have an appropriate balance sheet," Loomis Sayles & Co.’s Gaffney said. "It’s good common sense that, while the window is open, companies that are able to de-leverage, should."

Ford, based in Dearborn, Michigan, issued 345 million shares of common stock on May 12 and 13, increasing its shares outstanding to 3.1 billion, according to Bloomberg data. The automaker’s leverage ratio has fallen to about 77 percent from 90 percent in November, Moody’s data show. "There had been a lot of industrial names that had been selling shares; we believed there would be demand for it and the timing worked out well," Ford spokesman Mark Truby said. By using the cash from the offering instead of stock to fund the health-care trust, the company reduced the effects of dilution to shareholders, Truby said.

Ford’s $1.8 billion of 7.45 percent bonds maturing in 2031 have risen 10.4 cents to 66.25 cents since May 11, according to Trace. Shares of the automaker, which lost a record $14.7 billion last year, have fallen 6.7 percent since then. The stock is up 148 percent this year. "The market’s wide open," said Daniel Simkowitz, vice chairman in capital markets at Morgan Stanley in New York. "MGM and Ford are good underlying franchises, but they’re in a very tough part of the economy and they also had leverage. There’s a pretty broad-based set of investors that are willing to buy the optionality in these companies." Morgan Stanley, the second-biggest underwriter for U.S. equity offerings behind JPMorgan excluding self-led deals, helped manage offerings for Ford and MGM.

While secondary stock sales are surging, the market for initial public offerings hasn’t recovered, leaving out private equity firms looking to raise cash by selling their investments. The eight IPOs in the U.S. this year pulled in $1.9 billion, the lowest for any similar period since 2003, when 10 new issues raised $1.4 billion, Bloomberg data show. The S&P 500 has tumbled 41 percent from its peak in October 2007. "Companies are selling equity well below where it was a year or two ago, but realizing in the new world that’s a more appropriate capital structure," said Mark Durbiano, who manages $3 billion in high-yield debt at Federated Investors Inc. in Pittsburgh.

"You had MGM issuing equity at $7 a share and Hertz did a similar deal, though it’s not quite as stressed," Durbiano said. "It’s a price that was considerably below where it was a year ago on the realization that operating results are weak and that will continue to be the tone." Hertz, the second-largest U.S. rental-car company, sold 46 million shares at $6.50 on May 20, raising $299 million to "increase its liquidity" and for "general corporate purposes" including debt repayment, the Park Ridge, New Jersey- based company said in a statement that day. Hertz’s shares have fallen 19 percent to $6.59 since May 19. In May 2008, they traded as high as $14.49. Hertz’s $1.8 billion of 8.875 percent bonds due in 2014 have increased 6 cents to 89 cents, according to Trace. The debt yields 12.1 percent.

"A lot of our fleet debt is maturing toward the end of 2010, and this was part of a strategy to pave the way to make that process a lot easier," Hertz spokesman Richard Broome said. "Shareholders were asking us questions about the debt refinancing and how we were going to address this." Hertz’s debt-to-equity ratio has fallen to 67 percent from 89 percent in November, according to Moody’s. Dow Chemical sold 150 million shares at $15 last month, raising $2.25 billion to help repay a loan that was used to acquire rival Rohm and Haas Co. this year. Our equity issuance "speaks to our commitment to de- leverage the company’s balance sheet and maintain our investment-grade credit rating," said Bob Plishka, a spokesman for the largest U.S. chemical maker.

The sale was oversubscribed, meaning investors wanted to buy more stock than was offered, which shows "the confidence investors have in Dow’s long-term strategic direction," Plishka said. Midland, Michigan-based Dow Chemical’s $882 million of 7.85 percent bonds maturing in 2029 have gained 11.4 cents to 80.4 cents on the dollar to yield 10.2 percent since the equity offering was announced, according to Trace. Its shares are down 1.9 percent. "The trend is that what appears to be good for bondholders, equity holders feel is the same," Morgan Stanley’s Simkowitz said. "It’s very different than 2006 and 2007, where bondholders and equity holders were at odds with each other."

Gold sold like chocolate from German vending machines
Shoppers in Germany will soon be able to buy gold as easily as bars of chocolate after a firm announced plans to install vending machines selling the precious metal across the country. TG-Gold-Super-Markt aims to introduce the machines at 500 locations including train stations and airports in Germany. The company, based near Stuttgart, hopes to tap into the increasing interest in buying gold following disillusionment in other investments due to the economic downturn.
Gold prices from the machines – about 30 per cent higher than market prices for the cheapest product – will be updated every few minutes. Customers using a prototype "Gold to go" machine at Frankfurt Airport on Tuesday had the choice of purchasing a 1g wafer of gold for €30, a 10g bar for €245, or gold coins. A camera on the machine monitors transactions for money laundering controls. Thomas Geissler, who owns the company behind the idea, said: "German investors have always preferred to hold a lot of personal wealth in gold, for historical reasons. They have twice lost everything. "Gold is a good thing to have in your pocket in uncertain times."

Interest in gold has risen during the financial crisis, particularly in Germany, according to GFMS, the London-based precious metals consultancy. Retail demand reached an estimated 108 tonnes in 2008, up from 36 tonnes in 2007 and 28 tonnes in 2006. Jens Willenbockel, an investment banker who saw the machine while passing through the airport, told the Financial Times that he believed there could be a market for the venture. "Because of the crisis there is a lot of awareness of gold," he said. "It is also a great gift for children – for them getting gold is like a fairytale."

Obama's Regulatory Reform Plan: The Basics
Obama unveiled his sweeping Financial Regulatory Reform Plan today.  There are fans and detractors and much more information to come, but for now, here's what he wants to add, adding to and take away:
  • Financial Services Oversight Council
    This Council, to be chaired by the Treasury, would, according to the Plan, "help fill gaps in supervision, facilitate coordination of policy and resolution of disputes, and identify emerging risks in firms and market activities."  Proposed legislation would allow the Council to request information from any financial firm and charge it with "referring emerging risks to the attention of regulators with the authority to respond."
  • National Bank Supervisor
    This proposed agency is designed to "close the loopholes in bank regulation" and would supervise and regulate "all federally chartered depository institutions" as well as "all federal branches and agencies of foreign banks."  The Obama Administration wants the NBS to have separate status within Treasury and be led by a single executive.   The NBS would take over the prudential responsibilities of the Office of the Comptroller of the Currency, which currently charters and supervises nationally chartered banks and federal branches and agencies of foreign banks.
  • Consumer Financial Protection Agency
    This proposed agency would be charged with protecting consumers of credit, savings, payment and financial products and services, and the Plan therefore proposes to allow the CFPA broad jurisdiction to regulate the service providers.  It should, the Plan says, "have sole rule-making authority for consumer financial protection statutes" and the ability to fill in any gaps in current consumer protection statutes. States, however, are welcome to pass stricter consumer protection laws. 
  • Office of National Insurance 
    This office within the Treasury would "promote national coordination within the insurance sector" and "gather information, develop expertise, negotiate international agreements and coordinate policy in the insurance sector." 

The Plan describes six principles for insurance regulation:  1) Effective systemic risk regulation with respect to insurance; 2) Strong capital standards and an appropriate match between capital allocation and liabilities for all insurance companies; 3) Meaningful, consistent consumer protection for insurance products and practices; 4) Increase national uniformity through either a federal charter or effective action by the states; 5) Improve and broaden the regulation of insurance companies and affiliates on a consolidated basis, including affiliates outside the traditional insurance business; and 6) International coordination.

  • New authority to supervise all firms that could pose threat to financial stability
  • Expanded authority to oversee payment, clearing and settlement systems
  • Enhancement of Federal Reserve's authority over market infrastructure (i.e., "requiring all standardized OTC derivative transations to be executed in regulated and transparent venues")

  • Federal Reserve emergency lending authority for increased accountability will be revised to improve accountability

  • Office of Thrift Supervision
    The OTS currently supervises federally chartered thrifts and thrift holding companies.  The Plan states that "the nature and extent of prudential supervision and regulation of a federally chartered depository institution should no longer be a function of whether a firm conducts its business as a national bank or a federal thrift.  Therefore, what was under the umbrella of the OTS will now be the responsibility of the umbrella of the NBS.

Obama: Financial Regulations Seek Balance
Sweeping changes proposed in response to the economic meltdown weigh demands of financial system and consumers, Obama says. Blaming much of the current economic downturn on "the unraveling of major financial institutions and the lack of adequate regulatory structures to prevent abuse and excess," President Barack Obama is proposing a vast expansion of federal regulatory power over financial institutions, including the creation of two new entities—a Financial Services Oversight Council and a Consumer Financial Protection Agency—as well as two new overseers of banks and insurance firms.

The proposed new regulatory scheme includes new supervisory powers for the Federal Reserve for all financial institutions whose problems could pose a threat to financial stability and a requirement for hedge funds and other pools of private capital to register with the Securities & Exchange Commission. The sweeping nature of the proposals—the widest-ranging changes to the financial regulatory scheme since the Great Depression—is generating pushback from business interests over some of the provisions.

Obama describes the changes as a balancing of the interests of business and the public, according to a transcript of his remarks released Wednesday morning. "With the reforms we are proposing today, we seek to put in place rules that will allow our markets to promote innovation while discouraging abuse. We seek to create a framework in which markets can function freely and fairly, without the fragility in which normal business cycles bring the risk of financial collapse; a system that works for businesses and consumers."

The proposed eight-member Financial Services Oversight Council is to be chaired by the Treasury Dept. and is designed to "help fill gaps in regulation, facilitate coordination of policy and resolution of disputes, and identify emerging risks in firms and market activities," according to fact sheets distributed by the White House. It will replace the President's Working Group on Financial Markets and have a permanent staff at Treasury. The new Consumer Financial Protection Agency will regulate providers' consumer financial products and services, including credit, savings, and payment services. It will set standards for promoting financial services to consumers and have regulatory powers to supervise institutions for compliance.

"This agency will have the power to set standards so that companies compete by offering innovative products that consumers actually want—and actually understand," Obama says. "Consumers will be provided information that is simple, transparent, and accurate. You'll be able to compare products and see what is best for you. The most unfair practices will be banned. Those ridiculous contracts—pages of fine print that no one can figure out–will be a thing of the past. And enforcement will be the rule, not the exception." The plan would do away with the Office of Thrift Supervision, replacing it with a system aimed at closing gaps in coverage and keeping institutions from shopping for the most lenient bank regulator.

Christina Romer, the chairman of the White House Council of Economic Advisers, said Wednesday morning that the Administration proposal strikes "the appropriate balance" and that it was "not bulldozing the whole system." Representative John Boehner (R-Ohio), the Republican leader in the House of Representatives, countered by predicting "we'll have the federal government deciding what interest ought to be charged on credit cards, having the government decide what kind of financial products are available." The Financial Services Roundtable—a trade group for the financial services industry—aid in a statement that it "applauds the Administration's announcement of a proposal for modernizing regulation of the financial services industry. Our economic recovery depends on these reforms.

The Roundtable has long advocated regulatory reform and believes reform must be comprehensive, creative, and bold." However, the group said it is opposed to the Consumer Financial Protection Agency because it separates the regulation of the institution from the regulation of the products. "Each regulator will only have half the information," the group said, adding that the possibility of individual state regulation will promote a confusing patchwork of rules. Critics of the plan also argue that it imposes too many restrictions that will harm the ability of U.S. financial companies to compete in the global economy.

Obama plan urges review of Fed system
The Obama administration's regulatory reform plan calls for a review of the Federal Reserve System's structure, which the U.S. Treasury would then consider to propose possible changes, according to a document obtained by Reuters on Tuesday. "We propose a comprehensive review of the ways in which the structure and governance of the Federal Reserve System affect its ability to accomplish its existing and proposed functions," the document states.

It said the review would be led by the central bank's Washington-based board and would take a look at the governance of the 12 regional Fed banks and their role in financial supervision. The Fed would be called upon to propose recommendations by October 1, the document said. The document said that once the Fed issues a report, the Treasury would consider the recommendations and propose "any changes to the governance and structure of the Federal Reserve that are appropriate to improve its accountability and its capacity to achieve it statutory responsibilities."

The 85-page document details wide-ranging proposals to revamp U.S. financial regulation, and proposes the Fed become a "systemic risk" regulator to keep tabs on large firms and emerging financial threats that could hit the entire economy. The U.S. central bank has faced heightened political scrutiny after a series of high-profile bailouts of financial firms that have seen it put taxpayer money at risk.

In April, Congress passed a resolution that opens the door to a study to determine the "appropriate" number for regional Fed banks and calling on the central bank to offer more details on its emergency lending to banks. While members of the Fed's Washington board are confirmed by Congress, the presidents of the 12 regional banks are named by local boards of directors, with the consent of the Washington board. Some Fed officials think some lawmakers would like to make regional Fed presidents answerable to Congress.

In addition to calling for the study, the administration will propose legislation to require the Treasury secretary to sign off on any emergency lending the central bank undertakes under its current "unusual and exigent circumstances" authority, the document states. The Fed has invoked this authority on numerous occasions since the financial crisis struck. The document said that in each case during the crisis the Fed had sought and received the approval of the secretary, but that requiring prior written approval would "provide appropriate accountability going forward."

In an interview with Reuters Television in May, Treasury Secretary Timothy Geithner, the former president of the New York Federal Reserve Bank, said the Fed's structure had served it well by providing a diverse set of viewpoints. "But we're taking a fresh look at all aspects of our financial system now and we're going to take a fresh look at the role of the Fed in the system generally. That's a useful thing for us to do," he said.

Obama Plan For Fed Power Boost Could Become Lightning Rod
The Obama administration wants a super-charged Federal Reserve, but is balancing the expansion with a regulatory council that may check the Fed's new powers. The Obama administration's "Financial Regulatory Reform: A New Foundation" recommends a council to aid the central bank in monitoring threats to the U.S. financial system. It also calls for a broad review of the Federal Reserve System structure. But, on Capitol Hill, the proposal is still likely to end up a lightning rod for criticism of the central bank, raising questions about how much new power the Fed will actually gain at the end of the day.

The administration's financial regulatory reform proposal calls for the Fed to serve as an uber regulator of all large, interconnected firms that could jeopardize the financial system. "These proposals would put into effect the biggest changes to the Federal Reserve's authority in decades," the administration wrote in a draft paper on its reform proposals. However, skepticism of the Fed runs high in Congress. Even as experts laud the Fed for launching unprecedented programs to stem the worst financial crisis in decades, lawmakers such as Sen. Bernard Sanders, I-Vt., argue that Fed should disclose the names of the companies that have benefited from its lending programs. Other lawmakers argue the central bank failed to adequately regulate financial firms and address banks' risky practices ahead of the crisis.

Additionally, critics have argued that the central bank's tasks should be scaled back so that it can focus solely on monetary policy. "There is significant opposition to increasing the powers of the Fed in Congress and significant concerns over Fed independence," said Eurasia Group analyst Dan Alamariu. "This proposal is kind of a middle ground, trying to satisfy the Congress' wishes for a council-based approach and at the same time, having the Fed play a significant role within that council." Senate Banking committee Chairman Christopher Dodd, D-Conn., and others have called for a council of regulators to police systemic risks, rather than solely giving that authority to the Federal Reserve.

The Obama administration's regulatory overhaul seems to acknowledge such concerns by recommending a council as a way to coordinate with the Fed on systemic risk issues. According to the proposal, the new council would be led by the Treasury secretary and would also include the Fed chairman and various other regulators. It would "facilitate information-sharing" and identify emerging risks and advise the Fed about firms that could threaten financial stability. It also seeks to amend the Fed's lending authority to require the central bank to win approval from the Treasury secretary before extending credit to institutions in "unusual and exigent" circumstances.

The central bank has invoked its emergency powers many times since the start of the financial crisis to help aid companies such as Bear Stearns and American International Group Inc. (AIG). Furthermore, the proposal calls for a comprehensive review of the Federal Reserve System. The administration also recommends a new, separate consumer-protection agency to protect consumers when it comes to credit cards and mortgages. The question is whether these sideline proposals to review and cap the Fed's authority will be enough to soothe Capitol Hill concerns about the larger plan to make the Fed the dominant regulator of the U.S. financial system.

That said, it's likely the plan will look much different after lawmakers have a chance to review it, hold hearings and make modifications. "There continue to be real concerns regarding the conflicts of the Federal Reserve System, a la, the abrupt resignation of the chairman of the New York Fed last month," said Lendell Porterfield, the head of a bipartisan government relations firm in Washington and a former senior adviser to Sen. Richard Shelby, R-Ala.

He referred to Stephen Friedman, who resigned as chairman of the board of the Federal Reserve Bank of New York amid concerns about his role as a director and shareholder of Goldman Sachs Group Inc. (GS).
Another sign of lawmakers' frustrations comes in the form of legislation introduced by Rep. Ron Paul, R-Texas, that would expand the Government Accountability Office's authority to audit the Fed. The plan is gaining steam, with some 232 co-sponsors, meaning that more than half of the House of Representatives back the measure. Meanwhile, Republican leaders in the House have drafted their own regulatory reform proposal that would scale back the Fed's authorities rather than boost its power.

"Some in Congress already believe the Fed has sacrificed monetary policy for the sake of the banking system. How does adding more duties complicate or compromise their existing responsibilities?" said Porterfield.
On the other hand, proponents of a dramatic boost in the Fed's powers argue that the White House's regulatory revamp should have gone further. "The need to win a consensus across all the regulators, with their different views, constituencies, and institutional interests is likely to make it excessively hard to achieve the desired systemic safety," said Brookings Institution Fellow Douglas Elliott.

