Spectators at the parade to recruit civilian defense volunteers, Washington, D.C.
Ilargi: I don’t want to listen to those speeches anymore, I don’t want to hear Geithner say that it's "unfortunate" (as in: but necessary) that the man in the street has to pay for banks' losses. Most of all I don't want to hear Obama state that the salaries of bank executives should not be regulated because those of NFL players are not. That sort of "logic" is so full of false and misleading intentions, I simply want to be spared any more of it. The whole lot of them will keep on repeating that all's looking up until it’s very obviously not, at which point they’ll say that events that no-one could have foreseen got in the way of all the goodies. And people will believe them.
Somewhere in this world there must be a way to figure out what is really going on, or even what is real to begin with. I may have found such a place. See, I was going to start paying more attention to county courts in the US, where I figured Joe Blow's troubles go to die. Apparently, it'll take some digging to get anything like a nationwide overview. I did find a few short pieces on financial troubles leading to lay-offs in the court systems, at a time when the works pressure greatly increases, which is an interesting facet to look into, and probably a very widespread phenomenon. For instance, Illinois told Madison County that it will cut the annual probation allocation for salaries by 57%.
And then I found a court filings roll from this one county. Which maybe is all the story we need to get a good picture of what‘s happening "on the ground".
Trumbull County in Ohio has some 210,000 residents, a number that's been slightly declining over the past 30 years. It has a regional campus of Kent State University, and all in all looks like a typical county. But not all is well. I think all I have to do is leave you with the new complaints as they were published Monday, September 14. I think you’ll see what I mean.
TRUMBULL COUNTY COURT FILINGS
Published: Mon, September 14, 2009
- Fifth Third Mortgage Co. v. Rodney A. Kendall et al, foreclosure.
- PNC Bank v. Ricky A. Gallant, foreclosure.
- The Huntington National Bank v. Mark P. Jordan, foreclosure.
- Suntrust Mortgage v. Carla Hodge et al, foreclosure.
- Beneficial Ohio Inc. v. Randall Alfrey, foreclosure.
- First National Bank of Pennsylvania v. Carl E. Brant et al, foreclosure.
- Federal National Mortgage Assoc. v. Jeffery Hawout et al, foreclosure.
- Home Savings and Loan Co. v. Dennis M. Aiello et al, foreclosure.
- Deutsche Bank National Trust Co. v. Clyda M. Delich et al, foreclosure.
- Chase Home Finance LLC v. Brian Layer et al, foreclosure.
- Deutsche Bank National Trust Co. v. Richard McGlynn et al, foreclosure.
- Seven Seventeen Credit Union v. James B. Spencer, foreclosure.
- Bank of New York Mellon v. Donna Harris, foreclosure.
- Huntington National Bank v. Beatrice Fairchild et al, foreclosure.
- Bank of America v. Karen Stamp et al, foreclosure.
- City Bank NA (not Individually but solely as trustee) v. Michael Chuppa et al, foreclosure.
- Wells Fargo Financial Ohio v. Deborah Lewis et al, foreclosure.
- Deustche Bank National Trust Co. v. Todd L. Bowers, et al, foreclosure.
- Wells Fargo Bank trustee for First Franklin v. Velicity M. Sanders et al, foreclosure.
- Huntington National Bank v. Victor Hull et al, foreclosure.
- Bank of New York Mellon v. Edward Freel et al, foreclosure.
- Citimortgage v. Thomas Shirley et al, foreclosure.
- BAC Home Loans Servicing v. John M. Wright et al, foreclosure.
- US Bank NA v. Shawn Jeffco et al, foreclosure.
- Bank of America v. Nikola Drobnjak et al, foreclosure.
- Wells Fargo Bank v. Mark Wickham et al, foreclosure.
- Suntrust Mortgage v. Robert Burns et al, foreclosure.
- Chase Home Financial v. Michael Palombo et al, foreclosure.
- Liquidation Properties Inc. v. Dorothy Sabin, foreclosure.
- Deustche Bank National Trust Co. v. Timothy Gibson et al, foreclosure.
- BAC Home Loans Servicing v. Joe Hippo et al, foreclosure.
- Farm Credit Services of Mid America FLCA v. Michael Laswell, foreclosure.
- Nationstar Mortgage v. Kristina Dagres et al, foreclosure.
- Everhome Mortgage Co. v. Hugh L. McAleer, foreclosure.
- US Bank National Assoc. v. Joseph M. Vingle, foreclosure.
- Chase Home Finance v. Daniel Helmuth, foreclosure.
- First Place Bank v. Hernon Holdings Ltd., foreclosure.
- Huntington National Bank v. Thomas F. Komlanc, foreclosure.
- BAC Home Loan Servicing v. Shannon Hentosh, foreclosure.
- Huntington National Bank v. Phil Smith, foreclosure.
- H&S Financial Inc. v. Michael Richards, other civil.
- American Express v. Lisa Meluch, other civil.
- MBNA America v. Beth Cline et al, other civil.
- Unifund CCR Partners v. Paula Balint, other civil.
- In the matter of Evidence and in the custody of the Newton Twp. Trustees, other civil.
- Joseph M. Siwicki v. Karen Plott, other civil.
- Chrysler Financial Services Americas v. Veronica Markley et al, other civil.
- Sallie Mae Inc. v. Keith McAleer et al, other civil.
- Troy Capital v. Louis Santucci, other civil.
- Wallace Family Ltd. v. Enervest Operating LLC, other civil.
- Capitol One Bank v. Roberta J. Barrett, other civil.
- Citibank v. Marian R. Robinson, other civil.
- Midland Funding v. Steve Clementi, other civil.
- Midland Funding v. John Jacques, other civil.
- Midland Funding v. Darryl Knight, other civil.
- Theresa Vargo v. State Auto Insurance Co., other civil.
- Nationwide Insurance Co. of America v. Joshua Lynn, other civil.
- American Express Centurian Bank v. Daniel Smith, other civil.
- Cheryl Heald v. John Turner et al, other torts.
- Michelle Campana v. Quantum Fitness & Health Inc., other torts.
- Gail L. Reed v. Progressive Ins. Co. et al, other torts.
- Richard H. Wilterdik D.O. Inc. et al v. Robert Masters, other torts.
- Robert J. Gaves v. Overholt’s Champion Pharmacy, Inc. other torts.
- Stephanie Schuman v. Clarence C. Welchman et al, other torts.
- Norma Fenwick v. James Poling et al, other torts.
- Virginia Penn v. Gary Breen et al, other torts.
- Barbara Blevins v. Warren City Schools et al, workers’ compensation.
- Minerva Rivera v. Absolute Rehabilitation & Consulting, workers’ compensation.
- Capital One Bank V. Rebox Services, money.
- Ford Motor Credit Co. v. Tradgard Landscape Contra et al, money.
- Chase Bank USA v. Suzette Shafer et al, money.
- Discover Bank v. Joseph Lawson, money.
- Jaguar Credit Corp. v. Joseph Major, money.
- Capital One Bank v. Karen Myers, money.
- National City Bank v. Christopher E. Hoff, money.
- John Soliday Financial Group v. James J. Peterson, money.
- Beneficial Ohio Inc. v. Susan H. Kintz, money.
- Alan Travaglini v. Stephen Chelekis, money.
- Seven Seventeen Credit Union Inc.v. Gladys Burns et al, money.
- GMAC LLC. v. Earl Fullwiler, money.
Expect little and you may yet be disappointed
by Willem Buiter
Until yesterday’s defeat of Roger Federer in the final of the US Open at Flushing Meadows, the most disappointing development this year was the performance of president Barack Obama and his administration - and my expectations were modest to begin with. A major let-down on the ‘values’ front has been the disregard for basic human rights and civil liberties displayed by the administration in their treatment of the Gitmo detainees. I would add to that Obama’s reluctance to pursue possible criminal offences committed by members of the previous administration who may have been involved in aiding and abetting torture and other forms of inhuman treatment of detainees. Obama’s preference for ‘healing and reconciliation’ - aka the soft option, because without accountability and justice there can be no healing and reconciliation - puts him on moral thin ice.
In foreign policy, the only success has been the gradual but steady US disengagement from Iraq. That bit of good news is increasingly overshadowed by the open-ended nature of the US (or Nato) engagement in Afpak, where the US administration is in bed with two spectacularly corrupt regimes, without any clear, operational statement of its objectives and its exit strategy.
But it is on the economic front that the damage is really piling up. President Obama’s speech yesterday (the first anniversary of the collapse of Lehman Brothers) on the lessons from Lehman’s demise demonstrated once again that we are stuck with a president who knows little about economics and cares less. There was some perfunctory populist bank and banker bashing, but nothing concrete. Like most other political leaders in the financially benighted north-Atlantic region, president Obama will use the absence of international cooperation and the impossibility of unilateral action by any one country as an excuse to avoid radical reform of the cross-border banking and financial system. No doubt the French president, Mr. Sarkozy, will again threaten his by now traditional walk-out over some trivial issue, but the chances of international agreement on measures that could reduce the frequency and severity of future systemic crises are slim.
