Wednesday, July 8, 2009

July 8 2009: Stoneleigh and Aaron Krowne battle deflation

Samuel H. Gottscho City Lights December 5, 1933
Rockefeller Center and RCA Building from 515 Madison Avenue, New York. City

Ilargi: The following is part of an on-going conversation between Aaron Krowne (who runs The Mortgage Implode-O-Meter) and Stoneleigh on the subject of deflation. It began 3 days ago when Aaron sent me an email reacting to Stoneleigh's recent article The unbearable mightiness of deflation. Civilized and well-argued discussions are a welcome delight.

PS: 77 years ago today, July 8, 1932, the Dow reached its lowest point ever at 41.22.

Aaron: [You make] many good points. The way I understand it is that deflation is only happening in the financial economy, not the real economy.

Stoneleigh: Deflation is a monetary phenomenon - the contraction of money and credit relative to available goods and services. It is either happening or it is not. Price falls in nominal terms are a lagging indicator of deflation as a price driver, but there are other price drivers as well, such as wage arbitrage, scarcity, substitutability (or lack thereof) etc. Price movements have no explanatory or predictive value in their own right as they are the net result of many factors that vary for different goods and services.

Deflation will eventually cause prices to fall almost across the board in nominal terms, while leaving them less affordable than they were before due to the collapse of purchasing power. Purchasing power will collapse as access to credit disappears and the ability to earn an income decreases drastically with skyrocketing unemployment. Lack of purchasing power will come from most people having no money. Those (very) few who have preserved their purchasing power in liquid form will find everything is very cheap indeed once we are further into a deflationary spiral. 

Aaron: Many assets (i.e. cars, foreclosed houses) are transitioning from one economic sphere to the other.  In the real economy (where they are bought outright, not financed), these goods have lower prices.   But that doesn't mean "prices are falling" in the same sense as it would for a cup of coffee or your monthly power bill or health insurance -- and in fact all these prices are going up.

Stoneleigh: Prices will fall, but as prices lag a deflationary contraction, many prices have not fallen yet. We have not yet seen the impact of credit tightening on price support for many things, but it is coming. Already we are seeing credit limits cut, cards withdrawn, borrowing against property cut etc. All that will have an effect, especially as it has very much further to go. The market is temporarily rallying at the moment, as we said it would in March, but once the sucker rally is over, the decline will begin again and the impacts will be increasingly obvious.

Aaron: Nobody's savings or wages are actually going up in buying power, which makes the current "deflation" very different from the one in the 1930s, regardless of what one chooses to call it.

Stoneleigh: Savings will go up in buying power, at least those which are not lost to a systemic banking crisis, which is moving inexorably closer. Wages will go up in buying power, for those who still have wages that is, and that part of the population will be shrinking very substantially.

We are going to see circumstances similar to the 1930s. We are seeing the initial stages at the moment. By way of analogy, the sea has pulled back and the tourists are gawping at the newly exposed shells on the ocean floor, blissfully unaware that a tsunami is coming. The quantitative easing that the government is doing will be completely dwarfed by the forces arrayed against them as the power of the collective rushes for the exits over the next year or so.

Unfortunately, timely warnings are rarely credible at the time they are given, as they conflict with the received wisdom of the herd. In this case, the vast majority is expecting inflation, and messages to the contrary can seem laughable, but then so did warnings in 2005 about the housing bubble coming to an end. 

Aaron: Come on.  How are we seeing a "monetary phenomenon" ("the same as in the 1930s"), when what is going on clearly has more to do with a collapse in credit (not money), and we don't even have sound money as we did in the 1930s?  Are those differences supposedly immaterial?

I say, they are VERY material.  Credit collapse in an environment of fiat money produces debt deflation, not monetary deflation.  This means that price collapses are isolated to financialized assets, by and large. 

Stoneleigh: Inflation is an increase in the supply of money AND CREDIT relative to available goods and services, and deflation is the opposite. The contraction of credit, as credit loses 'moneyness', is a contraction of the effective money supply relative to available goods and services, which is deflation. Inflation and deflation are always and everywhere monetary phenomena. There is no difference between debt deflation and monetary deflation.

Price collapses will in no way be limited to financialized assets, although these should suffer greater losses than material goods. Illiquid securities could go to zero for instance, while oil certainly will not, but the price of oil nevertheless has further to go to the downside than we have seen so far as a result of the coming demand destruction. One would not expect price movements to be equal for different goods, services or financialized assets, but one would expect deflation to decrease price support across the board. Other price drivers, in one direction or the other, in combination with the effects of deflation, will determine the net effect on prices for each item.

Aaron: Note, for example, that the oil price has already rebounded strongly after becoming definancialized (yes the general market has rallied but oil has much more).  As inventories are relatively high, this shows oil is likely acting as a substitute sound money against the fiat currency, which cannot constitute any sort of durable safe haven.

Stoneleigh: When oil was over $140/barrel we predicted the price would plummet, and it did. In March when the market began its sucker rally, which we warned our readers was about to happen, we said that the price of oil would rebound with the general return of liquidity, before falling further once the rally was over. We stand by this prediction today, as the combination of the destruction of economic activity, the lack of purchasing power and the need for oil-producing nations to pump flat out in order to bring in as much revenue as possible will further undermine oil prices. However, as we have pointed out in our energy primer (Energy, Finance and Hegemonic Power ), demand destruction will sow the seeds of supply destruction.

We expect oil, and gold, to bottom early in this depression, and to increase enormously thereafter. A price increasing in nominal terms against a backdrop of credit collapse means that prices will be going through the roof in real terms. Ordinary people will find themselves entirely priced out of the market. Fiat currency, and cash equivalents such as short term bonds, are not a enduring safe haven, but are a safe haven for the time being. During the deflationary deleveraging, the preservation of purchasing power in liquid form is the key. Following deflation, it will be necessary to move into hard goods, which will be available at prices that will look very cheap to those few who retain access to cash.

Aaron: Those waiting for their basic expenses to go down and their fiat money to become worth more will be waiting until they are blue in the face.  And perhaps it is better they starve themselves of oxygen before meeting the monetary inflationary reality of the near future.

Stoneleigh: Most will see their basic expenses go through the roof in real terms (even as they fall in nominal terms), as they will have almost no access to goods and services, as a result of having no money or credit, and therefore no purchasing power. The very few who hold liquidity, and have been able to avoid losing it in a bank run, will find that their expenses will fall, but they will be a tiny minority. Monetary inflation is likely to be the scourge of the longer-term (ie many years hence), but it is not the scourge of the present or of the near future.
Aaron: I guess my main point of contention is the assertion that "there is no difference between monetary deflation and debt deflation".    The reason is because only a minority of assets (and most of them having to do with investing with a long-term horizon) are financialized (financed).  That seems factual to me... and the divergent path of the various prices seems to confirm it.

Certainly, while we are getting some spillover areas of prices going down, but some of the same prices are also going up from month to month, and structural costs evidently constitute a long-term rising tide.

Stoneleigh: Those rising prices are temporary, reflecting the previous credit expansion as a lagging indicator. I agree that 'financialization' opened the door to speculative excess and its aftermath, which drove prices up sharply and set them up for a huge fall. Not everything was subject to this kind of 'pump and dump', and therefore not all prices have been as volatile. Price movements are inconsistent as many price drivers operate simultaneously.

However, deflation at its most virulent is an extremely powerful price driver. We have yet to see its effects, and may have to wait until next year to do so, depending on the time lag between monetary contraction and the effects appearing in the broader economy.

I am expecting a late summer top for this current sucker rally, and for the downward trend to resume this autumn. If that downward trend becomes a market cascade, as I expect it to, then the effect on prices may not take too long to kick in. That is not to say that the time lag for everything would be the same. The rollover point for a new price trend could vary substantially. I would certainly expect the price of non-essential consumer goods to fall faster than essentials or regulated utilities, where there is more state influence over prices.

I do expect virtually all prices to fall in nominal terms at some point though, but not in real terms as we have discussed previously. Lower prices do not equate to greater affordability in a deflation, except for the lucky few who still have any money.

Aaron: The general assumption seems to be that we can only be "in" deflation or inflation, but I think it is evident we are in both, depending on whether you look primarily at real costs or financial assets. Again, this is a source of confusion, but when I say "inflation", by default, I mean the real economy sense -- as previously there was no popular acceptance of "inflation" referring to asset prices (and if you prefer money supply, the credit that financed these assets).

Stoneleigh: The use of the term 'inflation' to describe price movements rather than monetary expansion is a relatively modern convention. It represents the a popularization of the term, but a bastardization of its meaning in that such a usage obscures a very important concept. Inflation is a monetary phenomenon. We cannot, by definition, be in inflation and deflation at the same time, although price movements can certainly unfold in different directions simultaneously, depending on a number of factors.

Aaron: Cui bono -- who would it be convenient for to ignore inflation in asset prices while looking at "deflation" in goods as the bubble expands, then look at deflation in asset prices but ignore inflation in goods as the bubble pops?

Stoneleigh: I wouldn't suggest ignoring the effect on either assets or consumer goods as they are both part of the picture. However, explaining that picture requires a consistent analytical underpinning.

Aaron: I also do not buy the assertion that collapsing employment or "purchasing power" will cause price deflation. This is essentially the NAIRU philosophy and I would have thought it had been thoroughly debunked by the 1970s stagflationary experience and its inverse, the 1990s "great moderation" (low unemployment, low inflation). Withdrawn credit is a new twist to this, but when you think about it this is really no different than considering employment, as you are simply taking stock of the "demand" side.  When you consider that most people were already stuck in a position of being able to afford little more than the basics, then you can see that beyond big screen TVs, demand for goods and basic services is relatively inelastic.  So overall, I don't think this demand-side argument is compatible with the assertion that inflation is a monetary phenomenon.

Stoneleigh: We have yet to see a significant drop in aggregate demand, but it is coming. Demand is not what one wants, but one is ready, willing and able to pay for, and it is not inelastic when purchasing power is withdrawn. Without access to credit and without an income stream from employment, more and more people will fall by the wayside. Eventually they will be in the majority. We may find it inconceivable that a majority of people will have insufficient purchasing power to afford even basic essentials, but that has been  very common pattern in human history - a large proletariat ruled by a small elite, with an enormous wealth disparity.

The 1990s were not a time of low inflation, it was a time of enormous credit expansion. Consumer prices were held in check by global wage arbitrage and international price competition, so the excess found its way into assets.

Aaron: And I agree that inflation is primarily a monetary phenomenon.  I just do not believe that "money substitutes" act exactly like money.   By and large when we talk about credit and derivatives and such, we are talking about a realm of fiction that is detached from the real economy.  So I am surprised so many sharp analysts now seems to assign this realm some kind of central importance.  If I write a you a $1M IOU, and we toss it back and forth 1000 times, we have not just done $1B of business, or added $1B to the global economy, or anyone's income or asset base.  If we suddenly realize this, that does not constitute $1B of "deflation" either, though it might be disruptive for cloistered bankers or billionaires.

Stoneleigh: The period of time where money was chasing its own tail was adding to wealth expectations, and much of that wealth effect was propping up prices. Those who are of the opinion that they have a claim to a certain percentage of the real wealth pie will not readily concede that they do not. While currency inflation divides a wealth pie into ever smaller pieces, credit expansion creates multiple and mutually exclusive claims to the same pieces of pie. Everyone feels wealthier, but it is an illusion. Little or no wealth has actually been created, but the proliferation of claims has led to a very dangerous situation. Deflation is the process of extinguishing those excess claims once their existence has been generally recognized.

As there are probably at least a hundred claims to each slice of pie, thanks to leverage, the vast majority of claims will face extinction. This will not be an orderly process following legal niceties. On the contrary, those higher up the financial food chain will reach down and grab whatever they can in the way of real wealth in the biggest margin call in history. In other words, say good-bye to anything owned on margin.

Aaron: Back to money, as far as I can tell, so much money has already been printed that we are vulnerable to severe inflation if not hyperinflation if confidence in the dollar suddenly drops out. I reckon that massive interventions and propping have already taken place to prevent this from happening -- who can say? -- but it remains a great risk, and puts the US and the dollar in the same category as Argentina or Zimbabwe.

Stoneleigh: Forecasts of a collapse in the dollar are premature. Deflation will prop up the value of the dollar on a flight to safety, which will also drop bond yields to historic lows for a time. There is more dollar-denominated debt in the world than any other kind, hence its deflation will increase demand for dollars more than any other currency (except perhaps the yen as its carry trade unwinds). Eventually the value of the dollar will collapse, as all fiat currencies do, but that time is not now.

The amount of 'money printing' that as happened so far is completely dwarfed by the scale of credit contraction. We are not vulnerable to inflation as a result of this. On the contrary, most of it has disappeared into the black hole of credit destruction, never to be seen again. Much of the rest is being hoarded. It is doing nothing substantial to increase the velocity of money, although rallies are accompanied by a temporary return of liquidity along with the temporary return of confidence. In a very real sense, confidence IS liquidity. Once the rally is over, both will disappear again and the velocity of money will plummet.

Aaron: I think we are in agreement that long term, the risk is inflation -- but I additionally don't think we are "safe" right now. Specifically, the monetary authorities have no call to dramatically expand any sort of money or credit -- they are seriously playing with fire when they do so, as the vulnerable position of the dollar and the printing that has been done already form an underbrush of dry tinder.

Stoneleigh: I can see inflation in the very long term (ie years away at least), but to say that it represents the real risk is not a position I agree with. Deflation on the scale we are facing is simply devastating. It is a force that essentially sweeps all before it. Those who emerge shell-shocked from a deflationary depression will then have to face hyperinflation, once the power of the bond market has been broken thanks to the collapse of the international debt financing model, but that is a very long way off.

Aaron: Here is an additional argument you might want to consider on the question of whether or not consumer credit being withdrawn implies deflation. There are two main cases to consider -- people who are maxed (or "near maxed"), and those who do not use much credit and have lots of spare borrowing power.

In the latter case, the analysis is easy: credit being withdrawn has little effect on them, their behavior, or the economy (net demand for goods and services). On the other hand, if you are close to being maxed out, you have a problem.  You've basically been living off your credit cards, and your lines are being cut (or equivalently your APRs are going up). It would seem you might have to scale back demand.

But here's the the thing: you were probably maxed out on the credit cards because you had no choice. Specifically, whether or not you have the credit lines available, you have to pay your bills, feed yourself (and your kids if you have any), etc. The vast majority of those maxed out are not actually doing so on "discretionary" spending.

This means that when those lines are cut, the spending cannot really go away. Instead, the pressure falls back on state or national government to support these people. Sure enough, we find massive amounts of stimulus money going to extend unemployment benefits, provide matching for "TANF" and other welfare programs, etc. This is essentially fresh money printing to substitute for the withdrawn credit. The paradox of consumer credit is that those with the most of it "need" it the least. But those who need it the most will find other forms of support when they lose it.  So, at the end of the day, I don't think the cutting-back of consumer credit will have a very big effect on aggregate demand and hence CPI inflation.

Stoneleigh: Bailouts are never for the little guy, no matter what spin is put on them in order to sell them to the public. They are for the few insiders at the expense of everyone else. The population at large are the designated empty bag holders as the ponzi scheme hits its limit (From the Top of the Great Pyramid).

Saying that those who lose credit, and income from employment, will necessarily find other means of support, and that their demand will not therefore fall, seems completely preposterous to me. No government can afford to supply its populace to the extent that their demand would be unaffected. In fact, no government will be able to supply even the most basic essentials to all, let alone prop up demand at anything like current levels. A government pursuing that kind of strategy would be severely punished by the bond market very quickly.

Eventually this will happen anyway as a result of quantitative easing, but when it does, it will amount to hitting the 'emergency stop' button on the economy. Interest rates will shoot up into the double digits in nominal terms, and much higher in real terms. It will unleash a tsunami of debt default throughout the economy, as debts will no longer be remotely affordable. This will be hugely deflationary.

Governments facing very high interest rates (and there will be many) will have to slash spending to the bone. Just when people are most in need of support, they will be cast adrift in a pay-as-you-go world with no purchasing power. The effects of this will be gargantuan in terms of political unrest and upheaval. There is nothing governments, or anyone else, can do to avoid the consequences of the largest credit bubble in history bursting. We have had the party to end all parties, and now we have to deal with a hangover that will last for decades.

In California, Even the IOU’s Are Owed
The only thing worse than being issued an i.o.u. rather than a check from the State of California may be not getting the i.o.u. at all — at least in time to meet the deadline of your bank. But across California on Tuesday, many vendors who had been told they would receive the i.o.u.’s instead of actual money said they had not yet received them. And if they do not arrive soon, they may be hard to turn into cash.

Last week, the state began issuing the warrants for the second time since the Great Depression. It ran out of cash to pay its bills as the Legislature and the governor failed to resolve the state’s $26 billion budget deficit. Millions of dollars in i.o.u.’s, known as registered warrants, began rolling off the controller’s presses in lieu of checks to pay taxpayers, vendors and local governments. The warrants offer a 3.75 percent interest rate when they mature in October.

In most cases, banks around the state have agreed to honor the warrants only until Friday, in hopes that the deadline will prompt lawmakers to reach an agreement. As of Tuesday, 71,810 warrants to the tune of $108 million had been printed, but many had not yet been received. "We are out of cash now," said Carlos Flores, the executive director of the San Diego Regional Center, which provides services to Californians with developmental disabilities. The center is awaiting a $12 million warrant. "I can pay my staff next paycheck, and that’s it," Mr. Flores said.

Other state contractors who provide services to the disabled had similar stories. Mark Berger, the chief executive of Partnerships With Industry, which offers job placement and training for the same type of clients, said he, too, had yet to get a warrant. "I haven’t heard of anybody who has received one," Mr. Berger said. Jonathan Brown, president of the Association of Independent California Colleges and Universities, said he had yet to learn of a college that received the warrant in lieu of the state education grants.

"My expectation is that they will get them next week," Mr. Brown said. "That is a real problem because colleges and universities have cash flow needs at this time of year and usually use a line of credit to cover their expenses, and then fill that credit line up with tuition revenues." The majority of banks have been clear that they will not take the warrants after July 10. Banks "do not wish to facilitate the lack of resolution of the budget deficit by basically providing this accommodation for an extended period of time," said Rod Brown, chief executive of the California Bankers Association. "California must become more fiscally responsible."

Garin Casaleggio, a spokesman for the state controller, said that warrants were issued as bills became due, and that not every vendor would be issued paper immediately. People expecting money from the state who do not get a warrant by Friday have three choices. They can try to find an alternative bank or credit union willing to deal with someone who is not a customer, they can hold the warrant until it matures and collect the interest, or they can try their luck in secondary markets, where some people are already seeking to buy i.o.u.’s at a discount.

Because of a proliferation of potential customers on Craigslist and other Web sites, like, the California treasurer, Bill Lockyer, said Monday that his office would not redeem i.o.u.’s held by third parties unless they were accompanied by a notarized bill of sale.

Of course, it is not clear how attractive a piece of California’s debt would be to investors. On Monday, Fitch Ratings downgraded California’s long-term bond rating to BBB from A-, only two notches from junk-bond status, citing the state’s continuing budget drama. Matt Fabian, managing director of Municipal Market Advisors, said that general obligation bonds had the full faith and credit of the state behind them, but that i.o.u.’s had a lesser guarantee.

California IOU’s traded on secondary markets

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We've Wiped Out All The New Jobs Of The 21st Century
What's the best way to express just how bad the job market is? You could look at the soaring unemployment rate, or perhaps the ever-shortening work week. How about this: Total nonfarm payrolls, notes economist James Hamilton, are now back to where they were in mid 2000, and in a few months they'll certainly be back to pre-2000 levels. 21st century job creation: gone.

U.S. Food-Stamp Recipients Reached Record 33.8 Million in April
A record 33.8 million people received food stamps in April, up 20 percent from a year earlier, as unemployment surged toward a 26-year high, government figures show. Spending also jumped, as the average benefit rose. It was the fifth straight month of record participation in the Supplemental Nutrition Assistance Program, according to the U.S. Department of Agriculture, and up 1.8 percent from the prior month. Total spending was $4.5 billion, up 19 percent from the previous all-time high reached in March, the USDA said.

The government is boosting food aid in response to a jobless rate that rose to 9.5 percent in June from 9.4 percent in May. An additional $20 billion over five years was authorized for nutrition assistance in the $787 billion stimulus bill Congress passed in February. Utah had the biggest increase in the number of recipients from a year earlier, 46 percent, while South Dakota had the steepest jump from March, 6.4 percent.

Texas was the only state where the number of participants declined from the previous month. It still had the most recipients, 2.92 million, followed by California with 2.7 million and New York with 2.34 million. The average monthly benefit for an individual rose 17 percent from March to $133.28. An average of about 35 million people are expected to be receiving food stamps each month in the year that begins Oct. 1, according to the budget President Barack Obama sent to Congress in May.

Distressed Commercial Property in U.S. Doubles to $108 Billion
Commercial properties in the U.S. valued at more than $108 billion are now in default, foreclosure or bankruptcy, almost double than at the start of the year, Real Capital Analytics Inc. said. There were 5,315 buildings in financial distress at the end of June, the New York-based real estate research firm said in a report issued today. That’s more than twice the number of troubled properties at the end of 2008. Hotels and retail properties are among the most "problematic" assets following bankruptcy filings by mall owner General Growth Properties Inc. and Extended Stay America Inc., according to the report.

