Monday, August 16, 2010

August 16 2010: Deflation and you: Acting perfectly sensibly

Lewis Wickes Hine Where the money goes to May 1910
"Newsie buying candy with his hard earned cash in Bach branch office, 4020 Manchester Street, St Louis, Missouri"

Ilargi: It's been quite a while since we had a guest writer at The Automatic Earth, we should have more of those. Hint. Today, in any case, we do have one.

Aaron Wissner is a long-time Automatic Earth reader who also runs his own blog. Accidentally, Aaron is also busy organizing a series of Stoneleigh presentations of "A Century of Challenges" in the state of Michigan, which will take place September 10-19. We will post exact times and venues as they become available. And for those who can't attend, we are working hard on the completion of the video presentation of the talk. It should be ready within weeks, and we’ll post all details prominently here.

Both Stoneleigh and I were quite smitten with Aaron’s essay below. It provides a fresh angle and point of view of what deflation means beyond the usual lofty macro-economic terms that we usually phrase it in. At the same time, it may explain to people who tend to shy away from lofty terms what deflation is and where it originates.

Perhaps I can ask Aaron to do a follow-up dealing with what the consequences of deflation will be down the line. If he has the stomach for it, that is, because it would involve painting very scary pictures.

As a sort of lead-in to the essay, here’s a picture of a poll that the Guardian newspaper in Britain runs at present. It's all about sentiment, the same sentiment that Aaron talks about, as you will see. Funny, in a cruel sense, to see the discrepancy between political and industry messages vs what people in the street think and feel and fear. Even Tony Robbins has a video out (see below) warning people of a "major retracement". The Wall Street Journal runs an article entitled Boomers Threaten Economy, talking about who's spending less, or not at all. Which fits in perfectly with today's guest post.

In a side note, the greatest and most galling finance news today has got to be that the FHA, which guarantees about a third of all new US mortgages these days, is clamping down on the low side of the market, while at the same time guaranteeing multi-million dollar condos in Manhattan with taxpayer funds. Everytime you think you've seen the craziest moves of them all, you're already behind.

Aaron Wissner:

Deflation and You: A Guide to Understanding this Peculiar Economic Model

I just wanted to share a little bit about deflation. Deflation is when the combined amount of money and credit in an economic system is shrinking, and the velocity of money is stagnant or drops.

Once deflation begins, it is self reinforcing. To see how this works, first think of your own recent spending decisions.

If you are like me, your spending behavior and patterns have probably changed quite a bit since the housing bubble started to bust, and especially since the Dow Jones Industrial Average hit its all time high on October 11, 2007 and then started its wild ride down.

Before you begin to think about your spending behavior, though, one thing must be understood: Money is created by people when they take out loans. People offer up an asset or a promise, which the bank takes and files, and then the bank simply increases the number in their account. That is all there is to it. This might be hard to accept at first, but this is simply how it works in this economic model.

The amount of coins and dollar bills in the economy are a very, very small fraction of the total amount of money out there. Most of what we see as "money" is actually bank credit, which is created when people go to banks, are approved for a loan, and then spend that "money". If you imagine all those loans, all of them in the country, all at once, that is basically the money supply.

Behind each "dollar" (or bank credit) in a bank account, there is a loan document somewhere that was used to bring that "dollar" (or bank credit) into existence. If the size of all of those loans, let's just call this the "public debt" for simplicity, if that starts to shrink, for whatever reason, then that means there is less money in the economy. Less money to spend. Less money to earn.

At the moment, the money supply is shrinking because people are behaving perfectly sensibly. They see what is going on with the rising unemployment rate, the falling housing prices, the unstable stock market, the inability of the government to fix it, and the bad economic news that comes out on the TV, the radio, the internet, and in print.

What does a reasonable person do?

How have your thoughts for the future changed since October 2007? Think about that for a moment or two. Then, allow me to examine the top ten ways that I have changed my spending, and my thinking about what things constitute "money".

1. I don't think my house is a source of money anymore.

I used to think my house would increase in value, and that I was getting rich by just sitting on it, and that I could take out a huge home equity loan, and buy whatever I wanted.

Today, I think that if I'd take out the "Home Equity Line Of Credit" I've been approved for, I would not be able to sell my house for that amount, which is to say, I'd be stuck in my house, unable to sell, with no money. In fact, I don't want to take any money, not even a penny, out on this "HELOC".

True story: We were looking to buy a little summer cottage, and so we got this HELOC all set up, and we could have bought the place twice over using that HELOC, but I thought to myself, no way, I'm not doing it, I'm not going to put myself in debt, especially if the job market gets worse, and my wife, or I, or both of us, could lose our jobs. No, I'm not using that HELOC, and I convinced my wife that we shouldn't use it.

We weren't willing to bid much on the house, since we were only willing to buy it with money out of our current savings, and so it sold for even LESS than we would have bid, less than if we had been confident about the future.

2. I don't think that buying a house is a good idea.

I used to think that I could buy a second house, fix it up, use it, and then sell it for a tidy profit. Hey, yo, let's "flip that house".

Since 2006, I've seen that home prices were going down. And they just keep going down, relentlessly. Why would I buy until I was confident that prices were moving up? How many months of rising home prices would that take? Six months? A year? Why would I buy when there was a good chance that it would be worth less in the future? Why not wait?

And wait we did. We were looking for a second house, that summer home, for two years now, but the housing prices keep going down. Why would we buy?

In looking over the place we were going to buy this summer, we figured up the various monthly and yearly expenses, including taxes, and realized that we were going to be paying $4,000 per year, every year, at a minimum, just to have it.

Why not just rent some place for the week or two that my wife can take off in the summer, and stay at the parents’ house for the few weekends that we might visit?

Why saddle ourselves with another $4,000 annual obligation when the job market is looking worse and worse? We have enough bills as it is, plus two preschoolers to take care of.

No, buying a house is not a good idea, and buying a second house is really not a good idea.

3. I don't think I'll be getting any raises in the future.

It used to be that I'd get a 3%, or a 2%, or even a 1% raise to the top step of the salary schedule at the school where I teach.

This year, in negotiating a "master agreement" with the Board of Education, it took us over a year just to get our wages figured out for the year. That was a year beyond the end of our previous agreement. Our negotiating team had to fight tooth-and-nail to get a compensation package that wasn't all that much worse than previous years.

Then the state came and decided that since our state pension fund had lost billions since October 2007, and since the state was broke, that we needed to contribute more towards the pension that we had already been guaranteed, in a special teacher tax. The government showed that it could, in the swipe of a pen, decrease my salary, and our local negotiations really meant nothing.

I will be bringing home less this year, and the state is likely to try to cut salaries again, as it becomes clear that the budget is getting worse.

If I don't think I'll be getting any raises in the future, I'm certainly not going to spend like I'm expecting a raise, in fact, I started saving up, because we will need a cushion in hard times.

4. I don't see my pension fund, or my social security, as money.

A number of years ago, I was so excited about my state pension, that I "bought" five additional years of service credit, and sent the State thousands of dollars, so that I could either retire earlier, or have a bigger monthly retirement check. This was on top of the thousands that my school district already was sending back each month into "my" pension account.

Now, with all the news coming out about how all of the states are broke, and the pensions are underfunded, I don't think that any of "my" pension money will be there when I'm old enough to retire.

It's not "my" money anymore. I gave it to the State. It is gone. And I will probably never get it back.

So, I'm going to have to save for retirement myself, and not in a pension fund.

By the same token, with all the news about the national debt, and social security no longer paying for itself, I don't think that money will be there either.

The reports showing that most young people don't expect it to be there, well, that just confirms to me that it probably won't.

So, I'll need to start saving up more, on my own.

5. I don't see my 403(b), mutual funds, or stocks as money anymore.

At one time, we went to a "financial advisor" and agreed to set up a 403(b) investing in mutual funds. We believed that this was basically a sure thing, and sure, there might be dips and bumps, but it was definitely, DEFINITELY, better than keeping our money in a credit union savings account.

But, with the stock markets crashing over 50% from October 2007 to March 2008, I don't have any faith that my 403(b), or my wife's large 401(k), which she automatically contributes to each pay period, will be worth anything.

I don't even know how, or if, she could get out. Can she sell? I don't know.

If the market crashes, it may never recover, and most or all of that "value" will be gone.

So, we do not have that money for retirement either. Here, we have yet another incentive to save.

6. I don't think the banks are safe anymore.

I used to think that they were great places to put money, to save up, and at one point we had over a year's salary in our bank account. I suppose I thought that because I'd opened a passbook savings account when I was about 5 years old, and was always taught to save up for a rainy day.

Now, I see that the banks are being bailed out left and right, and that they are paying their employees huge salaries for doing nothing but draining money from the person on the street.

Lehman's failed. AIG failed. Northern Rock failed. Fannie and Freddie failed. And -most of- the rest are dead-men walking, "zombie" banks.

If any bank tried to sell all of its assets today, or even over the next month, or even the next year, (in the open market, that is), it would get far less cash back than what it owes to its depositors.

The banks are "insolvent". They are bank-rupt. But the government keeps on trying to "help them". Plus, more banks fail every single week. Here is the list.

When a local bank failed a few weeks ago, a bank which was flagged as "in trouble" on, and one that I had used as an example of a bank that would fail, well, when it failed, I FELT the failure.

Add to that the fact that the FDIC has used all of its money and is itself broke and is now relying on the government so that it can prevent a bank run.

And still more: I've learned that most banks only have as much actual cash as what is in the ATM machines and in the cash drawers. There are no piles of cash in the vaults.

Maybe, MAYBE, there is enough for a week or so of typical withdrawals, based on what they know people tend to take out in cash each week. But that amount is a tiny fraction, well less than 10%, of what the depositors believe to be in their accounts.

Finally, I've learned that depositors like us can only take out a certain amount of cash in a given day. At my credit union, the limit is $10,000 cash a day. At a smaller local credit union, the limit is $600 per day. If I had a lot of money "in the bank", I would not be able to get it out all at once.

All of these facts about banks combine to make me think that my deposits are not safe, and are not money in the same way as I used to think of them.

Obviously, I still think it is slightly safer, or more convenient, to have "money" in the bank, but only barely so. If I could figure out a way to save that money myself, and keep it safe from theft or fire, then I would only have as much in the bank as was necessary for paying bills.

7. I don't think of my gold coins as money anymore.

I used to think, when their prices were going up, that gold coins were so great, and a great investment. In fact, I bought in 2005, and now in 2010, those few coins have more than doubled in "value". There are websites galore that say "Buy Gold", and signs in shop windows that say "We Buy Gold", and everyone seems to think that "gold is REAL money".

But I've very recently realized that if there were a banking system failure, and people only had cash and gold coins to use as money, that the value of those coins would drop like a stone, because all the people that end up running out of cash would then be pulling out their coins to use as money, and this would happen all at once. The value of the coins would fall rapidly as they flooded the market, and my "doubling of value" would end up being "took a bath".

Interestingly, the American Gold Eagle 1-ounce coins do have a $50 mark on them. Perhaps they will not fall in value below that. That is some cold comfort with gold selling for over $1,200 per ounce right now.

The fact that I have them in the bank, and the bank could close at any minute, makes me less and less confident that I could use them as money. Also, the last time there was a major crash in the markets, back in 1929, the President of USA ordered all the safe-deposit boxes sealed, and all the gold coins confiscated and sold for a rate that the Government selected (See Executive Order 6102).

8. I don't think of our personal possessions as money.

I used to count the cars, the appliances, the electronics, the furnishings, the lawn tractor, even my clothes, as money. I could put them up for sale, and get a decent price, especially for the cars. In fact, I vaguely remember making a spreadsheet on the computer, listing all these sorts of things as part of my "net worth".

Now, everyone is starting to look broke.

There are tons of used cars on the market.

People only want things for free off FreeCycle or Craigslist.

My DVD collection isn't work $20 per DVD, like I used to figure. The video store chain in my area went out of business, and those same DVD's wouldn't even sell for $5.

I've been to some garage sales this year, and second hand stores, and arts and craft shows, and flee markets, and I start to recognize that most of this stuff is literally value-less, despite what it might have sold for in the past.

My personal possessions are no longer money.

9. I don't think I'll get any inheritance anymore.

For a couple of years, I received an "inheritance" check from my grandmother. Her stocks were doing well. Her house was increasing in value. She was healthy and happy. And this could have continued; I expected that, and I think my family did as well.

Now, my grandmother is in the medical care facility which costs thousands of dollars per month. The stocks had to be sold, and they had lost lots of value before that.

My grandmother's house has now been vacant for years, and the most recent attempt to sell it, for a new lower price, fell through.

I won't be getting any more checks. In fact, my wife and I have talked about saving up some money for my grandmother, in the case that she completely runs out, because her diminishing cash reserves are going fast.

And while I know that my parents are healthy and will live for another twenty or more years, I no longer see their house as increasing in value until then.

No, the values of homes are falling everywhere, and unlikely to even return to those 2006 levels. Historically, some housing bubbles have been so big that it has taken hundreds of years to return to the same level.

So, no "inheritance", which means even less money in the future.

10. I'm not spending money.

A while back, my wife and I made a nice long list of home improvements, trips we'd like to take, things we'd like to buy, and painted some pictures in the air of a fancy-dancy future: a new barn, a new carpet, a new hardwood floor, a new addition, a new fireplace, etc.

We aren't spending on those things because we think we need to have some extra money saved up, in the event that one or both of us lose our jobs, as we would need if for food, health care, taxes, and all those other bills.

We are saving. We are not spending, not really.

Everyone Is Doing It

If this story resonates with you, it is because parts of it resonate with all of us. We are the ones who have the capacity to spend, and yet, we save instead. We could increase the money supply by signing up for loans, and buying things, but we are not.

We are doing what anyone would do. The prudent thing. The logical thing. The responsible thing. The sensible thing.

But we are all doing this at the same time, including all of the businesses, and that is causing the money supply to shrink, day after day, and each new day makes us want to save more, and each new day we feel more that we need to get out, or stay out, or debt.

All of that money we are saving, those of us lucky enough to be able to save, that money goes into the banks, the same banks that are insolvent, and they can't get rid of it, because no one who is sensible will borrow it. They won't touch it with a 10-foot pole.

The banks -which are insolvent, with less in assets than they owe in deposits-, when they get in money, they have to find something to do with it, so they buy Treasury bonds, which "earn" the banks interest, and which are very safe bets. Contrast this with the choice of offering up subprime loans, or alt-A loans, or jumbo loans, or any of those. They aren't stupid. They know that they might not be able to sell those things anymore. They know those mortgages would be risky at best. They do the prudent thing and raise lending standards, and look elsewhere for profits.

"Go Out and Spend"

Savings in a bank, just like savings under the bed, are not being used to buy things, so it is as if that money did not exist. It has the potential to be money, but if it is not spent, then it can not be earned by someone else.

This lack of spending is slowing down the speed (velocity) at which money moves in the economy. It is the same as if there were actually less money.

Right now, both things are happening at once. The money supply, or credit supply, is shrinking because few loans are being created, and consequently, that money is not being used to purchase things AND the "velocity of money" is slowing because people are not spending at the rate that they once did.

Now, these two are really the same thing, what we're talking about is how much you are buying this year, as compared to, say, 2006. And not just you, of course, but everyone. And we're not just looking at "net income" paycheck money here, no, we're also looking at how much you, and me, and other people, are spending out of credit sources... whether they are increasing their debt load to buy things, like in 2006, or decreasing their debt load by paying off that debt, and not spending, like now.

Most important to this is that so many people continue to pay down the principle on their mortgages, while very few new mortgages are being created to make up the difference. The money goes into the banks, and never comes out.

As mortgages are paid down, the mortgage documents, also known as promissory notes, become worth less; their value as an asset is less.

An example: image that a person pays off $500 in principal on their mortgage. Now, that mortgage document is worth $500 less than the day before. If no one takes out a loan of at least $500 to replace that, then this $500 is gone from the money supply.

Remember that it is the total value of all the mortgages, the public debt, that determines the money supply.

As everyone is "getting out of debt", the money supply is shrinking.

Money is literally debt, in this peculiar economic model at least.

And as we all engage in this very, very, sensible, reasonable, logical paying down of debt, preparing for tough times, so too does everyone else, which means that people are spending less, so businesses are earning less, and then they have less to pay employees, and then those employees are either laid off, or their hours or wages are cut, so they can spend less, and then we see the unemployment report on the TV, and we all tighten our belt one more notch, and then we save a bit more, and we spend a bit less, and the businesses...

This is a vicious cycle which is self reinforcing. It is a positive feedback mechanism.

There is not a single thing that the political candidates, or the bank presidents, or the Federal Reserve chairman, or the Treasury secretary, or the President of the USA can do to make us stop acting sensibly.

What is deflation?

It is being sensible, all at once.

Boomers Threaten Economy
by Mark Whitehouse Wall Street Journal

America's baby boomers—those born between 1946 and 1964—face a problem that could weigh on the economy for years to come: The longer it takes for the economy to recover, the less money they'll have to spend in retirement. Policy makers have long worried that Americans aren't saving enough for old age. And lately, current and prospective retirees have been hit on many fronts at once: They have less money, they earn less on what they have, their houses aren't rising in value and the prospect of working longer to make up the shortfall has dimmed significantly in a lousy job market.

"We will have to learn to make do with a lot less in material things," says Gary Snodgrass, a 63-year-old health-care consultant in Placerville, Calif. The financial crisis, he says, slashed his retirement savings 40% and the value of his house by about half. Banks, home buyers and bond issuers are all benefiting as the U.S. Federal Reserve holds short-term interest rates near zero to support a recovery. But for many of the 36 million Americans who will turn 65 over the next decade—and even for the 45 million who have another decade to go— the resulting low bond yields, combined with a volatile stock market, are making a dire retirement picture look even worse.

Low yields present retirees with a difficult choice: Accept the lower income offered by safer bonds, or take the risk of staying in the stock market. Either way, their predicament could put a long-term damper on the consumer spending that typically drives U.S. growth. "If these rates stay as low as they are, then a lot more people are going to be hurting," says Jack Van Derhei, research director at the Employee Benefit Research Institute. The non-partisan outfit estimates that if current conditions persist, nearly three in five baby boomers will be at risk of running short of money in retirement. "There are going to be many luxury items that will simply have to be eliminated," for retirees to make ends meet.

Despite the market's rebound from the lows of 2009, nest eggs remain severely impaired. As of the first quarter of 2010, net household assets—homes, 401(k) plans, pension assets and other investments minus debts—stood at $54.6 trillion, down 18% from the end of 2007. That's an average of about $171,000 per person, much of which is concentrated in the hands of the wealthiest.

At the same time, the return people can hope to earn on their assets has fallen, particularly for those who switch into bonds or annuities to guarantee a fixed income. The average yield on U.S. government, corporate and mortgage bonds stands at about 2.4%, while stock-market valuations suggest a long-term return of about 6%. At those levels of return, some 59% of people aged 56 to 62 will be at risk of not having enough money to cover basic living and health-care costs in retirement, estimates Mr. Van Derhei. If market returns are higher—8.9% for stocks and 6.3% for bonds—the picture isn't a lot better: The percentage at risk falls to about 47%.

Before the recession hit, many economists assumed people would solve their retirement problems simply by staying in the work force longer. Now, "the recession has blown that idea out of the water," says Alicia Munnell, director of the Center for Retirement Research at Boston College and co-author of a 2008 book that advocated working longer. Older workers, who typically fared better than their younger counterparts in recessions, have been hit just as hard by layoffs this time around. As a result, the fraction of people 65 or older who are working has leveled off after a long period of growth. As of July, it stood at 15.9%, down from 16.3% in mid-2008.

With the overall unemployment rate hovering at 9.5%, many older workers have now found themselves at the back of the line to return to the work force. "Many employers seem to think it is not worth their time or effort to train me in a position," says Kathleen McCabe, 59, a former apartment manager in Tulsa, Okla., who has been out of work since April 2009. "They assume I will leave for retirement soon." The diminishing work prospects will require many older folks to make do with less—a discouraging outlook for firms hoping to sell them everything from restaurant meals to cars.

As of 2008, the latest data available, people aged 65 to 74 were spending 12.3% less than they did ten years earlier, in inflation-adjusted terms. They cut spending on cars and trucks by 46%, household furnishings by 35% and dining out by 27%. At the same time, they spent 75% more on health care and 131% more on health insurance.

The impact isn't limited to people on the verge of retiring. Younger people, too, will have to reduce consumption now to save enough money to get by in retirement. That's one reason Richard Berner, chief U.S. economist at Morgan Stanley in New York, estimates that even after the economy recovers, consumer spending will grow at an annual, inflation-adjusted rate of about 2% to 2.5% in the long term, compared to an average of 3.6% in the ten years leading up to the last recession.

