Monday, February 15, 2010

February 15 2010: Will Europe throw out Goldman Sachs?

National Photo Co. OINK December 1, 1925
"Miss Lois Hoover and pet pig, Washington, D.C."

Ilargi: Talking to friends over the weekend about the revelations of Goldman Sachs involvement in Greek "fantasy accounting", I said the EU should throw Goldman out and refuse to do any further business with the bank, but that I didn't think they would given Goldman's power in the financial markets. Late last night, former IMF man Simon Johnson wrote that he thinks the EU will indeed ban Goldman. Well, it would certainly would be a good step. Don't kick Greece out of the EU, but Goldman Sachs.

Even with the little information we have so far (Johnson suggests a long list of questions to gather more evidence), it's obvious that there should be enough reason to take measures. For instance, Goldman made some $300 million over a short period of time setting up swaps constructions intended to fool Europe -and investors- about Greece's real financial situation, and it continued such efforts as late in the game as three months ago. It's all certainly immoral, if not downright illegal. Buyers of Greek sovereign debt, just to name a party, certainly have the beginnings of a case against Goldman.

The moral hazard flipside, for lack of a better term, from the European point of view is that the European Central Bank, as well as some governmental offices in Brussels and Luxembourg, have at the very least been asleep while these shenanigans were ongoing, and who knows even actively participating. Moreover, it’s very possible that other European countries were (or even still are) setting up similar deals, and that other banks besides Goldman were assisting them. The New York Times mentions Italy and JPMorgan. A truly serious investigation should therefore be expected to cause quite a few political heads to roll. In other words, there'll be plenty of incentive for those in power to derail any truth-finding process.

Let’s see if Europe has more guts in tearing out its rotting parts than the US has shown in for instance the Goldman-AIG case, where nobody involved, from Bernanke to Paulson to Geithner, seems to be able to remember anything they did mere months ago. I'm not holding my breath, but Simon Johnson's letter has certainly added quite a bit of pressure. Still, we need to realize that both countries and financial institutions have legal departments that are experts in finding reasons not to open their books. So the first thing that needs to happen is for the Greek government to start throwing Greek bodies in jail. Then again, what if the current prime minister is himself involved?

This could be a good moment for the people of Europe to show how forceful their protests can be. They might be needed if they wish to know what happened. What we at least do know so far is that Greek politicians have sold out their voters’ futures for personal short term gains, squandering airport fees and lottery proceeds, among others. There may be much more where that came from.

It could get interesting.

Goldman Goes Rogue – Special European Audit To Follow
by Simon Johnson

At 9:30pm on Sunday, September 21, 2008, Goldman Sachs was saved from imminent collapse by the announcement that the Federal Reserve would allow it to become a bank holding company – implying unfettered access to borrowing from the Fed and other forms of implicit government support, all of which subsequently proved most beneficial.  Officials allowed Goldman to make such an unprecedented conversion in the name of global financial stability.  (The blow-by-blow account is in Andrew Ross Sorkin’s Too Big To Fail; this is confirmed in all substantial detail by Hank Paulson’s memoir.)

We now learn – from Der Spiegel last week and today’s NYT – that Goldman Sachs has not only helped or encouraged some European governments to hide a large part of their debts, but it also endeavored to do so for Greece as recently as last November.  These actions are fundamentally destabilizing to the global financial system, as they undermine: the eurozone area; all attempts to bring greater transparency to government accounting; and the most basic principles that underlie well-functioning markets.  When the data are all lies, the outcomes are all bad – see the subprime mortgage crisis for further detail.

A single rogue trader can bring down a bank – remember the case of Barings.  But a single rogue bank can bring down the world’s financial system.

Goldman will dismiss this as "business as usual" and, to be sure, a few phone calls around Washington will help ensure that Goldman’s primary supervisor – now the Fed – looks the other way.

But the affair is now out of Ben Bernanke’s hands, and quite far from people who are easily swayed by the White House.  It goes immediately to the European Commission, which has jurisdiction over eurozone budget issues.  Faced with enormous pressure from those eurozone countries now on the hook for saving Greece, the Commission will surely launch a special audit of Goldman and all its European clients.

This audit should focus on ten sets of questions.

  1. Which eurozone governments have worked with Goldman, and on what basis, over the past decade?  All actions prior to and after the introduction of the euro need to be thoroughly reexamined.
  2. What transactions has Goldman facilitated and how has that affected the reporting of European government debt?  (Under the Maastricht Treaty, eurozone government debt is not supposed to exceed 60 percent of GDP.) 
  3. In the case of Greece, the accusation is that Goldman deliberately and in a premeditated manner conspired to hide the true degree of government debt.  Is this true, and to what extent has Goldman helped other countries engage in similar transactions, e.g., countries now seeking entry to the eurozone?
  4. What is the full extent of Greek and other government liabilities, if these are accounted for properly?  Without this reckoning, it is impossible to design a proper level of European Union (or any other) support for weaker eurozone countries.
  5. Are there non-eurozone countries that have also been aided and abetted by Goldman in this fashion?  For example, are the UK and Switzerland implicated – and thus endangered?
  6. Has Goldman extolled the virtues of government debt in Greece, or other countries, while at the same time helping to deceive investors on the true risks inherent in those debts?  What were Goldman’s own holdings of these securities?
  7. Is there evidence that Goldman has structured similar transactions for the private sector – enabling companies to conceal the level of their true indebtedness?  Have securities issued by such firms also been endorsed by Goldman to the buying public?
  8. Were Goldman’s US-based supervisors aware of Goldman’s activities in Greece and other eurozone countries?  Did they condone activities that undermine the integrity of the European Union?
  9. Where was the European Central Bank while all of this was happening?  Has the ECB become dangerously enraptured with the new Wall Street and its “techniques”?
  10. Did any responsible official really think that what Goldman was constructing was really some sort of productivity-enhancing financial innovation – as opposed to a sophisticated form of scam?

The Federal Reserve must cooperate fully with this investigation.  Ordinarily, the Fed might be tempted to sit on useful information, but they can now feel themselves in Senator Bob Corker’s crosshairs.  Republican Senator Corker is willing to cooperate with Senator Dodd on financial sector reform, opening up the possibility of legislation that will pass the Senate, but he wants the Fed to lose its supervisory powers.  If the Fed refuses to help – willingly and fully - the European Commission with bringing Goldman to account, that will just strengthen the hand of Senator Corker and his allies.

If the Federal Reserve were an effective supervisor, it would have the political will sufficient to determine that Goldman Sachs has not been acting in accordance with its banking license.  But any meaningful action from this direction seems unlikely.

Instead, Goldman will probably be blacklisted from working with eurozone governments for the foreseeable future; as was the case with Salomon Brothers 20 years ago, Goldman may be on its way to be banned from some government securities markets altogether.  If it is to be allowed back into this arena, it will have to address the inherent conflicts of interest between advising a government on how to put (deceptive levels of) lipstick on a pig and cajoling investors into buying livestock at inflated prices.

And the US government, at the highest levels, has to ask a fundamental question: For how long does it wish to be intimately associated with Goldman Sachs and this kind of destabilizing action?  What is the priority here - a sustainable recovery and a viable financial system, or one particular set of investment bankers?

To preserve Goldman, on incredibly generous terms, in the name of saving the financial system was and is hard to defend – but that is where we are.  To allow the current government-backed (massive) Goldman to behave recklessly and with complete disregard to the basic tenets of international financial stability is utterly indefensible.

The credibility of the Federal Reserve, already at an all-time low, has just suffered another crippling blow; the ECB is also now in the line of fire.  Goldman Sachs has a lot to answer for.

Greek Probe Uncovers ‘Long-Term Damage’ From Swaps Agreements
A Greek government inquiry uncovered a series of swaps agreements with securities firms that may have allowed it to mask its growing debts. Greece used the swaps to defer interest repayments by several years, according to a Feb. 1 report commissioned by the Finance Ministry in Athens. The document didn’t identify the securities firms Greece used. The government turned to Goldman Sachs Group Inc. in 2002 to obtain $1 billion through a swap agreement, Christoforos Sardelis, head of Greece’s Public Debt Management Agency between 1999 and 2004, said in an interview last week.

"While swaps should be strictly limited to those that lead to a permanent reduction in interest spending, some of these agreements have been made to move interest from the present year to the future, with long-term damage to the Greek state," the Finance Ministry report said. The 106-page dossier is now being examined by lawmakers. European Union leaders last week ordered Greece to get its deficit under control and vowed "determined" action to staunch the worst crisis in the euro’s 11-year history. Standard & Poor’s and Fitch Ratings are questioning Greece over its use of the swap agreements, said two people with direct knowledge of the situation, who declined to be identified because the talks are private.

"Greece used accounting tricks to hide its deficit and this is a huge problem," Wolfgang Gerke, president of the Bavarian Center of Finance in Munich and Honorary Professor at the European Business School, said in an interview. "The rating agencies are doing the right thing, but it may be too little too late. The EU slept through this." Lucas van Praag, a spokesman for New York-based Goldman Sachs, the most profitable securities firm in Wall Street history, didn’t respond to e-mails seeking comment.

Greece, whose burgeoning budget deficit caused it to fail the criteria for joining the single European currency in 1999, joined the Euro in 2001. Member nations had to reduce their budget deficit to less than 3 percent of gross domestic product and trim national debt to less than 60 percent of GDP. Greek Prime Minister George Papandreou, who came to power in October after defeating two-term incumbent Kostas Karamanlis, more than tripled the 2009 deficit estimate to 12.7 percent. Greek officials last month pledged to provide more reliable statistics after the EU complained of "severe irregularities" in the nation’s economic figures.

The Finance Ministry report blamed "political interference" for the collapse of credibility in Greece’s statistics. There were "serious weaknesses" in data collection, especially with spending figures, as information often came from second-hand sources, the report found. The Goldman Sachs transaction consisted of a cross-currency swap of about $10 billion of debt issued by Greece in dollars and yen, Sardelis said. That was swapped into euros using a historical exchange rate, a mechanism that implied a reduction in debt and generated about $1 billion of funding for that year, he said. Eurostat, the EU’s Luxembourg-based statistics office, and the rating companies were both aware of the plan, he said. Officials for Eurostat couldn’t be reached for comment. Officials for Fitch, Moody’s and Standard & Poor’s didn’t return calls seeking comment outside regular office hours yesterday.

Sardelis said the agreement was restructured "a couple" of times while he was still in office. He left in 2004 and joined Banca IMI, the investment-banking unit of Italy’s Intesa Sanpaolo SpA’s. He said the fees, or the spread that Goldman Sachs was paid on the contract, were "reasonable." The New York-based firm made about $300 million from the agreement, the New York Times reported Feb. 14. Goldman Sachs bankers including President Gary Cohn traveled to Athens in November to pitch a deal that would push debt from the country’s health-care services into the future, the newspaper reported, citing two people briefed on the meeting. Greece rejected the offer, the New York Times said.

The government met with major international banks over the last month in order to explore options and discuss their involvement in financing Greek national debt, said an official at the Greek finance ministry who declined to be identified. Debt-financing operations are conducted transparently in order to be fully Eurostat-compliant, the official said. Goldman Sachs reported net income of $13.4 billion in 2009’s fiscal year, outpacing the $11.6 billion profit in 2007, its next-best year. The shares doubled last year to $168.84. S&P, Moody’s Investors Service and Fitch in December all cut Greece’s credit rating in December. The rating was lowered by one level to BBB+ from A- at S&P and the country’s debt was put on "credit-watch negative," signaling the company may reduce it again. Fitch cut Greece’s rating one level to BBB+, from A-. Moody’s cut Greece to A2 from A1.

Wall Street Helped Greece to Mask Debt Fueling Europe’s Crisis
Wall Street tactics akin to the ones that fostered subprime mortgages in America have worsened the financial crisis shaking Greece and undermining the euro by enabling European governments to hide their mounting debts. As worries over Greece rattle world markets, records and interviews show that with Wall Street’s help, the nation engaged in a decade-long effort to skirt European debt limits. One deal created by Goldman Sachs helped obscure billions in debt from the budget overseers in Brussels.

Even as the crisis was nearing the flashpoint, banks were searching for ways to help Greece forestall the day of reckoning. In early November — three months before Athens became the epicenter of global financial anxiety — a team from Goldman Sachs arrived in the ancient city with a very modern proposition for a government struggling to pay its bills, according to two people who were briefed on the meeting. The bankers, led by Goldman’s president, Gary D. Cohn, held out a financing instrument that would have pushed debt from Greece’s health care system far into the future, much as when strapped homeowners take out second mortgages to pay off their credit cards.

It had worked before. In 2001, just after Greece was admitted to Europe’s monetary union, Goldman helped the government quietly borrow billions, people familiar with the transaction said. That deal, hidden from public view because it was treated as a currency trade rather than a loan, helped Athens to meet Europe’s deficit rules while continuing to spend beyond its means. Athens did not pursue the latest Goldman proposal, but with Greece groaning under the weight of its debts and with its richer neighbors vowing to come to its aid, the deals over the last decade are raising questions about Wall Street’s role in the world’s latest financial drama.

As in the American subprime crisis and the implosion of the American International Group, financial derivatives played a role in the run-up of Greek debt. Instruments developed by Goldman Sachs, JPMorgan Chase and a wide range of other banks enabled politicians to mask additional borrowing in Greece, Italy and possibly elsewhere. In dozens of deals across the Continent, banks provided cash upfront in return for government payments in the future, with those liabilities then left off the books. Greece, for example, traded away the rights to airport fees and lottery proceeds in years to come.

Critics say that such deals, because they are not recorded as loans, mislead investors and regulators about the depth of a country’s liabilities. Some of the Greek deals were named after figures in Greek mythology. One of them, for instance, was called Aeolos, after the god of the winds. The crisis in Greece poses the most significant challenge yet to Europe’s common currency, the euro, and the Continent’s goal of economic unity. The country is, in the argot of banking, too big to be allowed to fail. Greece owes the world $300 billion, and major banks are on the hook for much of that debt. A default would reverberate around the globe.

A spokeswoman for the Greek finance ministry said the government had met with many banks in recent months and had not committed to any bank’s offers. All debt financings "are conducted in an effort of transparency," she said. Goldman and JPMorgan declined to comment. While Wall Street’s handiwork in Europe has received little attention on this side of the Atlantic, it has been sharply criticized in Greece and in magazines like Der Spiegel in Germany. "Politicians want to pass the ball forward, and if a banker can show them a way to pass a problem to the future, they will fall for it," said Gikas A. Hardouvelis, an economist and former government official who helped write a recent report on Greece’s accounting policies.

Wall Street did not create Europe’s debt problem. But bankers enabled Greece and others to borrow beyond their means, in deals that were perfectly legal. Few rules govern how nations can borrow the money they need for expenses like the military and health care. The market for sovereign debt — the Wall Street term for loans to governments — is as unfettered as it is vast. "If a government wants to cheat, it can cheat," said Garry Schinasi, a veteran of the International Monetary Fund’s capital markets surveillance unit, which monitors vulnerability in global capital markets.

Banks eagerly exploited what was, for them, a highly lucrative symbiosis with free-spending governments. While Greece did not take advantage of Goldman’s proposal in November 2009, it had paid the bank about $300 million in fees for arranging the 2001 transaction, according to several bankers familiar with the deal. Such derivatives, which are not openly documented or disclosed, add to the uncertainty over how deep the troubles go in Greece and which other governments might have used similar off-balance sheet accounting.

The tide of fear is now washing over other economically troubled countries on the periphery of Europe, making it more expensive for Italy, Spain and Portugal to borrow. For all the benefits of uniting Europe with one currency, the birth of the euro came with an original sin: countries like Italy and Greece entered the monetary union with bigger deficits than the ones permitted under the treaty that created the currency. Rather than raise taxes or reduce spending, however, these governments artificially reduced their deficits with derivatives.

Derivatives do not have to be sinister. The 2001 transaction involved a type of derivative known as a swap. One such instrument, called an interest-rate swap, can help companies and countries cope with swings in their borrowing costs by exchanging fixed-rate payments for floating-rate ones, or vice versa. Another kind, a currency swap, can minimize the impact of volatile foreign exchange rates. But with the help of JPMorgan, Italy was able to do more than that. Despite persistently high deficits, a 1996 derivative helped bring Italy’s budget into line by swapping currency with JPMorgan at a favorable exchange rate, effectively putting more money in the government’s hands. In return, Italy committed to future payments that were not booked as liabilities.

"Derivatives are a very useful instrument," said Gustavo Piga, an economics professor who wrote a report for the Council on Foreign Relations on the Italian transaction. "They just become bad if they’re used to window-dress accounts." In Greece, the financial wizardry went even further. In what amounted to a garage sale on a national scale, Greek officials essentially mortgaged the country’s airports and highways to raise much-needed money.

Aeolos, a legal entity created in 2001, helped Greece reduce the debt on its balance sheet that year. As part of the deal, Greece got cash upfront in return for pledging future landing fees at the country’s airports. A similar deal in 2000 called Ariadne devoured the revenue that the government collected from its national lottery. Greece, however, classified those transactions as sales, not loans, despite doubts by many critics. These kinds of deals have been controversial within government circles for years. As far back as 2000, European finance ministers fiercely debated whether derivative deals used for creative accounting should be disclosed.

