How to grow your GDP while killing jobs
Dorothea Lange No money at all August 1936
“Part of an impoverished family of nine on a New Mexico highway. Depression refugees from Iowa. Left Iowa in 1932 because of father’s ill health. Father an auto mechanic laborer, painter by trade, tubercular. Family has been on relief in Arizona but refused entry on relief rolls in Iowa to which state they wish to return. Nine children including a sick four-month-old baby. No money at all. About to sell their belongings and trailer for money to buy food. ‘We don’t want to go where we’ll be a nuisance to anybody.’”
Ilargi: I wouldn’t have assumed anything different, but I’m sure now. It’s really not helpful to have your network disappear for 30 hours straight. Not if you want to do an extensive daily round of reading and writing. Still, a short stint at a loud bar with a working network did leave me with a question that I’ll pose to you. To find the answer, I might have had to do some digging, and obviously that wasn’t going to happen. And besides, I think it’s an interesting enough issue to invite some feedback from you. Do ponder it for a moment though.
The Wall Street Journal ran an article yesterday titled Decade of Debt: $9 Trillion , which addresses the White House and CBO deficit reports that came out this week. The data look pretty grisly to me, and I definitely have the idea that the only reason they get underplayed in the media is that they deal with a future so conveniently far away the human eye finds an excuse for looking the other way. I also think that despite the fact that the numbers are real bad as they are presented, they’re still covered by a veneer of, let’s say, the kind of hedonistic arithmetic that makes GDP reporting so disputable. The overall picture as I see it reported is the familiar one of: this is troubling, but maybe “they” will find something in the meantime.
Anyway, to get to that question: there’s a set of graphs in the WSJ article that looks like this:
What struck me here is that about a year from now, GDP growth is projected as approaching 4%, while at the same time unemployment hovers close to 10%. In fact, unemployment and GDP both rise simultaneously for a while! And when I noticed that, my first thought was: I don’t think that is even possible. At least not in this situation. I think perhaps there may have been a short time in the US in the late 1930′s where you may have seen something similar, but I wouldn’t be too sure. Perhaps in the early 1940′s, but a war economy has its own set of rules.
What do you think? Is it realistic to expect a 4% GDP growth with that kind of jobless numbers?
There are of course always a few sidenotes that you must be aware of. First, somewhat curiously, Dennis Lockhart, the President and CEO of the Federal Reserve Bank of Atlanta, said yesterday that the real present US unemployment rate is not 9.4%, as officially reported, but 16%: Real US unemployment rate at 16%: Atlanta Fed President He’s talking about the difference between U3 and U6 numbers, of course. If people at his level start going public with this sort of claims, we could be in for interesting times. It would also sort of kill the question, because you’d have a hard time finding any serious voice insisting that GDP can grow at 4% while 1 in 6 members of the working age population can’t find a job.
Another point that I think needs far more scrutiny lies in the other side of the deficit reports. That is, in principle government borrowing has no immediate negative effect on the GDP, while when the government spends the money it borrows, that spending does indeed have a positive effect. Most people who follow the economy are by now so familiar with this kind of trickery that it doesn’t surprise them anymore, but it still merits pointing out every now and then. The underlying principle is that the government can boost today’s economic numbers by in effect spending money that has yet to be earned, by generations that maybe even have yet to be born.
The extent to which government interference influences the housing and mortgage markets is clearly enormous. If home prices were left simply to the markets, they would drop like boulders, which would drag down GDP numbers like there’s no tomorrow. There’s a report out today that claims second quarter GDP fell only by 1%, but that number has little meaning unless and until the effect of such government intervention is given the prominent place it should rightfully have. And when it is given that place, a 4% GDP growth in 2010 starts to look highly improbable. It’s in essence ridiculously bad accounting to pretend you can grow your economy by borrowing money from yourself. If you allow these accounting tricks, the more the government borrows, the higher the growth can be made to look.
When my connection was down yesterday, I -finally- started reading Les Leopold’s “The Looting of America” (Read chapter 1). There is a graph in the book that affects the same issue. If you want to raise GDP with high unemployment numbers, you clearly need to dramatically raise productivity per worker. Leopold shows that productivity and wages rose together from 1947 and 1973, after which they disconnect. Wages today are below 1973 in inflation adjusted dollars, while productivity has indeed gone up a lot. Is that the answer we’re looking for? Or do wages need to rise to raise a GDP that depends for 70% on consumer spending?
With all that in mind, my question should be clear, albeit perhaps a bit more challenging. Is it possible to grow your economy at a 4% rate when 10% of your population in unemployed?
PS: Much obliged: I noticed Michael Panzner ranks The Automatic Earth among his Top 10 Great Financial Blogs
Plunging tax receipts, soaring spending and a sluggish recovery will push the nation’s deficits dramatically higher over the next decade, creating new complications for President Barack Obama’s domestic agenda. The deteriorating budget picture, detailed Tuesday in separate White House and congressional reports, comes just as Democrats and Republicans prepare to resume the battle over Democratic plans to spend $1 trillion overhauling the nation’s health-care system.
