Ilargi: There has been a huge amount of interest in Stoneleigh's North American and European speaking of "A Century of Challenges".
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Ilargi: First, apologies to Rick Davis at Consumer Metrics Institute for stealing his line for today's title. What can I say? The mental image is just too good not to use.
And since I want to do another post on CMI and related data anyway today, it seemed kind of fitting. And if you think that The Automatic Earth posts on CMI data threaten to become a recurring feature, you just might be on to something. I still don’t think enough people realize just how powerful these data are when it comes to catching a glimpse beyond the veil of our future.
Last week, there was a temporary lull in the downfall of the CMI Growth Indices. Since, however, they have resumed plunging, and with an apparent vengeance. The least volatile (since comprised of more data) 365-day index has been in record low territory since September 10 2010 (record low meaning below the lows of the 2008 recession). The 91-day index slipped to a record low over the weekend: the 2008 low was -6.02, today's index has slipped to -6.11 and counting.
By comparison, the Q4 2008 official GDP number was even lower at close to -7%. The Bureau of Economic Analysis just corrected the Q2 2010 number last week to +1.7%. The CMI 91-day index was at around -2 for that period. Therein of course you also see the main problem with BEA government data: it’s October, and we just got a revision of April GDP.
The only CMI index that hasn't reached a record low vs 2008 is the 183-day one: it's at -4.27 vs a record of -4.61 on November 22, 2008. At the rate the CMI indices have been falling over the past week, that record could be broken within a week, maybe two.
In August, I started out with this (now updated) graph, which combines CMI's 91-day index, the S&P 500, BEA GDP, and the great work of Doug Short at dshort.com. The "twist" that I added to their work is the lining up of the peaks and troughs. This is not some haphazard notion: CMI provides leading indicators, as substantiated by the fact that, as we saw above, BEA GDP numbers are not available until many months after they actually occur; I have allowed for about one quarter. Likewise, the stock markets follow developments in GDP by another quarter. For those who do not believe or understand this, I suggest you simply look at the graphs and the data.
Here’s that first -updated for today- graph. (NOTE: Since I chose the BEA GDP data as the "anchor", the CMI 91-day reaches well into 2011; it’s what being a leading indicator means)
The second one adds the 183-day and 365-day data from CMI. The more data, the less volatility: the peaks and troughs have been dulled.
It’s a bit harder to conceive of the proper "time-shift" to apply to these indexes versus the other data: I’ve given them some shift, but not too much. This causes peaks and troughs to be somewhat out of whack, admittedly, but the fact that all three are updated on a daily basis by CMI makes me reluctant to shift them too much. Perhaps Rick Davis and I can strike up a conversation to see how CMI would interpret this.
A more "severe" (about one extra quarter) peak and trough lining up of the three CMI indexes would look something like this:
That said, I'm not overly worried about this, since the way I see it, the real value of CMI only gets greatly enhanced by combining and averaging their three indices. That is to say, I see the 91-day index as a sometimes possibly premature warning sign, and the 365-day index as one that may be getting too dulled to be entirely reliable when it comes to the "now", because its reliance on including 1 year old data risks hiding from view sudden but very real more recent data.
The reason I wanted to get back to the CMI data today is that I found a very interesting graph in the Wall Street Journal yesterday. It's in an opinion piece called The Trade and Tax Doomsday Clocks by Donald Luskin, chief investment officer at Trend Macrolytics LLC. Mr. Luskin holds an emotional plea for continuation of the Bush tax cuts, something I have a lot of questions about, but won't get into today.
Next time I'll address the problems with the "we can’t get back to normal if we don't do [insert preference]" theme. We're still having the wrong conversation, let's leave it at that for now.
But Mr. Luskin's graph is a gem. It compares the 1936-38 Dow Jones to the one we have today. The similarities look eery. And I know that many of you will say: why would history repeat itself, how can you know it will? And others would go a step further, like Mr. Luskin himself:
Thankfully, we're not repeating all the mistakes of 1937.
Ilargi: Followed by his hobby horse warning:
But Congress and the Obama administration are flirting dangerously with one of them by failing to extend the expiring low tax rates for all Americans.
Ilargi: However, when I sent Luskin's graph to CMI's Rick Davis yesterday, his response was:
References to 1937 are more than a little scary. That was the first time that Keynesians first uttered their battle cry: "The problem with the stimulus is that we haven't spent enough yet ..."
Ilargi: Mind you, I'm not sure Mr. Luskin would appreciate being labeled a Keynesian. Nor that Rick labels him as such, for that matter.
No, it's that graph:
NOTE: I corrected the lower X-axis timeline, which was incorrect, and added the future dates for clarity.
Now, if you can see my attraction to the CMI indexes, it should be obvious why this graph takes my fancy. It’s like: no, no-one has a crystal ball, but at the same time, if you spend all the money you have, today, without an income for the next month, I SO can have an idea where you’ll be 3 weeks from now. No certainty, you may win the lottery or get engaged to Paris Hilton or Donald Trump in that timeframe, but I can certainly have an idea. Like a 95-99% one.
And that's why I play around with these data and these graphs: to get myself and my readers as close to a preview of what’s to come as I can. Many, if not most, will discard it all offhand, certainly in the face of what today looks like relatively healthy stock markets. Well, they looked just great in August 1937, too, didn't they?. That is, until they didn't.
The data from the S&P and the DOW are so similar, for obvious reasons, that I’ll use two graphs to show you what's brewing. First, just GDP and S&P, still with the timeshift I applied. (Note: I’m running out of colors for the various graphs, and have to adapt them at times. Check my little color menu bottom left when confused)
And then with the data from the Luskin graph superimposed. As you can see, the over-(under?) lapping S&P blue line is hardly visible anymore. Not a surprise. Dow and S&P are two sides of a coin.
And last, the same but with the CMI 91-day index and the darker green bars that indicate my prediction for Q3 and Q4 GDP, derived from the average of the three CMI indexes.
Do we have conclusive evidence? No. Just like you, we won't know what tomorrow looks like till it's here: there may be a nuclear war, a meteor crater or a flu epidemic. But, that said, we're way beyond tea leaves and crystal balls by now.
And so the question presents itself: looking at these graphs, how confident do you feel about an economic recovery? How likely are you to go and buy stocks tomorrow morning, other than to trade them the same day?
And most of all, what do you think American consumers, who make up for over 70% of GDP, are most likely to do over the course of the next few months?? How about underwear for Christmas?
Here's one last graph, this one from CMI itself. It compares the 2008 recession and the 2010 "whatever it’s called don't call it a recession". And it doesn't take any prisoners, now, does it? Just look at the timelines. Their interpretation:
[..] looking ahead, should the 2010 event recover from its bottom exactly like the 2008 event did, it would still experience nearly another 490 percentage-days of contraction before ending -- resulting in a grand total of 1180 percentage-days of contraction for the 2010 event, fully 49% more severe than the "Great Recession of 2008."
Looking at the chart above, the striking difference between 2008 and 2010 is the implied longevity of the current event. Projecting forward, we will probably see another 30 days of political "Fear, Uncertainty and Doubt" ("FUD") pushing the blue line laterally to the right. And when the blue line eventually starts back up, we face the real possibility that the plateau visible in the left half of the chart's blue line is the new consumer "norm," reflecting the realities of a deleveraging U.S. consumer. If that is true, the economy's "800 pound gorilla" will have gone on a serious diet.
Told you I stole that one.
And talking about "would you buy stocks in the face of this data", for a preview of next time: we're fast on our way back to what "we" were 60-70 years ago, when there were 90%+ less "investors" relative to the total population than there are today. Talk about a dying breed. Banks are not the only zombies in our economies. We're all zombies. All our wealth has evaporated, and we're just not clueing in. Pension fund? Gimme a break. Value of your home? Get real. Indispensable at your job? Let's not go there. Look at the graphs for a while, and see you next time.
The Trade and Tax Doomsday Clocks
by Donald L. Luskin - Wall Street Journal
The nearby chart is an update of one I showed on this page in early July. It depicts how the stock market over the last year and a half has followed a path eerily similar to that of 1937. This week corresponds on the chart to mid-August 1937, when the cumulative effects of massive hikes in personal and corporate tax rates, severe monetary tightening, and aggressive business-bashing by the Roosevelt administration tipped the economy into the "depression inside the Depression." From there, stocks were in for the longest and second-deepest bear market in history.
Thankfully, we're not repeating all the mistakes of 1937. But Congress and the Obama administration are flirting dangerously with one of them by failing to extend the expiring low tax rates for all Americans. What's worse, we're close to repeating the mother of all policy errors, the one made not in 1937 but in 1930—the one that started the Great Depression. We're on track to resurrect the 1930 Smoot-Hawley Tariff Act.