The answer was no. But in 2002, accounting disclosure was required for many entities like Aeolos and Ariadne that did not appear on nations’ balance sheets, prompting governments to restate such deals as loans rather than sales. Still, as recently as 2008, Eurostat, the European Union’s statistics agency, reported that "in a number of instances, the observed securitization operations seem to have been purportedly designed to achieve a given accounting result, irrespective of the economic merit of the operation." While such accounting gimmicks may be beneficial in the short run, over time they can prove disastrous.

George Alogoskoufis, who became Greece’s finance minister in a political party shift after the Goldman deal, criticized the transaction in the Parliament in 2005. The deal, Mr. Alogoskoufis argued, would saddle the government with big payments to Goldman until 2019. Mr. Alogoskoufis, who stepped down a year ago, said in an e-mail message last week that Goldman later agreed to reconfigure the deal "to restore its good will with the republic." He said the new design was better for Greece than the old one. In 2005, Goldman sold the interest rate swap to the National Bank of Greece, the country’s largest bank, according to two people briefed on the transaction.

In 2008, Goldman helped the bank put the swap into a legal entity called Titlos. But the bank retained the bonds that Titlos issued, according to Dealogic, a financial research firm, for use as collateral to borrow even more from the European Central Bank. Edward Manchester, a senior vice president at the Moody’s credit rating agency, said the deal would ultimately be a money-loser for Greece because of its long-term payment obligations. Referring to the Titlos swap with the government of Greece, he said: "This swap is always going to be unprofitable for the Greek government."

Greece to resist push for greater austerity
Greece is expected today to resist pressure for an immediate tightening of its current austerity package as it fights to win back the confidence of international financial markets and its eurozone neighbours. Germany and the European Central Bank have been pushing Athens to strengthen its existing fiscal stability plan by adding measures such as a 1-2 per cent increase in value added tax and further public-sector wage cuts in return for financial assistance.

On French television last night, Jean-Claude Trichet, ECB president, called on Greece "to take the extra measures that will be necessary to make credible their turnaround plan". Athens is fighting to postpone any decision on further measures until mid-March, when officials from the European Union, ECB and the International Monetary Fund are due to carry out a forensic inspection of Greece's deficit-cutting programme. "It makes no sense to rush into additional measures until they are seen to be necessary," said a senior Greek official.

Eurozone finance ministers are due today to consider whether Greece needs to do more to achieve this year's target of reducing its deficit from 12.7 per cent to 8.7 per cent of gross domestic product. Greece maintains that additional measures announced this month - a fuel tax increase and an extra 1 percentage point cut in public-sector pay - are adequate to meet the deficit target. French officials said any announcement of fresh measures was unlikely today. Analysts remain sceptical over whether Greece's current plans will go far enough, especially after figures last week showed the economy contracted by 2 per cent in 2009 against a projection of 1.2 per cent. "It's hard to see how Greece can avoid a further tightening of fiscal policy," a senior Athens banker said.

French and German officials said they were willing to wait until the result of the mid-March mission. But the ECB is arguing for Athens to take further steps to boost tax revenues or cut spending. The ECB has been anxious to safeguard the eurozone's "no bail-out" clause but last week Mr Trichet backed a eurozone leaders' pledge "to take determined and co-ordinated action, if needed, to safeguard financial stability in the euro area". That suggested he believed ways could be found by which, in an extreme case, Greece could be helped without taxpayers' money from one country being used to help taxpayers in another.

EU takes Greek economy under its wing
Days after promising to support debt-laden Greece if necessary, the European Union will put the country under unprecedented fiscal surveillance this week, hoping to avoid the need for a bailout. EU finance ministers, meeting Monday and Tuesday in Brussels, will back the exceptional measure to instill some budgetary discipline into Greece where swollen public deficits and massive debt levels threaten the 16-nation eurozone as a whole. Market speculators are watching every move in Brussels.

On Friday EU heads of state and government promised coordinated measures and offered political support to Greece but no cold, hard cash, leaving analysts unimpressed. The 27 European leaders also voiced opposition to the idea of euro bonds or making an embarrassing call on the International Monetary Fund. "The summit was a political bailout and lacked substance on the framework of how assistance would work in practice," said Lloyds Banking Group economist Kenneth Broux. He added the hope that the meeting of eurozone finance ministers on Monday and counterparts from the whole EU on Tuesday would "fill in the blanks." He may be disappointed.

"You have to keep the markets guessing slightly. If you give out too much of a detailed plan, you provide a temptation to see how it will work," one European diplomat said. Nor does anyone want to reduce Greece's urgency to implement its austerity measures, especially given the pressure Athens is under due to social unrest back home. Greece has already announced tough action including raising the pension age and forcing public sector workers to accept cuts. Nevertheless the cost of borrowing for Greece on bond markets has risen sharply of late in response to the country's debt burden and on fears that its proposed measures might not be enough to strengthen public finances.

The markets will be watching as EU ministers follow advice from the European Commission and take the Greek economy in hand, setting a detailed calendar for the public deficit to gradually come down. The ambition is to help Greece reduce its public deficit to three percent of output in 2012. Last year it was estimated at a massive 12.75 percent and its overall debt levels are put at 113 percent. It's not just the figures that are a worry for Greece's eurozone partners, it's their reliability as well, as Greece has recently been criticised for being unable, or unwilling to produce sound statistics.

The EU ministers will also tell Athens that its macroeconomic policy puts the functioning of the eurozone in danger and will seek specific remedies; reform of the health and pensions systems as well as public administration and a general reduction in government spending. Athens will have to present its first progress report in March, another in May and on a three-monthly basis after that, an unprecedented level of micromanagement from Brussels. "We are not going to leave them alone," insisted Jean-Claude Juncker, president of the Eurogroup of eurozone finance ministers. It is hoped that the "total action plan" will allow for Athens to build a "coherent economic policy," as the European diplomat put it.

While Greece is being put under the financial microscope, some of its fellow eurozone nations -- Spain, Portugal and Ireland in particular -- know that their economies are not too far behind. In all, 20 of the 27 European Union nations are the subject of excessive deficit procedures. All the bad news has been hurting the euro which fell to a nine-month low of just over 1.36 dollars on Friday, down from around 1.45 dollars a month ago. EU Energy Commissioner Guenther Oettinger said Saturday that protecting the stability of the euro was crucial, and if member states refused to start cutting their deficits next year, European bodies should be given powers to intervene more broadly. The finance ministers are also set to consider ways to better coordinate all their national economic policies. The European Commission has promised to come up with suggestions soon to achieve this. Getting everyone to implement them may not be as easy.

The Greek Tragedy That Changed Europe
by Simon Johnson and Peter Boone

Plutus, the Greek god of wealth, did not have an easy life. As the myth goes, Plutus wanted to grant riches only to the "the just, the wise, the men of ordered life." Zeus blinded him out of jealousy of mankind (and envy of the good), leaving Plutus to indiscriminately distribute his favors. Modern-day Greece may be just and wise, but it certainly has not had an ordered life. As a result, the great opportunity and wealth bestowed by European integration has been largely squandered. And lower interest rates over the past decade—brought down to German levels through Greece being allowed, rather generously, into the euro zone—led to little more than further deficits and a dangerous buildup of government debt.

Now Plutus wants his money back. Europe is entering unprepared into a serious economic crisis—and the nascent global recovery could easily collapse due to the unsustainable and Ponzi-like buildup of government debt in weaker countries. At the end of the G7 meeting in Canada last weekend, Treasury Secretary Tim Geithner told reporters, "I just want to underscore they made it clear to us—they, the European authorities—that they will manage this [Greek debt crisis] with great care." But the Europeans have not been careful so far. The issues for troubled euro zone countries are straightforward: Portugal, Ireland, Italy, Greece and Spain (known to the financial markets, and not in a polite way, as the PIIGS) had varying degrees of foreign- and bank credit-financed rapid expansions over the past decade. In fall 2008, these bubbles collapsed.

As custodian of their shared currency, the European Central Bank responded by quietly opening lifelines to all these countries, effectively buying government bonds through special credit windows. Europe's periphery was fragile but surviving on this intravenous line of credit from the ECB until a few weeks ago, when it suddenly became apparent that Jean-Claude Trichet, president of the ECB, and his German backers were finally lining up to cut Greece off from that implicit subsidy. The Germans have become tired of supporting countries that do not, to their minds, try hard enough. Investors naturally flew from Greek debt—Greece's debt yields rose, and its banking system verged near collapse as investors and savers ran from the country.

But it's not just about Greece any more. Thursday's European Union summit ended with vague assurances of mutual support but did not fundamentally change the financial markets' assessment. Other countries can also be cut off from easy ECB funding, so worries have spread through the euro zone to Spain and Portugal. Ireland and Italy are also up for hostile reconsideration by the markets, and Austria and Belgium may not be far behind. If these problems are not addressed quickly and effectively, Europe's economy will be derailed—with serious, if hard to quantify, implications for the rest of the world.

Germany and France are cooking up a belated support package for Greece, but they have made it abundantly clear that Greece must slash public sector wages and other spending; the Greek trade unions get this and are in the streets. If Greece (and the other troubled countries) still had their own currencies, it would all be a lot easier. Just as in the U.K. since 2008, their exchange rates would depreciate sharply. This would lower the cost of labor, making them competitive again (remember Asia after 1997-'98) while also inflating asset prices and helping to refloat borrowers who are underwater on their mortgages and other debts. It would undoubtedly hurt the Germans and the French, who would suffer from less competitiveness—but when you are in deep trouble, who cares?

Since these struggling countries share the euro, run by the European Central Bank in Frankfurt, their currencies cannot fall in this fashion. So they are left with the need to massively curtail demand, lower wages and reduce the public sector workforce. The last time we saw this kind of precipitate fiscal austerity—when nations were tied to the gold standard—it contributed directly to the onset of the Great Depression in the 1930s. The International Monetary Fund is supposed to lend to countries in trouble, to cushion the blow of crisis and to offer a form of international circuit breaker when everything looks fragile. The idea is not to prevent necessary adjustments—for example, in the form of budget deficit reduction—but to spread those out over time, to restore confidence, and to serve as an external seal of approval on a government's credibility.

Despite the fact that the IMF was created after World War II essentially as a U.S.-Western European partnership, and despite the fact that Europe has strong representation at the fund and has always chosen its top leader, in this instance the fund has been reduced to not-entirely-helpful kibitzing from the sidelines. Dominique Strauss-Kahn, the fund's managing director, said recently on French radio that the fund stands ready to help Greece. But he knows this is wishful thinking. "Going to the IMF" brings with it a great deal of stigma; just ask the Asian countries that had to borrow from the fund during their crises of the 1990s. And many in Europe view the fund as an American-influenced institution—located three blocks from the White House for a reason—that would be invading Europe's territory.

In addition, French President Nicolas Sarkozy has serious personal reasons to push the IMF away. Mr. Strauss-Kahn is a serious potential challenger in France's upcoming elections; Mr. Sarkozy would hate to see the IMF play a statesman-like role on his home turf. Chancellor Angela Merkel, currently maneuvering to ensure a German is the next head at the ECB, is also concerned. The IMF might take the position that ECB policies have been overly contractionary—resulting in a strong euro and very low inflation—and not appropriate for member countries in the midst of a financial collapse. If the IMF were to support Europe's weaker economies, this would challenge the prevailing ideology among Frankfurt-dominated policy makers.

Nations outside Europe, such as the U.S., are naturally reluctant to get involved. Sending Greece to the IMF would result in some international "burden sharing," as it would be IMF resources, from its member countries around the world, on the line, rather than just European Union funds. Is the U.S. really willing to share the burden through the IMF? And how would the Chinese, for example, react if such a proposition came to the IMF? No industrialized democracy is in a particular hurry to find out. What is the solution? One possibility is to recognize that the current euro zone might not make sense. This is not a decision that anyone will take this week, but it may well be the fast-approaching reality.

If Europe really does want to save this version of the euro zone from collapse, what would constitute substantive steps? First, the EU leadership should recognize that, despite all its warts, the IMF has unique expertise in designing programs that pull countries back from the brink of financial collapse. The latest indications are that the IMF could be brought in as "technical assistance plus" to comb through the books of troubled countries, work with the governments to determine what macroeconomic programs are needed, and then monitor the conditionality of such programs while reporting back to the EU (and, more informally, to the IMF executive board). These programs would involve some upfront fiscal austerity to bring nations on a solvent path, but perhaps not as much as in the Franco-German bilateral-bailout scenario.

Second, Europe must soon create a multilateral funding system that ensured adequate finance was available to each nation that adhered to these conditional programs. This could be pooled resources of EU nations, and could be supplemented with IMF financing. Relying on money directly from France or Germany is unwise. Finding a robust deal directly between hard-pressed French and German taxpayers and Greek public sector trade unions will be difficult. German voters, in particular, are fed up with subsidizing other Europeans—who they feel, with some justification, have not made the adjustments they promised when the euro was founded. Greek civil servants, on the other hand, are already pushing back hard against what they are framing as unwarranted German intervention and harshness. The Europeans will experience firsthand what the IMF has long known. When you ride to the rescue of a financially embattled nation, your arrival is appreciated for about 20 minutes. Then people become embarrassed, resentful and even angry.

Third, the European Central Bank needs to adjust its policies, lowering interest rates further and allowing higher inflation throughout the currency union. If such looser money policies are not palatable to the Germanic core, then Berlin/Frankfurt should get on with the task of admitting that the euro zone itself is a failure.

Finally, if the troubled countries cannot adhere to the conditionality attached to their lifelines, the European Union needs a graceful way out. They need "living wills"—plans for countries to exit from the euro zone. The mere existence of such living wills could lead to serious complications—perhaps inviting further speculative attacks—but failing to prepare would be completely irresponsible. Frankly, it would be a disaster for weaker euro zone countries to leave the bloc. Exiting countries would need to rewrite all their contracts in terms of new currencies, converting as many liabilities and assets as possible into those, and then manage a new monetary policy. There would be legal challenges in international courts to rewritten contracts—some of which would certainly constitute default. Building trust in any new currency is always difficult. But a German exit from the euro zone, in a huff, cannot be ruled out—although its consequences could be equally chaotic.

Even following Thursday's EU summit, an orderly resolution of these problems seems unlikely. The Germans will push for draconian cuts to Greece's government spending and public sector wages but they won't budge on relatively tight monetary policy and the overly strong euro—and they definitely won't agree to loosen their own (German) fiscal policy. Ireland is already cutting hard. Such fiscal austerity leads to double-digit declines in GDP, and risks massive political revolts. Ireland's banks are today probably insolvent. Who can afford to repay their mortgages when wages are falling and unemployment rising? Irish house prices continue to speed downward. This is not an example of a "careful" solution—it is a nation in a financial death spiral.

Other EU countries will lobby for a continuation of the status quo. They would prefer the ECB keep lending to the periphery, and the problems be pushed off for another day. This too is no solution. For now Europe will try to muddle through. Greece will promise a pound of flesh, hoping not to pay, and other nations will be spared with promises of continued financing—but just for now. Financial markets know that this makes no sense, hence the "largest ever" short euro positions, betting on a further decline of the currency. If one country must make a substantial and painful fiscal adjustment, eventually the rest will follow. The implication for bondholders is obvious: Edge towards the door. Bond yields will stay high or creep up, until the next wave of financial crisis and contagion. The problems could easily jump beyond Europe; any sovereign with shaky finances can be hauled before the harsh court of international creditor opinion.

The Obama administration should not recuse itself from these problems. The U.S. must press Europe to act in a way that supports the broader global economy. We should encourage an orderly resolution to problems in Europe, and press the Europeans to bring in the IMF in an appropriate fashion. The U.S. must stop relying on Europe to be "careful," and instead cooperate assertively to help reduce the risk of further collapse in Europe. American leaders must also address problems at home. Unless and until the U.S. puts in place a plausible process to take its own government debt off an explosive path—for example, through an independent but Congress-backed fiscal commission of some kind, with everything on the table—we are vulnerable to the same kind of debt dynamics that now plague parts of Europe.

This is not a call for immediate fiscal austerity; that is the path back to the 1930s. But no country can go on issuing your debt without consequence when the buyers declare, "Enough!" In the case of the U.K. and the U.S., the macro situation remains stable only as long as foreigners buy and hold our government debt. This is a major economic and national security risk. Financial markets are telling us the euro zone is under threat, but the real message is much broader: Unsustainable debt dynamics can undermine us all.

States to Senate: Send more federal aid
States are looking to the federal government for more help balancing their budgets, but the Senate is not heeding their call. Federal aid to the states was among the top priorities in an early Senate job creation bill, as well as in a $154 billion measure passed by the House in December. But it has fallen off the list as Senate Democrats look to craft legislation that will attract bipartisan support.

Senate Majority Leader Harry Reid, D-Nev., on Thursday unveiled a jobs bill that does not contain state aid. A Senate Democratic aide said Reid hopes to back a state aid measure in the future. Republican support, however, remains questionable. Experts and state officials say they need to know now whether they'll get more funds. Governors are currently crafting their budgets and, for many, it will be their third year of contending with massive deficits due to declining tax revenues.

States are looking at a total budget gap of $180 billion for fiscal 2011, which for most of them begins July 1. These cuts could lead to a loss of 900,000 jobs, according to Mark Zandi, chief economist of Moody's "State and local government spending is a very important driver of the national economy, especially when the private sector is faltering," said Jon Shure, deputy director of the Center on Budget and Policy Priorities' State Fiscal Project. To close this gap, governors and lawmakers will be forced to lay off state employees, cut services and postpone capital projects, said Michael Bird, federal affairs counsel for the National Conference of State Legislators.

