"Motor car, Canadian Government Colonization Co."
Ilargi: The following essay was written by Ashvin Pandurangi, a law student at George Mason University. In it, he tackles the topic of our present predicaments in the light of complexity, a topic of course first and famously put center stage by Professor Joseph Tainter in the 1980's (listen to a fascinating recent Tainter interview here).
Complexity is an important issue in our times because it "describes" the inevitability of certain processes occurring in systems. While we might discuss exactly what is bound to happen exactly when, the overall drive and direction are indisputable: systems, as they grow, increase their levels of complexity, until they no longer can. That is, until it’s their very complexity that inhibits further growth. Then a move towards decreased complexity, or increased simplicity, must begin, a move that can be extremely painful, since parts of the system become redundant and must die off.
This is very relevant to our economic situation today. Pandurangi provides a nice example: much of the stimulus packages the US and other governments have issued will never reach the intended goals; the complexity of our societies forces much of it into the hands of all the separate layers the societies are composed of (example: 159 different US government institutions are involved in processing Obama's new health care bill).
In the same vein, you might look at our debt conundrum through the "eyes of complexity". Increasingly complex debt instruments have increased debts (disguised as easy credit), whether they are personal, corporate or governmental, to such levels that they can no longer grow -we can't pay them off anymore without assuming additional debt-. And since we have built our entire financial and economic systems on credit -and hence debt-, there must follow a period of deleveraging. A warning sign should be that for every additional dollar put into the system, returns today are diminishing to the point that they threaten to become negative.
It's hard to see how this could not be extremely painful for most of us. Joseph Tainter's pivotal work is called the Collapse of Complex Societies for a reason. In nature, in physics, systems don't collapse gradually, or very rarely so; in 99% of cases, it's more like sticking a needle into a balloon.
We may, some of us, be able to individually recognize the process, but as a group we will inexorably be driven to increase complexity, until we no longer can, and the system collapses unto itself, with little or no regard for our individual fates, or even our groups'. This is of course not only true for economics or finance, it's equally pertinent to resource depletion (energy limits are closely related to collapse) and waste production: you can push a system to a certain point and no further. Our tragedy is that we have no choice, as a group, but to keep on pushing until we're either pushing on a string or the system starts pushing back.
Those of you who are new to the concept of complexity as a deciding factor in the evolution of systems, including our societies, may need some catching up (do listen to the interview linked above). Others, who are familiar with Tainter, may have other issues with Pandurangi's take. On the whole, though, my view is that this is a subject worthy of quite a bit of attention, and this is a valiant effort.
A Fundamentally Flawed Perspective
The current U.S. administration has its eyes dead set on more fiscal stimulus and/or monetary easing to counter the ever-growing threat of severe deflation on the horizon. Despite the trillions added to our Treasury and Fed’s balance sheets in 2008-09, the 2010 Q2 GDP number is anemic (1.6%) even when it can be trusted as accurate. Most of the ever-optimistic (and late-to-reality) American investment banks have significantly revised their estimates for 2010 H2 GDP down to around 2%, while most serious analysts agree it will be closer to a negative print. Existing and New Homes sales in July 2010 have experienced record declines in the absence of government subsidies (~27% and ~35%).
Unemployment remains significantly higher than reported, as U-6 hovers at 17% and shows no signs of improving (includes workers who have given up looking for jobs – can we blame them when there are 5 workers for every job?). Close to 40 million Americans are on food stamps, 5 million on emergency unemployment benefits and 500,000 recently filed initial jobless claims in one week. Equity outflows from institutional investing firms have continued for months unabated and have totaled over $50 billion year-to-date. Confidence indicators have been gradually deteriorating among consumers and businesses, and that does not bode well for the largest pyramid scheme in human history.
On the other side of the American political divide, conservative Republicans who claim to identify with tea party activists argue for fiscal austerity and less government regulation/intervention in the economy. Leaving aside the glaring hypocrisy of these politicians (many of them contributed greatly to a doubling of the federal debt and expansion of subsidies/entitlements from 2000-08), there are still several other troubling aspects to their alleged views. One of these aspects is the gross injustice of asking a majority of the population to forego promised entitlements and economic relief after we already decided to bail out a small minority of the population.
Two wrongs don’t make a right, but neither does one wrong and a humiliating slap to the collective face. Another is the fact that many of these politicians have no idea what their policies really entail for the economy. As explained in sections below, it’s not as simple as cutting deficits, letting the free market take over and watching the flowers bloom as the sun shines on a new day in America. There will be a chaotic descent into economic depression and a need for governments to help mitigate the damages and promote structural reforms to the debt-based, fossil fuel economy. Speaking of fossil fuels, these politicians and pundits also naively ignore the critical issues of climate change and peak oil production or assume unregulated free(-falling) markets can eventually solve these issues on their own, without much negative impact to the economy.
The main critique of this essay is that the viewpoints described above have a fundamentally flawed perspective on our current economic predicament. Whether it’s the left or the right, the free marketers or the socialists or many of the shades in between, the mainstream consensus is one of desperate hope for a rapid return to continuous economic growth, low unemployment, relatively cheap finance and rapid consumption of natural resources. More generally, there is an insatiable lust for maintaining complexity in our modern systems of economic exchange and social organization. Of course, this critique is not true of everyone in the mainstream camps described above, but I find it telling that we rarely (almost never) hear the word “complexity” or phrase “peak” anything mentioned in their bitter debates.
One of the most familiar complex systems to Americans is our country's inter-connected network of highways, which allow the interstate travel of goods and capital (humans included). This flow mainly passes through large urban centers that act as hubs for the rest of the network. We could have built these highways and then left drivers to their own decisions on how to use them, but it became clear that completely unregulated networks of travel imposed unacceptable safety/economic risks for our society. In fact, the potential risks and instabilities of such a system were so large that it may have completely broken down before it led to any significant gains. Instead, we resorted to licensing procedures and various vehicle and highway regulations.
People who wish to take advantage of the highway system must first be taught the basics of operating a vehicle and pass a test of their knowledge. They must also follow the regulations imposed on them (speed limits, traffic lights, signs, etc.) and maintain their vehicles (annual inspections) under threat of economic or physical punishment. There is also the requirement that drivers get insured for accidents so that they will not pass off the cost onto taxpayers or innocent victims. All of the above are top-down policies used to manage a complex system containing numerous interacting variables. Many motor vehicle accidents still happen and many people still die each year because of them, but we have decided to put up with that level of instability in return for the efficiencies created. One can argue that even this somewhat balanced system is long-term unsustainable and destructive (especially considering environmental costs), but at least it has yet to fall apart.
Now we can compare the highway system to the significantly more complex, expansive networks of the global economy and specifically the financial markets that make international trade/investment possible on a global scale. Individual countries (or even major cities in the larger state economies) can be considered the central hubs for much of these economic flows. The flows are greatly aided by the use of financial instruments (bonds, letters of credit, etc.) that are much easier to “manufacture” than the goods/services being exchanged, though they may be harder to comprehend. Financial markets provide humanity with a method for pulling future energy/resources (real or perceived) into the present, which allows for greater levels of present-day trade, consumption and investment. The key point here is that these sources of energy/resources may not exist and/or be easily utilized in the much depended on future. A system can only retain or evolve its complexity as long as new energy/resource inputs are provided to it in ever-larger doses.
The credit bubble over the last few decades reflects an exponential growth of complexity in the global economy (and in all of human civilization as a result). In 1929 at the beginning of the Great Depression, the U.S. private debt to GDP ratio was about 150%. Fast forward to 2007, and we have more than doubled that ratio to a staggering 300%+ and many other countries have also followed in our misallocated footsteps (housing bubbles have developed in Canada, China, India, Australia and many Euro-zone countries to name a few). America could rightfully be accused as the primary driver of this bubble, since we have the global reserve currency and much of the debt incurred by people in other countries was denominated in dollars. We owe much of that status to our bloated military-industrial complex and reckless/malicious expansionist policies (the U.S. has 700+ military bases established around the world).
We also see that public debt levels in the global economy have reached levels much higher than those in the 1930s. The public debt to GDP ratio for the U.S. is either 90% (total national debt), 150% (total debt including GSE debt) or 900% (total debt including GSEs and unfunded entitlement obligations), with the latter two being the most accurate, which is probably why the Chairman of the Joint Chiefs of Staff (Mike Mullen) called it the “single biggest threat” to national security. As a result of this debt-fueled private and public spending spree, economic activity has reached a very large scale and scope around the globe and many new inter-dependencies have been created between countries, corporations and individuals. American people have increasingly found themselves relying on megalithic grocery/retail stores to secure supply of food and consumer goods from across the planet, while American corporations rely on labor, parts and services from many different countries.
Several global institutions have been designed to impose a top-down management structure for these complex economic and political relationships. Similar to state and federal regulatory bodies within a country, they are commissioned to “alleviate” inherent instabilities that arise from the operations of a complex, dynamic system. Needless to say, they have predictably failed at this goal even more miserably than the central governments of nation-states. The global credit (complexity) bubble is currently in the process of imploding due to its inherent Ponzi dynamics.
As is the case with any Ponzi scheme, it can only be maintained if new entrants continue buying into it, but most economic actors (individuals, corporations and governments) are now saturated with debt as their cash flows have stagnated or declined (they can barely afford to pay down existing debts, let alone take on new debt). Multiple claims to existing real wealth are destroyed as the bubble implodes and our societal systems, which are mal-adapted to credit contraction and slow/negative growth, begin to experience immense destructive pressure. This process is quite evident in the Euro-zone, where entire “sovereign” states are quickly descending into utter insolvency despite the newly-formed credit facilities of the ECB and IMF (the latter recently decided to eliminate the borrowing cap on their facility in a final act of desperation).
We must also keep in mind the role of feedback loops when discussing complex dynamics, since variable elements of a system constantly interact with each other in unexpected, but also generally predictable ways. As a system’s complexity increases, negative feedbacks provide a certain level of stability and the system can self-organize at a relatively stable equilibrium. However, at peak levels of complexity the negative feedbacks are overwhelmed by instabilities that have formed, and on the way down predictable positive feedbacks are the hallmarks.