The US officials supposed to lead the systemic reforms of the domestic and international financial system are the same people who failed to recognise the emerging disfunctionalities that produced the crisis, who indeed were responsible for creating some of these disfunctionalities, who failed to prevent the crisis, who re-fought the battle of the 1930s (and insist on taking great credit for doing so) and left us with the moral hazard nightmare legacy of the end of the first decade of the twenty first century.
On the fiscal side, Barack Obama is presiding over the biggest peace-time government deficits and public debt build-up ever. According to my back-of-the-envelope calculations there is about a 10 percent of GDP gap between the medium and longer-term spending plans of the Obama administration and the taxes the Congress is willing and able to impose. The reality that you cannot run a West-European welfare state (with decent quality health care, decent pre-school, primary and secondary school education for all), rebuild America’s crumbling infrastructure, invest in the environment and fulfill your post-imperial global strategic ambitions while raising 33 percent of GDP in taxes, has not yet dawned on the Obama administration or on the American people at large.
But it is on the international trade front that Obama has been most disappointing. The latest decision to slap a 35 percent tariff on Chinese tire imports could, with a bit a bad luck, be the beginning of a nasty little international trade tiff, and possibly of something more serious. The US International Trade Commission (“An independent federal agency determining import injury to U.S. industries in antidumping, countervailing duty, and global and China safeguard investigations; directing actions against unfair trade practices involving patent, trademark, and copyright infringement;”) - the dark heart of official US protectionism - had, in response to a complaint from the United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied Industrial and Service Workers International Union, recommended a 55 percent punitive tariff on imports of certain Chinese tires (this is on top of the existing 4 percent tariff). The president in the end signed an order for a 35 percent punitive tariff - possibly in an attempt to be just a little bit pregnant.
Whether or not these punitive duties are in violation of WTO rules time will tell. We know right now that it is a protectionist measure which is bound to enrage the Chinese, who announced retaliatory restrictions on imports from the US of poultry and vehicles (including poultry-drawn vehicles). Making the Chinese mad for no obvious domestic benefit (other than pandering to a relatively small sectional interest - the Steel et. al. Workers Union) is not smart. It comes right on the heels of a US slap in the face for its Canadian neighbours, who, under the Buy American provisions of the Obama stimulus act, cannot bid for US construction contracts, in direct violation of NAFTA.
A trade war in a global economy trying to escape from the worst downturn since the 1930s is the single event most likely to trigger a renewed collapse of global economic activity. The usual protectionist suspects in Europe (including, you guessed it, president Sarkozy of France) are already chomping at the bit to impose carbon tariffs on imports from China and India - an act that would be as close as you can get to open economic warfare short of blockading the ports of Mumbai and Shanghai. Clearly, the qualities one needs to get elected to high office in western democracies are not qualities that are likely to be helpful once you have achieved high office and are expected to govern and lead. To survive the selection process to become president you have to be able to stitch together a coalition of special interests that can provide sufficient financial and sweat equity resources to win this grueling race to the top. Once you get there, you should shed the unfortunate baggage you accumulated on your way up and govern in the interest of all the people. Few can do that. Apparently Obama is not one of them.
The Hard Truth About Financial Regulation
It's been a year since the $600 billion bankruptcy filing of Lehman Brothers and the financial market meltdown that forced the government into a multitrillion-dollar rescue of the U.S. banking system. But for all the talk and hand wringing (and billions in direct government equity stakes in major banks and loan and debt guarantees) there's also been little real progress on how, or if, Washington might regulate its way out of this kind of mess in the future. Don't expect that to change anytime soon, as markets become more, not less, complex and interconnected.
Despite multiple layers of government oversight and industry self-policing, dangerous gaps in regulation allowed a speculative bubble to build, and then burst, rocking the financial system as it hasn't been since the Great Depression. Its corollary, the belief that the government would step in to prevent an important bank from collapsing, created a sense of complacency about the risks being created. Yet neither the gaps nor the "too big to fail" concept have been eliminated.
In late August, representatives from the Securities and Exchange Commission and the Commodities Futures Trading Commission met to find a way to divide and conquer securities markets regulation, a feat made more difficult by the explosion in trading of complex derivatives and credit-related financial products in shadow off-exchange markets that aren't under direct supervision. These over-the-counter financial products are largely to blame for the collapse of Lehman and other major financial companies, including American International Group. The agencies, which have very different approaches to the workings of the stock markets, on the one hand, and the futures markets, on the other, have until Sept. 30 to come up with a plan.
The meetings are a precursor to the upcoming debates on the Obama administration's regulatory reforms, which some have criticized for stopping far short of the sweeping reforms ushered in by Franklin Roosevelt in the 1930s as his response to the Depression-era banking crisis. One of the biggest changes would be the naming of the Federal Reserve, already the lender of last resort, as the overseer of "systemic risks." That raises the possibility the central bank could soon be in the business of monitoring activities in corners of the market that have been seen beyond reach, including hedge funds.
Some of the proposals are bound to be mired in political infighting and turf guarding among the various federal agencies. The Federal Deposit Insurance Corp is already on record saying it favored the creation of a systemic risk council, not a single regulator, to oversee the risks undertaken by the biggest financial companies. As FDIC Chairman Sheila Bair noted in a recent opinion column in the New York Times, "The truth is, no regulatory structure--be it a single regulator as in Britain or the multiregulator system we have in the United States--performed well in the crisis."
Other proposals to close gaps in oversight include the creation of a regulatory agency for consumer financial protection, the consolidation of two federal regulatory agencies into one national bank regulator, and the bestowing of new powers on government agencies charged with overseeing banks, such as the ability to seize a non-bank financial company. Lehman, not a chartered commercial bank, fell as the government claimed to stand by helplessly watching. Rival investment banks Goldman Sachs and Morgan Stanley, which would be the only traditional major Wall Street firms left standing after September 2008, rushed to take on bank holding company status to avoid the same fate.
Having the power to seize a non-bank financial company would hopefully work to end the idea that any one company is too big to fail, Bair has said. But Lehman's collapse exposes another lesson the then-Treasury Secretary Henry Paulson seemed to be trying to avoid: in fact, "too big to fail" is alive and well.
For months regulators have acknowledged that some financial companies had simply grown too large and unwieldy and that dismantling them to a smaller size and more focused business would be to the benefit of the financial markets in general. Citigroup and American International Group, each with varying degrees of government assistance, are undergoing such a downsizing. But their continued existence only confirms the government's belief that there are some companies that are deemed so systemically important that their demise would cause more damage than any government bailout to prevent that demise.
By the time Lehman collapsed, after a mid-September weekend of frenzied negotiations among a dozen or so Wall Street chiefs at the Federal Reserve Bank of New York, the government had already taken control of mortgage titans Fannie Mae and Freddie Mac. It was teetering close to being forced to rescue American International Group. It had already been accused of overstepping in the March collapse of Bear Stearns and the subsequent government-assisted sale to JPMorgan Chase. By the end of that fateful September, Wachovia and Washington Mutual would both be forced to sell to rival banks.
Paulson was eager to prove he wouldn't let too big to fail change his mind about helping Lehman. But the subsequent freezing up of the credit and money markets--Lehman was a huge counterparty--prompted much second guessing about his failure to step in. A week later, spooked by the reverberations Lehman's collapse had on the markets, Paulson was proposing a $700 billion bailout originally intended as a government program to buy troubled assets from banks but which morphed into a program in which the government would take direct equity stakes in the major banks to prop up the system. Two of those banks, Citigroup and Bank of America, would have to return to the well multiple times for tens of billions of dollars in assistance.
By this spring, the rescue had morphed into a big confidence boosting operation designed to buy banks enough time to earn their way out of their troubles, including a round of stress testing of the 19 biggest, presumably most important, banks and a round a capital-raising. By identifying these banks, and forcing them through a stress test that seemed geared for success, the government basically signaled which companies it views as too big to fail.
One solution advocated by Bair and others: break up big banks. Citigroup is splitting itself up after years of empire building that created a company many considered to unwieldy to manage effectively. But that won't really fix things. Lehman was far from the biggest Wall Street bank, in fact it was the smallest of the big four still standing after the collapse of another relatively small firm, Bear Stearns, in March. Interconnectedness was the problem. And in our increasingly sophisticated and complex global financial system, it still is. How to eliminate that risk? This may be tough to swallow, but the truth is that you can't.