Let's start with taxes. If today's low rates expire at year-end per current law, that would at a stroke reduce after-tax income for every working American, the average reduction being 3.3% according to the Tax Policy Center. Do the math: 94% of income goes to consumption, and consumption is 70% of gross domestic product. All else being equal, if the Bush tax cuts don't get extended, that's a 2.3% hit to 2011 GDP. That means instant double-dip recession, starting at midnight, Dec. 31.
Why won't the Democrats who control both houses of Congress switch off this doomsday clock? It's because Democratic leaders and the Obama administration want to roll the dice for the sake of ideology, by giving tax relief only to the middle class while letting rates rise for higher earners. A growing number of Democratic dissidents have joined with Republicans in insisting that, in this weak economy, it's more prudent that relief be given to all Americans.
Some have even undergone a supply-side conversion. Forty-seven Democrats have sent a letter to House Speaker Nancy Pelosi citing the urgency of preserving low tax rates on dividends and capital gains for the sake of more job-creating capital formation. Democratic leaders blocked Congress from taking up the matter before the October recess, fearing a humiliating defeat. Last Wednesday a resolution permitting the House to adjourn without dealing with the doomsday clock passed by a single vote, over unanimous Republican opposition and nays from 39 Democrats.
When a bill comes before the House in the lame-duck session later this year, the games will really begin. House rules allow Mrs. Pelosi, as speaker, to offer legislation under what's known as "suspension of the rules," which limits time for debate but requires a two-thirds majority to pass, rather than a simple majority. If Mrs. Pelosi offers a bill under suspension that excludes the highest earners, there's little chance she'll get enough GOP votes for the supermajority she needs. That way she can blame Republicans for the defeat of an already doomed bill many Democrats oppose, shaming the GOP for "voting against middle-class tax cuts."
Meanwhile, as we await New Year's Day when today's low tax rates expire, American taxpayers, already beset by crippling uncertainty, have no choice but to keep listening as the ticking of the doomsday clock gets louder and louder.
Now to protectionism. Last week the House passed the Currency Reform for Fair Trade Act. It's an amendment that gives dangerous new protectionist powers to the notorious Smoot-Hawley Tariff Act, the proximate cause of the global Great Depression, which after all these years is still on the books. Democrats—all but five of whom voted in favor of the bill last week—would do well to remember that in 1932 Franklin Delano Roosevelt ran as a free-trader, pledging to lower Smoot-Hawley's tariff walls. The 99 Republicans who voted aye should know that Herbert Hoover's name lives in infamy for erecting them. Instead, Wednesday's vote was a bipartisan move to build those walls higher using currencies as the bricks and mortar.
The bill, if passed by the Senate and signed by the president, would mandate that the Department of Commerce take a foreign country's currency interventions into account in determining whether its trading practices are unfair. In the case of China—the target at which this bill is aimed—Commerce would determine that the amount by which the yuan is allegedly undervalued. The number being thrown around now by supporters of the bill, such as the AFL-CIO and the United Auto Workers, is as much as 40%.
The cost basis of Chinese-made goods exported to the U.S. would then be adjusted upward by that amount to determine whether they are being sold below cost, an unfair trade practice known as "dumping." Not a single Chinese export good could survive such a test—virtually the entire volume of China's exports to the U.S. suddenly would become subject to countervailing duties.
Surely China would retaliate. That makes the bill a nuclear threat of mutual assured economic destruction. If carried out, it would crush trade between China and the United States, which are huge export markets for each other. Suppose China blinks and revalues the yuan to avert the nuclear threat. Even if this creates some American jobs, which is doubtful, it would do so by making all Chinese goods more expensive in the U.S.—an immediate inflationary tax on American consumers.
At the same time, it would make goods priced in dollars cheaper for China to import, supposedly a boon to U.S. exports. But an unintended consequence is that it will make China an even more voracious competitor for oil. That's because oil is priced in dollars, so a revaluation would make it cheaper in yuan terms. Remember, during the period from 2005 to 2008 when the yuan was revalued under similar political pressures from the U.S., the price of oil rose, not coincidentally, to $147 per barrel from $60. That could happen again—and it would be another inflationary tax on U.S. consumers.
Both issues—extending today's low tax rates, and protectionism against China—are animated by the coming election. Once that has passed, presumably cooler heads on both sides of the aisle will prevail, and these twin threats to our fragile economic recovery will fade away. But sometimes such things can take on lives of their own. And sometimes in the heat of politics cooler heads do not prevail. If that happens now with issues as critical as these, then the economy and the stock market will be doomed to repeat the tragedies of the 1930s.
Economic Measures Continue to Slow
by John Hussman - Hussman Funds
The latest evidence from a variety of economic measures continues to suggest deterioration in U.S. economic activity. Probably the best way to characterize the latest round of data from the ISM and other surveys is that the data is coming in a bit less negative than we've anticipated, but continues to deteriorate in a manner that is consistent with stagnant economic activity.
To obtain a broad indication of economic performance, we averaged eight different measures reported by the ISM and the Federal Reserve. These included the ISM National, Chicago, Cincinnati and Milwaukee surveys, as well as the Federal Reserve's Empire Manufacturing, Philadelphia, Richmond and Dallas surveys. The chart below shows the average standardized value of the overall indices, as well as the new orders and backlogs components (a standardized value subtracts the mean and divides by the standard deviation of a given series, so all of the variables are essentially Z scores).
Closer inspection shows that all of these measures dropped below zero last month. That said, these measures are not as negative as what we observe from the ECRI Weekly Leading Index, for example, so at this point we can only conclude the likelihood of tepid economic growth, not outright contraction.
Still, with the S&P 500 at a Shiller P/E over 21, and our own measures indicating an estimated 10-year total return for the S&P 500 in the low 5% area, it is clear that investors have priced in a much more robust recovery than we are likely to observe. Our long-term total return estimates are consistent with what we observed based on Shiller P/E's here - since 1940, Shiller P/E values above 21 have been associated with annual total returns for the S&P 500 averaging 5.3% over the following 7 years and 4.9% annually over the following decade.
The activity indices presented above are closely correlated with GDP growth. On that note, second quarter GDP growth was revised last week to 1.7% annualized, which was up slightly from the first revision of 1.6% growth, but down from the initial estimate of 2.4%. Based on what we observe in other data, third quarter GDP is likely to reflect continued tepid growth, though the overall activity indices did not decline enough to suggest that the economy contracted in the third quarter.
As a side note on valuation, a number of observers have suggested that the low level of dividend payouts as a fraction of operating earnings is indicative of strong prospects for reinvestment, which is then extrapolated into assumptions for high rates of future earnings growth. Unfortunately, this argument is problematic on two counts.
First, forward operating earnings are not realized cash flows. As I've noted frequently over the years, forward operating earnings represent analyst estimates of the next year's earnings excluding a whole range of chargeoffs and "extraordinary expenses" as if they do not exist. While operating earnings provide a smoother measure of business performance, they don't provide a good measure of the cash flows that are actually deliverable to shareholders.
Losses that are booked as "extraordinary" are still losses, and represent the results of bad investments and a consumption of amounts that were previously reported as earnings. Similarly, the portion of earnings used for share buybacks is often expended simply to offset dilution from grants of stock to employees and corporate insiders, and again do to reflect cash that is deliverable to shareholders. In recent years, based on the widening gap between reported operating earnings on one hand, and the sum of dividends and increments to book value on the other, a great deal of what is reported as earnings ends up evaporating as extraordinary losses and share compensation.
The second problem with the low level of dividend payouts, relative to forward operating earnings, is that there is no historical evidence whatsoever that low payouts are accompanied by higher growth in future operating earnings. To the contrary, when dividends are low relative to forward operating earnings, it is a signal that operating earnings are temporarily elevated - typically because of transitory profit margins. As a result, subsequent growth in forward earnings is actually slower than normal over the following decade.
Dividend policy is set in a very forward-looking manner. Since dividend cuts generally result in very negative events for corporations, dividend payments are set to a level that management believes it can sustain. Relative to current forward operating earnings, indicated dividend payments are near the lowest level on record. If anything, investors should take this as a signal that managements do not expect present levels of earnings to be sustained at a level that is sufficient to justify higher payouts.
In contrast, high dividend payouts (as a ratio of forward operating earnings) typically reflect temporarily depressed operating earnings, and short-term margin compression. Accordingly, elevated payouts tend to be followed by above average growth in operating earnings over the following decade. The tendency for dividend payouts to lead operating earnings growth is depicted below (see Long Term Evidence on the Fed Model and Forward Operating P/E Ratios for details on forward operating earnings prior to 1979). Suffice it to say that the low level of payouts today most likely reflects elevated and unsustainable operating margins.