Policy makers have more immediate concerns, such as how to create jobs for the nearly 15 million unemployed. The predicament of retirees, though, demonstrates how policy decisions—for example, on whether to stimulate the economy through interest rates or government spending—can have repercussions for many years to come.

Is a Crash Coming? Ten Reasons to Be Cautious
by Brett Arends - Wall Street Journal

Could Wall Street be about to crash again? This week's bone-rattlers may be making you wonder. I don't make predictions. That's a sucker's game. And I'm certainly not doing so now. But way too many people are way too complacent this summer. Here are 10 reasons to watch out.

1. The market is already expensive. Stocks are about 20 times cyclically-adjusted earnings, according to data compiled by Yale University economics professor Robert Shiller. That's well above average, which, historically, has been about 16. This ratio has been a powerful predictor of long-term returns. Valuation is by far the most important issue for investors. If you're getting paid well to take risks, they may make sense. But what if you're not?

2. The Fed is getting nervous. This week it warned that the economy had weakened, and it unveiled its latest weapon in the war against deflation: using the proceeds from the sale of mortgages to buy Treasury bonds. That should drive down long-term interest rates. Great news for mortgage borrowers. But hardly something one wants to hear when the Dow Jones Industrial Average is already north of 10000.

3. Too many people are too bullish. Active money managers are expecting the market to go higher, according to the latest survey by the National Association of Active Investment Managers. So are financial advisers, reports the weekly survey by Investors Intelligence. And that's reason to be cautious. The time to buy is when everyone else is gloomy. The reverse may also be true.

4. Deflation is already here. Consumer prices have fallen for three months in a row. And, most ominously, it's affecting wages too. The Bureau of Labor Statistics reports that, last quarter, workers earned 0.7% less in real terms per hour than they did a year ago. No wonder the Fed is worried. In deflation, wages, company revenues, and the value of your home and your investments may shrink in dollar terms. But your debts stay the same size. That makes deflation a vicious trap, especially if people owe way too much money.

5. People still owe way too much money. Households, corporations, states, local governments and, of course, Uncle Sam. It's the debt, stupid. According to the Federal Reserve, total U.S. debt—even excluding the financial sector—is basically twice what it was 10 years ago: $35 trillion compared to $18 trillion. Households have barely made a dent in their debt burden; it's fallen a mere 3% from last year's all-time peak, leaving it twice the level of a decade ago.

6. The jobs picture is much worse than they're telling you. Forget the "official" unemployment rate of 9.5%. Alternative measures? Try this: Just 61% of the adult population, age 20 or over, has any kind of job right now. That's the lowest since the early 1980s—when many women stayed at home through choice, driving the numbers down. Among men today, it's 66.9%. Back in the '50s, incidentally, that figure was around 85%, though allowances should be made for the higher number of elderly people alive today. And many of those still working right now can only find part-time work, so just 59% of men age 20 or over currently have a full-time job. This is bullish?

(Today's bonus question: If a laid-off contractor with two kids, a mortgage and a car loan is working three night shifts a week at his local gas station, how many iPads can he buy for Christmas?)

7. Housing remains a disaster. Foreclosures rose again last month. Banks took over another 93,000 homes in July, says foreclosure specialist RealtyTrac. That's a rise of 9% from June and just shy of May's record. We're heading for 1 million foreclosures this year, RealtyTrac says. And naturally the ripple effects hurt all those homeowners not in foreclosure, by driving down prices. See deflation (No. 4) above.

8. Labor Day is approaching. Ouch. It always seems to be in September-October when the wheels come off Wall Street. Think 2008. Think 1987. Think 1929. Statistically, there actually is a "September effect." The market, on average, has done worse in that month than any other. No one really knows why. Some have even blamed the psychological effect of shortening days. But it becomes self-reinforcing: People fear it, so they sell.

9. We're looking at gridlock in Washington. Election season has already begun. And the Democrats are expected to lose seats in both houses in November. (Betting at InTrade, a bookmaker in Dublin, Ireland, gives the GOP a 62% chance of taking control of the House.) As our political dialogue seems to have collapsed beyond all possible hope of repair, let's not hope for any "bipartisan" agreements on anything of substance. Do you think this is a good thing? As Davis Rosenberg at investment firm Gluskin Sheff pointed out this week, gridlock is only a good thing for investors "when nothing needs fixing." Today, he notes, we need strong leadership. Not gonna happen.

10. All sorts of other indicators are flashing amber. The Institute for Supply Management's manufacturing index, while still positive, weakened again in July. So did ISM's new-orders indicator. The trade deficit has widened, and second-quarter GDP growth was much lower than first thought. ECRI's Weekly Leading Index has been flashing warning lights for weeks (though the most recent signals have looked somewhat better). Europe's industrial production in June turned out considerably worse than expected. Even China's steamroller economy is slowing down. Tech bellwether Cisco Systems has signaled caution ahead. Individually, each of these might mean little. Collectively, they make me wonder. In this environment, I might be happy to buy shares if they were cheap. But not so much if they're expensive. See No. 1 above.

Secular Bears Tend To Be Long Events….
by TPC

Are you betting on the return of the buy and hold strategy?  You might want to think again.  The last three secular bear markets lasted an average of 17 tears….

An Important Note Of Caution

The Trade Deficit Nightmare
by Michael Snyder - Economic Collapse

en they hear the word deficit, most Americans immediately think of the U.S. government budget deficit which is rapidly spiralling out of control.  But that is not the only deficit which is ripping the U.S. economy to shreds.  In fact, many economists commonly speak of the "twin deficits" that are destroying the U.S. financial system. 

So what is the "other deficit" that they are referring to?  It is the trade deficit.  Every single month, we buy much more stuff from the rest of the world than they buy from us.  That means that every single month there is a massive outflow of wealth from the United States.  Every single day, America becomes just a little bit poorer as Americans continue to run out and fill up their shopping carts with cheap plastic crap from China and dozens of other emerging economies. 

Not that trade is a bad thing.  Trade can actually be a very good thing.  But the gigantic trade imbalances that the United States has been running for years are absolutely bleeding us dry.  Unfortunately, our politicians have just stood idly by as each month we continue to transfer massive amounts of wealth out of the United States.

The U.S. Commerce Department recently announced that the U.S. trade deficit increased by 18.8 percent in June to $49.9 billion.  Most analysts had expected the figure to be somewhere around 41 to 43 billion dollars.

In the month of June, imports rose to approximately $200 billion while exports fell to about $150 billion. So can we afford to have a net outflow of 50 billion dollars each and every month? Of course not.

We had so much wealth as a nation that we could afford to do this for a while, but the reality is that if this keeps up the rest of the world will eventually drain us dry.

So just how dangerous is the trade deficit?  Well, world famous investor Warren Buffett once put it this way....

"The U.S trade deficit is a bigger threat to the domestic economy than either the federal budget deficit or consumer debt and could lead to political turmoil... Right now, the rest of the world owns $3 trillion more of us than we own of them."

But very few Americans talk about the trade deficit. Why?

Number one, it is because our education system has become so dumbed down that most Americans (especially among the younger generations) do not even know what the trade deficit is.

Number two, most Americans are so obsessed with frivolous things such as American Idol, Dancing With The Stars, Lady Gaga and their favorite sports teams that they could care less about thinking about real issues.

But they should be thinking about foreign trade, because it is literally destroying the nation. What we have done is we have allowed the monolithic predator corporations that dominate our economy to slowly but surely move their operations to countries such as China and India where labor costs less than a tenth of what it does here.  In the process, executives at those predator corporations are earning huge "performance bonuses" while millions of hard working middle class Americans are losing their jobs.

It is time to wake up.  Have you ever wondered why it is so hard to find a decent job out there right now?  Well, there is a good reason.  The giant predator corporations have decided that they don't really need us anymore.

Once upon a time, great American companies provided great American jobs for great American workers.  We created the biggest middle class in the history of the world and great industrial cities like Detroit, Michigan were the envy of the world. But have you been to Detroit lately? One of the greatest cities in the United States has become a hellhole.  The mayor says that nearly half the people there are out of work.

So what happened? Did the giant corporations who used to make stuff in Detroit stop making stuff? No, they are still making lots of stuff. They just aren't making their stuff in Detroit anymore.

Now, the truth is that it is really easy to jump on Detroit.  It is a city that has been mismanaged for decades.  But Detroit is far from alone. All throughout the "rust belt" you can find other Detroits.

At this point many of you may be thinking that people living in places like that should just move. That may be good advice, but the truth is that what has happened to Detroit is going to be happening everywhere.  It is going to come to your own neighborhood soon enough.  The giant predator corporations are going to continue to try to outsource and offshore every job they can.

Your job may be next. Perhaps you should start learning about the trade deficit. Perhaps you should start asking your representatives about it.

Just look at what all of this "free trade" and "globalism" did to our trade deficit between 1991 and 2005.....

Are you troubled by that chart? You should be. The U.S. economy is bleeding and the top politicians from both political parties act as if they could really care less.

What do you think is going to happen if tens of billions of dollars continue to pour out of the United States month after month after month? The economic prosperity that we have all been enjoying is not guaranteed to last forever.

The system of world trade that has developed over the past few decades has provided us with gigantic mountains of cheap plastic crap, but it is not a good system for America or for middle class American workers. Someday we will look back in horror at how incredibly stupid it was to ship our manufacturing base, our jobs and our prosperity to China.   

But the American people have made their choices.  They allowed the politicians to convince them that NAFTA, GATT and the WTO would be wonderful things for Americans. They didn't listen to the warnings about what would ultimately happen to our jobs and our economy. They didn't take the time to get educated about foreign trade and the exploding trade deficit.

So now we all get to pay the price.

US and China to clash over yuan fall
by Ambrose Evans-Pritchard - Telegraph

China is on a collision course with Washington after steering its currency sharply lower to protect its export industries, despite a near record trade surplus of $29bn (£19bn) in July. The yuan dropped at the fastest pace in almost two years last week and is now 1.8pc lower against a basket of currencies than in June, when Beijing announced the end to its fixed peg against the dollar. Western economists had seen yuan liberalisation as a sign that China is abandoning its mercantilist policy in a step-by-step move towards a floating currency, which was expected to rise. They misjudged China's motives badly.
Beijing still controls the yuan, so last week's drop reflects a policy decision. It is certain to infuriate hawks in Congress, who have called a hearing on China's currency in mid-September. Sander Levin, chair of the House Ways and Means Committee, said the US may have to consider retaliatory sanctions. "We must ensure that the international trading system ensures fair rules of competition. There is no real question that China's deliberately undervalued exchange rate is unfair, contributes to global trade imbalances, and costs the US jobs," he said.

Many on Capitol Hill suspect that China fiddled trade data with a "one-off" deficit in March when the Obama administration was preparing its verdict on whether Beijing is a currency manipulator. The fact that China is willing to defy the wrath of Congress may indicate the degree of concern in Beijing over the sudden slowdown in the Chinese economy as credit curbs bring the property boom to a shuddering halt. Industrial output has slowed abruptly.

Jim O'Neill, chief global economist at Goldman Sachs, said China's exchange policy was becoming a concern. He described its as "most odd" for Beijing to weaken the yuan at a time when US data has been weak and China's trade surplus has reached the highest in 18 months. "It is not a great week for those of us who believe the big era of US-Chinese global imbalances is behind us."

Tension between the US and China is escalating on several fronts. China has restricted exports of rare earth minerals by more than 70pc in the second half of this year, cutting off the world supply. China produces 97pc of these minerals, used in a wide range of high-tech industries, from hybrid engines to computers, mobile phones, radar, navigation and precision-guided weapons.

The US is to conduct naval manoeuvres with Vietnam in the South China Sea in response to live fire exercises by China, which has stepped up its claims to total sovereignty over a region disputed by a ring of countries. The US is also conducting manoeuvres with South Korea, prompting accusations of "gunboat diplomacy" in the Chinese media.

US cities face up to massive cuts
by Andrew Clark - Guardian

Flanked by two silver balloons bearing the words "I love you‚" and a forlorn blue cuddly toy, the face of 12-year-old Frank Marasco smiles out from a collage of pictures assembled by shocked neighbours on the veranda of his burned-out home. The young autistic boy died in a fire last week thought to have been sparked by a discarded cigarette.

The inferno should have been a routine job for Philadelphia's 1,900-strong fire brigade, the fifth biggest force in the US which handles four major incidents daily. But the nearest fire station to Frank's house, just two blocks away, was unavailable after a so-called "brown out". Firemen at the station, barely 90 seconds' walk from the site of the fire, were on a maintenance run after a 12-hour shutdown, part of a rota of rolling daily closures imposed by city authorities grappling with a wrenching deficit of $2.4bn (£1.5bn) over five years.

"Everybody was running around trying to get the little boy out – he was stuck on the second floor," said a distraught neighbour, Virginia DeShields, whose house was damaged by smoke. She believes the boy might have been saved if the local firehouse had been open: "It's all right if you want to cut. But you shouldn't cut where lives are concerned. You can cut the prison system, cut the libraries, anywhere. But don't cut people who save lives."

Philadelphia's city authorities contend that first responders reached the scene within three minutes – a timeline disputed by Philadelphia's fire union, Local 22, which says it was closer to six minutes before an engine with hoses and water arrived. But irrespective of whether he could have been saved, Frank Marasco's fate is a rallying point in a titanic struggle over cuts engulfing cities and states across the US which are taking desperate budgetary measures, ranging from shutting schools to switching off streetlights and replacing tarmac roads with dirt tracks.

Local government in the US has traditionally been leaner than its British equivalent, with minimal public healthcare, patchy public transport and an ingrained culture of contracting out to private operators. The worst recession since the war has caused a triple-pronged slump: unemployment has eroded income tax takings, a dive in house prices has hurt property tax and weak consumer spending has reduced sales tax. Funding is stretched to breaking point.

The National League of Cities estimates that US municipalities, which had revenue of $398bn last year, face a fiscal hole of between $56bn and $83bn over the two years to 2012. States, which fund broader services such as schools, prisons and highway patrols, are in a worse jam — they grappled with a $192bn shortfall in 2010, equivalent to 29% of their budgets, according to the Washington-based Centre on Budget and Policy Priorities. "We're seeing drop-offs in revenue that are breaking all records," said John Shure, deputy director of the CBPP's state fiscal project. "The irony is that people's needs are going up but the resources to meet them are going down."

Putting up taxes in a recession is politically unpopular and risks hampering a recovery. And borrowing money is not an option as most US local authorities are prohibited from going into debt. Shure says: "They're required by their own constitutions to have a balanced budget. There's no good answer."

The draconian nature of some cuts would cause even Britain's austere chancellor, George Osborne, to blanch. In Georgia, the county of Clayton, which encompasses down-at-heel suburbs south of Atlanta, axed its entire public bus service to save $8m, leaving 8,400 daily riders high and dry. Faced with a hole in its education budget, Hawaii's Republican governor simply shut down the state's schools on Fridays, moving teachers and pupils onto a four-day week.

Struggling to pay for upkeep of asphalt roads, counties in Michigan and South Dakota have been converting paved country roads to gravel, turning back the clock of modernisation. Then there are trivial, yet eye-catching examples — Miami has dispensed with the services of its chicken catcher. The California city of San Diego disbanded its 27-year-old mounted police force. The state of Washington scrapped its board on geographic names, deciding it could do without a body overseeing the historical and cultural consistency.

Colorado Springs, a city of 360,000 people on the edge of the Rocky Mountains asked voters to approve a tripling of property tax in November. They voted no. So the city switched off a third of its streetlights, removed litter bins from parks, put its police helicopters up for auction online and halted many bus services at 6.15pm. City employees have been asked to stump up more for their own healthcare, while community centres and pools are looking for private money to stay open. Residents of Colorado Springs are being encouraged to bring their own lawn mowers to trim the grass in public spaces. And anybody who strongly wants lighting can "adopt a streetlight‚" for $75 a year.

Barack Obama this week signed a federal aid package of $26bn for cash-strapped states, some of which will filter through to cities. But many argue this is not enough. Christiana McFarland, an expert at the National League of Cities, says: "Local authorities are in a serious situation at this point. In years past, we've been down to the bare bones in terms of budget. They're now cutting critical services such as public safety."

Back in Philadelphia, deputy mayor Everett Gillison says it is a "lie" that fire station "brown outs" compromise safety, blaming unions for a cynical campaign to protect overtime. But in a nation where firefighters are held in the top echelon of public esteem, the spectre of darkened firehouses is prompting anger. "That's right – you take pictures of it!" yelled resident Darren Braxton, pulling up in his car as the Guardian visited a shuttered fire station.

Braxton, a maintenance contractor, had some advice for the city authorities: "If you're trying to save money, do something else. You don't mess with the trash men because we'll become Filthadelphia. You don't mess with the police because young people round here don't value life and they be shooting people left, right and centre. And you don't mess with the firefighters because they put out fires."

Big chunk of economic stimulus yet to be spent by state, local governments
by Alec MacGillis - Washington Post

As Americans puzzle over why the economic stimulus package enacted more than a year ago has failed to restore vigorous job growth, one explanation has emerged from new reports: A lot of the money is not yet out the door. Detroit is struggling with 14 percent unemployment, but as of June 30 the city had spent less than 1 percent of the $8.8 million in stimulus funds it received for energy-efficiency initiatives. In budget-strapped Arizona, Phoenix has spent even less of its $15.2 million, and in hard-hit South Florida, Fort Lauderdale has spent $66,000 of its $2 million.

The $862 billion package was divided roughly in thirds among tax cuts, aid to states and the unemployed, and investments in infrastructure, health care and other areas. The first two have delivered most of their boost, but much of the investment spending is moving far more slowly. At the end of July, nearly 18 months after the stimulus passed, more than half of the $275 billion in investments had yet to be spent.

Underlying the slow pace is a defining tension: Officials want to get money out the door to jolt the economy but want to spend it carefully enough to meet long-term policy aims -- and avoid headlines about waste or fraud. "This is federal money we are stewards of, and we have to make sure we're spending it well," said Eric Coffman, senior energy planner for Montgomery County. By the end of June, the county had spent none of its $7.6 million in energy-efficiency funds. "Spending fast is not the only thing in the world. We want to make sure we get results."

Administration officials say the stimulus remains on schedule, with 70 percent expected to be spent by Sept. 30. And some economists note that the sluggish economy will still need a boost until 2012, the deadline for spending most stimulus cash. "Some stuff is taking a longer time to have an impact, but we still have over 9 percent unemployment," said John Irons of the Economic Policy Institute. "The fact that we still have dollars coming on line now should not be seen as a negative."

Many of the unspent funds lie in programs portrayed from the outset as true long-term investments, such as $8 billion for high-speed rail, $17 billion for health information technology and $10 billion for the National Institutes of Health. But other programs that had been viewed as quicker job-generators are also taking a while to get rolling.

'Green jobs' programs
Take, for instance, three programs meant to improve energy efficiency and produce "green jobs." The $5 billion program for weatherizing low-income homes is recovering from a slow start as officials wrestled with rules on wages and historic preservation, and as providers struggled to expand capacity. Only 3,000 homes were weatherized last summer, a sliver of the program's goal of 600,000 by March 2012. The pace has picked up, with 25,000 now being weatherized monthly. Still, barely a quarter of the funds were spent by the end of last month.

Moving more slowly are two other energy-efficiency initiatives, one for states and one for cities and counties. Of their combined $6.3 billion, $556 million had been spent by the end of July. Officials note that some of the remaining money is already at work but that states and cities will not pay out until projects are done. In the Washington area, Prince William County, with $3.2 million, had not spent any money by June 30, while Arlington County had spent only $4,000 of its $2 million. Fairfax County had spent $236,000 of its $9.6 million and Loudoun County $239,000 of its $2.2 million. Prince George's County passed much of its $6.6 million to towns, but many had yet to spend it.

Virginia, which is investing much of its energy-efficiency money in biomass energy production, had spent $10.2 million by the end of June -- a fraction of its $70 million but enough to put it in the top five nationally. Maryland has spent 10 percent of its $51.8 million but says it has millions more at work in retrofitting apartments. As of June 30, the District had spent $373,000 of its $22 million in state-level funds -- enough for a few TV ads and billboards promoting its tax on plastic bags -- but officials say millions more are being put to work modernizing schools. The District also received $9.6 million in city-level energy-efficiency funds; as of June 30, it had passed along $1.5 million, mainly to nonprofits. It says more will be spent on retrofitting fire stations and libraries.