The three steps to financial reform
by George Soros

The Obama administration is expected on Wednesday to propose a reorganisation of the way we regulate financial markets. I am not an advocate of too much regulation. Having gone too far in deregulating – which contributed to the current crisis – we must resist the temptation to go too far in the opposite direction. While markets are imperfect, regulators are even more so. Not only are they human, they are also bureaucratic and subject to political influences, therefore regulations should be kept to a minimum. Three principles should guide reform.

First, since markets are bubble-prone, regulators must accept responsibility for preventing bubbles from growing too big. Alan Greenspan, the former chairman of the Federal Reserve, and others have expressly refused that responsibility. If markets cannot recognise bubbles, they argued, neither can regulators. They were right and yet the authorities must accept the assignment, even knowing that they are bound to be wrong. They will, however, have the benefit of feedback from the markets so they can and must continually recalibrate to correct their mistakes.

Second, to control asset bubbles it is not enough to control the money supply; we must also control the availability of credit. This cannot be done with monetary tools alone – we must also use credit controls such as margin requirements and minimum capital requirements. Currently these tend to be fixed irrespective of the market’s mood. Part of the authorities’ job is to counteract these moods. Margin and minimum capital requirements should be adjusted to suit market conditions. Regulators should vary the loan-to-value ratio on commercial and residential mortgages for risk-weighting purposes to forestall real estate bubbles.

Third, we must reconceptualise the meaning of market risk. The efficient market hypothesis postulates that markets tend towards equilibrium and deviations occur in a random fashion; moreover, markets are supposed to function without any discontinuity in the sequence of prices. Under these conditions market risks can be equated with the risks affecting individual market participants. As long as they manage their risks properly, regulators ought to be happy.

But the efficient market hypothesis is unrealistic. Markets are subject to imbalances that individual participants may ignore if they think they can liquidate their positions. Regulators cannot ignore these imbalances. If too many participants are on the same side, positions cannot be liquidated without causing a discontinuity or, worse, a collapse. In that case the authorities may have to come to the rescue. That means that there is systemic risk in the market in addition to the risks most market participants perceived prior to the crisis. The securitisation of mortgages added a new dimension of systemic risk. Financial engineers claimed they were reducing risks through geographic diversification: in fact they were increasing them by creating an agency problem.

The agents were more interested in maximising fee income than in protecting the interests of bondholders. That is the verity that was ignored by regulators and market participants alike. To avert a repetition, the agents must have "skin in the game" but the 5 per cent proposed by the administration is more symbolic than substantive. I would consider 10 per cent as the minimum requirement. To allow for possible discontinuities in markets securities held by banks should carry a higher risk rating than they do under the Basel Accords. Banks should pay for the implicit guarantee they enjoy by using less leverage and accepting restrictions on how they invest depositors’ money; they should not be allowed to speculate for their own account with other people’s money.

It is probably impractical to separate investment banking from commercial banking as the US did with the Glass-Steagall Act of 1933. But there has to be an internal firewall that separates proprietary trading from commercial banking. Proprietary trading ought to be financed out of a bank’s own capital. If a bank is too big to fail, regulators must go even further to protect its capital from undue risk. They must regulate the compensation packages of proprietary traders so that risks and rewards are properly aligned. This may push proprietary trading out of banks into hedge funds. That is where it properly belongs. Hedge funds and other large investors must also be closely monitored to ensure that they do not build up dangerous imbalances.

Finally, I have strong views on the regulation of derivatives. The prevailing opinion is that they ought to be traded on regulated exchanges. That is not enough. The issuance and trading of derivatives ought to be as strictly regulated as stocks. Regulators ought to insist that derivatives be homogenous, standardised and transparent. Custom-made derivatives only serve to improve the profit margin of the financial engineers designing them. In fact, some derivatives ought not to be traded at all. I have in mind credit default swaps. Consider the recent bankruptcy of AbitibiBowater and that of General Motors. In both cases, some bondholders owned CDS and stood to gain more by bankruptcy than by reorganisation. It is like buying life insurance on someone else’s life and owning a licence to kill him. CDS are instruments of destruction that ought to be outlawed.

Hedge funds attack proposed EU regulations
Hedge funds have used their most prominent annual gathering – the GAIM conference in Monaco – to speak out against "disastrous" new regulatory proposals from the European Union. After a turbulent end to 2008 and an unhealthy start to 2009, managers and their investors are rallying round to fight off the new draft rules outlined in late April by the EU commission. "Hedge fund managers have been quiet for a long time on regulation because I think there’s a general assumption that it won’t come to pass," said one fund manager.

"We’ve assumed that the political will will follow the economic will. Historically that’s wrong. And now lots of us are beginning to think that maybe we’ve been a bit complacent." The EU commission’s draft directive on alternative investment fund managers controversially proposes limits on fund leverage and would require funds to be registered in EU countries in which they have investors. As well as speaking out against the EU, attendees at GAIM have also criticised an apparent lack of action from the UK government on the issue.

Several fund managers said they had previously had confidence in the UK’s ability to resist punitive regulation from Brussels, but were now fearful that the Brown government was too politically distracted to act decisively. "The [Financial Services Authority]’s hedge fund regulation has actually always been very good, and the UK has the infrastructure, the capital markets and the prime brokerages that make it ideal for hedge funds. But now we risk driving them out," said Simon Luhr, the managing partner of London-based SW1 Capital. "The prime minister can’t stand up for himself right now… I think it’s going to be a disaster." Three quarters of Europe’s hedge fund-managed assets, worth around $300bn, are managed out of London.

Other managers, though, were much more sanguine. Lobbying efforts have intensified in recent weeks and a considerable amount of behind-the-scenes work was going on said one major London-based fund partner. "I think people just need to be a bit patient. It’s only the first draft of the new rules," he said. Comments from City minister Lord Myners – himself an investment management industry veteran – have also given some in the industry comfort. Myners criticised the EU proposals as "naive" when they came out. Pierre Lagrange, a founding partner of GLG, one of the largest and most successful funds in Europe, was, meanwhile, more openly supportive of London’s future as an alternative asset management hub."My wife and I are actually planning a party to celebrate 20 years of living in London," he told delegates in a keynote speech.

Unemployment rises less than expected but experts caution against hailing recovery
The hope that Britain may be through the worst of the recession was strengthened by better than expected unemployment figures on Wednesday but economists cautioned against hailing the prospect of recovery. The number of people claiming jobless benefits increased 39,300 last month, almost half the 60,000 pencilled in by City economists. In the minutes from the Bank of England's last meeting, also released today, the central bank added that the chance of a continued sharp contraction in the economy has 'somewhat receded.'

Unemployment has historically been a lagging indicator in past recessions but economists believe that the slowing pace of rising claimant count is evidence that the labour market has opted for alternatives to job losses, including pay freezes and reduced working hours. Business leaders including the chief executives at Tesco and Home Retail Group, the owner of Argos and Homebase, have warned that rising unemployment is the biggest obstacle to the economy moving into a recovery. A broader measure of unemployment rose to 2.26m in the three months to April, taking the unemployment rate to 7.2pc.

"The claimant count unemployment data boost hopes that the rise in the number of jobless has tailed off appreciably after surging at the beginning of the year," said Howard Archer, chief UK economist at IHS Global Insight. "Even if the economy does manage to eke out some growth over the coming months, it is unlikely to be strong enough for some considerable time to come to lead to a net creation of jobs. The Bank of England revealed today that all nine members of the Monetary Policy Committee voted to keep interest rates at the record low level of 0.5pc. Although the minutes acknowledged that recent data from the economy had been 'encouraging', it cautioned that "there was no reason to conclude that the medium-term outlook for the economy, and thus inflation, had materially changed.'

Many UK business were still struggling to cope through the downturn, according to insolvency experts. "Any talk of green shoots is still grossly out of sync with the reality on the ground. From where I'm standing things are as bad now as they were a few months ago," said Alan Tomlinson, partner at the insolvency practitioners, Tomlinsons. "The small and medium-sized companies that we deal with each day are still being decimated by sharp drops in turnover, growing debts and, critically, the ongoing failure of the banks to lend."

Dutch banks' Eastern Europe exposure 11% of GDP
Dutch banks' exposure to central and eastern European countries, hard hit by the credit crisis and recession, is about 11 percent of the national gross domestic product, the Dutch central bank (DNB) said on Wednesday. Emerging Europe is suffering from the global recession and bad debt, which started to rise in the first quarter and will increase throughout the year as the region's boom comes to an abrupt end.

The Netherlands' exposure compares to 70 percent of GDP for Austrian banks, DNB said. Data from the Bank for International Settlement showed in January that Germany as a country had an exposure of 6.6 percent of GDP and Belgium 30.1 percent. The Dutch exposure covers countries such as Poland and Latvia, and DNB also included Russia and Turkey in the number, it said in its quarterly report. Based on the Netherlands' 2008 GDP of 595 billion euros ($826 billion), the exposure would amount to some 65.5 billion euros.

DNB did not name specific companies, but Dutch bank and insurer ING earned about 5 percent - or 3.3 billion euros - of its operating income last year from eastern European countries, including Turkey. Euro zone banks could see losses of 7 percent of their Tier 1 capital if worst-case scenarios for emerging countries in Europe, Asia and Latin America materialise, the European Central Bank said in its financial stability report on Monday.

Latvia: A lat to worry about
Inara Blumberga is at the centre of an unprecedented economic gamble. The librarian from the Latvian beach resort of Jurmula faces a big cut in her salary as the Baltic nation embarks on a risky plan to pull itself out of an economic crisis harsher than any other country in Europe is suffering. With the backing of the International Monetary Fund and the European Union, Riga is hoping that if it can impose enough pain on the domestic economy, it will be able to maintain its exchange rate peg to the euro. That would allow it entry into the single currency zone within the next four years. After months of dithering, the government last week put together a package of measures that will mean Ms Blumberga – who earns just 280 lats ($552, £337, €398) a month – along with hundreds of thousands of other public sector workers will suffer a 20 per cent pay cut. Even pensioners will see reductions of 10 per cent.
Latvia ran into trouble managing the unprecedented surge in credit-fuelled economic growth that rushed through central and eastern Europe, driven by EU enlargement and globalisation. As small, open economies, the Baltics were swamped with foreign loans, chiefly from Swedish banks, particularly in their overheated property markets. But while Estonia and Lithuania worked to slow the pace, Latvia’s leaders ignored calls for restraint until it was too late. The end came last autumn with a currency and banking crisis, which forced the government to go to an IMF/EU consortium for €7.5bn ($10.4bn, £6.3bn) in emergency aid. For now, the financial markets are giving Latvia the benefit of the doubt: fears of an immediate devaluation have eased since the 500m lat austerity package appeared to unlock the door to a €1.4bn slice of the pledged funds that had been withheld.

Nor have Latvians so far mounted the kind of violent protests that last winter helped bring down the previous government and paved the way for the emergence of the current centre-right coalition. As Ms Blumberga says stoically: "There won’t be protests like in January, as you can achieve nothing. People hoped for something in January but no one expects anything now." However, economists warn there are few precedents of a crisis-hit country successfully pulling itself out of trouble without devaluing the currency. Even Argentina, which has adopted one of the least conventional routes to recovery of recent years, devalued as part of its shake-out early this decade. "What they are trying to do is, to the best of our knowledge, unprecedented in economic history," Rory MacFarquahar, an emerging markets expert at Goldman Sachs, says of the Latvians. "It is politically extremely painful and I don’t know whether it is sustainable." More is at stake than the fate of this EU country of 2.3m, which regained its independence from the Soviet Union in 1991. If Latvia succeeds, it would send a powerful signal that the ex-Communist countries, having endured the turmoil of that transformation, have the resilience to cope with the current global crisis.
But if Latvia fails, it could have a knock-on effect on other troubled economies in the region, particularly those with fixed exchange rates, such as Estonia, Lithuania and Bulgaria. Around the globe, small and vulnerable countries are responding to the crisis with budget cuts. Unable to borrow their way out of trouble, as the US and the UK are trying to do, they are struggling to contain deficits by reducing public spending, including cutting pay bills by slashing government employee numbers. Some are resorting to radical measures. Iceland is preparing its biggest-ever budget overhaul. Lithuania is mulling introducing student fees. Estonia has postponed previously agreed increases in unemployment benefit. But no administration is going as far as Riga in cutting actual pay. Under the IMF/EU rescue terms, Riga has pledged to keep its budget deficit to 5 per cent of gross domestic product. But with the economy contracting much faster than then forecast, the deficit could reach 12 per cent without remedial action. Even with the latest cuts, it will be 7 per cent, a figure that breaks the IMF’s normal boundaries.
After years of the fastest growth in the EU, Riga now foresees the economy shrinking 18 per cent this year, the bloc’s worst recession. The outlook for 2010 and beyond depends on the economies of western Europe and Russia, Latvia’s main trading partners. Without dramatic improvements in the pan-European economy, Riga seems set for further rounds of tax increases and spending cuts to keep the deficit down and convince the IMF to continue its support and qualify for eurozone membership by the government’s 2013 target date. "The government wants to feed the cow less and milk her more often," says one bank chief executive. Reaching for an even more pessimistic metaphor, he adds: "In a swamp there is no bottom." Landmark property developments such as the twin Panorama Plaza towers on the road between Riga and the airport stand all but empty and shopping malls look forlorn. House prices fell by one-third last year, insolvencies are up and banks are repossessing more mortgaged properties and leased cars. "Business is in hibernation," says Gunnar Ljungdahl, who chairs the Swedish chamber of commerce in Riga.
In these circumstances, many governments devalue to spread some of the costs to foreign creditors and to boost the economy by making exports – which include wood products – more competitive. IMF officials have indicated that the organisation was divided over the wisdom of defending the lat’s peg but was finally persuaded by pressure from Riga’s EU partners as well as the Latvian government’s own refusal to contemplate devaluation. Latvia sees the currency peg as the linchpin of its economic policies. It helped drive down inflation and is the route to euro entry. Latvia’s governments have often been weak but have always defended the peg and supported the powerful central bank, where both the prime minister and finance minister used to serve. "For Latvia the peg is the last pillar of trust," says Henrik Hololei, an Estonian cabinet head at the European Commission. Also, Latvian officials argue that in a small economy, where 60 per cent of export value is in imported content, devaluation will not do much except encourage inflation. With some 90 per cent of all loans in euros, they add, it could bankrupt tens of thousands of companies and individuals. But the price of avoiding devaluation will be huge economic, social and political strains. Valdis Dombrovskis, prime minister, admits his main challenge now is "to preserve the social peace".
Some opposition politicians predict a rough autumn as unemployment rises from 11 per cent today to a forecast 20 per cent and those jobless for more than a few months find their benefits reduced to just 30 lats a month. Trade unions are planning a demonstration for tomorrow. The crisis could also exacerbate tensions between the majority and ethnic Russians, who comprise about 30 per cent of the population and sometimes hanker for closer ties with Moscow. Harmony Centre – a coalition seen by the other parties as pro-ethnic Russian – made strong gains in this month’s European parliamentary elections. Top spot went to Alfreds Rubiks, a former Riga mayor, who says: "Our government backs this budget but people do not." Yet most Latvians appear resigned to cuts. Many make light of today’s hardship compared to the Soviet era or the tough post-Communist transition. After years of big pay rises, some are reconciled to making sacrifices. Ivars Godmanis, a former prime minister, says survival will depend on the government and the people huddling together like "penguins".
These survival instincts will now be tested. Independent economists doubt whether Riga’s great gamble will work even with IMF/EU backing. Morgan Stanley analysts say: "Devaluation is inevitable and obviously getting closer." Even the IMF is unsure, warning that "correcting currency misalignment without nominal depreciation is extremely difficult". If Latvia’s stabilisation plan fails, the repercussions would be widespread. First, investors would question the strength of other fixed currency regimes, starting with Latvia’s Baltic neighbours. Estonia, with a fiscal reserve accumulated in good years, is in a stronger position than Lithuania. But both are enacting austerity budgets in the face of forecast GDP declines this year of around 15 per cent. Further afield, Bulgaria insists it can maintain its fixed exchange rate without IMF support. But its socialist government faces a drubbing in elections due next month. Elsewhere in the region, countries with floating exchange rates, including Poland, the Czech Republic and Hungary, have seen their currencies hit by market turmoil over Latvia. "We have seen the risk of contagion is still there," says Andras Simor, Hungarian central bank governor.
The brunt of any losses would be borne by Sweden’s banks, whose Baltic assets amount to $80bn, or 16 per cent of Swedish GDP. In an extreme scenario, Baltic credit losses would reach 34 per cent of loans for Swedbank and SEB, the two biggest, which the national regulator has warned to reinforce their capital reserves. The European Central Bank is also worried and has lent Sweden €3bn to guard against its banks’ Baltic exposure. As the Commission’s Mr Hololei says: "Many countries in the region are dependent on how Latvia will get out of the crisis." Cut off from international capital markets and still tens of billions of dollars in arrears with public and private creditors, Argentina has been a financial pariah since its 2001-02 crash led the country to take drastic measures to right itself – involving a $95bn debt default, writes Jude Webber. The country remains out in the cold because of its refusal to return to International Monetary Fund scrutiny of its public accounts, even after paying off its $9.5bn debts to the lender in one fell swoop in 2006.
But now, the global financial crisis has given respectable developed economies fighting with high debt, ballooning spending and lower international confidence a taste of what it feels like to be Argentina. In turn, the Latin American maverick is suddenly being viewed as a test bed for ways to restore stability. As worldwide recession bites, countries struggling to meet tough deficit limits and spending cuts the Fund has imposed on them as a condition of bailing them out are trying to assess whether Argentina’s go-it-alone stance works out any better than the fiscal medicine they are being ordered to swallow. "I wouldn’t be so quick to say that there is no alternative to the IMF," says Aldo Caliari at the Center of Concern, a Washington think-tank. He praises the exchange rate targeting and demand-led model that have been features of Argentine policy under Néstor Kirchner in 2003-07 and since then under the presidency of his wife Cristina Fernández, which led to six years of growth averaging 8.5 per cent in Argentina’s rebound from its crash.
In its transition out of chaos, Buenos Aires adopted a devalued exchange rate, kept real wages low, froze public sector tariffs and introduced a web of energy, transport and food subsidies. Together this was dubbed a "heterodox" approach, as opposed to the orthodoxy preached by the IMF. Argentina’s experience, as that of other countries struggling now, reveals that "in times of crisis, you’ll do what’s necessary to survive", says Mario Blejer, a former IMF official who headed the Argentine central bank for the turbulent first half of 2002. With governments worldwide seeking creative ways to combat the crisis – such as the US Federal Reserve buying government bonds – the eccentric has almost become the conventional, he adds. "I don’t know what is heterodox any more." Indeed, the Argentine crisis showed that "countries can default and the world doesn’t end", says a senior official at one multilateral lender. Ecuador, for instance, defaulted on $3.9bn of debt last year.
But Argentina has failed to move on by creating stable conditions for investment. As countries worldwide seek to emerge from recession, they will face the same challenges to improve competitiveness by boosting infrastructure, education, technology and labour productivity – tests that Argentina has so far failed. Furthermore, it has settled neither with private creditors, which rejected a debt restructuring in 2005 and whose legal action has barred it from tapping international markets, nor with the Paris Club of western creditor nations. Argentina last year promised to pay off its $6.7bn Paris Club arrears using central bank reserves, but that plan was buried by the international crisis. Since the default the government has, moreover, clung to the excuse of economic emergency to give it leeway to pursue its policies. That essentially allows Argentina to break contracts if necessary – alienating investors, who class it alongside Venezuela, Ecuador and Bolivia as the "bad boys" of South America.
The problems are hardly easing. They include higher-than-expected capital flight as savers take dollars abroad, and decelerating tax revenues – which according to Luís Secco, an analyst, mean Argentina is living way beyond its means. For every peso the state earns in taxes, it is now spending 1.8 pesos, he says. Mr Caliari adds: "The government cannot rest on its laurels. It needs to be more cautious about spending. Heterodox doesn’t mean you can ignore economic realities." The high outlays reflect a pre-election spending spree as Ms Fernández fights to retain a majority in Congress on June 28. The mid-term polls are being portrayed by the government as a referendum on its economic model: a choice between more of the high growth Argentines have become used to and a return to the chaos of previous years, when poverty and unemployment soared. "It isn’t important at this stage to have a programme or financial arrangement with the Fund," says Mr Blejer. "But it is important to slowly normalise international financial relations to gain access back to capital markets and improve the flow from other multilaterals."