The numbers — including a White House forecast of $9 trillion in additional debt over the next decade — could affect Mr. Obama’s efforts to increase spending in a host of areas, from education to foreign aid. Some budget experts also reiterated their belief that tax increases may need to hit families that the president has vowed to protect. White House budget director Peter Orszag, in an interview Tuesday, said the deficit projections are “higher than desirable” and the administration is working to bring them down in the 2011 budget proposal due early next year.
Asked if that meant tax changes affecting families earning below $250,000 — something Mr. Obama has pledged he would avoid — Mr. Orszag replied: “We’re in the midst of putting together the 2011 budget, and we’ll have more to say about that later.” The deficit projections, from the White House Office of Management and Budget and the nonpartisan Congressional Budget Office, came the same day the president renominated Federal Reserve Chairman Ben S. Bernanke. The deficit numbers complicate Mr. Bernanke’s task in navigating the economy toward stability and recovery. Fed officials say the U.S. must show progress on deficit reduction by next year to avoid the possibility of a rise in interest rates, which might be needed otherwise to entice global investors to keep buying U.S.-government bonds.
Big deficits could also weaken the dollar against foreign currencies. That could fuel inflation as the cost of imports rises in dollar terms. The biggest effect of the deficit numbers may be felt on the health-care debate. Deficit worries will force Democrats to put new emphasis on cost-cutting efforts in crafting health legislation, said Sen. Charles E. Schumer (D., N.Y.). Democrats can’t afford any “slippage” on their pledge to fully pay for the overhaul, he said. Mr. Orszag said: “We need to change health care in such a way that it reduces health-care spending over time,” adding that “the final legislation will do that.”
Both sides acknowledged Tuesday that the White House’s $9 trillion, 10-year debt projection will likely force Democrats to find new real savings in their health-care bills or risk defeat. “I don’t think this is going to bring Republicans to the table,” said Rep. Paul Ryan of Wisconsin, the ranking Republican on the House Budget Committee. “I think it will move Democrats away from the table.” An administration official said, “One would be very hard-pressed to call a $2 trillion addition to your [10-year deficit] forecast helpful, but this really does heighten the urgency” to tackle the growth in health care.
The Office of Management and Budget revised its May deficit projections to forecast a record, $1.58 trillion deficit for the fiscal year that ends Sept. 30. Spending, much aimed at stabilizing the financial sector and boosting the economy, will rise by 24% this year, the largest increase since 1952 and the height of the Korean War, according to the CBO. Tax revenues will fall 17% from last year’s levels, the largest drop since 1932.
Measured against the size of the economy, the deficit will hit 11.2% of the gross domestic product, a level not seen since 1945, although it is an improvement from the $1.84 trillion forecast in May. Over the next decade, however, the White House forecast turned bleak. In effect, the White House economists acknowledged the recession will be far worse than they projected early this year. The deficit will improve only slightly in fiscal 2010, to $1.5 trillion, worse than the $1.3 trillion forecast in May. And it will stay high, adding $9 trillion onto the federal debt through 2019. Borrowing alone will account for 40% of federal revenues in 2010.
“Putting the nation on a sustainable fiscal course will require some combination of lower spending and higher revenues,” warned the CBO, whose $7 trillion, 10-year deficit forecast is lower than the White House’s mainly because it assumes all of President George W. Bush’s tax cuts will expire in 2011, something neither party wants. The White House projection assumes most Bush tax cuts would remain in place.
If anything, the numbers understate the problem, said Douglas Holtz-Eakin, a former CBO director and campaign adviser to Republican Sen. John McCain. The White House forecast assumes the president will secure at least $600 billion in revenue over the next decade from forcing polluters to buy credits to emit gases believed to cause global warming. But a scaled-back version that passed the House would raise a maximum of $450 billion, and prospects for Senate passage are dim.
The White House estimate assumes any health-care plan will not increase the deficit. It provides $622 billion in cuts to Medicare and Medicaid to back that up, cuts some Democrats are balking at. The forecasts come as international lenders, especially China, are growing bolder about questioning whether they will keep buying U.S. government debt at today’s voracious levels, at least without a big increase in the interest rates paid out by the bonds. Rising rates would make the U.S. government’s borrowing costs much higher.
The spending surge this year doesn’t stem from a permanent expansion of government. Of the $700 billion increase in spending that the CBO forecasts for fiscal 2009, ending Sept. 30, $424 billion comes from the Troubled Asset Relief Program and the rescue of mortgage giants Fannie Mae and Freddie Mac, bailouts approved under Mr. Bush. About $115 billion stems from Mr. Obama’s stimulus plan. The rest comes from increases in spending on Medicaid, unemployment and other programs that rise automatically in an economic downturn. Beyond 2013, deficits will remain stubbornly high in large part because of spending on Medicare, Medicaid and Social Security. That isn’t tied to the recession, the CBO said; it will simply rise as baby boomers age.
Questions over strength of recovery
Amid the thin trading volumes of a typically sluggish August, investors have been caught off balance as the normal relationships between US equities, government bonds and commodity prices have broken down. At the end of July, the S&P?500 equity composite was below 1,000 points and the price of crude oil loitered below $70 a barrel. During August, the S&P and oil have risen to their highest levels in 10 months, amid hopes of a sustained recovery in the economy.