The slow spend-out seems incongruous considering how desperate state and local governments are for funding; on Tuesday, the House passed $26 billion in aid to states to prevent additional layoffs of public employees. But most stimulus programs must be used for specific purposes, not to plug budget holes. Many local and state governments say budget troubles have left them short-staffed, slowing their stimulus spending, though several have used some of the money to hire managers to oversee their spending. Louisiana is paying a company $5.7 million to handle its entire $85 million in energy-efficiency spending.

Mix of projects
After waiting for Energy Department guidelines last year, state and local officials spent months deciding how to use their funding. They opted for a mix of retrofits of public buildings; installation of low-energy streetlights and traffic lights; rebates for solar installations or insulation upgrades by residents and businesses; and workforce development. Some of the projects are less jobs-intensive than others. Loudoun, like many counties, is spending heavily on an energy audit by a consulting firm. Fairfax is investing in making its computer systems more energy efficient.

The plans then went to the Energy Department, which decided, among other things, whether projects needed a full environmental review. The department told Florida that several of its proposals did not pass muster, and until recently the state was still unsure how to redeploy $12 million. Fairfax was told that a proposal to replace windows conflicted with historic-preservation rules. And Alexandria, along with many other cities, has run up against Fannie Mae and Freddie Mac objections to a program that would let homeowners pay for energy-efficiency upgrades over time by attaching the cost to their property tax bill.

Now that the Energy Department has approved most plans, cities and states must still put projects out to bid and draft agreements with local partners. Matt Rogers, who is overseeing the Energy Department's stimulus spending, said he hoped monthly spending by both the state and city programs would soon reach $100 million, up from $60 million in July. Local officials also promised a surge. "The good news is that there will be a lot of spending in September. You'll see money being spent in big chunks," said Matt Groff, who is managing Prince William's grant. "Although it's taken a little while to get off the ground, there'll be less mistakes than there could've been if they were quick to approve early on."

CPI Has Nothing To Do With Deflation Risk
by David Goldman - Asia Times

Bloomberg reports that the first rise in CPI in four months has reduced fears of deflation. This is silly. Between 2000 and 2008, the Federal Reserve ignored the bubble in home prices because rents failed to rise, and CPI measures rent (or home rental equivalent) rather than home prices.

Now that home prices have collapsed, and homeowners are being turned out of their dwellings, rents have stabilized, because fewer people can buy houses and must rent instead. This is the consequence of a 22% all in unemployment rate. The only thing that has reflated during the dead-cat bounce that earlier masqueraded as recovery was the corporate profit picture, achieved largely through cost-cutting (more unemployment) or financial manipulation by the Fed, which handed banks the steepest yield curve in history.

Asset markets, though, reflect considerable deflation risk. A preference for cash and fixed-income assets over brick and mortar is a statement that physical assets are more likely to be cheaper in the future. There is a huge demographic tailwind behind fixed income markets, as I mentioned on the Kudlow Report Wednesday evening. The population  is aging rapidly: between 2005 and 2020, the proportion of Americans aged 60 and over will rise from 16.7% to 22.8%, according to UN data. For "more developed regions," the increase will be from 20% to 28%. That generates a huge demand for savings instruments. And that is inherently deflationary: aging savers buy future goods (securities) rather than present goods.

When the whole world wants to lock in fixed-income cash flows rather than buy physical assets, the income of pensioners also must fall. The rise in stock prices bespeaks a willingness to accept lower returns over time, as the fixed-income alternative pays less. This compels prospective retirees to save even more, in a self-feeding cycle. That in a nutshell is Japan in the 1990s.

Absent a fiscal reform that provides incentives to entrepreneurs to shift into physical assets, the Japan scenario is likely. There’s no more striking sign of deflation than private equity and real estate funds turning money back to investors. If the fund managers can’t find projects worth buying (which pay them handsome fees), it’s likely that corporate managers can’t either.

Economic fears rise as disappointing figures pile up
by Walter Hamilton and P.J. Huffstutter - Los Angeles Times

The U.S. economy and stock market ended one of the grimmer weeks of the year, as disappointing retail sales figures released Friday combined with other dismal data to heighten fears that the nation's nascent recovery is stalling. The retail report, which came only days after the Federal Reserve announced a new effort to prop up the economy, fueled growing concern that the U.S. is in danger of falling into a double-dip recession.

Rising anxiety was apparent worldwide this week. U.S. unemployment claims ticked up. The Chinese economy, a steady consumer of U.S. and global exports, showed signs of cooling. The Bank of England cut its economic growth estimates for Britain through next year, citing planned government budget cuts to reduce deficit spending. And investors huddled into the perceived safety of U.S. Treasury bonds even as yields skidded to a 16-month low.

Most economists believe a dip back into recession — as well as an equally debilitating bout of deflation, or broadly falling prices — will be avoided. But many have nonetheless warned that the prospects are rising, and say the more probable scenario isn't much more appealing: a protracted economic malaise with imperceptible growth and stubbornly high joblessness. "We are mired in a jobless recovery, and the government has run out of ammunition to help out the economy," said Sung Won Sohn, an economics professor at Cal State Channel Islands. "The current situation doesn't look very good."

The data come at a time when lawmakers in Washington are bickering over the need for — and affordability of — a second stimulus package. Last year's $787-billion stimulus is widely credited with preventing a far sharper downturn. But the spending programs it financed are winding down, and cash-strapped local governments nationwide have been resorting to layoffs and other cost-cutting measures.

The consternation has shown in the stock market, where the Dow Jones industrial average fell for the fourth day in a row Friday and ended the week down 3.3%. The blue-chip indicator has dropped 8% since its recent high in late April. Investors are worried that the inability to boost employment at this point in the recovery will constrain consumer spending and ultimately weigh on corporate profits. Corporations have notched impressive earnings over the last year and are sitting on large cash reserves. But much of their bottom-line improvement has stemmed from cutting costs rather than an upswing in demand.

"They've really chopped costs down, but now we're seeing a slowdown in revenue growth, and people are saying, 'How are they going to drive profits higher in that environment?' " said Brian Bethune, an economist at IHS Global Insight in Lexington, Mass. Investors have fled to Treasury bonds. The yield on the benchmark 10-year T-note slumped to 2.68% Friday from nearly 4% in early April. That's welcome news to potential home buyers, as it helped drag the rate on a 30-year fixed-rate loan this week down to 4.44%.

Even so, the Fed took a step Tuesday to bolster the economy by announcing that it would resume buying Treasury bonds, a program it launched in 2009 to help bring down long-term interest rates. It was largely a symbolic gesture, given the vast size of the government-bond market. But the upshot was unmistakable: The central bank wants to show it is standing sentry against the risk of a double dip.

Economists with Goldman Sachs Group Inc. said in a report that a double dip is unlikely, but nevertheless pegged the chance of one at 25% to 30%, which it termed "unusually high." Those fears were aggravated by the retail-sales numbers. Though the Commerce Department reported a 0.4% rise in sales in July, the improvement was due entirely to rising gasoline prices and pent-up demand for cars. Sales would have fallen 0.1% without those items.

Feeling the pinch is Cinema Secrets, a family-owned store in Burbank that sells theatrical supplies and cosmetics. As times grew tough, makeup and holiday costumes became unaffordable luxuries for many households. The store's sales are about half what they were two years ago, according to owner Maurice Stein. In far better times, the 76-year-old would be hustling to prepare for Halloween, stocking his shelves with faux broken bones, Frankenstein neck bolts and bottles of fake blood. This year he's trimming orders. His financial ledger is the scariest thing in the store.

"This is supposed to be our busiest time of year," Stein said. "If we're only down 35%, I'd consider that good news." He hasn't been able to pay his three children — who help him run the shop — in a year. Two have lost their homes to foreclosure. Stein's daughter has moved back home: Living with her parents was the only way for her to stay afloat. They all rely on Stein's Social Security checks and credit cards to pay the bills.

"The government talks about helping businesses, but we're not seeing one benefit of anything they're doing, and neither are my friends and neighbors," Stein said. "We knew that the economy was bad. We never expected this to go so long."

Some business owners said that when the economy seemed to be on the mend earlier this spring, they'd expected a rosier fall. But Pattiy Knox, who owns the North Hollywood fitness center BodyImage, said business was sluggish at best. The center, which specializes in personal training, saw its sales drop 27.2% in 2009 and struggle to remain flat this year, she said. Knox and her husband, Steve Saucedo, have tried everything they can to keep customers returning to the gym. They've cut the $80 monthly membership fee to $25 and reduced the $12 fee trainers pay to use the equipment. They promote their business through word of mouth: The advertising budget evaporated long ago.

"I keep thinking, 'I'm underwater and I can see the surface. If I can kick a little harder, we're going to be OK,' " Knox said. "But I've been kicking hard for a long, long time. The reality is, if people have money, they're not spending it. And if they're not going to spend it, there's not much you can do."

Growth angst drifts back to U.S. shores
by Pedro Nicolaci da Costa - Reuters

After worrying about Europe for several months, economists are now turning their focus back to the United States, where high unemployment and a historic housing slump just won't go away. The U.S. economy appears mired in a troubling limbo, not weak enough to signal an imminent downturn and not sufficiently sturdy to give businesses confidence to begin hiring again.

The latest economic data highlights the shifting fortunes on either side of the Atlantic, with a robust Germany propelling the eurozone as the U.S. outlook looks bleaker. A sharp widening in the U.S. trade deficit has forced economists to revise down estimates for second-quarter growth, indicating the slowdown has come even more quickly than pessimists expected.

"It's somewhat ironic but significant that the U.S. slowdown appears to have been triggered by debt concerns in Europe and in the end European growth is showing a pick-up," said Jim O'Sullivan, chief economist at MF Global in New York. "The question we're left with now is, 'Did this turmoil just set back or really short-circuit the recovery?'"

Answers were not forthcoming, but data over the coming week should help steer forecasters in the right direction. Among key releases are industrial production for July and, even more timely, the Philadelphia Fed's survey of regional manufacturing activity. Both are expected to show further firming, with output for U.S. industry projected to have climbed about 0.5 percent.

Ground-breaking on new homes, which after a four-year slump is now at under a quarter of its boom-time peak, likely stabilized at around a 560,000 unit annual rate after some see-sawing related to the expiration of housing tax credits. Steadfast weakness in housing, along with a stubbornly high unemployment rate of 9.5 percent, were some of the factors that last week led the U.S. Federal Reserve to try to offer even more monetary stimulus to the economy.

The Fed said it will funnel cash from maturing mortgage-backed securities it acquired during the financial crisis into further purchases of Treasury bonds in an effort to keep long-term rates low and spur more lending. The U.S. central bank's policy has inadvertently created headaches for the Japanese government, which is trying to figure out what to do about an ever strengthening yen that threatens to derail the country's already-meek recovery. Japanese Prime Minister Naoto Kan and Bank of Japan Governor Masaaki Shirakawa may meet as early as next week to discuss the matter, though policy options are seen as limited.

One Currency, Two Speeds
Even Europe's improving fate is not without its caveats. The countries at the center of the debt worries that generated global market turbulence in the spring, like Greece, Ireland and Spain, all fared pretty dismally in the second quarter. This puts even more pressure on Germany to maintain a growth rate strong enough to pull other eurozone members along. On Tuesday, investors will get a look at the ZEW economic sentiment survey, which took a steep dive as the European crisis heated up. It is expected to hold just about steady at a respectable reading of 21.

But Germany is simply not large enough to go it alone. Without a healthy U.S. expansion, say analysts, Europe's prospects would likely sour as well. In the United States, few indicators are as important as jobs. Unfortunately, weekly applications for unemployment benefits spiked again last week to 484,000, the highest level in nearly six months. This and other red flags have prompted Goldman Sachs economists, among the more bearish on Wall Street, to predict a 25-30 percent chance of a much-feared double-dip recession.

Any hint that they are right could trigger further action from the Fed, which signaled with last week's move that it would not sit idly by as the economy loses momentum. Further clarity on the outlook for monetary policy could come from a pair of Fed speeches this week, particularly remarks on Thursday by St. Louis Fed President James Bullard. Bullard made waves late last month when he presented a paper to reporters arguing that the United States was at risk of Japanese-style deflation and that the Fed's commitment to keeping interest rates very low for an extended period might boost, rather than lower, that threat.

U.S. Home Resales Due for New Low, Citigroup Says
by David Wilson - Bloomberg

Home resales in the U.S. may have tumbled to a record low in July as the expiration of federal tax credits dragged down the housing market, according to Josh Levin, a Citigroup Inc. analyst who follows homebuilders. The Chart Of The Day shows how his estimate for last month, an annual rate of 4.1 million units, compares with the monthly totals since the National Association of Realtors consolidated sales figures for single-family homes and condominiums in 1999.

Levin’s projection -- a departure from his usual research, he wrote yesterday in a report -- is about 10 percent below the current low. Sales of existing homes hit bottom in November 2008 at a rate of 4.53 million, matched in January 2009. The estimate amounts to a 24 percent plunge from June’s pace of 5.37 million. Investors don’t appear to anticipate a new low, he wrote, even though the association’s data on pending home sales point in that direction. Its sales index fell 30 percent in May after an $8,000 tax credit available to first-time homebuyers and a $6,500 credit for repeat buyers lapsed. July resale figures in 15 local areas confirm the outlook, he added.

This means a disappointing report would pose an "unusually elevated" risk for homebuilding stocks, Levin wrote. While the analyst affirmed a favorable view of the industry, partly because home resales are a lagging indicator, he added: "Investors who disagree should consider our prediction and position themselves accordingly." Two out of three economists who provided existing-home sales estimates to Bloomberg yesterday predicted the July rate, set for release on Aug. 24, will exceed the record low. Ward McCarthy of Jefferies & Co. called for 5.4 million and Action Economics LLC’S Michael Englund put the figure at 4.75 million. Wrightson ICAP, on the other hand, expects a 4.3 million pace.

FHA Gets Tougher on Mortgages
by Jennifer Waters - Wall Street Journal

Consumers looking for home loans backed by the Federal Housing Administration will face tougher hurdles and higher costs under new legislation and new rules that could take effect as soon as this month. Higher monthly fees, larger down payments and better credit scores are among the new initiatives intended to ensure that the FHA stays solvent. Its reserves, which are used to cover bad loans, plummeted to $3.5 billion at midyear from $19.3 billion in September 2008, according to a report from the FHA's parent, the Department of Housing and Urban Development.

Proponents of the measures applaud the FHA's efforts to preclude the need for a taxpayer bailout, while also stepping up the quality of its insurance portfolio. But critics fear that the moves will stifle an already sluggish recovery in housing and will be most burdensome on first-time home buyers who rely most on the FHA insuring their loans. The FHA backs 30% of all loans outstanding and is on track to insure 1.7 million loans by the end of its fiscal year Sept. 30, according to its recent quarterly report to Congress.

"This wouldn't be such a big deal if the economy was going well and houses were moving quickly," says Gibran Nicholas, chairman of CMPS Institute, which trains certified mortgage-planning specialists. "But when you're talking that the majority of buyers out there are first-time home buyers using FHA financing, now it begins to make a pretty big impact."

Here's a rundown on some of the initiatives:

Higher monthly fees. Earlier this month, Congress gave the green light for the FHA to raise the monthly premium it charges on loans; a presidential signature is expected. FHA-backed loans have looser restrictions than other mortgages on down payments -- now at 3.5% of the home's selling price -- but require borrowers to pay an upfront fee and a monthly fee. The legislation allows the FHA to hike the monthly fee to as much as an annualized 1.5% of the loan balance, up from 0.55%, though initially it will go only to 0.9%.

The initial fee was increased earlier this year to 2.25% from 1.75%, though the FHA has said it will bring it down to 1% with the higher monthly fee. Even with the decrease in the upfront fee, increasing the continuing fee is expected to generate $300 million per month, "which would replenish FHA's capital reserves much faster than is possible under the premium authority" now, according to the quarterly report.

Better credit scores. In its 76-year history, the FHA has never required a credit score from borrowers, though the lenders typically have. That would change under a proposed rule that the FHA is expected to adopt. The FHA would require borrowers to have at least a 500 score for FHA backing. At 580 and above, borrowers would be eligible for the 3.5% down payment. But those who fall between 500 and 580 would see their down payments jump to 10%.

That, however, is still well below scores of 660 to 720 that most lenders look for to accept only a 10% down payment. "No lender is going to do that loan for a borrower with a 580 score and only 10% down," says Christopher Gardner, chief executive of FHA Pros, an FHA approval service. For the FHA, "this change is dramatic," the quarterly report said. Among borrowers with scores below 580, loans 90 days in arrears, what FHA calls "seriously delinquent," have been three times as high as those for borrowers with scores above 580, the FHA said. Of the total FHA loan portfolio, some 6% are to borrowers who had scores below 580 at the time of origination, FHA Commissioner David Stevens told a House subcommittee in March.

Cutting sellers' contributions. This is the change that may have the biggest impact on borrowers, because it could nearly double their total upfront costs from just the required 3.5% down payment to a total 6.5%. Sellers have been able to contribute up to 6% of the price of the home toward the buyer's purchase. That was often done by paying some of the closing costs, such as the upfront FHA fee and other fees, amounting to about 3% of the purchase price. Sellers might also agree to pay for some needed repairs, sparing the buyers that expense.

As part of its proposed rule changes, the FHA wants to slice the seller's contribution to no more than 3%, which CMPS Institute's Mr. Nicholas says ups the buyer's ante to 6.5%. "Why [should] the home be less affordable to the buyer under the new rules," Mr. Nicholas asks. The FHA contends that this change will weed out sellers who artificially inflate the sales price to create the concession. It also will bring FHA in line with industry standards, according to

These are just the latest in a string of new policies that the FHA has imposed in the last few years and that could lead to substantially fewer buyers looking for the FHA insurance, turning instead to Fannie Mae or Freddie Mac programs. "Many of these reforms were long overdue as FHA did not respond effectively to changes in the marketplace that happened during the housing boom and the subsequent decline," Mr. Stevens told Congress.

Legislative battle on horizon for future of Fannie and Freddie
by Ronald D. Orol - MarketWatch

Now that the most sweeping financial reform bill since the Depression is law, Washington is finally getting around to dealing with the hard part: Fannie Mae and Freddie Mac. But even as the Obama administration prepares for an Aug. 17 conference on the U.S. housing finance system, lawmakers on Capitol Hill are preparing to battle each other and the powerful housing lobby over the future of the mortgage-finance giants.

The goal of the conference is to come up with a system that would win the support of enough lawmakers on Capitol Hill to pass while also ensuring a fully functional housing market that doesn't rely on taxpayer backing -- even in a severe economic downturn. It's a tall order. Many Republicans want to fully privatize the two entities altogether, while numerous Democrats want to enshrine a permanent government agency -- or agencies -- to buy and sell mortgages and mortgage securities.

"Conservatives are saying the government should be out of the business altogether and they should be privatized to compete in the private market," said Bob Kuttner, senior fellow at research and advocacy group Demos in Washington. "Democrats say if the government is going to run it, it should be a government agency and have set standards." Treasury Secretary Timothy Geithner is seeking a middle ground where the government would continue to offer some type of federal guarantee of mortgage loans to ensure that U.S. borrowers can easily finance the purchases of homes. But he has yet to provide specific details.

Among the obstacles for any agreement are the mid-term elections, fresh fears that the economy will fall back into recession, and the still precarious state of the housing market fully two years after the onset of the credit crisis. Still, the administration is working to develop a proposal with the aim of delivering it to Congress by early next year.

Crucial players
Practically all new U.S. mortgages are guaranteed by Fannie Mae and Freddie Mac and the Federal Housing Administration. Since the credit crisis began the Federal Reserve has purchased $1.1 trillion in agency mortgage securities as a means of propping up the market and keeping loan rates low. As the financial crisis intensified in September 2008, Fannie and Freddie were essentially nationalized to avoid losses and stem the credit contagion. They were taken over by the government in a conservatorship. Roughly $145 billion in taxpayer funds have been used to cover their losses.

Before their downfall, Fannie and Freddie were hybrid government-sponsored quasi-private entities that purchased whole mortgages, mortgage securities and asset-backed securities from banks and other direct lenders, packaged them, and sold them back to private investors as mortgage backed securities. The system was designed to ensure that adequate capital was available to banks and other financial institutions that lend money to home buyers.

However, starting in the 1990s Fannie and Freddie dramatically raised the risk they took on their balance sheets, and eased their underwriting standards, at the behest of lawmakers seeking to make home ownership possible for less qualified Americans. Their expansive purchases -- along with risky loans taken on by private mortgage investors -- helped drive the subprime boom and bust that took the economy to the brink in 2008.