China risks trade suicide
Beijing is playing with fire by issuing a `Buy China' edict for its stimulus package. As the world’s top exporter with a $400bn current account suplus and an economy that lives off the America and European market, it will pay the highest price if it triggers a global retreat into protectionist blocs. The Chinese elite no doubt feel provoked by what they call the "poison" of the US `Buy American’ clause, but the Obama White House managed to tone down the worst excesses of Capitol Hill and in any case the Chinese version is more restrictive.

It bans the purchase of foreign equipment for investment projects unless a special exemption is obtained. The measures apply to European goods, even though EU states have not imposed any such "Buy Europe" clause of their own. EU producers of wind turbines have already been excluded from a $5bn wind project, whether or not they have factories in China. Beijing risks making the same catastrophic error as the US Congress when it passed the US Smoot-Hawley Tariff Act in 1930. America was then the rising surplus power, like China today. It was the chief beneficiary of an open global system.

By imposing tariffs, Washington triggered massive retaliation. While nobody escaped the Great Depression that ensued, the effects were unequal. The US suffered a far steeper decline in output than the rest of the world. Britain muddled through relatively well in a trade bloc behind Imperial Preference. China’s action is extremely disturbing. It confirms what we have long feared, that the Chinese government is sufficiently worried about rising unemployment to adopt suicidal measures. Nor does this episode instill confidence in the `China recovery story’. While exports fell 26pc in April, imports were down by almost as much. There is no real rebalancing under way from external to internal demand. China is still running a massive surplus. It is flooding the world with excess goods, and exporting deflation. This is untenable. At some point, the West will react.

Alberta May Borrow as Much as C$5 Billion As Deficit Widens
Alberta, the Canadian province that sits on the largest pool of oil reserves outside the Middle East, may borrow as much as C$5 billion ($4.41 billion) over the next three years after posting its first budget deficit in more than a decade. "We haven’t let the ink dry on the final program yet, but we’re looking at bonds, and we’re looking at the opportunities," Finance Minister Iris Evans told reporters following a speech today at the Economic Club of Canada in Toronto.

The province will borrow C$1.1 billion this year and Alberta officials have been meeting with banks to indicate they may borrow more, she said. A decline in tax revenue led to the first deficit since 1993 last year, forcing the government to turn to debt markets for the first time in more than a decade. Alberta projected a record deficit of C$4.71 billion for the fiscal year ending in March, following a C$1.4 billion shortfall last year. Alberta’s gross domestic product is expected to contract by 2.5 percent this year, the steepest decline in 17 years, according to RBC Economics.

Green Green Shoots of Home
by Willem Buiter

For the past week, I have put the Green Shootometer in the garden and have taken regular readings.  The upshot is: the glass is definitely half empty - or half full.  Let me explain.
So far, so bad
As is clear from the most interesting blog post by Barry Eichengreen and Kevin O’Rourke, and its recent update on VoxEU, the global economy is, as regards some key activity indicators (industrial production, world trade, world stock markets), tracking the Great Depression of the 1930s with frightening precision and tenacity (see also Martin Wolf’s recent  column "The recession tracks the Great Depression" on this).    They date the start of the current global contraction in April 2008.
But here’s the good news
However, somewhat to my surprise, central bankers and policy makers turn out to be capable of learning, even across generations.  The lessons of the 1930s appear to have been learnt.  New mistakes are being made all over the place, especially as regards moral hazard, the too-big-to-fail problem and other incentives for excessive risk taking in the financial sector, but that won’t become a serious problem until the next bust following the next financial and asset market boom and bubble. Monetary policy has been vastly more expansionary in the current downturn that during the corresponding phase of the Great Depression, whether measured by official policy rates or by the behaviour of the world broad money stock.  As regards the actions by the monetary policy makers, the behaviour of the narrow money stock (monetary base) or the size of the balance sheets of the central banks would show an even more expansionary thrust.  Fiscal policy, unlike what happened in most of the 1930s is counter-cyclical.
In addition, the world has not launched a major trade war on itself.  Perhaps I should have said ‘not yet’.  Of the 19 nation states that made up the G20 at the London meeting on April 2, 2008, 17 had announced or introduced protectionist measures by the time of the November meeting in Washington DC.  While none of these measures amounted to open warfare, recent words and actions from India and China are extremely worrying.  In January, India banned the import of Chinese toys for a six-month period (supposedly because of safety concerns).  When China threatened to take the issue to the WTO, India lifted the ban after two months.  Last week, India’s Federation of Chambers of Commerce and Industry (representing SMEs) accused China of predatory pricing.  Today’s Financial Times reports that China has introduced a ‘Buy Chinese’ policy.  Even the watered-down version of the ‘Buy American’ policy enacted recently in the US caused considerable tension.  The world is playing with fire, trying to export its unemployment problems to other planets.
Inflexion points and turning points
If you eyeball Eichengreen and O’Rourke’s updated Figures 1, 2, 3 and 4 (reproduced below), you may feel that we are just about at the point where things are not just getting worse more slowly (as regards the level of global production and trade) but may actually be getting better: we may appear to have moved past the inflection point to the turning point.

Whether that interpretation is correct depends in part on which activity index you look at.  Unemployment will go on rising, possibly for several years.  Both industrial production and trade focus on physical goods, rather than on services.  Industrial production is a rather small share of global GDP (probably somewhere between 20 and 25 percent).  It also tends to be much more volatile that the production of services, because industrial production is subject to the inventory cycle. The inventory cycle overstated the severity of the downturn, especially in countries with relatively large manufacturing sectors, like Germany, Japan and Brazil.  Because of the nice property of inventory stocks that they cannot be negative, there is a natural non-linearity on the down-side of the inventory cycle.  So following world-wide de-stocking, a rebound in industrial production and GDP is all but a mechanical certainty.  There remain two key unresolved issues.  First, what target levels of inventories relative to planned or expected sales or production manufacturers, wholesalers and retailers will want to maintain.
This drives the strength of the strength of the inventory rebound.  Second, which components of final demand (private consumption, private fixed investment and government spending on good and services) will take over when inventory accumulation peters out again (exports are a source of ‘final’ demand for individual countries, but not for the world as a whole, since globally, exports equal imports). Global financial markets have normalised, in the sense that spreads have return to the levels just before Lehman fell over.  I must admit to feeling, in early September 2008, that financial market conditions were far from favourable, however.  So cardiac arrest may have been seen off, the patient is not about to jump out of bed and do a horlepip.  Access to capital markets has been restored for many of the larger firms, but the cost of funding tends to be high.   In part, the recent burst in capital market funding represents a diversion of funding demand away from the banks, which are generally still in a zombified state.  It also tends to be unavailable to SMEs.
What are the prospects for final demand?  Not too bright, I would argue, in the US.  Households are traumatised by capital losses on equity; if they are homeowners, they will have suffered massive capital losses on their homes.  While this negative wealth effect for households long housing (landlords) is balanced by a corresponding gain on those short housing (tenants), the collateral reduction caused by the house price collapse has short-term negative consequences for the ability to borrow.  In addition, if the collapse in house prices represented at least in part the bursting of a bubble, the capital losses of the landlords are not matched by corresponding gains (in present discounted value terms) for tenants. US demand has been supported by the Obama administration’s fiscal stimulus package.  With the Federal deficit likely to be somewhere around 13 to 14 percent of GDP this year, and public debt building up rapidly, not just as a result of these deficits but also as a result of off-budget increases in government (contingent) liabilities associated with the myriad financial support and rescue packages cobbled together for the US financial sector (and selected bits of the rust belt real economy), there is no scope for a further fiscal stimuli financed by debt issuance, unless this debt issuance were monetised by the Fed.
Monetary policy has been extraordinarily expansionary, with the official policy rate as close to zero as makes no difference and large-scale quantitative and credit easing.  This too is pretty much an exhausted set of policy instruments, except in conjunction with a fiscal stimulus.  Tax cuts or increased transfer payments financed by the issuance of Treasury debt that is purchased and monetised by the Fed is the real-world version of helicopter money.  There exists a scale for those operations large enough to stimulate demand.  The problem is their reversibility, once the output gap closes and inflationary pressures beging to build again.  Increases in public spending on real goods and services could also be monetised by the Fed. Again this will stimulate demand but is subject to the same reversibility or exit problems as helicopter drops of money.
All crossborder US banks, and probably most larger purely domestic US banks are now de-facto guaranteed against insolvency by the US government.  This is the moral hazard disaster I referred to earlier: too big and too politically connected to fail.  Even where it could have been used (for Federally insured deposit-taking banks), the US authorities have not invoked the special resolution regime for commercial banks to force the unsecured creditors to recapitalise the big banks, through mandatory debt-to-equity conversions, haircuts or similar measures.  Instead the tax payer was made to pick up the tab. But at least new capital has gone into the banks on a reasonable scale.  The US stress tests, cautious though they were, did lead to banks going to the market and successfully raising capital.  The fact that the methodology and the results of the stress tests are in the public domain also help build confidence. Many silly things have happened also.  Two attempts at getting the toxic assets off the banks balance sheet (the first one under Paulson through the TARP, the second one under Geithner through the PPIP) have failed.  This failure to adopt a consistent bad bank approach (let alone pursue the alternative good bank(s) approach), means that the surviving banks still have some of the toxic rubbish on their balance sheets, which inevitably acts as a drag on new lending.
Allowing 10 banks that had received public capital injections to repay the government is pandering to banks chomping at the bit to get the government out of their hair and return to the bad old ways that brought us the financial crisis.  Perhaps a couple of banks were truly in a position to repay the government, without impairing their ability to act as banks, that is, to engage in new lending.  The remaining banks will act to varying degrees like zombie banks - surviving, but engaging in little new lending and other business likely to stimulate activity and support a dynamic changing economy.  Following the Japanese example of recapitalising gradually out of operating profits generating in no small part because of explicit or implicit government guarantees of bank funding and high private lending rates is likely to lead to a Japanese-style lost quinquennium or even a lost decade.
The UK’s recession has turned out to be less deep than I feared and anticipated.  In part this is due to the large fall of sterling (still 20 percent weaker than before the downturn, despite the recent gains).  This good news, if it sticks, is qualified by the likelihood that any recovery will be slow and meek.  Household consumption has been remarkably resilient, but given the state of the UK household balance sheet, it is hard to see consumer demand growth being the internal locomotive.  Private investment, including residential and non-residential construction, is bound to remain weak for the foreseeable future.  Government spending will have to be cut soon in real terms if a public finance Armageddon is not to befall the country, which is in dreadful fiscal shape.  Tax increases are also all but unavoidable if fiscal-financial sustainability is to be restored.
Like the US banks, the UK’s banks are surviving but to varying degrees zombified.  Even those banks that have managed to stay out of the clutches of the state have had to engage in so much defensive balance sheet restructuring that they are falling way short in their supposed role as conduits for intermediation between households and non-financial enterprises.  There have been stress tests in the UK, but neither the methodology or the results have been put in the public domain.  They have therefore been quite useless as regards restoring confidence.  In addition, the tests were performed by the FSA, which does not yet have the personnel capable of performing a proper stress test.  Historically, it has been a box tickers organisation, dominated by lawyers and accountants - both quite useless skills as regards stress tests. As in the US, moral hazard has been king in the government’s approach to providing financial support to the banking sector.  Concentration has increased and the too big and too politically connected to fail problem has never been more acute.
The Euro Area has performed remarkably badly in this downturn.  This is partly due to the ECB, whose policy stance has been less expansionary than that of the Fed and the Bank of England.  Its official policy rate still stands at 1.00 percent, around 100 basis points above the level it should be at, and the Eurosystem has expanded its balance sheet less than the Fed and the Bank of England.  A more serious problem is that addressing the solvency of the banking system in the Euro Area has not yet begun in earnest.  There have been government capital injections (or announcements of such) when banks were about to fall over (Commerzbank and assorted Landesbanken in Germany, ABN-Amro and ING in the Netherlands, and many other banks in Belgium, Ireland, France, Italy and now Spain), but it has been even less systematic and on a smaller scale than in the US. In addition, the Euro Area banks have managed to keep the problem assets they have on their balance sheets under wrap.  No stress tests whose methodology and/or outcomes are in the public domain have been performed.
The European Commission now wants a uniform set of EU-wide stress tests, but only to give it and supervisors/regulators a sense of what the risk-map is, not as a prelude to mandatory capital raising and/or a restructuring of funding strategies. The Euro Area banks have used every accounting trick in the book to avoid revealing the existence of troubled or toxic assets and marking them to market.  The ECB recently estimated the additional capital required by the Euro Area bans at between €212 and €283 bn.  People close to the industry assure me that the true figure is at least twice that amount.  So Euro Area banks are likely to be or become zombie banks to a much greater degree than their US and UK counterparts.  They have revealed little, recognised less and are, to an unknown degree, still subject to material insolvency risk because of undeclared horrors on their balance sheets.  Their high degree of leverage also makes them extremely vulnerable to further balance sheet deterioration as conventional household, industrial and commercial loans go belly-up in increasing numbers as the recessions deepens and lengthens.
I don’t understand the Japanese economy.  Never have.  Probably never will.  I don’t understand why the official policy rate has been below 0.5 percent since 1995 - effectively in a liquidity trap.  I don’t understand why, given that first fact, the stock of outstanding public debt has not been monetised to the point that Japan has an inflation rather than a deflation problem.  I do understand, sort of, the inventory cycle Japan in going through and in which it now appears to have entered the inventory re-accumulation phase.  Unless Japanese consumers have a major change of heart, however, it is hard to see Japan as a global locomotive.
The emerging markets are a very heterogenous bunch.  Their recent economic performance and prospects range from quite good (India, Turkey, Brazil since the end of the destocking implosion), to prima facie quite good (China) to pretty mediocre or bad (Central and Eastern Europe), to dismal (Russia). Those emerging markets that (1) did not have their domestic financial sectors destroyed or excessively exposed to parent banks in the North Atlantic region; (2) are not excessively dependent on export demand and (3) are not too dependent on foreign funding are likely to do best and have a ‘V’-shaped recovery.  India ticks all the boxes.  Unfortunately for the rest of the world, it is still too small and too closed to be a global demand enging.  Brazil is fairly export-dependent.  Despite its stong net foreign financial investment position, its enterprise sector has a large foreign exposure, so there are vulnerabilities here.  However, with unusually restrained fiscal policy and unusually responsible monetary policy, it had prospects for becoming the medium-sized engine that could.
China is the great unknown. It is big enough to make a global impact.  It is, however, very export dependent.  It will have to swicth demand towards domestic final demand, including consumption of non-traded goods and services.  The potential is certainly there.  The extravagant Chinese saving rate can be tackled in the household sector by introducing a nation-wide unfunded social security retirement scheme (possibly with a contribution holiday for a couple of years up front), with greater public funding of health care and with increased public funding for education.  The state enterprise sector has been hoarding funds for a long time, and the Chinese government may finally be able to extract these surpluses. There also is much scope for environmental investment, investment in light industry and residential investment.  A key question is whether the Chinese authorities have the implementation capacity to steer this change in the composition of production and demand towards import-competing goods and non-traded goods and away from exportables.  Given enough time, they no doubt can, but it is not obvious that it will be possible to achieve this right now - over a horizon relevant to the cyclical state of the Chinese and global economy.
A map of government-sponsored investment programmes for China shows a marked concentration inland, which is consistent with the need redirection of final demand and production away from exports.  Whether this is a wish list or a list of project likely to result in production during the next two or three years I don’t know. Finally, there is the usual worry about the quality and bias in the Chinese statistics.  In China, as in most authoritarian states, statistics are not primarily a source of information, but a policy tool and a propaganda instrument.  Corroberation is therefore important.  Chinese energy (electric power) consumption historically tracks industrial production and GDP quite well.  Not so since the downturn began.  Power consumption has been declining despite continuing GDP growth.  As there has been no big push on energy conservation in China, either through prices or through administrative methods, this coexistence of rising GDP and declining power use is strange. Bottom line is, I continue to have doubts about the strength of the Chinese growth performance, but would welcome confirmation that eight percent growth or more this year is truly achievable.
There are other indicators to support the view that the global economy may be turning.  Commodity prices, including oil, are rising and well above their recent lows.  This is consistent with the view that emerging markets, which are notoriously energy-inefficient, are likely to be the early demand drivers in the recovery. Survey data, in the US, the UK and the Euro Area tend to be stronger than the hard data.  Of course, the hard data are not hard at all, but just survey data several times removed.  Against that, sentiment is fickle and volatile.  A massive sense of relief that the world is not falling apart completely may get reflected in an up-tick of consumer sentiment but may not translate neatly into an increase in consumer spending. But on balance, there are more signs that the worst is over.  There are also signs that the recovery whenever it started or may start, will be slow and reluctant.  Recoveries without healthy banks are possible, but more difficult. Those of you familiar with the lyrics, written by Claude "Curly" Putman Jr., of the country song and ultimate Schmachtfetzen  ‘Green Green Grass of home’, will know that the last verse (spoken) starts:
"Then I awake and look around me, at four grey wall surround me and I realize that I was only dreaming."
As far as I’m concerned, I’ve been down so long, it looks like up to me.