The scarcity of credit is causing property defaults in all regions and among every investor type, Real Capital said. "Perhaps more alarming than the rapid growth in the distress totals is the very modest rate at which troubled situations are being resolved," the report said. About $4.1 billion of commercial properties have emerged from distress, according to Real Capital. "In far more situations, modifications and short-term extensions are being granted, but these can hardly be considered resolved, only delayed," the study said. The June figures issued today are preliminary.

Our banks are beyond the control of mere mortals
At Oxford university, I often hear people say there is nothing wrong with the system: the problem is the vice-chancellor/master/bursar/ university officials. And, in a sense, they are right. If the vice-chancellor had the wisdom of Socrates, the political skills of Machiavelli and the leadership qualities of Winston Churchill, not to mention the patience of Job, he or she would be very likely to be able to fulfil the conflicting demands of the post. But such paragons are few and far between. In the meantime we must try to find structures that can be operated by ordinary mortals.

In the same way, the claim that the fault with the banking system lies not with the structure of banks but with the boards and executives that claimed to run them is both correct and absurd. In one sense, the claim is correct: boards and executives did not successfully perform the tasks assigned to them – tasks that not only did they claim to be discharging, but for which they frequently paid themselves very large sums of money.

But, in another sense, the claim is absurd: if the failures are both as widespread and as persistent as it appears, the problem is in the job specification rather than with the incumbent. If you employ an alchemist who fails to turn base metal into gold, the alchemist is certainly a fool and a fraud but the greater fool is the patron. The bank executives pilloried by the UK’s Treasury select committee of MPs were all exceptional people.

The vilified Sir Fred Goodwin was an effective manager who had slashed through the National Westminster bureaucracy and revived a failing institution – a task that had defeated many able men before him. His chairman, Sir Tom McKillop, offered experience and ability that met every possible specification for such a role in a big international corporation. As chairman of HBOS, Lord Stevenson was Britain’s supreme networker. This skill is a particularly valuable attribute in an environment where the essence of banking is to extract very large sums of taxpayers’ money while giving as little as possible in return.

His chief executive, Andy Hornby, was criticised for being a retailer. But Halifax, half of HBOS, needed retail expertise. The only thing it needed to know about complex securitised products was that there was no good reason to buy them. Like Sir Fred, Sir Tom, Lord Stevenson and Mr Hornby, most of the people who sat on the boards of failed banks were individuals whose services other companies would have been delighted to attract. If there was a problem of board composition, it is not an issue just for financial services companies but for the UK corporate sector as a whole. Perhaps there is such a problem, but the restructuring of financial services will not wait for its identification and solution.

The hapless four were criticised for their lack of banking expertise but it is, in fact, not clear what modern banking expertise is. The world of modern banking requires all the skills of these gentlemen, plus some others, and no one can expect to have all these attributes. It has been said of Jamie Dimon (who does not have a banking qualification) that his dominance exists because at every meeting all the participants know that he could do each of their jobs better than they could. But the business world cannot operate at all if it can operate only with individuals of the calibre of Mr Dimon. Better, as so often, to follow an aphorism of Warren Buffett’s: invest only in businesses that an idiot can run, because sooner or later an idiot will.

Our banks were not run by idiots. They were run by able men who were out of their depth. If their aspirations were beyond their capacity it is because they were probably beyond anyone’s capacity. We could continue the search for Superman or Superwoman. But we would be wiser to look for a simpler world, more resilient to human error and the inevitable misjudgments. Great and enduringly successful organisations are not stages on which geniuses can strut. They are structures that make the most of the ordinary talents of ordinary people.

Treasuries Rise as Refuge Demand Bolsters 10-Year Note Auction
Treasuries surged as investors seeking refuge from an economy whose recovery may take longer than expected submitted the most bids on record at today’s $19 billion auction of 10-year notes. Yields on 10-year securities fell the most since March 18, when the Federal Reserve said it would buy U.S. debt in an effort to cap borrowing costs. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 3.28. The note sale is the third of four this week totaling $73 billion. Traders speculated that company earnings reports scheduled to start today will show profits fell in the second quarter.

"The recession is still here, so the demand was strong," said Andrew Richman, who oversees $10 billion in fixed-income assets as a strategist in West Palm Beach, Florida, for SunTrust Bank’s personal-asset management division. The yield on the benchmark 10-year note fell 16 basis points, or 0.16 percentage point, to 3.30 percent at 4:41 p.m. in New York, according to BGCantor Market Data. The yield dropped as much as 18 basis points, the most since March 18, when it fell as much as 54 basis points. The 3.125 percent security due in May 2019 rose 1 9/32, or $12.81 per $1,000 face amount, to 98 1/2. It touched 3.278 percent, the lowest since May 21.

The 30-year bond yield fell as much as 15 basis points, the most in over five weeks, before tomorrow’s auction of $11 billion of the securities. The 10-year notes sold today drew a yield of 3.365 percent, below the 3.398 percent average estimate of six bond-trading firms surveyed by Bloomberg News. Investors bid for 2.62 times the amount of debt available at the June sale, versus an average of 2.40 at the previous 10 scheduled auctions.

Indirect bidders, a class of investors that includes foreign central banks, purchased 43.9 percent of the notes. At the June sale, they bought 34.2 percent, higher than the average for the past 10 sales of 27.9 percent. "There’s a real flight to quality going on here," said Andrew Brenner, co-head of structured products and emerging markets in New York at MF Global Inc., a broker of exchange- traded futures. "Everything points to a hiccup in the economy. There is tremendous demand for U.S. Treasuries."

The offering is the second reopening of the record $22 billion 10-year note sale on May 6, and the securities mature in May 2019. The June sale totaling $19 billion drew a yield of 3.99 percent, which was the highest since August 2008. Most U.S. stocks fell, with the Standard & Poor’s 500 index losing 0.2 percent. "We are seeing money coming out of equities mainly into the belly of the curve," said Paul Horrmann, a strategist in Jersey City, New Jersey, at ICAP Plc, the world’s largest inter-dealer broker. "We are caching a bid here when equities get lower on a small flight to quality trade."

Demand has been rising at the U.S. auctions, especially from indirect bidders such as foreign central banks. That investor class bought 54 percent of the three-year notes sold yesterday, up from 43.8 percent in June.
The levels of indirect bidders at recent sales of U.S. debt may have been affected by a rule change last month that eliminated a provision allowing some customer awards to be classified as dealer bids. After more than doubling note and bond offerings to $963 billion in the first half, President Barack Obama may sell another $1.1 trillion by year-end, according to Barclays Plc, another primary dealer. The second-half sales would be more than the total amount of debt sold in all of 2008.

Yields on 10-year notes touched 4 percent on June 11 on concern the government’s borrowing would deluge demand as the economy showed evidence of emerging from its deepest recession in 50 years. Since then, yields have fallen over 70 basis points as reports suggest the recession has further to run. The Labor Department said last week that the unemployment rate rose to 9.5 percent, the highest since 1983. Analysts estimate profits for companies in the Standard & Poor’s 500 index fell an average 34 percent in the second quarter and will decrease 21 percent from July through September, according to Bloomberg data.

Alcoa Inc., the first company in the Dow Jones Industrial Average to post results, reported a second-quarter loss that narrower than analysts’ estimates. Production cuts and workforce reductions helped the largest U.S. aluminum producer save money. The Fed announced on March 18 it would buy as much as $300 billion in Treasuries over six months to hold down borrowing costs. Falling Treasury yields have helped the central bank’s mission. The average rate on a typical 30-year fixed mortgage fell to 5.32 percent yesterday, from a 2009 high of 5.74 percent on June 10, according to North Palm Beach, Florida-based

Mortgage applications in the U.S. rose last week as refinancing jumped by the most since March and purchases climbed to the highest level in three months. The Mortgage Bankers Association’s index of applications to purchase a home or refinance a loan increased 11 percent to 493.1 in the week ended July 3, from 444.8 in the prior week. The group’s refinancing gauge surged 15 percent, while the index of purchases gained 6.7 percent. The Fed is scheduled to buy Treasuries due from July 2010 to April 2011 tomorrow, followed by four more purchases over the following two weeks, according to the central bank’s Web site.

How Long Before the Fed's Days Are Numbered?
by Michael Panzner

It's no stretch to say the Federal Reserve is garnering a lot of attention these days. On Wall Street, there's a big debate over whether the Fed's next big move will come too soon or too late. In Washington, the Administration is promoting a plan to give the central bank new powers to oversee systemic risks. Over in the House of Representatives, maverick Republican Ron Paul has gathered more than 245 co-sponsors for a bill requiring an audit of the Fed. In the media, there are questions about whether President Obama will allow Fed Chairman Ben Bernanke to keep his job when his term ends in January.

And finally, some commentators are wondering whether this allegedly autonomous institution will retain its independence in a post-crisis world. But few seem to be asking what I believe is the key question: how long before the Fed's days are numbered? Before you dismiss my words as a rant, hear me out. Why, for example, is the power to commit substantial resources on taxpayers' behalf, to influence many of the most important commitments and relationships of businesses, individuals, and governments, and to initiate economic and regulatory policies with far-reaching consequences, in the hands of unelected officials with unexceptional abilities and no real accountability?

And even assuming the current arrangement has been the default choice up until now, does that mean things are destined to stay that way? The financial crisis has forced many people to rethink all sorts of assumptions, structures, and approaches. Against this backdrop, there are many reasons to believe that the broader question of why we have a Federal Reserve at all will gain traction in the period ahead.

For one thing, we have a group of individuals, entrusted with the job of reading the economic tea leaves and enacting policies in response, which not only failed to anticipate the worst financial crisis this century, but has yet to make a usefully accurate forecast since the disaster started. Remember, Chairman Bernanke is the man who maintained that the subprime meltdown would remain "contained." He also said in March that he could see the now elusive "green shoots" sprouting throughout the economy.

And once the crisis began to unfold in earnest, what was the response of those charged with looking after our nation's economic and financial interests? Cynics might describe it as Keystone Cops-like chaos. On the one hand, we've had a reactive whirlwind of aggressive monetary measures that, while creating the semblance of stability, have resolved little and stymied desperately-needed restructuring. Worse still, a broad swath of corporate America is now dependent on government support for its continued existence.

Add that to the alphabet soup of Fed-devised bailouts and rescue plans, nearly all of which seem to have been designed to reward failure, subsidize mostly insolvent but politically powerful businesses, and obscure the reality of how bad things are, and you have a system that could be characterized as even more dysfunctional than it was before the bubble burst. While it might seem like tranquility, it is more likely the calm before the (next) storm.

Then there is all the damage the Federal Reserve caused before now. Most of those who've analyzed the facts and thought about how we got this point -- I don't mean the clowns on Wall Street or the commentators spouting nonsense from both sides of the aisle -- lay a great deal of the blame on the bubble-blowing policies initiated during the Greenspan era. And if you want to go back even further, ask yourself how is it that an institution charged with maintaining stability has overseen so many crises through the years and allowed our nation's currency to lose more than 95 percent of its purchasing power since the Fed's creation in 1913?

America's central bank hasn't just failed in its economic mission. It's track record as a regulator also leaves a lot to be desired. Among the many questions people should -- and will -- be asking is: how come the Fed was ignorant of and did little to rein in the leverage and lending misadventures of America's banks, many of which have long had Federal Reserve examiners ensconced in their offices? Moreover, how is it that an institution that should have known about the intricacies of derivatives was so oblivious to the threats posed by these "weapons of financial mass destruction"?

The truth is, aside from those periods when conditions and markets have set out a relatively easy path for central bankers to follow, the Federal Reserve has not lived up to its mission or its promise. Pretty soon, a growing number of people are going to be wondering why we need this institution at all.

Obama's Support Collapses In Rust-Belt Ohio
The weak economy -- or, more importantly, the failure to create jobs quickly -- is flensing Barack Obama's support on Ohio, a crucial electoral state.

Here's the announcement from Quinnipiac, which conducted the poll:

President Barack Obama gets a lackluster 49 - 44 percent approval rating in Ohio, considered by many to be the most important swing state in a presidential election, according to a Quinnipiac University poll released today. This is President Obama's lowest approval rating in any national or statewide Quinnipiac University poll since he was inaugurated and is down from 62 - 31 percent in a May 6 survey.

By a small 48 - 46 percent margin, voters disapprove of the way Obama is handling the economy, the independent Quinnipiac (KWIN-uh-pe-ack) University poll finds. This is down from a 57 - 36 percent approval May 6. A total of 66 percent of Ohio voters are "somewhat dissatisfied" or "very dissatisfied" with the way things are going in the state, while 33 percent are "very satisfied" or "somewhat satisfied," numbers that haven't changed since Obama was elected.

It's numbers like these, even more than bad economic data, that will really get Democrats to rally around a second stimulus, one that's especially focused on creating blue-collar jobs ASAP. Ed Rendell, who's home state of Pennsylvania shares characteristics with Ohio, was on CNBC this morning saying exactly that: This time, let's do that infrastructure stuff.

Nate Silver is a little skeptical, but even he concedes voters are judging Obama on the bad economy:

Ohio, of course, has suffered more than most states from the recession. It's employment rate, at 10.8 percent in May, is the eighth-highest in the nation, and has increased by 3.5 points (and counting) since Election Day:

States with Largest Increases in Unemployment Rate since November

What Ohio hasn't done, though, is suffer uniquely from the recession. It doesn't have it nearly as bad as its neighbor, my native state of Michigan, where unemployment is now at 14.1 percent. And what are Obama's approval ratings like in Michigan?

Not so bad. A Rasmussen poll in mid-June put Obama's approval there at 59-39, including 39 percent strongly approving (and remember, Rasmussen has tended to have very bearish numbers on Obama overall). An EPIC-MRA poll of Michigan in late May, meanwhile, had 61 percent rating his job performance as "excellent" or "pretty good".

The point is not that Obama's approval ratings aren't suffering because of the economy, nor that they might not be suffering more in states where the economy is worse. (Whoa, too many double-negatives there). I just doubt that there any problems Obama has that are so unique to Ohio that you wouldn't also see them manifested in Michigan or Pennsylvania (where Obama's approval numbers have also generally been fine). As such, I think the headlines this poll has generated have been a little overwritten.

Given Obama's support for the auto industry, the Michigan numbers may be inflated a bit. We'd be really curious about Indiana, a traditionally red state that went blue.

Power of Stimulus Slow to Take Hold
Five months after Congress approved a massive package of spending and tax cuts aimed at reviving an ailing economy, the jobless rate is still climbing and the White House is scrambling to reassure an anxious public that President Obama's prescription for economic recovery is on the right track. Yesterday, Obama took time out of his first presidential trip to Moscow to defend the $787 billion stimulus package, arguing that the measure was the right medicine at the right time. "There's nothing that we would have done differently," he told ABC News.

Back in Washington, senior Democrats on Capitol Hill were nervously contemplating whether additional government stimulus spending may be needed to pull the nation out of the worst recession since the 1930s. Senior administration officials acknowledged that the effects of the stimulus package have been overshadowed by an unexpectedly sharp drop-off in employment since the measure passed in February. But they reported that only about $100 billion has so far been spent and that as increasingly large sums flow out of Washington, the program is on pace to save or create 600,000 jobs over the next 100 days.

"It is clear from the data that there needs to be more fiscal stimulus in the second half of the year than there was in the first half of the year," White House economic adviser Lawrence H. Summers said. "Fortunately, the stimulus program designed by the president and passed by Congress provides exactly that."

Leading economists agree that the most powerful effects of the stimulus package have yet to be felt. But even if the measure lives up to Obama's expectations, it would barely offset the 433,000 jobs the nation lost last month alone, and the resulting employment would represent a drop in the bucket compared with the 6.5 million jobs lost since the recession began in December 2007. "Just 130 days out on the adoption of a very, very major effort to get the economy moving, certainly I don't think we can make a determination as to whether or not that's been successful," House Majority Leader Steny H. Hoyer (D-Md.) said yesterday. But, he said, "I think we need to be open to whether or not we need additional action."

Republicans, meanwhile, pounced on news that the unemployment rate increased to 9.5 percent in June and accused the Democrats of sinking the nation deeper into debt to finance an economic recovery package that has failed to save American jobs. Noting that the Obama administration predicted earlier this year that stimulus spending would keep the unemployment rate under 8 percent, Rep. Eric Cantor (R-Va.), the No. 2 Republican in the House, said, "I think any objective measure would indicate there's a failure when you have a commitment of nearly $800 billion in taxpayer funds and you have the type of job loss we're experiencing."

With many economists forecasting that the jobless rate will continue to climb -- and is likely to stay above 10 percent through much of next year -- Republicans vowed to make the 2010 midterm election a referendum on Obama's stewardship of the economy. "I think they're going to have some significant problems," said Sen. John Cornyn (R-Tex.), who leads the GOP campaign operation in the Senate, "and I view those as opportunities for us."

Despite the deepening pain of the recession, many Democrats in the White House and on Capitol Hill yesterday counseled patience. They said it would be extraordinarily difficult to win approval for more spending on the economy when Obama is pursuing a host of other expensive initiatives, including a $1 trillion expansion of the nation's health-care system. And they argued that the current stimulus package should be given a chance to work.

The stimulus was designed to deliver a gradually stronger push to the economy through the end of next year. It contains about $499 billion in new spending and about $288 billion in tax cuts for working families, businesses, college students and first-time home buyers. When the measure passed, the nonpartisan Congressional Budget Office predicted that about a quarter of the money would be spent by year's end, and that about 75 percent would flow by the end of 2010. So far, economists said, spending appears to be on track.

According to administration estimates, about $158 billion in new spending had been committed to specific projects by the end of June, but just a fraction of that money -- about $56 billion -- had been delivered to struggling state governments, unemployed workers and other recipients. An additional $43 billion had been left in the pockets of individuals and businesses through uncollected taxes, much of it the result of Obama's signature Making Work Pay tax credit for working families.

Those figures track closely with estimates by Mark Zandi, chief economist for Moody's, who calculates that the government made $242 billion in stimulus funds available for various purposes through the end of June and paid out about $110 billion. In a recent analysis, Zandi predicted that "the maximum contribution from the stimulus should occur in the second and third quarters of this year," when it will add more than three percentage points to overall economic growth. "It's pretty much according to plan in terms of the payout and in terms of its economic impact. This is in the script," Zandi said. The problem, he said, is that "the economy has been measurably worse than anyone expected," with a surprisingly sharp "collapse in employment and surge in unemployment" that caught most economists off guard.

"That's why the administration's forecasts have been so wrong," he said. The White House continues to predict that the stimulus package will save or create 3.5 million jobs by the end of next year. Zandi predicts it will fall short of that, producing about 2.5 million jobs -- still a significant impact. Whatever the number, Democrats are hoping it will be enough to convince voters that Obama is leading them out of the economic wilderness.

"I think the president was very clear that things were going to take a long time to turn around," said Rep. Chris Van Hollen (D-Md.), who leads the Democratic Congressional Campaign Committee in charge of electing Democrats to the House. Republicans "are making the argument to the American people that doing nothing would have been the best policy. And I don't think people will buy that. . . . "The measures we have taken have certainly prevented things from getting much worse."

Stimulus: Where's the $787 Billion?
Administration officials insist that it takes time to dole out money properly, which explains why so little has been spent so far. Call it the $787 billion question: Where is all that government stimulus money, and why hasn't it stemmed the heart-stopping slide in U.S. employment? The stimulus plan was all about jobs, after all. Key Obama Administration officials pledged to save or create between 3 million and 4 million jobs with the measure. But the federal government's employment figures on July 2 clocked in worse that expected, with job losses lurching to 467,000 in June and the unemployment rate reaching its worst showing since 1983, at 9.5%; many expect it to rise further still.

Public confidence in the stimulus plan is slipping and over the weekend, Vice-President Joe Biden suggested another stimulus plan is possible, something of a shift from Obama's position just two weeks ago that more spending isn't yet called for. Yet analysts and federal contracting experts say that, in many ways, stimulus spending is going about as quickly as expected. Dispensing billions of dollars, it turns out, simply takes time, particularly given government contracting rules and the fact that much of federal spending is funneled through the states.

Moreover, some spending was intentionally spread out over several years, and other projects are fundamentally more long-term in nature. "There are real constraints—physical, legal, and then just the process of how fast you can commit funds," says George Guess, co-director of the Center for Public Finance Research at American University's School of Public Affairs. "It's the way it works in a decentralized democracy, and that's what we're stuck with." Certainly, based on key numbers, it looks as if the five-month-old spending legislation has been slow to unfold.

Onvia (ONVI), a Seattle company that tracks federal spending, estimates that some $65 billion of the $420 billion that was in the stimulus package for contract and infrastructure spending has gone out the door. Federal officials offer similar numbers, saying $60 billion of the $499 billion in total stimulus spending has been disbursed. (The remaining $288 billion consisted of tax cuts.) But those numbers mask a lot of activity, analysts and government officials say. Onvia has identified some 18,500 specific projects covered under the legislation, and while just under 1,800 of them have had contracts awarded, another 5,000 or so have been put out to bid. For the remainder, funds have been allocated but not spent, says Michael Balsam, the company's chief solutions officer.