On the latitude for a constructive investment stance
Based on the data that we've observed in recent months, my view remains that a fresh downturn in the economy remains a not only a possibility but a likelihood. Little of the economic improvement we've observed since 2009 appears intrinsic, but instead appears driven by enormous government interventions that are now trailing off. Still, while I believe that there is a second shoe that has not dropped, I recognize that the full force of government policy is to obscure, stimulate, intervene and borrow in every effort to kick that can down the road.
I believe that the unaddressed and unresolved problems relating to debt service, employment conditions and housing are too large for this to be successful, but as we move through the remainder of this year - as I've said throughout 2010 - we are gradually assigning greater probability to the "post-1940" dataset. Accordingly, there are developments that could potentially move us to a more constructive position. We don't observe those at present, but an improvement in economic evidence and a clearing of overbought conditions, leaving market internals intact, would be one configuration that might warrant less defensiveness.
How constructive is "constructive"? Without an improvement in valuation levels, a constructive investment exposure for us here would likely be limited to a removal of perhaps 20% of our hedges, because the improvement in expected return and reduction in expected risk will not be dramatic unless valuations retreat sharply. That said, we occasionally observe conditions that warrant placing about 1-2% of assets into call options, which would allow a subsequent market advance to soften our hedges without actually removing the put option side of our defenses.
A better configuration would include a significant retreat in valuations and a massive, if uncomfortable, amount of debt restructuring. Those two events would be the best way to put the recent (and probably ongoing) debt crisis behind us, and could easily allow us to completely lift our hedges for an extended period of time in anticipation of an unobstructed recovery.
To some extent, I view current market conditions as something of a "Ponzi game" in that valuations appear neither sustainable nor likely to produce acceptably high long-term returns, and speculators increasingly rely on finding a greater fool. As the mathematician John Allen Paulos has observed, "people generally worry only about what happens one or two steps ahead and anticipate being able to get out before a collapse... In countless situations people prepare exclusively for near-term outcomes and don't look very far ahead. They myopically discount the future at an absurdly steep rate."
Undoubtedly, we have periodically missed returns due to our aversion to risks that rely on the ability to find a "greater fool" in order to get out safely. But it is important to recognize that speculative risks are not a source of durable long-term returns. At a Shiller P/E of 21 and a historical peak-to-peak S&P 500 earnings growth rate of 6%, a simple reversion to the historical (non-bubble) Shiller norm of 14 would require seven years of earnings growth and yet zero growth in prices. Stocks are not cheap here.
Meanwhile, the U.S. financial system appears to be a nicely painted dam, behind which a massive pool of delinquent debt is obscured. A significant correction in valuations and resolution of the growing backlog of delinquent debt may finally restore strong "investment merit" to the U.S. stock market, but only after a greater amount of pain and adjustment than most investors seem to anticipate.
In general, we want to take risk in proportion to the improvement we observe in the return that we expect per unit of that risk, primarily based on long-term historical evidence about what has occurred in similar conditions. For now, we remain defensive.
Enough With the Low Interest Rates!
by Charles R. Schwab - Wall Street Journal
Fed policy punishes savers without making credit more readily available.
The Federal Reserve's experiment with near-zero interest rates, which began following the credit crisis of 2008, has now become counterproductive.
As a temporary fix it served its purpose. It was an emergency antibiotic appropriate for the illness. But continuing with the experiment is disfiguring the economy and fueling doubt. Healthy economies find their own equilibrium based on market forces of supply and demand. When people don't think market forces are driving the economy and believe instead that it is being driven by excessive government intervention, they don't take the risks an economy requires.
It's time to stop the experiment and return to monetary normalcy. The negative impact of current policy is clear. The near-zero interest rate experiment is weighing on consumer and investor confidence, and the Fed signals its lack of confidence with each "extended period" proclamation. It is providing banks with low-interest financing that can be used to create modest returns through a carry-trade in U.S. Treasurys but is adding nothing to the velocity of money, which is what actually generates economic growth.
The Fed's super-loose policy has driven down the security and spending power of savers, particularly those in retirement who played by the rules during their working years and now depend on the earnings from their savings for a decent quality of life. As a result, savers and investors are being forced to take more risk with their money as they hunt for higher yields. The extreme monetary policy is also having no positive impact on the availability of consumer or business credit, job growth or consumer and business spending.
Consumer spending accounts for two-thirds of the U.S. economy. Despite record low rates, consumer borrowing continues to retrench. As of August, we'd seen our fourth straight month of contraction to $9.1 billion. Revolving credit-card debt shrank to $7.4 billion, continuing a 20-month stretch of declines.
Small businesses that create jobs are unable to borrow in any meaningful amounts except via 100% collateralized loans. Banks continue to hold large capital bases, mostly because they have no definitive signal yet from the federal government or regulators about what their capital requirements will be. So they take the most conservative path available—they sit on their money. Today there is more than $7.5 trillion of deposits in FDIC-insured commercial banks and savings institutions, earning—and doing—essentially nothing.
It is time to let the inherent power of economic forces engage. The Fed can help by removing the "extended period of time" language at its next meeting. Elimination of this language would remove some of the glue that has lenders stuck. The Fed should then move quickly to help rates float and find a more natural level. Lenders would be less afraid of getting slammed by a sudden shift in government monetary policy, knowing instead that their pricing of credit is based on market conditions, which have historical precedent and some measure of long-term predictability.
What bank today wants to offer and then hold 30-year fixed loans at these artificial and temporary rates? Right now most of that lending ends up with Fannie Mae and Freddie Mac—a government-subsidized pool of loans bearing no relation to a natural market for credit. Savers, who today see no end in sight to the Fed's zero-interest policy, would be more careful to avoid the temptation of chasing riskier longer-term yields, knowing that rates could move up at any time.
Our economy is ready to heal. It just lacks broad-based confidence among consumers and business people. It would be a giant boost to confidence if the Fed stood aside and returned to its traditional role as defender of monetary stability.
Mr. Schwab is founder and chairman of The Charles Schwab Corporation.
It's Time For The Fed To Stop Screwing Savers And Bailing Out Banks And Borrowers With 0% Rates
by Henry Blodget - Business Insider
Charles Schwab has written an eloquent plea in the Wall Street Journal calling for the end of the Fed's zero-interest rate policy.
We second that plea.
The Fed's zero-interest-rate policy, now going into its fourth year, is hosing people who are responsible and live within their means to bail out people and companies who don't (or didn't). Anyone who has saved money is being screwed by this policy. Anyone who borrows money is being rewarded.
The Fed's zero-interest-rate policy is also still giving a gigantic subsidy to banks by allowing them to borrow money from the government for nothing and then lend it back to the government at a ~3% interest rate. The spread on this trade continues to produce massive Wall Street profits, and, with them, enormous bonuses--without any of the risk that is normally supposed to accompany such profitability. Once again, this policy rewards those who helped cause the crisis in the first place, at the expense of those who didn't. (If you don't understand how great it is to be a banker right now, read "How To Make The World's Easiest $1 Billion").
Why does the Fed have a "zero-interest rate" policy? To stimulate borrowing. If money is free, the theory goes, people and companies will borrow a boatload of it--and they'll use it to buy stuff, make investments, and create jobs.
In a garden-variety cyclical recession, this policy works.
But this time it's not working.
Because this isn't a garden-variety recession. This is a recession caused by too much debt. (A balance-sheet recession, as the economists say).
You can't borrow your way out of a debt problem. You have to get out of it by doing what American consumers are now doing despite the Fed's attempts to stimulate more borrowing: by spending less, saving more, and paying down (or restructuring) your debts.
American consumers are cutting back because they, if not the government, have realized that they have too much debt--and they're taking steps to reduce it. They're starting to save again--5%+ of disposable income and climbing--instead of spending every penny they earned.
With consumers tightening their belts and the country awash in excess capacity, companies aren't borrowing money to make new investments. They're simply borrowing money to replace older, higher-priced debt--and, in the process, earning more profits for their shareholders (as a result of the artificially low interest rates). This is another gift from taxpayers to borrowers, and it comes at the expense of companies and people with money in the bank.
How much is the Fed's zero-interest rate policy costing savers? As Charles Schwab notes, there is more than $7.5 trillion sitting in FDIC-insured savings accounts alone (this doesn't include the trillions more money-market accounts and other short-term savings vehicles). At a normal 3% rate of interest, this money would be earning savers $225 billion a year.
Under the current zero-interest-rate policy, meanwhile, it's earning them nothing.
