Yard of tenement, New York City
Ilargi: Well, yes, I guess that the best thing Obama's finance gurus could have wished for is for people to believe that if they can pull off something once, they can continue to do so indefinitely. All they'd have left to do after that is pray like a swirling bunch of derwishes that those people will keep on thinking so until either a miracle happens and the economy shows actual growth - to replace the made-up version seen so far- or at least until they are safely out of office.
And I got to give it to them: they have even quite a number of readers of supposedly critically intelligent websites like the Automatic Earth going for the idea. Everything looks fine when observed from the right angle, so therefore it must be fine. The stock markets regained over half of what they lost, so the upswing we all feel so much more comfortable with is here and will go on for weeks and months and years.
Man may see himself as rational and smart, but the human mind is one big mothersucker for an upswing, any upswing, screw the odds. Them things just feel good, what can we say, what can we do? It's who we are.
Anyone remember what happened to the debt we were worried about not so long ago? Who cares, really? "They" must have gotten rid of that too, somehow, though I don’t understand how, but then, they are way smarter in that field than I am, and I know they are always looking out for me and my family. And the upswing they know I like so much.
Unemployment in the USA, even when calculated in the deceptive and distorted way we have now become so fully accustomed to that we hardly raise our voices anymore, is much higher today than it was a year ago. The official U6 number is at 17.5%, unofficial data indicate more than 1 in 5 Americans are effectively un- or underemployed. A few million more homes were foreclosed on in 2009. The number of hours worked is lower. Pay per hour is stagnant at best. $1.5 trillion in consumer credit card space was pulled. States are reeling and panicking over double digit budget shortfalls. Tax revenues are plummeting. Federal debt has risen by a factor higher than seen since WWII, if not even more. Add your own favorite stats and color the pictures.
Still, before any of these developments had even started, back in 2008 49.1 million US citizens had trouble finding enough food to eat. That probably means 15-20 million children. And don't forget that if they could have fed themselves, much of the food would have been of an inferior quality, since in most poor areas of the country, there's a hell of a lot more cheap burgers available than vegetables. Perhaps luckily for them, they couldn't even afford no high-fructosed whoppers.
But that was last year. In 2009, how many more hungry children did we add to the tally? Whatever their number, Obama and his administration chose and choose to ignore them. For Washington, saving Wall Street institutions is much more important. First you save the banks, and if there's anything left afterwards, you may -or may not, depending on what the polls say- look at the 30-some million unemployed and the 20-odd million undernourished children.
The money used to prop up the banks has led to the illusionary notion of actual profits being made. Which in turn is all the excuse that's needed to pay out bonuses, which in 2009 are set to reach new record levels. 20 million hungry children could be greatly helped with $1000 a year each for food. That would cost $20 billion, and still leave more than enough to pay some kind of bonuses. Or even better, dare we say it, pay back the government loans.
Where I come from, the description of a nation that leaves its children behind in hunger while showering its upper classes with lavish amounts of more luxury than they know what to do with evokes pictures of present-day Somalia or latter-day Rome and the let-them-eat-cake France of Marie Antoinette. Not of a socially and politically highly developed society of the 21st century.
For that reason alone, much the rest of the developed world will be greatly tempted to pull their hands away from America. They will simply conclude that a country that lets one out of every seven, six, five of its people go to bed without being properly fed, is a threat, plain and simple. The people in these countries will think that if their own representatives get too cozy with the US "leaders" who let that sort of thing happen, the same thing may some day soon be their fate.
"President Barack Obama called the USDA report "unsettling" and vowed to reverse the trend of rising hunger." The trend the report talks about is a year or more old. And still the president had no idea until the report came out? I'd say it's unsettling that he responds the way the does. Isn't it sort of his job to know when 50 million Americans go hungry? Is there anything at all more elementary than that for an elected "leader"?
The president has spent all he can afford, and more, on bailing out campaign donating bankers. He can't afford to feed the children, even if he would want to, which looks doubtful by now. Or rather, he might want to, just as he might want to send a manned mission to Mars by Christmas and reverse global warming by Thanksgiving. Not a priority, in other words.
"They can make this rally last for years". No, they can't, but they can make enough people think they can, and that's what counts.
Ilargi: This is not TV. You don't have to be just an observer on a couch, and frankly, you shouldn't. You can be, indeed you are, very much a part of the Automatic Earth. If and when you choose to be, that is.
Our Fall Fund Drive (please see the top of the left hand column) is happening right now. Your donations -and visits to our advertisers- make this site possible. Without you, there can be no Automatic Earth. We're not talking multi-thousand dollar donations, even though these are very welcome and would allow us to take the next few steps towards what we think this site could and should be, but essentially, for now, the Automatic Earth is being kept alive with donations of $100 or even $10 at a time.
And of course we'd like to thank all our past, present and future donors for your confidence in us. That can never be said enough, and there never seems to be a sufficiently adequate manner to express that gratitude in. But rest assured, you make us feel humble.
Meredith Whitney: "I haven't been this bearish in a year"
Close to 50 million Americans struggle to get enough to eat
More than 49 million Americans -- one in seven -- struggled to get enough to eat in 2008, the highest total in 14 years of a federal survey on "food insecurity," the U.S. government said Monday. While Agriculture Secretary Tom Vilsack said programs such as food stamps softened the impact of an economic recession, anti-hunger groups pointed to the huge increase from the preceding year when 36.2 million people had trouble getting enough food and a third of them occasionally went hungry.
"The survey suggested that things could be much worse but for the fact that we have extensive food assistance programs," Vilsack told reporters. "This is a great opportunity to put a spotlight on this problem." About 14.6 percent of U.S. households, equal to 49.1 million people, "had difficulty obtaining food for all their members due to a lack of resources" during 2008, up 3.5 percentage points from 2007 when 11.1 percent of households were classified as food insecure.
About 5.7 percent of households, or 17.3 million people, had "very low food security," meaning some members of the household had to eat less. Typically, food runs short in those households for a few days in seven or eight months of the year, USDA said. President Barack Obama called the USDA report "unsettling" and vowed to reverse the trend of rising hunger.
"Our children's ability to grow, learn, and meet their full potential -- and therefore our future competitiveness as a nation -- depends on regular access to healthy meals," Obama said in a statement. USDA's annual report was based on a survey conducted in December 2008, soon after financial markets slumped and when the jobless rate was marching toward its current 10.2 percent.
"The numbers are even worse than people otherwise believed," said Jim Weill of the Food Research and Action Center, an anti-hunger group. "We all know we have the worst downturn since the Depression." David Beckmann of the anti-hunger group Bread for the World called for stronger federal anti-hunger programs. "The recession has made the problem of hunger worse, and it has also made it more visible," he said.
Vilsack said the report represented "an opportunity here for the country to make a major commitment to end childhood hunger by 2015," an administration goal. He called on Congress to make it easier for poor children to get free school meals and to improve the nutritional quality of those meals. Child nutrition programs, which cost about $24 billion a year, are overdue for renewal but Congress is not expected to act before 2010. The administration backs a $1 billion increase but has not found offsetting cuts at USDA to pay for it.
The number of Americans receiving food stamp assistance soared above 36 million for the first time in August, the eighth month in a row that enrollment set a record, the USDA said earlier this month. As part of the stimulus package, food stamp benefits were raised temporarily through September 2010. Vilsack said it was too early to judge if the increase should become permanent.
New crisis ahead? 5 things to watch
Bob Janjuah is back, and dude, he's not happy about what you've done to the stock market. Then again, Janjuah is never really very happy. But now the great bear of the United Kingdom -- the chief market strategist at the Royal Bank of Scotland, to be exact -- is quite sure that stocks' bender over the past eight months is about to come to a terrible, concussive, tragic end. He's like a cop who wants to slap a DUI on your portfolio.
Should we care? Well, most bears aren't worth the kibble that's slipped into their cages at night. But give him credit: Janjuah is a little different. He made a sell-everything call on the global financial fiasco two years ago with impressive accuracy, and he hadn't been all Chicken Little about it for years before either. His view now is almost as negative as it was back then on everything but gold. Here's why he believes the end is near, the markets could get cut in half and lumps of yellow metal will trump stocks and bonds.
Janjuah believes that only five things matter now: three players and two forces. The players are the private sector (that is, individuals), the policymakers (government officials and central bankers) and the financial sector (brokerages and big institutions). The forces are balance-sheet repair and growth, which can also be viewed as final demand. The way these forces and players interact will determine how the next act plays out. Let's take them one at a time.
Player 1: The private sector
First, Janjuah believes that individuals get it. He says they know they borrowed too much and are reacting by borrowing and spending less, and saving more. This is expected to be a multiyear trend in the face of employment and wage fears, volatility in the economy and confusing messages from policymakers (e.g., "We have a major debt problem, so go out and borrow more!"). He believes ordinary Americans are fed up with being taken for chumps and have lost faith in a system that is bound to tax them to restore losses at banks. All they see is that the policymakers and financial sector have looked after each other at the expense of the private sector.
Indeed, they see no trickle-down to their lives from all the efforts taken so far, since they're not much invested in stocks, yet they sense there will be a big bill to pay anyway. As a result, Janjuah believes the private sector has changed its behavior, swinging toward prudence and precautionary savings, and away from the sort of spending that would juice earnings growth for retailers and manufacturers. Naturally, some people -- notably 20- and 30-somethings -- will consume irrespective of their anger. So Janjuah will essentially be right only if people 40 and older make these behavioral shifts.
Player 2: Policymakers
The strategist observes that policymakers were "totally wrong" through all of 2006 and 2007, and most of 2008, then finally got it once Lehman Brothers collapsed. They then did a great job of averting a total global financial meltdown but are now reverting to type by persisting with a "systemic war footing" policy even though the war is over. Although they understand, deep down, that printing money will create a huge risk of another debt-fueled asset price bubble, they heartlessly believe that it's OK to ignore it for now.
"Central bankers . . . are relying on the old failed policy of more and bigger asset bubbles on the hope that it equates to real and sustained growth for the private sector," Janjuah says wearily. "This reckless policy is creating the mother of all bad balance sheets -- that of governments." Janjuah believes there are two choices: the current path of more debt and more bubbles, which is the "worst possible outcome," as it will cause individuals to become even more cynical and thus withdraw more from spending -- or the path of austerity.
As you might imagine, he believes the latter will come, whether we get the former or not, and "the more we resist . . . the worse the endgame." He adds, "Everyone should hope that the great debasement experiment will be exited voluntarily and not forcibly" due to a citizen revolt or a dollar crisis. "Forcible exit is the path to another recession before the first one has been addressed, and it will be hugely difficult to emerge from."
Player 3: The financial sector
Janjuah believes the financial sector is largely confused at this point. On one hand, bankers and asset managers fear deep regulation and compensation restrictions, as well as demands to cut their balance sheets under threat of being broken up, taxed to death and vilified. But on the other hand, they are being allowed to use supercheap money provided by central bankers to bid up other financial assets. Moreover, banks are being told that they must cut balance-sheet risk while at the same time lend vigorously to the public, which is a contradiction.
He believes that going into 2007 and 2008, bankers were too greedy. By early this year, they were too fearful. Now they're too greedy and wishful again, as they are positioned to borrow and lend extravagantly to businesses despite real fears that genuine and sustainable growth is not likely without continued government assistance -- and that the public isn't buying, so any new inventory buildup will go down a rat hole.
Putting all the pieces together, Janjuah notes that the key issue now is whether policymakers' plans to keep printing money to solve the financial crisis will really work. Janjuah believes that the public has already determined the plans won't and that financial institutions are "hanging on by a few threads" after six months of weak economic reports that have been hyped by the media for being stronger than low expectations.
The strategist says his data show the coming retail season will demonstrate emphatically that the public is opting for austerity, causing the government to follow, basically by throwing up its hands and permitting a second round of recession. He thinks this is actually the "least bad" way out, because although it may take the global stock markets down 35%, the alternative -- more loose money and borrowed stimulus -- would take the markets down by half.
Janjuah had forecast early in the summer that the Standard & Poor's 500 Index would reach the 1,100 level by early November in a reaction to the severe lows of March. But now he's forecasting a return to the mid-900s by the year's end and the low 800s by the end of the first quarter. He looks for investment-grade corporate and government debt to outperform, and prefers U.S. and German bonds to British bonds. As for currency, he pooh-poohs all of them and ends the tirade with: "Gold, please."