In contrast, the yield on 10-year Treasury notes has made a circular journey, rising from about 3.50 per cent at the start of the month, peaking near 3.90 per cent in early-August, only to be trading about 3.42 per cent on Wednesday. “Something has to give when all you see are green arrows for prices across the major asset classes,” says George Goncalves, head of fixed-income strategy at Cantor Fitzgerald. “Strong commodities and stocks with falling bond yields cannot continue, at some point the normal relationships should resume.” The breakdown between equities and bond yields reveals how divided investors are over the sustainability of the economy’s recovery.
While some equity research touts a V-shaped recovery for the economy, bond investors believe the economy will only derive a short-term boost from the replenishment of inventories. Beyond a bounce in activity this year, the debt-laden consumer is in no position to pick up the baton and accelerate the recovery into 2010, many argue. “It may well be that more [bond] investors are signing on [to] the ‘sugar high’ from stimulus thesis and [are] worried about what crash lies beyond the boost from homebuyer tax credits, cash-for-clunkers and other temporary/transitory props for the US economy,” says Bill O’Donnell, strategist at RBS Securities.
The release yesterday of durable goods orders for July highlighted the dichotomy, with the headline number exceeding forecasts, while capital goods orders excluding defence and air orders fell 0.3 per cent, the first decline since April. Not even a deteriorating debt outlook by the White House and Congressional Budget Office, with the budget deficit seen rising a further $2,000bn over the next 10 years, has derailed the bond market’s rally. Recent auctions of new debt by the US Treasury have attracted solid demand from foreign central banks and investors, limiting concerns about the rising tide of new supply.
That comes amid deep misgivings in some quarters about the quality of the S&P’s rise of more than 50 per cent from its low in March. That rally represents the strongest rebound in stocks since the explosive short covering rallies of the 1930s when the market rose more than 100 per cent. Equity volume has been low, while the best performing stocks, such as AIG, Fannie Mae, Freddie Mac and Citi, have generally been those that were heavily shorted during the depths of the sell-off.
The rally in both Treasuries and stocks has caught some trading rates desks offguard and that has only boosted bond prices as dealers have reversed their lossmaking trades. But an even bigger trap could be brewing for investors banking on stocks following their usual September to October pattern of performing poorly. “As seasoned investors surely know, September has historically been the worst month for the market during the year,” say analysts at Bespoke Investment Group. This could explain why bond investors are driving yields lower.
“Everyone we speak with is keeping powder dry for the stock market weakening next month and during October and I think bond yields are falling ahead of that move,” says Tom di Galoma, head of Treasury trading at Guggenheim Partners. “One market is completely wrong and if equities don’t turn lower, then they could run quite considerably as money moves off the sidelines.” That could also spark a dramatic reversal in Treasury yields. However, expectations that inflation will continue falling makes bond yields look attractive, particularly when the 10-year note approaches 4 per cent.
“The economic data has been better, but we are not looking for the economy to experience explosive growth next year, while many global indicators point to disinflation,” says Bill Strazzullo, chief market strategist at Bell Curve Trading. He said weak labour hiring trends, falling real estate values and excess capacity in manufacturing would keep prices contained and boost the appeal of owning bonds. Then there is the performance of credit, which has generated huge returns for investors since the start of the year, with high-yield debt alone up 40 per cent. The lower end of Investment grade credit spreads have contracted more than two percentage points to 6.5 per cent since April, the lowest level since the start of 2008.
Credit has lagged behind the rise in equity prices and that has some analysts thinking that this helps explain why yields have fallen, while stocks have risen. “We have seen an asset allocation out of credit, because it’s had such a good run, and that money has gone into Treasuries,” said Gerald Lucas, senior investment advisor at Deutsche Bank. Another aspect of the financial crisis has been a narrowing of options for investors, with many investors preferring to place their money in liquid markets. The combination of rising risk tolerance and enormous amounts of liquidity supplied to the financial system by central banks, may explain why asset classes are rallying in unison.
“There is so much money in the system and it appears anything with a price is going up as people put cash to work,” says Mr Goncalves. “It’s perplexing to see different asset classes going higher in value.” It is indeed a trend that has plenty of people scratching their heads and warning it cannot last. “I would argue that if the recovery is sustainable then eventually rates at the short end will have to rise, and inflation expectations from the massive monetary stimulus will push rates higher in the longer maturities,” says John Prior, technical analyst at Killik Capital in London. “Unless we are going back to the Goldilocks economy of inflation-free growth, I don’t believe the current situation can continue indefinitely.”
FDIC: Number of troubled banks rises to 416
The Federal Deposit Insurance Corp. said Thursday that more lenders ran into financial trouble during the second quarter as the recession continued to saddle banks with soured loans. The FDIC said that the number of troubled banks rose to 416 at the end of June from 305 at the end of March. This is the largest number of banks on its “problem list” since June 30, 1994, when 434 banks were on the list.
Assets at troubled banks totaled $299.8 billion, the highest level since Dec. 31, 1993, the agency said Banks insured by the FDIC swung to a total quarterly loss of $3.7 billion from last year when they reported a total profit of $4.8 billion. Total reserves of the Deposit Insurance Fund stood at $42 billion, with the contingent loss reserve falling to $10.4 billion from $13 billion over the second quarter. Some analysts have been warning that growing bank failures could put pressure on the FDIC fund.