Not once since the start of this recession has the Fed acknowledged the real problem with the economy--that we borrowed way too much money and bought stuff we couldn't afford. It's time for the Fed to acknowledge that. It's also time for the Fed to reward behavior that will eventually get us out of the malaise: Debt reduction, savings, and a return to financial discipline. Lastly, it's time for the Fed to stop rewarding banks to doing nothing more than borrowing money for free from the government and lending it back to the government--and instead force them to earn their money the old-fashioned way, by making smart private-sector loans.
How can the Fed do this?
By simply raising short-term interest rates to a normal level, say 2%-3%. Not suddenly, not overnight--over the period of, say, a year. And not to a restrictive level. Just back to normal. Just back to where rates would be if the Fed weren't doing everything in its power to get the country to borrow its way out of a debt problem.
How To Make The World's Easiest $1 Billion
by Henry Blodget - Business Insider
NOTE Ilargi: The following was originally published December 10, 2009
With all the banks paying back the TARP money, some folks are assuming that the great Wall Street bailout is finally coming to an end.
But of course it isn't!
Taxpayers are still guaranteeing all big bank bonds (Too Big To Fail) and subsidizing huge bank earnings and bonuses with absurdly low interest rates.
But instead of bellyaching about it, you might as well just smile and cash in. After all, that's what Wall Street's doing.
So here's how to make the world's easiest $1 billion:
STEP 1: Form a bank.
STEP 2: Round up a bunch of unemployed friends to be "bankers."
STEP 3: Raise $1 billion of equity. (This is the only tricky step. And it's not that tricky. See below.*)
STEP 4: Borrow $9 billion from the Fed at an annual cost of 0.25%.
STEP 5: Buy $10 billion of 30-year Treasuries paying 4.45%
STEP 6: Sit back and watch the cash flow in.
At this spread, you should be earning at least 4% per year on your $10 billion of capital, or $400 million. Sure, there's some risk that the Fed will grow a backbone and raise short rates, but there's not much risk. (They have an economy to fix and banks to secretly recapitalize). And in any event, if the Fed raises short rates, making your $1 billion will just take a bit longer. (And if they REALLY raise rates, causing you to actually lose money, it will be someone else's problem.)
You'll have made $400 million in a single year! So pay yourself a fat salary for all your hard work. And pay your "bankers" fat salaries for all their hard work (But don't worry--your bankers won't actually have to do anything. You'll just need one of them to borrow the money from the Fed and buy the Treasuries, which he will be able to do part-time.) At the end of the year, celebrate. It's bonus time!
Don't be greedy. Pay yourself and your bankers the industry-standard compensation ratio of 50% of revenue. Your revenue was $400 million, so that creates a $200 million bonus pool. Pay each of your unemployed friends bankers, say, $1 million. And give yourself the rest for being such a smart entrepreneur and creating all the jobs and value.
Now, you've already made at least $150 million, so it doesn't really matter what happens next. But you're in this for the world's easiest $1 billion, right?
So proceed to Step 7.
STEP 7: Go public. After bonuses, your bank will be earning about $200 million a year, your capital ratio will be super-strong (10% equity-to-debt!), and your balance sheet will be clean as a whistle (all risk-free Treasuries!). So you ought to be able to persuade investors to pay you at least 20-times earnings, or a valuation of $4 billion. Sell 25% of the company for $1 billion.
STEP 8: Use your $1 billion of new equity to borrow another $9 billion at 0.25% from the Fed. Buy another $9 billion of Treasuries. Collect another $400 million a year. Pay yourself and your team bonuses that are twice as large as last year's. You deserve it! And you're now about $500 million to the good.
STEP 9: Wait for your stock to double or triple, which won't take long given your amazing growth trajectory and clean balance sheet. When your market cap hits $10 billion, sell another 10% of the company for $1 billion. Now you're really ready to grow.
STEP 10: If you want to get fancy and get nice profiles written about you in business magazines, start buying branch networks from defunct banks (the FDIC will pay you to take them) and start making actual loans. Also, start hiring trading desks to gamble on things more exotic than Treasuries. Yes, all this sounds risky, but just remember--the risk isn't yours, and you're already $500 million to the good.
STEP 11: Sell $500 million of your stock to a "strategic investor" and let the rest ride. Don't worry, if your traders and loan officers turn out to be idiots or the Fed suddenly raises rates, the taxpayers will handle it. And you've already made your $1 billion.
So, congratulations, you're now a billionaire! Now all there is left to do is celebrate!
* If you've been paying attention, you will note that the only potentially tricky step in this process is the "raise $1 billion of equity." Where, exactly, are you going to get $1 billion of equity? Well, you will have to do some selling there.
Basically, you'll have to tell a few investors about your awesome new business plan (see above) that will earn them returns of at least 20% on their equity from Day 1. A 20% return on equity is a lot, especially when the return is largely risk free. So you should have no problem raising that $1 billion of equity.
Given the government's desperate desire to get banks to start lending again, you might also want to try to hit up the government for some funds. The pitch will be simple: Old banks aren't lending because they're hiding embedded losses and need to protect their balance sheets. You don't have that problem. You'll use the equity to LEND. (And you will use it to lend! You don't have to say that you're going to lend it to the US government. None of the other banks are saying that.)
The Broken Global Banking System
by Ann Pettifor
Let's be honest: the banking system is now fully dysfunctional. It has failed in its primary purpose: to act as a machine for lending into the real economy. Instead the banking system has been turned on its head, and become a borrowing machine.
HuffPost readers, I know, are smart and on the button when it comes to bankers and their wicked ways. But how many Americans understand how broken and defective the banking system as a whole has become? For the crazy facts are these: bankers now borrow from their customers and from taxpayers. They are effectively draining funds from household bank accounts, small businesses, corporations, government Treasuries and from e.g. the Federal Reserve. They do so by charging high rates of interest and fees; by demanding early repayment of loans; by illegally foreclosing on homeowners, and by appropriating, and then speculating with trillions of dollars of taxpayer-backed resources.
A report out today, "Where did our money go?" from the London-based new economics foundation (declaration of interest: I am a Fellow of NEF) -- reveals that net lending to households and firms is negative. British banks are currently borrowing £12 billion ($18bn) a month to maintain existing levels of activity. According to the Bank of England, by 2011 they will have to borrow £25 billion ($39bn) a month -- and the Bank is sceptical they can continue to raise that level of funding.
According to the Bank of England UK banks are not alone in facing a significant refinancing challenge. Global banks are estimated to have around US$5 trillion of medium to long-term funding maturing over the next three years, and 'the scale of competition for funds in global markets' is intense.
By borrowing from the real economy, and then refusing to lend, except at high rates of interest, bankers are effectively performing a lobotomy on the real economy. They are cutting critical credit connections to and from the vital 'cortex' -- the region of the economy responsible for investment and the creation of jobs. Without a sound banking system and cheap, carefully regulated credit, the public and private sectors will not invest in e.g. green jobs or infrastructure. Output will continue to plummet, and unemployment and poverty to rise.
The banking system was invented in 14th century Florence, 16th Century London, and 17th century Amsterdam -- to create and disburse credit. We learned nearly five hundred years ago that a sound banking system could do just that, stimulating trade and other forms of economic activity. The effortless and almost costless creation of credit by both central and commercial banks creates deposits and savings -- and not the other way around.
This is contrary to the archaic ideas of the 'classical' economists (for which read: the Chicago School). Deposits and savings are not the result of economic activity; nor is Quantitative Easing. Instead they are the result of credit creation -- which can then be used to finance investment and jobs. Today, as NEF's report shows, thanks to the persistence of archaic, neo-liberal economic theories of finance, the banking system has frozen lending and been turned on its head.
Instead of lending into the economy, bankers are borrowing from the real economy.
Lunatic asylums are rightly discredited. Their treatment of patients was often barbaric and ultimately ineffective -- so they were consigned to the dustbin of history.
Like the asylums of yesteryear, banks are no longer fit for purpose. Their treatment of businesses and households is blunt and brutal. Built on monetary theory as outdated as Victorian lunatic asylums, the banking system is likely to implode again. That is why governments are cutting back on spending, and shoring up funds -- fully expecting another banking bailout. The governor of the European Central Bank declared as much in the FT on 5 September, this year.
What can Huff Post readers do? Get out of the 'veal pen' and refuse to cede the battleground to Tea Parties. In other words, organise, don't agonise.
Banks' $4 trillion debts are 'Achilles’ heel of the economic recovery', warns IMF
by Philip Aldrick - Telegraph
More taxpayer support is needed to ensure global financial stability despite the billions already pledged, the International Monetary Fund has warned, as banks remain the “achilles heel” of the economic recovery. Lenders across Europe and the US are facing a $4 trillion refinancing hurdle in the coming 24 months and many still need to recapitalise, the Washington-based organisation said in its Global Financial Stability Report. Governments will have to inject fresh equity into banks – particularly in Spain, Germany and the US – as well as prop up their funding structures by extending emergency support.