If this all transpires as expected, Janjuah further forecasts that the public will come to see central bankers' currency debasement as a failed policy that must be punished -- the opposite of the current circumstance in which the policy has been given the benefit of the doubt. He then sees the potential for new lows in stocks, with the S&P 500 trading in the 500s while gold goes to $1,500.
The forces: Balance-sheet repair and anemic growth
From there, the great bear sees three to five years of government, corporate and individual balance-sheet repair in which U.S. and British gross-domestic-product growth limps forward at around 1% a year -- "a long period of repair and refueling." And just for good measure, Janjuah calls this the "least worst outcome" because he thinks it would be more catastrophic if governments responded with more policy measures that further prolonged the inevitable. For those who need to be in stocks, he recommends sticking to "hard-currency, strong balance-sheet" countries such as Australia.
Future news headlines, he forecasts, will feature battles between central bankers, who at least privately are hard-wired to fear bubbles and inflation, and fiscal authorities, who want short-tem fixes to retain their jobs. Americans could think of it as a "rumble in the jungle" between those like former Federal Reserve Chairman Paul Volcker, who have the guts to defy politicians and puncture bubbles, and those like fellow ex-Fed Chairman Alan Greenspan, who believe bubbles are innocuous.
These forecasts are not particularly outrageous. I've said all along that the Fed's policies are experimental and that we therefore don't really know what the consequences will be. My own expectation is that governments and central banks will be successful at refloating the financial system, as they did in 1991 after the last credit meltdown; that the credit bull market that started in the spring will drag stocks along, kicking and screaming; and that the global economy will grow at a measured pace over the next few years without suffering a renewed catastrophe. But I'm always willing to entertain the possibility that I could be wrong, and I do not dismiss Janjuah's apocalyptic views out of hand. At present, my loose stop (yellow flag) on funds is a monthly close under the 1,003 level of the S&P 500, and my hard stop (red flag) is 945.
Longer term, Janjuah adds that the crisis must end with a commitment by policymakers never to let the gross misallocation of capital seen over the past two decades occur again. And that is a fact. "Wall Street must serve Main Street, and not the other way around," he says. "This is the clear lesson from the failures of the past 20 years." Amen.
The Worst is yet to Come: Unemployed Americans Should Hunker Down for More Job Losses
by Nouriel Roubini
Think the worst is over? Wrong. Conditions in the U.S. labor markets are awful and worsening. While the official unemployment rate is already 10.2% and another 200,000 jobs were lost in October, when you include discouraged workers and partially employed workers the figure is a whopping 17.5%.
While losing 200,000 jobs per month is better than the 700,000 jobs lost in January, current job losses still average more than the per month rate of 150,000 during the last recession. Also, remember: The last recession ended in November 2001, but job losses continued for more than a year and half until June of 2003; ditto for the 1990-91 recession. So we can expect that job losses will continue until the end of 2010 at the earliest. In other words, if you are unemployed and looking for work and just waiting for the economy to turn the corner, you had better hunker down. All the economic numbers suggest this will take a while. The jobs just are not coming back.
There's really just one hope for our leaders to turn things around: a bold prescription that increases the fiscal stimulus with another round of labor-intensive, shovel-ready infrastructure projects, helps fiscally strapped state and local governments and provides a temporary tax credit to the private sector to hire more workers. Helping the unemployed just by extending unemployment benefits is necessary not sufficient; it leads to persistent unemployment rather than job creation.
The long-term picture for workers and families is even worse than current job loss numbers alone would suggest. Now as a way of sharing the pain, many firms are telling their workers to cut hours, take furloughs and accept lower wages. Specifically, that fall in hours worked is equivalent to another 3 million full time jobs lost on top of the 7.5 million jobs formally lost. This is very bad news but we must face facts. Many of the lost jobs are gone forever, including construction jobs, finance jobs and manufacturing jobs. Recent studies suggest that a quarter of U.S. jobs are fully out-sourceable over time to other countries.
Other measures tell the same ugly story: The average length of unemployment is at an all time high; the ratio of job applicants to vacancies is 6 to 1; initial claims are down but continued claims are very high and now millions of unemployed are resorting to the exceptional extended unemployment benefits programs and are staying in them longer. Based on my best judgment, it is most likely that the unemployment rate will peak close to 11% and will remain at a very high level for two years or more.
The weakness in labor markets and the sharp fall in labor income ensure a weak recovery of private consumption and an anemic recovery of the economy, and increases the risk of a double dip recession. As a result of these terribly weak labor markets, we can expect weak recovery of consumption and economic growth; larger budget deficits; greater delinquencies in residential and commercial real estate and greater fall in home and commercial real estate prices; greater losses for banks and financial institutions on residential and commercial real estate mortgages, and in credit cards, auto loans and student loans and thus a greater rate of failures of banks; and greater protectionist pressures.
The damage will be extensive and severe unless bold policy action is undertaken now.
China has now become the biggest risk to the world economy
Far from taking over as the engine of growth from an exhausted West, China is making matters worse. Its "beggar-thy-neighbour" policies continue to play havoc with global trade and risk tipping the world into a second leg of the Great Recession. "The inherent problems of the international economic system have not been fully addressed," said China's president Hu Jintao. Indeed not. China is still exporting overcapacity to the rest of us on a grand scale, with deflationary consequences. While some fret about liquidity-driven inflation, Justin Lin, World Bank chief economist, said the greater danger is that record levels of idle plant almost everywhere will feed a downward spiral of job cuts and corporate busts. "I'm more worried about deflation," he said.
By holding the yuan to 6.83 to the dollar to boost exports, Beijing is dumping its unemployment abroad – "stealing American jobs", says Nobel laureate Paul Krugman. As long as China does it, other tigers must do it too. Western capitalists are complicit, of course. They rent cheap workers and cheap plants in Guangdong, then lobby Capitol Hill to prevent Congress doing anything about it. This is labour arbitrage. At some point, American workers will rebel. US unemployment is already 17.5pc under the broad "U6" gauge followed by Barack Obama. Realty Track said that 332,000 properties were foreclosed in October alone. More Americans have lost their homes this year than during the entire decade of the Great Depression. A backlog of 7m homes is awaiting likely seizure by lenders. If you are not paying attention to this political time-bomb, perhaps you should.
President Obama said before going to China this week that Asia can no longer live by shipping goods to Americans already in debt to their ears. "We have reached one of those rare inflection points in history where we have the opportunity to take a different path," he said. Failure to take that path will "put enormous strains" on America's ties to China. Is that a threat? It is fashionable to talk of America as the supplicant. That misreads the strategic balance. Washington can bring China to its knees at any time by shutting markets. There is no symmetry here. Any move by Beijing to liquidate its holdings of US Treasuries could be neutralized – in extremis – by capital controls. Well-armed sovereign states can do whatever they want. If provoked, the US has the economic depth to retreat into near autarky (with NAFTA) and retool its industries behind tariff walls – as Britain did in the 1930s under Imperial Preference. In such circumstances, China would collapse. Mao statues would be toppled by street riots.
Mr Hu sounded conciliatory last week. China is taking "vigorous" steps to cut reliance on exports, still 39pc of GDP. "We want to increase people's ability to spend," he said. Beijing is indeed boosting pensions and extending health insurance to the countryside so that people feel less need to save, but cultural revolutions take time. All we have seen so far are "baby steps", says Morgan Stanley's Stephen Roach. The reality is that much of Beijing's $600bn stimulus has been spent building yet more plant and infrastructure so that China can ship yet more goods, or has leaked into property and stocks. Credit has exploded. Allocated by Maoist bosses for political purposes, it has become absurd. China is rolling as much steel as the next eight producers combined. It is churning more cement than the rest of the world. Fixed investment is up 53pc this year. Once you know that Hunan authorities have torn down two miles of modern flyway so that they can soak up stimulus by building it again, or that the newly-built city of Ordos is sitting empty in Inner Mongolia, you know what must come next.
Pivot Asset Management said lending has touched 140pc of GDP, "well beyond" levels that have led to crises in the past. With the revolution's 60th birthday out of the way, the central bank has begun to tighten. New yuan loans halved in October. So be careful. Pivot said a hard-landing in China could prove as traumatic for world markets as the US sub-prime crash. The world economy is still skating on thin ice. The West is sated with debt, the East with plant. The crisis has been contained (or masked) by zero rates and a fiscal blast, trashing sovereign balance sheets. But the core problem remains. The Anglo-sphere and Club Med are tightening belts, yet Asia is not adding enough demand to compensate. It is adding supply. My view is that markets are still in denial about the structural wreckage of the credit bubble. There are two more boils to lance: China's investment bubble; and Europe's banking cover-up. I fear that only then can we clear the rubble and, very slowly, start a fresh cycle.
China's End Run Around the U.S.
As more free-trade deals exclude America, Beijing could dominate a new Asian trade bloc. President Barack Obama makes his first state visit to East Asia on Nov. 13-19. He'll start off in Tokyo, attend a meeting of the Asia-Pacific Economic Cooperation forum in Singapore, travel to Shanghai and Beijing, then finish up in Seoul.
It's a cover-the-waterfront trip, but the focus is on China, America's key trading partner and rival. The Obama team will express its concern that Beijing aims to boost locally owned companies, from commercial aircraft makers to express delivery services, all at the expense of foreign competitors. Washington also wants China, which has more than $2 trillion in foreign reserves, to let the yuan appreciate against the dollar. Finally, Obama and top Cabinet officials will press Beijing to stoke consumer demand at home and rely less on exports to drive growth. Rebalancing the economies of China and other Asia nations "is perhaps the most important thing we can do to restore growth and jobs in the U.S.," explains one senior White House official.
Beijing will likely respond by playing up the country's accomplishments: a huge stimulus package that pumped up spending at home and kept the world from sliding deeper into recession; signs of an increase in consumption; and a modest appreciation of the yuan over the last five years. China's ministers will also point out that Washington has its own work to do, especially in cutting the U.S. budget deficit, bolstering the dollar, and devising regulations to prevent another blowout.
What happens in Beijing next week will undoubtedly be important to U.S.-China trade relations. But trade developments throughout Asia will likely affect the American position in the region as much as, or more than, those meetings in Beijing. Even while it keeps up the dialogue with Washington, China is essentially doing an end run around the U.S. in Asia by pursuing a bewildering variety of free-trade pacts with its neighbors. "What China is doing is very smart and logical," says Linda Menghetti, vice-president of the Emergency Committee for American Trade, a Washington group representing U.S. multinationals. The White House, transfixed by problems at home and its own diplomatic dance with China, trails its rival in sewing up trade deals. The result could be a trade bloc dominated by the mainland.
China's trade diplomats have been exceptionally busy. Next year a deal to drop most duties on farm and manufactured goods goes into effect among China and 10 Southeast Asian nations. A landmark free-trade agreement between China and Taiwan is under discussion, while a financial-services pact with the island could be announced soon. Talks on liberalizing trade terms with Seoul and the Persian Gulf states are under way. China Premier Wen Jiabao just visited Egypt, where the Chinese announced a plan to give $5 billion in low-interest loans and export credits to Africa. In October, Vice-Premier Li Keqiang traveled Down Under to mend relations with commodity-rich Australia and discuss a new free-trade deal with New Zealand. With less success, Beijing has pushed for a regional currency that would weaken reliance on the dollar and increase the role of the yuan.
Why all the hustle? China's total trade volumes are expected to drop 20% this year largely because of the U.S. recession. Beijing has to keep exports growing to keep workers employed, and it needs commodities to turn into finished goods. China also needs other nations as customers and suppliers—if not the U.S., then Korea, Japan, Australia, and others will do. The Obama visit, meanwhile, may yield some movement on a U.S. pact with New Zealand and Chile. But important free-trade deals with Taiwan and Korea have been held up. One reason is the U.S. approach to these agreements. In its trade talks, the U.S. typically tries for universal, all-in-one deals that cover not only lower tariffs but also services, intellectual property rights, government procurement rules, and even labor and environmental codes. Initiatives by China and other Asian nations, in contrast, focus on simpler, narrower goals, such as a cut in tariffs or easing investment rules.