Ed DeSeve, senior adviser to the President for recovery and reinvestment, tells BusinessWeek that $157.7 billion has been "obligated" for projects of various kinds, roughly a third of total stimulus spending, and $43.3 billion has been distributed in tax breaks. "We think we're right on target," DeSeve says. He also argues that it makes more sense to count funds allocated to specific projects than dollars actually spent. "When do you buy something—when you use your American Express, or when you pay your bill?" DeSeve says. "You buy it when you use your American Express." Critics of the stimulus rollout argue that what matters most is when the dollars reach the economy—the equivalent of when American Express pays the merchant.

The U.S. Transportation Dept. recently stressed that it routinely reimburses states for payments to contractors on federal infrastructure jobs, meaning work can be under way for some time before states pay contractors and seek reimbursement from the feds. Doing otherwise risks wasting federal funds by overpaying up front, the agency said on an Administration blog. Still, some basic facts of federal contracting slow the process, analysts say. Funneling federal funds through state agencies can prove slower than awarding contracts directly. Seeking competitive bids—a process that's designed to ensure the government doesn't overpay or favor select contractors—also takes time. "It's really not going all that slowly when you take into consideration just the process to spend federal money," says Clint Currie, a transportation analyst for Concept Capital's Washington Research Group.

Similarly, funds allocated to help states with Medicaid and school costs began flowing pretty quickly, says Nick Johnson, director of the Center on Budget and Policy Priorities' state fiscal project. But there, some of the spending was explicitly earmarked for 2010 and even 2011. The Administration has said it hopes to meet Congressional Budget Office estimates that 70% of stimulus funds will be spent by fall 2010. "Everyone knew the recession wasn't going to end in a blink," Johnson says.

Other projects will take time by their very nature—as is the case with funds intended to foster what the Administration calls long-term, sustainable growth in industries supporting public transit or renewable energy. Transit funds that go toward replacing light-rail or subway cars could take years to spend, and building a new light-rail system could take a decade or more, as did Charlotte's 18-month-old light-rail system, says Guess, the American University researcher. Plus, state and local agencies must determine which projects actually qualify for federal funds under rules set by Congress.

One bright spot: Bids for many projects are coming in under expectations, sometimes by as much as 20% to 30% in the case of some transportation contracts, analysts and government officials say. Depressed demand for materials has lowered prices, while contractors are willing to work more cheaply than when construction was booming, notes Currie, the transportation analyst. There are other, less obvious impediments as well. In a few cases, lawmakers have sought to reject federal funds, as in South Carolina Governor Mark Sanford's failed effort.

Other programs that would have qualified for federal matching dollars under the stimulus plan have been cut as states face their own budget woes. As the unemployment rate rises across the country, some states are forgoing stimulus dollars specifically designated to help the unemployed. As of July 2, little more than half of the money had been claimed, and four states rejected it altogether, according to ProPublica, a nonprofit news organization. In some cases, states worried that accepting the money would require them to sweeten the benefits they offered laid-off workers at a prohibitive cost to the state.

If simply tracking stimulus spending has proven complex, determining how many jobs have actually been created or saved is even more daunting. Most Administration estimates come down to a fairly straightforward but indirect calculation: Each $1 million of government spending creates 10.9 jobs, or about $92,000 a year for each job, including benefits, administrative costs, and other overhead. Using that ratio, for example, a $1.6 billion contract to demolish and remediate a Washington state nuclear facility could generate 17,740 jobs, but whether it ultimately does, only time will tell.

Starting Oct. 10, stimulus-fund recipients must begin reporting more concrete details on jobs and spending at, and federal budget officials have made it clear that they plan to refine reporting requirements as time goes on, says Craig Jennings, a senior policy analyst with OMB Watch, a nonprofit group that focuses on budget issues. "It's not hopeless," Jennings says. The federal Office of Management and Budget "has been very clear on the fact that their approach is iterative. They're not going to get it right the first time." But even then, it won't be easy to square whatever job gains are claimed with rising unemployment. Few economists expect the jobs picture to improve this year, and many predict the national unemployment rate will rise to 10% or beyond. Ultimately, stimulus supporters argue that, without it, job losses would be even worse.

Treasury Taps Nine Managers for $40 Billion Toxic-Debt Program
The U.S. Treasury named BlackRock Inc., Invesco Ltd. and seven other managers for the Public- Private Investment Program, in an effort to remove as much as $40 billion in troubled assets from financial institutions. The Treasury will invest as much as $30 billion in the program, and the nine companies may raise a combined $10 billion, the department today said in a statement. The others are: AllianceBernstein LP, Marathon Asset Management LP, Oaktree Capital Management LP, RLJ Western Asset Management LP, the TCW Group Inc., Wellington Management Co., and a team of Angelo Gordon & Co. and GE Capital Real Estate.

The fund managers each must contribute a minimum of $20 million of their own capital and also raise at least $500 million from private investors within 12 weeks. The first closing on an established PPIP fund is expected in August, the Treasury said. "While utilization of legacy securities will depend on how actual economic and financial market conditions evolve, the programs are capable of being quickly expanded if these conditions deteriorate," Treasury Secretary Timothy Geithner, Federal Reserve Chairman Ben S. Bernanke and Federal Deposit Insurance Corp. Chairman Sheila Bair said in a joint statement.

Pacific Investment Management Co. isn’t among the selected firms. The Newport Beach, California-based unit of the Munich- based insurer Allianz SE said today in a statement it withdrew its application to serve as a manager "as a result of uncertainties regarding the design and implementation of the program." Pimco manages $756 billion, including the world’s largest bond fund. PPIP funds will initially target commercial mortgage-backed securities and non-agency mortgage backed securities issued before 2009, with an initial rating of AAA or its equivalent, the department said. If the program goes above $40 billion, it could utilize the Fed’s Term Asset-Backed Securities Lending Facility.

Today’s announcement reflects the scaled-down start of a program that was announced as having the potential to reach $1 trillion in distressed loans, mortgage-backed securities and other assets. The program was laid out to use $75 billion to $100 billion from the $700 billion Troubled Asset Relief Program alongside private-sector leverage. The asset managers named today will work on the Legacy Securities Program, one half of the original initiative. A second component dealing with whole loans, to be run by the FDIC, was delayed last month.

Geithner, Bair and Bernanke said the FDIC is committed to making the Legacy Loan Program available as needed. The FDIC is planning to test its PPIP mechanisms in July when selling the assets from a failed bank, the regulators said. The FDIC previously has named Georgia’s failed Silverton Bank as its potential test case. For the securities program, TARP-related executive compensation limits will not apply to asset managers or private investors, provided the funds are set up so that the asset managers and their employees aren’t controlling investors, the Treasury said in a fact sheet accompanying its statement. Private investors in the funds will be subject to a maximum investment of 9.9 percent in the PPIP funds, the Treasury said. There is no other limit on foreign investor participation.

The PPIP funds will be allowed to buy securities from sellers eligible under the TARP law. In general, sellers must be established and regulated in the U.S. and not owned by a foreign government, except under certain circumstances related to failed institutions, the Treasury said. The Treasury also released conflict-of-interest rules, developed in consultation with the Fed’s compliance staff, fund managers, and the Special Inspector General for the TARP, the Treasury said. The nine asset managers also have established relationships with 10 small, woman-owned and minority-owned financial services businesses, the Treasury said.

Boston Fed: Obama Loan Mod Program Unlikely To Work
A study released by the Federal Reserve Bank of Boston this week indicates that the $75 billion that the Obama administration is directing to the lending industry to encourage loan modifications probably won’t work. The four-month-old anti-foreclosure program has — at least so far — shown weak results. According to the Obama administration’s own estimate, "over 50,000" loans were modified to make payments more affordable for borrowers at risk of default, The New York Times reported. That’s a small number considering that millions of new foreclosures are expected in the next couple years.

Paul S. Willen, senior economist at the Boston Fed, told The Boston Globe that it would probably make more sense to give the money directly to struggling homeowners to cover their payments because lenders aren’t eager to do loan workouts because they aren’t profitable. The Obama plan would give bonuses and other incentives to loan servicers to modify loans ($1,000 for each loan they modify and $1,000 each year that a borrower says current on their modified loan payments). According to The Globe:

"Willen said the success bonus could have the unintended effect of steering loan servicers away from those who need help the most, and toward only those borrowers most likely to recover on their own anyway. He said that if modifications increase, it won’t be by much. "My guess is they are going to help people who are OK, and they are not going to help people who are deep trouble,’’ he said."

US stimulus helps create 14,200 summer jobs
President Barack Obama's $787 billion economic stimulus package will help put 14,200 teens and young adults to work this summer in Ohio, and most of the stimulus-funded highway projects in the state are reaching economically distressed areas, according to a federal report released Wednesday. All but one of the state's highway projects are scheduled to be completed within three years. The exception is the replacement of the 50-year-old Interstate 90 bridge in Cleveland, a major project expected to take four years, the U.S. Government Accountability Office said in a report to Congress.

The GAO's audit covers 16 states and the District of Columbia that together are getting about two-thirds of the stimulus money. The agency is issuing reports every two months to examine how stimulus funds are being used. Ohio, where the unemployment rate has jumped to 10.8 percent, the highest in more than a quarter century, expects to get $8.2 billion in stimulus money over the next three years. The summer jobs program will put young workers in parks, community colleges, hospitals and public schools.

The Obama administration intended for the stimulus to jump-start the economy, build new schools and usher in an era of education reform. But government auditors said many states are setting aside grand plans to stay afloat. That included Ohio, where stimulus funds make up about 5 percent of Ohio's general revenues for the $54 billion 2010-2011 budget. Ohio still faces a deficit, and Democratic Gov. Ted Strickland and Republican lawmakers remain deadlocked over how to balance the budget.

The stalemate is preventing some Ohio school districts from launching long-term education reforms because stimulus money for schools is tied to the state budget, GAO auditor Cynthia Fagnoni said. And as tax revenues across the state continue to drop, many school officials are just looking to retain programs and teachers they have and avoid large layoffs, Fagnoni said. Cleveland, however, is trying something different. School officials plan to offer 200 teachers who are at or near retirement the chance to stay and serve as teacher coaches or tutors for students. These teachers must agree to retire or resign after two years, when the stimulus act ends.

In the 16 states, about half the money set aside for road and bridge repairs is being used to repave highways rather than to build new infrastructure, the GAO said. And officials aren't steering the money toward counties that need jobs the most, auditors found. The Ohio Department of Transportation, which is getting $774 million in stimulus money, fared better.

Ohio has selected 210 transportation projects to get stimulus money, and 194 of them are located in economically distressed counties, the GAO said. Transportation officials told the GAO that since 79 of Ohio's 88 counties are considered economically distressed under federal guidelines, targeting projects in struggling areas wasn't difficult. The GAO didn't provide an estimate of jobs created under the stimulus plan but noted that as of June 25, Ohio had awarded 52 highway contracts valued at $92.1 million and construction on some projects had begun.

An unknown country
by Paul Krugman

A correspondent writes in, denouncing my latest column, and says that if things go my way we’ll end up with the government providing health care to everyone, which will “destroy the American way of life.”

Hmm. There’s a country this correspondent — and many others who denounce “socialized medicine” — should look at. It’s a country where there is, indeed, a substantial private health insurance industry, which pays 35 percent of medical bills. But the government pays a larger share — 46 percent. (Most of the rest is out-of-pocket spending.)

The country is called the United States of America.

The inevitable socialisation of health care financing
by Willem Buiter

Private insurance only works if there is risk. If the risk is eliminated, profitable insurance is impossible. This holds for health insurance as it holds for credit default swaps. When risk vanishes, insurance turns into redistribution. That’s a task for the state, whether through the tax payer or by mandated pooling in quasi-private insurance schemes of individuals with known heterogeneous health profiles.

The rise of genomics - the branch of genetics that studies organisms in terms of their full DNA sequences or genomes - will in the not too distant future kill off most private health insurance. That’s probably a good thing, for two reasons. First, because of asymmetric information, when there is risk and uncertainty about a person’s future health, health insurance markets are badly affected by adverse selection and moral hazard. Second, because the private health insurance industry is a monument to inefficiency everywhere and, especially in the US, a rent-seeking Leviathan whose ruthless lobbying efforts corrupt all it touches.

When it becomes possible early in life to map out a person’s future infirmities, illnesses, disabilities and eventual cause(s) of death (other than those due to accidents or violence), it becomes impossible to have health insurance based on market principles and the profit motive. With profitable health insurance impossible because you cannot insure a sure thing, there are but two options left. Either you leave those with poor health prospects to their own devices (the ‘tough luck’ approach) or you turn health insurance into interpersonal redistribution of income, that is, you socialise health care funding. This redistribution is from those with above-average health prospects to those with below-average health prospects.

Such a redistribution policy can either use general tax revenues (the way the British National Health Service is financed) or can involve subsidised health ‘insurance’ in a world with mandatory health insurance where those with below-average health prospects are pooled with the rest of the population and where individual health insurance premia do not reflect an individual’s health prospects - like the assigned-risk pool for car insurance in the US. Under either system there would be a minimum guaranteed quality of health care that everyone is entitled to, regardless of ability to pay, and that would be paid for either out of general tax revenues or out of the premia contributed by those with above-average health prospects.

I start from the proposition that health care, up to a collectively decided minimum standard, should be available to everyone. That is, it should be universal and mandatory. Obama’s plan does not include the provision that everyone has to have health insurance up to a minimum standard. If health care is to be universal, it should be de-coupled from employment completely. The availability of health care should be a function of the condition of being alive, not of the condition of being employed. Here too, Obama’s health care plans, which retain tax advantages for employer-provided health insurance, fall down badly.

With socialised healthcare financing, health care will be rationed for most people. If you include price rationing among the rationing mechanisms, health care will be rationed for everyone. Jones can get dialysis; Smith cannot. There is a liver for Blogs but not for Blags. Drug X (which costs thousands of dollars for a year’s supply) will be made available to persons with early stage breast cancer but not to those with late stage breast cancer. No hip replacements for those over 95, unless you are a member of the royal family etc. etc. With heroic, high-tech health care capable of absorbing most of GDP unless rationed by quantity or price, health care rationing - involving involuntary euthanasia by committee or market for those rationed out of access - will be part of all our futures.

The details of the health care rationing mechanism will be a matter of life and death - literally. It has always been thus when ability to pay was used to select those who would gain access to scarce and costly treatments in the market for health services. Rationing of life-saving and comfort-enhancing costly treatments in the British National Health Service has been achieved through various forms of administrative discretion, sometimes involving the (professional or unprofessional) judgments of physicians. Education, influence and connections - the trademarks of the ‘aristocracy of pull’ everywhere - have been key drivers of who gets what quality health care in the NHS since its inception.

It is essential that the health care rationing mechanism be transparent; it should also be contestable - in real time - by those excluded from a treatment they desire. New forms of discrimination will become politically important and old forms of discrimination (e.g. age-based, as in "why give a new kidney to 95-year old?" or "do we assign this incubator to the premature baby most likely to benefit from it or the one most in need of it?") will take on greater political significance. At work, people and committees will be playing God on an ever-growing scale. I wonder how they behave when they come home.

Note that nothing I have said sheds any light on the best way to provide medical care - on whether health services should be supplied privately, cooperatively, by the state, with or without regulation etc. It only concerns who pays, and there the answer is clear: you and I as tax payers or you and I as mandated providers of subsidies in large assigned-risk pools.

Shipping flashes early warning signals again
Port statistics are revealing. They were a leading indicator before the production collapse in the Japan, Europe, and the US over the winter, and they may be telling us something again. Amrita Sen at Barclays Capital says the number of Baltic Dry ships waiting to berth — mostly in China and Australia — has begun to fall after peaking at 154 in mid-June. The Capesize Iron Ore Port Congestion Index (a new one for me, I must confess) is replicating the pattern seen a year ago just before the commodity boom tipped over.

"The anecdotal evidence we are hearing is that vessel queues have been falling. There are reports of cancelled tonnage from China pointing to a slowdown in Chinese buying of coal and iron ore. "We are definitely expecting a correction. People have been building stocks of iron ore too quickly in anticipation of the stimulus package in China," she said. The Baltic Dry Index measuring freight rates jumped 450pc in the first half of the year on the China rebound, but has begun to fall back over the last two weeks. (Sen doubts freight rates will recover much since 1000 new ships are hitting the market this year and again next year, compared to 300 in normal years. There is obviously a horrendous shipping glut).

Over at Naked Capitalism they are reporting that international port traffic for containers (ie finished goods) is as dire as ever. The rates for 40-foot container from Asia and America’s West have actually fallen this year from $1,400 to $920. "There has never been a decline like this before," said Neil Drecker from the Drewry Report. "The container industry is looking at a $20-billion black hole of losses. We can expect a lot of casualties."

As readers can guess, I remain extremely sceptical of this commodity rally (although it was to be expected as part of the inventory restocking effect). It is not underpinned by real global demand. It is a anti-inflation play by funds betting that quantitative easing by the world’s central banks will lead to systemic currency debasement. That may ultimately happen, but the more immediate threat is the abrupt slowdown/contraction of the broad money supply (M3, adjusted M4) and the collapse in the velocity of money, as well a post-War low in capacity use (68pc in the US), and a massive global "output gap".

All the deeper signs suggest to me that action by the Fed, Bank of Japan, Bank of England, and the European Central Bank is still not enough to offset the deflation shock. Though I recognize that this is a deeply unpopular view these days in the blogosphere. Deutsche Bank has told clients to tread carefully. It says the global output gap is minus 6pc, and it is this gap — not the level of economic growth as such — that drives oil prices over the long run.

We have in any case seen a $10 dive in oil prices already as the doubts creep in on the global recover. Note that Deutsche Bank’s China team says the Chinese economy is "close to the cusp of the second down leg of a forecast `W’ on the back of tightening lending and slowing stimulus spending," according to the bank’s latest report `Still Wary of Global Cyclicals’. We are all longing to be bulls again, but we (Mankind, especially the West) have a long hard slog ahead to work off our debt depravities.

Shipping industry in deep water
Trade at international ports is on track to drop more than 10% this year, one of the steepest declines ever, according to a new maritime industry report. Cargo ships will carry 27 million fewer containers by year's end than they did in 2008 -- a reduction roughly equivalent to all of the cargo containers handled by the five busiest U.S. seaports in a typical year, according to London-based Drewry Shipping Consultants' Container Forecaster Report.

"There has never been a decline like this before. We have never seen numbers like these," said Neil Dekker, editor of the Drewry report. "The container industry is looking at a $20-billion black hole of losses. We can expect a lot of casualties." Because the ports of Los Angeles and Long Beach are so busy -- they handle more than 40% of U.S.-bound cargo container trade -- the wharves here are disproportionately affected by the drop-off in imports and exports, Dekker said.

The ramifications for the Los Angeles and the Long Beach ports will be felt in some of the best-paying blue-collar jobs in the nation, as longshore workers lose hours at the docks, truckers have fewer containers to carry and railroad traffic ebbs. The Inland Empire, which has the nation's second-highest unemployment rate among urban areas because of the collapse of its warehouse and distribution system, will continue to suffer, said Jack Kyser, chief economist for the Los Angeles County Economic Development Corp.

"The forecasts for 2010 call only for a very moderate recovery in trade volume. This is a long-term problem. It will take several years for us to get back to the trade levels we saw in 2006 and 2007," Kyser said. At the Port of Long Beach, the nation's second-busiest container port behind Los Angeles', trade volumes have been knocked back all the way to 2003 levels, according to spokesman Art Wong, wiping out all of the trade gains recorded during the boom years of 2004 through 2007. Similar results can be found at many of the major U.S. ports.

"It's unprecedented for us to see this kind of slide. Is it going to flatten out? Are we at the bottom? We don't know yet," Wong said. The continuing global recession has run so deep that it has caused Moody's Investors Service to downgrade its outlook to negative overall for the 53 U.S. ports whose credit ratings it tracks. But there is a bright spot for Los Angeles and Long Beach, according to a new report by Moody's. Even though the two ports are spending millions on expensive environmental improvements and legal battles over their plans to clean up the air, the ports remain attractive to shippers, the report said.

"Los Angeles-Long Beach are the two most highly rated ports in the U.S. Two of the primary drivers are their strong financial situations and their competitive market positions," said Baye Larsen, an analyst and assistant vice president at Moody's. "Both are a key advantage for those ports. They will be among the first to benefit when the recovery does come." Lori Kelman, spokeswoman for the Port of Los Angeles, said officials expect business to pick up toward the end of the year.

"Our port is positioned well to embrace that recovery," Kelman said. There are few indications that the turnaround will begin any time soon. The trade route that had been the most resilient in the face of the global recession -- between Asia and Europe -- has now succumbed to the downturn as well. So far this year, the last three years of growth in trade between Asia and Europe have been erased, Dekker said. The result, he said, would be consolidation throughout the shipping business.