In a complex economic system that has reached peak financial activity, debt destruction from pay-downs and defaults leads to falling aggregate demand, suppressed prices, shrinking profit margins, increased unemployment, which further reduces demand and suppresses prices. American states on the brink of bankruptcy are all too familiar with these positive feedback loops, as their high rates of unemployment have led to low tax revenues, leading to spending cuts/tax hikes, leading to lower incomes and higher unemployment, leading to even lower tax revenues and massive fiscal deficits. These are just two of many positive feedback loops which occur in a debt deflation, and it is important to remember there are other factors involved and cross-interactions between separate loops within a system. They are also not limited to just the economy but eventually find their way into politics and societal trends at large.
The Devil’s in the Details
President Obama’s administration, with the aid of various academics (such as Paul Krugman) and media pundits (such as those on CNBC), have embarked on a mission to restore “business as usual” economic growth through the use of fiscal stimulus, “loose” monetary policy and direct government intervention in the economy. The American Reinvestment Recovery Act allocated about $820 billion to various local governments and companies in an effort to create jobs. What they don’t tell you about the ARRA is how much of that money, as a matter of necessity, is wasted in bureaucratic institutions that distribute and keep track of the money as it is funneled down to economic actors.
Much of the money also goes to funding extremely misguided projects, such as tax credits for homebuyers that incentivized the construction of new homes when there is already a year’s worth of excess supply. Sometimes the money goes to fund the repair of roads that don’t even need any repair, as I have personally witnessed in my own community. New estimates have made clear that it is unlikely more than 1 million jobs were created by the ARRA stimulus, which amounts to $820,000 per job, some of which were not even productive for the general economy. Debt saturation and peak complexity is the primary reason why every additional debt-dollar spent into the economy produces significantly less than a dollar of productive economic value. The most that can be said by the administration about this fiscal stimulus is that it redistributed wealth from working class taxpayers to…well, other working class taxpayers, but also REITs (real estate investment trusts) and banks, and a bunch of money was lost in the process.
The loose monetary policies being used include keeping the federal funds rate and discount rate at close to 0% (rate at which banks can borrow from each other and the Fed) and purchasing debt assets such as mortgage-backed securities and treasury bonds (“quantitative easing” to inject liquidity into banks). Our central bank is now sitting on a portfolio of around $2 trillion in securities and has recently decided to keep that value constant by reinvesting principal pay-downs on mortgage and agency debt into long-term treasuries.
The above policies serve to keep a floor on mortgage rates and finance our government’s deficits at low interest (what used to be stealth monetization is now just monetization), while also providing cash to banks with the alleged hope that they will lend it out into the economy, where consumers and businesses will spend/invest the loaned money. Out there in the real world, no such lending has happened, as the banks are sitting on $1+ trillion in cash and the Fed is caught in a liquidity trap. This trap implies that any small increase in rates will have a disproportionate inverse effect on debt servicing costs and therefore spending and investment. As the notable Australian economist Steve Keen likes to point out, when the Fed’s objective is to create growth in the productive economy, the above policies simply amount to pushing on a string.
Private markets are currently saturated with debt and therefore very few people want to borrow money, and very few lenders want to make loans at affordable rates since debtors can barely pay back what they owe now. As mentioned before, interest rates have bottomed out and there is minimal economic activity to show for it. The velocity of money in the economy has collapsed, and the Fed’s policies merely transfer large sums of taxpayer money to major banks that use it to blow more speculative bubbles in stocks, bonds, commodities, and derivative bets on the price movements of those assets. A prominent blogger/author named Charles Hugh Smith would ask “cui bono” (who benefits?) from these policies, and the answer would not be 90%+ of our population (the top 1% hold 33.8% of all wealth and more than 50% of all stocks and bonds in America). Maybe a better question is who loses, and the answer to that would be a solid majority of American taxpayers and savers (since interest paid on deposits remains at next to nothing).
Another tactic used by the current administration is to directly intervene in the housing market to keep mortgage rates low and support prices, since they view housing as the primary cause of the current crisis. The U.S. Treasury (taxpayers) is currently guaranteeing more than 90% of all new mortgages issued in the last year through the government-sponsored enterprises of Fannie, Freddie and also the FHA. As we can see with the large downturn in recent housing data, this intervention has merely allowed us to kick the can a few feet down the road, and the can became significantly larger after we kicked it.
In effect, these interventionist policies keep prices artificially elevated for a little while and loan losses off of banks’ balance sheets, while homes become even less affordable for financially responsible people looking to buy. Even with record low mortgage rates, people are refusing to take on more debt to purchase an over-priced house unless there is a promise of a government handout lurking in the background, and the government simply cannot afford many more handouts. What much of the above interventionist policies amount to is a substitute of private debt held by politically influential groups for public debt held by the taxpayers and future generations, which ultimately creates even more disturbances in public credit markets and crowds out what’s left of private investment (more money has to go towards financing deficits).
The administration has also presented several “structural” fixes of the health care and financial industries for public consumption. These bills were thousands of pages long and filled with new regulations and tweaks to existing ones that really did nothing to address the underlying fundamental problems with these systems. The health care bill did little more than give the health insurance companies 30 million new customers through government mandate, and the “finreg” bill failed to break up the TBTF banks, audit the Fed or create transparency for risky derivative products. More importantly, these new top-down regulations have the inherent feature of creating unintended consequences in our complex society, despite the alleged best intentions of their creators, and can even make the targeted problem worse.
The financial reform bill created new restrictions on “angel investors” which will inadvertently stymie the creation/expansion of small businesses, while the behemoth investment banks will continue to exploit financial markets by hiring teams of lawyers to easily bypass the new regulations that affect them (as they are currently doing with the “Volcker Rule”) or by simply buying off the regulators. Meanwhile, as the administration pretends to combat fraudulent practices in the financial industry by creating a “Consumer Finance Protection Agency” (housed in the Fed), they actively aid financial institutions in committing accounting fraud by suspending federal rules that require them to mark their assets to market value (just another part of what many term “extend and pretend” policy).
Finally, another recent tactic of current governments has been the use of central bank intervention to suppress a politician’s worst nightmare in a deflationary economy, currency appreciation. The Swiss National Bank has admittedly bought up billions worth of Euros to prevent the Swiss Franc from appreciating too much during the ongoing European sovereign debt crisis of 2010, but they ended up taking significant losses on those transactions (and I’m confident that Germany didn’t mind the boost to exports provided by the Euro at 1.20 against the dollar). We can be rest assured that the central banks of the U.S., Japan and China have done the same type of intervention and will continue to do so when they feel it necessary.
Disregarding the inherent unsustainable nature of major economies racing to the bottom of the currency depreciation endgame, the marginal benefits of these interventions have severely contracted as their half-lives become shorter and shorter. Currency investors (who manage to trade $4T daily with 50x leverage) have realized that a central banker pushing a button somewhere to buy a few billion here and there will not change the fundamental economic realities faced by the global economy. Diminishing marginal returns, whether they are those of interventions or investments, are best viewed as a function of decelerating complexity. Razor thin margins in the global economy are no accident, but only the logical destination of our complex, infinite growth-based systems.
We should also consider the possibility that some or all of the above policies will miraculously be successful in creating sustained economic growth, price inflation, and wealth creation. In the case of such a rare event, the question still remains of when and how intervention can be stopped, and whether we will return to the same credit-based, consumption economy we had in the past. Will we merely restart the credit bubble and restore our modern lifestyles in the developed world? These questions in turn raise the issues of continued over-consumption of resources, environmental destruction and accelerating climate change, which are the most important long-term issues that humanity faces. After all, how long can an economy continue growing when billions of its supporting members around the world are dying of starvation, thirst and/or resource wars?
Conservative politicians/pundits who adhere to the Tea Party mentality are, at best, disingenuous in their promises of returning to the status quo of economic growth and complexity with fiscal conservatism and small government. They suggest that many of our economic ills can be cured if we simply withdraw all government fiscal/monetary supports and drastically reduce public spending. Now it is true that spending should be drastically cut in certain areas, and intervention should be drawn down to a large extent, but the question then becomes what happens if we do that and not much else.
The break down of complexity in a system does not adhere to human concepts of fairness, order or social stability. If these politicians actually follow through with what they promise, a lot of wealth will be destroyed as asset prices, wages and business profit margins fall drastically. Societies grown accustomed to continual growth and high standards of living will have their expectations dashed and will experience the societal equivalent of post-traumatic stress disorder. There will be deterioration in social order, an increase in crime rates, and an exacerbation of people’s distrust/paranoia of all groups perceived as “different” or those claiming a right to the same piece of economic pie (the increasingly heated debates over illegal immigration is a great example of this dynamic).
Austerity measures are being pushed heavily in European countries and by many people in America concerned about public debt. Their concerns are entirely valid and something should be done to reduce deficits, but we must also be candid with the global population about what the term “austerity” really implies. It is actually another way of promoting reduced complexity in our modern society. Just as our debt-fueled private and public spending sprees have pulled forward energy/resources to maintain and evolve complexity, a global or nationwide savings plan would pull the resource rug out from under our extremely complex systems. This loss of complexity necessarily means much less economic activity and access to goods/services across distant locations.
For example, a $1 trillion reduction in government spending could easily translate into an equivalent or slightly higher reduction in GDP. As profit margins for businesses are squeezed from price deflation, more people will be laid off and that will further reduce demand and prices in a classical positive feedback. A deflationary spiral into depression is an extremely messy process, and when it stems from a financial crisis, fragile supply chains of goods/services will be disrupted since producers, distributors and purchasers will have limited or no access to letters of credit. This aspect of a debt deflation was clear during the first Great Depression, when farmers would throw perfectly good milk into ditches while other people were starving down the road.