Chinese companies aren't complaining. After the Southeast Asian trade bloc decided to shed agricultural tariffs and ease manufacturing and property investment rules for Chinese companies, for example, Nanning-based Guangxi State Farms Group signed deals worth more than $620 million in the region. The U.S. has been talking about joining the same trade group since 2002. The delay puts American companies at a disadvantage, says Karan Bhatia, a former U.S. trade negotiator who now is General Electric's (GE) vice-president and senior counsel for international law. Most manufactured goods made in Southeast Asia will now enter China duty-free. But goods shipped from the U.S. will still face average duties of 9%. "That is a meaningful differential," Bhatia says. Much like Nafta, which prompted many global companies to produce in Mexico in order to export duty-free to America, many U.S. manufacturers will have to go to Southeast Asia to have better access to China. That would be bad for U.S. exports.
Obama is aiming to change the perception of American indifference. Trade issues will be on the agenda in Seoul and Tokyo as well as in Beijing, and Obama's team will include top economic officials Treasury Secretary Timothy Geithner, Trade Representative Ron Kirk, and Commerce Secretary Gary Locke, as well as Energy Secretary Steven Chu. The message, says White House foreign policy spokesman Ben Rhodes, is that "the President is very committed to being competitive in this region." The Administration also knows that American executives are getting nervous. "What the companies are expressing is a strong interest in the U.S. being engaged in [Asia]," says the senior White House official. "That is our position, not to sit on the sidelines." Rather than bringing concrete proposals, though, Obama is likely to talk in generalities, says Ernest Bower, Southeast Asia director at Washington's Center for Strategic & International Studies. "We are coming without any goodies in our basket," he adds.
The change in thinking in Tokyo and Seoul illustrates Washington's problem. In Japan, new Prime Minister Yukio Hatoyama aims to forge a trade group with China and South Korea. Rising exports to China have helped Japan's economy survive a plunge in trade with America. "There's a consensus among policymakers that Japan can't only rely on relations with the U.S., because Washington's global influence has diminished," says Keio University economist Masaru Kaneko. It's a similar story with Korea: In 2002 the U.S. took 20% of Korean exports. In the first 10 months of 2009 the American share dropped to 10.5%, while China accounted for nearly 24%. No breakthroughs in U.S. trade talks with Korea are expected. "I'm sure we will hear lip service about moving the Free Trade Agreement forward," says Lee Si Wook, a trade expert at the Korea Development Institute, a government think tank. "But actions will be lacking."
Is China headed toward collapse?
The conventional wisdom in Washington and in most of the rest of the world is that the roaring Chinese economy is going to pull the global economy out of recession and back into growth. It’s China’s turn, the theory goes, as American consumers — who propelled the last global boom with their borrowing and spending ways — have begun to tighten their belts and increase savings rates.
The Chinese, with their unbridled capitalistic expansion propelled by a system they still refer to as "socialism with Chinese characteristics," are still thriving, though, with annual gross domestic product growth of 8.9 percent in the third quarter and a domestic consumer market just starting to flex its enormous muscles. That’s prompted some cheerleading from U.S. officials, who want to see those Chinese consumers begin to pick up the slack in the global economy — a theme President Barack Obama and his delegation are certain to bring up during next week’s visit to China.
"Purchases of U.S. consumers cannot be as dominant a driver of growth as they have been in the past," Treasury Secretary Timothy Geithner said during a trip to Beijing this spring. "In China, ... growth that is sustainable will require a very substantial shift from external to domestic demand, from an investment and export-intensive growth to growth led by consumption."
That’s one vision of the future.
But there’s a growing group of market professionals who see a different picture altogether. These self-styled China bears take the less popular view: that the much-vaunted Chinese economic miracle is nothing but a paper dragon. In fact, they argue that the Chinese have dangerously overheated their economy, building malls, luxury stores and infrastructure for which there is almost no demand, and that the entire system is teetering toward collapse.
A Chinese collapse, of course, would have profound effects on the United States, limiting China’s ability to buy U.S. debt and provoking unknown political changes inside the Chinese regime. The China bears could be dismissed as a bunch of cranks and grumps except for one member of the group: hedge fund investor Jim Chanos. Chanos, a billionaire, is the founder of the investment firm Kynikos Associates and a famous short seller — an investor who scrutinizes companies looking for hidden flaws and then bets against those firms in the market.
His most famous call came in 2001, when Chanos was one of the first to figure out that the accounting numbers presented to the public by Enron were pure fiction. Chanos began contacting Wall Street investment houses that were touting Enron’s stock. "We were struck by how many of them conceded that there was no way to analyze Enron but that investing in Enron was, instead, a ‘trust me’ story," Chanos told a congressional committee in 2002.
Now, Chanos says he has found another "trust me" story: China. And he is moving to short the entire nation’s economy. Washington policymakers would do well to understand his argument, because if he’s right, the consequences will be felt here. Chanos and the other bears point to several key pieces of evidence that China is heading for a crash.
First, they point to the enormous Chinese economic stimulus effort — with the government spending $900 billion to prop up a $4.3 trillion economy. "Yet China’s economy, for all the stimulus it has received in 11 months, is underperforming," Gordon Chang, author of "The Coming Collapse of China," wrote in Forbes at the end of October. "More important, it is unlikely that [third-quarter] expansion was anywhere near the claimed 8.9 percent."
Chang argues that inconsistencies in Chinese official statistics — like the surging numbers for car sales but flat statistics for gasoline consumption — indicate that the Chinese are simply cooking their books. He speculates that Chinese state-run companies are buying fleets of cars and simply storing them in giant parking lots in order to generate apparent growth.
Another data point cited by the bears: overcapacity. For example, the Chinese already consume more cement than the rest of the world combined, at 1.4 billion tons per year. But they have dramatically ramped up their ability to produce even more in recent years, leading to an estimated spare capacity of about 340 million tons, which, according to a report prepared earlier this year by Pivot Capital Management, is more than the consumption in the U.S., India and Japan combined.
This, Chanos and others argue, is happening in sector after sector in the Chinese economy. And that means the Chinese are in danger of producing huge quantities of goods and products that they will be unable to sell. The Pivot Capital report was extremely popular in Chanos’s office and concluded, "We believe the coming slowdown in China has the potential to be a similar watershed event for world markets as the reversal of the U.S. subprime and housing boom."
And the bears also keep a close eye on anecdotal reports from the ground level in China, like a recent posting on a blog called The Peking Duck about shopping at Beijing’s "stunningly dysfunctional, catastrophic mall, called The Place." "I was shocked at what I saw," the blogger wrote. "Fifty percent of the eateries in the basement were boarded up. The cheap food court, too, was gone, covered up with ugly blue boarding, making the basement especially grim and dreary. ... There is simply too much stuff, too many stores and no buyers."
Hugh Hendry: The US Economy Has Reached Zero Hour<
In his latest fund letter, hardcore deflationist Hugh Hendry describes the entire reflation-based rally as a FAKE, and says the US has reached its "zero hour." (via MarketFolly)
...The surprise might concern the role that rising leverage has played in boosting GDP and in anchoring investors’ expectations to an unrealistic level of nominal GDP. Over the last decade, each marginal dollar of debt has generated less and less marginal income. We knew that there would be a "zero-hour" for the economy when the creation of new debt would not contribute to GDP growth. The government’s reaction to last year’s demand shock has been to increase its own leverage. But, with the economy operating at its zero-hour, we believe this incremental leverage will actually have a negative impact. That is to say, the public sector will fail in its attempt to bring the economy back to its previous level of nominal GDP. In this scenario, the outcome will disappoint the market’s expectations, which are rampantly bullish as evidenced by this year’s dramatic re-pricing of risk assets.
This zero-hour for America has perhaps arrived sooner than many had anticipated. It was heralded by the Japanese experience. Japan is the bogeyman that confronts all academic thinkers, regardless of creed, from Krugman to Ferguson, as well as all who would choose to intervene in the workings of the economy. In a debate I had with Mr. Ferguson in London last month, he claimed that Japan was an extreme outlier and could be ignored. Really?
GM Reports $1.15 Billion Loss, Plans Repayments
General Motors Co. delivered the first postbankruptcy look at its financial health, showing a company inching toward recovery but with daunting hurdles ahead. The auto maker reported a $1.15 billion loss for July 10 to Sept. 30, narrowed from GM's prebankruptcy days. The company also said it plans to accelerate repayments to U.S. and Canadian governments, with the first $1.2 billion installment due in December. GM Chief Executive Frederick Henderson described the performance as stable yet "unsatisfying."
While the company reported positive cash flow and a profit in its international operations, GM also lost market share around the globe and its European operations contributed $400 million to the overall loss. The company warned that cash flow will be negative in the fourth quarter as it takes charges and begins to repay government loans. The auto maker didn't provide comparable data as it reported earnings for the stripped-down company that exited bankruptcy protection as well as for Motors Liquidation Co., in which it bundled legacy assets such as dormant factories, equipment and real estate.
However, the report signals improvement from the third quarter of last year when GM lost $2.5 billion and burned through $6.9 billion in cash. GM is taking something of a bullish view of the global outlook next year, predicting industry sales of 62 million to 65 million vehicles. IHS Global Insight has projected sales of 61.3 million vehicles.
The results reported Monday underscore the growing importance of GM's operations outside its the U.S. Mr. Henderson said GM ventures in China are "throwing off cash" and that important emerging markets have stabilized after the global financial meltdown. The company posted positive cash flow of $3.3 billion excluding items and said its core North American unit lost $651 million. Its international business returned a profit of $238 million. The company's global market share fell to 11.9% from 13% a year earlier.
GM also tempered its expectations for U.S. sales next year, forecasting 11 million–12 million vehicles. Earlier this year, company executives said the market could hit 12.5 million vehicles. Mr. Henderson said the company "should be ready" for an initial public stock offering in the second half of next year but stressed the importance of beginning to repay U.S. and Canadian loans. "We think it's important that we show the taxpayer we can repay this investment," he said in a news conference.
GM's progress comes as rival auto makers have reported improved results following the dire conditions of the first half, helped by government incentive programs and steep production cuts. Toyota Motor Co. reported a surprise third-quarter profit, while Ford Motor Co. and Chrysler LLC reversed hefty cash burns. Mr. Henderson said the bulk of U.S. restructuring is complete, though the company is working to consolidate its massive operations in Michigan. Thousands of hourly workers remain laid off.
His most immediate task will be to craft a restructuring plan for the company's European operations following GM's decision to retain the money-losing Adam Opel GmbH unit. Mr. Henderson said the plan should be complete in "weeks" and that a new European chief will take over in the coming months. The third-quarter results don't comply with generally accepted accounting principles and exclude key items such as valuation changes for its pension and health-care accounts.
States Grab 'Millionaire's Tax'
States hungry for revenue are turning to taxpayers to make up the shortfall as they deplete rainy-day and economic-stimulus funds. To avert a popular revolt, many are resorting to a so-called millionaire's tax, which puts the burden on a smaller group of the very well-heeled. In response, some wealthy residents are rethinking their financial strategies, including where they reside. They may see some sense to moving before they sell a business, for example, or stop using certain kinds of trusts.
Doug Stanley, an attorney in the St. Louis office of law firm Bryan Cave LLP, said high personal income-tax rates are "definitely on the radar" of the wealthy clients he advises. For the rich in California, the question can be "do you really need to live in this state when you have a state next door that has a zero income-tax rate?" said Don Weigandt, a wealth adviser in the Los Angeles office of J.P. Morgan Private Bank. That next-door neighbor is Nevada.
Californians, who have a top individual rate of 10.55% on income over $1 million, actually gained in sideways fashion from recent rate raises around the country. The state dropped below Hawaii, Oregon and New Jersey on the list of places with the highest individual tax rates. Hawaii enacted a top individual rate of 11% on income over $200,000, Oregon has a new 11% rate on income over $250,000, and New Jersey enacted a 10.75% rate on income above $1 million.
The Tax Foundation in Washington, which tracks individual-income-tax rates and seeks a simple and stable tax policy, and Joseph D. Henchman, its tax counsel and director of state projects, predicts more states will follow suit with rate increases next year. If state revenues haven't recovered by then, he said, "we'll see a bitter fight over huge budget shortfalls across the country." Historically, state revenues recover after the general economic recovery, so the chances of such a scenario are high, Mr. Henchman said.