“While challenges remain, evidence is building that the U.S. economy is starting to grow again,” said FDIC Chairman Sheila Bair in a press release. “The banking industry, too, can look forward to better times ahead,” she added. “But, for now, the difficult and necessary process of recognizing loan losses and cleaning up balance sheets continues to be reflected in the industry’s bottom line.”
Bair said the FDIC has “ample resources” to protect depositors. “No insured depositor has ever lost a penny of insured deposits … and no one ever will,” she asserted. More than 28% of all insured institutions reported a net loss in the second quarter, compared with 18% in the year-ago quarter. “Deteriorating loan quality is having the greatest impact on industry earnings as insured institutions continue to set aside reserves to cover loan losses,” Bair said.
Can the soufflé really rise again?
Two facts that should give pause for thought.
- Japanese data released on Thursday showed that exports fell yet again in July. They are down 39.5pc to the US, and 26.5pc to China. Japan is the world’s second biggest economy. It lives on exports. It is also a key part of the supply chain for the Chinese economy. How can this hard data be reconciled with the extreme V-shaped recovery already priced in by the markets? By the way, Toyota is suspending a key production line at its Takaoka plant in central Japan. It is cutting global capacity by 1m vehicles.
- The Baltic Dry Index measuring freight rates for bulk goods and commodities has been falling almost continuously for eleven weeks, dropping from 4,290 to 2,778 on Thursday.
Is this just a glut of ships or is this telling us what the Shanghai market is also telling us, that credit tightening by the Chinese government is pulling the rug from underneath the latest commodity bubble?There is something wrong with the entire recovery tale, which ignores the fact that excess plant is still at the highest level since the Great Depression (capacity use is 70pc in Europe, 68pc in the US, 65pc in Japan, and as low as 50pc in some countries, according to the World Bank’s Justin Lin). Companies will have to cut jobs and investment. Soaring “confidence” indicators have decoupled from reality. The world economy is still prostrate. GDP has shrunk 4pc, 6pc, 8pc, even 12pc or more in a large group of countries. There it more or less sits, like a deflated soufflé.
An end to technical recession in France, Germany, and Japan because Q2 ( and undoubtedly Q3 to come) ekes out a rise from a collapsed base does not mean anything – except that zero interest rates worldwide, and a massive fiscal stimulus that is pushing public debts towards 100pc across the OECD states (and cannot easily be repeated once the first sugar rush subsides), has mercifully prevented the Great Contraction from turning into an immediate catastrophe. As the Bank of England’s Governor Mervyn King puts it: “It’s the level, stupid”. The level of economic activity is years away from full recovery.
The Bundesbank’s Axel Weber says it will take until 2013 for Germany to get back to where it was. He also warns, by the way, that there will be a second wave of the credit crisis as Germany’s home-grown troubles come to the fore. Round one was imported havoc from the US: round two will be rising defaults at home and a credit squeeze as ratings downgrades force banks to set aside fresh capital.
I have no idea when stock markets and commodities – especially base metals – will reflect the hard facts on the ground (ie, an end to the Chinese construction bubble). Timing is not my forte. Nor is the market. But I am absolutely convinced that those who think we can return to the status quo ante of the credit bubble as if nothing has happened are delusional. As almost every central banker in Jackson Hole reminded us over the weekend, it is going to be a very long hard slog.
Real US unemployment rate at 16%: Atlanta Fed President
The real US unemployment rate is 16 percent if persons who have dropped out of the labor pool and those working less than they would like are counted, a Federal Reserve official said Wednesday. “If one considers the people who would like a job but have stopped looking — so-called discouraged workers — and those who are working fewer hours than they want, the unemployment rate would move from the official 9.4 percent to 16 percent, said Atlanta Fed chief Dennis Lockhart.
He underscored that he was expressing his own views, which did “do not necessarily reflect those of my colleagues on the Federal Open Market Committee,” the policy-setting body of the central bank. Lockhart pointed out in a speech to a chamber of commerce in Chattanooga, Tennessee that those two categories of people are not taken into account in the Labor Department’s monthly report on the unemployment rate. The official July jobless rate was 9.4 percent.
Lockhart, who heads the Atlanta, Georgia, division of the Fed, is the first central bank official to acknowledge the depth of unemployment amid the worst US recession since the Great Depression. Lockhart said the US economy was improving but “still fragile,” and the beginning stages of a sluggish recovery were underway. “My forecast for a slow recovery implies a protracted period of high unemployment,” he said, adding that it would be difficult to stimulate jobs through additional public spending.
“Further fiscal stimulus has been mentioned, but the full effects of the first stimulus package are not yet clear, and the concern over adding to the federal deficit and the resulting national debt is warranted,” he said. President Barack Obama’s administration has resisted calls for more public spending, arguing that the 787-billion-dollar stimulus passed in February needs time to work its way through the economy.
Lockhart noted that construction and manufacturing had been particularly hard hit in the recession that began in December 2007 and predicted some jobs were gone for good. Prior to the recession, he said, construction and manufacturing combined accounted for slightly more than 15 percent of employment. But during the recession, their job losses made up more than 40 percent of all US job losses.
“In my view, it is unlikely that we will see a return of jobs lost in certain sectors, such as manufacturing,” he said. “In a similar vein, the recession has been so deep in construction that a reallocation of workers is likely to happen — even if not permanent.” Payroll employment has fallen by 6.7 million since the recession began.