The conservatives and libertarians also rave about the need for a complete extraction of government from economic and financial markets. While this extraction would certainly allow natural forces to take over and bring about a steady-state equilibrium sooner, it will be extremely ugly for some years. The method in which this is done is also important, because an immediate withdrawal of government supports from housing and financial markets would trigger major declines in economic growth and employment, as recent economic data should make evident. It would be more sensible to at least attempt a gradual withdrawal of support coupled with targeted aid to those most harmfully affected by the ensuing deflationary spiral. We should also remember that there’s a difference between funneling taxpayer money to banks via bailouts, quantitative easing, zero interest rate policy and various government backstops, and the government implementing fundamental structural reforms to the current setup of our financial institutions and credit markets. The latter must eventually be done to prevent the same exploitative systems we currently have from regaining their former levels of societal entrenchment.
Innovative Suggestions and Unanswered Questions
There are several other suggestions for “solving” our problematic encounter with peak complexity that attempt to restart sustained economic growth without introducing loads of new private/public debt or harsh austerity measures. For one, the government could abolish the Fed and literally print their own money (as Lincoln did with his greenbacks) and distribute it to households so they can pay down debts and spend/invest in the productive economy. This would allow banks to regain some value on their bad loans while also allowing consumers to get out of debt and regain some old spending/investing habits. We could also couple these monetary injections with structural reforms to the financial sector, limiting the ability of private banks to create unlimited credit and blow speculative bubbles. However, we can't analyze this situation in the vacuum of the American productive economy, since after all we are a part of a larger financial complex that stretches across the entire globe. I still find suggestions such as this one to be significantly more sensible than pure Neo-Keynesian or Libertarian policy prescriptions, so I will simply present a few questions that immediately come to mind (some of these are semi-rhetorical):
How will the domestic banks react as their debts are paid down with freshly printed money? Will they be concerned about inflation?
What about institutional investors currently holding cash and treasuries as their primary assets? Will this new stimulus spark a "risk on" mentality where assets/commodities are bid up and treasuries are dumped for cash to invest in risk plays? Can the Fed soak up all of these dumped treasuries and keep interest rates from rising and consuming a large part of government revenue (which would turn us into a much bigger Greece)?
What about our foreign creditors who will see others dumping treasuries while debts incurred to buy their cheap goods are being paid back with printed money? It is true that there will be much more debt overhang than money printed in the stimulus program, but hyperinflation is not so much an economic event as a sociopolitical one (internal or external loss of confidence in government institutions).
How much moral hazard will be created by such a significant bailout of debtors and creditors? Is current moral hazard already so high that marginal additions to it will be insignificant, or will it push us to a point where people, corporations and their politicians will refuse to ever abandon the current Ponzi system?
Another interesting policy idea is printed monetary stimulus and tax cuts for households combined with central bank monetization of treasury debt to offset lost tax revenues and keep interest rates stable. The federal income tax could be greatly reduced or even eliminated, and monetization could make up for the revenue shortfalls that result. This particular idea was actually mentioned by Ben Bernanke when speaking about Japan’s prolonged deflation and possible policy responses in a similar situation. Of course, with another idea designed to maintain the path of modern civilization comes more troubling questions (and all of the questions above still apply) :
As the dollar is devalued from printed stimulus and debt monetization, how will other major economies stuck in deflationary traps react to appreciating currencies and decreasing exports?
Follow up: Exactly how ugly can a trade war between major economies get?
How much stimulus will have to be applied before consumers and investors heal their scars, pull the cash out of mattresses and start spending/investing again?
Will the government pay back its expanded deficits with printed money, and if so what does this mean for the prospects of real or perceived inflation?
What will occur when “organic” growth has restarted and we attempt to unwind the drastic monetary policy interventions that have been undertaken? How do we restore our tax revenues in an acceptable way?
In light of these unanswered questions and others not asked yet, it appears that the more “innovative” suggestions offered to solve our predicament are still underestimating our complex, global society’s unpredictable reactions to various manipulations at the margin. Similar to the mainstream policies heavily criticized earlier, they certainly tend to ignore the tougher questions regarding what we will do to create a more sustainable society once we are successful in restarting economic growth for the time being. In all fairness, that issue is much broader in scope and more complicated to properly analyze, but it should always be lingering in the background. Taking into consideration all of the above criticisms of policies that attempt to maintain economic complexity, it is hard not to conclude that greatly reduced complexity is the only path to sustainability. There may not be anything “wrong” with our desire to maintain the complex systems we have evolved up to this point in time, except the fact that this desire may not be compatible with the laws of nature.
The Limits to Complexity
In 1972, several authors published a book entitled The Limits to Growth that explored the relationship between exponential population growth and finite resource supply/production. What they basically attempted to model was the extent to which a broad system (such as human civilization) could increase and maintain its complexity (best measured by population) in an environment with resource constraints that increase in an exponential or non-linear fashion. They viewed technological advances as a linear process that could not keep pace with the effects of population growth and resource depletion. In a subsection of the book, the authors made clear that their model was designed to illustrate what they termed “broad behavior modes” of human systems rather than make specific predictions regarding peak resources and population growth. They expanded on that concept using the following example:
If you throw a ball straight up into the air, you can predict with certainty what its general behavior will be. It will rise with decreasing velocity, then reverse direction and fall down with increasing velocity until it hits the ground. You know that it will not continue rising forever, nor begin to orbit the earth, nor loop three times before landing. It is this sort of elemental understanding of behavior modes that we are seeking with the present world model. If one wanted to predict exactly how high a thrown ball would rise or exactly where and when it would hit the ground, it would be necessary to make a detailed calculation based on precise information about the ball, the altitude, the wind, and the force of the initial throw. Similarly, if we wanted to predict the size of the earth's population in 1993 within a few percent, we would need a very much more complicated model than the one described here.”
With the above example, the authors are in essence describing a complex, dynamic system whose specific behaviors are unpredictable. The global economy certainly fits into this category, and of course it is entirely based on our current supply of energy/resources or the loosely estimated future supply we have borrowed against. This latter aspect of complexity represents the top of our global economic pyramid that is in the process of breaking down via “financial crises”, but more on that later. Our task here is not to determine exactly how the system will behave in the near future, but to take a bird’s eye view of general trends between multiple interacting variables. This perspective is something our current leaders, media pundits and mainstream academics fail to account for, and that’s why many of their “solutions” fall way short of achieving anything sustainable and are many times extremely destructive. We desperately need a fresh, new perspective on our current economic predicament before we can figure out the best ways to navigate through it.
Buzz Holling was instrumental in describing the adaptive cycles of complex ecological systems, and specifically he studied forest ecosystems. He identified 4 general stages of evolution in complex ecological systems (what he termed "fractal adaptive cycles"), and these could just as easily be applied to human systems that have been built on the foundation of those ecological systems (my descriptions will be greatly simplified – follow the referenced sources for more detail) :
1. Growth – The system finds an abundance of available resources and spaces which are exploited for material wealth, and this flow of energy/resources allows the development of many inter-dependencies, efficiencies and specialized functions. Diversity of agents within the system increases as does overall wealth.
2. Conservation – The system’s rapid growth decelerates as it becomes highly specialized and opportunities for novel exploitation strategies diminish. Increasing amounts of energy are directed towards conserving the existing system instead of growth, and “wealth” is extracted from the periphery to central parts of the system. The system’s complex inter-dependencies become more rigid and less resilient to disruptions that may propagate throughout the highly-connected networks of the system (Holling described the system at this stage as “an accident waiting to happen”).
3. Release – A relatively small triggering event exceeds the margins of error allowed in the system and pushes it into a chaotic liberation of energy and resources. The previous structures, relationships and complexities of the system are rapidly dismantled as central hubs deteriorate and networks are disconnected.
4. Reorganization – The fractured parts of the previous system re-structure themselves into more complicated relationships, but not necessarily in the way they were organized during the first growth phase. Typically, this phase leads to a restarting of the adaptive cycle in which many new opportunities for innovative development become available.
It is also important to note that complex ecosystems are typically composed of smaller systems and are also embedded in larger systems, creating a nested set of self-similar structures. Typically, the larger system can absorb much of the release from smaller systems contained within it, and act as a “memory bank” that allows rapid regeneration of the smaller system. If an individual American company goes bankrupt, its assets can typically be absorbed and immediately put back to use by other companies in that economic sector (assuming it does not have TBTF status). However, if the larger system is synchronized with the smaller system during the release and reorganization phases, then it could potentially lead to what Holling terms a “poverty trap”, in which low levels of wealth and connectivity are persistent.
It is pretty easy to see the progression of our global economy through the stages listed above. Since the industrial revolution, our fossil fuel inheritance has allowed local economies to become increasingly specialized, efficient and inter-connected with others to create even more efficiencies through trade and investment. On top of that, a smaller system of global finance has developed through equity and credit markets that traditionally facilitated productive investments in people, businesses and governments. Of course the last few decades have seen a rise in what can most accurately be called Ponzi finance, in which major creditors extract wealth from the global population by pushing non-productive debt on them and taking control of political institutions that could potentially stand in their way. To be fair to the debt pushers, we (in the developed world mostly) have gladly bought their drugs and have remained their loyal addicts to the bitter end.
The 2008 subprime housing crisis was the spark that ignited the release of our complex financial system, and unfortunately finance is such a large part of the global economy that there is not much of a larger economic system to absorb the fallout. It is also true that our oil-subsidized industrial economy is approaching its own stage of release that cannot be absorbed by an alternative energy economy, and as if things weren’t dire enough, it is arguably the case that our entire atmospheric system is synchronized as well due to the ongoing process of carbon emissions and climate change (the effects of which we are certainly experiencing now). The processes of growth and conservation in these systems of varied scales may have been temporally different, but it appears that the tipping points triggering release are converging within a few decades at most.
Instead of building resilience in the face of exponentially increasing complexity and decelerating growth, we have pushed forward full speed ahead and concentrated increasing amounts of resources/wealth in our corporate/governmental central hubs. We have become extremely vulnerable to any shocks that could potentially propagate throughout the system, as we recently witnessed when a few major banks held the entire global economy hostage. Now our debt-saturated governments are trying to save the current system by concentrating even more wealth in the center, but nature clearly has other plans. It is painfully clear that politicians, corporate executives, corporate media and all other central actors that have power to implement large-scale policies promoting resilience have chosen (intentionally or inadvertently – does it really matter?) their own material interests over that of the masses. We, as individuals and communities, must choose to implement our own policies of resilience, because we are ultimately a part of a much larger system than the economic, political or social systems that have been imposed on us.