The cutbacks will all work against an economic recovery. Already, states laid off 44,000 workers in the 12 months ending in January, according to federal labor statistics. In California, for instance, Gov. Arnold Schwarzenegger is proposing deep cuts to health care, education, the state workforce and social services programs. The governor is looking to Washington D.C. for $6.9 billion for its fiscal 2011 budget, on top of the $6 billion in stimulus funds it is using.

"We believe that providing funds to states will provide the flexibility critical to jumpstart our economy and create jobs," said Eric Alborg, communications director of the California Recovery Task Force. Massachusetts, meanwhile, is counting on $600 million in federal Medicaid funds that have yet to be approved by the Senate. The state needs the money to close a $3 billion budget gap for fiscal 2011, which comes on top of the $9 billion deficit it has closed over the past two years. Without that money, "everything has to be on the table," said Cyndi Roy, budget spokeswoman for Gov. Deval Patrick.

While many Democratic lawmakers on Capitol Hill back another federal bailout of the states, Republicans have said they don't think it's the best way to create jobs. A recent Congressional Budget Office report showed that sending money to the states for needs other than infrastructure does spur hiring, but not as much as increasing aid to the unemployed or cutting employers' payroll taxes. Still, CBO Director Douglas Elmendorf said in testimony Friday that providing aid promptly would probably have a significant effect on employment and economic output.

"Without further aid from the federal government, many states would have to raise taxes or cut spending by more than they would if aid was provided," Elmendorf said. "Such actions would dampen spending by those government and by households in those states, and more state and private jobs would be lost." Not only would state workers be impacted, but government contractors and suppliers would be too, Shure said. If the states curtain their spending, the companies that do business with them will likely downsize too.

Though the most recent version of the Senate jobs bill does not contain state aid, House Speaker Nancy Pelosi, D-Calif., on Friday urged her peers on Capitol Hill to take up the issue. "We will work to ensure that critical pieces of the House-passed Jobs for Main Street Act are enacted into law -- including investments in our roads, bridges, and public transit systems, support for job training initiatives, and funding to keep police and firefighters on the streets and teachers in the classroom," Pelosi said.  

L.A. budget crisis threatens jobs, credit rating
Los Angeles, the second-largest city in the United States, is confronting a mounting budget deficit that threatens to force thousands of job cuts, deplete its fiscal reserve and further damage its credit rating. The $212 million budget shortfall, projected to more than double next year, is attributed mainly to plunging tax revenue blamed on the region's sagging economy, falling property values and a 15 percent jobless rate -- one of the highest of any major U.S. city. "The last time we saw this kind of drop in revenue was the Great Depression," Miguel Santana, the city's chief financial officer, told Reuters. "It speaks to how severe this budget crisis is."

Mayor Antonio Villaraigosa and other senior city officials spoke on Friday with executives at Fitch Ratings, seeking to forestall a further diminution of Los Angeles' credit-worthiness. The city was downgraded late last year from a top rating of "AAA" to "AA-" as serious budget problems loomed. One major concern for holders of municipal debt is a plan by the city to use most of its $230 million reserve to close its current budget shortfall, Santana said. He added the city plans to replenish its reserve in part by leasing out its parking garages to private operators. But analysts said sharp revenue declines leave Los Angeles with relatively few options. "It's pretty simple. They are going to need to make some serious spending cuts," said Ian Carroll of Standard & Poor's.

The crisis has put Villaraigosa, a former labor activist, squarely at odds with unions that represent 98 percent of L.A.'s municipal work force, which in turn accounts for 80 percent of the city budget. Villaraigosa said last week he will propose the elimination of 1,200 to 2,000 city government jobs in next year's budget, on top of 1,000 positions the mayor last week ordered to be cut over the next few months. He hopes to achieve some cuts through attrition and by moving some workers into vacant positions in self-supporting agencies, such as the Department of Water and Power. But Villaraigosa has acknowledged that as many as 350 employees will likely be terminated in the initial round of cuts.

He also has suggested that large layoffs could be avoided if the unions were willing to accept pay cuts. "If everybody took a 5 percent cut, it would add $150 million to the general fund," the mayor said on Thursday at an event sponsored by the local business leaders. Union officials have bristled at those proposals. "We find it ironic that at the same time Congress is debating a jobs bill, the mayor of one of the largest cities in the country is talking about laying off 3,000 people," said Barbara Maynard, spokeswoman for the Coalition of L.A. City Unions. "The last thing Los Angeles or any city needs is to have more people on the unemployment line." She said before considering layoffs and pay cuts, the city should seek reductions from some of the $2.5 billion it pays for work performed by private contractors. Private law firms that bill the city for hundreds of dollars an hour, for example, "can certainly afford a pay cut more than a worker who is making $15 an hour," she said.

Unions are still smarting from concessions recently negotiated with the city to pare back most of a $400 million shortfall in the municipal pension system caused by losses on Wall Street. A key part of that deal was an early retirement package that moved 2,400 employees off the city payroll. For now, Villaraigosa has said he intends to keep police officers and firefighters exempt from the job cuts he is seeking, even though police and fire protection accounts for 75 percent of the city's general fund. In the end he vowed to do what was necessary to get the city's financial house in order. "There is no scenario, none, while I am mayor of Los Angeles where this city will ever be bankrupt," he said. "I can guarantee that."

Future Bailouts of America
by Gretchen Morgenson

As Washington spins its wheels on financial reform, it’s becoming painfully clear that the problem of entities that are too interconnected or "too politically powerful to fail" is also too hard for our policy makers to tackle. This is more than unfortunate, given how large the too-influential-to-fail gang has grown in recent years. Once a small membership organization comprising Fannie Mae and Freddie Mac, the mortgage finance giants, and the occasional troubled auto company, the Future Bailouts of America Club now includes a long list largely populated by financial institutions.

We can’t be sure who the specific members of this club are — regulators simply say they know ’em when they see ’em. But this much is certain: They’ve seen a lot of them lately. As taxpayers, we obviously can’t rely on lawmakers to address the risks we face from the ever-expanding corporate safety net thrown under teetering behemoths. But because we are footing the bills for these rescues — and will do so again if more crises occur — don’t you agree that we should know what these implied federal guarantees will cost us? If the government won’t reduce the size of the safety net, and it has shown no appetite for doing so, it should at least tell us the price tag.

Marvin Phaup, a research scholar at George Washington University who examines federal budgeting, is one who is urging such an assessment. An expert on government guarantees, his wholly sensible view is that it is dangerous for possible bailout costs to remain unmeasured and, of course, unrecognized in the budget. "If we are extending the safety net, extending the implied guarantee to the debts of a lot of other financial institutions, and we know those guarantees are valuable and costly, then we ought to start budgeting for it," Mr. Phaup said in an interview. "We can’t reduce the costs of these subsidies if we can’t recognize them."

Mr. Phaup has the bona fides to opine on this topic. He was the researcher at the Congressional Budget Office in 1996 who undertook the first efforts to assign a value to the implied federal guarantee backing Fannie and Freddie. When he prognosticated on the matter, the bailouts of those two hobbled entities were more than a decade away, but his C.B.O. report quantified the billions in benefits that the mortgage finance companies reaped each year from their implicit government backstop. In 1995, the report said, the value of the companies’ government subsidy totaled $6.5 billion; this amount largely reflected lower borrowing costs at the companies, a result of views held by investors that Fannie’s and Freddie’s obligations had Uncle Sam’s backing.

The C.B.O. report enraged Fannie and Freddie because it also showed how much of that financial benefit — fully one-third — the companies kept for themselves, their managers and their stockholders. Mr. Phaup’s analysis showed that, counter to the companies’ claims, Fannie and Freddie did not pass along all the benefits to homeowners in the form of lower mortgage rates.
Moreover, who actually believed in 1996 that the government would ever have to bail out Fannie and Freddie? Perish the thought and shame on silly researchers like Mr. Phaup for even considering such possibilities.

Fast-forward to today, and the government guarantees for Fannie and Freddie have become painfully explicit. While it’s unclear how much their rescues will cost taxpayers, last Christmas Eve the government removed the $400 billion cap on the amount of assistance it was willing to provide the companies in emergency aid through 2012. Today’s implied guarantees extend well beyond Fannie and Freddie. But owning up to future obligations associated with government backing is something that lawmakers are likely to fight vigorously. (Consider Social Security.) But ignoring such obligations doesn’t make them go away. And getting a handle on their possible cost is a worthy exercise, for several reasons.

First, Mr. Phaup said, if we assign a value to the guarantees, the government would be better able to charge for it. "Even if we don’t do that, by recognizing the cost now we will save more because we will either tax more or preferably spend less" to pay for it down the road if need be, Mr. Phaup said. "In the end, that’s really the only way to prepare for a contingency like a meltdown of the financial system."

A second benefit is that recognizing the costs of guaranteeing too-influential-to-fail institutions might reduce the ultimate obligation and persuade regulators and lawmakers to force those institutions to cut back on risk-taking. It’s not as if the costs associated with these guarantees can’t be accurately estimated. Valuing so-called contingent claims, chits that have not been called in, has become a much more sophisticated process in recent decades, Mr. Phaup pointed out. "We know how to do it for private firms," he said. "Fewer people in the government know how to do it, but those skills can be transferred."

Edward J. Kane, a professor of finance at Boston College, agrees that the costs associated with providing a safety net for complex and politically connected companies should be quantified. "People talk about systemic risk, but they have no metric of measuring it," he said. "If we recognize that obligations are being put on the taxpayer down the line, then they can be controlled and managed." Mr. Kane suggested that lawmakers create an independent entity to collect data from all the protected firms so a realistic price tag could be placed on possible bailout costs.

"We would force the institutions to give preliminary estimates and then challenge them," he said. The combined figure for all the institutions would represent the total responsibility being shifted onto the backs and wallets of taxpayers. "If government officials really wanted to do something, this is the kind of thing they would do," Mr. Kane said. That is the rub, of course. Lawmakers interested in re-election have little incentive to be truthful about what implied guarantees of powerful companies will cost the taxpayer. Better to brush it under the rug or pretend the costs don’t exist. Then, when they must be paid, policy makers can argue that it’s an unforeseen emergency and an odious necessity.

As the number of firms with implicit government backing has risen because of the crisis, so too have the expected costs of those commitments, Mr. Phaup said. And yet, under current budget policy, those costs will be ignored until the recipient of the guarantee collapses — the precise moment when the guarantee is likely to cost taxpayers the most. Three years into the crisis, we are no closer to reining in too-powerful-to-fail companies or eliminating the risks they pose to taxpayers. Both goals are achievable, yet our legislators refuse to do what is necessary to protect us from trillion-dollar bailouts down the road. It’s a disservice to a bewildered and beleaguered nation.

Goldman’s O’Neill Says 'Something Brewing' in China on Currency
Goldman Sachs Group Inc. Chief Economist Jim O’Neill said China may be poised to let its currency strengthen as much as 5 percent to slow the world’s fastest growing major economy. "I have a strong opinion that they’re close to moving the exchange rate," O’Neill said in a telephone interview from London after China’s central bank told lenders on Feb. 12 to set aside larger reserves. "Something’s brewing. It could happen anytime."

Chinese policy makers are seeking to restrain credit growth after their economy grew the fastest since 2007 in the fourth quarter. Banks extended 19 percent of this year’s 7.5 trillion yuan ($1.1 trillion) lending target in January as property prices climbed the most in 21 months. Officials in Beijing have resisted allowing gains in the yuan, having controlled its value since July 2008 after it strengthened 21 percent against the dollar in the previous three years. The status quo has drawn criticism from foreign policy makers who say keeping the currency undervalued has handed China’s exporters an advantage and inflated asset bubbles.

O’Neill, who coined the term "BRICs" in 2001, anticipating the boom in the emerging economies of Brazil, Russia, India and China, said China may allow the yuan to rise as much as 5 percent in a one-off revaluation and to then trade within a bigger band or against a larger basket of currencies. That would help counter international pressure, he said. "They need to do something to slow the economy down and deal with the inflation consequences," said O’Neill, who forecasts the Chinese economy is currently growing between 12 percent and 14 percent and will expand 11.4 percent over the year. "The more they do -- and the sooner -- the better."

The World Bank predicts China’s economy will grow 9 percent in 2010, faster than global growth of 2.7 percent. The government said last month the 2009 expansion was 8.7 percent. China’s yuan recorded its biggest weekly decline in more than a year last week on speculation importers bought dollars before this week’s Chinese New Year holidays. Vice Commerce Minister Zhong Shan said on Feb. 8 the government may allow the yuan to move in a "small range," while stressing the official stance is to maintain stability in the currency.

The yuan depreciated 0.09 percent last week to 6.8330 per dollar, the biggest loss since the five days ended Jan. 9, 2009. The reserve requirement will rise 50 basis points, or 0.5 percentage point, effective Feb. 25, the People’s Bank of China said. The current level is 16 percent for the biggest banks and 14 percent for smaller ones. Record lending last year and a 4 trillion yuan stimulus package helped China lead the recovery from the deepest global recession since World War II. Investors’ concern about investment bubbles in China, and what action the government may take to prevent or deflate them, has mounted this year.

"It will take a multi-faceted approach to slow the economy," Stephen Jen, London-based managing director at BlueGold Capital Management LLP., said in a Feb. 12 interview in which he predicted the yuan will be allowed to gain in the first half of this year. U.S. President Barack Obama said in a Feb. 9 interview with Bloomberg BusinessWeek that a stronger currency would help China to deal with "a bunch of bubbles" in its "potentially overheating" economy.

China's Bank Moves Jolt Markets
China signaled Friday it is acting more quickly than expected to rein in its booming economy, jolting international shares and fueling concerns over the challenges Beijing faces as it seeks to rein in one of the world's biggest economies. China's central bank moved Friday to further restrain bank lending by raising the share of deposits banks must hold as reserves. It marks Beijing's latest attempt to rein in last year's stimulus programs—a spree of bank lending that fueled Chinese growth and undergirded a weak global economy but now threatens to inflate dangerous asset bubbles.

Investors remain concerned about whether authorities can strike the right balance. "This is creating some concern here that they might slow down their economy so much that it impacts the global rebound," said Robert Pavlik, chief market strategist at money-management firm Banyan Partners in New York. China's announcement came as the European Union said that fourth-quarter growth in the 16 countries that share the euro was lower than expected, raising additional questions about the prospects for global recovery. In European trading shortly after China's announcement, the U.S. dollar rose and oil prices fell, a pattern that typically indicates investors are scaling back bets on economic growth. The dollar hit an eight-month high against the euro.

The People's Bank of China said it will raise the reserve-requirement ratio for banks by half a percentage point from Feb. 25, the second increase this year. That will make it standard for major banks to keep 16.5% of their deposits on reserve, though rates can vary by bank. Economists had expected such an increase, but not this soon. Beijing's announcement, at 6 p.m. Beijing time Friday, appeared timed to minimize the impact on Chinese shares: Shanghai's exchange is closed all next week for the Chinese New Year. On Jan. 13, the day after the government last announced an increase in reserve requirements, the index lost 3%. The benchmark Shanghai Composite Index is down 7.9% this year.

Some analysts said the latest move was less of a shock than last month's. "The first signals that the People's Bank were tightening made big waves in markets around the world, because the China recovery has been such a big part of the global story over the last few months," said Mark Williams of Capital Economics in London. "I wouldn't expect this move to have anything like the same impact." Others argue that such moves are necessary, and better done sooner rather than later. "It's better for sentiment to have a pre-emptive tightening rather than overheating" of the economy, says Claire Dissaux, head of global economics and strategy at Millennium Global Investments in London. Ultimately, if China grows at a 10% rate rather than a 13% rate, it still represents good news for the global economy, she says.

Compared with European central banks and the U.S. Federal Reserve, which adjust interest rates to stoke or rein in growth, China's central bank relies heavily on its reserve-requirement policy, most recently raising its reserve mark as high as 17.5% in mid-2008. The Fed's reserve requirement—which hasn't been used lately as a tool of monetary policy, but has been in the past—is 10%. China's torrent of new lending last year was central to its rapid recovery from the financial crisis. Credit from state banks financed a surge in new investment in real estate, public works and factories, which accounted for eight percentage points of China's 8.7% economic growth in 2009.

Domestic growth is important for China amid slow recovery in its markets in the U.S. and Europe. Should Europe's debt woes drag down the Continent's recovery, demand for Asian goods would be damped. A weak euro, meanwhile, will make it more expensive for Europeans to buy Asian products. The strength of China's economy, now among the world's largest, influences the global prices of the commodities it buys and the quantities of raw materials and goods that it imports from abroad. But the direct impact of the Chinese central bank's moves is muted because China doesn't allow them to influence the value of its currency. In contrast, when the U.S. or Europe tighten monetary policy, as China is doing, their currencies typically rise in valueagainst others, making their wares less attractive to other countries. By holding the yuan lower than markets probably would carry it, China spurs its exports.

There are indications that China's domestic run-up is far from slowing. On Friday, data from the country's electricity providers showed China's power demand rose 40% in January, suggesting the economy is growing so fast that it could be pushing the limits of existing infrastructure. But many investors are skeptical that China's economy can effectively use all of its new investment. Businesses are warning that massive increases in new industrial capacity in sectors such as steel and chemicals could crimp profits for years to come.