"These millionaire's tax increases will be very appealing because they help a short-term problem, even though they cause significant long-term damage," he said. The policy of raising state rates on the rich has failed before. Through the early 1990s, several states maintained double-digit income-tax rates, but eventually brought them down partly because legislators realized they were driving out entrepreneurs. To keep good talent, create jobs and drive economic growth, state tax systems had to be competitive with their neighbors.
Mr. Weigandt said the issue of high rates comes up with his clients most often in the context of selling a business. The question then is, "What can I do about my taxes," and it can be tempting to relocate when the answer is that the tax bill could be cut by as much as 40% by just changing residence to Florida, Texas, Washington, Wyoming or another state with low or zero tax on personal income. Picking up stakes needs careful thought and planning, though. States have gotten increasingly aggressive about tracking former residents and seeking taxes from them after they have moved.
How To Fix Wall Street? Step 1: Break Up Goldman Sachs...
Roger Ehrenberg, Founder/Managing Partner, IA Capital: "How do we fix Wall Street?"
- Improve transparency
- Regulate derivatives by placing them on an exchange
- Break up firms like Goldman Sachs (separate customer business and hedge-fund business)
Economists fear impact of 'dollar carry trade'
The global economy may be poised for the creation of a massive and potentially explosive "dollar carry trade" — just like the pre-crisis yen carry trade, only more frightening and potentially much bigger. The warning was issued today at a summit of Asia Pacific leaders in Singapore and comes as a diverse variety of assets have begun to display bubble-like patterns of inflation: everything from gold and copper to fine wine and Hong Kong penthouses.
The dollar carry trade, whereby investors borrow dollars at near zero interest rates to fund asset-buying sprees around the world, has been lurking as a possibility since the collapse of Lehman Brothers last year and the extreme monetary response to its aftermath. And as the carry trade grows more popular among investors it could add yet more downward pressure to the already falling greenback — especially if the "carried" (borrowed) dollars are immediately sold to buy non-dollar denominated assets in China or Singapore.
Many analysts now believe that it was the sudden unwinding of the yen-carry trade — immense pockets of investment funded by cheap borrowed yen — that sent the ripples of the Wall Street crisis so destructively around the world last autumn. Carry trades — borrowing at low rates to fund higher return assets — make perfect sense until markets turn sour and exchange rates shift too violently. At that point, the rush for the exit wildly exacerbates any crash. A collapse of the dollar carry trade has the potential to be even more harmful, principally because of its scale.
While a few prominent financial gurus have already warned of the threat of an emerging dollar carry trade, governments have steered clear of commentary on the issue until now. But today, talking on the sidelines of the Asia Pacific summit in Singapore, Donald Tsang, Hong Kong’s chief executive, admitted openly that the dollar carry trade had begun to spread and that the prospect "scared" him. Washington’s response to the recession, he said, ran the risk of emulating the behaviour of Japan after its own bubble collapsed in 1989 and allowing overly loose policy and a rock-bottom cost of money to inflate asset bubbles around the world. "Gyrations in financial markets and bubbles in asset markets remain ahead of us," he added.
Hong Kong is perhaps closer to the new asset bubbles than others: house prices there have risen 28 per cent this year and records for land price sales have been set with thudding regularity over recent weeks. Behind Mr Tsang’s concern, though, is the fixed relationship between the Hong Kong dollar and the greenback — the "dollar peg" that is the cornerstone of Hong Kong financial policy but is currently forcing Hong Kong interest rates to be much lower than the monetary authorities there would like. Hong Kong’s property inflation is, in effect, being driven my mortgages that are cheaper than they should be, but the authorities are limited in how they can respond.
Observers who have warned darkly of the emerging dollar carry trade include Nouriel Roubini, the chairman of RGE Monitor, an economic consultancy firm. He believes that the prolonged ability to borrow dollars cheaply risks planting the seed of the next financial catastrophe. Carry traders, he said recently, feel more comfortable with their positions because of the Federal Reserve’s promise to keep rates "exceptionally low" for an "extended period".
Others have tentatively raised red flags over the trade. Also attending the APEC meeting in Hong Kong, Robert Zoellick, the preisdnmet of the World Bank, noted that the risk of allowing liquidity to flow into equity and property markets in the region. "In East Asia, if you start to get a strong rebound in growth, and you've got a lot of liquidity, there is the question of whether one could start to face asset bubbles in particular markets," he said.
Don't Be Naive, Gold Is A Bubble
Dennis Gartman and Andrew Sorkin discuss the weak dollar and gold. Both see gold as a bubble. Yet Gartman still holds gold regardless. There's a great currency discussion overall from Mr. Gartman.
• 1:35 -- "I'm long gold... a bit."
• 2:00 -- "We have to remember, it's not the Fed's obligation to pay attention to the dollar. "
• 3:00 -- "Pick a number, [Gold] will continue to go up until it stops... It is a bubble. To say otherwise would be naive, that's really what it is."
South African gold on final deathwatch as top grade scientist finds residual gold is more than 90% less than claimed
The apparent bottom line in a paper published in the South African Journal of Science is that South Africa's gold industry is on final deathwatch, despite claims of massive existing below-ground reserves. Chris Hartnady, research and technical director of Cape Town earth sciences consultancy Umvoto Africa, has found that South Africa's Witwatersrand goldfields are around 95% exhausted, and anticipates that production rates should fall permanently below 100 tonnes a year within the coming decade.
Gold production from the Witwatersrand, the biggest known gold field in the world, peaked at around 1,000 tonnes in 1970 and has declined ever since. Hartnady says that while initially (1970-1975) the decline was "quite precipitous", it has been interrupted by only short periods of slight trend reversal (1982-1984 and 1992-1993).
Leon Esterhuizen, a London-based specialist analyst at RBC Capital Markets, has reacted to the research by saying that "South African gold is dying -- this is not new news", but adds "that it may be dying faster than we currently believe is novel". On the levels of reserves, Hartnady finds that the South African "residual gold reserve" after production through 2007 is only 2 948 tonnes, a little less than three times the 1970 production figure, and much less than 10% of the officially cited reserve.
The country's gold reserves are less than half of the current United States Geological Survey (USGS) estimate of 6 000 tonnes, and the country is not first, but fourth in world rankings, after Australia (5,000 tonnes), Peru (3,500 tonnes) and Russia (3,000 tonnes), Hartnady's research shows. The USGS currently cites South Africa's gold reserves at around 6,000 tonnes, while SA claims a 36,000 tonnes reserve base figure (or about 40% of the global total). Hartnady's findings are based on Chamber of Mines figures and mathematical modeling pioneered by the distinguished American geologist M. King Hubbert.
Esterhuizen comments that "most recent indications from Harmony (even with gold bullion at new dollar records over USD 1,100/oz) is that its old shafts - effectively the Free State gold field - are dying. DRDGold has got Blyvooruitzicht on life support and is trying to get permission to keep the plug in for a little bit longer (with everything around Blyvooruitzicht now having been shut down), while Pamodzi Gold's demise and Simmer & Jack's failure at Buffelsfontein just proves the point -- all of this, at record gold prices in rand terms".
Analysts have also expressed surprise, if not amazement, about recent comments from AngloGold Ashanti CEO Mark Cutifani to the effect that its South African operations will be restructured. How is it, analysts ask, that "the highest margin operating gold assets in South Africa are . . . being re-structured ?"
A growing number of skeptics are also asking whether Gold Fields's developing South Deep operation - which it bought in 2007 for USD 3bn - will truly ever be able to make money. It is already evident that it will probably never deliver a real return on the capital that it took to bring it to life, says Esterhuizen. He also notes particular current promises by both Gold Fields and Harmony of growth from the South African base over the next three years.
Hartnady's prognosis is pretty grim: "Given the energy and environmental problems associated with ongoing groundwater control, water-resource contamination by acid mine drainage, and the possibility of widespread mercury and other factors of pollution caused by illicit underground ore-processing by the zama-zamas (illegal miners), the glory days of South African gold mining appear to have arrived finally at an ignominious end.
"There can be no further illusions, maintained by unrealistic expectation of a future fortune, about the seriousness of the present situation. In their various possible forms, the slow-onset disasters of environmental degradation associated with the death-throes of a formerly illustrious industry now pose a serious threat, and may ultimately cost far more than the net present value of some 3,000 tonnes of gold".
Esterhuizen mentions a number of other challenges faced by South African gold diggers: royalties (a new thing), zooming electricity charges, BEE (black economic empowerment) burdens, safety shutdowns, "massive security costs", and ever-present currency exchange control. In these areas, Esterhuizen argues that "government may achieve a ‘small' miracle or, more likely, simply hasten the end".
Esterhuizen says that "a small opportunity may be the possible stronger future uranium market -- effectively reducing gold costs by obtaining revenue from by-products". This is already happening at a number of gold mines where uranium is also produced. Certain closed shafts known to hold good quantities of uranium are also being investigated for possible recommissioning.
White House hits out at Fed plan
Plans to strip the Federal Reserve of its bank supervision powers were rebuffed yesterday in two separate speeches by senior Obama administration officials. Chris Dodd, the Senate banking committee chairman, this week published draft legislation to merge four US banking regulators into one, with the Fed the most high-profile loser.
However, Austan Goolsbee, a White House economist, and Neal Wolin, deputy Treasury secretary, both pushed back against the plan yesterday as the administration abandoned its laisser faire approach to the versions of regulatory reform circulating in Congress. "No regulator had a perfect record leading up to the crisis," said Mr Wolin at the American Bar Association. "But in our view, the Federal Reserve is the agency best equipped for the task of supervising the largest, most complex firms."
Mr Dodd's bill goes further than a competing version in the House of Representatives and much further than the administration's original ideas in creating a banking regulator to resolve what he called the "alphabet soup" of supervisors. Staff drafting the bill tried to take account of fears that the Fed would be deprived of information necessary for ensuring financial stability and carrying out monetary policy. They sought to ensure that the central bank could get whatever information it needed from the largest US institutions at any time.
However, yesterday's speeches showed that their efforts had not proved sufficient to get the administration to back the plan, even though an official said last week that he was open to the idea. "If they [the Fed] are not integrally involved with the actual regulation and oversight of the institutions, you can, if you do it wrong, get in to a left hand doesn't know what the right hand is doing kind of problem in a crisis," said Mr Goolsbee at a conference organised by the Bloomberg news agency.
He noted that "they had a lot of problems in the UK as well" where the Financial Services Authority acted as a single regulator separate from the Bank of England. On Monday, the Senate banking committee will hear opening statements in support of its bill before a formal revision begins in December. If the bill is approved by the committee and then by the full Senate it will be combined with a House text before being signed into law by the US president. At any point, the single regulator proposal could be dropped.
Bernanke Signals Support for Letting U.S. Shrink Risky Firms
Federal Reserve Chairman Ben S. Bernanke said regulators should have power to shrink a bank that poses a risk to markets, signaling support for proposals in Congress that let the U.S. cut the size of financial companies. "The supervisors should be allowed by law to insist that the company divest itself or shrink its activities," Bernanke said today in response to a question after a speech to the Economic Club of New York.
Regulators could apply the power to a large institution engaged in proprietary trading when they determine that the company can’t manage the risks or doesn’t have enough capital and liquidity to engage in the activity, Bernanke said. Congress is considering legislation giving government the power to force the breakup of a firm that has become so large that its failure in bankruptcy could threaten the economy. Lawmakers are seeking to avoid ad hoc actions such as last year’s $700 billion bailout of large firms, including New York- based insurer American International Group Inc.
House Financial Services Committee Chairman Barney Frank has proposed giving the Fed power to limit company size by forcing the sale and transfer of assets and off-balance-sheet items. Senate Banking Committee Chairman Christopher Dodd’s plan would give that power to a new systemic-risk regulator that includes the Fed. Representative Paul Kanjorski, a Pennsylvania Democrat, is planning to amend Frank’s legislation to let regulators dismantle large systemically risk firms. Senator Bernard Sanders, a Vermont independent, unveiled legislation last week requiring the Treasury Department to name banks whose collapse could shake the economy and break them up in a year.
Representative Ed Perlmutter, a Colorado Democrat, wants to amend Frank’s bill so that the Fed could impose the Glass- Steagall Act, which split investment banking from lending and deposit-taking, on a case-by-case basis, an idea Bernanke appeared to reject. The law was repealed in 1999. "That kind of movement would not be constructive," Bernanke said.