Some people find economic theories and abstract mathematic principles extremely dry and unfamiliar. I’m pretty interested in economics and finance, but I still find it painfully boring to watch Ben Bernanke testify about monetary policy in front of Congressional representatives, who probably find it even more boring than I do (which may explain their weak excuses for questions). But most people familiar with the modern world, especially those of us in fully “developed” countries, have intimate experience with complexity on a daily basis. We are constantly bombarded with facts and data regarding events and trends progressing around the world. We attend colleges with dozens of specialized majors and tracks of study within those majors. People constantly tell us that the world has become “smaller” due to telecommunications technology, which is true in a sense, but they fail to mention the world has also become exponentially more complex.
It is especially easy for us to identify the advantages of increased growth and complexity. These advantages are mostly materialistic in the sense that we have more financial “wealth” and higher standards of living. The disadvantages are sometimes harder to grasp since they are more ephemeral in nature. We are more isolated from nature, disconnected from local communities and uncertain about the future. Some of our most basic concepts and values, such as fairness, equality, cooperation, compassion and ethical behavior, have been watered down to the point of being topics for dinner tables or the occasional academic journal, but nothing else.
There are certainly material disadvantages to a complex, highly-dependent society as well, since many people have lost the knowledge/ability to grow food, build things, fix things and generally be self-sufficient. However, there has been at least one extremely important advantage to complexity in the development of advanced communications technology, and especially the internet which has connected billions of people across the globe. Insightful thinkers can use the internet to communicate their ideas to people in a distant location such as me, and I can then use their ideas to write a short essay such as this one, and send it to several others. We can use the communications networks to take back some level of knowledge, cooperation and resilience that we may have lost.
There are five general areas of resilience that every individual and family should understand and take incremental steps towards. These include food security, water security, energy security, health security, and financial security. There are many tremendous writers out there that have written and spoken volumes on these issues and have generously shared their knowledge with anyone willing to read or listen.
The quicker we individually quit acting like deer caught in the headlights, and take actions towards resilience, the better off we will be as a collective species on a planetary system that has generously supported us, and continues to do so. The upcoming years will truly be a unique, eventful chapter in the history of human evolution. Perhaps in whatever records of history that may survive this rapid transformation, we will be known as the “peak generations” who sacrificed their extraordinary wealth, lifestyles, and comforts for a more simple form of social organization, where we re-organized to create a sustainable, just society. More likely, we will end up being the “peak generations” that fought desperately to defy reality and ended up in a heap of our own rubble. Either way, we should not focus on what society thinks about us now or how we will be remembered in the future. We should only be focused on doing what needs to be done, and then we should do it with no regrets.
For more of Pandurangi's writings, please join him at his site, Simple Planet
Defaults Account for Most of Pared Down Debt
by Mark Whitehouse - Wall Street Journal
0.08% — The annual rate at which U.S. consumers have pared down their debts since mid-2008, not counting defaults. U.S. consumers might not be quite as virtuous as they seem. The sharp decline in U.S. household debt over the past couple years has conjured up images of people across the country tightening their belts in order to pay down their mortgages and credit-card balances. A closer look, though, suggests a different picture: Some are defaulting, while the rest aren’t making much of a dent in their debts at all.
First, consider household debt. Over the two years ending June 2010, the total value of home-mortgage debt and consumer credit outstanding has fallen by about $610 billion, to $12.6 trillion, according to the Federal Reserve. That’s an annualized decline of about 2.3%, which is pretty impressive given the fact that such debts grew at an annualized rate in excess of 10% over the previous decade.
There are two ways, though, that the debts can decline: People can pay off existing loans, or they can renege on the loans, forcing the lender to charge them off. As it happens, the latter accounted for almost all the decline. Over the two years ending June 2010, banks and other lenders charged off a total of about $588 billion in mortgage and consumer loans, according to data from the Fed and the Federal Deposit Insurance Corp.
That means consumers managed to shave off only $22 billion in debt through the kind of belt-tightening we typically envision. In other words, in the absence of defaults, they would have achieved an annualized decline of only 0.08%.
To be sure, this analysis holds consumers to a harsh standard. Defaults happen even in normal times, and are typically offset by even stronger growth in new mortgage and consumer loans. By holding their debts steady, consumers are actually being a lot less profligate than usual.
That said, the way U.S. consumers are shedding their debts isn’t encouraging. Aside from defaults, many are finding relief by refinancing mortgages at extremely low interest rates — the same low interest rates that are making it difficult for an increasing number of older folks to generate enough fixed income for a comfortable retirement. The relief might help debt-ridden consumers get into a position to start spending again sooner than they otherwise would, but the borrower’s gain is the saver’s loss.
Americans' Net Worth Tanked In Second Quarter
by William Alden and Shahien Nasiripour - Huffington Post
Americans' net worth plunged in the second quarter of this year, new data from the Federal Reserve show, erasing the gains of the previous two quarters and adding evidence to the argument that the economy has entered a double-dip recession. The net worth of households and non-profit organizations dropped $1.52 trillion during the period from April 1 to June 30 of this year, according to the report released Friday. The new figure, $53.50 trillion, represents a 2.8 percent decline from the previous quarter.
The net quarterly loss, the data suggests, came from Americans' losses in the sagging stock market. Equity shares owned by households and non-profits tanked in the second quarter, dropping $1.88 trillion or 11.2 percent to $14.87 trillion from the previous quarter. The second quarter figure went down past the territory of 2009's third quarter ($15.32 trillion), almost to the range of the 2009 second quarter ($13.06 trillion), when equity was just starting to rise from its low of $10.94 trillion in the first quarter of that year. The Dow rose 4.1 percent in the first quarter of this year and fell 10.0 percent in the second quarter.
Total household wealth showed a 5.9 percent increase over the same period last year, which isn't saying much, since at that point the economy was only just beginning to improve. More significantly, Americans' net worth has approached levels not seen since the third quarter of 2009, when the total was $53.03 trillion, and when it was steadily increasing. The overall value of assets owned by households and non-profits dropped as well, sliding $1.56 trillion or 2.3 percent, to $67.41 trillion from $68.97 trillion in the first quarter of this year. Again, the figure entered territory not seen since the third quarter of last year.
The economy has been in the slow process of deleveraging. Overall household debt dropped in the second quarter by a seasonally adjusted annual rate of 2.3 percent, with both mortgage debt and consumer credit debt falling. For households and non-profits combined, the values of mortgage debt and credit debt in the second quarter (respectively $10.15 trillion and $2.40 trillion) fell from the first quarter figures of $10.20 trillion and $2.42 trillion, respectively.
Mortgage debt for households and nonprofits has been steadily falling since the most recent peak of $10.50 trillion in the first quarter of 2009. And banks charged off 2.9 percent of all loans in the second quarter, according to data compiled by the Federal Reserve Bank of St. Louis. The charge-off rate this year is higher than any other year since at least 1988. "Households are unable to pay off debt," Elizabeth Warren, President Barack Obama's newest top adviser on consumer and economic issues, said Friday during a conference call with reporters. "There's a substantial amount of debt written off."
In a tentative, and potentially outdated, cause for hope, the value of real estate assets owned by households in the quarter went up, a 0.3 percent increase over the previous quarter. Moreover, total tangible assets owned by households and non-profits increased in value 0.6 percent to $23.68 trillion. But the current housing situation, which has worsened since the end of June, suggests trouble.
"Looking ahead, the household net worth will move sideways as minor improvements on the financial side are likely to be offset by lower real estate asset values," Gregory Daco, an economist with IHS Global Insight, said in a release. "With employment recovering very gradually and housing prices remaining low, household wealth will make a very slow recovery."
Pension Gaps Loom Larger
by David Reilly - Wall Street Journal
Funds Stick to 'Unrealistic' Return Assumptions, Threatening Bigger Shortfalls
Many of America's largest pension funds are sticking to expectations of fat returns on their investments even after a decade of paltry gains, which could leave U.S. retirement plans facing an even deeper funding hole and taxpayers on the hook for huge additional contributions. The median expected investment return for more than 100 U.S. public pension plans surveyed by the National Association of State Retirement Administrators remains 8%, the same level as in 2001, the association says.
The country's 15 biggest public pension systems have an average expected return of 7.8%, and only a handful recently have changed or are reconsidering those return assumptions, according to a survey of those funds by The Wall Street Journal.
Corporate pension plans in many cases have been cutting expectations more quickly than public plans, but often they were starting from more-optimistic assumptions. Pension plans at companies in the Standard & Poor's 500 stock index have trimmed expected returns by one-half of a percentage point over the past five years, but their average return assumption is also 8%, according to the Analyst's Accounting Observer, a research firm.
The rosy expectations persist despite the fact that the Dow Jones Industrial Average is back near the 10000 level it first breached in 1999. The 10-year Treasury note is yielding less than 3%, and inflation is running at only about 1%, making it tougher for plans to hit their return targets. Return assumptions can affect the size of so-called funding gaps—the amounts by which future liabilities to retirees exceed current pension assets.
That's because government plans use the return rates to calculate how much money they need to meet their future obligations to retirees. When there are funding gaps, plans have to get more contributions from either employers or employees. The concern is that the reluctance to plan for smaller gains will understate the scale of the potential time bomb facing America's government and corporate pension plans. "It's unrealistic," John Bogle, founder of mutual fund giant Vanguard, says of the return assumptions in place at most pension plans.
Pension funds at companies in the S&P 500 faced a $260 billion shortfall at the end of 2009, according to Standard & Poor's. Estimates of the fund deficits faced by state and local governments range from $500 billion to $1 trillion. Some plans are beginning to trim their return forecasts. Earlier this month, New York State Comptroller Thomas DiNapoli said he would reduce the expected rate of investment return for his state's pension system, the third-largest in the nation, to 7.5%, from 8%.