“Progress toward global financial stability has experienced a setback since April ... [due to] the recent turmoil in sovereign debt markets,” the IMF said. “The global financial system is still in a period of significant uncertainty and remains the Achilles’ heel of the economic recovery.”
Although banks have recognised all but $550bn of the $2.2 trillion of bad debts the IMF estimates needed to be written off between 2007 and 2010, they are still facing a looming funding shock that will need state support. “Nearly $4 trillion of bank debt will need to be rolled over in the next 24 months,” the report says. “Planned exit strategies from unconventional monetary and financial support may need to be delayed until the situation is more robust, especially in Europe... With the situation still fragile, some of the public support that has been given to banks in recent years will have to be continued.”
Although the IMF does not mention individual countries, it is clear it has concerns about the UK. According to the Bank of England, British banks need to refinance £750bn-£800bn of funding by the end of 2012, £285bn of which is emergency support that expires in the same period. The IMF adds: “Without further bolstering of balance sheets, banking systems remain susceptible to funding shocks that could intensify deleveraging pressures and place a further drag on public finances and the recovery.”
The report welcomed banks efforts to recapitalise, noting that the average tier one ratio rose above 10pc in 2009, but cautioned that “despite these improvements, banking system risks are more elevated today”. Europe’s financial system, in particular, “remains vulnerable to downside risks and further funding strains if capital buffers are not strengthened”, the IMF said, naming the regional Cajas of Spain and Landesbanken in Germany.
Even US banks may need an extra $13bn of capital if “real estate prices fell significantly”. The research shows that the UK has been relatively prudent on bad debts and capital, having wirtten off all but $50bn of the bad debts identified by the IMF – just 10pc of the total. The IMF also called for urgent global co-ordination of banking reforms, chiding regulators for having failed to agree on the details: “The sooner reforms can be clarified, the sooner financial institutions can formulate their strategic priorities and business models.
In the absence of such progress, regulatory inadequacies will continue for some time, increasing the chances of renewed financial instability. “Policymakers cannot relax their efforts to reduce refinancing risks, strengthen balance sheets, and reform regulatory frameworks.”
Governments must also address their budget deficits and public debts to help resurrect confidence in the banks and “reduce the risk that sovereign debt concerns compromise financial stability”. “Fiscal risks remain high, particularly in advanced economies and significant structural weaknesses remain in sovereign balance sheets, which could spill over to the financial system, and have adverse consequences for growth over the medium-term,” the IMF said.
However, it added that governments now face a challenge in balancing “fiscal consolidation to reduce debt on the one hand while ensuring sufficient growth on the other”. The IMF estimates in its “baseline” scenario that Britain’s debts will reach 86.4pc of GDP in 2015. But should the austerity measures result in “growth of 1pc less than the baseline”, debts will rise to 99.2pc of GDP in the same period.
The bottomless bail-out
Ireland counts the rising cost of rescuing its banks
Bill Hicks, a chain-smoking comedian, loved to ridicule the “eternal-life fantasy” of the non-smokers in his audience. “Non-smokers die every day,” he jeered. “And you know what doctors say: ‘If only you smoked we’d have the technology to help you. It’s you people dying from nothing that are screwed.’”
This twisted logic seems now to apply to one of Europe’s most troubled economies. Ireland looks like an abstemious jogger that has suffered a heart attack. The yield on its ten-year government bonds neared 7% on September 29th, a record spread of 4.7 percentage points above those of Germany. Ireland has tried hard to fix its problems. Public-sector wages have been slashed and new taxes raised. The economy is already flexible. As its troubled banks eat up ever more cash, it now seems short of options to return it to health.
Contrast that with Greece’s flabby economy. It acted belatedly to address its troubles, and only then as a condition of a €110 billion ($145 billion) bail-out by the European Union and the IMF. But at least it can now tell a story of how the country’s ambitious reforms will bring it redemption. Greece is on target to cut its deficit to 8% of GDP this year. Spain too can point to a shrinking budget deficit and less stressed banks. Portugal, however, is slipping back: its budget deficit is likely to be bigger than last year, when it was 9.3% of GDP. The opposition is refusing to back the minority government’s 2011 budget (it wants spending cuts, not more taxes), making bond markets nervous.
For now, though, Ireland holds their attention, thanks to growing clarity about the scale of banks’ property-related losses and the amount of public money needed to rescue them. In March Ireland’s central bank said that the country’s three biggest banks must raise €28.4 billion of equity to meet a new requirement of 8% core Tier-1 capital by the end of the year. It said Anglo Irish Bank, a hugely reckless property lender that had been nationalised in January 2009, would alone need €18.3 billion. The reckoning took account of the likely losses from transferring the banks’ worst loans at a discount to NAMA, Ireland’s “bad bank”.
The Irish government injected €8.3 billion of capital into Anglo in the form of a “promissory note”, essentially an IOU. In August the value of the promissory note was bumped up to €18.9 billion, only a bit more than had been indicated in March but enough to make markets fret that bank-rescue costs were still rising (see chart).
On September 30th the bill did indeed increase. The central bank determined that Anglo needed another €6.4 billion in capital, to take account of bigger losses on NAMA assets. It doubled the cost of recapitalising Irish Nationwide Building Society (INBS), a small but troubled state-owned lender, to €5.4 billion. Ireland’s finance ministry said Allied Irish Banks might find only half of the €10.4 billion extra capital it needs by selling assets abroad. The rest will be raised by a rights issue, underwritten by the National Pension Reserve Fund (NPRF), a pot of money set aside to fund future welfare costs. At least Bank of Ireland, the country’s biggest lender, has enough capital to meet its new requirement.
Ireland’s government had hoped to keep this year’s budget deficit to around 12% of GDP. But the extra cost of fresh capital for Anglo and INBS will raise that to 32% of GDP, increasing public debt to 98.6% of GDP. On plausible assumptions Ireland’s gross debt may exceed 115% of GDP before it stabilises. Even that relies on a sustained economic recovery which is far from assured. Figures published on September 23rd showed that Ireland’s GDP fell by 1.2% in the second quarter. Recent data are more encouraging, says Gillian Edgeworth at UniCredit. But there is no sign yet of a convincing pickup in tax revenues.
The government plans a further €3 billion of measures to cut the deficit when it announces its 2011 budget later this year. Some are calling for more drastic action, though that would stiffen the headwinds blowing against a fragile economy. An alternative would be to force some bank losses onto creditors. The blanket guarantee on all bank debt and deposits made by the Irish government in September 2008 has now expired (though a separate scheme for new debt issues is being extended until the end of the year). That creates some limited scope to share the banks’ losses.
Ireland’s finance minister, Brian Lenihan, ruled out imposing losses on senior creditors, but said he expected subordinated debtholders to take a hit. One option would be to buy back Anglo’s €2.4 billion of such debt at a heavy discount to its face value. Such a trick has been used to boost Anglo’s capital before.
Ireland hopes that ending the uncertainty about the cost of bank rescues will drive a wedge between itself and the euro zone’s other troubled countries. Being bracketed together does not just scare away risk-averse lenders. Investors seduced by Greece’s 11% yields may wish to hedge their bets by selling the bonds of other euro-zone countries with weak public finances and poor growth prospects.
There is speculation that, if bond yields rise further, Ireland and Portugal might soon be forced to borrow from the European Financial Stability Facility (EFSF), the €440 billion fund established in June for struggling euro-zone countries. That is unlikely. Ireland has already raised enough money to finance this year’s borrowing requirement (it will spread the cost of bank bail-outs over several years) and has a big cash buffer besides. Portugal, too, is not anything like as desperate for cash as Greece was in the spring. But if Ireland were eventually forced to borrow from the EFSF, the fund might find it hard to impose conditions harsher than the ones it has volunteered for already. You cannot ask a non-smoker to give up cigarettes.
Joseph Stiglitz: the euro may not survive
by Kamal Ahmed - Telegraph
Joseph Stiglitz, one of the world's leading economists, has warned that the future of the euro is "looking bleak" and the fragile European economic recovery could be irreparably damaged by a "wave of austerity" sweeping the continent.
The former chief economist of the World Bank and a Nobel prize winner also predicted that short-term speculators in the market could soon start putting pressure on Spain, which is struggling with a large deficit and high unemployment. Last week, Moody's cut the country's credit rating from AAA to Aa1. The former adviser to President Bill Clinton also says that the banking sector has gone back to "business as usual" too quickly and that there are still risks of another financial crisis despite some improvements in regulation.