Partial consensus
Despite the divergent views, lawmakers actually are moving towards agreement that Fannie and Freddie should stop borrowing heavily from the capital markets. "There is a broad bipartisan mood to get rid of their portfolio activities and that was impossible seven years ago," said Mark Calabria, director of financial regulation studies at the CATO Institute in Washington. "The ground has shifted a lot."

Instead, Geithner and other Democrats seem to be moving in the direction of turning Fannie and Freddie into much smaller entities that buy individual mortgages, pool them and sell them back into the market to private investors who would pay a fee for a government guarantee of the security, argues Ted Gayer, fellow at the Brookings Institution in Washington. It's that guarantee that lies at the heart of the debate over Fannie and Freddie's future.

Republicans who don't back a fully private market are likely to push for a government guarantee that is available for any corporate mortgage investor packaging loans, not just Fannie and Freddie. "Are you going to say these are government agencies that package mortgages and sell them with a guarantee or are you let the government sell a guarantee to any institution?" Gayer asked.

Without such a guarantee, selling mortgage backed securities will be harder, if not impossible, and the flow of capital into the housing market will falter, crushing housing values again. Calabria added that some sort of government guarantee is likely because of the influence of the housing lobby, including the Mortgage Bankers Association, the National Association of Realtors and the National Association of Home Builders, who have been pushing for some sort of government backstop.

However, he argues that any sort of government backstop is a bad idea because it would subsidize mortgage risk, leading to further taxpayer losses. "The housing industry is dead set on having guarantees," Calabria said. "They will continue to have considerable sway among Republicans and Democrats." Fighting efforts to keep a government guarantee in place, a small contingent of conservatives, led by Rep. Jeb Hensarling (R., Texas) are seeking to wind-down Fannie and Freddie to an eventual point where they are fully private sector companies competing "on a level playing field" with the private industry. So far, his bill, "The GSE Bailout Elimination and Taxpayer Protection Act," has attracted 21 co-sponsors in the House.

Other issues
The policy debate over Fannie and Freddie will also be intense over other issues including:
  • The quality of any loans Fannie and Freddie will still be allowed to buy
  • Whether mortgage investors should be charged higher guarantee fees for riskier pooled mortgages and lower fees for plain-vanilla mortgage securities
  • Whether the companies should be broken up into smaller units to minimize the impact to taxpayers and the economy of any one of them failing.

Manhattan Luxury Condos Try FHA Backing in 'Game Changer'
by Oshrat Carmiel - Bloomberg

Whitney Gollinger, marketing chief for a Manhattan condo building with an outdoor movie theater and panoramic city views, is highlighting a different amenity to spur sales: the financial backing of the federal government. The Federal Housing Administration agreed in March to insure mortgages for apartments at the 98-unit Gramercy Park development, known as Tempo. That enables buyers to make a down payment of as little as 3.5 percent in a building where apartments are listed at $820,000 to $3 million.

"It’s a government seal of approval," said Gollinger, a director at the Developments Group of New York-based brokerage Prudential Douglas Elliman Real Estate. "We need as many sales tools as we can have these days, and it’s one more tool." The FHA, created in 1934 to make homeownership attainable for low- to moderate-income Americans, is now providing a lifeline to new Manhattan luxury condominiums after sales stalled. Buildings featuring pet spas, concierges and rooftop lounges are applying for agency backing to unlock bank financing for purchasers. The FHA guarantees that if a homebuyer defaults on his mortgage, the agency will pay it.

Seeking Approval
At least nine Manhattan condo developments south of 96th Street have sought approval for FHA backing since the agency loosened its financing rules in December, according to a database of applications maintained by the U.S. Department of Housing and Urban Development. The change allows the FHA to insure loans in new projects where only 30 percent of units are in contract, down from at least 50 percent. About 1,900 apartments in New York’s most expensive neighborhoods would be covered by the applications.

The agency also offers insurance to half of all mortgages in a single building after previously setting a limit at 30 percent, according to the new standards, which expire in December. The entire property must be approved for a buyer to get backing. Most of those that applied in Manhattan are buildings converted to condos or built since 2007. The FHA is filling a void left after mortgage-finance agency Fannie Mae tightened its condo lending standards last year.

The Washington-based company won’t back loans made in new buildings where fewer than 51 percent of the units are in contract, sometimes setting a requirement as high as 70 percent. That in turn makes mortgage lenders hesitant to make loans at developments under those thresholds, said Orest Tomaselli, chief executive officer of White Plains, New York-based National Condo Advisors LLC, which advises condominiums on how to adhere to Fannie Mae and FHA standards.

‘Not an Accident’
"It’s not an accident that the FHA is offering this -- not private lenders," said Christopher Mayer, senior vice dean at Columbia Business School’s Paul Milstein Center for Real Estate in New York. "An unfilled condominium complex is not the kind of thing that a bank looking to rebuild its balance sheet on real estate is looking to do." In New York City, the priciest urban U.S. housing market, the FHA insures loans of as much as $729,750, and permits buyers to borrow up to 96.5 percent of the price.

No buildings in Manhattan applied for FHA recognition between 1998 and 2008 -- though in those years the program didn’t require an entire property be approved and condo buyers could seek FHA-insured loans on their own, Tomaselli said. New development in Manhattan represented 23 percent of the sales market in the second quarter, compared with 35 percent two years earlier, according to New York appraiser Miller Samuel Inc. About 8,700 new apartments in the borough were empty as of June, partly because of a lack of available financing for buyers, said Jonathan Miller, president of the firm.

‘Ironic’ Move
"Something has to happen for this product to be marketable," Miller said. "I just find the whole thing ironic that FHA is providing financing for luxury housing." The FHA loosened the condo rules because of "market conditions," according to Lemar Wooley, an agency spokesman. "We are certainly cognizant of falling sales prices, limited availability of liquidity, etc., so we wanted to be flexible," Wooley wrote in an e-mail. "The risk was considered before issuance of the temporary guidance."

The new rules are a "game changer," said Ryan Serhant, vice president at Nest Seekers International, a brokerage with offices in New York and Florida. He’s marketing 99 John Deco Lofts, a 442-unit conversion project in downtown Manhattan that features a "zen" flower garden and Brooklyn Bridge views.

Regaining Support
The development, where sales began more than two years ago, had 10 units go into contract with FHA backing since approval in March. The FHA suspended its support for the building Aug. 3, according to the agency website. The property is working to have it reinstated, Serhant said. Angela Ferrara, who markets the Sheffield condos on West 57th Street, checks every day whether the 597-unit property, which applied to the FHA in May, has won approval. Ferrara, vice president of sales for New York-based the Marketing Directors Inc., says she is eager to start touting the FHA backing to potential buyers. That’s a reversal from the past, when government loan programs weren’t necessary -- or advertised.

"People would get the wrong idea, and think it was a different type of government-subsidized product," Ferrara said. "It was almost regarded as a negative, particularly in the luxury properties."
Now, she said, "It’s actually became a widely accepted marketing tool."

Lincoln Center, Tiffany
The Sheffield promotes amenities such as concierge service, a pet spa and massage rooms, according to the project’s website. A neighborhood guide on the site lists chef Thomas Keller’s four-star restaurant Per Se as a nearby attraction, along with Lincoln Center, Carnegie Hall and Tiffany & Co.’s flagship Fifth Avenue store. The Sheffield’s owner, New York-based Fortress Investment Group LLC, took over the condo conversion project in foreclosure last August after the original developer, Kent Swig, defaulted on a loan. With 56 percent of the converted units sold or in contract, the building has about 230 units left to sell, Ferrara estimates.

FHA is "definitely is a great solution right now," said Tomaselli of National Condo Advisors, which prepared the FHA applications for Tempo and Sheffield. "The savvy developers did it first," Tomaselli said. "But everybody else is catching up."

Brooklyn Sales
In the borough of Brooklyn, FHA support accounted for half of the 29 units sold at the 111 Monroe condos in Clinton Hill and a quarter of apartments in Williamsburg’s NV building, which is sold out after two years on the market, said David Behin, executive vice president at the Developers Group, a New York brokerage for new buildings. The FHA’s effectiveness will be limited in Manhattan because apartment prices are higher than in Brooklyn and the insured loan is capped at $729,750, Behin said. The median price of a Manhattan apartment in a new development was $1.4 million in the second quarter, according to Miller Samuel and Prudential Douglas Elliman.

"With apartments over $1 million, FHA isn’t going to help you," Behin said. "You’d have to put down 30 percent to get the loan of $729,000. And if you have 30 percent to put down, a bank will loan to you without FHA." Borrowers backed by FHA are essentially buying mortgage insurance, said Debra Shultz, managing director at Manhattan Mortgage Company Inc. in New York. Buyers pay an upfront premium of 2.25 percent of their loan value, and a monthly fee equal to about 0.5 percent of the loan amount for at least five years, she said.

21% of Mortgages
Nationwide, the FHA insured 21 percent of all mortgages made in the second quarter, or $71.4 billion worth of loans, according to Geremy Bass, publisher of the Inside FHA Lending newsletter. That’s close to the $79.5 billion total value of all FHA-backed loans in 2007. The agency’s backing of luxury condos "doesn’t look good," said Andrew Caplin, a professor of economics at New York University who co-wrote a paper titled "Reassessing FHA Risk."

"Manhattan wealthy people -- is this really who the FHA was set up to support?" he said in an interview. Caplin testified before Congress in March, arguing that FHA may need a taxpayer bailout because the agency relies on overly optimistic assumptions on unemployment, home prices and loan performance to predict losses.

Rising Defaults
Nine percent of all FHA-insured loans were 90 days or more past due or in the process of foreclosure in the first quarter, compared with 7.4 percent a year earlier, data from the Washington-based Mortgage Bankers Association show. The agency doesn’t require a minimum credit score for the mortgage insurance, though many lenders who fund the loans insist on a rating of at least 580, said Shultz.

The FHA is considering a minimum required score of 500, according to a notice the agency filed in the Federal Register on July 15. A person with a 500 rating is in the lowest one percentile of credit scores nationally and was likely delinquent on several accounts in the last year, said John Ulzheimer, president of consumer education for, a consumer and credit education company based in San Francisco.

Taking on Risk
"The government is taking on more risk," said Guy Cecala, publisher of Inside Mortgage Finance. "That’s the bottom line. They really can’t say no, because that’s their purpose. It’s to support the housing market when there’s no other funding." Until they heard about FHA, Asha Willis and her boyfriend, Cesar Rivera, didn’t think they would buy a place for at least five years -- enough time to save a 20 percent down payment, she said. The couple reasoned that they earned enough to make monthly mortgage payments, and began an apartment search in February, limiting their hunt to buildings with agency backing.

Willis, an attending physician at Maimonides Medical Center in Brooklyn; and Rivera, a sales associate at Chelsea Piers in Manhattan, toured several glass and steel high rises and decided on a one-bedroom at Toll Brothers Inc.’s Two Northside Piers in Williamsburg, Brooklyn. It didn’t have FHA approval at the time, but developers promised it was on its way, Willis said. "Our contract had a contingency that if they weren’t FHA approved we could get out of the contract," said Willis, currently a renter at Manhattan’s Stuyvesant Town. Prices at the building range from the "high $300,000s" to more than $2 million, according to Adam Gottlieb, project manager for Northside Piers. The property, which began sales in October 2008, received FHA approval in June.

‘Breaking Through’
Shultz, whose Manhattan Mortgage has sourced FHA loans for buyers in Brooklyn, the borough of Queens and on New York’s Long Island, said the last month brought a sudden surge of calls from would-be buyers seeking FHA insurance for Manhattan purchases. "It’s definitely breaking through to the Manhattan market," she said. 1 Rector Park, a Battery Park City rental building converted to 174 condos, got FHA backing in July and re-opened its sales office Aug. 5, a year after it was shuttered with no sales recorded, said Tricia Hayes Cole, executive managing director of Corcoran Sunshine Marketing Group. Her agency was hired to sell the units by the project’s lender, IStar Financial Inc., after it took possession of the property in November, she said.

Cutting Prices
In a second try to sell the units, IStar lowered the prices by an average of 30 percent, bringing the range from $290,000 for a 550-square-foot studio to $2.85 million for a three- bedroom unit with views of the Hudson River and Statue of Liberty, according to Cole. Two-thirds of the building is now priced at a point that could be covered by the FHA, she said. "It didn’t seem unnatural for us to open this up to our buyers," Cole said of FHA.

At Tempo, which is still under construction, developers are hoping that FHA approval will appeal to buyers of lower-priced units and inch the number of contracts signed to the 51 percent that conventional mortgage lenders require, Gollinger said. About 15 percent of the 98 units are under contract. The developers plan to tout FHA support in e-mails and other promotions in a sales push next month as the building nears completion, Gollinger said. "I never even dealt with this," she said. "All of a sudden it became an absolute must."

In This Play, One Role Is Enough
by Gretchen Morgenson - New York TImes

Meet Brad Miller, a Democratic representative from North Carolina who was elected to Congress in 2002, talks straight and understands how big banks can put consumers at peril. He is worth getting to know, not only because of his deep concern about the foreclosure epidemic, but also because he has made a compelling recommendation to level an exceedingly tilted playing field in mortgage finance.

Depending upon your perspective, Mr. Miller is either the right man in the right place on Capitol Hill — if you’re a consumer — or a threat to the status quo. A lawyer who worked on consumer protection issues in North Carolina, Mr. Miller is not new to battling banks. In March 2009, along with Representative William D. Delahunt, a Democrat from Massachusetts, he proposed the creation of an independent consumer agency; it became a part of the recent financial overhaul. This past March, Mr. Miller introduced a bill that would eliminate one of the most pernicious conflicts of interest in banking today: the dueling roles played by the big mortgage servicers.

These companies — the biggest are Bank of America, JPMorgan Chase, Wells Fargo and Citibank — operate as the back office for the mortgage lending industry. In good times, their tasks are fairly simple: they take in monthly mortgage payments and distribute them to whoever owns the loans. In many cases, large institutions like pension funds or mutual funds own the mortgages, and servicers are obligated to act in their interests at all times.

When borrowers are defaulting in droves, as they are now, loan servicing becomes much more complex and laborious. Servicers must chase delinquent borrowers for payments and otherwise manage these uneasy relationships, possibly into foreclosure. So where does the conflict of interest lie? Often, the same bank that services a primary mortgage owned by another institution also owns a second mortgage or home equity line of credit on the same property.

When that borrower has trouble meeting both payments, the servicer has an interest in making sure that amounts owed on the second lien, which it owns, continue to be paid even if the first loan, which it has no interest in, slides into delinquency. About two-thirds of primary mortgages are serviced by banks who do not own them but hold the accompanying seconds.

This conflict is a crucial reason that the government’s loan modification program has been so woefully ineffective. The Treasury Department never forced the second-lien holders who service troubled primary mortgages to reduce the amount they are owed by borrowers, even though such a move would give them a better shot at keeping their homes. Of course, the big banks that hold these second liens have little interest in letting borrowers write them off entirely, or in part, because the institutions would have to absorb huge losses on them. As long as the borrower is eking out payments on the second liens, the banks that own them can pretend that they are performing and keep recording them at high values on their books.

The top four banks hold approximately $450 billion in second liens that are supposed to take a backseat to the investors who hold the primary mortgages. But because of the front-seat role big banks play as servicers, they are in a position to put their interests first. "Unless we can make servicers modify mortgages through bankruptcy or eminent domain, the servicers are not going to reduce principle," Mr. Miller, 57, said in a recent interview. "Their stance does seem largely driven by accounting concerns — they are trying to maintain the fiction that the mortgages are worth the value they are carrying them at on their books."

Enter Mr. Miller’s bill, the Mortgage Servicing Conflict of Interest Elimination Act. It bars servicers of first loans they do not own from holding any other mortgages on the same property. Mr. Miller’s bill has not gained much attention since it was introduced in March. But it ought to, because the Dodd-Frank financial overhaul law is utterly silent on servicer conflicts.

The bill would give these institutions a reasonable amount of time to divest either their servicing businesses or their interests in home mortgages, Mr. Miller said. A likely outcome is that the four biggest banks would spin off their mortgage servicing operations. This would not only resolve the conflict between loan servicers and investors, but it would also result in smaller, less complex banks, he said. That is surely a major benefit.

Another is that Mr. Miller’s law, if enacted, would break up the logjam now thwarting mortgage modifications. "We must reinvent our mortgage finance system," he said. "This is a huge part of our economy, and we cannot have a healthy recovery with the housing sector as sick as it is." A member of the House Financial Services Committee, Mr. Miller concedes that he did not see the financial crisis coming. But he said that several years ago he became aware that increasingly poisonous mortgages were being peddled to consumers.

"These mortgages were not designed to increase homeownership; they were designed to trap people in debt and strip the equity in their home as home prices appreciated," Mr. Miller said. "For the financial industry, that increasing wealth from middle-class homeowners was an attractive target; if they could trap families in a cycle of borrowing every three years or so, then a lot of increased wealth in their homes would end up in the financial sector rather than with those families."

Mr. Miller recognizes that his is an uphill climb because the big banks have many friends in high places across Washington. "Americans have come away from this persuaded that everything has been done to help the banks and not to help them," he said. "And in a democracy, that’s a real problem." Still, he said he has recently noted a slight shift in the balance of power. "I’ve seen the banks going from losing no fights to losing a few fights," he said. "What I’ve found is the more fights we pick, the more success we have."
Here’s to more fights, then. Many more.

Bank Profits A Sign Of Economic Sickness, Not Health
by Steve Keen - Debt Deflation

The record $6 billion profit that the Commonwealth Bank is expected to announce today is a sign of an economy that has been taken over by Ponzi finance. Fundamentally, banks make money by creating debt, and the amount of debt we’ve been enticed into taking on is the sign of a sick economy rather than a healthy one. The level of private debt that is actually needed to support business and maintain home ownership at historic levels (ownership levels have fallen over recent years!) is possibly as little as one sixth the current level.

Because of that debt level, bank profits have gone through the roof as a share of GDP. Back before we had a financial crisis—when debt levels were far lower than today—so too were bank profits as a share of GDP. A sustainable level of bank profits appears to be about 1% of GDP. The blowout from this level to virtually six times as much began when bank deregulation began under Hawke and Keating, and then took off as Howard and Costello encouraged everyone to become “Mum and Dad Investors”, which meant borrowing money from the bank and gambling on share and house prices.

As readers of this blog know, I build models of financial instability, and in my models, one symptom of an economy that is headed for a Depression is a rise in bankers share of income at the expense of workers and capitalists. The model below has yet to be calibrated to the data, but the similarities with the actual data are still ominous.

One empirical reality illustrated by the model as well is that even if firms are the ones taking on the debt (as they are in this model—it does not include household borrowing), workers are the ones that pay for this in terms of a declining share of national income: rising debt is associated with a constant profit share of GDP but a falling workers share.

When the crisis really hits,  both workers and capitalists suffer as bank income goes through the roof—leading to a Depression. The only way out of this is to abolish large slabs of the debt, and coincidentally to drive bankers share of income back down to levels that reflect is supportive role as a provider of working capital for firms—rather than a parasitic role as the financier of Ponzi schemes.

This is the real debt story of our economy right now. As the first chart above indicates, private debt is far higher than Government debt, even after the increase last year due to Rudd’s stimulus package. Government debt is currently 5.5% of GDP, whereas private debt—even though it has fallen slightly due to business deleveraging—is over 150% of GDP: 27 times the size of Government debt. The so-called debate that the major parties are having over the size of Government debt is an embarrassment.

Your Textbooks Lied To You – The Money Multiplier Is A Myth
by TPC

The following comes from an excellent new paper from the Fed.  The paper describes the myth of the money multiplier and is an absolute must read for anyone who is trying to fully understand the current environment.  It turns much of textbook economics on its head and describes in large part why the bank rescue plan and the idea of banks being reserve constrained is entirely wrong:

"The role of reserves and money in macroeconomics has a long history.  Simple textbook treatments of the money multiplier give the quantity of bank reserves a causal role in determining the quantity of money and bank lending and thus the transmission mechanism of monetary policy. 

This role results from the assumptions that reserve requirements generate a direct and tight linkage between money and reserves and that the central bank controls the money supply by adjusting the quantity of reserves through open market operations.  Using data from recent decades, we have demonstrated that this simple textbook link is implausible in the United States for a number of reasons.

First, when money is measured as M2, only a small portion of it is reservable and thus only a small portion is linked to the level of reserve balances the Fed provides through open market operations.  Second, except for a brief period in the early 1980s, the Fed has traditionally aimed to control the federal funds rate rather than the quantity of reserves.  Third, reserve balances are not identical to required reserves, and the federal funds rate is the interest rate in the market for all reserve balances, not just required reserves.  Reserve balances are supplied elastically at the target funds rate. 