China's central bank appears to be reacting to signals of possible overheating. The government said Thursday that new local-currency loans totaled 1.39 trillion yuan ($203.6 billion) in January, nearly one-fifth of the government's target for the year of around 7.5 trillion yuan. Property prices were up 9.5% in January from a year earlier. Consumer-price inflation moderated to 1.5% in January from 1.9% in December, the government reported this week, though inflation is widely expected to pick up in coming months. The bank's efforts at monetary tightening appear aimed at taking the air out of real-estate prices without crashing the economy.

The moves contrast with the stance of the U.S. Federal Reserve and many other central banks, which are talking about tightening in the future but doing little of it now. The major thrust of Fed policy towards U.S. banks now is to encourage lending, not discourage it. The Fed's reserve requirement—which hasn't been used lately as a tool of monetary policy, but has been in the past—is 10%. Economists at Barclays Capital estimated that the reserve-requirement hike would withdraw about 300 billion yuan in liquidity from the banking system. That in itself would have little immediate impact on lending, Barclays said, since the central bank had in the last couple of weeks added about 600 billion yuan in liquidity to help meet the seasonal demand for cash before the Lunar New Year holiday.

Economists expect the central bank to continue raising banks' reserve requirements in coming months, although such moves mainly help to offset the money flowing into the banking system from China's large trade surplus and don't act as a sharp constraint on the economy. Many analysts also expect the central bank to take additional measures, such as hiking lending rates or allowing the currency to appreciate, but not until later in the year.

Dubai World Weighs Debt Deal for Banks
Dubai World may offer its creditors 60% of the money they are owed, backed by the sheikdom's government, as part of a deal to reschedule $22 billion of debt, people familiar with the matter told Zawya Dow Jones. The potential offer includes no provision for annual interest payments, but calls for creditors to receive 60 cents for every U.S. dollar loaned to the troubled conglomerate after seven years. Lenders would receive an interest payment at that time. Repayment would be guaranteed by the Dubai government. Dubai World is considering presenting the offer to creditors by April, the people said. Banks owed money by Dubai World include HSBC Holdings PLC, Royal Bank of Scotland Group PLC and Standard Chartered PLC.

Dubai World roiled international markets in November when it unexpectedly announced that it would seek a six-month standstill on its debts. The company met in December with 90 creditors in Dubai, but little detail on how the restructuring will work has emerged until now. An alternative proposal involves creditors receiving full payment, including 40% of their Dubai World debt in the form of assets in Nakheel—the company's property unit—with no government guarantee over the same seven-year period, the people said. A spokesman for Dubai World declined to comment on the terms. "Neither the government or the company have put forward any restructuring proposals to the lenders at this time," said a spokeswoman for the Dubai Department of Finance, which is financially supporting Dubai World.

Dubai shares fell Sunday after Zawya Dow Jones reported terms of the proposed Dubai World debt deal. The Dubai General Index closed down 3.5%. Worries over the company's debt-repayment plans sparked a selloff after initial gains in the market, said a trader at Shuaa Securities. The cost of insuring Dubai's sovereign debt against default rose to its highest level since November on Friday as concerns resurfaced over the emirate's large debt and a delay in presenting a deal to Dubai World creditors. Dubai's five-year credit-default-swap spread—a key measure of credit risk—surged close to half a percentage point to 6.32 percentage points in late trading Friday, according to CMA DataVision.

Creditors were divided Sunday on whether the Dubai World terms under discussion offer a good deal for banks. "This obviously represents a step forward," said Abdulkadir Hussein, chief executive of Mashreq Capital, the investment unit of Mashreqbank, which has exposure to Dubai World debt. "We've started to see some clarity on the process." A spokesman from HSBC declined to comment. Fahd Iqbal, a strategist at EFG Hermes, the Middle East's largest investment bank, said he expects negotiations between creditors and Dubai World to intensify. "The market was expecting either a large haircut and a shorter repayment or a smaller haircut with a longer repayment," Mr. Iqbal said. "We expect that Dubai World will go back and forth with bankers on the offer."

Speaking Sunday at a lunch in Dubai for British businesses, U.K. Business Secretary Peter Mandelson urged the emirate to settle its debts fairly and urgently to maintain its reputation with investors. "Dubai has to be conscious of the fact that depending on how it resolves the current problems will mean a great deal for how it secures investment in the future. Dubai has to tread carefully, openly and not for too long. It has to reach an agreement that's demonstrably fair," Mr. Mandelson said. The emirate is struggling to deal with debts estimated to exceed $80 billion. It borrowed heavily to build infrastructure during the boom of the last decade.

The safety-net frays
Governments used to worry about their banks. Now the reverse is also true

A senior HSBC executive reminisces fondly about the day he was parachuted into Latin America, a decade or so ago, to help run a recently purchased but troubled local bank. As he arrived he passed people protesting against the acquisition, some of whom were being carried about in coffins. For a moment he wondered whether that would end up being his fate. Until recently bankers’ tales of derring-do during the Asian, Latin American and Russian debt crises were kept for after-dinner drinks. Now, many of these old emerging-markets hands are in high demand during the day, as banks and investors ponder the potential effects of the euro zone’s debt crisis. "Sovereign risk has supplanted regulatory risk as the primary focus of bank bondholders," says Jonathan Glionna at Barclays Capital.

The prospects of a full-blown default by a European government still seem remote, especially given rising talk of a bail-out for Greece (see article). Yet were it to occur, the consequences could be nasty. Jörg Krämer of Commerzbank notes that the Greek government’s outstanding debt securities of €290 billion ($398 billion) dwarf the amount Lehman Brothers owed bondholders at the time of its collapse. Greek banks would be most exposed to the fallout. They hold about €39 billion of government debt, roughly equivalent to the amount of capital they have. There are rumours that Greek banks have also been keen sellers of credit-default swaps on sovereign Greek debt, in effect doubling up on their exposure to a debt crisis.

Commerzbank reckons that about 60% of the Greek government bonds issued over the past few years were sold to non-Greek European buyers, half of whom may have been banks. Any restructuring of Greek, or other euro-zone, debt could result in European banks having to take "massive write-offs", says Mr Krämer. American banks are less exposed to wobbly euro-zone countries, but the numbers are still pretty big. Barclays Capital reckons that the ten biggest American banks have total exposures to Ireland, Portugal, Spain and Greece of $176 billion.

The bigger concern, however, is not banks’ direct exposure to government bonds, which average just 5% of euro-zone banks’ assets, but the impact on their financing. The costs of funding for banks on Europe’s periphery are rising in tandem with the allegedly "risk-free" benchmark rates on the bonds of troubled European governments. Steep downgrades of the sovereign-debt ratings of countries such as Portugal, Greece and Ireland would probably translate into immediate rating cuts for their banks, as well as higher capital charges on banks’ debt holdings and bigger haircuts when using this debt as collateral. Regulators are busy designing rules forcing banks to hold more government bonds on the assumption that they are the most liquid assets in a crisis. That premise may not hold for every country’s debt.

A second concern is that the premium that investors demand for holding bank debt may also widen above the benchmark "risk-free" rate. "If governments are either less willing, because of competing pressures on budgets, or are unable to provide support then that could have a material impact on bank ratings," says Johannes Wassenberg of Moody’s, a rating agency. The consequences of even small changes in a bank’s borrowing costs can be extreme. JPMorgan, an investment bank, reckons that an increase of just 0.2 percentage points in the borrowing costs of British banks such as Lloyds Banking Group and Royal Bank of Scotland would trim their earnings by 8-11% next year, assuming they could not immediately pass these costs on to customers.

Fearsome as the prospects of sovereign default are, bankers also fret about the impact of avoiding one. In countries such as Portugal, Greece and Ireland, where big government deficits have to be cut back, loan growth is likely to decline and bad loans to increase as economies slow. Sovereign risk is out of the bottle. There is no easy way of putting it back in.

The Price Of Safety Just Went Up
Investors battered by market upheaval, including a 6% stock slide in recent weeks, have a new mantra for their portfolios: preserve, protect and defend. But they should be prepared to pay up. The price of portfolio safety is soaring. Low interest rates and high market volatility make it more expensive to construct products offering income guarantees, downside protection, and other sleep-at-night features. On top of that, Wall Street firms, still skittish from the financial crisis, are reluctant to offer generous guarantees. It all adds up to a dubious proposition for safety-seeking investors: Pay more for less.

Consider the most straightforward of "safe" investments. With the Federal Reserve holding short-term interest rates close to zero, the seven-day yield on taxable money-market funds recently sank to a record low 0.02%, and the average six-month bank certificate of deposit yields less than 0.5%. Risk-averse savers looking to improve on those rock-bottom rates find a panoply of often confusing and increasingly expensive options. One of the biggest sellers is still variable annuities, which are stock and bond funds sold with an insurance wrapper. The insurance industry got burned in the financial crisis after it offered overly optimistic income guarantees. It has since reined them in.

Now the fund industry is pitching mutual funds with annuity-like guarantees. Investors pay an extra fee in exchange for a lifetime income guarantee. But as with variable annuities, that guarantee is considerably pricier than it would have been a couple of years ago. Those who want stability can put their 401(k) money into stable-value funds designed to protect principal and provide relatively low, steady returns. But those funds' yields have fallen sharply over the past year. Another option is principal-protected notes and market-linked CDs that promise to return 100% of investors' principal if held to maturity. The bad news is that issuers are lengthening the period before the guarantee kicks in--in essence making the principal protection less valuable to investors.

Finally, there are products designed to sound safe that don't actually guarantee anything. Putnam Investments has lured about $1.3 billion over the past year or so to its four Absolute Return funds, which target annual returns of 1, 3, 5 or 7 percentage points over Treasury bills, respectively. The cheapest fund in the lineup is Absolute Return 100, which charges 1.25% annually. But since it is aiming to deliver returns of 1 percentage point over Treasury bills, it is comparable to a short-term bond fund, and the average fund in that category charges 0.92%, according to investment-research firm Morningstar Inc. What is more, in the 12 months ending Thursday, investors would have been better off in the average short-term bond fund, which gained more than 9%, versus a roughly 4% gain for the Absolute Return 100 Fund.

Jeff Carney, global head of marketing, products and retirement at Putnam, says the fees are justified in part because the funds use sophisticated strategies like trading derivatives and "shorting," or selling a borrowed security in hope of buying it back later at a lower price. These strategies should help the funds meet their objectives while minimizing risk, he says. But the funds' sizable fees "force the managers to take on a little more risk" than they would need to if expenses were lower, says Jonathan Rahbar, mutual-fund analyst at Morningstar. There are simpler, and often cheaper, ways for investors to boost portfolio safety. It doesn't take a financial engineering degree, for example, to make your own sort of "market-linked CD" that guarantees you will get back your principal even in the event of a market meltdown.

Wall Street has little incentive to sweeten the terms on its complex products as long as investors demonstrate such a tremendous appetite for safety and stability. Last year, investors yanked $8.8 billion out of stock mutual funds and poured $306 billion into more-sedate taxable bond funds. Even the wealthiest investors are getting much more conservative. Among U.S. households with a net worth of $5 million to $25 million, 27% describe themselves as "conservative" investors in 2009, up from 5% a year earlier, according to Spectrem Group.

The $555,000 Student-Loan Burden
When Michelle Bisutti, a 41-year-old family practitioner in Columbus, Ohio, finished medical school in 2003, her student-loan debt amounted to roughly $250,000. Since then, it has ballooned to $555,000. It is the result of her deferring loan payments while she completed her residency, default charges and relentlessly compounding interest rates. Among the charges: a single $53,870 fee for when her loan was turned over to a collection agency. "Maybe half of it was my fault because I didn't look at the fine print," Dr. Bisutti says. "But this is just outrageous now."

To be sure, Dr. Bisutti's case is extreme, and lenders say student-loan terms are clear and that they try to work with borrowers who get in trouble. But as tuitions rise, many people are borrowing heavily to pay their bills. Some no doubt view it as "good debt," because an education can lead to a higher salary. But in practice, student loans are one of the most toxic debts, requiring extreme consumer caution and, as Dr. Bisutti learned, responsibility. Unlike other kinds of debt, student loans can be particularly hard to wriggle out of. Homeowners who can't make their mortgage payments can hand over the keys to their house to their lender. Credit-card and even gambling debts can be discharged in bankruptcy. But ditching a student loan is virtually impossible, especially once a collection agency gets involved. Although lenders may trim payments, getting fees or principals waived seldom happens.

Yet many former students are trying. There is an estimated $730 billion in outstanding federal and private student-loan debt, says Mark Kantrowitz of, a Web site that tracks financial-aid issues—and only 40% of that debt is actively being repaid. The rest is in default, or in deferment, which means that payments and interest are halted, or in "forbearance," which means payments are halted while interest accrues. Although Dr. Bisutti's debt load is unusual, her experience having problems repaying isn't. Emmanuel Tellez's mother is a laid-off factory worker, and $120 from her $300 unemployment checks is garnished to pay the federal PLUS student loan she took out for her son.

By the time Mr. Tellez graduated in 2008, he had $50,000 of his own debt in loans issued by SLM Corp., known as Sallie Mae, the largest private student lender. In December, he was laid off from his $29,000-a-year job in Boston and defaulted. Mr. Tellez says that when he signed up, the loan wasn't explained to him well, though he concedes he missed the fine print. Loan terms, including interest rates, are disclosed "multiple times and in multiple ways," says Martha Holler, a spokeswoman for Sallie Mae, who says the company can't comment on individual accounts. Repayment tools and account information are accessible on Sallie Mae's Web site as well, she says.

Many borrowers say they are experiencing difficulties working out repayment and modification terms on their loans. Ms. Holler says that Sallie Mae works with borrowers individually to revamp loans. Although the U.S. Department of Education has expanded programs like income-based repayment, which effectively caps repayments for some borrowers, others might not qualify. Heather Ehmke of Oakland, Calif., renegotiated the terms of her subprime mortgage after her home was foreclosed. But even after filing for bankruptcy, she says she couldn't get Sallie Mae, one of her lenders, to adjust the terms on her student loan. After 14 years with patches of deferment and forbearance, the loan has increased from $28,000 to more than $90,000. Her monthly payments jumped from $230 to $816. Last month, her petition for undue hardship on the loans was dismissed. Sallie Mae supports reforms that would allow student loans to be dischargeable in bankruptcy for those who have made a good-faith effort to repay them, says Ms. Holler.

Dr. Bisutti says she loves her work, but regrets taking out so many student loans. She admits that she made mistakes in missing payments, deferring her loans and not being completely thorough with some of the paperwork, but was surprised at how quickly the debt spiraled. She says she knew when she started medical school in 1999 that she would have to borrow heavily. But she reasoned that her future income as a doctor would make paying off the loans easy. While in school, her loans racked up interest with variable rates ranging from 3% to 11%. She maxed out on federal loans, borrowing $152,000 over four years, and sought private loans from Sallie Mae to help make up the difference. She also took out two loans from Wells Fargo & Co. for $20,000 each. Each had a $2,000 origination fee. The total amount she borrowed at the time: $250,000.

In 2005, the bill for the Wells Fargo loans came due. Representatives from the bank called her father, Michael Bisutti, every day for two months demanding payment. Mr. Bisutti, who had co-signed on the loans, finally decided to cover the $550 monthly payments for a year. Wells Fargo says it will stop calling consumers if they request it, says senior vice president Glen Herrick, who adds that the bank no longer imposes origination fees on its private loans.
Sallie Mae, meanwhile, called Mr. Bisutti's neighbor. The neighbor told Mr. Bisutti about the call. "Now they know [my dad's] daughter the doctor defaulted on her loans," Dr. Bisutti says. Ms. Holler, the Sallie Mae spokeswoman, says that the company may contact a neighbor to verify an individual's address. But in those cases, she says, the details of the debt obligation aren't discussed.

Dr. Bisutti declined to authorize Sallie Mae to comment specifically on her case. "The overwhelming majority of medical-school graduates successfully repay their student loans," Ms. Holler says. After completing her fellowship in 2007, Dr. Bisutti juggled other debts, including her credit-card balance, and was having trouble making her $1,000-a-month student-loan payments. That year, she defaulted on both her federal and private loans. That is when the "collection cost" fee of $53,870 was added on to her private loan.

Meanwhile, the variable interest rates continue to compound on her balance and fees. She recently applied for income-based repayment, but she still isn't sure if she will qualify. She makes $550-a-month payments to Wells Fargo for the two loans she hasn't defaulted on. By the time she is done, she will have paid the bank $128,000—over three times the $36,000 she received. She recently entered a rehabilitation agreement on her defaulted federal loans, which now carry an additional $31,942 collection cost. She makes monthly payments on those loans—now $209,399—for $990 a month, with only $100 of it going toward her original balance. The entire balance of her federal loans will be paid off in 351 months. Dr. Bisutti will be 70 years old.

The debt load keeps her up at night. Her damaged credit has prevented her from buying a home or a new car. She says she and her boyfriend of three years have put off marriage and having children because of the debt. Dr. Bisutti told her 17-year-old niece the story of her debt as a cautionary tale "so the next generation of kids who want to get a higher education knows what they're getting into," she says. "I will likely have to deal with this debt for the rest of my life."

Refinancing unavailable for many US borrowers
The refinancing wave that swept the nation when mortgage rates hit historic lows last year is petering out, leaving behind millions of homeowners who could not qualify for the best rates. Half of the nation's borrowers have mortgages with rates above 6 percent even though the average rate on 30-year, fixed-rate mortgages has been about 5 percent for most of the past year, according to research firm First American CoreLogic. More refinancing activity would have helped household budgets, but also the national economy because homeowners might have spent some of the extra cash they pocketed, giving the recovery an added lift.