Mr Stiglitz, now a professor at Columbia Business School, makes the arguments in an updated edition of his book, Freefall, on the credit crunch. In the new material, exclusively extracted in today's Sunday Telegraph, he reveals fears that governments around the world will attempt to cut their deficits too quickly and risk a double dip recession.
Tomorrow, George Osborne will outline the Government's latest plans for multi-billion pound public sector cuts to tackle the historically-high UK deficit. He has faced criticism that the Coalition is in danger of cutting too hard and too fast but the Chancellor has said that without a credible programme for getting the UK economy into balance, interest rates will rise and growth will be choked off.
"The worry is that there is a wave of austerity building throughout Europe and even hitting America's shores," Mr Stiglitz said. "As so many countries cut back on spending prematurely, global aggregate demand will be lowered and growth will slow – even perhaps leading to a double-dip recession. "America may have caused the global recession but Europe is now responding in kind."
Mr Stiglitz warned that Spain, similarly to Greece, was now in the speculators' sights. "Under the rules of the game, Spain must now cut its spending, which will almost surely increase its unemployment rate still further," he said. "As its economy slows, the improvement in its fiscal position may be minimal.Spain may be entering the kind of death spiral that afflicted Argentina just a decade ago. It was only when Argentina broke its currency peg with the dollar that it started to grow and its deficit came down. "At present, Spain has not been attacked by speculators, but it may be only a matter of time."
Turning to the euro, Mr Stiglitz said that the different needs of countries with high trade surpluses, particularly Germany, and those running deficits such as Ireland, Portugal and Greece, meant that the single currency was under intense pressure and may not survive. He suggests that one way to save the euro would be for Germany to leave the eurozone, so allowing the currency to devalue and help struggling countries with exports.
"Countries that share a currency have a fixed exchange rate with each other and thereby give up an important tool of adjustment," he said. "So long as there were no shocks, the euro would do fine. The test would come when one or more of the countries faced a downturn."
Why It's Foolish to Weaken the Dollar to Create Jobs
by Robert Reich
I keep hearing the only way we're going to get jobs back any time soon is with a weak dollar. Baloney.
Here's the theory. As the dollar falls relative to foreign currencies, everything we export becomes less expensive to foreign consumers. So they buy more of our stuff, creating more jobs in the U.S. At the same time, everything they make costs us more. So we buy less from them and more from each other. Again, more jobs here at home.
Washington is actively pursuing a weak dollar as a jobs policy. (The dollar just plunged to a six-month low against the euro.) How? The Fed is keeping long-term interest rates so low global investors are heading elsewhere for high returns, which bids the dollar down. Every time another Fed official hints the Fed will start printing even more money ("quantitative easing" in Fed speak) the dollar takes another dive.
Meanwhile, Congress is ginning up legislation to allow the President to slap tariffs on Chinese imports because China is "artificially" keeping its currency low relative to the dollar. But using a weak dollar to create American jobs is foolish, for two reasons. First, no other country wants to lose jobs because its currency becomes too high relative to the dollar. So a weak dollar policy invites currency wars. Everyone loses.
At least a half dozen other countries are now actively pushing down the value of their currencies. Japan recently sold some $20 billion of yen in order to keep the yen down, the biggest ever sell-off in single day. Last week, Brazil's Finance Minister lashed out at the US, Japan and other rich nations for letting their currencies weaken to spur jobs. Brazil's high interest rates are attracting global investors and pushing up the value of Brazil's currency. This is crippling Brazil's exports and fueling unemployment.
Here's the other problem. Even if we succeed, a weak dollar makes us poorer. Imports are around 18 percent of the US economy, so a dropping dollar is exactly like an extra tax on 18 percent of what we buy. It's no big accomplishment to create jobs by getting poorer.
You want to know how to cut unemployment by half tomorrow? Get rid of the minimum wage and unemployment insurance, and make everyone who needs a job work for a dollar a day.
The Commerce Department just reported that U.S. incomes rose half a percent in August, the biggest jump since last September. That's good news. But it's no trend. Incomes plunged into such a deep hole last year that a half percent rise is still in the hole. Since the start of the Great Recession, millions of working Americans have had to settle for lower wages in order to keep their jobs. (Here at the University of California, the wage cuts are called "furloughs.")
Or they've lost higher paying jobs and can only find work that pays less. Or they've lost their benefits. Or their co-pays, deductibles, and premiums have soared. And their employer no longer matches their 401(k) contributions. Two-tier wage contracts are the newest vogue in labor relations. Older workers stay at their previous wage; new hires get lower wages and smaller benefits. Even a wage freeze becomes a lower wage over time, as inflation eats into it. For three decades America's median wage has barely budged, adjusted for inflation.
Get it? The goal isn't just more jobs. It's more jobs that pay enough to improve our living standards. Using a weakening dollar to create more jobs doesn't get us where we want to be.
Police training halts as agencies face budget cuts
by Kevin Johnson - USA Today
Even as hundreds of police officers across the country are losing their jobs, law enforcement officials say there is another disturbing casualty of the financial downturn: basic training.Nearly 70% of police agencies cut back or eliminated training programs this year as part of local government budget reductions, according to a survey this fall of 608 agencies by the Police Executive Research Forum, a Washington-based think tank. The cuts include a wide range of programs, from ethics and basic legal training to instruction on the proper use of force.
Harvey Hedden, executive director of the International Law Enforcement Educators and Trainers Association, says the cuts are "alarming." "In a lot of cases, training determines whether someone survives or not in our business," Hedden says.
Tulsa Police Chief Chuck Jordan says his department's entire in-service training program was shuttered for a year, beginning in June 2009. The shutdown interrupted crucial crime-scene investigation training and weapons instruction. Yet, faced with the prospect of layoffs, Jordan says the training cut was a "no-brainer." "We needed to keep people on the street and saw the cuts to training as a bridge to better times," Jordan says.
Daytona Beach (Fla.) Police Chief Michael Chitwood says his department's entire $200,000 training budget was wiped out this year because of municipal service reductions. The chief says he is working with local universities that have volunteered to help restore the programs, including instruction on the proper use of stun guns and how to defuse potentially dangerous confrontations with the mentally ill.
The chief says city leaders were aware of the risk of lawsuits related to potential officer mistakes and misconduct but that the city decided to "pay on the back-end." "The private sector was appalled when they found out about this," Chitwood says.
In Philadelphia, Police Commissioner Charles Ramsey says he refuses to curtail training because there is too much at stake. "When you cut back on training, officers are sued and fired. I learned a hard lesson from that," Ramsey says, referring to incidents during his previous stint as chief in Washington, D.C. "We're doing everything we can to avoid that." In some cases, the fallout may not be felt right away, but analysts say the scope of the cuts could soon create serious problems.
"When you pull away the support beams of a building, it doesn't fall down immediately," says Chuck Wexler, executive director of the Police Executive Research Forum. "But eventually, it's going to have an impact."
Yuan Revaluation for China's Own Sake
by Peter Stein - Wall Street Journal
U.S. lawmakers have put China's currency policy high up on America's political agenda. Nouriel Roubini believes it ought to be even higher on China's economic agenda. The famously gloomy economist, known in part for his prescient views ahead of the global financial crisis, says China needs to revalue its currency, the yuan, not because failure to do so hurts the U.S. Rather, keeping the yuan artificially low will lead China's own economy to hit a dangerous "growth wall" in the next two to three years, he said in an interview on the sidelines of the World Capital Markets Symposium in Kuala Lumpur last week.
Mr. Roubini, a professor of economics at New York University's Stern School of Business, isn't the only one to assert that China needs to appreciate its currency for its own sake. But amid the election rhetoric flying around Capitol Hill, where the House last week voted overwhelmingly to penalize Beijing over its currency practices, Mr. Roubini is possibly the most economically articulate observer of China to argue the point.
The starting point of Mr. Roubini's reasoning is familiar, and not even contentious: China needs to boost domestic consumption and reduce its reliance on exports. In fact, China's official government policy already embraces that concept. The problem, Mr. Roubini says, is that China's efforts to promote consumer spending ring hollow while the yuan remains weak. Consumption as a share of gross domestic product, in fact, has fallen to 36% from 45% in the last decade, compared with U.S. levels of about 70%.
The key, he argues, is the exchange rate. A cheap yuan keeps many foreign goods unaffordable, protecting state-owned enterprises, which also benefit from cheap credit. That's because suppressing the yuan's value requires China to keep interest rates artificially low. Both of these effects allow "a massive transfer of income from the household sector to the corporate sector," Mr. Roubini says.