US credit shrinks at Great Depression rate prompting fears of double-dip recession
Both bank credit and the M3 money supply in the United States have been contracting at rates comparable to the onset of the Great Depression since early summer, raising fears of a double-dip recession in 2010 and a slide into debt-deflation. Professor Tim Congdon from International Monetary Research said US bank loans have fallen at an annual pace of almost 14pc in the three months to August (from $7,147bn to $6,886bn). "There has been nothing like this in the USA since the 1930s," he said. "The rapid destruction of money balances is madness."
The M3 "broad" money supply, watched as an early warning signal for the economy a year or so later, has been falling at a 5pc annual rate. Similar concerns have been raised by David Rosenberg, chief strategist at Gluskin Sheff, who said that over the four weeks up to August 24, bank credit shrank at an "epic" 9pc annual pace, the M2 money supply shrank at 12.2pc and M1 shrank at 6.5pc. "For the first time in the post-WW2 [Second World War] era, we have deflation in credit, wages and rents and, from our lens, this is a toxic brew," he said. It is unclear why the US Federal Reserve has allowed this to occur.
Chairman Ben Bernanke is an expert on the "credit channel" causes of depressions and has given eloquent speeches about the risks of deflation in the past. He is not a monetary economist, however, and there are indications that the Fed has had to pare back its policy of quantitative easing (buying bonds) in order to reassure China and other foreign creditors that the US is not trying to devalue its debts by stealth monetisation. Mr Congdon said a key reason for credit contraction is pressure on banks to raise their capital ratios. While this is well-advised in boom times, it makes matters worse in a downturn.
"The current drive to make banks less leveraged and safer is having the perverse consequence of destroying money balances," he said. "It strengthens the deflationary forces in the world economy. That increases the risks of a double-dip recession in 2010." Referring to the debt-purge policy of US Treasury Secretary Andrew Mellon in the early 1930s, he added: "The pressure on banks to de-risk and to de-leverage is the modern version of liquidationism: it is potentially just as dangerous." US banks are cutting lending by around 1pc a month. A similar process is occurring in the eurozone, where private sector credit has been contracting and M3 has been flat for almost a year.
Mr Congdon said IMF chief Dominique Strauss-Kahn is wrong to argue that the history of financial crises shows that "speedy recovery" depends on "cleansing banks' balance sheets of toxic assets". "The message of all financial crises is that policy-makers' priority must be to stop the quantity of money falling and, ideally, to get it rising again," he said. He predicted that the Federal Reserve and other central banks will be forced to engage in outright monetisation of government debt by next year, whatever they say now.
Why We're Facing Deflation
Just as water is formed by the basic elements hydrogen and oxygen, deflation has its own fundamental components. Last week we started exploring those elements, and this week we continue.
I feel that the most fundamental of decisions we face in building investment portfolios is correctly deciding whether we’re faced with inflation or deflation in our future. (Later I’ll tell you when to worry about inflation.) Most investments behave quite differently depending on whether we are in a deflationary or inflationary environment. Get this answer wrong and it could rise up to bite you.
The problem is that there’s not an easy answer. In fact, the answer is, it could be both.
Today I got another letter from Peter Schiff, who seems to be ubiquitous. He says the rise in gold is because of rising inflation expectations among investors. Gold is predicting inflation. Maybe. But the correlation between gold and inflation for the last 25-plus years has been zero. I rather think that gold is rising in terms of value against most major fiat (paper) currencies because it’s seen as a neutral currency. The Fed and the Obama administration seem to be pursuing policies that are dollar-negative, and they give no hint of letting up. The rise in gold above $1,000 doesn’t really tell us anything about the future of inflation.
In fact, it’s my belief that if the Fed were to withdraw from the scene of economic battle, the forces of deflation would be felt in short order. The answer to the question “Will we have inflation in our future?” is “You better hope so!”
I wrote in 2003 -- when Greenspan was holding down rates too long in order to spur the economy -- that the best outcome or endgame over the course of the full cycle would be stagflation. I still think that’s the most likely scenario. The Fed will fight deflation and knows how to do that. They also know what to do when inflation becomes too high. But there’s a cost.
It’s not a matter of pain or no pain; it’s a matter of choosing which pain we’ll face, for how long, and perhaps, in what order. As I wrote a few weeks ago, like teenagers, we as an economic polity have made some very bad choices. We’re now in a scenario where there are no good choices, just less-bad ones.
In a normal world, the amount of monetary and fiscal stimulus we’re witnessing would produce inflation in very short order. That’s what has the gold bugs of the world excited. It’s their moment. They keep repeating that Milton Friedman taught us that inflation was always and everywhere a matter of too much money being printed. The answer to that is that the statement is mostly true, but not always and not everywhere (think Japan). The reality is somewhat more nuanced. Let’s review some things in my article from last year called The Velocity of Money. And this time, we’re going to go into the concept a little more deeply. This is critical to your understanding of what’s facing us.
The Velocity Factor
When most of us think of the velocity of money, we think of how fast it goes through our hands. I know at the Mauldin household, with seven kids, it seems like something is always coming up. And what about my business? Travel costs are way, way up. And as aggressive as we are on the budget, expenses always seem to rise. Compliance, legal, and accounting costs are through the roof. I wonder how those costs are accounted for in the Consumer Price Index? About the only way to deal with it, as my old partner from the 1970s Don Moore used to say, is to make up the rise in costs with "excess profits," whatever those are.
Is the Money Supply Growing or Not?
But we’re not talking about our personal budgetary woes. Today we tackle an economic concept called the velocity of money, and how it affects the growth of the economy. Let's start with a few charts showing the recent high growth in the money supply that many are alarmed about. The money supply is growing very slowly, alarmingly fast, or just about right, depending upon which monetary measure you use.
First, let's look at the adjusted monetary base, or plain old cash plus bank reserves (remember that fact) held at the Federal Reserve. That’s the only part of the money supply the Fed has any real direct control of. Until very recently, there was very little year-over-year growth. The monetary base grew along a rather predictable long-term trend line, with some variance from time to time, but always coming back to the mean.
But in the last few months, the monetary base has grown by a staggering amount. And when you see the "J-curve" in the monetary base (which is likely to rise even more!) it does demand an explanation. There are those who suggest this is an indication of a Federal Reserve gone wild and that 2,000-dollar gold and a plummeting dollar are just around the corner. They’re looking at that graph and leaping to conclusions. But it’s what you don't see that’s important.
Now, let's introduce the concept of the velocity of money. Basically, this is the average frequency with which a unit of money is spent. Let's assume a very small economy of just you and me, which has a money supply of $100. I have the $100 and spend it to buy $100 worth of flowers from you. You in turn spend the $100 to buy books from me. We have created $200 of our "gross domestic product" from a money supply of just $100. If we do that transaction every month, in a year we’d have $2,400 of "GDP" from our $100 monetary base.
So, what that means is that gross domestic product is a function not just of the money supply, but how fast the money supply moves through the economy. Stated as an equation, it’s Y=MV, where Y is the nominal gross domestic product (not inflation-adjusted here), M is the money supply, and V is the velocity of money. You can solve for V by dividing Y by M. Now let’s dig a little deeper. Y, or nominal GDP, can actually be written as Y=PQ, that is, GDP is the Price paid times the total Quantity of goods sold. Therefore, since Y=MV, the equation can be written as MV=PQ. But the point is that Price (P) is tied to the velocity (V) of money. You can increase the supply of money, and if velocity drops you can still see a drop in the P, or inflation.
Now, let's complicate our illustration just a bit, but not too much at first. This is very basic, and for those of you who will complain that I’m being too simple, wait a few paragraphs, please. Let's assume an island economy with ten businesses and a money supply of $1,000,000. If each business does approximately $100,000 of business a quarter, then the gross domestic product for the island would be $4,000,000 (four times the $1,000,000 quarterly production). The velocity of money in that economy is four.
But what if our businesses got more productive? We introduce all sorts of interesting financial instruments, banking, new production capacity, computers, and so forth, and now everyone is doing $100,000 per month. Now our GDP is $12,000,000 and the velocity of money is 12. But we haven’t increased the money supply. Again, we assume that all businesses are static. They buy and sell the same amount every month. There are no winners and losers as of yet.
Now let's complicate matters. Two of the kids of the owners of the businesses decide to go into business for themselves. Having learned from their parents, they immediately become successful and start doing $100,000 a month. GDP potentially goes to $14,000,000. But, in order for everyone to stay at the same level of gross income, the velocity of money must increase to 14.
Note: If the velocity of money does NOT increase, that means (in our simple island world) that on average, each business is now going to buy and sell less each month. Remember, nominal GDP is money supply times velocity. If velocity doesn’t increase and money supply stays the same, GDP must stay the same, and the average business (there are now 12) goes from doing $1,200,000 a year down to $1,000,000.