Finally, reservable liabilities fund only a small fraction of bank lending and the evidence suggests that they are not the marginal source data for the most liquid and well-capitalized banks. Changes in reserves are unrelated to changes in lending, and open market operations do not have a direct impact on lending. We conclude that the textbook treatment of money in the transmission mechanism can be rejected.  Specifically, our results indicate that bank loan supply does not respond to changes in monetary policy through a bank lending channel, no matter how we group the banks.

Our evidence against the bank lending channel at the aggregate level is consistent with other recent studies such as Black, Hancock, and Passmore (2007), who reach a similar conclusion about the limited scope of the bank lending channel in the United States, and Cetorelli and Goldberg (2008), who point out the importance of globalization as a way to insulate the banks from domestic monetary policy shocks.  Our findings are also consistent with the predictions of Bernanke and Gertler (1995) from over a decade ago that the importance of the traditional bank lending channel would likely diminish over time as depository institutions gained easier access to external funding.

Our evidence against the bank lending channel at the micro level is consistent with Oliner and Rudebusch (1995), but it contrasts previous findings of a lending channel for small, illiquid, or undercapitalized banks (see Kashyap and Stein (2000), Kishan and Opiela, (2000) and Jayartne and Morgan (2000)).  What is common in all these studies is that their sample periods cover the period prior to 1995, when reservable deposits constituted the largest source of funding.  As we have shown in Table 3, this is no longer a feature that characterizes bank balance sheets in the post-1994 period. 

Furthermore, Kashyap and Stein (2000) and Kishan and Opiela (2000) interpret a change in the sensitivity of bank lending to monetary policy as evidence of a bank lending channel.  We argue that changes in the sensitivity of bank loans may of funding, either. 

All of these points are a reflection of the institutional structure of the U.S. banking system and suggest that the textbook role of money is not operative. While the institutional facts alone provide compelling support for our view, we also demonstrate empirically that the relationships implied by the money multiplier do not exist in the stem from the demand side, and that a better test for the lending channel is to check whether bank loans are financed by reservable deposits.  Our findings suggest that this is not the case.

In general, our results echo Romer and Romer (1990)’s version of the Modigliani-Miller theorem for banking firms.  They argue that banks are indifferent between reservable deposits and non-reservable deposits.  Hence, shocks to reservable deposits do not affect their lending decisions, and changes to reserves only serve to alter the mix of reservable and non-reservable deposits.  Our findings in this paper support the argument that shocks to reservable deposits do not change banks’ lending decisions.

Since 2008, the Federal Reserve has supplied an enormous quantity of reserve balances relative to historical levels as a result of a set of nontraditional policy actions.  These actions were taken to stabilize short-term funding markets and to provide additional monetary policy stimulus at a time when the federal funds rate was at its effective lower bound. 

The question arises whether or not this unprecedented rise in reserve balances ought to lead to a sharp rise in money and lending.  The results in this paper suggest that the quantity of reserve balances itself is not likely to trigger a rapid increase in lending.  To be sure, the low level of interest rates could stimulate demand for loans and lead to increased lending, but the narrow, textbook money multiplier does not appear to be a useful means of assessing the implications of monetary policy for future money growth or bank lending." (
emphasis added)

Someone with Ben Bernanke and James Bullard’s email addresses might want to forward this along to them before they go talking up their supposed "silver bullet" of quantitative easing without realizing that it is unlikely to meet its desired goals.

Web of shadow banking must be unravelled
by Gillian Tett - Financial Times

A couple of years ago, it occurred to me that the 21st century financial system had come to resemble a huge ball of candy floss (or cotton candy, as Americans might say). For bankers had become so adept at slicing and dicing debt instruments, and then re-using these in numerous deals, they had in effect spun a great web of leverage and trading activity – in much the same way that sugar is spun in a bowl to create candy floss. From a distance, that activity looked impressive. But the underlying asset base was surprisingly small. Thus the key question that has hung over the system – and is doubly relevant now – is whether that cloud of trading activity could crumble back into itself? And what might the impact of that be?

Now, a fascinating little paper has just emerged from the International Monetary Fund that sheds light on this. This article*, by Manmohan Singh and James Aitken, is not pitched at a mainstream audience; it focuses on the issue of "rehypothecation" and its link to shadow banking. But that is a pity. For while the issue of rehypothecation might sound arcane, it is central to the financial system. The issue involves the collateral that typically underpins trading and lending deals cut by banks with hedge funds and other banks. In recent decades, whenever a bank has made a loan to a hedge fund or cuts a deal with another bank, this is typically backed by collateral, such as a mortgage-backed security or treasury bond.

In a sense this is similar to an ordinary mortgage loan: if a hedge fund fails to repay a loan, or honour a trade, a bank can seize that collateral in much the same way that a bank might grab a house if a mortgage defaults. But what makes these complex financial trades different from, say, a mortgage loan is that banks tend constantly to revalue the collateral, and adjust the deals to compensate. More important still, banks often churn, or "rehypothecate", that collateral. More specifically, when banks receive collateral from hedge funds, they often act as if they owned that collateral outright – and post that as collateral to support their own deals. Thus one piece of collateral can be churned several times to support several deals; hence that great financial candy floss cloud.

Now, until 2007 regulators tended to pay remarkably little attention to this, and even now the issue of rehypothecation is apt to be ignored by investors and policymakers, partly because most of this activity is very opaque. However, there are two reasons why it would make sense to track it much more closely. First, the price at which banks value collateral is a telling indication and early warning signal of how savvy financiers really feel about the risks in the system.

Second, as the IMF paper shows, this rehypothecation activity can be so frenetic it can significantly affect the overall volume of leverage in the system. The IMF paper calculates that, by 2007, the seven largest US brokers were getting about $4,500bn of funding from rehypothecation activity, most of which was not recorded in their accounts or the US government’s flow of fund data.

Moreover, if you factor that activity into estimates of the size of the shadow banking world, this sector had swelled to about $10,000bn in size in the US – double previous estimates. And, this had a fascinating cross-border dimension. In the UK, as the IMF notes, "an unlimited amount of customers’ assets can be rehypothecated and there are no customer protection rules". In the US accounts were segregated. Thus most funding has hitherto come from London.

Now, the "good" news, as it were, is that some of this candy floss cloud has now collapsed, because banks have become more risk-averse, and the collapse of Lehman Brothers alerted hedge funds to the risks of letting their collateral be rehypothecated in this way. Thus the IMF calculates that US bank funding from rehypothecation is now "only" $2,000bn-odd – or less than half its former size. That decline has clearly been painful for the banks. However, it does mean that some of the necessary, post-bubble adjustment is now taking place.

But the bad news is that it is still unclear how much more adjustment will occur, or what its impact on bank behaviour will be. After all, much of this rehypothecation activity remains rather mysterious.
Meanwhile, that odd discrepancy between UK and US law appears to remain in place, creating scope for future cross-border arbitrage. That might not matter now. But it could become important if risk appetite returns. Just one more reminder of why regulators will need to stay on their toes, particularly given the shortcomings of financial reform – and the propensity of the financial world to keep spinning those candy floss clouds.

* The (Sizeable) Role of Rehypothecation in the Shadow Banking system; Manmohan Singh and James Aitken, IMF July 2010.

Ireland can withstand the euro's ordeal by fire, but can Southern Europe?
by Ambrose Evans-Pritchard - Telegraph

Much of the world’s Viagra is produced at a single Pfizer plant in Ringaskiddy south of Cork. All its Lipitor API for cholesterol comes from a neighbouring site at Little Island. Desperate Housewives depend on anti-wrinkle Botox from Allergan’s plant in County Mayo. The slimming pill Siburtramine is produced by Abbott in Sligo. Drugs catering to the neurosis of a rich and aging mankind - as popular in Asia as the West - are the reason why Ireland’s exports defied the Great Recession of 2008-2009 when German and Japanese exports crashed. They are slump-proof.

Drugs and chemicals made up 57pc of Ireland’s €103bn exports last year. The IT giants Intel, Microsoft, Google, Paypal, and now Facebook all have well-known operations in Ireland, but Pharma quietly yields more money and jobs. Corporate tax of 12.5pc is half the story: the other half is a strategic industrial policy dating back to the 1990s. Unlike other GIIPS (Greece, Italy, Portugal, and Spain), Ireland has an open economy geared to global trade. It has at least a sporting chance of clawing its way out of a horrendous eurozone trap. It can reasonably hope that exports will slowly offset the collapse of domestic demand induced by a 13pc cut in public wages and the most draconian deflation measures since the creation of the Republic.

It has the flexibility to survive the EU’s hairshirt regime of "internal devaluation" - Laval deflation, to call it by an uglier name - aimed at regaining the 20pc-30pc in labour competitiveness thrown away by amateurish GIIPS leaders who never understood the implications of a currency union. Ireland can perhaps hope to carry out further spending cuts planned for late 2010 and yet again in 2011 without crashing into an irreversible debt-deflation spiral.

Certainly, the Irish people have shown Scandinavian cohesion. Dublin has seen no riots, and nothing like the terrorist acts against government officials in Greece. "There is a lot anger and a lot of fear: fear is proving larger," said Paul Sweeney, a life-long labour activist and now Economic Adviser to the Irish Congress of Trade Unions. "For once we are keeping our hot tempers under control. The government will learn at the next election that revenge is a dish best served cold."

Fergal O’Brien, from the Irish Business and Employers Confederation, said a quarter of Ireland’s private companies have cut wages, by 12pc on average. Dublin rents have halved. "Ireland has become a much cheaper place to do business. It costs 25pc less now than three years ago to set up a new enterprise," he said. One begins to discern a way out of calamity short of EMU exit, an option too traumatic to contemplate seriously and in Ireland’s case too tied up with the need to keep a distance from Britain’s clammy embrace. And yet, and yet, austerity is not making any appreciable dent on borrowing needs. The deficit will be 18.7pc of GDP this year. If you strip out bail-out costs for Anglo Irish, it is still stuck at around 12pc.

"We are chasing our tail," said Sean Sherlock, a Dail member for Ireland’s Labour Party. "There is a dangerous process at work where job losses are making it harder to cut the deficit. We are seeing emigration of Irish nationals once again to Australia, Canada and the US." Unemployment reached 13.7pc in July, eating into the tax base. Income tax revenue was down 9pc from a year ago. Ireland’s internal economy (GNP) has shrunk by 20pc in nominal terms -- part deflation, part recession -- as the debt stock rises. The IMF expects public debt to rise to 96pc of GDP by the end of next year. The candle is burning at both ends. Such is the deflation curse, all too familiar to any student of debt dynamics in the 1930s.

This pattern of sticky deficits, declining tax revenues, and recoveries falling short of "escape velocity" is visible across the eurozone’s arc of debt. Traders say fear of fresh bank woes have caused sovereign bond spreads to spike to crisis levels yet again. I suspect there is a deeper and more pervasive angst that the EU’s strategy is unworkable as designed, and that the EU’s €440bn bail-out fund relies on a string of assumptions that are not entirely credible, notably that Italy would remain serenly untouched by contagion and able to fund a simultaneous bail-out for Spain and Portugal if ever needed. The Stability Facility has bluff written all over it.

In Greece, meanwhile, the slump is accelerating. The economy contracted 1.5pc in the second quarter. Unemployment rose to 12pc. "The problems have not gone away, the cracks have just been papered over," said Gary Jenkins from Evolution Securities. The EU and the IMF have praised Greece for a "strong start", as well they might: they are dictating the policy; their own credibility is on line. It does not mean that any sane observer should believe them. The reality is that tax revenue is €770m short of target so far this year, with the worst deterioration in July when receipts dropped 7pc from a year before.

Or as the IMF stated in its latest report on Greece: "since the economy is relatively closed, the sharp cutbacks in public spending are beginning to affect activity without a strong response from net exports." There you have a hint at what the IMF technicians really think of a debt-trap policy that will leave Greece in hock to creditors for 150pc of GDP within three years, up from 115pc when the crisis hit. They call that a solution? In any normal situation the IMF cure for Greece would be devaluation and debt relief, allowing enough oxygene for austerity to work. But even to utter such a thought in Europe is Lèse majesté.

True, the eurozone clocked excellent growth in the second quarter, if there is any such meaningful concept as the eurozone. What in fact occurred is that Germany surged ahead with an undervalued currency, exporting Mercedes and BMWs to China. While Spain, Italy, and Portugal are being left ever further behind in a split-level union with an overvalued currency . The data is cruelly double-edged.
Portugal’s central bank has downgraded growth to just 0.2pc in 2011, and is expecting a stormy second half to 2011. Spanish premier Jose Luis Zapatero is already hinting at a double-dip recession. He has begun to talk of fresh stimulus for roads and infrastructure. Is Spain about to become the second country after Hungary to defy EU austerity doctrine? The plot thickens.

Let us allow that Ireland’s mix of heroic cost-cutting and sellable exports make survival within the German currency system theoretically possible. Can we say the same about others at this far gone stage? The question for the masters of the EMU is what Viagra does Greece have to sell the world, and what can Portugal and Spain offer to close a very big gap, very fast.

Payday loans quadruple as 1.2 million Brits borrow in short-term
by Jill Insley - Guardian

he number of people taking out costly payday loans has quadrupled to 1.2 million over four years, says a report by Consumer Focus. It estimates that employees borrowed £1.2bn in 2009 alone. Interest charges usually range from 13% to 18% but can be as high as 30% for a month-long loan from some online providers, generating APRs of 1,000% to 2,000% because of the short-term nature of the loans. When borrowers cannot afford to pay off the loan the following month charges can balloon.

Stephanie Derby took out a payday loan for £400 18 months ago. "I was working as a teaching assistant and not earning much money," she said. "I was behind on payments and needed cash quickly, so a payday loan was the last resort for me." Getting the money was easy. Derby took a few payslips into a branch of her payday loan provider to prove her income, and they paid out straight away. But paying back the loan was a different matter. "It took me about a year, by which time the amount had doubled. I had to pay cheques to renew the loan – it was frustrating and embarrassing. I just wanted to pay the money back but I was stuck. I would never do it again, even if I was desperate. The trouble was I didn't talk to anyone about my debt problems at the time."

In its study – Keeping the Plates Spinning – Consumer Focus warns that banks need to offer affordable short-term loans, and recommends stronger safeguards to protect consumers. Its research indicates that payday loan borrowers take out an average of 3.5 loans a year, with an average value of £294. Two-thirds of payday loan borrowers have a household income of less than £25,000. They tend to be young and single.

Consumer Focus stops short of recommending a ban on payday loans. Marie Burton, its financial services specialist, said: "These products are controversial, but we don't agree with calls for them to be banned. Outlawing payday loans could leave some borrowers vulnerable to illegal loan sharks. Instead we need sensible safeguards to stop borrowers becoming dependent on this high-cost credit."

Greece's economy deeper in recession than forecast
by Katie Allen - Guardian

Greece's recession deepened more than expected in the second quarter of 2010 after the country was rocked by its financial crisis and a series of government measures to slash public debt. Investment dropped and public spending slumped in the three months to June as Greek politicians battled to regain the confidence of financial markets and meet the conditions of a multibillion-euro bailout from the European Union and International Monetary Fund.

There was also a fresh warning sign that the economic crisis could further intensify social unrest, after a record jump in unemployment. The crisis has already led to widespread industrial action and public protests. With the fiscal squeeze only just starting, Greece is expected to remain mired in recession for the rest of this year. The country's ELSTAT statistics office estimated that second-quarter GDP fell by 1.5% during the three months, and was 3.5% less than a year ago. Those were steeper falls than the quarterly 1% and annual 3.3% contractions forecast in a Reuters poll of economists.

The falls were also sharper than in the first quarter. So while many fellow European economies, including the UK, were enjoying a quickening recovery out of recession in the second quarter, Greece's first-quarter contraction of 0.8% almost doubled. The statistics office said that the deterioration reflected a drop in investment and public spending cuts. Economists predict Greece's economy is unlikely to recover for some time yet as austerity measures continue to hurt consumers and businesses. The overhaul includes a public-sector pay freeze, a VAT rise, new laws making it easier for companies to lay off workers and a higher retirement age.

Giada Giani at Citigroup told Reuters: "We think the largest hit to private consumption from tighter fiscal policy is probably still ahead of us, as monthly indicators on consumer spending had not really plummeted yet in the second quarter. "On the other hand, net export probably provided a large positive contribution to GDP as export growth is lifted by improving global trade while import is depressed by falling domestic demand. "We expect growth to remain negative for the rest of the year, with an average decline of around 3.5% for 2010."

Reflecting the austerity measures and efforts to shrink the public sector, Greek unemployment posted a record jump in May. According to labour market data from the statistics service, the unemployment rate rose sharply to 12% from 8.5% a year earlier. It was the biggest annual rise since comparable records began in 2004, with the number of people out of work rocketing by 43% from May 2009 to 602,185. Echoing a report overnight from the International Labour Organisation (ILO), the Greek data showed young people were the hardest hit by the latest jump in unemployment. The jobless rate for 15- to 24-year-olds now stands at 32.5% in Greece.

According to the ILO, global youth unemployment has hit an all-time high and is expected to rise further this year. It says that of about 620 million economically active 15- to 24-year-olds, 81 million were unemployed at the end of 2009, the highest number since records began in 1991. That put the global youth unemployment rate at 13%. In the UK, labour market data yesterday showed youth unemployment slipped back in the second quarter. The jobless rate for 18- to 24-year-olds here is 17.5%.

German 10-Year Bonds Gain for Third Week as Investors Sell Greece, Ireland
by Anchalee Worrachate - Bloomberg

German 10-year bonds posted their third weekly gain as investors sought the safest assets on concern the fallout from Europe’s sovereign-debt crisis will derail the region’s recovery. Bond yields in France, Germany and Belgium fell to record lows while Irish borrowing costs rose at an auction of bills. A report two days ago showed the Greek economy shrank for a seventh quarter, sending the yield premium investors demand to hold the country’s 10-year bonds rather than bunds to the highest since the European Union announced a 750 billion-euro ($957 billion) package for the region’s most indebted nations.

"There’re a lot of artificial premiums in German bonds from the safe-haven flows from the markets like Greece, Spain or Ireland," said Robin Marshall, a director of fixed income at Smith & Williamson Investment Management in London. "With problems in those countries, growth is likely to be softer going forward." The yield on 10-year German bonds fell 12 basis points from last week to 2.39 percent as of 5:20 p.m. yesterday, after earlier reaching a record low of 2.37 percent. Greek 10-year bonds yields climbed 30 basis points to 10.55 percent.

Bunds rose even as a report yesterday showed Germany’s economy grew in the second quarter at the fastest pace since the country’s reunification two decades ago. German gross domestic product surged 2.2 percent from the first quarter, fueling euro- area growth of 1 percent, the fastest in four years. Economists had forecast GDP would rise 1.3 percent in Germany and 0.7 percent in the entire currency region. Spain’s GDP increased 0.2 percent from the previous quarter.

‘Sluggish at Best’
"While the German growth data for the second quarter has rebounded impressively, the picture at the periphery of Europe is very different with the GDP data from Greece, Spain, Portugal and Italy coming in sluggish at best, and in the case of Greece very disappointing," foreign-exchange analysts at BNP Paribas SA led by Hans-Guenter Redeker in London wrote in a research note yesterday.

Concern the recovery from the worst recession since World War II will be uneven has helped drive demand for the safest securities this year. Spanish bonds returned 1.5 percent this year and Irish debt 0.5 percent, compared with an 8 percent gain from German securities, according to indexes compiled by European Federation of Financial Analysts Societies. Yields indicate the region’s debt crisis has further to run. Catalonia, which accounts for a fifth of Spanish gross domestic product, has been shut out of public bond markets since March and the extra yield it pays over national government debt has almost tripled this year.

Consumer Prices
The yield difference for Spanish and German 10-year debt widened 32 basis points in the week to 185 basis points, while the Irish-German 10-year bond spread widened 57 basis points to 294 basis points. Bunds may extend gains next week on speculation prices in the 16-nation euro region fell last month. Euro-area consumer prices fell 0.4 percent in July from June, when they were unchanged, according to a Bloomberg survey before the European Union’s statistics office in Luxembourg publishes the data on Aug. 16.

China's Coming Property Bust
by Gordon G. Chang - Forbes

"Even if I don’t eat for the next 50 years, I still won’t be able to afford a flat in Shenzhen." As we were stuck in traffic last Sunday in his bustling hometown, a cab driver has just identified why the Chinese property market is the world’s biggest bubble at the moment. He makes a maximum of 4,000 yuan a month, but an apartment for his wife and two children will cost about 250 times that amount. The chubby dad has given up dreams of owning his own home in this southern China metropolis that borders Hong Kong.