Many borrowers who tried to refinance have found they're stuck because the value of their homes has tumbled and their equity has melted away. Others have been shut out because lenders tightened their requirements, demanding stellar credit and low debt. An effort by the Obama administration to overcome some of these challenges has fallen flat, frustrating many homeowners -- especially with mortgage rates expected to rise by year's end, if not sooner. "We've reached the point of burnout," said Amy Crews Cutts, deputy chief economist at Freddie Mac. "Most of the people who can refinance today have done so already."

Usually, borrowers refinance if they can save at least one percentage point on the interest rate, mortgage experts say, and even a savings of as little as half a point may make sense under some circumstances. Ultimately, the decision depends on whether the savings come in a time frame that makes sense for the borrower. Elaine Lewis and her husband are among those who were shut out. They could not refinance their Silver Spring house this month because it was appraised at $448,000 -- $60,000 less than they paid in 2004. They still have equity in the house. But because that equity is less than 20 percent, they are required to pay private mortgage insurance.

As they see it, their options are to pay the mortgage insurance and related upfront costs or come up with enough cash to pay down their principal, beefing up their equity so insurance won't be necessary. "Neither of those choices made financial sense since people refinance to save money, not to spend money," Lewis said. "It was terribly disappointing." Other borrowers have no equity, or they owe more than their homes are worth, making it nearly impossible to refinance. These "underwater" borrowers make up about a quarter of all households now that national home prices have plunged an average of 30 percent from their peak in 2006.

Refinancing activity took off after the Federal Reserve committed to buying a huge chunk of mortgage-backed securities in late 2008 to help loosen consumer lending. Mortgage rates immediately dropped below 6 percent and stayed there through 2009. They dipped below 5 percent last spring, and then hit an all-time low of 4.71 percent in early December, Freddie Mac reported. They have hovered around 5 percent since. Freddie Mac estimated that 5.8 million borrowers have refinanced since the start of 2009, saving $140 a month on average. The flurry of activity came nowhere close to matching the unprecedented refinancing boom in 2003, when rates dropped below 6 percent for the first time in decades. The economy was flourishing, and home prices were rising.

"But context is everything," said Cutts, of Freddie Mac. "In many ways it's surprising that with the financial markets in disarray and home prices falling across the country and eight-million-plus jobs lost that we'd have people taking out new loans in 2009." Still the numbers are not as impressive as they could have been, many economists said. "There are quite a few mortgages that are in the money, meaning they are well within the zone where refinancing makes sense," said Sam Khater, a senior economist with First American CoreLogic. "Given where rates are right now, refinance activity should be quite a bit higher than it is."

If the bulk of those people were to refinance, that would goose consumer spending, giving the wider economy a boost. Instead, refinance activity has dropped 60 percent from its peak in the spring, according to the Mortgage Bankers Association. This year, refinances should total $500 billion of all loan originations, down from $1.4 trillion last year, the group predicted. Larry F. Pratt, chief executive of First Savings Mortgage, said he has witnessed the challenges up close. "Historically, our rejection rate is less than 5 percent of all our refinance applications," Pratt said. "For 2009, it was nearly 25 percent."

To help borrowers, the Obama administration launched the Home Affordable Refinance Program nearly a year ago. The initiative aimed to help refinance the loans of borrowers with little or no equity in their homes but who are on track with their mortgages. These underwater borrowers are at greater risk of foreclosure, and the administration hoped that lowering their payments would decrease their chances of falling behind. The program was limited to borrowers whose loans were backed by mortgage financiers Fannie Mae and Freddie Mac. Originally it targeted borrowers whose loan balances were slightly higher than the property's value. The program was later expanded to include borrowers who owe up to 25 percent more than their homes are worth.

Yet fewer than 200,000 borrowers have refinanced through this program since its launch in March -- nowhere near the up to 5 million the administration projected to reach by June, when the initiative is to end. A Federal Housing Finance Agency official said refinancing under the program picked up in the final months of last year. Treasury officials have said the initiative has helped many borrowers. Some people probably abandoned it for a separate government-led program that also aimed to prevent foreclosures but offered even lower rates, according to housing advocates. But the refinancing initiative was also dogged by delays as lenders struggled to update their computer systems to accommodate the program. Another obstacle was that many homeowners have second mortgages or private mortgage insurance, which can get in the way of refinancing a primary loan.

Thomas Fox, a well-paid government contractor with excellent credit and relatively little debt, should have been the perfect candidate. He made a 17 percent down payment when he bought his home in Ashburn in 2007. Now he owes at least 5 percent more than the house is worth. Fox tried to refinance under the federal program, but his private mortgage insurance policy could not be reissued on a new loan, said his mortgage broker, Devon Segal of Apex Home Loans. "If the government's program won't work for this guy, someone with great credit scores and a strong income," Segal said, "it won't work for anybody."

They Just Don't See It
by Michael Panzner

OK, time for a pop quiz. When it comes to figuring out where things are headed, would you rather listen to these guys:
"U.S. Economy to Strengthen, Reducing Unemployment, Survey Says" (Bloomberg)
U.S. unemployment peaked in October and will retreat through 2011 as the economy strengthens, according to economists surveyed by Bloomberg News.

The world’s largest economy will grow 3 percent this year and next, more than anticipated a month ago, according to the median estimate of 62 economists polled this month. The jobless rate, which reached a 26-year high of 10.1 percent in October, will end the year at 9.5 percent.

Efforts to rebuild inventories, investments in new equipment and software and improving sales overseas will spur employment and household spending. Scant inflation will give Federal Reserve policy makers room to keep the target interest rate near zero through the third quarter, buying the economy enough time to reach a self-sustaining expansion.

"It’s a matter of time before strength in the economy effectively feeds on itself, with more employment leading to stronger spending, which in turn leads to more employment," said James O’Sullivan, global chief economist at MF Global Ltd. in New York. "The key is going to be the business sector leading the way and consumer spending following."

"U.S. to Grow 3 Percent This Year From Year Ago, Fed Survey Shows" (Bloomberg BusinessWeek)
The U.S. economy will grow 3 percent this year from a year earlier, faster than previously predicted, according to a survey of economists released today by the Federal Reserve Bank of Philadelphia.

The 42 respondents also expected a "slightly stronger labor market" this year than they did in the fourth quarter, the Philadelphia Fed said in a statement. The outlook for gross domestic product was more optimistic than the forecast in the fourth quarter of last year for 2.4 percent growth in 2010, it said. The U.S. unemployment rate will average 9.8 percent this year, the survey showed.

Or these guys [italics mine]:
"Corporate America Is More Pessimistic Than You Know" (Deal Journal)
Looking for an explanation for the deep freeze in merger & acquisition activity and the jittery stock market? Just ask the boards overseeing U.S. companies.

A whopping 66% of 1,200 corporate board members surveyed recently said U.S. companies wouldn’t return to "business as usual" until at least 2013, and will operate till then in an environment of sluggish sales and growth. Roughly 45% said the economy wouldn’t return to precrisis levels in terms of investment, employment and productivity before 2013, according to the survey, conducted by KPMG LLP, while 22% said it would come beyond 2014.

"Not withstanding what economists are saying about the recovery, we are hearing from board members that they just don’t see it,’’ says Mary Pat McCarthy, a KPMG vice chairwoman who oversaw the survey of directors at publicly traded companies of varying sizes across the U.S.

McCarthy spoke to Deal Journal this morning from Miami where KPMG was hosting a conference of primarily audit committee members of corporate boards. "We are hearing a steady drumbeat down here that a recovery is a way’s off," she said.

Another concern among board members: That the cost-cutting and layoffs that have helped boost corporate profits are going to hurt companies in the long term. The survey found that 67% of the respondents said were most concerned that cost-cutting would drain a company’s employee talent.

Other concerns: 36% said they worried cost-cutting would weaken internal controls, 25% said it could raise the risk of fraud and 22% said they thought the integrity of financial reporting could suffer in the hands of leaner staffs.

Yeah, I thought so.

Milestone Figures Grab Attention, but Their Impact Is Hazy
When the Dow Jones Industrial Average closed at more than 10000 for the first time, in March 1999, the chairman of the New York Stock Exchange and New York City's mayor gaveled the session to a close, then threw blue hats that read "Dow 10000" to traders on the exchange floor. This past week, as the Dow again flirted with 10000—it closed just below it on Monday, then finished Friday 99 points above the benchmark—the round number no longer inspires celebration, but still makes headlines. But why should investors care more about a rise from 9900 to 10000 than one from 9800 to 9900?

Arbitrary milestones pervade economics, finance and everyday matters. Some carry more meaning than others: Foreign-exchange markets can rattle national confidence when one country's paper money threatens to drop below parity with a rival's, which is a meaningful threshold because it is felt in the portfolios of those swapping currencies. It's less clear why double-digit inflation and unemployment should carry more political weight than rates just less than 10%, particularly given the controversies about how the numbers are calculated. The milestones are the result of our brains' attempts to impose order and assign categories to numbers that vary continuously. "You have to be able to draw some emotion or feeling from information in order to understand it," says Paul Slovic, professor of psychology at the University of Oregon.

Some arbitrary cutoffs are needed in order to make business decisions. The worst BBB- rated bond is hardly better than the best BB+ rated one, yet the former is investment grade and the latter junk. Further diminishing their importance, milestones often don't change when underlying conditions do. For example, it's a lot harder for an album to sell one million copies than before music was sold and swapped online, but that's still the criterion for platinum status. In baseball, some Hall of Fame voters treat 500 home runs and 300 wins as thresholds for sluggers and pitchers, respectively, even though homers have gotten easier to come by, and wins harder.

So whether we're talking the Dow or the dugout, these round numbers wouldn't matter, except for the fact that people think they do, thus making their importance self-fulfilling. Reading too much into a certain value of the industrial average seems particularly arbitrary. Unemployment, or currency-exchange rates, measure something tangible. But stock indexes have abstract values, representing some combination of the value of stocks in the index—not exactly the sum, because of stock splits and other complicating factors. So when unemployment hits 10%, it means one in 10 people who want to work can't find jobs, more or less, but when the Dow hits 10000, it isn't clear what it means.

On top of that, Dow 10000 doesn't mean the same thing now that it did when first reached in 1999, because the Dow isn't adjusted for inflation and the component stocks have changed. In October, when the average closed at more than 10000 for the first time since the financial crisis started a year earlier, that level was roughly equivalent to 7800 in 1999, when adjusted for inflation. Such milestones "are just round numbers that catch people's attention," says John Prestbo, editor and executive director of Dow Jones Indexes, which includes the industrials. "These are all just notches on the measuring stick." (The indexes are owned by News Corp., the publisher of The Wall Street Journal. News Corp. has agreed to sell the indexes to CME Group Inc.)

And yet there is evidence that round numbers in stock prices and indexes do matter, because such round numbers catch people's attention and influence trading decisions. Several studies on what can happen to stocks when the Dow is near a round number such as 10000 have been conducted. Some of these studies indicate that stock prices behave differently when the Dow is near a round number such as 10000, for instance by moving in lockstep or by falling just before the milestone is reached.

Among these studies is a work-in-progress by New Mexico State researchers examining patterns in Dow components just before and after the average has passed multiples of 1000 in recent years. They found the stock components exhibit herding, meaning they move in step with each other during these periods. That stocks from such varied industries would move in a coordinated way suggests that traders are reacting to the Dow rather than the merits of the individual stocks, the researchers say.

But other research hasn't found evidence of unique trading behavior when indexes near round numbers. Part of the problem is defining just what that behavior would look like. Some traders might regard a rise to more than 10000 as evidence of strength in the market; others might see a peak, and a prompt to sell. Still others might see the whole thing as irrelevant but anticipate round-number-minded behavior from fellow market participants and act accordingly.

These effects can be more easily disentangled by examining individual stocks, as Lukasz Pomorski, assistant professor of finance at the University of Toronto's Rotman School of Management, did in unpublished work. He found that a stock price passing a multiple of $5 is a sign of better future returns than a similar percentage rise in a stock that didn't pass such a round-number threshold. He theorizes that certain portfolio managers categorize stocks based on multiples of $5, and won't consider investing below such thresholds. "A $5 or $10 cutoff level is very arbitrary," Mr. Pomorski says.

Such behavior extends to currency markets, as Carol Osler, director of the Brandeis International Business School's Lemberg Masters Program in International Economics and Finance, demonstrated in 2000. She found that of so-called support and resistance levels identified by six foreign-exchange firms as points where a given currency was likely to stop rising or falling, 96% ended in a 5 or 0, compared with 20% if they had been chosen by chance. "Round numbers loom large in people's consciousness," Ms. Osler says. She notes that this may extend back to when counting was manual and five and 10 fingers were natural units.

A stock index, or a currency exchange, is at least a precise measure. Not so with unemployment, which is based on a survey, is adjusted for seasonal effects, doesn't account for part-timers and the like—and doesn't always rise when payroll counts fall. Still, economists will look to steady double-digit unemployment as one possible indicator that the current recession has become a depression, says Mark Zandi, chief economist of Moody's Analytics. And he finds it helpful that such a number can grab attention and galvanize reaction. "If we were perfectly rational beings, it shouldn't make a difference whether unemployment is 9.7% or 10% or 10.3% before we decide what to do," Mr. Zandi says. "But we're not."


Martin said...

Is there a specific reason why you use a Facebook user and not a Facebook page or group?

Unknown said...
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Unknown said...
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Stoneleigh said...


Insufficient knowledge (on my part) as to how Facebook works.

Martin said...

@Stoneleigh: Facebook is a mess anyway. I deeply hope it will not become the 'new' Web.

Hombre said...

From the Johnson-Boone article - "...If Greece (and the other troubled countries) still had their own currencies, it would all be a lot easier. Just as in the U.K. since 2008, their exchange rates would depreciate sharply. This would lower the cost of labor, making them competitive again ..."

What are the chances of a return to previous or separate currencies in Europe? Impossible? Or is that a realistic option/alternative to remedy somewhat the present predicament.

Greenpa said...

"former IMF man Simon Johnson wrote that he thinks the EU will indeed ban Goldman."

As wonderful as that would be, pure logic at work, I'll have to predict it will not happen, indeed may never be mentioned as a possibility in public again.

Remember all those billions Goldman plays with?
They could crack off 500 million for bribes, and never notice it.

And they will.

memphis said...

The Goldman/Greece interesting revelation when the US markets are closed, yet again.

Weaseldog said...

Ilargi, on a number of occasions, you've pooh-pooh'd my arguments that the current energy decline is coupled to our economic decline. I've made arguments explaining why I believe that there is a relationship.

You've simply replied that I'm wrong. But you have been unable to explain why you think our current situation is exceptional.

Can I assume that you don't have an explanation, that you're making your argument based on feelings or emotions? Is it just that you don't like the idea, so you reject it?

As you've been unable to explain it, should I assume this?

If you have a rational logical argument, even with a little math or spreadsheets to explain why you see the economy decoupled from the energy decline and can explain why crude prices continue to ride high, please educated me.

I just don't see it.

jal said...

During the depression, as seen from the recent pictures used by Ilargi, there was a wealthy class.

The present reset will also end with a wealthy class.

Those who bought themselves a wealthy class lifestyle, by using credit, will find themselves among the poor or enslaved by their debt burden.

Gravity said...

Gold is good; man is evil.

Ilargi said...


I've written about that so often I'm not too inclined to repeat myself. I may again one day though. As for your list of assumptions, if you think this joint is based on such things, I don't know why you come. Other than that, if you look around these days at what happens in finance, I have no idea how you could possibly link that to energy.

Ilargi said...


Once IMF is always IMF, the same would go for Goldman. But he says some things from time to time that I find useful.

Phlogiston Água de Beber said...

Gravity said...
Gold is good; man is evil.

Things can't be summed up in much fewer words than that, although "is" was not really essential to convey the thought. :)

Gravity said...

of course "the current energy decline is coupled to our economic decline", but this relationship is only very loosly coupled right now, even if oil dropped to 10$ a barrel, financial collapse would happily continue on its own momentum, perhaps ever so slightly slower.

VK said...

It seems so odd that Europe could end up worse than the US. For a continent that provides universal healthcare, solid unemployment benefits, good social safety nets, subsidized higher level education and generally promotes a more inclusive society is going to be worse off? Also not to mention lower energy use per capita as well as less religious fundamentalism. Also Europe doesn't have 200 million guns.

But then again, what seems to matter according to the pro US proponents is that collapse will be better in the US due to greater availability of land, water, energy and US military power.

So in the grand scehme of things, does taking care of your populace matter? As the core relation seems to be population to resources. In that regard Africa seems to be well endowed, the Govt has never taken care of the population and our resources have been exploited by the West and now China who probably won't be able to afford to use those resources! Bitter irony :(

Zaphod said...

VK, do I sense cognitive dissonance? Sounds kinda like when my kids lament that something at school wasn't 'fair'.

When situations get rough, I'm not sure those nice-sounding attributes of EU life really make much difference. Especially when so many nations around the world are filled with sub-human heathens who intend to despoil my Bible and eat my children - makes my trigger-finger itchy just thinking about it.

Rather than trying to decide who ends up with things "least bad", maybe it would be easier to start crossing off those who will lose first and worst?

snuffy said...

I have to smile a bit when I see the Gold-In-Sacks crowd now looking down the barrel of a audit "gun" in Europe.Greenpa,even with twice that in bribes,the collection of very-pissed-off regulators who will now take a hard look at the games that were played in Greece and the PIIGs might crack a lot of things open.It will be interesting to watch.