Each business now is doing around $80,000 per month. Overall production on our island is the same, but is divided up among more businesses. For each of the businesses, it feels like a recession. They have fewer dollars, so they buy less and prices fall. They fall into actual deflation (very simplistically speaking). So, in that world, the local central bank recognizes that the money supply needs to grow at some rate in order to make the demand for money "neutral."
It’s basic supply and demand. If the demand for corn increases, the price will go up. If Congress decides to remove the ethanol subsidy, the demand for corn will go down, as will the price.
If the central bank increased the money supply too much, you’d have too much money chasing too few goods, and inflation would rear its ugly head. (Remember, this is a very simplistic example. We assume static production from each business, running at full capacity. Let's say the central bank doubles the money supply to $2,000,000. If the velocity of money is still 12, then the GDP would grow to $24,000,000. That would be a good thing, wouldn't it?
The answer is no, because only 20% more goods are produced from the two new businesses. There’s a relationship between production and price. Each business would now sell $200,000 per month or double their previous sales, which they’d spend on goods and services that had only grown by 20%. They’d start to bid up the price of the goods they want, and inflation would set in. Think of the 1970s.
So, our mythical bank decides to boost the money supply by only 20%, which allows the economy to grow and prices to stay the same. Smart. And if only it were that simple.
Let's assume 10 million businesses, from the size of Exxon (XOM) down to the local dry cleaners, and a population which grows by 1% a year. Hundreds of thousands of new businesses are being started every month, and another hundred thousand fail. Productivity over time increases so that we’re producing more "stuff" with fewer costly resources.
Now, there’s no exact way to determine the right size of the money supply. It definitely needs to grow each year by at least the growth in the size of the economy plus some more for new population, and you have to factor in productivity. If you don't, then deflation will appear. But if the money supply grows too much, then you've got inflation.
And what about the velocity of money? Friedman assumed it was constant. And it was, from about 1950 until 1978 when he was doing his seminal work. But then things changed. Let's look at two charts, the first from Stifel Nicolaus Capital Markets.
Here we see the velocity of money for the last 109 years. The left side of the chart shows the velocity of money using both M2 and M3 (measures of the money supply).
Notice that the velocity of money fell during the Great Depression. And from 1953 to 1980, the velocity of money was almost exactly the average for the last 100 years. Lacy Hunt explained that the velocity of money is mean reverting over long periods of time. That means one would expect the velocity of money to fall over time back to the mean or average. Some would make the argument that we should use the mean from more modern times since World War II, but even then, mean reversion would mean a slowing of the velocity of money (V), and mean reversion implies that V would go below (overcorrect) the mean. However you look at it, the clear implication is that V is going to drop. In a few paragraphs, we’ll see why that’s the case from a practical standpoint. But let's look at the first chart.
And then let's go back to our equation, Y=MV. If velocity slows by 30% (which it well has in terms of M3 -- and it’s down more than 15% in terms of M2) then money supply (M) would have to rise by that percentage just to maintain a static economy. But that assumes you don’t have 1% population growth, 2% (or thereabouts) productivity growth, and a target inflation of 2%, which mean M (money supply) would need to grow about 5% a year, even if V were constant. And that’s not particularly stimulative, given that we’re in recession. And notice in the chart below that M2 hasn’t been growing that much lately after shooting up in late 2008 as the Fed flooded the market with liquidity.
Bottom line? Expect money-supply growth well north of what the economy could normally tolerate for the next few years. Is that enough? Too much? About right? We won't know for a long time. This will allow armchair economists (and that’s most of us) to sit back as Monday-morning quarterback for many years.
But this is important. The Fed’s going to continue to print money as long as they aren’t confident deflation is no longer a problem. They can’t tell us what that number is because they don’t know. My guess is if they did tell us, the markets would simply throw up -- especially the bond market -- which would of course, make the situation (from a deflation-fighting point of view) even worse.
Sir, I Have Not Yet Begun to Print
When faced with the possibility of deflation, I can almost hear Bernanke now: “Sir, I have not yet begun to print!”
When will they know when enough is enough? When the velocity of money stops falling. When we see two quarters in a row where the velocity of money is rising, then it’s time to start investing in inflation hedges.
Why is the velocity of money slowing down? Notice the significant real rise in velocity from 1990 through about 1997. Growth in M2 was falling during most of that period, yet the economy was growing. That means that velocity had to have been rising faster than normal. Why? It’s financial innovation that spurs above-trend growth in velocity. Primarily because of the financial innovations introduced in the early '90s -- like securitizations, CDOs, and so forth -- we saw a significant rise in velocity.
And now we’re watching the Great Unwind of financial innovations, as they went to excess and caused a credit crisis. In principle, a CDO or subprime asset-backed security should be good things. And in the beginning, they were. But then standards got loose, greed kicked in, and Wall Street began to game the system. End of game.
What drove velocity to new highs is no longer part of the equation. The absence of new innovation and the removal of old innovations (even if they were bad innovations, they did help speed things up) are slowing things down. If the money supply hadn’t risen significantly to offset that slowdown in velocity, the economy would already be in a much deeper recession.
The Fed has more room to print money than most of us realize, and my bet is we’ll find out how much more. At some point, they’ll probably print too much.
There Are No Good Choices
What we’re looking at in our near future isn’t inflation. We’re in a period where the Fed is in the process of reflating, or at least attempting to do so. They’ll eventually be successful (though at what cost to the value of the dollar, one can only guess). One can have a theoretical argument about whether that’s the right thing to do, or whether the Fed should just leave things alone, let the banks fail, etc. I find that a boring and almost pointless argument.
The people in control don’t buy Austrian economics. It makes for nice polemics but it’s never going to be policy. My friend Ron Paul is not going to be allowed to make monetary policy, although he might get a bill through that actually audits the Fed. I’m much more interested in learning what the Fed and Congress will actually do and then shaping my portfolio accordingly.
A mentor of mine once told me that the market would do whatever it could to cause the most pain to the most people. One way to do that would be to allow deflation to develop over the next few quarters, thereby likely hurting gold and other investments, before inflation and then stagflation become (hopefully) the end of our perilous journey. Which of course, would be good for gold -- if you can hold on in the meantime.
Is it possible that we can find some Goldilocks end to this crisis? That the Fed can find the right mix, and Congress wakes up and puts some fiscal adults in control? All things are possible, but that’s not the way I’d bet.
While there are some who are very sure of our near future, I for one am not. There are just too damn many variables. Let me give you one scenario that worries me. Congress shows no discipline and lets the budget run through a few more trillion in the next two years. The Fed has been successful in reflating the economy. The bond markets get very nervous, and longer-term rates start to rise. What little recovery we’re seeing (this is after the double-dip recession I believe we face) is threatened by higher rates in a period of high unemployment.
Does the Fed monetize the debt and bring on real inflation and further destruction of the dollar, or allow interest rates to rise and once again push us into recession -- a triple dip? The Fed is faced with a dual mandate unlike other central banks. They’re supposed to maintain price equilibrium and also set policy that will encourage full employment. At that point, they’ll have to choose one over the other. I can construct a number of scenarios, but they all end with the same line: There are no good choices.
Stiglitz Says Bank Problems Bigger Than Pre-Lehman
Joseph Stiglitz, the Nobel Prize- winning economist, said the U.S. has failed to fix the underlying problems of its banking system after the credit crunch and the collapse of Lehman Brothers Holdings Inc.
“In the U.S. and many other countries, the too-big-to-fail banks have become even bigger,” Stiglitz said in an interview yesterday in Paris. “The problems are worse than they were in 2007 before the crisis.” Stiglitz’s views echo those of former Federal Reserve Chairman Paul Volcker, who has advised President Barack Obama’s administration to curtail the size of banks, and Bank of Israel Governor Stanley Fischer, who suggested last month that governments may want to discourage financial institutions from growing “excessively.”
A year after the demise of Lehman forced the Treasury Department to spend billions to shore up the financial system, Bank of America Corp.’s assets have grown and Citigroup Inc. remains intact. In the U.K., Lloyds Banking Group Plc, 43 percent owned by the government, has taken over the activities of HBOS Plc, and in France BNP Paribas SA now owns the Belgian and Luxembourg banking assets of insurer Fortis. While Obama wants to name some banks as “systemically important” and subject them to stricter oversight, his plan wouldn’t force them to shrink or simplify their structure.