"We believe that, consequently, the basic makeup of the industry will change as companies either go bust, amalgamate or shrink, shedding assets and personnel in the process," Dekker said. Many shipping lines are consolidating and sharing cargo routes with competitors to reduce costs. The world's biggest shipping line, A.P. Moller-Maersk of Denmark, has a worldwide fleet that is bigger than the U.S. Navy. Maersk has been the Port of Los Angeles' biggest tenant in terms of cargo volumes. But this year it has sharply cut back its service in Los Angeles and to other ports to cut costs. Maersk Line, which operates 470 vessels and owns 1.9 million containers, says it lost $559 million in the first quarter of 2009.

Freight rates for transpacific trade, the amount that shipping lines can charge for a typical 40-foot container for cargo moving between Asia and the West Coast of the U.S., have plummeted to $920 from $1,400 at the beginning of the year, according to the Drewry report. The continued slump has dashed the hopes of many in the industry, who had come to believe that the recession had bottomed out and that a recovery was beginning. "At this moment we can't see anything particularly positive around the corner," Dekker said. "We don't want to be overly negative. That is just the reality."

OPEC 2008 oil, gas income tops $1 trillion, reserves up
OPEC's income from oil and gas exports jumped 35 percent to more than $1 trillion last year as world oil prices hit record highs of almost $150 per barrel, the group said in its Annual Statistical Bulletin on Wednesday. The Organization of the Petroleum Exporting Countries saw the total value of its petroleum sales abroad reach almost $1,007 billion in 2008, up from $746 billion in 2007, which was itself a record.

Benchmark U.S. crude oil futures started 2008 at just under $100 per barrel, rose to a peak of more than $147 in July and then retreated to around $40 by the end of the year, giving an average price for 2008 of around $99, up from $72 in 2007. OPEC, which groups 12 countries following the departure of Indonesia at the end of 2008, pumps around a third of the world's oil and straddles almost four fifths of the world's proven crude oil reserves. The increase in prices last year kept all of OPEC's members in current account surpluses with a group current account balance of $467 billion for the year, up 28 percent.

The world's biggest oil exporter, Saudi Arabia, earned $283 billion from petroleum exports last year, up from $206 billion in 2007, the report showed. The increase helped push up Saudi Arabia's national output by more than a quarter as its gross domestic product (GDP) rose to $482 billion in 2008, from $381 billion in 2007. OPEC's total GDP increased to $2.88 trillion last year from $2.27 trillion in 2007.

The group's proven crude oil reserves grew 7.9 percent last year to 1.027 trillion barrels from 952 billion in 2007 and 940 billion in 2006, the report said. The rise was mainly due to a reassessment of the proven crude oil reserves in Venezuela, which saw its reserves rise to 172 billion barrels in 2008, from 99 billion in 2007. OPEC's natural gas reserves rose 2 percent to more than 93 trillion cubic meters. The biggest OPEC gas reserves are beneath Iran, which had 29.6 trillion cubic meters of proven natural gas reserves last year, up from 28.1 trillion in 2007.

The second biggest reserves are held by Qatar, which had around 25.5 trillion cubic meters last year. Analysts have questioned the size of reserves in Middle Eastern OPEC countries, but several producers, including leading exporter Saudi Arabia, have denied suggestions that their reserves have been exaggerated. Saudi Arabia alone accounts for more than a quarter of OPEC's crude oil reserves at 264 billion barrels.

OPEC: Recession leaves lasting crimp in oil demand
Demand for OPEC crude has fallen so sharply because of the world recession that it will take another four years to recover to 2008 levels, the 12-nation oil producers' organization predicted Wednesday. The forecast was one of several profiled by the Organization of the Petroleum Exporting Countries in its oil supply and demand outlook to 2030 reflecting the deep crimp in the world's appetite for oil because of falling international industrial production and related developments that have lessened crude use.

OPEC meets more than a third of the world's annual oil demand, which the International Energy Agency has put at nearly 86 million barrels a day for 2008 - about 2.5 million barrels more than for recession-ridden 2009. In its annual report, the organization said the world would need 87.9 million barrels of crude a day by 2013 - nearly 6 million barrels less than previously expected. Of that, said the report, OPEC would need to produce 31 million barrels a day, compared to a daily 31.2 million barrels last year.

Some of the reduced need was due to the increased use of biofuels and other energy sources, said the report. Still, it suggested that much of the lessened demand was due to the global economic downturn.
Still, the 250-page report said that energy use up to 2030 was set to rise "under all scenarios," with oil and other fossil fuels continuing to represent the largest slice of the energy pie. "Fossil fuels will contribute "more than 80 percent to the global energy mix over this period," said the report. "And oil will continue to play the leading role to 2030."

Like oil suppliers in general, OPEC was hard hit by the plunge in demand starting last year as the world recession spread and deepened, said the report. It predicted that demand for OPEC crude, after falling this year will "rise slowly over the medium term, returning back to 2008 levels by around 2013." It also said that developing countries would account for any increase in demand, with industrialized countries continuing to be more harshly effected by the economic downturn and its protracted aftermath.

Demand from industrialized countries, which peaked in 2005, is expected to fall from a daily 47.5 million barrels last year to 45.5 million barrels a day by 2010 and will likely remain at that level up to 2013, said the report. While it named developing countries as "the main source of demand," the report suggested that could not make up for the stagnation in U.S. and other major consumers. Beyond forecasting that that by 2013, the world's overall appetite for crude will be 5.7 million barrels a day lower than it had forecast last year, it and noted that daily demand had already slumped by more than 4 million barrels already this year.

In developing countries, oil consumption was expected to rise by 23 million barrels a day between 2008 and 2030 to reach a daily 56 million barrels, with "almost 80 percent of the net growth in oil demand ... in developing Asia," said the report. "Nevertheless, per capita oil use in developing countries will remain far below that of the developed world," said the forecast." "For example, oil use per person in North America will still be more than 10 times that of South Asia."

G8 summit begins amid fears global economy is sinking back into recession
Growing fears that the global economy could sink back into recession after a brief rally dominated the agenda as the leaders of the G8 nations gathered in Italy for their annual summit today. Gordon Brown arrived in L'Aquila, in the region devastated by an earthquake in April, urging fellow world leaders to avoid complacency about the prospects for growth, jobs and investment. The prime minister's comments came amid recent downbeat data which has dampened hopes of rapid recovery.

The G8 leaders were due to discuss Barack Obama's plan for a crackdown on oil speculators amid concerns that the recent increase in crude prices threatened a double-dip recession. After falling from a peak of $147 (£91) a year ago to a trough of $35 at the turn of the year, oil prices last month rose above $70 a barrel. Although no new package of tax and spending measures will emerge from the three days of talks, the leaders hope to reach agreement on measures to cap energy prices and combat rising protectionist pressures.

Brown, who took centre stage at the G20 summit in London, was planning to warn fellow leaders that they needed to focus on the current state of the global economy rather than plan ahead for 2011 or 2012. Britain wants the meeting to address five key issues hindering recovery from the most serious global downturn since the 1930s – a credit famine, rising unemployment, protectionism, a lack of investment and oil prices.

Growth in the west's leading industrial nations has collapsed since the banking crisis last autumn, with output dropping at an annual rate of 4.9% in the UK, 8.4% in Japan, 6.9% in Germany and 2.5% in the US.
The G8 will draw comfort from the stabilisation of financial markets since the panic of late 2008 and signs that the $1.1 trillion package agreed at the G20 has prevented a threatened meltdown in eastern Europe.

But the G8 nations remain concerned that rising unemployment, expected to peak at a record 40 million people in developed countries next year, coupled with falling house prices will choke off consumer spending in the months ahead. Brown's hopes of a major breakthrough on climate change were dealt a blow when the Chinese president, Hu Jintao, was forced to fly home to deal with ethnic riots.

Brown is hoping the summit will make progress on the agenda for December's Copenhagen summit, which will seek to set a long and medium-term target for limiting global CO2 emissions and a package of financial aid to help developing countries adapt. Obama's willingness to sign up to a long-term target has improved the atmosphere for the climate change negotiations, but Brown believes a substantive deal in Copenhagen will be difficult to achieve without progress this week .

IMF says world economy ‘stabilising’
The global economy is starting to drag itself out of recession and will grow by 2.5 per cent next year, the International Monetary Fund said on Wednesday, a slightly rosier prediction than it made three months ago. The IMF said financial conditions had improved more than expected since it predicted in April that the global economy would grow by just 1.9 per cent next year. However, the Fund slightly lowered its forecast for this year, saying the global economy will contract by 1.4 per cent against its April prediction of a 1.3 per cent drop. "The world economy is stabilising, helped by unprecedented macroeconomic and financial policy support. However, the recession is not over and the recovery is likely to be sluggish," the IMF said on Wednesday in its World Economic Outlook report.

The more pessimistic outlook for this year was largely driven by conditions in Europe, where the IMF now expects Germany’s economy to shrink by 6.2 per cent and Italy’s by 5.1 per cent. As a group, the world’s advanced economies will contract by 3.8 per cent this year according to the report. They will also be slower to recover, not picking up until the middle of next year when they are expected to grow by an anaemic 0.6 per cent. In contrast, it predicted emerging Asian economies including China and India will grow by 5.5 per cent this year and 7 per cent next year. "However, the recent acceleration in growth is likely to peter out unless there is a recovery in advanced economies," the Fund warned.

The financial system has been shored up by a slew of extraordinary policy interventions, the Fund said in an accompanying report on financial stability. Funding pressures and counterparty risk have declined, reducing the likelihood of another event like the collapse of Lehman Brothers. "Nonetheless, vulnerabilities remain and complacency must be avoided," the report said. "The financial sector continues to be dependent on significant public support, resulting in an unparalleled transfer of risk from the private to the public sector." It said it was not the right time to start withdrawing such public support, but that "exit strategies" should be drawn up and may need to include the transfer of some programmes from central banks back to fiscal authorities.

"The crisis is morphing again"
by Mohamed El-Erian

Pimco’s chief executive comments on the suggestion from US presidential adviser Laura Tyson  that America should consider drafting a second stimulus package, since the $787bn plan agreed in February is proving "a bit too small."

Dr. Laura D’Andrea Tyson’s comments at the Nomura Equity Forum in Singapore were attracting considerable market attention on Wednesday, and rightly so. They come at a time when policy indications—actual, expected and perceived—have already become important drivers of relative and absolute valuations in a number of markets. Tyson echoed Vice President Biden’s weekend remark, observing that the US economic situation has turned out worse than what was forecast just six months ago. Interestingly, she also went further and suggested that, with hindsight, the government’s fiscal stimulus package was too small and a new one should be considered.

Tyson’s comments are sure to fuel a debate that will place policymakers in an even more challenging situation; and this becomes even more intriguing if you agree with the view I expressed in an FT comment piece last Friday that "consensus" currently underestimates how high the US unemployment rate will go AND how long it will persist at unusually high levels. The Tyson remarks are a vivid illustration of the extent to which the emphasis of the policy debate is shifting from the normalization of the financial markets to countering a worse-than-expected deterioration in jobs and wages. Indeed, while 2008 was about the serial unthinkables in the financial markets, this year is all about the lagged economic, political and institutional effects.

All this should make us feel even greater sympathy for policymakers. The nature, severity and continuous morphing of the global crisis have already put them on the defensive.  Inevitably, "first best" policy solutions are elusive; and even in the world of second and third best, what is economically desirable is increasingly becoming politically infeasible; and what is politically feasible may well turn out to be economically undesirable. As an example, consider the complex tug of war that faces policymakers keen to counter the poor and deteriorating employment picture. The attractiveness of another stimulus package is tempered by the realization that the country’s fiscal and debt dynamics have weakened considerably; and the possibility of maintaining loose monetary policy for a very long time (as a way to stimulate aggregate demand while, simultaneously, starting to restore fiscal sustainability) could eventually contaminate both inflationary expectations, as well as the global status and value of the US dollar.

The bottom line is a simple yet powerful one. The global crisis is morphing again. Having already contaminated (in a sequential and cumulative manner) housing, finance and the consumer, it is now threatening the potency and credibility of the economic policy making apparatus. As far as I can see, there are no first best policy responses that are readily available and easy to implement. Instead, the economy will continue to struggle, navigating both the adverse implications of last year’s financial crisis and the unintended consequences of the experimental policy responses. Given the inevitable socio-political dimensions, this story will play out well beyond the realm of the economy, policymaking and markets.

Recession increases suicide and murder
Unemployment and recession add to the death toll from suicide, murder and heart attacks but cut the number killed in road accidents, according to the most comprehensive analysis so far of the health effects of economic downturn. Researchers at Oxford University and the London School of Hygiene and Tropical Medicine analysed the effect of economic changes on mortality rates in 26 European countries from 1970 to 2007. Their conclusions are published online in the Lancet medical journal.

The authors wanted to make sense of contradictory theories and conflicting evidence on the impact of recession on health. Most analysts have emphasised the damage caused by increasing stress and mental health problems but some said people might become healthier in a downturn if, for example, they have to walk rather than drive. The results suggest that the various influences more or less balance out: there was little overall change in mortality across Europe when unemployment rose or fell over the past 40 years.

But there were significant differences between countries and between causes of death. The health impact of recession is worst where social spending is low, such as in eastern Europe, and least where spending is high, such as Scandinavia. A 3 per cent increase in unemployment led to rises of about 4 per cent in suicide and 6 per cent in murders but a 4 per cent fall in traffic fatalities. The biggest impact was on deaths from alcohol abuse, which rose 28 per cent. Although heart disease as a whole did not vary much with economic conditions, there was a significant relationship between recession and heart attacks in men aged 30 to 44. Heart attack deaths in this group increased 0.86 per cent for every 1 per cent increase in unemployment.

The researchers found that substantial government support to keep people in work and help the unemployed find jobs could reduce some of the adverse health-effects of recession. If social spending on these "active labour market" programmes exceeds $190 (£115, €135) per head of population per year, suicide rates do not rise with unemployment, the researchers found. In the UK, where about $150 per head is spent on active labour market programmes, the researchers estimated that between 25 and 290 suicides a year would occur as a direct result of the current financial crisis.
"If governments have funds to protect the working population in a recession, it is more effective to spend it on measures to help people get back to work than on healthcare or increasing unemployment benefit," said David Stuckler of Oxford, a co-author of the study. Martin McKee, of the London School of Hygiene and Tropical Medicine, said: "Suicides are just the tip of the iceberg: rising suicide rates are a sign of many failed suicide attempts and high levels of mental distress among workers and families." The authors said their analysis had limitations that might be overcome by further research: for example, the focus on entire populations meant the experience of vulnerable groups, such as migrants or refugees, was ignored. The use of death rates also meant that the conclusions "almost certainly understate the full effects of recession on health".

African Americans, Hispanics Lag on Retirement Savings
Regardless of age or income African-Americans and Hispanic workers contribute less often, and less money, to a 401k than white and Asian-Americans, according to a just-published study. Among the surprising findings: that African-American employees who earn $120,000 or more have saved $154,902 in their 401(k)s on average, versus $223,408 for their white counterpart—a $68,000 deficit that worries retirement experts. "Without a significant effort to improve savings and investing behaviors, African-American and Hispanic workers are in danger of retiring into poverty," says Mellody Hobson, president of Ariel Investments, an investment firm that sponsored the study along with benefit consultants Hewitt Associates.

Some companies have done a good job of engaging minority workers in retirement savings, but on the whole, while 77% of white Americans contribute to their employer’s 401(k), this study found only 66% of African Americans do, and just 65% of Hispanics participate. Whites also contribute more, an average of 7.9% of their income, compared to 6.0% for African Americans. African Americans are also less likely to invest in equities, and more likely to take out loans against their retirement savings or make hardship withdrawals.

And the sharp disparities are likely even worse today, with the economy well into recession. This study was conducted through December 2007, before the worst of the economic slump hit. The data, which includes information for nearly 3 million employees of 57 large U.S. corporations, "doesn’t even incorporate the financial crisis," notes Hobson. "You’re looking at numbers that shocked us even before that." (For more on the challenges of planning for retirement in the downturn here’s a link to our current special report.)

The high rate of borrowing from 401k worries Barbara Hogg, a principal at Hewitt and co-leader of the study, because that money is in danger of never getting back into the employee’s account, especially if they lose their job and are forced to quickly repay it or bear financial penalties. The study found that 39% of African-American workers had taken a loan, versus just 16% of their Asian American counterparts. And in the current downturn, minorities have been losing jobs at a faster clip than white Americans, notes Hobson.

"It puts them on shaky financial footing," she says. ( In a separate study, Hewitt found that between 2007 and 2008 hardship withdrawals from 401(k) accounts rose 20%.) On the other hand, many minorities report they are willing to save because they know they can get access to the money through loans or withdrawals if they do have an emergency. Fixing this kind of inequity might be hard to do. But the authors say mandating financial education and communicating better about saving for retirement would be two helpful steps. Hogg notes that companies and investment managers have traditionally touted 401(k)s as a means to financial empowerment and individual success.

"Other cultures may be less cultures of individualism and more of a community. They may need motivation beyond individualistic success." Whatever the marketing message, both Hogg and Hobson agree that students have to hear about the value of retirement savings earlier. "Today in High School you can elect to take woodshop or auto mechanics and not (have the option to take) a really great class on money and investing," notes Hobson. " The odds people are cleaning their own carburetors are declining, but making good informed money choices not only affects your life but future generations."

Yuan Deposes Dollar on China Border in Sign of Future
Huang Xinyuan, who sells mining equipment and pesticides to customers across China’s border with Vietnam, says he no longer wants payment in U.S. dollars and prefers the yuan. Sales using the greenback at Guangxi Jinbei Group, where Huang is vice president, dropped to 30 percent of contracts in 2008 from 87 percent in 2007. The yuan, which has gained 21 percent since it was allowed to strengthen against the dollar starting in 2005, offers greater stability, he said.

"In recent years, the dollar has gone in only one direction and that is down," said Huang, 45, in his second- floor office in Pingxiang, a town set amongst karst limestone hills and sugar-cane fields in China’s southwest Guangxi Zhuang Autonomous Region, three kilometers (1.9 miles) from Vietnam. "Settling our orders in yuan removes a major risk." China expanded yuan settlement agreements last week from border zones to its largest financial centers, including Shanghai, Guangzhou and Hong Kong. The program is being rolled out across Malaysia, Indonesia, Brazil and Russia, all nations seeking to reduce the dollar’s role as the linchpin of world finance and trade.

The central bank first brought up the concept of a supranational currency to replace the greenback in reserves in March. It will sponsor use of the yuan in trade by arranging export tax rebates. Russia and India said the global financial crisis had highlighted the dollar’s flaws and called for a debate before the Group of Eight leaders meet in L’Aquila, Italy, starting today. "It does give you an idea of what the future could look like," said Ben Simpfendorfer, chief China economist in Hong Kong at Royal Bank of Scotland Group Plc, the fifth-biggest foreign-exchange trader. "The Chinese see an opportunity at this point to raise questions about the dollar and its status as a reserve currency."

China, the biggest overseas holder of U.S. Treasuries, trimmed its holdings of government notes and bonds by $4.4 billion to $763.5 billion in April. Premier Wen Jiabao said in March that he was "worried" the dollar would weaken as U.S. President Barack Obama sells record amounts of debt to fund his $787 billion economic stimulus plan. "The objective is to develop a substitute for the dollar as the world’s reserve currency," said Tim Condon, Singapore- based head of Asia research at ING Groep NV, part of the largest Dutch financial-services group. "That will reduce the ability of the U.S. government to finance deficits with impunity."

Treasury Secretary Timothy Geithner said during a visit to Beijing on June 2 that Chinese officials expressed "justifiable confidence" in the strength of the American economy. China expects the greenback to maintain its role for "many years to come," Deputy Foreign Minister He Yafei told reporters in Rome on July 5. In Pingxiang’s Puzhai border zone, traders prefer the yuan. A parking lot that doubles as a wholesale market is jammed with container trucks with license plates from as far as Shandong, about 1,930 kilometers to the north. Garlic-laden motorcycles snake through a checkpoint to the border control.

Traders from Vietnam bring harvests of lychees and dragon fruit, departing with toys, household appliances and medical supplies to sell back home. Luo Huiguang, 27, who sells as much as 100 tons daily of onions and garlic, collects payment in yuan wired from Vietnam. "I prefer it to the Vietnam dong or U.S. dollar," said Luo as he shuttled between warehouses and trucks. "There’s less hassle and we don’t need to convert the currency."

Exporters typically set prices to earn 5 percent profit on sales, so 1 percent currency transaction costs and swings in the value of the dollar can wipe out returns, Simpfendorfer said. Many businesses lack the scale to hedge foreign-exchange risks, said Huang at Jinbei, which did $50 million in trade last year. Limited use of the yuan has been allowed since 2003 in border trade with Vietnam and Laos to the south and Mongolia and Russia in the north, according to a book published by the Beijing-based State Administration of Foreign Exchange.

The central bank extended settlement last week by offering companies in Shanghai and four southern cities tax breaks to start conducting trade in the currency with Hong Kong, Macau and the 10 members of the Association of Southeast Asian Nations, which includes Indonesia, Thailand and Malaysia. In five years, yuan contracts may account for 50 percent of China’s trade with Hong Kong, which totaled $204 billion in 2008, according to Lian Ping, chief economist in Shanghai at Bank of Communications Co., the nation’s fifth-largest lender. They may make up 30 percent of shipments between the nation and Asean countries that last year reached $231 billion, he said.