The only part I want to see the USA .gov involved in is the justice dept.I think the Europeans can fix their own wagon.

I think any aid to the states will have some real poison pills attached...else wise every state will line up at the water pump,[its free money don-ya-know]

The relationship of the people to the state is different in Europe.The state considers care of the population to be one of its major,if not the major ends to which government exists.I am sad to say that is not true of my own government.Care of corporate interests,and the military -industrial complex,as described by president Harry Truman is the baseline now.Or so it seems.

I think the too-big-to-fail is too big to exist.Nature and fate will take care of that I think,but
our "care" of the dinosaurs may sink this country,and accelerate our speed to the cliff.


Gravity said...

Of course the arbitrary limitations of legal currency transactions are only very loosely related to a direct breach of personal economic sovereignty encompassing an existential attack on the concept of individual nonnegotiable property rights.

FarmerAmber said...

Perhaps the European tendency to take care of its populace is a legacy of the fact that in European memory the populace has risen up (violently) and torn down the ruling class when they forgot to do so. There is a belief in Europe that, if needed, they could again take down a government if it no longer suited them.

The US has not had that happen, so I suspect our leaders and citizens don't realize that the citizenry can (and I think will soon) take back what is theirs. It is sad that we cannot learn the lessons of history. Sad, but predictable.

alex_uk said...

Stoneleigh ,

Have you a rough idea about when you are coming to Europe - I could then contact to see if I could get you a slot.



$$$Dollar$$$ said...

VK said:

It seems so odd that Europe could end up worse than the US. For a continent that provides universal healthcare, solid unemployment benefits, good social safety nets, subsidized higher level education and generally promotes a more inclusive society is going to be worse off? Also not to mention lower energy use per capita as well as less religious fundamentalism. Also Europe doesn't have 200 million guns.

But then again, what seems to matter according to the pro US proponents is that collapse will be better in the US due to greater availability of land, water, energy and US military power.

VK I don't think you are really "getting" it here friend:

1) How will Europe pay for all of these niceities with an insolvent, bankrupt state(s) that is/are crushed by debt? These institutions are all likely going to disappear if the "apocalypse" scenario that is bandied about here (that I rather subscribe to myself) happens. Come on man, you have the same understanding as I, and I "get it". There will be no "better off" in the coming future. There will be political, social and economy unrest. Period.

2) Good luck to the US maintaining any semblance of "normalcy" without access to energy inputs from abroad (from S. America , Africa and the ME). Good luck to maintaining the current level of military spending and the size of the military when access to the credit necessary to fund the military disappears. Ditto for food production, in addition to the dependency in foreign inputs (above).

Again, the attempt to try and split hairs as to who is "better off" is a futile exercise. The US and the EU each have their own relative strengths and weaknesses, but they both look to be screwed at the same level due to effectively the same magnitude and type of problems.

Bigelow said...

Favorite new bumper sticker:


Phlogiston Água de Beber said...

Does anyone know whether this inter-continental collapsification boxing match is a 10 rounder or 15? I may need to go out for some more snacks and refreshments. :)

There is much sound and fury over who has made the biggest mistakes, who has the best local resources, which population is most inclined to slaughter their leaders, which population has the Right Stuff to Make a World by Hand, etc, etc, etc.

I have no doubt that these things matter. I think quite possibly the most important problem facing both Europe and North America, post-collapse, will turn out to be our obsessive preparations to defeat an enemy that isn't coming. In the process, I believe we have left ourselves very vulnerable to an enemy that I'm pretty sure is coming.

Four ugly dudes on horseback.

The only continent where they've been battled much recently is Africa. I think that perhaps they may have the most resilience in battling those killers.

Hombre said...

VK said... "It seems so odd that Europe could end up worse than the US."
I don't think the fat lady has sung quite yet.
It's my guess (and that's what it is) that we are all--on both sides of the pond--going to sink at about the same rate into this economic quagmire.
One big ? mark in my mind is what happens on the other side of the globe, China-India and how it will effect the west.
Will the economic factors, debt, corruption, etc. trump the depleting, peaked resources?
Will a major war blow away all our presumptions and predictions?

Personally I don't like the USA/Euro comparisons and insinuations very much. I like to think we are all in this together and need to help each other "fall gently" if possible.

Unknown said...
This comment has been removed by the author.
Wyote said...

Pledge to the New Empire

I pledge allegiance to the currency of the United States of America
and to the reserve for which it stands
One world under Goldman-Sachs, incorruptible,
With solvency and credit for all.

Bigelow: My old favorite bumper sticker:


All The Best, Wyote

$$$Dollar$$$ said...

Oh as for Europe being more inclusive, go ask the Morrocans in the ghettos of Paris how that is working out for them. Or perhaps the immigrants in the ghettos of, OF ALL PLACES, Sweden (Stockholm). I think there might be some idealization of European ideals on this board. But make no mistake, I am NO USA apologist. I am sickened by many of the things I see going on in my own backyard.

scrofulous said...

I've written about that so often I'm not too inclined to repeat myself.

Please cite, thankyou

VK said...

See the question is what amount of energy/money is required to maintain social order?

For eg, what's the difference between an Ethiopia lets say and a Somalia. Both are to the North of Kenya, both are pretty arid. One is a total failed state but with excellent mobile coverage and a roaring pirate economy. The other is a pretty competent state, occasional starvation every few years but strong military and Govt.

Ethopian Population: 85 Million
Oil Use: 37,000 barrels per day
GDP Per capita: $900

Somalia Population: 10 Millionish
Oil Use: 5,000 barrels per day
GDP Per capita: $600

Now for comparison Germany has a similar population size to Ethiopia

Germany: 82 Million
Oil Use: 2,600,000 barrels per day
GDP Per Capita: $34,200

So if Ethopia can maintain stability with 37,000 barrels per day and a functioning Govt, can Gernamy? Most of the shock is going to be psychological. Even a 90% fall in incomes and energy use still lives the 'future' German much better off relatively than today's Ethiopian or Somali. But psychologically the shock will be too hard to bear plus the skills that the olden generation had are lost.

But if countries acknowledged collapse was coming, a 2 year crash course in Universities, Schools, Technical colleges etc could really equip kids for the future. They are far more adaptable and open minded. Things like farming, carpentry, cooking, basic electrical wiring, plumbing etc could all be taught within 2-3 years. That would greatly reduce the impact of declining resources, credit and oil.

$$$Dollar$$$ said...

VK - The money element is going to be absent. I agree that America's energy dependence is going to be a problem. It will be a major problem for Europe, but maybe worse for America. That said, Stoneleigh has noted that America has more energy reserves than Europe (coal, wind potential, gas, solar, hydro) so it is not exactly clear who has the advantage here. Ultimately, I think it is a waste of time to go too far into who is better off. The simple answer is neither bloc will be. There may be local variances, but overall the "West" is pretty screwed. I think a much more interesting discussion would be "West" vs. "East".

Unknown said...

I honestly don't think GS will be banned from doing business inside the EU. Do they deserve to be banned? Most likely. But GS owns the US government, and I'm sure there will be retaliation. Nothing fancy... just a revoke of UBS' US banking license over taxes... for starters.

$$$Dollar$$$ said...

So what is the line on Obama making it through his entire term to 2012 again?

snuffy said...

I think a lot of folks feel we have lost most of "the old ways" to the extent that most will suffer hardship when the "Phase-change"due our society hits full force.Sometimes I question that assumption,when I think of how many of us all have a father,sister or other family member...or of the older generation who still remembers....if it happens 20 years from now ,with the decay rate of "sustenance farming" knowledge,may be...but now,at least here,a whole lot of folks still remember canning,drying,and the rest.I does not require that every member ,remember...even 40-50 years ago there were those who excelled at such things.A slow-crash[slower?] is likely,given the desperate efforts to retain at least the trappings of a "civilized"society..
Most likely it will all change at different the saying."The future is here,just not spread around evenly"
A rough section of east L.A.will fare a bit different than Portland ,Oregon I think.[I hope}

The mental shock of gut-comprehension...the "Knowing"its broke and will never in your lifetime be fixed is what the killer will be.

Everyone has dreams of being the hero or heroine of their life's drama. How they adjust to whatever "Reality"exists when the system implodes will difficult to say.When joe six-pack,and mama six-pack cant get skittles for the kid is when it will get weird.I honestly do not know how they will break,left,right,or center.Or,and this is what concerns me,everyone will be the next hero in their own version of "The Road"or whatever apocalyptic type flick has stuck in their minds-eye...Mad Max comes to mind...and a thousand versions of "lord Humongous"

This is why the sailboat...plan B[smile]


Reluctant Poseidon Hamster said...

Cosminelus: Nothing fancy... just a revoke of UBS' US banking license over taxes... for starters.

Sounds about right.

Cue inbred banjos!

Anonymous said...

"The entire balance of her federal loans will be paid off in 351 months. Dr. Bisutti will be 70 years old.

"She says she and her boyfriend of three years have put off marriage and having children because of the debt."

That's just silly.

OK, she messed up royally. But now she has the freedom of nothing left to lose.

Do a Dr. "Patch" Adams, go work in a poor rural area for peanuts, don't carry any malpractice insurance, have some kids and be happy.

She'd have to deal with the debt for the rest of her life, but they can't take what isn't there, so she'd probably get by with making occasional nominal payments.

Reluctant Poseidon Hamster said...

Denninger - bless him - seeks a target for his displeasure with the Greek swaps, settling at length on the "essential purpose" of the swaps. "Did Greece lie to get into the EU?"

Did they? Unless I'm missing something (entirely possible), they lied not as much as most sub-prime US homeowners lied to get into their homes. Not that I love GS, but it seems the EU debt managers wrote a provision offering EU member states the very clear loophole which Greece (and Italy) exploited. From Risk Magazine swimsuit edition, July 2003:

"ESA95 states in a page-long ‘clarification’ that ‘streams of interest payments under swaps agreements will continue… having an impact on general government net borrowing/net lending’. In other words, upfront swap payments – which Eurostat classifies as interest – can reduce debt, without the corresponding negative market value of the swap increasing it. According to ESA95, the clarification only covers ‘currency swaps based on existing liabilities’.

Legitimate transaction

There is no doubt that Goldman Sachs’ deal with Greece was a completely legitimate transaction under Eurostat rules. Moreover, both Goldman Sachs and Greece’s public debt division are following a path well trodden by other European sovereigns and derivatives dealers..."

According to RM's 2003 article, ESA95 went on the books since 2002.

You'd think over 8 long years, somebody would've noticed.

“Eurostat was not until recently aware of this alleged currency swap transaction made by Greece,” [EUstat] spokesman Johan Wullt said by e-mail yesterday.

I'm thinking the big EU transglobal investigation may end where it begins, with Belgian super-sleuths crashing through each others' offices.

"My wife! My family!"

Greece and Italy. Others? And how much in total? And how much CDS insurance atop?

"Goldman Sachs is known for its conservative approach to credit risk, and chose to hedge its exposure to Greece by immediately placing the risk with a well-known investor in sovereign credit: Frankfurt-based Deutsche Pfandbriefe Bank (Depfa). According to sources, Depfa entered into a credit default swap with Goldman Sachs, selling $1 billion of protection on Greece for up to 20 years. Depfa declined to comment."

"My wife! My family!"

VK said...

Cosminelus: Nothing fancy... just a revoke of UBS' US banking license over taxes... for starters.

LOL! Agree. The Squid has it's tentacles everywhere. Also since there will be a dollar shortage coming up, so if GS is banned, the FED could always conveniently fail to arrange swap lines to Central Banks due to 'political' pressure ;)

Weaseldog said...

Ilargi said... "Other than that, if you look around these days at what happens in finance, I have no idea how you could possibly link that to energy."

I've written about that so often I'm not too inclined to repeat myself.

But I likely will again later.

If I took the the time to write that article again, would you read it?

Weaseldog said...

Ilargi, if you don't believe that finance is linked in any way to energy, and thus to the physical world, then that may be all of the explanation I need.

If you don't believe in it, you won't explore the connections. And so you have no reason to see the connections.

You've gone on at great length explaining what you believe, I just haven't seen yet anything you've written explaining how you validated your beliefs. What models you constructed. Or how you test your beliefs.

Those are the things I'm curious about.

And don't you understand that what I'm trying to do is understand how you came to do that. Because it will give me further insights?

scandia said...

@ Weaseldog....I think there is a misunderstanding. What I have interpreted from analysis by I & S is that, of course, energy is important in the mid term. The near term( now the present ) is a financial crisis.
Many agree that the resource wars are in full play. There is yet enough energy supply to foolishly spend it on war. This is becoming a crisis but not full blown yet. Not to the level of eradicating civilization as we know it.
The noose around our necks NOW is the financial crisis as demonstrated in deflationary money supply impacting resource/energy development.
Ilargi can speak for himself but he has written extensively about the two horsemen, energy supply and finance on The Oil Drum. It was there that I first read I&S and followed them to TAE. For I&S their experience must be like a singer having a hit song, they have to sing that favorite over and over again.
Such is the price of fame:)

Unknown said...

I give you this enjoyable rant about Greece and Bernanke (not directly related) in this fine Canadian blog I recently discovered.

Zaphod said...


Surely you know that Ilargi and Stoneleigh were editors at The Oil Drum before starting this gig? Few people in the world have as broad an understanding of energy issues as they.

At risk of inaccurately speaking for them, I would say they understanding perfectly the role of energy in a declining world, but that economics is the clear driver. A lot of pain is going to happen BEFORE we get to the point that energy is scarce.

I myself see energy, resources, and economics as linked, but it is important to note that even if, say, fusion works out tomorrow, cheap future energy alone is insufficient to prevent serious problems in the near term (and longer) due to existing credit situation and scale of the worlds problems.

Weaseldog said...

Gravity said... "@Weaseldog,
of course "the current energy decline is coupled to our economic decline", but this relationship is only very loosly coupled right now, even if oil dropped to 10$ a barrel, financial collapse would happily continue on its own momentum, perhaps ever so slightly slower."

I've actually started working on that article in which I'll attempt to explain the relationship and why it is more tightly coupled than it may appear on the surface.

It's a been years since I've written more than a few pages at a time on this topic. It deserves more, because several relationships have to be understood, to get a grasp of how they interact.

Back in 1999-2002, I was writing largely from a theoretical standpoint on this. But the model was useful in predicting the month of the 2001 crash. And using it, I determined that getting out of the market in January of 2001 was a safe bet. I sold everything. I also made the same recommendation to friends and family.

To gloss over it a bit I'll try to hit the key points here.

I knew that after that shakeout in 2001, the weaker players would be eliminated. So the predictive abilities of the model, as regards to timing, would decline. Especially since the peak was a shallow one, followed by a an all liquids peak. That left a lot of muddle room.

What the model did predict post peak, (and I was writing about this as far back as 1999), is that the financial sectors would attempt to decouple from the industrial sectors, and massive government intervention and bailouts would ensue.

The simple reason for this is that post peak, in aggregate, all industrial investments are losers. This is because with contracting energy flows, industry must contract.

Industry borrows money for improvements. Then can't repay.

Industry borrows money for materials. Then can't repay.

Industry borrows money for payroll. Then can't repay.

As a businessman, you'd be stupid farcking idiot to invest in industry. The bankers see this.

And the bankers are trying to create a firewall between their money, and real world businesses. A second economy would logically evolve that is separate from the physical economy.

But bankers need to eat and buy goods and furnishings. They can't completely sever their ties, so they play favorites with industries and rig the game.

Weaseldog said...

So how do you guarantee that your players make money in a declining environment?

You do so by selectively destroying competitors. Once you've destroyed enough competitors to a business, that business can then grow again, even though the aggregate market it is in, is shrinking.

You can do this with businesses and you can do it with countries. If you want to free up oil and coal for use by your favored corporation, then you can shut down the economy of the nation that the competitors are in. Shut down enough nations that aren't making you enough money, and it will free up oil.

Remember, the price of oil is not what is important to the scale of production. It's the quantity of oil available at a price that matters. To bring an industrial economy back to healthy growth, you wouldn't need price to come down due to shattering economics, but by creating growth in oil at a low price so that a growing economy doesn't see demand matching or exceeding supply.

Oil production must grow to provide industrial growth. If this can't happen. And it can't, then industrial growth can only occur for specific corporations, if their competitors are killed off faster than oil is declining. Then the oil (or energy) per corporation will be seen as growing.

The current financial turmoil is bound by the decline of energy. the shenanigans we're seeing are the logical strategies for coping with the decline of industry.

This isn't to say that these are the rational strategies for society at large. but from the viewpoint of the financial powers, this is the most sensible strategy they can take, to preserve their wealth and status.

This view also tells us what forms change is likely to take. Either these financial masters will succeed in enforcing massive austerity measures, so that they can keep industry growing in the select corners of the world they care about, or we're going to devolve into a depressionary nightmare. Either way, we'll ratchet down. War could cause our devolution to speed up as oil supplies are taken offline. Conventional war would also likely burn hot for a short while and smolder out.

Neither of these views seems to fit Ilargi's arguments very well. But Ilargi has argued that the economy has caused the oil peak. After the recovery, conventional oil production will grow again and exceed the 2005 peak.

I know of no nation's oil fields that could grow at such a rate to offset the world's decline in oil. there would have to be half a dozen Saudi Arabia's ready to be put online to perform such a feat. The power of exponents can be a terrible foe of hopes and dreams. I don't hold any hope that such an abundance of cheap accessible crude exists.

memphis said...

veryruffrdahead said...