US Treasury eager to extend Tarp into next year
The Obama administration is leaning towards extending the troubled asset relief programme into next year, retaining part of the $700bn war chest in case of another financial emergency. Although no final decision has been made, officials in the Treasury are wary of letting the fund expire as scheduled at the end of the year and are seeking to allay criticisms and fears about the future use of Tarp, which has been tapped to provide capital injections in a variety of companies from Citigroup to General Motors.
The financial system has stabilised since Tarp was first used last year and banks such as Goldman Sachs and JPMorgan Chase have repaid the government. But the administration is expected to extend its ability to make Tarp investments until October next year – without having to return to Congress – in case of another unforeseen calamity that can be mitigated with government money. If the administration were to give it up but then try to secure additional investment funds, it would face a potentially hostile Congress. Even extending it as authorised will face resistance. "Clearly, I’m against it," said Jeb Hensarling, a Republican member of the House financial services committee and of the congressional oversight panel that scrutinises Tarp.
To try to assuage criticism from both parties, the administration is touting the fact that it now expects "to use significantly less Tarp funding than authorised". It said last week that $366.4bn had been paid out and $472.5bn of $700bn had been committed. As the expectation for spending comes down, there is a reduction in the projected debt levels and a positive impact on the budget deficit. But the Treasury has a tough task to use a lower-cost Tarp as an example of fiscal conservatism, with Republicans and some Democrats saying their spending restraint is insufficient while liberals want to deploy the money in new areas to support small business, commercial real estate and housing.
Mr Hensarling called any suggestion of Tarp having a positive impact on the budget deficit "smoke and mirrors accounting" and said other ways for the Treasury to constrain the use of Tarp could only be "teeny tiny baby steps in the right direction". He said he had always doubted that the administration would give up its "$700bn of walking around money" and that he would keep calling for the programme to be wound down.
While the Treasury continues to hedge its bets, there is no doubt among many Democrats that the fund’s extension is an obvious move. "Of course it’s going to be extended," said one Democratic aide.
However, the Democrats are more divided on the issue. Barney Frank, chairman of the House financial services committee, has introduced a bill that would force the Treasury to transfer $2bn of Tarp and dividends paid by Tarp recipients into programmes for emergency mortgage relief and the redevelopment of foreclosed homes. Other Democrats have sided with Republicans to call for a quick wind-down of the programme.
Audit Is Critical of N.Y. Fed in AIG Bailout
The Federal Reserve Bank of New York caved into demands by American International Group Inc.'s trading partners that they be paid in full for complex securities they had insured with the company, saving some of the world's biggest banks from billions in losses, according to a government audit.
The audit, which was conducted by the special inspector general for the Troubled Asset Relief Program faulted the New York Fed for failing to use its leverage as the regulator of some of these banks to get them to accept lower prices for more than $60 billion in credit market bets, which were tied to souring mortgage-linked securities that had fallen in value. The banks that were paid off in full included Goldman Sachs Group Inc., Merrill Lynch and large French banks Société Générale and Calyon, which were represented by the French bank regulator in negotiations with the New York Fed last November, the report said.
The New York Fed, in a letter accompanying the report, said it "acted appropriately" in its dealings with AIG's counterparties. It said that its intervention in the insurer "was designed to prevent a system-wide collapse and achieved that end" by protecting the interests of AIG's insurance policyholders, debt holders, retirement plans, municipalities and other entities. It could not use its leverage as a regulator because it was acting on behalf of AIG, the Fed argues.
The audit provides a window into a bailout effort that has been shrouded by a lack of disclosure and questions over why the U.S. government in effect funneled tens of billions of dollars to the U.S. and European banks that were AIG's trading partners.
In November 2008, less than two months after the New York Fed first bailed out AIG with an $85 billion credit line, the insurer was still bleeding cash to meet calls for collateral from its trading partners. To halt the cash outflow, the government revamped the bailout package and created a company called Maiden Lane III, which bought complex mortgage-linked securities from U.S. and European banks to cancel insurance contracts that were forcing AIG to post collateral. The banks were effectively paid par, or 100 cents on the dollar, for those securities, which had declined significantly in value due to rising home-loan defaults.
The audit found that AIG's trading partners played hardball with the government and refused to agree to any discounted trades with the New York Fed and AIG. The financial firms claimed they contractually were due the full value of the securities and that they had a fiduciary duty to their shareholders. They also had another ace to play: Since the government already had shown its hand and made clear it wouldn't allow AIG to go bankrupt, the trading partners "had a reasonable expectation that AIG would not default on any further obligations."
The report acknowledged challenges the regulators faced, including insistence by most of the banks and a French bank regulator that they be paid in full. But the report said the "refusal" of the Federal Reserve and New York Fed "to use their considerable leverage" as banking regulators in negotiations "made the possibility of obtaining concessions from those counterparties extremely remote." The Fed says it needed to treat all of AIG's U.S. and foreign counterparties equally and to compel banks to take haircuts "would have been a misuse" of its supervisory authority.
The New York Fed's lack of leverage had its roots in decisions the central bank made earlier in the fall. Amid the mid-September 2008 collapse of Lehman Brothers Holdings Inc., the New York Fed was "confident" that the banking industry itself would solve AIG's problem, the report said. On Sept. 15, the day Lehman entered bankruptcy proceedings then New York Fed president Timothy Geithner tried to mobilize a consortium of banks to ante up a $75 billion loan for AIG. That effort fell apart, leaving the New York Fed scrambling. On Sept. 16, it agreed to lend AIG up to $85 billion on terms similar to what the private sector had been planning. The package was later modified to ease the financial burden on AIG.
Before the New York Fed stepped in, AIG had tried unsuccessfully to get banks to accept less than full payment to cancel swaps it had written. The New York Fed took over the negotiations in early November and contacted eight large banks about the possibility of accepting "haircuts" on their positions.
There were few takers. Large U.S. banks, including Goldman and Merrill, refused to accept concessions because they would have to realize those amounts as a loss, the report said. Goldman maintained, however, that it was hedged in the event AIG couldn't pay it. The French bank regulator, which negotiated with the New York Fed on behalf of two large French banks, also refused to negotiate concessions, the report said. Only one bank – UBS AG – said it was willing to accept a 2% haircut. The New York Fed ultimately decided that the most effective way to stop the cash bleed at AIG was to buy out the securities at par and cancel the swap contracts.
Treasury Secretary Timothy Geithner, who was at the time of the AIG bailout the president of the New York Fed, told the inspector general that "the financial condition of the counterparties was not a relevant factor" in the government's decision to effectively make the banks whole on their positions. A Treasury spokesman said the report "overlooks the central lesson learned from the unprecedented steps taken to support AIG...that the federal government needs better tools to deal with the impending failure of a large institution in extraordinary circumstances."
The New York Fed ultimately lent $24.3 billion to Maiden Lane III to finance its purchase of $62 billion in securities from AIG's counterparties, which kept the collateral they had earlier received from AIG to compensate for market value declines. At end September, its outstanding loan to Maiden Lane III was $19.3 billion, while the portfolio was valued at $23.5 billion.
Swaps Signal Worst Yen Since 2005 as Debt Overwhelms
The yen is poised for its worst tumble since 2005 as doubts about Japan’s fiscal footing double the cost of insuring its debt. The price of hedging against losses on $10 million of the country’s bonds with credit-default swaps soared this month to as much as $76,160 a year from $37,000 in August, as the new government planned record spending and borrowing even with tax revenue falling. The rise in debt protection costs contrasts with that of the U.S., where prices have fallen to about the lowest in a year amid unprecedented issuance. The difference in prices reached the widest ever on Nov. 9 after Japan’s debt grew to almost twice the size of the economy.
"The Japanese fiscal situation is horrific," said Richard Benson, who helps oversee $11 billion of currency funds at Millennium Global Asset Management in London. "We went short the yen against the dollar and the euro about a month ago" and then turned "more aggressive" on the trade as credit-default swaps rose and investors dumped Japanese bonds, he said, declining to specify the firm’s gains. Selling yen for euros and dollars would have returned as much as 4.3 percent since Oct. 1, data compiled by Bloomberg show.
Japan’s unprecedented debt, near-zero benchmark interest rate, ballooning budget deficit, sinking savings rate and worst postwar recession all are aligned against the yen. The Bank of Japan will stand alone in keeping borrowing costs at near-record lows next year to revive the Group of 10’s fastest-shrinking economy, making its assets less attractive to investors, median Bloomberg survey predictions show. The world’s second-biggest economy last year at $4.9 trillion will contract 5.7 percent in 2009, compared with an average of 2.5 percent for the nine other largest economies, according to median forecasts.
"We can’t rule out the possibility of capital flight away from Japan due to its deteriorating fiscal position," said Yuji Saito, head of the foreign-exchange group in Tokyo at Societe Generale SA, France’s third-largest bank. The yen has outperformed all 171 other currencies tracked by Bloomberg over the past two years, appreciating 24 percent to 89.45 per dollar today. The currency is up 12.9 percent from a five-month low on April 6, and has gained 1.3 percent this year. Now, 34 of 38 strategists in a Bloomberg survey see it falling by June 2010, including Landesbank Baden-Wuerttemberg, the most accurate of 46 forecasters in the six quarters ending June 30.
The Stuttgart-based bank predicts a 9.9 percent decline to 100 from 90.09 at the end of October, which would be the steepest eight-month drop in four years. Goldman Sachs Group Inc. in New York forecasts 105 in 12 months, a 14.8 percent slide from the Nov. 13 close. Option traders are the least bullish on the yen since July 2007 after the spread between demand for three-month contracts to buy and sell the currency narrowed by the most ever in the past year, so-called risk-reversal rates show. "Declines in risk reversal rates suggest underlying strong pressure to sell the yen," Societe Generale’s Saito said.
Outstanding government loans and bonds totaled a record 864.5 trillion yen ($9.6 trillion) on Sept. 30, making Japan the world’s most indebted nation. That’s 181 percent of gross domestic product, up from 94 percent a decade earlier and the most among the 30 countries of the Organization for Economic Cooperation and Development, which averages 79 percent. The U.S. has about $7 trillion of marketable debt outstanding, or about 50 percent of its GDP, according to government data.
While credit-default swaps indicate less than a 6 percent chance the world’s second-largest foreign-reserves holder will default, they show increased unease with the debt’s quality. The five-year contracts cost 67.42 basis points, or 0.6742 percentage point, of the sum covered a year. Of 20 developed countries tracked by Bloomberg, only Greece, Ireland, Spain and Italy have pricier swaps. Insuring the debt of Slovakia and Slovenia, which have the same credit ratings as Japan or worse, is cheaper.
Hedging against losses on U.S. bonds cost 27.5 basis points on Nov. 13, down from 100 on Feb. 24. The U.S. will sell a record $2.1 trillion in Treasuries this year and $2.5 trillion next, according to London-based Barclay’s Plc, one of 18 primary dealers that trade with the Federal Reserve. Government bond yields are used as a benchmark for companies such as Shiseido Co., Japan’s biggest cosmetics maker, and brewer Kirin Holdings Co. as they sell debt.
"It’s not really a question of default" by Japan, said Carlos Leitao at Montreal-based Laurentian Bank Securities, the second-most accurate economist in a Bloomberg survey last year. "It’s more the situation becoming so difficult, the government is forced to adopt more restrictive fiscal policies to bring deficits under control. That would further slow the economy." Finance Minister Hirohisa Fujii said on Nov. 10 that "maintaining the trust of investors in the government bond market is our priority" because "the most pressing issue we have to bear in mind when we outline next fiscal year’s budget is that government bond yields are surging."
International demand is already faltering. Foreign investors have sold a net weekly average of 130 billion yen in Japanese bonds this year, after averaging 94 billion in purchases the prior five years, Ministry of Finance data show. Yields on 10-year bonds, which reached 1.485 percent this month on an intraday basis, the highest since June, may rise toward 1.7 percent, said Kazuto Uchida, chief economist for Bank of Tokyo Mitsubishi UFJ Ltd., Japan’s biggest lender.
Japan will spend 10.2 trillion yen on interest payments this year, or 26.2 percent of tax revenue, up from 18 percent in 1990 and 18.9 percent in 2004, JPMorgan Chase & Co. of New York estimated in an Oct. 21 report. The percentage may rise to 36.8 in 2014 and 73.9 in 2019, the bank estimated. Domestic buyers will shore up demand for the securities, limiting yield increases, according to Koichi Kurose, chief strategist in Tokyo at Resona Bank Ltd.