The country's two biggest plans—the California Public Employees Retirement System, or Calpers, and the California State Teachers' Retirement System, or CalSTRS—both are undergoing reviews of projected investment returns that could lead to reductions later this year. Many plans have held onto an 8% return expectation though thick and thin. Such return assumptions partly reflect the heady years of the 1990s bull market. Public pension plans posted a median, annualized return of 9.3% over the past 25 years, but just 3.9% over the past 10, according to consulting firm Callan Associates.
The Oregon Public Employees Retirement System has had an 8% assumption since 1989. Its actual return averaged 10.7% annually from 1970 through 2009. The Teachers Retirement System of Texas has had a similar expectation since 1986, with an annual return of 9% return since then. A spokeswoman for the Texas system said it doesn't change assumptions "in response to short-term situations," and currently "sees no reason to change our investment-return assumption." A spokesman for the Oregon system said there are no special plans to review its return expectation.
The challenge for many plans, given investment horizons that can stretch out 50 years, is gauging which time period to look at when charting a future course. George Diehr, vice president of the Calpers board, said in May that the question is whether the credit crisis has "dramatically altered long-held assumptions about investing in the world's financial markets. Are investors in for a sustained period of meager or below-market growth? Or will the traditional business and economic cycles, the ones investors have grown accustomed to over the past couple of decades, return?" The outcome of Calpers's ongoing review "hangs on how we answer that question," a spokesman says.
Depressed stock prices aren't the only thing putting pressure on potential returns. Plummeting bond yields mean that plans' fixed-income portfolios will likely earn less in the future. A lower inflation outlook means that funds will have to generate greater real returns to meet their return targets. Funds use a so-called discount rate to estimate the size of future obligations to retirees, and thus the contributions needed to fund them. Corporate plans use a discount rate based on corporate bond yields. But government plans use their expected return rate on all investments as their discount rate.
The higher the discount rate, the smaller a fund's pension obligation. That gives public plans another big reason to hesitate before cutting their expected return rates. The Colorado Public Employees Retirement Association showed in its 2009 financial report the impact of reducing the rate. Using a 8% expected return rate, the plan faced a $23.4 billion deficit, based on market values, at the end of 2009. If the rate was cut to 6.5%, the shortfall would jump to $34 billion. Meredith Williams, the Colorado plan's chief executive, says cutting the rate "creates pain." Nevertheless, Colorado at year-end of 2009 cut its return assumption to 8%, from 8.5%. Mr. Williams says the rate may be lowered again later this year.
Others have been more hesitant. In 2009, Matt Smith, state actuary for Washington state, recommended that its retirement system cut its return expectation to 7.5%, from 8%. That advice was rejected by the state's pension-funding council. Mr. Smith says he thinks Washington and other states eventually will lower expected returns, but that it will be a slow process because reduced assumptions "will increase the cost of pension benefits, and right now the budgetary environment is a big obstacle to that."
Pension plans say they take a decades-long view of potential returns. "We can't knee-jerk our way through this. Funding a retirement system is a long-term proposition," says David Stella, secretary of Wisconsin's department of employee trust funds. Last year Wisconsin's plan reviewed its expected return rate of 7.8% and remains comfortable with it, he says.
Companies have found out the hard way that their options are limited. From 2005 to 2009, S&P 500 companies with pension plans expected to generate about $475 billion in returns. The actual returns were only about $239 billion, a 50% undershoot, according to Jack Ciesielski of the Analyst's Accounting Observer.
In recent years, some funds have tried to boost returns by shifting funds out of stock and into alternative investments such as hedge funds or private equity. Some find this approach too risky. This summer, the Virginia Retirement System cut its expected investment rate to 7%, from 7.5%, giving it the lowest assumption among the nation's 15 largest pension systems. The shift began in 2005, when the plan's board cut the rate to 7.5%, from 8%.
"There was a general thinking that equity markets were unlikely to repeat the period of the 1990s," explains director Robert Schultze. The alternative was to take more risk, he says, but the board didn't want to "stretch or be swinging for the fences" to meet higher investment expectations. Other plans, he predicts, will follow suit. "I just think people are going to be coming off that 8% view," he says.
Just Your Average 300-Year Bear Market?
by Robert Jay - Elliott Wave International
Long-Term Trend Forecasting is Actually Easier than Short-Term
Most people who analyze the present give too little thought to the past, even when previous decades or centuries offer acutely relevant information.This is particularly true in the financial world, where short attention spans are chronic. A Sept. 9 article in The Economist magazine put it this way:"The financial world seems to be obsessed with the short term. Fund managers are usually judged on their performance over a three-month period. The television news highlights daily moves in stock markets. Lots of hedge funds think in terms of milliseconds."But would you be surprised to learn that long-term stock market trends are generally easier to forecast than short-term ones? EWI's Robert Prechter says just that, and explains why on pp. 403-404 of his landmark book, The Wave Principle of Human Social Behavior:"...contrary to all current views on the subject, it is the long-term social trends, the ones that chaos scientists say are impossible to predict, that are in fact easier to predict... The reason that long-term trends are easier to forecast is that there are much more data to apply in one’s analysis of form (such as breadth, volume, sentiment and behavioral statistics...) as well as a higher component of accuracy in...aggregate stock prices."In fact, they are highly predictable in both general and probabilistic terms and somewhat predictable in specific terms. What is more, these facts pertain regardless of the time scale, as clarity of pattern is the prime determinant of predictability."
Let's take a look at long-term stock market prices:
Not even Major League Baseball can rival the stock market's wealth of statistical data. And after studying the relevant data and analyzing the long-term pattern, Prechter offered this conclusion in the May issue of The Elliott Wave Theorist: "The current bear market will be the biggest in nearly 300 years."Yes, Britain's "South Sea Bubble" in the early 1720s was the last time a bear market was comparable to what we may see unfolding now -- it's represented by that vertical drop which you see on the above chart.
Don’t Worry About China, Japan Will Finance U.S. Debt
by Alex Frangos - Wall Street Journal
China has been diversifying its $2.5 trillion reserves away from the dollar, causing some to worry that less Chinese buying of Treasurys would cause U.S. interest rates to rise and make it more difficult for the government to borrow. But Japan’s dollar buying in currency markets Wednesday shows Chinese reserve diversification might actually lead to even more demand for Treasurys.
Here’s how. As China diversifies out of U.S. dollar-denominated assets such as Treasurys, it is buying debt denominated in the currencies of some of its biggest trading partners. Not wanting to lose competitiveness themselves, those trading partners in turn buy dollars to keep their currencies cheap. As part of the diversification push, China has been a major buyer of yen, snapping up $27 billion in yen so far this year according to Japanese Ministry of Finance. Analysts say China’s buying has helped an already strong yen get stronger.
Now, Japan, feeling under pressure to weaken its currency, turned around and bought dollars, most likely in the form of Treasurys. It isn’t clear exactly how much dollar buying Japan will have to do to protect the yen from getting stronger, but it’s likely to more than offset China’s diversification into the yen. If the past is a guide, Japan spent $320 billion in its last intervention from 2003 to 2004. And this time the currency markets are 73% far larger, with $568 billion dollar-yen trading a day, according to the Bank for International Settlements.
Japan is not alone in this phenomenon. China has also bought South Korea’s currency, the won. And South Korea routinely intervenes in currency markets, buying dollars to keep its currency from rising too quickly, again offsetting China’s move out of the dollar.
US Foreclosures Hit Record High in August
by William Alden - Huffington Post
August saw more Americans lose their homes to foreclosure than any other month on record, RealtyTrac reported today. Banks repossessed a total of 95,364 properties in August, a 25 percent increase from the same period in 2009 and a 2 percent increase over this May's previous record. Foreclosure filings of all types, including default notices, scheduled auctions and bank repossessions (the three major stages of the foreclosure process), increased to 338,836 in the month, a 4 percent jump from July.
At the same time, though, the number of default notices that lenders issued to homeowners to initiate the foreclosure process actually went down. The August total of 96,469 was a 1 percent decline from July and a 30 percent drop from August of last year. It's significantly lower than the April 2009 peak of 142,064 default notices issued. That the numbers of repossessed homes and default notices (respectively the last and first stages of the process) are converging demonstrates that banks are trying to mitigate the flow of new homes to the market. As Bloomberg reported Wednesday, the glut of housing inventory means home prices could decline for at least three years.
Indeed, the number of properties with delinquent loans (30 or more days past due) that aren't yet in foreclosure is currently 4,947,000, or 9.22 percent of all mortgage-financed homes, according to data from Lender Processing Services. The total number of foreclosed properties on the market, LPS says, is 2,038,000. It's a bleak picture, but glimmers of hope emerge. The majority of Americans (at least, the majority of a 3,399-person sample) think the market has bottomed out, according to a survey released today by Fannie Mae. 47 percent of those surveyed said prices will remain flat for the next year and 31 percent predicted prices will rise.
Even in such trying times, the majority of a 2,967-person sample of Americans say it's "unacceptable" for homeowners to willingly walk away from a mortgage, according to a new survey from Pew Research Center. A whopping 59 percent of respondents condemn homeowners who choose to stop payments on "underwater" mortgages.
According to the RealtyTrac data, Nevada and Florida led the nation in rates of foreclosure filings (including default notices, scheduled auctions, and repossessions) in August, despite year-over-year decreases in activity in both those states. One in every 84 Nevada homes received some form of foreclosure filing, compared to one in every 155 homes in Florida. Arizona, California and Idaho were right behind Nevada and Florida in the foreclosure rankings.
Inflation? What Inflation?
CPI data was very weak this morning showing an inability for corporations to pass along higher prices and a general malaise at the consumer level. With the exception of energy prices (which has been highly volatile) the overall index was little changed and remains very low by just about any metric (via Econoday):“Consumer price inflation remained somewhat on the warm side, thanks to higher energy costs. However, core inflation eased further to nonexistent.
The overall CPI in August posted a 0.3 percent rise, equaling the boost in 2July. The latest gain topped the median forecast for a 0.3 percent advance. Excluding food and energy, CPI inflation slowed to no change, coming in below analysts’ expectations for a 0.1 percent rise. Playing a key role in softening the core rate was an unchanged shelter index.”