As Iraq runs dry, a plague of snakes is unleashed
Swarms of snakes are attacking people and cattle in southern Iraq as the Euphrates and Tigris rivers dry up and the reptiles lose their natural habitat among the reed beds. "People are terrified and are leaving their homes," says Jabar Mustafa, a medical administrator, who works in a hospital in the southern province of Dhi Qar. "We knew these snakes before, but now they are coming in huge numbers. They are attacking buffalo and cattle as well as people."

Doctors in the area say six people have been killed and 13 poisoned. In Chabaysh, a town on the Euphrates close to the southern marshland of Hawr al-Hammar, farmers have set up an overnight operations room to prevent the snakes attacking their cattle. "We have been surprised in recent days by the unprecedented number of snakes that have fled their habitat because of the dryness and heat," Wissam al-Assadi, one of the town's vets said. "We saw some on roads, near houses and cowsheds. Farmers have come to us for vaccines, but we don't have any."

The plague of snakes is the latest result of an unprecedented fall in the level of the water in the Euphrates and the Tigris, the two great rivers which for thousands of years have made life possible in the sun-baked plains of Mesopotamia, the very name of which means "between the rivers" in Greek. The rivers that made Iraq's dry soil so fertile are drying up because the supply of water, which once flowed south into Iraq from Turkey, Syria and Iran, is now held back by dams and used for irrigation. On the Euphrates alone, Turkey has five large dams upriver from Iraq, and Syria has two.

The diversion of water from the rivers has already destroyed a large swathe of Iraqi agriculture and the result of Iraq being starved of water may be one of the world's greatest natural disasters, akin to the destruction of the Amazonian rainforest. Already the advance of the desert has led to frequent dust storms in Baghdad which close the airport. Yet this dramatic climatic change has attracted little attention outside Iraq, overshadowed by the violence following the US-led invasion in 2003 and the overthrow of Saddam Hussein.

The Saw-Scaled Viper is blamed for more deaths than any other species in the world.

The collapse in the water levels of the rivers has been swift, the amount of water in the Euphrates falling by three-quarters in less than a decade. In 2000, the flow speed of the water in the river was 950 cubic metres per second, but by this year it had dropped to 230 cubic metres per second. In the past, Iraq has stored water in lakes behind its own dams, but these reservoirs are now much depleted and can no longer make up the shortfall. The total water reserves behind all Iraqi dams at the beginning of May was only 11 billion cubic metres, compared to over 40 billion three years ago.

One of the biggest dams in the country, on the Euphrates at Haditha in western Iraq, close to the Syrian border, held eight billion cubic metres two years ago but now has only two billion. Iraq has appealed to Turkey to open the sluice gates on its dams. "We need at least 500 cubic metres of water per second from Turkey, or double what we are getting," says Abdul Latif Rashid, the Iraqi Minister of Water Resources. "They promised an extra 130 cubic metres, but this was only for a couple of days and we need it for months."

His ministry is doing everything it can, he says, but the most important decisions about the supply of water to Iraq are taken outside the country – in Turkey, Syria and Iran. "In addition there has been a drought for the last four years with less than half the normal rainfall falling," says Mr Rashid. Large parts of Iraq that were once productive farmland have already turned into arid desert. The Iraqi Ministry of Agriculture says that between 40 and 50 per cent of what was agricultural land in the 1970s is now being hit by desertification.

Drought, war, UN sanctions, lack of investment and the cutting down of trees for firewood have all exacerbated the crisis, but at its heart is the lack of water for irrigation in the Tigris and Euphrates. Farmers across Iraq are being driven from the land. Earlier this month, farmers and fishermen demonstrated in Najaf, a city close to the Euphrates, holding up placards demanding that the Iraqi government insist that foreign countries release more water.

"The farmers have stopped planting and now head to the city for work to earn their daily living until the water comes back," said Ali al-Ghazali, a farmer from the area. "We pay for our seeds at the time of the harvest, and if we fail to harvest, or the harvest has been ruined, the person who sold us the seeds still wants his money." Najaf province has banned its farmers from growing rice because the crop needs too much water.

The drop in the quantity of water in the rivers has also reduced its quality. The plains of ancient Mesopotamia once produced abundant crops for the ancient Sumerians. From Nineveh in the north to Ur of the Chaldees in the south, the flat landscape of Iraq is dotted with the mounds marking the remains of their cities. There is little rainfall away from the mountains of Kurdistan and the land immediately below them, so agriculture has always depended on irrigation.

But centuries of irrigating the land without draining it properly has led to a build-up of salt in the soil, making much of it infertile. Lack of water in the rivers has speeded up the salinisation, so land in central and southern Iraq, highly productive 30 years ago, has become barren. Even such rainfall as does fall in northern Iraq has been scant in recent years. In February, the Greater Zaab river, one of the main tributaries of the Tigris, which should have been a torrent, was a placid stream occupying less than a quarter of its river bed. The hills overlooking it, which should be green, were a dusty brown.

Experts summoned by the Water Resources Ministry to a three-day conference on the water crisis held in Sulaimaniyah in April described the situation as "a tragedy". Mohammed Ali Sarham, a water specialist from Diwaniyah in southern Iraq, said: "Things are slipping from our hands: swathes of land are being turned into desert. Farmers are leaving the countryside and heading to the city or nearby areas. We are importing almost all our food, though in the 1950s we were one of the few regional cereal-exporting countries."

The experts recommended that, in addition to Turkey releasing more water, there should be heavy investment to make better use of the waterways such as the Tigris and Euphrates. But this year Mr Rashid says that his budget for this year has been cut in half to $500m (£300m) because of the fall in the price of oil. The outcome of the agricultural disaster in Iraq is evident in the fruit and vegetable shops in Baghdad. Jassim Mohammed Bahadeel, a grocer in the Karada district, says that once much of what he sold came from farms around the Iraqi capital. "But today, the apples I sell come from America, France and Chile; tomatoes and potatoes from Syria and Jordan; oranges from Egypt and Turkey. Only the dates come from Iraq because they do not need a lot of water."

Rightly feared: Iraq's deadly reptiles
*Saw-Scaled Viper (Echis carinatus) About 2ft long, this viper is blamed for more deaths than any other species in the world. Its bite causes extensive internal haemorrhaging in its victims. Recognisable by an arrow-shaped marking on the head.

*Desert Horned Viper (Cerastes cerastes) The Desert Horned Viper is typically found in sandy terrain and is a common sight in Iraq's southern deserts, identified by the bony horns over its eyes. It lurks in sand, only eyes, nostrils and horns above the surface.

*Desert Cobra (Walterinnesia aegyptia) Like most cobras, it is easily adaptable to various habitats. But locations occupied by humans are a particular favourite where shelter and rodents are on offer. Whilst this glossy snake does not actively seek confrontation, it can move with lethal speed when provoked.


dan w said...

Thanks Stoneleigh....

A question....

I am finding the deflation vs. inflation discussion absolutely fascinating. I was thinking that continued efforts at QE---in concert with an abandonment of the dollar as the world's reserve currency and a foreign creditor collapse---could mean a combination of the WORST elements of both dynamics: massive price INCREASES vis-a-vis the cost of commodities and goods/services necessary to everyday survival, while simultaneously a continuing and massive bout of DEFLATION (viz the evaporation of credit and attendant debt destruction).

So like, the stuff you need to survive everyday life getting more and more expensive, and yet nobody having enough money with which to buy the stuff---even if it were to FALL in price.


ca said...

Stoneleigh --

Extraordinary summary!

Could you provide some timelines for the unfolding of these events?

Anonymous said...


How long do you see cash being king? I currently hold both gold and silver bullion and am wondering about converting a portion to dollars to retain some purchasing power.

I very much appreciate what you and Illargi are providing. Thank you!!!

The Lizard said...

CA sayeth: "Could you provide some timelines for the unfolding of these events?"

If you buy into her description of events you will prepare, and a timeline will be irrelevant.

Be wise.

Anonymous said...

If the money supply was created by so much credit, and much of that owed debt will be defaulted upon, won't that decrease the money supply?

Or does that debt just float around and remain part of the money supply?


rapier said...

I'd been wondering about the state of Iraqi agriculture for a long time. I mean a really long time. Since the first Gulf War I guess. Admittedly I did only lazy web searches on the issue but such basis information is oddly highly specialized and not easy to find.

So here it is. The very birthplace of civilization, which means agriculture, and the fields are disappearing. Perhaps I'm a romantic but the portents are astounding to me. It's less astounding I suppose that the story is going almost unremarked but that in a way is even more freighting.

True the story is political as a weakened Iraq was powerless to stop the theft of the water from those mother rivers, the Tigris and Euphrates. Again the romantic in me is attracted to rivers. Their names, their stories. It is to me profoundly sad. Sad it has happened. Sad that the Great Global Strategic Thinkers think not of it at all.

el gallinazo said...

My e-address:

hpaulfuchs **(at)** gmail, a commercial company.

CA's collection of Stoneleigh's comments is now available as an attachment. I did no internal editing of it. I just reconstructed the file format. Email me a request and I will send it back.

Ishmael said...

Wasn't it really the birth of agriculture that marked a deadly shift for humans on this planet?

Agriculture enabled us to stop roaming. As it advanced, villages were established, then towns, cities, division of labor, economies, governments, population growth, need for slaves, need for trade, need for more space, need for war, etc.

The birth of agriculture was the day we all died.

Anonymous said...

Question: Does Willem Buiter really believe the garbage that he writes about incipient stabilization and recovery?

He definitely disagrees with our hosts regarding the medium to long term prospects for the economy and civilization.

I never know what to think about guys like Buiter. In some respects, he seems like a sharp guy. His suggestion to let the old big banks whither and die, while using public money to create new good banks seemed like a relatively good idea a few months ago (with emphasis on the relative aspect. It would obviously be better to undergo a wholesale reorganization of society away from fractional reserve lending).

Now Buiter just sounds like everybody else talking about recovery and "the worst is over." Does he say that nonsense to keep his invitations to high society parties and sherry at noon in the Financial Times dining club?

D. Benton Smith said...

Dear Stoneleigh,

Thank you for the unexpurgated summary.

Sort of stunning to get it all at once, laid out like a Federal Indictment, but that's okay. Nothing to gain from soft pedaling the truth, as the saying goes.

Someone observed that personal integrity consists of seeing, and that courage consists of clearly saying it.

Girl, you got buckets of both.

bluebird said...

Stoneleigh - Thank you for the summary, much appreciated.

Taizui said...

Thanks Stoneleigh,

Re #36 - Hard limits to capital and energy will greatly reduce socioeconomic complexity (see Tainter): Repeating a question from yesterday, how might energy costs impact the internet?

Some have posted opinions about internet becoming less free, less open, which seems likely, indeed it already seems headed that direction. Yet it has become so integral to today's world that extraordinary effort will probably be expended to keep it afloat. And in relative terms, the energy that requires would seem to be trivial compared to transportation, heating, and whatever industries survive.

Similarly with #35 (unaffordable oil) - I have a tractor which I use for gardening, and am extremely conscious about how much fuel I use. Interestingly, the amount is trivial compared to the consumption of my small car, which I fill without even thinking. However, when fuel is $20/gallon, the few gallons I buy would probably go to the tractor since it replaces manual labor that's well beyond my physical capacity.

Then again, perhaps I haven't yet comprehended the nature of the world we're entering. To attempt to do so seems like trying to solve an equation with an infinite number of variables - well beyond my mental capacity.

Dr J said...

Ishmael said - "The birth of agriculture was the day we all died."

I tend to agree from a health perspective.

Have a look at this:

Anonymous said...

Hasn't it been the case throughout history that if the rules that govern the system become too much for the government to bear, that they simply change the rules? The bigger the problem, the bigger the rule change.

I guess the biggest example would be how FDR broke the deflationary spiral of the Great Depression by simply changing the rules of the game.

How do you analyze this moment in history, and come to conclusions about what may happen in the future, when we have examples of governments changing the rules when things get so bad?

What makes you guys think that the rules will not change this time around?

ric2 said...

scary, brilliant, and like another commenter mentioned, reminds one of a 40-count federal indictment.

echoing dan wʻs point, chris martenson over at The Crash Course thinks inflation is on the horizon, citing the close correlation between government spending and cpi inflation (view chart). anyone have any thoughts on this? is the current credit destruction / deleveraging so historically unprecedented that this chart has no predictive value?

D. Benton Smith said...

@ Anonymous 11:34 PM

Re: rule changes

Right. Any Calvin and Hobbs fans in the house? Remember the way they play baseball?

Thus the term: "Calvin's Rules."

Earnest Lux said...


Thanks for the crop circle link.

Showed it to my wife, she said it was a work of art, implying that it was manmade I think. Did a bit of research on Circles and re presented what I discovered to her. She got interested too and we spent all day into the early hours of the morning combing the web for info.

We are both now pretty convinced that many are not made by human activity and that they are an attempt to convey information or establish communication.

We are going to do a lot of formal meditation and magic on all those Circle Symbols and see if we can decode them. You've done our family a big favour with that little link inclusion, I had forgotten all about Circles.

A modest money order is in the mail.

Crop Circlers are doing lot's of comparisons with many old religions and majiks (eg Tarot, Astrology). These folk prognosticate from their metaphysical musings that something big is gonna happen in August.

From my own musings on astrology- Late August.

Indexes are currently tracking as per some previous observations I made along these lines, somewhat more agressively than anticipated.

Ladies and Gentlemen, please return to your seats and observe that The Captain has turned on the seatbelt sign. We may experience a little turbulence from the weather system ahead just prior to commencing our descent. For your comfort we have provided all of Mr O's speeches on the in flight entertainment system, should you need some alprazolam please ask one of the flight attendants.

Anonymous said...


C and H called it Calvinball. Maybe we should call what is going on in Washington Calvinomics.

Here are some codified Calvinball rules from Simply Calvin and Hobbes.

1. All players must wear a Calvinball mask. No one questions the masks.

2. Any player may declare a new rule at any point in the game. The player may do this audibly or silently depending on what zone the player is in.

3. A player may use the Calvinball in any way the player see fits, from causal injury to self-reward.

4. Penalty assignments may be in the form of pain, embarassment, or any other abasement the rulee deems fit to impose on his opponent.

Anonymous said...

Considering how filthy and disrespectful humans can be even in the best of times, I shudder to think of a society without consistent trash removal--and that may be one of the least virulent consequences presented on Stoneleigh's list. But then again, I am the type that will bend over and pick up a stray piece of trash on any old street and toss it away.

Bonehead said...

@ Stoneleigh

Thanks. I think. #35 made me gulp.

@ ca

Re: timeline. See #35.

@ Taizui

There are orth ways to power your tractor.

Stoneleigh said...

Dan W,

So like, the stuff you need to survive everyday life getting more and more expensive, and yet nobody having enough money with which to buy the stuff---even if it were to FALL in price.

That is a description of what happens during deflation. Prices fall, but as purchasing power falls faster, it amounts to a huge decrease in affordability for almost everything, and for the essentials most of all. Prices can fall by 90% and the resulting price is still less affordable than today's prices (which benefit from enormous price support thanks to cheap credit). Deflation crashes purchasing power to an almost unimaginable extent.