Second-Quarter GDP Is Unchanged, Jobless Claims Edge Lower
The government left untouched its estimate of the U.S. economy in the second quarter, saying inventory liquidation was deeper than first thought and consumer spending not as weak — a positive sign for growth this summer. A separate report showed the number of U.S. workers filing new claims for jobless benefits declined last week, falling in line with economists’ observations that labor market conditions appear to be slowly stabilizing. The total claims lasting more than one week also fell back down after ticking up the previous week.
The Commerce Department on Thursday released its second estimate of second-quarter GDP, saying again gross domestic product fell at a seasonally adjusted 1% annual rate April through June. The data was favorable for third-quarter economic activity. It said inventories were slashed $159.2 billion in the second quarter, revised from a previously reported $141.1 billion cut. More liquidation in the second quarter suggests a lower need to cut so deeply in the third quarter, which would help economic growth.
The recession began in December 2007, according to the arbiter of such things, the National Bureau of Economic Research in Cambridge, Mass. The non-profit research group uses a broader definition of a recession than do many economists. The traditional definition of a recession is two consecutive quarters of a shrinking GDP. The current, third quarter began July 1. Economists expect a rise in GDP this summer, suggesting the recession is at or near its end.
GDP acts as a scoreboard for the economy by measuring all goods and services produced. It fell 6.4% in the first quarter and 5.4% in the fourth quarter. Wall Street expected a big change to second-quarter GDP. Economists surveyed by Dow Jones Newswires projected the revised data would show GDP fell 1.5%, instead of the 1.0% drop reported a month ago. Gauges on inflation were generally unrevised. Corporate profits rose 7.5% in the second quarter, after rising 16.6% during the first quarter.
Real final sales of domestic product, which is GDP less the change in private inventories, increased at a 0.4% annual rate in the second quarter, revised from a previously estimated 0.2% dip. Business spending fell 10.9%, revised from an 8.9% drop reported earlier. Most of GDP is made up of consumer spending. It slid by 1.0% April through June, revised from a previously reported 1.2% drop. U.S. exports fell by 5.0% and imports decreased an unrevised 15.1%. The original GDP report for the second quarter said exports fell 7.0%.
Residential fixed investment, which includes spending on housing, dropped by 22.8%, revised from a 29.3% plunge first reported. Federal government spending increased 11.0%, revised from a previously estimated 10.9% increase. The government’s price index for personal consumption expenditures climbed an unrevised 1.3% in the second quarter. The PCE price gauge excluding food and energy rose an unrevised 2.0%. The price index for gross domestic purchases, which measures prices paid by U.S. residents, rose 0.5%, revised from a previously reported 0.7% climb. The chain-weighted GDP price index was flat; originally, Commerce reported a 0.2% climb.
Initial claims for jobless benefits fell 10,000 to 570,000 in the week ended Aug. 22, the lowest level since Aug. 8, the Labor Department said in its weekly report Thursday. Economists surveyed by Dow Jones Newswires had expected a decline of 11,000. The previous week’s level was revised from 576,000 to 580,000. The four-week average of new claims, which aims to smooth volatility in the data, fell 4,750 to 566,250. That was the lowest average since the week ended Aug. 8. The latest drop in the weekly initial claims data follows two straight weeks of disappointing increases. For the week ending Aug. 15, claims had unexpectedly climbed, raising concerns that improvements in the labor market are still are not likely to be seen in the near-future.
Despite those recent setbacks, economists have tended to react a bit more positively to the weekly jobless claim figures because they are still seeing an overall downward trend in claims. Abiel Reinhart, an economist at J.P. Morgan Chase & Co., said in an interview with Dow Jones that he felt some people last Thursday over-reacted a little bit to the news that claims had risen by 15,000 in the week ended Aug. 15. “If you were to chart what has happened here over the last couple years , it still to me looks to be on a downward trend and I think it’s a matter of just having a little patience,” he said. In Thursday’s report, the number of continuing claims — those drawn by workers for more than one week in the week ended Aug. 15 — fell 119,000 to 6,133,000. That followed a rise of 2,000 the previous week.
A Plunge in Foreign Net Capital Inflows Preceded the Break in US Financial Markets
The peak of foreign capital inflows into the US was clearly seen in the second quarter of 2007, just before the crisis in the US that has rocked its banking system and driven it deeply into recession.
Are the two events connected? Had the US become a Ponzi scheme that began to collapse when new investment began to wane, and the growth of returns could not be maintained?
Watch the dollar and the Treasury and Agency Debt auctions for any further signs of capital flight, which is when those net inflows of foreign capital turn negative. And if for some reason the unlikely happens and it gains momentum, the dollar and bonds and stocks can all go lower in unison, and there is no place to hide except perhaps in some foreign currencies and precious metals.
The sad truth is that US collateralized debt packages and their derivatives have become toxic in the minds of the rest of the world, and there is little being done to change that, except an orderly winding down of the bubble, with the remaining assets being divided largely by insiders, and not price discovery and capital allocation mechanisms driven by ‘the invisible hand’ of the markets.
Unfortunately the Net Inflow Data is quarterly, and subject to revisions. But we have to note that the spectacularly rally off the bottom in the SP 500, not fully depicted above, is not being matched by a return of foreign capital inflows.