Stiglitz said the U.S. government is wary of challenging the financial industry because it is politically difficult, and that he hopes the Group of 20 leaders will cajole the U.S. into tougher action. “We aren’t doing anything significant so far, and the banks are pushing back,” said Stiglitz, a Columbia University professor. “The leaders of the G-20 will make some small steps forward, given the power of the banks” and “any step forward is a move in the right direction.” G-20 leaders gather Sept. 24-25 in Pittsburgh and will consider ways of improving regulation of financial markets and in particular how to set tighter limits on remuneration for market operators. Under pressure from France and Germany, G-20 finance ministers earlier this month reached a preliminary accord that included proposals to reduce bonuses and linking compensation more closely to long-term performance.
“It’s an outrage,” especially “in the U.S. where we poured so much money into the banks,” Stiglitz said. “The administration seems very reluctant to do what is necessary. Yes they’ll do something, the question is: Will they do as much as required?” Stiglitz is too pessimistic and the banking system will probably continue to strengthen, said Jim O’Neill, chief economist at Goldman Sachs Group Inc. in London. “I’m not sure why he’s saying it,” O’Neill told Bloomberg Television today. “The banks were close to near death. We’ve been to hell and back, so to speak, and we’re on the road to recovery.”
Stiglitz, former chief economist at the World Bank and member of the White House Council of Economic Advisers, said the world economy is “far from being out of the woods” even if it has pulled back from the precipice it teetered on after the collapse of Lehman. “We’re going into an extended period of weak economy, of economic malaise,” Stiglitz said. The U.S. will “grow but not enough to offset the increase in the population,” he said, adding that “if workers do not have income, it’s very hard to see how the U.S. will generate the demand that the world economy needs.”
The Federal Reserve faces a “quandary” in ending its monetary stimulus programs because doing so may drive up the cost of borrowing for the U.S. government, he said. “The question then is who is going to finance the U.S. government,” Stiglitz said. Stiglitz gave the interview before presenting a report to French President Nicolas Sarkozy that urged world leaders to drop an obsession for focusing on gross domestic product in favor of broader measures of prosperity. “GDP has increasingly become used as a measure of societal well being, and changes in the structure of the economy and our society have made it an increasingly poor one,” Stiglitz said.
Sarkozy said today in a speech in Paris that focusing on GDP as the main measure of prosperity had helped to trigger the financial crisis. He ordered France’s statistics agency to integrate the findings of Stiglitz’s study into its economic analysis. Assessing government’s contribution to economic output, which ranges from 39 percent in the U.S. to 48 percent in France, is one of the shortcomings of the GDP model, as is its difficulty in estimating improvements in the quality of products such as cars instead of just quantity, Stiglitz said.
Similarly, increased household debt may drive up output numbers, even though that doesn’t amount to a real increase in wealth, he added. While Stiglitz doesn’t recommend dropping GDP altogether, he wants governments to consider such matters, along with issues of environmental sustainability, in policy making. “Most governments make a fetish out of it. If you take one message out of our report, make it avoid GDP fetishism,” he said. “The message is to encourage political leaders away from that.”
Elizabeth Warren: Why Was Detroit Bailout Treated Differently Than Wall Street Bailout?
When poor lending practices brought the world's biggest banks and AIG to their knees, Washington delivered hundreds of billions in financial lifelines, with little to no restrictions. When car manufacturers in Detroit needed bailing out, Washington played hardball and made sweeping changes to the boards and management at both GM and Chrysler. Elizabeth Warren wants to know why two insolvent industries were treated so differently. Warren, chairwoman of the Congressional Oversight Panel, spoke with MSNBC's Dylan Ratigan about inequality in Washington's bailouts. Talking about Tim Geithner's answer to her question on the topic, she says:That answer was deeply distressing. [..] I think the problem has been all the way through this crisis, that the banks have been treated gently and everyone else has been treated really pretty tough.
Americans Have Been Taken Hostage
by Dylan Ratigan
The American people have been taken hostage to a broken system. It is a system that remains in place to this day. A system where bank lobbyists have been spending in record numbers to make sure it stays that way.
A system that corrupts the most basic principles of competition and fair play, principles upon which this country was built. It is a system that so far has forced the taxpayer to provide the banks with the use of $14 trillion from the Federal Reserve, much of the $7 trillion outstanding at the US Treasury and $2.3 trillion at the FDIC.
A system partially built by the very people who currently advise our President, run our Treasury Department and are charged with its reform. And most stunningly -- it is a system that no one in our government has yet made any effort to fundamentally change. Like health care, this is a referendum on our government's ability to function on behalf of the American people. Ask yourself how long you are willing to be held hostage? How long will you let our elected officials be the agents of those whose business it is to exploit our government and the American people at any cost?
As hostages -- was there any sum of money we wouldn't have given AIG? Why did we pay Goldman Sachs and all the other banks 100 cents on the dollar for their contracts with AIG, using taxpayer money, while we forced GM and others to take massive payment cuts? Why hasn't any of the bonus money paid to the CEOs that built this financial nuclear bomb been clawed back? And more than anything else -- why does the US Congress refuse to outlaw the most anti-competitive structure known to our economy, one summed up as TOO BIG TOO FAIL?
It has become startlingly clear that we as a country, and I as a journalist, had made a grave error in affording those who built and ran those banks and insurance companies the honorable treatment of being called capitalists. When in fact the exact opposite was true, these people were more like vampires using the threat of Too Big Too Fail to hold us hostage and collect ongoing ransom from the US Government and the American taxpayer. This was no unlucky accident. The massive spike in unemployment, the utter destruction of retirement wealth, the collapse in the value of our homes, the worst recession since the Great Depression all resulted directly from these actions.
Even with all that -- the only changes that have been made, have been made to prop up and hide the massive flaws on behalf of those who perpetuated them. Still utterly nothing has been done to disclose the flaws in this system, improve it or rebuild it. Last fall was an awakening for me, as it was for many in our country. And yet, our Congress has yet to open its eyes, much less do anything about it. In fact conditions have never been better for the banks or worse for the rest of us. Why is this? Who does our Government work for? How much longer will we as Americans tolerate it? And what, if anything, can we do about it?
As we approach the anniversary of the bailouts for our banks and insurers -- and watch the multi-trillion taxpayer-funded programs at the Federal Reserve continue to support banks and subsidize their multibillion bonus pools, we must ask if our politicians represent the interests of America? Or those who would rob America of its money and its future? As a country, we must demand that our politicians stop serving those whose business models are based on systemic theft and start serving those who seek to create value for others -- the workers, innovators and investors who have made this country great.
Derivatives still pose huge risk, says BIS
The global market for derivatives rebounded to $426 trillion in the second quarter as risk appetite returned, but the system remains unstable and prone to crises, according to the Bank for International Settlements (BIS). The BIS said in its quarterly report that total turnover of derivatives rose 16pc, mostly due to a surge in futures and options contracts on three-month interest rates. Stephen Cecchetti, the bank's chief economist, said over-the-counter markets for derivatives are still opaque and pose "major systemic risks" for the financial system.
The danger is that regulators will again fail to see that big institutions have taken far more exposure than they can handle in shock conditions, repeating the errors that allowed the giant US insurer AIG to write nearly "half a trillion dollars" of unhedged insurance through credit default swaps. The misjudgement was to think the banks and insurers were safe because their "net" exposure was modest. That proved to be an illusion.
"The crisis has cast doubt on the apparent safety of firms that have small net exposures associated with large positions," Mr Cecchetti wrote. "As major market-makers suffered severe credit losses, their access to funding declined much faster than nearly anyone expected. When that happened, it was gross exposure that mattered. "The use of derivatives by hedge funds and the like can create large, hidden exposures," he added, citing the discovery that firms in Brazil, Korea and Mexico held huge foreign exchange contracts in late-2008. "Experience during the crisis points to the need for fundamental improvements in the management of counterparty risk."
Rakoff Rakes the SEC
Oscar Wilde once famously said that a cynic is someone 'who knows the price of everything and the value of nothing,'" wrote federal Judge Jed Rakoff yesterday in a scathing order rejecting a $33 million settlement between Bank of America and the SEC. Credit the judge with highlighting the particular political cynicism that drives too many of today's regulators. The SEC alleged earlier this year that BofA had "materially lied" in shareholder communications prior to its takeover of Merrill Lynch, by failing to disclose bonuses owed to Merrill employees. New SEC chief Mary Shapiro figured she'd play off public outrage with a civil lawsuit that would earn some headlines. BofA in August settled for $33 million, neither admitting nor denying guilt.
Judge Rakoff was having none of it. In a 12-page opinion, he tore into the SEC for ignoring its own guidelines and penalizing shareholders rather than the individuals who supposedly acted improperly. The settlement "does not comport with the most elementary notions of justice and morality, in that it proposes that the shareholders who were the victims of the Bank's alleged misconduct now pay the penalty for that misconduct." As for the SEC's argument that this shareholder punishment will result in better management, the judge called it "absurd."