"The yuan will resume appreciation next year," Lian said. "More people will use the yuan in international trade." China’s central bank has limited the yuan’s gains in the past year to 0.3 percent to help support exports during the global recession. The dollar may depreciate by 5 percent annually against the currency over the next two years, ING’s Condon said. Simpfendorfer forecast the yuan will rise 5 percent to 6.5 per dollar from 6.833 by the middle of next year. The median forecast of 27 analysts in a Bloomberg survey was 6.7.

For all the concern that the dollar’s role is waning, China has continued to lead buying of U.S. assets. The greenback accounted for 65 percent of central bank reserves on March 31, up from 62.8 percent in June 2008, according to the International Monetary Fund in Washington. "This is not a six-month or one-year story," said Kenneth Akintewe, a Singapore-based fund manager who helps oversee $138 billion of assets at Aberdeen Asset Management Plc. "China’s desire to control the currency, particularly in the current environment, will supersede its ambitions for the yuan."

China’s currency isn’t fully convertible for investment purposes. HSBC Holdings Plc, based in London, and Bank of East Asia Ltd. in Hong Kong won approval in May to be the first foreign banks to sell yuan bonds in Hong Kong. Asian companies may be willing to accept yuan to win market share in the world’s fastest-growing economy, said Pushpanathan Sundram, a deputy secretary-general of Asean. The U.S. economy will contract 3 percent in 2009, while China expands 7.2 percent and the Asia-Pacific region grows 5 percent, according to World Bank forecasts.

"The use of the yuan may eventually boil down to simple economics," Pushpanathan said. "Given China’s growing share in international trade, traders may find it makes economic sense to make settlements in the yuan." Since December, the People’s Bank of China has provided 650 billion yuan ($95 billion) to Argentina, Belarus, Hong Kong, Indonesia, Malaysia and South Korea through so-called currency swaps, encouraging its use in trade and finance. Russia and China agreed to expand use of the ruble and yuan in bilateral trade on June 17. Brazil and China began studying a similar proposal in May.

Converting payments to a third currency "seems to be unreasonable" when Chinese partners are both supplying equipment and buying processed raw materials, said Pavel Maslovsky, deputy chairman of Peter Hambro Mining Plc, Russia’s second-largest gold producer. It develops iron ore projects in the Amur region bordering China. "The Chinese economy is in such a shape now that their project to export yuan may turn highly efficient," said Eduard Taran, chairman of OOO RATM Holding, a Siberian cement producer also considering buying Chinese machinery in yuan and exporting output in the currency.

About 160 kilometers north of Pingxiang, yellow cranes jut skywards from a dusty 3 square-kilometer construction site in the provincial capital of Nanning. The plot will house trade missions and businesses from the Asean countries. "Many countries view China as the savior in this global economic crisis," said Pan Hejun, vice-mayor. "It’s natural that other countries will be willing to use the yuan to settle trade and hold it among their reserves."

Treasury admits 'intellectual failure' behind credit crisis
The financial crisis was caused by a massive intellectual failure which ran through governments, regulators, banks and the wider financial system, the Treasury will today admit as it presents its definitive account of the past 18 months' chaos. The efficient markets theory which dominated the way economists viewed the world and financiers conducted business over recent decades was simply wrong and played a major part in the crisis, the Treasury is likely to conclude in its White Paper, to be presented to Parliament today.

It will claim that the intellectual foundations for the way banks' boards ran their companies, and the Bank of England and Financial Services Authority managed them, were misguided. The conclusions will form a key part of the White Paper, which will also contain detailed plans one of the biggest overhauls of UK financial regulation in decades. However, as The Daily Telegraph revealed yesterday, the document will stop short of suggesting any legislation for macro-prudential tools to go alongside interest rates as a means of controlling the economy and financial system. It will focus instead on overhauling the existing system to clamp down on banks taking risks.

Under the new rules, banks will be forced to hold more capital and liquidity, and will be subject to a ceiling on their gross leverage. The FSA will apply these rules to ensure that companies that take excessive risks, reward their employees inappropriately or borrow too much to expand too fast will be penalised. The FSA will be given a statutory role for maintaining financial stability, while the Bank will be permitted to use its Financial Stability Report to issue specific warnings to companies and to the FSA. However, the changes are at risk of being overshadowed by the European Union's own reforms, which may supercede some UK rules.

Germany May Shake Off Recession as Factories Ramp Up Production
Germany may be shaking off its worst recession since World War II as factories ramp up production to meet rising export orders. The government said today that industrial output rose 3.7 percent in May from April, the biggest gain in almost 16 years. Yesterday, it said manufacturing orders jumped 4.4 percent in May, the most since June 2007 and nine times the 0.5 percent gain forecast by economists. "May’s production and order data are really the first hard evidence that the economy is emerging from recession," said Nick Kounis, chief European economist at Fortis Bank in Amsterdam. "The underlying trend for production is improving dramatically" and suggests that the economy "will grow again in the third quarter," he said.

That may provide a boost for Chancellor Angela Merkel, who will seek a second term in office in national elections in September. Her coalition government is spending about 85 billion euros ($118 billion) to revive growth in Europe’s largest economy, which it predicts will contract 6 percent this year. Business confidence increased for a third month in June. "Soft-data green shoots have started carrying over into hard economic data," said Andreas Rees, chief German economist at UniCredit MIB in Munich. "After the summer break, the odds are rising that the German economy will manage a comeback into growth territory."

Support for Merkel’s Christian Democrats rose to the highest this year as Germans showed a preference for her leadership over that of the rival Social Democrats, according to a poll published by Stern magazine and RTL television today. German carmakers in particular are increasing output as a government incentive to trade in old vehicles boosts sales at home and depleted global inventories bolster export demand. Volkswagen AG, Europe’s largest carmaker, said on July 3 that car deliveries rose for a second straight month in June. MAN SE, Europe’s third-largest truckmaker, said the same day it probably broke even in the second quarter as the market for commercial vehicles showed signs of recovery.

The increase in factory orders in May was driven by an 8.2 percent gain in exports to countries outside the euro region. Domestic demand rose 3.9 percent. Governments worldwide have announced about $2 trillion in economic stimulus programs to help revive economic growth. Munich-based Siemens AG said on June 22 this may generate orders of about 15 billion euros ($21 billion) for Europe’s largest engineering company. British Prime Minister Gordon Brown is warning that policy makers mustn’t become too complacent that the worst of the recession is over. In the U.K., Germany’s third-largest trading partner, factory production unexpectedly fell for the first time in three months in May.

Rising unemployment may also curb household spending in Germany and damp any economic recovery. The country’s jobless rate rose to 8.3 percent last month. It will reach 10.5 percent next year, according to the Bundesbank. "Although there may well be setbacks in the coming months, the trend in production should point upwards," said Ralph Solveen, an economist at Commerzbank AG in Frankfurt. That increases chances that the German economy will return to growth in the third quarter, he said.

Europe Aims to Limit Derivatives Risks
In the wake of last fall's global financial meltdown, the European Commission wants derivatives to be traded on exchanges through clearing houses. The European Commission has outlined a list of measures that could be used to limit the potential risk posed by derivatives to the EU's financial system. Derivatives – such as "futures" and "swaps" – are financial products that derive their value from an underlying asset, such as oil, or a market variable, such as an interest rate.

The financial meltdown last autumn brought the $600 trillion (€430tn) market to the closer attention of global policy makers due to concerns over its huge size and opaque nature. "Derivatives markets play an important role in the economy, but the crisis has shown that they may harm financial stability," internal market commissioner Charlie McCreevy said in a statement on Friday (3 July). One factor adding to the lack of information on the sector is the largely 'over-the-counter' (OTC) nature of trading. Instead of going through an exchange, a large volume of trading is conducted directly between the two parties involved, either over the phone or by using electronic networks, allowing greater flexibility but reducing the information entering the public domain.

Credit default swaps (CDSs)– a contract between two parties in which one party offers insurance against a particular credit event such as a bank default – have been singled out as particularly risky due to the sector's high concentration in a small number of banks. US insurance company American International Group (AIG) nearly collapsed last autumn as a result of the large payouts it had to make to clients who had taken out CDSs against a Lehman Brothers default. To counter this, the commission document proposes the greater use of clearing houses – intermediary institutions that agree to fulfil the contract if one party is unable to keep up their side of the bargain.

Financial firms operating in Europe have promised Mr McCreevy that CDS trading will be conducted through clearing houses by the end of the month, with the commission also keen to see them used for other derivatives. Clearing houses "have proven their worth during the financial crisis" as illustrated by their role in managing the consequences of the Lehman Brothers' default, the commission said, while at the same time indicating it would not insist on greater clearing for the moment. Others proposals to reduce the risk posed by derivatives include product standardisation and the use of central data repositories.

Greater use of standard derivatives that are better understood could help reduce operational risks says the EU executive, whereas central data repositories would collect data on the number of transactions and the size of outstanding positions in a bid to provide greater transparency to the sector. Emrah Arbak of the Centre for European Policy Studies, a Brussels-based think-tank, said that greater transparency will not solve the problem by itself, however. "There are many examples of securities where the transactions are extremely transparent...and yet there are big problems," he told EUobserver, giving the sub-prime loan sector in the US as an example. The launch of the commission proposals marks the start of a public consultation, with a public hearing set for 25 September. After this the commission plans to come forward with concrete initiatives and possible draft legislation before the end of the year.

UK creates new super-regulator to avoid a future collapse of the financial system
The Government has announced the creation of a new super-regulator charged with ensuring that Britain’s financial system is never again threatened with collapse. The Council of Stability will bring together the Bank of England, the Financial Services Authority (FSA) and the Treasury and was unveiled as part of the Chancellor Alistair Darling’s eagerly anticipated White Paper on financial reform. The new Council will have responsibilities set out by statute and will be answerable directly to Parliament. The long-awaited White Paper was billed as the government’s road-map for rebuilding the financial system. Its contents have been shrouded in secrecy but in the event the Chancellor steered clear of radical reforms to the financial architecture and instead opted for re-inforcing the existing framework.

Shadow Chancellor George Osborne dismissed the plan, saying: "This White Paper ducks every difficult questions that needs to be addressed. It is more of a white flag than white paper." The Financial Services Authority also got more powers, some of which were designed to address the more controversial aspects of the financial crisis. The City watchdog will be charged with monitoring pay and bonuses. The Chancellor said financial institutions will be required to file detailed remuneration reports to the FSA every year. The regulator will have new powers to penalise firms whose pay structures are deemed to be inappropriate or encourage risk. Bank boards will be strengthened and non-executive directors being charged with monitoring risks more carefully.

On the thorny issue of hedge fund regulation Mr Darling avoided hard rules. He said: "And take account of new developments in the financial sector – including expanding regulation where necessary – for example systemically important hedge funds." The regulator will also be given a range new powers to deal with financial emergencies. The Chancellor ruled out forcing the separation of investment banks and retail banks in the form of Glass-Steagall but said that there will be requirements for higher levels of capital and lower leverage ratios. Mr Darling paved the way for more international regulation. He said: "Because these banks are often global, we also need an international mechanism for resolving large multinational banks – and we will be bringing forward proposals to the G20 finance ministers when they meet in London in the autumn."

The White Paper set out plans to help consumers and boost financial education. The Chancellor announced a national money advice line funded by the banks and a strengthened deposit protection scheme. The Chancellor said future stability would depend on greater competition but was vague on the specifics. He said: "We want to see greater competition and greater choice for consumers – as well as a bigger role for mutuals and building societies. So the OFT and the FSA will ensure that we maintain competition in the market for financial services – as we come out of this downturn we need to promote a competitive market than enables new entrants, which may include non-banking institutions, and innovation to benefit consumers and businesses."

The financial crisis that has swept through financial markets over the past two years has forced the UK Government to take on on at least £1.4 trillion of liabilities from troubled banks - more than the entire value of the UK economy. Gordon Brown and Mr Darling have for months promised a radical overhaul of the system. Mr Darling said last week that those in the City keen to return to the excessive risk-taking that triggered the crisis will be ‘brought back to earth.’ However he delayed any legislation regarding the key macro-prudential tools. The Shadow Chancellor dismissed the White Paper as a "totally inadequate response" to the financial turmoil of the past two years. He said: "After two years of talk in the Treasury, we will have a council that will bring together the FSA, Treasury and Bank of England. I thought that was what the tri-partite system was. The Chancellor should have come here to bury the tri-partite system, not to praise it."

UK government gives regulators power to curb bankers' pay
The Government has unveiled plans to give new powers to regulators to curb bankers' pay and clamp down on risky lending in the wake of the worst financial crisis in decades. Alistair Darling, the Chancellor of the Exchequer, told Parliament on Wednesday that the Financial Services Authority (FSA) will now have "powers to penalise banks if their pay policies create unnecessary risk, and are not focused on the long-term strength of their institutions." The financial crisis that has swept through financial markets over the past two years has forced the UK Government to take on on at least 1.4 trillion pounds of liabilities from troubled banks - more than the entire value of the UK economy.

The Chancellor also said said that he will draft laws to create a new Council for Financial Stability designed to bring together the Financial Services Authority, the Treasury and the Bank of England, and be collectively be responsible for financial stability. The so-called Tripartite system, devised by Gordon Brown when he was chancellor in 1997, has been widely criticised for failing to prevent the financial crisis that had plunged Britain into its worst recession in decades. The bonus culture that flourished in the City over the past decade has been the subject of intense public anger since the taxpayer was forced to bail out the banks in the autumn.

Mr Darling told Parliament that "from now on, I will require the FSA to report, every year, on how financial institutions are complying with their new Code of Practice for remuneration, and how they will deal with firms that don't comply." Governments around the world are working on ways to ensure the financial crisis, responsible for the worst global recession since World War II, is not repeated. George Osborne, the shadow chancellor, slammed Mr Darling's long-awaited White Paper as a White Paper duck. "The Chancellor should have come here to bury the tri-partite system, not to praise it," he said.

Swiss to stop UBS handing records to US
The Swiss government on Wednesday waded into the legal battle between UBS and the US authorities by saying it would forbid the bank from handing over confidential client information if a crucial court case next week required it. Bern warned it might go as far as confiscating the data, should a US court in Miami rule the bank was obliged to transfer the client names requested. The move marks a major escalation in the war of words between Bern and Washington over US demands that UBS hand over names of up to 52,000 US taxpayers holding offshore accounts in Switzerland.

Although the Swiss government is not directly involved, Bern is represented as a "friend of the court." In a filing revealed on Wednesday, the government warned it would issue a blocking order and, if necessary, confiscate all relevant material, to prevent UBS from complying, should the Miami court side with the US authorities. "UBS is unable to comply with the summon without violating Swiss law. The Government of Switzerland will use its legal authority to ensure that the bank cannot be pressured to transmit the information illegally, including if necessary by issuing an order taking effective control of the data at UBS that is the subject of the summon and expressly prohibiting UBS from attempting to comply," Bern said.

UBS has argued it cannot reveal the information without breaking Swiss bank secrecy laws, and such matters are best handled bilaterally between governments. The US has contended its action is valid, as UBS has admitted that Switzerland-based bankers broke US laws when visiting clients in America. Last February, UBS agreed to pay $780m to settle a separate, but linked, criminal action by the US authorities. However, a civil case requiring the bank to reveal up to 52,000 client identities remained open, culminating in next week’s hearings.

Legal experts said the conflict recalled a similar case in the 1980s, when the US sought information about Marc Rich, the controversial commodities dealer based in Switzerland. Both sides have used that precedent to justify their positions. Swiss ministers have acknowledged UBS have made grave mistakes in soliciting business from US clients, and recognised that the bank will face heavy penalties. Observers still expect an out-of-court settlement, involving heavy fines and possible other sanctions. But while the bank has long appeared ready for a deal, the US has stuck out for names, upping the pressure on UBS and turning the affair into a diplomatic issue.

Both sides have cited laws to justify their positions. However, Bern’s contention has been undermined by the fact that, in February, UBS was forced by the Swiss bank regulator to hand over 255 US client names most suspected of using sham companies to evade tax. Switzerland has subsequently also accepted international rules on greater transparency. But Swiss critics have accused the US of hypocrisy in moralising on tax evasion. Many have noted the irony that next week’s case will be heard in Miami, an established offshore centre for the – possibly undeclared – assets of thousands of rich South Americans.

The Financial and Economic Argument for No Green Shoots: No Deus Ex Machina for the Economy. 10 Charts Showing why There will be no Second Half Recovery in 2009.
The second half recovery argument took a significant blow last week when it was announced that 467,000 Americans were laid off in the month of June.  This number understates the problem because of BLS tinkering with the birth/death model and the headline number does not reflect the over 9 million Americans who are working part-time but want full-time work.  It also was little help that the state with the highest GDP in the nation is unable to manage its own finances and now finds itself in a $26.3 billion deficit and issuing IOUs.  This does not look like a green shoot recovery.  The problem of course stems from the initial premise dating back to the early part of this year that somehow, with the economic stimulus and bailouts that the economy would be back on its feet.  What did happen is the crony banking system is still intact but the real economy is deteriorating at the same pace.

In this article, I am going to layout 10 charts as to why there will be no second half recovery in 2009.  Before getting into the details, it is crucial to note that Americans have never lost so much of their net worth in any recession on record:

american household networth

In no time in history have Americans faced such a destruction to their bottom line.  Since the recession started, some $13.87 trillion in household net worth has evaporated.  Much of this of course comes from the housing bubble imploding but also, the stock market following the same path.  Now given that housing in many areas is still overpriced, we can expect that the bottom line will drop further as housing contracts.  The above chart has data up to Q1 of 2009 and given housing prices fell in Q2 of 2009 we should see another drop in household net worth.  The bottom line is Americans feel poorer because they are and this will have a major psychological impact on how they spend.  The green shoot argument hinges on the stimulus package that was some $787 billion.  Given the amount of lost net worth, this stimulus is a drop in the bucket.  Also, $287 billion of the plan was based on temporary tax breaks which are now being negated by many states raising taxes.  Part of the tax credit gave new home buyers an $8,000 tax break (this has run out for California).  Yet here we are issuing IOUs like some Dumb and Dumber reenactment.

If we break down the stimulus further, it really isn’t a stimulus plan as much as a “put a band-aid on the broken leg so things don’t get worse” stop-gap measure.  Much of the money goes to schools, Medicaid, repairing infrastructure, and helping the growing number of unemployed so to view this as the engine for second half growth is absolutely wrong.  It is a tourniquet to stop the bleeding.  However during this same time we committed some $13 trillion to the crony banking bailout and that is why you see some folks like Goldman Sachs trading at $143 a share up from their $47 low reached in March.  So the banking system and Wall Street were taken care of but Main Street was kicked to the ditch.  Here are the 10 reasons why there will be no second half recovery in 2009.

Reason #1 - Collapsed Auto Sales


It shouldn’t come as a surprise that the auto industry is in shambles here in America.  As you can see from the chart above auto sales are struggling even to get over the 10 million SAAR which doesn’t bode well for the future of many car companies.  The problem isn’t so much that cars that are being produced today are of low quality.  In fact, the opposite is true and cars today are being produced more efficiently and with better quality.  But like housing, they are too expensive once you take away the debt elixir.  Even the Governor of car happy California had this to say in a recent radio address:

“As a matter of fact I was just talking with a friend of mine who told me about an American company that is going to produce a car for $10,000 to $15,000.

Think about that. For $10,000 or $15,000 compared to the average car sold in America for close to $30,000.”

Now you should think about that.  How does this bode for companies that make those cars selling for the average $30,000?  The only reasons Americans were able to buy cars like they did for the past decade was because of easy access to debt.  That is gone.  Even if it came back, who in the world are car companies going to make loans to?  Someone that is unemployed or seeing their hours cut back isn’t in the mood to buy a $30,000 car.  So this big segment of the U.S. will be slow for the rest of the year.

Reason #2 - Housing Starts


The last time housing starts collapsed this quickly was in the Great Depression.  For a country with an economy built on real estate this chart tells you a lot as to why we are in this mess.  We over built with easy financing both at the commercial and retail level and here we are working through the excess that is left in the system.  The problem is, we have years of excess.  Nationwide foreclosures are at record levels thus ensuring us continued cheap inventory throughout the year.  Why would any builder want to start building right now to compete with that economic forecast?  Plus, new homes are more expensive than existing home sales and if you haven’t noticed, we’re in the middle of a deep recession.  The second half recovery crew apparently didn’t get the memo on this one.

Reason #3 - Single Family Home Sales


This above chart shows this divergence even clearer.  Calculated Risk calls the gap between new home sales and existing home sale the distressing gap.  In more normal times, the pattern for both of these usually trend together.  That trend has been broken.  Existing home sales are outpacing new home sales in large part because of foreclosure re-sales.  How are new homes going to compete with this?  They can’t and that is why they are losing.  Since foreclosures are sky high we can rest assured this pattern will continue for some time, definitely for the rest of 2009.