As a result, a quarter of China's GDP is the income or the retained earnings of companies, mostly state-owned. Those funds, rather than being distributed to the wider population through dividends, instead end up in assets such as real estate and new production facilities. China's stimulus package last year, which kept the country's growth from dipping below 8% even as most of the developed world was mired in recession, only exacerbated the problem. Capital expenditure as a share of its GDP jumped to 47% from 42% as state lenders financed spending on infrastructure, housing and new production.
All that spending is creating destabilizing gluts, particularly in production capacity. Mr. Roubini singles out the car industry as an example. This year, car sales jumped from eight to 12 million vehicles, a 50% increase. But production capacity went from 10 million to 20 million vehicles. "China now has 100 separate car makers," he says. "The U.S. has only three."
There's also a glut of commercial and residential real estate, he asserts, and even a glut of infrastructure, an area of Chinese investment usually singled out for praise. "You know, I go to China six or seven times a year, and you have brand-new airports three-quarters empty," he says. "Highways to nowhere all over the country." It's hard not to take issue with some of Mr. Roubini's arguments. China's infrastructure investments help it attract new investment from abroad, and new highways and high-speed trains are setting the stage for the development of China's less-advanced inland areas. Jonathan Anderson, an economist at UBS in Beijing, says a major chunk of China's fixed investment is in much-needed housing.
Mr. Roubini won't say how much he thinks the exchange rate has to change exactly. "Whether it's going to be 5% per year or 10% per year, it doesn't matter," he says. The faster, the better.
He dismisses the argument that China can't afford to let its currency rise. While exports will fall, "the real income of households is going to increase, and they're going to consume more. You export less and you consume more," he says. Growth shouldn't be affected, though apart from "some transitional effects," he figures. (Of course, that almost certainly understates the political challenge of going up against those parties with a vested interest in the old model.)
A rising yuan has other benefits, Mr. Roubini notes: It allows China to rein in domestic inflation and gain greater control over monetary policy, which can help stave off asset and credit bubbles of the sort that wreaked havoc on Japan's economy when they burst in the 1990s. "It's for their own sake they have to do it," he says. "Otherwise, they arrive at a growth collapse."
IMF admits that the West is stuck in near depression
by Ambrose Evans-Pritchard - Telegraph
If you strip away the political correctness, Chapter Three of the IMF's World Economic Outlook more or less condemns Southern Europe to death by slow suffocation and leaves little doubt that fiscal tightening will trap North Europe, Britain and America in slump for a long time. The IMF report – "Will It Hurt? Macroeconomic Effects of Fiscal Consolidation" – implicitly argues that austerity will do more damage than so far admitted.
Normally, tightening of 1pc of GDP in one country leads to a 0.5pc loss of growth after two years. It is another story when half the globe is in trouble and tightening in lockstep. Lost growth would be double if interest rates are already zero, and if everybody cuts spending at once. "Not all countries can reduce the value of their currency and increase net exports at the same time," it said. Nobel economist Joe Stiglitz goes further, warning that damn may break altogether in parts of Europe, setting off a "death spiral".
The Fund said damage also doubles for states that cannot cut rates or devalue – think Spain, Portugal, Ireland, Greece, and Italy, all trapped in EMU at overvalued exchange rates. "A fall in the value of the currency plays a key role in softening the impact. The result is consistent with standard Mundell-Fleming theory that fiscal multipliers are larger in economies with fixed exchange rate regimes." Exactly.
Let us avoid the crude claim that spending cuts in a slump are wicked or self-defeating. Britain did exactly that after leaving the Gold Standard in 1931, and the ERM in 1992, both times with success. A liberated Bank of England was able to cut interest rates. Sterling fell. The key point is whether you can offset the budget cuts.
But by the same token, it is fallacious to cite the austerity cures of Canada, and Scandinavia in the 1990s – as the European Central Bank does – as evidence that budget cuts pave the way for recovery. These countries were able export to a booming world. They could lower interest rates, and were small enough to carry out `beggar-thy-neighbour' devaluations without attracting much notice. We were not then in our New World Order of "currency wars".
Be that as it may, it is clear that Southern Europe will not recover for a long time. Portuguese premier Jose Socrates has just unveiled his latest austerity package. He has capitulated on wage cuts. There will be a rise in VAT from 21pc to 23pc, and a freeze in pensions and projects. The trade unions have called a general strike for next month. Mr Socrates has already lost his socialist majority, leaking part of his base to the hard-Left Bloco. He must rely on conservative acquiescence – not yet forthcoming. Citigroup said the fiscal squeeze will be 3pc of GDP next year. So under the IMF's schema, this implies a 3pc loss in growth. Since there wasn't any growth to speak off, this means contraction.
Spain had a general strike last week. Elena Salgado, the defiant finance minister, refused to blink. "Economic policy will be maintained," she said. There will be another bitter budget in 2011, cutting ministry spending by 16pc. Mrs Salgado has ruled out any risk of a double-dip. But the Bank of Spain fears the economy may contract in the third quarter. The lesson of the 1930s is that politics can turn ugly as slumps drag into a third year, and voters lose faith in the promised recovery. Unemployment is already 20pc in Spain. If Mrs Salgado is wrong, Spanish society will face a stress test.
We are seeing a pattern – first in Ireland, now in Greece and Portugal – where cuts are failing to close the deficit as fast as hoped. Austerity itself is eroding tax revenues. Countries are chasing their own tail. The rest of EMU is not going to help. France and Italy are cutting 1.6pc GDP next year. The German squeeze starts in earnest in 2011. Given the risks, you would expect the ECB to stand by with monetary stimulus. But no, while the central banks of the US, the UK, and Japan are worried enough to mull a fresh blast of money, Frankfurt is talking up its exit strategy. It risks repeating the error of July 2008 when it raised rates in the teeth of the crisis.
The ECB is winding down its lending facilities for eurozone banks, regardless of the danger for Spanish, Portuguese, Irish, and Greek banks that have borrowed €362bn, or the danger for their governments. These banks have used the money to buy state bonds, playing the internal "carry trade" for extra yield. In other words, the ECB is chipping at the prop that holds up Southern Europe.
One has to conclude that the ECB is washing its hands of the PIGS, dumping the problem onto the fiscal authorities through the EU's €440bn rescue fund. That is courting fate. Who believes that the EMU Alpinistas roped together on the North Face of the Eiger are strong enough to hold the rope if one after another loses its freezing grip on the ice?
A Mammoth One in Five US Borrowers Will Default
by Michael David White - Housingstory.net
A leading mortgage analyst predicts over 11 million homeowners will default and lose their home if the government fails to take more radical intervention.
Amherst Securities Group LP, one of the most respected names in mortgage research, has trumpeted an ambitious call-to-government arms in its October mortgage report.
“The death spiral of lower home prices, more borrowers underwater, higher transition rates (to default), more distressed sales and lower home prices must be arrested.” The authors dismiss recent talk of mortgage performance improvement as statistical sleight-of-hand magically conjured by modifications.
“This ‘improvement’ (in mortgage performance) simply reflects large scale modification activity having served to artificially lower the delinquency rate” (Please see the chart above of mortgage balances delinquent and re-performing. All charts in this post are from “Amherst Mortgage Insight” dated October 1, 2010.). The report offers an astounding forecast of the fate of severe negative-equity properties. Nineteen percent of properties with a loan-to-value (LTV) of 120% or greater are defaulting every year. A death-defying 75% of mortgages on 120% LTV properties will eventually go bad (19% + 19% + 19%, …).
The current crop of mortgages is already “impaired” at the one-of-five level. Nine of 100 are seriously delinquent. Six of 100 are “dirty current” (made current by modification). Five of 100 are seriously underwater (LTV greater than 120%) (Please see the chart above categorizing the forecast of 11 million defaults.). The authors, who describe current conditions as leading to “an impossible number” of defaults and one that is “politically unfeasible”, unveil a major arms race of measures to counteract the default tide.
The solutions include mandatory principal reductions, looser underwriting of new mortgage loans, leveraged capital pools for investors, and penalties for defaulting homeowners. Amherst reports that a family who defaults can live rent-free for 20 months on average. They propose that missed mortgage payments, including property taxes and insurance, be counted as W2 income.
They make note of recent new signs of distress including two record-low readings of existing home sales in the last two reports. Another block is that underwriting standards have grown much stricter at Fannie and Freddie. Only 2% of Freddie purchases are now bad-credit borrowers where they represented about 20% of borrowers in 2006. FHA purchase mortgages, however, which have by definition much more lenient lending guidelines, have exploded upwards from roughly 10% of their lending in 2006 to more than 50% today.
The buyer pool is also compromised by the fact that 17% of borrowers now have a seriously compromised credit history. After mortgage default a typical wait-time to qualify again is anywhere from 3 to 7 years. One of the more desperate measures suggested by the authors seeks a new mortgage for those who are now behind or in danger of failing. “This (default) can be fixed by re-qualifying borrowers who are in a home they can’t afford into one they can afford.”