If that inflow does not return, if the median wage of Americans does not increase, if the financial system is not reformed, if the economy is not brought back into balance between the service and manufacturing sectors, exports and imports, then there can be no sustained recovery in the real, productive economy.
The rally in the US markets is based on an extreme series of New Deal for Wall Street programs from the Fed and the Treasury, monetization, and the devaluation of the dollar.
The Political Phase and the Death of Nations
by Bill Bonner
The United States is in the third and fatal stage of a great country’s lifecycle — the political stage. In this stage, money and power migrate from the financial community to the political community. The politicians get away with taking trillions out of the productive economy and spending them on their pet projects and private corruptions. “Politics is about what works,” someone once said. Someone said it…someone who is an imbecile. Politics is not about what works, it’s about what you can get away with. And what you can get away with is often exactly what doesn’t work at all.
What the United States is getting away with, from a financial point of view, in addition to counterfeiting, is grand larceny on a Super-Madoff scale. It is borrowing trillions of dollars even though it has no way to honestly pay back the money. Still, so eager are the lenders to part with their money that the 10-year T-note yields a miserly 3.46%. The more the feds borrow, apparently, the more lenders are willing to lend. But this is a story that will end badly.
Warren Buffett described the America of the bubble years as “Squanderville.” Private citizens were living beyond their means, he pointed out. But he hadn’t seen nothin’. Now, government does the squandering. The politicians are spending trillions they don’t have on projects nobody was willing to pay for even when they had some money in their pockets. What the government can get away with now — under cover of a financial crisis — is a big grab for money and power. It ‘works’ in the sense the feds are able to get away with it. But it will prove fatal to the dollar…and to the US economy.
The Fed is intervening in markets as no Fed ever has. Its balance sheet — a measure of how much intervention it has done — has shot up in a way that is not only unprecedented, but also almost unbelievable. In an effort to provide liquidity, the Fed has bought up the contents of every neglected refrigerator on Wall Street. This smelly, furry stuff enters the Fed’s books as an asset, along with various not-so-pungent assets like US Treasury bonds. Altogether, the Fed’s balance sheet shows more than $2.7 trillion worth of this unappetizing hodgepodge.
“It’s not sound economics — nor is it ethical — to trash the US dollar and bail out incompetent investors who poured billions into CMBS at the peak of the bubble,” says Strategic Short Report’s Dan Amoss. “There is no longer a ‘systemic risk’ argument for The Fed to be propping up the price of such securities.
What happens next? We don’t know. But it is far too early to expect the Fed to withdraw its easy-money policy. The Fed will have to stay on this road for much, much longer. Why? Because the “green shoots” are shriveling up. There is no real economic revival. And there can’t be one until the underlying problems are corrected.
One of the big problems is too much capacity. During the Bubble Epoque the squanderers would buy anything. So, you could make an almost unlimited amount of money by providing them with things to buy. This meant building factories…buying trucks…and renting retail space. Now, however, the squanderers have come to their senses…or maybe they’ve just come to the limit of their credit lines. The squanderers now want to save their money. So, no need for so much retail space in the malls, so many trucks on the highways or so much retail space.
There are a number of sit-down restaurant chains that cater to the middle class — Applebee’s…Chili’s…Ruby Tuesday and a few others. They expanded greatly during the ’90s and ’00s in order to meet the desires of the big-spending masses. But now that the masses aren’t so free and easy with their money, the New York Times reports that these chains are in desperate competition for remaining diners. This competition is manifesting itself as price deflation.
Applebee’s offers dinner for two for only $20. Chili’s advertises entrees for just $7. Ruby Tuesday’s is going for a 2-for-1 deal. Buy one meal, get one free. All of them are making heavy use of discount coupons. Oversupply is producing deflation. Prices are falling as suppliers fight for demand by offering more for less. And over at the Red Roof…the roof has already caved in, as the chain has defaulted on its mortgage debt.
This is what you’d expect at the end of a long period of credit expansion. EZ credit brought forth too much demand and too much supply. Now, the demand is disappearing…and the suppliers struggle to hold on. Even now, we’re facing an economy in which 70% of our economic output depends on consumer buying. And consumers are in no condition to consume. Ergo, no buyers, no recovery.
Economic contraction is natural, normal and perhaps necessary to a market economy. And the current contraction will take years to sort out. Roofs have to fall in on thousands of enterprises, speculators and households. Then, the rebuilding can begin. But the Bernanke Fed is not about to let nature take her course. Don’t expect any tightening from the Fed anytime soon, dear reader…it is far too soon for that.
Governments are essentially parasites on productive activity. So the best governments are the smallest — meaning, the least parasitic. As has been said before, “That government is best which governs least.”
But now we are in the third and fatal stage of a great country — the political stage. In this stage, the parasites take over. Government governs a lot. And governing a lot costs a lot of money. In England, the government budget is bumping up against half the total GDP of the nation. In America, health care is still largely a private matter, so the government spends a smaller percentage of GDP…but it is a percentage that is rising quickly.
Where will the money come from? Taxes? Gordon Brown has already put the income tax rate up to 50%. Michael Caine, an English actor who moved from the U.S. to England to escape the high taxes of the ’70s, says he will tolerate 50%…but not a penny more.