The judge also had little sympathy for the SEC's argument that it would be too difficult to pursue executives, since they had been guided by lawyers. "If that is the case, why are the penalties not then sought from the lawyers? And why, in any event, does that justify imposing penalties on the victims of the lie, shareholders?" he asked. He also had harsh words for BofA, which has recently filed court papers claiming its proxy statement was neither false nor misleading. "If the Bank is innocent of lying to its shareholders, why is it prepared to pay $33 million of its shareholders' money as a penalty for lying to them?"
On this point, we think the judge is soft-pedaling the coercive nature of regulatory prosecution. Recall Eliot Spitzer, who used the threat of adverse media and falling stock prices to extort quick Wall Street settlements. Given all the dirty laundry already aired about this deal, including claims that Federal Reserve Chairman Ben Bernanke and former Treasury Secretary Hank Paulson forced a reluctant BofA to conclude its Merrill purchase, it's not surprising if BofA was willing to pay for it to go away.
Judge Rakoff's larger point that companies too often dip into the shareholder purse instead of fighting the good court fight is nonetheless true. He noted that this decision might have been "made even easier" for BofA given "the U.S. Government provided [it] with a $40 billion or so 'bailout.'" What was a "mere $33 million . . . to get rid of a lawsuit?" The judge had other complaints, but broadly the deal "suggests a rather cynical relationship between the parties: the SEC gets to claim that it is exposing wrongdoing on the part of the Bank of America in a high-profile merger; the Bank's management gets to claim that they have been coerced into an onerous settlement by overzealous regulators.
And all of this is done at the expense, not only of the shareholders, but also of the truth." The parties will go to trial in February. We look forward to it, especially in light of the recent news that Fed and Treasury knew all about these bonuses and stayed mum. Judge Rakoff has done a public service by exposing the political point-scoring that drives far too many regulatory actions.
U.K. Banks to Post Further $215 Billion Loss on Weak Economy, Moody's Says
U.K. banks are less than half way through posting 240 billion pounds ($398 billion) of losses on loans and securities, a reflection of the country’s economic weakness, according to Moody’s Investors Service Ltd.
British banks are likely to record losses of at least 130 billion pounds, in addition to 110 billion pounds lost since the beginning of the credit crisis in 2007, Moody’s said in a report today. The company “expects the sustained weakness of the U.K. macroeconomic environment to feed through into higher loan arrears with ensuing pressure on profitability and capital,” it said.
British taxpayers have provided about 1.4 trillion pounds of support to banks, becoming the biggest shareholder of Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc, while seeking to shore up capital eroded by writedowns. British banks have raised about 120 billion pounds of capital from the beginning of the credit crisis to mid-2009, Moody’s said. “We have been underweight on the banks for some time,” said Dave Bradbury who helps manage $6 billion at Canada Life Ltd. in London. “We are still worried about bad debts and the possible need to raise more money.” Standard & Poor’s last month estimated British banks would record 97 billion pounds of loan losses from 2009 to 2011, with bad debts peaking in 2010. The estimate was for domestic loans and didn’t include the overseas operations of banks, like the U.S. units of HSBC and RBS.
Banks face pressure on capital, along with depressed revenue and profitability, from the higher costs of attracting deposits and wholesale funding, Moody’s said. Further ratings downgrades are unlikely because the company has already incorporated risks, it added. Moody’s maintained its “negative” outlook for British banks. The company’s “base case scenario” anticipates a 40 percent peak-to-trough decline in British house prices and a 60 percent drop in commercial property, the report said. The highest losses will come from commercial real estate lending, where values have fallen 26 percent in the past 12 months, said the report. RBS and Lloyds are the most “exposed” to the construction and property sector, said Moody’s.
“Our analysis indicates there is a need for more capital in the banking system,” said Senior Credit Officer Elisabeth Rudman in an interview. Moody’s rating are based on the expectation that “high levels of systemic support” will continue, she added. Provisions for bad loans at Lloyds, the U.K.’s biggest mortgage lender, have already peaked said Chief Executive Officer Eric Daniels last month. The bank had provisions of 13.4 billion pounds in the first-half. Lloyds and RBS, have agreed to insure about 575 billion pounds of toxic and other risky assets with the government.
Government support has resulted in little change to senior debt and deposit ratings, which are expected to remain stable, Moody’s said. Separately, Spanish banks may be understating the true level of underperforming loans by 30 percent, an analyst at Credit Suisse Group AG said today. Bad credit on the books of the banks may still reach 150 billion euros ($218 billion), in 2010, Santiago Lopez, an analyst based in Madrid wrote in a report.
Gold investors warned to liquidate after 'buying frenzy'
London's leading gold forecaster has advised clients to liquidate holdings of gold and silver until the latest speculative fever abates, warning that futures contracts on New York's Comex exchange are flashing warning signals. John Reade, an analyst at UBS, said the number of "net long" positions held by speculators reached 29.02m an ounce last week, a record high. Investors watch Comex contracts as an indicator of froth in the market. Last week saw a jump of 6.4m ounces in net long contracts, a rare occurrence. When such sudden moves have occurred in the past, gold has fallen 5pc over the subsequent month on average.
The buying frenzy last week followed Chinese comments on the need for reserve diversification from dollars into euros, yen, and gold, as well as a proposal by the United Nations for a world currency. The dollar fell sharply, propelling gold to $1011 an ounce – tantalizingly close to its all-time high of $1030. Mr Reade, a repeat winner of the London Bullion Market Association's forecasting prize, said speculation in silver futures is even more extreme by some measures. Demand for physical gold – as opposed to paper contracts – has been flagging, with Indian jewellery demand well down on the levels a year ago and poor volumes reported in Turkey and Switzerland. The metal is trading at a discount on Istanbul's exchange.
"We recommend that nimble investors take profits on any long gold and silver positions, looking to re-enter after a correction," said Mr Reade. His price target is $950 over the next month, with fresh rallies in 2010. The last time net long contracts on Comex reached levels close to last week's high was in February 2008 as gold screamed to its historic peak. Prices crashed by $150 an ounce shortly afterwards. However, chartists say the technical signals are entirely different this time. Gold appears to be breaking through a "triple top", which could push prices much higher.
Europe warns recovery could be short lived
The European Commission today forecast that Europe would return to positive growth by the end of the year but that the recovery might not be sustainable in 2010. In a report that mirrors a warning last week from the National Institute of Economic and Social Research (NIESR), which said stagnation might follow an upturn early next year, the commission predicts a recovery in GDP growth in the second half of this year, helped by a rapid recovery in Germany, France and the UK.
However, it warns that for next year uncertainty is rife. "There are reasons to believe that the recovery could prove volatile and sub-par," it said, adding the full effect of the economic crisis on labour markets and public finances was still to be faced. The commission said: "Rising unemployment could weigh on consumption, while ample spare capacity and an anaemic credit supply might restrain investment." It concluded: "The strength of the recovery could surprise on the upside in the near term, but its sustainability is yet to be tested."
NIESR, an influential think tank, predicted last week that the UK economy would recover but that there might be a prolonged period of stagnation to follow because economic stimulus measures, such as car scrappage and VAT cuts, were about to end. The commission estimates that the Eurozone and the entire European Union will experience 0.2 per cent GDP growth in the third quarter against the previous quarter, and 0.1 per cent quarter-on-quarter growth in the fourth quarter, after two successive quarterly falls in GDP across Europe. Britain's third-quarter and fourth-quarter GDP growth is predicted to be 0.2 per cent and 0.5 per cent respectively. This compares with Germany's 0.7 per cent and 0.1 per cent and France's 0.4 per cent and 0.3 per cent.
It said: "The commission sees signs of an imminent economic recovery and fears of a prolonged and deep recession are fading ...The improved economic outlook reflects external conditions being increasingly favourable. Recent data for trade and industrial production, as well as business and consumer confidence, are generally encouraging." For the year as a whole, it expects Europe's GDP to fall by 4 per cent with the UK down 4.3 per cent, virtually unchanged from its earlier forecasts, which proved too optimistic about the economy in the fourth quarter of last year and the first quarter of this year. The commission will give further, more detailed predictions in its full forecast to be published at the start of November.
London retail sales tumble to cast doubt on the sector's recovery curve
London's retailers will today create shockwaves by posting their worst monthly sales for four years, ahead of results this week from some of the UK's biggest store groups that will provide a health check for the high street leading up to the critical Christmas trading period.
The department stores Debenhams and John Lewis, the fashion retailers Next and French Connection, the DIY group Kingfisher, and the furnishings chain Dunelm will all update the market this week. Further August sales data will be unveiled by the Office for National Statistics on Thursday.