That's just silly.

OK, she messed up royally. But now she has the freedom of nothing left to lose.

Do a Dr. "Patch" Adams, go work in a poor rural area for peanuts, don't carry any malpractice insurance, have some kids and be happy.

She'd have to deal with the debt for the rest of her life, but they can't take what isn't there, so she'd probably get by with making occasional nominal payments.

Oh, she has something she'll probably have to give up, and that's the lifestyle that so many perspective physicians anticipate.

I have a friend who practices veterinary medicine who graduated with $100K in debt. I don't think--certainly in the late 1990s--that there's much "education" that students receive about loan repayment, prior to their graduation. In 2003, interest rates dropped to (then) new lows, and I had to convince him to consolidate his loans and get the lower rate, which probably dropped his prevailing rate nearly in half. I taught this past summer at a technical school; the administration would mock students who were taking the loan money and then quitting school--as though they somehow weren't going to be responsible for the $$$. I couldn't believe it; even the school was oblivious to the ramifications of student loan default.

Until October, I worked with a fellow (who was moonlighting) who had $219K in student loan debt, at exceptionally low rates, making his monthly payments just under $1000 a month. Here's the thing though, he bought a practice, a house (got a phenomenal "deal" on it), two new Mercedes, furniture, and he/wife do "trips" every 6 weeks or so. I couldn't begin to understand it. Few physcians can sustain that kind of lifestyle, and certainly not in family practice just out of residency.

It's unfortunate that the young physician highlighted in the article is in such a financial mess, but frankly, I'm sick of hearing, "I didn't read the fine print." It's time for these people--who use someone else's money to pay for an education--to grow up and pay their bills.

memphis said...

Snuffy wrote:

Sometimes I question that assumption,when I think of how many of us all have a father,sister or other family member...or of the older generation who still remembers....if it happens 20 years from now ,with the decay rate of "sustenance farming" knowledge,may be...but now,at least here,a whole lot of folks still remember canning,drying,and the rest.

Yes, and no. I have one sibling, who's a still-employed autoworker, and as such, has benefitted from both salary and benefits. He's entitled to them. He lives quite comfortably but not excessively, compared to some others. He does, however, have a lawn that could pass for a golf course, it's so manicured, and he'd never open the windows in the summertime, utilizing AC when it's hot, because the air is so dirty. (He's a little anal over that house.) Yeah, despite how we were raised--on a farm--I think he's forgotten.

Hombre said...

Indiana Senator Bayh Quits! "Does Not Love Congress!"

Oh, right! As the youngsters say... ROFL or LMAO. Well... just so you are aware...

First, as a Hoosier, he is my Senator. Now, the timing... and why. Eveyone who can understand English will know by Thursday the 18th.

Matt Sledge, Huffington Post...
For many years Susan's membership on several major corporate boards (eight of them, in 2008) was something of an open secret. Only over the course of the health care reform debate was it widely spoken about in Indiana. With Bayh playing a prominent role in the haggling over the public option and medical device fees, it was impossible to ignore the fact that WellPoint, a behemoth insurer, was paying Susan Bayh hundreds of thousands of dollars.

Between 2006 and 2008 Susan earned $2.1 million from health insurers. Legal under Senate rules, Susan Bayh's refusal to step down from WellPoint's board, and her husband's denial that the millions she had earned from WellPoint would influence him, were greeted with derision from ethics watchdogs.

WellPoint faces firestorm over hikes, profits, Insurer's 727% rise in profits comes at inopportune time!

By Russ Britt,
LOS ANGELES (MarketWatch) -- WellPoint Inc. faces a firestorm of controversy as the health insurer's massive fourth-quarter profit gains are likely to become the center of attention as it seeks to raise premiums in California.

A group known as Health Care for America Now, or HCAN, plans to raise the point on Thursday, Feb. 18, at a press conference in Washington, D.C., as part of a general discussion on health-insurer profits. It plans to release a report on how much the nation's five biggest insurers made last year while cutting costs and members.

Anonymous said...


Ilargi said...


Now I said that finance is not linked to the real world? Where'd you find that?

No, the idea was that the financial crisis was caused by an energy crisis, and that's what I say is not true.

Look, it's not a discussion that has priority for me right now. That's all. Sorry if that hurts.

Phil said...

FarmerAmber said:

"Perhaps the European tendency to take care of its populace is a legacy of the fact that in European memory the populace has risen up (violently) and torn down the ruling class when they forgot to do so."

And today, we have this news report from @channel4news:

"Bomb explosion outside the JP Morgan offices in #Athens - minor damage to the building. No immediate reports of injuries."

Weaseldog said...

Ilargi said... "Weasel

Now I said that finance is not linked to the real world? Where'd you find that?"

You keep telling me I'm wrong without explaining yourself or specifying what I'm wrong about.

So you leave me guessing that because you're not specific, it must be a blanket statement that I'm wrong about everything.

"No, the idea was that the financial crisis was caused by an energy crisis, and that's what I say is not true."

I never made that argument. No one else did either. The words 'triggered' and 'caused' have distinct meanings. You keep using the word 'caused', but you're the only one arguing on that point.

I tried to clear that up by pointing out that avalanches happen, but loud noises can 'trigger' them. Loud noises don't 'cause' avalanches, but they effect the timing and severity.

It's semantics I know. But the meanings of these words are very different. Different enough that your reply has very little to do with my argument.

I had some email me and tell me that English is your second language. Perhaps that is all there is to this question? You misunderstood the meaning of these words?

"Look, it's not a discussion that has priority for me right now. That's all. Sorry if that hurts."

There is no need to get emotional about this. For me, this is an intellectual endeavor. Your position doesn't seem logical to me. It seems to have missing pieces and errors.

But you may be correct. It may be the case that I'm missing a datum that makes your position logical, and satisfies the contradictions.

Take care. I appreciate what you do write. Much of the financial world can be viewed purely through that prism. You're providing an interesting viewpoint on that basis.

Jim R said...

Bomb Explodes At JP Morgan Office In Athens - No One Hurt -- Zerohedge

zander said...

Quite extraordinary figures from UK today, large regional varitions akin to what Stoneleigh has mentioned on occasion, but in my area, Edinburgh,
The house prices were up an astonishing 11% ??? and SIXTEEN PC in Dundee, this is beginning to baffle me, regardless of bailouts, stimulus,Juggling, plate spinning and the rest of it I simply dont get these figures, theres collapse all around me now, people laid off, on short time, firms going bust, shops closing, folks hoarding cash,it's all tangible and clearly in evidence to me every day, and yet these stats seem to defy both logic and gravity, where are folk getting the readies to up the median house price by 11PC???
maybe I can reconcile this when I study the full figures leading to the bottom line.
Inflation 3+% as well


Max said...

Oil price and oil scarcity has been one part of the story.

Govts in various places wanted to keep the illusion of growth going with rising oil prices. Super low interest rates and lack of credit regulation were government policies and aided the debt bubble and house price bubble.

Super low interest rates did start when oil and nat gas prices rose to levels which cut economic growth. Debt fuelled stimulus did not start in 2008, its been going for many years.

Increased debt, including consumer debt and government debt did allow the illusion of growth to continue. It worked until recently. When consumers were maxed out on all kinds of credit the game was over. Rapid rises in oil prices and nat gas prices have taken chunks out of consumer income, and consumers already on the limit could not pay their mortgages, or buy more consumer stuff.

I would agree with Ilargi that the financial issues currently dominate immediate events but continuing high oil prices are a surprise. If this was a pure financial mess oil price should decline. Time will tell.

scandia said...

A rumour...just checked out the Cdn rant site. good summary of the Greek situation.
I wanted to post a comment but didn't understand how to answer the profile question What should I chose?

scandia said...

A thumbs up to Weaseldog for his latest comment!

scandia said...

Jeez VK...whose supporting the market to-day?!

Ka said...


Am I interpreting you correctly as saying:

- The financial powers that be, being aware of declining cheap energy and that that means there will be less and less industry going forward,

- have been blowing bubbles and so forth to engineer a deflationary future,

- with the intent of wiping out some companies/countries to consolidate a viable industrial remnant?

Makes some sense, but I wonder if the financial and political elites in fact have that much control over the situation.

Hombre said...

Weaseldog - Fellow canine, I would hate to get in a scuffle with you at the pub! You are persistent.;-)

BTW I think you have some quite coherent and valid points to the extent that the energy predicament runs entertwined and parallel with the economic debacle.
I have found Ilargi and the StoneLady to be expert in this area--the best--and a part of me wishes you would get the longer response you are seeking since we would all learn from it.
However... as a former performer, one does get tired of singing the same songs, and they have waxed rather comprehensively on this both at the Drum and here.
Still... good luck!

Ka said...

Does anyone with a better handle on the European political scene than I have care to prognosticate on the possible role going forward of the Old Left (I'm thinking, for example, of the remnants of the Italian Communist Party, which a few decades ago would get about 30% of the vote). It would seem that conditions are good for their making a comeback.

Sunshine said...

VK said:
“So if Ethopia can maintain stability with 37,000 barrels per day and a functioning Govt, can Gernamy?”


Does the word BARBARIAN ring a bell?

Me don’t think Ethiopians can uber-engeneer live human cremators, not because they are any less capable but because they have beating hearts.

Hombre said...

Ahimsa - Thanks for the link. I like to read Ruppert because he rants so well!! ;-)

One of my big concerns is in an area which I (who does?) know little about--space/cyber warfare. Ruppert predicts this again in this piece.
It is nearly unimaginable what would happen if a major portion of the world's digital communications system was shut down! Talk about a business downturn! That would be a catastophic stoppage of commerce!

Gravity said...

From the tragic article:
"Third, the European Central Bank needs to adjust its policies, lowering interest rates further and allowing higher inflation throughout the currency union."

That's swell, allowing inflation.
They have perchance not noticed yet how inflation largely comes about by people spending money, mostly borrowed money, and absent this effect it might be difficult to force it, at whatever rate.

Gravity said...

higher gas prices may trigger certain marginal people to default on a mortgage sooner, but it has very little direct causal connection to say, a novel scheme of hiding sovereign debt loads in swap form, thus distorting price discovery in related sovereign risk.

Really, as I understand it, Ilargi adequately acknowledges peak oil, but there is no directly useful coupling to financial collapse, with energy price and availability mostly effecting commercial collapse, specifically harming that segment of commerce which would otherwise not be decimated by credit contraction anyway.

Ilargi said...

Apologies for some delays in posting comments today. I spent the best part of it on a train, and Stoneleigh is on a long drive to Toronto for a farm show presentation for the APAO tomorrow. To prevent confusion, that's the AgriEnergy Producers' Association of Ontario, not the Asphalt Pavement Association of Oregon. I kill me.

I was trying to find additional details, but I can't. Still, If you're in TO, go see her! If you can find her, that is.

PS: Wait, I'm pretty sure it's here:

Canadian International Farm Show
Toronto International Centre
6900 Airport Road Entrance 6b, Suite 120 Mississauga, Toronto


Phil said...


It's easy, really, when you remember that the gap between rich and poor in the UK is still growing, and that it's the well-to-do who are buying, not the poor, who've been well pushed out of the housing market.

It's all temporary, anyhow:

"UK house prices 'to slump as credit crunch returns'
A second mortgage credit crunch that will send UK house prices into a new tailspin is looming, economists and credit experts have warned."

Weaseldog said...

Gravity said... "@Weasel,
higher gas prices may trigger certain marginal people to default on a mortgage sooner, but it has very little direct causal connection to say, a novel scheme of hiding sovereign debt loads in swap form, thus distorting price discovery in related sovereign risk."

That was the point of one of my previous comments. The decoupling is a reaction to the damage done to the industrial economy. The effects of the oil decline are forcing the bankers to change the way they do business. If it weren't for peak oil, they'd be happy continuing the predatory tricks they had been performing in previous decades.

Ka, the top bankers through the IMF have been pillaging nations since the 1970s. It's been a similar MO all along. Loan moneu and insist in having a hand at setting policy. Then set policies that lead to default. Enforce Austerity Measures to steal everything.

Step 1. Engineer a crisis.
Step 2. Get your people in government.
Step 3. Profit.

deflationista said...

so, this guy is dubbed a lone voice?

can someone explain to me why these people do not see what we all see?

VK said...

@ Martin

I guess if we ever reach the 5,000 friend limit on the TAE facebook user page, we'd have to set up a page or group. For now the user way seems ok, more personal IMO.

@ Scandia

No worries Scandia, the market confirmed it's primary change in direction a while back. The technical analysyts I sort of read are reckoning that the DOW's day of reckoning is near. I wouldn't be surprised if we saw sharp declines over the next 5-8 trading days. But then again markets have done stranger things. I'm uber bearish, now if only the market would listen to me and DOW 9000 for me :)

One can dream, can't he?

kjm said...

Paleocon -- I find it a bit odd that you mention your Bibe and your itchy trigger-finger in the same sentence.

Reluctant Poseidon Hamster said...

weaseldog: the top bankers through the IMF have been pillaging nations since the 1970s.

Not disagreeing, but can you give some numbers to back the assertion? Can anyone? Case study?

The difference between "pillage" and "salvage" is all in the $ numbers. How much hand-over-fist profit have these bankers earned for their institutions through IMF actions?

zander said...

@ Phil,

But the well to do are now a dwindling resource and the extra they are prepered to pay at the mo. must surely be more than offset by the amount the people whose standard of living is dropping (and who are much greater in number than "getting richer" side incidently) cant/wont pay,
not to mention defaults,the newly jobless, and the general reduction in wealth for the very many on the "getting poorer" side of the equation who entered the housing market in the past decade by the skin of their teeth.
It's not obvious to me at all I'm afraid.
Of course I agree the prices will fall, and heavily, thats a given, which makes the price rises in Aberdeen , Dundee (especially), and Edinburgh all the more difficult to fathom don't you think?
These are hardly insignificant numbers, 8, 11 and SIXTEEN percent.
It cant be just the well to do who are buying Phil, there doesn't seem to be enough of that class to keep the housing market moving let alone rising,
still, you can't argue with the facts.....


VK said...

@ Zander

It's even more surprising given the fact that mortgage lending has more than halved since the 07 peak!

So rising unemployment, more bankrupticies, more businesses closing down, people struggling to get buy and house prices rise!

What is the UK turning into? Canada??

Pffftt! Anyway best to imbibe large amounts of alcohol to overcome the anomalities of life.

Caith said...

zander: The Registers of Scotland have an excel spreadsheet of house prices and sales by local authority district. The prices may be going up, but the volume of sales isn't. In Dundee, first quarter sales volumes are: 2007: 1,042; 2008: 753; 2009: 435.

They don't seem to disaggregate by price of house. Maybe only the larger houses are selling now?

Ilargi said...


"can someone explain to me why these people do not see what we all see?"

I can't figure out what you're asking here.

Zaphod said...


First, I was being exaggeratingly sarcastic.

Second, most of the gun-owners I know are church-going Christians (that's the norm around here).

Third, my key point was that by the time shooting comes about, there will have already been a marketing campaign to dehumanize and denigrate the "enemy". With today's superb visual marketing, I expect this to become more nuanced than what we've seen with Iraq, Afghanistan, Pakistan, and Iran.

When it comes time for it, most will applaud the shift from "precision" warfare to "eradication".

Unknown said...
This comment has been removed by the author.
el gallinazo said...

Re real estate "inflation" in the UK and asset prices in general

Yes, one must always look at the volume as well, and if possible, the nature of the entities doing the transactions.

The volume on the US equities markets are way, way down. It's just the Squid's and JPMC's robots selling each other stuff at prearranged, programmed prices courtesy of money for free from the US taxpayers.

Wyote said...

Goldman note to IMF:

"Remember boys: Pillage first then burn."

Phlogiston Água de Beber said...


Weaseldog said...

Gravity said... "@Weasel,
Really, as I understand it, Ilargi adequately acknowledges peak oil, but there is no directly useful coupling to financial collapse, with energy price and availability mostly effecting commercial collapse, specifically harming that segment of commerce which would otherwise not be decimated by credit contraction anyway."

If we had continued industrial growth, then industry would be a good investment and there would be no credit contraction.

The credit contraction is occurring because industry is in fact contracting, and unable to grow profits to repay loans with interest.

This is a direct result of the energy supply's end of growth and slow contraction.

Weaseldog said...

Reluctant Poseidon Hamster said... "weaseldog: the top bankers through the IMF have been pillaging nations since the 1970s.

Not disagreeing, but can you give some numbers to back the assertion? Can anyone? Case study?"

I learned a lot about the IMF's activities by exploring their website.

They had it all documented. They had reports of their programs listed by nation, who they installed to government posts, etc... They documented the austerity programs.

Of course they put all of this in a positive light. As I explored report after report, I kept seeing the same pattern over and over.

That was back in 2001 when I really dug into it though. It's changed a bit since then.

There is lots of information on the web regarding their austerity programs and the effects.

Weaseldog said...

Reluctant Poseidon Hamster said... "weaseldog: the top bankers through the IMF have been pillaging nations since the 1970s.

Not disagreeing, but can you give some numbers to back the assertion? Can anyone? Case study?"

Something you'll find pretty quickly on the austerity measures once enacted...

The IMF takes a full 30% of the government revenue and control over the governmental budget. Taxes for businesses incorporated inside the country are raised dramatically. International corporations working with the IMF operate completely tax free.

Ilargi said...

"If we had continued industrial growth, then industry would be a good investment and there would be no credit contraction.