“If it goes to 51% I will be back in America,” he says.
Ahem…he might have to try somewhere else. Everybody’s gunning for the rich — in America as well as in England. Obama has pledged to raise taxes on the rich. The states, notably California, are desperate for more revenue too. Add federal, state and local levies…and private health care costs…and you could easily be over the 50% bracket in America too.
The history of European monarchies is largely a history of debt. Kings and queens squeezed what they could out of the turnips. Then they turned to the moneylenders. These lenders had to be careful. They were happy to extend monarchs credit, because in this way they gained a measure of control over them. But there were many dangers. Kings lost their heads…or went broke. Or, often, the monarchs could turn the tables on the moneylenders…and have their heads cut off. Reading the history of the loans to the French crown is eye-opening. It is amazing anyone wanted to lend at all. The risks were great; the rewards were few. Rarely were the loans settled honorably.
Government raises money. Sometimes it repays the loan with revenues from other taxes. Sometimes, it is the lender who pays the tax himself — either because the government defaults…or because inflation reduces the value of his money. What you come to see is that lending to the government — which always has the power to betray the loan and behead the lender — is merely another form of taxation. But the lender can blame no one but himself for his losses. The wounds he suffers are self-inflicted.
This is a story that often ends badly, if not disastrously.
Economic Crisis Strikes at Irish Heartland
A key gauge of Ireland’s economic health isn’t found in the island nation’s business districts or trading floors, but on the football fields of the rural west, where rosters of amateur clubs are getting so thin that villages are struggling to find talented players to field 15-person teams. Sean McManamon left Ballycroy — a picturesque village sandwiched between the Atlantic Ocean and the Nephin Beg mountain range — for a job in London in February after his small construction firm folded. Mr. McManamon, a midfielder who was a stalwart of the Ballycroy team’s defense, emigrated around the same time as three other players, leaving the village without an adult team for the first time in more than 50 years.
It is the 35-year-old father of four’s second stint as an emigrant. He hopes it is his last. Emigrating again, after being in London for eight years and returning in 1999 to capitalize on Ireland’s real-estate boom “was easily one of the hardest things I’ve ever done,” says Mr. McManamon, who left his family, a 100-acre farm and a nearly finished seven-bedroom home behind. “I never thought I’d leave Ireland again.”
Even as the economic crisis crimps migration world-wide, there are signs that Ireland’s particularly dire straits — unemployment hit a 14-year high of 12.2% in July and the central bank expects the economy to shrink by 8.3% this year — are pushing increasing numbers of workers abroad. Official emigration statistics will be released later this year; some economists believe Ireland could see outflows of up to 40,000 people a year, the equivalent of nearly 2% of the country’s labor force, for the next few years.
The U.S. Embassy in Dublin says Irish applications for short-term work visas are up in the last year. Irish emigrant centers across the U.S. report more new arrivals. Mark O’Donnell, director of human capital at Deloitte in Dublin, says 10% of the 2,000 Irish executives who are potential job candidates for his corporate clients are now working overseas, up from “pretty much zero” last year.
Most tellingly for many here, Ireland’s most popular sports — traditional amateur games called Gaelic football, which resembles a mix of soccer and rugby, and hurling, a sport similar to field hockey and lacrosse — are seeing domestic teams struggle as players head overseas in search of work. The Gaelic Athletic Association that oversees the teams was founded in 1884 to preserve Irish traditions amid rampant poverty and emigration. Now, Ireland boasts more than 2,500 GAA clubs; increasingly popular overseas teams cater to the country’s vast diaspora.
But teams here in Ireland, especially those along the sparsely populated rural west coast, are suffering as players leave. “You can tell what’s happening in a local Irish community by what’s happening with the GAA club,” says Mark Duncan, director of the GAA Oral History Project at the Dublin campus of Boston College. It’s a trope of Irish history, he says, that “if a village is struggling to field a team, something is wrong. There’s a sense of despair and crisis about the place, that you can’t hold on to your young people.”
The Irish have a long and painful history of leaving. Starvation and emigration amid the mid-19th century potato famine cut Ireland’s population by nearly a third, to 4.4 million in 1861. Emigration continued after Ireland won independence from Britain in 1921; more people left the country than came to it every decade until a 1970s economic revival stemmed the tide. But double-digit unemployment pushed people abroad again in the 1980s.
“For people who grew up here before the 1990s, emigration was a part of the national psyche,” says Alan Barrett, an economist with Dublin’s Economic and Social Research Institute. That changed when the economy took off in the mid-1990s, he says. “Some would argue that the greatest benefit of the Celtic Tiger was the notion that if you were born in Ireland you had a reasonable prospect of staying.” That notion is fading. Ballycroy native David Doran, 24, worked in Ireland’s construction industry for six years until work dried up in January. So Mr. Doran moved to London, where older brothers who emigrated years ago helped him find work. “There’s nothing here now,” he says, sipping a Guinness in one of Ballycroy’s two pubs while home on a recent visit.
The current outflow remains meager compared with Ireland’s past emigration waves. Unemployment rates are rising world-wide and some would-be Irish emigrants are returning home empty-handed. Many of those leaving Ireland now are also immigrants themselves. In 1996, 8,000 more people came to Ireland than left it, the start of more than a decade of inflows that turned the onetime emigrant nation into an immigrant hub. But foreigners are returning home amid the slump.