Stoneleigh said...

Anon @9:24,

How long do you see cash being king?

Several years.

I currently hold both gold and silver bullion and am wondering about converting a portion to dollars to retain some purchasing power.

IMO you need to hold liquidity. Gold and silver will both fall in price during deflation (silver more so than gold) as people sell not what they want to but what they can in order to raise desperately needed cash.

If you can afford to hold precious metals and still have all other bases covered (as per the How to Build a Lifeboat primer), then holding them for the long term makes a good insurance policy. If, on the other hand, you have to sacrifice liquidity to own them, then it's not worth it IMO.

Starcade said...

Over the next number of comments, I'll briefly address this list:

2) You see, that's the problem with everyone telling us not to spend credit as cash -- for most people (and for most governments), credit is the only available resource which kept things going.

Once that stops:

3) Cash won't be king. Guns will. Don't believe me? Cash won't do you any good when the guns are being pointed at your face for everything you've got. And I see that happening real damn soon now.

4) Printing will be the only means, however, to keep the process going. If Obama truly says "no" to enough people, he can kiss all social order goodbye. Printing, damning the consequences, is the ONLY alternative to a forced population elimination or redistribution.

5) For many people, bankruptcy is no longer feasibly possible.

As a result:

6) Forced labor or conscription is going to be the order of the day real soon now -- for it is the only way to sanely eliminate the population undesired, plus it's the only way to get back anything from the debtor class.

7) The pensions are dead, as are most of the poor before age 60. A "Logan's Run" situation -- which would require all living citizens to be meaningful after a certain age or be dead -- is not out of the question either.

8) The banks are completely dead -- the only question is whether there will be a currency, of any kind, left after the corpse begins to decompose.

14) See 6). The future potential earnings of any person are no longer even a mirage of a guarantee.

Stoneleigh said...

Anon @9:31,

If the money supply was created by so much credit, and much of that owed debt will be defaulted upon, won't that decrease the money supply?

Yes, absolutely. Credit functions as a money equivalent during the expansion phase, but evaporates once contraction begins in earnest. This is the essence of debt deflation.

Anonymous said...

TRASH: Another unintended consequence of agriculture.

As we settled, trash became a problem.

What makes you think trash removal will go away?

This will be a good job for those willing.

Starcade said...

15) The loss of all social order will result -- see my guess on what will be "king" of currency in the near future.

Most localities will all but resemble prison (complete with the requesite rapes and protection rings as part of the corruption spoken of later in the list).

16) See previous on both debtors' prisons and defaults. Margin calls will come in, and people (not just their belongings, but their very lives themselves) will be liquidated.

17-18) One of the reasons that much of America will be Third World. Don't believe me? Look at pictures of New Orleans post-Katrina and tell me they don't resemble, in many ways, sub-Saharan Africa.

19)People with no purchasing power simply won't exist in the new world. They'll either be conscripted, enslaved, or dead.

20) See 19). Except for the rich, there'll be no need for the rest except at chattel.

21) No need for education either, except for the rich.

The poor simply won't even be considered human anymore. And, unlike now, it will be _overt_ rather than covert.

22-24) The only reason those three are probably right is the dependence of the rest of the world on the US economy and Dollar. The Dollar has no other remaining value.

26-27) There will be no bottom until all the waste is revealed and flushed -- along with, bluntly, the lives dependent on that waste.

What people have to understand is that, without this level of free credit, etc., there's no way the current population could have ever gotten this high, national or world.

el gallinazo said...

Earnest Lux

If you are interested in crop circles may I suggest Star Dreams: Exploring the Mystery of Crop Circles (2007)
available through Netflix. Regardless of your take on their origins, many of them are amazingly intricate and beautiful, and the photography in this film does them justice.

Stoneleigh said...


I think the days of a free exchange of ideas over the internet are numbered, and not necessarily as a result of energy shortage. I think we're moving towards an era of much greater control over individual freedom (sadly). Also, collapsing purchasing power can easily prevent people from accessing services they previously afforded easily. IMO the cost of the internet (for both hosting and accessing information) will rise as purchasing power plummets. That would mean a lot less information available accessed by far fewer people. Once the energy crisis bites (a few years down the road), the internet is likely to be far more curtailed. It and electricity grids are two of the most complex manifestations of a complex society, and as such are unlikely to survive a large step down in socioeconomic complexity that I regard as inevitable.

I can see your tractor becoming your fueling priority, but I suggest you get hold of some good hand tools as well for the day when you won't be able to afford any fuel at all.

IMO the number variables is not that large. Money will be in extremely short supply, but will be necessary for everything once entitlements are gone. This means angry and desperate people going without. Salaries and benefits will be relentlessly cut while debts stay the same (another recipe for unrest). Savings, investments and pensions will plummet or disappear entirely, along with many jobs and homes. Sadly life is cheap when there is little or nothing to lose.

Starcade said...

28) There will be very little international trade.

31) ANYONE "different" will be eliminated, if not dehumanized first. I fully expect some form of "corn-pone Hitler", if not already in power, to take power very soon in at least parts of this country.

32) The only way unemployment will be reduced in the new world is NOT the creation of more jobs -- the resources won't be there. It'll be the elimination of population.

35) Ordinary people will probably not even be allowed outside of walled ghettos (or the aforementioned military/debtors' prison complex) within 5 years.

You're about to see why, in places like California, Michigan, and Ohio.

38) Taxation may be used, in this way, to increase the level of income and to increase the level of people which will end up in the conscription/slavery complex.

39) Freedom, already ceasing to exist, won't even be hinted at in the very near future.

40) The world will be not unlike a prison or the homeless on the streets -- rapes just because people feel like it, and, with enough connections, you're the one who will get shot for being raped.

In short, life itself will have NO value.

Anonymous said...

My read is perhaps 40%-60% of these have a chance of developing...some are too extreme..I hope.

My step daughter and her main squeeze are making plans for long term stay in Brazil.She was fascinated about the bric meeting that we were "uninvited" to.She just finished reading "Economic Hitman",and wanted to discuss all of the sins of the last 20 years...I gave her a list of books,staring with "The creature from Jekyll Island"and have offered to send her some more reading material

I am so pleased she is "waking up" politically.

I see some bad times coming,but if all of these come down we would not have a country take is there is a trigger point at which a substantial portion of the population will rebel....and its a lot closer than anyone will believe.When enough men see no way out...and enough people have lost everything,[and this is coming quick]...then there is no control because there is nothing to lose, if your life is nothing but pain...

I base this on the hope that some kind of rational actions are taken by those in power when they realize that its game over if they don't.No logic,just maybe misplaced hope.


Stoneleigh said...

Anon @11:34,

FDR could do that because the bottom was in and things were already improving. Obama has no such luck. He's not the next FDR, but the next Herbert Hoover. The worst of the unraveling will happen on his watch, although the depression will go on long enough that it will probably ruin both political parties in the US. Argentina went through several presidents in a matter of weeks, and the US could do something similar at the height of the crisis. I expect an independent populist to arise and preach extremism, and for that message to be welcomed by a traumatized populace.

Anonymous said...

Hey Starcade-

I would surely eat you first.

Your persistent, pathetic paranoia would insure your place on the spit.

Imminent doom is always around the corner. Yawn....


Stoneleigh said...


Is the current credit destruction / deleveraging so historically unprecedented that this chart has no predictive value?

Yes. Most of the promised federal spending will never materialize. The promise to spend is intended to restore confidence, which would remove the need for the promise to be kept. It's a confidence trick. Unfortunately, the market will call the government's bluff.

APC said...

I've been up for about 20 minutes, thought I'd check in to see if you'd posted. Made some coffee, then read your list.

So, good morning to you too Stoneleigh! You've just "made my day"!


Stoneleigh said...


I'm guessing you're not in my timezone ;)

I'm off to bed now because I have to be up in 4.5 hours.

jal said...

@ Starcade,
The Haiti situation should give some insight as to the possibles of future timelines of events.
What is happening in Iran could turn into a "black swan" event that could change all the timelines.
@ Stoneleigh
I'm going to save my seeds from my garden and after I will go on a gathering trip to get different fava bean varieties.

Anonymous said...


In what way was the 'bottom in' when FDR took the reigns in 1933? We were in recovery already? In what way?

Unemployment was at the peak and did not recover much in the following years. In 1933 UE was 24.9%. In 1934 it was 21.7%. In 1935 it was 20.1%.

Are you saying deflation was easing when FDR took office? I think you would be wrong to say so.

His ending of the gold standard literally stopped the deflation in its tracks.

Robert said...

enlightning as always , stoneliegh, as I have always said, if someone would just tell us the truth (good or bad) we can handle it. we just need to know what it is. Thank you!

It would seem that preparation is in order.

Once again, Thanks!

redboat said...

First, crop circles signaling Armageddon and now 40 bullet points on the End of the World as We Know It?
There is something much to linear about the thinking here. I enjoy the Ilargi's writing most of all because it's tonic.
I am dismayed you decided to print a manifesto of such sweeping doom as if it wouldn't be bad enough to muddle through a decade of a restructured economy. Because that's what this will lead to. Counter adjustments will be made, at great cost, but none-the-less we will not be following a classical scenario. The inventiveness, pro or con, of the human will is not factored anywhere here.

Anonymous said...

Hey Starcade-

Only a big pu$$y would whine as much as you do.

I bet you will taste better with lots of Ketchup.

Good night, Chicken Little.

Anonymous said...

That is a description of what happens during deflation. Prices fall, but as purchasing power falls faster, it amounts to a huge decrease in affordability for almost everything, and for the essentials most of all.

Deflation and hyperinflation have this in common. At the worst point of Weimar hyper-inflation people spent 95% of their income on food. Sounds like the same thing would happen with massive deflation.

The inflation vs. deflation question will only matter to those who are trying to prepare for one or the other. For the unprepared it won't much matter.

Anonymous said...

We need to realize we are all peasants to King Obama, there is no way out. trying to leave this country is futile. The govt will stop all persons trying to leave.

as was said said in a Metallica song, "you can do it your own way, if it's done just how I say" from the album freedom and justice for all. That phrase says a whole lot. think about it. We are only as free, as the gov't says we are.

The Iranian people can revolt against an election, but we in the USA cannot. If I were to hold a banner "Go to hell Dictator Obama" I'd be gathered up and thrown in prison. Think about it, we can't really say that much. We don't hold as much freedom as we think.

Anonymous said...

Stoneleigh's list presents some interesting dilemmas for those thinking souls who do not blindly reject or blindly accept. For instance, what advice to give the aspiring college student in terms of student loans in nation of increasing unemployment and possible nightmare debt scenarios. On the other hand, if things do not turn out as badly as Stoneleigh's list, the student (and parents) who passed on their educational opportunities will have lost quite a bit. After all, and last I heard, there is no lost time rebate handed out at the gates of heaven.

I suppose at the end of the day I would heed a wise old Taoist's advice: When in doubt, do. Something like a distant echo from a coffin ship halfway across the Atlantic, too late to turn back now. " Further" as the author wrote, Cassidy is at the wheel and those on the bus are flying down the mountain--one way or the other.

Vorlon said...

Mr stoneliegh,

Brilliant summary. This combines the deflationists' viewpoint with the climate chaos / peak oil (expected) timeline. TAE is definitely one of my fave daily must-reads.

Despite the above, I am still struggling with the Inflation vs Deflation debate. The best defence of the former that I've read so far comes from:

"The world has accumulated a great deal of debt, and it will take a long time for the savings rate to get to the point where debt can be managed. Rather than implement rational solutions to the debt bomb, we think politicians will dither and financial manipulators will continue to try to make money in the current crisis, therefore we expect there will be many more asset bubbles in coming years.

A few reasons why we say this:

1. Money supply growth is out of control, everywhere. Often this is due to pressure on central banks by politicians.

2. The velocity of money is starting to increase after a period of decline. Due to the resurgence of the shadow banking system.

3. The problems that have caused the present crisis (unregulated derivatives) are still continuing to be manufactured because they are very profitable to the manufacturers. Derivatives expand the shadow banking system, which further expands the supply of money and credit, thus adding more fuel to the bubble creating machine."

The deflationists claim that QE will not lead to hyperinflation if the velocity of money (VM) is zero. Well, the VM seems to be increasing. And the continued massive growth of derivatives (debt) counters the asset-deleveraging. If VM increases and debts grows, won't this be highly inflationary?

Welcome your views on the above link/comments. Thanks.

davefairtex said...


All of what you wrote makes sense, except for one thing. What stops the Fed from printing as much money as necessary to reflate?

I used to believe as you do - that we're going to be re-running the 1930s because of the destruction of money from all the defaults. It made complete sense. But then I read this article entitled "Puncturing Deflation Myths."

I was quite convinced by its main thesis - that any government with an unbacked fiat currency can inflate to ANY EXTENT NECESSARY - even to the tune of tens of trillions of dollars, enough to make up for all that lost credit. All it needs is the will to do so.

Seriously. What stops this from happening in your map of the future? What limit does the Fed have on it that prevents it from printing literally infinite amounts of money?

davefairtex said...

One added note - real inflation requires teamwork between the Fed and the Treasury. The Treasury cranks out new bonds, and the Fed buys them with new money. QE on steroids.

When Treasury spends the new money, it immediately enters the economy. That way there's no "velocity of money" issue. Treasury could buy anything - stocks, foreclosed houses, old milk bottles, used cars, anything it wanted to pump up the price for.

Presto, instant inflation. Housing prices stop dropping immediately if the treasury stands up and bids "current loan amount" for every house on the market.

All deposits can be guaranteed. All pensions paid in full. All problems solved - well except there's that pesky inflation issue.

And the side effect is, people holding cash get crushed. So preparation is tricky. Will you bet the Fed won't use their magic printing press? Because in a fiat currency they can print as much as they want, its just a matter of will they or won't they.

Starcade said...

Anon 235: Why don't you get from behind your computer and tell me when you're showing up in SoCal, and I'll give you a little taste of what's to come...

Persephone said...

Thank you Stoneleigh and Ilargi for having the compassion for humanity to share your wisdom with others.

APC said...

Stoneleigh said:

"I'm guessing you're not in my timezone ;)..."

Indeed not, though I was born at the Montfort Hospital on Montreal Road, spent the first 7 years of my life at CFB Uplands, went to Brookfield and Confederation High, started university at Ottawa U, and worked till the age of 32 for the Government of Canada. I've been out of Canada since 1995 and have for the past 10 years been raising 2 children with my wife here in the west of France (Brittany).

I sure would love to be able to ask you some case specific questions. Not of the type that can save me my investment portfolio, as I am not a highfalutin investor, but I have just committed the next 15 years of my life, (I am now 46), to a 50 thousand euro loan for a house I am just finishing up. Barn conversion.

And I worry.

Stoneleigh said...

Anon @1:49,

In what way was the 'bottom in' when FDR took the reigns in 1933? We were in recovery already? In what way?

The market bottom was in 1932/33. Markets are driven by herding behaviour, reflecting social mood, and where markets lead, economies follow. Sometimes there is a significant time lag - for instance the market decline was over before the rash of bank failures.

The mood had turned by 1933, alleviating the fear and risk aversion of the crash period from 1929 and allowing remediation to begin to work. There was a significant, but shallower, setback from 1937 that led to another bottom in 1942. That one was associated with a new round of hardship and, of course, war.

Politicians who preside over market crashes are presiding over times when the herd is looking for people to blame. The leader is the obvious choice, whatever he may have done or not done. Politicians cannot prevent such periods, and generally can do little even to alleviate the suffering of the masses. Even a politician who doing the best that was humanly possible would have found himself out on his ear by 1933, watching his successor benefit from the more constructive mood to follow.

Anonymous said...

"Seriously. What stops this from happening in your map of the future? What limit does the Fed have on it that prevents it from printing literally infinite amounts of money?"

As I understand it,
bonds are essentially 'slave tokens' - transferred debt from mortgages/loans to the international market.

They represent the future work potential of a nation. If you don't peg the cash you create against this promise of future work, other countries don't invest in your country, or if they do, you have to entice them in with high interest rates (what's happening at the moment at the 'long end' of the bond market).

If you need said borrowed cash to trade, you get ostracised, your currency and your ability to purchase disappear.

By making people invest a large % of their own money in their mortgages and threatening them with debtors jails if they default, you incentivise them to keep working.

In an largely obese nation (a clue to their willingness to work there!) with small downpayments for mortgages required, and unpayable negative equity, US slaves are increasingly 'ragged' round the edges and of low calibre.

Quite what will happen when every country in the world has to raise its rates to attract the pro rata small amount of investor capital around is anyone's guess, but it looks like the kiss of death for debtors everywhere.

It's gonna get bumpy.


Stoneleigh said...


Brittany is beautiful, especially the rose granite coastline and the Sentier des Douaniers. I haven't been back for a long time, but I like it very much.

You must have gone to school with quite a few of my friends, most of whom went to Confederation High School and are close enough to your age.

Your debt is a worry, even though a barn conversion in Brittany sounds really nice. I would suggest doing whatever you possibly can to pay it off ASAP, whether it's working overtime or selling something else to raise money or taking in a lodger. At least you are less in debt than most.

got2surf said...

Thank you Ms Stoneleigh.

I've been wondering why Ilargi does all the main posts... I know you are busy with your energy/tariff/gov. work. I'm in solar energy so these things are relevant, if you ever want to write about your work.

You are both great.