Keep in mind that we haven’t even seen the Alt-A and option ARM tsunami which will flood more inventory onto the market later this year and into 2010.  People ask, “how are you so sure the Alt-A problems will come to fruition?”  It is a simple problem and if you think about it, there is just no way around it.  Let us assume for the sake of the crony banking system, that the government does a massively boneheaded move and buys up all the toxic Alt-A paper in the market (which would be some $2+ trillion but we are being hypothetical here).  Okay.  Banks and Wall Street are saved again.  But one small problem.  The borrower still has the crappy loan!  So the default will still happen unless the government writes down the loan (and I don’t mean these pathetic loan mods which are basically turning loans into option ARMs).  If that happens, our deficit will explode even further which is not a good sign given how enormous it is now.  Deflation seems to be here in many sectors yet the fear of inflation and hyperinflation are ever present.

Bottom line is that there is no way around it and we will see more foreclosures and lower home prices.  Not a recipe for a second half recovery.

Reason #4 - Personal Savings Rate


You notice how financial networks don’t spend more than two seconds on this fact?  Want to know why?  It is because these financial networks view the average American as their pet consumption hamster.  They speak about unemployment as if it were some science project yet scream in climatic passion to help their banking overlords.  The fact that the savings rate is going up is good.  Yet this brings up the paradox of thrift.  Our society today massively relies on consumption with 70 percent of our GDP coming from this.  So it would logically follow that if Americans are saving more, they are spending less.  And the above chart shows the savings rate literally off the charts.  This is important since Americans have lived beyond their means for the past two decades and now that debt is collapsing, many are realizing that they were only living on borrowed financial time.

You don’t need to read hundreds of personal finance books to realize that to be financially secure, you need to save.  But how many times have we heard the so-called financial media highlight this?  Sure, they have their token frugal segments but 90 percent of their time is spent on pumping stocks and skimming on any deeper analysis.  The fact that they missed the deepest recession since the Great Depression puts their credibility (what is left of it) on the line.  I heard one of the networks say that we need to have “faith and hope” in the recovery.  Come on now!  This was coming from a network that ridiculed many bearish commentators about the housing bubble as “having the wrong faith.”  Unfortunately finances aren’t about faith.  We do have animal spirits but no animal spirit is going to save you if you lose your job or have a major mortgage recast in your future.  Americans realize this and are upping their savings rate.

One troubling anecdote which is also contributing to this is many employers have cut back their 401k contributions.  Given the market has gone down by 40% since its high, many are debating whether they should even contribute to their retirement account.  So instead, many are just putting their money in a cheap saving account.  Well at least we aren’t like Sweden offering a negative 0.25 percent rate.  As much as the government is trying to get people to spend, many are doing the opposite which is the right thing to do.  After all, I doubt the financial networks will be there to make up for your lost hours or employment should those green shoots not show up.  Speaking of lost hours…

Reason #5 - Hours Worked

hours worked

What was even more troubling than the 467,000 jobs lost last month was the fact that hours worked keeps declining with no foreseeable stop.  This is probably a better indicator of the overall economy since as we noted, over 9 million people are working part-time so that doesn’t show up in the mainstream unemployment number but would show up here.  When the economy does start turning around, there will already be people working that will simply go from part-time to full-time.  This is good for those that jump into the new role but this will keep a lid on any new employment growth for a very long time.  And keep in mind the trend is still heading lower.

As many of you know, unemployment peaks well after the recession is over.  This recession is far from over.  Many were expecting the second half to usher in massive rallies and easy money.  From where?  What sectors?  As we noted, the stimulus was more of a tourniquet.  In fact, in Q1 of 2009 the loss in American household wealth almost doubled the amount of the initial stimulus bill.

The hours worked component is important to keep our eye on.  This is a good indicator for early signs of recovery.  So far, there is no green shoot here.

Reason #6 - Unemployment

unemployment rate

The unemployment rate keeps moving up and most early estimates from analyst this year are blown out of the water.  States like California now have unemployment rates of 11.5 percent that have never been seen by a large part of the population.  It is amazing how little focus has been given to job creation.  If we spent half the amount of time as we did in bailing out the crony banks on job growth we’d be in much better shape.  But as many of you now know the U.S. Treasury and Federal Reserve when push comes to shove, answer to their banking oligarchs first and then to whatever they have time for.  It is amazing that the Federal Reserve which in its mission talks about maintaining stability has presided over:

The Great Depression

Multiple Recessions

1987 Panic

Technology Stock Crash

Housing Bubble

By this simple definition they have failed miserably.  They operate as a cartel and when things are going well, it goes better for those connected here.  When things hit the fan, they take care of their banking partners and take the average taxpayer out to dry.  That is why the unemployment situation is quickly falling apart.  In fact, that is why we have seen no employment plan come out from either the last or current administration.  No matter what tax break you give for buying a home, without a job it really doesn’t matter.  That is something that really amazes me in this current economic crisis.  Where are the jobs going to come from?  If anything, I can stand behind a job plan more than I can stand behind a crony banking bailout.  Yet all this time is devoted to saving Wall Street and banks.  Now you know who the Fed serves and it isn’t the American citizen.

Reason #7 - Renting Doesn’t Sound so Bad Anymore

renting vs owning

I remember these debates I would get into with colleagues during the housing bubble.  They would jokingly say, “it’s the first of the month, isn’t the rent due today?”  I would get a laugh out of it but in my mind, I knew they had a mammoth mortgage payment due on the same day, which to them was somehow different.  A few had neg-amortization loans like option ARMs which were building up no equity!  It was worse than renting.  Most of these colleagues now either rent or lost their home in the California housing implosion.  Yet the conversation has now shifted to the utility of a home and not so much the equity machine that many thought it was.

The above chart is important.  As you can see, over this decade the debt service for homeowners is still at a high while the debt service for renters has steadily decreased.  Part of this of course is many are now electing to rent instead of buying a home.  The rental market is now facing some challenges because of a flood of inventory.  As many of you know I own rental property and I have seen this first hand.  Yet the rental market is nothing like the housing market.  That is, you can drop your rents and the market will respond at some level.  Right now, you have some areas in Nevada and Arizona where you almost have to give away homes.  And for selling a home, you are restricted to the balance due otherwise you have to give someone money to sell your home or get your lender to agree to a short-sale.  Not many of these get approved.  Hence, many just walk away and that is why we are now seeing more rental inventory hitting the market.

The major shock is that housing prices do fall and can fall hard.  We have never seen a nationwide housing decline since the Great Depression.  What do you think those that lose their home in foreclosure will think later on?  Many will vow never to buy again once they get the stain of foreclosure off their credit history.  And many watching this will be extremely cautious in over paying.  The housing bubble machine has stopped.  There is no dues ex machina for the second half.

Reason #8 - S&P 500 Priced too High


Sometimes in life you get what you pay for.  Many people rushed into the stock market after the crash thinking it was the bottom.  Much of the recent buying is program trading resulting in low volume days and also, highlighting what a casino the market really is.  In fact, a former Goldman Sachs employee is now in trouble for trying to take away software from the ever powerful company.  The fact that they are trying to create programs that you can set on autopilot and make billions on tiny trends is absurd and show how nutty the market is; this is like having a robot sit at a Texas Hold’em table that will win 90 percent of the time and expecting people to play against it.  Yet when they make a horrible bet with say, AIG then the government (aka taxpayer) steps in to bail them out.  This is something that needs to be addressed now by the current administration.  People are starting to lack much confidence in the system and really don’t enjoy losing money to robots and computers.

If we look at the S&P 500 as we enter earnings season, we need to realize that prices may be cheap because they deserve to be cheap.  As we’ve noted, Americans are saving more thus cutting into consumption.  Household wealth has taken a major hit which will be reflected in a negative wealth effect.  So to expect that earnings will explode in the second half has no premise in reality.  Until we see stabilization in the employment figures and housing stops dropping like a ton of bricks, jumping into the stock market casino is at your own peril. 

Reason #9 - Deflation


In a recent article I gave 5 clear sectors where deflation is hitting the American family.  Inflation is not the immediate threat.  Wages are falling.  Home prices are crashing.  Auto prices are lower.  Demand destruction is causing price deflation.  That is clear and the CPI reflects this.  The trends that set this in motion are still present.  Wages will be falling further and home prices still have a way to go.  Having deflation in the second half is almost a guarantee and deflation does not bring good things to the stock market.  Have we even talked about commercial real estate?  There are many reasons why there will be no second half recovery.  There are few arguments to show us why we will see green shoots in the coming six months.

Reason #10 - Personal Consumption Expenditures

personal consumption expenditures

It should come as no surprise then, putting all of the above together that consumers are spending less and less.  As you can see from the chart above personal consumption expenditures have fallen off a cliff.  The trend is still lower.  Until this reverses there is little reason to believe in the second half recovery.

Keep in mind that if we reach this December in recession, it will be 24 months of being in an official recession.  This is the deepest cut to our national economy since the Great Depression.  If you are looking for green shoots we can start having that conversation once we see some semblance of stability in the employment numbers.  Keep in mind that housing is falling in spite of every imaginable bailout possible.  Loan modifications, tax breaks, and other propaganda have done nothing in stopping the inevitable reversion to the mean.  What it has done is wasted trillions in taxpayer money.

The second half recovery will not happen.  These 10 charts above represent an extremely large part of our society and where Americans hold their wealth.  The financial networks may have paid puppets to cheerlead for a second half recovery to keep their Wall Street masters happy but the vast majority of Americans see through their propaganda.  Even if they don’t see through it, they are feeling it through the horrible employment conditions, declining home values, and shrinking stock portfolios.


Greyzone said...

In a fiat monetary system, credit is money, and therefore a destruction of credit is a destruction of money.

The above point is the one that inflationists appear to never get. Aaron, while well-reasoned, misses this very point while even walking around it.

It doesn't really matter though. The inflationists have their predictions of $5000 gold and America-becoming-Zimbabwe so we'll see if those come true before we see the effects of massive deflation kick in - massive unemployment, generally falling prices, etc.

By the way, Aaron seems totally unaware of the number of major US companies that have cut wages and salaries across the board in the last year, from Fedex to Microsoft. If he wants some early signs of deflation in declining wages, those should have been it.

EconomicDisconnect said...

A new one up, right after I posted a comment on last one! I will read over the fascinating point by point in the morning.

Sorry, repost from last comment section:
Ilargi and Stoneleigh,
I wanted to say thanks for the last few articles. I finally felt I was sliding over to the deflation camp, and then today I say this part in a Mish pro deflation article:
"Please keep in mind every country on the planet is following the same stupid Keynesian Handbook so on a relative basis the US is not as bad as appears at first glance. Don't expect a complete collapse of the dollar to happen anytime soon."

And now I am all confused and back on a currency dislocation line of thought! I would add I am easily confused.

Edward Lowe said...

oh dear ... someone needs to spend some time in basic finance 101. The vast majority of all money in the fractional reserve system is printed into existence by the credit/debt mechanism. Moreover, a large percent of the money/debt created in the recent bubble was done so through non-bank actors via the securitization process. It doesn't take too many months of reading to get these points.

Once debt has been created the associated credit is deposited into cash accounts it becomes *real* money (or so people think). But it is in fact not money in the sense that a gold coin might have been money at one time, it is a credit in an account and no more. People spend these credits in much the same way that people once spent hard currency Some people even spend Federal Reserve Notes thinking that they are spending money. But, these notes are the extreme minority of exchanges, in the aggregate. I would bet that most exchanges are merely digital credits that move notional value from one account to another. And, again, almost all of those credits are attached to an underlying debt.

In other words, the financial economic IS the real economy.

Edward Lowe said...

lol Greyzone beat me to it!

Thanks GZ

Anonymous said...

Nothing like seeing two people talking right past each other.

This is a major problem these days. Turn on any TV pundit show. One side talks, the other side says the opposite, they holler over each other for a while for dramatic effect, neither listens to the other, nor do they care to. They go through the motions of 'debate' and then continue on their merry way, never the wiser. Everyone is an expert. Noone listens. Everyone thinks that they are right and can provide evidence to show you why they are.

Greyzone said...

"Greyzone i suppose you can look at it that way but that aside, would you have bothered to read the article if I had said that Mish said some bloke said 'the party' was on again? Of course I guess it seems not to matter that you did read it as you seemed more concerned with who made that statement than what it said or was based on ... a green shoot is presented and instead of trampling it into the ground like a proper doomer you worry the messenger. Phooey Grey, go to the back of the class but first take a lesson from VK. For any truth it might contain, he examines the statement and the graph it is based on.

-nom de plume-"

The fact is, nom, that I read Mish every day which is why I knew that your character assassination garbage smelled like crap.

There was no need to try to implicate Mish in this. You could have just as easily named the professor, as many of the readers here also read Minyanville (at least occasionally) and know who those people are too. I and many others read Naked Capitalism, The Prudent Bear, Calculated Risk, Financial Armageddon, and numerous other financial blogs, at least semi-regularly.

So next time think about marking yourself as an ass by trying to falsely impugn someone else to get them to go look at another blog. That's pathetic.

P.S. I don't need to evaluate the green shoot argument yet again. It's been thoroughly debunked already numerous times all over the web. So please stop wasting my time and the time of others unless you really have something useful to contribute aside from masturbating in public.

Shibbly said...

El G,
Regarding IRAs, Stoneleigh has stated (correct me if I am wrong) that she thinks the gov't will seize them during this massive wealth grab. Others too have suggested that the gov't will do this "in our best interest" and may freeze accounts, not allow early withdrawal and move them into T-Bills in order to support the USD and gov't spending. I also believe that Stoneleigh has said that cashing out now is the safest option, even with penalties and taxes because at least you will have something and if if you wait too long you may not have anything.
Regarding your friend, if she is 66 years old, there would not be an early withdrawal penalty and she could move the cash to t-bills. Is she concerned about the tax bill if she cashes out now? It sounds like taxes may be going up from now on, so at present time they are at the lowest we will see.

D. Benton Smith said...

If only $110 Billion of the $687 Billion stimulus has actually been spent, but we need another because the first was too small.


I resent being lied to so incompetently.

EBrown said...

Anon 9:43,
I too had a sense of "talking past one another" when I read the opening to this post. However, I don't think it was a case of not listening to the other as is so often the case on television. I think Stoneleigh gleaned the content of Aaron's queries and statements and attempted to direct his attention to pertinent dynamics of the financial system. I don't think Aaron has a firm grasp on how money creation works in the modern world and that this deficit is/was the major cause of the repetitive and tangential comments.

It really is a shame that "inflation" and "deflation" have subsumed the looser definitions of "general price increases" and "general price decreases". On 'the annoys Edmund' scale they go right up there with the use of "me" rather than "I" and "enormity" as a synonym for "big" rather than "gigantic evil".

I also understand Aaron's confusion. Several years ago when I really delved into peak oil I thought it certain that for the average american PO would mean massive inflation (and loss of purchasing power in this way). It was not until later, after educating myself on financial matters that I understood the power of deflation, its inevitability in a credit/money system, and how it truly is the unavoidable endgame for the way of life we're used to here in the west.

Anonymous said...

Greyzone I posted that bit out of Mish's column and at no time did I say it was by him, (if it read that way then, sorry, or, too bad, take your pick) try reading and you will see that. I also did not say I had set it up to manipulate; you made that accusation, off the bat. I merely suggested that you would likely not have read it if it had been written differently. I am sorry if you take yourself and your intellect so heavily -- that is the big problem with our society and it does great harm. Try looking at the stars or a blade of grass; sometimes I wish our leaders would. Reading, or rereading :), someone like Heller or Vonnegut would also be a plus.

Nom de plume

Anonymous said...

Dumb question. Stoneleigh says that because inflation and deflation are monetary phenomenon, the system cannot be both in inflation and deflation at the same time. Is it possible for things "in" the system (i.e., assets within the US) to be in deflation, while things outside the system (i.e., foreign oil) to be perceived to be in inflation at the same time? In other words, is it possible for dollars to be increasingly dear in the US while simultaneously becoming increasingly devalued outside the US, with arbitrage effectively forestalled by everyone trying to preserve their ability to service debts, taxes, and other expenses in their native currency?

el gallinazo said...

nom de plume 6:32

"Greyzone i suppose you can look at it that way but that aside, would you have bothered to read the article if I had said that Mish said some bloke said 'the party' was on again?"

nom de plume 11:32

"Greyzone I posted that bit out of Mish's column and at no time did I say it was by him, (if it read that way then, sorry, or, too bad, take your pick) try reading and you will see that."

And then you wind up with that patronizing blather to smell the stars. I don't even have a dog in this fight and I find it offensive.


Thank you. My memory is failing. I think you hit the major Stoneleigh notes. But I still don't quite figure how they are going to pull this off. Say your whole IRA is invested in shares of Amalgamated Dog Droppings. Are the federal thugs going to sell it off in your behalf and put the money in Treasuries which you cannot cash out until you hit 90?

el gallinazo said...

A 11:51

I think you are mixing your metaphors. You are using a monetary definition of inflation "in the system" presumably meaning the USA and a price definition for oil. While oil's price may rise, oil is not money or credit and cannot inflate or deflate.

Furthermore, while there is a connection between forex rates and inflation and deflation in various currencies, they are two different things and thre is no simple relationship.

But to answer your question "is it possible for dollars to be increasingly dear in the US while simultaneously becoming increasingly devalued outside the US" - the answer is yes. It is possible but less likely than the converse.

Unknown said...

The one point that Aaron made that I didn't think was well responded to was whether given a fiat currency, the government can't print/borrow into existence enough money to at least partially counteract the collapse of private credit. Stoneleigh's response was essentially that the government is too owned by the rich to do that. Maybe so, but it's still not an impossibility -- it's just a political question.

The other issue that seemed interesting was the distinction Aaron was making between the real economy and whatever you want to call the world of international finance. Given the trillions that have already been lost in the "fantasy" economy, when I look around at my life, my neighbors, my family, my city, nothing's really changed . . . yet. Aaron makes a decent point in that if it never really existed in the first place, it's "disappearance" is not that traumatic on the ground.

Interesting dialogue though . . .

Anonymous said...

"..Before getting into the details, it is crucial to note that Americans have never lost so much of their net worth in any recession on record.."

Doctor Housing Bubble's first graph shows American Household worth in the death plunge off the Matterhorn of peak worth in late 2007.

If you look at the angle of descent, it's steeper than the psycho rise in worth just preceding it. This seems like the die is cast on the nosedive speed.

Year's ago, on Letterman, he had stupid human tricks or something.
I think it was called,""Dropping Stuff Out the 8th Floor Window".

He had a cast iron Victoria bathtub placed in the alley behind the studio. It was filled with 150 gallons of chocolate pudding.

He had one of the guests drop a bowling ball out the 8th floor window and try to get it into the tub. First two tries missed but the third bowling ball was right on the mark.

The chocolate pudding seemed to fly out of the tub from the hydraulic displacement shock wave of the bowling ball in a circular high speed tidal wave and ended up covering the surrounding buildings and bystanders out to about 75 yards. The bowling went through the bottom of the cast iron tub, completely shattering it and the ball itself essentially vaporized to dust. It was amazing to see in slow mo replay.

The footage of that should be used to demonstrate what deflation does to an economy.

The bowling ball is Deflation

The chocolate pudding is perceived assets

The Bathtub is the Economy.

Anonymous said...

Thanks Ilargi & Stoneleigh, and to the many who have posted on TAE. For those who "got it" the following should give you a laugh:

A similar production may be coming on the topic of peak oil - after the plateau casts its shadow on the valley below. I think we'll find that preparing for peak credit was much easier than peak oil.


Anonymous said...

On 'the annoys Edmund' scale they go right up there with the use of "me" rather than "I" and "enormity" as a synonym for "big" rather than "gigantic evil".

From Merriam Webster online dictionary:

usage Enormity, some people insist, is improperly used to denote large size. They insist on enormousness for this meaning, and would limit enormity to the meaning “great wickedness.” Those who urge such a limitation may not recognize the subtlety with which enormity is actually used. It regularly denotes a considerable departure from the expected or normal (they awakened; they sat up; and then the enormity of their situation burst upon them. “How did the fire start?” — John Steinbeck). When used to denote large size, either literal or figurative, it usually suggests something so large as to seem overwhelming (no intermediate zone of study. Either the enormity of the desert or the sight of a tiny flower — Paul Theroux) (the enormity of the task of teachers in slum schools — J. B. Conant) and may even be used to suggest both great size and deviation from morality (the enormity of existing stockpiles of atomic weapons — New Republic). It can also emphasize the momentousness of what has happened (the sombre enormity of the Russian Revolution — George Steiner) or of its consequences (perceived as no one in the family could the enormity of the misfortune — E. L. Doctorow).

Anonymous said...


I know that you say this deflationary depression/crisis will last decades. But do you think a decade? Two decades? Three decades? Should I just commit suicide now? Serious question, because this is becoming very depressing.

lautturi said...

"OPEC oil, gas income tops $1 trillion, reserves up" -story points back TAE.

Anonymous said...

We have yet to see a significant drop in aggregate demand, but it is coming. Demand is not what one wants, but one is ready, willing and able to pay for, and it is not inelastic when purchasing power is withdrawn. Without access to credit and without an income stream from employment, more and more people will fall by the wayside.

Maybe we need to invent a new word for falling prices created by a drop in demand due to non-monetary causes. The monetarist school of thought has taken over the minds of even brilliant thinkers like Stoneleigh and entranced them. Just as everything looks like a nail when your only tool is a hammer so does everything look like a monetary phenomenon when your only lens of analysis is monetarism.