"The sell-Japan campaign is not likely to become a mainstream move, given the fact that Japanese investors hold over 90 percent of outstanding debt issued by the government," said Kurose, whose employer is part of the nation’s fourth- largest banking group. "In a country like Japan, where there’s a stable current-account surplus, rising debt issues won’t push up yields perpetually." Japan almost always exports more than it imports, current- account data show. That broad trade measure shows its surplus rose 0.2 percent to 1.57 trillion yen in September from a year earlier after also rising in August -- the first two straight increases since early 2008, the Finance Ministry said Nov. 10. The surplus allows Japan to finance deficit domestically so it doesn’t have to rely on overseas lenders.
JPMorgan said in its report that Japan’s dependence on domestic bond buyers may hurt demand. Such investors owned 93 percent of the government’s debt as of December, according to a ministry report. Because the Japanese are saving less, they will buy fewer bonds and drive yields up, the bank said, predicting that average families will be squirreling away none of their income within five years, down from about 17 percent in 1980.
"A reasonable estimate that falling savings pushes interest rates higher" by 2 percentage points "would quadruple debt service costs in 10 years," JPMorgan said. Vice Finance Minister Yoshihiko Noda estimated last month that bond sales may hit 50 trillion yen in the fiscal year that started April 1 due to slumping tax revenue, up from the unprecedented 44 trillion estimated in a budget that called for spending a record 102.5 trillion yen.
Tax revenue from April 1 through Sept. 30 totaled 10 trillion yen, 24 percent less than at the same point in the prior fiscal year and the least in 11 years or more, Finance Ministry statistics show. Japan’s deficit "is one of the most significant negative factors" weighing on its credit rating, said Takahira Ogawa, Singapore-based director for sovereign rankings at Standard & Poor’s. S&P isn’t considering changing its "stable" outlook for Japan’s AA international-debt grade, the company’s third highest, he said.
Fitch Ratings may review its AA- grade on locally denominated debt if the country violates its pledge to keep next fiscal year’s bond-issuance below 44 trillion yen, said David Riley, the firm’s head of sovereign ratings in London, in a Nov. 10 Reuters Television interview. "Economic conditions point toward a possibly extended period of deflation," Riley said in a Nov. 10 statement. "Should this happen, it will represent a material risk to the public debt outlook." In a Nov. 13 e-mail, he said he "cannot comment" on what sum might "trigger a rating action."
Consumer prices in Japan have fallen from a year earlier for eight consecutive months through September, including a July’s unprecedented 2.3 percent drop. Median quarterly forecasts predict that trend continuing through mid-2011. "If Japan’s sovereign debt loses its current rating, it would also lose its status as a safe-haven asset," said Soichiro Mori, manager of foreign-exchange promotion at FXOnline Japan Co. "Foreign investors definitely won’t be motivated to hold such debt." The DPJ won power on Aug. 30 by pledging to boost spending and cut taxes, unseating the Liberal Democratic Party, which reigned for all but 10 months since 1955.
Concern about DPJ fiscal policies worsened when Prime Minister Yukio Hatoyama, 62, appointed a former finance ministry civil servant, Jiro Saito, to head the postal service, according to investors such as Makoto Kojima, general manager of global markets at SBI Liquidity Market Co., a unit of financier SBI Holdings Inc. The party vowed to curtail bureaucrats’ power by opposing so-called amakudari, the practice of giving them jobs at state-run companies.
The Nikkei 225 Stock Average has lost 7.4 percent in yen terms since Aug. 28, the trading day before the election, making it one of the six worst performers of 89 primary equity indexes tracked by Bloomberg. The yen’s value "is not consistent with the underlying fundamentals, and that’s a huge opportunity," said Michael Hasenstab, who oversees $45 billion in fixed-income assets for Franklin Templeton Investments and is using forward contracts to bet on the yen’s decline. "The yen is very vulnerable."
The Debt Economy
by James Surowiecki
John Kenneth Galbraith wrote that all financial crises are the result of "debt that, in one fashion or another, has become dangerously out of scale." The recent financial crisis was no exception, with everyone—homeowners, private-equity investors, our biggest banks—taking on enormous amounts of debt. If it’s frustrating that the government is footing the bill to clean up the mess, it’s even worse that the government helped pay for the debt binge that created the mess in the first place, thanks to a tax system that actually subsidizes borrowing. Debt didn’t get dangerously out of scale because the system was broken. It got out of scale, in part, because the system worked.
The government doesn’t make people go into debt, of course. It just nudges them in that direction. Individuals are able to write off all their mortgage interest, up to a million dollars, and companies can write off all the interest on their debt, but not things like dividend payments. This gives the system what economists call a "debt bias." It encourages people to make smaller down payments and to borrow more money than they otherwise would, and to tie up more of their wealth in housing than in other investments.
Likewise, the system skews the decisions that companies make about how to fund themselves. Companies can raise money by reinvesting profits, raising equity (selling shares), or borrowing. But only when they borrow do they get the benefit of a "tax shield." Jason Furman, of the National Economic Council, has estimated that tax breaks make corporate debt as much as forty-two per cent cheaper than corporate equity. So it’s not surprising that many companies prefer to pile on the leverage.
There are a couple of peculiar things about these tax breaks—which have been around as long as the federal income tax. The first is that they’re unnecessary. Few people, after all, can save enough to buy a home with cash, so home buyers naturally gravitate toward mortgages. And businesses like debt because it offers them tremendous leverage, making it possible to put down a little money and potentially reap a huge gain. Even in the absence of the deductions, then, there would be plenty of borrowing.
The second thing about these breaks is that their social benefits are pretty much nonexistent. Advocates of the mortgage-interest deduction, for instance, claim that it increases homeownership rates. But it doesn’t: in countries where mortgage deductions have been eliminated, homeownership rates haven’t dropped. Instead, the deduction simply inflates house prices. The business-interest deduction, meanwhile, may lower an individual company’s taxes, but it also means that the over-all corporate tax rate is higher, so its real impact is to give companies with lots of debt an unjustified advantage.
If the benefits are illusory, the costs are all too real. Economies work best, generally speaking, when people are making decisions based on economic fundamentals, not on tax considerations. So, as much as possible, the tax system should be neutral between debt and equity, and between housing and other investments. It’s not, and, worse still, as we’ve seen in the past couple of years, debt magnifies risk: if companies or individuals rely on large amounts of leverage, it’s much easier for bad decisions to lead to insolvency, with significant ripple effects in the wider economy.
A debt-ridden economy is inherently more fragile and more volatile. This doesn’t mean that the tax system caused the financial crisis; after all, the tax breaks have been around for a long time, and the crisis is new. But, as a recent I.M.F. study found, tax distortions likely made the total amount of debt that people and companies took on much bigger. And that made the bursting of the housing bubble especially damaging. So encouraging people to take on debt qualifies as a genuinely bad idea.
But it’s not an easy situation to change. In 2005, a special Presidential panel on tax reform actually proposed eliminating the business-interest deduction and severely restricting mortgage-interest tax breaks. Those proposals, predictably, went nowhere. But we’re in a different historical moment now: the perils of too much borrowing have never been clearer. And there are precedents, on a smaller scale, for these kinds of changes. In the U.S., people used to be able to write off the interest they paid on credit cards. That tax break was abolished in 1986, and, the same year, the mortgage-interest deduction, which used to be unlimited, was capped. Great Britain, meanwhile, abolished its mortgage tax break in 2000.
Similarly, there are a number of countries, including Brazil and Belgium, that don’t give corporate debt a tax advantage over equity, while, just last year, both Germany and Denmark cut back sharply on their business-interest tax breaks, limiting how much interest companies can write off. Given the weak state of the economy and of housing prices, a wholesale rewriting of the tax code may be a bridge too far right now, but there are plenty of reforms—capping deductions, phasing them out over time, restricting their use by heavily leveraged companies—that would move in the right direction.
The clearest hurdle to these changes may be political, but the bigger hurdle is, in a way, psychological: because tax breaks on debt have been around so long, we can hardly imagine what it would be like if we changed them, and we tend to underestimate their influence in shaping our behavior. Subsidizing debt seems harmless simply because we’ve always done it. But the fact that you’ve had a bad habit for a long time doesn’t make it less dangerous.
Will the dollar bite investors on the derriere?
by Bill Bonner
We got back from South America on Friday...ready for a rest. So, we spent the weekend reading...and occasionally, thinking.
What we've been thinking is that the dollar is dead meat in the long run. But in the short run, it might have enough life in it to bite investors on the derriere.
The US stock market rose 73 points on Friday, to bring the Dow just 30 points south of the 10,300 mark. Why is this level important? It's not really. But it reminds us that this is still just in "bounce range." Big drops in stock prices are followed by bounces - always. A bounce of 50% of what was lost is not unusual. That's what happened after the Crash of '29, for example. So, there's nothing exceptional about what we're seeing on Wall Street.
Our comrades over at The 5-Minute Forecast provided this sobering chart in Friday's issue.
But here at The Daily Reckoning we're not smart enough or fast enough to play the countertrends. We want investment positions that we can ignore for years... We want to be able to go on a long trip...say, down the Inca Road or over the Hindu Kush. And when we come back, we want to find that we have at least as much money as when we left.
If stock market buyers - in the US - have more money a year from now than they have now, we'll be surprised. The private sector is still more than 2/3rds of the economy. And the private sector has begun de- leveraging. Nothing that has happened in the last 8 months makes us think that that trend is going to reverse any time soon. There are 70 million baby boomers who need money for retirement. They've got to save. That means cutting back on spending. And that means less income for business. Are stock prices really going to go up when business income is going down? No.
We leave our "Crash Alert" flag flying, here at the worldwide headquarters. We don't know when...or IF...stock prices will crash. But the downside risk is not worth the possible upside. Daily Reckoning readers should be out of all US stocks, except those they wouldn't mind holding through a 50% correction.
The other thing we mistrust - aside from politicians, stock promoters and tap water - is the dollar. But here the story is more complicated. Because the next downswing in stocks could push the dollar up! Everyone is betting against the dollar. And most think it is a one-way gamble. But it's not like Mr. Market to grant investors a one-way bet. He's got something up his sleeve.
Last week, The Financial Times reported that a group of IMF economists had made a "Plea to reduce demand for dollar reserves." That is another way of saying: find something else to put in your vaults rather than dollars! Why? Because a world money system that uses dollars as a reserve currency is fragile and vulnerable. It makes the whole world hostage to America's financial problems.
"The US, at the center of the system, was under pressure to run large current account deficits in order to supply the world with the dollar assets it wants, they said, while there was no effective discipline on either the US or countries such as China that have big external surpluses to adjust their policies."
This move by IMF economists is only the most recent effort to reduce the world's reliance on the dollar. Everyone can see the dollar is weak. And everyone with any sense wants to protect himself from it. On Friday, the price of gold moved up to $1,116. Gold is the obvious choice for those who wish to protect themselves from the dollar. But readers are cautioned: that doesn't mean the price of gold is going up.
Over the long run, sure. All paper currencies eventually go to their intrinsic value, which is zero. And gold always goes to its traditional value too - at a level where a man can take an ounce of it and get himself a suit of clothes, about 30 bottles of good whisky...one horse...or a trip across the Atlantic in economy class.
But things that ought to happen do not always happen when you think they should. It could take many years - of long, drawn-out recession...a la Japan - before the Bernanke Fed gets its helicopters revved up. In the meantime, all those hot shots who borrowed dollars from the Fed in order to bet against the greenback are going to be in trouble. They'll have to unwind their carry trade positions at a loss...and pay back more expensive dollars. The process could take years.
The US now has the highest unemployment rate of all major economies. Even France - historically, an economy with high jobless rates - is at 9.5% unemployment, while the US is 10.2%.
As for inflation, the lowest inflation rate among the world's larger economies is in - you guess it - Japan. After 20 years of on-again, off-again deflation, it's on again in Japan...with inflation at NEGATIVE 2.2%. But inflation is negative in the US too - at minus 1.3%. Both Japan and the US claim positive GDP growth, compared to Europe, which is still in recession. But throughout the world - except perhaps for the BRIC nations - growth is weak and hesitant.