I'm sitting and trying to time getting out of my energy investments. They've doubled recently, back to my buying price. Still well below the peak of 1 - 2 years ago.

Last Fall provides a good lesson in what to expect. Virtually everything fell in price. I figured peak oil would keep energy high but I was wrong. I expect more of the same...

I know this isn't a market timing blog so I try to refrain from market timing questions. I have learned here that prices can be low, and still be unaffordable...

I've been assuming the dollar will lose value (aka Peter Schiff), but understand the flight to safety phenomenon.

The accumulation of bad news and unsustainable trends leaves me certain that more hard times lie ahead. So I continue to try to stay abreast of the current situation to make the most of my meager savings while enjoying life and practicing ELP.

Thanks again to you both!

Anonymous said...

@ Stoneleigh

It appears that your worldview (and I am in agreement with you for the most part) is based on two substantial assumptions.

1. The banking system is completely insolvent.

2. We are at or near Peak Oil.

I have done a tremendous amount of research and still cannot answer those two questions definitively, mainly because the information is being hidden behind a wall of secrecy in both cases.

Let me ask you two questions....first off how can you be so certain that those two conditions exist (the data points are confusing and in a lot of cases contradictory at best) and what if your wrong regarding those two basic assumptions.....what would your amended future look like?

And as far as banks being insolvent, even if they are so far that fact has been successfully hidden from the market and things continue to roll onward....whose to say that they cannot continue this charade indefinetly? What do you see as the trigger event that will enable the market to finally realize for sure that they are truly insolvent and react accordingly?

Because it seems to me that absent those two big assumptions then the entire world view falls apart.


Stoneleigh said...

Dave Fairtex and CS,

For one thing, governments are reactive, not proactive, so the measures they take are generally too little and too late. Printing cannot keep up with the pace of credit destruction once deleveraging gets underway.

The bond market is indeed the major limiting factor. QE is a recipe for getting slaughtered in the bond market, which will eventually happen as more and more debt-junkie governments try to borrow more and more money from an ever-shrinking pool of funds. It really is a global issue, and all debtor nations will end up paying far higher rates for the their habit, which will mean having to slash expenditure to the bone and beyond.

I don't think we're heading for that imminently though. Despite the market pullback that's underway, I still expect (on balance of probabilities) the rally to continue until perhaps the late summer. Assuming it does so, fear will abate and we won't see that much QE in the meantime. Once the rally is over, fear will return, governments will be forced to resort to more QE and the downward spiral will be set in motion again.

Stoneleigh said...


IMO it's not critical whether we are or are not at peak oil at this point, although I think we are. Oil prices have fallen due to speculation in reverse and the beginnings of demand destruction. The latter has much further to go, and storage capacity is already nearly full. That is a recipe for lower prices, probably from this fall.

However, demand destruction, in combination with the increasing risk of conflict in oil-producing areas, sets up the conditions for supply destruction. What is in the ground is less significant than whether or not we can get it out, and I am expecting a lot of important infrastructure to be destroyed over the next few years. See the primer called Energy, Finance and Hegemonic Power on the front page.

As for the banking system being insolvent, just look at their level 3 assets and contemplate that those are worth pennies on the dollar at best. At some point there will be a substantial mark-to-market event and those assets classes will be revalued across the board. We have lived through a credit hyper-expansion grounded in ponzi dynamics. Those can only end in one way - as a giant Enron. See the primers on ponzi dynamics and deflation, as well as The Resurgence of Risk (also on the primers list).

el gallinazo said...


It just occurred to me that when the bond dislocation hits and the ten year note goes over 10%, then even the 13 week bill will be paying a few percent interest instead of 0.2% as now. So T-Bill holders will actually have some nominal income for a while? I imagine the curve will be parabolic though at the longer end.

Stoneleigh said...


Last Fall provides a good lesson in what to expect. Virtually everything fell in price. I figured peak oil would keep energy high but I was wrong. I expect more of the same...

Yes, deflation knocks price support out from under everything, although essentials should later benefit from relative price support (ie fall by less than everything else). IMO we'll see further falls in energy prices in the next stage of the decline, but in the long term I expect supply collapse, and that should send prices on a moonshot. If oil costs several hundred dollars a barrel at a time when so much purchasing power has been destroyed that a dollar seems like a lot of money, people will lose access to oil products. That's a few years away though.

A lot of energy companies are unlikely to survive the demand destruction phase, so hanging on to their shares is a risky bet. All equities are a very risky bet for the foreseeable future. I would cash out over the summer, hang on to the liquidity and think about practical (as opposed to equity) energy investments later.

I know this isn't a market timing blog so I try to refrain from market timing questions.

We take a crack at market timing now and then ;)

I've been assuming the dollar will lose value (aka Peter Schiff), but understand the flight to safety phenomenon.

Dollar debt deflation should cause significant currency appreciation, on top of the flight to safety. What matters most though is the value of cash relative to available goods and services domestically, and there cash will be king for a long time. See the primer called The Special Relativity of Currencies.

Stoneleigh said...

D Benton Smith,

Thanks :)

bluebird said...

With the possibility of bank runs and the closing of more banks in the future, those of us who have purchased Treasury Bills directly via, I'm still trying to determine if the T-bills might become stuck in TreasuryDirect and unable to be redeemed back to banks?

Since the government will be the last to fail, do you see the possibility that our Treasury Bills might someday be taken as the final way to fund government spending?

Stoneleigh said...

This intro is now a diary over at Daily Kos.

el gallinazo said...

I have had quite a demand for ca's saving of Stoneleigh's comments. Please excuse me if I don't get back on your individual comments accompanying your requests. Also, just for the record, I have not had the opportunity to read the collection myself. I simply file structured and compressed them.

And now, as Dylan sang in Desolation Row, it's off to "sniffing drainpipes and reciting the alphabet :>)

D. Benton Smith said...

@ Anonymous June 18, 2009 2:35 AM

re: insults directed at Starcade

Lay off the kid.

I have no problem with your feelings about Starcade's thinking, just the your lack of thinking in expressing your feelings.

Want to pick a fight? Fine. Use ideas and facts, not school yard taunts.

GunHillTrain said...

Hi Stoneleigh,

Regarding number 15: What do you make of the huge Chinese investment in transportation infrastructure (for example, perhaps 2,100 km of urban rail lines in the next decade)?

Is this simply their version of a stimulus package? Or do they have a different set of expectations than we (i.e, the West) do?

To put it another way: is this a boondoggle or a good investment?


Chaos said...

Much thanks to El Gal for compiling Stoneleigh's comments. Take your time getting back to us (or me, at least).

You two guys who are throwing out physical threats over the internet don't realize how silly you look. And you're dragging the discourse down into the gutter. Isn't Stoneleigh's example enough? Stop it.

VK said...

What an intro! A reap epic.

Bravo Stoneleigh, bravo!

Anonymous said...

Having worked in urban mass transit design, my guess is that the proposed extra 2100km would be necessary in the near future anyway to simply keep the Chinese cities functioning.

Grid lock is always just a breath away. The old expression, a chain is as strong as it's weakest link goes in spades for urban transit planning.

An economy depends on keeping things moving at a certain pace, especially people and goods.

One bottleneck can cascade out and paralyze a large area very quickly. Having a little extra cushion and a plan B in your transport grid is essential.

The extra urban rail KM could also be part of a stimulus plan but in reality, a dynamic economy such as China's is always on the edge of being out of balance to it's needs.

Unknown said...

El Gal,

I would certainly be interested in a compilation of Stoneleigh's comments as well.

Ian said...

I'd like to add my thanks to Stoneleigh for her excellent summary of views and also for the time and thought she takes to respond to the many questions put to her.

And of course Ilargi's excellent intros, choice of reading and views that are what this blog is all about.

I only wish that I could write and express myself as well as they manage to do every day. Let me just say how much I appreciate what you both are doing.

jal said...

The banking system will get its financing and be able to continue operating.
Obama’s plan and the law makers will make sure that it will continue to operate.

“make the Federal Reserve into a consolidated supervisor of large, systemically vital financial institutions and require higher capital standards and more scrutiny of banks' activities”

... 1) “You do not have enough reserve. You are ordered to buy more T-bills.”

... 2) “You have too many risky mortgages. Exchange them for T-bills with F&F”.

The result will be that the banks will get lower profits, or revenue stream and the gov. will have buyers for its debts.

The wealthy will make money no matter what happens.

Anonymous said...

re Stoneleigh's compliation.. Rather embarrassingly about half is Stoneleigh's erudite reply to my newbie question re oil pricing back in October.
Apols also to Ilargi for getting his back up: "Whoever makes any such suggestion doesn't know what they're talking about. Peak oil has no influence whatsoever on the collapsing financial markets"
Guess I'd been spending too much time at the Oildrum, by their very nature they're oilcentric.

Am here rather than there now though :)


el gallinazo said...

Back in the house for a moment to fetch some fittings:

So far I have had one complaint of a recipient not being able to open the files, presumably a Windows user. I have been using Macs since 1989, and what I did was done on a Mac which was to compile ca's email saves into four M$ Word files, being careful to add the .doc extension, which is not necessary in Macs. I then put them in a folder uncompressed and zip compressed the entire folder. I then ran it in reverse on my Mac, and everything seem to function ok.

So my question is - is anyone else having trouble bringing up these files in Word? (I could have also done them as .pdf's, but most people don't have software to edit .pdf files, so I figured that Word would give more flexibility.)

dan w said...

@ everyone....

GREAT thread!!!

Question re: INF v. DEF

With regard to price collapses---is it fair to argue that dollar denominated ASSET prices will collapse whilst simultaneously goods and services will increase in price NOT SIMPLY nominally, but actually??

Greenpa said...

Stoneleigh- I have one effect you might want to add.

The world's food supply will contract. This will be due to two causes; the collapse of oil based energy subsidies for agriculture; ie. tractor fuel, fertilizer, pesticides, grain drying; will mean yields will drop. Simultaneously, the cost to the farmer will remain the same; or rise; causing the same market dynamics that caused farmers during the great depression to dump milk and shoot cows. In that situation, the farmers literally could not afford to move their produce to market- they would lose twice what it cost them to grow it. That's coming soon.

Greenpa said...

oh, yeah; and crop spoilage post harvest will increase drastically.

Greenpa said...

Re Starcade- I do not share the view of the troll types. My guess is they are not aware of who Starcade is, or how his life has run so far. Living on the street might in fact tend to give one a grim outlook on things.

Armando Gascón said...

On the Argentinian way: Picturesque as the goings on in Argentina may have been, exemplified by a well-known video you discussed some time ago, the reconstitution of Argentinean economies comes from a well-drawn plan. A different question is how closely the populist Peronist government follows it.
Following the debacle after Menem and De la Rúa, the University of Buenos Aires -which has given Argentine some Nobel Prizes in Science and has well-qualified economists- draw a plan to attain growth with a measure of human care -or at least that's their take.
It is called "Plan Fénix" and if you google it you will get lots of links. Two of the most relevant

It is much hampered by the mania of the Kirchners (the presidential husband and wife team) to print the statistics it wishes, nothing like the real ones. In fact it is surreal: the minister says one thing, and the workers at the Statistical Department go on strike and say it is all lies. They don't get fired either!

Parrot Owner said...

Ishmael said:
"The birth of agriculture was the day we all died."

But on the other hand....if not for agriculture, most of us may not have been born...

Greenpa said...

And I forgot to mention irrigation- that will also drop drastically; both because of decreased water availability; and decreased oil availability to pump it. Drops both in acres, and yields.

Anonymous said...


Your description of what lies ahead in agriculture sounds a lot like the Old Soviet farm system. Produce rotting in the fields for lack of transport, a fuel allocation and price FUBAR, and the collapse/contraction of the big aquifers like the Ogallala putting the Kibosh on large scale irrigation.

Small local intensive gardening is not an option, it's the only choice.

OMG, I've got to go out and plant more potatoes.

These small gardens shouldn't be called Victory Gardens, victory over what?

How about Apocalypse Gardens?

Too dramatic.

Bush Gardens?

Sounds too entertaining.

Contractionary Deflation Gardens

Too wonky.

VK said...

Unemployment is easily double of what we see in the official data, as Tyler at ZH points out, unemployment benefit checks per person have more then doubled in the last year.

That is very very unlikely, it's much more reasonable to assume that benefits have remained the same per person but unemployment has doubled.

The relevant quote from ZH,

"In summary, over the past two years, while unemployment claims have climbed from 2,688 million in March 2007 to 6,157 in May 2009, monthly unemployment payments have skyrocketed from $3,238 million to $10,807 over the same time period. Furthermore, run rating June 15 intramonth results, indicates that this will be the all time most cash outflowing month for unemployment benefits, at $12,354 million.

What all this means is that the Average Monthly Unemployment "Paycheck" has exploded from on average $1,000 to $1,800 in recent months (and over $2,000 runrated for June). Has the government been "pushing" benefits to the unemployed since December of 2008, when the increase commenced? The trend can be visualized easily in the chart below."

ps - Even Buiter is smoking those green shoots of hope now! How the bears have morphed into bulls. He's looking for inflection points in the data to support an upturn BUT in the 1930's look at how many upturns there were?! Only to be followed by downturns. Ridiculous!!

Thomas said...

Question: Timing the collapse

I don't understand why the next leg down will occur this fall rather than fall of 2010, or spring of 2011 for that matter.

It seems as though the gov could keep hiding the losses in Pension funds for a while longer.

Greenpa said...

Stoneleigh- there is another option for universities; or at least for colleges. I attended Oberlin, which was founded around 1830 something as a cooperative venture. All students also worked for the community- often in making hay, harvesting grain, etc.

There still exist true scholars who are not interested in money. My guess- they will band together to form new colleges, and perhaps some universities, where pay will be in barter.

I've actually raised this subject with some top academics- and in fact, many of them would welcome such a climate, and the relief from grant writing and internecine combat. Several said "sign me up!"

This might also be a path to preserve higher medical and dental functions; and perhaps some internet services.

Of course- they might eventually need a wall.

Ishmael said...

Parrot Owner said:

"But on the other hand....if not for agriculture, most of us may not have been born..."

Exactly. You make my point. Without the billions of people added to the planet, we might have actually have a chance.

Anonymous said...

Too many words, too many reasons.

Money printing, Debt, fraud, overpopulation
...there you have it all

The machinery will lock up soon.

D. Benton Smith said...


You're on a roll.

I, for one, am very interested in where the line of reasoning winds up if you stick with it all the way through.

For example, what happens to land usage when farmers can't afford to cultivate all of their acreage the way they are used to? Will it go fallow? be farmed low intensity dry-land style with home-grown seed from last year's crop? rented to share-croppers? go back to the bank?

Thomas said...

Denninger has made an important observation.

The FED allowed $50 billion of liquidity to drain out of the financial system today.

That means a downward jolt will hit the stock market next week by Monday or Tuesday.

Why did it do this? needs to chase money back into 10 year Treasuries to drive down interest rates on mortgages.

Boy, this game is more rigged than I ever imagined

Stoneleigh said...


Agreed as to the impact on industrial farming, which is both capital and energy intensive. Add the effect of the collapse of global trade and the impact over time on the food supply is likely to be huge.

In the shorter term we would see a relative glut of food, as well as oil, due to demand destruction. As purchasing power collapses, so does demand, leaving farmers unable to sell their produce even as people starve, as was the case in the 1930s. Money is the lubricant in the economic engine. Without it that engine will seize up, with enough disruption of our just-in-time system to result in many people not being able to hang on through the worst of it.

It gives me nightmares quite frankly.

Anonymous said...

007Billion said:

There is something much to linear about the thinking here. I enjoy the Ilargi's writing most of all because it's tonic.
I am dismayed you decided to print a manifesto of such sweeping doom as if it wouldn't be bad enough to muddle through a decade of a restructured economy. Because that's what this will lead to. Counter adjustments will be made, at great cost, but none-the-less we will not be following a classical scenario. The inventiveness, pro or con, of the human will is not factored anywhere here.

I agree with this analysis. Why no comments about what 007Billion says?

While your manifesto is appreciated, it seems a bit hollow when you leave out the things mentioned by 007Billion and others.

Stoneleigh said...


I don't understand why the next leg down will occur this fall rather than fall of 2010, or spring of 2011 for that matter.

That is my best guess at the moment, but it is not cast in stone. IMO this rally is correcting the whole move downward from October 2007, and I would expect a correction of that size to take time to play out. The retracement so far has been quite shallow, suggesting a new recovery high down the line. After that the decline will begin again. I would be surprised if we didn't see fireworks this fall.

gregfb said...


I currently have no debt. I have on hand one half years worth of dehydrated food, a big berkey water purifier, first aid supplies, five gallons of oil for lamps, over the counter pain killers and vitamins etc. , a wind up radio, a high quality bike with many spare parts. My living situation is rural.

I'm thinking of adding a small wood stove in my home for heat for only the coldest weather. I've also thought about small solar panels but not sure of the cost or practicality. As I'm writing this I'm thinking and feeling " Can this really be happening? ". Any way back to the topic at hand. I also have a number of fire arms and a cache of ammunition so I could hunt if need be as I live with a number of friends.

I have a store of gold and silver and some cash. I can acquire more cash but I don't want to have too much or too little.

From what I've mention do you see any obvious blind spots in my preparation? Thanks to you both!!

D. Benton Smith said...

You observed: "Without the billions of people added to the planet, we might have actually have a chance.

Calls for people to leave voluntarily produced very low results.

el gallinazo said...


To paraphrase Clemenceau, you can do anything with an inflection point but sit on it.

Thomas said...