Monetarism certainly has its uses when analyzing monetary phenomena but it is a misleading set of theories when explaining pure demand and supply changes.

A case in point is the "money multiplier" fudge to partially account for demand. This is one of many gaping holes in monetarist theory where more traditional supply-demand driven fundamentals are grafted onto monetarist theory with sticky tape.

Demand destruction, whether created by lack of credit, currency, drop in population, emigration, or any other cause is still demand destruction. Demand destruction forces producers/suppliers to reduce prices in order to increase demand. Price elasticity is not always a monetary phenomenon, whatever von Mises or Friedman may have claimed.

KLR said...

**FLASH** Goldman Code Theft BOMBSHELL? - The Market Ticker

Something really ugly popped up on Daily Kos yesterday late in the afternoon.....

...GS, through access to the system as a result of their special gov't perks, was/is able to read the data on trades before it's committed, and place their own buys or sells accordingly in that brief moment, thus allowing them to essentially steal buttloads of money every day from the rest of the punters world.

Two things come out of this:

1. If true, this should be highly illegal, and would, in any sane country result in something like what happened to Arthur Andersen...

(2. ... is way off point....)

God help Goldman if this is true and the government goes after them. This would constitute massive unlawful activity. Indeed, the allegation is that Goldman alone was given this access!

Had to leave out Karl's minefield full of boldface/underscores, natch. Amazing story. Bets on Aleynikov receiving the Litvinenko treatment?

Gegner said...

Anonymous at 12:51 raises an excellent point...does our current global economy have 'decades' left?

I am somewhat less sanguine.

Time is a commodity the fraudsters are rapidly running out of.

Stoneleigh nails the fact that the bailouts aren't being done 'for' us but 'to' us.

This sort of opens the door for a more 'dramatic' conclusion to the events currently unfolding.

How far will the fraudsters go to save themselves from retribution?

Anonymous said...

What collapse in credit?

Karl is a pretty amazing article:

Kneale: You Asked For It....

"Consumers have de-leveraged? Uh, no.
Our banks have de-leveraged? Uh, no
The Fed has de-leveraged? Uh, no.
Government has de-leveraged? Uh, no."

Nothing seems to have been learned since last September.

Anonymous said...

Predictive Hex?

There are a lot of people on here who would love concrete numbers, dates, S&P values etc from I&S.

I&S' reluctance to be tied down to absolutes (publish and be damned!) is understandable, with so many variables. This reminded me of similar stance shown by the medical profession when asked by patients about life expectancy following terminal prognoses.

My wife's mum has cancer, and no one will give any indication of likely timescales for her decline.

We can look at other oblique indicators as to what they are implying - i.e. level of pain relief they offer, extent of chemo etc, as to what they really think her prognosis is.

I came across an article recently which attempted to circumvent this reluctance to give absolutes - by phrasing the question "Is it likely that..."

I've seen Denninger do this too - give 'odds' that an event *may* happen i.e. chances of (e.g) a sovereign default this year, x% up or down from y% last year.

I&S - have you considered then rejected this approach?

Or are we already at Defcon 1, where time is of the essence and everything else is just rearranging the deckchairs on the titanic?



Anonymous said...

In reality we only experience the affordabilty effects of inflation or deflation when we attempt buy or sell something.

On a daily basis we mostly only purchse gotta-haves like food and energy, the nice-to-haves like big houses new cars and long distance air flights don't get purchased.

Problems with affordability in the nice-to-have markets, especially for expensive goods, are a sure indicator of deflation.

VK said...

Karl is right on that one, nothing has been learnt, so they will be forced to learn. When full deleveraging comes it will be a sight to behold. Like stoneleigh says, a tsumami! The banks must eventually fail,asset prices will continue to plummet,unemployment is going to soar to above 50%. It's only a matter of time, tick tock goes the clock. I'm thinking the big fall comes in november.

VK said...

Anon 5.30, I don't understand how you can say they aren't willing to be tied down to any predictive value. The records are there in the blog and the comments section, DOW around 500 in less then 5 years, unemployment of over 50% as deleveraging takes hold due to the close relation between the two. The bear market rally was also accurately predicted and the subsequent fall as well. As Ilargi wrote a few days ago if a car is hurtling towards a brick wall at 200mph then predicting the future becomes very easy.

Anonymous said...

Hi VK - I didn't mean to imply they haven't given (accurate) predictions - rather that '% chance' was a way of indicating changes without having to put numbers or dates to their predictions. That's all. Their record to date has been exemplary, that's why we're all here :)

D. Benton Smith said...

@ Anonymous 12:38

Re: Enormity

You have absolutely NAILED the essence of the discussion (indeed the bulk of all discussion on TAE) but I reckon that fact will be casually dismissed by the majority... who are fixated on the conditions that have been 'normal' during the entirety of their own experience... but which are not the least bit 'normal' to the human condition throughout the previous 150K years or so of homo sapiens sapiens development.

The past couple of centuries have been a total anomaly. Cheap energy, sophisticated high-tech, transcontinental societal structures, and the like did not exist previously and will not exist hence. Thus there is little point in learning a great deal about how they work, other than to assure our own personal survival during the brief decades of the current devolvement.

Your grand children will not need to know how to operate a gps, reckon the rise and fall in bond yields, or figure out the precise details of how Goldman Sachs manipulated the economy of an entire planet with software, a big computer, and a large number of what are essentially illegal wiretaps of other peoples' computerized buy/sell schemes.

The world which so heavily rewarded such insane levels of abstraction will be no more. The brave new world will be once more like a much older world; one which favored a balance between strength and savvy. Abstract reasoning will be more tempered by physical pragmatism, and longevity will once again depend more upon genetic endowment than on medical insurance.

This is not to say TAE is not important. It very much IS important... because one must survive the short term in order to even have a long term.

That's why we are biologically hard wired to weight the present and discount the future.

Nevertheless, it would be wise to consider the sort of world our progeny will be moving into. It will be no more chaotic than this one... just different, older, more 'normal'.

Consider the enormity of our situation.

ca said...

Stoneleigh --

Thank you for this exceptional and adult dialogue with Aaron. It is not an easy subject to grasp.

I hope you can clarify one point for me. You say that you "expect the price of non-essential consumer goods to fall faster than essentials or regulated utilities, where there is more state influence over prices."

Currently, I am seeing the doubling of fees for turnpike tolls, professional licenses, etc. Are you saying that eventually these newly imposed government related fee will be reduced?

el gallinazo said...


And where would these numbers come from? I&S would have to pull them out of their hats. Their analysis is essentially qualitative which is fine by me. It's enough that the government and private economists publish false, BS numbers.

Why give a false sense of accuracy when it doesn't exist? "There is a very likely chance that....." is good enough for me rather giving a falsely precise probability.

Speaking of probability functions, to the poster who asked whether he should commit suicide now or wait, my suggestion is to flip a quarter while you still have one. Then you can blame the quarter and not Stoneleigh for your decision.

Anonymous said...

“Celente contends there are but three possible explanations for President Obama and his "brilliant" team of economic advisors "misreading how bad the economy was":

1. They're ignorant, despite PhD's and impressive resumes.
2. They are so arrogant they are incapable of acknowledging that anyone outside the incestuous Beltway circle could possibly get it right ... when they've got it wrong.
3. They actually do know better, but are lying.

"None of these suffice as excuses," concluded Celente, "but the inability or unwillingness to make accurate forecasts appears to be a Vice Presidential prerequisite." This past January, departing VP Dick Cheney sloughed off his administration's central role in accelerating the financial crisis and failure to head it off, claiming, "Nobody anywhere was smart enough to figure it out."”
Biden Admission:
Obama Plan Doomed
Gerald Celente

Anonymous said...

I think in uncertain times people crave concrete numbers, when it's unrealistic to expect them. I was trying, in my own chubby thumbed and inarticulate way, to profer a compromise 'barometer' which might be used in response to requests for a quantitative approach without (which has happened) "but you said x".
Egad. Where's that coffee? Sometimes things just don't come out the way you intended.

Anonymous said...

How Much Is A Petabyte?

Half Empty said...

Stoneleigh's pieces on TOD and TAE were the first solid point of reference I came across after encountering Peak Oil.

Maybe I'll forward my copy of John Rowbotham's The Grip of Death: A Study of Modern Money, Debt Slavery and Destructive Economics to Aaron to see if it helps him grasp that credit money is real money.

He's also incorrect about passing IOUs back and forth. The process might not have multiplied the amount of money involved but fees were skimmed off with every passing. These fees were individually small but multiplied millions of times over by the churning of CDSs etc. This 'real' money from investors - savers, pension funds, bank capital - went from the hands of the many to the very, very few, whose ability to put it to productive use at the ground level of the economy is negligible.

Ilargi said...


Obviously, turnpike tolls are not consumer goods. Just as obviously, government fees are not set by supply and demand. So your question is a bit odd.

Ilargi said...

cs, el G et al

Precise numbers are impossible to give. A correct trendline is all you're going to get, which puts you ahead of 99% of the population, which is not that bad a seat to be in.

I posted a video of an interview with the man who's unwinding Lehman Bros. a few days ago, which Calculated Risk also later posted.

His message is important in understanding the dynamics. He calls it "extend and pretend", i.e. everybody's hiding the real state of affairs and stretching both the truth and their resources to the limit and beyond, in the vague hope that all will magically turn for the better before they run out of space to stretch it.

Of course the end effect, which must become apparent at one point, will be that a huge amount of resources (out of a rapidly slinking pile) is being directed at not having to face the fall. Which will get all the more steeper on account of it.

Stoneleigh said...

Anon @1:48,

Maybe we need to invent a new word for falling prices created by a drop in demand due to non-monetary causes. The monetarist school of thought has taken over the minds of even brilliant thinkers like Stoneleigh and entranced them. Just as everything looks like a nail when your only tool is a hammer so does everything look like a monetary phenomenon when your only lens of analysis is monetarism.

I am not a monetarist. Having correctly identified the importance of changes in the effective money supply as a leading indicator of price movements (a very important one, but by no means the only one), monetarists prescribe purely monetary remedies, as if an economy were a machine and pulling this or that lever would automatically have this or that effect. This grossly underestimates the complexity of an economy, the foundation of which is actually subjective human influences grounded in collective psychology.

Many economic theories contain very useful insights, but IMO none fully describes the big picture. I would be very interested in spending a year or so weaving together the disparate threads into a coherent structure, but unfortunately I am very unlikely to have the time, considering the need to work for a living, the need to warn people here in realtime and how little time we really have before people will be far more interested in where their next meal is coming from than in abstract ideas.

If you read the primer on energy (Energy, Finance and Hegemonic Power) you will see that we do integrate many factors when making predictions. When it comes to strategic commodities like oil, real politik is extremely significant for instance.

scandia said...

D. Benton Smith, I'll add my duh to your huh...Indeed if the first stimulus wasn't spent why a second one? To funnel somewhere or to someone?
I am noting how relatively easy it is to design/announce a policy and how seemingly difficult it is to execute policy.
One can conclude that policy will not fix the system. I agree with Stoneleigh that this crisis of debt overload needs to play out.

Stoneleigh said...


Currently, I am seeing the doubling of fees for turnpike tolls, professional licenses, etc. Are you saying that eventually these newly imposed government related fee will be reduced?

Not necessarily, but they would not be expected to behave in the same way as prices which were freer to move with prevailing circumstances. Governments will be reluctant to lower fees like that as they will be trying to bring in revenue from wherever they can in order to compensate for the losses of tax revenue from shrinking economic activity. For the same reason I expect property taxes to rise, even as people's ability to pay decreases.

Other forms of government intervention can also have significant effects. For instance, governments are fond of things like price controls on essentials because they are initially politically popular, but these almost always backfire. If one is forced to sell below the cost of production, then one will cease to produce and shelves will be empty. Gas price limits in eastern Canada had the effect of shutting down rural gas stations, as they were not prepared to operate at a loss. The impact on rural populations was significant. In one part of Newfoundland, if memory serves, the nearest gas station was 3 hours drive away.

Stoneleigh said...

Anon @12:51,

I know that you say this deflationary depression/crisis will last decades. But do you think a decade? Two decades? Three decades? Should I just commit suicide now? Serious question, because this is becoming very depressing.

Don't do that. There is always something in life worth living for, but there's no question that it won't be the life you're used to.

Deflation itself will not last for decades. Deflation does not play out as a slow squeeze, and the bulk of the deleveraging should be over in a few short years. The instability and upheaval is what will go on for decades. This will involve a great deal of physical work and a level of physical risk that we in the developed world have never seen before, and there is no doubt that we will find this acutely uncomfortable at best, even if we are as prepared as we possibly can be. Still, we can surround ourselves with friends and family and enjoy the simple pursuits that humans have enjoyed from time immemorial.

Anonymous said...

Can psychology ever trump the numbers, or do chickens always come home to roost?
Why did the 30's bubble burst at 130% debt to gdp, yet we've managed this time to "kick the can" up to 300%+?
Is the problem this time the Lehman's legacy - if confidence is liquidity, playing 'guess who's got the toxic waste' has destroyed the confidence?
Would we still be kicking the can if Lehmans was still functioning, saying "I'll pay you back tomorrow, promise?"

Anonymous said...

From the Wilderness' Peak Oil Blog
From Jenna Orkin:

A cursory glance at the news would suggest that The Powers That Be and their spokesmen, the Mainstream Media, aren't trying to save the patient (us) from our current crises; they're trying to anaesthetize us through the dying process. The neverending story of Michael Jackson advances this agenda as we calmly moonwalk backwards off stage.

Not to torture that metaphor since I have no understanding of the moonwalk, but it would seem reasonable that all you need to do to fall behind in the world is to stay put while the world moves forward. Just keep on doing the same ol' tricks, crank out a few trillion more of that trusty ol' currency, while around you the scene has evolved; the currency, lost its trustiness.

But who could have known? Such a thing never happened before (except in Rome before the collapse of the Empire, China under Kublai Khan, France after John Law, Germany after World War I......)

VK said...

@ Anon 10:42

Another way to look at it would be to take Debt to GDP/ Population.

The Great Depression occurred at 165% Debt to GDP ratio, while today's crisis started at around 350% Debt to GDP ratio BUT the population in 1929 was 122 million for the US while today it is 305 million.

Using Debt to GDP/ Population

1929 = 165%/ 122 = 1.35
2008 = 350%/ 305 = 1.15 (surprisingly smaller!)

So per person Debt to GDP was higher in 1929, but ofcourse the current Debt figures don't include unfunded liabilities at 62 trillion nor all the derivatives bets which have gone bad and are being borne by society.

Stoneleigh said...

This intro is now a diary over at Daily Kos.

jal said...

Stoneleigh said...
Anon @12:51,

"... physical work and a level of physical risk... we will find this acutely uncomfortable at best, even if we are as prepared as we possibly can be."
Did you just say REALITY?

Did you just say that the western world population is going to be just the same as the majority of the population of the world?

I hate sharing my sleeping mat with bed bugs and lice.
"Would we still be kicking the can if Lehmans was still functioning, saying "I'll pay you back tomorrow, promise?" ''

That thought is so funny ...
If you accept parallel universe then go and find out how much time you were able to gain from the final denouement . .... in your dreams

VK said...

Via Bloomie, (holy s*it!)

China’s new lending more than doubled in June from a month earlier, increasing concerns bad loans and asset bubbles will emerge amid a credit boom.

New lending was 1.53 trillion yuan ($224 billion), the central bank said on its Web site today, bringing total lending this year to 7.4 trillion yuan. The calculation for new loans is preliminary, the central bank added.

Anonymous said...

el gallinazo,

Dontcha just love the expression about straining at a gnat and swallowing a camel?


is an interesting clip from a very outspoken Former Assistant Treasury Secretary on the bailouts, the dollar, and Goldman Sachs.

*note: the above is a direct quote of Mish's. (I wouldn't want to strain any ones imagination:)

nom de plume

Anonymous said...

Careful now, when jumping off into the predicative deep end and constructing the cult of personality--Karl said this, Stoneleigh predicted that. When historical curtains finally drop, and they always do, the shadow boxing the apocalypse actors are usually left stumbling around in in an empty theatre, as invisible and irrelevant as the false tornado they once chased.

Oh, but this time is different, the evidence is too strong, the math irrefutable. Fair enough. In which case, enough of the congratulatory back-slapping and ass-patting that seeks to elevate the deductive pragmatism of 20/20 vision into the realm of visionary status.

For every true prophet, there are thousands of bible thumpers preaching fire and brimstone in the back end of buses or on crowded street corners. If the economy is to die, and our way of life as we know it along with it, then bring along a leaking ark for all the media types still raising ‘I Told Ya So’ sails of self-promotion on the high seas of impending tumult.

Good acting is one thing, a WWF spectacle quite another.

Signed, The Aesthete

Anonymous said...


Like this you mean?

Will this wind..?

Not our noble hosts m.o.

Anonymous said...

Mankind is independent, unpredictable, extremely resilient and creative. The beauty in the system is the creative destruction. Rainbow ahead......

centiare said...

@ Pragmatic Progressive Can gov't print/borrow into existence enough money? Stoneleigh's response was essentially that the government is too owned by the rich to do that.

As much as I appreciate Stoneleigh's analyses & essays (this dialogue was just superb), readers should be aware that she possesses an enormous blind spot vis-à-vis the rich v prols.

And that is this: she is a subject of Her Majesty Queen Elizabeth II. Why is this important? Because unlike the US, French, Russians, Chinese, et al who engaged in extremely violent revolutions that overthrew their existing governments, GB, Canada, Australia, NZ and many other Commonwealth countries never went through this process.

In fact, when Stoneleigh emigrated from England, she chose to relocate to Canada. This should tell you something about her internal perspective regarding position, power & authority. And please don't take this as an ad hominem attack - it's merely an observation of how certain people react to a set of circumstances.

The point of this comment is two-fold:
* American citizens are sovereign & distinct from their government. Never forget this fact when considering the final end game.
* America was established by conquest. It is an extremely violent country that has managed to shield this reality from much of the world.

This is why I&S both avoid the fact that the US can (and might) print its way out of the deflationary cycle by whatever amounts are required ($25T -> $1Q [quadrillion] - does it really matter in a fiat world?). Of course, this would destroy the $USD, but our military capabilities & existing strategic positions around the globe are the ultimate trump card.

So what we read each day are these spot-on prognostications regarding the coming social chaos. Yet they are alongside seemingly incongruous claims that the "center will grab the resources", etc, and the prols will continue to labor along, defeated and resigned like downtrodden serfs with nary a reaction amongst them. WRONG! Wrong as can be.

my life, my neighbors, my family, my city, nothing's really changed . . . yet. If it never really existed in the first place, it's "disappearance" is not that traumatic on the ground.

Ah, but it is. Asset values may rise & decline, but contractual obligations are fixed. As Stoneleigh rightly points out, credit acts like money during periods of inflation (money/credit expansion). But as those excess claims are trimmed, and wealth seemingly evaporates, debt still remains fixed & intact.

What you (and the rest of us) are seeing is actually an indicator that the situation is much worse than is being portrayed: what does one do when there's no way out? Why, party on Wayne. With no one paying their CC, mortgage, rent and other bills, they're partying this summer likes it's 1999.

el gallinazo said...

The aesthete

My academic background was physical sciences and my sense of aesthetics marginal. In my universe, the creative thinker proposes a theory and then makes predictions about how future events and or experiments will unfold logically consistent with the theory. The more experiments/events coincide with these predictions, the more the theory is validated. Whether the originator of the theory wishes to pound his or her chest upon success is a matter of personal predilection.

If you find someone with a theory that appears to be validating correctly and the quality or existence of your life is highly correlated with the outcome of the predictions, then it is wise to act in accordance with the predictions in a protective fashion.

Your post seems to imply that all the theories are equally valid and the debate and inspection of them is solely a matter of egotism. This would imply that no one has a clue what's really going down and one might as well throw darts blindfolded. You, of course, are welcome to your opinion and the fruits of that opinion.

tob said...

I have one question about the money printing issue:

Who gets to own it?

Normally when the Fed prints money they lend it out with interest and the ones who get it promise to pay it back some day.

The American finacial class are in de facto control of the Fed and the government. In order for them to see money printing as a solution to their problem they have to find a way to transfer this mountain of cash from the Fed to them without them having to pay it back.

The only solution I can think of is for the fed to buy all the toxic assets directly and then just forget about them.

Is this realistic?

VK said...

Metal Minerals Scarcity and the Elements of Hope :(

el gallinazo said...


I am not even going to try to recant your "reflections" on the American collective character more than to note that we never chopped off the head of our President Charlie.

Your bottom line is that the managers can essentially destroy the USD as it is irrelevant since we can control the entire planet with our military prowess. Our military is quite depleted already from our endless adventures in two small, relatively undeveloped countries. Dream on.

The US military is enormously dependent on large quantities of petroleum products. Many people talk about how the US can control the world's oil fields. Complex mechanisms such oil refineries, port depots, and supertankers are incredibly vulnerable to accurate short range missiles with conventional warheads. Enough said.


Why should they forget about the debt when they con transfer it to the poles tab and turn them into even greater debt slaves?

Ilargi said...


"And please don't take this as an ad hominem attack"

Don't worry., We'll take it as just plain stupid.

Anonymous said...