The British Retail Consortium said that like-for-like retail sales in Central London plummeted by 5.9 per cent in August – the first month they have fallen this year after seven months of growth, which has hitherto been partly supported by foreign shoppers taking advantage of the weak pound. Retail sales fell by 0.1 per cent outside of the capital, which was the first time they had been ahead of London's this year, although the gap had previously been narrowing, according to the BRC-KPMG Retail Sales Monitor.
Stephen Robertson, the director general of the BRC, said: "These results don't suggest the recovery is underway. This is the lowest London sales growth since August 2005." He added: "Central London footfall saw the biggest drop for over a year and a half. The pound is less weak that it was, eroding London's appeal for overseas visitors. Like domestic shoppers, tourists are also more cautious." The religious event of Ramadan also began in early August this year, in contrast to September last year, which led to Middle Eastern visitors returning home earlier.
However, the data from the UK and London further confirms a slowdown in the retail sector after robust trading in June and July. While strong retailers, including Morrisons, Next and Kingfisher, which owns B&Q, have already posted profit upgrades recently and the worst fears of store groups about 2009 have not materialised, retailers are still nervous about the crucial Christmas trading period, when most make the bulk of their annual profits, particularly given growing unemployment and the rising savings ratio.
But Mr Robertson pointed out that London's retailers were up against a strong August 2008 – the third highest figure last year – when like-for-like sales actually rose by 8.6 per cent. Last month's better weather in the capital after the downpours of 2008 hit footfall as shoppers favoured outdoor leisure activities.
This week, the comments by Charlie Mayfield, the chairman of the John Lewis Partnership, are likely to be given the most scrutiny given that the eponymous department store is seen as a vital barometer of consumer spend. While trading at John Lewis, which posts half-year results on Thursday, has picked up since the first few months of the year, its stablemate Waitrose, the supermarket group, has been powering ahead – delivering marketing-leading sales recently.
Tomorrow, Debenhams is expected to post annual pre-tax profits of about £120m, but is expected to say that its fourth-quarter sales have dipped, partly because of the disruption caused by allocating store space away from costly concessions towards its own-bought ranges, say City analysts.
On Thursday, the ONS is expected to say that sales growth slipped in August. Howard Archer, the chief European economist at IHS Global Insight, said: "The fact is that consumers continue to face serious obstacles that are likely to limit spending for some time to come. These notably include sharply higher and rising unemployment, low earnings growth and heightened debt levels."
The disease of private debt is not cured
by Steve Keen
You have just come from your annual medical check-up where your doctor assures you that you are in robust health. Walking jauntily down the street, you bump into a practitioner of alternative medicine. He takes one look at you and declares, “You have a serious tumour! It must be removed or you will die.” You ignore him as you always have, and continue your merry way down the street. One day later, a stabbing pain suddenly cripples you, and you collapse to the pavement. In agony, your call your doctor, who initially refuses to send an ambulance because he knows you are well.
When you lapse into a coma and stop talking mid-sentence, your doctor concludes that perhaps something is wrong, and sends an ambulance to take you to hospital. Initially the doctor waits for you to revive spontaneously, because he still knows there's nothing really wrong with you. But as your pulse starts to weaken, he reluctantly calls a retired doctor who had experience of a similar inexplicable malady in the distant past. She prescribes massive doses of tranquilisers, pain-killers, vitamins, and oxygen – all substances that had been removed from the medical panoply due to recent advances in medical theory. Reluctantly, your doctor follows his retired colleague's advice – and miraculously, you start to revive.
After a year of expensive medical treatment, you return to the same robust health you displayed before your inexplicable illness. Triumphant, if somewhat puzzled, your doctor declares you well once more, and releases you from intensive care. As you stride confidently away from the hospital, you have the misfortune to once again bump into the practitioner of alternative medicine. “But they haven't removed the tumour!”, he declares. One shouldn't have to spell out the details of such an analogy, but in times of widespread denial, one has to:
- You are the economy;
- The tumour is a massive accumulation of private debt;
- Your doctor is Neoclassical Economics, and the retired colleague is a so-called "Keynesian" Economist (who doesn’t know it – since his medical textbooks were poorly written – but he’s actually following another economist called Paul Samuelson, not Keynes);
- The alternative medicine practitioner follows Hyman Minsky's "Financial Instability Hypothesis" (which is based on what Keynes actually did say – as well as the wisdom of Joseph Schumpeter and, in whispers, Karl Marx);
- The moment you hit the pavement is the beginning of the Subprime Crisis; The collapse of Lehman Brothers is the moment when you slip into a coma; and
- The day the doctor takes you off life support and declares all is well … is next month.
The final reason for me being a bear is that I am that practitioner of alternative medicine. Minsky’s “Financial Instability Hypothesis” has been ignored by conventional economists for reasons that are both ideological and delusional. A small band of “Post-Keynesian” economists, of whom I am one, have kept this theory alive. According to Minsky’s theory:
- Capitalist economies can and do periodically experience financial crises (something that believers in the dominant “Neoclassical” approach to economics vehemently denied until reality – in the form of the Global Financial Crisis – slapped them in the face last year);
- These financial crises are caused by debt-financed speculation on asset prices, which leads to bubbles in asset prices;
- These bubbles must eventually burst, because they add nothing to the economy’s productive capacity while simultaneously increasing the debt-servicing burden the economy faces;
- When they burst, asset prices collapse but the debt remains;
- The attempts by both borrowers and lenders to reduce leverage reduces aggregate demand, causing a recession;
- If the economy survives such a crisis, it can go through the same process again, with another boom driving debt up even higher, followed by yet another crash; but
- Ultimately this process has to lead to a level of debt that is so great that another revival becomes impossible since no-one is willing to take on any more debt. Then a Depression ensues.
That is where we were … in 1987. The great tragedy of today is that naïve Neoclassical economists like Alan Greenspan and Ben Bernanke allowed this process to continue for another three or more cycles than would have occurred without their rescues.
In 2008, they did it again – only with methods they would have disparaged a mere year earlier (“Rational Expectations Macroeconomics”, a modern neoclassical fad, preaches that government intervention can’t influence the level of economic activity at all – yet another belief that reality has recently crucified). This time, while the rescue has worked, the recovery they expect afterwards can’t happen – because there’s almost no-one left who will willingly take on any more debt. This time, there’s no re-leveraging way out. The tumour of debt has to be removed.
Government Spending Is Naked Without the Fed
President Barack Obama takes his show on the road today for what the White House says is a “major speech” on the financial crisis. And where better to deliver such a speech on the one-year anniversary of Lehman Brothers’ collapse than Wall Street? Today’s address will no doubt build on the administration’s report card, issued last week, on the $787 billion American Recovery and Reinvestment Act. The president’s Council of Economic Advisers determined that the ARRA added about 2.3 percentage points to real gross domestic product growth in the second quarter and created or saved about 1 million jobs as of August.
These estimates “are made by comparing actual economic performance” to the baseline forecast, the CEA said, which is like comparing real life to a Hollywood movie. While the CEA included the caveat that any definitive assessment of the stimulus’s impact is impossible because of the lack of a control study -- no one knows what would have happened without the intervention -- the Council concludes the intervention had “a substantial positive impact on real GDP growth and on employment in the second and third quarters of 2009.” Nonsense, according to Stanford University economics professor John Taylor. “I can’t see any evidence the stimulus is working,” Taylor said at a Sept. 10 dinner in New York sponsored by the Hoover Institution, where he is a senior fellow.
Real GDP fell 1 percent in the second quarter compared with declines of 5.4 percent and 6.4 percent in the previous two quarters, respectively. It sure looks as if some kind of dam acted to hold the waters back in the April-to-June quarter. The only component of final domestic demand to show an increase was government spending. Real consumer spending fell 1 percent, residential investment was down 22.8 percent and business fixed investment slumped 13.5 percent, all at a seasonally adjusted annualized rate. If the stimulus were working as advertised, consumption would have increased, Taylor said.
Economists have been arguing about the merits of fiscal stimulus for as long as it’s been a fixture of crisis management. All governments are guilty when it comes to intervention in the economy, tweaking the name and spinning the effect -- supply side, demand side -- to suit their political purposes. The question of whether it works is never settled to the satisfaction of either the proponents or opponents. How can we expect politicians to enact legislation that’s good for the economy if the economics profession can’t agree on what works and what doesn’t?
There is something intuitively appealing about the idea of fiscal stimulus, although it probably has something to do with the name. When animal spirits are depressed, some entity has to step in to get the economy moving, spending money that generates income for others, which begets more spending. Logic argues against such a notion. Think about it this way. The federal government is just like you and me (well, sort of). It gets a “paycheck” in the form of taxes (no, you can’t withhold the paycheck for non- performance of services). And it uses the money for “household expenditures,” including basic necessities (food and shelter for our armed forces), support for the unemployed, sick and elderly, and various pork-barrel projects.