Stoneleigh said,

"IMO this rally is correcting the whole move downward from October 2007"

Exactly my point, if this rally is going to retrace the whole downward move from October 2007, then we have a long way to go before we hit DOW 14000. Thus, I wouldn't expect to see the next leg down for quite a while. Fall of 2009 seems far to soon to see a full retracing of the collapse thus far. Fall 2010 or fall 2011 seems more likely.

Stoneleigh said...

007 Billion and Anon @12:59,

I am dismayed you decided to print a manifesto of such sweeping doom as if it wouldn't be bad enough to muddle through a decade of a restructured economy.

Of course that would be bad enough, but it isn't realistic. Think about the implications of ponzi logic as expressed in the primer on ponzi dynamics called From the Top of the Great Pyramid. The collapse of the debt structure is simply inevitable, and the other consequences flow from that. Bubbles have happened throughout civilization and there are clear lessons to be learned about how their aftermath plays out.

Counter adjustments will be made, at great cost, but none-the-less we will not be following a classical scenario.

Can you explain why you believe the aftermath of this bubble will be different, especially as it's the largest bubble there's ever been? Our predicament can't be wished away, however much we might like it to be.

The inventiveness, pro or con, of the human will is not factored anywhere here.

I think we'll plenty of inventiveness on the con side, as that would fit in with the collective mood we are moving towards. I can see us making this far worse than it need have been.

Greenpa said...

DB Smith- good questions. There is, actually, a very serious alternative agriculture in the works. Alas, only in one place at the moment, but farmers are actually growing these new crops now; unlike the debacle with perennial prairie grasses from The Land Institute; where results are perennially "in 20 years".

Woody Agriculture

The concept addresses many concerns. No plow; no seed. I happen to know these folks have demonstrated the ability of their "neo-hybrid" hazels to out-produce soybeans; today.

Many of the folks growing these crops are in fact looking towards peak oil as a driving factor- they're spread over most of the USA and Canadian provinces.

That website is about 10 years behind on updates- they're too busy "doing".

Greenpa said...

Stoneleigh- "It gives me nightmares quite frankly."


yeah, me too.

Stoneleigh said...


Exactly my point, if this rally is going to retrace the whole downward move from October 2007, then we have a long way to go before we hit DOW 14000. Thus, I wouldn't expect to see the next leg down for quite a while. Fall of 2009 seems far to soon to see a full retracing of the collapse thus far. Fall 2010 or fall 2011 seems more likely.

You misunderstand me. I am not expecting anything like a full retracement of that decline, only a partial retracement and a new recovery high before the decline resumes. It wouldn't surprise me if the DJIA hit 10,000 by late summer on a groundswell of misplaced optimism. If anything causes me to change my mind about where the balance of probabilities lies, I'll let people know.

Stoneleigh said...


Sounds well thought out to me. The wood stove sounds like a good idea. It might be good to concentrate on acquiring any practical skills you can imagine would be useful, if you haven't already done so that is. A lot of things have a steep learning curve and having the equipment is only the first step. Building social capital is important too.

el gallinazo said...

Anon 12:59

"I agree with this analysis. Why no comments about what 007Billion says?

While your manifesto is appreciated, it seems a bit hollow when you leave out the things mentioned by 007Billion and others."

Fine. You and 007Billion have a different analysis and point of view. You expressed it. Everyone here read it. Most people here thought it was inaccurate. You are upset that it didn't gain traction. You think that Stoneleigh's analysis is overly pessimistic. Most people here think it sucks but its accurate.

I was skyping with a close friend in Oaxaca last night. She is a very happy bubbly person - a pleasure to be with. She asks me why I am such a downer. Most of her assets are in two condos in DC, one of which she owes a serious mortgage on. So should we let our friends be happy until the wave crashes over them and drowns them? Tough call. I am not winning popularity contests. My movie night group last year was talking about sponsoring me for a Prozac prescription. Now they are calling me for financial planning :-(

Ahimsa said...

Greetings everyone!

Glad to be back home reading TAE daily. My husband and I were in Vermont for two weeks looking for a few acres. Prices are still high...


Great piece!


Right on re food supply.

el gallinazo said...


Glad you are back on and posting. Missed your comments.

Stoneleigh said...


I attended Oberlin, which was founded around 1830 something as a cooperative venture. All students also worked for the community- often in making hay, harvesting grain, etc.

There still exist true scholars who are not interested in money. My guess- they will band together to form new colleges, and perhaps some universities, where pay will be in barter.

I've actually raised this subject with some top academics- and in fact, many of them would welcome such a climate, and the relief from grant writing and internecine combat. Several said "sign me up!"

I'd sign up for that. Sounds wonderful. I might try that kind of thing around here, if there were enough other people to make it work. Shame our little internet community doesn't live closer together :(

D. Benton Smith said...

"I am dismayed you decided to print a manifesto of such sweeping doom as if it wouldn't be bad enough to muddle through a decade of a restructured economy."

@ Anonymous June 18, 2009 12:59 PM:
"Why no comments about what 007Billion says?"

I&S aren't writing this stuff to make people feel good, they're writing it because it is the truth as best they see it (and they see it more clearly than anyone else I've discovered so far.)

Would an engineer send you across a chasm on bridge that he knew would not bear your weight, simply because you really really wanted to be happy on the other side?

Of course not.

Engineers don't lament the material constraints, and physical forces that they must operate with. They just identify them, learn everything they can about them, and then design the best ways and means to deal with that reality as they can.

None of the above absolves anyone from the responsibility of doing their own thinking.

If, after careful review of the facts, you firmly believe that we are only up against a few years of moderately tough financial times, and will emerge into an essentially familiar world thereafter... then set your course accordingly.

But that scenario is not the one that I see spelled out by the facts.

Stoneleigh said...

Dan W,

With regard to price collapses---is it fair to argue that dollar denominated ASSET prices will collapse whilst simultaneously goods and services will increase in price NOT SIMPLY nominally, but actually??

Goods and services are likely to fall too as price support disappears with demand (where demand is not what you want, but what you are ready, willing and able to pay for). Even essentials should fall at first as demand dries up, although that may be a temporary state of affairs and I would expect them to fall less far than everything else due to relative price support (in comparison with other things). Those lower prices wouldn't equal affordability though - not at all. I would expect lower prices in the future to be much less affordable then, after a money supply collapse, than higher prices are now.

Further down the line, once we have seen supply collapse for essentials such as food and energy, we could see prices increase drastically in nominal terms, which would mean they were taking a moonshot in real terms. It depends how tight supply gets and what demand is doing by then. I don't think that scenario is imminent, but it could happen within 5 years. Supply would have to collapse to a minuscule fraction of what it is now, but that's quite possible (see Energy Finance and Hegemonic Power).

Chaos said...

I ignored 007Billion's comments because they weren't supported by anything but belief--no facts, records of predictions, just the same old blind faith in human ingenuity I've been hearing about for years.

Stoneleigh said...


Would an engineer send you across a chasm on bridge that he knew would not bear your weight, simply because you really really wanted to be happy on the other side?

Engineers don't lament the material constraints, and physical forces that they must operate with. They just identify them, learn everything they can about them, and then design the best ways and means to deal with that reality as they can.

That is a very good analogy. We don't want any of these things to happen at all. We will be badly affected just as everyone else will.

This is the scenario we see though, and there's no point sugar-coating it just because it's unpalatable. People need to understand what's coming in order to have a chance to prepare for it.

If people disagree, they are free to follow a different course. We are not attempting to impose anything on anyone.

jal said...

Stoneleigh said...

It wouldn't surprise me if the DJIA hit 10,000 by late summer on a groundswell of misplaced optimism.
The DJIA is about 8,500 today. It would need to go up another 18%. I’ll assume that the other indices would also follow that 18% projection. This would put the TSX from 10,000 to 11,800.
I don’t think that the market can be “engineered” for another upward 18%.
If I recall correctly, Dr. Doom had a projection of TSX reaching 11,000 before the end of the year.

That makes you more optimistic. :-)

Anonymous said...


Where are you looking in VT? I'm in North-central, and prices are very, very reasonable. We have friends that are about to close on a modest house on 10-acres (six arable) for $100k.

Lots of small-scale ag up here, lots of practical knowledge being shared.

Southern VT ain't quite the same. Better than lots of places, tho.

Greyzone said...

007Billion and his minions think that this time it will be different because we're "smarter", better, or somehow otherwise improved over those members of our exact same species who experienced prior collapses of this sort.

I have a friend who is an electrical engineer and he argues with me constantly about how things will turn out. Each time he thinks people are smarter, better, or otherwise improved over before, I am able to point out things that just make him put his head in his hands.

Homo sapiens is NOT a rational animal! That is the fundamental error that 007Billion and his friends fail to grasp. They read Stoneleigh mention herding behavior and then they completely ignore it, absolutely certain that people will instead act rationally. This is the exact same fallacy (disproven even!!) upon which the entirety of modern economics voodoo rests! These people (007Billion and the like) have drunk the koolaid in great massive draughts, imbibing themselves fully of the belief system and not giving a good god damn whether it is real or not. This behavior is just like the behavior that led to the very last tree being cut down on Easter Island.

Humans are not rational. We are a rationalizing species. 007Billion and the like are simply rationalizing, based on the current world paradigm. People like that are in for a rude surprise eventually.

Greenpa said...

Stoneleigh- if you really want to launch a cooperative college- I think your biggest problem would not be finding candidates, but screening the multitudes who would want to move wherever you are, to make some reasonable attempt to screen out the drones, fools, and incompetents.

Think of all the young faculty now losing any shot at tenure, or even a position; and all the new PhDs, with no real place to go. And the oldtimers who are totally fed up. Many would move in a second.

Done right, it could easily become a very prestigious (in a good way) institution very quickly. If you really get interested, let me know, I'll pass on the deliberations so far. :-)

Nassim said...

Thank you Stoneleigh for your summary - most handy. I am already half way down the list with my wife. She has seen collapse in Russia and so accepts it as one of those unpleasant things that do happen. Most Russian families have experience of repeated disasters.

The article regarding the disaster caused to Iraqi agriculture due to the neighbouring countries keeping the water to themselves is really important and little appreciated. Egypt is in a similarly weak geographic position but the people upstream are not as powerful as the Turks are.

I used to be a civil engineer and when I studied this subject at Imperial College in the last 60s and early 70's, we had a Turkish student in our class who was obsessed with learning all there was to be learnt about earth dams. I guess he helped build some of these huge structures.

There is one huge difference between the irrigation methods practised in Egypt and that practised elsewhere - in places such as Iraq. In Egypt, there is a network of canals that water the fields and a different, lower, network of canals that removes the residual water and returns it to the Nile. The water returns in a slightly more salty state than it had when it watered the fields - due to evaporation and to salts in the soil that were removed. This means that in Egypt the same land can be irrigated indefinitely without the land accumulating salts. That is the reason why Ancient Egypt survived for millennia.

In Iraq, the situation has always been different. Civilizations there grow and thrive for a period and then collapse. There have been many such cycles. It takes centuries for rainfall to "sweeten" the soil and to allow irrigation to become a practical proposition again.

Obviously, receiving only one quarter of the expected flow accelerates this process of collapse dramatically.

gregfb said...


In your opinion( best guess ) how long do you see the dollar remaining a viable currency.

Thank you!

Dr J said...

Nassim - Interesting comment. I drove from Cairo to Alexandria last year and was stunned to see the rampant development of gated communities with posh homes and golf courses on those ancient fertile Nile delta lands. Meanwhile in northern California, around Sacramento, years of poorly managed irrigation have left the land with salt residue that, along with water shortages, is going to wreak havoc on productivity. We don't seem to learn!

VK said...

@ Nassim

Very interesting comments, agree with the good Dr J.

Erin Winthrope said...

Stoneleigh's Ponzi Reference

I'm trying to understand Stoneleigh's reference to the credit system as a ponzi scheme that's bound to collapse.

Below, I'll provide my interpretation of what she means. Please let me know if I'm on the right track.

Where have we been? For the past 25 years, the shadow financial system (pension funds, university endowments, sovereign wealth funds, hedge funds, and insurance companies) have been incrementally buying more and more securitized debt products as a means to augment return on investment. As demand for these products grew, so did the lending. As lending standards were relaxed, risk and potential return-on-investment for securitized debt products grew as well. Once the last sucker bought the last McMansion at the top of the market, then the loan defaults began to accumulate and the first losses on securitized debt products began to appear. Demand for new securitized debt vanished. Once the securitization market evaporated, it became impossible for banks to extend new credit to existing borrowers. The borrowers, unable to refinance on more favorable terms, began to default in greater and greater numbers. Each default lowered asset (home) values, reduced the value of existing securitized debt, and further amplified aversion for new securitized-debt-products.

Where are we now? Most of the shadow financial system is still holding its securitized debt products in a dark vault and pretending the securities still maintain face value. In reality, they don't maintain anything close to face value. In fact, the losses grow day. But still, nobody sells. They sit on the paper, they tell the auditors to scram, and they pray for green shoots. Since nobody sells, we are in a holding pattern that looks like a market bottom (even though it's really just a bull-trap bottom).

Where are we going? Nobody sells because nobody wants to face the new reality that would exist if they booked such tremendous losses. Everyone is hoping that the FED, and the Bank of England, and other central banks will be able to slowly revive the securitization markets through quantitative easing programs like the FED's TALF program. But the central banks face a dilemma: the more they engage in quantitative easing to revive securitization, the more they feed fears of inflation. This fear drives up long term interest rates and forces more existing borrowers (whose teaser interest rates are about to reset) to default. On the whole, quantitative easing is a net negative, but it takes time for this realization to sink-in with the various market players still hiding the toxic paper. Eventually, one of these players can no longer hold-out. After losing sleep for months because internal models reveal the true extent of paper depreciation, the market player decides to cut his losses and live for another day rather than go down with the ship clutching worthless paper. As Chuck Prince of Citibank once said, "when the music plays, you must dance." So, once the selling of toxic paper starts at 50% or 60% losses, everyone else must quickly get on the dance floor and sell. The crescendo of selling drives prices for toxic paper into the basement and latecomers book 80% or 90% losses on their investments. The net effect: banks and insurance companies go belly-up, pennyless universities close their doors, pensioners are left out in the cold with nothing. In effect, we live in a very different world full of angry people looking for someone to blame and something to break.

All this we can expect to start sometime this fall.

Get your boots on.

Bob in Thailand said...


You have stated (I think) that debt destruction will outpace fiat money creation. Could you please elaborate on exactly why this must be so? As others have asked what exactly prevents the state from "helicopter drops" of any amount?

Thanks and I have enjoyed reading TAE immensely.

Dr J said...

Ed_Gorey - Bravo! You are almost as clear and succinct as Stoneleigh and that is high praise indeed!

el gallinazo said...

re ca's save of Stoneleigh's comments

For people having trouble opening the word files, I just also put them in .pdf format. From now on I will send out both zip file attachments.

Stoneleigh said...

Ed Gorey,

Very well put. One interesting point to add is that CDS contracts often confer benefits if a company should fail. There are many parties who have an interest in forcing such an eventuality for profit, which greatly increases the odds of a large-scale mark-to market event being precipitated.

Many CDS contracts were comparable to allowing me to buy fire insurance on your house, thereby giving me an incentive to burn it down for profit. Huge numbers of contracts were written as simple bets that something would fail, rather than actual insurance held by owners of an asset. The counterparty risk in the CDS market is huge as there were no capital adequacy requirements, so most bets will be worthless. The meltdown potential in the CDS market is very high indeed, and at last count it was (tentatively) valued at $62 trillion.

Ahimsa said...

El G,

Thank you kindly. :)

Dr J said...

Stoneleigh - would it be accurate to say that the proliferation of third party CDS contracts took the already substantial and precarious risk related to slack lending practices and securitization and, rather than mitigating it as was the original intent, actually amplified it exponentially?

Stoneleigh said...

Dr J,


Ahimsa said...

Anon. @2:09

We're looking for land only (without house) in North Central VT -- Elmore, Woodbury, Wolcott, Hardwick, etc. In what township do you reside?

Your friends appear to have found a great deal. Most 10 acre parcels we saw had an average asking price of $70,000. Real estate prices in VT have declined about 10 percent so far.

Yes, I love Vermont's small scale organic agriculture and cooperative spirit. When I visit VT, I feel like I'm not in the USA. There was a guy at the Hardwick's farmers market with a t-shirt that read "US Out of Vermont." :)

Dr J said...

Stoneleigh - if a rank financial amateur like me can understand this, albeit in retrospect, how is it that all the financial wizards like Greenspan, Paulson and Geithner weren't able to see it coming and take corrective action? This is the part I truly don't understand.

Mihai said...

Hi Stoneleigh,

I grew up in "communist" Romania so I got at least a taste of what totalitarianism feels like and how it operates. Even at its most repressive, the Soviet style of oppression was surprisingly ineffective at quashing criticism and controlling economic activity. For example, there was a thriving informal economy, which Orlov has argued provided a measure of resilience in times of economic collapse. The US is also a tightly controlled society in many ways, less by guns and informant networks and more by elaborate rules and subtle entrapment in the current (late?) Ponzi economy. In either case, the system of control has some complexity and requires energy to maintain, so in Tainter’s view a simplification will occur. My question is - what kind of simplification? Will thousands of pages of tax law be replaced by thugs pounding at your door because this is a simpler way to collect taxes? Or will many social systems like national taxation, military and law simply wither due to lack of specialists and energy to maintain them? In this scenario people may feel a greater sense of freedom (and simplification-enforced self-reliance) as there will be fewer official voices telling them what to do.

Thank you for all your insightful work!

VK said...