Feed your inner doomer child ... read this mornings Market Ticker

Also, for anyone who caught the weekly initial jobs claim report this morning, wipe the sweat out of your eyes, he has an interesting comment on that as well.

-uncle wiggley-

jal said...

tob said...
The only solution I can think of is for the fed to buy all the toxic assets directly and then just forget about them.

Is this realistic?
It is happening.
Since, Fannie and Freddie are "crown corporation", (the gov. is the owner), then the "crown corporation" will get the revenues, or restructured revenues from those assets. Those assets are no longer “toxic” in the hands of the gov. since they can hold them for 50 years, if they want.
The banks will not have that revenue stream. ( Look at other countries, Russia, China and see what they do)
The banks will be left holding the “other toxic papers” and their “good loans” and those revenues to try to cover the losses from their “other toxic papers”.


Ilargi said...


"The only solution I can think of is for the fed to buy all the toxic assets directly and then just forget about them.

Is this realistic?"

They might have to print a quadrillion dollars worth of some kind of paper they'd use to buy the toxic assets with.

Which would immediately make that paper a toxic asset.

So no, not realistic.

bluebird said...

There are many graphs on Google that depict the total credit market debt as a % of GDP, for the United States. This percentage is over 300%, for the U.S.

Does anyone have a link to a graph that shows the total credit market debt as a % of GDP, for the whole world? I must not be searching the Google correctly, because I am unable to locate any graph for the world.

Ilargi said...

I think I'm in a time warp. Both Mish and Tyler Durden post a week-old video of Max Keiser interviewing a photograph of of Paul Craig Roberts, saying Goldman rules the government. I saw that last week, and didn't get the newsworthiness bank then, let alone today.

And what's up with today's renewed excitement about Goldman reading the markets? I said last week that the only interesting part was that Goldman might regret calling the police. I also posted a piece on automated computer trading programs, which execute a vast majority of today's trades. It was clear then, and that hasn't changed. Any notion that Goldman has people reading trades before they happen seems futile, since they are done in milliseconds. Goldman probably has their computers hack in to client's systems, and that is likely limited to those clients that use, and pay for, part of their software.

But again, all that was obvious from the get-go.

Brimstone said...

The Pragmatic Progressive said...

The other issue that seemed interesting was the distinction Aaron was making between the real economy and whatever you want to call the world of international finance. Given the trillions that have already been lost in the "fantasy" economy, when I look around at my life, my neighbors, my family, my city, nothing's really changed . . . yet. Aaron makes a decent point in that if it never really existed in the first place, it's "disappearance" is not that traumatic on the ground.


that fantasy money is indeed very real given we use a fiat system. The reason we have not seen things completely explode due to the massive devaluation of those shadow assets, is that all the big banks are using a "mark to fantasy model". That is they are saying that the worthless derivatives are worth 100% of their original value and no one in a position of power is questioning them.

The catch is that when commercial real estate explodes, which is very close to happening and is likely to occur in the next year, the banks will not have enough oney to hide the losses and we will likely see some very large banks collapse very quickly.

In my opiniion this is what could percipitate the bank holidays that I&S have referred to several times.

Also consider that a huge % of US pensions and retirement funds are heavily tied to commercial real estate through various funds. people who had lost 40% of their retirement in the last down leg could very well lose everything in the next leg down.

The shadow financial instrument are very real are have not been seen because the US government just spent more then a trillion dollar to hide the carnage. Governments around the world have done the same thing, just in smaller $ amounts.

Anonymous said...

Ilargi and others, please consider the solution offered by E. Brown for the Fed's debt trap. Is her underlying conclusion sound? Would it work?
Is it a solution for California?

Brimstone said...


As an american let me respond to your earlier statement about US violence and individual sovereignty.

if it was currently 1950, i might agree with your comment, however the average american today is a sheep fit for slaughter. There is still a core of americans who are knowledgeable and capable, but the US political system has become corrupt enough so that what we have is essentially mod rule led by highly funded political and media Machiavellis.

Sadly america is much more likely to go out with a whimper then with a bang. the average sheep is far to scared of conflict to stand up to authority. Now the sheep just watch the bravado and violence on TV instead of taking part.

The USA really is Romes younger sibling, we have certainly followed in her footsteps.

Anonymous said...

Except that Rome lasted some seven hundred years and its decline and fall took some two hundred odd.

I guess the US as a parallel rose, expanded, and is falling in dog years - or maybe Internet time. I.e. if you want to compare it to Rome the timescales are significantly compressed.

Anonymous said...

Everything seems to have changed since that last jobs report, since it viciously undercut the green shoots claims. Here's Rasmussen:

The Rasmussen Reports daily Presidential Tracking Poll for Wednesday shows that 32% of the nation's voters now Strongly Approve of the way that Barack Obama is performing his role as President. Thirty-seven percent (37%) Strongly Disapprove giving Obama a Presidential Approval Index rating of –5.

The number who strongly disapprove inched up another point to the highest level measured to date and the overall Approval Index is at the lowest level yet for Obama.


In the wake of last week’s disappointing report on job loss, consumer confidex has fallen to the lowest level in two months. The Rasmussen Investor Index shows investor confidence falling to the lowest level in three months. The number of investors who say the economy is getting worse jumped from 43% before the jobs report to 51% today.

The peeps are getting restless.

Anonymous said...

Any notion that Goldman has people reading trades before they happen seems futile, since they are done in milliseconds.

I imagine you are on the button about that, but then what were Goldman Sachs so excited about that they would say that in the wrong hands, the stolen information would be able to (I think was said, at least roughly) 'influence the markets'?

-uncle wiggley-

Brimstone said...


not to stray to far afield here, but i believe the difference in lengths of empire is in energy intensity. The brighter you burn the quicker you die. And the US has consumed more energy in its brief history then probably any other empire before it.

Anonymous said...

Goldman's program - if others are aware of your algorithm, they could then use knowledge of your strategy to move against you.

Anonymous said...

Stoneleigh thanks. If deflation will run its course in a few years then what will cause the US to remain in a depression for decades to come?

Anon @ 12:51

Anonymous said...

Why does Stoneleigh occasionally announce that this post is now a diary over at the DailyKos?

Are we to be impressed by this?

Is the DailyKos really a mecca of deep thought?

Why do you tell us?

Stoneleigh said...

Anon @12:51,

Stoneleigh thanks. If deflation will run its course in a few years then what will cause the US to remain in a depression for decades to come?

It's not that all of the next several decades will be depressionary, but that they will be unstable and coloured by conflict on a variety of scales (from domestic political upheaval to nasty proxy wars to full scale war between great powers). There may be longer periods of relative calm or attempted recovery or other economic extremes such as hyperinflation within that time. Energy and conflict (much of which will be over access to energy) will be the most significant factors limiting recovery.

The last time a very major bubble burst - the South Sea Bubble of the 1720s - the resulting international upheaval lasted for decades and culminated in a number of revolutions, including France and the US. I would be very surprised if the impact of this larger bubble were less than that.

What is clear is that life will never be the same again. We will need to live within our means, both in financial and energy terms. That will be a colossal adjustment for populations used to living better than kings of old, thanks to the 100 or so virtual slaves we each have here in the developed world as a result of our unparalleled access to energy.

Stoneleigh said...

Anon @2:07,

Why does Stoneleigh occasionally announce that this post is now a diary over at the DailyKos?

Are we to be impressed by this?

Is the DailyKos really a mecca of deep thought?

Why do you tell us?

LOL - no it's not a mecca of deep thought at all. Putting posts up as diaries over there simply gets them more exposure, and brings more readers here. If people like a post here, and it is a diary at DKos, then they can recommend it there if they are members. If there are enough recommendations, a diary gets on the recommended list and will then be read by thousands more people.

Guess who said...

sorry to bring this up again, but...

enough with the whole anonymous thing! if you want to use a different name every time you post, great, do so, but its no more or less anonymous then making up random screen names.

Anonymous said...

Stoneleigh - Anon at 12:51 here again. So you are saying that a recovery is possible once the deflationary/deleveraging period has run its course? I had initially pegged a bottoming and beginning of a recovery in 2014-2015 based on the housing market and looking at historical data from the last deperession. Your thoughts?

Anonymous said...

Stoneleigh - Anon at 12:51 here again. So you are saying that a recovery is possible once the deflationary/deleveraging period has run its course?

Recovery is quite possible after we deal with energy decline, population adjustment and climatic change, and of course I guess that depends on what you mean by the word 'recovery'. My 'recovery' doesn't include the Walmart and I can only dream of the possibility of corner stores. But there should be more birds, I haven't heard a meadow lark in years, much much before any thoughts of a credit crunch and all.

-uncle wiggley-

Anonymous said...

SEC to call for Calif. IOUs treated as securities;_ylt=AhPGgrhqWsbQvI4DOUPKHea7YWsA?x=0&sec=topStories&pos=4&asset=&ccode=

Frank said...


No not _people_ reading pending transactions, computers reading them and trying to front run them. Even if they couldn't strictly get ahead of the transactions, they would know about them before they happened, while everyone else had to wait until the transaction committed. Milliseconds matter.

And in fairness to Goldman, even if they were not manipulating the market, anyone with Goldman's code could (if big enough) manipulate the market against them, and if smaller, go along for a free ride.

Remember -- Denninger spent much of his career working with computers. When the going gets geeky he is likely to have a better understanding than you.

Stoneleigh said...

Anon @12:51,

So you are saying that a recovery is possible once the deflationary/deleveraging period has run its course? I had initially pegged a bottoming and beginning of a recovery in 2014-2015 based on the housing market and looking at historical data from the last depression. Your thoughts?

I would agree with your timeframe for the initial deleveraging. The depression would be expected to continue for longer. My worry is that a major conflict could break out, as it did as a result of the last depression.

I would expect some form of recovery from perhaps 2020, but I don't expect it to look anything like the life we're used to. I think almost all of us will have very little money and quite likely a lot of health problems of varying degrees of seriousness. We are likely to be much less free than we are now, much less well fed and in possession of much less stuff. We are likely to be living much more simple, local lives and will be lucky to have any kind of employment. I expect we will be mentally tougher and much more used to physical effort. The proletariate will be very much larger.

Almost no one will be an investor. Investment is typically for the rich historically. Ordinary people only get involved in a mania, where virtual wealth temporarily encompasses them too.

VK said...

Hi Stoneleigh

When you mentioned the South Sea bubble leading to revolutions in the US and France, wouldn't that be the Mississippi bubble courtesy of John Law? (A scotsman)

I thought the South Sea bubble affected England only!?

JF said...


I usually come down on whichever side of the inflation/deflation debate represented by the last essay I read on the subject, which due to your extremely lucid and reasoned showing in the debate with Aaron, was with the deflationistas.

But this morning I watched a CSPAN video of Michael Panzner discussing his new book, and he pointed out that if the Fed decides that they are going to whatever is required to stimulate spending, they could resort to tactics such as crediting everyone's bank account with $25,000 - perhaps with the proviso that whatever amount remained at the end of the month would revert back to the Fed.

That's perhaps an extreme example, but it's possible to imagine variants where they might convince themselves that they would be able to exert some control and turn it off, or at least control the inflation such a action might ignite.

Panzner also mentioned that he could see the catalyst for something like that beings social upheaval, or some poltician's attempt to curry favor with the voters.

It seemed to me that once you conceded that the Fed might go straight to the people, as it were, instead of relying on the intermediary of the banking system, that inflation sooner rather than later was a possibility. It doesn't seem like it would be sustainable, as demand would probably peter out a month or two later. What do you think?

Ilargi said...


You don't know me. Why presume? Isn't that wasting your time and everyone else's?

Anonymous said...

Before Disaster (1934)
by Yvor Winters

Evening traffic homeward burns
Swift and even on the turns,
Drifting weight in triple rows,
Fixed relation and repose.
This one edges out and by,
Inch by inch with steady eye.
But should error be increased,
Mass and moment are released;
Matter loosens, flooding blind,
Levels drivers to its kind.
Ranks of nations thus descend,
Watchful, to a stormy end.
By a moment's calm beguiled,
I have got a wife and child.
Fool and scoundrel guide the State.
Peace is whore to Greed and Hate.
Nowhere may I turn to flee:
Action is security.
Treading change with savage heel,
We must live or die by steel.

If history rhymes, poetry should be a leading indicator...

Anonymous said...

John, this is a bit tongue in cheek so I hope you get a better response, but after the Fed gives out that 25,000 and everyone runs out and buys a new SUV what happens next?

-uncle wiggley-

Frank said...


Perhaps because you pretty grossly mistated what Karl actually said. The idea of putting people in the loop is preposterous, and nothing Denninger said implied that he was thinking of such a thing.

Since your English is excellent, the remaining possibilities I see are that you didn't understand what he was talking about or your brain was totally out to lunch.

Jim R said...


Read Ilargi's comment again. Then reply.

And, not everyone is as impressed with Karl's self-proclaimed computer geekery skillz as you seem to be.

Ilargi said...


You don't know me and you don't read. What do you expect?

Greyzone said...

One of the problems in discussing the GS code seems to be from the confusing public data issued thus far.

We know, for instance, that Sergey Aleynikov is no ordinary programmer, possessing patents that relate directly to computer network topology and routing. Further, the software he worked on at GS supposedly used some similar characteristics to his routing software patent - i.e. autonomous agents capable of hosting themselves on target computers to do various things.

Additionally, the DKOS article implies that GS was given access to the network of the NYSE, that is to say, physical access.

If the above facts are correct, then they could have very easily frontrun any trade by inserting a switch into the network at their access point and having the switch hold the incoming trade until the GS software analyzed it and submitted a trade of its own ahead of the incoming trade. Once those actions were complete, which can take place in milliseconds via programming, the original trade's data packet is sent on downstream by the switch.

Note that the above is not unusual behavior at all. Network switches and firewalls do process packets which can cause minuscule delays in forwarding the packet. If the code to analyze the incoming trade and fire forward a trade of their own on behalf of GS can work its algorithms in 500 milliseconds or less, I doubt that anyone would have noticed unless they were actually looking for such a thing.

In short, I have seen no concrete proof yet that GS did what was alleged but I can state that what was alleged is very possible to do. This, coupled with other circumstantial evidence, such as the 6 standard deviation move in trading patterns over the last few months as the GS automated trade portion of the NYSE grew and grew are all valid reasons to have a formal investigation into what has happened here.

Now please note that I do not expect any formal investigation here at all, as its not supposed to happen - investigating "friends" and all that in a fascist state. So I expect no visible action from these GS revelations, including no way to ever know which are true and which are not.

Gravity said...

Today's opening debate shows that there remains a fundamental disagreement about what substances can be considered to have an effect on purchasing power.

It would clarify things significantly to define all forms of money as five-dimensional vectored symbols, which are subject to functions of gravity as well as spin and momentum.

@ el gallinazo

Did you know that jet fuel doesn't burn hot enough to place highly anomalous amounts of put-options on both United and American airlines?

Anonymous said...


The one thing which everyone missed is whether the NSA also has this capability. With the money-making potential here, what do you want to bet on it?

The real money-shot is in keeping the architecture and protocol vulnerable, regardless of the outcome of investigative efforts. Care to wager on that one, too?

Also, I've known Karl professionally in the past. Yes, he is good, technically. Anyone who isn't impressed undoubtedly doesn't know enough to have an informed opinion. Sorry, you point-n-click GUI bozos don't count, regardless of how impressive you think your skills are.

Anonymous said...

July 15th 2009 a Derivative Disaster

bluebird said...

Anonymous @ 7:03 - July 15th 2009 a Derivative Disaster
What is significant about July 15th?

dan w said...

TAE remains my favorite blog on this planet...thanks I&S!!

my one cent worth...literally...

I am more convinced everyday that "we" underestimate the resources that the PTB both possess and will employ in order to keep the streets of the USA from running red.

I have stated many times, and reiterate here: the Obama team will NOT allow systemic collapse to bring chaos to the streets of the USA. Instead they will create the greatest geo-political charade in the history of history---making the Gulf of Tonkin "incident", resolution, Rolling Thunder, and war in Vietnam seem like a schoolyard spat in comparison.

I am predicting wider-war on a massive scale, accompanied by the most sophisticated propaganda campaign in history...all aimed at increasing federal tax revenues by some $1.5-$2 TRILLION over the next 12-24 months.

There simply is no other "solution" considering the ever-expanding debt morass that promises to sink the US empire altogether.

Hombre said...

Hi! Dan W...

Good to hear from you.

You are likely right that "There simply is no other "solution..."

I am not yet convinced that your scenario will evolve either. In short, I think there IS NO SOLUTION!

dan w said...

@ Coy...


There is always a solution. It's just the sometimes---often?---the solution is evil and barbaric and only "solves" the problem for a few....who watch from the tower as the rest perish.

Hombre said...

I hope it all hangs together until 2012... I can't wait for the Franken vs. Palin campaign!!

That'll make even our serious host Ilargi crack up!


Anonymous said...

Greyzone, if the stolen code requires physical access to a local router what good does it do the thief and why would GS be so excited.

-uncle wiggley-

jal said...

Hi Dan W
I hope everything is going good.

Another solution ...

Since the military spends 20% then lower that to 10% by mothballing and using the money for retooling for alternate energy.

thethirdcoast said...

dan w-

I have little doubt that the conflict you describe will break out in the next few years.

However, I do doubt the efficacy of the US MI-complex to wage that war. I pick up checks being a cog in that machine, and it is very clear that the contracting side is choking to death on its own inefficiencies.

Frank said...

>>Any notion that Goldman has people reading trades before they happen seems futile, since they are done in milliseconds.

What didn't I read? That's what Ilargi said. It's either a strawman or he doesn't understand what Denninger said. Take your pick.

Greyzone said...

GS would be upset because forensic analysis of the code would prove, beyond any shadow of a doubt, that GS was committing criminal acts. That's proof, proof that can bring GS down hard, even if the US Government refuses to act by foreign investors fleeing the US markets for fear of them being totally rigged. A player with the code, outside the US, could potentially blackmail GS by threatening to implode the market.

Also, depending on actual physical security in the NYSE, it might be possible to insert a switch someplace along the line without being known.

Finally, any other market that works along similar messaging patterns could also be manipulated in a similar fashion if you could compromise its network physical security.

Shibbly said...

El G,
"Are the federal thugs going to sell it off in your behalf and put the money in Treasuries which you cannot cash out until you hit 90?"
An article a while back posted here written by Pete Peterson (I think that was his name.... he is some sort of insider) stated that he believes a certain percentage of your salary, let's say 10% would be taken from the top and moved into an IRA in US treasuries. This of course is "for your own good" that would be saved for your retirement..... but you know the chances of seeing a penny of it (none). The cash would be used for the usual gov't spending.... interest to the bankers and the military. Mr. Peterson sounded pretty sure that this would happen. Stoneleigh often speaks of the free for all wealth grab by the elite.
In terms of existing IRAs, my guess (and this is only a guess since I am not on the inside) is that they would be frozen, so that no one could access them. The account freeze would be done in order to not contribute to the stock market crash. The elite would cash out and as Stoneleigh has said many times, you need the empty bag holders.....and who or what better than frozen IRA accounts.

thethirdcoast said...

I'm not going to comment on the precise mechanism of GS' market manipulation, but I will state that their track record of success seems to indicate they have a unique level of access not afforded to other market players.

I also thought of another significant issue that will arise if the US decides to initiate a shooting war - rare earth metals.

As fate would have it, China controls 97% of current world supply. If they decide to shut that down we would need a miracle to build an iPod, much less the guidance systems required for the planned fleet of F-35 Joint Strike Fighters.

Read and weep folks:
America's New Energy Dependency: China's Metals

Stoneleigh said...

Dan W,

I have stated many times, and reiterate here: the Obama team will NOT allow systemic collapse to bring chaos to the streets of the USA. Instead they will create the greatest geo-political charade in the history of history---making the Gulf of Tonkin "incident", resolution, Rolling Thunder, and war in Vietnam seem like a schoolyard spat in comparison.

I am predicting wider-war on a massive scale, accompanied by the most sophisticated propaganda campaign in history.

I am on record as comparing our current situation as comparable to 1939. The top for the mania was in 2000, then we had the initial decline 200-2002, a large-scale reflation in nominal terms 2003-2007, a secondary top in late 2007 and the next phase of the decline beginning from there. In the earlier depression the comparable years were 1929-1932, 1932-1937 and 1937-1942. The difference was that the last time the first decline was the most powerful and this time it will be the second. I fully expect conflict to erupt, at least partly in order to divert attention from a domestic meltdown and blame it on an external entity.

Where I differ from you is that I don't expect this to prevent (or even significantly postpone) the meltdown, just divert the blame for it.

Jim said...

Great comments all around! The more I read, the more I'm convinced that predicting the outcome is unknowable, given the enormous complexity of it all. But one thing I think we can all agree on is the complete "fakeness" and umsustainability of it all...and that some major changes are in store for all of us. Lower standard of living.

Ilargi said...

New post up



Anonymous said...

I tend to lean towards Dan W. comment about war, doing something (right or wrong) is better than doing nothing. There may actually be (no solution), but it's better to have tried and failed than never to have tried at all. i am not in the Obama camp, so don't get me wrong, BUT, this (USA) could all be a house of cards, paper tiger, call it what you will, where it's literally about to fall.