The US and the UK are both consumption economies. No consumption; no growth. But how do you get people who've consumed too much to consume even more? They know they can't afford to keep spending. And they know that going further into debt just makes the situation worse. What can you do?
You bribe them!
You give them more money, say, in unemployment assistance. Or, you give them a tax credit when they buy a new house. Or, you give companies a big tax break. In the most recent stimulus bill, for example, the feds do all three - including giving Pulte Homes a $450 million tax refund.
Here at The Daily Reckoning we never met a tax cut we didn't like. But with the deficit at 13% of GDP, we might make an exception. One way or another, someone's going to have to pay for the feds' big spending stimulus efforts. Taxpayers. Bondholders. Dollar holders. All of the above.
President Obama told the crowd in Singapore this weekend that he would make sure Ben Bernanke stayed away from his helicopters. The Chinese are the biggest holder of US bonds in the world. The Japanese are next. Between the two of them they fund a big part of America's current spending. Naturally, America's president is eager to keep the cash coming his way. So he has had to reassure the nation's largest creditor that their loans to the US will be repaid in good order...and good currency.
China alone has $2.3 trillion in reserves...most of it in dollars. Of course, the Chinese want to diversify out of greenbacks. But they're caught in a trap of their own making. If they turn away from the dollar, they undermine its value...and the value of their own reserves. What's more, America is still China's number one customer. They need to sell to America. And for that they need to keep their own currency from rising too much against the greenback. A higher yuan makes their products relatively more expensive compared to other exporters.
So, the infernal system continues...America creates dollars. The foreigners take them as though they had value. And they will have value...as long as they take them.
In the '90s and '00s the newspapers were full of stories about what a great place America was. Its economy was so dynamic...its entrepreneurs were so clever...its financial system was so highly evolved and flexible. What could go wrong? Everything! And now we're going to read a lot of claptrap about what an awful place it is.
"The American dream needs repair," is forerunner of the genre. In today's Financial Times, it focuses on the rigidities of the US system. The time was when a young American could start at the bottom and work his way up. Luck and pluck was all that it took. But now, according to scholars at the Brookings Institution, people stay put. If you're born poor in America you're more likely to stay poor than if you had been born poor in Britain, Denmark, Sweden or dozens of other countries.
What happened? The authors do not say. So we will. Success breeds failure. As a society becomes rich, more and more people find ways to game the system. The elite get tax credits, tariffs, and protective regulations. Every layer of bureaucracy makes it harder for new competitors to get ahead. And every new tax on income makes it harder for upstarts to join the ranks of the rich. The poor get their parasitic benefits too. Welfare, unemployment compensation, child tax credits, medicare, food stamps, social security - all of these programs give the poor an incentive to stay poor.
We spent the weekend reading. One of the books we read was Malcolm Gladwell's Outliers. Typically, Gladwell tells a good story, makes some interesting comments, and misses the point. Outliers is no exception. He describes how some groups came to America as immigrants and made successes of themselves. The Jews, for example. They arrived penniless in New York. The first generation started small enterprises. The second generation turned them into big enterprises. And the third generation became lawyers, judges, doctors, and Nobel Prize winners. He cites this example with approval. They made good, he seems to say.
We're not so sure. What we see is a class of people switching from freewheeling enterprise to highly regulated, status-oriented professions. The next thing you know, they're on Wall Street. Instead of adding value as merchants and manufacturers, they're subtracting it with mortgage-backed derivatives.
A Franco-German marriage of convenience
by Wolfgang Münchau
A photographer managed to capture that briefest of moments, heavy with historic symbolism, when Angela Merkel and Nicolas Sarkozy held hands during the November 11 armistice commemorations in Paris. The German chancellor and the French president got on famously, and wanted everybody to know it. It would be easy for a cynical reporter to belittle the ostentatious display of the Franco-German friendship. We all know the bilateral relationship has been poisonous for the last two and a half years, so why should we be impressed?
I believe the symbolism matters a great deal. It might even mark a new period of co-operation between the two countries. No, I am not forecasting a return to the times of Helmut Kohl and François Mitterrand. But a rational analysis of both leaders’ political options can come to no other conclusion than it is in their mutual interest to adopt, not necessarily an entente cordiale, but an entente stratégique , for three main reasons.
The first, and most important, is a desperate leadership vacuum elsewhere in Europe. Look at the European political landscape from the perspectives of Paris or Berlin. The European Commission has long ceased to provide effective leadership. Whoever is nominated as the first president of the European Council under the Lisbon treaty is likely to be someone with less visibility than either Mr Sarkozy or Ms Merkel. What about the other large European Union countries? David Cameron, the Conservative party leader and expected winner of next year’s UK general election, has aligned himself in the European parliament with what is considered in Berlin and Paris to be a grouping of anti-European wingnuts. The most frequent question about the UK in Paris and Berlin is whether a Tory government will withdraw from the EU. Forget about the answer. All the damage lies in the question.
How about Italy? Silvio Berlusconi is seen as a buffoon, not a man with whom Ms Merkel or Mr Sarkozy would form a strategic alliance. Spain will be preoccupied, for the next half generation, with the consequences of the current economic meltdown. If there is political leadership in the EU, it will, once again, have to come from France and Germany. The two will have to work together because there is no alternative.
The second reason is that the countries may in fact have more in common than meets the eye. Their economies are structurally different, but less so than is often portrayed. It is true that there is a yawning gap in fiscal policy, which is likely to persist even if the German government were to maintain a loose policy stance in 2010 and 2011. But, in spite of different views, Ms Merkel and Mr Sarkozy will eventually have to agree on a credible fiscal exit strategy, or risk tensions that could cast doubt on the future of the euro. Both governments broadly agree on the future of capitalism. They consider themselves liberal, in their respective national context, but opposed to the Anglo-Saxon variety of capitalism. And, together, they are likely to remain the only big powers inside the eurozone. As demand for global policy co-ordination increases, they must work more closely with each other before they can work with others.
Third, Ms Merkel and Mr Sarkozy are both likely to remain in power for some time to come. If they both win their next elections, another eight years of bilateral relationship beckons. They are both professional enough not to allow personal enmity to stand in the way of co-operation. I am not predicting the two countries will miraculously start to agree on everything where they used to disagree.
I recall an American journalist observing in the summer of 1989 that in his four years in Brussels he had never witnessed the celebrated Franco-German friendship in action. The two countries disagreed on almost everything. France was pushing for a single currency, while Germany was applying the brakes. This was the time when the EU negotiated the rules for the internal market and competition policy – rules on which France and Germany vehemently disagreed. French and German interests often did not coincide during the 1970s, 1980s, and 1990s. The value of the countries’ relationship consisted of an occasional ability to pull together when it mattered. Without this, there would have been no European monetary system in the 1970s, or Maastricht treaty and single currency in the 1990s. You could have lived in Brussels for years and observed nothing but quarrelling diplomats and poisonous political advisers. And then one day, the leaders got together and surprised.
The need for France and Germany to pull together today is strong and ever more obvious to an increasing number of people in both countries. We know what happens when the two countries fail to co-operate in a time of crisis. Just witness the EU’s dismal response to the financial crisis, and the lasting damage to the internal market and the cohesion of the eurozone. Another such episode would cause even more serious damage, and raise doubts in many people’s minds about the long-term cohesion of the eurozone. As Ms Merkel said in her speech in Paris last week, both countries will need to improve their relationship in the coming years. It is about time.
Deutsche Bank Drowning in Vegas on Costliest Bank-Owned Casino
Deutsche Bank AG’s Cosmopolitan Resort & Casino complex in Las Vegas, already the most expensive debacle in the city for a single lender, is now two years behind schedule, $2 billion over budget and under water -- literally. Deutsche Bank, the resort’s owner since it foreclosed on developer Ian Bruce Eichner last year, requires 24-hour pumps and containment walls after workers hit an aquifer below the Nevada desert floor. It’s another challenge for a project whose delays and redesigns have sparked lawsuits from condominium buyers and sales agents amid record declines in Las Vegas’s gambling revenue, home prices and hotel-room bookings.
The German bank’s foray into the heart of the U.S. gambling industry, where it’s also a lender to bankrupt Station Casinos Inc. and the unfinished Fontainebleau, looms as an "impending disaster," casino magnate Stephen Wynn said on a conference call with analysts last month. Wynn, who presides over the Wynn and Encore Las Vegas resorts, built the Bellagio next door to the Cosmopolitan.
Deutsche Bank took over the project after Eichner defaulted on a $760 million loan last year. The Frankfurt-based lender hired Related Cos., the developer of New York’s Time Warner Center, to oversee construction of the development’s two high- rise condominium and hotel towers, resort and casino. Cosmopolitan sits on 8.5 acres between the 76-acre Bellagio, MGM Mirage’s most profitable resort, and CityCenter, the firm’s newest development, packed on 67 acres.
So far, Deutsche Bank has had to write down 500 million euros ($748 million) on Cosmopolitan. The sum could rise if the Las Vegas market fails to revive, said Dirk Becker, an analyst at Kepler Capital Markets in Frankfurt. The bank is offering condominium buyers in one Cosmopolitan tower 74 percent of their deposit to walk away, according to a copy of the proposal provided by a lawyer for some purchasers. "Deutsche Bank had a difficult choice: selling an unfinished project or building the casino itself," Becker said. "The bank probably never wanted to become a casino-builder in Las Vegas, but selling the project right after the real estate crash could’ve led to higher losses."
Next door to Cosmopolitan, MGM Mirage and Dubai World, an investment arm of the emirate of Dubai, are completing the $8.5 billion CityCenter after lenders, led by Bank of America Corp., agreed to finance $1.8 billion. Further north on the Las Vegas Strip, work halted on the Fontainebleau in June with a bankruptcy filing after its lenders, including Deutsche Bank, refused further funding. The 63-story casino resort is about 70 percent complete.
In the case of Cosmopolitan, "the bank concluded last year that completing the project was an appropriate strategy," said John Gallagher, a Deutsche Bank spokesman in New York. "We cannot comment on the bank’s long-term plans for the Cosmopolitan. However, the bank has been and remains committed to building a world-class resort and casino that will become an integral, vibrant part of the Las Vegas economy."
Deutsche Bank executives who have applied for gaming licenses from Nevada casino regulators include Jon Vaccaro, global head of commercial real estate; Jeffrey Baer, head of global logistic services; Donna Milrod, head of regional oversight and strategy; and Eric Schwartz, a managing director in the bank’s commercial real estate group, according to Deutsche Bank and the Nevada Gaming Control Board. They are all based in New York. The four may become the first Las Vegas Strip casino-owning bankers to obtain the credential. The closest comparison: an affiliate of Goldman Sachs Group Inc.’s Whitehall Street Real Estate Fund underwent licensing as it took control of a portion of the Las Vegas Hilton, according to Thomas Hanna, coordinator of applicant services at the Nevada Gaming Control Board.
Gambling revenue on the Las Vegas Strip tumbled more than 12 percent this year through September, more than last year’s record 11 percent drop, according to the Nevada Gaming Commission. Las Vegas home values dropped 55 percent from their August 2006 high, according to the S&P/Case Shiller single family home price index. When Eichner, developer of the luxury condominium Continuum in Miami, broke ground in October 2005, the Cosmopolitan was slated to cost $1.8 billion and open in mid-2008, according to a press release at the time. Deutsche Bank now plans to open the doors in September 2010.
The current projected total cost of the project, according to analysts: $3.9 billion. That’s part of the reason the Cosmopolitan is the costliest project in Las Vegas for a single lender, according to New York-based research firm Real Capital Analytics Inc. As the costs of the development mount, high-end hotel rooms are popping up on the Strip, including 6,000 at CityCenter, the hotel, condominium, casino and mall complex opening next door to Cosmopolitan next month.
CityCenter will add 29 percent more so-called premium rooms on the Strip to the more than 20,000 available before Cosmopolitan opens, said Dennis Farrell, a casino debt analyst at Wells Fargo Securities LLC in Charlotte, North Carolina. Citywide, Las Vegas already has about 140,000 hotel rooms, according to the Las Vegas Convention and Visitors Authority. "The Cosmo is going to be a dormitory for people who want to go to CityCenter and Bellagio on either side," said Farrell. "You’ll have great views of both neighboring properties from the rooms, but I don’t know what other amenities they’ll be able to offer their customers that will be profitable enough returns on investment."