Was going through Dmitri Orlov's recent post and this is really worth having a read,

"François Cellier has recently published an analysis in which he shows that at roughly $600/bbl the entire world's GDP would be required to pay for oil, leaving no money for putting it to any sort of interesting use. At that price level, we can't even afford to take delivery of it. In fact, at that price level, we can't even afford to pump it out of the ground, because the tool pushers, roughnecks and roustabouts that make oil rigs work don't drink the oil, and there would no longer be room in the budget for beer."

Over time I expect with the decline in GDP that we would see, the 150 threshold lower. I wouldn't be surprised if the new 150 is around 90 dollars a barrel and that is where market meets brick wall again.

But imagine that, peak oil = peak beer. Grim stuff.

VK said...

@ Dr J

Stoneleigh - if a rank financial amateur like me can understand this, albeit in retrospect, how is it that all the financial wizards like Greenspan, Paulson and Geithner weren't able to see it coming and take corrective action? This is the part I truly don't understand.

It's only understandable if you consider the fact that their belief systems are so solidified, that they can not possibly see what they are doing wrong. On this blog itself, we have had numerous conversations on a meat based vs plant based diet. Your belief systems have come up against mine and Ahimsa's.

I reckon it's pretty similar with guys like Krugman, Summers, Stiglitz, Obama, Bernanke, Greenspan. They've always been considered smart, lauded by the press, they have garnered money, power, wealth, status, prestige etc from the current system.

It is their wish to save the system as they see it. Again, with peak oil, I get it, a lot of others get it but that doesn't mean that there aren't enough cornucopians out there who have the power to dismiss the 'doomer' mindset without solid facts. People still think that renewables will scale up, that we can conserve energy, that humanity can change, that "THEY" will come up with some new fangled energy source.

Ultimately it's a clash of belief systems more then facts. Perception is reality. So if you are Larry Summers, you have every interest in preserving the current system that has given you so much. If you Rex Tillerson (CEO of Exxon Mobil), then you benefit by denying peak oil, delaying any alternatives as this means greater profits albeit at the expense of the greater good.

VK said...

@ Dr J

Again, adding more points, I believe I wrote it some time ago. That there are 3 types of people in the current administration.

1) Optimists - Those who drink their own kool-aid and genuinely believe in neo classical economics and hope based economics. (70%)

2) Hopemongers - Those who know things are going to get dire, though the direness can vary BUT they LIE, they LIE and they LIE some more. Why? It's their job. Their salary depends on bullshitting the public and each other. (25%)

3) The psychopaths - these guys are uber-rational. They have actually seen what's coming and have planned for it in advance and intend to profit from it. They are charting a course for economic collapse because they want it to occur. These people are really dangerous, Machiavellian type princes. (5% of the total I reckon)

Dr J said...

VK - I suppose there is an analogy to our diet debate. This is an area where I have expertise and where I read emerging science and am engaged with the research community where the out-of-the-box studies are being done. My position, although orthogonal to the mainstream, is based on sound science. While I may be ahead of the wave in terms of a coming paradigm shift, many big name opinion leaders try to dismiss the evidence in order to preserve the status quo. Leaving aside the subtle and not-so-subtle corrupting influences of vested interests, I mostly ascribe this to human nature - it is hard to reverse course once you are so well established.

In the financial world, I suppose the same ethos would apply with perhaps a much greater corrupting influence. Or it could be vast incompetence or simple corruption. We would need a Pecora Commission to find out, I guess. Unfortunately, as long as they have Col. Sanders guarding the henhouse, I don't see that happening. The Obama reforms seem to reinforce that situation in terms of the enhanced role of the FED. Really too bad.

VK said...

@ Dr J,

I think the Planck Problem aptly describes our present conundrum. People who are smart are usually right and hate being wrong! So they look for ways and means to back up their evidence and insights eg Krugman, Roubini, Geithner etc.

Society has rewarded neo-classicial economists for too long hence they have established power and influence. And they quite enjoy it, when was the last time an Austrian economist gained much prominence? Even though they are usually right, their ideas don't 'gel' with the public or the establishment.


"In day-to-day life, as in science, we all resist fundamental paradigm change. Social scientist Jay Stuart Snelson calls this resistance an ideological immune system: "educated, intelligent, and successful adults rarely change their most fundamental presuppositions" (1993, p. 54). According to Snelson, the more knowledge individuals have accumulated, and the more well-founded their theories have become (and remember, we all tend to look for and remember confirmatory evidence, not counterevidence), the greater the confidence in their ideologies. The consequence of this, however, is that we build up an "immunity" against new ideas that do not corroborate previous ones. Historians of science call this the Planck Problem, after physicist Max Planck, who made this observation on what must happen for innovation to occur in science: "An important scientific innovation rarely makes its way by gradually winning over and converting its opponents: it rarely happens that Saul becomes Paul. What does happen is that its opponents gradually die out and that the growing generation is familiarized with the idea from the beginning" (1936, p. 97).

Psychologist David Perkins conducted an interesting correlational study in which he found a strong positive correlation between intelligence (measured by a standard IQ test) and the ability to give reasons for taking a point of view and defending that position; he also found a strong negative correlation between intelligence and the ability to consider other alternatives. That is, the higher the IQ, the greater the potential for ideological immunity. Ideological immunity is built into the scientific enterprise, where it functions as a filter against potentially overwhelming novelty. As historian of science I. B. Cohen explained, "New and revolutionary systems of science tend to be resisted rather than welcomed with open arms, because every successful scientist has a vested intellectual, social, and even financial interest in maintaining the status quo. If every revolutionary new idea were welcomed with open arms, utter chaos would be the result" (1985, p. 35) "

Anonymous said...

el gal said:
"So my question is - is anyone else having trouble bringing up these files in Word?"

I'm a mac user and one of the docs didn't open automatically. Had to select an app to open with. I chose Word and it opened fine. But there was something about it that was different from the other files, obviously. It was 'stoneleigh 2/20/09 - 3/23/09.doc ' fyi. Thanks again for sending these compilations.


Dr J said...

VK - so true. One of my colleagues has that Planck quote framed and on his office wall.

Anonymous said...


You might say I know that region very, very well;)

Walden is also nice, and tends to be a bit less expensive. Great community, too. And no zoning. Our friends are buying in Hardwick.

You are looking in the right spot. So long as you can handle the winters, it's hard to imagine a better place to ride out the future.

Greenpa said...

" it rarely happens that Saul becomes Paul."

And a good thing, too. I'm personally convinced that Saul's alleged conversion was a con. He co-opted the early church, egalitarian and non-powerseeking- and turned it into a vast money/power making enterprise; and a misogynistic one, at that.

Anonymous said...


@ VK

I do not agree that a discussion, e.g. on peak oil, where on the one hand, you have cornucopians, Yergin and other abiotic nonsense, and on the other, Hubbert, Simmons, the Hirsh Report, the IEA/EIA data and the Oildrum people doing some good work (as long as they do not touch finance), can be reduced to "a clash of belief systems".

In the first group, belief or deception is indeed the driving force, but in the second, people are going to great efforts to look at the data, address the facts and draw rational conclusions.

The first group has the advantage of being the establishment, the second represents the newer ideas that must work harder to be accepted.

It strikes me that the same may be said for the financial discussion.


Anonymous said...

Unfortunately I don't have too much time to write my piece as I have to go to work.

I think that most of you are mislead by trying to extrapolate the future based on the outdated experience from the 1930ties. I do not question the deflation and decreasing availability of oil but if you are talking about the collapse of everything in the US I think that you are applying the same static modelling approach stupid neoclassical economist have misused in their study. The society will change and people will try to adjust. They are not lambs going to be slaughtered. They may fight each other - but the demise of the current society model will not be static. If there is a replacement for the current model we will all be better off.

Whether the social order as we know it disintegrates or not I have no idea. I don't know much about the mentality of people in Texas. I only know they have guns.

Current wealth level can guarantee that even if peak oil effect is combined with GFC (I think that true peak oil hasn't arrived yet) nobody in the US will starve or has to live on streets - provided that very simple measures are undertaken. Otherwise yes, your society will collapse and there are a few countries in the world which will be more than happy to see that (what I mentioned the other day - for example your demise is what the Russians are patiently waiting for).

When I was a kid in the 1970ties in Central Europe I could hear a car passing the house every 15 minutes or so in the evening. Cars were articles of luxury. Yes there were shortages of everything but nobody was starving. We could live like that. Today you can have look at Cuba - we may hate that model but it is sustainable despite all the efforts of the US government, isn't it?

If you reduce your consumption level in the US by 30% it will still be much higher than in Russia or Poland which are reasonable wealthy countries right now. (not to mention China or India).

It is not the poverty - it is the rigidity of the social model based on overconsumption and the addiction to GDP growth. If you guys are able to build an alternative social model where GDP (or whatever measure you use) can rise and fall without causing great social dislocation your current problem is solved and we all are well equipped to face the next great challenge - the climate instability and running out of resources.

If not (and I am quite pessimistic) then the society based on competition and greed will start self-destruction when GDP falls by another 5-10%. How? I have no idea.

Another important personal experience from the 1980-90-ties:
Only certain social groups will suffer the rest may be better off. I was better off. If you don't lose your job you'll be fine even if your property value declines. These who loose will lose everything. This is how free market and competition works. Only should the system collapse there can be consequences for everyone and you'll start fighting between each other.

It is mainly a social and political problem - the economy is just the trigger. The whole American society, not only the economy is a Ponzi pyramid. (The same applies to some extend to Oz where I live but we'll cope don't worry mate)

I would argue that when the US society gets into the tailspin other western countries may be able to come up with viable solutions. We will have a precious one year delay - exactly the same as Deng Xiaoping had enough time to adjust when Perestroika in the USSR went out of control.

The only thing I fully agree with is that the current measures taken by the Obama administration are rather pathetic. He is even not an American equivalent of Gorbachov (who failed to save the country but largely prevented a bloody civil war) but his Russian equivalent was Konstantin Chernyenko.

Yours faithfully,
Eastern European Mongrel

tooearly said...

It has been suggested that Bernanke might actually make good on his promise of helicopter drops...

But why would we presuppose that such drops really serve the needs of the oligarchy?

Greenpa said...

Eastern European Mongrel: "nobody in the US will starve or has to live on streets - provided that very simple measures are undertaken."

Alas, I wish your view were accurate, but I think you've been exposed mostly to US propaganda.

The truth; from inside the USA is; people are already starving ( really, yes) and millions live on the streets. And no simple measures are ever undertaken.

We are not exactly the paradise we advertise we are, or that Hollywood shows.

thethirdcoast said...

@ Greyzone:

Like your friend, I am an electrical engineer, but I share many of your views on the future.

Personally, I am not sure we have "the technology" to get ourselves out of the fix we're in. Even more importantly I don't believe that we have the energy to get ourselves of the fix we're in.

Recent MSM fluff about Steven Hawking lobbying for increased space exploration and permanent moonbases are so patently ludicrous they are not worth factually deconstructing.

Phil said...

Going down.... Where were those green shoots, again, Mr Darling? "UK public borrowing hits record as tax receipts slump"

Anonymous said...


I know that people are starving and I don't believe in propaganda. This is so sad that things like that happen. The American society may or may not wake up in time. My point was that it is still possible to share the burden. If the paradigm is to compete until the very end - then the result is predetermined. Sorry about that.


VK said...

@ Francois

"In the first group, belief or deception is indeed the driving force, but in the second, people are going to great efforts to look at the data, address the facts and draw rational conclusions."

The same could be said of the science vs religion debate no? On the one hand we have science trying to rationalize human behaviour with facts and reason through experiments, analysis and observation. On the other we still have billions of people across the world who believe that a mythical being who is everywhere and anywhere at the same time created the Universe in the blink of an eye and that the earth is only 10,000 years old and that some prophet (usually male and having a beard) will come save humanity for all it's sins.

Now I admit to being spiritual and reading plenty on it, what I don't agree with is organized religion. Facts or reasoning can not deter the mass delusion of true believers be it neo classical economists or religious fanatics. Religion gives people satisfaction, a place to rest their heavy burdens or to simply blame someone, a world without God and one which is purely random and remote isn't quite as appealing as an all powerful being watching over you.

Same thing with economists, the Govt is a God like thing, with the ability to print and solve all problems. Growth is the dogma of this religion and satan is the devil of deflation! Hence it must be fought. There is no arguing with true believers IMO, they are blind to the reality (or in denial) that the omnipresent Govt is really quite powerless in the face of deflation.

VK said...

@ Mongrel

Thought you might like to share this with your Australian friends.

bluebird said...

Where I live, there are still people who believe in the green shoots and recovery. They are buying McMansions, luxury cars, and taking exotic vacations. Maybe they are prepared for the collapse and are living it up one last time, or maybe they believe the fake feel-good propaganda.

One other thing that is yet to unwind, are the derivatives. It is believed derivatives could amount to over $1 quadrillion on a market value of only $20 trillion. Those indeed could be the 'pop' heard around the world when the derivatives bubble bursts.

Thanks to everyone today for their comments.

Gravity said...

I would like to suggest an alternative method of crop circle formation.

Most of them, even the more intricate ones, are probably made in the classic way, by using ropes and feet to create patterns of trampled crop.

However, some of the recent fractal patterns seem to be too complex to fashion in this way.
There are certain anomalies in a few circles that suggest the crop stems were not trampled, but bent or deformed by an unknown method, some magnetic anomalies have been documented in and around circles.

The stems are sometimes bent in a way that could indicate some kind of microwave activity.

This phenomenon can theoretically be produced by certain classes of illegal geophysical weapons, through manipulation of charged layers in the atmosphere (ionosphere)with high-frequency radio-waves, it may be possible for an operator of such a system to direct a complex interference pattern of reflected EM-waves to ground level, purposefully creating patterns in various crops to demonstrate the level of control accuracy of the technology, and to mess with peoples heads, of course.

This theory is only valid because of unexplained magnetic anomalies, as well as structural anomalies in the effected crop stems, if these turn out to be non-existent or explainable in a less complicated way, the classic method is more likely.

Some kind of advanced electromagnetic manipulation by the military is far more plausible than aliens being responsible, though higher intelligence would probably use the same EM-based method to manufacture crop circles.

acrumb said...

KD also said deflation is on the menu...
Ssssshhh.... Its D-D-D-D-....

Persephone said...

I don't usually subscribe to the "shiny crown" club, but I recently heard the most recent interview with Cliff High.
The most recent ALTA report indicates that the derivatives bubble will explode in late summer due to a crop failure.

Also he note that between Oct. 26 and Nov.5 of this year, the $USD goes bust - not due to BRIC - but because it's the natural cycle of the currency.

I didn't really pay close attention until he said (paraphrased) "The banks were insolvent prior to Sept. 2008; however, it only made a difference when it was widely recognized. It is the same with the $USD."

Anonymous said...

I always am fascinated by the rationalized use of gradation--the big crash in the fall transforms into that which might prove interesting into the right to change one's mind.

As fall approaches, so has the certainty.

Anonymous said...

I have seen alot of complaints from the regulars here about the amount of posts questioning the analysis of I&S. Let me point out that because of these people, we have content from I&S that today prompted 135+ comments. I would rather see a comment section of genuine discussion and argument about methods and projections, than just a bunch of cheer-leading.

Honest John said...
This comment has been removed by the author.
Persephone said...

@tooearly 6:16

2 reasons - One is an attempt to counteract the deflationary spiral. (Which Stoneleigh points out the mint will not be able to catch up with the deflationary spiral)

The 2nd is to hyperinflate the national debt so that the debt is paid with cheaper dollars.

Of course, that also means those dollars are worth less to EVERYONE that uses them.

Anonymous said...


Yes I'm well aware of the housing bubble in Oz which will burst pretty soon.

My point is that it is whether the society organisation model is brittle or not what really matters.

The fall in GDP in Eastern Europe in 1988-1991 was of the magnitude of 30% (Poland) and nobody died of starvation. Yes it was really bad. But you guys cannot cope with a mere 5% fall so far. The difference is that in 1989 everyone knew the communist model was dead and people had no false hope while in the US people still believe in the neoliberal stuff and are in the state of denial regarding energy availability (oil).

Australia is >10 times smaller than the US, we do not have an empire to defend, what we sell (commodities) is still in pretty high demand, the society is a bit different and there is the one year delay in all the processes.

That's why I am pretty optimistic. We can detach early enough from the sinking Titanic.


Robert said...

Bing - a new search engine

Robert (aka Winifred)

tooearly said...

Question: as to point 4. Printing one's way out of deflation is impossible as printing cannot keep pace with credit destruction (the net effect is contraction)

Don't you mean IMPROBABLE?

Anonymous said...

WOW, what a bunch of crybabies. This little "woe is us" list tells me just one thing, that we have become so spoiled that our current economic situation that amounts to almost nothing in the grand scheme of human existence has people out of their heads. If history tells us anything, its that the doom and gllom scenarios never happen, neither do the rosy ones. We end up somewhere in the middle.

Sadly, this list ignores the human spirit and will to make our surroundings better. This list also ignores that Russia and China are no better positioned than the US, and anything that impacts us will impact them just as badly, or worse. Russia is teetering on collapse at any given point in time, and China's wealth is 100% due to the West. If we are not providing it, the fact that they have so much of our cash won't matter. China is still mostly impovrished, and the rest of China will revert back to that very quickly without the West's backing. Their economy may look impressive, but its a pittance compared to what they need to sustain their entire population.

Enough already, quit blubbering about the end of the world and go do something about it. Bunch of morons.

moratmarit said...

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remshad said...

thanks Stoneleigh
i love your post