Risk is so high in today’s real estate market that private money has largely left the mortgage category. The retreat is most easily seen in the jumbo mortgage market. Total jumbo mortgage origination has fallen from a high of $650 billion in 2003 to $92 billion in 2009 (see the chart above). Government loans account for 90% of current originations. “If government policy does not change, over 11.5 million borrowers are in danger of losing their homes (1 borrower out of every 5),”‘ the report said, which estimates the total of homes with a first mortgage at 55 million. “Politically, this cannot happen.”
Why we need to follow the Irish and restructure our 'zombie' banks
by Liam Halligan - Telegraph
In Dublin, early last Wednesday morning, a protester rammed a cement truck – with the words "TOXIC BANK" emblazoned on the side – into the ornate iron gates of the Irish Parliament.
The following day, Brian Cowen's government unveiled its plan to pump an additional €6.4bn into Anglo Irish Bank – the real-estate lender at the heart of the Republic's property meltdown. Having been nationalised in January 2009, the total cost of rescuing Anglo Irish could now be almost €30bn. An additional €3bn capital injection into the much bigger Allied Irish Bank was also announced last week, with the state becoming majority shareholder in Ireland's second-largest lender.
Finance Minister Brian Lenihan also admitted that even more rescue finance could be needed under a "severe hypothetical stress scenario" if Irish property prices fall further, and then fail to recover. In sum, Ireland's bank rescue, we now know, could cost this relatively small country an eye-watering €50bn – more than a quarter of total annual economic output. So huge are the immediate bail-out costs that the 2010 Irish budget deficit is now on course to hit an astonishing 32pc of GDP – 10-times bigger than eurozone member guidelines.
These are absolutely ghastly numbers, of course. But guess what? The fact that they're now in the public domain, that the government forced the banking sector to "fess up" its losses, meant that Irish sovereign debt rallied after ministers made their move. That's right – borrowing costs fell, a lot, as the all-important bond market signalled its approval at Dublin's determination to impose "full disclosure".
Back in 2009, Cowen and his team were widely praised as they took genuinely decisive action to get Ireland's fiscal house in order. The previous year, the Celtic Tiger had been severely wounded – after Ireland's runaway housing market and related construction boom went bang, the country enduring an economic implosion. This was made worse by the pound's fall against the euro, which meant Ireland lost competitiveness vis-a-vis the UK – still its biggest trading partner.
All this caused an unprecedented 7.5pc contraction in Irish economic output last year. Excluding profits made by the numerous multinational companies operating in Ireland, the drop was an even more shocking 11.3pc. As the economy went into a tailspin, borrowing costs surged, preventing the investment needed for recovery and turning bad debts even worse. As a result, Ireland's budget deficit soared to 14.3pc of GDP last year. Cowen responded by imposing a one-off fiscal squeeze equivalent to around 6pc of GDP – through a combination of pay restraints, tax rises and curtailed public spending. The Irish were implementing in 12 months cuts roughly equivalent to those which British ministers insisted would take four years.
Jean-Claude Trichet, European Central Bank President, called Ireland a "role model" urging other countries to "face up to their problems, as the Irish so clearly have done – something that's now widely recognized". Sure enough, by April this year, the "spread" the bond markets charge to hold Irish 10-year debt over the German "bund" equivalent was down to 139 basis points, less than half as wide as the year before.
Since then, this spread has widened once more, reaching 450bp prior to Cowen's announcement. Ireland is now being presented in a very different light. As anti-austerity protests raged across Europe last week, trade unionists argued that Dublin's predicament shows what happens if governments "fail to support the economy", by piling debt on ever more sovereign debt.
In the UK, senior Labour politicians, who earlier in their careers showed signs of economic literacy, are peddling the same economic snake oil. Ireland shows the "extreme dangers of austerity", they say. That's the message, of course, they must deliver to their public-sector union paymasters – manipulative, selfish men who represent less than a fifth of the British workforce. Senior Labour figures should know better – and they do! They've simply allowed their intellect to be trumped by their ambition.
A closer look at Ireland highlights the absurdity of what trade unionists are now saying. Ireland isn't Greece. Dublin hasn't tapped the European Union's €750bn rescue fund and last week's announcement makes it less likely it will do so – which is why 10-year sovereign bond yields fell more than a quarter percentage point, from 449bp to 422bp.
Yes, in recent months, Ireland's "bund spread" has widened – but so has that of all eurozone "peripheral" nations. This has been partly due to Germany's economic recovery – which has lowered yields on Berlin's sovereign debt – but also been because the eurozone has so far resisted printing money on the same grotesque scale as the US and UK. That's kept the euro relatively strong, making it even harder for small export-driven member states such as Ireland to recover.
A lot of the reason Ireland's new headline fiscal numbers look so bad is that they're far more honest than equivalent data being presented elsewhere – in the UK, for instance. Ireland's gross government debt is now expected to rise from 64pc to 98pc of GDP this year. That's not high by international standards, but the increase is obviously sharp. Having said that, because Ireland has large cash balances in its National Pension Reserve Fund – net government debt will actually be around 70pc of GDP, not much more than in the UK. Consider, also, that in contrast to Ireland, the vast majority of Britain's massive public sector pension liabilities are unfunded and off-balance sheet.
Ireland's annual deficit figure – projected to balloon to 32pc of GDP – also warrants examination. This number actually includes the cost of the bank bail-outs, unlike its UK equivalent. Labour buried the cost of the RBS and Lloyds capital injections, not including them in the published deficit figures, a convention the Tories look set to continue. If Ireland followed the same methodology, its 2010 deficit would be 11pc of GDP, similar to the UK.
British ministers argue that bail-outs are "financial transactions" from which the government may eventually reap a return. So they shouldn't be included in the deficit. Such a position not only undermines the UK Government's fiscal credibility – effectively "banking" a return before it has been made. It also means the UK Government is petrified of taking the necessary steps to force banks to disclose their smouldering off balance-sheet liabilities, write-off losses and engage in root-and-branch restructuring – as that would cause the public finances to collapse.
Yet, as Japan's experience shows, such restructuring needs to happen, lest Britain's new "zombie banks" drain the life-blood out of the economy for years to come. Such necessary events can now take place in Ireland, given that the losses are "out there" and already on the Government's books.
No-one is saying the Irish economy is out of the woods. The situation is fragile – and could deteriorate. But amidst the scary headline numbers last week, few commentators noticed that Ireland cancelled bond auctions planned for October and November. That's because after a lot of pain, and some very tough decisions, the Irish government already has the cash it needs to fully-finance its budget until the middle of next year. Very few Western countries are in a similar position.
Ireland has a lot more to do. The losses that will now soon be imposed on junior creditors of its bombed-out banks should eventually spread to senior creditors too – so lightening the taxpayers' load. But, by revealing the banking sectors' vast losses and outlining a credible plan to fund them, the Irish have taken a step that others have not yet taken. Ultimately, they'll have to.
Debtors jailed in Ohio despite laws against it
by Laura A. Bischoff - Dayton Daily News
Mayors’ courts and municipal courts in Ohio routinely jail poor people who don’t have the money to pay court fines and fees — despite laws and legal rulings against the practice, according to a 92-page report by the ACLU to be released Monday, Oct. 4.
Ohio has some of the strongest statutory language and case law against debtors prisons, the report says, but “Ohio judges and lawyers are often unaware of, or simply do not follow, the relevant law. As a result, countless Ohioans languish in prisons and jails, facing a growing mountain of debt,” the American Civil Liberties Union said.
Among the individual cases cited in the report involved a $7-an-hour dishwasher in Greene County. In 2006, Howard Webb owed $2,882.36 in fines and costs that had accumulated over a decade in various criminal and traffic cases. Xenia Municipal Court Judge Susan Goldie repeatedly issued arrest warrants for Webb because he had not made good on previous payment agreements.
Under Ohio law, a defendant may only be jailed for willful nonpayment of a punitive court fine and the defendant must get $50 credit toward his fine for each day he spends in jail, the report said. Defendants cannot be jailed for failure to pay civil expenses such as court costs, restitution or other related fees, it said. Nonetheless, Webb served 204 days in jail between 2000 and 2005 and another 126 days in 2006 but never received the $50 per day credit toward his fees, the report said.
Two years later, the Ohio Disciplinary Counsel reprimanded Goldie for “flagrant disregard for the law.” The report, titled ‘In for a Penny: The Rise of America’s New Debtors’ Prisons,’ detailed debtors prisons in five states and noted that the cost of arresting and incarcerating someone often exceeds the amount owed.