Cosmopolitan’s original design included a 75,000-square- foot casino, a 1,800-seat theater and a five-acre "Cosmo Beach Club" overlooking the Strip, according to the press release. Deutsche Bank declined to discuss subsequent modifications. Now the project is swimming in water from an underground aquifer that once irrigated the golf course at the now- demolished Dunes. These days, the water helps refill a fountain at the Bellagio that "dances" to ballads every half-hour -- and twice as often after dark.
The aquifer forms as runoff seeps into the ground and pools atop a layer of caliche, a cement-like rock, according to Bronson Mack, a spokesman at Las Vegas Valley Water District. Resorts often excavate through the caliche to build footings and parking garages, creating an ongoing need to pump water, Mack said. "The relatively high water table on this site required the installation of a pump system and containment walls,’’ said Gallagher, the Deutsche Bank spokesman. "This is not uncommon for any Las Vegas project that includes underground parking or other underground facilities. The temporary certificate of occupancy for the entire parking garage, including the pumping system itself, was granted in February 2009, and we have encountered no problems whatsoever."
Built around the Jockey Club resort, Cosmopolitan had no choice but to dig deep and build its parking garage below ground, regardless of the water, said Dan Fasulo, managing director for Real Capital Analytics. The Cosmopolitan’s subterranean parking structure was designed to hold 3,800 automobiles, according to the 2005 press release. "Any construction project of this size runs into problems," Fasulo said. "But to bump into an aquifer is just bad luck."
Thirst for Jobs Drives Towns to Beg Feds for Guantanamo Detainees
It's like the Olympics host-city selection all over again. A handful of towns are locked in tight competition for the privilege of hosting international guests -- only instead of Olympians, they're jockeying to welcome Guantanamo Bay detainees to their home towns. The reason? Jobs.
In a reversal of the not-in-my-backyard approach many lawmakers and communities have taken to the idea of housing the terror detainees stateside, the thirst for prison-centered employment has caused several U.S. towns to plead with federal officials to let them become permanent hosts to dozens of alleged killers. The prospect still has some residents and officials up in arms, but the fact that hosting terrorist suspects has generated strong local support for economic reasons is just the latest sign of the times -- hard times.
"At a time when Illinois is facing recession ... this is a lifeline. This is an opportunity," Sen. Dick Durbin, D-Ill., told reporters Monday, predicting that high-paying jobs with benefits packages would accompany a proposal to bring up to 100 detainees, in a revamped federal prison, to his state. "These people deserve a fighting chance to save their communities ... and this project will give them that chance." Durbin called it a "competition." Federal officials were visiting a Thomson prison in northwest Illinois Monday that the government might buy to house the inmates.
State officials say the conversion of the near-empty prison to a federal penitentiary could pump up to $1 billion into the local economy over four years and generate more than 3,000 jobs. Gov. Pat Quinn said in a statement that such a facility could cut the unemployment rate of Carroll County, where the prison is located, in half from its 10.5 percent level as of September. Quinn predicted local income could increase by up to $223 million annually. Charles Stimson, a former deputy assistant defense secretary for detainees, told FoxNews.com that costs would include spending up to $200 million to upgrade a facility, another $100 million a year for an operating budget and an unknown shift of annual federal homeland security funds to pay for additional terror threat monitoring and security for the community hosting prisoners.
"You're going to have to harden the facility so that people cannot commit acts against it. ... It will be a homeland security bonanza," he said. He warned that fraud and abuse would surely be commonplace in the process -- but also recalled an argument from former Defense Secretary Donald Rumsfeld in saying the cost of keeping such a facility is slight compared to the $3 trillion in losses to the global economy caused by the Sept. 11 attacks. Pentagon spokesman Bryan Whitman stressed Monday that no decision has been made as to where the federal government will relocate the prisoners. But Thomson's not the only city looking for some detainee stimulus.
Other communities that have expressed interest include Hardin, Mont.; Marion, Ill.; Standish, Mich.; and Florence, Colo. The surrounding Big Horn County in Montana has an unemployment rate of 10.2 percent, which approaches Carroll County's. Hardin's got a 460-bed detention center that's been sitting empty for two years. The city argues that the relatively new, modern facility would be easy to upgrade to accommodate the prisoners now in Cuba. And it's remote enough to make escape considerably difficult.
The county where Marion is located also has a relatively high unemployment rate, though below the national average, at 9.6 percent, according to September statistics. "Bring them on," Mayor Robert Butler said of the detainees over the summer. Housing detainees would entail restoring the medium-security prison to its former high-security status. But the restoration could also bring with it the return of lost jobs. In Standish, the county unemployment rate was a whopping 15.8 percent in September. Local officials there were looking to land a detainee deal to keep their shuttering local prison open, and the facility has been reviewed by prison officials.
Florence, which has a lower unemployment rate of 7.7 percent, has also pitched its federal Supermax prison as a potential home for Guantanamo detainees. Prison officials also have looked at the Navy brig in Charleston, S.C. But as the prospect of gainful employment wins over supporters to such host-city plans, several lawmakers say housing detainees locally carries too many risks. "Instead of focusing attention on policies that will create good private sector jobs for the future, they're offering us their prisons and calling this a dream come true," Rep. Judy Biggert-R-Ill., said Monday. "I'd like to say it's more like your worst nightmare."
U.S. Rep. Mark Kirk, a Republican running for President Obama's old Senate seat, circulated a letter among elected officials asking them to write to Obama opposing the plan. He said bringing Guantanamo prisoners to the state would make it a target for terrorist attacks. "At best, these people will also be able to convert other prisoners to the cause of Jihad against America," he told Fox News. "At worst, the anger and attention that is brought to the city of Chicago and the state of Illinois would make us a target." Senate Minority Leader Mitch McConnell told "Fox News Sunday" that he expects Illinois residents and lawmakers to object and that he and his colleagues will seek to block funding at the federal level. "Hopefully the Senate and the House will speak on this issue," McConnell said.
The Fate of the Yeast People
by Jim Kunstler
Every time I do a Q and A after a college lecture, somebody says (with a fanfare of indignation) - so as to reveal their own brilliance in contrast to my foolishness - "You haven't said anything about overpopulation!"
Right. I usually don't bother. Their complaint, of course, implies that we would do something about overpopulation if only we would recognize it. Which is absurd. What might we do about overpopulation here in the USA? Legislate a one-child policy? Set up an onerous set of bureaucratic protocols forcing citizens to apply for permission to reproduce? Direct the police to shoot all female babies? Use stimulus money to build crematoria outside of Nashville?
It's certainly true that the planet is suffering from human population overshoot. We're way beyond "carrying capacity." Only the remaining supplies of fossil fuels allow us to continue this process, and not for long, anyway. In the meantime, human reproduction rates are also greatly increasing the supply of idiots relative to resources, and that is especially problematic in the USA, where idiots rule the culture and polity.
The cocoon of normality prevents us from appreciating how peculiar and special recent times have been in this country. We suppose, tautologically, that because things have always seemed the way they are, that they always have been the way they seem. The collective human imagination is a treacherous place.
I'm fascinated by the dominion of moron culture in the USA, in everything from the way we inhabit the landscape - the fiasco of suburbia - to the way we feed ourselves - an endless megatonnage of microwaved Velveeta and corn byproducts - along with the popular entertainment offerings of Reality TV, the Nascar ovals, and the gigantic evangelical church shows beloved in the Heartland. To evangelize a bit myself, if such a concept as "an offense in the sight of God" has any meaning, then the way we conduct ourselves in this land is surely the epitome of it - though this is hardly an advertisement for competing religions, who are well-supplied with morons, too.
Moron culture in the USA really got full traction after the Second World War. Our victory over the other industrial powers in that struggle was so total and stupendous that the laboring orders here were raised up to economic levels unknown by any peasantry in human history. People who had been virtual serfs trailing cotton sacks in the sunstroke belt a generation back were suddenly living better than Renaissance dukes, laved in air-conditioning, banqueting on "TV dinners," motoring on a whim to places that would have taken a three-day mule trek in their grandaddy's day. Soon, they were buying Buick dealerships and fried chicken franchises and opening banks and building leisure kingdoms of thrill rides and football. It's hard to overstate the fantastic wealth that a not-very-bright cohort of human beings was able to accumulate in post-war America.
And they were able to express themselves - as the great chronicler of these things, Tom Wolfe, has described so often and well - in exuberant "taste cultures" of material life, of which Las Vegas is probably the final summing-up, and every highway strip, of twenty-thousand strips from Maine to Oregon, is the democratic example. These days, I travel the road up the west shore of Lake George, in Warren County, New York, and see the sad, decomposing relics of that culture and that time in all the "playful" motels and leisure-time attractions, with their cracked plastic signs advertising the very things that they exterminated in the quest for adequate parking - the woodand vistas, the paddling Mohicans, the wolf, the moose, the catamount - and I take a certain serene comfort in the knowledge that it is all over now for this stuff and the class of morons that produced it.
A very close friend of mine calls them "the yeast people." They were the democratic masses who thrived in the great fermentation vat of the post World War Two economy. They are now meeting the fate that any yeast population faces when the fermentation process is complete. For the moment, they are only ceasing to thrive. They are suffering and worrying horribly from the threat that there might be no further fermentation. The brewers running the vat try to assure them that there's more sugar left in the mix, and more beer can be made from it, and more yeasts can be brought into this world to enjoy the life of the sweet, moist mash. In fact, one of the brewers did happen to dump about a trillion-and-a-half teaspoons of sugar into the vat during 2009, and that has produced an illusion of further fermentation. But we know all too well that this artificial stimulus has limits.
What will happen to the yeast people of the USA? You can be sure that the outcome will not yield to "policies" and "protocols." The economy that produced all that amazing wealth is contracting, and pretty rapidly, too, and the numbers among the yeast will naturally follow the downward arc of the story. Entropy is a harsh mistress. In the immediate offing: a contest for the table scraps of the 20th century. We've barely seen the beginning of this, just a little peevishness embodied by yeast shaman figures such as Sarah Palin and Glen Beck. As hardships mount and hardened emotions rise, we'll see "the usual suspects" come into play: starvation, disease, violence. We may still be driving around in Ford F-150s, but the Pale Rider is just over the horizon beating a path to our parking-lot-of-the-soul.
It's a sad and tragic process and, all lame metaphors aside, there are real human feelings at stake in our prospects for loss of every kind, but especially in the fate of people we love. The human race has known catastrophe before and come through it. There's some credible opinion that "this time it's different" but who really knows? We have our 2012 apocalypse movies. The people of the 14th century, savaged by the Black Death, had their woodcuts of dancing skeletons. Feudalism was wiped out in that earlier calamity but, whaddaya know, less than a century after that the Renaissance emerged in a wholly new culture of cities. Maybe we will emerge from our culture of free parking to a new society of living, by necessity, much more lightly on the planet and for a long time, perhaps long enough to allow the terrain to recover from all the free parking.
Million in Ukraine Hit By 'Plague Worse Than Swine Flu'
A deadly plague could sweep across Europe, doctors fear, after an outbreak of a virus in Ukraine plunged the country and its neighbours into a state of panic. A cocktail of three flu viruses are reported to have mutated into a single pneumonic plague, which it is believed may be far more dangerous than swine flu. The death toll has reached 189 and more than 1 million people have been infected, most of them in the nine regions of Western Ukraine.
President of Ukraine Viktor Yushchenko has called in the World Health Organisation and a team of nine specialists are carrying out tests in Kiev and Lviv to identify the virus. Samples have been sent to London for analysis. President Yushchenko said: "People are dying. The epidemic is killing doctors. This is absolutely inconceivable in the 21st Century." In a TV interview, the President added: "Unlike similar epidemics in other countries, three causes of serious viral infections came together simultaneously in Ukraine – two seasonal flus and the Californian flu. "Virologists conclude that this combination of infections may produce an even more aggressive new virus as a result of mutation."
Prime Minister Yulia Tymoshenko has been touring hospitals where victims are being treated and presidential elections in January could be cancelled .Four men and one woman have died from the flu in Lviv, said emergency hospital chief doctor Myron Borysevych. Two of the dead patients were in the 22-35 age group, with two others over 60. He diagnosed the disease as viral pneumonia. "We have sent the analyses to Kiev. We don’t believe it’s H1N1 swine flu. Neither do we know what kind of pneumonia it is."