This is an index I altered from the CPI to try to include housing inputs with a marginally higher weighting on commodity inputs. It tells a much more dramatic story in the inflation data:
This chart includes the average cost of a house since 1990. The BLS excludes housing because its an investment and a rare purchase, however, I find that hard to justify. When you spend 5X your annual income on something it impacts your decision making for a long time. Obviously the purchases are rolling and occur at different times, but it’s by far the single most important input in ones every day spending decisions. Can I make my mortgage payment is the ultimate thought in every consumer’s head.
The other spending decisions all revolve around this one input. The actual CPI data is very good in my opinion and done in great detail and well justified. It comes very close to accounting for the average household’s expenses despite what the critics say. This, however, is a sizable flaw. We were suffering high inflation in the mid-2000's and yet the BLS told us everything was benign. Arguably the largest economic misstep in the history of the USA.
The Downside of Families Doubling-Up
by Phil Izzo - Wall Street Journal
More people are living with family in an effort to deal with the recession, but while the phenomenon is keeping the poverty rate lower, it has wider negative economic consequences.
In a presentation as part of its wider report on income, poverty and health insure, the Census Bureau noted a big jump in the number of individuals and families doubling up. The number of multifamily households jumped 11.6% from 2008 to 2010 compared to an increase of just 0.6% in the number of households. "If the poverty status of related subfamilies were determined by only their own income, their poverty rate would be 44.2%," David Johnson chief of the Housing and Household Economic Statistics Division at the U.S. Census Bureau said. "When their poverty status is determined based on the resources of all related household members, it is about 17%."
This slowing of household formation has been noted elsewhere. Calculated Risk highlights a quote from Time Warner Cable CFO Robert Marcus, who said the company’s "subscriber environment [is] very, very weak," thanks to high unemployment, high … vacancies and "really anemic new home formation." Fewer households means fewer consumers for businesses desperate for demand. At the same time, it continues to drag on a housing market that needs to burn off excess supply.
Meanwhile, the share of people age 25-34 living with their parents jumped to 13.4% in 2010 from 12.7% in 2008. Families sticking together has likely held down the poverty rate, noted Johnson. The poverty rate for adults age 25-34 living with their parents was 8.5%, but in that case they are considered part of a household. If their status was determined solely by their own income, 43% were below the poverty threshold for a single person. The struggles of young adults can have a broad economic impact. Parents supporting adult children have less money to spend on themselves, not to mention less income to save for retirement.
To be sure, there is a silver lining if the broader economy can improve. Necessity is likely the primary driver of the increase in multifamily households. Many of these families and children living at home may want to make the jump out on their own as soon as their economic standing improves. That could represent a strong shadow demand for housing, as well as a potential jump in household formation with a resultant boost in consumption.
Six US Bank Failures Put Total for Year at 125
by Dan Fitzpatrick - Wall Street Journal
Regulators seized six banks in the Southeast, Midwest and Northeast on Friday, marking 125 failures for 2010. There were three in Georgia with a combined $864.2 million in assets, $801.7 million in deposits and 18 branches. Community & Southern Bank of Carrollton, Ga., assumed deposits at the three banks, agreeing to pay the Federal Deposit Insurance Corp. a 1% premium for the deposits of Bank of Ellijay and First Commerce Community Bank and a 1.25% premium for the deposits of Peoples Bank.
Community & Southern Bank also agreed to purchase virtually all assets of the failed Georgia banks and share losses with the FDIC on about $602 million of those assets. The Georgia failures mark 14 for that state in 2010 and 45 since 2007. No state has more U.S. failures since the start of the crisis, said Alexandria,, Va.-based banking consultant Bert Ely. Other than Georgia, the largest number of bank failures since 2007 are 39 in Florida, 37 in Illinois and 32 in California. The six failures on Friday followed three weeks during which only one bank was shut, spurring speculation that regulators had slowed down. Now "they are picking the pace back up a little bit," Mr. Ely said.
Regulators are still on pace to shut more banks this year than 2009, when 140 failed. All told, 293 banks have been seized since 2007, according to the FDIC. That total is still well short of the tally in the savings and loan crisis of 1987-1992 when over 1,000 failed. The other banks that failed on Friday were in New Jersey, Ohio and Wisconsin. Phoenixville, Pa.-based New Century Bank assumed all deposits and agreed to purchase essentially all assets of the one-branch ISN Bank in Cherry Hill, N.J. New Century agreed to share losses on $64.8 million in ISN Bank assets.
In Ohio, Cincinnati-based Foundation Bank assumed all deposits and agreed to purchase all assets from the failed, one-branch Bramble Savings Bank of Milford, Ohio. In Wisconsin, regulators seized West Allis, Wis.-based Maritime Savings Bank, and Brookfield, Wis.-based North Shore Bank agreed to assume all of Maritime's deposits and purchase $177.6 million in assets. The estimated loss to the FDIC's insurance fund for the six failures Friday is $347.6 million.
Calpers in Talks With Schwarzenegger on $2 Billion Budget Loan
by Michael B. Marois - Bloomberg
The California Public Employees’ Retirement System said it is in talks with Governor Arnold Schwarzenegger’s administration on a proposal to borrow $2 billion from the fund to help the state balance its budget. Anne Stausboll, the fund’s chief executive officer, said her staff has been holding informal discussions with Schwarzenegger’s department of finance on a proposal that office has floated to credit the state with $2 billion this year as an advance on the roughly $74 billion the governor estimates the state would save during the next 30 years from his proposals to roll back pension benefits for government workers.
California has been without a spending plan since the July 1 start of its fiscal year as Schwarzenegger and Democrats who lead the Legislature remain deadlocked over how to fill a $19 billion deficit. The Republican governor has vowed not to sign any final budget unless it’s accompanied by legislation to permanently cut the state’s cost to finance workers’ retirement benefits.
"We are in informal discussions about this," Stausboll told the fund’s governing board today. "We received sufficient detail that we’ve been able to do some analysis. We have serious concerns about actuarial soundness, vested rights issues and IRS issues that could impact the tax-qualified status of this fund." The state must pay $3.9 billion this fiscal year to the pension fund, known as Calpers, to finance retiree costs, up from $145 million a decade earlier.
In 1999, lawmakers and then- Governor Gray Davis approved benefit increases that Schwarzenegger says the state can’t afford, and he wants them rolled back for new hires. He has supported proposals to require employees to work longer to qualify for pensions and to pay more toward benefits. Calpers, the largest public pension fund in the U.S., has $208 billion of assets under management.
FHFA: Banks Should Share Fannie, Freddie Bailout Costs
by Alan Zibel - Huffington Post.com
The nation's largest banks have an obligation to pay some of the cost for bailing out mortgage buyers Fannie Mae and Freddie Mac because they sold them bad mortgages, a government regulator said Wednesday. Edward DeMarco, the acting director for the Federal Housing Finance Agency, said the banks this summer have refused to take back $11 billion in bad loans sold to the two government-controlled companies, in written testimony submitted for a House subcommittee hearing Wednesday. A third of those requests have been outstanding for at least three months.
DeMarco said the banks have a legal obligation to buy back the loans and called the delays "a significant concern." He said the government may take new steps to force those buybacks if "discussions do not yield reasonable outcomes soon." In an interview with reporters after the hearing, DeMarco declined to give further details on what the government might do next. He said only that "we're looking for contractual obligations to be fulfilled."
Fannie and Freddie buy mortgages and package them into securities with a guarantee against default. The two mortgage giants nearly collapsed two years ago when the housing market went bust. The government stepped in to rescue them and it has cost taxpayers about $148 billion so far. The rescue is on track to be the most expensive piece of stabilizing the financial system.
Fannie and Freddie have a legal right to return bad loans, especially if they later discover fraudulent statements on applications. Any money they recover offsets their losses. The amount in question is a small fraction of the total government rescue, said Ed Mills, financial policy analyst at FBR Capital Markets. Still, lenders say Fannie and Freddie are trying to return too many loans. And in some cases, they are pushing back loans where it's not clear fraud was committed, the lenders say.
Mortgage industry consultant Brian Chappelle said the requests often apply to loans that met the mortgage buyers' guidelines at the time. "The industry believes that the pendulum has swung far beyond what is reasonable," he said. As a result, he said, lenders are being extremely cautious about making new loans.
Wall Street has worried that the costs of bailing out Fannie and Freddie could get pushed back on big banks. Fitch Ratings said in a report last month that the four largest U.S. banks could book losses of up to $42 billion if Fannie Mae and Freddie Mac force them to take back troubled mortgages they made. It also estimated that JPMorgan Chase & Co., Citigroup Inc., Bank of America Corp. and Wells Fargo & Co. could record $17 billion in losses if they repurchase a quarter of the mortgage giants' seriously delinquent loans.
The leading Democrat on the panel, a House Financial Services subcommittee, indicated the banks bear some responsibility. "We must begin to think about approaches for recouping taxpayers' money in the long run," said Rep. Paul Kanjorski. "We found a way to pay for the savings and loan crisis, and we can survey find a way to recover the costs associated with this crisis."
A bigger headache for lawmakers is figuring out what to do with Fannie and Freddie in the future. The Obama administration is working on a plan to restructure the mortgage market and make sure home loans are affordable. Officials don't plan to release details until next year. But Michael Barr, an assistant Treasury secretary, told the panel Wednesday that Fannie and Freddie "will not exist in the same form as they did in the past."
Sorting out the future of housing finance has been a divisive issue on Capitol Hill. And it could grow even more contentious if Republicans take control of one or both houses of Congress. Republicans have seized on the administration's management of Fannie and Freddie to illustrate Democrats' push for broadening the reach of the federal government. They say loans acquired by Fannie and Freddie since the September 2008 takeover have put taxpayers at risk.
"It's time for the government to get out of that business," said Rep. Spencer Bachus, the top Republican on the House Financial Services Committee. But Democrats and regulators say the loans acquired by Fannie and Freddie before their takeover represent the overwhelming majority of the companies' losses. New loans acquired since then have been performing well, they note.