And though Ireland is set for a steep decline, few believe it will see a repeat of the lost decade of the 1980s. The government has unveiled painful spending cuts to bring down the budget deficit — forecast to hit 10.75% of GDP this year. Emigration could even help in the short term, by keeping a lid on unemployment and whittling the government’s social-welfare payments. Years of strong growth also yielded a psychological boost that could lure emigrants home once recovery takes hold. “One of the benefits of the boom was that it proved Ireland is a viable economic entity,” says the ESRI’s Mr. Barrett. “So there’s a confidence that growth can be restored and that it’s possible to sustain on this island a population in excess of 4.5 million people.”
But the departures are hurting Irish towns and teams, especially along the western coast, where poor infrastructure and a lack of industry have long pushed workers away. Last year, Ballycroy — where the population has shrunk by more than half since 1941 to just under 700 — completed work on a new Gaelic football field.
On a recent Friday, the grass was calf-high and the changing rooms were strewn with trash. When Sean McManamon and other players emigrated to London this year, the town’s chances of fielding a full team evaporated. “We were small — we were a junior team and we played in the lower divisions,” says Eoin Sweeney, 31, a physical therapist whose family owns Ballycroy’s general store. “But it’s the tradition of the thing. This is the first time I haven’t played football in Ballycroy since I’m about 8. It hurts.”
Teams from bigger communities are also taking a hit. Some 35 miles east of Ballycroy, the streets of the 10,000-person town of Ballina are dotted with empty storefronts and “To Let” signs. Ballina’s Gaelic football team won the national championships in 2005. But the team has seen eight key players leave since 2008 and lost its semifinal match by two points earlier this month. “We suffer with emigration anytime there’s a recession,” says club treasurer Mickey Tighe, 42, who has been with the team as a player or manager for 25 years. “But this is the worst I’ve ever seen.”
Ireland’s new emigrants do benefit from perks that their predecessors lacked. Technology keeps them in steady contact with loved ones back home, while cheap and frequent flights make visiting easier. A round-trip flight from London to west Ireland can cost Sean McManamon as little as 40 pounds ($66), a price that lets him come home monthly. But it doesn’t erase the pain of being away. “All the money in the world doesn’t pay for not being home with your family in the evening,” he says.
German state may lend directly as second credit crunch looms
Germany could directly intervene in the credit insurance and lending markets as soon as September to head off a looming credit crunch, as it fears the economic recovery may soon falter as banks refuse to roll over loans. The finance minister, Peer Steinbrück, said broad sectors of the German economy are in trouble even if the country has avoided a full-blown lending crisis so far. “Conditions have become much tougher for some industries – electrical engineering, machine tools, suppliers, chemicals and shipbuilding. We have clear evidence from both small and large companies that lending is jammed.
“The banks are not stepping up to their responsibility to provide credit,” he told the German paper Handelsblatt. “Some indicators that have performed better, but… it is too early to say we have shaken off this crisis. There is still lots of risk and uncertainty, and no grounds for complacency. The fact that GDP proved better in the second quarter with 0.3pc growth is somewhat reassuring, but let’s not forget the economy has shrunk 7pc from a year before.”
Mr Steinbrück has now backed away from talk of forcing banks to lend, recognising they have to rebuild their capital, and shifted the focus to direct lending by the state. Among likely measures are use of the state-bank KFW to make “global loans” to industry on terms that pass on the full benefit of lower interest rates, as well state aid for credit insurance and trade finance. He said the bank rescue fund SoFFin still had €60bn left for support. While some measures have been discussed before, there appears to be a new urgency. Decisions may be made by “early September”.
The comments are hard to reconcile with the a record surge in the IFO business confidence index, which jumped for a fifth month to 90.5 in August. Sentiment is racing ahead of economic hard data. Axel Weber, the Bundesbank chief and until recently the arch-hawk, last week spoke of a second wave of the credit crisis as home-grown problems come to light, triggered by ratings downgrades that force banks to put aside more capital. “The first round of disruption in the bank balance sheets from structured credit products is behind us. Now we are threatened by stress from our domestic credit industry,” he said.
“They are in panic,” said Hans Redeker, currency chief at BNP Paribas. “They know the money supply and credit figures coming out are going to be awful.” He added that Germany’s stimulus measures have put off deep problems until after the election in September. The car scrappage scheme has brought forward demand, implying a cliff-edge drop when the scheme expires. Kurzarbeit (short work) schemes that subsidise companies to keep idle workers on their books are slowly bleeding corporate balance sheets. “This has delayed the restructuring that needs to occur,” he said.
Mr Steinbrück said markets are awash with liquidity again, but little is going into the real economy. “The banks evidently prefer to put their money into securities rather then granting new loans because they can get a higher return. After two years of financial crisis the gambler mentality is gaining the upper hand again.” The German authorities are deeply frustrated that so few banks have resorted to the rescue scheme to rebuild their capital base. Critics say the Bundestag imposed such stringent conditions that lenders have opted instead to rein in lending. Mr Steinbrück said state lenders pose a “systemic risk” to German finance. Few of the regional banks have a “viable” business model.