Prices for apartments in China are seriously out of whack. They were rising this year at the rate of 20% a month in some regions. Overall, residential real estate prices soared 68% in the first quarter of the year, compared to the corresponding period last year. In the second quarter, prices were up 12.2% from the first quarter, according to Nasdaq-listed China Housing & Land Development Inc. China is the world’s fastest appreciating property market.

So everyone recognizes that a correction must come soon, right? Not exactly. "I don’t see any bubbles," 44-year-old Zhang Xin told Hong Kong’s South China Morning Post. "The next few months will be a fantastic time to buy." Really? There were, a few months ago, 64.5 million urban flats that showed no electricity usage for six consecutive months. That’s one in four city apartments, enough housing for some 200 million people. The value of vacant apartments held by speculators is about 15% of gross domestic product. Beijing’s bank stress tests assume a 60% fall in property prices. In fact, official statistics show that property price increases slowed in July.

And there is more bad news for the residential market. Property developers, who are already building 20 million flats, have company. Local governments are constructing another 20-30 million, and other government agencies and companies are also building housing for employees. In any other country, developers would be slamming on the brakes. In China, they are hitting the accelerator. Ms. Zhang, , a one-time sweatshop worker who has since become a billionaire by building some of the most striking structures in China, is committing hundreds of millions of dollars to construction in Beijing and Shanghai.

Welcome to China, where universal economic principles do not seem to apply. Why are Chinese developers so optimistic? They assume that central government technocrats will soon abandon their efforts to cool the economy. Second quarter GDP growth of 10.3% lagged that of the first, when it jumped 11.9%. The growth of imports in July--22.7%--especially troubled analysts this week. The closely watched figure was far below June’s 34.1% gain and well short of the consensus estimate of 30.2% growth. The July import figure reflected the smallest gain since last November, when imports turned up for the first time in a year.

With the economy starting to soften, many in China expect Premier Wen Jiabao to start the money flowing again by relaxing the lending restrictions he put in place in April to cool the property sector. So, despite the enormous overhang of residential units in China, the betting is that construction will pick up soon. Accordingly, the mood in the property sector is maximum bullish, with China property stocks recovering almost all the ground they lost since April.

There are, however, three problems with this rally. First, Premier Wen can reintroduce stimulus spending and still keep his lending curbs in place. To maintain the loan restrictions would be sound policy, and although he has made more than his share of mistakes recently, it’s not wise to bet he will commit another enormous blunder.

Second, faith that Beijing can prevent a market collapse is misplaced. "The market is bigger than the government," independent economist Andy Xie writes. Property developers are forgetting that the central government can only delay--not avoid--a final reckoning in the property sector.

Finally, we have to remember our friend, the cab driver in Shenzhen. To make him lose hope in owning his own home is extremely bad politics. The overriding reality is that China’s incomes will not support housing prices at their current level, so there must eventually be an elimination of this gap. Because incomes cannot grow fast enough, prices must fall. Yes, the government will try to sustain the market, but Beijing’s measures are not stronger than market forces.

Chinese leaders, in the months ahead, have an impossible task. They must keep powerful property developers happy, not alienate hundreds of millions of Chinese who think they should be able to own their homes, and somehow repeal the law of supply and demand.

Gordon G. Chang is the author of The Coming Collapse of China.

Elizabeth Warren, likely to head new consumer agency, provokes strong feelings
by Brady Dennis - Washington Post

Somewhere along the line, Elizabeth Warren became a symbol. She's either the plain-spoken, supremely smart crusader for middle-class families that her supporters adore, or she's the power-hungry headline seeker her critics loathe, a fiery zealot disguised in professorial glasses and pastel cardigans.

But no one disputes that she's the most prominent and polarizing candidate to lead the new Bureau of Consumer Financial Protection. The idea for an independent federal agency to protect ordinary borrowers from abuses by lenders was largely Warren's idea, and Congress made it a reality as part of the legislation adopted last month to overhaul financial regulations. The bureau's director will be the most powerful new banking regulator in decades and the first with the exclusive mission of focusing on consumers.

As President Obama considers whom to nominate for that role, the debate has become less about who might get the job and more about whether Warren will or won't. Warren met Thursday at the White House with senior Obama advisers, but a presidential spokeswoman said no decision had been made. If Obama doesn't choose her, he risks infuriating his already-agitated liberal supporters who see Warren as the only logical candidate. If he gives her the nod, Obama risks deepening the financial community's distrust of his administration and sparking a confirmation fight. He would be elevating a woman who, despite her mild manner, has repeatedly proven herself a thorn in the administration's side during her tenure as watchdog over the government's $700 billion bank bailout program.

The real Elizabeth Warren doesn't so neatly fit the labels others readily attach to her. She was the child of a cash-strapped family on the Oklahoma plains, a teenage wife and young mother who became the only member of her immediate family to graduate from college, then went on to teach at Harvard Law School. Drawn to the field of bankruptcy, she initially took a jaundiced view of the irresponsible spendthrifts she believed were gaming the system, only to discover during her research a humanity in their stories that altered her life's work. She has long maintained the bearing of a straight-shooting, "aw shucks" Washington outsider, even though she began showing her Beltway savvy as a political infighter more than a decade ago.

So just how did Elizabeth Herring from Norman, Okla., become Elizabeth Warren, test case for whether Washington is really serious about reforming Wall Street? Hard work and happenstance.

On the move
Betsy, as her family always called her, was born in 1949. Her parents were hardscrabble Okies, forever haunted by the Dust Bowl poverty that had defined their early lives. "They hadn't recovered from the Depression, and I guess in many ways they never did," Warren, who declined to be interviewed for this story, recalled during a 2007 interview at the University of California at Berkeley as part of its "Conversations With History" series. "Those were the stories that permeated my childhood -- what it was like to have seven years of drought, what it was like when nobody had any money, what it was like when all your neighbors left to go to California or someplace where they thought there might be jobs."

Warren's parents had lost most of their savings when a business partner in a car dealership ran off with the money. Afterward, her father worked a series of jobs around Oklahoma City, including as a carpet salesman at Montgomery Ward and later as a maintenance man at an apartment complex. At one point, her mother took a job in the catalogue order department at Sears. Around the dinner table, the conversation revolved less around politics and more around carburetors. The Herrings' only daughter was no shrinking violet. "She was tougher than a snake, partner," said her brother David Herring. "She'd argue with anybody."

The family eventually moved from Norman to Oklahoma City, where Warren became a local phenom, as driven as she was intelligent. "She won debating awards and all this and that. She won the Betty Crocker award. She won everything. . . . She always just achieved," Herring said, calling his sister "probably the most tenacious person I've ever known."

One brother entered the Air Force. Another worked construction. The youngest went into the oil business. Warren graduated from high school at 16 and earned a full debating scholarship at George Washington University. In D.C., she studied speech pathology, aiming for a teaching career working with brain-injured children. She left GWU after two years, got married at age 19 to a high school boyfriend who worked at the Johnson Space Center in Houston, finished her degree at the University of Houston and had a daughter.

"I had a baby and stayed home for a couple of years, and I was really casting about, thinking, 'What am I going to do?' " Warren said in the Berkeley interview. "My husband's view of it was, 'Stay home. . . . We'll have more children, you'll love this.' And I was very restless about it." She carried that restlessness to New Jersey, where her husband's work had taken them, and earned a law degree from Rutgers University. When her husband was transferred back to Houston, Warren landed her first tenure-track post at the University of Houston and she stumbled into the cause that would define her career.

Warren became intrigued by the new bankruptcy code that took effect in 1979. She partnered with a fellow law professor, Jay Lawrence Westbrook, and sociologist Teresa A. Sullivan, now the president of the University of Virginia, to study the Americans who were ending up in bankruptcy court. "I set out to prove they were all a bunch of cheaters," Warren said in the 2007 interview. "I was going to expose these people who were taking advantage of the rest of us by hauling off to bankruptcy and just charging debts that they really could repay, or who'd been irresponsible in running up debts."

The trio visited courthouses in different parts of the country, carrying with them a portable copying machine they called R2-D2. "We're sitting there reading these files, entering data from hundreds of people, interviewing bankruptcy lawyers and such," Westbrook recalled. "You have a human story that goes together with all the numbers." What they found shook Warren's assumptions. "These were hardworking middle-class families who, by and large, had lost jobs, gotten sick, had family breakups, and that's what was driving them over the edge financially. Most of them were in complete economic collapse when they filed for bankruptcy," she said. "It changed my vision."

Warren divorced, remarried and moved on to teaching posts at the University of Texas, the University of Michigan and the University of Pennsylvania before settling at Harvard in 1995. All the while, she continued to dig deeper into what she has called the hollowing out of the American middle class, writing about the effects of bankruptcy on ordinary Americans and the dangers of predatory lending, warning about a collapse that was sure to come.

Another D.C. education
Warren navigated the capital's political waters long before the current crisis. Back in 1995, former Oklahoma Rep. Mike Synar (D), who was heading up the new National Bankruptcy Review Commission, recruited Warren to become the group's senior adviser. Warren demurred. "I didn't want anything to do with it. I wanted to stay in my office and focus on my academic research," she once recalled in an interview with the magazine the Progressive. "Mike promised that if I worked with the commission he would insulate me from any of the political parts to it. So I agreed on those terms to come work with him."

Synar soon died of brain cancer, but Warren pressed on, helping draft the commission's report and testifying before Congress, trying to beat back legislative efforts to restrict the right of consumers to file for bankruptcy. This was the Washington education of Elizabeth Warren, according to Westbrook, her longtime research partner, and it soured her on Wall Street's influence.

In a book she wrote with her daughter, Warren tells the story of how first lady Hillary Clinton vowed in a private meeting to help fight a bankruptcy bill pending in Congress that Warren warned would dismantle vital protections for families. President Bill Clinton subsequently vetoed the bill. But when the bankruptcy bill came back before the Senate in 2001, Sen. Hillary Rodham Clinton voted in favor. The lesson for Warren was that even a sympathetic ally could be swayed by wealthy special interests. "As New York's newest senator, however, it seems that Hillary Clinton could not afford such a principled position. . . . Big banks were now part of Senator Clinton's constituency. She wanted their support, and they wanted hers," Warren wrote.

By the time the financial crisis hit in 2008, Warren had studied the plight of middle-class families for decades and written extensively about the about the ways that lenders preyed on ordinary Americans. She had crisscrossed the country sermonizing about her findings and pitching her idea for a new consumer agency to the Democratic presidential campaigns, including the staffs for Clinton, Obama and John Edwards.

"It is impossible to buy a toaster that has a one-in-five chance of bursting into flames and burning down your house," she wrote in a now-famous 2007 article in the journal Democracy proposing such an agency. "But it is possible to refinance an existing home with a mortgage that has the same one-in-five chance of putting the family out on the street."

After the economy nearly collapsed, Warren seemed like a prophet. Senate Majority Leader Harry M. Reid ((D-Nev.) recruited her to become the lead watchdog over the government's $700 billion bailout fund. Soon, Warren was working out of a dingy office near Union Station, holding public hearings, churning out reports that criticized the government's handling of some aspects of the bailouts and mixing it up on TV with everyone from Charlie Rose to Jon Stewart.

'This grubby job'
The financial overhaul bill signed last month by Obama gives him authority to appoint an independent director of the new consumer bureau to a five-year term, subject to Senate confirmation. That director will have broad authority to shape the new bureau and remarkable autonomy after it is up and running to write and enforce rules governing credit cards, mortgages and other such loans. The administration has floated several candidates for the job, including Assistant Treasury Secretary Michael S. Barr and Eugene Kimmelman, a deputy assistant attorney general in the Justice Department's Antitrust Division. But Warren has drawn the most public support -- and the most ire.

She has received fervent backing from consumer advocates, labor unions, academics and scores of Democratic lawmakers. Tens of thousands of people have signed online petitions urging Obama to choose her. Her endorsements have ranged from the New York Times to to Dr. Phil. Others have made no secret about their distaste for Warren, questioning her qualifications and describing her as an ideologue.

"I get disgusted every time I hear her speak. It's like she's sitting in some ivory tower, not understanding the ramifications of anything she says," Anton Schutz, president of Mendon Capital Advisors, recently told Reuters -- a sentiment shared by others in the financial industry, though rarely so candidly. "Any person you put in that role really ought to have some industry experience." For her part, Warren has spent much of the summer outside of the public spotlight, declining interview requests and visiting family in California and Oklahoma. "I asked her point-blank, 'Do you want this grubby job or not? Why do you want this thing?' " her brother David Herring said. He said it was clear that if she were to end up leading the consumer bureau, it would be out of a sense of duty.

Warren's daughter and co-author on two books, Amelia Warren Tyagi, agreed that her mother has little appetite for politics or public life, and only her passion for consumer issues and the urgency of the crisis have kept her from returning to her quiet, tenured life at Harvard. "This is a once-in-a-lifetime moment to do the thing she cares about most," Tyagi said. "If she didn't think she could make a difference in Washington right now, she wouldn't be there."

The Big Interview with David Rosenberg 8/13/2010 9:29:12 AM
In an interview with WSJ's Kelly Evans, Gluskin Sheff's Chief Economist David Rosenberg warned that the chances of a double-dip recession are greater than 50-50 and that the recession may not have ended last year at all. He also called for the cutting of corporate taxes to spur job growth.

The Power Trip
by Jonah Lehrer - Wall Street Journal

When CEO Mark Hurd resigned from Hewlett-Packard last week in light of ethics violations, many people expressed surprise. Mr. Hurd, after all, was known as an unusually effective and straight-laced executive. But the public shouldn't have been so shocked. From prostitution scandals to corruption allegations to the steady drumbeat of charges against corporate executives and world-class athletes, it seems that the headlines are filled with the latest misstep of someone in a position of power. This isn't just anecdotal: Surveys of organizations find that the vast majority of rude and inappropriate behaviors, such as the shouting of profanities, come from the offices of those with the most authority.

Psychologists refer to this as the paradox of power. The very traits that helped leaders accumulate control in the first place all but disappear once they rise to power. Instead of being polite, honest and outgoing, they become impulsive, reckless and rude. In some cases, these new habits can help a leader be more decisive and single-minded, or more likely to make choices that will be profitable regardless of their popularity. One recent study found that overconfident CEOs were more likely to pursue innovation and take their companies in new technological directions. Unchecked, however, these instincts can lead to a big fall.

But first, the good news. A few years ago, Dacher Keltner, a psychologist at the University of California, Berkeley, began interviewing freshmen at a large dorm on the Berkeley campus. He gave them free pizza and a survey, which asked them to provide their first impressions of every other student in the dorm. Mr. Keltner returned at the end of the school year with the same survey and more free pizza. According to the survey, the students at the top of the social hierarchy—they were the most "powerful" and respected—were also the most considerate and outgoing, and scored highest on measures of agreeableness and extroversion. In other words, the nice guys finished first.

This result isn't unique to Berkeley undergrads. Other studies have found similar results in the military, corporations and politics. "People give authority to people that they genuinely like," says Mr. Keltner. Of course, these scientific findings contradict the cliché of power, which is that the only way to rise to the top is to engage in self-serving and morally dubious behavior. In "The Prince," a treatise on the art of politics, the 16th century Italian philosopher Niccolo Machiavelli insisted that compassion got in the way of eminence. If a leader has to choose between being feared or being loved, Machiavelli insisted that the leader should always go with fear. Love is overrated.

That may not be the best advice. Another study conducted by Mr. Keltner and Cameron Anderson, a professor at the Haas School of Business, measured "Machiavellian" tendencies, such as the willingness to spread malicious gossip, in a group of sorority sisters. It turned out that the Machiavellian sorority members were quickly identified by the group and isolated. Nobody liked them, and so they never became powerful.

There is something deeply uplifting about this research. It's reassuring to think that the surest way to accumulate power is to do unto others as you would have them do unto you. In recent years, this theme has even been extended to non-human primates, such as chimpanzees. Frans de Waal, a primatologist at Emory University, has observed that the size and strength of male chimps is an extremely poor predictor of which animals will dominate the troop. Instead, the ability to forge social connections and engage in "diplomacy" is often much more important.

Now for the bad news, which concerns what happens when all those nice guys actually get in power. While a little compassion might help us climb the social ladder, once we're at the top we end up morphing into a very different kind of beast. "It's an incredibly consistent effect," Mr. Keltner says. "When you give people power, they basically start acting like fools. They flirt inappropriately, tease in a hostile fashion, and become totally impulsive." Mr. Keltner compares the feeling of power to brain damage, noting that people with lots of authority tend to behave like neurological patients with a damaged orbito-frontal lobe, a brain area that's crucial for empathy and decision-making. Even the most virtuous people can be undone by the corner office.

Why does power lead people to flirt with interns and solicit bribes and fudge financial documents? According to psychologists, one of the main problems with authority is that it makes us less sympathetic to the concerns and emotions of others. For instance, several studies have found that people in positions of authority are more likely to rely on stereotypes and generalizations when judging other people. They also spend much less time making eye contact, at least when a person without power is talking.

Consider a recent study led by Adam Galinsky, a psychologist at Northwestern University. Mr. Galinsky and colleagues began by asking subjects to either describe an experience in which they had lots of power or a time when they felt utterly powerless. Then the psychologists asked the subjects to draw the letter E on their foreheads. Those primed with feelings of power were much more likely to draw the letter backwards, at least when seen by another person. Mr. Galinsky argues that this effect is triggered by the myopia of power, which makes it much harder to imagine the world from the perspective of someone else. We draw the letter backwards because we don't care about the viewpoint of others.

Of course, power doesn't turn everyone into ruthless, immoral tyrants. Some leaders just end up being tough, which isn't always a bad thing. The key is keeping those qualities in balance. At its worst, power can turn us into hypocrites. In a 2009 study, Mr. Galinsky asked subjects to think about either an experience of power or powerlessness. The students were then divided into two groups. The first group was told to rate, on a nine-point scale, the moral seriousness of misreporting travel expenses at work. The second group was asked to participate in a game of dice, in which the results of the dice determined the number of lottery tickets each student received. A higher roll led to more tickets.

Participants in the high-power group considered the misreporting of travel expenses to be a significantly worse offense. However, the game of dice produced a completely contradictory result. In this instance, people in the high-power group reported, on average, a statistically improbable result, with an average dice score that was 20% above that expected by random chance. (The powerless group, in contrast, reported only slightly elevated dice results.) This strongly suggests that they were lying about their actual scores, fudging the numbers to get a few extra tickets.

Although people almost always know the right thing to do—cheating is wrong—their sense of power makes it easier to rationalize away the ethical lapse. For instance, when the psychologists asked the subjects (in both low- and high-power conditions) how they would judge an individual who drove too fast when late for an appointment, people in the high-power group consistently said it was worse when others committed those crimes than when they did themselves. In other words, the feeling of eminence led people to conclude that they had a good reason for speeding—they're important people, with important things to do—but that everyone else should follow the posted signs.

The same flawed thought processes triggered by authority also distort our ability to evaluate information and make complex decisions. In a recent study led by Richard Petty, a psychologist at Ohio State, undergraduates role-played a scenario between a boss and an underling. Then the students were exposed to a fake advertisement for a mobile phone. Some of the ads featured strong arguments for buying the phone, such as its long-lasting battery, while other ads featured weak or nonsensical arguments. Interestingly, students that pretended to be the boss were far less sensitive to the quality of the argument. It's as if it didn't even matter what the ad said—their minds had already been made up.

This suggests that even fleeting feelings of power can dramatically change the way people respond to information. Instead of analyzing the strength of the argument, those with authority focus on whether or not the argument confirms what they already believe. If it doesn't, then the facts are conveniently ignored.

Deborah Gruenfeld, a psychologist at the Stanford Business School, demonstrated a similar principle by analyzing more than 1,000 decisions handed down by the United States Supreme Court between 1953 and 1993. She found that, as justices gained power on the court, or became part of a majority coalition, their written opinions tended to become less complex and nuanced. They considered fewer perspectives and possible outcomes. Of course, the opinions written from the majority position are what actually become the law of the land.

It's not all bad news for those in authority. Mr. Galinsky has found that under certain conditions, power can lead people to make fewer mistakes on tedious tasks, such as matching a color with its correct description. After all, if you're powerless, why bother?

There is no easy cure for the paradox of power. Mr. Keltner argues that the best treatment is transparency, and that the worst abuses of power can be prevented when people know they're being monitored. This suggests that the mere existence of a regulatory watchdog or an active board of directors can help discourage people from doing bad things. However, people in power tend to reliably overestimate their moral virtue, which leads them to stifle oversight. They lobby against regulators, and fill corporate boards with their friends. The end result is sometimes power at its most dangerous.