And just like many of us, the government spends more than it “earns.” So it has to borrow or raise taxes, in which case you and I have less money to spend. In other words, government spending is a wash in terms of the dollars spent now or in the future, except that you and I are more discerning about what we buy and how much we pay. Sure, when you throw enough money at the economy, there will be some GDP response, now versus later. But there’s no free lunch.
There is, however, a third possibility, akin to a magician’s wand. You and I can set up a high-tech counterfeiting operation in the basement, forging crisp hundred-dollar bills. The central bank does pretty much the same thing, creating money out of thin air, in which case the federal government has money to spend and it doesn’t come from you and me. The only difference is that we go to jail if we’re caught. If it sounds too good to be true, it is. Printing money increases aggregate demand in the short run but leads to higher inflation down the road.
Any discussion of fiscal stimulus -- whether it works, how big it should be, where it should be targeted -- must therefore start and end with monetary policy. That’s what provides the stimulus. It would go a long way toward alleviating the confusion if we stopped referring to bridge building and farm-price supports as stimulus and called them by their proper name: government spending. By that name, it doesn’t smell as sweet.
Get Ready for More Bank Failures
The worst financial crisis in a lifetime has produced surprisingly few bank seizures. Now, some analysts see the pace of failures picking up. By most measures, the past year has been the worst financial crisis in a lifetime. But not by one significant measure: Bank failures. The Federal Deposit Insurance Corp. has closed 92 banks so far in 2009, after seizing 25 ailing banks last year. By contrast, during the last banking crisis, 381 banks were seized in 1990, 268 in 1991, and 179 in 1992. Still, the pace of bank failures is accelerating. In recent days, three banks failed, including Illinois-based Corus Bank, doomed by $3.2 billion in construction loans, mostly to condominium developers.
The relatively slow pace of bank failures during the crisis is partly the result of government decisions to keep ailing banks open for as long as possible, says Louisiana State University banking professor Joseph Mason. Now, it appears, the FDIC is shutting down the bad banks at a faster rate. Since July 1, the FDIC has shuttered 47 banks, amounting to more than half of the FDIC's financial losses on the bad banks this year. The consensus among banking experts is that two to three times more banks could fail during this crisis, for a total of 200 to 300, says independent market strategist Doug Peta.
Put simply, the problem for banks is bad loans. Institutions have been hit by one type of problem loan after another, says Keefe, Bruyette & Woods (KBW) analyst Frederick Cannon. First, it was bad residential real estate loans, including the notorious subprime mortgages. The biggest bank failure of the crisis occurred on Sept. 25, 2008, when the FDIC closed down Washington Mutual and arranged for it to be bought by JPMorgan Chase (JPM). Another big failure was on July 11, 2008, when the FDIC, at a cost of $10.7 billion, took over IndyMac, a specialist in risky, so-called Alt-A residential loans.
Mortgage problems persist, but banks specializing in loans to developers have been hit hard in 2009. KBW data show that, of banks that have failed since 2007, an average of 28.8% of loans outstanding were construction loans, compared to 9.8% for the industry as a whole. At Corus, which failed on Sept. 11, 88% of its lending was construction loans. "This year is dominated by construction lenders," Cannon says. The next problem for banks is likely to be commercial real estate and other commercial and industrial loans, Cannon says. A healthy banking industry is a key ingredient to an economic recovery. Small businesses especially rely on bank financing, which has been hard to get recently.
However, an accelerating cascade of bank failures isn't all bad news for the banking industry as a whole. For one thing, bank "seizures are good for the survivors," Peta says. "[Failures] reduce the number of institutions indulging in 'Hail Mary' banking." In other words, a desperate, troubled bank is likely to offer high rates to attract depositors. That lures customers from strong banks to weak banks. Also, when banks fail, their stronger competitors can gobble up their branches and depositors "on the cheap," Peta says. For example, BB&T Corp. (BBT) became one of the nation's top-10 banks this month by asset size, according to rankings by SNL Financial. The reason: BB&T acquired Colonial Bank, which has $22 billion in assets, after its closure by the FDIC on Aug. 14.
At the same time, the problems at big banks might be giving smaller institutions a chance to win back market share, says Christine Barry, research director at the Aite Group . In her recent survey of almost 800 community banks, she found that more than half reported adding customers and deposits during the financial crisis. "While a lot of these banks are faced with big challenges, many of them are actually seeing a lot of opportunities," she says. Since the beginning of the financial crisis, investors have complained about a lack of transparency from banks. Without knowing what bad loans or toxic assets sit on bank balance sheets, it's difficult to assess how risky those banks really are. "The one thing the industry needs is information for investors to sort out who is strong and who is weak," Mason says. Regulators are still reluctant to release this data, for fear of scaring investors, says Mason. But he believes this approach is counterproductive and could prolong the recession.
Still, banking stocks have rebounded strongly this year, with the KBW Bank Index (BKX) up 141% since its low on Mar. 6. (But the index is still down 56% from two years ago.) What has boosted investor confidence isn't information, but the implication that many large banks are too big to fail, Mason says. "They're still living off the life support of various government programs," he says. A cure for ailing banks is time. With interest rates low, this should be a profitable time for many banks, Peta notes. The housing market is showing signs of recovery, with the most recent Case-Shiller Home Price index rising 1.4% from May to June. That's a good sign for a banking industry with many loans related to real estate. "We are making some progress," Peta says. If they make the right moves, some troubled banks can survive long enough, and earn enough now, to make up for losses of the past few years. But for hundreds of less fortunate institutions, time is quickly running out.
Europe Overtakes North America as World’s Wealthiest Region
Europe replaced North America as the world’s richest region last year as measured by assets under management, a survey by the Boston Consulting Group said. North America, defined as the U.S. and Canada, had $29.3 trillion in assets under management, compared with $32.7 trillion in Europe in 2008, according to the survey released today by the Boston-based firm. The U.S. remains the wealthiest country at $27.1 trillion and has the highest number of millionaires -- almost 4 million. Japan’s global wealth is No. 2 with $13.5 trillion and more than 1 million millionaire households.
Global wealth dropped for the first time since the survey started in 2001 as assets under management decreased 11.7 percent to $92.4 trillion last year from $104.7 trillion a year earlier. The credit crisis sent stock indexes to their worst annual losses since the Great Depression and slashed the value of real-estate holdings, hedge-fund and private-equity investments in 2008. The Standard & Poor’s 500 Index dropped 38 percent last year, the steepest annual decline since 1937.
“For the last few years, the industry was blessed with very substantial growth, markets kept rising and people kept getting richer and pumping more money to wealth managers,” said Monish Kumar, a partner and managing director in the firm’s New York office. “That era came to a crashing halt in 2008.” The biggest drop occurred in North America, where wealth plunged 22 percent, according to the survey. The second-biggest decline was Japan, where wealth fell almost 8 percent in local currencies. Latin America, defined by the survey as Mexico, South America and Central America, was the only region where wealth grew, by 3 percent.
Wealth is expected to begin a “slow recovery” in 2010, according to the survey. Assets under management will grow at an average annual rate of 3.8 percent from the end of 2008 through 2013 to $111.5 trillion. “We believe wealth will come back, but we remain conservative,” said Peter Damisch, a partner and managing director in Boston Consulting Group’s Zurich office. “Before 2013, we won’t get back to 2007 levels.” The number of millionaire households globally fell to 9 million from 11 million, with North America and Europe both experiencing decreases in the number of millionaire households by 22 percent, according to the report. The results are similar to a survey released in June by Capgemini SA and Merrill Lynch & Co. that found the number of millionaires slipped 15 percent to 8.6 million.
Singapore has the highest concentration of millionaires with 8.5 percent of the nation’s households having more than $1 million in assets under management, the report said. The amount of offshore wealth declined to $6.7 trillion last year from $7.3 trillion in 2007 as regulators pressured countries such as Switzerland to cut down on bank secrecy. Switzerland accounts for 28 percent of offshore assets with the United Kingdom at 23 percent. Singapore and Hong Kong may grow as offshore centers because of their proximity to other Asian countries and sophistication of Asian banks, the report said. Investors have had their confidence “shattered” by markets, scandals and failed financial institutions, according to Bruce Holley, a senior partner and managing director at Boston Consulting Group’s New York office and topic expert for wealth management and private banking for the U.S. That has resulted in a shift to lower-risk asset classes and investments that are liquid and simple, he said.
Brokers including Morgan Stanley Smith Barney in New York and Zurich-based UBS AG may lose a combined $188 billion of assets this year as advisers moving to independent firms take clients with them, Boston-based consultant Cerulli Associates said last week. The largest brokerages’ share of assets under management is expected to drop to 40.7 percent by the end of 2012 from 47.7 percent, according to the Cerulli report.