"There is no urgency," to reform the two companies, said Rep. Barney Frank, the committee's chairman. "The pattern of abuse they had engaged in has been changed...Fannie and Freddie are behaving differently and are causing far less problems."
The financial fallout was an 'Inside Job'
by Kai Ryssdal - Marketplace
Kai Ryssdal: I know I said yesterday that I'm not a big fan of anniversary stories, but this is kind of a big week. Two years ago today, Lehman Brothers went broke, kicking off a stretch of a crazy couple of months that we're still trying to recover from.
Documentary filmmaker Charles Ferguson has a new movie out -- "Inside Job, it's called -- that tries to explain what happened that fall and to figure out who's to blame.
So that's where we started when we talked, with me asking whether it's possible to blame individuals for the whole financial crisis, or whether the problems on Wall Street were more systemic?
Charles Ferguson:What has happened is that a very substantial fraction of the financial services industry has come to be outside the law, and as it has become increasingly powerful, it has attracted increasingly amoral people. Its behavior has become more and more dangerous to the financial system and to the American economy.
RYSSDAL: There was also a sort of trend of not talking about any of this stuff. There's a great moment in the film when one of the few regulators you've got on camera was Christine Lagarde, the French finance minister. And you started asking her about Lehman Brothers, and when she found out that it was going under.
FERGUSON: When were you first told Lehman in fact was going to go bankrupt?
CHRISTINE LAGARDE: After the fact.
FERGUSON: After the fact? Wow, OK. And what was your reaction when you learned of it?
LAGARDE: Holy cow.
RYSSDAL: Clearly, we're connected financially, but not so much along the lines of communication, huh?
FERGUSON: I was truly, truly dumbstruck when I learned the extent of the ignorance and disconnect in this, of the American regulatory system during the crisis. Paulson, Bernanke, were astonishingly ignorant of the consequences of their decision. They did not understand foreign bankruptcy laws, they did not understand that all transactions in London would be halted and then that would cause catastrophic financial results cascading throughout the financial system almost immediately.
RYSSDAL: I want to play something from the film. It's Allan Sloan, he's a senior editor at Fortune magazine. He's a well-respected financial writer. He tells a little story.ALLAN SLOAN: A friend of mine who's involved in a company that has big financial presence said, "Well, it's about time you learned about sub-prime mortgages." So he set up a session with his trading desk and me. And the techie who did all this gets very excited, runs to his computer, pulls up in about three seconds this Goldman Sachs issue of securities. It was a complete disaster. Borrowers had borrowed on average 99.3 percent of the price of the house, which means that they had no money in the house.
RYSSDAL: So for all the blame that Allan puts on Goldman Sachs -- and certainly they deserve it -- what about Americans looking in the mirror and saying, you know what, a little bit of this is our fault too.
FERGUSON: Well, certainly that's true to some extent. There was a bubble, and it was a big bubble and many people bought houses that they couldn't afford and were careless with regard to the loan documentation that they signed. But over half of people who received sub-prime mortgages actually would have qualified for a less expensive prime mortgage. They were steered into more expensive sub-prime mortgages by mortgage brokers who were paid extra money the more expensive the loan they made was. So it was something that was cultivated, and in many regards, forced upon the American people by the financial services industry.
RYSSDAL: How come nobody went to jail?
FERGUSON: Well, there's a simple obvious answer and then there's a deeper, more complicated answer, which I don't fully understand. The simple obvious answer is that this has become an out-of-control industry; a very, very powerful industry.
RYSSDAL: What's the more subtle reason that you haven't quite figured out?
FERGUSON: For some reason that I truly don't understand, this situation has not generated the level of popular outrage that similar or comparable things have generated at other times in American history. There have been other times in American history -- some recent, some long ago -- when our leaders, our business leaders, and/or our political leaders, have done something terribly wrong and more than once, the American people have risen up and said, "We simply will not permit this." And that hasn't happened here, yet. I think that part of the reason that it hasn't happened might be that people think that finance is too complicated for them to understand, and that the situation is too complicated for them to understand. And indeed one reason that I made the film is to make it clear that actually they can understand it.
Elizabeth Warren Didn't Want Permanent Appointment To CFPB: Barney Frank
by Ryan Grim - Huffington Post
Elizabeth Warren made it clear to the White House while it was debating her nomination to the Consumer Financial Protection Bureau that she was not interested in a five-year term to run the agency. Barney Frank, a Warren ally, delivered that message to the White House, he told HuffPost in an interview Thursday. "She always said she didn't want to be there as a permanent director. Some of the liberals are worried about it. It's almost an insult to Elizabeth. She wouldn't take this if there was the slightest impediment to her doing the job," he said.
An administration official said that Warren will be officially named on Friday as an "assistant to the president," the same title that Chief of Staff Rahm Emanuel and other top officials hold, as well as a special adviser to the Treasury, overseeing the establishment of the CFPB. There were extensive and nuanced discussions with the White House, said a source familiar with them, and the interim nomination emerged as her favored choice, as Frank says, but she has still not foreclosed the option of a full nomination or told the administration that she would flatly refuse one.
"Frankly, on her behalf, I talked to David Axelrod earlier this year, and I said, 'You know, Elizabeth doesn't want a full five year term. She'd like to set this up,'" said Frank. "She told me that, and I told Axelrod that." The administration, however, still has the option to nominate Warren to a permanent position. Frank said that he was "delighted" by the administration's choice. "I want to give credit to Tim Geithner for working this out. There's absolutely no chance that she will be anything less than fully independent. She wouldn't have taken the job," he said.
The administration's announcement has been greeted with some skepticism in progressive circles, as Frank acknowledged. Bob Kuttner, a co-editor of The American Prospect, was one such skeptic, but as the outlines of her new position become clear, he has embraced it. "This strategy is a win-win, on several grounds. It gives Warren full authority to set up the agency, without having to run the gantlet of confirmation hearings and a likely Republican filibuster," he wrote in a HuffPost blog post Thursday.
"This way, Warren will be able to get the agency quickly up and running in a manner that serves both consumers and progressive politics. Early directives to bring greater simplicity and transparency to credit documents will be extremely popular. Politically, the carping by the banking industry and its Republican allies will remind the public which side the GOP is on."
Frank said that she'll have more than enough time to set up the agency and get it moving in the right direction before she heads back to the Harvard faculty or elsewhere in politics. "There's no question that she'll be in there long enough," he said. "She's got two-plus years to do it. That's more than enough time," he added, referring to the rest of Obama's first term, which, of course, could be the first of two.
Warren allies, however, are still pushing for a permanent nomination. "While this is good news for American families, it is my hope that President Obama will nominate Warren to a permanent position to head up the CFPB," said Sen. Jeff Merkley (D-Oregon), shortly after the news broke on Wednesday afternoon. "She is more than deserving of the job and the Senate should have the opportunity to confirm one of the nation's strongest consumer advocates."
Irish government perilously close to calling in IMF
by Fionnan Sheahan and Emmet Oliver - Irish Independent
Taoiseach Brian Cowen last night insisted he would fight on -- but his economic woes deepened as a major new report warned the country was perilously close to calling in outside help from the EU or the IMF. After a disastrous three days, Mr Cowen offered little comfort to disgruntled Fianna Fail backbenchers as he failed to outline what changes he would make to his leadership, communications and lifestyle as a result of his 'Morning Ireland' interview debacle.
But the persistent grumbling over his leadership was overshadowed last night by two new economic blows. The cost of borrowing for the country moved higher again on international bond markets, after falling back following last week's government decision to split Anglo Irish Bank. And a report from Barclays, one of Europe's largest banks, said Ireland may yet need financial help from the IMF or the EU if conditions got any worse.
But a spokesman for Finance Minister Brian Lenihan said last night: "The Government's strategy for dealing with the economic and financial challenges has been commended by the EU Commission, the European Central Bank and many other international experts. "This strategy is at an advanced stage and is being implemented in an extremely open and transparent manner." Barclays said: "In the coming months the Government may need to seek outside help."
While Ireland has raised most of the money it needs for this year, the cost of Anglo and the scale of the deficit meant any further financial shocks could push the country over the edge, the bank warned. It said that there was little room for "further unexpected financial sector losses" and that Ireland was running out of economic room. The highly influential bank also advised Ireland to do a "deal" with Anglo bondholders. This could entail asking them to reduce the amount that they are owed in return for a partial stake in the bank.
Barclays said Ireland might apply for assistance from the IMF at some point in future if bank losses grow much bigger. It said going to the IMF before that could "cause alarm" on the markets. Ireland is expected to post a deficit of 25pc of GDP this year, when bank losses are added -- the largest in Europe.
Meanwhile, Ireland's borrowing costs continued to edge over 6pc last night as concern lingered over the financial position of the country. A plan from last week to split Anglo into two banks has failed to allay the concerns of traders. Two ratings agencies have raised questions over how much support the State is likely to give Anglo Irish Bank if it goes into a wind-down arrangement.
Greece is the only eurozone country facing interest rates as high as Ireland. Portugal, while also under pressure, is still able to borrow more cheaply than Ireland. The current high borrowing costs may drop if the Government can estimate the final likely cost of Anglo. The level of uncertainty about Irish bank losses continues to be a major negative for Irish bonds.
Mr Cowen said the rising cost of borrowing was a reaction to the demand in the bond market. "In relation to the bond spreads, they spread for all countries, as I understand it today," he said. Mr Cowen was in Brussels at an EU summit with the Foreign Affairs Minister Micheal Martin. The pair put on a united front in the wake of the key role that the minister played in forcing Mr Cowen to apologise for his disastrous interview.
The silence from the Fianna Fail backbenchers was an ominous sign for Mr Cowen as the saga continued to play badly among the public. But Mr Cowen said firmly that he believed he had the support of the Fianna Fail TDs and senators to continue in the job. "Yes, we don't expect a general election any day soon.
"We're in the process of working with a Government... on policies that are necessary for the recovery of the country. And our mandate is there until 2012," the Taoiseach said. The Labour Party blamed Mr Cowen's infamous radio interview for the latest hike in Ireland's cost of borrowing.