That, at least, is the lesson of a classic experiment by the economist Vernon Smith and colleagues. The study involved the dictator game, a simple economic exchange in which one person—the "dictator"—is given $10 and asked to divide the cash with another person. Although the dictators aren't obligated to share—they are in a position of pure power—a significant majority of people act generously, and give away $2 or more to a perfect stranger.

There is one very simple tweak that erases this benevolence. When the "dictators" are socially isolated—this can occur, for instance, if the subjects are located in separate rooms, or if they're assured anonymity—more than 60% of people keep all of the money. Instead of sharing the cash with someone else, they pocket the $10. Perhaps the corner office could use a few more windows.

Pakistan flood crisis raises fears of country's collapse
by Saeed Shah and Jonathan S. Landay - McClatchy Newspapers

The humanitarian and economic disaster caused by the worst floods in Pakistan's history could spark political unrest that could destabilize the government, dealing a major blow to the Obama administration's efforts to fight violent Islamic extremism. The government's shambling response to floods that have affected a third of the country has some analysts saying that President Asif Ali Zardari could be forced from office, possibly by the military, which has ruled Pakistan for more than half its 63-year history.

Other experts caution that the state itself could collapse, as hunger and destitution trigger explosions of popular anger that was already seething over massive unemployment, high fuel prices, widespread power outages, corruption, and a bloody insurgency by extremists allied with al Qaida. "The powers that be, that is the military and bureaucratic establishment, are mulling the formation of a national government, with or without the PPP (Zardari's ruling Pakistan Peoples Party)," said Najam Sethi, the editor of the weekly Friday Times. "I know this is definitely being discussed. "There is a perception in the army that you need good governance to get out of the economic crisis and there is no good governance," he said.

The Obama administration stepped up emergency aid this week to $76 million, anxious to counter the influence of Islamic extremist groups that are feeding and housing victims through charitable front organizations in areas the government hasn't reached. Some U.S. officials worry that those groups could exploit the crisis to recruit new members and bolster their fight to impose hard-line Islamic rule on nuclear-armed Pakistan. "I think the mid- to long-term radicalization threat accelerates because of the mass migration and the frustration that is coming from this," said Thomas Lynch, a research fellow at the National Defense University in Washington.

Pakistan is battling militant groups led by the Pakistani Taliban, whose strongholds on the country's northwestern fringe also provide bases to al Qaida, the Afghan Taliban and allied extremists fighting NATO and Afghan troops in neighboring Afghanistan. The Pentagon announced Friday that a three-ship taskforce carrying 2,000 Marines, Osprey tilt-rotor aircraft, transport helicopters and relief supplies is sailing for Pakistan. It will replace the U.S.S. Peleliu, an amphibious assault vessel steaming off the port of Karachi that's lent 19 helicopters and 1,000 Marines to the aid operations.

U.S. officials, who requested anonymity so they could speak more freely, downplayed the threat of near-term political upheaval, and they dismissed the danger of a coup, saying that the army chief, Gen. Ashfaq Kayani, wants the military out of politics. "The military is perfectly happy to let the civilian government screw up," one U.S. official said. "The military does not want to take over because they get blamed for all the deficiencies in government."

The potential for serious turmoil, these U.S. officials said, will grow after the floods subside. Then the government must grapple with the task of rebuilding roads, bridges and other infrastructure and caring for millions of impoverished, mostly rural people who've lost their homes, crops and livestock. "The Pakistani military quickly mobilized to support relief efforts in areas affected by the floods, and . . . seems to be handling things effectively," a second U.S. official said. "The popular ire so far seems directed at the (government). As with any natural disaster, the reconstruction phase can be a challenge, and that's when Pakistan's civilian agencies will need to step up to the plate. That'll be the real test."

The floods have affected 14 million people, of whom at least 1,600 have died and some 3 million have been left homeless. However, the impact will be felt throughout the impoverished country of 180 million. The World Bank said Friday that an estimated $1 billion worth of crops have been wiped out, raising the specter of food shortages. Damage to irrigation canals, the bank added, will reduce crop yields once the floodwaters are gone.

The situation worsened Friday as authorities ordered the evacuation of Jacobabad, a city of 1.4 million people in southern Sindh province, and forecasters warned that fresh monsoon rains in the mountainous northwest would send a new wave of flooding south down the central Indus River valley over the weekend. The PPP-led government came to power in 2008 elections that ended the last bout of military rule, which lasted eight years under Gen. Pervez Musharraf.

An economic slide that began just as the Musharraf era was ending has significantly worsened and the current administration is surviving on an International Monetary Fund bailout. It says that the floods could halve economic growth and force it to divert funds from development programs to relief efforts. Zardari, who went on with a high-rolling official visit to France and Britain while his country grappled with its worst-ever natural disaster, is the focus of much of the anger over the government's inability to cope. He assumed control of the PPP after the assassination of his wife, former Prime Minister Benazir Bhutto, in December 2007.

Only the courts could legally dismiss him and the government. However, the PPP rules through a minority government, and behind-the-scenes military pressure on its coalition partners could bring it down, forcing new elections, Sethi said. Another outright coup is considered unlikely, but few people rule it out entirely. "If the military takes over now, I can assure you that it will be the end of Pakistan, an end which will be punctuated by a very bloody civil war," said Asad Sayeed, a political analyst. "Pakistan is a very divided country right now."

Pakistan has lurched from crisis to crisis. Its most painful episode was the break-up of the country in 1971, when then-East Pakistan seceded and became Bangladesh. The bloody uprising in East Pakistan received a final push from Islamabad's poor response to a 1970 cyclone that killed an estimated 500,000 people. While there is no equivalent secessionist movement in what's left of Pakistan, some experts worry that the floods could boost popular support for hardline Islamists.

"Within months of Cyclone Bhola, an ideology — Bengali nationalism — feeding off economic deprivation and post-disaster hopelessness took half the country away," columnist Moazzam Hussain reminded readers on Friday in Dawn, the main English-language daily. "This time, a renegade religious ideology — feeding off the consequences of the present disaster — is drooling to take away the remainder."


Draft said...

Stoneleigh -

I've heard you make the comment that folks should invest in short term government debt via treasurydirect in addition to keeping cash.

But is there a way to put money into and take it out of treasurydirect without doing so via a bank account? Because I thought the main point of putting money in treasurydirect was to avoid keeping money in a regular bank.

--- said...

"Don't go in the water, and don't eat the fish."

John said...

Geart intro. So if deflation is being sensible, then inflation is being being "nuts", right? I guess the FEDS have been wanting us to be "nuts" all these years and maybe we are finally beating them at their own game and they are going "nuts". Nice to know we can get back at them in such a sensible way as saving for a rainy day. John

RobertM said...

That is a very nice explanation of deflation. What is doesn't mention is why our monetary system is based on debt instead of wealth. We would not be having most of these problems if not for that fact.

woodsy_gardener said...

Mobile Web question for the board.

In October I'll be moving off grid. I have 12 volt solar power for light, radio, music, and recharging my cell phone. I'll miss my internet connection but would be happy if I could receive just 3 sites on a Mobile Web cell phone: Yahoo Email, TOD Drumbeat, and TAE.

Is this possible with current Mobile Web phones?

jal said...

@ Aaron Wissner:

Nice simple explanation.

Here is the part that I liked ...

“ ... The money supply, or credit supply, is shrinking because few loans are being created, ... “

Too many people think that by having the gov. doing the borrowing that the economy will go back to where it had been.
The closed cycle of the gov. doing the borrowing and banks doing the lending is not helping the economy.
It is replenishing the justification for bigger bonuses.
It is making some liquidity available for institutional investors to pay out their depositors without declaring bankruptcy.

Keep your eye on the ramifications of the flood in Pakistan. It will be a game changer for the power brokers.


Lynne said...

Thank you Ilargi, Stoneleigh and Aaron!

That essay definitely resonated with me, and my own spending, saving and thinking has changed in very similar ways....I'll try to make this quick.

1) Doubling savings because we don't believe that I will have my pension.

2) Got completely out of debt and not willing to take on any more for any reason - i,e, bought used inexpensive car clear after my accident instead of new car with payments.

3) Taking short day trips rather than expensive vacations.

4) (Mostly) spending on "physical things we think we'll need" like garden tools, food preservation equipment, etc.

5) Eat out very rarely.

6) Like Aaron, we no longer list out "assets" as part of our net worth, just our cash.

7) I also have concerns about banks - which was once unheard of in Canada. I try not to spread this particular fear around.

There are more sensible things that we do. But we also do some super dumb things like in April we bought furniture. We already had some furniture, but this stuff matches. I don't really think it was coincidence that we did that when the market rally peaked. We're such little herd animals. I guess the first step is admitting you have a problem....

Thanks again.

Shamba said...

Thanks for the article and welcome to the new guest author. :)

FYI: There's an interesting and frightening article at Zero Hedge this morning.


This organization is focused more on hyper inflation than deflation but the interest is in how much contraction they think we will have to go through in the next decades and how our Western standard of living will decline.

peace to all, Shamba

Bigelow said...

“The only problem with being Bearish on the stock market now is that everyone else is Bearish, too.”
A Note on Sentiment (The Bullish Case for Stocks Part 1) -Charles Hugh Smith

Anonymous said...


Great expose! Thank you.

Do keep your savings out of banks, though. Too risky since banks are insolvent and might freeze withdrawals anytime. Keep your savings close to your chest, as Stoneleigh has said. :)

Bigelow said...

“I see things differently - and view this week's decision by the Bernanke Federal Reserve as yet another dangerous leap into experimental monetary management. Market perceptions remain the key facet of Bubble analysis - and not week-to-week changes in Fed holdings.

Not many weeks ago the focus was on the Fed's "exit strategy." Apparently, policymakers now recognize that there is no way out. It was suppose to have been a case of the Federal Reserve having used its balance sheet as an extraordinary policy tool in response to the 2008 Credit seizure, with the Fed dedicated to unwinding this unprecedented stimulus as the system stabilized. Today, not only is the Fed unwilling to normalize its securities holdings, it has signaled to the markets that it is able and willing to expand its balance sheet on an as needed basis. At least that's the way the markets will see things: the Fed is there ready to act quickly and forcefully as a reliable system backstop. No more worries about "exit" issues; and as the debt markets turn increasingly overheated, it's sure comforting to know the Fed is there to ensure marketplace liquidity. This is a very big deal.”

So Much for the Exit Strategy Doug Noland

Robert said...

Wissner notes: "The amount of coins and dollar bills in the economy are a very, very small fraction of the total amount of money out there."

What is to prevent the US from increasing the production of $100 bills or perhaps even introducing a $500 bill to compete with the 500 Euro banknote?

el gallinazo said...


There is no way to get your money out of without it going through a corresponding bank. But you can have any number of corresponding banks and can add new ones to your account as the old ones go belly up. You can also keep your money in an interest free account there available for immediate extraction. So when TSHTF, the game will be to find a bank that will give you the money in Franklin's when your wires the money. Giving the branch manager one of Ben's portraits (Franklin - not Bernanker) to grease the skids might help. Just keep the money in the treasury until you feel that you can convert it successfully. Pull out a small test run before anything big. Put your hat on a stick and raise it above the ridge line.

Stoneleigh recommends for Usakistanis you have too much cash to conveniently bury it. But you should keep enough cash for 6 months so you can choose the right time and bank to try to cash out of T-Bills as needed. Be alert. Like sex nowadays, some things are safer - nothing is safe.

Bigelow said...

“It should be no surprise that a nation growing 10 percent has a healthy gray economy running in parallel. That’s what happens when an all-powerful, top-down government mixes with vast supplies of capital. Crony capital thrives, be it kickbacks from construction projects, gifts to officials at weddings, payoffs from state monopolies such as the tobacco industry or spreading profits from land transfers.”
Beware $1 Trillion Lying Under Chinese Mattress

el gallinazo said...

@Aaron Wissner

Very good article. Comprehensive and down to earth.


I recommend that all Usakistani's turning 62 put in for their (reduced) SS benefits even if they have to hand half of them back in taxes for a year or two if they are still working.

Billy Preston sang:

Nothin' from nothin' leaves nothin'
You gotta have somethin'
If you wanna be with me

I figure 80% of somethin' is a lot bigger than 100% of nothin'.

scandia said...

Very interesting headline:
Harvard University fund sells all Israel holdings

unkle.smokey said...

I am trying to make sense of how to manage what little I have, so I have a question: My retirement is "self-managed" meaning I get to decide if it is in stocks, equities, bonds, etc. I moved it all to bonds quite some time ago, but after reading TAE I am thinking I should cash it out. That would mean a 10% penalty since I am under 59 1/2 as well as increased taxes. Are bonds subject to a bubble/bust like everything else? Is this something I should consider?

daniel.swint said...

Aaron: "the last time there was a major crash in the markets, back in 1929, the President of USA ordered all the safe-deposit boxes sealed, and all the gold coins confiscated and sold for a rate that the Government selected. (See Executive Order 6102)"

Actually, that executive order was signed in April 1933 and did not order the sealing of safe deposit boxes or confiscation of gold coins. It did order people to deliver their gold to a Federal Reserve Bank or FRB institution for a set price and said not doing so could result in a fine up to $10,000 and/or up to 10 years in jail. See the following link:

snuffy said...

Being just back from a fast trip to San Fransisco,I walked into this post after having spent a day in the fast-track calf.sunshine.I went though a area I had not been in 20 years,and saw a graphic example of the cancerous growth that hit California.Astonishment would cover it nicely.I could judge the same growth in the northwest,as I had observed it,slowly,but the "Head picture" I had of the bay area was one of twenty years in the past.
I suppose that cancerous growth is now what we will be paying for...endless malls,shopping centers,big-box serve...whom?Are we to open the gates wide to everyone who wants to live in America,trusting a new prosperity to come from millions of new emigrants with nothing but a dream,and the work ethic of whatever land they come from?All the clerks and "worker bees"I saw in the restaurants,gas islands, and retail were Mexican,and one heard Spanish,as often as English everywhere.One of the ongoing jokes in califonia is that"Everyone is from somewhere else".
I left the area with a deep discomfort,and wondered what will be the effect of the winter that we are now seeing come to the economy,on that wall-to-wall city from San Rafael to San Fransisco.The only change I saw to let you know your into a new city on the road is a sign....with the population of the area.

Now I am back at my little place in the woods 640 miles away,I can look back with relief,knowing that distance does help to bring perspective.I am worried about my family down there,but trust the judgment of a girl-child who has shown the wit to make a good place for herself,and wisdom to keep her eyes open to whats going on...

Its starting to look like the fuse is set for the fall..I don't know what will be the trigger,but the floods in Pakistan are making the desperate lives of those tribes living in "the Kush" even more problematic than normal.A friend in college was a exchange student who told me stories of his land.The areas where this flooding is happening is tribal,where everyone is armed,and deeply religious.Outsiders are not allowed mostly because when you cross the locals,you get shot dead,end of story.
With this sort of backdrop it would be easy for the ones who want trouble to say the floods are a punishment for lack of action against the American presence.Whipping up frenzied hate of outsiders is not hard when the population is wet cold,hungry and pissed at the world in general.And,just as icing on the cake,the Pakistanis have nukes.

The wobbles and waves get higher,and more uncertainty creeps into out lives daily.

I need to go work with my bees..

Bee good,or
Bee careful


VK said...

Hey Greenpa, if you're around, I think it was you who made available a link to a DIY wood gas generator last year. Was wondering if you could post the link again? Thanks. Also, the 10 year is smoking hot,up 38pc since April. There's a huge disconnect between the bond market and equities at present. I reckon bonds will sell off at some point but after reaching as low as 1-1.5pc initially as people flee from the peripheries, stocks and most corporate bonds. Should be a an interesting few months ahead. Most bears are quite scared of a big rally after being battered for more than a year. Fundamentals are about to trump sentimentals - debt liquidation.

Mr. Kowalski said...

While I agree with you folks and completely disagree with Paul Krugman, he might've been right in a recent article of his comparing this economic time with the "Long Depression" of the late 1800s.

By early next year, with a divided Congress and absolutely no hope for any more Keynesian "stimulus" packages, deflation's iron headlock with clamp down harder and harder, with Bernanke and Obama helplessly watching their careers {and our economy} crumble to dust:

Mr. Kowalski said...

Why on earth would anyone invest in treasuries ? Is 2%/yr over ten years really all that ?

If you're lookin for something better, try short S&P ETF's. Just because a particular market is going down does'nt mean you can't make money on the short side.

el gallinazo said...

re Krugman on Social Security today:

A friend emailed the article. My reply read:

Krugman is such a naive boy scout. If he lived 70 years ago in Poland, he would have objected to the SS-Totenkopfverbände commandant turning on the Zyklon B in his shower stall on a minor technicality as the thug pistol whipped him. The SS trust fund (you can take your pick as to which SS) was a Reagan led ruse to tax the shit out of the working poor while keeping the fiction of a progressive income tax in place. But Ole Bessie ain't producing surplus milk to pay for her feed this year, so its off to the slaughterhouse along Oligarch Avenue. And her haunches will wind up on Lord Blankfein's dish. Why do we have such freaking Ph.D. idiots bombarding us with effluvia from the Toilet Paper of Record?

el gallinazo said...

Re shorting the current market

I am currently short the S&P with ETF's, but this is still by no means a sure shot. In my case, there is no leverage, so I can't be squeezed).

However, the market is so rigged now by the Fed giving the PD's leveraged free money to pump the futures after hours, that I am beginning to suspect that all the retail could pull out 100% and the Coyote would still be walking on air. Of course, it doesn't mean bupkas unless you're a player, and even J6P is beginning to figure that out. The real economy will continue to implode.

The PD's must be holding a giant bag of dog droppings with all these S&P future longs, and as the retail market gets more pessimistic, I am wondering how many greater fools they can find to unload this stuff on. Maybe they will just unload it on the Fed (or maybe the Fed is now bypassing the PD's and putting its own bets directly down of the green velvet from 33 Liberty as Durden surmises.)

And then there is the issue of the junk bond frenzy. Is this some type of death wish? Who could be stupid enough to buy this shite? We are talking 6 month Ponzi explosion here. Someone must be desperate for some return. Reminds me of a guy dying of lung cancer sticking that last Marlboro in the hole in his throat.

Fuser said...

Nice post Aaron. I like your writing style.

Anonymous said...

RE: el gazzinazo, stock market

your comment about the retail investors are correct. the big boys are basically pig farmers selling the same pig back and forth driving up the price. their just hoping they're not the last bag or pig holder :-)

tooearly said...

"But I've very recently realized that if there were a banking system failure, and people only had cash and gold coins to use as money, that the value of those coins would drop like a stone, because all the people that end up running out of cash would then be pulling out their coins to use as money, and this would happen all at once."

does not compute.

VK said...

Why on earth would anyone invest in treasuries ? Is 2%/yr over ten years really all that ?

A near 40pc capital appreciation in a few months? :)

Hugh Hendry always reckoned that the end of the bond bubble would be spectacular, fireworks. We'd see a massive flight to safety into bonds and than - bang, a big sell off.

The worst of all worlds is a bond sell off and a stock sell off, this would bring despair. I still think there is room for this bond rally, they can still scare some money from stocks, junks and peripheries into bonds. Should be quite a show!

Richard T. Haard said...

Long time reader, lone comment today about Aron's excellent posting. In addition, farmers make 'new money' out of the earth, sun and water. True the scale does not compare to 'debt' though perhaps this is the new revolution

What he writes is what I am also about.

andrew said...

Ilargi, this guy Aaron Wissner is special! I got the impression that he is a teacher. He makes me proud to be a teacher just to share the same profession with him.

What a brilliantly clear and straightforward explanation of deflation! All credit (no pun intended) to Stoneleigh but I feel like I understand the concept better than ever now.

soundOfSilence said...


M1 (basically “cash in circulation”) has historically increased at a slow plodding rate. Up until 06/08 it’s a pretty flat slope ... and even the last 2 years, I didn’t plot it, but the rate of change doesn’t appear to be going “hog wild.”

This is somewhat of an over simplification; but based on the current population (308 million) if I’m doing the math right –last month there was $5,580.00 give or take in “paper money” in circulation for every man, woman and child in Usastain.

Yeah they could release more Franklins or pick a president and put him on a 500. At the end of the day that’s not going make much of a change in the amount of toilet paper per person floating around out there. I mean unless they decide to come out with a billion note and start dropping them from helicopters :-). At the end of the day 98% of the money out there is credit.

Alexander Ac said...