The credit contraction is occurring because industry is in fact contracting, and unable to grow profits to repay loans with interest.

This is a direct result of the energy supply's end of growth and slow contraction."

Well, at least we've found that your understanding of this finance crisis is, to put it mildly, inadequate.

To illustrate this, a simple referral to the 1930's suffices.

Credit is not some linear function of energy supply, and I find it hard to believe anyone at all would actually claim it is.

Credit shot up like mad between, roughly, 1998 and 2008, without a parallel increase in energy supply; there can be no doubt on that, I would hope. That mad dash in turn is the cause of today's contraction, not a parallel contraction in energy supply (there is none).


soundOfSilence said...

memphis said...
veryruffrdahead said...

Oh, she has something she'll probably have to give up, and that's the lifestyle that so many perspective physicians anticipate.

Is there some survey of perspective physicians that I can refer to for this expected “million dollar mansion on hill life-style” because otherwise that comes off as a variation of “welfare queens in Cadillacs?” Yes I know you have (had?) a friend with a family practice who spends more time vacationing in the Mediterranean than in his office – I would think he’s patients not being able to get in to see him would all leave for other physicians but then who’s to say?

I know, I know it says she expected to by a house (doesn’t say if it was a million dollars and/or on a hill) and a car (doesn’t say if it was a Toyota Corolla or a fleet of Mercedes) and get married. What’s wrong with a 1000 sq ft apartment, riding the bus to/from the practice and the single life?

Unknown said...
This comment has been removed by the author.
deflationista said...


the article:

describes hoenig as a lone voice... standing up to his colleagues and providing unprecedented testimony about our economic policy... mish did a piece on him as well---

hoenig declares that we face near term inflation because of fed policy....

my question was-- why don't these people see what we see? in other words-- why don't they see the deflation that you describe here--- and that most of us understand? and why would hoenig be considered such a lone voice when he is spouting the same bullshit that the gary north's of the world have been saying for years?

the talk of inflation is everywhere... i just dont get it...

i feel like our little group here are the only one's in the world who might actually know what is going on--- thanks to you and stoneleigh and your merry band of posters...

keep up the good work...

Stoneleigh said...


I'm short on time today because I'm away (running a farm show booth and working on the text for my employer's new website), so I can't get into a debate right now. However, if you send me the paper you're working on, I'll put together a response when I get a chance, and try to pull together the previous arguments you're looking for. That would probably be the best way to explore the issue for everyone who's interested.

Anyone in the Toronto area,

A minor correction to where I am:

Canadian International Farm Show
Toronto International Centre
Hall 5, Booth 5209 (APAO)
6900 Airport Road
Mississauga, Toronto

I'll be in the vicinity on and off for the next 3 days, splitting my time between manning the booth and finding a quiet corner to do all the other things I have to do before the AGM. I may therefore be hard to find on spec. If anyone wants to chat, the best thing would be to leave a comment with a specific time, and I'll try to make sure I'm at the booth at that time. I won't be able to check comments all that frequently though, so a reasonable amount of notice would be required.

Weaseldog said...

Ilargi said... "Credit is not some linear function of energy supply, and I find it hard to believe anyone at all would actually claim it is.

Credit shot up like mad between, roughly, 1998 and 2008, without a parallel increase in energy supply; there can be no doubt on that, I would hope. That mad dash in turn is the cause of today's contraction, not a parallel contraction in energy supply (there is none)."

Thank you for your reply Ilargi.

Conventional Oil production peaked and declined in 2001, then peaked again and went into decline in 2005.

All liquids peaked in 2008. This includes lower BTU byproducts and products with a much lower EROEI than conventional crude. All liquids is currently in decline.

The growth in natural gas has been lackluster. hovering around 1% per annum as of 2008. It's growth rate has been declining Further, natural gas is a lower BTU source than conventional crude. At such slow growth rates it cannot make up for the energy loss from conventional crude.

Coal production has also been growing at a lackluster rate. It's also seen a 1% growth rate up to 2008. It is also a lower BTU energy source than conventional crude.

If you look at EIA statistics, where they give a total on energy, you will see the illusion of growth. This is because they simply add up the quantities of the various sources, without regard for embodied BTUs. Adding cubic feet of natural gas to barrels of conventional oil, doesn't yield a particularly useful number.

On the EIA charts, one thing is glaringly obvious is that energy growth in raw BTUs was very near zero in 2008.

This is the equivalent of a 2%-3% energy deficit per annum. You must have energy growth to power industrial growth.

This credit explosion took off as world energy production growth was slowing.

This was a response to increasing production costs and an attempt to boost production. Remember, fuel prices are increasing in the late 90s and began an oscillation that coincided with financial bubble formation and bursting.

After 2001, world oil production went into a severe slump. We lost several years of growth that we've never made up for. We're now in double digit percentages below the projections for that time period.

World population continues to grow, though energy production doesn't. Debts continue to grow at rates that are far faster than energy production rates for any historical period.

Without energy growth, we can't have job growth. To get net job growth, we need energy growth to exceed the growth rate in new potential workers.

Debt accumulation, designed to spur job growth, simply produces economic and financial distortions. This money has to go somewhere and do something. It can't go to productive uses, because there is no growth in industry. So it goes into financial shenighans.

The data doesn't support your premise, so I must reject your argument.

So you have a model that takes into account the severe volatility we've seen in energy supply and pricing since 1998?

Weaseldog said...

Tero said... "Ilargi & Weaseldog:

Wouldn't you say that the availability of energy (as a central factor of production) causes optimism which causes people to attempt to expand the economy by taking out loans which causes the money supply to increase?"

Growth in energy supplies, powers the growth in industry. It allows the creation of more jobs, more product, plus better salaries and benefits.

When energy supplies are growing at rates of 2%+, the growth in all sectors of industry supports the expansion of the money supply. When industry takes out loans, it can repay them with interest. In this scenario, old fashioned banking is profitable and safe.

When energy growth is near zero or negative, industrial growth ends. Loans are not repaid. Credit scores decline. Bankruptcies ensue. Bankers start looking for alternative ways to make money.

Couple this with the removal of laws designed to keep banking relatively safe, and the bankers start investing in all sorts of gambling devices to keep growing profits.

Remember, growth is the cornerstone to our form of capitalism. The top financial firms aren't going to let anything get in the way of their exponential growth. And in a zero sum game, if someone grows, others must shrink.

Wolf at the Door said...

@ Brian,

"i feel like our little group here are the only one's in the world who might actually know what is going on..."

Either that or we all belong to a cult and don't even know it. I imagine that the Heavens Gate people expressed much the same sentiment all the way up to the end.

Unknown said...
This comment has been removed by the author.
zander said...

@VK, really?, ok I'll try that out tonight and maybe for the remainder of the week :)

@Caith, Tero, Elg.
Thanks guys, I think you've nailed it.
Volume down, the high end still transacting and inflating, medium and low end treading water at best with little transaction resulting in the high end housing market giving a skewed picture of the current median price due to the disproportionate number of transactions occurring there, and, like you say Elg an element of horse trading betweeen the "can still affords" gives the impression of buoyancy.
Uncannily similar to what Janet Tavakoli was expaining about the complex derivatives market pre crash on her excellent cameo piece on 60 mins

Only the smartest blog on the planet could sort out a parochial Scottish query with such accuracy :)


Anonymous said...


Hoenig invoked not only inflation but the specter of hyperinflation. And from what I read of his speech, he wasn't saying that it was here right now but that inflation (monetizing the debt) was a very possible outcome downstream because of the political pressures on elected representatives, and the corresponding political pressure that these politicians would then place on central banks.

And indeed, as I&S have commented numerous times, somewhere down the road that is exactly what these desperate men and women will do - inflate, because it's all they know how to do and they believe that what they do actually matters. It doesn't, just as human sacrifices didn't really matter to Mayan agricultural production, but that's what the central bankers believe and thus it is what they will do.

As for deflation, most simply don't want to even invoke that word. We get talk of "negative inflation" and "disinflation", all attempts at masking the reality of what is occurring - a massive contraction in the available money supply. I believe that these same central bankers are well aware of what is actually occurring but like the dread name "Voldemort" from the Harry Potter books, they refuse to even speak the word deflation out of utter fear of it.

No, it's not rational, but very little about modern economics is rational at all anyway. This often surprises some people, as they've been told since infancy that economics is a science. It is not. Economics is tribal voodoo, court astrology, and solipsist silliness attempting to masquerade as a science. I do believe that it is possible to describe a real science of "economics" which would contain a language for expressing resource flows, biological and ecological benefits and costs, and personal benefits and costs, but we are nowhere near such a real science today. And given our likely future, we probably never will be, even if it is at least theoretically possible.

team10tim said...

@ Brian,

Hoenig as a lone voice... because he is the only one at the Fed saying it.

Zaphod said...


It would be interesting to have a psychological profile of the "doomers" and "declinists" that frequent this and other sites.

I long saw myself as an optimistic person about everything, and how I'm pessimistic about may things. Is it a function of age, individual fiscal experience, or personal trauma, or of objective wisdom?

I hope the latter, but honestly I'm sufficiently unsure (in the face of others whom I've in the past respected who see our situation differently) to spend my time and money on mitigation activities that are sound no matter what -- less debt (eventually none), less consumption (especially energy), more "useful" hobbies, and a broader "support base" of friends. Still, I educate those around me about the irrationality of unfettered growth and almost inescapable economic and population drops.

I see myself still "bargaining" with my dreams and goals. Probably I'm delusional in that regard and things are worse than I secretly hope for.

Unknown said...

Someone was asking the other day about a consolidated document of Stoneleigh's posts.

I have three documents publicly available on SkyDrive that were posted awhile ago.

These are not recent. The first one dates back to the origins of TAE. I consolidated a number of documents that CA had compiled. The next two are posts of things that South Florida had compiled.

For some reason, when you download these it puts an underscore at the end (.doc_). You need to delete the underscore to have Word recognize the files or open directly from within a word processing program.

Phlogiston Água de Beber said...

@ Brian

Anyone that thinks they know what's going on, isn't watching enough channels.

Even at this moment, bank reserve accounts are inflating very nicely. Their loan portfolios, not so much. Which goes a long way toward explaining why our accounts are tending to deflate.

It seems there is always inflation somewhere. The sainted Paul Volcker is credited with having squashed inflation, back when dinosaurs still roamed the earth. Oh wait, maybe that was Toronados and Gran Furys. What he actually did was round it up and confine it to places like stock and bond markets. How do you think we got to DOW 10k in first place?

One thing I think we can be reasonably sure of, unless they make some monumental and unfathomable mistake, inflation will never again show up in our paychecks. My assumption is that they would regard that as far more horrifying than say the asteroid Apophos giving our planet a darned good smack.

Unknown said...
This comment has been removed by the author.
el gallinazo said...


We are indeed a cult. Pass the Kool-Aid por favor.
Hmm. Tastes a little bitter today.

el gallinazo said...

To the best of my knowledge, the only currently tenured professor on the planet who writes in English and has a clue what's happening in terms of the deflation catastrophe we are approaching is Steve Keen. Maybe Michael Hudson, who is totally focused on the theft of the millennium in terms of a transfer of wealth into neofeudalism, but doesn't seem to discussed the money and credit supply as much.

There are many in the financial industry who get it more or less, usually less because they underestimate the severity and duration. I would list some (and not exhaustively) as Robert Prechter (who does understand the severity) ,Tyler Durden, Mish, Mad Max Keiser, David Rosenberg. I didn't include Roubini in the professor category because, despite his media touting, he really doesn't have a clue how severe it will be.

Janet Tavakoli is both a delight to the ears and eyes, but like Hudson, she is more focused on the theft and less focused on its ultimate result. (Unfortunately, due to an incredibly crappy ISP, I was unable to watch her must recent presentation of this past week). Janet is a very ethical person, and she considers herself an expert on financial instruments, but not on macroeconomics, so she refrains from commenting in that area.

So, financial doomers are certainly a minority. But since (as Prechter has documented ad nauseum), the majority is invariably wrong, so at least in terms of accuracy (if not world outlook) this is rather positive.

Bryan McNett said...

>I long saw myself as an
>optimistic person about
>everything, and how I'm
>pessimistic about may things.
>Is it a function of age,
>individual fiscal experience,
>or personal trauma, or of
>objective wisdom?

I wouldn't classify this conflict as pessimism vs. optimism. It is a conflict between reality and fantasy.

It's very strange to me that society expects happy people to believe only the happiest stories, even if they are false.

I think this is an intended effect of the modern propaganda system. I don't remember my grandparents thinking this way.

When I presented my "drill baby drill" mom with the fact that offshore has only two years' supply, she replied that unless I could tell her a happier story, she'd keep believing in offshore.

The facts don't tell a happy story, but they describe what actually happens in the future, so I need them! I'm a pretty happy person anyway.

team10tim said...


Re: Energy and the economy. Essentially there are two schools of thought that speak different languages. The thermodynamics crowd model the economy as a heat engine that converts energy to GDP. And the Minskian crowd who model debt and lending instabilities in the economy.

Since we are near peak oil (probably a few years past it, but not yet at peak for coal and gas) I can understand why you might think energy is driving the contraction, or at least a contributing factor. But thermodynamics only give us the theoretical limits. It does not guarantee that we will reach those limits. It is entirely possible that we crash the economy even with a growing energy supply (see 1930, south sea bubble, dutch tulip bubble, etc.) and that's where Minsky comes in.

Minsky doesn't deal in the general equilibrium model like the overwhelming majority of economists (which is why they failed to see the crisis coming). He uses a very simple accounting model, and that model accurately predicted the financial crisis without any mention of energy. For a thorough review of the academic economists who predicted the crash see:
"No One Saw This Coming" Understanding Financial Crisis Through Accounting Models

Since peak oil and the financial crisis are happening at the same time it is difficult to disentangle the two, but try imagining what would have happened if the peak happened in 1930 or conversely imagine making all the bankrupt entities past, present, and future solvent by adding in extra oil production since 2005.

Zaphod said...

A potential liability, and perhaps a strength, of Eliot Waves and Prechter, would seem to me to be the basis of communications theory:

"It has been found that any repeating, non-sinusoidal waveform can be equated to a combination of DC voltage, sine waves, and/or cosine waves (sine waves with a 90 degree phase shift) at various amplitudes and frequencies. This is true no matter how strange or convoluted the waveform in question may be. "

Therefore, using empirical hind-sight, and enough terms, you can devise a set of "forcing" equations to create the observed pattern to any desired degree of accuracy.

If those functions are reasonable well-chosen, you'd have a "model", and perhaps that model can then make testable predictions.

Unfortunately, if you're not positive that you've captured every "wave", or if the observed waveform isn't truly repeating, the similarity (and the math) fails.

Taylor series expansion cannot deal with singularities (Black Swans?).

Given this, it would seem to me that Prechter, Eliot Waves, and similar cyclic models would best be used for predictions based on a basic "BAU long-term view", and the potential for Black Swans, energy peaks and even never-before-available global finance mechanisms, to add new, unexpected terms to the equation are likely.

In a scenario-gaming model, using a Prechter approach would seem to be one reasonable scenario to consider.

What is the best book on Prechter's theories?

memphis said...

Soundofsilence said:

memphis said...

Oh, she has something she'll probably have to give up, and that's the lifestyle that so many perspective physicians anticipate.

Is there some survey of perspective physicians that I can refer to for this expected “million dollar mansion on hill life-style” because otherwise that comes off as a variation of “welfare queens in Cadillacs?” Yes I know you have (had?) a friend with a family practice who spends more time vacationing in the Mediterranean than in his office – I would think he’s patients not being able to get in to see him would all leave for other physicians but then who’s to say?

I know, I know it says she expected to by a house (doesn’t say if it was a million dollars and/or on a hill) and a car (doesn’t say if it was a Toyota Corolla or a fleet of Mercedes) and get married. What’s wrong with a 1000 sq ft apartment, riding the bus to/from the practice and the single life?

Why would you quote me as though I had written the article? I said NOTHING about a million dollar house. NOTHING

I also took no position implying anything was wrong with a 1000 sq ft. apartment, riding the bus to/from work, or remaining single. Please refrain from putting words in my mouth.

How on earth could you attribute those quotes to me????

Look, I'd worked with enough (yes, more than one) physicians, resident physicians, medical students, nurses, advanced practice nurses, therapitsts, etc. to know that FEW spend years of study, denying themselves a life, that often costs them relationships and marriages to be satisfied with a 1000 sq ft. apartment, riding the bus to/from work, and remaining single. It was not unusual to spend more time with physicians--and they with us--because of work than our respective families.

So, no survey, just life's experiences. If that's not enough of an anecdote, too bad. It's all I've got.

Shamba said...

@ Robb

THANK YOU for those URLs.

Peace, Shamba

Ric said...

Grey zone says: I do believe that it is possible to describe a real science of "economics" which would contain a language for expressing resource flows, biological and ecological benefits and costs, and personal benefits and costs, but we are nowhere near such a real science today. And given our likely future, we probably never will be, even if it is at least theoretically possible.

I've been pondering this for a while now--why we will probably never see such an "economic" science--why our decisions are so short-sighted. A real economic science would not appear like science to most people today because it requires such things as:

1) Seeing a real value of life which can't be quantified, but still evaluated,

2) Seeing existence in a greater context than the individual, and

3) Not seeing death as something to avoided at all cost.

Two and three sound down-right uncivilized. It requires solving the "one versus many" paradox.

Ilargi said...

New post up.

Did peak oil cause the present financial crisis?