The Eurozone’s Autumn Hangover
by Nouriel Roubini
After a summer of Europeans forgetting their woes and tanning themselves at the beach, the time for a reality check has come. For the fundamental problems of the eurozone remain unresolved.
First, a trillion-dollar bailout package in May prevented an immediate default by Greece and a break-up of the eurozone. But now sovereign spreads in the peripheral eurozone countries have returned to the levels seen at the peak of the crisis in May.
Second, a fudged set of financial "stress tests" sought to persuade markets that European banks’ needed only €3.5 billion in fresh capital. But now Anglo-Irish alone may have a capital hole as high as €70 billion, raising serious concerns about the true health of other Irish, Spanish, Greek, and German banks.
Finally, a temporary acceleration of growth in the eurozone in the second quarter boosted financial markets and the euro, but it is now clear that the improvement was transitory. All of the eurozone’s peripheral countries’ GDP is still either contracting (Spain, Ireland, and Greece) or barely growing (Italy and Portugal).
Even Germany’s temporary success is riddled with caveats. During the 2008-2009 financial crisis, GDP fell much more in Germany – because of its dependence on collapsing global trade – than in the United States. A transitory rebound from such a hard fall is not surprising, and German output remains below pre-crisis levels.
Moreover, all the factors that will lead to a slowdown of growth in most advanced economies in the second half of 2010 and 2011 are at work in Germany and the rest of the eurozone. Fiscal stimulus is turning into fiscal austerity and a drag on growth. The inventory adjustment that drove most of the GDP growth for a few quarters is complete, and tax policies that stole demand from the future ("cash for clunkers" all over Europe, etc.) have expired.
The slowdown of global growth – and actual double-dip recession risks in the US and Japan – will invariably impede export growth, even in Germany. Indeed, the latest data from Germany – declining exports, falling factory orders, anemic industrial-production growth, and a slide in investors’ confidence – suggest that the slowdown has started.
In the periphery, the trillion-dollar bailout package and the non-stressful "stress tests" kicked the can down the road, but the fundamental problems remain: large budget deficits and stocks of public debt that will be hard to reduce sufficiently, given weak governments and public backlash against fiscal austerity and structural reforms; large current-account deficits and private-sector foreign liabilities that will be hard to rollover and service; loss of competitiveness (driven by a decade-long loss of market share in labor-intensive exports to emerging markets, rising unit labor costs, and the strength of the euro until 2008); low potential and actual growth; and massive risks to banks and financial institutions (with the exception of Italy).
This is why Greece is insolvent and a coercive restructuring of its public debt is inevitable. It is why Spain and Ireland are in serious trouble, and why even Italy – which is on relatively sounder fiscal footing, but has had flat per capita income for a decade and little structural reform – cannot be complacent.
As fiscal austerity means more recessionary and deflationary pressures in the short run, one would need more monetary stimulus to compensate and more domestic demand growth – via delayed fiscal austerity – in Germany. But the two biggest policy players in the eurozone – the European Central Bank and the German government – want no part of that agenda, hoping that a quarter of good GDP data makes a trend.
The rest of the eurozone is in barely better shape than the periphery: the bond vigilantes may not have woken up in France, but economic performance there has been anemic at best – driven mostly by a mini housing boom. Unemployment is above 9%, the budget deficit is 8% of GDP (larger than Italy), and public debt is rising sharply.
Nicolas Sarkozy came to power with lots of talk of structural reforms; he is now weakened even within his own party and lost regional elections to the left (the only case in Europe of a shift to the left in recent elections). Given that he will face a serious challenge from the Socialist Party candidate – most likely the formidable Dominique Strauss-Kahn – in the 2012 presidential election, Sarkozy is likely to postpone serious fiscal austerity and launch only cosmetic structural reforms.
Belgian Prime Minister Yves Leterme, as current holder of the rotating EU presidency, now speaks of greater European policy unity and coordination. But Leterme seems unable to keep his own country together, let alone unite Europe. Even Angela Merkel – in growing Germany – has been weakened within her own coalition.
Other eurozone leaders face stiff political opposition: Silvio Berlusconi in Italy, whom one hopes may soon be booted out of power; José Luis Rodríguez Zapatero in Spain; George Papandreou in Greece. And politics is becoming nationalistic and nativist in many parts of Europe, reflected in an anti-immigrant backlash; raids against the Roma; Islamophobia; and the rise of extreme right-wing parties.
So a eurozone that needs fiscal austerity, structural reforms, and appropriate macroeconomic and financial policies is weakened politically at both the EU and national levels. That is why my best-case scenario is that the eurozone somehow muddles through in the next few years; at worst (and with a probability of more than one-third), the eurozone will break up, owing to a combination of sovereign debt restructurings and exits by some weaker economies.
Brazil currency seesaws on central bank threat
by Samantha Pearson - Reuters
Brazil's real lingered around its previous session's closing level on Friday as investors tried to second guess the next move by the country's authorities to weaken the currency. The Brazilian real has rallied 5 percent since the end of June and over 100 percent since 2003, making exports twice as expensive and endangering the country's long-term growth. In early trading on Friday, the real BRBY was bid 0.06 percent stronger at 1.713 reais after opening lower.
A report showing U.S. consumer sentiment fell to its lowest in more than a year also left investors cautious worldwide. Meanwhile, Mexican and Chilean markets were closed for public holidays. Brazil's state oil giant Petrobras said on Friday it would increase the amount of shares available to meet additional investor demand in its massive stock offering. The fund-raising plan, which ranks as the world's largest on record, has been a major reason for the currency's recent appreciation.
But the real is now the world's most overvalued major currency, according to Goldman Sachs, and the central bank has stepped up its intervention efforts as a result. Since last Wednesday the bank has been calling two auctions daily, rather than just one, and increasing the amount of dollars it buys each time. Last Thursday alone, the bank purchased more than it did during the whole of February.
Stepping Up The Offensive
Traders now believe the next step would be to call three auctions on one day and then proceed to so-called "reverse swap" auctions, a form of derivative which would have the same effect as buying dollars in the futures market. If the real weakens much more, the central bank could "shift its policy somewhat, perhaps calling three (auctions) or even more," said Mario Battistel, the head of currency trading at Fair Corretora brokerage in Sao Paulo. The central bank said the last time it had called three auctions in one day to buy dollars on the spot market was on Jan. 15, 2004.
"If it doesn't manage to control the real by buying directly on the spot market, the bank will go into the futures market and do reverse swaps," Battistel said. Brazil's main newspaper, O Estado de S. Paulo, reported early on Friday that a government source said the bank could call a series of surprise daily auctions. A government source told Reuters on Thursday the central bank could enter "the market at both ends," implying intervention in the futures market.
Battistel said it was no coincidence that the government was surreptitiously sending these signals to the market just before Petrobras increased its already massive share offering. "There is a direct link. Until this Petrobras capitalization is over the market is going to see much bigger inflows than normal," he said. However foreign investment in Brazil is likely to remain high even after the Petrobras deal, due to strong domestic growth and interest in the country's higher-yielding debt, analysts said.
Your grandmother (but without the milk and cookies)
by Kurt Cobb - Resource Insights
Nicole Foss looks like she might be your grandmother coming to reassure you about something. But instead of milk and cookies you are served a cold dose of reality. According to Foss, one of the writers on the popular finance-oriented blog The Automatic Earth, the global economy is locked into an inexorable deflationary decline that cannot be stopped by governments or central banks. And, the world is headed for a depression worse than that of the 1930s.
Believe it or not, that's the good news. The bad news is that the problems we face in the emerging depression will be aggravated by fossil fuel depletion, in particular, the onset of world peak oil production. When one questioner asked Foss when she thought we might return to even the tepid economic activity we see today, she had a one-word answer: "Never."
Her explanation is that the interaction between the ongoing collapse of contemporary finance and the development of new oil and gas fields will leave us desperately short of these critical fuels over time. The weakness in the economy will lead to low investment in exploration for new oil and gas reservoirs which will, in turn, lead ultimately to a supply collapse. The supply collapse will lead to high prices which will depress economic activity and lead to recurrent economic contractions. When the new Great Depression is done, Foss claims that the world will be a completely different place with our current institutions swept into the dustbin of history.
Foss is remarkably good at delivering her message. She delivered it in person recently in a high school auditorium near where I live. Steady and clear, she methodically lays out her case for the scenario above with such logical precision and compelling analogies that you wonder just how one would go about making even the slightest dent in it. Of course, no one knows the future. Some people make lucky guesses--sometimes called "informed" predictions. But in the end it's never clear how to tell ahead of time whom to believe during the next round of predictions.
Nicole Foss does, however, seem remarkably informed. She is at ease talking about the necessity of acquiring your own tools and growing own your food. In the next breathe she's just as much at ease explaining with stunning clarity and brevity why the current chairman of the U. S. Federal Reserve Board is an even bigger fool that you thought he was. But she does this without any sign of personal animus. Ben Bernanke isn't a bad person. He's just confused and misinformed.
And, that leads us directly to Foss's mission: To inform people so that they will have the understanding and tools to weather the coming storm and to build a community that can survive and thrive through it. She also demystifies the world of finance with unusual pithiness. The most recent financial bubble was not the result of some impenetrable, new-fangled financial instruments. Rather its roots were the same as all financial bubbles: the rediscovery of leverage. Translation: If you borrow money from someone else and speculate with it, you can make a lot more money than if you just use your own. It's a tactic that works until it doesn't. And, when it stops working, the economy goes crash.
The post-Depression generation had learned that too much borrowing leads to tears, and so they were very careful not to take on too much debt. Eventually, the people who experienced these tears died, and others took their place in the economy. The success of those who took on debt for speculative purposes attracted more people who took on debt to do the same in every field of investment. Eventually, too many people borrowed too much, and many of them were unable even to meet their interest payments. That is where we are today. According to Foss, it will be years until that excess debt is either paid or defaulted on. And, that means deflation for several years to come at least.
Is she right? No one can know until we travel some years hence. But so far, I'm having a hard time cracking her logic.