I got a reaction to the Stoneleigh’s previous blog from an economist and he said the it is being compared uncomparable and sent a link to a “more realistic” comparison of current problems with 1929/30 from VOX economists…:

Global industrial production continues to recover – something for which policy deserves considerable credit….

Ilargi said...

"I got a reaction to the Stoneleigh’s previous blog from an economist and he said the it is being compared uncomparable and sent a link to a “more realistic” comparison of current problems with 1929/30 from VOX economists…:"

He obviously hasn't read Stoneleigh's piece, so what else is there to say? Apples and oranges?

"Global industrial production continues to recover – something for which policy deserves considerable credit…."

Funny that that is the one single meaningful graph, among many, that shows today as being less severe than the great Depression.

Stop talking to economists, they're a deluded crowd.


Unknown said...

I just came across this interesting statistic on the level of current accounts per country. Everybody should think what it means to them. Guess where UK and US are.

Unknown said...

There's an important part of Stoneleigh's advice that you are missing here.

We got to most of the points you mention about 8 years ago. So while others treated their homes as ATM's and increased their debt load, we paid ours down till it vanished as she advised. When governments all over the world started "guaranteeing" deposits, I started easing out some cash to give us about a month's worth of spending ability even when the banks failed, as she advised.

Oh, and when we moved into our new home for which we paid a little over the odds in 2007, we immediately wrote its value down to zero. We could afford to do that because we had no mortgage, but we also did it to remind us that our home is a place to live and eat and grow food and make things we need. It is not an "investment" of any kind beyond the most practical investment in our security.

But we have now moved to the next phase which is turning as much of this fictional money as we can into hard goods because there is no point in having "savings" in banks that fail and keeping too much cash is not safe anyway.

So we are converting that cash into tools, screws, glues, lubricants and sealants, seeds, fertilisers and lumber.

We are doing that now because, while an effect of deflation is falling prices, they are accompanied by failing businesses and there is no point waiting for the lowest possible price for something only to find that the company has failed and the products you really need are not available at any price. If you have the cash and see a future need for something, get it now, even if you pay a little more for it than you might theoretically get it for in 6 months or a year. It is better to be 6 months early than 5 minutes late.

We are also converting our time into learning opportunities; learning how to grow and preserve stuff, how to make and repair things.

The idea of financial investments is a punchline around here and not to be used in any serious discussion about the state of the world. If we truly believe the things that we read on TAE, we should be stepping away from the screen and getting to work.

Alexander Ac said...


thanks, I tend to agree - even without reading TAE - only that sometimes one can find also reasonable economists, but unfortunately not too often - like Herman Daly, Cutler Cleveland, and those others who to not see economic growth as useful or necessary..


Tom Therramus said...

Aaron's article is a model of clarity.

This being said, my intuition is that a Manichean division between deflation vs inflation oversimplifies our present parlous situation.

This perhaps speaks to the weakness of Aaron's essay. Its lucidity stems from it narrow perspective. Its very much about him and very much a story of an American middle class individual of the last few years.

If one broadens ones aperture, there is a data that the global situation is complex and non-uniform.

In a few examples

- There is evidence of growing inflation in the UK and EU - driven apparently largely by energy pricees

- There is ongoing growth of China and other Asian economies

- There is relentless upward pressure on commodity prices and the demands of a global population that will double again in coming years.

Even the US showed not fall, but a small upward blip in core inflation rate in the last month.

I just have not made up my mind yet as to what is going on or how to label it. Aaron's article is good read, but I have the gnawing feeling that he and perhaps the rest of us are missing something that perhaps may even not have a name yet.

Tom Therramus

Ilargi said...


"- There is evidence of growing inflation in the UK and EU - driven apparently largely by energy prices"

There is no inflation in the UK and US. There are select rising prices, but they have nothing to do with inflation. The "misunderstanding" is the result of a longstanding and likely deliberate misuse of the term inflation.

To follow your example, we would need to speak of energy inflation. And if only oil prices rise, we's say oil inflation. If only diesel prices rise, we get to diesel inflation. If it's only farm diesel, we have farm diesel inflation. And if farm diesel prices rise only in Michigan County, we have Michigan County farm diesel inflation.

Ad infinitum, well before the end of which we may hope people detect the absurdity.

When 15 years ago, when the economy was clearly still inflationary, computer components got cheaper all the time, how many times have you heard the term "computer component deflation"? Probably never. So why now "energy inflation" while the M3 money supply is shrinking at 8% annualized?


Unknown said...

That's a very interesting article on the FED and the money mulitplier. I'm still having trouble understanding something from yesterday. Maybe someone could help me with this?

“In QE, aside from its usual record keeping activities, the Fed converts overnight reserves into treasuries, forcing the private sector out of its savings and into cash. This is just a large-scale version of the coupon-passes it needed to do all along. Again, they force people out of treasuries and into cash and reserves.”

Shouldn't that first statement be reversed? A coupon pass is a purchase of Treasury notes or bonds by the Fed and the textbook definition says QE increases the reserves held by those purchases (forcing the private sector out of its savings (Treasury notes or bonds) and into cash).

So shouldn't the first statement say:
In QE, aside from its usual record keeping activities, the Fed converts treasuries into overnight reserves?

I'm not getting the logic here. Could someone explain in better detail?

ogardener said...

Haven't you all been distracted by those Moslems trying to build a Mosque at ground zero while the bankers and O'Bummer are surreptitiously planning on how to pull the financial rug further from under us? Privatize social security indeed. That's quite a racket they have going with the MSM eh? And I think that's really an achievement by the MSM getting the people to believe the911 was perpetrated by Muslim Afghani goat herders living in caves without electricity and running water. But hey, I still haven't found the Boeing yet at the Pentagon or understand why there was no jet wreckage in that Pennsylvania farm field. I suspect Aliens (those illegal kind) had a hand in it. Cause it's no fun being an illegal alien.

Eric Lilius said...

Joe Bageant has a new post up:
Understanding America's Class System
Honk if you love caviar

Wyote said...

Thanks for the home based article on deflation Aaron. Well written and heartfelt.

New Joe Bageant posted.

Anonymous said...

Mr. Kowalski, the situation is more complex than you appear to realize.

I recommend starting by reading things like this: The Tradition Of Mindless Stock Ramping On Fed POMO Days Is Back. No, the market is not "free" and yes, the market is rigged, quite deliberately. Shorting this market based on "fundamentals" is suicide right now because the central planners are going to do everything they can think of to maintain the fiction of recovery, and a rising or at least stable stock market is a large psychological lynchpin in that operation.

Because of the above, if you are investing to "make money" in this mess, you are likely going to lose, possibly big time. Right now the logical focus is on preservation of capital, which is why many people have turned to US bonds. If you look at the third chart in Karl Denninger's How Did The Word "Ponzi" Get Into The MSM? article, you can see the extent of deleveraging thus far in the third graph down in the article.

Regarding deleveraging, first, it is important to note that the deleveraging apparent in that graph has never happened on the current scale before. This tells me that we've reached a cusp in behavior and trend. Second, it is more important to note that the deleveraging that has actually occurred thus far is just a tiny fraction of the total systemic debt in the United States. This tells me we have a massive distance yet to fall in deleveraging to return to historic norms. And, as I&S both tend to note, returns to historic norms after periods of mania are often accompanied by hard overshoots to the downside.

Now look at that graph and tell me what is going to happen if that trend continues. Then look at the Fed POMO actions and the desperation apparent in those actions to play pump monkey in the stock market as a psyops warfare tool against the masses.

The number one financial priority right now for any sane person has to be (after making preparations for a vastly changed world) the retention of capital. If you make some money on the side, ok, but far more important is to not lose money.

Only after we've run way down that graph's downward leg will the possibility of hyperinflation open up. Until then deflation is the rule and a 2% nominal yield might be anywhere from a 3%-5% real yield if GDP resumes contracting at a rate of 1-3% per year (or even more).

So yes, bonds make lots of sense right now, unless you believe the calls of "green shoots" and other such nonsense. And if you believe that, then we can't even have a logical conversation.

jal said...

GEE! The markets are up today. Good time to cash out.


Where will the institutions get the money?

SELL their bad, non performing stocks ... BUY the IPO

Tom Therramus said...

Hi Ilargi,

...."There is no inflation in the UK and US."

Since hitting a low in Sep 2009 according to the Bank of England the month on month inflation rates (CPI) in the UK have been...

2009 Sep 1.0879%
2009 Oct 1.5455%
2009 Nov 1.9108%
2009 Dec 2.8311%
2010 Jan 3.4039%
2010 Feb 3.0109%
2010 Mar 3.3698%
2010 April 3.7239%
2010 May 3.3424%
2010 June 3.2432%
2010 July 3.0658%

Over a comparable period the Bureau of Labor Statistics in the USA the month on month inflation rate (CPI) is.

2009 Sep (-1.29%)
2009 Oct ( -0.18%)
2009 Nov 2.72%
2009 Dec 1.84%
2010 Jan 2.63%
2010 Feb 2.14%
2010 Mar 2.31%
2010 April 2.24%
2010 May 2.02%
2010 June 1.05%
2010 July 1.24%

The upward trend in the CPI for both the UK and US over this period is unmistakable, albeit that it is somewhat more pronounced for the UK.

...."There are select rising prices, but they have nothing to do with inflation."

The trends shown are the core inflation rates - and in the US CPI is not confounded by energy and housing inputs. They are broad rather than select indices of rising costs in the economy.

...."The "misunderstanding" is the result of a longstanding and likely deliberate misuse of the term inflation."

With all due respect, I'm having a hard time letting you have it both ways i.e., by suggesting that there is no inflation in the UK, when there quantifiably appears to be and then suggesting that the numbers aren't to believed in any case.

To re-iterate my original position, I remain cautious (and also more than a little curious) on whether what we are seeing develop fits into accepted models of how the economy work viz-a-viz inflation/deflation or whether something new is afoot here.

Agnostically yours,

Tom Therramus

Ilargi said...

That's just what I'm saying, Tom, they use a definition of inflation that's faulty.


Bukko Boomeranger said...

Earl said...

So we are converting that cash into tools, screws, glues, lubricants and sealants, seeds, fertilisers and lumber.

In the Grim World of the Afterscape, nails and screws would make a good currency! Useful for practical purposes, but also as a medium of small-change exchange. A 10-penny nail could be worth 10 cents in the world to come. If you can't afford gold and silver, stockpile nuts and bolts...

Stoneleigh said...


Rising prices (CPI) do not constitute inflation. Prices rises are lagging indicators of inflation (which is an increase in the supply of money and credit relative to available goods and services), complicated by other major and minor factors (such as global wage arbitrage or local scarcity). Prices have been rising as a lagging indicator of the rally we have experienced.

Using CPI changes as inflation takes all the explanatory and predictive power out of the concept.

Stoneleigh said...


Great :)

I agree that for those who can afford to do so, holding hard goods is a good idea. Being able to afford it means already holding no debt and having some cash reserves, as in your case. It means being able to buy yourself learning curve time, and that's important.

Even for those with less resources, it makes sense to secure access to things which are relatively cheap now and may be unavailable later. The harder decisions relate to things (such as land) which most could only afford with debt at today's prices. For larger items, people will have to wait until prices fall to a level they can afford.

Stoneleigh said...


Are you much younger than than 59.5 or quite close? Also, is your pot of assets pooled (ie shares in a bond fund) or separate?

If you're close to retirement age you might be able to get away with waiting. If you're younger then it's much riskier to wait. There won't be anything left by the time younger people get there. Also the doors are very likely to close on early withdrawls at some point.

Pooled assets are riskier than a pot with your name on it. You're still exposed to the risk that those managing the funds could go under though, and you could lose access to the assets.

Alpha Beta Soup said...

Thanks to Stoneleigh and Aaron's wonderful writings, I think I understand inflation/deflation. But what I still am not sure about is how that will impact me.

Right now, I have a ten dollar bill in my pocket. With that 10, I can either buy 5 gallons of cheap milk, or 2 gallons of the expensive organic hormone free milk. Assuming I still have a job when TSHTF, and I still have that 10 in my pocket, can I still buy milk?

I heard in the Great Depression farmers were dumping milk in the ditches, but I think that was because no one had a job, and didn't have 10 dollars in their pocket. Am I correct?


Stoneleigh said...

Mr Kowalski,

Why on earth would anyone invest in treasuries ? Is 2%/yr over ten years really all that ?

I wouldn't go for 10 years, I'd go for the shortest term you can get. That way you're not dependent on selling into the secondary market (where rising yields as a risk premium would mean falling prices).

The return OF capital is much more important than the return ON capital. Besides, real interest rates will be much higher than nominal rates in a deflation, so your actual return will be higher than it looks, thanks to the increasing purchasing power of cash and cash equivalents.

el gallinazo said...

AlphaBeta Soup

After you buy your milk, either cheap or organic and digest or indigest it, will you still have that $10 in pocket? That may answer your question with a little thought.

What I&S are saying ad nauseum is that your income (in general and for almost everyone not in the top 0.01%) will fall much faster than nominal prices. So if you have only a dime in your pocket and cheap milk has fallen to a dollar a gallon - where are you? Buddy can you spare a dime.


I recommend the following CNBC interview with Kyle Bass. First it's always fun watching a really smart guy talking to these huckster clowns on CNBC. But also Kyle has some really interesting observations. In two parts linked through:

Karl said...


Sitting over here in the UK with the late BBC news running. Headline is drop in inflation but concern that the Bank of England is missing its inflation target.

The UK really seems to be stuck in this 'inflation' deal at the moment. Even had an interview on the news piece of a city economist saying it may be time to raise interest rates to combat inflation. All these inflation worries on a day when another UK travel company went belly up. Cash flow problems being cited as the reason.

None so blind as those who dont want to see.

financier43 said...

There is a 1050 page tome written by Gerald D. Feldman entitled "The Great Disorder" which outlines in detail how the German central bank created the notorious German hyperinflation. Guess what? It was very simple.

The German government financed World War I by issuing government bonds to the general populace. After the war the Germans were faced with a huge domestic debt (War reparations were denominated in "gold marks" and could not be inflated away). The German central bank simply purchased the government bonds by running their printing presses-flooding the economy with money.

Bernanke can easily do the same. Don't bet too heavily on deflation!

unkle.smokey said...

Stoneleigh -
Thanks very much for your reply. I am 47 and my investment is pooled. So it sounds like waiting would be very risky.

TAE is a great site! Thanks to you, Ilargi, and everyone else who contributes.

Ventriloquist said...

Tom said...
Aaron's article is a model of clarity.

. . . .

This perhaps speaks to the weakness of Aaron's essay. Its lucidity stems from it narrow perspective. Its very much about him and very much a story of an American middle class individual of the last few years.

Excellent response, Tom.

This posting by Aaron is easily one of the most self-indulgent and narcissistic pieces ever posted on TAE. And I have been reading here for over two years.

It really is All About Him.

We are supposed empathize with his perspective and somehow personally validate his experience?


Not when his posting is dripping with a "woe is me" attitude.

Well, sorry Aaron. There are many other perspectives than yours that reflect a much, much different take

(as in . . . a profoundly more positive one, regarding our own personal strengths to cultivate and grow, not relating to the victimhood you seem to be wallowing in)

And you know what . . .?

Most of have not stooped to the level of whining that you portray.

Just get over yourself and suck it up.


Biologique Earl said...

Robert said: "What is to prevent the US from increasing the production of $100 bills or perhaps even introducing a $500 bill to compete with the 500 Euro banknote?"

For the time being the chance of this is about nil because the EU recently announced that it may eliminate the 500 Euro note. This is because it is 5 times easier to move large amounts of money across borders. Governments do not like the public to have the ability to move money without a track. Also, others such as drug lords love the large denominations for the same reasons.

The US is particularly paranoid about money moving without a trail.

BTW, in case no one has noticed there are two people using the Robert handle on this blog. :) Both have similar philosophies.

Tom Therramus said...

Hi Stoneleigh,

Tx for the response.

"...inflation... is an increase in the supply of money and credit relative to available goods and services, complicated by other major and minor factors ...such as global wage arbitrage or local scarcity."

This sounds like the basis of a numerical model. It would be useful to have a way of getting a quantitative picture of what you and Ilargi propose. Ever thought of collaborating with someone to construct such a model ?

..."Prices rises are lagging indicators of inflation"...

Accepting the proposition that CPI is a lagging indicator, the trend for the last year continues to upwards in the UK, and perhaps also in the US. How long is the lag that you propose between the real inflation rate and the CPI ?

Best wishes,

Tom Therramus

Bukko Boomeranger said...

How many here have ever had the dubious pleasure of handling a 500-euro note? Those suckers are like anchors made of money. Just TRY to get rid of them!

On a trip to Europe in 2007, my wife and I thought we'd avoid exchange fees and ATM charges by getting 10 of those from our man in Zurich. They were OK for paying for rental cars and hotels (I won't say how much my wife is prepared to spend on a single night's stay, because she reads these comments sometimes and she doesn't like me whingeing about her luxurious tastes.) But when it comes to mundane transactions, or even converting them to lower-denomination notes, you might as well be trying to pass counterfeits. Nobody wants to break one, even currency exchanges in Paris.

On our last night in Paree, we had a handful of 500-euro notes, but had gone through our lower-down currency. Essentially, we were broke with several thousand euros in our pockets! (Yeah, we had credit cards, but try buying a copy of the International Herald Tribune with those.) We wound up buying a 100-euro bottle of wine at one nice restaurant (a 1999 Echezaux Grand Cru, if any of you are wine buffs) just so they'd take our freaking bill.

I've heard that Europeans call the 500-euro notes "bin Ladens" -- because they;re often talked about, but seldom seen.

And for people like Ventriloquist (or are you the ventriloquist's dummy?) who have pedantic criticisms of Aaron, don't you realize he is trying to simplify a complex subject by using everyday examples? It's not "all about him;" it's all about the elusive notion of deflation, put in terms that people can relate to from their own lives.

I didn't read it thinking "Oh, Aaron Wissner is telling me about his wonderful life." I read it with a mind to seeing how the current thrift zeitgeist will implode the debt-based economic system. I can see how the behaviour he describes won't be done by individuals, either. When corporations and banks and investors adopt the same mindset, the debtbubble is going down. We'll be lucky if it just leaks air instead of 'sploding. Wissner made that clear. Maybe it was too confronting for you to wrap your heads around, so you're attacking the messenger...

soundOfSilence said...

And for people like Ventriloquist (or are you the ventriloquist's dummy?)

Just for the record " the current thrift zeitgeist will implode the debt-based economic system" is pretty much right along the lines of how I read it.

However - I think we're all better served here if we maintain basic civility - eh?

confronting present participle of con·front (Verb)

1. Meet (someone) face to face with hostile or argumentative intent.


Phil said...

Karl said...

Even had an interview on the news piece of a city economist saying it may be time to raise interest rates to combat inflation

But, by their newspeak definition of "inflation", raising interest rates would raise prices and cause more "inflation".

Fortunately, I saw through that sort of nonsense as a teenager (a long time ago).

ben said...

'What is deflation?

It is being sensible, all at once.'

given the Big Shit, such as derivatives and burning bin Ladens because one can (or is it bins Laden?), doesn't it seem like changing 'deflation', above, to deflationary would appear to be in order, and, furthermore, more representative of the post?


vk - thanks for your comment on the bond bubble.


tom -

do you really think the human population is going to double from here? i thought you were a PO datahead. what happened?

and do you think it's possible the price increases as a lagging indicator of inflation be residual momentum from the decades of inflation that culminated with the financial crisis?

Ilargi said...

New post up.

Fannie and Freddie: The Exit Doors are Shut


mercutio said...

Aaron wrote: "And as we all engage in this very, very, sensible, reasonable, logical paying down of debt, preparing for tough times, so too does everyone else . . . ."

Except for student loans. Which now total more than credit card debt. The student loan debt is held by people (like my children) who are, by definition, without a current job and about to graduate into an economy that has diminished job opportunities.

Aaron Wissner said...


Thank you all for your comments and feedback on "Deflation and Me".

I've also seen some interesting feedback at a couple other sites that reposted part, or all, of the post.

The audience I was trying to target with this piece was a general audience, one unfamiliar with economics, or monetary theory, or deflation.

The technique of using my personal examples is not one I enjoy using, for exactly the reason mentioned once above. In fact, I rarely employ such a technique in writing as it narrows the potential audience to those in a more-or-less similar position.

On the other hand, my particular audience in writing this piece was my wife; and secondarily my parents and sister; and "thirdly", my various friends with whom I'm "debating" deflation. For this particular audience, it seems to have been effective.

Thank you all, again, for all of your comments.



P.S. There are additional thoughts, reflections, and links regarding "Deflation and Me" on my journal page: